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Institute for Competitiveness & Prosperity

Working Paper 23January 2016

A PLACE TO GROW:Scaling up Ontario’s firms

The Institute for Competitiveness & Prosperity is an independent not-for-profit organization that deepens public understanding of macro and microeconomic factors behind Ontario’s economic progress. Research by the Institute is intended to raise public awareness and stimulate debate on a range of issues related to competitiveness and prosperity. It is the aspiration of the Institute to have a significant influence in increasing Ontario and Canada’s competitiveness, productivity, and capacity for innovation. We believe this will help ensure continued success in creating good jobs, increasing prosperity, and building a higher quality of life. We seek breakthrough findings from our research and propose significant innovations in public policy to stimulate businesses, governments, and educational institutions to take action.

The Institute was formerly the research arm of the Task Force on Competitiveness, Productivity and Economic Progress established in 2001 by the Ontario Premier, and led by Roger L. Martin. The Task Force completed its work at the end of 2014. The Institute is now advised by Ontario’s Panel for Economic Growth & Prosperity, led by Tiff Macklem.

Comments on this report are welcome and should be directed to the Institute for Competitiveness & Prosperity. The Institute is funded by the Government of Ontario through the Ministry of Economic Development, Employment and Infrastructure.

Copyright © January 2016The Institute for Competitiveness & ProsperityISBN: 978-1-927065-15-0

2 INSTITUTE FOR COMPETITIVENESS & PROSPERITY

EXHIBIT 1 Variables that influence firm size in Ontario 14EXHIBIT 2 Size breakdowns for employees and revenue per employee 15EXHIBIT 3 Additional labour only boosts revenue per employee in select sectors 15EXHIBIT 4 Larger firms get more out of each additional worker 16EXHIBIT 5 Facility size is related to more employees but not revenue per worker 17EXHIBIT 6 International trade increases a firm’s number of employees 18EXHIBIT 7 International trade is associated with greater revenue per worker in select sectors 18EXHIBIT 8 Large firms benefit the most from exporting 19EXHIBIT 9 Ontario’s manufacturing firms consistently gain from international trade 20EXHIBIT 10 Risky firms employ fewer people 21EXHIBIT 11 Moderate risk is associated with higher revenue per worker 21EXHIBIT 12 Only select firm sizes and sectors benefit from risk taking 22EXHIBIT 13 Proximity to a highway increases firm employment 23EXHIBIT 14 Proximity to a train station increases revenue per worker 23EXHIBIT 15 Product-oriented sectors rely on freight trains for inputs and delivery of outputs 24EXHIBIT 16 Agglomeration has a limited relationship with a firm’s number of employees 25EXHIBIT 17 Agglomeration has a weak relationship with revenue per employee 25EXHIBIT 18 Summary of variables associated with firm size 26EXHIBIT 19 Initiatives are not oriented strategically 29EXHIBIT 20 Most provincial initiatives do not have a sectoral focus 30EXHIBIT 21 Ontario’s initiatives mostly provide financial resources 31EXHIBIT 22 The small business deduction reduces incentive for firm growth 35EXHIBIT 23 Two tax neutral options for modifying Ontario’s small business deduction 36

Exhibits


A PLACE TO GROW: SCALING UP ONTARIO’S FIRMS 3

Contents

6

10

13

28

33

40

Foreword 4

EXECUTIVE SUMMARY

CHAPTER 1: ONTARIO’S BUSINESSES NEED TO GROWScaling up firms can increase Ontario’s productivity 11Together employee headcount and revenue per employee provide insights into firm size 11

CHAPTER 2: GETTING TO THE ROOT OF FIRM OPERATIONSOntario firm size methodology 14General inputs are not the only drivers of firm size 15Ontario’s firms excel by engaging in trade 17Ontario’s firms need to take on appropriate risks 20Geographic location influences firm size 22

CHAPTER 3: HOW DOES ONTARIO NOURISH FIRM GROWTH?Initiatives are not strategically oriented 29Government programs disproportionately target goods-producing sectors 30Initiatives are duplicative and uncoordinated 31Initiatives mostly provide financial resources 31

CHAPTER 4: MAKING ONTARIO A PLACE TO GROW

APPENDIX

Previous Publications 42


Foreword

ON BEHALF OF ONTARIO’S INSTITUTE FOR COMPETITIVENESS AND PROSPERITY, I am pleased to present our 23rd Working Paper, A place to grow: Scaling up Ontario’s firms.

Like many Canadians, one of my favourite sounds is the voice of Stuart McLean on the CBC. He often regales his audience with stories about Dave. Dave runs an independent record store, “The Vinyl Café,” whose slogan is, “We may not be big, but we’re small.” The line always draws a laugh from the live studio audience. Sadly, that slogan could also be the motto for businesses in Ontario. And that is no laughing matter.

For 14 years, this Institute has focused on, dissected, and articulated the root causes, and possible solutions for, the productivity problem that plagues this province. Amongst the factors that contribute to the productivity gap is the fact that Ontario has a smaller percentage of large firms than our US peers. Large firms are more likely to export, invest in R&D, make larger capital investments, and take risks. Therefore, it is essential for the sake of Ontario’s economic prosperity to find ways to “scale up” our successful small- and medium-sized companies into large, global companies.

However, in spite of numerous government efforts and, one would assume, private sector desires to become global leaders, nearly 98 percent of Ontario’s firms are defined as “small” while only 0.2 percent are considered “large.” Therefore, we at the Institute decided to make another attempt to offer solutions to this persistent public policy problem.

Rather than take the same approach in an effort to yield a different result, this Working Paper attempts to shift the ground on this policy debate in the hope of gaining traction and increasing impact. Ontario needs to adopt an alternative definition of firm size, and then design policies and incentives to build off of this new paradigm to inspire the type of investments and economy that the province needs.

This Working Paper also takes a deep look at the existing public supports for companies in Ontario, including the 127 initiatives directly or indirectly funded by the government of Ontario. At the very least, these programs could be more efficient and effective in trying to achieve their stated goals. Once again, we revisit some of the provincial tax policies, which seem designed to inspire companies to stay small.


The private sector must step up to solve this problem as well. The industry-specific results and solutions within this Working Paper can help businesses looking to grow their firms. But the private sector must continue to find ways to foster cross-industry collaboration and enhance their international trade practices. Without cooperation, information sharing, new markets, and exposure to global competition, we are doomed to stay small.

Jamison Steeve, Executive DirectorInstitute for Competitiveness & Prosperity

Ontario needs to adopt an alternative definition of firm size and then inspire the type of investments and economy that the province needs.

It is our hope that this Working Paper is useful for policy makers, politicians, and business leaders alike as they wrestle with how to best create a province that generates the type of economic growth that can employ people and fund valued public services. Ontario has long been known as “a place to grow.” Now, we just need to grow bigger!

The Institute for Competitiveness & Prosperity is grateful for the funding support from the Ontario Ministry of Economic Development, Employment and Infrastructure. We look forward to sharing and discussing our work and findings with all Ontarians. All comments and suggestions are welcome.


OVER THE FOURTEEN YEAR HISTORY OF THE INSTITUTE FOR COMPETITIVENESS & PROSPERITY, NO PROBLEM HAS FELT MORE INTRACTABLE THAN THE ISSUE OF SCALING UP FIRMS.

Both the provincial and federal governments regularly champion policies designed to support Ontario’s businesses. Tax credits, grants, and human capital supports are seen as tools that encourage firm growth while fostering a healthy business climate. But are these resources effectively allocated and based on the evidence? In essence, are they working? In this Working Paper, the Institute identifies the factors associated with firm size in Ontario and evaluates provincial initiatives directed toward businesses.

A PLACE TO GROW: SCALING UP ONTARIO’S FIRMS

EXECUTIVE SUMMARY


PREVIOUS RESEARCH conducted by the Institute demonstrated that Ontario’s productivity trails behind its peers. To some extent, this gap is related to the smaller percentage of large firms in Ontario. Scaling up small- and medium-sized businesses can improve an economy’s productivity since larger firms are generally more productive: they take advantage of economies of scale, invest more heavily in R&D, and generate proportionally greater export value and GDP.

Yet, in the face of multiple strategies to tackle the problem, the challenge remains. Despite a similar industrial composition, the province hosts a smaller proportion of large firms relative to its US peer states. The province’s economic and industrial landscapes have also changed and now predominantly provide services. Given the varying output of workers across sectors, the definition of firm size, which focuses exclusively on employee head-count, needs to adapt.

Using firm level data, the Institute estimates the factors associated with firm size (measured by both the number of employees and revenue per employee) for seven key sectors in Ontario.

The Institute also evaluates provincial initiatives designed to help Ontario’s businesses succeed. Government initia-tives were defined as any program or support structure that the government provides to assist businesses. The Institute found that the government of Ontario directly or indirectly funds or administers 127 initiatives for the province’s businesses. These initiatives span across fourteen provincial ministries in Ontario. Although most government programs claim to be directed at firm growth, the majority are not strategically oriented toward the factors associated with larger firm size. This suggests that public resources may be allocated inefficiently. Programs that are designed to support small businesses or businesses in slow growth sectors are counterproductive to the objective of scaling up companies and encouraging rapidly growing firms. Moreover, the Institute finds that Ontario’s programs are duplicative and uncoordinated with other public supports.

Both the public sector (via policy design) and the private sector (through strategic management) can use the results of this study to address the challenge associated with scaling up firms in Ontario. In order to encourage Ontario’s firms to scale up, the Institute recommends that the Ontario government:

• Adopt an alternative definition of firm size• Streamline initiatives directed toward firms• Ensure tax policy encourages firm growth• Correct Ontario’s low business investment• Re-evaluate the Canadian Controlled Private Corporation

requirement for programs• Encourage cross-industry collaboration within the

private sector• Strategically allocate resources toward increasing

firm inputs• Scale up initiatives that enhance international trade• Incentivize appropriate risk taking• Continue to maintain transportation networks and

promote agglomeration


Facility size

Importer

Exporter

Moderate risk

High risk

Proximity to highway

Proximity to airport

Proximity to train

Intra agglomeration

Total agglomeration

Employees

Facility size

Importer

Exporter

Moderate risk

High risk



Proximity to train

Intra agglomeration

Total agglomeration

Note: Results summarized are based on results that were found to be statistically significant at the 5 perecent level in the OLS regression.Source: Institute for Competitiveness & Prosperity analysis based on data from Dun & Bradstreet.

