Canada lags behind Australia on productivity—more business investment key to increased living standards

The Canadian-Australian Productivity Gap: Comparative Institutions and Policy Settings

• This essay reviews comparative institutional and policy settings in Canada and Australia to help identify the sources of Canada’s relatively poor productivity performance since the mid-1990s.
• Canada and Australia are similarly ranked on measures of their institutional, policy, and regulatory settings. But Australia outranks Canada on measures of economic freedom (9th versus 14th place), FDI regulatory restrictiveness, its overall tax system, attractiveness to global talent, labour market flexibility (as measured by the unemployment rate and productivity gains from the reallocation of labour), product and financial market regulation.
• Canada outranks Australia on measures of globalization, corporate taxation, cross-border tax rules and complexity, and innovation. However, Canada’s advantages on measures of globalization are largely an accident of geography rather than superior institutions or policy settings.
• Australia suffers a global economic integration and productivity penalty based on its geography, but this only serves to underscore Canada’s underperformance in overall productivity growth.
• Much of Australia’s superior productivity performance is due to a stronger investment share of GDP adding to the country’s capital stock.
• While the investment share of GDP differential between Australia and Canada has narrowed in recent years, breaking down investment spending by asset type shows that around half of this narrowing is due to an increase in the share of GDP in Canada that encompasses investments in housing rather than to higher business investment. Addressing policies that may be acting as impediments to stronger private non-residential investment spending should be a priority for Canadian policymakers.
• Canada’s functionally and geographically fragmented regulation of its financial system compared to Australia’s unified, national approach may help explain Canada’s weaker performance on business lending, which would in turn impair capital formation and productivity performance.
• Australia dramatically improved its relative position on the Fraser Institute’s Economic Freedom index in the 1980s and 1990s, broadly coinciding with the onset of its outperformance of Canada in growth in productivity and living standards.
• Australia enjoys a more internationally competitive tax system than Canada, particularly in relation to personal, consumption, and property taxes, although it underperforms Canada on corporate taxes and corporate tax complexity.
• Canada underperforms Australia in product market regulation and is at the more restrictive end of the OECD spectrum on this measure while Australia is at the less restrictive end. A broad-based deregulatory agenda focused on these categories of regulation, perhaps informed by a government-mandated advisory body like Australia’s Productivity Commission, could help lift Canada’s productivity performance.
• The Australian Productivity Commission conducts government-mandated productivity reviews every five years that examine productivity developments in the Australian economy and outline options for reform. Canada could benefit from the establishment of a similar government advisory body with a mandate to promote policies conducive to faster productivity growth.
• Australia’s experience points to long-run productivity payoffs from economic reforms. Australia’s extensive economic reforms were implemented mostly during the 1980s and 1990s. The productivity surge in the 1990s, while partly a global phenomenon, is also widely recognized as the payoff from earlier reforms that are reflected in the sharp narrowing in the size of the economic freedom differential between Australia and Canada over this period.