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Russel Metals Hamilton plant takes coiled rolls of steel and cuts them down into plates for which then can be turned into products, including heavy machinery. (Glenn Lowson for The Globe and Mail)
Russel Metals Hamilton plant takes coiled rolls of steel and cuts them down into plates for which then can be turned into products, including heavy machinery. (Glenn Lowson for The Globe and Mail)

A warning for Ontario: government-led innovation rarely works Add to ...

Ontario Premier Dalton McGuinty has presided over a precipitous economic decline – a fact confirmed by Roger Martin’s most recent Institute for Competitiveness and Prosperity report. The province is experiencing a long-term drop in prosperity vis-a-vis its North American peers. Five years on from the financial crisis and more than a month after the announcement of his resignation, Premier McGuinty’s Jobs and Prosperity Council is set to offer up ideas on how to reverse the province’s economic decline.

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Like the Drummond report, this document may prove decisive in framing the public policy debate for the current Liberal leadership race and, more important, the next election. Judging from a recent TVO panel, intervention may become the order of the day. Twentieth-century policy shorthands such as “industrial policy” and “sector supports” are being resurrected. The promotion of fuzzy policies around “innovation” and “clusters” continues unabated.

Government-led economic development and innovation initiatives usually fail and, in fact, often cause more harm than good. As the Ontario government finally turns its attention to the economy, here is a list of the biggest reasons why such government initiatives are so unsuccessful and frequently damaging.

Getting innovation right is tough

Even the private sector often fails to innovate in an effective way; the “gales of creative destruction” are constantly revealing winners and losers. Firms that were once at the forefront of innovation often fail miserably (see the sad decline of Kodak as an example). Even firms that are specifically designed to spur innovation, such as venture capital funds, also fail more often than not.

Harvard Professor Josh Lerner, in his excellent work on government support for innovation, shows that out of thousands of U.S. venture capital funds, only a few account for the majority of returns.

If the private sector is so lousy at innovation, it is fair to wonder how a government can expect to pick winners successfully. Yet governments are always trying to dole out “innovation” money. As Don Drummond recognized in his recent report, such policies “can be very costly with few results.”

Copying other jurisdictions rarely works

Many governments, looking for ideas to spur economic growth, cast an eye to successful examples of government action around the globe. Understanding successful government initiatives is certainly a good part of public policy development. However, copying other governments can often be a recipe for failure. It should not be forgotten that the genesis for the McGuinty government’s Green Energy Act was a 2008 tour of Europe by then-energy-minister George Smitherman. He was impressed with the apparent economic success of green energy policies in Germany and other European countries. The newspaper accounts at the time are interesting to read in light of the policy’s uncertain future and failure to engender “green jobs”:

“Imagine a world where we could emulate their success?” asks an animated Mr. Smitherman, 44, who later turns to Amy Tang, an adviser sitting across the table. “Sorry, now I’m getting all worked up. Am I frothing at the mouth?”

And “emulate” the province did. What the province failed to understand was that other European nations had a full decade head start over Ontario, that the economic/energy structure of Germany was not at all analogous to that of Ontario and that China was about to enter the renewables market in a big way. Understanding the key drivers of our own jurisdiction’s success is far more important than grafting on a strategy developed elsewhere. Instead of travelling to Germany for his policies, the then-minister should have strolled not 20 minutes down University Avenue from Queen’s Park, where a huge statue honoring Sir Adam Beck, the father of our hydro-electric system, is inscribed to remind us of his genius in allowing Ontario to “enjoy the benefits of low-cost electrical energy.” Hopefully, we have finally learned that aping other jurisdictions rarely works.

Rent seeking

Perhaps the most insidious effect of government interventions in the economy is “rent seeking.” Rent seeking occurs when actors gain a share of economic value through setting the political and economic rules, rather than through innovation or growing economic activity. These efforts create significant distortions in the broader economy, destroying value and economic potential throughout.

Industry structure is an important determinant to whether “rents” can be extracted. Telecom and the airline industry are examples of industry structures that keep economic value in the hands of a few firms, rather than spreading the fruits of productivity to consumers and the broader economy. As the Globe and Mail has pointed out, the structure of these industries has acted as a substantial drag on Canadian productivity.

A specific example in Ontario is when municipalities and the broader public sector are forced into “closed tendering” because of labour agreements. The results are predictable: when only one group has a monopoly on government contracts, the cost of services skyrockets. One City of Hamilton report estimated the extra construction costs due to being forced into “closed tendering” were as high as 40 per cent.

Often, the rationale for granting economic rents is to “protect” jobs and economic activity; the reality is far different.

Conclusion

The Jobs and Prosperity Council has a real opportunity to give the province a road map for growth after a period of listless economic drifting. In times past, better-resourced Royal Commissions have been able to provide governments with productive plans for dynamic growth (the MacDonald commission that proposed free trade comes to mind). Government is a crucial component of ensuring strong economic growth, but the interventionist path is fraught with pitfalls and unintended consequences. The Council, the Liberal leadership candidates, and provincial policymakers should be wary.

J.C. Bourque is a business strategy consultant in Toronto. He has worked on several campaigns for the Progressive Conservative Party of Ontario.

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