Tax cuts and stimulative spending plans are often touted as salves for Canada’s productivity problem. But policy-makers may find that other fundamental reforms are needed to resolve the issue.

Per-capita GDP in Canada lags the U.S. by about 19%, says a new report by the Organization for Economic Co-operation and Development. It’s not for lack of trying, as Canada’s labour utilization rate, which measures the hours worked per person, is actually slightly ahead of the U.S.’s.

Canadians are working harder and earning less — a situation that reflects the comparative shortfall in labour productivity. According to the report, Canada lags the U.S. by 21.4%. And Canada is not alone. The report focuses on productivity and economic growth throughout the 30 OECD-member countries; workers in Japan, Australia, New Zealand, Iceland, Switzerland and the Czech Republic are all in the same boat as Canada — working harder than Americans, but earning less.

The OECD notes that productivity growth in Canada has picked up since the mid-1990s, and GDP per capita has seen strong growth by international standards. But the gap between Canada and the U.S. remains large.

Indeed, not only is Canadian labour productivity significantly lower than that of the U.S., but the gap is widening. Between 1994 and 2004, Canadian labour productivity grew at an annual rate of 1.7%, vs 2.3% for the U.S. Canada now ranks 18th among the 30 OECD nations, and second-lowest among the G-7 industrialized nations, beating out only Italy.

The reasons for the productivity gap are many and varied. It has often been blamed on higher taxes that hamper investment in Canada. A report published earlier this year by the Vancouver-based Fraser Institute says Canada is facing a “productivity crisis.” It pointed to a variety of tax policy changes that could help spur the capital investment required to bolster productivity.

The problem goes beyond tax policy, however. In the inaugural version of the OECD’s study of productivity and growth, published last year, the group proposed reforms that would help each country in the survey improve its productivity. For Canada, that included reducing taxes on capital but also restraining health-care spending, reducing disincentives to work for those that have fallen into the social safety net, reducing barriers to foreign ownership (particularly in industries such as telecommunications, broadcasting and airlines), and liberalizing interprovincial trade, notably in the provision of professional services.

The most recent OECD report looks at the progress each country has made on its recommendations from the previous year. Overall, it finds that countries have made strides in improving productivity, but have not succeeded in encouraging workforce growth.

For example, governments have been slow to adopt reforms that would eliminate incentives for early retirement — a key issue, as many of the countries in the group face the problem of aging populations. Governments have been reluctant to make changes, it suggests, for fear that longer working lives for existing workers will, in turn, hamper job creation. However, pro-competition reforms are being pushed in the European Union, it says, and reforms in health benefits and education are underway in various EU countries.

Still, there has been some progress in Canada in the past year. The federal and some provincial governments have pledged cuts to various forms of capital taxation. But, the OECD maintains, there is scope to reduce taxes further. There has been progress in some areas in which the OECD recommended reform, including reducing interprovincial trade barriers and tweaking the tax system to reduce welfare dependency. But the other recommendations have hardly been touched.

To some extent, this is not surprising. Issues such as the future of the health-care system are much bigger than a simple effort to improve productivity. While the original report called for curtailing health-care costs, the update finds that federal funding in this area has increased. Governments are also committed to reducing waiting times — to keep the emergence of additional private care at bay, a development that probably will lead to higher spending still. Indeed, health-care spending throughout the OECD is ramping up inexorably.

There are other issues that are bigger than productivity but are more manageable than health-care spending; these include barriers to foreign ownership and competition. Foreign ownership remains a particular problem for Canada, which has some of the most daunting obstacles to foreign investors within the OECD. The financial services industry is certainly not immune to this problem (please see story below), but the initial report singled out telecommunications, broadcasting and airlines. Since that time, the OECD notes, a review of ownership restrictions in the telecom industry has been undertaken, but barriers to entry remain.

@page_break@Onerous restrictions on foreign ownership are important not just to the labour and product markets, on which the first version of the survey focused, but also to innovation. The new report expands its scope to include innovation because, as Jean-Philippe Cotis, OECD chief economist, noted in releasing the study: “Innovation is one of the main engines of long-run growth.”

The OECD finds that the world’s leading innovators are the Nordic countries, the U.S. and Japan. Above-average innovation was found in Continental Europe — in France, Germany, the Netherlands and Belgium. The non-U.S., English-speaking countries — such as Canada, Britain, Australia and Ireland — were found to be below-average innovators, albeit doing better than countries in southern and central Europe. The OECD notes that while Canada’s public spending on research and development as a proportion of GDP is among the highest in the OECD, business R&D spending is below average.

One of the OECD’s prescriptions for improving innovation — in Canada, in particular — is for the government to throw open the doors to increased foreign competition and investment. Higher private R&D spending is one positive side effect that could come from increased foreign investment. So the OECD calls for further relaxing of the restrictions on foreign investment, particularly in telecoms, broadcasting, airlines and banking, “to increase the available capital for new technology-based firms and to bring new technical and managerial know-how.”

As Cotis notes: “When innovation performance is found to be below the OECD average, while relatively high regulatory barriers stifle competition, we see a prima facie case for product market reform.”

It also recommends building stronger links between academia and industry to ensure that productive research leads to commercial exploitation.

Canada’s productivity problem will not be fixed overnight, and it is likely to take more than some simple tax policy tweaks to do the trick. More competition and other structural changes may be required. IE