Proceedings of the Standing Senate Committee on
Banking, Trade and Commerce
Issue 13 - Evidence - Meeting of May 11, 2005
OTTAWA, Wednesday, May 11, 2005
The Standing Senate Committee on Banking, Trade and Commerce met this day at 3:36 p.m. to examine and report on issues dealing with productivity.
Senator Jerahmiel S. Grafstein (Chairman) in the chair.
[English]
The Chairman: Honourable senators, good afternoon. Welcome to the Standing Senate Committee on Banking, Trade and Commerce. This is an experimental round table, and we welcome our first witnesses, as well as men and women in our audience who are watching on the World Wide Web from coast to coast to coast. There were over 85,000 hits in our last hearing, and we have heard from every region of the country. We will be broadcast delayed on CPAC; hence, I want to welcome all after you.
Before turning over the floor to our witnesses, I should like to say a few words on what we hope to accomplish today and tomorrow on this round table. We all know and accept how important Canada's productivity and global competitiveness is to our economy and our standard of living. For the past 60 years, since the Second World War, productivity has accounted for between one quarter and one third of our standard of living in Canada. Increasing our productivity is now the only way, in our belief, to increase our living standards.
There have been numerous studies and reports on productivity. I and my fellow committee members have read some of them in preparation for our round table. Before we finalize our report, we will have read them all.
We are taking a very comprehensive approach for our examination of productivity issues over the next few days. We are bringing together some of Canada's foremost and thoughtful experts, including our witnesses today, on the subject, together with expertise embodied by members of the committee. We are asking for the public's input in this hearing as well so that we can better understand the role the federal government can play in helping, as they should, our industries become more productive and more competitive.
These are some of the questions we hope to have addressed. Should we be investing more in public education? Does our tax regime need reform? Is the regulatory burden on the industrial and financial sectors dampening productivity? Is there more that the government could do, or less perhaps, to help Canadians profit in the new economy?
We do not know. I do not know. That is what we are endeavouring to discover by these discussions.
Before we begin, I should like to remind those of you watching us over the Internet and on CPAC's delayed broadcast that we want your input into this hearing as well. This is a new experiment; we are seeking to get the public's input as we study this matter.
Productivity, as you know, is a monumental problem in every region of the country. If you have a comment on something you are seeing here, or thoughts of improving Canada's productivity, we invite you to send us an email at banking-banque@senate.sen.parl.gc.ca. That will be emblazoned across the Internet screen. Thank you very much to our staff for doing that.
That address is on the screen right now, and we will super it a number of times during the course of these round tables. We want Canadians, experts and the public alike, to email us your views and any views you might have about the evidence you might hear today and tomorrow.
By the way, that does not exclude our experts. If you disagree with each other, or if you hear something today or tomorrow that you disagree with or agree with, we want to hear from you as well.
[Translation]
Productivity is a huge problem in all regions of the country. If you have any comments or suggestions on ways to improve productivity in Canada, we invite you to write to us at the address that is now appearing on the screen and that will appear several times during the round tables.
[English]
A final word about the inspiration for these hearings. It was our excellent deputy chair, the Honourable David Angus, who convinced us on the committee that productivity and competitiveness was a vital topic to keep Canada growing. We want to thank him, not only for his idea but also for his continuing support for this particular experimental hearing.
Let us begin. If the productivity equals the effectiveness with which inputs are transformed into outputs, how can the Canadian government improve that effectiveness?
We have with us today Niels Veldhuis, who is a senior research fellow with The Fraser Institute. All of us have very interesting comments to make about The Fraser Institute, but nobody can question its great expertise. Jean-Marc Suret is a Ph.D. fellow of the Center for Interuniversity Research and Analysis on Organizations and a professor at Laval University. Last, but not least, we have with us Bernard Courtois, who is the president and CEO of the Information Technology Association of Canada.
As we have advised you in the past, you have five minutes each. We have your briefs. They are all excellent. As I have said to you at the outset, if you wish to respond to each other or to us, orally or in writing or by email, please feel free to do so.
Mr. Veldhuis, please proceed.
Mr. Niels Veldhuis, Senior Research Economist, The Fraser Institute: Let me start by thanking the members of the committee for the opportunity to present today. I do so as a representative of The Fraser institute, but the opinions that I express here today are my own.
I will try to keep my comments to five minutes. You have my full brief. I hope you will take the time after the meeting to read it in full, if you have not done so already.
Productivity growth is an essential part of determining future living standards. First, let me take a step back and try to explain how Canada has done over the last 20 years in terms of living standards, and then I will address productivity.
Figure 1 on page 2 of my brief displays the average incomes in Canada relative to that in the U.S. The most commonly used measure of living standards is GDP per capita. You will see that, in 1985, GDP per person in Canada relative to the U.S. was 88 percent. That has since fallen to 84 percent in 2004.
The same figure also displays personal disposable income. Personal disposable income is the income that Canadians have after the payment of direct taxes. Personal disposable income also includes government transfers. You can see that Canada's income relative to the U.S. has fallen from 80 percent in 1985 to 67 percent in 2004, quite a substantial decrease.
The main question that we are here to address is why our incomes have fallen relative to the United States. The OECD recently released a study entitled ``Going for Growth,'' which investigated ways to improve living standards.
Labour productivity increases, the ultimate driver of real income growth, requires producing an incrementally larger amount of output per hour worked.
I think most economists and most people here would agree with that. Productivity growth, the increased efficiency with which we produce our output, is essential for increased living standards. An examination of labour productivity growth in Canada reveals that we have a serious problem.
Figure 2 on page 3 of my brief displays GDP per hour worked in Canada relative to that of the U.S. In 1985, GDP per hour worked was 90 percent of that in the U.S. That has since fallen to 82 percent. You also will see that Canada has decreased dramatically from 2001 to 2004.
In an international context, our labour productivity growth does not look much better. Figure 3 on page 4 displays average growth in labour productivity, GDP per hour worked, over the last 10 years. Canada ranks eighteenth out of 24 nations. Ireland, which ranked first, had labour productivity growth that was three times that of Canada.
One of the key determinants of labour productivity growth is the amount of capital that each worker has to work with. Workers that have more capital are able to produce more per hour, are able to demand higher incomes and thus increase their standard of living.
Governments play an important role in creating an environment with high levels of investment and high rates of productivity. There are many determinants of business investment — openness to trade, the education of the population, and regulations. One of the most important determinants, and the one that is damaging the investment climate in Canada, is business taxation.
Jurisdictions that penalize business investment, and thus capital, reduce the incentive for businesses to invest. Business taxes also reduce the amount of money that businesses have to reinvest in capital equipment and in new technology. This is why the economic research has consistently found that business taxes are an economically damaging way to raise revenue — that is, they are economically more costly than sales taxes, payroll taxes or personal income taxes.
Table 1 on page 5 of my brief displays the extent to which each of the G7 countries use particular taxes. You will see that Canada makes the highest use of the most damaging taxes — that is income taxes and profit taxes. Table 2 on page 6 details what is called the marginal effective tax rate on capital. This is the tax rate on capital if you include all business taxes — corporate income taxes, sales taxes on business inputs, depreciation schedules and capital taxes. You will see that Canada has the third highest marginal effective rate on capital among the industrialized countries. Only Germany and China have higher rates.
If governments are going to enhance our living standards and productivity, then we must reduce the marginal effective tax rate on capital. We must create an environment where businesses have the incentive to invest. Our specific recommendations are listed on the last page of my brief.
First is immediately eliminating the corporate capital tax. This is probably one of the most damaging taxes in Canada, as I am sure you are aware. It is a tax on equity and debt. It is scheduled to be eliminated completely by 2008, but removing it before then will dramatically reduce the marginal effective tax rates and increase capital investment.
Second is reducing the corporate income tax rates and increasing the small business tax threshold. Reducing the corporate income tax rates will stimulate capital investments and increasing the threshold for small business will reduce a barrier to growth. The research shows that small businesses grow until they reach the threshold and limit their growth thereafter. Increasing this threshold will increase the incentives for small business to grow.
Third is eliminating the corporate income surtax, which currently stands at 4 percent. Fourth is adjusting capital cost allowances to better reflect the true cost of replacing assets.
The federal government should encourage the provinces to harmonize sales taxes. Many provinces levy sales taxes on business inputs, which is another form of capital taxes.
Last is to reduce the middle and upper income tax rates. This will enable Canada to retain skilled workers and to provide citizens with the incentive to take risks, engage in entrepreneurial activity and to save and invest.
I look forward to answering your questions.
[Translation]
Mr. Jean-Marc Suret, Director, School of Accountancy, Laval University and Fellow CIRANO, as an individual: My remarks will be quite close to those made by my colleague. I will address the problem of financing for technology start- ups. That is an essential part of productivity gains. They must be able to develop themselves and then develop products, services and ideas that will help other companies improve their productivity.
[English]
The Chairman: Normally, we require that submissions be made in French and English. This submission is in French. The translation was slow. We have allowed this witness to go forward. I assume that senators have no objection to this. It is an excellent brief. I wanted to remark that it was not the fault of the witness. We simply did not get it done in time, but we hope to have it shortly. I see that senators agree. Mr. Suret, please continue.
[Translation]
Mr. Suret: We have measured the costs and the difficulties facing technology companies in obtaining financing. The results are quite frightening. The start-up companies that we met spend up to 50 per cent of the amounts they raise looking for financing. It is between 30 per cent and 50 per cent, in other words, a start-up company that raises $500,000 will have to spend $250,000 in some cases. The timeframe for obtaining funds is on average 12 months. Sometimes they wait 24 months.
It is clear that in these circumstances, the company is at an extremely significant competitive disadvantage in comparison with American companies where it takes about six months to obtain funds, where the amounts they obtain are four or five times higher, and where costs to obtain funds are much lower.
We wondered why that is. One of the reasons — it is also relatively serious — in our opinion, is government intervention. Government programs are detrimental in terms of financing small companies, and many of these programs have been analyzed. I am going to address the most significant one: labour sponsored funds.
As you know, labour sponsored funds are programs throughout Canada that, at present, collect about 70 to 80 per cent of the funds that enter the venture capital industry. Each year, this represents about $2 billion in Canada, 80 per cent of which is subsidized through tax expenditures. So the cost in Canada is about $1.6 billion per year. That is a huge tax expenditure. In our opinion, this tax expenditure is totally ineffective. We determined that only 30 per cent of the funds which were raised by labour sponsored funds went to private start-up companies. The rest went into bonds, stocks in large corporations, or projects of all kinds. The funds do not even respect the spirit that guided their creation.
Canada has invented the most ineffective corporate intervention model. Our brief contains a table that summarizes the cost per dollar invested of various programs in the United States, Israel, the United Kingdom, and so on. Every dollar invested in a small company, through a labour sponsored fund — especially the ones in Quebec — costs the public purse four dollars. The Americans can do it at no cost, and it costs the English between 30 and 40¢ per dollar, if we convert the currency.
Financing these projects is not cost-effective at all. We have measured performance of these projects at 8 per cent per year since the funds were created. That means we have created a program that takes money from taxpayers and gives it to the least profitable companies in the economy. It is penalizing the entire economy.
This is hardly beneficial for investors, and that leads to another problem, one that is different but one that we must nevertheless address. It takes money away from Canadian taxpayers. They will be poorer when they retire than they would have been if the program had not existed. Why invest in that? Simply because they are drawn to the tax credits. They are under the impression that each dollar of tax credits they receive is worth more than a dollar. They are drawn to that and invest billions in it. They are investing their retirement savings and getting poorer. That is a heavy responsibility for a government.
The final point highlighted by my Ontario colleagues is the crowding out effect. This kind of government intervention leads to the flight of private capital, and the loss of private capital, which is so important to the economy, is more significant than the contribution of subsidized funds.
All in all, we are seeing a reduction in available funding for Canadian start-up companies. My colleagues estimate that this reduction means 400 fewer investments per year in Canada, which represents $1 billion less for technology start-up companies. That is how an ill-conceived government program in which the federal government participates, penalizes companies. In our opinion, it is one of the explanations for the serious difficulties facing companies, all the more so since a quasi-monopoly has been created in certain regions.
