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PRODUCTIVITY WITH A PURPOSE: IMPROVING THE STANDARD OF
LIVING OF CANADIANS
INTRODUCTION
Ultimately, all government policies are designed to enhance the standard
of living of Canadians. They do so by providing certain core functions:
a legal framework within which the economy operates, stable fiscal, monetary,
and financial systems, public infrastructure, measures that protect the
integrity of the environment and that provide a sense of economic security.
These are public goods that the private sector cannot generally provide
and their efficient supply by government will support a well-functioning,
and growing economy. Governments also publicly produce some services because
Canadians may prefer that to the private provision of those services, and
the public provision of those services might be more efficient than their
private provision. In Canada the most notable example of this is basic
health care.
Nancy Hughes Anthony
All of these goods and services require economic resources, which merely
means that to enjoy their benefits, other, privately-provided benefits
must be given up. In total, the private and public goods and services that
Canadians consume must be produced and it is the value of this production
that ultimately constitutes the limit to our standard of living.
If we look back at our history, it is evident our standard of living
has increased enormously. By any measure, we are far better off today than
we were several generations ago. Mr. Paul Kovacs made this point well when
he told the Committee "if you take just an average Canadian family
of about 40 years ago, if you use today's measures, even with adjustments
for inflation and such, an average family of 40 years ago would be considered
poor today."
This phenomenon did not happen overnight, nor was it the result of any
single event. Instead, it was the cumulative result of many changes that
took place over the decades - it was the result of economic growth.
Even relatively high rates of economic growth do not present dramatic
effects from year to year. But over time, and cumulatively, the effects
can be astonishing. A 2 percent annual growth rate will not quite double
the amount of income in thirty years. A 3.5 percent growth rate will almost
treble income over the same period, approximately the length of one generation.
The difference, after one generation is approximately equal to the original
level of income.
Clearly then, economic growth is a long-run phenomenon. It is what produced
our current standard of living. It is what will determine our future standard
of living; consequently it is about our children and our children's children.
Governments need to focus more on long-term challenges. Long-term growth
tends to ameliorate much of what is viewed as current problems. Consider
again the lessons in arithmetic that economic growth offers. By the end
of 1999, the Canadian economy will produce about $900 billion in Gross
Domestic Product (GDP). With a 2.5 percent growth rate, this will increase
to $1,018 billion after five years and a 3.5 percent growth rate will push
it even further to $1,070 billion. These are reasonably achievable real
growth rates which suggest that five years from now the federal and provincial
governments will have an extra $38 billion to $55 billion in combined annual
tax revenues. This represents, at a minimum, one-half of what we today
spend on health care services.
The 1999 federal budget has been referred to by many as a "health"
budget, in large part because of additional health transfers, amounting
to $11.5 billion in total over five years. Raising the growth rate from
2.5 percent per year to 3.5 percent per year would pay for the health budget
initiatives, and much more, allowing the government to undertake other
initiatives as well.
Additional health transfers in the 1999 Budget amounted to $11.5 billion
over the next five years.
This is the case for economic growth. Canadian families are today facing
high debt burdens and stagnant disposable income. We all know about the
effects that demographic change will have on the demand for health-care
in particular and our society and economy in general. The number of seniors
will almost double by the year 2030 and the ratio of working Canadians
to retired Canadians will fall from the current 5:1 to 3:1. This is a 40
percent decrease in the number of working age Canadians per retiree and
clearly indicates that workers would have to be much more productive just
to maintain the current standard of living of all Canadians.
Economic growth is not a program for the benefit of business. It is
for workers, consumers, and taxpayers. It is for all Canadians. History
has shown us that all citizens in economies with strong democratic institutions
and market economies benefit substantially from economic growth. Indeed,
as stated well by Jim Stanford of the Canadian Auto Workers, "the
"P" word is on everyone's agenda...it's incredibly rare that
you would have agreement from economists on the right and left and the
middle about an issue, but productivity may be one of those things...improving
productivity, revitalizing productivity growth is a precondition for rising
living standards."
As we will discuss below, there is much we do not know about the determinants
of productivity. There is much confusion about measurement and other issues.
But, in the words of Thomas d'Aquino of the Business Council on National
Issues (BCNI), we should not "get bogged down in the details."
Instead, we should set as a goal the task of raising the standard of living
of Canadians. "No matter how we measure it, higher productivity is
necessary to reach that goal."
Fred Bienfeld
WHERE DO WE STAND?
The Canadian Standard of Living
There is a strong sense amongst Canadians that they are no better off
today than they were a decade ago. On a household basis,1
real disposable income is about six percent less than was in 1981, according
to Mike McCracken of Informetrica Inc. Other witnesses cited similar statistics
indicating similar results.
Chart 1 presents a historical view of the Canadian standard of living.
It looks at an index of real GDP per capita and real disposable income
per capita, both using the year 1971 as a base. This chart shows disposable
income growing faster than GDP through the 1970s and 1980s. In this decade,
on the other hand, disposable income declined while GDP has recovered.
Such a protracted decline in disposable income shows clearly the financial
pinch faced by Canadian families in the 1990s -- they have less ability
to purchase goods and services in the marketplace than they did a decade
ago.
Canada-United States Comparisons
The standard of living is calculated in most countries as the ratio
of GDP to population. This is not a perfect measure. Nevertheless it is
the one measure that is easiest to calculate and largely free of value
judgments. It measures the flow of resources available for current consumption
and investment - the ability of an economy to provide the goods and services
that are demanded by its citizens.
The Conference Board of Canada, Performance and Potential
1998
Over the past two and one-half decades, the American economy has been
able to provide a higher standard of living for its citizens than has the
Canadian economy. Chart 2 compares GDP per capita for Canada and the United
States. Using 1971 as a base,2
Canadian GDP per capita expressed in constant American dollars had only
increased by 13.7 percent by 1997. (Canadian GDP is converted into American
dollars on the basis of exchange rates, shown as the bars in the chart.)
It had increased by 30 percent as of 1990 but the recession, and more importantly,
the relative decline in the value of the dollar has caused this measure
of our standard of living to fall. By contrast, the American GDP per capita
grew by 54 percent since 1971.
Our failure to match the American rate of growth in living standards
over the 1990-97 period was due about equally to relatively weaker productivity,
relatively weaker reduction in the unemployment rate and relatively weaker
labour force participation.
Dale Orr
While it is common to see media reports making such comparisons, these
trends are in large measure subject to the very large changes that have
been experienced in exchange rates, and do not reflect well changes in
the standard of living. If, instead of using exchange rates, purchasing
power parity (PPP) is used, the trends in standards of living are more
equal. Not only do we see the growth of Canadian GDP per capita tracking
more closely that of the United States, the gap between the two countries
actually narrowed in this decade. This is in sharp contrast to the conclusion
drawn from GDP measures based on exchange rates, which show a dramatic
divergence.
Purchasing power parity is a technique that enables data for different
countries to be examined on a comparable basis. This concept compares the
cost of purchasing a standard basket of goods and services in a variety
of countries. It recognizes that many goods and services are produced and
consumed locally. While the exchange rate is important for Canadians who
wish to travel to the United States or to import goods from the United
States, they do not always do so. Instead they consume goods and services,
equivalent to the goods and services consumed by Americans, but which are
supplied locally.
In 1997, on the basis of purchasing power parity, one Canadian dollar
was worth approximately 77.7 cents American. In other words, if an American
purchased a bundle of goods and services in United States that cost $100
US, a Canadian wishing to purchase the same bundle of goods and services
in Canada would have to pay $129 Cdn. The Conference Board of Canada estimates
that the Canadian dollar is today worth 87 cents US, on the basis of purchasing
power parity, suggesting that it would cost only $115 Cdn to purchase here
what it cost an American $100 US to purchase in the United States.
Using purchasing power parity to compare international standards of
living indicates that the Canadian standard in 1997 was 46.4 percent higher
than in 1971. The American standard of living grew by 54 percent over the
same period of time. On this basis, the Canadian standard of living grew
faster in the 1990s than did the American standard of living. This is not
consistent with the conventional wisdom.
Not only does purchasing power parity significantly alter the trends
over time in standards of living, it also affects the relative levels.
Using the exchange rate suggests that, in 1997, the standard of living
of the Japanese was substantially higher than that of Americans. On the
basis of purchasing power parity, however, the Japanese standard of living
was slightly below that of Americans. This result is not surprising given
the high cost of living in Japan.
Moreover, the external value of the dollar suggests a lower standard
of living in Canada than is actually the case. More than one-half the gap
between American and Canadian standards of living disappears when purchasing
power parity is used instead of the exchange rate. (See Chart 3) The Canadian
level also improves in relationship to other G-7 countries.
It is important to realize just what the previous charts are telling
us. Chart 2 looks at trends since 1971. Even though the Canadian GDP per
capita growth has not been much below its American counterpart since 1971,
it masks the fact that a large gap existed at that time, one which the
Canadian economy has failed to close. According to the Conference Board
of Canada, Canadian GDP per capita, measured on a purchasing power parity
basis, is still about 80 percent of its American counterpart. There is
no evidence, according to the Conference Board, that this will change in
the near future.
Industry Canada also presented the Committee with estimates of the gap
in the standard of living of Canadians and Americans, expressed in Canadian
dollars. This gap is estimated to be between $7,500 and $8,750 in 1998,
depending upon the way in which it is measured.
It is important to distinguish between our standard of living and changes
in our standard of living. Over the past 25 to 30 years, our standard of
living has been growing at a rate slightly below that of Americans. Thus
we are becoming slightly worse off than our neighbours to the south. Our
actual standard of living, however, is substantially below that of Americans.
Industry Canada estimates the gap at between $7,500 and $8,750 Canadian,
per capita. This gap has existed for many years and can only be closed
if our rate of growth exceeds that of United States over a prolonged period
of time.
Productivity
In last year's pre-budget consultations report, Facing the Future:
Challenges and Choices for a New Era, the House of Commons Standing
Committee on Finance called for the establishment of a Productivity Covenant
by the federal government. The rationale for this was the belief by the
Committee that Canada was experiencing a decline in productivity growth.
As evidence of this, it was noted that not only had productivity been growing
in the 1990s at a substantially lower rate than in earlier decades, but
that our performance in this decade lagged behind that of the United States.
This was particularly true in the manufacturing sector.
Measurement is important in this, although it's important to remember
that measurement is backward-looking, it's not forward-looking, and that
is a significant problem.
Rick Harris
From 1990 to 1999, Canadian labour productivity growth in the manufacturing
sector exceeded that found in the United States for only three of the years,
according to data presented by the Conference Board of Canada. In the other
seven years, American productivity grew faster than in Canada, and in several
of those years the difference was significant. Indeed, the cumulative effect
shows that productivity in the American manufacturing sector grew 40% faster
than in Canada, a compound annual growth rate of 3.1 percent in the United
States vs. 2.2 percent in Canada.
Looking beyond the manufacturing sector to the economy as a whole, the
data suggest that labour productivity has grown in Canada at a rate not
much different from that in the United States. Nevertheless, the rate of
growth in the 1990s is substantially below that of the 1960s.
Our Standard of Living: the Role of Productivity
Put simply, our standard of living is determined by the quantity of
inputs we use in the production process and the efficiency with which we
use those inputs. Productivity is a measure of that efficiency. If productivity
is low, then we must use more inputs to maintain our standard of living.
More of us must be working or we must be working longer hours. On the other
hand, if productivity is high, we can maintain our standard of living while
at the same time enjoying more leisure.
