Proceedings of the Standing Senate Committee on
Banking, Trade and Commerce

Issue 3  - Evidence - October 27, 2011


OTTAWA, Thursday, October 27, 2011

The Standing Senate Committee on Banking, Trade and Commerce met this day at 10:32 a.m. to examine the present state of the domestic and international financial system (topic: Financing growth capital for SMEs).

Senator Michael A. Meighen (Chair) in the chair.

[English]

The Chair: Welcome colleagues. I will call to order this meeting of the Standing Senate Committee on Banking, Trade and Commerce.

[Translation]

Welcome to our meeting to discuss the domestic and international financial system. Our topic is financing growth capital for SMEs.

[English]

The Chair: I am Senator Michael Meighen and I am from Ontario. I have the honour to chair this committee. I will introduce the senators present. Senator Harb is from Ontario.

[Translation]

Senator Pierrette Ringuette from New Brunswick.

[English]

Senator Campbell is from British Columbia, Senator Moore from Nova Scotia, Senator Oliver from Nova Scotia, Senator Greene from Nova Scotia and Senator Gerstein from Ontario. We will have other senators joining us when they are free from other obligations.

Regrettably, we have a number of parliamentary association elections today. Around noon, and with no disrespect, some honourable senators will have to absent themselves.

We are continuing with the study of growth capital for small and medium-sized businesses.

We have two witnesses from Deloitte, which is one of Canada's leading professional services firms. We have Bill Currie, who is the vice chair of Deloitte Canada, sits on the board of directors and is the Americas managing director. He also leads Deloitte's banking practice in Canada. He is one of three authors of a study entitled The future of productivity: An eight-step game plan for Canada. I think all senators received a copy, and Mr. Currie will be taking us through it.

Joining Mr. Currie is Andrew Dunn, Deloitte's managing partner for tax.

Welcome to our meeting. Thank you for taking your time and agreeing to appear before us today, notwithstanding the short notice we were able to give you. I appreciate it.

If you have opening remarks, perhaps you will make them and then we will move to questions.

Bill Currie, Americas Managing Director, Vice Chair, Deloitte: I will go through the background of our findings. The PowerPoint document is a summary of the Word document report. I do not intend to go through this in any detail, although I might go to one slide later.

About 14 months ago, we invited Kevin Lynch to talk to us about the competitiveness of Canada. One thing that struck me as a result of that presentation was the productivity gap. I could not understand why we would be 25 per cent less productive than our American brethren. At Deloitte, we sponsored a study to try to figure out why that gap occurred and what we can do to solve it. We spent nine or ten months looking at it. We had three major work streams against that. First, we had hypotheses as to why productivity was so far below the U.S. and others. We looked at U.S. defence spending. Does that drive more innovation than in Canada? We looked at the percentage of unionized labour in Canada versus the United States — where we are over double — and for things that had correlations to why the productivity gap existed.

We did interviews of over 100 people across Canada and the United States. We talked to academics, business leaders and government officials. We spoke to a wide cohort of people to understand the issues and where they came from.

From those conversations, we heard that Canadian business leaders are more risk-averse than their counterparts in the United States. We heard that as an opinion over and over, but could find no research.

We sponsored a quantitative study where we interviewed 452 U.S. business leaders and 450 Canadian leaders to find out if there was merit to that. We found there was merit. We are more risk-averse. In Canada, there are two cohorts of people. There are risk avoiders and risk takers.

The Canadian risk takers looks exactly like an American one, behaving in the same way and investing in the same way.

People who are self-proclaimed risk avoiders in Canada are significantly more risk-averse than their U.S. counterparts. We have a tale of Canadian businesses who do not invest to the same degree that their American counterparts do, and do not accept the same level of risk.

We found six underlying reasons why Canada is less productive. One reason was that financing for early-stage business in Canada is significantly less than in the United States. I would argue venture capital is not absent here, but it is close. There were five other bases, and we made eight recommendations as a result.

This is not a government issue. This is an issue that requires the participation of government. Government has been very active on this file for many years. It requires participation from academia and business. We would argue there are many academics involved in this. As I understand, you heard from some yesterday. Business has not been as engaged as it probably should have been. It is difficult to bring business in. We have 40,000 business clients in every part of the country, at every size and segment. Our intent is to participate in this discussion as time goes forward and to encourage clients — and business in general — to get active on this topic. Without businesses active in direct participation, we continue to have a gap in our activity.

The Chair: For the benefit of people watching us and listening to us on CPAC, is there a definition of productivity?

Mr. Currie: The definition we use is gross domestic product per employed person in Canada.

I have not found anything that is a better definition. If you look on page 2 of our PowerPoint slide, it talks about employment rate times work effort. That is output per hour, which drives our GDP per population standard of living. In Canada, we work as hard as the Americans do. Hours are not a problem. Employment rate is not a problem. The level of employment in our country is not the issue. The issue is our output per hour. Every hour of work a Canadian does produces 25 per cent less than an hour of work for an American.

Senator Harb: Is the gross domestic product determined using the working population only or the overall population?

Mr. Currie: It is the working population. I believe that the math uses full-time equivalent.

We had eight recommendations.

Educate — entrepreneur and innovation at all levels of education. We think there is opportunity to improve curriculum at all levels, not only in graduate schools or universities but also in high schools. In undergraduate work, there should be a vectoring toward more business education and more education around quantitative things.

Populate — skilled immigration. We have an opportunity to improve the intake of immigration to Canada. As the demographics of certainty play out both in Canada and globally, there will be intense competition for immigrants. Obviously, today we are attractive to immigrants, so we need to ensure that we sustain that attractiveness going forward and that when immigrants come to Canada, we can employ them fast and well. That means we need to understand and approve their credentials and their educations, which is a problem today.

Innovate — improve the effectiveness of research and development.

Incubate — bolster the pool of risk capital for start-ups. We would argue that friends and family financing today in Canada exists. Angels exist, but our angel financing cohort is about half the size of that in the United States. Venture capital is very under scale in Canada and a real issue for Canadian businesses.

