The Branch Plant Economy

The term Branch Plant Economy is not a new one, and gained specific relevance for Canada in the early 20th Century, when US Companies began to build factories in Canada to circumvent pricey tariffs on importing their wares to the Canadian market. One example where this really took hold is the automobile manufacturing industry, centered in Ontario, that has churned out Chevys and Chryslers, among other makes, for both Canadian and foreign markets.  

While NAFTA destroyed the tariffs that caused these plants to be set up in the first place, Big Auto successfully lobbied the Ontario and Federal governments for subsidies and tax credits that helped their north-of-the-border plants remain cost-effective, and in some ways cheaper to operate, than their US counterparts. That lobbying strategy has been highly successful, and while it was overshadowed by the US auto industry bailout, the Ontario and Federal Government bailout of Canada’s auto industry was $3.3 billion, nearly 20% of the proposed US bailout package in 1998.

The Canadian auto industry typifies the modern idea of the branch plant economy. The term really grew legs in the 1960s and 1970s during a rise in Canadian economic nationalism, and fears that our country was becoming a U.S. Protectorate as a cause célèbre during Trudeaumania.  Most of the rhetoric around this idea is centered on the not-so-great visage of a nation whose factories (literal and metaphorical) and workforce are wholly owned and commanded by foreign companies, with the profits and fruits of their labour remaining largely overseas.  For economists, this is tantamount to the surrender of the nation’s sovereignty. If your paycheque in Canadian dollars is signed by a US-based company you are likely keenly aware how much command and control of your company’s destiny resides this side of the border.

In a white paper from the Canadian Advanced Technology Alliance, the organization argues that our country’s philosophy on innovation is all wrong.  On that point I couldn’t agree more. The CATA argues that while we have many programs in place to fund R&D, whether it’s the soon-to-be-reformed SR&ED or the NRC’s IRAP program, we have none in place which explicitly helps our countrymen reap the benefits of this R&D through commercialization.  The white paper suggests that the effect of this more than $7Bn/year in R&D subsidy spending is for taxpayers’ money to act as a stimulant to profitability outside of Canada’s borders.

Why?  Because funding the research without funding commercialization leads to a familiar story for those of us in the technology scene: the flip.  Canada’s venture financing having been anemic as it has during the past ten years, Canadian companies chasing great ideas have had to bootstrap, scrape, and starve their way forward—typically leading early investors and founders to the mutual desire to sell the business early.

Many of us, myself included, bemoan that while some great products and technologies have emerged from Canada (such as Flickr or BumpTop or Radian6) we typically fail to commercialize these in scale until they are purchased by a US entity.  Certainly these companies’ (mostly Canadian) investors are happy—since Flickr went to Yahoo!, BumpTop to Google, and Radian6 to Salesforce at sizeable bumps in valuation—but the profits generated from these innovations will be realized by a US entity, and in most cases the workforces don’t even remain in Canada.

A pessimist’s way to evaluate those three deals, presuming that they all claimed SR&ED / IRAP / CNMF money at some point in their evolution, is as the Canadian taxpayers in effect assuming R&D risk to the benefit of US companies and, arguably, a handful of investors.  In other words, much like the film and video game industries, not to mention the automobile manufacturing business, Canada’s tech industry functions as a Branch Plant Economy at worst, or as the equivalent of a Junior A hockey league at best.

The CATA advocates that the SR&ED program be reformed in a few trivial ways and, using the savings, that the subsidy be expanded to support commercialization activities associated with innovation. This is an interesting idea and worth the read.  On the other hand, having read the tea leaves I believe that the government’s position is that if it’s supporting the R&D component, the investment community is incentivized to fuel commercialization.

However, this is clearly not how things are going down in practise. Next to RIM, or previously Nortel, Canada can boast very few large-scale domestic tech industry successes. Anecdotally there are as many examples of global companies, such as Lululemon, which were built in Canada without any form of subsidy as there have been tech giants facilitated by giant R&D grants.  Across the border programs like SR&ED and IRAP are unheard of, though the US Government has subsidized a great many technologies via DARPA and NASA.

And startup veterans such as myself frequently argue that Canada’s SR&ED, IRAP, and CNMF funding strategies represent a rare advantage over founding and operating a technology company in Silicon Valley—so long as they are well-run programs and do not overburden startups with oversight and administrivia.

As for our neighbours to the south, it may simply be that proximity to their more free-flowing investment economy and greater density of large tech-oriented businesses (not to mention a market 10x the size) is too much of a temptation to resist for fledgling Canadian tech ventures.  Perhaps our nationalistic pride is a whimsical relic of the past, and we should instead just stop worrying and learn to love the bomb.

Does the CATA solution of subsidizing the commercialization, and not just the R&D component, of new technologies carry water for Canadian tech startups? Maybe. Does it open up SR&ED to even greater abuse by recipients who do not require it? Probably. Is there anything we can do to mitigate the prevailing trend of Canada’s tech industry as a Branch Plant Economy? You tell me.

Image: Courtesy The Henry Ford Museum (cc).