Productivity Puzzle

Jeffrey Simpson had a column (subscribers only but I've quoted the relevant parts) in the Globe last week on productivity. His main point seemed to be that politicians should spend a lot more time talking and worrying about productivity.

Says Simpson,

"One word should figure in every major political speech, whether from the left or the right.

The word scares people. It is poorly understood, or at least capable of multiple definitions. It isn't sexy. Nobody ever got elected talking about it -- at least not yet. But on this word, and on the ideas that lie behind it, depends our future prosperity and our ability to pay for social programs and to make our way in an increasingly tough, competitive world.

The word is productivity. Yesterday, for example, Conservative Leader Stephen Harper gave his end-of-session speech, chastising the Liberals, of course, and hinting at policy directions for his party. Not a word about productivity.

Mr. Harper is not alone. On the Liberal benches, only a couple of ministers such as Ralph Goodale or David Emerson dare mention productivity. As for the Bloc Québécois, forget it. Ditto for the NDP."

Now I don't deny the critical importance of productivity. After all, we all want to be paid more and the upper limit on how much someone can be paid is how much value they produce. And the two determinants of the value of what you produce are how long you work and your productivity. If you're like me, you'd prefer to make more money without having to work harder so productivity increases are generally the best bet for an improved standard of living.

But here's the thing: say I had to compare the importance to me of having a properly functioning liver vs. the importance of choosing the right clothes to wear in the morning. Obviously the liver is more important. But, given that I know very little about how my liver really works, that it seems to do its own thing without any intervention from me and that I wouldn't know where to start if I wanted to make decisions with my liver in mind, and that I wouldn't really know how much of an impact my actions would have, there's not much sense in me worrying too much about my liver on a day to day basis.

On the other hand, my clothing is fully under my control and I have a pretty good grasp of how some choices might work out and others wouldn't (although my girlfriend may disagree with this assessment).

As economic stats go, productivity is one of the most mysterious. Simpson is worried by the unexplained decline in Canadian productivity over the last few years (2000-2004), especially as compared to the U.S. Simpson seems to be especially worried by a study (which he of course doesn't provide a link to) by Andrew Sharpe and Jeremy Smith, of the Centre for the Study of Living Standards, and Someshwar Rao of Industry Canada - a study which specifically tries to figure out the source of this discrepancy. Simpson quotes the study authors,

"Current productivity developments are troubling, and if they continue, Canada's future prosperity is threatened, both in absolute terms and relative to other countries."

Simpson goes on from here to say,

"The core of better productivity is human capital development. Of course, it's also using materials more wisely, upgrading technology, working more collaboratively, restructuring work, ensuring competitive tax levels. But it's mostly about winning the battle of minds and skills in the global world.

Government policy should be measured against two questions: How does this improve our country's human capital development? Does this policy improve our connectedness and competitiveness with the global reality of tomorrow? To ask these questions is to throw out the window most of what the Martin government has done and what the opposition Conservatives propose."

But this series of abstract statements, while all very well, and a good summarization of the last 150 columns written by David Crane in the Star, doesn't really have much connection to the study he referred to earlier.

If you read the study (which, like always, I recommend - it's not that long and pretty easy reading) a different picture emerges. Here are some quotes:

"A definitive explanation for the recent interruption in productivity growth in Canada has proven elusive. But it would be premature to interpret recent developments as a downward shift in trend productivity growth.

In the last decade,Canada has suffered no major macroeconomic shock (excluding exchange rate shocks) and undergone no policy development or reorientation that would have had significant and long-lasting ramifications for productivity growth. Indeed, it can be argued that both the macroeconomic and micro-economic policy environments, characterized by stable inflation, falling debt/GDP ratios, budget surpluses, orporate tax cuts and increased federal funding for post-secondary education have become more, not less, productivity friendly."

Looking into the puzzle in more detail, we can see that while productivity (output/hour) has grown faster in the U.S. over the last 4 years than in Canada, the change in output has been almost the same between the two countries. Which of course means that the big shift has been towards Canadians working more hours than Americans. From the study:

"Business sector hours worked in the United States actually fell at a 1.0 per cent average annual rate over the 2000-2004 period, compared to a 2.1 per cent average annual rate of increase in 1996-2000. This decrease in total hours worked also lies in stark contrast to the increase in total hours in Canada,especially given that both countries experienced on average the same output growth over the period.

Total hours worked fell more than 2 per cent in both 2001 and 2002,with the loss dropping to 0.5 per cent in 2003 before reverting to an increase of 1.1 per cent in 2004. The decline in business sector employment in the United States after 2000 was less dramatic than that of hours. Employment fell at an average rate of 0.5 per cent from 2000 to 2004, well down from the robust 2.1 per cent rate of employment growth in 1996-2000 and in marked contrast to the 1.7 per cent increase in employment in Canada after 2000. Again, the employment loss was largely concentrated during the first two years of the period (-0.8 percent in 2001 and -2.2 per cent in 2002).

