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CHAPTER ONE
GOVERNMENT AND SME PERFORMANCE IN THE WORLD ECONOMY

GLOBALIZATION AND CANADIAN SMEs

The "globalized economy," which has rapidly developed during the latter half of the 20th century, is characterized by substantial capital formation, fostered by the transborder operations of large, multinational enterprises (MNEs). This process has gained momentum especially since the mid-1980s with the generally increased liberalization of international trade and instantaneous capital movements and the rapid advances in technology, especially in communications, transportation and information processing. As a result, MNEs, international organizations, national governments and SMEs have all found their environment transformed. The interlinking of national economies, coupled with the changing conditions for the creation of wealth, and the growing competition between economic actors have created significant challenges and opportunities.

Canadian firms find themselves in a period of what commentators refer to as a "paradigm shift" in which this country's comparative advantage in wealth creation is evolving from one heavily dependent on resource extraction into one which is increasingly dependent upon the acquisition and creation of knowledge-based industries and the application of their products throughout the economy. In broad sweeping terms, the Canadian economy traditionally relied upon an endowment of abundant natural resources and exports by firms (especially multinational enterprises) of relatively unprocessed commodities. The Canadian economy used to be "protected" from outside competition by tariffs and other barriers to trade, while relying upon multinational firms (especially US-based) to gain access to the largest markets in the world. It should also be noted that Canadian secondary manufacturing was preponderently under foreign (particularly US) ownership. The implication of this economic structure was a low demand and investment for research and development, ambivalence towards the development of a broad base of entrepreneurship and management skills and a general focus on creating strong financial institutions concerned primarily with the preservation of existing wealth rather than with investing to develop new sources of wealth.

The trend toward globalized markets is likely to continue because of liberalized trade and increased capital movements, innovation through technological advances and the global outlook by an increasing number of firms. In this environment, countries less well-endowed than Canada with natural resources can nevertheless create a comparative advantage for themselves with a skilled workforce, innovative and innovating businesses, an infrastructure of modern, reliable communication and transportation networks, and public sector policies and programs designed to create, attract and maintain investment capital.

CHANGING MARKET ENVIRONMENT FOR SMEs

SMEs have not generally been favoured by this fast-paced changing environment. Broadly speaking, the liberalization of trade through successive rounds of the GATT and the emergence of continental-sized regional free trade areas (i.e., European Free Trade Agreement (EFTA), the European Community/Union, the North American Free Trade Agreement, (NAFTA)) have tended to favour MNEs which, because of their size and resources, are better able to adjust to new challenges and take advantage of new opportunities. The emergence of efficient, relatively lower cost producers in the Pacific, South East Asia and Latin America has further sharpened the competitive environment for SMEs at home and abroad.

Before the Kennedy Round of the GATT (which, on average, cut industrial tariffs by35 percent between 1967 and 1971), SMEs were sheltered by relatively high tariffs in Canada. SMEs tended to subcontract with larger manufacturing or processing operations (e.g., the automotive industry), or to establish a domestic market niche in protected sectors such as textiles, footwear, furniture, white goods, electrical equipment and appliances, machinery and machine tools, and stationery and printing. Depending on domestic success, SMEs then ventured into export markets, particularly in the United States and in Commonwealth countries, given the proximity in the first case and preferential access in the second. Globalization has transformed this environment and increased the challenges faced by SMEs.

With the end of postwar reconstruction in Western Europe, the proportion of Canadian exports to those markets, including SME exports, began to decline. This development has been accentuated by the UK's accession to the European Community (EC) and by its successive enlargement from six to nine, then 12, and now 15 member states. To compete effectively in the vast market of over 400 million people, US, Japanese and Canadian companies have had to invest and establish operations inside the EC, which offered many location incentives, particularly in economically disadvantaged areas. This has been an environment in which large enterprises have had a distinct advantage.

At the same time, faced with protectionist forces in the United States, large Japanese and European firms established themselves inside that market, an option not usually available to SMEs. The bureaucratic paperwork and prohibitive legal costs of defending in antidumping or countervail cases, combined with a process that involves delay and uncertainty, create conditions which effectively discourage foreign SMEs from entering certain US markets and industries.

