Remarks by Sylvain Leduc
Deputy Governor of the Bank of Canada
Sherbrooke Chamber of Commerce
Sherbrooke, Quebec
October 3, 2017
Seeking Gazelles in Polar Bear Country
Introduction
You are probably all familiar with the inventor of the snowmobile,
Joseph-Armand Bombardier. He was from the Eastern Townships of Quebec and
he merits a place in our history books just as much as Maurice Richard and
Félix Leclerc.
You may be less familiar with Montréaler Arthur Sicard, who also had an idea
that had a profound impact on the Quebec and Canadian economies. Born in
1876, Sicard spent his childhood working on the family farm. He was often
prevented from delivering milk in the winter because of the snow blocking the
roads. Observing combine harvesters at work in the fields in summer gave him
an idea for a snowblower. Sicard's invention was launched in 1925, and the City
of Outremont bought the first model two years later. The snowblower not only
improved the lives of city dwellers by making car travel easier in winter, it also
had a major and unexpected impact on Canadian economic activity, facilitating
winter road transport between Montréal, New York and Toronto.
When we think of innovation, we think of people like Sicard and Bombardier, who
start from scratch, invent new products or processes, and create companies that
soon become drivers of the economy. These innovators help increase our
productivity.
In recent decades, advanced economies have experienced a sharp decline in
productivity growth. This trend is worrisome because, in the long run, productivity
growth determines the evolution of our standard of living. To give you an idea of
how much it matters, last year Canadians would have earned an additional
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$13,000 if our productivity had increased at the same pace as seen in the late
1990s.1
And since productivity determines the level at which the economy can operate
without creating inflationary pressures, understanding its evolution in an
inflationtargeting regime like ours is vital to us at the Bank of Canada.
Economists who are studying this trend are naturally asking whether there are
fewer innovators like Bombardier and Sicard today than in the past. They are
also trying to explain why productivity is weak in all advanced economies.
To answer this question, we have to look beyond the usual macroeconomic
indicators and examine the innovation process at the firm level.
Today, I would like to highlight some of the major trends in firm behaviour that
have given rise to vigorous debate among economists. First, I will describe how
the data point to declining dynamism in the Canadian economy. I will then offer
some possible explanations for this trend and will review how dynamism and
other factors affect economic growth. I will conclude by briefly discussing the
implications for monetary policy and achieving our inflation target.
Declining Dynamism
Let's start with a simple intuition: in a dynamic economy, innovative companies
are expected to emerge and replace companies with older business models.
Think of Sicard, whose invention clearly brought huge long-term benefits but also
led to job losses, especially the jobs of workers who cleared roads using
horsedrawn snowplows.
As such, a strong and dynamic economy should be driven, in part, by the entry of
new firms and the exit of less-viable firms.2 This renewal involves a needed
reallocation of labour toward growing industries.3 This dynamic process of
innovation was called "creative destruction" by the economist
Joseph Schumpeter in the 1930s.
Data collected by Statistics Canada show that there has been a surprising and
sustained decline in the entry rate of new firms since the early 1980s. Relative to
total active firms, the entry rate of new firms was 24 per cent in 1984. It has
decreased by half since then, which is a considerable drop (Chart 1). The firm
exit rate has also declined-but by less-from almost 17 per cent in 1984 to
about 11 per cent, according to the most recent data.
The decline in entry and exit rates is also reflected in the weaker rate of labour
reallocation.4 For the past 10 years, new firms have created fewer jobs than
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before. Simply put, the data seem to point to a loss of dynamism in the Canadian
economy.
This decline in dynamism is especially striking because it is broad-based. It can
be seen in almost all industries and across the country, showing up, for example,
in rates of entrepreneurship (Chart 2). This trend has also appeared in most
OECD countries.
Chart 1: Aggregate entry and exit rates of new firms have been declining
Aggregate entry and exit rates, annual data
%
25
20
15
10
1984 1988 1992 1996 2000 2004 2008 2012 2016
Entry rate Exit rate
Sources: Bank of Canada calculations using data from Statistics Canada's Longitudinal Employment
Last observation: 2016
Analysis Program. For the year 2016, quarterly firm creation data were used.
Chart 2: Chart 2: Rates of entrepreneurship have declined in all regions
Rates of entrepreneurship by region, annual data
%
0.6
0.5
0.4
0.3
0.2
0.1
0.0
Canada Quebec Ontario Atlantic region Prairie region British Columbia
1981 1990 2000 2014
Source: Bank of Canada calculations using data from Statistics Canada's Labour Force Survey
Last observation: 2014
The main concern about a loss of dynamism is that it will lead to less innovation
and diminishing long-term growth. The estimated potential growth rate of the
economy is about 1.5 per cent, adjusted for inflation. Compared with previous
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decades, when potential output sometimes rose to more than 3 per cent per
year, this is a significant drop.5 And this is the context in which the loss of
dynamism must be considered.
