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.)
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.
- Part five: Canada’s productivity crisis: misdiagnosed