Canada: OECD Predicts 5 decades of Economic Stagnation? Here's why:

Canada, the second largest country in the world, presents an intriguing economy to study due to the challenges it currently faces. While it may seem like a typical advanced economy with high living standards, incomes, advanced industries, and a sophisticated financial system, Canada is grappling with various macroeconomic issues. This has prompted concerns from economists and organizations like the OECD, who predict that Canada could be the worst performing advanced economy in the upcoming decades. Despite the uncertainty of future predictions, the raised concerns are considered legitimate. The country's projected sluggish growth is attributed to its unique regional position. Canada benefits from its close ties and proximity to the world's largest economy, the United States, making it a key trading partner. Additionally, its access to both the Pacific and Atlantic Oceans provides ample international trade opportunities, all within a peaceful environment. However, the downside of its geographic location is the vast uninhabited tundra covering most of its landmass, with the population heavily concentrated in a few urban areas near the southern border, close to the dominant U.S. economy.

Geography is not the root cause of Canada's challenges, but it has the potential to exacerbate many of its existing issues. It is essential to bear this in mind for future reference. The primary issue lies in the fact that Canadians do not exhibit the same level of labor productivity as their American counterparts. This is evident in the lower average salaries in Canada and the overall lower output per person compared to Americans. A significant portion of this disparity can be attributed to the fact that Americans work longer hours, allowing them to contribute more to their economy. However, even when accounting for working hours, Americans are over 30% more productive on average than Canadians. The average American worker generates $66 worth of value per hour, while their Canadian counterpart only produces $50 worth of value per hour. The reasons behind this substantial discrepancy are rather challenging to pinpoint. Some economists suggest that the variation in industry composition between the US and Canada plays a role, with the US boasting more high-income industry hubs that elevate the national average. For instance, Canada lacks equivalents to prominent American financial districts like Wall Street or tech hubs like Silicon Valley. If this explanation holds true, it implies that the difference in productivity may not be particularly meaningful, as a few standout sectors boosting the average do not accurately reflect the experiences of most participants in the economy. However, research from the OECD reveals that even when analyzed on a per-industry basis, Canada still lags behind the US in terms of productivity. Therefore, the argument that high-performing industries are solely responsible for the productivity gap does not withstand scrutiny.

The main reason is that the United States invests significantly more capital into enhancing the productivity of its workforce. In order to create goods, we rely on the factors of production: land, labor, and capital. Improving the productivity of labor can be achieved by having a younger, better-educated, and healthier population. Land becomes more productive if it is situated near water sources or abundant natural resources. Capital, which includes machinery and infrastructure, gains value with increased investment. Enhancing any of these factors will have positive effects on the others. For instance, better management of farmland can support a larger population of young workers. A larger population can lead to more innovations that enhance capital. Capital is crucial for increasing the productivity of both land and labor. For example, an accountant using a computer with Microsoft Excel can perform the work of two accountants using calculators or five relying on mental math. Similarly, a farm equipped with modern irrigation systems, genetically modified crops, and advanced fertilizers will yield more produce per acre compared to one without these capital assets. Economists define computers, calculators, fertilizers, and irrigation systems as capital – essentially, items that help in production.

Capital investments enhance the efficiency of both land and labor, an area in which Canada falls short compared to the United States. In 2019, Canadian businesses allocated $13,000 per worker annually towards capital expenditures, covering items ranging from office furniture to cutting-edge machinery. In contrast, American businesses invested $20,500 per worker, representing a 50% higher expenditure than their Canadian counterparts. This disparity is largely attributed to differences in infrastructure financing. The United States benefits from robust business investment opportunities, particularly through its expansive public markets that attract both domestic and international investors. While Canada also boasts its own public stock exchanges, they are smaller in scale and fail to draw the same level of international investment. Given the US's status as a prime investment destination, supported by factors like the use of the world's reserve currency, a favorable business climate, and its sheer size, it remains a preferred choice for investors.

Even privately held companies in the country are affected by this phenomenon. To illustrate, consider Bob and Marshall. Bob is the owner of a construction firm in the United States, while Marshall owns a similar company in Canada. Both entrepreneurs aim to secure a million dollars for purchasing a new warehouse for their equipment. Consequently, they begin seeking investors. The American company is more likely to succeed in this endeavor due to the higher availability of investment capital in the United States. In many cases of an initial public offering (IPO), the funds raised are not necessarily allocated to the company's operations but are used to reimburse early investors, enabling them to reinvest in new ventures. This practice is observed on both the Nasdaq and the New York Stock Exchange, similar to the Toronto Stock Exchange. However, the American markets are considerably larger in scale, providing greater liquidity for businesses of all sizes. Despite the disparity in capital investment between Canada and the US, it is impressive that Canadian workers maintain their current level of productivity. Nevertheless, the relationship between labor efficiency and capital intensity is not strictly linear. Eventually, workers will have the necessary tools for their tasks, and further investments will yield diminishing returns.

Why does this matter? Most countries worldwide have less productive workers compared to the US. Why isn't this a concern for them? The productivity challenge is particularly significant for Canada due to its unspoken competition with the US. Despite being allies with open trade policies and close cultural ties, Canada faces intense competition for talent. Approximately 45,000 Canadians relocate to the US annually, while only around 9,000 Americans move to Canada. This decision is primarily driven by opportunities. American workers generally earn higher salaries, especially highly skilled individuals. Top earners in Canada can significantly increase their income by moving to the US and benefit from lower taxes. Although social security is weaker in the US, it is not a major concern for high-income earners. This brain drain results in a persistent talent shortage in Canada, necessitating the recruitment of skilled migrants.

One of the consequences is the issue of housing affordability, particularly in Canadian metropolitan cities where most people reside. Rising real estate prices have been a challenge for Canadian cities over the past two decades, with the situation becoming more acute now. High land prices further strain businesses financially, limiting their investments in capital. Increased spending on renting or purchasing facilities reduces funds available for staff wages and essential tools for economic value addition. Moreover, businesses may find it challenging to secure financing as investors and banks are more inclined towards real estate investments. Ironically, the housing affordability problem exacerbates the trend of skilled Canadians seeking opportunities in American cities where they can earn more and pay lower taxes.

Canada ranks as the eighth largest economy globally, boasting a GDP of $1.64 trillion. This substantial GDP is distributed among a relatively small population of 38 million individuals, resulting in a GDP per capita of $43,258. The country's stability and confidence are commendable. A contributing factor to the high real estate prices in Canada is the perception of it being a secure investment haven for affluent individuals worldwide. With a robust and well-managed economy under a strong democratic government, Canada maintains its appeal. Despite stagnant growth, as projected by the OECD, there is little indication of improvement in the near future. Over the past decade, Canada has experienced minimal nominal GDP expansion. Regarding industries, Canada possesses thriving service, financial, mining, and agricultural sectors. Although overshadowed in some aspects by its southern neighbor, Canada still holds its own on the global economic stage.