It is unclear whether the creation of the Department of Industry in 1963 and of Industry, Trade and Commerce in 1968 and the alphabet soup of industrial and support development programs have contributed significantly to the ability of SMEs to compete successfully in world markets. The Foreign Investment Review Act, building upon the experience of the Auto Pact, was designed to require foreign investors to couple their offers with undertakings to ensure significant benefits to Canada such as employment, R&D, transfer of technology and, where applicable, exports. Many SMEs fell below the capital assets and employment thresholds of the full review process so as to benefit from these undertakings. They were virtually exempted from review subject to Cabinet approval. Hence, there were several takeovers, particularly of SMEs specializing in high technology and computer technology (e.g., Mitel). Moreover, with the establishment of Investment Canada in 1984, the "significant benefit" undertakings were virtually dropped.

With the advent of the electronic revolution, the explosion of information technology and the expansion of user and related services industries, the market environment has changed dramatically. Through mergers, MNEs are becoming larger, more efficient and highly competitive. The international rationalization of their operations, greater vertical integration and the emigration of firms to larger markets within regional free trade agreements (Western Europe and North America) have further eroded the competitive stance of SMEs.

In response to these developments, Canadian SMEs are increasingly focussing on the global market for their goods and services. They look on markets outside of the national border as both a target and a source of competition abroad as well as in the home market. As David Killins of Legacy Storage Systems stated, "We don't view foreign markets differently from our own domestic Canadian market." (66:2) This is especially true in the knowledge-based, high-tech industries where high up-front costs and economies of scale preclude focussing sales efforts only on the domestic economy. Paul Russo, President of Genesis Microchip, noted that "any participant in the microchip industry must have a global focus. Canada represents less than two percent of the world electronics market and, for us of course, less than two percent of our sales." (66:7) William Friend of ATS Aerospace Inc., commenting more generally on knowledge-based industries, noted that "Canada's domestic market is minuscule as compared with the United States. Canadian companies must export to survive" (submission, p. 7). Participation in the world economy is, therefore, recognized by Canadian exporters in the knowledge-based high-tech industries as essential to their success.

WHY IS GOVERNMENT CONCERNED ABOUT SMEs?

Because they matter: they are becoming agents of growth, innovation and job creation.

Just as Canadian companies and Canadian exporters have determined that they must reengineer and adapt themselves to the imperatives of the global marketplace, the public sector too is examining the priorities and principles upon which it determines where, when and how it carries out its activities. In doing so, policy makers are not only questioning how their actions affect the national economy, they are also examining how their actions affect the international competitiveness of Canadian businesses and their ability to participate in the global marketplace.

Government has traditionally been more concerned about larger companies. As the Report of the Standing Committee on Industry, Taking Care of Small Business, pointed out:

Over the last 50 years. . . economic, industrial and technology policy has been oriented towards the needs of big business, reflecting a view that equated largeness with economic strength and growth. Large size implies economies of scale, higher productivity, and increased sales both at home and abroad. As multinationals extended their operations into more and more countries, they were generally regarded as crucial to national economic growth, prosperity and even sovereignty.3
Why has it become important to focus on SMEs? A number of interrelated factors help to explain how SMEs have moved up on the political agenda. Chief among them are the linkages between international business development and Canada's external economic policies throughout the postwar period. Another important factor is the increasingly significant role that SMEs are playing in the creation of employment.

SMEs as the engine of economic growth

A growing number of studies suggests that SMEs are playing an increasingly crucial role in economic growth and job creation. A 1995 report released by Statistics Canada4 assessed the relative importance of SMEs to the Canadian economy:

