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March 2007
Vol. 8, no. 3

Perspectives on Labour and Income

GDP and employment growth
Philip Cross

A major economic development in 2006 was a slowdown in output growth but continued steady gains in employment. Over the long term, output growth typically exceeds employment growth by over 1% a year, reflecting the upward trend of productivity. The convergence of output and employment gains late in 2006 implies a diminution of productivity growth.

Output per employee and labour productivity are often treated as interchangeable concepts. However, the two have differences that can cause these series to diverge at times (Chart A). Most importantly, official labour productivity covers only the business sector, which excludes the 15% of gross domestic product (GDP) in the non-business sector (bypassing the conceptual problems of measuring productivity growth in this sector). As well, productivity is calculated as output per hour worked, not per employee. Hours worked are affected by changes in multiple jobholding, the mix of full- and part-time positions, and the length of the workweek. When this paper refers to productivity rather than output per employee, it is the data on business sector GDP per hour worked that are being used. Unless otherwise noted, the employment data come from the Labour Force Survey (LFS), while total output is aggregate real GDP, including both the business and non-business sectors.

The paper focuses on factors that contributed to the slowdown of both output per employee and productivity in 2006. Over the long run, productivity growth depends on population structure and skills, capital investment, research and innovation as well as institutional factors such as taxes and trade regulations. However, since most of these variables were little changed last year (except for some shifts in population and investment), they do not figure prominently in this paper.

The cyclical setting

Output growth often slows relative to employment growth for short intervals during recessionary periods as firms hoard some labour while cutting output. As recently as 2002 and 2003, output growth fell further below job growth and for a longer period than in 2006.

In fact, a narrowing of the gap has been the rule, not the exception, ever since the economy began to recover from a stall late in 2001 (Chart B). Year-over-year growth in output per employee was below 1% in 44 of the last 69 months, and negative for 16 of the 26 months between July 2001 and August 2003. Output growth struggled to keep up with employment growth most of the time—falling behind late in 2001, barely keeping ahead in 2002, and slipping below again in much of 2003. Only in 2004 and 2005 did output growth clearly exceed job gains, implying positive labour productivity growth. Even then, the productivity gains were far short of those in 1999 and 2000. So the convergence of output and employment late in 2006 is hardly new.

In retrospect, the slowdown of output per employee in 2002 and 2003 (confirmed by the official estimates of labour productivity) is more surprising than in 2006. The economy then was recovering from the near recession in 2001 caused by the bursting of the high-tech bubble and the shock of the September 11 attacks. Normally, the initial recovery from a cyclical slump in the economy generates large productivity gains as previously underutilized resources are put back to work. The situation in 2006 was the opposite. An economy operating at almost full employment, especially in Western Canada where growth was concentrated, would be more likely to show weak productivity growth.

Many transitory factors helped depress GDP growth in 2003, including the SARS epidemic, the discovery of mad cow disease, the power blackout in Ontario, fires in B.C., Hurricane Juan in Nova Scotia, and the start of the Iraq war. Altogether, these events resulted in almost no growth in GDP in the middle two quarters, when output growth trailed employment growth.

Comprehensive labour productivity data by industry are available for 2003. Interestingly, many of the same goods-producing industries whose productivity sagged in 2006 also struggled in 2003. Oil and gas saw productivity fall 7%, even as prices began to climb sharply. Manufacturing productivity was flat as firms faced the beginning of a sharp appreciation in the exchange rate. The sluggishness of productivity was widespread in manufacturing in 2003, just as it was in 2006.

Services contributed more to the productivity slowdown in 2003 than in 2006. Travel-related services such as accommodation and food obviously were severely affected by the SARS crisis in the first half of 2003, but they did not cut their staff to the degree warranted by demand (called labour hoarding).

