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Is Canada still in the ring?   |  July 1, 2007  

Canadian productivity is lagging the U.S. and every year we lose a little ground. Technology may be both the problem and the solution

by Danny Bradbury

 
It was a memorable year in Canada: 1981. Calgary was awarded the contract for the 1988 Olympic games, the Canadarm was used for the first time aboard a space shuttle and Canada finally agreed on how to patriate the constitution, giving us political independence from Britain. But what stands out in James Milway’s mind more than space exploration, sports or constitutional politics is the country’s gross domestic product (GDP)—or rather, the difference between ours and that of the U.S.

Milway, Executive Director at the Institute for Competitiveness and Prosperity, uses GDP as a benchmark for assessing productivity. “It measures what you’ve added in value to your resources,” he said. “It looks at how much you’re selling to Canadians and foreigners and how much you’re making from the markup on that.” It is also a fairly uniform measure across countries, he said, adding that it correlates closely with wages. This makes it a good way to measure competitiveness at a national level.

Superficially, Canada’s productivity in GDP terms looks healthy. At $42,500 per capita (2005 figures) it is second only to that of the U.S. Placed in historical context, however, it has taken a battering. In 1981, our per-capita GDP was $3,300 less than that in america. In 2005, the gap had widened to $9,200, and in spite of our general economic health, it has Milway fuming.

“We’d be happier if we were pursuing our productivity and prosperity agenda with a little more resolve than we are, but it’s hard when things are going so well,” he said. Milway doesn’t believe Canada need settle for second place. “I don’t think we should be satisfied to be so far behind the Americans when we drift a little further each year.”

Timid Canadians, bad tax plans
How did we get to this point? Let’s take another look at 1981: the launch of the IBM PC. Desktop computing was to be the catalyst for the development of a technology sector that would change the way we work.

And technology has transformative potential, said Andrew Sharpe, executive director of the Canadian Centre for the Study of Living Standards. “Technological progress is the driver of productivity growth,” he said. “New equipment embodies technological progress. You need new machines if you’re going to get gains in productivity.”

And yet canada is dramatically under investing, both in technology, and in machinery and equipment in general. In 2005, the average investment per worker in ICT-related equipment in the U.S. was $3,200. In Canada it was just $1,800. Again, this gap has widened since 1981 when it was closer to $500.

What gives? the average canadian likes gadgets as much as the next person, but we don’t seem willing to spend money on them. “canadians are more risk averse, less entrepreneurial, a little less willing to bet the farm,” said Brian Guthrie, who directs activities in innovation and knowledge management at the conference Board of canada.

And then there is the way we tax our ICT investments, said Bernard Courtois, president and CEO of the Information Technology Association of Canada (ITAC), a lobbying group for Canada’s ICT industry. The problem is that large parts of Canada still apply provincial sales taxes to large areas of software and hardware investment, he said. If these purchases were classed as value-added taxes, they could be charged back to the government by business customers. But as it is, businesses wanting to invest in ICT must shoulder an associated tax burden.

Some provinces are moving to change this. Atlantic Canada and Quebec have harmonized provincial tax with the GST and have established a value-added tax on all ICT investments, he said, while B.C. has at least harmonized software tax.

Ontario has made some moves to grease the ICT wheels. For example, the Ontario government pledged in its last budget to eliminate capital tax in Ontario by 2010, instead of 2012 as it had previously planned. Capital tax, levied on corporations based on how much capital they have deployed in the organization, has been criticized by the Fraser Institute as unfair to growth-intensive industries such as IT, that involve a lot of capital outlay. But it still lumps all ICT investments in with PST, Courtois said. “It’s a sales tax, which becomes a tax on investment.”

David Ticoll, chair of ITAC’s Competitiveness and Productivity Council, said the move to a software as a service model (SaaS) will help increase the level of investment, especially among small businesses. SaaS providers take software formerly run on expensive servers in a company’s offices and run them from servers in their own data centres. This eliminates the need for expensive infrastructure at the client end, and in some cases enables them to shift what would have been capital expenditures from the balance sheet onto the profit and loss side as an operating expense. This move is being partially driven by vendors that are “topping out in terms of the large enterprises, and now they’re doing a lot to target [the SMB] market. They’re putting resources into it,” Ticoll said.

But while giving small businesses the chance to use Internet-based computing services will open some doors, it is a model that has been tried before. At the turn of the decade, application service providers (ASPs) were trying to do exactly the same thing under a different marketing moniker.

Innovations fly away
While our general business investment in IT languishes, we’re also performing poorly when it comes to investing in our own technology sector. “Far too many ideas developed in Montreal or Vancouver are being commercialized by people in Boston or Raleigh, North Carolina,” said BCE president Michael Sabia in a speech at the Canadian Club last September. “Depriving our economy of the benefits of innovation; denying our businesses the rewards of their own R&D; and making Canada less competitive.”