Clustering — support is required for clusters.

Investment — Canadian businesses are extremely poor at investing in machinery and equipment. We invest half the amount that our U.S. counterparts invest. In technology and communication, we invest one third of the amount invested in the U.S. Despite having the things required to drive productivity — low interest rates, a high dollar and government incentives, Canadian businesses are still not investing in their own futures.

Accommodate — flow direct investment.

Reduce trade barriers and pursue new markets.

Those are the areas we recommend, and we have more specific things underlying those.

That is my quick overview of the work we have done in our outputs.

The Chair: Thank you, Mr. Currie.

Andrew Dunn, Managing Partner, Tax, Deloitte: I had the opportunity to present to this committee before with respect to retirement savings. I used more than my five minutes for prepared remarks; so today I will try to average down. Mr. Currie provided his comments to describe our productivity report. My background is tax. There are huge elements in tax policy that are important in improving productivity and giving Canada a leg up competitively. In particular, of the eight areas Mr. Currie talked about, there is the idea of incubating and helping businesses in early stages go from friends and family financing to more systematic and senior levels of capital-raised innovation. The Jenkins panel recently produced its report on how to stimulate innovation in Canada. There are important ways that the tax system can play a significant role in improving Canada's competitive position in innovation.

Of the eight, the third most significant tax priority in terms of building our productivity in Canada is the point of population. It is a subtle point, but I have a couple of comments. Much of that has to do with immigration policy, and a key element of that policy is making Canada an attractive jurisdiction. The individuals who are most likely to stimulate investment and innovation are those who are highly educated, mobile, professional and entrepreneurial. They simply have the most choices of where to live.

Ways in which Canada can be more attractive include a competitive personal tax regime. Canada has gone a long way in improving its business tax environment and reducing its business tax rates below those of its major trading partner, although on average across the OECD, its business tax rates are in the middle.

On the personal side, tax rates are high. We believe that the same approach employed to reduce business tax rates, which is a long-term signalling that suggests a point on the horizon that we would work toward gradually over a period of years, is an important effort in improving Canada's attractiveness to immigrants and, ultimately, in striving to build that populate element of increasing our productivity.

The Chair: How do you avoid putting government inadvertently or advertently in the position of picking winners?

Mr. Dunn: That is an interesting point. The tax credit regime, in the context of innovation, provides a series of rules under which any taxpayer is entitled to claim a credit for their activities to advance scientific knowledge and technological uncertainty in respect of a product or process. In that respect, the tax credit regime has the advantage of universality. It identifies the criteria, and people apply. A grants-based program is one in which government is, by definition, making choices of who will be a winner or a loser, not who already is a winner or a loser.

We have looked across our major trading partners and have seen a shift of economies moving toward a tax credit regime and away from the more direct grant-based funding. A mosaic is the right approach because you need to have a mix. However, directionally most countries have been shifting from grants to tax credits for this reason of not having to pick individual winners and losers.

The Chair: Would the tax credit kick in at the beginning? I am speculating, but might it be better to wait a certain period of time to see if the idea for a better toothbrush has gained some traction? If it has some traction, then apply for the credit. Just because you say you will make a better toothbrush, should the government shell out money before there is any indication of possible success?

Mr. Dunn: There are a couple of points; and part of it has to do with the matter of refundability, which I will come back to.

Following the theme of today's discussion, if an entrepreneur has an idea for a product and needs to invest in order to build a prototype or do further research, the most significant issue is cash flow. In that particular circumstance, for them to succeed they need to have sufficient operating capital to complete their research, build their prototype and perfect their process, whatever it happens to be and whatever the uncertain element is that they are working their way through. That is why angel investing is important and similarly why the tax credit regime should provide refundability in those early stages. By definition, that has to occur before the technology is proven.

The model in which government and the entrepreneur advance the uncertainty is a risk sharing.

Senator Oliver: I have two questions. The first deals with angels and the second deals with your report. Perhaps I could ask the second question first.

First, you spent nine or ten months doing a global study on this issue, and you have come up with eight points, starting with education and so on. Now that the study is done and you are starting to report on it, how will you follow up on those eight points?

Second, you both talked about angels, which are important to productivity and Canada's future. In your report, you said that angel investors typically seek to make investments of between $500,000 and $2 million. We were told yesterday that that is about the same level as American angels in seed stage companies that exhibit high growth prospects. Existing estimates collected by the National Angel Capital Organization suggest that in Canada angel capital is the largest source of start-up financing after friends and family, providing almost double the level of financing deployed by venture capitalists. Angels are extremely important in Canada. What can we, as public policy-makers, do to enhance the interest of angels to do more? Will it be through tax policy, Mr. Dunn, or something else? It is so important according to your statistics?

Mr. Currie: I will answer both questions and then ask Mr. Dunn to speak specifically to angels. We have strong opinions.

The report we worked on we did not do as a one-time thing but as part of a policy conversation that Deloitte chose to participate in actively over an extended period of time. We have a dedicated team associated with this full-time. We are funding that. I have been across the country and continue to go across the country speaking to different groups and participating in different forums.

We have relationships now with Industry Canada to work with some research, with Roger Martin's institute, with the Conference Board of Canada, with the Public Policy Forum. We, along with the Business Development Bank and the Bank of Montreal, are currently in the process of doing some national round tables on this financing topic specifically.

We have prioritized activities against our eight that we think, in the short term, we can help influence discussion and public policy to get change effected soon, and longer term on things that are cultural, that have to do with the academic community, et cetera. We are one of the largest recruiters in the country for business, commerce, engineering and computer science schools. We intend to use our positions within those universities to influence change in the academic curriculum and to support those changes going forward.

We are the large professional services firm in our country. We are fortunate in our partners, fortunate to be in the positions we are in, and this matters.