EMPLOYEES

REVENUE PEREMPLOYEE

Construction Manufacturing Wholesale Retail Information Finance Professional


Below are the effects of each variable on a firm’s employment level in a given industry. = variable increases a firm’s employment level = variable decreases a firm’s employment level

Below are the effects of each variable on a firm’s revenue per employee. = variable increases a firm’s revenue per employee = variable decreases a firm’s revenue per employee

Exhibit 2 Summary of variables associated with firm size


Strategic Economic Infrastructure ProgramONe-Source Ontario Exporters

Fund

Manufacturing and Processing Tax Credit

High Performance Computing

VentureNorth

Ontario Network of Entrepreneurs

Northleaf Venture Catalyst Fund

Innovation Demonstration Fund

Jobs and Prosperity Fund

Strategic Economic Infrastructure Program: Supports infrastructure

projects in Northern Ontario.

Venture North: Promotes tech start-ups in

Toronto-Waterloo.

Ontario Exporters Fund:Covers the cost of hiring an

experienced export manager.

Innovation Demonstration Fund:

Funds technology demonstration projects at

the pilot stage.

TRANSPORTATION AGGLOMERATION INTERNATIONAL TRADE

ONe-Source: Provides information on

government services and forms to start, operate, and

grow a business.

Ontario Network of Entrepreneurs:

Offers information on business programs, services,

and supports.

Manufacturing and Processing Tax Credit:

Finances projects related to manufacturing and

processing, fishing, farming, mining, and logging.

Jobs and Prosperity Fund: Invests in projects that

enhance productivity and competition.

Northleaf Venture Catalyst Fund:

Funds high-potential venture capital fund managers.

High Performance Computing:

Provides access to high performance computing for

SMEs.

INFORMATION PROVISION INPUTSRISK

127The number of programs that the Government of

Ontario funds for business development.

7categoriesTransportation network1 program

Agglomeration7 programs

Internationaltrade 7 programs

Risk12 programs

Informationprovision 30 programs

Inputs 67 programs

Other 3 programs


CHAPTER 1

SCALING UP FIRMS CAN INCREASE ONTARIO’S PRODUCTIVITY AND CLOSE THE PROSPERITY GAP BETWEEN THE PROVINCE AND ITS PEERS.

The province’s industrial composition and economic landscapes have changed. This demands a revision in the way firm size is defined in order to adapt to the changing context. In addition, it is important to consider the factors that foster firm growth as they have varying effects on companies depending on their industry classification.

ONTARIO’S BUSINESSES NEED TO GROW


Ontario has a smaller proportion of large firms compared to peer statesStatistics Canada classifies firms as “small” if they have fewer than 100 employees, “medium” if they have between 100 and 499 employees, and “large” if they have 500 or more employees.5 Following these defini-tions, 97.9 percent of Ontario’s firms were considered small, 1.9 percent medium, and 0.2 percent large.6

Allowing firms to grow and develop has been a challenge in Ontario. Although the province has propor-tionally more large firms than its provincial peers, Ontario has a smaller proportion of large firms compared to its US peers, where 0.3 percent of total firms are large.7 Furthermore, a greater proportion of Ontario’s firms are not growing particularly those in service industries, which tend to grow at a slower pace relative to their US counterparts.8

It is possible that Ontario lacks the capacity to support additional large firms due to its natural lack of population and firm density. To scale up Ontario’s firms, both policy makers and business executives need to better understand the factors associated with firm growth. Employee headcount alone fails to sufficiently capture the different sizes of Ontario’s firms.

Together employee headcount and revenue per employee provide insights into firm size

In order to grow Ontario’s firms, the characteristics associated with firm size and growth need to be under-stood. Existing research yields different conclusions, largely due to variations in methodology and definitions of growth. Some studies view growth as positive changes in a firm’s GDP contribution, employee headcount, assets, profits, or revenue

FOR AN ECONOMY TO FLOURISH, the business environment must be conducive to firm growth. Firm growth generates new jobs and is also an indicator of the firm’s acceptance in the market.1 This is because large businesses are more productive than small firms – they contribute proportionally more to a region’s Gross Domestic Product (GDP), take the greatest advantage of economies of scale, generate larger export value, and invest more in new technology and R&D.2

The Institute’s Working Paper 15 identified several factors associated with successful entrepreneurs (education, experience, maturity, and clusters), and proposed policies to support entrepreneurial, high-growth, high-impact firms. This Working Paper expands on that research by adopting a broader, sector-specific definition of firm size, modelling the factors that influence size, and assessing public initiatives directed toward Ontario’s businesses.

Scaling up firms can increase Ontario’s productivity

Ontario’s productivity level and growth rate lags its North American peers. The Institute estimates that, in 2014, Ontario generated $12,015 less GDP per capita than the median US peer.3 Scaling up firms is desirable because large firms are, on average, more productive.4 For Ontario, growing small- and medium-sized enterprises (SMEs) can reduce the province’s prosperity gap. For this reason, public resources should be directed toward promoting firm growth.

1 Jose Luis Barbero Navarro, Jose Carlos Casillas, and Bruce Barringer, “Forms of Growth: How SMEs Combine Forms of Growth to Achieve High Growth,” Journal of Management & Organization, 2012, Vol. 18, No. 1, pp. 81-97.

2 Institute for Competitiveness & Prosperity, Working Paper 15, Small Business, Entrepreneurship, and Innovation, February 2012, pp. 21-28; John R. Baldwin, Danny Leung, and Luke Rispoli, “Canadian Labour Productivity Differences Across Firm Size Classes, 2002 to 2008,” Statistics Canada The Canadian Productivity Review, 2013, No. 32, pp. 19-21; Industry Canada, Key Small Business Statistics – August 2013, 2013.

3 Task Force on Competitiveness, Productivity and Economic Progress, Thirteenth Annual Report, Finding its own way: Ontario needs to take a new tack, November 2014.

4 Institute for Competitiveness & Prosperity, Small Business, Entrepreneurship, and Innovation, 2012, pp. 21-28; Industry Canada, Key Small Business Statistics – August 2013, 2013.

5 A “firm” is a registered business establishment that employs at least one paid person, generates annual revenue of $30,000 or greater, or is incorporated and has filed a federal corporate income tax return at least once in the past three years.

6 Industry Canada, Key Small Business Statistics – August 2013, 2013.

7 United States Census Bureau, Number of firms, number of establishments, employment, annual payroll, and estimated receipts by small enterprise employment sizes for the United States and states, NAICS sectors, 2012.

8 Duanjie Chen and Jack Mintz, “Small Business Taxation: Revamping Incentives to Encourage Growth,” The School of Public Policy Research Papers, 2011, Vol. 4, No. 7, p. 2; Task Force on Competitiveness, Productivity and Economic Progress, Finding its own way: Ontario needs to take a new tack, 2014, p. 45.

9 Ann Ledwith and Michele O’Dwyer, “Market Orientation, NPD Performance, and Organizational Performance in Small Firms,” Journal of Product Innovation Management, 2009, Vol. 26, No. 6, pp. 652-61; John K. Paglia and Maretno A. Harjoto, “The Effects of Private Equity and Venture Capital on Sales and Employment Growth in Small and Medium-Sized Businesses,” Journal of Banking & Finance, 2014, Vol. 47, pp. 177-97; Loraine M. Uhlaner and André van Stel, “Disentangling the Effects of Organizational Capabilities, Innovation and Firm Size on SME Sales Growth,” Small Business Economics, 2013, Vol. 41, pp. 571-607; Thomas F. Cooley and Vincenzo Quadrini, “Financial Markets and Firm Dynamics,” The American Economic Review, 2001, Vol. 91, No. 5, pp. 1286-310; Danny Leung, Césaire Meh, and Yaz Terajima, “Productivity in Canada: Does Firm Size Matter?” Bank of Canada Review, Autumn 2008, p. 12.

10 Alexander McKelvie and Johan Wikund, “Advancing Firm Growth Research: A Focus on Growth Mode Instead of Growth Rate,” Entrepreneurship Theory and Practice, 2010, Vol. 34, No. 2, pp. 261-88.

per employee.9 There are also variations in measuring absolute versus relative size, as well as whether growth occurs organically or through acquisition.10


Ontario’s economy is changing, and so should its definition of firm sizeFirms that generate large revenues with few employees are becoming more common in jurisdictions that are transitioning to a knowledge-based economy.11 In Canada, the standard definition of firm size considers only employee headcount, but the current economic context may require a more comprehensive definition.12 Accordingly, the Institute analyzed firm size in terms of employee headcount and revenue generated by each employee.13

Given the shifting economic land-scape and differences between sectors, a singular metric of firm size is ill-suited for Ontario.14 For example, employee headcount may continue to be a defining factor for describing scale in the manufacturing sector, but this may not be the case in sectors like information, finance, and professional services, where firms are increasingly able to have a large economic impact with a relatively small workforce. Existing research also suggests that firm growth rates and trajectories vary by industry.15

To address economic and industrial realities, the Institute focused its analysis on seven important sectors of Ontario’s economy:

• Construction• Manufacturing• Wholesale trade • Retail trade • Information: Information and

cultural industries • Finance: Finance and insurance,

along with real estate and rental and leasing

• Professional: Professional, scientific, and technical services16

Together these sectors account for over 62.8 percent of total provincial GDP.17 In addition, whereas there is a mix of public and private corpora-tions participating in other sectors, the seven selected sectors are mostly composed of private corporations.18

Ontario’s industrial composition and economic landscapes have changed and sectors that provide services are growing in their share of economic importance. These changes are long-term and structural, and have policy implications when scaling up Ontario’s firms. Therefore, the definition of firm size needs to adapt and the factors that increase firm size must be considered.

11 Bill Currie, Lawrence W. Scott, and Andrew W. Dunn. “The Future of Productivity: Clear Choices for a Competitive Canada,” Deloitte Future of Canada Series, 2013, p. 2; Sven-Olov Daunfeldt, Niklas Elert, and Dan Johansson, “The Economic Contribution of High-Growth Firms: Do Policy Implications Depend on the Choice of Growth Indicator?” Journal of Industry, Competition and Trade, 2014, Vol. 14, No. 3, pp. 337-65; John C. Haltiwanger, Ron S. Jarmin, and Javier Miranda, “Who Creates Jobs? Small vs. Large vs. Young,” National Bureau of Economic Research Working Paper Series No. 16300, 2010.

12 W. Mark. Brown, “Testing for Provincial Industrial Structural Change Through the 2000s,” Statistics Canada Economic Analysis Research Paper Series No. 092, 2014.

13 Frédéric Delmar, Per Davidsson, and William B. Gartner, “Arriving at the High-Growth Firm,” Journal of Business Venturing, 2003, Vol. 18, No. 2, pp. 189-216. The authors suggest that firm revenue is a preferred measure of firm growth.

