Canada must fix its “innovation deficit” and unfocused, ineffective industrial policy: Business Council of Canada report

Canada has an “innovation deficit” and an unfocused, ineffective industrial policy that is limiting productivity and economic growth, according to a new report from the Business Council of Canada (BCC).

The country’s innovation policy needs structural reforms, including a modern science and technology architecture targeting advanced industries in which Canada has a comparative advantage, says the report by Robert Asselin (photo at right) senior vice-president, policy at the BCC.

“Canadian policymakers cannot continue to put forward tentative, short-term and ineffective measures that tilt the economy towards more consumption and less production,” the report, Engines of Growth, says.

“Not competing at scale in advanced industries means Canada will remain a low-innovation economy and, as a result, continue to slip on the global competitiveness scale.”

Canada runs trade surpluses in agriculture, timber, minerals, and oil and gas, but performs poorly in technologically advanced industries, the report says.

Such industries are where advanced economies compete and innovate, where productivity gains can advance rapidly and where wages are higher.

Advanced industries are sectors characterized by significant investment in R&D, high levels of technology integration and a skilled workforce.

They typically include industries such as energy, aerospace, biotechnology, information technology, advanced manufacturing and robotics, which drive innovation and economic growth through cutting-edge technologies and processes.

The BCC report points out that the Washington, D.C.-based Information Technology and Innovation Foundation’s Hamilton index shows Canada is lagging in advanced industries, trailing Mexico in total production and global market shares.

 “This is the result of an unfocused economic policy that has failed to link research, innovation and productivity enhancement in specific sectors where Canada has the potential for global leadership,” Asselin says in his report.  

Advanced industries ensure global competitiveness by capturing significant market shares and attracting foreign direct investment, according to the report. These sectors also contribute to societal benefits like health care advancements and better infrastructure, ultimately improving quality of life.

“Canada has considerable assets that are not being leveraged in this age of heightened competition: it has the human capital and the natural resources that can fuel innovation and economic growth.”

But Canada’s current policy approach favours rent-seeking and low-value manufacturing sectors, according to the report. Rent seeking refers to attempts by firms or organizations to gain money by economic and/or legal manipulation rather than by trade and production of wealth.

“Rent-seeking industrial policy stifles productivity and competitiveness by encouraging businesses to seek government hand-outs instead of focusing on innovation,” the report says.

The report notes that in industries like the automotive sector, the federal government has provided substantial subsidies to foreign companies, often preferencing assembly plants over domestic technology design and development.

In addition, preferencing small companies over large ones with incentives such as tax credits and innovation programs limits the potential for large-scale business investments, including in R&D, the report says. It notes that Canada has too few large companies and too few small and medium-sized companies are scaling up.

A more effective policy would adopt a modern science and technology architecture, designed to commercialize the best ideas, while nurturing talent and funding both fundamental and applied research, the report says.

Canada misfiring on several cylinders in productivity and economic growth

Canada has fallen from the 6^th most productive economy in the Organisation for Economic Co-operation and Development in 1970 to the 18th as of 2022, the report notes.

“Outside a recession, the Canadian economy has rarely been so structurally weak.” Essentially, Canada has experienced seven years of no per capita economic growth.

In 1984, the Canadian economy produced 88 per cent of the value generated per hour by the U.S. economy. By 2022, Canadian productivity had declined to only 71 per cent of that of the U.S.

Many parts of Canada – most notably in Ontario – have traditionally bolstered the economy through the manufacturing sector. But as a recent report by RBC Economics illustrates, the impact of manufacturing is half what it was to the economy in 2000, while mining has also shrunk.

The problem, Asselin points out in his BCC report, is as manufacturing has shrunk, it has not been replaced by high-value industries. In addition, investment levels in the oil and gas sector remain far below what they were a decade ago.

Meanwhile, businesses in Canada invest more in non-residential structures and less in intellectual property products. Canada invests about 40 percent less, as a share of GDP, in intellectual property products overall.