Unless we get change in the direction of our productivity, then our children will not be as affluent as we are. That is not an acceptable outcome when it is predictable that that will occur unless we make changes. We intend to continue to be a voice, if not the voice, of business in this conversation and move the agenda forward over time.

When it comes to angels, obviously, angels in Canada are more than venture capital. The sad thing is they are still half the size, roughly, of the United States. While our angel community exists and is becoming increasingly connected and active, it is not to the same scale as in the United States. Our venture is one tenth of what you would have in the United States, on a relative basis.

We believe that serial entrepreneurs, who generally are what angels are, are important not only for their money, but also for their knowledge and ability to guide start-up companies.

In incubators where we have executives and residents, and where we have people who can help our start-ups have a higher success rate, they are important not only for their money, but also for their insight, knowledge and ability to help manage risk of start-up companies going forward.

In our report, we recommend tax credits. I will let Mr. Dunn talk about that. The angel community matters a lot to us.

Senator Oliver: How do we get more, by tax credits or anything else?

Mr. Currie: There are tax credits. You can change behaviour, and this comes back to our clustering conversation. One of the things we have learned about this topic is that everything is related. When you talk about financing or angels, it also comes back to clusters.

In Waterloo, a couple of weeks ago I was at an organization called Communitech, which is an amazing place. It is an incubator, a not-for-profit organization created by people like Tom Jenkins, Mike Lazaridis and Jim Balsillie 15 years ago, and they said they were not going to have future entrepreneurs go through the same pain they were. They will create an entity to support technology start-up organizations in the Waterloo region going forward, leveraging their existing anchor industries, companies as well as the academic community and the community at large.

Communitech has 400 start-ups in their incubator. They get a one new a day. They have a 75 per cent success rate.

Senator Oliver: What do they have as capital to start, though?

Mr. Currie: It is exactly what we described: friends and family, angels and venture.

They have been able to go to the community and have ongoing conversations with sources of capital. They have, by force of nature, transparency and selling, increased the pool of angel capital in the Waterloo region materially by many times by saying, "This is what we are trying to do. These are the kinds of businesses we are sponsoring. Here are examples of success."

It is an interesting example of a well-run group in that community, changing the direction of the financing protocols.

Mr. Dunn: On the subject of what in particular could be done, there are a couple of observations. As Mr. Currie mentioned, we have travelled and spoken to different organizations and businesses. One example that springs to mind as you ask that question is a company I spoke to in Quebec City. They are in second-stage trials in respect of a pharmaceutical development, and, in their particular, case, they are doing almost entirely R & D activities. Coming back to Senator Meighen's question, to get refundability for R & D credits, you need to be a Canadian-controlled private corporation. In that space in which they are doing their research, there are no venture funds to provide that kind of funding in Canada, so they are turning to the U.S.

They are finding an extreme tension between their eligibility to get R & D support and their eligibility to get financing; they are directly contradictory. The more financing they get from the U.S. reduces the amount of financing they can get through the tax credit system.

The kind of tax credits we observe that will be most effective with the angel community are not the retail-based, labour-sponsored venture capital credits that were announced twenty years ago and were popular but have run their course. Those were small amounts of capital that were retail collected. There is a lot of infrastructure for any amount of capital.

We like the British Columbian model, where $200,000 per investor is eligible for a credit. It is a capped credit program and operates halfway between a credit regime that is subject to universality and a grant program, but it is a credit and is based on universality of entitlement but only on a first-come first-served basis.

That kind of approach is valuable. One of the reasons the retail approach was a problem is they were generalized funds, even though there was an effort at specialization. When you are making small investments — let me contrast it to later stage financing, like private equity — it involves significant due diligence, which is expensive, either done internally by having a big team of people or done externally by hiring external firms to come in to look and decide whether their projections, technology and so forth makes sense forth.

Angel investing, in contrast, tends to be somebody who is already focused on the area of the business. In doing that, that reduces the amount of due diligence and makes it more efficient per dollar of investment capital to get a return. We like that approach. It aligns more, and similarly, that clustering opportunity creates an area of specialization, so you have a number of different organizations, all sharing staff, not necessarily currently but consecutively, so people can move from one organization to another. Similarly, it is easier for an angel community to invest in a group of companies because they know something about what each of them does as opposed to a very generalized much more diverse view.

The Chair: Do most of the clusters involve mentoring?

Mr. Dunn: To be most effective, yes.

Senator Harb: I am troubled by this chart, in particular, your figure number 4, which shows Canada way behind Hungary, Czech Republic, Spain, Portugal, and so on. I am troubled, first, because we both know that, normally, when you decide on a productivity of some sort you use a formula, which I have here on page 7 — employment rate, work effort, productivities — and then you conclude with standard of living. Whenever you have a formula, then most of the time you have variables in the formula, the XYZ, to give you something at the other end.

Where you run into problems is if you do not give fair value to those variables, so as a result, if you do not give them proper value, you get a screwed-up result.

For example, when we talk about output per hour, how much weight did you give for somebody in the workforce who is a mine equipment operator, a car assembly worker, a high-tech worker, a teacher or a hospitality worker? You have a workforce here and each and every one of them fits into the equation, so you get the output. That troubled me a bit because you use this premise in order to move forward and build your case to come up with your eight recommendations.

Would you care to elaborate on that?

Mr. Currie: The point you are making is accurate. The reality is that productivity will vary by sector. The sectoral analysis that you can do in Canada today is limited because the guys who hold the data, being Statistics Canada, have not historically been willing to share it on a time-series basis. Today, Industry Canada has come to an agreement with Statistics Canada so that they will share that information and work with an external academic party to start to do the kind of analysis that you describe.

There are two things out there today that we know about. One is called SIBS, which is a study sponsored by Industry Canada. It has 4,200 business participants, and allows statistically significant analysis to 67 industry sectors. It is the first data we have seen and it is publicly available for a fee. It was introduced two weeks ago at an event I attended at the Rotman Institute for International Business.

