How Effective is Canada’s 2017 Budget in Enhancing Competitive Advantage?

Canada’s 2017 Budget comes at the heels of significant achievements by the Liberal Government of Prime Minister Justin Trudeau in the international and domestic trade arenas. At the international level, the conclusion of the Canada-EU Comprehensive Trade Agreement (CTA) and the initiatives aiming at strengthening trade with Asia are most notable. Domestically, the recently concluded Canada Free Trade Agreement (CFTA) is a major step toward further consolidating the Canadian domestic market and removing inter-provincial trade barriers.

While the ultimate benefits of these developments to the Canadian economy are yet to be seen, their real extent will strongly depend on Canada’s global competitive advantage. Consequently, since the challenges presented by expanding and growing free trade are proportional to the opportunities it makes available, then it is beneficial to assess the proposed 2017 Budget in terms of its effectiveness in meeting these challenges towards strengthening the competitiveness of Canada’s economy.

The State of Canada’s Competitiveness

According to the 2016-2017 Edition of the Global Competitiveness Index compiled annually by the World Economic Forum (WEF), Canada ranked (15) out of 138 countries included in the Index for that year. It came well behind the U.S., a primary trade partner within NAFTA. It also came behind Germany, a potentially strong competitor within CETA, who was ranked (5), Figure 1. The twelve drivers or “pillars” of competitiveness according to the WEF that compose the overall index, are grouped into three categories: Basic Requirements of competitiveness, Efficiency Enhancers, and Innovation & Sophistication.

In the Basic Requirements category composed of four pillars: Health & Primary Education, Macroeconomic Environment, Infrastructure, and Institutions, Canada’s standing is mixed, Figure 2. Its rank of (9) in health and education is relatively good and ahead of its overall rank, and is also well ahead of the U.S. and Germany. While in the important category of macroeconomic environment, Canada’s ranks of (41) well below its overall rank and far behind Germany but ahead of the U.S. Also, Canada fares well in infrastructure with a rank of (15) equal to its overall rank, but it lags both the U.S. and Germany in this pillar. As to institutions, Canada ranks (18), below its overall rank, but still ahead of both Germany and the U.S.

Canada faces several challenges in the Efficiency Enhancers group of pillars of competitiveness: Market size, Technological Readiness, Financial Market Development, Labor Market Efficiency, and Goods Market Efficiency, Figure 3. Market size is mainly a function of Canada’s population which is relatively small to medium size with a rank of (15) among the 138 markets covered by the Index. Naturally, Canada is well below the U.S. and Germany and consequently does not enjoy comparative advantage in this pillar. In technological readiness, which includes factors such as telecommunication services, internet services, foreign direct investment (FDI), and technology transfer, among others, Canada ranks (21), below its overall rank and well behind both Germany and the U.S.

On the other hand, Canada has a rank of (7) in financial market development, well ahead of Germany but behind the U.S. in this category. Canada also fares well in labor market efficiency with a rank of (8), well ahead of Germany, but behind the U.S. Similar pattern is observed in the goods market efficiency, the rank of (17) however, is below the overall rank and indicates a room for further improvement. Finally, the important pillar of higher education and training, which received notable attention in the 2017 Budget, Canada ranked (19), below its overall rank and that of the U.S., but little ahead of Germany.

Finally, in the fourth category of Innovation & Sophistication, where the former is a primary focus of the 2017 Budget, Canada is at wide disadvantage which justifies the special attention that this category has received from the Government. Canada ranked (24) in innovation well behind Germany (5) and the U.S. (4), and similarly ranked in business sophistication (24), behind Germany (3) and the U.S. (4), Figure 4.

Methodology of Budget Evaluation

Since the 2017 Budget is a policy and program based document, evaluating its effectiveness in enhancing Canada’s competitiveness would require a qualitative correlation between the relevant Budget policies with the above pillars of competitiveness. For this to be realized, the factors constituting each of the ten pillars were reviewed. From each pillar, a maximum of six factors were selected in which Canada received the lowest relative ranking and thought to deserve policy makers’ attention. The effectiveness of the 2017 Budget in supporting Canada’s competitiveness is then judged by the extent that its policies/programs address those factors towards strengthening them. The standing of Germany and the U.S. in these factors are also presented for comparison purposes and a clearer perspective.

The 2017 Budget Evaluation

Institutions

The biggest challenge in this category to business environment seems to come from “organized crime”, where Canada ranks (44), ahead of both Germany (64) and the U.S. (70). The next challenge comes from the important and cross cutting factor with great impact on the cost of conducting business; “burden of government regulation”, where Canada ranks (40) well behind both Germany (18) and the U.S. (29). The third factor is “business cost of crime and violence”, where Canada ranks (36) well ahead of Germany (63) and the U.S. (70).

“Favoritism in decisions of government officials” is also problematic, where Canada ranks (31) well behind Germany (17), but little better than the U.S. (37). Finally, Canada ranks (23) in “wastefulness of government spending”, slightly behind Germany (20) but well ahead of the U.S. (74), Figure 5.

The 2017 Budget is considered quite responsive to the challenge of fighting crime and violence, including organized crime. Under the general title of “Safety and Security for Canadians” it proposed several policies among which: a new strategy to address gender-based violence to which is allocated CAD 100.9 million over five-year period, modernizing the correction system, strengthening the family justice system, building a strong judiciary, and strengthening access to the Canadian justice system.

Moreover, the Budget proposes some measures to fight economic and financial crimes including: strengthening corporate and beneficial ownership transparency, strengthening Canada’s anti-money laundering and anti-terrorist financing regime, among others.

Reduction of wasteful government spending was also specifically targeted by the following measures: A comprehensive review of at least three federal departments with the aim to “eliminate poorly targeted and inefficient programs, wasteful spending, and ineffective and obsolete government initiatives”. A three-year review of federal fixed assets, and a review “of all federal innovation and clean technology programs across all departments”. Furthermore, the restoration of parliamentary approval of government borrowing will likely contribute to more efficiency by enhancing government transparency and accountability.

The 2017 Budget did not include however, any measures targeting alleged favoritism in decisions of government officials, neither it proposed any measure specifically aimed at reducing the burden of government regulations. Both factors are considered of vital importance to reducing the cost of doing business, which help in attracting investment to the technology sectors to which the Budget assigns high priority under its innovation strategy.

Macroeconomic Environment

The macroeconomic environment is quite challenging for economic policy makers and managers in their effort to strengthen Canada’s competitive advantage. Government debt is relatively high at about 91.5 percent of GDP, where its rank of (120) places Canada behind Germany with a debt level of 71 percent of GDP and a rank of (103), but ahead of the U.S. with a level of 105.8 percent of GDP and a rank of (128). Furthermore, Canada’s budget balance is in the negative, where it ranks (39) well behind Germany (10) who enjoys a positive fiscal balance. Canada is however well ahead of the U.S. who ranks (84) and endures a negative budget balance.

Similarly, Canada does not fare well in savings, which are required to meet the investment needs of the economy. It ranks (67) in gross national savings rate which amounts to about 20.5 percent of GDP. While Germany, who ranked (33) has a gross national savings rate of 27.3 percent of GDP. The U.S. however lags Canada with a rank of (80) and gross national savings rate of 18.7 percent of GDP, Figure 6.

According to the 2017 Budget, the macroeconomic environment is not expected to appreciably change over the 5-year budget horizon. The budget balance is expected to stay in the red while deficit is cut by about 42 percent over the period 2016/17-2021/2022. As to government debt, its future trend will be shaped, not only by the performance of the Federal Budget, but also by the performance of provincial budgets as well.

As to national savings, the 2017 Budget did not contain any specific direct measures aimed at increasing the national savings rate. It is noted however, that policy measures that aim to grow income, reduce cost of business and cost of living, or grow factor productivity, among others, should contribute to growth in savings. Achieving such outcomes however, is constrained at present by high household debt, which, according to the OECD stands at 175 percent of disposable income for Canada, compared to 93 percent for Germany and 112 percent for the U.S.. Another policy constraint is the fact the Canada’s economic growth is primarily driven at present by consumption with limited contribution from investment or factor productivity. Consequently, Canada would need to attract foreign investment to compensate for low national savings; one more overarching reason to improve the domestic business environment.

Infrastructure

With a rank of (15) in infrastructure, which is equal to its overall rank of competitiveness, one may deduce that the challenges facing Canada in this important pillar are only minor to moderate. But a closer look at the constituents of this pillar reveals issues that should be of special concern, Figure 7. Notwithstanding the fact that Canada lags both Germany and the U.S. in the quality of all modes of transport and overall infrastructure, it ranks (119) out (138) countries included in the competitiveness index in the subscription rate of mobile cellular service. It is only 82 percent, while in Germany the rate is 117 percent and in the U.S. 118 percent. This relatively low rate raises the important issue of cost and affordability of telecommunication services, which are usually a result of insufficient competition and other market failures.

