The Canada We Want in 2020

View/Download the PDF: Event summary – Innovation and Productivity

Introduction

On February 23, 2012, Canada 2020: Canada’s Progressive Centre hosted the second in our series of panel discussions based on The Canada We Want in 2020: Towards a Strategic Policy Roadmap for the Federal Government, a collection of policy essays we published in November 2011.  This panel centered on the topic of increasing Canada’s poor innovation performance and productivity growth.

The innovation and productivity discussion featured the following four speakers (in the order that they spoke):

Kevin Lynch, Vice-Chair, BMO Financial Group

• Peter Nicholson, Inaugural CEO, Council of Canadian Academies
• Lawson Hunter, Head, Competition/Anti-Trust, Stikeman Elliott
• Jim Stanford, Economist, Canadian Auto Workers

Kevin Lynch, Vice-Chair, BMO Financial Group

Kevin Lynch led off by framing productivity and innovation as a competitiveness issue (and questioning whether competitiveness today is achievable in the same was that it was in the past).  In Lynch’s view, innovation is the key source of productivity growth, which is, itself, the key to competitiveness. Lynch defined competitiveness as the ability of a country’s companies to sell goods and services around the world while maintaining and increasing standards of living at home.

Unfortunately, Canada has a serious productivity deficit, which has deepened over the past three decades.  Today, as Lynch pointed out, Canada’s productivity is only 72% of the level in the United States, and Canada places 20^th in the OECD for R&D spending (a rough proxy for innovation performance), down from 15^th a few years ago.  This is largely because the Canadian business sector spends a meager 1% of GDP on R&D (Canada’s government spending on R&D is favourable among OECD countries).  And, it is well established that Canadian business spends much less than the US does on productivity-enhancing investments in machinery and equipment (M&E) and information and communications technology (ICT).

Given these rather dismal statistics, Lynch posed the fundamental question: “how can we be competitive in the long term if we spend so much less than other countries on the things that are supposed to make business competitive?” He suggested part of the reason for the poor rate of business investment in productivity related capital is the result of an “innovation illusion” in this country.  Lynch pointed out that in the recent General Electric Global Innovation Barometer survey, 91% of Canadian business executives surveyed thought the reputation of Canadian business was good or very good on innovation, yet only 3% of business people from outside Canada agreed with that assessment.

In Lynch’s view, Canadian business is not figuring out new ways to do things as fast as our competitors — in other words, they are not very innovative.  Furthermore, he believes that the solutions to Canada’s innovation dilemma are by no means a problem for governments alone.  Yet Lynch does see the federal government as having a clear role to frame the public debate on productivity and innovation and provide “an enabling policy environment”.   According to Lynch, governments need to play a convening role and set aspirational goals, but business needs to step up to the plate and invest to increase productivity and innovation.

Lynch did suggest one specific area of federal policy that may need more work. This is competition policy — including more trade agreements — which helps determine whether Canadian firms are exposed to the full forces of global competition (which should drive productivity improvements).  He also pointed out that business financing remains a problem in Canada, and in particular that Canada has a weak venture capital industry, implying there might be a need for government to do more in this area.  Consistent with the recent report of the Jenkins Panel on federal R&D programs and tax incentives, Lynch believes that the federal R&D policy mix is too reliant on tax incentives (i.e. the Science, Research and Experimental Development Tax Credit (SRED)).  Lynch also pointed out that while Canada does relatively well on basic research output, we urgently need to find ways to enhance the commercialization and marketing of research, which remains weak.

Peter Nicholson, Inaugural CEO, Council of Canadian Academies

Peter Nicholson focused his remarks on an area that is almost never discussed in Canadian productivity debates: the importance of the public sector’s productivity performance.  He pointed out that the public sector is the biggest “industry” in this country, accounting for one quarter of GDP ($450 billion).  Given its scale and reach, policies in the public sector profoundly touch every aspect of society as well as set the context for the business sector.  If business innovation is important, an innovative public sector is at least as important, in Nicholson’s view.

Yet the irony is that governments have obsessed over business sector innovation and productivity for many years while totally neglecting the public service innovation agenda.  Nicholson pointed out that the recent report on reforming Ontario’s public services, chaired by Don Drummond, held out the aspiration for Ontario to have the best public services in the world.  Achieving this ambitious goal will require significant improvements in innovation and productivity in the public sector.

Nicholson stated that part of the problem with any drive to improve public service productivity is that these services are usually not subject to the discipline of private markets.  It is also inherently difficult to measure the productivity of most public services and apply private sector management techniques to them.  Another problem with improving public service productivity is that the internal incentives in government are the opposite of what is needed to induce innovation and productivity. Nicholson believes that governments have created an overly risk averse public service culture that is hobbled by an excessive accountability regime.

