Innovation is an important driver of productivity growth, which in turn is a major source of improvement in living standards. Given the growing importance of the natural resources sector in the Canadian economy, innovation in this sector is particularly relevant. This article, based on a much large study, using a systems-of-innovation approach, analyzes the innovation performance of the Canadian natural resources sector by comparing it to that of the Canadian business sector as a whole. The key conclusion of the report is that the overall innovation performance of the Canadian natural resources sector, especially the mining and oil and gas sectors, is strong and has improved in recent years.
Introduction
The most important source of long-term improvements in living standards is productivity growth. One of the main drivers of productivity growth is innovation, in products, production processes, organizational structures, and management techniques. Similarly, negative externalities that have an adverse impact on living standards, such as environmental degradation, can be reduced through innovation. The bottom line is that innovation is crucial to the economic performance and social progress of Canada.
Innovation in the natural resources sector is of particular relevance given the growing importance1 of natural resources to the Canadian economy. In recent years, the natural resources sector has faced an array of issues which threaten its international competitiveness. The innovation performance of Canadian natural resource industries will be a crucial determinant of their future viability. Adopting new technologies and practices and acquiring the latest vintage of capital goods will ensure that Canadian resource firms remain strong in the face of emerging international competition while improving energy efficiency and environmental performance.
The objective of this article is to broaden and deepen our understanding of innovation in Canadian natural resource industries through a systems-based approach to innovation. This article is an abridged version of a much longer report prepared by the Centre for the Study of Living Standards for Natural Resources Canada and readers are referred to the full report for discussion of the indicators assessed.
The natural resources sector (or natural resources industries) can be divided into three subsectors: energy, forest products, and metals and minerals. Exhibit 1 (next page) provides the detailed breakdown of each of those subsectors by NAICS (North American Industry Classification System) code.
Innovation indicators span innovative efforts by firms such as research and development (R&D) expenditures, worker education and skills, machinery and equipment (M&E) investment and the use of information and communications technology (ICT) but also efforts by government, in terms of the scale and scope of innovation support programs as well as taxation policies and research infrastructure in university research centres. By comparing these indicators for natural resource industries to the Canadian business and manufacturing sectors, we are in essence comparing the innovative capacity of the Canadian natural resource sector to that of the economy as a whole.
Defining Innovation
From a historical perspective, Schumpeter2 defines innovation as any of the following: the introduction of a new product or qualitative change in an existing product; new production processes that lead firms to restructure their operations; the opening of a new market; the development of new sources for raw materials or other outputs; and changes in industrial organization. It is interesting to note that each of these types of innovation has been observed in natural resource industries in Canada. Although more practical and narrow definitions of innovation have arisen over the past century, this insightful definition is useful to identify innovative activity as being a broader phenomenon than laboratory based R&D or product development.
The standard definition of innovation used by the OECD is from the Oslo Manual (OECD, 2005) and characterizes innovation as “the implementation of a new or significantly improved product (good or service), or process, a new marketing method, or a new organizational method in business practices, workplace organization or external relations.” The components of innovation include research and development, invention, capital investment and training and development. It is also noteworthy that innovation can be said to occur outside the firm, as many firms engage in co-innovation endeavors with their counterparts or rivals, and also draw upon government and academic support. The natural resources sector in Canada has traditionally conducted less intramural R&D than the overall business sector. As a result, many technologies the sector acquires as a means of increasing productivity or decreasing ecological footprints are not developed in-house.
