The OECD Has it All Wrong About Canada

The OECD came out with its Economic Survey of Canada last week and like so many other institutions and commentators before it, has got it all wrong. The report lauded Canada for its fiscal performance but gave it a failing grade for productivity growth. The report, amongst other things, criticizes Canada for its declining multifactor productivity, a measure of output denominated by an assortment of production inputs. The report asserts that multi factor productivity (MFP) has been declining since 2002 and seriously lagging that of the United States. The report adds that Canada’s factors of production mix is skewed heavily towards engineering structures to the detriment of machinery and equipement.

While MFP has been dropping in Canada since 2002, many would argue that looking at labour productivity is more important. Productivity per hour worked in Canada has grown from $156 to $183 from 1997 to 2011 an increase of 17% over the period, far from the alarming trend the OECD reports. Noteworthy however is the slowing growth of productivity growth during this period from a high of 2.61% in 1999 to the present growth of 0.75% in 2011

The error of the OECD report however is one of not looking into the underlying trends and the break down of productivity change by industry. If one breaks down the numbers to find out which industries contributed to the change in the overall economy a few truths become apparent. The slowing growth is mostly attributable to one sector: mining and oil & gas extraction. This sector registered the steepest loss in productivity since 1997 contributing -8.17% to overall per worker productivity in Canada. Virtually all other sectors contributed positively to productivity growth (with the exception of the public sector and its tangents). And since mining and oil & gas extraction is the fastest growing sector in Canada the loss in productivity weights down heavily on the numbers reported by the OECD.

MFP is weighted down even more heavily by the this sector, as much of new fixed capital formation originates from Alberta’s energy industry. So why isn’t this trend worrying? the answer lies in the basics of economics. Productivity in tangible assets tends to lagg investment by tangible assets. Basic macroeconomic models tend to assume a lagg of one year between investment in fixed assets and new production from those assets. But the oil sands development in Alberta is bucking that trend as the magnitude of those  investments is larger than ever before, and the huge oil sands mines of the Athabasca region are unparalleled in history.

Most of the mines under construction take between 5 and 10 years to reach capacity and since the oil sands developments are still relatively new, few if any of the largest mines are near capacity. Production in the oil sands is estimated to double within the next decade while employment will drop as temporary construction jobs in the sector are slated to be replaced by fewer permanent operating jobs.

These trends will lead to a complete reversal of the national productivity contribution of the sector, from the most negative to what will be the most positive contribution. Canada’s over investment in Engineering structures isn’t a fluke accident on the part of Canadian businesses. It is rather a sign that business leaders in the nation understand where Canada’s growth will come from in the future.

What is strange is that these developments are widely known, as the Canadian Association of Petroleum Producers widely communicates them. That the OECD and the Bank of Canada before it, have not picked up on these trends is testament to the short term vision of macroeconomic study at some of the most important economic institutions. One hopes that policy makers don’t get wound up in the noise from these economist and continue to provide policy changes geared towards letting Canada shift economic activity to where the nation has a comparative advantage.

Is the UN Marxist?

Dr. Flassbeck

I recently stumble upon an interview of Dr. Heiner Flassbeck the Director of  the United Nations Conference on Trade and Development’s department on Globalization and Development Strategies. In that interview he raised two points (at least in the first 5 minutes I forced myself to watch). The first one was that wages were broadly stagnant. The second point was that a struggle was occurring: not between north and south, not between developed and developing but between labor and capital! I’d first like to point out that he did not credit Marx with his assertion (plagiarizing a**). His ”refuses to die” idea was backed up with a chart of logged real wages and productivity from a speech given at the University of Berkeley by Damon Silvers. The chart showed that both variables tracked each other fairly precisely until the 1970’s at which point the growth trend of real wages unperformed that of productivity.

Now if we assume that the un-referenced data is correct and that by productivity it is implied labor productivity and that we are discussing about a chart describing the American labor situation, at face value it would seem that Dr. Flassbeck is right. But before throwing in the towel and replacing all our Bibles with Das Kapital (if you own a Bible), let’s examine the issue a little closer. Using a super standard macroeconomic growth model:

 where α and 1-α are the proportions of capital and labor respectively used to produce GDP (here Y) and with the entrepreneur/employer/firm/corporation/capitalist/slave driver trying to maximize profit through:

  we can derive what actually drives output growth per worker! It turns out it isn’t capital, it isn’t labor, it isn’t the choice of using one over the other it is… drum roll please… technology. So macro 101 tells us that productivity growth in the long run occurs because of improvements in technology. Even a business grad could have told you that. The crux of the problem however is that this very same econ 101 lesson would have told you that labor wage equals the productivity of that labor, like in the first 20 years of the chart.

Everything converges to trend eventually

The thing about this model is that it counts all labor as being the same. Try telling a German worker he’s the same as a Greek one. The real catalyst for the dichotomy resides in globalization, something Flassbeck seems to deny. If instead of calculating the productivity of labor  we calculate the productivity of capital we see that it is dependent on labor. A typewriter doesn’t write scripts without a writer. Let’s say as a publisher you can print 10,000 copies of a good book written by a French philosopher in the 18th century. Let’s say that suddenly an American writer comes along and is willing to be payed a quarter of the Frenchmen’s wage. While the French Voltaire still writes better books (is more productive) he has to convince you that your printing presses will make more money printing his book than say an increasingly popular Jefferson’s (increasingly productive). While for arguments sake the french 18th century writers are better than their american counterparts to not let the latter look like a good bargain the French will have to drop their wage demands. Similarly American workers need to start asking for less even if they are more productive than their Chinese rivals.