From 1945 to 1975, the real average weekly wage in Canada doubled. This was largely achieved through improved productivity. At the current rate, it would take about four centuries to achieve this feat.

Wage growth has largely decelerated due to a slowdown in labour productivity. After adjusting for inflation, the average weekly earnings have increased only 1.6 per cent between January 2015 and January 2024, or less than 0.2 per cent per year, BCC’s report notes. It’s a considerable change from a growth rate of more than 1.5 per cent per year that Canadian workers enjoyed over the previous two decades.

Countries that succeed in enhancing their economic performance typically do so by concentrating on sectoral strengths – for example electronics in South Korea, advanced manufacturing in Germany, financial services and biotechnology in Singapore, cybersecurity in Israel, pharmaceuticals in Switzerland, the report says.

Less than a century ago, South Korea and Singapore were among the world's poorest nations. Finland was significantly underdeveloped compared to its Western European peers.

Today, through technology-focused economic roadmaps and policies, the fortunes of these three countries have dramatically reversed, positioning them among the world's most advanced economies and leading to improved livelihoods for their citizens.

Five “pistons” for activating Canada’s economic growth

A “reindustrialization” approach aims to strengthen an economy's production capacities, emphasizing dynamic capabilities such as innovation, technological advancement and skilled workforce development. according to the BCC report.

The U.S. has been using this model for years with its Advanced Research Projects Agency approach, the report notes, where the government funds high-risk, high-reward research projects that drive technological innovation and economic growth, fostering advancements that private companies might not pursue independently.

The political economy of the moment, including the tech race with China, partly dictates industrial policy choices, report author Asselin argues. “The market will not itself ensure the supply of strategic goods linked to national security.”

For example, Canada and other nations face significant geopolitical and economic consequences from allowing 60 per cent of global semiconductor production – an indispensable asset for national economies – to be concentrated in the hands of a single company, TSMC in Taiwan.

Similarly, market forces alone are unlikely to achieve the rapid decarbonization of the economy that Canada needs. “Therefore, the government must implement strategic and targeted incentives to accelerate private investment in key sectors.”

Yet Canada’s increasingly uncompetitive tax regime for investors and corporations, coupled with an ineffective industrial policy that supports non-competitive sectors, further exacerbates the problem, according to the report. Trade barriers inside Canada remain highly problematic and constitute a major barrier to economic growth.

There are five “pistons” that can activate Canada’s economic growth, BCC’s report says:

1. Become a world leader in energy security. Canada has abundant, responsibly produced natural resources, a first-mover advantage in nuclear energy as well as all the elements of the supply chain, and a real – but not indefinite – opportunity in critical minerals.
2. Leverage Canada’s strengths. Canada should be designing, not assembling, the next waves of products and services in agriculture, energy, infrastructure, health care, computing, microelectronics, biomanufacturing and aerospace. This will ensure innovation is a core element of the country’s economic prosperity.
3. Fix domestic barriers to growth. Canada must stop “scoring in its own net” by correcting a dysfunctional regulatory framework and getting rid of internal trade barriers. Permitting reform for energy and infrastructure projects must become an urgent priority.
4. Develop a coordinated innovation plan. Canada can choose economic pragmatism over ideology and instead be strategic in the use of public investments. Institutions should foster economic growth and governments should reject both rent-seeking industrial policy and free-market naiveté.
5. Partner with the private sector. Canada can choose to build the right kind of public-private partnerships in advanced industries to foster innovation and productivity. Climate change and national security imperatives will not go away. The country must find the right balance between laser-focused government intervention and market dynamism.

Five “essential actions” are required

The report also suggests five “essential actions” to elevate Canada’s performance in advanced strategic industries:

1. As a medium-sized economy, Canada must be deliberate about sectors in which it can compete and have comparative advantages. There are several areas in which Canada can lead globally, including:

• Energy and technology, through:

• diverse energy resources, including oil, natural gas, hydroelectricity, nuclear, wind, solar, biomass and geothermal energy
• Innovation and application of decarbonization strategies, including for methane reduction and carbon capture and storage.
• Advanced infrastructure.

