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The ghost of Nortel continues to haunt Canada's tech sector

Next month marks a grim anniversary in the annals of Canadian business.

Nortel Networks, the former flagship of the country's high-tech industry, filed for bankruptcy protection on Jan. 14, 2009.

Three years on, the company's spectacular flameout remains a potent symbol of the country's failed innovation potential.

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Generous tax credits and a government that embraced Nortel's products weren't enough to save the company.

Nortel is now dismembered. Its brainpower and intellectual property is spread around the world.

But the damage is still being felt – on employment, research activity and the vitality of Canada's tech industry.

Canadian companies are still spending less on research and development than they did in 2007. The R&D budgets of the country's 100 leading research spenders shrank by a combined $1-billion in 2010 from its 2009 level, dragged down by Nortel's disappearance, according to Research Infosource Inc. It marked the fifth-straight year of declining R&D spending in this annual survey.

Nortel's influence stretched far beyond the company's own operations.

In 2007, the high-tech industry employed more than 70,000 people in the Ottawa area, once the hub of Nortel's global operations. Today, there are fewer than 44,000, a drop of nearly 40 per cent.

A significant cluster of technology companies remains in the nation's capital, many doing cutting-edge work. But they're typically small, and increasingly foreign-owned – subsidiaries of larger players in a global industry.

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The gutted shell of Nortel is winding its way through the bankruptcy process. In the summer, the company auctioned off a portfolio of 6,000 patents to Apple, Microsoft, Research In Motion and others for $4.5-billion in cash, marking the sale of its last significant batch of assets. The patents, many developed in Canada with generous government tax credits, covered everything from 4G wireless networks, Internet and voice technology to optical equipment and semiconductors.

What remains is a pile of cash left from the sale of these assets, tax losses and, interestingly, roughly $1-billion worth of unused R&D tax credits. With Nortel losing money before its collapse, the tax credits proved worthless.

Some of those tax credits, along with the loss carry-forwards, may eventually be used to offset taxes payable on the gains from asset sales. That could mean more money for creditors, including thousands of Nortel pensioners and former employees.

It's a small consolation for the country, which has pumped billions into R&D, but continues to struggle with lagging innovation and productivity. Canadian companies aren't investing enough in R&D. They're developing too few of their own products and services. And they're investing too little on productivity-enhancing technology.

Part of Ottawa's response to the Nortel bankruptcy was the creation of a federal task force to review government R&D incentives. Headed by Open Text Corp. chairman Tom Jenkins, the task force recently recommended scaling back the $3.5-billion-a-year Scientific Research and Experimental Development tax credit program, putting more money into direct support for companies and making better use of government purchases to spur innovation.

That may be only part of the solution.

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Canada must figure out a way to foster a new generation of Nortels, while nurturing existing tech companies.

Some experts say the answer lies in better incentives – not just for the companies who do R&D – but also for the businesses that turn their research into successful Canadian-made goods and services. Len Farber, the former director general of tax policy at the Finance Department, argues that a key policy lesson of the Nortel saga is ensuring R&D produces clear economic benefits for Canada. That may involve providing greater incentives, including additional income-tax breaks for companies that convert their R&D into successful Canadian-made products, argued Mr. Farber, now a senior adviser at law firm Norton Rose in Ottawa.

"We're incurring a large tax expenditure, but we're not getting as much benefit as we could," he acknowledged.

The solution may also be better incentives for investors to put their money into the kind of venture capital that sustains innovative companies. And more competition in domestic telecom markets couldn't hurt.

Canada has paid a steep price for the death of Nortel. It can't afford another.

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