Research & Publications

This report features enhancing productivity, boosting manufacturing and providing a fillip to exports in Canada all happening at the same time – a possible trinity. Independently developed by renowned economists, Robert Alexander Mundell (legendary Canadian economist) and John Marcus Fleming, the impossible trinity is a concept in international economics. It states that it is impossible to have all three at the same time – an open capital account, a fixed exchange rate and an autonomous monetary policy. The idea of impossible trinity has subsequently been widely used to elucidate other sectoral concepts and theories. In this research publication, we decided to buck the trend and talk about a possible trinity – where all three events can happen simultaneously. This trinity is increasing productivity, boosting manufacturing and growing exports. Given the deleterious effects of the pandemic and other geopolitical shocks, we should not look at this as a mere possibility but as an immediate priority for sustainable long-term growth.

Manufacturing has always been one of the key pillars of the Canadian economy. It contributes almost 10% to the GDP of the country and 8% to the overall employment. When manufacturing’s contribution to GDP is analyzed for G7 countries, Canada’s contribution has been fairly stable around 10%, which places us in the fifth position above UK and France. We have achieved a growth of 0.1% in manufacturing value added over the period 2018 – 2022. The decreasing share of manufacturing in Canada to overall GDP and the sub-optimal growth in the value added of manufacturing may place Canada at a disadvantage not only with respect to G7 but some of the emerging and developing economies as well. All the BRICS (Brazil, Russia, India, China and South Africa) countries as well as some of the G20 countries are vying for a sustained competitive advantage in global manufacturing. Manufacturing sector also occupies a major role in Canada’s exports. The share of manufacturing in overall exports has remained above 54% since 2019, though there has been a decreasing trend. Boosting productivity in manufacturing will result in a significant increase in exports, thereby improving trade balance.

The Manufacturing industry is undergoing a significant transformation, not just locally but also globally. R&D has evolved since the last century with a greater focus on digital manufacturing. While cost, delivery and quality were the key drivers of the manufacturing industry, there is an equally important pillar on Environment, Social and Governance (ESG) which has been added to the mix. The role of technology and digital transformation in industries has become increasingly important in recent years. The confluence of Industry 4.0, the effects of the global pandemic and war in Ukraine, and shifts in consumption patterns have a lot of implications for both customers as well as manufacturers. Changing customer trends have spurred businesses to adapt as shown in the figure below:

Productivity is a key variable for countries to understand economic growth. It measures the value generated per hour of work across various sectors that drive an economy. As a crucial indicator of economic health, productivity is influenced by factors that enhance efficiency and output. While stagnating productivity has been an issue for the Canadian economy for a long time, a recent speech by Senior Deputy Governor of the Bank of Canada, Carolyn Rogers, made this a talking point for all economists. Productivity is influenced by three main factors: capital intensity, labour composition, and multifactor productivity. The report looks into the performance of Canada’s manufacturing industry in each of these factors.

Capital intensity: Investment in machinery, equipment and intellectual property is one of the most important aspects of increasing productivity. The graph alongside shows the capital intensity ratios. Business investment declined after 2006 and investment per unit of labour has been declining since 2014. The decline in investments has been one of the contributing factors towards decline in capital productivity in the manufacturing sector by 0.4% over the period 2006 to 2022. This means that capital productivity in manufacturing was higher in 2006 than it was in 2022. We have become less efficient in using capital over the last decade and a half. Research studies showed that declining competition and a shift towards investment in intangibles contributed to the significant decline in investment intensity. This was further aggravated by tight labour market conditions (including the availability of skilled workforce), tax and regulatory burden.

Labour productivity is defined as the amount of real gross domestic product (GDP) produced by an hour of labour in an economy. The figure alongside shows labour productivity across the top ten sectors in Canada (in terms of their gross value added) and the overall industry in 2023 and the CAGR of their productivity from 2012 to 2023. Manufacturing sector’s productivity in 2023 was more than most of the top ten sectors and also the overall economy (denoted by all industries). However, the growth in labour productivity between 2012 and 2023 for manufacturing sector was lower than most of the other sectors. Lower capital intensity is one of the reasons behind the suboptimal growth in labour productivity, as it doesn’t provide the workforce with the adequate tools and machinery to upgrade their efficiency. The other reason is labour mobility. Due to the ongoing housing crisis, there is a shortage of houses in the proximity of manufacturing organizations and the businesses are therefore short of skilled labour. Another key factor is education, skills, and experience (labour  ) of the workforce. This is another area where Canada needs to improve as the contribution of labour composition to labour productivity growth has been almost flat in the last decade.

Multifactor productivity (MFP) measures the overall efficiency with which labour and capital inputs are used in the production process. It reflects changes derived from management practices, organizational shifts, technological knowledge, economies of scale, and other factors. Figure alongside shows long term MFP for US and Canada. MFP of the US grew at 4.2 times faster than that of Canada during the period 2000 – 2022. This is an indication that the overall business and managerial ecosystem was less efficient in Canada than in the US for the manufacturing industry. We lag behind the US in productivity because they have greater investments in tools and technology, higher skills and education in US and more focus on innovation. Also, there is a greater proportion of larger enterprises in the US, which explains part of the productivity gap between the US and us.

With so much of our exports depending on the manufacturing sector, the suboptimal growth in manufacturing productivity is adversely impacting our exports as well. Canada’s trade deficit  in manufactured goods averaged $10 billion per year in the 2000s but this deficit shot up to $197.8 billion in 20222. The growth (CAGR) of manufacturing exports over the period 2012-2023 was 4.2%  while growth for all other exports was significantly higher at 6.4%. As a result, the share of manufacturing in overall exports has come down from a high of 67.3% in 2016 to 57.6% in 2023.

