Mark Carney: The virtue of productivity in a wicked world
Remarks by Mr Mark Carney, Governor of the Bank of Canada, to the Ottawa Economics
Association, Ottawa, Ontario, 24 March 2010.
* * *
It is either brave or foolhardy of the Ottawa Economics Association to organize another
conference around Canada's perennial challenges of demographics, productivity, and
potential growth.
The cognoscenti wearily deride these shortcomings even while they acknowledge their
importance.1 After all, who really wants to talk about getting old? Similarly, the subject of
productivity is described as too dull, or worse, too threatening for Canadians. It is said to
imply working harder, not smarter, or to promote job losses rather than income gains. These
debates are thus thought best confined to the policy wonks, in order that our diagnoses and
prescriptions can occur in a parallel, forgotten universe.
However, one wonders, who would not want to be productive in their work? Is there a child
whom we do not want to reach his or her full potential? Could what Canadians expect of their
economy be so very different from what they expect of themselves?
Our ambitions for the Canadian economy should be bold. We are a country of immense
strengths and, as demonstrated during the recent crisis, considerable resilience.
Yet Canada does underperform. We are not as productive as we could be. Our potential
growth is slowing. Moreover, this is occurring as the very nature of the global economy, in
which we previously thrived, is under threat. This debate can no longer be avoided.
What, then, must be done?
There are two imperatives - one domestic, one international - to secure strong, sustainable,
and balanced economic growth for Canada. Both recall Aesop's fable of the ant and the
grasshopper, the moral of which can be best summed up as "idleness brings want." In short,
in a wicked world, Canada needs productive virtue.
Canada's slowing potential
This conference has already benefited from comprehensive reviews of productivity and
potential growth, so I would like to briefly summarize the Bank's views (which are largely in
accord with the emerging consensus).
We have a problem: demographic drag will increase in coming years. As the boomer
generation ages, labour force participation rates will decline and hours worked will fall. The
question is merely one of degree. For some age groups, there is a possibility that
participation rates will be higher than currently anticipated, particularly since participation
rates of older workers have risen since 1996. Moreover, there is a role for policy to reduce
further disincentives for participation in the labour market. Nevertheless, it will not be able to
reverse longer-run demographic pressures.
We have a second, much bigger problem: our abysmal productivity record. Over the past
decade, it has averaged a paltry 0.7 per cent, about half the rate recorded over the
1980-2000 period.
The combination of slower productivity growth and demographic shifts could well mean that
the average rate of potential growth for the Canadian economy will be closer to 2 per cent
going forward than the more than 3 per cent we enjoyed in the first half of the past decade
and the latter half of the 1990s.2
If this differential were to persist over a decade, the cumulative loss of income would be
almost $30,000 for every Canadian.3 Given Canada's demographic trends, the principal way
to avoid this loss is by improving our productivity.
First imperative: improving Canada's productivity
There appears to be ample opportunity to do so, since Canada is not as productive as it
could be. Canada's productivity ranking has dropped from third of the 20 countries in the
Organisation for Economic Co-operation and Development (OECD) in 1960 to 15th of the
current 30 members (see Appendix, Chart 1).4 After some promising signs in the late 1990s,
average labour productivity growth has since slowed dramatically (Chart 2).
In growth-accounting terms, the main culprit has been multifactor productivity growth, which
has slumped markedly, while capital intensity failed to pick up pace.5
I will sketch out three types of explanations based on the research done at the Bank of
Canada and by many of you in this room.6
First, measurement challenges for both output and prices in the resources and service
sectors could explain some of the shortfall.
