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Foxconn workers assemble a Hewlett Packard computer in 2012. (Gilles Sabrie/The New York Times)

Foxconn workers assemble a Hewlett Packard computer in 2012.

(Gilles Sabrie/The New York Times)

How to diversify an economy: Four lessons for Canada Add to ...

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This is part of an occasional series on Canada’s economy and its shift away from resources. Catch up on previous stories at tgam.ca/neweconomy.

When the commodity boom collapsed, the Bank of Canada and private sector economists looked for potential rays of sunshine amid the gloom.

They reasoned that a battered loonie and strengthening U.S. market would help spur Canadian manufacturing exports, boost trade in services and spark more investment outside the resource sector.

But the results have fallen below expectations. The U.S. recovery remains lacklustre, marked by weak productivity and falling business investment. Canadian exports have been declining since February. And the overheated real estate market that has propped up Canadian growth can’t be counted on as a long-term driver of economic expansion.

“Unfortunately, this growth rotation has shown signs of stalling over the past several months,” Toronto-Dominion Bank economist Brian DePratto said in a note last week.

That may be a blessing in disguise because it will put more pressure on Prime Minister Justin Trudeau to deliver on his pledge to make Canada over as an innovation hub that can carve out a strong, job-creating niche in a rapidly changing global landscape.

Mr. Trudeau put the international spotlight on that promise at the annual high-powered economic gathering in Davos in January, when he famously declared: “My predecessor [Stephen Harper] wanted you to know Canada for its resources. I want you to know Canadians for our resourcefulness.”

He will undoubtedly be highlighting this theme next week during his first state visit to China, which is in the midst of a crucial economic transformation of its own. This includes a costly 10-year government plan launched last year to drive manufacturing up the global food chain, as part of a concerted effort to become a world leader in such innovation-driven industries as aerospace and pharmaceuticals.

Most governments eagerly embrace the idea of building knowledge-based economies with the potential to provide the robust growth, job creation and earnings power that have gone missing in a large swath of the industrial world since the Great Recession. Poorer countries see innovation as a way out of their heavy reliance on boom-and-bust natural resources or low-margin manufacturing.

But such transformations are easier wished than accomplished.

“The question of how governments manage the transition of the economic structure is a very difficult one,” says former Bank of England governor Mervyn King. “Governments are very bad at second-guessing the industries in which one chooses to concentrate.”

Asked to list those he considers on the right track, Lord King adds: “It’s much easier to find examples of countries that are not doing it right.”

In Canada’s case, a single national policy would not work, says Dan Breznitz, co-director of the Innovation Policy Lab at the University of Toronto’s Munk School of Global Affairs.

Instead, each region should focus on exploiting existing strengths, such as energy-related innovations in Alberta or agricultural technology in the grain belt, where strong knowledge bases already exist.

Policy makers need to figure out which region “can compete and where and what it needs to get there,” Prof. Breznitz says. It’s “not just a simple matter of saying ‘we are embracing innovation’ and then come up with one size fits all. A country that did it properly – or mostly properly – is China.”

China has developed a national model, “but there is enough variance within that model to avoid a total meltdown if something bad happened to the global economy.”

Even those that have managed to come up with formulas that appear to be working have not discovered any magic elixirs. And in some cases, the successes have enriched only a small segment of society, widening income gaps while failing to lift the broader economy.

“Most countries – even the ones that have done something interesting – are a mix of good and bad,” says Christian Ketels, principal associate at Harvard Business School’s Institute for Strategy and Competitiveness.

Here are some examples of economic transitions that could offer some lessons for Canadian policy makers.



Old Town Pier in Helsinki. (iStock)

Finland

The small Scandinavian nation has long been regarded as a transformation success story. It consistently places at or near the top in surveys of global innovators – No. 1 in capacity to innovate, according to the World Economic Forum and fifth last year in the broader, annual Global Innovation Index published by Cornell University, French business school INSEAD and the World Intellectual Property Organization.

Weaning Finland off its long dependence on natural resource exports, specifically forest products, did not happen overnight or without careful public planning. But the revamping, which began in earnest in the 1990s, was a matter of some urgency.

Between 1991 and 1993, the country endured the deepest recession in its history as a direct result of the collapse of the Soviet Union, by far its largest trade partner. Thanks to a mostly barter arrangement, the Finns shipped otherwise uncompetitive manufactured goods to the Russians in exchange for cheap energy. When this fell apart, Finland’s gross domestic product plunged 11 per cent, the jobless rate peaked at 16.5 per cent and the stock market lost 60 per cent of its value.

“That basically triggered a whole rethinking of the country’s economy,” says Soumitra Dutta, dean of Cornell University’s business college and an architect of the innovation index. “They developed a national strategy at the highest levels of government.”

One key to the revival was a heavy emphasis on science education, which has churned out scores of skilled engineers.

Many of them landed at Nokia, which fittingly began as a pulp and paper company in 1865 and had become an electronics force by the mid-1980s. As a maker of mobile phones, it would become Finland’s global standard bearer in the new economy, before sailing into the same Apple hurricane that flattened BlackBerry.

But the battered Finnish economy is more than a single struggling tech giant.

Helsinki has become a hotbed of game developers and other small software producers, whose combined employment exceeds that of Nokia at its peak. Majority control of one prominent player, Supercell, best known for the hot-selling video game Clash of Clans, was flipped in June to Chinese Internet powerhouse Tencent Holdings for $8.6-billion (U.S.).

Finland is placing its tech bets on half a dozen sectors – information and communications, health care, energy/environment, forestry products, construction and mechanical engineering – each with a strategic centre that brings researchers, students and businesses together, identifies problems and shares developments regardless of where they’re created.

“There’s a linkage of key actors in the innovation ecosystem in the critical sectors,” says Stephen Ezell, vice-president of global innovation policy with the Information Technology and Innovation Foundation, a global policy think tank in Washington. “It’s a vital element that public policy has to get right to support innovation.”



The exterior of the E-Estonia Showroom, which showcases developments in information and communication technology, in Tallinn, Estonia, in 2014. (Fabian Weiss/NYT)

Estonia

When the smallest Baltic state was freed from its Russian yoke with the breakup of the Soviet empire in 1991, more than half the population had no telephones. Less than a decade later, every school was online and most people had home Internet access. By 2000, paper had disappeared from cabinet meetings. A couple of years later, much of the population had access to free WiFi.

In 2012, 15-year-old Estonians ranked sixth in science and 11th in math, ahead of the likes of Germany and essentially tied with Finland, among 65 countries involved in an international assessment of education systems. Now, children in primary grades are learning computer programming and almost all public services have migrated to the digital realm.

The government boasts that a would-be entrepreneur, whether Estonian or not, can set up and register a company via the Internet in less than 20 minutes from anywhere in the world. Filing taxes takes about five minutes.

The government has branded its innovation strategy e-Estonia to highlight the information technology hub built on a foundation of strong universities and policies that have proved attractive to investors.

Its best-known startup? Skype, which was acquired by eBay in 2005 and peddled to Microsoft six years later for $8.5-billion (U.S.). Another, Playtech, which makes software for Internet gambling sites, employs more than 5,000 people in 13 countries.

Starship Technologies, started by two Skype co-founders, is designing self-driving robots to deliver local packages and groceries at a fraction of the cost of human couriers or drones.

Like most innovation models, though, Estonia’s has its drawbacks.

For one thing, programs designed to boost the relatively small entrepreneurial tech sector haven’t been a big help to the broader economy. And when you provide easy digital access to a host of sensitive business, health, tax and other information, you had better have strong defences against hack attacks.

Key government, banking and other electronic systems came under sustained denial-of-service assaults for several weeks in 2009, marking one of the earliest foreign cyberattacks on a single country. Russia was believed to be the culprit. The Estonian solution: Place backup servers in half a dozen locations in other parts of the world to take over in the event of another attack or even the overthrow of the government.



An irrigation system sprays recycled waste water on a field in Kibbutz Magen in southern Israel. (Amir Cohen/Reuters)

Israel

When dealt lemons, some small countries have taken to making lemonade. Few have been more adept at it than resource-challenged Israel, which was best known in trade circles for its citrus exports as recently as three decades ago.

Israel still ships lots of citrus fruit (though few lemons) and other produce. But this is dwarfed by its exports of agricultural technology, much of it designed for use in arid climates like its own. It’s part of a government-orchestrated economic shift that was designed out of necessity and has served as a showcase for others contemplating a leap into the new economy pool.

“Every country has to have a national strategy. It has to make a few right bets, and hopefully with the right foundation, the bets pay off in the medium term,” says Cornell’s Prof. Dutta.

