The IPL newsletter: Volume 16, Issue 335

 Benefiting from the Next Production Revolution

Alistair Nolan and Dirk Pilat, OECD
The production of goods and services has been transformed in many ways over recent years. First, production increasingly takes place across borders, in global value chains. Second, production is increasingly knowledge-based and involves a mix of goods and services, a phenomenon also known as the “servitization of manufacturing”. Third and closely related, a growing part of production, in particular in the services sector, is affected by digitalization and can sometimes be delivered through digital means. And finally, a new wave of technological change is now fundamentally altering the nature of production, heralding what has been referred to as a next production revolution. Ensuring that these transformations support overall growth and well-being requires sound policies in many areas and is a current focus of OECD work.

A Policy Agenda for the Digital Economy

David A. Wolfe, Co-Director, Innovation Policy Lab
This new report, which gathers insights to date from the Creating Digital Opportunities project at the Innovation Policy Lab, highlights the profound shift from hardware, to software, to platform-based digital innovation. It argues that the critical research and policy challenge is to determine what parts of the production process can competitively be retained in Canada and what are the added value activities that can most profitably be carried out domestically. Designing policy with this increasing global division of activity in mind is critical to framing a successful digital strategy for Canada. Policy needs to focus on how to take advantage of this transition by building on and supporting Canadian strengths in software and then how to scale them more effectively. This report examines the areas in which government policy can support the developing digital economy in Canada and makes recommendations based on a survey of effective programs in other countries.

The Role of a Technology Development Agency
Researchers in the CDO network have documented the different types of policy instruments that have proved effective in those countries that have moved from a relatively low level of technological intensity to a much higher level of performance. A key feature in many of the success stories has been the use of a relatively low profile technology development agency, such as DARPA in the U.S., Sitra in Finland, the Office of the Chief Scientist in Israel or the Enterprise Development Program and International Service Program in Ireland. Key to the success of these agencies is the fact that they were effectively insulated from short-term political pressures to produce results and were staffed with technology experts from academia and industry who could target the agency’s investments to build innovative capacity in indigenous firms through their ability to experiment with new and emerging technologies and make long-term investments. These agencies were relatively inexpensive for the public purse, with budgets often in the range of $300-400 million a year; what was crucial for their success was the institutionalization of the agencies and the ability to pursue a long-term strategy. While not every investment has proven successful and some agencies have been more effective in sustaining their strategies over the long term, the evidence suggests that the model can be highly effective in shifting the technological trajectory of an indigenous high-tech sector to a path that will enable it to exploit new and emerging technologies with greater elasticities of demand in the international market place.

The Availability of Risk Capital
Canada also needs to expand the range of policy instruments available to support market driven innovation in the digital sector. Fortunately, there are a number of highly successful examples of programs that have worked well in other countries and that could be adapted to Canada. One of the most effective of these is the Small Business Innovation Research (SBIR) program in the U.S. A number of commentators have suggested that it should be applied in this country. Introduced in 1982, the Small Business Incentive Research Program was designed to simulate technological innovation particularly by small business and increase private sector commercialization of innovations derived from federal research and development. The SBIR program required federal agencies with R&D budgets over $100 million to set aside 2 per cent of their funds for the program. In the early 1990s, the program criteria were revised by Congress to increase the set aside to 2.5 per cent and to increase the emphasis placed on commercial potential for successful applications. By 2010 more than $16 billion had been awarded under the program with current expenditures of $2.5 billion a year. Numerous evaluations that have been conducted of the program have documented its positive effective on the growth and success of innovative start-up firms, including the increased likelihood of recipient firms attracting venture capital investments. It is unlikely that the program could be financed and delivered exactly as the U.S. program is; care would need to be taken in selecting a program design and delivery mechanism to ensure its maximum effectiveness in Canada. The Canadian Advanced Technology Alliance (CATA), has recently put forward a proposal to introduce an SBIR-type program in Canada by replacing the refundable portion of the SR&ED tax credit targeted at small business to a Canadian SBIR to be administered by a dedicated agency established for that purpose. The proposal merits serious examination by the federal government, as well as examine how the existing Build in Canada Innovation Program (BCIP) could be integrated into this new program. Another existing federal program with a proven track of stimulating innovation in small and medium-sized enterprises is the Industrial Research Assistance Program (IRAP). Numerous studies of federal innovation policy and a number of reports by leading industry associations have called for a significant expansion of the funding available for IRAP. Measures are needed to strengthen and expand the staff of IRAP and significantly increase its budget. 

