Falling Behind
Why Canada is fading on the global economic scene and what policymakers should be doing about it
Paul Vieira, Financial Post
Published: Saturday, September 13, 2008
As Prime Minister Stephen Harper and his Conservative Party lieutenants criss-cross the country ahead of the Oct. 14 election, one key message they have delivered is how, under their leadership, Canada is better positioned than most to weather the economic slowdown. They argued that despite doom-and-gloom reports from the likes of the Organization for Economic Cooperation and Development, the country's fundamentals remain rock solid.
At first glance, it is hard to argue with the Conservatives, given the near-record low unemployment, stable inflation, budget surpluses and solvent provinces.
But drill beneath the surface and a different picture emerges -- of a Canada not up to snuff with the rest of the industrialized world and the fast-growing emerging markets.
Whether it is taxes, lack of trade strategy, crumbling infrastructure or difficulty in drawing foreign investment, business leaders and economists say Canada faces multiple challenges that put us at a disadvantage compared with the rest of the world.
"I think we all have a sense of unease that we are not doing that well," says Jock Finlayson, executive vice-president of the Business Council of British Columbia.
In the global race for investment, Canada may be running at world-class speed, but the pace is not nearly fast enough, warns Anne Golden, president of the Conference Board of Canada, an Ottawa think-tank that has for two years in a row issued critical report cards on Canadian performance on the world scene.
"The fact is, other countries are doing better," she adds. And yesterday, for the first time, Mr. Harper acknowledged in a campaign stop in Halifax that Canada's economic foundation is on shaky ground. "Without increased competitiveness, Canada risks falling behind in the global economy and jeopardizing the gains we have made in the past few years," said a Conservative Party statement that accompanied details of yesterday's pledge to loosen foreign-ownership rules in uranium mining and airlines if Mr. Harper is re-elected prime minister.
With the election campaign officially underway, the Financial Post examines key government policies that are holding Canada back in the global race for investment and talent.
--------------------
Productivity: Canada 'sucks'
-1.4% - The decline in Canada's productivity over the past year
+3.2% - The increase in the United States' productivity over the past year
--------------------
The final report of the Competition Policy Review Panel, released in June, was a rude awakening for the federal government about Canada's place in the world. One of the report's main messages was that Ottawa and the business community cannot stand still and live by the same rules that have governed the country's investment and business in past decades.
"We cannot be content with simply being in the Top 10 or Top 20 among our international competitors," the report's authors wrote. "Globalization and the accelerating pace of change will continue whether or not we step forward to address these fundamental transformations.
If we want to control our destiny, we must acknowledge these issues and deal with them."
The report's authors drew a link between new policies that spur increased competition -- reducing or eliminating foreign-investment restrictions in such sectors as telecommunications, airlines, financial services and uranium mining -- and improved productivity.
As Mr. Finlayson describes it, productivity, or the output per hour of labour worked, is a measure in which Canada "sucks."
It certainly does, judging by the release this week of the most recent data on Canadian productivity. Labour productivity dropped 0.2% in the second quarter of 2008 -- the third consecutive reduction -- compared with a 1.1% productivity gain in the United States. Over the past year, Canada's productivity was down 1.4% while the United States recorded a 3.2% gain.
Among industrialized countries, Canada's average annual productivity growth for the 25-year period to 2006 was slightly more than 1%, better than only Italy, Iceland and Switzerland,
"Canada's poor productivity performance is the most serious problem facing Canada's economy, both in the short run and in the long run. Unfortunately, it will probably hardly be mentioned in this federal election campaign because that would involve a discussion of Canada's onerously high personal tax rates. Pity," says Michael Gregory, senior economist at BMO Capital Markets.
Boosting productivity involves a variety of factors, most notably investments in leading-edge machinery and equipment. But as a recent analysis from the C. D. Howe Institute concluded, the investment per worker in Canada lags the United States, Group of Seven countries and members of the OECD. "All this," the economic think-tank said, "despite a stronger currency that has made imported machinery more affordable."
