Canada needs new programs to support innovation in the high technology and digital sectors of the economy.

For the past four decades, a relentless wave of innovation in information and communications technologies (ICTs) has washed across the global economy. The embedding of microprocessors and sensors in a growing range of products is part of a neural system that communicates and interacts, controlling the rhythm at which it operates. Few countries can afford to ignore this trend, and most are positioning their digital sectors as the drivers of future growth. Brian Arthur said in the McKinsey Quarterly in 2011, “How we will fare in this world, how we will adapt to it, how we will profit from it and share its benefits, is very much up to us.” An important part of this transformation is the shift from hardware to software. This shift in functionality is lowering the entry barriers to many industries, making it easier for companies to introduce innovative new products that can disrupt existing industries — from automobiles and taxis to hotels and financial services — with cheaper software opening up infinite opportunities for disruptive new products.

The critical policy challenge arising from this transformation is to determine where Canada can compete in the rapidly changing digital economy, and which value-added activities can be most profitable domestically. Previous generations of federal policy were focused on the hardware side of the telecom and mobile sector during the boom, and it is this sector that has been hardest hit by the commoditization of hardware. The current shift of functionality from hardware into systems, through the embedding of software code, holds the key to the future of Canada’s place in the digital economy. The critical question is, how should government respond to these changes? Canada needs new programs to support innovation in the high technology and digital sectors of the economy.

Researchers in Canada and abroad have documented a number of policy instruments that are effective in moving countries from a low level of technological intensity to a much higher level of performance. In many cases this was done by relatively low-profile technology development agencies, such as the Defense Advanced Research Projects Agency (DARPA) in the United States, Sitra in Finland, and the Office of the Chief Scientist in Israel. Key to the success of these agencies is that they were insulated from short-term political pressures, and they were staffed by technology experts. These experts could target the agency’s funding toward building innovative capacity in firms, because they could experiment with emerging technologies and make long-term investments. Such agencies were relatively inexpensive, with budgets in the range of $300-400 million a year.

While not every investment was successful, the model was effective in shifting the high-tech sector’s technological trajectory onto a path that enabled it to exploit new and emerging technologies with greater elasticities of demand in the international market place.  A recent article by a former DARPA director argues that the key lessons learned at DARPA over many decades can effectively be transferred to other agencies and even private firms. The key to DARPA’s success consists of three elements: setting ambitious goals, using temporary project teams to carry them out, and maintaining complete autonomy in selecting and running its projects. The Canadian innovation system does not have an autonomous agency whose mission is to stimulate digital innovations that are close to the technological frontier.

We need a more focused approach to innovation in the ICT sector, building on proven strategies in Canada and other countries. First, we need to develop a sector strategy; given the pace of digital innovation, the strategy needs to be revisited periodically. A component of such an exercise should be the launching of an ICT/digital road map to explore existing strengths and determine the areas where we could achieve maximum leverage, in the shortest time, with the minimum additional spending. The results of such an exercise could be an important resource for the work of a strategic technology agency.  The federal government has an established track record in convening industry and sectoral round tables to draw up technology road maps that can be used to inform industry sectors about the direction in which the technological frontier is moving.

Second, we need to expand the range of policy instruments to support market-driven innovation in the digital sector. There are several successful examples of programs that have worked well in other countries and could be adapted to the Canadian context. One is the Small Business Innovation Research (SBIR) program in the US. Introduced in 1982, the SBIR program was designed to increase private sector commercialization of innovations derived from federal research and development. Federal agencies with R&D budgets over $100 million have to set aside 2.8 percent of their funds for the program. By 2010 more than $16 billion had been awarded under the program, and presently it has expenditures of $2.5 billion a year. Numerous evaluations of the program have documented its effect on the growth and success of innovative startup firms, including the increased likelihood of recipient firms attracting venture capital investments.

Third, we should expand successful Canadian programs with a proven record. One program that has been effective in stimulating innovation in small and medium-sized enterprises (SMEs) is the Industrial Research Assistance Program (IRAP). However, IRAP’s staff needs to be expanded and its budget significantly increased. While its mandate to stimulate innovation in Canada’s SME’s includes more than just the digital technologies, an increased budget for IRAP should be a significant component of a strategy to create digital opportunity for firms in Canada. In designing a Canadian strategic technology agency, attention needs to be paid to ensure that it complements and does not overlap with IRAP’s mandate.

The fourth element of the strategy requires support for scaling up technology firms for global markets. The federal and provincial governments have introduced important initiatives in recent years to support incubators and accelerators, and to increase funding for the venture capital market. However, this is only one part of the problem; the other part is that we do not grow enough start-ups to global scale. We need a new program to help digital firms grow to a global scale. The program should help firms to grow their revenue base, particularly by accessing global, not just continental markets; recruit, retain and develop managerial and technology talent; and ensure they have access to capital to grow their companies. It could supplement existing programs that support start-ups, such as the Canada Accelerator and Incubator Program (CAIP), the Ontario Network of Entrepreneurs (ONE), and Alberta’s Regional Innovation Networks. The program should be targeted toward start-ups with the most promising chances of success on the global stage, and it should be delivered through existing agencies with a proven track record of providing effective support for start-ups.

