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    Canadian Competitiveness

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    Canadian Competitiveness: A Decade after the Crossroads' Roger L. Martin, Michael E. Porter, Dean Bishop William Lawrence Rotman School of Management University Professor University of Toronto Harvard Business School "Te autor with sincere hank four individuals for providing valuable esearch suport athe tort: Nii [hua 3 Toronto cone: George Georgopouoe 9 Univers of Tent PAD cand economy and Dr (Custian Ketel and Daniel Vasquenresearhers mt he Inte for Stegy and Competitiveness tHerard Busnes Scho! L CANADA AT THE CROSSROADS: 1991 |i 1990, Monitor Company and Professor Michael Porter undertook a study of Canadian competitiveness co-sponsored ty the Government of Canada and the Business Council an [National Issues. The study culminated in a report, Canada ar the Crossroads, which was issued in October 19912, ‘The study was based on a model of competitiveness developed by Professor Porter’. It posits that the standard of living of aration depends on the productivity with which ituses its human, capital and natural resources, manifested inthe way in which its Firms compete. In tur, productivity is determined by f the interplay’of theee broad influences: a nation's Political, Legal and Macroeconomic Context; the Quality of the Microeconomie Business Environment, and the Sophistication of Company Operations and Strategy. Together they determine the capacity ofa nation to produce internationally competitive goods and services and support rising prosperity Determinants of Competitive Perri a — ‘The study examined Canada’s strengths and weakness in these areas both overall and ina ‘number of importsnt Canadian industries, including newsprint, central office telecommunications switches, life insurance, and environmental consulting. Findings Overall, we found that while the Canadian economy certainly had performed wel histovieally, a number of factors suggested that its standard of living relative to other leading economies was likely tobe challeaged. There were significant macroeconomic impediments holding back needed public investments as wel as fim level upgrading. Central among these was the budget deficit, which toad a 6.6% of GDP, over twice that in any G-7 country except Italy. The deficit ut upward pressure on real interest rates and created an unfavorable environment for invesient 5 chal Porter wal Monitor Company, "Canada athe Cosa, Business Coun on National less, 1991 > Michael E Pot, Compete Adiantage of Nas, Free Pres 1990 2 (22501 Roger. Man ana nel Potee and capital formation. High personal and corporate taxation rats further discouraged investmen: and effort. Finally, a highly developed social safety net was designed in a way that created disincentives for work and persona skill grading. erinaps more importantly, the study revealed a numberof weaknesses in the miroeeonomic business environment tht afflicted moch of the economy.* The absence of intense local rivalry combined with customers who were not demanding produced weak pressures for frm productivity and upgrading. Canadian related and supporting industries were often either shallow cor weak, slowing down productivity improvement and the rate of innovation. In addition, Factor conditions, especially with respect to specialized human capital and R&D infrastucture, ‘constrained the movement to more sophisticated ways of competing. F nally, research uncovered key weaknesses inthe sophistication of eompany operations and strategy. We found many firms content 1 compete in Canada, with litle orientation toward slobel competition. Those firms that di compete intemationally tended to focus on the U.S. ane pursue strategies that depended on natural resource advantages or lower labor costs than other G- “competitors instead of sophisticated produets and processes, Rather than seek out the most demanding customers both at home end abroad, Canadian firms were inclined to serve theless demanding segments. Also, Canadian firms filed to inves in upgrading the business environment at home through supporting specialized education or cluster development initiatives. The prevailing orientation, instead, was to believe such investments were the esponsibility of goveenment. Overall, due to Canada’s rich endowment of natural resources, a 19" century decision to protect the Canadian economy with high tariff baer, ad the presence ofa dominant neighbour to the stuth, Canadian institutions have been more inclined to replicate practices and strategies ‘ebsewhere rather than innovate to be uniquely positioned in global terms. Yet Canada’s rich endowment of natural resources has eroded in value. Because competitiveness in commodities derives largely fom finding lower-cost sources of raw materials and/or using lower cos abor to exploit te raw materials, competitive edvantage is fleeting. F ims around the world, especially inthe developing countries, have been entering markets with lower-cost raw materials o labor. In the main, they have been successful. In forest product, fo- ceample, firms have learned how to utlize low-cost southern-hemisphere eucalyptus hardwood te make pulp and paper that is more competitive than higher-cost notheen-hemisphere softwood See the price-seting mechanism is the marginal cost of production of the highest cost producer inte mare te result as een longterm sar presi on pulp and pape ies Tis ‘phenomenon of downward price