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Manufacturing: Make or break?

When the chief lobbyist for Canada's manufacturers needed a prop for a speech last fall to illustrate his industry's prowess, he didn't wheel in an Impala or show a slide of a Dash 8. He whipped out a BlackBerry.

"The BlackBerry is synonymous with innovation," Canadian Manufacturers & Exporters (CME) president Jayson Myers boasted in the speech. "And, yes, it is also synonymous with manufacturing - Canadian manufacturing." If BlackBerry creator Research In Motion Ltd. doesn't immediately conjure up the image of the windowless factory or smokestack commonly associated with the goods-producing sector, it nonetheless meets the definition of a manufacturer: It makes things.

In the wake of a recession brought on by the service sector - the purveyor of the intangible credit default swaps and mortgage-backed securities that brought the world economy to its knees last fall - developed countries are paying renewed attention to their manufacturers.

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They are expressing their new-found appreciation with more than just simple auto bailouts or protectionism. Many policy makers believe future growth once again lies in making things.

From Ontario and the United States to Germany and Japan, governments have rushed to stress the importance of a vital manufacturing industry to future economic growth. U.S. President Barack Obama's new "Middle Class Task Force" sees the reinvigoration of the "flagging" U.S. manufacturing sector as critical if average Americans - whose after-inflation incomes have stagnated for years - are to achieve real wage gains in coming years.

More than three decades of so-called "deindustrialization" in the developed world - which only a few years ago was being called a sign of progress by leading economists - is now up for reconsideration.

Part of the rethink stems from a new appreciation for the critical link between research and development and manufacturing. RIM's rapidly expanding family of smart phones, for instance, is the fruit of billions of dollars in research spending in Canada over many years. In fact, according to CME, manufacturers account for three-quarters of all business expenditures on R&D in Canada. A 2006 Organization for Economic Co-operation and Development study places the figure somewhat lower - at about 60 per cent. But either way, manufacturing provides more high-paying jobs for scientists, engineers and industrial designers than any other sector of the Canadian economy.

And though the service sector now accounts for 78 per cent of jobs in Canada, its economic fortunes are intimately tied to manufacturers. Where, for instance, would companies that peddle wireless communications services or software be without the devices manufacturers produce?

But while RIM maintains modern manufacturing facilities near its home base of Waterloo, Ont., the company's fantastical growth in recent years means that only a fraction - less than 15 per cent - of all BlackBerrys are still produced in Canada. Most are currently assembled in the U.S., Mexico and Europe. And RIM recently disclosed plans to begin outsourcing BlackBerry manufacturing to China, leading to analyst speculation that it would funnel contract work to outsourcing behemoth Hon Hai Precision Industry, also known as Foxconn.

It's not just the manufacturing of BlackBerrys that has gone global; so have the research activities behind the creation of RIM's smart phones. The company now has R&D operations in China, Germany, Britain and the U.S., in addition to its main research hub in Waterloo.

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RIM's global reach should be a source of Canadian pride, not anxiety. Yet, if the findings of two Harvard Business School professors are correct, it is not without its risks - not for RIM, which is doing what any smart company should - but for the Canadian economy.

Gary Pisano and Willy Shih recently documented a string of high-technology sectors - from consumer electronics to hybrid cars - in which the U.S. has lost its ability to create the products of tomorrow precisely because years of outsourcing have seen research, engineering and design jobs follow production offshore.

No one appears more sensitive to their argument than Mr. Obama, who has made the renewal of his country's manufacturing sector a key plank of his economy policy. Of course, instead of smokestacks, Mr. Obama imagines the U.S. factories of tomorrow producing high-tech electric cars, silicon chips and solar panels. Nevertheless, reindustrialization is in and the postindustrial economy is out.

The share of manufacturing employment and output has plummeted in all of the developed economies since the 1970s. Canada's manufacturing sector experienced a longer reprieve than most, as a sinking loonie relieved pressure on our goods exporters throughout the 1990s. But since the dollar began rising from its record low of 61.75 cents (U.S.) in 2002 - it closed Friday above 92 cents, after hitting parity in 2007 - manufacturing here has contracted dramatically.

By the end 2008, manufacturing's share of all Canadian employment had declined to 11.5 per cent from about 15 per cent four years earlier, a net drop of almost 400,000 jobs from a peak of more than 2.3 million in 2002. Luckily, the booming construction and oil and gas sectors were able to absorb thousands of suddenly jobless factory workers. Not any more. The recession took those sectors down, too.

By last month, barely 1.7 million Canadians were employed in manufacturing. The industry is down 230,000 jobs from a year ago, accounting for about 60 per cent of the overall employment drop Canada has experienced during this recession. Only about 10 per cent of Canadians now work in the sector.

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Until recently, economists, and to a certain extent governments, had pretty much ceased worrying about the size of the developed countries' manufacturing sectors. Earlier this decade, the International Monetary Fund even stopped referring to the world's richest nations as "industrialized countries" to de-emphasize the importance of manufacturing and began using the term "advanced economies" instead.

