Canada-U.S. performance gap in innovating, exporting and controlling global value chains has deep historical roots

Canada’s poor performance compared with the United States in innovating, exporting and controlling global value chains has historical roots going back centuries, according to a study by a University of Waterloo researcher.

Initial institutional differences – linked to the different ways each country separated from British colonial rule and subsequent historical events – set the two countries’ economies on distinct paths, says the study by Dr. Horatio M. Morgan, PhD, (photo at right) associate professor of international strategy and entrepreneurship, in the Conrad School of Entrepreneurship and Business at UWaterloo.

The U.S. historically started with and adopted more classically liberal mercantilist institutions than Canada, whose initial British mercantilist institutions were more restrictive than America’s, Morgan argues. American companies and the U.S. government were not as historically anchored to the British mercantile system.

“This initial institutional disparity is associated with American firms’ nationalistic and profit motives, plus their early attempts to organize and lead global value chains,” he says.

“Canada’s underperformance problem is partially a byproduct of prior institutionally induced path dependencies that still separate it from the United States today.”

Morgan’s study, “An Integrative Institutional Framework of the Canada-U.S. Performance Gap,” is published in Canadian Public Policy journal. He describes his study as a synthesis of existing research perspectives into an overarching institutional framework.

Research has shown that Canadian companies innovate and export less than their American peers, and generate lower returns from such activities, the study says.

The average Canadian exporter, compared with the average American exporter, generates a smaller unit value (profit margin or value added per exported unit), and on a smaller scale (export volume or quantity) and scope (the number of export markets, own-brand exports, or export varieties).

“These insights point to a business underperformance problem: Canadian companies are neither undertaking nor profiting from innovation and export activities at levels that can put Canada on the highest sustainable growth path,” Morgan says.

If Canadian companies have historically struggled to enter or organize superior global value chains in non-primary industries, “this problem could become more severe” as American and other global corporate leaders leverage disruptive information and communication technologies to reorganize global production, trade and investments through digitized global value chains, according to Morgan’s study.

For example, Apple, Microsoft, Google and Amazon in the U.S., along with Tencent and Alibaba in China, Samsung in South Korea and SAP in Germany, can digitize global value chains by deploying big data, advanced technologies (such as cloud computing, software as a service, artificial intelligence, and machine learning), or global digital platforms (global two-sided or multi-sided marketplaces).

Such companies can transform global value chains by modularizing or automating production processes, generating more tradeable services, and tracking performance.

Given globally leading multinationals’ control over global value chains, and the historical integrative institutional framework underlying the Canada-U.S. performance gap, “it is reasonable to ask whether and how Canadian businesses can perform even better in global markets,” Morgan says.

U.S. pursued a more business-friendly environment

Although Canada and the U.S. shared English colonial origins, unforeseen historical events – such as Britain’s colonial taxes and navigation laws and the American Civil War – drove self-reinforcing sequences of different institutional choices resulting in divergent economic paths in each country, according to Morgan’s study.

American businesses historically made more efforts than Canadian businesses to internationalize and innovate in a business-friendly U.S. environment. This environment was characterized by features such as a market-friendly patent system, lax enforcement of anti-trust laws, and debtor- or entrepreneur-friendly bankruptcy laws.

Essentially, the U.S. “tolerated less predictable or more extreme inequalities in exchange for accelerated industrial expansion and global dominance,” Morgan contends.

Canada, in contrast, had a historically strong preference for a hierarchical political economy, particularly manifested in a hierarchical class system (a landowning or gentry-like class that was historically superior to the merchant class).

“Although this political economy preference promised predictable and stable inequalities, it might have undercut Canada’s economic dynamism and long-term growth,” Morgan says.

The type of political economy Canada chose could mean that Canadian businesses were subjected to more substantial and enduring restrictions on the nature, scale and scope of their commercial activities compared with American businesses, he says.

 In contrast to early American companies in the post-independence era (after the American Revolutionary War ended in 1783), early Canadian companies in the pre-independence period (up to the 1931 Statute of Westminster that finalized legal separation from Britain) were more externally confined to the production and export of low-margin staples to Britain.

Given the staple-based interests of Canada’s early elites and the country’s staple-driven financial system, Canadian businesses could have been more unwilling and unable to compete in emerging high-potential secondary or tertiary industries (such as merchant shipping, telecommunications, automotive and electronics) on a global scale, Morgan says.

Also, America had more debtor-friendly or business-friendly corporate laws much earlier than Canada, he notes. The U.S. banned debtor prisons and officially adopted less punitive or more failure-tolerant bankruptcy laws and limited liability provisions than Canada before the mid-nineteenth century. Canada, in contrast, virtually operated without a federal Bankruptcy Act between 1867 and 1919.