The revolutionary potential of digital technology extends well beyond the ICT sector and could disrupt virtually every other sector of the economy. Much of the digital opportunity will play out in primary and secondary industries that are using digital technologies to change the way they do business (by raising productivity, increasing product diversity, and reducing risk). However,  one area where Canadian firms have lagged across the board is investment in software. The short-lived Digital Technology Adoption Program, administered by the National Research Council (NRC), was intended to remedy this problem, but the problem persists. The Business Development Bank of Canada (BDC) offers support to SMEs looking to adopt digital technologies. Whether through the NRC or BDC, we need a digital technology adoption strategy to assist SMEs in identifying the technologies most appropriate for them and to boost investment in software across all sectors of the economy.

The emergence of new materials is fundamentally altering manufacturing processes by introducing new software layers into traditional machining processes. Instead of classical “metal bashing,” metal manufacturing now is based on manipulation of the microstructures of the materials.  The shift from the embedding of control mechanisms in hardware systems to their design in software is creating broad opportunities for Canadian firms in both the ICT and the advanced manufacturing sectors.

The recent US initiative to establish a national network for manufacturing innovation, aimed at improving the manufacturing capabilities in a range of advanced technologies, merits close attention by Canadian policy-makers. We need a made-in-Canada technology-transfer centre, or “innovation hub,” focusing on the application of digital technologies in manufacturing processes. A sectoral strategy for manufacturing should build regional capacity to support new technology platforms in emerging areas such as “the connected car” in the automotive sector, or the integration of ICTs in a wide range of medical devices and the delivery of services.

Another sector being dramatically affected by digital technologies is financial services. A recent report from the Innovation Policy Lab at the Munk School of Global Affairs has documented the growing impact of ICTs on the financial sector through the rise of financial technology (fintech).  There are significant opportunities being created by fintech firms, but also challenges posed for established industry players. The fintech ecosystem needs more large, incubator centres that offer basic services, with high connectivity, at discounted rates. While a number of incubators exist, the inexpensive ones are far below the scale of those in London and New York, and the more expensive ones demand rents far higher than most start-ups can afford.

Initiatives to support the growth of the fintech sector may involve regulatory changes at the federal and provincial levels. Canada has one of the world’s most respected regulatory financial frameworks, but it also has a reputation for restricting innovations emerging from new companies. Canadian regulators urgently need to develop procedures to stay abreast of new technology developments, while facilitating rapid small-scale experimentation (that would scale-up when successful). The United Kingdom is experimenting with a “regulatory sandbox” that allows fintech firms to develop their technology in a controlled environment under the watchful eye of the financial regulator. If adopted in Canada, an initiative like this would encourage fintech development by attracting high quality entrepreneurs and investors, while also enabling information diffusion, collaboration, and the development of a vibrant ecosystem.

Finally, policy makers need to recognize the local context of digital transformation. This requires a more focused use of policy instruments to facilitate coordination, dialogue and interaction among digital technology firms, as well as support institutions at the local and regional levels. The concept of clusters identifies the effect of linkages among firms, universities and research institutes at the local levels. Clusters give small and medium-sized firms the opportunity to establish connections with larger partners and multinational firms. Adopting a cluster perspective provides a lens through which policy-makers can review and evaluate existing programs. Previous action plans have recommended the federal government support local and regional clusters. They have also advocated that universities, colleges, polytechnics and research institutions align their research and training efforts to meet the needs of existing and potential local clusters. Governments should support cluster organizations, whereby experienced actors in the private sector can assist cluster development by offering advice and guidance to new start-ups, supporting the entry and growth of firms in related areas and communicating the needs of local firms to local post-secondary institutions and research centres. We need a national network to share know-how and best practices on ways to improve the competitiveness and reinforce the development of clusters, building on the considerable experience in existing cluster organizations across the country.

This is an ambitious set of initiatives for any government, let alone one facing a wide range of other pressing policy issues.  Nevertheless  a policy agenda for the digital economy must be a priority for any government in Canada. Not since the onset of the first industrial revolution have we seen such a phenomenon — an interconnected set of technologies that has the potential to disrupt established industrial sectors and economic patterns, but also to generate new economic opportunities. While some of the initiatives set out above require new program spending, many can be achieved by reallocating existing program spending or refocusing the priorities of existing digital technology programs. The effectiveness with which all three levels of government grasp the digital opportunity — thus laying the foundations for future growth — will determine their economic and fiscal capacity to deal with the numerous other pressing issues.

This article is drawn from A Policy Agenda for the Digital Economy, one of a series published by the Innovation Policy Lab at the Munk School of Global Affairs, University of Toronto.

Photo: Denis Roger/

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