Canada's poor productivity record means the economy is not reaching its full potential, says the Toronto-based Institute for Competitiveness and Prosperity, which has led to a "prosperity gap" with its largest trading partner, the United States. The gap -- defined as the prosperity potential that Canada has failed to achieve and should aspire to attain -- stands at roughly $8,800 per person. That threatens to wider further, the institute warned in its most recent annual report, to an inflation-adjusted $13,700 by 2020 unless current trends, namely the poor productivity record, are addressed.
The Competition Policy panel delivered a similar message. "We cannot shy away from making the tough decisions required to enhance productivity today because the benefits will be realized tomorrow," it said.
Aside from productivity, other key areas policymakers need to focus on to boost Canada's presence in the world include infrastructure, taxation of business investment and personal income, and regulatory overlap. Governments have moved in these areas, but analysts say what has been proposed is too meek to have any meaningful impact.
--------------------
Infrastructure: The gap widens
$72B - Amount that should go to new projects
$123B- Amount that should go to maintain existing structures
--------------------
A report commissioned by the Institute for Research and Public Policy suggested last month Canada would need to spend up to $200-billion on highways, ports, schools, and sewage-treatment plants and such to bridge the country's infrastructure gap. The author, James Brox, a University of Waterloo economics professor, said $72-billion should go to new projects and $123-billion to the maintenance of existing structures.
"The decline of Canada's infrastructure stock has coincided with a market slowdown in productivity growth
especially in comparison with the United States," Prof. Brox says. "These relationships are not coincidental but, rather, reflect the fact that services provided by public infrastructure enter both directly and indirectly into private-sector manufacturing."
Governments have acknowledged the need to brush up the infrastructure; legislators in Ottawa and the provinces of Ontario and Quebec have allocated up to $65-billion over the next five to 10 years. Prof. Brox says that falls well short.
"It is clear that this financial commitment will need to be sustained and even increased over a longer period of time to close the infrastructure gap fully," he says, adding the inadequate response is because much of the responsibility for infrastructure has been shifted to local governments, whose revenue sources are limited. "This municipal fiscal shortfall has been recognized, but not fully remedied."
Public-private partnerships are one option, and they have grown in popularity in Canada. But the projects carry political risks, particularly when governments or municipal leaders change.
--------------------
Taxes: We're not innovative
46.2% - Current effective tax rate imposed on labour
29.1% - Current marginal effective tax rate or the combined levy businesses pay to government on investments
15% - Corporate income tax rate Conservatives have pledged for 2012
--------------------
Hitting Canadians even closer to home than schools and roads is the country's record on personal taxation. The C. D. Howe and others contend personal taxes remain too high, and present a hurdle for attracting new and skilled talent to the country. The C. D. Howe recently estimated that the effective tax rate on labour -- the levy imposed on last dollars earned -- stands at 46.2%, which experts say must come down to ensure Canada can attract high-skilled talent.
"In a mobile world, those headline personal income tax rates do make a difference, and that's part of the fiscal picture where we have lagged behind," said William Robson, president of the C. D. Howe.
Taxation on business poses even deeper problems for Canada. It was noted in a recent KPMG report that most countries are moving away from taxes on corporations in an effort to make their jurisdictions as attractive as possible for investment. As a result, countries are relying more on consumption taxes, such as sales taxes on goods and services.
The Conservative government has pledged to take tax rates on corporate income down to 15% by 2012, but analysts say the country's business tax regime remains among the world's highest -- largely through levies on business investment or the purchase of equipment and machinery. Moreover, Canada is bucking the global trend by cutting the federal GST by two percentage points. Complicating matters is that five provinces -- British Columbia, Saskatchewan, Manitoba, Ontario and Prince Edward Island--levy their own sales taxes, and those are generally slapped on business inputs such as computers and production equipment.
