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The competitiveness challenge.

There is widespread concern in Canada about the productivity performance of the economy and its implications for the future prosperity of the country. Total factor productivity (TFP) growth - i.e. output growth unexplained by additional labour and capital inputs - has been almost zero since the late 1970s, restricting the scope for improvements in living standards. Although Canadian income per capita remains the second highest among G7 countries (on a purchasing power parity basis), the gap with other OECD economies has tended to narrow. Mainly as a result of slow productivity growth, Canada's unit labour costs have increased relative to those in its trading partners. This problem is particularly acute in manufacturing, where the increase has been far in excess of that in the United States, Canada's major trading partner. As a result, many Canadian manufacturing firms are having extreme difficulty competing with their American counterparts and have suffered a substantial deterioration in profitability.

These problems are being addressed in the national debate about the "competitiveness" of the Canadian economy(14). After clarifying the meaning of such a competitiveness concept, this chapter focuses on Canada's poor productivity record, the reasons for this performance and how it could be improved. The imbalance between productivity and labour compensation growth is briefly discussed at the end of the chapter.

Defining competitiveness

In a broad sense, a nation's competitiveness can be defined as "the degree to which it can, under free and fair market conditions, produce goods and services that meet the test of international markets while simultaneously maintaining and expanding the real incomes of its citizens"(15). According to this definition, the notion of competitiveness has both short-term and long-term aspects. The short-term aspect concerns the ability to meet the test of international markets. A nation can have difficulty meeting this test if its unit production costs become higher than those of other nations. This kind of loss of competitiveness occurs when increases in wages and other costs are not compensated for by productivity growth. The long-term aspect of the definition, which is the main focus of this chapter, concerns real income per capita. A nation is considered to be competitive if, relative to other countries, it maintains or expands the real income of its citizens.

As labour productivity is the most important determinant of income per head, the long-term competitiveness of a nation essentially depends on its ability to improve the level of labour productivity relative to that in other countries and, to a lesser extent, on the proportion of the population working. The capacity to raise labour productivity levels mainly depends on improvements in the overall efficiency of the production process -- i.e. TFP -- and capital accumulation. The level of labour productivity relative to that in other countries also depends upon the terms of trade.

Assessing competitiveness: the productivity performance

Labour productivity levels

Like many other G7 countries, Canada has narrowed its labour productivity gap with the United States over the past four decades. It has been estimated that GDP per person employed in 1950 was 32 per cent higher in the United States than in Canada(16). OECD estimates suggest that labour productivity - measured as output per person employed in the business sector - was 29 per cent higher in the United States than in Canada in 1970, but that by 1990 it had fallen to 12 per cent. Approximately two-thirds of the progress since 1970 reflects higher labour productivity growth in Canada, with the rest being mainly attributable to the improvement in Canada's terms of trade relative to the United States; the latter is associated with the impact of the increase in energy prices since the 1970s.

Although Canada continued to close the productivity gap in the 1980s, albeit slowly, this progress was far from economy wide. Canadian labour productivity growth was better than in the United States in a number of industries (transport, storage and communications, construction, mining and utilities), which more than offset the weaker performance in manufacturing, wholesale and retail trade, and other services(17). The productivity performance in the manufacturing sector, which represents 17 per cent of output and 56 per cent of exports (compared with 22 per cent and 65 per cent respectively on average in G7 countries), was particularly disappointing. After continuing to decline in the 1970s, the manufacturing labour productivity gap with the United States - measured as the difference between real output per person employed in manufacturing in the two countries - grew markedly in the 1980s, increasing from 24 per cent in 1980 to 45 per cent in 1990(18). Meanwhile, other G7 countries continued to make advances against Canada: labour productivity in manufacturing had reached or surpassed the Canadian level by 1980 in Germany, France and Italy. Japanese labour productivity increased from 53 per cent of the Canadian level in 1970 to almost 90 per cent in 1990. After losing ground for most of the post-war era, United Kingdom labour productivity increased from 60 per cent of the Canadian level in 1980 to some 80 per cent in 1990.

