It's time to start worrying about productivity again

There were a couple of nice papers in the Centre for the Study of Living Standards' spring 2008 issue of their International Productivity Monitor. The reason we keep coming back to this issue is summarised in this chart from Business Sector Productivity in Canada: What Do We Know? (pdf), by Paul Boothe and Richard Roy of Industry Canada (click to see a larger version):

Labour productivity growth is the basis for long-run growth in real incomes, and this chart is why Canadian economists fret about productivity.

There are other sources of income growth that can be tapped in the short run, and Canada has been doing pretty well squeezing what it can from them. Boothe and Roy decompose the sources of income growth  in the following way:

• Labour productivity: Output per worker. This is further decomposed as capital deepening (the increase in the amount of productive capital per worker) and multifactor productivity (MFP), which is the increase in output that cannot be explained by the accumulation of inputs of production. MFP is usually interpreted as 'pure' technical progress, the kind that allows us to produce more with the same level of inputs.
• Working-Age/Total Population: Everything else being held constant, an increase in the percentage of the population that is of working age will increase income.
• Employment Rate: Everything else being held constant, an increase in the percentage of the working-age population who are employed will increase average incomes.
• Hours Worked per Worker: Everything else being equal, an increase in the hours worked per worker will increase average incomes.
• Net Foreign Income. The returns generated by assets held outside Canada, less the payments made to foreign owners of assets in Canada.
• Terms of Trade: An increase in the price Canadians receive for their exports relative to the price they must pay for imports represents an increase in buying power.

Here are their estimates for how these factors contributed to income growth since 1981:

Barely half of the income growth since 1981 came from increases in labour productivity, and another fifth  came from the fact that there were simply more people working. The percentage of working-age people has increased as the baby boom entered the workforce, and employment rates - especially among women - have increased. This can't be sustained: female employment rates are starting to level off, and the Working-Age/Total Population factor will start becoming a drag on growth in a few years as the baby boom cohort starts to retire.

The past few years have been pretty good ones for income growth - does that mean productivity has finally accelerated? Well, no. The authors very kindly agreed to run the numbers for the years since 2000 and to send me the results:

The run-up of the prices of oil and other commodities - and the subsequent improvement in Canada's terms of trade - accounts for more than half of the real income growth we've seen since 2000. That can't go on forever (right?), and when you take into account the increases in the relative size of the working-age population and the employment rate, it's somewhat disquieting to note that more than 3/4 of income growth since 2000 comes from sources that could not only disappear, but could also very well change sign and become a drag on growth in the medium term.

Yikes.

Which brings us to the second article in the IPM: An Analysis of the Causes of Weak Labour Productivity Growth in Canada since 2000 (pdf), by Jean-François Arsenault and Andrew Sharpe of the CSLS. They manage to find a silver lining:

Future labour productivity in Canada should pick-up compared to its 2000-2007 rate, even though there exists significant uncertainties as to the precise rate of growth that can be expected. Our analysis suggested that labour hoarding, increased training, high corporate profits and a rise in the Canadian dollar contributed to the slowdown in Canada; these four factors should in the long run lead to more intense use of labour, increased human capital and increased investment. A return to the 1973-2000 trend rate of 1.55 per cent thus appears reasonable. Moreover, with more room for convergence with the United States, it would not be surprising for Canada to exceed its trend rate.

Of course, they could be wrong:

[T]o the extent that future labour productivity growth in Canada will rely on MFP growth, any projection of future labour productivity growth must be interpreted as an informed approximation rather than a firm estimation.

Let's hope that they're right.

Comments

[rogue]

Was there any explanation or hypothesis to the reason for the stagnant Canadian productivity growth? Is it because of higher focus on less value-added services, less income growth vs. other countries, or less new businesses? Was there simply less new business opportunity?

[kio]

Labor productivity and labor force participation rate is a unique function of the growth rate of real GDP per capita. Two papers are accepted by the Journal of Applied Economic Sciences (http://jaes.uv.ro ). Will be published in October, 2008, but are also available as working papers.
Canada provides the best example for the link.

The Driving Force of Labor Force Participation in Developed Countries
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1130147

Abstract
The evolution of labor force participation rate is modeled using a lagged linear function of real economic growth, as expressed by GDP per capita. For the U.S., our model predicts at a two-year horizon with RMSFE of 0.28% for the period between 1965 and 2007. Larger part of the deviation between predicted and measured LFP is explained by artificial dislocations in measured time series induced by major revisions to the CPS methodology in 1979 and 1989. Similar models have been developed for Japan, the UK, France, Italy, Canada, and Sweden.

Keywords: labor force participation, real GDP per capita, prediction

The driving force of labor productivity
http://inflationusa.blogspot.com/2008/05/driving-force-of-labor-productivity.html

Abstract:
Labor productivity in developed countries is analyzed and modeled. Modeling is based on our previous finding that the rate of labor force participation is a unique function of GDP per capita. Therefore, labor productivity is fully determined by the rate of economic growth, and thus, is a secondary economic variable. Initially, we assess a model for the U.S. and then test it using data for Japan, France, the UK, Italy, and Canada. Results obtained for these countries validate those for the U.S. The evolution of labor force productivity is predictable at least at an 11-year horizon.

Keywords: productivity, labor force, real GDP, prediction, modeling

JEL Classifications: J2, O4