STANDING COMMITTEE ON FINANCE
COMITÉ PERMANENT DES FINANCES
[Recorded by Electronic Apparatus]
Thursday, April 29, 1999
The Chairman (Mr. Maurizio Bevilacqua
(Vaughan—King—Aurora, Lib.)): I would like to call
the meeting to order and welcome everyone here this
As you know, the finance
committee is doing a study on productivity. This
afternoon we have the pleasure to have with us a number
of experts on this particular issue. Mr. Mike
McCracken, CEO and chairman of Informetrica,
welcome. Dr. Jonathan Kesselman, economist for
the University of British Columbia, welcome again; you
were here yesterday. And welcome to Mr. Fred McMahon,
senior policy analyst, Atlantic Institute for
We will begin with Dr. Kesselman. As you know, you
have approximately five to ten minutes to make your
presentation and thereafter we'll engage in a question
and answer session.
Once again, welcome. You may begin.
Dr. Jonathan R. Kesselman (University of British
Columbia): Thank you.
I would like to talk about the relation between
taxation policies and productivity. If we were to draw
up a list of factors that determine an economy's
productivity and living standards and then eliminate
from that list those items not directly subject to
policy control, what would we be left with? A very
short list. There would be regulatory policies and
labour market policies, and certainly taxation policies
would be on any short list and is a very important item.
I should stress at the outset, though, that I don't see
tax policy as being a panacea for any problems with the
economy's productivity. Certainly it's a multi-factor
phenomenon, but taxes are important. Business taxes
certainly are part of the issues we would have to
examine in a productivity forum. Last year's report of
the technical committee on business taxation, the
so-called Mintz committee, offered many constructive
recommendations, all of them of course within the
committee's mandate of revenue-neutral proposals.
In today's fiscal environment I would suggest that
business tax cuts are a valid and deserving area for
spending some of the surplus. Among the Mintz
committee's many recommendations that are relevant to
the productivity goal, I would highlight two.
First, cut the general corporate tax rate for firms
that are not in the manufacturing, processing, and
resource sectors, which already enjoy lower rates.
These other omitted sectors, many of the service
sectors, software, and lots of high-tech and
biotechnology certainly do need the lower rates
we've been giving for a number of years in the
manufacturing and resource sectors.
The second item I'd highlight from the Minsk committee
would be to make the employers' premiums for employment
insurance experience-rated. That would mean that the
more stable firms and sectors would no longer be forced
to cross-subsidize firms and sectors with unstable
employment patterns. While business taxes do require
some attention, the personal tax should be, in my mind,
the centrepiece for the taxation component of
Of course the ultimate goal of raising productivity is
to raise the real living standards of Canadians. A
simplistic but popular view is that we need personal
tax cuts simply to allow Canadians to keep more of
their gross earnings. Undeniably that would raise
people's spendable private consumption, but the
personal tax changes must be designed to achieve much
more than quick tax relief.
Personal tax reform should aim to enhance three
things: in the short run, economic efficiency, which is
how well resources are allocated; in the medium run,
expansion of employment; and in the long run
productivity growth. All of these outcomes will
improve real living standards of Canadians.
In fashioning policies for personal tax, a key issue
is rate cuts versus base reforms. What are their
relative priorities? The most popular discussion of
the personal tax in Canada focuses on rate cuts alone.
Here I will argue that base reforms are more important
to augment productivity growth, although rate cuts will
play some role. My analysis and recommendations here
are based on a paper, which I've already made available
to the committee, currently being revised for
publication in the journal of the Canadian Tax
As background to this policy exercise, we need to do a
brief review of what is known about tax policies and
the economic performance of nations.
First, careful statistical analyses using
cross-national data find no systematic relation
between the size of government or total tax burdens
and real rates of economic growth. This of course runs
contrary to common wisdom that heavier taxation impedes
Second, examination of the raw figures shows that some
of the more heavily taxed countries of continental Europe
have produced superior productivity growth to that of
the U.S. or Canada. So do higher taxes actually
promote growth? I wouldn't think that's
necessarily a proper inference. A closer examination
of the tax structures of the various countries reveals
that the European countries use taxes much more heavily
based on consumption, such as value-added taxes like
our GST, and labour income, such as payroll taxes for
social security types of programs. And they rely much
less on capital income-based taxes than Canada or the
Third, in reviewing this evidence we obtained
further confirmation of this view from a growing body of
theoretical economic research that compares the
efficiency and growth attributes of various tax bases.
They find a consumption-based tax to be most favourable
to the growth of productivity and living standards,
followed closely by a tax base of labour income or
payrolls. Lagging substantially in this respect is a
tax base of total income that is labour plus capital
income, and by far the worst is a tax base of capital
The economic reasons for these findings are complex,
but one commonsense explanation is that taxing capital
income or taxing savings reduces the rate of
investment. With a smaller capital stock in the long
run, total output is lower and so are the productivity
and real wages of each worker. By shifting the
personal tax base toward consumption and away from
income, we can achieve these long-run benefits.
So what is the base of our existing personal tax,
which by convention we call a personal income tax? In
fact, for more than 90% of Canadians it is much closer
to being a tax on consumption rather than income.
There are two reasons for this. One is the
deductibility of savings for employer-based registered
pension plans and individual RRSPs, with an annual
ceiling of $13,500 per worker and 18% of earnings. This
means that workers earning up to $75,000 per annum can
shelter all of their capital income from tax if they
And the second feature is exempting from tax capital
gains on homes, the other principal means of saving for
The 10% or less of Canadians at the high end are
constrained by the contribution limits to registered
savings plans. They are in effect taxed on any
additional savings and the associated capital incomes
in the form of interest, dividends, and capital gains.
As a result, the personal tax in Canada is, as I've
said, a consumption-based tax for more than 90% of our people
and an income-based tax for the others. But this
latter relatively small group accounts for a
disproportionately large share of all savings and
investment in our economy. In view of the findings
that the efficiency and productivity costs are highest
when taxing total or capital incomes, this is simply not
smart economic policy.
The tax strategy I would propose is to reform the
personal tax base so that a larger number of Canadians
are taxed on a consumption rather than an income basis.
I'm not proposing a full move to a personal consumption
tax, as this raises difficult issues of transition and
equity with respect to the truly wealthy, those with
multi-millions or billions of dollars in assets.
There is an issue of how much emphasis should be
placed on rate cuts versus base reforms. My focus here
is not on taxpayers at the low and middle income
levels, where of course clearly further increases in
the taxable threshold are warranted. At higher income
levels, the focus of my comments, some rate
cuts are also needed. Ideally, over several years we
should aim for top marginal rates, federal plus
provincial together, of not much more than 45%.
Typically it's around 50% in many provinces now. And
the income level at which this top rate applies should
be sharply increased from the current $60,000 to
$70,000 up to probably in the neighbourhood of
Still, heavier emphasis needs to be placed on base
reforms shifting toward a consumption base than on rate
cuts. Shifting the base toward consumption does reduce
the effective marginal tax rate on capital income and
savings, even reducing it down to zero, even if the
statutory rate of tax is not changed. The empirical
and theoretical economic literature shows that the
efficiency and productivity gains will be larger for
reducing marginal tax rates on capital income than on
labour income. So a base shift is superior to a rate
cut. That is a first approximation.
To implement this strategy I would advance two key
proposals. First, raise the limits on contributions to
registered savings plans. Raise the ceiling from the
current $13,500 up to maybe $30,000. And even this
figure pales in comparison with the American allowance
for defined contribution pension plans of $30,000 U.S.
Some companion suggestions for this first major
proposal would be to explore the use of so-called Roth
IRA schemes. This is a new American
innovation. Explore their use in Canada. These allow
no tax deduction for the contribution to the plan, but
no further tax on investment earnings or withdrawals
from the plan. Other companion measures eliminate the
foreign content limit on registered schemes and extend
dividend tax credit to registered schemes.
The second key proposal in shifting the base would be
to reduce the portion of capital gains subject to tax
from the current 75% to 50%. That would achieve
several things. It would put us back to where we
were in our treatment of capital gains in 1987 and
earlier years. It would give added inducement to
entrepreneurial and job-creating activity. It would
bring us closer to the U.S. tax treatment of capital
gains, which has been lightened considerably in recent
Of course it would be moving us closer to a
consumption base in our personal tax by reducing the
effect of taxation on a key form of capital income.
I would also propose other base reforms to offset some
of the revenue costs of the proposals I've just made
and to meet any public concerns that these key
proposals are just tax breaks for the well off and also
because these other items in themselves would be good
tax policy. I would suggest that we limit interest
deductions for investment expense to the amount of
taxable investment income declared in a year. I would
eliminate or phase out the lifetime exemptions for up
to $500,000 of capital gains on farm and small business
assets. I would institute or explore a corporate
distributions tax along the lines of the Mintz
committee to make sure we're not paying out dividend
tax credits where in fact a corporate tax was not paid.
I would move away from a wide variety of other
schemes, such as the labour-sponsored venture capital
funds and other special tax provisions that have not
proved effective and that unduly complicate our tax
In closing, there is ample scope for personal tax
reforms that would contribute meaningfully toward
improved efficiency, job creation, and productivity
growth, all of which are prerequisites for improved
These policies might involve cutting some tax rates
but, much more importantly, they would shift the personal tax
base to consumption for additional taxpayers. At the
same time these policies would also achieve other
important tax objectives, such as simplifying the overall tax
system and making the tax treatment more even-handed
and neutral across industries, sectors, and types of
savings and investment.
The approaches to tax policy supported here would
contribute more to the economy's performance than a
strategy of highly targeted sectoral incentives and
reliefs. That approach to tax policy has littered our
past in areas such as energy exploration in remote,
high-cost regions; multi-unit residential buildings;
motion picture production; and many others.
That approach continues to stuff the government's
in-basket for tax policy ideas in areas such as the NHL
franchises and stock options for executives in the
high tech industry. There is a better way.
The Chairman: Thank you very much, Dr. Kesselman.
We'll now hear from Mr. McCracken. Welcome.
Mr. Mike McCracken (Chairman and Chief Executive
Officer, Informetrica): Thank you.
I know that Dr. Kesselman is going to have
to leave early. If you're expecting to be leaving for
a vote, I would be happy to have you put any questions
to him prior to that, because I'm here in Ottawa and
I can continue afterwards.
The Chairman: Dr. Kesselman, at what time do you have
Dr. Jonathan Kesselman: I'll have to leave just
after five o'clock.
The Chairman: Perhaps we'll do that. We'll start
with some questions for you, and then we'll get back to
Mr. Ken Epp (Elk Island, Ref.): Thank
you, Mr. Chairman.
That was a very interesting presentation, and I thank
you for it. A whole bunch of things came to my mind.
With regard to your idea of a consumption tax, would
you expand the GST and HST? Would you increase the rates
or the number of items to which it applies, or are you
steering away from that? You never mentioned the GST
except in passing.
Dr. Jonathan Kesselman: All of my
recommendations here pertain to the personal tax
and to shift its base toward consumption for a larger
number of people. As I've said, probably 90% or more
of Canadian taxpayers are already, in effect, subject to
tax on their consumption even though we call it an
The GST certainly is an alternative way of
increasing our reliance on consumption-based taxes.
There might be an argument for increasing our relative
reliance on the GST and cutting our relative reliance
on personal and corporate taxes. That would be one way
to do it. There might be political opposition to that.
But I think there are also good reasons for moving
toward a consumption base on the personal side rather
than leaning much more heavily on the GST. That is
simply because within a personal tax we can take
account of individual situations, such as disability
care expenses. We can take into account having a low
income. Of course, for the GST we do that with the
We can apply the personal tax with a progressive rate
schedule. The GST, of course, is a flat 7%. If you
raise the rate, it's going to be a flat 8%. So I think
it's probably preferable to shift our overall tax
system toward more reliance on consumption-type bases
through these types of reforms to the personal tax than
through trying to move to European style 15% and 20%
value-added taxes—in other words, a 15% or 20% GST.
Mr. Ken Epp: I don't know if economists buy into
this, but I believe intuitively it's accurate to state
that the higher we tax something the less that activity
will occur. In fact, if you were to tax something at
100%, it would normally cease altogether, whether it's
buying, selling, or whatever. If you reduce taxes on
something or make it tax free, then the market
prevails. If it's favourable and good for our
productivity as a country, which would then be good for
the economy, then the reduced tax is going to increase
that activity and increase the
economic growth and our productivity as a nation.
