Canada’s financial system rewards asset ownership over expansion. Fixing productivity means changing where investment flows.
by Manbo He
Originally published on Policy Options
April 30, 2026
Walk into any bank branch in a mid-sized Canadian city and you’ll find a loan officer who can get you a mortgage in 48 hours. Ask the same institution to finance a manufacturing firm that wants to automate its production floor and it’s a different matter. Three weeks later the bank will hand over a thick folder and long list of reasons why the project doesn’t quite fit the portfolio.
Canada does not have a productivity problem because it lacks innovative ideas. It has a productivity problem because its financial system is not built to fund them.
For years, governments have diagnosed the cause of our country’s chronic stagnant productivity as insufficient innovation. Canadian firms, the story goes, don’t market their research well, entrepreneurs take fewer risks and businesses lag in adopting technology.
The policy response has been consistent. More innovation funds. More tax credits. More incubators. A super-deduction introduced in last fall’s budget was among the latest iterations. It offers accelerated writeoffs for businesses that make investments to enhance their growth. Yet productivity continues to stagnate.
Canada produces ideas. What it does not do well is move money to firms capable of turning those ideas into output. Productivity rises when capital flows to businesses that can expand, automate and compete globally. But much of Canada’s financial structure rewards something else entirely: stability over dynamism and asset ownership over expansion.
Canada’s capital is flowing to the wrong places
For the past two decades, Canadian capital has been concentrated heavily in real estate, financial intermediaries (such as banks and insurance companies) and mature resource sectors. These industries can be profitable; however, they do not generate broad productivity gains. Canada devotes a larger share of total investment spending for residential housing than any other country in the Organisation for Economic Co-operation and Development (OECD). That share is more than one-third of all investment capital compared with roughly one-fifth in the United States.
Rising asset values have consistently delivered higher returns for businesses than investing in expansion or adopting new technology. In this sense, the financial system is not failing. It is working exactly as incentives have moulded it. The result is an economy that looks prosperous on paper while productivity stalls underneath.
Canada’s banks and pension funds are internationally praised for their caution, but that prudence has a hidden price. It has crowded out the risk-taking that drives productivity. The Canada Pension Plan Investment Board and its provincial counterparts have become world-class acquirers of mature toll roads, airports and utilities — often abroad. This is understandable. Their fiduciary duty is to maximize risk-adjusted returns for pensioners, not to serve as instruments of domestic industrial policy.
But the result is that Canada’s largest pools of long-term investment money are largely missing from the domestic growth stage in which productivity gains are actually made. The answer is not to weaken the obligation those funds have to protect retirees’ savings, but to create a dedicated growth fund — co-invested along with pension money — that absorbs enough risk to make supporting Canadian businesses a worthwhile proposition.
Meanwhile, many high-growth Canadian companies seek financing in the United States or relocate entirely — not because the talent isn’t here, but because expansion capital is scarce domestically. Cheap labour, protected markets or rising property values offer an easier return for smaller firms that only have weak incentives to invest aggressively in automation.
Governments are subsidizing the wrong end of innovation
Governments have consistently misread this dynamic. They subsidize innovation at the front end — funding research, startups and technology hubs — without addressing where the downstream capital goes. Innovation policy cannot succeed if the broader investment environment directs money elsewhere. A super-deduction helps only those firms already positioned to invest. It does nothing to shift current incentives that make investment less attractive than accumulating assets.
International comparisons are instructive. In the United States, deep venture capital markets and aggressive institutional investment funnel money toward firms capable of rapid productivity gains. In Germany and parts of Asia, industrial policy explicitly channels financing toward strategically important sectors.
But Canada relies on market outcomes shaped by tax structures, regulatory incentives and housing-driven wealth accumulation — forces that consistently favour growing assets over productive expansion. A 2025 report (pages 10-11) by the Business Development Bank of Canada shows Canadian venture capital investment as a share of gross domestic product (GDP) remained a fraction of that in the U.S.
Fix incentives, not just innovation policy
Reversing the trend does not require new technologies or another innovation strategy. It requires changing the incentives that govern where capital flows.
Consider one example — the principal residence exemption. It is among the largest tax expenditures federally and effectively makes housing the only major asset in Canada where gains are entirely untaxed. The policy made sense in a different era. Today, it reinforces the idea that residential real estate is the superior way to store wealth and fails to acknowledge that productive firms need risk to expand. Reworking the exemption even partially — such as capping it above a threshold — while at the same time reducing the effective tax rate on qualifying business reinvestments would begin to retune the signal about where Canadian capital belongs.
Canada’s “comfort trap” is stalling long-term economic growth
Besides changing tax rules, pension funds could also invest directly alongside others in growing Canadian companies. Regulatory frameworks could reduce interprovincial trade barriers and competition restrictions that quietly penalize growth. The One Economy Act nods in this direction, but inconsistent or conflicting regulations remain a substantial drag on firms wanting to operate nationwide and needing to justify investments meant to enhance output.
Productivity is not an innovation outcome. It is an investment outcome. Countries grow richer not simply because they invent more, but because they consistently channel capital toward firms that make workers more effective.
Canada has brilliant researchers, capable entrepreneurs and world-class institutional investors. What it lacks is a financial system pointed in the right direction. Fix the capital allocation. The innovation will follow.
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This article first appeared on Policy Options and is republished here under a Creative Commons license.
