INDU Committee Meeting

STANDING COMMITTEE ON INDUSTRY

COMITÉ PERMANENT DE L'INDUSTRIE

EVIDENCE

[Recorded by Electronic Apparatus]

Tuesday, November 23, 1999

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[English]

The Chair (Ms. Susan Whelan (Essex, Lib.)): I call the meeting to order.

On the agenda in front of you, we have two sections. I'm going to postpone dealing with the motions until we have a quorum of nine. We'll hear the witnesses' testimony first, but before we go to questions—I hate to do this—we'll have to interrupt and go back to dealing with the motions.

We're going to begin with the committee's mandate under Standing Order 108(2), a study concerning productivity, innovation, and competitiveness.

I'm very pleased to welcome our witnesses here this morning, who are from the Conference Board of Canada, the Centre for the Study of Living Standards, and Informetrica.

We'll have everyone's opening statements first. Mr. Frank, would you like to begin?

Mr. Jim Frank (Vice-president and Chief Economist, Conference Board of Canada): Thank you and good morning. Brenda and I are pleased to have this opportunity to assess some of the issues surrounding productivity and competitiveness.

The Conference Board started making a big point about this issue back in 1996, when we issued our first Performance and Potential report. We've continued to make this point for the last four years. We've been saying that productivity is the fundamental factor underpinning and maintaining our high quality of life. High productivity leads to high wages.

In thinking about how to improve our performance, the board believes we have to look at our society as an integrated whole, where economic and social policies interact together to allow us to achieve our potential. They are mutually supportive and synergistic.

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One of the handouts I've given you has some slides on it. You can see different slides that I'm going to speak to as I go through my remarks. I'll draw your attention to the key ones as I go forward.

In our 1999 P and P report, we took a major step forward by ranking Canada's performance on 40 indicators relative to six benchmark comparative countries: the U.S., Japan, German, Australia, Norway, and Sweden. We reported that Canada is just average among these countries. We are not at the top of the heap.

Remember that these are countries that are similarly placed in terms of industrial development and overall quality of life. We believe that by looking at what others are doing and by benchmarking ourselves against the best, we can see what is possible and learn from them.

Each country has strengths among the 40 indicators, but Canada stands out as having particularly good social policy results in areas of health, education, and social welfare. Also, our labour market and fiscal performance are improving—two areas where we have had difficulties over the past decade.

But where we are lagging is in productivity performance in manufacturing. Worst of all, our record in innovation is the weakest of all comparator countries. These are the two topics we're going to focus on today. We believe that our privileged position among the world's countries is not guaranteed into the 21st century unless we do better in these two areas.

We want to help Canadians understand that to increase our productivity we will have to look at a whole range of changes in what we do and how we do it. At the Conference Board, we are firmly convinced that there is no single or simple solution to improving our productivity—there is no quick fix—but we are also equally convinced that Canadians want to and can do better.

Before I go further, let me say a few words about the Conference Board. We are a private sector, not-for-profit research corporation funded mainly by business and government but also by other organizations and associations. Our mission is to be the leading private applied research institution dedicated to enhancing the performance of Canadian organizations in the global economy, hence our interest in Canada's productivity and competitiveness.

Let me turn now to the key messages we would like to leave regarding the performance of our manufacturing sector. This is the sector the board feels is critically important, because it comprises about 15% of our employment and because it is subject to international competition through trade. There are four key points I want to make this morning.

Labour productivity growth in manufacturing through 1999 has remained below that of the United States for six years in a row. Growth in unit labour cost is out of line with that of our major competitors. Our underlying competitiveness is being eroded. Without a falling dollar, we would not have come close to our 1990s trade success. The situation is not sustainable and adjustment costs will be severe. Businesses in all sectors should seek to learn how their own productivity can be measured and improved and benchmark themselves against their competitors.

In 1996, in the board's first report on Canada's performance and potential, we pointed to the shortcomings in our manufacturing productivity performance, and we pointed to the importance of productivity as the underpinning of what all Canadians want: a high and sustainable quality of life. We benchmarked Canada against the United States and showed that we had much room for improvement. This message was repeated in P and P in 1997, 1998, and again this year. Nothing has really changed. Our new estimates of labour productivity in manufacturing through 1999 show that Canada's growth rate will again lag behind that of the United States, for the sixth year in a row.

So far the debate in Canada is coming up short on the real issue. We are not addressing the interplay of productivity, costs, and the exchange rate on our manufacturing competitiveness. During the decades of the 1990s, we recorded average labour productivity growth of about 2.2% a year compared to 3% a year in the United States.

If you look at our chart on page 3, you'll see that this is the chart that I'm referring to at the moment. When we look at how our costs are tracking relative to our productivity growth, we find that the annual growth rate in compensation per hour worked for all employees in manufacturing has been increasing by about 3.3% a year, in contrast to 3.8% in the United States.

Taking the difference between compensation per hour worked and output per hour worked, we obtain labour costs per unit of output. They have increased by 1.1% a year compared to 0.7% a year in the United States. That's the third bar in that chart for each of the two countries.

It means that the compensation cost of producing goods has risen more quickly in Canada than in the United States, on a sustained basis through the 1990s. Our cost increases are outstripping our productivity increases. Our ability to sell abroad as well as to sell at home in the face of competing imports is deteriorating.

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So the Americans are generating higher productivity growth, and it is closer to their compensation growth. These compensation gains are therefore more sustainable. This is less true in Canada. We can take no pride in the fact that our compensation increases almost match those in the U.S. Our productivity growth is still too slow to support these increases.

We must understand that high incomes come from high productivity. The higher incomes of U.S. citizens are largely the result of their higher productivity and their ability to match compensation and productivity growth. In the end, their industrial competitiveness is reinforced by this capacity, something we need here in Canada.

The final part of the record of the 1990s relates to the impact of the exchange rate on competitiveness, and that's the fourth column in that chart on page 3. Even though our dollar rose a bit in the early 1990s, it has fallen about 2.4% a year since 1989. Thus we've seen our unit labour costs in U.S. dollar terms decline by 1.2% a year, while unit labour costs in the United States grew by 0.7%.

We know we had a great trade performance in the 1990s, and employment and manufacturing have increased significantly because of this. But the above analysis suggests strongly that this is not sustainable. Too much of it has been built on a devalued currency.

Because Canada's unit labour costs evaluated in U.S. dollar terms have fallen by 1.2% a year in the 1990s, our products have become cheaper. This has bolstered our competitiveness in U.S. markets, but it is also logical to conclude that this situation is hiding a fundamental problem: a weakening manufacturing competitiveness. This is the part of the debate around productivity that is so far missing and on which we think Canadians must focus.

As we end the 1990s, it seems clear we've built our house on an unsafe foundation. Our lower dollar has allowed Canadian manufacturers to avoid controlling their costs relative to their ability to improve their productivity, and it also takes the pressure off attempts to improve productivity.

Over the last two decades there has been a great deal of research on the sources of productivity growth and why manufacturers in Canada seem to underperform those in the United States. The basic conclusions were reported in P and P 1996 and relate to the following broad areas.

The pace of change in the industrial structure has been slower in Canada than in the United States, and we did not move as quickly into faster productivity growth industries such as electronic and communications industries. There is also evidence that Canadians have less capital equipment to work with than Americans.

Furthermore, the contribution of R and D spending to industrial growth has been lower in Canada than in the United States. Our innovation processes, our industrial structure, our ownership structure, and the pace of innovation in Canada could all stand improvement. Generally they are seen to be slower than in the United States.

These analyses focus on the structure of the economy and its industrial mix. They do not focus on the microeconomic factors that affect the productivity of individual firms, where at the end of the day we have to find our solutions. This research is found in the management literature, where organizational effectiveness and management innovation capacity are the central topics of discussion.

In P and P 1998 we pointed to the importance of human resource management techniques that align the incentives of people within those organizations and help create what we called an environment of inventiveness at work. Innovation systems that foster risk-taking and ensure that new ideas are quickly brought to market are non-trivial elements for the modern manufacturer to develop.

Highly productive organizations are those that are able to create additional economic value through innovation in products, processes, and organizational structures and behaviours. These are among the areas of organizational effectiveness we have referred to as the softer but harder things that underlie higher productivity.

In the final analysis, we have not found a single simple solution to improve our productivity. It is clear that many factors affect our ability to produce goods efficiently, and these include organizational effectiveness as well as the policy framework set by governments.

At the organizational level, the ability of people to put all the pieces together depends on their basic skill sets. Their education levels and on-the-job training affect everything from their ability to make optimal use of equipment to their ability to take on new activities quickly and efficiently. And the importance of attitudes towards doing an honest day's work for an honest day's pay cannot be overstated.

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The ability of management to innovate and to bring forward new products is probably the element in the productivity mix that is the most difficult to measure and evaluate. The capability of management must not be overlooked as we seek ways to boost our performance.

In the past two weeks we released our first annual innovation report. We benchmark Canadian firms on about 70 indicators, and we find evidence that strong innovators outperform weak innovators. But we also find, for seven measures of innovation, that Canada is near the bottom of the group, and that since 1981 the situation has worsened in almost all cases.

The last area we want to emphasize has to do with our poor record of on-the-job training and development in Canada. We report on this in our P and P work, but the message that adult literacy and our high school dropout rate are serious challenges is still not as well understood as necessary. With a 15% high school dropout rate and some 52% of Canadian adults in manufacturing having level-one or level-two literacy on a five-level scale, it is no wonder we have trouble boosting innovation and productivity in manufacturing.

