Three Scenarios for the Economy in New Brunswick

Published in the Telegraph-Journal 27th January 2012

Many New Brunswickers get the same feeling when listening to Finance Minister Blaine Higgs explain that they must want less from the provincial government as it wrestles with record debt and deficits. They want to know what he is going to do about it and why it hasn’t happened yet. The minister appears increasingly more frustrated that not everyone subscribes to his sense of urgency over the province’s fiscal challenges, even though there appears to be a widespread recognition that the situation is untenable. Some groups, especially the health care sector and teachers’ unions, are expecting deep reductions in services which will have a significant impact on their members.

For over a year since the election, the government has been working on an economic plan without revealing very much about what the implications of this plan might be. Some have commented that the government has very little latitude over its decisions because of the gravity of the challenge, but there are three scenarios that roughly approximate the options facing New Brunswick. Each scenario leads to very different outcomes not only in the short term but for the future of the province in the long run.

The first scenario represents the least deviation from the present course. This stay-the-course option largely maintains the status quo and reflects the view that only relatively minor measures are necessary to address the economic challenges facing the province today. Supporters of this analysis claim that major alterations to institutional relationships or historic economic bargains would be destabilizing and counter-productive and favour incremental changes that maintain current benefits. Proponents of the status quo tend to be hopeful that the future trajectory of the economy will favour New Brunswick. Views of the supporters of this scenario typically include health care costs responding to technological solutions, and support consolidating for projects such as shale gas drilling because they would provide relief in the form of jobs and revenue to government.

The second scenario is a managed strategic reduction of government operations and investments providing a much more narrow range of services to the public. Conceivably this could mean less support to industry as well but the hallmark of this scenario is that it represents the recognition that New Brunswick’s future is one of inevitable decline. There are many examples in the U.S. where state governments have made decisions to manage a strategic retrenching in the face of declining industries. Pennsylvania hasn’t fully recovered from the dramatic restructuring of its steel industry and northern Maine is a shadow of its former self. In both states, governments deliberately engineered a strategic retreat of services and entitlements in areas where traditional industries had declined and where population decreases followed. This scenario is perhaps the most radical of options and even more so in locations that currently rely most on government support.

The third scenario is really the obverse of the second where government transformation, investment and direct involvement become the infrastructural foundation for the growth and revitalization of the province. One of the cardinal assumptions of the arguably most risky option is that an ambitious remaking of the province and its relationships and institutions are not restricted to economic questions but include political and social ones as well. Questions that would figure prominently in this scenario would be whether we have a vision larger than ourselves and if we can find the balance between self-interest and sacrifice required to advance an agenda that promotes and supports that vision while remembering the profound challenges involved in actual transformation.

Each of these scenarios assumes a far more widespread conversation and even heated arguments about what we want New Brunswick to be, not only today but in twenty and fifty years. One of the key success elements of this conversation will be ensuring that it involves everyone in the province.

The Delusions of a Self-reinforcing Belief System

One of the speakers at the recent conference at Bretton Woods hosted by the Institute for New Economic Thinking (INET) was Lord Adair Turner, who heads England’s financial regulator. He challenged almost every fundamental assumption that has been the theoretical foundation for Western economists and policymakers since 1945. Leaders in Washington and other capitals, he claimed, have become hypnotized by a “self-reinforcing belief system” that prescribes liberalizing markets as the best and only answer for economic problems. Freeing markets from government control, Turner argued, does not necessarily maximize economic growth. He added that growth itself should not be the ultimate aim of a good society. Rich countries would be in better shape by trading off some growth for greater stability and equality.

What was notable about Lord Turner’s remarks is not only what they reveal about the current state of thinking in economics. Divisions have proliferated not only at the theoretical level but in practical terms and these divisions are more acute today that at any time since the post-war period. That era featured the creation of the institutional cornerstones of economics – the World Bank and the IMF – but was also a time of fierce contestation between Keynesians and economist more sympathetic to exposing the world to market discipline without the involvement or interference of government. The jury is still out on who won that round, but the financial crisis clearly has called many models into question.