You're not really talking along that line at all. You
want to reduce capital taxes. I think you're saying
that by doing that, you want to increase
investment and capital, which is good for productivity.
I hope I read you correctly there.
How about income? If you tell people that their
marginal income is at 65%, which it is for a lot of the
poorer people in our country, and if you look at the
total implications of earning money when you're making
$20,000, there's a tremendous hit on it and, as a
result, a huge disincentive to take part-time work and
that type of thing. What is the effect of those taxes
on the economy and on productivity? I would think
that's where we would want to put some emphasis.
Dr. Jonathan Kesselman: Here I'm talking about
higher earners, which are not the largest part of the
population but which are very important for aggregate
savings and investment decisions, and even though the
public may not like people who are well off, they are,
as a result, very important for the economy's
productivity growth, real wages, and living standards.
So by reducing the tax on capital income, as you say,
this will augment savings and the capital stock, and in
the long run it will raise the wages of people with
average and even below-average skills, and there will
be more jobs.
I agree with you as well that people who earn, say,
$20,000 to $30,000 and who have children are facing
very high marginal tax rates because of the
way we have structured some of our child tax benefits
and other refundable credit programs, and I think that
certainly does deserve some attention. It's not an
easy thing to fix. Of course, you can fix it by
scaling back the benefits, but that's probably not what
we want to do.
In terms of productivity growth, savings, and long-run
growth, if you focus on what needs to be done in the
tax system that affects higher earners, I would say
it's more important to be taxing them on a consumption
basis than to be cutting their marginal tax rates.
Now, there's probably room for some of both. But if we
had to make a trade-off, it's important to remember
that based on what we've observed in different
countries and based on what we know from the economics,
the cost to the economy in efficiency and growth is
heavier when you tax the capital income at the margin
than when you tax the labour income.
Mr. Ken Epp: One of the very important factors, in
my view, is that the world has shrunk. We used to be
almost isolated simply because transportation and
communication were so slow and cumbersome, whereas now
we trade money across the world in milliseconds and
certainly goods and services are much more mobile.
What is the effect of Canada's tax system versus that
big neighbour to the south? You didn't really address
You compared us somewhat to the Europeans, and
of course we're competing with them as well. But our
really big competitor is the United States, and their
tax regime is really quite different. We're told, for
example, that they have half the unemployment rate
we do. As a result, their gross domestic product per
worker is way higher and they have higher productivity.
We're suffering in that area. So is there not an
imperative for us, as a country, to bring our tax
system more closely in line with what the Americans are
Dr. Jonathan Kesselman: I would say we should look
at it. We should consider the effects of having a
different tax system. In fact, the Canadian tax
structure and tax mix is quite close to that of the
U.S., much closer to that of the U.S. than to that of
Europe. The U.S.—that is, the federal government and
states—rely just about as heavily on the income tax as
a percentage of total taxes as Canada does, which is to a
greater extent than many other countries around the
If you look at my particular proposals, in
shifting the base toward consumption for higher
earners but not for multi-millionaires, these in fact
would bring us closer to the U.S. system; that is,
reducing our effective tax rate on capital gains to a
50% inclusion rate. If you combine that with my
proposal for a top total marginal rate of 45%, in
effect you'd have a 22% or 22.5% effective tax rate on
realized capital gains. The U.S. recently moved to a
top federal marginal tax rate on capital gains of 20%,
but there are state taxes as well. We would be very
competitive in that area.
My other main proposal was to raise the limits of
allowable contributions to registered savings plans.
Again, we would only be coming somewhat close to what
the U.S. currently allows there.
If I could turn this around, we could alternatively,
if we had the revenue available and didn't want to have
many government activities that Canada does have that
the U.S. does not have, cut our tax rate
schedules to look very much like the U.S. federal tax
and a typical state tax. We would still be
taxing our residents much more heavily than in the
U.S., even with the same rate schedule, because they
allow a lot more items to be deducted. I'm not
referring only to mortgage interest, but also to these
much wider allowances for tax-sheltered savings and the
capital gains treatment.
So, yes, what I'm proposing here would go some way
toward making our system more like that of the U.S. And
I think if I were stressing anything, it would be that
if we're concerned about productivity.... Of
course we cannot attribute whatever relative success
the U.S. has had in productivity growth to taxes alone,
and we also have to remember that U.S. productivity
growth has been pretty poor in the international
comparisons; only Canadian productivity growth has been
poorer. So I would stress that we have to look not
only at the comparison of tax rate schedules; we have
to delve into the personal tax, into what's really
being taxed, what is the base, what are the economics
of what we're doing now—are they wise or are they
not? I think they're not fully wise. And if we look
in substance at the U.S., we will find they are already
where I'm suggesting we should be headed in these
Mr. Ken Epp: Mr. Chairman, I've used ten minutes.
If others want to have some questions, I'm willing to
The Chairman: Yes, thank you, Mr. Epp.
Mr. Paul Szabo (Mississauga South, Lib.): Thank
you, Mr. Chairman.
Very slowly I'm learning more about
the pitfalls of measuring productivity. I think it
also applies to maybe some of the solutions for
improving productivity. I wanted to focus on
the one example of the RRSPs.
If you were to increase the limit from $13,500 to
$30,000, I dare say that an awful lot of people, where
both spouses were working, would all of a sudden become
one spouse working because there would be a very
significant jump in the opportunity to split income by
purchasing spousals and achieve a windfall on a tax
rate where the deduction was available at the highest
marginal rate purchasing spousals. And they would come
out, and with the structure of a RIF, be taxed on the
way back into the taxpayers' hands at a lower marginal
In other words, the government
could effectively lose 50% of the tax revenue on the
incremental RRSP contributions. So there's a flaw
here, in that your discussion sort of assumes that there is a
perfectly efficient transfer of personal income tax
revenue into consumption tax revenue, but this is an
example of where there would be some leakage. In fact,
to make it up you would have to increase tax rates as
well in order to compensate for that loss. So I would
issue a caution about simple solutions to complex
If your objective were just to improve
productivity—and maybe you can comment on this—it
seems to me that since we only measure it in the
private sector, all we have to do is privatize as much
of the government's activities as possible, which are
efficient and fully employed, and become as inefficient
as possible by hiring as many people as we possibly can
for jobs that are not meaningful. That would improve
the employment rate in the private sector, because the
private labour force participation would go down. The
effective employment rate in the private sector would
go up, and productivity would go up. So the
conclusion, it sounds like, is that if governments were
as inefficient as they possibly could be, productivity in
a country would go up. It sounds too good to be true.
Dr. Jonathan Kesselman: I'm going to focus
on your first comment, which is the only one that
really addressed what I had to say, if that's fair
Mr. Paul Szabo: Okay.
Dr. Jonathan Kesselman: I used $30,000, obviously,
as a talking point and to provoke thought. What I'm
saying is that even that is only two-thirds of what is
allowed in contributions in the U.S. under defined
contribution trustee plans.
First of all, I'm not proposing that we change the 18%
of earned income limit, so it's not as if someone
earning $50,000 could put $30,000 into the spousal
plan. So that would provide some control on it.
Secondly, as we reduce tax rates, we flatten schedules
a bit more, which seems to be the direction. It's
certainly the direction at the provincial level, and it
would be the general direction we've seen at the
federal level, although not by great steps. By doing
this, we reduce the incentive for this kind of spousal
But if, upon close examination, that were deemed to be a
real concern of this scheme—that is, a high earner
who's currently constrained by the dollar limit on
these contributions now can contribute more and put it
into a spousal scheme and then it's withdrawn within a
short number of years—obviously we could rewrite the
regulations on how much can be contributed to spousal
schemes. That would be, I think, a fairly simple
Mr. Paul Szabo: I understand that there is an
opportunity after a certain number of years to withdraw
in the spouse's hands, and, yes, you could deal with
But what if you just leave it in and in fact fully
realize the windfall on the rate differential? This is
not available to RRSP contributors at the lowest
marginal rate, when they pay 17% federal on the way
to get the deduction and they're going to pay tax at
seventy. So they have no opportunity for the windfall
on the rate.
The other important thing it does is it enhances
income redistribution in the reverse, because, as you
know, a deduction in our tax scheme benefits a
high-income earner over a low-income earner. So the
more deductions you provide for Canadians and the more
participation of high-income earners, the better the
shelter of income earned in an RRSP program, etc.,
they're going to get. It's another example of
how there would either be leakage or dilution of
the progressivity of the income tax system in itself.
Dr. Jonathan Kesselman: What we have in mind
here is shifting the base itself for people who are now
being taxed really on an income basis to a consumption
basis. That means, yes, they will pay less tax while
they're working if they put more into the plan, but
when they retire they'll be paying more. You
may call it a deduction because that's how it would be
implemented, but that's just the mechanism we use
to implement a consumption-based tax.
I think something more can be said for shifting
the personal tax base more toward consumption for more
people with earned incomes
above $75,000. Yes, it would reduce
revenues today, but it would give governments
additional revenues 10, 15, and 20 years from now, when
these individuals retire and we will face a real
problem in financing hospitals, old age homes and all
the very expensive medical care for seniors.
So we will have less revenue now, other things equal,
but we will be building a kind of investment in terms
of future revenue of government in the years when it
will really be needed and there may be very difficult
problems generating those revenues, because, as you
know, retirees proportionately will be a lot larger
part of the population and there will be fewer
Mr. Paul Szabo: I think the theory, at least on
the RRSPs, is flawed from the standpoint that the
growth in the carry forward of RRSP room is an
indication that more and more people are realizing
there is a limit to how much you should be putting away
in RRSPs. You can't utilize it all in your retirement
years before you die, and if you have a big pool left
and there's no tax-free rollover, you are going to be
smacked at the highest possible rate.
Strategically, investors are basically saying there is
only a certain amount you should be putting into RRSPs,
in terms of a lifetime limit because the inefficiency
in crystallizing that windfall gain on rate—you just
can't do it if you have too much. I suspect for 99% of
all Canadians, anything more than $500,000 in RRSPs
at age 65 is more than enough.
Dr. Jonathan Kesselman: Okay, but what I'm
addressing here is not average earners but
above-average earners who are currently constrained by
the contribution limit. These are not the people who
are generally underutilizing their available room.
Many people with sort of average earnings in
blue-collar jobs, and sort of intermediate-paid people
in white-collar, semi-professional jobs, wonder whether
it's worth saving, in terms of looking ahead to when
they retire. Unless they have enough savings and
assets accumulated, they're going to be subject to all
kinds of clawback provisions, whether it's GIS, OAS
clawbacks—who knows. The seniors' benefit, which
didn't go through, would have done more of that.
So if you're in the middle, it may not be rational to
save that much. If you're at a higher earning level,
it definitely is, because you're going to be beyond that
anyway. There are people earning $90,000, $100,000, and
$150,000 who are currently constrained in their
ability to save in a way that is economically efficient
and doesn't tax the current income.
Mr. Paul Szabo: Thank you, Mr. Chairman.
The Chairman: Thank you, Mr. Szabo.
Ms. Karen Redman (Kitchener Centre, Lib.): Thank
you, Mr. Chairman.
I have a learning curve on this productivity and I
have moments of enlightenment. One of the moments of
enlightenment I had at an earlier presentation by
witnesses is that productivity is really
backward-looking, not forward-looking. We're looking
at the performance of one year versus the performance
of a previous year.
I think back to the efforts in the fiscal constraints
this government went through in bringing down the
deficit, but paying down the deficit wasn't a means to
itself. We paid down the deficit so we could free up
money to put in other places for Canadians.
So I look at productivity. Now we have a good fiscal
policy and a good monetary policy. Unemployment may not
be where we want it, but it's coming down. Should we
be looking at a longer-term productivity scale rather
than the short run?
Dr. Jonathan Kesselman: I don't know whether you
were here yesterday or had access to the minutes, but
Professor Osberg was telling us that when we're thinking of
many policies to improve productivity, such as adult
education and post-secondary education, we have to look
twenty years down the road and more, before enough people
are affected and are enough of the total labour force
that can really see the impact.
In the taxation policy area, I guess I was
suggesting that improved tax policies—and I gave my
interpretation as a professional in the area, but of
course you could find professionals who might well
disagree equally learnedly—appropriate tax
reforms, and base reforms can lead to rising living
standards for Canadians in three timeframes.