Second, lags associated with the economy's adjustment process could be obscuring
otherwise strong performance. These include:

longer-tailed resource investments that require substantial upfront expenditures
before natural resources can be turned into output, all the while drawing on more
marginal reserves; and
 the large-scale restructuring of industries and the reallocation of capital and labour
to new industries, which naturally dampen productivity as they take place.7
Third, there appear to be deeper structural determinants that will require more concerted
efforts on the part of business and government to address:
2
In April 2009, the Bank of Canada lowered its forecast for the growth of potential output to 1.2 per cent in
2009, 1.5 per cent in 2010, and 1.9 per cent in 2011 from 2.4 per cent in 2009 and 2.5 per cent in 2010 and
2011, reflecting significant structural changes and subdued corporate investment.
3
As expressed in 2009 dollars.
4
Compendium of Productivity Indicators, Organisation for Economic Co-operation and Development (OECD),
2006 and 2008.
5
Multifactor productivity measures joint influences on economic growth, such as technological change,
efficiency improvements, and returns to scale. Its growth rate is calculated as the difference between the
growth in the amount of output produced and the growth of the quantity of all inputs used, such as labour and
machinery and equipment.
6
For a recent summary of Bank of Canada research, see R. Dion, "Interpreting Canada's Productivity
Performance in the Past Decade: Lessons from Recent Research," Bank of Canada Review (Summer 2007):
19-32, available at: http://www.bankofcanada.ca/en/review/summer07/dion.pdf; and R. Dion and R. Fay,
"Understanding Productivity: A Review of Recent Technical Research," Bank of Canada Occasional Paper
2008-3, available at: http://www.bankofcanada.ca/en/res/dp/dp(y)_2008.html.
7
Bank of Canada research suggests that job reallocation across firms is a significant positive factor explaining
Canadian labour productivity growth over the 1992-2006 period. D. Leung and S. Cao, "The Changing Pace
of Labour Reallocation in Canada: Causes and Consequences," Bank of Canada Review (Ottawa: Bank of
Canada, Summer 2009): 31-44. Available at: http://www.bankofcanada.ca/en/review/summer09/leung.pdf.
BIS Review 36/2010

Canada under-invests in machinery and equipment (M&E), training, and innovation -
in fact, all of the underlying drivers of productivity.

Canadian workers have about half the amount of information and communications
technology (ICT) of their American counterparts. ICT capital has been linked to
stronger multifactor productivity growth in many countries.8

With its highly educated workforce, flexible labour markets, and high rates of firm
entry and exit, Canada appears to have all the ingredients needed to be an
innovation leader. However, it is only 16th among the OECD countries in the
intensity of business research and development.9

Our dismal multifactor productivity growth indicates that Canadian firms do not
effectively use the capital that they purchase.10
Some possible explanations for why we both under-invest and appear to use capital so
poorly include:

the wrong skills mix: Canada has a well-educated labour force but, perhaps as the
structure of the economy shifts, not in the areas required;

small firms: Compared with the United States, Canada has proportionately more
small firms that are significantly less productive than large firms;11 and

in particular, inadequate competition in some sectors, especially network industries
that have spillovers throughout the economy, including telecommunications,
electricity, and retail.12
Whatever the combination of reasons behind Canada's poor productivity record, there are
several avenues available to policy-makers to encourage sustainable longer-run growth.
It is important to acknowledge that successive governments have taken many steps in the
right direction. Canadian businesses benefit from a sound macro-policy environment,
including sustainable fiscal policy and credible monetary policy, which delivers low, stable,
and predictable inflation. Corporate tax competitiveness - particularly for new investment -
has improved markedly over the past decade and is now among the most attractive in the
industrialised world. Canada has also actively pursued trade openness through new
agreements and unilateral tariff reductions.13 Staying the course in these regards is likely the
single most important contribution of the public sector.
8
This is not related to industrial structure-it is found in most industries. See A. Sharpe, "What Explains the
Canada-US ICT Investment Gap?" Research Report 2005-2006, Centre for the Study of Living Standards
(CSLS), December 2005.
