Thoughts on the Knowledge-Based Economy

There’s been a lot of buzz about how this country and its communities need to transition to a knowledge-based economy in order to remain competitive, thrive, and even to survive in some cases.

I tend to agree (in the interest of full disclosure, I do have a bias- I’m a partner in an internet technologies firm that is heavily reliant on IP to generate revenue).

Let’s talk about this knowledge-based economy thing and highlight some of the challenges ahead, both nationally and locally.

First off- what is a knowledge-based economy? That can be tough to pin down in a well-defined sense. But, as the term implies, a knowledge-based economy is at heart an economy that relies on the creation of intangibles and intellectual property in order to create wealth. An easy example on the micro level is the creation of Facebook, which makes revenue by selling advertising on its site, targetable to the 600-some odd million users who use it; Facebook has generated an ecosystem, where other companies can use its platform to generate revenue- such as social game maker Zynga (creator of the much-loathed and much-loved FarmVille).

Note that even if knowledge-based companies don’t retail physical goods and services directly, they’re almost always involved in the process indirectly. For example, my firm owns and operates a B2B real estate marketing brand specializing in high quality eMarketing products which are used by real estate agents and brokerages. This is a knowledge-based entity, and though it doesn’t sell tangible products directly (aside from some signage and business cards), it closely supports professionals who do sell tangible products (namely, property and housing).

Confusion about the knowledge-based economy comes from an often-missing part of the equation: the knowledge-based economy is indelibly tied to the value chain of manufacturing and the retailing of tangible goods and services. If you were to remove the manufacturing and retailing of physical goods from the economy with your magic wand, a knowledge-based economy would be largely unsustainable. This is not to say that our nation MUST have strong tangible and intangible facets (though this would be preferable), as the interconnectedness of the 21st century world means that manufacturing can (and usually does) happen in other areas which have more lax labour regimes and lower cost of production in an economy of scale. Capital, like energy, flows along the path of least resistance. The state of our manufacturing sector shouldn’t be blamed on corporations or the greed of business owners, as it’s actually our societal lust for low-priced products that is the root of what ultimately drives manufacturing overseas. But, I digress.

If we can’t competitively manufacture (a generalization, yes, but an accurate one), then the growth of knowledge industries is certainly essential to our long-term economic health (traditional natural resources aren’t everywhere, after all… and certainly aren’t infinite; thus, relying on the resource sector as a long-term economic driver is certainly a folly). Canada has a reputation for high-quality innovation in a number of fields- among them, aerospace and high-tech (before the demise of Nortel, anyway- and RIM may not always be the shining beacon that it has been). Sadly, other countries have shown more rapid growth in high-tech than we have in the past decade (in my opinion, high-tech is a cornerstone of knowledge-based economies).

Before we talk about what challenges there are for transitioning to a knowledge-based economy, let’s define the term ‘high-tech’. It has a few different meanings, based on the perception of the individual. ‘High-tech’ has been used to describe:

  • technology developers/manufacturers (Nortel, RIM, Cisco)
  • technology integrators (the ill-fated Vonage, Skype, Telus Healthcare)
  • software developers (OpenText, Corel, Sage)
  • internet technologies (Google, Facebook, Yahoo)
  • hybrid-tech companies [those who do a bit of everything] (Microsoft, Apple, Hewlett-Packard)

Thus, the common idiom of ‘high-tech’ can be used to refer to a company like Cisco, which develops and manufactures computing hardware (and to a lesser degree consumer electronics), as well as Facebook- which brought online social networking to the mainstream and sells advertising. Though they’re both ‘high-tech’, these two companies carry on vastly different businesses and rely on revenue models that are apples and oranges to each other. But the one big thing they have in common is this: reliance on leveraging intellectual property (IP) to generate revenues.

