In their exasperation about stagnating living standards, Canadians have a point

Last week, the Trudeau government announced its revamped Cabinet containing 39 ministers. This vast leadership committee is not only larger than most choirs, it far exceeds the number of executive ministers in other countries such as the United States (15, plus the President and several other attendees), New Zealand (20), the United Kingdom (23), and Australia (24). Indeed, even those executive cabinets may be too large.

The science of organisations (i.e. the theory of groups and teams) indicates that optima l “team sizes” for effective decision-making tend to be in the range of 5-12 members. As groups grow beyond that, members become increasingly unable to coordinate, make sound decisions, and take action. Individual accountability and productivity also falls. Canadians must hope its new federal cabinet can function as a high-performing team and defy the evidence from organisational science.

Canada’s predilection for elephantine federal cabinets is all the more surprising given that the country has one the most decentralised systems of government in the world. Canada’s national government holds far fewer responsibilities and powers, compared to subnational governments (i.e. states/provinces), than is the case in most other countries.

Nonetheless, after the pandemic, the first order of business for Canada’s new federal cabinet should be to address the stagnation in living standards over the past decade or more. A recent report from the OECD offers some sobering statistics. Contrary to claims advanced by the Trudeau government and others prior to the pandemic, Canada’s economy was not “solid” or “strong”. Far from it. Confirming a widespread belief among households that they were “not getting ahead”, Table 1 of that report confirms that there was very little growth in Canada’s real gross domestic product (GDP) per capita over the 2007 to 2020 period (Figure 1). Let’s quickly review what determines GDP per capita and then look at the data.

A quick refresher on the arithmetic of living standards

As noted in a previous blog, GDP per person is determined by the humble rules of arithmetic.

Specifically, growth in real GDP per person equals the sum of growth in:

• Labour productivity – real output per unit of labour input (i.e. real GDP per hour worked), determined by how intensively and well an economy uses capital, technology, skills and scale to produce goods and services; and

• Labour utilisation – hours worked per head of population, which is the product of the economy’s employment rate (employed workers per capita) and total working hours per employed worker.

As explored in a previous blog, there is unlimited scope to raise living standards over the long run through higher labour productivity. However, there is very limited scope to do so through higher labour utilisation.

What does the data say about Canada’s economic performance over 2007-2020?

Canada’s performance ranks in the third quartile among advanced countries for growth in real GDP per person over 2007-2020 (Figure 1). In other words, we were towards the back of the pack but not right at the back. Canada’s growth rate averaged just 0.8% per annum over the period, well below the OECD average of 1.3% and below that of Australia, Germany and the United States (all 1.1% per annum). The good news is the Canada’s performance was at least marginally better than a few other back-of-the-pack G7 countries. France, United Kingdom and Italy all did worse and ranked in the fourth quartile.

Figure 1:

What were the contributors to Canada’s economic performance over 2007-2020?

Labour productivity

All of Canada’s growth in per capita GDP over 2007-2020 came from labour productivity growth. The contribution was evenly split between increases in capital per worker and growth in trend labour efficiency (i.e. gains in technological advancement and scale, and skills per worker). Still, Canada’s labour productivity growth was comparatively weak and ranks in the third quartile among advanced countries (Figure 2). Our labour productivity growth was close to the back of the pack, but not quite at the back.

Figure 2:

Labour utilisation

Canadian policymakers tend to be preoccupied with labour utilisation. This is despite labour utilisation growth being intrinsically limited in its potential to raise per capita GDP over the long run. In contrast, labour productivity growth has unlimited potential to raise living standards (again, see here

for further discussion). To be candid, many Canadian policymakers are barking up the wrong tree when it comes to strategies to grow the economy in a way that raises people’s real incomes.

It is striking that the two centrepieces of the Trudeau government’s economic growth strategy are focused on labour utilisation: (a) ramping up immigration numbers to the highest levels in more than a century; and (b) introducing a national childcare scheme. Whatever the other merits of these policies, neither is likely to be sufficient or effective as an economic growth driver that raises Canadian real per capita income over time. On childcare, the 2021 Federal Budget (page 54) states that, if fully implemented, the programme announced by the Trudeau government would raise GDP by (only) 0.05% per annum over the next two decades. On immigration, while having a larger population, larger labour force and bigger major cities through immigration does raise GDP, there is no economic theory or evidence that the strategy does anything to raise per capita GDP, which is what really matters for living standards. Even the proponents of high immigration (quietly) admit its effect on per capita GDP is nugatory or perhaps even slightly negative.

Immigration is also not a solution to the challenges posed by population ageing and rising provincial health care costs (whereas higher labour productivity growth is a solution but receives scant attention). Contrary to often repeated claims, immigration does not materially affect the age structure of the population. As a policy lever, it is not a magical elixir that can make Canada’s overall population younger. This is due to two basic arithmetic reasons that are often overlooked: (a) the share of newcomers each year is still very small relative to Canada’s total population, so the younger age of newcomers each year does not “move the needle” for the age structure of the total population; and, (b) because immigrants (including this author) age along with the Canadian-born population. These realities are clearly demonstrated in Charts 4 and 6 in Robson and Mahboubi (2018), among other studies.

So what does the data say? Is Canada’s labour utilisation focus paying off as a path to higher real incomes? Notwithstanding high levels of immigration, OECD data shows there were no gains at all in labour utilisation in Canada during 2007-2020 (Figure 3). In fact, Canada achieved zero growth in labour utilisation over the period, ranking in the fourth quartile among advanced countries. Demonstrably, Canadian policymakers have been focusing their attention on labour utilisation strategies that are having no impact at all on raising GDP per person. To repeat the earlier point, they are simply barking up the wrong tree.

Figure 3:

Conclusion

Prior the pandemic, the federal government, its agencies and even some in the media repeatedly claimed that Canada’s economy was “solid”. Clearly, this was not the case. As one of the most indebted countries in the world – with the combined debt of households, corporations and governments now standing at over 3½ times nominal GDP – one might have expected to see Canada’s economy rocketing along over the past decade and yielding gains in real incomes. Borrowing should have resulted in meaningful investments and gains in the country’s productive capacity. It did not.

Canada’s economic performance over 2007-2020 – as measured by its ability to deliver gains in real incomes for people – was poor. Canada ranks towards the back of the pack among advanced countries on this key metric. This is mainly due to weak labour productivity growth, with Canada ranking in the third quartile among advanced countries. At the same time, despite the overwhelming focus of federal policymakers on strategies ostensibly aimed at boosting labour utilisation, labour utilisation actually made no gains whatsoever toward growth in GDP per capita over the period.

What is missing from the economic growth game-plan favoured by federal policymakers is a focus on tax, regulatory and other structural reforms that would encourage higher labour productivity. This is the only sure path to higher living standards over time. Canadians are right to be exasperated that they are “not getting ahead” – the evidence is that, on average, they are not. After the pandemic, addressing the stagnation in living standards should be priority number one for Canada’s gigantic new federal cabinet.