Productivity gap adjustment

429. As discussed in Section 6.3.1 above, NERA‘s study used a population of 72 U.S. electric and combination electric/gas companies. In these circumstances, Dr. Carpenter indicated that to the extent that utilities in Canada have different productivity expectations than utilities in the U.S., an adjustment to the NERA‘s TFP number would be required in a Canadian PBR context.⁵⁰³

430. Dr. Carpenter observed that there is a well-documented productivity gap between the Canadian and the U.S. economies, with Canadian productivity growth rates consistently lower than productivity growth in the U.S. For example, Dr. Carpenter pointed to a Statistics Canada study that found that average annual MFP growth was 0.9 percentage points lower in Canada than in the United States from 1961 to 2008.⁵⁰⁴ In addition, Dr. Carpenter observed that in its TFP analysis, NERA showed that on average, productivity in the U.S. economy grew

0.95 percentage points per year faster that productivity in the Canadian economy over the 1972 to 2009 period.⁵⁰⁵

431. At the same time, the ATCO companies‘ expert acknowledged that while the existence of the economy-wide productivity gap has been documented by government statistics and academic studies, the specific causes of the gap are not well understood and it is not clear whether a similar

501 Transcript, Volume 1, pages 141-142; Transcript, Volume 4, pages 611-612; Transcript, Volume 8, page 1415;

Transcript, Volume 11, pages 2133-2134; Transcript, Volume 13, page 2589.

502 Exhibit 630.02, EPCOR argument, paragraph 31; Exhibit 628, AltaGas argument, pages 12-13; Exhibit 648.02, ATCO Gas reply argument, paragraph 94.

503 Exhibit 98.02, Carpenter evidence, pages 25-26.

504 Baldwin, John and Wulong Gu, Productivity Performance in Canada, 1961 to 2008: An Update on Long-term Trends, Statistics Canada, August 2009.

505 Exhibit 98.02, Carpenter evidence, page 29.

productivity gap exists in the electric and gas utility sector. For example, Dr. Carpenter noted that studies relying on the Statistics Canada data typically define the utility sector more broadly, including power generation and transmission in the electric sector and water and sewage utilities in the gas sector.⁵⁰⁶ Thus, these studies may not provide an accurate estimate of productivity growth for electric or gas distribution companies. As a result, Dr. Carpenter conceded that there is no evidence to permit a direct comparison of Canadian and U.S. productivity growth rates for electric or gas distribution companies.⁵⁰⁷

432. Despite the lack of direct empirical evidence, Dr. Carpenter concluded that it is likely that the economy-wide productivity gap between Canada and the U.S. persists at the utility sector level. Dr. Carpenter arrived at this conclusion as a result of following considerations.⁵⁰⁸

First, Dr. Carpenter indicated that he was not aware of any evidence that differences in the composition of the two economies drive the different rates of productivity growth.

For example, Dr. Carpenter noted that the proportion of total GDP generated by the various sectors of the Canadian and the U.S. economies is not very different.

Second, Dr. Carpenter noted that he was not aware of any compelling evidence that there is one sector or a group of sectors in the Canadian and the US economies that drives the productivity gap. According to Dr. Carpenter, there is evidence that the productivity gap occurs in a wide range of sectors, which is likely to include the utility sector.

Third, Dr. Carpenter observed that while there is some disagreement among researchers as to the possible explanations for the U.S.-Canada gap, he had seen no reason to believe that the productivity gap is unlikely to affect the utility sector.

433. As a result of these considerations, Dr. Carpenter indicated that NERA‘s TFP estimate for the U.S. companies needed to be adjusted for the observed U.S.-Canada productivity gap.

Using the economy-wide productivity estimates from Statistics Canada and the U.S. Bureau of Labour Statistics presented in NERA‘s report, Dr. Carpenter proposed an adjustment of

approximately -1.5 percentage points to NERA‘s TFP.⁵⁰⁹

434. Furthermore, Dr. Carpenter expressed his view that the recommended productivity gap adjustment was conservative for Alberta. The ATCO companies‘ expert noted that the CSLS report⁵¹⁰ and another productivity study⁵¹¹ show a Canada-Alberta productivity gap, with Alberta having slower productivity growth in the utility sector and in the business sector in general.