Small and medium-sized enterprises are an essential component of the Canadian economic system. In recent years, they have come to account for a larger and larger percentage of total employment. Between 1978 and 1989, firms with less than500 employees increased their share of employment from 56 percent to 63 percent. To some extent, this is the result of an increase in the importance of the service sector relative to the manufacturing sector. Firms in the service sector are on average smaller than in manufacturing; however, even in manufacturing, small firms have been increasing in importance in a large number of industries. The greatest change has occurred in manufacturing industries where new flexible technologies have been introduced.
Small firms then form the dynamic backbone of the modern economy. Nevertheless, small firms are regarded as being vulnerable and subject to the vicissitudes of the business environment. Large firms are often considered to have the ability to ride out difficult economic times and even to be able to influence the environment that affects them. Small firms are seen to possess certain innate advantages that are offset by critical failings.
Another recent Statistics Canada study focussed on job creation for both the entire Canadian economy and the manufacturing sector over the 1978-1992 period. The authors of this study concluded that the net growth rate of employment is higher for smaller than for larger firms.5

In its most recent report on the profile of SMEs in the Canadian economy,6 Industry Canada concluded the following:

Despite this increasingly important role of SMEs in the Canadian economy, relatively few of them are successful exporters. A number of studies indicate that fewer than150 Canadian companies are responsible for more than two-thirds of all Canadian exports in any given year. A policy imperative would be to broaden and diversify the base of Canadian exporters so that the economy is not heavily dependent upon the activities of a few companies. The accepted belief is that large companies are capable of fending for themselves in the international marketplace and that a greater priority should be placed on assisting Canadian SMEs.

Linkages between trade policy and trade development

SMEs must operate within a complex framework, increasingly affected by international and domestic institutions and the interplay between the two. Of particular interest here are federal government policies and programs intended to promote international trade and foreign government policies and programs which inadvertantly inhibit access by Canadian firms to foreign markets.

In such an interdependent world, governments attempt to manage the level of integration of the domestic economy in the world economy through the establishment of bilateral, plurilateral and multilateral institutions and agreements. The Canadian government's approach since the beginning of the postwar era has been to pursue an activist trade policy based on three key objectives:7

These general objectives have been pursued along five broad fronts by:

In the pursuit of these objectives, the Canadian government has played an active role throughout the postwar era in multilateral trade negotiations under the GATT. These negotiations have led to a significant reduction in tariff levels, the elimination of some non-tariff barriers to trade and the development of trade rules and dispute settlement mechanisms. Canadian barriers to international competition were lifted further by the implementation of the NAFTA on January 1, 1994 and the Uruguay Round Agreements under the GATT, followed by the establishment of the World Trade Organization (WTO) one year later.

Under both agreements, tariffs and non-tariff barriers to trade are further reduced or eliminated. They also provide rules governing trade in services, intellectual property rights, and investment as well as improve dispute settlement mechanisms. The NAFTA represents generally a more accelerated version of the trade liberalization established by the WTO agreements. The NAFTA also includes provisions in a number of areas (e.g., financial services) that the WTO does not cover as comprehensively. Worthy of note is the fact that the WTO reduces by roughly 40 percent the tariff preferences that the United States had provided to Canadian exports and the preference that Canada provided the United States under the FTA and now NAFTA.

Both agreements will further encourage, if not force, companies to adjust to international competition and become even more integrated into the world economy. By opening up new markets for Canadian goods while at the same time allowing greater access for foreign competitors in the Canadian market, these agreements will likely lead to companies citing "survival" as an increasingly important determinant of their export strategy. At the same time, the literature suggests that firms will increasingly adopt a "niche market" strategy, seeking to exploit the advantages of specialization in a more open globalized economy.

Many witnesses expressed concern about how international trade agreements are opening up the domestic economy to foreign competition. Additionally, the reduction and elimination of tariffs have given rise to a regulatory environment of non-tariff barriers. At the same time, foreign markets are sometimes very difficult to enter because larger companies use trade actions as a threat to any new entrants into the market. This is becoming increasingly prevalent as tariffs are being eliminated and are exposing domestic industries to greater international competition. The concern is that only large companies have the resources to challenge foreign competitors either in domestic courts or through international dispute settlement mechanisms. Indeed, many large firms view the costs of these challenges as just another cost of doing business. For SMEs, such actions can be a serious challenge.

