Building and Sustaining Canada's Digital Economy

Summary

Long a global centre for telecommunications equipment and data networking, Canada was recognized as amongst the world's early leaders in the new "Digital Economy", We were amongst the first nations to digitize significant national records and cultural works, to ensure rural and remote communities were internet connected through innovative government programs such as "SchoolNet" and the "Community Access Program" (CAP). and to implement a major effort to make federal information and services available to citizens and businesses through the Internet. When residential broadband access started to become available, we were amongst the "early adopters".

Yet over the past few years we appear to have "lost our way", and are slipping behind other more organized and aggressive nations. Canada must not allow itself to become simply the best "consumers" of the equipment and digital content produced by others! A digital economy strategy needs to put Canada back at the forefront of the technologies driving this important field, leveraging our entrepreneurial spirit, business skills and organizational and intellectual capabilities to make Canada a global powerhouse with a myriad of companies and cultural organizations riding the digital wave. In today's hypercompetitive global market government support in its many forms is essential for success. From creation of an appropriate policy framework, to the right spectrum licensing rules, to the optimum direct and indirect supports for our ICT and digital content companies, we need to "get it right".

To enhance take–up of new technologies, continuation of accelerated tax write–offs for ICT enabled productivity improvements is needed, while recognizing that SMEs make up the vast majority of our ICT companies. Regarding infrastructure improvements, Canada should ensure that spectrum auctions and licensing costs are not driving up consumer prices, and governments need to directly invest more in extending broadband to all internet users. Within our innovation sectors, and the ICT industry specifically, we need to shift the focus from an over reliance on "soft" or "indirect" government support for technology such as funding basic research in universities and providing broad tax credits for qualifying R&D, to a more targeted system of direct supports through an improved IRAP, better support for industrial clusters, a U.S. style Small business Innovation Research Program, a reformed SR&ED system, and a consumer or "Angel" level VC tax credit system. To facilitate Canadian development of digital content in today's HD/3D world, we need to be supporting emergence of cloud computing multi tenant platforms, and development of new automation tools to facilitate content production. More attention is also needed to ensure we "grow our own" ICT professionals, while taking advantage of the excellent skills immigrants are bringing with them, and governments at all levels need to ensure better support to encourage SMEs to provide skills training to their staff.

Submission

Our Input by Discussion Theme:

1. Innovation using Digital Technologies

The fact that Canadian companies continue to fall behind in productivity improvements compared to our major competitors, and that this (inter alia) has been directly linked by experts to our low investment rates in ICTs, is no longer news. Having observed the problem of low corporate investments in new technologies (and ICTs specifically,) for some time now, we believe it to be connected to the fundamental nature of our economy, and Canadian business culture generally. With a very high proportion of Canada's private sector being made up of SMEs compared to major competitors such as the U.S. and Europe, (and at the lower end of the SME scale, at that,) and with most companies not being directly involved in technology intensive fields, employers do not see the necessity of investing in innovation compared to other more pressing priorities. Their chief preoccupation is making the next payroll and focusing on increasing their sales, with little time left for thoughts of how to improve productivity within their own small company. That's generally something they see as being the province of "the big guys". An attitude which must change.

Increasing take–up of new technologies and ICTs in particular will require tax regimes that make SME managers favour investment in innovation and productivity tools over other uses of their limited funds, along with education provided through their industry associations. The 100% write–off of computer equipment in one year, as provided for in the "Stimulus Budgets", is a good example, but while it was overly generous for the two year window available, it was far too narrow in its application. Rather than simply office desktop PCs and related peripherals, (very few of which are made here in Canada,) an accelerated write–off provision needs to apply to a broader range of office and manufacturing equipments that incorporate computers or other ICT elements within them. And industry associations should be contracted by governments to get the message out to their members about the advantages of such programs.

