INDU Committee Report

Product Sales and Shipments

Sales of Canadian manufactured goods rose steadily but modestly each year between 2002 and 2007 even while the Canadian dollar rose in value, and only began to fall slightly in 2008 in response to the rising currency (paradoxically at a time when the Canadian dollar was actually retreating). Canadian manufacturers sold $559.9 billion and $607.3 billion worth of goods in 2002 and 2007, respectively, representing an increase of only 9.6% in this five-year period. By way of comparison, Canadian manufactured goods sales grew by 29.4% in the five years preceding the rise in the value of the Canadian dollar — a period noted for the Canadian dollar’s decline in value to an all-time low of 61.79¢ US. Canadian manufactured goods sales, however, dipped to $604.7 billion in 2008, representing a decline of just 0.4% over 2007.

Figure 4

Source: Statistics Canada, The Daily, Monthly Survey of Manufacturing, May 15, 2008 and various other issues.

The annual data actually mask a more disturbing trend in the sector’s most recent sales performance. In 2008, manufactured goods sales were down only slightly, but changes in the value of the Canadian dollar were not the principal cause. Indeed, the retreat of the Canadian dollar since November 2007 bolstered manufactured goods sales in the second and third quarters of 2008 to a record high. When the data is presented on a quarterly basis, however, it becomes clear that the poor sales performance in 2008 was limited to the fourth quarter of 2008 (see Figure 4), the result of the global recession. Canadian manufactured goods sales were $143.2 billion in the fourth quarter of 2008, down 9% from $157.4 billion in the third quarter of 2008. The recession continued to have an adverse effect on manufacturing sales in 2009. Manufacturing sales were $126 billion in the first quarter of 2009, a drop of 12% over the fourth quarter 2008. These two quarterly declines were the largest declines in sales from one quarter to the next since Statistics Canada began collecting the data in 1992. The next largest quarterly decline in sales was less than half this size, -4.4% from the fourth quarter of 2000 to the first quarter of 2001.

The Canadian manufacturing sector is heavily concentrated in Ontario, followed distantly by Quebec and Alberta. These three provinces accounted for more than 85% of total Canadian manufacturing shipments in 2008. Not surprisingly, Ontario incurred the greatest decline in shipments in both absolute and relative terms of any province between 2002 and 2008. In fact, manufacturer shipments from all provinces but Ontario were higher in 2008 than in 2002. So Ontario, which accounted for 53% of total Canadian shipments in 2002, accounted for only 46% of Canadian shipments in 2008.

Employment

Depressed foreign demand and poor financial results — the consequence of the large appreciation in the value of the Canadian dollar — have brought about numerous plant closures and shutdowns and many rounds of employee layoffs in the manufacturing sector. Since its peak of 2.3 million in November 2002, employment in the manufacturing sector has been in decline. By July 2008, manufacturing employment was just shy of 2 million. The total number of employees laid off by the manufacturing sector in this period was 375,100 or 16.1% of its employed labour force in November 2002 (see Figure 5).

Figure 5

Source: Statistics Canada, Labour Force Survey, various dates.

Employment within the sector recovered for three months following July 2008 — when the Canadian dollar retreated and manufacturing sales recovered — but as the recession took hold in the United States in the second half of the year, employment turned downward once again. By March 2009, manufacturing employment in Canada stood at 1.8 million, down a further 136,900 in just eight months since July 2008. Furthermore, job losses in the first quarter of 2009 were 102,400, a loss that is twice as large as any quarterly loss incurred during the “commodities boom”. Clearly, the global recession has been far more devastating to employment in Canada’s manufacturing sector than was the global “commodities boom”.

Profitability

With the retrenchment of shipments beginning in 2001, falling prices in “real” or purchasing power terms (i.e., rising less than the rate of general inflation) as of 2001, and soaring energy costs since 1998, operating profits in the manufacturing sector declined from $54.7 billion in 2000 to $33.5 billion in 2003, representing a decrease of 39% in just three years. Management responded to the more competitive environment by laying off a substantial number of employees and shutting down numerous plants beginning in 2003, with the result that operating profits rebounded to $45.2 billion in 2004 and hovered about that level ever since. On a quarterly basis, operating profits within the sector hovered in the $11 to $12 billion range until the recession hit in the fourth quarter of 2008 when they declined to $10.5 billion (see Figure 6).

