The Relationship between Labour Productivity and Real Wages Growth in Canada and OECD Countries

In the long run, the most direct mechanism by which labour productivity affects living standards is through real wages, that is, wages adjusted for changes in the cost of living. Economic theory holds that at the aggregate level the growth of real wages are determined by labour productivity growth, a relationship mediated by the labour's share of output and labour's terms of trade (the price of output relative to the price of goods that workers consume). Neither increases in the labour share nor labour's terms of trade are likely to be a sustainable way of raising real wages because they fluctuate within fairly narrow bands. Only labour productivity growth can raise living standards in the long run. If short-and medium-term changes in the labour share or labour's terms of trade mean that Canadians are not benefitting from higher labour productivity in the form of higher real wages, then why should they support policies to increase labour productivity growth? The release of data from the 2006 Census has sparked debate over the causes and consequences of the finding that median earnings of individuals working full time on a fullyear basis barely increased between 1980 and 2005. Adjusting for inflation, annual earnings increased from $41,348 to $ 41,401 (in 2005 constant dollars), a mere $53 over 25 years. Over the same time period, labour productivity in Canada rose 37.4 per cent. If median real earnings had grown at the same rate as labour productivity, the median Canadian full-time full-year worker would have earned $56,826 in 2005, considerably more than the actual $41,401. These facts do raise an interesting and important question that this report seeks to answer: what accounts for the divergence between the growth of labour productivity and the growth of real wages?