Prescriptions for growing the economy – Blog #22

7 February 2022

Budget time in Canada is almost upon us and many organizations are making pre-budget submissions. Economic growth is a main driver of our standard of living and quality of life so growth plans are always a key part of any budget. Yet there is no consensus on how best to grow the economy. Many approaches have been proposed. Two recent approaches show some of the different ideas being proposed:

  • RBC Economics, in a recent article1 propose a focus on investment and human capital.
  • A recent book by the French economist Philippe Aghion proposes a focus on the process of creative destruction and the role of competition.

The RBC Economics approach starts by noting that real economic growth rates in Canada fell from an average of 4.1% in the 1970s to 2.1% between 2010 and 2019, and the trend is for this to continue unless we do something different. The graph below shows two scenarios – more of the same, or a better approach, with Canada’s GDP over time. The difference between their trend growth and high growth scenarios by 2035 is $200 billion.

 

    Source:  RBC Economics

For this to change they say Canada needs to see a big shift in actual business investment and innovation. There is a significant investment gap between Canada and the US, which leads to a productivity gap such that an hour’s work in Canada produces only 74% of the value of an hour in the US. They also noted Canada’s poor innovation performance, where we are poorly rated in international league tables. A shortage of talent is also slowing economic growth, and they advocate paying more attention to the untapped potential of women, visible minorities and Indigenous people.

Based on this analysis they propose a six point plan:

  1. Embrace new approaches to innovation policy.
  2. Forward-looking policy, public infrastructure and blended finance for climate action.
  3. Promote services trade and Canadian platforms; protect intellectual property and data.
  4. Increase competitiveness with tax, competition, and regulatory policy.
  5. Attract, develop and retain new sources of talent.
  6. Education and labour market policy for lifelong learning

 

The Aghion book focuses on the process of innovation itself – creative destruction, and how best to get more of it. The idea of creative destruction was first described by the Austrian economist Joseph Schumpeter. New innovations make older innovations obsolete and as they are adopted they create many new jobs but also destroy the jobs involved in producing the older innovations. This sets up a conflict between the older innovations and the new ones. So the incumbent firms have an incentive to slow down or stop the new ones getting adopted.  Which brings us to competition, as the more competitive a market is the less power the incumbents have to stop the new innovations. Research shows that the more creative destruction that takes place the higher is economic growth.

 

Different firms react to competition in different ways. Strong firms are stimulated to do better and combat the new innovations. Weaker or complacent firms do their best to impede their new competitors. The effect of these two responses is shown in the diagram below:

 

There is a large literature showing how the US has become less competitive in recent decades, and how this has slowed productivity and economic growth. A large factor has been the increase of lobbying of politicians by large incumbents to maintain the status quo. In Canada the Commissioner at the Competition Bureau has noted the decline in competitiveness of the Canadian economy and called for updating the Competition Act to create a more competitive economy. We just need to think of how major sectors of the Canadian economy are concentrated – airlines, telecommunications, digital services, etc. A particular concern is how large incumbents are able to acquire their budding competitors and so stifle competition. This is a major concern in areas of rapid technological change such as digital services.

So a proposal arising from the Aghion analysis is to create a more competitive Canadian economy by strengthening the Competition Act and preventing large incumbents acquiring budding competitors.

 

Conclusions.

So what should we think of these two approaches?

Everything is the The RBC Economics approach is useful and would help growth, but they do not spell out their “new approach” to innovation policy in detail and they do not mention competition policy.

The Aghion approach looks at the fundamental drivers of the economy, the role of creative destruction and the role that a competitive market plays in stimulating creative destruction and economic growth. It fills the gaps in the RBC approach.

 

Combining these two approaches would definitely boost economic growth.

 

Peter Josty

 

References:

  1. https://thoughtleadership.rbc.com/the-great-canadian-restart-how-2022-can-spark-an-era-of-greener-more-robust-growth/
  2. The Power of Creative Destruction by Philippe Aghion   Harvard University Press 2021

This Blog first appeared on www.thecis.ca