Fifteen years after the first report on Canada’s competi- tiveness by Michael Porter of Harvard in 1991, Canada’s ability to produce high value-added, knowledge-based products has actually deteriorated relative to that of other countries, according to OECD reports in 2004 and 2006. It is a surge in resource prices ”” not a cornucopia of paradigm-bust- ing ”œmust-have” innovations ”” that is keeping Canadian exports high and bringing in billions of dollars of foreign investment. This despite broader market access through free trade arrangements, lower taxes, increased spending on R&D, and a tremendous number of papers and conferences about adjusting to the global, knowledge-based economy.
One obvious conclusion is that Canada’s piecemeal approach to coordinating its national innovation system (NIS) has failed adequately to serve the national interest. How serious is this? Canada’s innovation performance flies way below its economic rank as a G7 country and is continuing to fall in rela- tion to that of competitors. Canada’s business competitiveness, as ranked by the World Economic Forum, has slipped to 16th. On the OECD database, science and technology (S&T) indica- tors are uneven in that strengths in education are matched nei- ther by proportional S&T spending nor by commercialization of new knowledge, nor by number of R&D personnel or produc- tion of science and engineering graduates and postgraduates (OECD S&T Scoreboard 2005). These indicators matter. They are telling us that Canada is losing its capacity to generate a rela- tively high living standard and that other countries are creating the platforms they need to outperform Canada economically.
Canada has not paid the full cost of its NIS shortfalls yet because of good macroeconomic management, our lucky portfolio of natural resources and economic integration with the US. But the downside is that Canada’s sources of net trading value remain intermediate sub-components for prod- ucts designed and patented elsewhere or resource-based out- puts produced for foreign markets with global capital. Long after the demise of colonial empires, Canada continues to run a substantially colonial economy.
What’s wrong with that is that, first, resources are non- renewable and, second, resources are themselves of value only because others are using them to create products of superior value. There is no convincing sign that the value generated by intermediate product production or resource exploitation is suc- cessfully creating platforms for higher levels of prosperity in Canada. Indeed, Canadian per capita incomes are now signifi- cantly below those in the US and on that measure all but two Canadian provinces rank among the poorest states in the US, according to Roger Martin of the Rotman School at the University of Toronto.
In the past, Canadians sought to overcome the reality of a weak indus- trial sector with protectionist trade policies that effectively raised the price of incoming products so that Canadian domestic manufacturers could com- pete. In today’s economy such strate- gies will fail not only because they fly in the face of sound economics but also because Canada’s domestic economy is not itself large enough to support an advanced economic base of competi- tive scale. Instead, thanks to NAFTA and the World Trade Organization, Canada participates as an integral part of the North American economy, which has made some Canadian firms among the most efficient in the world.
But if those firms are doing things right, the question still remains whether they are doing the right things. Of the Globe and Mail/ Commerce top 50 Canadian firms by revenue, almost all are resource related, in pro- tected service sectors, retail giants or companies that focus on activities whose intellectual property, marketing and financial flows are mainly organ- ized elsewhere. Only 3 of the 13 Canadian firms in the Fortune Global 500 are technology companies (Magna, Bombardier, Nortel). This contrasts starkly with most other G7 countries whose big industries have a heavier S&T presence and therefore a higher propor- tion of revenues generated from S&T- based innovators. Canada’s industrial structure perhaps represents a success- ful commercial adjustment to globaliza- tion in its first phase of regional market openings. Strong companies can grow in Canada. But our economic base is not likely to generate the prosperity Canadians need to meet their social and economic challenges going for- ward. Canadians have no companies of global scale in computers and software, life sciences, pharmaceuticals or any other industry likely to add significant- ly to living standards.
Already, for example, Canada is having trouble meeting the costs of social programs Canadians count on. As our population ages and work- force participation declines, Canada needs to become more innovative and more competitive to make up the dif- ference, just to maintain current living standards. The formula for doing so has so far eluded policy-makers, despite a stream of prosperity initiatives and innovation strategies announced in succession since the mid-1990s.
Before proceeding, some defini- tions and a discussion of terms might be useful. National competitiveness rates the ability of countries to produce high-value products for the global marketplace. National productivity rates the value of outputs compared with inputs either of labour (labour produc- tivity) or labour and capital (total fac- tor productivity). Innovation is the ability to develop new pro- ductive processes and prod- ucts so as to achieve high productivity and competi- tiveness. The link between productivity and living standards is complex. For example, a surge in com- modity prices may raise productivity in that sector, but since that sector is an input to manufacturing, those higher prices may actually lower productivity in the economy as a whole. However, if the higher resource prices stimulate innovation to reduce the need for expensive inputs, the result will be not merely high pro- ductivity overall, but additional com- petitiveness owing to new, cost-saving processes. That higher competitiveness will enable living standards to rise.