Nor is it unusual for Organisation for Economic Co-operation and Development (OECD) countries to experience two (or more) years of little productivity growth. Just since 2000, 10 of the 29 OECD countries with data available experienced such an episode. Interestingly, Norway and Australia are both currently experiencing little or no growth in output per employee. Like Canada, both have large natural resource bases—a source of much of the productivity slowdown in Canada.1

Some of the attention paid to the slowdown of output per employee late in 2006 may be due to concerns about a repeat of the 2002-2003 episode, which lasted two years. But the 2006 episode could also be transitory, with productivity growth quickly resuming as in 1998. Analyzing the 2006 trend in productivity by industry is the first step in understanding the reasons behind the slowdown.

Industry trends

Most of the 2006 downturn in output per employee originated in goods-producing industries (Chart C), down 1.9% between December 2005 and November 2006. The drop largely reflected output in these industries switching from 3.3% growth late in 2005 to a decline of 1.9% during 2006.

Within the goods-producing sector, almost all industries posted lower productivity during the first three quarters of 2006 (Table). Output per hour worked declined by nearly 10% in the resource sector, shaving a full 1% from overall productivity growth (Chart D). Mining and oil and gas extraction led this drop, as output grew slowly and employment raced ahead by over 10%, the most of any industry.

In recent years, the productivity of new discoveries of conventional oil and gas has fallen as the industry moved from easy-to-exploit fields in the west to less-productive sources.2 Output in non-conventional oil projects, for example, now accounts for nearly half of the oil produced in Canada. And, as output from non-conventional sources has risen, output per employee in oil and gas has fallen sharply.

Last year's drop in productivity in mining, oil and gas was part of a long-term downward trend. The declining productivity of conventional wells and the shift to lower-productivity output from the oil sands is reflected in a 28% drop in labour productivity in the industry since its peak in 1999 (Chart E). Most of this reflects a 60% hike in employment in the oil and gas sector, almost all in Alberta. The employment increase was led by the oil sands, which hired thousands of workers on megaprojects that will not begin producing oil for years. These employees are involved in logistics, management and recruiting; those actually building the plant are classified in construction.

Events specific to the last two years aggravated this long-term downward trend. Oil sands output was depressed in 2005 by a major fire, which halted production at the largest producer for nearly nine months. The resumption of production at this plant helped boost oil sands output in 2006. Because productivity in the oil sands is less than for other oil sources, this see-saw movement in production in 2005 and 2006 contributed to lower productivity growth last year (because of the increased share of low-productivity oil output in 2006 after a decline in 2005). As the oil sands gears up production, output per employee will increase, even if the level is not as high as from conventional fields. More generally, the extraction of oil from the oil sands will likely become more efficient over time.

This situation highlights one of the pitfalls in looking at short-run movements in productivity. Conceivably, productivity could be rising within every component industry, but these gains could be masked by a shift from industries with high productivity to those with lower productivity, leading to a drop in overall productivity.

As well, oil production last year was hampered by a number of disruptions. These included accidents at the Hibernia and Terra Nova platforms offshore from Newfoundland where productivity is relatively high, costing months of production. Understandably, given the shortage of labour in the oil patch, firms kept their staff during these interruptions.

Mining outside of oil and gas is increasingly located in remote parts of the country or requires digging deeper into the earth's crust. The best example is diamond mining, which currently is located almost exclusively in the Northwest Territories. Some of the drop in productivity in metal mines reflects the exhaustion of the most productive sources, just as with conventional oil and gas. The most obvious example is gold mining, where annual output has fallen steadily since 2001.

Several of the largest mining industries experienced production difficulties in 2006 as strikes reduced output of nickel and copper in the fall. Since the LFS counts strikers as still employed, output per employee is lowered. (Hours worked reflects the strike absences, so labour input in the productivity measures is not affected.) Potash output was curtailed during protracted contract negotiations with buyers in China.3 Work stopped on the world's largest uranium project at Cigar Lake in October because of flooding, delaying sales for years (Hoffman 2007). As with oil and gas, shortages of labour induced employers to keep workers on the payroll when production was temporarily disrupted.

None of these problems have recurred so far in 2007, so some recovery in productivity can be expected. Potash producers signed deals with Chinese buyers early in the year, new labour agreements averted a strike in the nickel industry, and the ice road to mines in the north posted its second-earliest opening date.

