Many factors affect productivity growth, not just the rate at which countries' businesses patent new products and processes
Canada’s abysmal productivity growth has been the subject of countless studies. From 1976 to 2000 the growth in our labour productivity — real output per worker hour — was not stellar but, at 1.69 per cent per year, was decent enough. At that rate of growth, it doubles every four decades. Because what people produce in large part determines their incomes, that means living standards can double every four decades, which means they quadruple over eight decades, which is roughly current life expectancy.
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After 2000, however, the rate of growth of labour productivity fell sharply: to less than 0.9 per cent per year. At that rate, it doubles only every eight decades. But much of that 0.9 per cent was the result of increases in how much capital workers were using. Once you account for that, total productivity growth was actually negative.
As many economists have pointed out, including yours truly, real GDP per capita has stalled since 2018 and in 2023 it actually fell — by 2.4 per cent — and is likely to fall again in 2024. Our stalled and now declining productivity is fast becoming a crisis. Canadian incomes are falling behind those in other countries, especially the United States, our most important competitor for investment, entrepreneurs and skilled workers. We are setting ourselves up for a brain drain as people and businesses seek better opportunities elsewhere.
Jim Balsillie, former co-CEO of BlackBerry, thinks he has the answer to our slow productivity growth. As he put it in National Post last Saturday: “Over the past 40 years, the global economy has undergone a rapid, unprecedented shift from a traditional tangible asset production economy to a knowledge-based, intangible assets economy.” He then argued that Canadians own too little intellectual property (IP) and data and are therefore missing out on the economic rents that come from selling ideas to the rest of the world.
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Perhaps. The IP that is produced by innovation does improve the return to capital in many undertakings but the effect is primarily concentrated in technology and manufacturing, which are not actually that large a part of the economy. Why Canada does not have sufficient IP ownership is not clear, however, and Balsillie does not provide an answer. Nortel and BlackBerry accounted for the lion’s share of IP produced in Canada in the past 40 years but were unable to sustain their innovative advantage. Nortel went bankrupt and BlackBerry is now a shadow of its former self.
It’s also not clear that IP is as crucial as Balsillie insists. Some countries have grown rapidly without strong innovation records. Ireland, for example, was one of the fastest growing OECD countries over the past 40 years but cashing in on IP ownership was not the main reason why. Instead, smart economic policy involving free post-secondary education, infrastructure development and a uniquely competitive corporate tax regime attracted investment from around the world.
Balsillie’s major beef is that Canadian governments are getting outdated advice from economists who focus on tangible capital and business competitiveness but ignore the knowledge-based economy. Of all the thousands of experts he could have named who do emphasize investment and competitiveness, I was singled out for criticism. I wear that badge with honour, however, especially since MIT’s Robert Solow, father of modern growth theory and winner of the Nobel Prize in economics in 1987, who passed away in December, would have been a far more deserving candidate for straw man, given his pre-eminent intellectual and policy influence over the years.
Economists do understand the knowledge-based economy is important but it is not the only source of productivity gains or economic rents — that is, returns above and beyond the cost, including profit, of developing a product, asset or idea. Since the 1500s, Canada has benefitted from resource wealth that has yielded substantial economic rents.
When economists like me talk about the importance of investment, however, we don’t mean just nuts-and-bolts capital like machines and buildings. We also mean investment in research and development, mineral exploration, branding, information and communications, software and other intangibles. Many such investments won’t happen without legal protection under patent, copyright, trademark and property rights law that is enforced so innovators can earn the profits they need to cover their costs and risk.
But nuts and bolts count, too. New machines boost incomes by incorporating embedded technologies. In the 1990s, high levels of investment enabled Australia’s productivity to grow impressively even though its research and development record was poor. Canada has long had one of the most supportive tax and subsidy systems for R&D but our adoption rates have often been low as the ideas were used in U.S. production, not here.
Since the 1970s, despite what Balsillie says, Canada has been ramping up intangible investment more quickly than tangible capital. In 2020, Statistics Canada estimated that nominal intangible investment grew by a whopping 600 per cent from $7.1 billion in 1976 to $143 billion in 2016. As a share of total investment, intangible investment doubled to 40 per cent during this time.
With such rapid growth in intangible investment, why has Canada’s productivity growth slowed so markedly? To answer this question, it’s best to go back to Robert Solow’s “growth accounting,” which shows how the growth of labour productivity has three sources: increases in “human capital” due to more working hours adjusted for greater experience or education; capital deepening, i.e., using more capital per worker; and the “Solow residual” — whatever isn’t explained by more and higher-quality labour or increases in physical capital.
The residual is a “black box,” but an important one: Solow’s original estimates credited it with half the growth of U.S. labour productivity in the mid-20th century. Subsequent research has related it to innovation, management quality, the size of the market, how well resources are allocated and, as shown by Daron Acemoglu and James Robinson in their 2013 book, Why Nations Fail, institutional factors, such as laws, politics, taxation and social customs.
So: how much has intangible capital raised total factor productivity? According to Statistics Canada, not as much as one would hope or Balsillie would have us believe. Since 2000, almost all of Canada’s labour productivity growth has come from capital deepening. Another fifth has come from improvements in human capital, but that has been offset by a decline in the Solow residual. The intangible expenditures contributing most to growth have been R&D, software acquisition and mineral exploration. While discovery and IP have had a positive impact, other factors seem to be getting in the way, causing overall productivity to fall.
If economists have failed, it is that we really don’t know just how much the different factors are contributing to the falling Solow residual in Canada. In all likelihood, there is no single silver bullet. What we do know is that falling per capita GDP will not be good for Canadian society.
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