When It Comes to Investing in Innovation, It’s Government if Necessary but Not Necessarily Government

Against the backdrop of trade war volatility, discussions among Canadian economists have continued to revolve around a familiar issue: chronic underinvestment has, in large part, led to the productivity crisis the country finds itself in today. There hasn’t been enough investment in machinery and equipment, research and development (R&D) or software. Investment in non-residential structures fell when oil prices tanked in 2014 and has remained subdued ever since, despite record levels of crude production. Canada’s underperformance in business investment has been particularly striking relative to the United States (graph 1) but has lagged far behind many other advanced economies as well.

So what can be done to close this investment gap? Lack of access to financing has been an ongoing issue. For instance, most small‑ and medium‑sized enterprises (SMEs) fund investment by drawing on personal savings. Friends and family also crack the top three sources of funding, and bank loans are near the top of the list as well. However, venture capital (VC) and angel investing are much less widely used. The scale of VC investment in Canada pales in comparison to the United States (graph 2), even after adjusting for differences in population and economic size.

Government can play a role in closing this funding gap. Until recently, the federal government had what was known as the Strategic Innovation Fund (SIF). The SIF was intended to support investment in Canadian R&D, accelerate the growth and expansion of innovative businesses, attract and retain large-scale investments to Canada, and advance collaboration between academia and industry. As of mid‑February 2025, the SIF had funded 143 projects to the tune of $10.4B. However, the SIF was recently replaced by the Strategic Response Fund, which focuses on “ensuring companies in key sectors do not just survive the immediate trade pressures but pivot to grow in the face of them”—an important objective given the current circumstances but one that is very different from the mandate of the SIF. One is reactive, the other proactive.

The new focus on defence spending also has the potential to improve business investment in Canada through government procurement. The Defense Advanced Research Projects Agency (DARPA) in the United States is a well-known example of how government support for R&D can catalyze innovation. In Israel, roughly two-thirds of startups are in cybersecurity. If procurement is done wisely, Canada can leverage the substantial planned increase in domestic defence spending to support an innovation ecosystem at home.

Governments can do more to boost investment by just getting out of the way. Reducing the number and complexity of regulations would help, in addition to improving the transparency and certainty of regulatory processes. The push to lower interprovincial trade barriers is a good example. Changes to the approval process for “nation-building projects” is a step in the right direction as well but should apply to all projects, not just those handpicked by Cabinet. Making the tax code simpler, more neutral and more certain could also go a long way to supporting business investment and reducing the tax burden on companies without materially impacting government revenues. Rolling back the increase in the capital gains inclusion rate was the right decision in this regard. Now comprehensive tax reform should be near the top of the federal government’s agenda.

Finally, it’s important to recognize that innovation and productivity are not the same thing. Innovations that are widely adopted can improve productivity. And that investment is more likely to happen when innovations are cheap and of obvious and immediate benefit to businesses. For example, the Global Innovation Index 2025 determined that while Canada ranks highly in terms of inputs to innovation, it has had less success in turning these into productivity growth and other outputs (World Intellectual Property Organization, 2025 External link.). A recent C.D. Howe Institute study External link. also found that despite Canada being a global leader in artificial intelligence (AI) research, it is a global laggard in adoption. This needs to change, and governments can foster that change through tax credits, expanded training, and by ensuring academic funding is tied to applied research.

In these troubled times, government has an important role to play in encouraging business investment and improving productivity. But we can’t tax and spend our way to prosperity. Sometimes government also needs to get out of the way. To paraphrase former Canadian Prime Minister William Lyon Mackenzie King, the country’s guiding philosophy on encouraging investment in innovation should be “government if necessary but not necessarily government.”