Productivity fell in utilities last year. Mild winter weather depressed demand for electricity and gas at both the start and the end of the year. Not surprisingly, utilities did not lay off staff since they had no way of knowing when demand would jump (as the recent bout of cold weather illustrated).

Productivity in agriculture, forestry and fishing fell steadily throughout 2006. A poor grain crop helped dampen farm output. Nevertheless, agricultural employment rose slightly during the year. Interestingly, all of the increase originated in central Canada, led by southwestern Ontario. There, many people who had farms but worked in factories lost their primary job. As a result, they then reported farming as their primary job, raising employment in agriculture. This is a good example of how events can produce unusual movements in industry output per worker in the short term.

Forestry experienced one of the largest swings in the growth of output per worker between 2005 and 2006, from double-digit increases to double-digit declines. The rapid increase in 2005 reflected the consolidation of output in large, more efficient mills in B.C. and the ramping-up of output as the U.S. housing market peaked. The severe slump in U.S. housing demand last year depressed output. This was compounded by the closing of many small mills in eastern Canada late in the year when Quebec lowered its harvesting quota for timber by 20% and the softwood lumber agreement with the U.S. took effect.

Manufacturing

Output per employee declined in manufacturing in 2006 following two years of growth. Factories so far this decade have not come close to matching their stellar productivity gains during the high-tech boom in the late 1990s.

The downturn in manufacturing productivity reflects a slump in output, which lowered capacity utilization (the main determinant of productivity in the short term). Manufacturing output fell 4.8% in the first 10 months of the year, recovering slightly at year-end, and productivity typically falters during contractions (Chart F). While the rising dollar has given manufacturers a strong incentive to boost productivity every year since 2003, this was easier to achieve in 2004 and 2005 when output rose 1.9% and 0.7% respectively. When factory output fell in 2001 and 2002, manufacturers saw productivity also retreat.

What of the argument that the re-structuring of industries, especially in manufacturing, should transfer resources from low- to high-productivity plants? The economy in 2006 saw many factories close in low-productivity industries such as textiles, clothing, furniture and even autos. Meanwhile, growth continued in high-productivity and capital-intensive industries such as petroleum refining. Surely this should have boosted overall productivity?

A statistical test of the theory that employment, on balance, was being transferred to more productive industries was conducted by constructing a Laspeyres (fixed-weighted) index of output in manufacturing. In layman's terms, this holds the weight of each industry constant at its 2003 share of employment. Almost no difference from the Fisher current-weighted index currently used was seen (Chart G). This surprising result arises because, while labour productivity was higher in some industries whose share of output was higher, their productivity was nevertheless falling throughout 2006. As well, output fell in some industries with high productivity, notably primary metals and computers and electronics.

These results are consistent with past research showing that inter-industry shifts do not have a large impact on overall productivity growth in the short term. Productivity ultimately depends on actual gains within specific industries, not shifts between industries with different productivity levels. Productivity in manufacturing last year was sluggish across almost all industries, swamping the effect of inter-industry shifts. Falling productivity in industries such as aerospace, primary metals, paper and petroleum may reflect specific industry events such as supply disruptions or strikes. It may also reflect a natural inclination to temporarily relax close scrutiny of costs when presented with sudden great wealth, such as occurred in metals and petroleum.4

Services

Overall, output per employee in services escaped the large deceleration recorded for goods, continuing to grow at about its long-term average, and well above the SARS-induced slump in 2003 (Chart H). Several industries posted solid gains, notably consumer-related industries, which benefited from strong demand. Still, growth was restrained by a shift to public and business services where, by definition, productivity growth is limited.

Nearly 40% of monthly GDP growth in services is estimated using employment. For most, largely in the public sector, this is due to the conceptual difficulty in measuring output. Since no market price exists for the output of these services, Canada follows the same accounting practice as the U.S. of using labour input growth (adjusted in some industries for changes in the quality of the labour force) as the proxy for real output growth. As a result, productivity growth in these industries, by definition, is limited. While the non-business sector is excluded from the official measure of labour productivity, it does affect GDP per employee, and hence has influenced the current debate.

