No Time to Lose, so Much to Gain: Accelerating the Innovation Agenda

April 12, 2002

At your meeting with members of the Canadian Council of Chief Executives in Montreal on April 9, 2002, you expressed a strong desire to reinforce the Innovation Strategy outlined by the federal government in February. You acknowledged the importance of robust economic growth in maintaining and improving the quality of life of Canadians and to this end, you asked members of the Council for specific advice on actions that could be taken in the short term that would make a real difference in improving the environment for business and economic growth.

While last year’s economic slowdown appears to be giving way to recovery, the war on terrorism did force the federal government to shift priorities in the December 2001 budget and defer consideration of many promising ideas for improving Canada’s competitiveness. Neither the economic cycle nor periodic crises, however, need deflect Canadians from a continuing and shared commitment to innovation, and we see much that Canada can and should do to accelerate progress even in the short term.

Today, we would like to offer some initial thoughts in this respect, to highlight some key areas for rapid action that we think warrant more detailed examination in the months leading to the government’s planned National Summit on innovation this autumn.

ECONOMIC AMBITION IS THE KEY TO SOVEREIGNTY

Two years ago, the members of what was then known as the Business Council on National Issues warned that Canada stood at a crossroads. As we wrapped up the first phase of our Canada Global Leadership Initiative, we expressed great confidence in Canada’s ability to become "the best place in the world in which to live, to work, to invest and to grow." But in a statement entitled Global Champion or Falling Star: The Choice Canada Must Make, we said that if Canada failed to match its strategies to the accelerating pace of global change, it would fall short in meeting the economic and social goals that Canadians share.

Our message was widely seen at the time primarily as a call for major tax cuts. While we did see tax cuts as a precondition for rapid progress, our focus was in fact on the vital role of innovation in every sector of our society, on the need to be leaders rather than followers, both as enterprises and as a country. We therefore were impressed by the ambitious goals laid out by the federal government in its innovation strategy and we congratulate you and your department for the paper Achieving Excellence: Investing in People, Knowledge and Opportunity. Its conclusions show clearly that we and the government now share a real sense of urgency about the need to improve Canadian productivity and competitiveness.

As Achieving Excellence makes clear, the Council and the federal government agree that Canada has a strong foundation for growth, that Canadians can stand tall within an open global economy and that it is time to push our collective efforts to a new level. We also agree that without vigorous action to move forward, Canada risks an outflow of talent and capital that could reduce the standard of living and quality of life of all Canadians. As you observed in unveiling the innovation strategy, it is only by creating an environment in which Canada’s best is also the world’s best that we will be able to "make our own decisions, for our own future, in our own way. And that is the true meaning of sovereignty."

We would extend this observation by applying it to the private sector. It is only by ensuring that Canada’s best companies are also among the world’s best that Canadians can prevent what has been called the "hollowing out" of our economy. Whether through foreign takeovers or as a result of the global growth strategies of Canadian enterprises, a significant number of our country’s head office jobs have been migrating abroad. These decision-making jobs are important not just for the salaries and tax revenue they generate directly, but for their impact on everything from growth opportunities for smaller businesses to the health of the voluntary sector in Canadian communities. Any successful strategy for maintaining Canada’s economic sovereignty therefore must include a focus on attracting and retaining the decision-making jobs that accompany the head-office operations of globally competitive companies.

We would emphasize that the nationality of ownership is not the issue here. Canadian and foreign firms operating multinationally face similar pressures in forming their strategies. What matters to Canada is the extent to which companies and their decision-makers see this country as a compelling location for operations serving the North American and global market.

Innovation is driven by global engagement, by exposure to the relentless worldwide competition for ideas, people and capital. In order to compete effectively within the global economy, Canada must welcome international flows in both directions. But as industries consolidate worldwide, size has become increasingly important. Too often, restrictions within Canada have left Canadian companies unable to seize important opportunities for growth and turned them into sellers rather than buyers. If Canada is to become the home of choice for competitive global enterprises, we must enable our companies to achieve the size and stature needed to compete on the global stage.

Your department’s discussion paper has identified many of the key goals and targets that Canada will have to meet in order to fulfill bold ambitions for economic prosperity and sovereignty. In particular, we agree on the need to continue ramping up investment in research and development and to ensure that more of the ideas developed in Canada evolve into successful enterprises serving the global market. We agree on the goal of developing the most skilled labour force in the world by increasing the supply of graduates with advanced degrees, by modernizing the immigration system and by branding Canada as a destination of choice for skilled workers. We support the government’s desire to see the evolution of new clusters of innovation in communities across Canada.

