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The Canadian Productivity Review Number 6 |
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Investment and Long-term Productivity Growth in the Canadian Business Sector, 1961 to 2002by John R. Baldwin and Wulong Gu Executive summaryThis paper makes use of the databases at the heart of the Canadian Productivity Accounts to examine the sources of growth in the Canadian economy and the history of productivity growth in Canada over the period from 1961 to 2002. It employs new time series using the North American Industry Classification System. The growth accounting system provides the framework for the analysis. This analysis, based on a production framework, decomposes output growth into the portion that comes from increases in labour and capital and a residual (entitled multifactor productivity) that captures the component that is not directly related to the increasing use of labour and capital. Measures of multifactor productivity growth are often used to assess the rate of growth of technological progress. They are of intrinsic interest because consumers benefit directly from higher productivity growth in terms of lower prices. Baldwin et al. (2001) show that on a cross-section basis, industries with higher multifactor productivity growth have the lowest rate of price increases. Successful productivity growth also affects an industry's international competitive advantage. Baldwin and Yan (2006) demonstrate that, at the industry level, changes in the relative Canada–United States price are inversely related to estimates of changes in relative multifactor productivity in Canada and the United States. The growth accounting framework provides estimates of the relative importance of labour inputs, investments in capital and productivity growth. The data that are required to address this issue also allow changes in the composition of capital and labour inputs to be investigated. In addition, the underlying factors that determine labour productivity (multifactor productivity, capital deepening, and increases in skill level) can be measured. Since the database is constructed at the industry level, all these relationships can be pursued both at the level of the total economy and for individual industries. Several questions are posed in this section of the paper. 1. What has been the history of productivity growth over the period? Estimates of annual productivity growth have fluctuated considerably over time. They are quite volatile in the short run. They are often high at the end of the business cycle and fall during recessions and slowdowns. This makes interpretation of short-run trends difficult. Moreover, short-run averages are extremely sensitive to the choice of endpoints. Analysts who wish to argue that crises exist can use the high points just before the end of a business cycle and the low points at middle of recessions. There are, however, discernible long-run trends in Canadian productivity growth — both labour and multifactor productivity. There was a long decline from the early 1960s to 1990. Since then, productivity growth has picked up. The break point appears to correspond with the start of the 1990s — the decade when investments in information and communications technologies began to receive so much attention. It is significant that both productivity and output growth trends are correlated. Higher output growth is generally accompanied by higher productivity growth. This could either be because high growth periods make the introduction of new technologies easier or that rapid technological change fans higher growth rates. A word of caution is, however, required here. High output growth rate industries are not necessarily those industries with the highest labour productivity growth. At the industry level, high growth does not necessarily translate into higher productivity or vice versa. 2. What types of capital are used in the growth process? In 2002, the largest component of aggregate capital services was machinery and equipment outside of information and communications technologies (non-information and communications technologies machinery and equipment), followed by building structures and engineering structures. Non-information and communications technologies machinery and equipment accounted for 27.0% of aggregate capital services in 2002, building structure capital accounted for 24.3% of aggregate capital services, while engineering structure capital, 18.3% of capital services. It should be noted that the latter two made up over 42.0% of the total — much more than the machinery and equipment component. Capital consists of a great deal more than machinery and equipment — and most of the capital that workers have to work with comes in forms other than machinery and equipment. The share of capital input accounted for by non-information and communications technologies machinery and equipment remained virtually unchanged over time. The share of the remaining assets (building structures, land and inventories) declined during the period from 1961 to 2002. The decline in inventory's share has been associated with the application of 'just-in-time' production methods. The decline for buildings and engineering structures has been the result of long-term increases in capital productivity in those sectors that make the most use of this type of infrastructure investment — transportation, communications, utilities, and water (see Baldwin and Dixon, 2007). There has been a long-term shift in capital services towards machinery and equipment and away from structure capital, land and inventories in the Canadian business sector. Of machinery and equipment capital, information and communications technologies increased the most. Over the period from 1961 to 2002, information and communications technologies capital increased at an annual rate of 14.1%. The dramatic increases in information and communications technologies capital services occurred as the price of information and communications technologies capital declined relative to other forms of capital. Canadian businesses have made large investments in information and communications technologies to take advantage of the dramatic decline in the price of information and communications technologies capital. 