Business Enterprise R&D

Key Messages

Why is business R&D important to innovation?

Business enterprise research and development (business R&D) is an important indicator of business commitment to innovation and a key input into many high-value-added types of innovation. Although R&D is not a direct measure of innovation performance—because such investments can be poorly selected and valuable results are not guaranteed—the development of new or improved products, processes, and services frequently requires R&D efforts.

R&D “signals a firm’s commitment to the systematic generation and commercial application of new ideas,” according to the Council of Canadian Academies’ Expert Panel on Business Innovation.¹ Indeed, R&D indicates that a firm is serious about exploring or generating new ideas with a view to developing those ideas into new or improved products, services, or processes.

Research shows that business enterprise R&D—sometimes referred to as “BERD”—is associated with productivity and GDP growth. A multi-country study by the OECD found that a “sustained increase of 0.1 percentage points in a nation’s BERD to GDP ratio would eventually translate to a 1.2 per cent higher GDP per capita, other things being equal.”² Thus, business R&D provides a useful, albeit partial and imperfect, proxy for business innovation performance.

How do the provinces rank relative to international peers?

The provinces continue to receive very poor grades for business R&D relative to international peers. As in the previous report card, eight provinces get D– grades and take up the bottom positions in the overall rankings. Business R&D as a share of GDP is only 0.74 per cent in B.C.—less than one-third the 2.58 per cent spent by firms in top-performing Japan. At only 0.3 per cent of GDP—less than an eighth of Japan’s business R&D—P.E.I. slips five places and sits last among provincial and international peers.

Japan (2.58 per cent of GDP) is joined by Switzerland (2.43), Sweden (2.29), and Austria (2.21) as the only peers to get A grades on this indicator. Previously ranked second, Finland falls to seventh and drops to a B on the current report card, with business R&D falling from 2.28 to 1.93 per cent as a share of GDP.

Quebec outperforms all provinces, with business R&D of 1.44 per cent of GDP, but trails nine international peers and spends just more than half of what Japanese firms spend as a share of GDP. This performance earns Quebec a C grade. Ontario gets a D for business R&D intensity of 1.12 per cent of GDP—slightly higher than in 2013. It matches the performance of the U.K. (1.12 per cent) and does better than three international peers—Netherlands (1.11 per cent), Ireland (1.09 per cent), and Norway (1.04 per cent)—as well as the Canadian average (0.9 per cent).

Despite a small uptick in business R&D since the previous report card—from 0.82 to 0.9 per cent as a share of GDP—Canada continues to languish in last place among international peers. Canada has been a D performer since the 1980s. Its business R&D declined both as a share of GDP and in absolute terms from $15.6 billion (0.95 per cent of GDP) in 2011 to $14.8 billion (0.87 per cent of GDP) in 2013, before moving back up to $15.9 billion (0.9 per cent of GDP) in 2015.³

To match the peer average of 1.69 per cent and make the top 10 among international peers, Canada would need to almost double its business R&D intensity. Even then, Canada would achieve only a C.

How do the provinces rank relative to each other?

Quebec is the highest-ranking province, with a grade of C, followed by Ontario with a D. Both provinces have business R&D above 1 per cent of GDP. B.C. (0.74 per cent) and Alberta (0.59 per cent) rank third and fourth, respectively, among provinces, but still achieve only D– grades relative to international peers. Manitoba, Saskatchewan, and the four Atlantic provinces also get D– grades, with business R&D in all six of those provinces sitting below 0.5 per cent of GDP.

How has provincial performance changed over time?

Between 1991 and 2001, business R&D as a share of GDP increased in every province except New Brunswick and Alberta, where it declined marginally. In 2001, Quebec (1.74 per cent) and Ontario (1.7 per cent) had business R&D that ranked fourth and fifth, respectively, among international peers.

For one or two years following the dot-com crash in 2001, business R&D dropped in most provinces and international peer countries. Since then, however, while international business R&D has recovered and gradually climbed, business R&D in most provinces and Canada as a whole has plummeted.