On average, Canadians are not as well off as Americans - this fact is
well-known. The size of the gap, and its persistence over time, is not
as well known. Industry Canada estimates the gap at about 25 percent in
1998, measured on the basis of GDP per capita, which is approximately where
it stood in 1961. This differential, of course, varies over time. In the
1980s, and especially in the 1990s, there has been a marked deterioration
in Canada's relative standing vis-à-vis the United States.
The standard of living comprises three basic elements. Mathematically,
it is the product of the rate of productivity, multiplied by the employment
rate, multiplied by the participation rate. Productivity is the ratio of
GDP to the number of employees, adjusted to take into account changes in
the average number of hours worked.3
The employment rate is measured by the proportion of the labour force that
is actually employed, i.e. it is merely the inverse of the unemployment
rate.4 The
participation rate, on the other hand, simply measures the proportion of
the population that is in the labour force.
Andrew Sharpe
Productivity is not a concept that is easily understood. Professor Rick
Harris put it in context by explaining what productivity is not. "Productivity
is not consumption. Productivity is not incomes. Productivity is not wages,
it's not profits, it's not employment. It's some measure we have about
how efficiently we produce whatever it is we produce...it's a measure of
how efficiently the economy uses its resources to produce goods and services."
Thomas d'Aquino of the Business Council on National Issues (BCNI) put
it even more succinctly when he described productivity as "...the
value of goods and services produced in relation to the time, money and
resources used to produce them. Canada's productivity performance determines
how much a Canadian can make for a day's work." Productivity, according
to Jim Stanford, "...involves getting more things, not getting less
of things."
While this may seem simple enough, it has become evident to the Committee
that the issue of productivity is not well understood. This point was stated
well by Peter Smith of the Aerospace Industries Association of Canada,
when he said that many Canadians do not understand "...the direct
link between productivity and our standard of living. Without a fundamental
understanding, it is impossible for many Canadians to recognize the productivity
challenge facing Canada today. The result is a disturbing level of complacency
that if left unchecked will relegate Canadians to even lower and lower
standards of living."
But productivity is not the be all and end all of economic life. Basically
the goal is to improve the quality of life of Canadians and that's a much,
much broader concept than, say, GDP per worker or GDP per capita
Andrew Sharpe
While productivity is clearly a determinant of the standard of living,
it is not the same thing. Indeed, it is only one element that determines
the standard of living. This confusion was evident in some of the testimony
before the Committee. For example, some witnesses made a sharp distinction
between productivity growth in industries or firms where employment was
expanding, and those in which it was contracting, arguing that productivity
gains in stable or contracting industries did not enhance the productivity
of the economy. This is not so. Productivity measures the efficiency of
the production process. We measure productivity by considering resources
that are actually employed. We do not include those resources that are
not being employed. Consequently, productivity gains in an industry where
employment contracts will enhance economy-wide productivity in the same
way that productivity gains in expanding industries will enhance economy-wide
productivity. They may not, however, directly enhance our overall standard
of living, as measured by GDP per capita.
Productivity, while an important determinant of our standard of living,
should not be considered an end in itself. In other words, we should not
seek to enhance productivity simply for the sake of enhancing productivity.
An example put forward by Fred McMahon illustrates this. Consider the case
of social assistance recipients who now find themselves with jobs. These
are likely to be low-paying, low-skilled, low-productivity jobs. The average
level of productivity for the entire economy will decline. The standard
of living will, however, increase. If enhancing productivity, rather than
enhancing the standard of living of Canadians, is a goal, such a move would
be seen as counterproductive. Good sense, however, would suggest that the
opposite is in fact true.
McMahon further suggested that such an example might explain part of
the apparent gap between productivity growth in the United States and in
European countries. The United States has been creating jobs over a wide
range of skill levels. European countries, on the other hand, have not
been creating jobs and low-skilled workers have been shut out of the job
market. This makes European productivity look good but it does nothing
to enhance the standard of living of Europeans.
According to the Centre for the Study of Living Standards, labour productivity
is the relevant measure if we are interested in the impact on standards
of living. This measure tells us "...how much is produced by each
worker and hence how much real income there is to be distributed among
the population." Andrew Sharpe reiterated this point before the Committee.
There was, however, no consensus. Professor Harris felt that total productivity
growth was more important in terms of dynamic gains to the economy. In
his view, investment affects total factor productivity, not just labour
productivity. Stewart Wells of Statistics Canada agreed with him, while
Professor Erwin Diewert tended to agree with Sharpe.
Short-run and Long-run Effects
According to a study by Dale Orr and Bob Dugan,5
the recent poor performance of the Canadian standard of living was due
almost entirely to poor labour market performance. From 1990 to 1997 labour
productivity grew by almost one percent per year. It was the decline in
the participation rate and the employment rate that constrained increases
in the standard of living to about 0.5 percent per year. This contrasts
to the experience of the 1980s when the standard of living was increasing
by about 1.7 percent per year due to productivity growth in excess of one
percent per year and an increase in a participation rate of more than 0.5
percent per year.
Dale Orr
Productivity growth in the 1990s is only slightly lower than it was
in the 1980s. The growth in the standard of living, however, is much lower
and three-quarters of this decline is due to the reduction in the participation
rate.
Productivity is measured by GDP per person employed. The denominator
merely measures the inputs that go into the production process. During
a business cycle, inputs are not necessarily varied proportionately to
output - this is especially true of employment. Consequently, labour productivity
will vary over the course of the business cycle, even though no fundamental
changes have taken place in the production process. Productivity declines
sharply as the economy moves into recession and it grows as the economy
starts to recover.
In the short run, labour productivity is a residual. Output grows by
a certain amount, labour inputs adjust only slowly to output growth, and
as a result labour productivity can go up or down. In the long run, however,
business firms are likely to have some estimate, or belief, as to changes
in labour productivity. Their hiring decisions will then be based on forecasts
of changing demand and their estimates about productivity growth. The hiring
and firing decisions will then follow.
Rick Harris
Longer-term trends in labour productivity, however, are affected by
developments that extend well beyond the business cycle. The concept of
labour productivity is important because it can affect output in the economy
even when capacity is fully utilized. That is, the unemployment rate may
be as low as it could possibly get, the participation rate could be as
high as it could reasonably be expected to go, and the stock of capital
could be used to the fullest extent possible. Does this mean that once
the business cycle reaches its peak nothing can be done to enhance output
or the rate of economic growth? Not at all.
It is at this point that innovation and technological development offer
the promise of economic growth and higher standards of living beyond that
which is offered by full employment. The quest for full employment, while
important in the short run, provides a limit to the standard of living
that the economy can provide. The quest for enhanced productivity is the
means by which this limit is overcome.
Unfortunately, the public debate is often mired within the confines
of the business cycle. The media understand the concept of unemployment,
and these statistics are reported monthly. They are less comfortable with
the concept of productivity, whose statistics are reported less regularly
and are far more difficult to comprehend.
While Andrew Sharpe and Dale Orr concentrated on Canada's poor labour
market performance in the 1990s as a factor in explaining our stagnating
standard of living, Professor Harris took a longer-term view. "Productivity
change is inherently a long-term change. That's just the nature of the
problem. Think about human resource development. We now have a sort of
compelling evidence being produced by child psychologists ...that very
early childhood development is extremely important in terms of subsequent
human capital formation. You literally have to have a 30 or 40 year horizon
when you talk about developing those kinds of resources."
This is precisely the point raised by Dr. Fraser Mustard. He spoke to
the Committee about the "real brain drain", namely literacy,
low receptive vocabulary and early childhood development. Social interventions
when children's brains are still malleable have the potential for enormous
economic and social returns, enhancing the human capital that could be
acquired by young Canadians. This would, on the one hand, enhance their
likelihood of being in the workforce and increase their productivity once
in the workforce. Both of these effects would lead to a higher standard
of living, but only well into the future.
Maureen Farrow was the most adamant of all witnesses in distinguishing
between the short run and the long run. In her view, productivity is really
about the long run and as a result is not subject to any quick fixes. As
she told the Committee, "I think it's very important for this Committee
to distinguish between the productivity debate and the high unemployment
debate and the tax debate because they are linked but one is quite short-term
and productivity is really a long-term concern..."
She reiterated and reinforced this point by saying, "... Long-term
productivity will help us no end in maintaining our quality of life and
enjoying full employment and all the benefits that come from that."
And if we take a longer-term view, labour productivity is clearly the
most important element in the determination of our standard of living.
In 1998, it explained 83 percent of the income gap between Canada and the
United States, according to Industry Canada. This is low by historical
standards. Industry Canada calculates that lower labour productivity accounted
for 96 percent of the income gap between Canada and United States over
the past decade.
Productivity Levels vs. Productivity Growth
The distinction between short run and long run productivity can be thought
of as the distinction between productivity levels and the rate of growth
of those productivity levels. When we talk about using our capacity fully,
both capital and labour, the goal is to ensure that the level of productivity
is as high as it could possibly be, given our capital stock and the existing
technology. But once our capacity is fully employed and productivity reaches
its highest possible level, what then?
I think that productivity growth, correctly measured and correctly targeted,
involves improving standards of living, improves growth, involves getting
more of things, not getting less of things.
Jim Stanford
The answer lies with productivity growth, which refers to the ability
of our economy to increase the measured level of productivity over time,
even when our capacity is fully utilized. Thus, short run concerns can
be thought of as challenges to ensure that resources are being used efficiently
and fully. They are concerns about the level of productivity.
Long-run concerns can be thought of as meeting the challenge to increase
productivity levels, and possibly even to increase them at ever faster
rates. This is much more of a dynamic issue. It is a function not of existing
technology but of new technology. It is the result of invention and innovation
in science, business, education, and management techniques.
Productivity, Labour Relations and Unemployment
One of the greatest concerns about technological innovation and productivity
enhancement relates to the impact that it has on the level of unemployment.
Many see the increased use of labour-saving technology as a threat to employment
and the standard of living of Canadian households.
Despite the fact that technology has changed substantially in modern
economies over the past decades, we have actually seen an increase in the
proportion of the adult population working in the market economy. Consequently,
it is not at all clear that new technologies pose any kind of threat to
employment opportunities. Instead, what they are likely to do is to change
the nature of work and the labour market skills that are required of workers.
This changing nature of work can, on the one hand, increase the opportunities
and job satisfaction of workers while, on the other hand, relegating low
skilled workers to poorly paid occupations. As evidence of this, Garnett
Picot of Statistics Canada informed the Committee that about 60% of the
jobs created in the 1990s were professional or managerial, whereas there
was virtually no growth in blue-collar jobs.
The increasing use of technology tends to have a positive impact on
employment in the service sector. Even such labour saving technologies
as automated teller machines, computers, price scanners, etc. may displace
workers directly but enhance the demand for services through the creation
of higher incomes. This additional demand follows from the fact that the
demand for services increases more than proportionately with increased
incomes. Thus, according to the OECD, there is a positive relationship
between employment and information technology investment.6
Professor Richard Lipsey speaks about the need to implement changes
in the organization of production. According to him "in more and more
industries, rigid job descriptions are becoming obsolete. Effecting the
required changes in the organization of labour is proving yet another conflict-ridden
process, as occurs with many changes that must be made in the facilitating
structure in response to technological change."7
Engineering and physical sciences are vital to technological progress,
but the same is true of management science, including human resources management.
The importance of human resources management was indicated to the Committee
by witnesses from the Canadian Policy Research Network and the Canadian
Labour Market and Productivity Centre. Canadian firms do not appear to
see the value of innovations in labour-management relations. Approximately
70 percent of establishments are still managing their human resources in
traditional ways. Shirley Seward of the CLMPC indicated that we would be
misguided if we think of labour-management relations only in terms of days
lost to strikes. In her view, it is "...the day-to-day interaction
between business and labour at the workplace level and the kinds of things
that they do cooperatively," that affects labour productivity.