We are starting now to play with that data to find out if we can answer the question you are asking because it is important. However, you need the Statistics Canada stuff. The problem with that is there is so much data that the current research plan is 300 pages long. They have to figure out what to do with all of this material and they have to ensure that it is sanitized so that there are no individual pullouts.

That is particularly an issue when you get to the large end of the business — some large private Canadian companies like Irving, McCain and others — where it is difficult to disguise the data because of the unique nature of those companies. There is work going on to do that.

We have not found a proxy. We have found people who have opinions. Your point is not wrong. You would like to look at all of Canada from a sector point of view and say we are great at mining, which is a huge amount of productivity that we get because I have one guy doing 10 tons of coal every day; and then we are terrible in whatever else. Today we only have the aggregate.

Everyone that I have talked to, in academia and everywhere else, believes that the direction the aggregate shows is correct. It would be great to have more sectoral stuff because you would be able to be much more focused on your investments and activities, but today it does not exist. We sort of had what we had to get to where we got to. We are participating with government and others as we go through this next level of thinking because we would really like to get the sectoral data.

Senator Harb: That takes me to my second point, which is your chart, number 13, on page 16, where you talk about private sector R & D induced per dollar, per government. Out of 30 countries, we came dead last, way behind Hungary and Spain, and even Turkey, Italy and Greece — Greece, which is on the verge of not being able to make its payments; we are way behind them.

Senator Tkachuk: That should tell you something.

Senator Harb: Again, it is very telling. How do we decide on how to measure those factors? How much due diligence do we do when we look at the data being provided for us to use in our formulation to decide where we sit on that chain?

I submit that your point about clusters is the most important point we have heard this morning — what is happening in Waterloo and elsewhere. We saw it here in Ottawa not long ago when we had one of the finest companies by the name of Nortel. As a result of Nortel and the other case you brought up, Research In Motion, we ended up having a cluster and lots of spinoff. There was a lot of talent that existed in those companies; in the case of Nortel, I think over 2,000 companies were established and some of them went on to become some of the most dynamic in the world.

I guess what I am trying to say here is that I would have liked to see, somehow, the eight points that you came forward with shifted a bit to the areas where we could excel and we are not. As you said, no one can beat Canada in the mining sector; it is impossible. We have some of the most fascinating mining companies in the world. However, in the technology sector, we used to be some of the best in the world but we may be falling behind.

Why? Because a Chinese company was able to beat Nortel in a contract proposition in Africa by 30 per cent. Nortel, the best in the world, was not able to gain the contract because someone else produced it cheaper than they can produce it themselves.

Rather than be all things to all people, perhaps we should is focus on the sectors that can provide the most output in order to improve our productivity — the technology sector, for example, the biotechnology sector. Let us focus on that and figure out what the government can do in order to make winners out of those corporations or out of those start- ups.

When you tell me about small- and medium-sized businesses — grocery owners and small outlets and so on — that is great. They need help and some of them are getting it and everything is okay; but the areas that the government should be focusing on are areas where we can change rules, regulations and laws to ensure that these organizations can move forward.

I will stop there.

The Chair: We will get a comment from the witnesses.

Mr. Currie: Relative to the data in the report, I think the slide you are looking at, without having it in front of me, is probably sourced to OECD data, which is common and generally thought to be credible. Again, I think that is what it is but it could be someone else. Generally, we will only use data that we think has a credible underpinning and has common approaches from country to country to try to normalize noise.

Sadly, we invest a lot of money in research and development and we get a relatively small return on the investment as compared with others. It is a frustration. That is obviously why the Jenkins panel was sponsored and has come to its output. I will let Mr. Dunn talk about SR&ED as we go forward.

As to the clusters and the focus, we are a strong believer in clusters. The Communitech hub is amazing — I think Waterloo is unique. It has done phenomenally well. Ottawa, with Nortel no longer here and some others, needs more energy against its cluster. I think it had one of the strongest clusters in the country.

I spend a bunch of time talking to CEOs in the city and they are worried because they have lost some of the energy and the anchors. There is probably a revitalization that is required in Ottawa to change that trajectory back up. Waterloo is still booming because of the cluster. They are focused on technology. They are not confused about what they are doing.

You go inside Communitech and you have 40 start-ups in this incubator. You also have RIM, OpenText, the University of Waterloo, Laurier University, Conestoga College, Christie Digital and Google all on the same floor. They have a program, for example, where Waterloo co-op engineers or computer science students are paid to do a term to think about their next big idea to become an entrepreneur in Canada, and they sit inside this incubator. There is phenomenal thinking and innovation going on in that place.

I agree with your cluster comments completely. We guess but we do not really know where the points of high productivity are or where our opportunities to improve are. We do know that when you get to high-tech start-ups in Canada, they are disadvantaged relative to the U.S.

We have American private equity firms and venture capital firms coming into Canada to finance the best of the best Canadian technology companies. That is good; I believe in the free flow of capital. The problem is they take the people south.

The business leaves Canada with the brains, because in the United States their IPO will be more than 50 per cent higher than in Canada from a multiple perspective. They have much more financing and they get tons of intellectual support from the venture community and the technology community in Silicon Valley and elsewhere.

This financing piece is a real issue because it is not just about the money. These entrepreneurs will grow their businesses and the best of them will get picked off by Sequoia and end up in Silicon Valley unless we intervene to change that financing so that they have money and capabilities to do that, thus the clustering. We see the same kind of clustering happening in Edmonton around a different kind of technology, mostly focused on oil field services, et cetera, but high tech.

It is the same in Quebec City. I was in Quebec City earlier this week, on Tuesday. Again, I was talking to the CEO of Industrial Alliance. They are trying to build a cluster focused on technology and the support of the insurance industry because Laval has a great actuarial program and they have good insurance companies. It is something they can do. You see this across the country but no coordination. You do not see any sharing of ideas unless it happens accidentally. You do not see people going out to learn from the guys in Waterloo, who I think are the most advanced; or the guys at MaRS, or some of the others. Stuff is happening, but it would be good to get systemic support to share ideas and to advance the agenda around some of these innovative things because they work.

