A New North Star II Revisited

Six months after the release of New North Star II, the case for a mission-driven economic strategy is even more relevant. The pandemic has highlighted the need for a new industrial strategy to cultivate domestic innovations and technologies in Canada's national interests and authors Robert Asselin and Sean Speer revisit their analysis and recommendations and find a compelling model in the US’s DARPA model.

Introduction

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The COVID-19 crisis has turned global politics and domestic public policy, like everything else, upside down. Although such sentiments can often be exaggerated, it certainly seems as though the pandemic has hastened an end to the post-Cold War paradigm of free markets and globalization.

The truth is that the days of the neo-liberal economic consensus were probably over even before the current crisis began. In hindsight, one can probably peg their demise to the global financial crisis of 2008–2009. The subsequent decade or so — including the rise of populism, increased trade protectionism and Donald Trump’s chaotic presidency — has been disjunctive. The old paradigm had ceased its utility, but we were unable to conceive of a new framework for understanding the exigencies of the 21st century.

The pandemic has brought these challenges into sharp relief. The COVID-19 crisis is ready-made to expose the underlying problems with the old paradigm and to bring expression to its successor. It has accentuated powerful forces including the dominance of technology firms, the geopolitical competition between the United States and China and the erosion of domestic productive capacities in advanced economies due to efficiency-driven offshoring. And in turn this has led to renewed interest in a role for industrial policy to cultivate domestic firms and technologies that can compete globally and put the value of national production ahead of well-established globalization agendas.

The evidence from the United States, United Kingdom, Japan, Germany and the Netherlands seems clear: the post-COVID paradigm will involve a recalibration of the pre-COVID paradigm and a renewal of an industrial strategy framework that sees a greater role for the state in supporting technological innovation and shaping market outcomes within domestic borders.

We co-authored a report titled A New North Star II (along with CIBC economist Royce Mendes) in April 2020 on what these developments mean for Canada. The ensuing months have only reinforced the major changes occurring in the realm of “geoeconomics” and the need for Canadian policymakers to shift the country’s economic policy framework in the direction of the guiding hand of industrial policy.

The purpose of this short essay is to unpack and advance some of the key ideas in our long report. The goal is to address some of the questions that we have received since it was released, especially in the light of evolving circumstances. In particular, this essay will focus on (1) the return of “geoeconomics” and how it is reshaping the economic paradigm for the post-COVID world, (2) the necessary conditions for a mission/challenge-driven industrial strategy and (3) an instrumental institutional reform to better support Canadian-based innovation and technological development.

The World is Changing

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As A New North Star II outlines, the world of economics, geopolitics and technology was changing prior to the COVID-19 crisis. Two separate yet interlinked forces were behind these major developments.

The first is the rise of the intangibles economy, which is transforming where economic value is derived and who participates in it. As others have documented, intangible capital (including intellectual property, data and software) has unique characteristics and features relative to physical assets (such as plants, machinery and equipment). The biggest may be its scalability at close to zero marginal cost. Think of data, for instance. A single dataset can fuel multiple algorithms, analytics and applications so the data owner operates with minimal costs and with a much greater chance of dominating a market.

The production economy, which is the basis for how our current paradigm thinks about economic growth and comparative advantage, tends towards mutually beneficial exchange. The intangible economy, by contrast, seems to be more inherently monopolistic and, according to economist Arnold Kling, can “help to explain rising economic inequality.” The investors, firms and countries with significant stakes in intangible assets are the winners in this new winner-take-all paradigm.

And there is no question that intangible assets are becoming a greater source of investment and economic value in modern society. Just consider, for instance, that annual Canadian investment in data alone has grown by more than 40 per cent since 2005, while investment in machinery and equipment has only increased by 8 per cent. The transition to the intangibles economy is even more significant in the U.S. where these assets have gone from 16 per cent of the value of the S&P 500 in 1976 to 91 per cent in 2019.

The second major development is the growing geopolitical and technological rivalry between the United States and China, which is reshaping the basic precepts of the globalization and its institutional manifestations. The relative stability of unipolarity is over. A renewed era of great power competition is now the backdrop for domestic and foreign policymaking.

These U.S.-China bilateral tensions are marked less by ideological conflict than the previous Cold War and more by an evolving and ongoing economic competititon. At its core, it is primarily about which country will dominate the intangibles economy. U.S. Vice President Mike Pence has called it a battle for the “commanding heights of the 21st-century economy.”