3. What types of labour are used in the growth process? Since 1961, the composition of the labour force has changed dramatically (Gu et al. [2002]). From 1961 to 1979, the share of younger workers (less than 25 years) first increased dramatically and then fell continuously until the mid-1990s. As this group of post-war boomers aged, workers in the age group from 25 to 44 years, increased from the 1970s to the early 1990s and then declined. This long demographic cycle led first to a decline in the average experience of the workforce and more recently to an increase. There have also been dramatic changes in the educational qualifications of the labour force. The percentage with only high school has fallen steadily, and those with post-secondary degrees has increased. For example, those with some post-secondary education increased from less than 10% in 1961 to over 40% by 2000. The declining average age occasioned by additions of relatively large portions of younger workers early in the period, and then an increase in experienced workers later as these workers matured, led to quite opposite effects on the contribution to labour inputs that came from upgraded skills — what is termed 'labour composition' in this paper. The effect of the changing level of experience occasioned by first a greening of the labour force and then its aging follows an inverted U — with first a decline coming from the experience component then an increase. But the impact of changing experience in most periods is small. Far more important is the increase in the skill component that comes from increases in education levels. And since upgrading of education levels is more or less continuous during the period, this force provided most of the increase caught by the labour composition or quality component of labour input growth. 4. What is the relative contribution of capital, labour and productivity growth to economic growth? The growth accounting framework decomposes output growth into three components — the growth in labour inputs, the growth in capital inputs and multifactor productivity. Output needs labour and capital inputs and growth in output can be constrained by shortages of either of these factor inputs. In a world where population growth is constraining future increases in employment, maintaining present growth rates will depend on whether growth rates in capital or multifactor productivity can be accelerated. Historical experience may give some indication of the possibilities for substitution here. For the period from 1961 to 2002, output grew 3.9% per year in the business sector. Capital services contributed 1.8 percentage points or 47.3% of the business sector output growth. Labour input contributed 1.5 percentage points or 38.1% of the output growth. A good portion of the growth in both labour and capital came from changes in the composition of each aggregate — that is, the composition of the inputs changed from the less productive to more productive inputs over the period. The growth that is due to upgrading accounted for about one-third of total growth for both labour and capital. Multifactor productivity growth was the least important source of output growth in the business sector and contributed 0.6 percentage points or 14.6% of the output growth. The growth in capital services then has been more important than the growth of labour over most of the period and offers possibilities for compensating for future reductions in the growth in labour that are expected to result from declining population growth in Canada. Many factors influence the rate of growth in labour inputs — changing socio-economic factors that lead to higher labour force participation by women, increases in participation by older males, and immigration. Over the period studied, the growth rate in employment has decreased slowly. If these declines continue in the future, overall growth may fall unless capital or measures of multifactor productivity growth increases. However, the historical record does not show that either of these components have increased enough over the last three decades to offset the decline in labour growth that has already occurred. The contribution made by the growth in capital has fallen over the period — by even more than the contribution of labour growth — starting in the 1980s and continuing into the 1990s. The residual, unmeasured category (multifactor productivity growth) has also declined since its high point in the 1961 to 1973 period — though, there is evidence this decline reached its low point at the end of the 1980s and has recently begun to rise. Nevertheless, the average growth in multifactor productivity over most of the period has not been large — especially compared to the growth in labour inputs. And it is less obvious that increases in this component are likely to offset future declines in the growth of labour. For those who wish to compare Canadian multifactor productivity estimates to those of other countries, it should be remembered that the Canadian Productivity Accounts calculate the labour and capital inputs with 'quality' components included. That is, the Accounts do not just sum hours worked across all groups of workers or sum capital across all asset types. The Accounts calculate weighted averages