On the issue of "Government as Model Users", current Canadian governments are on the opposite end of the scale from this expression. Over the years, concerns over minimizing short term purchase price as well as growing risk aversion have led to an unfortunate attitude and policy of "The lowest price, at any cost". In other words, a focus on the quickest and least price purchase, no matter whether there are longer term costs to the government, and without any regard to larger societal costs. Combine this with a cultural attitude that assumes products from huge multinationals based in other nations must clearly be better quality than anything built "at home", as well as unwillingness within governments to invest the added time and energy to find and trial Canadian technologies able to do the job equally as well, and we have a very difficult situation for Canadian firms. Worse yet, technology companies reply on their own governments as "reference clients" when attempting to sell offshore to other governments, so the lack of willingness of Canadian governments to buy Canadian when able significantly harms the ability of our companies to win international contracts.

There are limits to what can be done within the existing trade agreements, though it is actually the AIT that has more restrictions than our international agreements. However, there are still opportunities for governments to support Canadian technologies, particularly through pre–procurement R&D. Canada desperately needs a program such as the U.S. Small Business Innovation Research (SBIR) program to give Canadian ICT companies the opportunity to address government needs at an early stage. Independent studies of that program have demonstrated enormous benefit to American society over the years, and similar results should be possible here. In addition to the SBIR program, we note that Canadian governments tend to take a very restrictive interpretation of what leeway they have to work directly with Canadian companies to ensure they can meet Canadian government requirements.

In particular, Canadian security and defence requirements should be more broadly interpreted to ensure Canadian companies have the opportunity to compete for and meet these needs, and the existing Regional and Industrial Benefits (IRB) program should be modernized to ensure foreign companies make real commitments to real investments and expenditures with Canadian firms. The current approach of requiring only 20% of IRB commitments to be in place at contract award, with the rest essentially being on a "best efforts basis" is clearly inadequate, and the range of activities permitted under the program far too narrow. Commitments undertaken by large foreign contractors under this program should be capable of being met by investment in Canadian Venture Capital Funds, by supporting and assisting Canadian companies within the contractor's area of business to sell internationally in complementary product / service lines, and by direct (minority) investment in Canadian firms both within and without the contractor's own area of business. Failure to meet these contractual commitments should be accompanied by financial penalties.

2. Digital Infrastructure

We note the indications that the federal government strongly supports relying on market forces and minimizing administrative burden. At the same time, the paper acknowledges the need to improve broadband access (undefined) to our rural and remote areas. Unfortunately, in the area of spectrum auctions and licensing fees, "maximizing reliance on market forces" has had the unfortunate impact of adding significantly to citizen and business costs for telecommunications services, in both the mobile phone and internet access areas. The billions of dollars Industry Canada has raised through mobile spectrum auctions add considerable amounts to the cost of every cell phone user, and in an enormous but thinly populated country such as ours, the high cost of spectrum combined with the high cost of infrastructure to cover rural and remote areas inevitably results in high service costs for users. Adding more companies to the carrier mix in an attempt to increase competition does not result in lower user costs in such an environment, as only a few new users are attracted despite the huge new investments required.

We note as well that "the approach of the Government of Canada has been to fund broadband directly through funding initiatives…". Regrettably, the amounts being provided for this purpose are but a small fraction of the enormous spectrum revenues received by Industry Canada, and given that Canada continues to slip further down the list of "best connected nations", one must conclude that this policy has not been successful compared to the practices elsewhere. Governments of other large nations such as the U.S. and Australia are directly financially supporting roll out of broadband network access to areas less served, and are realistic enough to realize that competition alone will not provide adequate coverage. Much more funding is being provided to ensure broadband access to rural and remote areas then Canada has seen fit to commit.