Reflecting the Drummond Report, Nicholson argued that a genuine commitment to increasing public service productivity is the only way of achieving fiscal sustainability without compromising public services.  Canada needs, in his view, a much more innovative, efficient and productive government to tackle a series of major, structural issues, which include:  finding a fiscally sustainable way to deliver public healthcare to an aging population; finding a way to re-design education for the information age; building a modern infrastructure; and designing innovative regulation that protects the public interest without stifling business innovation.

One specific public service area Nicholson singled out for productivity improvement is the diffusion of best practices in healthcare.  For this he advocated applying to the health sector a variation of the agriculture representative model that revolutionized agriculture productivity in the last century.  He also argued that Canada needs a new model to teach “digital natives” how to develop the critical faculties necessary to function in an information intensive culture. He argued that this requires a new R&D program for education, perhaps funded through a Canada Foundation for Innovation in Education.

In the final analysis Nicholson made a strong plea for governments to focus on innovation in their own backyards as much as on trying to get the private sector to innovate.

Lawson Hunter, Head of Competition/Anti-Trust, Stikeman Elliott

Lawson Hunter approached Canada’s productivity and innovation challenge from a regulatory standpoint.  Like Nicholson, Hunter argued that the federal government needs to lead by example on innovation, and he sees that example lying in the federal government’s regulatory function.

Hunter claimed that despite significant deregulation in the late 80s and early 90s, Canada still has a significant regulatory burden and the federal government clings to an outdated regulatory paradigm.  Citing an OECD study, Hunter claimed that if Canada were to have adopted the least restrictive regulations of the OECD countries surveyed, Canada’s average productivity growth would have been 0.75% higher per annum over the period 1985-2003.

Hunter singled out agriculture supply management as an example of anachronistic regulation that stifles productivity and innovation.  Remaining foreign ownership restrictions that apply in some sectors, such as communications, are another example of regulations that prevent Canadian firms from building the scale that can lead to better innovation and productivity performance.

He advocated a new regulatory paradigm that puts business innovation and productivity at its core. In his view, now would be an opportune time to do this, for two reasons. First, it has been decades since a fundamental review of federal administrative law and regulatory functions has taken place.  Second, changing the regulatory system to make it much more “self limiting” would put an end to the disruptive departmental reviews that take place periodically (one of which will be presented in the March 2012 budget).

Any new regulatory paradigm needs to seek to hold what Hunter called “regulatory creep” in check.  Most regulations are imposed under statutes that delegate to the executive broad authority to regulate in the public interest. This has led to regulatory creep.  Our current model, in Hunter’s view, should be replaced by a “standards based approach” to regulation that would eliminate unnecessary and outdated regulations.  The so-called “Oakes test” could form the basis of this framework.  This would require any regulation to have a clear and pressing objective, be proportionate to that objective, intervene to the minimum extent necessary to meet the objective, and meet a cost-benefit test.  In Hunter’s view, such a change would bring much-needed rigour to the regulatory process.  It should be supplemented with an effective legal review mechanism.

In closing, Hunter made a plea for the federal government to re-set the regulatory agenda such that it would have a meaningful impact on business productivity, would limit market distortions, and would vigorously promote competition.

Jim Stanford, Economist, CAW

Jim Stanford challenged conventional economic thinking on productivity, embodied in the Macdonald Commission report of the mid-1980s.  He pointed out that since governments began implementing elements of this report, Canada has seen a relative productivity growth decline vis-à-vis the US (from about 90% of US levels to around 70% now).  He argued that the Macdonald Commission paradigm — which rests on free trade, open markets, de-regulation, balanced budgets and lower taxes on income and capital — has not produced the promised productivity gains, quite the opposite in fact.  Thus unconstrained competition and deregulated markets might not, in Stanford’s view, be the optimal policy approach.

He then addressed some of the unique structural features of the Canadian economy that could militate against strong productivity growth.  Notable amongst these are resource-dependence and the disproportionate role of small firms in Canada’s economy.  He also claimed that free trade and globalization have hurt Canadian productivity growth.

Stanford argued that the countries that are currently growing fastest have not embraced the deregulated competitive market model (e.g. emerging markets or BRICS, and continental Europe, especially Germany and Scandinavia).  His basic point is that we have been gripped by the notion that free markets deliver productivity, but in Canada the evidence shows otherwise.  As a result we need to challenge that core assumption of economics.  Stanford favours the “developmental state theory”, where markets are pushed and constrained to do the most efficient thing.  Instead of targeting the residual free market barriers to improve productivity — as Hunter and Lynch argue — we should be challenging the starting assumption that free markets are the key to productivity.

Stanford also argued that we need to constrain and regulate the path of resource development in Canada, especially petroleum resources, and that governments should curtail foreign investment, especially in resource industries.  Proactive sector strategies that build tradable innovative industries, with high wages and high capital investment are needed.  He also suggested we need to manage exchange rates instead of accepting “Dutch Disease” as an inevitable feature of our resource endowments.