National innovation system is a con- cept used by the OECD to group together the elements that make up a country’s innovation capacity, from the education system to the science base to macro and micro demand and much in between. If these elements function synchronously toward the goal of improving national innovation performance, then it is clear that (1) a country actually has a NIS as opposed to simply an array of system elements and (2) when the elements are working together, as a system, they will be mutually reinforcing and generate superior performance ”œfor free” as a result of policy coherence. Examples of successful NISs abound, especially in Asian tigers and Scandinavia, as meas- ured by OECD performance indicators, and backed up by World Economic Forum competitiveness rankings. Unsurprisingly, the US has the most powerful NIS in the world and is par- ticularly outstanding in its ability to commercialize new knowledge, despite weaknesses in public education at high school and primary levels.
Perhaps it’s the success of the US in commercializing innovation, but a lot of policy-makers think an NIS is just gaudy patter for commercialization. Make researchers more sensitive to market needs, and bingo! Problem solved. If that were true, however, Canada would probably be a world leader already, owing to the measures already taken. Experience shows there’s more to man- aging a successful NIS than the relatively simple issue of commercialization. The challenge is one of understanding com- plexity and the gains that emerge from coherence. That’s what generates the positive feedback among system ele- ments ”” gains available for free, as a reward for good management.
To understand what is going on (or in Canada’s case not going on) in pros- perity creation, let us examine more closely the concept of a national innova- tion system. The OECD recently outlined a diagram of a generic NIS (figure 1).
An NIS is a ”œsystem” that enables countries to generate innovation. There is a demand side, encompassing nation- al as well as regional and global con- sumer and industry demand, and a supply side that includes R&D entities such as small and medium companies (SMEs), large companies, research insti- tutes, universities. Market forces typical- ly undersupply knowledge, which for investors may be too easily shared and difficult to evaluate at the level of ideas and early research and therefore only weakly tradable, according to Aghion and Howitt in 1997. Public policy per- forms a dual function: creating induce- ments to innovation and attempting to control the result through regulation and education policies.
An NIS may expend from time to time a larger quantity of resources than it takes in directly. However, in so doing, it generates a profitable return by transforming and energizing the broader economy. Wealth, economic growth, superior competitiveness and ultimately higher living standards are achieved by upgrading and revolution- izing the economy through applica- tions of innovative technologies and organizational change.
The catch is that to deliver on the promise, the system has to work coher- ently and is subject to instability when that coordination is lacking. Indeed, one advantage of taking a system approach to the innovation problem is that it frames and highlights the policy challenge of coherence and coordina- tion. If the aim of the system is to promote knowledge broadening and deep- ening in national industries, public policy has to operate in support of that goal. It makes no sense to encourage post-secondary education and then handicap companies so that they move the best graduates offshore. It makes little sense to expect business to match government funding of R&D unless business can see a rationale linked to wealth capture. If the tax system does not reward channels for exploiting or commercializing the R&D that is devel- oped under a tax credit system, then the R&D will remain unexploited in that jurisdiction.
Regulatory policy, too, must be based on scientific integrity and evidence. Finally, the internal motor of the system is Schumpeterian competi- tion ”” creative destruction of the obsolescent by the new: a witheringly competitive dynamic designed to pro- duce champion enterprises.
A closer look at the NIS diagram suggests how the elements of the sys- tem can easily get out of sync. The good functioning of the NIS depends on two systems cycling together such that each provides positive feedback to the other.
There is an outside, macro system that links (box 1) global demand to (box 2) framework policies to (box 3) the political system and to S&T poli- cies that together create (box 4) the conditions for supplying the infra- structure to enable (box 5) the private sector to satisfy demand. This system has its own output and feedback loops between its components that serve to maintain and increase their performance, but as with many com- plex systems, there is no overall sys- tem controller to set a correct level (deus ex machina or central planner) because the correct level of activity cannot be known in advance. Ultimately, the macro system is directed by the attractor force of global demand, and the components must be able to adjust and co-evolve. The problem is that policy choices can and, in Canada’s case, do inhibit the system’s response.