Shirley Seward
Lipsey goes on to say that labour is now in intense competition in a
globalized market. What is now important is human capital. Consequently,
it is important that individuals acquire the skills that are required to
form this human capital.
The Canada-United States Productivity Gap: Is It For Real?
In January of this year, the Centre for the Study of Living Standards
published a short report entitled The Canada-U.S. Manufacturing Productivity
Gap: An Overview. This document examined the trends in manufacturing
productivity between the two countries. It concluded that the gap between
Canada and United States has not narrowed and indeed has widened significantly.
Since 1981 manufacturing productivity in the United States grew by 3.2
percent per year compared to 1.9 percent per year in Canada. The already
poor productivity performance in Canada deteriorated sharply in the 1990s
so that by 1996 our level of productivity was only 72 percent of that found
in the American manufacturing sector.
Andrew Sharpe
This was a continuation of a trend that started in the early 1980s.
This conclusion was based on labour productivity measures but if total
factor productivity was considered the results were essentially the same.
What is also of concern is the fact that productivity growth in manufacturing
was better than that found in the economy as a whole. And finally, for
the period 1981 to 1996, Canada's productivity performance was substantially
below that of other G-7 countries, amounting to only 60 percent of the
G-7 average.
The report did find this result somewhat surprising. Nevertheless, it
suggested several reasons for it. In the first place it found that the
American productivity growth was almost entirely the result of developments
in the high-tech sector. That sector accounts for a much larger share of
the American economy than it does in Canada. If this sector is excluded,
the Canadian performance actually exceeded American productivity growth.
The second explanation for the differential was a relatively weak performance
of the Canadian economy. Output growth increases productivity because it
enables firms to use their capacity more fully, enjoying economies of scale
through long production runs. With capacity being underutilized, there
is generally little incentive to seek productivity gains.
In addition it was suggested that Canadian firms do not embrace new
innovations to the same degree that American firms do. (See Chart 4) This
chart compares the rate of technology utilization by American and Canadian
manufacturing firms, by size, for 1989 and 1993. It demonstrates that the
rate of technology utilization by Canadian firms has increased over the
four-year period under examination. Large Canadian firms invest in new
technology at about the same pace as do large American firms. Small Canadian
firms were the technological laggards in 1989 but they have significantly
increased their use of technology, and consequently the Canadian average
grew.
Daniel Schwanen
We tend to think of research and development as something that is undertaken
by large firms, research institutes, government laboratories, and universities.
Small businesses also need to innovate to improve their products, their
manufacturing processes, and services they provide. In the view of the
Association of Canadian Community Colleges, our current approach is "...
missing the mark when it comes to the innovation needs of Canada's small
and medium enterprises."
Pierre Killeen spoke about community colleges as unique institutions
designed to enhance the economic development of local communities, including
the small-business community. These colleges are themselves entrepreneurs
as they offer their services on a fee basis, providing valuable assistance
to SMEs.
The CSLS report also suggested that human capital in Canada was as good
as human capital in the United States. By the measures of enrolment in
post-secondary education, adult literacy rates, or spending on manpower
training, Canada compared favourably to the United States.
More recently, the CSLS published another study entitled "New Estimates
of Manufacturing Productivity Growth for Canada and the United States."
This report, using a slightly different set of data, found that recent
productivity growth was virtually identical in the two countries. Only
in manufacturing was there a significant difference.
Like the earlier study, this report found that American productivity
growth in manufacturing was almost exclusively limited to two sectors,
the industrial machinery and electronic sector and the other electronic
equipment sector - i.e. what is generally referred to as the high-tech
sector. According to data provided by Statistics Canada, developments in
the American high-tech sector are quite startling. From 1990 to 1995, multi-factor
productivity in the American electrical and electronic products sector
grew by more than 8 percent per year whereas it grew by only 1.5 percent
per year in Canada. In commercial and industrial machinery the American
productivity growth rate was still almost twice that of the Canadian productivity
growth rate, almost 4 percent versus just over 2 percent.
Growth in total factor productivity was actually higher in Canada than
in the United States, contradicting the results published in the earlier
study. Therefore, the Centre concluded, that it might be premature to start
looking for explanations of the difference between Canadian and American
productivity growth rates, when such a difference might not exist.
The fact that American productivity growth in the manufacturing sector
is concentrated in the high-tech sector should not be reason for complacency.
If this concentration suggests some kind of data or measurement error,
that is one thing. If, on the other hand, it indicates that fast-growing
sectors tend to locate in the United States rather than Canada, that is
a matter of concern.
It now appears that the Canadian productivity performance has not been
as gloomy as has previously been thought. Recent revisions to the System
of National Accounts indicate that productivity growth in much of the 1970s,
1980s, and 1990s has been fairly consistent, although still substantially
below that experienced prior to 1973. Moreover, it is now widely recognized
that the OECD statistics miscalculate Canadian productivity growth because
they use employment rather than hours worked as an input. This totally
misrepresents productivity trends because it fails to take into account
the growing incidence of part-time employment.
Nevertheless, although the gap in productivity growth rates between
our two countries is not as large as was previously thought, even the revised
statistics show sharply accelerating growth in American productivity in
the middle of this decade.
Fred Bienfeld
Although productivity growth in Canada has not been significantly different
from that of United States in the last two decades, there is still a gap
between productivity levels in Canada and United States. According to Andrew
Sharpe, this gap is about 20 percent of GDP and has not changed since about
1973. This conclusion was shared by many of the witnesses who appeared
before the Committee.
Statistical Mis-measurement
There are several reasons why official measurements of productivity,
and productivity growth, may be misleading and why international comparisons
may give a false picture. In the first place, Canadian productivity statistics
look only at the business sector, ignoring therefore the government sector,
and health and education. In other countries, notably the United States,
education and health are more likely to be provided by the private sector
and, hence, included in productivity measures. It is not clear, however,
just how this distorts the apparent productivity gap between our two countries.
Nevertheless, it is clear that official statistics have not kept pace
with the changing nature of the economy. As stated by Professor Diewert,
"... the statistical system is still mired in the structure that was
started or worked on in the `40s and `50s and the whole statistical system
hasn't moved to better coverage of services." Some of these specific
issues will be dealt with later in the report.
This mis-measurement can occur as a result of several factors. As John
Baldwin of Statistics Canada pointed out, productivity estimates can be
thought of as being at the top of the pyramid, and will contain all of
the errors that are found in the component parts. Secondly, these estimates
can be highly sensitive to the way in which nominal statistics are deflated
so as to calculate real output.
John Baldwin
WHAT ARE THE FORCES BEHIND RECENT PRODUCTIVITY TRENDS?
As noted above, there has been a very clear decline in the last three
decades in labour productivity growth in Canada, the United States, and
other industrialized countries. Several factors have been identified as
the causes of this decline. They include such things as a decline in the
rate of capital accumulation, the growing importance of the service sector,
a lack of technological progress in certain industries, and the increasingly-regulated
nature of industrial economies.8
Capital Accumulation
The rate of growth of real, business, non-residential investment has
declined over time. In the 1970s it grew by more than 8 percent per year
falling to 3.2 percent in the 1980s and down to just over one percent in
the first half of the 1990s. This followed the trend with respect to growth.
When the economy was performing briskly, investment rates were high. Now
that growth rates are lower, so is the rate of investment.
The OECD publishes national accounts statistics for member countries.
According to the statistics, net investment, i.e. gross investment less
depreciation, has seen a significant decline. In the 1970s it was in excess
of 10 percent of GDP and reached a peak of 14.7 percent in 1974. In 1990s
it has been in the range of 5 percent to 6 percent of GDP.
This trend is portrayed in Chart 5. It does not show the entire picture,
however. Jim Stanford also presented the Committee with data on investment,
expressed as a proportion of the existing capital stock. Whereas net investment
averaged about 5 percent of the capital stock in the 1960s and 1970s, there
has been a steady decline in the past two decades. It is now in the neighbourhood
of 2 percent to 3 percent of GDP.
The implication of this is a failure to see the capital-labour ratio
grow. It is this ratio that enhances labour productivity because it gives
workers more and better tools with which to work, and the new capital often
has newer technology embodied in it. Today, the Canadian capital-labour
ratio is not much higher than it was in 1982. By contrast, the American
capital-labour ratio is about 15 percent higher.
Mike McCracken reported a similar trend with respect to real, gross,
government fixed investment. Whereas that investment amounted to close
to 5 percent of GDP in the middle of the 1960s, government investment effort
is now about one-half as great.
The Increasing Importance of the Service Sector
Today, about two-thirds of total GDP and three-quarters of total output
originates in the service sector. Fifty years ago, only one-half of GDP
was accounted for by services. As measured productivity growth in the service
sector has historically been less than in the goods producing sector, some
analysts suggest that this change in the composition of output is an important
factor in explaining our declining productivity growth trends.
As noted earlier, much of the American productivity growth has been
concentrated in the high-tech sector. This is not surprising, nor is it
unique to the United States. A recent report by the OECD compared labour
productivity growth in various sectors of the economy and concluded that
productivity grew fastest in the high and medium-high technology industries
followed by manufacturing, all industries, and the service sector, in that
order. The gap between services and high-technology was substantial everywhere,
over the period 1980 to 1995.9
OECD, Technology, Productivity and Job Creation - Best
Policy Practices
According to a study by the Bank of Canada, productivity growth in the
goods-producing sector was almost twice as high as that in the service
sector for the three decades ending in 1994.10
More recently, the gap between the two sectors has narrowed but that has
been because of the declining rate of productivity growth in the goods
sector.
Why is measured productivity growth in the service sector so low? One
obvious answer is that the service sector is very labour-intensive and
hence cannot make use of increasing amounts of new, and better, capital
the way the goods-producing sector does. There are only so many haircuts
that a barber can give in one day, for example. This view, however, fails
to recognize the very heterogeneous nature of the services sector and the
types of services that are increasingly being provided.
The communications sector has experienced the highest growth rate of
any industry. There, productivity has grown by almost 6 percent per year
from 1961 to 1994, which is twice as fast as the growth in the goods-producing
sector.
The communications sector however is clearly an anomaly. Surprisingly,
the finance, insurance, and real estate sector displays some of the poorest
productivity performance among service industries in the economy as a whole.
While these data do not go beyond the year 1994, they nevertheless pertain
to a period of time in which the sector was undergoing dramatic change,
investing in computer and information technology on a very large scale.
Indeed, it has engaged in the greatest accumulation of computer-related
capital of any sector in the economy. Yet for the period 1981 to 1994,
when many of these changes were taking place, productivity per person grew
by only one-tenth of one percent per year.
One of the problems with measuring productivity in the service sector
is the fact that it is extremely difficult to measure a unit of output.
Even more important is the fact that quality changes cannot be measured
easily. Given these two difficulties, many analysts suspect that the productivity
measures calculated for the service sector are inaccurate and, more likely
than not, underestimate the rate of productivity growth. Again, the financial
sector is a good place to look. This sector has not only changed the way
it operates, through the large-scale introduction of computer and telecommunications
equipment, it has dramatically changed the nature of the products that
it produces. Canadians now have 24-hour access to their funds and to credit,
from almost anywhere in the world. They can pay their bills from the comfort
of their home by phone or by computer. They can trade stocks on the Internet
and the cost of such transactions is only a fraction of what it was a decade
ago.
Jim Frank
It is unlikely that the productivity measures have been able to keep
pace with these changes. The substitution by consumers of mutual funds
for bank deposits is one example of this. Banks are increasingly earning
their revenue on the basis of fee for service rather than interest rate
spreads, yet it is this latter variable upon which productivity is measured.