In the short run, they can give us more efficient
allocation of resources, such as time and capital. How
do we use our time? Do we paint our homes, or hire
other people to paint them and use our time to earn
more money that we can pay them with? Of course the
higher the rate is, the bigger the gap—the bigger the
hurdle is to earn, pay taxes and then hire someone
else. You hear of lawyers painting their own homes all
the time. So in the short run, an improved tax system
would improve the efficiency with which we use existing
In the short to middle term, meaning two, four, or five
years, I would hope and expect that improved tax policy
would augment job creation. In other words, more
people would be working, of those who want to work.
In the longer term of five to fifteen and even thirty
years, with the increased accumulation of capital, the
increased investment in new techniques, research and
development, new products, we would get the
productivity gains. But all of these things mean we
would have more valued real output per person—per
worker, per population. They are all crucial to
raising living standards.
So we can debate about measures of productivity and
whether Canada has really done worse than the U.S., or
really done much worse than the U.S. Of course the
U.S., as we've said, and I'm sure you've heard here, is
not a wonderful model to take on productivity growth.
They've done rather poorly internationally. But we
certainly can say, looking at real income or real GDP
per person in Canada, we have been lagging seriously
behind the U.S., since the latter 1980s in particular.
We were converging on the U.S. for the couple of
decades leading up to the late 1980s, and then we
started to see a growing gap. I think these policies
try to address it in a variety of ways.
Ms. Karen Redman: You mentioned the U.S. earlier
and you talked about models where they were having
greater growth and productivity, and in fact we're the
one country that's doing worse in productivity than the
U.S. In the European models you referenced, how
similar or dissimilar are their tax structures and
mixes, compared to Canada's?
Dr. Jonathan Kesselman: There's considerable
diversity within continental Europe. Britain and
Ireland have rather different approaches, with more of
an Anglo view of these policies. There is diversity,
but on average, we would say the continental European
countries rely much more heavily on payroll taxes than
Canada. The U.S. also relies somewhat more heavily on
payroll taxes than Canada. A payroll tax is a tax on
labour income, not capital income, so it is one
approach that's close to a consumption base. I'd have
to give you the two-hour lecture to explain it, and I
Secondly, they rely significantly more heavily than
Canada—not radically more—on indirect consumption
taxes, by which we usually mean value-added taxes,
sales-type taxes. They rely relatively much less on
income taxes, both personal and corporate, than Canada
and the U.S.
The Chairman: Okay. Thank you.
A final question from Mr. Brison.
Mr. Scott Brison (Kings—Hants, PC): Thank you,
Thank you, Dr. Kesselman. It's good to hear from you
again. I enjoyed your presentation at the Canadian Tax
Foundation and your paper on the brain-drain issue.
You did some work on that as well.
The day before yesterday we heard from one of the
presenters that productivity is closely related to
investment, particularly foreign investment, in a
country. There can be significantly positive impacts
on productivity from increased foreign investment.
With the mobility of capital, I'd appreciate your input
and feedback on how the taxing of income on capital can
have a deleterious effect on foreign investment in
Canada, and ultimately on productivity.
If taxing income on capital is bad, then surely taxing
capital itself is even worse, because we're doing that
in Canada. One of the sectors we have in Canada that
is doing very well and employs a lot of Canadians is
the Canadian banking and financial services sector. In
fact, over 50% of Canadians own shares in banks. But
it's politically popular sometimes, or palatable, to
attack banks just because they're banks. But that
doesn't make necessarily good public policy.
I'd appreciate your feedback on what effect
the capital tax on banks and on our financial service
sector can have ultimately on productivity.
Lastly, I'll just shoot a few questions at you
and get it all over with at once. In terms of a shift to
consumption-based taxation, your views on that I share.
One of the criticisms I hear from other
individuals is that of potentially negative impact on
product progressivity. I know one of the concepts
you described at the tax foundation meeting was the
lifetime horizontal equity issue. Is that what you
were speaking of earlier in terms of this shift over
a person's lifetime, that the progressivity issue would be
addressed? I would appreciate your clarification on
that, because I think it's important for people to have
a better understanding of that concept.
Dr. Jonathan Kesselman: If I answered all of
your questions in depth, I would force out the time
for your other panel members.
Quickly, foreign direct investment generally is a
way in which countries can access technology and
managerial methods developed in the parent firm
Foreign direct investment, studies have been showing,
can be very much affected by the tax climate, but in
this case certainly much more the corporate income tax climate
than the personal income tax climate. Here I would
basically say read the Minsk committee report and what
it has to say in that area. There are complex issues
of how corporations....
If your corporate tax is too
high, basically, through a wide variety of
things from transfer pricing to how they finance
themselves, if you're a high-corporate-tax
country you can end up losing all your base. They do
all of their borrowing in your country, so all of the
interest expense is there and the revenue somehow
appears elsewhere. But I would not add anything to
what you'll find in an excellent report.
Capital taxes—again, they are covered carefully in
that report. There is surprisingly little known and
little work has been done from an economic and a
careful objective statistical standpoint on the effects
of capital taxes in Canada. As you know, most provinces
have them, as well as the federal government. They're
much heavier on the financial sector, although many of
the provinces have them at lower rates on non-financial
No tax is a good tax, virtually. The question is, are
these worse than the alternative for getting the
revenue, assuming you need the revenue? So I will not
say anything further than that. On capital taxes, read
what the Minsk committee had to say. They did
commission at least one study on it, although it did
not really get into any empirical examination.
On your last matter, the critique of moving further to a
consumption base in our personal tax and the
effects on progressivity—well, I would go back first to my
response to an earlier question as to why not use the
GST. My answer was if you for good economic
reasons want to shift your tax system to a heavier
reliance on consumption-type bases, I would prefer to
do it through the income tax or through the personal
tax jargon. We could still keep calling it an income
tax, as countries do, even the U.S., which is even
further toward a consumption base, because we do have
control over the rate schedules. We can keep it as
progressive as we want.
If a shift to a consumption
base is highly supported by economic efficiency and
productivity and growth reasons, if we do that and
then we don't like the effect of it on progressivity,
we can of course change the rates. We can even raise
them at the top end if that's what the government of
the day wants. I was suggesting before that I didn't
think the rates should go higher.
The Chairman: Thank you.
We'll now proceed to Mr. McCracken.
Mr. Mike McCracken: Thank you. Thanks for the
opportunity to come before you and to talk about
productivity. I didn't know that we were going to get
into the intricacies of tax policy. It's a little
early in the season for that. But there is perhaps
some link, although you won't see much of that in my
What I'd like to do is to essentially try to help you
by separating out some concepts, setting a bit of the
scene as to where we're at and talk a little bit about
something called the production function. I think
you have heard about it from others, but I hope I can
simplify that a little bit. Then I'd
like to talk to you a little bit about something called
social capital or social cohesion, and conclude with a
couple of comments on what we might do.
Just as backdrop to my comments, I'd like to have you
think about a typical state as being made up
essentially of three stacked boxes, one box being
the workplace in which we find labour and capital and
technologies and resources and management and producing
goods and services. Essentially, the unit here is the
worker or the firm.
Stacked on top of that is a
marketplace in which goods and services are bought and
sold, prices signal relative demand and supply,
where inputs used by the workplace may also be traded.
And here we think of transactions taking place between
parties, or a market for a particular item.
Finally there is society, in which we of course find all
of us and the people. Quality of life is a matter of
concern, the structures amongst people and the concepts
of family, culture, education, at least as it used to
be known, and participation in society. Again
we're talking about a unit here of a person or some
subgroup of society.
In that same chart, just add some other words to
what's in those boxes—and you have copies of all these
foils—you can think of the employees, corporations,
labour unions, consumers, retailers in the marketplace,
minorities, majorities, safety nets, redistribution on
a societal side. So you cam amplify each of these
little boxes somewhat.
What I'd like to do, though, is to point out to you
that the role of governments is an important part of
this framework. In particular, the sides of these boxes
are determined essentially by three influences—the
traditions in the society, the laws of the state, and
the external influences on the organization.
For example, looking at the workplace, it's the
corporate laws and the labour laws that form a good
part of the structure of the workplace. Intellectual
property laws affect what happens there. Work ethic,
discipline in terms of the traditions also have their
Similarly, the marketplace is framed by laws
defining private property, laws of contracts,
coupled with the norms of society in terms of voluntary
buy-and-sell decisions and honesty and service norms.
Finally, of course the society itself can be
conditioned by both individual and group rights,
constitutional issues, state responsibilities and, on
the tradition side, the notion of caring and trust of
the state, as well as the external pressures on
In some sense it's in this last societal effect
and in the context of how all of these things work to
move an economy forward, in particular the market
system, that we find the role of capitalism, economics,
and much of the discussion of productivity.
Now, if you take this framework, it's very useful to
note three words that get mixed up a lot, but
that over a number of years we have found to be quite
conveniently allocated out in the following fashion.
The term “productivity” is best reserved
for discussions about the workplace, essentially about
the firm. It's a concept at that level, or a government
department or another organization, i.e., the workplace.
It's the base for competitiveness and it certainly is
an important part of the overall real-income gains. But
we ought to recognize that there are some other parts
The second element, the notion of competitiveness,
which is the element we're seeing right here, is a
concept of marketplaces where relative costs determine
if operations of a firm, or indeed an industry,
are sustainable on a long-term
basis. But the issue there is
one of competitiveness vis-à-vis other industries or
other products or indeed internationally.
Finally, a concept that is not unrelated to
productivity and competitiveness, but not the same, is
the notion of prosperity. Prosperity is a concept we
associate with society and includes improvements in
real incomes, quality of life, equity and environmental
sustainability. Those are all its goals or objectives.
If we look at it in that way, we can ask ourselves
what we might do in each of these areas to make
improvements. In the area of productivity, the list is
a relatively short one, in terms of direct effects on
what you can do in a workplace. You can improve the
human resources. You can have a higher investment
effort, which some people think shows up in two ways.
One is in the form of a higher capital stock per worker, and
the other is where a better quality of capital stock is
brought to the workplace.
You can try to foster the adoption of new
technologies. You can provide a better infrastructure
within which these firms operate in terms of roads,
waters, ports, airports etc., and information
infrastructures. We can also try to do what we call
the productivity twist. This is not a new dance, but
it's essentially a way of trying to ensure the growth
moves toward those sectors that are relatively high in
productivity, from those that are relatively low.
That's something one would like to see happen. It's
not always something one can control.
How you do it is of course the area of the
government's side of the policies, and there's a lot of
rhetoric. There are also lots of very loose chains in
terms of what works, how quickly it works, etc. There
is a strong belief in this town—or used to be at
least—that less inflation has a lot to do with
improving productivity. We've had a lot less inflation
for some time, without any visible effects on the
productivity side. So we remain alert and hope it shows
Better macroeconomic performance is something
I certainly think would work a lot, but again we
haven't seen that for awhile. There's the right framework
policy. It's a generic term, in sense, and includes things like
intellectual property law and improvements in the overall
way way markets
On better education and training, again there are some
long lags getting the signals right. These are often
code words for not subsidizing, getting prices that are
not non-distortionary, etc. There's ensuring people
have the capacity to use the skills they have, and you
have the right organizational structures. This is
sometimes is affected by laws in a country where you
can't adopt certain forms of organization that may be
more appropriate for the circumstances.
It's interesting to look at these things because
you'll see some of the suggestions you've no doubt
heard about for productivity really showing up on the
competitiveness end. Again, improving the efficiency
and effectiveness of the marketplace is an approach
toward improved competitiveness. Governments are
involved in regulations, standards, taxes, subsidies,
crown corporations and international agreements, again
affecting relative prices and their performance—again
a competitiveness issue not as directly affecting the
productivity in the firm.
What do you do? You look at the standard list,
improve the regulatory processes, reduce internal
barriers, improve access and improve information
infrastructures. Some think assisting Canadian firms to
enter new markets may be of help, although a lot of
these things have been tried with relatively modest
pay-offs so far.
Finally, on the prosperity story you're looking for
rising real incomes for all Canadians, sustainable
environment, contributions to world economies through
aid, adequate safety nets, and improvements in a
balance, in the sense of regional economies, and
amenities, in the sense of parks. There's also how you
operate—in other words, the participation of citizens
in processes being seen as important.
How do you get there? The short list includes things
like improved redistribution of incomes, efficient
health care systems, high-quality education systems
available to all, volunteerism and charity being
encouraged, and involving citizens in determining their
That's sort of the look at what you're trying to do.
