Industrial policy may have part of the answer to Canada’s productivity problem

Steve Lafleur | April 24, 2024

The Trudeau government’s latest budget contained a number of splashy items, ranging from housing policy to national defence. In the midst of a national housing crisis and with mounting geopolitical threats, it’s no surprise that these policy areas are getting attention.

Another issue that the government sought to address in the budget is Canada’s lagging productivity. It’s perhaps less well understood, but one that will determine Canada’s ability to fund solutions to our most pressing national challenges. Dusting off the industrial policy playbook may be part of the solution.

Canada’s productivity challenges aren’t new, and aren’t news. Economic commentators have been raising flags about them for years. A recent speech by Carolyn Rogers, senior deputy governor of the Bank of Canada, injected some urgency into the discussion.

“You’ve seen those signs that say, ‘In emergency, break glass.’ Well, it’s time to break the glass,” she said.

In other words, productivity is no longer just a problem. It’s an emergency.

Why should Canadians care?

But why should ordinary Canadians fixate on productivity? Next to the increased cost of living – particularly the cost of shelter – productivity can seem like an abstract concept. Why spend money trying to make firms more efficient when many households are having trouble paying the bills? It’s an important question that elected officials need to answer.

But productivity isn’t a mere statistical artifact. Nor is it something that just pads the corporate bottom line. It determines how much Canadians can produce, and therefore how much we’re able to enjoy.

Investments in productivity – ranging from big ticket items like cutting-edge machinery to improve manufacturing output, to marginal tweaks like better software to improve agricultural output – mean we’re able to produce more goods and services per hour worked. Put simply, it means we get more output for the same amount of effort. Increased productivity means an increased standard of living, and a greater ability to finance important social programs.

Let’s use housing as an example. Several analysts have estimated that Canada is short over three million housing units. That is a daunting number. To meet that goal, we need more output. Unless we’re going to make a massive push to get young people into the building trades or completely reorient our immigration policy to focus on construction workers, we need to build more housing units per worker. In other words, we need more productivity.

Increasing productivity isn’t easy. If it was, we’d have already done it.  It’s easy enough to tell firms that they ought to invest more in equipment or software. But they need to have the right incentives and the right tools at their disposal.

One potential tool to hit the accelerator is industrial policy. It’s a broad concept that means different things to different people. The idea that there is a role for the state to nudge private companies in a particular direction is often thought of as antithetical to a market-oriented economy. In reality, we’ve always done some form of industrial policy. This ranges from past large-scale interventions to build out Alberta’s oilsands to tax credits for research and development.

There’s plenty in the budget that broadly falls under the industrial policy umbrella aimed at bolstering clean technology, artificial intelligence, Indigenous reconciliation and other key priorities.

A cynic could argue that the federal government is merely throwing money at stakeholder groups. Indeed, some skepticism is warranted. After all, if there’s money to be made on something, why doesn’t the private sector just step up?

Private firms can’t always address broad public interest

The trouble is the incentives often don’t line up. Let’s take another example: supply chains. Global supply chains normally work like magic. Our highly globalized economy provides us with an array of goods and services previous generations could only have dreamed of.

However, COVID-19 and the Russian invasion of Ukraine have shown that we can’t take that stability for granted. Geopolitics, natural disasters and infectious diseases, among other things, can disrupt supply chains. That is inconvenient when we’re talking about trinkets from Amazon. It’s a disaster when we’re talking about life-saving vaccines. We need to ensure that we don’t put all our eggs in one basket. No one wants to have to hoard toilet paper again.

This is where industrial policy can come in. Sometimes there are broader public interests that individual firms don’t have the right incentives to address. There’s no shortage of examples. Reshoring or shortening supply chains is expensive and can put companies at a competitive disadvantage; firms might face cost barriers to adopting cleaner technologies; they might not see the monetary value in reconciliation with Indigenous Peoples; and they might not have the ability to undertake heavy upfront costs for research and development on the technologies of the future. This is where governments might have a role to play.

Canada wouldn’t be the first major country to experiment with industrial policy. Countries ranging from China to Germany are pursuing aggressive industrial policy strategies. Even the United States has embraced industrial policy, perhaps best embodied by the American government’s Inflation Reduction Act and the CHIPS and Science Act. This have led to an explosion of construction activity.

This new activity isn’t just building widgets for the sake of creating jobs. It means that a share of the most advanced semiconductors on earth will now be built on American soil, helping to reduce the world’s dependence on semiconductors produced in Taiwan. Given geopolitical threats in Asia and lingering worries about supply-chain predictability, having these vital inputs built in North America is an unalloyed good. There’s a reason why even conservatives like U.S. Senator Marco Rubio want to double down on industrial policy.

That isn’t to say that industrial policy is completely uncontroversial, let alone perfect. It’s not hard to find failed examples of industrial policy initiatives. Governments engaging in industrial policy need a sound strategy, good data and rigorous evaluation. They also need to know when to cut their losses. These are all easier said than done.

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The sheer size of recent industrial policy initiatives, such as multibillion-dollar electric-vehicle battery manufacturing facilities or tax credits for clean-energy investments, should focus our collective minds on getting value for money. While industrial policy may be necessary to maintain or expand a presence in certain heavy industries that are being generously funded by other countries, the costs can be enormous. We can’t simply cut blank cheques. We need to get these investments right more often than not.

Efforts to boost productivity in the medium to long term come at the expense of short-term priorities. Bluntly put, if we’re going to spend a dollar on factory construction rather than health care, we need to make sure there’s a plausible and attractive payback. One of the key objectives of boosting productivity is enhancing our ability to generate the tax revenue needed to pay for services like health care, after all.

While industrial policy might be a promising avenue to boost productivity, we shouldn’t step into it lightly. We need credible, evidence-based policies linked to a coherent strategy rather than ad hoc decisions. We also need strong governance, policy design that attracts private capital rather than replaces it, and effective and timely implementation. It’s good that the government is thinking about productivity, but it’s not a matter of flipping a switch. We need to get the details right.

Getting these details right is what motivates the IRPP’s Building New Foundations for Economic Growth research program. We will continue to produce and share research aimed at bolstering Canada’s productivity long after the budget ink is dry.