Canada

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Canadas Competitiveness-- Strengths and
Challenges Presentation to the Industry
Canada / ITAC Whiteboard Session on
Competitiveness Indicators, November 5, 2007by
Someshwar RaoMicro Economic Policy Analysis
BranchIndustry Canada

• November, 2007

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1. What is Competitiveness
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The concept of competitiveness

• At micro level, a firm is said to be competitive
  if it is profitable and maintains or gains market
  share in a world of fair and free markets with
  intense domestic and international competition
• Measures of competitiveness are often calculated
  at industry level as data on individual forms are
  proprietary
• At macro level, according to OECD, a nation's
  competitiveness is the degree to which a country
  can, under free and fair market conditions,
  produce goods and services which meet the test of
  international markets, while simultaneously
  maintain and expand the real incomes of its
  people over the long term

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The drivers of competitiveness

• Productivity, which measures efficiency of
  resources used to produce goods and services, is
  the long-term driver of competitiveness
• Only growth in productivity will allow firms to
  compete internationally and maintain and improve
  real income
• New investments in education and skills,
  machinery and equipment (including ICTs),
  physical and technological infrastructure and
  innovation (including commercialization) will all
  contribute to improvements in productivity,
  competitiveness and prosperity
• However, in the short run, cost structure (unit
  labour, capital and energy cost) and relative
  output price will have significant impact on
  firms trade and output performance and hence
  their ability to compete in international markets
• Movements in exchange rates also will impact the
  cost structure and relative output price in the
  short- to medium-term

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2. Canadas Strengths
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The Canadian economy has performed very well in
the last ten years

• Over the 1997-2006 period, Canada experienced the
  fastest growth in real GDP among G-7 countries.
• Over the same period, Canadas real GDP per
  capita grew at an average annual rate of 2.4,
  the second best growth rate in the G7 countries.
  
• Canadas superior performance in employment
  growth largely contributed to the stronger growth
  in per capita real income.
• Employment in Canada increased at 2.0 per year
  since 1997, compared to an average rate of 0.9
  in other G-7 countries.
• Canada was the only G-7 country with a government
  budget surplus during the 2000-2005 period.

Economic Growth in G-7 Countries, 1997-2006
Real GDP Growth Real GDP per Capita Growth Employment Growth
Canada 3.4 2.4 2.0
U.S. 3.0 1.9 1.0
UK 2.7 2.5 0.9
France 2.3 1.9 1.1
Italy 1.2 1.2 1.3
Germany 1.4 1.3 0.5
Japan 1.0 1.0 -0.3
Source Statistics Canada, U.S. Bureau of
Economic Analysis, U.S. Bureau of Labor
Statistics, and OECD Economic Outlook, 2007.
7
Canadas standard of living is among highest in
OECD countries,
Global Perspective on Living Standards (Relative
GDP per capita, 2005, U.S.100)

• A significant component of our quality of life is
  represented by our standard of living, our GDP
  per head.
• Canadas GDP per capita is 2rd highest in the
  G-7, and 10th among the wealthy OECD nations.
• Canadas living standard was 19 percent below the
  U.S. in 2005.

G-7 countries
Other OECD countries
Source OECD Productivity database, 2006
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as well as in terms of national income per capita
Global Perspective on Living Standards (Relative
GNP per capita, 2005, U.S.100)

• Canadas GNP or income per capita is 2rd place in
  the G-7, and 9th among the wealthy OECD nations.
• In 2005, Canadas per capita GNP was about 21
  percent below the U.S. level.
• The GNP-based rank changed significantly from the
  GDP-based one for some countries. The biggest
  change in rankings is for Ireland, whose position
  falls from 4th richest country in terms of GDP to
  only 8th richest in terms of GNP.

G-7 countries
Other OECD countries
Source OECD estimates for 2005 and Penn World
Tables Note The data on GDP per capita in 2005
were converted to GNP per capita using the ratio
of GNP to GDP in 2000.
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Macro-economic framework in Canada is sound and
stable

• Sound fiscal and monetary policies establish the
  foundation for Canadians to invest in physical,
  human and knowledge capital.
• Low and stable inflation, coupled with sound
  fiscal policy lead to low interest rates and
  boost investment in innovation.
• Canada has established a sound macro-economic
  framework.
• The appreciation of the real exchange rate can
  also increase the motivation for investing in
  knowledge capital.
• Squeezed margins from foreign sales can require
  firms to upgrade their products, services and
  production techniques.
• Increased competition on domestic sales can
  provide the urge to firms to differentiate their
  products and undertake research and development.

Long-Term Bond Yields
Government 10 year bond yields Source
Statistics Canada
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Canadas trade policy supports access and
exposure to world markets
Openness to trade in G-7 Countries and Australia

• Canadas trade policy is built on a series of
  successful bilateral and multilateral trade
  agreements making Canada a very outward oriented
  country.
• Trade exposure and foreign direct investment
  stimulate competition and innovation, and
  increase productivity.
• Sectors most liberalized under FTA/NAFTA
  experienced the greatest productivity gains in
  Canada.
• Yet, Canadas barriers to trade and investment
  remain higher than most other industrialized
  countries, particularly in some services
  industries like transportation,
  telecommunications and finance.

Openness is defined as sum of merchandise
exports plus merchandise imports divided by GDP
and then multiplied by 100.Source World Bank
Barriers to Trade and Investment
Note The scale of the indicator is 0-6 from less
to highly restrictive. Source OECD, 2004,
Product Market Regulation in OECD Countries, 1998
and 2003 (rev.).
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Product market regulations are among the lower
side
Product Market Regulations

• Marketplace framework policy establishes the
  market incentives for firms and individuals to
  invest in physical and human capital and to
  compete and innovate.
• Product market regulations can reduce the
  potential gains of introducing new and innovative
  products and the incentives to invest in
  knowledge and to commercialize innovation.
• Much of Canadas higher product market
  regulations are the result of higher barriers to
  trade and foreign direct investment.