The “Systems” Approach to Innovation and Clusters
A popular conceptual measure of innovation is National Innovative Capacity (NIC), defined by Porter and Stern3 as “a country’s potential – as both a political and economic entity – to produce a stream of commercially relevant ideas.” NIC depends on the technological sophistication of an economy, as well as the size of the scientific and technological labour force. Additionally, NIC reflects the array of investments and policy choices of the public and private sector that determines the incentives for and productivity of a nation’s R&D. The main elements of NIC are common innovation infrastructure, firm-specific conditions and the quality of the linkages between them. Innovation infrastructure includes human, financial and technological capital as well as the policy environment surrounding them. Additionally, it includes basic research, which has no immediate application at any given time. Relevant policies include the degree of antitrust regulation, the protection of intellectual property and the extent of tax-based incentives. These factors combined constitute an overarching system of innovation for a country. That is, a country’s capacity to innovate, as measured by NIC is the direct outcome of the interdependence between industry, government and academia. This article adopts the systems approach to innovation and assesses not only the role of firms in the innovation process but also the role of government, universities and research institutes.
The systemic nature of NIC is also stressed by Veugelers (2005), noting that individual innovation indicators should be interpreted with caution, as the effectiveness of the overall system is not well defined by a handful of indicators. Additionally, she warns about the limitations of inter-industry comparisons of innovation performance as structural differences can account for differences in innovation performance. Some factors that influence such discrepancies are outlined below.
• Technological opportunities differ across industries, with the ICT sector for example having huge opportunities for technological advance.
• The size of the innovating unit differs across industries, which is large in certain sectors such as motor vehicles and small in others such as machinery.
• The objectives of innovation vary, with certain sectors favouring process innovations and others product innovations.
• There is diversity among the sources of innovation, with suppliers being crucial in agriculture, users in software, and in-house R&D laboratories in chemicals.
These types of structural characteristics are particularly relevant in evaluating the innovation performance of Canada’s natural resource sector.
An Analytical Framework for Assessing the Canadian Innovation System for Natural Resources Industries
The Centre for the Study of Living Standards has developed an analytical framework for assessing Canada’s innovation system for natural resource industries (Exhibit 2). Innovation or innovative industries are defined as those that develop new products, processes, organization structures, and business practices including marketing through R&D and/or those that adopt new products, processes, organization structures, and business practices including marketing by monitoring best practices in other sectors or countries. The outcomes arising from innovative industries are higher productivity levels and a higher degree of international competitiveness, which in turn ensure that the industry prospers and the living standards and economic well-being of the population improves.
Innovation in natural resources industries in Canada is influenced by the characteristics of the natural resource industries and by firm behaviour. The natural resources industries have a number of unique characteristics, including high capital intensity, homogeneous products, highly competitive international markets, output price volatility, environmental effects of production, a complex regulatory environment, a high degree of foreign ownership and control, a significant degree of inter-industry vertical linkages, and above-average profitability.
Firm behavior related to innovation is affected by both the environment external to the firm and the characteristics of the business leadership. The former include the state of aggregate demand, the exchange rate, environmental and social concerns, industry structure and competitive intensity, among others. The latter include ownership and control structures affecting decision-making, entrepreneurial drive and willingness to assume risks, managerial training, business strategy, and willingness to cooperate with others. These factors influence innovation in all industries, not just natural resource industries.
The support infrastructure for innovation in natural resource industries includes the overall state of sciences and technology relevant for natural resource industries from both a basic research and applied research perspective in both Canada and abroad. Innovation draws upon this knowledge base.
This infrastructure also encompasses government framework policies, including macroeconomic policies such as fiscal policy, microeconomic policies such as tax policy and intellectual property (IP) policy and government policies directing targeting innovation in natural resource industries, including R&D tax credits and grants for business R&D, financial support for higher education R&D and research in government labs. The universities represent an additional component of this support infrastructure for innovation in natural resource industries, both undertaking basic and applied research and educating skilled personnel. Collaborative efforts related to innovation between government and business, universities and business, and among all three players represent a final element of this support infrastructure.
As noted above, natural resources industries have a number of characteristics that distinguish it from other sectors and hence influence its innovative performance. Exhibit 3 summarizes these effects.
Emerging Challenges Related to Innovation in Natural Resource Industries
Natural resource industries in Canada face a number of emerging challenges that could serve as obstacles to innovation.