We also recognize that an ambitious agenda requires resources. The government has worked hard to forge ahead with its innovation agenda despite the economic slowdown and the demands of the war on terrorism. Fiscal constraint, however, is no excuse for inaction. As you observed during our meeting this week, "drift is not neutral." Innovation is a process driven by a burning desire to do better, and a period of tight resources should be a time to focus even more urgently on how to make the most of what we have.

We see many opportunities for innovative policies to make a real difference even without the ability to commit significant new resources. Today, we would like to put on the table some preliminary thoughts on where the federal government could boost the impact and momentum of its innovation strategy even in the short term.

CREATING GLOBALLY COMPETITIVE CANADIAN INDUSTRIES

Canadians have good reason to be proud of our country’s progress to date. Despite the unexpected fiscal demands of the past year, the federal government is still on track for continuing budget surpluses. Inflation remains firmly under control as increased competition has pushed consumer prices lower in many sectors. Tax rates have come down significantly as well, leaving families with more to spend and businesses with more to invest. Canadians continue to sell more to the rest of the world than we buy, leaving both our current account and merchandise trade balances comfortably in surplus. And the Canadian economy has become significantly more diversified, with natural resources now accounting for less than 30 percent of all exports.

We are confident that Canadians can overcome the challenges that lie ahead, but past progress is no guarantee of future prosperity. To ensure that Canadians continue to enjoy their superb quality of life and a rising standard of living, we need to work together intensively in building a steadily more competitive economic base.

Canadians trying to build globally competitive enterprises still face a daunting range of impediments that flow from public policy. The many tax breaks and regulatory exemptions for small business, for instance, help entrepreneurs to survive but can be a significant barrier to rapid growth. For their part, Canada’s largest companies tend to be relatively small players on the global stage, and yet can find their ability to grow hampered by competition policy and other regulatory measures that focus on Canada’s modest market. In some sectors, governments limit the growth of Canadian enterprises either through direct ownership or by imposing restrictions on the private ownership of corporate shares. And across a wide range of issues from environmental approvals to corporate mergers, Canadian enterprises are subject to staggering uncertainty and costs through complex and lengthy regulatory processes that cry out for greater transparency and predictability.

Canada’s regulatory framework also remains highly fragmented. This is especially damaging in capital markets, imposing unacceptable costs not only on the financial services sector, but on companies in all industries as they grow and seek access to capital. More broadly, much can and must be done to build on the principles embodied in the Agreement on Internal Trade and to ensure that Canadian enterprises are able to function efficiently from coast to coast.

Undoing policies that harm Canada’s growth is just the beginning. Other countries go much further, working consciously to improve their business environments and to help their businesses compete more effectively abroad. We need to see governments and industry working together in extending the Team Canada concept used to enhance our trade missions abroad. The team that Canada needs now is an alliance of governments and industry that is committed to building a fundamentally more competitive business environment at home.

While many regulatory and legislative impediments to competitiveness affect businesses across all sectors, it is important to note that each industry faces unique challenges in the global marketplace. If Canada’s goal is to build global leaders, it also will be necessary for governments and business to work together to refine our strategy on a sector-by-sector basis. This is not a matter of reviving an old-style industrial policy of "picking winners", but rather of identifying and addressing the challenges and opportunities related to business growth within each industry.

We acknowledge that the bulk of new investment and action to improve competitiveness must be made by the private sector. In large firms and small, from coast to coast, the decisions of individual shareholders, managers and employees will determine how quickly our economy grows. At the same time, it is vital to recognize that business strategies are heavily influenced by government policies. Public policy cannot create globally competitive enterprises, but if we want Canadian enterprises to compete effectively, governments must encourage their ambitions and enable them to achieve the necessary stature and level of expertise.

Above all, therefore, we would reinforce the government’s recognition in its innovation strategy of the importance of improving the business and regulatory environment. In fact, we would suggest that this is really the single most important element in a national strategy to create a culture of innovation that permeates Canadian society. The starting point for such an agenda must be a commitment to collaboration between governments and industry in identifying and eliminating Canada’s remaining barriers to global competitiveness.

ENCOURAGING BUSINESSES TO GROW THROUGH INNOVATION

Governments cannot effectively encourage innovation in the private sector without a fundamental commitment to innovation within their own policies and programs. We see the potential for a process of creative renewal that could be pursued within the next few years regardless of fiscal circumstances. This review would focus on the key federal drivers of innovation.

