INDU Committee Meeting

STANDING COMMITTEE ON INDUSTRY

COMITÉ PERMANENT DE L'INDUSTRIE

EVIDENCE

[Recorded by Electronic Apparatus]

Tuesday, February 8, 2000

• 1532

[English]

The Chair (Ms. Susan Whelan (Essex, Lib.)): I call the meeting to order, pursuant to the committee's mandate under Standing Order 108(2), a study concerning productivity, innovation, and competitiveness.

We're very pleased to welcome our witnesses. Today we have with us from the University of British Columbia Dr. John Helliwell, professor of economics; and Dr. Jonathan Kesselman, professor and director, Centre for Research on Economic and Social Policy. From Simon Fraser University we have Dr. Richard Harris, professor of economics.

What I would like to do is to have each of you provide us with your opening statement or your opening comments, and then we'll proceed to questions in a round-table format. So if a member has a question, it could be directed to all three. If he directs it to one of you and the others wish to comment, either just jump in or try to signal me, and I'll try to recognize that.

I would propose that we proceed in the order I've identified. If that's a problem or if there's another order you'd like, I'd be more than happy to follow that. Otherwise, we'll start with Dr. Helliwell. Is that okay?

Dr. John Helliwell (Professor of Economics, University of British Columbia): That's fine. Are we ready to start?

The Chair: Sure, whenever you're ready.

• 1535

Dr. John Helliwell: I've been asked to address questions primarily concerning labour market linkages between Canada and the United States, and more explicitly questions known under the title of the brain drain.

I got into this in two ways. One was by doing a lot of studies about the extent to which economic relations are tighter within countries than between countries, and finding that trade linkages are much tighter within Canada than they are between U.S. states and Canadian provinces.

In the course of that study we looked at migration, and we found that in general, from census records in both countries, a Canadian who's found in Vancouver is about a hundred times more likely to have come from another province than they are to have come from a U.S. state.

The Chair: Excuse me, Dr. Helliwell. We're just trying to clarify the sound. Could you just hold for one moment? We're having difficulty. We need to have the volume louder at this end. Could you maybe move your microphone a little closer to you? That's great. Don't pull it too far.

Dr. John Helliwell: How's that?

The Chair: That's much better. Thank you, Dr. Helliwell. I apologize. Please continue.

Dr. John Helliwell: Should I continue or start again?

The Chair: Maybe start again, just for clarity's sake.

Dr. John Helliwell: I was explaining that I've been asked to focus primarily on labour market linkages and issues related to the brain drain. I came into this field in part from studies about the extent to which national economies are tighter than cross-border linkages—in other words, whether globalization is already here or is something merely to which we're moving, in slow or fast pace.

We discovered in migration studies, from census data in both countries, that interprovincial migration is much more important than migration from states to provinces, and that it was a hundred times more likely that someone in British Columbia who wasn't from British Columbia was from another province, rather than from a U.S. state of similar size and distance.

For the United States, however, we found that although it was much more likely that someone would have come from another state rather than from a Canadian province, there was much more migration from Canada to the United States than from the United States to Canada. Indeed that's been true for more than 150 years.

We can then assess the effect of that by going back and asking, from U.S. census data, what the shares of Canadian-born are in the U.S. population. At the turn of the century—the last turn of the century, in 1900—the Canadian-born in the United States were more than 15% of the population in Canada. That number has been almost steadily dropping throughout the century, so that by the early and mid-1990s, it was down to 2%. So there's roughly a seventh as big a share of Canadians born in Canada and living in the United States now as there was a century ago.

The issue of the brain drain of course, as it appears in the press and policy discussions, is much less focused on the total population than it is on people of high education and skills. To get a closer handle on that, we gathered the records together for all of the graduates at the University of British Columbia since it started producing them, about 1920, and in all the various degrees, and asked how likely it was that a graduate would be living in British Columbia, in the rest of Canada, or in the United States.

We found a striking parallel between these more highly educated people and the population as a whole. In particular for the bachelor's graduates of UBC, including those who went on to higher education afterwards, of the 1950s graduates, about 15% are now living in the United States. That percentage has been steadily dropping, and by the early and mid-1990s, it was about 2%.

As you move to the graduate programs, which are naturally a focus of a lot of study of highly skilled workers, we find a much more cosmopolitan picture. Roughly 15% of UBC's PhDs are living in the United States. That's almost exactly the same share for the 1960s PhDs as for the 1990s PhDs. Of course there are a lot more moving to the United States now, because in 1960 we were producing 20 PhDs a year and now we're producing more than 20 PhDs a month.

• 1540

Also since 1960, of course, our intake to our PhD programs has become much more cosmopolitan. We find that 7% of our PhDs actually come from the United States. More than half come from outside Canada—are not Canadian citizens—while after they finish, the graduates are more likely to be working in Canada than elsewhere. So net, of course, our universities at the very highest level—at least, UBC is a special case—are drawing in the highly trained from Canada and elsewhere, the best of the highly trained, treating them to training as PhD students, then sending them all over the world subsequently, but in fact keeping a larger share of the graduates than we attract Canadians in the first instance.

Another study of the local market that's relevant is a study by the Laurier Institute of the software and high-tech industry in B.C. B.C. faces an unusual difficulty, with high local costs, an economy that has been pretty sluggish during this decade, and higher tax rates than other jurisdictions in Canada. There has also been a lot of worry because B.C. is closer to the software network homes of Microsoft in Washington, just over the border, and Silicon Valley in California, and people who like the climate here tend to like it in Seattle and California as well.

The institute did a survey of the local firms as to how many people had come in and how many had left in a sample year of 1998. I was struck by the fact that although the headlines that came out of this study were, in part, about how many of these firms had lost employees to the United States, what was quite obvious from the data was that in that year 1998, although quite a number of firms lost employees to the United States—and that's no surprise given the often better opportunities and higher salaries there—there were more people moving from the United States into the B.C. software industry—50% more—than there were moving from that same industry to the United States.

The industry was growing so fast that it was attracting people into British Columbia from the United States in numbers even greater than the numbers of those who were moving from British Columbia to the United States. That has to be an unusual situation, because historically, of course, there have always been more Canadians moving south than Americans moving north. Also, that's a particular industry where, if there's a gap at all between the two countries, it clearly favours the U.S. more now than normally.

There's one final numerical point I'd like to make because it will be apparent to those of you who follow the press on this question. That is a study by the Conference Board of temporary movements of Canadians to the United States. Under NAFTA, there are these TN visas that allow, with relatively little fuss, Canadians who have work—and they must have a bachelor's degree or above, typically, to have this automatic access—to get into the United States with a minimum of formality.

Surveys like the Statistics Canada survey of the 1995 grads, our survey of UBC grads, and others, show that this is now the favourite form of access to the United States for those who want to go not just temporarily but perhaps permanently. The study by the Conference Board showed a very rapidly ramping-up series for the number of people taking on these TN visas, suggesting that although the most recent United States current population survey suggests that the number of Canadian-born living in the United States in early 1999 was less than it was in 1990, by a margin, these temporary visa numbers have in fact been rising very strongly.

So there are two things we have to ask ourselves: how do we interpret those numbers and, secondly, what can we get by way of information to let this question be settled once and for all? One thing that has not been noted by people looking at these numbers is that anybody who gets one of these temporary visas either has to move to a more permanent form of migration or get a new visa the subsequent year. Anybody who's on a TN and still on a TN several years after coming in will be in the current year's TN crop as well as last year's and those of the years before that.

• 1545

So you can't simply sum up the number of visas that have been issued if you want to know the number of Canadians working in the United States under one of these criteria. You have to take the current year's total flow of TN visas and exclude all the past ones, because they've either converted to a permanent form or come home, and then add to that the sum of the people who have come on more permanent visas during the period. I've not done those sums very precisely, but I think they will end up being pretty close to the kinds of numbers we get from the U.S. current population survey.

The final word on this question of brain drain between Canada and the United States, in terms of numbers, will be provided, of course, by the U.S. census of 2000. To supplement that, there is of course the Statistics Canada survey of 1995 graduates and where they are, which tends to match the UBC numbers very closely, and there is more information coming across from different Canadian universities.

I think I have given you enough to get started. Of course there are a number of literature references of papers we could offer to the committee for subsequent data if you need it, but this should get the discussion started.

Thank you.

The Chair: Thank you very much, Dr. Helliwell.

Dr. Kesselman, please.

