Executive summary

The performance of the Canadian economy relative to its U.S. counterpart has received considerable attention from the analyst community. And most of the time, these evaluations make use of summary statistics like gross domestic product (GDP) or productivity (GDP per hour worked) to analyse differences in performance.

Both of these measures capture in succinct form the myriad of events that affect the domestic income that the economy is creating by transforming labour and capital into output. As such, they provide a useful summary of what is happening to the income that is being generated by domestic production.

Data from the National Accounts can also be used to evaluate other concepts of income — concepts that take into account changes in the potential purchasing power of income that occur from relative price shifts, the income that flows to or from abroad because of international investment and the capital that is consumed during the production process and must be replaced if standards of living are to be maintained. These real income measures are referred to, respectively, as real gross domestic income (GDI), real gross national income (GNI), and real net national income (NNI).

These measures receive less attention than GDP-based measures. For many purposes, GDP-based measures may be adequate — because the measures are often similar in the short run. However, ignoring differences in these measures can hide important long-term trends and one could sometimes miss important changes in direction.

This paper demonstrates just how important divergences between these measures have been over the last 25 years — and how they can modify our interpretation of events.

In the period before 2000, all of the measures indicate a long-term decline in the relative performance of the Canadian economy — though the various real income measures decline more than the production-based GDP measure, especially in the 1980s. These were years in which the resource economy in Canada was in decline. Resource inputs as a percentage of GDP were falling around the world. Relative commodity prices were declining. Increases in the amounts that were being remitted abroad from Canada were less than increases in payments that were being received from abroad. As a result, the various income measures actually declined more than GDP.

All that has changed with the commodity boom that Canada experienced after 2000. Prices of exports have increased sharply, relative to the prices of imports. Canadian receipts of income from abroad have increased dramatically, relative to payments abroad. The concatenation of these events — coupled with China and India emerging as important players in the world economy — has led to a dramatic increase in real income growth in Canada relative to GDP growth. And this has also affected Canada–United States comparisons. Canada had a strong terms-of-trade improvement from 2002 to 2006 due to rising commodity prices, an appreciating currency and falling world prices for manufactured goods that contributed greatly to real income growth. The U.S. measures of real income were much less affected by these factors.

From 2002 to 2006, U.S. real GDP per capita grew 9.3% while Canadian GDP per capita rose 7.0%, making it appear that the U.S. economy was outperforming the Canadian economy. Once changes in resource prices and the exchange rate, international investment income and capital consumption are accounted for, real income per capita in the United States increased by 8.6%, which was similar to its GDP per capita growth. However, the Canadian measure of real income per capita rose 15.6%, more than twice the per capita real GDP growth in Canada and nearly double the U.S. rate.

As a result, comparisons of the relative per capita performance of the two countries hinge crucially on whether or not the terms of trade and international income flows are incorporated into the analysis. If the terms of trade are excluded, and relative real GDP per capita growth (or relative productivity growth) is the focus, Canada appears to have been performing worse than the United States from 2002 to 2006. If, however, the impact of the terms of trade, international income flows and depreciation are included in the analysis, Canada fared much better. In fact, its growth outperformed the United States by as much as 7.0 percentage points from 2002 to 2006.

The long downward trend in Canada's fortunes versus its American partner has reversed in very short order. After 2000, real income levels returned to levels not seen since the mid-1980s. And much of this has been due to the much maligned resource economy. Studies of the Canadian economy in the late 1990s often emphasized that the salvation of the Canadian economy lay in high-tech growth in the manufacturing sector — partly because of the high rates of growth in this sector in the United States, partly because the prices of the commodities provided by the resource sector seemed to be in secular decline.

The performance of the post-2000 Canadian economy has shown the advantages of having a diversified economy with a not insignificant resource base. A diversified economy has some of the same advantages as a diversified stock portfolio. Some sectors may decline slowly for long periods of time — only to experience a dramatic change in fortunes. Canada has had just such an experience.

View the publication Canadian and U.S. Real Income Growth Pre and Post 2000: A Reversal of Fortunes in PDF format.