pressure has been clearly evident across commodities ove Bice 180, commodity prices have moved downvard it fel USS ata ae of approx) 0.6% per year as shown below. “See Box (page 8) on the Microeconomic Business Environment andthe Role of Chistes for fer discussion of theo. 3 {22001 Roge. Man ans ena Pose Long-Term Trends in Commodity Prices se Sonmodty Pls nee aa US Dota: 101-2080, Relatively high aif barriers from 1878 to 1989 protected Canadian firms ouside natural resource firms and encouraged them to imitate products and processes developed elsewhere. In addition, the tarif barers encouraged foreign-owned firms to setup in Cenada to replicate in ‘Canada their operations elsewhere in order fo gain acess tothe Canadian market. Original Conclusion and Recommendations We found Canada to beat a eitcal crossroads as of 1991. Due to Canada’s impressive endowment of natural resources, its well-educated population, and its proximity tothe US, the nation had enjoyed economic prosperity anda high standard of living. However, we concluded that this favorable situation was likely to erode and produce a decline in standard of living unless ‘Canada and its Firms chose a distinctly diferent path, ‘We outlined an alternative path that could retsn and enhance the nation’s competitiveness, We ‘recommended that governments move aggressively to restore a favorable racroeconomic context for Canadian business by tackling the budget deficit and reducing personal and corporate tax rates. We also recommended tht governments eliminate the barirs to inter-provineial rade and investment that relaxed competitive pressures and fractured an already small economy. \With respect to the microeconomic business environment, We ollered recornmendations in each ofthe four areas. With respect to Context for Firm Strategy and Rivalry, we recommended that governments pursue policies to enhance the intensity of domestic competition rather than ty to produce national champions shielded from competition inthe home market. In Demand Cndiions, we recommended that governments adopt more stringent and forward-looking regulatory standards and restructure government procurement to make the government a more sophisticated and demanding customer. With respect to Factor Condiions, we encouraged governments to invest more heavily in education and specialized sills development and o step lp the pace of deregulation in infrastructure sectors. In addition, we encouraged technology development policies more connected to industry clusters and mechanisms for faster adoption of new technology. ‘ 2200 Repeat anh Pes BOX 1 -The microeconomic Environment and the Role of Custer nines oupreie isoe nl opie i atacand ae ae ie ‘tren apn ros othe nas rin to ‘Quality ofthe Microeconomic Business Environment Fresno uggs spied ty dered condtio eng sophie md Seman amen wt mane are Ym ame more ope Fol fis, Peru ae ce presse stp re ‘demand cern swe, Beeii pes sae sped by acme rj Satyr rity leas cal amps eo ote ‘iter ono ett eedsof uses. Sch acon Mpegs ace ay ‘Son ems competing ine ae rte, Sper apr viet te stunt poor ro sno incnng tse ir cha tenuate pal rence a el ‘pei nosh ee nasi sod al econ wr Ars ‘Some or anced te polity of monroe en some in [rasa ern alan pecan so fy sch ies) er thatase fs eg nate py ene te ai bey ues ‘55 al Fac ny rs i ey re Tipo ewes neering iscnig panic dive cig of ‘tte el vals The ese ehomte ol as enue e iba isan uli ndsties pri ean o pnd el naar nd ‘duran! titans. The en hap oe asters apsy to sees custncseven ten, suring eve ae pst Cord. indies non costed prog ee hr, The Const tone atone, Ip ron mv eto nn tint ei ine ‘Dead geoph serng a Poul emetive os a baleen In Related and Supporting Industries, we tesanamended that governments ensure that programs in all policy areas are tonsstent with the development of clusters rather than spreading similar Firms across many pars of the country, as has been the case 00 often in Canade through its historical policies of regional development We also outlined a new trajectory for Canadian firme, The central challenge was to move to inmovation-driven modes of ‘competing. sophisticated processes and products: rather than competing on raw materials o labour cost advantages. To do 50 it would be necessary to rationalize product lines, reduce levels of diversification and dedicate more attention and resources on upgrading the Canadian home diamond. Firms needed to develop the capacity to sellin important markets globally and tap into leading-edge research excellence in specialized technologies. 5 ‘9:0 Rag. Mein an tal Pater TL. CANADIAN COMPETITIVENESS: PROGRESS SINCE 1991 (On one hand, Canada has enjoyed spectacular macroeconomic turnaround since 1991. Between 1991 and 195, the Canadian government managed to bring the federal budget deficit down from 1 second wors! among G-7 countries level of 6.6% of GDP to the best, witha surplus of 0.9%, Elimination of the Federal Budget Deficit so y—___Seneral Government Budget Defic Interest rates, using the 3-month Treasury bill rate as 9 proxy, fll over 60% from an average of 11.85% inthe 1988-90 perio to 497% in the 1998-2000 period, providing a much more trative environment for investment. Inflation fll from 4.6% (1988-1990) to 2.1% (1998- 2000, a level not seen in 30 years.