Perspectives podcast: Why Canada's lagging productivity could harm your standard of living

Stephen Meurice: What does the word “productivity” mean to you? Maybe how often you go on Instagram while you’re supposed to be working? Or how many emails you respond to in a day. For Scotiabank’s Chief Economist Jean-François Perrault, productivity is an economic concept. And one that people don’t always understand the significance of.

Jean-François Perrault: I mean, it's probably the most important economic variable that we have. For us, it's the number one public policy issue. There's no question about that.

SM: Productivity is basically the measure of how much a country can create per working person.  
 
JFP: So, when productivity levels are rising, it means that you are producing more with the same set of resources than when productivity is declining.

SM: And right now, in Canada it is declining. And we were already behind. That has some big implications for Canadians’ standard of living.

JFP: At the end of the day, if you can't generate an increase in the standard living for your population, then the economy is failing people or governments are failing people. There is nothing more important.

SM: So JF is here today to give us a crash course on productivity. He’ll tell us exactly what it is, how it’s calculated, where Canada stands and why finding a solution to declining productivity is so difficult. I’m Stephen Meurice and this is Perspectives.

JF, thanks for coming back to the show. It's always a pleasure to have you here.

JFP: Always a pleasure to chat.

SM: Alright. So today we want to talk to you a little bit about an economic concept that you hear about a fair amount in the news, but that I think maybe people don't always get the significance of, it maybe feels a little bit nerdy. It feels a little bit in the economic weeds, so to speak. And that's productivity. Could you give us a basic definition of what productivity is to start with?

JFP: Yeah, I mean, like at a really high level of productivity is the amount of stuff that we produce per person that's working. So, it's a measure of an economy's ability to produce things in a more or less efficient way. So, when productivity levels are rising, it means that you are getting more out of workers, you are producing more with the same set of resources than when productivity is declining. So, it's a really important measure or determinant of standard of living. It's obviously a really important determinant of competitiveness. So, strong productivity is good and low productivity is a problem.

SM: Okay. Is there an easy way of explaining how it's measured? Is it like GDP divided by…

JFP: Unfortunately, not. I mean, so at a really high level it is, economic activity divided, say, by the number of hours that people work in the economy. Much, much easier said than done. Easier to measure, for instance, in the manufacturing world than it would be in the services world. Like, I don't know what my productivity is, right?

SM: [laughs]

JFP:  I write reports, I do podcasts, I talk to people. How that productivity is captured is very different than, say, if I were to be a carpenter and I build homes. So, there is a tremendous amount of complexity to measuring productivity. And as our economy becomes more and more service-oriented, which is the case in a lot of advanced economies, that service part of the economy is much more difficult to measure than the goods part of the economy. So, there are tremendous complexities in calculating productivity. But those complexities, they are just as difficult to handle here as they are in the U.S. or any other country that we compare ourselves against.

SM: But how accurate is it? Given the complexities, given how you know, you talked about your own productivity, how it's difficult to measure. Are productivity measurements accurate or that kind of estimates?

JFP: They’re always estimates, but you get a sense from other economic data whether or not it confirms what's going on on the productivity side. So, if you're losing market share as a country, for instance, in a certain sector, then you might ascribe that to decline in productivity or relatively better competitiveness on the part of whatever company or country you're trading against. When you look, for instance, at inflation or when you look at profit margins. You know, the more productive a firm is, the more profit margin typically there is. When you look at, say, the impact of wages on inflation, well the more productive you are, the more wages are able to rise in a non-inflationary way. So, there's various ways of kind of looking at things to give you a sense as to whether or not the productivity data are telling you what you think they're telling you. And generally speaking, that's the case. So, despite the inherent flaws that exist in the measurement of productivity, there's enough science behind there to be reasonably confident that what they're capturing might not be exactly the right level, but it's giving you a sense of where things are going.

SM: Right, and especially comparatively over time I guess.

JFP: Yeah, exactly.

SM: So why is it important? What does it say about the state of the economy when productivity is flat or declining or not doing as well as other countries? Why does it matter?

