The end of hope: Inside Canada’s growth and productivity crises
Globe and Mail columnist Andrew Coyne has been sounding the alarm on Canada’s declining growth and productivity for years. Last month, he gave the prestigious Harry Kitchen in Public Policy lecture at Trent University about the problem. What follows are edited excerpts of an extraordinarily illuminating and timely speech.
I’ve been asked to speak on what I’m going to call Canada’s growth crisis. We in the media, of course, are in the habit of declaring absolutely everything to be a crisis — you know, just because it’s Tuesday. But I hope to persuade you that we have a serious problem on our hands and talk about some of the reasons we got into this mess, and some of the ways we can get out of it.
ON THE GROWTH PROBLEM:
Canada’s sluggish rate of economic growth has been a matter of concern for decades. In the 1950s and 1960s, growth in real output (after adjusting for inflation) averaged in excess of 5 percent annually. By the 1970s, that had slowed to roughly 4 percent, to 3 percent in the 1980s, 2.4 percent in the 1990s, 2.1 percent in the 2000s. And in recent years it has averaged just 1.5 percent.
The picture looks even worse in per capita terms, where slow growth has given way to no growth. Indeed, with growth in real GDP is now at or below the rate of growth in population and the country is facing the prospect of absolute declines in per capita output — not for a quarter or two, but for years on end. Real per capita GDP will have fallen in five of the last six quarters, leaving it no higher than it was in the fourth quarter of 2014. Nine lost years, maybe 10, with no end in sight. There has been no longer period of stagnation since the 1930s.
Growth may not be the only thing, but it is an important thing. When an economy ceases to grow, it isn’t only living standards that suffer. So do the things that rising incomes buy. 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: Hope. Without the universal lubricant of growth, all of the divisions within a society, between the classes,
between the generations, between sexes and races — and this is Canada after all, the regions — are likely to be more inflamed. As the saying goes, when the watering hole runs dry, the animals start to look at each other differently.
There’s a particularly urgent need for growth in this country. Put simply, we are entering a time as a society unlike any that has ever existed. By 2050, roughly 25 percent of the population will be over the age of 65. Compare that to the early 1970s, when the over 65s made up just 8 percent of the population.
The fastest growing cohort today are the centenarians. This has two primary implications. One is cost, particularly for health care. As a rule of thumb, per capita consumption of health care doubles for each 10 years over the age of 55. All told, the C.D. Howe Institute’s Parisa Mahboubi calculates population ageing represents a net unfunded liability in the order of $3.9 trillion, with a T. That’s on top of the unfunded liabilities in the Canada Pension Plan, on top of the federal net debt of $1.2 trillion and the combined provincial debt of roughly $800 billion. All told, that’s an implied public sector obligation in excess of $7 trillion, or nearly two and a half times our annual GDP.
Now factor in the second implication: relatively fewer people of working age. Not too long ago, there were as many as five workers for every retiree. Before long, that ratio will have fallen closer to 2.5 to 1.
The implications are particularly dire for the provinces. Every year, the Parliamentary Budget Officer issues a fiscal sustainability report, including long-run projections of each of the provinces’ net debt-to-GDP ratios. Two of the provinces, Manitoba and Newfoundland, are looking at debt-to-GDP ratios in excess of 70 percent. Two more, Prince Edward Island and B.C. are headed in that direction. For perspective, when Saskatchewan nearly hit the debt wall in 1990s, its debt-to-GDP ratio was in the high 40s.
But the federal government is hardly in the clear. It has its own long-run fiscal pressures, from underwriting the provinces to expensive new social programs the current government has introduced, to the potentially massive costs of rebuilding the Canadian military for a dangerous new world. And that’s assuming we’re not hit by some kind of fiscal and economic shock from a housing market meltdown to another oil price collapse to a major international war, It doesn’t take much tweaking to show a federal debt-to-GDP ratio rising north of 50%.
