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Taking the long view

16_flickr5795216284_4effc791d1_bTrends in the standard of living in central Canada and the United States

by Pierre Fortin

It’s a good idea to get away from daily press reports on the economy from time to time. They focus almost exclusively on what happened yesterday and may happen tomorrow. They rarely pay attention to longer-term trends showing where we come from, where we are going, and what we can do to mend our ways and improve our future.

In this article, I focus on trends in standards of living of Ontario and Quebec, the two provinces that form central Canada, and compare them to the trend in the United States over the last 15 years (1999–2014). This period of half a generation covers a full business cycle. It contains a solid expansion (1999–2008) as well as a recession and slow recovery (2008–2014). It is long enough to reveal basic trends, but short enough to avoid returning to our ancestors.

As an object of study, central Canada has three desirable characteristics: it comprises a good part (55 per cent) of the Canadian economy, it is rather homogeneous economically, and it is not dominated by extractive industries.

One thing at a time: my goal here is more to report on facts than to engage in deep analytical reflection. In conclusion, I offer a few thoughts about the future.

Four sources of the standard of living

The average standard of living of a society is the purchasing power that its members get on average from the income generated by its annual economic production. Statistics Canada calls it “real income per capita.” It is equal to gross domestic product in current dollars (“income”) divided by the price index of final purchases (“real”) and by total population (“per capita”).

For analytical purposes, I break down the standard of living into a product of four canonical sources:

Standard of living = Demography x Employment x Productivity x Terms of trade.

Demography means the percentage of total population with age between the ages of 15 and 64. Since the 15–64 age group is the main source of active workers, an increase in this percentage leads to more production, income and purchasing power per capita – a higher standard of living.

Employment refers to the percentage of this 15–64 population who hold jobs. If other conditions are the same, the larger this percentage, the higher the standard of living will be.

Productivity is the average volume of economic production (constant-price GDP) per employee, which depends on hours worked, educational attainment, available equipment and technologies, and the organization of labour. The more each worker produces, the higher the standard of living will be.

The terms of trade factor for a society is the ratio between the average price at which it sells its production to those in other societies and the average price at which it purchases goods and services from other societies. What we purchase is not exactly the same as what we sell, since we sell exports but purchase imports. The standard of living increases if the average selling price increases more than the average purchasing price.

I examine how each of these four factors has evolved and has contributed to changes in standard of living in Ontario, Quebec and the United States during the 15-year period 1999–2014.

Demography

16_Figure-1Figure 1 tracks the 15–64 population as a percentage of total population from 1999 to 2014. In this period, demography has been less favourable to the standard of living in Quebec than in Ontario and the United States, particularly in the last five years. In 2014, for example, there were 3,000 fewer Quebecers in the 15–64 age group than in 2013, while the total population had increased by 61,000. Population aging is also occurring in Ontario and the United States, but later and less dramatically than in Quebec. Statistical agencies foresee a continuation of the decline in the weight of the 15–64 population in all regions over the next decade.

Employment

16_Figure-2Figure 2 shows how the employment rate has evolved in the three regions. The U.S. performance has been dismal, particularly in the 2008–09 recession and the following nonrecovery. Ontario was also hard hit by the recession, but has now almost recovered to its 2007 employment rate. Quebec’s performance has been nothing less than spectacular. In 1999, its employment rate lagged six points behind those of Ontario and the United States. Since then, it has increased every year except briefly in 2009, and has now caught up with Ontario’s.

The rise in Quebec’s employment has two main causes: a shallower and shorter recession in 2008–09, and a jump in the employment rate of women aged 15 to 64 from 60 per cent in 1999 to 70 per cent in 2014. The magnitude of the recession in Quebec was made smaller by the absence of an auto industry in the province and the timely launch of the Quebec Infrastructure Plan in 2007–08. The large increase in women’s employment rate came from the supply side: the rise in educational attainment and a string of family policy initiatives that emphasized connections with the labour market, including a low-fee childcare system, enhanced parental leaves, a work premium and the setting of the minimum wage at a stable 45 per cent of the average wage. There was no similar upward trend in Ontario women’s employment rate.1

Productivity

The productivity of workers depends on two main factors: how many hours they work each year, and how many goods and services (or “output”) they can produce per work hour given their educational attainment, the available equipment and technologies, and the organization of labour.

