Canadian economy will need to be more innovative

TORONTO, Nov. 25, 2015 /CNW/ - In the coming decade, the strength of Canada's economy will depend on the ability of firms to deliver tradeable, higher-value added products and solutions, finds a new report from CIBC World Markets.

"Canada lost more than 10 per cent of its manufacturing capacity in the dark days of the loonie's overvaluation and the new capacity that will soon emerge will be very different than what was lost," says Benjamin Tal, Deputy Chief Economist, CIBC World Markets, who co-authored the report Adjusting to The Value-Added Economy with economists Royce Mendes and Nick Exarhos. "Firms focused increasingly on creating solutions as opposed to just building products will take centre stage. Already, trade in service industries, like engineering, architecture, computer and financial services, is larger than traditional measures suggest and will grow even larger."

Exports of Canadian services have risen faster than exports of goods over the past decade, and more importantly, are three times less volatile than merchandise trade, the report says. The primary reason for this relative stability is that trade in services is more diversified. Unlike merchandise exports, where 75 per cent of trade is done with the U.S., only about 50 per cent of Canadian services exports go stateside.

Tradeable goods and services represent as much as 70 per cent of the Canadian economy and 80 per cent of all jobs. Yet, according to Statistics Canada, they account for only 16 per cent of gross exports.

"How is it possible that services represent such a small fraction of exports while accounting for 70 per cent of GDP and 80 per cent of all jobs?," says Mr. Tal. "The answer, your economics 101 professor would say, is that most services are untradeable. After all, you cannot export a haircut."

But, Mr. Tal points out that was more the case 20 years ago than it is today due to the globalization of production and supply chains.

"Trade in services is usually nothing more than an afterthought," he says. "That tendency should change. "

Indeed, the share of exports generated by services is understated in conventional trade statistics, the report says.

When looking at the Organisation for Economic Co-operation and Development's Trade in Value-Added Database (TiVA), which captures every stage of the production process in addition to direct exports, the share of tradeable services in Canadian gross exports is not 16 per cent, but more than 40 per cent, the report says.

"If tradeable services were important in the past, they will be even more important in the future," says Mr. Tal. "It is not a stretch to suggest that, when measured correctly, the value of exports of business services can surpass merchandise exports in the coming decade."

"But, with these changes, there will be challenges," says Mr. Tal. "Companies will have narrower windows to capitalize on proprietary know-how or products, and current financing avenues and educational models are also not fully equipped to effectively support the new wave of entrepreneurialism."

In the coming cycle, smaller business will get smaller, with new technologies and the power of e-commerce making it is significantly cheaper and easier to establish and run a small business, the report says. The highest concentration of micro businesses will be in the professional, scientific and technical services sectors.

"Having access to capital and incubators will be important to the success of these smaller companies," says Mr. Tal.

Most of their early stage funding comes from family and friends or angel investors who are willing to provide early patient capital. Following some lean years in the aftermath of the global financial crisis, venture capital funding has grown, but it remains focused on later-stage investments as opposed to seed and early stage companies, $1.3 billion in 2012 versus just $602 million, respectively.

"To truly take advantage of the emerging environment, firms will need to invest heavily in research and development," says Mr. Tal.

Fortunately, Canadian small- and medium-sized enterprises (SMEs) already account for almost half of all research and development spending in the country, the report says.

Mr. Tal also points out the potential impact of the Trans-Pacific Partnership (TPP) "could be very significant" on Canada's service sector.

While most of the discussion focuses on dairy, auto or forestry industry, TPP actually covers a broad range of services through a 'negative list' approach, which means that all service sectors fall under the agreement unless a country excludes them, the report says.

The complete CIBC Capital Markets report is available at: http://research.cibcwm.com/economic_public/download/if_2015-1125.pdf

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SOURCE Canadian Imperial Bank of Commerce