Official statistics sometimes merely assume that a service sector has
no productivity growth. For many services, output is measured by hours
of input, and as a result productivity cannot grow.11
This is as true of Canada as it is of the United States. Output is estimated
on the basis of operating costs for such institutions as credit unions,
Investment Funds, and the Bank of Canada.12
Another possible source of mis-measurement relates to the way in which
productivity is calculated in the computer sector. The Bank of Canada report
suggests that the way productivity indices are constructed in Canada may
"upwardly bias the output of computer manufacturing at the expense
of computer-using industries..."13
This potential mis-measurement could be serious for the banking sector
because of its heavy investment in computer equipment. In 1991, investment
in computers accounted for 43 percent of total investment in machinery
and equipment in the trade, finance and business services sector. This
was far higher than in any other sector of the economy.
Chart 6 examines the service sector and attempts to establish a link
between investments in computer and information technology and total factor
productivity growth. The chart looks at three variables. The series "computers"
refers to the proportion of total investment in 1995 that was dedicated
to computers. The series "computer investment" refers to the
relative change in the real stock of computers over the period 1992 to
1995. The series "TFP" refers to the growth of total factor productivity
over the same period.
This chart offers a very negative portrayal of the role of computers
in productivity growth.
The American government statistics on service sector output and productivity
are subject to the same kinds of measurement errors that plague Canadian
statistics. The American banking industry has embraced new technology in
the same way that the Canadian banking industry has. Nevertheless, official
statistics show that American banks today are only 80 percent as productive
as they were in 1977. Few who study the industry could accept such conclusions.
Official statistics show that American banks today are 80 percent as
productive as they were in 1977.
Furthermore, the technological investments that have been made over
the past decade largely exclude Internet-related investments. Yet it is
with respect to the Internet that a large part of today's high-tech investments
are being made, and where dramatic innovations are expected in the future.
Thus, if it is true that the productivity benefits of information and computer
technology appear only with a lag, then it is entirely possible that even
greater productivity gains can be expected in the near future.
The Special Case of Computers, Information Technology and Productivity
One of the perplexing questions about the impact of increasing computerization
of the economy relates to the apparent absence of any significant, measurable
benefits for productivity. Not only are businesses spending large amounts
on investments in computers and information technology, without any significant
increases in productivity, but those sectors of the economy that are the
most intensive users of information technology seem to be performing most
poorly. The Centre for the Study of Living Standards14
addresses this issue and recognizes that there may be a problem with respect
to the measurement of output in the service sector. It does not consider
however the possibility raised by the Bank of Canada study, namely that
productivity might be measured correctly but attributed to the wrong sector.
Three possibilities are most commonly offered to explain this paradox.
In the first place, it is possible that computers are having the expected
effect but that statistical measures are not able to capture these effects.
A second explanation relates to the lags that exist between the introduction
of new technology and the emergence of its beneficial effects. All major
technological changes require a long period of time during which the new
technology is diffused throughout the economy and users learn how to employ
it effectively and efficiently. Sometimes this takes decades.
Finally, it is argued by some sceptics that the value of computers and
information technology in the workplace has been vastly oversold. This
technology is expensive, it requires a great deal of training, and its
possesses the potential to disrupt the workplace.
The CSLS concludes that a priority area for the government should be
the development of better output measures, especially for the service sector.
The Committee concurs with this conclusion, having heard similar sentiments
from numerous witnesses.
Evidence of Benefits from High Technology
In the United States, some economists are now accepting the fact that
high-technology does indeed have the potential to enhance productivity.
They cite the fact that productivity has been picking up in recent years,
well into the current business cycle. Typically, the big productivity gains
tend to occur early in the business cycle, when output is growing but firms
are not yet rehiring.
The reason for this, as some economists at the U.S. Federal Reserve
Board are now suggesting, is that computers had little positive impact
on productivity early in this decade but that they are now contributing
significantly to growth. The Chairman of the Federal Reserve Board, Allan
Greenspan, is now referring to "higher, technology-driven productivity
growth." It is possible therefore, that the lagged-benefits hypothesis
is indeed a valid one.
As Chairman of the Federal Reserve Board, Greenspan is naturally concerned
about inflation. When he speaks about growth, he always considers how it
affects capacity utilization and therefore inflationary pressures.
Since 1994, the American unemployment rate has continued to decline,
yet the rate of capacity utilization has been falling. In Canada on the
other hand, the capacity utilization rate has been growing alongside falling
unemployment. Even though the Canadian unemployment rate is much higher
than the American rate, our measured rate of capacity utilization is about
4 percentage points higher than in United States. This result is worrisome.
From a business cycle point of view, this suggests that the American economy
has the capacity to expand more than the Canadian economy even though our
unemployment rate is much higher. (See Chart 7.)
Daniel Schwanen, of the CD Howe Institute, cited the composition of
our economy as one factor that might help to explain our relatively poor
productivity performance vis-à-vis the United States. In
his view, we lose up to 0.4 percent in productivity growth every year simply
because our economy comprises sectors that tend to have lower productivity
growth by their very nature. In other words, if the American economy had
the same structure as the Canadian one, its productivity performance would
be lower.
WHAT DRIVES PRODUCTIVITY AND ECONOMIC GROWTH?
According to Professor Harris, there are three primary factors that
affect productivity. The first is investment. The higher the rate of investment
as a percentage of GDP, the higher will be the rate of productivity growth.
The second factor is human capital and labour skills. A more educated and
skilled labour force enhances productivity because it allows employees
to work smarter and to use newer technologies. Finally, free trade is an
important determinant of productivity growth, especially for small open
economies. Indeed, Harris believes that broadly-based free trade is one
of the most important things that the Canadian government could do, and
has done, to enhance productivity. It is this free trade that has enabled
the Canadian economy to "...re-orient management, labour and the whole
host of industrial practices,...integrating ourselves in this North American-based
manufacturing system..."
[T]here's no single lever on which there is a consensus that we should
pull in order to improve productivity. Some will emphasize reduced taxes.
Others will emphasize investments in anything under the sun from early
child care to research and development, to university research to whatever.
I don't think we have the knowledge to quantify the impact of each of these
things.
John McCallum
Investment and Capital Formation
There is a wide range of evidence to suggest that productivity is linked
to investment. Economies that save and invest more than other economies
tend to experience stronger growth in productivity, output, and standards
of living. This is not surprising. With more capital, labour productivity
is higher.
But there's more. The benefits of investment often spill-over to other
firms and other industries which have not made that investment. These externalities
are linked to such factors as learning-by-doing, and demonstration effects.
And, as noted earlier, new technology is embodied in new capital goods.
This investment is strongly affected by tax policies. Higher marginal
tax rates reduce the after-tax return to capital and discourage its accumulation.
Moreover, in a world of inflation, this disincentive is magnified because
taxes are applied to nominal, and not real, returns. With high inflation,
it is possible that the real after-tax rate of return is zero or even negative.
Investment is also affected by the economic environment in which entrepreneurs
must operate. Anything that adversely affects their view of the future
will discourage investment. For example, large government deficits that
are viewed as unsustainable raise the spectre of future tax increases.
This will discourage investment in the same way that actual tax increases
discourage it.
Investment in modern capital and technology is expensive and risky.
It requires a financial system that can transfer resources from savers
to investors. Monetary and financial sector policy are vital in this regard
to the extent that they contribute to the maintenance of a well-functioning
financial system.
The role of education and human capital
There are several ways in which education could contribute to the enhanced
standard of living of Canadians. The first is the obvious observation that
those with higher levels of education have a lower incidence of unemployment
and enjoy higher average incomes than those with lower levels of education.
Statistics were presented to the Committee by Sally Brown of the Association
of Universities and Colleges of Canada, which showed that "...the
unemployment rates of university graduates in mid-career stood at 4 percent
compared to 7.7 percent for high school graduates and over
14 percent for those who have not completed high school."
I think that one of the really important neglects, despite several serious
tries, has been the neglect of the development of highly skilled artisans
in this country, both the development of it and the respect of their role
and contribution. It's not just a matter of banging people through university
degrees.
David Slater
Chart 8, based on data supplied to the Committee by the Association
of Universities and Colleges of Canada, shows quite clearly how income
is related to education and age (i.e. experience). Not only do those with
higher education enjoy an income premium over those with less education,
this premium grows with experience. The fact that these individuals tend
to be employed more often and earn higher rates of pay suggests quite clearly
that their productivity is higher than that of those individuals with less
education. Thus they contribute more to the economy.
Education promotes the development of human capital. This capital can
have relatively large spillover effects, as is noted later on in the section
on the "brain drain." The existence of a well-educated workforce
also affects the investment decisions of firms. With a large stock of highly-skilled
workers, firms are more likely to invest in the capital that can make use
of those skills. This clearly enhances productivity. Without such a pool
of skilled workers, firms will choose to either make investments elsewhere
or to choose technologies for use in Canadian plants that do not require
such highly-skilled workers. In such a case, measured labour productivity
will be lower.
We maintain that the way to enhance human productivity is through learning
and training and that these activities ought to be the focus of government
attempts to stimulate productivity. Understood in this light, the rallying
call becomes "let's get learning" not "let's get productive,"
which most Canadians tend to equate with working harder, for less money
or being replaced or being downsized.
Pierre Killeen
The other important role of education deals with the distributional
effects of economic growth. By making education available to all Canadians,
economic opportunities are widely distributed amongst Canadians. Thus the
distribution of income is likely to be more even in an environment in which
education is publicly supported than it would be in an environment where
education is only privately supported. Public support for higher levels
of education and ongoing manpower training, as well as tax support for
the concept of lifelong learning, therefore contribute to a more even distribution
of income and wealth in Canada.
Human capital is the product of education and training. The Canadian
economy can provide this human capital or it can import it. David Slater,
in speaking about the post-war factors that led to our golden age of growth,
recognized the importance of imported human capital when he referred to
the "...very large inflow of well-trained migrants. The skills in
working with stone and brick and so on that came with the Italian migrants
was just fantastic. We, in fact, in this country relied for highly skilled
artisans, including tool and dye makers and so on, very largely on the
importation rather than generating these people ourselves."
International Trade and Competition
Trade is an important determinant of productivity growth because of
the effects on competition but, as well, because it enables firms in a
small economy to reap the benefits of long production runs and economies
of scale that are available to firms in larger economies. Professor Daniel
Trefler told the Committee that there is quite strong evidence to suggest
that the Canada - United States Free Trade Agreement (FTA) did enhance
the productivity of those sectors which saw their tariff protection reduced.
He believes that the FTA caused those sectors to see an increase in productivity
growth of one-half of one percent per year. This he thinks is a significant
amount.
Government trade policies increase competition and allow countries to
specialize in products they are good at making, boosting productivity and
competitiveness
One of the reasons for this result is the fact that trade exposes firms
to new and innovative competitors, and enables them to copy and adapt those
innovations. To achieve this benefit, however, it matters with whom we
trade. According to Trefler, "There's lots of reasons to want a Free
Trade Agreement with say Chile...But if we're interested in productivity,
we need integration with Europe, with the Germanys, the Italys, the Japans,
the United States."
Competition in markets is an important element in fostering innovation
and technological change. Indeed, technological progress resembles the
dynamic process of competition embodied in the phrase "creative destruction."
Barry McLennan
Competition means that firms must continually strive to be better, or
else they will lose market share and profits and their very survival could
be in jeopardy. Competition forces firms to keep prices low, quality high,
and to continually strive for new and better products, and new and better
ways to produce them.
This is only possible if barriers to entry are non-existent or minimal.
This means that domestic markets should be open to foreign as well as local
suppliers. Its means that regulations should not keep new firms, or new
owners of existing firms, out of markets.
