Canada just can't keep up. The decline of Nortel coincides with a troubling reality: Research spending is shrinking, productivity is sliding, and we're still leaning too heavily on our resources
When Michael Davis-Burchat moved to Finland for a job at Nokia Corp. last year, the Canadian-born industrial designer made the switch for more than a chance to work for the world's biggest cellphone maker or live amid the Jugendstil architecture of his adopted Helsinki neighbourhood.
At Nokia, Mr. Davis-Burchat found a "learning corporation" that is constantly receptive to new ideas about the way to design its phones and move into the exploding sector of wireless applications and services.
"Ninety per cent of [North American] companies approach innovation by altering their existing products," Mr. Davis-Burchat says. "They end up being really good at an old paradigm, instead of going out into the world to see not just what people are doing, but what they are trying to do, and designing their products accordingly."
This may help explain why Canada is losing at the innovation game. Yet, policy makers seem strangely unmoved even as Canada's productivity stagnates, its manufacturing sector craters and its resource industries wait out the recession with the casual assurance that the next commodities boom will elevate them - and the country - from the dumps.
Politicians seemed similarly unperturbed at the insolvency and break-up of Nortel Networks Corp., and the pending sale of one of its key units to a Nokia subsidiary.
The decline of Nortel, which began with the bursting of the global technology bubble in 2000, coincides with a worrying widening of the productivity gap between Canada and the United States, a dangerous drop in business spending on research and development here, and the country's increasing dependence on natural resources to fuel economic growth.
Between 1981 and 2000, Canadian companies' expenditures on R&D grew by almost 10 per cent annually. But since 2001, they have been flat in real, after-inflation terms and have declined by fully one-fifth when expressed as a percentage of gross domestic product.
At its zenith in 2000, Nortel alone spent almost $6-billion on R&D. By 2008, that had fallen by more than 70 per cent to $1.67-billion, based on average Canada-U.S. exchange rates. The outlay still amounted to 15 per cent of Nortel's sales last year, however, making it one of the country's most R&D-intensive firms.
Canada's new R&D players - BlackBerry inventor Research In Motion Ltd. being the most notable - remain too few to alter a troubling reality. RIM spent 6.2 per cent of sales on R&D in the fiscal year that ended Feb. 28, less than half of Nortel's level of investment last year.
Still, RIM's R&D budget as a percentage of its sales is several times that of Canada's biggest oil and gas companies, which have been stock market stars throughout this decade and which remain the foundation on which the country has pinned its hopes for a rapid recovery. Despite overflowing profits in recent years, EnCana, Petro-Canada and Suncor have spent less than 0.5 per cent of annual revenues on R&D.
That raises questions about where Canada's wealth will come from in future decades. Economies thrive by developing new products and processes that the world demands. While the prospect of triple-digit oil prices and renewed fury in the fertilizer market will clearly fuel Canada's post-recession economy for a while, resources have always proven to be a highly unreliable creator of wealth.
Prices plunge as fast as they rise, and the booms bring with them nasty, unintended consequences, such as a shortage of skilled labour as young people see less need to pursue costly higher education when even burger-flippers can earn premium wages. What's more, as non-renewable resources dwindle or become more difficult to access, the cost of extracting, much less processing them, increases rapidly.
Yet, Canada's decades-long attempt to move out of its "staples trap" appears not only to have stalled, but to have to taken a giant step backward.
The staples theory was originally developed in the 1920s by historian Harold Innis to explain Canada's development as a provider of valuable raw resources - initially fish and fur - to the British Empire. It was later seized on by the economists on the left to explain Canada's failure to move into higher value-added industries. Canadians, they argued, had developed a "commodity mentality," resigned to sending unprocessed resources abroad, instead of building a modern economy at home. The small group of elites that got rich on these resources controlled the political levers to ensure nothing changed.
Indeed, it didn't for while. The U.S. eventually replaced Britain as our biggest export market. Though the destination was different, the dynamic was not. Each wave of economic growth in Canada was driven by U.S. demand for our lumber, newsprint, oil or hydro power. We did little, it seemed, to shake off our mantle as hewers of wood and drawers of water.
Though the staples theory seemed outdated as Nortel rose to prominence and Ontario's auto sector grew to overtake Michigan's, it has been revived recently by economists to explain the slide back into resource dependence. Raw or lightly processed resources declined steadily as a share of Canada's exports between 1960 and 2000, falling by half from 90 per cent to about 45 per cent. But since the beginning of this decade, their share of exports has risen dramatically to 65 per cent in 2008, according to new research by Canadian Auto Workers economist Jim Stanford.
