With industrial policy, Ottawa intervenes in the economy to Canada’s detriment

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Craig Alexander is a contributing columnist for The Globe and Mail. He has served as chief economist at Deloitte Canada, the Conference Board of Canada and Toronto-Dominion Bank.

Canada needs to harness competition and open markets to drive productivity and prosperity. Sadly, the country has gone in the other direction in recent years.

Government intervention has grown dramatically through industrial policy, which is government efforts to shape economic outcomes by targeting specific industries, firms or activities. It involves the application of subsidies, tax incentives and regulations. The argument for such policies is the belief that free markets will not generate desired economic, social or national-security outcomes. However, the expansion of industrial policy over the last decade has been both dramatic and excessive.

To illustrate, economist John Lester published a report in March showing that Canadian federal business subsidies rose 140 per cent over the past nine years, compared with just 17 per cent over the preceding nine years. This reflects the Trudeau government’s belief in the power of government to drive outcomes. In some cases, the expansion of industrial policy has been warranted to address market failures, such as measures aimed at reducing inequality and addressing climate change. However, virtually every problem has been tackled with additional business subsidies, tax incentives and regulations that have deeply distorted price signals throughout the economy.

It is important to remember that market prices provide powerful information about where to put effort or where to deploy limited resources, which increases efficiency by boosting income and lowering costs. Competition in open markets can also be a powerful catalyst for driving innovation and investment as well as constraining the ability of firms to raise consumer prices.

In March, Bank of Canada senior deputy governor Carolyn Rogers delivered a speech that called for increased market competition to encourage businesses to scale up and to incent investment to address Canada’s productivity crisis. Last month, Matthew Boswell, Commissioner at the Competition Bureau, reinforced this message in these pages and highlighted that his group’s research showed that the competitive intensity in the Canadian economy fell between 2000 and 2020. He wrote: “Too often in Canada, laws, policies and regulations create barriers – which are outdated and no longer serve the public interest – to competition.”

Past analysis by Deloitte and the Business Council of Canada has found that excessive government regulation is the single greatest obstacle to Canada’s international competitiveness. The key message is that Canada needs the right balance between industrial policy that checks market failures or suboptimal social outcomes while still allowing market forces and prices to fuel efficiency and innovation.

Currently, policy is skewed toward too much intervention. Professor Lester’s research shows that more than one-third of federal business subsidies are not addressing a market failure and many federal subsidies do not generate benefits that exceed their costs. He found that 80 per cent of subsidies are currently having a negative economic impact. Getting rid of those ineffective business subsidies would save the federal government $32-billion. And removing the market distortions created by these subsidies could boost competitive outcomes and productivity.

The preference for greater industrial policy in recent years also overlooks its inherent limitations. Governments do not have the information or the ability to predict which industry or firm will be the next global leader or will generate the greatest prosperity for its citizens. The myriad of price distortions created by the vastly increased number of industrial policy measures makes it hard to assess whether individual incentives, subsidies and regulation are having the desired effect. The conduct of policy can also be inconsistent. For example, the federal government recently increased subsidies for artificial intelligence research and development while simultaneously imposing higher capital-gains taxes on the tech sector.

Politics can undermine industrial policy and its effectiveness. For example, when Canada launched its Innovation Superclusters Initiative, every region of Canada just happened to have an associated supercluster. Was this really identifying Canada’s comparative advantages or was it an exercise in government-directed regional development? Politics can also be seen in the excessive focus on small business, which is popular with voters. Two-thirds of federal business subsidies go to small and medium-sized businesses. While start-ups warrant additional support, some small business subsidies are counterproductive because they incent firms to stay small.

Choosing priority sectors or focusing on selected groups of firms is at odds with the fact that there are rapidly growing firms of all sizes and in every industry. Instead of trying to pick winners, policies to encourage growth and investment should strive to keep a level playing field across industries and firms.

Canada needs smart industrial policy that achieves the public interest with the least disruption to market prices and outcomes. Sadly, the recent dramatic expansion of industrial policy is falling well short of this mark to the detriment of Canadian prosperity.