Northern Edge: Building a Nation of Innovation

June 13, 2001

I want to talk to you today about innovation. This is, after all, today’s public policy mantra, the focus of an upcoming federal white paper. But I want to make it clear that I am not here to talk about innovation just as the new codeword for the old debate over productivity and competitiveness. They are related, yes, but a national strategy for innovation has to involve far more than pumping money into research or expanding high-speed access to the Internet.

I see innovation as a much more fundamental concept, one that operates on two levels. First, it is a process. It is the process through which new ideas are not just developed, but put to good use. Second, innovation is an attitude. It is an attitude that rejects the idea that the way we do things today is the best possible way. It is an attitude that will not stand still, that insists we can and must do better. And it is an attitude that must infuse every part of our society if Canada is to forge ahead and deliver real and sustainable gains in quality of life for all of its citizens.

I fully support the idea of making Canada one of the most research-intensive countries in the world. But we cannot address research in isolation. Research is part of a chain of innovation, one that extends forward, through the process of commercialization, entrepreneurship and corporate strategy. It also extends back into issues of schooling and access to education. The innovation chain is linked not just to the private sector, but also to the way governments deliver services and relate with citizens. Ultimately, the chain of innovation binds us as a society — and determines the extent to which we are able to fulfil our potential as a country.

Canada’s model of economic and social development is widely envied. Some people may think that we can muddle through with incremental tweaks here and there. But I think we need to be much more ambitious. I think we need to build a nation of innovation.

Why? Let me suggest two reasons. The first is pragmatic. The world is changing around us, and we can be leaders in that process or passive recipients of whatever the rest of the world determines should be our lot. The second reason to be bold is one of moral duty. Canadians are rightly proud of the values that drive our society, but if our values are worth sharing, surely our country has a responsibility to spread them around, to be an agent of change within the community of nations.

I do not pretend that building a nation of innovation will be easy. As a small and relatively open economy, Canada has been a huge beneficiary of globalization. But even the progress we have made to date took a great deal of courage and determination. As a country, we took the leap of faith into free trade. Governments made the tough choices needed to turn deficits into surpluses. The Bank of Canada wrestled inflation to the ground. And Canadian businesses from coast to coast had to learn to cope with a whole new level of competition.

A few people like Michael Porter of Harvard University have suggested that while Canada has made great progress on the macroeconomic front, Canadian business has done very little and should get off the pot. It is true that productivity growth in Canada has been much slower than that in the United States overall, but let us look at why. I would suggest two reasons.

The first was covered in great detail earlier this week by Pierre Fortin of the Université du Québec à Montréal. In his brilliant analysis of the roots of the Irish economic boom, he showed that productivity growth flows from business investment in new machinery and equipment. The rate of investment in new machinery in turn is driven primarily by the rate of return, in other words, by profits. Ireland’s corporate income tax rate will still be one third of that in Canada even after the cuts here are fully in effect. But its effective tax rate on capital investment is even lower, less than one quarter of Canada’s. What gets rewarded gets done. As companies made money by investing in Ireland, the country’s unemployment rate plunged from 16 percent to just three percent — and its per capita income doubled in just 11 years.

There is an additional reason that some Canadian businesses may have failed to invest as much in innovation and productivity as they might otherwise. This is related to openness or the lack thereof. Free trade made Canada’s economy much more open, but many industrial sectors remain protected in one way or another. Ownership restrictions, for instance, both hamper new competition from abroad and make it more expensive for Canadian companies to raise capital and expand beyond our borders.

So while average productivity growth has lagged, the private sector is not a monolith. Many of Canada’s largest companies have launched themselves with great vigour into the global market — but smaller companies in general have been slower to adopt new technologies and have fallen behind on productivity. The result is that the top two percent of corporations pay two thirds of the corporate income tax bill.

