Dan Breznitz is the Munk Chair of Innovation Studies at the University of Toronto, as well as the co-director of the Canadian Institute for Advanced Research’s program on innovation, equity and the future of prosperity. He served as the Clifford Clarke Economist for the federal Department of Finance during 2021-22.
This essay is the first in a series, Prosperity’s Path. Successive governments have been warning about Canada’s slowing productivity for more than three decades. Now as the cost of living rises and per-capita economic output shrinks, this problem has reached an inflexion point. Dan Breznitz lays out how we got into this productivity crisis, and how we can get out.
If there is one thing Canadians are united about – it is the importance of the middle class. The middle class is our anchor, our measure for being a healthy society and our national aspiration is that each and every Canadian should be able to join and enjoy it.
On almost every front that should ensure that Canada’s middle class is healthy and prosperous, we have been doing very well. Over the past 45 years we became the world’s most educated country. Unlike what some politicians like to claim, Canadians are hard-working, and participation in the labour force among 18- to 64-year-olds is higher than both the United States and the average for Organization for Economic Co-operation and Development (OECD) countries.
We have developed an impressive, extremely high-performing research and higher education infrastructure that continues to punch above its weight. Lastly, our businesses have enjoyed rising profits – rising faster in the past decade than profits among many global peers.
But the reality is that our middle class is facing a serious problem, and the reasons for it are puzzling. The benefits of this educated work force, research-intensive higher education and highly profitable business sector are not translating into economic well-being for the middle class. Real median wages of Canadians have barely changed since 1976 (yes, that was 48 years, or two generations ago). As a result, Canadians need a two-income household and must work for longer hours than their international peers to achieve comparable standards of living.
To put it in sharp, painful, middle-class perspective: Analysis of data from the OECD and Statistics Canada on the way people spend their time shows that Canadian couples now work so much that they have a full eight months less time to spend with their children before they turn 18, than their peers in other rich OECD countries and Group of Seven (G7) economies. Indeed, Canadians have lost more than 10 per cent of their leisure time since 1988.
If the foundations are so strong, why is the Canadian middle class getting shafted?
The answer is our systematic failure in both innovation and engagement in new knowledge by both the private and public sector.
Simply put, Canadian businesses and government could have used the publicly financed gift (enhanced by immigration) of a highly educated, highly skilled and highly motivated work force – and matched it with the best technology – to become the most innovative and productive economy in the world (and then shared that extra wealth with workers). Instead, both our government and our businesses have opted for a model in which they underpay overqualified Canadians to work with barely sufficient equipment and technology to avoid all risk associated with buying, using and developing new technologies and products.
The result is stagnant wages, poor-quality jobs, skills mismatches, continuously declining-in-quality public services and 48 years of missed economic growth opportunities. This is what is known technically as a low-wage, low-innovation, high-skill equilibrium. The price of Canada getting stuck in it has been paid by the Canadian middle class.
To understand why fixing our failure in innovation is key, we need to understand the role of productivity in wage growth.
If we want to be able to pay every Canadian better wages, improve health and well-being and our quality of government services, we have to increase productivity. Productivity, in this case, is the output per worker. In order to continuously pay higher wages, the output per wage-earner must go up. In short, we must increase productivity if our aim is to increase wages.
On this issue, the headlines are sober enough – Canada moved from having an average of 3-per-cent productivity gains before 1976 to less than 1 per cent (0.9 to be exact) since 2000 (that is for the past 24 years and counting). And Canadian companies are now operating at 71 per cent of the productivity level of American firms, partly because our annual economic growth has plummeted since 2008. Measured in real gross domestic product (GDP) per person, the average growth between 2008 to 2017 was 0.56 per cent and, while there was some temporary improvement since, we are now back to those levels. No wonder real median wages declined, and Canadians found themselves working more and more just to keep up.
It is true that if we look at other G7 economies, we will see that slowing productivity since the 1970s is a malaise that has affected all of them. But why has Canada been doing so badly, and are there changes within national productivity gains that explain why Canada’s middle class has been shafted so gravely?
The answers are chilling, and hint at a long-term systemic failing that cannot be fixed by just spending large amounts of our taxpayers’ money on a random and never-ending array of short-term, meaningless policies with catchy names.
Broadly speaking, there are three kinds of productivity gains to be had: labour, capital and, the most important one by far for rich advanced economies such as Canada, total (or multi) factor productivity (TFP or MFP). Let’s look at each in turn:
Labour: A main source for productivity gains is having better-skilled and better-educated workers. Here you might think that Canada should excel. However, to enjoy the gains from more educated workers, they need to be working in jobs and industries that actually use their new skills. This is the reason why Canada’s productivity gains from workers are lagging all of our G7 peers, apart from Japan. We can graduate as many top-level engineers as we want, but they can’t help productivity if their skills are not utilized, and they’re not given the tools they need to excel. Which brings me to the next point.
Capital: These are the productivity gains that organizations achieve by employing newer and more capital equipment, such as the latest information and communication technologies that improve performance across a wide range of economic sectors. On this, Canadian public and private sectors are the worst performers among all G7 economies. By failing to invest in productivity-enhancing technologies, our lagging productivity gains have an obvious explanation.
However, the true dilemma of growth in Canada and other advanced rich economies is that the marginal impact of adding more skill and more equipment is quickly declining the richer and more advanced your economy is.
