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Canada’s productivity crisis: misdiagnosed

An Econowatch special report on productivity (part five)


 

If you spend any time reading about the Canadian economy, you have inevitably come across the Great Canadian Productivity Puzzle. Canada’s productivity is much lower than that of other countries, and we don’t really know why. Neither do we seem to be able to fix the problem. Policymakers have used every trick in the book to try to boost productivity, but the results have disappointed. Productivity growth matters because it drives up our purchasing power: if it lags, so will our standard of living. And yet—here’s where things get interesting—Canadians are far better off than one would tell looking at our dismal productivity performance over the past 20 years. How did we do it? In this six-part special report, Maclean’s in-house economist Stephen Gordon investigates the mystery. (With a contribution from Econowatch editor Erica Alini.)

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If Canada was a closed economy, the only way to raise Canadians’ purchasing power and standard of living would be to increase domestic output. But Canada trades, and since 2002 the price of a lot of the stuff we sell, especially commodities, has gone up relative to the price of the goods and services we import. This has increased Canadians’ purchasing power exactly as if we didn’t trade and had boosted our aggregate production.

Our response to higher commodity prices was the logical one: shift investment toward the resource sector and away from other industries, manufacturing in particular. But you’d never know that looking at Statistics Canada’s estimates of productivity for these sectors.

(Note: multifactor productivity, or MFP, is commonly seen as measure of technical progress—the increase in output that cannot be explained by the accumulation of labour and capital inputs. For more on that, see part two.)

If you ignore the fact that the prices of resources relative to manufactures increased sharply after 2002, you’d interpret the shift from manufacturing to resources as a productivity-reducing reallocation of capital and labour. And that’s what Statistics Canada’s estimates of MFP suggest. But technical progress is a matter of rearranging productive assets to make things that are of higher value, so you want to take those price changes into account.

In an article (pdf) published in the Fall 2012 issue of the International Productivity Monitor—published by the Centre for the Study of Living Standards—Erwin Diewert, a professor of economics at the University of British Columbia, and Emily Yu, an economist at the Department of Foreign Affairs and International Trade, did just that. They applied a methodology designed to capture the income-boosting effects of shifting inputs to industries where prices are rising, and they obtained productivity estimates that are much less alarming than those produced by Statistics Canada.

It is too early to conclude that the Diewert-Yu results are definitive, but the study does make clear that not taking into account price-induced sectoral shifts can significantly understate productivity gains. (Another article (pdf) in that issue of the International Productivity Monitor raises other problems with Statistics Canada’s methodology, and there are responses from Statistics Canada’s analysts. More on that in the sixth and last installment of our special report.) The research debate is ongoing, but there is obviously something wrong with the way Statistics Canada currently estimates multifactor productivity, or at least with the way it is interpreted. The claim that there has been no technical progress in the Canadian business sector over the last 40 years is literally incredible.

Economist Gérard Debreu, a Nobel prize winner, was once asked why he titled his landmark monograph Theory of Value instead of Price Theory. His answer was: “Because value equals price times quantity.” The key here is that both quantity and price are important. In an economy that trades, significant improvements in productivity are not a sufficient condition for income growth—they aren’t even a necessary condition. What is being produced can be more important than how much is being produced. Policy-makers should not be focused exclusively on quantity-based measures of productivity at the expense of the development of an economy that has the flexibility to reallocate resources in response to changes in relative prices.

I’m not arguing that policies aimed at increasing productivity are misguided. For a given set of prices, improvements in the conventional measures of productivity will increase output and incomes. But it is a mistake to pay attention only to one part of the value equation and to ignore the effects of prices changes. Prosperity doesn’t come from producing more of something that no one wants to buy.

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INDEX:

  • Part five: Canada’s productivity crisis: misdiagnosed

 
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Canada’s productivity crisis: misdiagnosed

  1. Could it be that they’re both right (Stats Can measure of MFP and D&Y?)

    Oil and Gas example. Oil is at $30 /barrel , all inclusive cost is $20/barrel, difference is $10.

    Seemingly overnight, oil doubles to $60/barrel. Profit in the short term is $40 ($60-$20). Increased profits leads to more cash flow for re-investment, rising stock price (P/E ratio as a proxy). Rush to invest.

    Major new play (oil sands) is recognized and promoted. Competition heats up. Costs rise: equipment and labour, executive compensations (often based upon stock performance), professional wages etc. And oilfield workers.

