Mediocrity Versus Excellence: The Choice Facing Canada

September 15, 1999

Dear Prime Minister,

In June, the members of the Board of Directors of the Business Council on National Issues (BCNI), known as the Policy Committee, offered you a few brief thoughts on the need to enhance the competitiveness of the Canadian economy in order to support a healthy society. We also promised to keep you up to date on the progress of our Canada Global Leadership Initiative.

Last Thursday, we met again in Vancouver to review the initiative and to exchange views on the state of the Canadian economy and its prospects in the months ahead. We would like to take this opportunity to highlight some key themes that are emerging from our initiative in the hope that this will provide constructive food for thought as your government contemplates a Speech from the Throne this autumn.

In particular, while we continue to see great potential for progress within the evolving global economy, we have to warn you that in our view, the country faces serious consequences if we do not move quickly to consolidate our strengths and to address key failings. Our central message is one of urgency. Canada has very little time to act, and the costs of inaction are likely to be severe within a remarkably short period of time.

JUST HOLDING OUR OWN

No one can dispute the enormous progress that Canada has made in recent years. As the 1990s began, we faced an imminent collision with the "debt wall" that would have devastated much of what we cherish in this country. Since then, most governments have restored order to their finances, inflation and interest rates have dropped sharply, exports have grown dramatically and we have seen a surge in both jobs and confidence.

The World Economic Forum has ranked Canada as the fifth most competitive economy in the world for the second year in a row. At the same time, the country has held the number one rank in the United Nations Human Development Index for six straight years. This is a remarkable testament to Canada’s ability to combine economic progress and social development.

That said, the world has not stood still. Canada still falls short in too many ways. More Canadians have jobs, but their real, after-tax incomes have stagnated, and the growth in our standard of living has failed to keep pace with that of our major trading partners. Setting aside measurement issues, our productivity performance has been lacklustre and our record of innovation less than stellar — both of which suggest further stagnation in incomes in the years ahead.

From the overwhelming dynamism of the United States to the relentlessly rapid progress of Australia and the stunning reinvigoration of Ireland, the world is rife with examples of other countries that have adapted to the new challenges of the global economy even more effectively than Canada. Instead, in its most recent survey of the Canadian economy, The Economist magazine concluded that Canada is just "Holding its own" — an accurate but disappointing reflection of the reality we see today. Holding our own is simply not good enough.

THE NEW RULES OF THE GAME

These are exciting times in the global economy, ones that hold much potential for Canadians to excel. But to succeed, we first must accept that the rules of the game have changed fundamentally. We cannot hope to meet the needs and aspirations of Canadians simply by using cyclical economic strength to restore old ways of doing things. That course may bring temporary relief, but in short order will leave both working Canadians and those dependent on government services even worse off. What is at stake is nothing less than Canada’s future as a vibrant economy and healthy society, one capable of charting its own course in world affairs and of providing the opportunities that all Canadians wish for their children.

The transformation of economies around the world has been led by technology. Ever more powerful computers and ever cheaper and faster telecommunications have created new industries and enabled sweeping changes in how people live, work and do business. Speed, flexibility and innovation rule the day.

Lester Thurow has said that in the new knowledge economy, "the ability to open up the new and close down the old becomes the most important ingredient of economic success". Technology gives agile new companies access to incredible opportunities in the global economy, but creates new obstacles at the same time. Existing companies, for their part, must rethink every aspect of their businesses and sometimes cannibalize past successes in order to ensure future growth. The willingness to embrace such dramatic change explains much of the extraordinary economic turnaround in the United States economy during the 1990s.

The old ingredients of success — land and minerals, trees and oil — had the virtue in Canada’s case of being stuck in place. Canada’s borders ensured that the benefits of its resources flowed to Canadians. The critical elements for success in the knowledge economy, by contrast, are extremely mobile.

Ideas now roam freely across global networks, fracturing and reintegrating with blinding speed. Capital is equally swift to seek out and take advantage of new opportunities wherever they may appear. And people with the skills to make best use of ideas and capital become, as a matter of course, global citizens able to live and work wherever they choose.

