What can Canada learn from the EU on productivity?

Peter Josty is Executive Director of The Centre for Innovation Studies in Canada. 

What can Canada learn from the EU on productivity?

Both Canada and the European Union (EU) have serious productivity issues.

The EU has recently produced a major report proposing ways to improve productivity in the EU. Are there any lessons for Canada from this report?

In both Canada and the EU, productivity compared with the U.S. has declined significantly in the last few decades. The table below shows a comparison for the decline since 1995.

Source: European Central Bank, Business Development Bank (data for 2022)

Similarities between Canada and the EU

Canada has many similarities with the EU:

• Both have a structure consisting of many entities (provinces and states).
• Both are multilingual (the EU has 24 official languages).
• Both are rich, with a high GDP per capita. According to the World Bank, in 2023, Canada had a GDP per capita of US$53,372, compared with US$40,824 for the EU.
• Both are democracies where major policies are developed through a process of negotiation.
• Both have periodic secession crises, some successful (Brexit) and others not (Quebec, Greece).
• Both have political tensions with the centre (Ottawa and Brussels) that wax and wane.
• Both spend less than the OECD average on R&D (1.6 percent of GDP for Canada, and 2.3 percent for the EU).

Differences

There are also significant differences between Canada and the EU:

• The EU has a population more than 10 times that of Canada.
• The centre in Canada (Ottawa) has significantly more power than the centre in the EU (Brussels). Each entity in the EU is a sovereign state and has far more powers than a Canadian province.
• The EU is much more complex than Canada. The EU consists of 27 countries with 24 official languages.
• The EU economy is much more diversified that Canada’s, which has a largely resource-based economy.
• Canada is much older than the EU. Canada was founded in 1867, while the EU was started with six countries in 1957 with the Treaty of Rome.

Policy processes to address the problem

Both Canada and the EU have been unable to develop and implement policies to increase their productivity relative to the U.S.

Both have developed a novel way to create a plan to improve productivity – asking a senior figure to produce a report to recommend ways to improve productivity.

For the EU, this person was Mario Draghi, former president of the European Commission and former prime minister of Italy.

For Canada, this person is Mark Carney, former governor of the Bank of Canada, who chairs a Liberal Party task force advising Prime Minister Justin Trudeau on economic growth.

Draghi’s report was issued in September this year; Carney’s work has just started.

Draghi’s report: The future of European competitiveness

This is  a very long and comprehensive 400-page report, so this is a very brief summary.

The report starts by laying out the current state of EU competitiveness. The EU is strong in mature industries where the potential for breakthroughs is limited. Starting in 2040, the EU workforce is projected to decline by two million workers a year. Because of this, the EU will need to “lean more on productivity” to drive growth in the future. 

Productivity is presented as an existential threat to the EU: if the EU can’t provide prosperity and freedom to its citizens, it will have lost its reason for being.

Europe largely missed the digital revolution led by the internet and the productivity gains it brought; in fact, the productivity gap between the EU and the U.S. is largely explained by the tech sector.

The report notes that, if one were to exclude the tech sector, the EU’s productivity growth gap with the U.S. is reduced significantly to just 0.2 percentage points. A significant reason for this is the large amount of regulation in Europe that is described in detail in the report.

The report identifies three main areas for action:

1. Closing the innovation gap with the U.S. and China. The report points out that the EU produces many innovative ideas but has failed to translate these ideas into commercial products and services. The Single Market has fragmented, which drives high growth companies overseas.
2. A joint plan for decarbonization and competitiveness. EU companies still face electricity prices that are two to three times those in the U.S. Natural gas prices are four to five times higher. This price gap is primarily driven by Europe’s comparative lack of natural resources.
3. Increase security and reduce dependencies. Security is a precondition for sustainable growth, and the EU is particularly exposed, due to its geographical location, and is hugely reliant on imports of digital technology. The key driver of the rising productivity gap between the EU and the U.S. has been digital technology.

The report identified three barriers that prevent achieving these main goals:

1. Europe is lacking focus. “We articulate common objectives, but we do not back them by setting clear priorities or following up with joined-up policy actions. For example, we claim to favour innovation, but we continue to add regulatory burdens onto European companies, which are especially costly for SMEs and self-defeating for those in the digital sectors. “
2. Waste of common resources. “We have large collective spending power, but we dilute it across multiple different national and EU instruments.”
3. The EU does not coordinate where it matters. “Industrial strategies today – as seen in the U.S. and China – combine multiple policies, ranging from fiscal policies to encourage domestic production, to trade policies to penalize anti-competitive behaviour, to foreign economic policies to secure supply chains."

To implement this plan and boost growth and productivity gains, Draghi says the EU needs both public and private investments of €750 billion to €800 billion per year, which is up to five per cent of the EU’s total GDP. His report includes 170 recommendations.

The reaction and implications for Canada

The report was welcomed by many industry groups as a necessary wake-up call. No one has criticized his diagnosis of the problem. The main criticism has been for the enormous amount of money he proposes spending – equivalent to over $1 trillion CDN per year.

Some of Draghi’s diagnoses sound eerily like Canada’s challenges – for example, the inability to turn ideas into commercial products, the fragmentation of the internal market, and failure of companies to adopt digital technologies. The report states that just removing trade friction within the EU could increase GDP by 10 percent.

Other observations are much less relevant – particularly those relating to energy and security, and the declining population.

Perhaps the main message for Canada from this report is that the status quo is not acceptable. Draghi makes the case, very convincingly, that declining productivity and competitiveness is a very serious problem that must be addressed with the highest priority. Incremental changes are not enough, and bold thinking will be needed.

Another key message is a cautionary tale about the role that excessive regulations can play in inhibiting productivity growth, particularly in the tech sector.

That is a message that Canada, which is often criticized for over-regulating, also would do well to heed.

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