21, December 2022
Can Government intervention increase R&D spending?
Canadian governments have wanted to increase R&D spending for a long time. In the Blog we’ll look at a couple of policies that have been tried and see how they worked out.
Why choose R&D spending?
Two main reasons. First, there have been some specific numerical goals in the past, so that makes it easier to determine if the goals were met, compared, for example, with increasing diversification or productivity, which are harder to measure. Second, there are reliable statistics produced by Statistics Canada.
Why do governments want to increase R&D spending?
This is usually articulated along the lines: “R&D today means more higher paying jobs tomorrow”1. However that view seems to be based on the linear model of innovation, where basic research leads to applied research, then production and finally dissemination. That model has been roundly criticized2 but continues to be influential. Modern theories of innovation focus more on feedback between the different stages. Whichever model of innovation is used to justify increasing R&D, it is widely acknowledged that developing new knowledge through R&D is the foundation of a 21st century economy. So the goal of increasing R&D spending is very worthwhile.
Policy #1: Fifteenth to fifth
In 2001 the Federal government introduced its “Fifteenth to Fifth” program, with the objective of improving Canada’s ranking for GERD/GDP from 15th place to 5th place by 2010. The analysis pointed out that while government and university spending on R&D (as a percentage of GDP) were comparable to the US, business spending was much less, about half the US level. This was accompanied by a number of new measures in the 2001 budget:
- Expanding the Canadian Foundation for Innovation to support research infrastructure at universities
- Doubling the Canada Research Chairs program
- Increased funding or NSERC and SSHRC
- Establishing several new research centers including the National Institute or Nanotechnology (NINT)
- Expanding agricultural research.
Policy #2: Scientific Research and Experimental Development (SR&ED)
Canadian governments have been providing tax relief for R&D sending since at least 1944. The current program was introduced in 1977, and the wording “Experimental Development” added in 1986. The program currently costs about $4 billion annually, and supports 25,000 claimants, 65-70% of them small businesses. Most provinces have added a “top up” to the federal program.
Canada offers one of the most generous R&D tax incentives to businesses in the G7.
What was the result of these policies?
The graph below shows GERD/GDP for Canada and the US from 2000 to 2020, together with the OECD average.
In 2002 Canada spent 2.1% of its GDP on R&D, and in 2021 that number had declined to 1.6%. Canada’s ranking in 2020 was 19th. So it is clear that neither policy has achieved its objective of increasing R&D spending in Canada as a percentage of GDP.
Why didn’t the policies work?
If you dig a little deeper into the numbers, it becomes clear that Canada has a very competitive Higher education research sector. Canada has 0.5% of the world’s population, 2% of world GDP and 4% share of peer reviewed research publications3. Where it falls behind in in Business research, or BERD.
In hindsight it is clear that the measures adopted in 2001 targeted almost exclusively the education sector, an area where Canada was already strong.
The SR&ED program has been criticized as being a “one size fits all” policy.
What can be done?
The Federal government is embarking on a review of the SR&ED program. Some of the ideas discussed include:
- Reducing red tape
- Making the program more generous for firms that take bigger risks
The Business Council of Canada has proposed several changes4 including:
- Providing a preferential rate to advanced industries with high concentration of R&D
- Fixing the imbalance between small and large firms. The current program is more generous to smaller firms.
- Adopting an “IP Box” approach that would tax income from patents and other intellectual property at a special low rate.
To answer the question posed at the beginning of this Blog, these particular government interventions clearly didn’t increase R&D spending.
There often seems to be a sense of frustration “you can take a horse to water but you can’t make it drink” about discussing business R&D spending. I think this misses a crucial point. Companies don’t spend on R&D because they want too, but because they have to, to maintain their competitiveness or implement a growth strategy. Many Canadian companies have been doing very well without spending much on R&D. A great deal of Canadian industry is oligopolistic, where a few companies dominate the market. In these situations competition is lessened and the need for R&D is reduced. Some examples:
- Three companies dominate telecommunications;
- Two companies dominate airlines;
- Five companies dominate banking;
- Three companies dominate grocery stores;
- Two companies dominate print media;
- Two companies dominate beer;
- There are many more examples.
So the best way to increase R&D spending – that will also improve a host of other factor such as low spending on IT, low employee training, etc.- is to make the economy more competitive. That means more anti-trust enforcement, and updating the Competition Act (the Canadian government has already announced some small steps in this direction). Even the the Commissioner at the Competition Bureau has noted the decline in competitiveness of the Canadian economy and called for updating the Competition Act to create a more competitive economy.
- Budget speech Paul Martin 2001.
- The Linear Model of Innovation: The Historical Construction of an Analytical Framework. Benoit Godin. http://www.csiic.ca/PDF/Godin_30.pdf
- Competing in a Global Innovation Economy: The Current State of R&D in Canada. Council of Canadian Academies http://new-report.scienceadvice.ca/
- Business Council of Canada https://thebusinesscouncil.ca/publication/scientific-research-and-experimental-development-sred-reform/