We need a fountain of youth to dissolve the social arteriosclerotic structures in the body politic.

C.P. Kindleberger

Productivity growth and innovation are key drivers of growth in living standards and economic well-being. While these two phenomena are difficult to measure, it is fair to say that, by the traditional benchmarks in use, Canada is not doing that well on these fronts. It is not that productivity growth and innovation do not exist in Canada. New and better ways to design and produce new and improved processes, goods and services are noticeable every year. But there is a significant gap in productivity growth and innovativeness between Canada and the United States, Canada’s major trading partner, as well as vis-à-vis many OECD countries. Therefore, there are reasons to believe that Canada is not doing as well as it could. As a result, our living standards, measured on a GDP per capita basis, have deteriorated relative to the US, but also to the OECD average over the last while. Indeed, the gap would appear to have been growing over the last 25 years.

The opportunity cost of not taking action to counter this trend is quite high. One can calculate how much larger the Canadian GDP might be if, over the last 20 years, innovation and productivity had been improved sufficiently to increase the rate of growth of GDP by half of one percent per year: the size of Canada’s GDP in 2005 would be larger by $100 billion. One can only imagine how such additional resources might be used to meet priority social needs whatever they might be.

If there is such broad agreement on the benefits of productivity growth and innovation, it might be expected that private, public and social agents would invest the requisite amount of resources and effort to generate more of both. But the imperfect knowledge we have about both processes and the uncertainty about what one can expect from such investments mean that such ventures are perceived as quite risky. This is why spending on R&D is so much lower in a relatively risk-averse society like Canada.

An additional reason for under-investment in productivity enhancement and innovation is that those investing will not necessarily capture the full benefits of their investment because of spillovers onto other non-contributing partners. For instance, Daniel Trefler in a Policy Options‘ piece a few years ago quotes a study showing that by doing nothing, Canada might experience a growth rate of productivity of 2 percent if the US were persuaded to invest 1 percent more in R&D. This can only encourage free-riding and discourage investment in these areas.

Finally, there are also signs that Canada, despite being a relatively young country, is becoming an “aging economy” plagued by social rigidities that prevent it from adapting smoothly and quickly to meet the new challenges posed by the evolving context. Such an aging economy is marred by “a decline in risk-taking, clinging to old techniques even when new and more economical (ones) are available, resistance to rationalization, a propensity for feather-bedding,” and in general it loses some of its capacity to transform, as Charles P. Kindleberger in The Aging Economy and Mancur Olson in The Rise and Decline of Nations have pointed out.

Such dysfunction would normally prompt public authorities to design policies likely to correct these market failures and to eliminate these social rigidities. Yet despite a decade of momentous efforts by Industry Canada to put these issues on the national agenda, Canadians have not been swayed. Surveys quoted by William Watson in The Review of Economic Performance and Social Progress would appear to indicate that only 14 percent of Canadians with a high-school education or less understand what is meant by the productivity growth and innovation issue.

This lack of concern is due to a great extent to three mental blocks.

The first one is a blind spot plaguing a major segment of the economics profession. It has led too many economists to occlude from their radar screen issues of productivity and innovation because of the elusiveness of these topics. Even though it is clearly appreciated that they underpin any increase in the level of income per capita and growth in the standard of living, the sources and causes of productivity gains and innovation are so badly understood and appear so diffuse— the research results about these issues so inconclusive, the measurement problems so daunting, and simple mechanical solutions so unavailable— that economists have tended to direct their research attention toward the “firmer terrain” of fiscal and monetary policies, and the magic of fiscal and balance-ofpayments surpluses and deficits.

The second one is the growing anti-economic-growth sentiment fuelled by the diverse campaigns of moralists, environmentalists, deficit hawks, and the like— crusaders who have underlined the costs of economic growth and denounced the so-called “cult of efficiency.” These forces are powerful in the United States but they are even stronger in Canada. This is significant because economic growth, through the strong pressure of demand that it generates, ignites more competition for resources, and a more forceful push to reorganize the processes of production in the face of scarcities.