The federal government has recognized that in order for Canadian companies to take advantage of the opportunities represented by more liberalized trade and investment regimes, the nature of the support of and by trade commissioners must change. Canada in the World, the federal government's most recent statement on Canadian foreign policy objectives and priorities, states that trade commissioners will place more emphasis on explaining and providing advice to exporters on Canada's international trade rights and obligations, particularly as they relate to market access:

. . . There will be less emphasis on providing commercially available information, and more on the exercise of our international trading rights (pursuant to the WTO and NAFTA, for example) and on state-of-the-art market intelligence gathered through Canadian embassies and consulates abroad.8
In one of the more comprehensive studies of Canada's international business development programs, Andrew Griffith,9 a foreign service officer and former trade commissioner, argues that closer trade policy and trade development linkages are both possible and desirable. He suggests that:

Trade policy and trade development may have different styles. Trade and investment development is entrepreneurial, activity-driven and results oriented. Trade policy is bureaucratic, process-driven and incremental. Yet this distinction is becoming less relevant as the requirements of our business clientele become more sophisticated. Trade development, particularly in OECD markets, requires `applied' trade policy; our market intelligence and advocacy roles are more and more required to deal with market access and related trade policy issues than before. Trade development is no longer trade promotion - organizing trade fairs and missions, identifying distribution and marketing channels - but must, as more and more trade commissioners realize, address institutional and other barriers that have traditionally been considered the preserve of trade policy practitioners.

THE INTERNATIONAL BUSINES
DEVELOPMENT INDUSTRY IN CANADA

International business development is well established and growing because the exigencies of competition are forcing companies of any size to consider, react to and capitalize on change within the globalized economy. The industry is growing especially around SMEs because it is they who, relative to larger corporations, have to look outside their organization for specialized advice and financial assistance.

In this industry, government and the private sector work both independently of and in cooperation with each other in serving the needs of potential and existing SME exporters. The industry is dominated by large established players, but their position and level of expertise is being challenged by a growing group of smaller, more specialized firms that are able to provide a range of innovative services to the internationally-oriented SME. The larger players (e.g., governments, banks, insurance firms) are attempting to reorient and reengineer their marketing efforts from a strictly large-company focus to a broader definition of "clients" or "customers" to include SMEs. The smaller players (e.g., NORTHSTAR Trade Finance Inc., Millenium, Prospectus Inc., 11 Corinfo, the Progress Payment Program at the CCC, the SME Exporter Team at EDC) have focussed on specific niches that were either previously not being served by the private or public sectors, or have emerged as a result of changes in technology, the rise in the role of information in overall company strategy and other competitive factors. In many cases, these smaller service players are getting all of the attention because of their narrow focus and specific service or mandate, while the larger players attempt to carve out for themselves a role that is sustainable and provides lasting value. At the same time, all of these service providers are continuously faced with an environment of constant change in which new competitors with different approaches to the same basic business problems are emerging to challenge their hold on a specific slice of the market. And because of technology, the low cost of communication, and other fundamental changes that are taking place, this new competition can come just as quickly and as effectively from halfway around the globe as it can from across the street.

Another important current feature of this industry is that government programs and services are increasingly competing with the private sector for customers, while benefiting from certain cost advantages (e.g., no taxes, access to capital at lower rates and lower overheads). Nevertheless, as Millenium President Ron Doyle, a risk and credit insurance broker, explained, when he looks for the right price for customer on export financing, he looks not only to EDC but also to Canadian, and increasingly foreign-based, financial services firms. Sometimes the EDC bid is the best; sometimes he recommends a private company to his client. To him, EDC is just one of many potential suppliers of credit.

The same phenomenon is taking place in the market intelligence industry. Firms like Prospectus Inc., 11 Corinfo and InfoGlobe are taking the raw data that is available from government or in the marketplace, repackaging it, and then selling it, not only to private companies but also back to government itself. At the same time, technology advances and the information highway are making access to information from around the world almost instantaneous. When an SME needs market intelligence, therefore, there are a large and growing group of service providers to consider. And even if DFAIT and its trade commissioners provide these services at no cost, SMEs are weighing the value of the service relative to those services it can get from the private sector. Sometimes DFAIT is the most useful source; other times, the SME turns to a private service provider.

