AND STANDARD OF LIVING:
PAST, PRESENT AND FUTURE
Daniel J. Shaw
22 November 2000
TABLE OF CONTENTS
G-7 Countries Productivity Performance
Canada-United States Productivity Gap
CAUSES OF CANADAS POOR PRODUCTIVITY PERFORMANCE
Innovation Gap between Canada-U.S. Manufacturing
Foreign Direct Investment and Free Trade
in Small and Medium-Sized Manufacturing Companies
Business Sector Competitiveness
Canadian Standard of Living
Productivity and Standard of Living Performances
PRODUCTIVITY AND STANDARD OF LIVING PROJECTIONS
AND STANDARD OF LIVING:
PAST, PRESENT AND FUTURE
For most of the 20th
century, Canadians have seen their standard of living improve steadily
and at a breath-taking pace comparable to that of the United States.
As a consequence, Canada emerged from World War II as the second-wealthiest
industrialized country in the world. In fact, those who look beyond the
economic data to measure well-being which would further include
other social indicators such as health and education, as does the United
Nations often conclude that Canada is the best nation in which
to live. Canadas well-crafted social union based on
the principle of sharing our economic success between regions, provinces
and people certainly deserves much credit for this situation.
However, when we strip away the social data and look solely at the economic
data relating to well-being, which is after all the fundamental building
block of these indices, a very different picture emerges today.
Canada is no longer atop this economic pyramid. Canada is not only
not the second-wealthiest nation anymore, it is not even in the top ten
among the industrialized countries.
Since the end of World War
II, Canada has seen its standard of living erode by comparison to other
advanced countries, such as West European states, selective Asian
Tiger nations and, in the 1990s, even the United States, as a result
of our declining growth in productivity relative to these countries.
In comparison to its chief competitor countries, Canada at the
start of the third millennium has in some respects been slow to
adapt its institutional matrix to the new economic environment, which
is characterized by the process of globalization and the emergence of
a knowledge-based economy. As a result, Canada depends too heavily
on its cheap dollar vis-à-vis the U.S. dollar for a respectable competitive
position in world (mainly U.S.) markets, which essentially means that
we have lowered the external value of our wages and incomes to get more
economic activity and closer to full employment. However, no country
ever got rich by taking a national pay cut, which is what is implied by
a depreciating currency; and, more importantly, this economic strategy
does not bode well for the broader social index of well-being because
we risk losing our long-standing ability to redistribute our retrenching
The purpose of this paper
is to: (1) provide a recent historical overview of Canadas
productivity record vis-à-vis the G-7 countries, particularly the United
States; (2) advance plausible explanations for this performance,
including the contributions of well-known economic determinants of productivity;
and (3) provide the link between productivity and the standard of living.
Using the most recent established trends, a general projection for the
first decade of the third millennium will be ventured.
Providing a definition of
productivity, a term that is not universally understood, is
a useful start to the study of this topic. A general interpretation
of the term productivity is that it is one of a number of
key indicators of the vitality or strength of an economy, and possibly
the most fundamental determinant of long-term economic growth.
It measures the relationship between the physical volume of goods and
services produced and the resources used in the production and transactions
processes adopted by that economy.(1)
Productivity is the measure of the efficiency with which people, capital,
resources and ideas are combined in the economy. Accordingly, the country
that integrates capital and talent in the most effective way will be the
worlds leading economic powerhouse.
There are two widely accepted
measures of productivity. The most easily understood of these is
labour productivity, which is simply the amount of output produced
by an economy divided by the amount of labour employed (either in terms
of working persons or hours worked) in that economy. However, as
a partial productivity measure, it can be influenced by more intensive
use of other inputs, most notably capital but also natural resources (possibly
at the expense of the environment if not carefully and properly integrated
The second is a broader
concept that is known as the multifactor productivity or total factor
productivity measure, which bundles labour, capital and intermediate
inputs (inventories, energy, materials and supplies) together into a single
input statistic. This measure cannot be observed directly, but indirectly
by tracking the growth of outputs and inputs and assigning any residual
output growth not explained by input growth to an improvement in multifactor
With this understanding,
we can now evaluate Canadas productivity record. Labour productivity,
as measured by gross domestic product (GDP) in constant 1992 dollars per
hour worked, was $26.40 in 1976; by 1999, it amounted to $34.06.
Although this performance points to increasing labour productivity levels
in the economy over the past 25 years, the implied average annual
growth rate does not appear stellar; its compound annual growth rate was
only 1.1%. Labour productivity in the manufacturing sector, by comparison,
was $20.52 in 1976, but by 1999 it was $31.36. The manufacturing
sector thus displayed considerably more growth in productivity in the
1976-1999 period (1.9% per annum) than did the economy as a whole.
The closing of this gap can, in part, be attributed to free trade, as
will be discussed when we venture explanations for Canadas recent
For a good picture of this
performance, see the graph in Figure 1 which provides the rates of growth
of both productivity measures in the business sector since 1966.
The data are divided into four periods commensurate with the business
cycles experienced by Canada over this time; this purges the statistics
of any cyclical bias. The trends in both measures are similar.
Between 1966 and 1973, Canada enjoyed a favourable rate of growth in productivity,
approaching 4% per annum in terms of labour productivity and more than
2% in terms of multifactor productivity. Since this time, however,
Canadas growth in productivity has hovered just above 1% in terms
of labour productivity and just below 1% in terms of multifactor productivity.
Although Canadas productivity
performance since 1973 is somewhat discouraging, little light can be shed
on the nature and extent of the problem without first attempting a multi-country
comparison. Without such a comparison, we simply cannot tell if
this poor performance was specific to Canada or general to the industrialized
world and beyond our control.