9
A recent report concluded that "too many businesses in Canada are technology followers, not leaders" and
stressed the need for "innovation-based business strategies." See P. Nicholson, "Innovation and Business
Strategy: Why Canada Falls Short," International Productivity Monitor, No. 18 (Spring 2009): 51-71. Available
at: http://www.csls.ca/ipm/18/IPM-18-Nicholson.pdf.
10
Using a growth-accounting framework, Baldwin and Gu show that multi-factor productivity (MFP) is the main
culprit in Canada's lagging productivity performance. They note that two sectors in particular - mining and oil
and gas extraction and manufacturing - account for much of the slowdown in MFP growth in this decade. See
J. Baldwin and W. Gu, "Productivity Performance in Canada 1961-2008: An Update of Long-term Trends,"
Statistics Canada, 2009.
11
D. Leung, C. Meh, and Y. Terajima, "Productivity in Canada: Does Firm Size Matter?" Bank of Canada
Review, Autumn 2008. Available at: http://www.bankofcanada.ca/en/review/rev_autumn2008.html.
12
OECD, Economic Policy Reforms: Going for Growth, 2010.
13
See The Budget Plan, Department of Finance, Canada 2010.
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These core framework policies can be supplemented by measures to foster innovation and
commercialization, investments in strategic infrastructure, and incentives for scale.
Finally, it is vitally important that current global financial sector reform efforts yield a stable
and efficient financial system that channels the capital necessary for long-run growth.
In general, while there is always more to do, governments have put in place conditions for a
productivity revival. Business, thus far, has disappointed. In fact, productivity growth fell in
the latest recession, the first time this has happened in three decades. Looking forward,
despite the availability of capital, relatively strong balance sheets and improving economic
conditions, corporate Canada does not appear ready to invest. Investment intentions for
2010 remain modest and largely driven by the public sector.
This appears unwise.
The coming global winter?
There could be tough times ahead. Canadian grasshoppers, perhaps basking in the
historically easy access to the U.S. market and the relative abundance of resource
opportunities, could be in danger of wasting their days in the sun and finding themselves
unprepared for the winter to come.
Canada's productivity challenge is made more pressing by an international economic
landscape that is changing dramatically. A powerful and sustained restructuring of the global
economy has begun. The pace and volatility of global growth are likely to be quite different
than during the so-called "Great Moderation" earlier this decade. The considerable
uncertainty about medium-term global prospects will require concerted, co-operative
measures to moderate.
The second imperative: the G-20 framework
Policy-makers must work to ensure that business can operate, as much as possible, in an
open and stable global economy. At a minimum, this means living up to the G-20
commitment to resist trade and financial protectionism. More proactively, it means substantial
reforms to build a more resilient, open, global financial system. Ultimately, as I will discuss in
a moment, securing strong, sustainable, and balanced global growth will also require
changes in behaviour and policy adjustments on several fronts.
While the recent financial crisis had many causes, its intensity and scope reflected
unprecedented disequilibria. Large and unsustainable current account imbalances across
major economic areas were integral to the buildup of vulnerabilities in many asset markets.
In recent years, the international monetary system failed to promote timely and orderly
economic adjustment.14
Further postponing adjustment will only serve to increase vulnerabilities. In the past, the
frustration of adjustment by current account surplus countries generated deflationary
pressures in the rest of the world. Similarly, today, the adjustment burden is being shifted to
others. Some advanced countries - including Canada - have recently seen sizable
appreciations of their currencies. Their ability to increase domestic demand in response is
limited.
The net result could be a suboptimal global recovery, in which the adjustment burden in
those countries with large imbalances falls largely on domestic prices and wages, rather than
on nominal exchange rates. History suggests that this process either could take years,
repressing global output and welfare in the interim or lead to another crisis, which would
accelerate adjustment, but at a terrible cost.
The G-20 framework could address this issue
The G-20 framework to promote strong, sustainable, and balanced growth in global demand,
launched last November in St. Andrews, Scotland, is an attempt to learn these lessons from
history.