JFP: I mean, it's probably the most important economic variable that we have. At the end of the day, just pretend there are no countries and only companies. And you’ve got one company that’s productive, one company that’s un-productive. So, one company that's competitive, one that's not competitive. Well, over time, that uncompetitive company, it’ll  go bust. It'll get taken over by the competitive one, so the more productive one. And the same kind of applies at a more aggregated level, when a country is less productive than its trading partners, well that trading partner is going to gain market share in the global world or in the country that we're talking about. So, it's a very important determiner of our standard of living. If we want to raise standard of living, you've got to raise productivity. And if productivity is falling, then it is very, very difficult to sustain increases in the standard of living and in fact, probably leading to decline in the standard of living.

SM: Right. I'll come back to the standard of living thing in a second. But just so I'm clear, you did that comparison of two companies. Say they make the same thing, they're competing in the same space, but one is able to make more widgets than the other widget company with the same amount of input. Is that basically what productivity means?

JFP: That's exactly what that means. And it means that company then, the more productive one, is either able to generate a profit or is able to sell at a lower price, which eventually will force the other company to go under.

SM: So then at a national level, it's aggregating all of those companies, all of the effort that's put into creating products or services or whatever that gives you the overall rate. And you compare that to another country. They're doing more with what they have than we are?

JFP: Absolutely. Maybe another way to think about that, building on this concept, is if you have an economy that is more productive, you effectively have an economy that's able to sustain higher wages. Right? If a company is more productive, they're able to pay the people more because those people are generating more output. So, people are better off because they're earning more, because everybody is doing better from an economic perspective – companies and individuals.

SM: Right. So that's where the standard of living aspect of it comes in. Can you explain that a little bit more? Because that's always the link that's made is if your productivity isn't growing, your standard of living is not growing. How does that work? What's that equation?

JFP: Well, I mean, you can think of it in very, very simple terms. For instance, in GDP per capita. So, the amount of stuff that we produce as an economy in relation to the number of people in that economy. So, if you are more productive, if productivity is increasing, you're raising the standard of living by essentially increasing the amount of things that the economy has produced for a given number of people. And of course, that production is then paid out in profits or wages or whatever it is. And that increases standard of living for folks within that economy.

SM: Okay. So, let's look at Canada then. How has Canada's level of productivity looked, we’ll sort of look retrospectively for now, over the last 20 years? 30 years? Or historically, are we a country that has generally increased productivity or not?

JFP: So, there's two dimensions to that. There's what we call the level of productivity, then there’s the growth of productivity. On both counts, we haven't done very well. So, the level of productivity relative to, say, the OECD, Canadian productivity is always below what our advanced economy peers have been able to generate. And this has been a longstanding issue. We are just less productive. And that's, you know, that’s one thing if you were less productive 30 years ago and that changes over time, then great. The challenge is we've been less productive for a number of years, and we've not been able to really close that gap because our productivity isn't rising at the same rate as it is in other countries. So that gap between how productive we are versus our trading partners has increased over time. And that's the second part of the problem. So not only are we not as productive, but we're also not keeping up with what others have been able to generate.

SM: And has that corresponded to standards of living versus OECD countries over that period of time?

JFP: Yeah, so if you look for instance, at GDP per capita, it changes over time, but we've generally underperformed relative to a broad range of advanced economies. And that reflects, in part, this productivity issue.

SM: I'm sure there are multiple causes, but why does Canada lag behind comparable countries on productivity?

JFP: Nobody really knows. Because if we knew that, we wouldn't have the problem that we've got. So again, come back to like a company. Companies put workers and technology together to produce stuff. Whether those are goods or services, doesn't matter, you need those two things. So, the challenge is and what we know to be the case in Canada, is business investment in Canada has been below the OECD for quite a while, 20 or 30 years. So Canadian businesses invest less than, say, American businesses, European businesses. So, as a result of that, you know, you think about this company that's got to put labour and workers and capital together. If you're not throwing as much capital into countries or economies as your partners are, then productivity doesn't go up as much. So, we know at the very least that investment is an issue. The challenge then becomes, okay, well, investment is an issue, how do we change that?

