Next federal government should spur business investment to help raise living standards

Most Canadians want a productive economy, which delivers higher standards of living. Unfortunately, the typical Canadian household has experienced stagnant wage growth and virtually no improvement in living standards in recent years, even before the pandemic and economic turmoil.

According to Statistics Canada, household income per person (adjusted for inflation) increased by only 1.5 per cent from 2015 to 2019. This is below the sub-par growth rate of 5.2 per cent from 2010 to 2014. By way of comparison, as recently as 1997-2000, household income per person grew around four times faster than in recent years.

While there’s no single explanation for the slow rate of growth of real incomes in Canada over the past decade or so, an important contributing factor has been the notable decline in investment in physical capital assets (machinery, equipment, etc.). Our recent study found that from 2010 to 2019, the growth rate of total investment in Canada was below the United States and most other developed countries. Prior to 2010, Canada generally enjoyed a faster investment growth rate than other wealthy countries, on average, including the U.S.

Moreover, residential housing construction accounted for a disproportionately large share of the growth of total investment in Canada compared to other wealthy countries, while Canada’s corporate sector accounted for a disproportionately small share, especially in two key categories—machinery and equipment and intellectual property products such as software. These categories are most closely associated with improvements in productivity which, in turn, spur improvements in living standards.

Unfortunately, the worrying trends don’t stop there. From 2015 to 2019, the decline in business investment was fairly widespread throughout the Canadian economy. And a majority of industries in Canada reduced investments in machinery, equipment and intellectual property products during that period.

Again—why should Canadians care?

Because investment in capital assets is critical to sustained productivity growth, which is the ultimate source of higher real incomes and improved living standards. Hence, it’s hardly surprising that stagnating living standards coincide with declining investments in productivity-improving capital assets in Canada.

Therefore, the federal government—whatever it may look like after the election—should make reinvigorating the growth of private-sector investment a policy priority. This does not mean, however, that government should actively promote investments in specific favoured industries such as “clean energy” or the entertainment industry through targeted direct and indirect subsidies. In reality, encouraging businesses to compete for such subsidies diverts valuable private-sector resources towards activities such as lobbying that do not help improve productivity.

Indeed, a more efficient approach to improving the business investment environment would involve broad measures such as eliminating regulatory red tape that imposes economic costs, especially on small and medium-sized businesses, with little to no offsetting social benefits. And restructuring the tax system so there are greater incentives to invest in productivity-enhancing assets. In this regard, the current capital gains tax exemption for owner-occupied residential housing—an exemption that does not extend to other asset categories—is undoubtedly part of the reason that investment growth in Canada’s household sector has outpaced investment growth in the business sector.

While extending a major capital gains tax advantage to investors in owner-occupied homes—but not to investors in productivity-enhancing business assets—might be good politics, it’s bad economics.