The third one has to do with public officials’ fundamental lack of appreciation of the central importance of preceptoral politics as part of their burden of office. Leaders must be educators, animateurs, persons called upon to reframe the citizen’s views of the public realm, to design the organization of mutual education, and to “set off the learning process” necessary to elicit, if possible, a latent consensus, as David Marquand aptly points out. In the words of political scientist Robert A. Dahl, the purpose is to elicit “enlightened understanding”: what would lead citizens to choose with “the fullest attainable understanding of the experience resulting from that choice and its most relevant alternatives.”

The role of public officials in educating individuals in their mutual and civil commitments has clearly atrophied. Most officials in Canada have been passively recording the results of opinion polls, and have not shouldered their responsibility as “preceptors,” alerting citizens to the importance of productivity gains and innovation.

Progress is made in generating productivity growth and innovation when individuals and organizations actively apply their entrepreneurial intelligence, ingenuity and imagination to better coordinate existing activities, or to fill gaps in such coordination in the name of making better use of existing resources. Rarely is this a matter depending on a single individual. It is, most of the time, the result of the collaboration of many individuals who must have a modicum of trust in one another if they are to cooperate. This poses a major challenge of governance, because governance means effective coordination when knowledge, power and resources are widely distributed.

Ingenuity, entrepreneurship and trust are social capacities that constitute factors of production like land, labour or capital. But they are special factors of production, “enabling resources” that are at the core of what Alfred Marshall called “organizational capital.” The supply of technical ingenuity depends on an adequate supply of underpinning institutions supporting the production and maintenance of such capacities and on adequate pressure to make active use of these enabling resources.

This institutional support takes the form of public goods (such as effective market signals, wise funding agencies, industrial associations, agoras where research institutions and industrial concerns may cooperate, working networks, effective governments as facilitators and catalysts, etc.) that provide material and psychological infrastructures to entrepreneurs and innovators, facilitate contact among them, help create coalitions, provide constructive coercion, etc. As for the pressure to take action, it emerges from competition and the working of the free market in response to scarcities and bottlenecks. These forces press commercial concerns into continually improving and innovating in order to survive.

Economists have been rather reluctant to probe the murky terrain of these “interpersonal enabling resources.” It has often been left to political scientists like Thomas Homer-Dixon or Francis Fukuyama, or to some maverick economists like Harvey Leibenstein to explore this socio-psychological and organizational underground. Their work has shown that there are identifiable forces, institutions and contexts that tend to promote a greater degree of entrepreneurship, trust and ingenuity. Scarcity of resources, greater availability of capital, associations and clusters, and ample research funding may tend to foster it; social rigidities and market failure may impede it. The challenge of putting in place the required support and pressures that may succeed in catalyzing productivity growth and innovation processes calls for a fuller recognition of the blockages built into the ethos and in the institutional setting, and a better appreciation of the full potential of competition.

Over the long run, a socioeconomy’s institutional fabric (i.e., the rules of the game that enable, guide and motivate behaviour) evolves. And this triggers significant changes in its growth experience.

The Ancien Régime (that more or less prevailed until the commercial and industrial revolutions in Western economies like Canada) was instituted to ensure a minimization of collective risks, subject to an adequate income constraint being met. It was a safety-first ethos. In the century preceding Confederation, that ethos changed. One saw the emergence of a Régime Moderne— the percolation of institutions like the limited liability company and other social technologies that attempted to “maximize (more or less) the overall valued-added subject to a maximum risk constraint.” Canada’s constitution was drafted within an era dominated by the ideology of growth.

The acceleration of economic development (and the heightened degree of uncertainty and turbulence which accompanied this acceleration of change) led to the emergence of a new institutional environment in the 20th century— le Régime Contemporain (what has come to be labeled the welfare state)— a set of institutions designed to reduce risk of societal and individual disasters, subject to a minimum income restraint. We are still somewhat trapped in this ethos.

