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Business Commentary Low labour productivity growth puts onus on Canadian economy’s supply side

David Williams is vice-president of policy at the Business Council of British Columbia. Jock Finlayson is the council’s executive vice-president and chief policy officer.

The Canadian economy can be analyzed from the demand or supply side. On the demand side, economists sometimes lament that “if not for this or that temporary influence” – e.g. oil prices, trade uncertainty or global events – the economy would be humming. The Governor of the Bank of Canada often talks about using interest rates to finesse demand into a “sweet spot,” where the economy is operating at full capacity and inflation is stable around the bank’s 2 per cent target. This is an important goal. When demand is insufficient, capital equipment and the available work force are not fully utilized.

Arguably, however, these days insufficient demand is a second-order problem. The more intractable problem lies on the economy’s supply side, mainly because of anemic labour productivity growth.

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Let’s consider the Bank of Canada’s latest projections for actual versus potential real GDP growth. If all temporary negative factors abated and all idle capacity was absorbed, the economy could at best sustain GDP growth of less than 2 per cent per annum without generating above-target inflation. By historical standards, that is utterly meagre. But right now, it’s the best the country can hope for.

From a supply side perspective, the situation is more worrisome. Canadian GDP growth appears to be firing on one-cylinder: population growth. Canada’s population rose by a remarkable 530,000 in 2018 – the largest annual jump in more than four decades. Births minus deaths (“natural increase”) contributed just 103,000 persons to the population increase. The rest came from net immigration inflows, including permanent and temporary residents, that are among the highest in a century.

Looking ahead, the federal government is on course to supercharging population growth by adding 1.33 million new permanent residents between 2018 and 2021. Only 15 per cent of these will be in the refugee or humanitarian categories, so this is largely an economic development strategy.

Population growth raises GDP by increasing demand for consumer goods, housing, infrastructure, public services and so on. It also expands the size of the work force. But it does not raise GDP per person. That matters. Real GDP per person, not total GDP, is the key measure of a country’s living standards.

Yes, the Canadian economy is getting bigger because of a rising population. But this one-cylinder economic strategy is not doing much to boost average living standards. In fact, recent growth in Canada’s real GDP per person is close to zero. This arithmetic helps to explain why people nowadays seem increasingly skeptical about whether economic growth leads to improved individual prosperity.

The vital, missing ingredient in Canada’s economic strategy is labour productivity: that is, output produced per hour worked. It’s a function of capital intensity, skill intensity and the extent to which labour and capital are put to their most productive uses. Growth in labour productivity has been tepid over the past decade and shuddered almost to a halt in 2018.

What can be done to spur productivity growth? A comprehensive review of Canada’s inefficient and uncompetitive tax system would be a good place to start. The last such review was in the 1960s. Sound tax policy should promote capital formation and attract talent. And it should encourage firms to innovate and to pursue scale, not incentivize them to stay small.

Competition policy should ensure markets are characterized by vigorous competition and new entrants. “Survival” is a powerful motivator of business innovation and the movement of skilled labour, capital and entrepreneurial talent to better uses.

Canada’s byzantine regulatory approvals processes should be streamlined and modernized to welcome rather than repel capital formation. Finally, a stepped-up program of infrastructure investment should focus on improving transport and communications infrastructure.

There is little prospect of achieving meaningfully higher growth in real GDP per person or real wages, or being able to afford better public services, without a sustained, material improvement in Canada’s labour-productivity growth rate. If policy-makers are truly interested in fostering better living conditions for Canadians, that is where they should be directing their attention.

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