SM: Right. Just before we get there. So, when you talk about business investment, that's essentially companies, broadly speaking, putting money into new technology, into innovation, into ways of doing things better, faster, cheaper. And Canadian companies do less of that than our peers and our competitors.

JFP: Yeah, absolutely.

SM: Why is that?

JFP: We don't really know why that is. I mean, part of the story is probably linked to the fact that more of Canadian GDP is produced by small and medium sized enterprises than would be the case in Europe or the United States. And of course, the larger the number of small companies you have, well those companies have, you know, harder access to capital, they're more precarious, they have a harder time taking chances on things. So, there's probably a correlation there between the size of the typical Canadian firm relative to, say, again, the Americans or the Europeans. That puts a little bit of a brake on their ability to invest. That's part of it. And then there's other related things like maybe tax policy's got a role to play, maybe labour laws or regulation got a role to play. Maybe interprovincial trade barriers have got a role to play in terms of keeping companies smaller than otherwise would be. But the simple truth is we don't really know exactly why. Economists have all kinds of answers for these things.

SM: That’s what you are. So you should have some of those answers [laughs]

JFP: Yeah, but I'm an honest economist. [laughs] You know, the reality is I think if you look at the academic literature, if you look at the empirical literature on what's been driving productivity or the barriers for productivity, there isn't really a well understood view as to why it is that we are where we are in Canada. As a result of that and it makes it very difficult to have very firm policy prescriptions as to what the change to improve that.

SM: So, this is maybe getting into culture more than economics, but are Canadians more risk averse than, say, the United States or maybe some other places? Are we more conservative?

JFP: That could be part of it, right? Like, maybe we are just less aggressive in pursuing business opportunities because we value other things a little bit more than some of our competitors do. That's entirely possible. So, there might be this mentality dimension to it. And you see there are elements of that in how kind of corporate Canada behaves. So, for instance, Canada is fantastic at producing STEM graduates. So science, technology, engineering, and math, like we have one of the highest rates of STEM graduation in the world. Yet our firms use less STEM graduates than European or American firms. Canadian firms have less professional managers than American or European firms. And so, you know, you look at the management structure like how many of those people have MBAs, for instance, relative to the Americans and Europeans? We have less of those. We have more familial relationships in kind of the management structure of organizations than perhaps the Americans or the Europeans do. So, there's something that we're valuing there, that business owners value, which is perfectly legitimate, that maybe is behind some of this or might be a factor behind some of this. But there is probably a bit of a cultural element to that.

SM: So, if this phenomenon, which as you said, has been going on for decades really already, if it carries on, what's the long-term impact of that? How do people who don't necessarily understand economics and all of that, how should they know that they're being affected by this phenomenon that's existed in Canada for a long time?

JFP: One of the consequences of stagnating or declining productivity is it has an impact on what we call real wages. So, wages, once you adjust for inflation. And if you are observing as a country that wages are stagnating, again, in a real sense that is a consequence of lower productivity. So, there is a very real consequence for people. If your economy is stagnating because it's difficult to trade, because you're not competitive on global markets. Well, those are less growth opportunities than otherwise would be the case. So, some of this stuff is, you see it perhaps on the wage side, some of it you see it in terms of, or perhaps you don't see it because it's like you're missing out on opportunities that are not evident, right? So, you're growing less rapidly than otherwise would. And that's harder for people to observe. You know, it's a combination of those things that makes it more difficult to sustain significant and long term increases in economic activity and jobs and wages and our standard of living if we're less productive rather than countries that are more productive.

SM: So, if you're less productive, you're probably going to end up less competitive on price and therefore just less competitive generally with companies or countries that are more.

JFP: Yeah, and it makes it easier, say, for foreign firms to come in and buy domestic firms. You know, foreign firms bring bringing more technology, more capital, more innovation and transform some Canadian industry. So, there's a link at the end of the day of how much of our economy is Canadian, quote unquote Canadian in some sense, because again, as our competitors make gains in areas in which we're unable to make gains, well just like you see in the corporate world, well you got some takeovers, right? Companies come in, ‘I’ll take this company over because I'm better at making stuff than they are. And I'll put those operations together and take advantage of that.’

SM: So, the toughest question, I guess, given the difficulty of even identifying why our productivity is bad, how do you solve the problem when you're not even really sure what the cause is?

