Canada's Economy Beyond the Year 2000

Head Table Guests

Duncan N.R. Jackman, Managing Director, Fulcrum Investment Corporation and a Director, The Empire Club of Canada; Donald C. Lowe, Chairman, Sedgwick Ltd. and Vice-Chairman, Magellan Aerospace; Yuri Chumack, OAC Student, Humberside Collegiate Institute; The Reverend Vic Reigel, Christ Church, Brampton; Hazel McCallion, Mayor, City of Mississauga; Peter Smith, President and CEO, Aerospace Industries Association of Canada; John Clappison, Regional Senior Partner, Metro Toronto, Pricewaterhouse Coopers; Peter Pauly, Professor, Economics and Business Economics and Associate Dean, Joseph L. Rotman School of Management; Andre Hidi, Co-Chief Executive Officer, Saloman Smith Barney Canada; and Kenneth B. Rotman, Co-President and Managing Director, Clairvest Group Inc. and a Director, The Empire Club of Canada.

Introduction by George L. Cooke

The Empire Club is pleased to welcome as guest speaker today, Mr. David Caplan. Mr. Caplan is Chairman and CEO of Pratt & Whitney Canada, a Canadian corporation and a subsidiary of United Technologies Corporation of Hartford, Connecticut.

Pratt & Whitney was founded in 1928 by Montreal businessman James Young and today is one of the largest members of Canada's aerospace community and the world's leader in its class in the design, development and production of gas turbine engines.

The company is the second-largest private investor in research and development in Canada. Pratt & Whitney employs more than 9000 people in four Canadian provinces (Quebec, Ontario, Nova Scotia and Alberta).

Mr. Caplan was born in Montreal. He obtained his Bachelor of Commerce from McGill University in 1961 and became a Chartered Accountant in 1963. He articled for Riddell, Stead & Co., Chartered Accountants, from 1961 to 1964. He joined Pratt & Whitney Canada in 1964 where he has been involved in increasingly important finance and management functions. He was named Vice-President, Finance and Administration in 1976, Executive Vice-President in 1980, President and CEO in 1984, and has been their Chairman and CEO since July 1994. Additionally in 1994 he was recipient of the Canadian Aeronautics and Space Institute C.D. Howe Award. Mr. Caplan will outline his perspective as to Canada's economic prospects and priorities for the next millennium, making the case for a greater focus on the knowledge-based industries that will help distinguish successful nations from also-rans.

Mr. Caplan, welcome to The Empire Club of Canada.

David Caplan

I'm honoured and pleased by the opportunity to address such a distinguished audience and I hope to utilise this venerable Empire Club podium to spark some meaningful dialogue about Canada's future economic prospects.

The theme of my remarks today, as advertised, is "Canada's Economy Beyond the Year 2000." Given the recent volatility of stock markets, the depressed Canadian dollar and the financial world in general, a more prudent choice of topic might have been "Canada's economy next week." Nevertheless, I intend to adhere to my original script and share some views about where I think we're headed--or more to the point--where we ought to be headed, as Canada approaches the threshold of a new millennium.

The turbulence and uncertainty clouding the near-term outlook serve only to underscore the key issue I wish to raise regarding our economic prospects for the next century, namely, the urgent need for Canada to continue to become less dependent on commodities and betterknown for its world-class technology and know-how.

It's true that--at roughly 35 per cent--commodities account for a much smaller share of Canada's overall exports than they once did. However, we still rely on a sizable surplus in the commodities category to offset our habitual deficits in the trade of services--a fact not lost on the international financial community. Like it or not, Canadians still tend to be tagged with the "h" word, as in hewers of wood. Along with the Scandinavians and Australians, we are perceived as being overly dependent on exports of commodities--a view reflected rather vividly these days in the depressed value of the Canadian dollar.

The fact of the matter is that the slump in global commodity markets, magnified by the Asian crisis, has severely affected Canada's recent GDP performance. In fact deflation in commodity prices has been a reality for nearly two decades. And judging by the anemic economic numbers we're seeing of late, it's evident that our knowledge-based and high-tech sectors simply don't have sufficient critical mass to make up the shortfall even though our biggest customer for manufactured goods, the U.S., is still growing.