* ‘The economy slso became more export-oriented with exports asa share of GDP increasing from 125.2% in 1989 10 43.2% in 1999, the highest share among G-7 counties and by fer the larg increae over the period ‘Bank of Cnaca Revew ‘ (2001 Roger. Mets ar hone Por Incrosee in Canadian Relative Export intoncity Exports as a Poreentage of GOP “TTL et Despite the impressive macroeconomic performance, Canada’s relative prosperity has fallen ‘While GDP per capita measured a purchasing power parity grew at a compound annual rate of 4.1% between 1990 and 1999, mech of that growth was due to the depreciation ofthe Canadian dolla. The same mettic measured a the current exchange rate only reached | 2%, puting Canada atthe lower range of OECD countves. Canada slipped from 3” in the world, a position it had occupied for decades, to 5" over the period.” Had Canada maintained 3” place in the world, the income forthe average family of four in Canada would have been higher by CDNS10,000 in 1999, or approximately $500 per month in after-tax family purchasing power —a substantial diference in standard ofliving. Consistent with its perfomance on standard of living, Cenade registered strikingly poor performance in productivity growth. Poor relative productivity grow inthe 1980's was continued in most ofthe 1990s during which Canadian moliactor productivity growth trailed all ofthe G-7 countries bya wide margin.® * OECD National Accouns Volume I-Main Aggegites. Measured areal US at Purchasing Power Psy. ‘Rankings ited exclude ciystate Singapore an tiny counties Luxembourg and Iceland, which would be move comparable os single Crain city than o = country rch as Cana "Inn interesting nays, Baldwin, Maynard and Wel damon that Canad’ roc performance ‘urn the 190s wos aavrey eee @ signet op me popoton the poptaonhlang obs, ‘ater tha the rodctny of hore boing jobs. Joh Baldwin, Jnn-Paere Maya ahd Steward Wel, ‘recy Growth ana nde Unies UMA, Sing 290.1124 ‘Ba06t Roget Man nf Metal Poe Canadian Productivity Growth, 1 Aatage Percent Grom in Multlactr Productivity ‘hah In manufacturing, this poor productivity performance resulted in a decline in Canada’s ‘manufacturing productivity restive tothe US feom 81.0% in 1990 t0 69.9% in 1999.° Canada took the leser pth fom the crossroads in 1991. ‘There has not been a clear and relentless focus on upgrading productivity and pursuing global competitiveness. ‘The growth of the Canadian ecenomy in the last ten years has been fuelled primarily by a higher proportion of employed person in the workforce and longer working hours, especially inthe second half ofthe decade. In ccntrast, capital investment experienced a declining growth rate, and multifactor productivity grewth was strikingly low. * Tasty Cams, Presoaton oe CerpoateGonemance Branch, Febery 7,201, base on Stasis Canals ‘ond US Bure of Labor Seas 8 (92001 Roper, Matin ar cha Pe Growth in Canadian Capital Stock Por Worker In the traded goods sector, the decline in relative productivity" combined withthe fallin worldwide commodity pries during the 1990's precipitated the dramatic ill inthe Canadian dolar. Ietraded at 87 cents US at the release of Canada a the Crossroads, bt fell by mid-1998 twa trading range of 63-69 cents US." The fallin the exchange rat erode the lving-standard “of Canadians further. ‘While some laud the lower Canadian dollar as enhancing competitiveness oy decreasing the relative price of our exports, the true effect is exactly the opposite. A low Canadian dollar dulls the incentive for upgrading and competing on any basis other than lower price. In addition, in the Canadian context, the low dollar makes investment in upgrading more expensive. ‘Approximately 70% of Canada’s installed machinery and equipment is imported." Consequently, the low dollar during the 1990's made machinery and equipment imports dramatically more expensive, which is likely to have contributed toa fall inthe growth rate of ‘pital sock per worker, thus making labour productivity growth stil more difficult to achieve. The impressive growth in exports as well was fuelled by the devaluation ofthe Canadian dollar. Furthermore, the share of exports tothe U.S. climbed oa striking 88% in 1999, up from 70% in 1988. The strong performance of the U.S. economy was a mayor driver of Canada’s export ‘gow. Canada’s export performance, then, is more a function of lower Canadian prices due to the exchange rate and proximity tothe U.S. than a sign of enhanced competitiveness Canadian Microeconomic Challenges ‘Why did Canada’s impressive macroeconomic turnaround fil to transate nto higher productivity and thus a higher standaed of ving? We frst tur tothe development of Canada’s “Robert Latiance an Lawrence Scent, ~The Exchange Rat, Prod [Bank of Canada Review, Winer 198-200. Bank of Canada Reve. ®Lafanee and Scheb p22 iy, and th Standard of Living” BE 22. ° 122001 Reger. Matin wn Mca Pse rnicroeconomic business environment in the last decade. Then we discuss typical choices companies have made inthis context. Inthe 1991 study, we found that several features ofthe microeconomic envionment reinforce the slow productivity growth. These made it more challenging for Canaan firms to innovate because there are fewer tools and less pressure for upgrading and seeking more advanced competitive advantages Canada has made progress inthe microeconomic business environment in a numberof areas. ‘The level of competition has increased, fuelled primarily by more openness to trade both from caher countries and within Canad Though there are weaknesses, Canada also enjoys strength in its microeconomic environment ce which it ean build, While overall R&D spending i lov, there ate incications that the roductivity of