"We thought Canada was moving beyond the simple extraction and export of resources, but I'm more tentative about that than I was two years ago," said Keith Brownsey, a professor of policy studies at Mount Royal College in Calgary, who co-edited a 2008 academic volume on the topic. "We are becoming more and more reliant on natural resources."
Does it matter? Can't we still get rich - or at least maintain our standard of living - as long as the U.S. and the rest of the world hunger often enough for our oil, gas, lumber, potash and coal?
Experts doubt it. Canada's resource sector has a poor record of innovation, depending almost entirely on equipment and processes developed abroad. Yet, innovation is the only sure way to create wealth. And, though the link is not always absolute, R&D spending is almost always a sine qua non of innovation.
Barring an extension of the workweek - Canadians already put in more hours than Americans and are virtual workaholics compared with Europeans - innovation is the only sure way for Canada to be more productive. It is the key to maintaining our standard of living and providing increasingly costly public services for an aging population.
The innovation imperative has struck home with particular urgency in Central Canada. The upward pressure exerted on the Canadian dollar when commodity prices rise - a phenomenon experienced before the recession and one that promises to return with a bang after it eases - leaves Ontario's manufacturing sector unable to cope as it earns less and less on its sales abroad. Long dependent on a cheap loonie to drive exports, manufacturers are now paying the price for having invested too little on productivity-enhancing equipment or the development of higher-value-added goods - in other words, for having failed to innovate.
Productivity grew at a rate of 1.8 per cent in Canada in the decade to 2006, compared with 2.8-per-cent annual growth in the U.S. The result is that the output of the average worker here fell to 76 per cent of the U.S. level in 2006, a precipitous plunge from 90 per cent in 1984. Recent data show the trend continued in 2007, as productivity rose 2.7 per cent south of the border, while falling 1.2 per cent in Canada.
"Canada is not being productive because it's not being innovative," said Robert Brown, chief executive officer of Montreal-based CAE Inc., the world leader in aircraft flight simulators and training. "A lot of innovation occurs at the interface with the customer. But when you look at the make-up of Canada's economy, with so much dependence on resources, there is less contact between [our biggest] companies and end users."
Mr. Brown recently chaired a panel on business innovation set up by the Council of Canadian Academies, a federally funded research body. The panel's damning final report, tabled last month, presented the sobering picture of an economy that is trailing badly when it comes to innovation, which the report defines as finding "new or better ways of doing valued things."
Part of the reason lies, paradoxically, in our proximity to the biggest economy in the world. While Canada typically measures its performance relative to its southern neighbour, hands-down our largest trading partner, U.S. industry is itself losing ground relative to competitors in China, Taiwan and South Korea.
All sorts of theories exist about why this is occurring. One involves the overwhelming political influence of powerful, entrenched industries in North America - for example, coal south of the border, oil north of it and Big Three auto makers on both sides of the divide - which is seen to have blunted the ability of Canadian and U.S. governments to encourage much-needed economic transformation.
The result is that public policy often benefits one group - the one with the best lobbyists or political sway - at the expense of the overall economy. Nothing buttresses this theory better than the bailouts of General Motors and Chrysler.
Strong governments in Asia and Finland, on the other hand, have been able to resist the self-interested demands of individual sectors, and have implemented country-wide innovation strategies that, while not without hiccups, ultimately increase the size of a country's economic pie over time.
Another reason cited for the relative decline of North American manufacturing is that functions outsourced in the 1990s enabled Asian competitors not only to improve the products they assembled, but also to develop altogether new and more sophisticated ones. This trend speaks to the close link between manufacturing and design, clearly underestimated by a generation of North American business leaders who sought short-term profits by moving production offshore.
Consider personal computers. Asian firms, such as Taiwan's Acer and Asustek, started out as original equipment manufacturers, or OEMs, that assembled PCs for U.S. companies. But an intense desire to move up the value chain spurred the Taiwanese firms to branch into PC design. They are now beating the Americans at their own game.
Acer and Asus sell their products under their own name and now lead in netbooks, the mini-laptops that have taken an otherwise moribund the PC market by storm this year. Acer is now the world's No. 3 seller of PCs and could soon surpass U.S.-based Dell for second place.
In an article in the current issue of the Harvard Business Review, Gary Pisano and Willy Shih point out that Amazon's new Kindle 2 - the electronic tablet that could transform the way we read books and newspapers - could not be made in North America because the capacity to manufacture many of its high-tech components no longer exists on this continent.
