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Innovation policy in a crisis

I thought I'd share this document I put together on how Ottawa might respond to the crisis. I'm pleased to see that a couple of these elements that I sent into the ether in late March seems to resemble the policies implemented in April.

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In the span of two weeks, the global economy has been upended by the near-ubiquitous and near-instantaneous impacts of the global coronavirus pandemic. Unlike previous recessionary periods that had either limited or gradually-spreading geographic impacts, Covid-19’s economic impact has touched both supply and demand factors worldwide seemingly overnight.

The result is the onset of an economic crisis of unparalleled proportions. Rapid increases in unemployment in major consumer markets will create near-immediate decreases in consumer spending. Expectations of decreases of up to 50% in some consumer categories are common. By extension, corporate spending will decrease in all discretionary categories. In some geographies, notably China, venture capital funding has decreased by over 50%. The subsequent impact on high-potential growth companies, and by extension national economies, is immense.

In Canada, this crisis and the disequilibrium it has caused across the economy risks usurping not just short-term labour markets but rather risks severing the momentum that Canada’s innovation system has developed over the past decade. As a point of reference, the dot-com crash of 2000 saw over fifty percent of tech startups disappear while venture capital funding for startups took nearly 18 years to return to pre-crash levels. Canada cannot afford the same impacts today. While policy makers understandably focus their efforts at present towards the immediate challenges related to wage supports and business solvency, attention will have to shift quickly to attenuating the factors that risk derailing Canada’s ability to rebound post-crisis and maintain, if not capture new, opportunities in global innovation supply chains.

Doing so requires attention to several factors that influence the activity and success of innovative companies, notably small and medium sized enterprise (SMEs). First and foremost is business solvency and labour force stability. The government’s immediate moves to support wages and to provide flexible financing for SMEs, as done in other jurisdictions including the UK, Denmark, France and others, is the appropriate first step in buying time for these firms.

Moving forward, however, past economic crises provide insights on the behaviour of firms that can and should be used to inform proactive policy in the face of the Covid19 pandemic and its economic impacts. The following policy brief highlights how Canadian innovation policy makers might react proactively to the challenges facing the high-potential SMEs they have worked hard to position for success.

Which firms win post-crisis?

A Schumpetarian view of the evolution of firms during a crisis holds that while it may be impossible to save all firms, those who are able to capture new opportunities created by periods of economic disequilibrium and who are able to weather the storm of uncertainty caused by the crisis are those who will prosper post-crisis.

Who are these firms? The best answer to this may lie in the research conducted by Harvard Business School professor Dr. Ranjay Gulati. His study of over 4700 firms and their strategies related to adaptation during an economic crisis highlights two important findings. First, firms that choose to cut employment deeply during a recession have the lowest correlation with post-crisis recovery. Maintaining a firm’s talent is key to post-crisis rebound. Second, Gulati finds that the winners post-crisis are those that focus on operational efficiencies while investing “comprehensively in the future.” He defines investment here as talent, research and development and marketing activities.

Evidently, convincing a SME owner to invest during a crisis is a difficult proposition to sell. As SMEs focus on survival, conserving cash becomes a paramount priority. This research, however, indicates that efforts must be placed on convincing these firms to invest, when their gut reaction is cut or at freeze. Doing so, however, rests on the presence of policy tools that work to convince SME owners to build long-term capacity and resilience rather than to cut it.

The following outlines potential means of doing so in core “investment” areas:

1. Double down on validated high-potential firms

In spite of government guarantees on wages, the desire to protect cash in an uncertain environment is likely to curtail SME and startup spending on the very elements that propel them forward – research and development. And while this trend is likely to be global in effect, the firms, and host jurisdictions, who will compete most effectively in the post-crisis environment are those who find ways to maintain momentum for their high-potential, highly innovative firms.

In addition, past crises have shown a significant trend towards the consolidation of employment in large incumbent firms at the cost of startup activity.[1] While there are certainly benefits to large firm growth, that it comes at the cost of young, entrepreneurial firms, in particular the high-growth firms we know are responsible for a disproportionate share of net new job creation, again points to the need to double down support on high growth and high potential firms during this period of instability.

In Canada, the identification and validation of these firms is most effectively conducted by the Industrial Research Assistance Program, (IRAP) and its army of industrial technology advisors. The program is widely held up as one of, if not, gold star of Canada’s innovation support system for its provision of both technical and financial assistance to validated high-potential firms.

As was done in the wake of the global financial crisis in 2009-2011 and the operationalization of the government’s Economic Action Plan, IRAP should today be utilized as a vehicle to flow incremental funds to validated, high-potential companies across the country. While wage supports and loan financing can be made available to all, a more select recipient list of this incremental funding should be prioritized to help position these firms, and Canada’s innovation economy to survive and grow rapidly in a post-Covid19 world.

2. Incentivize flow of graduates and researchers into industry

Alongside the potential deflationary impact of the crisis on research and development spending, past recessions indicate significantly negative impacts on new entrants in the labour force, notably graduates, and an equally negative impact on the capacity for innovation and growth within SMEs.

Across historic recessionary periods, young labour force entrants bear the brunt of the economic impact as firms choose to forego hiring for new roles and older employees choose to stay longer in their roles. Forced to sit on the sidelines, new graduates face the prospect of sustained under or unemployment or, often, to return to school. Long-term impacts include a 5 to 17.5% percent wage deficit versus non-recession graduates that is found to last for upwards of 15 years.[2]

For SMEs navigating the crisis, layoffs and hiring freezes represent rational decisions based on cash flow. In Canada, the global financial crisis saw 42 percent of SMEs cut the number of their employees and 16 percent instituted hiring freezes. While rational, these moves also act to sever the momentum that innovative small firms have, lengthen the time and cost necessary for post-crisis recovery and ultimately distance these firms from the new opportunities that are present at times of crisis.

