Canadian Metalworking

Hidden costs: Will Canada’s rush to resources stifle future growth?

Canada has the resource wealth that most countries can only dream of. But will our focus on resource extraction - and its impact on manufacturing - come back to haunt us?

(Photo: Eric Kounce/WikiCommons) Resources

(Photo: Eric Kounce/WikiCommons)

Manufacturing and resource sectors have always had a strained relationship.

Ever since the term “Dutch Disease” was popularized in the 70s and 80s, it seems the debate surrounding the benefits and perils of a resource-inflated dollar gets more polarizing each day.

Canada’s been no stranger to this debate, and with oilsands growth expected to double by 2020 it’s likely more conversation is ahead.

Compounding the issue in Canada is that most manufacturing is in the country’s east, while much of our resources, namely oil, are found out west, leading to a divisive and political split in opinion.

The reality is the debate over Dutch disease is never as cut-and-dry as many might like it to be – there are simply too many more factors at play.

Currently, much of the west’s manufactured goods come from eastern Canada. Effectively a “trickle-down” of prosperity that Ontario and Quebec stand to benefit from.

But much of the industrial activity associated with the oil industry are tasks that require a certain skill set, and have finite room for productivity growth.

Canada is fortunate to have the resource wealth most countries could only dream of. But how can we be sure we haven’t over invested in that sector to the detriment of our manufacturing base? What do we stand to lose by simply being “hewers of wood and drawers of water”?

It’s a not simple question to answer, but one that Canadians must examine so we can strike a balance between the two industries – have our cake and eat it too, so to speak.

The state we’re in

When former Ontario premier Dalton McGuinty derided Canada’s dollar as a petro-dollar, he touched on a major nerve out west. Why shouldn’t Alberta, with its abundance of black gold, be allowed to cash in on their resource wealth?

But there was some truth to McGuinty’s concerns. Back in 2006, a report conducted by the Library of Parliament showed that Canada was in fact starting to exhibit some of the symptoms of being a petro-dollar.

The International Monetary Fund (IMF) and The Economist magazine had both found evidence suggesting Canada’s dollar was tied to the rising price of oil. Since that 2006 report, oilsands operations continued to expand, and the dollar continued on a fairly steady ascent to where it is now, around parity with the U.S. dollar.

And of course, a high dollar is the bane of the country’s manufacturing base because it increases costs to manufacture and decreases margins on products sold globally.

But Peter Howard, president of the Canadian Energy Research Institute (CERI), is quick to point out that eastern manufacturers stand to gain something from the exploding resource sector out west.

“The number they (Canadian Association for Petroleum Producers) quote is, for every dollar spent in the oilsands development, 30 cents of that is buying products sourced out of eastern Canada – which is primarily Ontario and Quebec.”

He also suggests that if the current operations in the oilsands are allowed to run for another 25 years, then they’ll contribute approximately $1.5 trillion to the Canadian economy, $44 billion of which would end up in Ontario (and primarily it’s manufacturing base).

But some evidence suggests the high dollar has been a burden to the Canadian manufacturing sector. In 2011 – with the dollar running neck and neck with the greenback – employment in manufacturing dropped to just 10 per cent of the country’s employment share, the lowest since WWII.

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Natural selection?

But not everyone sees oil as the culprit for this decline in Canadian manufacturing.

“A lot of the changes that took place in Canadian manufacturing over the last decade would have happened regardless of what happened with the dollar,” says Michael Burt, the Director of Industry Sector Economics at The Conference Board of Canada.

Burt, who co-authored a December 2012 report about Canada’s trade patterns, views manufacturing’s decline as a case of natural selection.

“China was not anywhere near the same factor it was in 2001 as it is today, and it’s captured market share in Canada. It’s captured market share in the U.S. and so we’ve seen a development of a new equilibrium in North American trade,” says Burt

“The dollar has probably accelerated that transition, but it would have happened to a large extent anyways.”

He also suggests that it’s simple economics.

“If you look at it in terms of the raw materials we make here in Canada, prices for those items have risen by about 75 per cent over the last decade. Over the same period, prices for manufactured goods have risen about 15 per cent, so as a business… I’m chasing after where the better returns are.”

There are other skeptics of oil’s role in the decline of manufacturing, notably Jack Mintz, the Palmer Chair of University of Calgary’s School of Public Policy, who recently published a study citing declining manufacturing as a trend amongst other OECD countries as well.

Naturally though, that opinion is divided. A contrasting report from the Canadian Centre for Policy Alternatives, titled The Bitumen Cliff suggests our push for oil is a going to hurt the manufacturing industry in the long run, and the damage has already started.

It argues that since 1999 Canada’s manufacturing sector has declined faster than those of other OECD countries, and they use the auto industry as a prime example.

“When the industry peaked in 1999, Canada ranked as the fourth-largest assembler in the world and benefited from a $15-billion trade surplus in automotive products. Canada’s auto industry was well placed in terms of labour productivity and cost competitiveness,” the report states.

