BUSINESS

ON THE BRINK

A new report, three years in the making, paints a stark picture of Canada’s lagging performance and provides a road map for future economic success

PHILIP PREVILLE November 27 2006
BUSINESS

ON THE BRINK

A new report, three years in the making, paints a stark picture of Canada’s lagging performance and provides a road map for future economic success

PHILIP PREVILLE November 27 2006

ON THE BRINK

A new report, three years in the making, paints a stark picture of Canada’s lagging performance and provides a road map for future economic success

PHILIP PREVILLE

BUSINESS

EXCLUSIVE REPORT: HOW TO FIX CANADA

“We don’t work enough.” So said former Quebec premier Lucien Bouchard last month in a televised interview, tongue-lashing Quebecers for their poor work ethic. The province’s economic situation, as he saw it, was akin to treading water: people had grown accustomed to a comfortable standard of living based in large part on government programs and services— everything from education to health care to generous public pensions—but had given little thought to how those bills get paid. “There is a level of comfort [right now] that is dangerous because the days ahead will not be easy, they will be very difficult,” he said. His solution: “We must work more!”

Bouchard was half right, and not just about Quebec. Canada’s economy has been underperforming for years. But the fix isn’t

for all of us to put in extra time at the office. Canadians already have among the longest working weeks in the developed world, with more hours and less vacation time than most. On average, Canadians work roughly the same hours as Americans. The real problem is that, during those hours, we produce 20 per cent less output. Canadians don’t need to work harder. We need to work smarter. How to do that, and thereby turn Canada into the most successful country in the 2lst century, is the subject of a soon-tobe-released Conference Board of Canada Report, three years in the making: “Mission Possible: Sustainable Prosperity for Canada.” On the surface, things look pretty good. Canada is enjoying low unemployment and low inflation. Our currency is stronger than it’s been in a generation. Corporate profits

have been at a steady high. Ottawa keeps racking up huge budget surpluses.

But in comparison to our global peers, Canada’s economy shows signs of trouble and neglect. Twenty years ago, Canadian average income was $2,000 less than that of the average American; by 2003 the gap had widened to a whopping $6,000, and growing. In 1990, Canada ranked fifth in the world in per-capita income; now we sit in 10th spot, surpassed by such countries as Ireland, Norway, the Netherlands, Denmark and Australia. The value of our exports has been growing, but that growth has been fuelled almost entirely by energy and mining, as the world buys more of our resources, and relatively less of everything else. Our exports of goods to the United States, which stood at $359 billion in 2000, have merely held steady, chiming in at $366 billion last year—even as consumers in America, Canada’s largest trading partner, have been on an extended spending spree. Other measures are just as worrisome: for years we have lagged behind others in the pace of our economic growth and

productivity growth, and our share of foreign investment has also been sliding downwards for nearly two decades.

It sounds like the kind of joke Canadians love to tell about themselves. Hey Canada, how are you doing? Moderately well, under the circumstances, and improving, but slower than most, relatively speaking. Indeed, by some measures, Canada appears to be taking a beating in the global marketplace. The IMF, in its September World Economic Outlook, predicts that 135 other countries’ economies will grow faster than ours in 2007 Our GDP has fallen below two per cent of the world’s total, still large enough to rank us eighth largest in the world. But we are slipping in the global rankings and, with countries such as Spain, Mexico and Brazil gaining fast, our place at the G8 table is increasingly more symbol than substance. (The Spanish media has been openly advocating that they should replace us in the G8.) “Nothing in our economy is broken,” says Conference Board vicepresident and chief economist Glen Hodgson, “but nothing is optimized either. And we are losing ground as a result.”

In 2003, the Conference Board, an Ottawabased, non-partisan think tank whose mission is to bring business people and policymakers together, realized that things were

amiss and decided to act. In regular discussions with senior business and government leaders, a disturbing consensus emerged: even though the economy appeared to be firing on all cylinders, Canada was adrift. “We were a wealthy nation with no clear vision of how we fit into the world, and no plan for ensuring our continued prosperity,” says Hodgson. In response, the Conference Board launched the most ambitious initiative in its 50-year history: the Canada Project, a three-year research program that would take off the rose-coloured glasses, provide an honest assessment of where Canada stands, and chart a course for the future.

The Canada Project’s final results are now in, with the forthcoming release of “Mission Possible: Sustainable Prosperity for Canada.” The three-volume report, released exclusively to Maclea?i’s in advance of its January publication, is perhaps the most comprehensive attempt to reimagine the

Canadian economy since the Macdonald commission more than 20 years ago. While that report’s bold stroke was to propose free trade with the United States, a major theme of “Mission Possible” is that the NAFTA agreement is past its due date: the changing global economy is rendering it insufficient.