Today, the lines are drawn in similar fashion between the supporters of fiscal austerity and those that maintain that the real challenge lies in employment, not debt. Battles are being fought over whether basic market theory can account for the way people make economic choices, whether advanced computing power will allow us to map human economic behavior in the same way weather or climate change is tracked, or whether the concept of a rational, self-equilibrating market even makes sense in the wake of the financial crisis.

The real question in economics today is whether anyone will emerge to follow the paths of  to chart a new course for a generation.

The False Polarization Between Economy and Environment

Published in the Telegraph-Journal 24th January 2012

When President Obama recently rejected the Keystone XL oil pipeline proposal that would extend from Canada to the Gulf Coast, he did so in the face of the claim of House Republicans that tens of thousands of jobs would be lost by not approving the project.

“[T]he president cannot find a way to say yes to jobs,” said Charlotte Baker, spokeswoman for the House Energy and Commerce Committee.

The assertion that there is a clear division between the interests of the environment and the prospects for economic growth and jobs has featured prominently in recent debates and discussions on energy in both the U.S. and Canada.

By increasing the heat over the Northern Gateway hearings and establishing a direct linkage of the Gateway to thousands of jobs, the Canadian federal government has succeeded in raising the political risks of the project to anyone who would oppose it. And discussions about the potential benefits and risks of shale gas increasingly are couched in the language of necessity. We need shale gas development because we need jobs and government need revenue.

But some executives in the energy industry are calling the political battle between economy and environment a false dichotomy. Speaking at a recent international clean energy investment conference, Mark Vachon, vice president of GE’s successful Ecomagination program and a member of GE’s Corporate Executive Council, called environmental performance a key driver for business.

“There’s this theory that you have to pick one: economics or environmental performance. That’s nonsense. Innovation is the way you can have both,” said Vachon. A major player in clean energy, GE has a business strategy which has meant investing more than $5 billion in clean tech R&D while Ecomagination has generated over $85 billion in revenues through 2010.

This is not the first time that industry and politicians have played the jobs economic prosperity linkage cards.

In the U.S., the automobile industry engaged in an unprecedented lobbying campaign when it was faced with intense pressure to respond to changes in vehicle emissions standards and safety regulations. The Clean Air Act was passed in 1970, but not before the auto industry had forecast that untold thousands of jobs were in jeopardy if the bill was passed. In fact, the competitiveness of the American auto industry was enhanced by new regulations and employment continued to rise across the industry after the passing of the Clean Air Act.

As opposition to the development of large-scale energy projects has increased, the proponents of economic benefits and job creation have allowed it to underplay the costs and risks inherent in these projects including that the extraction and production of tar sands oil in the fields of northern Alberta would cause far more greenhouse gas emissions than drilling for conventional crude. The Northern Gateway project is faced with almost monolithic opposition from First Nations peoples in the west. And in the U.S., lobbyists and House Republicans have attempted to market the project as way to reduce America’s reliance on Middle Eastern oil even though a substantial amount of the pipeline oil that would be refined on the Gulf Coast would be earmarked for foreign export.

One of the more clear themes moving into America’s national elections is the perception of a profound conflict between the economy and the environment. This theme is also increasingly a prominent feature of debate in Canada. But when leading investors from global firms representing a cumulative portfolio worth trillions of dollars gather to explain why the economy and the environment are inextricably linked, we should be less certain that jobs will be created only by conventional means in which the environment must be subordinated to putative economic progress. The evidence continues to mount that an innovative approach to economic development can simultaneously create jobs and support environmental sustainability.

Innovation Challenges Investment Paradigms

Published in the Telegraph-Journal 20th January 2012

A critical factor responsible for the failure of many companies is that managers don’t have effective or efficient tools to help them to understand markets, analyze competitors, develop brands, select employees and develop strategy. In the absence of reliable knowledge, other tools are brought to bear to fill in the gaps. This is particularly true with firms that are seeking to finance innovation.

