This Selected Issues paper reviews empirical evidence on the main determinants of the real bilateral exchange rate between the Canadian and the U.S. dollars, with particular emphasis on the role played by cyclical and longer-term economic factors. The paper aims to identify the nature of the shocks that have contributed to the recent downward trend in the Canadian dollar. The analysis shows that fluctuations in the real bilateral exchange rate can be explained reasonably well by its long-term fundamentals. The paper also analyzes inflation and the natural rate of unemployment in Canada.

Abstract

This Selected Issues paper reviews empirical evidence on the main determinants of the real bilateral exchange rate between the Canadian and the U.S. dollars, with particular emphasis on the role played by cyclical and longer-term economic factors. The paper aims to identify the nature of the shocks that have contributed to the recent downward trend in the Canadian dollar. The analysis shows that fluctuations in the real bilateral exchange rate can be explained reasonably well by its long-term fundamentals. The paper also analyzes inflation and the natural rate of unemployment in Canada.

V. “BRAIN DRAIN” FROM CANADA TO THE UNITED STATES1

1. Available data indicate that emigration of highly skilled Canadian professionals to the United States increased substantially in the 1990s. This emigration of highly skilled individuals—“the brain drain”—has potentially significant implications for the Canadian economy. While the flows of emigrants particularly in occupations such as physicians, nurses, engineers, and computer scientists has increased significantly, the size of the emigration flows has been small relative to the stock of existing workers in Canada who are employed in these occupations. At the same time, immigration of workers with similar skills has at least partially offset the number of emigrants to the United States. However, while no firm consensus exists on how the productivity of immigrants to Canada from the rest of the world compares with the productivity of Canadian-born workers, available evidence suggests that immigrants to Canada may be less productive because it takes some time for them to catch up with Canadian-born workers in terms of earnings. As a result, the loss of Canadian professionals to the United States is likely to have imposed a net cost on the Canadian economy.

2. One factor that may serve as an incentive for highly skilled individuals to emigrate from Canada to the United States is the relatively higher personal income tax burden in Canada compared to the United States, especially the burden applicable to the higher-income segment of the work force. A reduction in personal income tax rates could reduce the incentive for highly skilled Canadians to migrate to the United States.

A. Data on the Size of Canadian Migration to the United States

3. The average yearly flow of permanent skilled emigrants from Canada to the United States rose from about 3,100 in the period from 1982 to 1989 to 4,834 during the period from 1990 to 1996 (Table 1).2 Within this group of skilled workers, the average yearly flow of Canadian professionals who emigrated to the United States rose from 1,743 over 1982–89 to 2,689 over 1990–96, while the corresponding yearly averages were 985 and 1,756 for Canadian managerial workers. This increase in the average yearly gross flows of Canadian emigrants to the United States, coupled with the decline in the flows of U.S professional and managerial workers who emigrated to Canada during 1990–96, led to an increase in the net flows of professional workers from Canada to the United States. DeVoretz and Laryea (1998) argue that this increased emigration has been costly for Canada because emigrants embody education subsidies paid by Canadian taxpayers. The authors calculate that the net emigration of Canadians to the United States in four occupational categories (managers, natural scientists, professors and teachers, and professionals) resulted in an aggregate taxpayer subsidy of $651 million in 1993–94 (about 0.1 percent of GDP) from Canada to the United States. Concentrating on the occupational categories of professionals and managers, DeVoretz and Laryea (1998) estimate that the social cost of the emigration of these workers from Canada to the United States over the longer period from 1982 to 1996 amounted to $6.6 billion (0.8 percent of GDP in 1996) and a net subsidy to the United States of $3.7 billion (0.4 percent of Canada’s GDP in 1996).

Table 1.

Canada: Bilateral Immigration Flows by Occupational Group, 1982-96

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Sources: Data are reported in Devoetz and Laryea (1998). Data on Canadian emigration to the United States are taken from the U.S. Department of Immigration and Naturalization. Data on U.S. emigration to Canada are taken from the Canadian Department of Immigration and Naturalization.

Includes professionals in the natural and social sciences, teaching, medicine and health, and the performing arts.

Includes workers in precision production, machining, crafts, and repair and construction occupations.

