Head Offices and Innovation: Competing for Well-Paid Jobs in Services

January 29, 2008

Thank you for the opportunity to appear this morning as part of this Committee’s investigation into the challenges facing Canada’s service sector.  This covers a vast range of jobs in the public, private and non-profit sectors, but I will focus my initial remarks this morning on two specific types of highly skilled and well paid work: head-office jobs and those involved in research and innovation.

The subject of head offices came to the fore last year as a result of the foreign takeovers of several major Canadian enterprises.  These transactions revived fears in some quarters of a potential “hollowing out” of Canada’s head offices.  As a CEO-based organization, the Canadian Council of Chief Executives believes strongly that head offices matter a great deal to the wellbeing of all Canadians, and we decided to dig deeper into the issue of head-office jobs and how Canada could be more effective in attracting such work.

The first point I would make is that where a company’s shares are owned, does not necessarily determine where it decides to set up centres of high-level decision-making.  Many of the Canadian subsidiaries of foreign-based multinationals function as centres of leadership with North American and even global responsibilities.   By the same token, Canadian-based companies tend to expand their range of management jobs located abroad as they move into international markets and recruit talent globally.  In other words, Canada has to compete to be a preferred location for head-office jobs within Canadian and foreign firms alike. 

Last year we carried out a detailed survey of our member CEOs on the issue of mergers and acquisitions and on how companies decide where to set up head-office activities.  The responses indicated two dominant drivers.

The first is tax policy.  The economic evidence on corporate taxation has been clear for years: high corporate taxes simply don’t pay.  This is a critical issue for all companies in the service sector, because Canada’s current corporate tax structure is heavily biased against services.  Given the current crisis in manufacturing, it is understandable that policy makers want to focus in the short term on how to retain jobs in that sector.  But Canada will be counting on services to provide the bulk of its future job growth, and its tax system actively discourages investment in this area. 

The C.D. Howe Institute has noted that in the service sector, Canada has the second highest marginal effective tax rate on new business investment in the industrialized world, behind only the United States.  Even high-tax jurisdictions such as Sweden understand the importance of tax policy to business investment.  Despite an overall tax burden higher than Canada’s, Sweden’s effective tax rate on business investment is 42 percent lower than ours — and less than half the rate that applies to the service sector in this country.

When it comes to attracting head-office jobs, personal tax rates also come into play.   It is true that individuals thinking about where to live and work take many factors into account that contribute to their overall quality of life.  But people with high skill levels who can earn high incomes anywhere in the world undeniably focus on what they can buy with their after-tax incomes.  As the C.D. Howe Institute put it in its submission to the Competition Policy Review Panel: “Policies that enable companies to pay high gross incomes, and personal income taxes that leave a larger share of those gross incomes in the pockets of the people that earn them, are a key source of competitive advantage for a jurisdiction that seeks high-value business activities.”

Let me turn now to a second, very different issue that also has a huge impact on decisions about whether to locate head-office jobs in Canada.  The fact is that senior executives of large companies must travel a lot.  They must manage operations, build relationships with customers and deal with investors.  The reality for growing Canadian companies is that many of these employees, customers and investors are in the United States, and the time it takes to travel plays a major role in where a given executive wants to live.

At one level, this reinforces the importance of efficient airports with good connections.   But the broader issue for Canada is the efficiency of its border with the United States.  Our country has been working hard since the terrorist attacks of September 11, 2001, to ensure that our neighbour’s understandable focus on its own security does not impede legitimate traffic across the border for people or goods.  My organization has been in the centre of these efforts, most notably through our role as the Canadian secretariat to the North American Competitiveness Council.  But the fact is that despite strong cooperation and development of new technologies, crossing the border is frequently a major hassle.  What is more, the gradual implementation by the United States of its Western Hemisphere Travel Initiative, which is scheduled to include a requirement for a passport at land crossings by mid-2009, seems likely to make border delays worse.

A Canada-United States border that creates regular delays for business travelers provides a powerful incentive for top executives to live on the same side of the border as the bulk of their operations, customers and investors.  For expanding Canadian companies as well as foreign multinationals looking at where to locate North American responsibilities, that means looking south rather than north.  We may never eliminate all risk of border delays, but the worse the picture looks at the border, the harder we will have to work on other fronts to attract top jobs to Canadian communities.

Before closing, let me address the other source of high-value work that I mentioned at the outset, research and innovation.  We know that business investment in innovation is a fundamental driver of a more competitive and prosperous economy, but by at least one key indicator, business expenditure on research and development, Canada’s record is mediocre at best.

Last year, our Council therefore agreed to launch a joint project with Industry Canada.  The first phase of this project was a CEO-level survey to dig deeper into what drives company decisions in this area.  In particular, it asked what factors encourage companies to invest as much in innovation as they do, and what prevents them from doing more.  And it asked what factors matter most when companies decide whether to invest in innovation in Canada or elsewhere — and how well Canada is doing by those criteria.

The survey confirmed that intense competition is the most important driver of innovation, but its evaluation of Canada’s strengths and weaknesses was sobering.  CEOs applauded Canada’s strong pool of talented people and its high quality of life.  But they said its two greatest weaknesses are its regulatory environment and its treatment of intellectual property — the true currency of the knowledge economy. They also rated these two factors as the ones that matter most when companies decide whether to invest here or in other countries.  

The result is stark.  When asked about their companies’ intentions over the next three years, most CEOs said their investment in innovation in Canada would likely remain flat.  And most of the companies that do plan to increase innovation spending significantly say they will make those investments outside Canada.

To conclude, we believe that jobs in head-office functions and research are a critical source of Canada’s future growth and prosperity.  The competition for such jobs is fierce.  And if Canadian communities want to do a better job of attracting both the necessary business investment and people, there are some key policy levers that matter most: competitive personal and business taxes, an efficient Canada-United States border, and an effective regulatory system that speeds the process of innovation.