Economic theory predicts that, all other things being equal, as unemployment declines, it is more difficult for employers to hire workers, thereby pushing up wages, which then leads to higher inflation and eventually higher interest rates. However, economists in the US generally agree that the current business cycle has been different in that strong declines in unemployment have not brought on significant wage pressures, thus leading to tamed inflation. This, in turn, enabled the Federal Reserve Bank to keep interest rate, for a long period, at a historically low level. Puzzled by this unusual phenomenon, economists have come up with various explanations, including:
In this article, we aim to provide some insight into this phenomenon and its applicability to Canada. To this end, we focus on certain aspects of the labour market in the US and compare them to the Canadian labour market.
As Figure 1 shows, US unemployment has peaked in 2010 at 9.6% and has been on a strong declining trend since then, reaching a level of 4.9% in 2016. The median weekly real wage has reached a peak of US$828 (in 2016 dollars) in 2009 and declined to a level close to US$800 by 2014. In 2015, it finally reached its 2009 level and surpassed it only in 2016, by a mere 0.6%.
Figure 2 presents the same data for Canada. Like the US, Canada reached an unemployment peak rate in 2009 of 8.4%, following by a decline at a significantly lower pace than the US, reaching a level of 7.0% in 2016 (vs. 4.9% in the US). Surprisingly, Canada’s median real weekly wage was on a general uptrend from 2006 to 2014, while the US wage level stagnated. In 2015 and 2016 the Canadian median real weekly wage stalled, precisely at the time when the US wage finally showed signs of recovery. By 2016, the median real weekly wage in Canada was 1.5% higher than the level in 2009 (vs. 0.5% in the US).
It should be noted that the impressive performance of the US, with regards to unemployment, is somewhat deceiving, as it is largely the result of a decrease in the labour participation rate (from 66.2% in 2006 to 62.8% in 2016 - a decline of 3.4 percentage points, whereas Canada’s participation rate declined by 1.3 percentage points only (from 67.0% in 2006 to 65.7% in 2016). Thus the unemployment rate in the US benefited from a significant number of people leaving the workforce. This is illustrated in figure 3 below.
In order to gain a better insight into the labour markets, we removed the public and resource sectors from our analysis. In the public sector, employment and wage trends are not necessarily a reflection of the strength of the economy. We removed the resource sector (including agriculture), since employment and wages in this sector are strongly influenced by commodity prices, which have been highly volatile during the examined period (e.g. Canada’s commodity index increased by 29.3% between 2006 and 2008 and declined by 49.0% between 2008 and 2016), adding statistical noise to the analysis. We refer collectively to the industries that exclude public and resource sectors as “private, non-resource sector”. Figures 4 and 5 replace the total median wage by an average wage of the private non-resource sector in the US and Canada.
Figure 4 suggests that the real average wage in the US private non-resource category declined slightly from 2006 to 2008 but fully recovered by 2009. From 2009 to 2014, the average real wage was relatively stable. In 2015 and 2016, we have seen significant increases in average wage level in that sector.
In contrast to the US, Canada’s real average wage in the private non-resource sector was on a general uptrend level from 2006 to 2016. Overall, from 2006 to 2016 cumulative wage increase in Canada was an impressive 9.5% (vs. 4.0% in the US).
To better understand the drivers of the seemingly better performance of the Canadian labour market, we divided the private non-resource sector into 3 categories:
Figure 6 shows that the goods producing category in the US enjoys a higher average wage level than the other two categories. However, since 2006 the difference between the average wage level at the goods and high wage services categories shrunk considerably, reaching a level of only 4.0% in 2016 (vs. 12.8% in 2006). The average wage gap between high wage services and low wage services increased at the same period from 56.4% to 61.0%.
In summary, during between 2006 and 2016, the high wage service category enjoyed a real increase in wage level (cumulative of 7.8%), while the goods category (negative 0.6%) and the low wage service category (increase of 4.4%) lagged behind.
Figure 7 shows that, like the US, the goods category in Canada enjoys a higher average salary than the other two categories, however, in contrast to the US, the gap between the sectors in Canada has not changed significantly from 2006 to 2016. The average wage gap in 2016 between goods and high wage service categories dropped modestly from 6.8% in 2006 to 6.5% in 2016 and the gap between high wage services and low wage services remained 56.4% during the same period.
In summary, during the 2006 to 2016 period, all three categories in Canada enjoyed similar and strong real wage gain. In contrast, in the US the high wage service category saw a significantly higher wage increase compared to the other two categories, which experienced relatively weak gains.
During the reviewed period, the strong wage increase in the Canadian goods category was supported by a strong gain in productivity of this sector amounting to 12.3%, on a cumulative basis. In the US where no wage gains were made, productivity in the goods category lagged significantly behind Canada (latest data available for 2015 shows a cumulative gain since 2006 of approximately 6.0% vs. 10.3% in Canada during the same period).
