Edited testimony by Andrew Sharpe, CSLS Executive Director given to the Senate Standing Committee on Banking, Trade and Commerce hearings on productivity, May 11, 2005, Ottawa, Ontario

Why is productivity important? Productivity is our economic destiny. At 1 per cent productivity growth, living standards double in 70 years. If we can raise productivity growth to 3 per cent, we can double living standards in 24 years. If we can attain 2 per cent productivity growth over the next 30 years, financial problems related to aging in terms of the cost of health care and pensions will largely evaporate. Thus if we do well in terms of our productivity, we will solve many potentially divisive societal problems.

But perspective on the productivity issue is needed. Productivity is certainly important, but it is not everything. I would argue that economic well-being and quality of life are higher-level concepts that trump productivity. However, productivity is essential because it contributes significantly to the economic well-being and quality of life of Canadians. In certain circumstances, there may be tradeoffs between productivity and well-being and quality of life. But such tradeoffs are not fundamental. Consequently, it is very important that society focus on productivity.

Today, in my remarks I will first briefly address recent productivity developments in Canada and the United States. I will then put forward six policies to improve productivity in Canada for this committee to consider.

Recent Productivity Developments

What has happened recently is unprecedented in our economic history in terms of productivity developments. In 2003, we had a rate of productivity growth in the business sector of 0.1 per cent. In 2004, we did even worse. It was zero. Thus, in the last two years, there has been virtually no productivity growth in the business sector in Canada. Productivity is here defined on an output per hour basis, which is the most relevant measure of labour productivity.

In stark contrast to recent developments in Canada, productivity growth in the United States has soared. Output per hour in the business sector advanced 4.3 per cent in 2003 and 4.0 per cent in 2004 for a two-year increase of over 8 per cent. This has lead to a cumulative difference of about 8 percentage points between labour productivity growth rates in the two countries since 2002, with the result that Canada’s level of business sector output per hour, as a proportion of that in the United States, has plummeted from 81 per cent in 2002 to 74 per cent in 2004. This represents a major deterioration in our relative productivity performance vis-à-vis the United States.

The Centre for the Study of Living Standards has done a significant amount of work on the factors behind recent developments in productivity growth in Canada and the United States. This research can be found in an article published in the Spring 2005 issue of the International Productivity Monitor and a more detailed research report on the topic that has been submitted to this Senate Committee. This section is based on that research.

It appears that the very rapid productivity growth in the United States is due to an acceleration in the pace of technological change. Productivity growth picked up in the second half of the 1990s, a development found due to advances in the information and communications technology (ICT) area. Since 2000, there has been a second productivity growth rate acceleration to over 3 per cent per year, again likely linked to ICT, particularly to its more widespread and effective use. This is an extremely positive development for both the United States and Canada. In the long run, Canada lags the United States in terms of economic developments. The technological transformation currently taking place in the United States will eventually spill over to this country, boosting productivity growth, even though in the short term U.S. developments may increase the gap between our two productivity performances.

What is happening in Canada? First, I will preface my remarks by saying I am a hostage to the data that Statistics Canada produces. They are known to change their numbers. They revise the productivity numbers frequently because they revise the output numbers. The average revision for business sector output per hour growth over the last six years has been 1 per cent per year upward, which is a significant change. On June 10, Statistics Canada is releasing revised productivity estimates. We may see some of our poor performance in 2003 and 2004 disappear with the new numbers. But it is unlikely that they will raise productivity growth estimates from 0 to 2 per cent. If they do, there are some serious problems with the methodology used to compile our productivity estimates, if there is that much revision.

We have identified three key factors that appear to explain what is happening to productivity growth in Canada, particularly since 2000. This is preliminary analysis, so is subject to revision. First, the rate of productivity growth in the information and communications technology (ICT) sector has fallen significantly. In the second half of the 1990s, productivity growth in the ICT-producing sector was around 11 per cent a year. Since 2000, it has fallen 1 per cent per year. This sector is relatively small in size, accounting for 4.5 per cent of business sector employment, but such a large turnaround (12 percentage points) can significantly affect aggregate productivity growth, and more important, changes in productivity growth. Indeed, in terms of the sources by industry of the decline in the productivity growth rate since 2000, we have identified that a large proportion of it was due to ICT manufacturing and, to a lesser degree, ICT services. While the ITC-producing industry may be on the cutting edge in terms of technology, it has experienced tough times in recent years.

A second key factor appears to be a slower rate of growth of aggregate demand. The economy since 2000 has been growing more slowly, and experiencing lower levels of capacity utilization, than it was in the second half of the 1990s, which was really a boom period. Slower demand growth results in slower productivity growth because there is less spreading of overhead costs, learning by doing and fewer increasing returns.

Finally, since 2000 Canada has experienced a much slower rate of growth in machinery and equipment (M&E) investment and ICT investment than in the second half of the 1990s. The capital intensity of machinery and equipment and ICT, defined as M&E and ICT per hour worked, is also growing at a much slower pace.

