Where does the growth in labour productivity come from?

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Since increases in labour productivity are associated with higher economic growth, higher standards of living and higher real incomes, analysts have investigated the sources of improvements in labour productivity.

There are many reasons behind the growth in labour productivity—increases in the amount of machines and equipment available to workers, a higher proportion of skilled workers, increases in plant scale, changes in organizational structure, and improvements in technology.

Using the growth accounting framework that has been adopted by the Organisation of Economic Co-operation and Development in its recommendations regarding productivity measurement,⁵ the Canadian Productivity Accounts can be used to divide labour productivity growth into the part coming from increases in capital intensity, increases in skill levels of workers (referred to here as a change in labour composition)⁶ and from all other sources—what is referred to as multifactor productivity (MFP) growth:

ΔGDP / Hours = (ΔMFP) + S_k * Δ(Capital / Hours) + S_l * ΔLC, (2)

where ΔGDP / Hours is the growth in labour productivity, ΔMFP is the growth in multifactor productivity, S_k is the share of gross domestic product (GDP) accruing to capital, Δ(Capital / Hours) is the growth in the amount of capital (machines, buildings and engineering structures) available per hour worked, S_l is the share of GDP accruing to labour, and ΔLC is the growth in the measure of labour skills.⁷

Labour productivity can grow as a result of higher capital intensity per worker. For example, stronger investment in information technology can raise capital intensity. As information technology has become less expensive, firms have substituted information technology for labour and other forms of capital.

Labour productivity can grow also as a result of a higher proportion of skilled workers. Upgrading workers' skills via education or via increased experience can increase labour productivity. Canadian companies can upgrade their workers' skills through formal schooling, on-the-job experience or retraining.

MFP captures all other effects. It is the residual factor capturing a host of influences—amongst them, changes in technology.

We have used this framework to decompose the growth in labour productivity into the proportions that come from increases in capital intensity, labour skill levels and MFP (Figure 3).

Over the period from 1961 to 2005, increases in capital intensity contributed to 1.1% of the 2.1% increase in labour productivity, higher labour skills to 0.4%, and MFP, 0.5%.

Figure 3
Sources of labour productivity growth, business sector

The deterioration in labour productivity growth from the 1960s to the 1970s resulted primarily from the slowdown in MFP growth from 1.5% to 0.2%, and to a lesser extent, a slowdown in the growth in labour composition due to a slower growth in skilled labour (from 0.7% to 0.2%). The contribution made by capital intensity increased from 1.4% to 1.6%.

The slowdown in labour productivity from the 1970s to the 1980s, from 2.0% down to 1.4%, was primarily the result of a decline in the growth in capital intensity and, to a lesser extent, to a decline in MFP performance.

Labour productivity performance in the 1990s reflected a turnaround in MFP growth. The contributions of capital intensity and labour composition were virtually unchanged since the 1980s.

The post-2000 period has seen a further decline in labour productivity growth. This decline is due to a decline in the growth of capital intensity and a much larger decline in MFP growth.⁸ The decline in MFP growth accounted for 65% of the decline in labour productivity growth from the 1988-to-2000 period to the 2000-to-2005 period. The decline in capital intensity accounted for 27% of the decline.

 

5. See http/www.oecd.org/dataoecd/59/29/2352458.pdf.

6. See Gu et al. 2003.

7. For a discussion of the growth accounting framework used to generate this formula, see Baldwin and Gu 2007b.

8. See Statistics Canada 2007d.