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Study: Impact of small-firm disadvantage on the productivity gap

Jan. 13, 2014 – The gap between the levels of labour productivity in Canada and the
United States is due primarily to the larger share of employment in
small firms in Canada and their comparatively lower labour productivity
vis-a-vis large firms. Labour productivity is defined as gross domestic
product (GDP) per hour worked.

While small firms are often regarded as dynamic and innovative, in
many cases, they may not be able to exploit the scale economies
associated with size and, therefore, possess a productivity disadvantage
relative to their larger counterparts. A country with a large
proportion of employment in small firms, it has therefore been
suggested, is likely to have relatively lower levels of aggregate
business-sector productivity.

Analysis of the importance of this explanation for the Canada /
United States gap in labour productivity levels requires comprehensive
and comparable data on firm-size distributions in Canada and the United
States and on differences in productivity levels across firm size
classes.

Two papers released today provide new comprehensive data on labour
productivity differences across size classes in the two countries. They
also analyze whether differences in industrial structure between Canada
and the United States, along with differences in productivity
performance of small firms relative to large firms, can explain the
productivity gap between the two countries.

Differences in size distributions between Canada and the United States

The first study, "The Distribution of Gross Domestic Product and
Hours Worked in Canada and United States across Firm Size Classes,"
examines and compares labour productivity levels in Canada and United
States in the business sector for small and large firms
from 2002 to 2008. It quantifies the relative importance of small and
large firms in Canada and the United States using measures of both
output (GDP)
and labour input (hours worked) and compares the relative labour
productivity levels of small versus large firms. For this study, small
firms are defined as having 0 to 499 employees while large firms are
those possessing 500 or more.

Over the 2002 to 2008 period, the importance of large firms in the business sector, as measured by their share of GDP
and hours worked, was smaller in Canada than the United States.
In 2008, large Canadian firms generated 46.6% of business sector GDP and 29.2% of hours worked. Large firms in the United States, in turn, produced 53.9% of GDP and 44.4% of hours worked.

At a detailed industry level, the large-firm share of GDP
in the United States was greater than 50% in more individual industries
than in Canada. The cross-country differences were particularly large
in the service sector. The large-firm share of the services sector
was 40.2% in Canada in 2008, compared with 52.8% in the United States.
The large-firm share was 55.4% in the goods-producing industries in
Canada that year, compared with 56.8% in the United States.

Overall, the gap in labour productivity levels between small and
large firms was larger in Canada than in the United States. Canadian
labour productivity levels in small firms were about half those of large
firms. In the United States, small firms were about 70% as productive
as large firms.

Impact of the small-firm disadvantage on the Canada–United States productivity gap

The second study, "Canada–United States Labour Productivity Gap
across Firm Size Classes," examines whether having a larger share of
hours worked in small firms that were relatively less productive than
large firms accounts for the gap in aggregate labour productivity levels
between Canada and the United States.

Since aggregate productivity is just the weighted sum of the
productivity of the underlying enterprises that make up the economy,
changes in size distributions or relative productivity (all else being
equal) will result in changes in aggregate productivity levels. For
example, increasing the proportion of the more productive large firms,
while holding constant their relative productivity, will increase
aggregate productivity. Increasing the relative productivity of small
compared with large firms, while holding constant their relative
importance as measured by the share of hours worked, will also increase
aggregate productivity.

The paper provides estimates of the impact on Canadian aggregate
labour productivity levels of increasing the share of hours worked in
Canadian large firms to US
levels. It then quantifies the impact of increasing the relative
productivity of small-to-large firms in Canada up to the relative
productivity ratio of small firms to large firms that exists in the
United States.

The study finds that an increase in the share of hours worked of large firms in Canada to US
levels would have increased Canadian labour productivity levels by
about 6% in 2002 and reduced the productivity gap. Bringing the relative
labour productivity of small compared with large firms up to US
levels would have increased Canadian labour productivity levels by
another 11% in 2002 and would have had a greater impact on reducing the
productivity gap.

Together, decreasing the relative importance of small firms in the
economy and increasing their relative productivity compared with large
firms accounts for most of the gap in productivity levels between Canada
and the United States in 2002.

Changes in the economy that occurred between 2002 and 2008 reduced
the relative contribution of the small-firm sector to about 60% by 2008.