Growing Demand for Skills
A commonly cited issue in Canadian natural resource industries is the need to attract and retain skilled labour. In particular, the impressive growth of the oil and gas and mining sectors in recent years has created very strong demand for workers with specialized technical skills. A lack of skilled workers to engage in research, identify the technological needs of natural resource industries, and most importantly to effectively use the latest technologies, can represent a weakness of innovative capacity and hence is potentially a major impediment to innovation. Evidence of the skills challenge facing natural resource industries is widespread.
Addressing Environmental Concerns
Due to the extractive nature of the natural resources sector, issues surrounding sustainability and the environment have increased the pressure on natural resource industries to “clean up.” This has increased the importance of environmental innovation (eco-innovation) and led to the emergence of green technologies and industries. Environmental considerations are especially important in the energy industry, and it is often criticized for contributions to global warming. Objectives such as these require significant investment in science and technology. Because the benefits of these goals accrue to both firms (in the form of reduced costs, greater yields and increased employee safety) and society as a whole (in the form of reduced environmental externalities), there is a substantial case for more collaboration between industry, government, academia and research institutions.
Accessing Unconventional Mineral Deposits
A challenge that threatens the competitiveness of the Canadian mining and energy industries is the difficult logistics of accessing unconventional mineral and energy deposits. Canada has responded very well to this challenge in the case of the oil sands, through developing world-class technologies to extract bitumen from these deposits both through mining operations and in-situ extraction techniques. In terms of mining, there are a number of world-class mineral resources in Canada located at enormous depths and at remote locations. The challenge for firms in this industry will be to exploit these deposits in a cost-effective manner through the development of new techniques. Innovation is crucial.
Moving Up the Value Chain
Canada exports many natural resources, including logs, minerals and ores, and petroleum and natural gas in a raw or unprocessed state. There may be potential for Canadian firms to move up the value chain to create additional value added and employment in Canada by more processing of raw natural resources in this country. It is largely market forces that account for the current split or distribution between the export of unprocessed resources versus their processing in Canada. One approach would be to use regulation to require firms to undertake more processing in Canada. However, a less interventionist approach may be for firms to develop new processes and products that make it cost effective to process and transform more natural resources in Canada instead of exporting them in an unprocessed state. Innovation is of course the key to the development of these new processes and products.
Increased Globalization and Market Consolidation
The natural resources sector has seen the emergence of a number of very large multinational firms in recent years, particularly in the mining sector and to a lesser degree the forest products sector. Unfortunately, except for the gold industry, there are no Canadian firms among these multinationals (indeed, the takeovers of Alcan and Inco contributed to the growth of these foreign mining multinationals such as Rio Tinto and Vale).The implications of this movement toward market consolidation for innovation in natural resources industries in Canada are uncertain. On the one hand, the Canadian operations of these multinationals gain access to the technologies of these firms developed in other countries, although since Canada is already a world leader in mining technology it is unclear how valuable this access will be. On the other hand, these mining multinationals may locate or even relocate research activities in their home country, or in other countries in which they operate, resulting in less R&D being undertaken in Canada.
Overall Assessment of Canada’s System of Innovation in Natural Resource Industries
Innovative depends not only on the R&D efforts, labour quality, machinery and equipment and ICT investments of business, but also on the quality of institutional infrastructure that supports business innovation and the linkages between firms and these supportive institutions (government and universities). The basic stock of knowledge upon which natural resource industries draw for innovation as well as the degree of collaboration between firms also make up the innovation system.
This article concludes that the Canadian mining and energy sectors are innovation leaders, both relative to other Canadian industries and to these sectors in other countries. The strongest piece of evidence to collaborate this finding is the expert assessment of the science and technology of Canadian industries conducted by the Council of Canadian Academies in 20064. It found that out of 197 sub-areas of science and technology the top ten industries were all natural resource industries, with the Alberta oil sands number one. A second development that confirms the innovative nature of natural resource industries is the technique of fracking, which allows producers to recover natural gas from shale deposits. This innovation constitutes a massive technological shock to the natural gas industry. It has greatly increased the supply of natural gas and put downward pressure on prices.