Note The scale of indicators is 0-6 from least
to most restrictive of competition Source OECD
Indicators of Product Market Regulation, 2003
(rev.)
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barriers to entrepreneurship are the lowest
among G-7 economies
Barriers to Entrepreneurship

• Barriers to entrepreneurship decrease market
  opportunities for firms and individuals to
  innovate and compete.
• Barriers to entrepreneurship are decreasing in
  Canada and are the lowest compared to other G-7
  countries.
• Canada tops the G-7 in terms of low regulatory
  cost of business -- the least number of
  procedures and processing time.

Note The scale of indicators is 0-6 from least
to most restrictive of competition Source OECD
(2004), Indicators of Product Market Regulation,
1998-2003 (rev.)
Days Required to Establish a New Business
High income OECD countries. Source Doing
Business in 2006 - The World Bank Group
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and labour market regulations are also among
the least restrictive

• Employment protection legislation tends to impede
  adjustments in the labour market.
• The U.S., followed by the U.K. and Canada have
  the most liberal employment protection
  legislation
• Other G7 economies have significantly more
  restrictive labour market regimes.
• Still, a gap persists between Canada and the U.S.
• According to the OECD, the employment protection
  legislation for permanent employees is more
  stringent in Canada than in U.S. and U.K.
  (regulations on procedural requirements notice
  and severance pay and the prevailing standards
  and penalties for unfair dismissals)
• The same is true for temporary employment
  contracts (maximum number for successive
  renewals maximum cumulated duration of the
  contracts and allowed reasons for which a
  fixed-term contract can be offered).

Employment Protection Legislation
Note The scale of indicators is 0-6 from least
to most restrictive of competition. Source
Nicoletti, Scarpetta Boylaud, OECD Working
Paper 226, (2000), Table A3.11.
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3. Challenges Facing Canada
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Canada lags several OECD countries in
productivity level
The Sources of GDP per Capita with Respect to the
United States, 2005
Effect of labour utilization (U.S.0)
GDP per capita (U.S.100)
GDP per hour (U.S.100)

• In 2005, Canadas labour productivity, not labour
  utilization, was the main factor behind our lower
  living standard vis-à-vis the U.S.
• Estimates vary, but most recent OECD
  calculations suggest a gap of 24 percent between
  Canada and the U.S.
• Canadas productivity level was 5th out of G-7
  countries in 2005.

Note Labour utilization equals total hours
worked per capita. Source OECD Productivity
database, 2006.
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and in trend productivity growth
Labour Productivity in Selected OECD Countries
(1985-2004, 1985100)

• Labour productivity and MFP growth have been
  lower in Canada than in many other advanced
  economies.
• MFP performance has been worse than the
  productivity of labour suggesting overall poor
  efficiency gains in production, lagging
  technology adoption and sub-optimal production
  practices.
• During 1985-2002, MFP in Canada grew at an annual
  average rate of 0.5 percent, compared to an
  average of 1.2 percent per year for Australia,
  France, Japan, Italy, UK, and U.S.

Multifactor Productivity in Selected OECD
Countries (1985-2004, 1985100)
Note MFP is based on harmonized price indexes
for ICT capital goods. Source OECD, Productivity
Programme.
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Productivity and working-age population are key
sources of growth in living standards in Canada
over the past two decades
Sources of Income per capita growth in Canada
1981-2006 (percent)

• Real income (GNP adjusted for terms of trade) per
  capita grew at an annual average rate of 2.1
  percent over the period 1981 to 2006.
• About 60 percent of that growth corresponds to
  improvements in labour productivity.
• Multifactor productivity growth accounted for 33
  percentage points (56 percent of the labour
  productivity growth). Physical capital deepening
  accounted for the remaining growth.
• The improvement in terms of trade accounted for
  17 percent of the increase in real income per
  capita. Most of the gain took place over the
  period 2002-2006.
• The growth in the share of working-age population
  in total population and growth in employment rate
  accounted for 12 and 9 percent of the income per
  capita growth.

Labour productivity Multifactor productivity Capital deepening 59.6 33.4 26.2
Working-age Population 11.8
Employment Rate 9.3
Hours Worked per Worker -2.8
Net Foreign Income 5.1
Terms of Trade 17.0
Total 100
Income is GNP corrected for terms of
trade Working-age population population 15 years
and over. Source Industry Canada computation
based on data from Statistics Canada
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Slower growth and aging of the population will
reduce our capacity to grow
Growth of Working-Age Population and Labour
Force, Canada, 1951-56 to 2016-21

• Demographic trends will reduce the growth of the
  working-age population (15-64) and of the labour
  force.
• Starting around 2010, the falling share of the
  working-age population (wp/p) and declining
  participation rate (I/wp) will both make a
  negative contribution to the growth of our
  standard of living.
• It means that Canada needs to depend more and
  more on productivity growth to raise our standard
  of living and our quality of life.

Source Statistics Canada
Components of Growth in GDP Per Capita
Source Statistics Canada and projections using
COPS demographic projections
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and increased competitive pressures from
globalization is adding to the urgency of
improving our productivity performance
Share in World Exports of Goods and Services
Other Emerging Economies

• The globalization of trade and investment is
  accelerating growth rates rose sharply in the
  1990s with the emergence of China as an economic
  powerhouse.
• Technology has been a key enabler and driver of
  globalization and of the offshoring of services
  to low cost countries.
• Globalization will intensify further as trade and
  investment barriers continue to fall and
  communications become ever cheaper and easier.
• Economies will continue to blend into an
  integrated world economy, with an increasingly
  global specialization and worldwide product
  supply chains.