The board believes lifelong learning will have to become much more of a watchword for business and our society if we are to achieve our potential. At the moment the evidence is that those most in need of literacy improvement don't even believe they have a problem or that it affects their work.

The impact of government policies is important too, because they affect the framework within which business is carried out. Governments can get in the way of entrepreneurship by imposing regulations and legal processes that hinder change and innovation among enterprises of all sizes. They can erode the incentive to compete by providing protection and limiting markets. They can tax inputs such as labour or equipment and deter investment.

We want to end by saying wise Canadians will concentrate their efforts on productivity improvement with a vengeance. They will work hard to find sound measures in their organizations, measures that are relevant to their businesses and that can be benchmarked against other organizations. Otherwise their jobs will be at risk, whether they are a labour leader, a president, or a wage or salaried earner.

Building a culture of productivity improvement is going to be a huge challenge for Canadian organizations, yet it is the only task that will ensure we can meet our goal of a high and sustainable quality of life. Our reports on Canada's performance and potential emphasize the need to improve our record of adult literacy and our high school dropout rate. They also highlight our very poor innovation performance and the complexity of making significant progress in these areas.

But if we really want to maintain what we have as a society, never mind improve on it, we will have to do much better in the areas of developing and maintaining people skills and in boosting our innovative capabilities and productivity.

With those comments, I'd like to stop now. I look forward to the discussion period. Thank you.

The Chair: Thank you very much, Mr. Frank. I'm now going to turn it over to Dr. Andrew Sharpe, the executive director of the Centre for the Study of Living Standards.

Dr. Sharpe, please.

Mr. Andrew Sharpe (Executive Director, Centre for the Study of Living Standards): Thank you very much, Madam Chairman.

I'd like to thank the committee for the invitation to appear today. I'm very glad to see the industry committee is investigating the productivity problem. I believe this is the second standing committee doing that this year. This attention to the issue is very well merited, given the importance of productivity as a key determinant of our standard of living.

I'm going to address the manufacturing productivity issue, and in many ways my comments are complementary to those of Jim. In fact I agree with much, if not all—well, probably not all, but most—of the comments he made. I'm going to go a little deeper into this issue of manufacturing productivity, which is a topic the Centre for the Study of Living Standards has been looking at recently in depth. In fact we are planning a conference this January on exactly this topic. I believe I've circulated the preliminary program to you.

As Jim pointed out, in the 1990s we've had about 2.2% average annual output per person-hour increases in manufacturing productivity, and that compares to about 3% in the United States. This differential of around 1% has meant our productivity level in manufacturing has fallen from about 78% of that in the United States in 1989 to about 73% in 1998. This compares with an overall productivity gap of about 20% with the United States. In other words, our average output per hour in the total economy is about 80% of that of the United States, yet in manufacturing it's only 73%.

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This poses three questions for us. The first, a general question, is why is our labour productivity lower than that of the United States in manufacturing and overall in the aggregate economy? The second question is why is productivity growth in the 1990s in manufacturing slower in Canada than in the United States? I guess a third and related question is why is manufacturing doing worse than the non-manufacturing sectors in terms of the overall productivity level vis-à-vis the United States?

Those are the issues I'd like to pose. I don't think, at this stage, there's any definitive answer to that, although we have a fairly good idea. I'll just go through some possible explanations.

First, I'd like to say there's been a large number of possible hypotheses put forward to explain our relatively poor manufacturing productivity growth. In fact you can have a laundry list. I'll just go through some of them, just throw them out in the air for you. I'll get into what I think are the key factors in a minute.

People have talked about the low value of our dollar, which has shielded manufacturers from the imperative to improve productivity growth. People talk about the poor performance of small firms in Canada relative to small firms in the United States. People talk about measurement differences and how we put together our productivity numbers. They talk about greater labour rigidities in Canada, the slower pace of economic restructuring, which is one Jim mentioned, our higher taxes, our poorer managers. For those there is anecdotal evidence, one could argue, to support them.

I would argue, though, that the key explanations are probably in other areas, although they are related to some of those.

To get at the explanations for this gap, we have to look at the determinants of productivity growth. There's a mass of literature on this, and there is certainly expert disagreement on the sources of productivity growth, but overall, productivity researchers have identified about six major areas of concern, which I'll go through. I'll just list them off and then I'll go through them in more detail.

One key determinant of productivity growth is the whole question of capital accumulation. A second is technical progress and innovation. A third factor is human resource quality. Three other general factors are the macro-economic framework of the economy, the micro-economic framework, and what I call industrial structure and intersectoral shifts. I'll go through all those six factors and how they've affected the gap in productivity between Canada and the United States.

I passed out a brief paper that summarizes this, but I will say my comments here are really preliminary in a sense. We are having this conference in January where we have 15 papers with researchers from Europe, the United States, and Canada looking at this issue. The results of that conference may change my perspective on this issue. In that sense, the research on this issue is still in an early stage.

If one looks at capital accumulation, because capital is essential for productivity growth, the more capital a firm has, in general, the more highly productive it is. It's true that basically our investment in machinery and equipment has, as a share of GDP, been lower than that of other countries. So one could argue that has been a factor.

When one compares capital and labour ratios between countries, however, there's a major problem here in the sense that there are problems in the measurement of the capital stock. One of the trickiest areas of economics is to get a handle on how we put together estimates of the capital stock. Different agencies in different countries use different depreciation rates. For example, in Canada we write off equipment very quickly in terms of the national accounts, about 18% a year, compared to a depreciation rate in the United States of 4% a year. So actually one cannot really compare capital and labour ratios between Canadian and American manufacturers from the official data. There's uncertainty about that, but in general I think it is true that our overall capital per worker is less than that in the United States, and that certainly explains part of the overall slower labour productivity growth.

One ironic thing, though, is a lot of debate about productivity has been in terms of total factor productivity. I'm not going to get into that today at all, because I think labour productivity is a superior measure of productivity if you're looking from the point of view of living standards. If you're concerned with efficiency in the use of resources, then capital productivity is probably a better measure. But from the point of view of living standards, it's labour productivity.

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It's very complex the way researchers put together the estimates of total factor productivity. There are disputes right now between Statistics Canada and Industry Canada on what is the best way. It greatly confuses the debate, because we have not actually done that badly in terms of total factor productivity growth vis-à-vis the United States, because we apparently use less capital than they do. When a country uses a lot of capital then it's probably going to have a poorer performance in terms of total factor productivity but do better in terms of labour productivity.

In any case, I think there is something to the point of view that we do have a lower capital per worker in Canada than in the United States, despite the technical difficulties with that measurement.

The next question is the point about technical progress and innovation, because the bottom line is that productivity in the long run is driven by technical progress. The key here is that Canada imports over 95% of its technical progress from other countries, particularly the United States. So it's not our R and D effort in Canada as much as it is the world R and D effort that results in our using the latest innovations. However, if we don't do the R and D in Canada we may be less able to adapt it from other countries. And we certainly spend a lower proportion of our GDP on R and D than other countries.

So from that perspective, again I agree with Jim: I think there is something in our relatively poor innovation performance in the R and D area that has contributed somewhat to the slower productivity growth. But it's really very hard to put precise estimates on that.

In terms of human resources, here I think there's less of a problem than there is in the two first areas I mentioned. If you look at the percentages of post-secondary students, we have literally the highest in the world in terms of post-secondary students as a percentage of the relevant population group. We may have problems in high school completion or industrial training, but I don't think they're as severe as some people have made out. So I think overall our human resources have done quite well. While there are still problems—you can never say there's no problem, because then you become complacent; you always want to highlight the problems. But overall, I don't think the problem of our gap lies in the human resource area.

If we look at the other two more general macro-environment issues, the macro-economic environment is very important for productivity growth. Unfortunately, economists disagree on what is the most appropriate macro-economic environment. Some of them say all that matters is low inflation, all that matters is getting the deficit down, reducing the debt-to-GDP ratio, and that will take care of itself in terms of robust economic growth. That hasn't happened in the nineties until very recently.

Some argue that in the latter half of the nineties we've had a very favourable macro-economic environment and eventually it's going to pay off. That may be true, but another perspective is that the macro-economic environment is linked to the overall aggregate demand conditions, and they have been very weak in the 1990s overall, although they picked up a little bit lately. If you have poor demand conditions, manufacturers cannot have long production runs; there's less scope for economies of scale, and you do poorly in terms of overall productivity growth. Definitely in the 1990s our manufacturing output growth has been inferior to that in the United States. So it's possible that has contributed to our slower labour productivity growth.

The micro-economic environment refers to trade policy, competition policy, tax policy, regulation. There have been many changes and improvements, I would argue, in our micro-economic environment of the 1990s for productivity improvement, and I don't really think there's a lot we can do in this area. I don't think there are massive differences between our micro-economic environment and that of the United States. We've done a lot in that area; I don't think we have to improve that in many ways. On the margins we can improve productivity, but it's probably not the key area.

The final factor and I think the key one is the whole question of industrial structure and intersectoral shifts, because all manufacturing productivity in a sense for the total sector is a weighted average of the productivity of the different subsectors of 20 manufacturing industries. And there are different growth rates and productivity levels within those sectors.

