By Alan M. Field

When the Canadian Auto Workers union sat down across from the three big North American automakers last year for rounds of new contract negotiations, the talks involved an intense debate about labour productivity in Canadian plants, along with labour costs, wages and other economic issues. In 2011, Sergio Marchionne, Chief Executive Officer of Chrysler Group, said that wage rates in the Canadian auto sector were uncompetitive. For his part, General Motors Co. Chairman Dan Akerson described Canada as “the most expensive place to build a car in the world right now.”

The issue of Canadian labour productivity has taken center stage in recent talks about wage rates, not just in the automotive sector, and about prospects that Canadian industry will be able to compete successfully worldwide. At an economic policy retreat in 2011, Canadian business leaders urged Finance Minister Jim Flaherty to reduce the pay of “overpriced” Canadian workers, by such means as anti-union “right to work” legislation.

The problem is not that Canadian wages are too high, say economists, but that the productivity of Canadian manufacturers is not growing as quickly as that of their major competitors in North America, Asia and elsewhere. According to a study by Statistics Canada, real hourly wages of the majority of Canadian workers actually stagnated between 1981 and 2011. “Over that entire 30-year period, the average hourly wage of full-time workers rose by just 14 per cent (and that includes the top 1 per cent),” noted Jim Stanford, economist for the Canadian Auto Workers Union. “This compares to growth of over 50 per cent in real GDP per person over the same period. Productivity in Canada has been miserable over the last decade.”

According to Statistics Canada, between 2002 and 2010, Canadian unit labour costs rose by 67.6 per cent in U.S. dollar terms, while U.S. unit labour costs fell by 10.8 per cent. Between 2002 and 2010, output per hour in U.S. manufacturing rose by 47.1 per cent compared to a meager 10 per cent rise in Canada. Mr. Stanford noted that cumulative productivity growth in Canada’s business sector from early 2006 through autumn 2011 – a period of five and a half years – was “precisely zero.” Canadian businesses are now “only 70 per cent as productive as U.S. businesses.” In 1984, before Canada negotiated its free-trade agreement with the United States, Canada was 90 per cent as productive as the U.S., according to data supplied by Statistics Canada.

“That is a huge loss of competitiveness compared to the U.S. and countries like China, which more or less peg their currencies to the U.S. dollar,” said Mr. Stanford. “This readily explains why we lost over 500,000 manufacturing jobs over that period.” Measured in Canadian dollar terms, however, Canadian unit labour costs rose by only 9.9 per cent between 2002 and 2010. “The appreciation of the Canadian dollar against the U.S. dollar has obviously been the key factor behind loss of competitiveness and jobs,” said Mr. Stanford.

An enormous challenge for prosperity

Low productivity levels represent “an enormous challenge” for Canada’s future prosperity and competitiveness, according to the Conference Board of Canada. In 2008, Canada ranked in 16th place – nearly dead last among its 17 peer countries — in terms of labour productivity. Only Japan ranked lower among its peers. By 2008, Canada’s level of productivity had fallen to 80 per cent of the U.S. level, compared with 90 per cent of the U.S. during the mid 1980s. “Despite a broad and growing consensus that Canadian productivity needs to be improved, the gap with the U.S. is widening, not narrowing,” said the Conference Board of Canada report. At the turn of the latest century, twelve years ago, Canada’s labour productivity was about 90 per cent of that in the United States, but it is now about 70 per cent of the U.S. level, said Andrew Sharpe, Executive Director of the non-profit Centre for the Study of Living Standards, based in Ottawa. “The manufacturing sector has suffered the worst decline over this period, as its annual labour productivity growth rates dropped from 4 per cent to just 0.1 per cent.”

Mr. Sharpe cited several factors behind this deterioration: First of all, the Canadian dollar appreciated significantly, making Canadian manufacturing exports more expensive to foreign buyers in their local currencies. Second, the economy of the United States – by far, Canada’s largest foreign market – did not do well. Third, Canada began to face greater competition from low-wage emerging markets where local manufacturers were dramatically increasing their output and labour productivity.

According to a report by the Conference Board of Canada, if Canada’s labour productivity growth rates had matched those of the U.S. between 1988 and 2008, individual Canadians would have become much wealthier, Canadian corporate profits would have become much higher, and all levels of governments in Canada would have brought in billions of additional dollars. More specifically, if Canada’s labour productivity growth rate had merely matched that of the United States between 1988 and 2008, per capita GDP in Canada would have been $8,500 higher by 2008, personal disposable income per capita would have been $7,500 higher, corporate profits would have been 40 per cent higher, and federal government revenues would have been 31 per cent higher.