China
India
Source World Bank
Other emerging economy includes Brazil, Hong
Kong, Indonesia, Mexico, Korea, Malaysia, the
Philippines and Thailand. It excludes Singapore,
as the data for Singapore on exports of goods and
services in this series were not available.
Commercial Services Trade as Percentage of GDP,
1990-2004
Germany
Canada
India
China
U .S.
Japan
Data for 2004 are only available for a few
countries. Trade Imports Exports Source
World Development Indicators (WDI) database World
Bank
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4. Canada under-invests in key areas
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Canadian investment performance is weak in
several areas

• Adoption and diffusion of new technologies
• ME Investment
• ICT Investment
• Research and Development
• Total expenditure in RD
• Business expenditure in RD
• Commercialization of new knowledge
• Public Infrastructure
• Highly skilled labour
• Proportion of highly skilled workers across
  industries
• Output of highly skilled labour from universities

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Canada lags many OECD countries in ME investment

• Physical capital deepening (capital per unit of
  labour input) contributes to improvements in
  labour productivity and living standards.
• Physical capital deepening, especially ME
  capital, is associated with the adoption and
  diffusion of new state-of-the-art technologies.
• Canadas ME investment, as a percentage of GDP,
  was the lowest in the 1980s and the 1990s among
  the G-7 countries, and most other OECD countries.
  
• Canadas weak performance in ME investment did
  not improve over the period of 2000-2004. Its
  ME investment as a percentage of GDP was still
  the lowest among G-7 countries.
• The ME investment gap between Canada and the
  U.S. increased in the 1990s as well as during the
  2000-2004 period.
• Over the 2000-2004 period, Canadas ME
  investment, as percentage of GDP, was 8.2
  percent, compared to 9.1 percent in the U.S.

Machinery and Equipment Investment as a
Percentage of GDP (Percent)
Source OECD National Accounts
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The Canada-U.S. ME capital gap is large and
increased in the 1990s

• The Canada-U.S. ME capital intensity gap in the
  business sector increased from 39 percent in 1992
  to 44 percent in 2004.
• ICT contributed about 34 percent to the ME
  capital gap in 2003.
• The increase in the ME capital gap was more
  dramatic in the manufacturing sector. It
  increased from around 21 percent in 1992 to over
  46 percent in 2004.
• ICT contributed about 24 percent to the ME
  capital gap in 2003.
• The differences in industrial structure in the
  two countries did not contribute significantly to
  the ME capital gaps.

Relative ME Capital Intensity in Canada,
1987-2004 U.S.100
Manufacturing Sector
Business Sector
ME capital stock per worker (specific sector
ME investment PPP based). Data for other
countries are not available. Source Statistics
Canada and U.S. Bureau of Economic Analysis
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across most industries
Relative ME Capital Intensity in Canadian
Industries, 1997 and 2004 (Capital stock per
worker US 1)

• Canadian industries are generally less ME
  capital intensive than their U.S. counterparts.
• In 26 out of 29 industries, the ME capital
  intensity in Canada was lower than in the U.S. in
  2004.
• The ME capital gap increased in 19 industries
  between 1997 and 2004.

Source Statistics Canada and U.S. Bureau of
Economic Analysis
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The importance of ICT in ME capital increased
across all industries
ICT Capital Stock as a Percentage of Total ME
Capital Stock in Canada 1987 and 2003 (per cent)

• Between 1987and 2003, the share of ICT capital in
  total ME capital increased in all industries,
  except transportation equipment and professional
  services.
• ICT capital, as a percentage of total ME
  capital, in the Canadian business sector
  increased from 14 percent in 1987 to 20 percent
  in 2003.
• In general, ICTs are more important in service
  industries than in other industries.

Source Statistics Canada and U.S. Bureau of
Economic Analysis.
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Canada also lags some OECD countries in ICT
investment
ICT Investment in Selected OECD Countries,
1985-2004 (As a Percentage of Non-residential
Gross Fixed Capital Formation, Total Economy)

• ICT investment as a percentage of total
  investment rose rapidly in the 1990s in most
  developed countries.
• In 2004, the share of ICT investment in Canada
  was higher than that in France, Germany, Italy or
  Japan, but lower than that in UK and the U.S.

2002 for Australia, Japan, New Zealand, Norway
and Spain, 2004 for Canada, Germany, Korea and
the United Kingdom, 2003 for all other
countries. Note Estimates of ICT investment are
not yet fully standardised across countries,
mainly due to differences in the capitalisation
of software in different countries. See Ahmad
(2003). Source OECD, Productivity Database,
March 2006.
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Canadas RD investments are increasing

• Investment in innovation leads to higher labour
  productivity and income growth.
• Research indicates that Investment in innovation
  is important to countries at or close to the
  technology frontier such as Canada.
• R D expenditure is a widely used proxy for
  investment in innovations.
• R D investment is also thought to be important
  for firms to absorb advanced technologies from
  other countries.
• RD expenditures as a percentage of GDP increased
  over the past two decades.
• Business RD intensity increased from 0.6 percent
  in 1981 to 1.3 percent in 2001 and declined to
  1.0 percent in 2004.
• Gross RD expenditures, including government and
  other non-business RD activities, also trended
  up.

RD Expenditure as a Percentage of GDP in
Canada, 1981-2004 (percent)
BERD Business Expenditures on RD GERD Gross
Expenditures on RD. Source OECD, Main Science
and Technology Indicators, 2005-2
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but concentrated in a few industries
BERD as a percentage of value added in Canada
1987 and 2001 (percent)

• The improvement in RD investment over the past
  two decades is concentrated in two industry
  groups
• machinery and equipment and
• pharmaceuticals.
• Why arent we seeing improvements all over the
  industry spectrum?