In relation to what's happened in the 1990s, I passed out a document about new estimates in manufacturing productivity. Unfortunately, I didn't have enough copies for everyone. We did a study earlier this year looking at the industry-by-industry productivity growth, and we found that more than half of the Canadian industries, of the 19 industries at the two-digit level, actually experienced superior labour productivity growth in Canada in the nineties to those in the United States. So most industries in Canada are actually doing better than the United States.

There are two industries that completely dominate the picture. These are the machinery industry and the electrical and electronics equipment industry—if you want, the new economy type, high-tech industries. In those industries, the United States has done much better than Canada. In fact those two industries account for literally all the increase in real output in manufacturing in the United States.

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In addition, those industries have much higher productivity levels than do the other industries. So basically, if you exclude those two industries, Canada actually increased productivity at the rate of around 2% a year, which is the same as the overall manufacturing, but in the United States the increase was literally 0.2%, much lower. Those two industries really are the key story for our inferior manufacturing productivity growth.

There has been a massive shift of resources in the United States towards those two high-tech industries. I am assuming we're getting our numbers right. We're assuming very large price decreases in the computer sector. If we're not getting our numbers right, then all these numbers really don't mean anything. Let's hope the statisticians are getting the numbers right. But as I say, these industries have grown by leaps and bounds, and they are a much larger share of the American economy than they are of the Canadian economy.

So that shift into new very high-tech industries appears to have been slower in Canada, but we really haven't had a good study to show why that is the case, whether it's linked just to our lack of innovation, or just to the agglomeration economies that are found in the United States high-tech sectors, where everyone wants to be, which has resulted in massive growth in those industries. So in that sense, when we talk about manufacturing, it's very important to distinguish the performance of those two industries and the performance in other industries, which has not been that bad.

To conclude, again, as I say, I think our understanding of this issue of manufacturing productivity is preliminary. After our conference we'll have a better understanding of the overall issue. But I would like to reiterate Jim's point about the importance of those two high-tech industries in explaining our inferior performance vis-à-vis the United States.

The Chair: Thank you very much, Dr. Sharpe.

Before I turn to Mr. McCracken, I'm going to deal with the motions while I have a quorum of nine. I know some people will leave for House duty around ten o'clock, or when the House opens. I apologize to the witnesses for doing this in the middle of the proceedings.

In front of you we have the supplementary budget and the working lunches, which was business arising from the subcommittee. Maybe I could have somebody move the first motion on the supplementary.

Mr. John Cannis (Scarborough Centre, Lib.): I'll move it.

(Motion agreed to) [See Minutes of Proceedings]

The Chair: Now the second motion, regarding working lunches.

Ms. Marlene Jennings (Notre-Dame-de-Grâce—Lachine, Lib.): So moved.

(Motion agreed to) [See Minutes of Proceedings]

The Chair: Thank you. I apologize very much.

Mr. McCracken.

Mr. Michael McCracken (Chairman and Chief Executive Officer, Informetrica): I was just seeing a good example of productivity. Getting that through required good timing and everyone's participation.

What I'd like to do is perhaps step back and not get quite as technical, but you'll hear some of the same themes coming through. I'd like to spend a minute on what productivity is and how it relates to some other concepts that people often refer to in the same breath. I'll make a couple of observations there, try to get a sense of what matters and what to do in terms of improving it, and also figure out how we are doing.

Essentially, productivity is a ratio of outputs to inputs. So you can think of it in real terms as tons of steel per production worker. You can think of a symphony performance as the output relative to the inputs of a concert hall: the musicians, the conductor, and the attention of the audience. You can think of productivity in the policy area, with decisions on an unemployment insurance program over the inputs: research base, consultation, political debate, and so on. Or you can think of sausage as an output relative to the inputs: the butcher, equipment, services, and the animals that not necessarily participate voluntarily in that. In fact the sausage-making and the decisions on UI may be a similar process in some people's minds.

What you find very quickly when you start doing that is that complications arise. There is a tendency to try to find a way of adding together the outputs and the inputs; hence we end up with some notion of constant dollars. But we're very quickly moved away from physical measures of output over physical measures of input, even though we do try to approximate it that way.

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Another way of sorting these things out that I have found useful is boxes, as I call them, on the second chart, in which productivity is a concept of the workplace. So I basically anchor the notion of productivity as a concept at the level of the firm, or government department or other organization—that is, the workplace. It is the base for competitiveness and for real income gains, but not the same as that.

The notion of competitiveness is a concept of marketplaces. Here we're talking about the relative costs. These determine whether the operations of a firm will be sustainable, and indeed whether certain industry can continue.

But even that is not what it's all about, because in fact that competitiveness in the marketplace is the base for or part of the story of what happens in society, the third box in the diagram. Prosperity is a societal concept that has to do with improvements in real income, in the quality of life, equity and environmental sustainability, all those being some of the goals.

The simple point is you can have productivity growth and not achieve competitiveness; you can have competitiveness and not achieve prosperity. The point is that actions are required all the way up that chain to be successful.

If we look at productivity, we think we know what it takes to cause it to happen directly, the driving forces. I've summarized those on a chart: improved human resources; higher investment effort; adoption of new technologies; better infrastructure on the public side; as well as what Andrew Sharpe just described to you, a productivity twist where you try to emphasize, if you can, the production in areas in which you have particularly high levels of productivity per person.

From the policy side, there's some debate, but they basically break into the notion of less inflation, a better macro-policy, right framework policies—you hear a lot about that—and then a series of human resource issues, which Jim Frank mentioned as important: better education and training; the capacity to use skills; and the right organizational structures for business.

You have a similar story on competitiveness. Competitiveness has to do with improving the efficiency and effectiveness of the marketplace. Internationally, it's a question of your relative price, quality, deliverability, and service. With governments, it's an issue of what kinds of regulations, standards, tax subsidies, crown corporations, international agreements, and so on. And of course there is that issue of the provision of physical infrastructure to move goods to market.

So what needs to be done from a policy viewpoint on competitiveness? Improve regulatory processes, reduce internal barriers to trade, improve access to international markets, expand the information infrastructure, and assist Canadian firms in entering new markets. These are not new things for governments to be doing, and they continue to put some effort into that.

Prosperity, though, comes down to this: Do we in fact achieve rising real incomes for all Canadians? Do we have a sustainable environment? Are we making contributions to the rest of the world through aid, and so on? What are we doing to our regional economy? What about amenities?

Then, how's our style? Are people participating in this process or not? The “how” there is quite different. The “how” there is redistribution of income from a growing pie, efficient health care systems, a high-quality education system, encouragement of volunteerism, charity, and involving citizens in determining the goals we have.

Let's now come back to the whole issue of productivity. I'll throw a little arithmetic at you, but this is mainly just a device to broaden the discussion somewhat.

Most of the discussion about productivity is in the context of what's called a “production function”. Basically, it says output depends on the labour inputs and the capital inputs, and that's what you've heard us describing here from the technical side.

A number of years ago it was observed that other things besides that belong in the production function. In particular, for many industries, the capital is provided free to companies by governments. So-called infrastructure, physical infrastructure, turns out to be important too. You don't have much of a trucking industry without roads. Certainly clean water is a key input to the food processing sector, and so on and so forth.

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It has become apparent too that technology matters, so we've added this letter “T” where essentially you're looking at the amount of spending on R and D, at the adoption rates of new technology, etc.

A few years ago, in fact in the early 1960s, it became apparent that even with the notion of technology, physical infrastructure and capital and labour, it wasn't enough to understand the differences between countries and sectors...and also over time in a given country.

The letter “S”, standing for social capital or social cohesion, was added to the mix. This has in fact been a very exciting dimension of work more recently, with growing evidence that differences in social capital between countries have a lot to do with explaining different productivity performances over time. Two studies, one in 1997 and one in 1998, underlined this and also determined that this was the way in which the arrows went.

Even if you put all of that in there, there's a good chance there are some other things that belong in addition to this, and I've just added “X, W, and Z.”

Certainly one of the things, in my view, that belongs is the degree of economic slack in the economy. One of the characteristics of the Canadian economy, unlike the U.S. economy, has been our choice, by policy-makers, to run this economy with a couple of the spark plugs pulled out. We're essentially running on four cylinders on a six-cylinder or eight-cylinder automobile. That keeps the pace and speed of the automobile under control for those who are worried about inflation, but it is not clear that it's very helpful from the viewpoint of real income growth or in terms of productivity growth.

The last line on that slide also reminds us that aside from whatever the inputs are, we ought not forget that firms produce something besides widgets. The output of firms includes some good things—trained people. So even if the firm goes into bankruptcy, the residual will be people who have received training, experience, etc. Firms also produce baddies. They produce pollutants. Firms collapse, disappear, and then they go in and find out, my God, they left behind a set of residuals that will cost millions of dollars to clean up.

Why do you want to include that broader view of outputs? The very simple example, taken and done in the context of the U.S. economy, was an examination of the productivity growth in the electric power industry in the United States. If you observe its performance in the post-war period, you come away with the impression of essentially very little progress. In other words, you have 40 or 50 years in which productivity growth, for all practical purposes, has been zilch.

If, however, you include as the output of the electric power sector the pollutants that it produces, what you will observe is that they have greatly reduced those pollutants over the post-war period. If you put a value on those and count it as a negative output, then in fact what you observe is about a 1% or 1.5% per year growth in productivity in the electric power industry with that augmented output measure. It's important to think about not just the input side but also the output side when we discuss productivity.