Raising capital is an ongoing and unending challenge for corporations. It is particularly difficult when financing innovation, in part because of the highly uncertain nature of the breakthrough or disruptive technologies that innovation may present. This is an increasingly well-known problem for start-up entrepreneurs but the investment challenge also exists for established firms.

At the outset, a fundamental problem is that proposals to create growth by exploiting potentially disruptive technologies or products cannot often be supported by hard numbers. Markets for these technologies or products can be small initially, and substantial revenues may not materialize for an extended period of time. Too often, when the financing of disruptive technology projects are pitted against incremental sustaining innovations in the battle for funding, the incremental projects receive approval while the seemingly riskier projects get delayed or die.

But an additional and more vexing problem is that managers in established corporations traditionally have used financial analysis tools and methods that can make innovation investments very difficult to justify. The most common system for green-lighting investment projects only reinforces the flaws inherent in these tools and methods.

This constellation of problems has come under the analytical microscope of Harvard University School of Business professor and author of The Innovator’s Dilemma, Clayton Christensen. His recent research asks why “so many smart, hardworking managers in well-run companies find it impossible to innovate successfully”. His team’s investigation has concluded that a misguided deployment of three financial-analysis tools is involved in what he calls “the conspiracy against successful innovation”. According to Christensen, the application of discounted cash flow and net present value to evaluate investment opportunities is “responsible for management underestimation of the real returns and benefits of investments in innovation”. In addition, his research reveals the way that fixed and sunk costs are reflected when evaluating future investments confers an unfair advantage on challengers and encumbers incumbent firms that attempt to respond to competition. Finally, his team claims that an excessive emphasis on earnings per share as the primary driver of share price and hence of shareholder value creation diverts resources away from investments whose payoff lies beyond the near term. This has resulted in an investment shortfall in business models where liquidity events are beyond the immediate horizon.

Christensen’s view is that the way these financial tools are commonly used in evaluating investment opportunity creates a systematic bias against innovation. He blames the commonly used stage-gate approval process— feasibility, development and launch—for much of the analytical distortion. His research reinforces that project teams generally know how good the financial projections need to appear in order to successfully win funding. Alternative methods, such as discovery-driven planning challenge some of the paradigms of financial analysis but they can help managers innovate with a more accurate projection of future value, and with less cost and risk. Christensen’s wider claim is that some of the tools typically used for financial analysis and decision making about investments distort the value and likelihood of the success of investments in innovation. Although he identifies business schools as laggards when teaching finance and investment, he states that there’s a better way for management teams to grow their companies. This involves paradigmatically different thinking about organization, planning, control and leadership and points to the critical importance of universities in determining the future of innovation.

Can Shale Gas Rules Be Strict Enough?

Published in the Telegraph-Journal 17th January 2012

At the root of the resistance against hydraulic fracturing (fracking) in New Brunswick are the environmental, public health and economic risks associated with the natural gas drilling activity. In response to the opposition to drilling, Premier Alward has promised that he wants New Brunswick to have “the strongest shale gas exploration regulations on the continent”. If the regulatory standards include not only exploration but ongoing drilling itself, the government’s promise is striking.

Today, the standards of regulation are notoriously weak in many jurisdictions across North America, and many people complain about a lack of information about drilling practices. In the U.S., a regulatory loophole in the 2005 Safe Drinking Water Act prevents the U.S. Environmental Protection Agency from regulating fracking. In addition, drilling companies are not required to disclose critical information about their operations. This is beginning to change. In Texas and New York, regulations are undergoing a complete overhaul in response to public demands for better information and improved oversight and enforcement of drilling operations.

In Texas, a premium has been placed on getting better knowledge to the public. As of early 2012, new regulations require drilling operators to report the chemicals used in the fracking process. While the primary concern is that drilling could contaminate drinking water supplies, the practice itself involves drilling deep into the shale rock formation, fracturing the rock with water and chemicals to release the natural gas and disposing of the resulting wastewater that flows back up the well with the gas.