However, because ATCO Electric and ATCO Gas make up a significant part of the utility sector in Alberta, Dr. Carpenter indicated that adjustment for a Canada-Alberta productivity gap may not be appropriate since the resulting X factor would be ―ATCO-specific‖ rather than reflective of the industry productivity trends.⁵¹²

435. AltaGas agreed with Dr. Carpenter that in the case that the TFP analysis ―did not focus on the Canadian gas distribution industry, an adjustment for the U.S.-Canada productivity gap

506 Transcript, Volume 6, page 1004, lines 4-25.

507 Exhibit 98.02, Carpenter evidence, pages 26-27.

508 Exhibit 98.02, Carpenter evidence, pages 27-29.

509 Exhibit 98.02, Carpenter evidence, page 30, Tables 2 and 3.

510 The CSLS report was discussed in Section 6.3.7 of this decision.

511 Rao, Someshwar, Andrew Sharpe and Jeremy Smith, An Analysis of the Labour Productivity Growth Slowdown in Canada since 2000, International Productivity Monitor, Spring 2005.

512 Exhibit 98.02, Carpenter evidence, pages 33-34.

would generally be appropriate.⁵¹³ With respect to the Canada-Alberta productivity gap, AltaGas observed that the CSLS report (from which the existence of such a gap was inferred) was

conducted on an experimental basis. As such, AltaGas did not propose to make an adjustment for differences in productivity growth between Alberta and Canada.⁵¹⁴

436. EPCOR submitted that neither the company itself nor its expert Dr. Cicchetti have

proposed an adjustment for the productivity differences between the U.S. and Canada or between Canada and Alberta. During the hearing, Dr. Cicchetti explained that the data for Canadian companies do not exist in a fashion that would allow anyone to have an authoritative opinion on the difference in productivity between Canadian and U.S. electric distribution utilities.⁵¹⁵ At the same time, when establishing the components of EPCOR‘s PBR plan, Dr. Cicchetti urged the Commission to recognize that the actual trend in input prices for labour in Alberta are likely to be above the past trends in the U.S. reflected in NERA‘s data.⁵¹⁶ As a result, EPCOR submitted that the Commission should not increase the X factor ―to something more than -1.0 per cent‖ that Dr. Cicchetti recommended for the company, given the difference in U.S. and Alberta labour economics.⁵¹⁷

437. Fortis noted that the company did not ground its X factor approach or recommendation on the basis of a productivity gap. Furthermore, Fortis submitted that the relevant Canada to Alberta considerations in the company‘s proposal were with respect to the I factor, where the appropriate ―Albertasizing‖ of input price measures was undertaken.⁵¹⁸

438. The CCA did not believe that any adjustment to the X factor to account for the

U.S.-Canada productivity gap was necessary. Having examined the analysis of MFP conducted in several papers by Statistics Canada, PEG found that productivity growth differences between the United States and Canada ―vary so widely by industry as to render economy-wide differences in productivity growth useless in quantifying differences in productivity growth between specific industries in the two countries.‖⁵¹⁹ In addition, PEG observed that the productivity gap between the U.S. and Canada was largely due to differences in sectors that do not include utilities, such as mining and oil extraction and manufacturing.⁵²⁰

439. In a similar vein, NERA indicated that it was not aware of any evidence to point to a productivity gap between U.S. and Canadian utilities:

NERA has seen no evidence to point to a productivity gap between US and Canadian utilities. The existence of a macroeconomic productivity gap between the US and Canada does not necessitate the existence of a productivity gap between US and Canadian utilities – or even suggest such a gap for companies, which operate as regulated utilities in markets subject to highly similar sets of accounting, administrative and legal

institutional arrangements in the US and Canada.⁵²¹

513 Exhibit 628, AltaGas argument, page 30.

514 Exhibit 628, AltaGas argument, page 31.

515 Transcript, Volume 11, page 2009, lines 16-24.

516 Exhibit 233.01, AUC-ALLUTILITIES-EDTI-9(b).

517 Exhibit 630.02, EPCOR argument, paragraphs 74-75.

518 Exhibit 633, Fortis argument, paragraphs 130-131.

519 Exhibit 376.01, ATCO-CCA-42(c).

520 Exhibit 376.01, ATCO-CCA-42(c).

521 Exhibit 291.02, Calgary-NERA I-9(c), Exhibit 195.01, AUC-NERA-7.

440. Calgary stated that there is fundamentally little if any difference between the productivity of the U.S. and Canadian distribution utilities.⁵²² Similarly, the UCA expressed its concerns with establishing the existence of a productivity gap between U.S. and Canadian distribution

