Thursday, June 7, 2012

Canadian Productivity Gap

There has been a lot of hand wringing about the apparent productivity gap between the USA and Canada. My question today is about how real this gap actually is. For the past twenty years of free trade, Canada has been competing head to head with the USA on what is generally a level playing field. Thus this gap should be observed easily on the ground and it is not.

This generally means it is time to question the damn statistics. A philosophy of promoting productivity numbers in the USA against a natural inclination to conservatism in Canada can easily supply a lot of gap without even knowing it.

The other big potential issue that may not be getting a proper accounting is that of counting the labor force itself. It is the one area that can be diddled. Do not count 15,000,000 illegal unreported immigrants and your productivity leaps. I do not know that this has happened but it would make up most of the Canada USA gap by itself. Canada does not have anything but the slightest underground economy and can not use this diddle.

Other aspects of the Canadian economy are simply far better managed and visibly so and these may be uncounted in terms of a productivity calculation.

It is likely time we had a lively debate over the production of the productivity calculation for both countries. These are all formulas put together decades ago and they have all been subjected to political bias since. My favorite diddle is the consumer price index which gets cuter and cuter in terms of designing a standard basket of goods. The numbers produced bear little relation to the facts on the ground that has seen real necessities climb in cost steadily for years.

Canada's productivity gap is worse than ever

By Ian Martin, Financial PostMay 29, 2012

In the long run, our well-being is dependent on productivity growth,” says Eric Lascelles, chief economist at RBC Global Asset Management.

It’s not often economists will admit to bafflement, especially on a matter of utmost importance to national economic health.

As the predominant measure of standard of living, productivity of labour in Canada, has fallen notoriously short of standards set by the U.S. Economy.

For years, economists prescribed the typical remedies: reduced tax and regulatory burdens, free trade, low and stable inflation, interest rates and government debt.

Canadian governments mostly listened, adopting a national policy agenda deemed conducive to improving productivity and competitiveness.

On the output side, the results have been “pathetic,” economist Don Drummond said in a recent journal article in which he condemned “everything I have ever done on productivity.”

He estimated that policymakers in Canada had implemented about 70% of the measures typically advocated by analysts.

The World Economic Forum has ranked Canada in the 92nd percentile among the economic and policy environments required for a highly competitive economy.

Yet output per hour worked in the business sector averaged just 0.7% annual growth over the past 10 years, opening up a competitive shortfall of 30% against the United States.

Even during the last recession, which typically affords plenty of incentive for the business sector to operate leaner, Canada’s labour productivity slipped for the first time in eight recessions spanning the past 30 years, according to Statistics Canada.

It’s frustrating,” said Eric Lascelles, chief economist at RBC Global Asset Management. “Canada should be massively more productive than it was before and yet we still seem to be falling behind.”

While the economy has performed relatively well in spite of this competitive disadvantage, the economic implications of the productivity gap for Canadians are profound. They may also be unavoidable.

In the long term, productivity is one of the most important factors in determining standard of living, interest rates, inflation, and a lot of other things,” said Benjamin Tal, deputy chief economist at CIBC World Markets.

Mathematically, GDP growth is the product of two forces — the application of more labour and/or productivity enhancements.

In the process of recovering from the financial crisis and ensuing recession, Canada returned to output growth through the expansion of its labour force.

The U.S. predicated its growth on improving productivity.

In 2011, Canada’s labour productivity improved by 1.4%, which isn’t exactly horrible, until set aside U.S. gains, which measured 3.8%.

It’s impossible to meet that benchmark,” Mr. Tal said, arguing that comparing Canadian productivity to that of the U.S. is unfair. “They’re able to squeeze so much out of the existing labour force.”

There are merits to the Canadian approach of building economic strength through numbers. The jobs lost to the recession were recovered relatively quickly, an accomplishment that still eludes the U.S. Economy.

But demographic pressures strain Canadian labour forecasts more so than in the U.S.

An aging population translates to fewer workers as a share of the total population, which will constrain fiscal flexibility and the capacity to grow.