THE INNOVATION CHALLENGE

In addition to its still valuable heritage of natural resources, Canada is a good source of well-educated, creative and intelligent people, full of ideas and possessing a significant pool of accumulated capital. But where it really matters in today’s knowledge-based economy, we are still not dynamic or agile enough.

The outstanding productivity, economic and jobs growth in the United States can be traced back to the information technology (IT) sector. According to the United States Department of Commerce, IT industries contributed more than one third of that country’s economic growth between 1995 and 1998 while accounting for just eight percent of its GDP. By 2006, 50 percent of the American workforce will have jobs as either producers or users of information technology.

The Canadian economy continues to reduce its dependence on natural resources. But our manufacturing sector remains smaller overall, and our electronics and machinery and equipment sectors are both smaller and less productive than their counterparts in the United States. This has contributed to Canada’s relatively slower economic growth and to our inability to close the productivity gap.

Investment is critical to the process of innovation and therefore the catalyst for higher productivity, more rapid growth and improving job prospects. Yet here too, Canada’s performance falls short. According to Industry Canada, investment in machinery and equipment as a percentage of GDP remains some 35 percent below that of the United States. And our share of foreign direct investment is falling, both within North America and globally.

In Managing National Innovation Systems, the OECD suggests that "innovation is a key driver of long-term economic growth, the primary basis for competitiveness in world markets and part of the response to many societal challenges". Canada’s record on innovation — as embodied in spending on research and development, commercialization, domestic patent applications, and estimates of economic growth in innovative industries – is not good enough.

Your government is to be applauded for efforts to date to make innovation policy part of overall economic policy. A stable macroeconomic environment and appropriate infrastructure, education and training policies all encourage innovation. But clearly much more needs to be done, by governments, by educational institutions and by the private sector.

THE CANADA GLOBAL LEADERSHIP INITIATIVE: EARLY THEMES

When we launched this ambitious 12-month project last spring, we said that our objective was to make Canada the best country in the world in which to live, to work, to invest and to grow. We intend to develop a concise list of actions that could make a real difference in giving Canadians and their enterprises a critical edge in the global economy of the 21st century.

Since then, we have forged ahead on numerous fronts. We have recruited an outstanding external Board of Advisors. Many of the members of this board, including some of the best minds in Canada and abroad, are now engaged in a broad array of research work. This includes work related to capital markets, securities regulation, competition policy, e-commerce, entrepreneurship, issues related to small and medium-sized enterprises, productivity, corporate and personal taxation, human capital formation, education reform, the quality of the public service, the role of the voluntary sector, Canada-United States border issues, and the impact of globalization and technological change on the process of government.

While it is too early to draw any conclusions from this work in progress, some clear themes are emerging. First is that the evolution of the world economy requires Canada not merely to tinker with change, but to make a quantum leap into a new era. Second is that while this will require many changes in public policy, the most formidable and yet vital obstacle to overcome is one of attitude. And third is that while taking the right actions could leave all Canadians better off, continued complacency could have dire consequences.

CONSEQUENCES OF INACTION WILL BE SEVERE

To give an indication of where Canada is headed in the absence of any serious effort to change, it is worth revisiting the "brain drain" debate and extending it into our own experience as managers of enterprises within the global economy.

While the statistical data suggest that the absolute number of Canadians moving to the United States is relatively small, they also confirm unequivocally that Canada’s best and brightest are the most likely to leave. The latest survey of 1995 graduates shows that PhD graduates were eight times more likely than average to have moved south, and that 44 percent of those leaving ranked themselves in the top ten percent of their class. The same tendencies are clear within our experienced workforce, with tax data showing that people making more than $150,000 a year are eight times more likely than average to leave the country.

This trend is driven by more than just Canada’s high personal tax rates. If our most talented citizens are leaving in search of higher pay and greater opportunities to work on the leading edge in their field, the government must consider why these attractive opportunities are not being created in Canada. We would suggest that excessive corporate taxation plays a key role, because these are the taxes that discourage the business investment needed to spur innovation, productivity and the creation of higher-skill jobs.