4. In addition to the significant increase in the number of permanent emigrants, there has also been a sharp rise in the number of temporary migrants from Canada to the United States since 1989. New visa categories have been created under U.S. immigration law as a result of both the Canada-U.S. Free Trade Agreement (FTA) in 1989 (the TC visa) and the North American Free Trade Agreement (NAFTA) in 1994 (the TN visa), which have greatly facilitated the movement of workers, especially professional workers, from Canada to the United States (Table 2). The main advantage of the TN visa is that it has reduced the cost of employing a temporary immigrant in the United States, as it is no longer necessary for the employer and the potential employee to prove that there will be no adverse effects on the employment of U.S. workers. The establishment of the TN visa status has become, as DeVoretz and Laryea (1998) note, a “backdoor to permanent emigration into the United States,” because the rates of conversion from temporary to permanent status is high for some kinds of workers. For example, more than 37 percent of intracompany transfers between Canada and the United States in 1996 resulted in a switch from temporary visa status to permanent resident status.

Table 2.

Canada: Flows of Canadian Non-Immigrant Professionals and Their Families to the United States Under FTA and NAFTA, 1989-96

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Source: DeVoretz (1998). Data are originally taken from United States Department of Justice, Immigration and Naturalization Service, Statistical Yearbook of the Immigration and Naturalization Service (Washington, D.C.: Immigration and Naturalization Service, Office of Policy Planning, Statistics Branch), various years.

5. Cast in the broader perspective of overall migration into and out of Canada, it can be argued that emigration of skilled workers to the United States may not have had a substantial impact on Canada.3 Data on overall migration indicate that losses of highly skilled individuals to the United States in a number of key professions have been more than offset by the inflow of skilled migrants from the rest of the world (Table 3). While Canadian emigrants to the United States outnumbered U.S. emigrants to Canada in every year over the period from 1986 to 1996 in the occupations of physicians, nurses, engineers, computer scientists, natural scientists, and managerial workers, net migration to Canada from countries other than the United States offset this net loss of emigrants to the United States in all of these occupations, except for physicians and nurses. These data also indicate that, although the number of Canadian emigrants to the United States has grown significantly in the last ten years, the size of the flows are relatively small in relation to the stock of skilled workers in key occupations (Table 4).

Table 3.

Canada: Net and Gross Immigration Flows for Selected Occupations, 1986-96

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Source: Data are taken from Statistics Canada (1998).

A minus (-) sign denotes a deficit for Canada.

Table 4.

Canadian Emigration to the United States For Selected Occupations

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Source: Statistics Canada (1998).

6. The argument that the brain drain from Canada to the United States is not a serious problem because any losses to the United States are offset by inflows from the rest of the world implicitly assumes that immigrants to Canada can substitute one for one with Canadian emigrants. DeVoretz and Laryea (1998) argue that immigrants impose “churning costs” on the recipient country, relating to administrative and settlement costs of the immigrants, but more importantly, to costs that arise from the fact that immigrants may not be as productive as the emigrants that they replace. DeVoretz and Laryea (1998) note that the “entire post-1967 stock of professional immigrants typically took 10 to 15 years to catch up with the earnings of their Canadian-born cohorts” The difference in earnings between Canadian-born workers and non-U. S. immigrants may arise for a number of reasons, including language barriers. The data reported by Statistics Canada (1998) on the number of immigrants from countries other than the United States include individuals who declare themselves to have the appropriate qualifications for certain professions, but they may not be able to obtain the necessary certification to practice their professions in Canada. For these reasons, it may be misleading to conclude that immigrants from the rest of the world can replace Canadian emigrants on a one-for-one basis.

7. Taking into account the earnings gap between Canadian-born workers and non-U.S. immigrants to Canada, as well as administrative and settlement costs of new immigrants, DeVoretz and Laryea (1998) provide some estimates of the churning costs that arose from Canadian immigration during the period 1982–96. They estimated that the costs of replacing the outflow of highly skilled workers from Canada to the United States over this period amounted to $12.5 billion (1.5 percent of GDP in 1996), with most of this cost ($11.2 billion, or 1.3 percent of GDP in 1996) occurring in the period 1989–96 when there was a significant increase in Canadian emigration to the United States.