Obviously, the benefits would have been even greater if Canada’s labour productivity growth had actually outpaced that of the United States. “Increasing our productivity growth performance over the past two decades to equal that of our neighbour would have significantly increased Canadian wealth and improved our standard of living,” said Mario Lefebvre, Director, Centre for Municipal Studies at the Conference Board of Canada. “Productivity growth is the key ingredient to improving our economic well-being,” said Alan Arcand, Principal Economist at the Centre for Municipal Studies at the Conference Board of Canada. “It is even more essential as the demographic tsunami of an aging population approaches. Without improved productivity growth, Canada’s underlying economic potential will begin to fade when labour becomes scarcer after 2015.”

Neglecting capital improvements

Canada’s under-performance in labour productivity has nothing to do with the skill sets of country’s workforce. Overall, Canada can rightfully boast one of the leading workforces in the world, note economists at the Conference Board of Canada and elsewhere. Compared with most other developed countries, for example, Canada has a very high proportion of college- and university-educated workers in its labour force. Only Finland surpassed Canada in the Conference Board of Canada’s analysis “How Canada Performs,” which measured six different socio-economic categories. Canadian business leaders also ranked their country’s quality of education as among the Top 10 in the world in the 2011-12 Global Competitiveness Report produced by the World Economic Forum. Mr. Arcand emphasized that this decline in the growth rate of labor productivity does not reflect any decline in the quality of Canada’s work force.

So why have Canadian companies – especially its manufacturers – been falling further and further behind? Although Canada has a well-educated workforce, “It has not been given the required physical capital – machinery and equipment, technology, and infrastructure – to maximize output for the hours worked,” said Mr. Arcand. “The good news, if there is any here, is that Canada’s labour force is not lacking in skills.”

Although the quality of Canada’s labor force has improved steadily over the years, investment in the physical capital of Canadian industry has not grown as rapidly. According to the Conference Board of Canada, beginning in the mid-1980s, growth in the ratio between physical capital and labor in Canada slowed dramatically, as productivity growth fell sharply. From 1962 to 1984, Canada’s labour productivity grew by an annual average of 2.8 per cent, before slowing down to an annual average growth rate of 1.2 per cent between 1984 and 2010. Productivity growth and levels of productivity itself should not be confused, noted the Conference Board report. Productivity growth is the indicator that attracts most attention in the media, but the “actual level of productivity (that is, the dollar value of output per hour worked) is equally of interest.”

Canada’s comparative neglect of physical infrastructure has been exacerbated by the rise in the prices of the country’s energy exports, which has driven up the value of the Canadian dollar. Mr. Stanford said that this neglect “is closely tied to our growing resource dependence.” With energy prices at such high levels, more and more capital was drawn into that sector. But productivity in that sector naturally declines because “you harvest what is readily available first, and then move onto other, less readily available resources. As a result, you put more eggs into a basket with less productivity.”

Commonly known as The Dutch Disease, this series of processes often occurs as an increase in revenues from natural resources makes a given nation’s currency stronger compared to that of other nations (manifest in its higher exchange rate), but results in the nation’s other exports becoming more expensive for other countries to buy – thus, making those other exports – including manufactured goods – less competitive. The term was coined in 1977 by The Economist to describe the decline of the manufacturing sector in the Netherlands after the discovery of a large natural gas field in 1959.

In the case of Canada, the damage from The Dutch Disease is multi-faceted, noted Mr. Stanford:

• Manufacturing output and employment in Canada have both declined sharply, with 600,000 Canadian jobs lost since 2000. In July 2011, unprocessed and semi-processed resource exports accounted for a remarkable two-thirds of Canada’s total exports, the highest figure in decades.

• Canada’s currency has appreciated sharply against the U.S. dollar, making Canadian manufacturing exports less competitive.

• Canada’s overall trade balance has deteriorated, since the growth in resource exports has been insufficient to offset the decline in other exports, such as manufacturing, tourism and services. “This surge in resource exports, even with high global commodity prices, still isn’t enough to pay our bills in world trade. Trying to pay for sophisticated high-tech imports by digging more resources out of the ground ever faster is a losing battle,” said Mr. Stanford.