In Quebec in particular, government funds represent 80 per cent of available funds. That means that all aspects of competition in the capital market have been removed, competition that is essential to facilitate the financing of small companies.
[English]
The Chairman: Did you say that it is 80 per cent in Quebec?
Mr. Suret: Yes, 80 per cent of the venture capital is linked to government intervention.
The Chairman: Is that the same across the country?
Mr. Suret: No.
The Chairman: What would be the percentage in Ontario?
Mr. Suret: It is less in Ontario because the structure of the labour-sponsored funds is different in Ontario.
[Translation]
People can withdraw their money from the labour sponsored funds in Ontario after five or seven years. That means the funds do not grow much. That is very costly for the government. The money is put in these funds and withdrawn after five years. In Quebec, people who put money into a labour sponsored fund must leave it there until they retire, which means that the funds grow year after year. The largest fund to date is $6 billion. The others are growing. The structure is not quite the same, so Quebec is more penalized than the other provinces because of this particular structure.
[English]
The Chairman: Thank you. Mr. Courtois, please proceed.
[Translation]
Mr. Bernard Courtois, President and Chief Executive Officer, Information Technology Association of Canada: Thank you, Mr. Chairman. I will make my remarks in English, but I would be pleased to participate in the discussion in French or English.
[English]
The information and communications technology industry — ICT — represented by our association is highly globalized. Many of our companies sell most, if not all, of their products and are designed sometimes from the outset to operate on a global market and not in the Canadian market. We have an interest in productivity and competitiveness from that angle because we operate very much in a global competitive environment.
Our particular interest is the special role of our industry as it becomes more and more recognized as the driver and enabler of productivity in the rest of the economy. We live at the heart of competitiveness and productivity. In that vein, I cannot understate the importance of the topic that this committee is examining today.
We believe that at this time Canada needs a wake-up call on the subject of productivity and competitiveness. There is a danger of a sense of complacency in this country. While we are doing pretty well, in order to truly retain our place in the future, we need a sense of intensity around these issues. In terms of the link between productivity and ICT, we have a position paper, which has been distributed, that touches upon the mounting evidence that investment in ICT, and, in particular, the use of ICT and how enterprises and governments change how they do things, truly drives productivity in a modern economy. The papers also note that productivity comes from investing, not just in productive equipment but also in people and their skills. Productivity is not only about cutting costs, which of course are essential for competitiveness and therefore growth of enterprises, but also about growing output.
We have a number of references in the brief about the way in which the tight link of ICT, which is more and more pervasive in all kinds of operations and sectors of our economy, is at the heart of productivity. I will not review all of that, although there is considerable evidence.
There is also mounting evidence that the economic importance of our sector is dual. We are a fairly large sector, with about 550,000 employees, a disproportionate share of private-sector R & D. We represent about 5 per cent of GDP, and eight or nine times that in terms of what we do in R & D in the Canadian economy from the private sector. We are living at the heart of innovation and productivity. That causes us to look at our industry in a broader way. We tend to look at our industry and its future as being heavily linked to the productivity and success of the other sectors of our economy and of how Canadian governments use productive technology.
We are also noticing, as Mr. Veldhuis has pointed out and as we point out in our brief, evidence of the prosperity gap and the productivity gap between ourselves and the United States. We refer to the various studies of the Institute for Competitiveness and Prosperity that point out that we have built one of the world's most competitive and prosperous economies, but they admonish that we cannot stand still, that our trading partners in both the developed and the developing worlds continue to advance, and that strengthening productivity is the most significant challenge facing Canadians. For us, the reference to what is happening in both the developed and developing worlds resonates significantly.
Our industry is at the heart of another significant phenomenon that is sweeping the world at this time. Another global shift of labour is taking place. First, it was manufacturing, and we can all see what is happening to manufacturing in developed countries and what happened first in Mexico and then other jurisdictions and then China. That same phenomenon is now happening with knowledge work. Knowledge work in some ways is easier to move around than manufacturing plants. There is not as much physical plant to move around, and you do not have to be as close to the market. Our industry, by making the movement of knowledge no cost, and also by being at the forefront of using the kind of knowledge work that can be moved around, is living this in both ways.
That is causing us to say that we must not try to play ostrich and deny this phenomenon. We must strategize to succeed in it and find our successful place. That causes us to say that there is a great danger of complacency. The gap in productivity between Canada and the U.S. has not been explained. It has been analyzed, and some of the sources have been found. Generally, it comes from under-investment in Canada compared to the U.S., but why Canadian enterprises under-invest compared to their peers is not quite clear. We have some intuitive reasons. Certainly the low Canadian dollar caused a sense of complacency, perhaps. Another phenomenon that might cause a sense of complacency here is that the developing economies, as they get large — China, India and so on — will consume more and more of our natural resources.
There is a great danger that Canada and Canadians will feel they are doing pretty well around that and a danger that we could slip back into being hewers of wood and drawers of water. As the Institute for Competitiveness and Prosperity says, we need to avoid a vicious, downward economic spiral of under-investment, reduced productivity, reduced capacity to invest and further reduced productivity, et cetera, where we would miss out on the promise that we have because Canada has the capacity to succeed in a knowledge-based economy. We would give that up if we fall for the complacency that will come from the success in selling our natural resources.
Looking at how we can intervene in that, ITAC is particularly concerned about the relatively low rate of investment in productivity, particularly in information and communication technology, within Canada's small and medium-sized business sector. That sector, which employs most Canadians and created 36 per cent of net new jobs in 2002-03, is seriously underutilizing information and communications technologies. We refer in our briefs to CeBI's reports and studies and their ``Fast Forward 4.0'' report highlighting the problem.
Minister Emerson also referred to that, saying that ``while some Canadian firms are global leaders in the generation and production of ICT, too many Canadian firms, mostly in the small and medium-sized enterprise sector, have been slow to adopt powerful new technologies.'' That has negative implications for Canadian competitiveness. We have seized on that as a challenge. In March, we announced the creation of an ``eTeam,'' composed of the senior executives who work with the SME market in Canada to try to find ways in common of breaking down the barrier to adoption of productivity-enhancing ICT solutions by these businesses.
We think other public policy initiatives may be required. The Industry Minister has talked about the interest in tax incentives to spur adoption, and we think the time is appropriate to give this idea further study, particularly since countries we compete with have already established measures to accelerate adoption. We refer to Japan, for example, which has recently introduced significant investment incentives for acquisition of ICT equipment. The U.K. in 2004 introduced a 50 per cent first-year allowance on ICT assets by small and medium companies. Those are the types of ideas we will have to implement. There is a range of things we need to do. We need to look at our tax system to make it better performing. We will need to look at some incentives as well to spur greater productivity by our SMEs.
I will conclude with this need for a call to action or wake-up call that we think is required at a broader level. In its January 2005 release, the Institute for Competitiveness and Prosperity recommends an action plan to encourage business, government and individuals to work together to realize Canada's prosperity potential. At ITAC, we definitely believe it is time to convene some means for Canadians — we are a small nation, after all, in the global scene — to come together to develop such a strategy as a pressing matter.
The Chairman: Thank you, Mr. Courtois. You took the words out of the committee's mouth. We are the wake-up call. We are preparing an action plan. That is why we are here today. I appreciate you affirming our mission statement.
Senator Angus: Welcome, gentlemen, to the awake Senate. You have probably read many contrary things about senators. We do believe in the need, as the chairman said, for a wake-up call to Canadians. We have convened you here — along with our audience that we hope is watching and listening out there in cyber land. I think you will have noticed, Mr. Courtois, that we are trying to take advantage of some of the information and communications technology that you speak of. We are hoping to derive some greater productivity in terms of our own contribution to public policy.
I will start with a few short things that might set the tone for further questioning. You have all emphasized the big productivity gap as between Canada and the United States. That gap has been there for a long time. It seems to have widened substantially since 1973, as far as can I see. That may not be a magic date, but some writers suggest it is.
Is it just with the U.S? We are now in a globalized economy. I see personally, in my small way, a problem in terms of a productivity gap between the North American marketplace, in which we are, granted, a relatively minor player, and the global competitors such as Asia, India and China. Would you comment on that, please?
Mr. Courtois: I see it as coming from both ends. The United States is, like Canada, in today's world, a high-cost jurisdiction. You must be careful about that notion of high-cost jurisdiction, but obviously, in our industry, if you are looking for the cost of an engineer or a Ph.D. in software development in China or India, it will not be in the same order as what we have here. Canada would be viewed more as a middle-cost jurisdiction because we have a range of advantages.
With the U.S., it is really the output and the prosperity gap. As a Canadian, I see no reason why we should accept a prosperity gap with the U.S. With other countries, it is a different thing. We are in a period of transition that will last some time, where some countries have costs that are so much lower than ours that we must adjust, and we must adjust in part by using those countries as part of our production chain. Otherwise, we will simply lose out.
I will presume that you can look at productivity growth from year to year. It really depends where you started. Another country can grow its productivity faster than ours but may be less productive to start with. However, at the moment, the cost gap is so high between ourselves and those developing countries that it will have a tsunami effect on our economy if we do not adjust. Looking at productivity gains means not only looking at how we operate at home but also how we integrate a global supply chain.
Mr. Veldhuis: If you look at figure 3 page 4 of my brief, you will see labour productivity growth in all of the industrialized countries. Canada falls behind most industrialized countries, and neither Canada nor the U.S. are among the top performers. Ireland, for one, has dramatically changed its economic environment to one that attracts business investment and increases productivity, and they have done so in a short amount of time. Canada can certainly look to Ireland as an example. Norway, Sweden and Finland are countries that use damaging taxes to a much lower degree than Canada. Canada can learn from certainly learn from these countries.
[Translation]
Mr. Suret: In terms of innovation, since that is the part that we have spent the most time looking at, Canada appears to behave somewhat like OECD member countries, however it is the countries outside the OECD that move most quickly in terms of growth in innovation, patents, the working of a patent, and so on. In terms of growth rates, we are being outpaced by countries like Israel, Finland, Sweden and others. We often compare Canada to OECD member countries and we say that it is not all that bad. But it is the countries that are outside the OECD that are doing much better than we are. We have a problem with respect to innovation and innovative companies.
[English]
Senator Angus: You have each mentioned one reason for the productivity gap, be it in a global sense or a U.S.- Canada sense. For example, Mr. Suret talked about the lack of available investment monies, venture capital, at the proper costs here to businesses. Mr. Veldhuis talked about the business taxes. These taxes, as far as we know, at least, and to be totally non-partisan for the moment in the atmosphere in which we find ourselves, are being used to support a lifestyle that is very Canadian. The government has to get the monies to finance, as an example, our health care system. These business taxes — which, I agree, are very punitive, and I have for many years been outspoken on the subject; they are a great disincentive for Canadian productivity. What would you replace those tax revenues with? Again, since you raised it, Mr. Veldhuis, would you care to comment on that?
Mr. Veldhuis: In short, nothing. One of the critical aspects of generating revenues is that it is easier to generate them from a larger base than a small base. If you decrease business taxes, you will grow your base. Even if you do not replace those taxes, you will get increased revenues because your base is that much larger. If you want to replace them and keep revenue neutral from the get-go, I would say replace them with taxes that are less damaging. Go with the model that Sweden has gone with, or that Finland has gone with — sales taxes, more payroll taxes and those other less damaging taxes.
Senator Angus: You are right in the parish where this subject is often discussed. For example, we have frequently discussed with officials from the Department of Finance the subject of capital gains tax. You have mentioned that. You talked about the capital tax.
Recently, we talked about tax incentives for charitable giving, which in itself can have rather an interesting effect on productivity. I think you would agree. The Finance people tell us that they cannot afford to lose that revenue, that if they do the whole structure and balance of our economy will shift. I have never accepted that. Do you have some kind of concrete data to show that it would be — I do not think the right word is revenue neutral. I think what you are saying is that if we abolish those punitive business taxes, the increased productivity and the new revenues generated from those businesses would replace other taxes, such as, income tax monies; is that right?