    With oil remaining at $60, if the costs rise to $40, flat MFP (StatsCan) relative to the $30 situation, but MFP declining over time immediately after the price jump until costs catch up to doubling of oil price.

    If inflation continues, and the spread narrows, (say costs rise to $45/barrel) lower StatsCan MFP.

    Yet, if the growth came from a less profitable industry (shift) according to D&Y, net overall gain in D&Y MFP.

    I guess my confusion arises over the use of the term “productivity”. Perhaps “economic efficiency” works better for me. Because, if an oil & gas employee was basically doing the same job, but was now paid double for it, I wouldn’t consider that a gain in productivity. On an individual basis, probably would lead to less work/more leisure time.

    And if inflation continues in the O&G sector (wages, goods and services), while bitumen prices stagnate or decline (due to physical bottlenecks), this can’t be good for the long term viability of the industry. Sticky costs and whatnot.

    Short form: Is this just economic semantics?

  2. Tom Sawyer wasn’t particularly productive, but he had a higher standard of living because he was able to fool his friends into paying him for the privilege of working for him. I don’t think this analogy is far off the mark.

    • And no-one could say that Tom Sawyer was lacking in imagination or initiative!

  3. The full employment rate in Canada used to be a little over 5 percent now it’s normalized art 7.1 percent? This is to be seen as positive? Why do we continue to be the most generous country in the world towards immigration?

  4. It’s far too early to proclaim Canada’s productivity problem has been misdiagnosed. According to the Conference Board of Canada, the paper from W. Erwin Diewert and Emily Yu could actually indicate *worse* productivity with a “careful reading”:

    The article titled, “Canada’s Productivity Problem Can’t Be Measured Away” says,

    “The debate over methodology and measurement obscures the fact that no matter what method is used, our productivity growth is still dismal. In fact, a careful reading of the new research indicates that Canada’s productivity performance could actually be worse than thought!

    “Canada’s weak productivity growth has caused us to slip further and further behind the United States and other major industrial economies in terms of real income per capita—something that hits every Canadian in the wallet. The need for concerted action on productivity growth and innovation must remain a national priority if we hope to maintain our high living standards. …

    “Indeed, when all the elements are pulled together, these authors produce overall results for productivity growth since 1961 that are slightly below Statistics Canada’s estimates. Rather than offering a new hypothesis that stronger growth in multi-factor productivity has saved the day, this methodology appears to confirm our poor performance.”

    The Conference Board of Canada: Canada’s Productivity Problem Can’t Be Measured Away
    http://www.conferenceboard.ca/insideedge/2013/mar2013/mar27-insideoutlook.aspx

    • Much research has been done showing that a resource based economy has a diminishing impact on standard productivity figures exactly because of the difficulty in extracting diminishing availability of these resources. This new study includes the ever increasing price of these commodities because of their scarcity and provides the counter to the falsehood of standard productivity calculations. This makes sense to anyone who understands that industries associated to the extraction of such commodities, i.e.s oil and gas require more manpower but at high profits. Studies such as the one cited in this article are welcome.

      • Are commodities like oil and gold going to keep increasing? Or are we simply in a resource boom (that can be followed by a resource bust)? Take, for example, the early 1980s. The world was in a deep recession. The price of oil and gold was extremely high. Then when the economy recovered in the mid-1980s, the price of oil and gold crashed. Already we are seeing signs of the gold bubble bursting as the US economy begins to recover. So betting everything on a resource boom lasting forever does not seem like a good bet to me.

        • I totally agree. However corporations have a vested interest in extracting the resource where it is available and shipping the raw commodity to an pre-established area where processing can take place. For example, for decades Falconbridge was extracting the copper and nickel ores from their mines and shipping it overseas to process it. Thus Canada was simply another venue much like third world countries that have no processing facilities. Our government is encouraging the same thing with our oil without any second thought even though it has now been acknowledged that we have one of the largest reserves of oil in the world. It is up to Canada to encourage corporations to set up shop in Canada to process our raw goods even though Canada now has one of the lowest corporate tax rates in the G-20. Go figure. .

  5. According to the OECD, Canada’s multi-factor productivity is just as bad. From 2000 to 2010, we ranked #16 of 19 countries with 0.1% growth. (The US had 12 X that: 1.2%.)

    My guess is that there’s not much room for productivity gains digging holes in the ground. (The resources become harder and harder to get at, reducing productivity over time.)

    The greatest productivity gains will come from information-based technologies.

    In the end, rises in wages are not sustainable unless founded on productivity gains. (Economics 101.)