Onetime angst about McJobs - the early 1990s shorthand for low-paying, highly precarious service-sector employment - had given way to a sense of postindustrial bliss. After all, while Japan, which remained far more dependent on manufacturing than almost any other developed economy, suffered through its lost decade, the United States prospered despite outsourcing manufacturing jobs to Asia. In the new Internet age, making "things" was increasingly considered old-economy fare.

"The deindustrialization of the U.S. economy is actually a sign of strength, not weakness," IMF economist Ramana Ramaswamy and Cambridge University professor Robert Rowthorn noted in the Harvard Business Review in 2000. "Having an ever more efficient manufacturing sector matters less and less for maintaining the dynamism of the U.S. economy. The real driver of growth is the service sector." Deindustrialization was simply seen as a natural progression. Rapid productivity growth meant it took fewer and fewer factory workers to produce the same amount of goods; rising affluence meant individuals were consuming more and more services, from restaurant meals to pedicures; and globalization had allowed less-developed countries to take on the mundane task of punching out widgets, toys and VCRs.

This sanguine view is also expressed in a Statistics Canada study, published in July, by analysts John Baldwin and Ryan Macdonald. They concluded that the traditional measure of deindustrialization - manufacturing's declining share of employment and gross domestic product - does not fully capture the sector's evolution in recent decades.

The relative value of Canada's manufacturing output has fallen because higher productivity has resulted in lower prices. That is a positive development for consumers. And while manufacturing volumes have remained fairly constant in recent decades, Canada has moved to produce more high value-added durable goods, such as cars, and fewer low value-added semi- or non-durables such as clothing and newsprint.

In theory, it shouldn't matter whether a country produces goods or services as long as the size of its economic pie is growing. But in reality, manufacturing's declining share of economic output and employment has been accompanied by a growing gap between rich and poor.

"The manufacturing economy was one that created a prosperous middle class in which moderately educated people could obtain a [high]standard of living," said Christopher Kollmeyer, a lecturer in the sociology department at University of Aberdeen in Scotland, who recently published a much-noted study on the causes of deindustrialization.

"The service economy is more bifurcated. There's a high-end - with accountants, lawyers, investment bankers and doctors - but there's definitely a bigger low-end. A service economy tends to polarize the distribution of wealth in society." Nowhere is the fallout of deindustrialization as evident as in Detroit. In the heyday of the Big Three U.S.-based auto makers, no American urban centre had a higher median income or level of home ownership than Motor City. But the closings of one auto plant after another in recent years has decimated the ranks of Detroit's middle class.

Loonie's low-tech legacy

For all of RIM's success, the U.S. actually has a greater proportion of high-tech manufacturing than Canada. In fact, a 2006 OECD study noted that Canada's manufacturing sector is still far more dependent on producing low-technology goods than most of its counterparts in the U.S. and the rest of the developed world.

High-tech wares account for about 40 per cent of all manufacturing output in the U.S., South Korea and Britain. They even make up about 30 per cent in Mexico, which now produces many of the flat-screen TVs (including the Sony and Sharp brands) sold in North America. In Canada, however, high-tech manufactured wares account for less than 20 per cent of the goods we produce. Among the Group of Seven advanced economies, only Italian manufacturers make a smaller proportion of high-tech goods.

Canada's reliance on low-tech goods is one legacy of a low loonie, which allowed Canadian manufacturers to coast along for the better part of a decade without upgrading their machinery and equipment or moving up the global value chain to produce more sophisticated wares. Indeed, for every RIM, Canada has hundreds of manufacturing laggards - as evidenced by the sector's paltry 10-per-cent gain in productivity since 2000, or barely one-quarter of the advance made by U.S. industry.

The downfall of Nortel Networks Corp. has not helped matters here. Five years ago, Nortel sold off its manufacturing operations to Singapore-based Flextronics International Ltd., which took over Nortel's manufacturing installations in Montreal. Flextronics continued to produce telecommunications network equipment at the plant on Nortel's behalf on a contract basis until last fall, when it closed the facility, which employed 700, and transferred the work to a factory in Mexico.

Nortel's demise places a lot of hope, and expectations, on the shoulders of the likes of RIM. But like almost all of its tech peers, including iPhone creator Apple Inc., RIM now counts on outsourcing firms such as Flextronics, Toronto-based Celestica Inc. and Luxembourg-based Elcoteq SE, to make the bulk of its handsets. RIM sold 26 million BlackBerrys in its most recent fiscal year, which ended in February, more than a sixfold increase from the four million handsets it sold in 2006. To keep up with demand, it has had little choice but to look to such electronics manufacturing services (EMS) firms, which produce BlackBerrys in the U.S., Europe and Japan.

Is that something Canada should worry about? According to Harvard Business School's Mr. Pisano and Mr. Shih, no country should be indifferent to outsourcing, especially when it comes to high-tech wares.

"There are relatively few high-tech industries where the manufacturing process is not a factor in developing new - especially, radically new - products," Mr. Pisano and Mr. Shih insisted in a recent Harvard Business Review article. "The decline in manufacturing in a region sets off a chain reaction. Once manufacturing is outsourced, process engineering expertise can't be maintained because it depends on daily interaction with manufacturing ... In the long-term, an economy that lacks an infrastructure for advanced process engineering will lose its ability to innovate."