Mr. Veldhuis: That is right. It is known as the virtuous circle. You reduce taxes, increase economic activity and you get more revenue. Within Canada, there have been good examples of that, in primarily Alberta and Ontario, and to some degree in Saskatchewan, where they have reduced taxes and are now able to spend more money per person than before. Reducing taxes has increased revenues in their case.
[Translation]
Mr. Suret: There has been widespread use in Canada of what we call up-front credits. We provide a tax credit to encourage behaviour, and we do so at the outset. Virtually all studies in the world show that this type of intervention is ineffective. It leads to all kinds of behaviour that does not make sense economically, since people will invest for the tax credit and forget about monitoring the company, the investment and so on. Recommendations are unanimous; most countries have abandoned up-front credits in favour of back-end credits. When you have a back-end credit in the form of a capital gains exemption, for example, you pay close attention to your investment. If, regardless of what happens to your investment, you have the tax credit, you do not monitor it.
Senator Angus: Can you explain why Canada uses these up-front credits?
Mr. Suret: The big difference between Canada and other countries is that it has not reviewed these intervention programs. In Israel or the United States, or other countries, a program lasts four or five years; it is re-evaluated, analyzed and changed. The labour-sponsored funds program dates back to 1979. It has not been changed since then. Small investment companies in the United States have changed their program at least four or five times with the help of Senate committees. In Canada, we do not change programs, even when they do not work.
[English]
Senator Harb: I am somewhat of a contrarian here. To a large extent, we are all dizzy when it comes to looking at productivity. We think we know it, but I have some doubt. Let me run an example by you, and you can tell me whether or not I am right.
When we deal with productivities, we can look at clusters. For example, let us look at information technology or technology as a whole. I am aware of at least one Canadian company that has offices in North America as well as in Latin America, Europe and Asia. That company conducts its business in such a way that a research and development project is conducted on a 24-hour basis. There is a labour pool in North America that works on it for a certain portion of that 24 hours, and then it moves to Europe and finally to Asia. It continues on a 24-hour basis until they produce it. Where does that fit in the equation of measuring productivities?
What factor do you use? Obviously, there are different factors. An engineer here is paid, say, $50,000, in India, $25,000, and in China perhaps $12,000. We are talking about a Canadian company that is selling its product. If you were to use a parallel type of corporation, say, one that used low-tech, that is probably a different animal all together. I would like your comment on that.
If we talk about input and output as a measure of productivity, ideally, you want to have 100 per cent efficiency. That is fine. The reality of what are you talking about is what goes in between the input and the output. You are talking about the variations between Canada and the other countries. Recently, the UN issued a report stating that, in terms of standard of living and quality of life, Canada is the second best country in the world. I need your comment on that. How do we measure whether we are better off as a society or worse off as a society when it comes to the question of productivity, keeping in mind my examples?
Mr. Courtois: Our industry is the poster child for the phenomenon you just talked about. When people are locating things around the world so that work on a project continues, when the time comes to have work done in our time zone, we want some of that work, if not all of it, to be in Canada as opposed to the U.S. or Brazil. Yes, there are jurisdictions in the world where the cost of an engineer or Ph.D. is lower than in Canada, but we have certain other advantages. Risk is always an important element. Proximity to the customer if something goes wrong is another element — in other words, how long it takes for your product developers to go and see the people who doing the R & D, et cetera? We have a range of things, including our quality of life and including the openness of our society.
In our industry, the most successful labs look like the United Nations — they include people from around the world. Canada's openness is a great advantage in being able to attract these people.
In productivities and competitiveness, it is not just a question of cost of what you get as output and quality for those costs. We are not completely out of the ballgame just because some of our costs are higher. It is a question very often of building a critical mass of expertise around a particular ability to generate innovation that will cause people to come back time and again and not move that around. In that sense, governments have often helped start advanced industries in countries like Canada by taking some government work and putting it into the private sector where you create a critical mass around which those people are then used to try to sell those services around the world.
Here I return to the question of taxes. Taxes and a more efficient tax system are important, and you need to keep working at it. However, it must be a range of solutions to succeed in today's world. There are opportunities that we miss in terms of innovation.
We tend to view our public spending as a problem, instead of looking for opportunities. We spend $130 billion a year on health care as a country, but we are not looking for opportunities to generate innovation. Every country in the world faces the same problems. We have the ability, with a single-payer system perhaps, to generate innovations that can generate businesses that will supply the health care system that will sell their services around the world, but we do not view it that way. We do not even fund our health care system so that it can invest in innovation for the longer term. The investments for the longer term get to compete with investments for how many beds are available in emergency next month, and it tends to suboptimize the investment in our system.
There are many things where we spend our public money in a way that we are not looking for opportunities for innovation and fostering Canada's success in this environment. It is not just a question of throwing money at things.
The Chairman: Mr. Courtois, just as I admonish the senators to be more productive in their answers, that means more concise, I hope you and others would be as well. We want to hear from all our witnesses and senators. Thank you for the information, which is important, but let us make it more concise. Mr. Veldhuis, did you want to respond?
Mr. Veldhuis: Let me quickly address health care. This is probably one industry that is becoming a drag on productivity in Canada. Health care consumes about 10 per cent of gross domestic product.
Senator Angus: It is becoming a drag.
Mr. Veldhuis: It is becoming a drag on productivity because Canada does not invest in the advanced technologies.
Senator Angus: As Mr. Courtois said.
Mr. Veldhuis: That is correct. The single-payer system is the second most expensive in the world. We do not get the technologies because we do not have the right incentives for innovation; that is a huge problem.
In terms of the senator's question on standard of living and the UN report, I have not looked at the UN report. However, if we want to improve our quality of life, we must produce more goods and services and increase our incomes. If we have more income, we can obviously spend more on health care, education and on the things that maybe the UN report has judged to be quality-of-life indicators.
Senator Hervieux-Payette: If I look at your recommendation on page 6, you list a number of items where you say we should do this and that. If you were prioritizing — and I show my bias — would you say the adjustment of capital cost allowances to better reflect the true costs of replacing assets would be one of the first three?
Mr. Veldhuis: Yes, absolutely. If you look at the figures that the Department of Finance puts out, they calculate welfare gains based on the per dollar tax reduction. The largest welfare gain comes from capital cost allowances. This affects new and incremental investment so that would be first in terms of increasing welfare. Second would be capital taxes, and the third would probably be corporate income taxes.
Senator Hervieux-Payette: Not one of you has talked very extensively about the decrease of foreign investment in Canada compared to other countries, and that we are less attractive. Whoever feels comfortable responding, I should like to know your opinion on how we could stimulate more investment. More investment would mean, I suppose, more productivity. I will leave that pending and ask my question to Mr. Suret.
[Translation]
Mr. Suret, a few years ago, a study was conducted on the Quebec and B.C. models for labour sponsored funds. It seems that the B.C. model was more profitable, because it was managed like a private fund. I did an update, since the comparison dates back several years. These people boasted of exceptional performance. I will let you do the assessment.
In your opinion, what would be the impact of putting an immediate end to federal tax credits? We would recover several billion dollars and re-establish the federal fiscal balance. Don't Quebec workers and people working in this field currently have enough funds to invest in Quebec? In other words, stopping will not have a negative impact on the Quebec economy, but a positive impact, if I understand your comments correctly.
Mr. Suret: An economy like Quebec's would need $250 million per year in venture capital if returns in research and development were to be as high as they are in Israel, which is a model in terms of R & D. The FSTQ collects a billion dollars a year and we think it has enough to invest for the next 10 years. So putting an end to this tax credit would absolutely not have a detrimental impact on financing for companies. The governance problems you referred to are particularly serious in Quebec, since we are in an incredible situation where the people investing the money have two seats on the board of directors, which has 17 seats, whereas the union, which does not invest a cent, has 15. The structure is slightly different in the other provinces where the governance problems are a little less serious. However, performance, and my Ontario colleagues have looked at that as well, is more or less the same with a few exceptions. Some labour-sponsored funds are doing slightly better, and they are the ones associated with large banks like Roynat, which has a labour-sponsored fund. We start to wonder when the Royal Bank starts to receive tax credits for labour- sponsored funds.
Senator Hervieux-Payette: Mr. Courtois, you talked about Japan where there is either a tax credit or a 50 per cent accelerated depreciation. I want to go back to your colleague's comments on investments in the health sector. The vast majority of these investments are in the public sector. Do you have a miracle cure to accelerate the use of new medical technology, knowing that the federal government is in somewhat of an ambiguous situation? We already have an $800 million fund to upgrade medical equipment in hospitals, and we realized that part of that sum was put, for Quebec, in an Ontario bank account. Do you have a recommendation for the federal government to improve performance in this extremely important sector that represents several billion dollars, if we take into account the federal government and the provincial governments? It seems that equipment is not improving over time. The same is true for laboratories in other sciences. University laboratories are in ruins. If money is invested in education, it must be used for equipment and not buildings.
Mr. Courtois: As regards sciences in general in universities, the federal government can intervene directly at certain levels, especially at the postsecondary level. We must, in fact, build capacity both in terms of equipment and in terms of the number of students at the most advanced levels, because we are lagging behind the United States in this area. As in most companies today, there is a shortage of funding in the education system. Some companies want to provide assistance from the pre-school level right to the end. As for the health care system, it is not easy because of the federal and provincial jurisdictional issues. As an association involved in technology and as simple taxpayers, we see huge sums of money going from one jurisdiction to the other without necessarily any performance criteria on the receiving end.
In our opinion, there should be good faith in dealing with the problem of interference in other areas of jurisdiction, but when people sit down at the table, could they not develop common strategies to make a distinction between long- term investments and not allow short-term problems from preventing us from ever resolving the problem? If we cannot become more efficient, the problems will still exist two or three years down the road. It is a vicious circle. We need communication and good faith. We think the money is there. It can be controlled, at least at the provincial level and through agreements between the federal and provincial levels of government. It needs to be invested differently.
Senator Massicotte: When we talk generally about the productivity gap, to draw a comparison with the United States, there are two or three sectors in particular that explain 80 per cent of our differences. In forestry, for example, we are more productive than our US neighbours. The other sectors are electronics and services. Can you be more specific about these sectors? Where are our deficiencies and where are we behind in comparison with the United States?
Mr. Courtois: We have examined several sectors, including retail, some manufacturing sectors, and some financial sub-sectors. In this last area, there are sectors in Canada that are major users of productive and not-so-productive technology. Our team examined sectors that were similar, and we noted that there was underinvestment in Canada as compared to the United States.
Senator Massicotte: Which sectors are less productive than in the United States? The Bank of Canada conducted a study on that two or three years ago.
Mr. Courtois: I only looked at sectors that should be linked logically. If there are sectors that use less technology in Canada, that invest less, it must be those that are less productive.
Senator Massicotte: Perhaps someone else would like to comment. Can you name two or three specific sectors where we are lagging behind the United States? Because we cannot generalize, since there are sectors where we have the upper hand.
[English]
Mr. Veldhuis: I have not looked at the sector-specific date, although I am sure Mr. Andrew Sharpe has. I am not concerned with which sectors are productive. The proper role of the government is to create an environment in which all sectors can be productive. We need to look less at specific sectors, specific assets and specific firms and talk more generally about the environment as a whole.
The Chairman: On that point, we have aggregate productivity measures from Statistics Canada. We will make those available. As Senator Massicotte points out, if we are into macroeconomics nothing will happen. We want to know, site specifically, which industries are lagging behind and why. If we make generic policy recommendations, we will end up with a generic policy result, which is nowhere. If we make specific policy recommendations, then we can have people held accountable. Governments are to be held accountable, and sectors should be held accountable.
Mr. Courtois: From what we have seen, there are some sectoral differences. Mr. Sharpe might have some information on that. Generally, we do not know why. You can find, in the peer to peer sector, in Canada and the U.S, comparable-sized firms. We intuitively surmise, which means that we guess, about the reasons why certain industries lag behind. The low Canadian dollar at some times gave us a sense of complacency. Because the Canadian market is smaller than the American market vis-à-vis a risk-reward relationship, we are going to put more money on the table because we will make more money in the U.S. in a comparable size firm because the market is bigger, but that is all surmise. We do not really know.