Moreover, with rural communities spread out across vast geography, broadband microwave links are often the obvious way to link internet service back to larger centres. High capacity point to point radio should be capable of providing backbone service at much lower costs than either dedicated fibre or attempting to negotiate use of other carriers' infrastructure, which has its own difficulties, as pointed out in the discussion paper. However, Canada's spectrum licensing fees, designed in a period when radio links carried relatively small amounts of data, are extremely expensive for high capacity links, making the cost of radio links for a 10 Gig capacity link essentially the same as building dedicated in–ground fibre connections! In the U.S. the licensing cost has been about 1/10^th the cost of fibre over the past few years, and as part of the U.S. stimulus package was dropped even further in order to encourage more rapid roll–out of rural broadband.

In short, Canada's spectrum auction process with monies essentially going into general revenues, along with Canada's very high spectrum licensing fees for radio links, are direct causal factors in the high cost of mobile telecommunications and slow progress in roll–out of broadband to rural / remote communities, as other nations have obviously realized. And the amounts the federal government has been prepared to invest in offsetting these costs has been entirely inadequate to stop the slide in Canada's international "connectivity" position.

3. Growing the ICT Industry

Over the past decade, Canada has put in place extraordinarily effective programs to better fund university level research. (Notwithstanding that all universities find it difficult to support these basic infrastructure needs of these many new "Chairs" and other programs.) The Canada Chairs program, other programs listed in the discussion paper, and similar more recent initiatives have attracted attention around the world. Unfortunately, these multi–billion dollar investments have not often led to innovation, or the creation of new businesses, products and services.

Canada's spending on university research is second only to Sweden as a share of GDP, (OECD 2006 data) if not first by now, as our investments have continued to grow since the most recently available studies. Compared to the U.S. we are spending almost twice as much, as a share of GDP, on university research. Moreoever, fully 78% of Canada's university level research is "basic" or "fundamental" research aimed at increasing overall human knowledge, usually resulting only in the publication of theoretical papers in scientific journals. The other 22% is considered "applied" research, aimed at supporting the development of new technologies and supporting development of new products & services. Contrast that to our largest trading partner, the United States, where about 54% of university R&D is basic research, and 46% (more than twice the rate of Canada,) is "applied". (All OECD figures) Unfortunately, American universities are also much better at supporting the creation of new companies and products from university developed intellectual property than Canada's institutions. While the discussion paper indicates that "…some of the most successful ICT companies in the world…" (are) "spinning out of universities…", this has rarely been the case in Canada. In fact, government labs (including the NRC in particular,) have just as often been the source of significant discoveries that have been spun out to successful companies. Only 17% of new start–up companies in Canada originate from university research, compared to 42% in the U.S. (NAO — U.S. and StatsCan)

Research does not generate wealth and employment, aside from the actual researchers and assistants themselves. Commercialization does, which is where Canada should be putting much more effort as part of any digital economy strategy.

When then considering where such support should be focused, studies in the Canada and the U.S. continue to show that most job generation occurs in SMEs, not large corporations. (Indeed, U.S. research shows that virtually ALL employment growth there over the past few years has been from SMEs!) Greater support to technology intensive companies should therefore be a fundamental component of Canada's digital economy strategy. While Canada has a high level (if not overly rich) of indirect support programs through the extensive funding for university research, as well as support through the problematic SR&ED tax credit program, its direct support of the technology intensive sectors is extremely poor. OECD figures show that Canada spends five times what the U.S. does on indirect support (chiefly the SR&ED tax credit system and university research grants,) while the Americans spend nine times as much, as a portion of GDP on direct support for small business as we do! (OECD–STI Outlook 2008) Clearly, significant adjustments to our present approach are needed. Other countries have significant budgets for innovation support: France OSEO support for innovation is greater than 700 million Euros; Finland, population 5 million has in excess of 500 million .through Tekes, CDTI in Spain is close to 1 billion Euros; In the U.S. the DoD budget portion alone of the SBIR program is $US 1,172,097,675.