Canada’s high rates of personal taxation, however, have become a critical problem for Canadian companies trying to expand their global presence. They must move promising employees abroad to gain the global experience that will be critical to effective leadership in future. Yet once such Canadians find they can have both lower taxes and a higher quality of life elsewhere, they often refuse to return, even to take up positions with greater responsibilities. Persuading foreigners with critical skills to move to Canada, especially from the United States, is increasingly difficult.

Global economic integration also is having a powerful impact on the growth strategies of Canadian and foreign-owned multinationals alike. The combination of better technology, cheaper communications and liberalized trade rules is encouraging transnational enterprises to organize their structures by function rather than geography. In such cases, Canada has the potential to gain new and expanded operations with global responsibilities, but at the same time is certain to see more regional operations diminish or disappear entirely.

In this process of restructuring, reinvention and consolidation sweeping the global economy, Canadian companies are facing a severe disadvantage. The combination of a weak currency, high corporate and personal taxation and policies and regulations that restrict growth and diminish the value of Canadian equities are leaving many major Canadian enterprises highly vulnerable to foreign takeovers. A low Canadian dollar does help exports, but it also cripples the ability of Canadian companies to recruit top talent and makes it more difficult for them to grow through acquisition rather than being acquired.

Successful Canadian-based companies will continue of necessity to grow primarily abroad. This means developing more relationships with foreign suppliers, customers and investors. They may well seek alliances, joint ventures or mergers as part of their strategies for growth, and certainly will need to base a growing portion of their workforce outside Canada. The Canadian companies that are achieving the greatest success in the global economy also face growing pressure to move key functions closer to the majority of their customers and investors.

This does not mean that Canada will see an abrupt exodus of companies fed up with their home country. There will be no convoy of Brink’s trucks heading over the Peace Bridge. But Canada does face an accelerating loss of key head office functions and the high-paying jobs that go with them.

Such transitions can take place in many ways. The most obvious, of course, one exacerbated by the low value of the Canadian dollar and the lower valuations assigned by global markets to Canadian equities, is outright acquisition and integration by foreign buyers. Mergers and alliances also provide a path toward greater scale for Canadian corporations, but may involve a relocation of executive offices to another country. And in some cases, a Canadian company’s very success in expanding abroad may lead to a significant shift of senior managers.

Recently announced acquisitions, mergers and strategic decisions demonstrate that this process already is underway, and based on the early work of the Canada Global Leadership Initiative, we believe that many more such moves are possible in the months and years ahead.

If this trend does accelerate, the costs to Canada will be considerable. Head offices represent far more than a source of well-paying jobs and career opportunities. They play a key role in making decisions that affect economic growth, in nurturing new enterprises and helping them onto the world stage, and in supporting vibrant and strong communities.

As the chief executives of major enterprises in Canada, we want this country to succeed. We want Canada to be the home of choice for world-beating enterprises. We want to help Canada grow, to contribute to our communities and to give our children access to global opportunities without forcing them to leave home for good. But there are powerful and growing forces at work today that are affecting career decisions and corporate strategy alike. If Canada wants to reverse these trends, it has very little time left to act. By the time the costs become obvious, it will be too late.

FINDING THE RIGHT BALANCE

We agree with the conclusions of the OECD’s latest annual report on Canada, which said that the federal government should give the highest priority to cutting personal taxes, should accelerate reductions in Employment Insurance premiums and should work with the provinces to lower business taxes. But we want to make perfectly clear that there is more to meeting the challenge facing Canada today than cutting taxes.

A substantial and early reduction in Canada’s excessive tax burden on both corporations and individuals is needed urgently. But lower taxes must be part of a broader strategy to stimulate innovation, productivity, competitiveness, employment and incomes. The challenges ahead demand collaboration and creative thinking, and it is unfortunate that so much of the policy debate has been oversimplified into a confrontation between tax-cutters and big spenders.

The BCNI intends to make specific policy recommendations in a number of areas in the months ahead as it proceeds with the Canada Global Leadership Initiative. At this stage, however, we would underline a more basic concern. Even more threatening than any given policy is Canada’s ambivalent attitude toward success.

