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Commentary

When bad news is good news, make fudge

August 13, 2013
by David Robinson
In: David Robinson

David Robinson, Economist, Laurentian University.

In “A Detailed Analysis of the Productivity Performance of Mining in Canada,” Celeste Bradley and Andrew Sharpe concluded that “the productivity performance of mining in Canada has been very poor.”

This seems like bad news, but it is caused by good news, and bad news will make it better, according to the authors.

Fortunately, all the bad news for mining is actually good news for the mining supply sector. Confused? Welcome to productivity theory for the mining industry. To understand why good news is bad news, we go back to Economics 101.

We all know that supply curves slope up in the short run. For example, if the price of gold rises, producers will increase output by opening mines that lose money when prices are low. Adding higher cost operations drives down average productivity, so good news in the form of high prices produces bad news in the form of falling productivity.

Really good news can be really bad. After a big jump in the price of gold, companies around the world try to increase production as fast as they can.

They roll out ambitious expansion plans. Growing demand for supplies drives up price. That’s bad … no, that’s good – we’re suppliers, not miners. The price of equipment goes through the roof. That’s good for suppliers too, but it generates bad news. Faced with skyrocketing prices, companies scale back their expansion plans.

In Economics 102 we learn about long-run supply curves and economies of scale. Once new mines have been brought on line and old mines expanded with new and better equipment, costs start to fall.

According to the basic theory, they fall right back to the original level. Since bigger operations can be more efficient than small ones, costs can even fall below the starting level. Long run economies of scale kick in. One of the great good news stories in modern history is that economies of scale have brought mining costs down and made metals cheap.

Of course, it is also bad news too. Mining is not an ordinary industry. With more and bigger mines, we exhaust the high-grade deposits faster. Moving on to lower grades and more remote locations drives up costs. Productivity falls.

According to Statistics Canada data, labour productivity in mining fell by 2.21 per cent per year between the 2000 cyclical peak and 2007. Capital productivity fell 0.28 per cent per year. In the race between depletion and technology, depletion was winning. Here is where the “fudge factor” comes in. Managers may think they are the ones who achieve productivity by getting the right mix of all the different kinds of labour and capital used in mining.

They are partly right. Economists like to add the level of technology as a separate variable. In some models they just multiply basic output by a capital “A” that they call “Total Factor Productivity.” The “A” is literally a fudge factor. It explains any increase in production that doesn’t come from adding more labour or more capital.

When “A” increases, productivity increases. And where does “A” come from? Not from hiring stronger, smarter workers or investing stronger, smarter dollars. Nor does it come from mining company innovations.

In 1999, less than one in 10 Canadian mining companies developed new technologies in-house. Instead, 50 per cent of mining companies in Canada purchased new off-theshelf technology, or customized and modified existing technologies In other words, productivity improvements in mining came from stronger, smarter machines, programs, training systems, inventory systems, and instruments developed by the mining supply sector. Mining suppliers are the fudge factor.

The smart way to support Canadian mining is to focus on innovation in the mining supply sector.

It is also the way to create Canadian jobs. Mining will continue to shed jobs as companies replace workers with machines.

The trick is to make the jobs reappear in Canada’s supply sector. So here is a simple idea for the new Minister of Industry for Canada, James Moore, for Joe Oliver, the Minister of Natural Resources and for Greg Rickford, the new Minister of State for Science and Technology: promote mining productivity by promoting the supply sector. In other words, make fudge.

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