BERD business expenditures on RD. Source OECD,
ANBERD and STAN databases.
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Canada performs relatively poorly on gross
expenditure on RD

• Canada spends less on RD investment than other
  industrialized countries, despite a generous
  fiscal incentive -- the Scientific Research
  Experimental Development (SRED) Tax Credit
  Program.
• Canada ranked 12th in the OECD in terms of gross
  expenditures on RD (GERD) as a percent of GDP.
• In particular, Canada trails the leader by more
  than 2 percentage points and lags the U.S by
  almost ¾ of a percentage point.
• About 70 percent of the gap with the U.S. was due
  to lower RD intensity at the industry level.
  The remainder was due to differences in the
  industry composition between the two countries.

GERD as a Percentage of GDP, Top OECD Countries,
2003 or nearest year.
Source OECD, Main Science and Technology
Indicators, 2005-2,
30
due to weak RD investment by business

• Canada ranks 13th in the OECD in terms of
  Business Expenditure on RD.
• Several reasons have been advanced to explain
  Canadas lagging performance, including the
  impact of higher foreign ownership.
• Official RD data, which capture
  domestically-produced RD spending only, may
  therefore underestimate investment in innovation
  by Canadian firms.
• Recent work by Statistics Canada shows that when
  expenditures for foreign payments for RD
  services and payments for royalties and license
  fees are included, the Canada-U.S. knowledge
  capital gap in 1999 was reduced to 0.40
  percentage point from 0.92 percentage point.

BERD as a percentage of GDP, 2003 or nearest year
2000 for Switzerland Source OECD, Main
Science and Technology Indicators, 2005//2,
31
and in most high tech sectors

• Canadas lagging RD performance is also
  apparent when we benchmark our performance
  against other countries in the top five high tech
  sectors.
• Although we lead in the office machinery and
  computer sector this sector makes up a relatively
  small share of Canadas output.

RD Intensities of High-tech industries as a of
value added, 2002
Source Aleb ab Iorwerth, Canadas Low Business
RD Intensity the Role of Industry Composition,
Finance Canada Working Paper, 2005-03, March 2005.
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and government
Government-spending RD as a percentage of GDP
for 2003, selected countries

• We rank 15th in the OECD in government spending
  on RD, as a proportion of GDP, despite federal
  investment in RD increasing 29 from 1997 to
  2003.
• But we do well in RD performed by the Higher
  Education sector, where we lead the G-7.

Source OECD, Main Science and Technology
Indicators 2005-2
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Canada has a generous tax support for RD, but
with less direct support

• Canadas government tax assistance including RD
  tax credits is very generous by international
  standard.
• But, it provides less direct support to business
  RD.
• Research intensive industries that have long lead
  times to commercialization (e.g., fuel cell,
  biotechnology) are unable to fully benefit from
  accelerated tax deductions and tax credits.
• Firms in these sectors have gone to public
  capital markets or foreign partners,
  disqualifying themselves from access to the
  refundable tax credits.
• Accelerated tax deductions and
  non-refundable tax credits only benefit taxable
  (profitable) enterprises.

Government Support for BERD
BERD GDP
BERD Financed by Govt
Tax Assistance
14
0.2
12
0.15
10
8
0.1
6
4
0.05
2
0
0
EU
Italy
Japan
France
Finland
Canada
Sweden
Germany
Denmark
Total OECD
Netherlands
United States
United Kingdom
Source Source OECD MSTI Database
2003-2. Warda, Jacek, Extending Access to SRED
Tax Credits, December 2003. Tax assistance is
represented by one less the b-index - higher
numbers higher tax benefits. Note The B-index
is equal to the after tax cost (ATC) of a 1 of
RD expenditure divided by 1 less the corporate
income tax (t) ATC/(1-t).
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Canada is also weak in commercialization

• The World Economic Forum ranks Canada 27th on
  propensity to compete on the basis of unique
  products and processes.
• Exports of high-tech products as a percent of
  total manufacturing exports commercialization
  in international markets is well off the US
  pace.
• Canadas purchases of foreign intellectual
  property for further domestic development
  declined in the last decade to levels well behind
  both Germany and the UK.

Introduced innovations new to Canada or the
world. Source Mohnen and Therrien, How
Innovative are Canadian Firms Compared to Some
European Firms? A Comparative Look at Innovation
Surveys, Merit Research Memorandum, 2001-033,
Maastricht, 2001.
High-Tech Exports(as of Manufacturing Exports)
US 100
Australia Data available until 2001. Source
National Science Foundation, Science and
Engineering Indicators, 2006.
35
Overall Canada has a low innovation performance
despite favourable innovation framework conditions
Canada Vis-à-Vis Best-Practice Countries in
Individual Policy Areas

• Innovation performance of Canada (innovation
  activity and technology diffusion) ranked 10th in
  a group of 27 OECD countries, whereas it ranked
  3rd in terms of overall innovation framework
  conditions (along with Finland and the U.S.).
• The Spider-web indicates where framework
  conditions in Canada differ from the index values
  of the top 4 innovator countries (U.S., Finland,
  Sweden, and Switzerland).
• Canadas performance is particularly weak in
  public investment in RD, and lags in research
  quality, sufficient knowledge workers, and
  conditions for technology diffusion.
• This is an enigma that we have to solve. Despite
  the favorable conditions that we offer, we do not
  reap the projected benefits. Why?

Source OECD. 2004. Benchmarking Innovation
Performance and Framework Conditions
Contribution from Denmark and Norway, DSTI/IND
2004/6. Paris.
36
Canadas public infrastructure capital has
trended down
The real ratio of Public Infrastructure Capital
Stock to GDP in Canada, 1961-2005

• Research indicates a strong positive relationship
  between public investment in physical
  infrastructure capital, productivity and
  competitiveness.
• Public investments in physical infrastructure
  support productive activities by business and
  government, movement of goods and services, and
  communications. In short, investments in physical
  infrastructure reduce operating costs of doing
  business in Canada and improve competitiveness.
• But, Canadas investments in public
  infrastructure did not keep pace with the
  economy.
• The real public infrastructure capital stock/GDP
  ratio trended down over the period 1961-2005.
• Similarly, public infrastructure capital stock
  per employed person fell from 15.5 thousands in
  1977 to 12.4 thousands in 2005.