Challenges for a Smooth Transition to the Knowledge-Based Economy in Canada

Plentiful. Among them:

  • Geography and Geopolitics
  • Business and investment climate
  • National politics (though perhaps lessened with the CPC in power as a majority)
  • High cost of advanced communications services (broadband, mobile, et cetera)

There is no Silicon Valley in Canada (though at different times Toronto, Vancouver, and Montreal have all been referred to in the popular media as ‘Silicon North’). The low population density in this country tends to work against the critical mass of ideas necessary for brilliant innovation at the concept stage within the tech sector (with the exception of the seven major urban centres, of course, which have higher population densities). The low-population density factor is especially detrimental when considering that Silicon Valley and its support systems are a mere eight hour plane ride from Pearson (shorter from Calgary and Vancouver). Many Canadians have relocated to California and been incredibly successful in the tech sector. In fact, non-profit group theC100 is solely dedicated to promoting and supporting Canadian tech entrepreneurship in Silicon Valley. The mere existence of such a group speaks to the dismal conditions for high-tech firms in Canada at the same time that it speaks to the quality of tech innovation borne in this country at the concept stage.

The business and investment climate (particularly venture capital) is also currently a detractor to economic transition. Currently, the national economy is in the middle of a fragile recovery (we may be in the ‘middle’ of this recovery for several years to come). Uncertainty in global markets, combined with a red-hot commodities market typically works against knowledge-based companies at the seed and startup stages in particular. Economic resources are limited (though to the individual, the economy seems limitless due to its overall size). If you had ten million dollars to invest in a company, what would you do- take a flier on an internet startup that either could quadruple your money in five years or leave you shirtless in six months? Or, would you invest that money in a commodities company that provides a high-demand resource into global markets (such as gold, potash, or crude oil) and will give you a steady return of 6-10% per year on your money annually (when you can also sell that position at any time to make back your initial ten million, and then some)? Capital flows along the path of least resistance. Thus, the resource sector in this country is far more attractive to venture level investors than the tech sector. It also doesn’t help that there’s far less private venture capital in Canada than there is in our neighbour to the south, even when compensating for factors like population and market size. As Sir Terry Matthews put it ‘… it’s like a desert out there.’

National politics certainly plays a role in any economic transition. This one in particular could be extremely sensitive, given that the manufacturing sector currently makes up about 10% of the employed labour pool nationally (source: Statistics Canada, May 2011). This of course is predicated on the assumption that if government attention and support shifts to knowledge-based companies, that manufacturing-based companies will feel the pinch even more than they have. The sensitivity comes from the fact that manufacturing has a disproportionately loud voice in the public sphere, primarily due to unionism and its well-established, well-funded lobbying assets and mechanisms. This risk to transition is perhaps somewhat lower now that the CPC rules Ottawa with a majority government- its stance on unionism and labour disputes has been made quite clear by its actions in the Air Canada strike, and more recently, the Canada Post conflict (the national service disruption was a lockout by management- not a strike, as many have called it).

The high cost of advanced communications services such as broadband and mobile are also a hindrance to consumer adoption, and thus, a hindrance to economic transition. The digital communications technologies that make our world smaller are the infrastructure upon which a sustainable knowledge-based economy must be built, after all. We can consider them the four-lane freeways, seaports, and rail lines of the new economy. If the cost of adoption among the mass market is prohibitively high, the consumer base for the knowledge economy is smaller than it should be- and a bigger market almost always means higher profits, which attract more investment capital. Canada currently ranks 26th in price offering for broadband technologies, according to research done by the OECD (meaning that a consumer can purchase monthly-subscription broadband services cheaper than here in twenty-five other countries, benchmarked to the USD). In price per megabit per second (of advertised speed), we rank 25th with an average of $1.46 and an average monthly line cost of $56.99 (benchmarked to the USD). By comparison, second-place Japan averages $0.12/mbps with an average monthly line cost of $24.68 (again, in $US). There are a variety of factors for this price disparity- the big telcos will say it’s infrastructure (valid) and supply/demand (also valid), while the free-market proponents will scream oligopoly, price-fixing, and lack of competition (all valid as well). Canada has slipped considerably in broadband penetration, now ranking 22nd globally- no doubt in part due to pricing disparity with other nations. Capital flows along the path of least resistance- especially in the consumer spending arena. Wireless technologies such as cellular phones are in a similar state, as data-delivery has become the battleground of that industry in the past five or six years (even more so now that wireless telco has evolved to become primarily an application delivery ecosystem instead of a make-phone-calls-from-anywhere industry).