In a very provocative piece last year, in March 1998, Arnold Harberger put forward a view of productivity in a rather different way, which might be of help to you. He essentially interpreted productivity, particularly total factor productivity of the residual. He just relabelled it and said let's talk about real cost reductions; that's what it's really about—at the firm level it's real cost reductions. Just to quote him, he says:

...it gives life to the residual, viewed as real cost reduction in a way that remote macroeconomic externalities never did. It gives the residual body, in the sense that the number of dollars saved by real cost reduction is a tangible and measurable quantity. It gives the residual a name (real cost reduction), an address (the firm), and a face (the face of the entrepreneur, the CEO, the production manager, etc.) And finally, we shall see that there can be vastly different expressions on that face, even as we move from firm to firm in a given industry, as the TFP experience of a period moves from sharply positive to devastatingly negative.

• 0950

Now, the point he had made and one of the things we hoped his work will encourage in Canada is an examination at the individual firm level. If productivity is a firm concept, you ought to go looking for it at the firm. On a comparison across firms in a given industry, what he found was vastly different performances in firms in the same industry.

It strikes me that it's from there that we have a lot to learn about how one can make an improvement in the overall productivity. This certainly links in well with the practices of the Conference Board and others that encourage a benchmarking against the best firms either in the country or even more broadly. The only extension I would add to the Harberger view is that we remember it is also the face of the employees, as opposed to just the employers, who belong there.

We could talk a bit more about social dimensions, but let me, for the purposes of this meeting, leave that aside.

Here are a few things you need to concern yourself with. Remember productivity is a firm-level concept. Reducing slack in the economy would help. Remember infrastructure spending. Infrastructure spending in Canada has been declining in the post-war period. Worry as much about the social context as you do the technology and don't worry about the other factors. Also recognize that productivity is the start of a long trail through competitiveness to prosperity.

At the back of the handout I provided you with a few charts that will give you the context within which we operate. The GDP gap, in my view, is quite large in Canada—currently a little under 9% of GDP. That's a waste of about $80 billion per year. On our investment effort, the percentage of our GDP that we put into investment has been declining at almost all levels. In the area of infrastructure it is about half of what it was in the 1960s.

Just to reinforce the notion that productivity is only part of the story, if you look at labour productivity and real wages, one of the things you will observe in Canada is that real wages have not been reflecting the productivity gains that have in fact been occurring, particularly as viewed by the employees. So that very first line of transmission of the gains of productivity into real incomes has been in fact held back or cut off in Canada because of slack labour markets and the relative power or lack of power of labour.

As a result, real disposable income in Canada, on a basis that 1981 equals 100, on a per household basis today is about 6% below the 1981 level. On a per capita basis, it's about 5% higher, but still below the 1989 levels.

So almost by any way you would measure prosperity in some broad income sense, we have been doing very poorly. We've also been doing very poorly in terms of convergence on our employment rate with the U.S., and we have a particularly low percentage of people working.

When we look at some measures of social cohesion, social capital, again we get disappointing indicators. One indicator that's specific to business is the percentage of managerial and administrative share in total employment. One of the interesting characteristics is the degree to which this number has been rising both in the U.S. and Canada. It is currently running about 14% of total employment.

If you look at this ratio across countries, very interestingly, all the European countries are at about 5%. Japan's about 5%. North America—Canada and the U.S.—is at about 14%. Perhaps it's reflective of some of the associated difficulties.

While we make the comparison, as you were hearing here, with the United States, which is an important comparison for trade purposes, for manufacturing purposes, productivity growth in North America—the U.S. and Canada—has been no screaming hell relative to the rest of the OECD and relative to many other countries.

Let me stop at that point. I'll be happy to respond to any questions that come up.

The Chair: Thank you very much, Mr. McCracken.

I'm just going to let the witnesses know that if a question is not addressed to you and you have a comment, let me know. This is to be a round table type of discussion.

Mr. Penson.

• 0955

Mr. Charlie Penson (Peace River, Ref.): Thank you, Madam Chair.

Welcome to the witnesses here today. I certainly wish we had more time to talk to this very interesting panel, but we'll do our best with the time we have.

It seems to me that how this associates with Canadians is their standard of living. Productivity has to come down to some kind of a measure for most Canadians. What that means, in my view, is what it does to their standard of living.

I've heard it this morning and I've heard it all over that the standard of living is going down. The amount of net pay people are getting is less. What they can buy with that net pay is even less than they would like. We've had this phenomenal export growth, particularly since the free trade agreement with the United States. Why hasn't that carried us forward?

Mr. Frank, I want to get into the difference in the dollar between Canada and the United States. It seems you've made the point fairly strongly that it's a faulty foundation to be building Canadian business on. We have this dollar differential. We have NHL hockey teams now saying that if we don't subsidize the difference between the Canadian and U.S. dollar, they're moving. We've lost a lot of companies. We've lost a lot of young people to the United States in terms of brain drain. How can we correct this dollar difference? In addition to that, if we don't move to correct it, where are we going to end up as a result?

Mr. Jim Frank: There are lots of things that drive the value of a currency. We've talked a little bit about macro-policy this morning. Monetary policy is one of them, as it relates to interest differentials. We've been trying in Canada to maintain an inflation rate that has been quite low for almost ten years now. We've been quite successful at doing that. We have had much lower inflation than the United States for a number of years. We have slightly negative interest rate spreads. One would think, as time passes, our currency will start to rise as a result of lower inflation rates in Canada. So that's one direction you would anticipate coming to. If you ask how you'd fix it, you would try to have an economy inflating much less quickly than your main competitor.

The other aspect has to do with the general attractiveness of a country as a platform for investment, because that drags cash into the country to build plants and equipment to manufacture or to sell, whether it's goods or services.

So the issue here for us, and a point we've made in our performance and potential work, is Canada is a tiny little place in the world. It somehow has to compete with other countries as a place to invest and to do business, to service bigger markets.

Ask yourself how attractive we are. How competitive are we? Our major competitor, let's not kid ourselves, is 150 miles from us. If the United States is seen to be a better place to invest, then more money will naturally flow there. Our currency, of course, will be weaker as a result of that, relative to the U.S. currency. So there's some element of that attractiveness of a country as a platform.

Mr. Charlie Penson: Mr. Frank, can I just interrupt to ask you something? How big a drag are our debt and high taxes in that regard in attracting that new investment, which brings the new technologies into Canada?

Mr. Jim Frank: I can't answer that with any precision for you. I honestly don't know. Perhaps my colleagues could address that.

Mr. Charlie Penson: I guess the reason I'm asking is that it just seems to me we're paying down our national debt now. We've finally got to balanced budgets at least. We're paying down our national debt at $3 billion a year. It will take 191 years at that rate to pay it off. I was just wondering what kinds of signals that sends out around the world.

Mr. Jim Frank: Perhaps I could address it this way for you. If you are looking at two different possibilities for a site to invest in, and one site has, I'll say, a heavier dose of taxation to support than the other site has, where do you choose to go? That is only one determinant of an investment decision, although it is an important one, frankly.

• 1000

If you look at the experience in Ireland, it's generally viewed that the reduction in tax rates there, particularly in corporate taxation, was quite instrumental in turning that economy around. But again, I frankly don't know how serious that issue would be in Canada—just an editorial on that.

At the board we did a lot of work on comparing tax load between industries in Canada and the United States. By and large, corporate-tax-wise we have a pretty competitive system here. The real challenge for our country, I think, is not, is just being equal good enough? It is, are we going to have to be better than the United States? That's the theme in this report each year. Just running even with them in certain things probably won't serve us well.

So taxes are important, but I can't tell you how closely they would be linked to, say, the value of the currency.

The Chair: Dr. Sharpe wishes to reply.

Mr. Jim Frank: Just quickly, the third issue around currency is the commodity price situation, and I think you understand that argument.

The Chair: Dr. Sharpe, you wish to comment?

Mr. Andrew Sharpe: Yes. I have a couple of comments on your point about productivity and living standards. It's of course in the long run that productivity is the key determinant of trends in living standards, defined as GDP per capita. In the short to medium term, there's also a key determinant of living standards, and that's the employment-population ratio: how many people are employed compared to the overall population?

Actually, what happened in the 1990s explains the decline in our living standards. It's not productivity deteriorating; it's the fall in the employment-population ratio. In fact, if you look at GDP per worker, there's actually no deterioration at all in the 1990s compared to earlier periods. Even in manufacturing, which is not as key to living standards as the total economy, even there, we talk about the gap. What happened was that the United States improved its productivity performance in the 1990s. In Canada we didn't, but we had approximately the same rate of growth as we did in the 1980s.

It hasn't been a deterioration of productivity performance that explains the deterioration in our living standards. It has been this fall in the employment-population ratio due to the higher unemployment and also, and even more importantly, due to the very large decline in our labour force participation. I think that's the key factor.

Then we can get into a discussion of monetary policy, fiscal policy, which played a role in that slackening—

Mr. Charlie Penson: In those terms, labour rate participation rather than how many people are unemployed, you would put it in the other—

Mr. Andrew Sharpe: There are two: the unemployment rate and the labour force participation rate together give us the employment-population ratio. Both of those factors working together determine the overall employment-population ratio.

Mr. Charlie Penson: I think anybody who travels in the United States these days can actually see that. People are better off. They have more people in the labour force. I think California has an unemployment rate of 1.5% or something these days—

Mr. Andrew Sharpe: That's right.

Mr. Charlie Penson: —and they're advertising, trying to get skilled workers.

Mr. Andrew Sharpe: Exactly. They have been very successful.