Real Public Infrastructure Capital Stock per Job
in Canada (000), 1961-2005
Source Industry Canada calculation based on data
from Statistics Canada.
37
also lags some other G-7 countries
Maintenance and development of infrastructure, G7
countries, 2003

• According to the World Competitiveness Forum,
  Canadas performance lags behind France, Germany
  and the U.S. in maintaining and developing public
  infrastructure, but is superior to Japan, Italy
  and the U.K.
• Canada also lags Germany, the U.S. and France in
  the efficient use of public infrastructure.
• More than 80 percent foreign multinational
  executives surveyed indicated that the poor state
  of public infrastructure adversely affected
  Canada as a destination for foreign direct
  investment.
• According to the Conference Board of Canada,
  infrastructure gap in Canada is estimated to be
  between 50 billion and 125 billion, 6 to 10
  times the level of all current government
  infrastructure budgets combined.
• The infrastructure needs are particularly acute
  in the west coast (B.C.), because of the rapid
  expansion of Canadas commercial links with China
  and other Asian Pacific countries.

Source The World Competitiveness Yearbook,
2003 Note The rating scale ranges from 0 to 10,
with 10 being best.
The efficiency of distribution infrastructure,
G7 countries, 2003
Source The World Competitiveness Yearbook,
2003 Note The rating scale ranges from 0 to 10,
with 10 being best.
38
Canadas labour force has become more educated
Percentage of the Population 25-64 with a
University Degree or Above in Canada

• Investment in human capital makes an important
  contribution to increasing our standard of living
• Rising skill levels are an important source of
  productivity growth
• An innovative economy requires a highly skilled
  workforce
• The capacity to adopt advanced technology depends
  on the level of workforce skills
• With increasing competition from emerging
  economies in global markets, Canada and other
  advanced economies will increasingly specialize
  in exports with high skills content
• As workforce growth slows due to population
  aging, increased levels of skill will be required
  to maintain growth in standards of living.
• Canadians are now more educated than before.
• The share of the population aged 25-64 with at
  least university education increased from 14
  percent in 1990 to 22 percent in 2004.
• Skill levels have grown across all Canadian
  industries.
• All industries except health services experienced
  an increase in the share of workers with at least
  university education from 1981 to 2003.

Source Statistics Canada
Percentage of Hours Worked by Persons with
University Degree or Above in Canadian Industries
Source Statistics Canada.
39
making Canada one of the worlds most educated
nations
Percentage of Population 25-64 with Tertiary
Qualification, 2003

• Canada has one of the highest capacities for
  supplying skilled labour. Among selected OECD
  countries
• Canada ranks first in the proportion of the
  population with tertiary credentials.
• Canada has the highest proportion of college and
  trades graduates, but trails the US and Norway in
  the proportion of university graduates.
• Canada ranks second in terms of average years of
  education of the working age population.

Source OECD, Education at a Glance, 2005.
Average Years of Education of 15-64 Year Olds
Across Selected OECD Countries
Source OECD, Bassanini et. al., ECO/WKP(2001) 9,
2001.
40
Wage premiums for university graduates have risen
Men 25-34 Percentage Wage Premium over High
School (1980-2000)

• From 1980 to 2000, wage premiums for male
  bachelors graduates relative to high school
  graduates rose from 30 to 52. The bachelors
  degree premium for women rose from 51 to 61.
• Wage premiums increased slightly for other male
  post-secondary graduates, but not for other
  female post-secondary graduates.
• These increases occurred in spite of rapid
  increase in the percentage of 25-34 year olds
  with a post-secondary credential.

Women 25-34 Percentage Wage Premium over High
School (1980-2000)
Source Boothby and Drewes (2006), Canadian
Public Policy, XXXII(1), Table 6.
41
University education is important for scientists
and engineers across industries
University Graduates as a Percentage of
Employment in Natural and Applied Science
Professions, by Industry, 2001

• Professionals in natural and applied sciences are
  the driving force of technology development and
  technology adoption.
• In the economy as a whole, about 60 percent of
  professionals in natural and applied science have
  a university education.
• The percentage is much higher in mining,
  utilities, professional services, educational
  services, and manufacturing.

Source Statistics Canada
42
But Canadas performance in producing new HQP is
weak
University Graduation Rates, 2000

• University graduation rates benchmark the rate of
  production of skilled knowledge by universities.
  The inflow of university-educated youths into the
  Canadian labour force represents 28 of all
  entrants.
• Canada lags many OECD countries including the UK
  and the U.S.
• Canada has also fewer Ph.D. graduates than most
  other G-7 countries and Australia.
• Canadas lower university graduation rates and
  lower secondary completion rates mean that the
  average years of schooling that new school
  entrants are predicted to complete are lower in
  Canada than in many other OECD countries.

Source OECD, Education at a Glance, 2002.
New PhD Graduates per Million Population, 2000
Source Mario Cervantes, OECD Science and
Technology Policy Division, "Trends
in supply and demand for Human Resources in
Science and Technology",
Presentation at the Joint CNR-OECD Workshop.
43
and Canada lags the U.S. across industries
Hours Worked by Workers with at Least a
University Degree, 2000 (percent of total hours
worked)

• On average, Canada has fewer workers with
  university education than the U.S.
• In 2000, the share of hours worked by workers
  with university education was 16.3 percent in
  Canada compared to 26.7 percent in the U.S.
• Canadas weaker performance is seen in all
  industries except business services.

