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ProductivityWhy should we care about productivity? Why should we care about productivity?Compare Canada today with earlier times, and one fact stands out: Canadians live better. A good deal of the credit for this improvement should go to improvements in productivity. Through it, Canadians get more goods and services from the effort that they devote to work. Through it, they secure economic progress and earn bigger paychecks. The power of productivity has made Canada more prosperous. Productivity is improved by increasing the efficiency with which the production system transforms inputs into outputs. Canada has prospered by improving the efficiency of its production system in a number of different ways. Workers today can produce more per hour worked because of a number of changes. First, Canada has become more productive by building capital—adding more machinery, factories, offices and research facilities that workers can employ in the production process. Second, Canada has become more productive by upgrading workers’ skills, whether through formal schooling, on-the-job experience or retraining. Third, Canada has become more productive by introducing new technologies that increase output, improve efficiency and lower costs. Fourth, Canada has become more productive by improving the organization of production processes. Canada has become more productive through trade too. Through trade, companies gain access to cheaper inputs, a deeper pool of investment funds and technology from around the world. Trade enlarges markets, thereby allowing companies to grow larger and to exploit economies of scale that contribute to improved efficiency. History shows us the impact of productivity growth. At its founding in 1867, Canada was primarily agrarian, with more than 90 percent of the population toiling on farms. As tractors, threshers, irrigation and high-yield seeds made individual farmers more productive over the past century or so, Canada could feed itself—and expand its export markets—with far fewer agricultural workers. Displaced farmers flocked to cities, where they found work assembling cars, building houses, generating electricity and making an abundance of consumer goods. Over time, factories grew more automated and experienced large gains in productivity. Workers moved from assembly lines to jobs in retailing, medical care, finance, management and services. Over the course of our history since confederation, the cumulative effects of productivity on living standards have been astounding. Per person output has grown 25-fold since 1870. In just the past two generations, average real income in Canada has more than doubled, thanks largely to increased productivity. As societies get richer, they expand the type of goods consumed. A hundred years ago, most income was devoted to the basics of food, clothing and shelter. As output per hour increased steadily over the years, Canadians have taken advantage of their added productivity in the form of material gains—more cars, bigger and better-equipped houses, an abundance of other goods and services—including publicly provided health care. As a result of productivity gains, Canadians have not only steadily increased their consumption of material goods, but also have increased their leisure time. Productivity growth has allowed Canadians to reduce the average number of hours worked per year from 2,364 hours in 1947 to 1,986 in 1970 and just 1,751 today.
What do productivity statistics show?Statistics Canada measures the growth in productivity that occurs over time. Productivity statistics provide a snapshot of increases in the efficiency of the Canadian economy. Changes in productivity capture our progress in improving our capability to produce output as we increase our inputs. Productivity growth thus captures the increase in our production efficiency. Increases in productivity stem from improvements in knowledge and in production techniques. These increases can occur because plants become larger and exploit scale economies, use higher quality labour, or introduce better quality products. They can also arise from organizational changes in management or the way in which production is organized on the shop floor. In an economy as large and diverse as that of Canada, it’s a Herculean task to calculate a summary statistic for productivity that in 2004 sums up the efforts of 16.2 million workers, employed in millions of establishments that produce almost about $1.3 trillion in output. Statistics Canada does so in its productivity program that uses an integrated set of data sources produced by the National Accounts. This section provides empirical estimates of the extent to which productivity growth contributes to economic growth and improvements in our real income. The assessment of Canada’s productivity performance begins with a review of the historical record. Past productivity growth is examined to provide an historical benchmark. The first step in assessing productivity performance is to take stock of what the available productivity measures cover and what they mean. Output growth must come either from growth in inputs and/or from growth in productivity. Indeed, this is the principle that underlies the basic method of estimating productivity growth (see below). Productivity growth is the growth in output in excess of that of inputs, like labour. The basics of estimation of productivity growthProductivity growth cannot be directly observed and measured. Rather, it is calculated as the growth in the amount of output relative to the amount of resources used to produce that output. A partial productivity measures output growth relative to the growth in one particular input. For example, the growth in labour productivity would be calculated as the growth in output over a period less the growth in labour inputs over the same period. Similarly, the growth in capital productivity would be calculated as the growth in output less the growth in capital input. The most commonly used measure of partial productivity growth is labour productivity. It will be affected by the amount of capital that is provided to workers. Capital is simply the investment made in machinery, equipment and buildings. Plants that have more capital tend to have a higher output per hour-worked. Since it is important to know whether output per hour worked is high or low, or if it changes just because of the amount of capital that is being provided to workers as opposed to other factors like technical change, Statistics Canada also produces what has become known as a multifactor productivity measure. It bundles both labour, capital, and intermediate inputs together in an input measure and measures the amount of output produced by a standardized input bundle that is made of labour, capital, and intermediate materials. A multifactor productivity measure allows for growth in more than one input. Usually (as is the case in this paper), it involves the two inputs labour and capital. The growth in multifactor productivity can be calculated as the growth in output less the growth in a combined index of labour and capital inputs.
