Fraser Forum

Waning U.S. productivity growth threatens Canada’s economic health

Printer-friendly version

The U.S. Labor Department recently reported that U.S. nonfarm business productivity—the goods and services produced for each hour worked by American workers—decreased at a 0.5 per cent seasonally adjusted annual rate over the period April-June 2016. This was the third consecutive quarter of falling U.S. labour productivity, the longest period of declining productivity in the U.S. since 1979. Moreover, average annual labour productivity growth was only 1.3 per cent from 2007-2015 which was  half the rate of growth from 2000-2007 and almost two-thirds lower than the productivity growth rates experienced in the late 1990s and early 2000s.

Clearly, there has been a structural change in the productivity growth performance of the U.S. economy.

Productivity growth is arguably the single most important measure of the economic health of a country.  In particular, it is typically the main contributor to an increasing standard of living and is the basis for non-inflationary increases in wages and salaries. A declining U.S. productivity growth rate is therefore a cause for major concern about the future growth rate of the U.S. economy. Real output increases because of a rise in hours worked and/or an increase in output per hours worked (i.e. labour productivity). Since the labour force participation rate has been consistently declining pretty much from 2006 to the present, any future growth in hours worked arguably depends upon growth of the working age population; however, projections are for the working age population in the U.S. to grow at a slower pace than in previous decades, at least through 2025. Hence, any significant increase in U.S. real economic growth is dependent upon a substantial improvement in that country’s productivity growth rate.

Any assessment of the future of U.S. productivity growth should confront the issue of why productivity growth has been so slow, really since 2003. In fact, there is some controversy surrounding this issue. One school of thought holds that technological change has been and will continue to be substantially slower in the 21st century compared to the 20th century, as the “low hanging fruit” of innovation has largely been harvested. This view has been challenged by many as ignoring a recent pick-up in research and development spending by U.S. companies, as well as promising developments in new areas of technology such as robotics, artificial intelligence, biotechnology and 3-D printing.

A less controversial potential source of the declining U.S. productivity growth rate referenced above is a slowing in the rate of new capital formation (or investment). The productivity of labour is a direct function of the ratio of capital to labour. Hence, a slowdown in the growth of the capital to labour ratio will reduce the rate of growth of labour productivity. In this regard, gross capital formation as a percentage of gross domestic product for the U.S. averaged 19.3 over the period 2008-2015 compared to 22.4 over the period 1995-2007. In contrast, this percentage for all economies was virtually unchanged comparing 2008-2015 (23.9) to 1995-2007 (24.2), and it actually increased in the case of Canada from 21.1 in the 1995-2007 period to 23.9 in the 2008-2015 period.

There are various possible contributing factors to the relatively weak recent rate of capital formation in the U.S. Two prominent factors are the relatively high U.S. corporate tax rate and the growth of government regulations. The former reduces the after-tax rewards for risk-taking and encourages U.S. firms to hold retained earnings overseas, while the latter divert investment away from productive innovations and new firm start-ups to compliance with government rules and restrictions. Under the Obama administration, the effective U.S. corporate tax rate increased relative to other countries, while government regulations proliferated. Given recent polls showing Hillary Clinton with a commanding lead in the presidential election race over her Republican rival, the outlook for a change in these policies is not promising, particularly as Clinton has failed to identify lowering corporate tax rates and reducing government regulations as part of her election platform.

Given that Canada’s economic growth is leveraged to the growth of the U.S. economy through Canada’s large dependence on the U.S. market for its exports, the unfavourable outlook for U.S. productivity growth should be of concern to Canadian companies and policymakers. As well, a continued stagnating standard of living for many Americans will perpetuate the strain of populism in the U.S. that has encouraged both presidential candidates to adopt protectionist stances toward international trade and investment. The populist movement in the U.S. and the growing political antagonism toward free trade and open capital markets pose a profound long-run threat to Canada, a small open economy that is highly dependent on U.S. trade and foreign direct investment.

 

Subscribe to the Fraser Institute

Get the latest news from the Fraser Institute on the latest research studies, news and events.