The dangers of ‘value added’ mythologies

Trevor Tombe
January 4, 2016
It’s a common refrain in Canada: we shouldn’t be mere drawers of water or hewers of wood, but should support and even subsidize the creation of “value-added” manufacturing jobs. But primary resource industries like mining and oil and gas extraction actually produce far more added value than most manufacturing and processing sectors. The problem with value added, writes Trevor Tombe, is that most of its advocates chronically misrepresent the concept, which leads to bad policy decisions that cause more economic harm than good.

The dangers of ‘value added’ mythologies

Trevor Tombe
January 4, 2016
It’s a common refrain in Canada: we shouldn’t be mere drawers of water or hewers of wood, but should support and even subsidize the creation of “value-added” manufacturing jobs. But primary resource industries like mining and oil and gas extraction actually produce far more added value than most manufacturing and processing sectors. The problem with value added, writes Trevor Tombe, is that most of its advocates chronically misrepresent the concept, which leads to bad policy decisions that cause more economic harm than good.
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It’s a common refrain in Canada: we shouldn’t be mere drawers of water or hewers of wood, but should create “value-added” manufacturing jobs. This sentiment shapes policy debates right across this country. In British Columbia, there is a slogan: “B.C. Logs for B.C. Jobs”, which calls for restricting raw log exports in favour of local processing. In Ontario, some are concerned that the Trans-Pacific Partnership will destroy value-added jobs in the auto sector. In Quebec, the government recently bailed out Bombardier – an aircraft manufacturer whose marketing material often touts its “high value added jobs”. The province provided $1 billion, taking a 49 percent stake in the struggling CSeries jet project, and there is pressure on the federal government to chip in too. If Ottawa bites, it will likely be because some “business case” touts the “value added jobs” associated with the firm.

Striving for more value added is perhaps nowhere greater than in Alberta. Ever fearful of being overly “dependent” on primary oil and gas production, the province has long subsidized refining and processing activities – most recently with billions for the Northwest Upgrader project – all in the name of supporting value added. The new NDP government will likely do more of the same. In setting up the province’s Royalty Review, for example, Premier Rachel Notley specifically directed it to “encourage diversification opportunities, such as value-added processing.” So virtuous is the cause of diversification that it apparently even trumps the environment. The Notley government’s recently announced climate change plan includes a cap on emissions from oil sands facilities, yet value added upgrading activities may be exempt.

It’s worth exploring what value added actually is, and some of the consequences of policies meant to promote it.

Something has “added value” if it creates output that is worth more than the total cost of its intermediate inputs. That is, if the price of the good exceed the cost of material or service inputs required for its production. Manufacturing activities that transform various parts into a more valuable finished product clearly add value. But the phenomenon is by no means unique to manufacturing or processing. A trucker adds value by transporting a product from Montreal to Ottawa, so long as the product is valued more in Ottawa than Montreal. A logger adds value by making a log from a tree. An oil rig adds value by pumping oil from under the ground to the surface. From the perspective of the economy as a whole, it does not matter how value is added, so long as it is.

Sectoral added value is essentially measured by the total amount of income a sector generates. Wages paid to workers, profits collected by firms, rent earned by building or land owners, all add up to a sector’s value added. There are some subtle complications, but this intuition is almost always sufficient. Conveniently, Statistics Canada collects and organizes this data for anyone to see. For each dollar of output from the mining sectors, for example, 71 cents of income – and therefore 71 cents of value added – is created. In other sectors, it is much lower. For wood products manufacturers (the “value added processing” of logs) 32 cents of income is created for each dollar in output. Refineries have the lowest, with only 11 cents of income on the dollar.

Added value can also be measured on a per job basis. As illustrated in the accompanying chart, it varies substantially across sectors, from a high of $1.3 million per job in oil and gas extraction, to a low of $22,000 per job in animal production. Obviously the idea that manufacturing is a more value added activity than raw resource extraction is simply false.