14 Toke Reichstein, Michael S. Dahl, Bernd Ebersberger, and Morten B. Jensen, “The Devil Dwells in the Tails: A Quantile Regression Approach to Firm Growth,” Journal of Evolutionary Economics, 2010, Vol. 20, pp. 219-31.

15 Delmar, Davidsson, and. Gartner, “Arriving at the High-Growth Firm,” Journal of Business Venturing, 2003, Vol. 18, No. 2, pp. 189-216.

16 Selected sectors are based on the North American Industry Classification System (NAICS).

17 Statistics Canada, “Gross domestic product (GDP) at basic prices, by North American Industry Classification System (NAICS), provinces and territories, 2014, annual,” CANSIM Table 379-0028.

18 For example, the province plays an active role in the utilities, educational services, health care and social assistance, and public administration sectors.


THE INSTITUTE MEASURED THE FACTORS ASSOCIATED WITH FIRM SIZE AND FOUND THAT NOT ALL VARIABLES HAD A UNIFORM EFFECT, AND THAT THE RESULTS VARY BY SECTOR.

Policy initiatives geared toward scaling up firms cannot follow a “one size fits all” approach. Instead, both business leaders and policy makers need to recognize and adopt the positive results of each variable on the seven different industries.

GETTING TO THE ROOT OF FIRM OPERATIONS

CHAPTER 2


This method makes it possible to differentiate the way firms respond to changing variables given their existing size (Exhibit 2). The quantile method also avoids making arbitrary cut-off points with regards to size; instead it takes all information into account with emphasis on firms most similar to the size in question. The inherent difference between large and small firms would be ignored if not for the quantile regression approach.

A NUMBER OF INTERRELATED factors are associated with a firm’s employee headcount and revenue generated per employee. Using data from over 140,000 firms in Ontario, the Institute identified firm and location character-istics associated with firm size.

Four groups of variables were analyzed to explain how firms evolve from small to medium, and medium to large: general inputs, market access, firm structure, and location (Exhibit 1). A regression analysis was then applied to estimate the effect of these characteristics on both measures of firm size. In total, the Institute included 31 variables in the model that describe both firm and location characteristics. Eleven of the variables with the greatest impact or potential for policy design are discussed in the following sections.19

Ontario firm size methodology

The analysis was conducted using both a traditional Ordinary Least Squares (OLS) approach and a detailed quantile regression. The OLS results provide a simple benchmark for each variable’s effect and the quantile regression complements this by depicting the effect at specific firm sizes. Quantile regressions allow variables to have varying effects on firms of diverse sizes, rather than imposing a uniform effect on all firms. For example, the effects of being in proximity to a highway, taking on risk, or gaining access to markets may be completely different for a firm at the 90th quantile which has 42 workers, relative to the median sized firm which has only eight employees.20 The OLS model would force the effects to be identical for both of these firms, which is likely an unrealistic assumption.

19 Variables such as a firm’s age are acknowledged to be important factors in size but policy implications are limited.

20 A firm in the 90th quantile for employees has more employees than 90 percent of other firms in their sector.

Employees Importer Moderate risk Proximity to highway

Facility size Exporter High risk Proximity to airport

Population density Integration Proximity to freight

Construction Intra-industry agglomeration

Manufacturing Total agglomeration

Wholesale City

Retail Population without high school

Transportation Population with trade certificate

Information Population with upper education

Finance Average personal income

Professional Unemployment

Other

Subsidiary

Age

Age squared

Three-digit NAICS

Note: Integration represents a firm that is listed as having a secondary sector in which they operate. The firm can be “Integrated” with any of the other sectors. The bolded variables are analyzed within the Working Paper and are considered to have the greatest impact or potential for policy design.Source: Institute for Competitiveness & Prosperity analysis on data from Dun & Bradstreet.

Exhibit 1 Variables that influence firm size in Ontario

Market access Firm structure LocationGeneral inputs


General inputs are not the only drivers of firm size

The Institute assessed two key inputs utilized by firms: labour, as measured by number of employees and capital, which uses facility size as a proxy. These are major inputs of production and are necessary in all sectors to varying degrees.21

Labour has a greater effect on service-producing firms, but the effect varies with firm sizeIn Ontario, the retail and professional

sectors benefit the most from increasing a firm’s labour force (Exhibit 3). On average, a 10.0 percent increase is associated with a 0.6 percent increase in revenue per employee for these sectors. As firms in these sectors scale up, they not only get larger but also more productive. Hiring additional employees can improve a firm’s production process by bringing in diverse knowledge, skills, and experiences.22 This, in turn, can provide a firm with the human capital necessary to tap into new markets and innovate.

Number of employees Quantile

Construction

Manufacturing

Wholesale

Retail

Information

Finance

Professional

10th 50th 90th

Revenue per employee Quantile

Construction

Manufacturing

Wholesale

Retail

Information

Finance

Professional

$99,600 $119,500 $259,000

71,700 119,500 219,900

159,400 225,800 423,300

75,400 132,000 239,000

75,700 99,600 129,500

104,600 129,500 408,300

67,600 112,000 129,700

10th 50th 90th

2 5 20

2 8 42

2 5 20

2 5 20

2 6 25

2 5 23

2 5 22

Note: The Canada-US exchange rate from the BoC Q1 2015 was used to convert US dollars into Canadian dollars.Source: Institute for Competitiveness & Prosperity analysis based on data from Dun & Bradstreet.

Exhibit 2 Size breakdowns for employees and revenue per employee

21 Regression models also include industry dummy variables which control for specific industry characteristics at the 3-digit NAICS level. These variables account for unobservable differences across industries, which reduces the effect of different capital requirements across industries. This means differences in facility size are more likely to be related with differences in capital investment and usage and not intrinsic differences amongst industries (such as line of business or type of goods and services provided). Each sector is also modeled independently, which means that different capital requirements across sectors are not being picked up by differences in facility size requirements.

22 Hermann Schwind, Hari Das, and Terry Wager, Canadian Human Resource Management: A Strategic Approach, Toronto: McGraw-Hill Ryerson, 2010.

Ontario, 2015Effect of a 1% increase in labour on revenue per employee (%)

Revenue per employee change

-0.02

0.08 %

0.06

0.04

0.02

0.00

Note: Solid bars highlight results that are statistically significant at the 5 percent level. The effects of labour on revenue per employee in the construction, manufacturing, wholesale, information, and financial sectors are statistically insignificant. Source: Institute for Competitiveness & Prosperity analysis based on data from Dun & Bradstreet.


Exhibit 3 Additional labour only boosts revenue per employee in select sectors


By contrast, the construction and manufacturing sectors (both of which produce goods, rather than services) have the lowest returns to additional labour. Increasing the number of workers employed by firms in these sectors may increase total output without any significant improvements to the production process. In other words, each additional worker in the construction and manufacturing sectors can add a body to the produc-tion line, but will not necessarily enhance productivity.

These results suggest that increasing employee headcount does not benefit all sectors uniformly; service-oriented sectors can use additional labour to expand their market outreach and innovation, while goods-producing sectors may use these resources to incrementally increase their output.

The results also vary by firm size (Exhibit 4). When the number of employees are divided into quantiles for analysis, the revenue per employee returns to labour for each additional new hire is not uniform and therefore increasing employee

headcount might not fully enhance Ontario’s productivity.

This is evident for firms in the manufacturing and information sectors, which experience decreasing returns to scale when they are below the 60th quantile in revenue generated per worker but exhibit increasing returns thereafter.23 Here, larger firms may be able to afford additional resources, such as an experienced management team or accounting staff that can generate increasing returns to the expansion of their labour force. By contrast, firms in Ontario’s retail and professional sectors demonstrate a positive relationship between employee headcount and revenue per worker, across all firm sizes (rather than an initial decrease in productivity). This analysis further reveals that the benefits associated with increasing a firm’s employee headcount are not uniform, either across or within a given sector. Policy makers and business owners should take these findings into account when looking to scale up Ontario’s firms.

Ontario, 2015Effect of a 1% increase in labour on revenue per employee, by quantile (%)


0.00

-0.02

-0.04

0.10 %

0.08

0.06

0.04

0.02

Note: The construction, wholesale and finance sectors are omitted due to inconsistency of statistical significance.Source: Institute for Competitiveness & Prosperity analysis based on data from Dun & Bradstreet.

Revenue per employee quantile (%)50 60 70 80 90 1000 10 20 30 40

Manufacturing

Retail

Information

Professional

Exhibit 4 Larger firms get more out of each additional worker

23 Manufacturing and information sectors have statistically significant benefits after $154,000 and $122,000 revenue per worker, respectively.


Facility size has a minimal effect on a firm’s revenue per employeeThe physical space a firm occupies is used as a proxy for its capital holdings. In Ontario, a bigger facility size is associated with a larger labour force, but this has little bearing on revenue generated per worker (Exhibit 5).24

Ontario’s firms excel by engaging in trade

Accessing customers is an important aspect of growing a business. Companies should constantly seek new markets and reach new customers, either domestically or abroad. Given Canada’s small domestic market, it is vital that Ontario businesses engage in trade in order to promote firm growth. While the size of local markets, measured using surrounding popula-tion density, did not demonstrate a significant impact on revenue per employee, engagement in interna-tional trade showed large returns in both revenue per employee and number of employees.

Increasing trade is strongly correlated with real GDP growth.25 Exporting could prompt firms to hire more workers for production, and expand their customer pool to generate greater revenue per worker compared to strictly serving a local market.26 This is because exporting increases market reach, takes advantage of economies of scale, and incentivizes innovation.27

In addition, firms that import are expected to increase in scale, especially if the goods or services that are imported are unique or of a higher quality than what is available domestically. Here, importing can increase the number of employees a firm requires, as well as the firm’s revenue generated per employee due to product or service differentiation.

24 Despite the small coefficients found for revenue per employee, they are statistically significant. Large growth could result in substantial improvements to revenue per worker.

25 Industry Canada, Key Small Business Statistics – August 2013, 2013, p. 19.

26 Daniel Seens, SME Profile: Canadian Exporters, Industry Canada, 2015, p. 18. It may also be that firms with a greater number of employees and revenue are more likely to engage in international trade, but the Institute’s quantile analysis can help overcome this issue.

27 John R. Baldwin and Beiling Yan, “Empirical Evidence From Canadian Firm-Level Data on the Relationship Between Trade and Productivity Performance,” Statistics Canada Economic Analysis Research Paper Series No. 97, 2015; Paul Westhead, Mike Wright, and Deniz Ucbasaran, “The Internationalization of New and Small Firms: A Resource-Based View,” Journal of Business Venturing, 2001, Vol. 16, No. 4, pp. 333-58; Elena Golovko and Giovanni Valentini, “Exploring the Complementarity Between Innovation and Export for SMEs’ Growth,” Journal of International Business Studies, 2011, Vol. 42, pp. 362-80.

