Elections, we would hope, are a time to grapple with the biggest issues facing the country. As each leader makes their pitch in the final week of the campaign, Canadians should be focused on how they address one particularly daunting challenge: Canada has an acute productivity problem—and since productivity is the key driver of wages, we also have a prosperity problem.
From 2014 to 2023, Canada’s output per hour worked rose just under 3 percent, beating only five other OECD countries. The productivity/prosperity gap with the United States widened from a quarter to about a third over the same period, continuing a slide that began in 2000.
As discussed in a recent C.D. Howe Institute special report, Canada’s productivity problem is the result of low investment, particularly in machinery and equipment, and a low propensity to innovate relative to our peers. Canada spends less on tangible capital per worker than in the United States and other countries, in large part because the cost of capital is high relative to the cost of labour. To fix this problem, Canada’s next government must lower the tax burden on tangible capital and reform immigration to focus on attracting and employing highly skilled newcomers.
To boost investment, our next government should reduce the corporate income tax rate by 2 percentage points and set the stage for a fundamental reform of the tax system that will make it more competitive and supportive of investment.
We must stop filling lower-skilled job openings through immigration, which keeps productivity and wages low by discouraging investment in new equipment and technologies. We must also end the tragic waste caused by accepting newcomers before confirming that their credentials meet our standards. Too many immigrants are unable to work in their field of expertise because of delays in recognizing credentials. And some newcomers find out, long after arriving in Canada, that their qualifications do not meet our standards.
The provinces hold most of the cards in credential recognition, but the federal government could break the logjam by financing the systematic assessment of foreign accreditation agencies. Canada should start by identifying foreign agencies that meet or exceed provincial standards and give priority to applicants certified by them. We should follow up with a case-by-case evaluation of accreditation agencies, and specific educational institutions and programs, in other countries.
Much of Canada’s innovation problem can be traced to low spending on R&D, a low propensity to patent the inventions flowing from this R&D, and an unexpectedly low impact on productivity from the inventions that are patented. For both overall and business R&D spending, we rank sixth in the G7 and slightly below the median in the OECD.
Canada’s R&D performance would improve if the Scientific Research and Experimental Development tax credits were reformed by reducing the small firm subsidy rate and increasing it for large firms, making the subsidies refundable for all firms, and delivering assistance independently of filing a tax return.
The low propensity to patent is acute for academic research. A recent study found that Canada produces just over half the patents that would be predicted based on the quality and quantity of its academic research. We could make some progress here if federal funding for patentable academic research were conditional on developing plans for commercializing the resulting inventions.
Our weaker link relative to other countries between patents and productivity growth arises because a low share of inventions developed here are brought to market in Canada, not because of lower quality patents. Foreign ownership of Canadian inventions contributes to this, but the key reason is that too many small, innovative firms sell their intellectual property to foreign firms rather than commercialize it themselves.
Several policy changes would tilt the calculus in favour of commercialization in Canada. Enhanced government support for risk capital would reduce reliance on foreign sources, which encourages selling to these suppliers. Shifting some support for R&D to commercialization would also help. A good starting point here would be to give the Industrial Research Assistance Program a new mandate to support commercialization of inventions rather than R&D. Eliminating capital gains taxation on the sale of qualifying small business shares to a Canadian resident would strengthen the incentive and ability to scale up in Canada.
Small and medium-sized firms employ about 64 percent of private sector workers in Canada, compared to 46 percent in the United States. Small firms are much less productive and pay lower wages than large firms, so firm size is contributing to the productivity gap with the United States. While a smaller, more geographically dispersed economy means we cannot eliminate the firm size gap with the United States, we should review small business policies to ensure they do not encourage more small-scale production than necessary. A good starting point would be to eliminate the preferential income tax rate for small businesses and the more generous SR&ED incentive for small firms, which both encourage entry by firms that are not growth-oriented.
Canada is facing threats to its economic security and territorial integrity from the United States. Responding to these threats is job one, but Canada’s next government must not lose sight of the need to fix our productivity problem.