Productivity growth

As in other OECD countries, economy-wide labour productivity growth slowed abruptly in Canada in the mid-1970s. After expanding at an average annual rate of 2.8 per cent over 1960-73, labour productivity grew at only 1.5 per cent in 1973-79 and then slowed further to 1.2 per cent in 1979-90. This slowdown was broadly in line with that in the OECD area as a whole - Canadian labour productivity growth in the 1980s was around three-quarters of the OECD average, as in the period 1960-73. But, whereas the contribution of TABULAR DATA OMITTED capital accumulation increased in Canada (which attenuated the decline in labour productivity growth between the 1960-73 and 1979-90 periods by 0.2 percentage points per year), it decreased, on average, in most of the OECD area. Thus, the decline in labour productivity growth in Canada since the mid- 1970s is attributable to lower TFP growth to a much greater extent than on average in other OECD countries.

Looking at the three sub-periods shown in Table 9, it can be seen that the initial decline in TFP growth following the 1973 oil price shock was less pronounced in Canada than in the OECD area. TFP growth in Canada declined from an annual average rate of 2.0 per cent in 1960-73 to 0.8 per cent in 1973-79, whereas it fell in the OECD area from 2.8 to 0.5 per cent over the same period. Subsequently, however, Canada's TFP growth continued to decline (to zero in the 1980s) whereas it started to recover in other OECD countries (where it accelerated to 0.8 per cent). For the first time, TFP growth in Canada was lower than in the United States, with both countries well below most other OECD economies.

Estimates of trend TFP growth(19) over the past three decades show that the decline occurred in two stages. Trend TFP growth appears to have fallen abruptly in 1971 (even before the first oil shock), from 2.9 to 1.7 per cent per year, and then again in 1978, to 0.1 per cent. The post-1973 decline was pervasive across sectors. In manufacturing, it fell from 1.3 per cent before the mid-1970s to almost zero in the 1980s, roughly the same as for the economy as a whole. The mining and agricultural sectors experienced even bigger reductions in TFP growth in the late 1970s, but have since staged a productivity recovery. Finally, most parts of the large service sector have also experienced lower productivity growth since 1973, insofar as this can be measured. The pervasiveness of the problem is suggestive of economy-wide causes which are examined below.

Reasons for the productivity slowdown

Exceptional circumstances in the post-war era

The decline in Canada's productivity growth occurred in the context of an international productivity growth slowdown. There clearly have been a number of reasons common to all industrialised countries explaining this development since the 1970s. One of these, on which there does seem to be widespread agreement(20), is that productivity growth in the first two decades of the post-war era was unusually high relative to longer historical trends. Various factors combined to make possible this "golden era", including the potential for "catch-up" to the productivity leader (the United States), the expansion of international trade and post-war reconstruction. The large productivity gap between the United States and the rest of the world gave other countries, with well educated workforces, the opportunity to achieve rapid productivity growth by imitating American production and organisation methods. Frequently, large markets were required to be able to adopt profitably these technologies and the unprecedented expansion of world trade at this time provided this, especially for smaller economies. In addition, post-war reconstruction meant that in many countries an unusually high proportion of the capital stock was of recent vintages and therefore embodied new technology.

All these special factors contributed to unusually high productivity growth in Canada in the post-war years until the early 1970s. The productivity gap with the United States, which was 32 per cent in 1950, had narrowed considerably by 1970. When these factors passed, Canadian productivity growth slowed. Seen in this light, the productivity slowdown since the early 1970s reflects in part a return to a more normal trend.

In addition, the fact that Canada profited less from the expansion in international trade than many other industrial countries in the 1970s and part of the 1980s may explain why the slowdown in Canadian productivity was particularly pronounced. Indeed, since 1970 the ratio of exports (of goods and services) to GDP has grown little, and at 24 per cent in 1991 was only slightly above its 1970 level; over the same period the average export ratio for the OECD area increased from 13 to 21 per cent. This contrasts with the post-war period when Canada's international trade expanded significantly, with its export to GDP ratio rising from 19 per cent in 1955 to 23 per cent in 1970. Productivity in some industries, notably automobiles, received an extraordinary boost from the specialisation made possible by these earlier developments; the North American Auto Pact, in particular, underpinned high productivity growth in the automobile industry over 1965-70.

Energy-price shocks

The fact that trend TFP growth in Canada fell to almost zero in 1978 and has not recovered since suggests that there was more to the productivity growth slowdown than the passing of the post-war special factors enumerated above. A number of explanations for this phenomenon have been proposed over the years but suffer either from being difficult to test empirically or from failing to explain the persistence of the slowdown. Among these explanations, the first considered is the energy price shocks of the 1970s. This could have contributed to abnormally poor productivity performance both directly through the substitution of capital and labour for energy in production (output unexplained by labour and capital inputs -- i.e. TFP -- would clearly be reduced by this substitution) and indirectly through accelerated obsolescence of the capital stock, inter-industry resource shifts and capacity underutilisation.

