Industry Committee on Nov. 22nd, 2007

[The Vice-Chair, Liberal, Dan McTeague]

Good morning everyone. At the request of several members, we will begin this morning's meeting.

This is the fourth meeting of the Standing Committee on Industry, Science and Technology. On the agenda, pursuant to Standing Order 108(2), we are studying the services sector in Canada.

Colleagues, we have with us today three witnesses: Tom Wright, who is the assistant deputy minister, industry sector; Janet King, director general, service industries and consumer products branch; and from the Department of Finance, Ms. Colleen Barnes, acting director, financial institutions, financial sector policy branch.

Witnesses, welcome here this morning.

This is our first meeting since last June, so our colleagues may be a little peppy this morning. In fact, you won't have to worry about me at this point, because the chair will be taking over.

You will each have 10 minutes for opening statements, at which point colleagues will then be asking you questions.

Thank you for being here. We look forward to hearing what you have to say.

[Tom Wright, Assistant Deputy Minister, Industry Sector, Department of Industry]

Thank you very much, Mr. Chairman.

Given that the decision to study the services sector is a recent one, we did not have much time to prepare the data. However, we have distributed a deck—I am sorry that it was not available earlier—which we will use to try and give you a general overview.

We'll try to share with the committee today a little bit of a 30,000-foot look at the services sector, and particularly at key trends. Perhaps this will point your deliberations towards some of the challenges.

My plan is to go through this deck and then turn to my colleague Colleen Barnes, from the Department of Finance, who will be able to speak in a little more detail about the finance and insurance sector within that global umbrella of the services sector.

I'll turn to page one of the deck I've distributed to members. The first point to make in looking at the services sector is that it is hugely diverse. We're not talking about a sector that is homogeneous in very many respects. It is important, and unambiguously. Two-thirds of GDP and employment get affected through this sector.

It encompasses both public and private sectors, and so what you're going to be seeing is government and non-market services as well as producer services. That will become important as you pursue your investigations, because this is a segment of the economy that is inextricably linked with manufacturing. Their role vis-à-vis the balance of the economy is something that is important to understand.

This is particularly the case if you start taking a look at marketing, procurement, logistics, and that sort of thing. In fact, there are studies out of the OECD that would suggest to you that services account for upwards of 25% of the value-added activity. So it's a very important sector, but understand that wide element of diversity.

I mentioned to you that it accounts for over two-thirds; in fact, it's close to 70% of the economy. It's important to recognize as well--if you look at the chart on the bottom right-hand side--that the share of services in total economic activity has been increasing over time. So this isn't a stagnant portion of our economy; there has, in fact, been shift there. You'll see that as a portion of the economy it's been relatively stable over time, at some 70%. There's been a dimension of growth, and we'll see that in some of the subsequent slides.

On slide three, you see some of the detail. I made the point at the outset that this is not a homogeneous sector. You can't look at it as being all the same jobs, all the same kind of activity. Here you get a snapshot of some of that variation. This particular snapshot tries to outline the relative contributions to GDP. You'll see that the largest components are real estate, wholesale, retail, finance, and insurance, and yet down at the other end you have a series of things such as tourism, which are far smaller contributors to the overall GDP of the economy.

In the centre, you'll see that there are large segments that are industries performed with the assistance of public funding, and by that I'm referring to health care, government, education. Those are major contributors as well.

Slide four starts to point out that, while this has been a relatively stable component, growing somewhat at 70% of the economy, there have been elements of growth, and in a sense they have grown faster than other elements of the economy. You'll see there that the total economy has grown by some 2.8%—I'm talking about the last five years here—whereas the services sector has grown at an average of some 3.2%.

The fastest elements of growth are wholesale and retail, associated with a healthy economy. Also among the areas, you're seeing growth in arts and entertainment, albeit at the bottom end. I would note that none of them are demonstrating negative growth; there has been growth in all segments of services.

Turning to slide five, clearly the contribution of service industries to employment has increased over time, and here you will see that there was a bit of a change around 1958, when services started to exceed the goods-producing sector in terms of employment. Back in 1946, 40% of Canadian workers were in the service sector, and today you'll see that it is a far higher proportion. The service sector accounted for some 90% of the increase in employment in Canada between 2005 and 2006, so you'll see that there is clearly activity going on in this sector.

