Canada’s Two Economies – Implications for Workers

What follows are my speaking notes for a recent McMaster Labour Studies/CAW educational event – a fair bit of it condensed from some of my earlier pieces but this update may be of interest….

I will talk about our two economies in two senses, growing class divisions, the growing gap between workers and the corporate elite and growing regional/sectoral divisions resulting from a process of economic re- structuring in response to external forces which is having major negative impacts on central Canada in particular.

The common thread is neo liberal policies which have deliberately reduced the bargaining power of labour in the labour market and also scaled back state interventions to shape our economic development in the interests of workers and communities.

Our economy is now heading into a significant downturn, according to the IMF and the Bank of Canada, Ontario likely in recession already.

The current downturn/recession in the US is making the already serious problems caused by the high Canadian dollar, a growing problem since 2002, far worse.

Not going to talk much today about growing US and global financial crisis, but a few key points.

Yes, the trigger was the sub prime crisis, lots of money lent by an irresponsible and reckless financial sector to high risk mortgages, with defaults now growing because of the still deepening collapse of US housing prices. US house prices are now expected to fall 20%.

The affected US plus international banks and hedge funds have taken big losses, an estimated $1 Trillion and are now much more reluctant to lend money to both households and high risk businesses, especially in the US.

At a deeper level, the crisis is the inevitable end to a decade of US expansion built on ever rising consumer debt, as opposed to higher consumption driven by rising wages.

US households have gone deeper and deeper into debt to finance spending, wages stagnant as in Canada due to the fact that almost all income growth has been at the very top and the fact that good jobs and worker bargaining power have been squeezed by ongoing industrial restructuring.

The US manufacturing crisis began long before that in Canada and, like our’s, has its roots in an enormous trade deficit with Asia, especially China.

US expansion was maintained by borrowing at low interest rates from surplus countries in Asia and then re-lending to US households (as well as private equity and speculative hedge funds). That has come to an end, meaning we are likely to see quite a prolonged US recession.

The only real way out, and this is barely on the agenda, is for the Asian surplus countries to expand their imports so the US can grow its way rather than shrink its way out of a huge imbalance of trade and financial flows. A strong economy in Canada requires continued growth in both the US and Asia.

The key difference between Canada and the US is that we are cushioned, to some degree, by strong Asian demand for our resources.

In short, we will not escape the US recession and the deepening loss of the US market for our exports, especially auto and forest products. But we will do better if, and it is a big if, expansion continues in Asia and if Asian development becomes more driven by internal demand (which requires rising wages and expansion of a social safety net, in short a major political shift from the repressed labour/export driven growth model supported by the Chinese state and the global transnationals which have shifted new investment, production and jobs to China).

Superficially, the Canadian economy and labour market were doing well until quite recently, about 3% economic growth in 2006, a bit less in 2007. An unemployment rate was at its lowest level since the early 1970s at about 6% and an all-time high employment rate of 63.5% in 2007. ( This is the proportion of the working-age population with jobs.)

However, in 2007, there was very little job growth in paid jobs (define) in the private sector. The public sector expanded (which is good) but increased public investment in infrastructure and services will be hit by a deepening private sector downturn. New “jobs” were disproportionately in self employment. Of the 358,000 new jobs created December 2006 – December 2007, less than 10% (34,000) were private sector employees; 31% were in self-employment; and 60% were public sector jobs.

Until recently, the loss of manufacturing jobs was having little impact on unemployment. Displaced workers were finding new jobs, some moved West, some moved into construction jobs (though this sector is now slowing) and some moved into often lower paid jobs in private services. Unemployment in Ontario and Quebec and most of Atlantic Canada is now rising.

Looking at the impacts of the manufacturing crisis on workers, the simple fact of the matter is that manufacturing jobs are not easy to replace with jobs of comparable quality. They pay about $21 per hour on average compared to hourly wages of perhaps $15 per hour in private services where most of the net new jobs are being created.

Manufacturing jobs are more likely than average to be full-time jobs and to provide pension and health benefits.