There’s only one way to deal with this, and that is faster growth. Politicians often say we can just grow our way out of it — for once, it’s true in the long run. It doesn’t have to be a lot faster, so long as it is sustained. If we can get our growth rate up and keep it there year after year, decade after decade, the next generation or two will be so much richer than we are that they might be able to afford the crippling costs of looking after us in our dotage.
The long-term growth trajectory of an economy really is responsive to policy — certainly it is to bad policy. If you doubt it, consider the classic example of Canada versus Argentina, where Argentina had roughly the same per capita output as Canada at the beginning of the 20th century. By the end of the century, it was barely half as productive. And it is long-run growth rates that ultimately determine a country’s standard of living. Business cycle fluctuations that seemed terribly important at the time appear as mere blips in the long run growth chart. Get the micro foundations right, and an economy can grow faster for longer and at lower levels of unemployment without overheating.
ON THE CASE FOR PRODUCTIVITY
So the need for faster growth has never been more clear or more urgent. And yet, just when we need it most, growth has all but petered out, and the slowdown has been especially pronounced in Canada. Fifty years ago, Canada ranked eighth among all OECD countries in GDP per capita. As of 2022, we were 15th. And in the future? Canadians were jolted by a graph in the 2022 budget showing the OECD expects us to have the slowest growth in per capita GDP among its member countries over the next 40 years.
Per capita GDP in Canada has now fallen to just 73 percent of U.S. levels, from 92 percent in 1981. Research by the economist Trevor Tombe has shown that Canada’s richest province, Alberta, would rank 14th among U.S. states. The poorest five provinces now rank among the six poorest jurisdictions in North America. Ontario ranks just ahead of Alabama. British Columbia is poorer than Kentucky.
Where once we were well above the OECD average, we are on the verge of falling below it. We used to be richer than countries like Austria, Germany, Belgium, Finland, Iceland and even Ireland. Now they are all richer than we are. And even this somewhat overstates our position. Canadians work more hours, on average, than people in other countries — measured in output per hour worked (or labour productivity), however, we ranked 18th in 2022.
Over the last 50 years since the OECD was founded, growth in labour productivity in Canada has been the slowest among the organization’s charter members, tied only with Switzerland. This is not something we can just shrug off any longer. Canada could get by in recent decades with mediocre productivity growth because of two things: rapid growth in the labour force and high and rising commodity prices. But labour will not be so plentiful in future, and the commodity price boom is not something we can bank on for the long-term. So that leaves productivity, which not only has not improved, but if anything is getting worse.
This abysmal performance year after year, decade after decade, has been the cause of a great deal of scratching of heads among economists. It even has a name: the Productivity Puzzle. How could we be performing so poorly? We did everything right! For a while in the 1990s and 2000s, Canada seemed to be an example of everything that orthodox economics would recommend as recipes for prosperity. We signed a sweeping free trade deal with the United States and went on to sign dozens more with other countries; the Mulroney tax reform slashed top marginal rates of corporate and personal tax rates, with further cuts in corporate rates to follow; we brought inflation down to 2 percent, converted massive deficits into surpluses. Still, growth rates declined. I think the safest thing to say is that these were necessary but not sufficient conditions. We may have got a lot of things right, but we’ve also still got a lot of things wrong. As Adam Smith famously said, ‘there is a lot of ruin in a nation.’
ON OLIGOPOLIES AND INTERNAL TRADE BARRIERS
We might have liberalized much of our international trade, but important sectors of our economy — telecommunications, financial services, air travel — were organized to this day as protected oligopolies, theoretically open to competition but effectively off-limits thanks to restrictions on foreign investment. Others — the Post Office, rail travel, liquor boards — remain government monopolies for no reason other than it would be too hard to break them up.
Prices may generally guide economic activity in this country, but in too many sectors, those price signals are clouded either by overt subsidies to business (calculated by one recent estimate at $14 billion a year, just at the federal level), or by preferences to corporations and to individuals buried deep within the tax system. In every case, the effect is to persuade consumers and workers and investors to make decisions about allocating resources based not on the real costs and benefits to the economy of each choice, but on what subsidies, tax goodies, or regulatory preferences are attached. Most disgracefully of all, 157 years after Confederation, we still do not have a functioning common market, which was a large part of the point of the enterprise. Rather, commerce must fight its way through hundreds and hundreds of interprovincial trade barriers.