G-7 Countries Productivity Performance
economies would, of course, be its partners in the G-7 countries; however,
a detailed comparison of productivity between these countries cannot be
attempted because of different data definitions and statistical methodologies.(3)
For example, the way these countries calculate multifactor productivity,
particularly with respect to the estimates of the capital stock, differs
significantly. Indeed, many statisticians have problems even with
Canadas capital stock estimates because they appear excessively
volatile. Furthermore, because these estimates do not include land
and inventories that tend to grow at a slower pace, whereas the U.S. data
does, Canadas multifactor productivity measure overstates the contribution
of capital accumulation to growth. Therefore, the analysis in this
paper is restricted to labour productivity levels and growth rates, although
even here a compromise is needed. The ideal indicator of labour
productivity would include the number of hours worked, but only statistics
on the number of people employed are widely available across the G-7 countries.
for Economic Co-operation and Development
Figure 2 captures the performances
of G-7 countries in terms of growth rates for labour productivity between
1960 and 1997. In this period, Canada outperformed only the United
States; as a result, its performance was well below the G-7 country average.
However, a more complete picture of labour productivity emerges when productivity
levels, not just their growth rates, are evaluated. Figure 3 illustrates
labour productivity levels of the G-7 countries in 1999, but, before getting
too far ahead, it would be informative to step back and remember that
the United States and Canada were by far the worlds most productive
countries at the end of World War II.(4)
The devastation of European and Japanese industries in the aftermath of
this war would give an initial advantage to North America; however, this
situation was expected to erode over time as these countries re-established
their pre-war status. The data from Figure 3 confirm these expectations.
European and Japanese productivity levels have converged to those of North
America; their industries have continuously upgraded their production
capabilities with the development and importation of best practice technologies
from around the world.
for Economic Co-operation and Development
Because Figure 3 measures
productivity on a per worker basis, the gap between Canada and the United
States is somewhat overstated when compared to productivity measured on
a per hour worked basis. On the other hand, Canadas performance
relative to that of the European members of the G-7 countries is slightly
overstated.(5) The data are,
nevertheless, clear and unequivocal: the United States remains the
most productive country in the world, but Canada no longer holds second
place. Italy and France are respectively the second and third most
productive of the G-7 countries. Canada is in fourth place, although
this may be a temporary phenomenon because Germany is in the midst of
reunifying and integrating the moribund East part of the country to the
very productive West.
Canada-United States Productivity Gap
So far, this review of Canadas
productivity performance has revealed nothing new or unexpected.
We must now explore for the possibility that the aggregate productivity
data somehow mask the performances of specific sectors where public concern
is warranted. In this case, a Canada-United States comparison will
suffice because the business sectors of these countries are the most comparable;
we are also each others largest trading partner and primary competitor
country on world markets in a number of traded commodities and manufactured
Canada and U.S. Bureau of Labor Statistics
Figure 4 presents the Canada-United
States productivity gap between 1977 and 1999. Canadian labour productivity
underperformed relative to that of the United States during this period.
The average Canadian worker who produced just under 90% of what the average
American produced in 1977 produced little more than 80% of what the average
American worker produced in 1999. Similarly, the average Canadian
worker employed in the manufacturing sector produced 90% of that of the
average American manufacturing sector worker in 1977, but he or she produced
only 67% in 1999.(6)
The productivity gap between
Canadian and U.S. manufacturing sectors appears to manifest itself more
in small and medium-sized enterprises (SMEs).
In 1973, large plants
had levels of productivity about 15 percent above the national total,
but two decades later it was about 40 percent above. On the other hand,
small plants had levels about 15 percent below the national average,
and this had widened to about 30 percent about two decades later.
In other words, there has been a widening gap in productivity between
small and large plants since the early 1970s.(7)
This is particularly troubling
because SMEs are largely responsible for the increase in business start-ups
and employment in Canada over the past three decades. Indeed, when
this trend is combined with the observation of a lower physical capital
investment rate that may be the leading cause of poor productivity in
Canadian manufacturing, knowing full well that SMEs have lower capital-to-labour
ratios relative to large companies, the composition or structure of the
Canadian manufacturing sector immediately looks suspect. It could
very well be that the small size of Canadian manufacturing companies explains
a good deal of the Canada-United States productivity gap in manufacturing.
CAUSES OF CANADA'S POOR PRODUCTIVITY PERFORMANCE
Three aspects of Canadas
poor productivity performance need explanation. The first involves
the sets of factors that have contributed to the decline of productivity
growth rates across the industrialized world since 1973. These would
include lower investment rates in physical capital, particularly in machinery
and equipment (M&E), and the (so far) unrealized productivity gains
from extensive investments made in computer or information and communications
technologies (ICT). Canada likely shares these causal factors with
other countries of the industrialized world.
The second aspect concerns
the factors that led the Canadian manufacturing sector to lose pace with
that of the United States since the late 1970s, thereby enlarging the
pre-existing productivity gap between the two countries. Canadas
productivity experts seem to agree that, rather than the entire manufacturing
sector, two subsectors are primarily to blame: (1) the electrical
and electronic equipment subsector, and (2) the industrial and commercial
machinery subsector. The probable sources of this gap are:
a deficiency of R&D; a Canadian failure to access U.S. product and
production process knowledge in a timely fashion; and slowness to adopt
new technology. A more debatable contributor to the innovation gap
is the relative loss in foreign direct investment (FDI) in North America,
an important factor on which Canada has traditionally relied for accessing
and diffusing productivity-enhancing technologies and products.
