Why Canada is no slouch

Stephen Gordon explains why the oft-repeated claim that we are a productivity laggard is all wrong

Why Canada is no slouch

Michael S. Williamson/The Washington Post

If you spend any time reading about the Canadian economy, you will have come across analyses pointing out Canada’s poor productivity performance. If Canadian productivity had kept pace with the United States over the past decade, Canadian GDP would be 20 per cent higher than it is now. It is easy to conclude that Canada is in danger of dropping out of the club of rich-world economies: Former Bank of Canada governor Mark Carney once noted that Canada has “a productivity deficit versus virtually every other advanced economy.” As a general rule, productivity growth is what leads to rising incomes and standards of living. Strong growth in commodity prices, we are told, might be enough to sustain income growth for now, but without more rapid productivity growth, what will happen when the prices of oil and other resources fall?

These concerns are, to a great extent, misplaced. Higher resource prices aren’t a reprieve from slow productivity growth; they’re a reason why measured productivity growth appears to be so slow. Canadians are much better off than the common storyline would suggest. In fact, we may not have had a productivity problem in the first place.

In an economy that does not engage in international trade, the only way to increase incomes is to increase production. There are many ways to generate increases in per capita output and income, and productivity is the catch-all term used to describe them. Purchasing more physical capital, such as machinery and equipment, and spending more time on education and skills training will generally increase productivity. Tax incentives are also used to encourage investment in new equipment, and governments can do much to produce better education outcomes. ?But these will only go so far, and it does not appear that these factors are behind the slowdown in productivity in Canada (although there’s always room for improvement). Firms actually increased purchases of investment goods sharply during the 2000s, and Canada’s education system holds up well in international rankings.

In Canada, productivity is commonly measured using an index of technical progress called multifactor productivity (MFP), which essentially shows the part of economic growth that comes from things other than the accumulation of capital and labour. But there is something very curious about Statistics Canada’s estimates for MFP. They are little changed from what they were 40 years ago. This would seem to suggest that virtually all of Canada’s real, per capita economic growth in the last two generations has been generated by labour and the accumulation of capital. And if you take MFP seriously as a measure of technical progress, you’d conclude that the Canadian business sector is using the same technology it used 40 years ago. The notion that there has been no technical progress over the last two generations is, literally, incredible.

Where Canada has undoubtedly made a lot of progress in recent years has been in international trade. The surge in the prices of oil and other commodities increased Canadians’ buying power during the 2000s. The prices of the things we were selling grew faster than the prices of the things we were buying. Most of the increase in purchasing power during the 2000s—and, contrary to the 1990s, this was a decade in which there were broad-based gains in real wages and incomes—came from the higher prices Canada’s exports commanded on world markets.

The increase in commodity prices attracted labour and significant amounts of capital to the mining and oil and gas sector. But Statistics Canada’s estimate for multifactor productivity in the mining, oil and gas extraction sector has been on a downward trend for decades. Interpreting MFP as a measure of technical progress would also lead to the conclusion that technology used in 1961 was almost three times more advanced than the technology available now. That clearly cannot be.

There are several explanations for why MFP estimates for the resource-extraction sector might underestimate the actual rate of technical progress. An obvious one is that resource companies extract the “low-hanging fruit” first. The drop in output as firms move on to higher-cost projects would be interpreted as a fall in productivity, even if the technology in place stayed the same. If you ignore the fact that the prices of resources 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.

In a 2012 article in the International Productivity Monitor, 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, adopted another approach. 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. Instead of showing no growth over the last 40 years, they find that MFP grew at an average rate of 0.7 per cent a year, which is roughly comparable to rates in the U.S.

The research debate is ongoing, and it is too early to conclude that the Diewert-Yu results are definitive. But it seems clear that ignoring the gains from shifting to sectors where prices are high can significantly understate productivity growth. Ignoring these gains can also lead to counterproductive policies that actively prevent these shifts by propping up declining sectors.

Improvements in conventional productivity measures are not a sufficient condition for income growth; they aren’t even necessary. What is being produced can be more important than how much. This isn’t to say that policies aimed at increasing productivity are misguided. But it is a mistake to pay attention only to one part of the value equation and to ignore the effects of price changes. Prosperity doesn’t come from producing more of something that no one wants to buy.

Stephen Gordon is an economics professor at Université Laval and a regular contributor to the Maclean’s Econowatch blog.

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Why Canada is no slouch

  1. “Finding Fertile Ground: Identifying Extraordinary Opportunities For New Ventures.”
    By Scott A. Shane
    If you want to start up a new business that has the greatest growth potential and highest rate of success then target new technology applications. This little book is an excellent primer for anyone who’s contemplating starting up a new business and is looking for some pointers. Even if you’re not it’s still an interesting read. Each chapter is explained in plain, easy to understand, terminology.
    You can either get a copy at your local library or on Amazon.

    • Haven’t read the book, but I agree the greatest wealth-creating and productivity-boosting opportunities for our country come from high value-added exports based on new technology applications. How many average Canadians are going to start up bitumen extracting companies? Resources are terrible for creating good jobs and business ventures. This is the 21st century, not the 19th. We need to compete with the rest of the developed world, not developing countries (unless we want to become one.)

