High productivity doesn’t guarantee prosperity

 We all know that Canada’s slow rate of productivity growth in the past decade or so has been uninspiring. On the face of it, this is a serious problem: everything else being equal, higher productivity leads to higher wages and incomes. But everything else isn’t always equal.

Real wages in Canada and in the United States have tracked each other pretty closely over the past 30 years, notwithstanding the widening productivity gap. And if you look at broader measures of income and purchasing power, Canada has been outperforming the U.S. for more than a decade.

 The consensus explanation for this divergence is of course the strong growth in commodity prices: strong resource prices have allowed us to enjoy higher incomes despite our poor productivity record. Where I think the consensus narrative goes wrong is when it goes on to speculate about what might happen if and when resource prices fall.

Instead of viewing high commodity prices as a temporary reprieve for low productivity growth, it is probably more accurate to view high resource prices as the cause of low productivity growth.

When commodity prices are high, capital and labour react to this price signal by shifting out of other sectors and into the resource sector. The shift out of manufacturing -- the so-called ‘Dutch Disease’ -- is a part of this process. (See here for why we shouldn’t be thinking of it as a disease.)

This shift increases average incomes, but it also reduces average productivity. Standard productivity indices measure the quantity of output produced by a certain level of inputs. But the business of resource extraction is very much a matter of working harder and investing more in order to obtain smaller amounts of increasingly valuable commodities. Since the usual productivity metrics look only at the quantity produced and not its value, labour productivity in the mining and oil and gas extraction sectors has been falling over the past ten years.

The reallocation of labour and capital to a sector in which productivity is falling likely explains much of Canada’s recent poor productivity record. If commodity prices fall and if capital and labour shift back out of the resource sector, we can expect average productivity to increase more rapidly.

This increase in productivity wouldn’t necessarily be good news, for the same reason that current slow rates of productivity aren’t bad news. When we think about productivity, output is the implicit measure for economic welfare: more output means more income. But this only works if prices are held constant. If prices are falling, then higher rates of productivity growth may not be enough: a large increase in quantities multiplied by an even larger reduction in prices still ends up in a reduction in the value of what is produced. Making more of something people don't want to buy doesn't guarantee prosperity.

Productivity is important, but it is possible to put too much emphasis on it. What really matters is value: price times quantity.

Original Article
Source: Globe
Author: stephen gordon