Ontario, 2015Effect of a 1% increase in facility size on employment and revenue per employee (%)

Revenue per employee and

employment change

-0.2

1.4 %

1.2

1.0

0.8

0.6

0.4

0.2

0.0

Note: Solid bars highlight results that are statistically significant at the 5 percent level. The effect of facility size on revenue per employee in the financial sector is statistically insignificant. Source: Institute for Competitiveness & Prosperity analysis based on data from Dun & Bradstreet.


Labour

Revenueperemployee0.014 0.049 0.021 0.010 0.036 -0.0590.012

Exhibit 5 Facility size is related to more employees but not revenue per worker


the exchange of goods and services, they might not actually produce additional value per worker. On average, firms in Ontario’s construction, manufacturing, finance, and profes-sional sectors generate higher revenue per employee when they are involved in international trade, and should be further encouraged to do so (Exhibit 7).

Benefits of international trade vary by sectorNot surprisingly, firms involved in international trade have, on average, more employees because engaging in foreign markets demands additional labour resources relative to strictly serving the domestic market (Exhibit 6). Yet there are exceptions such as in the

retail sector, when exporting, and the professional sector, when importing, as these activities do not appear to increase employment size.

However, not all sectors generate higher revenue per worker when engaging in trade. Although more employees may be required to facilitate

Ontario, 2015Effect of trading activities on revenue per employee (%)

Revenue peremployee change

-10

20 %

15

10

5

0

-5

Note: Solid bars highlight results that are statistically significant at the 5 percent level. The effect of importing on revenue per employee in the construction and information sectors and the effect of exporting on revenue per employee in the information sector are statistically insignificant. For firms that import and export, the effect is the summation of both bars. Source: Institute for Competitiveness & Prosperity analysis based on data from Dun & Bradstreet.


Importing

Exporting

Exhibit 7 International trade is associated with greater revenue per worker in select sectors

Ontario, 2015Effect of trading activities on employment (%)

Employment change

-5

30 %

25

20

15

10

5

0

Note: Solid bars highlight results that are statistically significant at the 5 percent level. The effect of importing on employment size in the professional sector and the effect of exporting on employment size in the retail sector are statistically insignificant. For firms that import and export, the effect is the summation of both bars. Source: Institute for Competitiveness & Prosperity analysis based on data from Dun & Bradstreet.


Importing

Exporting

Exhibit 6 International trade increases a firm’s number of employees


Firms in Ontario’s wholesale, retail, and information sectors that trade internationally may increase their number of employees without seeing a corresponding increase in revenue per worker. Firms in Ontario’s infor-mation sector, for example, employ 26 percent more workers when exporting, on average, with no signifi-cant change to revenue per worker.

Interestingly, not all sectors benefit equally from importing and exporting. Firms in Ontario’s construction and wholesaling sectors generate four and seven percent more revenue per worker when exporting, respectively. On the other hand, importing has no effect on the manu-facturing sector, and importing has a negative effect on revenue per worker in the wholesale sector.

Benefits of international trade vary by firm sizeGains from trade are not exclusive to Ontario’s largest firms; some sectors demonstrate consistently positive benefits from trade across all firm sizes.28 Smaller firms can accrue benefits if they successfully enter a foreign market. However, the effect of exporting trends upward with firm size.29 This is particularly true for the construction, manufacturing, and wholesaling sectors, suggesting that firms must first prove the success of their products in local markets before exporting to foreign markets (Exhibit 8). By establishing themselves with a sufficient revenue base, firms can be better equipped to enter a new market or capture market share without disrupting their current operations.

28 Firms with revenue per employee above $119,000 in construction, $100,000 in manufacturing, and $199,000 in wholesale demonstrate consistently positive returns from trade.

29 Firms with revenue per employee above $210,000 in construction, $174,000 in manufacturing, $349,000 in wholesale, and $130,000 in professional have much stronger benefits from exporting.

Ontario, 2015Effect of exporting on revenue per employee, by quantile (%)


0

-2

-4

16 %

14

12

10

8

6

4

2

Note: The retail, information and finance sectors are omitted due to inconsistency of statistical significance.Source: Institute for Competitiveness & Prosperity analysis based on data from Dun & Bradstreet.


Construction

Manufacturing

Wholesale

Professional

Exhibit 8 Large firms benefit the most from exporting


Moreover, Ontario’s SMEs tend to innovate less than large firms. This effect is then amplified because the province has a greater proportion of SMEs.32 Research conducted by Statistics Canada further suggests that Ontario’s firms do not lack the resources to innovate but rather have a minimal appetite for the risk associated with innovative projects.33

The effect of firm risk varies by sector and firm sizeThe Institute uses two firm-level credit risk scores as a proxy for risk- taking behaviour.34 The first risk level

Firms in Ontario’s manufacturing sector demonstrate the most consistently significant gains from international trade, with both importing and exporting activities associated with strong additional revenue per worker (Exhibit 9). Manufacturing firms with $100,000 (30th quantile) revenue per employee generate an additional 2.2 percent revenue per employee when exporting and 1.5 percent when importing. Yet, firms generating $219,000 (90th quantile) per employee attribute a 6.5 and 6.0 percent increase in revenue per employee when exporting and importing, respectively. Firms that export and import would see a 12.5% increase. Manufacturing firms that are able to effectively source their supply chain and then distribute their final product to a global consumer base can become much larger and more productive than firms that do not engage in trade.

Trading internationally can require substantial additional labour and capital. While labour demand increases with trading, often it does not boost revenue per employee as significantly. Governments must pay special

attention when selecting firms and sectors to receive assistance to enter new markets, as the expected benefits can vary immensely. The Institute’s analysis reveals that sector-specific trade promotion is related to greater revenue per worker for firms involved in manufacturing, finance, and professional services. For Ontario’s construction and wholesaling sectors, firms should be encouraged to export. Further, the Insitute’s analysis reveals that firms of all sizes can benefit from international trade, but establishing a successful local market might be required first.

Ontario’s firms need to take on appropriate risks

Fast growing firms are often associated with the entrepreneurial activity generated by innovative ideas, prod-ucts, or processes.30 However, a firm’s propensity to innovate and the inten-sity of their innovation relies on their willingness and ability to take on risk.

Research shows that many Canadian small business owners choose not to be growth oriented, which could be attributed to a greater aversion to risk.31

Ontario, 2015Effect of trade on revenue per employee in the manufacturing sector, by quantile (%)


0

-2

16 %

14

12

10

8

6

4

2

Source: Institute for Competitiveness & Prosperity analysis based on data from Dun & Bradstreet.

Revenue per employee quantile (%)60 80 1000 20 40

CombinedExporterImporter

Exhibit 9 Ontario’s manufacturing firms consistently gain from international trade

30 Chris Parsley and Sonja Djukic, “The State of Entrepreneurship in Canada.” Industry Canada, 2012; Evangelia Papadaki and Bassima Chami, “Growth Determinants of Micro-Businesses in Canada,” Industry Canada, 2002. Entrepreneurial intensity can be measured by a firm’s willingness to take on personal financial risk. “Innovation” refers to a new or improved product, process, organizational structure, or marketing initiative.

31 Currie, Scott, and Dunn, “The Future of Productivity: Clear Choices for a Competitive Canada,” Deloitte, 2013, p. 14.

32 Golovko and Valentini, “Exploring the Complementarity Between Innovation and Export for SMEs’ Growth,” Journal of International Business Studies, 2011, Vol. 42, pp. 362-80.

33 “The Canadian Provinces Special Edition: Key Small Business Statistics,” Industry Canada, 2013.

34 Dun and Bradstreet calculated two credit risk scores for firms based on default likelihood. Credit risk scores do not fully capture firms taking calculated or innovative risks. Results should be interpreted with caution.


represents moderate risk, while the second depicts a firm with substantial risk of default. With the exception of firms involved in construction and wholesaling, Ontario’s firms with higher risk generally employ fewer workers (Exhibit 10). Risk taking may depict a firm that does more with fewer employees due to innovative

processes, or it may simply be captur ing weaker firms that cannot afford to employ as many people relative to their less risky counterparts.

Although risk-taking behaviour is typically associated with a smaller workforce, moderate risk is associated with greater revenue per worker. In

other words, moderate risk is benefi-cial, while high risk is detrimental to growing revenue per worker (Exhibit 11). These results highlight the need for Ontario’s firms to strive to innovate and be competitive in an ever-changing marketplace, while avoiding overly-risky behaviours that could lead to a firm’s collapse.

Ontario, 2015Effect of risk on revenue per employee (%)


-4

8 %

6

4

2

0

-2

Note: Solid bars highlight results that are significant at the 5 percent level. The effect of moderate risk on revenue per employee in the construction and wholesale sectors and the effect of high risk on revenue per employee in the manufacturing, wholesale, finance, and professional sectors are statistically insignificant. Source: Institute for Competitiveness & Prosperity analysis based on data from Dun & Bradstreet.


High

Moderate

Exhibit 11 Moderate risk is associated with higher revenue per worker

Ontario, 2015Effect of risk on employment (%)

Employment change

-40

20 %

10

0

-10

-20

-30

Note: Solid bars highlight results that are statistically significant at the 5 percent level. The effect of high risk on employment size in the wholesale sector is statistically insignificant. Source: Institute for Competitiveness & Prosperity analysis based on data from Dun & Bradstreet.


Moderate

High

Exhibit 10 Risky firms employ fewer people


Firms in the construction and whole-sale sectors appear to employ a larger labour force when engaged in higher risk activities, but fail to increase their revenue generated per employee. Conversely, the manufacturing, retail, information, finance, and professional sectors succeed in generating greater revenue per worker when adopting a moderate level of risk.

The Institute also finds that certain firm sizes are better equipped to take advantage of innovative activities (Exhibit 12). For firms in Ontario’s professional sector, those that generate relatively lower revenue per employee benefit proportionally more from undertaking moderate risk. Risk taking in the professional sector could involve expending funds on innovative manage-ment techniques, conducting R&D that will improve business operations, or pushing the business to undertake projects with greater risk-reward levels. However, in the province’s information sector, larger firms reap the most benefits. Finally, manufacturing firms of all sizes consistently demonstrate about a one percent increase in revenue per worker by taking on moderate risk.