There is another divide within the private sector that is worth exploring. Foreign-owned firms in Canada have traditionally been much more aggressive than domestic firms in carrying out research, developing world-first innovations and exporting the resulting products. Foreign investment, in other words, remains a vital conduit through which ideas and innovation diffuse through the broader Canadian economy.

However, a study by Statistics Canada last year showed that the key to innovative behaviour is actually not foreign ownership. Rather, it seems to flow from global engagement. When the researchers compared the innovation performance of foreign firms with that of Canadian-based multinationals, they found almost no difference at all. The difference in innovation performance flowed from whether a Canadian company’s attention was focused abroad or on the domestic market. This has some important implications.

In the course of writing our book, Northern Edge: How Canadians Can Triumph in the Global Economy, Tom d’Aquino and I spoke at length with the chief executives of more than 50 major companies in Canada. We talked about the evolution of their corporate strategies, about the factors driving their strategies and about the implications for the country. It is clear to us that major Canadian companies are firmly geared toward global competition and international expansion. This global orientation, however, is a double-edged sword for Canada.

Canadian companies moving into global markets must expand their operations abroad. They must raise money on global markets. As their network of operations, customers and investors becomes continental and global, they must move Canadians abroad and recruit people with skills and expertise that cannot yet be found in Canada. For Canadian companies to succeed globally, they must attract and integrate ideas, investment and people from other countries.

As we point out in Northern Edge, the result over time is that successful Canadian companies can become less attached to their home base. Occasionally, as when NOVA Chemicals shifted most of its head office functions from Calgary to Pittsburgh, the impact is obvious. But ties can quietly loosen in other ways. For instance, the head office operations of Bombardier remain firmly rooted in Montreal, but the Canadian content in its jets has been declining steadily, by three to four percentage points a year. Nortel Networks continues to use Canada as its primary base for research, but as John Roth described vividly in late 1999, there has been a diaspora of the company’s executive team.

This process, however, is not unique to Canada. Multinational companies worldwide are reorganizing their operations along functional rather than geographic lines. Instead of setting up subsidiaries to provide a broad range of services to customers in specific countries, they are establishing centres of expertise to do specific jobs for the company on a continental or global basis.

Canada is clearly capable of winning such broader mandates. In Northern Edge, for instance, we note that Nestlé Canada has established a role as the global centre of product innovation and testing within the Swiss-based food giant. Similarly in banking, HSBC sees its Canadian unit as the preferred place to develop and test new products before rolling them out globally. These companies were both drawn to Canada by a combination of talented people, sophisticated consumers, highly developed infrastructure and a market small enough to try new ideas without breaking the bank.

IBM Canada is another example of a subsidiary that successfully bid for broader responsibilities as its global parent reorganized. A decade ago, it was like most multinational subsidiaries in Canada, focused on domestic clients. But in just two years, 1998 and 1999, IBM doubled the number of executives based in Canada. Many of these executives and thousands of IBM’s Canadian employees now have North American rather than domestic responsibilities.

On balance, however, Canada’s position remains precarious. In a 1999 survey of the member chief executives of the Business Council on National Issues, 40 percent of respondents put the odds that their own job functions would leave Canada within a decade at 50/50 or higher. More recently, a study by the Conference Board of Canada confirmed the danger of a "hollowing out" of corporate decision-makers within Canadian companies and foreign-owned subsidiaries alike.

The loss of even a few key decision-makers within a corporation can have a real impact on surrounding communities and on the country. Let me offer another example from Northern Edge. This one involves Air Liquide, a French-based multinational that operates in 60 countries. In 1999, this company invested in two major projects in Canada, one in Hamilton and the other in Edmonton. Both projects were run by the same division, reporting to the same executive, a Canadian based in Houston. But the project management teams came from two different locations, the one for Hamilton from France and that for Edmonton from Texas.

In a post-project analysis, Air Liquide discovered that the Hamilton plant had twice the European content of the Edmonton one. The Edmonton project in turn had much greater American content. Even though both projects were run by the same division of the same company, the people making decisions on the ground continued to deal primarily with suppliers that they knew and trusted personally.