The unionization rate in manufacturing is 30%, more than double that in private services. About one-third of these manufacturing jobs are held by women and many are held by recent immigrants.

Past experience has been that long-tenure workers displaced by industrial re-structuring experience significant wage losses in the range of 25% in new jobs.

Continuing low unemployment and strong employment growth drove fears of higher inflation until recently, but the high dollar and the effects of a slowing economy mean that inflation is low (well under 2% Bank of Canada target).

From the perspective of working people, the real issue is why apparently low unemployment in recent years has not been benefitting us. It is not that long ago that the Bank of Canada, the International Monetary Fund and the OECD all thought that an unemployment rate much below 8% would spark a sharp increase in real wages.

This is simply not happening. Real wages were pretty flat until 2007. Between 1997 and 2006 average hourly wages adjusted for inflation were basically flat except for professional/managerial workers and fell for many so called lower skilled workers. Working households got ahead in terms of consumption by working more hours (mainly because more women were working in full-time jobs) and by borrowing more (as in the US). The household savings rate is basically zero. As in the US, the housing boom has recently been driven by new entrants to the market taking on very high levels of debt (no down payment 40 year mortgages).

At best, wages are now running a bit ahead of prices, up about 4% year over year and wage settlements in 2007 averaged 3.3%. Wage stagnation is mainly due to relentless competitive pressures in traded sector of economy and the fact that good jobs are still hard to find. Private sector union density continues to fall to under 20% and minimum wages and basic employment standards plus a much reduced EI program have mainly maintained rather than countered a large low wage sector.

Over the 1990s period of expansion, profits rose to a record high share of national income which has helped squeeze wages and real wage increases were mainly confined to the top 20% and higher.

A new Statistics Canada study of top incomes has found that the income share of the top 1% of individuals soared from 8.6% to 12.2% of pre-tax income between 1992 and 2004, while incomes for the bottom 80% of individuals, adjusted for inflation, increased only marginally. As the average (inflation-adjusted or real) income of the top 1% rose from $268,000 to $429,000 between 1992 and 2004, their incomes rose from 601 times the income of the median taxpayer (the person in the exact middle) to 737 times as much. At the very, very top, the top 0.01%, about 15,000 taxpayers in 2004 had an average income of $5.9 Million in 2004 and collected 1.7% of all income, 11,522 times as much as the median taxpayer.

There are similar trends at the level of pre-tax family income, with the income share of the top 1% of families rising from 7.8% to 11.2% of the total, 1992-2004.

In the expansion since the early 1990s the share of part time jobs
and self employment remained high compared to the 1980s, but did not increase further.

To summarize, most workers did not share in the growth of national income generated by the long period of expansion which ran from the early 1990s to very recently. As in the US, a lot of economic growth has been generated by rising household debt and the housing market, rather than by more broadly based sustainable prosperity.

Jobs are now again becoming more insecure and precarious and many good jobs are being lost to industrial restructuring and the crisis in the manufacturing sector. More than 300,000 manufacturing jobs were lost 2002 through 2007 and the pace of job loss has recently begun to accelerate. 130,000 manufacturing jobs were lost in 2007 and there have been further losses in 2008 to date.

The Canadian economy is being driven by a geographically and sectorally concentrated resource boom. Prices of oil and gas and many base metals have soared, leading to increased production and major investments in new capacity, most notably the Alberta tar sands and new mines. As in past periods, the key driving force of Canadian capitalism is foreign demand for our resources.

The boom is being driven mainly by increased global commodity prices as a result of strong Asian growth, record high prices for oil, many minerals, for example, potash, as well as high agricultural prices. Financial speculation also seems to be a major factor behind the resource boom, which might yet collapse.

These higher commodity prices, along with the huge US balance of payments deficit, have led to a major appreciation of the Canadian against the US dollar. Since 2002, the dollar has risen from a low of 62 cents US to parity and about half of this run up has been since early 2007 (meaning the impacts of the run up in 2007 are still mainly in the pipeline).

