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“THE NEW GLOBAL REALITY: YOU WANT TO BE COMPETITIVE, YOU BETTER BE INNOVATIVE!”

by

The Honourable Kevin G. Lynch

Vice-Chair, BMO Financial Group

to

Institute of Public Administration of Canada L'Institut d'administration publique du Canada

64th Annual Conference

St. John’s Newfoundland August 20, 2012

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THE NEW GLOBAL REALITY: YOU WANT TO BE COMPETITIVE, YOU BETTER BE INNOVATIVE! Introduction

Why does innovation matter so much for our competitiveness today? What is the role of government in building an innovative economy? Where is there scope for innovation in public administration during an era of fiscal restraint? All good, pertinent and challenging questions, and ones with which public servants should be earnestly grappling because getting the answers right will be crucial for Canada’s future.

Long banished to the periphery of public policy and corporate strategy, innovation is

now front and centre, as a core element of the solution to countries struggling with austerity and low growth, and companies confronting stagnating sales, new overseas competitors and declining competitiveness.

The public policy starting point for innovation is the context, and the context we now

face is pervasively global and profoundly changing. Structural trends and seismic events are reshaping economies, societies, politics, power and expectations around the world. And, this changing context is shifting the “drivers of success” for the Canadian economy. Six such pivotal trends include:

o Pervasive globalization: the global center of economic gravity is shifting towards Asia with the rise of dynamic emerging economies in Asia and elsewhere. The “new global reality” is increasingly a two-speed world, where the West is in the slower lane.

o Demographics: for the first time in a very long time, we’re collectively aging in

Western countries, and this will have underestimated consequences for potential economic growth through slowing expansions in the labour force, and for longer term fiscal frameworks through increasing pension and health care costs. One consequence is that the hunt for talent is going global, and the winners, both countries and firms, will be in the driver’s seat in the new global competitiveness.

o Information revolution: from the Internet to Facebook to Tahrir Square, we have

moved from a connected West to a hyper-connected world. This hyper-connected world is changing the reality of what a market is, how markets are accessed, and where work can be done in real-time distributed systems. It is redefining the nature of communications, both the medium and the style of messaging and, as the Arab Spring has demonstrated, anyone with a smart phone is now a journalist.

o The ultimate hang-over: the global financial crisis of 2008 is like the hangover

that will never end, no matter how many aspirins governments and financial systems in many countries take. It has spawned a low growth, low interest rate,

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high volatility environment in the developed world, with continued deleveraging and uncertainty a fact of life in Europe and a lingering reality in the United States.

o The decline of trust: the cumulative effect over the last decade and across

countries of corporate failings, environmental disasters, financial crises, government mishaps and misleading public information has led to substantial and sustained loss of trust by the public in leadership broadly defined.

o New global competitiveness: today, it is increasingly productivity and innovation

that drive competitiveness. In advanced economies, it is less low costs and massive scale and more flexibility and creativity; it is less geography and more capacity.

So, in this future, what will competitive economies look like? Tom Friedman

believes we have progressed to a hyper connected world where, for innovation-driven, global corporations, the mantra is now: “imagined here, designed there, manufactured elsewhere, sold everywhere.” Michael Porter believes we can only have competitiveness with rising living standards in Western countries if we reinvent ourselves as high productivity growth economies, led by innovation. Even President Obama believes that “Innovation is the first step in restoring American competitiveness”.

And why do they all believe that innovation is so pivotal? Simply put, innovation is the ability to create new products or services, produce existing products or deliver existing services in new ways, and develop new markets. Innovation is clearly not the same as research and invention; rather, it is the process of turning new ideas into commercially successful goods and services that bring perceived value to consumers. Or, more colloquially, research is a process that transforms money into knowledge, and innovation is the process that transforms knowledge into money.

Innovation is crucial to the economy because it drives productivity, and a more

productive economy grows faster, adapts better, and supports higher wages, more jobs and improved living standards. It helps answer the question of how a high-wage economy like Canada's can compete with those of emerging countries. It is as much a social imperative as an economic one: increasing productivity growth through innovation raises the living standards of a society just as it increases the competitiveness of an economy.

Where does all this leave Canada? Frankly, we are wedged between the new global reality and an economy that has not stressed productivity, innovation and diversification. Consider a few, rather dismal, facts:

o Canada’s business productivity levels are now only 72% of U.S. business on average, and we no longer have a low dollar to subsidize poor productivity.

o Canada’s business spending on R&D is 1.0% of GDP, well below the OECD average of 1.6%, half that of U.S. business and almost a third Swedish business. Canadian business has the dubious distinction of ranking 20th in the OECD in research, at a time when innovation is the life blood of the new competitiveness.