Competition helps to foster an environment in which productivity growth
may emerge. As summarized by Professor Lipsey, "Competition among
three or four large firms often produces more innovation but a single firm,
especially if it serves a secure home market protected by trade barriers,
seems much less inclined to innovate."15
Firms exposed to competition must introduce modern technology in order
to survive, especially if that competition comes from firms that engage
in best practices. This is not true of firms that are sheltered from competition.
Indeed, such protection allows them to survive even though they may be
inefficient and employ outdated technology.
For small economies that kind of competition generally arises from international
trade. Free trade has the added benefit of expanding the markets in which
firms operate, and hence, enables them to achieve economies of scale that
would not be possible in a small, domestic market. It is for this reason
that Canadian export-oriented firms tend to have higher levels of productivity
than domestically-oriented firms. In the United States, on the other hand,
import competition affects productivity positively.16
This suggests that the achievement of economies of scale through the exports
generated from free trade are important for productivity growth in Canada.
In the United States, firms that supply the domestic market may already
have achieved those economies.
Foreign direct investment is often seen as a beneficial factor for productivity
growth. This is primarily because it enables economies to import technology
from more technologically advanced economies. It has the added benefit
of increasing competition. But when that foreign direct investment is the
result of attempts by foreign firms to leap tariff or non-tariff barriers,
the impact on productivity is often minimal.17
This confirms the oft-held view in Canada that branch plants add little
benefit to the Canadian economy. Put another way, the foreign direct investment
that Canada receives in a world of free trade is likely to be more economically
advantageous than that which we received in a world of high tariff barriers.
Technological Progress
By international standards, research and development intensity is low
in Canada, at approximately 1.4 percent of GDP.
Research and development is an important contributor to technological
progress. Although Canada does not engage in a great deal of R&D, that
does not mean that, as a nation, we cannot take advantage of research undertaken
elsewhere. There is some question, however, as to our ability to adapt
and use such imported research. There tends to be a positive relationship
between the amount of research undertaken locally and the ability to exploit
research.
We have a number of multinational enterprises, such as Nortel, Pratt
& Whitney, Frosst, ...three of those companies account for 44% of the
R & D in Canada.
Arthur J. Carty
This relationship is stronger in a world of increasing specialization.
This is due to the difficulty of importing ideas. To adapt the research
of others to local conditions requires a strong understanding of the technology,
understanding why it works, and knowing its limitations. This is especially
true of management and organizational innovations. American auto-makers,
for example, faced numerous problems when they tried to adapt Japanese
management techniques to their own domestic plants.18
Thus technological progress is about more than scientific research and
development. It is very much about institutions and the way in which we
organize our political and economic way of life. A classic study of economic
history, entitled How the West Grew Rich has concluded that societal
attitudes that accept change are necessary conditions for technological
progress to take place. According to that study, societies grew rich because
they were "...willing to tolerate and accept social and political
change... The West has grown rich, by comparison to other economies, by
allowing its economic sector the autonomy to experiment in the development
of new and diverse products, methods of manufacture, modes of enterprise
organization, market relations, methods of transportation and communication
and relations between capital and labour."19
History shows us that economic growth is not simply about achieving
efficiency in a static sense. Nor is it purely a matter of using more labour
or more capital. Economic growth is much more about changes in technology,
allowing us to produce new goods and services and produce them in new and
innovative ways. It is about invention and innovation, scientific experimentation
and new management techniques. And what is becoming increasingly evident
is the fact that the rate of economic growth is not just a result of factors
beyond our control. It is something we can affect by government policy.
In the words of economists, growth in modern economies is endogenous. While
we cannot control it completely, we can encourage it by a set of appropriate
policies.
Technological progress is as much about the adoption and diffusion of
existing knowledge as it is about the creation of new knowledge. Canada
is a small economy on the world stage. There is much to be gained by learning
from what others have discovered and using their discoveries. The diffusion
of technology enables individual firms to make use of the existing stock
of scientific knowledge. For them it does not matter whether that knowledge
was developed in Canada or elsewhere.
We have in Canada a very interesting example of a high-tech sector that
appears to be very successful yet is not able to make use of government
programs that help to diffuse technology. The biotechnology sector in Canada
is very successful by world standards. We have the second-largest biotechnology
sector in the world. Yet Technology Partnerships Canada (TPC) appears to
have passed this sector by. According to Dr. Barry McLennan, TPC has funded
70 projects in the past few years but only two have been in the biotechnology
sector.
The aerospace industry is a useful example of the impact of innovation
on productivity and global competitiveness. The aerospace industry is a
leading advanced technology sector in Canada, one of the largest R &
D investors. In the last five years alone. Industry sales have grown at
three times the rate of Canada's GDP, fuelled by exports that have grown
to 80% of our sales. However, notwithstanding this impressive performance,
we still face productivity and competitive challenges from our global competitors
who are investing even more in R & D and innovation.
Peter Smith
The role of taxation
The link between taxation, economic growth and the standard of living
has recently become the subject of policy debate. With higher levels of
taxation, the disposable income of families declines and thus there appears
to be a link between taxes and the standard of living. This is the popular
view of the relationship between the standard of living and taxes. By providing
tax relief Canadians would have more disposable income and thus be able
to purchase more market goods.
According to Professor Jonathan Kesselman of the University of British
Columbia, this view is too simplistic. He sees tax reform as the route
to the achievement of three goals. In the short run, tax reform would promote
economic efficiency by improving the allocation of resources. Next, it
would promote the expansion of employment and in the long-term it would
enhance productivity. In his view, reforming the tax base is more important
than cutting tax rates.
The more appropriate way to link taxation to the standard of living
is the manner in which it affects the incentives faced by individuals and
corporations. What is important is not just the level of taxation but the
composition of those taxes and the way in which they are imposed on the
economy. For example, a variety of European countries face higher tax burdens
than Canada, yet they have been able to achieve better productivity and
faster growth than we have.20
Why is this the case?
Jonathan Kesselman
One possibility is that the Canadian tax system relies too heavily on
taxes that have large distortions on the economy. They create the greatest
disincentives to engage in those activities, such as savings and investment,
that promote productivity enhancement. In this regard, the most costly
taxes are income taxes on capital while the least costly taxes are those
on consumption and labour. The reason for this is straightforward. Capital
is vital to high levels of productivity and to rapid rates of productivity
growth. In a world of globalization, it is extremely mobile. As a result,
any attempt to tax it at relatively high rates will result in capital moving
elsewhere.
Personal tax reform should aim to enhance three things. In the short
run, economic efficiency, that is how well resources are allocated. In
the medium run, expansion of employment and in the long run productivity
growth. All of these outcomes will improve real living standards of Canadians.
Jonathan Kesselman
Compared to other countries Canada relies very heavily on the personal
income tax, and we tax capital income at higher rates than do other countries.
This is true not just of the United States but also of European countries
such as Sweden, the Netherlands, Britain, and Italy. In part, this is due
to the fact that we tax consumption and labour income, via payroll taxes,
at rates substantially below those of other countries and thus are forced
to rely heavily upon broadly-based income taxes.
On the corporate side, several issues were raised before the Committee.
The first was a different treatment of the various corporate sectors. Some
receive preferential treatment over others. Witnesses, such as Kesselman,
argued that this distorts business decisions and creates an inefficient
allocation of resources. This sentiment was echoed by Rick Egelton of the
Bank of Montreal, who added that the tax rates are highest on those sectors,
such as services, that are associated with the new economy, and we tax
the least those that are part of the old economy.
Professor Kesselman also suggested that the employer component of EI
premiums should be experience-rated, which simply means that those sectors
that constitute a heavier drain on the system should pay more.
The Canadian Federation of Independent Business stressed the adverse
effects of profit-insensitive taxes. The government's increasing reliance
on capital and payroll taxes negatively affects the cash flow of small
businesses even when they may be earning only small profits or suffering
losses.
The other component of corporate, and personal, taxes that was subject
to criticism related to the tax treatment of capital gains. Investments
in risky ventures, for example small knowledge-based firms, are impeded
by a relatively high tax burden on capital gains. The American evidence,
as presented to the Committee by Douglas J. Porter of Nesbitt Burns, indicates
a negative relationship between the capital gains tax rate and capital
gains tax revenues. This suggests that not only do accrued capital gains
become realized when tax rates are low, but that the investments generating
those capital gains are encouraged by low tax rates. The capital gains
tax rate in the United States now stands at about 20 percent, whereas in
Canada it is closer to 40 percent for those in the highest tax bracket.
According to Dr. Mustard, the Canadian tax system does not provide incentives
for the long-term commitments that build wealth. In his testimony before
the Committee, he said "...I am not cheerful about your tax policies
and your capital gains tax, in companies like Ballard, where you use stock
as a method of paying people."
The Brain Drain
The export of Canada's elite labour force can have a substantial, negative
impact on productivity, economic growth, and thus the standard of living
of all Canadians. There are several reasons for this, according to Professor
Kesselman.21
In the first place, highly-skilled workers generate benefits that flow
to the economy as a whole. They enable Canadian firms to be competitive
internationally, providing jobs for all Canadians, even most with lesser
skills. They are the crucial factors of production in knowledge-intensive
industries and thus help the Canadian economy to evolve into a knowledge-based
economy.
Lars Osberg
Highly-skilled workers are also highly-paid workers, and therefore the
source of substantial tax revenues. They also tend to rely less heavily
on government services. Thus they are generally net contributors to the
fiscal position of governments and their departure means that those who
remain in Canada must pay higher taxes in order to maintain the level of
services to which they have become accustomed. These higher taxes, however,
will further discourage productivity increases and economic growth.
The brain drain, to the extent that it exists as a significant phenomenon,
not only affects our productivity growth but it is in turn a result of
our productivity record, since increases in wages and salaries are ultimately
linked to productivity increases. Highly-skilled Canadians are attracted
to the high incomes they can earn in the United States, and the gap is
a direct function of our poor productivity record.
Whether or not Canada is experiencing a brain drain is a subject of
much debate. Statistics Canada believes that we are, on balance, a net
recipient of skilled labour. A recent study, by the Bank of Montreal, which
puts migration trends within a longer-term context, also concludes that
there is no great exodus at present.22
Nevertheless, there is strong anecdotal evidence that highly skilled Canadians
are leaving in ever-increasing numbers. In the last half of the 1980s Canada
was losing about 15,000 skilled workers to the United States every year.
About one third of these individuals were permanent migrants. In this decade,
migration to the United States of highly skilled labour has grown substantially.
The number of permanent migrants, however, has not changed much. What we
are witnessing instead is a substantial increase in the number of temporary
migrants to the United States.23
Whether it be permanent migrants or temporary workers, Canada is clearly
losing more high skilled workers to the United States than we are receiving
in return. Depending upon the field of specialization, the gap is significant:
we are permanently losing to the United States four times as many engineers
as we are receiving in return, nine times as many health professionals,
almost six times as many management professionals, and two and one-half
times as many professors and teachers.24
The brain drain is an issue that is shrouded in controversy and poor
measurement. The data presented to the Committee by Statistics Canada provide
no evidence of a widespread and systematic loss of highly skilled labour.
Indeed, it suggests exactly the opposite, that we are the net beneficiaries
of well-educated and highly skilled workers. Moreover, the data on temporary
migrants are highly unreliable. They are subject to administrative practices
that change over time. For example, according to Statistics Canada, every
time a Canadian hockey team crosses the border to play in the United States,
the movement is recorded as a temporary migration of workers. The same
would be true in reverse when American teams come to Canada.