The high Canadian dollar is mainly a function of the commodity price boom, plus the weakness of the US dollar.

Since major Asian currencies (notably those of China, Japan and Korea) are closely tied to the US dollar, Canadian competitiveness with Asia has been severely eroded. The higher Canadian dollar means loss of our markets in the US to Asian exports, PLUS loss of the domestic Canadian market to Asian exporters.

Non resource-based manufacturing and the forest industry are experiencing a major crisis due to a slowdown in exports to the US. This reflects slower growth in the US market for products like paper, lumber, autos and parts and a loss of the Canadian share of the US market to rising Asian imports because of the high Canadian dollar. In 2007, China accounted for 16.3% of US imports, up from 10.7% in 2002. Over the same period, the Canadian share of US imports fell from 18.2% to 16.3%.

Meanwhile, Asian producers have grabbed a much larger share of the Canadian domestic market for manufactured goods. Since 2002, the US share of Canadian imports has fallen from 72% to 64% as the fall of the US against the Canadian dollar has mainly benefitted Asian exporters.

A large deficit in the trade of manufactured goods, defined as non resource-based goods, has opened up since 2002 and our trade deficit with China and developing Asia is now even greater as a share of the economy than that of the US. We are now running a $30 Billion annual trade deficit with China.

Our overall merchandise trade surplus, once quite high, has shrunk to almost zero despite high energy and mineral prices and we now import about $1.30 worth of manufactured goods for every $1 of manufactured exports. Our deficit in trade of manufactured goods rose from $22.4 Billion in 2002, to $59.9 Billion in 2007.

This was driven by a shift from a large surplus to a small deficit in automotive trade and a big increase in the trade deficit for machinery and equipment (from $9 Billion to $21 Billion). (Manufactured goods are defined here as machinery and equipment, consumer goods and auto products combined, as opposed to resource-based and industrial goods such as pulp and paper, ore concentrates, chemicals, and fertilizer which are at best only semi processed.)

We import $35 Billion worth of goods, mainly consumer goods and machinery and equipment, from China, but export just $7.7 Billion worth of goods, mainly resources, to that country in return. We also run large trade deficits with Korea, Japan and virtually every country in the world except the US, which is the almost exclusive buyer of our oil and gas exports.

Laid on top of the problems caused by the high dollar are specific problems in the forest sector and the automotive sector and the fact that many Asian markets for manufactured goods are not truly open to Canadian or US exports.

While some parts of manufacturing have remained profitable, the competitiveness squeeze caused by the high dollar and the huge and growing trade deficit with Asia has resulted in the loss of some 300,000 manufacturing jobs since the peak in 2002. Jobs have been lost to plant closures and to layoffs caused by lower production, a corporate drive for intensified productivity in remaining operations and outsourcing of production inputs to other countries as part of the creation of global value chains. For example, Bombardier is selling into the Chinese market by agreeing to subcontract more work to Chinese suppliers, who will then produce components for export to Canadian production.

By sector, job losses have been greatest in auto, forest products, clothing and, in the capital goods sector, computers and telecom equipment which have never fully recovered from the dot com bust of 2000.

The impact has also been greatest in the unionized manufacturing sector, half of the job losses even though unionization rate is 30%. Companies are trying to cut costs and concentrating cuts in unionized plants.

Relatively few manufacturers are taking advantage of the high dollar to purchase mainly imported machinery and equipment in an effort to restructure their operations in a more positive way for workers. Very few seem to be expanding training. The dominant response to a more competitive global market has been to shift non resource production out of Canada, rather than upgrade the productivity, innovativeness of production capacity in Canada.

We need to look at the manufacturing crisis in a longer term perspective.

We actually did well from the mid 90s to 2002 in terms of manufacturing job creation. We recovered many jobs lost in the recession of the late 1980s/early 1990s. However, there was not a lot of new investment (auto being a partial exception) and our manufacturing sector remained limited in terms of being able to produce sophisticated high value, high quality products which can support high wages and require skills and sophisticated equipment.