The combined impact of these is considerable. A 2019 International Monetary Fund study found the average internal trade barrier to have an effect on trade equal to that of a 21 percent tariff. All told, the study found liberalizing internal trade barriers would add nearly four percentage points to GDP. That’s another $112 billion, or roughly $11,000 for a family of four every year, forever.
ON INDUSTRIAL POLICY
Well, somewhere in all this, I venture to suggest we may find the beginnings of an answer to our productivity puzzle. But first, what are the answers that have been tried to date by governments of various stripes?
There are the constellation of policies that might be grouped under the rubric of industrial strategy or industrial policy, subsidies to business and sectors thought to be particularly strategic, the cultivation of national champions to be protected from foreign takeovers.
These are in turn rooted in a number of untested assumptions that governments are better placed to divine our industrial future than private investors whose livelihoods depend on it. That there are particular sectors that are more befitting of an advanced industrial economy than others: manufacturing rather than resource extraction, high technology rather than low, goods rather than services, based on the notion that higher value-added industries are to be preferred, which might be called the value-added fallacy. What companies want are higher profits, what workers want are higher wages. What both should want is higher productivity.
It’s productivity that ultimately determines wages and living standards, not where you happen to be in the value-added chain. If a project is economic but provides more benefit to society in terms of what consumers are willing to pay for versus the cost of the resources it used in production — if a project is economic, it doesn’t need a subsidy. If it isn’t economic, it doesn’t deserve it. The only game it keeps our guys in is a losing game.
Scarcely more successful are the suite of policies the government presents in the name of modern supply side economics. The basic underlying rationale that policy should aim to improve economic capacity generally rather than dictate particular outcomes is sound enough. And the policies? More investment in infrastructure, more investment in education skills, more investment in research and development. Well, they certainly sound sensible. It’s when you get into the details that you realise how ill-thought-out it really is.
It turns out it matters not just how much money is being spent, but by whom and in what circumstances. If decisions on infrastructure spending or education or innovation are being made not in a decentralized way that is responsive to cost and benefits by people risking their own money, but by politicians in a bunker somewhere, chances are the bang for the buck will be suboptimal.
ON INFRASTRUCTURE
Just because you call it infrastructure doesn’t mean it necessarily pays off in higher productivity. It depends. Infrastructure, for what? For whom? What costs and what benefits? If only there were some sort of market test of the return on investment in infrastructure, some way of gauging whether the benefits exceeded the costs.
Well, there is. If the projects are to be financed by user fees, for example. If consumers are willing to pay the fees and if the fees are enough to cover the cost, that would suggest the project was worth pursuing. It’s a test, not just of costs and benefits, but of whether there’s actual demand. But the minute you attach such a measurable return, the case for borrowing on the public tab arguably disappears. Private investors could be enticed to supply the necessary funds in return for the flow of revenues. Public goods, as we know, are things where you can’t charge a price for the consumers. And if you can finance something privately, you probably should. Tax dollars are scarce like anything else. Logically, they should be reserved for things that can only be financed through taxes. When you pay for things with taxes that could be paid for in other ways, you are shortchanging the things that can only be paid for with taxes, the genuine public goods. So yes, historically low interest rates were an argument that somebody should be borrowing and investing in these projects. It just didn’t necessarily follow that it should be the government.
ON EDUCATION
There’s little doubt that other things being equal, more education, more human capital will make for more productive workers. But are other things equal? Canada has the most highly educated population in the OECD, with 54 percent of its adult population, according to the 2016 census, having graduated from post-secondary education. We spend among the most of our GDP on higher education of any country in the OECD, behind only Chile and the United States. But where’s the evidence that it’s actually paying off in terms of higher productivity?