[Translation]
Senator Massicotte: Ten or 15 years ago, the United States invested billions of dollars in technology. Economists everywhere wondered why they were not seeing results or returns on their investments. We started seeing results five or seven years ago. How can you explain that?
Mr. Courtois: Mr. Greenspan was the first to realize it. He was very sceptical until the late 1990s. He saw the investments, but he did not see the impact on national productivity. In the late 1990s, it started to become obvious. Productivity analysts realized that the effect on productivity came from the way in which we changed our operations to take advantage of what technology had to offer. Experts say that in this sector, there will be even more innovation to come in the next 10 years than there was in the last 10 years. And in the last 10 years, we have seen wireless technology, the Internet, and so on. But there are no productivity gains if the government does not change the way it works in order to take advantage of it. That is why there was a delay of several years between the initial investment and now.
Senator Massicotte: Money is not the solution, we need change.
Mr. Courtois: It cannot be a passive thing. We cannot just throw money on new technology and expect results, we really have to think hard about our operations.
Senator Massicotte: In the medium and long term, there is a direct link between a country's savings rate, the world's savings rate and the investment rate. We hope that with a high investment rate we will get high productivity. The link is a direct one. In the short term, there is not necessarily this link but when you look at Canada, the USA and many western countries, the savings rate is very low. Historically, it is the lowest we have ever seen in Canada for the last 40 or 50 years. First of all, there is a concern because people are saying that if the savings rate is so low, eventually our investment rate will be low. So that means the economy will suffer over the long term. Do you have anything to say about that? Are we right in believing that?
Mr. Suret: The savings rate is relatively low. What would be a bit more worrisome would be the inability of people to fund their retirement. That is a problem. In terms of investment, what is important is to know where the investment is going. If we have programs that skew, so to speak, the allocation of funds and if we set things up so that billions of dollars are going to the least productive projects in an economy, we may have the savings rate we want, but we will never get anywhere. Not only do we need savings, but they actually then have to go to the best products, the best projects and the best businesses. That is not what we have right now. That is not what we are observing and that is where the concern lies.
Senator Massicotte: Today, our investment rate is far higher than our savings rate. We are borrowing money from other sectors or other countries as such and, indirectly, the argument is given that this affects the Canadian dollar. It is negative. Eventually, we will have to settle that question.
Mr. Suret: The differential in the exchange rate has more to do with it than that imbalance, but I will let the macroeconomists take care of that one.
Senator Plamondon: My question is about labour-sponsored funds and it is for Mr. Suret. I have problems understanding that, on the one hand, you are saying that labour-sponsored funds, especially in Quebec, are going into bond funds and private corporations that are in a growth period and therefore do not actually need extra funds. On the other hand, you are saying that if those funds were invested in small venture companies, then it would not be productive. I would like to know when it would be advisable to invest in something risky rather than in a sure thing based on what you were telling us before about the labour-sponsored funds?
My second question: What are our priorities? My question is for the three witnesses. Is it enough to cut costs or should we not invest in human beings, instead? This brings me back to education. Are our children and future generations being trained to be critical thinkers, to innovate, to think or will they simply be trained to do work that will give them good grades and that won't leave much room for critical thinking? Have you stopped to look at this faculty that people have to be objective and to be able to think in order to innovate?
Mr. Courtois, you were addressing technology. You can have a technology which is very productive today, but which, tomorrow, will be replaced by another one and trashed bye the consumers. I am thinking about computers and their paraphernalia.
My third question concerns the fact that Canadian business is less and less Canadian because of acquisitions and globalization. For example, Canada wants to increase from 30 per cent to 100 per cent the amount of pension funds that can be invested outside of Canada. Do you think that could harm productivity?
Mr. Suret: As far as labour-sponsored funds go, I said the funds invested about 30 per cent of their assets in small private corporations. The rest goes to bonds and elsewhere. The first thing it tells us is that there is not a big enough pool of profitable investments and they cannot invest all the funds that they have.
In the Quebec case, they are pulling in $1.3 billion a year and they can only invest about $200 million. They have to invest the rest where they can so they have to take on investment projects with a very low profit margin.
Senator Plamondon: So the fund is economically viable but not its objective. Is that it?
Mr. Suret: The fund does not have enough good projects to ensure its economic viability. So it has to invest in all kinds of things and you wind up with the results that you get. It is a question of imbalance between what is being done and real needs. On the other hand, the real needs, as we know them, and what is called the equity gap, present themselves during the first stages of a business start-up. That is where the State has to step in.
Now, with labour-sponsored funds, they can intervene just about anywhere. They even have the right to invest, as they do, in real estate in Poland and in terms of Canadian competitivity, I cannot see how investing in that sector over there can be useful.
As for your second question, I share your concern about universities. The Soros Foundation is doing a lot of good work on that right now. They are very worried, more specifically, about business taking over universities. They allege that more and more people will be trained to produce in the short term and that short-term research will be done with business in mind, rather than doing fundamental research. So I quite share your concern in that area.
Mr. Courtois: Our sector has a view on this which is not necessarily where the problem comes in. It is true that Canada has to continue building up a strong scientific capacity because that is absolutely essential in today's world. However, in our sector, we are seeing that success for a country like Canada is not generating more science PhDs than India or more engineers than China. We won't be able to do that. So, what advantages do we have? Our graduates, then, must be able to think critically and they need a broader education, education in the aspects of human interactivity.
We are noticing that business has a weakness on the selling and marketing side of products. There is a danger of producing innovations that do not generate jobs or improvements in quality of life in Canada because we are weaker than some others in marketing our ideas even though we are considered as being a very open country.
You need a broader education for this and there is something lacking in what we are teaching our youth in that area. We have to educate them to have more open minds. They also have to be able to interact with people and customers because you have to sell to those people. It is true that we represent business and that is the kind of knowledge we want to see, but we realize that for a country like Canada, you need more than just a focused education.
Senator Plamondon: So there is a deficiency in that sector.
Mr. Courtois: Yes, absolutely.
[English]
Senator Oliver: I have two brief questions about productivity for Mr. Courtois. You mentioned the word ``clusters'' in your direct testimony and in an answer. Would it improve our productivity in Canada if we had more technology clusters in large university towns like Vancouver, Toronto, Montreal and Halifax? Halifax has six universities. We could start commercializing some of the research we did there. Would that help with productivity?
If we had more electronic business solutions in procurement, supply chain management and so on led by government so that industry would start to employ it as well, would this help our productivity in Canada?
Mr. Courtois: Yes to both. Obviously, cluster are extremely high performing in an economy. They create a critical mass and things get attracted to them. Governments, on the other hand, cannot create clusters. Clusters have to come. You need a combination of a university environment and a business environment built around a specialty that can be world beating, and you build around that.
Senator Oliver: Can government be a catalyst for it?
Mr. Courtois: Yes, the government can put in money. Sometimes, when we see a real cluster developing, government can put in some enhancement money when the right formula is there. The right formula must be the combination of something that is driven by the market, a market pull as opposed to technology push or skills push. Community has to get involved. We are getting to know what the formula is for clusters. You cannot create them, but when you see them beginning to happen, you can accelerate them a bit.
The government as a lead user makes a big difference. When you are talking about commercialization of innovations, governments spend a lot of money. They can get the virtuous circle. They get the benefit of innovation, and they can help stimulate, at early stages of commercialization, as a lead user. Hence, they get the double benefit of not only improving their operations but also taking something that is at an early stage of commercialization and giving it that extra push. Governments should very much count on that. In our industry, many people are worldwide successes, and in many cases government business at the start has been quite instrumental in that. We are not advocating that you throw money at it. We are advocating cases where governments can be better as a result.
Mr. Veldhuis: I disagree. We have a government innovation agenda that has reached over $9 billion, another $800 million allocated in the 2005 budget, and our R & D as a percentage of GDP is still low. It is declining relative to other countries, to the U.S. Again, this notion that activist government will somehow stimulate innovation and progress does not bear any fruit. Government is there to provide the type of environment that gives businesses the incentive to come in and invest in R & D.
Mr. Courtois: If I may, to put a perspective on that, you have to understand the role of government and the role of business. It is not the role of government to commercialize; that is the role of business. However, it is the role of government to build up our country's scientific capability. Businesses will then use the individuals to sell products from that. When you get the roles right, then you can do the spending right.
Mr. Veldhuis: I disagree. Look at the countries that have high rates of productivity growth. They create the type of environments where businesses invest in technology and are leading edge in technological process. Government intervention, throughout history, has failed at providing those types of innovations.
The Chairman: We will be interested in your emails to us about both those positions.
Senator Tkachuk: You said payroll taxes were less a drag on productivity than corporate taxes. Could you explain that further? I always thought that payroll taxes were a drag on productivity.
Mr. Veldhuis: In terms of productivity, the main thing that affects productivity is the amount of capital that workers have. If you penalize or take away the incentive to invest in capital, that will harm your standard of living the most. Therefore, taxes that are a direct tax on capital, such as corporate income taxes, capital taxes, sales taxes on business inputs, are the taxes that will have the most detrimental effect.
Senator Tkachuk: We are running EI surpluses. Those surpluses are then directed into general government revenue. Obviously, they are in excess of what is needed to do the program. Therefore, if the worker had kept it, there would be more savings and more investment. All of those things would be happening that are not happening because that money is just used up.
Mr. Veldhuis: That is right. I do not disagree with you. Certainly, if you reduce the taxes on individuals, payroll and income taxes, you will get increased savings and increased investment and increased risk taking and entrepreneurial activity. Which one is more harmful in terms of the economy? The research shows it is capital taxes rather than payroll taxes.
Senator Tkachuk: Because of the shortfall, our Canada Pension Plan is now 9.9 percent, either paid individually as self-employed or split by working for somebody else. All that cash is to pay back for programming that has already been spent over the last two or three decades; that is the reason that we are short. Is that a huge drag on productivity? That is coupled with the fact that it is low-income earners, those between $3,500 and $40,000, that are paying all of the need for future generations rather than it being split all the way up. That must be a drag on productivity.
Mr. Veldhuis: It is even worse than those that are earning $40,000. If you look at the 1997 reforms, most people would be outraged if they knew where most of the money came from. Most of the money came from freezing the exemption, not increasing the $3,500 exemption at inflation. Therefore, our newspaper carriers are the ones that saved this program.
Does it have a drag on productivity? It certainly has a drag on savings, the amount of money that lower-income earners have to save. The government has not done a good job of addressing the fact that we could get more savings out of lower-income people if we had the right sort of programs.
The RRSP program is good if you earn a certain amount of money; but if you are a low-income earlier, there could be different programs, like prepaid tax programs, where you pay the tax first and then you do not pay any tax when you take it out. There are other ways of inducing lower-income people to save.
Senator Angus: I am told by some guru in the field that in terms of the Canada-U.S. productivity gap, one of the negative factors that we face here in Canada, quite apart from the ones you have mentioned, has to do with our cold climate. I was surprised to hear that, and then I thought about it. In certain industries, there are expenses involved with heating, and clothing and working conditions are other factors. Is there anything to this?
Mr. Courtois: I am not sure. I have not heard that as being one of the negative factors. Indeed, if anything, in history, it has probably been a positive. Sometimes when people face challenges, they try harder and in more innovative ways. The fact that we are ahead of the rest of the world in telecommunications has often been attributed, at least in part, to our climate because we have to.
Mr. Veldhuis: If you look at Hong Kong in the 1950s — this is an island that has no natural resources and is virtually a rock. It has been remarkable in improving living standards, probably the highest rate of economic growth because it is the most economically free economy. The government does not get involved. It is easy there to invest and to create business and jobs.
[Translation]
Senator Massicotte: Mr. Suret, your business has a good reputation and you do a lot of research. Do you agree with the answer that we got before that taxes on the workforce are less important than taxes on capital to increase productivity?
Mr. Suret: The capital tax is in fact the key element.
Senator Massicotte: How important is infrastructure in comparison with productivity? Should it be financed by the federal government or by the municipal government?