JFP: Well, I think part of the challenge that exists in the productivity landscape is, for a very long time, productivity was thought of as a kind of a bad word. You know, you increase productivity by firing people. So, it wasn't viewed as, from an economic view it was viewed as positive, but like from a popular perspective, you know, any time a firm says, ‘We're going to take some measures to increase productivity.’ Well, that's instantly viewed as, ‘Okay, well, how many people are going to fire?’ So, there's this kind of bad connotation historically associated with productivity. I think the first thing is you got to get people to think a little bit differently about that. Productivity's actually about increasing our standard of living. It's about making us better off. So that's, I think, the very minimum in terms of developments that we need. The second I think is you need politicians just to be humble about this. And say, ‘Listen, we know that we've got a productivity issue. We don't really know how we're going to solve it, but we're going to try all kinds of things. We're going to, you know, not be dogmatic about it. We're going to talk to the labour folks, we’re gonna talk to business folks. We’re going to see, for instance, if there's a way for both businesses and labour unions to come up with some ideas as things that they collectively think might work in terms of advancing productivity.’ But it really requires kind of a shift in mindset away from being worried about the transformation that is required and worried about the cost of disruption to one of, ‘These are the opportunities that are available to us if we were to progress on the productivity side.’ And in some sense, it's kind of fortunate because I mean, there is going to be an election counted in a couple of years or maybe before, we'll see. And it's a chance, I think, to have a really interesting conversation and ideally interesting proposals on the productivity side from one party or another. That is invigorating in some sense. So, our hope would be for all parties as they think about their platform for 2025 to put productivity square in the middle on that and be very aggressive in trying to pursue things that might change the dial. Now understanding again that this is a space in which we don't really know what works or not, and it's going to require trial and error. It's going to require things that probably are going to fail. But that's the nature of productivity itself. Like you've got to take chances to innovate, you’re not always going to get it right. But it does require, I think, a fairly activist frame of mind to make a difference.

SM: By activist, do you mean in terms of policy prescriptions? Mostly what you've talked about is sort of on almost an educational level, getting people to understand the importance of it and bring parties together and so on. Are there policy prescriptions or a role for government to play? Because I think probably some people would argue that one of the problems in Canada is already too much government, not too little.

JFP: Yeah, no, absolutely. And it's not clear that this is the result of government policies. This is part of the productivity paradox. Like we're not sure exactly why it is that it is weak. We're not sure exactly why there is less investment. Now, some folks will say it's because corporate tax rates are too high. But then you look at countries that have higher rates of productivity and that actually have higher corporate tax rates or have higher personal income tax rates like the European countries. Labour costs in Europe are way higher than they are here. Tax rates are generally way higher than they are here. Yet, they're able to invest and able to generate significant productivity gains, more than we've been able to. So that's part of the challenge. It's not clear what role government can play in this space and that's what makes it very difficult, because on the one hand you've got the business community who will say, ‘Well, listen, we'd like you to do this and this and this, but we feel constrained by the regulatory environment, access to finance.’ Whatever it might be. Red tape. And, you know, governments who have tried to do a whole bunch of things in the last 20 years, very few have had a lasting impact on productivity. So, there's this notion in some circles that, you know, you can bring the horse to water, but you can't necessarily make it drink. And that might be at play as well.

SM: So, no easy path forward in solving this problem that you said it is maybe one of the most important economic concepts that people should be aware of.

JFP: It is I mean, from our perspective, there is nothing more important. At the end of the day, if you can't generate an increase in the standard living for your population, then the economy is failing people or governments are failing people. There's no question about that. And the experience of the last few years, last year in particular, where we've seen a significant decline in productivity, productivity levels in Canada are back to where they were like in 2017, 2018. So, we've been scaled back from already weak levels to even weaker levels. For us, it's the number one public policy issue. It's difficult to overestimate how important productivity is to our well-being.

SM: All right. I think we'll leave it there. That was really interesting, JF. Thank you so much for coming.

JFP: Thank you.

SM: I've been speaking with Jean-François Perrault, he is the Chief Economist at Scotiabank.