High oil prices are raising concerns about Dutch disease, a debilitating illness at best. But to ordinary companies the illness sounds like economic theory how will they know if they have it?

In theory, Dutch disease can be contracted by any economy that produces a key resource and has a manufacturing sector, too. Suppose the world price of the resource shoots up, causing the sector to boom. This will generally cause the economy’s currency to appreciate, putting stress on the manufacturing sector. Something like this happened to the Netherlands in the 1970s when energy prices jumped and the Dutch guilder rose hence the name of the illness.

Obviously, the current situation has the potential to inflict Dutch disease on Canada. Oil prices have ratcheted higher in the past year, boosting the Canadian dollar into the mid-80s against the U.S. dollar. While high oil prices benefit some exporters producers of petroleum, oil and gas equipment, energy exploration companies and engineering firms others receive fewer Canadian dollars for each U.S. dollar export sale. Only if exporters are importing some inputs do they have any chance of offsetting the stronger currency, because those import costs are reduced.

In today’s context, the impact on exporters can be more profound. With central banks acting to keep inflation under control, higher energy prices are likely to cause prices to decline in other sectors. This is because higher energy prices take purchasing power away from other goods and services. Thus, some companies are finding themselves in a perfect storm: higher energy prices, lower U.S. dollar export prices, and fewer Canadian dollars for each U.S. dollar sale.

Profit margins should reveal the presence of Dutch disease when it arises. In the wake of the big rise in oil prices and the jump of the Canadian dollar since mid-2004, profit margins for the economy as a whole have been essentially unchanged, at around 8%. But this masks major moves in margins in certain sectors. In particular, margins in mining and energy have gone up significantly, from 14-16% to over 20%. Most other sectors have seen margins remain pretty flat.

The manufacturing sector has seen a relatively modest decline in profit margins since mid-2004, from just over 7% to about 6%, but the sub-sectoral details show more evidence of Dutch disease. Margins in wood and paper products have declined from nearly 11% to almost 6%, and manufactured wood product margins have fallen from over 14% to about 9%. Non-metallic mineral products have seen margins slashed from over 10% to below 3%. Motor vehicles and parts have margins of less than 1% today, down from 3.5% in mid-2004. In contrast, margins have increased in alcohol and tobacco (to over 29%), fabricated metals and machinery, computers and electronics, transportation equipment, and furniture.

The bottom line? Symptoms of Dutch disease are beginning to appear, with profit margins expanding in the energy sector and contracting in a number of manufacturing sub-sectors. What happens next depends on how long the stresses last and that all depends on energy prices.

Stephen Poloz is Senior Vice-President, Corporate Affairs and Chief Economist, Export Development Canada.