    OECD Stat Extracts: Productivity -> Muli-factor Productivity
    http://stats.oecd.org/Index.aspx?DatasetCode=LEVEL

    • Indeed you are partially correct but fail to take into account that the price of the commodity extracted increases in inverse proportion to its availability. Gold and oil are great examples and consequently productivity figures must take into account the value of the commodity in relationship not just to the manpower required to extract them but the intrinsic value associtaed with the increasing rarity of the commodity itself. OECD, Conference Board of Canada and Fraser Institute figures be damned.

    • Ron Waller: Look up. See that vapor trail? That’s the point of this series, flying *way* over your head. But hey, thanks for reading.

      • According to the Conference Board of Canada, you have no idea of what you’re talking about.

        You keep ranting about a 6 year rise in real median and average wages from 2004 to 2010 (according to Statistics Canada.) But this rise in wages is likely a short-term phenomenon caused by 3 factors: a) a construction boom (founded on a housing bubble and record levels of personal debt); b) a resource boom (which are historically followed by resource busts; the high wages are due to the remote location of the jobs making them undesirable to most Canadians; Harper has brought in a 15% discount on foreign temporary workers to bring down wages in the resource sector); c) perhaps the 60% rise in the dollar from 2003 to 2008 (a market distortion.)

        In order to see if this “magic trick” is anything more than a short-term market distortion there needs to be more data. My guess is that this bubble is going to burst because there are a lot of downward pressures on wages at present, including a dollar overvalued by 25% (according the OECD) which makes wage costs 25% more expensive than our American counterparts. This lack of wage competitiveness is causing companies to move south of the border, which helps drive down wages here.

        Canada will be better off betting on a sure thing: actually increasing productivity to boost wages; than risking everything on a bad bet: going “all in” on low-productivity resources, falling further down the value-added chain, getting left behind the rest of the developed world.

        • And the vapor trail drifts off into nothingness….

          • I’ll take the Conference Board of Canada over your flaky hypothesizing any day…

            “The debate over [multi-factor productivity] methodology and measurement obscures the fact that no matter what method is used, OUR PRODUCTIVITY GROWTH IS STILL DISMAL. In fact, a CAREFUL READING of the new research [by Diewert and Yu] indicates that Canada’s productivity performance could actually be WORSE than thought!

            “Canada’s WEAK PRODUCTIVITY GROWTH has caused us to slip further and further behind the United States and other major industrial economies in terms of real income per capita—something that hits every Canadian in the wallet. THE NEED FOR CONCERTED ACTION ON PRODUCTIVITY GROWTH AND INNOVATION MUST REMAIN A NATIONAL PRIORITY IF WE HOPE TO MAINTAIN OUR HIGH LIVING STANDARDS.” (Emphasis mine)

            I strongly suggest you read this article. These are economists who are taken seriously and actually know what they’re talking about.

            Conference Board of Canada: Canada’s Productivity Problem Can’t Be Measured Away
            http://www.conferenceboard.ca/insideedge/2013/mar2013/mar27-insideoutlook.aspx

          • BTW, this series is all junk economics founded on muddle-headed contradictory hypotheses.

            First: a) Canada has dismal productivity but had rising wages in any case. According to the Statistic Canada report “Wage Growth over the Past 30 Years: Changing Wages by Age and Education” in the Summary, it concludes the rise in mostly low-skilled wages was due to “economic shocks” in construction and resources. There is nothing “magical” about that. Too much demand for construction labor drove up wages. Resource jobs are in remote locations and require higher wages to attract workers. Ta da!

            Second: b) Canada actually had high productivity during the 2000s that supported rising wages. The Conference Board of Canada blows this hypothesis out of the water. Productivity in resources, especially Alberta oil, continues to fall because the oil becomes harder to get at. Surface-mined bitumen is less productive than conventional oil wells; in-situ is less productive than surface mining. So what would one expect during the 2000s as the economy shifted away from manufacturing to resources? A great drop in productivity growth which is exactly what we got.

            It’s too bad economics is not a science or this agenda-driven pro-oilsands claptrap would’ve been exposed for the nonsense it actually is. BTW, can you actually support your position in a debate, or must you resort to arrogating non-existing authority? If you really knew what you were talking about, it would be easy enough…

            Wage Growth over the Past 30 Years: Changing Wages by Age and Education
            http://www.statcan.gc.ca/pub/11-626-x/11-626-x2012008-eng.htm

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