R&D is high, Canadian scientists have performed wel ir global tems growing the numberof patents granted in the US over the 1986-1999 period by 153%, second highest in ‘the world (afer Irae a 302%) and higher than the US itself (123%). And the patens earned by Canadians were of high quality. The propertion of patents that ae highly cited was third in the world behind only the US and Irae, Canadas long tailed the advanced countries on the proportion of researc personnel in the workforce, But Canada moved up from sixth. fifth among the G-7 counires in research personnel per ten thousand workers between 1985 and 1998 and grew the proportion at the second fastest rate among the seven counties. “There as also been some sign of improvement in the sophistication of Canada’s exports. For ‘example, in 1990, 45% of Canada’s exports were resource-based goods and ofthese 78% were Inprocessed or semi-processed commodities, By 1997, these proportirs fell to 43% and 64% respectively, showing that Canadian exporters were moving away from the stereotype of hewers ‘of Wood and drawers of water" Also, oer the 1989 to 1997 period machinery expors, long a Canadian weakness, increased ffom 3.4% to 5.5% of exports, a substantal increase, albeit from a low base. Canada’s firms have also made progress in operational effectiveness. The adoption of FTA and NAFTA and globalization led Canadian firms to reduce their levels of d verification and ‘ntionaize product lines in order to focus on businesses in which they cauld compete internationally. A comprehensive study by Baldwin, Beckstead and Cav2s (2000) examines changes in diversification in Canadian manufacturing firms and plans over 1973-1995." They found that fies reduced diversfietion across industries and plants redaced diversification a:ross products in the 1990's The significant changes may be atributedto the FTA and NAFTA, tet changes were beginning in the mid-1980's as @ consequence ofthe wade liberalization ‘rocess that began withthe Kennedy round ofthe 1970's and the Tokyoand Uruguay rounds of {he 1980's. The study also shows that export intensity (ie. exporstGDP) in manufacturing, increased in the 1990 and the plants of export industries became highly specilized Tove Cops Re Ure ra et "El Me Bt Ce “Chas nh Ohno of Cad wing Poms "i Sts Gans SOE To garnet oe Despite this progress, however, Canada's overall microeconomic competitiveness hes waned Cnad’s investment in specialized human resources to support innovation and upgrading nas diminished. Public spending on both secondary and post-secondary education asa perceniage of CDP, though high in comparative tems, was in decline between 1982 and 1995.” The dedine in secondary education spending was less worrisome as the evidence is mixed on whether additional investment atthe K-12 level improves educational efficiency. More worrisome, however, is the accelerating decline in public investment in postsecondry 'MishaelE. Pore and Gregory C Bon, “Innovate Capac and Proper: The Nex Compeiivenese ‘Cuilnge The Glob Compeiteness Report 200, New York: Oxford University Press, 200. "putin next ur pragrpts run fom Porter and Monitor, “Con a he Crosoads, 91 ‘De to {625 from be SM es in the 1991 st b (©2001 Roper. Main ane hal Per In addition, the industry had weaknesses in its microeconomic context. Although, thee were @ numberof rivals, they didnot compete on innovation and upgrading. As with most pars ofthe Canadian forest roduets sector, Canada lagged by a decade or more in implementing new techniques such as the production of groundwood pulp and the use of asada process for chemical pulping The lack of local related and supporting industries, such as equipment suppliers made the likelihood and challenge of technological upgrading more difficult. Historically lx environmental regulation had also not prepared Canadian fis forthe heightening of environment concems about the forest products sector worldwide (Overall, the industry personified the crossroads faced by the economy as a whole. The lack of pressure for upgmding had left the Canadian fr with smaller machines, lower labour productivity and lower capital spending than their international competitors. With goveraments, especially in Britsh Columbia, patting upward pressure on wood fibre costs through higher ‘tumpage fees, the 1990"s promised to be more challenging than the previous decades ‘The question was Would Canadian firms move forward to higher productivity and more distinctive strategies or would their fundamental competitiveness erode? Unfortunately, relatively litle has changed over the past decade with respect to the Canadian newsprint industry and its approach o competition. The tends already in evidence at the time of Canada at the Crossroads have continued and Canadk’s position inthe industry has eroded. Characteristic of many commodities, prices in the industry have continued their longterm drift downward a rel rate of approximately (1.1%) per year as shown below: Real Newsprint Prices over Time Nowsret(0), US parm on "Newsprint, a commodity product, continues to decline as a proportion of global pulp and paper production, dropping from 39% to 30% between 1989 and 1999, Increases have come inthe production of value-added grades of paper and paperboard.” 