On the positive side, the Canada-United States Free Trade Agreement (FTA)
has been identified as having enhanced the Canadian manufacturing sectors
Finally, the third aspect
deals with SMEs, particularly those that are Canadian owned, and their
contribution to the widening of the productivity gap in manufacturing.
The causal factors of these last two aspects of productivity are likely
to be unique to Canada. All of these explanations will be investigated
A slow pace of capital investment
can be seen to have led to a lower growth rate in labour productivity
across the industrialized world. In some sense, this seems obvious;
because people are more productive when working with more and better tools,
lower growth in the capital-to-labour ratio as a result of lower capital
investment translates into lower growth in productivity. However,
there may be more here than meets the eye.
It has been estimated that
about 80% of all technical progress comes from, or is embodied in, new
machinery and equipment.(8)
Thus, significant and protracted lower investment in physical capital
regardless of any change in the capital-to-labour ratio
may result in lower productivity growth through a stunted rate of technical
progress in the economy. Another way of looking at this is to consider
the average age of the capital stock. It is generally understood
that new capital, particularly that classified as M&E, is more likely
to embody newer and best practice technologies than is older capital.
Thus, an aging capital stock (which may result from a lower capital investment
rate) can reduce productivity growth simply because technical progress
(at least 80% of it) is coincidentally stunted.(9)
Indeed, the mere slowing of the decline in the average age of M&E
(i.e., not simply an aging M&E) can slow both the rate of technical
progress and productivity growth in the economy. Researchers have
confirmed the existence of this development, often referred to as the
vintage effect, and made preliminary estimates of its deleterious
economic impact.(10) Finally,
because new physical capital often implies complementary worker training,
a decline in capital investment may also entail a reduction in human capital
investment another positive correlate of productivity. Thus,
both the direct and indirect effects of a lower rate of fixed capital
formation can lessen the growth of productivity.
The Organisation for Economic
Co-operation and Development (OECD) is the best source of information
on net investment. It reports that net investment net of
depreciation charges for its member countries hovered in the vicinity
of 12% in the 1970s, 10% in the 1980s, and trended down to about 5% in
the 1990s. These data are pointed in the same direction as productivity
growth of the industrialized world, thereby suggesting lagging investment
as a contributing factor.
From the perspective of
the business sector, the 1990s decade was particularly noteworthy for
the investments made in information and communications technologies (ICT).
Indeed, virtually all industries and sectors of the Canadian economy made
considerable investments in ICT in the 1990s in the hopes of modernizing
their operations and offices; the general understanding was that this
would raise productivity levels. Firms across the industrialized
economies of the world followed the same investment pattern. The
Centre for the Study of Living Standards, however, reports only on the
Canadian service sector circumstance:
[B]etween 1992 and 1995,
investment in office computers in the Canadian services sector rose
by 64.2 per cent in real terms, but total factor productivity advanced
a meager 1.2 per cent. Even more perplexing
, the service
industries with the highest proportion of computer investment in total
investment tended to experience the worst total factor productivity
Table 1 provides further
evidence, broken down by subsector.
As this poor productivity
performance relative to ICT investment is largely mirrored elsewhere in
the Canadian economy and evidence appears at best mixed when using data
from across the industrialized world, one is left to question the promise
of what has been described by the pundits as the ICT dynamo.(12)
As one notable productivity expert, Robert Solow, put it: We
see computers everywhere but in the productivity statistics.
This unexpected development,
labelled by some economic researchers as the computer-productivity
paradox, has been explained in the following way. Major technological
innovations in the workplace such as the computer, communications
technologies and peripherals require considerable time before they
are diffused throughout the economy and before they can be operated effectively
and efficiently. This explanation suggests an analogy with electricity,
which took more than 40 years, until the 1920s, before demonstrating any
appreciable productivity improvements.(13)
Computer Investment and Total Factor Productivity Growth
in the Service Industries in Canada, 1992-1995
as % of
Total Investment 1995
Real Computer Investment
Communications and Other Utilities
Finance Insurance and Real Estate
Health and Social Services
Hotels and Restaurants
Total Services Sector
for the Study of Living Standards, Productivity: Key to Economic
Success, Table 8, p. 35.
The lag in productivity
improvements from investments in ICT may be due to the difficulties in
effective implementation of the new general-purpose technologies, which
are often institutional in nature, in contrast to incremental technology
improvements. Indeed, if these barriers did not go beyond the simple
issues of affordability and worker training, they would have largely been
overcome by the power of computers, as it increased by leaps and bounds,
and the rapidly decreasing prices in the past two decades. Institutional
changes, however, cannot take place overnight and sometimes require younger
generations to fully execute. Human nature is just not as flexible,
adaptable or even amenable to fundamental change as is often required
by the new technologies, and its timeframes for adjustment are clearly
more protracted. It has been suggested that such institutional changes
possible flattening of workplace hierarchies;
formation of multidisciplinary work teams within this hierarchy;
delegation of more decision-making to the working level in combination
with more two-way communication and control;
work conditions (hours and place of work);
payment schemes based on productivity or profitability performances;
wholesale revamping of the industrial relations rule-making labyrinth
and its supporting institutions.
History provides few precedents
of such fundamental change to act as the basis for comparison or prediction.
In a general way, we can conclude that the Industrial Revolution
transformed small cottage businesses into large industrial complexes when
it brought production out of the home and into the factory setting.
The increased mechanization of the production processes required the loss
of personal choice in determining the intensity, consistency and duration
of ones work effort through subjecting them to a decision-making
hierarchy that assigned people to highly specialized activities in order
to ensure continuous and coordinated throughput.(14)
Todays economies of scale and productivity gains could not have
been realized otherwise.(15)
Although people were well rewarded for this loss in sovereignty and their
assignment to often mind-numbing activities, a professional class of negotiators
emerged to ensure that the adopted factory disciplines did not stray too
far from productivity considerations. Generic factory work rules
became institutionalized and have come to be practised the world over,
but this took a century or more.