“By 2006, however, the large automotive trade surpluses had melted away, generating Canada’s first automotive trade deficit in a generation. By 2011, Canada was running a chronic automotive trade deficit of $15 billion per year. During the same period, some 50,000 well-paid auto jobs were lost.”

Some, like Howard, try to take a more diplomatic approach, suggesting there are benefits too,

“A lot of the Ontario manufacturing sectors have retooled, have realigned their source material, so they can compete globally.”

But, once shops retool, there will still be a higher dollar getting in the way of their export business, and one major factor is often left out of the equation – one that really divides the two industries.

The x-factor: Innovation

There is an intangible value to manufacturing that we tend to forget.

During the creation process trial and error takes place. Mistakes are made, lessons are learned, and the end achieves an improvement to the process or design.

The value of this process is hard – if not impossible – to properly quantify, but must be considered.

The Obama administration has started to do just that with the creation of the National Additive Manufacturing Innovation Institute (NAMII). It’s a signal the country is getting serious about manufacturing again, embracing inventive technology, which requires extensive research, but could have enormous payoffs.

But Canada has routinely dragged its heels in this regard.

“There’s good evidence broadly speaking, that Canadian manufacturers spend less on R&D than our American counterparts. You know, other measures like rate of productivity, rate of growth, those sorts of things we already lag on,” says Burt.

“There’s a lot of discussion about why… it may be management practices here in Canada. We’re a little more conservative than other countries, it may be the fairly high amount of foreign ownership in our manufacturing, it’s more of a branch plant mentality. We’re not doing the research here. We’re doing the doing, if you will.”

Whatever the reason, Canada has been slower to commit more focus and financial resources to manufacturing, even though Ontario employs nearly a million people in the sector, making it the second biggest in North America, behind California.

But, the Americans have embraced industry all over again – and they’re seeing results. Recently, General Electric’s Appliance Park has reopened, and found a way to make a more efficient version of their water heaters and sell them for less money.

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Another example of the value of innovation is the machine tool maker DMG/Mori Seiki. The multinational company opened a new facility in Davis, California in July of 2012.

At the International Manufacturing and Technology Show (IMTS) in Chicago this past September, company president Dr. Masahiko Mori spoke to an audience of industry journalists about the decision to put the operations in Davis.

He talked at length about the value of having a company that could build more than just machine tools. A good company, he said, should be able to build good engineers.

A sentiment that Adam Hansel, the COO of Mori Seiki’s Digital Technology Laboratory Corp., echoes.

“Why we chose to do California specifically, instead of the Midwest, or say, Chicago, is because we’ve had an R&D facility there since 2000, and we wanted the R&D and production to be able to work together to make a better product,” he said.

The new factory currently builds the company’s NHX4000 and NHX5000 machines for the North American market, but the collaboration between the new factory and the R&D facility is where the real value lies.

“The idea is that the factory is an incubator for people to learn all about machine tools, and how they work, and the people who have greater aptitude will have greater opportunities in the company.

“It’s not just a factory that’s taking drawings from some design group somewhere and building something… it’s a collective effort, and it goes both ways. Not just the guys building machines learning, we have our mechanical engineers get out on the floor and experience it firsthand too, so they become better engineers and are able to design a product that’s easier to work with.”

Part of the company’s decision to come to the U.S. was driven by economic factors, and an overall strategy geared towards international growth. But there’s still been a concerted effort to put some focus back on industry, especially with new and innovative technologies opening up more possibilities.

The Conference Board of Canada recently held a summit on innovation in downtown Toronto and in a statement, the think-tank’s CEO, Daniel Muzyka emphasized its value, saying, “Only the constant pursuit of innovation can ensure long term success.”

But overall that innovation isn’t happening here.

The previously mentioned Bitumen Cliff report also paints a bleak picture for Canadian innovation, and it’s particularly critical of the oil patch’s role in such a field.

According to the report, the petroleum sector devotes just three-quarters of one per cent of industrial GDP to research, well below the average for Canadian businesses as a whole. In contrast, the manufacturing industry allocates more than five times as much to research.”

Also cited is the fact that while manufacturing accounts for just 13 per cent of Canada’s GDP, it also accounts for well over half of all private sector R&D in the country.

Labour productivity growth in the mining and petroleum sectors is also poor. In those industries, the productivity rate has declined by almost 25 per cent over the last decade, helping drag the country’s average under one per cent per year over the same time.

So much of the work taking place out west simply isn’t adding value to our economy the same way manufacturing can. But the interconnectedness of the industries certainly fuels confusion over what helps and what hurts our economy. The reality is both resources and manufacturing rely on each other.

It’s not to say there are no benefits from the resource industry. Resources are wildly valuable, and the idea that a shop in Mississauga is able to supply goods to Fort McMurray is positive.

But if our mad dash to extract resources is coming at a cost to manufacturing then it’s worth taking a minute to step back and reconsider.

Oil wells dry up, but manufacturing fosters innovation in a way that will continue long after pipelines stop flowing. A healthy manufacturing base is a leg the Canadian economy needs to stand on, not just for now, but for future generations.


Productivity Centre