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Market Insights:
When Productivity Growth Becomes Counterproductive

Don Curren June 11, 2019

You wouldn’t know it from the rising tide of political rhetoric ahead of this year’s federal election, but Canada’s biggest problem at the moment may be an elusive, hard-to-measure economic phenomenon with an intimidating name – productivity.

More accurately, the problem is productivity growth – or the lack thereof.

If the feeble productivity growth recorded in Canada in the last few years persists, there will be two major negative consequences – a stagnation in living standards and a declining ability to compete in an increasingly cutthroat global economy.

The first is because productivity is, according to mainstream economic thinking, the only way to improve living standards. (This article will focus solely on labour productivity for simplicity’s sake.)

A growing population – as Canada’s is now – will increase the size of a country’s economy (technically its potential output), but will do nothing for per capita income or living standards. Yes, the economy is larger, but the size of the population has increased at the same rate, so, on average individuals are no better off.

The only thing that will drive increased incomes for Canadians as a whole is growth in labour productivity – a rise in the amount of inflation-adjusted output generated per hour of work. And that’s dwindled significantly over the last few decades, as this StatsCan graphic shows.

But productivity can’t be addressed in isolation. To pursue productivity growth without ensuring that its rewards are equitably distributed is risky. History has shown that when inequality grows, disenfranchised populations become more likely to upset the established order – and often set the economy back, wiping out the gains achieved. Unfortunately, many mainstream economists (and the policymakers influenced by them) tend to ignore this reality.

I’m going to illustrate my point by analyzing a sentence that appeared in a speech delivered in late May by Bank of Canada Senior Deputy Governor Carolyn Wilkins.

The speech, delivered in economically beleaguered Calgary, was titled “Economic Progress Report: Investing in Growth” and focused on the critical role of business investment in driving productivity growth and nourishing the Canadian economy.

Even though productivity is technically outside the Bank’s mandate – which is focused on controlling inflation – its officials should be lauded for drawing attention to the problem of flagging productivity growth.

The sentence I’d like to parse is about one-third of the way into the speech. Unlike many sentences that appear in speeches by central bankers, it’s not a long, complex sentence replete with qualifications, conditional clauses or arcane jargon.

Here it is: ““Higher productivity growth means stronger growth in wages and incomes.”

At first glance, it seems an unobjectionable point and one that’s aligned with mainstream economic thinking.

The problem resides in the verb “means.” It seems to assert a close causal association between the two – almost as if productivity growth by definition produces growth in wages and incomes.

It’s true that at many points in history, productivity and wages have grown at the same pace. But it’s also true that wage growth and productivity gains can diverge.

The chart below records the large divergence between the growth in labour productivity and hourly compensation in the US from 1948 to 2017.

Senior Deputy Governor Wilkins’ observation is linked by a footnote to an article on the Bank’s website which is cleverly entitled “Making cents of wages.”

It makes a similar assertion about the link between wages and labour productivity growth, but does acknowledge that the two can deviate at times; “Over time, the average wage in the economy tends to rise at about the same rate as inflation plus the rate at which labour productivity grows,” it says.

The validity of that depends on how you define “over time” and “tends.” Below is a chart illustrating the path of wage and productivity growth in Canada. It shows that the divergence isn’t as stark as the US, but doesn’t seem entirely compatible with the assertion they “tend” to converge “over time.”

The article does acknowledge that “Improvements in technology help increase productivity but don’t always benefit everyone.”

“Some people’s jobs are disrupted by these advances in technology. But overall, gains from better technologies help increase Canadians’ living standards,” according to the Bank’s article.

Yes, we’re all familiar with the disruptive effects of technology on some peoples’ working lives. But there are other factors that have undermined the connection between productivity and wage growth and that apply even to those whose careers haven’t been battered by technological change.

Economists often seem to assume that when some development boosts the economic growth as a whole – take trade for example – the benefits will automatically be broadly and equitably distributed. That all sectors of the economy – labour and capital – will benefit seems to be an underlying assumption of their advocacy of trade liberalization.

But, to invoke a hoary old cliché of economic debates, a rising tide doesn’t necessarily lift all boats – unless they’re all equally buoyant. If some of them are struggling to stay afloat, they’ll just get swamped when the rising tide hits.

In the decades preceding the 1980s, there were several factors that ensured the rewards of productivity growth were distributed broadly – for example, less-monolithic product markets, geographically constrained supply chains, and a heavily-unionized labour force meant workers had more bargaining power than they do now.

But recent decades prove that productivity growth is a necessary condition for wage growth, but not a sufficient one. For productivity growth to trigger commensurate gains in wages, there have to be policies in place to ensure its benefits are widely dispersed.

This is not just an issue of fairness and equity. It’s also important simply to ensure stability. The perception that the economic gains of the last few decades all went to the “1 per cent” is one of the key drivers of the “populist” movement in the US and around the world.

If the rising tide lifts only a few opulent yachts and not all the other craft riding the economic tides, the result, to push the metaphor past the breaking point, will be mutiny.

That’s when productivity growth becomes counterproductive. When the perception that its fruits aren’t being shared fairly, there’s a risk those that feel aggrieved will upset the whole applecart, to move, metaphorically, from the open seas to the economic apple orchard.

To re-iterate, this piece isn’t intended to be a criticism of Senior Deputy Governor Wilkins and her colleagues at the Bank of Canada. It’s unfair to expect that the central bankers address all the ins and outs of complex economic issues when making a lunch-time speech at the local Chamber of Commerce, and the object of this exercise is to point out a pattern of thinking that arguably pervades mainstream economics, not quibble with the wording of such an address.

In fact, the Bank of Canada deserves credit for trying to draw attention to the issue at a time when politicians seem firmly inclined not to.

The latter group need to step up to the plate. Or, to revert to the rising tide metaphor/cliché, to seize the helm of the economy and steer it to more productive waters.

After all, failing to confront the need to bolster Canada’s productivity growth, to let living standards stagnate and the country to decline as a competitor in the global marketplace, would be the most counterproductive result of all.

Don Curren
Market Strategist and Content Editor

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