Challenges for a Smooth Transition to the Knowledge-Based Economy in Peterborough, Ontario

On a macro level, the Greater Peterborough Area faces these challenges in its transition to a knowledge-based economy. Currently, the services/hospitality sector, coupled with manufacturing, are major drivers of employment within the community. Thankfully, the bigger manufacturing players (Siemens and General Electric) are highly-specialized and require highly-skilled labour. Additionally, the margins on the end-products which are manufactured or re-manufactured at these facilities tend to be quite healthy (for instance, nuclear power technologies). These two factors reduce the likelihood that these manufacturing operations will be relocated to lower-cost areas in South East Asia. Though, risk does still exist to the manufacturing base from smaller players (for instance, the near-fatal over-reliance by Ventra plastics on automotive sector clients circa 2008 and the closure of Unilever/RAGU in 2010). Growth in manufacturing in North America is unlikely to be a major economic driver in the coming decade, and any new manufacturing operations will likely be based on advanced technologies which reduce the required input of human labour anyway (ergo, fewer jobs created than in the past). Thus, focussing on manufacturing is unlikely to bring a good return on investment to the local economy.

Hospitality and services  will be a high-growth employer in the coming years, based partly on the demand for labour outstripping the future supply. Indeed, projections suggest that without intervention the hospitality sector will experience a labour shortfall of 300,000+ workers nationally by 2025 (source: Ontario Culinary Tourism Alliance, 2007). This will create a very pointed demand for culinary and hospitality professionals, which will drive up wages and ultimately the price to the end consumer (almost certainly creating a mini-bubble which will self-correct as demand falls in response to the rising prices).

I mention these two industries because they are currently the forerunners to compete with the high-tech industry for government grants and support resources (federal, provincial, and municipal) in the coming years. Personally (again, I do have an inherent bias), I believe that tech is the most sustainable of the three industries, and presents the best opportunity to create wealth for this community and its residents. Knowledge-based companies (like tech) create high-paying jobs because at the root of it, intellectual capital simply cannot be created by machines (whereas products and food can)- with the exception of derivative intellectual capital (such as the creation of databases; which are ultimately of little value without ideas for their application). The creation of knowledge cannot simply be picked up and moved overseas, like manufacturing can (show me someone who wants to pack up and move to a country in southeast Asia with a lower standard of living, and work for half the pay, and I’ll show you a crazy chicken).

How do we create a knowledge-based economy in this community?

The foundations are already here. Geographic proximity to the nation’s nexus of capital (Toronto’s Bay Street and the TSX), sparse as it is for venture funding. Outputs of new, highly-skilled labour in the form of Trent University and Fleming College. Closeness to major transportation networks such as the 401/407 and St. Lawrence Seaway (remember, the knowledge-based economy is stronger and more sustainable when intertwined with the traditional economy- in fact, the most viable first phase of transition to a knowledge based economy is perhaps in using intellectual capital to enhance the efficiency and productivity of the traditional economy, something which the tech sector excels at). Also, this community has room to grow- both outwards and upwards (the footprint efficiency of existing real estate in the city core can still be nudged upwards, as there are no skyscrapers here currently and an abundance of low-value properties which have become dilapidated). Lastly, support mechanisms do exist in this community for business creation. The GPAEDC, CFDC, and Innovation Cluster being at the forefront (in addition to the BDC, EDC and the usual host of federal and provincial agencies which support business creation).

