Canadian R&D spending is weak

Today’s Daily from Statscan points to a new short review of Canadian R&D spending, 2002 to 2006. They report:

Spending on industrial research and development (R&D) will edge up this year, according to reported intentions.

Canadian companies will spend an estimated $14.9 billion on R&D, up 1.3% from the preliminary figure for 2005.

Manufacturers will spend an estimated $8.3 billion, up 2.2% from 2005, compared with just under $6.0 billion in the services sector, which would be virtually unchanged.

R&D spending in manufacturing is still recovering from a 3.4% decline between 2002 and 2003. Most of this decrease occurred in the information communications (ICT) sector, in particular, communications equipment.

This summary is kind to Canadian businesses, whose R&D performance has actually been quite weak. An increase of 1.3% (albeit preliminary) is better than zero, I suppose. But when we put the numbers into constant dollars, there is a diminishing trend. The linked publication shows this in Chart 1. Why is Statscan pulling their punches in the Daily?

The bigger issue is that as a share of GDP, R&D spending has been falling. We are reinvesting an ever-smaller share of our income. Thanks to the online national accounts from Statscan, I calculate that industrial R&D spending as a percent of GDP was 0.99% in 1997. It rose to 1.29% in 2001, but has been falling since then, to 1.07% in 2005. If the 2006 estimate holds, and assuming nominal growth of GDP of 4% for 2006 (a conservative assumption), it will fall further to 1.04%. This is not good. And relative to other major countries, our R&D share of GDP is on the low end despite a very generous program of tax credits for R&D.
A look at the dates above shows an interesting feature: the decline in R&D as a share of GDP occurred just as federal corporate tax cuts came in to effect. These were supposed to “boost our competitiveness” and make Canada a more attractive place for investment. We know that corporate profits as a share of GDP are up, up, up – from 10.0% in 1997 to 13.8% in 2005, which is (or is close to) an all-time high. And that’s pre-tax profits – corporate tax cuts will reinforce those gains at the end of the day.

In spite of those gains, reinvestment, whether into R&D or broader measures of investment, has been disappointing: investment in machinery and equipment was 7.6% of GDP in 1997 and 8.1% in 1998 and 1999, but has fallen to 6.6% in recent years; investment in non-residential structures was 5.0% in 1997 and 5.1% in 2005, though it dipped to 4.4% in 2002 before recovering.

The bright spot is new residential construction: from levels of 4.5 to 5% of GDP in the 1997 to 2001 period, it surged to 6.5% in 2005. These numbers underline a current boom that is driven so much by real estate and residential construction. New residential construction creates jobs that feed other parts of the economy, and that is a good thing, but residential construction does not drive increases in our productivity, much less R&D spending. For that we need to look at capital investment in machinery and equipment, and non-residential structures.

This lack of response to corporate tax cuts was pointed out last year in a piece done for the CCPA by Andrew Jackson. He remarks:

The cost of capital to business is much more strongly influenced by the level of interest rates than by
corporate taxes.

Corporations, of course, will take tax rates into account when calculating if a particular investment is profitable, and where it should be made. But corporate tax rates are a small factor among many others at play. And it is far from clear that general, across-the- board tax cuts are the best way to lever new investment. General tax cuts may just provide windfalls to corporations for investments that would have taken place anyway.

Moreover, it must be noted that there is a wide range of businesses for which tax competitiveness is
not much of a factor in where to invest. It is true that manufacturing investments are fairly mobile, and can be made anywhere in North America or even around the world. But this is not true for investments in much of the service sector, such as retail trade and many financial services, since investments must be made in Canada in order to serve the Canadian market.

Finally, it should be noted that corporate tax cuts erode the fiscal basis for public investments which can lower business costs and improve productivity.

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