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Archived — Research Summaries: Working Paper 2008-01: Role of Competition in the Canada-U.S. Productivity Gap: Empirical Evidence from Industry Panel Data

by Malick Souare

Many observers have rightfully expressed concerns about future prospects for Canada's economic growth and improvements in living standards, mainly because of Canada's lagging productivity level and/or growth relative to some Organisation for Economic Co-operation and Development (OECD) countries, and in particular to the U.S. Over the years, several potential factors have been put forward to explain Canada's weak productivity performance with respect to the U.S. Among them are the following three related factors: lower investment in fundamental innovation [as measured, e.g., by research and development (R&D) intensity], lower investment in applied innovation or the adoption and diffusion of new technologies [which are typically embodied in new machinery and equipment (M&E) — including information and communications technology (ICT) — capital], and the lack of competitive pressures (e.g., in product markets). Since competition is generally seen as the single leading catalyst for fundamental and applied innovation, this paper analyzes the role of product market competition in the Canada-U.S. productivity level gap. To this end, we develop an empirical framework in which competition exerts both direct and indirect effects on productivity, the latter through its impacts on fundamental and applied innovation. We find statistically significant evidence that the competition intensity differential (between Canada and the U.S.) has contributed to the Canada-U.S. productivity level gap directly, and indirectly through lower investments in both R&D activities and M&E (including ICT) capital. Overall, the discrepancy in competition intensity accounted for about 8.26% of the Canada-U.S. total factor productivity level gap over the 1987–2003 period in the business sector. We also find statistically significant evidence that Canada's relative poor performance in productivity and investments in technology adoption have acted as a self-reinforcing mechanism, which further causes detriment to the country's productivity.

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