Environmentalists and landowners are eager to learn what acids, hydroxides and other materials have been pumped into specific wells. New regulations also involve the mandatory disclosure of the volume of water needed to frack each well. Experts view this as critical information to evaluate how fracking affects water supplies. Under the new regulations, the public will be able to check a website to review chemical and water disclosures in Texas. The public also wants more information about whether the water comes from aquifers or reservoirs or has been recycled from other fracking operations.

If Texas has already begun changing the rules for drilling, regulations in New York may determine the future of fracking in the U.S. New York congressman Maurice Hinchey is seeking to energize support for much tougher national regulations. In a letter to New York Governor Andrew Cuomo, Hinchey makes recommendations that he claims must be addressed before New York allows drilling. Many of these recommendations could become part of the regulatory fabric in that state.

Hinchey calls for a cumulative impact analysis of natural gas drilling to understand the full impact drilling could have on New York’s water resources, air quality, local roads and other public infrastructure and an analysis of the potentially negative economic consequences of drilling, such as impacts on tourism and agriculture. He calls for a comprehensive wastewater treatment plan detailing where and how large amounts of flow-back and produced water will be treated or disposed, including how toxic or radioactive contaminants will be removed. Hinchey also calls for a prohibition on the use of toxic chemicals in all fracturing fluids in order to prevent groundwater and surface water contamination. And he calls for a complete ban on land spreading of shale gas drilling waste fluids and a prohibition on the use of reserve pits or centralized impoundments for fracking fluids and flow-back water.

New York’s new rules on drilling may have a domino effect; they clearly will represent the toughest regulations on the continent. Will New Brunswick be able to meet or exceed these regulatory standards or will the bar be set too high? And while regulations may be a necessary condition for the support for shale gas drilling in this province, will they be sufficient to gain the widespread support that will be necessary?

Innovation Policy at a Crossroads

Published in the Telegraph-Journal 13th January 2012

One of the challenges of Canada’s tech industries is becoming big enough to achieve the objectives that its entrepreneurs, venture capitalists and policymakers envisage. This means not just producing brilliant ideas, but converting them into profitable commercial reality, creating jobs and yielding the sorts of innovations that revolutionize old industries and spawn new ones.

For more than forty years, policymakers and researchers have agreed that at the root of this challenge is how government can most effectively and efficiently play its role. It’s not simply a money issue. Past recommendations from organizations as varied as the Economic Council to the Science Council to the National Advisory Board on Science and Technology have ranged from a national industrial strategy to an innovation extension policy.

Today, the Canadian Advanced Technology Alliance (CATA) is calling on governments at the federal, provincial and municipal levels to formulate and issue comprehensive innovation plans that together will effectively foster the creation, retention and growth of innovation and entrepreneurship so that Canadians can receive the full benefits of this country’s investment.

Canada’s largest technology association, CATA has called for the federal government to play a critical role by rationalizing its programs supporting business innovation, including the Scientific Research and Experimental Development Program (SR&ED), and rolling them up under a dedicated organization accountable for the successful closure of Canada’s innovation and commercialization gap. Among its immediate action priorities, CATA urges the federal government to focus on creating an environment that successfully commercializes Canadian innovations, long recognized as an impediment to Canadian competitiveness. CATA advocates funding commercialization through the reallocation of a portion of existing SR&ED tax credit expenditures and focusing on Canada’s “Priority Strengths” defined by the Council of Canadian Academies and the Science, Technology and Innovation Council.

This approach would address the funding shortfall for early stage businesses and the financing of growth opportunities in established businesses. It would also promote the rationalization of a currently unnecessarily complex regulatory climate that places a drag on innovation.