In contrast, contemporary
business practices are allowing employees to work at home and to tele-commute
to work, while, at the same time, enabling managers to spin off numerous
business opportunities to smaller satellite ventures so that the firm
can better focus on core activities. Hence, the Information Revolution
appears to be de-scaling the activity levels of firms and putting work
back into the home. The emergence of lean or flexible manufacturing
techniques further orchestrated the dismantling of rigid work rules in
favour of worker activism for taking advantage of the new-found human
capital dimension of their job assignment.(16)
Firms are also providing financial incentives to ensure workers
continuous motivation and productivity, as well as attempting to tie down
this footloose and intangible knowledge capital. Although
these workplace changes will undoubtedly accompany ICT, they are likely
to take considerable time before being fully implemented. It has
since been suggested that we are on the cusp of a productivity boom in
which the dawn of the Information Revolution is likely to be as
powerful and relentless as the early stages of the Industrial Revolution.
We can only hope that this is the case.
Innovation Gap between Canada-U.S. Manufacturing
The striking element in
Canadas productivity performance is the fact that, overall, the
business sector fared about the same as that of the United States for
more than three decades. However, one significant sector
manufacturing fared miserably. The value of manufacturing
output represents approximately 20% of both economies and the similarity
of these economies and their forces of change suggest, other things being
equal, that their manufacturing performances should not have been so different.(17)
What immediately stands
out is the disparity between the productivity of the electrical and electronic
equipment and industrial and commercial machinery subsectors of the two
countries, with the United States decidedly superior.(18)
Over a period of roughly two decades, this difference can have a significant
impact on the structures of both economies. Only one telling conclusion
can be drawn from these results. If we accept that the high technology
sector is fuelling much of the increase in economic activity and productivity,
and is responsible for propelling the economy towards a knowledge-based
society, then the United States is farther along this road than is Canada.
Viewed through these narrow lenses, the U.S. manufacturing sector
appears to be far better prepared for the future and for the prosperity
and challenges the Information Revolution may hold than is the
Canadian manufacturing sector.
Machinery and equipment
manufacturing industries, largely belonging to high technology, are distinguished
from most other manufacturing industries in that they are characterized
more by product innovation than process innovation. Thus, the Canadian
manufacturing sectors poor relative productivity performance suggests
that solutions might be sought in the product innovation policy area.
For confirmation of this, we must look to: R&D expenditures;
indicators of access to foreign sources of knowledge (for Canada, particularly
the United States); and technology adoption rates.
The OECD reports Canadas
gross expenditure on R&D as a percentage of GDP to be 1.6% in 1998,
considerably below the OECD average of 2.2%. Significant R&D
spenders are Japan (2.9%), South Korea (2.9%), Finland (2.8%), and the
United States (2.7%).(19)
The world leaders in R&D are thus spending as much as 80% more per
dollar of GDP than is Canada. Amongst our comparator countries, Canada
has the second-lowest R&D expenditures as a percentage of GDP among
the G-7 countries. However, this situation may be partly due to
factors beyond our control. R&D is relatively lower in small
businesses than it is in large businesses, and Canada has more small businesses
relative to the Americans. The second structural feature of the
Canadian economy is the high degree of foreign ownership. R&D,
like other central-office functions, is prone to be conducted in the home
country. This is particularly true of the U.S. companies in Canada.
When one combines this situation with the fact that foreign ownership
in Canada is disproportionately high in technologically intensive industries,
partly because the Americans are the technological leaders, Canada suffers
from deficient R&D despite very generous tax incentives to engage
in these innovative activities.
One does not, of course,
have to undertake R&D to enjoy its benefits; one can piggyback on
the R&D of others. Innovations can be imported from abroad by
purchase, entering into a licensing agreement, or being a recipient of
FDI (foreign direct investment). One is constantly reminded that
Canada represents less than 1% of the worlds population and is probably
responsible for only about 2% of the worlds original ideas that
can be used by industry. Consequently, Canadian R&D vastly understates
the availability of new technology to Canadian industry, and its implications
for economic welfare are even more important when one factors in the cost
of this availability (foreign technologies are frequently much less costly).(20)
Although it is difficult
to evaluate Canadian access to foreign knowledge, a rather novel method
was uncovered by Manuel Trajtenberg of the Canadian Institute for Advanced
Canadian firms take out a patent in the United States, they are legally
required to cite all related older US patents.
and 1993 Canadian patents taken out in the US cited US patents 15,000
times. This is hard evidence of Canadian piggy-backing.
The problem is that Canadians cite US patents much less than expected
only 65 per cent as often as US patents cite previous US patents.
Canadian firms clearly are not fully exploiting the knowledge made public
by the US patent system.(21)
This disadvantage in the
acquisition of knowledge dissipates with time, however. But hard
evidence of insufficient technology adoption in Canadian manufacturing
was provided in a 1998 Statistics Canada study:
In the five industrial
sectors fabricated metal products, industrial machinery and equipment,
electronic and electrical equipment, transportation equipment, and instruments
and related products
Canadian plant managers feel that
Canada suffers a technological disadvantage. This is borne out
by the technology use data. In these sectors, Canadian plants
are less likely to use any advanced technology than U.S. plants, although
the gap has been halved with 73% of Canadian plants and
81% of U.S. plants using at least one technology.
of the technology gap can be attributed primarily to differences in
the size of markets. Canadian plant managers tend to place a greater
emphasis on improvements in product flexibility or reductions
in setup time as benefits of technology adoption and the need
for market expansion as an impediment to technology is given
relatively greater weight than it is in the United States.(22)
So Canada again falls victim
to its small size.