Let's talk more specifically about productivity. In
particular, what you will have learned over the last
two days is that at the firm level, if we think about
productivity, it's essentially some ratio of outputs to
inputs. It's sometimes written out as a production
function, where output is some function of some set of
A lot of what you heard on the first day argued that
the inputs were labour and capital, in some form. They
went through various weighting schemes and measures of
both labour and capital, to talk about the residual
productivity that showed up and was not explained by
changes in those inputs.
I'd like to take in a slightly different direction
from what you have heard. The simplest form is to first
recognize there is a legitimate role for some or all of
government activities, as part of the production
function at the firm level. Obviously, if you're a
trucking firm you don't very do very well when there
are no roads. If you have bad roads you don't do very
well, and if they get improved you do better. That is
a gain that will show up in you being able to produce
more output with the same inputs at that point.
Of course, it's particularly advantageous if you don't
have to pay for those roads. Then you can in some
sense internalize the entire cost reductions associated
with that. But this is equally true for almost anyone
in business who requires, for example, such things as
clean water as an input or someone to handle the
garbage or sewage they're producing. Those are also
handled by the infrastructure in society. Someone may
want to know what the market prices are at the present
time, so a statistical agency may be in place that adds
those numbers up and tells them about them—again, a
form of infrastructure.
However we measure it, there have been a number of
attempts to do so. A number of empirical studies have
found a positive role for infrastructure in the
production function, as part of the explanation of what
goes on. In a sense that also contributes to
productivity. In particular, if you don't keep your
infrastructure up and invest less in your
infrastructure, you will have a productivity slowdown
as a result. It takes time but you can manage to screw
it up, with some effort.
The new growth theory, which you probably heard
something about on the first day and possibly
yesterday, also emphasizes technology. The t in
the line here is an important part of the story about
productivity growth. You will have heard about
the virtues of R and D, innovation, and adopting new
technologies. Some have suggested you can pick this
effect up most directly by including the investment
ratio directly, or the investment in machinery and equipment
ratio directly in your production function.
If you go back a few years, though, the production
function was written out much more broadly. It
included what I call s, which is a whole series
of factors dealing with the society you are in and the
institutions in your society. In particular, the term
now being bandied around quite widely is social capital
or social cohesion. There's growing evidence
that this also has a direct effect, a causal link, from
improvements in social cohesion or social capital to
economic growth, productivity and investment ratios.
The work of Irma Adelman in the 1960s was the
first in which that showed up.
There are other factors. I won't go into them in
great length, other than as x, w, and
z—however you want to run them out. But I would
just point out that some of this includes the state of
the play of the economy. Quite frankly, in Canada, for
the last roughly 25 years, we have been operating well
below the potentials of this economy. We have been
operating in a world Leibenstein at one stage would
have referred to as X-efficiency. We aren't doing
what we could do with the smarts and the capital we
have; i.e., we have high unemployment and unutilized
In that environment, the notions of allocative
efficiency are relatively minor
issues compared to the huge
dead-weight losses associated with operating well below
what you could be doing. And that strikes me as the
A final point is I suspect that throughout your
discussions over the last two and a half days, the
left-hand side of this whole productivity function, in
terms of outputs, has been left. People talked
about it as GDP or the value-added or gross output, or
something like that, but I have to tell you that this
is probably a mistake. Things are produced jointly by
corporations, by governments, and by other
organizations, other than the output for which they
earn money or get credit for.
Let me give you a very simple example. In the United
States, if you take the electric power industry in the
post-war period and examine, in the framework that you
were using on the first day, and ask whether they
had any productivity growth, the answer is no,
basically. If, however, you add to the output of the
electric power industry in the United States in a
negative way, if you penalize them for
their pollution, created air pollution, particularly on
SOx, NOx, VOCS, all of the
local pollutant gases, and value those, as we are now
doing, at the prices that are being generated by
environmental taxes in that area, or trading permits,
then you find something very interesting. It is that
this industry, in the post-war period, has gone from
one that was polluting a lot to one that today is
polluting a lot less. And if you value this as part of
its output, as society is saying they want to do now,
then you find the productivity growth on that basis in
electric power is on the order of 1.5% to 2% a year.
What does that mean? It means before we get all
worked up about a single measure of productivity
growth, we really need to step back and ask what the
whole picture we're looking at is. If, for
example, in the last 10 or 15 years Canadian businesses,
with very low productivity growth being measured as we
now are doing, are all becoming much better in terms
of their environmental progress, if they were producing
skilled people well over and above their own
requirements, as they were learning by doing, if they
were participating in their local economies and
societies in a way that was strengthening those and
not being measured in their output, then we might ask,
why are we all upset about this productivity side?
Of course we don't know what they've been doing
because we don't measure those kinds of things. And if
we have any suspicions at all, it's that probably such an
augmented productivity measure might look worse rather than
better from the recent performance.
I'll skip the social capital slide and I'll
talk a little bit about another view, which, again, is
that of a chap by the name of Harberger. I'll simply leave
with you a reference to him. Your people here on the
research side can get the information. A recent
article of his—his presidential address to the
American Economic Association last year—hones in on
this notion of productivity as a firm-level concept.
It also says start thinking of it in a much more
mundane way; don't waste your time trying to figure
out this technology and all this other stuff. It
basically comes down to whether you are or you aren't getting
real cost reductions from any source. And if you use
that framework, you may find that it's easier to say
you understand why that would cause a real cost
reduction, even if it's not some high-tech product.
What do you do? The simple measure I would suggest,
if you're concerned about productivity, as I've defined
it at the firm level, is to then recognize that it is
where you're focused; you're trying to improve
productivity through changes in the behaviour in the
organization of work at the level of the firm.
Reducing slack would help a lot. If you have a 10%
output gap in the economy, closing this gap quickly
would provide you a big boost to productivity growth,
in my view, to investment, and certainly to the
prosperity of the economy. Remember,
infrastructure does matter. Worry about
the societal effects,
social capital, as much as you worry about technology,
and don't forget about the other factors that are at
If we ask how we have done, we come away with not a
very happy picture, because it's the transmission from
productivity through competitiveness to prosperity
where in fact disappointments are large. Real wages
themselves have not kept up even with the slow
productivity growth we've had. A large gap has
opened from labour's perspective on what they have
obtained from working. So this has, in some sense,
held back income gains and consumption in society.
However, from business' viewpoint they don't see it
quite the same way. This chart here gives you some
illustration. You have a copy of all of these charts
in the back there as well. I will not go through all
of the charts, but essentially what's happened is a
gap has opened up from 1981 forward between real wages
and productivity of about 8%. And even in our forecast
out through 2006 this narrows only shortly, although
that's assuming current policies are continued.
However, when you look at it from the employers'
viewpoint and deflate those wages by the prices the
producer gets, they're roughly in line. And this is
where, in some sense, there is a disconnect between the
prices that are seen by business and the prices used in
the consumer price index. The other reason is you
might say there's poor productivity growth, yes, but at
least it's still growing, but in fact if you look at
what I think people are more conscious of, which is
real disposable income, on a per household basis today
real disposable income is about 6% below
the level of 1981. It is down from the 1990 peak of
about 104% by about 10%.
That's a very large reduction in real disposable
income per household. So it's not surprising that
people are unhappy. It's not surprising we have a
retail sector in this country that's not doing well.
On a per capita basis the story isn't quite as bad, but
it nevertheless still shows us today well below the
levels of 1989-90.
What about investment? We hear about the
wonders of investment. But if we take a look at the
investment effort in Canada—the top line is total
investment—from an investment ratio up around 25% in
the 1960s and early 1970s, this has been declining to
below 20% from about 1990 on. If you look at the
components you see that the business investment,
business non-residential, is down; you see housing is
roughly stable at about 5%; and you see that perhaps
the biggest percentage relative drop has been in
government fixed investment from about 5% down to about
2%. And this has been steady erosion in the provision
of roads, highways, airfields, ports, infrastructure
spending in the information sector, etc.
If we look at another factor that is part and parcel
of this whole exercise, which is the degree to which
income distributions are affected, the basic story is
one in which we have been getting a less even income
distribution in Canada since 1973 on both the before
tax and the after tax and transfer.
On the unemployment rate, I mentioned earlier to you
that after tracking with the United Stated for the
period from 1945 on this chart up through 1980
roughly, in 1981-82 we opened up a two-percentage-point
gap with the United States. We now have managed to
open it up to a total of 4% in the last recession. In
my view, this is a choice that's being made by
policy-makers in Canada and one that is costing us quite
dearly. A rough estimate is we're losing about $80
billion per year—per year—in forgone output by not
being at the same unemployment rate as the United
States at the present time.
Let me not go too much on. I'll skip on the
participation rate, employment ratio. On the social
cohesion indicators, just so you get a sense of how
some of those measures show up, one interesting one is
what's called the bureaucratic burden. This is a ratio
of people who are in the management and administrative
sector to the total employment in Canadian industry.
This has risen from about 7% in the early 1970s up to
about 14% today. When you compare this to Europe, these
numbers are about three times higher than the European
numbers and Japanese numbers, about the same as the
The other line indicated on the chart is the same movement
among the women managers as a share of the total. It
has risen, although somewhat less rapidly.
Another indicator is the circulation of daily
newspapers per person, and I'm using here age 15 and over.
Again, there is a steady trend downward. This measure across
many countries is used as a sign of social capital or
social cohesion. It's a proxy for interest in
political and civic matters. This circulation has been
declining in Canada, absolutely on a per capita basis,
for some time. All of this of course is without any
adjustment for quality of those newspapers. I won't get
into the sign on that.
One indicator you may find interesting is that
in some countries
they consider an increase in the number of lawyers per
thousand as a sign that the people cannot handle
relationships on their own, and that there is less
trust or social cohesion in that society. I have only
the data here from 1985 forward, but the number of
lawyers per thousand population in Canada has risen
from 1.7 to 2.2 per thousand.
Finally, an indicator of how much people are
involved is simply the voter turnout in federal
elections, a number some of you will be familiar
with. One of the things we can observe since
1972 has been a marked decline. Note that the pattern
in some of those years is when you have an election
call with a short lag between an earlier
election, you tend to get a lower number as well. But the
general trend has been downward. I understand this is
also reflected in most provincial breakdowns.
So there is a sense of what's been happening over the
last 10 to 20 years, and there are a lot of other measures in
the same vein, that our social capital and social
cohesion have eroded. And if that is an important
variable in your production function,
then it too could be explaining this productivity
slowdown, and would suggest these are the kinds of
things that may be more amenable to fixing by
governments than by some policies dealing with upper
income tax brackets.
The Chairman: Thank you, Mr. McCracken.
We'll now hear from Mr. McMahon.
Mr. Fred McMahon (Senior Policy Analyst, Atlantic
Institute for Market Studies): Thank
you very much, Mr. Chairman.
I don't know if your staff mentioned to you how I
travelled here, but I'm not sure any committee studying
productivity should be hearing from someone who came up
to Ottawa from Philadelphia by train, and plans to
return to Halifax by train. I guess I'm just lucky the
old carriage routes are closed; otherwise I'd still be
outside New York.
In that kind of a perverse sense I'd like to describe
to you an instance where an increase in productivity
can actually lead to a decrease in productivity. And
I'm going to recommend a policy that will actually
lead to a decrease in productivity.
Imagine there has been, perhaps through technology,
some spontaneous increase in the productivity
available out of low-skilled workers. That enables
employers to hire more low-skilled workers. It enables
them to pay more, perhaps bidding them off social
assistance. Now their productivity as low-skilled
workers has increased but it's still below the average
level of productivity. So that increase in
productivity, by bringing more low-skilled workers into
the workforce, actually lowers your per capita
Now, the same sort of effect can be done
controversially, through cutting back on social
assistance, so being on social assistance is less
remunerative than work, or less controversially through the
tax code, through earned income tax credits or just
raising the personal exemptions.
By bringing more low-skilled workers into the
workforce, as I say, you actually lower per capita
productivity. This may be—I missed the
scintillating session on methodology earlier this
week—one of the reasons why
U.S. productivity seems at odds with what's actually
going on in the economy. In effect, many European
countries have excluded a whole class of low-skilled
workers from their economy, where the United States is
absorbing more and more low-skilled workers into their
Having made that point, I'm going to veer off and talk about
largely Atlantic Canada, but it has national impacts.