Back in the 1980s, the G7 countries were the only ones that really mattered: accounting for the vast majority of the global economy, they were the focus of our trading efforts. Today, emerging economies—spurred by growth in Latin America and Asia, particularly China and India—now account for more than half of the planet’s economic output. “The tectonic plates of the global economy have shifted,” says Hodgson. “This change is permanent.”

Yet it’s not a kill-or-be-killed battle of the fittest, where he who works most wins. This is where Bouchard has it all wrong. Merely

piling on the overtime is no solution. South Koreans try to compensate for their low productivity by working vastly more hours, but they still end up with incomes that are a fraction of Canadian levels. A better approach for Canada is to emulate countries such as Norway, Ireland, the Netherlands and Denmark: all have strong social programs, enviable records for environmental sustainability, and workforces that are more productive than Canadians. That translates into a better standard of living: they work fewer hours and still generate more income per capita.

“No one has been talking about our economy being adrift, but it’s an absolute fact,” says Hodgson. “The things Canadians cherish—our standard of living, our natural environment, our health care and public education systems—will become unsustainable if we don’t act now.”

“Mission Possible” sets out five key areas for improvement:

1. Creating a Canadian common market:

Other countries are coming to grips with a changing world, but Canada doesn’t have a game plan. Given that trade policy hasn’t been a priority in Ottawa for over a decade, some might say we don’t even have a clue.

It was back in 1984 when Prime Minister Brian Mulroney declared, in a speech to New York’s business community, “Canada is open for business.” When the ensuing Free Trade Agreement, and later NAFTA, came into effect, most Canadians believed that the complex, sometimes fretful job of opening up our economy—removing tariffs and allowing the free flow of goods, services and investment—was over and done with. And people joked that maybe, one day, we’d have

CANADA IS STILL a G8 nation—barely. And not for much longer.

free trade between the provinces too. Two decades later, it’s no laughing matter, says “Mission Possible.” Every day, Canadian businesses fight through a tangled web of socalled non-tariff barriers: each level of government forces companies to re-register their business and re-license their staff, subjects them to its unique approvals processes, procurement policies, technical requirements and environmental standards, and establishes its own disclosure and privacy regimes —often for the sole purpose of protecting a local industry from competition.

“Canada is trying to compete in a global economy,” says Hodgson, “but we make it difficult for companies to even do business in a neighbouring province.” Fully one-third of all businesses surveyed by the Conference Board said non-tariff barriers hindered their competitiveness, while 26 per cent said they had lost business because of them. The barriers are especially detrimental to small business: a 2004 study by the Canadian Chamber of Commerce found that firms with less than 50 employees were more likely to abandon operations in provinces where they encounter a trade barrier. No surprise, then, that “Mission Possible” calls for the longoverdue creation of a common market within Canada, similar to the European Union.

Alberta and British Columbia put an end to those problems earlier this year when they signed the Trade, Investment and Labour Mobility Agreement, or TILMA—a wide-ranging pact that, in the words of Alberta Intergovernmental Affairs Minister Gary Mar, “will create the second largest economy in Canada,” surpassed only by Ontario. The Conference Board predicts that removing barriers between the two provinces could add

as much as $4-8 billion to Canada’s GDP; B.C. predicts TILMA will create 78,000 jobs there. The TILMA agreement says that any other province willing to sign on must automatically be accepted, and Saskatchewan, Manitoba and Ontario have all mused about doing so. “Mission Possible” is calling for more bold steps like TILMA.

Creating a Canadian common market also represents an ideal opportunity for enshrining principles of sustainability in the national economy. Surveys conducted by the Conference Board show that businesses are less concerned with what regulations say than with the time and cost of complying with them. In other words, they’re glad to conduct the environmental assessment, but would prefer to have the feds and provinces agree on a single, common set of standards. “The common market is an opportunity to establish a new vision for environmentally sound growth and development, and to apply that vision across the country,” says Hodgson.

2. New ideas, please—encourage innovation: Canada ought to be a global leader in innovation. Our workforce is highly educated, we rival the world for technological savvy in many industries, and we have one of the most generous tax regimes for research and development. And yet, like a rocket ship idling on the launch pad, our innovation efforts have produced surprisingly poor results.