Output growth in 2006 was heavily concentrated in industries where employment is used as the proxy for output growth. As of November, year-over-year growth in these industries was 2.1%, compared with 1.3% in the rest of the economy. This is a reversal from both 2004 and 2005 when they grew at only half the rate of other services. Such industries accounted for about 40% of the year-over-year growth of total GDP by the end of 2006, doubling their contribution at the start of the year (Chart I). This reflects both increased activity in these industries and slower GDP growth in other industries.

The increase of nearly 20 points in the share of GDP growth occurring in these industries reduced overall output per employee by 0.1 points during 2006. The expansion was led by more spending on health care services outside hospitals. As well, demand picked up for religious and charitable organizations. These gains outweighed a sharp slowdown for education and recreation services.

Output in some business services is also projected using employment growth. This is most common for industries with no other source of monthly data, such as professional, scientific and technical services.5 These industries grew faster than the rest of the economy. However, because they are a fraction the size of the public sector, they had little impact on overall productivity growth.

Excluding the non-business sector, the year-over-year growth of labour productivity in services hit 1.8% in the third quarter, down from 2.7% at the end of 2005. Growth was led by wholesale and retail trade, continuing a trend of large productivity gains in these industries since 2002. Wholesalers and retailers have benefited from lower import prices since the dollar began to rise in 2003, while the shift to big-box stores also boosted productivity.

Some services saw productivity growth slow during 2006. Not all these decreases are necessarily a negative development. For example, the accommodation and food industry saw productivity decline slightly as it started to resolve the labour shortages that hampered its growth (but boosted measured productivity) in 2005. The biggest turnaround was in Alberta, where a 12% year-over-year drop in jobs in December 2005 was followed by a 9% gain during 2006. Similarly, the transportation industry was able to find more labour in 2006 after employment fell in 2005. Transportation output has grown steadily in recent years, reflecting the turnaround in the airline industry (after severe losses due to September 11th and SARS) and the boom in shipping commodities and containers by rail and water (especially to and from Asia).

The calculation of industry output per employee is sometimes impossible for definitional reasons. The best example is owner-occupied housing. The National Accounts follows standard international practice and treats homeowners as renting from themselves. This estimate, totalling $90 billion last year, is driven by changes in the stock of housing. Since no employment is involved, productivity is undefined (one reason that output per employee in the non-business sector can grow or shrink over time). After several years of double-digit growth, the stock of housing growth is starting to moderate, reflecting the slowdown in the housing market. This will trim real GDP growth in the future, while having no impact on employment.

Employment

Income growth has been driven by labour income, up 5.3% in 2006, boosted by the strong gains in employment. This strength was captured by both measures of labour input: the Labour Force Survey (LFS) and the hours worked used for labour inputs in the productivity estimates.

There are important conceptual differences between LFS employment and the hours worked used in the productivity estimates. The LFS treats multiple jobholders as just one employed person, while labour input captures them through hours worked. Productivity excludes important sectors of the economy such as the non-business sector.

If the slowdown in labour productivity in 2006 is a real and pervasive phenomenon, what broad economic factors could explain it? The most obvious place to look first is the cyclical state of the economy. The 16-year-long expansion of employment accelerated in 2006, with most of the growth in full-time positions. This sent the unemployment rate to its lowest level in the 30-year history of the current Labour Force Survey. Many industries struggled with labour shortages, notably in Alberta and B.C., but even the Atlantic provinces were affected by year-end as manufacturers there reported more shortages of skilled and unskilled labour than in central Canada.

Labour shortages and quality

Tight labour markets and shortages can often lead to slower productivity growth. Employers increasingly search out and hire less productive workers. When the U.S. labour market tightened at the peak of the high-tech boom in 1999 and 2000, for example, productivity growth slowed over a full point.

Several measures show declining labour quality, especially in western Canada. Employment rose faster last year for the youngest and oldest segments of the population—the least productive. For the young, below-average productivity reflects less experience and training; for older workers, the issues are eroding skills, a new career and less attachment to the labour force.6 While neither trend was new last year, their growth accelerated sharply.