The implication of this overall positive assessment of the innovative performance of natural resources sector (or at least the mining and energy parts of the sector) is that Canada’s system of innovation for natural resource industries is working quite well. The innovation performance of Canadian natural resource industries is strong as measured by most indicators. For example, natural resource industries outperform the Canadian business sector in terms of productivity levels, M&E intensity, adoption of new technologies, collaboration efforts between firms, and R&D personnel.
The strong innovative performance of most natural resource industries has only been possible because of the effectiveness of the overall system of innovation, more specifically the infrastructure that supports these innovative efforts. Canada has one of the most generous R&D tax credit schemes in the world. Governments also provide grants for business R&D. The federal government undertakes research in its own laboratories that can be used by natural resource industries. Through its granting councils, the federal government supports research in the university sector that can be used by natural resource industries. The universities themselves are also crucial for innovation in natural resources industries, performing both basic and applied research relevant to these industries and producing graduates who will assume positions in these industries. A number of collaborative organizations have been established that bring together governments, universities and businesses to foster innovation in the natural resource sector.
Despite the overall strong innovative performance of most natural resource industries, there is always room for improvement. For example, R&D intensity in most natural resource industries (and at the natural resources aggregate level) is below the all industries average. Part of this poor performance is due to structural characteristics of the industries. Two of those structural characteristics are particularly relevant in this case: 1) process innovation tends to be more important in natural resources industries than product innovation; 2) innovation in natural resources industries frequently takes the form of new machinery and equipment, which are produced by other industries in other NAICS codes. However, the fact that R&D intensity in some natural resources industries has fallen over the past twenty years may be a source of concern.
Yet it can be argued that what matters in the end is innovation outcomes, not innovation inputs. If the Canadian natural resources sector can be a world leader in innovation without directly undertaking R&D, what is the problem? The system of innovation in Canada, through R&D conducted by universities, government, or capital equipment and materials providers, etc. appears to be undertaking sufficient R&D related to natural resource industries to make the sector world class. One must look beyond BERD as a driver of innovation outcomes.
Another indicator in which natural resources industries had a poor performance overall was labour force skills. Again, part of this can be attributed to structural factors specific to those industries (e.g. highly skilled workers in specific industries are not necessarily the ones with the most formal education), but part can indicate a more pervasive problem, which might hinder innovation performance in the medium-run.
Finally, the role of the government in promoting innovation can always be improved. In particular, a number of ways to increase the effectiveness of the SR&ED program have been put forward. Proposed changes include the reduction in red tape in support program application processes and new support programs that target innovation in specific industries.
This is an abridged version of a report prepared by the Centre for the Study of Living Standards (CSLS) for Natural Resources Canada. The full report is posted at http://www.csls.ca/reports/csls2012-06.pdf. Email: andrew.sharpe@csls.ca
About the Author
Dr. Andrew Sharpeis Founder and Executive Director of the Ottawa-based Centre for the Study of Living Standards (www.csls.ca), a non-profit -independent economic research organization focusing on research on productivity, living standards and well-being. He holds a PhD in economics from McGill University.
References
1. Nominal value added GDP growth for natural resource industries in Canada has outpaced that of the business sector between 2000 and 2008, averaging annual growth of 5.7 per cent versus 4.4 per cent, respectively (CANSIM table 379-0024).
2. Schumpeter, J. (1934) The Theory of Economic Development (Cambridge, MA: Harvard University Press).
3. Porter, Michael E. and Scott Stern (2001) “National Innovative Capacity,” in K. Schwab, M. Porter, and J. Sachs (eds.) The Global Competitiveness Report, 2001-2002 (Oxford: Oxford University Press.
4. Council of Canadian Academies (2006) “The State of Science and Technology in Canada.”