• The Canadian economy has experienced a broad shift from tradable to non-tradable sectors, so that “exports in general constitute a significantly smaller share of total production than a decade ago. This both reflects, and reinforces, the deterioration in national trade performance,” said Mr. Stanford.

• Research and development in the business world has declined by almost one-third since 2001, measured as a share of the Canadian economy, and it is getting worse. Currently, Business R&D stands at just 0.9 per cent of Canada’s GDP, representing only a small fraction of the investments being made by businesses in such countries as South Korea, Sweden, Finland, the U.S., and even China. Canada has the most generous tax subsidies for R&D among the member nations of the Paris-based Organisation for Economic Co-operation and Development (OECD), which brings together 34 wealthy industrialized nations. “Yet there is a growing consensus among innovation experts that across-the-board tax cuts have very little impact on business investment in capital and technology,” said Mr. Stanford.

• Canada has failed to build global companies outside the worlds of finance and natural resources. “Canadian firms are well-known in mining and petroleum, and a small number of other industries such as banking. But in terms of being able to develop and sell high-value, innovative products to the world, Canadian firms are almost invisible,” said Mr. Stanford.

Attracted by the prospect of making high returns from ever more valuable natural resources, many Canadian companies feel little pressure to pursue innovative, capital-intensive alternatives, Mr. Stanford continued. “Why invest in innovation when you can get pretty easy money from the resource boom?” said Mr. Stanford. “Canadian companies have become lazy and coddled, by international standards,” he added. “There are very few Canadian companies that compete in global echelons. Once, we used to point to Nortel and Blackberry.” But Nortel disappeared, and “Blackberry’s decline only highlights our general failure to build a national innovation system.” With the exception of the banks, there are now only a few major manufacturing brands based in Canada, including aircraft manufacturer Bombardier and automotive component maker Magna International.” Even small European countries such as Sweden and the Netherlands have a greater number of globally competitive firms, Mr. Stanford added.

All of these trends have combined to contribute to “the worst decade of productivity growth in Canada’s postwar history,” argued Mr. Stanford. Moreover, many are overlooking the fact that productivity in resource industries – Canada’s current strength — tends to decline over time because “it is increasingly costly to extract more remote or marginal deposits,” he added. Thus, Canada is “putting increasing economic emphasis on industries with declining productivity, and that pulls down our national performance.”

The mixed blessings of a higher Canadian dollar

For his part, Mr. Sharpe cautioned that economists view labour productivity growth from a very different perspective than do corporate executives. Economists focus on the growth rate in production – namely, “how many physical goods” are produced by the economy. In that regard, they view real GDP as a proxy for measuring output. In contrast, businesses think foremost about profitability. They care most about the value added that they get from each extra unit of output. Thus, “Businessmen and economists are talking about different things.” If prices for output are high enough to allow a profit – as they are for Alberta’s energy exports – then, even negative labour productivity growth in that product sector is acceptable for business executives who manage those companies.

Mr. Sharpe added the rise in the value of Canada’s currency “has had mixed effects on productivity” depending on the time period. In theory, a cheaper Canadian dollar has been good for Canadian manufactured exports because it made Canadian products less expensive to foreign buyers. But it has also been a bad thing because many Canadian companies import a lot of machinery, and that machinery has become more expensive. To the extent that Canadian exporters – such as commodity producers who enjoy higher prices on global markets – can take advantage of foreign demand and sell well despite the higher value of the Canadian dollar, those companies also have “less incentive to innovative” – since their exports are automatically more profitable.

For his part, Mr. Sharpe believes there is “an element of truth” in the argument that Canada is suffering the ‘Dutch Disease.’ But merely recognizing such a fact does not solve the problem. “There is no doubt that the Canadian dollar has been overvalued,” he said, and that it has had a positive impact on Alberta’s oil and gas exporters. Based on the theory of Purchasing Power Parity (PPP), the Canadian dollar should be worth about 90 U.S. cents, according to a recent analysis by OECD economists.

The less obvious impact of lower productivity

Aside from the damage done to Canada’s competitiveness, these developments have significantly widened “economic and fiscal gaps within Canada,” said Mr. Stanford. For example, in 2005, Newfoundland’s GDP per capita exceeded the average Canadian GDP for the first time in history, and the following year, Ontario’s GDP per capita fell below the national average, also for the first time in history. Since 2006, added Mr. Stanford, the income gap has widened between the three “have” provinces – Alberta, Saskatchewan, and Newfoundland & Labrador – and all of the other provinces, which have become “have-nots.”