Dr. Jonathan R. Kesselman (Professor, Department of Economics; Director, Centre for Research on Economic and Social Policy, University of British Columbia): Thank you.

Earlier I submitted to your committee three of my recent studies on public policies needed to spur Canadian productivity. These were papers on brain drain, capital gains taxation, and personal taxation. My presentation today will focus on the third of these papers, but first I'd like to offer some brief observations relating to tax policies and brain drain. Of course, my colleague John Helliwell has addressed this topic in greater detail and is certainly more expert on it in terms of your questions.

The evidence to date is that brain drain from Canada is relatively limited and is concentrated in a few sectors and that we are large net recipients of skilled workers from the rest of the world. However, we can't, in my view, be complacent about the situation, especially in view of the growing problems faced by Canadian business in attracting and retaining skilled workers.

For our economy to grow rapidly in the high-tech sectors, Canadian business needs not only to retain our homegrown talent but also to hire critical technical and managerial skills from the U.S. When the firms are forced to pay large salary premiums to compensate for the higher Canadian personal taxes—as they report they do in many cases—Canadian business either bears higher costs that make it less competitive or it forgoes those skills in a way that will hobble growth here.

Yet, as I stress in my brain drain paper, which is available to your committee, there is no magic policy pill such as sharp tax cuts, since we need to reach a delicate balance between the right amount of and kinds of public services and an acceptable level of taxation. Taxes that are too high will handicap Canadian productivity and employment growth and perhaps lead to more brain drain. Taxes that are too low, on the other hand, will imply deteriorating public infrastructure and a meaner society, both of which would make our nation a less attractive destination for business and for talented workers and managers.

One lesson for public policy in this area is unambiguous, though: there must be priority for channelling public expenditures to those areas that promote productivity and social goals of the top rank. When we waste public funds on political and regional goals, such as things you might have been debating in the House of Commons today—grants for business and jobs—we either crowd out productive spending on education, health care, and infrastructure, or we carry higher than necessary tax burdens that penalize the competitiveness of the Canadian economy. In short, a prerequisite for a competitive private sector is a more competitive and better focused public sector.

Now I'll turn to the primary topic of my presentation, which is the specific tax policies needed to promote productivity and growth of the Canadian economy.

The federal government's official policy stance has been that future tax cuts must stress personal income taxes before business or payroll taxes and must address the concerns of low- and middle-income taxpayers before the concerns of those at higher incomes. This approach may meet the political test of popularity, but it defies the mandates of economics for productivity-oriented policy.

• 1550

Future tax policies need to focus on supply-side incentives for efficiency and growth of the economy, with demand-side considerations very secondary. This follows from concern over the improvement of long-run real wages, work opportunities, and living standards in Canada.

The Bank of Canada's actions to tighten monetary policy indicate that aggregate demand is now deemed to be sufficiently buoyant, aside from selected regions. Any tax policy changes that add to consumer demand are likely to be countered by further monetary tightening. In contrast, tax policies that favour savings shift final demand from consumption toward investment, which does not further strain demand. Indeed, it augments the economy's productive capacity.

The official focus on personal income taxes, or PIT, and benign neglect of corporate income taxes and payroll taxes for EI appear to reflect an overly simplified view of taxes. It takes the names of the taxes rather than their economy substance as being paramount.

Canada does rely relatively heavily on PIT in its total mix, though no more than the U.S., at about 38% of total revenues, and relatively lightly on payroll taxes, or PRT, compared with most countries, including the U.S. However, for workers at low and moderate incomes, the PIT and PRT are both essentially taxes on labour income. So holding PRT rates artificially high—that is, beyond the needs of the employment insurance program—in order to finance larger PIT cuts for those at low and moderate incomes is a saw-off. It maintains a highly regressive tax on labour earnings in the PRT in order to reduce PIT on low to moderate earners. The optics are better for reducing the PIT, but the economic substance is little different.

Another federal argument against faster, sharper cuts in the PRT is that most of the gain would go to business via lower employer premiums. But this assertion ignores the economic incidence of such payroll taxes. While the immediate impact is to provide reduced costs for employers, in the longer term most of this benefit is shifted to workers in the form of higher gross wages and salaries. Of course, the government will not garner the political benefit of this increase in living standards for workers. It would prefer to pursue tax policy in a way that provides more direct recognition of its role in the process.

The official resistance to cutting business taxes via the corporate income tax is similarly founded on a desire to reap political credit from large numbers of taxpayers. The general public does not support business tax cuts because it does not understand the short- and long-run adverse economic effects of high or distorted business taxes. But there is little excuse for the government not to act on the compelling analysis of its own Technical Committee on Business Taxation or the more recent calls for non-revenue-neutral corporate tax cuts by that committee's chair.

The most urgent tax policy needs for enhancing efficiency and growth of the economy are better incentives for savings, investments, entrepreneurship, and innovation. These needs relate more to capital markets than to labour markets, but insofar as they relate to labour markets, it is those for higher-skilled and higher-paid occupations rather than lower-skilled workers. Hence, policy changes should concentrate on sensibly chosen cuts in business taxes and on PIT changes that reduce higher marginal tax rates, particular as they apply to savings and investment. If a large share of the total revenues for tax policy available in the 2000 and later budgets is devoted to these purposes, vital long-run economic payoffs can be secured.

For the corporate income tax, the most important change is to reduce the basic tax rate on firms outside the currently preferred manufacturing and processing sectors. The highest tax sectors include many of the high-tech and other higher-growth service sectors. Once the playing field has been levelled, there should be further moves to reduce our corporate tax rate below that of the U.S. The direct and indirect benefits to the Canadian economy, which would flow back to the public sector as higher revenues from all taxes, would make this change doubly rewarding.

For the PIT, the most important changes for productivity include three areas.

• 1555

The first is lowering marginal tax rates at upper, middle, and high incomes and sharply raising the income levels at which the highest rates apply through both federal changes and provincial changes, such as those recently proposed in Alberta and Saskatchewan.

The second is reducing the inclusion rate for taxation of capital gains from 75% to 50%.

The third change is sharply increasing the access to tax-recognized retirement savings.

The latter two changes are, in my view, more crucial than steep cuts in the statutory tax rates at the highest incomes. These changes will shift our personal tax system further toward an economically efficient and growth-enhancing consumption base. They will greatly reduce the marginal tax rates on savings and capital income. They will also reduce overall tax burdens for venture capital, growth companies, entrepreneurs, and workers with the professional, technical, and managerial talents that are most vulnerable to emigration.

Reduced tax inclusion for capital gains is likely to cost little in the short run and may even increase revenues. The evidence about longer-run revenue cost of this change is mixed, but at least the longer-run costs should be substantially less than indicated by a naive, static computation. This change could be paired with reform or curtailment of the current $500,000 tax exemption for gains on small business shares and farm assets. This would also promote equity across taxpayers.

Increased access to tax-recognized savings could be achieved either by raising the dollar ceiling on current tax-deferred savings plans, such as the registered pension plans and RRSPs, or by instituting new tax-prepaid savings plans, following the example of the Roth IRAs in the United States.

With such TPSPs, as I'll call them, the access to tax-recognized savings could be expanded for higher earners at zero or even negative upfront revenue costs, with associated changes in tax-deferred savings contributions. Such access could also be much improved for lower earners. This change would reduce taxes on higher earners constrained by the current contribution limits and reduce the marginal tax rates on the earnings from which they save.

At lower and moderate income levels, much of the total tax relief could be achieved by faster cuts in the payroll tax toward the long-run rates needed to sustain the EI program. The accumulation of massive surpluses in the EI account is an open invitation for spending on new program benefits without the kind of budgetary scrutiny that all new spending programs should face. Any additional tax cuts at lower incomes should focus on raising the taxable threshold beyond the modest increases of the last two federal budgets. A reduction in the middle-bracket tax rate would also be desirable for the incentives of those at middle incomes.

Tax policy over the next several budgets needs to remain focused on the productivity and growth objectives. If properly used, the amount of revenues available for tax policy should be adequate to foster major improvements in the economy's long-run performance.

If still more funds are needed than the federal government is willing or able to devote to tax cuts, then other base-broadening reforms for the personal tax should be implemented. Many of these would also improve equity across taxpayers, such as including workers' compensation benefits and curtailing interest deductions that exceed investment income.

Undeniably, pursuit of the tax priorities suggested here will require courage and leadership by the federal government. It will have to assume the task of educating the public about the economic prerequisites for improved growth and living standards, much as it did with eliminating the federal deficit.

