A person walks past multiple for-sale and sold real estate signs in Mississauga, Ont., on May 24, 2023.Nathan Denette/The Canadian Press
Charles St-Arnaud is chief economist at Alberta Central. The following is adapted from a recent report by the financial institution.
Canada’s poor productivity performance has now been characterized as a national emergency. However, this mediocrity is nothing new. Back in 1970, Canada had the sixth-highest labour productivity among 32 OECD countries; it now ranks 22nd. As of 2023, Canada’s labour productivity is 30 per cent below that of the United States. Even when compared with similar countries – small, open industrialized economies – Canada’s performance falls short of Sweden’s and Denmark’s by 30 per cent, by 40 per cent relative to Norway’s and by 5 per cent compared with Australia’s.
Chronic underinvestment is the reason for Canada’s weak productivity. While total private investment as a share of GDP has been above that of both the U.S. and Australia since the 1970s, Canada’s non-residential investment has been persistently weaker over that period. More specifically, investment in machinery, equipment and intellectual property has been consistently lower. Moreover, while this type of investment increased to 10 per cent of GDP in the U.S. since the late 2000s, Canada’s measure declined to about half that.
On the flip side, residential investment has diverged from that of the U.S. and Australia since the late 2000s, reaching 8.5 per cent of GDP. This is more than double the comparative figure in the U.S. and more than 3 percentage points higher than in Australia. Most of the increase in Canada is attributable to a rise in renovation and homeownership transfer costs (i.e., housing market churn).
As a result, Canadians currently spend as much per year as a share of GDP on renovations and homeownership transfer costs as they do on machinery, equipment and intellectual property. In other words, we are investing more in less productive investments than improving the stock of capital.
Why is Canada spending less on productive investment? Rather than looking at the demand side and asking why businesses are not investing, it is important to look at the supply of capital to finance investment. Most businesses need to borrow money to invest, and a lack of available money or high financing costs will hamper the capacity of businesses to do so.
For one sector to invest, another sector must save to finance investment. In other words, the availability of funds in an economy is limited and scarce. Even if one sector wants to invest but others are unwilling or incapable of saving and lending funds, investment will suffer.
Poor performance of non-residential investment could result from a “crowding out” of the corporate sector by other sectors swallowing all available lending. First, businesses were crowded out by big government deficits in the 1980s and 1990s. As a result, government borrowing, through bond issuance, ended up absorbing all net lending from retail and non-resident investors. Then, from the early 2000s onward, the significant net borrowing from households rose at a rate of 3.5 per cent of GDP per year, swallowing most of the available net lending and crowding out corporations yet again.
The competition for investible funds means lending should go to the sector that can offer better returns to the lender, suggesting that the risk-adjusted return is insufficient to lend to corporations. This may be the result of two important factors: 1) a higher risk on corporate lending relative to lending to households, especially when considering the appreciating value of the collateral for mortgage lending (i.e., fast-rising house prices over the past two decades); and 2) higher capital requirements for corporate lending, leading to comparatively costlier loans.
As we devise ways to improve productivity in Canada, it is crucial to not lose sight of how required investment will be financed and ensure that businesses have access to required capital. This will involve 1) incentives to increase lending to corporations, such as reforming the current set of financial regulations to promote lending to businesses and reducing regulations that favour lending to households to the detriment of other sectors; and 2) incentives for households to save a greater share of their income to reduce their own borrowing and provide the funds required for business investment.
With housing affordability and the significant mortgage borrowing associated with it likely to remain important issues for many years to come, there is a risk that the funds available to corporations will continue to fall short, leading to lower investment and productivity.
To solve productivity and support investment, measures will need to be put in place to ensure that businesses have adequate access to the financing required to increase their level of investment. Otherwise, Canada’s chronic productivity underperformance will continue.