Mr. Suret: We could start by cleaning up the tax system and regaining funds in terms of tax expenditures. These are things that we do not often think about. We could clean up the vast majority of tax expenditures and come up with enough money to provide a partial or total capital gains exemption. It would be a simple shift. There is no need to come up with other ways of financing. The people at C.D. Howe have been making those recommendations for a long time.
[English]
Senator Massicotte: Productivity is deemed to be the solution to the coming demographic challenge we have in our country. What could we do to help? Obviously, productivity is measured per capita, and a lower percentage of our population will be working 20 years from now than it is today. What should we do to help achieve that significant productivity gain we must have to even maintain our quality of life?
Mr. Veldhuis: The only way we will maintain the programs Canadians have chosen — health care and education — is to grow the base of our economy. The only way you do that is to get workers producing more per hour that they work. The only way to do that is to get the business investment that we need. You also need the human capital, but Canada does well on human capital. You need the business investment, and the way you do that is by not penalizing business investment.
The Chairman: I want to make a comment. Perhaps you can respond in writing.
When we start gathering these analyses, either comparing us to the United States or comparing us to the OECD or to other countries — high cost, low cost, soft climate, hard climate — it is clear that Canada is facing a crisis of productivity, wherever you look. We are underproducing, and it is a form of economic separation. We are economically separating ourselves from the more productive countries in the world.
When you think about this, perhaps you will come back to us with some specific recommendations that we could make. This is very troubling to all of us. You can sense it by each of the senators who are concerned. We do not know the answers. We hope to get some of the answers, or some feeling.
In each statistic and chart we have looked at, whether it is from Statistics Canada or the private sector, the economic separation is on. It is on in terms of productivity. We would be interested in you coming back after you listen to the rest of the evidence and giving us more focussed responses. We thank you for your attendance today, for your preparation and briefs.
We now have another set of witnesses. Welcome. We are delighted that you are here with us today. We are continuing our experimental round table study in productivity and competition. We have many questions but not too many answers. We are delighted to welcome Mr. Andrew Sharpe and Mr. Bruce Winchester.
Please proceed, gentlemen.
Mr. Bruce Winchester, Director of Research Services, Atlantic Institute for Market Studies: Honourable senators, you are to be congratulated for using your position as distinguished public representatives to deliberate on this important issue.
Improving productivity matters because without at least matching the output per worker of our competitor nations, the very foundation of our social contract in Canada would be in jeopardy. From the perspective of the public policy think tank that happens to be located in Atlantic Canada, the Atlantic Institute for Market Studies, AIMS, has seen firsthand the pernicious impact of the decline in productivity. Atlantic Canada's challenge in accomplishing economic convergence with the rest of Canada is parallel to the overarching challenge of improving national productivity. Barriers to greater prosperity in Atlantic Canada can be grouped into three categories — public policy barriers, human capital barriers and barriers to the adoption of new technologies. These do not function in isolation but they do have distinct characteristics.
Over the past few years, AIMS has published extensively on these subjects. In particular, I draw the attention of senators to our studies on equalization, in particular the report entitled ``Taxing Incentives,'' which shows the pernicious impacts of equalization on provincial taxes. It is important to think about one of the conclusions the author found, which is that the provinces in receipt of equalization tend to have higher tax rates and tend to impose heftier taxes on weaker bases. These are capital taxes and business taxes. They are the ones we refer to when speaking to improving productivity.
In addition, the federal government has piled on top of equalization a system of regional subsidies and support. As of this year, the federal government will handout about $1.8 billion to help support industries in economically disadvantaged parts of the country. In the case of Atlantic Canada, the biggest of these agencies, the Atlantic Canada Opportunities Agency, ACOA, has played a dubious role in the region's economy. While it is often touted as bringing productive innovation to the region, unfortunately, that is not what the grants and contributions given out by the agency have done. More often, they have hindered productivity. In particular, rather than increasing the available pool of investment capital, ACOA's free money has pushed out investors who cannot compete with these kinds of terms, namely low-cost borrowing. As a result, we hear from firms pursuing innovation, and they tend to balk at the bureaucratic approach of ACOA in the face of diminished options for securing private capital investment. It is a vicious circle. The ACOA money pushes out money and then the high provincial capital and business tax rates also push out more money. It is tough for those firms trying to be innovative in the Atlantic region.
At the other extreme, there is a kind of revolving-door support engaged in by ACOA, whereby they come back time and time again, in the parlance of ACOA, ``to maintain jobs.'' The problem is that, as ACOA contributes money to maintaining jobs, they are effectively subsidizing less productive industries, which is to say, the federal government's policy is subsidizing less productive industries. Basically, this grant is making up for the fact that it is more expensive to produce in the Atlantic region. Certainly, this is one of the barriers to productivity that we see in Atlantic Canada. In both cases, less intervention on the part of government would be a good thing.
The next public policy barrier is labour, which tends to bleed into the realm of human capital. Employment Insurance, which is perhaps one of the most hotly debated and paradoxical programs in Atlantic Canada, is hotly charged because the fear of altered benefits creates a very real and visceral reaction in certain communities that sense any changes would be the death knell for them. However, it is paradoxical that the EI system has created labour shortages. Despite regionally high levels of unemployment, we find examples of firms that are unable to fill positions. We read headlines in the newspapers in Atlantic Canada of entire industries that are either expecting labour shortages or experiencing labour shortages. The bottom line is that people decide to avail themselves of employment insurance in some instances. As a result, there are not enough people to fill the job openings. That has a tremendously negative effect on productivity.
There are other negative aspects in terms of productivity. The Employment Insurance program does not allow businesses to engage in a rational marshalling of their resources. If people are stuck in an economic and cultural mode where they are being propped up by unemployment benefits, employers are able to pay their employees less. Those employees do not need to earn as much money because employment insurance fills the gap in their income. At the same time, workers have no incentive to invest in themselves, and so, as a result, many of them are unable and unwilling to invest in new skills, capabilities and abilities to add to productivity. Again, we have this vicious cycle of EI propping up unproductive agencies and of discouraging people from investing in human capital, which we know to be important.
As I mentioned before, at certain times of the year in certain regions, we find labour shortages, which is paradoxical because we think of Atlantic Canada as having extremely high unemployment and needing this program. In additional, we see that high rates of taxes by the local and provincial governments also discourage investment. Hence, these policies combine to make it difficult to encourage productivity in Atlantic Canada. That is part of the reason that the region has not converged with the rest of the country.
One last thing to consider is the failure to adopt new technologies. I will speak to aquaculture because it is an example of a technology that is important to Atlantic Canada. It also demonstrates that, even though innovative and productive technology might be involved, sometimes it is not adopted soon enough, the result of which is many negative effects on the rest of the economy.
There has been movement in the aquaculture industry, but the fundamental problem revolves around the regulatory environment. This environment has substantially discouraged adoption of new technology and thus development of the industry. The current gatherer mode of fishing could be replaced by a more efficient farming mode of production. By changing the production patterns of fishing, secondary fishing industries could also change and adopt new technologies, which is to say that the fishery could be more productive. Then there would be spillover effects, which we are not seeing because the aquaculture industry is not vibrant. These spillover effects are all about technological innovation, in biotechnologies, pharmaceuticals and environmental areas. Without this keystone industry — and we do not have a robust aquaculture industry — nothing happens.
Government needs to rationalize the regulatory and property environment around aquaculture. This is important in Atlantic Canada, but you can also see it nationally. New modes of production will not be adopted if you cannot make it happen. If you do not have high-quality property rights to impose or innovate this new industry, then you will be unable to proceed. At the same time, if you are not assured of the intellectual capital being protected — high-quality property rights protection — then it is difficult to go ahead with certain kinds of innovations.
The institute has published extensively on the aquaculture industry. I would invite honourable senators to take a look at some of the items on our website. I will send some material to the committee clerk as well for the perusal of senators. There is a significant amount of material on this.
The Chairman: Any case studies to prove your point would be welcome.
Mr. Winchester: There is considerable material on our website. We have been internationally recognized for our role in sparking the debate on aquaculture. It is an important issue in Atlantic Canada.
Some people will come before and argue that big programs and broadband environmental regulations will help Canada acquire and develop ``the next big thing.'' If the experience in Atlantic Canada is any indication, government would do better to stay out of the way and stick to its key role in ensuring both physical and intellectual property rights, encouraging investment in human capital and attracting people and investment to the country.
A fundamental reform to equalization payments and EI must be adopted. An expert panel will speak to equalization, and we will go forward and speak to them. However, senators should think about and be aware of the negative impacts of this federal policy. We have seen much about such things as removing disincentives on natural resources, where there may be some changes. The program needs to be changed so that the disincentives for provinces to reduce business taxes and capital taxes can be changed. The federal government can make changes and reduce, but if that is not followed in kind by the provincial governments also reducing some of those burdens, then you will not find a growth of investment in the region.
As well, there needs to be reform to the Employment Insurance program. It can no longer be used to encourage seasonal employment and early, unskilled entry into the workplace. We cannot afford to have that happening when we are trying to improve productivity. The EI program must return to its original intent, as a temporary income-support program. There are many different things that could occur: for example, changing the intensity rule, changing the level at which one must work to qualify for initial benefits.
However, one of the innovations that we talked about is rather interesting and worth considering — that is, changing the premium structure.
In the United States, employment insurance is done at the state level. There are big differences between the premiums charged to an employer who frequently lays off employees versus one who does not. In fact, premiums are much larger if you lay off your employees. This is important for productive innovation because it will encourage companies to employ people they intend to keep on their payroll. Therefore, those people can invest in their own skills, but also those companies can invest in themselves. If we had a differential premium charge rather than a flat premium that all employers pay under the current system, then we would discourage the kinds of things that we have seen and make these jobs more permanent rather than temporary.
You need only look at the differences between the unemployment rate in New Brunswick and neighbouring Maine where they have this kind of system. We see in Maine that the employment rate is much lower for all of the reasons I have mentioned before.
I will conclude by saying that there are three areas to be considered. We need to look at changing the policy environment so that equalization and employment insurance do not discourage innovation. We need to ensure that, when government intervenes and gets involved in protecting things like property rights, the right kinds of property rights are protected and that the regulatory environment is made simple, more effective. If we do not, those will be substantial barriers to innovation.
The Chairman: Mr. Winchester, I want to suggest to you that we are interested in your general comments, we are interested in macro comments, but we are also interested in statistical support for all or any of your statements. Anything that you can give us in a statistical model to demonstrate the effectiveness of what you are saying would be appreciated. You have made some wide, sweeping analyses of some of the programs. That is fair. We would like to get any statistical models that you can show to demonstrate the efficacy of what you have suggested.
Not to criticize you, Mr. Winchester, but to commend Mr. Sharpe, our next witness, who has done exactly that. He has given us some very interesting statistics to plough through.
Mr. Andrew Sharpe, Executive Director, Centre for the Study of Living Standards: Honourable senators, I thank you for the invitation to appear here today.
The Centre for the Study of Living Standards is an economic research institute based in Ottawa. We are independent and non-profit. We do a significant amount of work in productivity, living standards and economic well- being. We have a journal called the International Productivity Monitor, which is distributed throughout the world.
Why is productivity important? Productivity is our economic destiny. If we have a 1 per cent productivity growth, we will see living standards double in 70 years. If we can raise productivity growth rate to 3 per cent, we will double in 24 years. If we can attain 2 per cent productivity growth over the next 30 years, all the problems related to aging in terms of the cost of health care and pensions will pretty well evaporate. If we can do well in productivity, we will solve many potentially important societal problems.
However, a perspective on this issue is needed. Productivity is important, but it is not everything. I would argue that economic well-being and quality of life are probably higher-level, more important concepts than productivity. However, productivity contributes significantly to the economic well-being of Canadians and to our quality of life. There are tradeoffs, but overall they are not that important. Hence, it is important that we focus on productivity.
Today, I want to first talk about productivity developments and then about policies to raise productivity. I have put forward six concrete policy suggestions for this committee to consider. I have submitted a document to you that we prepared for this committee on recent developments in productivity in Canada and the United States. I will not talk about that. There is quite a bit of material there. I will summarize the key findings.