  2. The Conference Board of Canada has a completely different take on the W. Erwin Diewert and Emily Yu paper. In an article titled, “Canada’s Productivity Problem Can’t Be Measured Away”, they say with a “careful reading” this paper suggests our productivity problems could actually be worse off:

    “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 [Diewert-Yu] 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.”

    Canada cannot afford to gamble everything on a resource boom and productivity fairies. Most provinces can’t just start digging holes in the ground. Canadians want and deserve good job and business opportunities across the country. We don’t want to become migrant workers getting shipped off to remote parts of the country to find work. We need to follow examples like Germany and South Korea, not Russia.

    Conference Board of Canada: Canada’s Productivity Problem Can’t Be Measured Away
    Glen Hodgson, Senior Vice-President and Chief Economist, Forecasting and Analysis

  3. According to the OECD, Canada ranked #16 of 19 countries in multi-factor productivity growth from 2000 to 2010. The US had 12 times the amount of productivity growth we had during this period!

    These results are not at all surprising given our economy shifted away from high productivity-growth value-added exports towards negative productivity-growth resources.

    If we want, we can bury our heads in the tar sands on this very important issue. But that won’t stop us from getting kicked in the behind!

    Canadians are so much more than hewers of wood and drawers of bitumen. It’s time to put our talents to good work and produce real productivity growth. There are no productivity fairies coming to save us.

    OECD StatExtracts: Productivity -> Multi-factor Productivity

    • If all of these analyses are correct why is our standard of living comparable to those of countries with MFPs superior to ours? Something doesn’t jive. Research has shown that our resource based economy requires more manpower than in the manufacturing sector. The tar sands alone account for one third of the productivity figures being mis-used as a guide to our wealth. What gives????

      • What research shows a resource-based economy requires more manpower than manufacturing? The fact is the oil sands employs 75,000 people. But the oil sands dollar (overvalued by 25% according to the OECD,) cost Canada 500,000 manufacturing jobs (since 2004.)

        It’s only been a short period of time since our economy turned from manufacturing to resources and productivity fell through the floor. So it’s too early to tell what repercussions will be felt.

        According to Statistics Canada, there was a rise in average and median wages in Canada from 2004 to 2010. But they attribute this to two “economic shocks”: a construction boom and a resource boom. The demand for construction labor caused labor costs to increase. (The boom is founded on a housing bubble and record levels of personal debt.) The rise in wages due to resources is based on the remote location of the jobs which makes them undesirable.

        So what we see is the construction boom coming to an end. Harper is giving corporations a 15% discount on foreign temporary workers to drive down the cost of resource labor. Our highly overvalued dollar makes Canadian wages uncompetitive; this means there will be a downward pressure on wages as companies continue to move production out of the country. So where will our economy be in 2020 or 2030 if we continue to risk everything on faulty economic principles? Hopefully we’ll be smart enough not to find out the hard way.

        Statistics Canada: Wage Growth over the Past 30 Years: Changing Wages by Age and Education

    • I’ve always maintained that Canada should be a nation of entrepreneurs. If it wasn’t for John Diefenbaker scrapping the Avro Arrow, Canada might have had a dynamic aerospace industry capable of making its own fleet of world class fighter, interceptor, and bomber aircraft to sell to other G-20 countries instead of relying on the inherently flawed F-35’s that the US want us to buy. The Maritime shipbuilding industry was allowed to languish for so long that we’ve resorted to using plans from other countries for the construction of our naval destroyers and corvettes. Canada could have had its own Silicon Valley, been exporting its expertise in the Solar Power and Green Technology Alternatives, plus pioneered many new applications in the field of Biochemistry. With a fairly competent and robust business infrastructure that utilizes many university sponsored research programs we should have a long list of highly trained engineers and technicians beating a path to our door in hopes of exploiting any number of business opportunities awaiting them here. Although the Alberta Tar-sand projects are providing Canadians with a number of high paying jobs the Harper government is concentrating too much of its efforts to promote it at the expense of other pursuits that could be as equally advantageous for Canadians in the long run. It’s high time that we all woke up to the possibilities that confront us.

      • Agreed. Here’s a related article I recently came across:

        >> “Are we doing enough to make that capital available? The answer is no,” says Adam Chowaniec, chair of advocacy group Startup Canada.

        “If you’re in the resource industry or the oil industry or you want to make movies, then you can invest and get tax credits. If you want a small technology company, then you’re on your own. There’s no support.” <<

        FP: Canada surfs Silicon Valley for immigrant startups, but can it keep them?

        • Crowdfunding has been an important factor in filling in the gap. Whereas many new tech start-ups wouldn’t qualify for a standard business loan there’s a number of new tech products/applications that have received some significant start-up capital bypassing the a-typical venture capitalists and angel investors of the past. The real work then begins bringing the product into the production and marketing process, a task that will really determine just how successful the whole operation is.

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