16_Figure-3AFigure 3a shows that annual hours per employee declined in the three regions between 1999 and 2014. The decrease was very large in Quebec (10 per cent), sizable in Ontario (6 per cent) and smallest in the United States (3 per cent). In 2014, average annual work hours were down to 1,595 in Quebec, 1,725 in Ontario and 1,791 in the United States. The main drivers were decreases in average hours of full-time workers and increases in part-time work among men, spread across all industrial sectors. The marked preference of Quebecers for shorter weekly and annual work hours is a long-term phenomenon confirmed by these data.

Figure 3b shows that the growth of output per work hour in the two central Canadian provinces has lagged behind that in the United States. Cumulatively, between 1999 and 2014, hourly productivity increased by 25 per cent in the United States, 18 per cent in Quebec and 17 per cent in Ontario. This translates into annual average growth rates of 1.5 per cent in the United States, 1.1 per cent in Quebec and 1.0 per cent in Ontario.

16_Figure-3BThe explanation for productivity growth remains a mystery in the current economic growth literature.2 There have, however, been a number of interesting attempts to explain the slower growth of Canadian relative to U.S. productivity illustrated in Figure 3b.

For example, John Baldwin and his colleagues at Statistics Canada have pointed out that small firms, more prevalent in the smaller Canadian economy, are less productive than large firms.3 Andrew Sharpe and his colleagues at the Centre for the Study of Living Standards have suggested that the Canada-U.S. productivity gap could to a large extent originate in the wide Canada-U.S. gap in investment in information and communications technology (ICT).4 They point out that annual ICT investment in Canada has been about 40 per cent lower than in the United States since 1987. Peter Spiro, at the University of Toronto, has suggested that the main cause of weak productivity growth in Ontario, particularly in manufacturing, has been weak aggregate demand.5 But a synthesis of explanations for lagging productivity growth in central Canada is not yet at hand.

16_Figure-4Terms of trade

According to figure 4, between 1999 and 2014 the evolution of terms of trade played cumulatively in favour of Quebec. The main reason is that, while the ratio between international export and import prices increased in both Quebec and Ontario, the increase was much larger in Quebec. Meanwhile, this ratio declined in the United States.

Standard of living

In figure 5, the trends in demography, employment, productivity and the terms of trade pictured in the preceding sections are combined to give the overall trend in the average standard of living of each region from 1999 to 2014. The result is that the standard of living increased cumulatively by 18 per cent in Quebec, 16 per cent in the United States and 11 per cent in Ontario.

16_Figure-5Table 1 summarizes the specific contribution of each of the four factors to the cumulative increase in regional standards of living over the period. Differences between regions were mainly due to employment and productivity. The employment rate (row 2) grew remarkably in Quebec, grew slightly in Ontario and declined somewhat in the United States. Productivity (row 3) grew significantly in the United States, grew slowly in Ontario and grew even more slowly in Quebec.

The reason Quebec did better overall than the other two regions is that the province’s employment rate increased so much that it more than offset its very poor productivity performance. Quebec’s productivity was dragged down by the sizable decline in work hours per employee. This largely reflected Quebecers’ fast-rising preference for nonworking time (more part-time employment, shorter work weeks and longer holidays) in this period of declining unemployment.

16_Table_1Output per work hour grew more slowly in central Canada than in the United States. But in Ontario the employment rate increased only slightly and thus could not, as in Quebec, close the gap with fast-growing productivity in the United States. Hence the relatively slow increase in Ontario’s standard of living.

Real personal disposable income per capita

The concept of standard of living, or real income per capita, is all-inclusive. It comprises all types of income (GDP) that are generated in the national or regional territory. Real personal disposable income per capita is a more limited concept of income per capita. It includes about 60 per cent of GDP in Quebec and Ontario, and a bit more in the United States. Real personal disposable income is that share of GDP distributed to households (persons) as labour, investment and transfer income, net of personal income taxes. It is income at the disposal of households to consume or to save. It excludes the investment income paid out to foreigners, the profits firms retain in order to reinvest in structures and equipment, and the net income (taxes less transfers) governments can spend to provide public goods and services such as national defence, health care, education and transport.

16_Figure-6Figure 6 shows that, from 1999 to 2014, real personal disposable income per capita increased cumulatively by 33 per cent in Quebec and 23 per cent in Ontario and the United States. The Quebec advantage in growth of general standard of living between 1999 and 2014 (figure 5 and table 1) is also evident in growth of real personal disposable income per capita during the period.

A few thoughts on the future

It is not possible to draw firm conclusions about the future of the standard of living from its trend over the past 15 years. The future is uncertain. However, among the four sources of increase in the standard of living, we have a reasonably good idea on what to expect from demography – from Statistics Canada for Ontario and Quebec, and from the OECD for the United States.

