"Business must step up to the plate"
A new era of global competition is emerging. Canadian firms must innovate or perish. To do so, improving productivity levels is key.
Unfortunately our productivity track record has been dismal since the early 1970s, when it rose 4 per cent annually. Since then it moderated to a meagre average annual pace of 1.6 per cent. And for the most part of this decade, labour productivity growth dropped further to a shockingly low 0.7 per cent. This means that Canada has gone from the fifth-most efficient economy in the industrialized world in 1970 to 15th position in 2009. It also led to Canada dropping from the fifth-highest income per person to the 10th slot over the past two decades. Based on these recent trends, Canada will continue to decline in ranking over the coming years.
There are many explanations for Canada's depressing performance. A major factor is weaker business investment and innovation.
Canadian companies have invested less than other countries in productivity-enhancing and innovative technologies. In 2008, machinery and equipment per worker in Canada was a mere 49.1 per cent of that in the United States. The ratio of capital per unit of labour - capital intensity - grew at an average annual pace of 0.5 per cent per annum between 1984 and 2008, compared with 2.8 per cent over the preceding two decades. Canadian companies are also severely underutilizing information and communication technologies (ICT). ICT is revolutionizing business and individual lives, but the stock of ICT capital per worker in Canada in 2008 was only 45 per cent of that in the U.S.
This weak investment performance is a major conundrum, particularly when one considers the economic backdrop before the recent recession. Between 2002 and 2007, the economy was growing at a solid pace. Retained earnings were piling up. Corporate taxes were falling. Interest rates were not high. The Canadian dollar appreciated by nearly 40 per cent, materially lowering the cost of imported machinery and equipment. We should have seen a dramatic business investment boom. What actually occurred in terms of investment in machinery and equipment was simply unimpressive: Despite robust profits and retained earnings growth, nominal business investment in machinery and equipment rose at only 5 per cent per annum. Economists will often talk about the strength of real business investment in this period, but that only came about because of falling prices.
Why did businesses not respond? Firms were not being innovative and did not take advantage of the favourable environment. This can best be illustrated by a benchmark for business innovation and the skill with which firms are taking advantage of new technologies and more skilled workers. It shows that Canada in 2008 stood at the same level as 1970. This must change.
The good news is that an extremely favourable environment for business investment and innovation is upon us once again. Governments have been instrumental in setting a favourable backdrop. The effective marginal tax rate on capital has been declining and will continue to do so in the near term. Indeed, Canada is poised to become one of the most competitive jurisdictions for capital investment in the industrialized world. This has been facilitated by lower corporate income tax rates, the elimination of capital taxes, and the harmonization of sales taxes in some provinces. Although interest rates will likely rise over the coming years, the level of borrowing costs will remain low for some time. The economic recovery is supporting solid earnings growth. The Canadian financial system is open for business and credit is flowing. The Canadian dollar is also likely to hover at close to parity over the next couple of years. We cannot afford to repeat history. But the question remains whether businesses will respond this time around or whether yet another opportunity will be lost?
There have been many voices raising concerns about Canada's dismal productivity record. Bank of Canada Governor Mark Carney suggested that the medium-term trend growth rate in the Canadian economy would be around 2 per cent, materially slower than the traditional assumption of 2.8 per cent. The Parliamentary Budget Office has cautioned that federal deficit reduction could be challenged by the likelihood of only 2 per cent growth per annum.
Getting to 2 per cent real GDP growth on a sustained basis requires an improvement in productivity. Without any increase in output per hour worked, Canada's aging population will only support a trend economic growth rate of close to 1.3 per cent in the years ahead. While foreign competition should be a powerful motivator for increased capital investment and innovation, demographics should also be pushing firms to find better ways to employ labour. It is only a matter of time before the aging population leads to renewed labour shortages.
Businesses must step up to the plate. The economic and policy environment is right. The time is now to invest in new innovative and productivity-enhancing technology, to meet the competitive pressures of the future and address the looming demographic challenges. Increased investment and innovation is not only in the interest of businesses, it would also materially benefit workers and governments.