DFAIT is also finding its programs and services frequently overlap with those offered by other levels of government. The proliferation of international business development programs at the municipal and provincial levels has been a function of the tremendous liberalization of trade over the last thirty years and, as a result, an exponential expansion of export trade. It is becoming clear that as a result of these two developments, provinces and municipalities have become increasingly skilled in trade development and, therefore, better able to service SMEs. There are suggestions that the federal government should withdraw from services and programs that were needed fifty years ago, but which are now provided by provinces and municipalities. However, federal services and programs may still be required for the smaller provinces.

Between the private sector and government is a growing group of trade associations and other nongovernmental organizations. NGOs are unique in that they receive funding from both the private and public sectors for different activities. As a result of their non-profit status, these organizations operate on a different cost structure basis that allows them to undertake activities that a profit-oriented firm could not consider. Trade associations in particular have traditionally provided a bridge between the private and public sectors, acting as a representative voice of a particular group in the private sector and as a sounding board for different policy options. Trade associations can provide services that neither the private sector nor the public sector can deliver in the same kind of way because they attract people who are interested in and want to be involved in public policy issues while placing them in an organization and environment free of government bureaucratic procedures (e.g., ministerial responsibility).

There seems to be a growing convergence toward this kind of model for the delivery of international business development programs and services. The Forum for International Trade Training (FITT) is one of the more recent manifestations of this. FITT started out as a coalition of government departments, trade associations and private sector companies which acted together and made financial and in-kind contributions to establish a national certified program in practical international business training. Started in 1992, it is expected to be self-financing in 1996.

Governments are also increasingly establishing mechanisms for greater private sector input into the mandate and operation of international business development programs and services. For example, while this Committee, as part of its mandate for this study, has been probing some of the issues raised by the Special Joint Committee Reviewing Canadian Foreign Policy, it has also focussed its attention on the recommendations made in the Wilson Report, which got its name from L.R. Wilson, the CEO of BCE Inc. who chaired this private sector review of international business development programming. The Committee also heard from the cities of Calgary, Toronto, Montreal and Kitchener about the role of private sector representatives in their international business development activities. Both federal Crown Corporations that were investigated during this study - the Export Development Corporation and the Canadian Commercial Corporation - have public and private sector representatives actively involved in the direction of their activities through membership in their boards of directors.

WHAT IS GOVERNMENT DOING FOR SMEs?

The Minister of Foreign Affairs and the Minister of International Trade (and since early 1996, the Minister for International Cooperation) are responsible directly for a number of individual trade development programs and one (formerly two) Crown Corporations that provide services to assist Canadian companies to succeed in international markets:

The Committee focussed its review on the specific assistance for SMEs that is available from each of these departments or agencies. For example, in the case of the EDC, the Committee reviewed the effectiveness of the Emerging Exporter Team (EET) and the Master Accounts Receivable Guarantee Program (MARG), but did not investigate the Corporation's activities that are directed toward larger companies. The EET was established specifically to address the export financing needs of SMEs; the MARG is an initiative sponsored by the EET to assist SMEs in securing greater access to export financing.

Budget allocations

Appendix 1 provides a series of charts to explain the allocation of program funds for international business development. Chart 1 provides a five-year breakdown of the budgets for the IBD Branch, the Export Development Corporation, the Industrial Cooperation Program at the Canadian International Development Agency (CIDA Inc.), and the Canadian Commercial Corporation. Chart 2 shows Vote 1 funds (used by posts abroad for programming) between 1994-95 and 1997-98. These are funds that will be administered under the newly-created Program for International Business Development (PIBD). This envelope was recently created to combine a number of smaller programs into one coordinated program. These smaller programs include: Program for Export Market Development-Government Initiated (PEMD-GI); World Market Trade Development (WMTD); Access to North America (ANAP); Investment Development Program/Technology Inflow Program (IDP/TIP); National Trade Strategy (NTS); Post-Initiated Projects (PIPP); and Going Global (GG). The budget allocated for this envelope is projected to decline from $32.589 to $15.157 million over the 1994-98 period.

