Four global megatrends threaten Canada’s low-innovation business strategy

Canada’s low-innovation business strategy is threatened by four megatrends that are likely to force companies to become more innovative, says a former deputy chief of staff for policy in the Prime Minister’s Office.

“The low-innovation business strategy will not change until the strategy stops working,” Peter Nicolson told Research Money.

Businesses will continue to not invest in innovation until global megatrends hit the companies’ bottom line and make them realize that a much greater commitment to innovation is key to profitability, he said.

Canadian businesses haven’t needed to innovate because for decades they’ve managed to generate increasing profits as a proportion of GDP, Nicholson, former inaugural president for the Council of Canadian Academies, says in a policy report on Canada’s economic performance.

“So why on earth would the business community as a whole change a strategy that has been producing increasing profit relative to the size of the economy, particularly when to change it is profoundly risky and involves venturing into areas where you’re not expert in,” he said in an interview.  

Nicholson’s report is published by the Johnson Shoyama Graduate School of Public Policy, a collaboration by the University of Saskatchewan and the University of Regina.

In the report, he argues that four megatrends that will shape the world economy and the geopolitical environment for the foreseeable future are poised to challenge Canadian businesses’ neglect of innovation. These megatrends, which Nicholson says are well established and gaining momentum, are globalization, technology, environmental sustainability, and population aging.

These megatrends are of particular significance for Canadian business strategy because of the country’s outsized reliance on the U.S. market, Canada’s lagging investment in information technology, the prominent environmental footprint of the Canadian economy, and demographic changes expected to impact productivity, according to Nicholson’s paper.

“Together, these [megatrends] appear destined to profoundly disrupt Canada’s low-innovation equilibrium,” it says.

Canada’s economic growth and per-capita GDP have declined over the last decade. But so has the per-capita GDP growth rate of essentially all of Canada’s comparator peer countries, according to Nicholson’s report. The report references data on comparative economic growth and income levels from 1945 to 2018, compiled by the Maddison Project at the University of Groningen in the Netherlands.

“There has been a generic slowdown in growth since the mid-1970s, basically,” Nicholson said.

Nevertheless, Canada’s economy has grown, on average, at the same rate as the U.S. for 70-plus years, “thanks to sound institutions and tight integration with the U.S. economy, but in spite of weak innovation by Canadian business,” his report notes.

Sound institutions more important than fluctuating economic growth

Having sound institutions in Canada, as in other economically successful developed countries, “make a huge difference. They’re basically the differentiator between the successful societies and those that aren’t,” Nicholson said.

According to his report, the three different groups of institutions that matter are those that:

• build human capital and maintain a basic standard of welfare and fairness in society.
• support the rule of law in property rights, in ensuring investment occurs in a predictable way, and in other areas governed by a legal system.
• deliver competent and non-corrupt government.

Nicholson pointed to Taiwan and South Korea, which have gone from being ultra-poor in the 1950s to catching the U.S. and other world-leading economies by 2010.

“They did it through really beefing up their institutions of research, capital-building, and developing a legal system that investors could trust in,” he said.

In comparison, Mexico and the Philippines, which in being geographically close to the U.S. had greater advantages than Taiwan and South Korea, have economies that are still producing at 30 to 40 per cent of U.S. GDP per capita, he added.

Along with sound institutions such as the Bank of Canada, Canada has been able to maintain its low-innovation business strategy because of record revenues generated by the oil and natural gas sector (due to high world oil prices), a booming real estate market until very recently, and a prospering financial sector, Nicholson said. “There are the three pillars of the Canadian economy.”

How megatrends threaten Canada’s economic growth

But Nicholson maintains Canada’s economic pillars and long-term growth are threatened by the four megatrends he cites in his report:

Globalization: Long-term economic opportunity is shifting from a North American market where Canada has enjoyed unique advantages of geography, language and business culture – resulting in an “outsized dependence on the U.S. market” – to markets where Canada has little established position, except as a commodity supplier.

“To maintain Canada’s position in the U.S. market, and to develop a much stronger place in high-growth markets, Canadian exporters need to become more innovative and outward looking,” says the report.

Technology: Information technology is transforming virtually every aspect of economic and social behaviour, and is the platform on which all other leading technologies depend. Yet Canadian small and medium-sized firms have for years invested much less per worker in IT than do their counterparts in the U.S. and several other advanced countries. The gap is especially large in software and databases, which now constitute the leading edge of IT-based innovation and are likely to be the principal drivers of future productivity growth.