This minimum-risk ethos remains much stronger in Canada than in the United States. The credo and the rhetoric of a major segment of the Canadian intelligentsia still appear to maintain that the welfare state is intervening insufficiently (although it already redistributes a major portion of the GDP) and is under threat (although all efforts to reform it would appear to have failed). Indeed, in 1999, according to Frank L. Graves and Richard Jenkins in The Review of Economic Performance and Social Progress, 50 percent of Canadians were convinced that concern about productivity was “manufactured” by large business and wealthy Canadians, and that productivity and innovation were the priorities of Bay Street, not Main Street.

In Canada, a Nouveau Régime— one adapted to the new circumstances (favouring a pro-growth stance subject to certain constraints on the degree of individual and collective risks to be incurred)— has therefore failed to materialize. The opportunity costs of this failure of governance have been high, for one can ascribe much of the productivity and innovation gap to this dysfunctional ethos.

Modifying the institutional environment is necessary, but it may not be sufficient. Unless there is some pressure on agents and organizations to improve their performance, considerable slack may remain in the operations of the socio-economy. This is where competition can make quite a bit of difference.

As William Baumol points out it in The Free-Market Innovation Machine, oligopolistic competition among large firms is the prevalent pattern in modern socio-economies. And for these firms, innovation is the prime competitive weapon. Indeed, the great power of the free enterprise system is that it tends to generate a certain process of routinization of innovation-generating activities, for productive innovation is so crucial to the survival of organizations that they cannot afford to leave innovation and productivity gains to chance. Moreover, greater effectiveness in making use of licensing agreements and joint ventures, and in facilitating the processes of commercialization and dissemination of new technologies, allows both for some internalization of innovation spillovers, and for speedier and lower-cost transfer of technological innovation.

In the new industrial organization, built on modular structures and extensive networks and clusters, small and medium-sized firms are integrated horizontally and vertically in structures of production that put a fair bit of pressure onto them to continually improve productivity and to innovate, as Raghu Garud documents in Managing the Modular Age. To the extent that these realities are not as extensively developed in Canada as in other countries, there has been less pressure to facilitate the emergence of networks of firms and regional clusters, or to orchestrate and integrate activities in loosely coupled units where information dissemination, communities of practices, and standard-setting play the dominant role in pressing sub-units to increase productivity and to innovate.

The pressure of international competition is forcing Canada to do something about productivity growth and innovation. While a low Canadian dollar has allowed Canadians to hide the harsh reality of loss of market share when productivity and innovation do not keep up with competitors, this reality is now upon us.

This will entail a major reframing of Canadian perspectives, much restructuring and a fair bit of retooling, but these changes will materialize in the reverse order, because it is easier to tinker with mechanisms than to modify the basic structures of a system, or to transform mindsets. Yet the theory of “what business a system is in,” structures and roles, and technologies are fundamentally intertwined, and any change in one forces modification in the others.

Retooling: missing mechanisms. The Canadian economy is being crippled by the country’s relatively poor performance in R&D, and its slowness in the adoption of new technologies. There has already been some pressure to reduce corporate taxes in the hope that it may induce higher levels of investment in new machinery and equipment and in R&D, and faster adoption and fuller use of the new information and communication technologies. In particular, more generous depreciation rules may entice firms to invest more in modernizing their machinery and equipment. But a greater enrichment of the R&D tax credit regime (one that is already quite attractive) will not suffice, and may even be wasteful. One must rather put the emphasis on enriching what Peter Nicholson calls “the R&D environment.”

This has already begun, with initiatives in respect to research infrastructure like the Canada Foundation for Innovation. But it must also mean that “governments should encourage the activities of industrial associations and other forms of collaboration that permit the efficient flow of information among firms and industries in a country,” to quote Rolf Weder and Herbert G. Grubel. The facilitation by governments of the construction of technology roadmaps is a good example (www.strategis.ic.ca); revamping the role the Canadian Intellectual Property Office to make it more effective might be another.

But there is a potential for such collaborative ventures to generate rentseeking activities, and so there must be a concurrent effort to increase the competitive pressure. This will come with the necessary liberalization of Canada’s restrictions on foreign direct investment, which is bound to provide the sort of pressure needed to entice the private sector in Canada to become more productivity-minded and more innovative. In the same spirit, the elimination of inter-provincial trade barriers might also heighten the level of competition, and put additional pressure on the private sector to modernize its machinery and equipment faster.

Restructuring: a new industrial organization. Productivity growth and innovation will not be generated by edicts of governments. They will emerge mainly from the threat of foreign suppliers, and will be the result of a change in the nature of industrial organization. In place of the large national firms that occupied centre-stage a generation ago, one has seen the emergence of looselycoupled local systems of innovation (matching well the capabilities and competences of city-regions and communities of practice within global networks) that have succeeded in breaking down the value chain into a variety of discrete functions. These new systems of innovation have used various forms of linkages (partnerships, affiliates, joints ventures, vertical specialization, specialized suppliers of diverse sorts, etc.) that do not require common ownership, but generate considerable pressure to increase productivity and to innovate.

Governments may have a role to play in facilitating the transition to this new “mode of production” that is blossoming in other parts of the world. Helping these local systems of innovation to emerge and to fit into global networks is at odds with the current mythology built around the creation of “national systems of innovation.” This will call for a revolution in the mindset of Canadian firms that still routinely beg for much protection and substantial subsidies from their governments, and not for help in transition toward a more productive and innovative industrial organization.

The dynamics of the new industrial organization is one based on modularity and competition and neural-net-type innovation systems, based on unrestrained participation in the global markets of ideas, technologies and intermediate commodities. It calls for a co-evolutionary, polycentric governance approach and a mix of institutions that put emphasis on knowledge generation, and use targets not as absolute objectives but as a set of incentives to readjust expectations, change habits and search for a new direction of innovation.

This calls for ongoing discussions with all the meaningful stakeholders in meso-forums capable of focusing the strategic search for the synergies and interactions that are most visible, and the interventions most likely to be effective. Clusters, networks and filières are the new units of analysis, and the most useful meso-forums are likely to be provided by the sort of metropolitan technology councils that the Science Council of Canada proposed in 1984, or through an active strategy of support for business networks.

Reframing: the strategic state. There is also a need to provide a new language of problem definition. As long as the citizenry clings to its utopia of an entitlement to a no-risk world, and to a regime of redistribution to compensate for bad outcomes, it will continue to operate in an irresponsible manner. We live in a high-risk society, and the only reasonable entitlement is insurance to compensate for bad events, as Michael J. Mandel argues in The High-Risk Society.

Expectations are being modified, as we speak, and the sense of entitlement to universal protection against uncertainty is being eroded. Business and industry are more and more faced with the tough realities of international competition, and the nationstate can do little to protect it from having to innovate to survive. But the official rhetoric continues to pretend that this is not happening, and the unrepentant welfare statists continue to preach that it should not happen. The public discourse needs to adjust if the requisite pressure for more risktaking, more entrepreneuship and more ingenuity is to materialize.

This difficult message will have to be conveyed to all citizens and organizations. They have to understand that the more modest and more modern “strategic state” is in the process of replacing the old welfare state, and that it means the end of government as we know it and its replacement by a more open, multi-level, polycentric and less coercive “governance,” based on partnerships among the private, public and civic sectors.

To borrow a phrase from Geoffrey Vickers’ Human Systems Are Different, this paper “is concerned not with solving problems but with understanding situations.” Problem-solving is never more than 15 percent of governance: the rest requires a deeper understanding of less fully describable and less-well-structured realities.

The task ahead is not easy. It will require much experimentation and the acceptance that experiments will differ from sector/region to sector/region and will often fail. Therefore, the guidepost in such experimentation cannot be instant success but minimum regret.

Governance failures cannot be corrected by simply adding on mechanical contraptions. In the end, it requires some reframing, some cultural change. But strategic reframing must be built on restructuring and on retooling. All this requires some virtues not currently in good currency. Patience and compromise are two important ones.