Slide six starts to take a look at retail trade accounts, and that is the largest share of employment. The retail trades account for a huge amount, fully 16%, but if you take a look at total employment in the economy, we're talking in the order of 10.9 million people as of 2006. Retail and health care are the largest ones. That's not particularly surprising, I don't suspect. In the overall composition--you see that we have bars indicating 2002 and 2006--there is relative stability. You see the variation through the sub-sectors, but there is relative stability across time.

As you would expect, given all of those facts so far, retail has created the most jobs within the services sector since 2002. Over the past five years, you'll see, the increases are in retail, health care, and administrative support, and again, it hasn't fallen in any of them. It's an important dimension to recognize. This is a segment of the economy that is, in fact, growing.

It's important to understand what the distribution of wages looks like in this sector. The hourly wage in the services sector, on average, was $20.59 in 2006. It's below manufacturing, which over that period of time clocked in at $23. However, there are significant differences. At the outset I suggested to you that the services sector is not homogenous, and again, you see that lack of homogeneity reflected here in terms of wages. Perhaps not surprisingly, we have a number of sub-sectors in services that are above the national average, and it comes as no surprise, obviously, that there is a group that is below the national average.

As show on slide nine, productivity growth has in fact been quite high in the services sector relative to other portions of the economy. It has been gaining ground, and it's outperformed the other sectors. It's an important dimension to recognize that this labour productivity growth rate is greater in the services sector.

In terms of exports, services account for a relatively small share of total Canadian exports, but it's been somewhat consistent over time. Exports totalled about $64 billion and about 13%. Imports constitute about 16%, and the bulk of this is in what economists would term commercial services. Commercial services comprises a broad basket of activities that covers communications, construction, insurance, and the financial sector.

There is a whole host of sub-elements there. I think if you were to talk to economists about some of this, they might get into some of the challenges of data in this sector. It's important that data be consistent. With the evolution in the economy, global value chains, and inter-firm commerce, keeping accurate records of some of this data becomes a bit of a challenge on some fronts.

There has been absolute growth in exports, and I think that's an important dimension.

On slide 11 I've tried to capture a bit of a summary of some of these slides. Services is a large portion of the economy. It does provide an essential support to the other segments of the economy. It has accounted for most of the job gains of late. There's always an assumption that it has low-paying wages, but a number of components of this sector offer very good and above-average wages. It's a diverse sector. It has been experiencing increased investment that has led to its increased productivity. And the exports are there. They're significant. They're growing somewhat. There is opportunity for the future.

I will stop there.

I do not know if I used the ten minutes allotted to me, Mr. Chairman, but with your permission, I will give the floor to my colleague from the Department of Finance, Colleen Barnes, who will talk a bit more about the services sector elements that affect the financial industries.

[The Chair, Conservative, James Rajotte]

Thank you, Mr. Wright.

Ms. Barnes.

[Colleen Barnes, Acting Director, Financial Institutions, Financial Sector Policy Branch, Department of Finance]

Thank you very much.

I want to talk to you today a little about what we could pull together quickly for the committee on the financial services sector. I'm open to responding to questions and getting you more information, depending on the questions you might have.

I'll give you a little bit of a profile of the sector overall and talk a little bit about the financial performance we've seen recently of the banks and life insurers, which we tend to track pretty closely, and then just talk a little bit about the global activities of Canadian banks and life insurers.

The financial sector is one of the key pillars of the economy. It's one of those infrastructure sectors that's there for both manufacturing and the other services industries. It's made up of a variety of different entities, including banks, trust and loan companies, credit unions and caisses populaires, life insurance, property and casualty insurance, securities dealers, leasing advisers--a full range of entities. These entities vary from having federal regulation, joint federal-provincial regulation, or some just provincial regulation.

The sector accounts for about 700,000 jobs in Canada. That constitutes about 4% of national employment. It also has been growing in terms of its contribution to GDP as a sector. Two decades ago it was running about 4.5% and now is up to 6.2%. It's a source of high value-added jobs. If you look at Mr. Wright's presentation, the wage level in that sector, finance and insurance, is quite high. As I said, it plays a critical role in the economy in terms of the allocation of capital and the distribution of risk across the economy.

