Canadian growth and productivity

Two Canadian macro articles diverted me from my best laid plans today. Side by side, the two make for some interesting observations on the state of the Canadian economy, as well as some fodder for thinking about what drives investment. The first, a Statscan piece by Phillip Cross, is a demand-led investment story, with most attention on the resource sector, while the second, by Andrew Sharpe of the Centre for the Study of Living Standards, looks to supply-side solutions to improve Canada’s productivity performance.

Statistics Canada’s economic review for 2006 shows in spades how most of the new investment in Canada has been demand-driven, and externally-driven, in particular from our booming resource sectors:

The current boom in commodity prices is now entering its fifth year. … [M]etals took the lead in pushing up prices to record levels last year. So-called ‘blue-collar’ metals such as copper, nickel, zinc and iron ore spearheaded the advance, overshadowing their more illustrious precious metal cousins, such as silver and gold. This reflects higher demand in the rapidly expanding industrial base of developing countries, notably China. … [E]nergy and metals prices were high enough to stimulate more investment in most areas. … Firms continued to pour money into [Alberta oil sands] investments, tripling from $5.2 billion when the current surge in oil prices began in 2003 to a planned $16.1 billion in 2007.

The economic benefit side generally focuses on employment growth, which has been spectacular, especially in the West. Missing from Cross’s analysis, however, is anything to do with real wage gains. In the very same issue of the Canadian Economic Observer, there are some tables that show that, despite the strong employment creation in the labour market, and cries of skill shortages, real wage gains have been weak. Average hourly earnings grew by just 2.4%, slightly higher than inflation, in 2006. The same is true for wage settlements. Yet, we should be seeing stronger upward pressure on wages in accordance with the state of the labour market.

Another missing element from the Cross article is the lack of decent productivity growth in spite of other strong economic indicators. This is where Andrew Sharpe’s article, Lessons for Canada from International Productivity Experience, published in the International Productivity Monitor, comes in. After reviewing our rather dismal productivity performance of late, Sharpe turns to the experience of six countries: The US, UK, Ireland, Australia, Finland, and Sweden.

Unfortunately, rather than take a fresh approach, Sharpe essentially restates the conventional wisdom of supply-side measures widely accepted at senior levels of the Canadian bureaucracy. I find it curious that he takes as a starting point the views of the OECD and McKinsey, both of which proffer ideological views on the issue that are not actually that well-grounded empirically.

The four broad lessons emerging from Sharpe’s analysis are:

  1. deregulation of product and labour markets to promote greater competition (key targets here are telecommunications and milk marketing boards);
  2. greater human capital formation, including faster integration of immigrants with skills, and basic skills formation among the overall population;
  3. adopt new technologies faster, rather than seek to create new technologies through R&D (by expanding federal technology diffusion programs and harmonizing provincial PSTs with the GST);
  4. reduce “institutional rigidities”, such as seasonal EI supports and interprovincial barriers to labour mobility.

I doubt anyone would disagree with (2), except to point out that Canadian governments should be dedicating much more money to education at all levels, starting with early learning programs, through K-12 and post-secondary (an Irish lesson is free post-secondary) and ending with retraining programs that could be greatly enhanced out of the EI surplus.

Item (3) is interesting in that it reinforces the notion of gains from widespread adoption of new technologies, innovations and ideas. As suggested in this post on the benefits of spillovers, this implies weaker, not stronger, intellectual property protection (in contrast, a few statements in Sharpe’s article would appear to blanket endorse stronger IP protection, although these do not figure into his recommendations).

Items (1) and (4), however, I have a problem with. In the context of agreements like TILMA, barriers to inter-provincial labour mobility are often invoked, but while there are some issues in some professional areas, mobility concerns are greatly overstated. I am disappointed that with (4), Sharpe buys into this so easily, alleging in his article:

the role of institutional rigidities in impeding productivity growth and the identification of these rigidities and their removal. Specific rigidities in Canada include … [t]he Employment Insurance (EI) program, which provides income support for the unemployed in seasonal occupations, discourages
to some degree mobility to regions where permanent employment prospects are more promising.