Another recommendation is changing the ratio of indirect tax measures to direct support for R&D intensive companies by permitting all companies to qualify for refundable tax credits, regardless of ownership. This would provide incentives for Canadian and American companies to continue R&D in Canada and would involve establishing a pre-commercialization tax credit for product development work beyond purely R&D which would be administered through NRC’s Industrial Research Assistance program (IRAP). A controversy has emerged over whether it is appropriate for Canadian taxpayers to fund R&D projects in which the ownership of some of the corporations may not be Canadian-owned. But the funding for IRAP support of young tech company R&D work is frequently challenging without the range of expertise and investment required to complete the project. Supporting the full range of research for technological innovation if it is undertaken in Canada makes far more sense than some Canadian firms being unable to complete critical R&D or pre-commercialization projects at all. This is of particular importance in smaller provincial and municipal jurisdictions where the number of qualified players may be more limited.

Those involved in the increasingly integrated development environment required by Canadian firms to effectively respond to today’s rapidly changing market opportunities agree that the status quo is unacceptable. The problem is not that substantially more funding is required. Instead we need a coherent and collaborative policy framework that will encourage Canadians to lead as creators, innovators and adapters of next generation technologies. In Canada, we don’t need to reinvent the wheel to achieve our planning goals.  We already have much of the necessary road maps, blueprints and strategies to begin our travel to this destination.

Government Must Support the Tech Sector

Published in the Telegraph-Journal 9th January 2012

A confounding paradox exists in the tech sector. Over the last twenty years, the combination of exponentially greater computing power, the decreasing cost of application development and a greater recognition of the value of information technologies has supported a steady demand for technology software and hardware. For users both corporate and consumer, the rewards have been greater agility, speed and efficiency over a wide range of products such as telecommunications, automotive and productivity-enhancing applications. Consumer electronics have greatly increased in functionality while prices have come down across the board. Corporations have marshaled improvements in enterprise resource planning, data mining and quality management to reduce overall costs and speed to market.

But at the same time, major challenges have created an uncertain future in many of Canada’s high-tech communities. In 2007, Ottawa-Gatineau’s tech sector employed more than 70,000 according to Statistics Canada data. But by 2011, the number of high-tech jobs in that region had declined to below 44,000, a fall of almost 40 per cent. It’s true that the Kitchener-Waterloo Technology Triangle region experienced an employment boom in recent years, but that hiring binge has ground to a halt with the instability at Research In Motion. Hiring forecasts have become more conservative in Toronto, Montreal, Calgary and Vancouver. The troubling downturn in tech futures is mirrored in the U.S. where large firms continue to perform well but where the good news increasingly is a reflection of their off-shore holdings.

The global credit crisis did not help. Beginning in 2007, the financial crisis stifled borrowing and equity financing; a shortfall of sufficient investment to finance ambitious growth is a recognized factor in the lackluster expansion in the sector. The high-flying Canadian dollar has not been helpful for many export-oriented firms. Many of the jobs that have been lost have been transferred to lower cost locations such as China, India, Brazil and Korea. In the last ten years, these countries have also significantly ramped up capabilities in design, architecture and engineering so that they essentially have become equal to all but the most sophisticated. Capabilities have become ubiquitous.

Outsourcing has become a common practice among tech companies and many of the manufacturing and basic engineering jobs that have been sent overseas are unlikely to return. So even in the event that the sector regains momentum, it may not be able to create jobs in Canada in the same numbers as before.

New models of competition are beginning to emerge on the horizon in which the biggest unknown variable is the role of government. These models are based on the recognition that, for many companies in the tech sector, it’s becoming more difficult for many companies to produce proprietary products. Large companies such as IBM, HP and Microsoft are a few of a dwindling number that can afford the total development cost of their product line, including process research and development. Increasingly, the new models of competition recognize that the total cost of development can be so great that support from government is required to ensure a stable environment for the participants. One of the critical factors of success of the tech sector in China is the role of government in promoting infrastructural stability, even if that support frequently has been crude. However, in Canada and the U.S., there is only a dim awareness of the fundamental conditions that make the interdependence between corporations and government necessary.

In the face of mounting challenges, the tech sector is at a crossroads. To succeed, we will need to answer the question of the role that government must play in fostering the retention and growth of the industry such that Canadians obtain the full benefits of the country’s investment.

Which Promises to Keep?

