Latest / The Productivity Podcast with Fexingo: Output, Efficiency, and Long-Term Economic Growth / Why Canada Tops the G7 in Total Factor Productivity Gains
Transcript
- Lucas: When you hear 'productivity leader in the G7,' what country comes to mind first? Luna: Germany, probably. Or the US, given the tech sector. Lucas: Reasonable guesses. But since 2020, the country that's actually posted the strongest total factor productivity growth in the G7... is Canada. Luna: Wait — Canada? The same economy everyone calls a branch-plant with low business R&D? Lucas: The very same. And I want to drill into why that's happening, because it challenges a lot of assumptions about what drives productivity. The data is from Statistics Canada and the OECD — Canada's total factor productivity, which measures how efficiently labour and capital are combined, grew at an annualized rate of about 0.8 percent from 2020 to 2025. That's ahead of the US at 0.5 percent, Germany at 0.3 percent, and the UK at basically zero. Luna: So the narrative that Canada is just a resource-based economy with low innovation — it's not matching the numbers. Lucas: It's not. And the first reason is something that doesn't get enough credit: Canada's banking system. During the pandemic, Canadian banks didn't need a bailout. They kept lending. That meant small and medium businesses — the ones that drive most productivity gains at the margin — could actually invest in automation and software in 2021 and 2022, while in Europe and the US, credit was much tighter. Luna: So it's a financial-stability story as much as a policy story. Lucas: Exactly. The second big factor is immigration. Canada brought in over 1.3 million new permanent residents between 2022 and 2024. But the key is not just the number — it's who they let in. About 60 percent of economic-class immigrants had a university degree, and they're young, typically in their late 20s or early 30s. That's prime-age workers who boost labor-force participation right when many G7 countries are dealing with aging workforces dragging that rate down. Luna: You're essentially importing human capital at its peak productivity window. Lucas: Precisely. And that shows up in the data: Canada's prime-age labor-force participation rate — people 25 to 54 — hit 86.5 percent in 2024, the highest in the G7. More people working, and working more productively, because they're in their highest-output years. But there's a third driver that I think is the most interesting for long-term productivity: the way Canadian R&D tax credits are structured. Luna: You mean the Scientific Research and Experimental Development program — SRED? Lucas: Right. SRED gives a refundable tax credit of up to 35 percent on R&D spending for small Canadian-controlled private corporations. The key word is refundable — if a startup has no taxable income yet, they still get the cash. That's different from the US R&D tax credit, which is mostly non-refundable and only benefits profitable companies. So Canadian startups in fields like clean tech, AI, and biotech have been able to sustain higher R&D intensity during the early, cash-burning years. Luna: That could explain why Canada has a disproportionately high number of AI labs relative to its economy — like the Vector Institute, Mila, Amii. Lucas: Exactly. And those labs produce process innovations that spill over into the broader economy. Total factor productivity captures exactly that kind of spillover — it's not just making existing things cheaper, it's figuring out new ways to combine inputs. So Canada's TFP gains reflect these three things: stable credit during a crisis, a demographic boost from targeted immigration, and a tax credit that de-risks early-stage R&D. Luna: But there has to be a catch. Canada has a well-known business-investment gap — companies invest less in machinery and equipment per worker than almost any other G7 country. Lucas: That's the big paradox. Canada's capital intensity — capital per hour worked — actually declined by about 2 percent between 2019 and 2024. So they're getting more output from each unit of labour and capital, but they're not adding enough capital. That suggests the TFP gains are coming from better use of existing resources, not from upgrading equipment. And that might not be sustainable. Luna: You can only squeeze so much efficiency out of old machines before you hit diminishing returns. Lucas: Exactly. The Bank of Canada has warned about this. And it's why some economists are skeptical that Canada can maintain its TFP lead. If business investment doesn't pick up, the gains from immigration and SRED will eventually plateau. But here's what I find genuinely encouraging: the provinces that have seen the biggest TFP improvements — British Columbia, Ontario, and Quebec — are also the ones that have reformed their SRED programs to include more applied research partnerships with universities. That's a structural change, not a one-time boost. Luna: So the