I'll take you through some of the big sectors, or big sub-sectors, in the financial services areas starting with banks and deposit-taking institutions in general. We have about 21 domestic banks in Canada, 24 foreign subsidiaries operating here, 22 full service branches--these are entities that lever off of the capital in the home markets, as they don't need to have as much capital in Canada--and we have six lending branches.

It is, however, a sector that is fairly concentrated in Canada. The big six banks, which would be Royal, TD, Scotia, CIBC, Bank of Montreal, and Banque Nationale, account for about three-quarters of the assets in the deposit-taking sector in Canada. The provincial entities, such as the caisses populaires and the credit unions, would account then for about 12%, and foreign banks about 8.5%. So the other Canadian institutions are relatively small and account for only about 2% of our deposit-taking sector.

Our banks are very prominent in our capital markets in Canada. If we just take the year to date, the equity raised in Canada, the five large banks accounted for about 65% of that underwriting. So not only are they big on the deposit-taking side, they're also big in our capital markets. The capital markets activity has grown for our Canadian banks. It's about 27% of their assets right now and it used to be about 19% maybe a decade ago, so it's an area they're doing more in.

On life insurance, we have about 100 life insurance companies in Canada. These companies employ about 51,000 people full time, but the sector overall accounts for about 120,000 people once you include the advisers and the assessors and adjusters. We've got some concentration here as well. The big three, which would be Manulife, Sun Life, and Great-West Life, account for about 60% of domestic net premiums. The foreign players then are the next biggest. There are about 53 of those, accounting for 22% of the premiums, and then the other domestic smaller companies, about 18%.

On property and casualty insurance, we have about 214 players in the market and that sector accounts for about 110,000 people in Canada, 40% directly working for the property and casualty insurers and 60% being the brokers and adjusters. This industry is not as concentrated. The largest entity, which I think is probably ING, would account for about 11% of net premiums. It's not as concentrated as life insurance and banking and it's more heavily foreign-dominated. So foreign players in Canada earn about 58% of the net premiums earned.

There are other elements of this sector. If the committee wants more information on those, I would be happy to get that for you. For example, there are 476 credit unions in Canada. Those are provincially regulated. Also, there's Desjardins in Quebec. Then the securities industry, for example, employs about 41,000 people in Canada, so that's a significant industry segment as well.

We had done a presentation looking at what the recent performance of banks and life insurance companies has been in Canada. Both sides of this industry have been very profitable and doing very well. Even through the August market turmoil, they seemed to be weathering those developments quite well.

We've seen over the last decade or so the banks averaging between 15% to 20% return on equity. There was a dip in 2002 when a lot of companies pulled out of the United States commercial loan market. Scotiabank had a big writeoff in Argentina, so there was a little dip there. Then in 2005, when CIBC did their Enron writeoff, there was a little bit of a dip. But they've certainly been trending now up over 20% in terms of returns, so they're doing well.

Also, since 1990 we've been looking at impaired loans as a percentage of all the loans that the banks are carrying. It looks like the intermediation function is getting even better in Canada. That could be a function of the strong economic times that we have been enjoying, but it does look like credit underwriting decisions are getting stronger. Both the banks and insurers have very strong capital positions vis-à-vis the requirements that OSFI, the Office of the Superintendent of Financial Institutions, requires of them.

In terms of the size of the Canadian banks, they are mid-sized players when you look at all global banks. You have the Royal sitting at about 40th. That would be our largest bank in terms of assets, compared with global banks. Going all the way down, the CIBC would be about 58th. So we rank in the mid-tier group of banks in the world.

On the insurance side, again, we see very good capital ratios. We have three very strong companies there in Manulife, Sun Life, and Great-West Life. It's a sector where there's been a lot of consolidation in the last few years. In 2002 Sun Life acquired Clarica. In 2003 Great-West Life acquired Canada Life, and in 2004 Manulife bought John Hancock in the United States. These transactions have really improved the performance of Canadian life insurance companies, or those three in particular. Unlike the banks, the insurance companies globally are within striking distance of the top players. Manulife ranks about third or fourth in the world in terms of global insurance companies, and Great-West and Sun Life would also be in about the top 12.