In the services categories, however, Canada lagged the US in productivity gains, especially in the high wage service category, where the US gained approximately 12.0% between 2006 and 2015 compared to approximately 7.0% in Canada. On the surface, this data defies the economic principle of wage gains tied to productivity gains (i.e. Canada saw a higher wage gain despite a lower productivity growth). However, this equation can be disrupted by increased outsourcing and automation. There is a general consensus that Canadian service companies have been lagging US companies in outsourcing and adoption of automation. One indication that supports this notion is the dismal picture of business investment in Canada over the last decade. Investment per employee in Canadian non-resource industries has seen practically a stagnation over the last decade compared to an increase of approximately 30% in the US. Another possible explanation for the lower wage gains in the US may be the higher flexibility of the labour market in the US, which enabled employers to reduce wage levels during the financial crisis, where in Canada, stricter labour rules generally kept wages from declining.
Figure 8 shows that most of the pain in this business cycle was felt by the US goods category. From 2006 to 2014 employment in this category fell by 15.6%. Since the goods category is the highest paying category, it follows that overall wages in the US have stagnated during the reviewed period, especially given the fact that the average real wage in this category, during the same period, declined by 2.9%. The 8.4% increase in high wage services’ employment between 2006 and 2014 combined with a 4.2% increase in the average wage of this category (during that period) helped to offset the decline in the average wage of the goods category, resulting in a relative stability in the real average wage of the private non-resource sector during the years 2006 to 2014.
The increase in the overall US wage level since 2014 was driven by the continuous strong wage increase in the high wage service category supported by a recovery in employment and wage level in the goods category. The low wage service category fell behind the high wage service category both in terms of employment and wage level.
The wage trends in the US support the notion that the US labour market was driven by increasing outsourcing and automation in the service sector, which tend to benefit highly skilled employees. It also helps explains the social divide that was apparent in the latest US presidential election (the so called “blue collar-white collar divide”).
Similar to the US, Canada’s goods category suffered from a decline, albeit at a significantly lower rate. This is illustrated in figure 9. By 2009, Canada lost 6.4% of its goods employment (compared to 17.7% decline in the US). By 2016 the cumulative employment loss in Canada since 2006 was only 2.2% (compared to 12.4% in the US). Employment performance of the service sector in Canada also outperformed its US counterpart.
This divergent trends of the two countries help to explain why the US export makeup during the last decade became more service oriented with 34.1% of exports in 2016 made of services (compared to 28.6% in 2006), where services in Canada made only 15.4% of its exports in 2016 (a mere one percentage point increase from 2006).
Over the past decade, Canada’s labour market has outperformed the US by providing employees across all sectors stronger wage gains. This coupled with a low exchange rate may explain the strong economic growth in Canada, which is mainly a consumer led story. The Canadian superior economic performance is even more compelling given that, according to equality measures, growth has not come at the expense of equality.
However, this superior performance is no reason to be complacent. Behind the obvious trends, there is an underlying transformation of the US economy, over the past decade, which is moving away from goods and low value added services into more high value added services. This was likely achieved, amongst other factors, through increasing reliance on outsourcing and automation. As the data shows, the US labour market has turned the corner in 2014. This will lead eventually to higher wage gains and higher interest rates in the US that, in turn, may affect negatively the Canadian consumer-led growth economy.
In Canada, we seem to have generally kept the make-up of our economy and have taken a more cautious approach to outsourcing and automation. This had a negative impact on our service categories’ productivity, which helps to explain why Canada is lagging behind most developed countries in its services export.
While the course of action taken by Canadian companies helped us avoid the social upheaval, we have seen in the US, we need to recognize that this comes at the expense of lower productivity, which may eventually come to haunt us. With the growing importance of the services sector as a source of wealth creation for modern economies, Canada cannot afford to lag behind on this front. In recent years, the low Canadian dollar shielded us from the negative consequences of this low productivity trajectory. However, this is a recipe for economic shocks down the road, when inevitably macro-economic conditions change. In particular, the deregulation process that is taking place in the US, coupled with the prospect of lower US corporate taxes and increased level of regulations in Canada, will have a negative impact on our ability to compete, especially in the goods category.
To avoid such shocks, Canada needs to support the expansion and creation of high value added service industries and ensure that our post-secondary education institutions provide relevant skills to our students. In particular, our workforce need to acquire skills geared toward artificial intelligence, in order to turn the trend toward automation from a job killer to a job creator. By acknowledging the challenges faced by the Canadian economy and following this recipe, Canada would have a better chance of increasing productivity without undermining its healthy social fabric.
Michael Dobner is the National Leader of PwC Canada’s Economic practice
The following staff of the Economic practice assisted in data gathering and analysis: