Proceedings of the Standing Senate Committee on
Banking, Trade and Commerce
Issue 3 - Evidence - October 26, 2011
OTTAWA, Wednesday, October 26, 2011
The Standing Senate Committee on Banking, Trade and Commerce met this day at 4:18 p.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: Good evening colleagues. I will call to order to meeting of the Standing Senate Committee on Banking, Trade and Commerce. I am Senator Michael Meighen and I have the pleasure of chairing the committee. Professor Cumming, can you hear me clearly?
Douglas Cumming, Professor, Schulich School of Business, York University, as an individual: Yes, can you hear me?
The Chair: Yes. I advise everyone there is a slight lag between the audio and video. We will get used to it quickly, I am sure.
The Chair: Can you see us, Professor Cumming?
Mr. Cumming: Yes.
The Chair: Everyone should behave well, then.
Welcome to our session. I will start by introducing you to the senators present this evening. Unfortunately the deputy chair of our committee, Senator Hervieux-Payette from Quebec, cannot be with us. However, we have a good representation from across the country. There is Senator Gerstein from Ontario, Senator Larry Smith from Quebec, Senator Greene from Nova Scotia, Senator Oliver from Nova Scotia, Senator Harb from Ontario, Senator Ringuette from New Brunswick, Senator Moore from Nova Scotia, Senator Stewart Olsen from New Brunswick and Senator Massicotte from Quebec.
You have a good turnout today and we are all interested in your views.
I should mention to the viewing public at home, on CPAC and on the World Wide Web, that we are continuing with our study of the financing of growth capital for small and medium-sized businesses. As I indicated, our guest today — who is joining us via video conference for the first part of our session — is Professor Douglas Cumming from the Schulich School of Business at York University.
Do you have opening remarks you might like to make?
Mr. Cumming: Thank you. I am a professor and the Ontario Research Chair at York University at the Schulich School of Business. I teach MBA and master's of finance courses in private equity and venture capital and I supervise Ph.D. students working in this topic area.
I have been at York University since 2007 and have done similar work at universities in the U.S., the U.K., Germany, the Netherlands and Australia. As well, I have done consulting work for both governments and private corporations in many of these countries.
Most of my work is in private equity and venture capital, although I have done some studies in banking and other forms of finance, largely concentrating on entrepreneurs. I have spoken before your committee once before, regarding the Business Development Bank of Canada. I appreciate the opportunity to come back and speak again.
The Chair: We apologize for the short notice. We are grateful that you accepted our invitation. Please proceed if you have further comments.
Mr. Cumming: I thought we might talk about venture capital in Canada today, things to do with angel tax credits, and perhaps issues involving innovation hubs that have been publicly funded in Canada and other countries. These are some topic areas I thought might be of interest, but I am open to talk about whatever is most pressing at your end.
The Chair: I am sure that senators will have many questions. Before I start preparing a list of questioners and opening up the floor, I will ask you a question. In terms of the encouragement of the financing of small and medium- sized enterprises, are we going in the right direction in Canada?
Mr. Cumming: That is a difficult question to answer. The best way to think about it is in terms of our historical context. Canada has had an unusual venture capital market. For many years, the major source of funding for venture capitalists was labour-sponsored venture capital funds. They are essentially like a mutual fund, set up to invest in small private companies that venture capitalists would normally back. Instead of having institutional investors like pension funds, endowments, insurance companies and other large institutions investing in the funds, labour funds are set up as retail funds. Investors like you and I can make the contributions to the funds, and professional fund managers invest the money on our behalf.
In exchange for investing, retail investors like you and me receive tax credits that drastically reduce the amount of tax that we would pay, because they are RRSP eligible investments. For example, on a $5,000 investment — if you have over $100,000 of income — your after-tax cost would be in the neighbourhood of about $1,300. Labour funds have been attractive, from a tax standpoint, for individuals to invest in. As a result, the labour funds that were first set up in Quebec in around 1983 — followed subsequently by most of the other provinces in the late 1980s and early 1990s, except Alberta and Newfoundland — became very large. Around the turn of 2000, they were the dominant player in the venture capital market in Canada. Relative to their performance, the growth of labour funds was surprising.
I have tracked the performance of these funds going back to the early 1990s. To put it in the starkest terms, if you put a dollar into a labour fund in 1990, today you would have about a dollar. The economic rate of return has effectively been zero. Over this period, the only time in which the funds had a rate of return that exceeded the 30-day T- Bill index was at the peak of the Internet bubble. It was barely over the index for a couple of quarters and then subsequently dropped to roughly zero.
The program is very expensive because normally we like programs that are generating economic rate of returns. If you remove the tax incentive there is still value being generated, and that is not the case with labour funds. With that backdrop of the history of where we are with venture capital in Canada, it has been an unusual market relative to most countries in the world. Most countries in the world do not have these retail venture capital funds, and certainly not with the massive presence they have in Canada.
The changes that have been happening recently have been in Ontario. In 2005, they announced the phase-out of the retail labour-sponsored venture capital funds. We are now in 2011, and the phase-out was to take place over a number of years. Initially it was scheduled for 2010 and got pushed back due to the lobbying efforts of fund managers whose livelihoods depend on the existence of this tax credit in that industry. The lobbying pushed that back, and we are now in a transition period. If we are to understand, as a broad picture of financing, these high-growth companies that we know and love in Ontario and the rest of Canada, the labour funds still have a dominant role in the other jurisdictions, particularly in Quebec, but in Ontario, it is essentially a transition period where the funds are evolving into other entities, while the Government of Ontario has reintroduced other incentives to support venture capital, namely through three programs. We have an innovation accelerator fund; an Ontario venture capital fund, which is a fund of funds that has about $500 million in capitalization; and an Ontario emerging technologies fund, which is a direct fund investor that has about $200 million invested in Ontario growth companies.
I want to stress one thing as well to give you a sense of venture capital in Canada relative to other countries. The Canadian landscape now has around 2,000 labour funds, which were about half the market; a little more than half the capital under management was in labour funds. These days, it is about 20 to 25 per cent. It still exceeds that of the private independent venture capital funds — or typically the ones we know and love.
If you were to think of the famous venture capital funds that finance the companies that have grown up to be super successful and amazing for innovation, R & D, creating jobs and all the things we like, these are typically the private funds set up as limited partnerships. These funds have financed many of the companies that we use on an everyday basis. Companies like Facebook, Google and Apple — all the companies we know and love — do not have as much of a presence as the labour funds do in Canada, even up until today.
If you were to look over the last decade, on any year-to-year basis, anywhere from 25 to 50 per cent of the deal value comes from the U.S. We have a strong presence of international investment into Canada through investors that are investing cross-border.
These are some unusual features of the financing of high-growth entrepreneurs in Canada, and that is where we are at today. There is a bit of a transition phase that we are going through in Ontario, with the replacement of one program with another. Then the other provinces have not followed suit.
The Chair: That is very helpful. If I can put in one request, I would be interested in your views on what I think was one of the thrusts of the Jenkins report, that direct funding seems to be more favoured than tax credits and that the program of tax credits has not worked very well. I would be interested in your views on that later, but I will turn to my list of questioners now.