Economic growth and productivity performanceGDP growth rates calculated over short time periods fluctuate considerably owing to business cycles. When analysing a country’s long-term performance, we want to measure the trend in economic growth. That is, we want to measure economic growth that has had business-cycle effects removed. There are several ways of doing this. One common approach is to measure GDP growth over the economic cycle. This is done by calculating the average growth rate between two consecutive peaks of the cycle. Nevertheless, it should be recognized that there is no ideal time horizon over which an average economic growth rate should be calculated. If the average growth rate is calculated over a short time period, average economic growth rates are likely to fluctuate considerably owing to business cycle effects. If the average growth rate is calculated over a longer time period, significant changes in the growth performance of an economy may not be apparent for some time. For example, if the Canadian economy experienced an increase in its trend GDP growth in the very recent past, this improvement would not become apparent for some time if a longer run average growth rate were being used. Figure 1 contains the average annual growth of real GDP in the business sector1 over the 1961-2004 period and its various sub-periods, reflecting different economic cycles. Over the whole period, economic growth increased at about 4% per year on average. Economic growth was quite remarkable during the 1960s, averaging almost 6% annually. Beginning in the 1970s, economic growth has experienced a steady slowdown, from 4% during the 1970s, down to a 3% in the 1980s and 1990s.
Figure 1. Trend in Real GDP, labour productivity and hours at work, business sector, (average annual in percent)Output growth can be driven by the increase in the resources devoted to production or the efficiency with which these resources are employed. Consider the case of labour input. Output will increase if there are more hours worked or if the existing set of workers produce more per hour worked (if labor productivity goes up):
where Hours is the number of worker-hours. Again Figure 1 depicts changes in each of these factors over time. For the entire 1961-2004 period, labour productivity advanced at a 2.0% annual average, accounting for slightly more than half of the increase in GDP growth. The rest is attributed to hours which increased at 1.8% per year on average. Much of the decline in economic growth that took place between the 1960s and the 1970s was attributable to a slowdown in labour productivity growth—from 3.5% to 2.1%. In contrast, the slowdown in economic growth in subsequent periods was due to the downward trend in the number of hours at work. Productivity growth in the 1990s was slightly higher than in the 1980s.
Productivity’s contribution to living standardsProductivity growth can also be related to changes in aggregate living standards—when the latter is measured as GDP per capita. GDP per capita is equal to the product of GDP per worker and the ratio of the number of workers divided by the total population:
where L is the number of worker-hours and Pop is the population. Increases in GDP per worker can come either from an increase in labour productivity or from increases in the ‘work effort’ of the population—the number of hours worked per person. The latter is the product of the average hours worked by those who are employed and the ratio of the number employed divided by the population. Figure 2 depicts the share of total growth in real GDP per person that was accounted for by the growth in labour productivity. In each period, labour productivity has accounted for the bulk of real GDP growth.
