Relying on weak currency limits investment, productivity

Service sectors hardest hit by poor exchange rates: study
||Last Updated: 10/31/2006

Many business leaders and financial experts worry the strong Canadian dollar will negatively affect exports and competitiveness. But a recent study shows that a weak currency can hurt a country's economy.

A currency depreciation reduces investment in physical capital — such as machinery and equipment — which can limit Canada's productivity and economic growth, according to a new report by the Conference Board of Canada in conjunction with the Social Sciences and Humanities Research Council (SSHRC).

"These findings should sound a warning bell for policy-makers concerned about Canadian competitiveness. Investment in physical capital is an important driver of productivity growth, and lagging labour productivity explains much of the Canada-U.S. income gap," said Constance Smith, co-author of the study and a professor at the University of Alberta. "Policies that weaken the exchange rate have important — perhaps unintended — consequences for industry investment, productivity and economic growth."

The study,

The Exchange Rate and Wages: How They Affect Capital Investment

, examined 17 developed Organisation for Economic Cooperation and Development (OECD) countries, including Canada. It found the effect of the exchange rate on investment levels is significant in the short term and often persists for years, particularly in an economy's service sectors.

In addition, the study demonstrated that increases in real wages, without corresponding gains in labour productivity, reduce investment in the medium and long term. Thus, inflexible labour markets — created by inter-provincial mobility barriers or policies such as mandatory retirement — may hinder investment, which could negatively affect future productivity gains and economic growth.

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