Mr. Dunn: I wish to throw in a couple of quick comments on one systematic way to do some of that better. I think the statistics that you are pointing to are the reason why we are having this conversation.

Using OECD data, Canada was the third best tax regime for providing tax incentives for research and development in 2008 for small businesses but it was the ninth best for large businesses. Pause and think about that for a moment. I will also say that since 2008, since that most recent OECD cut of data, 11 of the top 24 countries that provided tax incentives for research and development increased them during that time; Canada has been stable in the credits and incentives that it has offered.

Businesses make decisions about where to invest multinationally. This is a comment that is more geared at larger businesses but it is equally true about highly mobile entrepreneurs. They make that decision based on forward information — that is, what they expect an incentive regime and an environment to be at the time of the success of their efforts as opposed to over the period between now and again. Again, that is why it is important to have long-term signalling and to talk about the policy objective of where we will go. As other countries become more competitive by announcing that they are moving in that direction, then they simply become more attractive to entrepreneurs and to large businesses that look to do more innovation.

On a quick interesting element of efficiency, a U.S. multinational has no incentive generally to do R & D in Canada these days. The United States is responsible for almost one third of the R & D globally. If you take into account that a U.S. multinational operating in Canada, the reason for that has to do with a technical issue on how tax credited for R & D are determined. They are not refundable for large business or for non-Canadian controlled business. When a U.S. multinational without refundability repatriates the earnings from R & D conducted in Canada to their U.S. parent, they simply pay the delta of whatever tax savings they have in Canada and have to pay it back. If the credit was refundable, even if it was refundable ultimately three years later or even, Senator Meighen, as you are suggesting, at the time of the commercialization of that research, refundable at any time, then it changes how the tax treatment is done on repatriation in the U.S. In other words, a U.S. multinational has not just a timing advantage but a permanent advantage in doing research in Canada.

I leave that with you to think about.

The Chair: That is certainly food for thought.

Senator Massicotte: I appreciate your report; I appreciate your insights. Many people have done studies on the whole issue of productivity, as you know. The Bank of Canada has been trying to handle this issue for the last 20 years. They have issued a lot of reports. The impression I got from all the reports that I have read so far is that no one knows for sure. I hope your latest attempt to explain it will be useful, but so far it has been like a moving target.

If you look at the Bank of Canada reports, their major explanation, possibly — because they are not so sure — is the lack of investment in modern equipment by enterprise. If you look at the reports over the last six months, they are pleased with the fact that Canadian businesses are now seemingly making capital expenditures to modernize their plants and, therefore to become more efficient. It has nothing to do with the productivity of the human beings or of the labour force; rather, it is the tools that allow for more productivity. You get to that issue and you then come to around eight or nine solutions to get there, including the venture capital side.

I largely agree. It is a good shopping list of things we could do. One could argue that it cannot hurt because it all seems to be positive. Let meet play devil's advocate a bit to flush out some of your thoughts.

Yesterday, Senator Tkachuk made a good summary of capitalism and market forces. You look at our own history as a country — and you can look at the history of many countries — and every time we seem to try to engineer success by governments, per se, it has proven to be a failure or an immense, significant waste of money. You can take a look at clusters. Many countries have tried; we have tried. Take a look at grants. Our history as a country has a page full of a lot of money spent without much success. There is no shortage of money for sure, or capital. It is an allocation issue. Maybe the most significant problem when you talk about venture capital, which is the purpose of our study, it that is not profitable. There is no money into it because it cannot make money. There are a couple of reasons why. One is that you have distortions which you are encouraging by government intervention, labour funds, and so on, and all kind of tax credits. It if you look at the report by Jenkins, he is saying that the R & D credit has not worked and it is costing billions of dollars to taxpayers. We should get out of it. Oddly, he is also recommending grants — now you are really trying to pick winners and losers. One should say, "Just get outside of the marketplace."

This morning I was reading the Mackenzie report on venture capital and private equities on 2010 for Canada and the United States. They are basically saying, as we heard yesterday, that maybe it is not profitable because it is that cycle. If you look at the cycle of venture capital, there was excessive capital. Industry, in 2008, suffered immensely; the markets suffered immensely. Maybe you just let it be. If you look at the deals so far this year, there seem to be a lot more deals — not more creation of funds, but more deals are happening. Maybe in two or three years the issue will be resolved. The more you distort the marketplace, the more you delay it, the more you cause consequences that were never intended. Why not just let the market take place? Why so much government intervention per se?

The Chair: I will give you another question, Senator Massicotte, but let us get the reaction of the witnesses to that.

Mr. Currie: We have a strong focus on our business community. We are not about government intervention.

Concerning this problem, though, if you look at the history, venture capital in Canada spiked in 2000 and 2001 and then we had a dot-com burst. It melted down. The people who were in venture capital at the time — and you could argue whether or not we ever had skilled venture capitalists to scale in Canada — lost their money and funding and went into other things. We had labour-sponsored funds that were confused policy instruments that created noise in the marketplace that was not constructive. They almost always had limits on it. For example, you have to be in these industries, you have to be in these provinces, you cannot go international, et cetera. In our opinion, they were failed policy instruments. They were trying to do too many policy things under one umbrella and it did not work. It created noise in the market. Again, it dulled the capability.

I think that as we have gone forward — and we talked to a lot of people about this — you get consistent feedback around the need and the lack of capable venture capital. OMERS' announcement recently about their fund, which is $230 million, does not solve the problem but it at least starts. It is a professionally managed, successful and well- capitalized group. John Ruffolo, who runs that fund, hopes to take that fund to $1 billion after proving he can make money in this place Canada. I think you are right. People question whether there is enough skill to get funds that can do it, whether there is enough human capital that are able to manage venture funds effectively and whether or not they get into the market in such a way that they can be economically viable.