My point here is that innovation is driven by talented, skilled, well paid and very mobile people. In seeking to spur growth through innovation, therefore, Canada must compete not just for investment dollars but to be the kind of place that such people want to live and work.

Canada’s natural beauty and excellent social and economic infrastructure help to create an attractive quality of life. At the same time, other aspects of our geography and economic factors such as high taxes work against us. To the extent that taxpayers see real value for what governments take from them, a country can get away with charging a certain tax premium. But no country seeking to attract and retain innovative people can escape a broader issue, that of social attitudes.

In its 2000 comparisons of countries around the world, the Global Entrepreneurship Monitor confirmed that social and cultural values can be at least as important as the economic environment in stimulating entrepreneurial investment. Entrepreneurs, it suggested, want to feel socially valued, whether they succeed or fail.

A 1999 study looking at why some American cities are much more successful than others in fostering high-growth businesses made this point even more forcefully. According to Cognetics Inc., traditional factor costs like wage rates and energy are all but irrelevant. Rather, it said, high achievers flock to places that respect and recognize what they do. Such respect is far from universal. As the study put it: "Not all communities welcome somewhat crazy upstarts who steal their customers and their labor force, and in the process, become wealthier than anyone else in town, particularly if they let you know it. Said another way, tolerance and recognition of new and different people doing new and different things is the hallmark of a place in which entrepreneurs will start and grow companies." If as Canadians we do share ambitious goals for our country, we have to make sure that our social attitudes welcome the kind of people who drive change.

I do not see anything un-Canadian about being ambitious. No one has any qualms about crowing when the United Nations ranks Canada as number one in the world for quality of life. Nor should we shy away, therefore, from daring to suggest that Canadians ought to enjoy average incomes that match Americans — and maybe even exceed them. After all, more people making more money for themselves also provide more resources and more choices to the country as a whole.

By 1999, real per capita Gross Domestic Product in Canada was US$6,700 less than that of the United States, a gap that has been widening steadily. To reverse the trend and to close that gap within the next decade, Canada’s economy would have to grow twice as fast as that of the United States. That’s not impossible. But sustaining such a record for a decade would be very tough. We may not succeed, but at least if we shoot for the moon we have a crack at getting into orbit.

At the same time, we have to make sure that everyone wins. In Canada, the real disposable income of the top 20 percent of the population has remained steady at five times that of the bottom 20 percent for more than two decades. To the extent that we were a just society when Pierre Trudeau left office, we remain a just society today. And as we seek to boost the overall standard of living of Canadians dramatically, we also have to ensure that the worst off Canadians continue to see their incomes rise at least as fast as the average.

We are not going to achieve anything like that kind of progress simply by carrying on the way we have to date. Canada has come a long way, but so have our competitors, and they are not standing still. Making and sustaining further gains in standard of living can only be achieved by a broad and fundamental commitment to innovation. Such a commitment in turn will require significant changes to the way we work, the way we live and the way we run our country. Real innovation is never easy.

This does not mean, I want to emphasize, abandoning the core values of Canadian society. To the contrary, you cannot be a leader in innovation by copying the other guys. We can learn from them certainly, but the idea that globalization means we should all act like Americans is ludicrous. Canada must pursue its own path, build its unique features into a compelling story for investment and people alike.

What might an agenda for innovation look like? There is no one silver bullet, but I would suggest four broad thrusts.

First, a national strategy for innovation must be founded on sound fiscal and regulatory policy. Canada has made huge progress on the macroeconomic front. Interest rates are down. We have begun to pay off significant chunks of public debt. And we have seen personal and corporate tax cuts that will make a real difference in spurring entrepreneurial activity, business investment and personal incomes.