Senator Massicotte: Our focus is very much on small and mid-sized businesses, predominantly on why we do not have a very large growth sector for innovation. As a country, why are we falling behind on innovation — with the focus very much on financing?
The evidence we have so far is if we look at the last five years, venture capital for SMEs has basically dried up because they are not making any money. In fact, you got zero returns in the last three to five years. There is a lot of money in the marketplace; there is no lack of capital, so I will not worry about where the capital will come from. I am convinced that if one could see profit or potential profit, the problem would be rectified immediately; that is my quick analysis.
Why is the sector not profitable? You testified before on this same question. Is it because there are a bunch of complicated structures, motivated by tax incentives, which makes it such that cheap capital is distorting the normal market rules for allowing profit capital? All the venture capital funds are gone; they are not interested in Canada anymore because they cannot make a dollar. Is that why? Why is our market so distorted, and how do we correct it?
Mr. Cumming: There are a number of issues there.
You made a point about having cheap capital — say through labour funds — that arguably could bid up deal prices and lower rates of return through making the market unduly competitive for those that are private independent funds that do not enjoy the tax credits that labour funds do. Some of my work is certainly consistent with that view.
However, just as a more general point, if we look at the U.S. venture capital market over the last decade since the collapse of the Internet bubble in 2000, and then the subsequent legislative changes that happened there — particularly with Sarbanes-Oxley, the average U.S. venture capital fund has not done very well at all in the last decade. It has been a particularly underperforming sector. I stress that is the average; the index performance on average has not done very well.
When you look at the details, there are significant discrepancies across top quartile funds and bottom quartile funds. The way we phrase it in academic jargon, which I do not like using, is "performance persistence." This is also commonly used in industry.
To give you a sense, if you were to say what will be this year's best mutual fund and look at last year's best mutual fund, that would be a terrible predictor of what fund will do well this year. There is very little performance persistence in mutual funds, whereas in venture capital the performance persistence is massive. The best predictor of who will make money next year is who made money over the last few years. The top quartile funds do very well and they consistently do very well.
Famous examples would be Kleiner Perkins, a Silicon Valley fund that has been around since the 1970s. They are a fund manager that has set up many funds over the years; I think they might be on number 15 or so now. They consistently do better than the average fund. Similarly, the bottom quartile fund managers consistently lose money.
This is an unusual thing about venture capital. When you say the average performance in the industry, that is a difficult animal to get around. We have some top performers that make money consistently and then we have bad performers that lose money consistently. That is one aspect.
The second aspect that is very unusual, and something that I think is very relevant for your committee, is that when you look at performance in venture capital, some changes have been going on in the U.S. in the last 10 years. In the U.S., we have had legislative changes like Sarbanes-Oxley and other things that have made it much more difficult to take a company public.
Venture capitalists invest in small companies, often for three to five years, with the expectation of realizing capital gains by selling that company; it was once small but it is now big and we are going to sell it to someone else. It could be an acquisition sale, say if we invest in Skype and sell it to eBay. A big company buys out the company and the investors make a big rate of return. They do not get the rate of return from dividends on equity or interest on debt; they get the returns from capital gains, so you need to have a viable exit outcome.
In the U.S., before 2002, the typical company that could go public would be $100 million to $200 million in capitalization. Then you have a big enough company that you can list on NASDAQ or possibly the New York Stock Exchange. That company would go public and generate a great rate of return for the investors.
Now the situation is much different. Instead of being a $100 million to $200 million company, to make it profitable for the investment banks and other players in this industry to take a company public, the company has to be way larger. Estimates these days are that you can go public if you are, for example, a $1-billion company. That changes the nature of venture capital investing quite significantly. To go from a start-up company, like Apple — two guys in a garage, they get venture capital, and in three to five years to make it a $1-billion company — is very unusual. There are some popular examples we have seen in the media lately that include Facebook or LinkedIn. These are companies that are venture- capital-backed and will likely go public very soon. Those companies have massive billion-dollar-plus valuations. The normal size of a company you could take public now is much bigger. Even though you have some good examples, those are not the normal companies that that we used to see going public. That makes it difficult for the venture capital industry in the U.S. — with listing standards being much higher and trickier than we have seen in Canada in that context, with the legislative requirements among other things — to take companies public.
What is the situation in Canada relative to the U.S.? We have much lower listing standards. To give you a rough sense, to take a company public, the listing standards for the Toronto Stock Exchange are about the half the level of what they are on NASDAQ. If you go to the Toronto Venture Exchange, to take a company public the listing standards are even lower.
The Chair: For those listening who perhaps are not familiar with it, could you briefly indicate what you mean by listing standards? Is it a monitoring amount?
Mr. Cumming: Definitely. Not every company can list on a stock exchange. The stock exchange will have requirements about the minimum quality level of the company before it will let investors exchange shares on that exchange. To buy and sell shares through the exchange, the company has to meet minimum quality standards. Depending on the exchange, that could be something to do with market capitalization, the size of the investment, or size of the company in terms of all the equity outstanding. It could have a revenue requirement or a profitability requirement, and those types of things.
Sometimes there are vague listing standards and exceptions, but as a crude approximation, the New York Stock Exchange has listing standards roughly double those of NASDAQ. NASDAQ has roughly double those of the Toronto Stock Exchange. The TSE senior market has listings standards that grossly exceed those of the Toronto Venture Exchange. It would be double and then some. Our venture exchange has been set up as a way to compete with typical venture capitalists. Private venture capitalists that finance small growth companies are roughly in the same market as companies that could consider listing themselves on a stock exchange — and raising money that way — at least on the Toronto Venture Exchange. The listing standards are very low, and we have an unusually high proportion of backdoor listings. With our unusually high proportion of backdoor listings, you could say it is like regulatory arbitrage where companies can list themselves on an exchange. You can list a shell company on the exchange. Then the shell company buys into the private company, so the private company gets a listing without even having timely disclosure of what the company is about. In other words they are known as reverse mergers to make it even easier for companies to list.
One thing we have discovered is these very low listing standards in Canada have a very small certification effect — almost a really weak certification effect — about the quality of the companies. When a company lists in Canada, the signal to investors that it is a good company is much less than what would you have in other countries. That makes the valuation of those companies much smaller. The exit opportunities for venture capital investors in Canada is arguably weakened in the sense that their exit outcomes for taking companies public is not as attractive relative to what we might see in other countries around the world, given the lower listing standards.
The Chair: Professor Cumming, I realize this is a complex subject and very nuanced and it is hard to give short answers, but let us try and keep our answers and questions as short as possible.
Senator Massicotte: We are hearing that there is a shortage of venture capital. The evidence we are getting is because there is not enough profit. Do I understand that your opinion is if we got rid of labour funds, the problem would be rectified?
Mr. Cumming: I think the transition is slow and difficult when you have wealth destroying regulation. It is not an overnight fix, but that is a very important and necessary step to help Canada's venture capital market. I see no value in keeping that program in existence, and I applaud Ontario for having made that change.