These legal disparities point to a protracted period of inadequate debtor protection and stigma in Canada compared with the U.S., Morgan says. “Thus, bankruptcy or business failure could have initially exposed Canadian entrepreneurs and executives to relatively high personal or psychological costs.”

For instance, he says, Canadian entrepreneurs and business leaders could have suffered from elevated stress or depression as a result of social isolation in jails, diminished social status, and the stigma of financial imprudence or moral failure, combined with high financial costs – including forgone future earnings due to imprisonment plus the loss of private assets to settle unpaid debts with creditors or investors on unfavourable terms.

“Moreover, these psychological and economic costs could have significantly tempered risk-taking and forward-thinking business strategies among early Canadian business leaders.”

Canadian business leaders probably had more to gain from “strategic continuity,” or strategically leveraging pre-existing staple trade and relations, than from the “strategic change” practised by American leaders of industry, Morgan says.

Canadian strategies in U.S.-controlled global value chains

Given the historical patterns in each country and the insights provided in previous research, it is important to reevaluate what appears to be purely rational Canadian strategies in U.S.-controlled global value chains, Morgan says.

It makes a difference if Canadian businesses primarily specialize in upstream activities, such as supplying raw materials or intermediate goods, in global value chains led by American multinational corporations, according to his study.  

If Canadian companies are predominantly upstream specialists in U.S.-controlled automotive global value chains, an equilibrium featuring low Canadian business innovation or U.S.-mediated global expansion seems reasonable, Morgan says.

“For instance, Canadian entrepreneurs or companies could reasonably favour incremental process innovations over radical product innovations or indirect exporting through U.S.-controlled global value chains rather than direct exporting in global markets.”

Morgan argues that if Canadian entrepreneurs or companies generate valuable intellectual property in the form of patents, they could – given the U.S.-controlled global value chains –rationally favour short-term IP monetization strategies (such as immediate payoffs from the outright sale of patents to American firms) versus long-term IP commercialization strategies (such as generating new or improved products through globally scaled companies).

Morgan says these and other seemingly rational strategies could partially reflect the enduring distortive effects of two historical factors in the Canadian context: (a) prior excessive “psychological anchoring in,” or commitment to, the British mercantile order; and (b) the potentially diminished capacity for strategic change due to prior limited opportunities to learn and deploy long-term business strategies in the past.

Canadian business leaders and the Canadian government have long been “psychologically disincentivized” from pursuing long-term business or national strategies that could challenge the established economic order, whether under British or American hegemony in the nineteenth or twentieth century, respectively, he says.

“Under these conditions, Canadian business leaders could be more susceptible to institutionally induced myopia [e.g. favouring short-term payoffs rather than longer-term investments] in contemporary global value chains than their American peers.”

Lessons from the rise and fall of Canadian global companies

There are lessons to be learned from the spectacular rise and demise of earlier global Canadian companies, such as BlackBerry and Nortel, in non-traditional industries such as electronics and telecommunications, Morgan notes.

BlackBerry operated as a vertically integrated global company from the time it advanced from a two-way pager to the BlackBerry smartphone in 2003, to the peak of its operations around 2011. The company primarily designed, produced, marketed and sold its own smartphone devices, which used its closed operating system.

However, Apple would release its first iPhone in 2007, eventually overtaking BlackBerry. In contrast to BlackBerry, Apple has controlled an electronics global value chain. Although Apple has been primarily responsible for design, marketing and sales functions in the U.S. market, its global value chain partners (Toshiba in Japan, Infineon in Germany, and Samsung in South Korea) have been producing key components that are eventually assembled abroad and re-exported to Apple under contract trade.

Unlike Blackberry, Apple has also operated as an anchor firm in a large ecosystem of independent app developers who can collectively grow to its operating platform by introducing new apps, Morgan says. “In other words, Apple has derived a sustainable competitive advantage from organizing and leading a platform-driven or digitized smartphone global value chain.”

Canadian firms currently in the information and communication technologies industry could face new challenges as global value chains with American anchor firms become more digitized in the twenty-first century, he warns.

There is an established group of global Canadian tech companies (such as CGI, Open Text, and Shopify) alongside global upstream specialists in the automotive industry (such as Magna International and Linamar Corporation), among other non-primary industries.

“One important thing to explore is how enduring [and historical] institutional barriers could undermine their potential to enter, organize or lead digitalized global value chains,” Morgan says.

Under changing market dynamics, he says, the underlying risk is that Canadian executives or entrepreneurs could inadvertently undermine their companies’ potential for functional updating and value appropriation in superior global value chains. “As a result, the gap in Canada-U.S. business performance could be even more persistent and wider than it would otherwise be.”

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