Those immigrants coming in can't be compared directly to the people
we're losing to the U.S., but comparing them to the entire native born
Canadian population, the immigrants are 1.6 times as likely to hold a bachelor's
degree, and they're 3 times as likely to hold a masters, Ph.D. or a medical
degree. So they are very highly qualified.
Scott Murray
On the other hand, the Committee is presented with anecdotal evidence
that suggests it is a very real problem in certain sectors of the economy.
Those who must recruit executives and professionals find it difficult to
attract non-residents to work in Canada. Peter Smith, for example, noted
that Bombardier is the third-largest manufacturer of airplanes in the world.
Nevertheless, it still finds recruitment difficult. In addition, we were
told by Sally Brown of the Association of Universities and Colleges of
Canada, that Canadian universities are losing senior faculty not only to
the United States but to other countries as well. Our institutions of higher
learning are so uncompetitive that they cannot attract the best professors.
Instead, they are replacing senior faculty with junior faculty members.
While the brain drain might not be a significant drain on Canada's productive
capacity in aggregate, its existence even on a small-scale might be telling
us something about the nature of our economy. The fact that it appears
to be a serious problem in certain areas tells us something about the ability
of the Canadian economy to provide opportunities for its citizens, especially
its younger citizens. It, like a fever, might not be threatening in itself
but tells us that the patient is sick. Thus, it matters that 40 percent
of the graduating nursing class leaves Canada. It is also important to
know that, while New York law firms may not be recruiting a large number
of Canadian law graduates, they are recruiting a high proportion of the
best, one-half of all A-student graduates from Osgoode Hall Law School,
for example.
By way of summary at the aggregate level, are we experiencing a brain
drain to the U.S.? Unquestionably, yes, over a range of occupations affecting
the health industries the most, almost certainly the direct result of a
lack of opportunity for those workers in Canada.
Scott Murray
SOME BASIC LESSONS LEARNT BY THE COMMITTEE
The discussion above gives a flavour of what is known about productivity
and its relation to the standard of living. The Committee will continue
its investigation within the context of its Pre-Budget Consultations and
make recommendations to the government next fall.
Nevertheless, it is clear that there is a need for better statistical
analysis in this area. Our understanding of productivity, and the statistics
we collect, is still based on the old economy. If governments wish to promote
policies relevant to the new economy, the economy of the future, it is
important that they have the basic knowledge to formulate appropriate policies
and to judge the efficacy of those policies.
The Committee recommends, therefore, that the federal government ask
Statistics Canada to formulate a research agenda for the betterment of
its statistical compilations regarding productivity measurement and provide
the necessary support to pursue that agenda.
Although it is clear that much still needs to be known about the process
by which productivity is enhanced, and increased over time, there were
several areas of consensus. We can summarize them under three broad categories.
The first relates to the economic and institutional environment created
by governments. This can be thought of as the broad macro environment.
The second area of consensus relates to the importance of capital accumulation
in the productivity equation. The third element is innovation.
Providing an appropriate macroeconomic environment is the role of government,
in particular the federal government. This refers to monetary policy, fiscal
policy, trade and competition policy. It involves prudent and responsible
fiscal policy, as characterized by balanced budgets and low government
debt. On the monetary side, it is evidenced by low and stable inflation
and low interest rates. Trade and competition policy conducive to productivity
growth means low entry barriers and access to world-scale markets. On the
trade side, it is important that we pursue greater economic integration
with the most developed nations so as to reap the benefits of their best
practices.
Catherine Swift
Capital can be thought of as comprising three distinct elements. There
is physical capital, human capital, and social capital. To some extent
all are linked together, but nevertheless, each has a distinct role to
play. Physical capital, comprising machinery and equipment, and public
infrastructure, have traditionally been the most important source of productivity
gains. The higher the capital/labour ratio, the higher will be the level
of labour productivity. Public infrastructure, for example roads, sewers,
water systems, enable the market economy to function efficiently. Clearly
then, physical capital comprises one component that is provided by the
private sector and another provided by the public sector. The government
has an important role to play with respect to both components. It finances,
and typically directly provides, public infrastructure. Investment in private
capital is influenced by the macroeconomic environment as well as the tax
system. The government must ensure that the level of taxes, and the composition
of those taxes, does not hinder the accumulation of private capital.
The Department of Finance, Economic and Fiscal Update,
1998
Human capital reflects the skills, and ability to learn new skills,
inherent in the labour force. It is the result of education and labour
force training. Increasingly, however, it is also thought to be the result
of early childhood development which essentially determines the extent
to which education and labour force training can be effective. Since human
capital rests with individuals, it is ultimately their choice to make such
investments. Government, on the other hand, is the primary supplier of
basic education. It also affects, through the tax system, incentives for
the acquisition of such capital.
Social capital is a more nebulous concept. Several witnesses spoke of
its importance. For example, Mike McCracken considered it to be an important
element in the productivity equation. One of the elements of social capital
is, for example, an equitable distribution of income. But while a more
equal distribution of income might be associated with higher standards
of living, it seems to be more the result of economic growth rather than
a determinant of it. Fred McMahon argued that policies designed to foster
economic growth might have a negative impact on income distribution initially
but this result eventually reverses itself. Dr. Mustard, when discussing
the slowdown in growth that appeared after 1975, noted that it becomes
more difficult to effect a redistribution of income when economic growth,
and income growth, is slow or non-existent. In this sense, social cohesion
results from productivity enhancement and economic growth, and does not
cause it. In other words, we must first bake the pie before we can cut
it up and distribute the slices. The bigger the pie, the more slices we
can cut, or the larger the slices might be.
The same thing can be said about the health of Canadians. Does a healthy
society promote growth or does growth enable us to have a healthy society?
The Committee heard testimony that American automobile firms decided to
locate plants in Canada because of the quality of the workforce - they
were more committed to their jobs, and they did not suffer from some of
the health and drug-related problems that afflicted American workers. This
point is undoubtedly true, and a healthy workforce is essential to productive
workforce. However, as noted by Thomas d'Aquino, it requires a productive
economy to make investments that are needed for a healthy workforce. This
seems to be an example of a virtuous circle, with a healthy workforce leading
to more productivity leading to a healthier workforce.
Government is the primary provider of this social capital.
The final element is innovation. Again, it is to some extent linked
to some of the elements mentioned above. But in many respects, its value
to productivity arises from institutions, the market which fosters a dynamic
process of competition, the structure of firms which determines how change
is accepted and implemented, and the incentive structure which affects
the willingness to undertake such changes.
Innovation tends to have large spillover effects, consequently private
decisions will generally lead to an under-investment. That is why most
countries have policies designed to encourage information creation and
diffusion. In a small open economy, it is important to determine the relative
importance of information diffusion and information creation, and the links
that might exist between the two.
The government affects innovation to the extent that it allows a society
to be open, with the free exchange of ideas. Regulations, that affect the
way in which ideas are used and diffused, will also affect innovation.
The Committee also learned to distinguish between the short and long
term. The Canadian economy performed less than admirably through much of
this decade and many of our economic problems are the result of this under
performance. These are important matters and must be addressed by government.
At the same time, we have come to realize that the standard of living and
productivity are very long-term concepts. They require that the government
focus its attention beyond the business cycle and further into the future.
There is no quick fix. The payoff of enhanced productivity comes well into
the future.
Maureen Farrow
Three Views on a Productivity Covenant
It is vital that government policy exploit the benefits that come from
enhanced productivity. The federal government should, therefore, commit
to a Productivity Covenant with Canadians. Just as Program Review is an
ongoing examination of federal spending, this Covenant should subject all
existing government initiatives (spending, taxation and regulation) to
an assessment which evaluates their expected effects on productivity and
hence the standard of living of Canadians. Every new budgetary initiative
should be judged according to this productivity benchmark. (House of Commons
Standing Committee on Finance, Facing the Future: Challenges & Choices
for a New Era)
"I remember a number of years ago, every government policy was
supposed to go through an environmental assessment. Maybe it's time to
think about... how friendly is this particular budget measure to productivity
growth. We may not be able to measure it, but we can look at the measure
and say this particular tax change doesn't hurt productivity growth. Do
we really want to do that? Maybe that's the type of mindset we should carry
forward in the future." (Rick Egelton, Bank of Montreal)
"The risk is there is so little consensus that everybody around
this table will have their own pet project and wrap it up in a productivity
blanket and you're going to be told 101 different things you should do
to raise productivity in support of all of our various projects. We may
be right, we may be wrong but it's such a broad amorphous thing. You're
not going to necessarily know whether any particular project is pro or
anti-productivity." (John McCallum, Royal Bank of Canada)
GOVERNMENT INITIATIVES TO DATE
As noted earlier, economic growth and enhanced productivity are long-term
challenges. They result from investment and innovation, both of which are
inherently risky. Thus they can only flourish in an environment that minimizes
risk and uncertainty.
Getting the Fundamentals Right
The federal government has undertaken two major initiatives that promote
such a favourable environment. One was the commitment to price stability
and another was the elimination of the federal deficit and the new commitment
to gradually reducing the debt load.
Thomas d'Aquino
The fiscal trend towards ever increasing debt and rising debt to GDP
levels was generally viewed as counterproductive and unsustainable. It
was counterproductive in the sense that it drained savings from the economy,
savings that would normally go towards investing in productive assets.
It was also counterproductive because, by increasing risk premiums, growing
government debt led to higher real interest rates. Any initiative, like
an investment or innovation, that produces benefits only in the future
will be discouraged by such high interest rates.
The pursuit of price stability is also a crucial element for long-term
economic decision making. Price stability leads to lower interest rates.
More importantly, however, price stability restores the informational value
of the price system, allowing investors to make better-informed decisions
as to the most productive uses for their financial capital. In addition,
price stability removes some of the distortions caused by the tax system.
According to Peter Howitt, "inflation impedes the functioning of the
long-term capital markets essential for the operation of efficient but
very roundabout techniques of production, by forcing savers and investors
to engage in an unwanted gamble concerning inflation when they use these
markets." It also discourages saving by introducing "extraneous
uncertainty."25
Bank of Canada, Monetary Policy Report, May 1999
There are several ways in which this occurs. The most pernicious effect
of inflation is to reduce capital formation because taxes are applied to
nominal and not real returns. This reduces the after tax real return on
investment and hence discourages its formation. In addition to the reduction
in long-term capital formation, inflation tends to change the composition
of investment, away from plant and equipment and into real estate. A large
part of technological progress, approximately 80 percent,26
is embodied in new equipment and anything that discourages investment in
new equipment hinders technical progress.
In pursuing these broad policy initiatives, often referred to as "getting
the fundamentals right," the federal government has restored to the
Canadian economy two essential ingredients for growth and has set the stage
for other policy initiatives to be effective.
Enhancing Competition
The process of technological change responds to economic signals, prices
and profits. Price stability helps to ensure that those signals are accurate.
Competition, on the other hand, ensures that relative prices reflect market
conditions.
The primary way in which a small economy can ensure that its markets
are subject to competition is to open up its borders to free trade. Canada
has done this through the Free Trade Agreement (FTA) with the United States
and the North American Free Trade Agreement (NAFTA) signed with the United
States and Mexico. Further free trade agreements with Chile and Israel
also boost competition in domestic markets.
Jim Frank
To see how dramatic the impact of free trade has been, we need only
look at trade statistics with the United States. Since 1990, both imports
and exports have more than doubled. Indeed, Canadian trade now amounts
to more than 70 percent of GDP. In the mid-1980s it was about 55 percent,
and in the mid-1950s it was only 30 percent of GDP. The fastest growth
in trade has occurred in those sectors that have been the most liberalized
as a result of the Canada-United States FTA.27
Competition is also enhanced by ensuring that there is free trade within
the country. In this regard the internal trade agreement, while less than
perfect, also subjects domestic producers to greater competition. Modern
technologies mean that distance and transportation costs are no longer
effective barriers to competition. Regulatory changes and trade agreements
are needed to ensure that those barriers in fact come down.