In recent years, the federal government has increased substantially its commitment to research. The provision of more money to fund both direct and indirect costs of research and to develop and retain top talent in Canada’s universities and colleges marks an important start to the process of accelerating innovation. The federal innovation strategy makes it clear that additional public investment will be forthcoming as resources allow.

The government also has facilitated a growing flow of private funds to post-secondary institutions, most notably by improving the tax treatment of donations of publicly traded securities. Combined with direct government support, further improvements in tax rules and a growing flow of corporate investment in university research and infrastructure should ensure that Canada’s post-secondary institutions are well equipped to function as wellsprings of innovation in the years ahead.

Our concern is that too little attention has been paid to the next stage in the innovation process, that of turning Canadian ideas into growing global businesses. Universities and colleges are making determined efforts to improve the flow of ideas into the marketplace, but the rules covering the ownership and marketing of intellectual property developed with public money remain fragmented. The process of identifying, protecting and finding markets for intellectual property is complex and requires highly specialized skills that are in short supply across North America. The result in Canada appears to be a proliferation of spin-off companies but relatively few examples of rapid business growth.

Improving Canada’s performance in this area requires more than money. It requires at the very least even stronger collaboration between universities to deepen institutional expertise in the commercialization process. Comparisons with models used in other countries also suggest that researchers, universities and the country would benefit from creation of a national framework to govern the ownership and commercialization of intellectual property created through federally funded research.

At the next stage in the innovation process, the government has recognized the importance of continuing to build the pool of venture capital, but its proposal to consolidate federal efforts through the Business Development Bank of Canada (BDC) is unlikely to be sufficient.

Canada lags the performance of the United States in two aspects of venture capital. One is the supply of angel investors, the number of successful entrepreneurs able and willing to invest their expertise as well as money in the next generation of enterprise. Only improvements in the tax system and business environment can address this gap over time by enabling more entrepreneurs to succeed and reap the substantial profits required for personal investment in high-risk start-up ventures.

The second is in institutional venture capital investment by pension funds. American pension funds are major players in venture capital. Canadian funds, on the whole, invest only miniscule amounts of their capital in this area. Instead of enabling entrepreneurs to tap into this vast pool of existing capital, Canada opted many years ago to offer large tax credits to individuals willing to invest in Labour-Sponsored Venture Capital Corporations. These funds now account for about half of the entire supply of venture capital in Canada and the tax credits on contributions cost the federal treasury $260 million in 2000 alone. Yet there has never been any review to determine if this is in fact a cost-effective way for governments to help entrepreneurs get access to venture capital.

The government also continues to devote large sums of money to business subsidies. Despite decades of investment in subsidies for human resource and regional development, Canada’s small and medium-sized enterprises continue to lag both large domestic enterprises and their global counterparts by almost every measure of technological innovation and productivity. Here, we would suggest that goals and programs based on the number of jobs to be created or maintained in the short term are at best of limited value and at worst counterproductive.

The relatively slow pace of adoption of new technologies in Canada is reinforced by the country’s labour market policies. These policies restrict the flow of people into and within Canada, delay recognition both of formal credentials and informal learning and encourage companies to maintain existing patterns of relatively low-skill or seasonal employment instead of investing in new technology and worker skills. Both Achieving Excellence and the companion innovation paper from Human Resources Development Canada, Knowledge Matters: Skills and Learning for Canadians, recognize many important elements of this challenge, especially in terms of investment in training, recognition of skills and the need to improve the immigration process.

To enable Canada to make the best use of its formidable pool of human talent, federal and provincial governments must launch a joint assault on the remaining barriers to labour mobility within the country. In addition to joint actions through means such as the Agreement on Internal Trade, this will require a renewed commitment to effective reform of the Employment Insurance system at the federal level.

The 2010 deadline in the innovation paper for completing a review of Canada’s most important business and regulatory regimes is far too modest. We think it is possible within the next three years to review and change where appropriate the regulations, policies and programs that are the key federal drivers of innovative behaviour. By 2005, the government should consider in particular:

• Adopting a national framework for the commercialization of intellectual property created with federal support;
  
• Improving access to venture capital through pension funds and carrying out a critical review of the effectiveness of Labour Sponsored Venture Capital Corporations;
  
• Reviewing all business subsidies from a zero-base perspective, maintaining only those that have a transparent and demonstrable impact in encouraging innovative behaviour and increasing productivity, especially in small and medium-sized enterprises; and
  
• Reforming the Employment Insurance system to remove incentives for both employers and provincial governments to maintain existing patterns of relatively low-skill or seasonal work at the expense of investments in new technologies that would create more highly skilled and better-paid jobs.