Today’s slower growth means that we will have less room for further cuts to the overall tax burden — but still leaves plenty of room for creative approaches to tax reform. Simply put, some forms of taxation do much more damage to economic growth than others. By one OECD estimate, an extra dollar of corporate income tax reduces economic growth by nine times as much as an extra dollar raised through sales taxes. If Canada wants to maintain both a competitive tax burden and a relatively large public sector, it has to shift its tax mix. We discuss a number of options in the book, including a shift toward taxation of consumption within a progressive income tax system.

We have to take a similar approach on the spending side, finding more money for key priorities without raising total spending. Innovation in terms of government spending means investing in new ideas. But it also requires a willingness to walk away from approaches that year after year prove that they do not work.

For instance, despite decades of subsidies to business intended to foster regional development, the Atlantic provinces are now the poorest jurisdictions in North America outside of Mexico. And the welfare trap built into the equalization formula is coming under fire even from its greatest beneficiaries. If we are going to do better in improving the lives of people in every part of Canada, the first step is to acknowledge that some of our traditional tools are not up to the task.

Smarter spending and tax policies must in turn be reinforced by a more open economic environment. We need to make sure that more Canadian companies are exposed to both the challenges and opportunities of the global economy. And we need to be much more effective at integrating Canada’s economic space, so that our enterprises have a sound base for expansion abroad.

The second major thrust in a national strategy for innovation must be a focus on people. Even at the most obvious level, we can only pump as much money into research as there are qualified researchers to do the work. More broadly, Canada cannot hope to succeed as a country unless all Canadians are equipped for success as global citizens.

There is a limit to the federal government’s ability to interfere in provincial jurisdiction when it comes to education. But I put it to you that innovation in our public schools is an urgent national challenge. To dramatically improve the achievement of all students, we need to transform our schools from relics of the industrial era into true engines of the knowledge economy.

Beyond high school, we also need to make sure that all adult Canadians — employed, self-employed and unemployed — have access to opportunities for lifelong learning. In Northern Edge, we suggest two approaches. The first is to expand opportunities to save for education. The government has proposed in principle a further tax-sheltered individual learning account, and I hope that the final version will enable contributions both from governments and employers.

But to ensure access to post-secondary education at all ages, we need further measures to reduce individual risk. We suggest that in addition to tax relief on student loan interest, governments provide a tax credit equal to a significant portion of the principal in each year that the graduate remains a Canadian taxpayer. In addition to reducing a student’s risk, this ensures that the greatest benefits of public investment in education flow to those who put their learning to work for their fellow Canadians.

Making the most of our domestic talent pool is not enough. As I suggested earlier, we also need to make Canada a magnet for innovative people from around the world. Our existing openness to immigration already makes an important contribution to the vibrancy of our economy and society. But we are far too passive when it comes to recruiting high achievers with particularly valuable skills sets or experience. Immigration officials must become partners in marketing Canada’s virtues abroad and in facilitating the entry of skilled people that Canadian employers want to hire.

This brings me to the third key thrust in a national strategy for innovation — the need to make our mark on the world. Canada’s past contributions to global peace and economic development have left an important legacy of respect. At the same time, our small trade-dependent economy has been a huge beneficiary of multilateral trade and investment liberalization. But on the global stage as at home, an innovative approach is key to enhancing Canada’s reputation in ways that will add to our ability to attract both people and investment.

Canada must continue to be an active player in multilateral discussions — from new trade negotiations to debt forgiveness and environmental issues. Within North America, we have to recognize that trade is becoming entwined with issues such as defence, energy security, illegal immigration and drug trafficking. We suggest that the time has come to explore the dimensions of the next great continental project.

Canada, however, cannot walk tall in the world solely on the strength of its economic prowess. In order to maintain the momentum for trade and investment liberalization, we have to do our part in demonstrating its benefits to the world’s poorest citizens. The countries that have benefited the most from globalization have been those with strong social capabilities — the political, legal and financial infrastructure needed to make a country a realistic candidate for greater flows of private investment. We suggest that Canada needs to rebuild its reputation in the field of international development — not only in responding to crises of disease and poverty, but in transmitting its hard-won experience in making democratic institutions work.