Published in the Telegraph-Journal 3rd January 2012

Election campaigns in many ways are all about promises. Promises to reduce taxes, improve service delivery of health care and education, repave roads and fund economic development strategies are the cornerstones of political speeches calculated to win voter support. More recently, campaign promises have also begun to focus on reducing debts and deficits. Not all of these promises can peacefully co-exist with one another in the same room.

In March, Finance Minister Blaine Higgs in his government’s first budget eliminated a number of small government agencies and authorized budget reductions to school districts, municipal grants and rural health care. Even so, the provincial deficit is now estimated to reach more than $545 million in 2011-12, $100 million more than Higgs had forecast in March and New Brunswick’s debt will rise to more than $10 billion by the end of this fiscal year. Higgs has placed the blame for the growing deficit on reduced revenues from personal income tax, lotteries and liquor sales. He has also been openly critical of some of his cabinet colleagues’ inability or unwillingness to subscribe to the cost-cutting agenda.

After two quarterly reports showing that the deficit was not yet under control, highway tolls have resurfaced as a potential means of generating revenue. This is a key concession for a political party that campaigned fiercely against tolls in 1999. The promises to put a full court press on the deficit and debt have placed into jeopardy some commitments that carry expensive price tags. A key pledge from government’s election platform to permanently freeze seniors’ property tax assessments for all homeowners over 65 has been shelved as too expensive.

The harsh realities of debt have pushed the government into a corner and have forced it to take extra measures to arrest the fiscal slide. Higgs is looking seriously at “every revenue” in every department and every line item.

One of the most obvious and hotly debated sources of revenue is increasing the HST by 2 per cent to bring it to 15 per cent. A widely accepted estimate for the amount of this revenue is approximately $250 million per year so the total revenue of the 2 per cent increase would be approximately $750 million for the balance of this government’s current mandate. For a government that recently announced it was pulling 21 snowplows from roads and reducing staff and salt use in an effort to save $4 million, the additional HST revenue source is a significant one. As a consumption tax, the HST is inherently progressive and various contingencies can be put in place to ensure protection for seniors and the financially disadvantaged.

There are increasing questions whether a key obstacle to increasing the HST is a technical one. The Taxpayer Protection Act, introduced by the Bernard Lord government in 1999, requires a referendum for any new tax, toll or increase in the HST. To save money, this referendum could piggyback on the infrastructure of the municipal elections slated for May 2012. If this is too soon to condition voters to arguments on either side of the referendum, a standalone referendum may be necessary.

No one wants to pay more taxes. And there is a near-consensus that we need to increase the effectiveness and efficiency of government. The election campaign promise to not increase the HST does matter. But right now, other things matter more. We do need to ensure that our debt is growing more slowly than our tax base. But most critically, we need a major increase in government revenue to get us out of our fiscal trap and the promise to hold the line on the HST is standing in the way.

The Republican Campaign to Capture Your Imagination

Which Republican candidates will be working as Fox commentators later this year? It’s a fair question given that a substantial number of the candidates appear to be more suited to work in the entertainment industry than standing for office. And we’re not talking about the documentary category. We’ve already lost Bachman and Cain and Palin has declined to play, but one suspects that we will still be holding our sides from laughter before its over. Nominate the candidate of your choice for the television program most appropriate to him/her today!

Students are not blind to markets

IT industry analysts have argued that firms increasingly are finding it difficult to recruit cross-trained professionals who are skilled in technology and possess business expertise. This is due in part to an almost 40 percent drop in computer science enrollment in the U.S. since 2002, according to industry analysts and in part that the entire market crashed in 2008 because of the financial crisis and has still to recover.

Universities, corporations and government should not expect students to be ignorant of the market. If the industry collapsed contributing to a decline in enrollment a year later, that is not a problem for students. But it would be a problem if students continued to enroll without any jobs on the horizon. Corporate recruiters say they want cross-trained professionals who understand IT, business and markets. However, would they really want to recruit individuals who make their life career decision without taking the employment market into account?