Mr. Charlie Penson: I guess for Canadians that's the attractiveness of moving to the United States. Is that why we're losing some of our people?

Mr. Andrew Sharpe: In fact one would have expected a larger flow of people to the United States from Canada in the 1990s, given the massive employment opportunities there compared to Canada. I'm surprised there weren't even more people going. According to John Halliwell, statistics don't show at all that there's been a massive increase in the number of people going to the United States—partly due to regulations on immigration.

I wanted to turn just briefly to your point about the dollar and the effect of the falling dollar on our living standards. I'll argue just the opposite: the low dollar has contributed to our living standards in the 1990s.

There are two effects of the dollar. First off, if the dollar declines, the prices of our imports go up. That means our inflation is somewhat higher than it would have been, so everyone is slightly worse off because of those higher prices. So a falling dollar can definitely lead to a decline in living standards.

But there's another effect: when you have slack in your economy, as Mike McCracken rightly emphasized, a falling dollar can result in increased cost-competitiveness and increased exports. We've actually seen that. We've had very strong export growth for the 1990s, in part linked to our decline in currency. Well, that decline in currency leads to additional jobs, and those additional jobs mean more income for Canadians and therefore an increase in our overall standard of living.

Mr. Charlie Penson: But you're saying it's in the short term as opposed to the long term.

Mr. Andrew Sharpe: That's right. It's in the short to medium term.

Econometric models show that our overall living standards have actually been improved by the decline in the dollar—in the short to medium term, anyway. Maybe there'll be negative long-term effects, but certainly we can't say that the decline in our dollar has resulted in a decline in GDP per person in the 1990s.

The Chair: Mr. Frank, do you have a final comment?

Mr. Jim Frank: I am just compelled to ask the question this way for us. If 68¢ hasn't had any impact on our living standards and so on, while it has clearly boosted our export performance...and we've been very lucky for the last couple of years, mainly because commodity prices collapsed around the world and deflation was the risk. In China today and in Japan, deflation is the issue. Surely to goodness...if 68¢ was a good idea, why don't we try 50¢?

• 1005

Depreciating our currency will not serve us well. The only way we can boost our trade performance and domestic employment is by continuing to depreciate our currency. I think, with respect, that we're going to have some serious difficulties. At some point, there is a relationship between the cost of stuff we import and consume and our currency—at least I think there is.

Now I agree with you on the short run, Andrew. There's no debate around that. The reason we've been focusing on this issue around competitiveness and the Canadian dollar is that over a long enough period of time it's going to—at least, we think so—start to show up, and it will show up in weakened competitiveness in our industries.

The Chair: Thank you.

I'm just going to let Mr. McCracken make a comment and then we're going to move on to the next question.

Mr. Michael McCracken: Okay, very quickly, there are all kinds of different ways in which you can think about exchange rate depreciations.

One way I have found convenient, at least, to think through things is to think of it as a tax that has been put on all consumers through higher import prices. The proceeds of that tax are taken and given to the business community who are exporting or who are competing against imports because now they have more room, if you will, to raise their prices. So far we can't see anything but a transfer from people to business.

Then the question comes up: what does business do with that transfer, with that increased income? If they invest, if they expand, if they improve employment, then you can say, hey, that was a good idea—compared to the loss of income that the individuals have. We find in our models that there is in fact a net improvement, but it's not as nice an improvement as you would get if business would go ahead and invest anyway, without requiring the subsidy from consumers to them.

In terms of the overall performance of the economy, it's enhanced on the employment side, but real disposable income does not improve under a depreciation by anywhere as much as corporate profits improve, for example.

I think one of our problems in Canada has been that lack of an environment to encourage businesses to say, okay, under that circumstance, I really want to invest, I really want to expand. It's of course because we tell them we're not going to let this economy grow too rapidly, we're not going to let it overheat, so what they say is, why should I invest?

Mr. Charlie Penson: Or they invest outside the country.

Mr. Michael McCracken: Or they'll go outside. That's the other problem. That's right. So you lose it that way.

On this employment ratio, just as footnote, on your handout at the top of page 9 there's a chart that shows the employment ratio and the participation rate over time. The numbers after 1998 are a forecast, but prior to that they're the history, so you get a sense of that dip that Andrew Sharpe was referring to.

The Chair: Thank you very much.

Mr. Cannis.

Mr. John Cannis: Thank you, Madam Chair.

I too would like to welcome the panel. I'm just so happy to see that there's debate on that side like there is on this side. I really don't know where to start. It's a most interesting issue.

I just want to start by quoting Mr. McCracken when he said ratio of outputs to inputs.

Going back to some of Mr. Sharpe's comments, you talked about benchmarks, you kept referring to benchmarks. One of the areas you kept referring to, of course, was the area of education, training, lifelong learning. I agree with you very much.

Just for the record, as I'm sure you're well aware, in trying to resolve this issue, as we all agree, I believe, it's not one bolt that we can put in and say that's it, it's over. It's a combination of bolts: labour, training, lifelong learning, and employers' obligations to keep their staff up to date are there.

I'm hoping, for the record, that as for this shared responsibility—now that we all know labour training is a provincial jurisdiction—that they too identify it. I don't know if you have spoken to our provincial counterparts. You talked about—if you could elaborate on it—literacy, the high school dropout rate. It dawned on me when I was watching a program just the other night about an area in Virginia, I believe, where the average income was $10,000. The primary reason was the fact that most of the people in that area had very limited education and as a result had limited skill sets and no attractiveness.

• 1010

What do we do, in your view, to move forward positively and to get the message out that we need a well-trained, well-educated force? To my knowledge—and correct me if I'm wrong—a 15-, 16- or 18-year-old who today unfortunately is on the unemployment rolls should be in school, should they not? Should we enforce mandatory programs to make them stay in school? How do we overcome that?

I want to touch on something you said, Mr. McCracken, with respect to a comparison. I've heard you speak in the past. You and others told us years ago, as a government coming in, look, take care of your deficit, take care of your GDP ratio, and get your finances in order, because that will fix it, or part of it.

Mr. Michael McCracken: I don't think you will find me on the record as ever having said that to this government, but that's neither here not there.

Voices: Oh, oh.

Mr. Michael McCracken: Some of these other fellows, yes, but in fact I think I've been just about the opposite of that.

Voices: Oh, oh!

Mr. John Cannis: Monetary policy and training of the labour force—is that the main thrust, would you say, Mr. Frank?

Mr. Jim Frank: Perhaps I can ask you to look at page 8 in the handout I gave you. I want to give you a mental picture.

Now, Brenda has done a lot of work at the board on this literacy issue. If you look at the bottom of page 8, you'll see the percentage of youngsters who do not complete high school. This goes across the country.

The average for Canada is around 15%. By the way, we're giving them lots of time to finish high school. They get until the age of 24 to do it. We're asking whether they finished high school by the time they were 24. You'll see that about 15% still do not do that.

The next part of the story is that if we lose that proportion of our population, how can we possibly expect them ever to be self-sustaining and to add value in their society by working? Chances are, it's not going to happen.

What's a solution here? My wife is a high school teacher. She's been in a classroom teaching mathematics for 30 years. It is a real challenge to match the child's capacity and interest with programming. If I left you with one message that I believe is true for Canada, and maybe the United States as well, it would be that we have this focus on universities and university programming with an excess of zeal that is not serving well a lot of our young people.

So I think there needs to be more matching of youngsters with their capabilities. The obvious areas are in the technical schools, the colleges, the institutes—

Mr. John Cannis: Matching them earlier on in their lives, you mean?

Mr. Jim Frank: Yes.

Mr. John Cannis: When they go into high school?

Mr. Jim Frank: For youngsters who are 15 and going up, when they have an aptitude for certain areas we should allow them to pursue that as opposed to the current programming, which they find boring or find they are incapable of handling. That's just one editorial on that.

Perhaps I can now get you to notice the bottom of page 9, with regard to document literacy skills.

Brenda, if you can add something to this, feel free to do so.

The international adult literacy survey has three different areas—documents, prose, and mathematics. All we're showing you here is document literacy. There are five scales. Level one is the bottom and level five is the top.

Notice that in Canada, about 41% of our adults are at levels one and two of document literacy. In manufacturing, ladies and gentlemen, it's 52% in the lowest two levels.

In practical terms, level one literacy says you cannot read and write. Level two says you can do a little bit of that, but you'd have trouble filling out a job application form, for example.

Look at the next page, at the middle chart on page 10. We asked people in that adult literacy survey what they thought of their skill set. We asked that of the two low levels. Almost 30% think they have good document skills and another 30% think they have excellent document skills. So of the bottom two levels, 60% think they're good to excellent.

Then, as the last chart on page 10 shows, we asked them if it made any difference on the job, to which 60% said they didn't think it was limiting at all.

• 1015

Brenda has coined the phrase “Know versus know-not”—that is, a lot of people in our economy don't know that they don't know.

At the Conference Board we push this stuff at the organizational level, because that's where productivity happens. I shouldn't say “happens”; that's where you make change occur. You have to drive it at that level.

But if you don't have good on-the-job training—and we can document and show that Canadian organizations assess themselves as having poor on-the-job training records—then how are we going to turn this around?

So the dropout rate and on-the-job training are two really important things, and they're human capital development.

The Chair: Mr. McCracken.

Mr. Michael McCracken: I have just a quick point with regard to on-the-job training. It strikes me that this a place where linkage to the state of the macroeconomy is important.

