An outdated myth about business investment is hurting the Canadian economy

Would you invest $10,000 knowing you would lose $9,000? How about putting $100,000 from your business into ideas that yield a $90,000 loss? This is what a tireless procession of government officials, pundits, think-tanks, academics and establishment economists urge Canadian businesses to do to solve the country’s long-standing productivity decline.

Canadian businesses are “sitting on dead money,” a former Bank of Canada governor famously proclaimed. Canadian businesses are “too complacent” and lack the incentive to invest, say pundits and self-styled innovation experts. Our business leaders need to invest in new equipment and machinery, say economists. Anachronistic think-tanks keep repeating the claimed insight. Journalists then repeat it as gospel, blaming it on “culture” without understanding the underlying economic structure at hand. Government-commissioned reports, from the 2008 “Compete to Win” report to the 2011 Jenkins report to the recent Advisory Council on Economic Growth reports all lean into the self-referencing trope — Canada’s productivity and prosperity would increase if our businesses would stop being complacent and would invest their cash to unlock gains that are waiting for them on the other end of accessible markets.

What each one of these reports and commentators fail to account for is that the nature and structure of modern economy has changed and with it, what constitutes a profitable business investment opportunity. Over the past 40 years, the global economy has undergone a rapid, unprecedented shift from a traditional tangible asset production economy to a knowledge-based, intangible assets economy. The wealth effects and power of intellectual property (IP) such as patents, copyright and trade secrets, and now data assets permeate virtually every sector of the global economy.

In the knowledge-based economy, businesses do not invest their money where they don’t have freedom-to-operate (FTO) because in global value chains, investments without appropriate ownership of IP do not and cannot yield positive returns. Freedom-to-operate is a foundational concept in the knowledge-based economy that represents the ability of a business to carry out commercial plans without infringing on someone else’s IP. The more valuable one’s stock of IP is, the bigger their freedom-to-operate runway is and the easier it is to yield high returns from investments. Companies that own valuable IP scale more easily, pursue or create new markets more quickly and have the capacity to block new entrants completely, including by acquiring early-stage companies on the cheap. Canada’s businesses own dismal amounts of IP and consequently lack opportunity to invest gainfully. Yet so much repetitive, uninformed advice pushing investment irrespective of companies’ IP assets has resulted in Canadian policy-makers now institutionalizing this unsubstantiated economic theory.

IP ownership is a precondition for successful investment

Following the narrative that Canadian businesses’ investment is key to improving our declining productivity, in the 2022 federal budget the government proposed the creation of an “Innovation Agency,” now called the Canada Innovation Corporation. The agency’s mandate was to help with the “low rate of private business investment in R&D and the uptake of new technologies,” thus solving “Canada’s main innovation challenge.” How this agency would turn around Canada’s low business investment has never been explained.

Early in 2022, I made the argument that Canada’s policy community lacks understanding of the contemporary economy and needs to rebuild institutions to equip them with relevant, updated advice and research. Without updated capacity, Canada’s economic strategies are polluted with advice straight from 1970s. Just last month, establishment economists like Jack Mintz continued assessing the economy through a tangible production cost lens, misframing the low business investment analysis through a production economy lens where “businesses don’t adopt the latest capital, resulting in high unit costs that make it hard to compete in international markets.” Mintz and his peers seem not to understand how the zone of competition has foundationally changed in the modern economy, namely from competing on production costs via scale to competing via owning IP and controlling data that have marginal production costs at or near zero.

Now, 40 years after the advent of the knowledge-based economy, it’s not just our public discourse that remains stuck in the past. Virtually all of Canada’s current economic development programs follow the logic of the traditional, production-based economy. They feature tax incentives, grants or subsidies focused on the creation of jobs regardless of where the majority of wealth is generated, the quality of those jobs or even which country’s economy they benefit. There is no strategy to increase IP ownership and freedom-to-operate for Canadian business. One more granting agency, such as the proposed Canada Innovation Corporation, will not increase business investment nor fix Canada’s productivity performance.

In the traditional production-based economy, business investments — such as in new machinery and advanced equipment — enabled companies to lower costs and/or produce higher quality products for a ready market. Production inputs such as capital equipment, material inputs and labour were available in competitive markets. In this type of economy, business investments in new equipment or machinery yielded enhancements in product cost or quality, which enabled a company to grow its revenue and profits. If business investment was lagging, the government would increase incentives by lowering interest rates, providing tax breaks or depreciating the national currency.

Today, IP and data are the most valuable economic and national security assets, and they are used to create new products, markets and revenue. Innovative companies don’t compete on costs in supply chains. Instead, they compete in global value chains with their ability to collect rents based on IP ownership. IP is used by companies to capture all the benefits of innovation that come in the form of licensing or litigation strategies. Because IP is by definition a monopoly right to ideas, owners of IP use it to exclude competitors entirely from entering established markets. Sophisticated IP strategies give companies the necessary freedom-to-operate to ensure their investments turn to profitable new revenue.

The relentless monopolization of knowledge and information over the past few decades has, as innovation economists have shown, “restricted investment opportunities for many firms in different countries.” In this type of economy, freedom-to-operate soars in its strategic relevance and explains why we are seeing a global race in patents filed across all industries and sectors. This IP race has a direct impact on business investment opportunities. “The new gold rush to acquire IP rights and the absence of public investment in knowledge have started to exert negative effects on investment opportunities, and the blocking effects of intellectual monopoly have become stronger than incentive effects,” says leading innovation economist Ugo Pagano.

