The productivity puzzle: How could we be doing so poorly? We did everything right!

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So we are agreed that Canada is in a growth crisis. Attempts have been made to downplay it. If you calculate real per capita GDP using the Consumer Price Index as your deflator, for example, rather than the GDP price index, you get a marginally less depressing result. I stress marginally: Instead of fourth quarter per capita GDP being slightly lower than it was nine years earlier, it is slightly (1.1 per cent) higher. And yes, other measures of living standards, e.g. real wages and disposable incomes, have not stagnated to the same degree. But sooner or later these, like per capita GDP, tend to rise or fall in line with productivity.

Which is really the issue. Labour productivity – output per hour worked – in Canada has not just been falling for the past year and a half, or moving sideways for nine years. Relative to other countries, it has been falling for the past 40 years: from close to 90 per cent of U.S. levels in the early 1980s, to nearer 70 per cent today. That, more than any short-term trend, is what really ought to worry us.

We are talking, that is, of growth as a secular, rather than cyclical, phenomenon. Needless to say, this is not the kind of growth politicians typically talk about. Most of politics revolves around whether the economy is growing faster or slower, not over the long term, but now, this minute, something over which politicians have very little actual control but for which they are eager to claim credit, or cast blame, as the case may be: a simple matter of pulling a lever on a wall marked “fiscal” or “monetary” policy.

What is productivity and why is it so low in Canada?

But the problem with Canada’s economy is not utilization, but capacity; not so much that growth is below potential as that potential growth itself is rather less than it might be. That’s not due to any deficiency of demand, but of the economy’s ability to supply goods and services to meet the demand. Fixing that requires looking at the microeconomic foundations of the economy – the hard work of figuring out why or if a particular market isn’t functioning as it should – rather than macroeconomic lever-pulling.

And it is long-run growth rates that ultimately matter, as far as a country’s standard of living is concerned. Business cycle fluctuations that seemed terribly important at the time appear as mere blips on a long-run growth chart. If you doubt it, consider the classic example of Canada versus Argentina: where Argentina had roughly the same per capita output as Canada at the beginning of the 20th century, by the end of the century it was barely half as rich.

But this is the puzzle. We’re no Argentina. The history of the past 40 years has not been one of Argentinian fecklessness and extravagance. Quite the contrary. For a while in the 1990s and 2000s, Canada seemed to be an example of everything that orthodox economics would recommend as recipes for prosperity. We signed a sweeping free-trade deal with the United States, and went on to sign dozens more. The Mulroney tax reforms slashed top marginal rates of corporate and personal tax rates, with further cuts in corporate rates to follow. We brought inflation down to 2 per cent, converted massive deficits into surpluses, the works. Still productivity slumped; growth rates fell. How could this be? We did everything right!

I think it’s safe to say these were necessary but not sufficient conditions. It’s true that we got a lot of things right – and not only in recent years. That we have grown as rich as we have has less to do with resource endowments – see Argentina – than with basic foundations such as democracy, the rule of law, private ownership, enforceable contracts. And certainly, in an economy based on prices, a reliable currency – the language in which prices are expressed – is essential, as are sustainable public finances, without which inflation is unlikely to stay low for long.

But while we’ve got a lot of things right, we’ve also got a lot of things wrong. We might have liberalized much of our international trade, but important sectors of our economy – telecommunications, financial service, air travel – are organized as protected oligopolies, theoretically open to competition but effectively off-limits thanks to restrictions on foreign investment. Others – the post office, rail travel, liquor boards – remain government monopolies to this day, for no reason than because it would be too hard to break them up.

Prices may generally guide economic activity, but in too many sectors those price signals are clouded, either by overt subsidies to business – the Fraser Institute has lately reckoned these at more than $50-billion in 2022, all levels of government combined – or by exemptions and other preferences buried deep within the tax system. In every case, the intent, if not the effect, is to persuade consumers, workers and investors to make decisions about resource use based not on the real costs and benefits of each choice, but on what subsidies, tax goodies or regulatory preferences are attached.

Most disgracefully of all, 157 years after Confederation we still do not have a functioning common market; rather, Canadians wishing to trade with one another must fight their way through hundreds and hundreds of interprovincial trade barriers. The combined effect of these is considerable. A 2019 IMF study found the average internal trade barrier to have an effect on trade equal to that of a 21-per-cent tariff. All told, the study found liberalizing internal trade barriers would add nearly 4 percentage points to GDP – that’s another $112-billion, or roughly $11,000 for every family of four, every year, for ever. A Senate committee found even higher potential gains, on the order of 7 per cent of GDP.