There are some obvious trouble spots when it comes to Canada’s ability to innovate. We score poorly in our collaborative efforts between business, government and universities, and we have fewer researchers in our labour force than we should. But the biggest problem is that—despite the favourable tax treatment—Canadian businesses lag behind most of their OECD counterparts in R&D spending, and the proportion of our GDP that we spend on R&D has actually been declining since 2001, while that of many European countries is on the rise.

Research suggests that innovative com-

panies are more successful than others: they grow faster, are more productive and generate higher-paying jobs. And when innovations are converted to marketable products and services, they can also spur trade and prosperity. Think Sweden and Finland: both countries helped develop cellular technology, and as cellular phones have proliferated worldwide, they continue to reap the benefits of research leadership. Canada is reaping the same benefits from its signature innovation success in wireless communications: the BlackBerry. “We should have dozens of BlackBerry-style success stories,” says Hodgson. “We ought to imagine our future as the BlackBerry economy.” We ought to be developing new technologies, registering patents, starting up businesses and sellling our innovations worldwide.

“Our economy represents about 1.8 per cent of global GDP, and that’s not likely to grow,” says Hodgson. “The real question is, what is the best way to ensure it doesn’t shrink further? What will our 1.8 per cent look like 20 years from now? Will it be oil, lumber, metals and other raw materials? Or will it be innovative products and services that people around the world will pay a premium for?”

3. NAFTA is no longer enough—reinvigorate trade with America, while making China our next great trading partner: In 1993,74 per cent of all Canadian exports went to the United States; by 2005, that figure had risen to 84 per cent. And yet, according to “Mission Possible,” “NAFTA is a mature agreement that has largely stalled.” One problem is that, even as

Productivity and output

How leading countries compare. US = 100.

our U.S.-bound exports have gone up, their profile has been changing, and not for the better: we are becoming more hewers of wood and drawers of water, not less so. We are sending the Americans more and more raw commodities (oil, natural gas, metals and other resources) and a smaller proportion of manufactured goods. Trade in services (everything from call centres to financial services), never strong to begin with, has also seen a relative decline. Services exports now stand at 12.5 per cent of our total, well below the OECD average of 22 per cent. This trend is particularly worrisome: the services sector now makes up two-thirds of our domestic economy, yet we haven’t figured out how to export it. A whole segment of potential export growth and wealth creation is going unfulfilled.

Meanwhile, outside NAFTA, the world economy has undergone a vast metamorphosis. China has grown into a trading giant. India is becoming a global leader in the services trade. The European Union is bringing growth to onceperennial underperformers such as eastern Europe and Spain; the latter’s economy has grown to roughly the same size as Canada’s. The United States has made a higher priority of trading bilaterally with emerging players, and some of their trade agreements may prove more comprehensive than NAFTA, putting Canada’s preferred status in the United States at risk. Indeed,

China will soon supplant us as America’s top trading partner. As “Mission Possible” puts it, “We risk becoming just another spoke in America’s preferential trade wheel.”

The first step to addressing this problem is for Ottawa to make trade policy a priority once again. Successive federal governments have allowed us to lose focus, with some unpleasant consequences. Canada is no longer part of “the Quad,” the informal leadership group once made up of Canada, the United States, Europe and Japan, which traditionally steered key international trade meetings. Australia, with a stronger commitment to free trade and stronger ties in Asia, has essentially usurped our spot. We may soon find ourselves crossed off another guest list: our sliding global ranking will make it difficult for us to hold on to our seat at the G8 table.

But our crucial trade relationship remains with the Americans. As Hodgson points out, every day in this country, millions of people wake up and go to work, and their jobs are all about one thing: America. Ottawa must

take action to maintain and strengthen that relationship. The effort starts with ensuring a seamless border. “Anyone who has travelled through the Detroit-Windsor corridor knows how fragile the border situation is,” says Hodgson. In addition to hindering existing

trade, decaying infrastructure and customs delays also hamper investment: increasingly,

Canadian businesses seeking to expand into the U.S. market would rather build new facilities there than expand existing operations in Canada. A seamless border means making major infrastructure investments: fixing roads and bridges, but also developing better systems for reporting, scanning, and preclearance. It also means taking America’s security concerns seriously, co-operating on matters of immigration, intelligence gathering and security control.

The Canadian economy needs to develop its capabilities in services exports, and NAFTA’s provisions for service industries can be greatly expanded, especially in transportation: opening up the commercial air, truck-

ing and maritime industries would spur investment and help create a seamless network of transport corridors between both countries.