Geographic location influences firm size

A firm’s success is also affected by its location. Many factors must be considered when a firm decides where to locate, such as the distance to the nearest highway, airport, or train station.35 Highways and train stations help move goods to their final destination while airports transport employees, executives, and customers.

35 Only King’s and 400-series highways were used to determine a firm’s proximity to a highway. Major freight train stations were used to calculate a firm’s proximity to a train station. Ten major non-military airports that accept passenger planes were used to determine a firm’s proximity to an airport.

Ontario, 2015Effect of moderate risk on revenue per employee, by quantile (%)


0

-2

12 %

10

8

6

4

2

Note: The construction, wholesale, retail, and finance sectors are omitted due to inconsistency of statistical significance.Source: Institute for Competitiveness & Prosperity analysis based on data from Dun & Bradstreet.


Manufacturing

Information

Professional

Exhibit 12 Only select firm sizes and sectors benefit from risk taking


For all sectors in Ontario, a firm’s proximity to a highway was positively and significantly related to its number of employees. Firms that are further from a highway employ fewer workers. However the relationship is small, as a 10.0 percent increase in proximity to a highway only increased employment by 0.5 percent, at most (Exhibit 13).

This relationship was even less pronounced for revenue per employee (Exhibit 14). This may be because firms plan their location before they begin operating. Firms that require access to highways, airports, or freight trains are unlikely to situate themselves far away from one. The Institute believes the distance to these transportation

networks can influence firm size, but this relationship may not be fully captured in the model.

Ontario, 2015Effect of a 1% increase in proximity to transportation network on employment (%)

Note: Solid bars highlight results that are significant at the 5 percent level. The effect of distance to airport on employment size in the construction, manufacturing, wholesale, retail, finance, and professional sectors and the effect of distance to train station on employment size in construction, manufacturing, and finance sectors are statistically insignificant. Source: Institute for Competitiveness & Prosperity analysis based on data from Dun & Bradstreet.


Highway

Employment change

-0.02

0.05 %

0.03

0.02

0.01

0.04

0.00

-0.01

Airport

Train

Exhibit 13 Proximity to a highway increases firm employment

Ontario, 2015Effect of a 1% increase in proximity to transportation network on revenue per employee (%)

Note: Solid bars highlight results that are significant at the 5 percent level. The effect of distance to highway on revenue per employee in the manufacturing, wholesale, retail, information, finance, and professional sectors, the effect of distance to airport on revenue per employee in construction, manufacturing, wholesale, retail, information, finance, and professional sectors, and the effect of distance to train station on revenue per employee in the construction, finance, and professional sectors are statistically insignificant. Source: Institute for Competitiveness & Prosperity analysis based on data from Dun & Bradstreet.


Highway


-0.01

0.02 %

0.01

0.00

Airport

Train

Exhibit 14 Proximity to a train station increases revenue per worker


Across all firm sizes, the largest and most consistent increase in revenue per worker occur for manufacturing and wholesale firms located in close proximity to a train station (Exhibit 15). Consequently, firms in these sectors may have a relatively higher dependence on freight trains to transport these goods, implying that further distance from trains can negatively impact the amount of revenue generated per employee. The continued expansion of trans-portation networks in Ontario will allow existing businesses to more easily access local and international markets. New transportation options also open up additional locations where businesses can grow to their full potential.

Ontario’s firms have likely reaped the benefits from agglomerationAgglomeration plays a role in shaping the relationship between a firm’s export performance, innovation, and overall productivity.36 Intra-industry and total agglomeration can also influence firm size. The Institute calculated each firm’s intra-industry agglomeration level by dividing the number of firms sharing the same three-digit NAICS code (similar business operations) as the firm within five kilometres by the total number of firms with that NAICS code in Ontario. Total agglomeration measures the portion of all provincial firms within a five-kilometre radius.

In general, intra-industry agglom-eration is associated with a greater number of workers employed by a firm, while total agglomeration is negatively related to employee headcount (Exhibit 16).

Ontario, 2015Effect of a 1% increase in proximity to train station on revenue per employee, by quantile (%)

Exhibit 15 Product-oriented sectors rely on freight trains for inputs and delivery of outputs


-0.01

-0.02

0.06 %

0.05

0.03

0.04

0.02

0.01

0.00

Note: The construction, retail, information, finance and professional sectors are omitted due to inconsistency of statistical significance.Source: Institute for Competitiveness & Prosperity analysis based on data from Dun & Bradstreet.


Manufacturing

Wholesale

36 Roberto Antonietti and Giulio Cainelli, “The Role of Spatial Agglomeration in a Structural Model of Innovation, Productivity and Export: A Firm-Level Analysis,” The Annals of Regional Science, 2011, Vol. 46, No. 3, pp. 577-600.


When assessing firm size according to revenue per employee, it appears that certain sectors benefit from agglomer-ating around firms that are involved in similar sectors (Exhibit 17). For example, the revenue generated by employees in Ontario’s information and professional sectors is positively associated with additional

intra-industry agglomeration. This could be the case if these sectors make use of specialized labour and knowledge spillovers from surrounding companies. Firms involved in retail are likely concen-trated alongside other retailers in order to encourage higher customer traffic. This can, in turn, lead to

greater revenue per worker. However, the magnitude of this relationship is small. Doubling the average amount of intra-industry agglomeration in the professional sector only leads to a 0.045 percent increase in revenue per employee. That said, caution should be taken when interpreting these results, as the difficulty in increasing

Ontario, 2015Effect of a 1% increase in firm agglomeration on revenue per employee (%)


Note: Solid bars highlight results that are significant at the 5 percent level. The effect of total agglomeration on revenue per employee in the manufacturing and wholesale sectors and the effect of total agglomeration on revenue per employee in the manufacturing and professional sectors are statistically insignificant.Source: Institute for Competitiveness & Prosperity analysis based on data from Dun & Bradstreet.


Intra

-0.02

0.03 %

0.01

0.00

0.02

-0.01

Total

Exhibit 17 Agglomeration has a weak relationship with revenue per employee

Ontario, 2015Effect of a 1% increase in firm agglomeration on employment (%)

Note: Solid bars highlight results that are significant at the 5 percent level. The effect of intra-industry agglomeration on employment size in the information and professional sectors and the effect of total agglomeration on employment size in retail, information, finance, and professional sectors are statistically insignificant. Source: Institute for Competitiveness & Prosperity analysis based on data from Dun & Bradstreet.


Intra

Employment change

-0.02

0.03 %

0.01

0.00

0.02

-0.01

Total

Exhibit 16 Agglomeration has a limited relationship with a firm’s number of employees


agglomeration by even one percent is immense. It is also possible that there are more pronounced, long-run benefits associated with firm agglomeration that might not be captured in the model.37

Many factors affect the growth of firms from small to large both in number of employees and revenue generated per worker, many of which are statistically significant (Exhibit 18). Companies within each sector can draw conclusions and general

guidelines on how to scale up their operations and increase the produc-tivity and prosperity of Ontario.

37 Per-Anders Havnes and Knut Senneseth. “A Panel Study of Firm Growth Among SMEs in Networks,” Small Business Economics, 2001, Vol. 16, No. 4, pp. 293-302.

Facility size

Importer

Exporter

Moderate risk

High risk



Proximity to train

Intra agglomeration

Total agglomeration

Employees

Facility size

Importer

Exporter

Moderate risk

High risk



Proximity to train

Intra agglomeration

Total agglomeration

represents a possitive effect represents a negative effect Note: Results summarized are based on results that were found to be statistically significant at the 5 perecent level in the OLS regression.Source: Institute for Competitiveness & Prosperity analysis based on data from Dun & Bradstreet.

Exhibit 18 Summary of variables associated with firm size

Employees



Revenue per employee


The Institute’s research suggests that employment is not strongly related to revenue per worker. Firms that engage in international trade and moderate risk are, in general, larger than those that do not. A firm’s proximity to transportation networks and its level of agglomeration are also related to firm size. Notably, these results vary by sector and initial firm size. This suggests that there is no “one size fits all” approach to scaling up firms in Ontario. Public programs designed to assist firms, as well as strategic decisions under taken by business owners, should account for these nuances.


CHAPTER 3

PUBLIC PROGRAMS CAN PROVIDE THE FINANCIAL RESOURCES AND PHYSICAL, SOCIAL, AND HUMAN CAPITAL NECESSARY TO ENCOURAGE FIRM GROWTH.

Yet the public programs in Ontario are not strategically oriented. Even more disappointing is the finding that programs are duplicative, uncoordinated, and not directed toward sectors that are most likely to grow. The province must reconcile its programs to stimulate the needed business growth to close the prosperity gap.

HOW CAN ONTARIO NOURISH FIRM GROWTH?


LIKE MOST GOVERNMENTS within OECD countries, Ontario provides support to its businesses through a number of policy instruments in recognition of the key role businesses play in increasing an economy’s health and vitality.38 These include preferential tax treatment and grants to support firms looking to acquire talent and expertise. Given the abun-dance of these initiatives, it is worth assessing whether these initiatives are effective and efficient policy tools.

The Institute estimates that the government of Ontario directly or indirectly funds or administers 127 initiatives for the province’s businesses, spanning 14 provincial ministries. (For a list of the programs and details, please visit www.competeprosper.ca). 39 These supports are in addition to the 104 federal programs directed toward Ontario firms (which similarly span 14 federal departments); this is in addition to the numerous resources provided at the municipal level and by the private sector.40

38 Duanjie Chen, Franc C. Lee, and Jack M. Mintz, “Taxation, SMEs and entrepreneurship,” OECD Science, Technology, and Industry Working Papers 2002/09, 2002, p. 6.

39 Ontario Ministry of Economic Development, Trade and Employment, Fewer Burdens, Greater Growth, Ontario Open for Business Burden Reduction 2013 Highlights, 2014. On average, Ontario’s businesses have relationships with eight different branches and ministries of the provincial government.

40 Some of these programs are exclusive to Ontario’s firms while others are applicable to firms across Canada. The Institute was only able to analyze the count of provincial and federal initiatives, and cannot comment on the resources allocated and services provided through individual initiatives.

41 A program was deemed to encourage firm growth if it influenced a firm’s financial or capital resources. In several instances, programs had multiple objectives. In these cases, the Institute selected the primary objective of a program based on the emphasis directed toward a given input.

The Institute analyzed Ontario’s business-oriented initiatives, the majority of which list firm growth as their primary objective but do not provide a definition of what it means for a firm to “grow.”41 Here, the Institute reiterates one of its recom-mendations from Working Paper 15: Ontario should assess whether initiatives directed toward businesses are effective (Do they achieve their stated objective?) and efficient (Do they expend the fewest resources possible, while achieving their goals? Is government obtaining the best return on its investment?). Government, businesses, and the general public stand to benefit from a holistic assessment of existing supports. For government, evaluating initiatives would improve inter- and intra-governmental coordination. Ensuring program effectiveness can also enhance firms’ experience and success from participating in these initiatives.