The increase in energy prices would have rendered obsolete capital stock in energy-intensive industries and energy-intensive capital equipment in all industries. Because the obsolete capital, scrapped or under-used, would still have been counted as part of the capital stock, capital inputs to production would have been overstated and TFP understated. The energy-price rise would also have induced a transfer of resources into the mining and petroleum industries; TFP growth in these industries was below average and, with rising marginal costs of extraction, deteriorated markedly as the industries expanded. As for capacity utilisation, it dropped after the oil price shocks as workers were initially unwilling to absorb the real wage cuts implicit in the energy-price increases. The apparently odd situation of workers in a net energy-exporting country having to accept real pay cuts is explained by the fact that the income gains from higher energy prices mainly accrued to a small number of sparsely populated provinces (notably to Alberta), not the whole country.

For a variety of reasons, though, the direct effects of the energy-price shocks were unlikely to have been important. First, energy represents such a small proportion of business costs (8 per cent in 1973) that it would have taken an enormous substitution of capital and labour for oil price increases to contribute significantly to the slowdown in TFP growth. On the basis of a three-factor -- capital, labour and energy -- production function estimated for Canada(21), a reduction in energy use per unit of output of approximately 13 per cent per year would have been required to obtain a 1 per cent per year slowdown in TFP growth in the period since 1973. In fact, energy use relative to output fell by a little under 2 per cent per year, about 30 per cent over the entire period. Second, trend TFP growth declined in 1971 and then fell further in 1978 before the oil price shocks. Finally, real energy prices fell markedly in the late 1980s but TFP growth has not yet rebounded -- energy use per unit of output has, in fact, continued to decline in Canada, as elsewhere.

The indirect effects of the energy-price shocks were probably more significant, although they cannot be easily quantified. This is particularly true of the capital obsolescence factor. Among other factors, it was found in an OECD study(22) that capacity utilisation also affected trend productivity. This effect could be caused by low investment levels during sustained periods of capacity underutilisation, slowing the pace at which the technical characteristics of the capital stock are upgraded. Capacity utilisation was also found to be a factor explaining the productivity growth slowdown in another study(23), although the use in this study of a TFP measure unadjusted for capacity utilisation suggests that the explanation only has validity in the short term. This analysis also suggests that interindustry resource shifts were important, although again, the extent to which these are linked to the energy-price shocks is not clear.


A reason why Canada may have been more adversely affected by the energy-price shocks than other industrialised countries, at least over part of the slowdown period, is its greater intensity of industrial energy use. The subsequent shift in demand away from energy-intensive products undoubtedly harmed Canadian industry relative to the less energy-intensive industries in other countries. In addition, the proportion of the capital stock rendered obsolete by the oil price hikes was probably greater than elsewhere, given energy-intensive Canadian production methods. Another relevant factor, at least in the 1970s, was the transfer of resources into lower productivity growth mining (including petroleum extraction). Countries without natural resources did not suffer a similar drain on their productivity growth.
Table 11. Energy use
A. Total final energy consumption
                     Ratio to GDP(1)
                 1973   1979   1989   1990
Canada           0.55   0.52   0.41   0.39
United States    0.44   0.40   0.31   0.30
Japan            0.29   0.24   0.18   0.18
Germany          0.39   0.36   0.28   0.27
France           0.35   0.31   0.24   0.24
Italy            0.33   0.29   0.24   0.24
United Kingdom   0.39   0.36   0.28   0.28
1. Total final energy consumption in millions of tons of oil
equivalent divided by GDP volume in dollars and prices of 1985.
Source: OECD,IEA, Energy Balances of OECD Countries, National
B. Real energy prices and energy/output ratio in the
manufacturing sector
                                   Per cent
                            Canada         United States
                       1974-79  1980-86  1974-79   1980-86
Annual growth in:
Real energy pries          5.9   4.5(1)      8.4    5.1(1)
Energy/output ratio        0.4  -4.4        -2.1   -3.5
1. 1980-85.
Source: Pulling Together, Economic Council, 1992.