Of the various sub-sectors within manufacturing, beverage and tobacco product manufacturing, paper manufacturing, transportation equipment manufacturing, printing and related support activities, primary metal manufacturing, fabricated metal product manufacturing and plastics and rubber products manufacturing experienced a decline in productivity (between the period 2012 and 2023). The most significant amongst them is transportation equipment manufacturing, which is not only important within manufacturing but also a major contributor to exports (the second after minerals and petroleum). A detailed analysis of motor car exports (HS code 8703) revealed that the exports from Canada reduced from more than USD 40 billion^[1] in 2019 to around USD 37.8 billion in 2023. The automotive sector is where Canada has a Revealed Comparative Advantage (RCA)^[2] of greater than 1. Paper and paperboard items (HS code 48) saw a lukewarm growth in exports between 2019 and 2023. Some of the specific items within paper such as newsprint and uncoated paper experienced a net decline in exports despite having a very high RCA (greater than 10). Another sector which saw a decline in exports during the same period was electronic integrated circuits (reduction from USD 1.1 billion¹³ in 2019 to USD 0.84 billion in 2023). During the same period, imports have increased. While Canada does not have a comparative advantage in this sub-sector, it is one of the priority sectors for the country and a lot of investments are being planned in this sector.

We have proposed a three-pronged roadmap for improving productivity in the manufacturing sector – upskilling manufacturing personnel, encouraging investments and boosting exports and going long on digital transformation.

For upskilling manufacturing personnel, we have proposed SPARK methodology which refers to Skills, Portability, Access, Resources and Knowledge to address 4 fundamental pillars: upskilling, labour mobility, immigration and education. To address the Skills gap in the manufacturing sector, stakeholders should support SMEs through programs like Technology Access Centres and leverage tax incentives to promote training and innovation, enhancing productivity and competitiveness. Enhancing labor mobility (Portability) can be achieved by investing in modular housing, transportation infrastructure, and integration programs, providing relocation assistance, and promoting remote work, thus addressing housing shortages and labor market needs. Immigration policies (Access and Resources) should be aligned with labor market demands through targeted programs like the Global Talent Stream and developing an Interactive Skilled Immigrant Employment Portal to match skills with opportunities and facilitate smooth workforce integration. Reorienting education (Knowledge) involves promoting manufacturing careers through partnerships and programs in schools, colleges, and among underrepresented groups, enhancing sector awareness and encouraging diverse talent to join the industry.

To address investments and exports, we have developed the “PIVOT” strategy to address cross-cutting issues. Canada should develop a comprehensive industrial strategy (Policy and strategy) that addresses geopolitical shifts, digital transformation, and climate change by enhancing capital and labor productivity through targeted public and private investments. This strategy requires coordination among federal and provincial agencies, collaboration with educational institutions, and global partnerships. A bipartisan political economy approach is crucial to support this integrated policy framework. To boost investment (Investment facilitation) and capital productivity, Canada should implement proactive policies with attractive incentives, improved ease of doing business, and strong ESG considerations. Drawing inspiration from U.S. legislation, Canada needs to enhance parameters like construction permits, electricity access, and contract enforcement. By addressing these areas, Canada can become a more appealing destination for both domestic and foreign investments. To navigate deglobalization, Canada should re-establish global value chains (Value Chain approach) with trusted allies by evaluating its trade basket, particularly in manufacturing. This involves studying subsectors to map value chains, identify comparative advantages, and explore import substitution and trade deals with friendly countries. Implementing the National Supply Chain Task Force’s recommendations is essential for ensuring an efficient supply chain and robust transport network. To enhance capital intensity in Canada’s manufacturing sector (Outreach programs), significant investments are needed from SMEs, which make up over 99% of the industry. Simplifying access to finance and markets through programs like the Strategic Innovation Fund and better-designed market access initiatives can support these enterprises. Canada’s participation in Hannover Messe 2025 will further showcase its strengths and expand market opportunities for Canadian firms. To boost capital investments in the manufacturing sector, Canada should implement tax incentives (Tax incentives and reforms), such as a proposed 20% refundable manufacturing investment tax credit. Drawing lessons from the U.S. Inflation Reduction Act, Canada can rationalize tax incentives to promote clean energy and manufacturing technologies. Re-evaluating and aligning the tax framework with long-term sector strategies is essential for stimulating economic growth.

Implementing digital transformation strategies offers undeniable benefits, improving supply chain efficiency, cost reduction, and operational scalability through technologies like big data, advanced analytics, and IoT. These advancements enhance real-time decision-making, process security, and customer experience, driving firms toward becoming Tech-Driven factories to stay competitive. Digital transformation now aligns with business strategies to address external shocks, sustainability, and transparency, with a PwC survey highlighting resilience, flexibility, and sustainability as top priorities.

To ensure seamless digital implementation, manufacturers must focus on:

1. Organizational Set-up and Operating Model: Success depends on having the right people and teams leading transformation, with a model where digital teams drive core business functions.
2. Robust Digital Backbone and Data Governance: Stable IT architecture and strong data governance are essential, ensuring data quality for decision-making and aligning IT with long-term organizational goals.
3. Governance and Internal Controls: Aligning transformation with strategic objectives requires a top-down policy and bottom-up implementation approach to manage risks and adhere to regulations.

Significant investments in people and systems are crucial, with companies investing over 3% of annual revenue more likely to achieve higher returns. Firms should carefully choose investments based on varied payback periods and industry-specific use cases, adopting a tailored approach to identify key drivers and develop use cases for digital transformation.