Regulatory reform has also led to more competition in domestic markets.
Primary examples of this are the telecommunications and transportation
markets. But similar initiatives are being undertaken in the financial
sector as well. Examples include the crumbling of the financial pillars,
greater openness with respect to foreign financial institutions, and new
ways of organizing financial institutions. In this regard the federal government
is proposing to allow foreign banks to directly branch in Canada and it
is giving serious thought to allowing co-operative financial institutions
to organize themselves into banks.
With the publication and examination of the report of the Task Force
on the Future of the Canadian Financial Services Sector, the federal government
has opened the door to a possible, profound modernization of the Canadian
financial sector.
While regulatory reform has helped to increase competition, services
have often been shielded from foreign competition through investment and
trade restrictions. The technology of the services sector has also made
it difficult to trade services over long distances. This is now changing.
In addition, the World Trade Organization (WTO) Agreement on Financial
Services will help to break down some of these barriers and consequently
enhance competition.
Governments can, and often do, get in the way of enterpreneurship by
imposing regulations and legal processes that hinder change and innovation
among enterprises of all sizes, not just big ones. They can erode the incentive
to compete by providing protection and limiting markets.
Jim Frank
Taxation
With elimination of the federal deficit, the government of Canada is
now able to undertake a reduction in the level of taxation faced by Canadians.
The tax/transfer system can have a significant effect on the productivity
performance of the economy. Taxation not only reduces the disposable income
of Canadian households, it affects the incentives that they face. The government's
initial reductions were designed to lower the tax burden on low- and middle-income
families and to help remove some of the barriers to labour force participation
that are faced by families with children. Tax relief has now been given
to all Canadians.
The 1999 budget eliminated the 3% surtax for all remaining taxpayers.
More needs to be done however. High marginal tax rates also affect incentives
to work and to save. Modest initiatives have begun. With the elimination
of the 3 percent surtax all marginal tax rates have been reduced. Nevertheless,
the marginal tax rates faced by Canadians are significantly higher than
those faced by Americans. This is true of labour income and it is true
of investment income.
Investments for a productive economy
In recent budgets the federal government has undertaken a number of
initiatives designed to enhance the economic infrastructure, both physical
and human, of the Canadian economy. On the physical side, the Canada Works
Program which was a tripartite infrastructure program helped to improve
the transportation and municipal infrastructure system in Canada.
The Conference Board of Canada, Performance and Potential
1998
Similar initiatives have been taken with respect to research infrastructure
and human capital development. The Canada Millennium Scholarship Foundation
and the $2 billion initial federal endowment helped to ensure that young
Canadians have access to post-secondary education.
The creation of the Canada Foundation for Innovation, the enhanced funding
for the granting councils, and the creation of the Canadian Institutes
for Health Research have added to the research and development capacity
of the Canadian economy. As importantly, these initiatives are helping
to stem the brain drain, keeping some of the best and brightest talent
in the country.
$200 million has been invested in the creation of the Canada Foundation
for Innovation.
As a small economy, Canada cannot match the research and development
activities of larger countries, in absolute or relative terms. It has often
been assumed that Canada can take advantage of scientific endeavours in
the rest of the world, merely adapting new inventions and innovations to
the Canadian environment. But in many cases, this adaptation is as complex
and expensive as the initial research and development. If this is true,
then those economies that actually produce basic research have a distinct
advantage over those that merely attempt to copy them.
In that case, government initiatives that actually encourage research
and development activity are necessary for the promotion of innovation
and technological development. This is why enhanced support for the granting
councils and the creation of research-related establishments are important
to enhancing economic growth. This is also why Canada's generous tax incentives
for R&D are also important.
$90 million will be invested over the next three years in the development
of Centres of Excellence.
The reform of unemployment insurance
In 1996, the federal government reformed its system of unemployment
insurance, re-naming it Employment Insurance and significantly altering
some of the parameters of the program. It was found, for example, that
changes to the structure of the economy were excluding a larger proportion
of the workforce from participation in the program while at the same time
the nature of the program led to counterproductive behaviour on the part
of workers and employers.
Some employers were using unemployment insurance as part of the remuneration
package offered to employees. It had become an earnings supplement. In
other instances employers found themselves competing with unemployment
insurance for workers. Those workers suffered no penalty by extending the
duration of their unemployment. As a consequence, the reservation wage
(i.e. the wage the job seekers expect to receive before they will accept
the job offer) and the duration of unemployment were pushed to artificially
high levels by the previous system of unemployment insurance.
The unemployment insurance system also contributed to economic inefficiency,
according to Fred McMahon. "In Atlantic Canada...there were in many
months twice as many people collecting UI as were actually unemployed and
about two-thirds more people collecting regular UI then were actually unemployed."
Even during periods of high inflation, there were "labour shortages
throughout Atlantic Canada."
The recent reforms have changed all this. Nevertheless, some witnesses
believe that further reforms are needed. In particular, they argued for
an end to the implicit wage subsidy that the EI program offers to some
industries. This occurs as a result of the far greater reliance on EI benefits
by employees in certain sectors and a proposed solution is to have the
employer premium based on the layoff experience of workers in that sector.
In the 1999 Budget, EI premiums have been reduced. For employees, premiums
are now $2.55 per $100 instead of $2.70 per $100 in 1998. This will lead
to a $1.1 billion reduction in EI premiums by the end of 1999.
Gross domestic product per capita has been used here as a measure of
the standard of living because it provides a measure of the ability of
a country to meet the needs of its citizens. It has several advantages.
Data are readily available. They are, for the most part, free of value
judgements. And they are collected in a fairly consistent manner in most
countries, so that international comparisons can be readily made.
GDP per capita is not without its flaws, however. It fails to recognize
the value of non-market production and consumption. Annual GDP also does
not take into account the timing of consumption. In one year, Canadians
might be borrowing heavily from abroad to finance that consumption. In
another year, GDP might be at a similar level without foreign borrowing.
Nor does GDP per capita take into account leisure.
Finally, GDP fails to take into account a variety of negative consequences
of economic activity and social circumstances. It does not properly take
into account the effects of pollution, crime, congestion, ill health, etc.
Nor does it take into account such things as income inequality, income
insecurity, the risk of unemployment, etc.
Concluding Remarks
In conducting these hearings, it has become evident to the Committee
that enhanced productivity is not something we seek as an alternative to
other policy goals. It is not an either/or proposition. Instead, productivity
enhancement is a goal we seek to achieve in order to have the resources
to achieve other goals.
Thus we should not pursue a productivity agenda at the expense of other
social and economic goals. Quite the contrary. We should pursue a productivity
agenda as part of a broader initiative to enhance the standard of living
of all Canadians.
As well, we should not pursue this agenda because of any real, or apparent,
gap between our productivity and that of other countries, particularly
the United States. While international comparisons are useful in providing
us with benchmarks against which we can measure our own performance, these
comparisons should not dictate our own policy priorities. The goal is not
to become more like Americans or Germans or Japanese. The goal is to achieve
our potential and to deliver the highest standard of living possible, now
and in the future. And whether or not our productivity performance is slightly
better or worse than we thought it was, it is clear that we can do better.
Enhancing productivity is all about having more resources to satisfy
the wants and needs of Canadians. Improved productivity provides them with
more disposable income. It provides government with more resources without
having to impose higher taxes. And it enables government to achieve more
with the resources at its disposal.
If there is one word that is most relevant to the concept of productivity,
that word is investment. There are a variety of reasons for this. In the
first place, investment is an activity that produces benefits in the future
and hence requires a longer-term outlook. This is true of productivity
as well. There are no quick fixes to achieving our productivity potential,
and the benefits of enhanced productivity will show up only in the future.
Government policies designed to enhance productivity must therefore be
based on a longer-term time frame.
If the government is going to pursue productivity increases as a major
goal, it would be very beneficial to provide longer planning horizons in
its budget. Two-year rolling deficit targets have served us well in eliminating
the deficit. Now, however, it is appropriate to provide an indication of
longer-term priorities and goals.
Investment is also a key word because it is through investment that
productivity is ultimately enhanced. Whether it be private investment in
machinery and equipment, private investment in research and development,
public investment in infrastructure, public investment in education, or
individual investment in human capital formation, it is the creation of
some form of capital that is the key to enhancing productivity in the future.
Improved productivity is something that is largely achieved within the
private sector. It is up to the business sector and individual Canadians
to enhance productivity. They do so by investing in plant and equipment
and new technologies, by engaging in research and development, by being
innovative, by taking risks, and by investing in their own human capital
on an ongoing basis.
Despite the fact that productivity is determined on the shop floor,
and in the corporate headquarters and laboratories of firms, government
does have a significant role to play in the decisions that are made by
these firms. The government is responsible for creating the environment
in which the economy operates. It sets the monetary and fiscal environment
of the economy and hence has an impact on business and consumer confidence.
The tax system affects the incentives faced by workers, savers, investors,
and entrepreneurs. And finally, government has a role to play when markets
fail, i.e. when the social benefits of certain activities differ from the
private benefits. In this respect government is a complement to, but not
a substitute for, the market.
THE COMMITTEE'S GUIDE FOR ENHANCING PRODUCTIVITY
The following is a list of some guiding principles that the Committee
believes to be important for increasing productivity. This list sets out
the role of government in creating a favourable climate that would be conducive
to enhanced economic growth.
Getting the fundamentals right
The overall policy framework of the government is vital in establishing
the economic environment within which the private sector operates.
- Reducing the debt to GDP ratio
- Low inflation
- Low short and long-term interest rates
- Continued Program Review to focus government on those areas in which
it has a role to play and a contribution to make to Canadians' standard
of living
- A Productivity Covenant to provide a benchmark against which government
policies are judged and to help ensure that they are consistent with enhanced
productivity
Tax policy
Taxes have a significant impact on the incentives faced by individuals
and corporations. Tax policy is not just a matter of the overall tax burden.
Marginal tax rates and the definition of the tax base can also have a significant
impact on those incentives.
- Higher basic personal exemptions to remove lower income families from
the tax rolls
- Lower marginal tax rates
- Eliminate the 5% surtax
- A corporate tax system that is neutral and treats all industries as
consistently as possible
- Corporate taxes which are, to the greatest extent possible, based on
profitability
- Internationally competitive tax rates
- Capital gains taxation to encourage risk taking
- Tax provisions such as Employee Stock Option Plans that enhance productivity
by encouraging employees to share in the risk and profits of firms
- A re-examination of the threshold for the small business tax rate
Support for education and skills development
These measures recognize the fact that our competitive advantage increasingly
lies with our labour force.
- Enhanced access to post-secondary education
- Tax support for higher education and life-long learning
- Tax support for education related savings
Support for R&D
As the use of new technology is the key to greater productivity in the
long run, these measures are designed to promote the development and diffusion
of new technologies.
- Tax support for research and development
- Programs for technology diffusion
- Support for research infrastructure
- Adequately-financed granting councils
Social and labour market reform
Efficient labour markets are as important to enhancing productivity
as are efficient capital and goods markets.
- EI reform
- Measures to overcome the "welfare wall"
- Secure social safety net
Trade policy
Trade policy enhances competition and expands markets. It allows Canadian
firms to achieve economies of scale and long production runs that might
not be possible if they served only the domestic market.
- Additional free trade agreements like NAFTA
- Multilateral agreements like WTO
- The elimination of internal trade barriers
Letting the market work
As productivity enhancing measures are most likely to be undertaken
by the private sector, it is important that the market environment in which
the private sector operates provides the correct signals and incentives.