“Mission Possible” says that deepening NAFTA should be a top priority. But here’s the tricky part: “We need to devote the same efforts and resources to China, on the same massive scale,” says Hodgson. Our share of global exports and investment to China has actually been on the decline, and we are no longer among China’s top 10 trading partners. “China sees us as a source of energy and raw materials,” says Hodgson. “Anything else we send there is basically by accident.” Trade policy should be geared towards facilitating exports of services, and also importing components to reduce the cost of goods manufactured in Canada—a way of making China’s manufacturing prowess work for us. “Mission Possible” argues that “every serious Canadian company of material size should be attracting in-house China expertise.” The report also recommends pursuing trade with India and other emerging nations in Asia and Latin America, as well as renewing relationships with old partners in Europe and Japan.

But trade deals aren’t what they used to be. Canada, with a market of a mere 32 million people, faces a paradox: countries willing to pursue bilateral negotiations with us tend to be marginal, while the larger players we want to engage are less interested in negotiating with us alone. What’s more, an international trading system based upon hundreds of overlapping bilateral agreements — derisively known as the “spaghetti bowl”—is not in Canada’s interests. Rather than go it alone, “Mission Possible” recommends that Canada push for NAFTA to become a negotiating bloc, establishing common region-to-region trading terms for all member nations.

Canada can also stay in the big leagues by pushing for league expansion: think beyond the G8, and turn the “Group of 20” finance ministers and central bankers into a higherlevel “Leaders 20” gathering. Faced with being voted off the G8 island, we have to build a new, wider circle of influence.

4. They don’t trade like they used to—in the new era, we need more foreign investment:

Most people think of international trade as a simple accounting ledger: “Exports good, imports bad,” as Hodgson puts it. The con-

Nothing in our economy is broken, but nothing is optimized either. We are losing ground as a result.1

ventional wisdom is that, so long as we do more cross-border selling than buying, we’re fine. Global trade simply doesn’t work that way. Today, it’s all about integrative trade, a term coined by Hodgson (and now in increasingly widespread use) to describe the way companies actually operate: they create exports by importing components from numerous foreign countries, invest in facilities abroad, attract foreign investors for their home operations, sell products through foreign affiliates, and outsource services to offshore partners. The auto industry illustrates the concept: historically speaking, Canada’s largest export has been cars and car parts, and its largest import has been—wait for it—cars and car parts. It’s all part of a larger process: firms like Ontario’s Magna International export parts to the United States, where they are combined with other parts from around the globe to make larger components— seats, dashboards—which are then shipped back to Canada for assembly into a finished automobile, which is itself exported back to the U.S. A typical car manufactured in Canada contains only 45 per cent “Canadian content.” The same goes for other manufacturing sectors of the economy, whose average domestic input is only 51 per cent.

Generally speaking, the more complex the final product, the more likely its supply chain of parts and components will reach outside

Canada has the second-highest level of statutory restrictions on foreign ownership in the OECD

Canada and around the world. Research in Motion, the Canadian inventors of the BlackBerry, have a global network of suppliers who produce components and ship them to Waterloo, Ont., for final assembly. The same goes for Bombardier. Canadian manufacturers, whether they make parts, components or

finished products, are increasingly integrated into global supply chains.

At the heart of integrative trade lies the touchy phenomenon of foreign direct investment, or FDI. FDI is already integral to our economy: estimates suggest that as much as 40 per cent of our bilateral trade with the United States is intra-firm, with companies such as DaimlerChrysler moving components and finished products back and forth across the border. The hand-wringing over foreign takeovers that is so common in Canada doesn’t come naturally to some other countries. The U.K. maintains the most welcoming regime among OECD nations for attracting FDI. And when American investor Warren Buffett purchased Israeli toolmaker Iscar for $4 billion in September, Israel’s prime minister called the sale “a great boon to the Israeli economy.” Canadians need to recognize how FDI has changed. “Companies used to use FDI to get around trade barriers,” says Hodgson. “If they couldn’t export products to Canada because of tariffs, they would invest in a branch plant. Today, firms use FDI to position Canadian capability into their global supply chains. They invest here if they believe Canada can help them compete globally.”

But what if we can’t help them compete? Over the past generation, Canada’s share of inbound global FDI has actually declined, from 6.4 per cent in 1990 to 3.4 per cent today. Surveys show that investors find Canada an “average” place to invest. If Canada wants to become a major player in this game and start attracting a greater share, says “Mission Possible,” we should start by removing the impediments. Canada has the secondhighest level of statutory restrictions on foreign ownership among OECD nations—particularly in financial services, media and telecommunications—and one of the OECD’s highest marginal tax rates on capital investment.