Let me explain why. You can consider Atlantic Canada
as something of a test case. Researchers feed rats
megadoses of various substances to see if they're toxic at
lower doses. I think Atlantic Canada has had megadoses
of various perverse policies that are
doubtless toxic at lower levels.
To tell you that, I have to explain how poorly Atlantic
Canada has been doing. I was one of the first to point
out that over the last 35 years Atlantic Canada has
slowly caught up with the rest of the country,
with the exception of the early period of the 1970s
before the oil crisis, when we were shocked by a whole
bunch of economic development efforts in Atlantic
Canada, which as it turns out lowered our growth rate.
There's a vast literature developed on something called
the convergence effect. That's the ability of lagging
economies to catch up with advanced economies. All
that seems to be required is that you share a market
system, various institutions, and the rule of law.
Comparing Atlantic Canada's convergence with areas that
do not have our regional programs, we aren't lower than
them, we're so much lower it's embarrassing.
Atlantic Canada has caught up to the rest of Canada at
one-third to one-half the rate you would expect with no
regional programs at all—one-third to one-half the
rate of U.S. states where there are no regional
programs—some people say the military is, but when
you examine the numbers that disappears;
one-half to one-third the rate of Japanese prefectures;
one-half to one-third the rate of European regions so
diverse as a region in Spain compared to a region in
Europe does have regional policies, but
these policies are dwarfed by what goes on in Atlantic
Canada. For instance, the wealth transfer from the EU
to Ireland is about one-tenth the level of the wealth
transfer from Canada to Atlantic Canada. If you take
out EU agricultural subsidies, it's about one-twentieth
Atlantic Canada is the only place I know of that
gets a similar level of aid as that other star
performer, Corsica. Aid to Atlantic Canada on a per
capita basis dwarfs U.S. aid to Israel, and they got
a pretty nifty army out of it. What we got was Sydney
Steel and Sydney Coal. What this vast flow of largely
politicized resources has done is enable government to
act upon a negative-sum view of the economy. Notice I
didn't say zero-sum view, but negative-sum view. In other
words, when any job disappears it's never going to be
replaced unless some government activity is involved.
Thus we hang on to declining industries, we
bloat the fisheries, we do all sorts of perverse
Hanging on to outmoded industry only suppresses job
creation and productivity. One of the reasons the
United States is probably doing so well right now is
that wave of hugely politically unpopular lay-offs in
the late eighties and early nineties. Firms were showing
large profits and everyone was asking how they could lay
people off when they had such large profits. They said
it would reduce employment. It was a negative-sum
view of the economy. Nobody intervened, and what this
allowed U.S. firms to do was move into new economic
activities, spark a powerful rate of growth in the U.S.
economy, and, by letting outmoded jobs go, bring
unemployment rates in the U.S. economy down to near
The trouble with the negative-sum
view of the economy is it has a devastating impact on
economic organization, both on the management side and
on the labour side. It encourages rent-seeking, looking
for grants and favours in which productivity is almost
out of the equation, rather than profit-making through
Profit-making is a path to both greater productivity
and job creation. Profit-making gives you the
resources and the incentive to invest and create new
jobs in new areas.
Considering the largeness of the market economy, it is
almost infinitely larger than what's available through
various rent-seeking activities, which are very
much like a negative-sum game. Government has a certain
pot of money, and as outmoded jobs become more and more
expensive to maintain, you can maintain less and less
of them with the government funds.
The negative-sum view of the economy is clearly wrong,
demonstrably wrong. If it were not, Halifax and Ottawa
would have been devastated by the vast civil service
cuts. In fact, Halifax is on an historic roll that, up
to this point anyway, has very little to do with the
offshore. So we're doing rather better after the
federal government withdrew money from the Halifax area
economy. If this were true, this negative-sum view,
Pittsburgh would be the pits after the collapse of its
steel industry. In fact, unemployment in Pittsburgh is
almost vanishingly low, whereas in Cape Breton, where
we held on to the steel industry, employment seems
almost vanishingly low.
I'll just take a moment to describe a study of
competitiveness in Nova Scotia versus New England. It
found out that the New England products were much less
costly than the Nova Scotian products. You may think
the New England firms paid their workers less than Nova
Scotian firms, particularly the low-skilled workers. In
fact, the biggest differential between New England
firms and Nova Scotian firms was that they paid their
low-skilled workers more. Perhaps it's that the U.S.
was producing shoddy goods. In blind tests before
experts the Nova Scotia products were rejected. Maybe
it's that big bugaboo that we just don't have capital
flows to Atlantic Canada and therefore our equipment is
outmoded. In fact, in almost all cases the equipment
in Nova Scotian firms was more modern than that in New
England firms because they got government grants to buy
it. In some cases the New England people were buying
second-hand Nova Scotian equipment. So here's what you
had: New England firms producing cheaper and better
quality goods with older equipment while paying their
workers dramatically more than Nova Scotian firms. In
other words, the Nova Scotia productivity was horrible.
What did the study say that was due to? It was due to
rent-seeking, as I've just described, and looking to
government for grants and favours, not just economic
development grants but contracts and so on. So this
large government presence severely suppressed
productivity in Atlantic Canada. Now, this study wasn't
produced by a far-out, right-wing group,
unless you consider the Atlantic Canada Opportunities
Agency a far-out, right-wing group.
So what can government do, then, to spur productivity?
We need to depoliticize the economy as much as
possible. I agree with Mike and Dr.
Kesselman that government investment can increase
productivity, but it has to be depoliticized, sensible
investment. For instance, with regard to the
millennium fund, I read with horror about the
politicians from my region going down and shaking hands
with people and doing absolutely nothing worth while when
we should be building roads, schools, and hospitals.
Those things increase social betterment, but
they also lead to economic improvement. As a matter of
fact, when government money flowed at its peak through
Atlantic Canada, our investment and infrastructure went
down. We were spending it on political stuff.
If you want to spend on things that improve
productivity, the international research fairly
strongly suggests that infrastructure, particularly
transportation infrastructure, is about your best
investment. It also suggests that post-secondary
technical institutions, smaller-level ones, also have a
great spurt of productivity.
You notice I left out lower levels of
education, because studies going back to the 1960s show
that output in education, the standard school system,
is completely unrelated to expenditures. In fact,
there's some evidence that the more you spend, the
worse the output on education. So you need a reform
of the structure of education, as opposed to
putting more money into it.
Finally, on taxes, clearly, if government
focuses on things that actually do Canadians good,
rather than do politicians good—the negative-sum view
of the economy is a great view for politicians, because
you get to protect existing interests and then go
around with job-creating projects that everybody gives
you credit for—leaving more money in the pockets of
Canadians, particularly lower-income Canadians, will
help spur productivity growth, even if it creates a
paradox in the United States. Leaving more money for
firms to invest will not just leave them more money to
invest, but will increase the incentive to invest.
Thank you very much.
The Chairman: Thank you, Mr. McMahon.
Before we go to the question and answer session, I
noticed, Mr. McCracken, that you were taking notes
while Mr. McMahon was speaking. Perhaps you would like
to express your point of view on what Mr. McMahon has
Mr. Mike McCracken: Regional growth in Canada is a
very complex issue. It's a rural issue, and it's an
urban issue. It also hinges very much on a question of
what are you going to take as a given. One of the
debates in Canada, which has not been answered and
which is an ongoing one, is with regard to the
distinction between place prosperity and people
prosperity. Is our focus only to improve the incomes
of people, regardless of where they live, or are we very
much concerned about also maintaining people's
well-being and the societal structure we have in
different parts of this country?
Those who suggest that the answer is the market only
and that we ought to in some sense let things work out,
let people move, tend to put greater emphasis on people
prosperity. That is also, I would say, the default
view of the United States. One talks, for example,
about Pittsburgh today having a low unemployment rate.
I can tell you that there were many decades during which
Pittsburgh was under great strain, and it did not
happen that Pittsburgh became prosperous solely by
Now, there are many parts of the United States that are
in decay and are being allowed to decay. Stop and
finish, that's their choice.
I tend, though, in the Canadian context to think that
at least in a relative sense we probably put more
weight on place prosperity than on people prosperity
alone; that is, we want people to be able to be making
progress where they are, and this means we have a much
more complex problem in terms of how we want to do it.
That may have some trade-offs in productivity levels or
productivity growth. We should be cautious also in
distinguishing between these two. You may make certain
choices that have a difference in productivity level,
but that may not necessarily mean you're going to grow less
I think these would be the main comments I would make.
I would make just one other comment, which is that there are
measures we produced many years ago and that we continue to
look at that can avoid the simple-minded view that if
you employ people at lower productivity rates than the
current average, it somehow is going to lower your
Let me give you a simple conceptual way to do things.
You can say that we will put everyone who is currently
unemployed on government employment at a social wage
equal to the unemployment insurance benefit. If we did
that tomorrow, the GDP would be higher by unemployment
insurance benefits, and the total employment would
equal our total labour force. It would be employment
plus unemployment today. So then you would be looking
at a measure that is our gross domestic product plus
the unemployment insurance benefit over the total
labour force. That sort of augmented view of labour
productivity is then not going to be befuddled by
changes in the unemployment rate. What it does,
however, is it really focuses your attention in another
If you were to then disaggregate the economy into a
bunch of sectors, you would observe, aside from our
traditional twelve or thirteen sectors, this fourteenth
sector, which is the unemployed sector, which is
producing very low output; it's producing just the UI
benefit per person who is unemployed. You would
see that the challenge in our society is moving people
out of low-productivity jobs into higher-productivity
jobs. It's that sectoral movement that you want to
do. You want to have less weight, fewer things being
produced in a sector with low productivity, and more
being produced in higher.
I think if you go through that, you won't fall into
the trap of worrying about damaging productivity growth
as a result of lowering unemployment. If in fact that
were the dominant arithmetic, we would expect in
Atlantic Canada, of course, the highest productivity in
the nation, given that it has the highest unemployment,
and we know that's not the case.
The Chairman: Mr. McMahon.
Mr. Fred McMahon: Sure, and in fact drawing
lower-skilled people into the labour force was not
something that I feared would lower productivity. In
fact when you do bring more lower-skilled people into
the labour force on a per capita basis—and I'm not
sure Mr. McCracken understood that—it will lower the
overall productivity on a per capita basis but
increase the economy's overall production. Furthermore,
the best way to move people into higher-productivity
jobs is to first get them into any job at all, because
the path to higher productivity is largely through
employment experience. That's terribly important.
As for place versus people views, as I've said,
Atlantic Canada has converged on the rest of Canada at
one third to one half the rate we would have normally
expected without any regional programs. Mr. McCracken
is quite right: a large part of that question is the
rural-urban spread. That too has a lot to do with
government policy. One of the great drivers of
productivity after the end of the Second World War,
believe it or not, was the depopulation of the
farms—people moving from agricultural activities into
higher-productivity urban and so on activities. In fact
that surplus farm population that was soaked up around
the early 1970s is one of the reasons for the slowdown
in productivity growth throughout the western world at
While that was happening to improve productivity
everywhere else, in Atlantic Canada government programs
were shovelling more and more people into rural,
low-productivity activities. For instance, while
agricultural employment in Canada climbed by about a
third—a third, two thirds, I forget which—between
1961 and the mid-1970s, employment in Atlantic Canada's
fishing industry in the late 1980s was two and a half
times what it had been in 1961. Most of those were
marginal, non-productive jobs supported by various
forms of subsidy. So in effect we maintained an overly
large rural sector in Atlantic Canada through a whole
number of quite perverse government programs. That
slowed our productivity growth, and that in large
measure created the urban-rural question, which Mr.
McCracken referred to.
The Chairman: Thank you.
Now we'll proceed to the question and answer session.
Mr. Ken Epp: Thank you, Mr. Chairman.
Thank you for your presentations.
I'm really curious about the role of government when
it comes to wealth distribution. We have governments
in this country that are very eager to take money from
those who earn it and give it to those who don't. This
is done on a personal scale, and it's also done on a
provincial scale, with the federal-provincial
transfers. It seems to me that even though it
redistributes the wealth, and hence the effect of the
economy is spread out over the whole country by
practices like that, our overall productivity is
affected because of the fact that those who actually
earn the income have a disincentive. And those who
aren't earning anything—in other words, who are not
actively producing, actively participating in our
economy—are encouraged to remain inactive.
How would you respond to that? I'd like a response
from both of you.