This brings me to the fourth and final thrust of a national strategy for innovation: better governance. Innovative policies on taxation and spending can only flow from innovation within our democratic institutions. It is clear that public faith in these institutions has been in steady decline. As the federal Parliament breaks for the summer, I want to suggest that the time has come for a major shake-up.

Many good ideas for Parliamentary reform have been advanced over the years. One common theme has been the need to return power and prestige to individual members of Parliament. Members should have more freedom to cast votes that reflect their own judgment and the wishes of their constituents. Parliamentary committees should be places where all parties can work together to shape legislation. As in the Quebec National Assembly, ministers should participate in the full committee process, not just appear once to defend their bills as written.

We also suggest Parliamentary scrutiny of key appointments — to the Supreme Court and Federal Court, to the Bank of Canada and to regulatory bodies. Appointments to the boards of directors of Crown corporations also should be reviewed — and the government should then delegate to those boards the authority to appoint the CEO. Such public scrutiny need not tie the government’s hands, but greater transparency is essential to rebuilding public trust.

These are not changes that require constitutional amendments. They could be made at any time. I recognize that in Parliament as in the public service and in corporations, real innovation takes real courage. But the fact remains that members from all parties have made important recommendations at one time or another. I suggest that no national strategy for innovation should be taken seriously unless the first step is a commitment to innovation in the workings of our democratic institutions.

Let me conclude by noting that in the global competition for the people and investment that drive human progress, there is little to distinguish the very good from the best. Even small advantages can have a huge impact. Other countries also offer sound democratic institutions, superb social and economic infrastructure, well educated people, access to major markets and so on. But those that excel always have an edge, some characteristic that sets them apart.

Let me offer three examples of the strategies that have been pursued by other small, modern, democratic countries. Switzerland has for centuries built a reputation for neutrality, discretion and security. This has provided the foundation both for its renowned banking industry and more broadly for its economic prosperity and social stability.

The Netherlands adopted a strategy geared to being the preferred European gateway for multinational corporations. In addition to its superb seaport and airport facilities, it offers corporate laws that make it the preferred place to locate legal head offices, backed up by special personal tax rates for expatriate employees of multinationals. This special treatment has made the Netherlands a head-office hotbed, without damaging the country’s renowned social cohesion.

For its part, Ireland combined bargain basement corporate tax rates with a policy of wage restraint aimed deliberately at boosting corporate profits. The result has been an explosion of foreign investment that has made Ireland a high-technology manufacturing powerhouse.

I do not think Canada should go after bank accounts like Switzerland, legal entities as in the Netherlands or factories as in Ireland. Rather, I suggest that Canada should aim to be the preferred base for centres of expertise within global companies, a place where ideas and people and capital come together from all parts of the world. Instead of passively watching the hollowing out of our existing head offices, we should be making this country the obvious place for head office functions to bulk up, a place where innovative leaders and key decision-makers choose to live and work.

Making Canada a magnet for top talent will not be easy. As I have suggested here, we are going to have to rethink many of the policies on which we have relied in the past. But as multinational enterprises everywhere lose their traditional home-country ties, as they evolve into truly multicultural organizations, where else could key employees feel more at home? If we can get our act together, if we can commit ourselves to a real agenda for innovation, the tolerance and diversity of Canadian society could become our unique selling proposition, that extra edge that would set us apart from other strong contenders.

All of us will have to contribute to meeting this collective challenge. In government, in business and in the voluntary sector, as managers and employees, as consumers and investors, as parents and neighbors, and above all as citizens, we have an obligation to take risks and to support others willing to take risks on our behalf. I am convinced that together, we have the right stuff. As the clamour on Parliament Hill dies down, it’s time to take a deep breath and get on with the job.