If the productivity puzzle is a challenge to conservative economic orthodoxy, it is no less to the progressive alternatives: whether in the more overtly interventionist agenda of “industrial strategy” advocates, or in the suite of policies, much favoured by this government, known as “modern supply-side economics.”

About the former – subsidies to businesses and sectors thought to be particularly “strategic,” the cultivation of “national champions” to be protected from foreign takeovers, and so on – little more need be said, other than: it’s been tried. God knows it’s been tried. Indeed, even the Trudeau government professes to abjure “picking winners,” as such. The “big bets” it is making, it swears, are not on particular companies, but on particular technologies.

But the principle, and the fallacy, is the same. No one knows what the “technologies of the future” are. Everyone’s guessing. The only thing that can be said with any confidence is that most of the technologies of the future are still in the future: Much of the jobs and growth in the years to come will be in industries that do not exist yet, indeed that haven’t even been dreamt of – just as much of the present-day economy is made up of industries and technologies that did not exist/were not dreamt of 20 years ago.

As for those “modern supply-side” policies, the basic underlying rationale, that policy should aim to improve economic capacity generally, rather than dictate particular outcomes, is sound enough. And the policies – more spending on infrastructure, more spending on education and skills, more spending on research and development, or more broadly “innovation” – certainly sound sensible.

It’s when you get into the details that you realize how ill thought out it is. In particular, what you find is an obsession with aggregates – with how much infrastructure spending, or how much education people are getting, or how much R&D spending – with the quantity, that is, rather than the quality. And you find very little clear thinking about the role of government, and why and where government needs to get involved.

If decisions on infrastructure spending, or education, or innovation, are being made, not in a decentralized way that is responsive to costs and benefits by people risking their own money, but by politicians and civil servants spending other people’s money and responding to an entirely different set of incentives, chances are that the bang for the buck will be suboptimal.

There’s no guarantee that infrastructure spending will have any great effect on productivity, just because you say it will. It depends: infrastructure for what? For whom? At the least, you’d want some way of gauging whether the benefits exceeded the costs, some sort of test of the demand for a given project. Well, there is a way: charge a fee to use it. If consumers were willing to pay the fees, and if the fees were enough to cover the costs of the project, that would suggest the project was worth pursuing.

But then, the minute you do attach such a measurable return, the case for public funding disappears. Private investors could be enticed to front the necessary funds, in return for a share of the revenues. What matters is not just how much you spend on infrastructure, in other words, but who spends it, and how it is spent.

The same applies to education and skills development. There’s little doubt that, other things being equal, more education – more human capital – will make for more productive workers. But are other things equal?

Canada has the most highly educated population in the Group of Seven, with 58 per cent of its adult population, according to the 2021 census, having graduated from some form of postsecondary institution. We spend more than almost any country on higher education, as a percentage of GDP. There are many good reasons to invest in higher education, but if the argument is “it pays off in higher productivity,” that doesn’t seem to be the case. Not as we are currently spending it.

As for innovation – oy. Some years ago the Harper government attempted to tally up all the various federal innovation programs. They found more than 60, worth billions of dollars annually, spread across 17 different federal agencies. Most of them had been around for years, if not decades: the Idea to Innovation Program (I2I), the Technology Demonstration Program (TDP), the Industrial Research Assistance Program (IRAP), the Automotive Innovation Fund (AIF), the Strategic Aerospace and Defence Initiative (SADI), the Strategic Network Grants (SNG), the Networks of Centres of Excellence (NCE) and so on. To say nothing of the flagship Scientific Research and Experimental Development (SR&ED) tax credit, now in its 80th great year.

The Liberals consolidated a number of these into a single program, the Strategic Innovation Fund. But then they added new ones of their own. Who can forget the “superclusters” program? Or Innovative Solutions Canada? The Canada Growth Fund? The Canada Innovation Corporation? The provinces have hundreds more. Altogether, Canada is estimated to have one of the most generous systems of R&D support in the world.

And what do we have to show for it all? Falling private R&D spending, falling capital stock and falling productivity.

So we know what hasn’t worked. I’ll have some thoughts on what might work better in a future column.