What has happened recently is unprecedented in our economic history in terms of productivity developments. In 2003, we attained a productivity growth rate in the business sector of 0.1 per cent a year. In 2004, we did worse — it was zero. Hence, in the last two years, we have had no productivity growth for the business sector in Canada in terms of output per hour, which is probably the best measure of productivity.
On the other hand, the United States has done the opposite. They have had a productivity growth rate of over 4 per cent per year for the last two years. That is a gap of about 8 percentage points between the two countries. The level of output per hour in Canada, as a proportion of that in the United States, has plummeted from 81 per cent in 2002 to 74 per cent in 2004. That is a major deterioration in our relative productivity performance vis-à-vis the United States. We have done a significant amount of work on the reasons behind the gap, and I will refer you to some of our documents in the International Productivity Monitor.
Today, however, we are talking more about growth rates.
I will just give a brief overview of what has happened. First, in terms of the United States, what appears to have happened there is acceleration in the pace of technological change. We thought that was the situation in the second half of the 1990s, when productivity increased significantly in the United States. However, since 2000, there has been a second productivity growth rate acceleration in the United States. Now, the trend for productivity growth rate seems to be over 3 per cent a year. This is an extremely positive development for both the United States and for Canada, in the long run, because we tend to lag behind the United States in terms of our economic developments. These technological changes happening in the United States will spill over to Canada in the future. It is positive that the United States is doing so well, even though, in the short term, it is leading to an increase in the gap between our two performances.
What is happening in Canada? First, I will preface my remarks by saying I am a hostage to the data that Statistics Canada produces in productivity growth. They are known to change their numbers. They revise the productivity numbers frequently because they revise the output numbers. If you look at the average change over the last six years, it has been 1 per cent per year, which is a significant change. On June 10, they are releasing revised estimates of productivity. You may see an improvement at that time. I do not know if that will happen. It could get worse; I do not know. It is unlikely that they will revise all of it. Let us hope not. If they do, there are some serious problems with our statistical estimates, if there is that much noise in the data.
We have identified three key factors that appear to explain what is happening in Canada, particularly since 2000. This is preliminary analysis, so it is subject to revision. First, the rate of productivity growth in the information and communications technology sector, or ICT, seems to have fallen significantly. In the second half of the 1990s, productivity growth in the ICT-producing sector was around 11 per cent a year. Since 2000, it has been about -1 per cent a year. That sector is relatively small in terms of its size.
The Chairman: That is contrary to what we heard from Mr. Courtois, who said they are on the cutting edge of productivity. When I look at those numbers, they support what you say, that productivity seems to be on the reverse.
Mr. Sharpe: It appears that way. First off, that sector suffered a major collapse in recent years, so this might be a temporary phenomenon. It is true that they are on the cutting edge. There could be other reasons, reasons linked to the structural problems in the sector with not letting people go combined with a big slump in output, which can lead to poor growth in productivity.
We have identified, in terms of the sources of the decline in the productivity growth rate since 2000, on an industry basis, that a large chunk of it is due to ICT manufacturing and, to a lesser degree, ICT services.
A second key factor appears to be a slower rate of growth of aggregate demand. The economy since 2000 has been growing more slowly than it did in the second half of the 1990s, which was really a boom period. We had a slowdown, particularly in 2000 and 2001, and then in 2003 we had a number of shocks that reduced economic growth. Overall, when you have slower economic growth, you also have slower productivity growth, because you have less learning by doing and less economies of scale.
Finally, we have seen a slower rate of growth in machinery and equipment investment and in ICT investment. They are still growing, but the growth rate is much slower. When you look at it on a per hour basis, that is, the capital intensity of machinery equipment and ICT, it is also growing, but much slower.
Hence, we have identified those three areas as the three factors behind slower growth.
We think our productivity growth will rebound in the future. That is largely driven by technological developments as we have seen what is happening in the United States. I do not think it is a crisis situation right now. We should be doing better, and we need policies to do better, however, I do not think it is in crisis. We cannot overreact. It is important not to overreact.
Turning to the policy area, this was not in the document I handed out to you because it is more of an analytical document. Policy is a little different.
I want to put forward six public policies to raise productivity growth in Canada. First, I will preface my remarks by saying that in terms of the business sector, it is important to recognize that business-sector productivity is the responsibility of the business sector, not government. Government creates the right framework for businesses to improve productivity. I will be looking at public policies, but it is the business sector itself, through its own actions, that must take responsibility for productivity growth through investment, through innovation and through improving human capital. Those are the three key drivers. The business sector already has an incentive to do that, but it is the role of the public sector to facilitate the business sector productivity growth.
The first policy is that it is very important that we maintain a full employment environment. Full employment means that there is not slack in the system. It means that there are economies of scale, learning by doing and less inefficiencies. It is important that the Bank of Canada pursue a monetary policy that allows us to have as low a rate of unemployment as is compatible with stable inflation and to keep interest rates low. That is a framework for macroeconomic policy.
The second key policy area for government is that government should assist in the promotion of the diffusion of new technologies. Ultimately, it is new technologies that improve productivity. Canada contributes only a small percentage of the new innovations in the world, because we are such a small country relative to the total world. Certainly R & D is important, but while many companies do not do R & D, they can use best business practices or technologies. Businesses in Canada should be aware of what are best practices throughout the world. They already have incentive to be aware, but government can facilitate that through information provision, through programs such as NRC's IRAP — Industrial Research Assistance Program — which promotes diffusion of new technology. I stress the importance of new technologies and their diffusion.
The third key policy area is fostering competitive markets, particularly in the product area. It is important that there be competition. The best tonic for productivity growth is competition. When you are in a competitive environment, you have an added incentive to introduce new technologies, to train your workers and to be on the cutting edge. Competition is really a key element of productivity growth.
The fourth key area is that it is very important that we promote the movement from low- to high-productivity activities for our workforce by region and by industry. Subsidizing declining industries is not in the productivity interests of Canada. There are political reasons for that, and I understand that; it may be necessary in certain cases. However, overall, we should be trying to facilitate the movement of resources from, say, low-productivity regions to high-productivity regions through mobility grants and through providing better information for these people to move and other types of incentives in that area.
The fifth key area that we should be looking at is investments in post-secondary education, both in terms of the teaching and, of course, in research and development. Why does the United States have the highest productivity level in the world? The answer is that it has basically the most cutting-edge technologies. Why does it have the most cutting- edge technologies? The answer is that the U.S. has the best research universities in the world. There have been many spinoffs from the universities in the Boston area, and Silicon Valley associated with Stanford University. Even in Canada, we see that with Waterloo University in terms of spinoffs with RIM. It is important that we have strong research universities. They can create technologies in the long run.
Finally, for the sixth possible area that we can consider, I want to look at a very interesting fact. I said that the United States is the leading country in the world in terms of technologies. That is definitely true. However, in terms of output per hour, it does not have the highest level of output per hour in the world. A number of European countries have higher levels of labour productivity than the United States, including France. Why does France have a higher level of labour productivity than the United States? There are two reasons. First, there are many government regulations on minimum wages that keep out the less skilled people, so that the employment rate is lower. However, France also has fewer working hours per year, which has a positive effect on productivity. If you work 30 hours a week instead of 40, on an hourly basis you will be more productive on 30 hours. You will produce less at 30 hours than 40, but in terms of output per hour, you will be more productive at 30. There will be less time for meetings. You will be more concentrated and focussed on your job if you know you are only at work 30 hours a week. The French have done that through legislation. I am not necessarily advocating that; that might be too heavy-handed an approach. However, policies that promote longer vacations and more public holidays contribute to our economic well-being because we have more leisure time. We lose income to a certain degree, but on an hourly work basis, we become more productive. The key is an output per hour basis, not total output basis.
Those are six areas that this committee can look at in terms of specific policies to improve productivity.
Senator Angus: Mr. Winchester, do you live in the Maritimes? In Nova Scotia?
Mr. Winchester: The institute is headquartered in Halifax.
Senator Angus: Is that where you are personally based?
Mr. Winchester: I am based here in Ottawa, but the institute does its work in the Atlantic region.
Senator Angus: I wonder if you said some of the things that you said to us today in Halifax.
Mr. Winchester: I had the pleasure of talking about the unemployment insurance question in particular on talk radio in Halifax a few months back.
Senator Angus: Did they like it? Did they like you?
Mr. Winchester: I did not give out my hotel room, if that is what you are asking.
Senator Angus: I was interested in four or five of your points about ACOA and abolishing it and so on. You have touched a welcome chord with me. There is a man in Ottawa whose initials are S.H. Mr. Harper made some statements about these things and he was very unpopular.
Senator Tkachuk: So did Mr. Brisson.
Senator Angus: It seems to me they were the same things. The things you are saying, which I fully agree with, have to do with aid and assistance programs that are misdirected. That might be an overgeneralization. You are saying they could be more efficiently directed. If it were you wanting to improve productivity in those provinces in Atlantic Canada, you might make some major adjustments that would result in improving the productivity; is that right?
Mr. Winchester: That is absolutely the case.
The Chairman: Do not lead the witness on a partisanship issue.
Senator Angus: Your Lordship, I am not leading the witness.
Mr. Winchester: I will stay away from partisan comments.
The Chairman: This committee has been very good in trying to shield its partisanship. We are trying to get at the facts as best we can.
Senator Angus: That is right.
The Chairman: I will allow our deputy chairman to pursue this, but let us put it in a positive light, if we could.
Mr. Winchester: You have definitely hit on the points we have made. The institute has done a number of studies by a number of different authors from different parts of Atlantic Canada — studies in Newfoundland, New Brunswick and Nova Scotia. I know I am sometimes unpopular at family gatherings in Shediac when I talk about how employment insurance is a problem, until my wife's aunt comes into the room and talks about having difficulty hiring people for her hotel. She often finds herself short-staffed because employees, given the choice, may not be as interested in coming to work. Let us just leave it at that. It is not talked about in some circles in Atlantic Canada. I have had numbers of conversations with people. You will certainly be unpopular with a certain segment of the workers, but amongst small business people, medium-sized business people, you will find quiet applause when talking about these kinds of disincentives. From a productivity point of view, this is pernicious.
As I said in my remarks, the cost of EI not functioning properly is tremendous not only for the region, not only for those of us in Atlantic Canada who want to see the region succeed, but it also costs the rest of the country, too, in terms of productivity lag. It is something worth considering, and looking past the partisan politics, looking at what is in the best interest of all of the residents in the region and the country at large.
Senator Angus: Mr. Sharpe, you listed the six potential policy initiatives that might be taken. In regard to number four, promote movement from low- to high-productivity areas in the workforce, I have heard it often said that the Americans are so much better than us in terms of the workforce moving to where the jobs are.
We have a certain region, which Mr. Winchester has been talking about, where, due to unfortunate economic circumstances, like the cod stocks or the fishing industry, unemployment is high. There is a great need for labour out in the oil sands, I was told. I went there recently with another Senate committee. Is this the type of thing you mean, that we need to encourage mobility in this country from areas where there are low employment opportunities, be they productive or otherwise industries, to areas where there are new, more productive businesses going on?
Mr. Sharpe: Absolutely, and it is happening right now. The population of Newfoundland declined in absolute terms in the 1990s significantly. People have their own incentive to follow economic opportunity. Many of those people did go to Alberta. There are many Newfoundlanders living in Fort McMurray.
By providing information, these people have opportunities. Low airfares are great for people getting out there. They can come back to visit their family three or four times a year. That is a very positive development to promote mobility. Any policies that can promote mobility are great.
Some people will say that we are depopulating certain areas of rural Newfoundland. Unfortunately, that is true, but there are not a lot of alternatives. It is important to do our best to find opportunities in those areas, but to the degree that we are unable to do that the population that cannot find work should move to the urban areas of Atlantic Canada, which are much more dynamic than the rural areas, or to more dynamic parts of the country.
Senator Angus: How do we do that? From what I read, and it was inherent in your remarks, there is, unlike in the U.S., a reluctance in Canada to migrate to the areas. The U.S. must have a magic bullet or something that gets them to do that, and you are suggesting we need to find that in Canada.
