Canada’s poor productivity is due to lack of business investment in machinery, equipment and software, slowness in adopting new technologies, and failed government policies, according to some economic and policy experts.

Government tax policy – including tax credits to support research and development – creates an incentive for Canadian companies to stay small, where they can’t afford to adopt new technologies, be as productive, or pay higher wages as larger firms do, they said during a webinar presented by the Information Technology and Innovation Foundation (ITIF) based in Washington, D.C.

Canada’s lack of competitiveness in some key sectors like banking, telecommunications and airlines, along with some of world’s tightest restrictions on foreign direct investment, also hobble investment, innovation and productivity, they said.

“This lack of investment in capital is the primary reason for why our economy has underperformed in recent years, and particularly over the last decade,” said Charles Lammam (photo at right), principal at Lammam Economics and Advisory, and former executive director of policy and budget to Ontario’s minister of finance.

“We’re seeing capital flee the country. We are seeing more capital leave Canada than come [to the country],” with the difference now amounting to about $1 trillion dollars, he said.

“In addition, we're seeing companies within our borders de-capitalize . . . they're just not investing in in all the things that drive productivity,” he added.

More than $1 trillion in investment left Canada between 2015 and 2024, marking the largest capital exodus in the country’s history, with $2 exiting for every $1 of incoming foreign direct investment, according to a new report by RBC Thought Leadership.

“We are in a crisis, a crisis that predates the Trump threats, and these new threats from the president [and] from geopolitics, are colliding with an existing crisis,” Lammam said.

“Generally, there are better investment opportunities elsewhere [than Canada],” said Leonard Waverman (photo at right), professor emeritus of finance and business economics and former dean of the DeGroote School of Business at MacMaster University.

The global competition, including in AI, quantum and other new technologies, is intense, he said.

“We’ve need a reset in policy. If we don't adopt [new technologies] quickly, we're going to be left even further behind than we are now.”

Canada has lost a lot of economic momentum during the last 10 years, by growing so slowly in income per capita and not adding sufficient capital, Waverman said.

“We can't get back on the path in three years. It's going to take 20 to 30 years if you have an upgrade in both of those things to get back to where we were,” he said.

“This is an incredible problem for Canada. It's something that all governments should be working on and changing policies to allow us to move up to a new trajectory,” Waverman said.

The ITIF published a report last May about how underinvestment in capital equipment hinders Canadian productivity growth.

That report found that 11 percent of GDP in the U.S. is invested annually in machinery, equipment and intellectual property, compared with just eight per cent in Canada, said Rob Atkinson (photo at left), founder and president of the ITIF.

The amount of productive capital stock in Canada, such as machinery, equipment and software, fell from 40 percent of GDP in 2013 to 36 percent in just a decade.

In some Canadian industry sectors, the decline in capital stock was steeper during the same period. Capital stock in mining and oil declined 27 percent, and manufacturing dropped 15 percent.

Business investment per worker in Canada fell 16 percent over 10 years while this investment went up in every other developed country, including in the U.S. by more than 26 percent.

Canadian businesses are also slower than their international counterparts in adopting leading-edge technologies, Atkinson noted.

In 2022, Canada ranked 17^th in the world in adoption of manufacturing robotics per worker – far behind leading robotics adopters such as Korea, China, Germany, Japan and even the U.S.

AI adoption by businesses in Canada is about half of what it is in the U.S. “And AI adoption is going to be critical for productivity growth and competitiveness in Canadian enterprises, not just private sector enterprises but the government and nonprofit organizations,” Atkinson said.

 Canada’s plethora of small business invest less and aren’t as productive as larger firms

Atkinson questioned what he called “this enamoured love affair” among many in Canada for small businesses (those with one to 99 paid employees).

Small businesses constituted 1.07 million, or 98.1 percent, of all Canadian businesses as of December 2023.

Yet on average, compared with large companies, small businesses invest less in capital equipment, are less productive, pay lower wages, injure their workers more, and invest less in pollution control, Atkinson said.

“So all these things that we would want to have as an economic system, to help our working people, our workers, having a small business-driven economy goes the other direction from that,” he said.  

Lammam pointed out that Canada has a series of preferences in its tax system that encourage the predominance of small businesses in Canada and provide an incentive for them to remain small.

“We have many more proportionately micro-firms, very small firms than in the U.S.,” he said. “I think that we're seeing [in Canada] is the response to the incentive.”

A series of tax preferences gives Canadian-controlled private corporations either lower corporate tax rates or more preferential access to major tax credit programs like the Scientific Research and Experimental Development (SR&ED) program, Lammam said.

The federal corporate tax rate for small businesses in Canada is nine percent, on the first $500,000 of active income, but the rate for large businesses is 15 percent.

“And then on top of that you have all the provinces that have similar gaps. In the case of Ontario, it's currently 3.2 percent for small firms under $500,000 of income and it skyrockets to over 11 percent when they become larger,” he added.

“So when you combine the provincial and federal rates, you could face a marginal tax rate, as a small business once you cross the $500,000 threshold, that more than doubles.”