Canada has already been teetering on the edge of recession, recording four consecutive months of negative growth through the summer. The economy regained some vigour in the most recent period, but I think there is a general consensus that we are headed for a slow-down. Indeed, the possibility, if not probability of an outright recession in the next 24 months is greater today than was anticipated just a few months ago.

At any rate, the recent deterioration in business conditions gives companies and countries alike cause to review their strategies. And, frankly, looking further down the road, I see a continuing strategy of over-reliance on commodity exports becoming even more of a problem for Canada in the knowledge-based global economy of the new millennium. More and more of the world's commodity needs will be satisfied by third-world countries as well as Russia.

The world we'll see as the new millennium unfolds is going to look very different from the one we know today--especially in terms of the division of wealth. As Canadians, we belong to the fortunate 14 per cent of the world's population that live in industrialised countries and control 76 per cent of the world's wealth. But over the next 20 years or so, when those troubled Asian tigers regain their teeth--as they surely will--and the economic development of Russia, China and India accelerates, there is going to be a significant shift of purchasing power to emerging economies.

Today, world GDP is about $30 trillion. According to DRI, a respected U.S. economic forecast group, it will increase to $107 trillion by 2017. What is more interesting is that 20 years from now, more than half of the world output will be produced by today's emerging countries, up from less than 25 per cent currently. Over the next two decades, several billion people who currently bear the "have not" tag in terms of economic status will become consumers of the products and services that will still come mainly from industrialised nations. I know this scenario may appear to be premature, but those estimates are supported by demographics, technology and strong fundamental trends.

Here is another interesting take on the DRI study.

Some 80 per cent of today's world GDP has been generated since World War II. It took us 50 years to get to the current $30 trillion. During the next 20 years, we will add $77 trillion to world output--over three times the total wealth created over the last half century. This unprecedented growth will bring huge opportunities in manufacturing and high-tech exports, a sector that usually creates the best jobs.

From a strategic perspective, countries wanting to be key players in this new era of wealth-creation should be taking steps now to ensure they have the appropriate policies and strategies in place. In Canada's case, I would suggest that entails putting a greater focus on the knowledge-based, advanced technology industries which will help distinguish successful, industrialised nations from also-rans in the new world order beyond the year 2000. As the Conference Board of Canada concluded in a major report a year or so back, "Innovation is the only means by which a high-wage economy can sustain its competitiveness and ensure growth and employment."

Speaking of advanced technology industries, it might be appropriate at this point to give you a brief sketch of my own company so that you know where I'm coming from. Pratt & Whitney Canada is part of Hartford-based United Technologies Corporation. UTC's businesses include Pratt & Whitney's U.S. operations, which produce engines for military aircraft such as the F-15 and F-16 fighters and for large commercial jets such as the Boeing 747, 777 and Airbus aircraft. Other members of the UTC corporate family include Otis Elevators, Carrier Air Conditioning, Sikorsky Helicopters, UT Automotive and Hamilton Standard.

Our Canadian roots go back 70 years to 1928, when the company was founded to provide support services for U.S. built Pratt & Whitney engines. In 1951, the Canadian unit began to manufacture piston engines under license, a typical branch-plant arrangement. Then, in the late 1950s, Pratt & Whitney Canada launched its own gas turbine, design-and-development programme that resulted in the PT6 turboprop--the company's first family of homegrown turbine engines.

The rest, as they say, is history. With some 9,500 employees worldwide--including 1,000 at our facility in Mississauga--Pratt & Whitney Canada is now the world's leading manufacturer of small and medium-size gas turbine engines for the aviation industry. We have a unique world-product mandate to design, develop, manufacture, market and support engines for business aircraft, helicopters, regional transports, military trainers and utility aircraft. Since 1964, we have delivered more than 45,000 engines and it is estimated that every two seconds an aircraft fitted with Pratt & Whitney Canada engines takes off somewhere in the world.

Pratt & Whitney Canada has become the global market leader, with a 30-per-cent-plus share in the sectors where we compete, against giants the likes of General Electric, Rolls Royce, Allied Signal and others. Despite the fact that practically every engine we compete against is heavily subsidised through government ownership or military procurement to a degree simply not attainable in Canada, we have managed to more than double our worldwide market share since the mid-80s.

Our success going up against the world's best in a very tough business can be directly attributed to our sustained commitment to research and development. Over the past decade, we have invested nearly $2.5 billion in R and D at our facilities in Quebec and Ontario. Investments of that magnitude make us the R and D leader in Canadian aerospace and we rank second only to Nortel among all Canadian companies in R and D spending.

