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.