This is the latest version of an argument that first gained credence two decades ago as the U.S. grappled with an ever-expanding trade deficit with Japan. All of the hot new technology of the 1980s - from videocassette recorders to Walkmans - seemed to be coming out of the Land of the Rising Sun. Yet, only a few years earlier Japan had been churning out only the low-tech products that U.S. manufacturers no longer cared to make - much like China has now been doing for the past decade.

Japan's move into high-tech design and production, beating U.S. manufacturers at their own game, led two University of California at Berkeley professors to conclude - somewhat controversially at the time - that "manufacturing matters."

"There is no such thing as a postindustrial economy," Stephen Cohen and John Zysman claimed in their 1987 book, Manufacturing Matters. "The wealth and power of the United States depends on maintaining mastery and control of production." Mr. Cohen and Mr. Zysman disputed the common the idea that service-sector jobs could fill the void left by factory ones. "Many of the high value-added service jobs we are told will substitute for industrial activity are not substitutes; they are complements. Lose industry and you will lose, not develop, those service activities."

By the 1990s, however, as the dot-com boom fuelled U.S. economic growth, their warnings went largely unheeded. Outsourcing gathered steam, as Asia became the locus for the manufacturing of personal computers bearing the labels of major U.S. brands. It wasn't long before the research and design activities that led to subsequent generations of PCs also moved to Asia to be closer to manufacturers there.

The result, according to Mr. Pisano and Mr. Shih, is that "nearly every U.S. brand of notebook computer, except Apple, is now designed in Asia, and the same is true for most cellphones and many other handheld electronic devices."

RIM co-chief executive officer Mike Lazaridis insisted in an interview that the company's move to conduct more R&D abroad "is just a sign of growth." Besides, he stressed, he needs no lessons in the symbiotic relationship between R&D and manufacturing.

"We have a relatively large and very advanced manufacturing organization [in Waterloo]and the reason for that is the tight coupling between engineering and manufacturing," he said. "The kind of manufacturing we do in Waterloo is really a kind of R&D ... Our manufacturing here is literally footsteps away from engineering. A lot of learning goes on between the manufacturing team, the global supply chain team and engineering team."

The Waterloo manufacturing site, which employs about 1,900, focuses on RIM's newest products. Insights from the manufacturing team in Canada are passed on to subcontractors, which assemble BlackBerrys in far-flung locations across the globe according to RIM's minute specifications.

The reality, Mr. Lazaridis explained, is that RIM couldn't do all of its research and manufacturing in Canada, even if it wanted to. Though more than half of RIM's nearly 13,000 employees are still located here, Canada's share of the jobs will likely fall as the company grows further.

"Initially, we were hiring a lot of people from the University of Waterloo, Wilfrid Laurier University and Conestoga College here in town. But they couldn't keep up with our needs," he said. "We now have a big office in Bochum, Germany, and they're doing R&D on a couple of products being developed there. That's just a sign of growth."

Still, if manufacturing, research and new product development are as interwoven as Mr. Pisano and Mr. Shih insist they are, don't policy makers here need to take note? Mr. Obama certainly has. The new U.S. administration has vowed to make sure that the new "green" manufacturing jobs it aims to create with generous subsidies to electric car makers and renewable energy companies do not move abroad.

Many economists are skeptical, however, that those kinds of government policies are the right ones.

"Do [governments]really have the skill sets to determine which sectors are going to be the winning sectors down the road?" said Fred Lazar, an economics professor at York University's Schulich School of Business. "If anyone thinks he or she has those skills, that person should be in venture capital or private equity where they could make a lot more money than they could as a government bureaucrat." Instead, Prof. Lazar insisted, governments should strive to create an environment that favours entrepreneurs like Mr. Lazaridis and his co-CEO Jim Balsillie. And they should "encourage the creation, development and evolution of as many companies that are going to be at the forefront of their industries as possible and worry less about where they do their R&D or manufacturing. Worry more about retaining their head offices, because that will result in a disproportionate share of [R&D and manufacturing]activities remaining in your country."

Bank of Nova Scotia chief economist Warren Jestin is equally leery of policies that favour manufacturing over other sectors of the economy. "The trend has been for manufacturing to be a smaller and smaller share of developed economies over time.

"The idea that we can buck that trend is probably not achievable," Mr. Jestin said. "Moreover, if we try to achieve it, it would come at a very, very high cost." Adopting policies that favour manufacturing over services, Mr. Jestin added, "misses the basic point: It is the skills and educational level of your population that will determine your prosperity."

It might be a bit too nostalgic, if not naive, then, to believe that the conditions that allowed generations of postwar assembly line workers to live the good life with a high-school diploma or less can ever be broadly recreated in North America. But if Mr. Pisano and Mr. Shih are right, a country that sits idly by while its manufacturers outsource production, risks seeing coveted jobs in research, engineering and industrial design eventually go abroad, too. Does that make RIM Canada's tech canary in the gold mine?

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About the Author

Columnist Konrad Yakabuski writes on politics, policy and business for The Globe and Mail’s Comment section and Report on Business. More

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