The reason for this is that we cannot look at the productivity of labor and wages in a closed circuit but rather in a World wide context. So while I’m sure the communist chart is correct in it’s assertion that industrialized wages aren’t keeping up with its equivalent productivity, I’m quite certain that on a global basis the gap between the real wage and labor productivity is shrinking. Just to be sure I’ll be crunching some numbers and getting back to you on this after exams.

Could Carney Be Wrong

Mark Carney the Bank of Canada’s Governor has been one of the most vocal central bankers Canada has yet seen. He intervenes in the media often and repeatedly about some of his worries concerning the health of the Canadian economy. His chief worries revolve around three subjects broadly vassal to the theme of international competitiveness. The first of his worries is that Canadian manufacturers aren’t using the combination of low interest rates and high Canadian dollar to invest in cheap foreign capital goods. His second ”keep me up at night” issue is that of Canadian businesses’ low exposure to rapidly developing countries and over exposure to stagnant markets. His third problem and dilemma is that of rapidly escalating household debt load. While not explicitly saying so, Carney’s fear is that Canada will increasingly ressemble the pre-crisis US; a debt saddled and internationally uncompetitive economy. Commentators have been doing a fair bit of wall painting by noting that Canadian Households are second in indebtedness in the G7+BRIC category. Economic nationalists regularly plaster business newspapers with doomsday scenarios foreshadowed by Canada’s perennially lagging productivity. Alright, let’s breath… wait a minute and think about this.

It is a little funny that Carney’s most recent musings about Canadian manufacturers and business came less than a week after the latest numbers of the Canadian Survey of Business Investments . The survey’s data reveals that new capital expenditure (read fixed capital formation) is expected to run at the fourth highest clip in over two decades, only failing to surpass the dotcom bubble fueled investment mania at the turn of the millennium. One would have thought that the BoC Governor would have taken note of such a survey. It seems that manufacturers were just waiting for the Goldilocks’s moment of low interest rates, easy lending conditions and better international sales prospects to start investing. A traditional Canadian conservative way of doing business, one that served Canada’s financial sector well during the crisis. In any case with Chairmen Bernanke of the Fed’s pledge to keep interest rates near zero through 2014, Canadian manufacturers probably expect their low rates + high currency combo to persist a while longer, so what’s the big rush to invest? As noted above business investment isn’t our central bankers only preoccupation. Our aversion to developing nations export markets tick’s him off as well.

When it comes to Canadian exporters’ choice of export markets, I propose that bureaucrats who have never managed anything other than a hyped up economic think tank (say a central bank) or sovereign debt investment bank department (say at Goldman Sach’s), stay out of real businessmen’s head. When Mark Carney proposes exporters start doing business with emerging markets, which ones is he talking about? Is he talking about Russia? a country where ex-KGB mafia is indistinguishable from the oligarchical business class and where the contracts you sign are only as good as the prevailing mood of the Kremlin? Is he talking about Brazil? Brazil a country where if your company spills a drop of oil in the ocean your executives risk loosing their passports and being prosecuted by only thinly-veiled xenophobia infected local prosecutors. Maybe, he meant China? That very same country that will toss Rio Tinto executives in jail just to squeeze a better deal out of those executives’ native country and supposed business ally Australia. International business is a tough business in itself, why don’t we let those entrepreneurs that have first hand experience decide when they want to abandon the largest markets of the World (Japan, US and Europe) for some of the riskiest markets on Earth.

We’re left to examine the remaining entry on the Carney sin list. Our profligacy and lack of thriftiness. So Canadian household debt levels have jumped to never before seen heights. With interest rates at a historic low this is to be expected. The number however only gives an incomplete picture of Canadian households’ health. Household average debt says nothing about the distribution of that debt. In the US, the subprime crisis became a crisis because debtors were at or not far away from the bottom of the income distribution. In Canada most of the ongoing issuance of debt is for mortgages, and less than 9% of Canadians have less than 10% equity in their homes. If we add the two together it says that on average wealthy Canadians are the one’s increasing their average debt load, since homeowners that own a decent amount of home equity are generally well off. Something which makes sense as most wealthy Canadians do not need to indebt themselves to live, whether they choose to invest when their financing costs go through the floor is a whole other ball game. Maybe commentators want to come out with more data on the distribution of indebtedness in Canada before alarming national rate strategist.

The accusation that Canada is uncompetitive however is rooted in other numbers than simply those on indebtedness or exposure to this or that foreign market; it is rooted in the fact that on an aggregate level more Canadian workers working longer hours have not been producing as much. The US has seen its per worker productivity increase faster than Canada’s for much of the last few decades. Something that we should all be worried about in normal circumstances. Canada is not living in normal circumstances. Canada is in the midst of reallocating some of its labour and capital resources to a sector where it actually holds a comparative advantage. For the last few years Canada’s workers, corporations, entrepreneurs and capital markets have been investing time and effort in developing its valuable natural resources. There are very long lags between payoff and investment for some of Canada largest most capital intensive projects. The Business Investment Survey forecasts fixed capital formation in the resource extraction industries will beat the record set last year by $13 Billion dollars. For now this money creates little revenue, profits or exports but 3, 5, 10 years down the line expect to see GDP jump. Building Oil Sands steam assisted gravity drainage mines takes years, likewise BHP Billiton’s Jansen potash mine wont be operational for years. The Canadian mining landscape is only now starting to bubble, when it starts to boil those productivity numbers we spend so much time worrying about will become jokes. All in all Canada is shifting. The economic landscape we now see will not be the same. Mr Carney rest easy, Canada’s households and entrepreneurs have got this one under control.