That seems ironic to Mr. Stanford, given the intentional efforts of previous generations of Canadians leaders to move their country’s economy away from dependence on natural resources. “Traditionally, Canadian policy makers were preoccupied with escaping our status as a supplier of natural resources and commodities,” argued Mr. Stanford. “A series of pro-active policy efforts were aimed to allow Canada to overcome its role as a ‘hewer of wood, drawer of water,’ and helping us emerge as a full-fledged, diversified, industrialized economic power in our own right,” he added. “In the first decades after World War II, Canada made considerable progress in this regard. By the turn of the century, well over half of our total exports consisted of an increasingly sophisticated portfolio of value-added products —including automotive, aerospace and telecommunications equipment. And Canadian firms and technology were increasingly recognized around the world.”

Mr. Stanford noted that this historic trend was reversed beginning at around the turn of the current century. “Resource industries have become ascendant once again in setting Canada’s overall economic and policy direction,” led by the enormous expansion in the petroleum sector center on Alberta’s oil sands; most of which is exported in raw or barely processed form. Now this structural shift “is profoundly remaking Canada’s economy, our role in the world, and indeed our very federation.” Yet apart from occasional bursts of rhetoric, it has been the subject of relatively little careful analysis. Mr. Stanford argued that while powerful market forces have contributed to make its economy resource-dependent, this process “is by no means inevitable or ‘natural.’”

Rather than dare to compete against global manufacturers, a lot of business activity in Canada has been moving into “non-tradable sectors” of the Canadian economy; that is to say, locally focused businesses and services, such as construction. Despite the fact that Canada has signed numerous free-trade agreements in recent years, exports as a percentage of Canada’s GDP have declined from about 45 per cent in 2000 to only 30 per cent today. This trend, which Stanford calls “perverse,” means that “Canada’s economy is actually de-globalizing. In other words, “Other [non-resource] exports have declined faster than resource exports have grown,” said Mr. Stanford.

Glen Hodgson, Senior Vice-President and Chief Economist at the Conference Board of Canada, said that a major factor behind Canada’s flagging labour productivity growth was Canada’s failure to address its antiquated regulatory restrictions, including those involving inter-provincial commerce. “The free-trade agreement with the U.S. in 1990 was critical, but we didn’t follow up” by doing away with a lot of regulations, said Mr. Hodgson. It wasn’t until 2010 that British Columbia and Alberta signed a free-trade agreement, known as the Trade, Investment and Labour Mobility Agreement. Meanwhile, Canada’s two largest provinces – Quebec with seven million people and Ontario with ten million – “are still talking about [creating] an understanding about free trade between them.”

According to Mr. Hodgson, part of the problem is that provinces like Quebec and Alberta focus too much attention on their own unique challenges, so they “want to regulate their own affairs,” rather than have the federal government do so. “There is a reason why the word ‘provincial’ has a negative connotation.” The attitude of provincial authorities is that “we reserve the right to be a little different in our regulations,” even if doing so raises the costs of doing business – and lowers labour productivity. “Part of the challenge in Canada is figuring out who the regulator is,” added Mr. Hodgson.

What needs to be done?

In recent years, Canadian policy makers have already taken numerous moves aimed at facilitating labour productivity growth, notes Mr. Sharpe. Both the federal government and several provinces have eliminated taxes on capital investment. In 2009, the federal government also eliminated import tariffs on a broad range of machinery and equipment, and committed itself to eliminating all remaining tariffs on manufacturing inputs as well. Corporate taxes have been lowered, and many areas of activity have been deregulated. The Conference Board of Canada has also praised the Trade, Investment and Labour Mobility Agreement between British Columbia and Alberta. “These are good policies, but they have not had an impact on the problem of lower productivity growth,” said Mr. Sharpe. Economists who suggested such measures would solve the productivity issue “exaggerated the impact of these policies on the problem,” Mr. Sharpe added.

Now Canada is pushing ahead with negotiations for ambitious new free-trade pacts – one with the European Union, and the other – known as The Trans Pacific Partnership – with a wide range of countries bordering on the Pacific in both Asia and the Americas. These agreements are expected to reduce regulatory barriers to trade not just between these various nations, but within them. Widely described as “deeper,” more comprehensive pacts than traditional trade pacts, the new agreements should increase competitive pressures on Canadian (as well as U.S. and other) firms to invest more funds in the capital equipment they need for boosting their productivity more rapidly.