It's not hard to see why this gap in employment/hours might have occurred:

"Since 2000, profits have been at record levels in Canada, averaging 12.4 per cent of GDP. In contrast, profits have been at low levels in the United States, averaging 8.7 per cent. It may not be coincidental that during this period labour productivity growth decelerated in Canada but accelerated in the United States, as profitability affects firm behaviour, which in turn influences productivity.

The near-record low profits in the United States appear to have prompted employers to undertake workplace reorganization and to downsize employment levels in an attempt to reduce costs. The declines in U.S. employment in 2001, 2002, and 2003 attest to this desire on the part of employers to run a lean operation. Indeed, Gordon (2003:247)cites the unusual degree of downward pressure on profits as one of the two most compelling hypotheses to explain the post-2000 productivity growth acceleration in the United States.

As for the explanation of the difference in profits between Canada and the U.S., the obvious candidate is the big difference between our economies - Canada's is much more dependent on commodity prices. As the study notes, commodity prices have been 'booming' since 2000. Not only does increased profits reduce the need for companies to fire people, but it also depresses productivity in another way as well,

"As commodity prices rise, natural resource extraction industries have an incentive to exploit ever more marginal resources,since even minimal increases in production can have a large positive impact on profits. In general, profitability trumps productivity as an objective for firms. Normally the two objectives go hand in hand, but when they diverge,as for example when commodity prices are extremely high, the productivity of the natural resource sector suffers. This feeds into poorer productivity growth in the natural resource sector as a whole and,in turn, at the aggregate level (CSLS,2004). It is important to not however that a productivity deterioration arising from higher commodity prices is not necessarily bad for
income because of the improvement in the country's terms of trade."

Other possible culprits from the study are a slowdown in foreign direct Investment and a slowdown in business investment in technology (especially in IT).

Even with all this reasoning, the study authors remain, as quoted above, somewhat mystified by the numbers and even seem skeptical that they are right.

"It is important to underline that the productivity estimates discussed in this article are subject to revision, and these revisions can be significant. Indeed, in the six years between 1997 and 2003,there was an average annual upward revision of one percentage point between initial and current productivity estimates (Kaci and Maynard,2005)."

..and later,

"These conclusions should be considered tentative for two main reasons. First, as noted earlier in the article, Statistics Canada has in recent years revised its productivity growth estimates in an upward direction and to a considerable extent. Although this article employs the most recent data available at the time of publication, future historical revisions could significantly affect productivity estimates for the 2000-2004 period. Thus, our analysis and conclusions are subject to change if significant data revisions take place."

Talk about hedging your bets!

So what's my point? My point is that it's easy for Simpson to say that politicians should be talking about productivity and shaping policies around improving it, but it quickly gets hard when you actually look closely at productivity and try to understand what drives it. Simpson himself gets confused when he says that,

"[we have had essentially zero productivity growth over the past two years], that's fact. And zero productivity means zero growth in real incomes, jobs, prosperity."

If the study demonstrates anything it's that growth in jobs and too much prosperity (for companies) is a big part of what's keeping productivity down!

Maybe a politician is going to go out to the summer barbecue circuit and say,

"We have to increase productivity growth in Canada. That means driving down commodity prices and corporate profits so that companies need to lay people off and get lean and efficient. Plus we have to intervene even further in the market to bias business towards investing in machinery so they can get more productive instead of hiring so many more workers. Of course we're not sure if our numbers are even right, or if our suggestions will even work, but still, productivity is king, and I'm talking about it, you bet I am..."

Maybe, but I doubt it.

The study concludes as follows,

"..future trends in living standards in Canada are largely in the hands of Canada's private sector, as there is little governments can do to force businesses to pursue productivity improvement when this is not consistent with profitability objectives. Nevertheless, Canadian governments can facilitate productivity-enhancing investments by fostering a highly competitive business climate."

(emphasis added)

I'm sure our business leaders (led as always by Thomas d'Aquino) will be sending out the message loud and clear that what Canada really needs in order to be prosperous is a more competitive business climate. Look for the bosses at Westjet and Air Canada to be promoting the opening of the skies to foreign carriers. Look for the big bank heads to be asking the government to say 'No' to mergers and 'Yes' to more foreign competition. Look for all business leaders to agree that record high corporate profitability (and the accompanying record high CEO compensation) has been dragging down productivity and that something must be done.

Simpson may want politicians to talk about productivity all the time, but on an issue this murky and complex I wouldn't be surprised if they just continue to generally avoid mentioning it for the most part, sticking to things that they understand and that they can actually change for the better - and to be honest, that's fine by me.