Senator Harb: Thank you very much. I have a couple of questions for you. As the chair has indicated, we are looking for some specific suggestions so we can take them to the government. The government can either introduce laws or change regulations so we can encourage more people and entities to invest in venture capital.
Are you, or have some of your students, done a study to look at what some of the best practices are on the international scene? Who did what? What worked and what did not work? If you have studies that one of your PhD or master's program students has done that you would be interested in sharing with us, that could help greatly.
Mr. Cumming: Definitely. I spent the better part of the last dozen or so years thinking about that issue. I have done this by examining data from over 40 countries around the world. To cut to the chase, the typical issue that arises is that direct investment programs are very tricky to set up without causing distortions. Direct investment programs — and I would put into that bucket labour funds, even though it is a tax subsidized direct investment program, that one type of fund gets that another type of fund does not. That is a program that has caused massive distortions. In other countries where direct investment schemes have been set up, they typically have not worked out with the intention they have been set up to work out as.
By contrast, if you look at the data from around the world, simple things like lowering capital gains tax rates have been extremely effective in spurring on venture capital in different countries. I have seen many studies on this — some of my own work and many that are not my own work — and unambiguously, those are things that have helped venture capital tremendously. Even the very start of the modern day U.S. venture capital industry was helped out by a significant lowering of the U.S. capital gains tax rate. Those tend to be much more effective and simpler than creating investment schemes designed to help companies on.
I know time is short but I want to add one exception, which is the recent trend has been for public policy-makers to set up innovation hubs. I could give a couple of examples in Toronto. For instance, we have a centre known as MaRS in downtown Toronto; there is another one in Markham, known as the Innovation Synergy Centre. Where data have been collected from them, the centres tend to show a significant amount of value added. A caveat is I am a data guy and I see a dearth of data that have been available from these centres so far. However, the data that have been available are highly consistent with the view that these are well-functioning programs.
Senator Harb: I take it from that you will be prepared to share with the committee whatever information you may have with specific recommendations coming out of those best practices that your office has looked at.
Mr. Cumming: I would be very happy to share research studies. Again, it is all empirical work. I do not like to say anything unless it is backed up by data.
Senator Moore: In your earlier comments, you said there is a strong presence of international venture capital investors in Canada, especially from the U.S. Have you looked at the total amount of dollars invested in venture capital in that sector in Canada, and have you looked at the percentages from the U.S. and from other countries?
Mr. Cumming: Yes. Roughly, for the first two quarters in 2011, the total amount from foreign investors is about $190 million. That would be, give or take, about 25 to 30 per cent of the total amount invested. If you were to go back into 2007, which is a year where there was more investment, the foreign investors comprised about half of the venture capital invested in Canada. Over the last 10 or so years, in a typical year, about one quarter to half of the total investment in the country is from foreign investors.
The other thing that is interesting that might be worth mentioning in this context is that U.S. investors invest more per deal. A typical venture capital deal for a single round from a Canadian investor financing a Canadian company is around, on average, $2 million to $2.5 million. For a U.S. investor investing in Canada, the typical deal is over $5 million. It is, on average, twice as large as the Canadian investors are investing in Canada. They comprise a big part of the market, and they typically are investing more money.
Senator Moore: That 2011 figure of $190 million, is that all U.S.?
Mr. Cumming: Yes, that is U.S. dollars invested. Actually, I should be a bit careful — the available data that I have at my fingertips does not break down very well which country that is coming from. However, I know from other work that the majority of foreign investment coming into Canada is American investment.
Senator Moore: If, as Senator Massicotte says, they cannot make money here, what are they doing here? They invested $190 million.
Mr. Cumming: There is a big distinction between the top quartile funds and the bottom quartile funds. There are some people that make a lot of money in this industry, and they exist in the business for a very long time. The fund managers that are top quartile return very attractive returns to their investors; and there is a big portion of the bottom quartile that lowers the average amounts.
Senator Moore: Do you know which quartile this $190 million comes from?
Mr. Cumming: I would like to say with data, but there has been a lack of evidence on that so far. I am not going to say without being able to answer that precisely.
Senator Oliver: I was interested in your comment about lowering capital gains because, as I am sure you know, this particular committee has done the seminal work in Canada on lowering capital gains. Its reports actually moved the government to make the changes it did less than 10 years ago in two tranches.
My question to you is about angels; when you began talking, you mentioned something about the angels' tax rate. I would like to know what recommendations you would have for us about ways of attracting more angel financing. What are their concerns? Are they looking just for exit strategies? What have you learned from looking at the 40 or so other countries you have worked in?
Mr. Cumming: The angel tax credits are becoming very popular. This is a new trend in the last couple of years. I think around 30 to 35 of the U.S. states have introduced specific angel tax credit programs, where the tax break typically is in the neighbourhood of 25 to 40 per cent for qualifying investments. This is a recent popular trend that people seem to like, and it is catching a lot of attention these days.
There has been talk by the Ontario government of introducing such a tax credit in Ontario, particularly over the past year. The thing with angel tax credits is that in terms of empirical evidence, I would say the jury is still out because much of these programs are so recently introduced. We like to gather lots of data and examine what the outcomes and investment patterns have been over a long history in response to these policy changes. That is a relatively new thing; in a few years, I bet we will be able to say much more about it.
What I like to mention in view of these tax credit programs is that people have to be careful about introducing tax credits thinking that they are going to solve all problems at once. There can be distortions that are introduced when you put in such tax credits.
One type of distortion, for instance, is that if you set up the parameters of who is eligible and who is not eligible for the tax credit, you tend to get both investors and entrepreneurs reclassifying themselves in order to fit within the scheme. They might not necessarily have originally intended on being in the scheme, which could make it more difficult for the companies that the program was intended to be qualified for, as well as for the investors that it was intended to be directed at.
The other thing is that angel investors share at least one important similarity with venture capital investors — namely that it is not just about the money, it is about the value added. This is why we have top quartile funds and bottom quartile funds; the value added in monitoring and screening is much better among some investors than others.
If you apply an angel tax credit widely, a very sophisticated angel investor — a well-known example would be the folks you see on Dragon's Den — would be in the same bucket as my Uncle Bob. Those are two very different types of individuals and you want to incentivize one versus the other. Introducing such a program is arguably best done by having a fine-tuned and nicely implemented structure that does not capture the types of investments that you do not want to be part of the program, because these things are very expensive to implement. They can involve massive expenses for other folks that are not enjoying such tax benefits.
Senator L. Smith: In listening to you and some of the witnesses we have had to this point, it appears the key to venture capital is risk management. You alluded to the fact that the successful people are better at managing that risk than people at the lower tier.
If you had a magic wand and you had to suggest steps for revitalizing the venture capital market in Canada — which we know is significantly different in size of deals and complexity than in the United States — could you suggest three key steps that must be taken to resurrect or restructure or reposition venture capital in Canada?
Mr. Cumming: That is a great question. Consistent with what I said before, I would start by saying we should encourage the provinces, other than Ontario, to drop labour-sponsored venture capital funds. We have a long history of data that unambiguously shows that that program is not helpful for our market. It is very expensive, costs us over $1 billion a year, does not help, displaces other investors and impedes generating returns. It is not a good program. That would be first.
Second, government arguably does have a place in fostering venture capital markets. Around the world, everyone wants to recreate the success of Silicon Valley. People think that innovation and entrepreneurship will be the key drivers of the wealth of nations around the world. Everyone is trying to figure out that magic ingredient. One type of program that has been successful in other countries is to have greater government presence in encouraging institutional investors to invest. That can be done through fund of funds programs, which have enjoyed success in other countries and spur on the creation of local, talented venture capitalists.
For the data we have seen, that has been a useful program and a good way for government to get involved to build the source of capital. It is not coming from retail investors, but spurring on the institutional investment. The government can take a role in that through a variety of ways, one of which is — as in the Ontario Venture Capital Fund program — to take a back seat in collecting returns from these investments, which encourages other institutional investors to make investments.
If I had to pick a third, it is useful to think about our top-tier funds, and finding ways to encourage top-tier funds to have a presence in Canada. If one were able to get those fund managers that have had consistent records of top quartile performance not to just make cross border investments. We know from our long history of Canada what happens in terms of spillover effects. Issues with the brain drain and other things happen when we make investments, of which other countries enjoy the benefit. We might find ways to encourage those funds to have a greater local presence. That type of local stimulation is important because there is a lot of evidence on issues to do with agglomeration. Agglomeration economy is getting high-tech areas built up, encouraging entrepreneurs to locate here, and it can have a lot of spinoff benefits. That can be a good thing for Canada, but it is not just funding anyone. It could be very useful for having Kleiner Perkins or Sequoia Capital type of fund manager — at least a greater number of those folks — to have a presence in certain parts of Canada. I do not want to pick one region over the other. We could think about ways to encourage agglomeration that will help our high-tech, innovative and entrepreneurial sectors.
The Chair: Before turning to Senator Hervieux-Payette, professor, you pointed out the dangers of distortion by some tax incentive schemes. In your opening remarks you mentioned the MaRS organization in Toronto. They were a witness last week. If my memory serves me well, one of the government programs that MaRS seemed to favour was matching funds alongside private investors who had put the money up and appeared to make serious progress, and then the government comes in and matches. The government is thereby not in the business of picking winners. They let the private market do that. Their money is nonetheless useful to a start-up enterprise that finds difficulty in attracting loans from conventional lenders. Would you also approve of that?
Mr. Cumming: Yes, I like that idea very much. Matching programs put people on the same page and give the right incentives. We minimize any negative incentive effects from just pure subsidies. The matching programs are useful.
I can talk a little bit more about the International Synergy Centre in Markham, the ISCM, than I can about MaRS, largely to do with data availability. First, I will say more broadly about data availability. With these centres, it would be great if there were record-keeping issues that were a little more transparent and open for the public such as academics to scrutinize. I have seen a lot of data from the ISCM, or at least from one sub program there. I will give a few numbers. For at least the three years that I have seen data, the sub program costs were in the neighbourhood of about $650,000. The entrepreneurs that came through that centre raised over $6.5 million from angel investors. The entrepreneurs were more likely to generate sales improvements and patents, get strategic alliances and obtain financing. That is after a very rigorous look at the data from all sorts of issues that could confound the statistics. Those results seem quite robust. That seemed to be a fairly strong program. As an academic, one thing I love to encourage policy-makers to is to force more open record-keeping and allow people like me to have a better access to data. That is certainly one program that was willing to open up its books in a nice way.
Senator Hervieux-Payette: I agree that the labour funds are still costing taxpayers a lot. Would you contemplate phasing that out? What would be your strategy to make this happen? It is not a miracle. It is not a success story where we can say every person who puts his money there would beg us to continue at the same speed.
My second question concerns the $5 million compared to the $2.5 million, meaning American versus Canadian. Do you mean that amount of money comes at the same phase of development, or is the American amount larger because they invest at a later stage? We have to compare apples and apples.
Mr. Cumming: Yes. I will start with the first question regarding labour funds: How do we phase them out, and is it worthwhile to phase them out in all the provinces?
Certainly, it is one thing that needs to be phased out over time with an announcement of a planned phase-out. Ontario did it with an initial announcement of a five-year lag; they announced in 2005 that the tax credit would no longer exist in 2010. Lobbying pushed that to the end of this year, so it is effective in 2012. That is one way to allow businesses to readjust themselves because it is such a drastic change.
I can give you a couple of anecdotes about the difficulty of making those kinds of changes. I know some folks at a university in Quebec that did some work on the labour funds in Quebec. They presented some extremely negative results about the Quebec labour fund program, and they told me that they had faced tremendous difficulty in doing that type of work as academics. They faced threats of having their research funding removed and other such issues. They told me that they felt like they were working in a backwards, non-academic or free environment.
That type of work, even as an academic, can be difficult to do, given the dominance of those types of folks who control such large amounts of capital. They can have a significant political influence and try to stop anyone from saying anything in an objective way.
I should say that those people do not get paid to say something one way or the other and neither do I. It is purely a non-financially motivated thing where we write papers based on what the data say unambiguously, which is that this is a value-destroying program. That would hopefully address the issues in your first question.
On the second question about U.S. investors, they are making investments sometimes at a later stage and often are brought in on follow-on investments. However, I have done this even comparing the initial investment amounts — as you say, apples for apples — at the same start-up level. Typically, U.S. investors invest a much larger amount relative to their Canadian counterparts. This tends to be roughly double the amount, at least on average, even when we do the apples-for-apples comparison. The same is true for U.S. domestic investments, when they invest in domestic entrepreneurs in the U.S. The investment amounts tend to be larger.
This issue has been known for quite some time. I remember being at a Conference Board of Canada presentation a number of years ago and people raised the issue: Why does the U.S. invest more per company? Is that not damaging to our Canadian investors?
It is hard to know, just like in the seed stage of development, the start-ups, exactly who needs the right kind of capital; how frequently are the investors staging the investments with subsequent capital infusions? Do they syndicate with the right degree, having multiple investors?
To cut to the chase, one might say that given the structure of the Canadian market and lack of depth, there arguably are some distortions in Canada that are not as present in the U.S. context, where investors appear to be adding more value to their companies.
The Chair: I am afraid we are going to have to leave it at that. We are out of time.
On behalf of all my colleagues, thank you very much indeed for giving us your time this afternoon at very short notice. If you have any specific suggestions, in addition to the ones you mentioned during our talk, please send them along to the clerk.
Mr. Cumming: I definitely will, and let me express great thanks for the opportunity to be with you today.
The Chair: Colleagues, we have our second witness of the afternoon with us. Mr. James Milway is Executive Director of both the Institute for Competitiveness & Prosperity — a nice combination — and the Martin Prosperity Institute. We hope we will talk a lot about prosperity this afternoon, Mr. Milway.
I know you are under a time constraint, as are we. We will conclude at 6:15, I promise. There will probably be more questions that senators would like to ask, but we will have to keep our questions and answers concise.
Thank you for being with us. We appreciate your taking the time.
James Milway, Executive Director, Institute for Competitiveness & Prosperity: My pleasure.
The Chair: As you know, we are trying to wrap our minds around the complex problem of financing of small and medium-sized enterprises. With the Jenkins report that has just come out, there is some material that no doubt you have read and absorbed, but we would like to hear what your perspective is. You have, I think, an opening statement, so I would ask you to give that. Then, if you would be so kind, we will have questions from senators.
Mr. Milway: Thank you very much for inviting me to participate in the discussion. As we say, our greatest prosperity improvement opportunity in Canada is to strengthen our innovation capabilities. As we have shown over the past several years, we are also less productive than other developed economies like the U.S., France and Germany. That is to say, we are less capable in Canada of creating value from our human, physical and natural resources. The economic progress that we have created in Canada over the past few years is the result of more people working, and working more hours, than in many of the other peer jurisdictions. We are working more but we are not working smarter.
These two challenges, strengthening our innovation and improving productivity, for us are one and the same since product and process improvements result in more value being created with the same resources. Many observers argue correctly that an important element of our economic progress is the success of our small and medium enterprises. We hear observations that these smaller businesses are the backbone of our economy, that they are the engine of job growth and that our innovation performance is highly dependent on their success. Small and medium suppliers are critical to the success of our globally competitive firms and exporters, ambitious entrepreneurs challenge the current business environment, making the status quo uncomfortable and sometimes providing that spark of creative destruction as described by the famed economist Joseph Schumpeter.
Small businesses are indeed the backbone the economy. All of this is true, but much of our public policy is based on an exaggerated sense of the extreme importance of small businesses to our economy and on the need for special support for that sector of the economy. We should avoid overemphasizing their importance and the impulse to favour them in our public policy.
To be sure, businesses with fewer than 500 employees make up more than 99 per cent of our enterprises in Canada, yet larger businesses account for about 40 per cent of our employment. Larger businesses also account for 46 per cent, nearly half, of our economic output as defined by GDP. Larger businesses have a stronger productivity and innovation record, consequently they pay higher wages. No doubt the large globally successful firms of today were once small businesses, but the odds of a specific small firm becoming a global leader in the future are infinitesimally small, like lightening striking the same place twice or winning the lottery.
We hear that start-ups are the engine of job creation but within 10 years four out of five start-ups fail. To be sure, the one-in-five surviving firm, on average, continues to grow, but the net effect is that for every 100 new jobs created by start-ups, only 94 are still around 10 years later.
Our tax system has a preferential inclination for small businesses, from the lower tax rates on smaller firms to the greater tax credits supporting R & D, yet larger firms conduct most of Canada's R & D.
Most of what we think about successful entrepreneurs is inaccurate. Most entrepreneurs who have built Canadian global leaders started their business in their 30s or later and had related business experience, despite a prevailing view in some quarters that entrepreneurs need to start right out of school. Successful entrepreneurs are more likely to be highly educated, not the stereotypical student who is bored with school and has to drop out to support the business growth. Most of our highly successful business start-ups were founded by people with scientific and engineering educational backgrounds but these successful start-ups were built on the basis of customer focused innovation and not new-to-the-world invention. Most of our successful start-ups were exporting in their first five years of existence.
Attitudinal research says that the public admires the small business person more than most other occupations and professions. Every federal and provincial budget includes new measures to support the success of small businesses. Every political party has part of its platform devoted to small business. Yet there is little, if any, evidence that small- and medium-sized enterprises require special treatment in our public policy. Our challenge is to do what we can to improve the odds of success of the tiny number of start-ups that have the drive, ambition and capabilities for larger scale success, our future global leaders.
If we are proposing an approach to public policy for small and medium enterprises, that is based on the premise that a small fraction of these businesses have the potential to grow significantly and become contributors to our innovation, productivity and prosperity. This means we should avoid the overarching policies for all start-ups and smaller businesses; focus instead on creating a supportive environment that breeds success and on eliminating frictions for successfully growing businesses.
We also recommend that government policy continue to pursue ways of supporting specific companies that have a solid chance of success or fostering networks of like-minded entrepreneurs, mentoring opportunities and advice on expansion. We are still doing more research in this area, but some of the recommendations that we will be proposing are starting to emerge. The kinds of recommendations we are considering include the following.
First, continue to support economic policy that promotes innovation and productivity growth in all sectors. Our small and medium enterprises mirror the economy as a whole and are an integral part of its various sectors. They will succeed to the extent our economy succeeds.
Of particular relevance to small- and medium-sized business are policies related to education and industry clusters. If more of our young people pursue post-secondary education, we will improve the quality of our start-up businesses. Governments and educators should work with small business groups to increase the breadth and depth of focused business education and training opportunities.
Public policy that strengthens the environment for industry clusters will also help improve the quality of entrepreneurial start-ups. We should build on current approaches that are customized to specific businesses. In many cases, public policy for small- and medium-sized enterprises is one-size-fits-all. Yet the needs and aspirations of a stable, locally focused small business are much different than an aggressive export-oriented entrepreneur. For politicians and public servants, it is much less risky to design programs for all small and medium businesses, but this has the drawback of spreading scarce public resources too thin. It is riskier for governments to seek out high potential firms and provide tailored assistance to their success.
We encourage governments to experiment in this area, identifying opportunities for assisting specific firms in areas like funding market research, export market development and management training. Our province, Ontario, has tailored programs. We urge that these be monitored closely for expansion opportunities and for relentless pruning where results are not achieved.
Expand government procurement to create opportunities for small- and medium-sized businesses and all businesses. More and better government outsourcing is an improvement opportunity for government service and for the success of our private sector. In areas like customer service, transactions processing, human resources systems and information circulation, governments will find service improvement and cost reduction opportunities to contracting with the private sector. We are not recommending special treatment for domestic firms or for smaller firms; but because of proximity and local knowledge, our domestic firms will have an advantage in winning open competitions for providing these services. Winning such contracts will provide our growth-oriented entrepreneurs with reference customers and valuable experience to support their success.
End the special tax treatment for label sponsored venture capital corporations. This financing vehicle was designed to help growing firms gain access to venture capital. It encourages the average Canada to become a venture capital investor. At the provincial level, where supported by provincial tax policies, it often had time and place requirements. It was a vehicle for reducing taxes, not increasing wealth. In sum, labour-sponsored funds encourage quantity of venture capital but not quality. They are a major part of the reason Canadian venture capital returns have been so dismal over the past decade. Research by James Brander at UBC showed that these special venture capital corporations, and other forms of government sponsored venture capital, underperform in financial returns and in the broader contribution to overall innovation if we use patents as a measure. Douglas Cumming's research indicates that they crowd out private investment. Here, in Ontario, we are ending the special tax treatment of these vehicles and we urge the federal government to do so as well.
As a general principle, make the tax system as neutral as possible. Explore specific changes to help growth oriented small and medium enterprises, though. Our research indicates no good reason for much of the preferential tax treatment given to small- and medium-sized businesses. They are not challenged with market inefficiencies that require government correction, and they do not as a group provide economy-wide benefits for which they are not rewarded.
As other corporate tax changes are implemented, we encourage governments to work at reducing the income tax benefit that small- and medium-sized businesses receive versus larger businesses and to narrow the gap between tax rates for large businesses and small businesses.
At the same time, we are encouraging governments to explore tax changes that promote investments by growth- oriented firms of all sizes, reducing capital gains taxes when firms go public, and lowering the impact of capital gains taxes as barriers to asset sales for entrepreneurs looking to sell their businesses.
In summary, small- and medium-sized businesses are indeed the cornerstone of our economy. They operate in all industries and across all regions. They provide jobs and incomes for a large number of Canadians. However, public policy does not need to provide special treatment and support for them. Large businesses are major employers and, in fact, are critical for our success in innovation, productivity and prosperity. It makes little sense to transfer the resources through our taxing and public spending system from larger to smaller firms.
Our focus with small- and medium-sized businesses has to be on encouraging those firms that aspire to and progress towards becoming large businesses. While some public policy can be specifically aimed at helping such firms succeed, much of our success will come from a supportive environment for innovation and productivity by all our firms and people.
I would be pleased to take any questions.
The Chair: Thank you, Mr. Milway. I am sure there will be one or two questions.
This is becoming a hobby horse of mine. MaRS was our witness last week and they are keen on government matching funds. In other words, they felt that was a way of reinforcing success. The private sector put up the money. It was not the government picking winners, so to speak, but reinforcing success. Professor Cumming seemed supportive of that type of approach. Are you as well?
Mr. Milway: I think it is better than the current options we have with labour-sponsored funds. We have to ask ourselves: Do we really have a shortage of high-quality venture capital in Canada? Do we need government to step in and help enhance that quantity of capital?
I think our challenge is the quality of venture capital. Our venture capitalists have not been very astute at making great investments that are providing great returns, so I would be worrying more about that.
To the extent that government matching gets in line or goes where the private sector has already decided to put the skin in the game, I can see the benefits of that; however, it is not one of the first priorities I would be focusing in on.
Senator Ringuette: Mr. Milway, thank you very much for your presentation. I am not very familiar with your organization. Could you indicate to us the funding source and so forth to do your research?
Mr. Milway: The Institute for Competitiveness & Prosperity, which is the hat I am wearing today, is the primary source of this research. We are an independent research organization, but we are funded almost entirely by the Province of Ontario. We are in business to support the Task Force on Competitiveness, Productivity and Economic Progress, which is chaired by Roger Martin at the Rotman School, and so we receive funding from the province. We develop a work plan as to the research that we want to undertake in a given year, and we proceed fairly independently and report directly to the public. We do not lay out our reports to the minister and in front of the legislature in Ontario; instead, we receive funding and do our research independently and report publicly.
Senator Ringuette: I am quite surprised by your comments with regard to SMEs. We are seeking recommendations with regard to how to increase the level of angel funding and venture capital funding for start-ups and SMEs to foster and help them create, as you said, a supportive environment for innovation and productivity.
All the evidence I have seen so far indicates that the larger corporations in Canada have easy access to capital. They have the big tax credit for research and development and so forth, whereas the start-up has access to none of these funds. An R & D tax credit for a start-up is useless because they are not making any money at that stage. If we want to create a supportive environment for a start-up, how can we do it?
Mr. Milway: I think we can do it with a longer-term approach than trying to put in specific mechanisms. One of the things we find is that the most successful firms are led by highly educated people. The number of successful firms that were started up by people with not just bachelor degrees, but graduate degrees, is something like two times the general level of education in business.
The more we can fund post-secondary education and help and encourage our young people to get an education and stay in school as long as possible, this will help small business. That does not help them directly, but that is the fostering the environment we were talking about.
In terms of helping them with capital, I guess I need to see evidence that there is a market failure here. The market looks askance at start-up firms because there is no track record and the capital that will be invested is at risk. That is our market. That is the way it is.
Where governments have stepped in to try to help fix that, although I am not sure that anything needs fixing — and this is where James Brander's research comes up — the record is pretty sad. The returns from the businesses that have been supported with government-sponsored venture capital are very bad. You might argue that this is okay because we know that these are riskier ventures, but these firms also do a worse job in terms of creating innovation and patents.
Is there a problem that has to be solved? I do not doubt that smaller businesses face a bigger challenge in starting up and getting going, but that is the nature of our system; and the ones that are successful will find a way to get through, and they do get through.
Senator Massicotte: Thank you for your participation. First, let me thank you for your presentation and for your three- or four-pager. It may not directly address our subject matter, which is venture capital, but it does remind us about the facts. I think you have the facts right; 80 per cent of businesses do not last five years. I think it is good for all of us to be reminded to forget all the loose talk; what is the reality of the importance for companies?
Let me bring you back to the subject matter. This committee has a mandate specifically to say we have noticed there has been a significant decrease of venture capital funds. The reason we are concerned about it as parliamentarians is that we associate that capital to be fundamental to the growth of our country and to our economic prosperity. You are putting that in doubt a little bit, so that is a good debate. We are saying it is a lack of capital. The facts also show lack of return. Yes, some are successful, but overall there are very low returns compared to what one would expect, given a risk scenario.
In your presentation and your comments you are saying two things: First, the labour funds have distorted the marketplace, because nearly 100 per cent of return is from tax returns and not from market returns. Maybe that is the reason, and that will get corrected in time.
You are also saying that we do not have very good managers and that most of the venture capital funds are not properly managed, which is maybe motivated by other reasons. We have a managerial problem, you say, combined with an educational problem.
Let us take that argument further. Are you saying we should do nothing? Because we know, as a matter of fact, that there is a shortage of capital, or a significant decrease of capital, and basically no profits.
Is our hypothesis wrong? Our hypothesis is that shortage of capital will affect innovation, growth and prosperity. Is that maybe what is wrong; or do we just leave it as it is, and 10 years from now we find that every innovative firm is elsewhere other than Canada?
Mr. Milway: I think most of the premises are correct. It is true there is a significant decrease in the amount of venture capital that is out there. The same is true in the United States. It is partly because the economy is weak and there is not a lot of capital that wants to be chasing high-risk ventures.
That is the nature of a competitive capitalist economy; the capital comes and goes. We can try to second guess the market and say we are smarter than the market so we will make these investments in venture capital, even though people with their own skin in the game decide that is not what they want it do.
Regarding the results, the record of that kind of assistance is not so good. It is one of those things — is it a problem that government has to solve? It is the reality of the marketplace right now.
One of the things that we ought to be thinking about — we are thinking about it at the institute, and I would encourage you to investigate this yourself — is to what extent is the venture capital model that we all know and love a dinosaur? The U.S. returns have not been so good lately either, so it is possible that venture capital has gotten too big and fat, that it is pouring tons of money into ventures and chasing businesses that should not be capitalized, on both sides of the border. We are worse than the U.S., but the U.S. venture capital returns these days are no great shakes either.
