Why it’s better to make cellphones in China

Why can’t we bring back all those factories that have gone offshore? In fact, why can’t we source and manufacture everything here? The experts say it’s not a good idea.

Foreign Affairs Minister Chrystia Freeland with US Secretary of State Rex Tillerson in May 2017.

Renegotiating, let alone ripping up, NAFTA was on no one’s radar when US President Trump made it the linchpin of a key point in his Make America Great Again campaign. Since winning office, he has consistently pushed the America First, Buy American, Hire American agenda. In October, he took another swipe at free trade and globalization by threatening to “severely” penalize US companies that set up shop overseas.

While President Trump speaks to (and stokes) Americans’ fears about lost jobs, it’s also true that some Canadians are just as frustrated with globalization. They see it as the reason manufacturers have left Canada for low-cost producers, leaving Canada to import products that could be made here. They aren’t wrong. If we look at the auto sectors in Canada, the US and Mexico, nine of the last 10 auto assembly plants built in North America have been constructed in Mexico, with one going to the US. Canada did not benefit from those investments — at least not directly. But does that mean we didn’t benefit at all?

What would happen if we flipped the current reality and sourced and produced all the components of, say, a car and a cellphone, here in Canada? Would they be cheaper or so expensive few could afford them? Would we be better or worse off economically, both as a country and individually? Put simply, is globalization good?

The answer is both yes and no and involves a look at an economic theory called comparative advantage, which makes the case for international trade and globalization.

COMPARATIVE ADVANTAGE 101

The law of comparative advantage dates back to at least 1817, when it was described by English political economist David Ricardo in his book Principles of Political Economy and Taxation. Essentially, a country has a comparative advantage if it can produce goods and services relatively more efficiently and at a lower cost than another country. The theory goes on to state that by specializing and trading according to their comparative advantage, all countries can benefit from international trade.

For example, Canada has an abundance of high-skilled labour. Mexico has an abundance of low-skilled labour. Therefore, Canada has a comparative advantage over Mexico in the production of goods that require high-skilled labour. It’s because countries have been playing to their strengths and specializing in what they do better relative to other countries that we now have an integrated global economy and labour has been segmented or divided to reflect those strengths.

The iPhone 5&6: Which countries manufacture the components?

Of course, any discussion about globalization and its economic impact is layered and multifaceted. “When we think of globalization, it involves the movement of goods, services, capital, people, technology and ideas across international borders,” says Walid Hejazi, associate professor at the Rotman School of Management at the University of Toronto. “If we were to consider the impact of all these dimensions on the Canadian economy and on the incomes of Canadians, that would be a really complex analysis, but it would no doubt show that globalization has increased the number of jobs in Canada enormously, along with average incomes.”

That’s certainly been the argument made by Canadian Foreign Affairs Minister Chrystia Freeland as she works to modernize/save NAFTA. Her go-to statistics: Canada’s trade with Mexico and the US accounts for more than 75% of our merchandise exports. Ten percent (1.9 million) of all jobs in Canada are linked to exports. Canada’s economy is 2.5% larger or $20 billion richer every year than it would be otherwise because of NAFTA.

It’s certainly also true that when countries “misbehave” or “fall out of favour” with the international community, they are punished with sanctions limiting their access to the global economy, says Hejazi. “Put another way, where would you never want to live? North Korea. And which country is most opposed to globalization? North Korea.”

But what about all those auto manufacturing jobs that Canada has lost as a result of globalization?

A QUICK LOOK AT THE HISTORY OF AUTO MANUFACTURING IN CANADA

First: for those who are nostalgic for more protectionist days, at no time were cars 100% sourced and manufactured in any one country. Technology and materials were crossing borders even as early as the 1920s. That said, prior to the Canada-United States Auto Pact of 1965, Canada had assembly plants producing a wide variety of vehicles.

“The results were terrible,” says Bernard Wolf, professor emeritus, economics and international business, Schulich School of Business at York University in Toronto. “There were no economies of scale because our market is so small. Runs were short and costs were high. It worked only because of the high tariffs the government imposed on vehicles produced elsewhere more cheaply.”

To put market size in perspective, each year, more vehicles are sold in California and more pickup trucks are sold in Texas respectively than in all of Canada.

“It was the 1965 auto pact that rationalized much of the industry between Canada and the US, not NAFTA. A lot of people don’t get that,” says Wolf. “The Big Three [automakers] realized that producing a few of many models is stupid and the Canadian government saw it, too. It’s much more efficient to produce many of a few, most of them for export to the US, and thus gain the benefits of mass production while importing the majority of models.” The immediate result of rationalization: a substantial reduction in the price of vehicles to Canadian consumers and a much more competitive Canadian industry.

Fast-forward to NAFTA and now there is a three-way market. Labour-intensive automotive parts are produced in Mexico because labour is cheap there (autoworkers in Mexico earn about $6 an hour in total wages and benefits versus $60 an hour for autoworkers in Canada, plus Mexico has lower electricity and operating expenses). Some of those parts are then imported into Canada and the US. There is now an integrated market with goods going back and forth, and parts for a vehicle crossing borders several times.