If you have an unemployment of 7.2%, or a youth unemployment rate of 14%, which is the current unemployment rate for people under 25 in Canada, you have to ask yourself, as an employer, “Why would I train?” The issues becomes, even from a public viewpoint, “Why should we bother?”

What you observe in tight labour markets is quite the contrary. In the United States today, when you have unemployment rates of 1% in some of these urban ghettos, employers are out there saying come on, we'll train you; we'll put a bus down there, bring you to work, give you the training, and then we'll give you a $16-an-hour job. Why is that happening? It's not because of the altruism of business; it's because that's the only way they can get workers. They're basically profit maximizers, cost minimizers.

So we can exhort them to do on-the-job training, but you're not going to see any of it as long as the calculus, to them, says, well, wait a minute; it's cheaper to hire someone off the street than to do the training ourselves. That's not something the firm, in some sense, has control over; that's directly the responsibility of the Bank of Canada and the Department of Finance.

The Chair: Mr. Cannis, you have a final question.

Mr. John Cannis: The comment was made that when the economy heats up, of course, we step in to slow it down. We hear the U.S. sometimes....

Can you explain that for me? When an economy is in a robust state, why would Greenspan or whomever go in and say we're going to step up, raise the rates, and slow down the economy? Why would they do that, Mr. Frank?

Mr. Jim Frank: The argument occurs around a concept of full employment. The non-accelerating inflation rate of unemployment, or NAIRU, is the unemployment rate below which inflation is believed to start to accelerate. In other words, it moves from 2% to 3% to 4%.

The Conference Board's estimate for Canada is, as we speak today, around 7.8%. In other words, our NAIRU is 7.8%. I have to admit freely to you that there is a lot of argument around this on decimal numbers, but think of it as somewhere in that neighbourhood.

If, when unemployment nationally falls below that level, you believe labour markets are so tight that the wage increases employers are forced to pay to keep their staff and to get new ones outstrip productivity gains, and therefore require the cost increases to be passed on, yielding higher inflation rates at the pump or at the store or wherever you measure it, then that's the argument. Across the country, clearly there are significant differences here.

Let's look at the situation right now in Canada with regard to forecasting. In Alberta it's generally agreed that Alberta is running above full employment. What you see in Alberta are pay settlements in industrial relations that are running at roughly twice the rate of increase in Ontario. This has been going on now for about a year.

So what you're seeing there is a microcosm of the theory, at least, that when unemployment rates fall into that tight category, the pay increases start to accelerate, and at some point you will see some inflation coming out of it. We've not seen that yet, neither nationally nor in Alberta. So that's where this comes from.

The argument then becomes, well, if you want to keep inflation under control, then as soon as you start to get into that territory you make speeches about how labour markets are too tight and how we have to tighten things up and slow things down so that people can't get too much relative to what they're producing. That leads to price increases coming through in the consumer price index measures of inflation. That's the argument.

• 1020

In the United States, since mid-1997, every state has been at or above full employment measures, with the exception of Hawaii. Hawaii has not because it got hit very hard with the Asian problems. Yet in the United States, where's the inflation coming? Where are the wage costs push problems coming? They're not obvious. Yet the federal government is clearly saying now they're more anxious about the possibility of inflation picking up more quickly than they're willing to live with. We saw a similar move here in Canada.

How serious this will be is open to debate. If we get a soft landing, as we describe it in the United States, Canada will probably follow suit, and we won't have a serious slowdown. At least that's our sense of how it will work out. But that's the theory and the logic behind it.

The Chair: Mr. McCracken, you had a comment.

Mr. Michael McCracken: It's a bankrupt concept and a poor guide to policy. To say you go out and deliberately raise unemployment for purposes of lowering inflation is analagous to saying you're worried about the environment, so you're just going to close down the companies. If that were our policy for fighting environmental problems, the corporate sector would be the first to belly up and say “Wait a minute. You have to find another alternative. There has to be a better way.” In fact, we know there are better ways. We have taxed polluters. We have “don't litter”. We have all kinds of controls, exhortations, tax-based systems, etc. All those could be used equally well in concern about inflation.

If we are really going to start applying this negative concept on a regional basis, that's great, but let's dust off a regional tool. Let's have, for example, personal income tax increases in Alberta to slow it down, and tax cuts in the rest of the country to speed them up. We can do it on a postal code basis if we want to fine-tune. There's certainly some merit in that, if it avoids higher interest rates for all Canadians and the bankruptcy of firms and individuals throughout the country.

The Chair: Thank you. Thank you, Mr. Cannis.

[Translation]

Mr. Dubé, please.

Mr. Antoine Dubé (Lévis-et-Chutes-de-la-Chaudière, BQ): I could not read everything for lack of time, but it's all very interesting and I thank every one of you for providing us with all those data.

Do you have a spread of those data by province?

Mr. Andrew Sharpe: At the Centre for the Study of Living Standards, we have set up a data base on productivity where we have data for each sector in each province.

For instance, for Quebec, we have the data for about a hundred industries and we have estimates starting from 1984 going up to 1997, I believe. We'll get the data for 1998 in a few weeks. You can access it free of charge on the Internet. We have estimates for the labour productivity level and also for the growth rates. We also have estimates for capital productivity and total factor productivity. Everything is there for you to check.

Mr. Antoine Dubé: At your Internet address.

I am particularly interested by capital productivity. Very often, in the public perception, the labour costs, the number of days worked during the year, the time lost because of strikes or sick leave, etc. are the things that have to matter. But capital is also a factor. And Mr. Frank from the Conference Board said rightly that in this regard, we are at a disadvantage with the United States because the investors go where there is economic growth and where the growth of their capital will be higher in their view. How can we fight that trend?

[English]

Mr. Jim Frank: That's certainly part of the challenge. I can't give you a simple answer to this. I'm very concerned personally, as a Canadian, that our country isn't as attractive as it will have to be, particularly because the North American market is becoming so integrated and so much a single market.

• 1025

If you think of it in this way, it's almost impossible, from our perspective, to think of the Canadian auto industry as distinct from the U.S. auto industry. It's a North American industry. Where that investment flows is very much a function of where the people who make the decisions around the most profitable and productive place locate an engine plant or an assembly plant. That's what drives it. You immediately go to things around the firm level issues. That's why the Conference Board keeps harping on the point.

Organizations that deal with this—executives, unions, and the people on the shop floor—make a difference. It goes to the training, the decisions around what's most profitable, the regulatory regime, and environmental issues that are very much at the top of people's minds today. For example, there's been a lot of argument about development at Voisey's Bay. That's just a current example of a potential development that will take quite a long time to get going, as we thrash that out. Are we going to be making the right decision or not? I don't know. The same thing would apply to auto industry investment and high-tech investment.

The challenge is to fix this for Canada and make it a relatively more attractive place. That's what you have to try to come up with. It won't be just one thing. Taxes won't do it, training won't do it, R and D incentives won't do it. A package of the whole picture will have to be attended to.

[Translation]

Mr. Antoine Dubé: We could divide the industrial area into two sectors: on the one hand the traditional businesses and on the other the modern businesses. We hear that it is often easier to improve the qualities of a person than to correct his or her shortcomings, but on a country level, some regions are dragging their feet or have more difficulties.

For example, one of you talked about the Atlantic region, about its remoteness, etc., hence its lower productivity level. It's fine to say that we are going to improve the situation for the stronger regions in their best performing sectors, but what happens to whole regions which are destined for unemployment and who become a burden for the whole country?

Mr. Andrew Sharpe: It is of course a challenge. We have regional development policies in Canada. We know that there is one for the Atlantic region, one for Quebec and one for Western Canada. There is no magic bullet for that. The solutions are always the same. We have for instance human resources development in Atlantic Canada and innovation, mostly in small and medium sized businesses. The solutions are the same for the poor regions and for the rich ones.

Mr. Antoine Dubé: But if they are the same, they do not remedy the situation. How can we correct the situation?

Mr. Andrew Sharpe: In a capitalistic economy or in a free market economy, we will always have aggressive regions and others that are less aggressive. This is part of the game. Therefore, you cannot have a system where each region has the same growth rate. Some regions will do well for a certain time thanks to the commodity price and others will not fare as well.

Mr. Antoine Dubé: We often talk about the growth rate and the productivity rate and we have a tendency to compare them with that of other countries. I have been in the sports business, where a younger but less fast athlete can improve more quickly his performance. But at a certain point, it is more and more difficult to improve beyond excellence.

Is comparing the increases in growth rate the ideal measure? Shouldn't we instead weigh progress taking into account the productivity level itself?

Mr. Andrew Sharpe: Good question. It is true that in the past, we had a growth rate of 2%, it was not that bad, for in 35 years, we managed to double the standard of living. But if the United States have a growth rate of 3%, they will grow more quickly and the gap will increase between the standard of living in Canada and the standard of living in the United States, even if that of Canada continues to increase 2% per year.

Do we want a measure of our standard of living as compared to that of the Americans or a measure of the standard of living of Canadians as such? The standard of living of Canadians, in absolute terms, increases 2% per year, but that of the Americans increases 3%. So they become richer and richer compared to us.

• 1030

Therefore, the question is: do we want to know the standard of living of Canadians in absolute terms or in relative terms? There is no easy answer to that question.

[English]

Mr. Michael McCracken: Let me throw a little light on that last point.