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o Canadian business spends only 48% as much as U.S. business on ICT (information and communications technologies) and only 75% as much on leading edge machinery and equipment --- both instrumental to productivity growth.

o Canada’s trade is highly concentrated with the United States (over 75% of Canada’s exports), and no dynamic emerging economy accounts for more than 1% of Canada’s exports (save China which is only 3%).

Herein lies Canada’s challenge --- we are a sophisticated economy, with a well-

educated and multicultural workforce, and a very high standard of living. We are one of the great economic success stories. But the global marketplace we operate in is dynamic not static. Competitiveness is increasingly bifurcating into either enormous scale with low costs or high creativity and flexibility with premium prices. In this changing world we are a high wage economy and a chronic underperformer in innovation and productivity. Canada simply cannot sustain above-average living standards and below-average innovation investment and productivity growth, especially with a Canadian dollar around parity, weak U.S. growth and growing demographic pressures.

In this new global reality, Canada is over-invested in trade with slower growing

Western economies and under-invested in continual innovation in the goods and services we produce and how we produce them. What this means is we need to diversify: to shift more of our future trade towards a strategic set of dynamic emerging economies; to focus on the new middle class in these emerging economies, not solely on selling them natural resources; and to change the nature of what we sell and how we sell it, in both our core U.S. market and in the new emerging markets, towards more innovative goods and services that rely on meeting changing consumers’ needs at premium prices.

Innovation Nation: The Challenge Ahead

While Canada has produced world class innovative firms and exceptional innovators,

no one would rank Canada as an “innovation nation” or a nation of innovators. The reality is that Canada’s productivity and innovation challenge runs deep and broad. The keys to its solution lie in many hands --- the private sector, universities, financial markets, individual entrepreneurs and of course the public sector. And, the urgency of greater, faster, and more sustained action rises as the pace at which the global economy is changing, increases.

Getting the “macro conditions right” is absolutely necessary, and Canada has done

well on this front. We have low levels of net public debt, low corporate tax rates, high public investment rates in university research, sound financial system, strong civic institutions and a commitment to fiscal balance, which most governments in Canada are implementing at present albeit at different paces and intensities.

But these are clearly not sufficient for success in creating an innovative and

productive private sector --- the facts above speak for themselves. So what is missing?

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Governments need find the right balance between pressure for change and support to change, both key elements in encouraging firms to innovate. We should not forget the oft-cited observation that “most people don’t change because they see the light, they change because they feel the heat”. Competition and exposure to diverse foreign markets create pressure on firms to innovate and improve their productivity, just as well designed programs and tax incentives can support corporate innovation.

While there are a number of Canadian businesses that have demonstrated exceptional

innovativeness through entrepreneurial risk taking, they are more the exception than the rule. There is not enough competitive pressure in the Canadian economy to drive most firms to continually seek productivity growth and new innovations. As a result, our average competitive performance is well below our best performance.

To be successful at innovation, firms need to organize for it, manage for it, and create

incentives for it. Today, the majority of innovations start with consumers and front line staff, not research labs. But to turn the knowledge of consumer wants or needs into innovative, commercially viable goods and services requires corporate leadership, an openness to new ideas from customers and staff, non-hierarchical channels for expressing them inside firms, and organizational structures within firms to turn ideas into iPods.

Diversity plays an important role in creating inventions and innovations --- the

creative process is anything but linear, and new perspectives, learnings, experiences, backgrounds can provide that creative spark. Immigration provides such talent diversity, and the innovation impacts can be dramatic: between 1995 and 2005, 25 % of all new U.S. high technology firms had at least one foreign-born founder.

Corporate innovation is not the sole preserve of high technology firms; indeed,

innovation can have equal impacts on productivity and competitiveness in the retail sector, the manufacturing and the natural resource sectors. Whatever the sector, what is changing most about corporate innovation strategies is the shift to “open innovation” rather than solely “in-house innovation”. Proctor and Gamble now sources 50% of new products outside the firm. However, no matter how open, networked or collaborative their innovation model, firms still need internal “receptor capacity”--- both organizational and technological --- to be successful at continual innovation.

And governments --- federal, provincial territorial and municipal --- have to be part of

the productivity and innovation solution, not just in the policies they establish but also in the way they work. Government accounts for a sizeable proportion of GDP in Canada, and innovation-led improvements in the productivity of the delivery of government services would improve our national competitiveness. Governments need a productivity focus and lens, just like the private sector; after all, they are huge suppliers of health and education services, security, taxes and pensions, information, regulatory compliance and a myriad of other services --- all of which are amenable to innovation and productivity.

