In today's Financial Post, MLI's Philip Cross lays out some of the fundamental misunderstandings people have when they think of "innovation" and how these misunderstandings lead people to reach conclusions about the economy that may not be based in reality.  What do we mean when we think of "innovation" and what forms are best for Canada's economy?  Philip Cross explains.

Copy-cat innovation

Philip Cross, Special to the Financial Post, May 23, 2013

Innovative thinking on innovation sadly lacking

The Science, Technology and Innovation Council released its bi-annual report this week, continuing the tradition of 'groupthink' evident in its previous two reports. To be fair, measuring innovation is an impossible task, since it includes everything from product innovations to new processes and technology to marketing and organizational structures.

Inevitably the report's primary focus is on some of the inputs into the process of innovation (like R&D), and not the outcome, which hopefully is more innovation. But unless we can say what successful innovation is and measure it, monitoring a partial list of inputs is hardly satisfying. By focusing on those things that can be quantified, the report makes a commonplace but fundamental error of social science that anything that can't be counted doesn't count. Friedrich Hayek devoted his Nobel Prize acceptance speech to the errors of analysis along exactly these lines.

The report discusses things largely because data about them exist, even though what is being measured is only partly or tangentially related to innovation. The most obvious example is research and development, to which whole chapters are devoted.

There is not enough discussion of the pitfalls and limitations of relying on R&D to understand innovation. The report acknowledges that "the significant investments that Canada's natural resource industries make in exploration and evaluation activities and in field testing facilities" are not counted as R&D, but clearly are innovative. However, that is the last we hear of the problem of this type of 'hidden' innovation.

The report does not recognize the full implications of Canada's resource-based industrial structure. Comparing R&D as a share of GDP across countries shows that resource-based nations are usually in the bottom half. Conversely, nations that rank high in R&D do so partly because they often have no resource base, including Israel, Korea, Japan and Denmark. To advocate that Canada should have an R&D structure like Israel or Japan either misunderstands the differences between the industrial structures of these economies or says we should renounce our resource heritage.

Besides R&D, another indirect input used to measure innovation is cross-border trade in business services, but these exclude intra-company technology transfers. Since we live next door to the world capital of innovation (think Apple or Google), is there a need for Canada to duplicate U.S. efforts in innovation?

This is not a trivial question, but goes right to the heart of trying to understand Canada's innovation performance. Innovation is costly. It requires diverting resources, possibly from higher value-added activities, which would slow growth and dampen the standard of living. Innovation is not an unambiguous or unalloyed good. Its advantages must always be weighed against its costs. It could make perfect sense for Canada to be a free rider on U.S. innovation; instead of being a poor imitator, it might make sense for us to specialize in other things we do better. Copying innovations pioneered by others is a major source of global growth–one of the driving forces of the convergence between emerging economies and developed ones is precisely their ability to be free riders on innovation.

The report does not discuss the implications of the changing sources of Canada's growth over the past two decades. The 1990s were driven by growth in business services and especially manufacturing, culminating in the ICT bubble. Since 2002, growth has been dominated by natural resources, construction, and public services. Many of these sectors invested relatively little in R&D and yet their performance exceeded that of some sectors that invested the most. And it's wrong to regard natural resource industries as not innovative, despite their low ranking in traditional R&D. At yesterday's forum in Ottawa hosted by the Forestry Products Association of Canada, every second word was a variant of innovate. In a recent paper on myths surrounding natural resource development, I argued that resource boom in Canada actually dates to when oil sands output began to surge in 1998, thanks to innovative new technologies, not when prices began to rise late in 2002.

The model that underpins the thinking in the STIC report is that education is the basis of science, which drives research, which leads to innovation and thus economic growth. This model is unduly influenced by the focus on R&D and other 'measurable' variables. The role of other types of innovation, such as Apple's relentless focus on design, is not captured by this approach.

More fundamentally, the slavish devotion to innovation as unambiguously good for growth is never questioned. Yet it was innovation in the U.S. financial industry (which securitized sub-prime mortgages and insured them with credit default swaps) that facilitated the meltdown in their housing and banking industries.

In the conclusion, the report advocates more direct funding of R&D, especially through procurement policies. Why? Because other countries do it. But is there evidence that this produces more innovation? No. Apparently, when it comes to innovation policies, the report says we should ape what others do, rather than being innovative and research-driven in our approach.

What a delicious irony.

Philip Cross is Research Coordinator at the Macdonald-Laurier Institute and the former Chief Economic Analyst at Statistics Canada.

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