ON RESEARCH AND DEVELOPMENT
Or take the innovation agenda. Now it’s well-established economic principle that basic research, blue-sky research with no immediate commercial application is the sort of thing that governments need to fund. You can’t rely on markets because there’s no incentive for a private firm to spend money in research that does not pay off in new products but can be siphoned off by its competitors. By the same token, government should not be in the business of funding research directed to commercial uses. Not only is this unnecessary, but it inevitably tilts the pitch in favour of certain activities over others, some technologies, products and firms at the expense of the rest. Nevertheless, governments of all stripes feel it’s their duty to spend heavily on both basic research and applied research. After all, more research equals more innovation, equals higher productivity equals more growth. Right? This fervour has only grown, the less the results anyone has to show for it.
When the Harper government reviewed federal R&D programs in 2011 — I don’t have more up-to-date research on this, but I don’t imagine the situation has changed greatly — they found support totalled $5 billion every year, delivered through more than 60 programs spread across 17 different agencies, and that’s just at the federal level. There are hundreds more innovation programs at the provincial level, and who knows how many others lurking among the nation’s municipalities and universities. To innovate in the agricultural sector in Ontario alone requires the help of no fewer than 45 such programs, courtesy of seven federal and provincial departments, all on top of the flagship federal tax incentive, the venerable Scientific Research and Experimental Development tax credit.
Altogether, Canada is reckoned to provide among the most generous systems of R&D support in the world. Is there a pattern emerging here in the results of all these hundreds of billions of dollars of support, this Manhattan project of industrial research? Not only have all these programs not helped the cause, they seem actively to be retarding it.
The Liberals only added to these. A short list of Liberal innovation programs would include the Superclusters Program, Innovative Solutions Canada, the Strategic Innovation Fund, the various government-sponsored venture capital funds administered by the Business Development Bank — all the way to the Canada Growth Fund, the Canada Innovation Corporation. Oh, and did I mention $50 billion in subsidies for battery manufacturers in more recent budgets? And what do we have to show for it? Falling capital stock, falling productivity, falling relative living standards year after year after year.
ON SOLUTIONS
Perhaps we need a shift in approach. What we’ve been doing hasn’t been working terribly well. What should we do? We can start by grasping the seriousness of the situation. As I hope I’ve convinced you, we do not have a growth problem, we have a growth crisis — at the very moment our fiscal and economic pressures are mounting, growth is collapsing. Incrementalism is not going to cut it. I’m afraid it’s time to think in much more radical terms.
What would a serious pro-growth agenda look like? Let’s go back to our basic Solow-Swan Growth Model: growth in output is the sum of changes in labour plus capital plus technological change. Well you say we’ve got plenty of labour, and it’s true. Employment in Canada is at or near all time highs, not only in absolute terms, but as a proportion of the working age population. But if you look at employment as a proportion of the whole population, the picture changes — including the over 65s, it’s flatlined. So anything that can be done to increase labour supply is to the good; generally mobilizing every spare person-hour of labour.
But the more immediate problem is on the capital side. Investment in Canada has fallen to levels that can only be described as anaemic. The alarming deterioration in our productivity performance closely tracks the extraordinary relative decline of business investment in Canada.
The OECD tracks investment growth, fixed capital formation across its 38 member states, plus nine others. From 2011 to 2015, Canada’s performance was merely awful, 37th out of 47. From 2015 to 2023, it was appalling — 44th. If per capita growth has been similarly lagging, it is much more to do with the shortage of capital than a surplus of labour. Our workers are less productive than other countries’ workers because they have less capital to work with. As recently as a decade ago, gross fixed capital formation (GFCF) per worker in Canada was within striking distance of the United States, about 95 percent. It has since declined to 68 percent. As of 2022, each Canadian worker had on average about $19,000 to work with in constant 2015 U.S. dollars versus almost $29,000 for every American worker.
A similar decline has been observed relative to the OECD generally. As of 2022 we stood 15th in the OECD. In 2013, just a decade ago, we were eighth. So slow is the rate of new investment each year that is not even enough to replace existing capital as it wears out or grows obsolete. A recent study for the C.D. Howe Institute notes the real stock of capital per worker has been on a downward trend since 2015, a deterioration unlike anything since these measures began.
