How To Solve Canada's Productivity Problem

March 08, 2012

Government in Canada having reached the summit of efficiency, politicians have lately taken to scolding the private sector for failing to do the same. In language reminiscent of war-bond drives, businesses find themselves increasingly exhorted to raise productivity, as if they were letting down the side.

"Governments are doing their part," Tony Clement, then the industry minister, complained. "Where's business?" Often this takes the form of a sporty metaphor. Government has been investing, according to Finance Minister, Jim Flaherty: "We have to now ask the private sector to step up to the plate."

Now, sticklers may point out that businesses are under no actual obligation to raise productivity. They will make the required investments if it is in their interests to do so.

Nevertheless, there is a germ of truth somewhere in this rhetorical Petri dish. Policy-makers have got a lot of things right over the last 20 years. They've freed trade, cut corporate tax rates, beat inflation down to near-zero. Yet productivity growth in Canada has lagged behind that of most other developed countries. As recently as 2000, Canadian workers were 85 per cent as productive as those in the U.S. Since then that ratio has fallen to 70 per cent.

So baffling is this "productivity puzzle" that some economists have all but given up trying to understand it. Notable among these is Don Drummond, lately observed redesigning Ontario. Yet even he declares himself stumped. In a recent paper he confesses that "if asked today what policy changes should be implemented to promote productivity growth I would need to say I do not know."

Steady on. Even if governments have made some progress in unwinding past policy failures, they still have plenty of work to do. All of the literature on productivity stresses the vital role of competition as a driver of productivity. Yet important sectors of the Canadian economy, for example transportation and telecommunications, remain protected, over-regulated backwaters. Governments at every level continue to hand out billions in subsidies to businesses, rewarding inefficiency and distorting investment; billions more are dispensed via tax preferences. Income tax rates have been slashed for corporations, but remain as high as ever for individuals. And so on.

It's possible, moreover, that the productivity problem has been overstated: that, to the extent Canadian business has failed to invest or innovate, it has rational causes. There are three ways this might be true.

The first has to do with the rapid rise in prices over the

last decade for the commodities Canada exports, such as oil: as economists say, there has been an improvement in Canada's "terms of trade." One way to raise living standards is to increase productivity: if you can make each thing for less, you get more things. But another way is by charging other people more for the things you make. So part of our productivity problem may simply be a reflection of our good fortune in possessing resources that are in high demand around the world.


The flip side of that, second, is the decline in manufacturing, driven in part by the rising "petrodollar," of which the Ontario premier has recently complained. Delve into our overall productivity performance, and you find it is largely driven by sharp declines in the manufacturing sector. Why is that? A recent StatsCan study finds that factory production has fallen so far below capacity that firms are using capital less efficiently, giving up economies of scale they would previously have enjoyed.

A third factor may be the rapid growth in Canada's labour force, a combination of the baby boom and the increasing numbers of women in paid work. Notwithstanding the best efforts of government, Canada's labour market managed successfully to absorb these newcomers; on the brink of the financial crisis, in 2008, the employment rate hit an all-time record 63 per cent. With so much labour on hand, firms had less need to invest in new machinery: it was cheaper to just take on more workers.

But over the next few decades, the labour force is projected to grow much more slowly, if at all. That's concerning: if productivity growth does not rebound, living standards will take a hit. But it's possible that we will see our recent experience reversed: that businesses will respond to the shortage of labour by investing in machinery, thus raising productivity.

Still, I wouldn't want to bet the farm on it. Drummond figures governments have put in place about 70 per cent of the reforms he would advise. Rather than casting about for entirely new prescriptions, how about we get cracking on the 30 per cent that remain?

- Source: Andrew Coyne, Montreal Gazette


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