As manufacturing of PCs and cellphones moved to Asia, the impetus increased there to leverage innovation in order move out of the low-margin assembly business and up the technology value chain.
For example, development of lithium ion batteries - initially used in small electronic devices, but now seen as key to building a viable electric car - has occurred almost entirely in Asia.
The result is that GM's all-electric Volt, set to hit the market in 2010, will use a lithium ion battery that was designed and built in South Korea.
The battery accounts for about half of the car's total value, sparking doubts about whether the Volt qualifies as a U.S. "innovation" at all.
"GM had no choice but to look abroad. Rechargeable battery manufacturing left the U.S. long ago," explain Messrs. Pisano and Shih, both professors at Harvard Business School. "When U.S. companies largely abandoned the 'mature' consumer electronics business, the locus of R&D and manufacturing - not just for the laptops, cellphones and such, but also for the batteries that power them - shifted to Asia."
As the U.S. goes, so goes Canada. President Barack Obama has outlined ambitious objectives to reassert U.S. leadership in innovation, notably in developing environmental technologies to spur economic growth. Given the integrated nature of the North American manufacturing chain, Canada has more riding on the President's success than our leaders care to admit. "If the U.S. declines too quickly, we have a serious problem," warns John Curtis, a distinguished fellow at the Centre for International Governance Innovation in Waterloo, Ont.
The consequences of this global power shift could show up in lower pension benefits, substandard health care and rickety infrastructure for future generations of Canadians. Early signs are already apparent to discriminating eyes, such as those of Mr. Curtis, a former chief economist in the Department of Foreign Affairs and International Trade.
"We are declining relative to many other parts of the world," he said. "You don't really feel it unless you're cosmopolitan and travel a lot. You now stay at the three-star hotel instead of the four. But our cities - and the country as a whole - are quite clearly relatively less well off than before."
Mr. Curtis faults, at least in part, the failure of governments in Canada to move quickly enough: "Our policy machine is just too slow. If we don't get on the ball, we're just going to get hammered."
Where he sees languor in our policy apparatus, CAE's Mr. Brown detects an aversion to interventionist industrial strategy among governments. But as Canada has relied on the free market - auto bailouts notwithstanding - to determine its champions, governments elsewhere are actively nurturing their own winners.
"We seem to believe the free-market system will work, but no one else operates that way," Mr. Brown said. "If you rely only on market forces, you are going to react to what others are doing, rather than anticipating what is going to happen."
Like Research In Motion, CAE is in an increasingly rare specimen: a Canadian-based and -controlled technology leader. It recently announced plans to invest $274-million - $100-million of it from the Quebec government - to find ways to extend the company's expertise in flight simulation to other sectors, such as training doctors.
"We set up an innovation group five years ago to see how we could apply the competitiveness we have in aerospace elsewhere," Mr. Brown said. "There are all kinds of areas where you can apply modelling and simulation technology to train people."
It's not always necessary for companies to develop new technology, as long as they adopt innovations made elsewhere. But even here, Canada lags. The Council of Canadian Academies report found that investment by Canadian companies, including foreign-owned subsidiaries, in productivity-enhancing computer hardware and software was only 60 per cent of the level found among U.S.-based companies in 2007.
When it comes to R&D in Canada, the report concluded foreign-owned subsidiaries tend to pull their weight only when coerced by government. The pharmaceutical sector stepped up its research spending in exchange for enhanced patent protection, while IBM set up research operations in Canada to become eligible for government contracts.
Foreign-owned auto makers, on the other hand, have conducted little or no R&D in Canada. GM and Chrysler are the only car makers with engineering centres in Canada. But their R&D spending, even as a percentage of sales, is a tiny fraction of the amount at their home bases in Detroit.
General Motors of Canada Ltd. currently employs about 100 engineers engaged in R&D activities, according to spokesperson Stew Low. It has promised to spend "almost $1-billion" on R&D in Canada over the next seven years as part of its $10.6-billion bailout by the federal and Ontario governments. But even that amounts to barely 1 per cent of annual sales, based on GM Canada's pre-crash revenues.
Research will become increasingly important to the competitiveness of Canadian auto plants as a strong loonie and wage concessions south of the border wipe out much of the edge they once held over U.S. facilities. But Washington's promise to provide $25-billion (U.S.) in loans to companies there to help develop more fuel-efficient cars threatens to widen the already gaping research chasm between each country's auto sector.
"Without comparable support in Canada, manufacturing capacity could follow the funding, taking engineering work and suppliers with it," warns the Academies report.