We must also turn our attention to the other side of the FDI coin: given the wealthy country that it is, Canada is a surprisingly weak foreign investor. Though we recently crossed the threshold into investing more abroad than others invest here, Canadian businesses could do a far better job of investing abroad to establish their own global value chains. Nearly half of our outbound FDI is in the United States, and much of that is in the financial services industry. The key is to encourage more firms in more industries to invest abroad by establishing the policies and support systems they need, such as signing foreign investment protection agreements (FIPAs) with key nations. FIPA talks have begun with India and China, and they should be a top priority.

5. Our aging labour force—we need more seniors at work: In 2007, the first wave of baby boomers—the population swell born during the post-war period roughly between 1946 and 1966—will turn 61 years old. As it happens, 61 is the average age at which Canadians retire. Next year, boomers are likely to begin exiting the workforce in droves. “We have, at most, 10 years before the wave starts undermining our economic performance and social well-being,” says Hodgson.

There are currently five working-age Canadians for every person over 65. But low fertility rates mean that, as more people retire, the growth of Canada’s workforce will slow to a trickle. Over the next two decades, the workers-to-seniors ratio will fall to 3:1, leaving fewer people in the active labour force to support a growing burden. Left unaddressed, the problem could result in a chronic shortage of skilled labour. “This is good news for

workers, because wages will go up,” says Hodgson. “But it’s also bad news: without enough labour, our economy won’t be able to grow.”

The problem is further compounded by early retirement. For years, government income support and employer pension plans have encouraged Canadians to walk away from their careers early. And Canadians, understandably, have taken up the offer: Canada’s average retirement age fell from 64-9 in 1976 to its current 61.4 years.

As “Mission Possible” points out, we’re already feeling the pinch. To meet our needs for skilled labour, we rely more heavily than ever on immigration—immigrants currently account for 70 per cent of the growth in our labour force. But immigration alone cannot come close to making up the impending labour shortfall. The best way to deal with the demographic shift is to, quite literally,

put it to work. It’s simple math: with seniors making up such a large proportion of the population, says the Conference Board, only a slight upward move in the average retirement age would produce a noticeable increase in the labour force.

to take the first, small steps to addressing the problem: earlier this fall, Ontario became the ninth province to repeal its mandatory retirement legislation (B.C. remains the lone holdout). But that is the least governments can do: if we want to keep grandpa and grandma working, we’ll need to make it easier for them to take jobs, and more profitable for them to keep them. Other countries are now doing far more to get workers to extend their careers, including financial incentives, training programs, placement services, phased retirement programs and pension reforms.

“Mission Possible” says Canada should do the same, and recommends phasing out the early retirement provisions of the Canada

CANADA IS A TRADING nation. Trade now accounts for 72 per cent of Canada’s GDP, up from 52 per cent in 1990. If our borders were shuttered to international trade tomorrow, nearly three-quarters of our economy would grind to a halt. Jobs would disappear by the thousands. Governments would sink into deficit and debt. Funding for universities and hospitals would evaporate. This is all theoretical, of course—but then again, in the security-obsessed, post-9/ll world, with America living by the new axiom that “security trumps trade,” it doesn’t always seem so far-fetched. What that 72 per cent really means is that all aspects of our domestic economy are linked to our trading relationships with other countries, whether directly or indirectly, and Canadians must plan accordingly. “The things we think of as domestic policy—non-tariff barriers, regulation, our investment climate, education and skills, innovation, productivity—now need to be linked to our international trade policy,” says Glen Hodgson. “Canadians cannot live in a bubble.” And if, as Hodgson says, the tectonic plates of the global economy have shifted for good, Canada cannot afford to stand still. M

Pension Plan, which are overly generous, while lowering taxes for seniors who extend their careers after age 65.

Employers must also start taking the issue seriously. A 2005 Conference Board study showed that, while 88 per cent of Canadian businesses were aware of the problem of the aging workforce, only eight per cent plan to hire retired employees. When the American bookstore chain Borders commissioned a study on its customers and discovered that more than half of them were over age 45, they changed the makeup of their workforce: 16 per cent of Borders employees are now over the age of 50. Some companies in Europe have invested in ergonomically designed production plants and offices to make seniors more comfortable in the workplaceall part of a plan to extend workers’ careers.

The best way to deal with Canada’s looming labour shortage is to keep grandma and grandpa working