Foreign Direct Investment and Free Trade
is the growing economic and political integration and interdependence
of countries as a result of trade, investment, movement of persons, and
the dissemination of knowledge. Multinational enterprises have been
at the centre of this globalization process. These seemingly denationalized
and borderless corporations, encouraged by recent advances in transportation
and communications technologies, have begun to outsource the manufacture
and assembly of selective (non-core competency) components of their complex
products to affiliates and strategic allies across national borders, thereby
taking advantage of the new trade environment sweeping the globe.
In other words, the locations of critical stages of manufacture and assembly
are being chosen to ensure that the entire production process more fully
exploits competitive advantages wherever these exist, whether because
of economies of scale, scope or learning by doing, or because of greater
factor specialization. The business sectors of most industrialized
countries have thus internationalized their activities, weaving an intricate
web of linked activities around the world.
The economic effects of
these new global strategies extend beyond corporate competitiveness and
profitability. Both inward and outward FDI convey substantial economic
benefits in the form of productivity gains arising from increased factor
specialization, the faster diffusion of new technologies and products
to host countries, and increased competition for domestic companies.
FDI is of increasing importance
to Canada as a host country, but more as an outward investor. The
outward stock of FDI originating from Canada has risen more than sixfold
from US$22.6 billion in 1980 to US$156.6 billion in 1998, while its inward
stock has risen more than two-and-a-half times, from US$54.2 billion to
US$141.8 billion over the same period. Canada, in fact, became a
net FDI exporter in 1997.(23)
Moreover, the global integration of the Canadian economy that this investment
entails also triggered increased specialization in the production of those
goods and services in which the Canadian economy has a comparative advantage.
This globalization process,
which is allied with declining costs for communications and transportation,
appears to have begun in the early 1980s, but it is unclear what to make
of the accompanying trend for Canada to receive less FDI relative to the
rest of the world. On the other most notable aspect of globalization,
increased world trade flows were identified as a boost to Canadian productivity.
For industries that experienced
average tariff cuts, the FTA raised the productivity by 0.6 per cent
per year over the 1988-95 period. In industries that experienced
large tariff cuts, productivity grew by 1.5 per cent per year.
These are very large numbers. The FTA boosted productivity further
by reallocating workers and investment out of low-end manufacturing
and into high-end, product-innovation oriented manufacturing.
By the narrow criterion of raising productivity, the Canada-US trade
deal must be judged a success.(24)
What is surprising, however,
is that the FTA did not bring more prosperity to Canada. The economists
and trade experts prior to signing the FTA were predicting a convergence
in productivity levels between Canada and the United States. Obviously,
other factors were at play and further research is warranted.
in Small and Medium-Sized Manufacturing Companies
The greater employment growth
and poorer financial performance of SMEs relative to large businesses
over this period suggest a slower growth rate in the capital-to-labour
ratio of SMEs. This does not augur well for their labour productivity.
Consider recent work (see Daly and Helfinger referenced above) which shows
that the relative levels in value added per employee between large plants
and small plants has shown a significant divergence from the early 1970s
through to the mid-1990s. Moreover, relative to the United States,
there has been a slight gain in Canadian large plants vis-à-vis the U.S.
national average, but for the small Canadian plants there has been a dramatic
drop from the national average. This pattern of lower productivity
levels in the small establishments shows up also in lower wages, lower
profits on average, etc. So there is a problem here in small business
in terms of its productivity levels, particularly when the increases in
employment have been so dramatic.
The researchers data
point to low productivity levels being heavily concentrated in small Canadian-owned
plants. The productivity of large Canadian-owned plants was comparable
to that of large foreign-owned plants in Canada; however, small Canadian-owned
plants were only about two-thirds as productive as small foreign-owned
plants. One explanation for this difference is the relative abilities
of large and small businesses to access and adopt foreign R&D and
technologies. Small Canadian-owned firms are at a disadvantage with
small U.S.-owned firms.
Plants whose ownership
resides outside of Canada are more likely to use technologies than domestically
owned plants and the magnitude of the difference in general has not
declined. But some of the differences are related to size and
once size is considered, there are differences in the rate at which
different sized domestically controlled plants have been closing the
gap with foreign controlled plants. In large plants, the difference
has generally declined. This is not the case for medium and small
plants. That the overall domestic adoption rates continue to be
lower than foreign adoption rates in all of the major functional groups
then is the result of relatively poorer performance in small and medium-sized
The three terms productivity,
competitiveness and prosperity can apply
equally to people, firms, markets, or even society. In the modern
economy, however, it is more useful to assign the concept of productivity
to the firm, competitiveness to the marketplace, and prosperity to the
nation-state. The rationale for this assignment is that an individuals
productivity is usually embodied in the products of firms; a firms
competitiveness provides many industry-wide spillovers and may reflect
common resource pools, competition policy and regulatory frameworks; and,
finally, prosperity is usually distributed over the country by some measure
of government intervention.
There is also a hierarchical
linkage between these terms. Productivity is a concept of the workplace
because it is the foundation for competitiveness. The notion of
competitiveness is a concept of the marketplace, where we are talking
about relative costs that determine whether the operations of a firm are
sustainable. Finally, prosperity is a societal concept relating
to competitiveness through the latters ability to deliver improvements
in real income, the quality of life, equity, and environmental integrity
and sustainability. This hierarchy from productivity to competitiveness
to prosperity means that productivity should not be viewed as an end in
itself, but a means to obtain prosperity, where prosperity is taken to
be something more than GDP per capita.