B. Incentives for Canadian Emigration to the United States

8. On average, wages are higher in the United States than in Canada, and this provides one incentive for Canadian workers to emigrate. Moreover, given the higher wages in the United States, a significant public subsidy for higher education in Canada tends to provide a further incentive for emigration because the subsidy increases the supply of highly educated workers. The establishment of two temporary visa categories under the FTA and the NAFTA has lowered the costs of emigrating from Canada to the United States and has become an avenue for more permanent emigration.

9. Relatively high personal income taxes in Canada, compared to those in the United States, are also likely to be a significant incentive for emigration. The Canadian personal income tax becomes applicable at income levels that are lower than in the United States.4 Moreover, the highest marginal income tax rates in Canada become applicable at income levels that are much lower than in the United States.5 For an income level as low as $30,000, the marginal income tax rate in Canada (federal and provincial) is about 40 percent, while in the United States, the typical marginal rate (federal and state) is about 26 percent. At income levels between $30,000 and $95,000 in Canadian dollars, the differential in marginal income tax rates between the two countries widens, as Canadian rates increase more steeply than U.S. rates. There has been a significant increase in the emigration of Canadian workers engaged in professional and skilled occupations to the United States in the 1990s, and the income of these occupational groups falls on average between $37,000 and $90,000. In some of these occupations, the average income exceeds $60,000, and the tax differential between Canada and the United States is greatest for incomes between $60,000 and $95,000. Table 5 provides a comparison of the tax liabilities of individuals with various levels of income at certain locations in the United States and Canada to illustrate the combined effects of federal and provincial/state income taxes in the two countries.

Table 5.

Canada: Comparison of Personal Income Tax Liabilities Between Canada and the United States, 1997

(All values are in U.S. dollars)

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Source: Robert Brown, “Tax Impacts on People Transfers: Notes and Tables to Illustrate a Talk,” CD. Howe Institute, 1997.

U.S. taxes include federal, state, and social security taxes.

Canadian taxes include federal, provincial, and CPP taxes.

10. Figures 1 and 2 present plots of the number of Canadian professional and managerial workers, respectively, who emigrated to the United States over the period from 1982–96. Both of these figures also include plots of two variables that may influence the decision to emigrate: the difference between the Canadian and the U.S. unemployment rates (defined as the Canadian rate minus the U.S. rate) and the difference between the ratio of personal income taxes to GDP in Canada (at the federal and provincial levels) and the United States (at the federal and state levels). As shown in both figures, the increase in the number of Canadian professional and managerial workers who emigrated to the United States over the period is clearly associated with a positive, and rising unemployment rate differential. Also, the difference between the personal income tax to GDP ratios widened over the period from 1989 to 1991, which coincided with the sharp increase in the number of Canadian skilled workers who emigrated to the United States.6

FIGURE 1
FIGURE 1

CANADA: PROFESSIONAL EMIGRANTS FROM CANADA TO THE UNITED STATES

Citation: IMF Staff Country Reports 1999, 014; 10.5089/9781451806854.002.A005

Sources: DeVoretz and Laryea (1998); Statistics Canada; Department of Finance, Government of Canada; Economic Report of the President, 1998; and U.S. Bureau of the Census.
FIGURE 2
FIGURE 2

CANADA: MANAGERIAL EMIGRANTS FROM CANADA TO THE UNITED STATES

Citation: IMF Staff Country Reports 1999, 014; 10.5089/9781451806854.002.A005

Sources: DeVoretz and Laryea (1998); Statistics Canada; Department of Finance, Government of Canada; Economic Report of the President, 1998; and U.S. Bureau of the Census.

11. A number of changes were made to the personal income tax system in Canada between 1986 and 1991 that could help explain the rise in the personal income tax to GDP ratio in Canada relative to the United States. The income surtax on all taxpayers was increased to 3 percent in 1987, from 1.5 percent in 1986. This general surtax was increased to 4 percent in 1989, and to 5 percent in 1990. In 1989, an additional high-income surtax of 1.5 percent was introduced and subsequently raised to 5 percent in December 1991, bringing the total surtax to 10 percent for individuals in the top tax bracket. The income threshold at which the high-income surtax became applicable was also lowered in 1991. In 1986, full indexation of the personal income tax system was replaced by partial indexation, which drew individuals who were previously exempt from taxation into the tax base and pushed others into higher tax brackets.7

