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Victor Marquez, an assembler at Standen's Limited in Calgary, grinds a heavy truck spring. (Chris Bolin/Chris Bolin For The Globe and Mail)
Victor Marquez, an assembler at Standen's Limited in Calgary, grinds a heavy truck spring. (Chris Bolin/Chris Bolin For The Globe and Mail)

Why Canada's manufacturing sector is dwindling Add to ...

Stephen Gordon is a professor of economics at Laval University in Quebec City and a fellow of the Centre interuniversitaire sur le risque, les politiques économiques et l'emploi (CIRPÉE). He also maintains the economics blog Worthwhile Canadian Initiative.

The Canadian manufacturing sector employed more than 2.3 million people in 2002. By last September, manufacturers had shed some 580,000 jobs - more than one in four - and most of these losses occurred before the recession. There are few signs that this trend will reverse itself soon.

This decline isn't necessarily a bad thing: contrary to a widely-held belief, there's nothing intrinsically important about the manufacturing sector. The transition went fairly smoothly before the recession: the fall in manufacturing employment was largely due to attrition, not layoffs. And one of the surprises of the recession is that manufacturing unemployment is now lower than it was before the recession - although this result was largely achieved by workers leaving the sector altogether.

But it's a puzzle nonetheless: output per worker in the manufacturing sector has been increasing more than three times as fast as the economy as a whole. If productivity growth is the key to sustained prosperity, then shouldn't manufacturing be increasing in importance?

A popular explanation for manufacturing's woes is the increase in commodity prices and the resulting appreciation of the Canadian dollar, but this is only part of the story. A more complete narrative would take into account movements in the prices of manufactures and of consumer goods. The standard theory of the firm predicts that increasing productivity will lead to higher real wages, and the data are generally consistent with the theory. The problem is that the firm uses the price of its output to calculate real wages, while workers use the prices of consumer goods to calculate their purchasing power. Increasing productivity may allow wages to increase faster than output prices, but if it may not be enough to preserve workers' purchasing power if consumer prices are rising faster than producer prices.

The fundamental problem facing manufacturing firms is that the prices have been growing more slowly than consumer prices. CPI inflation has averaged 1.85 per cent a year since 2002, but the Industrial Price Index for all manufactures has only increased at a rate of 1 per cent. And since motor vehicle producer prices have been falling at a rate of -4.6 per cent a year, the auto sector would have had to sustain productivity growth rates of more than 6 per cent simply to maintain workers' buying power. In contrast, the Bank of Canada's commodity price index increased at an average rate of 2.9 per cent (6.8 per cent during the 2002-08 boom).

Monetary policy can do little to change this ranking: a more expansionary stance would increase the prices of all goods, not just those produced in the manufacturing sector.

Shifting workers from sectors where prices are weak to sectors where prices are growing more strongly is part of a sensible strategy for increasing national income. The decline in manufacturing employment will only be reversed by more rapid growth in that sector's producer prices.

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