The figures bear this out. According to the Leaders’ Roundtable on Commercialization (LRTC), a panel of 50 business leaders formed by the Conference Board of Canada in 2004, Canada is lagging behind Europe in commercializing innovative products. Only four Canadian firms in 10 generated more than a quarter of their sales from innovative products, compared to seven in 10 European firms. Conversely, almost six in 10 Canadian firms got less than 25 per cent of their sales from innovative products, compared to three in 10 European firms.

The LRTC is calling for more global investment money to help bolster Canada’s innovative industries. “Availability of venture capital may be a partial indicator of the risk aversion of Canadians,” said the Conference Board’s Guthrie. He said the average VC funding round in Canada raises one third the capital of the average U.S. deal, “and yet I can’t see that it costs less to get a business going in Canada than the U.S.”

But the government isn’t helping, experts said. Ken McKenzie, a professor of economics at the University of Calgary and fellow in residence at the CD Howe Institute, said here again there is a tax problem, this time through a federal tax regime supposedly designed to support research and development.

R&D tax credits are partly refundable and can be claimed back as cash, but this applies only to very small businesses. Medium and large companies are unable to do the same; they must instead write R&D tax credits against their taxable income, rather than claiming back the cash. That’s fine if you’re making a profit, but next to useless if you’re operating at a deficit, as many R&D-led firms are. If they’re not making a profit, then they’re not paying tax and they need cash, not credits. “The larger companies that are relatively profitable benefit. The smaller companies that are just beginning and aren’t paying taxes benefit. But there is this middle layer of medium-sized companies that don’t immediately benefit from the tax credit,” McKenzie said. And yet it is those medium-sized companies, trying to get new innovations to market, which need the break.

Milway’s solution is simply to remove the barriers. “What the government ought to be doing is making the tax system as neutral as it can be,” said Milway, who dismissed special tax credits and instead wants to level the playing field. “Much better to have a low tax rate on business overall.”

But some observers point out the economic conditions here are different than in the U.S. It’s easier to simply let the market take care of itself when a large military budget has plenty of technology firms lining up at the trough. Others argue that we need a more centralized direction on the part of government—a vision that will establish centres of excellence in the Canadian technology sector and promote them on the national stage. Finland, for example, is known for its mobile data technology.

Missing a Canadian vision
What are we known for? “In Canada you have to look at where you have the potential to be world leading, and then because you spend on R&D anyway, you encourage collaboration between educational institutions, government and the private sector,” Courtois said.

The tech sector was a centre of excellence thanks to companies like Nortel, according to Guthrie. “That was driven by need, by distance, of course. We lost that one, just like we’re in the process of losing fuel cells.” Guthrie advises picking four or five development areas that could be potential centres of excellence. Ideally, they’d be integrated enough so that the whole would be more than the sum of the parts, but connected loosely enough that if one or two didn’t develop, the others wouldn’t suffer. “It’s more than a cluster, it’s a full integration supply chain in a global market as well,” Guthrie said. He acknowledges Stephen Harper’s attempts to talk up Canada as an energy superpower, but said he needs to focus and suggests sustainable clean energy as an example.

Ireland is a case in point. Years ago its economy was in the hole and its young people were leaving. Then it decided to focus on software and became the jumping-off point for North American firms wanting to break into Europe. It’s a centre of excellence in localization services, for example.

“What about a vision? The thing that comes to my mind is running a railroad across Canada. That’s probably the last time we had a Canadian vision,” Guthrie said. “What really caused them to do it faster is that they were excited and fired up about it.” But then, Canada was an infant nation then, with different priorities and problems. Who’s going to step up this time?

SIDEBAR

Investing in people
 
Underinvestment in ICT is only half the problem for Canadian businesses, according to Doug Cooper, general manager of Intel of Canada. “We have an interest in increased investment, but the root of the problem is this issue of not having made the transition to a knowledge economy,” he said. What Canada is lacking is the management skill to capitalize on these investments. “You can’t just stick a laptop in someone’s hand and expect him or her to be productive.”

Where will these skills come from? “The issue is not in the area of the ICT specialists. The issue is in the non-digital literacy of the average employer in Canada,” said Paul Swinwood, president of the Information and Communications Technology Council. He said small businesses in Canada don’t have the time or money to train non-technical people on the job. “They’re not putting in place the ICT skills to move their companies forward and increase productivity.”

Swinwood said tomorrow’s ICT skills will focus on business relevance, as executives will need both a sound understanding of business and a robust knowledge of ICT. “You can always get software coded in India, China or Belarus. But making it work in the companies in the actual applications is probably where we’re going to be playing."

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