Initiatives are not strategically oriented

The Institute analyzed initiatives directed toward Ontario’s firms based on how they align with variables associated with firm size (Exhibit 19). Most initiatives (53 percent) provide firms with resources to increase their general inputs (financial assistance, and human and physical capital), such as the Ontario Film & Television Tax Credit, the Strategic Jobs and Investment Fund, and the Ontario Venture Capital Fund. Relatively fewer initiatives support international trade and taking on an appropriate level of risk. However, these factors are associated with the greatest increases in scale for firms’ employee headcount and revenue per employee. This suggests that many initiatives directed toward Ontario’s firms are not strategic as they do not target the factors found to increase firm size and productivity.

Primary orientation of Ontario’s initiatives

Exhibit 19 Initiatives are not oriented strategically

Note: Figures are rounded to the nearest whole number. Information provision refers to initiatives that provide resources about business development, application submissions, databases, or management insights. This does not include information provision about international trade, which is included in the international trade category.Source: Institute for Competitiveness & Prosperity analysis based on publicly available information.

Other, 2%

Risk, 9%

Agglomeration, 6%

International trade, 6%

Inputs, 53%

Informationprovision, 23%

Transportation network, 1%


Goods producing 19.7% 22.6%

Agriculture, forestry, fishing and hunting 13.4 0.9

Mining, quarrying, and oil and gas extraction 1.6 1.2

Construction 0.0 6.0

Manufacturing 1.6 12.2

Multiple goods producing 3.1 -

Service producing 17.3 77.4

Wholesale trade 0.0 6.3

Retail trade 0.0 5.0

Information and cultural industries 7.1 3.8

Finance and insurance, and real estate and rental and leasing 0.0 23.0

Professional, scientific, and technical services 3.9 6.9

Multiple service producing 6.3 -

Goods and service producing 7.1 -

None specified 55.9 -

Note: Not all sectors are included in the detailed breakdown. Source: Institute for Competitiveness & Prosperity analysis based on publicly available information and CANSIM Table 379-0028.

Exhibit 20 Most provincial initiatives do not have a sectoral focus

Proportion of initiatives (%) GDP share (%)Sector

42 This analysis was done using 2-digit NAICS codes. Although this is a broad level of analysis, the lack of concentration within a more specific industry classification would have rendered a more detailed assessment meaningless.

43 An additional 12 percent of all provincial initiatives are available to firms in the professional sector, but these resources are also available to other sectors.

22.6 percent of Ontario’s GDP and disproportionately received 19.7 percent of targeted programs.

In Ontario, not all sectors have the same potential for growth. Efficiently enhancing Ontario’s productivity means allocating resources toward sectors that are well positioned to grow. The share of employment and GDP in Ontario’s construction, finance, and professional services sectors have been growing. Yet, these are not the sectors targeted by public policy. Government has the opportunity to use procurement programs to funnel valuable experience and funds through to these sectors while obtaining high quality services. To the best of the Institute’s knowledge, there are no provincial initiatives that specifically target the construction or financial sectors, and only four percent of initiatives are exclusively for the professional sector.43 Relatively more initiatives (22.1 percent) are specifi-cally designed for the agricultural, manufacturing, and information sectors, all of which have declined in

Government programs disproportionately target goods-producing sectors

The Institute organized the 127 initiatives offered by the province according to the primary sector targeted (Exhibit 20).42 Notably, most initiatives (55.9 percent) are not aimed at a specific sector, although there is a trend toward supporting Ontario’s goods-producing sectors. Approximately 19.7 percent of initiatives are specifically designed for companies in these sectors, with the majority of these resources directed at agriculture.

There is an almost inverse relation-ship between the sectors targeted and their GDP contribution. The smallest sectors receive the most attention while those with the greatest potential are neglected. Service-producing sectors contributed 77.4 percent of GDP but only 17.3 percent of programs are directed at these sectors. Conversely, goods-producing sectors contributed


their share of both employment and GDP.44 This suggests that public resources are directed at protecting shrinking sectors rather than promoting growing ones.

Initiatives are duplicative and uncoordinated

Some provincial programs directed at firms are duplicative (they provide similar resources) and uncoordinated (they do not recognize other existing initiatives). There are 29 initiatives across 9 ministries in Ontario designed to provide information to business owners. These programs provide information on general business development, international trade, management insights, while others provide various databases.

As an example, the Institute estimates that Ontario’s Ministry of Economic Development, Employment, and Infrastructure (MEDEI) offers general information for businesses looking to broaden their market access through five separate initiatives, namely, the

Community Export Development Program, New Exporters to Border States, One-on-one Export Market Consulting, Trade Fact Sheets, and US Customs and Compliance Seminars. These are in addition to other programs designed to help busi-nesses engage in exporting that are offered through Ontario’s Ministry of Citizenship, Immigration and International Trade along with the Ministry of Natural Resources and Forestry. An additional six programs across three other ministries provide financial support for businesses looking to engage in international trade. In total, this means that the government of Ontario currently runs eleven programs through five ministries, all to assist firms in inter-national markets.

In 2014, MEDEI committed to reducing the time and costs that businesses spend on “unnecessary government paperwork, regulations, and processes.”45 The government also noted that streamlining regulatory processes, improving

44 Statistics Canada, “Gross domestic product (GDP) at basic prices, by North American Industry Classification System (NAICS), provinces and territories, annual (percentage share),” CANSIM Table 379-0028; Statistics Canada, “Canadian business patterns, location counts with employees, by employment size and North American Industry Classification System (NAICS),Canada and provinces, December 2014, semi-annual,” CANSIM Table 552-0001. An additional 13 percent of all provincial initiatives are available to firms in the agricultural, manufacturing, and professional services sectors, but these resources are also available to other sectors.

45 Ontario Ministry of Economic Development, Trade and Employment, Fewer Burdens, Greater Growth, 2013.

46 Ontario Ministry of Finance, “Turning the Corner to a Better Tomorrow: 2011 Ontario Budget,” 2011, p. 76.

47 Commission on the Reform of Ontario’s Public Services, Public Services to Ontarians: A Path to Sustainability and Excellence, 2012. The report strictly analyzed 44 funding programs across nine ministries.

customer service, and modernizing compliance initiatives can help reduce regulatory burdens on businesses. This is in addition to the 2011 Ontario Budget promise to undertake a review of direct business support programs.46 The Institute commends the province for undertaking these initiatives, and recommends that these efforts continue.

Initiatives mostly provide financial resources

Don Drummond estimated that, in 2010-11, the Ontario government provided over $1.3 billion to busi-nesses in the form of direct supports (including grants, loans, and loan guarantees) and $2.3 billion in indirect supports (through tax expen-ditures and sector-specific credits).47

The Institute estimates that nearly two-thirds of provincial initiatives offer financing, while the remaining initiatives provide physical, social, or human capital (Exhibit 21). Some financial support programs include

Resources provided by Ontario’s initiatives

Other, 1%Finance & capital, 4%

Physical, social, and human capital, 32%

Finance, 63%

Exhibit 21 Ontario’s initiatives mostly provide financial resources

Note: Figures are rounded to the nearest whole number.Source: Institute for Competitiveness & Prosperity analysis based on publicly available information.


the Ontario Innovation Tax Credit, the Agricultural Drainage Infrastructure Program, and Scale up Ventures. Initiatives that provide physical, social, or human capital include Business Advisory Services and the Collaboration Voucher Program.

Providing financial resources is important to encourage firm growth.48 Small businesses typically finance their operations quite differ-ently than larger firms, relying on the personal resources and credit history of the firm’s owners to access new credit.49 Data from Statistics Canada’s Survey on Financing and Growth of Small and Medium Enterprises show that about 94,000 of Canada’s SMEs consider obtaining financing to be a serious obstacle to growth.50 This may be the case if private financers are unwilling to provide resources to small firms due to asymmetric information regarding their credit worthiness.51 Alternatively, there may be adequate financial resources available for SMEs, but these resources can be difficult to navigate. Ontario’s SMEs may not have the staff required to seek out and apply to existing provincial programs.

Public programs can provide the financial resources and physical, social, and human capital necessary to encourage firm growth. However, public programs in Ontario are not strategically aligned with factors associated with larger firm size. In addition, Ontario’s policy initiatives are duplicative and uncoordinated, and are not directed toward sectors that are most likely to grow. Although the majority of programs provide firms with financial resources, it is unclear whether these initiatives are effective and efficient. Ontario should evaluate existing initiatives to ensure that public resources achieve these objectives and actually promote firm growth.

48 Kim P. Huynh and Robert J. Petrunia, “Age Effects, Leverage, and Firm Growth,” Journal of Economic Dynamics and Control, 2010, Vol. 34, No. 5, pp. 1003-13.

49 Traci L. Mach and John D. Wolken, “Financial Services Used by Small Businesses: Evidence From the 2003 Survey of Small Business Finances,” Federal Reserve Bulletin, October 2006, p. A167; Industry Canada, “Financing Statistics Special Edition: Key Small Business Statistics,” 2013, p. 10.

50 Meghana Ayyagari, Asli Demirgüç-Kunt, and Vojislav Maksimovic, “How Important are Financing Constraints? The Role of Finance in the Business Environment,” The World Bank Policy Research Working Paper No. 3820, 2006; Industry Canada, “Financing Statistics Special Edition: Key Small Business Statistics, 2003, p. 10.

51 Industry Canada, “Financing Statistics Special Edition: Key Small Business Statistics,” 2003, p. 10; Robert E. Carpenter and Bruce C. Petersen, “Is the Growth of Small Firms Constrained by Internal Finance?” The Review of Economics and Statistics, 2002, Vol. 84, No. 2, p. 299.


CHAPTER 4

BOTH THE PUBLIC AND PRIVATE SECTORS CAN USE THE RESULTS OF THIS STUDY TO ADDRESS THE CHALLENGE OF SCALING UP FIRMS IN ONTARIO.

Adopting an alternative definition of firm size, streamlining existing initiatives, and fostering a culture conducive to growth can achieve this objective. In addition, strategically allocating firm resources, encouraging international trade, incentivizing appropriate risk taking, as well as maintaining transportation networks and promoting agglomeration can provide firms with the tools required to make Ontario a place to grow.

