Issues with regulatory structures limit the growth of productivity in financial services, experts say
Canada’s economy is falling far behind its peers in terms of productivity, but its financial-services sector can play a major role in driving the economy.
In a new commentary from C.D. Howe, Policy Analyst Farah Omran and Associate Director for Research Jeremy Kronick stressed that when it comes to productivity growth — a key ingredient for long-term sustainable growth for advanced economies — Canada has lagged many other countries in the Organisation for Economic Co-operation and Development (OECD) for the past 15 years.
“Moreover, the contribution of the financial services sector to this productivity growth has been underwhelming,” the two wrote.
Using the OECD’s measure of industry contribution to productivity, they found that Canada’s financial space falls in the middle of the pack from 2001-2017, accounting for 0.18% of the country’s economy on average over the period. It fell behind countries to which it is often compared, including Australia (0.45%), Norway (0.27%), and Sweden (0.20%).
However, financial firms may hold significantly more potential than their performance suggests. Omran and Kronick noted that the financial sector employs proportionately more people with post-secondary and postgraduate education than other parts of the Canadian economy; it also includes more intellectual property and information technology as part of its non-financial capital compared to the overall economy on average.
“At the same time, the financial services sector promotes growth and productivity within other services that are complementary (such as accounting) or that serve as inputs (such as communications), which are similarly skilled-labour intensive,” they added.
Part of that limited potential is due to regulations surrounding the fintech space.
“[Lending fintechs] often face regulations that are similar to those of their traditional bricks-and-mortar counterparts, although they might pose a different, often lower, level of risk to the overall stability of the financial system,” they said. Payments fintechs have fallen through the legislative cracks as regulations often focus on traditional payments service providers.
Canada is also hampered in its ability to attract foreign capital. Based on net foreign direct investment inflows, they said that Canada lags behind Australia, the United States, the Netherlands, and the United Kingdom.
“Canada continues, however, to be significantly more restrictive with respect to FDI than are many of its counterparts, mainly due to stringent screening mechanisms on foreign acquisitions that require the investor to show a net benefit to Canada, as well as restrictions on equity ownership,” they said.
Canada’s financial system could also stand to improve the efficiency of its credit and equity financing, as it ranks last among the OECD countries sampled in terms of small business lending as a share of total business lending. It also falls near the bottom in overall business and small business lending as a percentage of GDP, and shows the largest spread between interest rates on loans to SMEs and those to large firms.
Omran and Kronick suggested that policymakers should consider deepening Canada’s capital markets beyond domestic bank debt financing, particularly when it comes to SMEs. They also argued that while small businesses and start-ups already make use of private equity financing, there should be “a suite of policies aimed at enhancing investment opportunities in Canada, as well as creating an environment for deeper, more patient equity capital.”