I have seen some promise of the government moving in the directions suggested here, albeit more gingerly and in more fiscally constrained forms, in the House of Commons finance committee's report from its productivity round table and its more recent report on the 2000 budget. Now what remains is for future budgets to embody these ideas in a focused and bold manner.

Thank you.

The Chair: Thank you very much, Dr. Kesselman.

I am now going to turn to Dr. Harris from Simon Fraser University.

Dr. Richard Harris (Professor of Economics, Simon Fraser University): Thank you, and good afternoon to the committee. I welcome this opportunity to speak to you.

I prepared some overheads, but apparently the technology here is not quite up to making overheads large enough on the screen for us to use them. So I will speak to my notes and try to get the basic message across.

• 1600

My comments are going to focus on the issue of the Canada versus United States manufacturing productivity gap. I was recently involved with the Canadian Centre for the Study of Living Standards, and Professor Jeff Bernstein and I organized a conference on this, which was held in January, at which a number of new research results were reported. I'd like to highlight some of those results for the purposes of the committee.

Why is the manufacturing productivity gap important? Well, there are a number of reasons. Historically, it's been measured perhaps more so than almost any other productivity statistic. It's often the one that gets the most media attention, and of course in the Canadian historical debate, given the importance of the United States as our largest trading partner, it has attracted by far the most attention, for a variety of reasons. It's also true that many people have their own pet theories about what to do about any particular productivity number.

I guess the focus of my comments is going to be that one has to be very circumspect both in the interpretation of these numbers and in drawing policy conclusions, although at the end of the day we're going to have to do that, and I'll indicate where my policy inclinations come down.

I should point out, to begin with, that the focus on manufacturing as opposed to services is becoming more and more problematic, given both the size of the service sector in the modern economy and the fact that, when one looks at manufacturing, service is increasingly accounted for as an important input. In fact, given the reorganization of the economy, what was previously thought of as manufacturing is in many ways now counted as service activity. This is one of the many problems we face.

Also, the markets today are really focused on international comparisons—that is, we're interested in comparing countries—and this raises very difficult issues because in fact, even though the statistical agencies do their best, they have limited resources and at the end of the day what they do is quite different.

Where does Canada stand at the moment on the issue of relative labour productivity? We have some new numbers from a project that has been going on at the University of Groningen under the support of the OECD, using some more consistent ways of measuring labour productivity. Labour productivity is defined now as real value added per worker, and the Canadian numbers are not very comforting. If one looks at the data starting in 1960, Canadian value added per person employed stood at 80% of the U.S. levels. By 1973 it had gone to 84% of U.S. levels. By 1987 it had dropped to 77% of U.S. levels. In 1998, the most recent numbers, using the ICOP methodology, it's at 69% of U.S. levels. Now, if we take these statistics at face value, this is extremely disturbing, and one would argue that this, in and of itself, would account for much of the decline in Canadian living standards.

It is interesting, however, that one of the important corrections, first of all, is to adjust for the fact that productivity depends upon how many hours worked, and society can choose to work less or work more. It turns out that in Canada, I don't know if we choose to work less, but we do work less. If you look at the 1998 numbers, our productivity per person employed is 69% of the U.S. levels; on an hourly basis we're only at 75% of U.S. levels. There, in and of itself, is one of the significant differences one has to look for in interpreting these numbers. Nevertheless, that's a very big difference and something of great interest to account for.

If we look at the ICOP data on particular sectors, in 1997 relative to the U.S. they include the following sectors: food, beverages, and tobacco; wearing apparel; chemicals; and electrical machinery and equipment. I'm going to come back to this last sector, electrical machinery and equipment, because the data on this sector in comparing Canada and the United States unambiguously dominated the more recent discussion, but it is also true that it has had some historical importance.

Now I want to talk a bit about what may seem a pedestrian issue, but the fact of the matter is we have to get into this because interpretation is everything. The OECD numbers, of which the ICOP is typical, use as their measure of output, in order to construct their productivity indexes, value added. A project recently completed by Industry Canada with the help of Statistics Canada, using what they've referred to as their KLEMS data set, attempts to account for the study of total factor productivity. This goes a long way towards removing a lot of differences that show up in these ICOP studies.

• 1605

The attempt here is both about using a total output measurement and, secondly, to account systematically for differences in the way the two countries have measured the capital inputs and the labour inputs. I'll get to each of these separately, but at the end of the day the productivity number, which is supposed to represent differences in technical efficiency between countries—that is, total factor productivity—gives a remarkably different picture of the productivity situation of the Canadian manufacturing industry than the labour productivity numbers would suggest.

Let me give you a few examples. I'll put this chart up, and if we look at total factor productivity numbers for Canada relative to the United States in 1995, where the U.S. is treated as a base of one, we have, for example, a number of Canadian industries for which Canadian total factor productivity exceeds U.S. total factor productivity. This includes tobacco, which is presumed to be twice as technically efficient; petroleum refining, 15% more efficient; and motor vehicles, 7% more efficient. Interestingly, electrical machinery, the industry about which we'll talk more, is reported on this basis to be only 2% less efficient than comparable U.S. levels.

What is remarkable is that even though there appears to be much less difference between total technical efficiency or total productivity, there is still a very significant difference in the data between labour productivity. Labour productivity levels, even corrected for all these various adjustments both on the input side and the output side, is still significantly below U.S. levels.

What does that suggest? That suggests that rather than technical efficiency differences or the fact that somehow Canada is using inferior technology or inferiorly educated or trained workers, it has something to do with the availability of the other inputs.

I want to stress in my discussion two particular inputs—two of the big ones, obviously. The first one is hours.

For the last 20 years in Canadian versus U.S. manufacturing, one of the most remarkable and significant differences has been the fact that in American plants, workers work longer. In 1998, roughly speaking, in Canadian manufacturing, workers worked 37 hours per week. In American manufacturing in the same year, they were working about 42 hours per week. This is a systematic difference. It has grown in the last decade, and it still persists.

There are a number of explanations both on the macro and the micro side as to why those differences might persist, but the basic fact seems to be that we know in micro-studies, if you take a given number of employees and you work them longer hours, within limits, you achieve certain productivity gains. That is, you get more output per worker by adding hours per worker, making people work another shift or overtime or working longer, than adding more workers. Of course this is a very big part of the debate about the American versus the European style of manufacturing system. Nevertheless that's one of the big facts, and any explanation of productivity differences between the countries has to accommodate that.

The other difference, which is extremely striking, is capital per worker. Average labour productivity can go up either because total factor productivity has risen, which appears not to be the big contributor to that, or the fact that capital per worker is different.

One of the remarkable differences between the two countries has been the fact that capital per worker has consistently grown in the U.S. manufacturing sector, including through the 1990s, while in fact, although it had grown significantly through the late 1980s, from 1990 through 1996 capital per worker declined significantly both in absolute and growth rates.

The order of magnitude here is absolutely staggering when one looks at this. According to the OECD, by 1998 capital per worker in Canada was 34% of U.S. levels. That is a number that cannot be seriously believed, which tells you something about the difficulties in measuring capital. But it does suggest that there are some serious problems on the investment capital side, and I'm going to come back to that in some of my comments later.

• 1610

There are some other curious things about the differences that have emerged between Canada and the U.S. One of the most interesting is the fact that in the data it appears that Canadian manufacturing is using intermediate inputs at a rate of growth much faster than they are in the United States. Over the last decade, Canadian inputs of what we would call intermediate inputs—you think of those as services or goods in process—have grown at a rate 30% faster than those in the United States.

That is a very striking difference between the two countries, and as yet we have no systematic explanation of why that is true. One might be that there has been greater outsourcing going on. It might be that we have greater two-way flows in components between the countries due to greater specialization due to the free trade area. But there's a very significant difference in the productivity numbers, and it has some important implications.

I want to tilt focus now, having put that sort of broad background as to what I think, groping towards some of the potential explanations. I don't want to propose these as open explanations. I think they're in the way of hypotheses that are on the table. But really, in order to address policy considerations, I think it's extremely important that we try to resolve this, first of all.

First, it seems to me the overwhelming question here is why is capital per worker, both growth rates and levels, apparently so abysmal relative to the United States? There are two possible explanations. One is the relative price explanation, about which I have a very nice chart here that I'll send to the committee.

