How to grow Canada’s productivity? Competition, competition, competition

In real estate, the mantra for added value is: Location, location, location.

In increasing Canada’s productivity and economic growth, the strategy should be: “Competition, competition, competition,” says journalist Andrew Coyne (photo at right).

 “You want an innovation policy? Competition is the most effective innovation policy,” Coyne, columnist with The Globe and Mail and a member of the At Issue panel on CBC’s The National, said in a keynote talk to Canada’s Productivity Summit in Calgary. 

There’s a tendency in Canada to treat innovation as if it were a piece of industrial machinery in itself, he said. “You inject a certain amount of government funding for R&D at one end, you get a certain amount of higher productivity at the other.”

But this just isn’t the case, he said, noting there’s barely a correlation between what he called Canada’s “heroic” levels of tax assistance to stimulate business spending on R&D and actual spending on R&D.

“There’s very little connection between aggregate spending on R&D and innovation, still less on higher productivity and higher output.”

Yet study after study has linked the importance of competition to innovation, productivity and economic growth, Coyne said.

He pointed to a 2009 Council of Canadian Academies report that found competition is one of the most potent incentives for innovation, both because of the benefits innovation can provide and, more importantly, the threats that can be averted if innovation keeps a firm running ahead of its competitors.

Coyne also cited the federally appointed Competition Policy Review Panel, led by business executive L. R. (Red) Wilson, which noted in its 2008 report, Compete to Win, that the primary drivers of productivity growth are the investment, innovation and adaptation fostered by openness and competition.

Despite the fundamental importance of competition to productivity growth, when you look across the Canadian policy landscape, “you see competition everywhere being constrained,” he said. “Lack of competition is a pervasive problem in Canada, not as an accident of history, but as a matter of deliberate policy.”

Canada may have liberalized much of its international trade, but important sectors of the country’s economy – telecommunications, financial services, air travel and others – “remain protected oligopolies,” he said.

Sectors such as the post office, rail travel and liquor boards “remain in many provinces across the country state monopolies, for no other reason than it would be too difficult to break them up.”

There’s a lack of competition in Canada’s health care system and in supply management, where it results in Canadians paying two and three times the market price for staple food items, Coyne said.

On top of interprovincial trade barriers, federal policies restrict foreign companies from competing in protected sectors, he said. “Too often, industries are not regulated in the interests of the people who use them – consumers – but in the interests of the industries themselves.”

By muzzling competition, governments not only [hurt] consumers but constrain the “relentless search for new and better ways of doing valued things,” Coyne said.

“Most disgracefully of all, 157 years after Confederation, we still do not have a functioning common market. Rather, commerce is forced to fight through hundreds and hundreds of interprovincial trade barriers.”

A 2019 study by the International Monetary Fund found the average internal trade barrier in Canada to have an effect on trade equal to that of a 21 percent tariff, imposing losses on the economy equal to four percentage points of GDP, Coyne noted.

“We can’t afford this anymore. We’ve got to start cracking open these cozy little oligopolies and dismantling these ancient monopolies.”

Canada needs to increase productivity to pay future bills

Productivity in Canada is declining at the very time when there’s an urgent need for economic growth in the country, Coyne said.

“We’re not just talking about the level of productivity or even the rate of change in it, but about increasing the rate of change, increasing the growth rate of productivity. That’s the challenge in front of us.”

Canada’s population is aging, the workforce is retiring, and people in the post-war Baby Boom generation are living longer on average.

By 2050, roughly 25 percent of the Canadian population will be over the age of 65, an increase from the 19 percent today and up from just seven percent in the early 1970s.

Not so long ago, Canada had five times as many workers for every retiree. Soon, that ratio will be closer to 2.5 workers for every retiree.

Canada’s aging and longer-living population is driving up the consumption and cost of health care, which already is absorbing almost 50 percent of provincial source revenue (excluding federal transfer payments), Coyne noted.

Add in the costs of pensions and elderly benefits, and the C. D. Howe Institute calculates that population aging represents a net unfunded liability (promises to pay that governments have not set aside revenues to cover) of about $3.9 trillion.

