Invisible Hand Has Failed Canadian Innovation

The Globe and Mail is running an interesting series this week on Canada’s miserable performance in business innovation and productivity.  Here is the main page.

Barrie McKenna’s long piece on Saturday set the stage.  The “infographic” that went with the article included some interesting tidbits:

• Canada provides by far the richest indirect government supports for business R&D of any country in the world (thanks to our juicy but ineffective R&D tax credit system). Yet we have just about the smallest level of direct government support for business R&D anywhere (except for Greece, Poland, and Mexico).  This latter approach has been derided as “picking winners” by a generation of neoliberal policy-makers (it consists of project- or company-specific grants, loans, and subsidies, rather than economy-wide tax cuts).  Yet the evidence suggests it’s been far more effective for innovation champions like Korea, Ireland, France, and even America than Canada’s indirect approach.
• Through the postwar golden age, when Canada’s economic development stategy was guided by somewhat-nationalist interventionism, Canada’s productivity rose secularly and dramatically.  We went from being poor cousins of the Americans (70% of relative productivity in the business sector after WWII) to almost-peers (reaching over 90% by 1984).  That’s when the Macdonald Commission recommended economy-wide free trade with the U.S.  Why?  Because the economists said that would harmonize our productivity with the U.S., eliminating the final remaining 10% productivity gap.  (And, in fact, the computerized economic models which were designed to sell the agreement literally imposed that productivity increase by assumption … surprise, surprise, showing how beneficial free trade would be for Canadians! The government’s current models, like the one being used to sell CETA, are just as dishonest.)  What actually happened?  Canadian productivity went south (literally, as well as figuratively).  Now caught in a free-trade resource trap, putting all our eggs in the basket of non-renewable resource extraction (an activity which demonstrates secularly declining productivity), we have fallen back to where we were in 1945: barely 70% of U.S. levels in the business sector.  That’s a stunning failure that should give cause for a fundamental rethink of everything we’ve done since 1984.

One very silly aspect of the G&M series is the ridiculous “poll” they posted, regarding what productivity-bosting initiatives the government should pursue.  The choices consisted of:

• “Welcoming more foreign investment” (we have hardly been unwelcoming, and the surge in incoming FDI over the past decade, overwhelmingly focused on resources, has made our productivity worse, not better).
• “Diversifying our trade links” (being tied to the U.S. right now is a problem, no doubt, but our trade performance with all other countries is much worse, both quantitatively & qualitatively).
• “Pursuing big infrastructure projects” (this is the only choice with a shred of genuine potential, although even the wording of this option makes is sound like a boondoggle).
• “Deregulating pre-internet industries, like telecommunications” (the bizarrely self-contradictory wording of this choice — telcommunications is a pre-internet industry??? — says it all!).

Poor readers are not even allowed to select “none of the above”!  This poll highlights the extent to which neoliberal common sense (free competition fosters efficiency) is so bred into popular discourse, that the paper’s editors literally couldn’t think of any options outside of that frame worthy even of thinking about.  I guess I should be thankful for small blessings: at least the poll didn’t propose “Cutting business taxes to foster innovation-enhancing capital investment.”

Nevertheless, I think there is an opportunity for progressives to take advantage of the current frustration and confusion in mainstream policy circles over the failure of Canada’s innovation and productivity performance despite (or perhaps because of) the business-friendly neoliberalism of the past quarter-century.  This is a fundamental link in the dubious logical chain of trickle-down economics: “create a business-friendly, deregulated environment, and business will respond with entrepreneurial energy & efficiency.”  And this link is on the verge of snapping completely.  We can advance instead a modern vision of consciously-directed sectoral development, learning from the experience of Asia, Latin America, and — yes — even America.  We can arguethat we must deliberately build a larger presence in desireable industries (not just chasing “smokestacks,” but expanding investment, production, and exports in any high-value technology-intensive tradable sector), instead of waiting for the market to dictate our “comparative advantage.”

The Globe and Mail invited me to contribute a comment to the series, which is posted below.

On productivity, the ‘invisible hand’ lacks visible success

When it comes to Canada’s lousy record in productivity and innovation, the standard prescription of economists is both clear and predictable.  They believe that unregulated markets are the best way to allocate resources and determine the composition and of output.  Therefore, to improve efficiency and innovation, simply improve markets:  Eliminate “distorting” taxes.  Eliminate regulations.  Sign more free trade agreements.  Cut “red tape”.  That will unleash the full potential of the private sector to innovate and optimize, and Canada will become a northern tiger.

Canadian economic and social policy has been generally following this advice for a quarter-century.  Taxes are lower, globalization is embraced, labour markets are unforgiving, business is freer (and more profitable) than any time in our history.  Ironically, however, the more vigorously we pursue the holy grail of self-adjusting markets, the worse our productivity and innovation has been.

Over the last decade, Canada ranked 30^th out of the 34 countries in the Organization for Economic Cooperation and Development in annual labour productivity growth.  Relative to our neighbour and biggest trading partner, our record’s been even worse.  Since 1984 (when the Macdonald Commission recommended comprehensive free trade with the U.S., precisely to boost our productivity to their levels), Canada’s business sector has faded from 90% of U.S. productivity levels, to 70%.  The promise of free trade, tax cuts, and deregulation to spur productivity (and deliver trickle-down benefits to the rest of us) has been utterly broken.

This seeming contradiction between Canada’s business-friendly policy environment, and the failure of the resultingly empowered private sector to deliver innovation and productivity growth, puzzles economists who advocate market-driven approaches.  They search for some remaining imperfections or residual market impediments to explain the failure of Canadian productivity and innovation to take off.

But what if the starting assumption of their model – namely, that unconstrained private market forces always produce the most efficient, innovative economy – is not justified?  What if, in fact, markets work more productively and creatively when they are guided, supported, and constrained, rather than simply being unleashed?  What if the best approach is to challenge and direct markets to more productive and innovative outcomes?

International experience reinforces my scepticism of market-driven policy.  The successful state-led industrialization experience of several Asian and Latin American economies in recent decades, where policy was pro-active and interventionist, suggests that innovative, productivity-enhancing growth does not occur spontaneously as a result of market forces.  Instead, the “visible hand” of government intervention, manifested in a wide range of forms, is more strongly associated with qualitative and quantitative economic progress.  Targeted subsidies, strategic trade interventions, active industrial strategies in high-tech industries, domestic procurement strategies, and even public ownership of key firms have all been more effective in promoting innovation and export success than Canada’s hands-off approach.

Canada’s poor performance, from this viewpoint, is a consequence of our liberalisation – not a paradox.  Of course, large government by itself is no more a guarantee of productivity success than small government: interventions must be smart, efficient, and disciplined.  But experience shows clearly that market forces on their own cannot be relied on to guide the economy to its innovative, efficient potential.

To meaningfully address and reverse the continuing failure of Canadian innovation and productivity, therefore, we need to adopt a more open-minded approach to economic policy.  We must set aside our knee-jerk assumption that private market forces produce optimal, innovative outcomes.  Instead, we should view effective public interventions and leadership as a key asset in nurturing investment and growth in the most desirable industries of the future.

This approach has been derided as “picking winners” by a generation of market-worshipping economists, who believe that only the private sector can pick winners.  (In fact, the private sector cannot pick winners … as any mutual fund investor can attest!)  But we cannot continue to wait for the forces of unregulated private competition to develop Canada’s economy in a sustainable, diversified manner.  If we want to maximize Canadians’ potential for innovation and productivity, we will have to collectively step into the fray and make it happen.