An additional explanation frequently encountered is that Canada was slower to adjust to the energy-price shocks. The fact is that energy-price increases were not fully passed through to users until 1985, when the National Energy Programme was abolished. Consequently, Canadian industry was slow to adopt more energy-efficient production methods.

This last explanation fails, however, to account for the persistence of Canada's productivity slowdown. While it is true that the resource misallocation resulting from such policies is likely to have reduced the level of national income and productivity in Canada compared with those in other countries, it has no systematic implications for trend TFP growth. This is because productivity growth concerns volumes of goods and services produced, not their value. Resource misallocation will only affect trend productivity growth insofar as it alters the allocation of resources between sectors with different trend productivity growth rates or different productivity levels measured at base-year prices. This distortion presumably resulted in more resources than otherwise being used in energy-intensive industries but it is not clear whether these industries have above or below average productivity growth. Moreover, as noted earlier, the timing of the productivity-growth slowdown and the fact that no recovery has yet been observed suggests that other factors have been at work.


Education has an important influence on productivity, albeit one that is difficult to quantify. Because labour inputs to production are not quality adjusted, output attributable to human capital inputs (i.e. education) is accounted for as TFP growth. Consequently, highly-educated individuals and populations tend to have higher productivity for a given physical capital stock, although many elements, including the relevance of the education to work and the incentives to use human capital efficiently, will determine the extent to which this is so. Education is also thought to impact on TFP growth through its effect on labour flexibility. Well-educated workers tend to be better able to adapt to new technologies and organisational methods.

Thus, for education to be a factor explaining the productivity growth slowdown, there would need to be evidence of a falling off of the contribution of skills relevant for work. Moreover, to contribute to the greater productivity slowdown in Canada than elsewhere, Canada's education system would have had to deteriorate relative to other countries or to be inferior at a time when education became a more important determinant of productivity growth. The lack of comparable time series data precludes an international comparison of educational outputs over time. There are, however, reasons (related to advances in information technologies) to believe that education may have become a more important determinant of productivity growth in recent years.

Canada has devoted increasing resources to education throughout the postwar era. Expressed as a proportion of GDP, education expenditure is higher in Canada than in any other G7 country and is the third highest of the OECD countries for which data are available. In terms of the "effort in education" measure, which is the ratio of the amount spent per student to average per capita income, Canada ranks second after Japan in elementary and secondary education. At the post-secondary level, however, Canada ranks somewhat lower, coming after Japan, the United Kingdom, the United States and Germany.

Participation rates in formal education are also high by international standards; and the share of the population graduating from high school and gaining post-secondary qualifications has increased in the post-war era. The proportion of 16 to 19 year-old Canadians in full-time secondary education now ranks third behind the United States and Germany. However, a disturbingly large proportion (24 per cent)(24) of students fails to complete high school.
Table 12. Total expenditure(1) on education
1987 figures in local currency and at current prices as
percentage of GDP
Canada             7.12
Australia(2)       5.63
Denmark            7.57
France(2)          6.59
Germany            4.41
Japan(2)           6.38
Netherlands        7.33
United States(2)   6.44
1. Including transactions relating to loans for Denmark,
Germany, Japan, the Netherlands, and the United States.
2. 1986.
Source: Education in OECD countries, 1987-88, OECD, 1990.

In addition, Canada's education system scores highly on the proportion of the relevant age cohort gaining post-secondary qualifications. At the post-secondary level, the proportion of 20 to 24 year-olds participating is second only to the United States amongst the major countries, and is well ahead of the participation rates in the other countries. The proportion of the relevant age group gaining non-university qualifications at this level is second only to that in France, amongst G7 countries. With respect to university qualifications, Canada has the highest proportion of the relevant age cohort gaining a first degree but has a middle ranking for higher degrees, behind the United States, France and the United Kingdom.

Despite these relatively favourable features of the Canadian education system, there is evidence of deteriorating standards in the system. Competence in TABULAR DATA OMITTED basic skills appears to have declined over the past 25 years. The composite score in the Canadian Test of Basic Skills (developed by Nelson Canada) indicates a deterioration of some 6 per cent since 1966 for Grade 8 students. The deterioration is found in all major skills, but is greatest in language skills. Interestingly, according to a recent study by the Economic Council(25), this is the area giving rise to the largest number of complaints from employers about prospective labour-market entrants. Poor standards of attainment are also highlighted by the large proportion of students leaving high school without basic literacy and numeracy skills. A recent Statistics Canada survey found that 30 per cent of high school graduates had difficulty reading and tried to avoid situations that required reading. In addition, some 36 per cent of high school graduates could not perform simple numerical operations which would enable them to meet most everyday requirements. Whether this performance represents a deterioration from earlier periods is not clear because time series of these tests are unavailable. However, the results of the Grade 8 test suggest that skills of high school graduates may well have deteriorated.