"We are still one of the highest-tax jurisdictions in the world when it comes to new investment," says James Milway, executive director of the Institute for Competitiveness and Prosperity. "Our tax mix would benefit if we had more GST and less corporate tax. But in Canada, we are going the opposite way," he adds in frustration. "No one would accuse Canada of being innovative when it comes to tax policy."
Overall, Canada's marginal effective tax rate-- the combined levy businesses pay to all levels of government on their investments -- stands at 29.1% this year. That is an improvement from 2007, but still puts Canada in the top third highest among industrialized and developing markets, as calculated by the C. D. Howe Institute. Analysts say that is expected to remain the case for the immediate future.
The federal government likes to compare its standing on business taxes against other members of the Group of Seven. But economists say comparisons should be made to a wider grouping of countries given the growing accumulation of wealth in developing markets.
"Federal and provincial governments continue to reduce corporate income and capital taxes but this is not sufficient to scale the walls," the C. D. Howe said in a July paper looking at Canadian tax policy. At the very least, the think-tank has argued, all provinces should push down their corporate income tax rates to 10% so that Canada's overall levy on business income falls below the average of OECD countries. Also, provinces that haven't harmonized their sales taxes should do so immediately.
Mr. Finlayson says business tax reform is necessary because Canada desperately needs to attract investment from high-value, high-paying sectors, such as pharmaceuticals and specialty chemicals, to offset the inevitable end to the commodity boom.
"It has proven much tougher to grow businesses in B. C. that are competing in international markets outside of the resource base," says the executive with the B. C. business council. "The risk is that the commodity boom will end. And if prices come down, and history tells us they will, then we are going to have hollowed-out wealth-producing sectors as a result of the higher dollar."
--------------------
Regulations: 'Tyranny of differences'
13 - The number of securities regulators in Canada
1 - The number of securities regulators in the United States
--------------------
Among the other issues threatening to hold Canada back is the "tyranny of small differences" of a regulatory scheme created by Canada's three levels of government.
One of the most talked-about and notorious examples deals with securities regulations, and how Canada has 13 different regulators whereas the United States has one single watchdog, the Securities and Exchange Commission. Numerous blue-chip panels have recommended adopting a single regulator, but the provinces have balked.
"The regulatory burden and overlap is not only dragging us down, but is discouraging foreign investment," Ms. Golden of the Conference Board says. "Companies don't want to come here and be hassled. The fact we have 13 securities regulators to handle 2% of the world's money is just a hassle."
Regulatory differences among the provinces and between Canada and its biggest trading partner, the United States, present threats to prosperity. A blue-chip federal advisory committee warned in 2004 that Canada's "outdated [regulatory] system is an impediment to innovation and a drag on the economy because it can inhibit competitiveness, productivity, investment and the growth of key sectors. Other countries are reforming their systems, and Canada cannot afford to be left behind."
But as demonstrated by the securities regulation situation, Ottawa cannot act alone; it must work in conjunction with the provinces. In some cases, municipalities have to be on board as well.
"One of the problems we have in Canada is that the country is too big, too diverse. There are too many levels of government to be able to define and implement coherent strategies at the microlevel," Mr. Finlayson says. "So, how the heck do you develop a focused approach to attracting global businesses when you have so many players and a large piece of geography?"
Myriad political protests have also dogged attempts by Canada, the United States and Mexico to harmonize regulations through the Security and Prosperity Partnership, making it difficult for controversy-averse legislators to act.
In the end, observers say, Canadian policymakers will only move to enact policies that get us up to speed with the global pack if their hands are forced. As long as high commodity prices deliver robust incomes and boost trade, nothing will change.
"Who did the most dramatic things lately? Ireland. Why did they do it? It had hit the wall and couldn't take on any more debt. So, I don't think governments will act until they have to," Mr. Milway says.
"It would be nice if governments could get ahead of the curve. But unfortunately, in democracies, governments don't act until they have to."