I think we run a danger of focusing on the desirability of having a faster productivity growth rate than the United States, as if that were the key element. If the productivity growth of the U.S. is 3% and ours is 2%, that is a preferable outcome to one in which that of the U.S. is 1% and Canada's is 1% or even 2%. The reason for that is that more rapid productivity growth in other regions.... And this would also be true, incidentally, within Canada, for Quebec to be growing more rapidly than the rest of the country. That is because those rising incomes in that other region will in fact create markets for us and improve our well-being as well over time.

So it's very simple to slip into a view that this is a competition, but in fact countries don't compete and peoples don't compete. Companies compete in specific commodities and prices, and certainly differential productivity may help them in their games, but not in the game of life. The game of life is an issue of whether we can raise the real standard of living across the area. We ought to be encouraging and celebrating positive improvements in real income, wherever they occur. Now, if we can get them ourselves, great; that's always preferable. But it ought not to be seen as at the expense of others.

Thank you.

The Chair: Thank you very much, Mr. Dubé.

Mr. Malhi, please.

Mr. Gurbax Singh Malhi (Bramalea—Gore—Malton—Springdale, Lib.): Thank you, Madam Chair.

What percentage of business people, investors, or the people working in the high-tech industry or the professions are moving to the States every year? Do you have any message to the federal government or the provincial government to improve the situation?

Mr. Jim Frank: Last summer the Conference Board published a report called Are We Losing Our Minds?, I think it was. It was very controversial for us because we came out full square behind what has come to be called the brain drain issue and said we think it's important and it's an increasing problem. The debate is around the significance and the interpretation of the temporary visas issued to Canadians to work in the United States. That's what the debate is about.

In other words, does it mean anything if more and more Canadians are working in the United States and getting, by and large, these TN-1 visas, which are mostly all issued for one year? There are exceptions in the case of nurses now, which are issued for only six months, so there is some double-counting.

I guess if we made a mistake when we released the piece we pushed the issue a bit too hard, but in retrospect and in the last say four months since we did publish it, it's become pretty clear to us that the issue is real and it's a serious one.

Statistics Canada, of course, was taking the position that it's individual counts of people that matter and that a new Canadian with a PhD is equivalent in productivity to Andrew or myself, which may be the case or may not be the case, but that was the position I think Mr. Fellegi took.

At the same time, they did get some additional information out of national revenue material on the numbers of Canadians that had ceased residence in Canada for taxation purposes. In the 1990s that increase.... I'm sorry not to be perfectly prepared for this, but I think the numbers went from around 20,000 at the beginning of the decade to around 27,000 in 1997, an important point there being that it's 1998 when we will, I believe, see another increase in those numbers.

• 1035

You asked, what do we do about this? From our point of view, the reason people go to the United States is not to get lower taxes. You go to the United States because you get a better job with higher income. When you look at the tax rates and how much you get to keep of that, that's icing on the cake, as it were. But when you think of the people who actually migrate to the U.S., they're not going there saying they want to get lower taxes. They're going there because they say they want to get that better job with more money.

Now, when they turn around and ask themselves two years later if they should come back to Canada, and they find they cannot earn as much here and they keep less of it, then of course it is much less likely they will return to Canada.

Of course weather is a non-trivial factor. I always use that as a possible explanation for some of this, although I don't think that drives a lot of it either. So of the first three factors only taxes is the more marginal one.

It brings us full circle then to how we create in this country a platform that's clearly advantageous for developing high-income jobs and lots of them. In our country, if we don't celebrate high-income jobs and lots of them, we're not going to be able to have what we want. Yes, it is not a competition between countries. People move. Countries don't move.

The last point is this. In 1994, when NAFTA was put into place, I believe a structural change occurred between our country and the United States. It has never been easier for Canadians to work in the United States than it is today. And I hope we do not have a serious recession in the United States that cools that market off so Canadians have to find jobs at home, because I believe the consequences of that will be far more serious than any of us want to entertain. It's a serious issue, we think.

Mr. Gurbax Singh Malhi: So you think the wages are the main concern.

Mr. Jim Frank: Wages and opportunities.

The Chair: Thank you, Mr. Malhi.

Mr. Brison.

Mr. Scott Brison (Kings—Hants, PC): Thank you, Madam Chairperson.

It's good to be here today. I serve on the finance committee. This is the first time I've actually participated in the industry committee. The finance committee studied the productivity issue last year. It was a little bit like trying to identify how many angels there are on the head of a pin. It reminds you of what H.L. Mencken said at one point: “For every complex problem there is a simple, neat, plausible solution that's wrong.” I think you're quite right: there are a lot of things we can be doing better, and we're probably better off developing a list of those things, as opposed to dealing with the theoretical side of it, and just try to identify those things we can effect change in.

On the tax side, seeing as how there's an opportunity now for tax reduction, some of us are concerned that tax reduction may be based on political palatability, as opposed to reducing taxes that may actually have the best impact in the long run for productivity growth and economic growth for Canadians.

The Mintz report, which was introduced a year ago June, addressed some of the distortions and structural problems within the corporate tax system in Canada. It wasn't implemented, in part because in a revenue-neutral situation it would have created winners and losers. But it did identify the issue that in Canada we tax in a way that discriminates against the technology sector and the service sector—for instance, those areas of the economy we probably should be positioning ourselves to participate in more in the new economy.

Would you suggest implementing the Mintz report and perhaps using some tax reduction to offset some of the impact on the traditional sector to try to provide a situation whereby, combining tax reform and tax reduction, everyone would win? Would that be one way we could address a distortionary element in our corporate tax system that may be impacting productivity and investment in growth sectors?

Mr. Jim Frank: I have not read the Mintz report, so I'm not able to go at the details of that at all. Maybe one of these other fellows could react more effectively to your point. I would simply say that any economist will look at a tax regime and will say the least distortion the better.

• 1040

If you want to encourage things to happen, you shouldn't tax them. So if you want a lot of investment then you've got to be careful how you tax it. If you want a lot of initiative and innovation and change to occur then you've got to avoid taxing innovation and change. I think the issue around distortions is where you have to come down on it.

There is the question of the overall level of taxation in Canada, and that is, to a very great degree, a political question. As we say at the end here, on the issue around sustainability of our social policy program in Canada, if taxpayers believe they're getting good value for their health, education, and social welfare spending, no problem. But if they don't, then we're going to have a problem with sustainability, and that becomes a political issue, and we know how that's unfolded recently. I don't know how it will unfold going forward.

The Chair: Mr. McCracken.

Mr. Michael McCracken: I just have a couple of quick points.

One of the challenges complicating any kind of tax reform in Canada that has to be kept in mind is that it's not as though if we took the taxes off corporations tomorrow they would not pay any taxes. Many of our corporations are multinational corporations, transnational corporations, and they will pay, essentially, the tax in their home, or a greater amount if we tax greater than that. So one of the conditions that sometimes defines our tax system is to make sure we grab every penny we can for Canada, because if we don't the U.S. Treasury picks it up. That's a further complication.

Keep in mind, we did go in 1991 with a new tax system, the GST, the purpose of which was in fact to not tax business inputs, in particular capital. If you look at the machinery and equipment investment as a share of GDP, there's no strong evidence that has responded to that tax relief that has been granted. We took off a rather large manufacturer's sales tax at that time. So one has to ask what's going on here. Obviously more than just the tax system matters.

I would love to just say let's not tax corporations at all, because then I think we would find it doesn't make a hell of a lot of difference, and we would get by this whole issue that somehow that was the factor. We're all paying it anyway as individuals; it's not the corporations that are paying it. So it would flow right through, hopefully, although there may be some lags in doing that.

I think, you know, on the issue of what you do on the tax side and what you do, if you will, to solve some of these problems, a lot of it hinges on whether you can get the economy back growing at a rapid enough pace that people find it an attractive place to expand, to hire people, to train people, to invest. I don't see that happening as long as we have the macro-setting being one of let's keep things slow. It will stay slow as long as we continue with that attitude.

I think all you'll do with tax cuts is fuel the flame and then immediately have it doused by cutbacks elsewhere or by higher interest rates.

Mr. Scott Brison: Given the relationship between investment and productivity, would those taxes...? For instance, our capital gains tax regime in Canada is about twice as oppressive as that of the U.S. Would that not be an area we should address, particularly in light of access to capital issues and the degree to which our capital tends to be locked up? In a way that is a bit of a distortion.

For your information, to reduce our personal capital gains tax burden to what would be equivalent to that of the U.S. would be about $250 million per year. Not dealing with it has more to do with perceptions of reducing capital gains tax than realities.

Mr. Michael McCracken: Something so cheap should not have a big effect, then, should it?

Mr. Jim Frank: The catch with that argument, though, Mike, is that what we don't know about the people who leave the country is what their financial capacity is. I guess the concern the Conference Board had with the foot-loose brains argument is that it's our higher income, it's our higher innovation, it's our higher entrepreneurial talent that tends to leave the country. I mean, let's be real about this.

• 1045

When you look even at the Statistics Canada and Revenue Canada data, it clearly shows a much higher proportion of high-income people, people with salaries of $150,000 a year or more, $100,000 to $150,000—1% of the tax filers in that category of $150,000 or plus, rough cut—are actually ceasing to be residents of Canada. I don't know enough about tax law to know what happens to that individual's portfolio, presuming they have one, when they cease being resident in Canada for tax purposes. Who collects the dough on it and—

Mr. Michael McCracken: It's realizable and they owe the tax at that point.