Mr. Sharpe: There have been studies done on the relative degree of mobility between Canada and the United States. Most of the data is on a state basis or a provincial basis. There are 50 states and we have 10 provinces, so obviously you will have more mobility when you have 50 jurisdictions rather than 10.
There are many people in Canada that move in response to economic opportunities. In absolute terms, we have a certain amount of regional mobility of the population. It is hard to say that we have less than the Untied States.
Some people argue that the Employment Insurance program is what keeps people in Atlantic Canada. There might be a few anecdotal incidences of that, but overall, if we got rid of EI — which we will not do, I am sure — many people would just find jobs locally. They would put together two jobs a year. You would not necessarily see a massive out- migration from Atlantic Canada to Alberta if we got rid of the EI program, not that we will do that.
We have to do some tinkering in those areas, but we do not need to eliminate social programs to force them to move. We should not go that far.
Senator Angus: What I am getting from your answer is, first of all, it is one of your six recommendations. Then you said, in fact, it is happening.
Mr. Sharpe: It is happening, but we can facilitate it more.
Senator Angus: Why is it happening?
Mr. Sharpe: Economic incentives. People want a job so they go. It is definitely happening.
Senator Angus: You were mentioning Fort McMurray. As I said, I was there with the Energy Committee last month. One of the members of that committee is a former premier of Nova Scotia. We were in a restaurant, and he left the table and came back so excited. He said, ``I have just counted — there are 111 people in the restaurant and 96 of them are from Nova Scotia.''
The Chairman: He said 96 were his relatives.
Senator Angus: That was later — 87 were his relatives.
The Chairman: We are talking about Senator Buchanan.
Senator Angus: Things are happening, but I am wondering if we have found the secret. If you were in government and you could do one thing to give people an incentive to move like that, what would you do?
Mr. Sharpe: It would probably be mobility grants — give them an opportunity to go out there. If an individual does not have the job and goes looking for one, those costs could be deducted when preparing an income tax return. That would be a very specific recommendation that you could look at. Right now, you cannot deduct expenses related to job seeking, especially if you do not find a job.
Senator Massicotte: I want to repeat for the attention of our committee, I gather, Mr. Winchester, that the comments you are making is that any obstacle to the mobility of capital and labour obviously affects our productivity negatively. I gather that is the point you are making vis-à-vis employment insurance.
As a Senate, we are not political, and therefore we should try to tackle those things that the House of Commons is more politically sensitive to. EI is a good one. The other one is regional grants, or DREE.
You mentioned that Atlantic studies have indicated that they have not provided a significant return on capital, that it has usually been a waste of money and that it has been somewhat motivated to be nice and political. That is another one we should get to.
However, I am surprised about your comment with equalization payments. That is why I think Senator Angus was asking where you come from and whether you have made any speeches on that. EI is hard to explain, but I agree 100 percent with you. However, I am surprised about equalization. I know you tried to show a relationship. Can you explain your thinking to me.
Mr. Winchester: Let me backtrack a little bit on the question of equalization. We are not suggesting that it should be cut off, eliminated or otherwise. What we have found through a number of different studies, and in particular I draw your attention to one entitled ``Taxing Incentives,'' is that equalization-receiving provinces experience a number of disincentives.
I can tell you, having just been down to provincial budgets, those disincentives are very clear. We see provinces that have rates on provincial corporate income taxes that are much higher than the rest of the country — and in particular, capital taxes, which are about 30 percent higher. Part of that is because the equalization program, the way it is currently arrayed, does not penalize provinces that make a decision to have a higher tax rate than the national average, in spite of the fact they might have a weak tax base.
What is interesting is that by levying taxes on some of these weak tax bases, they actually reduce their tax base. They actually make their tax base weaker in the process of having these higher taxes. That is the kind of things we have seen in the studies.
What we need to do, and this is not necessarily the work of this committee, is be aware of the fact that some of the things that occur in equalization create the wrong kinds of incentives for provincial governments. If they have higher corporate tax rates than the rest of the country, we need to look at ways to make that function better. What is interesting is that, in most of the Atlantic provinces, corporate taxes only account for about 5 per cent of own-source revenues. If they were to eliminate their corporate taxes, the amount of revenue they would have to recoup would be very small compared to many other things. If equalization were reconfigured so that those kinds of incentives were in there, it would be better.
Senator Massicotte: What you are saying is nearly a moral hazard — in other words, they receive compensation for the fact they are poor, reducing the incentive for the provinces.
You may be right that the capital tax in Quebec is higher but they get more grants. One can make the argument that without the equalization payment, there would be even a greater difference because obviously the cash is going somewhere. There is a study going on; there have been some advisors appointed to study equalization. It seems that what you are saying is do not cut off equalization but maybe reformat the way it is calculated — the 33 indexes we use to discern how we average out. You are saying study how it is allocated, but do not cut off the program.
Mr. Winchester: Change the programs.
Senator Massicotte: That is politically more acceptable.
Mr. Winchester: The bottom line is that you have to change the program so it works. You have to change it so that it helps productivity overall. More important, in a perfect world, the program would put itself out of business.
Senator Massicotte: It should, and it does. If you notice, the equalization payment is a large sum that is going down when adjusted for inflation.
Mr. Winchester: Saskatchewan is a good example.
Senator Massicotte: Mr. Sharpe, you made some slightly controversial comments. You say that the Bank of Canada should ensure that its interest rate is low enough to encourage full employment. That was a popular Keynesian theory 20 or 30 years ago. The whole world is now saying that is not the right policy, that central banks should concentrate on one issue, which is inflation, in other words, the value of the low currency.
Senator Angus: You have to be fair to the witness by saying that you are a long-time director of the Bank of Canada.
Senator Massicotte: Are you saying that we should go back 20 to 30 years ago with that economic policy?
Mr. Sharpe: There are different definitions of full employment. The standard definition of full employment is the unemployment rate that is consistent with stable inflation. You can argue that that rate is around 6 per cent. Our unemployment rate right now is about 6.8 per cent. I am not talking about 3 per cent unemployment.
Senator Massicotte: The bank is saying that that is a factor they do not even consider. They just said inflation.
Mr. Sharpe: They targeted inflation, but they take into account the economic circumstances of the country. They are always debating whether increasing the interest rates now will have a negative effect on economic activity.
I work with the Bank of Canada in terms of looking at the productivity issue all the time. They are aware that is it a multifaceted world. Their responsibility is to maintain that inflation target, but there are other variables they have to be aware of. I do not think they would disagree with my statement that a fully employed economy is the best way to have a strong economy.
Senator Massicotte: You say that we do not have any significant research universities. Our Canadian policy, which is something we should consider further, is that we have average universities. We have averaged out our skill sets, and we have not had, perhaps, the political courage or the conviction to have elite universities such as they have in the United States. You are saying that we should get away from that and be more selective — obviously, that would affect tuition fees.
Mr. Sharpe: I do not think I said that we have no significant research universities. I am a graduate of the University of Toronto, which likes to think of itself as a significant research university.
However, I would say that we do not have research universities of the calibre of the top private universities or even public universities, such as Berkeley, in the United States. Even the University of Toronto would recognize that it is not at the calibre of an MIT or Harvard.
Senator Massicotte: However, we should have that?
Mr. Sharpe: We do not have that and we should. Obviously, there is an issue of how you want to redistribute the grants, whether you want an equitable distribution across regions or focus it on the key research universities.
I would have somewhat of a bias towards focusing it on our top 10, say, of key research universities. That is really where the key developments in technology will be coming from.
Senator Massicotte: In talking about France, you seemed to show preference to measuring productivity on a per hour basis, as opposed to per capita. However, most economists would say the measurement is per capita.
Mr. Sharpe: Do you mean per worker or per capita?
Senator Massicotte: I mean per worker. Many economists would say, ``Why not just work harder?'' In fact, that is one of the solutions being recommended for the demographic side, or having a greater participation of our workforce.
In your mind, do you really believe that per hour is more important?
Mr. Sharpe: Absolutely. Of course, we can get more output if we all work harder, but why would we want to do that? We would not necessarily be better off. There are other things in life than work. One should measure productivity on a per hour basis. The amount of input is measured in time, which is hours, not the amount of people that are working.
The Chairman: Senator Moore lives in the Maritimes and as such would like his insights on some of the issues raised there. From there, we will go to the West, to Senator Tkachuk and give you his perspective from Saskatchewan.
Senator Moore: Senator Angus, I find your disparaging remarks with regard to ACOA interesting. It was created by your former leader, Mr. Mulroney.
Senator Angus: That is right. It was working well in those days when it was all grants.
The Chairman: This is why this discussion is a little unproductive, but I will allow it to go on.
Senator Moore: No, it is not. It is instructive. With respect to the same gentleman, SH, who said that Atlantic Canadians all have a defeatist attitude, you tell him to come to Atlantic Canada and tell the people that. That really bothers me.
With regard to ACOA, Mr. Winchester, at the start, it was a granting agency. Since 1986, it has been a loan agency. It is not free money. It is repayable loans. I know that it is meant to be a risk facility where the chartered banks refuse loans to applicants. It has had an 80 or 85 per cent success rate in the repayment of loans.
It is the agency that has provided the funds for our Atlantic Investment Partnership, which has been a huge success in providing research innovation funding in the Atlantic provinces. That was a $7-million program, which was funded through the recycled ACOA loan repayments. From that point of view, it has provided some good regional economic incentive and opportunity in our provinces.
I am interested in your comments with regard to intellectual property. I do not know if you are aware of the Atlantic universities network that was set up last year. They are trying to put in place a structure that will determine ownership, percentage-wise and so on, whether it is between government, the private sector, the university and the researcher who might discover something. I do not know if your institute has looked at that, and I would be interested in our comments.
Senator Robert Dole in the United States introduced a bill that was made law and provides that type of framework. I know the people at the network in Atlantic Canada are looking at that as a leading example of how to put something in place. Maybe it is something we should be looking at as a national model.
Were you aware of that? Have you looked at that?
Mr. Winchester: If I may disagree with some of your statements about ACOA, and I will not belabour the point, but I will give you a few statistics that I have gathered on my own in studying the agency. In spite of the fact that it is a now a loaning agency, only about a third of its portfolio, and that is an annual budget of $300 million to $600 million, is in fact repayable. A 15 per cent repayment rate is about what they have netted. Indeed, of the repayable contributions, better than one third of them have been completely written off. It is a dubious claim, at best, to say that the loans are effective. Part of the reason we have been critical of the agency is that it has been less than forthright in providing details about what it does.
That being said, it is an issue that we could debate in a number of other forums.
Senator Moore: Are those current numbers?
Mr. Winchester: They are current.
Senator Moore: When did you do them?
Mr. Winchester: I am in the process of doing some of the calculations, and some of them go back to studies that have been done by others.
Senator Moore: Maybe you can provide that to the chair.
The Chairman: We have asked all of our witnesses, if they refer to any statistics that will support their contentions, to supply them to us as soon as possible.
Mr. Winchester: I am more than happy to supply that.
The Chairman: It is hard for us to argue with you statistically unless we look at your models, and then can pull them apart and come back to you. I want to get that information. That will be useful, and we will circulate that to all members of the committee.
Mr. Winchester: I do not say that to be argumentative. I merely say that is not a fished-out-of-the-air type of comment. We studied it and looked at it.
The comments you made about intellectual property rights are important. We have looked specifically at aquaculture as an industry, and we spent a great deal of time looking at it. Fishing is very important to the economy and to the culture of so much of what occurs in Atlantic Canada. We have been enthusiastic as an institute about the wide-ranging potential for that industry. There are a number of intellectual property right questions that will come up. There are many good models that will work to help decide who owns what.
Unfortunately, in the case of aquaculture, it is less an intellectual property rights problem and more a fisheries jurisdiction issue. There is a lack of clarity as to where you can do this activity of aquaculture. I will send you links and references to some of the studies we have done on fencing in the seas, because that is the real problem with that industry progressing.
Senator Moore: It takes away from the traditional fishing areas. I can see the problem.
Mr. Winchester: It is politically contentious, too, in some cases.