But will such measures be enough? On a more negative note, however, governmental spending on infrastructure is expected to grow more slowly in the medium-term as governments turn their attention to deficit fighting. According to the Conference Board of Canada, a national debate on productivity would raise awareness about what needs to be done, and a defined productivity strategy—including enhanced infrastructure investment, a focus on advanced education, and eliminating remaining barriers to commerce between provinces – would begin to make up three decades of lost ground.

Surveys show that manufacturers around the world increasingly realize that labour productivity growth is critical to their success. In a survey commissioned by Kronos, Inc., a U.S.-based provider of workforce management software, labour productivity ranked as the most important factor for achieving manufacturing success in the eleven countries surveyed between March and April 2012. In the survey, other factors such as modern infrastructure, governmental support, and foreign direct investment all ranked below labour productivity in significance, in the views of manufacturing executives.

In the future, Canadian manufacturers will come under increasing pressure to increase labour productivity in order to boost their exports. “Manufacturers today are judged on a world stage, and their treatment of labour is under the scrutiny of governments, downstream supply chain partners and end consumer,” said Gregg Gordon, Senior Director at Kronos. “With developed countries facing high levels of unemployment and falling wages, emerging nations can no longer rely on low cost labor as a growth strategy.” As a result, companies based in emerging nations are moving “to develop a skilled, productive workforce to compete globally.” As manufacturers in Canada and elsewhere around the world seek growth in foreign markets, they will need to invest more in improving their labour productivity growth.

Innovative new directions

Leading economists agree that public policy changes alone will not be enough to jump-start faster labour productivity growth. Companies will need to focus on developing innovate new products in which they have a competitive advantage, as well as innovative production techniques and best management practices. At the Conference Board of Canada, Mr. Hodgson said that Canadian firms should use their strong currency as “a driver of adaptation. Canadian exporters must either boost their own productivity or they must specialize” in products where they face less competitive pressure from abroad. In the absence of such a fundamental change in direction, “Canada is losing market share in the United States to the Chinese,” he added.

Companies need to search through their entire corporate “value chains” to find those business practices where they can make innovative adjustments; not necessarily in their product line-up, but in the way they manufacture, transport and market their products, Mr. Hodgson said. Every business sector can benefit from “more innovation as an organization. To stay rich, Canada has to be led by brain power,” he added.

For his part, Mr. Sharpe said that “it is important to recognize that business sector productivity is primarily the responsibility of the business sector, not the government.” Although government “creates a favourable framework for businesses to improve productivity,” 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.”

Nevertheless, Mr. Sharpe suggested that governments in Canada should pursue macroeconomic policies that give 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,” he added.

Mr. Sharpe also suggested that governments should assist in the promotion of the diffusion of new technologies. “Ultimately, it is new technologies that improve productivity” but “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.” For this to occur, even smaller Canadian companies should become aware of best practices throughout the world. Mr. Sharpe said, “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.” Mr. Sharpe cited the Industrial Research Assistance Program (IRAP), run by the National Research Council, as an example of a successful program that promotes the adoption of new technologies by small and medium sized businesses in Canada.

Mr. Sharpe also suggested that government facilitate 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,” he advised. “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 and industries from low-productivity regions to high-productivity regions 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.”

For his part, Mr. Stanford provided his own list of suggestions for improving Canada’s productivity growth: First, he argued that the federal government work together with other stakeholders – including provincial governments, labour organizations, business, R&D institutes – and should establish a network of Sector Development Councils in a range of goods and services-producing industries. The councils would work to identify opportunities to stimulate more investment and employment in Canada; to develop and mobilize Canadian technology; to utilize technologies developed in universities and other educational institutions; to invest in sustainable products and practices, and so forth.

Too much attention has been paid to wage rates, but not enough attention to overall costs and to the issue of flagging Canadian labour productivity, Mr. Stanford asserted. “Direct hourly labour costs are less than five per cent of the total cost of designing, engineering, manufacturing, transporting and selling a new vehicle, yet they capture 99 per cent of the attention. If the analysts are serious about preserving and building this industry for the long term, they’d better look beyond the headline-grabbing labour talks and start to imagine an all-round industrial policy framework – like those in other successful jurisdictions – that offers a more promising economic recipe.”