That’s on top of the unfunded liabilities in the Canada Pension Plan, which amount to roughly $1.2 trillion. The federal net debt adds another $1.2 trillion, and the combined provincial debts a further $800 billion.

“All told, we have an implied public sector obligation in excess of $7 trillion, or nearly 2 ½ times our annual GDP,” Coyne said.

“The only way out of this conundrum is faster [economic] growth. That’s the only way. It doesn’t have to be a lot faster, so long as it’s sustained, so we can get the magic of compounding working in our favour.”

But when it comes to productivity and economic growth, Canada is moving in the opposite direction of where it needs to be going.

Coyne said in the 1950s and 1960s, real output in Canada grew by more than five percent annually, on average.

By the 1970s, it had slowed to roughly four percent, then three percent in the 1980s, 2.4 percent in the 1990s, and 2.1 percent in the 2000s.

In recent years, it has averaged just over 1.5 percent – less than one-third the growth rate of the 1950s.

“Growth in GDP is now below the growth in population, meaning real per capita [output] is falling,” Coyne said. “At our present rates of growth and output and population, the country is looking at a future of continued absolute declines in per capita output, not for a quarter or two, but for years on end.”

“A society that cannot look forward to a future of rising living standards is one that is deprived of one of the primary motive forces of human behaviour – yes, hope,” he added.

Economic growth per capita GDP in Canada has now fallen to just 73 percent of U.S. levels, from 92 percent in 1981, he noted. “It isn’t only the U.S. we’ve been following behind, it’s everyone.”

Fifty years ago, Canada ranked eighth among Organisation for Economic Co-operation and Development (OECD) countries in terms of growth per capita GDP. As of 2022, the country was 15^th. And the OECD projects that Canada will have the slowest growth in per capita GDP among member countries from now to 2060.

“We used to be richer than countries like Austria, Germany, Belgium, Finland, Iceland, Ireland. Now all of them are richer than we are,” Coyne said.

In labour productivity – measured as output per hours worked – Canada ranked 18^th in 2022. Over the last 50 years, growth in labour productivity in Canada has been the slowest among the OECD.

“We have a growth crisis, in other words, because we have a productivity crisis,” Coyne said. “In the long run, the primary driver of growth is productivity, and in the long run the productivity prognosis is not good.”

Stop funding applied research and end business subsidies

Canada’s productivity has been slow to respond to the remedies of orthodox economics – tax cuts, low inflation, balanced budgets and free trade, Coyne said. “It has proved even more of a challenge to the practitioners of unorthodox economics.”

These unorthodox economics include a constellation of policies that could be described as industrial strategy or industrial policy, he said. They include providing subsidies to businesses and sectors thought to be particularly strategic – such as manufacturing versus natural resources extraction – and cultivating national champions to be protected from foreign takeovers.

“These in turn depend on the number of underlying and dubious assumptions that governments are better placed to divine our industrial future than private investors whose livelihoods depend on it,” he said.

The whole enterprise “is fundamentally misconceived,” Coyne maintained. “There’s no way around this: if a product is economic, it doesn’t need a subsidy. If it isn’t economic, it doesn’t deserve it [a subsidy].”

The second suite of policies that government uses falls under the category of “modern supplies and economics,” he said. These policies include more spending on infrastructure, skills, R&D and innovation.

On the face of it, such policies seem to make sense, Coyne said. “It’s when you get into the details that you realize how ill thought-out the whole thing really is.”

In particular, he said, government is obsessed with broad aggregates: how much infrastructure spending there is, how much education people are getting, how much R&D spending is going on – “with the quantity, that is, rather than the quality.”

 “If decisions on infrastructure spending, or education, or innovation are being made not in a decentralized way that is responsive to cost and benefits and people risking their own money, but by politicians in a bunker somewhere, chances are that the bang for the buck will be suboptimal.”

 When it comes to research, it makes sense for government to support “blue-sky” academic research that has no immediate application, Coyne said. “By the same token, however, governments should not be in the business of funding applied research – that is, research that is directed to commercial uses.”

