The Lay of the Land: Prospects for Improving Financial Competitiveness

Alberta’s financial sector has not grown to match the province’s overall rise in economic importance to Canada. From 1997 to 2022, Alberta’s population rose from 2.5 to 4.5 million and Alberta’s share of GDP rose from 11 per cent in 1997 to 14.9 per cent in 2021. Alberta’s financial sector, 14.7 per cent of Canada’s in 1997 and 15.3 per cent in 2022, barely budged. A dynamic and efficient financial sector sustains long-term economic growth by allocating savers’ money to the highest value-added capital investments. These are usually innovations — either product innovations (making more or more valuable products from given inputs) or process innovations (making given outputs from less or less costly inputs). Either way, innovation adds to overall wealth by letting firms create more from less, the definition of productivity growth. Themore accurately the financial system allocates savers’ wealth, the faster standards of living, government tax bases and GDP can rise. Various national and subnational governments throughout the world have enacted policies aimed at boosting productivity growth by better directing capital to its highest value uses, especially to finance innovation. These policies can be divided into two classes. The first class of policies are direct government interventions. These are often counterproductive, at best ineffective, and successful only under unique conditions which do not prevail in Alberta. Government can directly subsidize corporate R&D, industrial policies and business research programs, but has proven bad at picking winners and at keeping politics out of such decisions. Postwar industrial policies financed reconstruction in Europe and Japan, but rebuilding is fundamentally different from sustained long-term productivity growth. Otherwise, government interventions of this sort have near-perfect failure rates. Some governments seek to boost economic activity by becoming “tax havens” — that is, by attracting businesses’ head offices with low tax rates. In general, this requires only a small office, or even just a post office address, in the tax haven. Tax havens are usually microstates with tiny populations, so small tax revenues from each of many notional head offices fund their small governments well. However, the strategy works less well for larger economies, such as Alberta. The largest tax haven, Ireland, boosted its GDP substantially, but only because national income accounting includes in its GDP the global sales of firms notionally headquartered there. Ireland’s GDP rose; its standard of living did not. Moreover, international agreements to penalize tax havens heavily are coming into force, and Canada’s interprovincial equalization program would likely reallocate any excess tax capacity Alberta gained. Other governments seek to boost economic activity by “regulatory arbitrage” — that is, adopting laws and regulations that help firms avoid the laws and regulations of other jurisdictions. The U.S. state of Delaware has tailored its financial regulations, tax laws and other laws and regulations to gain revenue from incorporation and other business fees. Delaware lets firms claim the state as the place of their legal incorporation, even though their functional head offices and facilitiesare elsewhere. One reason firms like Delaware is that its laws can be used to stop corporate takeovers. This can be economically destructive because takeovers can rejuvenate badly governed firms, but the consequences of corporate misgovernance need not affect Delaware. Regulatory arbitrage can induce a “race to the bottom,” in which jurisdictions outbid each other for fees by offering ever laxer laws and regulations. This often ends badly, as when Forbes magazine labelled the BC stock exchange the “scam capital of North America.” Small stock issuers had liked the BCSE’s lax regulations, but investors did not and the failing exchange was folded first into the Alberta Stock Exchange and later into the TSE Venture exchange. The second class of policies require more effort, patience and wisdom, but often work. These have government focus on its core competences to improve the “lay of the land” to attract productivity-enhancing economic activity. This happens where governments provide public goods and services that people and firms deem worth the taxes. For example, Delaware has expert economists vet its laws and regulations and vets its judges for their knowledge of economics. Consequently, Delaware courts provide uniquely economically literate resolutions of business disputes. To the extent that this, rather than legal and regulatory laxity, attracts companies, no race to the bottom ensues. Alberta might do likewise. The two major U.S. high-tech hubs, Silicon Valley and Cambridge, are in California and Massachusetts, respectively — both relatively high tax states. Both hubs centre on elite research universities that provide ongoing supplies of brilliant high-tech entrepreneurs as well as financially and technologically highly skilled employees. Health care, school quality, law and order and other public goods and services figure into people’s decisions about where they study, found businesses and build lives. A growing local population of highly skilled people attracts more businesses seeking skilled employees, and this attracts more skilled employees. An economic law of gravity can take over to make a high-tech hub self-sustaining despite episodes of poor government. Venture capital firms, investment banks and other financial institutions arose to fund emerging high-value-added innovative firms. Alberta may wish to evaluate legal, regulatory, health care, education and other public policy reforms by how they would improve the lay of the land. Policies that attract and retain innovative firms and the skilled workers they need boost productivity growth, the primary determinant of living standards. Alberta may also wish to review laws, policies, regulations and public-sector bureaucracies periodically and eliminate those that do not enhance the lay of the land. Government worth the taxes can attract economic activity, and savings, from all over the world to Alberta. Government not worth the taxes, even if the taxes are low, sends economic activity and savings elsewhere. Fortunately, the lay of the land is most affected by things that lie within the traditional core competences of government: law, regulation, education, health care and the efficient provision of public goods and services that firms and people value for tax rates they deem worth paying to be in Alberta.

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