Canada's small and medium-sized enterprises (SMEs) are the engine of recent economic growth, but they are not investing enough to keep that engine running efficiently. That is the core message from a new note by Scotiabank Economics, the research arm of Scotiabank, released Friday. The bank argues that if these businesses became more productive, the entire Canadian economy could see a significant boost.
SMEs—firms typically with fewer than 500 employees—produce more than 55% of Canada's economic output and employ about two-thirds of the country's workers. Yet they account for only 49% of business investment. That gap matters because investment in new equipment, software, and processes is what allows a company to produce more per hour worked, a key measure of productivity.
Why productivity matters
Productivity growth is often described as the foundation of rising living standards. When workers can produce more in the same amount of time, businesses can afford to pay higher wages without raising prices. That is why economists and policymakers watch productivity numbers closely.
Scotiabank's note points out that SMEs have delivered most of Canada's modest productivity gains in recent years. Large companies and the usual "reshuffling" of workers across firms and industries have contributed less. This is a notable shift, as large firms have traditionally been seen as the main drivers of productivity improvements.
The bank's analysis suggests that a meaningful improvement in SME productivity could raise economy-wide labor productivity by roughly 3% to 32%, depending on how widespread and deep the gains are. The wide range reflects different scenarios—from modest, targeted improvements to a broad transformation of the SME sector.
What's holding SMEs back?
Scotiabank identifies several barriers that keep small businesses from investing and scaling up. These include regulatory frictions that add costs and delays, difficulty accessing financing, internal trade barriers between provinces, and tax structures that penalize growth. For example, a small business that expands may face higher tax rates or lose certain benefits, which can discourage it from taking the next step.
The bank's conclusion is that targeted policy changes could help more small firms become big ones. Reducing red tape, making it easier for SMEs to get loans or equity funding, removing interprovincial trade barriers, and adjusting tax rules to reward growth could all encourage more investment.
What it means for investors
For everyday investors, the productivity story is not just an abstract economic concept. It has direct implications for their portfolios and their wallets.
If SMEs become more productive, the economy can grow without generating as much inflation. That is because when businesses produce more per worker-hour, they can spread the same wage and overhead costs across more goods and services. This lowers "unit labor costs"—the labor cost embedded in each dollar of output. When those costs rise more slowly, the economy can expand without pushing prices up as quickly.
For households, that means wage gains are more likely to translate into real purchasing power, after accounting for inflation. It also means interest rates may face less upward pressure than they would if growth came mainly from stronger demand with the same old capacity. Lower interest rates are generally good for stocks and bonds, as they reduce borrowing costs for companies and make future earnings more valuable.
Investors can also look at this from a sector perspective. If SMEs invest more, companies that sell equipment, software, and services to small businesses could benefit. Think of technology providers, commercial lenders, and industrial suppliers. However, the note does not single out any specific stocks, and investors should always do their own research.
The broader context is that Canada's productivity has lagged behind other developed economies for years. This is a well-known issue that policymakers have struggled to address. Scotiabank's note adds to a growing chorus of economists calling for structural reforms to boost the country's long-term growth potential.
For now, the bank's scenarios are hypothetical. But they highlight the potential payoff from getting the policy mix right. As Canada's budget faces a spending squeeze, any policy changes that could lift productivity without adding to fiscal pressure would be welcome. And with the Bank of Canada's next rate decision approaching, the productivity outlook is one factor that could influence the central bank's thinking.
In the meantime, investors should watch for any signs that SMEs are starting to invest more. That could show up in business investment data, loan growth, or earnings reports from companies that sell to small businesses. As household credit holds up and retail rebounds, the health of the SME sector will be a key indicator of Canada's economic trajectory.
Scotiabank's note is a reminder that the biggest gains often come from the smallest players. If Canada can unlock the potential of its SMEs, the payoff could be substantial—not just for the economy, but for the investors who are positioned to benefit.