16_Table_2This suggests looking at projections for, say, the next decade. I take existing demographic projections for 2014–2024 as given. I assume the other three sources of standard of living (employment, productivity and the terms of trade) change at the same average annual rate as they did over the past 15 years. The results of this projection are reported and compared to actual data for 1999–2014 in table 2.

The major development over the next decade is that the population dependency ratio will increase rapidly in all three regions, with Quebec in the lead and Ontario and the United States not far behind. It can readily be seen in table 2 that, other things being equal, the declining weight of the 15–64 population will slow the average annual growth rate of real income per capita (the standard of living) by 0.6 or 0.7 of a percentage point everywhere (the difference between line 3 and line 1, or between line 4 and line 2). A smaller percentage of the population will be at work, provide individual care and pay taxes to support a rising tide of the nonworking and increasingly old in the population.

Since little can be done to move the terms of trade in a favourable direction – they are like international “acts of God” – any offset to the demographic brakes will have to come from faster-rising employment rates and productivity.

The first principle in this endeavour is to make sure that the macroeconomic environment is conducive to full employment of human and material resources. So, first, we must make every effort to adopt monetary and fiscal policies that avoid recessions and support recoveries.

Then, on the employment side, we must deal more effectively with the high school dropout rate, increase educational attainment, help immigrants integrate more quickly into the labour force, and remove obstacles to women and older people joining and staying in the work force. These are obvious directions for public policy to take.

It is trickier to find policy that accelerates productivity growth. There is an array of options but no silver bullet in this area. A few elements that deserve mentioning are: develop entrepreneurship and managerial talent in general, combat monopolies, support new free-trade initiatives and protect existing agreements, encourage expansion of Canadian multinational firms, revise the equity and effectiveness of research and development tax credits, examine alternative ways of organizing health care and social services, repair and expand public infrastructures, replace group- and sector-specific tax breaks and credits with more general taxation rules, and tax consumption more and investment less.

There is room in central Canada for faster – and, of course, more inclusive and sustainable – economic growth. In absolute levels, Quebec and Ontario are more or less on par in productivity and standard of living, but they both lag about 15 per cent behind the United States in these two dimensions. So, even in a global environment that may not be favourable to growth, central Canada could show a better than average performance simply by catching up with the United States. This is particularly true in innovative sectors such as information and communication technology, where the central Canada–U.S. productivity gap is currently largest.

Notes

1Atlantic Canada has also experienced a large increase in female employment in the last 15 years. Male employment also increased significantly. This was likely due to the demand-led increase of 29 per cent in real GDP per capita (1999–2013) following the resource boom in the region. Meanwhile, Quebec’s real GDP per capita increased by only 15 per cent. Two papers using longitudinal microdata have estimated that the low-fee childcare system introduced in Quebec from 1997 has had a highly significant impact on women’s employment. See Michael Baker, Jonathan Gruber and Kevin Milligan, “Universal Childcare, Maternal Labor Supply, and Family Well-Being,” Journal of Political Economy, Vol. 116, No. 4 (August 2008), pp. 709–45; Pierre Lefebvre, Philip Merrigan and Matthieu Verstraete, “Dynamic Labour Supply Effects of Childcare Subsidies: Evidence From a Canadian Natural Experiment on Low-Fee Universal Child Care,” Labour Economics, Vol. 16, No. 5 (October 2009), pp. 490–502.

2 One leading expert in the area, Professor Elhanan Helpman of Harvard University, actually titled his book summarizing current knowledge on productivity and economic growth The Mystery of Economic Growth (Cambridge, MA: Harvard University Press, 2004)!

3 John Baldwin, Danny Leung and Luke Rispoli, Canada–United States Labour Productivity Gap Across Firm Size Classes, Catalogue 15-206-X, No. 033 (Ottawa: Statistics Canada, 2014).

4 See the summary by Vikram Rai and Andrew Sharpe, “Can the Canada-U.S. ICT Investment Gap Be a Measurement Issue?” International Productivity Monitor, No. 26 (Fall 2013), pp. 63-85.

5 Peter Spiro, “A Sectoral Analysis of Ontario’s Weak Productivity Growth,” International Productivity Monitor, No. 26 (Fall 2013), pp. 20–35.

 

Pierre Fortin is Professsor of Economics at the Université du Quebec à Montréal.



About the Author

Pierre Fortin
Pierre Fortin is Professor of Economics at the Université du Québec à Montréal.




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