Canada – at both the federal and provincial levels – has hundreds of programs that spend billions of dollars every year to support research, innovation and commercialization, he noted.

“Altogether, Canada is reckoned to provide among the most generous systems of R&D support in the world," he said.

“And what do we have to show for any of it? Falling capital stock, falling productivity, falling relative living standards year after year after year. So perhaps we need a shift in approach.”

Possible solutions to Canada’s “productivity puzzle”

First, Canada should sustain high immigration levels to meet labour demand – not dramatically cut them as Ottawa has announced – as well as generally mobilize every person in the country who can work, Coyne said.

“The problem isn’t that our population is growing at 1.5 percent or two percent per annum. The problem is that our economy won’t grow any faster than that,” he said.

Canada’s population grew as fast or faster in the 1950s and 1960s, but it wasn’t a problem, because the economy grew even faster, he noted. “The problem is not too many people. The problem is too little capital.”

As recently as a decade ago, investment in capital formation per worker in Canada was within striking distance of the U.S.’s investment, or about 95 percent of U.S. levels. Canada’s investment has since declined to about two-thirds of that in the U.S.

As of 2022, each Canadian worker had on average about $19,000 to work with, in constant 2015 US dollars, versus almost $29,000 for each American worker. “The real stock of capital per worker is falling and has been since 2015.”

Since around 2000, investment in residential structures has approximately doubled as a percentage of GDP, while investment in machinery and equipment has roughly halved.

The solution to raising the level of investment in capital formation is to reduce the barriers to investment, and taxes and tax rates are the most important lever to do so, Coyne said.

Canada’s tax rates remain higher than in many comparable countries, not only corporate taxes but especially personal income taxes, he said.

“At the very least we could broaden the tax base, eliminating many of the hundreds of special tax preferences and exemptions, known as tax expenditures, that litter the tax code and apply the revenues to cutting [tax] rates.”

The other big barrier to capital formation in Canada is foreign investment controls, Coyne said. While it’s still appropriate to apply a net-benefit test to foreign takeovers of Canadian firms, government should adopt the recommendation of the 2008 Wilson panel and reverse the onus, he suggested.

“Rather than require proof that the takeover is of net benefit to Canada before it is allowed, require proof it is of net disbenefit before it is forbidden.”

 Another barrier to attracting the right kind of investment, he said, are the billions of dollars in subsidies offered to Canadian businesses every year, and tax preferences given to corporations and individuals.

Eliminating distortionary tax preferences is as important as lowering marginal tax rates, along with eliminating business subsidies, Coyne said. “We need not just sweeping tax reform but sweeping subsidy reform, a comprehensive program of de-subsidization.”

When it comes to government regulations and stimulating competition, the test should be: consumers first, he said.

In a market economy, he noted, it is consumers who, by choosing among the offerings of competing firms, drive each company to look constantly for ways to lower costs and raise productivity.

“Ultimately the consumer interest is the economic interest,” he said. “If every regulation was subject to the test of whether it served the consumer interest, whether it put consumers first, the country would be a lot more prosperous and its consumers a lot less angry.”

The good news is that it is possible for government to implement new policies to change the course Canada is on, Coyne said.

He pointed out that Canada and Argentina had roughly the same per capita output at the start of the 20^th century. By the end of the century, Argentina was barely half as productive as Canada.

Also, the European debt crisis from 2009 through the 2010s began with Greece being unable to repay or refinance its government debt. In Canada, Coyne noted, there are credible projections that within 25 to 30 years, one or more provinces default on their debts.

“We have a choice. We can look at that [debt default] coming down the pike and say, ‘Oh, we’ll deal with it when it happens.’ In which case we’ll have to make a lot of really tough decisions in a hurry that are going to hurt a lot of people,” Coyne said.

“Or we can learn from the experience of the mid-1990s and get out in front of the curve and get started now.”

More than 700 business and community leaders attended Canada’s Productivity Summit, which was organized by the School of Public Policy, with the Government of Alberta as its presenting sponsor.

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