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Canada's persistent productivity decline over the past three years poses a challenge for the Bank of Canada's efforts to curb inflation. Despite expecting productivity to rebound during the post-COVID-19 recovery, it has fallen in eleven of the last 12 quarters, returning to 2016 levels.
This productivity slump not only hinders economic growth but also contributes to rising unit labor costs, a significant factor in inflation pressures due to higher wages.
Bank of Canada Governor Tiff Macklem acknowledged this issue, stating, "Weak productivity growth has been a recurring problem in Canada." This assessment followed the bank's decision to maintain its benchmark interest rate at a 22-year high of 5%, signaling a period of slower economic growth.
The central bank's forecast of a return to the 2% inflation target by mid-2025 faces challenges, especially after August's inflation surged to 4%, driven by higher gasoline prices and a 5.2% annual wage growth rate.
Derek Holt, head of capital markets economics at Scotiabank, highlighted that rapid wage gains do not correlate with productivity growth, which has been plummeting.
The rise in unit labor costs presents a dilemma for the economy: businesses may reduce their workforce to protect profits, or monetary policy could tighten further.
Money markets are anticipating another rate increase by the Bank of Canada in the coming months, with a transition to easing expected by the end of 2024, albeit at a slower pace compared to the Federal Reserve.
While Canada has experienced record levels of immigration, bolstering economic growth, per capita GDP growth remains lower than in the United States. Investment levels per worker are also significantly lower, with Canadian businesses investing 55 cents per worker compared to every dollar invested in the United States in 2021.
Structural factors further impede productivity, including Canada's vast geographical size, leading to higher transportation costs, a prevalence of small businesses that invest less, and the presence of oligopolies that reduce competition in sectors like banking and telecommunications.
The overarching concern is that with stagnating productivity in recent years, all wage gains may ultimately translate into price increases, intensifying inflationary pressures, warns Doug Porter, chief economist at BMO Capital Markets.