The Ontario government recently announced that it's reducing the small business corporate tax rate further, from 3.2 percent to 2.2 percent, Lammam said.

In addition, for the SR&ED program, small businesses receive significantly higher and more accessible refundable tax credits that are much larger, as opposed to non-refundable credits for bigger firms, he said.

Small businesses are eligible for a 35-percent fully refundable investment tax credit on qualified expenditures, up to annual expenditure limit of $6 million. Large businesses receive a 15-percent non-refundable credit (which reduces tax payable only) on qualified SR&ED expenditures.

Provinces often provide additional, enhanced credits for SMEs, sometimes resulting in total R&D subsidies of over 60 percent of expenditures.

The bottom line is that Canada’s tax system provides an incentive that keeps companies small, investing less in new technologies than large firms, being less productive and paying lower wages, Lammam said.

The key point is that Canada shouldn’t want  to encourage “micro-firms” through the tax system and other mechanisms, he said.

“We want to help grow major world beaters, the next Unicorn. And whatever we can do to help bridge that gap through better tax policy – whether that's through personal income tax changes, general corporate tax changes, or capital gains changes – we should explore those things and not kind of double and triple down on one of these unintended consequences that we're seeing through the small business [tax] preferential.”

Lack of competition and barriers to foreign investment are hurting innovation and productivity

Foreign firms with operations in Canada are also more productive on average than domestic firms and invest more in capital equipment, Atkinson said. But there seems to be much more skepticism now in Canada about foreign firms, he added.

Lammam said a lot of Canadians are concerned about sovereignty these days in light of the geopolitical developments.

“They have an anti-foreign investment sentiment, whether it's access to critical minerals or telecommunications” or new foreign entrants in other sectors.

Canada also is one of the most restrictive nations in the world when it comes to foreign direct investment, he said.

The country puts up the most barriers to foreign investment in major sectors of the economy that stand to have significant economic benefits from such investment, including airlines, banking, and telecommunications, he added.

“We need to rethink that, in my view, be a bit more surgical in terms of the areas of national security risk and think about what are the benefits of foreign firms coming into Canada.” Those benefits include technological transfer, head offices and jobs in Canada and new ways of doing business.

But foreign firms are a competitive threat to Canadian companies in a domestic economy where competition in certain sectors is weak. Without competition from foreign firms operating in Canada, Canadian companies in those sectors don’t need to invest in new technologies to gain a competitive advantage over rivals, Lammam said.

“Unless you have those competitive threats, you just not going to see the technological adoption because it's typically a necessity,” he said.

Instead, if there’s an abundance of low-skilled, low-cost labor, which Canada has had over the last several years – until recent policy changes – due to immigration, “it's going to tilt the decision to [invest in] labor instead of capital,” he added.

Having a relatively protected banking sector in Canada, for example, results in trade-offs, Lammam noted. Canadians end up having less choices in banking compared with Americans, less innovation in financial products, and higher banking fees.

“Right now, there’s a policy environment that favours incumbents over the new entrants, at the expense of our innovation sector, our productivity and our investing,” Lammam said.

Waverman noted that Canada’s banks don’t invest as much in SMEs compared with other countries, because Canadian companies are small, harder to deal with, more expensive and riskier. “That’s a failure of our banking system,” he said.

Lammam said Competition Bureau Canada is currently doing a market study on the issue, because they’ve observed that small firms face higher loan interest rates compared with large firms. “The spread between the two is among the largest in the developed world,” making it hard for small companies to borrow from banks.

The lack of competition in the industry means banks aren’t incentivized to take on risks. But part of it has to do with government oversight of banks through the Office of the Superintendent of Financial Institutions (OSFI), Lammam noted.

The OSFI has a “risk-weight” for small business lending that requires a fairly high capital ratio when lending to small firms in Canada, he said. “And that can be a deterrent for banks that want to lend to small businesses.”

From the bank’s perspective, on their marginal loans they have to face higher capital requirements and more risk with SMEs versus a stable and predictable revenue stream through mortgage lending, for example.

Mortgage lending doesn’t have the same capital requirements and the risk is “socialized” through the Canada Housing and Mortgage Corporation, a public institution that protects downside and risk for mortgages.

“So it makes sense for the banks to want to lend to residential mortgages over risky SMEs,” Lammam said.

The OSFI said it is proposing lowering risk weightings for low-rise residential real estate projects and loans for SMEs to provide banks with more flexibility to lend money and invest. The proposal is intended to reduce “unnecessary burden without compromising the safety and soundness of financial institutions,” the regulator said.

Lammam agreed with Atkinson’s suggestion that Canada needs to expand its appetite for risk, because the downside of not doing so is much higher in the current geopolitical environment than it was previously.

“Absolutely I think the pendulum has swung too much toward protection and stability, at the expense of economic dynamism,” Lammam said.