Mr. Fred McMahon: First off—and I guess this is
putting on my left-wing hat—if you had to take a
single measure of society's success, fairly low income
distribution would be perhaps the best measure to look
at. Now, that said, just as you mentioned, you have to
very carefully balance policies that redistribute
income with policies that generate income.
The other side, and going a little bit further,
policies that generate income—and the evidence isn't
fully in on this yet—at first seem to increase
inequality, and then as the economy adjusts begin to
lower inequality again. That happened in Margaret
Thatcher's Britain about seven, eight, nine years after
she became prime minister and starting reorganizing
society. Income distribution actually began to lower
again. It's happening now in the United States over
the last two or three years. So wealth generation
itself is very important in resolving inequalities.
Mr. Mike McCracken: I guess the one common area of
agreement we would have is that if we were running a
fully employed society, we would be in a much better
position. Quite clearly, if we were so doing, we would
find that probably income distribution would not be as
maldistributed, would not be getting as bad as it has
That would happen primarily because of access to
employment by low-income Canadians. It would also
include perhaps some relative strength of bargaining
for people who are employed vis-à-vis their employer.
They might get something approximating the productivity
gains that are occurring in their firms. It would also
probably occur for everyone in that kind of an
environment where people have some security in their
lives and some hope that they will be more willing to
improve productivity where it's in their control,
through better organization of work changes and through
suggestions on how to improve work.
The evidence I have seen, both internationally
and in Canada, suggests that an improvement in the
income distribution, meaning a more even income
distribution, has a positive effect on the economy, on
economic growth, on productivity, on its performance,
on social cohesion. So it perhaps is not what you want
to hear, but that seems to be the evidence.
We also have been talking about income distribution,
not wealth distribution. I'm sure it was just an
oversight by Mr. Kesselman, but as part of his overall
package, the ultimate conversion of income taxes to
consumption taxes should end with a substantial, if not
100%, inheritance tax at the end of it. I think he
just didn't have time to get to that particular issue
in his comments.
We're one of the few OECD countries without that, by
the way. So we ought to think of the full package if
we go down that road. That might help provide
governments with assets for redistribution elsewhere.
In terms of the incentive or disincentive effect, I've
been before this committee for a number of years and
talked to people for many years, and we have two
schools of thought in the world. One is that you have
to provide more after-tax income so people will work
harder. There's another view that you have to sort of
cut wages so people will work harder. It tends to be
somewhere around the average income that these two
effects seem to go in opposite directions. So when I
hear we need tax cuts for the rich, it's always so
they'll work harder. When I hear we can't afford wage
increases, it's so that we make sure that these people
at the lower end are adequately taken care of. So be
cautious in terms of these effects.
By and large, people everywhere want to work. It's a
social activity. They want to earn their way. The
view that somehow people out there, generally other
people out there, are happy with social assistance and
the degradations that go with that, are happy on
unemployment insurance benefits, or the two-thirds that
don't have any are happy with all that leisure time, I
think is just not
correct. You might want to talk to some of them.
The Chairman: I have a question. You said that
there are people out there who say you have to pay
people lower wages so they work harder. Can you
tell me one person who said that?
Mr. Mike McCracken: Yes—anyone who says we can't
afford to increase minimum wages because if we do we're
not going to be able to hire any of these people, no
one will hire them, so we cannot have at the low end
any increase in minimum wages. That tends to be the
standard of the BCNI approach to all of these things.
But when it comes to adequate wages for them to work,
it's preferably something like $100,000, $500,000—some
350 times the lowest employee's average income in their
firm, for CEOs.
It just seems to me there's a bit of a schism in all of
this discussion. We don't talk about the importance of
income for survival. We don't talk about basic income.
We don't talk about minimum standards. All the
evidence the United States has produced, and some other
countries, on minimum wages is that they don't in fact
cause the unemployment of low-skilled and entry-level
firms, but rather in fact that this serves as a useful
base, provides in fact the positive income effect,
particularly insofar as that stimulates consumption by
that group, who usually spend it all.
So there's a whole tendency to say give me more money
and I'll do better, but don't give anyone else any
money because it will be bad for them.
Mr. Fred McMahon: Mr. Chairman, could I straighten
something out here? No one has said that lowering
wages increases the work effort. The actual argument
is that lower wages enable employers to hire more
people and this therefore creates an overall larger work
effort in the society.
I disagree with Mr. McCracken on his reading on the
literature of minimum wages, but that would get quite
The other thing I would very quickly add is I don't
think people like living on social assistance, but the
trouble is that it does show up in the research.
People seem to be willing to take the road of least
In Atlantic Canada during the peak of UI, whatever,
there were in many months twice as many people
collecting UI as were actually unemployed, and about
two-thirds more people collecting regular UI than were
actually unemployed. The statistical agencies were
reporting labour shortages throughout Atlantic Canada
when we had double-digit inflation, and twice as many
people collecting UI as unemployed in some months.
In The Netherlands, where they had a similar sort of
system, except it was their disability system, in one
of the healthiest countries in Europe you found one
million of six million workers classified as disabled
and able to collect 80% of their previous pay, I think
it was, for the rest of their lives.
I don't think people like social assistance, but the
evidence shows that if you create a generous social
program it builds up more and more people. This might
have been one of the things Lars Osberg was talking
about yesterday, looking at ten, twenty, forty years
down the line. Unfortunately, social assistance seems
to get passed on through the families, so it becomes
almost a family business. To break that chain, it's
going to affect the next generation or even the
following generation after that.
The Chairman: Mr. Epp.
Mr. Ken Epp: Thank you.
I think that generally speaking, if people were told
they would continue to have the same income as they
have now but they didn't have to come to work any more,
probably 80% or 90% would opt to say they're not going
to come to work.
We're talking here unemotionally, and I know we have
to bring that social aspect into it. That is part of
our society. But if you deal only with the empirical
values of productivity, I believe that the imposition
of this redistribution of wealth is a negative for our
total productivity. Mr. McCracken, would you not agree
Mr. Mike McCracken: No. I think if you talked
about offering people the same salary as they have
today, perhaps some would. That tends not to be the
generosity levels of any of our social programs or any
of the proposals for a basic income.
What we do see in fact is a change in our society in
the last 30 years, where increasingly people have
entered the labour market in order to sustain an
adequate family income in the face of great
difficulties, with two people working rather than one.
We've gone from a society in which about half of the
families were single-earner to one in which now
single-earner families are about 15% of the total, about the
same number as our single-parent families. The
dominant type of family now is the dual-earner family.
Even with that, we see this group having great
difficulty—in fact not able to, on average, get an
increase in real disposable income per household, for
the last 18 years.
Mr. Ken Epp: Have you analysed why that is?
Mr. Mike McCracken: Sure.
Essentially, high unemployment and low real wages are the
principal culprits over this period, partly offset by
tax and income policies up through about 1994-95, and
more recently further hurt by cuts in transfer
payments both by federal and provincial governments.
So the after-tax, real disposable income per household
of Canadians continues to decline even in a recovery
period in this country.
Mr. Ken Epp: Are you then saying that the
reduction of income equates in your mind to a reduction
Mr. Mike McCracken: No. I'm saying that's what
the income story is. Productivity is a firm-level
concept. In a firm, you have an entrepreneur who tries
to organize a group of people and some capital to
produce something. The productivity measure is
essentially what those outputs that he produces are
relative to the inputs, and is there anything magic
happening—i.e., is there any additional output being
produced with the same input. If people are insecure,
if people are not trustful of their management, not
trustful of the society in which they operate, they
tend not to contribute toward improving that
productivity in that firm, and that shows up as less
rapid productivity growth.
It also means they themselves are going to have
great difficulty in making progress because their real
wage is not likely to get increased by that employer.
That's how it comes in and affects the outcome. But
as I say, we have had some productivity
improvement over the last 10 or 15 years, and
nevertheless we still haven't been able to translate
that into increases and real disposable income per
household. So there's obviously something else on top
of that, and that is of course the obvious—the slack
that's been created in this economy deliberately as a
choice in policy to run with higher unemployment rates,
and then more recently a withdrawal of governments
from the unemployment insurance system, from social
assistance, and cuts in the levels of benefits in those
Mr. Fred McMahon: There's another obvious reason
why Canadian disposable income hasn't risen, and that's
the increasing tax burden.
Mr. Mike McCracken: Yes, but it's not just there.
If you look at the tax as a share of the earned income,
that's not where the action is. It's on the transfer
side. You can decompose it and look at the parts and
it's just not part of the story. Now, yes, you could
have cut taxes instead, but that's not the issue. And
indeed, we've had tax cuts in some of the provinces—Ontario,
Mr. Ken Epp: I want to know what your
response is to the role of capital and the role of
technology in improving production, because it seems to
me it's much more significant than we acknowledge. I
used the example yesterday, and for my colleagues
here my apologies for the repetition.
When I was a
youngster, my dad with his two boys farmed 10 quarters
of land, and now my brother with his two boys farms the
same land plus another 40 quarters. And it's producing
about twice as much per acre as what we did when I was
a youngster. There's no doubt in my mind that
productivity-wise my family now is doing just an awful
lot better than they did when I was a youngster at
home many years ago. So productivity has gone up, but
their income seems to be less.
The difference is
due primarily to bigger machinery, better technology,
use of fertilizers and all those other things. So
technology has had a great impact on that.
The overall wealth of our nation, distributed over our
population, should then be better if our productivity
is better, but in fact it appears not to be. Everybody
seems to be worse off than they were when I was
young—or have I just forgotten because I'm old?
Mr. Mike McCracken: First off, just as a rough
approximation, I think you're using a somewhat longer
time period for your comparison than has been typical
of some of the productivity discussions we've been
having here, which have been on just the last decade.
I would think, looking back, in the post-war period
we've done pretty well on the productivity growth
front. We've certainly had some slowdown in the last
decade or decade and a half. In some sectors, such as
agriculture, productivity gains have continued. It's
an interesting sector because you made the side comment
that you didn't really feel your income had improved
all that much in that process.
Mr. Ken Epp: They're making half as much.
Mr. Mike McCracken: But making it up in volume is
the old story. When you have a productivity gain in a
competitive industry, then who gets it is less clear.
Often it goes forward in lower prices. The fact you're
still around in farming in Canada, for example, would
mean you were able to achieve productivity gains
sufficient to still be able to produce goods at
record low commodity prices in the world.
The commodity prices are affecting your incomes, but
productivity is real output over real inputs, and
that's where you've made it. It's an efficiency gain,
and that's what productivity is about. Whether it is
something you can capture depends on the state of the
markets you're operating in. One of our interests in
making sure productivity gains get to the rest of
society is we operate in markets that are competitive,
so prices are lowered by those actions. Otherwise, I
will never see the benefits of the productivity gains
from your farm through any other mechanism.
If you capture them as a productivity gain in
pharmaceuticals, what does the pharmaceutical company
do with the increased profits from whatever step they
used to get cost reductions? If they put it into R and
D, I might see the benefit of that five or ten years
later in a better medicine. If they remit it abroad in
dividends to their parent company, then it becomes a
little more difficult to trace the benefits that come
back to me. If they use it for a gold-plated building
in Toronto, then it's not clear I'll ever see it unless
I go to Toronto and ooh and aah at the building. So we
have to make sure we also understand these gains from
productivity and how they are shared.
That essentially means it has to show up as investment
or as something like investment—R and D, etc. It has
to show up in higher wages for the workers, dividends
being paid to the owners of the company, or lower
prices. Those are essentially the channels through
which the productivity spreads through your economy.
All of those channels have positive effects on the
economy, but also redistribute income, at the same
time, to different groups.
That's sort of the process by which it happens. Of
course, by the way, governments often benefit from that
productivity as well because they have a tax rate
applied to some base, that base goes up, and they
receive more income. That's the other way there is a
return to society. Governments are in better shape and
can, in turn, if they choose, recycle that to people in
lower taxes, greater transfer payments, or more
The Chairman: Thank you, Mr. Epp.
I have just a very short question. Can you identify
one component of your equation that is more important
Mr. Mike McCracken: Keep in mind what
you have in the equation are the things you are in
some sense explaining the output by, so the
productivity is essentially what you can't explain by
So the additional factors I bring to bear are the ones
that are often omitted.