Comparing educational attainment internationally, the limited evidence available suggests that Canadian students perform relatively poorly. This is true in mathematics, where students from two provinces included in an international comparison were outperformed by students in some other countries, and in science, where -- according to another comparison -- students in most Canadian provinces turned in a below countries' average performance. Bearing in mind the qualifications required in interpreting these results(26), the above-mentioned Economic Council study concluded that Canadian children compare favourably in science and mathematics at age ten, but that by the end of secondary school achievement is weak(27).

Moreover, Canada does not have a well developed system to teach specific job skills and provide guidance during the school-to-work transition period, and this may mean that educational attainment of school leavers is not made use of in the economy as effectively as it could be. Although vocational courses are offered at most secondary schools, only 10 per cent of students participate in them. The rest of the high school student population does academic courses which prepare them for post-secondary education, even though only 30 per cent continue on to this level. In part, the low participation in vocational courses reflects societal biases against jobs in technical fields and the skilled trades, which are regarded as "second class" relative to the academic profession and university degree programmes. But the poor integration of such courses into the regular post-secondary apprenticeship system, may also be a factor in their lack of popularity. In addition, the distribution of apprentices across occupations has not evolved in line with the structure of employment -- more than 90 per cent of apprentices are still in manufacturing, construction and traditional services despite high employment growth in "dynamic services" (i.e. transport and communications; utilities; finance, insurance and real estate; and business services)(28).

Employer training effort is also relatively weak in Canada. The amount spent by the private sector on training and education (0.25 per cent of GDP) is less than half of what is spent in the United States and around one-eighth of British and German expenditure (Table 14)(29). As in many other OECD countries, large firms (with over 1 000 employees) account for a disproportionate share of total training expenditure -- they represent 45 per cent of training expenditure but employ only one-quarter of the labour force.

Research and development

R&D is undertaken to improve the quality and range of goods and services produced and to reduce their costs of production. Because R&D is not counted as an input in productivity calculations, its contribution to labour productivity is included in TFP. Real R&D expenditures have grown significantly in the past two decades in Canada, suggesting that this factor should have contributed positively to TFP growth. Nevertheless, it is possible that a low level of R&D could have harmed Canada's productivity performance relative to other countries' if R&D has become a still more important factor in productivity growth elsewhere in recent years.
Table 14. Private sector expenditure on training and education
As a proportion of GDP(1)
Canada            0.25
United Kingdom    2.17
Germany           1.96
Japan             1.40
United States     0.66
France            0.48
1. Selected dates between 1982 and 1987.
Source: Economic Council of Canada, Employment in the Service
Economy, 1991.

Canada's total R&D expenditures are low by world standards, particularly in the private sector. Both total non-defence and private R&D expenditure as a proportion of GDP are less than in other G7 countries except Italy. Moreover, such R&D expenditures are also lower than in all medium-sized OECD economies, except Spain and Australia. This situation is a feature of most Canadian industries: in the manufacturing sector, for instance, the ratio of business R&D expenditure to value added is below the G7 average in twelve of sixteen sectors. Even in the resource sector, which is of vital importance to the Canadian economy, R&D expenditures are also low by international standards(30).

It is not clear why this is the case. Explanations advanced include Canadian industries' resource intensity, small average firm size and high level of foreign ownership. None of these explanations is, however, fully convincing. While R&D expenditure in the resource industries is low relative to the national average, it is also weak compared to other countries. Similarly, R&D is particularly low in Canada's small firms; in comparison, firm size does not appear to be so tight a constraint in other OECD countries. Finally, R&D expenditure by foreign-owned firms in Canada is not much below the national average. One thing which is clear, however, is that the tax regime is not part of the explanation. Studies(31) show that Canada's R&D incentives are the most generous among the industrialised countries and have made after-tax R&D costs lower there than in the United States.

