Mr Thiessen clarifies some points regarding the economy,
productivity and standard of living in Canada
Remarks by Gordon Thiessen, Governor of the Bank of Canada, to The Fraser Institute in Vancouver,
British Columbia, on 6 December 1999
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Over the past couple of years, there has been considerable debate about productivity and our standard
of living in Canada. For the most part, the discussion of these issues has been useful, but at times it has
been somewhat confusing.
There are so many different facets to productivity and the standard of living that they cannot all be
covered in one speech. My objective today is relatively modest - to try and clarify some of the basic
ideas and measures and to explain where monetary policy fits in this debate.
I will start by focusing on the relationship between the standard of living and productivity. Next, I will
talk about some of the different measures of productivity. I will finish with a few words on how
monetary policy can contribute to rising productivity and rising standards of living.
The connection between the standard of living and productivity
A country's standard of living and its productivity are not the same thing, although over the long run
they are closely linked. This distinction has not always been made clear in some of the commentary I
have seen.
When we speak of a society's standard of living, we are typically referring to the individual well-being
of its citizens. In principle, our standard of living should reflect both economic welfare and social
("quality of life") elements, such as a clean environment, a low crime rate, freedom of expression, etc.
But because the social elements are difficult to assess and to weigh properly, the focus is usually on
measures of our economic well-being.
There are a number of different indicators of our economic welfare. The most common one measures
how much output is produced in our economy, on average, for every man, woman and child in Canada
(real gross domestic product per capita). There are also various measures of real income per person,
before and after taxes (such as gross national income per capita and personal disposable income per
capita).
If we look closely at any one of these measures, it is clear that productivity is a critical factor in the
determination of our standard of living. But it is not the only factor. And when there are changes in
any of the other elements that influence our economic welfare, our standard of living can, for periods
of time, change in ways that appear to be disconnected from trends in the growth of productivity.
As an example, let us look at the simplest yardstick of living standards - output per capita. Clearly, this
is closely related to the output produced per worker - which is the most common measure of
productivity. But it also depends on the number of people employed relative to the total population.
Through the 1960s, 1970s and 1980s, output per capita in Canada increased more rapidly than
productivity. But over the past 10 years, it has fallen behind the growth in productivity.
Canada's lacklustre standard-of-living performance in the 1990s, which we have heard so much about,
has less to do with slower productivity growth than with the fact that the proportion of the population
that is actually employed has not been increasing. This is in contrast to the rising trend of the previous
three decades, when an increasing number of women and baby boomers were entering the labour
market.
During the 1990s, trends in employment rates in Canada also diverged significantly from those in the
United States, contributing to an increased gap in living standards between the two countries. This
weak employment growth in Canada partly reflects the extensive and difficult restructuring that our
private and public sectors had to undergo in a relatively short time compared with the United States,
where the process started earlier and was spread over a longer time period.
If we measure our standard of living in terms of how much of the national income goes to each and
every Canadian, then we are not just talking about the volume of goods and services we produce. We
are also talking about the world prices we receive for what we sell abroad relative to the prices we pay
for imports - that is, our terms of trade.
During the 1970s, world prices for the primary commodities that Canada exports soared relative to
prices in general. And they remained high through to the early 1980s. Since then, however,
commodity prices have typically been on a downward trend. And, of course, they fell sharply in the
wake of the Asian crisis in 1997-98, before partly recovering in 1999. We have to take this into
account when we examine what happened to our standard of living in the 1990s compared with earlier
decades.
We also need to look at what has happened to personal income after taxes. From the mid-1970s to the
early 1990s, tax revenues did not cover government spending and we were getting deeper and deeper
into debt. In other words, we were living beyond our means. During the 1990s, taxes rose and
government transfers and other expenditures were cut back relative to the size of our economy to
reduce the burden of those large public debts that had accumulated during the previous two decades.
Measures of after-tax income in the 1990s reflect that sobering reality.