Discussion

Following the four presentations, there was a lively discussion moderated by Don Newman, Canada 2020 Advisory Board Chairman. Questions came both from the floor and via Twitter.  Below are some of the key points made in the discussion:

• In response to Stanford, Kevin Lynch argued that in the 1980s and 1990s Canada was converging towards US productivity performance by adopting better methods and because our private sector was integrating more. However, more recently, the US has gone through productivity and innovation waves that Canada has not experienced, and this explains the widening productivity gap between Canada and the US.
• Lawson Hunter made the point that there is too much rent-seeking going on in Canada due to regulation.  In response to Stanford’s criticism that deregulation has not proven to drive productivity, Hunter noted that he is not calling simply for deregulation but also regulating differently and better.
• Providing some further historical context, Peter Nicholson pointed out that productivity growth has been a problem in Canada for decades and on innovation measures we have never done particularly well.  For him, this is a signal of an innovation deficit, which has been a continuous feature of the Canadian economy for as far back as we have data.
• Reflecting one of the central arguments in The Council of Canadian Academies 2009 report, Innovation and Business Strategy: Why Canada Falls Short, Nicholson pointed out that Canadian business has been able to succeed without being very innovative, because our companies have been on the upstream of highly integrated North American value chains.  This produced a unique industrial structure where most of the innovation was done for Canadian business in the US.  In Nicholson’s view, Canadian firms have always been good “plant floor innovators”, but have never been good at the kind of innovation that is at the core of business strategy.  The incentive structure in the Canadian economy has been such that Canadian companies could do well without being innovative, thus “under-investing” in productivity enhancing technologies and in skills has actually been the rational thing to do for many firms and sectors.
• Further developing his argument for a more activist industrial policy, Jim Stanford singled out the Auto Pact is an example of an interventionist policy that worked and that built a vibrant strategic sector of the Canadian economy by typing “free trade” to investment and production commitments from firms.
• Kevin Lynch made the argument that a low dollar in the late 1990s and the first decade of the 21^st century played a big role in holding back productivity.  In his view it was not rational for companies to spend on new equipment, on R&D and on talent when they had such a competitive advantage due to the exchange rate.  A dollar at or near parity — which has been a feature of the Canadian economy for several years now— should help fix this problem, in his view.  Jim Stanford countered this and pointed out that the data shows capital investment spending was actually stronger when the dollar was low.
• Lynch also claimed that Canada is too afflicted by “Quarterly Capitalism” or the “Myopia of the Moment”, which militates against making the necessary longer-term, productivity enhancing capital investments.

Conclusion

All panelists agreed that Canada’s productivity growth and innovation performance are woeful and have been in this state for a considerable period of time.  The panelists also agreed that this is a fundamental problem that we must fix or our standard of living will be (and is already being) negatively affected.

Where they differed was on the sources of Canada’s productivity and innovation deficit.  That said, both Peter Nicholson and Jim Stanford singled out the unique industrial structure of the Canadian economy — although they emphasized different dimensions of that structure — as being a big part of the reason for slow productivity growth and poor innovation performance, especially relative to the U.S.

Hunter and Stanford agreed on little else than that there remains a significant role for targeted federal action (through public policy and regulatory/de-regulatory policy) as a means to improve business innovation, though their prescriptions are polar opposites of one another.  Kevin Lynch suggested we may have reached the limits of targeted federal public policy on productivity, and that the role of the federal government going forward should be to focus more on educating Canadians about the problem and on goal-setting.

Although Peter Nicholson’s presentation focused on public sector productivity, in the discussion period he supported elements of both the Hunter and Stanford approaches, i.e. a new regulatory paradigm aimed at improving productivity, and perhaps some targeted industrial policy to help build innovative sectors, as the federal government had done decades ago.

Overall, the panel discussion suggested that a significant role for the federal government in the country’s productivity and innovation realm remains as necessary as ever, if not even more urgent.

The Canada 2020 View

Canada 2020 concludes from this discussion that we may need a “made-in-Canada” policy model to overcome what seem to be some strikingly unique features of the Canadian economy and industrial structure.  Importing theoretical models or general purpose prescriptions from other jurisdictions —as we have tended to do over the last quarter century — is probably insufficient to overcome the particular features of the Canadian productivity and innovation dilemma that are to a large degree a by-product of Canada’s industrial structure, economic history and proximity (both geographically and culturally) to the United States.  The federal government needs, therefore, to adopt a flexible policy approach and regime that blends elements of the more conventional Macdonald Commission paradigm, with elements of a more activist and targeted industrial policy, focused on some key strategic sectors where the potential productivity and competitiveness pay-offs are greatest.