One of the remarkable differences in the two countries over the last decade has been the change in relative prices of factor inputs, which was documented recently in this Industry Canada-Statistics Canada work.

If we look back, in 1979 you found that the price of capital services in Canada was roughly 20% more expensive than that in the United States. By 1995 capital was 90% more expensive in Canada. This is capital services, not the cost of capital, the cost of borrowing money. This represents what we call “the user cost” in economics, using a unit of capital services.

Basic economics tells you that if you have a very large relative price increase like that, it is not very surprising that you substitute labour for capital. Exactly that appears to have gone on, and exactly the opposite is true in the United States. So for whatever reasons, this remarkable divergence in relative input prices must be an inherent part of the story about why Canada and the United States have had different productivity tracks.

On the other hand, the other thing that came up in this conference, which was quite interesting, is that it's quite unlikely that the situation is as bad as the OECD numbers would suggest. That is simply because Canada and the United States have historically used different ways of estimating their capital stock. The bottom line would be that Canada has tended to use shorter depreciation lives than the United States, which has tended to reduce the capital stock estimates in Canada.

I don't want to suggest that what Statistics Canada is doing is incorrect. It may well be that what the BLS is doing in the United States is incorrect, but they are quite different and it does end up drawing different implications, which tend to show up as hard data in lots of studies that get reported in the media. But these are in fact basically differences in methodology, not fundamental economic differences.

I now want to talk to two particular sectors I talked about before, machinery and electrical and electronic products. This is where the recent U.S. advantage, as measured in the official statistics, is both remarkable and persistently different between the two countries. From 1989 to 1987, looking at the total factor productivity, not labour productivity, total factor productivity grew in these sectors at an astounding 13.26% annual rate relative to a Canadian growth rate of 4.68%. If you were to remove these two sectors from the productivity comparisons between the two countries, you would discover the remarkable fact that the U.S. has actually reported a negative productivity growth rate while Canada has reported a not insignificant annual growth of 2.17% in total factor productivity. So I guess the question is, is any of this for real?

Of course, those two sectors have been the highest sectors in terms of growth rates, although they account for a relatively small total share of U.S. GDP, about 1.2%. Nevertheless it has had a remarkable effect on statistics. So what's going on here?

• 1615

We had a very interesting paper presented at the conference by two of the BLS employees responsible for the methods that are used in constructing these productivity numbers. They referred to the rather dramatic effect it's had in these two sectors of switching to what are referred to as hedonic methods for correcting for changes in computer prices. The U.S. was concerned with the fact that real productivity improvements were not being measured in the official statistics due to the output of computers, due to the remarkable increase in the power of computers, so they started correcting price indexes.

Let me just show you how important this was. Suppose we set the deflator for this sector, computers and semiconductors in 1992, at 100 in both countries. In 1995 the U.S. deflator was 49 and the Canadian deflator was 109. This is still true in the statistics recorded today.

What this means is that in terms of the numbers reported, if you took the same nominal value of output, the U.S. reported this as a doubling of real output while the Canadians would have reported this as a 10% decline in real output. This statistical difference, which is now only beginning to be changed as of 1996—Statistics Canada has moved partly this way—remains quite frankly the biggest single contributor to the explanation of the gap between the Canadian performance and the American performance.

Until these measurement problems can be resolved I think we would have to say that the evidence is that we have a problem with labour productivity. It's probably not a problem in these high-tech sectors until we get more evidence, but that's not to say that there aren't some implications.

Let me talk briefly about some of the other things that were said that were quite interesting. We had some papers on case studies, one on chemicals and one on autos. It's quite clear that the people in those industries—this is reporting for the large firms—felt there was no productivity problem at all. They both denied they had any productivity problem. In fact this is remarkable given the OECD data, because the OECD data shows that the Canadian chemical industry is basically flat on their back. A steel company executive claimed there were no significant plant level productivity differences that he could see in the mini-mill industry between Canada and the United States. That's an interesting counter-factual to the official statistical evidence.

Research and development—well, there are lots of studies on research and development—

The Chair: Dr. Harris, I hate to interrupt, but are you almost finished with your opening statement?

Dr. Richard Harris: Yes.

R and D does not seem to be the explanation. Openness does not seem to be the explanation. When you look at TFP there still seem to be traditional convergence effects. To the extent that we seem to have a problem, it is the investment problem. That goes back to the comments of my colleague, Jon Kesselman. To the extent that we have an investment problem, which explains the labour productivity problem, it seeks an explanation ultimately in tax or exchange rates.

Thank you.

The Chair: Thank you very much.

All three of you have provided us with a lot of information, and obviously we're going to have a lot of questions. I need to let everyone know up front that there's a vote anticipated in the House at 5:30, which means we have approximately an hour for questions before the bells start. So I'm going to ask if we could try to keep that in mind with the responses and the questions.

Mr. Penson, please.

Mr. Charlie Penson (Peace River, Ref.): Thank you, Madam Chairman.

It was a very interesting presentation, I thought. The one thing I didn't hear anybody talking about, however, in this whole productivity puzzle is what debt repayment might do to the equation. I know Pierre Fortin has come out strongly saying not only to cut taxes but also to pay down debt. I'd like a comment on that, as to how that might influence the productivity. It seems to me that there is a confidence factor that needs to be addressed, and I think that's part of it.

The other area in the limited time I have would be the dollar differential between Canada and the United States. When Canadian companies start updating equipment, technology for reinvestment in plants, and so on, in many cases they are buying U.S. technology and U.S. equipment, or from outside of Canada, with the difference in the dollar rate. It would seem to me that that is fairly significant.

I'd like a comment on those two areas, if you don't mind.

The Chair: Mr. Pension, are you directing that to all three?

Mr. Charlie Penson: I think I'd like both Mr. Kesselman and Mr. Harris to comment.

The Chair: Maybe we'll start with Dr. Kesselman.

• 1620

Dr. Jonathan Kesselman: The issue of debt paydown certainly could be a constructive element in an overall program of improving competitiveness and productivity. I think there might be many possible channels, but one would be reducing interest rates, reducing long-term interest rates, freeing up more capital. Of course, capital sloshes around in this world across borders, so you can't pin it down that much.

If the government retires debt or retires additional public debt, that means there is less drain on domestic savings going into the public sector and therefore domestic savings are more available for investment in Canadian industry. But as we say, of course, the international fluidity of capital makes—

Mr. Charlie Penson: So there's not much competition for those investment dollars, if you like. Would that be true? Industry would not have to compete.

Dr. Jonathan Kesselman: That's right.

As to the exchange rate, just one reaction. I think my co-panellists may have more sophisticated reactions. Certainly having a low dollar does mean that Canadian industry, in buying foreign capital and paying foreign royalties and licensing fees, has to pay more in Canadian dollars. However, Canada is a very large world trader and exporter, and the low dollar also means we are more competitive in selling our goods abroad. Since these capital goods that are needed to produce our exports are only a component of the total costs, the low dollar actually—other things being equal—makes us more competitive. Even though we have to pay more for the capital input, we get more in Canadian dollars for each widget we sell abroad. So that is at least largely offsetting. But I'll leave that to my colleagues to take it further.

Mr. Charlie Penson: Can I just interject and ask you a question in that regard? My understanding is that a lot of the manufacturing sector imports a lot of components from the United States, for example. So the product that's being produced in the end has a lot of components that are not manufactured in Canada and therefore the U.S. dollar becomes a factor there. Is that not true?

Dr. Jonathan Kesselman: That is true. All I'm suggesting is that, particularly in the automotive sector, where there's a lot of specialization in the parts production, we import a lot of them, but then we end up exporting a lot of finished cars or larger assemblies where there's labour value added in Canada. So again it's this offsetting effect.

Mr. Charlie Penson: Okay.

The Chair: Thank you.

Dr. Harris, please.

Dr. Richard Harris: Let me respond first to the debt repayment issue. I think there are lots of good public policy reasons to pay down the debt, but I don't think productivity is one of them. There is very little evidence that I can point to that suggests that countries that have very low debt levels have very significant productivity advantages. So whatever one may think about the virtues of paying down the debt, intergenerational equity and so forth, I do not think, at least at the debt levels we're at, they're rooted in productivity concerns.

With the expected exchange rate, I actually don't think there's any question about it at all. In the nineties, this dramatic change in relative prices that has occurred between capital and labour in the two countries is undoubtedly due to the real depreciation of the Canadian dollar. We import vast quantities of machinery and equipment.

