An employee on the factory floor at Plitron Manufacturing in Toronto. Statistics Canada said Friday that Canadian factory sales fell 3.3 per cent in February.Darren Calabrese/The Globe and Mail
Canada's poor track record on productivity over the past three decades remains a source of endless debate for economic wonks. Recent research by the Organization for Economic Cooperation and Development, a leading international economic research organization, offers a fresh perspective worth considering.
OECD research suggests that stronger productivity growth in advanced economies, and resulting higher living standards, are still possible if the strongest-performing firms are able to grow and prosper – and if we stop keeping the weakest firms on life support.
Overall productivity growth in OECD countries is being impeded by policies and practices that sustain weak firms, slowing the dynamic reallocation of capital and labour toward the stronger performers. The "waves of creative destruction" that underpin healthy and dynamic market economies – identified by Joseph Schumpeter more than 70 years ago – are not being allowed to work effectively.
Productivity is easier to understand than it sounds. At its simplest, think about it as business revenue per hour worked. Much of the OECD's recent productivity research focuses on performance at the firm level, where there can be massive differences in annual productivity growth among firms within a given industry or sector.
The strongest firms – called "frontier firms" by the OECD – have achieved impressive annual productivity growth of about 3 per cent annually. This robust growth rate is three times higher than Canada's recent annual productivity growth rates. But the remaining firms in the OECD analysis, and in particular the weakest firms, barely see their productivity growing.
The firm-level productivity differences are even more striking in services, which are now the backbone of modern economies – representing 70 per cent or more of national gross domestic product. Frontier firms in services have achieved productivity growth of 5 per cent or more annually. The weakest services firms have actually seen a productivity decline in some years.
There are a number of possible explanations for these sharp differences in firm-level productivity. Barriers to labour mobility top the list for a complex federation like Canada. Significant and subtle provincial labour regulations have created many barriers to credentials and skills being recognized, preventing workers from moving easily across sectors and provincial boundaries. Better pan-Canadian alignment on labour regulations, and a reduction or elimination of such barriers wherever possible, would be an obvious step in the right direction.
Policy toward business is another productivity-inhibiting factor. Canadian policies have focused on supporting small businesses through lower tax rates and reduced regulatory demands, but these incentives have not led to the kind of high-productivity frontier firms that boost growth. The focus of Canadian policy needs to shift toward businesses that are demonstrating sustained high growth rates, investment in innovation and sales in international markets.
Mediocre management may be a key ingredient inhibiting firm-level productivity and resource reallocation. Canada scores very poorly on business management skills in the OECD analysis, particularly in professional services. Weak management capacity limits the ability of Canadian firms to compete effectively in global value chains, now the dominant business model for many successful firms. Canada has high-quality management education, but the number of individuals within businesses with leading-edge management capacity has to grow.
The productivity lexicon is also expanding. "Patent trolls," particularly in the U.S., may be impeding innovation by compelling new market entrants – often in high-tech sectors – to pay compensation for the generic patents held by the so-called trolls. Unproductive "zombie firms" that do not have enough net income to fully service their corporate debt are being kept alive by their bankers, notably in heavily indebted southern Europe (and in China). By keeping unproductive firms alive, banks can postpone using their loss reserves and having to raise more capital to rebuild their financial base – thus delaying a day of financial reckoning for the banks themselves.
There is no easy answer to the Canadian productivity quandary. The OECD research on firm-level performance, however, can help us to ask the right questions about policy and business practice, and to set priorities for action. If firms with strong productivity growth are being held back by weak firms that are not freeing up scarce human and financial resources, then we should stop propping up less-productive firms with no clear strategy for growth – regardless of the immediate political fallout.
If barriers to labour mobility are a major factor, reducing those barriers should be a top policy priority for the federal and provincial governments. If Canadian firms have demonstrably weaker business management capacity, business and government should have a collective action plan for addressing that weakness.
We should not expect different productivity results if we refuse to change. Canada is already paying a price for chronic weak productivity growth. It's time for a new plan, informed by improved performance by individual firms.
Glen Hodgson is senior vice-president and chief economist at the Conference Board of Canada.