INDU Committee Meeting

STANDING COMMITTEE ON INDUSTRY

COMITÉ PERMANENT DE L'INDUSTRIE

EVIDENCE

[Recorded by Electronic Apparatus]

Tuesday, February 15, 2000

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[English]

The Chair (Ms. Susan Whelan (Essex, Lib.)): I call the meeting to order, pursuant to the committee's mandate under Standing Order 108(2), a study concerning productivity, innovation, and competitiveness.

I'm very pleased to welcome all of our witnesses here today. What I would propose is that we have opening statements from each of the different groups or representatives, and from there we'll go to questions in a round-table format, where a question is addressed to either the entire panel or to one person. If you want to participate, just signal or indicate to the chair, and I'd be more than happy to accommodate that.

I have a request that Peter Drake from the TD Bank Financial Group go first.

Mr. Drake.

Mr. Peter Drake (Vice-President and Deputy Chief Economist, TD Bank Financial Group): Thank you, Madam Chairman.

I don't know whether my handout has been distributed.

The Chair: Yes, it has.

Mr. Peter Drake: It would be very helpful if it were, because my brief remarks are illustrated in the handout.

I'm going to talk briefly about some aspects of productivity: its recent performance, how it relates to economic growth and investment, where Canada stands in relation to its most important trading partner—the United States—and how strong and improved productivity growth could make a significant contribution to improving Canada's eco-efficiency and its environment.

Turning to the handout, the first chart shows the compound annual economic growth during the 1990s for each of the G-7 industrialized economies. The chart shows that Canada's economic performance, along with that of Germany, ranks second among the G-7 economies, after the Untied States.

However, Canada's economic growth in the 1990s—at 2.1% per year—was in fact the worst performance in four decades. It was hurt by a restructuring in the private sector early in the decade, necessary to move toward the efficiency and competitiveness required in a global economy. And our economic growth was hurt by a retrenchment by governments, beginning in mid-decade, necessary to reduce and eliminate their deficits and to begin to pay down their debts.

The gap in growth between Canada and the United States is significant. Historically, the Canadian and U.S. economies have grown at about the same rate. For example, in the 1980s the U.S. only slightly outpaced Canada, growing 3% per year compared to Canada's 2.9%. It raises the question as to why the gap opened up and whether Canada will continue to fall behind the United States.

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The second chart shows TD's economic forecast for each of the G-7 economies in 2000. Despite the dismal performance for the decade as a whole, economic growth in Canada began to pick up in the second half of the 1990s, and this year we expect that Canada will lead the G-7 economies and will outperform the United States for the first time in five years.

One of the differences in the growth in the two countries will be consumer spending, which accounts for approximately two-thirds of economic output. In Canada, we expect that rising employment, rising wage rates, and some further reduction in the personal income tax burden will allow consumers to accelerate their spending. In the United States, rising short-term interest rates and diminished stock market gains will cause consumers to pull back on their spending.

Growth in western Europe is picking up, while growth in Japan, we think, will continue at last year's rather sluggish rate. Productivity is more likely to improve when an economy is growing rapidly, so this year's expected economic performance places Canada in a fairly good position to improve its productivity.

The next chart shows the level of pre-tax corporate profits for each year in the 1990s, and profits as a percent of nominal gross domestic product. As the chart shows, pre-tax profits began to recover in the latter half of the 1990s, both actual profit levels and profits as a percentage of gross domestic product. We expect further profit gains this year and next—this year about 12%, next year a little more than 5%—in light of the further recovery in commodity prices and continued strong demand, especially in U.S. markets for Canada's exports.

Profits are related to productivity in the sense that they're necessary for investment to take place, and investment is a necessary ingredient for productivity gains.

The third chart shows the levels of investment in machinery and equipment as a percent of real GDP, and I should point out that machinery and equipment include things such as high-tech advances like computers and related items.

Investment in machinery and equipment is certainly an important driver of productivity growth, though it is by no means the only one. The level of investment in machinery and equipment in Canada actually declined a little in the first half of the 1990s, but a strong pickup in the second half of the decade enabled it to rise for the decade as a whole by nearly 90% to about $73.5 billion in 1999, and we expect it will exceed $83 billion in 2001. As a percentage of GDP, it rose from 5.3% in 1990 to 8.5% in 1999. We would expect it to reach about 9% in 2001.

Over the page we turn to productivity, and the first chart shows the compound annual growth in real output per hour worked for the 1980s and 1990s for Canada and the United States. Now, there are several ways of measuring productivity, and this is just one. This one measures labour productivity across the whole economy, and it does reflect the influence of virtually all of the factors that determine productivity, such as economic growth; investment; infrastructure; education; and public policies, such as tax policies and regulatory policies.

As the chart shows, the United States dramatically outpaced Canada in productivity growth in both the 1980s and the 1990s, but Canada did do a little better relative to the United States in the 1990s. More specifically, in the 1980s, Canadian labour productivity output per hour worked grew at 0.7% per year. In the United States it grew at 1.8% per year. In the 1990s, Canada improved to an average of 1.1% per year. The United States maintained its previous pace of 1.8%.

The next chart shows levels of productivity on a comparable basis in Canada and the United States during the 1980s and 1990s, using the same measure of productivity as in the previous chart. Canada's labour productivity was significantly lower than that in the United States 20 years ago, and the gap has widened since then.

Specifically, in 1980 Canadian productivity was about two-thirds of that in the United States. By 1990 it had fallen to about 62% of that in the United States, and by 1998, which is the last year for which we have data, it was a little less than 59%. So in this sense, Canada has two productivity problems: its productivity is lower than that of the U.S., and its productivity continues to grow more slowly than that of the U.S.

The U.S. has benefited from tremendous growth in technology industries, many of which Canada lacks. These structural differences account for much of the productivity gap. You can't change this difference in structure—Canadian reliance on resources versus U.S. reliance on technology—in the very short term, but productivity gains can be achieved in virtually any industry.

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The good news is that Canada's recent strong record on monetary and fiscal policy means a better climate for investment and for productivity gains than was the case in the earlier decade. Ideally, we would raise productivity levels in Canada faster than in the United States. Much more realistically, what we could hope to do is improve on Canada's past track record; for example, try to aim for something in the order of an average annual increase of 1.5% in the current decade.

We point out in our little text box on productivity challenge that there are some things we think we can do. We think the federal and provincial governments must lower tax rates to enhance Canada's tax competitiveness, especially on the personal income tax side vis-à-vis the United States.

We need to put in place policies that will promote a well-educated, well-trained workforce and create a more favourable climate for investment. Canadian governments must keep budgets roughly in balance to keep the government debt-to-GDP ratio on a downward track. Overall, we think these measures will help boost productivity, certainly a required step in order to raise living standards in Canada over the next decade and improve on the very dismal performance in the last decade.

The environmental challenge is to raise productivity gains and living standards, but that can also help Canada meet its environmental challenges. After all, productivity gains are essentially about doing more with less. Not all productivity gains are necessarily helpful to the environment, but if the economic backdrop is encouraging to productivity gains, it will be much easier to promote the specific productivity gains that will be helpful to an improved environment.

One of the things we are thinking about is the specific commitment that Canada has made under the Kyoto protocol. Obviously some of the industries are going to have some difficulty meeting these emission reductions, and we will be looking with great interest to the federal strategy, which we expect late this year or early in 2001. Again, overall, I think the fact that our economy and government finances are in the best shape of the decade will certainly help us with this challenge.

In conclusion, productivity gains can certainly help Canada meet its environmental challenges. We think the backdrop is certainly an excellent one to proceed on that, but quite clearly, it's not going to happen automatically. We're going to have to work at it.

Thank you. I look forward to hearing the other participants and to participating in the discussion.

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

I'm now going to turn to the National Round Table on the Environment and the Economy, with Dr. Stuart Smith, the chairman, and Mr. David McGuinty, the executive director and chief executive officer.

Dr. Smith, please.

Dr. Stuart Smith (Chairman, National Round Table on the Environment and the Economy): Thank you very much, Madam Chairman.

We have decided that both David McGuinty and I will answer questions afterwards, but I will make the presentation on behalf of the round table.

As you know, the round table is a multi-stakeholder body that brings together people from industry, environmental groups, labour, academia, and first nations. We've been doing work on eco-efficiency, which basically means we've been developing, together with industry, standardized measures by which industry can report on how efficient it is being with the use of energy and material. This is a very important concept. Industry is very interested in it, and it has great implications for Canada.

There are two points I want to make in my address this morning. The first is that we should not be totally focused on labour productivity, because there is a move afoot toward total factor productivity. By the way, I have no disagreement with what Mr. Drake has said. I agree with everything he has said, but I think we should realize the limitations of labour productivity as a measure.

The second point is that the move towards total factor productivity represents a very serious threat to Canada's economy, and particularly makes it even more imperative that we move to diversify that economy and make it less dependent on natural resources, although obviously resources will be important to this country for the foreseeable future.

Much of the work we have done has been informed by the opinions and research of Amory Lovins at the Rocky Mountain Institute, the World Business Council on Sustainable Development, in Geneva, and investment specialists who are tracking shareholder value. As you may know, shareholder value in recent years has proven to parallel fairly well the degree of environmental consciousness that firms have been exhibiting.

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Let's talk about total factor productivity, if we might. We all know the traditional factors that make up an economy are capital, labour, and land. The third factor, land, really represents everything nature provides. It's the natural environment. It includes both natural resources, renewable and non-renewable, and the ability to absorb wastes, or if you like, the regenerative capacity of the environment. That's a factor that is never talked about, because all the productivity figures we hear have to do with output per hour worked, output per person hired, output per week of employment, or whatever.

The problem with that is it's a derived number. Nobody runs their business that way. Nobody actually figures out from day to day how they're doing on output per employee, unless it's a very standardized business that's been around for donkey's years. Generally speaking, people want to know if they're making any money, if they're getting a return on investment. If anything, it's the output of capital on capital they're interested in, the productivity of capital.

But now there's a movement toward taking an interest in that third factor, that land factor. People are now saying: Can we make more money by reducing the amount of material we use? Can we make more money by reducing the amount of energy we use?

In the old days, return on investment and labour productivity pretty well went together, because mostly what you were doing was substituting new machines for old people. Therefore the two figures tended to go together. But not now. There are companies now—and I'll give you some examples—that are substituting people and new technology, people and new knowledge, for materials. So the labour productivity number may not look that terrific, but the total factor productivity number and the amount of money they're making look a whole lot better.

That's very important for us to understand, so that we don't become fixated on labour productivity as the main focus of our interest. Although labour productivity does give you a good idea of what happened in the past, it's a derived number. You find out at the end of the year how the country has done on labour productivity. Nobody knows while it's happening, because the companies don't measure this. That's not how they operate.

New technology is converging with freer and more competitive markets and with new forms of specialization to allow the substitution of knowledge, and to some extent services, for materials and energy. If you look at the U.S. and German economies, you'll find that both of them in the last five years have diverged from their previous path of reliance on energy.

GDP and energy used to go together. The last five years, they've separated. GDP is continuing to go up, and energy has flattened out. This has happened in both those economies. There is less dependence on energy, and for that matter, I will argue, less dependence on material as well, and we'll see some reason to believe that.

Realize how important this is for Canada. This is a terribly important trend that we have to pay attention to.

The productivity of natural resources is increasing, and that is a very important thing to realize. Sometimes the firms that do this are being driven to improve environmental performance. They may see that the carrying capacity of the biosphere is limited, they may see that down the road limitations are going to be put on them by international agreement or by government regulation, or they may worry about consumer demand or investor opinion. For various reasons, they're improving their environmental performance.

But frankly, I would argue in most instances that's a by-product. In most instances they're making changes to save money to respond to international competitiveness demands. The fact that they're helping the environment is trumpeted, and they're rightly proud of it, but it wasn't their main reason for doing it in the first place.

So what's happening is you have this drive to achieve efficiency, not just from labour, but from all the materials and energy the firms are using. I'm just going to put four examples in front of you.

There's a movement now toward small-scale, distributed energy generation. Particularly in the western provinces, people will be very familiar with that. The reason for this is you now have new materials from which you can make new efficient micro-turbines, or even small, not necessarily micro, but mini-turbines. As a consequence of that, you can set up your energy generation, mostly using natural gas, but you can set up your energy generation and avoid wasting the heat, because now it's small enough that you can make use of the heat locally. You can also avoid the need for transmission lines and all the losses that occur, plus all the materials that are required. That's one example.

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Another example is, as you know, manufacturers are increasingly being required to take life-cycle responsibility for what they produce, and they're saying to themselves, “Well, if I'm stuck taking responsibility for this thing from cradle to grave, maybe I ought to hang onto this. Maybe I ought to have a second look. Maybe I shouldn't hand it over to somebody else, and then I have to pick up his mess.” So they're beginning to understand that they're not really selling the product, they're selling the service that product brings. Consequently, they're starting to reorganize the way they do business.

An example is Interface Carpets, which I'm sure you've all heard of. They don't sell carpets any more. They sell a floor covering service. They come into your office, put down carpet tiles, which they own, and from then on, whenever they get worn out, they come in at night and replace those tiles. They don't just take up your whole office, disrupt your business for a week, put new surfaces and new glues and solvents into your place. They just replace the tiles. The consequence at the end of the day is that there's much less going to landfill and much less waste. They take back the old tiles and recycle them to the extent they can. Essentially, they're in the covering service business.

I'll give you another example, which is Xerox. Xerox figures that if they're going to take responsibility for their machines from cradle to grave, they won't even sell them to you in some instances. They won't even lease them to you. It's their machine. They'll provide you with documents. That's what you really want: documents. Since they have control of these machines and are stuck with them anyway, they now have an incentive to reuse all the parts they possibly can. So they design their new machines to use as many of the old parts as possible, refurbish the old parts, and keep recycling them over and over again. The net result is that they have to buy much less in the way of material. But they're providing a document service now as opposed to selling you a machine.

Another example is Dow Chemical with Safety-Kleen. It used to sell you tonnes of solvents you could degrease your machines with. What Dow Chemical and Safety-Kleen are now offering people is a degreasing service. They'll come in and do the degreasing for you. They'll take responsibility for the solvents. They'll take them away with them at the end of the day.

So what's their incentive? They make more money the less solvent they use. Now they're offering you a service. They get paid per unit degreased. They use their expertise in degreasing. They know exactly the right amount of solvent. You don't have to train all your employees about the safety aspect of each solvent. They know all that. It's their expertise. They take the responsibility to deal with the environment. You don't have to worry about inspectors bothering you. So it's a great service for you, and it saves you money. Dow makes more money by selling the expertise of their people than they do by selling solvent. Now they use much less solvent. They've also learned how to take back the used solvent and redistill it to use a second, third, and fourth time.

Now, there are many examples like this, but we don't have time for them all.

The implications for Canada should be obvious, including a long-term continuation of the decline in terms of trade, that is to say, relative prices, for our resource products, because we're going to be continuing to put out a product that people are learning to do with less of. That has been the case. We said this at the Science Council back in the 1980s. We told the Macdonald commission that technology was going to substitute for materials, but they didn't believe it. Now it's becoming very obvious not just that technology is substituting for labour, but that technology and labour together are substituting for materials and for energy. This is very important to a country that is a producer of those two items.

Resources are currently enjoying strong demand. I'm personally investing in them at the moment, but let me tell you that's not going to be for the long term. Resources always go up and down. They're always cyclical. When they're up, we think we're on top of the world, but when they go down, we realize that the long-term trend is downward. That is going to accelerate. It's not going to stop, because of the factors I've pointed out.

In conclusion, total factor productivity, which includes the productivity of resources, is coming. It's here. It maximizes shareholder value. For Canada it means we must increase our presence in knowledge-intensive industries and further reduce the degree of dependency on natural resources.

Labour productivity numbers are limited in what they tell us about the economy. It's mostly a historical look at the economy. The real problem is that when you're in the wrong kind of businesses, the aggregated labour productivity numbers come along later to confirm that. But for that matter, so does the value of your currency. So it doesn't take a genius to figure out that we're in the wrong type of business. We just have to see what the world thinks of our dollar, and that tells us enough. Labour productivity, generally speaking, will not say much that's different from that. To the extent that people are used to provide specialized services, then labour productivity statistics might even be less useful than in the past.

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The final word is that we're already moving in government and in companies to increase this country's presence in knowledge-intensive enterprise, but there's a need for much greater emphasis on entrepreneurial development and application of new knowledge-based products throughout our economy, and there's room for using those in all parts and all sectors of our economy.

Thank you very much.

The Chair: Thank you very much, Dr. Smith.

I am now going to turn to the Canadian Institute for Advanced Research, Dr. Fraser Mustard, the founding president and Bell Canada fellow.

Dr. Fraser Mustard (Founding President and Bell Canada Fellow, Canadian Institute for Advanced Research): Thank you. I hope you all have a copy of this. It's rather nice to follow Peter and Stuart. Peter has emphasized that our productivity has been a question and still is. Stuart has raised the question of total factor productivity, which I'm also going to use.

I come here using knowledge that I obtained from three programs of the institute: health, human development, and economic growth. Just to say it bluntly, your health and well-being are primarily determined by where you live and work throughout your life cycle. The quality of that social environment is ultimately determined by what your economy is like. Those two things are hubbed powerfully together, and if you're thinking about sustainable environments, both physical and social, these are pretty fundamental issues that tie to the economy. That is the basic theme I'm going to give you.

The first chart is a quote from The Economist magazine saying “Economic Growth, Explaining the Mystery”. We started a program on economic growth in the institute because neo-classical economics really could not cope with the power of innovation in changing economies. The essay in The Economist magazine is extremely important.

There's a book at the back end of this document that comes out of that program, which says that the public policies that relate to innovation are fundamentally different from the public policies that relate to business cycles. Governments have a huge problem trying to cope with that issue. It's an interesting essay, and I'm pleased to see they identified the institute in terms of Paul Romer's book.

The next chart is taken from Fogel, a Chicago economist, a historian, a Nobel Prize winner. What he plots here is the population of human beings on the planet over a long period of time. He notices a huge break point that coincides with the Industrial Revolution. One of the things this demonstrates is why death rates dropped. They dropped as a result of the improved prosperity in the west. It was not due to medicine and it was not due to public health; it was due to a direct effect on early childhood. We'll take you through all of Fogel's work on that. That's an extremely important message.

The second thing you'll notice with that chart of population growth that faces the world and Canada is that the speed of new knowledge development—which Stuart is referring to—and technology change is exponential. Very few things are put on this chart in terms of what's taking place, but basically you are in a globalized world with a huge population that is faced with its challenge of how you take new knowledge and use it, and Canada has been fundamentally weak in that exercise. You have to see yourself within this very global pattern of changes taking place.

The next chart—I put this in, but Stuart has made life easy for me—indicates that if you try to measure technological change and economic growth, you have to slip to something like total factor productivity. This chart is from Paul David's work looking at the transition from steam power to electricity as an energy source for U.S. industry. Electricity starts to kick in about 1890, but it takes about 40 years before steam power is totally taken out, and during that transition of this major technological change total factor productivity goes flat.

The average wages for people in the middle income and lower tend to go down after we standardize. So we know there are profound effects on people in these changes.

I didn't know Stuart was going to make the pitch, so I dragged along a quote from Moses Abramovitz, who should also have had a Nobel Prize. He was puzzled, as a trained economist, as to how you measure the power of innovation in changing economies, because it's the biggest single driver. Moses says total factor productivity is it. I reinforce exactly what Stuart says, and I would plead with the Government of Canada to start making sure that measure comes out more often in our statistics. I'd include the banks in that plea as well.

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Fortin and Helpman are two economists. One is at Harvard and the other at the Université du Quebec. They did a plot on total factor productivity for Canada. You see it in the next chart. It matches everything Peter said in terms of that. It tends to go flat around 1975, and that's about when our standard of living starts to slide down. We don't become poor, but we don't grow in relative wealth. Therefore our attempts to sustain publicly financed instruments get cut way back in our system.

The next little chart is an interesting one for you to think about. It's an old chart that I've used many times. It really comes out of book 2, chapter 3, of Adam Smith. Adam Smith talks about productive and unproductive labour. My economic colleagues did not like Paul Romer showing me that particular chapter.

It's an interesting chapter, because unproductive labourers are called physicians. Smith is rather negative about physicians. He calls us menial servants. I felt that was kind of insulting. Nevertheless, he includes lawyers. How many of you are lawyers in the room? Good. Well, you've joined the menial servant class. He also included opera singers. Of course the basic point he's making is that the wealth a society generates from what I will call its traded goods and services, on the left-hand side, generates the wealth that allows you to do other things that aren't primary drivers on that instrument.

If you think of the new concepts of economic growth, that chapter in Adam Smith is enormously important. I'm not talking about business cycles when I talk about that. If you want to think about the challenge, the upper left-hand box, which is scaled approximately to where people worked in Canada 10 years ago, is the box you have to be concerned about. How well is it doing? How well it's doing drives what's going to take place.

If we take Sudbury, when they stop mining nickel in Sudbury, they're going to have to put something else in to generate the real wealth base for Sudbury. To Inco's credit, it has virtually automated its mining techniques. It cut back its labour force, but it still becomes increasingly productive because it has applied the new technologies into it. The challenge for all societies is how you operate that system.

The next one simply shows you a Government of Canada document. If you assume that our productivity went flat in total factor productivity around 1975, the fat cats—most of us in this room over 45—have done all right. We've tended to sustain our wages. But those of you who are young haven't done as well. That's basically the kind of change that gets caught when you're in this.

If you want to think about this as a technological change, we talk about computers, but the best way of thinking about it is as an analogy to the Industrial Revolution, which used fossil fuels as an energy source to replace muscle power, which changed societies. This is a chips-for-neurons revolution. It's really a way of putting into total systems low-level intelligence functions, which transform everything you do.

It's interesting that Martin and Porter, in the document they released in January, pointed out, as I think Peter was saying, that we've improved our macroeconomic indicators but we really have not gotten our increased productivity. Our standard of living relative to the rest of the western world, at least, has declined. That's an important point.

Trefler, who's in the CIAR economic growth program, points out that we have very low business R and D expenditures. I think it goes back to Stuart Smith's days with the Science Council. It goes back to the National Advisory Board on Science and Technology. We basically have not created the industrial capacity to make the investments for that purpose. In Canada there's really a poor commercial uptake of new knowledge and a slow rate of new technology adoption.

How do you change from a replication economy to an innovation-driven economy? You have to change your tax structure, the corporate tax structure. I'm a firm believer that the capital gains tax on investment in real innovation businesses should be removed, whereas the capital gains on making money playing with money, what I call fiscal roulette, should be increased. Our incentive structures are fundamentally wrong, and our governing instruments have not really picked up that challenge.

If you're going to have a geopolitical entity called Canada in a knowledge-based world, you have to learn how to create national cluster capability. Let me emphasize that. If you can't create national cluster capability, you won't have the manpower base to drive a new knowledge-based economy. Fortunately, the revolution in communications and transportation makes that possible.

Let me just digress for a moment. I hope somebody has come to you and talked about the national centres of excellence program. That was started in the last decade, or the 1980s decade, to be quite straight about it.

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That program was designed to build national clusters in key knowledge fields, and it has worked. You have groups of people in universities and research laboratories across this country working collaboratively on frontiers of knowledge.

All of that was supposed to build new businesses. However, look at the next chart, which looks something like a Greek temple. I happen to chair the board of one of these, so I've lived through this. We have done nothing about creating the microeconomic environment, if I can use that language, to take that knowledge and put it into businesses. We simply are a disaster at that.

If you as politicians are interested in having some reason to sustain a geopolitical entity called Canada in this rather horrendously changing world and you want to be able to create wealth, you have to focus on how you create a microeconomic environment to transfer that knowledge into productive instruments in different regions of the country. It can be done, but nobody talks about it, and I would recommend highly that you spend some time exploring this particular story.

Next, a little bit of self-interest in that I happen to be on the board of Ballard Power Systems, and I just want to bring out a little story here.

Why are fuel cells being developed in Canada? Well, an entrepreneur by the name of Geoffrey Ballard decided he could make it work. He lived a threadbare existence until a venture capitalist from Ventures West came in behind him. But that still wasn't going to get that anywhere.

It's very interesting in terms of what Stuart Smith said. The head of Daimler in those days recognized that automobiles using internal combustion engines would not be very popular in European cities in the future. They had already started to invest in fuel cell technology. Fortunately, Geoff Ballard was way ahead of them, which led Daimler to invest in Ballard.

What that means in the global system is that here is a potential user of the technology, not based in Canada, tapping into something that's been developed in Canada. I happen to believe it's ecologically sound and it's enormously important, because you could replace buses in Mexico and Toronto and so on and strip away all the environmental effects they currently produce by way of their current systems.

The next point in this that Canadians have to be alert to is that other business leaders do this. The new chairman of the board of Ford, William Clay Ford, Jr., decided to shake up this stuffy board. He said they were going to become an ecologically sound company. Eureka for an automobile company, but that's what he said. He said they were going to go into fuel cells. Guess who knocked on the door of Ballard? Ford.

So Ford and Daimler are both investors in Ballard. They don't control it at the moment, but that tells you something about what's taking place.

Now, what that means is that if Canada creates capabilities in certain areas, then people from outside Canada will actually come and knock on your door if you're smart enough about how to do that.

I have a little funny note here. You'll notice The Economist magazine writes rather positively about it, but I thought you should see the Globe and Mail's January 13 editorial, written by somebody who knows next to nothing about fuel cells, I suspect. When he says fuels cells are difficult to repair, you wonder if he's ever seen a fuel cell.

How many of you have ever seen a fuel cell? They're simple devices, extremely simple devices. Powerful technology goes into them. But if a Canadian so-called national journal can't get his story straight when the rest of the world can, there's a very significant media problem that this country has to face up to. Until you can generate a capability to tell the true stories of what Canadians do and not totally rely on people outside, you'll have a great deal of difficulty moving our economy forward.

I just wanted to emphasize that point. Stuart knows it better than I do.

Let me conclude with a little chart. As some of you know, we did a report for Mr. Harris on early childhood effects on learning, behaviour, and health throughout the life cycle. I won't bore you with that, but you do have a copy of the second chapter of that report, which is the economic argument with regard to why this is an equally important side of the environment issue.

Societies that know how to invest in societies that support early childhood development will have literate, numerate societies. I won't take you through all the details. We pointed out to Mr. Harris that Ontario is behind the rest of Canada, which is a very important, significant point for him.

What the chart shows you in terms of your brain, which is the instrument by which we use the new knowledge, is that it is most malleable in the early years. The payments that you and I make in our society—overcoming disabilities, training labour forces—kick in on that solid line, and just remember one thing from my presentation: the primary determinant of the health and well-being of all of you in this room, in terms of physical and mental health, is what happened to you in the first six years of your life.

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So if you package all that together as a committee, you have to make your challenge to get this point out and to get it out in a way that makes sense to Canadians, because they're quite responsive to it.

I hope we will see sound recommendations from this committee for the future.

Thank you.

The Chair: Thank you very much, Dr. Mustard.

We're now going to turn to the Institute for Sustainable Development, with Colin Isaacs, president, Contemporary Information Analysis Ltd.

Mr. Colin Isaacs (President, Contemporary Information Analysis Ltd.; Institute for Sustainable Development): Thank you very much, Madam Chair and members of the committee. It's a pleasure for me to be with you this morning and to have the opportunity to talk about eco-efficiency.

I should first say that I hold a number of volunteer appointments, including the chair of the national policy forum of the Canadian Environmental Industries Association, but my remarks this morning are entirely my own and are not representing any particular organization.

I should also say that I have no disagreement with the key messages presented by the previous speakers. I think you'll find a high degree of agreement among all of us.

The link between environmental performance and economic performance has been the focus of a great deal of attention since the World Commission on Environment and Development. The Brundtland commission produced its report, Our Common Future, in 1987. That report defined the concept of sustainable development as development that “meets the needs of the present without compromising the ability of future generations to meet their own needs”. Since 1989, my company, as one of many organizations around the world, has been turning that concept into practical strategies for business and government.

There is a large number of sources of information documenting the link between environmental performance and economic performance. Perhaps one of the most significant for Canada was the 1991 report, Canada at the Crossroads: The Reality of a New Competitive Environment, prepared by Professor Michael Porter.

In that report, Professor Porter said:

...stringent standards and regulations for product performance and environmental impact can create and upgrade competitive advantage by pressuring firms to improve product and process quality. Further, standards that anticipate international trends often have particularly beneficial effects. Canada's record in creating more sophisticated demand through strict, anticipatory standards and regulations is mixed. With some exceptions, environmental standards have rarely been at the forefront of international practices, with the result that such industries as pulp and paper are having to undertake substantial investments simply to catch up.

While the last decade has shown us that incentives and economic tools may be more effective than regulations in achieving enhanced environmental performance, the core of Professor Porter's message—that environmental performance leads to higher economic performance and that Canada's record in this area is mixed—is still valid.

The concept that a company and a country can profit from pollution prevention is not unexpected. Waste, whether in the form of garbage, air pollution, water pollution, or release of hazardous materials inevitably represents a loss of those raw materials that went into production of the waste, along with all of the inputs—energy, water, and so on—that were consumed during production of the waste material. Eliminating waste means that raw materials are being used more efficiently and that fewer inputs are required for manufacture of the desired product.

However, the nature of our economy and of our industrial sectors means that implementation of pollution prevention is not always as simple or as obviously profitable to the company as my example might suggest, hence the emergence of innovative engineering technologies and knowledge-based service industries designed to assist industry and government in achieving the pollution prevention challenge.

Today, Canada's environment industry is a major engine for job and wealth creation. It helps traditional industries achieve their environmental and economic goals and contributes significantly to Canadian productivity. It's also arguably one of the most important sectors of our economy in terms of enabling our nation as a whole to meet its obligations arising from international accords, such as the Montreal protocol on ozone-depleting substances, Agenda 21, and most recently the Kyoto accord.

• 0945

The environment industry in Canada today consists of over 5,000 companies with annual sales in excess of $19 billion, or 2.2% of Canada's GDP. Canada's environment sector employs about 220,000 people, making it the third-largest employment sector in Canada, following pulp and paper and the chemical industry. It's a knowledge- and technology-based industry. In the environment industry, 50% of workers have a university degree or college diploma. Environmental companies are located in every region of the country, and exports exceed $1 billion.

Many of Canada's environmental companies add value to society as a whole by providing jobs and economic growth in local, provincial, and regional economies; by protecting, preventing degradation to, and enhancing local ecosystems; and by improving the quality of life of Canadians by reducing harmful pollutants that may damage health.

However, it's clear to those of us who work in sustainable development and environmental management in Canada and in the international arena that Canada is not a leader in this field. This may already be having an impact on our competitiveness in environmentally sensitive consumer markets such as those of many western European nations, and its impact will increase in the future.

As the value of the Canadian dollar rises against the U.S. dollar, the importance of cost savings from eco-efficiency will increase for the Canadian economy. Unless we are aggressively implementing eco-efficiency initiatives, as others are already doing, including especially energy efficiency, waste reduction, and pollution prevention initiatives, we can expect that our products will become increasingly less competitive, even in our largest market. U.S. companies are currently implementing eco-efficiency initiatives at a more aggressive rate than Canadian companies.

One of the measures of eco-efficiency is implementation of environmental management systems in the private sector. The world standard in environmental management systems is known as ISO 14001. As of August 1999, Canada stands 22nd in the world in terms of total number of companies with ISO 14001 certification—well behind Japan, with 2,338 certifications; Germany, with 1,400; the U.K., with 1,009; and the U.S., with 480. According to my sources of data, Canada had just 100 ISO 14001-certified companies by August 1999.

When calculated per unit of gross domestic product, our ranking is even worse. We're 34th in the world in terms of ISO 14001 certifications per unit of GDP—behind all of our major competitors and behind such countries as Korea, Thailand, Brazil, and Mexico.

Some will argue that our poor showing is unfair, because many companies have implemented environmental management systems but have not had them certified to the ISO 14001 standard. While there is some truth to that, our showing in terms of ISO 14001 implementation is so dismal that even if we had twice the reported number of ISO 14001 companies, we would move only a few places up the scale. To become a world leader in corporate environmental management, and hence to become environmentally efficient and to reap the resulting economic benefits, we need to encourage at least six times as many companies to adopt the ISO 14001 environmental management system or its equivalent.

I would add that I was told by a representative of the Standards Council of Canada yesterday that several thousand companies in the United States are poised to implement ISO 14001 EMS systems within the next two years. There's no such waiting list for companies in Canada.

We must obviously ask why Canadian companies are falling behind in environmental performance compared to companies in other countries if it represents such an economically sound strategy. My experience suggests a number of reasons.

There has been very little leadership or encouragement in Canada for improved environmental performance within the domestic economy. Encouragement does not need to be financial, but could be such initiatives as improved access to government procurement for companies that are ISO 14001-registered, mention in ministerial speeches, prestigious awards, and so on.

• 0950

In the United States, senior political leaders have been explaining the merits of the sustainable development and pollution prevention approaches for several years. It's clear that this has resulted in a higher priority for corporate environmental performance in that country in comparison to Canada during the most recent time period. The same thing can be said for western Europe.

Secondly, business leaders in Canada still expect command-and-control regulations from government, and they're waiting for government to tell them what environmental requirements must be met. Although Canada is nominally moving away from command-and-control-type regulations, the reality is that progress is very slow, and business has been burned in the past because early-action voluntary initiatives have not been recognized when government has subsequently introduced mandatory requirements. To a large extent, this has occurred at the provincial level, but few business leaders differentiate between being burned by federal or provincial environmental regulations.

Thirdly, most Canadian business schools are not yet teaching sustainable development, and few business leaders grasp the business opportunity it represents. Similarly, few financial houses give recognition for advanced environmental performance, although this is beginning to change, particularly in U.S. and European capital markets. Some of you may be familiar with the Dow Jones sustainability index that was recently introduced.

Finally, in Canada, industry associations have sought to control and limit the environmental agenda of their sector to a much greater degree than in the United States or western Europe. In these countries, environmental performance has been a factor in domestic competition for at least 10 years, and major corporations are accustomed to the concept of competition based on high environmental performance and eco-efficiency. Developing countries and economies in transition are learning more from the European experience than from the Canadian experience.

To conclude, I have four recommendations that the committee may wish to consider: first, that the Government of Canada implement an environmental regime that gives recognition and encouragement to environmental leadership and voluntary action by individual companies; second, that the Government of Canada encourage the adoption of advanced environmental management systems by Canadian industry in the same way as European and United States government agencies are encouraging such practices; third, that the Government of Canada adopt a green procurement program that gives the advantage to suppliers who can demonstrate advanced environmental responsibility, all other factors being equal; and finally, that all Canadian industrial and economic development strategies and programs, whether focused upon the domestic or the export markets, give priority to those companies and organizations that can demonstrate the highest standards of environmental performance.

Thank you very much.

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

We're now going to begin with questions, with Mr. Penson, please.

Mr. Charlie Penson (Peace River, Ref.): Thank you, Madam Chair.

It's a very interesting panel this morning. Thank you for coming and making presentations.

I have an observation that may be totally out to lunch, but I'd like your reaction nonetheless.

Several members of the panel have talked about the switch to knowledge-based, more service-based industries, bumping the commodity-based sector in terms of importance in many countries—Canada, the United States, and the European Union, for example. But I wonder if that isn't just a sign of a more mature economy. We still are pretty dependent upon resource-based extraction in many other parts of the world, so it's just a shift from countries like Canada to third world or developing world countries. We still require those natural resources; it's just that Canada and other countries like Canada are taking advantage of a more mature economy in terms of providing services to that sector, and we're not really shifting the total global impact in that regard. So that's my first question.

I think it was Dr. Mustard who talked about the poor uptake of technology for Canadian business. My second question would be: What would you say? How much is government policy responsible for that? Therefore, the follow-up question would be: Is there something government can do? I noticed Pierre Fortin talks about, in terms of productivity, lack of productivity and the divergence between Canada and the United States, our needing to reduce taxes and pay down debt, for example. So I put that out to you: How much can be done by government in these areas?

• 0955

The Chair: Who wants to start? Mr. Smith.

Dr. Stuart Smith: I don't mind starting. There's no question that there is a natural resources sector and there always will be one in the world. Canada can certainly do well to become the experts who service that sector, wherever that sector happens to reside. We have excellent companies doing that now, based on the latest technologies, many of which I'm sure, you're quite familiar with.

Having said that, there's also always going to be a market for cheap labour in the world. The question is, does Canada want to be the country that seeks to meet that particular need? The real problem is that the real price you can get for your resources in relative terms is going to decline. It has been declining and it will continue to decline. So in that sense, while we're always going to be in the resource business, we have to be much less dependent on it than we've been in the past.

The world still regards our dollar as a commodity dollar, as you well know, and until this country has diversified with a truly revolutionary, active, deliberate policy to diversify this economy, we're going to be on that decline. We used to be second in the world in per capita income, and now where are we? I'm sure Peter has those numbers, but it's getting farther down the list all the time and it's just going to continue that way.

There's no question that we are the experts in resource exploitation and we definitely can use high tech to help that sector, wherever it happens to be. It's not necessarily always in the Sudan, but that's another issue.

The other matter has to do with technology uptake. And that's a tough one. I think Fraser Mustard can answer it better than I, because his institute has done a fair amount of study on that.

So I really will just have a brief word, but I believe the taxation system has to be drastically altered. This is not necessarily the round table speaking, this is just Stuart Smith speaking. It has to be drastically altered in order to get people to introduce new and better technology wherever possible.

I think I'll turn that over to Fraser or Peter.

Mr. Charlie Penson: Before you do that, can I ask you, Mr. Smith, is that partly a confidence factor in investors coming into our country to make investments? Is it a lack of confidence that you're speaking about here in terms of taxation and government policy, or what?

Dr. Stuart Smith: What I'm saying is that I don't know how big people think the problem is, but I think we have a huge problem. I'm not here to be a crepe hanger, not at all. I'm a great believer in Canada, and I believe in the resourcefulness of Canadians and our ability to compete with anybody when we put our minds to it. But I look at what happened in Ireland and what a change was brought about there by a drastic change in the fiscal regime. That was not the only thing happening in Ireland, but I'm just saying that was one of them.

I believe there's a tremendous need for some drastic changes, particularly in people investing in riskier ventures and not being hammered by the taxation system. But I know Fraser and Peter and others will have something to say on that subject.

Dr. Fraser Mustard: I thought I might just comment on the first part as well. When you are dealing with an extraordinary explosion in knowledge, which the human race is now engaged in, in the fields of science, you are always faced with how that knowledge is going to be used.

If you get into the biological sciences, which I was referring to in the NCE program, which deals with the structure and function of proteins... You may think that's good for eating, to get the amino acids to keep you turning over, but actually that story has huge ramifications in chip design, because these biological products will bring probably part of the new designs down the road, which is another materials field that won't bear much relationship to ore bodies that you and I think about.

Or if I think about the membranes that are in the fuel cells, these are polymers, and these will be constructed out of these new ingredients that are coming from a different source other than our extractive resource-based industries, and because they're knowledge based they become therefore very valuable in your society. I think it's when you start to think about it that way that the knowledge uptake question begins to make sense for you.

• 1000

I struggled with the institute's first program on artificial intelligence and robotics. Stuart Smith will understand. We knew that the chip function replacing neurological functions would allow a lot more things in society to become what you and I would call automated, such as the A-320 aircraft I came up in this morning. Basically, the pilots are not necessary if it's properly programmed. It would take off and land on its own. I don't trust it, but it will do that. There's also your banking machine.

If you start to think of the power of that revolution, one of the places where we thought it would have its biggest effect is in our resource-based industries. The length of time it took for Inco to take up this knowledge—because I know this history—to get to the automated mining structures they have now was massively long, unnecessarily long, because basically it didn't have what I will call the structural capacity in the organization to do it.

So resource-based industries do take it up, but it's difficult for them to take it up. They're not culturally driven that way, whereas if I deal with Ballard, it's competing against Toyota, which invests $800 million a year in its fuel cell development. We don't have that kind of budget. If we're not sharp and stay where the knowledge base is, we'll be knocked out by Toyota down the road. As Mr. Porter mentioned, the competitive framework is extremely important for you to do that.

I'd just like to follow up on Colin's point. Why are fuel cells so exciting to the world? The State of California has a regulation for zero emission vehicles. Thirty million people have imposed that. It's rather interesting. That's driving those companies. Also, smart people understand about procurement. Our first three buses went on the streets of Chicago, purchased by U.S. taxpayers' dollars for the Chicago transit authority, fuelled by hydrogen. We are just lousy in our use of procurement.

I'll give you a little aside. When Ballard announced it was going to build a large manufacturing plant for the engine systems, there were no phone calls from any Canadian province asking, why don't you put it here? The phone calls came from the United States. Why is it that Mike Harris didn't have the courage to phone and say “We're going to put 200 hydrogen-powered fuel cell buses on the streets of Toronto if you put your engine plant in Windsor”? You just have to ask yourself the question: Where are we with the wisdom and our own procurement for our own society?

Knowledge uptake is driven by the capacity of the system to do it. As you become a much more branch-plant economy, which is high risk, knowledge uptake functions will be largely located where the leadership of those corporations is at the present moment. So we have to think about how you look at it. If you look at the structure of our own BCNI, how many of the heads of BCNI today are actually responsible for running global organizations rather than a branch plant of some other global organization?

The Chair: Thank you, Dr. Mustard.

Mr. Drake.

Mr. Peter Drake: I'd like to deal very briefly with the second part of the question and the issue more generally of the influence of government policy on productivity.

I think the first point is that productivity—and it has already been mentioned here—is a difficult story to get out, even the issue of labour productivity versus multifactor productivity. We use labour productivity because we think more people are familiar with it. But the fact is—and both these gentlemen are right—that particularly when we're concerned with the environment, multifactor productivity is a very important issue. I'm going to take Dr. Mustard's suggestion, and I think we'll put out some more stuff from TD Economics.

I think one of the practical difficulties for government, quite aside from the specific initiative Dr. Mustard has suggested, is that productivity is a very multi-faceted thing. There are all sorts of things that contribute to productivity, including regulatory policy, tax policy, and education. Quite clearly, the work Dr. Mustard has done on early childhood development has a very real relationship to productivity.

When one tries to consider this in the context of specific governments making specific policies, I think it's very difficult for a government to come up with one single productivity initiative. There's nothing wrong with it doing that in specific areas, but it is so broadly based. There are also issues as to which levels of government are responsible. So I think that however difficult the task, if governments really do want to make a contribution to productivity, and they should, this is a theme that is going to have to run through deliberations in all sorts of areas. I think that's difficult for governments to do, but I think it's tremendously important.

The Chair: Mr. Isaacs, did you have anything you wanted to add?

Mr. Colin Isaacs: I'll pass at this time. Thank you.

The Chair: This will be your last question, Mr. Penson.

Mr. Charlie Penson: I'd just like to ask a short supplemental question.

What I was driving at was the divergence in the productivity gap between Canada and the United States in the last six years. Is that because industry in the United States has decided on their own largely to make those kinds of investments? Is it government policy that's the difference? That's what I'm driving at.

• 1005

Mr. Peter Drake: It's a combination of those things. Obviously you start off with an industrial structure in the United States that is helpful to the development of technology, and government policies have certainly had an influence. So again, the answer is not a simple one. It's a combination of those things. If government policy is conducive, then you can expect a better response on the part of industry.

Dr. Fraser Mustard: Let me add to that.

I said why don't we learn from our experience? I said you should look at the national centres of excellence programs in the biological sciences to begin with, and look at Industry Canada's policy for those programs for the future.

First of all, you have built a network infrastructure capability in a thinly spread-out country. Porter says you have to have clusters, and these may be working. They are working reasonably well from a research standpoint. We have no industrial business creation cluster to take that knowledge and make use of it. Colin's point about business schools is dead-on.

I'm leaving here and going out to the board meeting for PENCE, and I have to take the group through our assessment that we cannot meet Industry Canada's expectation that the spin-out from this network will generate sufficient business to produce money to fund, to sustain, that research network. In the United States nobody would expect that. The National Institutes of Health is funded by the U.S. government as an infrastructure function to support their bio-science industry.

How on earth we ever came up with a policy like this in a country that doesn't have much of a bio-science industry, I just don't know. It's basically stupid. We'll try to penetrate into your government to get them to understand this, but basically we're not looking at the micro-economic environment, if I can use that language, that is necessary to be successful in a new knowledge-based world, as a thinly spread-out country, and I emphasize that to you. This network operates across the country in small and large communities—at least, Saskatoon you consider a small community—and it works, but there isn't the capacity to capture the knowledge to put it into embryonic businesses that the venture capital world can come in behind.

The Chair: Dr. Smith, you wish to add something?

Dr. Stuart Smith: Yes, very briefly.

The United States has a huge advantage over us. We're in the wrong businesses. We're the poor little rich boy. We have had so much in the way of easily exploited resources that we haven't had to move into the knowledge-intensive sector. Sweden had to move from wood into saws because their wood wasn't good enough. They had to move from iron ore into stainless steel because their iron ore wasn't good enough. Ours has been good. The United States had a military program that allowed them to develop every conceivable kind of technology. They have many clusters of population and many clusters of education in the middle of these clusters of population. We have very few.

The only way we're going to compete and get into the right businesses is with a drastic change in the macro policies, a drastic change that encourages people to invest in new ventures, to invest in new technology, and to create new clusters like the Kanata one right here. We don't have very many possibilities of this. Only a few places could do this: Calgary, Vancouver, Toronto. There are not many that can do it, but we must have a drastic change that the whole world will sit up and take notice of. Business as usual will not do it.

The Chair: Mr. Murray, please.

Thank you, Mr. Penson.

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

Gentlemen, one of the great privileges of being a member of Parliament is having access to people like you. Any one of you could sell at a Canadian Club luncheon on any given day, and it's nice that in a small group we can have this opportunity to talk to you.

I'm having difficulty actually framing a question. I really want to build on this discussion about the art of the possible in government. The longer you serve as an MP, I think, the idea of having a benevolent dictatorship appeals to you more and more.

A few things were mentioned in the course of the discussion that stuck in my mind, such as the idea that where you grow up, how good the economy is has such a fundamental impact on your health and well-being. I think, for example, of miners in Cape Breton Island and how governments have for many years tried to keep them down in the mines. One could argue that's not necessarily the healthiest environment for them to be living in, and it might have been better for them not to have been encouraged to be there. In Sudbury, when the nickel runs out, it's government that the people in Sudbury are going to turn to for help, I would assume.

• 1010

Again, Dr. Mustard, you know that our colleague John Godfrey has championed this idea of putting more resources into the early years of children's lives. The reaction from constituents who call my office tends to be that they're afraid government is going to take over the upbringing of their children. They say to please just put more money in the pockets of parents and they'll look after their kids, thank you very much. They don't want this state intrusion.

Now, I know you would suggest that they're not understanding what this is all about, that we're not doing a good job of getting the message out, but I've always wrestled with this idea of how you manage that microeconomic environment that is part of the problem. Before I got into politics, I worked for Northern Telecom. Going back to the early 1990s, I was conscious of the brain drain in that I saw a lot of my colleagues moving to the States and not wanting to move back. They'd argue with me that they couldn't do this to their families because their quality of life was so much better in terms of their income.

So the question in my mind is always this: How do you micromanage as government so that you're not providing some privilege to some group in society at the expense of some other group? If we accept that all of society will improve as a result of encouraging all of these measures you've all suggested, how do you, as a government, deal with the people who demand that government be there to backstop the coal mines in Cape Breton or, say, to be there some day when the nickel runs out in Sudbury?

As I say, it's a rather mushy question, but that's the reality of governing: the demands on government are from a wide cross-section of people and it's hard to drive ahead with these productivity improvements. I'll just throw that out for any comment you may want to make.

The Chair: Dr. Mustard.

Dr. Fraser Mustard: I'll try for you. You've asked a question that is really pretty generic. It gets back to Stuart Smith's point about transformation from what is a resource-based world into a new global world driven by ideas. What's a government's role? Well, as citizens, we elect a government to try to ensure that the policies and regulations that governments put on societies and that affect economics and social structures are sound and sensible.

Market economies with no social accountability are very dangerous, because the society in which you live and work ultimately drives all the engines, so there's a subtle balance there. My economic colleagues, people like Amartya Sen, who got the Nobel Prize last year, are pointing out that economics has to more carefully involve the social structure dimension. That doesn't mean that you go through standard backstopping, but you have to start thinking it through in terms of what it means.

For old people like me, there may not be very much you can do, but for the next generation coming up, there's a hell of a lot you can do, because the infrastructure in education then becomes enormously important for society—and I mean good education, through all those periods, through the early years and such. By the way, if you read the report to Mr. Harris, his government does not take up the development of children; what he creates is the infrastructure to ensure that families can do that, and it's very important, because this is getting back into your argument. There's a subtle kind of government policy that you have to think about.

Now, when you flip it up, how does Sudbury move ahead? Well, Sudbury has some interesting things. It has a pretty sophisticated automated mining technology development, which could be ecologically sound and could be exported around the world, as Colin was saying. That's a new business for Sudbury, and that can survive even if the ore body disappears. It has developed very sophisticated sensing systems that are used around the world for looking over terrains and what not.

All of those are knowledge-based developments, and shrewd people make sure that those developments take place there, through whatever ways you can produce incentives for them. As Colin said, you can use procurement strategies to develop some of this, which is what the U.S. military has done. The huge advantage of today's knowledge-based world is that people don't have to all be in one place. You can create electronic clusters, which this country desperately needs to do to better replace the railroad system. Otherwise, you're not going to maintain the geopolitical entity down the road. You can do all those things and you can trade knowledge and you can do developments.

• 1015

If you think about it that way, in terms of how you as a politician have to think about how the revolution can affect sustaining the geopolitical environment that we will want to sustain as a country, and if you start to ask those questions of yourself, you'll begin to see some of the opportunities.

The Chair: Thank you.

Mr. Drake.

Mr. Peter Drake: Just as a couple of very brief thoughts, one of the things you are effectively asking is how government manages or contributes to change. I think the simple answer is that it does so with great difficulty and with great patience. With the mistakes that governments have sometimes made, I think we presume they were totally government responsibility. I think it clearly must be an interaction. Indeed, sessions such as this are most helpful. Governments in a sense must both lead and follow.

I think one of the things governments can do—and it may seem to be a very small thing in the context of the important concepts that are being talked about today—is continue doing what they're doing. One of the things that happened in the 1990s was that governments had to get themselves fiscally back into some kind of shape. I think one of the things that will make it a bit easier for governments to manage change is having their constituents get the sense that both governments are in decent fiscal shape, and indeed that their tax levels are reasonable. I think reasonable people will pay reasonable taxes, and I think that's what we're moving back to. The continuation of that will help, as will a great deal of interaction and discussion.

I guess the other thing is the mention of the Cape Breton mines. Most people don't like change, and that's never going to be any different. Sometimes giving people what they think they want is not always the best thing. It's very easy for someone who is outside of government to say government should take that courageous step. I realize that. But I think that's an important thing to remember.

The Chair: Mr. Isaacs.

Mr. Colin Isaacs: Very briefly, I would certainly agree with Dr. Mustard and Peter Drake on this theme. Once again, the concept of sustainable development gives us a lot of assistance in identifying business opportunities and employment opportunities for Canadians.

A couple of years ago, my company undertook a study for the economic recovery commission in Newfoundland, looking for business opportunities based on higher environmental performance, economic opportunity, and meeting the needs of society. I'll just share a couple of examples very quickly.

There is still a very healthy crab fishery in Newfoundland. The crabs are caught, cleaned, frozen, and shipped to Japan. We identified an opportunity to work with a major food company to process those crabs in Newfoundland into higher-value-added products—in other words, gourmet food products for sale in Canadian and U.S. gourmet food stores—hence providing an opportunity for increased employment in Newfoundland as compared to shipping the resource offshore.

As another example, Newfoundland has a fairly active vegetable sector for vegetables such as cabbage and turnip and that kind of thing. Because of the climatic conditions, they are grown without pesticides. There is no requirement for pesticides there. At the moment, those naturally organically grown vegetables are being sold into Newfoundland markets at the same price as ordinary vegetables. By exporting those from Newfoundland to the organic food markets of the northeastern U.S. and the Toronto-Ottawa area, there's a tremendous opportunity to add significant value, and hence to increase opportunities for Newfoundland farmers.

We're currently doing that kind of work in Brazil and elsewhere. There are tremendous opportunities for the growth of business based on sustainability. The role of government, in my view, is not to invest in those businesses, but to help identify the opportunities and to encourage private sector investment in the business opportunities that have been identified.

There are lots more examples we could draw on of where that opportunity really exists. The key is to anticipate and prevent the disaster caused by change to a more sustainable economy. Yes, some industries will disappear, but there's enough work to do, enough business opportunity to maintain a very high level of employment in Canada if we can see that kind of leadership and that kind of opportunity identification from all of our governments.

The Chair: Thank you.

Dr. Smith, do you have anything to add to that?

Dr. Stuart Smith: I have lots that I'd like to say, but in the interests of time I won't.

The Chair: All right, thank you.

Mr. Jones.

• 1020

Mr. Jim Jones (Markham, PC): I'd like to go back to the Inco example that you quoted there. Why did it take management so long to make the transformation from their technology to more modern technology? Is this happening in a lot of other industries?

Dr. Fraser Mustard: I brought Inco up.

Every institution, including government, is affected by the composition of its leadership at any particular time, and leadership is influenced by sets of circumstances. If government has been stable, without too much change, the cadre of the shape of the political parties will reflect that. But if you get caught in complex change, as you all know, the structure of political parties will change. For example, we were still spending heavily, as you know, but without a wealth base that you could tax to sustain that spending, so eventually we had to bite the bullet and cut back public spending.

I think corporations also face that, so you come back to the point that Colin made about Mr. Porter's book and to things that Stuart Smith was saying back in the days of the Science Council of Canada. Management moves when the competitive forces actually are there to make it move. You have a chance if you have a good board—if I can use that language—that is sensitive to that and will rejig management if necessary.

When I think about why the new chairman of Ford told his management to go into fuel cells, he had a pretty stuffy old board that wasn't going to. In his mind, I think, Ford will not be making its money making cars and trucks in twenty years' time. I think he wants to make it an energy company for the future, because he knows you can use fuel cells for portable power and stationary power, as well as for transportation. He sees that.

If you can't flip that leadership into your organization, you run behind the game. A good culture—and this is the thing that's important for governments to do—has to make it attractive to keep that kind of dynamic leadership boiling around in your society. You don't create it, but you can certainly create the infrastructures that make it attractive enough to keep it there.

I think of the financial institutions that are here. I don't know much about financial institutions, but I bet they're working like hell to make sure their leadership is capable of adapting their role to the new economy. That might mean letting banks come together, but I don't know. I remember we turned it down.

Mr. Jim Jones: Those are the kinds of things you have to think about.

The Chair: Mr. Jones, Dr. Smith wanted to add to that.

Dr. Stuart Smith: I don't mind hearing Mr. Jones. I had an answer for Mr. Jones on Inco, but—

Mr. Jim Jones: I just wanted to say something, and then you can answer it.

I was expecting that maybe with the tax policy, the depreciation and that, the incentives were not there to maybe modernize their plan, in comparison to the same tax policies that might be in place in the U.S.

Dr. Stuart Smith: That's a good lead-in.

If I might, Madam Chair, Mr. Jones, there's only one nickel company that moved downstream as opposed to just being a straight commodity producer. That was Sherritt, and it did so because it had the worst ore deposit of all of them. Having the worst ore deposit, they had no choice but to start producing coinage and other nickel-based products that they could try to sell.

When I was arguing with Inco way back when I was Liberal leader back in the 1970s, they were actually selling nickel to people who made anti-pollution devices. They even bought the company that was making the anti-pollution devices in Georgia or someplace in the southern United States, but they still wouldn't clean up their own stacks at that time. They couldn't see the advantage to promoting their own product in a downstream way in this manner.

The problem with Canada is that we have ups and downs. When you're in the downs, you go to these companies and say it's time to really do things differently. They say to you that you might be right, but that they're just in a survival mode, so don't bother them. When they're up, you go in and say it might be time to do things differently. They ask if you're crazy, because things are great.

It's the same in politics. It's the same with Mr. Murray's question. You get elected by telling people things are terrific. You don't get elected by telling people things may look terrific today, but they could be very bad in the future and therefore we're going to have to take drastic action today. People will ask if you're crazy, because things look pretty good to them.

If you want to change the tax system... and by the way, it wasn't because of the tax system that Inco didn't move. My argument would be that we have to make our tax system twice as attractive as that of the Americans—not as attractive as that of the Americans, but twice as attractive as theirs—to get the kind of action we need here. But if you go and do that, if you take the wealth generators and tax them less, then ordinary citizens perceive this as somehow being unfair. If you say to them, well, it's time for drastic action, and that's why we did it, they say “It's not time for drastic action; things look pretty good to us.” You get defeated at the polls. That's the problem.

• 1025

As we said a long time ago—I remember citing this back in the 1970s, and Fraser will remember this—the problem with us is we're going to get boiled to death half a degree at a time and we won't jump out of the bath, like the famous frog who gets boiled to death in hot water. It just doesn't hit us hard enough for us to get the people behind us, and that's the political conundrum. But I think we have to start trying to educate our people that we are in a cyclical situation and that the long-term trend, however good it looks now, is not good and we have to take drastic action.

Mr. Jim Jones: Yes, Fraser again mentioned that.

Can you explain what you mean by that? Was it “natural” or “national” cluster strategy?

Dr. Fraser Mustard: The way the generation of knowledge works in today's world, you don't do it all in one institution; the fields are very broad. There is an advantage in linking people in different institutions together to create what is called a “cluster”. Silicon Valley is a well-known cluster around Stanford and places like that. That's a physical proximity, and you have a cluster in the Nortel systems around Ottawa.

But if you think of the fields that are moving, if you think of the revolution in genetics and the understanding of the structure and functions of protein, it's awesome what's taking place there. Think of the practical application of that. If you can get research in B.C., Alberta, Saskatchewan, Manitoba, Ontario, and Quebec working in that field together, then what you're doing is building a knowledge transfer, a knowledge development function that is national but is competitive with any other jurisdiction. So it ties in internationally, which flows the knowledge in.

If you look around Saskatoon, you'll find some biotech companies that come out of that interaction. If you look around Vancouver, you'll see the same story. You'll see it in Edmonton, in Toronto, and in Montreal.

By doing that, you've then tied together your country, because you have a group of people in regions who are committed to the new kind of world. By making that work, you have a kind of identification that is national, not controlled by the government but national. This has shrewdly involved quite a few provinces in it as well. The partnership function here gets around that terrible squabbling you get between the provincial and federal politicians in this business.

I think the important thing for you as a committee, if you haven't been through this, is for somebody to take you through the networks of centres of excellence program, because it was geared to create knowledge-based clusters across the country that would help sustain the country and help feed into the new economy.

The Chair: Mr. Jones, do you have another question?

Mr. Jim Jones: Yes, I do have another question.

You mentioned capital gains and that they should be eliminated. Over the last number of years, what has really been the impact of having taxes on capital gains versus maybe having a more lucrative capital gains system?

Dr. Fraser Mustard: I'm thinking about incentives when I use that language.

I know the story of Geoffrey Ballard fairly well. He's fairly wealthy now, but the risk he took in gambling that he could take this technology and convert it into fuel cells was awesome. That risk is totally different from your investment into some kind of capital fund that makes money playing in the bond market and the stock markets. Sure, there's a risk there, but Ballard's risk was huge.

Why not let the man have the gain that he made by putting a new technology out into the world? Why do you even have a capital gains tax on whatever he gained from that? It doesn't make sense to me, because you and I know there's a benefit to all of us from getting a new environmentally sound technology out into the world and building the business with it.

So I argue strongly that you should sharply differentiate between capital gains that I make through playing fiscal roulette with my investment house, versus what a creative person does to society. That's a tough wicket, but a lot of people argue that this is extremely important now when you start to look at incentives for the future.

The Chair: Thank you, Mr. Jones. Have you finished?

Mr. Jim Jones: I was really curious when somebody mentioned that from an educational standpoint Ontario lags the rest of Canada. Why is that?

• 1030

Dr. Fraser Mustard: You should get a copy of our report.

Mr. Harris, to his credit, was concerned about early childhood. He understood the relationship, having been a teacher, between what happens pre-school and what your performance in the school system is like: it's extremely important. That's why he asked for the report. We then were able to pull out very hard data for him. Your basic capacity for the future can be monitored by your verbal skills at the ages of four to five. It has huge predictive power for a whole range of things, including health issues.

We were able to pull data for Ontario that show every socioeconomic point, from poor to rich—McCain and Mustard were the co-chairs of this—and show that at the rich end, the top end, 10% of the children were having difficulty and 35% of the children at the bottom end were having difficulty. The biggest number of children in difficulty are your middle class. At every point on the scale, Ontario's children were behind the rest of Canada.

If you then look at another measurement, which is what we call functional literacy, Ontario, against the same socioeconomic markers, scores behind four other provinces in Canada—Quebec and the three prairie provinces. That fits the verbal skills story. We know these things are linked.

We were then able to show that this is not an income distribution function, which is extremely important, because a lot of people argue about poverty. Poverty is not a good thing, but this said, there's something else. It turns out that one of the biggest drivers is parenting structure. It's not just a question of good parents; it's a question of the very powerful social and economic changes taking place. About 68% of women with children under six are now in your labour force.

So coming back to Colin's point, businesses have to learn how to design family-friendly workplaces. There are actually American businesses doing that, to make good structures for keeping them. We know one bank—not your bank—where the highest sickness absence rate is that of young women, low on the pay scale, with children. That's not a good sign and it's not good for the bank. We've told the bank about what they could do to straighten it out, because it's also an environmental issue, if I can put it on the table.

Your growth in single-parent families has been huge, and there's nothing wrong with that. These are not teenage moms; these are actually women who separate, for good reason, into the system. So when you identify the change in the ecology, if I can use that language, of our labour force and its involvement, then it becomes enormously important to become sensitive to how you build community capacity—you'll notice the language—to provide the support systems that can replace some of the intergenerational family structures that you and I grew up with, to help in this area.

So wherever you come from, if you look at your community assayer... I just want to try out one thing on you. There's an outfit called Giant Tiger stores, which, as some of you may know, operates low-cost places in 90 communities in Quebec and Ontario. Two or three years ago, I met with the gentleman who runs it and talked about this subject. He said he did not want government taxation and putting it back in because government programs don't work. I said, how about a tax credit to you if you build an early childhood development centre for your employees that is open to your community? He said he'd like that.

Do you see what I'm trying to get at? He was not unreceptive to taking the steps that are necessary in his own business to come in on this sort of thing.

The Chair: Just before we move on, Dr. Mustard, I just want to clarify something. I'm a bit confused. Did you say that the Province of Ontario is following your advice now? I know that in my community junior and senior kindergarten programs have been slashed, and that would be the zero to six years group.

Dr. Fraser Mustard: I'm not here as an exponent of any province. What I can say to you is that in my work in the Founders' Network, I see there are a variety of communities across Canada now trying to address this question, including the Yukon, which is rather interesting. It has a first nations interfacing question that is extremely important in this. Manitoba is quite powerfully moving down this road. I think Mr. Harris will face some competition as to whether he will be able to develop his initiative ahead of some of the other provinces.

I think the good news is that provinces are moving on this field sensibly—and with a variety of things that we could go through, but you don't have time this morning. Mr. Harris himself, as far as I know, is committed to putting the recommendations in the report into action and has taken steps in that direction.

The Chair: Well, Dr. Mustard, I would hope that you'd visit other parts of Ontario and see that he's moving backward in some areas. But we won't go there right now.

Mr. Penson, please.

• 1035

Mr. Charlie Penson: I have a short question for Mr. Isaacs.

I was on the foreign affairs and international trade committee prior to this, and we were doing a study into what Canada's negotiating position should be at the WTO round. At our hearing in Winnipeg, your organization made quite a good presentation, I thought. It had to do with subsidies and the negative effect of subsidies on the environment, as an example, and the fact that it didn't really promote industries to adapt to the kinds of changes we were hearing about in resource-based industries. The mines in Cape Breton, for example, would probably be an example of where subsidies tend to keep inefficient operations going and of where it really hurts their ability to innovate.

Could you just confirm or tell us what your views are on that area?

Mr. Colin Isaacs: I'd be happy to. However, I think that presentation was made by the International Institute for Sustainable Development, not my organization. I'm very familiar with their report and their position, though, and I would concur with it.

A large number of subsidies are environmentally perverse. In other words, the net result is increased harm to the environment or a maintenance of something that is not environmentally and economically sustainable.

Realistically, I think we have to recognize that for the economy as a whole, if it's not profitable it's not sustainable. I mean, that's a reality, because our economy works in a free enterprise system, and generation of profit is a necessary part of keeping something going.

Now, there may indeed be situations where the costs are incurred in one part of the economy and the benefits arise in another part of the economy, and some types of transfer are necessary. There's the whole area of economic instruments for environmental management. Today I gave you a newspaper article I wrote that includes some discussion of this in the context of some proposals in Ontario for emissions trading, for reduction of air emissions. That's an example of those transfer programs. But those are quite different from subsidies.

Of course, it would be possible to balance environmentally perverse subsidies with environmentally beneficial subsidies. I think it's clear that no one in Canada has a desire to go down that road, and therefore we should indeed be looking at overall reduction and eventual elimination of subsidies in order to allow the market to work more effectively.

That itself will require a number of conditions. One is a more full cost accounting of environmental costs in the fees and charges levied on users of common resources. It will require a corresponding shift in the attitude of many of our major trading partners, because if we operate in Canada or in a world without subsidies when our trading partners are continuing to operate with subsidies, that may put our manufacturers and producers at a competitive disadvantage.

So this is by no means a simple area, but the overall trend towards removal of subsidies is one I would heartily endorse.

Mr. Charlie Penson: Your point, I guess, is that in trade negotiations we should try our best to negotiate levels of subsidies down. I gather you concur with that?

Mr. Colin Isaacs: Absolutely.

Mr. Charlie Penson: Okay.

The Chair: Thank you, Mr. Penson.

Very briefly, Mr. Cannis, please.

Mr. John Cannis (Scarborough Centre, Lib.): This will be just a quick question. Most of my questions have been answered.

You talked about developing clusters of excellence and investing in them, and we've talked about encouraging private sector investment. We compared ourselves with the U.S. and what have you. From a banking point of view, I'd like to ask, has there been any study with respect to the Canadian attitude, the Canadian mind, their risk-taking as a people in comparison with others? Are we now more comfortable in venture-risking or in investing? Is that a factor in all of this?

Mr. Peter Drake: I'm not aware of specific studies, so I can't quote any data, but it would be my sense that we are more comfortable with risk-based investing.

Speaking very broadly, first of all, the movement from a high- to a low-interest rate environment has engendered a very significant change. People now invest in equities that clearly are more risky than investing in GICs or bonds simply because they can't get the returns. So that's one thing that has driven this.

• 1040

It is also my sense that there has been a distinct improvement, a distinct growth in the availability of venture capital in Canada compared with say 10 or 15 years ago. Indeed, even the large organizations such as my own have a venture capital arm that specifically focuses on that type of investment.

One implication, of course, is whether it is sufficient—are we good enough at taking risks—and of course the answer is no, we're not good enough at taking risks. I think Dr. Mustard made some reference to some of the things that might encourage that. Yes, there has been an improvement, but I think we have a long way to go.

The Chair: Dr. Smith.

Dr. Stuart Smith: I'm on the board of one of the labour-sponsored venture capital companies, and we had a terrific influx of capital under the old rules. Government got panicky, because they said “Look at all that capital going in there”, and one of the big venture capital companies didn't invest it quickly enough. So the government tightened up the rules and made it much less attractive. The consequence is that there's been a drying up of that source of capital.

This was an unwarranted panic on the part of the government. They ought to go back to the rules the way they were, or at least a whole lot better than they are now. It is very difficult to raise capital there.

I'm in the process, with three colleagues, of starting up a dot-com company. I can tell you, it is a lot easier to talk to venture capitalists in the United States about a $5-million investment than it is in Canada. In Canada they all say “Yes, $5 million, that's very interesting, but what can we do with one million or three-quarters of a million to start?” This is the automatic reaction. We simply don't have that gung-ho mentality here.

We could develop that mentality if, as Dr. Mustard suggests, we eliminate the capital gains on such investments. We could develop it if we had a much more attractive regime for the taxation of stock options and if we could generally reduce corporate taxes—I'm not opposed to reducing corporate taxes generally, as a matter of fact—and increase the capital cost allowance on new equipment, new technologies, if they can be shown to be demonstrably better, or let's say 25% or 30% more efficient or better than the previous one.

There are a number of things we could do to change the climate and get people thinking of venture capital. If people leave an investment in a new company for five years, it is preposterous that they should have to pay capital gains taxes at the end of that time. It's not the same as somebody flipping a piece of real estate overnight, or going in and out of a mutual fund from week to week. Fraser Mustard is right: we have to draw those distinctions.

There has to be an understanding that venture capital is not only a good thing, it's an absolutely vital thing for Canada at this point. The government's panic about the labour-sponsored funds is and was unwarranted.

The Chair: Thank you.

I want to thank everyone for being here today. We're running out of time and we have other witnesses this morning. It's been a very interesting discussion.

I want to add a couple of comments to the end of the discussion as we go on into having others with us. We're going to be looking at a number of different sectors in the coming days.

We're talking a lot today about natural resource commodities and the fact that the long-term pricing of them is declining, which may suggest that Canada is becoming poorer as a result. There are others who would say that's not actually the fact, that prices are declining because companies are investing heavily in machinery and equipment that's actually lowering the cost of production, and competition is therefore driving the price down as a result, and that people are getting richer as a consequence. So the real danger from specializing in commodities is that they sell solely on price, and competitive advantage can only come from technology innovation rather than from product innovation.

Also, when we talk about generating growth from product innovation, that leads to product differentiation and branding, which can also make Canada wealthier as we look at a number of aspects we've been studying and where we're going to go in the different sectors in the coming days.

I think there's also a danger in Canada that business can be almost stunted from being solely focused on the natural resource development. There are a number of other aspects for Canada to look at.

• 1045

Today's discussion has been very interesting. It's going to lead, I think, to a lot more further discussion at this committee on a different level and a different depth.

We want to thank you all for joining the table and for being here today. We hope you'll read our report with interest. If you have any further comments, we'd welcome them.

We're going to suspend for two minutes while we exchange witnesses. We have other witnesses waiting.

I thank you all again for being with us.

• 1046

• 1052

The Chair: I call the meeting back to order. We're very pleased now to welcome our next group of witnesses. We have with us today, from the University of Toronto, Roger Martin, the dean of Rotman School of Management; and from Nesbitt Burns, Douglas Porter, senior economist and vice-president.