This misunderstanding can have serious economic consequences. The first and most obvious consequence is that public subsidies to so-called value added activities expose governments (and taxpayers) to financial risks. Projects may or may not work out, leaving government to pick up the tab. These costs can add up. The Canadian Taxpayers Federation reckons the Government of Alberta under premiers Peter Lougheed and Don Getty blew roughly $2.3 billion by the early 1990s on failed attempts at diversifying Alberta’s economy (not adjusting for inflation). The biggest failure was NovaTel – a joint telecommunications venture between the Nova Corp. and Alberta Government Telephones, Telus’ predecessor – which eventually cost taxpayers over half a billion dollars. Not all of the Alberta government’s diversification efforts were failures, but as Ted Morton and Meredith McDonald found in their comprehensive review for University of Calgary School of Public Policy titled The Siren Song of Economic Diversification, the losers far outstripped the winners.

A broader consequence of subsidizing firms on the basis of their supposed value added is lower productivity in the overall economy. Suppose for a moment that labour markets function perfectly. In this case, the economic value of a worker is revealed in the going wage rate. Firms that have valuable jobs will be willing and able to pay this wage; those that don’t, won’t. A subsidy distorts this decision. With access to government funding, a firm could afford to hire the worker even if the underlying value of the job is low. This will deny the worker to other firms and the overall economy suffers. Simply put, a subsidy can shift employment towards subsidized activities that are potentially less valuable than others.

Tombe - Inset

These displacement effects are a real cost to the economy. Beyond creating winners in one sector and losers in others, they also shrink the size of our economic pie. Economists call this a “misallocation”, and it is now well established that distortions to the allocation of employment and capital can have sizable negative effects on overall productivity.

This matters. Canada’s productivity lags behind the United States. The most recent data suggests our economy is 10-15 percent less productive, depending on the measure, and it has been getting worse. If we closed the productivity gap with the United States, Canada’s GDP would rise by between $200-300 billion – or roughly $7,000 for every single Canadian. Governments should pursue policies that enhance productivity, not diminish it. We shouldn’t subsidize or otherwise artificially support any sector on the basis of its supposed level of value added; to do otherwise is harmful to the economy. (To the extent that markets fail, of course, corrective subsidies and taxes may be justified. But this is not how subsidies to “value added activities” are typically justified – because it is a very tough case to make.)

There are other costs beyond these economic ones. Subsidies to refining and upgrading activities, for example, can have serious environmental consequences. New Brunswick’s Irving Oil Refinery alone emits nearly 3 million tonnes of GHG annually, and refineries account for over 15 percent of that province’s overall emissions. It’s a pattern repeated across the country. Saskatchewan’s Co-Op Refinery emits 1.7 million tonnes of GHGs; Alberta’s Strathcona Refinery, 1.5 million; Quebec’s Raffinerie Jean-Gaulin facility, 1.3 million. The list goes on. To put these numbers in context, consider emissions from some coal power plants – often singled out as particularly damaging to the environment. Alberta’s Sundance Plant emits about 2 million tonnes of GHG per year per unit (the plant has six units), Saskatchewan’s Shand Station emits 2.3 million tonnes, Nova Scotia’s Point Aconi plant emits almost 1.4 million. These are right in line with typical refineries. There is an odd inconsistency between political support given to refineries on the one hand and opposition to coal power on the other.

How costly are these greenhouse gas emissions? If the implied external costs of carbon are, say, $40 per tonne (a reasonable estimate) then a typical refinery may cause around $50 million in environmental damages per year. If a government seriously believes emissions are bad, the logical policy response is to tax refineries so they internalize this external cost – certainly we do not want to subsidize them. This is precisely what carbon taxes are meant to do. If we subsidize refining and upgrading, then we’ve limited (or potentially reversed) any environmental gains from a carbon tax.

With real economic and environmental costs, calls to “support value added sectors and jobs” can do more harm than good. So what can we do? As I can think of no policy where it would be useful to actually know a sector’s value-added, we should stop using the phrase entirely. It pollutes public policy debates and is an entirely useless concept for most policy decisions. Almost every use of the phrase is incorrect and, worse still, misleading. When I hear a politician, a business or union leader, or other public commentators refer to value added, alarms bells go off. I hope this reaction spreads.


Trevor Tombe is an assistant professor of economics at the University of Calgary and author of the recent School of Public Policy research paper Better off Dead: “Value Added” in Economic Policy Debates.

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