Infrastructure investment

Physical infrastructure supports or complements other productive activities. For example, roads and ports, which form a part of physical infrastructure, are a prerequisite for trucking and shipping transport services. In principle, the better a country's infrastructure, the greater should be the productivity of other investments made there.

As in other OECD countries, infrastructure investment in Canada fell markedly in the 1970s and 1980s. In Canada, this decline reflected the completion by the end of the 1960s of major projects such as the Trans-Canada highway system and the Canada-U.S. St. Lawrence Seaway, the reduced need for school buildings, as the baby-boom generation moved through the education system, and the need for restraint on government expenditure. These developments coincided with the slowdown in TFP growth. The same observation in the United States has prompted some investigators to conclude that such a slowdown was significantly explained by the fall in infrastructure investment(32). Subsequent research applying this methodology to a number of countries indicated, however, that the statistical results underlying this conclusion are not robust(33). In addition, examination of a longer time series for the United States suggested that the relationship between productivity performance and infrastructure investment was restricted to the post-war period. Hence, it remains unclear what, if any, was the effect of the decline in infrastructure investment on TFP growth in Canada.

Macroeconomic policies

Macroeconomic policies could affect TFP growth mainly through their influence on investment decisions. Policies which discourage investment will tend to reduce the pace at which new technologies are embodied in the capital stock and cut TFP growth. In addition, macroeconomic policies can distort choices on capital inputs to production, lowering TFP. High interest rates in the OECD area in the 1980s, resulting from government budget deficits and the need to restore the price stability lost in the 1970s, arguably kept investment and the pace of technical change below what it otherwise would have been. Moreover, the increased policy uncertainty associated with high inflation and budget deficits could also have depressed investment and growth.

Empirical evidence from a range of cross-country studies suggests that macroeconomic policies do impact on productivity growth(34). In view of the large deterioration in Canada's budgetary and inflation performance in the 1974-85 period, macroeconomic management over this period may have reduced TFP growth. Considerable uncertainty, however, surrounds this conclusion. In particular, there does not appear to have been a reduction in private-sector investment activity -- through which a deterioration in macroeconomic policies could affect growth. In fact, private sector investment expenditure remained broadly stable (allowing for business cycles) and rose in relation to GDP in the second half of the 1980s. There was, however, an increase in construction investment in the financial climate -- first inflationary and then volatile -- of the late 1970s and 1980s, as in many other countries. This may not have been the most productivity-enhancing investment.

Improving long-term competitiveness

Since the mid-1980s the Canadian Government has explicitly been implementing policies to increase both the level and trend growth rate of TFP. These have involved restoring macroeconomic balance -- by reducing budget deficits and lowering inflation (see above) -- and structural reforms. The latter have included, in particular, the introduction of a modern Competition Act (in 1986), the deregulation of the energy and transportation sectors, the liberalisation of foreign direct investment, the privatisation of selected public corporations, expansion of markets through the FTA and a comprehensive tax reform programme.

Despite these policies, trend TFP growth has not yet rebounded. This could mean simply that it is still too early to see one; there is considerable uncertainty in Canada, as elsewhere, about the adjustment path to the improved TFP expected to result from structural reforms. In addition, TFP estimates based on the conventionally measured capital stock may be understated since structural change may have made some of the existing capital stock economically obsolete.

The Government has maintained its policy strategy to improve productivity in its last two budgets. As indicated in Part II, these budgets contained additional measures to reduce fiscal deficits and to meet the initial medium-term targets set out in this regard. Moreover, the commitment to price stability was reinforced by the announcement of inflation targets. With respect to structural reforms, the 1992 Budget committed the Government to further privatisation and deregulation. At the same time, a "Prosperity Initiative" has been launched to help identify and build a consensus around further reforms needed to generate ongoing improvements in productivity and efficiency. Some of these reforms are discussed in the remainder of this section.

Education policy

As already noted, Canada spends a lot on education but does not appear to be getting good value for money, at least insofar as outputs relevant to productivity growth are concerned. Too many students are graduating from high school functionally illiterate and/or innumerate. The drop-out remains high. Few students at high school are involved in vocational courses and there are few apprentices, especially in the dynamic parts of the service sector. Provincial governments are either reviewing or implementing reforms to address these problems.

