Productivity growth is key to breaking inflation\u0027s momentum, writes Ted Carmichael
When there is this excess demand, workers who see their real income and standard of living being reduced by rising prices respond, not surprisingly, by demanding higher wages to catch up.
If the rise in prices persists, common knowledge and expectations begin to change. Every business knows that other businesses are raising prices to maintain their profitability. Every worker knows that other workers are asking for a faster pace of wage gains and are changing jobs, if need be, to get them. That is the situation we currently find ourselves in.
Inflation gathers momentum when total compensation per worker outpaces the growth of output per worker, or productivity. A useful measure for capturing this relationship is growth in unit labour costs. When inflation picked up in the 1980s, compensation per hour outstripped productivity and unit labour costs grew by as much as six per cent per year. The 1990-91 recession pushed up unemployment and slowed wage growth, and productivity rose as the economy recovered, driving unit labour costs down.
The recent inflationary shock pushed Canada back into a situation more like the 1980s. Compensation is rising, but productivity is not. Unit labour costs have grown an average of 4.8 per cent a year since the end of 2019. At the end of last year, the latest data show, compensation per hour was growing at a 5.2 per cent pace while productivity wasat a 1.5 per cent pace, resulting in unit labour cost tearing along at 6.7 per cent.
Breaking the momentum of Canada’s inflation will require some combination of slower compensation growth and faster productivity growth. Neither will be easy, and the inflationary late 1980s and recessionary early 1990s are both episodes we would like to avoid.
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