Government growth ultimately hits Canadians in the wallet

The key determinant of improved living standards is improved labour productivity—essentially, the value of goods and services produced per work-hour. Hence, as Canada recovers from the pandemic, and governments increase spending and rack up debt, the consequences of larger government remain a critical public policy issue.

Basically, government borrowing and spending reallocates productive “inputs” (labour, for example) from the private sector to the government sector to facilitate the provision of government services. Consequently, if productive inputs are used more efficiently in the private sector, the transfer of those inputs to produce more government services will reduce overall productivity growth.

Crucially, the productivity growth differential between the government and private sectors in Canada is dramatic. Using the standard measure of labour productivity—the ratio of the value of output (adjusted for inflation) divided by hours worked—labour productivity increased by 31 per cent in Canada’s business industries compared to 12 per cent in the government sector from 2000 to 2020.

In addition, the productivity performance of the government has been deteriorating. For example, labour productivity in the government sector increased by 7.3 per cent from 2000 to 2010 compared to 4.5 per cent from 2010 to 2020. Yet labour productivity in business industries increased by 8.7 per cent from 2000 to 2010 compared to 20.5 per cent from 2010 to 2020.

Of course, some economists may object to a direct comparison of productivity changes in the private and government sectors, noting that governments provide services while businesses provide both goods and services. If it’s more difficult to improve the productivity of services than goods, government will be at a disadvantage in any direct comparison of productivity performance.

But consider this. From 2000 to 2020, in businesses that only produce services, labour productivity increased by 38 per cent compared to, again, the 12 per cent increase in the government sector. To be sure, there are problems in measuring service sector outputs and productivity, especially in the case of government services where the value of output must be imputed in the absence of market prices. One must therefore be cautious when comparing productivity performance in the government sector to private-sector service industries. However, large differences in productivity growth rates between the sectors persist.

A second possible objection is that some government services (education, for example) facilitate faster productivity growth in the private sector. Hence, we should credit some portion of the measured productivity growth in the private sector to the government sector.

But while one can argue that a healthier and better-educated workforce facilitates greater productivity growth in the private sector, a substantial portion of government activity may actually harm the productivity performance of private-sector businesses. For example, excessive government regulation discourages productivity-enhancing capital investments and innovation, particularly among small and medium-sized firms. When taking the entirety of government spending into account, the overall activities of government, on balance, may actually discourage rather than promote private-sector productivity growth.

As policymakers in Ottawa and across Canada consider the appropriate size and scope of government in the emerging post-pandemic era, it’s important to give proper weight to the consequences of larger government for our long-run productivity performance. In this context, it’s not just that a greater share of our incomes will be diverted from private spending to pay down government debt, but the future incomes of Canadians will be substantially lower due to the growing size of government.