Kevin Yin is a contributing columnist for The Globe and Mail and an economics doctoral student at the University of California, Berkeley.
As a new era of geopolitical risk has altered Canada’s calculus on trade and foreign policy, Canadians are increasingly calling for a strategy of economic sovereignty. However, there are right ways and wrong ways to do this.
Real economic sovereignty requires using markets for what they do best – allocation, competition and discovery – while using the state to correct the frictions that stop that from happening. We must ask ourselves where individuals are not sufficiently incentivized to act in the way we need, and how to amplify our strengths along these lines without sheltering ourselves from competition. That Canadians are now united in their desire to build the economy represents a once-in-a-generation opportunity to do so.
The guiding principle must be to create a better playing field for Canadian-owned companies (amplify strengths), but also a fairer one (don’t shelter weaknesses). Cutting red tape, offering smarter tax incentives and deploying government capital all help. But they only work if we are clear about the market failure we are fixing and we remain neutral about who benefits.
What we must avoid are anti-competitive policies where we hand out arbitrary advantages to certain industries, corporations or activities. As one of this year’s economics Nobel laureates, Peter Howitt, once argued in this very newspaper, protecting our economy in the short run should not come at the expense of dampening creative destruction.
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Canada has a poor history of giving aid to specific companies or actions, without fixing the broader environment they operate in. In the past few years, the government has doled out bespoke handouts to EV companies such as Stellantis and Northvolt, and has previously bailed out national darlings like Bombardier repeatedly. Our federal government is now chasing Stellantis with legal action, and Quebec officially cut its losses with Northvolt in September, having thrown $270-million down the drain with it.
Bombardier eventually failed anyway, sold off many of its assets to Airbus, and Quebec taxpayers were saddled with a loss of around $400-million. Canada has a tendency to get too excited about these narrow investments, without scrutinizing why they weren’t already privately funded. The Liberal’s new innovation strategy is an improvement on the past, but parts of it risk going too far in this direction.
One example is the nearly $1-billion pledged in the new budget for AI infrastructure like data centres over the next five years. Of course, few doubt that AI will be a key contributor to economic growth, even if the AI bubble pops. But data infrastructure is only one part of AI development, which itself is only one part of an entire tech industry (and a part that has not yet paid an actual dividend).
At present, 95 per cent of organizations are getting no returns on their AI-related investments, as per an MIT report, and even tech darlings like OpenAI are bleeding billions each quarter. Large lenders like Deutsche Bank are hedging their data centre loans, clearly worried that AI profits might not materialize in time. By making this investment, the government is taking an overly strong stand on capital allocation, and making taxpayers bear a risk that would be better evaluated and borne by private funding.
Other aspects of Ottawa’s plans are better but miss some key opportunities. For example, the Liberals have pledged an additional $440-million to the Scientific Research and Experimental Development (SR&ED) tax incentive. Economists generally believe that research will go underfunded by markets alone owing to the spillover benefits other companies get from new knowledge. The SR&ED certainly addresses that concern. However, the enhancement is still only a patchwork solution for the program’s pre-existing flaws.
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For one, the SR&ED already provides well over $4-billion in tax credits every year, which is arguably too much relative to its usefulness. And despite the generosity of our R&D incentives relative to countries like Sweden or Germany, Canada has thus far failed to generate a comparable level of research spending.
This is in part because the SR&ED incentive has been bureaucratically complicated for companies to navigate (which the government says it will fix). It is also because it does not support the commercialization of that research, nor does it incentivize either the intellectual property or the resulting profits to stay in Canada (neither of which is being addressed in the enhancement). At minimum, the SR&ED still needs far more streamlined processing and stricter conditions on nationality to work properly.
More broadly however, countries that are doing far more R&D are not always the ones that have the most generous state incentives. The more fundamental problem is that Canada lacks enough large high-tech companies that compete globally via innovation. Germany, Sweden and the United States, by contrast, all have enormous R&D-intensive companies headquartered at home.
We also do not necessarily want to imitate Britain and France, which have higher R&D spending but far higher costs of incentives. In this sense the SR&ED expansion is a bit of a weak-leverage solution; it does not shelter weaknesses – anyone can earn the credits – but it is an expensive way to amplify strengths. The question is not just how to make existing companies do more research, but how to create new companies that will fight to remain at the cutting edge.
More than marginal improvements in R&D spending, growth comes from coming up with ideas that people are willing to pay for. What warrants more support is the risk-taking that can generate these ideas. Founders bear all of the downside of entrepreneurship, risking their careers and savings, while many of the upsides spill into the broader economy – an externality-based rationale for state support.
Creating new cohorts of Canadian champions also keeps incumbents on their toes, since upstarts might replace them at any point. Yet at just under 0.5 unicorns per million people, Canada is performing well below more startup-friendly countries in this area.
In this spirit, an especially promising part of Ottawa’s plans is the $1-billion being invested over three years in the Business Development Bank of Canada’s (BDC) fund-of-funds initiative, and the additional $750-million for early-growth-stage companies facing funding gaps. Announced in the recent budget, this is a significant expansion of funding over the previous iteration of this program, and a promising emphasis on early-stage growth.
The BDC initiative does not invest directly in companies but rather invests across a mix of private funds and leaves the actual allocation decisions to those funds. Such a strategy preserves government neutrality, while crowding in private capital from the pension funds and other large lenders that would otherwise face unstable funding risk. It helps overcome the capital bottleneck that tech entrepreneurs face in Canada to generate these new ideas, and it can earn the taxpayers a return on their investment to boot.
The program is an excellent example of augmenting the private sector’s ability to identify promising companies, while not allowing special interests to hide from competition. No further details have been released about the early-growth-stage funding plan, so we can only hope that it aligns with similar principles.
In a world that increasingly emphasizes might over right, Canada can and should be far more ambitious when it comes to choosing its own economic destiny. The government has shown us some encouraging signs, but also that there is still much work to be done.