The secret sauce of US productivity.

Canada’s productivity has declined relative to the US such that a Canadian worker now produces just 50% that of a US worker. However, since World War 2 productivity has actually been quite similar between the two countries, as shown in the graphic below. What we might call a Great Divergence happened starting in 2001. What caused this? And what happened in 2001?

The first thing to say is this is not just a Canadian phenomenon. US growth in productivity has surpassed all Euro area countries and Japan, as shown in the graph below.

So, we can re-frame the question:? Why has the US productivity grown so much faster than Canada and other G7 countries?

I suggest that there are three factors to explain this that are unique to the US: oil ?production, the Magnificent 7 and offshoring.? Let’s examine them.

Oil production.

Since 2007 US oil production has increased by 13 million barrels a day, more than two and a half time 2007 production, as shown in the graphic below. This has had a huge effect on the US economy. Because oil production is one of the most productive sectors of the economy it has raised productivity considerably. Also, as Bloomberg reports, oil and gas extraction has seen the fastest labor productivity gains of any sector in the past decade.

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Texas and Alberta have an almost identical GDP per capita ($US84,000 for Texas, $US82,200 for Alberta) because both have large oil and gas deposits.

The origins of the rise in US oil production can be traced to the 1990’s. Fracking (hydraulic fracturing) had been in use for a long time in the US, to extract oil and gas from shallow hard rock.? However, during the 1990’s and early 2000’s, the technology was significantly improved with the use of horizontal drilling and microseismic mapping. The rise of fracking in shale began in 2003 and was called the “shale gale” and it led to a huge increase in drilling in shale formations in the US.

Magnificent 7

The Magnificent 7, the name given to the leading technology companies – Google (Alphabet), Nvidia, Amazon, Tesla, Facebook (Meta) and Apple – have had an outsized impact on the US economy:?

·?????? They comprise 35% of the market capitalization of the S&P 500, $US15 trillion, roughly equal to the UK, Japanese and Canadian stock markets combined.

·?????? They spent about $US200 billion on R&D in 2022.

·?????? They employ more than two million people.

They each dominate their sector and have enormous market power. They invest heavily in research and development and that allows them to maintain their competitive advantages and dominate their competition.

Many of these companies were founded around this time before starting their explosive growth:

·?????? Google – 1998

·?????? Nvidia – 1993

·?????? Tesla – 2003

·?????? Facebook - 2004

According to research from Bain and Company, technology companies like the Magnificent seven are 40% more productive than the average company.

Offshoring.

In the 1980s US companies began outsourcing to low-cost countries. This accelerated after China joined the World Trade Organization in 2001. The US became a global leader in outsourcing, far more than other countries. Forbes magazine says that the U.S. stands as a dominant force in global outsourcing generating $62 billion of the $92.5 billion global outsourcing industry. It is estimated that 5 million US jobs were offshored in the last 25 years.

A report from Statistics Canada shows that offshoring has a direct effect on manufacturing industry productivity by raising average firm-level productivity. Firms engaging in offshoring thus become more competitive and may then expand their market shares at the expense of less productive firms.

How permanent is the US advantage?

No advantage lasts forever. US oil production will eventually be limited by moves to reduce greenhouse gases and by lower cost alternatives; the dominance of the Magnificent Seven may be reduced by anti-trust actions and normal competitive forces, and the trend to offshoring may be reversed by government policies. But the advantage looks to stay in place for several more years, if not longer.

Conclusion

These three factors – offshoring, oil production and the Magnificent 7 - go a long way to explaining why US productivity has grown so much faster than Canada and other G7 countries. The divergence began in 2001 when China joined the WTO, fracking technology became established, and many of the Magnificent 7 were founded around then. The advantage will not last forever but should persist for at least several more years, at least.

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Peter Josty