Between 2002 and 2012, business R&D as a share of GDP fell in seven provinces. Quebec and Ontario each lost more than a third of a per cent, pushing those provinces down to the middle of the international rankings. Only Newfoundland and Labrador, P.E.I., and Alberta had increases in business R&D, but given their low starting points and strong growth among international peers, that growth has not been enough to lift them from the back of the class.

Since 2013, there have been small increases in business R&D in some of the provinces and Canada overall, but not enough to have any impact on the grades or rankings.

Why do provinces lag on business R&D?

Many explanations for Canada’s weak performance on business R&D have been examined and discussed over the years. Canada’s economy is weighted more toward resource-based companies than are the economies of many peers, and the resource sector tends to perform less R&D than other sectors. Notably, the economies of the top provinces, Quebec and Ontario, are weighted much more to manufacturing than to mining and to oil and gas extraction. By contrast, in provinces where mining and oil and gas extraction constitute a large share of the economy—particularly in Newfoundland and Labrador, Alberta, and Saskatchewan—business R&D intensity is low.⁴

However, analysis conducted by the Council of Canadian Academies’ Expert Panel on Business Innovation found that “generally lower Canadian R&D spending within the same sectors in both the United States and Canada accounts for a greater proportion of the gap [in business R&D between the two countries]…than does Canada’s adverse sector mix—i.e., the greater weight in Canada’s economy of resource-related and other activities that have inherently low R&D spending.”⁵ In fact, compared with OECD averages, Canadian R&D intensity is better in only seven of 23 sectors and substantially better in only four of these.⁶ With few exceptions, Canadian businesses across sectors have lower business R&D intensity than their OECD peers.

Much of Canada’s falling business R&D intensity is due to the declining health of the manufacturing sector and the weak R&D intensity of the sectors filling the gap. Since 2000, R&D intensity in Canada’s manufacturing sector has averaged 4.2 per cent as a share of GDP—far higher than the 0.08 per cent in construction, 0.67 per cent in mining and oil and gas, and 0.82 per cent in the services sector. When manufacturing made up nearly 20 per cent of the business sector as a whole in 2000, its higher R&D intensity elevated the overall Canadian performance. But given that manufacturing’s share of the business sector fell to 13 per cent by 2014 while its R&D intensity slid from 4.3 to 3.9 per cent, its past tendency to lift Canada’s overall rates has weakened. That share was replaced by growth in construction and services, both of which are weak R&D spenders. In short, the decline of one of Canada’s only high R&D sectors has exposed the weakness of other sectors.

Health of Manufacturing Sector Influences Canada’s Business R&D

	Share of the business sector (per cent)				R&D intensity (R&D as a percentage share of GDP)
	2000	2008	2014		2000	2008	2014
Agriculture, forestry, fishing, and hunting	2.2	2.1	2.0		0.42	0.53	0.32
Mining and oil and gas extraction	10.9	10.0	10.4		0.17	0.81	1.04
Utilities	3.3	3.1	3.0		0.75	0.58	0.54
Construction	6.9	8.2	8.8		0.07	0.12	0.06
Manufacturing	19.6	14.7	13.0		4.34	4.37	3.91
Services	57.1	61.9	62.8		0.60	1.00	0.87

Sources: Statistics Canada; The Conference Board of Canada.

Could problems with the data account for Canada’s poor performance?

An alternative explanation for at least part of Canada’s low and declining business R&D was raised by the University of Toronto’s Impact Centre in a 2016 report.⁷ The report argues that data collection and reporting methods used by Statistics Canada and the OECD are different. Specifically, the Impact Centre highlights two discrepancies: First, Canada does not report business spending on social sciences and humanities research, while other countries do. Second, R&D that draws on existing knowledge (to improve products, services, and processes) but does not generate new knowledge is counted elsewhere in the OECD, but not Canada.

Based on an illustrative analysis using a handful of companies, the Impact Centre suggests that the discrepancies might have the effect of Canada’s business R&D being under-reported by as much as 73 per cent. Applied to the current report card, this change would vault Canada from 16th to 11th place among international peers, though Canada would still earn no better than a grade of D. In other words, the effect is substantial, but correcting it would still leave Canada among global laggards on business R&D.