71909 Aanual Review, Canaan Pulp and Paper Asosaton website wv 1 201 Roger. Mare nde Per In this environment of falling prices and slow growth, Canadian share of world expos of | newsprint has fallen from 629% in 1991 to 53% in 1997, a significant reduction.” Continued _growth inthe use of TMP and recovered paper has weakened Canada's basic wood fre advantage ‘ith a weakening competitive position due fo advances in the use of low cost ibres and greater irvestment in upgrading abroad, the Canadian sector depended on the falling Canadian dalla to saintain its competitiveness. In a commodity industry such as newsprint, competitiveness and. ‘frm profitability are determined by the firm’s postion on the global delivered cash cost eurve as ‘shown below. Newsprint mills onthe left ofthe cost curve are competitively strong snd profitable while mills onthe right are weak and unprofitable. Canadian mills (marked by the ‘dts onthe cost curve) ae reasonably well positioned onthe cost curve with firms most heavily Positioned inthe third quartile. A smaller number of mills ae inthe more compete first and ‘second quartiles, and a substantial number inthe uncompetitive fourth quartile. Global Newsprint Industry Cost Curve Neveprint Mil Cost Poon wth CONS at USE." However, the acceptable position of Canadian firms is largely a function ofa low dollar, hich ‘Sood at approximately $.66US at the end of 2000. If the Canadian dolar were back nesr its 1991 level of USS0.85, the ills would be positioned as follows and the Canadian industry would be in precarious positon, 5 ial, Pome, LN SIC Trade Static, Revson 2 Caster Mapping Projet a the Ist for Srey and ‘Competiveness, Harvard Business Schoo Global Newsprint Industry Cost Curve ‘esprint Mil Cost Postion with CONS at USE.88* ‘tan exchange rae of $.85US, viually the entre Canadian newsprint industry would be positioned inthe feurth quartile ofthe cast curve with cash costs almost $100/tonne higher. In this way, a depreciating currency hides fundamental competitiveness problems, rather than indicating roe competitiveness Even with a falling curtency, the Canadian paper and forest industry has not performed well compared to global competitors. In 2000, the Canadian industry had a retur on capital «employed of 4.0%, well below the average return for Europe (5.9%) and the US (6.0%). Finland was e particularly impressive performer witha return of 7.094. Pethaps the most substantial change in the newsprint industry is increased globalization, ‘consistent with the overall globalization of the pulp and paper sector. Asian share of glabel demand grew from 10% to 15% between 1989 and 1999, spurring a wave of investment in Asan capacity Some rajor firms began to acquire outside theie home markets in order to establish « more glabal presence. ‘The leaders in this new wave were the Scandinavian firms, who invested heavily to upgrade ‘themselves and thei local environment during the 1990's. At home, they worked together ‘through industry associations and linkages with universities to promote innovation. The average ‘worker inthe Scandinavian industry has a related university degree and a high level of technological ltery. Abroad, firms invested heavily in North American assets Swedish/Finnish Fim Stora Enso scquieed US fine paper producer Consolidated Papers and Finland's UPM-Kymmene acquired Canadian fine paper producer Repap Canada, Norways's [Norske Skog purchased Canadian newsprint player Fletcher Challenge Canada, and recently ‘made a bid for Pacifica Papers, the Canadian firm to which the newsprint assets of MacMillan 2 Richard A. Keleras“Canaian Paper & Forest Prodi Equity Macs er the Edge oa“ Managed Cycle", {Canacian Plp and Piger Assocation, Paper Week Ineratonl, 200 "1009 anal Revie Candin Pulp and Paper Aetosaton webte Bloedel were spun: In addition, Bowater, a US newsprint manufacturer, equired Avencr, sueeessor to Canadian Pacific Forest Products Norske Skog is particularly interesting example, because the company made a decisive move ‘ut ofa home market that it considers detrimental to its long-term competitive advantage. Lacking ast local cluster, i has moved toroid w keep up with competitors from stronger luster envizonmerts like Sweden and Finland, While sucess isnot certain this aggressive strategy exposes Norkse Skog to competitive pressure often needed to motivate a strong ‘upgrading effort. ‘The Canadian newsprint industry ha participated passively inthe globalization of the industry through the acquisition of thee ofthe seven major Canadian players by global competitors. Abitibi has focused on consolidating the industry within Canada, having combined Abitibi-Price, Stone-Consolidated, Quebec and Ontario Paper Company, and Donahue into Canada's dominsnt player Abitibi-Corsolidated. In contrast, Abtibi-Consolidated has made only very minor forays ito the global industry with one joint venture in Asia and no presence in Europe or Latin ‘America, Though te global industry focus has shifted to value-added papers, Abitibi- Consolidated has sen the proportion of value-added papers fall from 30% ofits portfolio vo 25% over the 1996 to 1999 period.” Unie its Seandinavian competitors, which have invested more heavily in upgrading at home, ‘expand in the faster growing value-added papers sector, and acquired to ereate global reach, the Canadian pallp and paper sector ~exemplifed by newsprint has focused primarily on| domestic consolidation rather than on upgrading and globalizing. ‘These tends were evident at the time ofthe 1991 study. The Canadian industry had a choice 10 ‘upgrade its capability in newsprint, migrate to more value-added products and establish a more robust global positon or to continue the status