Nationwide, employment rose faster for people 55 and older (6.7%) and youths (1.5%) than for prime-aged workers (1.4%). As a result of increased demand, the unemployment rate for youths hit a record low of 9.7% by last December, and both the employment and labour force participation rates of people 55 and over hit record highs.

Shortages induced employers in Alberta and B.C. to turn most to the youngest and oldest. In Alberta, the increase was most pronounced for youths, where jobs rose 5.6%, boosting their employment rate from 64.1% to 65.3% between December 2005 and December 2006. B.C. was more reliant on older workers. While employment growth for prime-aged workers slowed to 0.9% during 2006, it rose 12.6% for older workers (including those 65 and over, up 1.7 points to 8.3%), twice the increase for 2005.

In Alberta, people with high school education or less accounted for over half of all employment growth in 2006. This was by far the most ever, and a distinct change from the 1990s when employers showed a marked preference for people with more than high school education (Chart J). B.C. saw a similar but less pronounced shift. Still, the Business Council of British Columbia felt that the shortages were severe enough to lower its forecast for GDP growth in 2007 (Finlayson 2007).

The decline in the education level of workers was symptomatic of the tightness of the labour market, not a deterioration in the quality of jobs available. In other words, the lower quality at the margin was driven by the supply of workers, not the demand of employers (who clearly would have preferred hiring people with better skills).

Not all measures of labour quality deteriorated last year. Employment of youths aged 15 to 24 slowed during the year except for Alberta. And the ranks of the self-employed fell during 2006, despite a brief rally at year-end. (The self-employed have lower productivity than employees).

However, employers reacted to the lower skill level of employees by stepping up training. Detailed employment estimates show employment in business schools and computer and management training institutes rose sharply last year, a marked departure from the previous five years.

Besides hiring less productive workers, employers may change their behaviour in ways that lower productivity. They could be more reluctant to lay off workers temporarily for fear that they would get jobs elsewhere and not return. Similarly, firms may hoard labour in anticipation of large projects coming onstream later. Reports say this is already occurring in the oil sands.7

Business investment points to higher productivity growth. Fuelled by record high profits, firms have stepped up investment outlays by a steady 10% in each of the last three years. The increased competitive pressure caused by the sharp rise in the exchange rate since 2003 would be a major incentive for firms to spend more. Similar pressures in the U.S. early this decade led to a sharp improvement in productivity.

Productivity rarely slumps for an extended period when investment is expanding (Chart K). This is encouraging for a rebound in productivity growth in the short run, holding out some prospect that the current slump will not be as prolonged as in 2002-2003. One factor that may explain the divergence of investment and productivity in 2006 was that so much of investment was driven by the energy sector, where the payoff in higher output will not materialize until later. Manufacturing, the sector with the largest incentive to invest in productivity-enhancing machinery and equipment, reined in such spending (presumably reflecting the intense pressure on profit margins) after a 10% gain in 2005 helped boost productivity that year.

Conclusion

Several economic and statistical reasons explain why productivity slowed in 2006. Nationally, growth shifted to industries where productivity declined, notably mining. Many industries, especially in western Canada, are struggling with labour shortages. Employers hired less-skilled labour and spent more time training employees. More generally, the shift of resources between industries, and increasingly regions, implies resources will not be productive during the transition. Finally, more industries were affected by one-time events last year, such as disruptions in the mining sector and a record warm winter that curtailed production.

The major question at the moment is not whether a slowdown in output relative to employment is occurring, but whether this slowdown is related to temporary factors (such as weather or other production disruptions, or a sudden shift of resources to new industries and regions) or signals the beginning of a longer-term slump in productivity caused by labour shortages, an aging labour force, or structural changes in the economy. Most of the variables studied in this paper point to transitory factors dominating in the short term. One exception was labour shortages in western Canada, partly caused by development of the oil sands.