I'm very pleased to welcome both of you, and I apologize for the short delay in starting. I would propose that we hear both of your opening statements and then move to questions. You may have some comments on what you heard earlier. I know some of you came in towards the middle of it.

Mr. Martin, if you're ready, please begin.

Dr. Roger Martin (Dean, Joseph L. Rotman School of Management, University of Toronto): Thank you for the opportunity to speak to this committee.

Just by way of quick introduction, I'm a Canadian, but for 17 years, starting in 1981, I was a strategy consultant around the world, much of the time outside Canada. In September 1998 I came back to the University of Toronto to become dean of the Rotman School of Management. On the way through all of that, in 1991 I headed up a study of the Canadian economy, which resulted in a book called Canada at the Crossroads. So the talk, which hopefully you have in front of you, is called “Canadian Competitiveness: Nine Years After the Crossroads”. It gives my updates on what I think has happened since then.

If I start at page 2, I see on one hand a fabulous macroeconomic turnaround engineered by this government, and we can be very happy and proud of these changes, from quite a bad situation in 1991 to quite a good situation from a macroeconomic standpoint. The budget deficit was second only to Italy among the G-7 in 1991, and we thought it would never go away. We're now in surplus, and our performance is actually the best among the G-7.

We knew we had to become ever more of an exporting economy in this globalizing world, and our exports as a percentage of GDP have increased, again, more dramatically than any other country. Although there's a bit of a negative to that, which is that we did it by way of discount, and I think this was spoken of before. We managed to sell more at significantly reduced prices. So there's a little bit of a dark cloud. But overall, it's right to consider this a fabulous macroeconomic turnaround.

But on page 3 I highlight troubling trends in overall competitiveness. This turnaround in the macro environment has not produced a wonderful competitive situation. The thing I point to that I find most problematic is our dropping in the world in terms of our ranking in GDP per capita, which is the best broad measure of prosperity of an economy. In 1990 we were third in the world—a position we'd held for many decades actually, if you take out tiny little city-states such as Hong Kong and Luxembourg. For what I think of as real countries, we were third in the world, and had been that for a long time.

• 1055

By 1998 we were fifth in the world, and if we had been third still, if we had simply kept up our rating, that ranking we had for many decades, we would have per family of four in Canada $13,000 each, for every family of four, which is $650 a month in after-tax income. So every Canadian family could have afforded a house, with almost $100,000 more, could have financed the mortgage and been no worse off, or bought another car, etc. This is what I think of as the most troubling trend in our competitiveness.

At risk of giving too negative an example, the comparator we have to keep in mind is New Zealand, fourth in the world in GDP per capita in 1946; after the Second World War, fourth in the world on the basis of exporting all sorts of agricultural products around the world. By 1970 they were ninth in the world. By 1998 they were eighteenth in the world, and now the difference between New Zealand being eighteenth and New Zealand being fourth is $32,000 U.S. per family in New Zealand. It's that kind of decline we're in danger of when we lose touch with where the leading economies in the world are.

If I ask the question, how can we explain this paradox, we fixed the macroeconomic front, which is what we were all worried about in 1991, and took dead aim at the deficit. The trouble is that it turns out there are three factors that work together to make an economy prosperous, competitive, and highly productive. They are having a stable and effective political, legal, and macroeconomic context and then a microeconomic foundation that includes how sophisticated companies are in their operations and strategy and things about the quality of the microeconomic business environment. And those are things like: What kind of intellectual property protection is there? What kind of legal system is there? Are there good competitors, good telecommunications infrastructure? These are all things at the micro level rather than macro level.

When we look at that on page 5, what we see is that Canada is not where it needs to be, especially in company operations and strategy. This is an index of how we do on that bottom box, our microeconomic foundations, and we're ranked eighth in the world there, actually worse than our GDP per capita rating, which is fifth in the world. And that has to do with both our microeconomic environment being quite strong, fourth in the world in this study that a colleague of mine has done, but also that in company operations and strategy we're twelfth in the world.

If we go to the fourth column, a problematic aspect is the nature of competitive advantage sought by Canadian companies. If the question is, on one hand, do our firms seek competitive advantage on the basis of low-cost labour and low-cost raw materials, or on the other hand, unique products and processes, we are much more to the side of low-cost labour and low-cost raw materials—twenty-first in the world on that ranking. In a similar study, we were twentieth in the world in innovation, nineteenth on product design, fifteenth on control of international distribution.

What we have is an economy in which, while it's working well at the macroeconomic level, it turns out that the macroeconomic level has become, to a great extent, table stakes in international competition. You have to have that working well, but it is the microeconomic context—and a big piece of that is how companies perform—that actually makes the biggest difference now in relative standard of living.

Why is that? If we just dig deeper, turning to page 6, the sophistication of a company's strategy and operations is a function of the key strategic choices they make, and those choices determine the degree to which they make available to themselves the productivity and competitiveness levers that could be available to them. If they have a set of aspirations and goals that are low—a goal to actually only be a good Canadian company rather than a good global company—they'll make choices about where to play perhaps in Canada or a portion of Canada. And in terms of how to win, they may make a choice to try to win on the basis of low-cost labour or raw materials. Those kinds of choices are inconsistent with increasing competitiveness and productivity.

• 1100

If we turn to the next page, there is a set of choices that are incompatible with competitiveness and productivity increases, versus being supportive of competitiveness. What we find in Canada is too many firms being in the left-hand column versus the right-hand column. This is a key underpinning of the weakness in productivity and productivity growth. In this global economy, the column on the right-hand side is the column that empowers firms to upgrade the way they take labour capital and raw materials and convert them into products.

If they have an aspiration to be globally competitive, to compete around the world, and to be second to no comer around the world, and they make a choice to play globally rather than locally, to serve the most demanding customers and to win on the basis of unique products and processes, then they will increase their productivity and become stronger and more competitive.

We have too many in the left-hand column. That's why our company operations and strategy ratings are as weak as they are.

We could ask the question, are we doing everything we can to help these firms out? I would make an argument that says, no, we're not.

I now turn to page 8. These are the effective tax rates for domestic firms in the G-7 countries. We are taxing our firms at the highest end of this spectrum. In fact, Germany is in the middle of enacting a number of quite radical changes, and just about two weeks ago a piece of this was enacted. They'll be at the low end, and we'll be alone at the highest end.

What I would say on this is that we have created an incentive structure whereby the incentive for companies to upgrade in ways that make them more profitable is low. I would argue that this is an area where we may think we have a choice. We may think we control this and that we can decide whether or not to tax companies at a high level. I would like to argue that I don't think that's the case. In my life in strategy consulting, I certainly saw many companies that thought they could control something that was convenient for them. Our banks didn't want to give high-yielding products to their customers. They'd rather have them in basic deposits, because that was the most profitable thing. What happened? All their deposits went to mutual funds. They just left. It would have been inconvenient for them to lower the money they were making on plain vanilla deposits, but certainly less convenient than having the market go away completely.

This is an area where it is going away. If you look at our tax revenues for 1965 versus 1995, in 1995 corporate income taxes were half what they were in 1965. It's going away. The only question we have to ask is whether we want to chase our companies out of Canada and discourage them from investing before it goes to nothing or do something proactive. I think that's actually the only question.

On whether we have an environment that helps these companies choose to innovate rather than replicate what people are doing elsewhere, we see on page 9 another assessment, which again was done by the colleagues I work with, which shows us far down, ninth in the world, in our capacity for innovation. This is a combination of the economy's capacity and firms' capacity. Again, on this rating, which is made up of seven sub-ratings, there's only one where we're in the top 10, and that is our spending on higher education as a percentage of GDP. But on that score our rating has fallen over time. Over the last 20 years we've been falling, and we're about to get passed by Denmark and Finland in that category. So we haven't really helped with our policy to create an environment in which firms are inclined to innovate.

• 1105

The last factor, again, is overall taxes as a percentage of GDP. This speaks to the question of incentives to live, locate, work, save, and invest in Canada. Again, we are dramatically higher than our closest neighbour. The question is—and I have addressed this in various articles I have written—what does this do to our incentives? I don't think it's positive.

In summary, as on page 1, I'd say that what we have in terms of Canada's positioning in the international economy and our positioning for growth in prosperity, in productivity, and in competitiveness is that in a political, legal, and macroeconomic context, we've moved, thankfully, from among the worst in the G-7 to among the best in the G-7. However, the one piece of this that's increasingly out of line is our taxation. It's simply out of line for purposes of competitiveness. The position there is that we've replicated what others have done pretty well but not perfectly well.

On the quality of the macroeconomic business environment, we're fourth in the world according to the global rating. That's down from third the year before, but it's still quite high. One of the challenges in that environment is a weaker capital-raising environment versus that of the U.S. I know that was referred to in the previous panel.

Again, we're a replicator. There's nothing we say that's unique and different about our microeconomic environment that supports business; nothing, absolutely nothing.

Finally, on sophistication of company operations and strategy, I think we're a second-tier performer. Far too much of the economy is in replication strategies, producing the same product as others, with the same process, using low-cost labour or raw materials. There are many laudable exceptions, which I won't go into, but that would be our position.

What I would say is that if we're going to increase our prosperity and take ourselves up from fifth to third, we're going to have to move from an economy that's based on replication to one that's based on innovation. I think uniqueness and innovation have to be pursued in all three of the categories, all three of those blocks. Canadian governments have to go beyond simple replication of the macroeconomic moves of other countries.

In terms of what we've done, laudable as it is, if you ask the question, have we done anything different, then I think the answer is a firm no. Countries that have stepped out and done something different have prospered.

Ireland is the best case. In 1987 Ireland had 50% the GDP per capita we had. Imagine, 50%. Every Irish house was half the size. They had cars two years older. They could go to the doctor half as many times, take half as many vacations, and have half as many household appliances.

That was Ireland in 1987. In the year 2000 they will have a higher GDP per capita than Canada. Ireland is a richer country than Canada now. That's only 13 years later.

What did they do in 1987? They cut corporate taxation dramatically. They now have a third the rate of taxation on capital investment than the rate in the United Kingdom, and a fifth the rate in Canada.

I'm not saying do exactly that, but I'm saying they did something unique and different. It's that type of thing we have to do.

In terms of the microeconomic environment, we have to create a uniquely favourable microeconomic environment with the best infrastructure for doing business and the best education for doing business. I think the government has taken some steps with the millennium chairs and the challenge foundation, etc., but still, in the last three years, for example, 48 of 50 American states have increased spending on education by an average of 16%. In Canada over the last three years we have decreased spending on education by 3.3%. So that's not distinct in any way we'd want to be distinct.

Finally, I think our companies have to become obsessed with competing on the basis of unique products and processes.

Those would be my thoughts, Madam Chairman.

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

We are now going to turn to Mr. Porter, senior economist and vice-president at Nesbitt Burns.

Mr. Porter.

Mr. Douglas Porter (Senior Economist and Vice-President, Nesbitt Burns Inc.): Thank you, and good morning.

Committee members, I would like to thank you for the opportunity to address you today. I congratulate the committee for keeping the focus on the crucial productivity issue even at a time when the economic backdrop in Canada does appear so favourable.

I'd like to stand back today and take a bit more of a macro or bird's-eye view of the productivity issue, and that includes dealing with some first principles. I brought along some charts that I'll talk around, but I'll start out dealing with my ten observations on Canadian productivity.

• 1110

First of all, as you heard in the prior panel, there are many different measures of productivity, but I believe the focus should be on output or value added per hour work, since it can be most accurately compared across countries.

There are two important points here. One is that increased productivity means working smarter, not longer, since the concept is per hour. But second and more important is that the emphasis should be on value added and how to increase it.

Typically, in discussions on productivity, the stress is always on producing more and more units of a certain good per hour, whereas the stress could instead be on producing units of greater and greater value. For example, one electronic video game is worth more and creates more wealth for the producer than does churning out 100 hula hoops. So the physical volume of output shouldn't be the only terms on which we measure productivity.

I should point out that while rising productivity is likely to be the primary source of wealth creation per capita over the long term, it isn't the only factor when employment is below full capacity. In other words, when unemployment is very high, incomes can be boosted more quickly by increasing employment than by raising productivity. But Canada is now again approaching something close to full employment, so the focus again should be on productivity growth in Canada.

The second observation is that productivity growth is important for all sectors of the economy and not just manufacturing. A great deal of attention is paid to manufacturing since it's seen as competing internationally and it's easier to measure productivity in. However, value added can come from any sector of the economy, not just the output of goods.

Secondly, even the measurement issue may not be entirely clean on the manufacturing side. For example, there's some evidence that U.S. manufacturing productivity data are inflated by the use of temporary workers to the detriment of other sectors.

The third observation is that the level of Canadian productivity is considerably below that in the U.S. for the economy as a whole, on the order of 25% to 30%. Last year, when the productivity issue was front and centre, there was debate over whether Canadian productivity growth was indeed trailing that of the U.S. in recent years, but neither side of the debate doubted that the level of output per hour was considerably lower in Canada. That translates into a lower standard of living.

We also found it somewhat disturbing that the gap in the level of productivity did not narrow at all in the 1990s between Canada and the U.S., even after the free trade agreement and the massive restructuring of industry early in the decade.

The fourth observation is that new data suggests that the gap between Canada and the U.S. was not stable in the 1990s, and this is perhaps where we can turn to some of the charts. Instead, if you look at page 3, the gap in fact widened further between the U.S. and Canada, and that's whether you look at manufacturing or the economy as a whole.

Statistics Canada actually told us last year that productivity growth was similar between Canada and the U.S. in the 1990s. However, substantial upward revisions to the U.S. numbers late last year revealed that productivity growth has in fact been much stronger than earlier thought in the U.S. in the 1990s, so that the gap is widening. You can see that clearly from page 4, before and after the revisions in the U.S. Thus any complacency on this front was certainly misplaced.

Speaking of Statistics Canada, there's no indication that we'll see similar large upward revisions to the Canadian numbers.

To put an example on that, U.S. productivity growth last year was 2.9%, which is simply amazing at this late stage of the business cycle. Canada's figures are not in yet for 1999, but based on the early numbers it looks like our total economy productivity growth was about half of the U.S. level. That's something between 1% and 1.5%, which for a typical year is not bad, but stacked up against the U.S. it clearly pales.