I believe that productivity growth in Canada will rebound in the future to at least the 2 per cent range. This pick-up will be largely driven by technological developments, as appears to have been the case in the United States. It would be an exaggeration to say that we are currently experiencing a productivity crisis in this country. We should be doing much better, and we need policies to do better. But it is not a crisis. We should not overreact.

Policies to Improve Productivity Growth in Canada

Turning to the policy area, I want to put forward six public policies to raise productivity growth in Canada. First, I will preface my remarks by saying that it is important to recognize that business sector productivity is primarily the responsibility of the business sector, not government. Government creates a favourable framework for businesses to improve productivity. But it is the business sector itself, through its own actions, that determines productivity growth in its sector. Business decisions concerning investment, innovation and human capital, the three key productivity drivers, largely determine business sector productivity growth.

The first policy is the pursuit of a macroeconomic environment that gives a high priority to full employment. Full employment means there is no slack in the system, or unused potential. Such a situation results in increasing returns through economies of scale, learning by doing, and elimination of operating inefficiencies. It is important that the Bank of Canada pursue a monetary policy that allows us to have as low a rate of unemployment as is compatible with stable inflation by keeping interest rates low.

The second key policy area is that government should assist in the promotion of the diffusion of new technologies. Ultimately, it is new technologies that improve productivity. Canada contributes only a small percentage of the world supply of new innovations because we are such a small country relative to the total world. Certainly R&D is important, but the vast majority of Canadian companies do not undertake R&D. They can, however, adopt best business practices or technologies. Businesses in Canada should be aware of what is best practice throughout the world. They already have an incentive to do this, but may lack the means to keep abreast of technological developments, particularly small businesses. Government can facilitate adoption of best practice technologies by business through the provision of information. The Industrial Research Assistance Program (IRAP) run by the National Research Council is an example of a successful program that promotes the adoption of new technologies by small and medium sized businesses in Canada.

The third key policy area is the fostering of competitive markets, particularly in the product market area. Competition is important. Indeed, it is likely the best tonic for productivity growth. In a competitive environment, businesses have an added incentive to introduce new technologies, to train workers and in general to be on the cutting edge.

The fourth key policy area is facilitating the movement of the workforce from low to high productivity activities, both on an inter-regional and inter-industry basis. Subsidizing declining industries is not in the productivity interests of Canadians. It may in certain cases be necessary for political reasons to temporarily prop up declining sectors. But the main thrust of public policy should be to facilitate the movement of resources from low productivity regions/industries to high productivity regions/industries through, for example, mobility grants and tax incentives and through providing better information on employment opportunities in dynamic regions for persons in low employment opportunity regions.

The fifth policy area is investment in post-secondary education, both in terms of the teaching and, of course, research and development. Why has the United States experienced such strong productivity growth in recent years? Because it develops the most advanced technologies. And how is it able to develop these technologies? Because it has the best research universities in the world. There have been many commercial spin-offs from basic research undertaken at the top research universities. Stanford University, for example, has fostered the development of Silicon Valley. This spin-off phenomenon has also been present in Canada, although to a lesser degree. Research in Motion, one of Canada’s leading high-tech firms, grew out of Waterloo University. It is important that Canadian universities have a strong research capacity. Long-run productivity growth depends on this capacity.

Finally, the sixth policy I would like to put forward to improve productivity is the reduction of working time. The United States is the leading country in the world in terms of technologies. But it does not enjoy the highest level of productivity defined on an output per hour basis. A number of European countries, including France, have higher levels of labour productivity. Why is this the case in France? There are two reasons. First, France has adopted a number of policies (e.g. high minimum wages) that keep less productive persons out of employment, raising productivity levels through a composition effect. Second, the French work many fewer hours per year than North Americans. While this has a negative effect on output per worker, it has a positive effect on output per hour worked, the true measure of productivity A person who works 35 hours a week rather than 40 tends to be more productive on an hourly basis. The worker will be less tired, and more focused as the more limited time available for work will be used more effectively. For example, less time will be wasted on meetings. One of the effects of the 35 hour work week legislation in France (which has recently been modified) has been to increase productivity, even though the purpose of the initiative was to increase employment.

I am not advocating the heavy-handed bureaucratic French approach to working time reduction. However, actions that reduce working time through longer vacations and more public holidays, whether initiated by government or through collective or individual workplace bargaining, can have two positive effects. First, such policies contribute to economic well-being by increasing leisure. Second, while there is some output and income loss, this is offset somewhat by workers becoming more productive on an hourly basis, the true measure of productivity.

In closing, I would like to reiterate the importance of productivity for the economic destiny of Canadians and applaud this Committee for choosing to examine this issue. I hope the six policy areas I have suggested will prove useful to the committee for its development of policy recommendations to improve Canadian productivity performance.