companies based on the difference in productivity in the overall Canadian economy compared to the overall U.S. economy. In their evidence, Dr. Cronin and Mr. Motluk presented the results of various studies of Canadian electric and gas distribution utilities showing that the TFP growth rates of Canadian distribution companies were ―notably higher‖ than for the U.S. distribution companies as measured by NERA‗s TFP growth rate.⁵²³ As such, the UCA‘s experts argued that there was a reverse productivity gap between U.S. and Canadian distribution companies.⁵²⁴ Commission findings

441. Parties did not dispute the fact that there presently exists a well-recognized difference between the rate at which the U.S. and the Canadian economies have been able to improve productivity (referred to as a ―productivity gap‖). Using macroeconomic productivity data from Statistics Canada and the U.S. Bureau of Labour Statistics, NERA showed that, on average, productivity in the U.S. economy grew 0.95 percentage points per year faster that productivity in the Canadian economy over the 1972 to 2009 period.⁵²⁵

442. At the same time, parties could not agree on whether the same productivity gap exists between the U.S. and Canadian electric and gas distribution industries. Little direct evidence on whether a gap exists is available. Dr. Carpenter and Dr. Cicchetti pointed to the fact that it is not possible to directly review the productivity gap in the electric and gas utility sectors, as no data on productivity growth for Canadian electric and gas companies exist.⁵²⁶ The UCA experts proposed examining TFP growth estimates of Canadian utilities obtained from various regulatory proceedings for this purpose. However, in the Commission‘s view, because the TFP estimates introduced by Dr. Cronin and Mr. Motluk represent a variety of sources, methods, samples and time periods, it is uncertain whether these estimates can be directly compared to NERA‘s TFP calculation to make a judgment on the existence of a productivity gap for the electric and gas distribution industries between the two countries.⁵²⁷ As such, the Commission will proceed with evaluating the indirect evidence of a productivity gap between U.S. and Canadian utilities.

443. On a conceptual level, the Commission agrees with NERA‘s and the interveners‘

proposition that the existence of a macroeconomic productivity gap between the U.S. and Canada does not mean that there is a productivity gap between U.S. and Canadian utilities. As Dr. Lowry explained:

And also the thrust of my evidence is that if you look under the hood of the Canadian economy and go sector by sector, it's nothing, you know, remotely true that all the sectors are behind their American counterparts. The numbers are just all over the place. So there's very bad predictive value by saying that for a given industry just because the Canadian economy's productivity trend is slower that therefore a given sector should be slower.⁵²⁸

522 Exhibit 629, Calgary argument, page 28.

523 Exhibit 299.02, Cronin and Motluk UCA evidence, pages 76-79 and 86-87.

524 Exhibit 634.02, UCA argument, paragraphs 134-135.

525 Exhibit 80.02, NERA report, page 20, Table 4.

526 Exhibit 476.01, Carpenter rebuttal evidence, page 41; Transcript, Volume 11, page 2009, lines 16-24 (Cicchetti).

527 Exhibit 299.02, Cronin and Motluk UCA evidence, pages 78-79.

528 Transcript, Volume 13, page 2562, lines 11-19.

444. To examine which particular sectors of the Canadian economy contribute to a

productivity gap, parties relied on a number of government and academic studies. For example, Dr. Carpenter observed that one Statistics Canada study⁵²⁹ found evidence of the labour

productivity gap in six of the nine industries examined, including utilities and transportation, manufacturing, retail trade, information and cultural industries; and finance, insurance, and real estate. Another study⁵³⁰ that Dr. Carpenter relied on identified a U.S.-Canada productivity gap in 20 of 33 categories, including electric utilities, gas utilities, mining, food, textiles, printing, and electrical machinery.⁵³¹

