As the price of oil continues to plumb fresh 5-1/2 year lows, Canada's manufacturing heartland – buoyed by a resurgent American economy and loonie whose wings have been clipped – will be needed to pick up the slack.
There's just one problem: there isn't much slack.
Heinz in Leamington, Electro-Motive in London, Sterling Truck in St. Thomas: These plant closures in the years leading up to and following the financial crisis added up and had a crippling effect on the economy of southwestern Ontario. The surviving companies, however, are firing on all cylinders, leaving little room to ramp up output.
In a new report, CIBC economists Avery Shenfeld and Andrew Grantham detail the legacy of these plant shutdowns on the manufacturing sector. Even though output remains well shy of its pre-recession peak, they found, manufacturing firms' capacity utilization rate is sitting at levels consistent with the previous period of expansion.
As such, manufacturers' ability to cash in on rising U.S. demand may be hampered in the short term by capacity constraints. The good news, according to the economists, is that with a sub-85-cent loonie, Canada is poised to win its fair share of "geographic beauty contests" as companies look to expand.
Some of the industries that endured the largest losses in productive capacity over the past decade (furniture, computers and electronics, and transportation equipment) are also the ones that have less room to increase production, CIBC's economists observe. What's more, demand for the products made by these firms is also the most sensitive to changes in the value of the Canadian dollar, according to the Bank of Canada.
But just as short-term fluctuations in the price of oil don't radically affect investment plans in Alberta, so too is there a lag between the decline of the loonie and the renaissance of manufacturing in Canada.
"We will need to sustain an 80-85 cent Canadian dollar for several years to come for all of the benefits to show through in our factory sector," said Mr. Shenfeld and Mr. Grantham.
Mike Moffatt, professor of economics at the University of Western Ontario and one of the Canadians with the most knowledge of and passion for southwestern Ontario, wonders how much foreign exchange will factor into this equation.
"There were many companies that got burned in the late '90s counting on a low exchange rate," he said. "Manufacturers have become very risk-averse when it comes to making decisions based on currency values, and tend to estimate fairly dramatic worst-case scenarios."
Executives at General Motors Co. and Ford Motor Co. struck a similar tone in recent days, saying that the level of the Canadian dollar didn't have a sizeable impact on where they decided to expand capacity.
"That can't be true in the long run; it would imply that relative production costs have no bearing on plant location decisions," argue Mr. Shenfeld and Mr. Grantham.
There are two primary factors that might reverse the Canadian dollar's bout of softness: a firmer oil price or a Bank of Canada that is more inclined to raise rates. Without the former, the risks of the latter materializing are minimal.
While caution is warranted after what has been a lost decade for southwestern Ontario, the prospect of green shoots emerging in the manufacturing sector comes as welcome news not just for the region, but at a much-needed time for the nation.