Source Rao, Sharpe and Tang, 2004, Productivity
Growth in Service Industries A
Canadian Success Story, Industry Canada Research
Paper.
44
Canada is also showing weakness in retaining HQP
Ratio of Outflow to Inflow From Permanent
Migration Between Canada and the U.S. Managerial
and Selected Professional Occupations, 1990-1997

• Canada is losing highly skilled people to the
  United States.
• Canadians who moved to the U.S. were better
  educated than both the Canadian-born population
  and recent immigrants to Canada.
• 49 percent of Canadian emigrants to the U.S.
  between 1994 and 1999 aged 16 and over had a
  university degree. This compares with 12 percent
  among Canadian-born people and 21 percent among
  immigrants to Canada who arrived during
  the 1990s.
• Recent post-secondary graduates who moved to the
  US
• Came disproportionately from higher level
  degrees, especially PhDs
• Those who moved for work-related reasons cited
  higher salaries and greater availability of jobs
  in the U.S.

1
1
1
1
1
Share of Individuals with University Education in
population aged 16 and over in 1990s
Source Statistics Canada Education quarterly
review, May, 2000
45
Immigrants are highly educated but may lack the
skills required by the Canadian economy
Proportion of Population aged 25 to 44 with
University Education, 2001 Census

• In 2001, 53 of recent immigrants aged 25 to 44
  had a university education compared to 23 of
  Canadian-born.
• Despite their higher level of educational
  attainment, recent immigrants with a university
  education earn 58.4 less than their
  Canadian-born counterparts.
• The earnings differential suggests that the
  skills contribution of university educated
  immigrants to the Canadian economy is less than
  that of Canadian-born university graduates.
• This could occur because immigrants have lower
  levels of the skills needed in the Canadian
  economy or because their skills are not fully
  used.
• Data from the 2003 literacy survey (IALSS) shows
  that despite immigrants high levels of
  schooling, their literacy skills are lower than
  those of the Canadian-born.

Source From The Changing Diversity of Canada
2001 Census, Statistics Canada. Recent
Immigrants those who arrived 1996-2000.
Average Earnings of Recent Immigrants and
Canadian-Born Workers, 2000
SourceStatistics Canada, Daily October 8, 2003
Note
Recent Immigrants those who arrived 1995-1999.
46
Canada also lags in training
Participation Rates for Workers 25-54 in
Employer-Sponsored Job-Related Training Across
Selected Countries

• The existing labour force can acquire skills
  through on-the-job training.
• Canadas labour force participates less in
  job-related training than in the U.S., the U.K.,
  and many other countries.
• Average hours per employee spent in training are
  also lower in Canada than for other countries.

Source Employment Outlook, OECD, 1999 Chart 3.1.
47
5. Possible explanations of under-investment
48
Possible explanations include

• Output composition effects - scope (e.g., Canada
  is still a resource-based economy)
• Scale (e.g., small Canadian market size of
  firms)
• Extent of competitive pressure (e.g., barriers to
  foreign competition)
• Business skills and experience (e.g., less
  educated entrepreneurial and managerial
  workforce)
• Quality of risk capital (e.g., venture capital)
  and
• Incentives (e.g., taxes on capital).

49
Low investment in RD may be partially explained
by the structure of the Canadian economy
GDP share of natural resources industries in the
business sector, 1987-2003

• The Canadian economy is often described as a
  resource-based economy.
• In 2004, natural resources and mining represented
  about 7 percent of value added GDP in the
  Canadian business sector and about 3 percent in
  the U.S.
• Although the evidence suggests that the
  industrial composition of output is not important
  for explaining our gap in RD performance, there
  are reasons to believe that our manufacturing
  sector is more resource-oriented than in most
  innovative economies relying more on primary
  transformation of resources rather than secondary
  or tertiary transformations where innovation
  inputs and commercialization are more important.
• The diversity of value-added activities in the
  Canadian business sector is more evenly
  distributed than in the US.
• While diversity can mitigate the risks of
  industry-specific economic fluctuations,
  industrial diversification can also reflect a
  lack of specialization.

Diversity of industrial value-added of the
business sector, 1997-2004
Source Statistics Canada and Bureau of Economic
Analysis (US).
50
Canadian firms are too small to compete abroad
Average shipment per manufacturing firm, 2002 (in
000s)

• Scale economies and specialization are often seen
  as drivers of industry productivity and firm
  competitiveness.
• Manufacturing firms in the U.S. have, on average,
  twice the scale of Canadian firms.
• In 2002, average shipments per firm across
  manufacturing industries were C58 million in the
  U.S. compared to C24 million in Canada.

Source IC calculations from Statistics Canada
and U.S. Census Bureau data.
51
Canada has barriers to foreign competition

• Inward foreign direct investment brings both
  tangible and intangible capital to the host
  country and generates direct and indirect
  economic benefits.
• An OECD study suggests that Canada has investment
  restrictions in a number of key service sectors
  that are much higher than average and than in
  the U.S.
• Canadas foreign ownership restrictions are
  confined to a few sectors notably electricity,
  transport, and telecommunications services.
• The OECD has remarked that foreign ownership
  restrictions. particularly in the
  telecommunication sector, are burdensome for
  Canada and policy objectives should and can be
  achieved through other means, some of which
  already exist.

Foreign Direct Investment Restrictions by
Industry, Canada and the U.S.
Note The scale of the indicator is 0-1 from no
to complete restriction. Source OECD, 2003,
Policies and International Integration
Influences on Trade and Foreign Direct
Investment..
52
and trails the U.S. on Competitive Pressure
factors
Competitive Pressure Factors (Canada versus U.S.)