12. Since 1991, the difference between the personal income tax to GDP ratios in Canada and the United States narrowed, but remained positive, mainly on account of tax increases in the United States that became effective in 1993.8 The gap also narrowed because the personal income tax to GDP ratio declined in Canada between 1991 and 1994, mainly as a result of reductions in the general income surtax (from 5 percent in 1991 to 3 percent in 1993), but the tax ratio rose again between 1994 and 1996 on account of “bracket creep” resulting from the lack of indexation in Canada. Despite the narrowing in the personal income tax differentials between Canada and the United States in 1991–96, emigration of skilled workers from Canada to the United States continued to rise. A number of factors could serve to explain this development, including differences in real wages between the United States and Canada and the differential unemployment rate.

13. Table 6 contains the results from pooling the number of Canadian professional (PROF) and managerial (MANG) emigrants into a total emigrant group (EMIG), and regressing this group on the differential unemployment rates (DIFFUR) and the differential personal income tax to GDP ratios (DIFFTAX). This regression allows the coefficient on DIFFUR to vary by type of emigrant (PROF and MANG), but imposes a common coefficient on DIFFTAX. The results reveal that the coefficients on DIFFUR are of the expected sign, significant at the 1 percent level for professional emigrants, and significant at the 3 percent level for managerial emigrants. The coefficient on DIFFTAX is of the expected sign and significant at the 1 percent level. It should be noted that these results merely suggest that DIFFUR and DIFFTAX are positively correlated with the number of Canadian professional and managerial emigrants to the United States and that these variables may be important factors in explaining the rise in emigration since 1989. Still, this regression omits a number of other factors that are likely to be relevant in explaining the movement of skilled workers from Canada to the United States, some of which cannot be quantified.

Table 6.

Canada: Regression Results for Professional and Managerial Emigrants from Canada to the United States

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Notes:1. EMIG = pooled sample of Canadian professional and managerial emigrants.2. PROF = number of professional Canadian emigrants to the United States.3. MANG = number of managerial Canadian emigrants to the United States.4. DIFFUR = Canadian unemployment rate - U.S. unemployment rate.5. DIFFTAX = Ratio of personal income taxes (at federal and provincial levels) to GDP in Canada minus the ratio of personal income taxes (at the federal and state levels) in the United States.6. Equations are estimated over the period from 1982-1996 using annual data.7. Standard errors of the coefficients are reported in parenthesis.* Significant at the 1 percent level.** Significant at the 3 percent level.

List of References

  • Brown, Robert, 1997, “Tax Impacts on People Transfers: Notes and Tables,” CD. Howe Institute, Toronto.

  • Globerman, Steven, and Don DeVoretz, 1998, “Trade Liberalization and the Migration of Skilled Workers,” Simon Fraser University.

  • DeVoretz, Don, and Samuel Laryea, 1998, “Canadian Human Capital Transfers: The United States and Beyond,” CD. Howe Institute, Toronto.

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  • Statistics Canada 1998, “Brain Drain or Brain Gain? What Do the Data Say?, slides and speaking notes.

1

Prepared by Stephen Tokarick.

2

DeVoretz and Laryea (1998, p. 4) define a permanent migrant as someone who “has the intention of holding permanent employment.”

4

For example, a single-income tax payer in Canada can earn about $7,000 and a taxpayer with two children can earn nearly $12,000 before incurring any federal tax. No provincial tax would be applicable in these cases, since provincial taxes are calculated as a percentage of the basic federal tax. A single-income taxpayer in the United States can earn the equivalent of about $9,700 in Canadian dollars before incurring federal tax, while a married couple with two children can earn as much as $25,000 in Canadian dollars free of federal tax. It should be noted however, that state tax laws vary, so it may be possible for an individual to be exempt from federal tax and liable for state tax.

5

In Canada, the highest marginal income tax rates (federal and provincial) become applicable at an income level of about $60,000, while in the United States, the highest federal and state rates kick in at an income level of about $430,000 in Canadian dollars.

6

The differential increased from about 2.5 percent in 1989 to 4.5 percent in 1991.

7

Indexing adjustments are made when the inflation rate exceeds 3 percent.

8

The differential declined from 4.5 percent in 1991 to 3 percent in 1996.

Canada: Selected Issues
Author: International Monetary Fund