In my own view, the explanation of so-called
disembodied technical change or the residual factor
productivity growth, or what have you, probably has
most to do with things like infrastructure of
government. It has a lot to do with the social
cohesion of the country. Certainly the evidence I've
seen piling up in that area is quite interesting. It
probably has a lot to do with—if you haven't adjusted
for it already—the human capital of your management
and the kind of relationship management has with
its workers. In other words, it's the quality of the
working place. Those are the kinds of factors that
What probably aren't on the list in a major way, and
certainly aren't on my list, are things that are
derivative of the kinds of incomes and the way you
treat them from all of that—i.e., the income tax
system, the GST, or any of that type of stuff.
Certainly the belief that if we could change the
saving rate it would somehow have some magic effect
has the whole thing backwards, in my view. We should
focus on investment and its later effect on saving. We
can't affect investment by changing the saving rate
through some policy. We've demonstrated over the last
25 years that doesn't work.
The Chairman: You're saying it's quite difficult
to isolate and give value to the inputs.
Mr. Mike McCracken: Any one factor. It also
depends on the industry. For example, in the biotech
industry in this country today, probably the single
most important thing to determine its future
productivity is some sorting out of the regulatory
environment in which it's going to operate. Without
that, nothing will happen.
In some other sector, like road transportation in New
Brunswick, it may be completing the highway system in a
form that will allow full use of a full load of a car
or truck, in moving goods and services.
In some other industry, it may be another problem.
Sometimes it won't even be where you thought it was.
There was a huge productivity gain four years ago in
rail transportation in this country, when a tunnel was
enlarged in Ontario that allowed containers to move
from Halifax to Chicago non-stop, double-decked. The
investment was made in going under the St. Clair River
in Ontario, but the whole productivity improvement was
very large in rail transportation. So it's sometimes
not always obvious, when you're dealing with these sorts
of networks, as to where and how you can get a gain out
The Chairman: So we have to be quite careful
looking at it from sort of a sectoral productivity
Mr. Mike McCracken: In each sector you need
something. There are some general senses. Someone has
to say “I'm going to make that investment. I want to
make an investment because I have some sense that five
years from now in this country, I'm going to need it.”
With the kind of slack economic performance we've had
for many years, many business are now saying “I don't
really need to expand. I don't really need to take
that gamble. I think I'll wait a while.” That
cautious mode is not very helpful for productivity
The Chairman: We're going to go to Ms. Jennings
and then to Mr. Brison.
Ms. Marlene Jennings (Notre-Dame-de-Grâce—Lachine,
Lib.): Thank you, Mr. Chair.
I apologize for missing part of your presentation, Mr.
McMahon. The questions I'm going to ask you may be
redundant or non-pertinent because you may have
addressed them in your presentation.
You talked about human capital, social capital, and
the various safety networks in place and how they can
impact negatively on productivity growth in a society.
You used the Atlantic provinces as an example, where
governments have poured money in there and it's had an
negative effect, according to the studies you're basing
your comments on.
You also went into the issue of welfare, social
assistance, and how that has just created a cycle of
families. I'm perplexed, because the studies I've seen,
which appear to be longitudinal studies on the whole
issue of social assistance and whether or not it
creates a dependency that goes from generation to
show that it's actually a very small
percentage of the group that happens to. The
overwhelming number of people who actually use social
assistance come in and use it for what it was meant to
be; that is, as a temporary aid because, for example,
you've lost your job and you have no right to
unemployment benefits, that kind of thing.
A woman who
has left an abusive situation has no job skills because
she hasn't been in the job market, and she has no
income support. She moves in and, particularly now, is
able to get the training that's required because we
have all kinds of programs that do assist with this,
and then she moves out. Generally, she moves out into
a low-paying job where she may actually have less
income than what she was making under the social
assistance, if I'm just going to use that as an
According to the studies I've seen, which are long
studies that have been around for a long time, you do
have a percentage where it is a generational issue, but
I don't believe it goes even to 25%. In the majority
of cases people move in and people move out.
How have you taken that into effect when you talk about
government policies and assistance having a negative
impact on productivity?
Mr. Fred McMahon: Everything you've said is quite
correct. In fact, it is a minority of the people who
use social assistance or most other programs who become
trapped. That doesn't mean it's not a problem. I can't
recall the numbers, but if, as you pointed out, it is 25%,
then that's a horrendously high number.
Ms. Marlene Jennings: It's not. I'm just throwing
Mr. Fred McMahon: Yes. Most people pass in and
out, and if they're only on it for a few months, they
just take up a small amount of income. That's not the
The problem, as you pointed out, is beginning to
develop the intergenerational transfer. Ireland, for
instance, never had an unemployment problem until about
the early 1970s. There was little social assistance.
The Irish moved away if they couldn't get work. They
came to North America or England. Since the 1970s and
the establishment of a more or less generous social
assistance program, in the inner cities of
Ireland, such as Dublin and Cork—and this
is what the labour union leaders told me when I was
over there—you have families with no tradition of work
for two generations now.
So you're quite right that people move in and out, but
that's not the problem. The problem is when it becomes
a pattern of life. The community—
Ms. Marlene Jennings: I'm going to interrupt you
for a second. I'm glad you raised the
issue of Ireland, because I am familiar with Ireland. You
may be right. There was no social assistance.
Mr. Fred McMahon: It was low.
Ms. Marlene Jennings: It was very, very low.
Basically what happened is that there was no work, and
as they grew up and became educated—and it's a
highly educated population—people simply stayed at
home. Their parents, who had some kind of income
support, supported them in many cases. Now they are
eligible. Oh, yes.
Mr. Fred McMahon: They tended to leave home, and
Ms. Marlene Jennings: Some did, but a lot remained
there. You didn't have a complete exodus of the young
population. There were a lot who remained there, and
they lived with their parents.
We see the same thing happening in other areas of the
world, such as the United States and Canada, where
people are unable to move into the work field because
there are barriers. Their parents, who have some form
of income, whether it be retirement income or their own
wealth they've been able to acquire, are helping their
children live if there is no other assistance
available to them.
Mr. Fred McMahon: Immigration actually seems to
have been the main outlet. In fact, until fairly
recently the Irish did not have a well-educated
population. It was only in the late 1960s when
secondary school was made free—
Ms. Marlene Jennings: I'm talking about the
last 30 years. I'm sorry, I didn't make that
Mr. Fred McMahon: Okay. As I say, immigration was
the main outlet. I've not seen a lot of evidence
about the stay-at-home, though
I'm sure it played a role.
Ms. Marlene Jennings: It's significant in the same
way that if we're talking about the generational
problem in terms of social assistance, as you said,
whether it's 10%, 5%, 15%, or 20%, it's a problem that
needs to be addressed. In the same way, using the example of
Ireland, whether it was 10%, 15%, 20%,
or 25%, it was a reality.
Mr. Fred McMahon: I'm not really sure where
this is leading us. As I say—
Ms. Marlene Jennings: The point I wanted to make
was did you take into account the social capital and
the fact that having social safety programs and a
social safety net can in fact assist in productivity,
because it allows people to move into the net when they
are having difficulty and then to move back into the
Mr. Fred McMahon: So you would approve of the type
of welfare reform in the United States, where it's
strictly restricted so that people can only move in and
out and not develop a long-term dependence on it.
Ms. Marlene Jennings: I think that's something
that could definitely be looked at. But the point is
that right now the overwhelming majority of people
who do use social assistance in Canada do not use it on
a long-term basis.
Is that correct?
Mr. Fred McMahon: Yes. As I said before, I agree.
I think you have to be very careful when you
develop your safety net programs. I approve of
the safety net. I don't think—
Ms. Marlene Jennings: From what I heard, it didn't
sound as if you did.
Mr. Fred McMahon: I approve of the safety net.
You have to be very careful in developing it so as not
to set up a perverse program that gets passed on
through generations. I have complete sympathy, as I
say, for the safety net.
I think we have troubles when it gets perverse,
as it did in Atlantic Canada where in some communities
100% of two-income families were collecting UI and
where people were refusing work because they were on
UI. It got terribly perverse in The Netherlands with
their disability system. By the way, the way the
labour unions and the Dutch government are handling
that is to privatize—and this is a left-wing
parts of the disability system. It should be there for
those who are disabled; it should not become a way of
life. And you have to take great care in designing
policy in order to avoid that. I think you and I
Ms. Marlene Jennings: I agree with you on that.
Do I still have some time left, Mr. Chair?
The Chairman: Yes, and what is the final question you
were going to ask?
Ms. Marlene Jennings: Thank you, Mr. Chair. I'm
glad you've made that clear.
The last question I was going to ask was you were
talking about conversion effect—
Mr. Fred McMahon: I said convergence.
Ms. Marlene Jennings: Convergence effect. You
used the aid to Atlantic Canada as an example. Do you
have other examples related to Canada, either regional
or at a more micro level?
Mr. Fred McMahon: I've obviously focused on
Atlantic Canada. That's where I'm from.
As I say, I have looked at the evidence from the
United States, Europe, and Japanese prefectures.
Also, I've looked at somewhat similar evidence
on international foreign aid, which
is really revealing, with regard to the impact of
wealth transfers to developing countries. Foreign aid
does no good and may even do damage when it's
transferred to countries with bad policy regimes.
By the way, if you transfer $1 million to a foreign
country for education, you find absolutely no impact on
education spending. It's just fungible all the
way through. On the other hand, when it comes
to transfers to nations
with good policy regimes, which focus on infrastructure
and not on politicized spending or rewarding the elite,
you find very powerful effects from foreign aid.
I think the problem in Canada has not been the wealth
transfer to the Atlantic region but the highly
politicized way it has been spent and the distortion and
support of industries that make no economic sense.
The Chairman: Thank you, Ms. Jennings.
Mr. Scott Brison: Thank you, Mr. Chairman.
Thank you, Mr. McCracken and Mr. McMahon, for your
I appreciate both your perspectives. In fact I think
there's a fair bit of common ground in terms of where
the rubber hits the road and practical policies that
couldn't in fact work. But then again, I like
The New Republic and The National Review
as well, so perhaps I appreciate that kind of
The disincentives I feel exist on a micro level
involve, in a lot of cases, sometimes overlap and
inconsistencies between federal and provincial
programs. I know in my own constituency there is a
widespread case where there are disincentives for those
who are currently, for instance, receiving social
assistance, a direct disincentive to taking a
minimum wage job. To me, it seems perverse that
The decision by one of those individuals to
stay on social assistance, as opposed to work, is a
perfectly rational response to an irrational policy.
They're making a decision not to deprive their family,
and I understand their response. But my question to
both of you would be, what form of government policy
would best address the issue of disincentives that
exist at this level? And I do believe on a larger level
it becomes a productivity issue.
That's my first question.
Secondly, I'd appreciate your feedback in terms of
the brain drain issue, and particularly as it seems to
be affecting disproportionately those in the high-tech
sector. We are seeing some of our best and
brightest young people, particularly those in
relatively high income levels, who are choosing to
leave because of opportunities elsewhere. How can
that affect productivity, particularly if the IT sector is
one of the sectors that should be playing a more
In terms of the Canadian dollar, some argue that the Canadian
dollar is a reflection of lower productivity, or a
nation's dollar is a reflection of lower productivity
and the exchange rate mechanism operatively reflects
productivity. Some other people would argue that it in
fact also can create a self-perpetuating prophesy, in
that companies may in fact not be making the types of
investments in technology because of the fact
they're hiding behind the low dollar policy that exists
now. I'd appreciate your perspective on the impact
of the decline in the
Canadian dollar on Canadian productivity.
Lastly, Mr. McCracken, you were mentioning that
productivity is best applied to the workplace. The
Statistics Canada presenters a couple of days ago said
they had intentionally carved out education and health
care when measuring productivity in Canada, and I see
that as a bit of a problem, because if we carve out the
areas of education and health care, it's a fairly large
segment in terms of our workforce. They are also both
areas that can impact productivity in terms of output
in the long term, particularly if knowledge-based industry
is going to be the growth area.
So I would appreciate either or both of your
feedbacks on how best we can measure productivity, or
perhaps improve our measurement by in fact measuring
public-produced goods, as opposed to purely
market-produced goods, because I think that's something
we have to get our heads around.
Mr. Fred McMahon: I think you're right, that Mr.
McCracken and I agree actually on most things. We put
on that show of disagreement just for your amusement.
The Chairman: We gathered that. Thank you.
Mr. Fred McMahon: I'm sorry, I meant to respond to
this when you raised it, because it's a very difficult
question, what you were talking about, the
disincentives to enter the workforce.