Senator Moore: It is politically and practically so. If people have been fishing the same area and chasing a certain species in a regular cycle each year, and suddenly you put a pen around it for an aquaculture site, why would that not be a problem?
I went through this probably about 15 years ago in Nova Scotia in the waters of Mahone Bay. We set up an aquaculture grid, taking into consideration the traditional fishing grounds, ferry routes, yacht racing routes and private properties. Once you get that lease, you own that water column, top to bottom, right into the beach. These things can be worked out. I do not know if you looked at that model in Nova Scotia, but it works very well, and I know it has been used in other provinces. It can be done, and you can avoid these jurisdictional situations. They are not insurmountable.
I am interested in your remarks with regard to EI. What do you do with respect to the historic seasonal industries? There is a cycle here that is historic and documented. Are you saying that people who might be in business related to tourism or the fishery or logging, whatever the seasons dictate, should be paying more? They are not doing this out of choice. They are not hiring and laying people off out of choice. That is dictated by the climate and the particular resource that they are working with. How do you balance that with your call for increased premiums to be paid by employers who lay off? Are you thinking of those type of industries as being ones that should be subjected to that proposal?
Mr. Winchester: You cannot rule industries out, unfortunately. The example that I mentioned in reference to Senator Angus' question was in fact a seasonal industry. My wife's aunt owns a hotel and restaurant just outside of Shediac, and they have difficulty hiring people. Hers is a seasonal business. Clearly, there is something wrong with the incentives in the EI program when seasonal businesses cannot even hire people. It is a real problem. Industries that are seasonal do present a challenge for their workers.
At the same time, since we are talking about productivity and not the politics of unemployment insurance, let us recognize that if we encourage people to work for a portion of the year only, be it in a seasonal industry or otherwise, they are less productive in terms of the overall output of the economy. Let us also not forget that if they get into a cycle where there is no incentive for them to invest in their own human capital, then they will be stuck in a system where they have to go back for a payment under EI or some other thing. That is not an ideal situation from an economic or even a cultural perspective, but it is even worse when you are trying to improve productivity. You need to think of it in those terms and move past some of the politics of it. I agree that it is difficult to tell people that their lifestyle will change.
Senator Moore: Let us look at the example of your relative who owns a B&B. Let us assume that your aunt she can the B&B six months of the year. People are working there, helping her, working as clerks or housekeeping, whatever they are doing. What is the cure? You say that for the other six months, they should find another job somewhere else, of course, if they can. What should happen with regard to those seasonal workers?
Mr. Winchester: There are two basic choices. You expand your season so that it eventually becomes twelve months instead of six or —
Senator Moore: The climate in seaside Nova Scotia in the winter time does not permit that.
Mr. Winchester: Alternatively, you develop other industries or other tourist industries. The classic example that comes to mind is that I used to work as a ski instructor. The vast majority of the instructors that I worked with would ski in the winter and teach swimming or golf in the summer. None of them was ever unemployed during the year because they were located here in Ontario and western Quebec where you cannot get EI as easily as you can in Atlantic Canada and because they were able to find two jobs in two different kinds of industries and put them together. That is perhaps a bad choice, but again, from a productivity point of view, from an investment in human capital point of view, that is far better than doing nothing.
Senator Moore: You mentioned these various items that you thought would help with respect to productivity and things we needed to overcome. Did you mention the matter of Senator Kelleher's pet, the interprovincial trade barriers? Have you mentioned that?
Mr. Winchester: No.
The Chairman: We are looking at that.
Senator Moore: Yes. It seems to me that it is a very important thing in terms of moving things around.
Mr. Sharpe: I did not mention that. I do not think it is that important; I think it is overrated. Most of the interprovincial barriers are linked to government procurement policies by provinces, and they are quite reluctant to get rid of those policies. We have been working on this issue for well over a decade and have not made much progress. The barriers are not that large in terms of most goods and services, so I do not think it is a priority for productivity improvement.
The Chairman: We will be having a special study on that. I appreciate your comments.
Senator Tkachuk: You mentioned in France the per hour productivity level and the 35-hour work week. Is the Government of France not attempting to change the law to allow employers to increase the weekly work week because of lack of productivity just recently?
Mr. Sharpe: There have been changes to the legislation somewhat. There is a new government in France, and they made changes. The 35-hour work week actually was not a policy to increase productivity. It was a policy to reduce unemployment by creating jobs. When you go from 40 hours a week to 35, basically you will be more productive, but you will do less work, so that means the firm would have to hire other people, and that would increase employment. That was the reason. There is both an employment gain and a productivity gain to working fewer hours a week.
Senator Tkachuk: Why were they trying to change the law?
Mr. Sharpe: They recently changed it because it was a project of the socialist government of France, and the new government of the right found it a little heavy-handed in certain areas. They have not completely changed it, but they have made a number of changes; it is less heavy-handed than it was before.
Senator Tkachuk: I would also like to see the research on that, Mr. Chairman, if we could, or anything that you have that would back up that argument.
Mr. Sharpe: In terms of improving productivity?
Senator Tkachuk: Yes, that would be helpful.
Mr. Sharpe: We have an article coming out later this month on exactly that issue by the head of research at the Banque de France.
Senator Massicotte: From what I read, it did not work. The shortening of the hours did not create more employment. One could argue that there are many obstacles to labour in France. Am I correct that they are reversing their position because it did not work?
Mr. Sharpe: The reason it did not create more employment is because it created more productivity. Firms did not need any more workers because the workers who were working fewer hours were just as productive as when they were working longer hours. The productivity gains were much more than expected.
Senator Massicotte: Why are they reversing that position as of two months ago?
Mr. Sharpe: They reversed the position because the legislation was not popular with many people in France, particularly on the right. It created an inflexible situation in certain firms, so the government decided to change the legislation.
Senator Massicotte: From what I read, in fact, people took to the streets. It was not popular with the employer.
Mr. Sharpe: That is right.
Senator Massicotte: Your answer seems to be saying for political reasons — that for political reasons, they would have maintained it. That is why the prime minister is not very popular. The employers were very much in disfavour of the change.
Mr. Sharpe: I will provide you with some documentation. There are different interpretations of the changes in France.
The Chairman: That would be interesting. If you could give us a cost benefit of those changes, that would be very useful.
Mr. Sharpe: I will do that.
Senator Tkachuk: Is productivity measured by sector? Do you have the numbers by sector?
Mr. Sharpe: Absolutely.
Senator Tkachuk: How do you measure government productivity for people who work for the government?
Mr. Sharpe: There are many problems in the measurement of government productivity, to put it bluntly. We do not do a good job of it at all.
In respect of market output, basically you can have a price for it and you can deflate nominal output with the price deflator to create a real series. However, in the government sector, we do not measure output independent of inputs. The wage bill is considered the output of the government sector. By definition, there are no productivity gains in the government sector.
Senator Tkachuk: It is part of the total statistical package when you are trying to measure productivity.
Mr. Sharpe: There is a big debate about that. There is the total economy, which includes government, and there is the business sector, which excludes government, and recently there has been a big debate between the Finance Canada and Statistics Canada over which measure is more useful.
Senator Tkachuk: The numbers we are talking about exclude government employees.
Mr. Sharpe: That is right. I could have given you the numbers that include government employees, but the consensus is that because we measure productivity so poorly in the government sector we should look only at the business sector.
Senator Tkachuk: If you included government employees, it might drag the numbers down.
Mr. Sharpe: That is right.
Senator Tkachuk: Therefore, the more people you have working for the government, the bigger the drag on productivity.
Mr. Sharpe: In terms of measuring productivity growth, that is right.
Senator Tkachuk: For example, if you consider Nunavut, where either you work for the government or you do not work, how would its productivity be measured, or is anything measured?
Mr. Sharpe: If you work for a Crown corporation that produces output, then that is considered part of the business sector. It is only public administration that is considered government in terms of the national accounts. I do not know about Nunavut. If you measure the output of those sectors by wages only, then they will not see much productivity gains, for sure.
Senator Tkachuk: Consider the increase in the size of government. Since 1997, the size of government has increased by 50 per cent.
Mr. Sharpe: The share of employment, right.
Senator Tkachuk: That is right. With that, you are taking resources from the private sector into the public sector. That has got to be a tremendous drag on productivity, even to the private sector, because you are removing cash that would normally be spent in the private sector on the public sector.
Mr. Sharpe: It depends on a number of factors. As I mentioned, the growth rate of government productivity is zero, but wages can be higher in the government than in the private sector. If you move someone from the private sector to government, the value-added of that person may be higher as an employee in the government because those wages are higher. That would have a positive effect on the overall productivity level.
However, in terms of growth rates, you are right. There is a downward bias to the overall statistics because of the way in which we measure output in the government sector. You are absolutely right, senator.
The Chairman: Senator Oliver and I attended at Microsoft's headquarters for governments in Redmond, Washington. We were given a book that showed a comparison of governments' efficiency under E-governance. It seems that Canada has gone from number two or three to number one in the world because we have done the transformation more quickly to E-governance, which has increased its productivity substantially. I will undertake to circulate that. Senator Oliver spoke at that conference and I though that I would bring that evidence forward because we have none on that topic. It is important to clarify that for Senator Tkachuk and for committee members that Canada has made remarkable progress.
Mr. Sharpe, are you familiar with that?
Mr. Sharpe: I wanted to make a comment. Although I said the official statistics show that there has been no productivity growth in government, we know that is not true because there have been massive productivity gains in government. You have only to look at Statistics Canada figures to know how much more they produce with fewer workers and greater computerization. That is true in all sectors of government.
The Chairman: My understanding is that, as of last year, we were number one in the world, and we have increased our productivity. I want to ensure that there is a balance on the record.
I have an interesting observation to make. No witness today has mentioned, thus far, lack of leadership as a reason for lagging productivity in the business sector. We will have a discussion later this year about productivity in the banking sector as they try to convince us that they should merge and consolidate, about which we are open-minded. We know that some banks have been much more efficient and productive in expanding outside our borders.
Mr. Sharpe, could you give us a comparative analysis of how poorly or well our CEOs do than CEOs in other countries, when we are lagging behind.
Mr. Sharpe: I am not an expert on business leadership issues. You are talking about leadership from business and not about government leaders. Is that right?
The Chairman: The evidence we have heard so far today has been clear: The business sector is lagging in practically every category.
Mr. Sharpe: There is an argument. Mr. Roger Martin, Dean of the Business School at the University of Toronto, argues that our managers in Canada do not have the right training compared to managers in the United States in terms of how to think strategically about a business plan and how to develop productivity. There may be some self-interest in his argument because he is Dean of the Business School, but there might be an element of truth in it as well. I would not dismiss that argument. Certainly, to make the corporation profitable, an effective CEO has to be concerned about the productivity of the corporation.
For example, Mr. Paul Tellier took over at CN about 10 years ago and made it one of the top industries in North America in respect of productivity. Prior to that, it was one of the lower level railway firms in terms of productivity. That is a good example of a leader who had a productivity agenda and succeeded in that agenda. In certain industries, it is much easier to do than in other industries.
The Chairman: Mr. Sharpe, could you obtain any studies prepared on that matter alone? Business leaders always complain to me about how unproductive government is but then I receive the E-government studies that show the opposite. I look at all of the studies presented here that show how unproductive business is. I do not think they are two solitudes, but perhaps we should analyze this less from anecdotal information and more from statistical standards. It is important for us.
Mr. Sharpe: I agree. It is hard to measure leadership in terms of quantification. Certainly, the idea is correct; you need leaders to drive the productivity agenda forward.
Senator Massicotte: If I may add a comment, Mr. Chairman. They are measuring productivity by industry such as forestry and rail. We are excelling against the world standards in those industries. It cannot be our school system or our leaders because we are good in some and not in others. Perhaps it is more structural. If it is educational leadership, then it would be cultural and very broad. Yet, our problem is not broad.
The Chairman: That provides some insight to the debate that we will have in committee when we look at the factors to consider for our recommendations for Canadian public policy.
Thank you Mr. Sharpe and Mr. Winchester.
The committee adjourned.