The fifth observation is that the gap in productivity levels is particularly high for small and medium-sized firms. Unfortunately, here the data is only available for manufacturers, and large firms are considered those with 500 employees or more. You can see the differences on page 6.

Large firms are as productive as those in the U.S., which makes sense since large firms can, and will, relocate resources away from low-productivity plants and areas toward high-productivity plants, until productivity is almost equalized across all their plants. But this equalizing mechanism probably does not apply to smaller and non-multinational firms.

Unfortunately for Canada, our output is highly dependent on small and medium-sized businesses, much more so than is the case in the U.S. So the fact that relative productivity is weaker in small firms does mean that we have much lower productivity overall. This doesn't mean, however, that I think we should punish high-productivity sectors such as large firms in order to support the small.

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The sixth observation is that the gap between Canadian and U.S. productivity growth in the 1990s has been highly concentrated in just a few industries, especially machinery and electrical and electronics. Some see this as comforting. Some, such as Robert Gordon of Northwestern University, cast doubt on the U.S. productivity boom because it is so concentrated in these few industries.

Gordon has suggested that computers have only helped us become more productive in producing more computers. But I would say this is precisely what one would expect to find, that the biggest productivity gains would be in the high-tech sector, because this is where the bulk of the innovation is. And eventually this productivity growth will strengthen in other sectors of the economy. We're already seeing some signs that this process is underway in the U.S.

This leads to the seventh observation, which is that productivity or value added is highly dependent on innovation. Ideally, if the best, most efficient production process is already widely known, then business will be already operating at close to maximum productivity. To further increase productivity requires innovation and/or a new process, and this again goes back to the value added concept. The best way for a firm to increase value or wealth is to come up with a new product, a new idea, or a new process.

The eighth observation is that innovation, quite simply, is driven by increased investment, whether in skills or in machinery and equipment.

The ninth observation is that investment and capital will flow to where opportunities for profits are. Capital, simply put, reacts to signals. If those signals are distorted by varying subsidies and/or tax rates, investment will not be allocated as efficiently as possible. Certainly steps can be taken by policymakers to increase the pool of investment by encouraging venture capital, and steps can be taken to make investment more attractive through lower taxes, but the economy is very efficient, left on its own, in sending signals as to where that investment capital should best be directed.

The final and most important observation is that profits, investment, and the stock of venture capital are consistently lower in Canada as a share of the economy than in the U.S. Accordingly, productivity is lower. While our tax regime, with much higher capital gains rates and generally higher corporate rates, may not be the only factor behind the underperformance, and it may not even be the most important factor, it is a factor that policymakers can and should control.

Moreover, given that countries around the OECD have implemented or are planning significant tax cuts, the gap between Canada and the rest of the world on the tax front could widen further in the years ahead. So effectively, we must run fast just to stand still against our key competitors on the tax front. For example, Germany, Japan, Australia, and the U.K. have cut corporate and/or capital gains taxes, and that group of countries basically spans the political spectrum. And perhaps most important for Canada, both the Republican candidates and Al Gore are proposing further tax cuts in the U.S. in the years ahead.

We can tinker around the edges on micro policy, but I believe the most effective good can be accomplished on the macro front, and that's through a more favourable tax regime. So my message is quite straightforward: the biggest improvement to productivity can come through, quite simply, lower taxes, whether on the capital gains front, in corporate taxes, or in the personal income tax regime.

Thank you.

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

I'm now going to turn to questions. Mr. Penson, please.

Mr. Charlie Penson: Thank you.

That was a very interesting presentation. I agree with just about everything that was said.

On the question of investment, Mr. Porter, you've summed it up pretty well: investment flows to where a good opportunity is presented for business. Canadian businesses, Canadians in general, are now investing more in direct foreign investment outside Canada than we are in direct foreign investment in Canada. That crossover took place a couple of years ago, and it's increasing dramatically.

I would suggest some of it is taxation policy and some of it is policy to do with things such as land claims and environmental impact studies that take a long time and are very expensive. The Canadian mining industry is an example. About $8 billion of Canadian investment in Chile was pulled out of parts of Canada.

So I guess the question is about confidence in terms of investments. Do investors need that kind of confidence in the direction of government?

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As for the other question I have, I hear you loud and clear on your suggestion to reduce taxes, but there's another debate taking place in Canada in regard to lowering taxes versus paying down debt, or a combination of both. Given that a third of each tax dollar that comes to Ottawa goes to service our debt, do you have any comments on the idea that you would just stick to tax reduction and basically do nothing on the debt repayment? Where does debt repayment factor into your suggestions?

The Chair: I assume you're directing that to both.

Mr. Charlie Penson: Yes.

The Chair: Who wants to start? Mr. Porter?

Mr. Douglas Porter: Sure, thanks.

Starting with the foreign direct investment question, I will point out that very recently the flows have actually turned back in favour of a small net inflow into Canada, just within the last four quarters. It would have been absolutely staggering to me if we weren't seeing a net inflow of foreign investment simply because of where the dollar is. Our assets are so attractively priced right now, with the dollar being so undervalued, that I would find it shocking if we didn't see a large inflow of investment.

I would regard the fact that we're only seeing a small net foreign direct investment inflow right now as being somewhat disappointing. Really, simply put, we should be seeing a wave of investment, given the low level of the dollar right now. Effectively, our assets are going dirt cheap when compared to those in the rest of the world.

There's no question that foreign direct investment is attracted by the regulatory regime and the tax regime, and the opportunity for investment profits. I think the fact that we haven't been seeing even greater inflows into Canada recently does cast some doubt on how confident foreign investors are in Canada.

In terms of the question on the choice between paying down the debt and reducing taxes, I would say that if we were starting out in a situation in which the Canadian tax regime was roughly comparable to those of our main competitors, the focus should be on paying down the debt. But I think we are in a situation in which we are clearly losing investment and are clearly falling behind on the productivity front largely because of the tax regime, so that should be where the short-term focus is. Also, we are seeing the debt starting to come down to more reasonable levels.

Over the short term, it's not obvious that there would be a large payback to the economy from paying down the debt. In other words, we've already gotten interest rates down effectively to where they are in the U.S. In terms of the macro economy, there therefore wouldn't be a lot of immediate payback from lowering the debt.

Mr. Charlie Penson: Are you suggesting that we sort of grow our way out of it, then?

Mr. Douglas Porter: Longer term, I think the pressure should definitely still be on slowly but surely bringing down the debt. I don't think we can necessarily completely grow our way out of it. A small net paydown in debt every year is quite a prudent and advisable strategy, but whatever other resources we have should go to reducing taxes first and foremost.

The Chair: Mr. Martin.

Dr. Roger Martin: Thank you.

On your first question on the flow of capital, I think it's great that the fellow who figured out the international flow of capital is none other than Robert Mundell, probably the greatest Canadian economist of all time, who just won the Nobel Prize. He figured out in the 1960s that capital will flow to the place where it earns the highest after-tax returns internationally. It seems so obvious now, but it wasn't when he was doing his research.

I think it's interesting to point out that it was his influence that caused the Government of Canada, under Turner, to index tax brackets in 1971. That helped Canada out-perform most other economies during the 1970s, as we didn't engage in bracket creep. That would be an example of being unique, of not replicating what other people do.

I think the international capital flows are a very important issue, and I would subscribe to your point of view that there is currently a lack of vision and leadership around what this economy is standing for. That's what causes investors to not believe this is the economy to invest in unless, as Doug has pointed out, our assets are extremely cheap.

Again, I don't want Canada to win on the basis of our being dirt cheap; I want us to win on the basis of our having the most valuable assets in the world. I think this government, which has shown such great leadership on the issue of deficit reduction in the early 1990s—and the provincial governments; everybody got together and had a common goal—needs to show some leadership now on prosperity.

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On the question of where I would put the focus of tax cuts versus paying down the debt, I think the focus absolutely has to be... We have an historic opportunity, in this $90-billion surplus, to change the fundamental incentive structure for working, saving, and investing. So not only do I think it should be oriented towards tax cuts, because we are in a desperate situation with respect to our prosperity... We are sliding dramatically in our relative prosperity, so we face a desperate situation on that front. What needs to change is tax cuts that are oriented directly towards the incentives to work, save, and invest on the margin.

So many of the tax cuts that have been suggested, that have been leaked, are tax cuts that leave the marginal incentives completely unchanged. For example, they may be laudable from a social policy standpoint, but increasing the child tax credit does nothing for the marginal decisions, because the marginal dollars get taxed exactly the same. Raising the GST credit, even increasing the threshold of the tax brackets, does very little to change the marginal incentives for Canadians generally and is extremely expensive.

So I wouldn't actually pay down the debt—I agree with Doug that we have it manageable—because of the absolutely critical importance now of changing the incentive structure. I'd invest as much as possible into changing the marginal incentive to work, save, and invest.

Mr. Charlie Penson: Mr. Martin, I gather from what you're saying—and I just want to confirm it—that during this growth period in the economy, you would use that period of time to make the structural change in terms of taxation, because you're worried that if Canada slips into the other side we haven't addressed the taxation side and we'd slip further behind. Is that true?

Dr. Roger Martin: Absolutely. For me, even though ours is an absolutely great country, the New Zealand scenario is simply there looming. They didn't take seriously their decline as they declined from fourth to ninth. It was like, “Oh well, maybe this is not so great”, but then it was, boom, off the edge. That would be the absolute focus for me at this point.

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

Mr. Lastewka, please.

Mr. Walt Lastewka (St. Catharines, Lib.): Thank you, Madam Chair.

Thank you both for your presentation.

Mr. Porter, I want to go to your graph on page 3—actually, pages 3 and 6, I think it is. I want to understand this better. The total economy, productivity growth, until about 1985, stayed close to that in the U.S. and then separated. Maybe you could explain some whys in there. At the same time, when I look at the manufacturing portion, I see it stayed very close right up until 1994 or 1995 and then started to separate. Then when I look at the small business graph on page 6—

The Chair: Whose paper? Are you looking at Mr. Porter's?

Mr. Walt Lastewka: Yes, on page 6.

The Chair: Okay.

Mr. Walt Lastewka: The small plants in Canada really seem to have gone downhill from the 1970s and 1980s and continue to have a larger gap compared to those in the U.S.

Could you explain to me some of the whys there and what needs to be done to get small business from being the problem of the productivity gap to adding for us?

Mr. Douglas Porter: Okay. I'll just start with the chart on page 6.

First of all, I think the changes in the time series—in other words, the change from 1977 to 1987 to 1992—among these groups is not that significant or important. I think the main message here is that there appears to be a real problem among small firms, and that is not only not going away, it appears to be actually worsening in recent years, or as recently as the data are available. So that really is meant to be the main message here: that's where the productivity gap really is important.

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In terms of proposed solutions, to be quite frank, I don't think there is any simple solution to it. I don't think there's any magic silver bullet solution. The only thing I can stress again is that capital will be invested where it finds the opportunity for profit, and those profits can best be helped by reducing taxes. I would suggest that probably the lowest-cost way of doing that is by reducing capital gains taxes.

I'll actually get back to that in a minute. I'll start off by going back to page 3, on the total productivity.

I would make the case that we first saw the gap in U.S. and Canadian taxes really begin to open up in the early 1980s, and it took some time for it to show up in terms of its impact on the overall economy or the productivity statistics. It did take a few years, especially on the manufacturing sector as a whole. It showed up more readily in the total economy.

In terms of what explains why manufacturing was able to keep pace better, there again I think firms and investment can move across borders rapidly, especially in manufacturing. If a large manufacturer can produce something more efficiently in Sudbury or in Tennessee, they will move to that area. In other words, in manufacturing there is more pressure to keep productivity in line between the two countries.

Because that gap has really only opened up in the last couple of years, I'm not entirely convinced that it's a true picture. In other words, I'm not sure the data are completely accurate. But if it is, I think it is sending a real warning signal, and it probably goes back to the different structures in the two economies; in other words, because the U.S. has so much more in the high-tech semi-conductor industry. The manufacturing of hardware is where the real productivity gains have been felt in the last couple of years; they're probably seeing the bigger gains in manufacturing more recently.

Mr. Walt Lastewka: I always like to ask this question: if the automotive sector were taken out of there, would our problem be worse or better?

Mr. Douglas Porter: It would be worse, as far as I understand.

Mr. Walt Lastewka: It would be worse?

Mr. Douglas Porter: Yes.

Mr. Walt Lastewka: The other thing that has concerned me is that when our dollar goes down and we're able to export goods and so forth and we get to be more competitive, a complacency seems to set in, with manufacturing relying on the dollar. As soon as the dollar goes up, we find ourselves not advanced enough; and before we know it, we lose and we get into the negative side. Are you seeing that as one of the problems over cycles?

Mr. Douglas Porter: That is certainly a problem that there has been a lot of discussion about. It's called the lazy manufacturer problem. I'm not convinced that it's necessarily that our manufacturers get lulled into complacency. I think what happens is that as the dollar declines, a lot of industries that are marginal and maybe wouldn't survive in the case of a higher dollar, and are perhaps lower productivity, are able to survive because of the cheaper currency. That probably does tend to bring down our productivity numbers.

Another problem is that as the dollar declines it raises the import costs for businesses, and businesses import a lot of machinery and technology, especially from the U.S. and Japan. That reduces their ability to invest as the dollar declines and probably also brings down productivity.

So I think there are a number of channels through which a lower dollar actually can depress productivity.

Mr. Walt Lastewka: Mr. Martin.

Dr. Roger Martin: I would confirm your concerns and maybe put it in an even more general context.

All the work that I and my colleagues have done on global competitiveness, understanding it, would suggest that firms become globally competitive on the basis of dealing with pressure, having pressure put on them to make choices, to be more innovative and be more clever in making investments. So pressure is a very good thing, and whenever you release the pressure valve by lowering your currency, that is bad for decision-making in companies about how to compete in more sophisticated ways.

I think in a couple of ways it is tragic what has happened to the Canadian dollar. It has made us poorer; we've taken a 25% pay cut as Canadians since we did the study in 1991. It is really quite terrible. In fact, if that 25% pay cut were factored into the comparative GDP per capita numbers, we'd be fifteenth in the world already. So it's bad for making us poorer and bad for taking pressure off our companies to make the kinds of choices that are necessary for them to compete.

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Mr. Walt Lastewka: My feeling has been very strong that we hide behind the lower dollar, and then when the dollar goes up, we think we can recoup overnight and we can't.

Dr. Roger Martin: That's right.