What’s more, innovation economists have also shown that countries with low IP ownership, such as Canada, exhibit higher costs of investment that systemically reduce the return on business investment, both in unit economics and addressable market size. Countries that create sophisticated freedom-to-operate strategies manifest an upward trajectory in business investment because it’s profitable. This creates a virtuous cycle of success, while countries with low IP ownership manifest a constrained and expensive business investment environment.

Canada not paying attention to IP ownership

You cannot commercialize ideas you don’t own. Canada has a dismal record of IP ownership because our policy and traditional business community failed for decades to understand the changing nature of the economy. Despite high public investments in research and talent development, Canada’s deficit on IP payments and receipts is widening at an alarming rate, a position we now share with developing economies.

The mining sector, one of Canada’s traditional prosperity engines, sheds a light on how our companies are restricted in their freedom-to-operate strategies and subsequently new, high-margin revenues. Since 2015 there have been 90,000 mining patents filed relating to resource blasting, exploration, processing, refining, transport and automation among other categories. Teck Resources, Canada’s largest miner, has filed seven patent applications in that period. A company with such a weak IP position should not make investments into all the varied aspects of mining knowing it will hit an IP wall that includes the thicket of 89,993 patents built by its competitors.

But it’s not just complex industries such as mining and oil where Canada is ceding value-added gains. Production of face masks, which saw unprecedented demand during the recent pandemic, is equally contended in global value chains. There are 9,750 global patents filings related to masks. 3M, the maker of the popular N95 mask, is a top owner, with 413 patents to its name. Because no Canadian company has meaningful ownership of mask-related IP, our government was forced to give $35 million to 3M to set up production in Canada and commit “to long-term agreements to buy masks from the company” where the profits and wealth effects will not accrue to Canada’s economy. No Canadian company should be lectured about making investments into producing advanced masks because such investment will only result in a loss.

The most troubling examples however are where Canadian governments pursue economic development strategies that deliberately limit the freedom-to-operate of Canadian firms. The most recent case was a smart city project launched by Google and championed by three levels of government called Sidewalk Toronto. Though the project was scrapped after years of criticism and a lawsuit by the Canadian Civil Liberties Association, Google filed 25 patents directly related to the initiative in Toronto even as its champions were selling it as a “partnership” exercise for Canadian companies. This is on top of hundreds of patents Google has filed for its city-related technologies overall. So even with the original project in the dust bin, uninformed champions of this project, including all three levels or government, have manufactured a permanent disadvantage for Canadian smart city innovators.

Simple as the imperative sounds — own more valuable IP so you can create stronger, longer and wider runways for your business’ expansion — the concept appears difficult to understand for leaders of flagship innovation organizations. Elissa Strome, executive director of Pan-Canadian AI Strategy, recently said that patenting “is not a major course of action in this sector” nor is it “actually relevant.” Yet in the real world, not only is there a race for artificial intelligence IP, that race is changing the conditions of competition not just between companies but between nations. According to the World Intellectual Property Organization, in the past decade China has filed 389,570 patents in the AI area alone, establishing that country’s ownership of 74.7 per cent of the world’s total.

When faced with criticism for this remarkable lack of awareness, Strome’s Canadian Institute for Advanced Research paid for a report claiming that Canada is doing great on IP ownership by counting all AI patents filed in Canada without indicating whether their owners are Canadian or foreign. The fact is over 75 per cent of the IP owned by government-funded researchers in Canada is owned by foreign companies.

It’s hard to decide what is more troubling — that our “innovation” leaders still don’t know that IP ownership is a precondition to commercialization or that they think Canadians deserve to be duped with creative accounting.

Canadian economy will keep eroding absent relevant strategies

In their new book “New Knowledge: Information, Data and the Remaking of Global Power,” scholars Natasha Tusikov and Blayne Haggart detail the global race for IP and its implications for economy and society, including innovation, competition and investment. In accessible language they not only provide the history of how knowledge became monopolized but crucially how IP rights emerged as a significant form of structural power for companies and countries competing in global markets. This structural power is not only making markets more concentrated but functions a lot like feudal systems of centuries past, including the soaring inequality.

Yet holding onto these myths is not just a matter of low-quality economic discourse and political spin. The Organisation for Economic Co-operation and Development (OECD) recently projected that Canada’s economy will be “the worst performing advanced economy over 2020-2030 and the three decades after,” even though the economic design of the knowledge-based economy levels the playing field for small open economies. Countries such as Sweden, Singapore, Israel, Switzerland and Taiwan have capitalized on it while Canada sits on the sidelines.

Last month a National Bank Financial report recalculated Canada’s GDP per capita after the release of Q3 population data showing Canada’s per-capita GDP fell a whopping 4.4 per cent in the third quarter. “Just over half of Canadians are about $200 or less from not being able to meet their financial obligations, including one-third who are insolvent, the highest proportion since MNP’s consumer debt index began five years ago,” said Canada’s largest consumer insolvency firm.

None of these harmful outcomes will change if our policy-makers keep relying on outdated advice. It is bad enough that our policy-makers keep failing to understand the changed nature and the structure of the knowledge-based economy and the low IP ownership across Canadian industry. They also need to stop lecturing Canadian businesses that compete globally to do what they cannot and should not do — make investments under conditions that generate poor returns.

“It ain’t what you don’t know that gets you into trouble,” said Mark Twain with insight that could apply perfectly to Canada’s economic discourse. “It’s what you know for sure that just ain’t so.”