Supporting the macroeconomic level, and reacting to it, there is an interior system in which (figure 1, box 5) the private sector company system interacts with (6) the education and research system, including (7) interme- diaries, to generate transformative products and strategies to satisfy (1) global demand. In this interior system, the principal actor is (5) the company system, with some resources from (3) the political system. Again, the inter- nal links are non-linear (because, to name just one consideration, they operate at different time scales).
For example, it takes time to train and develop expert researchers and excellence is based on the develop- ment of critical masses of investiga- tors. Yet the ups and downs of the business cycle (or for that matter fads in public policy) can cause surges in supply and demand for technical grad- uates that swing back and forth through science and engineering facul- ties, destabilize research and alter fac- tor costs that in turn feed back upon the business system to affect invest- ment decisions. The US avoids this to some extent by buffers created by supremely well-endowed science and engineering faculties and reliance on foreign students to fill them.
Although the company system is shown as a force that seems to set or accept upper and lower limits of performance to the education and research system, there is again no system gover- nor or controller that knows the ”œcorrect” level of activity at which the education and research sys- tem should be operating. Moreover, the nature of uncertainties intrinsic to knowledge development and value capture explain the two-way arrows between (5) the company system and (4) the support- ing infrastructure.
The two systems are interdependent and linked in ways that make overall coordination difficult with- out a clear sense of national priorities. For example, crucially, for (box 5) the company system to operate effectively, (box 4) the supporting infrastructure must be able to absorb the business risk associated with investing in knowledge-based transfor- mation. Its ability to do so helps set the level of business investment in knowledge development. However, the capacity of (box 4) the supporting infrastructure for risk absorption in turn is directly influenced by (box 3) the political system and in turn by (box 2) framework policies, specifically macro and micro policy. Another important point, as the diagram shows by means of a single-headed arrow, is that the feedback on infrastructure development to the political system derives from sources mainly outside the innovation cluster: cost of credit and the level of competition of the financial services industry is deter- mined by other considerations than impact on innovation. The risk toler- ance in the US financial system arises from its greater breadth, depth, trans- parency and sophistication than any other system, as well as a thirst for innovation born of competition that is unique worldwide.
Canada’s innovation performance provides evidence of deep policy con- flict and lack of coordination within the NIS that impedes the mutual enhancement of the dual cycles within the innovation system. To cite a well- documented few (numbers refer to the boxes in figure 1): framework condi- tions (box 2): the tax system is harsh on capital gains and on recapturing the government interest in R&D and on investment in machinery and equip- ment to the point that it impedes the risk absorption of supporting infrastruc- ture (box 4). Hence business investment in innovation is lower than in compar- ative OECD countries. This affects (box 6) the education and research system. Lack of investment in innovation low- ers wages for researchers and discour- ages enrolment in advanced science degree courses, such that lack of quali- fied personnel in turn discourages investment and further research. Among other consequences, this reduces the political power of science and engineering interests, so (box 3) the STI policies generated by the political system often fail to receive adequate scrutiny. Consequently, there are many flaws in micro-policies related to innovation: e.g., Canada relies disproportionately on universities for early-stage commercial- ization without adequate transitional measures to take innovation from lab bench to capital markets, hence too many small start-ups lack the resources to develop further; Canada’s intellectual property laws are relatively weak, especially in life sciences; govern- ment guidelines for industries whose technology crosses government silos (e.g., environment and industry) are slow to emerge.
Additional barriers to innovation arise from the persistence of bad ideas that still have powerful constituents: overly restrictive rules on foreign investment, especially in financial services, telecommunications, aero- space and civil aviation, and energy generation, for example. These and other regulations can impede industry transformation and competition, and thus local demand for leading-edge sci- ence and engineering solutions. Another problem: technology procure- ment in the heavily government- financed health care system is deficient, hurting suppliers, doctors and patients alike.
Under-investment in science means Canada has a relatively smaller population of engineers and scientists than other G7 countries and top com- petitors elsewhere. Moreover, as Canada spends proportionately less than relatively better endowed coun- tries on the science base, that propor- tional gap is unlikely to close. Consequences at (5) the company sys- tem include relative lack of powerful S&T companies, which in turn affects the career prospects for MBA students who might wish to become managers in such companies, so that Canada has relatively few managers experienced in commercializing S&T products.