Business Sector Competitiveness
The link between the business
sectors productivity and its competitiveness at least in
terms of costs is simple. With some knowledge of average
wage and currency exchange rates, labour productivity can, by a mathematical
equation, be converted into labour costs per unit the traditional
measure for comparing the competitiveness of rival countries business
sectors. Indeed, comparing the performances of unit labour costs
in a common currency over a significant period of time reflects fairly
accurately the trends in the relative competitiveness of close competitor
countries, such as Canada and the United States.
Figure 5 illustrates the
relative competitiveness of Canadian and U.S. business sectors in two
periods: the 1989-1998 business cycle (the short term), and the
past four business cycles, 1966-1998 (the long term). The base year
in which the index is set at 100 for either period is 1966 and 1989.
Although both periods saw the value of the Canadian dollar depreciate
relative to that of the U.S. dollar, which made Canada the more competitive
of the two, in every other respect the performances of the two sectors
were different. Indeed, the periods can be marked for the reversals
in relative performances of the two countries in terms of labour productivity,
wages and unit labour costs in their own currencies.
Compensation and Unit Labour Costs,
Canada and the United States, 1966-1998
(in percentage points)
Over the past four decades,
labour productivity in Canada has grown by 73.6 percentage points,
which was 10 percentage points more than that in the United States. Canadian
labour compensation exploded in this period, however, handing the U.S.
business sector about a 150 percentage point gain. In ones
own currency, unit labour costs in Canada thus grew by 372.8 percentage
points, which was 63.8 percentage points more than that in the United
States. However, because the Canadian dollar depreciated by 25.2%
in this period, this unit labour cost disadvantage was reversed in Canadas
favour by 55.1 percentage points when converted into U.S. dollars.
Alternatively put, the competitiveness of Canadas business sector
improved by 13.5% relative to the United States business sector between
1966 and 1998.
In contrast, in the 1989-1998
period, the competitiveness picture of the two countries was somewhat
different as the growth in U.S. productivity outperformed that in Canada
by one percentage point (12.3 versus 11.3 percentage points). Growth
in labour compensation was more restrained in Canada in this business
cycle, providing the Canadian business sector with an 8.3 percentage point
advantage (31.6 versus 39.9 percentage points). In ones own
currency, unit labour costs in Canada thus grew by 18.2 percentage points,
which was 6.4 percentage points less than in the United States.
Again, because the Canadian dollar depreciated in the period, by 18.4%,
the unit labour cost advantage was boosted further by 21.7 percentage
points when converted into U.S. dollars. Alternatively put, the
competitiveness of Canadas business sector improved by 28.1% relative
to the United States business sector between 1989 and 1998 due to restrained
wage settlements and a depreciated currency. Both events were the
result of depressed domestic demand and adverse terms of trade with the
decline in international primary commodity prices in the 1990s.
The Canadian dollar depreciated
by 18.4% vis-à-vis the U.S. dollar in 1989-1998, providing more than 77%
of the improvement in the cost competitiveness of the Canadian business
sector vis-à-vis the United States in that period. A depreciating
currency is, therefore, an extremely effective way of boosting competitiveness
both in the short and longer term, but particularly the former.
However, productivity increases accompanied by no more than matching
wage and salary increases (in a non-inflationary environment) is
the more effective competitiveness strategy because it does not involve
a decline in the external value of wages, which is consistent with the
objective of prosperity and an improving standard of living.
Canadian Standard of Living
The standard of living is
defined by the countrys GDP per capita, which, for Canada, in 1999
was estimated at $31,454. In comparison, the standard of living
of the average American is estimated at $50,816 using a currency exchange
rate of US67¢ per Canadian dollar, or $40,516 using an exchange rate of
US84¢ as calculated by the OECDs purchasing power parity formula.
This PPP exchange rate formula tries to capture the relative buying power
of different currencies in terms of a representative basket of goods.
Using this formula, the
difference in income per capita between Canada and the U.S. is more than
$9,000 per year per person. If the prevailing exchange rate of 67¢
cents is used, this difference would be more than $19,000. Therefore,
the standard of living gap between Canada and the United States is estimated
to be between 22% and 38%, depending on which of these calculations is
for Economic Co-operation and Development.
Figure 6, on the other hand,
provides a broader comparison, illustrating levels of standard of living
of the G-7 countries for 1998.(26)
Given that the United States had the highest productivity of the G-7 countries,
it is not surprising that it is the country with the highest standard
of living in the world. Although Canada was in second place among
the G-7 countries at the beginning of the 1990s, it is now tied for third
place with Japan, having being overtaken by Germany. The standard
of living gap (in constant 1992 US$) between Canada and the United States
has also widened in this period, by eight percentage points.
Productivity and Standard of Living Performances
When one compares Canadas
ranking for standard of living amongst the G-7 countries in 1989 and 1996
to its ranking for productivity in 1989 and 1997, there is a similar showing.
Canada fell from second to third place in the former ranking and from
second to fourth in the latter. Furthermore, the Canada-U.S. standard
of living gap of 20% in 1989 widened three percentage points by 1999,
while the gap in productivity widened only one percentage point. Although
there is an obvious link between productivity and standard of living,
it is not a direct one. A precise mathematical formula does exist, however.
Standard of living, or output (GDP) per capita, is equal to productivity,
or output per hours worked, multiplied by the number of hours worked and
divided by the number of people in the labour force multiplied by the
labour force participation rate:
The two output per
capita and output per hours worked should move closely together
unless something happens to the second and third terms of this equation.
