Experts have long assumed that the solution to Canada's decade-long productivity slump is to get companies to innovate and invest more, typically via tax incentives.
But new research, by independent economist Someshwar Rao and Jiang Li of the University of Victoria, suggests it's a much broader problem.
The real productivity killer, they argue, is weak demand for everything that Canada produces.
Fully 93 per cent of the huge drop off of productivity in Canada from 2000 to 2012, compared with the 1990s and 1980s, can be traced directly to a drop in after-inflation GDP growth, according to a study to be published Tuesday in the fall issue of the International Productivity Monitor.
Productivity grew an average of only 0.8 per cent per year from 2000 to 2012, nearly half the rate of earlier decades and well below U.S. gains.
Productivity is regarded as the best barometer of economic health because it drives wages and incomes.
"You can't increase productivity growth unless you address weak demand growth," explained Mr. Rao, a former top economist at the Economic Council of Canada and Industry Canada, and one of the country's leading productivity experts.
"Since we depend on trade so much, we are impacted not just by the slowdown in the domestic market, but also by the demand in our export markets."
In the past decade, exporters have been stung by the surging value of the Canadian dollar as well as the stalled European and U.S. economies.
The bad news for Canada is that it is going to be very tough to improve the country's productivity performance in the years ahead as the global and Canadian economies head into a slow growth environment.
Mr. Rao said productivity growth is likely to remain below 1 per cent a year for the foreseeable future.
That's because the economies of Canada's key export markets are sluggish, including, the United States, Europe, Japan and East Asia.
That means weak incomes for workers, depressed government tax revenues, and less money for social programs, the study concluded.
There are the key policy lessons from the research, according to Mr. Rao. One is to make sure governments do not move too radically to reduce debts and deficits because that could hit growth, which in turn will kill productivity growth.
Second, Canada should diversify its export markets to large and fast-growing economies, such as China, India, Brazil, Indonesia and South Africa.
And finally, Mr. Rao said governments should drive demand by focusing on productivity-enhancing investments, including roads, buildings and telecommunications infrastructure.
The whole demand-side of the productivity conundrum has been overlooked for too long, said Andrew Sharpe, executive director of the Ottawa-based Centre for the Study of Living Standards, which publishes the International Productivity Monitor
"It's a very important part of the story that's been neglected in the productivity debate, because we are always focused on supply side – R&D, investment in information technology and such. That's important, but if you don't have the demand to realize that potential, then everything you do on the supply side won't have the full impact," he said.
The bottom line is that Canada needs a buoyant economy before it can invest in new equipment, technology, human capital and innovation, according to Mr. Sharpe.