It’s right at our doorstep and it’s hard to see how, other than through high productivity, we’re going to deal with that,” said Philip Cross, a senior fellow at the C.D. Howe Institute and former chief economic analyst at Statistics Canada.

Mr. Drummond estimates the Canadian labour force will be growing at about 0.3% per year by the end of this decade.

If the pace of Canadian productivity growth remains as it is, the economy will experience about 1% real growth. Factor in inflation and nominal growth would sit at about 3%, Mr. Drummond said. “That will not permit much increase in wages or corporate income.”

Canada’s stubborn lack of competitiveness resonates through the entire economy, impairing growth forecasts and limiting wages, meaning less disposable income, less consumer spending, fewer tax receipts, less government spending and higher deficits.

As a proportion of the national economy, the productivity gap in the business sector against the Americans means Canadians forfeit about $300-billion in lost output each year.

Had Canada matched the productivity record of the United States over the past 25 years, personal disposable incomes would be $7,500 higher, a recent Conference Board study found. Corporate profits and government revenue would have been 40% and 31% higher, respectively.

In the long run, our well-being is dependent on productivity growth,” Mr. Lascelles said.

For many years, mitigating forces have served to mask Canada’s productivity shortcomings.

The low value of the Canadian dollar did so throughout the 1990s, keeping Canadian manufacturing artificially competitive through the advantage of relatively low prices.

High commodity prices in the following decade supported Canadian growth in spite of competitive disadvantages.

We’ve been able to get away with it because the world has been throwing money at us for our goods, in particular our resources,” Mr. Cross said. “That’s helped mask some the discomfort we would have been feeling from some of this.”

When the dollar appreciated, it provided the incentive to enhance productivity and narrow the gap against the U.S. An inflated dollar makes imports cheaper, allowing for an increase in machinery and equipment imports and productivity-enhancing capital investments.

The current account deficit in machinery and equipment shows Canadian businesses taking advantage of the currency shift, having quadrupled over the past 10 years.

That, too, has failed to reduce the productivity gap.

Economists are no nearer a consensus on the cause of the problem. Theories abound.

There is probably a cyclical element to Canadian productivity shortfall resulting from close trade links to a weak U.S. Economy.

A lot of our productivity-enhancing measures are designed to tailor to the U.S. market, and the U.S. market is not asking for anything,” Mr. Tal said.

Factor out some of the more transient factors and Canadian labour underperformance may not be as pronounced as it seems.

It’s possible that we are seeing an increase in structural productivity, but the cyclical element is masking it,” Mr. Tal said. “It’s possible we are improving without knowing it.”

The spike in commodity prices may also play a role.

You look at the energy sector and its productivity is just falling apart,” Mr. Cross said. “The oil sands is a tough way to extract oil. But that just goes hand in hand with the increase in prices. We have found all the easy-to-find cheap oil and the oil you’re going to exploit now is the more expensive stuff.”

That tradeoff may simply be inherent in an economy with strength in resources. High commodity prices, which have pushed up the value of the Canadian dollar, may also provoke a deterioration in competitiveness, Mr. Lascelles said.

Part of the explanation may be that resource industries tend to engage in less productive activities when commodity prices are high.

Other resource-based economies have certainly experienced the same phenomenon, he said.

Should global commodity markets weaken significantly, the Canadian dollar would probably fall, thereby improving the competitiveness of Canadian manufacturing.

Canada should actually be celebrating this remarkable balancing act,” Mr. Lascelles said. “As much as we all would love the Canadian manufacturing and resource sectors to be firing on all cylinders at the same time, the reality is, it’s usually one or the other.”

Either way, prices have helped to ensure Canadian economic health.

But given demographic trends, Canada can’t just rely on shifting fortunes to level out growth prospects, Mr. Cross argued.

We’ve gotten away for 20 years in this country with not-great productivity because we’ve had offsetting developments in the price mechanism. Can you count on that forever? Probably not,” he said. “It’s hard to imagine how you’re going to get another break in the price mechanism that will help you offset the aging of the population.”

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