The G-20 framework stresses the shared responsibility of countries for global economic
performance. Under the framework, members have agreed to a mutual assessment of their
monetary, exchange rate, fiscal, and financial policies, with the assistance of the
International Monetary Fund (IMF). The implications of these policies for the level and pattern
of global growth and the risks to financial stability will be reviewed by finance ministers and
central bank governors in preparation for agreement on any common actions by G-20
leaders in Canada and South Korea this year.
To illustrate what is at stake, the Bank of Canada has generated three scenarios for the
evolution of global growth and current account positions.15
The first is a business-as-usual scenario (Chart 3). No significant changes are made to the
current mix of policies, which creates a situation similar to the one that led to the recent
crisis. In particular, advanced countries do not make the fiscal adjustments necessary to
stabilize their debt dynamics, and their household savings rates do not increase.16 As well,
emerging Asia continues to finance the U.S. deficit through reserve accumulation, effectively
impeding real exchange rate adjustment.
In the short run, this combination of policies provides a fiscal boost, but it does not last. In
response to the rising public debt burden, global interest rates begin to rise, crowding out
private investment and ultimately lowering potential growth. This, in turn, further worsens the
fiscal situation. Global economic growth falls steadily and, by 2013, it is only 2.7 per cent
(compared with the 4 per cent average rate during the Great Moderation of 2002-07). More
alarmingly, global imbalances reassert at an explosive rate. Paths for public and external
debt are unsustainable and could lead to another crisis.
An obvious lesson to draw from this scenario is that advanced countries need to engage in
fiscal consolidation over the medium term. Indeed, that is the express policy of all
industrialised countries. But would that alone be sufficient to rebalance the global economy?
Consider a second scenario in which there is fiscal consolidation in advanced countries such
that debt-to-GDP stabilizes by 2015 (Chart 4).17 Other countries maintain current policies. In
particular, there is neither a real effective exchange rate adjustment nor an increase in the
trend of domestic demand growth in Asia's emerging economies.
In this scenario, there is deficient demand globally. With monetary policy constrained by the
zero lower bound, deflation emerges. As a consequence, real interest rates increase sharply,
growth stalls, and fiscal consolidation becomes more difficult.
It is cold comfort that global imbalances are effectively eliminated. The cost is a prolonged
global recession, with massive foregone output. If this scenario were to occur, the risk of
protectionism would undoubtedly rise, potentially exacerbating the damage.
Finally, consider a "framework scenario," one that highlights the large gains that the G-20
process could - and should - produce (Chart 5). In this case, the fiscal consolidation of the
second scenario is complemented by policies to increase domestic demand in emerging Asia
and a modest real effective depreciation of the U.S. dollar (across all major currencies).
In this case, current account imbalances stabilize at low levels and, more importantly, global
growth rises to 3.7 per cent in 2010 and 4.5 per cent in 2011. Growth is strong, sustainable,
and balanced.
There is no doubt we would all be much better off with the last scenario (Table 1). By 2015,
the difference in the level of global GDP between the deflation and framework scenarios is
about 12 per cent (Chart 6).18 For Canada, the difference would be 10 per cent of Canadian
GDP.19
The morality of global imbalances
If the gains to rebalancing are so considerable, why isn't it assured that countries will take
the necessary steps? There are two issues: misdiagnosis and coordination.
Regarding the former, some view global imbalances, not as a missed opportunity but, rather,
a modern morality tale. To them, deficit countries are the profligate grasshoppers whiling
away their hours in the sun, while the surplus countries are ants prudently husbanding
resources in anticipation of winter.
The problem with this diagnosis is that it ignores the symbiotic nature of the global economy.
Excess savings in some countries go hand-in-hand with excess dissavings in others. Taken
to the extreme, the husbanding of resources makes the economic winter more likely. The
thrift of the Swabian housewife or the obsessive self-insurance of the emerging giants is
globally debilitating and self-defeating. Hegel's observation that all societies die from the
morbid intensification of their own first principles comes to mind.