Advanced infrastructure includes smart transportation systems (high speed rail), advanced communications (5G networks), sustainable energy systems (smart grids, solar, wind, hydro, nuclear), water and waste management, digital infrastructure (cybersecurity systems, cloud computing), public infrastructure (advanced medical facilities, telemedicine and health information systems).

• Ag-tech:

With high global demand for Canadian agricultural products, including grains, livestock, specialty crops and agri-food products, Canada’s agriculture sector has substantial market opportunities. Canada should further leverage its strengths, including in precision agriculture, robotics and automation data analytics and AI, vertical farming and indoor agriculture.

• Advanced materials:

The growing global demand for advanced materials provides market opportunities for Canada to export high-tech materials and technologies. With a rich natural resource base for raw materials, competitive edge in mining and processing, and expertise in material science, Canada is well-positioned in this field.

• Biotechnology:

Canada's biotechnology sector has significant potential due to robust R&D, a skilled workforce and substantial investment. Growth in medical, agricultural, and environmental biotechnology is driven by strong research institutions.

2. Canada needs a talent strategy that includes high-skilled immigration

Currently, Canada’s immigration policy appears to be overly concentrated on meeting the labour market's immediate needs, particularly by addressing acute shortages in low-skilled and low-wage occupations that have arisen since the pandemic in sectors such as accommodation and food services, the report says.

To enhance economic growth, it is essential to implement a robust immigration policy. Economic immigration drives innovation and entrepreneurship, contributing significantly to economic dynamism. A well-structured immigration policy is vital for fostering a more dynamic and technology-driven economy.

3. Canada needs a new Science & Technology architecture for the modern era to compete in strategic sectors

Canada’s current Science and Technology (S&T) architecture is not producing innovation at the same pace as peer countries, the report says.

Canada must focus on how, through mechanisms and incentives, to translate intellectual capital (public R&D) into private R&D and ultimately into innovation and economic growth. To do this, the country must create and build bridges and institutions of collaboration between the public and private sectors.

Canada needs a modern incarnation of what were once corporate labs in its innovative industries – where industrial research carried out in collaboration with governments, universities and businesses has led to true large-scale innovation in the economy.

A new advanced research projects agency would drive technological progress, innovation and heighten economic competitiveness, according to the report.

4. Policymakers need to better understand economic rents in an increasingly intangibles economy

The global economy is increasingly driven by intangible assets, and countries that can harness these assets will be the most competitive. Intangible assets include things like software, patents, brands, and human capital.

Companies holding valuable IP rights can earn significant rents by licensing their inventions or creations to others, thereby gaining a competitive advantage and potentially dominating their markets.

In the digital age, data has become a valuable asset. Companies that collect and analyze large datasets can derive economic rents through insights that drive business decisions, improve products, or enhance customer experiences.

The value and economic rents in designing an iPhone, for example, far exceed those in assembling it. Designing involves high-value activities like R&D, software development and brand management, which capture significant economic rents due to IP, brand power, and ecosystem control.

Taking the automotive industry as an example, Canada must decide whether to lead in designing the next generation of battery technology or simply provide subsidies for foreign companies to assemble products. For success, Canada should adopt a forward-thinking approach that emphasizes technological advancement and high-value production, the report says.

5. Canada’s current innovation policy needs structural reforms

There are four structural challenges to reforming innovation policy:

• Raising GDP per capita: This is more important than focusing on job creation and retention because it reflects increases in productivity and economic efficiency, which are essential for improving overall living standards.
• Political capture of industrial policy: The political desire to spread financial resources to all sectors and all regions is not effective given Canada’s relatively small scale. Subsidizing firms with limited economic impact is far less cost efficient compared to building talent and R&D strength in advanced industries.
• Addressing academic and bureaucratic sclerosis and gatekeeping: The current S&T funding model is outdated and not adapted to the scale and scope of current challenges: climate change, pandemics, technological innovation and national security. In general, the granting councils funding incentives at the academic level do not incentivize risk-taking and the development of breakthrough technologies. There is no or very little challenge-driven research focused on solving industrial problems.
• Lack of coordination: Every “innovation” organization under the responsibility of the federal government – whether it’s the Canada Foundation for Innovation, Mitacs, the Business Development Bank of Canada, Export Development Canada, regional development agencies, granting councils, or the National Research Council – work independently of each other. Their impact is limited in the areas where they are most needed – in strategic and advanced industries.

