The Fallacy of the Value of a Low Loonie


Conventional wisdom has it that a low dollar is a competitive advantage for Canadian manufacturers. It is easy to show that this is not the case. It does provide an advantage for natural resource industries whose primary resource values are not directly related to currency values, but that is a sector largely eschewed by our government.

To understand why there is no currency advantage to manufacturers, consider the case of Acme Widget Company. Acme Widget makes widgets in Ontario and Michigan. It wants to double its production capacity at one of its plants and has to decide which one.

A widget has three components, one made in Canada, one made in the US and one made in Indonesia. Let’s assume the Canadian dollar (CDN) is trading at 0.75 to the US dollar (USD). The Michigan plant pays $1.00 USD for the part from Indonesia. The part costs the Ontario plant $1.33 CDN because the trade is in USD. The Michigan plant buys the US part for $1.00 USD while the Canadian plant has to pay $1.33 CDN. The Ontario plant pays $1.00 CDN for the part made in Canada but the Michigan plant only pays $0.75 USD.

The total cost for materials for the US plant is $2.75 USD and for the Canadian plant, $3.67 CDN which is $2.75 in USD. In other words, the relative value of the two currencies offers no competitive advantage to either plant on a materials basis.

But there are other costs associated with production. Suppose the employees are paid the minimum wage. In Michigan, that is $8.50 / hour USD while in Ontario it is $11.40 / hour CDN or $8.55 USD. On wages alone, it is a toss-up. However, one must also include the cost of statutory benefits such as health insurance, EI, and pension plan premiums which in Ontario, are all costs to the employer.

Further, electricity costs are important. Time of day use, purchase contracts, and unbundled charges for distribution and other services are complex and require a case by case analysis based on projected usage characteristics. One might need to consider other utilities such as water and sewer rates also.

Finally, there are municipal, state or provincial, and federal taxes to consider. The regulatory framework may be important in terms of adding additional operating costs. With NAFTA coming under review, tariffs and border taxes may be a consideration.

In conclusion, the relative value of the Loonie has no impact in the long run, on the material cost of manufacturing. The costs that will affect a decision to build a new plant or extend an existing one are all soft costs associated with the local jurisdiction being considered, and what incentives might be negotiated with governments.

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