- Reduced business subsidies
- Privatization
- Reduced use of economic regulation to limit competition and market
entry
- Reducing the burden of regulatory compliance, especially with respect
to SMEs by rationalizing regulation, removing ineffective and uncompetitive
regulations, replacing social regulations with direct government programs
- Use of rigorous Regulatory Impact Analysis Statements in order to determine
if new regulations are beneficial
We were told by numerous witnesses that, in pursuing a productivity
agenda, we should not succumb to the temptation of trying to pick winners.
There is no magic formula leading to higher productivity. While there are
both macro and micro-policies that the government could use to enhance
productivity, and while both avenues should be explored, broader initiatives
are probably the best to take in a world of uncertainty. Getting the economic
and fiscal fundamentals right is a perfect example. These initiatives are
clearly contributors to enhanced productivity and can only improve future
economic performance.
Another obvious contributor is a more open and flexible economy. The
Governor of the Bank of Canada, Gordon Thiessen, argued that promoting
greater flexibility was one of the most beneficial things the government
could do to enhance the productive capacity of the economy. Such flexibility
should characterize product, labour and capital markets.
We believe that our approach to deregulation of the financial services
sector, as outlined in The Future Starts Now: A Study on the Financial
Services Sector in Canada, provides a good example. Unless there are
legitimate consumer protection, safety and soundness, or competition concerns,
we recommended that financial institutions be as free as possible to pursue
new opportunities. A similar approach could be applied to other industries
as well.
In the same vein, measures that encourage investment, work force attachment,
risk-taking, etc., are also undoubtedly beneficial to productivity enhancement.
The most important instrument at the government's disposal in this regard
is the tax system. The effect of tax changes on productivity depends upon
the nature of the tax changes (whether they apply to investment or labour
income, whether they reduce marginal tax rates, how corporate taxes are
reduced, whether taxes apply to capital, income, or payrolls). Nevertheless,
a balanced reduction in taxes can have only beneficial effects on productivity.
As we have noted earlier, the government has taken a variety of initiatives
that satisfy our guiding principles for productivity enhancement. The Committee
obviously supports the continuation and expansion of such endeavours. Nevertheless,
there are several areas that we believe the government should consider
initially and could start quickly to move on.
While the federal government has started to reduce personal income taxes,
first in a targetted fashion, then more broadly, there is still much potential
for additional tax relief. The high income surtax remains in place. The
capital gains tax rate is about twice that found in the United States.
Taxpayers are subject to the highest marginal tax rate at a level of income
well below that at which Americans are subject to their highest tax rate.
The middle marginal tax rate is still higher than it was originally intended
to be. The federal and provincial governments continue to tax the capital
of financial institutions and other corporations. The threshold at which
the small business tax rate ceases to apply has been eroded over time and
needs to be re-examined. The tax system might not be appropriate for the
"new economy" and might need to be reformed so as to support
measures such as employee stock ownership plans that have the potential
to enhance productivity.
The other area in which productivity enhancing measures have a great
potential is with respect to even greater free trade - it increases competition
and offers larger markets to Canadian companies. In addition to NAFTA,
Canada has signed free trade agreements with Chile and Israel. South America
remains a choice opportunity for free trade. But so does Europe, a continent
which, now having a common currency, constitutes an economic market that
rivals that of the United States. Free trade and unrestricted investment
between Europe and Canada will challenge Canadian corporations to be more
productive as they would be competing with the best corporations in the
world, alongside those in North America and Japan.
Finally, we see great potential in further deregulation of the Canadian
economy. Economic regulation, which limits entry and controls prices and
business activity, is not as prevalent as it was in the past. Several previously
heavily regulated industries are now subject to intense competition. Telecommunications
and transportation are two Canadian examples of this, but this type of
regulation has not been totally eliminated in those sectors.
There is still more to be done, however. The financial sector, although
having enjoyed substantial legislative and regulatory reform in the past,
is still far from being as flexible as it could be. Now that the United
States is finally pursuing a profound regulatory reform of its own, the
pressure for reform in Canada can only grow. And when we recognize that
communications innovations such as the Internet will truly allow Canadians,
Americans, and others to shop the world for financial services, Canadian
institutions will have to increase their productivity to match that of
foreign institutions.
Productivity is affected by more than just economic regulation. Any
regulation imposes a compliance burden on business firms, especially SMEs.
These regulations require time and effort to comply with. Unless there
are valid policy objectives, and benefits to Canadians, associated with
these regulations, that time and effort would be best employed in making
firms more efficient.
These broad areas of focus do not constitute an exhaustive list of initiatives
that the government can still take. We propose them as complements to the
other items listed in our guide to productivity enhancement which are as
vital to increasing productivity. The government should, of course, continue
to support education and skills development, and research and development.
It should continue to provide a favourable fiscal and monetary environment.
And it should continue to invest in infrastructure. The Committee believes
that these areas are ones that the government could look at initially.
THE COMMITTEE'S FINANCIAL SERVICES SECTOR MODEL
In the Committee's response to the Task Force on the Future of the Canadian
Financial Services Sector, we presented a model for financial institutions
that contains most of the elements that we believe to be important in enhancing
productivity. This model is presented below, in terms of initiatives that
we supported. The Committee does not present this model as the best, or
favoured, option. It is, however, an approach which is consistent with
the preconditions for productivity that we set out above, it is appropriate
given the nature of the financial sector, and it could be adapted for the
rest of the economy.
Structural Flexibility
- A lightly regulated financial holding company model
- A single ownership regime that would apply to financial institutions
on the basis of size, not the type of institution
- A flexible definition of wide ownership
- Demutualization of insurance companies, with the potential to engage
in amalgamations during the transition period, after conversion from a
mutual to a stock company
- The ability of small Schedule I banks to re-categorize on the basis
of the recommended ownership regime
Competition
- The promotion of new entry via reduced capital requirements in some
cases, a streamlined approval process, and the elimination of the "one
size fits all" approach to regulation
- The ability of foreign banks to establish direct branches in Canada
(Bill C.-67)
- Enhanced access to the payments system for non-deposit taking institutions
- Measures to ensure access to other financial networks
- Greater functionality of Automated Teller Machines (ATMs)
- The creation of cooperative banks
- Greater powers for credit union centrals
Taxation
- Support for the removal of the withholding tax on arm's-length borrowings
- The elimination of special capital taxes
- A reduction in capital taxes in general
- The promotion of the common capital base
- General support for the use of profits sensitive taxes
- A Favourable Macro and Regulatory Environment
- Initiatives making legislation consistent with electronic commerce
- New accounting guidelines
- A well-defined merger review process for financial institutions
- A consumer protection regime within the context of broad financial
sector reforms
- Measures to improve services to knowledge-based industries and small
and medium-sized enterprises
- Centralizing supervisory functions within OSFI
- Reducing regulatory overlap and duplication
- Negotiating a set of rules with the United States, governing the provision
of services by "virtual" financial institutions
These hearings highlighted some of the statistical confusion that characterizes
the productivity debate now taking place in Canada. The fact that renowned
international and domestic institutions could come to different conclusions
about our productivity record, indicates just how difficult it is to measure
this variable. Indeed, the fact that an increasingly large part of the
economy presents very real measurement difficulties is also testimony to
the statistical and measurement challenges that we face.
While good data are important for the conduct of good public policy,
we should not allow the current statistical challenges and controversies
to detract from what we do know about the factors that contribute to improved
productivity. The Committee believes that enough is known about this subject
so that a productivity agenda should play an important part in the formulation
of government policy. To this end, we believe that government initiatives
should be judged in their consistency with this agenda. Thus we believe
that the government should subject all of its initiatives to some type
of test, ensuring that these initiatives contribute to, and do not detract
from, productivity enhancement.
1 Trends
in income per household will be affected not just by trends in income per
capita, but also by changes in the average size of households.
2 These charts
set 1971 GDP levels at 100. This does not mean that Canada and the United
States had the same GDP per capita levels in that year. This technique
is used merely to compare cumulative growth in the various economies over
time.
3 Often,
productivity measures use as a denominator the number of hours worked.
As long as there is no tendency towards greater part-time or full-time
employment, using the number of employees gives an accurate measure of
productivity levels and changes.
4 This is
the convention used by Orr and Dugan. Frequently the employment rate refers
to the proportion of the working-age population that is employed.
5 Dale Orr
and Bob Dugan, Our Standard of Living-Our Productivity: How Are We Doing?
WEFA Inc., 1999.
6 OECD, 1998,
p. 51
7 Richard
G.. Lipsey, Economic Growth, Technological Change, and Canadian Economic
Policy, C. D. Howe Institute Bene factors Lecture, 1996, p. 25.
8 R. Salgado,
"Productivity Growth in Canada and the United States," Finance
& Development, Dec. 1997.
9 OECD, Technology,
Productivity and Job Creation - Best Policy Practices, 1998, p. 46.
10 Dinah
Maclean, "Lagging Productivity Growth in the Service Sector: Mis-measurement,
Mismanagement or Misinforma tion?" Working Paper 97-6, Bank of Canada.
11 Michael
R. Darby, "Causes of Declining Growth," Policies for Long-Run
Economic Growth, Federal Reserve Bank of Kan sas City, 1992, p. 6.
12 Dinah
Maclean, "Lagging Productivity Growth in the Service Sector: Mis-measurement,
Management or Misinformation?" Bank of Canada, Working Paper 97-6,
p. 14.
13 Ibid.
p.14.
14 A.
Sharpe, Productivity: Key to Economic Success", pp. 31-33.
15 Richard
G. Lipsey, Economic Growth, Technological Change, and Canadian Economic
Policy, CD Howe Institute Benefac tors Lecture, 1996, page 4.
16 Dirk
Pilat, "Competition, Productivity and Efficiency," OECD Economic
Studies, No. 27, 1996/II, p. 124
17 K.
Shigehara, "Causes of Declining Growth in Industrialized Countries,"
in Policies for Long-Run Economic Growth, p. 30.
18 Peter
Howitt, "Endogenous Growth Theory: Taming the Winds of Change, or
Tweaking Neoclassical Economics?" In Thom as J. Courchene, Editor,
Stabilization, Growth and Distribution: Linkages in the Knowledge Era,
The Bell Canada Papers on Economic and Public Policy, 1994, Page 133
19 Nathan
Rosenberg and L.E. Birdzell, Jr., How the West Grew Rich: The Economic
Transformation of the Industrial World, Basic Books, Inc., New York,
1986, p. 332.
20 Jonathan
R. Kesselman, "Tax Cuts for Growth and Fairness," Policy Options,
December 1998
21 Jonathan
R. Kesselman, Policies to Stem the Brain Drain - Without Americanizing
Canada, March 1999.
22 Bank
of Montreal, "Trends in Canada-U.S. Migration: Where's the Flood?"
Economic Analysis, March 24, 1999.
23 The
Conference Board of Canada, Performance and Potential, 1998, Ottawa,
1998, p. 111.
24 Ibid.,
p. 109.
25 Peter
Howitt, "Endogenous Growth Theory: Taming the Winds of Change, or
Tweaking Neoclassical Economics?" In Thom as J. Courchene, Editor,
Stabilization, Growth and Distribution: Linkages in the Knowledge Era,
The Bell Canada Papers on Economic and Public Policy, Queen's University,
Kingston, Ontario, p. 141.
26 Centre
for the Study of Living Standards, Productivity: Key to Economic Success,
Report prepared for the Atlantic Canada Opportunities Agency, March 1998,
p. 26.
27 Daniel
Schwanen, Trading Up: The Impact of Increased Continental Integration on
Trade, Investment, and Jobs in Canada, CD Howe Institute, March 1997.