Even with the fact that we are very open, Canada's spending share of nominal M and E investment relative to GDP is 11% less than the United States. It's been a very dismal performance, as a nominal. Then if you convert those into real, this is a very serious problem.

So it's absolutely true that the exchange rate depreciation has certainly accommodated Canadian firms in boosting output, but it has come at a long-run cost, and that long-run cost has been upgrading both new plants and new equipment.

The Chair: Dr. Helliwell, did you have anything to add to that?

Dr. John Helliwell: Sure. On the debt repayment, I agree with Rick Harris that it's not tightly linked to productivity itself. Indirectly there are two links, however. One is that only by getting the debt much lower will the government have enough financial credibility to ride through the next recession that is inevitably coming without having to raise taxes and make the recession worse than it otherwise would have been.

• 1625

Another argument is that as the debt gets lower, then it is to possible to offer tax rates that are lower in the long run, sustainably lower, because, like today, one-third of the revenues is going to pay interest on the debt. To the extent that is ameliorated, the tax rates can be lower in the long run. Another way of putting it is that a tax rate postponed is a tax rate that can be credibly larger and over a longer term.

On the dollar differential, there's a narrow answer to that. Rick has rightly suggested that it makes it very hard for the people who would need to have the imported capital—relative to their U.S. competitors, however. That's not really the case, because they're buying capital at precisely the same price as the Canadian firms are. In fact, the Canadian firms have an advantage because they're acquiring cheaper labour in Canada, which they're combining with the capital. So they still have a net advantage over their U.S. competitors even if they're buying the same machine out of Philadelphia.

The Chair: Thank you, Mr. Penson.

Mr. Lastewka, please.

Mr. Walt Lastewka (St. Catharines, Lib.): Thank you, Madam Chair.

Thank you, gentlemen, for your fine presentations.

Mr. Helliwell, you discussed the 1995 temporary visas. I thought you were going to say a little more about the reasons those visas came in and about the actual effect of being part of the brain drain. Were the temporary visas in the U.S. mainly put in to encourage more people from Canada to work in the States? I wasn't quite sure of your conclusion on that.

Dr. John Helliwell: In the first instance, I wasn't analysing why the measures were brought in, though quite clearly the intent was, as part of NAFTA, to make it easier for people to facilitate the expanded trade flows by means of cross-border movements, both temporary and in the longer term.

Whether it was anticipated that the numbers would be as large as they are, I'm not sure. Clearly the trade increases that have taken place northbound and southbound since FTA are bigger than what was forecast in the first instance. It's probably true, then, that the entailed migration of people to further that trade has also risen. In a way, the statistics that I'm getting from the census and so on show a surprisingly small number of permanent long-term moves of people in response to the FTA.

It's quite to be expected that there would be a lot of temporary flows, but as I suggested in my discussion, the TN visas include people who are rolling them over and staying longer as well as people who are going for a shorter period of time.

Mr. Walt Lastewka: Thank you.

Mr. Kesselman and Mr. Harris, you talked about the Canadian dollar and the fact that in some cases people have to pay more because of royalties and incoming components. At the same time, there's an advantage for Canada. Have you been part of any studies to say where the break-even point is...that the low Canadian dollar, as it rises, is a negative to us? Is there a break-even point on the Canadian dollar as it rises?

Dr. Richard Harris: Let me take a crack at that. For the economy as a whole, it's a sort of continuum. There are some industries that are going to do extremely well at the current Canadian dollar because their input costs are largely in Canadian dollars and their revenues are in U.S. dollars. As the exchange rate goes up, they'll be pressured. There are other industries, like, for example, the high-tech industries, that have to buy software and technology, and there are people who of course would be benefited by an increase in the Canadian dollar and compete largely on the quality of their product rather than on price.

The economy consists of a mix of these kinds of activities. An increase in the dollar is going to pressure those who basically compete on cost and benefit those who are in this higher-tech, innovative sector. So I wouldn't say there's a definitely a break-even point. From where we are now, it's quite clear that if the dollar were to be at 80¢ tomorrow, there would be a awful lot of firms that would be in trouble without a sufficient period in which to adjust.

Mr. Walt Lastewka: You used the 80¢ figure. I'm going to admit that I'm a former General Motors executive. As soon as we hit the 79¢ level, there's a lot of panic on the Canadian side; because of payments to the U.S., it gets us into a problem. You mentioned 80¢. Is it still around 79¢ or 80¢ that Canadian firms would have difficulties if they solely rely on the Canadian dollar to be their selling point?

• 1630

Dr. John Helliwell: If I can add to that, the measure of what purchasing power parity would be, or in other words, what the exchange rate would be at which cost levels would be the same in the two countries, still runs in the low eighties, at 82¢, 83¢, 84¢. It depends on the method used. On average, Canadian firms could still be cost competitive at a dollar that is above the 80¢ range. Of course there will be some who are competitive at a much lower dollar but cease to be very competitive when they get as high as 80¢, so there is always somebody going over the line. There are others that could handle a 90¢ dollar like rain falling off a Vancouver back.

Mr. Walt Lastewka: I would like to now switch over to what we talked about in terms of the low M and E—machinery and equipment—compared to the U.S. Is this because we continue to be a branch plant country? What are the reasons for investment in machinery and equipment in Canada continuing to lag investment in the U.S.? I didn't hear the reason; you gave the percentage, I think, at 11%, but what is behind that lack of investment?

Dr. Richard Harris: I think there are a variety of explanations, none of which is ultimately conclusive. One, of course, is what I referred to earlier, which is just the change in the prices in the two countries. It's much more expensive, relatively, for a Canadian firm to purchase capital as opposed to labour, so that's an elementary consideration that is not insignificant given the amount of change.

Second would be tax reasons. The United States has some specific provisions in its tax code that allow very generous depreciation write-offs on machinery and equipment. The OECD has recently done some numbers on this wedge, which are actually quite startling. I don't know whether they're correct or not, but it's certainly true that the Americans seem to favour investment in machinery and equipment relative to any other OECD country, by a fairly significant magnitude.

Finally, I have to think that we have to look at the early nineties as a somewhat unusual case. The macroeconomic and political circumstances that hit this country in the early nineties—the shift in monetary policy, the fight against the deficit, the political crisis in the country—all had a remarkably and significantly negative effect on confidence. The data we're talking about here mirrors a lot of the early nineties, so that cannot be discounted.

The Chair: One last question, Mr. Lastewka.

Mr. Walt Lastewka: In regard to the measurement of labour productivity, I think it was Mr. Harris who talked about 1982, 1987, and 1998. We always get ourselves in a discussion about how we're not using the same parameters, that we're not comparing apples with apples. It seems that we're at the point where we need to settle that and use whatever the U.S. system is, because they're not going to change and we're not going to come up with a new system. We should be able to compare apples with apples against the U.S. since we live right next door. What is your comment on that?

Dr. Richard Harris: I agree. I think one of the good things about this recent work that Industry Canada and Statistics Canada did is that they moved us a long way towards at least producing some comparable numbers. That's unlike, for example, the other numbers that I referred to.

More generally, this requires resources for our statistical agencies, both in Canada and the United States. It is not the case that the U.S. statistical agencies are necessarily the world's best. They are still using some very dated survey methodology. Even though we think we ought to compare ourselves to the Americans all the time, it's not always the case that the Americans are “best practice” in this particular game, so that's a bit of a problem.

Dr. John Helliwell: It's worth noting that the cooperation between the agencies in the two countries is pretty good and getting better. Particularly on the trade side post-FTA, there were a lot of attempts to use each country's primary data to help the other country's trade statistics.

The changes that have subsequently been made in the U.S. measures of their imports and exports, particularly their exports, are much bigger than the the Canadian measures, where the discrepancies between the two country's statistics in that area were resolved to make them much more like the original Canadian numbers. On some of these productivity adjustments, I suspect there is give on both sides; it should be done.

The Chair: Thank you very much, Mr. Lastewka.

• 1635

[Translation]

Mr. Dubé.

Mr. Antoine Dubé (Lévis-et-Chutes-de-la-Chaudière, BQ): I listened to your presentations carefully. Over the Christmas break, I spent some time reading about this issue, and asking questions of individuals and business people.

Sometimes studies on this issue are incomplete, because when we talk about the brain drain, we don't always consider all the variables. It is generally acknowledged that the Canadian tax system is not as beneficial to individuals as the American system. However, people seem to forget that the federal and provincial governments do pay for some services in Canada, such as health. I travelled in the United States during the break and I noticed that most people had to purchase health insurance, which is often very expensive. Evidence of this is seen is the number of people who cannot afford to purchase health insurance. It seems people rarely take this aspect into account.

