State of the Nation 2010

5. Resources for Research and Development

Gross domestic expenditure on research and development (GERD) is total expenditure on research and development performed in the country during a given period. Domestic performers of research and development include government (federal, provincial and provincial research organizations), business enterprise, private non-profit, and higher education. Funding for GERD comes from domestic and foreign sources.

The share of GERD relative to the size of a country's Gross Domestic Product (GDP) is a commonly used indicator of innovation performance. This has been a useful international benchmark and guides many science, technology and innovation strategies around the world.

As a share of GDP, R&D expenditures in Canada lag behind the G7 average (Figure 1). From 2006 to 2008, GERD/GDP in Canada dropped from 2.0 percent to just over 1.8 percent. This change was partly due to rapid GDP growth; however, growth in Canadian GERD also lagged that in the G7 over this period.

Figure 1: Gross Domestic Expenditure on Research and Development as a Percentage Share of Gross Domestic Product (2006 and 2008)

Figure 2 shows that among some of the top R&D-performing countries, including Canada, total GERD/GDP ratios over the past 10 years show mixed trends. Over this period, ratios substantially increased in Japan, China and South Korea. Canada showed a modest increase.

Figure 2: Gross Domestic Expenditure on Research and Development as a Percentage Share of Gross Domestic Product, for Selected Countries, 1981 to 2008

Increasing Canada's research intensity and fostering innovation requires concerted and coordinated efforts by the three principal Canadian R&D-performing sectors: the private sector, the higher education sector and government. Figure 3 shows the R&D funding and performance that are undertaken by these three principal performing sectors and other supporting agents such as private non-profit organizations.5

Figure 3: Major Flows of Research and Development Funding in Canada, 2009

In the period from 2006 to 2009, government, higher education, foreign sources and private non-profit sectors all increased their funding for R&D. Interestingly, the private non-profit sector increased its overall funding of R&D by just over 16 percent (in current dollars), the most over the period of 2006 to 2009 compared to the other sectors. During the same period, Canadian business expenditure on R&D declined in inflation-adjusted terms. The Government of Canada directly funded just under $6 billion of R&D performed in Canada in 2009 (in current dollars), an increase from 2006 of just under $500 million or 8.6 percent. Almost half of this $6 billion was carried out in Government of Canada institutions and labs. The remainder of about $3 billion for R&D (in current dollars) was performed by the higher education, business and private non-profit sectors. In-house government R&D as a share of GDP fell slightly to 0.188 percent in 2008 from 0.195 percent in 2006 (as reported in State of the Nation 2008) and the gap between Canada and the G7 (minus Japan, for which data are not provided) continued to widen.6

Figure 4 shows the trend of R&D performed by federal and provincial governments, business and higher education sectors from 1998 to 2008 in constant dollars. According to this figure, in Canada, growth in higher education R&D performance was responsible for just over half of the growth in total R&D over the period of 1998 to 2008: higher education performance of R&D grew from just under $5 billion in 1998 to just over $8.5 billion in 2008 (inflation-adjusted dollars).

Figure 4: Gross Domestic Expenditure on Research and Development by Performing Sector, 1998 to 2008 (Constant 2002 Dollars)

Figure 5 shows that business-financed R&D performed by universities has grown substantially in Canada, especially since the early 1990s. In 2009, university-performed R&D was 6.3 percent of total business funded R&D (which includes R&D financed and undertaken by businesses and R&D financed by business but undertaken by other sectors). This share was down from the peak of 6.6 percent in 1992, but was above the more recent peak of 2000 (preceding the tech collapse of 2001). While the growth in the share has slowed in recent years, the secular trend over the past two decades is upwards.

Figure 5: Business-Financed Research and Development Performed by Higher Education, 1971 to 2009

Figure 6 shows that Canada is near the top of the OECD, and ranks number one in the G7, in terms of higher education research and development (HERD) as a percentage of GDP. In 2008, higher education R&D was 0.644 percent of GDP, down slightly from 0.664 percent in 2006.7 HERD includes all research performed in higher education organizations such as universities and affiliated teaching hospitals. Canada's lead increased from 1997 to 2001 because of its investments in research infrastructure (such as laboratories), and from 2001 to 2007 because of investments in research. The spending rate and the balance of funding between infrastructure and research have remained stable over the last decade. Figure 7 shows that federal HERD expenditure consistently increased from 1997–98 to 2008–09. The level of expenditure in infrastructure increased from 1997–98 to 2001–02, and then remained relatively stable from 2001–02 to 2008–09. Announced on January 27, 2009, as part of the Government of Canada's Economic Action Plan, the Knowledge Infrastructure Program provided $2 billion to support enhancement at universities and colleges over two years.