quo. In large par, the Canadian industry chose the Inter, while other countries’ newsprint industries chose the former. ‘While the newspriat industry remains an important Canadian industry and one with leading alobel export share, itis an industry that has allowed its positon to decay slowly rather than invest in upgrading od innovation. It will remain an important Canadian industry for years to ‘one, but its unlsely contribute (ea high and rising standard of living onthe eurent path It ‘ill continue to lose share ina business whose output is falling slowly in real value. The newsprint industry isa metaphor forthe Canadian economy. Is trajectory, as well as the covers evidence suggests that Canada has followed theless favourable path described in Caneda atthe Crossroads, Substantial progress has been made in the macroeconomic context, and there fate some microeccnomie improvements. However, the progress has not been suicent to more Canada ahead in relative terms against other highly developed economies. Finally, companies hhave on average ct reacted to these changes in their competitive environment by taking the necessary decisions to upgrade their strategies and operations. Asa consequence, Canada is Arittng slowly dovn in relative ranking across a number of measures from GDP per capita, to productivity, to GCR ranking, to Innovation Index > Noi Consoiae nmol Reports IIL THE WAY FORWARD Canada again is ata critical junction of its development and must ensure that it does not squander its macroeconomic achievements. The new, more fundamental challenge isto improve Canada’s microeconomic business environment and upgrade the strategies and operations fits companies. Only inthis way will the progress made so far translate into real prosperity gains for its population. The way forward t greater competitiveness and greater prosperity for Canada is through innovation not repcation of what other countries and companies have done. Building on the Macroeconomic Progress ‘While Canada’s meroeconomic environment has improved dramatically, it stil tals that ofthe US, Cenada’s mos: important competitor, especially inthe area of taxation. Canada only made progress on improving the competitiveness of its tax system late in the 1990's. As of 1997, Canada's tax burden asa percentage of GDP (36.8%) was significantly higher than that of many. of Canada’s imporant trading partners such a the US (29.7%), Japan (28.8%) and Mexiee (16.9%). Alberta and Ontario led with ax reforms and were followed by the federal government with its February 2000 bueget and the subsequent mini-budget released in October 2000, ‘The federal {government improved personal income axes by restoring inflaton indexation, lowering the rates 8nd inclusion thresholds of al the brackets, eliminating the 5% surtax and substantially reducing. the capital gains tax (by lowering the inclusion rate from three-quarters to one-half), The federal goverrment also lowered corporate taxes with the basic federal corporate tax rare expected to decline by 7 percentage points to 21% by 2008. This represents progress, however even with this reduction, Canada’s general rate (36.3%) willbe higher than the average OECD. rate (3496) and will not match the superior tax environment ofthe US or countries such as Finland, Sweden and Ireland. The key determinant for firm investment in upgrading i the effective tax rate that wil be applied to an additional deilar of investment. The effective marginal rate reflects the implementation of the statutory rat and takes into consideration aspects such as deductions for capital eosts tax credits and capital taxes levied by various level of government.” Even when fully implemented, the effective marginal tax rte in both manufacturing and services in Canada wil he substartially higher than in UK, Germany, Italy, Sweden and Ireland, even if they stand completly stil while Canade implements its reductions. And it will match the US by 2004 only if the US stands completely stil while Canada reduces. Fundamental tax reform i a daunting task, but at this point Canada remains behind the US, ts ‘most critical competitor for human and corporate assets, Tinkering onthe margin has litle > Duamjie Chen, “Th Margins Efcive Tex Rat The Only Tax Rate th Maes in Cpl Allocation” CD. Howe Insite Bahgrouner, Augest 2, 2000 Jack M. Mintz, “Die February 2000 Federal Bud's Busines Tax Mestre: ls Canada Misting the Boa? C0. Howe fst Backgrounder, March 23, 2000p. Duasie Chen, "Intensonl Tax Progra”, Rotman School University of Toro, (Sato oger. Marin an tel Poe rospect of succeeding. Canadian govemments have a great opportunity to show innovative leadership in taxation policy and inspire Canadian firms to do likewise with their strategies for international competitiveness. (nthe personal taxation front, further reduction inthe capital gsi tax t provide stil stronger incentives for investment in building new businesses would provide a boost for innovation. In “aditon, given the importance of building specialized haman capital, investment in any sor of specialized skill acquisition should be made fully tax deductible for individuals as well as for fms (nthe corporate taxation front, the governments must take into consideration that with rapidly inereasing globalization, corporations have greater scope to choose where to invest and have rmore opportunity to determine in what jurisdiction to earn corporate income. International tax arbitrage is shrinking the share of revenues from