Canada's most successful federal support program for new technology intensive companies (including in the ICT field) is the Industrial Research Assistance Program of NRC. However, this program is seriously under funded. The normal annual budget is just $145M, with about $80M of that available for companies meeting the IRAP criteria, and a series of technology advisors across Canada funded from the remainder. Fortunately, in the past two years it was also given $45M annually from the FedDev program, plus $200M over two years from the "stimulus budget". But those increments are scheduled to end after this fiscal year, and IRAP will go from about $225M a year directly available to support ICT and other technology research work in the private sector, back to $80M, while it's real need is in the area of $450M to $500M. Even if the funding levels of this year and last were maintained, hundreds of additional companies could be assisted, though many more would still be left out in the cold. IRAP is a wonderful and effective program for ICT companies, though it is too often "running on empty". Indepedent studies have confirmed IRAP funding of industrial R&D has generated returns for the Canadian economy from the government's investments of at least seven times.

Canada is also failing to leverage the presence of a number of large multinational firms willing to partner with small Canadian ICT companies, which is an essential component of supporting the emergence and growth of industrial clusters. In addition to the NRC's existing clusters program at eleven institutes across Canada, additional steps need to be taken to support this important phenomenon, just as is already the case in other nations. For example, we would suggest an R&D support program aimed at small innovative companies that can show they have an agreement with a larger "strategic partner" firm for the development or refinement of products and services intended for the use of, or sale by, the "strategic partner" company. This would support in a meaningful way the technology intensive ICT SMEs that need to be part of any digital economy strategy, rather than directly funding the larger multinational firms. And it would allow the major firms to have new products and services developed for them "off the books" at very low cost.

In addition, a risk sharing investment program to support the development of new technologies and products amongst larger, more established, companies needs to be introduced. The present Strategic Aerospace and Defence Initiative (SADI) is working well for companies within those sectors, but does nothing for the many ICT firms not in the defence or aerospace fields. SADI, and its predecessor TPC, are also too cumbersome and slow in response to be of much use to ICT companies in today's environment, so a more nimble approach is required. A similar program aimed at the ICT sector, able to respond more rapidly, in which government makes direct risk based / cost shared investments is needed, as many of the more sophisticated ICT systems essential to our digital economy are now extremely complex and costly to develop. With such a large proportion of Canada's ICT companies being small SMEs, they cannot take on the development of sophisticated new systems without such assistance, a reality that has been recognized by many other nations. Without such support mechanisms, our ICT companies are finding it impossible to obtain the funding necessary and are often sold off at low prices to larger foreign firms.

We must also take the opportunity to comment on the importance of a serious and independent (of CRA) review of the SR&ED Tax Credit system. While government likes to point to SR&ED as its preeminent support program for technology intensive companies developing new products and services, the reality is that the system has become somewhat dysfunctional. Originally envisaged as an entitlement system to encourage technology SMEs, it's administration by CRA has taken on a decidedly enforcement flavour, with unrealistic views within CRA of what constitutes industrial R&D, and large expenditures by applicant companies to attempt to build their case for the benefits.

For young companies, especially the privately held firms that qualify for "refundable" tax credits, SR&ED can be an essential support mechanism for their work. And the availability of refundable credits should be broadened in recognition of this. However, for large corporations qualifying for tax credits under more limited circumstances, the reality is that such credits are accounted for internally by most companies in a manner which results in SR&ED benefits never being part of the decision factors considered when deciding where and when to do such R&D work. This situation obviates the intended benefits of the program and is an inefficient use of tax expenditures. The very broad range of technologies and projects currently considered eligible also suggests that we may be "spreading the jam too thin", and that we could have greater impact by focusing on the specific areas and themes already incorporated within the government's Science & Technology policy, which were established on the basis of external independent advice.

Finally, with respect to the issue of venture capital availability within Canada, we are truly in a very serious situation now, with the amount of VC funding of Canadian tech companies having dropped an incredible 73% from 2002 to the end of 2009. The problems are numerous, and will take years to work our way out of, but governments (federal and provincial) need to continue directly supporting venture investment funds in the meantime (such as through BDC). And governments also need to find ways to encourage institutional lenders such as corporate and public pension funds to return to this asset class.

