Atlantic Institute for Policy Research Highlights
Economic policy commentary and research from the AIPR

When labour costs outpace productivity

Author: Herb Emery

Posted on Aug 7, 2019

Category: Manufacturing , Social Policy , JDI Roundtable , Regional Economics , Labour Markets

New Brunswick’s economy is sick.
Since the 2008 Great Recession, New Brunswick has been plagued by a chronic condition called “Baumol’s cost disease”, caused by the double whammy of an aging population and sluggish business investment. We have fewer people in the labour force and our businesses either don’t have the confidence or resources to invest in productivity-enhancing improvements.

The result? Labour costs are going up but productivity is not.

While we try to treat the symptoms with increased immigration, the long-term cure for what ails us is investment and innovation to drive productivity growth.

Baumol's cost disease happens when there are increases in wages for jobs that have experienced little or no increase in labour productivity due to competition for labour from jobs which have experienced productivity growth. For slow productivity growth jobs, this Baumol effect lowers the competitiveness of businesses. For the public sector (including health care and education), the Baumol effect raises the tax burden of paying for services. 

Labour productivity refers to the value of output produced with an hour of work. When labour productivity increases, revenue generally goes up. The firm can pay workers more without reducing profitability. In contrast, if wages rise but labour productivity does not, then firm profitability declines and businesses are less competitive.

That’s what’s happening in New Brunswick. Wages are rising but the value produced by an hour of work has not increased. Firms are becoming less and less profitable.

In the decade prior to 2008, after adjusting for inflation, average hourly wages in New Brunswick increased by 0.6 percent per year and labour productivity was rising by 1.8 percent per year. In the decade since the 2008 recession, wages have been increasing by around 1 percent per year but labour productivity is increasing by only 0.5 percent per year. That is Baumol’s cost disease.

Out-migration of people leads to a decline in business competitiveness

New Brunswick has had lower labour productivity and wages than other provinces for a long time. We lose a sizeable part of our potential workforce to provinces where pay—and labour productivity—is higher.   

Prior to 2008, New Brunswick was a labour abundant economy, meaning competition for workers wasn’t an issue. If one worker quit, there were others around willing to work at the going wage rate. Back then, out-migration did not put upward pressure on New Brunswick wages. Competition among workers for jobs tended to temper the growth rate of wages even when labour productivity was rising.

Since 2008, our population has aged and we have found ourselves with a much smaller population of young people. New Brunswick is no longer labour abundant. That means that out-migration and competition for New Brunswick workers is putting upward pressure on wages.  Employers in New Brunswick struggle to pay higher wages because labour productivity is not rising. Labour costs are worsening the bottom line and undermining business competitiveness. 

Government policies are kicking the economy when it’s down.

New Brunswick’s problems have been compounded by a series of government decisions to allow labour policies, programs and regulations to exacerbate the “Baumol effect”. With no productivity growth, increases in WorkSafeNB premiums, introducing a paid statutory holiday, raising the minimum wage relative to the average wage are all added payroll costs that cannot be covered out of higher labour productivity. Employers have even less room to raise wages to meet the wage competition from other provinces or employers in New Brunswick. 

Baumol’s cost disease weakens business capacity to absorb the impacts of carbon pricing, rising energy costs and should it happen, property taxes applied to the value of machinery and equipment. In short, government policy has eliminated any surpluses or reserves available for business investment that could raise productivity and cure the disease

Baumol’s cost disease is relevant to the problem often labelled a “labour shortage’ in the province. General economic principles suggest the solution to a labour shortage is higher wages. Higher wages attract workers to firms and the higher labour cost temper the demand for labour. 
So why isn’t this happening in New Brunswick?

Baumol’s cost disease could explain why wages haven’t risen sufficiently to address labour shortages. Wages can only rise so far in a low-productivity growth environment before firm exits and deaths become inevitable. We may be closer than we think.
Stop thinking “labour shortage”. Start thinking “cost disease”.

Framing the problem correctly is the first step to finding the right solution. The interpretation of New Brunswick’s economic challenge as one of a labour shortage, rather than a cost disease, has led to a focus on trying to fix the situation by increasing labour supply through immigration, education and training. 

There is no doubt that New Brunswickers need to overcome their indifference to out-migration. But simply attracting and retaining won’t fix the problem.  

What ails New Brunswick can only be cured with productivity growth. The competitive pressures that raise wages in the province are not likely to abate simply because our wage levels remain lower than other places. We need to raise our labour productivity by returning to pre-2008 private sector, non-residential investment levels.

New Brunswick must encourage investment in advanced manufacturing processes (automation) that raise labour productivity. We need to continue to invest in research and development to drive productivity enhancing innovation. And most of all, we need a provincial government that understands that it has the power to cure this disease.

First, the government can take steps to address all the harms listed above that have been done to business competitiveness in New Brunswick since 2007. Second, we need an attitudinal shift among our political leaders, who see their role as maintaining business health while feeding labour more to gain votes. 

Politicians need to pay closer attention to the conditions that enable business to survive in what is, by virtue of its location and population, already an uncompetitive locale. While it’s politically rewarding to focus policies on the labour side of the equation, there won’t be any votes left to win if we allow our firms to exit and die from preventable “cost diseases”.

A version of this commentary was published in the Telegraph Journal on August 7, 2019 and is reproduced here with permission from Brunswick News.



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