Growing Start-Up Firms to a Global Scale
A key challenge for Canada in dealing with the competitive issues of how to both start and grow indigenous firms in digital technology involves dealing with the dual problems of scaling up and the evaluation of technology firms by the capital markets. The recent demise of Nortel, the buyout of key telecom firms like JDS Uniphase and Newbridge Networks and the substantial downsizing of RIM/Blackberry all point to the challenges of growing and sustaining indigenous Canadian firms in the digital economy. Governments at both the federal and provincial levels have introduced a number of important initiatives in recent years to expand support for incubators and accelerators, as well as expand funding for the venture capital market. These policies have helped to expand the support available for start-up firms and the degree of funding available to finance them; starting new firms is just one part of the problem. The other part is the fact that we do not grow enough of our start-up firms to the global scale, so that when one disappears, the dynamism of the whole system is jeopardized. Canada needs additional policies to support the scaling up of digital firms once they have been launched.

The Impact of Digital Technology Across the Economy
While the information technology sector underpins the emerging second industrial revolution and the platform economy, its revolutionary significance lies in its potential to impact and disrupt virtually every sector of the economy as an enabling and transformative technology. A large share of the economic impact of the digital opportunity will play out well beyond the ICT and manufacturing sectors of the economy, in the primary and secondary industries that are using digital technologies to change the way they do business (by raising productivity, increasing product diversity, reducing risk) and to restructure global production networks. This suggests that a key concern for the federal government, working jointly with their provincial counterparts, might be to chart effective strategies to ensure that Canadian firms are provided the support needed to take full advantage of this potential, no matter what sector of the economy they operate in. There is an opportunity to work with industry associations, who have already done a considerable amount of work on the technological changes impacting their industries, to develop sectoral strategies that can identify and target specific initiatives (which can often be funded through existing federal and provincial programs) to promote the adoption and diffusion of digital technologies across their sectors.

Local and Regional Strategies for Digital Innovation
The final policy area that deserves mention is the importance of including a “local context” perspective to maximize the impact of federal policies at the local level. The advantage of adopting this approach is to use existing policy instruments in a more focused and coordinated way to facilitate coordination, dialogue and interaction among the constituent elements, especially firms, at the local and regional level. Clusters are one approach that have proven effective as a policy instrument in fostering linkages between firms, universities and research institutes and providing a basis for firms to take better advantage of market opportunities. They also afford the opportunity for small and medium-sized firms to establish connections with larger partners and multinational firms. This focus on the local and regional dimension of digital innovation is based on the recognition that Canada is large and diverse economy that requires policy responses that are tailored to this diversity and able to take full advantage of successful local initiatives. The effective implementation of this approach at the local and regional level requires a greater degree of coordination between all three levels of government and their respective economic development agencies.

This is clearly an ambitious agenda to lay out for any government, let alone a new one that faces a wide range of pressing policy issues. Despite this fact, the report argues that the policy agenda for the digital economy must be a priority area for any government in Canada for the reasons described at the outset. Not since the first onset of the industrial revolution have we seen an interconnected set of technologies with a similar potential to both disrupt our established industrial sectors and economic patterns, but also to generate new economic opportunities for ourselves and future generations. While some of the initiatives set out above require new program spending, many can be achieved through a reallocation of existing program spending or a refocusing of the priorities of existing programs on the digital dimension of the economy. Collaborating more closely with provincial and municipal governments can also leverage existing program spending at those levels. The effectiveness with which all three levels of government grasp the digital opportunity and succeed in laying the foundations for future growth will determine their economic and fiscal capacity to deal with the numerous other issues pressing in upon them.