Fortunately, the 2017 Budget recognizes the need to upgrade Canada’s infrastructure by proposing the establishment of an infrastructure bank. The Canada Infrastructure Bank will, according to the Budget statement, “be responsible for investing at least $35 billion over 11 years, using loans, loan guarantees and equity investments. These investments will be made strategically, with a focus on large, transformative projects such as regional transit plans, transportation networks and electricity grid interconnections.” The investments will also help catalyze complementary programs at the province and local levels, which should enhance the benefits of this important initiative.

As to the comparatively low subscription rate of the mobile-cellular network, the Budget does not have any specific proposals. It does however propose programs to increase the coverage of the related high-speed internet so it serves Canadians, “no matter where they live”. Specifically, it proposes a “new program, Connect to Innovate, focused on investing in backbone networks—the digital highways that carry traffic between communities—with support also available for last-mile applications.” The Budget further proposes measures to make home internet access more affordable for low-income families. Notwithstanding the importance of these initiatives, they do not sufficiently address the issue of low cellular subscription rate, nor the possible issue of cost and affordability, which impact not only low income Canadian households but all Canadians and the important Canadian business sectors. The availability of cost effective, high quality telecommunication and internet services are essential for an attractive business environment.

Higher Education and Training

Overall, Canada falls behind both the U.S. and Germany in this important pillar of competitiveness, Figure 8. Although It is ahead of both countries in gross enrollment rate in secondary education and in internet access in schools, it is however behind Germany in the quality of the education system but little ahead of the U.S. Furthermore, Canada is behind both countries in extent of staff training, and curiously behind in tertiary education gross enrollment rate. The latter should be of policy concern, since it can be the result of many factors, such as affordability, access or availability, and limited returns on higher education, among others.

Two specific proposals in the 2017 Budget target the issue of affordability of tertiary education which will likely improve the enrollment rate. The first is the proposal to increase access to Canada learning Bond, by increasing awareness of the program and reducing barriers to access. The second is the proposal to amend the Canada savings Act to “simplify the application process, ensuring that more children who are eligible for these benefits receive the support they need to help pursue post-secondary education”.

Indirectly, the special emphasis by the 2017 Budget on strengthening Canada’s innovation capacity will help create high quality employment opportunities in the targeted high technology sectors, which should in turn enhance the attractiveness of tertiary education.

Financial Market Development

Canada enjoys a very good rank of (7) in this important pillar of competitiveness, mainly due to three factors where the financial market is distinguished: soundness of banks, regulation of securities exchanges, and protection of legal rights. But Canada’s financial market does not do as well in most other factors which are considered very important drivers of competitiveness and necessary complements to innovation; a high priority of the 2017 Budget. For example, Canada does not fare well and is ranked behind the U.S. and Germany in venture capital availability, in the financial system meeting business needs, in affordability of financial services, and in the ease of access to loans, Figure 9.

The 2017 Budget focuses on protecting financial market stability. It proposes to “introduce targeted legislative amendments to bolster the toolkit for managing the resolution of Canada’s largest banks, modernize the deposit insurance framework, and strengthen the oversight of systemically important financial market infrastructures which clear and settle financial transactions”. It does not however address the important issues identified above, where Canada’s financial market is comparatively lagging and believed to be serious constraints on the effectiveness of the financial market and its role in economic development.

The 2017 Budget indirectly addresses the issue of venture capital availability, where this may be partially eased by the extent that the 2017 Budget proposals on innovation will catalyze venture capital availability from the banking sector. The proposal “to create a new $1.26 billion five-year Strategic Innovation Fund to consolidate and simplify existing business innovation programming” could be such a catalyst. Also, the proposal aiming at “supporting Canadian innovators through venture capital” by making available through the Business Development Bank of Canada “$400 million on a cash basis over three years, starting in 2017–18”, should partially contribute to mobilizing private venture capital.

Technological Readiness

Canada, with a rank of (24) leads both the U.S. (38) and Germany (29) in internet bandwidth, and its ranked (20), behind Germany (17) but ahead of the U.S. (25) in FDI and technology transfer, Figure 10. It falls however, well behind the two competitors in the important technology absorption at the firm-level which is considered a good proxy for firm-level productivity and innovation, it ranks (31) in comparison to a rank of (4) for the U.S. and (12) for Germany. Canada is also well behind in the subscription rate of mobile-broadband with a rank of (60) compared with a rank of (13) for the U.S. and a rank of (35) for Germany. As was previously explained for mobile cellular service under the pillar of “Infrastructure”, the low subscription rate can be due to limited geographical coverage and more importantly due to high service cost and low affordability.

