This column is 99.9 per cent value add

'Value-add" is a term you hear a lot. It is always on the Bullshit Bingo cards at political conventions, economic conferences and anywhere members of the commentariat gather to dazzle each other with polysyllabic words.

‘Value-add” is a term you hear a lot. It is always on the Bullshit Bingo cards at political conventions, economic conferences and anywhere members of the commentariat gather to dazzle each other with polysyllabic words.

Value-add is indeed a crucial economic concept, but unfortunately the idea has only a tenuous connection to what many politicians and talking heads mean when they use the term.

In technical economic jargon, if you buy $60 of “doodads” and turn them into “widgets” that you can sell for $100, then you have added $40 of value. This value is somehow split between the “factors of production,” which include land, capital and labour. How the $40 gets split depends if you live in a workers’ paradise, capitalist wonderland or a good old-fashioned agrarian feudal society.

Where the fuzzy thinking starts is when people start to make assumptions about where the value-added comes from, based more on myth and wishful thinking. In the last year, I have heard quite a few politicians suggest that manufacturing is “value-add,” while the resource sector is not. And many others have suggested we need to have more “value-add” activity closer to home, rather than exporting raw logs or raw bitumen.

The idea that manufacturing is somehow better and more important than resource production is more than 100 years old. Think back to Industrial Revolution England.

The farmers in Anglia or the tin miners in Cornwall were using techniques that had hardly changed in centuries, while the new factory workers were amazing the world with vast quantities of cheap manufactured goods. The great wars of the 20th century highlighted the need for an advanced manufacturing base to build the tanks, ships and airplanes.

It is also a lot sexier to visit the Boeing factory in Seattle than a pulp and paper mill in Gatineau.

However, in today’s economy, the general assumption that manufacturing is more value-add than resource production is wrong so often as to be a useless guide to policy.

An ounce of gold is worthless at the bottom of a Yukon creek, yet worth more than $1,500 when you sell it. Depending on how much capital and labour it took you to get that ounce, it might be a much better deal than manufacturing doodads into widgets in competition with the Chinese, Americans, South Koreans and Germans.

An economist working on restructuring the East German economy after the collapse of the central-planning system there once made a telling remark about Wartburg, which manufactured an up-market version of the Trabant car. He said that the factory took $5,000 of perfectly good raw materials, added $5,000 of labour, and produced a car worth $4,000. Society was better off if you just sent the workers on vacation.

The critical thing is the prices of the inputs and outputs at each stage of production, or the “value chain.” If copper prices are high and wire prices are low, then it is quite possible that copper mining will be value-add while smelting or wire manufacturing might not be.

Sometimes people bring up the risk of manufacturing capabilities disappearing forever. In the copper example above, Canada’s wire factories might shut down due to a mining boom. And then when the boom ended we would have lost our wire-making abilities and be at the mercy of foreign wire tycoons.

It’s theoretically possible, but few industries are that strategic and uncopyable. And as the governor of the Bank of Canada recently pointed out, most forecasters are predicting commodity prices will be sustained by Chinese and Indian demand for years to come.

The other myth is that we need to have the whole value chain in Canada; i.e., that we are suckers to sell raw materials to foreigners. You hear lots of people saying they want Canadian logs to be made into furniture in Canadian factories, or Canadian bitumen made into premium gas in Canadian refineries.

There are a few problems here. Scale and specialization mean that there are real benefits to having global supply chains. Suppose each country, or each region or even each city, depending on how far you take this, was forced by government “value-add” rules to have its own copper smelter, furniture industry, fertilizer plant, oil refinery, steel stamping mill and so on. You’d need rules taxing or banning foreign imports so that Canadians had to buy Canadian furniture, cars and televisions.

You would, in effect, have recreated our economy before free trade. And that would be a bad thing, since free trade has driven increased choice and competition and also higher productivity and incomes in Canada.

Let’s look at another central planning disaster to illustrate how this kind of thinking looks when taken to its ultimate conclusion. In his 1950s Great Leap Forward program, Mao Zedong decentralized value-add manufacturing activities to the maximum possible in order to foster rural development. At one point, there were over 20,000 community steel furnaces. It was a disaster.

Furthermore, Canada has limited resources of labour and capital. Say a new oil refinery is around $5 billion, give or take. Given how over-heated Alberta’s economy is, think how much extra it would cost to build now.

And why build it, if existing refineries in the U.S. or Canada have spare capacity? And even if they didn’t, wouldn’t it make more sense from a global perspective to build it in a place with high unemployment and close to demand such as Texas or California?

Canadian politicians don’t want to go as far as Mao of course. They just want to tinker a bit with the location of some furniture factories and oil refineries, putting out some self-congratulatory press releases and burying the extra cost somewhere out of sight.

Our politicians should spend more time fixing our health and education systems, and less time second-guessing where oil executives put their refineries. And if they don’t like this column, I would point out that it is 99.9 per cent value-add, since I used less than 10 cents of paper and pencil lead.

Keith Halliday is a Yukon economist and author of the Aurore of the Yukon series of historical children’s adventure novels.