Are Wages the Key to Productivity Perfomance?

I have posted below a response by a senior Government of Caanda official to my earlier post on why the Canadian econmy is operating below capacity – the core subtance of which is to suggest that wages are too low to stimulate needed productvity gains. A somewhat usuual, out of mainstream response…

> This was a nice note Andrew. I have become increasingly interested in the hypothesis that better productivity growth in Canada is less likely to come from governments, with their sterling record for efficiency gains, pushing on the string of policy–induced microeconomic gains in productivity and more out of tight labour markets raising real earnings and stimulating firms to make more efficient use of workers, effectively becoming more capital intensive. I think that, notwithstanding government exhortations for firms to get more efficient in Canada, that they are efficient: they are making more use of labour relative to capital than in the U.S. because labour is relatively cheaper in Canada. This does, of course, imply that if labour becomes more costly then firms whose demand is not rising may well start shedding jobs to generate that productivity growth. But, last time I checked, a rather large part of any historic productivity gains comes from resource reallocation to more productive uses, not in situ (e.g. in a job and firm) gains. See the attached email I sent to XXX >

“We remain puzzled by Canadian productivity performance against that in the U.S., wondering why Canadian firms are choosing to be inefficient relative to the U.S. in having less output per worker. As I like to ask: are Canadian firms actually being perfectly rational in having more labour intensive means of production in Canada because labour is relatively cheap compared to the U.S.? To help answer this I asked what the relative cost of labour to capital is in the U.S. and Canada. My old division at Finance provided me with the data and it turns out to be true: labour has over the last twenty years become considerably more expensive relative to capital (the user cost, not the deflator) in the U.S. while it has not become much more expensive in Canada. The difference is labour costs, as our capital costs have not diverged that much. Maybe we have the chicken before the egg when we think we (government; although talk about the pot calling the kettle black) need to ‘make’ the economy more productive to permit higher real earnings. Maybe we just need more expensive workers to make firms choose a higher capital-labour ratio which will result in more GDP per worker.”