What we know is that we do not have this level of this third stage financing. Assume that friends and family are there; assume we have angel, which we would like to see improved. This is where the problem is, namely, in the third stage financing.

Unless you have that, then we end up pushing people out of our country. They will find the money, if it exists and they have the capability; it just will not be in Canada. Many of them simply stall. A business with the potential to grow to $1 billion gets stalled at $5 million because they cannot get the funding to reach the next level; and it takes years before they become traditionally "bankable." Then, you have more conservative lending than you get in the venture capital stage. Alternatively, they might go prematurely to initial public offering, IPO, which is very easy to do with the TSX Venture Exchange in Canada. The problem is that they get stuck in a junior company rut without the proper funding and resources.

I do not disagree with you philosophically. It would be nice if we could back away and people would come into this market with money. However, to date we have not seen that, with some very specific exceptions. What does it require? It requires some intervention on the part of government in order to encourage people to go out the risk curve beyond where they sit today on mid-stage financing, venture capital pools, et cetera. We are still working through the specifics of what we believe to be the right answer.

We have been working with the Public Policy Opinion Forum and a number of other people. There are different views. Roger Martin would tell you that venture capital is not the answer because it is not profitable and not sustainable in the U.S; you cannot get returns. Perhaps the answer is merchant banking. There may be nuances as to what will work in Canada, but where we are today is not sustainable, and the markets have not healed themselves to solve this problem. There is demand for money; but there is no money to meet the demand.

Mr. Dunn: May I comment on what you said about the Jenkins report? It did not say to remove R & D credits, but, for clarification, it talked about simplifying the program.

The mandate of the Jenkins panel was to be cost neutral. In effect, what things could be done in total to benefit innovation without spending more money? One of their recommendations is to simplify the R & D regime and, in effect, to shift the balance. I will come back to a couple of things that I mentioned earlier.

Eleven of the 24 top countries offering tax incentives have increased them in the last three years. Most countries have been moving from grants to tax credits. Certainly there is no silver bullet but whatever the solution is, it includes a healthy tax credit regime. I am happy to elaborate on that point.

Senator Massicotte: We are talking about a lack of funding with the result that we are seeing fewer start-ups and less innovation and the consequences in this country on economic growth and prosperity. Around the world, there is a difference between the entrepreneurship culture of a country and the level of competition. In France, entrepreneurship is poor and the orientation of business is negative. One could argue that the government should concentrate on that and on creating competition. As you know, competition is the fundamental flaw or ingredient to our capitalist system. If there is not good competition, then the system does not work. Maybe we should focus on those two things and forget about our comparison to Silicon Valley. The whole world has spent billions of dollars to try to replicate it. Maybe we should lose that and concentrate on we can do; we might be more productive with our solutions.

Mr. Currie: Jenkins was not allowed to go into competitiveness. The competitive intensity in Canada is below where it should be. There are artificial constraints around protecting industries from being sold to non-Canadians or being sold at all, depending on where you are. Telco Management Inc. is an example as are others.

Canadians are fat and happy. We have gone a long time with a 65-cent dollar and a free trade agreement with the largest trading nation in the world. As a result, we have enjoyed a good standard of living, but it not sustainable. The fact that today we are fat and happy, we feel better than we actually are.

One of the solutions is to increase competitive intensity, which means taking down barriers so that there is more activity in the marketplace and free flow. We do not ever believe that Canada should be the same as the U.S. There is a price to being Canadian, and we believe that Canadians are happy to pay that price for a collective society that has health care and other things, as well as a kinder and gentler nature. I do not think that the price is a 25 per cent delta between Canada and the United States.

We look at Silicon Valley and at Boston. We are also trying to do Canadian best practices across the piece because it is a different environment here. There are things that we can learn out of Silicon Valley, but we are really interested in taking things like Communitech Waterloo and wondering what else we can do in Canada. There is a Canadian clustering solution here, which is not the same as what happens in the U.S. You cannot make the clusters artificial; they have to be community sponsored and have anchors. You have to have Research in Motion, RIM, OpenText and the University of Waterloo. In Edmonton, the University of Alberta has to be aligned with the incubator, which they have and is two or three years old. They have 40 countries in their incubator, but they do not know each other. They should know each other really well because the same things are happening all over. If you go to Communitech and ask what is happening in venture capital, the guy might say that the third Wednesday of each month they get the 10 best inside companies to pitch for money to the venture capitalists. This is probably the most successful incubator in the country. They get the venture capital guys but not enough to fund 50 companies; and they get Silicon Valley guys; those things happen.

Your point about competitiveness is right. The competitive intensity in Canada is too low.

We have the human capital for small company start-ups and entrepreneurs. Our university graduates are willing to do this, but they run into barriers. We might encourage and provide what they need but it does not mean "give for free." Today there is so much friction as a result of financing and other impediments to success of start-ups that it causes grief. I see no data saying that small business drives all innovations. Nortel had 4,000 patents. I believe the data exist now but to date there has been no fact base to say that is where it is. It comes back to the sectoral analysis as well as the size analysis. People are starting to learn and have the conversation about whether small business is the place to go and whether it is all small business or only tech companies? What is the answer? That is a conversation that needs to happen. Data exist in the Survey of Innovation and Business Strategies, SIBS, and at Stats Canada. We have had the conversation but it has not been a fact-based conversation.

The Chair: In terms of venture capitalists and angel investors, do you see any trends or advantages for individuals or branches of pension funds involved?

Mr. Currie: Yes. We would argue that by definition an angel investor is an individual. Generally, a serial entrepreneur has made a lot of money and participates not only in funding but also in coaching the entrepreneur on how to be successful.

These people generally have made a lot of money, are intellectually curious and often have a number of these things going at the same time. We would say that "angel" and "fund" do not go together. Angels are investors, and we can get them to collaborate with each other because they are always looking for deal flow and activities.