corporate income taxation a corporations move ahead of govemments in managing their tax exposure. In this environment, Canada should explore the dramatic reduction of eorporate income taxation. Jack Mintz, Cenada's leading exper in corporate tx policy, advises that rather than simply trying to match US comporate res, Canada should aim to creat distinctive Canadian advantage for businesses to locate here to serve the North American marke.” Improving the Microeconomle Business Environment Canada’s microeconomic environment is relatively advanced, but is fling behind. The nation must become more aggressive to stop losing ground compared to other advanced nations. Investments in education, traning and specialized skills upgrading have among the highest pay- aff of any investment government can make in improving the microeconomic environment for business. This is especially the ease i investments create the specialized skis that are relevant to Canada’s clusters of strength. While there are examples of such investments in Canada, for example the Ontario Access to Opportunities program designed to dramatically increase the Frovince’s annual output of engineers and scientists, the Canadian record overall is dsappoiting Universities and university research play a significant roe in the innovalive capacity ofa nation University graduates are major participants inthe development of innovation-enbancing, ‘nowledge-based industries.” In addition to secking their graduates, knowledge-based industries look to universities to perform related research and development. Canads historically led the world in public spending on higher education as a percentage of GDP, but has been on a long-term path of decline that has accelerated daring the 1990's, Higher spending itself will not ensure greater prosperity unless there are other improvements inthe nnieroeconomic business environment. However, it is interesting to note that seven ofthe top ten. ‘counities on the Innovation Index increased their public spending on higher education (Y@ of GDP) over the 1975 to 1995 period, while Canada and two others did nc. On average, the former seven increased their GDP per capita a a rate 37% faster than the ater three (including * ck M. Mintz “Why Canada Na Undertate Busines Tax Reform Son”, CD. owe Ist Backgrounder, November 4 1998 “Munroe Blam, Growing Omar's lanwaton Syte Fig 4 0 ‘amor Roger. Marta mht Per Canada). Instead, edica Canada needs to make an unprecedented level of investment in specialized to bolster Canadian managerial skill in strategy. ‘A second opportunity are is to encourage firms to build global strategies pursuing more ambitious goals, Canadian firms that succeed competing globally should receive enthusiastic public support. Success models should be given high public profile and successful global pioneers recognized conspicuously. Canads could create an award for Canadian global competitive success with a prestige equivalent othe Baldridge Award for Quality, which has catalyzed a huge and beneficial quality movement inthe US. A third area of opportunity is in luster development. There is room for governments to show ‘grater entrepreneurial acumen and zeal in providing suppor to clusters, whether in providing specialized training and research institutions, specialized infrastructure, or incentives for related ant supporting industis to co-locate, Governments should seek out cluster participants and proactively understand their needs at atime when eaty action can havea transformative impact, ‘There is lite evidence worldwide that governments can svcceed in choosing investment industries proactively. However, governments can and do promt the health and development ofclusers by understanding thei specialized factor requirements, determining which have such high evel of externalities involved that individual firms will not invest to create ther, and proactively invest on behalf ofthe industry. Such investments can include specialized edicational programs, specialized infrastructure, o special regultory regimes. Government at all levels has acrtical role to play in ereating a beter environment for uperading competitiveness. But todo so, Canadian governments also will ave to rise above replicating the scons ofits main competitors. Canada can move ahead and be the first to implement new leerningson the productive role of government in the 21" century. For example, when Chile privatized its social security system to create the conditions for an efficient capital market to bloom, i broke significantly with the policies of similar developing countries. In doing soit ‘rated substantial advantage for Chilean firms in raising pivate capital Trunsforming Company Operations and Strategies While the macroeconomic context and the microeconomic business envizonment create the conditions for prosperity, ultimately companies need to take advantage ofthese conditions to imcke choiees consistent with produetivity upgrading. Research on fiem-evel competitiveness has revealed the critical importance of distinctive sintegy. Flem-level competitive advantage rarely results from benchmarking against competitors and replicating their choices, Rather, competitiveness results from making a se of choices that produces a distinctive positioning and is manifested ina tailored system ofa This activity system creates customer value distinct from competitors and makes replication by competitors dificult by confronting them with painful trade-offs.” “The single most