Figure 6

Source: Statistics Canada, Canadian Economic Observer, various dates.

The manufacturing sector’s net profit or earnings performed similarly to operating profits, declining from $35.6 billion in 2000 to $19.5 billion in 2001, representing a decrease of 45% in just one year, before recovering to $30.4 billion in 2007. Net profits in 2007 and 2008 were about 15% below that recorded in 2000. Finally, the manufacturing sector’s profit margin and return on capital employed that were in the vicinity of 8% and 9% in 2000, respectively, have both declined and hovered about 7% in this period.

Competitiveness Factors: M&E Investment and Labour Productivity

The Canadian manufacturing sector’s austere employment performance between 2002 and 2008 stands in stark contrast to its sales performance and contribution to GDP. The sector’s employment in 2008 declined 13.8% from its 2002 level, whereas the sector’s contribution to GDP declined by only 2.1% in the same period (see Figure 7). The difference between these two economic indicators of the sector suggests that the loss in competitiveness of the Canadian manufacturing sector as a result of the rather large appreciation of the Canadian dollar forced manufacturers to raise their labour productivity levels by focusing on labour shedding rather than on investing more on productivity-enhancing M&E.

Figure 7

Source: Statistics Canada, Gross Domestic Product by Industry and Labour Force Survey, various dates.

The manufacturing sector’s record of investment in M&E parallels its operating profits record, though the turning points of the former precede those of the latter by about one year. Manufacturing sector M&E investment peaked at $18.8 billion in 1999, retreated to $15.1 billion in 2002, and then marched upward to $17.0 billion in 2008 (see Figure 8). Throughout this period, M&E investment averaged approximately 40% of operating profits.[15]

Figure 8

Source: Statistics Canada, CANSIM Table 281-0009.

Figure 9

Source: Russell Kowaluk and Will Gibbons, Manufacturing: The Year 2007 in Review, Statistics Canada, Catalogue No. 11-261-M, April 2008.

Despite the respectable record of the manufacturing sector in managing the business conditions under its direct control (i.e., reallocating production, shedding labour, reducing product lines, outsourcing non-core inputs) between 2002 and 2007, lost economies of scale due to declining demand and stagnant investment in M&E because of relatively low profitability have conspired to produce a chequered labour productivity growth record. Labour productivity in the manufacturing sector had grown, on average, by 1.7% per annum between 2002 and 2007, which is considerably below its 1998-2000 performance of more than 4% per annum (see Figure 9). On a more positive note, the manufacturing sector outperformed its much larger business sector counterpart, whose labour productivity averaged only 1.1% growth in the 2002-2007 period.

Looking Ahead: New Orders, Business Opportunities and Financing

The preceding analysis covers the past and takes us to the present. The Committee now looks to the manufacturing sector’s immediate future. For such a perspective, the Committee relies heavily on witness testimony and the economic indicators that they provided to the Committee. Particularly informative was the Canadian Manufacturers & Exporters’ (CME) business conditions survey of March 2009. This survey included responses by 717 companies with operations across Canada and varying in size from those that employ as few as one person to those employing more than 500 persons.

About one half of all manufacturers who responded to the survey expect the value of their new orders to fall from current levels over the next three months; one-third of these manufacturers believe new orders will remain about the same as in the first quarter of 2009; and the remaining 18% of manufacturers believe that their new orders will increase in the second quarter of 2009 (see Table 2). Although these responses are not, in the main, positive, they are more positive than the February responses to the same set of questions.

Table 2
Canadian Manufacturers & Exporters
Business Conditions Survey, March 2009

Source: Canadian Manufacturers & Exporters.

In the aggregate, manufacturer inventory levels, whether of materials or finished goods, are believed to be too high (see Table 2). This suggests that the lower levels of new orders that manufacturers expect to receive over the next three months will more often be drawn from their finished goods inventories rather than leading to new production (and, hence, new employment opportunities). Materials inventories are also likely to be drawn down in the next three months, so their demand for materials is likely to be lower as well (therefore, the indirect employment effects of the new orders received will also likely be suppressed).

Table 3
Canadian Manufacturers & Exporters
Business Conditions Survey, March 2009

Source: Canadian Manufacturers & Exporters.