Venture funds are funds. The challenge is to find people who are capable of making third stage investments that allow them, on aggregate, to have a positive return in a time frame that seems reasonable. Again, that is patient money. You need to think of it as seven-years-plus money and you need organizations like the Ontario Municipal Employees Retirement System, OMERS, with people who have that time horizon and the ability to attract skilled managers to make those funds successful.

I was talking to John Ruffolo, CEO of OMERS Ventures, who said that he was talking to someone from the Business Development Bank of Canada. They were both looking for people who can manage funds. OMERS won because BDC is owned by the Government of Canada and cannot pay what OMERS pays for those skills. It is a human capital issue. If you can get money, you will attract capital. It is not like there is a not money in Canada or elsewhere. It is a case of getting a return on the money by finding managers who can make these investments, which is a highly skilled thing to do. You do not create those guys. They do not come straight out of Ivy with those skills. It takes years to develop those skill sets; and I think we are missing them today.

The Chair: Where do they get those skill sets?

Mr. Currie: They get them by owning businesses, being serial entrepreneurs, lending to those companies to some degree, through private equity firms and participating in these markets where they get an area of expertise.

Mr. Ruffolo's expertise comes from working with Mr. Dunn and our tax practice in the high-tech space. Having served and consulted 200 high-tech companies over a 20-year career, he developed an understanding of how they make money and who was successful and why. Therefore, Mr. Ruffolo ends up highly knowledgeable.

Senator Ringuette: We should invite OMERS to appear before the committee.

I looked at your risk behaviour index, in which you look at 900 companies. What were the sizes of those companies? Were you looking at SMEs or big business?

Mr. Currie: We looked at both. It is a spread that kind of goes with the nature of the economy in Canada or the U.S. We did not make a specific selection because we could not get enough to be statistically significant. By its nature, our survey will end up looking like the economies in which we did it. The U.S. firms will be bigger than the Canadian firms, but they will be spread across the economy.

Senator Ringuette: I believe that Canadians and Canadian businesses are risk averse to the same degree. They have a lack of marketing skills in comparison to our U.S. counterparts. We lack aggressiveness and how-to in seeking our market share. If we were to focus on increasing that knowledge, our marketing skills and access to markets, we would somewhat lower this risk-aversion index.

Mr. Dunn, you indicated that the clusters work in isolation, and they are working in isolation. That speaks to a communication issue. I remember hearing the Canada Research Chairs who appeared before the Standing Senate Committee on National Finance. My request to them was to put on their website what research they are doing to try to make contact with potential start-ups and marketers. We are also averse to communicating and sharing. Maybe we are looking at all of this from the financing perspective. Maybe we should look at an entirely new skill set.

Mr. Dunn: I have a couple of comments.

The University of Waterloo, which we referred to a couple of times, has a Master of Business, Entrepreneurship, and Technology program. I believe that learned behaviours make somebody more successful as an entrepreneur. It goes beyond risk aversion. We surveyed only the risk aversion but some of the other elements that you describe by observation are certainly reasonable, and we would observe the same things.

In terms of the communication element of education, communication helps to educate to the extent that it helps to share observation and experience. When you commercialize technology, depending on what part of research or development you are doing, communication can be a commercial disadvantage.

Senator Ringuette: The competition.

Mr. Dunn: You want to have a timing advantage over your competition as you improve a process or product. In general, that is a very reasonable comment.

Senator Ringuette: In terms of government policy or programs, how can we increase our marketing skills, knowledge and access in order to reduce risk aversion in Canadian businesses?

Mr. Currie: We believe that academia has a role to play in helping to reverse this. The challenge is that it will not happen overnight. It is a generational thing. We need to intervene in defining curricula, improving technology transfer offices and at all levels of education, not just the university level.

There is no way to quantifiably determine whether we teach risk management as well as our U.S. counterparts teach. However, we looked at the curricula of Canadian graduate business schools and at those of U.S. graduate business schools — the top 10 universities in the U.S. and Canada. We found that U.S. schools had a lot more courses on entrepreneurship, innovation and things that would push the spectrum, whereas Canadian schools were very traditional in their approaches and curricula. We believe there is an opportunity to work with academia to change how they think.

Canadian universities are very "siloed," and the politics go with this. If you are in the engineering school at Queen's University, you do not have any course load to take an arts course or a commerce course, and the commerce school does not have any course load to take an arts course. Part of that is driven by university politics and faculties that want to keep their students in their faculty. That does not do us a great service.

The quality of our education is very good, but we do not necessarily take advantage of it holistically. A business student who is required to take a course in fine arts will end up being more creative; and a more creative person will be better at marketing. There are things we can do to shift how we think about those courses in addition to adding courses.

At earlier stage education, primary and secondary school, we should have business as well as traditional math. If there is business, it is very rudimentary. It might be around financial literacy such as managing a bank account. It does not talk a lot about macro-economics or even fundamental business issues. It is important to do that.

It is also incumbent upon the business community, as alumni of universities and high schools, to participate in that training. They could talk to business students about what the world really looks like. It is particularly important for entrepreneurs or the self-employed.

Senator Ringuette: I agree with you. In our federation, post-secondary education is the responsibility of the provinces and territories. You must come up with a marketing ploy for the provincial and territorial governments to provide that information.

Mr. Currie: We have been talking to the Ontario government. We have also been talking in Ottawa to the Prime Minister and the Privy Council Office, collectively, and others. Obviously, there is no direct federal intervention. However, the federal government gives a lot of money to universities; it sort of comes without condition. There may be an opportunity to use that avenue. This is not an overnight thing. We need to shift the agenda or at least get it on the agenda that a broader education than what currently exists should be focused on people who will have careers in business.

Senator Ringuette: Will you look to communicate the results of your study beyond the Government of Ontario?

Mr. Currie: Oh, yes, we are everywhere.

Senator Ringuette: I hope you make a stop in New Brunswick.

Mr. Currie: We will be coming at the end of November, I believe.

The Chair: Are there further questions?