445. However, the Statistics Canada study⁵³² referenced by the CCA‘s experts, PEG, did not support this conclusion and showed that ―the MFP trend of the engineering sector of the

economy which includes energy utilities actually exceeded that of the U.S. over a recent sample period.‖⁵³³ Another study by Statistics Canada⁵³⁴ quoted by PEG showed that in the 2000 to 2008 period, the decline in the business sector MFP growth rate was due chiefly to declining

productivity in two industrial classifications: mining and oil and gas extraction, and

manufacturing.⁵³⁵ The UCA also presented the results of an academic study⁵³⁶ showing that for the period from 1961 to1995, Canada was ―significantly more productive than the United States in coal mining, construction, tobacco, petroleum refining, electric utilities, and gas utilities.‖⁵³⁷ 446. Without engaging in a debate on the methodology, time period and relevance of the academic studies discussed in this proceeding,⁵³⁸ the Commission observes that there is no consensus in the literature on whether a productivity gap exists for the utility sector in general or for the electric and gas distribution sectors in particular. On a related issue, Dr. Carpenter pointed out that there remains a disagreement among the researchers as to the possible explanations for the U.S.-Canada productivity gap.⁵³⁹

447. Furthermore, as Dr. Carpenter indicated, some of the academic studies on productivity referenced by the parties in this proceeding refer to the Canadian utility sector in general, which includes power generation and transmission in the electric utilities sector and water and sewage systems in the natural gas utilities sector.⁵⁴⁰ As such, it is uncertain whether the productivity of the utilities sector reported in the studies is an accurate reflection of the electric and gas distribution companies‘ TFP growth.

529 Baldwin, John and Wulong Gu, Productivity Performance in Canada, 1961 to 2008: An Update on Long-term Trends, Statistics Canada, August 2009 (No. 25), Statistics Canada.

530 Gu, Wulong and Mun Ho, A Comparison of Industrial Productivity Growth in Canada and the United States, Published in Industry-level Productivity and International Competitiveness between Canada and the United States, 2001.

531 Exhibit 98.02, Carpenter evidence, page 28.

532 Baldwin, Gu and Yan, Relative Multifactor Productivity Levels in Canada and the United States: A Sectoral Analysis, The Canadian Productivity Review, June 2008 (No. 19), Statistics Canada.

533 Exhibit 636, CCA argument, paragraph 102.

534 Baldwin and Gu, Productivity Performance in Canada, 1961 to 2008: An Update on Long-term Trends, The Canadian Productivity Review, August 2009 (No. 25), Statistics Canada.

535 Exhibit 636, CCA argument, paragraph 102.

536 Lee, Frank C., and Jianmin Tang. 2000. Productivity Levels and International Competitiveness between Canadian and U.S. Industries. American Economic Review, 90(2): 176-179.

537 Exhibit 634.02, UCA argument, paragraphs 136-138.

538 Exhibit 476.01, Carpenter rebuttal evidence, pages 42-46; Exhibit 650, AltaGas reply argument, paragraph 87.

539 Exhibit 98.02, Carpenter evidence, page 29.

540 Exhibit 98.02, Carpenter evidence, page 26; Exhibit 476.01, Carpenter rebuttal evidence, page 45.

448. In light of the conflicting evidence from the government and academic research, and the uncertainty of whether the results of such research can be used for establishing the existence of a productivity gap between U.S. and Canadian distribution utilities, the Commission considers that no definitive conclusion can be reached on the existence of such a gap. Further, the Commission finds it to be significant that parties observed the business, operational and regulatory similarities between utilities in both jurisdictions. For example, NERA commented on the similarity of the institutional frameworks in which the Canadian and U.S. utilities operate. As NERA explained:

[F]rom the constitutional foundation through to administrative practices, accounting practices and judicial review, Canada and the United States have virtually

indistinguishable regulatory environments – so much so that the US Hope and Bluefield decisions are even cited in Canadian rate cases.⁵⁴¹

449. Dr. Cicchetti also pointed to similarities in the business environment between the utilities in the two countries by observing that electric and gas distribution companies in both the United States and Canada ―are certainly the last remaining holdout in the U.S. context of unionized employees.‖⁵⁴²