It is no accident that the growing trends towards intangible capital are exacerbating the U.S.-China relationship. The winner-take-all dynamic seems to discourage bilateral cooperation and instead incentivizes a race to accumulate intangible assets within one’s domestic borders. That these assets often have a dual purpose that stretches from the commercial realm to the national security realm only reinforces the imperative. It is therefore changing how governments are thinking about publicly funded research and development, intellectual property policy and foreign investment regimes.

In particular, policymakers around the world are responding to these “geoeconomic” developments with new thinking about the role of public policy to support domestic innovation and cultivate firms and technologies that give them national advantage. Even before the COVID-19 crisis, we were seeing the European Union, United Kingdom and others respond by shifting from a laissez-faire approach to a regional and national interest-driven model focused on key sectors and technologies based on national priorities and competitive advantage. This growing interest in a policy framework designed to cultivate domestic champions in the intangibles economy may be best reflected in a quote recently attributed to British Prime Minister Boris Johnson’s top aide: “Countries that were late to industrialization were owned/coerced by those early (to it). The same will happen to countries without trillion-dollar tech companies over the next 20 years.”

The pandemic has only reinforced these paradigmatic changes. The crisis has further exposed the decades-long decline in key domestic productive capacities in advanced economies, the heightened tensions in the realm of geopolitics and the growing significance of the intangibles economy. If the old globalization paradigm was already under stress, COVID-19 has imposed even greater pressure on its pre-pandemic intellectual and policy trappings.

Politicians from different countries and different ideological persuasions are beginning to bring expression to a new policy agenda for this era of geoeconomics and the post-COVID recovery. It is striking to witness the emergence of a nascent consensus forming around the renewal of an industrial strategy framework that sees a greater role for the state in supporting technological innovation and shaping market outcomes within domestic borders. It ranges from the European Union’s Recovery Fund to Joe Biden’s “made in America” agenda and virtually everywhere in between.

One of the lasting effects of the COVID-19 crisis may indeed be an end to a disjunctive decade and the rise of a new economic paradigm that is better suited for the technological and geopolitical environment.

What Does This Mean for Canada's Economic Interests?

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These developments are placing significant pressure on small- and medium-sized economies around the world. But the impact may be most profoundly felt by Canada.

As a mid-sized economy dependent on trade for two-thirds of its GDP, Canada is highly vulnerable to any disruption to the global trading system. This is the reason, of course, that we have relied so heavily on the multilateral rules-based international order as a foundation for our economic stability and prosperity. But that the U.S. and China are our first and third-largest trading partners, representing 60 per cent of the total value of Canadian trade in 2018, means that a protracted, zero-sum conflict between these two global giants will necessarily have far-reaching consequences for Canada’s economic and geopolitical interests.

The extradition case of Huawei chief financial officer Meng Wanzhou and its political fallout (including the unlawful detention of two Canadians by Chinese authorities) is a prime example of how Canada cannot avoid being implicated in these transpacific tensions. The inadvertent collateral damage that Canada has suffered is a reminder that only Canada will be concerned with its interests — no one else will.

Canadian policymakers must now contend with the attenuation of our long-standing strategic anchors: a United States committed to our economic welfare and the counter-balance of a high-functioning multilateral system.

These big, structural changes are occurring at the same time Canada is struggling to gain a foothold in the intangibles economy. Although our previous research shows that intangible assets are an increasingly significant share of economic value in the country, we are still underperforming relative to peer jurisdictions. This can be seen in Canada’s poor performance on patents, its small number of leading global firms and the country’s weak productivity record. One proof-point: economist Frances Fong has shown that Canada’s annual productivity rate for the past two decades is less than half the mean rate of the 1960s and 1970s.

There are exceptions of course. Shopify, for instance, has emerged in the pandemic is a major global player in e-commerce. Its crisis-related eclipse of our largest bank as the most valuable publicly traded Canadian company sends an important message. But the pre-COVID challenges described above have not disappeared and will continue to have significant implications for Canada’s ability to compete globally as well as the wages and living standards of Canadian workers and households.

The pandemic-induced recession has only worsened the situation. It has exposed our woeful lack of domestic productive capacities in strategic industries and the inherent risks of our overdependence on China. It has also, of course, led to a massive contraction in our economy and historic job losses.