One thing we watch with these institutions, particularly the large Canadian banks and life insurances, is their global activity, because it's interesting to see what they're doing abroad. With Canadian banks, in terms of their assets, about 65% are domestic, but 34% would be coming from their foreign operations. It's weighted a little more heavily on the life insurance side, where they're getting about 54% of premium income from their operations outside of Canada.

Each of these institutions has its own strategies in terms of its global aspirations. We've seen BMO, TD, and Royal really focusing on the U.S. retail market in recent years. Scotiabank is the most global of the Canadian banks. They have a global retail strategy and they have significant presence in Mexico and many Caribbean and Latin American countries. They're also focused on Asia, as are most of the other institutions. CIBC's building on the Caribbean, and all banks are pursuing global wholesale banking, as well, outside of Canada and pursuing wealth management opportunities abroad.

There's been a lot of consolidation of the large life insurance companies domestically, as I mentioned, and also the big Hancock deal with Manulife. Manulife's now a major global player and has significant operations in North America and Asia. Sun Life is looking at operations in Europe, in the U.S., and also in parts of Asia, and Great-West Life is looking for acquisitions and growth in the U.S. and Europe.

That is what I've prepared. I'd be happy to take any questions.

[The Chair, Conservative, James Rajotte]

Thank you, Ms. Barnes, and thank you very much, Mr. Wright.

We'll now go to questions from members. The first round will be six minutes and the second round will be five minutes.

We'll begin with Mr. Brison, for six minutes, please.

[Scott Brison, Liberal, Kings—Hants, NS]

Thank you very much for being here with us today.

I have a question on the linkage between manufacturing and the service sector, particularly around design and engineering. With a global supply chain economy, the question for any country is: where are you in that supply chain?

I think it was in the eighties that there was so much concern in the U.S. and Canada about the trade deficit with Japan. Ultimately it was determined that a lot of that trade deficit was on low-margin products. The design for the televisions was still in North America, but the low-end manufacturing had evolved toward Japan.

I'm interested in what the trend line is around the design and engineering part of the manufacturing sector, which is still in the service domain. With the emergence of countries like India particularly, in this range, are we keeping up or is the trend line negative in terms of our capacity to compete and succeed in what has traditionally been considered an area of comparative advantage for Canada or the United States?

[Tom Wright]

To answer your question precisely, we'd have to get some data. You're talking about a trend line, so I'd have to try to get some data to answer that element of your question.

I think you're referencing a couple of other very important elements, and one is the notion of the global supply chain. That very much touches engineering and design. It also touches a whole host of the other elements of whatever business an entity may be in. We've actually done some work on global supply chains with some elements of the industry. My colleague may be able to speak to you a little bit about that in detail.

I wanted to pick up on the anecdotal notion. I actually was asking a similar question of a senior executive of an aerospace company the other day: what does the future hold? I was sort of looking out. The explanation I got back is that...less concerned about trend, and wanting to seize the comparative advantage of being able to have 24-hour engineering. This particular executive was associating value to the notion that the project could be worked on here today in Canada, and later tonight, whether it was India or wherever else in that portion of the globe, that same piece of research was going to evolve another step.

In this executive's mind, it had been determined that the comparative advantage that would accrue to the success of his company here in Canada in a global business was going to be at the pace at which that work could take place.

[Scott Brison, Liberal, Kings—Hants, NS]

So just to clarify, he was assuming that geography would be an advantage in terms of response time.

[Tom Wright]

That's correct, using the 24 hours of a day with geography to keep the design and the engineering going for the full 24 hours rather than just the 9-to-5 environment.

So that was an important piece of the puzzle. But he also cautioned that in some of the areas where there's a high degree of proprietary work going on, you want to keep a lot of it here in Canada.

This is anecdotal, so I apologize for....

[Scott Brison, Liberal, Kings—Hants, NS]

So with the death of distances as a determinant in the cost of telecommunications and with the advances in telco, the other question is whether or not geography will continue to be an advantage when somebody can be working on an R and D project in India and just as effectively liaise with a manufacturing design group here in Canada as if they were next door.

If we're looking towards the future and we believe that higher-margin jobs and the research and development and design and engineering sides are really important to our economy, we ought to be augmenting and strengthening tax and regulatory measures to focus on those to make Canada more effective in that particular space. We can't be great at everything, but it strikes me that we should be considering that.

