by Creig Lamb, Daniel Munro. Originally published on Policy Options
March 3, 2021
Business enterprise expenditure on research and development (BERD) has long been considered an imperfect but useful indicator of innovative activity in developed economies. If firms are spending money to explore and develop new ideas, products, processes or services, then they are engaging in innovation. Not all business research and development (R&D) spending will result in a launch of high-value products and services, or productivity-enhancing processes. In the aggregate, however, the more business R&D spending we see, the greater likelihood of some firms succeeding.
The well-known sad trombone story about Canada is that our business spending on R&D as a share of GDP is well below the Organization for Economic Co-operation and Development (OECD) average and has declined over the past two decades – both a reflection and a driver of our lacklustre innovation performance. But new data suggest that interesting shifts are under way.
The nature of some recent business R&D spending signals that Canadian-based firms are increasingly aware of the importance of developing intangible assets – like data, digital services, brands and design – to drive productivity and growth. Unfortunately, many of the Canadian-based firms that are spending on new kinds of R&D are foreign-owned, raising questions about who ultimately benefits.
From manufacturing to services
Until recently, Canada’s BERD was dominated by the manufacturing sector. In 2001, 64 per cent of business R&D in Canada was performed by manufacturing businesses. By 2018, manufacturing’s share of R&D had declined to 31 per cent and, based on preliminary estimates, is expected to decline even further to 29 per cent in 2020.
Over the same period, businesses in the services sector became the dominant investors in R&D, almost doubling their share from 32 per cent to 61 per cent of total BERD in 2018. This is estimated to have risen to 64 per cent in 2020, based on intended R&D expenditures. The decline of manufacturing R&D can explain much of the overall decline in Canada’s BERD levels from 1.25 per cent of GDP in 2001 to 0.8 per cent by 2018.
ICT R&D: accelerating the intangible shift
While the service sector as a whole tends to be less R&D intensive than manufacturing, the rise of Canada’s highly innovative digital economy provides some nuance. Mirroring trends in the rest of the economy, the information and communications technology (ICT) sector in Canada has witnessed a decline in R&D spending on manufacturing hardware but an increase in R&D spending on software – a shift in focus from tangible to intangible assets. Canada’s most valuable company, Shopify, typifies the trend. With its substantial focus on software- and services-related R&D, Shopify is now among the leaders in lists of Canada’s top R&D spenders.
In 2014, ICT service industries made up 27 per cent of Canada’s total BERD expenditures. By 2018, this rose to 36 per cent and is estimated to have risen to 39 per cent in 2020 based on preliminary data. Nearly half of the shift can be attributed to one software industry: computer systems design.
These software firms are highly R&D intensive. In 2018, the average firm in ICT spent roughly $670,000 more than the average manufacturing firm on R&D. As well, R&D spending as a proportion of value add was five percentage points higher in ICT than in manufacturing. Moreover, software R&D is not confined to the ICT sector. Software-related R&D spending is increasingly taking place across the economy – from manufacturing to finance – as more and more firms embrace digital technologies to improve products, processes and services.
This trend reflects an intangible shift taking place across Canada and globally. A rising share of economic growth and prosperity is being driven by intangible assets and investments, including data, digital services, brand equity, marketing and training. A declining share is driven by tangible assets such as buildings, machinery, equipment and product inventories. In many ways, this is a positive for Canada, because countries making the intangible shift are often better positioned for higher productivity and growth.
Our previous work shows that Canada has been making the intangible shift at a slower pace than other countries. Yet, while the R&D intensity of Canada’s ICT sector continues to lag that of ICT sectors , the signals we see in recent business R&D spending are promising.
Who benefits from the R&D shift to intangibles?
Unfortunately, Canada may have difficulty capturing the gains from the rise in intangibles-related business R&D. When we look at who exactly is driving the intangible shift in R&D in Canada, we see troubling signs.
A growing proportion of R&D is being conducted by large, foreign-owned firms operating in Canada rather than Canadian-owned firms operating domestically. Large multinationals like IBM, Apple and Google have set up research shops in Canada to benefit from our labs, university-based research institutions, highly skilled researchers and R&D incentive programs. In 2018, 41 per cent of business R&D in the ICT sector was conducted by foreign-owned firms, up from 31 per cent in 2014. These firms are R&D powerhouses. The average foreign ICT firm spent $11.9 million on R&D in 2018, compared to just $1.1 million on average by domestic firms in the sector.
To be sure, foreign-driven R&D activity generates jobs for Canadians and provides researchers with opportunities to engage with and learn from world-leading technology firms. This engagement contributes to the long-term development of our innovation capacities, and expands the networks of Canadian researchers and entrepreneurs who might later start their own firms. As well, as ideas and researchers circulate among foreign- and domestic-owned firms, we may benefit from knowledge spillovers in the broader innovation ecosystem.
Still, the fact that a large and rising share of intangibles-focused R&D activity in Canada is being led by foreign-owned firms means that domestic firms have to compete harder for talent and market share for their products. It also means that intellectual property developed by Canadian researchers who work for those firms, or partner with them through academic-industry collaborations, likely generates greater benefits for foreign investors and owners than Canadians.
Is this value extraction worth the gains in jobs and knowledge spillovers? Would Canada be even further behind in making and benefitting from the intangible shift if not for the R&D activities of foreign-owned firms in Canada?
It is encouraging to see a shift towards intangibles-focused R&D among ICT firms, especially as business R&D spending continues to decline. But industry consolidation and concentration of benefits can happen very quickly in an intangibles-focused digital economy. With intangibles-focused R&D increasingly being led by foreign-controlled firms, Canada risks having large parts of its digital economy, including the talent and data that feeds it, and the intellectual property it produces, working for the benefit of others.
Photo : Prime Minister Justin Trudeau uses Shopify’s augmented reality technology as Shopify’s Daniel Beauchamp looks on in Toronto on May 8, 2018. THE CANADIAN PRESS/Nathan Denette