Recommendations to the federal government

Asselin in his CCB report makes 17 specific recommendations, across four major areas, to the federal government:

Productivity initiatives:

• Place GDP per capita growth and productivity at the top of the government’s agenda and direct key federal institutions – such as the Finance Department and the Privy Council Office - to make them central parts of their mandates.
• Initiate a comprehensive cross-departmental review of all industrial policy programs to assess their effectiveness in raising productivity and GDP per capita growth.
• Undertake a comprehensive review of the tax system to better incentivize private sector investments and boost wages.
• Streamline infrastructure funding and establish an advanced infrastructure fund focused on productivity-enhancing projects like ports, electricity generation and climate adaptation.
• Establish a National Asset Recycling Program, drawing from Australia's successful model, to identify and privatize suitable public assets. The proceeds should be strategically reinvested into high-priority infrastructure projects to drive economic growth.
• Implement a harmonized federal-provincial environmental assessment process for projects of national strategic importance.
• Reform the Scientific Research and Experimental Development program to offer preferential rates to sectors with a high concentration of R&D and provide ongoing incentives for innovative firms to invest in long-term R&D.

Competing in advanced industries:

• Conduct comprehensive industry analyses and develop a long-term innovation strategy for advanced industries where Canada has a comparative advantage, such as energy and energy technology, ag-tech, advanced infrastructure, and biotechnology. The government should develop a detailed competitive analysis of these industries.
• For each targeted sector, craft a 10-year public-private partnership roadmap focusing on talent, R&D and technology design, development and adoption. Implement specific strategies tailored to the needs of each critical industry.
• Ensure that all federal policies, programs and practices are strategically aligned to support and enhance Canada’s innovation, productivity and competitiveness in these vital sectors.

Science and technology architecture and development:

• Establish a Canadian Advanced Research Projects Agency (CARPA) modelled after the U.S. ARPA, with dedicated streams for energy, ag-tech, biotechnology and advanced infrastructure. This agency should advance and commercialize research critical to Canada's advanced-industry capabilities and ensure that the research is strategically aligned with the industrial challenges of Canadian industries. The agency should establish a dedicated procurement framework specifically tailored to CARPA’s mission of fostering high-risk, high-reward R&D and focusing on acquiring innovative products and technologies that emerge from CARPA-supported projects.
• Transform key institutions like Innovation, Science, and Economic Development and the National Research Council into cutting-edge S&T organizations. This should involve a significant streamlining of organizational structures to focus on technological innovation and enhancing industry collaboration.
• Implement a robust coordination mechanism that aligns and integrates the efforts of entities such as the Canada Foundation for Innovation, Mitacs, the Business Development Bank of Canada, Export Development Canada, regional development agencies, the granting councils, and the NRC. By ensuring these organizations operate synergistically under a central framework, the effectiveness of Canada’s innovation efforts in key sectors will be enhanced.
• Replace the Office of the Science Advisor with a new Privy Council Science and Technology Policy Office modelled on the U.S. White House Office of Science and Technology 

Talent development:

• Working with provincial governments, support initiatives that maintain and strengthen a STEM talent pipeline, including expanding graduate programs in fields like microelectronics, AI, engineering, computer science and genomics.
• Working with provincial governments, broaden educational and training programs to include advanced industrial skills, preparing students and workers for modern manufacturing roles.
• Design immigration policies to prioritize long-term economic growth over short-term labour needs. This strategy will sustain the supply of high-skilled talent essential for productivity growth.

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