We suggest that a shared fed/prov consumer or "Angel" tax credit system, modeled on the successful B.C. example, would also be very helpful in attracting additional domestic funds, while federal organizations such as BDC, EDC and DFAIT need to do more to spread the word internationally that Canada is an excellent place for such investments, and the ICT field an innovative and mature area for investment within Canada.

4. Canada's Digital Content

Sitting on top the networking infrastructure is another limiting Digital Infrastructure element, relating to content creation. Today the growth in High Definition (HD) and or 3 dimensional (3D) demand is driving massive change in the content creation supply chain. In order to play in this space a Canadian content provider has to obtain both the knowledge and infrastructure for this critical development tool. Providing secure and tenanted access to shared computing and storage services, utilizing a Canadian cloud will be essential for success in this industry. Companies that specialize in tools and algorithms for production automation will also thrive in this environment facilitating a global leadership position based on knowledge not price of labor based competition. Canadian institutions will also benefit greatly from this asset which again should be shared across regions not individually built and maintained through separate inefficient budget allocations.

As global quality of service networks come online, Canada has the opportunity to define and lead the standards for this highly lucrative space but only if the right investment is made in the critical underlying infrastructure.

At the same time, it's important that Canada also focus on developing the intellectual property of digital content, for exploitation across all channels, rather than only becoming an outsourcing hub for large multinational (largely American) content producers. This combination of continuing to develop state–of–the–art digital content tools and technologies, along with production of original content for exploitation across movies, television, gaming, character licensing, and so on, can drive enormous economic advantage for the nation. Simply taking in the work needed by foreign content owners ensures we will, in fairly short order, be replaced in turn by companies in lower cost economies.

5. Building Digital Skills

As pointed out in the discussion paper, Canada is facing a number of significant talent shortfalls in the coming years. This is largely due to the significant drop in the number of young Canadians enrolling in electronics and software engineering programs, and their community college technologist equivalents. But our failure to develop the mechanisms for fed/prov cooperation that would more quickly recognize and leverage the enormous education and skills that many new immigrants bring to this country is also a significant issue.

Clearly, not enough is being done to communicate to high school students about the enormous opportunities available in Canada within the digital economy. High school career guidance staff seem to still believe that the IT and telecom industry in Canada collapsed back in 2001–02 and never recovered, which is far from the truth. As noted in the discussion paper, there are now over 31,500 firms directly engaged in the "Digital Economy", more than existed back in 2002, and accounting now for about 5% of Canada's GDP.

In addition to encouraging more young Canadians to enter the Digital Economy, much more needs to be done to ensure that new immigrants can similarly participate. Often, restrictive professional licensing requirements, and a lack of integration programs for technologists not requiring professional licensing, are holding back well trained new immigrants from full participation in the economy. Provincial governments, which control the professional licensing bodies, and the professional bodies themselves, need to recognize that the enormous population of well trained ICT professionals now working in the developing world for a fraction of Canadian wages is a much larger threat to Canada then any concerns they may have about the job impacts on their existing provincial work force of licensing greater numbers of engineers and other professionals.

Canadian companies also have to be supported more appropriately by both federal and provincial governments when it comes to skills upgrading and training within the existing workforce. Large companies are able to absorb temporary absences and worker training costs more easily than small ones. But as noted earlier, with such a large proportion of our corporate base in Canada made up of relatively small SMEs, (including in the ICT sector,) programs are needed that enable small companies to offer training and ongoing learning to their staff at minimal expense to the company, as is often the case in Europe.

Perhaps equally important, the vast majority of the entrepreneurs who launch and try to build ICT companies in Canada do so from a technical education background, with very few having much formal business training. And at more senior levels of Canadian business, we fall far behind major competitors such as the United States. Only about 8% of Canadian SME top managers have an advanced business degree, compared to 18% in the U.S. (Conference Board — 2007.) Canada needs more highly educated business managers if our ICT companies are to grow to the size necessary for global success.

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