There is also the issue of the cost of living. It does not cost the same to purchase a house in Quebec City or Toronto as in a large American city such as Atlanta or Dallas. Although people may be attracted by American companies, they realize once they are in the U.S., after weighing all the factors, that they may not have made the right decision.

I would now like to talk about business issues. My colleagues spoke about the exchange rate, and it was mentioned that there were both advantages and disadvantages. You were telling us that the work week was longer in the United States—42 hours, compared to 38 hours here. I acknowledge that it is useful to compare Canada to the United States, because we have signed a free trade agreement with the U.S., but we must remember that it is generally thought that Americans work the longest hours in the world, with an average higher than the figure in Japan. People seem to forget that we compete with other countries besides the United States.

Productivity was mentioned, and comparisons are often made between the number of hours of work. I think I remember Mr. Kesselman stressing the importance of capital for productivity. What would you recommend to us in this regard? What can the government do?

I'm thinking particularly about the industry of shipbuilding. It is having a great deal of trouble finding the capital required to build ships, which cost hundreds of millions of dollars. Without necessarily lending money to shipbuilding companies, could a government not provide loan guarantees or other similar measures to help them become self-financing in the long term?

[English]

The Chair: You're asking that question to everyone, Mr. Dubé?

[Translation]

Mr. Antoine Dubé: Yes.

[English]

The Chair: Who wants to start? Dr. Kesselman.

Dr. Jonathan Kesselman: I'm not sure anything I've said would give you assistance or guidance on how to assist a particular industry such as shipbuilding in the Atlantic provinces. It may be that Canada is not competitive in some industries, and certainly shipbuilding is one that has had traditionally many forms of direct and indirect government subsidies to sustain it. Of course that's true in that industry in some other countries as well.

Although I can't answer your question, I would say it would be desirable, not particularly for that region or for people with skills in shipbuilding in a particular community, but on average for Canadian workers, if our tax system were more neutral, more even-handed, in the way it treats the various industries.

• 1640

Currently the corporate income tax has relatively strong preferences for investment in the manufacturing and processing industries, as well as many of the resource industries. These are old economy industries. They're important to Canada still and they will remain important, but they are not where the big growth is. They are not where the knowledge sector is. They are not where big productivity growth is most likely—that is, in a wide range of service, both software and hardware, and new products. Of course some of those are in manufacturing, but many of them are not.

If you're outside the manufacturing, processing, and resource sector, you're paying, as a corporation, a decidely higher rate of corporate tax. That is something that was addressed in this technical committee on business taxation, which I referred to earlier. It was a committee set up by the Department of Finance in Ottawa, and it undertook a very careful study of the issues in Canadian business taxation.

One of its most important recommendations, with which I concur, and probably most Canadian public finance economists would concur, is that we should equalize the playing field—that is, we should reduce the tax rate on these other sectors of the economy, including service sectors and high-tech sectors.

If that means even raising the rate on the manufacturing and processing sector, so be it, but if we're now in a general mode of overall tax reduction, perhaps we can approach it unlike that committee, which was told to recommend things on a revenue-neutral basis. We're probably in a position now where we can simply say, let's reduce the basic corporate income tax rate as it applies to industries outside of the manufacturing and processing area, and let's bring it down until they are all paying at the same rate, and at a lower rate than many of them are paying now.

The Chair: Thank you.

Dr. Jonathan Kesselman: This doesn't help shipbuilding, very likely, but it would be in the interest of the average worker, the average person in the economy, in the long run.

The Chair: Thank you.

Dr. Harris.

Dr. Richard Harris: I really have not that much to add, except I know that my personal and the country's experience with selective industrial subsidies has not been one of renowned success. So although I'm sympathetic to many of these considerations of boosting local industry through those types of subsidies—and in this particular case the issue was capital subsidies—I'd have to say the Canadian experience has not been particularly positive. So on balance, I would not want to go down that route.

The Chair: Do you have anything to add, Dr. Helliwell?

Dr. John Helliwell: On the issue of taxes and the brain drain, the points made were quite right. People who are moving don't always go to the low-tax jurisdiction. They understand that taxes are not for nothing—that on average, countries that have higher rates of taxation also provide higher levels of public service. One goes where the mix is best.

Surveys of more highly educated people who've moved put tax differences usually a distant third behind job opportunities and family as reasons for moving. That's not an argument for saying you don't want an efficient tax system, but it's another way of saying that not only is the brain drain pretty small beer in total numbers, but taxes are not the primary factor as a driver.

The Chair: Thank you.

Thank you, Mr. Dubé.

Mr. McTeague, please.

Mr. Dan McTeague (Pickering—Ajax—Uxbridge, Lib.): Thank you, Madam Chair.

I just want to take up from where you left off, Dr. Helliwell. Am I to understand something of a difference between you, Dr. Helliwell, and Dr. Kesselman? Dr. Kesselman has clearly made the case for more generous and equal corporate income tax consideration than manufacturing and processing industries. Are you suggesting, Dr. Helliwell, that a company looking to invest in Canada for the purpose of augmenting Canada's productivity might not necessarily look for a IT decrease, but rather might well want to consider other considerations, the so-called mix you referred to?

Dr. John Helliwell: The companies that invest in Canada are going to be looking for the kinds of services they get, the kinds of communities they're in, the education levels of the workforce, and so on. With all those things, the better the society you have, the more people will want to either move there or work there.

• 1645

You can't easily get a wedge between me and Jon Kesselman when it comes to tax neutrality, however. I've been advocating a tax system that treats equals equally for thirty years or more, and I have not yet seen a good reason for changing my mind on that one.

Mr. Dan McTeague: Dr. Kesselman, could you perhaps give me an idea of the comparative advantage that exists in the United States with respect to the corporate income tax system as it treats new technologies industries?

Dr. Jonathan Kesselman: Well, I'll try.

Overall Canadian corporate income tax is not wildly above that in the U.S. In fact when you compare particular provinces with particular states, depending on industry, you can find some of them are treated more lightly in Canada than in the U.S., because we have not only federal corporate tax but also provincial corporate tax. It's similar in the U.S. Most states apply it at both levels.

There may be elements here where certain things can be written off more quickly in the U.S. I'm not an expert on that. Certainly in terms of hard capital, as Professor Harris has said, the depreciation of hard, fixed capital is generally faster in the U.S. than it is here, which is a kind of cashflow advantage to a business through the tax impact.

In terms of other soft costs, I'm not aware of major differences. In general it would be true, though, that the high-tech sector, if they're not engaged in manufacturing, would typically be bearing somewhat higher costs in an average jurisdiction in Canada relative to an average jurisdiction in the U.S. That's something we could remedy by getting the general corporate tax rate down in Canada to that currently enjoyed by the manufacturing and processing sector, which would then help high-tech firms that are involved more in service provision rather than manufacturing.

Mr. Dan McTeague: Thank you.

You cited the petroleum and automotive industries as a situation wherein—I hope I have this correct—U.S. technology productivity is greater than that of Canada. I think you mentioned 15%. Is that a correct understanding of what you had suggested earlier?

A witness: Actually it's the other way around. Canada is more productive than the United States on grounds of technical efficiency, but not labour productivity.

Mr. Dan McTeague: In that case, my final question is, could you give us an illustration of the impact of the level of foreign ownership that is prevalent in some of the key industries in Canada, particularly petroleum and automotive, since those two industries represent two of the leading economies, as provincial jurisdictions go, within Canada? Are those, in any way, shape, or form, barriers to being able to devise, design, or implement policies that might help productivity, both from the labour and from the technical point of view? Do you see those as inhibitors?

I leave it to all three of you, if any one of you wants to answer that.

The Chair: Who wants to start?

A witness: What is the inhibitor? The existence of foreign ownership?

Mr. Dan McTeague: The level of foreign ownership and the decision perhaps by a corporation not to make an investment within Canada unless there are sufficient inducements, or unless there is a different technical, perhaps far more robust, well-educated society.

I'm looking to see if, in the industries that were cited here, petroleum and automotive as an example... I think we all appreciate that in the case of automotive, where both Walt and I come from—I come from the Japanese end and he comes from the American end—the level of decision-making that might help improve Canada's productivity is increasingly determined by entities outside Canada, whose interests may be far more different from the interests of those of us who are trying to achieve public policy in the field of economics.