Digging out of this economic hole will require more than a mere “return to normalcy.” The paradigm that preceded the pandemic has been fundamentally disrupted. Our competitors are preparing for a post-COVID world that looks significantly different. Canadian policymakers cannot return to business as usual.

It requires nothing short of a fundamental shift in Canadian policymaking. This will require strategic policy choices. It will not just happen. There is a role for public policy to shape market outcomes. That is the role of industrial policy.

Principles for a Mission/Challenge-Driven Industrial Strategy

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The good news is that our political class seems to understand the magnitude of the changes that have been accelerated by the COVID-19 crisis. Elected officials ranging from Innovation, Science and Industry Minister Navdeep Bains to Ontario Premier Doug Ford have signalled that our post-COVID recovery agenda must not just be about stimulating economic activity in the short-term. It must also start to shift Canada’s policy framework in the direction of protecting and advancing the country’s national economic interests in the era of geoeconomics.

As we wrote in A New North Star II, we have come to the view that this will require Canada to adjust its economic framework to an industrial strategy designed to cultivate capacity and scale in key sectors, sub-sectors and technologies. This is not a call for a new dirigisme, but rather the need for greater intentionality in Canada’s economic policy framework. Markets are a critical tool for economic development, but they cannot become an end in and of themselves. The aim must be the advancement of Canada’s national economic interests, which should be defined as rising exports, productivity and ultimately higher living standards for Canadian workers and households.

The goal here is not to prop up traditional industries or firms for nostalgic reasons. Instead a modern industrial strategy would aim to build a comprehensive policy programme around the most dynamic and productive parts of the economy, in order to build the scale necessary to compete in the intangibles economy.

This point cannot be overstated: as a mid-sized economy, Canada cannot afford to “spread the peanut butter too thinly.” An industrial strategy in areas of comparative advantage such as agri-food, energy and renewables, health care and life sciences and advanced manufacturing can leverage pre-existing domestic strengths and bring them to scale and ensure they are capable of competing for global market share.

Fundamentally, then, it amounts to a new framework for conceptualizing Canada’s economic interests across the full range of policy areas and tools including programmatic and regulatory design, R&D investments, trade negotiations, foreign investment reviews and other policy choices. The ultimate goal is to tilt the country’s overall policy framework in favour of high-value, strategic parts of the economy.

A new paper published by the U.S-based Center for Strategic and International Studies (CSIS) lays out 10 principles to guide these policy choices. It is a worthwhile read for Canadian policymakers responsible for developing a post-COVID recovery plan.

We will not outline it all here, but we would like to elaborate on the authors’ first principle that an effective industrial strategy must have a “clear mission.” This is consistent with our analysis in A New North Star II.

A mission is a big challenge to orient an industrial strategy. Such a mission undoubtedly has public and private dimensions. It touches the economy, but it also broader implications, including national security, climate change or even social outcomes. It is less about targeting individual firms or even particular sectors and instead about targeting a challenge that will require innovation and new technologies to ultimately overcome. A mission can thus be seen as a basis for the public and private sectors to come together in the name of a “wicked problem.”

The idea of a mission-driven industrial strategy is often characterized as a “moonshot” in reference to NASA’s Apollo mission in the 1960s. The goal of putting a man on the moon necessarily involved a combination of public and private interests, economic and non-economic considerations and an imperative on innovation and domestic technological development. Douglas Brinkley’s wonderful history, American Moonshot, tells the powerful story of how a “grand challenge” from the Kennedy Administration not only resulted in Neil Armstrong’s famous moon walk, but it also had lasting effects on American science and technology due to the tremendous innovation that was produced along the way.

Economist Mariana Mazzucato sets out five conditions to inform a successful mission-driven model. They are:

1. Be bold, inspirational with wide societal relevance: Missions should engage the public. They should make clear that through ambitious, bold action, pursuing the mission will have an impact on people’s daily lives.
2. Set a clear direction — targeted, measurable and time-bound: Missions need to be clear. They will necessarily have long-term and unforeseen effects, but the mission itself must have a clear timeline or goal.
3. Be ambitious, but realistic: Mission objectives should be forward-looking and ambitious, but rooted in research and innovation across the entire innovation chain including feedback effects between basic and applied research.
4. Encourage cross-disciplinary, cross-sectoral and cross-actor innovation: Missions should be framed in such a way as to spark activity across multiple scientific disciplines, industrial sectors and different types of actors.
5. Missions should not be achievable by a single development path or technology: They must be open to different solutions through an iterative process of trial and error.

