What might a serious growth agenda look like? More labour, more capital, and more incentive to use both wisely

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The good news about the recent budget is that it at least talks about per capita GDP, however briefly. The appalling performance of Canada’s economy on this crucial measure has been the subject of growing alarm outside of government. Yet it was not considered worth so much as a mention in the fall economic statement.

Neither did it come up in Budget 2023. Nor the 2022 fall economic statement. Budget 2022 gave it a chart, mostly as an advertisement for the government’s policies on child-care subsidies and the “transition to a low-carbon economy,” then dropped it. Even in Budget 2024, it is brought up largely to dismiss it as a concern. A “strong, temporary rise in immigration,” it explains, has “weighed on average income and productivity in the short term.”

But this, it seems, is no more than a statistical illusion. Recent immigrants always start off with lower incomes, but catch up over time. That, coupled with “the government’s investments in economic growth,” the budget assures us, “mean weakness in GDP per capita is largely temporary, not systemic.”

This is a little hard to square with that chart in Budget 2022, projecting Canada’s per capita GDP growth to finish dead last in the OECD over the next 40 years. Neither has per capita GDP only recently become a concern. To be sure, it has been falling, in absolute terms (after adjusting for inflation), for five of the past six quarters. But it has been essentially moving sideways for several years. And it has been falling relative to other developed countries for decades.

A new study by Statistics Canada finds that “real GDP per capita is now 7 per cent below its long-term trend.” To return to trend in 10 years, it calculates, “GDP per capita would need to grow at an average annual rate of 1.7% per year” – more than twice as fast as it has grown, on average, this century.

Suppose, unlike the current government, we took growth seriously. And suppose we acknowledged that the current approach – subsidies for industries the government finds exciting, subsidies for research, a growing pile of “innovation” programs – has not succeeded. How might we go about it instead?

On one level what makes an economy grow is tediously simple, a function of labour, capital and technical change. More labour – more people working, and more of them working longer hours – plus more capital (machinery and equipment, but also intellectual property, education and skills) for each worker, plus more ingenuity in how these are combined, should lead to higher growth. But these are more easily observed than engineered.

A casual observer might think we had more than enough labour. Indeed, the government is hardly alone in blaming the recent nosedive in per capita GDP on the surge in labour supply. Other things being equal, that should mean less capital investment per worker, and therefore less output per worker.

But that assumes the supply of capital remains fixed, or at least that current investment levels are a given. But Canada’s economy absorbed as high or higher numbers of workers in the past, without suffering declines in per capita output – because investment was growing just as fast. The problem is not that population is growing at 2 or 3 per cent a year, but that the economy isn’t.

And as Canada’s population ages, we’re going to need every person-hour of labour we can find. The employment rate, as a proportion of the population of working age (15 to 64), may be near an all-time high, at roughly 75 per cent (it was just over 60 per cent 50 years ago). But measured as a proportion of the population it is just 61 per cent – no higher than it was in 1988, and well below its 2007 peak. As the share of the population in retirement grows, it is likely to fall further.

So as a starting point, we should be doing everything we can to increase the supply of labour. Immigration is one way to do this. So is continuing the decades-long influx of women into the labour force (federal daycare subsidies may help here), as are policies to encourage people to work more years of their lives (paying Old Age Security from age 65, rather than 67 or later, as the previous government had proposed, is distinctly unhelpful) and to work more hours in a year. To say that current policies – a top rate of personal income tax, in most provinces, in excess of 52 per cent – are unhelpful on this last point would be to understate matters greatly.

On its own, however, an increase in labour supply is likely to be insufficient. We don’t just need more workers, working longer: We need each of those person-hours to generate more output. In a word, we need to raise productivity.

Increasing Canada’s anemic rate of investment is a major part of this. The reason our workers aren’t as productive as workers in other countries is they have less capital – and less up-to-date capital – to work with. Just in the past decade, gross fixed capital formation per worker, to give it its formal name, has fallen from about 95 per cent of U.S. levels to roughly two-thirds. Over the same period, we have fallen from eighth in the OECD to 15th.

So slow is the rate of new investment each year that it is not even enough to replace existing capital as it wears out or grows obsolete. Researchers with the C.D. Howe Institute have found that “the real stock of capital per worker has been on a downward trend since 2015 – a deterioration unlike anything since these measures began.”

