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Growth in Canadian labour productivity fell in the post-2000 decade compared with the 1990s. The manufacturing sector was responsible for most of this slowdown.
This paper examines the conditions that were related to this event. It focuses first on key differences in the general economic environment in the two decades. It then decomposes changes in productivity into underlying components to examine whether differences in those components suggest causes that relate to changes in the economic environment.
The 1990s and the period from 2000 to 2006 differed in terms of underlying demand conditions faced by the manufacturing sector. During the period from 1990 to 1996, average tariffs on Canada–U.S. trade fell significantly as the North American Free Trade Agreement (NAFTA) was implemented. In addition, the Canada–U.S. exchange rate depreciated over much of this period. The trading environment post-2000 was very different. Most of the tariff reductions pursuant to the Canada–U.S. free trade treaties had already been implemented; at the same time, the Canadian dollar appreciated relative to the U.S. dollar post-2003, making Canadian exports less competitive in U.S. markets. Reflecting these tariff and exchange rate movements, the export/sales ratios of the manufacturing sector rose in the 1990s and then declined after 2000.
The post-2000 period also saw the development of excess capacity in the Canadian manufacturing sector. Overall, capacity utilization in manufacturing averaged 86% in 1999, then declined to 81% in 2003, and only returned to 83% in 2006. Capacity utilization declined in 16 out of the 20 manufacturing industries in that period.
Some of the excess capacity that developed post 2000 originated in the general economic slowdown in North America and resulting large declines in exports that occurred early in the period; however, after 2000 several industries experienced significant declines in demand that were also related to major long-term structural adjustments. The electronic product manufacturing sector went through readjustment after the collapse of the dot-com bubble in the early 2000s. Pulp and paper contracted as newspapers in the United States faced increasing competition from the Internet. Petroleum refining declined as energy demand declined in response to rising energy prices. Non-durable goods industries such as textiles, leather and clothing were faced with increasing global competition from imports from emerging economies that resulted in falling output volumes in these industries.
The accompanying slowdown in productivity growth and output growth after 2000 in manufacturing was widespread. Of the 45 manufacturing industries at a North American Industry Classification System (NAICS) three-digit level of aggregation, 35 industries saw declines in labour productivity growth after 2000 compared with the period from 1988 to 2000.
To understand the role of restructuring in the productivity growth slowdown, this paper decomposes total labour productivity growth into components: a within-plant component that captured the effect of capital deepening, technological progress, scale economies, and variable input utilization at the plant level, and a between-plant component that reflects the effect of the reallocation of inputs and outputs across plants on aggregate capital deepening and aggregate multifactor productivity (MFP) growth.
The question of interest is the extent to which most of the decline in labour productivity growth came from a decline in capacity utilization or whether it came from other sources—a decline in general efficiency or a decline in the impact of the reallocation of resources that generally tend to affect productivity growth. As a by-product, the analysis also provides estimates of the extent to which the benefits of reallocation come from a shift in the importance of businesses that have higher capital intensity or higher efficiency.
The decomposition uses microdata on manufacturing plants in the Canadian manufacturing sector in the 1990s and post-2000 period. These microdata are especially constructed for the project from data derived from administrative and survey records maintained by Statistics Canada.
The analytical exercise requires empirical estimates of the parameters of a production function that determine the impact of changing capacity utilization on productivity. These are estimated in this paper using microrecords derived from plant data. Different econometric techniques are used to examine the robustness of the conclusions to alternate estimation strategies.
The estimates indicate that from 55% to 90% of the aggregate productivity slowdown is because of the pro-cyclical nature of productivity arising from changes in the level of capacity utilization. In the post-2000 period, the economy grew more slowly: the Canadian manufacturing sector contracted at an annual average rate of 0.3% in the 2000-to-2006 period compared with 3.4% annual growth in the 1990-to-1999 period. Non-instantaneous adjustment of production inputs such as capital and labour led to excess capacity and lower productivity estimates (as unobservable capacity utilization results in over-measurement of variable production inputs). Alternate estimation techniques yield even larger estimates of the degree to which the slowdown was the result of the development of excess capacity.
Differences in the impact of excess capacity across sectors indicate this impact was particularly severe for firms and industries that served export markets: this supports the interpretation that this development stemmed from changes in the trade environment, as exporters had large declines in labour productivity growth in the post-2000 period. Indeed, almost all of the aggregate labour productivity growth slowdown after 2000 was driven by exporters. The decline in labour productivity growth is more pronounced in foreign-controlled plants than domestic-controlled plants, as foreign-controlled plants are more export-oriented. In addition, the effect of excess capacity was observed more in durable goods industries where the impact of excess capacity on productivity is greatest because of the nature of the production process.
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