Still, foreign ownership is not the biggest reason for Canadian companies' R&D deficit. Despite a disproportionately large resource sector, compared with other developed countries, Canada has been a laggard when it comes to developing technology used to extract or process resources, or to blunt the environmental impact of such activities. Alberta's vow to plow $2-billion (Canadian) into the development of carbon capture and storage technologies is a start, but hardly a game-changing one.
"The failure of Canada to develop global export leaders in advanced machinery and equipment for the resource sector is one particularly telling indicator of the country's innovation shortcomings," the Academies report concludes.
In contrast, Finland used its expertise in the forest industry to become the world's leading provider of equipment used to harvest trees, and the machinery and chemicals used to turn them into paper products. The move has proved prescient as pulp and paper-making shifts to modern, low-cost mills in the developing world, fuelling global demand for expensive Finnish machinery, chemicals and expertise.
Despite years as the world's biggest exporter of forest products, Canada never showed the same forward thinking or ingenuity. Its forest industry now finds itself far down the value chain, still pumping out basic pulp and newsprint, and unable to compete with low-cost players from emerging economies.
Now, Nokia Siemens Networks (NSN) - a joint venture between Nokia and Germany's Siemens AG that is controlled by the Finnish company and run out of Helsinki - is poised to acquire Nortel's pivotal LTE, or long-term technology, division. LTE could transform the cellphone business by increasing the download speeds of wireless devices by a factor of 10. The business potential for Nokia, which is moving beyond simply making phones to providing the applications and services that run on them, could be limitless.
So, why Finland and not Canada?
The expression "necessity is the mother of invention" comes to mind. Though Finland's history is full of rude awakenings, as it alternately succumbed to Swedish and Russian invaders in previous centuries, the collapse of the Soviet Union in 1991 was its biggest economic setback. The breakup of Finland's biggest trading partner sparked a near depression in the nation of 5.3 million. Economic output shrank 13 per cent over three years and unemployment rose to 20 per cent from 3 per cent.
The crisis prompted much collective soul-searching, enabling the government to rally Finns behind the idea that the country's revival lay in innovation. Government spending on R&D grew rapidly, even as overall public expenditures were slashed.
No company epitomized the transformation of the Finnish economy more than Nokia. The company (which takes its name from the river where its founders built a pulp mill in 1865) nearly went bankrupt in 1991. Its conglomerate strategy - making everything from telephone cables to car tires to TV sets, and selling them to consumers in the Nordic and Soviet-bloc countries - no longer proved viable. Backed by massive government research funding, Nokia dropped its other businesses to focus exclusively on making wireless communications devices, just as the global cellphone industry was poised to explode.
Today, Finland spends 3.5 per cent of its GDP on R&D, compared with less than 2 per cent in Canada. In 2008, Nokia alone invested €6-billion ($9.8-billion) in R&D, or 12 per cent of its sales, including €2.3-billion in research and development spending at NSN, the unit that is buying Nortel's key LTE assets and technology.
The Finnish Miracle is an example of an economy emerging from the pits to overtake those it used to envy. It's hardly the first. In 1982's The Rise and Decline of Nations, economist Mancur Olson advanced the idea that countries whose economic foundations have been suddenly shaken or destroyed subsequently tend to grow and innovate faster than more stable nations. The reason? Such crises break the hold of vested interests on government policy makers; dramatic change becomes a question of national survival.
Mr. Olson cited the industrial resurgence of Japan and Germany in the postwar period to explain his thesis. While Japan and Germany prospered in 1970s, the economies of other developed countries, such as the U.S. and Britain, became bogged down in interest group politics, resulting in "institutional sclerosis" and slow growth.
So far, a harrowing financial crisis and painful recession do not appear to have created the momentum for profound, innovation-led economic change in Canada. Perhaps we haven't suffered enough to feel the need. Besides, the next commodities boom is just around the corner, isn't it?
"We don't have really serious crises in Canada. We just seem to lurch," opines Wendy Dobson, a former associate deputy minister of finance in Ottawa and now a business professor at the Rotman School of Management. "The 1995 referendum was a crisis - but that was political. Economically, we just muddle on."
The price of that is a slow but steady erosion of our standard of living. And the loss of people like Mr. Davis-Burchat, the Canadian-born designer now toiling at Nokia.
He and his wife, who is also Canadian, "have learned to make graavilohi in the Finnish tradition and are pretty much addicted," he says of the traditional raw salmon dish.
After all, national delicacies are rarely improved by innovation. Unlike economies.