Social Policy in Ontario

The devil is in the details: What economists may be missing

Posted on July 17, 2012 in Policy Context

Source: National Post — Authors: Munir Sheikh

NationalPost.com – business/financialpost.com – productive conversations
Jul 17, 2012.   Munir Sheikh, Special to Financial Post

Canada’s lack of productivity is often seen as a macroeconomic issue. Listen to any debate on the nation’s productivity woes and you’re bound to hear talk of corporate tax rates, R&D funding models, import/export activity and so on.

But ask any enterprising business person what is essential to a successful and profitable business and you will likely hear about the importance of leadership, good management, hiring the best and the brightest, staff incentives to encourage employees to contribute up to and beyond their potential, being aware of what is going on beyond the four walls of his or her company, and having an organizational structure that is flexible and nimble enough to act quickly to make efficient decisions in the face of change. These “micro” facets of business are generally referred to as “organizational innovation.”

However, economists tend to focus more on macro factors — the importance of the contribution made by human capital, physical capital and technology. The more “micro” considerations — so critical to the success of a business — are captured only in the residual parts of economists’ assessments, which they label multi-factor productivity. There is research in the U.S. that compares two companies with polarized emphasis on these micro factors. The company that invests heavily in innovative processes to improve its operations can be twice as productive as the one that doesn’t.

Economists’ approach of relegating the micro factors to the periphery of their calculations might not be so bad if those factors were small, or at least stable. The problem is, they’re not.

The world is changing rapidly and the factors on a business leader’s mind are becoming increasingly important. As a result, the multi-factor productivity residual so coveted by economists ends up becoming more like an “index of our ignorance,” representing the contribution of what they see as “intangibles,” but what business decision makers see as the core facets of their enterprise.

Canadian labour productivity growth has dropped sharply over time to an average of about 0.8% a year between 2000 and 2010 from 2.8% between 1960 and 1980, and 1.6% between 1980 and 2000. These are sharp declines that are not experienced by many other developed countries such as the U.S. or Australia. What explains this deterioration, which has resulted in stagnant incomes? In short, it could be a lack of attention on the decline of the “intangibles.”

Calculations by Statistics Canada show that the impact of so-called intangibles turned from a strongly positive 0.6% average growth between the 1960s and 1980s. They fell to 0.3% in 19802000 and dropped further to -0.6% between 2000 and 2010.

The message one should get from these numbers is that we — and the economists who calculate our productivity — can no longer afford to ignore these residuals. The residuals have turned largely negative despite a number of structural reforms over the past two decades, such as NAFTA, GST, price stability, the elimination of the fiscal deficit and the CPP/QPP reform.

It’s almost as though there’s a glass ceiling that is blocking progressive structural policy changes from having a positive impact. The challenge now becomes understanding what’s creating that glass ceiling.

Research undertaken in some countries, such as the Netherlands and the U.S., shows intangible factors such as the introduction of new products (product innovation) and new production processes (process innovation) are critical to productivity. However, the research also suggests that any benefits a firm derives from these forms of innovation critically depend upon how good it is on organizational innovation — precisely the elements of business operations that economists include only in the residual of their assessments. These findings may be just as relevant for Canada. If we have weak organizational innovation, it would explain why all the productivity-enhancing policy changes we have introduced may not be bearing fruit.

The trouble is, we do not have enough data to undertake serious research on the impact of organizational innovation on productivity. Some data on the topic are available from Statistics Canada and should be examined to gain whatever insight one can in studying the problem of declining productivity growth in Canada. Beyond that, however, there is a need to survey Canadian businesses on their organizational structures and innovation practices in a consistent and ongoing manner to be able to carefully study the links that have been found to be important in other countries.

As New York Times columnist Paul Krugman once said, productivity is not everything, but almost everything. Without enough growth in productivity, it simply is not possible to achieve our economic, social or environmental objectives. Any investment undertaken to study promising channels that create productivity would be worth the money.

Munir Sheikh is Distinguished Fellow at the School of Policy Studies, Queens University and a Distinguished Visiting Scholar at the School of Public Administration, Carleton University.

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Tags: economy, globalization, standard of living

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