Canada's future prosperity dependent upon increasing investment and raising productivity

Institute of Competitiveness & Prosperity

Under investment in education, R&D and capital equipment, combined with a low level of urbanization relative to the US is contributing to a widening gap in GDP per capita between Canada and its southern neighbour, according to the latest report from the Institute for Competitiveness & Prosperity (IC&P). The report partly blames the previous federal government, which has used its annual budgetary surpluses on measures favouring consumption rather than investment - a decision that has created downward pressure on productivity.

The IC&P's new report - entitled Rebalancing Priorities for Canada's Prosperity: Report on Canada 2006 - was unveiled last week at a one-day conference in Ottawa. Heading up a roster of economists and academics, IC&P chairman Roger Martin presented its main findings, arguing that the emphasis on consumption undercuts attempts to raise productivity at a time when globalization is becoming all pervasive.

"The fundamental problem is high consumption and low productivity. We're consuming too much of the current prosperity," says Martin. "We need to set targets for investing or we will consume our way into oblivion."

Martin is critical of the previous Liberal government for its weak record of investment. Of the $61 billion in "accidental surpluses", only 31% was invested, according to IC&P's criteria, while the remainder was directed towards "an orgy of consumption". That consumption includes fiscal transfers to so-called "have not" provinces, particularly in Atlantic Canada - a hotly debated issue at the conference. Martin says that unless the trend towards consumption is reversed, the prosperity gap will double over the next 20 years.

For IC&P, increased spending on transportation, communication and housing is classified as investment. But primarily it means lower corporate taxes in a variety of areas and a dramatic reduction in "perversely high marginal tax rates for individuals". IC&P calls this approach Smart Taxation, which it argues will encourage the private sector to invest in people, equipment.

Martin points to Ireland, Denmark and Sweden as countries with smart taxation policies, even though their overall tax rates differ considerably. He recommends that Canada consider several changes to its business taxation, including the elimination or reduction of taxes on capital investments and the elimination of corporate income taxes. The result, he says, would be greater job creation, higher physical and capital investments, the adoption of new technologies and more money for social and health programs.

When asked why the higher corporate profits enjoyed by companies today are not translating into increased business investment, Martin says it could be due to a lag effect, adding that increased investment is only a matter of time. His analysis was challenged by Jim Stanford, an economist with the Canadian Auto Workers.

Stanford says he agrees with IC&P's contention that investment needs to be defined broadly and capital spending must be boosted. But he took issue with IC&P's measurement of prosperity by GDP per capita. In particular, he questioned its assertion that more than half of the $8,700 prosperity gap between Canada and the US is due to the difference in the number of hours worked per week.

Stanford also pointed to the recent surge in corporate profits as an indication that business needs more encouragement to invest. He calls the widening gap between investment and profits as "a wedge of diminishing business credibility", adding that the IC&P's analysis of corporate taxation is the report's biggest weakness.

GST CUT INEFFECTIVE

In addition to criticizing the previous Liberal government of favouring consumption over investment, the report takes the current Conservative administration to task for its determination to cut the GST.

"If the goal is to have more savings, investment and work incentives, then governments should lower or eliminate the taxes on these activities," states the report. "To replace lost revenue, they should focus taxation on consumption. Ultimately, individuals would work and invest to generate income for consuming goods and services - so tax revenue opportunities would not be lost."

The Canadian venture capital (VC) industry came under strong criticism, both for its poor returns on investment and the labour-sponsored segment of the sector - the latter alternately described as "dumb" and "a fraud". Labour-sponsored investment corporations are an example of "abject failure by design", says Martin, adding that they have nothing to do with labour and "besmirch labour's name". His view was backed by Stanford but challenged by Rick Nathan, president of the Canadian Venture Capital Association.

The IC&P calls for a strengthening of Canada's innovation system and recommends a shift for focus of R&D support toward innovation demand. It argues that the success of Canada's generous R&D tax credits has been limited because they "only give companies a tax break for research they were planning to do anyway". It also cites high marginal tax burdens and a lack of highly trained managers as negative mitigating factors.

Martin says the small size of Canada's business education sector and its under funding play a major role in the lack of highly qualified personnel. Another factor is Canada's high illiteracy rate. Deborah Roseveare is a senior OECD economist and head of its Canada Desk. She says that, in addition to low productivity, Canada is being held back by the nine million citizens who fall below the level required to function in a knowledge-based economy.

To obtain a copy of IC&P's latest report, go to www.competeprosper.ca.

R$