In the initial stages of an economic downturn, companies tend to hang onto their employees — they do not want to lose them and their acquired and specialized skills — and do not resort to laying them off until it becomes clear that a recovery is not firmly in sight and it is more important to preserve their “bottom line”. In this stage, companies often choose to either internally finance or seek increases in their operating line of credit to compensate for their depressed operational cash flow. According to the CME survey, only 22% of manufacturers sought to increase their line of credit; 78% did not require such a financial measure (see Table 3). More than half of those companies who sought to increase their line of credit did so to cover current expenses (52%); while 37% of them did so to expand their businesses (either to cover current expenses or research and development (R&D) expenses). About half of those companies who sought an increase in their line of credit received it (49%), one-third was refused, and the remaining 18% have not yet received a reply. Of those refused, the financial institution thought that, in 31% of the cases, the industry that the loan applicant was engaged in was too risky; in 27% of these cases, the company did not have the required collateral; in 12% of these cases, the company had too high of a debt load; and, in 4% of these cases, the company withdrew its application because of high bank fees.

Many Canadian companies realize that they must get ready to take advantage of the new opportunities that the forthcoming economy recovery will present. Such a belief is best captured in the testimony of one of the Committee’s witnesses:

We should not lose sight of the fact that in this very challenging economic time there are also opportunities that the many companies have. As we emerge from this recession knowing that customers will be wanting different things, and things delivered differently, the nature of manufacturing itself is going to change. We have to spend some time not only looking at the current condition of the sector but also at what the nature of Canadian manufacturing is going to be over the next decade or so as we emerge from the recession.

Jayson Myers, Canadian Manufacturers & Exporters, 6: 9:15

Ongoing structural changes in manufacturing were singled out by the witnesses. Most notably, the appearance of China and other “emerging economies” on the international trade scene were proving to be stiff competition in the production of both intermediary goods and consumer products, particularly those products that tend to use low levels of labour skill and technologies. One witness was quick to remark on both the appearance of China on the international scene and on the increased skill requirements demanded by Canadian manufacturers:

We’re also seeing increasing competition from emerging markets. Perhaps most telling has been the emergence of China on the world’s stage, as a result of their entering into the WTO in 2001. ... Another big change is that the skill requirements for our manufacturing workforce are increasing. We’re becoming more skill intensive, and this means manufacturers are increasingly competing with other segments of the economy for workers. Finally, we’re seeing the disappearance of low-value-added, labour-intensive industries here in Canada.

Michael Burt, The Conference Board of Canada, 6: 9:10

The Committee believes that these two developments are somewhat related: the emergence of China on the international scene with its array of manufactured products that are intensive in low-skilled labour has forced an industrial restructuring within Canadian industry towards manufactured products intensive in highly skilled labour and the newest technologies.

This structural adjustment means that Canadian manufacturers must continue to change, must adapt and must reorient their activities accordingly:

The money today is not made in production. The money is made in the services, the design, the engineering, the research, the innovation, the logistics, the delivery, and the customer service that goes around the product. Nevertheless, the product is an important anchor.

Jayson Myers, Canadian Manufacturers & Exporters, 6: 9:15

The Committee believes that, in general, Canadian manufacturers understand these developments and the challenges they impose. At the same time, many of them realize the opportunities that change often brings. For a number of these manufacturers, the realization of the business opportunities that present themselves or are sought out will require external financing. Unfortunately, 59% of manufacturers report that they are experiencing some difficulties in obtaining adequate levels of financing. The greatest difficulties are experienced in accessing financing for operating lines of credit, working capital purposes, capital investment, and investments in new technology (see Table 4).

Table 4
Canadian Manufacturers & Exporters
Business Conditions Survey, March 2009

Source: Canadian Manufacturers & Exporters.

In conclusion, the Committee understands that in an economic recession credit conditions become tight, which may impair companies with good investment projects in obtaining debt financing. In time, credit conditions will ease and allow manufacturers (in general) to invest in M&E to raise their productivity levels to compete more effectively on world markets with foreign firms. The Committee also recognizes that there is a good chance that, in the wake of a global economic recovery, we may see a return to the worldwide “commodities boom”, led once again by countries such as China, India and those of Southeast Asia, and a rise in the Canadian dollar in the vicinity of parity with the U.S. dollar. In this scenario, Canada’s manufacturing sector will continue to be challenged to raise its labour productivity levels by investing in new M&E rather than continuing on its current path of directly reducing employment. Public policies must reflect this new fundamental reality.