Our aerospace sector is small but quite strong and has done quite well (though jobs being partly shipped offshore to maintain competitiveness).

Auto was quite strong for much of the last decade and is a much bigger part of Canadian than US manufacturing. Its future is crucial but the big 3 in Canada are fast shrinking production and jobs.

The Canadian capital goods (machinery and equipment) sector outside of aerospace is small and weak. For example, we import mining and forest industry machinery and equipment despite having a large domestic market; have developed very little in way of new energy and environmental technologies.

We produce very little in the way of consumer goods, which now mainly come from Asia not from here or the US.

Even resource based manufacturing has been historically limited to low value-added products, example, we export pulp and paper and lumber, not high quality papers, windows, doors, customized wood products, concentrated ores rather than highly refined metals, frozen fish not high quality processed fish products, natural gas rather than petrochemicals.

Business has generally failed to build strong linkages from our resource base both backwards (inputs of goods like machinery and high end services) and forwards (resource processing).

This failure partly reflects the very high level of foreign ownership and high level of integration with US. Transnational corporations don’t really care about increasing the Canadian content of resource exports, only profitability. Governments have failed to push the kinds of policies which make a difference and many were undercut by FTA and NAFTA, example, export restrictions on unprocessed resources, requirements to add value in Canada, conditions on foreign investment etc. (That said, government policy can still make a difference, example, Newfoundland under Danny Williams has insisted on Newfoundland content in new oil and mineral development deals.)

The key point is we relied on the low dollar too much in the mid 1990s to 2002 period – companies under invested and we made ourselves vulnerable to a shock which has now arrived.

New investment now is mainly concentrated in the oil and gas and mining sectors. Energy and mining accounted for over 40% of all business investment in 2007, compared to about one third through most of the 1990s. These huge investments are driving a major industrial construction boom, lots of short term jobs in some regions, with some positive impacts on Canadian suppliers.

Since 2002, our exports have become even more dominated by resources and industrial materials such as ores and concentrates, chemicals, potash etc. The share of manufactured goods in our exports (machinery and equipment, auto, consumer goods) has fallen from 52% to 42% since 2002. We are seeing a major reversion to our role as a resource producer for world markets, rather than a more inward driven and controlled path of economic development.

The conventional wisdom is that re-structuring of the manufacturing sector is not a major problem and that the economy is “adjusting well.”

However, manufacturing is an important direct source of almost 2 million good jobs due to above average productivity, in turn the result of higher than average capital investment per worker and a strong base of skilled workers. Manufacturing operations also support many spin-off jobs, including good jobs in business services and in transportation. Even though manufacturing has been and will continue to shrink as a source of direct jobs due to rising productivity, it still supports many good jobs in both private and public services.

To show how manufacturing supports jobs, an Informetrica study estimated the impact of a $10 Billion or 3.3% increase in manufacturing exports sustained over 4 years. (The effect of a fall in exports would be the same in size, though a negative rather than a positive.)

This increase in exports would generate 67,000 new direct manufacturing jobs, PLUS another 48,500 spin-off jobs, three quarters of which would be in the service sector (everything from financial and legal services, to hotels and restaurants).

Most of the positive job impacts would be in central Canada, about one-half in Ontario and one-quarter in Quebec. One in four of the new jobs would be in Atlantic Canada and the West.

The increase in exports would generate a significant increase in government revenues, enough to reduce the debt of all levels of government by $8 Billion and enough to also finance new annual spending of $2 Billion on public services. This would create another 26,500 jobs, mainly in the public sector.

It is true that there are also good jobs in the resource sector, but mines and oil and gas production are extremely capital intensive operations. Once built, they will require relatively few workers. And, of course, there are huge negative environmental impacts from large-scale resource extraction.

Manufacturing is often denigrated as part of an “old economy” which must be replaced by a new “knowledge-based economy”, but the majority of all business research and development in Canada takes place in manufacturing, especially in industries like aerospace and electrical machinery and equipment. Skill levels in manufacturing have been rising.

