Eat or Be Eaten

Ken alexander: This summer, amid widespread concern about foreign takeovers of key Canadian corporations and whole industries, in the Globe and Mail you and rbc president and CEO Gordon Nixon laid out a stark warning about Canada’s economic future. Arguing that we are midway through a “transformational era” (1980–2030) as significant as the core of the Industrial Revolution (1780–1830), you suggest that there will be near-total winners and losers, and that if Canada doesn’t play its cards right it will be “hollowed out.” This comparison is intriguing. Was the Industrial Revolution not a very different form of economic globalization?

Roger martin: Indeed, it was very different, but the comparison is apt based on challenges to how we now engage in productive activities and the problems and opportunities this brings. In England prior to the Industrial Revolution, the economy was largely rooted in cottage industries, wherein small numbers of employees churned out small volumes of goods using production processes that involved very little capital investment. No player in any particular industry grew to a scale necessary to do things more efficiently, engage in research and development, or invest in machinery and equipment.

In the subsequent fifty years all this changed. Firms invested in large factories with new machinery and took advantage of economies of scale. This led to efficiencies, brand names (albeit primitive ones), and in many industries competition between several large opponents, further spurring innovation. The transformation created challenges: old physical assets (e.g., little shops) and human skills (e.g., hand weaving) became much less valuable, and existing knowledge bases were rendered obsolete. It also created problems. The new factories were far more dangerous than tiny predecessor shops. Heartless businessmen exploited workers generally and introduced large-scale child labour. As a consequence, many countries resisted the Industrial Revolution. However, productivity growth and real wages (anemic for centuries) grew significantly, with incomes growing fastest in the countries that embraced change — in particular the UK and US. Wages and productivity have grown at a higher rate ever since, opening the way to much, much higher standards of living in the industrialized world.

The current period is similar in that globalization is forcing changes in the nature of production. Canada is particularly interesting because we had high tariff barriers before the Free Trade Agreement (fta, 1989) and then the North American Free Trade Agreement (nafta, 1994), and our firms had an incentive to gear their production activities (approach and capacity) to the Canadian market only. This meant lower economies of scale and less ability to amortize the costs of big investments (e.g., r&d) over a large volume of sales. Prior to the fta, Canada tended to produce companies that were national in scope (except for the resource sector, which had no tariff protection). To the extent that these companies sought to grow, it was primarily by diversifying within Canada, which is why we had big broad conglomerates like Canadian Pacific, Bell Canada Enterprises, and Domtar. These firms didn’t need managers with international experience, offices and factories around the world, or stock listings in New York or London.

As globalization proceeded and Canada opened its market to freer trade, Canadian firms faced a completely different success model — overseas operations, global managers, global economies of scale, higher R&D spending, etc. — innovations foreign to the vast majority of Canadian firms before 1989. Thus, in many respects, corporate Canada faced challenges similar to England’s cottage industry circa 1800; competitors of a sort they had never encountered before were suddenly eating their lunch.

Recent calls for protectionism and restrictions on foreign takeovers are no different than attempts to disallow the use of new production methods 200 years ago. Again, the dislocations are real and jolting, and there is no guarantee that absorbing the costs will be worth it in the end. Nonetheless, it will be a huge lost opportunity for those who do not figure out how to take advantage of globalization by changing their approach to competing.

KA: For Canada, didn’t this transformation begin with the FTA, and through it did we not essentially drop our mixed private-public approach to economic sustainability? Didn’t pre-FTA Canada subsidize certain industries (through R&D grants, tax breaks, etc.) with the expressed purpose of sustaining companies with a national scope and international potential that, because our internal market lacked economies of scale, could not do so themselves? Indeed, isn’t one of the critical flaws of the FTA and NAFTA that the importance of subsidies to the Canadian economy is not adequately articulated? Didn’t we leap into the transformation with both feet, unaware, and aren’t we now seeing the fallout?

RM: Canada took its first step toward recognizing that something was going on in the global economy with the fta. Arguably, that meant that Canada started to take appropriate action a decade after the transformational era really took off. I give Canada and Donald Macdonald high marks for bravery, but I give Canada low marks for speed. I don’t think that the characterization of Canada dropping its “mixed private-public approach to economic sustainability” is correct. There are numerous misconceptions about the Canadian economy, past and present, and one is that it is dramatically different than the US — that we are drawers of water and hewers of wood, they are industrialists; we have heavy state intervention, they are free market aficionados. The numbers just don’t support this view — not even close.

When we study this question, we divide the economy into forty-one industrial clusters — automotive, processed food, information technology, etc. — and, comparing Canada to the US in terms of what industries people are actually employed in, the top eleven are the same, and in almost the same order. The two economies are remarkably similar. Canadians’ views get skewed because we ship large amounts of resource goods across the border, and thus resources show up prominently in Canadian export statistics. America uses nearly all of its own resources.

The broadest way to measure the public-private mix is to see what percentage of economic activity flows through government hands, as measured by total tax revenues as a percentage of the gross domestic product. In the US it’s 32 percent; i.e., at some point US governments get their hands on 32 percent of economic activity and do something with it — build things, provide services, take it from one and give it to another, etc. In Canada it’s 37 percent. Is this differential indicative of a meaningful difference in the level of state involvement? I don’t think so. If we compare Canada’s industrial heartland, Ontario, to America’s three most prosperous industrialized states (Massachusetts, New Jersey, and New York), we get even smaller differences — Ontario (37 percent), Massachusetts (34), New Jersey (35), and New York (36). For Ontario to have matched New York’s spending level in 2004, it would have had to reduce spending by a mere $7.7 billion.