Mr. Walt Lastewka: We get ourselves lulled into being less innovative and concerned, and then when the dollar goes up, we want to change things around to start Monday. And you can't do that.

Some firms in Canada use the present dollar exchange—say, an 85¢ dollar exchange—in order to keep their organizations slanted in the way of being competitive. Many don't, and it's to our detriment when we get this low dollar.

Dr. Roger Martin: Yes, and I think those are the clever companies. I know a couple of them who just cost everything out at 85¢ because that's where they think it ought to be, and if they're not making money at that level, they say that is unsatisfactory. But they are very few.

Mr. Walt Lastewka: Thank you, Madam Chair.

The Chair: Mr. Lastewka.

Mr. Jones, please.

Mr. Jim Jones: Thank you.

Can you give me examples of what you mean by marginal incentives?

Dr. Roger Martin: Sure. It would be the tax rate on the last dollar earned by a Canadian individual or company. At a certain point, a Canadian individual says “The value that I could accrue from working one more hour is less than the cost to me of working that one more hour”, or “The value that would accrue to me by spending and consuming something rather than investing is greater for the spending and consuming versus investing.” And the thing to which is most sensitive is the tax rate you face on that last dollar.

There are obviously some societally positive things about a progressive tax system, but the unfortunate thing about the progressive tax system is that the marginal dollar gets taxed the highest. So the progressive tax system has built into it a disincentive to work, save, and invest.

That's why I say if, for example, without cost you could change the Canadian tax system now to take away from higher-income Canadians the 17% rate... On the first $30,000, higher-income Canadians pay 17%. That is a big cost to the treasury of their paying 17% on that first $30,000. But they act on the basis of 29%, which is what they're going to pay on the incremental dollar. If we did away with the 17% bracket for richer Canadians, we could take down their marginal rate to 26% from 29%, stimulate the economy dramatically, and not spend a single dollar on tax cuts. That would be completely neutral.

Mr. Jim Jones: So you're saying a person making $100,000 would pay 26% flat.

Dr. Roger Martin: Yes. Under that scheme they would actually pay more taxes than they pay now, but they would have an incentive to work a little harder, invest a little harder, make $105,000 rather than $100,000, and end up with more after-tax income in their pocket, making the economy better.

So when we're talking about spending the $90 billion, there are some pieces of it we actually wouldn't have to spend. And notice that I'm not taking money from poor people and giving it to rich people; I'm saying the way we take money from rich people is utterly destructive to the economy and economic growth—utterly destructive.

Mr. Douglas Porter: I'd like to make one extra comment. I fully agree with Roger, by the way. But one of the things to take into consideration is that we don't have to look just at the top marginal tax rate. Another critical factor is at what income level the rising taxes kick in. In other words, a way to increase incentives is to actually increase the thresholds at which each one of the tax brackets kicks in. So that can certainly help middle-income earners and low-income earners as well.

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To me, that actually is where even greater differences in incentives lie between Canada and the U.S. The top marginal rate in the U.S. doesn't kick in until you're earning $250,000 U.S., whereas in Canada it's closer to about $60,000 or $70,000. Simply put, I think that's ridiculous. In other words, somebody who is very close to the medium income is facing the top marginal tax rate. That's another area I would certainly focus on.

Dr. Roger Martin: On the one hand, I utterly agree. On the other hand, it's an expensive way to get done what you want to get done. Let's say you increase the 17% threshold from $30,000 to $35,000 and the threshold on 26% from $60,000 to $70,000. The only Canadians who feel a difference in incentive on the margin are the ones between $30,000 and $35,000, who happen to be in that little gap, and between $60,000 and $70,000. All wealthy Canadians, who are still at 29%, will get a free tax break on the income they make between $30,000 and $35,000 and $60,000 and $70,000.

That puts more money in their pockets, but it doesn't change their incentive at all. That will do very little for the economy. If they can spend the money better than the government, and we can argue that's possible, that would create a little benefit. But what will create the big benefit is changing their incentive as to where they stop working, saving, and investing.

Given my druthers, I would leave the brackets where they are, even though I agree they're egregiously low, and fix the marginal tax rate on each bracket.

Mr. Douglas Porter: Just so we're clear, I actually do agree that first and foremost it would be nice to bring down the marginal rates. Certainly it would be expensive to boost the brackets. But in terms of the number of people affected and how many people's incentives would change, basically you do have to go after the middle class.

Dr. Roger Martin: I agree, but if you went to 16%, 25%, and 28%, you would get 100% of Canadians on the margin with a little different incentive.

The Chair: We'll agree to disagree on that.

Mr. Jones, this will be your last question.

Mr. Jim Jones: I have two questions.

In lieu of what has happened in Ireland and the tax reductions in Germany and Finland, and with Gore and George Bush, who are running for President, saying that they're going to cut taxes, what is Canada's first priority on tax cuts, corporate or personal?

Dr. Roger Martin: I actually would cut corporate taxes, because there is absolutely no justification for having higher corporate tax rates. With Canadian individuals, you can say that the government does give a unique package of goods and services and environment. We can make an argument that says there's something unique about that, and that justifies the tax rates. On the corporate front there is no justification whatsoever. You're taking companies that can locate wherever they want and charging them higher tax rates, and they will choose to invest and earn their income elsewhere. So it's the most dangerously out-of-line tax. However, given my druthers, I would lower both of them, focusing whatever amount of the $90 billion you choose for tax cuts on creating a meaningful decrease in the marginal tax rates.

Mr. Douglas Porter: I hesitate to answer the question just because I think we're so far out of line on everything that it really is tough to decide which to go after first. I would make the case that while I also agree that corporate taxes are probably the priority, politically it would be an easier sell if it were done at the same time as personal taxes. So I think probably a broad-based move across all taxes is the way to go.

In terms of which one I think should be cut the most, I personally believe that in terms of incentives, capital gains should be cut first and the most. I think it would have the lowest cost to the treasury.

I actually didn't have a chance to talk about my very last chart, chart 12. Looking at the U.S. experience, there is basically no relation between capital gains tax rates and revenues. One case where there was a relation was in 1986, just before the capital gains tax rate was increased. All kinds of people cashed out just ahead of that, and there was a huge inflow of capital gains just before that rate went up. After that, there has really been no relationship between the capital gains tax rate and the amount of money that the U.S. government or treasury has taken in as share of GDP.

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Our case is that lowering capital gains can actually lead to increased revenues on the capital gains tax front.

The Chair: Thank you, Mr. Jones.

Mr. Jim Jones: I just have one more quick questions.

Roger, in your charts on pages 4 and 5, “Canada Lags...” and “Sophistication of Company Operations and Strategy”, I looked at Ireland, and I see that they're way down in all the numbers. I would have thought that Ireland was doing really well. I thought they'd be a lot higher. Why aren't they higher?

Dr. Roger Martin: I think it's in part because Ireland has come on so fast, so recently. I think you'll see them coming up in these numbers. But on that front, if you go to the page before, on that macro box, they just sailed by everybody and created a distinctive environment there. That has propelled them and has given them the chance to invest in the microeconomic foundations. You should think of them as a poor country, a tragically poor country in 1987, that is now investing in their prosperity only because they have the means to do it now.

Mr. Jim Jones: Thank you.

The Chair: Thank you, Mr. Jones.

Mr. Murray, please.

Mr. Ian Murray: Thank you very much.

Professor Martin, when you were talking about moving from a replication economy to an innovation economy, you mentioned that we need to do something unique. It seems that we need a sort of national discontinuity here.

You mentioned Ireland's example, but I wondered if you had a suggestion for a Canadian example. We've talked about playing off the tax system, both corporate and individual, but if Canada were to essentially wake up the world to Canada... I mean, I don't know what “made in Canada” means any more to people around the world. It probably doesn't mean anything except that maybe it's some natural resource of some kind. But if you want to have the “made in Canada” branding worth something and you also want to have this unique application, whether it's fiscal policy or whatever, do you have any suggestions of what we could do that is actually unique and is not just following, say, Ireland's example?

Dr. Roger Martin: One of my views, which I've written about—and I would be happy to get you the piece I wrote—is that I think it is arguable that we are into the knowledge economy full swing, and it's the most youthful economy ever. Arguably, we're now at a point where, in our most important industries, the software and technology industries, kids know more than their parents, by far. You can ask the question, who does the software administration of the computer systems in your house? If there are any 14-year-olds, they do it—not the 29- or 30-year-olds.

So if I take that as the basis, youth is more important in the global economy than it has ever been. I would take our tax system and completely turn it around to make it the most attractive tax system in the world for young people.

I think it's actually silly—and many silly things arise over long periods of time, so it's not anybody's silliness—that we have income tax charged on the basis of the slice of your life that is that year. What that results in is that we have really rich people who are old who are getting to pay 17% on the first $30,000 of their income. It does nothing useful for the economy, and they need the money less. It is young people who are raising families, who have bought their first house, who are deep in debt, and who are paying off educational debt, who need the incremental money—desperately. Yet we start charging them extremely high rates, as Doug said, early on in their lives, if they can get about $60,000, which many young 22-year-old engineers start to make.

Why don't we change it so that you are taxed on your lifetime taxable income? The first $500,000 of your lifetime taxable income is taxed at 17%, the next $500,000 is taxed at 26%, and the remaining is taxed at 29%. You would transform Canada into the most attractive place in North America for young workers to come and work, and it would enable you to have the highest incentive to save, work, and invest targeted at the right places. That would be revolutionary. Nobody else in the world does it, and it would put us on the map on a tax basis.

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Mr. Ian Murray: What about the carrot-and-stick approach to individual companies, particularly small businesses, if you wanted to wake them up, essentially, to what they should be doing? We have small business tax rates, etc., that don't seem to be sufficient to wake them up.

Dr. Roger Martin: Again, I like small businesses, but the small business tax thing just is not a good idea. I don't know where it came from; I should study the history of it. But what's looming for every small business is that if you get past the following size, the marginal rate goes up. Where is the incentive structure there to get large? The incentive structure is to stay small, and in fact what you see in lots of small businesses is the proliferation of small businesses, where an individual owns 12 small businesses, all of which get the lower tax.

It's sort of quaint. It's quaint to be nice to small businesses, but it serves no economic purpose other than quaintness.

Mr. Ian Murray: There is that “small is beautiful” idea that started in the 1970s, when E.F.—

Dr. Roger Martin: E.F. Schumacher, yes.

Mr. Douglas Porter: Just briefly, that goes back to my one comment about how it's critical to level the incentive structure as much as possible, not to create false distortions through subsidies and different tax rates. That's really what I wanted to say.

Mr. Ian Murray: Okay, thanks.

The Chair: Mr. McTeague, please.

Mr. Dan McTeague (Pickering—Ajax—Uxbridge, Lib.): Thank you.

The great part of having one of the last questions is that you get to hear other members ask very similar questions, so what I wanted to start off with has been answered severally.

I was just wondering, Mr. Martin, if you'll be meeting with the other Mr. Martin to deal with the upcoming budget.

I had a profound interest in your comments, and I just wanted to find out if monetary policies by governments outside of the fiscal question of what you tax and what you don't tax, whether we have a more innovative tax system that encourages the model that you've given... I think that deserves a little bit more explanation, and that may be exactly where I'm heading.

But before I get there, I just wanted to ask if there's any element to the fact that some of the countries are doing very well, have lower degrees of foreign investment, are nations that are demographically far more populated, although that may not work in the case of some of the Middle East nations, etc... whether or not Canada, being much more open to foreign investment and subject to everyone else's monetary policy, can actually command the kind of tax cuts that Japan, Germany, and the U.S. have undertaken?

Dr. Roger Martin: I believe they can, and I believe the countries that have been doing extremely well in the nineties—the countries that have gone by us, literally, on the fly—are Norway and Denmark, for example. They're very open, they're smaller than we are in GDP and in population and the like. I do think, although other countries around the world may not like it, that Alan Greenspan sets global monetary policy, and I think it behooves every country in the world to be consistent with his monetary policy. As long as he's around showing good leadership, it makes sense. And I don't think that's a constraint on prosperity, but rather, it has set up an environment in which there's opportunity for countries around the world to prosper even if they're small and open.

Mr. Dan McTeague: I was wondering about that, because last summer a lot of us were very nervous about the Asian flu and the sudden attack on the Mexican economy and others that were subjected to basically predation by capital moving by the nanosecond and by not having the right politics. It may be one thing to have the right policies as far as taxation is concerned; obviously it's an addition if you have a welcoming tax policy. But in that kind of circumstance, what I hear, particularly in the area of corporate taxes, is the prospect of trickle-down—that good pensions, good health, good education, the other elements that attract a company to a country like the ones you've named or even Canada... They may not necessarily be looking at the question of taxation, but at the relative wealth of the nation to which they are going to sell their products.

As many of us know, we've transformed ourselves over this period of time from a manufacturing economy to a warehouse economy also, which suggests that there is a tremendous amount of wealth here, perhaps at a certain level. I wonder if the question of the nature of the dominance of foreign investment in Canada in key sectors of the economy inhibits the wonderful prospects of being able to attract capital.

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Dr. Roger Martin: Well, I think it makes it trickier and it's a challenge. Our policy should be oriented towards making this a very attractive place for business capital of all sorts to want to be housed, and we should be trying to make it a place for foreign-owned companies whose operation in Canada is a globally oriented operation.

So the whole notion of having world product mandates and world centres and the like is very important for Canada's future, and we should make it a place where Canadian companies want to grow, prosper, get big, and globalize. But I think it's tricky with so much foreign investment, and we have to work harder at it.

Mr. Dan McTeague: Thank you.

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

I would like to thank both Mr. Martin and Mr. Porter. I apologize again for the slight delay in starting, but it has obviously been a very good discussion and we appreciate your presentations. If you have anything further to add to the committee as we go on with our hearings, we would be more than happy to hear from you.

Perhaps you each have a final parting comment for us.

Dr. Roger Martin: I would just say I'm extremely impressed with the work Industry Canada is doing on this. Kevin Lynch, Serge Nadeau, Andreï Sulzenko and the like are doing wonderful work in this area. Congratulations.

The Chair: Thanks very much, Mr. Martin.

Mr. Porter.

Mr. Douglas Porter: Thanks again for giving me the opportunity to speak to you today.

The Chair: Thank you both for being here.

I would remind committee members that we have another meeting at 3:30 in this same room. Thank you.

The meeting is adjourned.