Weak productivity putting living standards at risk: report

(October 5, 2005) Productivity is an issue likely to be on government agendas in the coming year. The Canadian economy has been one of the best industrial world performers in recent memory, but the country’s “remarkably bad” showing in the productivity arena will threaten the standard of living here if it is allowed to continue.

A new report from TD Economics, entitled Canada’s Productivity Challenge, points out that productivity growth dropped to a virtual standstill in 2003 and 2004. Although a similar slowdown was also experienced in other major industrialized countries, Canada’s underperformance has been particularly notable. Canadian productivity grew more slowly than 18 out of 22 OECD (Organization of Economic Cooperation and Development) countries since 1960.

There’s a perception among Canadians that stronger productivity will result in fewer jobs. Along with this, some government policies (that few people seem willing to part with) maintain government revenues and help less productive firms.

TD economist, Don Drummond writes that stronger productivity growth in fact allows for faster economic growth without leading to higher inflation. Households benefit from having additional income without losing their purchasing power to inflation, businesses have the opportunity to benefit from stronger profit growth and governments in turn get additional tax revenues to support health care, education and other social priorities.

Demographic trends also suggest that better productivity performance will be an increasingly important factor in fueling future economic growth.

The TD report examines the various factors affecting Canada’s performance, outlines lessons and puts forth a number of recommendations aimed at improving the country’s current productivity dilemma.

“What Canada needs is a shift in focus away from consumption and towards savings and investment,” says Drummond. “This is not just about tax cuts. It’s about a cultural shift involving a major review of public policy and an increased commitment by the private sector to investment and innovation.”

Among the list of recommendations, he says governments must lower disincentives to save and invest and encourage increased competition, reduce the remaining barriers to foreign investment in Canadian companies and eliminate barriers to inter-provincial trade. Government should also work to avoid policy subsidies, tax breaks and other incentives aimed at specific industries. “Such incentives targeted at the sectoral level are often counterproductive. They reduce the drive for productivity by limiting the competition and can lead to international trade disputes,” says Drummond. “Industrial policy too often amounts to taxing the winners to subsidize the losers.”

Another recommendation, which could in turn offset the outcry that would likely come with subsidy elimination, Drummond says a reduction in corporate income tax rates and the introduction of capital tax credits would be beneficial. He says provincial capital taxes should be eliminated.

The report also calls for a reduction in personal marginal tax rates, which act as a deterrent to work, save and invest, and a shift towards reliance on user fees and consumption taxes.

Finally, investment in post-secondary education and infrastructure are two other areas that could boost productivity. Handled effectively, governments could rely on increased use of public-private partnerships in infrastructure development.

TD economists stress that above all, a review of new or existing policy initiatives must pass the fundamental test that any boost to productivity created must be greater than any advantage that would be gained by taking the costs of the new initiative and simply lowering taxes by the same amount.

Businesses meanwhile need to step up and put a larger emphasis on research and improve Canada’s track record in developing commercial applications from new innovations. Although corporate profits have grown rapidly in the past few years, this growth has not been accompanied by a matching increase in capital spending, despite the fact the strengthening Canadian dollar has, at the same time, created favourable conditions for reinvestment by reducing the cost of imported machinery.

“While the onus is on governments to create the right incentives for stronger productivity growth,” Drummond says “the ultimate responsibility rests on the shoulders of the private sector.”

Filed by Kate McCaffery, Advisor.ca, kate.mccaffery@advisor.rogers.com