of the growth in hours worked using 56 different categories of workers and 28 different types of assets. By doing so, the Canadian Productivity Accounts take into account the different productivity of inputs. The difference between the weighted growth rate of the different inputs and the simple sum of all hours or all capital is referred to as the effect of the changing composition of labour or capital — the labour and the capital composition effect, respectively. This procedure yields substantially higher estimates of the growth in factor inputs (labour and capital) and concomitantly lowers estimates of multifactor productivity growth. For example, the labour composition effect averaged 0.7% annually from 1961 to 2002. This translates into an average of about 0.5% annually when multiplied by the share of labour to give the contribution to output growth of shifts in labour composition towards more skilled workers. The same capital composition effect averaged around 1.5% per year, which is about 0.6% per year when multiplied by capital's share, to give the contribution that shifts in capital composition to more productive assets had on output growth. If these two composition effects were added back into the multifactor productivity estimate of 0.6% annually, the uncorrected multifactor productivity estimate would increase to 1.6% per year — an increase of almost 300%. It is important then to take into account the heterogeneity of factor inputs — for it changes the conclusions that can be drawn from the growth accounting framework. We conclude here that most of the growth came from increased factor inputs — not from disembodied technological progress. If we had not corrected for the changing quality of factor inputs, we would have drawn the opposite conclusion. If we are to rely on higher rates of multifactor productivity growth in the future to maintain economic growth rates, we need to forecast whether increases are possible and whether they are sustainable. The historical record does not suggest large increases are likely. It also does not suggest they are very sustainable. The contributions of labour and capital are much more stable than is multifactor productivity. Multifactor productivity growth is largest in the 1961-to-1973 period. It is lowest in the 1979-to-1989 period. The growth in capital services, though in decline, was generally more important than the growth in labour services. Together the growth rates in these two factor inputs have contributed over 1.0 percentage points of the 2.3 percentage points decline in output between the periods from 1961 to 1973 and 1973 to 2002. The rest of the decline comes from a much lower growth in multifactor productivity. However, between the 1980s and 1990s, while the growth in labour and capital inputs declined, multifactor productivity increased enough to substantially offset these declines. 5. How important are the various factors that determine the growth in labour productivity? Growth in labour productivity is of interest because it is closely connected with changes in real wage rates over the long run. For the 1961-to-2002 period, labour productivity grew at annual rate of 2.2% in the business sector. Capital deepening was the most important factor. It contributed 1.2 percentage points and 53.2% of the labour productivity growth. The change in labour composition was an important source of labour productivity growth in the business sector for the 1961-to-2002 period, contributing 0.5 percentage points or a quarter of labour productivity growth in the business sector. A positive labour composition effect captures the increase in the average educational attainment and experience levels of the workers. The importance of the labour composition component therefore demonstrates that investments in education and training have made a significant contribution to labour productivity growth in Canada. The contribution of information and communications technologies capital deepening to labour productivity growth showed a large increase over time. In the 1961 to 1973 period, little of capital's contribution to labour productivity was from information and communications technologies investment. In the 1989 to 2002 period, about 58.6% of the productivity contribution of capital services can be attributed to information and communications technologies capital deepening. And it is significant that it is during the latter period that multifactor productivity growth has once more picked up. This has been used by some to suggest that it is not so much increases in capital intensity as the type of capital that matters. Multifactor productivity growth contributed the remaining 0.6 percentage points or 26.1% of labour productivity growth. Measures of multifactor productivity growth is often associated with technological change, organizational change, scale economies or changes in utilization rates.1 While contributing substantially to labour productivity growth, its importance is nevertheless, in this framework, behind investment in general. But this type of conclusion needs to be qualified. The growth accounting framework decomposes contributions from different factors into separate and independent components for the purposes of simplicity. In the end, the types of technological change embedded into the multifactor productivity measure is no doubt a function of investments in new technologies, in new organizational forms, in new ways of doing business, and in research and development. A more detailed set of measures in all of these areas would just expand the list of types of capital assets that are behind technological progress. In two of the periods, capital deepening and multifactor productivity have moved together. From 1961 to 1973, the contribution from both was high. From 1979 to 1989, both declined relative to earlier periods. This suggests that there are particular time periods when it is technology that is being driven by investment in the type of traditional assets that are measured in capital stock. In other periods (1973 to 1979), capital deepening is high but multifactor productivity was nevertheless lower, thereby suggesting that traditional investments were not sufficient conditions in this sense for technological progress — that there may have been deficiencies in this period in the complementary expenditures that are required for change. 