So these are some of the factors that have weakened the link between productivity and living standards
in recent years. In the long run, however, productivity is, without a doubt, the key element
contributing to our prosperity. Productivity growth is the foundation for real income growth - it allows
businesses to pay higher real wages and still keep costs down and remain profitable.
There is one important difference between productivity and the other factors that influence our living
standards. The difference is that there are no constraints on productivity and its ability to contribute to
improvements in our welfare on a sustained basis. The other factors are constrained by physical,
institutional, and legal limitations. For example, there is a limit to the proportion of the population that
can, and will, engage in economic activity. Similarly, there are limits on the length of the work week.
On the other hand, there does not seem to be an upper bound on capital accumulation over time or on
the growth of human knowledge or on the degree to which both can result in higher productivity.
Productivity: the Canadian record
But I have been talking about productivity without defining it properly or describing how we measure
it.
Measures of productivity tell us how much output we can produce from the effective use of various
inputs - skilled workers, capital equipment, technological innovation, and managerial and
entrepreneurial know-how. Increases in productivity trace improvements over time in our ability to
boost output by finding new and more efficient ways to use these inputs.
The most commonly used, and best-understood, measure of productivity is labour productivity. It tells
us how much output is produced per worker or per hour worked. Of course, labour productivity is
affected by experience and education as well as by the amount of capital equipment (notably
machinery and equipment) that is available to workers. So, ideally, we would prefer to use the
measure that combines labour with all these other inputs - what we economists call total factor
productivity.
In practice, however, it is very difficult to measure the amount of physical capital in the economy.
Also, it is not clear how best to take account of improvements over time in the quality of the various
inputs. And, of course, measurement problems are worse in the services sector, where output is also
notoriously difficult to estimate. Because of these difficulties, analysts usually focus on the more
straightforward measures of labour productivity. This has the added advantage of being closer to
measures of standards of living and more directly comparable across countries.
With that as background, let me now turn to the "facts" on productivity in Canada, as best we can
measure them, and see how they compare with those for the United States. We should, of course, keep
in mind that the relevant statistics for the two countries, while similar, are not always comparable. For
example, there are differences in the way some prices are measured, particularly for high-tech
equipment, as well as differences in adjusting for changes in the quality of inputs. Moreover, last
month, the Americans revised their productivity figures upwards, following revisions to their national
accounts going back to 1959. To a significant extent, these revisions reflect a definitional change that
now treats computer software as an investment (instead of a business expense as before), and therefore
as part of the country's gross domestic product.
These definitional changes probably make the U.S. productivity figures less comparable with ours
than before. So one should be careful not to draw strong conclusions from comparisons that focus too
narrowly on these data. Nevertheless, we can still comment on the broad trends.
Through the 1950s and 1960s and into the early 1970s, labour productivity in the overall business
sector in Canada grew rapidly. It averaged close to 4 per cent per year - somewhat higher than in the
United States. From the early 1970s to the mid-1990s, productivity growth slowed sharply in both
countries - to less than half that rate. It has picked up in the latter half of the 1990s, especially in the
United States, where an investment boom has given U.S. workers substantially greater amounts of
capital equipment to work with.
Some commentators have paid particular attention to productivity growth in the manufacturing sector,
even though manufacturing accounts for less than 20 per cent of total economic activity in both
countries. They believe that the measures for this particular sector are more reliable and more relevant
for international competitiveness.
Since the 1980s, labour productivity in the Canadian manufacturing sector has risen at a significantly
slower pace than in the United States. To a large extent, this stronger showing by the U.S.
manufacturing sector reflects the remarkable performance of two industries - electrical and electronic
products and commercial and industrial machinery. These industries have benefited the most from
dramatic advances in computer technology, and they have a much larger weight in the U.S. economy
than here in Canada.
As a last comment on the facts about our productivity performance, I would like to stress the need to
distinguish clearly between the rate of growth and the level of productivity. While this may seem
selfevident, there has been a certain confusion on this score in some of the recent public commentary.
The rate of growth in our productivity has certainly slowed since the early 1970s, as it has in most
industrial countries, for reasons that are still not fully understood. But the level of our productivity has
been rising, not falling. And it cannot be blamed for the decline in some measures of our living
standards during the 1990s.