COMBINING PRUDENCE AND INNOVATION IN FISCAL POLICY

In the public and private sectors alike, leadership in a world of change requires constant efforts to anticipate and adapt to emerging challenges. Some developments, like the war on terrorism spawned by the attacks of September 11, are abrupt and unexpected. Others, such as steady escalation in the cost of public health care and the need to address climate change and other environmental issues, require long-term strategies. But no matter what challenges preoccupy us in the years ahead, there will be constant pressure to find new and better ways of achieving our continuing goals as a country.

This world of heightened risk and uncertainty reinforces the need for prudence in fiscal policy. Canadians already have learned the hard way that ratcheting up public spending, especially with borrowed money, is a recipe for economic decline. The pace of spending growth projected in the December 2001 budget is clearly unsustainable. The burden of public debt still weighs on our country’s future prospects, diverting resources to paying interest and keeping tax rates too high. We continue to encourage the federal government to plan for budget surpluses and set aside significant contingency funds so that at worst, Canadians will not plunge back into the deadly cycle of deficits, and at best will reduce quickly the burden of public debt.

No matter how ambitious, new government initiatives to encourage innovation need not and should not involve net new expenditures. Almost by definition, they should seek first to make better use of existing resources. Certainly none of the suggestions that we have made here would require government to grow overall. Indeed, one of the conclusions that is likely to flow from an effective review of federal initiatives is that the innovation agenda would be served better through changes to the tax system and regulatory regime than through program spending.

The bulk of the investment that will drive innovation must come from the private sector. It therefore is critical for the country’s tax structure to provide the right incentives for businesses to invest not just in research, but in the adoption and marketing of the results of that research. The improving economic outlook suggests that there will be room for some targeted tax measures in the next federal budget. Even if the fiscal room for net tax cuts remains limited in the short term, there remains plenty of opportunity for innovation within Canada’s tax structure.

The economic evidence is quite clear in terms of what forms of taxation do the most damage both to innovative behaviour and to economic growth. Quite aside from the impact of the overall size of the tax burden, Canada’s existing structure discourages innovation by leaning more heavily on business capital and income than on payrolls and more heavily on personal savings and income than on consumption.

No form of taxation is more damaging to innovation than capital taxes, because they penalize directly business investment in assets such as new machinery and equipment. As its top fiscal priority, the federal government should announce that its capital tax will be eliminated by 2005 and encourage provincial governments to do the same. Even if slower growth persists, elimination of capital taxes should proceed as part of a broader review of the tax structure at both the federal and provincial levels.

As you acknowledged at our meeting this week, there is more to the goal of tax competitiveness than simply tracking other countries and trying to stay in the same ballpark. Canada should be looking at ways of using its tax structure to create a meaningful advantage over its major competitors. There is no realistic prospect of matching United States tax rates on personal incomes, for instance, but Canada already offers lower payroll taxes and is, at least in some provinces, becoming quite competitive in corporate income tax rates.

Regardless of the course of the economic cycle, the focus of tax policy in the short term should be on consciously shaping Canada’s tax structure to create a real incentive for Canadian and foreign businesses alike to choose this country as their base for serving the North American market.

A SHARED COMMITMENT TO ACCELERATING INNOVATION

The list of ideas and priorities that we have laid out here does not respond fully to the request you made at our meeting this week. As we indicated at the outset, our intention is to build on this framework and offer detailed recommendations in the months leading to the National Summit this autumn.

Our main point at this stage is to emphasize how much more could be done without delay to accelerate the pace of innovation in Canada. As you put it so well in unveiling the government’s strategy papers in February, there is indeed "no time to lose and so much to gain".

The members of the Canadian Council of Chief Executives are committed to building innovative and successful global enterprises in this country. Given the importance of the innovation agenda, we are taking the liberty of sharing these initial thoughts with the Prime Minister, with your colleagues in the Cabinet and with other Canadians who share ambitious goals for our country’s future.

We look forward to working with you and with the government to accelerate the process of innovation in Canada in the public and private sectors alike and to create the conditions necessary to ensure an improving quality of life for all Canadians.