Support for activities that enable employers to hire new graduates and innovation-related talent are subsequently necessary to ensure forward momentum for both graduates and employers continues both during the recession and the immediate period beyond it. Programs such as MITACS Accelerate should be looked to in the short-to-medium term to deliver enhanced support to employers to continue hiring new graduates, in particular for those firms who benefit from IRAP or other government support.

3. Replace organic customer demand with government demand

No form of support for high-potential firms is as valuable in the long-term as real customer demand. And while the economic crisis may have caused the – temporary – evaporation of organic customer demand around the globe, governments can play a significant role in dampening the worst effects by ramping up efforts to procure in a trade-permissible fashion from innovative domestic companies.

Canada benefits from the presence of pre-existing government innovation procurement programs, notably Innovative Solutions Canada (ISC). Now merged with what was formerly known as the Build in Canada Innovation Program (now known as the ISC Testing Stream), ISC acts as a valuable first customer to innovative Canadian startups and SMEs. Together these programs act as a seed fund for proof of concept development, prototype development and customer validate for high-potential firms.

Today, as small firms struggle to find sufficient demand, these programs should be ramped up immediately to operationalize challenges in several key areas with both immediate and longer-term applications relevant to healthcare (testing, sanitation, detection), social services (elderly service provision, delivery services), IoT and data, and other digital services (education, networking). To exploit the full potential of its reach and impact, ISC should be operationalized and funded as a temporary vehicle (and funding agent) for challenges and testing by municipalities and provinces.

Other government programs, notably the Champions and Partnership streams of the Low Carbon Economy Fund, can fulfil a similar purpose with a distinct focus on Canada’s cleantech and green technology SMEs. Reauthorizing these programs to target emissions heavy sectors (buildings, transportation) or targeting sectors adversely affected by the current economic climate (transportation, tourism) could be done via short-term call for proposals. This approach would target larger companies/employers who are more likely to either have cash on hand or be able to borrow in a low-rate environment.

4. Engage innovation stakeholders in the development of this strategy

The development of Budget 2017 and the Innovation and Skills Plan that was at the heart of the government’s approach to innovation and economic growth benefited significantly from a deep engagement with industry expertise. Be it the development of the Innovation Agenda at ISED and its two dozen roundtable sessions across the country, the Advisory Council on Economic Growth’s work coordinated by the Department of Finance or the subsequent development and operationalization of the Economic Strategy Tables, these consultations with external voices allowed departmental officials as well as elected officials to seek the external contribution of ideas as well as the validation or critique of initiatives tabled internally.

Today, the severity of the crisis facing Canada’s innovative SMEs and startups does not allow for a drawn out or periodic consultation process as were designed in 2016. Rather, speed is of the essence, in part to acknowledge and assuage the concerns of industry, and evidently to help shape a longer-term response in anticipation of economic recovery.

To do so, ISED and the Department of Finance should collaborate on the immediate development of a Task Force on Economic Recovery that is internally led but that engages (online) in a systematic fashion with external stakeholders to frame and shape solutions such as those presented above for delivery in a comprehensive fashion in the near term. The internal design of this Task Force, as opposed to an external advisory board, is based on the time and politics required for formal appointments, neither of which can be afforded at this time.

Conclusion

An optimist’s view of an economic crisis calls on a Schumpetarian view of the evolution of firms and industries. While it may be impossible to save all firms, those who are able to capture new opportunities created by periods of economic disequilibrium and who are able to weather the storm of uncertainty caused by the crisis are those who will prosper post-crisis.

Promoting this resilience and preparing the ground for recovery from a policy perspective should subsequently pay attention to the signals that are available to it that firms qualify as “Schumpetarian survivors.” Canada’s innovation system is well-equipped to do so thanks to the presence of IRAP and its industrial technology advisors. Building on this insight, and the knowledge that the propensity to retrench is high amongst SMEs during a crisis, policy makers should look to existing program vehicles to enable the following targeted interventions:

1. Ensure innovative firms continue investing in R&D through increased IRAP funding;

2. Insure the flow of new graduates to innovative firms through enhanced MITACS funding;

3. Create short and medium-term customer demand for SMEs through procurement;

4. Engage with industry in the creation of an immediate “economic recovery plan.”

As fast as this economic crisis has materialized, and as deep as the immediate focus on survival and solvency must be at present, policy makers must think three steps ahead in the development of a recovery strategy that positions innovative firms and high-potential firms to not just survive but ultimately to prosper in a post-crisis environment. A failure to do so will not only see the efforts of the past decade to build Canada into an innovative world leader disappear, but will also push us further down the list of innovative economies as others in developed and developing economies alike act more decisively to plan proactively for both survival and eventual re-emergence post crisis. As harsh as the impacts of this crisis may be in the near-term, we cannot lose sight of that re-emergence and the immediate need to position our highest-potential firms to maintain momentum wherever possible and support them proactively in planning for their post-crisis growth.

DH.

[1] https://eig.org/news/lessons-from-the-great-recession; https://www.bankofcanada.ca/wp-content/uploads/2015/10/dp2015-11.pdf [2] http://www.econ.ucla.edu/tvwachter/papers/Schwandt_vonWachter_Cohorts_final.pdf

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