Why are average incomes in B.C. so much lower than in other Pacific Northwest regions?

A recent blog by my colleagues, Jock Finlayson and Ken Peacock, identified that British Columbia offers a lower average standard of living than all other Pacific Northwest regions except Idaho (Table 1). In 2019, the last year before the pandemic, B.C.’s real gross domestic product (GDP) per person was CAD $53,400. While this was close to Montana (and Ontario), it was considerably less than Oregon, Alberta, California, Washington, and Alaska. Indeed, just across the border in Washington state, GDP per person was more than 60% higher at CAD $87,400.

Table 1: Average living standards are poorer in B.C. than in comparable jurisdictions

The arithmetic of living standards

GDP per person is determined by the humble rules of arithmetic. 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.

The first element, labour productivity, is by far the most important determinant of GDP per person in the long run. Let’s explore why this is true.

An illustration: The differing fortunes of Worktopia and Productavia

Worktopia – a jurisdiction where policymakers focus on raising labour utilisationTo illustrate why labour productivity is the main determinant of living standards in the long run, let’s imagine two fictitious countries (or sub-national jurisdictions). The first we’ll call “Worktopia”. Arguably, Worktopia is an extreme version of Canada and B.C. Policymakers have put their focus and energy into making gains in GDP per person solely through higher labour utilisation. They care little about labour productivity, which never changes.For a while this approach worked. Through various strategies to reduce unemployment and boost labour force participation and average working hours, Worktopia was able to raise GDP per person by chalking up higher hours worked per capita. In fact, Worktopian policymakers were so successful that their economy has reached a point where everymember of the population has a job regardless of age. Moreover, through the miracles of science, people now work 24 hours a day, 7 days a week, 365 days per year. At this point, labour utilisation (remember, this is hours worked per head of population) has reached its maximum and GDP per person stopped growing. To be clear, Worktopia can still make its economy biggerby adding population through net immigration and births, but that will not change GDP per person one iota.Can you guess Worktopia’s growth in GDP per person over the next 1, 5, 20, 50 years? That’s right. Zero! There is no longer any possibility of gains in living standards for the hard-toiling people of Worktopia. Quite simply, by relying solely on gains in labour utilisation, they have pinned their hopes to an economic growth strategy with a natural ceiling. Productavia – a jurisdiction where policymakers focus on raising labour productivityRight next door to Worktopia is another country we’ll call “Productavia”. Productivians tend to think of their neighbours as misguided workaholics letting the best of life pass them by. So long as anyone who wants a job has one (they dislike unemployment too), Productavians couldn’t care less about labour utilisation. Some people work, but lots don’t as they spend their time growing up, growing old or contributing to society in other ways. Those that choose to work feel that working 40 hours a week is plenty. There’s no appetite to change the status quo. Higher labour utilisation is not seen as a path to higher living standards. Thus, labour utilisation remains constant.What’s different about Productavia is that policymakers there are obsessed with labour productivity. They want their economy to generate as much output as possible with the limited hours that their leisure-loving citizens are prepared to work. This requires a heavy focus on investing in capital, technology, skills and scale, as well as ensuring scarce resources are put to best use. Policymakers see themselves like a team of engineers constantly reviewing and fine-tuning the engine and performance of their Formula One car for its next big race.In fact, competition in Productavia is fierce. There are consumer protections and standards, but there are few regulatory barriers protecting firms from domestic or international competition in product markets for goods and services. Firms must adopt the latest technologies – to stay ahead of their rivals – or else they are likely to perish.The latter is not necessarily a bad thing because workers dislike wasting their time at a failing business; they prefer to move to a company with expanding opportunities, the latest technologies, and better pay.Productavian companies are continuously investing in their capital stock. Employees find themselves training with the latest equipment and technologies. New capital projects are continuously getting underway. There are clear social and environmental goals to be met, but policymakers strive to make the regulatory processes as transparent, timely and certain as possible.The overall tax system is progressive: affluent households pay more in taxes than poor households. However, taxes as a share of GDP are modest because policymakers periodically conduct holistic reviews to make sure the tax system is simple, fair and efficient. No one wants tax arrangements to unwittingly distort Productavia’s well-balanced economic engine. When a company is successful through sales growth or product/service innovation, it does not face increasing rates of corporate tax. Similarly, personal tax rates and thresholds are set so as not to discourage the efforts of workers and entrepreneurs who sacrifice their time and savings to study and upgrade their skills to earn a higher income. Sales taxes rates are kept low because they are charged across a broad range of goods and services (except exports). Sales taxes are also charged once on final sales – not multiple times at intermediate stages along the value chain. Thanks to Productavia’s successes, it can afford a generous and comprehensive social safety net of income and service supports. Like the tax system, the social security system is also periodically reviewed to evolve with society’s changing needs. There is a strong public education system attuned to the evolving needs of employers and labour demand. A well-funded and organized public health care system ensures a healthy population and workforce. There is universal access to basic health services. There is a disability insurance scheme supporting people with disabilities and their care-givers. And there is a pharmaceutical benefits scheme providing subsidised access to prescription medicines.In summary, Productavian policymakers have created the conditions for higher labour productivity. Its companies face incentives to continuously invest in capital equipment, technology and skills – and to strive for economies of scale. Firms that don’t keep up, fail. This frees up their employees and capital for better uses elsewhere in the economy.Can you guess what Productavia’s GDP per person will be in 1, 5, 20, 50 years? It’s limitless. Why? Because growth in Productavian living standards is determined by the pace of technological change and the ability of businesses and workers to adapt to it. Unlike their Worktopian neighbours, they have pinned their hopes to an economic growth strategy with no natural ceiling.

Conclusion

British Columbia offers a lower average standard of living than all other Pacific Northwest regions except Idaho. This is mainly a result of B.C.’s (and Canada's) lower labour productivity growth over time. In other words, over time, our economy has become relatively inefficient and outdated compared to other Pacific Northwest economies. Indeed, the slowdown in Canadians’ real pay growth since 2000 is broadly in line with the slowdown in labour productivity growth (Williams, 2021). The situation has gotten worse, not better. In fact, for the five years to 2019, Canadian real GDP per person grew by only 0.3% per annum (Williams, 2020). Excluding recessions, this is the weakest performance on record for Canada’s economy. The allegory of Worktopia and Productavia illustrates the humble arithmetic of living standards. Labour utilisation is a fundamentally constrained path to higher GDP per person. In contrast, labour productivity is a fundamentally unlimitedpath – living standards are determined by the pace of technological change and our ability to adapt to it. If Canadians and British Columbians want to see their real incomes increase over time, they should follow the path of the “work-smarter” Productavians instead of the “work-more” Worktopians.