Warning for Canada—government red tape burdens U.S. productivity

The U.S. economy is enduring a dismal stretch of low productivity growth. It was recently announced that labour, measured as the total output of goods and services for each hour of labour, declined at a one per cent seasonally adjusted annual rate in the first quarter of 2016 for the non-farm business sector. Since the economic recovery began in mid-2009, labour productivity has increased at an average annual rate of 1.3 per cent—the worst performance over a seven-year time period since the late 1970s to mid-1980s.

Productivity growth is a critically important performance feature of an economy. In particular, it’s the main source of overall economic growth and rising standards of living. The relatively stagnant real incomes of most Americans over the past decade reflect the severe recession of 2008-2009, but they also reflect a substantial slowdown in productivity growth in the post-2000 period.

Numerous explanations have been offered for the worrisome slowdown in productivity growth. One broad explanation notably associated with the economist Robert Gordon is that technological change is occurring at a much slower rate than in the past, perhaps because the era of major innovations is behind us. Others dispute this pointing to recent and emerging technological breakthroughs in areas such a biopharmaceuticals and 3-D printing among other innovative developments.

Yet another broad explanation of poor recent productivity performance is that the U.S. economy is suffering from secular stagnation, which, in turn, is the result of too much savings and too little consumption. The “spending deficit” discourages capital investment, since businesses need less capacity to produce output at lower levels of aggregate demand. This, in turn, depresses the rate of productivity growth, since increases in the capital to labour ratio are an important stimulant to labour productivity growth. A problem with the secular stagnation thesis is that lowered spending rates may reflect consumer expectations of lower real income levels in the future owing to factors such as uncertain employment prospects, higher taxes and the like. In this way, expectations about relatively slow future rates of growth of income and productivity can become self-fulfilling prophecies.

One prominent potential explanation of the U.S. productivity slowdown is government regulation. The accumulation of such regulations diverts productive resources that might be used for other purposes such as research and development and capital investment in order to fulfill regulatory obligations. This diversion can contribute to slower productivity growth and reduced overall real economic growth.

Indeed, a recent study published by the Mercatus Center covering 22 U.S. industries over the period 1977-2012 found that federal government regulations—by distorting investment choices that lead to innovation- created a drag on the U.S. economy amounting to an average reduction in the annual growth rate of the U.S. gross domestic product of 0.8 per cent. If regulations had been held constant at levels observed in 1980, U.S. per capita income would be more than $13,000 higher than it is currently.

The U.S. productivity experience should be a cautionary tale for legislators everywhere, including Canada. Regulations are difficult to remove once implemented, as they create groups in society with vested interests in preserving regulations that shield those groups from direct or indirect competition.  The available evidence suggests that there is a potentially large economic payoff to eliminating regulations that have net social costs, as well as to forbearing from implementing new regulations with unfavourable benefit-cost rations. In the meanwhile, the (likely) continued proliferation of government regulations bodes ill for future U.S. productivity performance and economic growth and, therefore, for Canada’s economic growth prospects which are so heavily leveraged through trade ties to the performance of the U.S. economy.