Dr. Richard Harris: Okay, I understand.

Those are very legitimate concerns. In fact this is the dark side of globalization in many ways. The thing about Canada, though, is this is not a new problem for Canada. We've been a small open economy relative to the world's largest economy for a very long time. For my entire life we've been talking about the branch plant phenomenon in one way or another. So this is not new.

• 1650

I think we can say two things. On balance, looking at the broad Canadian historical experience, foreign ownership has tended to bring technology and other market access benefits. It's difficult to imagine that an economy the size of Canada's could not sustain the kind of income levels we have without foreign ownership.

It's also true, of course, that Canadian corporations have been big acquirers of service and other outlets in the United States and other countries, and that's also part of the globalization. So from a public policy perspective, I really think we're going to have to live with the open capital market regime, at least vis-à-vis the other OECD countries. I don't really see that we have a lot of public policy levers we can start to pull on the question of foreign ownership.

Mr. Dan McTeague: Thank you. That's very interesting.

Thank you, Madam Chair.

The Chair: Mr. Helliwell.

Dr. John Helliwell: I can think of four short points to add, one that's relatively good news and three that are not so good.

On the good news side, the automobile industry has of course been foreign-owned right from the very beginning, and yet it is one of those industries where there's absolutely no gap and often some advantage in the Canadian firms. So clearly no laggardly nature in that industry has been brought about by its foreign ownership. I think the secret is that the industry has taken a more balanced view of its Canadian-U.S. operations than almost any other industry has, which has led to a fairly balanced productivity outcome.

There are some industries, however, that have operated behind the tariff barrier in Canada. When FTA came along and they were retrenching in the nineties...and for a lot of the migration reasons I talked about before. It's pretty expensive for an American firm to ship people back and forth into a foreign country. If you're going to cut one plant, it often makes more sense to keep your establishment near, in your home country. Quite a number of Canadian subsidiaries were closed during that period. If they'd been independent at the outset, they may have rationalized and reoriented themselves in the new market and left more Canadian capacity and more efficient capacity.

Thirdly, one of the real puzzles is to explain why Canada, which has the most rich fiscal incentives for industrial R and D, has the lowest R and D percentage in industry of all the G-7 countries. One of the reasons that's sometimes given is that the R and D is often a head office function that's kept close to the U.S. parent's head office. Canada, with the largest share of U.S. ownership, then sees the consequences of that.

The final point is that there's worry in the local economy here that, for example, if major community-oriented local companies are taken over and their head offices are then found elsewhere, it will be harder to get the same degree of local community involvement that builds a good rapport between business and the community in which it operates. It's simply harder to do if the management is not present locally and living in that community.

The Chair: Thank you.

Mr. Jones, please.

Mr. Jim Jones (Markham, PC): Thank you, Madam Chair.

Brain drain and job drain: 4% of the top Canadians in this country pay 16% of the income tax. I believe the top 10% paid between 27% and 30% of the income tax. These are the people who are leaving for the U.S. Some are leaving for better-paying jobs, but some are not only leaving for better-paying jobs but also taking their jobs with them. What do we have to do to retain those people here?

Dr. John Helliwell: The bigger the tax gap, the more you're going to get tax-related migration. Now, one of the biggest groups to move has actually been the high-income tax filers. Where you get quite big tax gaps you can get people moving for tax reasons. That may not involve many career choices. It's much more likely to involve the shift of tax-paying residents.

That's the fiscal cost of a big tax differential. When mobility is high, it sets some limits on how different one country's tax system can be to another country's tax system.

Since the overall impact of tax differentials on mobility is fairly small, it can't be the dominant factor in deciding the nature of a country's tax system. It's simply not true that the mobility is high enough to force equality between tax rates and essentially government safety nets and what the tax rates are used for.

• 1655

The current gap between Canada and the United States is bigger at the high end than it is on average. In fact, the gap works the other way at the low end. In some sense, you might say that the Canadian set of values has a more progressive tax and transfer system than does the U.S. one. People who like a society like that are more likely to stay. People who either don't like it or don't want to pay for it are more likely to move.

As John Kesselman has argued in some other work, when you have two different societies providing different services and different styles of taxation and different views of what government ought to do and how it ought to do it, you get some migration both ways of people who are finding a community more to their taste. That being said, if all countries are moving towards modestly lower tax rates, you may pay a little extra premium if you're too far behind the pace.

Mr. Jim Jones: If you look at low, middle, and high income in Canada, the tax rates for that, and the brackets that encompass, how does that line up with the U.S. in terms of low, middle, and high income?

Dr. John Helliwell: John, you have more precise numbers on this.

Dr. Jonathan Kesselman: I'll try to say something useful. At the low end, generally the combination of taxes and various tax-type credits and other social payments is definitely more favourable in Canada than in the U.S.

Mr. Jim Jones: Hang on one second. What's the definition of a low-income earner in Canada, and where's the salary cut-off, the income cut-off, on each one of those levels?

Dr. Jonathan Kesselman: That's pretty subjective, of course, but I would say that persons earning right up to average full-time earnings, which is somewhere in the $30,000 Canadian range, are bearing lower burdens than in the U.S. Of course, the low $30,000s is not comfortable middle class but it's not quite working poor.

We hit our highest marginal rates of tax at around $60,000, based on individual earnings in Canada, and somewhat higher levels before you hit the federal high-income surtax in some of the provinces that have high-income surtaxes. So $60,000 to $70,000 typically would be where you would start to incur the highest rates of tax here.

In the U.S., the very highest federal income tax rate is, gee, in the order of $200,000 U.S., based on family income. So it's much higher. However, the actual top marginal rates paid once you are at the top are really not all that different in Canada than in the U.S., given that most states also have income taxes. They're not as steep as provincial taxes are here, but they're there in 40-odd states.

As well, there are payroll taxes. The medicare premium part of the social security tax keeps going without any upper limit, and that's another couple of percentage points added on. Moreover, the basic social security payroll tax, including the medicare, goes up to around $80,000 U.S., I believe. The ceiling here is around $35,000 Canadian, when you pay no more. Moreover, the rate in the U.S. is about 15% or so of payroll tax. Here it is going up to 9.9% over a few years. We're in the order of 7% or 8% now.

Once you start adding in all these other taxes, including property taxes for like-valued properties in many parts of the U.S., which are heavier than they are in their counterparts in Canada, and take the whole picture, the state as well as the federal income tax in the U.S., and the way the payroll taxes bite substantially more heavily and at much higher incomes in the U.S. than where they seize it in Canada, then at least in some comparisons—for instance, user fees are more common in the U.S.—the differential is not as radical as you get from reading news columns that simply compare the U.S. federal income tax alone with the Canadian federal plus provincial income tax.

• 1700

Mr. Jim Jones: If I look at Canada and the U.S. in the high-tech sector, Canada's GDP from high tech is around 20%. In the U.S. roughly 40% to 45% of their GDP is coming from the high-tech sector. I would like to relate this somehow to the investment in capital. Are the depreciation rates in Canada different from those in the U.S.?

Also, looking at this investment in capital over the last number of years and where you quote the 13% versus 4.68%, was the shift in the U.S. investment in capital more to the strategic investment, like the high-tech sector, where Canada sort of kept investing in the old industries instead of in the strategic industries? I mean, these numbers could be even worse than they actually are.

Dr. Richard Harris: There is a difference between looking at the high-tech sector as the use of high-technology inputs versus I believe what you are referring to, which is probably one of these definitions about high technology as sort of a stacked classification of sectors that tend to either use high-technology workers or produce high-technology output.

The bulk of spending on so-called high-technology products is really computers and software, and most of that is used in the service industries. If you look at it from that perspective, the countries are not that different.

Where the countries differ significantly is the fact that in the United States in the semi-conductor and electrical and electronic products, which produce computers, the growth of output in those sectors is dramatically higher than in Canada. So that is a sectoral definition.

Mr. Jim Jones: That's what I was referring to, more that type of investment versus just the personal computers and computers into offices and that. I am referring more to robotics, instruments. Why don't we get some of Intel's investment here to make memory chips or substrates or large integrated circuits? It seems like most of it is kept in the U.S.

Dr. Richard Harris: Well, of course one of the advantages of globalization is specialization. It is not necessarily the case that all countries are going to have a semi-conductor industry. Comparative advantage says that countries will specialize in those things they do best. It is certainly not the case that economic productivity and growth is enhanced necessarily by everybody having a semi-conductor industry. So I think we have to set that as sort of a benchmark.

