INST Committee Report

            Beginning in the latter half of the nineteenth century, after substantial public investments had been made in railway and telegraph networks, large and more complex industrial organizations began to appear in Canada and elsewhere around the world. New advances in applied science, the increasing division of labour, and the emergence of a new managerial class promoted the growth of the modern industrial complex, as the corporation began to spread its activities both horizontally and vertically. These new technologies dictated massive investments in capital, as well as a commitment to building integrated production operations extending both backward into core raw material supplies and forward into marketing and distribution networks. In this way the corporation, bolstered by new financial instruments for funding growth, could realize the inherent economies of scale and scope in the new production methods, while securing the necessary returns on investment (i.e., organizational integration eliminated many hold-up problems in the value-creating chain).

            The exploitation of these scale economies provided a great source of prosperity and, in fact, complemented the wealth creation that followed from the efficiencies obtained through industrial specialization with the opening up of international trade since the Middle Ages. Indeed, the new production processes emerging from the so-called Industrial Revolution led to the creation of many new industries at the same time as they considerably transformed many old industries. Unfortunately, the good came with the bad. The unprecedented cost advantages bestowed on large-scale operations benefited those who were first to transform their businesses in conformity with the new economic realities, while vanquishing the remainder. This provides us with a stark lesson on the importance of the business sector remaining nimble and flexible in face of profound social change.

            In a sense of déja vu, yet another profound societal revolution is in progress that offers us as many economic opportunities and challenges, if not more, than did the Industrial Revolution. Today’s source of societal change is characterized by the vast and substantive breakthroughs in science that have boosted rates of technical progress — manifest in both products and production technologies — over the past decade. These changes have accumulated in such numbers that people have seen fit to coin this transition period to a knowledge-based society as an Information Revolution; information technologies being the precursor of many further and far more advanced technological leaps forward to undoubtedly follow.

            Knowledge, or "human capital," is the currency of these productivity gains, not physical capital or financial size or might, as dominated an industrial economy. Corporate managers, now under pressure to raise productivity through innovation rather than through economies of scale, have thus focused on designing lean production capabilities by downsizing their core activities; non-core functions and sub-assembly activities are today being out-sourced. The modern firm has also strived to de-layer its management hierarchies and replace them with multidisciplinary teams that take advantage of the diverse skill sets of its workforce. The successful business enterprise in this environment must therefore make sure that it out-sources peripheral capacity rather than knowledge; which, given its distinctive and "footloose" character, must vigilantly be sought, combined, integrated and maintained. This is the modern-day lesson that cannot be forgotten in the transition to a knowledge-based economy.

            From the perspective of the country, rather than the firm or industry, the production, diffusion and use of information and technology are key to achieving sustainable growth in a knowledge-based economy. Not surprisingly, we are witnessing firms and individuals spending more and more resources on producing knowledge. For example, Figure 1.1 demonstrates that investment in knowledge, defined narrowly, now represents 7.9% of OECD-wide GDP. Canada fares well on this score — investing about one percentage point more per year than does the typical OECD country — despite being a traditional laggard in terms of R&D activity levels. When we include private expenditures on education and training as an investment in knowledge, this figure would exceed 10% across the OECD.

            Whether defined narrowly or broadly, this investment in knowledge remains less than half that invested in physical capital (see Figure 1.2), but now rivals investment in machinery and equipment, which was 8.6% per annum in 1995; though it should be understood that machinery and equipment, particularly that which is new and state-of-the-art, also embodies substantial knowledge. Nevertheless, when comparing Figures 1.1 and 1.2, it is evident that Canada has done a relatively better job in investing in knowledge than in physical capital in comparison to other OECD countries. If there is weakness, it lies in our R&D activity levels. The Committee recommends:

            With any revolution, whether industrial or informational, new products, technologies, firms and industries are created in relatively short order. A so-called "new economy" emerges, but its counterpart, the "old economy," which is composed of traditional industrial activities, does not simply fade away with time. The technical opportunities and challenges confronting these traditional industries vary and those that successfully respond carry on, although their activities will invariably change, both in their type and in the way they are organized. Obviously, those firms and industries that do not respond adequately to the challenge fail. For this reason, the Committee agrees with Dr. Baldwin that:

            As any new knowledge will be useful in differing ways and amounts to different industries, technological winners and losers within and between various industries will emerge. The Committee was provided with some early results, as provided by several Statistics Canada studies and surveys. It appears that a large proportion of innovations are created in a few core industries such as the chemical, electronic, machinery, and instruments industries. Indeed, firms in this core sector are twice as likely to report innovations as firms in the other sectors.

            The opportunities for innovation also vary across the spectrum of firm sizes, ownership nationality, and the degree of international market penetration — each forcing different methods of adaptation. For example, there is considerable specialization of function across different actors in the innovation process. The smallest firms report innovations at about half the rate of the largest ones, but they tend to be part of some innovation network involving large firms. The rate of innovation by multinational firms was considerably greater than for purely domestic firms. However, if domestic firms are also exporters, then they tend to innovate just as much as foreign-owned multinationals.

Innovation within the business sector has taken two general forms:

            Given the lack of pricing freedom with increasing foreign competition, either innovation strategy has become increasingly important:

            Although not without its difficulties in implementation, the solution to this perennial business conundrum is relatively straightforward:

            Finally, the mere activity of innovation is itself biased in terms of labour requirements and aptitudes. Statistics Canada reports that innovation has tended to increase the demand for white-collar workers relative to blue-collar workers. Though this is not surprising, as we are constantly reminded that the quintessential resource of today’s knowledge-based economy is human capital and explains the high rate of investment in education.

            Most people understand that R&D activities contribute to economic growth through the application of new technical knowledge to the development of new products and processes. These are the direct economic benefits of R&D. Industry advocates were quick to remind the Committee of this impact:

They were also confident to predict a future very different from what we see today:

            Industry advocates also well understand that the benefits of R&D transcend the strict needs of the business community. Social objectives are important too.

            However, R&D also has indirect benefits that probably far outweigh these direct benefits over the longer term. These indirect benefits would include: increased competencies developed by researchers and other people related to the research process; and improvements in the "innovation system," in part the result of more expertise and interaction amongst those working within this system. While these resources remain inputs to the innovation process, one witness clearly recognized them as outputs of R&D as well:

More specific R&D contributions to the economy were studied and reported:

            The data also suggest that being an R&D performer increases the probability of a firm reporting an innovation from about 10% to 40%. Furthermore, placing a heavy emphasis on technology, the production and engineering side of the firm, also increases the probability of a firm being an innovator by about the same number of percentage points according to Dr. John Baldwin of Statistics Canada.

            These results are significant enough to make it worthwhile for the Committee to spend some time finding out where Canadian industry stacks up against the rest of the world in terms of R&D. Here, as noted above, the evidence is not encouraging:

            A relatively small group of innovators and specialized R&D performers thus characterize the Canadian economy and hand-in-hand with this structure is the development of research networks.

            The Committee finds this situation a bit disturbing. When we combine the fact that Canada is importing most of its technological advances, rather than developing them here at home, thereby deriving the above-mentioned direct benefits of R&D, Canada is not fully capturing the many indirect benefits of R&D. This suggests that "freeloading" off foreign R&D is not in fact free; Canada pays in the form of lower value-added activities and lower skilled, lower paying job opportunities. Canadian industry is actually being stunted when not fully engaging in R&D, the primary input to innovation. Indeed, if we are as a country going to make a successful transition to a knowledge-based society, an "innovation culture" must be established in Canada. Attitudes must change: