INDY Committee Meeting

STANDING COMMITTEE ON INDUSTRY

COMITÉ PERMANENT DE L'INDUSTRIE

EVIDENCE

[Recorded by Electronic Apparatus]

Tuesday, June 16, 1998

• 1519

[English]

The Chair (Ms. Susan Whelan (Essex, Lib.)): I will call the meeting to order.

Pursuant to Standing Order 108(2), this is a study on information technology and preparedness for the year 2000.

• 1520

We have the Insurance Bureau of Canada before us today as witnesses for our discussion on preparedness for the year 2000. We're very pleased to have Mr. Alex Kennedy, executive vice-president, general counsel, and corporate secretary; Mr. Mark Yakabuski, director of government relations; and Mr. Wayne Thorpe, vice-president, commercial lines underwriting, Dominion of Canada General Insurance Company.

I welcome you all today. I believe that you have an opening statement. We'd like you to begin with that before we go to questions.

Mr. Alex Kennedy (Executive Vice-President, General Counsel, and Corporate Secretary, Insurance Bureau of Canada): Thank you very much.

The Insurance Bureau of Canada is the national association of the private property and casualty industry. It's a self-funded organization whose members represent in excess of 85% of the general property business written in Canada.

IBC took steps early in 1997 to draw to the attention of its member companies the fact that they are rarely, if ever, going to encounter a problem that is so deceptively simple, but which has such widespread power and scope for economic disruption as the year 2000 problem. The loss potential from the year 2000 problem makes the ice storm losses pale to insignificance by comparison.

I think the recent publication by the Canadian Bar Association of its paper, Countdown to 2000: The Legal Issues, will be very helpful to business. This is one of the best papers we have seen so far as analysing the problem is concerned. It makes a very comprehensive list of the issues that need to be looked at, and anyone who is serious about understanding the complexity of this problem will want to access this paper.

The task force of senior executives appointed by Mr. Manley made two specific recommendations dealing with insurance. The first one was that the insurance community should provide its corporate clients with early notification of the importance of the year 2000 issue and the requirement of the availability of a formal year 2000 plan. The second one was that the industry should make the issuance of the renewal of a policy contingent on the availability of a formal action plan.

While these were helpful suggestions, quite frankly, the idea that insurers would have some way to assess such action plans is at best problematic. It would require us to know about the internal workings of the systems of a company than the IT people in the company itself know, so I don't think it's a realistic expectation. Nevertheless, it did help to galvanize our industry around the issue, and the question of early notification is, I think, paramount. It's very much the message that we've been conveying to our own members.

Within our association, we are responding to the task force recommendations and the concerns of our members regarding potential coverage and exposure issues. I'd like to outline briefly for you what we have done and the rationale for it.

Insurance is intended to respond to accidental losses. Computer date-recognition problems, which in fact involve operating issues that have been or should have been known to business and their suppliers for many years, simply do not qualify in most people's view as fortuitous events.

That said, it's important to understand why we didn't simply recommend a blanket exclusion of coverage. That would have been the very easy thing to do. Such an action could, and probably would, be seen to be in contravention of the Competition Act.

Section 45 of the Competition Act effectively prohibits companies from getting together and agreeing not only on the price of a product, but also on the terms of the product, such as an exclusion of coverage if this is going to lessen competition unduly. If we were to come forward to the industry with one wording excluding all covered and were to actively participate in ensuring that companies follow that approach, the likelihood is that if that approach were implemented in any part of Canada where a reasonable number of companies in the market adopted the approach, it would be interpreted as a breach of section 45.

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The other section of the Competition Act of particular concern to us is section 49. This is a section that is specific to federal financial institutions. It provides that every federal financial institution that enters into an agreement with another federal financial institution with respect to the kind of service to be provided to a customer, and every director, officer, and employee of that federal institution who knowingly makes that agreement, is guilty of an indictable offence, and the penalties are pretty severe. Unlike section 45, section 49 has no requirement about lessening competition unduly.

The effect of these two sections is to make us, in most cases, pretty cautious about what we do. What is imperative in the current situation is that coverage decisions with respect to date recognition problems have to be made by individual insurers acting on their own.

We're addressing the year 2000 issue in two key areas. First of all, we've developed an educational campaign to inform businesses that their insurance contracts cannot be expected to automatically cover computer date recognition losses. The first stage of that campaign is actually getting off the ground tomorrow, with some adverts in some of the newspapers. We've also produced some pamphlets, which will be made available to small businesses and others through our broker community and through the companies themselves.

Secondly, we've developed optional model wordings for our standard commercial property and liability insurance policies to clarify coverage limitations. We as an association have never developed wordings on directors' and officers' liability insurance or on errors and omissions insurance, so we're not offering any advice to our member companies on these forms.

We've also developed a questionnaire, which I'll mention later.

We did a survey of insurance companies to identify activities that would help their efforts to achieve year 2000 compliance for their own computer systems. User group meetings were held as a means of sharing information, and these have proved to be quite helpful. I believe another meeting is planned for early in 1999 to see how companies are progressing with compliance.

Because of the important role of agents and brokers in encouraging their business clients to take preventative action as soon as possible, we included a representative of the Insurance Brokers Association in our committee. And from the outset, we have been at considerable pains with our own members to let them know that as an association, we cannot solve their problems; all we can do is draw attention to the potential exposure.

Our committee decided very early on that the industry was faced with a unique opportunity to develop a risk assessment tool that could be used by both brokers and underwriters to identify year 2000 exposures and to educate policyholders. This tool is a questionnaire that asks for generic types of information, and if it's properly completed, an underwriter looking at it should be able to determine whether the business is well organized and has matters under control or whether it hasn't. For both the insurer and the broker, it's an opportunity to better know the risk and to better know the customer.

The questionnaire can be used as part of the policyholder's education effort, and it helps to determine if the year 2000 issues will impact on the business risk. Because of the fact that a client's business may be placed with several insurers under subscription policies—and this is particularly the case with commercial risks—and because of the work involved in having to obtain completion of different questionnaires for each insurer in a timely manner, we were looking for a questionnaire that would find wide acceptance in the marketplace. We believe we have come up with this.

Our committee has developed endorsements to add an exclusion to current wordings, and as an alternative we've provided policy wordings in which the exclusion is incorporated, supplemented by endorsements to delete or amend the exclusions. For property clauses there are alternative choices for the circumstances in which the exclusion will not apply. Our committee is presently completing the development of endorsements and wordings for our remaining policy forms and having them translated. Our members have been made aware of their availability.

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We quite recently held a seminar in Toronto, which attracted a large number of people. The wordings and questionnaire were introduced at that meeting.

The Office of the Superintendent of Financial Institutions and some of the provincial regulators have been in touch with insurance companies under their jurisdiction, asking about their plans to deal with the year 2000 issue. TRAC Insurance Services, a leading insurance rating agency in Canada, has also been asking companies about their plans. So it's fair to say the industry is very much aware of the problem and is acting responsibly to try to deal with it.

If we can leave one message with you, however, it's that insurance isn't the solution to the year 2000 problem. Our members will do what they can to put their own houses in order and to alert their insureds to the risk, and for those who can afford it, some coverage may be available, but business should not be looking to the insurance industry to bail them out with the year 2000 problems.

Thank you.

The Chair: Thank you very much, Mr. Kennedy.

We're going to begin with questions from Madame Lalonde today.

[Translation]

Ms. Lalonde, please.

Ms. Francine Lalonde (Mercier, BQ): Thank you for your presentation and for sharing your concerns. Could you tell us about this risk assessment tool you introduced at the seminar you held in Toronto? You say it's one of the best services you can offer. Could you tell us about it?

[English]

Mr. Alex Kennedy: The questionnaire is designed to obtain as much information as possible about the nature of the risk so the underwriter and the broker can assess whether the applicant for insurance, or the insured in the case of a renewal, has taken steps within his control to do what should be done with the year 2000 problem.

Mr. Thorpe was the chairman of our committee. He may wish to add something about the nature of that questionnaire.

Mr. Wayne Thorpe (Vice-President, Commercial Lines Underwriting, Dominion of Canada General Insurance Company; Insurance Bureau of Canada): The questionnaire is designed in two parts.

The first part of the questionnaire is somewhat technical. It goes through the process of trying to find out whether their computer systems are adequately changed to comply with year 2000 recognition of date. It asks questions about embedded chips. If they're, for instance, a manufacturing plant that has robotic equipment, there are a lot of embedded chips in that type of equipment. So the questionnaire is designed to tell the underwriter what equipment is in those types of facilities and what the business owner has done to make sure his equipment is in compliance with year 2000.

The questionnaire then goes on to ask questions that will allow the underwriter to decide whether or not the risk is insurable, because of the basis on which the business has been compliant. It will allow the underwriter to either say “Yes, we will insure that risk, because we are satisfied that the business is year 2000 compliant” or “No, the risk is such that it is not insurable, in our view”.

[Translation]

The Chair: Ms. Lalonde, do you have another question?

Ms. Francine Lalonde: Yes. I don't find your answer reassuring; on the contrary, it raises more questions. As far consumers are concerned, be they businesses or individuals, the important thing is to make sure their policies cover the risks. In your presentation, you say that for you to try and eliminate the risks is out of the question. In any case, you don't have the right to do it.

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Now you tell me that the questionnaire is intended to check whether the risks are insurable. I'd like you to explain what you mean by that because it is not an answer, rather, it raises more questions.

[English]

Mr. Wayne Thorpe: First of all, it should be understood that our insurance policies never were intended to cover year 2000 events. Year 2000 is not an accident; it's not a fortuitous loss. It is something that has been known within the community and within industry for at least a decade or two. So there is no coverage under insurance policies.

The committee has put an awareness campaign together to sensitize business owners that they cannot rely on their insurance policy to cover a year 2000 loss and that they should take steps to mitigate that loss. The questionnaire will at least alert them to the fact that they have a problem and that they should try then to solve that problem and mitigate the loss. So the questionnaire, in our view, is helpful not only to the insurance industry but also to the individual business consumer as well.

The exclusions—the additional language we've put in our policy wordings—are simply to clarify the fact that there is no coverage for a problem arising out of a computer not being able to interpret a date. So the policy has really clarified the intent that there was no coverage there to begin with.

[Translation]

Ms. Francine Lalonde: I was not expecting that kind of answer. Obviously, people should not wait and rely on their insurance coverage, because we know how disastrous it would be in terms of production and services. So nobody has any interest in waiting.

I'm going to get a little more precise. Some people could think that they have done everything they believe is necessary to get ready for the year 2000. Even in these circumstances, they would not be covered by their policy? What's the use of having insurance then?

[English]

Mr. Wayne Thorpe: Well, there is a possibility that there may be some coverage under the liability policy. It will be interesting to see how the courts interpret the policy wordings. If someone has done their utmost to fix their year 2000 problem and thinks they have mitigated their loss, and through some third-party source their system goes down, it may well be that the court would take that situation as being accidental and there may be some cover.

What we see coming out of year 2000 is that a lot of litigation will be commenced, as we feel many lawyers—certainly the plaintiffs' bar—will challenge the policy wordings to see whether or not cover will be available. But the intent, again, is that most policies will not cover a year 2000 event.

The Chair: Thank you.

Mr. Murray.

Mr. Ian Murray (Lanark—Carleton, Lib.): Thanks, Madam Chairman.

Gentlemen, thanks for joining us this afternoon. It just struck me, as we were talking about this question of what is accidental and what people should expect, that some of your member companies may find that they thought they were year 2000 ready and then find their systems crashing. If that were the case, I wonder how they would then react to others who thought they were also ready. That may be more a question for the courts than for the insurance companies.

I want to ask you about what areas you think will be problem areas for the insurance business. For example, say security systems in people's homes and businesses fail to function and there's an increase in successful break-ins as a result. Is that an area in which you may be projecting increased problems for the industry?

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Mr. Wayne Thorpe: Yes. That is one area of activity that we see as being a problem. There are a number of things. Anything that carries an embedded chip, such as a smoke alarm, fire alarm, or burglar alarm system, could be vulnerable to a year 2000 misrepresentation of date problem. So again in those circumstances the direct loss that was created by the computer and the loss to the equipment itself would not be covered. Some insurers will pay for the damage as a result of a break-in.

Policies are designed in such a way that should a system fail today there would still be recovery for the resultant theft in that particular building but there wouldn't be any coverage for the system itself. So there will be circumstances where there will be some resultant damage covered.

The wordings designed by IBC are flexible enough to exclude year 2000 activity totally or allow member companies to add back in main perils coverage, so they could add back in riot, vandalism, and malicious acts as an example. They could add back in theft and those types of things. And of course under the act there is coverage for resultant fire, explosion, or lightning. So should a sprinkler system fail to work and there was a fire, the resulting fire damage to that particular plant would be covered no questions asked, because that's in the statute.

Mr. Ian Murray: In other words, you do insure against technical failures at present, and we're talking about one potential technical failure here that insurance companies aren't comfortable with in terms of making projections. Do you anticipate that this could involve lengthy court battles, with insurance companies being in court as a result?

Mr. Wayne Thorpe: We anticipate that there'll be a substantial amount of litigation as a result, because I think there will be lawyers who want to test the words, to see exactly what they mean. That is not unusual. We have that experience on a daily basis in settling losses. What we foresee, though, is that while there may not be a lot of insurance dollars spent on actual loss, the industry will experience an increasing cost for litigation.

Mr. Ian Murray: So we could see insurance premiums going up rather substantially as a result of this after the year 2000 sometime. That's something we might be able to anticipate?

Mr. Wayne Thorpe: That's a possible scenario, although the industry is somewhat fragmented. The largest insurer only writes 11% or 12% of the business in the country, so there are several insurers, a number of insurers, and the marketplace normally is very competitive. So unless the industry saw a horrendous loss coming out of this event, I wouldn't anticipate the rates going up substantially.

Mr. Ian Murray: I suppose that's because what Mr. Kennedy talked about in his opening words, when he said the year 2000 problem will make the ice storm losses pale to insignificance by comparison. In other words, you're anticipating probably a very substantial claim result.

Mr. Wayne Thorpe: Yes.

The problem we're faced with is the insured losses may not be as great as some of the additional costs in defending and/or adjudicating some of them. If that expense got to the point where it indicated we needed to have a rate increase, then the industry, sure, would probably take some rate increase.

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We're talking primarily of commercial risk rather than personal risk, although should a public utility have a problem, Ontario Hydro as an example, then I think we would be into a situation not unlike the ice storm, because it's January 1 and in Canada January 1 is very cold. If there was some interruption within provincial power sources then we could see some substantial loss due to sewer back-up because sump pumps cease to run or food spoilage because freezers were not operating, those types of things. That's just a scenario. Who knows if that will happen.

One should ask the question of the provincial utilities as to whether or not they are going to be year 2000 ready. I think that is going to be a major problem.

Mr. Ian Murray: We've done that.

Mr. Mark Yakabuski (Director, Government Relations, Insurance Bureau of Canada): To elaborate, there's no doubt that there could be some additional costs as a result of the year 2000 problem after January 1, 2000. Those could have some incidence on insurance costs, as would a whole number of factors. We don't know how much, in the end, the ice storm will affect premiums. It's too early to tell. There are so many factors that go into establishing insurance rates. There's that to consider. There's also the fact that one way of reducing the incidence of year 2000 is by being proactive now and by designing the questionnaire that Alex Kennedy talked about, by having insurers sit down with businesses at this time and apprise them of the risks with which they have to deal. This is a way of perhaps avoiding some of those costs.

Tomorrow in the Globe and Mail and the Financial Post we will be running ads from the Insurance Bureau of Canada sensitizing businesses to the year 2000 risk and advising them that they should talk to their insurance agent or broker. We think this is a way of reducing some of those costs on the front end.

Mr. Ian Murray: Thank you.

The Chair: Thank you very much, Mr. Murray. Mr. Schmidt, please.

Mr. Werner Schmidt (Kelowna, Ref.): Thank you, Madam Chair.

Thank you, gentlemen, for appearing here today. It's good to see you again.

I have a couple of questions. The first one has to do with the testing. Unfortunately, I was late; I didn't get here on time. I thought the meeting started at 3.30. But that's an excuse. Actually, it's a reason too. I guess I should have known. Nevertheless, the testing issue is probably the most complex and the most time-demanding thing in this whole operation. I want to ask you two questions with regard to testing, and there's another question following that.

Your brokers and your insurance companies—there are two groups here—have you asked them to test their equipment?

Mr. Alex Kennedy: I think it's fair to say that we have been in touch with our member companies. We've no direct relation with the brokers. Mr. Thorpe can probably speak to that more directly than I can. The companies are certainly on notice. Most of them will be issuing the policy renewals that they issue in October, which will have an expiry date in the year 2000. So they will want to ensure by October that these things are in fact year 2000 compliant. I am quite certain that companies will also be asking their brokers very specific questions on this as well, but Mr. Thorpe can maybe speak to that.

Mr. Wayne Thorpe: As an individual company, we've been working on our year 2000 issues since the fall of 1996. We need to be ready to issue policies with expiry dates 2000 at the end of October of this year. We expect that will happen with no problem. That's our system side. On the business enterprise side we have made changes to our policy wordings that have been previously described.

The last thing we have done is gone to our suppliers, who are our brokers, and asked them if their systems are year 2000 compliant and to give us a status report as to whether they are. We've asked our reinsurers the same question. In fact we will ask any company that we do business with, either from an outsourcing point of view or that supply us with product, whether or not they are year 2000 compliant.

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Mr. Werner Schmidt: I think that's very commendable, but that's not my question. My question is have you established a test, and do you know what the tests are?

I can tell you all kinds of things. You can ask me whether I am year 2000 compliant, and I'll say yes, I am. How do you know that I in fact can tell you with authority that I am ready? I can go through your questionnaire, but that still doesn't tell me anything. I want to know what the test is you apply to make sure that you in fact are ready, and do you ask for those results?

Mr. Wayne Thorpe: The test in our own case is that we have to go in and change every line of code we identify that has a date sensitivity. So it's a horrendous problem. In our own case we have gone out to a consultant. They have been working with us since that period of time. We have inventoried our lines of code as to which ones will create a problem, and we then set about testing them and fixing them.

First of all we do the inventory. We put a strategy together as to how we would test them, and then we actually do a compliance test. We convert the code and do a compliance test to satisfy ourselves that we're compatible.

Mr. Werner Schmidt: That's good. Do you ask this of all your other companies as well?

Mr. Wayne Thorpe: We don't ask that specific question.

Mr. Werner Schmidt: Why not?

Mr. Wayne Thorpe: We assume, when we ask the question of whether they're compliant, that they've gone through this exercise.

Mr. Werner Schmidt: Do you know what happens to people who assume in this business? I mean, really—let's get serious here. The thing could collapse on January 1, 2000, or December 31, 1999, and we assume things. Gentlemen, I'm not a bit impressed with assumptions here. We have to know.

Mr. Mark Yakabuski: One of the things that is happening, which Alex Kennedy referred to, is that there is a rating agency, TRAC Insurance Services, which rates insurance companies, both life insurance companies and property and casualty insurance companies. They have been doing extensive surveys of all of the insurance companies in Canada and associates in the United States and elsewhere. If companies are misleading major rating agencies, they're going to have to answer for some big stuff. I don't believe they are.

Those surveys have shown, as did the government's report of Task Force 2000, that of all the industrial sectors, the financial services sector was by far the best prepared to date for the year 2000 problem. While things are not perfect, the TRAC surveys do show that the level of compliance in our industry is among the highest of industries in Canada.

Mr. Werner Schmidt: Madam Chair, may I indulge the committee with a paragraph here that I found extremely unsettling?

According to the Gartner Group, the percentage of companies that are likely to experience failures of critical systems is between 30%-50%, up from 10% in 1997.

In other words, the problem is getting worse, not better.

Because of such failures and related Year 2000 costs, Gartner Group believes that there is a 70% chance of a global economic downturn. Dr. Edward Yardeni

—who I'm sure you've heard about before—

believes that there is a 60% chance of a global economic recession. Whatever the case, time is running out! According to Fortune Magazine (May 25, 1998), “the latest Information Technology Association of America (ITAA) survey on the Year 2000 software conversion found 44% of respondents have experienced Year 2000 failures under actual operating conditions and 67% have reported failures under test conditions...[the ITAA is] urging all organizations to make Year 2000 the top priority to assure smooth sailing over the century dateline.”

It's this kind of thing that causes me to question. I thought we were doing very well. In fact, as things were progressing in this committee, I thought we were doing better. Now I get something like this, and I say to myself, just a minute now; have we been given a bill of goods here as a committee? Do the people just tell us that things are good so we'll shut up and won't put people to the task of answering tough questions, or is it really as serious as this? Because this says that with less than 18 months to go, we are about half ready.

Mr. Mark Yakabuski: One of the things I've heard is that it all depends what you define failure as. There may be some area where there might be failure. Now, the 30% to 40% failure rate you're talking about—is that a massive failure, or just a minor failure of the companies' systems? Whether it's a massive or a minor failure is very significant as to what the consequences are.

Mr. Werner Schmidt: You're absolutely right. Sure.

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Mr. Mark Yakabuski: I think most people, frankly, are hedging their bets out there. They are not willing to say they are completely year 2000 compliant because of the risk of saying that, since some failures are simply not possible to predict. But among many companies there is a level of comfort. I think some of the problem might be how failure is defined.

Mr. Werner Schmidt: I agree. My concern is not to say you fellows are not telling us the truth. That is not my point at all. My point really is to emphasize with you and everyone else the necessity of telling people they have to test their systems.

It is not good enough to fill out pages of questions—have you done this, have you done that? Did you get inventory? Do you have the one million or ten million lines of code identified? The point is, do they work after they are identified, after the rectification is done or the replacement or whatever the case might be? That becomes the key question. Right from the beginning, we have had difficulty getting that question answered. You are not testing, either.

Mr. Mark Yakabuski: But you have to build incentives into the system. We cannot go in and insist that a company test. We have no authority to do that. But if a company knows there's no blanket coverage for year 2000 losses and they know those losses might be considerable, if you are a business person and you know insurance is not going to cover these losses, is there not a very strong incentive to do the testing you are talking about?

When your insurance broker or agent sits down and goes through this with you, you must be a senseless fellow if you do not actually take heed. As part of the process, we are building incentives that should work toward the goal you are trying to accomplish.

The Chair: Last question.

Mr. Werner Schmidt: Madam Chair, yes. I agree, and I will quit with this.

It seems to me that you are a very community-responsible organization and that you care about people. I think it would be a simple question that could solve the issue: Did you test? Are the tests available? Those are very simple questions.

Mr. Alex Kennedy: Yes. In response to that, I think most companies that are working with this problem are trying to prioritize the issue. There are some issues that have to be dealt with.

Mr. Thorpe referred to the policy renewals that are going out at the end of October. It is imperative that they be tested and that that is working. There are other areas that can wait until nearer the time, and I think most people are probably going through that process.

The Chair: Thank you very much.

I will now turn to Mr. Lastewka, please.

Mr. Walt Lastewka (St. Catharines, Lib.): Madam Chair, thank you. I want to hit this in two areas, one to follow up Mr. Schmidt.

Is TRAC Insurance Services tracking Y2K compliancy? Do they have a report out?

Mr. Wayne Thorpe: They have a report out on behalf of the property and casualty industry, and I believe also the life—

Mr. Walt Lastewka: Could we have a copy of that report?

Mr. Mark Yakabuski: Yes.

Mr. Wayne Thorpe: We can probably try to get it for you. I mean, it is TRAC's report. It is obviously not our report. Having understood that, we can probably get you a copy of it.

Mr. Walt Lastewka: Madam Chair, I would like to have it recorded that we get a copy of that report. If there are any problems in our getting it, we will deal directly with TRAC.

Mr. Mark Yakabuski: We will try to get it for you. Again, some of this surveying is ongoing, because the issue is not—

Mr. Walt Lastewka: I understand that.

Mr. Mark Yakabuski: In terms of what is available to date, we will contact TRAC to see if they can send you a copy of their work. How is that?

Mr. Alex Kennedy: Obviously TRAC cannot compel any companies it approaches to answer. I know they have had some difficulty in getting answers in some cases.

Mr. Walt Lastewka: You are hitting it exactly where I was going. We are finding very clearly that as we talk with more associations and we get into the volunteerism and data to be given voluntarily and so on.... But this is a very serious matter.

Associations have responsibility to their stakeholders. In reverse, stakeholders also have some responsibility back to the associations. I view the experience that we had with the pharmacy associations earlier. The good part was that we heard them at the beginning. The bad part was that they were not ready. They have done a lot of work in the last three or four months, and I commend them for their additional work.

That is why I ask the question. I really want to know where the insurance industry is at. If Y2K tracking is to be done by TRAC Insurance, then I want to see that.

• 1600

I did see a comment in the paper concerning those insurance companies that aren't ready, that they're going to go out of business. I saw that comment and I meant to bring it and read it into the minutes today, but I forgot about it. That's why I really want to know, is the insurance business ready themselves or not?

For my second question, I want to go back to understanding your seminar and your questionnaire. Has that already been sent out throughout your organization? Has that been sent out? Has that been processed by now?

Mr. Alex Kennedy: It's in the process of being sent out.

Mr. Walt Lastewka: If I go back to my various agents in the Niagara area and ask them, they will have received it. Is that right?

Mr. Alex Kennedy: It's in the process of being sent out. We were having the wordings and I believe the questionnaire also translated into French.

Mr. Wayne Thorpe: Just a point of clarification there. The wordings were sent out to the member companies, so they would not necessarily fall into the hands of the independent broker or agent unless those companies with which they deal had given them that information.

What I think you will find is happening within the property and casualty industry is that we feel that awareness is our best ally. You made the comment that if an insurance company is not ready, it will go out of business. Well, the fact is, if small business is not ready, they'll go out of business too, or have a good chance of going out of business.

From our point of view, it makes a great deal of sense to spend some money on awareness. So not only will the Insurance Council of Canada mount an awareness campaign, I think what will happen is each individual insurer will also mount their awareness campaign within their policy-holders. In our own case, as an example, we are sending out a notice with every renewal and every piece of new business that we write, alerting people to problems or to look at their problems or possible problems with year 2000.

I think from that point of view, the broker community should be aware, and they in turn should be making their clients aware. If they do not, the backstop for us, at least, is that we are making the client aware of it with a direct mailing piece.

The Chair: Thank you very much, Mr. Lastewka.

Mr. Schmidt.

Mr. Werner Schmidt: Thank you, Madam Chair.

I have one specific instance to raise. Recently I was in a situation where people were replacing embedded chips and ordered replacement chips from a manufacturer and there was the same chip in a series of machines or whatever—installations—same number, same chip, same manufacturer. When they tested—these were manufactured in the same year—they discovered that most of them worked but one did not. Now, this was in a mission-critical instance.

Since it was a test situation, they were able to recover the situation quite nicely. But had this happened in a real-life situation—in fact, a life was involved—where would the liability rest in this instance?

Mr. Wayne Thorpe: I would suggest that the liability rests with the manufacturer of the chip. If it was a life-threatening situation and the individual—

Mr. Werner Schmidt: It was, in this case.

Mr. Wayne Thorpe: —died, then I'm sure the estate would sue the manufacturer of the chip for faulty workmanship.

Mr. Werner Schmidt: Would the insurance company incur any liability in such a case?

Mr. Wayne Thorpe: The wordings are designed in such a way that they would not probably insure that, because the words basically say that it may be a latent defect. The manufacturer ought to have known or should have known that it was a problem.

It goes back to the comment I made earlier. If a court, in adjudicating that, made a decision that the manufacturer did all in his power to make sure that those chips were functional—and in your scenario it looked as though most of them were acceptable—

Mr. Werner Schmidt: Yes, they were.

Mr. Wayne Thorpe: —the court may very well rule that it was an accidential situation and there would be cover available, but that would have to be decided by a court.

Mr. Werner Schmidt: Thank you.

The Chair: Thank you very much, Mr. Schmidt.

Mr. Peric.

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Mr. Janko Peric (Cambridge, Lib.): Thank you, Madam Chair.

Gentlemen, if I buy a policy for a car or property and I'm not under any assumption that I'm covered or that I will be covered.... I sign an agreement, a contract, I pay for it and I'm covered. There's no assumption, there's no doubt. How can you be under some kind of assumption that the members of your association are going to test? Can you tell us that your members tested your system or not, yes or no?

Mr. Wayne Thorpe: I'll defer to Alex, because you're talking about the association. My comment is that they do not have the power to force any company to do testing. The only way the industry would be forced to test and prove the tests would be through our own regulator, which is OSFI.

Mr. Janko Peric: Have you taken any steps toward that?

Mr. Alex Kennedy: We have ourselves and through our sister organization, which deals with the collection of statistics, been in touch with every insurance company. Every effort has been made to impress upon them the necessity to be prepared for the year 2000.

Again, we can't control exactly what's going to happen. We can draw it to their attention. We're trying to do this through public advertising and through pamphlets that we're making available to draw it to the attention of consumers, small business and large businesses the fact that they have to deal with this problem. I don't think anyone should be looking to the insurance industry to bail them out of the year 2000 problem. It's a problem that business and industry have to deal with.

Mr. Mark Yakabuski: You may already have seen, Mr. Peric, that a number of insurance companies are out there on their own placing ads in major newspapers, etc., saying 564 days and counting, for example. The year 2000 problem is fast upon us. They are taking a pretty proactive approach. I have not seen any other institutions in Canada taking out half-page ads in the Globe and Mail and elsewhere saying that the year 2000 problem is real, you'd better contact your insurance broker or agent and talk about this.

Unlike the Canadian Bankers Association, the Insurance Bureau of Canada is a voluntary association. Companies decide to be members of our association or not. Most of them do. So we work cooperatively to accomplish these things, but we don't have the authority, as I know you are perhaps asking, to say they must give us the proof that they've tested their systems.

Mr. Alex Kennedy: I think it's fair to say that the federal superintendent's office and individual provincial regulators are also in touch with companies asking for evidence as to what they are doing to make themselves year 2000 compliant.

The Chair: I would like to clarify two issues. I'm not sure I understood them correctly, but I thought I heard you would be sending out policy renewals at the end of October that would let people know that they're not covered for the year 2000. Was that correct, or that the policy renewals will go out at the end of October? I misunderstood that.

Mr. Wayne Thorpe: We are sending out, both on our personal lines products and our commercial products, a notification to policy-holders that the intent of policies do not cover a year 2000 event.

The Chair: Are you sending those out now, or at the end of October?

Mr. Wayne Thorpe: That's happening now. The comment about October was that the industry works 45 to 60 days in advance of renewals, so at the end of October we will be issuing policies with an expiry date in 2000. Our systems have to be ready to accept those policy dates in 2000. By the end of October, the part of our system that issues policies will be year 2000 compliant. That's the point.

Mr. Alex Kennedy: Wayne is talking about a situation where the company delivers its renewals to the broker and the broker then gets them out to the client.

• 1610

The Chair: Okay. The other thing I want to touch on briefly was Mr. Yakabuski's comment about the ads we've seen in the paper. One of our colleagues, Mr. Bellemare, raised this at the meeting we had with the Canadian Bar Association, and they suggested to us that there is insurance available for the year 2000.

So as much as there are some insurance companies advertising that you may not be covered, there are others advertising that you will be covered. I think there is confusion out there, and I'm just not sure who's really going to be liable when it comes down to coverage for the year 2000 and where insurance companies are going to find themselves.

I was recently approached by a small business in my riding and was told that my householder was fearmongering and that I shouldn't have done that, and that they had insurance. I said “Well, your insurance won't cover you”. They said “Yes, it will”.

So I don't think the message is getting out as quickly as it needs to, and I'm very concerned that as we talk about renewals and things happening, there's not a lot of time left for people to deal with this and there are fewer people to fix the problem. It was very clear from the Canadian Bar Association that they were under the assumption that there is insurance coverage for year 2000 problems.

Mr. Wayne Thorpe: There are some coverages available. They're extremely expensive. They are more like a financing scheme rather than insurance. They are probably designed for Fortune 500 companies and won't be applicable to small business.

What happens is that the companies are forced into an audit, not unlike what Mr. Schmidt has been alluding to. It's very stringent. They have to prove to the insurer that they are in fact compatible. The cost to do the audit runs anywhere from $60,000 to $100,000, depending on the size of the corporation that's asking for the audit. If they are found to be compliant after the audit, then there will be insurance available. It's sold by very few companies, so it's not widely available, and I would suggest it's only available to those companies that can afford that kind of research and cost.

The Chair: I have one final question.

Do you have a question as well, Mr. Bellemare?

Mr. Eugène Bellemare (Carleton—Gloucester, Lib.): Yes. The chair was referring to this Globe and Mail ad by Royal Insurance, for example. There's a disclaimer. It says most of the business losses caused by year 2000 failures are not covered by insurance policies.

As the chair mentioned, I asked that question to the Canadian Bar Association, and in their answer they stated—and I'm translating from French to English—that there are errors and omissions. There is professional responsibility—I may not have the right English terminology. We can also buy protection against the risk of the year 2000. These are three areas in which they suggested there is insurance.

In the case of being insured against the year 2000, I see that as a glowing item that would appeal to insurers—hey, there's something we can really sell to people and make money off it—justly so, correctly so, properly so. But as to errors and omissions, people buy insurance to cover themselves for errors and omissions—lawyers, for example. If they took a small firm that took due diligence, wouldn't they be covered for year 2000 for errors and omissions without extra charge?

Mr. Wayne Thorpe: I think the three of us at the table are probably not qualified to comment on errors and omissions or directors and officers. Our own particular company doesn't sell either one of those products. But I would make the comment that if a board of directors, as an example, did all of the due diligence necessary to make sure that the management of that firm of which they were the board of directors did everything in their power to be year 2000 compliant, then the errors and omissions or the directors and officers liability policy would probably respond.

Mr. Eugène Bellemare: May I continue?

The Chair: Briefly.

Mr. Eugène Bellemare: Something concerned me in one of your answers—I'm not sure which of the three. You said if someone died because of a malfunction of a medical instrument or device, the next of kin would be suing the manufacturer.

• 1615

If a husband dies and he had a Pacer III, which has a time-sensitive chip in it, and Madame says he was insured for x amount and wants to collect because he died, do you mean to suggest from your answer that there's going to be a hassle for collecting the x amount, that she will have to prove that there wasn't a problem with Pacer III?

Mr. Wayne Thorpe: She may be able to collect under the life insurance policy; I'm not sure of that and I'm not qualified to answer. If there were an insurance policy on the life of that individual, that's a possibility.

My comment was that if she were suing for damages, she would sue the manufacturer.

Mr. Eugène Bellemare: No, you're not—

The Chair: I think you should be aware that we have the Insurance Bureau of Canada, and they're not responsible for life insurance. They're responsible for property and casualty insurance, so they can't comment on life insurance policies. That wouldn't be proper. Okay?

Mr. Mark Yakabuski: I think the incident you're referring to was brought up by Mr. Schmidt, who was talking about a malfunction of a chip, and I don't know whether it was a medical device or not.

But if I can come back to your point, while there might be errors and omissions coverage and year 2000, I think we have to clarify a misperception that might be out there. If there is some coverage available, it's available for those people who have done absolutely everything that is to be done to become year 2000 compliant. It's not there available for the guy running his business, sitting back and saying I have insurance coverage therefore I don't have to do anything; it's there for people who have done everything they can and some of these coverages might apply. But let's make sure we get that perception correct.

The Chair: Thank you.

Our witnesses have to go shortly, and I want to clarify one last thing. It came up briefly in discussion, and I want to understand.

If there were a power grid failure, would people be covered for property and casualty?

Mr. Wayne Thorpe: The industry at this point in time has not done anything as a result of personal property coverage. It's primarily being preoccupied with commercial risk. In the wording currently, unless the industry changes the wording, there would be resultant damage cover available under homeowners policies, as an example.

The Chair: Okay. Thank you.

We appreciate you coming before us today and taking the time to review the different evidence that has been before the committee. We welcome the fact that you are going to be notifying all the members of your group, and hopefully they will then notify all the people they act on behalf of and represent and get the message out as quickly as possible.

We are trying to bring awareness to the issue as a committee and trying to ensure that all Canadians can function, and function well, on January 1, 2000. We want to thank you for being with us.

Mr. Mark Yakabuski: Open your newspapers tomorrow morning. Thank you very much.

The Chair: We will do that. Thank you very much.

We're going to suspend the proceedings for about five minutes while we change witnesses.

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• 1630

The Chair: I'll ask everyone to please take their seats. We're going to resume our hearings. I will call the meeting back to order.

Pursuant to Standing Order 108, this is a consideration of chapter 1, “Pressure Points in the Medium Term”, and chapter 6, “Improving Productivity”, of the report entitled Growth, Human Development, Social Cohesion. This session has to do with our long-term study on sustaining Canada with regard to research and other issues related to this.

We have several witnesses before us. Mr. Alan Nymark is the Associate Deputy Minister of Health, who's representing the Treasury Board Secretariat today. From Industry Canada, we have Dr. Serge Nadeau, director of the micro-economic analysis directorate. Dr. Surendra Gera is a senior policy and research adviser in the micro-economic policy analysis branch.

This is incorrect, I believe, Mr. Nymark. If you would like to correct that when you begin, you're more than welcome to.

We have opening statements, and I'll turn it over to you now.

Mr. Alan Nymark (Co-chair, Public Service Policy Research Committee): Thank you very much, Madam Chair. I'm Alan Nymark, the Associate Deputy Minister of Health. I'm here not in that capacity, but as the co-chair of the policy research committee in the public service.

My co-chair, Jim Lahey, who is now the deputy secretary for intergovernmental affairs at the Privy Council Office, has unfortunately had a death in his family and is not able to make it today. I will try to carry that responsibility on my own hook. So as I say, I'm here not from the health department, but as co-chair of the policy research committee.

If the chair wishes, I thought I would introduce the policy research committee in process terms and then go over a number of broad conclusions reached by the committee some 18 months ago I guess that were the basis for the first report. Then I will turn it over to my colleagues from Industry Canada, who will be addressing particularly the issue of productivity growth in Canada.

I believe that my slide deck has been circulated in advance. I will in essence use that and go through it page by page, if that's satisfactory.

This may take about 15 minutes. Would that be all right?

The Chair: That's fine.

Mr. Alan Nymark: Thank you very much.

The policy research initiative was launched in 1996 by the Clerk of the Privy Council. It was done so on the basis of a determination by her that the government, after a number of years focusing on management issues as a priority for the government, needed to take a look at the policy development capacity that exists within the federal public service.

Within that context, a number of deputy minister task forces worked away on that issue over the recent years. Ivan Fellegi, the chief statistician, had done a paper for the Privy Council Office on what the policy process is all about and how to improve it in the federal public service.

Mel Cappe, who at the time was Deputy Minister of the Environment, had done a task force on how to cooperate on a horizontal basis in complex policy issues, such as climate change. How do a variety of departments come together in order to arrive at policy recommendations for the government?

• 1635

This process, the policy research committee, was seen in that context. Its focus is on research, not on policy. Its focus is on the analytical capacity that exists within the federal government in order to provide policy advisers of government with good analysis of issues that are important to the government to be looking at. It was not established to look at short-term issues and it was not established to look at issues that were in the prerogative of any single department, but it was established, again, to look at horizontal issues, complex issues that require a variety of departments, a number of disciplines—economics, political science, law, whatever they are—to come together in an integrated way to investigate issues from a research point of view.

The initial focus was to look out a number of years. This was done in 1995-96. Its original intention was to look out some 10 years into the future so that it was trying to identify what trends or pressures on a global basis would be extant at that time, and then, working back from that, ask what we know about those sorts of situations and what do we need to do research on in order to be able to assist governments as they try to grapple with those issues.

A classic issue would be if we know that there's going to be an aging population and if we know that the finances of the pension plan, for example, may not be appropriate to be sustainable and look after that kind of aging population. Then we would ask what kind of research is necessary to investigate that so that policy people would be in a position over the next number of years to be advising governments on it.

It involves some 30 departments of government. Primarily it is at the assistant deputy minister level. This group of departments came together over a period of about three months to put together the first report, and we've evolved since that time.

We produced the first report in I think it was September or October 1996. That was discussed by the whole deputy ministers' community as being helpful to them in thinking about medium-term issues and whether they had the capacities in their departments to be doing the kind of analytical work that was necessary to address these kinds of issues.

We were asked to continue our work; it was thought that this was helpful. We were asked to continue our work and we have now created four research networks within this community in the federal government. One is on growth, and I understand that is your primary interest today. Within the growth network, one of the fundamental issues is productivity performance; my colleagues from Industry Canada will address that issue.

The second network is on human development, a third is on social cohesion, and a fourth on global challenges and opportunities. Each of those networks is co-chaired by two assistant deputy ministers and involves 10 or 12 or 15 departments of government, and they establish a research agenda over a period of two or three years to be working on the analysis of the issues that have been identified.

In addition to these four networks, we have launched an integrated research program on the knowledge-based economy, knowledge-based society. It was thought as a result of our work that the knowledge intensity issue is a pervasive one across society and that we needed to bring a better focus on addressing this issue.

All of our efforts are coordinated by a small secretariat of about ten people, who assist the networks in bringing the integration of these ideas together.

• 1640

The first year or so of our efforts were largely internal within the Public Service of Canada. This was an attempt to raise the profile of the value of research within the public service, to give it value. We want to stress the importance of the analytical part of the policy development process, but as mentioned on page 4, we've been asked now to.... The research community is not limited to the federal government; it's not limited to governments. The broader intellectual community and the universities and think tanks, etc., within Canada and beyond Canada, are important parts of the overall network process.

We've held a number of conferences and we've brought together 40 think tanks in Canada to address what we have done and what their agendas are to try to see if there is a desire to work together in this area. We've visited the OECD and a number of governments. On page 4 we mention the French government, but we've visited a number of governments to see how the reforms of their institutions or their public service are also trying to deal with this issue. We wanted to know how you deal with your analytical capacity within your institutions in a forward-looking way.

I'll speed up a little here, Madam Chair. The first thing we did was try to identify a number of trends that we felt were important to understanding the kinds of pressures that would be on us over the next decade or so. The first one is on the issue of globalization and North American integration. Every once in a while there is a questioning of whether in essence globalization is inevitable. Are we living in a much more globalized world now than we used to be? It's not entirely clear. Certainly we've been increasingly globalized over the last 50 years, but probably at the turn of the century the world was a more globalized place than it is today. Trade was a greater share of GDP at the turn of the century than it is today. If you take a long-term perspective on this, you do go through certain cycles of globalization, but clearly in the last 50 years we've become much more globalized.

For Canada, in particular, the striking feature in the last 50 years with Canada is that we have become globalized in a regional sense in a much more intense way than in a multilateral sense. We are very much part of a North American economy. Although we have all kinds of economic and other kinds of relationships beyond North America, the striking feature is we're particularly integrated in a North American sense, with—I'm not sure I recall the exact numbers—80% of our trade or something now being within the North American continent, whereas 50 years ago it was probably a little more than half that.

Our conclusion was that over the time perspective we were looking at, which was nine or ten years, there was no sense in worrying about this issue as to whether we would become less or more globalized. The inevitable trend for the next foreseeable period of time is to increase our openness on a global basis, and it's quite likely that we may continue to be more integrated in an economic sense within North America.

The second trend we looked at was the issue of technological change and the information revolution. It's become quite commonplace to talk about the rate of change speeding up. Again, if one asks economists whether that is true or not, it's not at all clear that it's true, it's not at all clear that the evidence suggests that the rate of change is speeding up in the world.

• 1645

We again set that issue aside. It's kind of like dancing on the head of a pin. It was quite clear to us that the complexity of technological change, particularly brought on by the enabling features of a technology such as information.... And quite possibly the next wave beyond the information revolution may be the biological or the genetic revolution over the next 25 years or so. Those kinds of technological changes make a fundamental difference to the way our economies and our societies operate.

The notable feature here is that if that's the case, then where does Canada stack up? Are we adapting to that kind of technological change in a way that is similar to the way other countries are adapting, or are we faster, or are we slower? The conclusion here was that we may well be somewhat slower in the nature of the way we're adapting to technological change than many other of the G-7 countries.

In regard to environmental pressures, particularly since Gro Brundtland's report on sustainable development it's widely recognized that environment is indeed a global issue and not a local issue. It impacts locally, but its potential transmission is on a global basis. The challenge was moving relatively to seeing the trade-off between environmental issues and competitiveness issues to seeing environmental issues in a quality-of-life context, the environment as it affects people through their health or whatever, as opposed to primarily focusing on environment in a competitive context, which was the focus of attention in the 1980s.

The fourth issue we looked at was demographics. Demographics change one year at a time, so in essence they change slowly; but if you look over a long period of time, they're changing quickly. There are large structural changes going on in Canadian demographics. Literally the face of Canada is changing, both in terms of age, as you well know.... The baby boom being 10 million people in Canada, when it hits the retirement age that is likely going to mean that behavioural change will be determined by that cohort in the society and that the aging process may well not be similar to aging processes previously. They will demand different services and different attention from previous elderly cohorts.

Again, on the demographic front, one of the very striking features is that the aboriginal community stands out as a complete outrider in terms of the demographics, and by that I mean the proportion of youth in the aboriginal communities.

Concerning the fiscal context, you'll recall this report was at least two years ago now, and we were still very much in a deficit. We were starting to look ahead at that time to say, well, assuming we could manage the deficit, what do we do next on the fiscal front? How important is debt versus managing our finances by either reducing taxes or undertaking investments? We've made a number of comments on that.

One of the striking things is that from a research as opposed to a policy point of view, there is no easy road map here. You will not find the research community with a consensus on this matter. Politically—and I don't mean partisan politically—you may reach a consensus on this issue, but the research only suggests that a lower debt-to-GDP ratio is good. They don't suggest what an optimal ratio is, and they don't suggest how fast to get there.

• 1650

On the international side, we looked to the issue of multiple centres of power. We looked a bit at the implications of there being a pre-eminent power now in the light of cold war and what that would mean in terms of Canada's foreign relations.

If I could turn to the first theme, growth, which I will briefly deal with, since my colleagues are here to do that, as professional economists will tell you, without productivity there are no income gains, and if there are no income gains, there is very little ability to deal with the issues of social capital. So if you're looking at enriching your society, you have to deal with the fundamental issue of how to encourage higher productivity growth. Canada's productivity record has not been a great one since the 1970s. It is a very complex issue, with very complex answers, not simple answers, to that question.

One of the complex parts of that is if our productivity record has not been that good over the last 25 years, then if the new wave is going to be a knowledge-based economy and we're not as good on dealing with adjustments on the knowledge intensity of the economy, then what are the peculiar challenges to Canada in enhancing our productivity?

The second theme is human development, on page 9. We documented the emerging imbalances in society. In fact, less time is spent on paid work over our life cycle now, and it's highly unevenly distributed.

There are those who are working much harder and longer than they used to, and there are those who are working much less and not as hard as they used to. Therefore, those distributions of paid work are leading to a variety of issues, such as income inequality and issues surrounding the affordability of pensions in the future.

There is also heightened insecurity because the changes at the edge of transforming from school to work and from work to retirement are less stable and people are required to work in multiple jobs over their careers. There is a heightened insecurity around those transitions.

On inequality, I think Canada has prided itself as being a more equal country, as it were, in terms of incomes, than the United States. There are signs that may be changing; therefore that creates challenges in a public policy sense.

Social cohesion is a topic that is increasingly being studied at the research level around the world. What we mean by social cohesion itself is a highly debatable subject among researchers, but it appears there are increasing fault lines in society, whether urban-rural, or public-elite, or income inequalities, or regional inequalities. The issue is, how do we deal with those? How do we reduce those inequalities? Is the reduction of those inequalities a goal that society wants to pursue?

The global challenges and opportunities on page 11 address a number of issues. Looking at Canada's comparative advantage, which traditionally was in the resource sector, then moved to the manufacturing sector, then moved to the service sector, in a knowledge-based economy, where will Canada's advantage be? Who will we be competing against? Therefore, in essence, who are the winners and losers in society as you go through that kind of adjustment?

On economic integration, there is no reason to suggest that will slow down. If it is not going to slow down, then what are the impacts of economic integration, whether within North America or on a broader basis, for our social policies, for our cultural policies?

• 1655

On threats to global human security, it was noteworthy that in 1996, the G-7 summit for the first time addressed global human security issues surrounding the perception and reality that contagious diseases, infectious diseases, are on the rise again. We thought they were declining and would continue to decline. They are no longer continuing to decline. How do countries cooperate to ensure that they are paying enough attention to this issue?

We did not address the issue of governance or federalism in a direct way. There were a number of issues that we did not really take on as specific issues. We didn't deal with our military capacity. We didn't deal with our natural sciences. We tended to deal mostly with the humanities and the social sciences. So while this may sound reasonably comprehensive, there are a number of areas of inquiry that the community felt were kind of beyond its scope to deal with. At some point in the future, we may well do that.

One of the issues we did address was governance in the sense that if issues are more complex in the future, such as not how do we deal with child poverty, which may be the responsibility of one department, but how do we deal with child development, which may be the responsibility of four or five departments, how do we ensure there are governance mechanisms in those departments and that research capacity in those departments is sufficiently integrated?

We are undertaking a number of projects now. We are developing some new themes for investigation, such as beginning to look at the role of gender in research. We're looking at how to integrate natural sciences into the policy research capacity of the government. They tend to stand outside the government. And as many of you know, that's a fairly controversial issue in the public service right now. Natural scientists do not naturally work easily with political scientists and lawyers, etc., so how do we try to get them involved in this process? So we're doing some thematic research plans.

The knowledge-based economy society research project is progressing well and we expect to have a major conference on that in 1999.

We have started our outreach activities with think tanks, etc., but we've also started to talk to provincial governments to ask what they are doing about their policy research capacity. How can we cooperate? How can we share agendas? We're planning an overall national policy research conference in October of this year.

Thank you, Madam Chair.

The Chair: Thank you very much, Mr. Nymark.

I'm now going to turn to Dr. Nadeau and Dr. Gera. I would ask if you could try to be a little briefer in your opening remarks. We have a lot of questions we'd like to get to.

[Translation]

Mr. Serge Nadeau (Director, Micro-economic Analysis, Micro- economic Analysis Directorate, Industry Canada): Good afternoon, ladies and gentlemen. As you know, the document we discuss today was published almost two years ago. The economic environment has changed, and our research has led us to new conclusions.

What I'd like to do, Madam Chair, if it's agreeable, is to spend five or ten minutes to give you an update of Chapter 6 of the report by going through the document I distributed, which is entitled Improving Productivity: The Key to Raising Living Standards. As you will notice, the challenges described in Chapter 6 remain the same. However, there are now many more reasons to be optimistic in terms of productivity in Canada. So, if it's all right with you, I'd like to spend five or ten minutes on that.

• 1700

[English]

Let me first define productivity. What do we mean by productivity? Productivity is, by definition, the amount of output obtained per unit of input. For example, labour productivity is the ratio of GDP per unit of labour. Hence, productivity improvements refer to the ability to produce more output with fewer or the same amount of inputs.

Let's go into the crux of the matter and turn to page 3 of the deck and see what Canada's productivity performance has been over the last 30 years, basically. The chart on the left-hand side of page 3 shows that productivity growth has been very slow in Canada for some time. In fact, the chart also shows that the slowdown has been very widespread, but the issue is that Canada has fared the worst. We see here that there has been a productivity slowdown across all G-7 countries, but Canada's has been the worst since the 1960s. Also, even more troublesome, is that Canada is the only G-7 country to have experienced a productivity decline since the 1970s.

In terms of productivity level, chart 2 on the right-hand side shows that productivity in Canadian manufacturing is about 70% of that in the U.S. at this point in time. This lower productivity level is across all industries in the manufacturing sector. What are the implications of that? The charts on page 4 show that the slowdown in productivity growth is a major cause of the slowdown in the growth of our living standard. Let me give you some background.

Growth in living standards depends on three factors: first, growth in capital—for example, growth in machinery and equipment; second, growth in labour—of course, the more people work, the richer we are; third, growth in productivity. The chart on the left-hand side of page 4 shows that the growth in living standards from 1980 has been about a third of that in the previous 20 years. The chart on the right-hand side of page 4 shows that slower productivity growth accounts for approximately 60% of that.

What are the reasons for this? First of all, let me point out that this is an area of very intense research. Why have we experienced such a productivity slowdown? Evidence points to a number of reasons, including some of an international nature, such as severe recessions in 1981-82 and 1990-91 and also slower adjustments to the 1970s energy price shocks. So there are some reasons that are international in nature, and Canada had more or less no influence on that.

On the other hand, there are reasons of a domestic nature, including what we often call our innovation gap, potential skill mismatches and low investment. Let me examine each one of these in turn.

The charts on pages 5 and 6 provide evidence that Canada has an innovation gap. The chart on the left-hand side of page 5 shows that we have a smaller critical mass of high-tech manufacturing than all other G-7 countries. The chart on the right-hand side of page 5 shows that we have lower private sector R and D spending than all other G-7 countries except Italy. Other evidence that we may have an innovation gap includes the fact that, as shown on page 6, U.S. companies are quicker in adopting new technologies.

That is evidence of an innovation gap, but there's also the issue of human resources. As we know, human resources is a very, very important complement to innovation. Indeed, as shown on page 7, the lack of skilled workers is the most often cited impediment to innovation, and this is cited by all sizes of firms, not only small firms but also large firms.

On the issue of skilled workers, page 8 shows that Canada has maybe the best infrastructure in the world to produce knowledgeable workers. Indeed, we have the highest post-secondary enrolment rate in the world and spend the most on education among our major competitors. However, as shown on page 9, there are potential skill mismatches. The chart on page 9 shows that we're turning out fewer science graduates than most of the other G-7 countries except the U.S., and that's a cause for concern.

• 1705

Another productivity-related concern is the slow rate of investment in Canada. The chart on the left-hand side of page 10 shows that investment in machinery and equipment in Canada has been significantly lower than that in the U.S. for some time. Even more troublesome is the fact that the net stock of capital in the manufacturing sector actually declined in the 1990s.

These are all explanations of the slowdown in productivity growth over the last 30 years or so.

What is the government doing about this? Let us first realize that there is no overnight fix to the productivity slowdown. The objective of the federal government is to provide an environment that is conducive to productivity improvement. Key to such an environment are excellent macro-economic fundamentals that Canada now possesses, a balanced fiscal situation. We were the only G-7 country with a surplus in 1997. In fact, the international community is so impressed that the Institute of Management Development, which ranked 46 countries in the world in terms of competitiveness, ranked Canada as the best fiscally managed country in the world.

We have also one of the lowest inflation rates in the world, and, as you know, a balanced fiscal situation. A low inflation rate means low interest rates—that we have now—and higher investment, which was a major cause of our productivity slowdown. Canada is now also one of the most open countries in the world.

At this point in time—differently from two years ago—we can say we have the right macro-economic fundamentals. But excellent macro-economic fundamentals are not sufficient for success. The federal government is also implementing a macro-economic strategy for growth that includes a strategy on innovation—for example, the Canada Foundation for Innovation, CANARIE, and so on and so forth, human resources, connectiveness in trade and investment. The focus now has shifted onto our macro-economic strategy, and the strategy is paying off. This was not apparent two years ago, but now results show that maybe there's light at the end of the tunnel.

Page 12 lists several signs that productivity is on the rebound. Chief among these is that business investment is picking up. In fact, in 1997 machinery and equipment investment grew at the fastest pace since 1981. The technology adoption gap with the U.S. is also closing. Canada is now ranked first among the G-7 for technology potential. We are also the most open economy in the world, and the international community also agrees that we are improving.

Page 13 shows that Canada's competitiveness position has moved from twentieth place in 1994 to fifth place in 1997, according to the World Economic Forum. The Economist also places Canada's business environment third among that of 58 countries over the next five years, an improvement from fifth place in 1996.

With this, I would like to close my opening statement. Thank you for your attention.

The Chair: Thank you very much, Mr. Nadeau.

I'm now going to turn to Mr. Schmidt to begin our questions.

Mr. Werner Schmidt: Thank you, gentlemen, for appearing here this afternoon.

I would like to ask a couple of questions, Mr. Nadeau. What is the relationship between productivity and taxation levels?

Dr. Serge Nadeau: The level of taxation can influence human skills development in the sense that it may have an influence on the brain drain, for example. That hasn't been verified yet, but it could. Taxation may also have an influence on investment. Of course the higher taxation is on capital, the least investment there could be. These are the two main channels through which taxation can influence productivity.

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Mr. Werner Schmidt: If those two factors are so significant, or if taxation has that kind of input, why doesn't your research reveal that in terms of its charts?

Dr. Serge Nadeau: We don't have any good measures of that impact. These are two channels through which taxation could influence productivity. However, we don't have any results on the impact of taxes on, for example, the brain drain. We don't have any results of the impact of taxes on investment.

Mr. Werner Schmidt: Maybe you don't, but there are other people who do. The point is, at least a correlation could be established. There is a clear indication that doesn't take big research to plot. For example, the increase in taxes and the decrease in productivity: I think if you were to plot those on the same graph, you would see that the gap increases dramatically. As taxes increase, the productivity gap goes down. That's exactly what your graphs show.

Dr. Serge Nadeau: First of all, you're right. A lot of research has been done. On the other hand, the results vary a lot. There is no consensus among economists about that.

You're right that if we do a straight correlation, maybe there's.... On the other hand, there are many other factors besides taxation—many, many other factors.

Mr. Werner Schmidt: I'm not debating that. The point is there is a connection. That's the point I'm trying to make here. As recently as June 8, Maclean's magazine quotes a particular individual—he's a businessman, I think in Vancouver, although I'm not sure about that. His name is Reid. It says:

But Reid has concluded that the “biggest single difference” is the prospect of lower taxes.

That is, as between productivity and as between people staying in Canada or going to another country, and particularly the United States.

For you to say there's disagreement among economists.... There may be a disagreement as to the degree of influence, but there's no disagreement that there is an impact. That's the point I wanted to make here. Are you prepared to accept that there is a connection, and that it is an inverse relationship between increase in taxes and increase in productivity?

Dr. Serge Nadeau: As I've said, beyond the anecdote I've not seen any very reliable research showing there is a strong connection.

Mr. Werner Schmidt: Do you accept the fact that there's a brain drain in Canada today?

Dr. Serge Nadeau: That's another issue that is open to question, and in fact one that we're looking at very closely. I can cite, for example, Dr. Fellegi, who says that we have a brain gain, not a brain drain. And I could cite other researchers who argue that we have a brain drain. This is a very thorny issue, and we are investigating the issue. That's very important—

Mr. Werner Schmidt: It's extremely critical.

When do you think that research will be completed?

Dr. Serge Nadeau: We have some research that will come out around January or February.

Mr. Werner Schmidt: Thank you.

Dr. Serge Nadeau: We could make it available to you once—

Mr. Werner Schmidt: I'd be very happy to see that, because I think it's really significant—

Mr. Ian Murray: He'll be gone.

Mr. Werner Schmidt: I want to see that research regardless of where I am. It's very, very important.

The indication toward the end of your report is rather interesting. There are two points I'd like to make about it. I found one very interesting. It's sort of a humourous thing.

I notice that the first of it is beautifully coloured and beautifully statistically supported. Then, on page 12, suddenly we're out of graphs and we're out of numbers and we simply have statements saying that Canadian firms are adopting technology at a faster rate and that the technology adoption gap is closing. If you could find all those numbers before, how can you make this statement without having numbers in there?

Dr. Serge Nadeau: I'll tell you what happened. I knew I had about seven minutes and I would have needed six charts. Actually, I have them here.

Mr. Werner Schmidt: Oh, you have them.

Dr. Serge Nadeau: Yes.

Mr. Werner Schmidt: Would you distribute them? That would be great.

Dr. Serge Nadeau: I didn't make copies, but if the members want to have copies, I'd be more than happy to do so.

Mr. Werner Schmidt: Yes, please. Please do.

Dr. Serge Nadeau: Some of the things that are in there are already in the deck. For example, international trade is expanding. It's already in the presentation. But we will make copies available to you. This is all supported.

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Mr. Werner Schmidt: I'm sure it is. You wouldn't be here this evening if you hadn't supported it. I'd just like to see this stuff, that's all.

Dr. Serge Nadeau: Yes, sure.

Mr. Werner Schmidt: I like pictures.

The other part is, do you have confidence that page 12 will project forward into the future?

Dr. Serge Nadeau: I'm very optimistic. The situation now is much better than it was a few years ago.

I hate to make predictions. I don't think we should be in the business of making predictions. On the other hand, all the indications are there. The situation is tremendously better than it was a few years ago. And it's not only internal; the international community is feeling that way too.

Mr. Werner Schmidt: Thank you, Madam Chair.

The Chair: Thank you very much, Mr. Schmidt.

Mr. Lastewka.

Mr. Walt Lastewka: Thank you, Madam Chair.

Thank you for your report.

When I see these manufacturing numbers and so forth—and it's not the first time I've seen them—I'm always concerned with the fact that the automotive industry plays a large part in the manufacturing. I've asked this before. Have you taken the automotive industry out of there to show us what the rest of the manufacturing is doing?

Dr. Serge Nadeau: Let me start, and then maybe Surendra can help me on that.

We have done simulations to learn the contributions of the various sectors. Surendra, correct me if I'm wrong, but the results don't change. It's basically that.

The automotive sector is doing very well in terms of productivity. It's one of the most productive manufacturing industries.

Dr. Surendra Gera (Senior Policy and Research Adviser, Micro-Economic Policy Analysis Branch, Industry Canada): Actually there's evidence to suggest this. When we look across the manufacturing sector at the various industries, the data tells us that the total factor productivity gap between Canada and the United States has increased across all industries. Nevertheless there are some signs with respect to some of the resource industries and some of the service industries that the factor productivity has improved.

It doesn't answer the question you're asking, about taking the transportation sector out of the manufacturing sector. That has done well, but the fact of the matter is there are other sectors of the economy that have done well but do not necessarily show up in the manufacturing sector.

Mr. Walt Lastewka: This committee has had discussions before on why we don't have more engineering and architecture graduates. Your graph on page 9 sure spells out where we're pushing our students to go. Actually we're almost dead-on with the United States on this, so they must be doing the same thing. Yet we're so much higher in the other, with the 56%. I'd like to know what the answers are to fixing it.

We've talked with university presidents here before about the cost of putting engineering students through university. Of course we get into that all the time. Have you come up with something from the graphs that we should be doing as a country? What are we doing wrong? What should we be doing to get more of the...? I see Italy at 12% in engineering and the U.K. at 14%, and another graph shows the U.K. is going to be number one or number two for business environment. Does that follow that synopsis of engineering talent?

Dr. Serge Nadeau: This is consistent with the productivity levels we have now. For example, Canada has low productivity growth, and it doesn't seem we are providing the right skills. As a country, what can we do about this? Again, this is a very difficult question. Sometimes it's suggested that providing information on the likelihood of employment and so on and so forth—providing the right information—to students would help them make the right career choices.

• 1720

Mr. Walt Lastewka: When I look at page 6, on the use of technology by Canadian and U.S. firms, I understand the fact that there's a Y2K problem, but in addition to that, we're really short on computer-aided design people, CNC people, and programmers. At the same time, we're not graduating them from school.

Dr. Serge Nadeau: That's right.

Mr. Walt Lastewka: That's the message we got when we talked with our presidents of universities once before about what we need to do in that area.

On page 10, I would be interested to know what caused that dip in the 1992-93 era.

Dr. Serge Nadeau: It's the recession. It's the 1990-91 recession. The recovery in Canada has been very slow. As you see, though, in 1997 it's picking up.

Mr. Walt Lastewka: What caused the fact that in the U.S. it went up and in Canada it went down? Normally we always talk about how we follow the U.S. or lag behind the U.S.

Dr. Serge Nadeau: But the recession in Canada was much more severe than in the U.S., and in fact in Canada it lagged for a much longer time than in the U.S. That's the fundamental reason: the severity of the recession.

Mr. Walt Lastewka: So that's the summary of that?

Dr. Serge Nadeau: Yes.

Mr. Walt Lastewka: Thank you, Madam Chair.

The Chair: Thank you very much, Mr. Lastewka.

Now I'm going to turn to Madame Lalonde, s'il vous plaît.

[Translation]

Ms. Francine Lalonde: Thank you for your presentation. Before I ask my question, I'd like to mention that the first part of this enormous document to be made public was Chapter 6, which deals with productivity. It happened following a request under the Access to Information legislation by a Citizen journalist last December. Then, the Chairman of the Social Sciences and Humanities Research Council came to the committee to talk about a report which had been commissioned by Ms. Bourgon and which is entitled Growth, Human Development, Social Cohesion.

I looked at that presentation and I thought that it would be helpful to have the complete document. Thanks to the committee and the Department of Industry, we got this document last December, but the committee hasn't had time until now to study it.

I read it from cover to cover and I find it extremely interesting; my question is in two parts. You just told us that you are going to consult parliamentarians, even those who belong to the party in power, as well as provinces, but that's two years later. How come these people haven't been involved or simply informed of this study where we find some very disturbing facts that cannot be brushed aside simply by saying, in the last three pages, that productivity is no longer a problem?

In the last paragraph of Chapter I that we are studying, on page 58, it says:

In our federation, significant aspects of human development are in provincial jurisdictions, while principal macro-economic and many micro-economic levers are federal. This suggests that no amount of disentanglement or elimination of overlap and duplication between the provincial and federal governments will remove the need for assuring that federal and provincial policies are complementary. At present, Canada lacks both the institutions and the culture that would make more intense collaboration workable.

And this is the last sentence:

Failure to achieve federal-provincial collaboration would make it difficult to deal effectively with the pressure points highlighted in this paper.

How come you didn't involve more people, particularly the provinces?

[English]

Mr. Alan Nymark: Thank you very much.

• 1725

On the issue of the nature of this exercise and the degree to which it's an open, public exercise versus one that has only recently become known, it's important to go back and understand why we launched this exercise. It was in recognizing that this was more about undertaking a cultural change within the public service to give more importance to the issues of research. How do we ensure that researchers, mostly at a junior level within the public service, see the value in research, see it being used in the policy development process, work together across departments more than just within their departments, and become well-connected to researchers outside of the federal government?

In brief, I guess the concept here is that research is more about the process than it is about the product. Many of these questions that are in this volume or that Serge Nadeau has spoken about—take productivity for example—are at the research level, the analytical level, and have been troublesome issues for 25 years. If you were to ask economists what the single most important issue is that in essence the economics profession has failed to provide a clear answer on, it would be the issue of productivity.

It's not as though there are final answers or single answers, but to make sure that our public servants are encouraged to be looking at these difficult issues and contributing in a way such that they don't feel threatened that they will, in essence, be held accountable for the results of the research efforts and at the level of policy. That's not their job; their job is to do research and analysis.

Having been asked to do this, we began by simply asking departments what they were doing in the area of sustainable development or productivity. We went to the industry department and asked what they were doing in the area of human development.

We kind of had to cull out interesting research from all of these departments that was going on to support the programs or policies in that particular department. We tried to pull them together here as our first output.

We recognize that this is research, this is not policy. This represents a kind of an amalgamation of thinking on these issues, it doesn't represent government policy.

Ministers, frankly, never saw this work. Public servants are working on this work. So now the issue is this. We've done this ourselves, so now let's reach out to the think tanks and provinces and share our experiences, and the process of trying to discover these answers will go on.

The Chair: Do you have a last question, Madame Lalonde?

[Translation]

Ms. Francine Lalonde: Mr. Nymark, I would like to believe you when you say that it's just research for research's sake, but I think that if it had been the case, it wouldn't have had the influence it had. Let's take for instance the challenges which are highlighted all through the document. Here, it says that they are crucial challenges. For instance, we can see that gaps are widening, and that social cohesion is being undermined by various factors, to the extent that, in the context of North-American integration, we can ask ourselves what it means to be Canadian.

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The thread that runs through the whole document—where Quebec and the provinces are not mentioned even once—is concern about our identity and the future.

Regarding the government it says:

The challenge it will have to face will be to convince Canadians, who are going to benefit from much more limited services compared to the taxes they pay, of the need to cut even more, while still playing a visible and relevant role. If it doesn't do that, the government might well lose the support of important elements of Canadian society, particularly the middle class.

It's Ms. Bourgon who commissioned this report. She saw the evidence you gathered regarding innovation, as well as this Chapter 6 on productivity. As we know, the 800 million innovation fund was established at the time we were cutting everywhere. It was clear that something had to be done and to start with, the government targeted those sectors which needed help. You can't say that this is research for research's sake. The objective is to help and to give directions to decision-makers.

[English]

Mr. Alan Nymark: I agree that there are very few places in the Government of Canada where we do research for research's sake. By and large, that is a task universities participate in. We do research as one part of the policy development process.

Other equally important parts of the policy development process are consultations with stakeholders, intergovernmental discussion, international discussion, improvement of our data and methodology, and the parliamentary process. Each of those stages in the policy development process is extremely important. What we're focusing on here is trying—

[Translation]

Ms. Francine Lalonde: But you haven't started yet.

[English]

Mr. Alan Nymark: —to say, to start with, “You, as a junior economist in the Department of Industry, do you have the skills, do you have the connections to the research community to enable you to make a contribution to these very difficult issues that we have?”

There may be some views expressed here on the issue of social cohesion, views about the complexities that we're facing in Canada. By and large, those complexities are shared on a global basis. The French government, when we happened to be visiting there, had 10,000 unemployed marching on the Champs-Élysées because there are serious social cohesion problems in France with immigration and other things. We were sharing with them how we deal with these issues of social cohesion at a research level and what work we have under way.

You mentioned the issue of innovation. We visited the OECD. In its annual report in 1995, the OECD identified an innovation gap in Canada, and we've had a very close relationship with researchers in the OECD since then. We've sponsored a lot of work at the international level in this area and I think they feel that our research in the area of innovation is probably—I won't say “leading” in the world—really quite advanced.

So I'm not apologizing for the research. I'm just trying to emphasize that there's a very big difference between research and policy. These documents, I guess, are a first attempt by the research community within the Government of Canada and we will be coming forward with more documents over time. We're now having public conferences that are quite open.

As I say, in the last three months or so we've probably visited provincial governments.... Because most provincial governments don't try to collect all this in one place and have single departments doing research, we almost don't know who to talk to or whether they have the equivalent of what we have now, which is the policy research committee.

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I recently met with the executive director of the management council in Alberta, who said, “Jeez, we'll have to think about how we could organize to even talk to you about these issues, because unless you bring 100 specialists to the table, how do you engage with these issues between governments?”

We're learning by doing. We're gradually getting more confidence in regard to being prepared to discuss these issues more publicly, and I think it augurs well for the future.

The Chair: Mr. Murray.

Mr. Ian Murray: Thanks very much.

Dr. Nadeau, I'm looking at your “good news” page—page 12—again. It struck me that perhaps there could be a relationship between consumer and business confidence and productivity growth, just from looking, for example, at these positive signs such as investment in machinery and equipment. If one were to track business confidence over a period of time, would you see productivity increasing as well?

Dr. Serge Nadeau: That would be related, because, as you say, business confidence is related to investment, and investment is related to productivity—maybe with a lag.

You point out something that maybe I could have added there, which is the sense that business confidence was at its highest level in the previous quarter, the last quarter of 1997. That's part of the optimism.

Mr. Ian Murray: So perhaps as a society we have to think positively, as much as possible.

I just had one other question, again about page 12, where you mention that the supply of human capital is increasing faster than that of most OECD economies. I recognize that we have a higher enrolment in post-secondary education and that we also spend more on post-secondary education, but we've also been told that our society is aging, and we also know that we depend on immigration to have any growth in population. I'm just interested in how this works when all the OECD countries are probably in a similar situation, not quite identical to Canada's, perhaps, but most of us—at least the G-7 nations—are competing for the skilled people.

To what do you attribute that supply increasing faster than that of other OECD countries, other than just university enrolment, which, again, we've already seen is largely in the humanities?

Dr. Serge Nadeau: Well, I will qualify that. You're right that this statement is based on the fact that university enrolment rates are the highest among all the G-7 countries—and in the world, in fact.

On the other hand, it's true that we also have many students who are in the humanities, but still, this is a positive factor. Maybe we should have more graduates in sciences, but at least we have the infrastructure to produce skilled workers. That's the thrust of this statement.

Mr. Ian Murray: Okay. I just wanted some clarification about that. Thanks very much.

The Chair: Thank you very much, Mr. Murray. Mr. Schmidt.

Mr. Werner Schmidt: Thank you, Madam Chair. I have a couple of questions.

Are you familiar with this earlier document, the big heavy-duty one we have here? In that document, I'm referring to page 176. I'd like to tie what's on that page together with the graphs on page 8 and the graphs on page 5 in the document you gave us today. There are three related questions here.

There seems to be a relationship between the innovation that takes place in a nation and the amount or proportion of money spent on R and D vis-à-vis the gross domestic product. That relationship seems to run through this big, heavy-duty document as well as your short version here. Is that pretty well a general observation on your part?

Dr. Serge Nadeau: Yes. To a large extent, I guess, there is a consensus among economists that the more innovative a country is, the more productive it's going to be. However, we cannot attribute productivity growth to only one factor, like R and D, for example. There are other factors.

• 1740

Mr. Werner Schmidt: I appreciate that. As for establishing a causal relation on a single variable, I appreciate the difficulty you have in your research, but there seems to be that sort of a thread running through it. I think there's a lot more that needs to be done in this area. I'm really leading up to a crunch question. It could be one, but I don't know if it is.

Coming back to page 176, the emphasis here is on the diffusion of knowledge. In particular, I was interested in the second-to-last paragraph on that page. Toward the end of that paragraph, it says:

...it has been estimated that the rate of return on R & D is 35 per cent for firms with university links, compared to 13 per cent for firms without such links...

Regardless of the linkage here with universities or otherwise, I'm struck by the figures of 35% and 13% for the return on R and D. So if 1.5% of the GDP is spent on R and D but the return on that investment is at the tune of 13% to 35%, with that kind of a range—I know this doesn't establish the causal relationship—doesn't that lead you into perhaps considering in-depth research about the economic return of R and D expenditures?

Dr. Serge Nadeau: We are doing a lot of research on the economic return of spillovers and the direct impact. It's very difficult to boil it down to a figure.

Mr. Werner Schmidt: I appreciate the difficulty, but it seems to me that if the public purse is involved—it is—in NSERC, SSHRC, various other granting councils, universities, the Canada Foundation for Innovation, and things like that, and if we can show to the public, the academic community, and the business community that a dollar spent on research and development is going to return somewhere between 13% and 35%, then that's a worthwhile investment.

So is there any attempt to study to the point where you can show that dollars spent on research and development is really an investment? It seems to me that therein lies a large part of what needs to be done in our country.

Dr. Serge Nadeau: As I said, there's a lot of research that's being done on this issue. Also, government policy is in line with your statement in the sense that the returns on research and development expenditures have a high return.

Look at the Canada Foundation for Innovation, for example, and other government initiatives—that's consistent with what you mentioned. Also, the minister and the deputy minister, all the time when they meet businesses—we're involved in preparing presentations for them—they stress the fact that R and D is crucial.

Mr. Werner Schmidt: Okay. So if that is so clear, why then has the government embarked on a policy of reducing R and D expenditures? You see, that's where the contradiction comes in. We've now had, in the last budget, a bit of an increase, but all it has done is establish the previous level of spending. It's really inadequate.

It's no wonder we have some problems. If that's a key engine to drive our economy, then that's the last place you should cut rather than the first place to cut. That's exactly what has happened.

I'd like to register a caveat with you. When you do your research, I notice that when you compare on page 8 the amount of money spent—this is a comparative kind of thing, so we don't know what the actual numbers are—Canada spends the most in education and the least in R and D. Now one would think that there would be, if we're going to spend that much money on education, some sort of correlation between productivity and education.

We were told years ago.... Milton Friedman I think was one of the first ones who did a study on education as an investment and the return on that investment. Here we have a situation where we spend the most.... In fact we have the highest enrolment in post-secondary education, but our productivity is going down, so the correlation is a negative one here.

• 1745

I'm hoping that when you do your study, you discover what the connection is. There has to be some kind of relationship, because R and D is directly related to education.

Dr. Serge Nadeau: You are right in the sense that, yes, skilled workers and researchers are directly related to R and D, and of course education. But there are many other factors that are determinants of R and D and also many other factors that are determinants of productivity. As we saw earlier, while we have the highest rate of education, we had some problems and the investment rate was rather slow.

As I said, we do a lot of research on the determinants of R and D. For example, in Canada we have a large proportion of small businesses, and small businesses have a propensity to do less R and D than large business. That is an explanation that is often used to explain the fact that Canada does not do as much R and D.

Mr. Werner Schmidt: That's not acceptable. There's no way. I think we have to be very, very careful. It's too easy to escape this way.

There's the taxation level. There is the brain drain thing that's happening here. There's the composition of the kind of education that is going on. I think the mix was mentioned by my colleague, Ian Murray, just a moment ago. There's the fact that we have fewer science graduates. That mix is there, as well as the mismatch that I think you mentioned yourself earlier. I think it's very significant.

If we are going to have a document like this that's going to be the research foundation on which we, as legislators, ought to establish public policy, then we better have research that comes through with a clear indication. If there's one thing that's clear in this, it's that it's so fuzzy that you cannot build a consistent policy based on this. There is one thing over here. There is nothing over here. There is a contradiction over here. There is nothing being brought together.

I think this is a draft copy. It says it's a draft interim report here, so perhaps it's not complete. So I may be somewhat unfair, and I don't want to be that way. But I would caution you that when you present this kind of material to legislators, put it forward in such a way that we can see what's related to what and in what manner it's presented so that in fact we can come to a conclusion that makes some sense and can be supported by the research not only in one section of the paper, but all the way through.

The Chair: Mr. Nymark.

Mr. Alan Nymark: If I might make a comment on that, I think you are absolutely right in identifying what kind of incentives would make private sector firms recognize the value of doing business in a certain way, i.e., encouraging innovation within their own businesses. I think you're quite right that if you can clearly articulate the rates of return on investment in this area, then self-interest will lead to different behavioural responses in the business community.

On your issue of the relationship between expenditures on R and D and productivity performance, I think there's a consensus on that issue among researchers on a global basis. That's certainly so at the OECD. I think there's a consensus in the United States that this analysis at that level of R and D and productivity only gets you so far.

I would say the trend in research on innovation now is to move away from those kinds of aggregate figures of R and D and productivity and move down within the firm and investigate how successful firms mix their skills, innovation, capital, and management know-how into the successful formula on the shop floor. I would say that's where most of the research on innovation is going now. And the Department of Industry and other groups in the federal public service are definitely not only trying to keep up but be at the forefront of that kind of research.

• 1750

One of the problems with research is that since it's one part of the policy development process it often isn't conclusive. If there are problems in presentation then those can be fixed, but where research is inconclusive then I think, as you're suggesting, our job is to present the options and the array of possibilities in a way that is easy to understand for decision-makers who have to try to absorb this kind of material.

The Chair: Thank you very much, Mr. Nymark. Thank you very much, Mr. Schmidt.

Mr. Lastewka, please.

Mr. Walt Lastewka: Thank you, Madam Chair.

I want to discuss the same theme that Mr. Schmidt did. I want to go down a checklist of things that affect, for example, the lack of productivity.

The one thing that comes to my mind, and we've talked about it many times before, is our internal trade policy in Canada. It doesn't help for the productivity. I've been trying to get more and more people to quantify it for me. The amount of research on it, as far as I'm concerned, is insufficient, because I'd like to be convinced more.

What is the internal trade causing across Canada as far as our productivity figures are concerned? We've had discussions here before about standards when students graduate from university. If they get an accounting degree, they can practise here but they can't practise over there, and vice versa. That does away from doing things across the country.

What I was looking for is a menu of all those ideas that could help us to have more discussion on either side. Decisions would have to be made on which ones to prioritize and so forth. It would be nice to have that menu of things, those that help and those that hinder, when it comes to productivity so we could explore a larger avenue.

Mr. Schmidt, I think you were going along that line.

Mr. Werner Schmidt: I'd also like to have confidence that we're going to end up where we want to go.

Mr. Walt Lastewka: I'd like to hear any comments you might have on what the barriers of internal trade are really causing us now in productivity in the country. Do you have data on that? Do you have information on that? Do you have a cost factor on that? Have you done research on internal trade?

Dr. Surendra Gera: Actually at Industry Canada there are a number of papers that have been produced. For example, they look at what are the impacts on trade creation and trade diversion of the FTA, and what it did to internal trade. Did it take the trade away from provinces and extend trade with neighbouring states in the United States?

So we've done that research. As you're probably aware, the internal trade agreements are not yet complete; there are many sectors yet where the discussions are going on. This has been a continuous source for OECD, for example. In most of their annual reviews of Canada right from 1995 on they've been listing this progress as to what exactly Canada has done in terms of this progress over the internal trade across the provinces. As I said, recently, as early in the second week of May, we had a delegation from OECD, and one of the questions came up along the same lines—do we know what exactly it's going to contribute to the efficiency process and lead to productivity.

All we can say at this point is that theoretically obviously there's absolutely no doubt in our mind that to the extent that the distortions can be reduced across the provinces in terms of the production efficiency it should contribute to and enhance the productivity. I haven't come across any particular research at this point, but definitely it's a very important point, and the point is well taken.

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Mr. Walt Lastewka: I would probably take the attitude and say I don't believe there is a problem with internal trade, so show me what it does to loss of productivity. I think we need to see more than just a number. We need to see facts and effects of the productivity problem.

Mr. Alan Nymark: I first looked at the internal trade issue when I was a staff member of the Royal Commission on the Economic Union and Development Prospects for Canada in the mid-1980s. For the first time, we attempted to quantify the barriers internal to Canada.

The expert we used at that time was Dr. John Whalley, who is an international trade expert. We asked him to apply his econometric models, which are used normally on international barriers, to internal barriers. I think it is one of those frustrations Mr. Schmidt is referring to: the fact of the matter is he could not measure those barriers very easily.

In addition to theoretical evidence—which is lower barriers, greater economies of scale, therefore greater efficiencies, therefore higher revenues, therefore greater increases to national output—he added his preliminary international trade model analysis, which said lower barriers are better. But barriers were in the range of, I believe—this is 13 years ago, so don't quote me on it—about 1.5% of GDP. Although 1.5% sounds like a small number, 1.5% of GDP in dollars is a very large number. That was the range he was talking about at the time.

The business community at the time was not at all sure that econometric modelling of the size of the impact of these barriers was the way to go. So as I recall, the Canadian Manufacturers' Association did quite a massive study by surveying business people in terms of what the real problem is here.

If you're in the beer industry, what is the nature of the decisions you're taking vis-à-vis the building of your plants or the costing of your products because you have to have a plant in every province in order to sell in every province? That was the situation back in the mid-1980s.

Therefore you got, as economists would say, a lot of anecdotal evidence to say this is a real problem, and I don't care whether you can measure it or not; I'm telling you from a business strategy point of view that I cannot get the economies of scale.

On the beer issue, they said there was one brewery in Michigan whose vat was larger than all the vats in Canada put together, so its per unit costs were much less. It was that kind of evidence that was brought to the discussion by the Canadian Manufacturers' Association.

About three years ago the Canadian Chamber of Commerce also redid those surveys with the business community and then made representations to government about the value of this. So different kinds of evidence are being brought to bear on this issue.

I must say, back at the Macdonald commission time, there was an estimating of the cost of internal barriers at about 1.5% or 2% of GDP. The best guess by the economists we hired at that time was that this was significantly less than the barriers within the economic union but about the same as the barriers within the United States.

Sometimes in Canada we think there are very large—

[Translation]

Ms. Francine Lalonde: Between States?

[English]

Mr. Nymark: I'm sorry, that's between the states within the United States.

The Chair: Thank you.

[Translation]

Mr. Dubé, please.

Mr. Antoine Dubé (Lévis, BQ): Madam Chair, can I share my five minutes with Ms. Lalonde? I am going to ask three brief questions.

[English]

The Chair: No, Mr. Dubé, I prefer for you to ask one question at a time, because they have to have the time to answer.

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[Translation]

Mr. Antoine Dubé: Are the various numbers in the three documents you presented today available by province or by region? I know that you often say that there are five regions.

Mr. Serge Nadeau: In fact, the data on the national accounts has recently been revised, and the source of information is not the same for each province. When we have to analyse the performance of provinces or regions, it creates quite a problem. By the way, Industry Canada has just started researching the performance of regions, in terms of the knowledge-based economy. If you are interested in the outcome of this research, it will probably be available in six months to a year. We'll be pleased to share this information with you.

Mr. Antoine Dubé: Regarding governance, you explore the issue of what could be called the management of public affairs. You talk about intergovernmental relations. With which department or which council do you work on this? For example, do you work with the Council for Canadian Unity?

Mr. Serge Nadeau: Exactly which chapter are you referring to?

Mr. Antoine Dubé: Mr. Nymark raised the issue of governance and of provincial-federal and institutional relations. It's on page 12. How can the federal and provincial governments work more effectively with non-government partners? I would like to know with whom you are cooperating in this area.

[English]

Mr. Alan Nymark: As I indicated in one of my responses, we're now approaching all provincial and territorial governments to see how they would like to work with us. I think we probably talked directly now to about five. By the end of the summer, we will have completed our discussions with all provincial and territorial governments.

We don't have a fixed view as to how we should do that or improve that because each government may wish to do it a little differently. So we're open to suggestions.

[Translation]

Mr. Antoine Dubé: The Council for Canadian Unity is not involved?

[English]

Mr. Alan Nymark: Yes. As I suggested, there are some subject matters that frankly we haven't taken on directly. I think from a policy point of view, there are clearly federal-provincial aspects and unity aspects to probably all of these issues, but if you ask an economist, on the issue of innovation, to provide advice on the national unity aspects of that work, you're probably asking the wrong person.

[Translation]

Ms. Francine Lalonde: Let me continue. You say in the Introduction, on page 2:

Other elements of Canada 2005 deal with international and security issues, machinery and administration of government, national unity and the state of public opinion.

So other groups are working on these issues. That's what it says here. Your own group is doing some research on growth, human development and social cohesion and, now, globalization. That's it, right?

The issue of social cohesion has been raised. It's one of the three themes. You say on page 58:

This report underlines interdependence in policy making: social objectives cannot be pursued independently of economic capacity; and economic recovery cannot be sustained without progress on problems of human development and social cohesion.

That's what you state on page 58.

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When you do some further research, are you going to take into account what the government has done, first, maintaining a restrictive monetary policy, the new employment insurance which, we believe, made things worse as far as social cohesion is concerned, as well as the reduction of the Canadian social transfer which has also made things worse as far as health, education and social cohesion are concerned? Is this going to be analysed in the research which is going to be available in a few months?

[English]

Mr. Alan Nymark: At the broad, philosophical level, there's a lot of room for debate as to whether social responsibility and fiscal responsibility are compatible or competitive public policy objectives.

I'm not here to speak for the government; I'm here to speak for the researchers who put this together. I think that researchers, particularly on the economic side—that's my guess—would suggest that you can't have social responsibility without fiscal responsibility. So the issue then becomes whether you pursue them at the same time or pursue one and then the other.

I think that most of the time, governments try to pursue both objectives at the same time. However, in the 1980s and early 1990s, particularly in Canada, the fiscal responsibility appeared to get out of hand. A lack of dealing with fiscal responsibility was clearly leading in a direction that would not allow social responsibility. I think that preference was given to fiscal responsibility for a period of years.

That's presumably now changing. There still may be debates around that, but there's at least a capacity to treat both objectives at the same time on a more even balance, because we have at least made progress on the fiscal responsibility side. I have to say that this is a researchable issue, but it's probably a more political issue.

The Chair: Thank you very much, Madame Lalonde.

I want to thank the witnesses for being with us today. We've been waiting to meet with you, and we've been rearranging our schedule.

We regret that your colleague couldn't be with you, Mr. Nymark. Unfortunately, the committee was here and people were already in Ottawa, so we went ahead with the meeting. I appreciate your input and we look forward to meeting with you again in the future.

The meeting is adjourned.