Canadian policy makers profess to seek the goal of more and better job opportunities and higher incomes for Canadians. Yet both existing policies and discussion of alternatives are consistently tinged with suspicion and mistrust of any people or enterprises that do excel. High incomes are a source of envy rather than celebration. Winning a lottery is tax free, while capital gains from investment in a successful high-risk business venture face punitive levels of taxation. Past a certain size, corporate growth is something to be curbed rather than encouraged.

Success at both the personal and corporate level should be an aspiration to be nurtured, a goal to be encouraged and an achievement to be celebrated. Instead, it seems to be a vaguely embarrassing anomaly that should be taxed until it goes away. The future of our economy and the quality social programs that it supports depend on changing that attitude. If we want to offer our citizens first-class education, top-notch health care and an effective safety net, we have to recognize the critical role played by successful individuals and their enterprises.

There is no doubt that excessive taxation discourages entrepreneurial energy and undermines the incentive to innovate and to improve productivity. But it also does great damage to Canada’s brand abroad, tarring this country as an unfriendly and unproductive place to invest.

ACTION TODAY, A FRAMEWORK FOR TOMORROW

We urge you and your government to move as quickly as possible to address those issues where the required policy changes are obvious. In particular, we recommend that you use the forthcoming Speech from the Throne and that the Minister of Finance take advantage of the autumn fiscal update to lay out a commitment to an ambitious multi-year objective for tax reduction and a framework for making progress toward that goal.

We fully support your desire not to permit the government’s finances to slip back into deficit and we repeat our support for continuing reduction in Canada’s excessive burden of public debt. We accept that making firm commitments to specific tax reductions more than two years out involves an unacceptable degree of risk. But we believe that it is realistic to set an overarching goal and lay out a plan for achieving that goal.

A year ago, we recommended a seven-year framework for tax reduction that would cut personal taxes by about 20 percent in addition to significant reductions in Employment Insurance premiums and corporate taxation. Because growth has exceeded the very conservative projections we used last year, it now seems likely that this degree of progress could be achieved within the next five years. The government also should be able to bring Employment Insurance premiums down to a break-even level within the same timeframe.

Based on our estimate of the likely surplus in the current fiscal year, there is likely to be room for about $5 billion in fiscal measures in the February 2000 budget provided that the government resists the temptation to engage in expensive new spending programs. Our preliminary recommendations for this next stage in tax reduction are attached, and we will update them closer to budget day as the fiscal situation becomes clearer.

But the specific measures that you and your government choose to adopt in the next budget are less important than the context in which you frame them. A credible commitment this autumn to a significant reduction in the tax burden would enhance substantially the immediate impact on consumer and business behaviour. It would therefore accelerate economic growth and generate additional revenues that would in turn reduce the effective cost of the tax cuts to the treasury. It would reinforce the scale and perceived benefit of the cumulative reduction in the minds of taxpayers. And it would bolster the reputation of Canada and its government abroad as being committed to fiscal responsibility and to creating an attractive environment for investment, innovation, entrepreneurial activity and economic growth.

COMMITMENT TO A BRIGHT FUTURE

We have been blunt in discussing the challenges facing Canada and the urgency of taking substantive action to address the country’s shortcomings. But we firmly believe that the obstacles we face can be overcome. If Canada works conscientiously to consolidate its advantages and eliminate those disadvantages within its power, we can make this country a uniquely attractive place for all Canadians of this generation and the next to grow, to prosper and to achieve their aspirations.

It is worth noting that in the past, the BCNI has been forced to recommend policy directions that, while necessary for the good of the country, also involved painful medicine. Those past sacrifices now make it possible to set as a shared goal today measures that will build a higher standard of living and a better quality of life for all Canadians. But the choices Canada makes within the next one or two years will determine whether we slide irrevocably toward mediocrity or succeed in building a truly excellent future together.

Prime Minister, it is in this spirit of fundamental optimism and potential collaboration that we have laid out our thoughts today. We hope that you see our comments as both provocative and constructive, and we thank you for this opportunity to renew our continuing dialogue.

Sincerely,

On behalf of the Board of Directors,
Business Council on National Issues