April 18, 2013
A Weakening Manufacturing Sector and Rob Ford’s Dream
Chief Economist, CanaData
Manufacturing sales in Canada in January were -0.2% month over month, according to the latest survey results from Statistics Canada. Durable goods sales (mainly aerospace and auto-related) were -0.7% month over month, while non-durables were +0.3%.
Sales in current (i.e., not adjusted for inflation) dollars in the sector have been flat for about a year and a half. In “constant” dollars, they’ve been edging downward since mid-2012.
The manufacturing sector in Canada faces stiff international competition. It will continue to experience difficult times in the years ahead. Nor will the domestic scene offer much relief. An expected weakening in residential construction starts will hurt retail first, but then inflict pain on manufacturers as well.
Let’s set the scene by looking at some history. Between early 2005 and mid-2009, employment in the sector took a beating, with 500,000 workers slashed from payrolls. Since then, the number of positions has been relatively stable. (It’s interesting to compare employment in manufacturing with construction. The number of jobs in construction in Canada rose by half a million – i.e., almost exactly compensating for manufacturing’s loss – between early 2002 and mid-2011.)
An adjustment in our currency is currently offering some help for manufacturers. During the last couple of years, the loonie has been trading in a range from $0.97 US to $1.03 US. It has recently been testing the bottom of that band. The lower-valued Canadian dollar provides a spur to export sales, but it will only last until commodity prices start heating up again. (Higher raw material prices usually lift the value of the loonie.)
Labour and material costs, along with productivity growth, factor into the outlook for the industry.
Beginning near the turn of the century, a great deal of manufacturing activity left North America for Asia to take advantage of the low wage rates overseas.
The cost of labor in China – while still below U.S. and Canadian standards – has begun to climb. A movement towards more workers’ rights and benefits is also underway. But there are plenty of other countries around the world with labor cost advantages. For example, the continent currently recording the fastest gain in year-over-year gross domestic product (GDP) is Africa.
The U.S. has made more forward strides (although many would call them “steps backwards”) in adjusting wage rates downwards than we have in Canada. During the worst of the recession, the unemployment rate in the U.S. (10.0%) rose to a level much higher than here (8.7%).
At the same time, the drop in employment during the recession in America was considerably steeper (-5.0% year over year at one point versus -2.0% in Canada).
The recovery in jobs south of the border has taken longer. The number of long-term unemployed has been exceptionally high. Therefore, more laid-off workers in America have been willing to accept lower wages in order to return to the job force.
The U.S. labour force has demonstrated a greater willingness to seek part-time positions. Uncle Sam has seen many of his “nieces and nephews” take on low-paying second and, in some cases, even third jobs.
Right-to-work legislation – allowing workers to opt out of union membership – has proven so successful in formerly impoverished southern states that it’s now being adopted in a number of rust-belt jurisdictions in the Northeast and Midwest (e.g., Michigan).
In Canada, the Ontario Conservative Party has promised to enact similar legislation if voted into power. The Tory’s primary motivation for such a move would be to protect overall auto sector employment. (The ruling Liberals are sitting atop a precarious minority government.)
In auto assembly work and parts manufacturing, it’s no longer a given that Canada’s future is assured. Mexico has taken over as the major supplier of motor vehicle products to the U.S.
The federal and provincial governments can generally be credited with providing an environment – in terms of investment incentives and a low corporate tax rate – that is favorable to the manufacturing sector.
At the same time, there’s a harsh reality to be faced. Investment in manufacturing has become an international game. There are often bidding wars – with escalating subsidy offers – to attract new auto-making plants or research facilities.
That’s the labour side of manufacturing. What’s happening on the material side? There is one corner of manufacturing that has acquired a huge input cost advantage.
Due to the opening up of vast new reserves of natural gas – thanks to hydraulic fracturing – the cost of this important fossil fuel in North America is only a fraction of what customers in Europe ($12 to $15 per million cubic feet) and Asia ($18 to $20, with Japan at the top end) are paying.
Firms using natural gas as a power source or to heat plants have gained a substantial cost advantage. This effect is even more pronounced if natural gas is employed as a feedstock in their industrial processes, for example in the chemical and petrochemical fields. Plastics and other products derived from polyethylene, ethylene, ethane and other derivatives come to mind.
The free trade agreement Canada is expected to soon sign with Europe will open up some opportunities. Canada and Mexico will have duty free access to an attractive overseas market. The U.S. is still on the outside, although President Obama in his most recent State of the Union address expressed his desire to initiate talks with Europe to reach a similar pact.
This leads in another interesting direction. Whether one is philosophically for or against infrastructure stimulus programs, it can hardly be denied that they help the building products side of manufacturing.
Infrastructure projects are a tried and true means to stimulate certain kinds of economic activity.
Here’s where I finally get to expound on the mayor of Toronto’s subway dreams. Rob Ford was elected with a platform advocating more rapid transit in the city, with subways favored over LRT systems. He’s taken heaps of criticism in the mainstream media over the comparative costs of the two alternatives. In a global context, however, he has some good “leads” to draw on.
Consider the following. China is proceeding with infrastructure projects at a rapid pace, with subway work high on the agenda.
In the industrialized world, the two top-tier cities – at least from a business and financial standpoint – are New York and London. They’re both undertaking stunning new subway projects.
In New York, three underground commuter rail links are under construction – the East Side Access route, the Second Avenue Subway line and extension of the No. 7 subway connection – for a combined dollar expenditure of $16 billion. One section of the work, including an immense underground concourse, is taking place 16 storeys below Grand Central Terminal.
In London, there’s an even bigger project underway, the Crossrail link for £15 billion (or $24 billion in U.S. dollars). This will feature 118 kilometres of track joining such points as Heathrow Airport, Canary Wharf and Abbey Wood. The blueprints call for major tunneling beneath the city’s centre. (A recent excavation revealed a “Black Death” burial site.)
During most winters, neither London nor the Big Apple has to deal with as much snow as Toronto.
So what league does Toronto want to play in? The “big boys” build subways. Underground transit has a permanence that can’t be matched on the surface.
A pick-up in the manufacturing sector is needed if its symbiotic relationship with construction is to thrive. The current one-way flow is obvious. More construction activity has been leading to increased sales by building product manufacturers.
But our on-site component would like to see manufacturing someday return the favor. Better sales and profits in manufacturing will hopefully lead to an improved level of investment in physical plant.
Then more workers in hard hats can begin to insert shovels into the ground.
For more articles by Alex Carrick on the Canadian and U.S. economies, please see his market insights. Mr. Carrick also has an economics blog.