Figure 6: Higher Education Performance of Research and Development, 2006 and 2008

Figure 7: Federal Expenditures on Higher Education Research and Development (Constant 2002 Dollars)8, 1997–98 to 2008–09

Direct and Indirect Government Funding of Business R&D

Governments use various tools to encourage private sector investment in R&D. These tools can be classified into direct support and indirect support. Direct support encompasses grants, loans and procurement. Indirect support includes R&D tax credits, R&D allowances and reductions in R&D workers' wage taxes. The best balance of tools to use varies from country to country and is determined by the market or system failure being addressed and the type of R&D that the government wants to stimulate.9 System failure has been described as the lack of coherence among institutions in an innovation system and in incentive structures.10

Indirect support reduces the marginal cost of R&D activities.11 Canada uses indirect funding to a greater degree than direct funding (Figure 8a). In 2009, over $3 billion in tax assistance was provided through Canada's Scientific Research and Experimental Development (SR&ED) Tax Incentive Program.12 Based on a review of earlier studies, a 2007 evaluation of the SR&ED program by Finance Canada reported that the measure stimulated, on average, $0.91 of R&D spending per dollar of revenue foregone.13 The authors found that while there is weak evidence that direct assistance may have a somewhat larger impact on business R&D spending, this is offset by weak evidence that indirect assistance may have a somewhat greater spillover effect.14 The evaluation concludes that the "empirical evidence is still too ambiguous" to reach a conclusion about which type of support achieves the best results.15

Figure 8a: Indirect Government Support through Research and Development Tax Incentives, 2008

Although Canada has one of the most generous R&D tax credit programs in the world, Canada is below the OECD average in terms of business expenditures on research and development. A number of countries with higher business expenditures on R&D provide more R&D support through direct funding. Figure 8b shows direct government funding of business R&D in a select group of OECD countries.

Figure 8b: Direct Government Funding of Business Research and Development, 2008

Direct support can leverage private financing. Public funds can, for example, complement private funds to support company initiatives that align with government priorities. Direct funding can be an effective way to support R&D in priority areas. Recent federal budgets have introduced initiatives in Canada to enhance direct funding. Budget 2009 provided an additional $200 million over two years to the National Research Council of Canada's Industrial Research Assistance Program (NRC-IRAP), which is the principal program through which direct support is delivered to small and medium-sized enterprises (SMEs). For fiscal year 2009–10, IRAP's budget included about $187 million in direct support to firms.16 The Canadian Innovation Commercialization Program (CICP) for small and medium-sized enterprises was launched in September 2010. The CICP is a two year, $40 million pilot initiative that will support up to 20 innovative demonstration projects.

Direct funding through grants, subsidies and loans is the most common form of support for business R&D in OECD countries.17 Finland recently reviewed its funding model, recognizing that tax incentives can complement a system traditionally dependent on direct support alone.18 In conducting its review, Finland identified Norway as a country with a well-functioning model that employs both direct and indirect support. In 2008, the ratio of direct to indirect support in Norway was approximately two to one.

5 – Federal Funding of Business R&D includes direct grants and contracts from the federal government for R&D performed in the business enterprise sector in Canada. This figure does not include SR&ED tax credits, or repayable loans that may be made under certain federal programs. Foreign funding of R&D includes all funding of R&D performed in Canada, which is funded by a foreign source, if the financing of the R&D involves an international transfer of funds from a foreign country into Canada. This includes transfers of funds between, for example, foreign parent companies and their Canadian affiliates for R&D projects carried out in Canada. Return to text

6OECD (2010), Main Science and Technology Indicators. Return to text

7OECD (2010), Main Science and Technology Indicators. Return to text

8 – Federal Expenditures on Higher Education R&D are defined as the three Granting Councils and the Canada Foundation for Innovation's (CFI) expenditures on R&D in the Higher Education Sector. Infrastructure includes expenditures for all CFI programs except for the Infrastructure Operating Fund (IOF), and equipment and tools programs from NSERC and CIHR. Research includes all other research grants from the granting councils and the IOF portion of CFI. Return to text

9OECD (2010), "Firms investing in R&D (PDF)," OECD Measuring Innovation: A New Perspective. Return to text

10 – Johan Hauknes and Lennart Nordgren, Economic Rationales of Government Involvement in Innovation and the Supply of Innovation-Related Services, The STEP Group, 1999. Return to text

11OECD (2010), "Firms investing in R&D (PDF)," OECD Measuring Innovation: A New Perspective. Return to text

12 – Department of Finance Canada, Budget 2010: Leading the Way on Growth, 2010, p. 86. Return to text

13 – Mark Parsons and Nicholas Philips, An Evaluation of the Federal Tax Credit for Scientific Research and Experimental Development (PDF), Department of Finance, 2007, p. 8. Return to text

14, 15 – Mark Parsons and Nicholas Philips, An Evaluation of the Federal Tax Credit for Scientific Research and Experimental Development (PDF), Department of Finance, 2007, p. 54. Return to text (14)Return to text (15)

16 – National Research Council of Canada's Industrial Research Assistance Program (NRC-IRAP). Return to text

17OECD (2010), Science, Technology and Industry Outlook 2010, p.103. Return to text

18 – Anne Palkamo, Finland Plans Tax Incentives for Companies' R&D Activities, Tekes, 2009. Return to text