Chart 3 shows Vote 10 funds (allocated, with various pay-back provisions, to firms and other organizations to advance the international business development objectives of the department) in 1995-96. Allocations under headings of Economic Policy, Trade Policy, and Political Affairs are considered trade-related policy funds, not business development per se. The chart also includes, from the previous chart, the allocation of Vote 1 funds on a single line for comparison and consistency.

PRELIMINARY CONCLUSIONS AND RECOMMENDATIONS

Since 1993, there have been a number of internal and external reviews of the federal government's international business development activities. With respect to external reviews, the Special Joint Committee Reviewing Canadian Foreign Policy and the Wilson Report made a number of recommendations to the government about international business development programming. These were followed by a response by the federal government to the Review and the release of Canada in the World, an official government statement on Canada's foreign policy objectives and priorities. Since the release of these reports, a number of committees, task forces, and other activities have been launched to respond to these recommendations.10

These official statements, reviews, and new initiatives indicate a clear shift away from general financial assistance and toward a more service-oriented focus with a specific emphasis on SMEs. In evaluating this change in orientation, a number of questions arise: Is DFAIT asking the right questions? Are government services complementing what is available in the private sector? Or is government competing with Canadian firms? Has government successfully shifted its emphasis from providing financial assistance to large, well established firms to focussing on providing services to SMEs which frequently have very little experience in the international marketplace? And, most importantly for this inquiry, do these initiatives respond to the needs of SMEs?

The Committee heard from a number of SMEs from five different sectors of the economy and from all regions of the country. Generally speaking, the Committee received mixed reviews of the federal government's international business development programs. Some witnesses have had very good experiences, while others were less than enthusiastic. There was general agreement that further measures should be taken to coordinate programs and services, streamline operations and reduce overlap and duplication. There was also general agreement that government should limit itself to providing services that are not available in the marketplace but which are necessary to assist SMEs internationally. At the same time, there was a general sense that expectations are too high about what government can deliver effectively, and that government programs and services should be more focussed and targeted at those activities that are not available, particularly at competitive rates, in the private sector. Indeed, it was those government services that satisfied a specific market niche such as the MARG Program and had a clear sense of purpose that generated the most positive responses from SMEs.

The federal government needs to define still more clearly its role in international trade and business development. The Committee recommends that any review of the government's role be guided by the following principles:

  • Programs and services should be focussed primarily on SMEs, in particular to SMEs that are ``new entrants'' into international markets;

  • The government's principal role is to stimulate and facilitate, not to subsidize;

  • Government programs and services should supplement and complement private sector providers rather than duplicate and compete with what is made available by the provinces, municipalities and the private sector; and

  • Government programs and services should be adapted to the specificities of each province, region and economic sector

    The next three chapters examine what SMEs have identified as their specific needs in developing successful international business development strategies. Each chapter describes the main federal government programs and services that are available to address these needs, what the witnesses said about their relative effectiveness, and the conclusions that can be drawn about appropriate roles for government in assisting SMEs in the international business development strategies.

    3Taking Care of Small Business, Report of the Standing Committee on Industry, October 1994 p. 2.

    4Statistics Canada, Strategies for Success: A Profile of Growing Small and Medium-sized Enterprises in Canada, (Ottawa: Government of Canada, 1995, Catalogue 61-523E).

    5Have Small Firms Created a Disproportionate Share of New Jobs in Canada? A Reassessment of the Facts, G. Picot,J. Baldwin and R. Dupuy, Statistics Canada Research Paper Series, No. 71, 1994. (In this study, small firms were defined as having fewer than 500 employees.)

    6Small Business in Canada: A Statistical Overview, Entrepreneurship and Small Business Office, Industry Canada, December 1994.

    7Michael Hart, What's Next: Canada, the Global Economy and the New Trade Policy, (Ottawa: Centre for Trade Policy and Law, 1994), p. 4.

    8Department of Foreign Affairs and International Trade, Canada in the World: Government Statement, (Ottawa: DFAIT, 1995), p. 20.

    9Andrew Griffith, From a Trading Nation to a Nation of Traders: Toward a Second Century of Canadian Trade Development, DFAIT: Policy Planning Staff Paper, No. 92/5, p. 77.

    10For a list of these initiatives, please see Appendix 2.

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