The other thing is that in terms of outsourcing, even on the service side, we've seen the call centre-type jobs that were in Canada and servicing North America increasingly go offshore; we're seeing a trend in that. Those had been considered low-margin or low-value service jobs, but now they're actually evolving into higher value-added jobs, because you're dealing with the engineering- and IPC-type service jobs.

For all members, I just think that as we're trying to understand this, we ought to really drill down on what is happening in this high-value area.

If you could help me with that trend line or get back to us with that trend line, particularly around India but not exclusively India, it would be helpful.

[The Chair, Conservative, James Rajotte]

Thank you.

Did you want to respond to that, Mr. Wright?

[Tom Wright]

I would just say that, yes, we will do some research on the trend line and get back to the committee on that.

Also, I would note your observation that jobs such as call centre jobs, which were viewed as lesser-skilled jobs some time ago, are in fact evolving. When one starts to look at trend lines, one has to be careful of the apple and the orange...because of some of those changes.

[The Chair, Conservative, James Rajotte]

Thank you.

We'll go now to Madame Brunelle.

[Paule Brunelle, Bloc, Trois-Rivières, QC]

Good morning and thank you for being here.

I will continue in the same vein as Mr. Brison. Competition from emerging countries, including China, has meant that things are really very complex and that we have lost a number of markets. This is particularly true in the case of the manufacturing sector. We have had a tendency to tell ourselves that we should invest more in research and development and make our engineering firms work more in order to develop leading edge expertise. Moreover, I am told that more and more emerging nations, whether it is China or India, are also training engineers.

If the federal government does not act more forcefully in this matter, will we not see a situation develop where the research and development sector and the high technology sectors will experience the same difficulties as the manufacturing sector? If that is the case, should the government intervene? What should we do?

[Tom Wright]

I'm not sure I have the answer to all of your questions. Having said that, I understand very well.

It is clear that China and other countries are making progress. There are an enormous number of engineering and other science graduates. It is obvious that that will create competition. The government has set up the framework for science and technology advice, which deals with some of these aspects in terms of the possibilities for Canada. The government has already tabled an approach for this aspect.

I will quote the example I used earlier. Mr. Brison spoke of global value chains. The globalization of business is very important today. That means we must find a way of using the fact that China and India are making progress. The example I gave to the person I was talking about earlier was obviously the aerospace sector. That person explained to me that she would use it and that she would find an advantage for Canada in the fact that China and industry are developing their engineering sector.

We have to work on both levels. We have to increase our domestic capacity in Canada and find a way to deal with the reality of those countries as well.

[Paule Brunelle, Bloc, Trois-Rivières, QC]

Do you have the impression that the government is playing catch-up with what is happening elsewhere? Do you find that we are always two steps behind? Do you think we could develop a vision and try and establish an industrial policy and development policies that are more proactive?

[Tom Wright]

As a good public servant, I am always proud of my government.

[Voices]

Oh, oh!

[Paule Brunelle, Bloc, Trois-Rivières, QC]

Which does not prevent us from doing better.

[Tom Wright]

We can always do better in everything.

[Paule Brunelle, Bloc, Trois-Rivières, QC]

Do I have a bit more time, Mr. Chairman?

[The Chair, Conservative, James Rajotte]

You have three minutes.

[Paule Brunelle, Bloc, Trois-Rivières, QC]

Ms. Barnes, you talked about banks and insurance companies. They seem to be in a strong position. They make a lot of profits. The criticism we most often hear comes from the users, from the people. The complaints have to do with interest rates and with insurance companies that write up clauses in very fine print in their contracts, to the degree that people always have the impression they are being had.

Is the role of your department to defend the interests of the people, or those of the companies?

[Colleen Barnes]

The financial institutions established here in Canada come under our department. We must always maintain a balance between the consumers and the industry. The companies must be very strong, because that generates spinoffs for the people who are shareholders in the banks and for retirees whose pension funds are invested in these institutions.

But we must never lose sight of the other two goals: that consumers be well protected and served by the institutions, and that the stability of the framework be maintained.

[Paule Brunelle, Bloc, Trois-Rivières, QC]

We saw the debt overload of the American population. Loans were granted for up to 80% of the value of a house, for example, and that created a major crisis. Will this have any effect on Canada?