How can we increase investment rates? By lowering barriers to capital formation. Tax rates, for one. This is less a matter of ideology than arithmetic. Suppose an investor needs to earn at least a 10-per-cent return after tax to justify putting capital at risk. At a marginal tax rate of 50 per cent, that excludes any investment paying less than 20 per cent before tax. Cut the tax rate to 33 per cent, on the other hand, and the threshold pretax return falls to 15 per cent. A lot of investments that weren’t viable at the higher tax rate suddenly become viable.

And the other barrier to capital formation? Foreign investment controls. We will not be able to sustain the kind of high rates of investment we will need in future just from domestic capital sources – not with a household savings rate of just 5 per cent. We’ll need to supplement them with the savings of foreigners.

That will require us to be more open to foreign investment than we have been. In particular, we should think seriously about adopting the recommendation of the 2008 federal 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 harm. Takeovers could still be blocked for reasons of, say, national security. They just couldn’t be blocked for no reason.

Higher rates of investment, however, only get you part of the way. How that investment is deployed is at least as important. To ensure capital is allocated efficiently, you need two things: accurate information on the costs and benefits of different investments, and the incentive to make use of that information.

In a market economy, this sort of information is conveyed through prices. But prices can be distorted: by inflation, which envelopes the whole price system in a fog of confusion, and by subsidies, which distort some prices relative to others. We’ve done relatively well in recent decades at controlling inflation. But business subsidies – whether of the explicit, cash kind, or the more insidious kind, buried deep in the tax laws – have proliferated.

The economist John Lester has calculated that, at the federal level alone, business subsidies have increased 140 per cent over the past nine years, and are on course to reach $50-billion in 2027-28 – more than half as much as the federal government will collect in corporate tax revenues. Of these, he estimates, less than two-thirds are even notionally addressed to correcting a legitimate market failure; of these, barely a third actually do so, or in a way that offers more benefit than cost.

In other words, about 80 per cent of current federal business subsidies are ripe for elimination. (A similar bonfire of the subsidies at the provincial and municipal level would be ideal.) A particular target should be the special low rate of tax for small businesses. Every study shows that small businesses have much lower productivity, on average, than larger businesses, and while a few (a very few) small businesses go on to become large, the tax preference gives them every incentive to stay small.

But just because you give people accurate information doesn’t mean they’ll necessarily use it. Investments cost money. They disrupt established ways of doing things. They often mean people lose their jobs, and they always involve risk, to the firm or individual managers. People won’t take all this on unless they have to – unless, that is, they fear the competition will eat their lunch if they don’t.

So the indispensable final ingredient in any growth plan is competition. It is the threat of competition that typically induces businesses to invest in the first place, as it is competition that punishes foolish investments, and rewards the wise. And competition – not subsidies – is the key to any sensible innovation policy.

You are not going to lift a $3-trillion economy off the floor by throwing research funds at a few universities or tax credits at “industries of the future,” even supposing anyone knew what they were. Rather, you need every manager at every one of Canada’s 1.4 million businesses to be lying awake at night thinking of all the little things they could do to improve operations tomorrow.

The literature on productivity is emphatic on this: it isn’t about gee-whiz moon shot inventions. It’s about improvements generally. Often this is achieved not by any world-beating breakthrough, but simply by adopting best practices already in effect elsewhere. It is, in short, best thought of, as the Council of Canadian Academies has put it, as an economic process, not a technological one. And competition is the driver.

God knows Canada could use some. Competition is restricted in this country in countless different ways. There are the hundreds of interprovincial trade barriers, which alone have been calculated to reduce per capita GDP by between 4 and 7 per cent annually. There are the particular barriers to competition in three large, capital-intensive sectors – telecoms, financial services and airlines – insofar as foreigners are constrained from entering the market.

There are the remaining state monopolies, such as in alcohol, postal service and rail travel. There are our notoriously lax competition laws. And more besides. So great is the task, and so vital, that it has been suggested Canada follow the example of the U.S.’s White House Competition Council, an agency with a continuing mandate to identify and bring forward proposals for pro-competition reforms.

This is no time for half-measures. Canada’s somnolent rate of economic growth, and the productivity problems that underlie it, would be of concern at the best of times. But given the massive costs coming our way from population aging – and from climate change, and from rising threats to our national security – we have no alternative: reform, radical reform, is imperative. Otherwise we are headed, slowly but inexorably, for disaster.

The good news is that a modest increase in annual growth rates, compounded over many years, is enough to avert the crisis. The bad news is it is impossible without it. Let’s get started.