Relative Price Movements and Labour Productivity in Canada: A VAR Analysis

In recent years, the Canadian economy has been affected by strong movements in relative prices brought about by the surging costs of energy and non-energy commodities, with significant implications for the terms of trade, the exchange rate, and the allocation of resources across Canadian sectors and regions. While the energy and mining industries have benefited from these movements, the pressure on the manufacturing sector has intensified, since many firms in this sector were already dealing with growing competition from low-cost economies such as China. The adjustments undertaken within the Canadian economy are readily noticeable through investment decisions, as well as through production and employment reallocation. Using vector autoregressive techniques, the authors examine how an appreciation in commodity prices and the subsequent reallocation of resources across sectors will affect hours worked and output growth and, ultimately, aggregate and sectoral labour productivity growth in Canada. Results suggest that the impact of a positive relative price shock will – in the adjustment process – lower productivity growth in the primary and the non-tradable sectors, and increase it somewhat in the manufacturing sector. The overall impact appears to be slightly negative on aggregate labour productivity growth, but this effect is only temporary.