important priority for Canadian prosperity i to bring about a transformation in ‘the way Canada's companies compete, Historically, natural resource endowments and high tariff Yoner& Bond, “Iovate Capac and Prosperity", 2000, “Michael E, Pore, "What States? Harvard Busines Review, November December, 197 0 ‘Sates nour Monn sd shel Pa barriers have combined to produce a tendency toward ase of company strategy choices tha: are sistinetly incompatible with global competitiveness. This set of choices is incompatible with rising prosperity. t does not lead tothe intensive investments in upgrading necessary for high productivity and international competitiveness. Instead, investmerts are oriented toward national or local competition. R&D spending is low and investments in branding minimal, If the nation is to move forward, a greater proportion of Canadian Fiems must make an altertative set of choices. These ae shown on the right column in the igure, Strategic Company Choices win oxtstCrosiberes tn bs Conpetanes ie stoterelconseierens| cena oreetvaneet atone | [Stearate menos || Suan sdvrtage “nd Gosle ‘Semcwcmpatce || omrgttacomute, oka fa nay ne county ‘eed pin | ee ng “sergmoncsy Set an sheen wien oa] | Une wera Howto ea mow acres [cen naD Win ine aD ‘cal ein ak anda J Inresource-intensve industries, Canadian firms must move to more unigue production processes and evolve their positions to more differentiated industry segments. The increasing share of processed goods feng exported from Canada’s resource-based industies is encouraging fist step, but much more technological upgrading is needed. Beyond ths, resource fms must increasingly expos technological and managerial expertise rather than simply expon the commodities themselves. This will manifest itseIFin more aggressive outward foreign Outside the resource sector, progress will equire a changed atiude toward their strategies and their business env ronment onthe pat of many Canadian firms. Firms most move beyond assimilating best practices ereated elsewhere to pioneering new best practices. And most, Jmportantly, they must pursue distinctive strategies. In addition, Canadian firms must take greater responsibilty for enhancing the local microeconomic context in their sector and strengthening thei eluster. This requires a tricky combination of behaviors. On one hand, fierce competition wih local rivals will strengthes the cluster by creating pressute for upgrading and providing customers with more opportunity to be sophisticated and demanding. On the other hand, some forms of cooperation te promate 2 (62001 Roger. Matin ara Pere “specialized factor creation (for example, through support of educational institutions) and improvements in infrastructure will result in higher productivity forthe industry asa whole. ‘Competing Through Innovation: The Tecommunications Cluster Wile, an envionment tat makes innovation and upgrading challenging, many Canadi industies followed the pater of the newsprint industry, some industries look a different couse “That they have succeeded competing glaballyon the bass of sophisticated products and processes, even in some high technology lds, revesl the real potential of Canada. ‘The Drogress since 1991 ofa second industry we stdied, the central efice switch industry, ilustrates how an industry can compote glabaly from & Canadian hore base In 1991, cera ofice switch equipment for elocommuniations services providers was Canada’s most prominent snd important high technology industry. Cental ofie switches comprised approximately 25% of slobal telecom equipment sales. Canada's succes illustrates the principles we have outlined Thanks to anealy dessin to innovate tough moving fom analog wo dia switches, Canada’s Northern Telecom enjoyed the leading marketshare in the important digital segment as ofthe time ofthe study ‘The prospects fo the industry looked quite strong as of 1991. Norther Telecom had spawned spin-olf firms such as Newbridge Networks and Mitel. A vibrant telecommunications equipment cluster in the Orawa area as forming, Canadian firms hed shown the inclination to innovate and upgrade. Northern Telecom had also pursued aggressive international expansion, rather than staying at home. ‘The tlecommunications equipment cluster enjoyed relatively sophisticated home demand from Canadian customers who were privately owned and regulated rather than government owned as they were in most counties ouside North America, Canadian cluster partieipants also enjoyed favourable access to high-quality personnel due to relatively trong investment in specialized human eapital development in telecommunications-related fields by Canadien governments, Canada had also built up sophisticated research capacity in this Fel However, there were challenges forthe Canadian cluster going Forward. Competitors were envious of Northern Telecom's leading marketshare inthis rapidly growing industy. Early deregulation inthe US carer business created an environment in which the most demanding and sophisticated customers were increasingly located inthe US marke. Over the past decade the central office switch industry has evolved in ways few have predicted, The central office switch declined dramatically in importance and was replaced by optical systems as the diving segment. Thanks to bold strategy, early collaborative research withthe National Research Council (NRC), and a bt of luek, Nortel Networks emerged by the end ofthe

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