Posted on: August 30th, 2017
By Peter G Hall, Vice-President and Chief Economist
The stakes are high. For some, they’re about as high as they get. Tough talk south of the border has Canadian exporters worried that if they don’t relocate to the U.S., they will lose their sales there. These fears are not made up; they are real. And they are being validated by U.S. buyers who have bought in to ‘America first’ thinking. All year exporters have been asking me what I think they should do. Clearly, every business situation is different, and the answers have depended on the particulars of the situation. But is there a common response, a set of guidelines that every firm feeling pressure can consider?
Before getting to the answer, a bit of context: the U.S. is still overwhelmingly Canada’s largest customer, and by far the largest international recipient of Canadian direct investment abroad. While some characterize this outward investment as bad for the Canadian economy, believing that the money would be better spent here, EDC Economics has always viewed this as a necessary element of integrative trade – an efficient, business-directed expansion of supply chains globally that permits our enterprises to be efficient on a world scale. Without this, sales would at the least be impaired, and at worst, non-existent.
This practice has in fact not hollowed out the local economy, but has accompanied a dramatic diversification of Canadian sales to markets all over the world. In a number of industries, it has enabled Canada to achieve a scale of operation and specialization that would be unlikely if simply confined within our own borders. If left free to make efficient decisions about global activities, successful businesses will make the right decisions.
Add political pressure, and the game changes considerably. In this case, it’s no longer about standing up foreign investments on their own merits, but forcing activity under threat of losing the business – whatever the cost implications are. At first blush, it seems that there is not much choice. Nobody wants to forego hard-won contracts, so the short-run solution seems to favour capitulation. That has been the response of many I have spoken with in the first half of the year, with some even saying that their flag-waving U.S. buyers are willing to pay for it. Does any of this add up, or is there another way we should be looking at it?
Those considering relocation for political reasons need to do the math. A first consideration is that U.S. industrial capacity is tight. In certain industries, like the auto sector, wood products, furniture, paper production and certain parts of food processing, levels of capacity utilization are greater than during the red-hot growth just before the Great Recession. That means that getting into the U.S., already an expensive proposition, is going to be a fight for limited existing capacity, and limited capacity to create new capacity. If going, prepare for ‘No Vacancy’ signs.
A second factor is the labour market. Even if a firm succeeds in finding space to operate in, there may not be workers to fill it up. The unemployment rate is 4.4 per cent and falling. It hardly ever gets that low. True, there are still ample amounts of displaced workers looking to get into the market, but many of these require training or re-training, possibly an expensive proposition.
OK, assuming success on these first two factors, there’s a third: all of the costs of this new operation will be in U.S. dollars. That’s right, transplant the process, and you’re now paying roughly 30 per cent more for everything. And if you were getting paid in USD to begin with, that will be a pure margin hit. If you were taking payments in canuck bucks, even worse.
Two more considerations: if everyone in the world is rushing in to the U.S. for the same politically-motivated reasons, fighting for that same limited capacity, imagine the extra cost pressures – and the consequent interest rate increases. Finally, if your buyer is willing, for ‘patriotic’ or other reasons, to absorb all or a large part of your higher costs – and everyone else’s in their supply network – aren’t you just a little worried about their medium-to-longer-term viability in today’s globally competitive marketplace?
The bottom line? It gets pretty freaky when it seems a head of state is taking aim at your business model. And when your key buyers buy in to the rhetoric. But at the end of the day, you still have to make a buck. A quick move to hedge your bets could be as costly as standing your ground. As always, it is best to do diligent homework and make an informed decision.
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