This is quite a list (far from com- plete) of policies which may seem adequate in isolation that have cas- cading consequences that destabilize Canada’s NIS. Other dimensions include Canada’s political capacity to handle scientific controversy, the impact of weak intellectual property protection on business strategies, etc. Yet the root cause of this jumble can be traced to a single factor: policy incoherence with respect to innova- tion or, otherwise put, the failure of the NIS managers to find ways to coordinate their efforts so that Canada’s NIS functions as a stable, coherent system with a single objec- tive, namely to enable the national performance in the creation of global- ly traded high-value products to become a national competitive advan- tage with respect to peer countries.
An explanation for this failure is that policy shops in Canadian governments dealing with NIS ele- ments are not rewarded for keeping the full NIS picture in view. Instead, they compete with each other for political attention using economic arguments that stress the importance of single-factor solutions, e.g., more support for R&D, better program sup- port for SMEs or exports by particular sectors, etc. Despite the role of cross departmental agencies and secretari- ats, there is no powerful body in gov- ernment which continually monitors and analyzes the Canadian NIS and rates policy choices based on improv- ing the coherent functioning of the system as a system. To underline a cliché from the 1980s, micro industry policy remains too intent on rowing oar by oar and not enough on steering the boat as a single vessel.
One might well ask whether the incoherence in the Canadian NIS is not offset to a large extent by the degree of integration with the US economy. Canada’s innovative firms operate in US dollars, aim at US-based customers (often performing contract research), seek venture financing in the US, armour-plate their intellectual property rights in the US patent system, draw on a domestic science base with close ties to the great research centres of the US, and seek out top researchers and managers with US experience and professional networks. The Canadian NIS in this perspective is an add-on to the US system in which relatively generous Canadian tax credits and exchange-rate-driven lower oper- ating costs compensate to some extent for the other shortcomings in Canadian innovation policies. Indeed, many Canadian researchers are in fact members of US-based teams and sup- ported by the National Institutes of Science to levels unobtainable in Canada. From this perspective, Canadian innovation is essentially North American innovation. The US is dominant and Canadians are paying a small price to sit at a table at which a great number of players will emerge as significant winners. As to the ”œsystem attractor” ”” global demand ”” Canadian companies have won a con- siderable market share in the US econ- omy by being the most reliable suppliers of sub-components, beating out US domestic and foreign rivals both. Indeed, southward expansion has completely transformed the Canadian economy and made it a lot more competitive than it was a gener- ation ago. But those gains reflect suc- cessful trade policy, not innovation policy, and also the way the world worked a generation ago, before 9/11 (and threats of border impediments) and the entry of the BRIC countries (Brazil, Russia, India and China) as full participants of the global economy.
Also, seeking solace in North American integration assumes the level of incoherence at work in Canadian innovation policy serves some other, compensating national goals. This is in no way the case: it serves no rational policy objective that Canadian output per capita, management education lev- els, and science and engineering popu- lation should be proportionately anything but leading among North America and its main trading partners. Canada’s ability to assert itself in North America’s future depends upon our sci- entific and engineering performance as much as anything else.
What therefore are the major causes of Canada’s continuing innovation policy incoherence? More specifically, why is it so difficult for Canadian tax, regulatory, education and immigration policies to adopt national innovation as one of Canada’s highest priorities and in con- sequence align policies coherently to serve science-based innovation? One reason is that at a conceptual level, innovation is seen as just another claimant on public spending rather than as an activity nourished by com- plex systems in which government’s role is at once subtle yet essential. More crucially, before policy-mak- ers can embrace a systems approach to innovation policy, there must be a shift in the way policy is framed with- in policy circles. To put the problem into OECD jargon, Canada must shift from phase 1 innovation policies that emphasize science and education to phase 2 policies that stress coordination and policy coherence.
To understand how difficult a challenge that is for Canada, consider the following questions:
Who in Ottawa advocates at cabinet level for science and engi- neering values and what induce- ments are in place that evaluate management according to NIS performance?
In all the brouhaha about ”œaccountability” what significant mechanisms are in place in the federal government to promote cross-departmental, comprehen- sive ”œpolicy evaluation” and ”œorganizational learning” at a sys- temic level?
Leading-edge sciences, especially those that cross categories such as life sciences and nanotechnology, challenge cherished beliefs and call out for informed technology foresight in policy-making. How well equipped is Ottawa’s policy machinery for providing leader- ship in these areas?
Unfortunately, to ask those questions is to answer them. Canada’s macroeconomic policy is a success because government learned to con- trol its own spending. But government cannot directly generate a high- performance NIS. To get Canada’s NIS to function with the necessary coher- ence, government has to become as adept at the management of complex- ity and the inducement of system coordination as it now is at manipulat- ing macroeconomic levers.