Back to the Source
To better understand the possible effects of a loss of dynamism, we need to
understand its causes-a more difficult task than it sounds. Some leads are more
promising than others. The fact that we see this loss of dynamism not only in
Canada but also in most OECD countries suggests that its causes are not unique
to Canada and that there may be common factors.6
A first factor to consider is population aging. The younger you are, the more likely
you are to become an entrepreneur and start your own company.7 The appetite
for risk is perhaps more intense when you have less to lose and the expected
benefits are spread out over a greater number of years. However, our data show
that the rate of entrepreneurship has dropped for all age groups. Indeed, we
even see that the decrease in entrepreneurship is greater among people aged
25 to 44.8 So population aging can explain only part of the decline in
entrepreneurial activity.
On the other hand, this decline may be because emerging entrepreneurs face
greater opportunity costs than before; that is, the shortfall in income they would
suffer if they quit their job to launch their company is now higher. In fact, since
the 1980s, the most significant decrease in entrepreneurship rates that we've
seen has been among those whose wages have increased the most; namely,
university graduates.9 New technologies, which often benefit those with more
technical skills, have likely contributed to this trend.
In many cases, these new technologies also generate significant economies of
scale and network effects that lead to greater industrial concentration, in turn
leading to a loss of economic dynamism. On the one hand, the expectation of
positive benefits is what encourages business innovation. On the other hand, if
the largest companies constantly increase their share of the market, it is
increasingly difficult to compete with them.10
In fact, industrial concentration figures are quite astonishing. In the United States,
industrial concentration since the early 1970s has increased in 75 per cent of its
industry sectors. There are now fewer US firms listed on the stock exchange than
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there were 40 years ago, while US GDP is three times higher.11 In line with this
trend, markups in several industries have been steadily increasing over the past
three decades.12 Here in Canada, the rate of industrial concentration is
historically high. Estimates from economists at Innovation, Science and
Economic Development Canada tell us that the median concentration of
Canadian industries in the early 2000s was about 75 per cent higher than in the
United States.13
The economies of scale and network effects in several sectors put new firms that
produce at higher costs at a disadvantage. You must be very optimistic and have
a great deal of confidence in your business model to launch a retail business
these days, when giants like Walmart and Amazon are making life difficult for
established companies. For example, with its diverse network of producers,
Walmart can change its source of supply to minimize operating costs a lot more
easily than a newly launched company can.14
However, the effects of concentration and declining entry rates on innovation and
productivity are not unequivocal. Many large companies use leading-edge
technology and are pushing boundaries as never before-such as the firms
developing self-driving cars. Today, large companies know that they must
continually invent new products or services to stay one step ahead of their
competitors. A good example of this is Apple, with the introduction of its iPhone
in 2007 and the different versions the company has introduced since then.
Dynamism and Potential Growth
Competition is therefore essential to innovation and can certainly come from
established companies. But the possibility of new companies revolutionizing an
industry encourages established firms to innovate. Viewed in this light, the loss of
dynamism could be symptomatic of a decline in innovation and long-term
productivity, paradoxically during a period when technological advances seem to
be increasing exponentially. Indeed, this question may warrant further
investigation so that we better understand which new firms are most likely to
contribute to growth.
Statistics show that the shelf-life of new companies ranges between two
extremes. About half of firms close their doors within five years of their creation.
But younger companies that do make a name for themselves tend to grow very
rapidly. It is this propensity to grow by leaps and bounds that inspired the term
"gazelle."
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These young, transformative companies that are growing at dizzying speeds
have a good chance of developing new technologies that increase productivity.
However, the impact of innovation on productivity is difficult to assess.
Breakthroughs in robotics, artificial intelligence or financial technologies are
phenomenal, but are still not reflected in our productivity measures at the
national level And the impact of an innovation is very uncertain, which
(Chart 3).
is why many new companies go bankrupt after only a few years. Predicting
whether an innovative company will revolutionize markets is just as risky as
guessing if a first-round choice in the hockey draft will become a new superstar
goalie like Carey Price. Most of the time, you get another very ordinary player.
