Special Report
September 05, 2024 | 09:26
Productivity Now Redux
Economics
Economics
Canada’s productivity puzzle remains unsolved. Output per hour fell yet again in Q2, even as the U.S. advance was sturdy. And, yes, the weakness is a problem. |
The chasm between Canadian and U.S. productivity continues to widen. In the second quarter of the year, Canada’s output per hour worked fell at a 0.7% annual rate, compared with a solid 2.5% U.S. advance. More concerning is that the meek quarterly result is no fluke, as it matches the performance over the past four quarters (-0.7%), compared with a sturdy 2.7% y/y gain in the U.S. economy. If this was just a one-year trend, we could perhaps put it down to short-term cyclical factors. But, even over the past five years—i.e., looking through the pandemic—Canadian productivity has averaged a decline of 0.1% per year since mid-2019 compared with growth of 1.9% stateside (Chart 1). U.S. productivity has thus outpaced Canada by 10% in the past five years alone. This persistently weak performance continues to knock Canada further down the global productivity ladder in level terms (Chart 2). Looking at GDP per hours worked in U.S. dollar terms, the OECD finds that Canada has now slipped even below Italy and Spain, and is losing sight of the U.S. and most Northern European economies. (The calculation is done on a PPP basis, so the recent softness in the loonie is not a factor.) True, Canada is clinging to the OECD average, but the group now includes the high-population/low-productivity economies of Poland, Mexico and Turkey, which bring down the average. The Bank of Canada has even rung the bell, and deemed the weak productivity trend an emergency. While we may not love the term ‘emergency’—it’s not so much that the house is on fire, it’s more that it’s being eaten by termites—we do appreciate some sense of urgency around this fundamental problem. Not to pile on, but yet another way to view the similar troubling trend is the relative deterioration in real GDP per capita (Chart 3). StatCan highlighted in the Q2 national accounts that even respectable 2.1% GDP growth was still not enough to keep up with torrid population growth of 3.2% over the past year. Indeed, GDP per capita has now fallen 3% from pre-pandemic levels and has barely budged on net in the past decade. Starkly, this suggests that there has been virtually no net improvement in the average standard of living in Canada for a decade. We considered the “why” and “what can be done about it” in a Focus piece last year (“Canada’s Perennial Productivity Puzzle”, November 2, 2023). The short answer was that some structural issues may work against fully closing the gap, but we need a full-economy effort to strengthen business capital spending, starting with a more favourable investment climate. The root problem is the relatively low level of investment as a share of the economy—Canada has tended to lag the U.S. in prior decades, but the divergence has widened noticeably in the past 10 years (Chart 4). We are sympathetic to the view that the ready availability of low-wage labour, in part through the Temporary Foreign Workers program, has played a role in tilting firms away from productivity-enhancing investments. One straightforward way of demonstrating that tilt can be found in the Bank of Canada’s own Business Outlook Survey. Each quarter, businesses are asked how likely they are to hire more employees and to boost capital spending. In all but two quarters in the past 25 years, a greater share of firms have been willing to hire more versus investing more, which speaks volumes (Chart 5). Another issue is the skew in capital spending aimed toward housing, which may be drawing the focus, as well as much-needed investment, away from other, potentially more productive endeavours. At one point from late 2020 until early 2022, Canada was investing more in residential construction than in machinery & equipment and non-residential structures—that almost certainly has not happened before, as the long-term average is 2:1 the other way around. While we appreciate the need for a steady supply of new housing, especially at a time of torrid population growth, the ongoing fixation on real estate is simply not healthy for productivity. |
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Bottom Line: Canada’s woeful productivity performance is real and it continues. This is not a problem confined to one region or sector—say manufacturing—it is a whole economy issue. And while it may seem like an esoteric topic for many, the reality is that unless it is properly addressed, Canada’s relative standard of living will continue to weaken. Appendix: Total Factor Productivity vs. Labour ProductivityAs an aside, we would like to challenge a recent opinion piece, which opined that Canada’s weak productivity isn’t a big deal since it’s largely driven by the oil & gas sector (“Canada’s productivity problem isn’t that big if we exclude oil”, Pau Pujolas and Oliver Loertscher, Globe and Mail, August 12, 2024). It’s tough to know where to begin with this one, other than to point out that the authors were looking at total factor productivity (TFP) and not labour productivity. TFP is an interesting theoretical concept, but labour productivity ultimately drives real personal disposable income and the standard of living. So, while the rest of us are discussing apples, the authors are looking at kumquats—it may not be wrong, it’s just a totally different conversation. TFP considers how efficiently an economy uses both capital and labour to produce output. The authors’ main contention is that a high share of capital was poured into the energy sector, and the oilsands in particular, and those outlays may not have always been of prime efficiency. But TFP isn’t always an apt comparison, and can lead to silly conclusions. Consider this simple example of two neighbouring farms: Farmer A invests $50 in a good shovel, and then works 12 hours a day for six days (or 4320 minutes in total) to dig up a field. Meantime, Farmer B invests $50,000 in a decent tractor with a tiller, and does the same job in 5 minutes. But TFP calculations may find that Farmer A used the combination of capital and labour more ‘efficiently’, since A spent 1/1000 as much on capital as B while it took ‘only’ 864 times as long to do the task. In the authors’ words, “comparing the productivity of Jacques Villeneuve and Donovan Bailey in travelling 100 metres would unfairly favour Mr. Villeneuve due to his Formula One car.” But that gets precisely to what our problem is compared with, say, the United States. We could have the fastest workers in the world (Donovan Bailey), but they don’t stand a chance in competing, if everyone else is moving ahead in an F1 car. The very root of our low levels of labour productivity is that capital spending lags well behind many other major economies as a share of GDP. Simply, while our workers are armed with a baton and sneakers, others have Ferraris and McLarens—or we have shovels, they have tractors. More specific issues on this opinion piece include the fact that the data cited only take us up to 2018, and Canada’s most serious productivity issues have in fact arisen since then. And, finally, it is misguided to assert that the energy sector is somehow dragging on Canadian productivity now, when the biggest investments were made years ago, when the entire oil & gas sector accounts for less than 5% of GDP, when the sector has the highest levels of output per worker, and when Alberta’s nominal and real GDP per worker is much higher than in the rest of the country. |