ON POPULATION
When people blame rapid population growth for the decline in per capita GDP, I have to beg to differ. The problem isn’t that our population is growing at 1.5 precent or 2 percent per annum. The problem is that our economy won’t grow any faster than that. Or to put it another way: the problem is not too many people, the problem is too little capital.
Productivity was an issue long before the recent population boom began. Yes, other things being equal, more workers equals less capital per worker equals lower productivity. But other things are not necessarily equal. The willingness to save and invest is not set in stone. It responds, among other things, to changes in policy.
ON INVESTMENT LEVELS
So the first priority, it seems to me, is to raise investment levels. That may seem obvious, but it does not seem to have been at all obvious to those in power who have only recently discovered that we have a productivity problem. For all the attention paid to raising human capital, none at all seems to have been paid to the old-fashioned kind, physical capital.
Indeed, the situation is again worse than I’ve let on. When you disaggregate gross fixed capital formation into its component parts — so first you separate out private versus public investment, and then you separate out the different kinds of investment— you find a striking trend. Since around 2000, while investment in residential structures has roughly doubled as a percentage of GDP, investment in machinery and equipment — the kind of thing that raises productivity — has roughly halved.
ON TAX REFORM
I’m sorry if this is maybe a little predictable, but high rates of taxation on capital income remain an important barrier. Yes. Canada’s rates are not as high as they were 50 years ago, but they remain higher than in many comparable countries — not only on corporate taxes, but especially on personal income tax, where the top marginal rate has increased so much so that our top rates are now among the highest in the developed world.
Perhaps the moment has arrived 30-odd years after the last major tax reform to think bigger. At the very least, we could broaden the tax base, eliminating many of the hundreds of special tax preferences and exemptions that litter the tax code and applying the revenues to cutting rates. More radically, we could adopt the recommendation of many economists and abolish the corporate income tax. Corporations, after all, do not ultimately pay the tax, but pass it on, some to shareholders and consumers, but most, as recent research suggests, to their employees in lower pay. If so, it would not only be more efficient, but more fair to tax corporate earnings at the personal level.
If there’s one reform we could really make, it is to abolish the preference for small businesses. We have too many small businesses in this country. I don’t want to eliminate small businesses, but I don’t want to favour them in the tax code. All the research shows that small businesses have lower rates of productivity, lower growth prospects, etc., and what we’re doing in the tax code is basically encouraging businesses to stay small.
ON FOREIGN INVESTMENT
The other barrier to capital formation is foreign investment. We will not be able to sustain the kind of high rates of investment we’ll need in the future just in our domestic savings, not with a household savings rate of just 5 percent. We need to supplement with the savings of foreigners, and we need to be open investment. We may think of ourselves as being relatively open to foreign investment. The OECD, which studies these things, begs to differ. So in particular, I think we should take seriously one of the recommendations of the late, lamented Competition Policy Review Panel and reverse the onus in the current opaque net benefit test on foreign takeovers. Rather than require those in favour to prove it is of net benefit to Canada, require those opposed to show it is of net dis-benefit.
But as with anything else, it’s not just the quantity of investment that matters, it’s the quality. How can we be sure that new capital is being put to its highest and best use, the kind that increases productivity?
Tax reform is part of that. Eliminating distortionary tax preferences is as important as lowering marginal tax rates — maybe even more important. But so is eliminating business subsidies. On the same principle, people make better decisions about how to use scarce resources when they know what things cost. When they don’t, they make dumb decisions; when the costs are hidden from them, they make dumber decisions. So we need not just sweeping tax reform, but sweeping subsidy reform, a comprehensive program of de-subsidization. It makes no earthly sense, for example, that in the name of regional development, we subsidize every part of the country, in effect attempting to redistribute from everybody to everybody. But it’s no smarter to be subsidizing every industry and every corporation within each industry, as we are perilously close to doing.