Figure 7 illustrates Canadas
productivity and standard of living performances over the past two business
cycles using this mathematical formula. It explains the decline
in Canadas living standards in the 1990s. It is not because
productivity deteriorated. In fact, if one looks at GDP per worker,
theres actually no significant deterioration at all in the 1990s
compared to the 1980s. It has been the fall in the number of hours
worked, primarily due to a rise in the number of unemployed and a shift
from full-time to part-time jobs, and also, and even more importantly,
due to the very large decline in Canadas labour force participation.
Consulting Figure 7, the growth rate of GDP per capita is smaller than
that of labour productivity in 1989-1998 by exactly the sum of the declines
in the labour participation rate, the employment rate and hours per job
in the period. This is the exact opposite of the 1981-1989 period
in which the growth in GDP per capita was greater than that of labour
productivity. Labour participation, employment and hours per worker were
all positive in that business cycle.
Canadas standard of
living performance in the 1990s relative to that of the United States
is also explained by these economic relationships. Canadas
standard of living fell relative to that of the U.S. over the 1990s because
of a relatively weaker labour market performance, not a relatively weaker
productivity performance. Actually, Canada almost kept up with the
U.S. with respect to productivity growth rates over the 1990s, but we
did not keep up to them with respect to standard of living growth rates.
More than anything else, this may have been because of a worsening terms
of trade (i.e., prices of exports divided by prices of imports) in the
period. A decline in the terms of trade means much slower income
gains and poorer employment prospects, both of which are borne out in
the data. In terms of levels, though, more than 95% of the gap in
the standard of living can be explained by the gap in productivity levels
between the two countries; poor labour market conditions can only explain
the remaining 5%.
PRODUCTIVITY AND STANDARD OF LIVING PROJECTIONS
This paper devoted a lot
of effort to digging up the past, then taking us to the present in terms
of productivity, competitiveness and standard of living. Projecting
the future course of these social indicators is all that remains.
At first glance, it is tempting
to simply extrapolate Canadas historical performance out a decade
or two. This is the easiest way of tackling the problem. In
fact, John McCallum, former Chief Economist of the Royal Bank of Canada,
chose this route and offered the following conditional prediction:
if trends established in the 1990s are projected out to 2010, Canadians
standard of living will decline to 50% of that of Americans.(27)
This conclusion is quite straightforward and provides Canadians with a
clear wake-up call that is intended to stimulate public discussion of
policy changes to arrest and reverse this sorry decline. Although
it is hard to find fault in the motives and intended effects of taking
this course, this paper prefers to take a different route. There
is clearly enough evidence, even in this short treatise, to conclude that
the assumed condition of the above prediction is not likely to occur.
Economic trends of the 1990s
are unlikely to continue into the first decade of the 21st
century. In fact, trends in key economic indicators of productivity
and standard of living of the last half of the 1990s were different than
those of the first half. They are simply getting better and are
more encouraging. The terms of trade improved remarkably in 1999
and 2000. Investment in physical capital, most notably machinery
and equipment, is now up significantly from the early 1990s. The
labour market is expanding both in terms of the labour force participation
rate and a declining unemployment rate. Consequently, these more
recent labour market developments will likely force standard of living
growth rates back in line with productivity growth rates and this should
be sufficient to arrest the widening of the standard of living gap between
Canada and the United States. The pivotal public policy question
remaining is really whether the resurgence of the Canadian productivity
growth rate of the past year (2.2% in the first half of 2000) is the beginning
of a trend and is not merely cyclical in nature. If the answer to
this question is no, then the pessimists will likely have
their day. On the other hand, if the answer is yes,
Canada will likely improve its productivity relative to the United States.
The latter forecast has
a better probability of occurrence if the resurgence in U.S. productivity,
which is related to protracted computer-related investments by the business
sector, ever materializes in Canada. Canadian business sector investment
in information and communications technologies has lagged behind our U.S.
competitors, which suggests that the payoff in the form of higher productivity
levels and growth rates that are linked to the Information Revolution
is likely right around the corner for Canada. Finally, this paper
was limited in the sense that it provided a cursory look at the possible
explanations for Canadas productivity performance. It did
not go deeply into all the determinants of productivity, most notably
omitting those with a public policy dimension. However, this paper
did hint at a positive contribution made by Canadas trade policy
to productivity in the manufacturing sector, most notably the FTA.
Positive change in the course of other government policies related to
taxation, regulation, research and development, and human capital development
if they are significant and stable over the longer term
could also conceivably narrow the long-standing Canada-U.S. innovation,
productivity and standard of living gaps.
If this type of measure suffers from a weakness, it is that it inadequately
accounts for quality improvements of products and insufficiently records
the contribution of technology enhancements. It, therefore, understates
Canadas true productivity growth over longer periods.
The choice between the two measures is usually governed by the intended
use. Labour productivity is a superior measure of productivity from the
point of view of living standards because they are more closely related.
On the other hand, the multifactor productivity measure is better equipped
to review and evaluate resource allocation decisions of firms, industries,
sectors or economies.
There are a number of measurement problems, the first of which concerns
the independence of output and input measures a particular problem
of service industries that construct output indices based on input measures.
The second involves the use of chained or fixed-weighted index numbers
when comparing price or quantity of two different periods. Most
economist-statisticians prefer the chain-weighted index as it is better
able to capture changes in relative price structures. To date, only
the United States has adopted chain-weighted indexes.
This figure is based on an index of productivity levels with the United
States set at 100. For purposes of direct comparison, all G-7 country
productivity values are converted to U.S. dollars according to 1999 purchasing
power parity (PPP) formulas.
Americans work more hours per week than do Canadians. On average,
Canadian manufacturing employees work 37.5 hours per week, while
American manufacturing employees work about 42 hours. The average
North American worker also works more hours per week and more weeks per
year than does the typical European. The implications for the above productivity
data are that if you take a given number of employees and you work them
longer hours (within limits), you will achieve productivity gains.
