January 1, 2014

Why Canada Can’t Keep Up

To close its yawning productivity gap with the rest of the developed world, Canada will have to restructure its economy.

For the past three decades, Canada has been stuck in a productivity rut that shows little sign of reversing despite almost 30 years of national debate, government reforms and new incentives. Today, Canadian worker productivity has plunged to 72% of U.S. levels, down from 90% during the 1980s. That gap is even wider when measured against the average worker in most of the 34 countries that comprise the Organisation for Economic Co-operation and Development (OECD). 

One result: The growth in Canada’s hourly output per worker is a paltry 0.7%, ranking the country a lowly 18th among the group of industrialized OECD nations. Meanwhile, the United States’ growth is fifth at 1.9%. Korea ranks first with more than 4% growth.

That productivity malaise is forcing a national public policy debate in Canada. It is also forcing U.S. manufacturers to look for more cost-effective relationships at home and in other countries such as Mexico when the economics and market opportunities make sense. In 2012, for the first time, Mexico overtook Canada in production of light vehicles for the North American market. In that year, the U.S. share fell to 65%, Canada’s lingered at 16%, and Mexico’s more than tripled to 19% from a scant 6% in 1990, and it is still growing. 

At the same time, Canada is aggressively searching for ways to reduce its overreliance on free trade with its neighbor south of the border. If that search succeeds, Americans should expect to see fewer Canadian natural resources, goods and services, as those exports are increasingly diverted toward emerging centers of global economic power in Asia and South America. Success, however, will depend on whether Canada can effectively attack its chronic productivity drag and the resulting lack of global competitiveness. 

“We work harder and harder, use up our natural resources faster and faster, while the [lag in productivity] keeps us less rich, less able to provide public goods and less competitive,” explains Kevin Lynch, vice chairman of BMO Financial Group. Lynch, a former high-ranking member of the Canadian federal government in Ottawa as clerk of the Privy Council and secretary to the federal Cabinet, has studied the issue extensively. Canadian perception is part of the problem, he wrote in a 2010 essay in The Globe and Mail. “Canadians see more people working and goods being produced as proof that productivity is not a problem. While the illness worsens, the patients believe they are feeling better.”

A Star by Some Measures

That’s because many of Canada’s macro-economic vital signs simply don’t match the symptoms of a country struggling to raise its productivity. By almost any other global measure, Canada is a superstar. 

  • Its national debt is lowest among major industrialized nations in the G7.
  • Its national pension plan is actuarially sound.
  • Its corporate tax rate is about 14 points lower than in the United States.
  • The average Canadian income is the same or slightly higher than in the United States.
  • The Canadian economy has been better at job creation than the United States.
  • Of the 430,000 jobs lost in Canada as a result of the 2008 financial crisis and ensuing recession, all have been recovered, and an additional 600,000 have been created. For its part, the United States is only 80% of the way toward replacing the jobs it lost in the recession. 

Nevertheless, underlying these stellar statistics is a productivity problem the scope of which is now a serious challenge to maintaining Canada’s high standard of living and continued prosperity.

The reasons for the poor track record are known and numerous, most notably a reliance on a weak Canadian dollar to artificially support inefficient industries. But just as important are Canada’s resource-based economy coupled with increasing commodity prices, and a reliance on a traditional business model dominated by the United States, the destination for 75% of Canada’s exports. 

A low dollar and high commodity prices made Canada competitive—but for the wrong reasons. During the 1990s, Canada enjoyed a significant cost advantage when exporting to the United States due to the currency advantage and a free-trade agreement signed in 1989 that afforded Canadian goods open and preferred access to the largest market in the world. Today, however, that has changed. The Canadian dollar now hovers close to, or at, the U.S. dollar, and bilateral trade agreements signed by the United States with other countries have canceled out Canada’s special competitive advantage. A 2013 report by accounting and consulting firm Deloitte, “The Future of Productivity: Clear Choices for a Competitive Canada,” found that exports from Canada to the United States remained flat amid rising exchange rates from 2004 to 2008 and have grown sluggishly since then. Compounding the problem, Canada faces the daunting task of trying to raise its productivity with a stronger currency and rising commodity prices, Deloitte concluded.