6. What are the differences in growth profiles at the industry level? This paper also examines industry performance using the growth framework at the industry level. It asks whether the trends depicted at the level of the total economy are widespread or concentrated only in the largest industries. The investigation posed several questions: 6.1 Does most productivity growth come from one sector? At the industry level, goods industries tend to have higher productivity growth than the services sectors. But there are exceptions to the rule. Information industries have had some of the highest growth rates both in terms of labour and multifactor productivity. The information sector has benefited from the information and communications technologies revolution (Beckstead and Gellatly, 2003). Over the entire period, high growth rates can be found in both goods and services — in information and transportation on one side and in manufacturing and agriculture on the other. Agriculture continues to shine in terms of productivity growth — a phenomenon that has continued throughout most of this century. High growth occurs both in new economy and old economy industries. There are no easy generalizations about where productivity growth and technological change are highest. This suggests that technological advances are neither easy to predict nor easy to classify. They occur at different times, in different places. 6.2 Is the importance of capital accumulation uniform across industries? The economy is made up of industries that range from highly capital intensive to more labour intensive. Capital accumulation is the dominant source of output growth in the two natural resources industries (mining and oil and gas extraction; and utilities), as would be expected. But the other sectors where capital is important are the finance, insurance and real estate industries. Labour input is the most important contributor to output growth in professional services, and education and health care services industries. Those two industries are labour-intensive industries. But even there, capital is an important source of output growth. In the professional services industries, the contribution to output growth from labour was 3.1 percentage points, compared with 3.0 percentage points from capital, 2.5 percentage points from intermediate inputs, and -1.9 percentage points from measures of multifactor productivity growth. The two distributive trades industries (retail and wholesale) have relatively higher contributions from labour than capital. 6.3 Is capital deepening the prime contributor to labour productivity growth? The contributions to labour productivity growth differ substantially across industries. In some, capital deepening is the dominant contributor to labour productivity growth. But in these industries, there is no consistent pattern as to whether multifactor productivity growth makes higher or even positive contributions to labour productivity growth. Increasing the quality of the labour force is important in most industries — though less important than multifactor productivity growth in most industries. And there is less variability across industries in the contribution of skill upgrading than there is in either capital deepening or in multifactor productivity growth. The growth in the knowledge economy is being felt across all industries (see Baldwin and Beckstead, 2003). 6.4 How do the new economy industries differ from the old economy industries? The share of new economy industries in the business sector is small and has shown little change over time. Over the period from 1961 to 2002, new economy industries accounted for between 7% and 8% of nominal gross domestic product in the Canadian business sector. Natural resource industries were more important than new economy industries in terms of their contribution to nominal gross domestic product in Canada. In 2002, the natural resource sector accounted for 18.8% of nominal gross domestic product in the total business sector. New economy industries had the highest labour productivity and multifactor productivity growth over the period from 1961 to 2002. Natural resource industries had the second-highest labour productivity growth, but in this sector multifactor productivity growth is lower than that of the other business sector industries. Investment and capital deepening is a more important source of output and productivity growth in natural resource industries than in new economy industries. Technological progress has been more rapid in new economy industries than in natural resource industries. 6.5 Are fluctuations in the total economy's productivity growth coming primarily from one sector? Productivity fluctuations at the level of the aggregate economy cannot be attributed to a particular sector or a particular industry throughout the period. The identity of individual industries, whose productivity growth rates decline, changes over periods — thereby indicating that the changes that are occurring are idiosyncratic and industry specific. Technological change does not have its impact felt consistently across the industry set.
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