Now, has Canada invested in the wrong sectors? I don't have the answer to that. All I can say is that it is quite clear, looking at the recent data, that the United States has had spectacular growth in those two sectors. We have a much smaller share of that output. Maybe we made a mistake. Time will tell.

The other question is what public policy instruments came to bear on that. That is something that needs a lot more research.

The Chair: Thank you, Mr. Jones.

Mr. Lastewka, you have another brief question?

Mr. Walt Lastewka: Yes, I have two questions.

The auto industry and the components in the auto industry play a major part in our exports and so forth in Canada. Sometimes I feel we should kind of separate the automotive and parts component industry and the rest of Canada, the manufacturing, to be able to compare our productivity. Have you any opinions on that? Does the automotive and parts community kind of blur getting at our manufacturing industries across Canada?

Dr. Richard Harris: I am not sure why you would separate them out. It's just an issue of information. It's always interesting to know what a particular sector's productivity performance is. Automobile manufacturing components compete for the use of resources with all other sectors in the economy. Therefore, from the point of view of assessing performance of the economy as a whole, I think the last thing you would want to do is leave out southern Ontario.

Maybe I am misinterpreting your question.

Mr. Walt Lastewka: No, I am looking at it because the automotive is so predominant. Does it allow us to get at the other manufacturing sectors properly?

Dr. Richard Harris: Well, certainly the buoyant U.S. demand in the nineties, this tremendous U.S. boom, which has recently been to a considerable extent a consumer-led boom, has been a great boom for our automobile industry. There's no question about that, with the dramatic growth in exports. It obviously has in some sense crowded out investments in other activities because the resources are being put into automobiles. But I don't think that's a bad thing. That's just a natural reflection of the way the economy, at the margin, uses its resources most efficiently.

• 1705

Mr. Walt Lastewka: My second and last question, Madam Chair, was to ask Mr. Harris a little bit more about the hours worked.

When you compared Canada and the United States, 37 hours versus 42 hours, can you tell us a little bit more on the hours worked compared to Europe or some countries in Europe? The vacation hours and time off the job in the U.S. are less. Is it absenteeism? Could you give us more facts on why we have that differential?

Dr. Richard Harris: Well, one possibility is that if you look at the broader cross-spectrum of countries it may be due to the degree of unionization. As you know, the degree of unionization is lower in the United States than in Canada. So that may be one of the explanations.

I think in the aggregate Canada-U.S. numbers—and these numbers include overtime and vacation time and all that stuff—there is another factor I did not speak to, which is the fact that Canada has an unusually large share of very small firms in its manufacturing sector. The size distribution of firms in Canada is quite different from that of the United States. This has always been a bit of a puzzle. These statistics may reflect in part the presence of these small firms in the overall sample.

If you were to look at a big auto plant in Oakville and one in Detroit, I guess the question is—I ask you—would there be a significant difference in hours in those plants? My guess is the answer is that it's probably not as significant as these differences would suggest.

Mr. Walt Lastewka: The last data showed that it is different, and it showed very clearly that U.S. employees in auto plants take less time off for vacation time than Canadians do.

If I reflect on my European experience, where they've got their time-off laws and so forth, the European hours of time off are a lot larger than even Canadian time off. Of course my data is getting a little bit old, so I was looking for any new information you may have concerning Canada versus U.S. versus Europe.

Dr. Richard Harris: Well, certainly versus Germany and France it's absolutely true that the United States still has much longer hours in manufacturing than either of those two countries.

Mr. Walt Lastewka: Thank you.

The Chair: Thank you very much, Mr. Lastewka.

As chair of the committee, I don't usually ask too many questions, but I do live in southwestern Ontario and grew up on the border, so I guess this whole issue of brain drain sometimes preoccupies me. Growing up in a community and living in a community today where I have Americans who choose to live in Canada because they consider it a safer society and I have neighbours who still work in the United States yet choose to live in Canada, it's kind of the best of both worlds in some sense, because they don't have to move from where their family is to have the type of employment they want.

I'm not sure it's really a brain drain when I see people... I'll use the DaimlerChrysler situation, because that's probably the best one I can think of, where they have a huge research institute located in the United States, about an hour or an hour and fifteen minutes from Windsor. They also have a research facility now in conjunction with the University of Windsor. A lot of co-op engineering students who go through the research facility in Windsor end up finding full-time employment at the research centre in the United States. Yet the head of Chrysler for the United States right now is actually a Canadian, originally from Windsor, and the head of Chrysler Canada in Windsor right now is actually an American.

I see the investment and the decisions that are made benefiting Windsor when I look at the mini-van plant and know that sitting at that head table the gentleman from the United States is actually Canadian-born and from Windsor. When they take a look at what's going to happen with the mini-van plant in Windsor, that's good news for Canadians all around. I don't consider that a brain drain.

I mean, am I missing something in the statistics of brain drain?

Dr. John Helliwell: One of the arguments in favour of flows being smooth from one country to another is that it develops a kind of understanding of the other country and its institutions and possibilities that allows both trade and investment to be smarter than they otherwise would be. The example you pose is evidence of just that. In many ways what may be stopping Canada from getting a larger share of what otherwise would be attractive ventures at the frontier is the lack of knowledge about Canadian opportunities and institutions on the part of U.S. firms. In the Windsor context you see much more of the two-way flows, and you can see some of the advantages that can be reaped from that.

• 1710

Certainly in the decades in the past when we simply didn't have the high education potential for producing the highest levels of PhD research and training in Canada, it was absolutely normal for people to go to the United States or Europe for their training and then come home. They not only brought back education, but they also brought back awareness that allowed them to be more global than they might otherwise have been. Now the flows are more two-way at the education level, but they still produce the kinds of benefits you speak of.

The Chair: Okay. Further to that, when you take a look at not even high-paying jobs, but even what I would call more middle-income jobs, such as the nursing profession, that's always been, especially in border communities... Windsor has another example, which is a university training facility and a college that both have nursing as an education.

The Detroit hospitals have a high number of Canadian nurses, up to 40% in a couple of the hospitals. Their employees would be Canadians crossing the border and working in the States and coming back to Canada, choosing to live in Canada yet work in the United States only because obviously the Canadian system can't assume that many nurses in a graduating year. Yet they want to live in their community in which they've grown up or where their families are. So it's kind of an interesting situation.

When we talk about what's happening in the high-tech sector, and we see the graduates that are being picked up from the University of Waterloo as an example and taken immediately to the States, do we have the companies in Canada to offer them that employment?

Dr. John Helliwell: Well, the statistics I quoted earlier from the study of the high-tech industry in British Columbia suggested that in fact the flows from the United States to British Columbia were greater than the flows from B.C. to the United States in 1998 by a substantial margin. So obviously there are job opportunities and ventures that are attracting people in, as well as the more obvious and more talked about lure of Silicon Valley.

The Chair: Okay.

I just have one final question. I don't know if you can answer this or not. When we talk about taxes and we say they shouldn't be too high but not too low, does anybody know where the right level is? Any ideas?

Dr. Jonathan Kesselman: The right level is determined in a democracy by the representatives of the people. All we can do as academic economists, as the three of us are, is to have a better understanding and to try to communicate to people such as you, committee members, ways to improve the operation of the tax system and the costs and damage to the economy of a tax system of given characteristics, and how to make it better.

The benefits of public spending are not for any expert to say. I mean, we can talk about the costs of financing them, not just the dollars, but the damage to the efficiency of the economy and the growth of the economy. Those are inevitable, even with the best tax system. But they have to be set off against the benefits of public services and helping the poor, however they're construed by voters as interpreted by our elected representatives. I don't think anyone can say exactly where that is. It will differ over time in a country, and it will differ across cultures and countries.

The Chair: Thank you.

We know how busy all three of you are, and we do appreciate the time you've taken with the committee today. Obviously the committee members are going to have to go back and read the papers again and take a look at this testimony again. I think I heard one of you say we should pay down the debt, and the others say that maybe isn't the way to deal with the situation. So we are going to have to take another look at the evidence here today.

Dr. Harris, if you could provide us with a copy of your overheads we would appreciate that as well.

We do thank you. We know you're all very busy. The time you spent with us here is going to be very valuable to our report. Thank you very much for joining us.

The meeting is now adjourned.