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-aÌ€-vis many OECD countries. Therefore, there are rea- sons 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 pro- ductivity growth and innovation, it might be expected that private, public and social agents would invest the req- uisite 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 per- ceived 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 produc- tivity enhancement and innovation is that those investing will not necessarily capture the full benefits of their invest- ment 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 produc- tivity of 2 percent if the US were persuaded to invest 1 per- cent 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 ”œaging 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 ”œa decline in risk-taking, clinging to old techniques even when new and more economical (ones) are available, resist- ance 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 agen- da, 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 under- stand 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 plagu- ing a major segment of the economics profession. It has led too many econo- mists to occlude from their radar screen issues of productivity and innovation because of the elusiveness of these top- ics. Even though it is clearly appreciat- ed 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 under- stood and appear so diffuse ”” the research results about these issues so inconclusive, the measurement prob- lems so daunting, and simple mechani- cal solutions so unavailable ”” that economists have tended to direct their research attention toward the ”œfirmer terrain” of fiscal and monetary policies, and the magic of fiscal and balance-of- payments 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 ”œcult of efficiency.” These forces are powerful in the United States but they are even stronger in Canada. This is sig- nificant because economic growth, through the strong pressure of demand that it generates, ignites more competi- tion for resources, and a more forceful push to reorganize the processes of pro- duction in the face of scarcities.

The third one has to do with pub- lic officials’ fundamental lack of appre- ciation of the central importance of preceptoral politics as part of their bur- den of office. Leaders must be educa- tors, animateurs, persons called upon to reframe the citizen’s views of the public realm, to design the organiza- tion of mutual education, and to ”œset 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 ”œenlightened understanding”: what would lead citizens to choose with ”œthe fullest attainable understanding of the experience resulting from that choice and its most relevant alternatives.”

The role of public officials in edu- cating individuals in their mutual and civil commitments has clearly atro- phied. Most officials in Canada have been passively recording the results of opinion polls, and have not shouldered their responsibility as ”œpreceptors,” alerting citizens to the importance of productivity gains and innovation.

Progress is made in generating productivity growth and inno- vation when individuals and organ- izations actively apply their entrepreneurial intelligence, inge- nuity and imagination to better coordinate existing activities, or to fill gaps in such coordination in the name of making better use of exist- ing 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, ”œenabling resources” that are at the core of what Alfred Marshall called ”œorganizational 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 net- works, effective governments as facili- tators and catalysts, etc.) that provide material and psychological infrastruc- tures 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 inno- vating in order to survive.

Economists have been rather reluc- tant to probe the murky terrain of these ”œinterpersonal enabling resources.” It has often been left to political scientists like Thomas Homer-Dixon or Francis Fukuyama, or to some maverick econo- mists like Harvey Leibenstein to explore this socio-psychological and organiza- tional underground. Their work has shown that there are identifiable forces, institutions and contexts that tend to promote a greater degree of entrepre- neurship, 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 produc- tivity growth and innovation processes calls for a fuller recognition of the block- ages built into the ethos and in the insti- tutional setting, and a better appreciation of the full potential of competition.

Over the long run, a socio- economy’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 Régime (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 con- straint being met. It was a safety-first ethos. In the century preceding Confederation, that ethos changed. One saw the emergence of a Régime Moderne ”” the percolation of institutions like the limited liability company and other social technologies that attempted to ”œmaximize (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 Régime Contemporain (what has come to be labeled the wel- fare state) ”” a set of institutions designed to reduce risk of societal and individual disasters, subject to a mini- mum 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 insuffi- ciently (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 con- cern about productivity was ”œmanufac- tured” by large business and wealthy Canadians, and that productivity and innovation were the priorities of Bay Street, not Main Street.

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In Canada, a Nouveau Régime ”” 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 envi- ronment 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, oli- gopolistic 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 routiniza- tion 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 com- mercialization and dissemination of new technologies, allows both for some inter- nalization 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 medi- um-sized firms are integrated horizontal- ly and vertically in structures of production that put a fair bit of pressure onto them to continually improve pro- ductivity and to innovate, as Raghu Garud documents in Managing the Modular Age. To the extent that these real- ities are not as extensively developed in Canada as in other countries, there has been less pressure to facilitate the emer- gence 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 com- petition 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 innova- tion do not keep up with competitors, this reality is now upon us.

This will entail a major reframing of Canadian perspectives, much restructur- ing 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 ”œwhat busi- ness 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 gener- ous 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 ”œthe R&D environment.”

This has already begun, with initia- tives in respect to research infrastructure like the Canada Foundation for Innovation. But it must also mean that ”œgovernments 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 rent- seeking activities, and so there must be a concurrent effort to increase the com- petitive pressure. This will come with the necessary liberalization of Canada’s restrictions on foreign direct invest- ment, 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 elim- ination of inter-provincial trade barriers might also heighten the level of competition, and put additional pres- sure on the private sector to modernize its machinery and equipment faster.

Restructuring: a new industrial organi- zation. Productivity growth and innova- tion 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 loosely- coupled local systems of innovation (matching well the capabilities and com- petences of city-regions and communi- ties of practice within global networks) that have succeeded in breaking down the value chain into a variety of discrete functions. These new systems of innova- tion have used various forms of linkages (partnerships, affiliates, joints ventures, vertical specialization, specialized suppli- ers of diverse sorts, etc.) that do not require common ownership, but gener- ate considerable pressure to increase pro- ductivity and to innovate.

Governments may have a role to play in facilitating the transition to this new ”œmode of production” that is blos- soming 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 ”œnational sys- tems 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 unre- strained participation in the global markets of ideas, technologies and interme- diate commodities. It calls for a co-evo- lutionary, polycentric governance approach and a mix of institutions that put emphasis on knowledge generation, and use targets not as absolute objec- tives 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 filié€res are the new units of analysis, and the most useful meso-forums are likely to be provided by the sort of metropoli- tan 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 lan- guage 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 com- pensate for bad outcomes, it will con- tinue 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 entitle- ment to universal protection against uncertainty is being eroded. Business and industry are more and more faced with the tough realities of interna- tional competition, and the nation- state 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 risk- taking, more entrepreneuship and more ingenuity is to materialize.

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

To borrow a phrase from Geoffrey Vickers’ Human Systems Are Different, this paper ”œis concerned not with solving problems but with under- standing situations.” Problem-solving is never more than 15 percent of gov- ernance: 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 cor- rected 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.

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