Three Policies to Improve Productivity Growth in Canada



15

D. Productivity Drivers

In order to develop policies to improve productivity performance, it is important
to first identify the drivers of productivity growth.10 The standard starting point for the
discussion of the dynamics of productivity growth is the simple neo-classical growth
accounting model. In this model, there are three key factors determining labour
productivity growth. The first is investment in capital goods, which determines the size of
the capital stock and hence that amount of machinery and equipment and structures
available to each worker. Higher ratios of capital to labour, or capital intensity, boost
labour productivity. The second is investment in human resources, which determines the
quality of labour input. More human capital makes a worker more productive. The third
is the pace of technological progress, which is very roughly proxied by the rate of total
factor productivity growth. Technological progress is affected by the development of new
knowledge through R&D.

Capital investment, human capital, and technological change can be considered
the proximate sources of labour productivity growth, but they themselves cannot explain
why productivity growth actually takes place. Rather, it is the decisions of business to
invest and innovate and of workers to acquire human capital which are the driving force
behind business sector productivity advance. These decisions are affected by many
factors such as the state of business confidence, the entrepreneurial spirit of the business
class, and government policies. The latter are the focus of this paper.

Government policies affect the environment in which business operates in myriad
ways. The existence or absence of the rule of law is an obvious example, although of
more relevance to developing countries than developed countries. Macroeconomic
policies that affect the business environment include monetary policy, fiscal policy, tax
policy, trade policy, among others. Policies of a more micro-economic nature that affect
the business environment include competition policy, regulatory policies, and intellectual
property protection.

The magnitude of the impact of government policies on business sector
productivity growth is very difficult to gauge. There is no doubt that through bad policy
government can have a very detrimental effect on economic and productivity growth.
Stagnant countries rife with corruption and lacking appropriate governance structures
testify to the ability of government to kill the economy. Developments in Zimbabwze
drive home this point. Thankfully, such a situation is not relevant to a developed country
such as Canada with its democratic traditions, strong rule of law, and professional public
service.

Long-run business sector productivity growth in Canada is primarily driven by the
pace of technological change, supported by human resource development. Technological
change may be either embodied, what is embedded and hence put into use through new
capital equipment, or disembodied, that is not embodied in new equipment, such as

10 See Harris (2002) for a more comprehensive discussion of the drivers of productivity growth.



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