Solutions to these problems are likely to involve a redirection in the focus and organisation of existing programmes rather than increased expenditures. In the formal school system (primary and secondary), more emphasis needs to be given to the teaching of basic literacy and numeracy skills. Vocational courses at the secondary school level also should be better integrated into both the post-secondary vocational education system and the workplace to provide more coherence to such education and to make it more attractive to students. Better career counselling for secondary school students might also contribute to increased participation in vocational courses, which would help to lower the drop-out rate. More generally, however, increased participation in such courses is going to require a change in society's present negative attitudes towards jobs in technical fields and the skilled trades.

Apprenticeship programmes need also to be developed in the dynamic parts of the service sector. Existing programmes should be regularly updated to ensure that they remain technologically relevant. Were secondary-school vocational courses to become integrated with apprenticeships programmes, it would be possible to shorten the length of such programmes, thereby reducing their cost to both employers and apprentices. In the area of employer-based training, new ways need to be found to encourage employers to increase their efforts. The increasingly competitive environment should produce incentives for business to develop a more productive workforce. Another option that could be considered would take the form of a regulated minimum proportion of the payroll to be spent on training, along with a requirement for employees to reimburse part of the costs if the employee leaves his job before a certain period has elapsed. A risk to bear in mind with this minimum expenditure solution, however, is that resources can be wasted on ineffective training.

Labour-market flexibility

Greater labour-market flexibility could improve productivity growth by increasing the ease with which labour can be redirected to more profitable uses, a resource transfer which frequently involves adjusting to new technologies and organisational methods. General education levels and the match between skills demanded and offered are clearly important in this regard. So too are the incentives and institutional infrastructure in the labour market. In order to increase the capacity for the unemployed to rejoin the workforce, the Government in recent years has switched funding from the unemployment-insurance system to fund training under the Labour Force Development Strategy. As noted in Part II, funding for training under this scheme was raised to C$ 2 billion in 1992, which represents 9.6 per cent of unemployment insurance funds. The potential exists to expand this scheme to 15 per cent but, for the moment, the pace of expansion is constrained by public-sector administrative capabilities.

Geographical mobility is also an important aspect of labour-market flexibility. There are a number of barriers to labour mobility in Canada, including: the non-recognition of professional qualifications from other provinces; and the linking of unemployment-benefit duration to regional unemployment levels. Removal of such barriers to mobility would increase labour-market flexibility, and hence could improve productivity growth.

Trade liberalisation

Canada has significant barriers to both international and interprovincial trade. At the international level, the average duties in 1990 on all imports and on all dutiable imports were respectively 3.5 per cent and 10 per cent. The drain on economic efficiency from import barriers also depends upon their distribution. Import barriers on textiles, clothing, and footwear presently peak at 25 per cent. Protecting these low productivity growth industries is bound to have undermined Canada's overall productivity performance. With respect to interprovincial trade, the major barriers are: government procurement policies, which favour local suppliers; agricultural supply management arrangements, which set product quotas and control quota movements; and policies favouring local wine, liquor and beer industries. Labour mobility also is affected by professional standards that restrict entry for out-of-province residents and by local-preference hiring policies. Capital mobility is impeded by regionally-based subsidies and tax breaks intended to influence company location and by controls on land ownership by non-residents.

The Canadian Government recognises the drain on productivity resulting from trade barriers and is working to lower them. The tariff reductions agreed in the FTA will progressively eliminate duties on imports from the United States over the next five years. The FTA has also created pressures for tariff cuts on imports from third countries where U.S. duties are lower. These pressures result from cross-border shopping or, in the case of productive inputs, from Canadian producers' competitive disadvantage. In response, the cross-border shopping package of February 1992 eliminated tariffs on many third country products. In the event of successful negotiations for the NAFTA and the present GATT round, further reductions in trade barriers will be implemented.

Some progress has also been made in reducing interprovincial barriers during the past decade. An important initiative in this regard was the establishment in 1987 of the Intergovernmental Committee of Ministers on Internal Trade (ICMIT). The Committee's work has led to an agreement on government procurement which became effective in April 1992. There has also been a recent agreement on beer marketing practices by six provincial and both territorial governments. Other developments include: the agreement reached by the Council of Transportation Ministers in 1991 to reduce barriers further in the trucking industry; and agreements reached by agricultural ministers to consult on new regulations which could adversely affect the movement of agricultural and food products (1989) and to work towards the reduction of technical barriers within the next five years through the adoption of common national standards (1991). Nevertheless, there remains much to do. Compared with other countries, the Canadian internal market is still highly fragmented. Other federations, such as the United States and Germany have been considerably more successful in preventing internal barriers. Even groups of nations participating in regional trade agreements, such as the EC or ANZCER (Australia and New Zealand), have made more progress towards unifying their markets.

