So, to continue with my recent interest in Canadiana, impelled by, well, being in Canada!
There is an interesting puzzle about Canadian economic development. Well, there are many many interesting puzzles, but what particularly grabs my attention at this moment is why Canadian productivity has persistently lagged the United States.
Below I show Canadian total factor productivity (TFP) as a percentage of American TFP between 1950 and 2014. Save for a few halcyon years in 1973-80, Canada has consistently lagged the United States. Moreover, the gap turned into a chasm in the 1980s and grew even larger after the Great Recession.
The productivity gap predates WW2. After World War 2, Canada lagged the United States in total factor productivity. That is to say, a Canadian worker in the same industry with the same skills and working on the same machinery produced less than her American equivalent. In the early 20th century, the superficial gap was just as large: the average Canadian worker added only 81% as much value per hour as his counterpart south of the border.* (Table 6 on page 25.**) Canadian workers, however, used rather less machinery than their American counterparts, so TFP closed to about 94% of the U.S. level ... remarkably similar to the gap in 1950-67.
In fact, the gap widens if you go further back. In 1900, GDP per capita (the crudest measure) in Canada ranked only 80% of the United States. In 1870, it was 70%. Canada appears to have had more-or-less that income gap with the United States back to 1820.
Heck, the gap goes back to even before the existence of either the United States or Canada! Vincent Geloso (Texas Tech) has a paper comparing 18th-century Quebec with New England and finds that living standards were about 31% lower in what eventually became Canada. (Remember, there was no settled European population in modern Ontario back then.)
So what caused the gap? A seminal 1964 paper by H.E. English pinned the gap on American protectionism: Canadian businesses operated at too a small scale and tried to produce too wide a variety of products. In other words, Canada wasn’t big enough. (You can find a 1980 study making the same argument here.)
This seems plausible. And as theories go, it has the advantage of explaining why the United States has enjoyed such a lead for so long over so many places. Everywhere else is too small! There are just too many damn countries in the world. Those of you who have read my opinions about secessionism will know that I would find this a very gratifying conclusion.
But the scale explanation does not seem to fit with the big widening of the gap since free trade.
Or does it? It is true that trade costs between the U.S. and Canada are still pretty high. And it is true that interprovincial trade barriers place even bigger obstacles on Canadian firms than American protectionism. And it is true that the returns to scale in Canadian businesses are pretty high. (Page 130 of the 2009 World Development Report.) Canada has lots of small firms compared to America (consistent with the scale economy argument) and those small firms tend to be less productive than their American counterparts (sort of maybe could-be consistent with the scale economy argument).
Statistics Canada ran an interesting thought experiment to test the hypothesis. They found that if you altered the size mix of Canadian firms to look like American ones you would close the productivity gap by 5 percentage points while if you made Canadian small firms as productive as American ones you would close it by nine. (Table 6, counterfactuals one and two.) Fixing both effects would close two-thirds of the gap, call it 16 points.
But that is not the entire gap. In fact, it leaves an unexplained gap bigger than the total gap in the 1950s.
Or the 1870s, for that matter. Kris Inwood (University of Guelph) and Ian Keay (Queen's University) conducted a similar exercise for Canada in 1870. They could get Canadian TFP to rise from 93% of the U.S. level to 97%, which cuts most of the gap. (You can find an outline of their paper here; the main one is paywalled.) Strangely, they downplay their finding, which seems like a very Canadian thing to do. The punchline is not that a gap remained, the punchline is that they explained more than half of it!
So the fact that Canada had a protected small market explains a little more than half the 19th century gap and about two-thirds of the modern one. But that still leaves two puzzles. First, what explains the rest of the gap in both periods? And second, why has the gap grown so much larger recently, despite NAFTA and all the ways modern communications should make service exports easier?
It is a great pair of questions.
But I mentioned three in the title, no? What’s the third puzzle?
I will post on that later, but it’s even weirder than the productivity gap ... it’s that median incomes in Canada may have finally pulled even with the United States. That is to say, for the first time ever it matters not to most Canadians that they live in a fundamentally less-efficient economy than their southern neighbors. And that’s the biggest puzzle of all.
* The gender shift is deliberate.
** John Baldwin and Alan Green, “The Productivity Differential Between the Canadian and U.S. Manufacturing Sectors: A Perspective Drawn from the Early 20th Century,” The Canadian Productivity Review (Statistics Canada: December 2008).