In Israel’s case, those bets logically began with military-based needs – in defence, aerospace and communications. Even today, only a small fraction of the country’s hefty research and development spending is earmarked for such fast-growing global tech sectors as life sciences.

To solve a shortage of investment capital, another chronic problem for would-be innovators lacking deep pockets and large markets, the government ushered in a program in 1993 linking high-tech wannabes to U.S. venture capitalists. To lure the foreign money, Israel offered to match whatever dollars the investors brought to the table, taking on a chunk of the risk but none of the potential gains.

“It turned out to be really effective because it gave an incentive to U.S. firms to go to Israel and invest in startups there,” says Joel Blit, an assistant economics professor at the University of Waterloo.

The country came by its moniker, Startup Nation, honestly. The strategy, which included a hefty dose of deregulation, spawned hundreds of fledgling tech players, many of them designing products and parts for global supply chains. Only Silicon Valley has produced more startups over the past two decades.

By the end of the 1990s, Israel ranked second to the U.S. in the amount of private equity invested as a share of GDP. And annual R&D spending of more than 4 per cent of GDP puts Israel near the top of research-intensive economies.

Japan, traditionally a big research spender, comes in at about 3.6 per cent. Canada has been heading in the wrong direction, with the ratio falling to 1.6 per cent in 2014 from more than 2 per cent 15 years ago.

But like other countries that have scored innovation successes, Israel can’t afford to rest on its laurels.

The challenge facing any government seeking to reshape its economy is that policies have to be flexible, the U of T’s Prof. Breznitz says.

What sets apart countries or regions that have managed to continue to innovate and grow over a long period is their ability “to overcome the problems and bottlenecks stemming from their successes by immediately changing policies,” says Prof. Breznitz, who advises Israel’s powerful Office of the Chief Scientist, a government agency that steers state innovation policies.

As an example, he points to the restructuring of the Chief Scientist’s office to examine the broader societal effects of the successful innovation drive.

These include widening income disparity – the largest in the 34-country Organization for Economic Co-operation and Development – as a relatively small number of entrepreneurs and investors have corralled the lion’s share of the wealth generated by the tech wave.

“The ‘Startup Nation’ label exists, but large parts of the economy are not part of it,” Harvard’s Prof. Ketels says.

The failure to spread the benefits of tech developments more broadly has also hurt productivity. “That’s been a weakness of the Israeli innovation ecosystem that I would counsel Canada not to copy,” says Mr. Ezell of the global policy think tank.



Foxconn's headquarters in New Taipei City, Taiwan.

Taiwan

Certain countries do a particularly good job of tailoring their innovation strategy to fit smoothly into global research and supply chains in everything from electronics, clean energy and transportation to biotech and financial services.

Taiwan has been doing just that for decades. Silicon Valley might be the place where new tech ideas are hatched. But Taiwan – or Taiwanese-based global contract manufacturers such as Foxconn and Wistron – is where the concepts are likely to become reality.

The transformation began in the early 1970s with the creation of the Industrial Technology Research Institute, a non-profit organization designed to spearhead the shift from labour-intensive, low-tech assembly to sophisticated high-tech manufacturing. ITRI laid the groundwork for a world-leading semiconductor industry and fostered technological breakthroughs in a host of other areas from materials and lasers to biotech and solar power.

“They were very intentional about identifying key parts of these emerging global value chains and the products they wanted to get into,” Mr. Ezell says of the Taiwanese planners. “Their drive into specialized, large-scale precision manufacturing was a very organized development in competitiveness and innovation strategy.”

In an era of global sourcing, “China and, to a certain degree, Taiwan are the only places where people can take 10,000 components and figure out how to manufacture them into one product in less than three months,” Prof. Breznitz says.

He points to Apple’s iPhone as an example. Shortly before its hugely successful launch, the company opted for a glass touch screen instead of plastic. The change helped make a Hong Kong supplier enormously wealthy. But it was left to giant Foxconn to figure out how to assemble the phones.

Taiwan’s experience is yet another example that when it comes to economic transformation, “you can’t just leave it to private sector entrepreneurial drive and luck,” Prof. Dutta says.

It’s time, he argues, to dispel the myth that economy-impacting innovation happens when governments “cut all the regulatory red tape and then stand aside to let market forces rule. In almost every case of successful entrepreneurship and innovation, governments are playing a key role.”


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