Think about it: Adding 50 top-of-the-line factories to an economy that has none, has a significantly bigger marginal impact than adding those same 50 to an economy that already has thousands of them. While it is true that an economy with thousands of factories can add more than just 50, the relationship between the two is not linear. At some point, in proportional terms, you run into diminishing returns.
Think about how the same issue goes for labour; moving your labour force from having only basic education to one with university degrees has a massive impact on productivity. But how much more schooling can you add to a labour force that already has an average of 14 years of formal education?
This is why innovation is crucial, and this is why looking at TFP is so important when analyzing the overall health of an economy.
Dan Breznitz is the Munk Chair of Innovation Studies at the University of Toronto, as well as the co-director of the Canadian Institute for Advanced Research’s program on innovation, equity and the future of prosperity.Alexis MacDonald/SUPPLIED via THE CANADIAN PRESS
Total/multifactor productivity is a term invented by economists for a somewhat opaque phenomenon. TFP is the residual productivity left over after we account for that generated by changes in labour and capital. It’s the black-box productivity that isn’t explained by the labour and capital contributions. When we unpack the TFP black box, we see that the contribution it makes comes partly from management – and mostly from innovation.
The stark reality of the Canadian economy since 2000 is that our TFP growth has evaporated. In fact, from 2000 to 2008 it was negative. Meaning that our business and public leaders managed to take the world’s most-educated and hard-working people and employ them in ways that so dramatically underutilized their skills and creativity that they became less productive.
To put it in sports terms, we had a team with more talent than my sorry Maple Leafs, and we managed to do even less with it than the Leafs did (yes, that amazingly managed hockey team that failed to win anything since 1967 while having the highest ticket prices in the NHL and getting any player they ever wanted).
But this is just management. The most important thing for growth is innovation. Indeed, innovation is the only way for an advanced economy such as Canada to have sustained productivity and wage growth as well as improved welfare.
So, what is innovation?
Innovation is not just the invention of new things. Inventing is the act of coming up with a novel idea, and Canada is pretty good at that. Innovating is the act of applying ideas to develop and offer new or improved products and services in any stage of production and in each and every sector of the economy – making things better, more reliable and cheap enough so that every human has access to them.
It is here that we truly and tragically fail in each and every facet of innovation, from research and development (R&D), where Canada won the all-time wooden spoon by becoming the only OECD economy in which its business-sector investment in R&D declined annually from 2001 until 2019, and is now standing at the developing-countries level of just above 1 per cent of GDP, far away from the world leaders at 5.3 per cent or the OECD average of 1.99 per cent. Even when we add all public R&D and measure gross domestic R&D, Canada still significantly lags the G7 and the OECD average, and the gap with the leaders only grows.
Now, we know we catastrophically fail at commercializing our own inventions as the story of artificial intelligence (AI) – a field mostly invented in Canada on Canada’s taxpayers’ dime – demonstrates. From being global leaders in its invention, we have fallen so low that by 2024 no city or institution in Canada is at the top of AI global leadership any more.
But maybe we are world leaders in other forms of innovation?
Sadly, no matter the indicator and the proxy you use, no matter how you torture the data, since around 2000 we find slow but constant decline. Economic Complexity Index? We have a comparatively less-sophisticated and complex economy than in 2001. Our public- and business-sector adaption of new technologies? Last place in the G7. Patents and other intellectual property? We are not even in the race.
In short, the smarter Canadians become, the more relatively stupid our economy and public sector becomes. A trajectory that is reminiscent of another, once-very-rich, highly educated, immigration-based country, with vast natural resources – Argentina.
Some have argued that this is just our culture. What can one do, so the theory goes, Canadians just have a sub-par achievement culture. Interestingly, both current affairs and history demonstrate the failure of this “lazy-bums, risk-haters are us” argument. After all, many Canadians that move after university to the United States somehow suddenly excel. But those moving to the United States have spent decades being deeply immersed with that bad Canadian culture. To blame the issue on culture forgets that. Additionally, this story of decline is a recent development. Until around 2000, Canada was clocking advances on all those measures.
So, what happened in the second half of the 1990s that so effectively and systematically moved us down toward a slow decline?
The first thing that might come to your mind is the North American free-trade agreement (NAFTA), and you would be correct. But it is not the actual trade agreement that we signed. NAFTA was just the embodiment of a series of decisions to commit ourselves to a very specific economic ideology. A naive view of global markets as a magical force that would mysteriously fix all of our woes without our government needing to do anything. The only thing Canada needs to do, according to this theory, is to truly believe in “The Market” and let it work its magic without any intervention or strategy. A sort of religious belief that happily led us to thoroughly dismantle our ability to govern, even of basic things such as ensuring competition. Worse, we fall asleep at the same time that all of our trading partners strategically built up their government capacities, specifically so they can they shape the global market and, even more importantly, their participation in it.
The result is that once we start a decline in every domain, from innovation to health and crime, our federal government finds itself time and time again unable to strategically and decisively act to counter it.
Our very own action led us to become a country adrift without an ability to govern, any capacity and ability to develop and implement a strategy, or indeed even openly discuss what it wants to be in the future.
Innovation is a perfect example of this.
And who are the ones that pay for all of this?
Our middle class.