Figure 2. Sources of growth real GDP per person (percent)However, it should be noted that the periods of the 1970s and 1980s experienced substantial increases in the percentage of the population that were at work and this contributed substantially to the increase in the standard of living during this period. This increase was due mainly to increases in the participation rate of women during this time period.
Distributing the gains from productivity growthAggregate GDP measures the returns to both labour and capital. Distributional concerns lead to questions about whether the share going to labour increases over time, in particular how productivity growth is related to real wage rates. The previous section made the point that productivity growth raises living standards. But how does this actually come about? The most direct way in which productivity improvements benefit people is by raising their real incomes. If higher productivity means lower costs and these savings are passed on in lower prices, consumers will be able to purchase goods and services more cheaply. The increased spending that these higher real incomes allows produces flow-on effects throughout the economy. To see the relationship, Figure 3 compares the trend in labour productivity and real hourly labour compensation over time.2 The picture that emerges from this figure is that real labour compensation and labour productivity are closely related in the long run. Most of the increase in productivity was passed through to an increase in real labour compensation during the 1960s, 1970s, 1980s and 1990s. The deterioration in labour productivity between the 1960s and the 1970s and 1980s translated into a slowdown in the growth in real labour compensation.
Figure 3. Labour productivity gains and real hourly labour compensation (percent)
Where do increases in labour productivity come from?Since increases in labour productivity are associated with higher economic growth, higher standards of living and higher real incomes, analysts have investigated the sources of improvements in labour productivity. There are many reasons behind the growth in labour productivity—from higher capital available to the workforce, to a higher proportion of skilled workers, to increases in plant scale, to changes in organizational structure, to increases in technology. The Canadian Productivity Accounts can be used to divide labour productivity growth into the part coming from increases in capital intensity, increased in skill levels of workers (referred to here as a change in labour composition)3 and all other sources—what is referred to as multifactor productivity growth:
where Labour productivity can rise as a result of higher capital use per worker. For example, stronger investment in information technology can raise capital intensity. As information technology has become cheaper, firms have substituted information technology for labour and other forms of capital. Labour productivity can rise also as a result of higher percentage of the growth that comes from higher skilled workers. Upgrading of workers’ skills can increase labour productivity. Canadian companies can upgrade theirs workers’ skills, through formal schooling, on-the-job experience or retraining. Multifactor productivity captures the effect of technological change and all other effects. It is the residual factor capturing a host of influences—amongst them changes in technology. In Figure 4, we have broken down the growth in labour productivity into that coming from the growth in capital intensity, increases in labour skills and the growth in multifactor productivity. Over the period from 1961-2004, the 2.0% increase in labour productivity growth can be decomposed into a 0.9% increase in capital intensity, a 0.4% increase arising from higher skill levels, and a 0.7% increase due to a growth in multifactor productivity.
Figure 4. Sources of labour productivity growth, business sector (percent)
The deterioration in labour productivity growth between the 1960s and the 1970s resulted primarily from the slowdown in multifactor productivity growth from 2.1% to 0.4%, and to a lesser extent, a slowdown in the growth in labour composition due to a slower growth in skilled labour (from 0.5% to 0.1%). The contribution made by capital intensity almost doubled over the same period. The slowdown in labour productivity between the 1970s and the 1980s, from 2.1% down to 1.2%, was primarily the result of a decline in multifactor productivity performance. Labour productivity performance in the 1990s reflects a major turnaround in the multifactor productivity growth. The contributions due to the growth in capital intensity, and to less extent labour upskilling, have fallen in the 1990s. The post 2000 period has seen a further decline in labour productivity. This decline is almost entirely due to a decline in capital intensity. During the post 2000 period, multifactor productivity has grown more rapidly than in the 1990s.5
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is the growth in labour productivity, 
is the growth in multifactor productivity, 
is the share of GDP
accruing to capital, 
is the growth in the amount of capital available per hour worked, 
is the share of GDP
accruing to labour, and 
is the growth in the measure of labour skills.