“I certainly think that there’s no question that the appreciation of the Canadian dollar has challenged the competitiveness of our exporters,” Tiff Macklem, senior deputy governor at the Bank of Canada, told Forward. “If your business strategy is to simply wait and hope that the Canadian dollar is going to depreciate substantially and that is going to increase your competitiveness, that strikes us as an awfully risky business plan.”

Spending on People Instead of Machinery

Until recently, that plan seemed a lot less risky. A lower dollar lulled businesses into spending more money on labor to produce goods and services rather than investing in machinery and equipment, which is generally imported and more expensive. In the short term, employees and management were happy, and shareholders didn’t complain because the strategy lowered corporate costs and bolstered balance sheets. But it dramatically deprived Canadian manufacturers of the productivity opportunities that new generations of machinery and technology offer. The result: Canadian businesses typically employ just 75% of the machinery that their American counterparts use. In 2010, Canadian companies invested 65% as much per worker in new machinery as U.S. firms—and 66% on information and communication technology, according to Deloitte. Inevitably over time, as machinery aged and less of it was replaced, Canadians have had to work harder with fewer, and often more inferior, tools.

“We underinvested in machinery and capital, and a low dollar allowed us to do that,” says Lynch. “Why put all that money into capital when you are already competitive at a 72-cent dollar?”

Deloitte’s findings illustrate how pervasive that attitude has become. According to the report, private-sector investment in research and development in Canada as a percentage of GDP lagged substantially, relative to other OECD countries. On average, Canadian businesses spend 0.9% on R&D—18th among OECD countries, and below the OECD average of 1.6%. American businesses ranked seventh with R&D spending at 1.9%.

Interestingly, the study also found that over a third of businesses, 36%, assumed they are investing more than their peers, but they’re actually investing less than the median. “They think they are dealing with the issue, but the pace and scale is not what is required. They’re moving at 30 kilometers an hour while their competitors are moving at 40 kilometers,” says Lynch.

With the big money directed toward labor costs, not surprisingly, those costs now outpace productivity. The Deloitte study shows that, between 1997 and 2010, the U.S. dollar cost of Canadian manufacturing wages rose at a compound annual growth rate of 5%—one of the fastest in the OECD. Of that, 46% was attributed to the rising Canadian loonie. As a result, the Canadian labor rate is now roughly on par with that of the United States, thus eliminating one of the traditional cost advantages the country previously enjoyed.

The View From Labor

“There’s this whole myth of the lazy manufacturer in Canada and how it inhibited growth and innovation,” says Jim Stanford, a Canadian economist at Unifor, a 300,000-member labor union formed last year from the merger of the Canadian Auto Workers (CAW) and the Communications, Energy and Paperworkers (CEP). 

Stanford blames free-market forces, deregulation and free-trade agreements for the productivity rut. What Canada needs, he argues, is a national industrial strategy with state intervention to create “sectoral development” focusing on high-value industries with specific outcomes rather than depending on the volatile vagaries of free markets. “The free-trade agreements have clearly failed the promises that were made in the 1980s,” he says. Rather than harmonizing upward to U.S. levels, Canada has moved in the opposite direction. “That productivity promise has been utterly betrayed.”

The union economist also blames free-trade agreements for causing a “re-orientation” in Canada away from manufacturing and high-value industries toward what he calls “the extraction policy of raw materials.” This pushes Canada back into its traditional image as “hewers of wood, drawers of water” and now, he says, “scrapers of tar,” referring to the oil sands in Alberta. “From a productivity perspective, it’s perverse to invest more and more of our capital and our creativity in industries with declining productivity,” Stanford argues.