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While we have many programs to encourage innovation, we lack alignment of interests, strategies and support mechanisms across governments, the private sector and the higher education sector. What we need is a clearer “frame”, or ecosystem, around which the various participants in the innovation system can coalesce. While such an ecosystem in reality will be complex, dynamic and somewhat sector specific, it will have core common elements such as a clear sense of collective and individual purpose, active collaboration among private sector firms, governments, universities and financial markets. And the establishment of such alignment and the frame for it requires the use of the “convening power” of governments to engage leaders across the economy.

One possible “frame” for the Canadian ecosystem could include four basic elements:

the “macro innovation environment”, where governments, both federal and

provincial, play a lead role in establishing the public finance, tax, regulatory, competition, trade and broad-based support environment --- the “ objectives and rules of the game” if you will;

the “micro innovation environment”, where universities and community colleges play a lead role in developing the talent and the research excellence Canada needs, and in collaboration with the private sector (not in isolation from), and where governments deploy more customized supports when there are market gaps and a lack of scale;

the “community innovation infrastructure”, where the modern version of industrial policy, that of picking sectors and broad technologies with the potential to win, takes shape, and it brings together at the local level governments, universities, financial sector, mentors, angel investors and peers, all of whom have a key role; and

the “organizational innovation infrastructure”, where firms play the lead role in putting the structures, incentives and capacity in place within corporations (and outside with research centres) to drive continual innovation.

Innovation in Government Besides the framing role for government, the government sector, as you well know,

is a multi-faceted player in innovation through: the public policy it sets; the way it delivers public services; and, the standards it sets for what it buys. The good news is that Canada has some excellent public analysis of what government can do in this regard through the work of the Wilson Panel (The Competition Policy Review Panel, June, 2008) and the Jenkins Panel (Panel on Federal Support to Research and Development, October, 2011) as well as the recent OECD Survey of Canada (OECD Economic Surveys: Canada, 2012). Further, there is much that we can learn from experiments and experience in other countries.

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Drawing on both this research on innovation at home and promising successes abroad, I would offer several areas where the public service itself could examine the potential for innovation and change within government. And I do not think that innovation and austerity are incompatible --- indeed, in flush times, it is more difficult to tackle the status quo not less, and lean times offer more understanding of the need for change as well as the impetus of necessity.

The five areas that I would encourage you to examine are procurement; regulatory

processes; health care delivery; shifting to less indirect and more direct innovation support; and helping SMEs go global. Let’s touch briefly on each in turn.

First, consider the enormous potential procurement has to stimulate and support

innovation, without impeding competition concerns or value-for-money concerns of auditors general. With respect to government procurement, a giant change would be to modify the standard procurement mandate towards something akin to “innovative goods and services at the best price” and away from the current mandate of “goods and services at the lowest price”. This would have a major impact on both start-up firms and established firms that are branching out into more innovative and less standardized products and services.

Second, more efficient processes working backwards from the business or citizen

perspective, using technology to improve the process without any reduction of standards; a slow process is neither a necessary or sufficient condition for a rigorous standard.

Third, we have a great health care system in Canada but the Canada Health Act

(CHA) enshrines principles not the status quo, and there is much scope for innovation and productivity in the way we deliver health care consistent with the CHA. As a very micro example, look at what the application of “lean processes” at St. Joseph’s Hospital in Toronto has done for processing times and patient satisfaction.

Fourth, Canada is an outlier among OECD countries in its reliance on tax

expenditures to encourage and support private sector innovation, and without much evident success. It is timely to consider reducing this excessive reliance on passive tax expenditures, and re-directing support towards targeted, active and customized types of support. This could include experimenting with interesting Israeli and U.S. models of “de-risking” support to venture capital.

And fifth, getting many more Canadian SMEs trading throughout Canada (and

putting pressure on governments to eliminate internal trade barriers as part of the experience), across the NAFTA region and around the world. The experience from other countries is that the more Canadian SMEs engage in trade in new and diverse markets, the more experienced, innovative and productive they will become. But, we still have only a minority of our firms trading outside Canada, and fewer still outside NAFTA, and this could be a useful area for innovation in programs and policies.

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Conclusion To conclude, despite our challenges, there is absolutely no reason for Canada to be an

innovation and productivity laggard. Governments can and should play a leadership role, and it is not all about spending --- part of its role is framing the questions and convening the players. Business, university and labour all need to be part of the innovation leadership imperative. We also need our public service leadership fully engaged – you are a tremendous national resource of knowledge, analysis and policy capacity, and being nonpartisan and without sectoral self-interest, you have a unique contribution to make to the public good of improving Canada’s innovation and productivity.

We all need to make the question “What will it take for Canada to build an innovative

and productive economy?” part of our ongoing public discourse, as well as the continued focus of future budgets and corporate Canada’s strategic business plans.