lesson for other G7 countries might be less about copying Canada's specific policies and more about the combination: stable finance, demographic strategy, and R&D incentives that actually reach small firms. Lucas: Right. You can't just raise immigration numbers — you have to target high-skilled prime-age workers. You can't just offer an R&D credit — it has to be refundable so early-stage companies can use it. And you can't control a banking crisis, but you can regulate to make sure your banks are resilient enough to keep lending during one. Luna: Honestly, if walking through the economy with us has made something click — if this episode gave you a new way to think about what actually drives growth — it's worth mentioning that listener support is what keeps this show ad-free. There's a page where people who find value in what we do can chip in the equivalent of a coffee. Lucas: Yeah, and it's genuinely the smallest ask possible. If today was worth a coffee to you, that's the link — buy me a coffee dot com slash fexingo. No pressure, no perks, just helping us keep doing this. Luna: Alright, back to Canada's productivity story. One more angle I want to explore: does this TFP lead show up in real wages, or is it just a statistical artifact? Lucas: Great question. Real median wages in Canada grew about 3.5 percent from 2020 to 2025, adjusted for inflation. That's better than the US — which saw essentially zero real wage growth over the same period — but it's not as strong as the TFP numbers would suggest. Some of the productivity gains have been captured as corporate profits rather than wages. Luna: So the productivity is real, but the distribution is uneven. Lucas: Exactly. And that's a recurring theme in productivity economics — gains don't automatically flow to workers. Canada's labour share of income, which is the portion of GDP that goes to wages and salaries, has actually declined slightly since 2020, from about 53 percent to 51 percent. So while the pie has grown, the slice going to labour has shrunk a bit. Luna: That's the same pattern we've seen in other G7 countries. But if Canada's TFP growth is real, policymakers should be able to address the distribution issue without killing the productivity engine. Lucas: Right. And there are some signs they're trying. Several provinces have increased their minimum wages significantly — Ontario went to 17 dollars an hour in 2025, British Columbia to 18.50. That might compress the distribution a bit, but it could also push firms to invest in labour-saving technology, which would reinforce productivity growth. It's a delicate balance. Luna: Let's zoom out. If Canada's TFP lead is real, what does it mean for the rest of the G7? Is there something to learn, or is Canada's situation too unique? Lucas: I think there are three takeaways that are portable. First, the banking system matters for productivity in ways most macro models don't capture. Canada's big five banks are highly concentrated, but they're also highly regulated — they have to hold more capital than Basel III requires. That stability meant they kept lending when others froze. Second, immigration policy should be thought of as a productivity policy, not just a population or humanitarian one. The age and skill profile of immigrants directly affects the aggregate production function. And third, R&D tax credits need to be designed for the users who need them most — small, unprofitable companies — not just large profitable ones. Luna: So the US, for example, could learn from Canada's SRED program if it wanted to boost startup R&D. Lucas: Absolutely. There's been bipartisan talk in the US about making the R&D credit partially refundable, but it hasn't happened. Canada shows that it can work. The cost is about 3 billion Canadian dollars a year — roughly 0.1 percent of GDP — and the payoff in terms of TFP growth has been significant. Luna: What about the criticism that Canada's productivity numbers are inflated because of the oil sands? That's a capital-intensive industry that can distort the aggregate. Lucas: That's a fair point. The oil sands are a big part of Canada's economy, and they did see productivity improvements from better extraction techniques. But if you strip out the energy sector, Canada's TFP growth is still positive, just a bit lower — around 0.6 percent annualized. So the story isn't just oil. Manufacturing, especially in the auto parts and aerospace sectors, has also posted solid gains. Luna: It sounds like Canada's productivity story is more nuanced than the stereotype suggests. Lucas: Much more. And it's a reminder that productivity leadership doesn't always come from the usual suspects. Sometimes it's the country you overlook that has the most interesting lessons. Luna: So the next time someone says Canada is just a resource economy with a banking cartel, you can point them to the TFP data. Lucas: Exactly. And maybe to that buy me a coffee page too — buy me a coffee dot com slash fexingo.