Environmental Sustainability: In 2022, fossil energy products accounted for $203 billion of export revenue – 26 per cent of Canada’s goods total. “This revenue is at great risk in the medium-term as the world turns to non-emitting energy sources that are not only more environmentally sustainable but also becoming cheaper,” says Nicholson’s report.

His report says this threat to Canada’s fossil fuel-reliant economy can be mitigated and transformed into new market opportunities, but only through innovation and enormous investment in technology, including in methods to sharply reduce emissions in the oil and gas sector.

Population Aging: The latest population growth projections by Statistics Canada, under a range of low to high assumptions regarding fertility and immigration, imply that Canada’s working-age population (aged 15 to 64), as a proportion of the total, will decline steadily from 66 per cent in 2021 to between 58 per cent and 61 per cent by 2068.

Along with a declining workforce, Nicholson’s report notes that many of today’s jobs are vulnerable to automation, raising the prospect of “technological unemployment, at least during a significant transition period. Canadian business will face a growing challenge to innovate, either to stay at the leading edge of automation or to find ways to increase productivity if labour supply tightens.”

Canada needs more diffusion of innovation among businesses

Federal government spending aimed at directly influencing micro-behaviour by businesses – including trying to incentivize innovation – adds up to a few tens of billions of dollars, Nicholson said.

But this spending, while large in certain sectors, amounts only to a “perturbation” in the entire economy compared with the revenue of Canadian businesses, he noted. This revenue ranges from top-line revenue (total revenue) of more than $5 trillion to bottom-line revenue (net income after deducting expenses) of about $550 billion.

Nicholson said when he wrote the 2011 Jenkins Report on Canadian innovation there were only two federal innovation programs that most businesses knew about – the Scientific Research and Experimental Development tax credit program and the National Research Council’s Industrial Research Assistance Program (IRAP).

Now, Innovation, Science and Economic Development Canada alone is responsible for 46 different innovation programs and initiatives, all of which have yet to move the needle on Canada’s productivity growth.

“This proliferation of really fairly insignificant programs probably has zero-net benefit, maybe even negative, because it could be more effectively delivered through a smaller number [of programs] and better resourced,” Nicholson said.

However, no matter how much money government spends on trying to incentivize innovation by Canadian businesses, 98 per cent of innovations used in Canada are going to originate elsewhere, he said. “But what’s really important in economic terms is to be a quick and effective adopter and adaptor of innovations from wherever around the world.”

“In terms of innovation policy, the most potent mechanisms are to encourage diffusion of innovations, to SMEs particularly,” he added.

To that end, Canada should invest much more in programs that diffuse innovation across business sectors, Nicholson said. He urged much more government investment in IRAP and in the Canada Digital Adoption Program, and that the new Canadian Innovation Corporation make innovation diffusion in businesses a top priority.

The federal government also should use its “procurement muscle” to support innovation by Canadian companies, Nicholson said.

Canada also needs to invest in a “renaissance” in the resource sector, primarily through developing critical minerals needed for electric vehicles and EV batteries, wind turbines, solar panels and other applications, he said.

However, the country needs to expedite the licensing and permitting needed to get critical minerals discovered, mined and produced, he said.

It has been a long time since Canada built massive projects in the national interest, such as the transcontinental railway, the TransCanada Highway and the St. Lawrence Seaway, Nicholson said. “So we’ve lost the nerve to undertake mega-projects.”

But unless Canada develops the full supply chain of critical minerals – and accepts some environmental trade-offs in doing so – the federal and provincial government’s $28.2 billion of investments in Volkswagen’s and Stellantis-LG’s battery-manufacturing facilities in Ontario “will have really been misspent,” he warned.

Another action needed in Canada’s resource sector, “which is crucial to getting through to the next stage of economy, is the energy transition through renewables, and doing that somehow without tanking the oil and gas sector and the regional economy,” Nicholson said.

He said while the Alberta government’s seven-month moratorium on approving renewable energy projects may have a short-term political rationale, “You do send a pretty bad signal to the investment community.”

Ultimately, Nicholson expects the world market will compel the Alberta and federal governments to work together to reduce greenhouse gas emissions and end the dependence on fossil fuels.

However, if world prices for oil and natural gas continue to be strong and companies start to make new investments in these fossil fuels, “it will be very hard for Alberta and Ottawa to come to terms,” he said.

On the other hand, China, the U.S. and other countries are moving to decarbonize, because renewable energy has become cheaper than fossil fuels and China and India want to avoid serious air pollution problems, he said.

Said Nicholson: “I think global factors are going to bring Canada and Alberta onto the same page. But the timing is very uncertain.”

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