The drivers of domestic demand cannot be concentrated in the same countries forever. As
the Managing Director of the IMF has suggested, not all countries can simultaneously export
their way to growth.20
The framework process does not appeal to a country's altruism. As shown in Table 1, the
framework scenario is pareto improving - every region is better off under it.
The second issue is coordination. To stimulate private domestic demand, surplus countries
could enhance their social safety nets, reform financial systems to liberate trapped savings
from small and medium-sized enterprises, and sharpen relative price signals (in part through
greater exchange rate flexibility). While it is in their own interests to implement these policies,
surplus countries could be further encouraged by industrialised countries implementing the
necessary complementary measures.
In particular, industrialised countries must develop credible medium-term plans for fiscal
consolidation and implement them once the recovery is firmly entrenched. Moreover, it is
essential that industrialised countries, particularly those at the epicentre of the financial crisis,
implement a series of financial reforms to increase the resilience of the global financial
system. This means more and better bank capital, improved market infrastructure for
derivatives and funding markets, and a series of initiatives to end "too-big-to-fail."21
It will not be enough to propose. Measures must also be credibly implemented. That is why
the peer review process of the Financial Stability Board (FSB) and external reviews by the
IMF are so important. Through these processes, financial reforms could increase actual and
perceived systemic stability and thereby encourage mutually supportive policies in surplus
countries.
Finally, all countries will need to maintain their commitment to price stability. I will now turn to
this issue in Canada before concluding.
Update on the inflation outlook
The global economy has evolved largely as expected. Strong growth in many
emergingmarket economies has been accompanied by positive though uneven growth in most
advanced countries. Although the level of economic activity is now somewhat higher than
projected, the outlook for inflation and economic growth in the global economy over the near
term remains essentially unchanged, with exceptional monetary and fiscal stimulus
continuing to provide important support in many countries.
Economic activity in Canada has surprised slightly on the upside in recent weeks relative to
the projection in our January Monetary Policy Report. Growth has been driven mainly by
domestic demand, but exports have also recovered further in response to improving external
demand. Significant policy stimulus, combined with increased confidence, improved financial
conditions, and higher terms of trade, are the main factors supporting growth in Canada's
domestic demand.
At the same time, the persistent strength of the Canadian dollar and the low absolute level of
U.S. demand in certain key sectors, such as autos and housing, will continue to act as
significant drags on economic activity in Canada.
Core inflation has been slightly firmer than projected, the result of both transitory factors and
the higher level of economic activity. The outlook for inflation should continue to reflect the
combined influences of stronger domestic demand, slowing wage growth, and overall excess
supply.
At its 2 March 2010 decision, the Bank reconfirmed that the target overnight rate can be
expected to remain at its current level until the end of the second quarter of 2010 in order to
achieve the inflation target. This commitment is expressly conditional on the outlook for
inflation, which will be updated in the Bank's next Monetary Policy Report, to be published on
22 April.
Conclusion
In conclusion, the twin challenges of boosting Canadian productivity and of implementing the
G-20 framework globally are daunting. But the gains are considerable. Now is not the time to
rest on our laurels or to take an open global economy for granted.
The Bank is committed to tackling these important issues. We have a broad research agenda
on productivity. We are working with our domestic and international partners to reform the
global financial system. We are active participants in G-20 framework discussions, not
merely because they offer the best outcome for the global economy but also because they
are in Canada's interests.
Finally, and most fundamentally, the Bank has an unwavering commitment to price stability.
The single, most direct contribution that monetary policy can make to sound economic
performance is to provide Canadians with confidence that their money will retain its
purchasing power. That means keeping inflation low, stable, and predictable. Price stability
lowers uncertainty, minimizes the costs of inflation, reduces the cost of capital, and creates
an environment in which households and firms can invest and plan for the future.
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