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economic insight

The conventional wisdom is that a weaker Canadian dollar is good for the economy because it makes our exports more competitive.

And that's mostly true, at least in the short run.

The cheaper dollar is offsetting the pain of lower commodity prices by boosting the profits of price-sensitive manufacturers and natural-resource producers. It also keeps Canadians at home, and gives tourism operators and other businesses dependent on cross-border traffic a new pricing edge.

But there has been remarkably little discussion about the longer-term effects of the loonie's big dive.

The dollar has now lost nearly 20 per cent versus the U.S. dollar in the past year; five cents since Canada Day alone.

The benefits could prove to be illusory, and short-lived. Research suggests the low dollar may not be the miracle drug for Canada's ailing export sector. A cheaper dollar risks making Canadian manufacturers, in particular, less productive, and discourages investment in new technology by making imported equipment and software more expensive.

A 20-per-cent drop in the dollar would cause already anemic Canadian labour productivity to fall by 4.5 per cent, Bank of Canada economist Ben Tomlin estimated in a 2014 working paper.

"Depreciation that allows a firm to compete more easily in the short run actually causes firms as a group to become less productive, and hence less competitive," explained Peter Howitt, a Brown University economist and fellow at the Toronto-based C.D. Howe Institute, in a research paper released last week.

"Although a low exchange rate makes Canadian exports more competitive in the short run, it also might make exports less competitive in the long run."

Evidence suggests our exports are becoming less sensitive to changes in the exchange rate. The 20-per-cent drop in the dollar over the past year should have boosted exports 10 per cent, based on historic patterns, according to a Toronto-Dominion Bank report. Instead, they are up just 5 per cent.

Back in the 1990s – the last time the loonie was in a similar downward spiral – experts fretted about the "lazy manufacturer" syndrome. Namely, that the low dollar would become a crutch, breeding a complacency among businesses about investing in innovation and productivity.

By the early 2000s, the trend had reversed. The dollar was headed back up again. Companies learned to live with it, or they failed, as many did in the Great Recession.

The survivors adapted to long ascent of the dollar – from the early 2000s to 2011 – by focusing on making products and services that compete primarily on quality, rather than price, according to Dan Ciuriak, a former deputy chief economist at the federal trade department.

Many companies also took greater advantage of so-called global value chains to stay competitive, Mr. Ciuriak pointed out. Production that required a lot of labour was moved offshore, while operations at home were strategically focused on higher value-added activities.

The problem is that these successful "quality-based companies," as Mr. Ciuriak calls them, depend on a relatively high dollar to purchase imported software and equipment.

For these companies – the sort of technology-focused export champions that Canada desperately needs – the cheaper dollar may actually be doing more harm than good by making these inputs significantly more expensive.

"So for the segment that emerged and thrived under the high dollar, we would not expect to see a big surge in output due to a low dollar," Mr. Ciuriak said.

Even if manufacturers wanted to take advantage of the cheaper dollar to invest in new Canadian export capacity, they are unlikely to do so because there is little certainty a 75-cent (U.S.) loonie is here to stay. Companies that lived through the 1990s and the 2000s know the unpredictable ups and downs of a currency.

The Bank of Canada acknowledged in its July monetary policy report that the lower dollar is having a significant "pass-through" effect on inflation, swelling the overall consumer price index by roughly 0.7 to 0.9 percentage points. But the central bank insists the effects will fade over time.

It's not clear that the cheaper dollar will help the cutting-edge sectors of the economy over the long haul.

And it may even do them harm.