• Competition and rivalry forces firms to focus on
  productivity improvement and invest in physical
  capital, knowledge and human capital.
• Competition is often less intense in Canada than
  in the US, particularly in service-producing
  industries that focus on the smaller Canadian
  market (Conference Board of Canada, 2004).
• According to the Executive Opinion Survey of the
  World Economic Forum, Canada trails the U.S. in
  17 of the 23 Competitive Pressure factors which
  measure the degree of rivalry that induce firms
  to invest in physical capital, knowledge and
  human capital.

Source The Institute of Competitiveness and
Prosperity, Realizing our prosperity potential,
Third Annual Report, November 2004. (Exhibit 18,
at p. 47).
53
Canadian production is increasingly concentrated
4-Firm Concentration Ratio, Manufacturing
Industries

• Canadian manufacturing firms are becoming larger
  in order to benefit from scale economies and
  improve their competitiveness in the global
  market.
• On the other hand, increased Canadian
  concentration of domestic production can reduce
  the competitive intensity in domestic markets,
  which could be detrimental to innovation.
• Production in Canada is more concentrated than in
  the U.S. in all manufacturing industries except
  for the Apparel industry.

Combined production share of the four largest
firms determined by the value of shipments.
Source Statistics Canada,
Industrial Analysis Branch
54
Canadian business managers are less likely to be
university graduates than their U.S.
counterparts, especially from business programs
Degrees (BA, MA, PhD) Conferred per Thousand
Population (2002/03)

• Skilled managers and business professionals play
  a vital role in the overall efficiency of firms
  and markets.
• Overall, Canadian business managers are less
  likely to be university graduates than their U.S.
  counterparts.
• Twice as many managers in the U.S. are university
  graduates from business programs.
• Could that explain in part why our firms are less
  innovative, perform less RD, etc.?

Source Rebalancing Priorities for Canadas
Prosperity, Institute for Competitiveness and
Prosperity, 2006.
55
Canadian companies operations and strategies
undervalue innovation, compared to those in most
of other G-7 countries
Company Operations and Strategy Ranking

• The World Economic Forum ranks Canadian companies
  considerably lower in company operations and
  corporate strategies geared towards improving
  entrepreneurship and productivity.
• In 2003-2004, Canada ranked 14th among 101
  countries in company operation and strategy an
  integral part of business competitiveness.
• More Canadian businesses are concerned with
  minimizing cost rather than raising revenues via
  the introduction of new products, services or
  production techniques into the market.
• In 2001, less than 40 of establishments in
  Canada considered that developing new products or
  production techniques was relatively important,
  very important or crucial in their general
  business strategy while more than 50 thought
  that reducing labor and other operating cost were
  important.

The company operations and strategy index
measures the extent to which company strategies
and operating practices are oriented toward
innovation versus other modes of competing.
Canada lags most of its G-7 competitors on this
measure. Source World Economic Forum,
Global Competitiveness Report, 2004-2005
General Business Strategy in Canada, 1999, 2001
Source Employer portion of the Workplace and
Employee Survey, Statistics Canada.
56
Effective corporate taxes on physical capital are
high in Canada
Effective Tax Rates on Capital for Large and
MediumSized Corporations, Selected Countries,
2005 Average for Manufacturing and Service
Industries ()

• The business tax regime can have a significant
  effect on investment in physical capital and the
  creation of knowledge and its commercialization.
• Taxes impact productivity growth and output
  growth through their effects on savings and
  investment, entrepreneurship and risk taking,
  work effort, and net migration, particularly of
  skilled workers. Taxes can also influence
  decisions to upgrade skills.
• Higher taxes on capital investment, an important
  factor determining the user cost of capital,
  discourage corporate and entrepreneurial
  investment in Canada.
• Canada has one of the highest effective corporate
  tax rates on capital in the world.
• In 2005, Canadas tax rate on capital for large-
  and medium-sized firms was the second highest
  behind China.
• Announced reductions in corporate taxes in Canada
  and the U.S. to date will not close the tax gap
  significantly.

Source Mintz, Jack, et al, C.D. Howe Institute,
e-brief , Attention G-7 Leaders Investment
Taxes Can Harm Your Nations Health. September
20, 2005.
57
and pervasive across industries
The Effective Corporate Tax Rates in Canada and
the United States, 2002

• Canadian effective tax rates on capital were
  above the U.S. levels for all non-resource
  sectors.
• The rate gap with the US is primarily due to
  higher federal and provincial capital taxes in
  Canada, faster CCA rates in the US, and
  provincial sales taxes on business inputs.

Source Chen and Mintz, 2003, How Canadas Tax
System Discourages Investment, C.D. Howe
Institute Backgrounder.
58
The generous tax-based support for industrial RD
may be offset by high effective tax rates on
capital
Relative Generosity of RD Tax Incentives

• Canadas Scientific Research Experimental
  Development (SRED) Tax Credit Program is widely
  recognized as providing one of the most generous
  systems of tax-based support for industrial RD.
• Globally, support for industrial research in
  Canada (direct funding of business RD
  expenditures et fiscal expenditures) is much more
  important (40 to 50) than what is offered in
  the United States.
• But high marginal effective corporate tax rates
  on capital operate might be discouraging
  corporate and entrepreneurial investment.

Canada
100
U.S.A.
85
Japan
84
U.K.
80
France
77
Germany
71
Italy
71
Source Warda, Jacek, Rating Canadas RD Tax
Treatment A 2003 Update, December, 2003.
59
Returns on human capital investment are also
reduced by high taxes
Effective Tax Rates for First University Degree
Graduates, 1997 (percent)

• Return to education is one of the most important
  driver of human capital accumulation and a factor
  in retaining mobile skilled labour in Canada.
• Canadas effective tax rate on university
  graduates was on average 15.9 percent, almost
  twice as much as that in the U.S.
• High personal taxes affect savings and
  investment, entrepreneurship and risk taking,
  work effort, and net migration, particularly for
  skilled workers. They can also influence
  decisions to upgrade skills.
• The tax wedgethe difference between the gross
  and net of taxes wagesis higher in Canada than
  the U.S. for highly mobile individuals.

