March 10, 2021

It’s not about winning but we can’t help but notice we’re losing (part three): Productivity—why Canada lags behind the US

Productivity is at the heart of the human desire to continuously create and improve and yet it’s rarely given the attention it deserves.

In this commentary series, we are uncovering and reframing the concept with people at the centre. In our first commentary, we showed productivity’s immense role in improving our lives. In our second, we dug into why—after decades of dynamism, and despite the innovation of many new technologies—productivity growth has stalled since 1970.

Now, we circle back to a puzzling question: It’s been well documented that Canadians are less productive than Americans and have been for decades, but why is this so?

To be sure, it is not a competition; productivity growth can and does occur in both countries over time. Still, it is important to ask what explains the gap, because answering this question could reveal some insights to help us to unlock our own potential. Therefore, in this commentary, we seek to explain the persistent wedge between the two countries.

The US-Canada productivity gap

To put the difference in perspective, Canadians make around $54,000 CAD per year on average while their American counterparts make around $67,000 CAD. In other words, by traveling just a few hours south, incomes increase almost 25% on average. What is it about the US or Americans that is different?

Part of the gap is unrelated to productivity: Americans work more hours than we do—about 3.5% more. If Canadians worked the same number of hours as Americans, they would instead make closer to $56,000. That closes the gap a little, but the remaining 20%-point disparity is due to a difference in the value of output produced per hour worked (i.e., productivity). While the average American worker produces $66 of value per hour, the average Canadian workers produces just $50 of value per hour. What enables Americans to work not harder but rather smarter than Canadians.

What doesn’t explain the gap?

Much research has focused narrowly on differences in taxes as the key driver. Some have even gone so far as to say that lowering taxes alone will eliminate the gap entirely. Interestingly, though it is likely one component of a bigger puzzle, research has not conclusively proven that tax differences are a primary driver of the gap.

A difference in industrial composition, for the most part, can also be ruled out as a major driver. In fact, the Canada-US productivity gap is seen across almost all industries.

Finally, the share of the population living in urban areas is surprisingly similar between the two. Though there is greater proximity to a larger number of major cities in the US than in Canada—which could have some synergies for innovation—this factor has not been extensively researched to date.

What does contribute to the gap?

Businesses’ investment in tools and technologies for employees, the skills and ability of the workforce, innovation, and business size are all essential in explaining the labour productivity gap.

Greater investment in tools and technology

Perhaps the biggest factor is the notable difference in the amount spent on machines, tools, and technologies (capital) per worker—what economists call “capital intensity”. As of the first half of 2019, Canadian businesses spent about $13,000 per worker on capital, while their US counterparts spent $20,500. The gap is especially notable in spending on information and communications technology (ICT) capital where Canada spends at a level of less than 50% that of the US.

However, focusing narrowly on this factor by itself ignores the important interplay with the others. For instance, if individuals and businesses do not know about or know how to adopt and use the tools or technologies effectively, just telling Canadian businesses to “buy more capital” does little to address the problem.

Underlying the gap in capital is both a skills and innovation gap between the US and Canada. These gaps have been found to be important contributors to the difference in business investment of machinery and equipment and ICT.

Difference in skills and education

The skills gap isn’t obvious at first blush. In terms of years of schooling, Canada and the US have equally educated populations so it is easy to dismiss that as a contributing factor. However, there are some important differences: as of 2019, the proportion of the population with a Bachelor’s degree or higher is 38% in the US versus 33% in Canada; while 2% of the population aged 25-64 have received a PhD in the US, this number is less than 1% in Canada.

A compounding factor is the persistent emigration from Canada of people with specific highly productive skill sets. In particular, tech talent developed in Canada is likely to move south of the border upon graduation. With 25% of STEM graduates from top universities working abroad, Canada is left with persistent skill shortages in these areas.

Additionally, the larger presence of research universities in the US compared with Canada creates a fertile environment for not just generating new ideas but also incorporating these ideas into practice.

More emphasis on innovation

Relatedly, the innovation gap is also believed to contribute to the lack of business investment. This is seen in both the “input” of innovation and the “output”. R&D spending, a proxy for input, represents 2.7% of US GDP but only 1.6% of Canada GDP.

Unsurprisingly, output of innovation is similarly imbalanced: the US produces roughly double the number of patents per person than Canada which, as many have noted, lacks a strategy to ensure Canadians benefit from Intellectual Property developed domestically.

Greater proportion of large corporations

Finally, compared to the US, Canada is home to a relatively large number of small companies (those with less than 500 employees), and comparatively few large businesses. Small businesses are, on average, less productive than larger companies. According to research by Statistics Canada, the greater prominence of small businesses explains a large part of the productivity gap between the two countries.

In addition to greater efficiencies of production and management, bigger businesses may also be better suited to invest in the scale of R&D and take the financial risks necessary to drive major change.

Why we see more small businesses in Canada is less clear. One thought is there may be barriers—trade, financing, institutional, regulatory, or taxation, among others—limiting the ability of small firms in Canada to grow. This is an area worth investigating further to ensure Canadians can scale and commercialize their ideas into valuable products and services.

What does this mean for Canada?

While we may be envious of the higher productivity in the US, there is more to the story. The lesser-known truth is that growth over the last few decades has not greatly benefited the average worker. Since 1970, productivity in the US has more than doubled while workers’ wages have increased by just 15%. This “decoupling” of productivity and wages has occurred across most OECD countries, including Canada; however, it has been more prominent in the US. This is an important consideration for Canada’s own policies.

This exercise provides some insights into the important interplay of human capital, business investment, innovation, and business size and has also raised several questions for further analysis, such as why Canadian firms are smaller.

But it also serves as a cautionary tale that productivity growth does not always drive the increase in wages that we expect. In developing policies to encourage greater productivity, therefore, we cannot lose sight of our ultimate aim of this work: improving the lives of Canadians, generation after generation.   

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