We would add five additional conditions that Canadian policymakers ought to consider in developing a mission-driven industrial strategy.

• Missions should be politically durable: The selection of missions should account for the goal of political durability. They should focus on broadly shared goals so that they are not negatively affected by political transition.
• Missions must be highly selective: Not every political issue or industrial sector can be a mission. At that point, it just becomes a communications exercise to satisfy (or mollify) special interests. The Apollo mission was so compelling partly because it was a unique priority.
• Sustained public investment: A mission-driven approach cannot be viewed as a one-off announceable. President Kennedy’s speech at Rice University in 1962 was not just a regular speech. It set in motion a sustained political and fiscal commitment to the goal of putting a man on the moon by the end of the 1960s. A mission must be understood by political actors, the bureaucracy and the market as something different than usual political rhetoric. It must be a sustained priority with sufficient resources to be successful.
• Account for Canada’s pre-existing comparative advantages: The Apollo mission started from a position of strength due to America’s strong scientific research capacity and pre-existing aerospace sector. For a mission to ultimately be successful — including producing large, commercially applicable spillovers — there needs to be public and private capacities in place to leverage them in the market economy.
• Benefits should target domestic firms: Capturing the spillovers from a mission-driven model is crucial if it is to have long-term benefits to the economy in the form of innovation, new technologies and ultimately productivity gains. The goal should be to have those gains realized by domestic-based firms through intellectual property and technology transfer.

An industrial strategy built on these solid conditions would be better positioned to withstand the political economy challenges often associated with industrial policy and produce the spillovers that can fuel new firms and technologies and contribute to higher rates of productivity.

It would become a basis for co-ordinating pre-existing policies across departments and developing new ones in support of the mission. We do not think that a mission/challenge-driven industrial strategy would require incremental public outlays. The federal government already spends a lot on discovery research, applied research and business subsidies. The goal here is to bring greater coherence to how these public dollars are targeted and used.

This approach will no doubt have its critics. We have heard from them since A New North Star II was released in April. The principal argument is that government cannot or should not “pick winners or losers” and so the economic policy framework ought to be neutral. Yet the concept of market neutrality has never existed anywhere in the world — it only lives in some textbooks and columns. It furthermore neglects the geo-economic circumstances in which we find ourselves as well as the extent to which federal policy already tilts in favour of certain market outcomes over others. And it also ignores successful examples of mission-driven experiences in the United States and even here in Canada.

The Case for a Canadian DARPA

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The previous section emphasized that an industrial strategy framework is, by definition, multi-faceted. It is about developing a coherent policy agenda across a range of government departments and legal, policy, regulatory and operational areas. There is not one silver bullet. This is about adopting a coherent and more intentional approach to economic policy.

A New North Star II outlined an innovation continuum — ranging from education to R&D support to government procurement — that would need to form the foundation of an industrial strategy for Canada. It included multiple policy recommendations for federal and provincial policymakers.

We do not want to rehash all of them here. We encourage Canadian policymakers to consider them as part of their post-COVID recovery planning and a more general shift in the direction of industrial policy. But we would like to unpack one idea that we think is particularly important if Ottawa is going to better support domestic innovation and technological development.

As we have discussed elsewhere, the key to improving Canada’s innovation and productivity performance is to address the structural weaknesses in our innovation ecosystem. Canada performs relatively well at the beginning of the innovation chain in discovery research and the start-up stage but it does poorer in the later stages of the innovation chain including scaling small- and medium-sized enterprises, late-stage capital financing and growing global firms in non-protected and regulated sectors.

There are various causes at play here. Our public R&D system is not sufficiently linked to Canadian industry and therefore does not sufficiently enable technology transfers or commercialization. We undervalue our intellectual property and give it away to foreign firms too easily. And our policy framework places too much emphasis on supply-side supports and neglects the demand side of the equation.

In response to these challenges, we believe Canada needs to adopt a DARPA mission/challenge-driven model to drive innovation, scale Canadian-based firms and increase productivity.

