Wake up Canada, you have a business investment crisis

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Capital investment is the lifeblood of economic growth and, therefore, of higher living standards. So the collapse of business investment growth in Canada in recent years is cause for alarm.

Increased capital, both tangible (machinery, equipment) and intangible (software, for example), boosts the productivity of workers and enables organizations to produce new products and implement more efficient production and organizational techniques.

But from 2015 through 2017, gross fixed capital formation (essentially all capital investment) in Canada increased by only 2.5 per cent – just slightly more than one-third the growth of total capital investment in the United States. Moreover, growth of Canada’s capital stock during this period largely reflects the construction of residential housing.

By way of illustration, household investment – essentially residential dwellings – increased to more than 36 per cent of total fixed capital formation in 2016 compared to about 33 per cent in 2014. In contrast, corporate investment’s share of total investment fell from around 53 per cent in 2014 to 47 per cent in 2016.

Essentially, business investment growth in Canada has vanished in recent years.

While Canadian cities such as Vancouver and Toronto enjoyed booming construction, there was essentially no growth in new machinery, equipment, software and other corporate assets that help make Canadian companies more efficient, profitable and capable of paying higher wages.

The growth in construction of residential dwellings was undoubtedly a response to surging housing prices, primarily in Vancouver and Toronto. How much house price increases – including apartments and townhouses – were driven by speculation, as opposed to real demand for places to live, remains undetermined. However, signs are emerging that house price increases are tapering off, perhaps even reversing.

It’s questionable whether business investment will increase to offset a likely slowdown of residential construction. While Canada’s ‘successful’ negotiation of a new free trade agreement with the U.S. removes some political uncertainty that has discouraged business investment, the imposition of tariffs (in the name of national security) by the administration of U.S. President Donald Trump remains a real threat.

Of greater concern, the U.S. corporate tax rate is now significantly lower than Canada’s rate. In addition, businesses in the U.S. now benefit from a substantial reduction in regulatory red tape while the regulatory environment in Canada, particularly in the energy sector, is becoming increasingly problematic for businesses.

And there’s more evidence Canada has become a less desirable place for business investment (particularly compared to the U.S.). From 2005 to 2014, inflows of foreign direct investment (FDI) to Canada averaged 24.2 per cent of FDI inflows to the U.S., compared to 8.5 per cent (or almost two-thirds less) from 2015 to 2017. Since FDI primarily represents investments to manage and operate host country businesses, the geographical distribution of FDI remains a reasonable indicator of the relative attractiveness of doing business in countries.

So what’s the solution?

While there’s no simple policy remedy to Canada’s business investment crisis, policy-makers must first recognize the problem and its consequences.

To date, the government of Prime Minister Justin Trudeau has downplayed concerns.

But Canadians would be better served if the federal government and the provinces acknowledged the country’s serious business investment problem and began proposing substantive solutions.

Reducing corporate tax rates and increasing the excluded amount of capital gains subject taxes would be a good start.

Steven Globerman is a senior fellow at the Fraser Institute.

business investment

The views, opinions and positions expressed by columnists and contributors are the author’s alone. They do not inherently or expressly reflect the views, opinions and/or positions of our publication.

By Steven Globerman

Steven Globerman is Resident Scholar and Addington Chair in Measurement at the Fraser Institute as well as Professor Emeritus at Western Washington University. Previously, he held tenured appointments at Simon Fraser University and York University and has been a visiting professor at the University of California, University of British Columbia, Stockholm School of Economics, Copenhagen School of Business, and the Helsinki School of Economics.

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