Stagnant productivity is a creeping problem that has eroded our appetite for innovation

The Canadian work force is less productive because, on average, companies here use less capital and technology, are less innovative, and operate at a smaller scale in an economy plagued by insularity. And it’s getting worse.

Limited private-sector investment in research and development and work force upskilling has left Canada lagging behind peer countries

When Finance Minister Chrystia Freeland tabled her budget last year, Canada’s growth prospects were identified as a significant vulnerability and priority for the government. She sensibly recognized human capital and the green transition as the first two of three “pillars” required to tackle the problem, then identified the third as the “Achilles heel of the Canadian economy” – poor productivity.

Having recently torn my Achilles tendon, I can tell you the sharp, sudden pain experienced is quite unlike the slow, creeping problem that productivity growth has become in Canada. This is not an issue that suddenly emerged, rather it has sunk intrinsically into the fabric of our commercial activity and eroded Canada’s appetite for innovation.

Compared to peer countries, our productivity has been receding for decades, and its importance has been largely ignored by Canadian business and political leaders. An Achilles injury, while extremely unpleasant, means you hobble around for a few months until you get back on your feet – but that isn’t the case here. Our productivity stagnation continues to spread to all areas of the economy, like a malignant tumour.

While some economic indicators are rosy for Canada – unemployment is low, wages are rising – productivity rates are not. Labour productivity growth has slowed to less than 1 per cent today from 2.7 per cent in the 1960s and 1970s. The OECD has us ranked dead last of all the advanced economic countries in the world in its predictions for real GDP per capita growth from both 2020-30 and 2030-60.

While it’s widely known that Canada lags the United States, we have also fallen behind France, Germany, Britain, Australia and Italy in productivity. The Canadian work force is less productive because, on average, companies here use less capital and technology, are less innovative, and operate at a smaller scale in an economy plagued by insularity. And it’s getting worse.

It’s not just about having a more market-driven economy. Germany is outperforming us with a highly socialized economy and massive government investments in information and communications technology, as well as an advanced apprenticeship system and a business culture that prioritizes worker training.

When one works through the numbers, it is clear that the primary reason for our malaise is a lack of private-sector investment in research and development and in work force upskilling. Canada ranks 17th of OECD countries regarding the percentage of GDP spent on R&D and among the lowest of G7 peers.

To catch up, Canada must show discipline in focusing incentives to catalyze the private sector where it can have the greatest impact. We must prioritize R&D and training incentives that contribute to physical and human capital efficiency strategies.

Stagnation was less concerning during the longest bull market in history, when a forceful rising tide of monetary policy fuelling economic growth was able to mask many concerning, deeper trends. But that veil has now been removed, revealing that Canadian firms are not well-positioned to innovate and grow.

The United States contributes to our economy through its innovation and production, but it is also our biggest competitor. The number of patent applications submitted by Canadian businesses in 2020 was roughly 1.6 per cent of those submitted by American businesses, which is staggering underperformance even when Gdp-adjusted.

Foreign companies and investors looking at Canada will always use the U.S. as a benchmark, given our shared geographic and cultural features. The Americans, recognizing we are at an industrial and economic turning point, have thrown down the gauntlet with public policy and privatesector initiatives to further advance their productivity growth over the coming decades. The most significant being the Inflation Reduction Act, earmarking Us$500-billion in new spending and tax incentives to boost clean energy, labour skills and other areas that will contribute to future productivity growth.

To avoid falling further behind, our government should respond meaningfully in the federal budget this week. Last year’s budget introduced the yet-to-be-defined $15-billion Canada Growth Fund, which would use public money to entice more capital to invest in Canadian industry and is one of several bodies created to help Canadian firms innovate. While these are steps in the right direction, they lack the scale the U.S. can deploy and run the risk of having the government or other public bodies choosing winners, something that private capital is much more adept at.

A policy lever that Canada has considered but never implemented is an “intellectual property box,” which would tax income from patents and other intellectual property at a lower rate, effectively guarding against “poaching” from lower tax jurisdictions.

Recent budgets have attempted incentivization through things like the scientific research and development program that provides tax incentives to businesses that conduct qualifying R&D activities. These are available for eligible R&D expenditures, including depreciation expenses on capital assets – matching them to the revenue they generate over time. But programs like these need to be expanded broadly across industry and made straightforward. Unfortunately, eligible candidates often don’t receive the intended incentives owing to narrow application of the rules by our tax regulators.

The 2022 budget included some tax incentives for small businesses, but these appear more driven by politics than sound economic planning. OECD data shows that productivity growth is typically driven by the top 10 per cent of firms in an industry – the biggest players. This year’s budget should include incentives for large firms located in sectors rife for innovation, in energy, e-commerce, advanced manufacturing, transportation and finance, to spend directly on R&D, and simplify the process so they can move with alacrity to get things built and skills developed.

On skills development, Canada has a natural advantage with its broad public support for immigration and merit-based application program that brings in a high percentage of working-age people with credentials. But immigration already accounts for almost our entire labour force growth – the greater challenge lies in ensuring new workers can contribute with their potential and skillsets.

According to Statistics Canada, more than 25 per cent of immigrants with foreign degrees end up in jobs that they are overqualified for, in roles that require a high-school diploma at most. Improving recognition of foreign credentials, simplifying our immigration processes, and strengthening training and education opportunities are all important ways to gear our human capital strategy towards productivity. With economic demands shifting quickly, employers have skin in the game and will need to intensify efforts to implement work-integrated learning.

The future of our country depends on a more productive economy, underpinned by improved R&D spend and a more skilled work force. In this budget, the government must embrace every tool at its disposal and commit to bold action if it wants to be the architect of a prosperous, innovative Canada that stands tall in the face of international competition.