What is DARPA? Established in 1958 in response to the Soviet Union’s launch of Sputnik, the Defense Advanced Research Projects Agency (DARPA) was created by U.S. President Dwight D. Eisenhower out of a sense of urgency. There was a sense that market forces alone would be insufficient for the U.S. to keep up in the space race. The Soviets had not beat the Americans with the first satellite in space based on superior scientific capacity or financial resources. It was a co-ordination problem that was holding the U.S. back. The market case for private actors to pull together these disparate resources and develop a domestic satellite capacity was too weak. DARPA could step in and fill the gap.

Since then, DARPA has contributed to a number of significant commercially applicable innovations, including the building blocks of global positioning satellites (GPS), the first computer mouse and the protocols that underpin the modern Internet. DARPA is now at the forefront of the vaccine race for the coronavirus.

Its business model is highly complex and straightforward at the same time. DARPA is an anti-bureaucracy public organization. It has contributed to U.S. economic and technological dominance with a budget of slightly more than $3 billion annually.

It starts with an urgent need or challenge. This is not just about discovery research. It is about harnessing science to solve critical real-world problems. According to two former DARPA officials, “the presence of an urgent need for an application creates focus and inspires greater genius.”

These R&D projects tend to be on the frontier of new technologies and new applications. DARPA’s mandate is “high-risk, high-reward” initiatives. Its list of failures is no doubt longer than its successes, but its net effect on U.S. innovation and commercialization is profound. By pushing the envelope on pre-market yet commercially applicable research, it is enabling technological development that can be strategically valuable and commercially profitable, but which the market may not initially support.

Another strength is that DARPA builds temporary project teams — its permanent staff is only about 220 employees — from industry and academia to work on projects with time-limited durations. The goal is to enable a new commercially applicable discovery and then let market forces take it from pre-market development to commercialization. DARPA can then reorient to a new project. Canadian policymakers would need to consider how to ensure that a Canadian-based DARPA had similar human resource flexibilities in a unionized, federal labour environment.

The organization’s role is primarily a priority-setting and co-ordination function. DARPA does not directly perform research or operate any research laboratories, but rather executes its R&D programs mainly through contracts with industry, universities, non-profit organizations and federal R&D laboratories. This enables DARPA to choose the best partners on any given project. Analysis by the Congressional Research Service shows that about two-thirds of its research dollars are directed to private-sector partners.

Canada currently lacks a comparable co-ordinating body. The National Research Council conducts useful basic research and has sought to get more involved in applied research including the use of challenges in areas such as artificial intelligence, cell and gene therapy and clean fuels. It is a key part of Canada’s industrial research ecosystem and will be even more critical in an industrial strategy framework. But it does not have the priority-setting and co-ordination role that DARPA plays in the United States.

We are not the first ones to reach such a conclusion. The 2011 Jenkins Panel report recommended the creation of an Industrial Research and Innovation Council (IRIC) with a clear business innovation mandate (including delivery of business-facing innovation programs). IRIC would be an arm’s-length organization that would target business support programs based on evidence rather than political considerations.

The panel’s recommendation is still outstanding. The federal government should move in this direction, but with the caveat that IRIC (or whatever is it is ultimately called) should have an explicit, mission/challenge-driven mandate. Its distribution of R&D resources ought to be based on a limited set of clear missions rooted in the conditions and principles in the previous section.

Adopting a DARPA challenge-driven approach will better enable more industrial research, greater technology transfers to the private sector and ultimately help grow Canadian global champions. It ought to be a priority for federal policymakers as they develop the country’s post-COVID recovery plan. The Jenkins Panel’s analysis is a useful source of governance and operational analysis in this regard.

Conclusion

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The free market and globalization economic paradigm was under stress following the 2008–2009 global financial crisis. The separate yet linked forces of the intangibles economy and the U.S.-China geopolitical and technological competition that it was fuelling was reshaping the economy and broader geopolitical landscape. The return of “geoeconomics” produced a disjunctive decade.

The COVID-19 crisis has only imposed further pressure on the old paradigm. A new one is now emerging as advanced economies prepare their post-COVID recovery plans. It will see a renewed role for the state to support technological innovation and more actively shape market outcomes within domestic borders. Canadian policymakers will need to be ready with their own to support Canadian-based innovation and technological development. This short paper and its long-form version from April 2020 set out a “new north star” to guide this critical policy work.

PPF is grateful to our project partners who made New North Star II possible.  For more on the project, click here.