We tend to believe that the highest tax rates in
Canada are on high-income people. That's wrong. The
highest tax rates in Canada are on people moving from
social assistance into the workforce, and oftentimes
it's well over 100%.
You face two problems there. One is the employment
trap, which says that you don't move into work because
you actually lose income when you move into work. And
then once you address that, you face the poverty trap,
because what happens if you start rewarding people to
move into work is you begin to tax it away at a higher
level as they go up the scale, so improvements in
income don't translate.
There are two ways to address this. One, which has
happened a lot in the United States, has been
cutbacks on social assistance. The initial
evidence there is—actually it wouldn't be politically
correct to say it in Canada—quite promising. It seems
that about a third—don't hold me to that—of the
people on social assistance will move into the labour
force when you cut back or limit benefits.
The kinder way is to do it through various tax credit
programs. Our personal exemption for low-income people
is criminally low, much lower than in Britain, much
lower than in the United States. I don't know why
we're taxing somebody who's earning under $20,000, but
we do. That's absurd.
The brain drain is not something I particularly
studied, so my comments on that will be very quick.
Obviously the tax regime has a fair amount to do with
it. The evidence I've seen suggests that a
lot of people go to the United States because they find
it a more dynamic and interesting place. So it's just
not low income or high taxes; there are other things
Something Mr. McCracken said earlier I would
pick up on here. He talked about firms generating
trust and enthusiasm on the part of their employees.
The United States business sector, from the studies
I've seen, has been far more effective at that than
Canada through various profit-sharing and stock-sharing
plans and by moving decisions down the scale. Canadian
business still tends to be too hierarchical and so on.
Those factors—more employee involvement, more
decisions down the scale—seem to have as significant
an impact as the actual income and the high taxes. So
it's a problem that's difficult to address through
policy, because it may be a failure of the Canadian
As for the low dollar, I really wish I was able to tie
these three things together in some way to make a
thread, but I can't.
Mr. Scott Brison: I'd like to have a book about it.
Mr. Fred McMahon: The low dollar, continuing
depreciation, is a fool's path to prosperity. Just as
you said, people, the manufacturing sector, for
instance, will look at it and say “We can
compete at this level, and when we can't the dollar will
probably fall again”, rather than making the necessary
investments in not just physical capital but human
capital, which by the way is another area where the
United States firms are much better than Canadian
So the low dollar may have saved us to some extent,
but it's a path to poverty in the long term. And that
path is tied to our weak productivity performance.
The Chairman: Mr. McCracken.
Mr. Mike McCracken: I don't know what we agree on.
Let me just say what I think and then you can decide
whether there's any overlap.
In terms of the disincentives for employment and the
anecdotes of people refusing to go off social
assistance to take a job, too many times that job is
one at minimum wage, unknown hours, insecure in terms
of its duration, maybe just part-time, and with usually
lousy benefits. You wouldn't move off social
assistance to take that kind of a job.
So you want to make a change there. It comes down to
a society in which there's sufficient forward motion
and demand for workers, whereby in fact decent jobs at
decent wages with decent benefits are available.
Anything else is certainly not the kind of move that
people should be making.
On the brain drain, in terms of the macro-picture, we
should not forget that Canada today brings in 200,000
people from the rest of the world, net. So if there is
a brain drain, I think we are the drain. We're the
receivers of human capital from around the world.
Countries all over the world are educating their
people, sending them off sometimes to Canada even at
their cost to be educated, and then having them stay
here. If we want to do something about it, maybe
we should pay back the countries from which we take
their best and brightest.
In terms of the high-tech companies who are perhaps
having some challenges maintaining certain of the
people, they do have options if they want to keep them:
pay them more, challenge them more. And if your
concern is whether Microsoft is going to move forward
sufficiently rapidly to dominate the world, then look
at world productivity. Maybe it is better that they go
down there to help them do that.
On the exchange rate, there are a number of different
issues, but let's recognize what an exchange rate
depreciation is in the first instance. It is a
transfer of a huge amount of income from the personal
sector to the corporate sector. Essentially, consumers
pay more for both their imported goods as well as for
all of those domestic prices in Canada that are set
relative to foreign prices. And the companies receive
that: import-competing sectors get higher prices, and
exporters obtain higher revenues. So that's sort of
Then the question comes down, what do they do with it?
If they invest and expand and use it for hiring
additional people, and if they're able to pass on those
gains in lower prices in competitive markets, then in
fact there's a hope that out of all of that there will
be an employment improvement for Canadians. So there
will be some payback to the personal sector. But if
they sit on it, or if they take the profits and send
them abroad, then in fact there's no gain, from the
viewpoint of the Canadians who have made that transfer.
In terms of its effect on behaviour of companies,
there is very much a two-edged sword, a
carrot-and-stick kind of an effect. If you have a
depreciated currency, you have more profit, so you
should be able then to invest more and to sell more in
open and competitive markets. But many firms have
squandered that benefit over time. And certainly when
we see a substantial appreciation of a currency, in
Canada as well as in other countries, we see that many
companies' feet are put to the fire. They essentially
have to adapt.
At one time there was a substantial appreciation of
the Swiss franc, so much so that they were concerned
they were going to lose their entire manufacturing
sector. They lost a lot of it, but the parts that
remained were highly productive. They were forced to
adapt to change to become extremely modern.
So if your focus was only on productivity growth, you
might find that what you want to do with business is a
two-by-four between the eyes, and that's a good strong
appreciation. It has a by-product of also improving
real income of people in that process.
Unfortunately, we seem to have little capacity to move
the dollar around as we want, from a viewpoint of
policy, but rather have to live with the consequences
of whatever happens.
On the more general issue of measurement, when you
leave out sectors in calculating your productivity
measures—like the public administration sector, like
education, like health care—essentially what you are
doing is recognizing that we are not able at the
present time, or have not so chosen, to put in a
productivity growth element to those measures in our
national accounts. So by leaving them out, we are
implicitly saying we will assume their productivity
growth is not unlike what's happening in the rest of
the sectors, focusing on the business sector, for
Indeed, though, it would be very useful to contain it,
because for example in public administration, an area
that of course some of you think has no productivity,
are in fact some of the best documented improvements in
productivity growth that have ever occurred. For
example, look at cheque clearing: it's a very simple
process, but if we look at the number of people
required to clear a certain number of cheques today,
there's been a phenomenal improvement in that
productivity. The capacity to monitor, for example, a
whole series of functions on the stock exchange by
regulatory authority—the productivity of that
operation has been enhanced immeasurably by computer.
So any measures of productivity growth that you would
look at in the public administration area might well
show major gains, and certainly in health care as well,
and in some parts of the education system, with perhaps
a lot more to come as people expect increased use of
computers, Internet, and distance learning in that
area. But we still have this problem of valuing the
outputs of education, valuing the outputs of health
care, and valuing the outputs of good public
Until we solve that problem, we're going to continue to
leave them on the side, at roughly 20% of the economy.
If the other 80% does very well, then that's a good
The Chairman: Thank you.
I have one final question. As we engage in this
debate about productivity, what becomes apparent of
course is the fact that you can look at any factor in
society and say that it's related to productivity,
obviously. If you're looking at a breakfast program
for children who will go hungry, of course that is
related to productivity. If you're looking at taxes,
that is related to productivity. If you're looking at
international trade and fiscal monetary policy and
human resources development and so on and so on, that
is related to productivity.
One of the challenges of this committee will be to
perhaps isolate some areas where we can in fact give
some advice to the government as to areas we perhaps
should focus on that would have some kind of impact on
productivity. Some of it of course is short term,
other issues we raise are medium term, and others will
be in the long term. Can we get a sense from both of
you as to what areas you would move quickly on to have
a quick impact on productivity?
Mr. Fred McMahon: The first thing I would do would
be to increase the personal exemption and study other
ways to move income to lower-skilled workers. As I
say, while that might reduce per capita productivity,
the social benefits are huge, and it increases the
productivity over all of society by bringing people
back into the workforce. It can make some of these
marginal jobs more attractive by leaving more income
with the people.
The important thing to understand about marginal jobs
is that when somebody first enters or re-enters the
workforce, very often their income goes up thereafter
as they get labour market skills and so on.
I would like as well to second Dr. Kesselman's overall
thrust without going into the details. We do need
lower tax rates on capital to encourage capital
formation. Referring to both The Netherlands and
Ireland, in both cases the labour unions took a lead in
talking about wage moderation to improve profit margins
for companies. This is labour unions saying they have
to hold wages down so companies can get more profits,
so there would be more investment and more incentive to
Now, that's not going to happen in Canada. I can't
imagine the recently retired Bob White saying we need
higher profits here. But government can have an impact
through the taxation rates on capital. Mr. McCracken
was right earlier when he said it's both investment and
savings. Causality flows both ways. You have to make
capital less expensive to use.
I would encourage government to focus, as I said
before, on those things government does best. Get rid
of all the fancy frills, which cost the Canadian
taxpayer billions of dollars every year, and focus on
things like infrastructure, health care, education,
things that have been shown to bring benefits to all
Canadians, both economic and social benefits, rather
than what all too often happens, which are fancy titles
in search of a program.
So those are the three things I would do: focus
government spending; widen the personal exemptions for
low-income people; and work on the tax on capital.
The Chairman: Thank you.
Mr. Mike McCracken: I'll give you a complementary
list, with no tax measures.
Essentially, let's think of two issues. One is the
focusing on productivity. I think the other thing that
as a committee you will no doubt have as a result of
these three days, if nothing else, is an awareness of
the effects of other programs, policies, etc., on
So I think it will
serve you well to be thinking, as you talk about tax
systems or other issues you'll be dealing with, bank
mergers and so on, that they may also have side effects
on the productivity side.
Let's focus just on the productivity side. My sense
of the priorities in some relative sense of
importance is that perhaps all-important is
that we must first say that what we're trying
to do as an objective is to get to a full-employment
economy. Without that, we're going to be in some sense
continuing to talk about the difficulties of
productivity but we'll have none of the adjustment
mechanisms in place working that in fact help improve
productivity. We can't move people from sector A to
sector B if we're not in a fully employed economy.
It's very difficult. It's very easy if you can get a
job in another sector that pays more; then the
signal's very clear, and you make the move. But when
you're unsure about whether you're going to have a job
in the future, and when you have large degrees of
unemployment in your society, and uncertain employment,
as we have currently, then it's a very tough sell.
Part of that strategy is to go to full employment,
lower real interest rates, increase infrastructure
spending by governments, train people in business....
We keep talking about the long lags from education to
improve human capital, but you could much more directly
work on the existing stock of human capital if you
could get business in this country to provide adequate
training. Well, they don't, and the reason they don't
is there's no incentive to do so. They can hire
someone who's well trained right off the streets. But
if they couldn't, they would have a stronger
incentive to do that training internally.
You can also make some further steps, I think, on the
post-secondary education side, and particularly in the
more broadly based trainings, ones that do bring
together the sciences and humanities. That's the kind
of world I think we increasingly need to have.
Finally, focusing on social capital, social cohesion,
building trust in the institutions in this country,
including trust in government, I think would go a long
way toward improving the performance of our society and
the capacity for it to in some sense pull on the rope
in the same direction.
I note that comments have been made about Ireland.
Ireland's also I think dealing increasingly in an
environment where there is trust among the
partners—business, capital, labour, and
government—some of that perhaps through the relatively
newly formed Irish Economic Council.
Certainly one minor thing we could do in Canada is
what we did back in 1963 and 1964—to establish a
national productivity council and the next year fold
that into the Economic Council of Canada as a consensus
organization. We've lost that. We lost that in 1991
and 1992, for a variety of reasons. Let's just say
that historically it's no longer here. It does,
however, leave us without a place to talk. It leaves
us without a research basis on an ongoing basis on such
issues as productivity, employment, corporate
concentration, and so on. So it well might behoove us,
if we did nothing else, to revisit the need for such an
institution on an ongoing basis to focus on
productivity as well as many other issues.
Thank you very much.
The Chairman: Thank you very much, Mr. McCracken
and Mr. McMahon. We certainly appreciate your
comments. I'm sure we'll be reviewing them as a
committee as we prepare to write a report to the
Minister of Finance on our findings.
This is indeed a very challenging issue, one that will
require a lot of thought and analysis. I think the
committee feels we're up to this challenge. This will
become, of course, an issue the public will debate, not
just this year but I think for many years to come.
Thank you very much.
The meeting's adjourned.