The challenge posed by the Impact Centre report is an important one that requires further investigation. For example, while the Impact Centre claims that social science and humanities research is not reported, Statistics Canada does include a count of social sciences and humanities research in its R&D tables.⁸ It is possible that what Statistics Canada counts as social science and humanities research does not align with OECD practice, but this is not clear. Moreover, the method used by the Impact Centre to estimate the extent of underreporting relies on a sample of only 10 firms—not nearly enough to reach general conclusions.

Nevertheless, if there are outstanding discrepancies between the Statistics Canada and OECD data, these should be addressed by the agencies collecting and reporting the data. Accurate and comparable datasets are essential to understanding Canada’s innovation capacity and performance.

How can the provinces improve on business R&D?

In part, the performance of the provinces and Canada as a whole is determined by structural features of the economy. Until manufacturing reclaims a larger share of the economy and exerts its higher R&D intensity impact on aggregate business R&D—or some other sectors increase their R&D intensity—Canada’s performance will continue to lag.

But while a manufacturing recovery may be good for many reasons, hoping for a recovery just to see an improvement in business R&D risks losing sight of the larger issue, which is that many other sectors in the Canadian economy are weak on R&D relative to international peers. There is need and room for improvement across the economy, whether or not manufacturing recovers.

Faced with increasing competition and persistent demographic and economic challenges, business leaders in a range of sectors may be waking up to the fact that the risks of not conducting R&D are beginning to outweigh the risks of doing so. Gradually introducing more competition—for example, by signing new trade agreements and eliminating lingering protectionist measures—while providing focused R&D incentives to key sectors of the economy may help boost R&D activity by Canadian businesses.

There may be limited advantages to simply increasing the amount of government support for business R&D. In fact, the type of support may matter more than the amount of funding. Canadian governments’ support for business R&D as a share of GDP (0.17 per cent) is higher than seven of the international peers that outrank Canada in this report card—including the top three peers, Japan (0.15 per cent), Switzerland (0.03 per cent), and Sweden (0.13 per cent).⁹

Of the seven top international jurisdictions on the business R&D report card, four provide no indirect support through tax incentives for it at all: Switzerland, Sweden, Germany and Finland. Their support is entirely direct. Another leading jurisdiction, the United States, leans heavily toward direct support (72 per cent direct versus 28 per cent indirect). Fourth-ranked Austria splits support about evenly between direct (48 per cent) and indirect (52 per cent) government support for business R&D.

By contrast, in 2015, only 24 per cent of Canadian government support was provided directly, while nearly 76 per cent was provided indirectly through tax incentives. First-place Japan follows the Canadian pattern (20 per cent direct, 80 per cent indirect support), but this is the exception rather than the prevailing pattern for most leading countries. Indeed, with nearly all leading jurisdictions providing largely or entirely direct support, it is worth exploring whether a shift in Canadian policy to direct support may be warranted.

Nonetheless, business R&D improves only when businesses start spending more, so actions to address Canada’s weakness will need to look beyond policy and toward the factors shaping business decision-making in each province.

Footnotes

1    Expert Panel on Business Innovation, Innovation and Business Strategy: Why Canada Falls Short (Ottawa: Council of Canadian Academies, 2009), 49–50.

2    Ibid., 50, citing OECD, The Sources of Economic Growth in OECD Countries (Paris: OECD, 2003).

3    Spending amounts are in 2007 constant dollars.

4    Expert Panel on the State of Industrial R&D in Canada, The State of Industrial R&D in Canada (Ottawa: Council of Canadian Academies, 2013), 93–96.

5    Expert Panel on Business Innovation, Innovation and Business Strategy, 6.

6    Expert Panel on the State of Industrial R&D in Canada, The State of Industrial R&D in Canada, 22.

7    Impact Centre, Canada’s Business Spending on R&D Isn’t as Low as We Think (Toronto: Impact Centre, 2016).

8    Statistics Canada, CANSIM table 358-0001, Gross Domestic Expenditures on Research and Development, by Science Type and by Funder and Performer Sector.

9    OCED, Measuring Tax Support for R&D and Innovation (Paris: OECD, 2016).