We have been wondering about micro-ventures; ought the venture capital industry be thinking more about smaller, targeted, focused, bootstrap investments rather than the large traditional venture capital investments? Maybe the whole venture capital model is broken and it cannot be fixed. It is something we are wondering about ourselves at the institute.
The other thing I would say about the labour-sponsored funds is not so much that they are distorted, I think they are just bad. They are badly designed vehicles for bringing venture capital to innovative entrepreneurs and to harness innovation in Canada.
They bring in retail investors, when the kind of investor you want in venture capital is a smart, sophisticated investor. They encourage tax breaks when not generating wealth. Then when they are applied at the provincial level, there are a lot of restrictions on them: you have to invest them here in Ontario; you have to invest them by the end of this quarter or by the end of this year, because a lot of them are just sitting on the cash. I am maybe harping on it too much, but I think they are a badly designed vehicle; never mind the distortion, they are just bad.
Senator Massicotte: It is very good; you are even questioning if there is a problem. Maybe it is just the normal dynamics of the marketplace.
Let me jump to the big picture. I saw some tables recently relative to innovation in the world. It compares different countries — Canada, predominantly the U.S., England and so on. We always compare things to Silicon Valley and the Googles of this world, but if you look at what people call innovative firms, the United States has a significant number of leading worldwide innovative firms compared to Canada and many other countries.
A lot of us for the last 20 or 30 years have tried to find a formula to replicate that, which would cause economic growth, employment and so on. What is your assessment? Are we chasing a dream? Is there something special there we should not even try to duplicate? Is there something wrong with us?
Mr. Milway: It is a good question. In Ontario for our work, we pick the 14 largest U.S. states to say here is who Ontario should be comparing to, and they are all more prosperous, innovative and productive than Ontario. We are talking California, Massachusetts, Texas, Michigan, Ohio, et cetera.
In that group of peer states, the only two that are ahead of everybody — they are ahead of the whole world in venture capital — are Massachusetts and California. In Massachusetts, it is Harvard-based bio-medical and MIT high- tech venture capital, and in California it is Silicon Valley.
However, a state like Pennsylvania — a humdrum state with decent prosperity in the scheme of things in the U.S. — is more prosperous and productive than Ontario. It pays higher wages than us and is more innovative, yet we have probably as much venture capital in Ontario per capita, per GDP, as they do.
Part of the question for all this is should we be looking at the U.S. or are there two places in the U.S. that are totally different than the rest of the planet — Silicon Valley and Massachusetts — and that is the way it is? We have great hockey players; they have great venture capital in those two places for a long variety of historical reasons, and we should be careful when we compare ourselves to them or aspire to those results.
I am not saying do not aspire, but they are different; they are perfect storms that have created super markets and super sources of venture capital. I do not know if that answers your question.
Senator Massicotte: You are basically saying, like all of us, that they are phenomenal examples of growth. Many countries tried to replicate that, unsuccessfully, and what you are saying is do not even give it a try because it is probably impossible. We can talk about it for 30 or 40 years. There is probably a lot to learn, but it is not an easy one. It is not one that will be copied and replicated easily, I suspect.
Mr. Milway: In some sense, I am being quite negative and destructive here. I am saying what we have tried so far does not work, so let us stop doing that.
I wish I had a list four things that if you implement this tomorrow, Canada will be the source of all venture capital and all innovation. I can only tell you that a lot of what we are doing does not work and a lot of it is based on the misdiagnosis that we need more venture capital, not better venture capital.
The Chair: I think that sums up your view very clearly.
Senator Tkachuk: From a public policy point of view in Canada, we focused on small business because we denigrate large businesses politically. Part of the problem is a cultural problem in Canada. The reason we have good hockey players is because we want our children to aspire to be good hockey players. We work hard at taking them out to practice every morning and making them work hard and saying that is important to their well being.
We do not do that in business. I think the success of the American model is because they did the opposite. Recently they have been having a little problem with that, but I think they might figure it out.
I am not sure a government should do anything except treat all businesses the same; have the same tax rate for business; treat business as a proud and wonderful place for people to go to; have universities not denigrate business, which a lot of them do; and produce great engineers, great doctors, great research, great scientists and all the people who will create wealth.
We know instinctively what creates wealth. I do not know whether there is any research on that, but I do not think it is that complicated a question.
I invested in the union venture capital funds and I do not even like unions. I invested for the tax credit; it had nothing to do with venture capital. As soon as you do stuff like that, people invest for all the wrong reasons. Of course, the reason they got the money was because of the tax credit, not because it created any profits.
We knew from years ago that it was not going to work, but we continue to do it. I agree with you on that.
There have been a number of books and studies done on that and the creation of success. For instance, one topic is how you get kids out of the ghettos in the States, and they have a list of reasons: get a high school education; do not get pregnant; do not take drugs and you will get out of the ghetto. It is not that complicated, right? Do not invest in labour funds.
I will let you comment on that, but I would like to discuss this because I think it is something our committee should talk about a little more.
The Chair: Senator Tkachuk is never provocative, as you can see.
Mr. Milway: I think you are right. As I said in the opening remarks, we have a love affair with small businesses. My father was a small businessman; most of us know small business people. This is not in any way to denigrate small business people or to say that large business people are the source of all good. It is simply to level the playing field. There is no evidence academically or even anecdotally that small businesses are somehow affected by market failure. From the economist's perspective, government intervention typically comes in when the market is not working the way it should. There is very little evidence that the market is not working the way it should with respect to small business.
Every time we have a discount on the tax rate for small business, it means we have to raise the tax rate on larger business, and I am not sure that leads to a good allocation of resources. I do not see why we should be punishing success.
Senator Massicotte: You raise a very good question. On the education side, we all know, unfortunately so, that the culture of the family is a great determinant as to whether kids go to university or not. It is not financial; it is the culture and the role model of the parents that dictate the probability of going to university.
Some countries talk about entrepreneurship. We do have a highly educated workforce in Canada as compared to many countries. Maybe we do not have, as Senator Tkachuk referred to, an entrepreneurial culture. It is true that in many circles, we diminish the value of business owners. If you look at the polling, unless you are a small business owner, you are sort of frowned upon as if you were a crook or a capitalist or whatever you want to call it.
I wonder if it is not a cultural problem within families. It is true Americans are more pro-business. Most Americans, as you know, must travel to go to a state university. They leave home; therefore, they have already made the sacrifice to move to where the school is, whereas we are more sedentary. Is it a cultural problem? Maybe we are just not pro- business enough.
Mr. Milway: I am not sure it is a cultural problem. We did some research a few years ago with Allan Gregg where we looked at the attitudes of Ontarians. This was Ontario research compared against the large states I was referring to earlier. We looked at things like whether the average Ontarian is more or less risk-taking in attitudes in what they would say over the telephone in a survey. This was not like putting probes on them and investigating that way; it was determining how questions were answered.
Americans and Ontarians answer questions very much the same way. For example, you inherit $2 million; how much would you put into a mutual fund? How much would you put into bonds? How much would you invest in a new business? Americans answer about the same as we do.