A principal barrier to the transition is, in my opinion, a near-absolute vacuum of capital support at the seed and startup stages. This is typically an area which is serviced by the private-sector; but, due to the overall nature of venture capital in Canada, this area is quite barren. The seed and startup stages (in the venture cycle) represent the highest risk for investors, due to the high rate of failure (though I would argue that the high rate of failure has a lot to do with the lack of available capital funding mechanisms and support for early-stage companies). Thus, the limited venture capital in Canada naturally flows to companies in the growth and mature funding stages (capital flows along the path of least resistance).

So, what’s the solution?

The big one would be an increase in available venture capital to fund companies at the seed, startup, and growth stages. Attracting additional capital to Canada (and Peterborough) in the form of venture capital funds and firms is an unlikely scenario, due mainly to our proximity to the red-hot venture capital markets in the United States. Thus, we need to be creative and tap unconventional sources of capital more efficiently, creating large pools of capital by aggregating small individual sources of capital. The angel investor model excels in this area; angel networks are on the rise in Canada (and North America) as the opportunities which funding seed and startup stage companies become more widely realized. At the policy level, it is absolutely essential to support the growth of this funding model. One such way of supporting this funding model is through creation of a tax credit which would allow angel investors to write off x% of their investment as a direct credit at the federal or provincial level (thus making this type of investment more attractive to those with a net worth of $5-50 million; individuals with higher net worths are typically involved at the venture capital level if involved at all). A program based on this model currently exists in British Columbia, and is highly successful (a recent study of the $30 million program revealed that for every dollar spent, the return to the provincial treasury was $2 and the return to the federal treasury was $1). Government policy funnels unimaginable sums into revenue-losing programs at every level; it would seem that allocating money into a revenue-neutral or revenue-generating program should be a no-brainer. Crowd-sourced funding is also another answer- where multiple investors contribute small sums to a pool of wealth (think Kiva, but as a for-profit), thus spreading the investment risk across a wide base (you might not be okay with losing a ten million dollar investment, but odds are high that you’d be able to swallow fifty or a hundred dollars if the investment went south). One of the current barriers to crowd-sourced funding is outdated securities regulation which was designed to police the investment community at the million and billion dollar level. Write the OSC an angry letter on the subject (I have).

Unfortunately, we have little control over programs like this at the municipal level. However, what we can influence at the municipal level is the development and support of business-creation mechanisms, such as incubators and mentorship programs… as well as support mechanisms for high-wealth individuals interested in investing in early stage companies (for example- research services, networking events, and limited fund-matching programs). Additionally, the creation of a community fund specifically for investment in early-stage companies would go a long way towards fuelling transition to a knowledge-based economy (realistically, this would have to be a private/public partnership utilizing funds from the public sector and funds+managerial experience from the private sector in order to be viable in the long term).

One area of opportunity is in the creation of a dedicated business incubator. In the tech industry, ‘incubator’ typically refers to cutting-edge operations which support entrepreneurs through the concept and seed stages (with financial support and mentorship) and sometimes into the actual startup stage (as in the Silicon Valley Y-Combinator program, which guarantees $15,000 in seed funding and $150,000 in venture funding to every accepted application). This type of investing is typically high-risk, but when approached with a portfolio strategy (ie- one big success will pay for fifteen failures) is sustainable and can be quite lucrative. However, incubators aren’t restricted to the tech industry- there are examples of several successful Canadian incubator programs which service a broad array of early-stage companies (Vancouver’s Network Hub, Toronto’s MaRS Project, Calgary’s Al Ross Technology Centre– even Port Hope’s IDEAHub is in the roster of the Canadian Association of Business Incubation).

Whatever path we as policy makers, business people, and citizens ultimately choose in order to facilitate economic transition will be a difficult one. But, I believe the people of this community (and nation) are ultimately up to the challenge. Prove me right.