However, there is a significant gap in levels of productivity between Canada and the United States
ours is below theirs. Since access to ideas and technology is international, we would have expected
that gap to narrow, as it did during the 1950s and 1960s. But it hasn't. For this to happen, productivity
in Canada has to grow at a faster pace than in the United States. This is the challenge we Canadians
face if we are to bring our standard of living closer to that of our southern neighbours.
How can monetary policy support productivity growth?
Economists have not been particularly successful in explaining differences in rates of productivity
growth over time or across countries. As a result, there is no widespread agreement on what can be
done to bring about faster productivity growth on a sustained basis.
Nonetheless, I would like to make some comments on what would be helpful in this regard. And I
would certainly emphasize that we should always scrutinize our economic policies for any potential
impact on productivity.
When it comes to monetary policy, there is an increasing international consensus that the contribution
central banks can make to encourage growing productivity and higher standards of living is to provide
a low-inflation environment.
Low and stable inflation reduces uncertainty about future price movements, lowers the incidence of
boom-and-bust cycles in the economy, and helps to keep interest rates down. All of this encourages
investments in equipment and new technology that should lead to productivity gains. When I look at
the impressive productivity record of the United States over the past couple of years, I am struck by
the exceptionally large investments in machinery, equipment, and technology that have taken place
there.
I know that the depreciation of the Canadian dollar through late 1997 and 1998 has kindled some
concerns that a weak currency blunts the incentives for export industries to improve productivity. And
that has led to some suggestions that Canadian monetary policy, rather than targeting low inflation,
should set targets for the Canadian dollar. Or that perhaps our currency should be pegged to the U.S.
dollar.
It is true that in a period of high, and potentially rising, inflation, a depreciating currency adds to the
confusion about what is happening to relative prices and contributes to an attitude that any cost
increases can be passed on. Thus, businesses may not be as concerned about improving productivity as
a cost-cutting measure. But that is not the case in Canada today - inflation is low and stable, and the
Bank is committed to keeping it that way. Businesses know that they will generally not be able to pass
on cost increases, and so they focus on cost control.
The argument that a depreciated currency tends to discourage productivity improvements also ignores
today's powerful global competitive forces and the strong drive of businesses to increase their market
share and their profits as well as raise the prices of their stock.
In my judgment, our floating exchange rate works well. It absorbs the impact of, and facilitates the
adjustment to, extraordinary shocks that hit our economy from time to time, such as the sharp drop in
primary commodity prices in 1997-98. As part of that adjustment, the low Canadian dollar has
encouraged businesses outside the primary industries to expand their presence in foreign markets. But
they can maintain those gains only if they continue to work hard to increase productivity and to ensure
that they stay competitive as our currency regains strength.
Concluding thoughts
To conclude, it is almost impossible to overemphasize the importance of rising productivity as the
fundamental long-term factor contributing to healthy economic performance and prosperity. Over
time, gains in productivity are the basis for growing incomes and rising standards of living.
Compared with the strong performance of the 1950s and 1960s, Canada's productivity record since the
early 1970s has been rather disappointing. Even though the level of our productivity has been rising,
we have not made any headway in bringing it closer to that of the United States.
Recent developments in Canada, however, offer some promise of improvement. Productivity growth
has picked up in the past couple of years in response to the cyclical recovery and the structural
changes in our economy. And investment in machinery, equipment, and technology has increased
sharply in the past three years, much the same way as it did in the United States some years earlier.
But there is no room for complacency. Increases in productivity do not just happen. These days, good
productivity performance seems to be related to changing technology - an openness to adopting it and
a flexibility in adapting to it. That is what we must strive for in Canada.
We will also need to maintain a stable macroeconomic environment that combines low inflation and a
prudent fiscal policy. This will help foster a climate conducive to initiatives in innovation, risk-taking,
and investment that can contribute to sustained productivity gains. I can assure you that the Bank of
Canada will continue to do its part, by keeping inflation low and stable.