Canada’s environment is stacked against investment in the country

From 2014 to 2024, Canada’s inflation-adjusted GDP per capita grew only 3.2 percent, while in OECD countries on average GDP per capita grew 15 percent and in the U.S. it increased by more than 20 percent, Lammam said.

Prior to 2014, Canada had roughly the same amount of capital flowing out of the country as the net foreign direct investment coming into the country, he said. “And something happened in 2014 where there's this gap that emerges, where funds from individuals, pensions and companies are going elsewhere rather than coming into Canada.”

The portfolios of Canada’s largest pension funds, the so-called Maple 8, are increasingly not domestic but instead invested outside the country, he noted.

Governments need to ask why the pension funds don’t see the same level of opportunity within Canada as outside of the country, Lammam said.

Through various policies, he said, “I think we've created an environment that is stacking the deck up against investment, whether that's [in] resource development or other forms of investments where the rates of returns aren't there in Canada. And we're seeing capital just flow to where they can get higher rates.”

Lammam did a deep dive article on Canada’s “red tape state” for The Hub. The data shows an economy heavily restricted by all levels of government (federal, provincial and local), leaving very little room for entrepreneurs and the private sector to innovate, he said.

When direct public spending (currently 45 percent of GDP) is combined with tax expenditures and the economic value of regulated industries, governments direct or influence nearly two-thirds of the Canadian economy, Lammam said. “We are kidding ourselves if we think this is an unfettered free market economy.”
Sector by sector is dealing with embedded rules, hidden (and visible) restrictions and compounded costs. His deep dive breaks down:

• The massive compliance burden of Canada’s tax system.
• Hidden regulatory charges inflating housing prices.
• Protective “moats” shielding Canada’s concentrated industries from competition.
• Rules that slow or kill major project development.
• Cascading requirements like dual-language labelling that impose prohibitive costs on small businesses and inflate everyday food prices.
• Fragmented provincial markets that act as internal trade barriers.
• Environmental command-and-control regulations layered on top of environmental taxes.

“The international data is clear: we are lagging behind our peers on regulatory competitiveness and openness to investment. It’s no wonder why we struggle to attract capital, development, and dynamism,” Lammam said.

Canada must create an economic environment that allows for responsible resource development, for new entrants to enter, and for small firms to grow rather than relocate, he said.

“We are in a deep hole and it's going to take some pretty significant policy change, because in my view a lot of this is policy-related,” Lammam said.” These are not inevitable consequences. They flow from the incentives that firms and individuals face in the Canadian economy.”

Government needs “big, bold change,” including major tax reforms

Canada’s biggest and strongest firms are leaving the country and going into the U.S. to take advantage of the capital pools there.

But Canada doesn’t really have an access to capital problem per se, given all of the investment money within Canada that’s leaving the country, he pointed out, adding the question is, “Why isn’t that money staying here?”

It is because of Canada’s policy framework, tax system, regulatory system and lack of competitiveness in the economy, Lammam said.

Expansion of government and the public service over the last decade has “crowded out the private sector,” he said. “All these things matter and they’re all interconnected. That’s what’s driving capital outside of the country.”

Atkinson pointed out that the Mark Carney government put forward in Budget 2025 the productivity super deduction, write-offs for capital investments and an accelerated investment incentive.

But Waverman said those measures “aren’t coherent. It’s got to be something across the board.”

For example, interprovincial barriers to the movement of people and goods that still exist, procurement in health care, and the transferability of medical records among provinces, are  all issues that needs to be fixed, he said.

Lammam commended the Carney government for putting forward the productivity super deduction, but said that “ it doesn’t match the moment in terms of the scale of where we're at.”

“It’s a very targeted deduction. It's for specific sectors, not all capital investment, and it's temporary,” he pointed out.

“Capital wants certainty. I don't think a temporary, very targeted measure is going to move the needle the way it needs to in this crisis.”

Canada needs much more bold major changes “to meet this crisis moment, and the 2025 budget announced falls short of that in a significant way,” Lammam said.

The country needs to be thinking big when it when it comes to corporate taxes and capital investment write-off, he said.

Ireland, for example, offers a highly competitive corporate income tax rate globally. Estonia has no corporate tax on retained earnings – essentially offering a 100-percent write off reinvestment.

Canada is one of the countries that relies the least on consumption taxes in the developed world, Lammam said. Consumption taxes are less economically harmful than taxes on income, he added.

“And so there's room to move there. We can scrap a lot of these narrow targeted measures that we have currently, so-called tax expenditures. They cost the Treasury billions of dollars.”

“What we need is big bold change. I think we need to look at the headline rates both for corporate tax and personal tax if we're if we're serious about changing course during this crisis,” Lammam said.

Last week, Prime Minister Mark Carney announced plans for a first-ever Canada Investment Summit September 14 and 15 in Toronto, aimed at drawing 100 of the world’s top CEOs, investors and global business leaders.

The gathering, to be co-hosted by the Canadian Pension Plan Investment Bord and the Public Sector Pension Investment Board, is part of Carney’s plan to attract $1 trillion in investment to Canada over the next five years.

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