ON COMPETITION
You want an innovation policy? Competition is the most effective innovation policy. There’s a tendency in political circles to treat innovation as if it were a kind of piece of industrial machinery: You inject a certain amount of government funding for R&D at one end and out pops higher productivity at the other. It isn’t so. You can find a correlation just between Canada’s heroic levels of tax assistance for R&D and actual spending on R&D, but there’s very little connection between aggregate spending in R&D and innovation, and still less with higher output.
We begin to be on firmer ground if we understand innovation less as a scientific process and more as an economic one. As the Council of Canadian Academies put it in its report, Innovation and Business Strategy: Why Canada Falls Short, innovation is best defined as new or better ways of doing valued things. The real gains in productivity do not typically come from startling technological breakthroughs or gee-whiz inventions, but from thousands of incremental gains at every stage of production in businesses large and small. Often, these amount to nothing more than adopting existing technologies or best practices already in place elsewhere. And what drives companies to do that? Competition. Competition. Competition. Competition.
What comes out in all the literature on productivity is the critical importance of competitive intensity in creating the incentive for businesses to innovate. Companies innovate not because they can, but because they must. Because of the fear the other guy will eat their lunch if they do — it’s when managers lie awake at night thinking of all those little things: ‘What can I do tomorrow on the shop floor to make things run smoother?’ that much innovation occurs. As the Council of Canadian Academies noted, competition is among the most potent incentives for innovation, both because of the benefits innovation can provide, and the threats that can be averted if innovation keeps a firm running ahead of its competitors.
And yet competition is everywhere constrained in Canada. Lack of competition is a pervasive problem, not as an accident of history, but as a matter of deliberate policy. Why is our health care so expensive, yet produces such mediocre results? Because no one in the system knows what anything costs, certainly, but more because no one has any incentive to find out what anything costs. The hospital administrator does not need to know whether her hospital is charging more or less than its competitors for a tracheotomy. It has no competitors. Why do Canadians pay two and three times the market price for such staple food items as milk, eggs, butter and poultry? Because their producers have been organized into government-sponsored price fixing rings backed by production quotas and protected by three-figure tariffs — the whole racket dignified by the euphemistic name of supply management. Why is the postal service so glacial and yet so costly? Because Canada Post, unlike postal services across Europe, remains a statutory monopoly. Why is Via Rail so slug-like and unpleasant? Because it, too, remains a monopoly.
Maybe we could afford to put up with this nonsense in the past. We can’t anymore. So let’s get serious. Let’s start to dismantle these ancient monopolies. And while we’re at, let’s crack open those cosy little oligopolies in telecommunications, financial services and domestic air travel.
We know that real competition in air travel, for example, has to come from allowing foreigners to compete in our airspace. And yet we have these obscure laws restricting or forbidding foreign airlines from flying point to point within Canada. We even give it a strange and esoteric name — we call it cabotage, as if it were this weird and unearthly practice that would never be practised in a civilized country.
We can’t afford that kind of nonsense anymore.
Industries are not regulated in the interests of the people who use them — consumers — but in the interests of the industries themselves. That’s not only a matter for consumers, it has broader implications for productivity and innovation and for wages, which depend on both.
In a market economy, it is consumers who, by choosing among the offerings of competing firms, drive each to look constantly for ways to lower costs. Muzzle competition and you not only despoil consumers, but you constrain the relentless search for new and better ways of doing valued things. That alone fuels gains in productivity.
It strikes me that all the measures that might be introduced to bring more competition to the Canadian economy can be summed up in two words: consumers first. If governments understood nothing more than that, that consumption is, as Adam Smith put it, the sole end and purpose of all production. And that therefore, “the interests of the producer ought to be attended to only so far as it may be necessary for motive for promoting that of the consumer.” And if every regulation were subjected to the test of whether it served the consumer interest, whether it put consumers first, the country, I submit, would be a lot more prosperous and consumers a lot less angry.
Thank you very much.
Reprinted with the kind permission of Trent University.