450. In light of these considerations, the Commission finds that no adjustment to NERA‘s TFP is necessary to account for the observed economy-wide productivity gap between the U.S. and Canada. The Commission observes that Dr. Carpenter was not aware of any jurisdiction in Canada that has adjusted a TFP estimate in setting the X factor in recognition of the productivity gap between the two countries.⁵⁴³

451. With respect to a Canada-Alberta productivity gap, the Commission notes that Dr. Carpenter‘s conclusions as to the existence of such a gap were largely derived from the examination of the CSLS study.⁵⁴⁴ However, as the Commission explained earlier in this section and in Section 6.3.7, because the CSLS study used the same methodology and underlying data that Statistics Canada employed in calculating its MFP indexes, it is not clear to what degree the results of this study are reflective of the productivity trends in the electric and gas distribution industries.

452. More importantly, the Commission explained in Section 6.2 of this decision that the X factor should reflect the average rate of productivity growth in the industry. Accordingly, the Commission agrees with Dr. Carpenter‘s observation about the size of the ATCO companies and concludes that because the companies in this proceeding make up a large part of the utility sector in Alberta, an adjustment for a Canada-Alberta productivity gap (in the utility sector) would result in an X factor that would reflect the companies‘ own experience rather than industry productivity trends.⁵⁴⁵

453. Dr. Cicchetti proposed that when setting the X factor for Alberta companies, some recognition be given to the fact that the actual trend of input prices for labour in Alberta is likely to be above the past trends in the U.S. that are reflected in NERA‘s TFP estimates.⁵⁴⁶ In

541 Exhibit 391.02, NERA second report, page 20.

542 Transcript, Volume 11, page 2071, lines 3-6.

543 Transcript, Volume 4, page 635, lines 7-11.

544 Exhibit 98.02, Carpenter evidence, page 33.

545 Exhibit 98.02, Carpenter evidence, pages 33-34.

546 Exhibit 233.01, AUC-ALLUTILITIES-EDTI-9(b).

EPCOR‘s view, the consequence of this would be that NERA‘s TFP growth rate would be higher than the actual TFP growth rate for Alberta.⁵⁴⁷

454. The Commission has a number of concerns with the EPCOR proposition. First of all, Dr. Cicchetti did not provide any information on the relative labour inflation in Alberta and the United States for NERA‘s study period to support his conclusion that labour inflation in Alberta has been consistently higher than labour inflation in the U.S. over this entire period.

455. Furthermore, the actual impact of labour inflation on the TFP estimate is not so direct as to warrant an immediate upward adjustment to NERA‘s estimates. NERA explained that its overall input index (in the form of a Tornqvist-Theil volume index) primarily captures changes in input volume.⁵⁴⁸ Because NERA used the number of employees as a labour quantity

measure,⁵⁴⁹ the resulting TFP estimate is largely, but not completely, insulated from the effect of labour inflation. NERA explained that its overall input index ―is affected by input prices to the extent that the input expenses are the shares by which the input volumes are weighted.‖⁵⁵⁰ Since NERA used nominal dollars to construct the input price shares,⁵⁵¹ adjusting for higher labour inflation (assuming that the labour inflation in Alberta was consistently higher than in the United States) would result in a higher share of labour in NERA‘s input index. However, a higher share of labour in the overall input index does not necessarily lead to a reduction to TFP. For example, if the rate of growth in the labour index (i.e., labour quantity) were lower than the rate of growth of the capital and materials indexes (quantities of capital and materials), assigning more weight

measure,⁵⁴⁹ the resulting TFP estimate is largely, but not completely, insulated from the effect of labour inflation. NERA explained that its overall input index ―is affected by input prices to the extent that the input expenses are the shares by which the input volumes are weighted.‖⁵⁵⁰ Since NERA used nominal dollars to construct the input price shares,⁵⁵¹ adjusting for higher labour inflation (assuming that the labour inflation in Alberta was consistently higher than in the United States) would result in a higher share of labour in NERA‘s input index. However, a higher share of labour in the overall input index does not necessarily lead to a reduction to TFP. For example, if the rate of growth in the labour index (i.e., labour quantity) were lower than the rate of growth of the capital and materials indexes (quantities of capital and materials), assigning more weight