Mr. Scott Brison: The other issue though is that stock options are used as compensatory assets, particularly in the high-tech sector. So for those people it becomes even more—

Mr. Jim Frank: At what price are those options valued? At the issue price?

Mr. Scott Brison: Yes. The capital gains tax has to be paid at the time they're exercised.

Mr. Jim Frank: But if the person is resident in the United States for tax purposes, does he or she pay them in tax in the U.S., or does the Canadian government get a slice of the action?

Mr. Scott Brison: There's a departure tax.

Mr. Michael McCracken: When they leave they don't pay taxes.

There's a fundamental difference there. You want to address something, Scott. In the United States, if you are a citizen of the United States, you pay tax on your world income regardless of where you live; you pay tax to the United States even if you are not living in the country. So you get a credit for earned income abroad, but that's about $70,000 a year.

In Canada, if you leave the country, you don't pay tax to Canada. If you leave, that's history. You pay only at the time you depart on the assets you have at that time.

So if you want to look at something that will provide incentive to keep people home, just treat them like the U.S. does for tax purposes. Make it so residents, citizens of Canada, would pay tax on their Canadian income or their income as Canadians regardless of where they live. That would certainly change the signals, and then the stock options in the United States would be realizable here.

Mr. Scott Brison: And under the current system with our departure tax, the incentive really for someone who is young, bright, and upwardly mobile is to leave early—you shouldn't wait. And it's having a perverse impact on a lot of people where they're actually being advised they should leave early, as opposed to building your career or your company here.

Mr. Michael McCracken: And you've also of course paid their education, you've gotten them born, you've supported them as a country for God only knows how long, and now they run off. Make them pay.

The Chair: Thank you.

Mr. Scott Brison: Thank you very much, Madam Chairman.

Mr. Michael McCracken: Thank you for that idea, Scott.

Mr. Jerry Pickard: The longer I sit here, the more I realize a little learning is a dangerous thing. I see very different viewpoints, questions directed toward certain issues that each political party runs and answers coming in relatively similar fashion.

I was quite intrigued by Mr. McCracken's view of the exchange rate being considered a tax on society, and in particular the working people, and business reaping that tax. We would expect at that point that business would put those dollars back into Canada and Canada would be a far more attractive place to live, which I believe Mr. Frank is saying we have to build on and make develop.

For the life of me, I think this can't be the end point of the position you put forward, Mr. McCracken.

The Chair: Mr. Brison, I have to ask you not to talk to the witnesses, please.

Mr. Scott Brison: My apologies.

The Chair: Thank you.

Mr. Jerry Pickard: I have to think that for whatever purposes, if a business's decisions are made not on a national affiliation they're made on the profits that are taken in the boardroom, and if a business does have a far better advantage because of the lower dollar, I would think this would translate into a lot of businesses locating in Canada, which does not appear to be the case. There are many issues we've talked about. I look at the auto industry in the Windsor area, which I'm more familiar with, and I would suggest it's not just the corporate boardroom there, it's all the extraneous support industry that fits around this industry in the Windsor area that makes it go and makes it very successful—and similarly through southwestern Ontario.

• 1050

Again, we're hearing of other regional problems that come into this factor as well. Ontario complains on a very regular basis that our fair share in taxation is not helping Ontario grow and Ontario move forward.

Is the business climate in provinces like Ontario, in particular I would say southwestern Ontario, in position to attract industry where it may not be the same scenario in...I'll use Newfoundland, because they're remote from much of the country and because they do need support and because they don't have—

Mr. Charlie Penson: We might be remote from them.

Mr. Jerry Pickard: That's a possibility too.

I'm not denying that there are locations for business where we are very competitive in this attraction of industry, manufacturing, and even productivity. But there are areas where we may not be. Are we taking those things into consideration when we're doing all of the broad-based comment about Canada and Canada's competitiveness in the world economy?

The Chair: Dr. Sharpe.

Mr. Andrew Sharpe: In terms of our ability to attract investment, it's true that Canada's share of North American foreign investment has been falling in the 1990s. We often see that statistic. However, if you look at the actual investment in dollar terms, even controlling for inflation, there's been a large increase in foreign investment in Canada in the 1990s. Many foreign firms have decided to expand operations here or to take over a Canadian company, and that's linked in part to the low dollar. In fact, some Canadians have been complaining that we're selling all our companies to the Americans because the low value of the dollar means that it's so cheap to take over Canadian companies, that this is becoming a problem in terms of foreign ownership.

You look at the auto sector. A lot of the auto investment has been because of our competitive cost advantage, in part due to our low dollar, and is also linked to our very moderate wage increases, which have been less than in the United States in the 1990s. In particular sectors, like the auto sector, there have been very strong gains in productivity, comparable if not superior to those in the United States.

Overall, I think we've been quite competitive in terms of attracting investment. If you look at the United States, in terms of the world economy and the problems in Asia and other countries, there's been a lot of capital that has gone into the United States in the 1990s. Compared to that, we haven't had as much in terms of a share of the North American total capital flow, but in absolute terms we've done quite well. So I don't really think there's a major problem in Ontario in terms of the ability to attract capital. We can always do better, and I could point to certain problems, but overall I don't think it's been a major constraint on our economic development.

The Chair: Mr. McCracken.

Mr. Michael McCracken: Yes, let me just complete the circle.

I thought your question was quite perceptive on this issue of depreciation. The rest of the circle is this: What is the ideal circumstance? The ideal circumstance is one in which, in a firm, we see and obtain higher productivity growth. This in turn allows higher real wages to be paid in that firm, which means higher real incomes for those Canadian workers. And by keeping that wage gain in line with the productivity gains we then also keep the firm competitive so its unit labour costs don't change, so it's still able to sell its goods abroad. Let's call it the “virtuous circle” that we're after.

If we do that sufficiently we will in fact more likely see an appreciation of the exchange rate, which will bring with it an added benefit that will then allow Canadians to buy more goods abroad for the same number of Canadian dollars. It will result in an improvement in their real income.

So what you want is what we call an earned appreciation—earned, because your productivity growth is rising. That's one of the channels through which you benefit from productivity gains. The issue about the depreciation being a vehicle for sopping up slack in the economy works when you have high unemployment. It is a partial adjustment to that slack, and then the appreciation occurring as your labour markets tighten up is a way in which you can take some of the heat off the economy, keep some pressure downward on prices and transfer income back to Canadians.

• 1055

What we have to see is more of that up part, which we haven't yet seen. That's the hope of what lies ahead. What we should observe when that happens is improving productivity and appreciating currency, and at that time we should say let's celebrate the appreciation of the currency as long as we're earning it, as long as we're not artificially doing it through high interest rates or not doing it by giving away the farm to foreign investment that comes in and boosts the dollar up artificially. So that's the flip side of it.

The Chair: Mr. Frank.

Mr. Jim Frank: I keyed in your question around differences across the country between Ontario and other provinces. I do agree that countries and provinces don't compete in that one sense of pricing themselves and trying to sell themselves, but regions do compete with one another. And it's very clear now that Ontario has set out on a course to try to have a tax regime on the personal side that is as competitive as Alberta's. Alberta has trumpeted its Alberta advantage now for I don't know how long, five years or more. It's very much a province that has diversified enormously over the last twenty years in the face of significant difficulties and fundamental disadvantages. It's landlocked, it's in the middle of the continent, and there are no major markets within shooting distance compared to where you're from, where within that industrial triangle in Ontario, within a day's drive, I don't know how many—

Mr. Jerry Pickard: Sixty percent.

Mr. Jim Frank: Yes, a very large market is available. So where you are makes a difference.

What I think is starting to happen in Canada is that provinces are realizing they have to somehow compete with one another for investment and development and so on. And we see Quebec with incentives to invest in industries in Quebec. We see Ontario complaining about this and Alberta pushing buttons on one end or another with their tax regime. So it's happening within the country. But an area that has a fundamental disadvantage, because of distance or climate or whatever, either has no choices or it somehow has to be better than the next-best alternative. And that's the challenge for what we often think of as disadvantaged regions. Where I come from in central Alberta is a farming area, and there just aren't a whole lot of things you can do there other than farm. So the capacity of that area to expand was very limited.

With the removal of the Crow rate, what you've seen in Manitoba and Saskatchewan and Alberta is diversification in agrifood. And I would say that's a good thing, because it will create more value-added within those provinces and develop employment and business opportunities for people.

The Chair: I really have to apologize to all the witnesses and people. We do have another committee scheduled in this room in a few minutes, so we are going to have to stop there. This discussion has been very interesting and we appreciate the witnesses coming to join us.

I'll leave you with one final comment, as another southwestern Ontario member of Parliament. I sat and heard about the dollar and the fact the dollar needs to go back up. And I know that one of the areas where we are most productive right now in Canada is the automotive sector, yet our wages are higher than those in the United States. So I've never seen the wages come down. I know they're being paid in Canadian dollars, but if the Canadian dollar's value were to go up, that would cause an interesting situation to develop. It's something we all may want to consider as we make these analyses, that the dollar needs to go back up. We're on a different wage scale based on what our level of dollar is right now.

So I throw that out there. And I also throw out there that in Windsor, to join the manufacturing you do have to have a grade 12 education, and you have for several years. So it would be interesting if you could take your studies and cipher them out and look at what the recent hirings have been, especially in the automotive sector, and the university education that you now find in the plants.

Anyhow, I'll leave that. I want to thank you all for being with us.

The meeting is adjourned.