By Almon, Michael-John; Tang, Jianmin
International Productivity Monitor , No. 22
THE INDUSTRIAL STRUCTURE of the Canadian and U.S. economies have each been in a pro longed period of evolution that has become even more pronounced in the wake of the 2008 financial crisis and subsequent economic downturn that a number of journalists have taken to calling "The Great Recession". (2) While the two firmly interconnected economies face a host of similar internal trends (such as the declining share of the labour force concentrated in primary and secondary industries) and external pressures (the increasing competitive pressures from emerging markets among them), the reactions and adjustments of various industries have not necessarily been of uniform direction and magnitude on both sides of the border. (3)
Canada's business sector has generally underperformed its U.S. counterpart in two key (and related) economic indicators over the past two decades: real gross domestic product (GDP) growth and aggregate labour productivity growth (see Summary Table). (4) In order to understand the driving forces behind what appears to be divergent performances of two highly integrated economies, it is not enough to merely know that the Canadian business sector has underperformed, but becomes necessary to
identify the sources of growth in both countries. To that end, we analyse the industry contributions to real GDP growth and to aggregate labour productivity growth in Canada and the United States from 1987 to 2008. We also compare and contrast the results in order to identify which industries are more important as sources of growth and to better understand the shift in the composition of the two economies.
The de-industrialization of advanced economies has been a well-publicized trend in the postwar period, with the share of the economy accounted for by manufacturing and primary industries diminishing over the decades as more and more economic activity occurs in serviceproducing industries. (5) Caves (1980) has shown that the growth in the demand for goods is outpaced by the growth in the demand for services as economic gains lead to rising real incomes, but the recent acceleration of this trend likely has more to do with the unbalanced foreign and domestic supply and demand conditions that have emerged in recent years. This lack of balance results in uneven changes in the relative price of real output and that, in turn, leads to an adjustment in how production resources are allocated across industries. A simplified model of the economy developed by Baumol (1967) suggested, at its core, that resources will be absorbed predominantly by "stagnant" industries and have a downward impact on the overall labour productivity growth rate of the economy. It should be noted that this particular result, often called "Baumol's cost disease," is still subject to rather vigorous dispute and discussion (Nordhaus, 2006).
In order to best capture this facet of the conversation, the decompositions of industry-level contributions for both real GDP and labour productivity growth are conducted using a decomposition method developed by Tang and Wang (2004, 2010). (6) We feel that this particular framework is the most appropriate way to decompose industry-level contributions due to its ability to effectively utilize the implicit information inherent in the chain-Fisher index method of computing real economic activity, while simultaneously preserving the additivity feature of traditional decompositions that use fixed-weight real GDP.
In the case of real GDP growth, this decomposition technique allows us to identify how much of the contribution to growth stems from the quantity effect and how much from the price effect. The use of the chain Fisher index to con struct real GDP, as is done by both the Canadian and U.S. statistical agencies, (7) results in the inclusion of the value of production as well as the real quantity of products or services produced in the economy in real GDP, but it also results in a loss of additivity to real GDP, increasing as one moves away from the base year. …