However, the Deloitte study challenges some of Stanford’s main assumptions. Canada’s poor

relative productivity, declares the report, “is more about business performance than the structure of our economy.”

For one, changing Canada’s sector composition to match that of the United States by shifting away from natural resources into other industries, such as technology, would only reduce the gap in productivity growth between the two countries by 5.8%. Why? Because Canada lags the United States “in nearly every sector,” Deloitte concludes. For example, manufacturing productivity in the United States grew more than six times faster than Canada’s manufacturing sector. Meanwhile, U.S. labor costs have declined 12% since 2000, while Canadian costs have soared 23% during the same 12-year period. 

No One Sector or Region

Between 1990 and 2009, Deloitte found, Canadian manufacturing posted annual productivity growth of 2.3%, well below 3.3% in the United States. Productivity performance from 2000 to 2008 was especially weak in Canada, growing at an annual rate of 0.9%, less than one-sixth of the U.S. growth rate. The problem is not unique to a single region or a sub-sector. Only two of the categories measured in the study—non-metallic mineral products and primary metals—showed a level of productivity growth equal to, or higher than, the United States. The rest were dismal: -5.6% in transportation, -3.7% in paper products and printing and -3.2% in chemical products. 


“The problem with the view that our poor productivity performance is a reflection of the commodity sector is that our weak performance is pretty broad based across most sectors of the economy,” explains the Bank of Canada’s Macklem.

Even Canada’s much-celebrated financial sector has not risen above the productivity malaise. In fact, its American peers have outperformed it, mostly because Canadian banking is heavily invested in the bricks and mortar of retail banking relative to investments in information and communications technology south of the border.

Shifting more Canadian workers out of smaller companies and into large firms, which are generally more productive, apparently won’t solve the problem either. “If Canada had the same employment share by firm size as the U.S., only 2% of the $13 per hour productivity gap between Canada and the U.S. would be closed,” says the Deloitte report.

Why? Productivity levels are lower in Canada across firms of every size. In both countries, small enterprises employing fewer than 100 people account for 98% of the total, but the average productivity of a company with fewer than 500 employees in the United States is 14% higher than in Canada, and large firms in the United States are 20% more productive than companies north of the border.

What to Do?

So how does Canada narrow its yawning productivity gap with its major trading partners? That depends on whom you ask.

Labor economist Stanford argues that at some level “we have to stop with the tough-love browbeating and actually ask ourselves, how come Canada is still digging stuff out of the ground instead of producing electric cars or sophisticated energy-saving appliances or biopharmaceutical products.” He points a finger at Canadian business leaders, who he claims for too long “have satisfied themselves with the easy money that’s made in resource extraction and finance.”

Rick Waugh, chief executive of Scotiabank, agrees that an “unhealthy” reliance on the U.S. market has not prepared Canada for the next century. Exporters (mainly manufacturers) have been “stuck in an old way of thinking,” the CEO of Canada’s third-largest bank told an audience at the Toronto Board of Trade last year. “It has made us complacent and too comfortable to sit back and be happy trading with ourselves … rather than sharpening our skills to take on the bigger world.” Waugh advocates forging new trade alliances in emerging markets, where the growth rate forecasts are between 4% and 7% in the next decade, as the path to future prosperity.

Meanwhile, academics and government representatives, like Kevin Lynch, argue innovation is the key to driving productivity rates up. The private sector and corporations need to be much more rigorous about managing innovation and treating it like any other line of business, he says. “Innovation doesn’t just happen; serendipity is not a strategy for innovation.”

Ultimately, the success of any strategy will depend on changing attitudes and perceptions in executive suites as well as the shop floor. In the meantime, the measure of how steep the investment required to sustain and improve productivity growth still baffles Canadians. The proof of that much is in the numbers.

Theresa Tedesco is chief business correspondent at the National Post, a major daily newspaper in Canada, based in Toronto, Ontario.