The 2017 Budget gives high priority to strengthening innovation, whose related initiatives and proposals are likely to enhance the attraction of Canada to foreign direct investment and consequently support technology transfer. This subject will be revisited later when discussing the factors of innovation.

As to increasing firm-level technology absorption, this level is influenced by several economic and institutional factors, most important of which is the nature of competitive advantage and the extent of exposure of Canadian firms to competition, especially in international markets. Although the 2017 Budget did not specifically address this factor of competitiveness, several of the proposals made in the context of enhancing innovation and strengthening exports, such as gearing toward export promotion to take advantage of the new free trade agreements, will motivate growth in firm-level technology absorption.

Business Sophistication

Canada does not fare well in this highly relevant pillar of competitiveness. A relatively narrow value chain limits the availability of local suppliers for intermediate and complementary technological products. It ranks (46) in the breadth of the value chain, well behind Germany (5) and the U.S. (7), Figure 11. The heavy reliance on a single market, that of the U.S. for 75 percent of exports, and a relatively lower emphasis, to date, on export driven economic growth, weakens the incentives to build sufficient marketing channels in international markets. Canada ranks (25) in extent of marketing, compared with a rank of (1) for the U.S. and (7) for Germany. On the other hand, the dominance of natural resources and medium level technology products in the export slate, weakens the incentives for improving the quality of its competitive advantage. Canada ranks (39) in the nature of competitive advantage well behind Germany (10) and the U.S. (18).

While the 2017 Budget does not directly address the above challenges, it never the less embraces innovation with the objective of benefiting from the opportunities that the expanded trade agreements will offer. The Budget proposes the adoption of an ambitious innovation and skills plan, which among its main objectives, growing Canada’s exports of goods and services by 30 percent by 2025. It also aims at doubling the number of high growth technology companies from 14 to 28 thousand over the same period.

However, to realize such ambitious goals, the Innovation and Skills Plan must address the above shortcomings, especially marketing and distribution. On the other hand, the successful implementation of this Plan, due to its emphasis on high technology sectors, is expected to improve the nature of competitive advantage, expand local supplier quantity and widen the value chain. It should be noted however, that due to market size and the globalization of value chains, it will be beneficial for Canada to leverage the much wider and sophisticated high technology value chain of its only neighbor the U.S., in a way similar to what is already the case in the car and other transport vehicles industry.

Innovation

Finally, in the important pillar of innovation, Canada faces several challenges, with a rank of (24) placing it well behind the U.S. (4) and Germany (5). The advanced technology sector gets limited support from government procurement, and reflects comparatively underutilization of advanced technology in government operations with negative implications on productivity. Canada’s rank of (67) in this measure places it well behind Germany (6) and the U.S. (11).

Canada also falls behind the two competitors in the extent of company spending on research and development (R&D), capacity for innovation, university-industry collaboration, and quality of scientific research institutions. All these factors are closely related and interdependent, Figure (12).

Considering the above innovation challenges, the focused response of the 2017 Budget to these challenges and the priority given to building innovation capacity is commendable.

On the top of relevant initiatives and proposals noted earlier in this article, the 2017 Budget includes several other initiatives of direct relationship to innovation, and specifically intended to address the above challenges. According to the Budget the Government will, among others:

• “Increase investment in innovation by business in six key areas—advanced manufacturing, agri-food, clean technology, digital industries, health/bio-sciences and clean resources.

• Accelerate a small number of business-led innovation “super clusters” that focus on innovative industries.

• Increase the number of collaborations between industry, post-secondary institutions and research institutions.

• Reinforce world class research strengths at post-secondary institutions in areas such as quantum computing, stem cells and artificial intelligence.

• Assist Canadian innovators in finding a first customer to test and validate their technologies through the federal government.”

Furthermore, the Budget promises to strategically leverage government procurement to help innovative companies grow, while its promise “to make Canada an advanced, digital environment” should contribute to raising the level of technology absorption and enhancing the nature of competitive advantage of Canada’s economy.

In summary, the initiatives and proposals of the 2017 Budget are judged to be necessary but not sufficient for enhancing Canada’s competitiveness. Complementary policies are needed to improve the investment climate, reduce the cost of business, increase the national savings rate, broaden the technological value chain, and build international marketing and distribution capacity, among others noted above.

K.Z.

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