And further recommending:

Reduction in interprovincial barriers to labour mobility in the professions and the trades to allow a greater role for market forces to influence the reallocation of workers from low productivity/low wage to high productivity/high wage jobs, an important source of productivity growth.

Yet, the evidence from Cross’s Statscan article suggests that neither of these “rigidities” seem to be much of a problem:

Four provinces and one territory saw their populations shrink, matching 2005 as the only other year with such widespread declines. The provinces were Newfoundland, Nova Scotia, New Brunswick and Saskatchewan, along with the Northwest Territories (as well, growth was minimal in PEI and Manitoba). Migration to Alberta was the principal reason. In every instance, net outflows to Alberta more than accounted for the drops in population.

Alberta proved to be an increasingly attractive destination for people from all provinces, large or small, rich or poor. Alberta received a net inflow of 57,105 people from other provinces, the largest inter-provincial movement of people to one province on record back to 1972 (easily exceeding the previous mark of 46,133 people moving to Ontario in 1987). The trek west accelerated sharply over the last two years, as word of the Alberta boom spread: after an average net inflow of just 11,000 people in 2003 and 2004, inter-provincial migration accelerated to 34,423 in 2005 before its record-setting performance last year. In the last decade, the net inflow of 285,620 inter-provincial migrants was the equivalent of 10% of Alberta’s overall population in 1996, and nearly half of its growth of 600,600 people.

Sharpe is also enamored with the need to stimulate competition by deregulation (1) to unleash our latent productivity potential. The devil is in the details in these proposals, and it seems to me that Sharpe just takes a knee-jerk “competition is good” approach, when there are many subtleties at the sectoral level. Much of the new competition would come via market access from foreign companies, which may or may not be a good thing from a broader public policy perspective. More competition, as was the case with the Canada-US FTA, may improve productivity on average, somewhat, but this is due to the less productive being driven out of the market. And overall, free trade did not deliver on its promises of closing the Canada-US productivity gap, so why this will now be the case, from a few remaining areas, eludes me.

In the Statscan article, there is another interesting passage that contrasts with Sharpe:

The major financial trend last year was an upsurge in mergers and acquisitions, both in Canada and around the world, often funded by private equity. As a result, foreign direct investment (FDI) in Canada rose to $76 billion last year, second only to the record $99 billion at the peak of the ICT mania in 2000. Only two years ago, FDI in Canada totaled less than $2 billion. Foreign interest centred on our increasingly lucrative mining companies. Several iconic companies closely identified with Canada’s economy were taken over, including Inco, Falconbridge and the venerable Hudson’s Bay Company.

For a rich but middle-power country such as Canada, a broad range of public policy issues are also at stake beyond notions of economic efficiency. Countries need to have the capacity to make trade-offs based on their own democratic institutions, including criteria such as universal access, cultural considerations, social objectives or regional development. Maintaining the flexibility to pursue such options should not be dismissed. Deregulated approaches may act as a barrier to cross-subsidization by utilities, whether under public or private control. For example, government policy may ensure that all regions have access to electricity or telephony at reasonable prices, by charging slightly more in urban areas to cross-subsidize lower prices in rural areas. These activities play a redistributive role that is rooted in issues of equity and access, rather than just economic efficiency. In the absence of such interventions, in many areas of the country market prices may be monopoly prices, or markets may not exist at all.In key areas of the economy, a country can reasonably argue that the public interest necessitates measures to keep out or restrict foreign competitors. Telecommunications, energy, banking and other vital services, though run through the private sector, should not necessarily be forced open to foreign competition. In these areas competition is likely to be limited at best, due to the high upfront costs of entering the market. And in extreme cases, such as that of California in 2003, deregulated competitive markets actually led to a gaming of the system that bilked US$10 billion from ratepayers into the hands of companies like Enron. I’m all for some competitive rivalry but the “deregulation and competition” mantra seems simplistic to me.

The discourse on productivity also consistently misses out on the matter of distribution. Productivity per hour can essentially be thought of as the wages and profits arising to labour and capital, respectively, from the economic activity in question. Recommended measures to boost productivity, especially of the supply-side variant, may succeed in increasing productivity, but there is nothing that says that the gains will be shared equally between capital and labour.

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