Source Collins and Davies, 2003, Tax Treatment
of Human Capital in Canada and the United States
An Overview and Examination of the Case of
University Graduates, in North American
Linkages Opportunities and Challenges for
Canada, ed., R. Harris, Calgary University of
Calgary.
Income tax plus employees and employers security
contributions, 2004 (as a of labour costs)
Single individual without children at the income
level of the average production worker Source
OECD Taxing wages 2003/2004
60
On the other hand, favourable tax treatment may
in part explain low returns to venture capital
Before Tax Annual Rate of Return () on Venture
Capital Investment, 1994-2004

• Risk capital is a vital source of funding for
  innovative businesses.
• Returns on venture capital investments, a measure
  of the quality of the venture capital industry,
  are much lower in Canada than in the U.S.
• Overall, the rate of return on venture capital,
  over a 10-year investment period, ending on
  December 31, 2004, was only 3.6 in Canada,
  compared to 26.0 in the U.S.
• Note many analysts have attributed this
  quality problem to the significant role of
  labour-sponsored venture capital corporations in
  Canada the favourable tax treatment for
  individual investors may reduce the quality of
  management of these funds (less incentive for
  high pre-tax rates of return due to preferential
  tax treatment)

Source Venture Economics/NVCA (U.S.) Macdonald
Associates Limited (Canada).
61
However, Government debt-GDP ratio in Canada have
declined dramatically since the mid 1990s
General government net financial liability as
percent of GDP

• Many claims were and are made that governments
  poor fiscal situation, weak (high) Canadian
  dollar and higher corporate taxes are the main
  reasons for hollowing-out.
• But the available research do not show a
  systematic relationship between hollowing-out and
  the above mentioned variables.
• Furthermore, the overall business climate in
  Canada has improved dramatically. If
  hollowing-out did not happen when the economic
  fundamentals were not in Canadas favour, there
  is less danger that it will happen now.

Source OECD
62
the recent corporate tax cuts would give Canada
a competitive edge over other G-7 countries,
Corporate Tax Reductions in Canada ()
2007 2008 2009 2010 2011 2012
Existing rates 22.12 20.5 20.0 19.0 18.5 18.5
Proposed rates 22.12 19.5 19.0 18.0 16.5 15.0

• Based on the Economic Statement announced by
  Finance Canada on October 30, 2007, corporate
  income tax rate would be cut from 22 percent in
  2007 to 15 percent in 2012, which will make
  Canada the most competitive tax in the G-7
  countries.

Corporate Income Tax Rates for G-7 Countries,
2012 ()
Includes capital tax equivalents Source
Economic Statement, Department of Finance,
Canada, 2007
63
and the value of Canadian dollar vis-à-vis U.S.
currency has increased by over 50 since 2002
Average annual US dollar per Canadian dollar

• The sharp rise in the value of Canadian dollar
  would stimulate investment in physical, knowledge
  and human capital and improve Canadas
  productivity and competitiveness by
• increasing competitive pressure
• lowering the cost of ME investment.

Sources World Bank and Bank of Canada
64
6. Indicators of ICT industry competitiveness
65
Canadian ICT sector is relatively smaller than in
other countries...
Share of ICT Sector in the Business Sector Value
Added, 2003 or latest
of total business value added
1995 16th 2003 17th (out of 25)

• The share of ICT sector in the total business
  sector value added in Canada was 7.6 percent in
  2003, 2.9 percentage points lower than the U.S.
  share and 1.4 percentage points lower than the
  average share of all OECD countries.

Top 5 countries
Source OECD Key Indicators, http//www.oecd.org/d
ataoecd/20/6/34083289.xls
66
...and less RD is performed by the Canadian ICT
sector
ICT Sector RD Expenditures, 2003 or latest
Percentage of GDP

• RD expenditure to GDP ratio in Canadian ICT
  sector is much lower than the U.S. ratio and also
  lower than the OECD average.

9th
Top 5 countries
Source OECD, ANBERD and National accounts
database, October 2006 http//www.oecd.org/docume
nt/23/0,2340,en_2649_201185_33987543_1_1_1_1,00.ht
ml
67
Canada is loosing market shares in the US...
Import shares of U.S. ICT imports, by country

• From 1997 to 2005, US ICT imports from the world
  increased from 156 billion to 256 billion, 5.8
  (CAGR). During the same period, US ICT imports
  from Canada decreased from 10.3 billion to 9.5
  billion
• Canadas decreasing share of US ICT imports was
  largely a result of decreasing computer and
  peripheral equipment imports from Canada. From
  1997 to 2005, they declined from 3.4 billion to
  1.6 billion
• China has become the dominant ICT supplier in
  the US from 1997 to 2005, Chinas share
  increased from 6.6 to 32
• Chinas increasing share is largely a result of
  increasing US computer and peripheral equipment
  imports from China, up from 4 billion in 1997 to
  40 billion in 2005
• China is also making gains in the telecom
  market, US telecom imports from China increased
  from 1.7 billion in 1997 to 14.9 billion in 2005

68
...and in the BRIC countries
Canadas share of BRIC countries ICT imports

• From 1997 to 2005, Canada lost ICT import market
  share in all BRIC countries, with the exception
  of India
• In China, due to strong growth in global ICT
  imports, Canada lost import share but Chinese ICT
  imports from Canada tripled between 1997 and 2005
• In India, Canada maintained its share because
  Indian ICT imports from Canada increased as fast
  (six fold) as global Indian ICT imports
• In Russia and Brazil, Canadas decreasing ICT
  import share was a result of a decline in imports
  from Canada