As we are constantly told, Canada will do best in a changing global economy if we shift to production of goods and services which sell in world markets because they are innovative, of high quality and/or unique. With countries like China and India becoming major exporters, only a highly productive economy built on innovation, knowledge and skills will sustain high wages and living standards. We should be exporting sophisticated goods and services to China and developing Asia, but it is they rather than we who are climbing the value-added ladder through active industrial development and managed trade policies.

The Informetrica study also showed that the manufacturing jobs crisis is hollowing out almost all manufacturing industries, not just those (like clothing) which are most vulnerable to very low wage competition. Electrical equipment and computers, both usually considered to be on the more innovative end of the spectrum, as well as auto have been among the big losers.

Canada’s deficit in the trade of manufactured goods has exploded in recent years. It’s true that we are now exporting more oil and gas and minerals, but resource exports can finance only about one-fifth of our imports. Some see service exports as the way to pay our way, but services make up only 13% of our exports; we run a huge ($14 Billion) deficit in the trade of services and service exports have not been increasing rapidly.

Put it all together and an ever-increasing manufacturing trade deficit is unsustainable. Sustaining healthy manufactured exports remains critical to the country’s balance of foreign payments.

There are big structural problems down the road if we allow manufacturing to shrink too much, especially if growth is driven by an energy sector which is based on non-renewable resources being extracted far too fast, in an environmentally unsustainable fashion, with little value-added in Canada.

As a key case in point, the Keystone pipeline proposal approved by the National Energy Board means increased production of bitumen from the Alberta tar sands will be refined in the US, just as dwindling natural gas supplies from Alberta have been diverted from value-added, job-creating petro-chemical production to natural gas exports. Most of the gains of the recent energy boom are being captured by owners of oil and gas companies, many of them foreign-owned.

Resource-led economies are prone to boom-bust cycles and to have a relatively narrow core of good jobs, as opposed to diversified economies with a strong manufacturing base which are more stable and have relatively more jobs in higher productivity sectors.

Many people say increases in oil and commodity prices ‘explain’ the rise of the Canadian dollar. However, this does not mean that the dollar is at the ‘right’ level so far as the needs of the real economy are concerned.

The Canadian dollar may be mis-perceived as a ‘petro currency’ and the link between oil prices and the dollar is more a financial as opposed to real economy linkage, driven by foreign financial and direct investment in resource sector equities more than by an expansion of the resource sector itself. Actual oil exports in terms of volume have not increased much, the tar sands are not yet producing major amounts and new mines are still being built.

It is far from clear that rising commodity prices will soon translate into a rising trade and current account surplus which would justify rapid exchange rate appreciation. In point of fact, our positive overall merchandise trade balance with the rest of the world is disappearing.

Oil exports (crude oil plus refined petroleum products) make up only 12% of our total exports and this is unlikely to rapidly increase given the depletion of conventional oil supplies and the long lead times before exports from the development of the tar sands begin to grow rapidly. Current oil exports amount to far less than the struggling auto sector which still contributes about 20% of exports. Energy exports in total account for close to 20% of exports, but this includes natural gas exports for which prices have recently been at depressed levels. Also, while our terms of trade do improve with higher oil prices, there is an offset arising from the fact that we also import large quantities of oil.

The rise in the exchange rate of the Canadian dollar since 2002 was, as noted, mainly driven by commodity prices and the weakness of the US dollar. That said, neither of these factors entirely explain the run up from mid 80 cent US level to parity since mid 2007. The Canada US interest rate gap played a role, as the Bank of Canada only slowly became more concerned about a slowing economy than about an inflation “threat” from low unemployment.

How do we get out of the crisis:

• Work internationally to balance North America/Asian trade through currency changes and promotion of labour/democratic rights and an inward driven development model in China and elsewhere.

• Implement active industrial development policies, including major investments in “green jobs”; government support for positive industrial re-structuring; controls on foreign investment/foreign takeovers.

• Slow down the pace of tar sands development through an end to subsidies and regulation of exports.