There’s been much buzz in the media this morning about the findings of the Organisation of Economic Cooperation and Development (OECD) with respect to Canada’s state of macro-economic affairs.
While early headlines were quick to pick up on the report’s broad-based message that Canada’s economy was on the right track and set to see growth, they also noted there were “key long-term challenges” to which our leaders should take heed. Most notably, as an economy, we must be more attentive to our ballooning household debt and our perpetual lack of productivity.
“Tax breaks to manufacturing and natural resources penalize services, which are a critical emerging area for the knowledge economy.”
The latter point should be of key interest for business leaders and policy makers alike. Canada is an innovation and productivity laggard relative to its OECD counterparts. The report notes several factors that contribute to this stagnancy.
To the chagrin of anti-corporate activists, the OECD points out that while Canada has made some progress with respect to reducing Corporate Income Tax (CIT) — one of the lowest in the G7 — more progress is still needed if we are to foster an attractive environment for our blooming knowledge economy.
“Tax breaks to manufacturing and natural resources (abstracting from oil and gas royalties) penalise services, which are a critical emerging area for the knowledge economy.”
The report appropriately notes that while the current tax structure for small business is effective, the scaled tax rate discourages businesses from growing by penalizing them with progressively higher taxes as they do so.
“The reduction in the general federal CIT [corporate income tax) rate will serve to reduce the disparity in treatment of large and small firms, and to that extent should encourage small innovative firms to expand sales, enter foreign markets and attain the scale needed for successful innovation, competitiveness and high MFP growth.”
As any business that has attempted to fund research and development via public funding knows, the traditional system of allocating these resources through tax credits was inherently flawed. Big business used tax consultants to help them acquire public funds for R&D projects they were doing anyway while small businesses were getting the short end of the stick.
When the federal Conservatives revealed the 2012 budget in late March, it revamped the funding model in response to recommendations from the Jenkins Panel (led by OpenText head Tom Jenkins).The OECD lauded the government’s changes — namely the reduction of the Scientific Research and Development (SR&ED) tax-credit pool in exchang for a $400-million Venture Capital (VC) fund and more money for the grant-based Industrial Research Assistance Program (IRAP) — but cautioned it against “picking winners”.
Funding innovation through financial markets
It’s little secret that VC funding in Canada has been desolate since the bursting of the Dot Com bubble, but the dearth in VC capital is as much related to the way VC funds are allocated as it is to their accessibility. As the report notes:
“Indeed, some 50% of the VC market is publicly funded, compared with less than 5% in the United States. However, a large portion of this investment is directed to regional development rather than small firm growth. Canadian enterprises supported by private, as opposed to public, VC appear to have superior performance in terms of value creation and innovation intensity overall. More worrying is evidence of crowding out of private projects by public VC (Brander et al., 2008).”
The report goes on to state that if Canada is to generate R&D that leads to innovation, and, in turn, higher productivity levels, a co-funded system of public-private VC investment — in which the private partner makes the investment decisions — must come to fruition. While the $400-million VC fund is seen as a bright spot, it still relegates VC funding to the public sector, which has been traditionally poor at identifying companies that will raise the innovation bar.
Opening closed competition
As Jeremy Leonard noted recently in his Financial Post commentary, the key to higher productivity (and wages) is the removal of barriers to competition that artificially insulate Canadian business and stunt competition. While recent legislation (namely in the telecom sector) has undoubtedly made progress in this arena, the OECD report notes that more work needs to be done, specifically referencing the government’s controversial blocking of foreign investment and ownership in Canadian potash.
“Barriers to FDI are mainly in the form of ownership restrictions or regulatory discretion over mergers and acquisitions in specific sectors. The more general “net benefit test” has long been thought to have insignificant disincentive effects. However, its recent first-time use by the government to deny proposed investments in certain sectors (aerospace and potash) and subject others to questionable scrutiny (Target), relatively low thresholds for review in sheltered sectors (culture), and a lack of transparency in the review process, could have a dissuasive effect on future FDI and on openness to Canadian companies abroad (Bergevin and Schwanen, 2011). The federal government recently announced that targeted improvements to the administration of the Investment Canada Act will be introduced to enhance transparency while preserving investor confidentiality.”
Indeed, there’s little incentive for the massive companies associated with these industries to find efficiencies and become more productive if they can rest easy knowing that the government will prevent foreign competitors from invading their turf.
Bridging the commercialization gap
While Canada maintains an impressive track record of research, little of that research actually contributes to products, services and technology that benefit society. We have a commercialization gap. Part of the gap, as noted in the OECD report, can be attributed to Canada’s conservative business culture, which is highly risk averse because barriers to competition have ensured Canadian businesses are rarely exposed to risk.
“The best way to stimulate willingness to take risk may be to boost competitive pressures and openness”
“More generally, an apparently high degree of risk aversion in doing business, rooted in a fear of failure is one characterisation of Canadian social attitudes toward commerce. These attitudes are partly confirmed by surveys, which also point to a greater dependence on government help than on market opportunities for commercial success (Deloitte Research, 2011). The best way to stimulate willingness to take risk may be to boost competitive pressures and openness, as discussed above, and to complement this by enhanced attention to management training and diversity at all educational levels.”
The report notes an interesting phenomenon in education as it relates to innovation and productivity. To enhance productivity, we need more people coming up with ideas that will streamline processes and generate efficiencies. Unfortunately, we don’t have the right people and enough people to do this in the industries that need it most. The solution?
Immigration, of course, is one, but more importantly, a new emphasis needs to be placed on “tertiary education” and primarily that found in community-colleges that can offer a streamlined path to certification in skills that will be in increasingly desperate need throughout the country.
“Colleges differ from universities in that their programmes tend to be shorter in length and emphasise practical, technical and occupational training for the labour market. While colleges typically grant diplomas and certificates rather than degrees, a small but growing subset of “polytechnic” institutes has emerged that grants baccalaureate degrees and differentiates itself by its focus on applied research for industry.”
Unfortunately, due to a lack of consensus among these different post-secondary institutions, the transferability of students from one type of educational institution to another is at best challenging and at worst prohibitive.
Meanwhile, universities will need to do a better job of focusing their research programs on challenges currently being faced in the private sector (rather than things that make academics go hmmm…)
“Academics should be provided with stronger incentives to produce research relevant to business needs”
“Academics should be provided with stronger incentives to produce research relevant to business needs, starting with the peer-review granting process, then sharing their IP with business through collaborative efforts and finally having some form of ownership rights over their patented inventions.”
The long and short of it
In reviewing the OECD’s recommendations, it’s fairly clear the Paris-based organization is encouraging a general movement toward small government and greater free enterprise. Indeed, lower corporate taxes, private-sector guidance in public VC allocation, the removal of barriers to foreign ownership and competition, shifting educational models to meet market demands, and basing academic research and private-sector needs are all recommendations likely to cause advocates of big government to get hot under the collar.
The report and its recommendations point to a troubling trend in the way Canada’s government, private sector, and workforce operate — a trend of which all parties should be wary and one they should work toward combating — regardless of where they may sit on the political spectrum.