Changing Canadian Economy

This is an excerpt from Gov Poloz's article on Bank of Canada website.

Advances in technology lead to higher productivity and greater production, which in turn permit the development of new economic activities and increased specialization in jobs. Over time, the lion’s share of these new activities has arisen in the service sector. Joseph Schumpeter called this process “creative destruction,” because improving how we do things destroys the old while creating the new. And the key facilitator of this growth process is trade, both domestic and international; otherwise, we would all have to be jacks-of-all-trades.

Let me illustrate with the Canadian experience. At the time of Confederation, about half of working Canadians were employed in agriculture in one form or another. Of course, technological advances led to enormous increases in productivity, creating opportunities for people to move away from farms and into cities. New technologies, coupled with the newly available workforce, sparked the creation of whole new activities, both in manufacturing and in services.

By the 1920s, only one-third of Canadians were still involved in agriculture. By the 1950s, that figure was down to 15 per cent and, today, it is less than 2 per cent. And, yet, agricultural output today is more than three times what it was 80 years ago.

Clearly, agricultural employment fell because technological advances and scale economies allowed for greater output with fewer employees. And this freed up the labour that allowed for the industrialization of Canada and fuelled the development of the service sector.

The same process is continuing today with the decline in employment in goods production. New technologies, automation and robotics are allowing for higher productivity and output with fewer workers. Canadian factories are about five times more productive today than they were in 1955. This means more output per worker, not necessarily fewer workers. Indeed, improved productivity is essential to compete internationally, which is itself essential to maintaining or growing a business. In other words, without increases in productivity, the business itself and all of the associated jobs can be lost.

This is the creative destruction process at work. Specific jobs lost to automation are gone. Exporting companies who closed their doors in the wake of the global recession in 2007–09 are unlikely to return. Rather, surviving companies will expand, and other, new companies will grow in their place.

Naturally, I am oversimplifying the matter. The real world is far more complex than our economic models suggest. Even the distinction between goods and services is a blurry one. Consider the smartphone in your pocket. Yes, its manufacturer used circuits, wire, plastics and other materials. But it also needed research and development, engineering, design, software, transportation, trade, finance, legal, sales and accounting services. And certainly your phone would be totally useless without telecommunications services, not to mention after-sales service, including a call centre to help with problems.

Rather than a dichotomy between goods and services, it is much more useful to think of a spectrum—from raw commodities at one end to pure services at the other. In general, the further up the value-added chain the manufactured product, the more services are embedded in it.

There is reason to believe that the Canadian economy has a comparative advantage in some of the service categories I just mentioned, as well as others, such as tourism. We have the necessary ingredients: a highly educated labour force supported by strong universities and colleges; entrepreneurs with access to business incubators; a beautiful and interesting country that many would like to visit; a multicultural workforce that helps us to serve domestic and international markets. And, that comparative advantage has been strengthened by the decline in the Canadian dollar in the past couple of years—a symptom of falling resource prices, and a facilitator of the rotation of growth from resource production to other sectors.

Filling the Hole

So, how can we fill the economic hole I spoke of earlier? Of course, monetary and fiscal policies are doing their part to support the recovery. But can growth in the service sector play a role? It already is, and we can expect its contribution to grow in the years ahead.

Since the onset of the global financial crisis, growth in Canada’s service sector has been stronger on average than in the goods sector. Most of the employment growth seen in Canada since late 2014 has been in service industries that pay above-average wages, helping to support national income.

Services are also a bright spot in the export picture. Exports of services have continued to grow, both relative to goods and in absolute terms. In the first half of 2016, Canada was on pace to export more than $100 billion in services, almost $25 billion more than five years earlier. At a time of sluggish trade growth worldwide, exports of Canadian commercial services such as engineering, research and development, and financial services have grown by more than five per cent annually since 2000. And tourism exports are now generating about $17 billion per year, over $2 billion more than five years ago.

We’re particularly excited by recent developments in information technology (IT) services. We are seeing increasing numbers of foreign companies locating the IT service components of their supply chains in Canada. The publication fDi Markets reported that during 2015 and the first half of this year, 65 projects were announced or launched by foreign companies employed in knowledge-intensive services such as smartphone applications and custom computer programming. It is worth noting that last year, the average wage across highly digitalized industries, which includes IT services, was 17 per cent higher than the average Canadian wage.

The Bank recently conducted an in-depth survey of about 50 exporting companies and industry associations in the IT service sector. Bank staff asked many of the same questions we ask in our Business Outlook Survey. They found that IT service exporters were more optimistic than the average Canadian company. Many of these firms, which are located right across the country, reported double-digit sales growth.

Most of them said they expected sales growth to continue to be strong, particularly export sales, and fully three-quarters of them are expecting to hire more people. None said they are looking to cut employees. A large majority said they are looking to invest in research and development. And nearly half said they are planning to boost spending on physical investment. But the companies are not typically planning to invest in what one would traditionally think of as industrial machinery; rather, they are investing in equipment such as computers and software.

And, of course, the other place where these companies are planning to invest is in people. The companies in the survey who said they would have difficulty meeting an unexpected increase in demand almost unanimously cited a shortage of skilled workers. In fact, the idea of physical capacity is almost irrelevant in this industry. To increase sales, these firms need to hire, and possibly train, sales and support staff, programmers, developers and computer engineers.

The data are limited, but evidence suggests firm creation in this industry is above the average of the rest of the economy. Output has grown by more than 15 per cent since the start of 2011—a faster pace than the rest of the service sector and more than double the pace of the goods sector. In the past five years, the industry has grown by close to $8 billion and now represents more than 3 per cent of our economy. This is the kind of creation that follows the destruction.

These are just some of the channels of growth that we expect will replace what we have lost in the past few years. There will also be contributions from our more traditional exports. Agricultural exports, for example, have grown by more than 13 per cent in the past five years, including $2.4 billion in canola and pulse crops. Pharmaceutical exports have grown by $7 billion; machinery and equipment, $3 billion; furniture, $2 billion. Even the “other” export category is more than $1 billion higher than it was five years ago. When you put all of these examples together, you can see that we are making real progress in filling that hole I talked about earlier.

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