Chart 3: Labour productivity has slowed in Canada and the United States
Labour productivity growth, annual data
%
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
Canada United States
1984-1994 1995-2004 2005-2015
Source: Statistics Canada Last observation: 2015
Nevertheless, among OECD countries, firm productivity is operating at two
speeds. Firms at the cutting-edge of technology-big guns such as Google and
Tesla-are three to four times more productive than other companies.15 Given
the declining dynamism we are seeing, this gap is not being reversed by the exit
of less-productive firms, which probably feel less need to adopt cutting-edge
technology. These firms therefore contribute to reducing national productivity. In
this context, encouraging the adoption of new technologies is essential.
Given that about a quarter of productivity growth is driven by innovations from
new firms, gazelles play an essential role, particularly in the high-tech sector.16
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So it's worrying that the share of gazelles in the Canadian economy has declined
markedly since 1997 (Chart 4). Surprisingly, we see this decline in the
information and technology sector.
Chart 4: The rates of entry of both new firms and gazelles have declined
Index: 100 = 1997, annual data
Index
110
90
70
50
30
Entry rate of new firms Gazelle rate
Note: The entry rate of new firms is obtained by dividing the number of entries by the average total number of firms in the previous and current year. Gazelle rate is
defined as the number of gazelles divided by total number of firms.
Source: Custom tabulation from Statistics Canada's Longitudinal Employment Analysis Program Last observation: 2012
That said, the entry and exit rates of new firms also follow the business cycle,
and the Canadian economy has performed a lot better than expected over the
past five quarters. For example, productivity has increased significantly since
mid-2016, especially in the goods sector. It is also encouraging to note that the
most recent data show that the rate of entry for new firms appears to have
stabilized over the past few quarters (Chart 5).
The economy's growth rate is expected to decline over the next few quarters, but
it should still exceed that of potential output. We therefore expect an increase in
entry rates and a decline in business exits over the coming quarters.17 Moreover,
the contribution of new firms to increasing the productive capacity of the
economy could give rise to a virtuous circle of growth.
For the Bank, understanding how the productive capacity of the economy
evolves is crucial. Indeed, our monetary policy is based on the fact that the rate
of inflation tends to stabilize near our target of 2 per cent when the economy is
running at capacity. When the economy operates at a level higher than potential
output, inflation tends to accelerate and, conversely, decelerates when the
economy operates below its potential output. An increase in productive capacity
resulting from new firm creation would therefore allow the economy to grow
faster without creating inflationary pressures. In concrete terms, higher potential
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output would lead to a long-term improvement in the standard of living of
Canadians.
Chart 5: The rate of entry for new firms may have finally stabilized
Four-quarter moving average, quarterly data
%
4.0
3.5
3.0
2.5
2007Q1 2008Q1 2009Q1 2010Q1 2011Q1 2012Q1 2013Q1 2014Q1 2015Q1 2016Q1 2017Q1
Source: Bank of Canada calculations using Statistics Canada's quarterly firm creation data Last observation: 2017Q1
Conclusion
In recent quarters, Canada's economic growth has been strong, exceeding that
of all the other G7 economies. The sharp depreciation of the Canadian dollar
following the drop in oil prices may have contributed to the growth of gazelles by
facilitating access to external markets and increasing the benefits of greater
economies of scale. What I find encouraging is that, despite the decline in
dynamism, the sectoral adjustment required as a result of the fall in oil prices
happened within the anticipated time frame. This episode shows that the
Canadian economy is still flexible enough to absorb a major shock.
That said, significant challenges remain, as our productivity is still well below that
observed south of the border.18 Productivity growth could certainly be increased
by reducing the barriers that future gazelles may face, which would further
stimulate the Canadian economy. A report from the World Bank notes that
Canada is one of the easiest countries in which to start a business.19 On the
other hand, it is nevertheless more difficult for businesses to grow beyond a
certain point, possibly because of the size of our markets. The free trade
agreement with Europe is an encouraging example, because it can help our
gazelles grow. Here in Canada, the agreement signed earlier this year on
reducing barriers to interprovincial trade is also a good sign, although several
areas are still excluded. In addition, new gazelles are likely to have more difficulty
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financing intangible investments, which they increasingly need, than tangible
investments, which, unlike the former, may be offered as collateral.
I would be remiss if I did not mention a Sherbrooke initiative that is addressing
these challenges. I'm talking about Sherbrooke Innopole, an organization
dedicated to accelerating business development in five new areas. In
collaboration with the city, Innopole three years ago founded Espace-inc, a
business incubator whose results have exceeded initial expectations. So far, it
has helped launch 24 companies.20 Similar initiatives are under way elsewhere in
Canada. We hope they will be successful and that they will help entrepreneurs of
the calibre of Sicard and Bombardier to emerge.
In the meantime, the best contribution the Bank of Canada can make in this
regard is to promote economic stability by keeping inflation at 2 per cent, thereby
facilitating investment decisions.