MAKING ONTARIO A PLACE TO GROW


ADOPT AN ALTERNATIVE DEFINITION OF FIRM SIZEThe current classification of firm size solely assesses employee headcount and uses overly broad thresholds. It fails to consider other variables that influence a firm’s success and does not differentiate between sectors. A better measure of firm size is required in order to effec-tively target firms with programs and assistance.

The Institute recommends that a definition that considers employee headcount, revenue per employee, as well as variation across sectors, can be more informative for policy makers and business owners. Adopting an alternative definition of firm size can yield policy recom-mendations that better represent the business context and allow Ontario’s business owners to more accurately evaluate their performance.

STREAMLINE INITIATIVES DIRECTED TOWARD FIRMSAs it currently stands, some initiatives offered by the government provide contradictory and incomplete information. This can confuse and mislead business owners, wasting their resources while discouraging an entrepreneurial culture. Here, the Institute recommends that Ontario and Canada collaborate within and across governments to streamline initiatives directed toward firms. Programs should also undergo frequent internal evaluation to determine if the objectives are being fulfilled. Programs that are underutilized or fail to achieve their intended goals (firm growth, increased employment, higher R&D output, etc.) should be dismantled or revised.

In particular, federal and provincial programs that provide information to businesses are designed to act as a one-stop shop for information, but are uncoordinated, incomplete, and difficult to navigate. In the absence of a unified government resource, the Institute has published a list of the provincial and federal programs available to Ontario’s businesses on its website.

52 US Small Business Administration, “What We Do,” accessed November 6, 2015, https://www.sba.gov/about-sba/what-we-do/.

The Small Business Administration (SBA) in the US is a good example of how the government can streamline public initiatives. Established during the 1950s, the SBA is an independent agency of the federal government that helps start, build, and grow businesses.52 The SBA acts as a comprehensive source for information provision and delivery of key financial resources as well as human and social capital supports.

Likewise, Ontario’s Ministry of Government and Consumer Services currently operates ONe-Source, which helps businesses navigate government supports and forms and provides information on how to start, operate, and grow a business. This resource could be updated and expanded using the existing IT infrastructure and senior management leadership (as done through ServiceOntario). Alternatively, the government can build off the Ontario Network of Entrepreneurs, a suite of programs and resources funded by the MEDEI.

At the national level, the program BizPaL coordinates information on what is required to start and grow busi-nesses, and is jointly managed by the federal, provincial, territorial, and municipal governments. Although this initiative strictly focuses on permits and licenses for businesses, BizPaL demonstrates that inter- and intra-governmental collaboration on this file is possible.


FOSTER AN ENVIRONMENT FOR BUSINESSES TO GROWOntario needs to rethink existing policies that may restrict firm growth. These include the Small Business Deduction (SBD), the requirement that firms are a Canadian Controlled Private Corporation (CCPC) to access govern-ment services, and the existing regulatory environment that may all be hindering firm growth.

Ensure tax policy encourages firm growth. Relative to large firms, small firms enjoy many tax preferences and more favourable access to government subsidy programs.53 The SBD reduces the provincial corporate income tax rate from 11.5 to 4.5 percent for the first $500,000 of a firm’s annual earnings before income tax (EBIT) (Exhibit 22).54 The SBD is phased out as a firm’s assets rise above $10 million and is eliminated when they reach $15 million.55

The SBD is seen as a politically motivated program that discourages firm growth and reduces government revenue. A recent assessment of the SBD found that

Note: The SBD begins being phased out for firms with assets above $10 million and is completely removed after assets exceed $15 million.Source: Institute for Competitiveness & Prosperity analysis based on data from Canada Revenue Agency.

Exhibit 22 The small business deduction reduces incentive for firm growth

Ontario, 2015Small business deduction

0

2

4

6

8

10

12

14%

0 100,000 200,000 300,000 400,000 500,000 600,000 $700,000

Provincialcorporate

income tax rate

11.5%

4.5%

7.0%

Earnings before income tax

53 The underlying objective of these initiatives is to improve economic performance by mitigating market failures.

54 At the federal level, the SBD reduces the corporate income tax rate from 15 to 11 percent. Further, the SBD applies to qualifying active business income of a Canadian-controlled private corporation.

55 Department of Finance Canada, “Strong Leadership: A Balanced-Budget, Low-Tax Plan for Jobs, Growth and Security,” 2015. The Liberal Party of Canada proposed further reducing the SBD to nine percent.

56 Benjamin Dachis and John Lester, “Small Business Preferences as a Barrier to Growth: Not So Tall After All,” CD Howe Institute Commentary No. 426, 2015. This means that small firms are being incentivized to stay small or not report EBIT greater than $500,000.

57 ibid.

Canadian firms cluster at both the EBIT threshold and within the asset phase-out range.56 This means that small firms may being incentivized to stay small or not report EBIT greater than $500,000. Moreover, the SBD negatively impacts the public purse. The SBD is estimated to have reduced government revenue by $3.2 billion in 2014.57 From a policy perspective, recouping forgone tax revenue means that government must either cut spending or impose higher taxes elsewhere.

The Institute reiterates the recommendation from Working Papers 18 and 21 to modify the corporate income tax rate. The Institute proposes two tax neutral options for


Note: Areas depicted are for demonstrative purposes only and may not reflect the actual tax rate required to be tax revenue neutral. Area A represents the tax revenue gained and area B represents the tax revenue lost. Option 1 would be implemented with tax rates gradually stepping upwards in a similar way to private income tax.

Exhibit 23 Two tax neutral options for modifying Ontario’s small business deduction

Option 1: SBD phase out

0

2

4

6

8

10

12

14%

0 100,000 200,000 300,000 400,000 500,000 600,000 $700,000

Provincialcorporate

income tax rate

Provincialcorporate

income tax rate

Earnings before income tax

A

B

Option 2: SBD removal

0

2

4

6

8

10

12

14%

0 100,000 200,000 300,000 400,000 500,000 600,000 $700,000Earnings before income tax

A

B

changing the SBD (Exhibit 23).58 A tax neutral policy ensures that the total tax revenue generated for the government before and after the change remains the same.59 Option 1 avoids the large tax jump by gradually phasing out the SBD up to the general corporate tax rate of 11.5 percent as firms increase their revenue. The tax rate would increase incrementally, just like personal income taxes. Option 2 provides an alternative option whereby the SBD is eliminated and replaced with a lower general corporate tax rate for all firms. Under this approach, medium and large firms would face a lower tax rate than before and there would be no disincentive for firm growth.

A third alternation to the corporate income tax scheme could be an exemption on a firm’s additional earnings over the previous year. By allowing a firm to pay income tax on only their last year’s income, it would retain a large sum of free capital for reinvestment while growing. Allowing a firm to retain funds in order to attain scale would lead to larger firms that contribute more to the economy and pay a larger amount of tax in subsequent years.

58 Tax neutrality is highlighted as areas A and B can always be made equal to each other despite the difference in graphical size due to the number of firms paying that level of tax.

59 By lowering the general tax rate, large firms are expected to grow and this can further add to the tax base.

60 Institute for Competitiveness & Prosperity, Fourteenth Annual Report, Disruptions ahead: The making of a dynamic and resilient Ontario economy, November 2015; Statistics Canada, “Gross domestic product, expenditure-based, provincial and territorial, 2013, annual,” CANSIM Table 384-0038.

Correct Ontario’s low business investment. Ontario may be lagging its US peers in firm size due to low busi-ness investment. The Institute calculated that, in 2013, business investment per establishment in Ontario sat at $137,300, well below the North American peer median of $229,000.60 Low business investment leaves Ontario’s workers lacking the buildings, machinery and equipment, and intellectual property required to compete in a global marketplace. Ontario needs to find a way to encourage local and foreign business investment without playing the difficult betting game of picking winners. Continuing to


work at promoting sectors where Ontario holds a competi-tive advantage can ensure that investors see an expected return on their investment. Ontario can also work to ensure investment stability though consistent govern-ment action that is well broadcast to the public. Investors shy away from investing when they have concerns that government regulation may get in the way.

Re-evaluate the Canadian Controlled Private Corporation requirement for programs. Many programs, including the Small Business Deduction, require a company to be a Canadian Controlled Private Corporation (CCPC). This policy appears out of place as it discourages Canadian companies from accepting foreign investment to avoid losing their CCPC status. Instead, promoting companies that operate within Canada, employ Canadian workers, and pay Canadian taxes should be the goal of governments and their programs. Having this arbitrary requirement is in contrast with growing Ontario and is likely contributing to lower levels of business investment and firm size.

Encourage cross-industry collaboration within the private sector. Cross-industry collaboration should be encouraged within Ontario. Currently programs mainly match private firms with government or academic institu-tions.61 There are opportunities for private businesses to partner up on projects or ventures that are currently going unexploited. By matching for-profit firms with different specialization together, Ontario can expect increasingly innovative and profitable projects to be completed.

61 Institute for Competitiveness & Prosperity, Disruptions ahead: The making of a dynamic and resilient Ontario economy, 2015.


STRATEGICALLY ALLOCATE RESOURCES TO INCREASE FIRM INPUTS

Government and business owners should strategi-cally increase firm inputs (namely labour and capital). Increasing firm inputs should be made on a sector- specific basis and occur alongside other initiatives that can grow businesses.

Scaling up firms by increasing employee headcount yields the greatest returns to revenue per employee in Ontario’s service-producing sectors. The Institute’s research suggests that firms in Ontario’s retail and professional sectors exhibit the strongest relationships between employee headcount and revenue generated per employee. Additional employees in these sectors can bring in diverse knowledge, skills, and experiences that provide firms with the human capital necessary to tap into new markets and innovate. However, this does not seem to be the case for firms in Ontario’s goods-producing sectors, especially construction and manufacturing, which failed to demonstrate any productivity benefits when enlarging the size of their labour forces.

However, the returns associated with growing a firm’s labour force are not consistent. There are other initiatives that policy makers can encourage, and business owners can adopt, to scale up firms. The Institute estimates that 53 percent of Ontario’s initiatives for businesses are designed to increase a firm’s number of employees or capital stock. Arguably, these initiatives should be more strategically allocated and should strive to balance the various factors that are associated with increasing firm size and productivity. These include engaging in interna-tional trade, adopting an appropriate level of risk, and making tactical firm location decisions. Government initiatives should also undergo more stringent evaluation to determine their effectiveness at producing their desired outcomes.

SCALE UP INITIATIVES THAT ENCOURAGE INTERNATIONAL TRADE

The Institute recommends that policy makers continue to find ways to assist firms entering new markets with training, guidance, and safety. However, the Institute’s analysis reveals that not all firms in every sector benefit uniformly from trade. Import and export activities are related to larger revenue per worker for firms involved in manufacturing, finance, and professional services. Firms in Ontario’s construction and wholesale sectors appear to only benefit when exporting, but not importing.

There may be insufficient public support for Ontario’s firms to engage in international trade, and the Institute encourages the government to review existing programs and investigate whether there is demand to fill the current gap. Currently, only six percent of Ontario’s initiatives are designed to encourage international trade. These initiatives provide export insurance, new exporter grants, and consultation on how to best enter new markets. Furthermore, only three percent of Ontario’s initiatives are directed toward sectors that demonstrate a positive and significant relationship between revenue per worker and international trade.


INCENTIVIZE APPROPRIATE RISK TAKING

The Institute finds that firms that adopt a moderate level of risk generate, on average, higher revenue per worker. This is especially the case for firms in Ontario’s manufacturing, retail, information, finance, and professional sectors. By contrast, firms considered to be high risk tend to employ fewer workers and generate less revenue per worker. When private sector investors do not provide firms with the resources required to take on this risk (possibly due to the problem of asymmetric information), government intervention may be beneficial.

Only nine percent of Ontario’s initiatives directed toward businesses encourage firms to undertake appropriate risk taking. This is despite the fact that adopting a moderate level of risk, according to the Institute’s analysis, can boost revenue per employee by over five percent in some sectors. Moreover, the majority of public initiatives directed toward firms provide financial supports and, of the programs that do target a sector, most are directed toward manufacturing or professional services. To ensure that public resources are allocated strategically, Ontario should expand the scope of initiatives designed to encourage appropriate risk taking.

CONTINUE TO MAINTAIN TRANSPORTATION NETWORKS AND PROMOTE AGGLOMERATION

The Institute’s research suggests that a firm’s distance to transportation networks can influence firm size, measured by either employee headcount or revenue per worker. These results are most significant and consistent for firms in Ontario’s manufacturing and wholesaling sectors. However, the Institute believes that the benefits associated with physically locating close to transporta-tion networks exceed the benefits captured by the model. The Institute recommends that government continue to update and build upon existing transportation networks, as appropriate.

When planning to establish or relocate their business, owners should also ensure that they situate themselves in an area of optimal firm agglomeration. Only six percent of Ontario’s initiatives directed toward businesses look to increase firm agglomeration. Again, given the sizable benefits of agglomeration in the long-run, especially in Ontario’s information and professional service sectors, policy makers should ensure that public supports are sufficient.

Policy makers and business owners need to ensure that decisions to scale up Ontario’s firms are based on evidence. Adopting an alternative definition of firm size and growth, streamlining existing initiatives, and fostering a culture of growth can achieve this objective. In addition, strategically allocating firm resources, encouraging international trade, incentivizing appropriate risk taking, as well as maintaining transportation networks and promoting agglomeration can provide firms with the tools required to make Ontario a place to grow.


APPENDIX

Many factors play a role in determining the current size of a firm. In order to determine how firms in Ontario can increase in size the Institute made use of Ordinary Least Squares (OLS) and quantile regressions. The regressions are run by including variables of interest alongside control variables. The control variables ensure accurate regression results for variables that have potential policy implications. Two separate regressions are run in order to determine the effect key variables have on both measures of firm size. The two dependant variables are the natural log of employees and the natural log of revenue per employee at the firm level.

The two regressions are run as follows:

(1) ln(Employees)i = α1 + β11 X1(i) + β12X2(i) + β23 X3(i) + β24 X4(i) + ε1(i)

(2) ln(Revenue ⁄ Employees)i = α2 + γ21ln(Employees)i + β21 X1(i) + β22 X2(i) + β23 X3(i) + β24 X4(i) + ε2(i)

ln(Employees) Importer Moderate risk ln(Proximity to nearest highway)

ln(Facility size) Exporter High risk ln(Proximity to nearest airport)

ln(Population density) Participates in secondary sector: ln(Proximity to nearest freight)

Construction Intra-industry agglomeration

Manufacturing Total agglomeration

Wholesale City

Retail ln(Population with high school)

Transportation ln(Population with trade certificate)

Information ln(Population with upper education)

Finance Average personal income

Professional Unemployment

Other

Subsidiary

Age

Age squared

Three-digit NAICS code

X2 Market access X3 Firm structure X4 LocationX1 General imputs

The model included 31 variables grouped into four distinct categories: X1 (i) general inputs, X2 (i) market access, X3 (i) firm structure, and X4 (i) location variables.


The firms in Ontario vary to a great degree and span the spectrum from small local operations to multination corporations. Changing variables do not have the same effect on firms of different sizes. The quantile regression extracts the effect on multiple firm sizes to be used in conjunction with the average OLS results. Obtaining results for firms in all stages of their lifecycle can illuminate which policies may have the greatest benefit on each grouping. The quantile of the dependant variable being analysed is denoted by τ. τ can take on any value in the range (0,1) and a value of 0.5 would represent the median with the largest half of the observations above and smallest half bellow the cut-off. The quantile regression derives its beta coefficients in a similar way to OLS.

Quantile Qτ(Yi|Xi ) = arg min E [ρτ(Yi – q(Xi))] q(X)

ρτ(u) = 1(u > 0) • τ|u| + 1(u ≤ 0) • (1 - τ)|u|

The ρτ equation allows different weights to be put on observations above and below the quantile level being evaluated (τ).62

Special care is taken to ensure the models estimates are correct. The traditional assump-tion that the error terms are independently and identically distributed is likely to fail in this dataset. The method of clustering errors is selected in order to allow correlation between firms that reside near one another while maintaining the traditional assumption of independence across groupings.63 Failing to control for clustering within groupings can lead to overly small standard errors that erroneously depict statistical significance.64 Within the dataset, Ontario is naturally broken down into 49 geographic areas known as census divisions. These census divisions serve as the clusters in the regression analysis.

The Dun and Bradstreet dataset may also suffer from a problem of double counting. The Institute was unsure if key variables were accurately attributed to the firm and location they belong to. To improve the confidence in the results, firms that are listed as either headquarters or subsidiaries were removed.

Transportation network and agglomeration variables were constructed from latitude and longitude data included in the dataset for each firm. The latitude and longitude of each firm were taken and plotted against an overlay of Ontario. The three transporta-tion network variables were calculated by finding the straight line distance to the closest highway, airport, and train station. Using a similar technique, the number of firms within a five-kilometre radius were counted and then divided by the total number of firms within Ontario. The result represents the agglomeration level around each individual firm (total agglomeration). This procedure was then repeated but counted only firms with the same three-digit NAICS code (intra-industry agglomeration). The intent of the intra-industry agglomeration calculation is to capture geographic groupings of similar firms.

62 Joshua D. Angrist and Jorn-Steffen Pischke, Mostly Harmless Econometrics: An Empiricist’s Eompanion, Princeton: Princeton University Press, 2009, pp. 269-71.

63 A. Colin Cameron and Douglas L. Miller, “A Practitioner's Guide to Cluster-Robust Inference,” The Journal of Human Resources, 2015, Vol. 50, No. 2, pp. 317-72.

64 ibid.


Previous Publications

Annual ReportsFIRST ANNUAL REPORT – Closing the prosperity gap, November 2002SECOND ANNUAL REPORT – Investing for prosperity, November 2003THIRD ANNUAL REPORT – Realizing our prosperity potential, November 2004FOURTH ANNUAL REPORT – Rebalancing priorities for prosperity, November 2005FIFTH ANNUAL REPORT – Agenda for our prosperity, November 2006SIXTH ANNUAL REPORT – Path to the 2020 prosperity agenda, November 2007SEVENTH ANNUAL REPORT – Leaning into the wind, November 2008EIGHTH ANNUAL REPORT – Navigating through the recovery, November 2009NINTH ANNUAL REPORT – Today’s innovation, tomorrow’s prosperity, November 2010TENTH ANNUAL REPORT – Prospects for Ontario’s prosperity, November 2011ELEVENTH ANNUAL REPORT – A push for growth: The time is now, November 2012TWELFTH ANNUAL REPORT – Course correction: Charting a new road map for Ontario, November 2013THIRTEENTH ANNUAL REPORT – Finding its own way: Ontario needs to take a new tack, November 2014FOURTEENTH ANNUAL REPORT – Disruptions ahead: The making of a dynamic and resilient Ontario economy, November 2015

Working PapersWORKING PAPER 1 – A View of Ontario: Ontario’s Clusters of Innovation, April 2002WORKING PAPER 2 – Measuring Ontario’s Prosperity: Developing an Economic Indicator System, August 2002WORKING PAPER 3 – Missing opportunities: Ontario’s urban prosperity gap, June 2003WORKING PAPER 4 – Striking similarities: Attitudes and Ontario’s prosperity gap, September 2003WORKING PAPER 5 – Strengthening structures: Upgrading specialized support and competitive pressure, July 2004WORKING PAPER 6 – Reinventing innovation and commercialization policy in Ontario, October 2004WORKING PAPER 7 – Taxing smarter for prosperity, March 2005WORKING PAPER 8 – Fixing fiscal federalism, October 2005WORKING PAPER 9 – Time on the job: Intensity and Ontario’s prosperity gap, September 2006WORKING PAPER 10 – Prosperity, inequality and poverty, September 2007WORKING PAPER 11 – Flourishing in the global competitiveness game, September 2008WORKING PAPER 12 – Management matters, March 2009WORKING PAPER 13 – Management matters in retail, March 2010WORKING PAPER 14 – Trade, innovation, and prosperity, September 2010WORKING PAPER 15 – Small business, entrepreneurship, and innovation, February 2012WORKING PAPER 16 – Making sense of public dollars: Ontario government revenue, spending, and debt, May 2013WORKING PAPER 17 – Untapped potential: Creating a better future for service workers, October 2013WORKING PAPER 18 – Taxing for growth: A close look at tax policy in Ontario, October 2013WORKING PAPER 19 – The realities of Ontario’s public sector compensation, February 2014WORKING PAPER 20 – Building better health care: Policy opportunities for Ontario, April 2014WORKING PAPER 21 – Open for business: Strategies for improving Ontario’s business attractiveness, May 2015WORKING PAPER 22 – Better foundations: The returns on infrastructure investment in Ontario, September 2015

The Institute for Competitiveness & Prosperity105 St. George StreetSuite 9000Toronto, Ontario M5S 3E6Telephone 416 946 7300Fax 416 946 7606

Should you wish to obtain a copy of one of the previous publications, please visit www.competeprosper.ca for an electronic version or contact the Institute for Competitiveness & Prosperity directly for a hard copy.

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