Right now, about 85% of the vehicles assembled in Canada and more than 80% of the auto parts made here are shipped to the US and Mexico. “Soon we’ll see Chinese and Indian automakers building in North America. Canada will benefit because we will be supplying all these new auto assembly plants,” says Tony Faria, director of the office of automotive and vehicle research at the Odette School of Business at the University of Windsor in Ontario.

As for all those jobs going to Mexico, cost is a big factor, but it’s not the only reason non-automated manufacturing has migrated. Brands also want to be close to their customers and build support. Manufacturing in the markets they sell to makes companies less foreign and their products more attractive. Plus, Mexico has year-round open-water ports on the Atlantic and Pacific oceans, as well as free-trade agreements with every country in South America and many in Europe that Canada does not have such agreements with.

Still, globalization isn’t just about jobs. “With globalization we are getting more and better products more cheaply,” says Faria. “Not every benefit is going to be a job benefit. Many will be consumer driven. For example, right now, the cost of parts going into a vehicle is about $19,000. Some sources estimate that would go up at least 30% if all the parts were made in Canada,” says Faria. “Retail prices would go up, pushing some people into the used-car market.”

THE ELEPHANT IN THE ROOM: AUTOMATION

“If you look at the data for the last 50 years, the demand for routine skills versus cognitive skills has been falling regardless of globalization,” says Hejazi. “Any routine skill that can be automated is being automated. Canada Post was hit with a massive backlash when the postal-code system was introduced in the 1970s. That was independent of globalization but globalization has accelerated it and taken it to the extreme.”

For those pointing to NAFTA and globalization for lost manufacturing jobs, there are about 140,000 workers employed directly in parts and assembly today. That’s roughly the same number employed in the sector before the economic downturn. That said, it does take fewer workers to produce the same output — a reality that will only continue because of automation and robotics. “The Chrysler minivan assembly plant in Windsor makes 350,000 vehicles a year and has for several years. At one time in the 1960s it employed 11,000 workers to achieve that output. Now it employs just more than 5,000 people,” says Faria. “This would have happened regardless of globalization or NAFTA.”

Technological advances will continue to eat away at manufacturing jobs. The only questions are how fast this will happen and what Canada will do. Professor Michael Manjuris, chair of global management studies at Ryerson University in Toronto, points to Germany as a way forward. “Germany has been successful in manufacturing post-Second World War because of its focus on quality and the ability to compete on a world-class level — not because it makes all its components there. Canada used to do that in a number of areas of manufacturing and won world recognition. We need to return to government policies that encourage the growth of high-skill, high-value-add manufacturing.”

He cites a focus on raw materials and particularly oil exports as another reason Canada’s manufacturing sector has shrunk. “We have an educated workforce and manufacturing infrastructure but the government didn’t support the sector because it was benefiting from strong oil prices. That’s changed and the federal government sees the need to shift to more advanced types of manufacturing,” Manjuris says.

“Comparative advantage and globalization will help. Companies like McDonald’s, Apple and Amazon look at the world as one market. They want to move production to where they gain the most efficiency and pay the lowest costs and they want to sell to markets where they can generate the highest revenues and profits,” he says. “That globalized competition will raise our capabilities. If we continue to improve efficiency and quality and start to create more unique products that make it difficult for others to be competitive we’ll be fine.”

Case in point: Apple’s iPhones. Hugely popular and expensive, they are largely assembled in China with parts coming from suppliers in 28 countries. According to research company IHS Markit, it currently costs Apple US$295.44 to produce the new iPhone 8 Plus with 64 gigabytes of NAND flash memory. The bulk of that cost is in materials (US$288.08), many of which simply aren’t available in the US. Only US$7.36 goes to basic manufacturing. President Trump would like production moved to the US, a move that the Nikkei Asian Review has reported will more than double the cost of the phone, which retails starting at US$799.

WINNERS AND LOSERS

Let’s take a look at what happens in a world without NAFTA. All those companies that have tapped into global supply chains to maximize efficiency at minimum cost will lose. “It’s not just about going to a place where the cost is lowest. They have to be able to deliver a quality product,” says Hejazi. “Without NAFTA, all of a sudden all those efficiencies are lost. If Trump has his way and cars and cellphones are made in the US, the price goes up significantly, exports collapse and people lose their jobs. It’s completely the wrong strategy. The right strategy is to embrace globalization. That said, when you do that, there will be people who win and people who lose.”

So, is globalized production a good thing? “It’s fantastic,” says Wolf. “The problem with globalization has been that there have been huge gains but those gains have not been equitably distributed.”

Freeland has said the key to everyone winning in a globalized world is to have both equitable domestic fiscal policies and free-trade agreements. You can’t have one without the other. “It is incumbent on the government to tax the people who benefit and help the people who lose with education and healthcare,” says Hejazi. “The wrong thing to do is to close yourself off to the world.”

MADE-IN-CANADA PARTS

Before the Canada-US Auto Pact took effect, Canada had a 5% share of the North American auto industry. This increased to 18% of a much bigger sector in 1987. In 1999, nearly three million vehicles were produced in Ontario and Toyota’s Cambridge, Ont., plant was the most productive car factory in North America. Eight major global car and truck manufacturers had plants in Ontario, more than any other province or US state. In 2001, the Big Three automakers spent $30 billion on Canadian-made parts.