Senator L. Smith: Small- and medium-sized businesses have a 1 per cent direct write-off from revenues available for training in house. I spent some time when I was younger in the training business. The statistic that always baffled me was that about 90 per cent of money spent by companies on training people was spent on technical training, and less than 10 per cent was spent on people training, which are the soft skills required to market, sell, et cetera.

Is there something that provincial and federal governments can do to stimulate business, in particular entrepreneurs, to look at the directional skills for corporations?

Mr. Dunn: We have a couple of premises. I have said that there is no silver bullet. A mosaic of different approaches creates the right environment to be more productive and innovate more. We prioritized the elements.

In our research we valued education but we would see that more as broader-based education to help people be more successful as entrepreneurs. It is not apparent in anything that we have looked at so far that there is an issue in respect of training within organizations; although, I do not think we have a view on that subject.

Senator L. Smith: You have corporate entrepreneurs and other entrepreneurs — people cross the lines. From an educational perspective, some universities in fourth year business programs bring outside people in to lecture. At McGill University one professor burned the book on his fourth-year marketing program and brings entrepreneurs from outside to share their experiences with the students.

How much more can we do in that area to foster the mentality? You talk about innovation and to me, part of that is all about mentality.

Mr. Currie: I believe that we need to do a lot more of that. Real life experiences you get from talking to entrepreneurs and business people in general add a lot of value to the educational experience that goes beyond what you can get in a classroom. We recommend taking greater advantage of alumni networks for universities and leveraging the business community to create an understanding of entrepreneurship, risk taking, and the reality of being in a business community. It is important that we continue to advocate for that and to push both academics and the business community to join together and help teach our students to be more aggressive in their careers.

Mr. Dunn: To the extent that there is risk-averse behaviour, training within a business, sharing experiences and describing methodology reduces that risk-averse behaviour because it provides some degree of certainty and reduces the ambiguity of an outcome. In that respect, it is positive.

Senator L. Smith: Canada Research Chairs gave out $203 million. The feedback I received, because I made the announcement, was that in many situations with research chairs, there is confusion as to the outcome. Should we make stricter rules for demanding outcomes and perhaps have government interact with entrepreneurs? Where do the research chairs take their five-year or seven-year studies when they are complete? What are the outcomes? Taking some of this to market, what is the connection to entrepreneurs?

Mr. Currie: When we looked at those 28 things, we were disappointed because Canada does not stack up very well. However, we are good at writing white papers. We are the OECD winners at writing white papers, but we are not the winners when it comes to commercialization. In fact, we are far behind. I have two views on this.

Senator Massicotte: Senate committees are the best at papers.

Mr. Currie: Most research chairs should have outcomes; something specific should be required, but not all. I was at the Perimeter Institute for Theoretical Physics in Waterloo. The Bank of Montreal was just funding the chair and they had a world-renowned MIT professor of quantum physics come up to the front. The Perimeter Institute has 30 or 40 professor researchers in-house. They have no goals, no targets and no students. They are there to think. They do pure research. Mike Lazaridis, founder and Co-CEO of Research In Motion, is funding that with help from the Government of Canada and others because they believe that quantum physics is the next big wave. I am not sure what quantum physics are, but I know that if you are going to drive innovation, you have to have places that are absolutely world class.

We were there doing a presentation. Minister Flaherty was there and a bunch of guys who looked like me dressed in suits were there. Members of an advisory council for quantum physicists from around the world and we were having dinner in the same space. My favourite was the guy wearing sandals and orange socks, but he would have way more IQ points than I have. They come to the institute from around the world because it is a magnet for geniuses. There is a place for pure research and also a place for outcomes.

Senator Greene: It would be interesting for me and the listening audience to know why 25 years ago we matched the U.S. in productivity, but now we are at about 85 per cent. What have they been doing differently or what have we not been doing that we did before?

Mr. Currie: We have to look at what happened during that time frame. We had a currency that was low and a free trade agreement that gave us access to the U.S. market, which has the most competitive intensity in the world. The U.S. continued to invest because to be successful, they have to continue to get better and better. Their economy over that time shifted from manufacturing and agriculture to high-tech services because manufacturing went to China and some of the low end services went to India. In response, the U.S. upped their game. They continued to be more productive and to shift sectors. They are driven and intensely competitive.

We rode along on their coattails, to some degree, but we have not had the same level of intensity. Our companies are fat and happy, so they do not invest in machinery and equipment in their own businesses; so they do not feel pain. I do not believe that they sensed they were falling behind, when in fact they were doing just that. Now, they wake up and see that they are behind and trending. Those are some of the things that drove that.

Senator Massicotte: That is a good explanation of what has happened over 25 years. American competitiveness has been around for at least 150 years. What happened 25 years ago when it was equally competitive to Canada? You talked about the dynamics of the marketplace. Why was Canada equally productive 25 years ago?

Mr. Currie: After World War II, Canada had the fourth largest navy in the world. We are a small country, and our participation rate in that war was way beyond the size of our relative economies. On a per capita basis, we were way beyond what the United States contributed to that effort in lives, effort and everything else.

The generation coming out of that was confident in building a young country and were at least as competitive as the United States — intensely so. We reached the point where we had structural advantages that cost us our edge.

Senator Massicotte: In 1985, 40 years after the war, we still had that benefit from the large navy.

Mr. Currie: We had a population of leaders who grew up and lived through the depression and who had a work ethic, a focus and a discipline that made them country builders.

Senator Massicotte: They were better than the Americans.

Mr. Currie: No, they were equal to the Americans.

Senator Massicotte: Let us leave it at that.

The Chair: Mr. Currie and Mr. Dunn, this has been a stimulating morning for us. You have given us clear, fairly short answers, which we appreciate. Everyone had a chance to ask questions. You have given us much food for thought. We liked the clarity of your explanations and your down-to-earth examples. We thank your firm for undertaking this study. It will be very useful to the country.

Unless there is anything else, we are adjourned.

(The committee adjourned.)