Or if you ask, is it a good thing to be competitive in business? Is it a good thing to be competitive with your next- door neighbour for having the nicest house? We answer pretty well the same as Americans. Both of us like small businesses as much as each other. Small businesses are the most popular; everybody looks to small businesses as the great people in both countries.
Where we differ is in our attitudes towards education. Americans have a much more positive attitude towards education than we do. If you ask an American, what is the highest level of education a kid should receive today? The biggest response is a graduate degree. You ask the same question to an Ontarian, they would say a technical diploma, not even a bachelor's degree.
The Americans value an education more than we do, and that is about the only significant attitudinal difference we found relative between the two countries.
I think you are absolutely right that it is in the family and to what extent the family promotes education. It comes back to the fact that our small businesses will be more successful if the founders are better educated. In fact, our big businesses will be more successful to the extent their managers are better educated. We are big believers in education, but we do not think it is about Canadians being wired differently than Americans.
What would be helpful on this front is if we could instil more competitive intensity in our markets. A lot of our industry sectors are still devoid of competition from abroad. There is nothing like competition that will force you to innovate, or someone who is threatening your existence.
The Chair: It is interesting, Mr. Milway, that if Americans value higher education more than we do, that they notwithstanding pay more for it.
Mr. Milway: Yes, they pay more for it, but I think research after research has shown that the cost of education is not a big deal. It is important, but there are many other important things that determine whether or not a young person goes on to university, such as family structure and family support. All those things can overcome any income disadvantages that are there.
Senator L. Smith: I was hot on that educational question for you because in Quebec, as an example, we have a dropout issue that has been well-documented throughout the country. Some years ago, between Ontario and Quebec, I think the Ministers of Education got together and they put a bet on that within 10 years, both provinces would have an 80 per cent graduation rate from high school within a cycle of five to six years. After 10 years, apparently Ontario succeeded. Both were at 69 per cent at the time, but Ontario went to 80 and Quebec is still at 69. It goes back to the question of culture.
If we agree that education is critical, how do we provide incentive to parents and create the cultural shift? Does government have a role in that? Do we have to become cheerleaders? How do we incent people, especially in Quebec? As an example, we have such a social culture there are 2 million people in Quebec who do not pay income tax. There is no question that in Quebec alone the biggest challenges are poverty, education mentality and how to change that because we have so many opportunities in front of us with resources, et cetera. Unless we can create a mind shift, I do not see how this will necessarily occur. What do you think the government can do to create some of that?
Mr. Milway: I think cheerleading is one of the ways that could help. I think our premiers and our members of Parliament at every chance they get should tell young people that for a successful future, education is important. Our leaders, both political leaders and business leaders, should be getting the message out to our young people that education is important.
As we go through worrying about our deficit situation federally and provincially, the temptation is to cut education. That is what we did the last time we went after deficits in the 1990s. I caution against deficit-cutting that is only on education. I think education is an investment in our future.
In addition, I think provincial Ministries of Education, colleges and universities need to be thinking about creative ways of teaching and program delivery. I am no expert in this area, but there are a lot of kids who just do not do well in the traditional academic setting.
To the extent we can find different pedagogy and different styles of teaching, that is something we ought to explore because a lot of our kids are not going on and they are falling through the cracks. It is such a tragedy at both the individual and societal levels, a kid who drops out of high school and does not go on to post-secondary education. That is a loss for all of us. We ought to be figuring out ways to help and encourage the kids who do not learn the traditional ways to move on to more advanced levels of education.
Senator Oliver: As you know, the study that we are doing is called financing small- and medium-sized enterprises, venture capital and other support for research and development. Your real expertise and what you do on a daily basis for the province of Ontario is competitiveness. I would like to know, in terms of competitiveness and the use of information technology, what you would recommend that we look at in terms of financing for small- and medium- sized enterprises. Would you say that the government should be saying and doing certain things with respect to information technology to improve our competitiveness? What other things do you recommend we do to help these small- and medium-sized businesses? That is your core expertise.
Mr. Milway: I will give an answer similar to the one I gave on venture capital. It is education and tax rates. On the tax rates, until now, until what the federal government has been doing and what is being followed in the provincial governments like Ontario, until recently, Canada has been one of the worst jurisdictions in the world for making new investments in technology, or in anything for that matter. We taxed very high with corporate tax rates, federally and provincially. A lot of provinces applied the sales tax. We even had the capital tax. There was that disincentive built into our system until a few years ago in Canada that discouraged people from making those investments. I think what the feds and the provincial governments have done, especially here in Ontario and in other provinces, will help solve that problem, because our businesses do under-invest in information technology.
The other way we can get at that, and again this is not a short-term fix, is education. The research Stats Canada has done shows that where you get the most beneficial returns from technology is where you do the more complex or complicated installation. It is not just a matter of automating your receivables list or your sales call list; it is a matter of changing the way you do business and using technology as an enabler to do that. That requires managers who know their way around, and one predictor of that is education. We do know that small and medium enterprise managers are less well educated than large business managers. We are significantly less well educated at the managerial level than our U.S. counterparts. Again, this is not a short-term fix. We just have to keep working and, in the long term, the benefits will be there.
If I knew how to help small businesses make good ITC investments that got great returns, then I would certainly be proposing that, but we have to work on the quality of our managers at the small business level and, for that matter, at the large business level as well. I do think the tax changes that we put in place federally and provincially will help.
Senator Oliver: The government's current plan is to continue to reduce taxes, so we are on the right track.
Mr. Milway: I think so. We could reduce taxes more if we levelled off the small- and medium-sized firms' tax rates. Currently, large businesses pay more. Is the glass half empty or half full? Large businesses pay more than they need to because small businesses are getting the break.
Senator Massicotte: How much money is that? Do you know?
The Chair: The picture is frozen again.
Senator Oliver: Can you hear us now?
Mr. Milway: I can hear you perfectly, but your picture is frozen.
The Chair: So are you.
Senator Massicotte: You are saying everyone should be treated fairly. There is a strong argument there, and we can believe in that. If you reduce the advantage that small businesses get, you could reduce the large corporate. How much money is that? Do you have any idea what impact it would have or what percentage the activist income a large company would pay as a consequence?
Mr. Milway: No, I do not. I do not have a number. I do not know how much. If you move small business up and large business down to equalize, I honestly do not know how much we are talking about, but I would be pushing revenue neutrality to the extent that you lower one, you raise the other. Realistically, no government will raise the tax rate on small businesses. I do not see anyone that suicidal. However, I have seen it happen in some provinces that, as governments decide they need to cut corporate rates, they cut more in the large firm than the small firm. Over time, the two will converge. That is a long-winded answer to your question. I do not know the amount of dollars we are talking about.
The Chair: Mr. Milway, thank you. Your picture may be frozen, but certainly your mind is not, and we appreciate it.
Mr. Milway: Thank you very much.
The Chair: We are sorry for the short notice.
Colleagues, that brings our session to a close. Tomorrow morning, at 10:30, we will welcome two representatives from Deloitte who will be talking to us about their work The future of productivity: an eight-step game plan for Canada. That should also be very interesting.
(The committee adjourned.)