A factor acting towards an integrated internal market is mounting external pressure. The FTA has exposed Canada's food processing industry to competition from American producers not weighed down to the same extent by the costs of agricultural supply management policies. Consequently, there is now an important industrial lobby in favour of lowering agricultural protection in Canada. Supply management policies will come under further pressure in the event that the present round of GATT negotiations is successful. In addition to these external factors, more rapid progress towards achieving a single internal market would make a valuable contribution to increasing the competitiveness of the Canadian economy.

Support to research and development

As government support for R&D is already generous, reform in this area does not call for an increase in government's provision of resources. Rather, reforms should focus on how the effectiveness of existing support can be improved. One way in which this could be done is to focus more resources on the diffusion of technology. OECD nations are increasingly of the view that the ability to create technology is outstripping the ability to use it, and that diffusing existing technologies is a relatively low cost way to enhance technological capability. Countries which have been highly successful in commercialising technology, such as Japan and Germany, have placed considerable emphasis on technology diffusion in their R&D policies. Given the importance of small firms in the Canadian economy, such programmes could prove particularly beneficial.

The efficiency of Government R&D expenditure in Canada has been undermined by a number of factors, including: duplication of research between government laboratories and universities; and inadequate linkages between government laboratories, provincial organisations, universities and the private sector(35). The Government has initiated a number of programmes to address these problems. Among these is the establishment of the Centres for Excellence, which link up top researchers of universities and major corporations. In addition, measures have been taken to support the creation of new sectoral or technological alliances involving government, the private sector and the academic community. Efficiency could, however, be further improved by shifting a greater proportion of government-funded research to the private sector, increasing specialisation amongst universities and rapidly completing the automation of the patent search process(36).

Restoring cost competitiveness

Canadian labour earnings do not yet fully reflect the country's relatively poor productivity growth over the past decade or so. Consequently, there has been some loss of international cost competitiveness, especially against the United States which accounts for three-quarters of Canada's exports and two-thirds of its imports. Relative to the United States, unit labour costs (ULCs) in the business sector are now around 6 per cent higher than the average level since 1960; but in the manufacturing industry alone, this ratio is about 40 per cent, with this large gap having opened up in the second half of the 1980s. The deterioration in manufacturing cost competitiveness has almost certainly contributed to Canada's loss of export market shares over the last ten years or so. Canada's manufactured exports have grown 17 per cent more slowly than its export markets for manufactured goods since 1980 -- by comparison, total OECD area export growth was only 7 per cent lower than export-market growth for manufactured goods over the same period.

The large increase in the manufacturing sector's relative ULCs is explained both by much lower productivity growth and by greater increases in wage compensation in Canada than in the United States during the 1980s; the Canadian dollar was little changed over the same period. Around 40 per cent of this deterioration in cost competitiveness can be traced to lower productivity growth, with the rest being attributable to higher wage compensation. Despite strong productivity growth, U.S. hourly wage compensation rose at an annual average rate of 4.7 per cent -- in Canada, the corresponding increase was 6.5 per cent. To a significant extent, the wage growth in Canada was associated with higher inflation. The fact remains, however, that by 1991, hourly manufacturing wage compensation in absolute terms (expressed in U.S. dollars) was 13 per cent higher in Canada than in the United States(37).

The policy reforms already made by the Government and the future reforms being discussed in the context of the Prosperity Initiative can be expected to help solve this cost competitiveness problem. However, the long and uncertain lags before these effects materialise would seem to suggest that a more immediate response may be needed to moderate the significant adjustment pressures on Canadian industry and to improve the attractiveness of undertaking new investment in the context of the increasingly integrated North American and world markets. The recent exchange-rate depreciation may alleviate the problem somewhat provided it does not get passed on to wages. This risk is not great in the current circumstances given the slack in the economy. But, exchange-rate adjustment cannot address the long-term competitiveness problem of how to achieve higher standards of living. Instead the focus must remain on improving productivity performance.
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Title Annotation:Canada
Publication:OECD Economic Surveys - Canada
Date:Sep 1, 1992
Previous Article:Economic policy.
Next Article:Recent trends and short-term prospects.

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