Pratt & Whitney Canada's 1997 and 1998 R and D expenditures of over $400 million per year equated to more than 20 per cent of sales--double the norm in our industry and far above the 1.5-percent average for Canadian manufacturers. Looking at things from another perspective, our company last year accounted for almost one-third of the Canadian aerospace industry's total investment--and over 4 per cent of all private R and D investment in Canada. So, to use the vernacular, we do put our money where our mouth is when it comes to preaching the virtues of R and D.

Although we plan to reduce our R and D efforts somewhat in coming years, we expect our R and D investment will be about 15 per cent of sales on average, still well above the norm for our industry. However, like other members of the aerospace industry, we will not be able to sustain investments of that magnitude indefinitely without an appropriate level of government participation. That is why the aerospace industry has been calling for an increase in government repayable investment--a need that has grown increasingly urgent. I said repayable because the entire participation of the Canadian government in the Technology Partnerships Canada programme is repayable through royalties. In fact, without any further investments by government in R and D projects, we would still be committed to repaying government for its past contributions for the next 15 to 25 years. These payments are in the form of royalties that will continue for the entire life of the engine production programmes. Government partnership remains critical to the long-term success of our industry in Canada. Without it, we will not be able to compete on a level playing field with U.S., Europe and other countries. That will inevitably push one of Canada's major high-tech sectors into decline, at least in terms of R and D investment as well as value-added work, a reality we are already experiencing in the aerospace industry. I'll come back to this later.

Back in 1959 it was a combination of Pratt & Whitney Canada's R and D efforts and the federal government's investment in the PT6 engine programme that facilitated our entry into the gas-turbine era and ultimately made us the number-one manufacturer of small gas turbine engines in the world. Similarly, it was our ambitious R undertakings way back in the late 1980s and early 1990s that seeded the big gains in sales and market share we've achieved in recent years. In 1998, we will achieve a record $2 billion in sales. And we remain very optimistic about the next few years. This continued growth in sales generates a lot of wealth for Canadians in different ways. First, we employ over 8,000 people in Canada. Secondly, we purchase some $500 million in goods and services from more than 3,000 Canadian suppliers and finally, P and WC's activities generate something like $500 to $600 million a year in tax revenues for federal, provincial and municipal governments in Canada.

Average weekly earnings of workers in Canada's aerospace sector are well above the average for all Canadians and I believe the situation is similar in most other high-tech sectors. What's more, advanced technology industries also employ a disproportionate number of highly paid technical and professional staff. These are some of the reasons why it is so important for Canada to have high-tech industries like aerospace. The high-growth economic activity, the high-quality jobs and substantial tax revenues derived from such industries are critical to generate the wealth required to fund our health-care and education systems of the future.

In addition aerospace, which consistently ranks as this country's leading high-tech export sector, has become an increasingly important generator of export earnings for Canada. Aerospace is the only Canadian high-tech industry that consistently makes a positive contribution to Canada's trade balance.

However, I am concerned that we don't have sufficient critical mass in our high-tech sectors as we enter the next millennium. Indeed, an OECD analysis goes so far as to suggest that Canada suffers from an "innovation gap." Consider, for instance, that only 14 per cent of Canada's manufacturing sector qualifies as high-tech, compared to 24 per cent in the United States. The OECD also found that Canada ranked dead last among G-7 countries in terms of its rate of productivity growth over the past 15 years. The gap between Canada and its main economic partner, the United States, is significant and explains part of our loonie troubles. What's more, we continue to lag all other G-7 nations save Italy in terms of percentage of GDP spent on research and development.

These numbers should be a concern for Canada's economic future, when one considers that productivity growth and innovation are prerequisites for long-term competitiveness and rising incomes. And I'm not certain the picture will improve quickly, unless we take some very deliberate action on a national scale to create and sustain an environment more conducive to innovation.

Appropriate fiscal, tax, education, human-resource and regulatory policies are all key components of such an environment. In some of those areas, Canada stacks up quite well against the competition. In others, there is ample opportunity for improvement.

Elsewhere, Canada compares favourably with other G7 countries in terms of having an exceptionally well-educated population. One of the challenges we face, though, is to maintain that enviable status in the post2000 world, where higher education and specialised training will be more crucial than ever before. Although Canada leads all OECD nations in terms of total spending on post-secondary education as a percentage of GDP, we're nonetheless faced with a scarcity of financial resources to support the system.