The United States has recently revised its data so that computer software
investments are treated as a capital expense that depreciates over its
expected life rather than as consumption expense. Canada has not
made such a revision. To some extent, this tilts American productivity
levels disfavourably in the earlier period (1950-1980) and favourably
in the later period (1980-1999), suggesting the better U.S. performance
over the study period is partially a statistical artifact.
Donald Daly and Michael Helfinger, Small Business in Canada
U.S. Manufacturing Productivity and Cost Comparisons, Centre for the
Study of Living Standards Conference on the Canada-U.S. Manufacturing
Productivity Gap, 2000, p. 14.
J.B. DeLong and L.H. Summers, Equipment Investment and Economic
Growth, Quarterly Journal of Economics, 106, 1991, pp. 445-502.
Furthermore, an aging capital stock implies higher repair and maintenance
charges per unit of output; and a diversion of resources from other productive
activities to repair and maintenance is certainly not conducive to the
growth of productivity.
See S. Gera, W. Gu and F.C. Lee, Capital-Embodied Technical Change
and the Productivity Growth Slowdown in Canada, Industry Canada, Working
Paper No. 21, 1998, pp. 11-12.
The Centre for the Study of Living Standards, Productivity: Key to
Economic Success, March 1998, p. 32.
For a review of international studies of ICT and productivity, see S.
Gera, W. Gu and F.C. Lee, Information Technology and Labour Productivity
Growth: An Empirical Analysis for Canada and the United States, Industry
Canada, Working Paper No. 20, March 1998.
The better distribution and conveyance of power by electrical means permitted
factories to: (a) locate at greater distances from waterways; (b)
rather than being built in three-story cube-like designs, become longer
and more rectangular in shape to make way for Fordist-like assembly production
lines; and (c) shift from downtown city cores to outlying industrial parks
to obtain greater real estate for these larger factories. In this case,
manufacturers were not willing to immediately abandon their existing plant
and equipment. Only once their facilities had become significantly
depreciated and outdated, did it become financially feasible to take full
advantage of the productivity benefits of electricity by implementing
Because an individuals productivity had become highly dependent
on that of colleagues in such a setting, one could argue that the surrender
of such decision-making to a shopfloor manager was to ensure that these
colleagues would not shirk their assigned tasks. Thus, direct authority
superceded contractual relations as the dominant governance mechanism.
The key principles behind mass production techniques are product and component
part standardization, special-purpose equipment and the elimination of
skilled labour on the assembly line.
The key principles behind lean production techniques are: the just-in-time
availability of components for assembly in order to economize on inventories;
autonomous control of defects, whereby assembly line workers can stop
the process when defects are found and until its source is identified
and corrected in order to economize on re-work stations and
costly manufacturer recalls; and the replacement of unskilled and specialized
assembly line workers by multidisciplinary teams that would, through quality
circles, further contribute to improvements in the production process.
The next section suggests that, in fact, other things may not have been
equal. Both industries began diverging in their performances beginning
in the late 1970s, probably because of the immutable forces of globalization
and the ensuing specialization, but the FTA may have further contributed
to the specialization in both economies.
The U.S. statistical agency, in calculating the productivity of the electronics
industry, adjusted the real prices of these goods (i.e., computer products)
for their quality differences (i.e., computational power, speed and other
characteristics), whereas the Canadian data do not reflect this adjustment.
This means that the price index for these products is rising faster in
Canada than in the United States (actually, it has Canadian prices rising
by 9% and U.S. prices falling by 51% between 1992 and 1995), thereby generating
a greater growth rate in productivity in the United States than in Canada.
The Canada-U.S. differential productivity in this subsector is, therefore,
largely a statistical artifact, but not completely. Caution must be used
when citing this subsector as a cause for the Canada-U.S. productivity
gap; indeed, one should be wary of making too much of this disparity.
Organisation for Economic Co-operation and Development, Main Science
and Technology Indicators, 1, 1999, Table 5.
It has been argued that, prior to 1973, U.S. R&D boosted Canadas
total factor productivity growth rate by about 0.9 percentage points and
that this boost faltered to somewhere between 0.3 and 0.4 percentage
points with the decline in U.S. R&D since 1973. See J. Bernstein
and T. Mamuneas, The Contribution of U.S. Spending to Manufacturing
Productivity Growth in Canada, presented at the Centre for the Study
of Living Standards Conference, January 2000. However, there is
one caveat. Strangely, this paper does not use control variables to account
for other contributing factors to the productivity slowdown, such as depressed
aggregate demand in Canada in the 1990s or the possibility that Canadian
managers failed to tap into U.S. R&D when compared to previous periods,
and, therefore, does not adequately separate out R&D capital as a
Daniel Treffler, Does Canada Need A Productivity Budget?
Policy Options, 20, July 1999, p. 68.
J.R. Baldwin and D. Sabourin, Technology Adoption: A Comparison
Between Canada and the United States, August 1998, pp. ix and
United Nations, World Investment Report 1999: Trends and Determinants,
Daniel Treffler, Does Canada Need a Productivity Budget? 1999,
J.R. Baldwin, E. Rama and D. Sabourin, Growth in Advanced Technology
Use in Canadian Manufacturing During the 1990s, Statistics Canada,
11F0019MPE No. 105, 2000, p. 24.
This diagram is based on an index, with the United States set at 100.
For purposes of direct comparison, all G-7 country GDP per capita
values have been converted to U.S. dollars.
John McCallum, Will Canada Matter in 2020? Current Analysis,
Royal Bank of Canada, February 2000.