One lesson to retain from 2006 is that large irregular movements are more likely to occur in an economy where natural resources are a growing part of output. Monthly output in mining has the most variability of any sector of the economy. Since this sector employs relatively few workers, contradictory short-term movements in output and employment could easily recur in the future. The best practice in such situations is not to place too much emphasis on short-term movements in productivity and instead look at them in the context of previous periods of growth when productivity temporarily sagged.

Notes

  1. Even in the U.S., where productivity rose 2% in 2006, the slowdown earlier this decade led the Federal Reserve Board to observe that "the recent slowdown in labor productivity may be at least in part a temporary cyclical response . rather than a meaningful downshift in the longer-run trend." (BGFRS 2007, 18).

  2. According to the National Energy Board (NEB), the initial productivity of gas wells in western Canada has fallen by almost two-thirds since 1996 (NEB 2006, 23). For oil, the NEB characterized western Canada "as a maturely explored basin, with diminishing finding rates and relatively high finding and development costs. Most of the larger pools have been discovered and smaller fields are increasingly difficult and costly to find." (NEB 2005, 17).

  3. "In 2006, potash production was idled at a number of Saskatchewan mines while producers waited for the Chinese government to settle on a pricing regime. As a result, large-scale shipments of Saskatchewan potash didn't begin until August." (Financial Post 2007).

  4. Similar results were found for economy-wide Laspeyres versus Fisher indices of productivity at the 2-digit level, using detailed employment data from the Survey of Employment, Payrolls and Hours.

  5. Also, these industries are ultimately benchmarked to data not based on labour input (such as tax data that capture all costs and revenues) and then deflated with a market price index. Based on the historical relationship between labour inputs and these final measures of output, the monthly estimates of growth are modified to minimize the possible revision. Interestingly, the last time that the contribution to growth from such industries was as large as last year was in 2003. At that time, their contribution to growth also peaked at over 40%, partly because of stepped-up demand for health services during the SARS crisis. Not surprisingly, this helped pull down output per worker that year. It is also noteworthy that this did not signal a new trend, as productivity growth quickly rebounded in 2004 and 2005.

  6. An aging labour force can significantly lower productivity. One recent study estimated that the impact on Canada peaked in the 2001-to-2006 period, with annual losses in productivity of 0.2 percentage points (Tang and MacLeod 2006, 598).

  7. For example, the Long Lake consortium said Phase 1 of the project was delayed by a 20% shortfall of labour productivity due to worker inexperience. It also said it was moving up work on Phase 2 for fear of losing employees as well as their position in the growing queues for supplies and equipment (Ebner 2006).

References

  • Board of Governors of the Federal Reserve System (BGFRS) 2007. Monetary Policy Report to the Congress. February 14. 21 p.

  • Ebner, Dave. 2006. "Nexen project in oil sands on budget and on time: But worker inexperience causes problems." The Globe and Mail, April 28, 2006. B5.

  • Financial Post. 2007. "Potash producers reach early pricing agreement with China." National Post, February 9, 2007, FP4.

  • Finlayson, Jock (ed.). 2007. B.C. Outlook. February. Vancouver. Business Council of British Columbia. 6 p.

  • Hoffman, Andy. 2007. "Cameco extends delay over flooded mine." The Globe and Mail, February 8, 2007, B4.

  • National Energy Board (NEB). 2006. Short-term Canadian Natural Gas Deliverability 2006-2008. October. Calgary. 46 p.

  • ---. 2005. Short-term Outlook for Canadian Crude Oil to 2006. September. Calgary. 58 p.

  • Tang, Jianmin and Carolyn MacLeod. 2006. "Labour force ageing and productivity performance in Canada." Canadian Journal of Economics. Vol. 39, no. 2. May. p. 582-603.

Full article in PDF

Author
Philip Cross is with the Current Economic Analysis Division. He can be reached at 613-951-9162 or perspectives@statcan.gc.ca The research paper Recent Trends in Output and Employment from which this article is adapted is available on the Statistics Canada Web site at
http://www.statcan.ca/english/research/13-604-MIE/13-604-MIE2007054.pdf.


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