Ensuring a proper level of financing for the education system is a top priority. But then we also have to develop the proper environment and opportunities for our expensively educated young people. A combination of high Canadian taxes and superior job prospects--with remuneration in U.S. "greenbacks"--is already luring large numbers of graduates south of the border.

To create adequate opportunities for our educated people will require that our private sector make a greater commitment to innovation than the less than two-percent-of-R and D-to-sales ratio I noted earlier. Sustained, long-term success in the global marketplace cannot be achieved unless Canadian companies are prepared to allocate more of their resources to research and product development--even if that entails foregoing some short-term profits.

However, in many cases--aerospace being one--the private sector can't do it alone. We need an ongoing commitment from Ottawa to support vital research and development in order to help level the playing field for Canadian high-tech players of all stripes in their struggle to win--and hold--an increased share of world markets.

Ottawa this year allocated a total of $250 million to Technology Partnerships Canada, its principal programme for the support of innovation in knowledge-based industries such as environmental technology, biotechnology as well as aerospace. Significant as that may be in the Canadian context, it pales in comparison with the level of support available from governments where current and future competitors for a bigger share of the global pie are based.

Back in the 1989-90 fiscal year, Ottawa allocated some $300 million for strategic assistance to the aerospace sector under the old Defence Industry Productivity Program or "DIPP," as it was commonly known. Flash forward to fiscal 1998-99, and you'll find that the aerospace industry's share of this year's allocations from Technology Partnerships Canada, the successor programme to DIPP, is only $166 million. In 1989, the government's $300 million accounted for 25 per cent of the total $1.2 billion invested in R and D by the aerospace industry. Today, the $166 million invested under the TPC programme represents only 11 per cent of total R and D investments. Not surprisingly, the Canadian aerospace industry has developed an increased number of partnerships with major subcontractors, which partly explains why spending in R and D has not kept pace with sales growth and has resulted in a serious decline in Canadian value-added work.

Despite substantial sales increases, Canadian value-added has slipped from 66 per cent of sales back in 1995 to 54 per cent today, on an industry-wide basis. That is more than a 10-per-cent decline in just four years and I believe it reflects the sharp reduction in government R and D investment. The trend will continue if nothing changes.

Like I said, the need to develop a knowledge-based economy has not been lost on places like the U.S., Europe, South Korea and Japan, even during these difficult times. If rival nations offer an environment more conducive to innovation, one could logically conclude that R and D which otherwise would be undertaken here will go elsewhere. This will serve to increase the "innovation gap" between Canada and other industrialised countries, and lead to a further decline in the proportion of Canadian R and D and value-added in our aerospace sector.

If nothing changes, Canadian aerospace firms will continue to be aggressively pursued by foreign suppliers and partners who, backed by financial support from their governments, are able and willing to share the risk in new Canadian programmes.

It's not as if we aren't capable of playing in the big leagues, or that Canadian know-how doesn't measure up. The aerospace industry's experience offers tangible proof to the contrary. Over the past five years, we have grown at triple the rate of Canada's GDP and passed Japan to become the world's fifth4argest player in aerospace, trailing only the U.S., the U.K., France and Germany. What's more, the lion's share of our sales are exports--some 80 per cent of the forecast.

Fifteen billion dollars plus in 1998 sales will go to foreign customers. And I'm confident that--given the proper environment--Canada's other knowledge-based industries can equal or match that sort of winning performance.

It was at a forum, not unlike this one, back in 1904, that Sir Wilfrid Laurier uttered his famous--"The 20th century belongs to Canada." Perhaps Sir Wilfrid overstated things a little bit. But we do have a truly marvellous country, which holds every bit as much promise today as it did at the turn of the previous century. However, if we are to realise that tremendous potential as we move into the 21st century, we must strive to ensure that this country becomes recognised around the world as much for its know-how and highly skilled people as for its natural resources. Only then will Canada and Canadians be assured of their rightful place in the knowledge-based, global economy and maintain its position amongst the wealthy nations of the world.

Thank you very much.

The appreciation of the meeting was expressed by Kenneth B. Rotman, Co-President and Managing Director, Clairvest Group Inc. and a Director, The Empire Club of Canada.