Canada's Innovation Underperformance: Whose Policy Problem is It?
For three decades Canada has been supporting innovation primarily through one of the most generous tax incentive policies in the world, one that currently represents about C$ 4.7 billion in foregone federal tax revenue per year. The failure of this policy, however, is clear to anyone who has been paying attention to the many published reports.
They lament Canada’s innovation performance, whether it’s the latest benchmarking report from Canada’s Science, Technology and Innovation Council, another ‘D’ grade on the Conference Board of Canada’s periodic report cards, or the 2009 assessment by the Council of Canadian Academies scrutinizing the root causes of Canada’s innovation performance.
Put simply, if Canada is to improve in this area, the country needs substantive policy changes now that can bring about clear divisions of responsibility between the federal government and provinces –fewer tax incentives and more direct support to firms. Further, innovation policy in Canada is a tangled mess of both federal and provincial programs and policies that overlap and confuse as much as they help.
If Canada is to maximize its support for industry R&D, the federal and provincial governments should untangle and rationalize who does what. With a national outlook, the federal government is best positioned to maintain the indirect and generic support for the innovation process.
Indirect policies and programs focus on the framework conditions that support innovation, including tax incentives, favourable tax rates, the regulatory environment, and support for research. Generic supports focus on the process of innovation and can involve support for technology transfer from university to industry or for commercialization. The provinces, on the other hand, should retain responsibility for direct, strategic investments.
These are policies and programs that target particular sectors or industry clusters. This division would significantly simplify the program landscape and ensure greater emphasis is placed on direct investments that align with local innovation objectives. It would also allow the provinces to better support the existing comparative advantages of their communities and to take advantage of local and regional networks and knowledge in recognition of the fact that, the innovation landscape and local industry capabilities differs considerably from St. John’s to and Vancouver (and everywhere in between).
For this to succeed, the federal government, in addition to withdrawing from direct investments, should also reduce its expenditures on the Scientific Research and Experimental Development (SR&ED) Tax Incentive Program - which is by far the largest innovation expenditure. These funds should be redirected to provincial governments to be used for direct incentives because direct incentives work.
As a number of studies have indicated, direct forms of support can achieve better outcomes than R&D tax credits alone. One study using Canadian data found that firms that benefited from both tax credits and R&D grants were more innovative than firms that made use of only tax incentives.
Moreover, not only were they more innovative, but Canadian firms using both types of programs also made more world-first innovations and were more successful in commercializing their innovations. One reason why direct incentives work is that they encourage firms to invest in R&D in times of product market uncertainty, which, in a global economy, can be significant.
To this end, the federal and provincial governments should negotiate intergovernmental agreements, modeled after Growing Forward agreement, which allowed the federal government to define overarching objectives and conditions for investments in agriculture, but empowered provinces to direct funds to suit regional needs, embedded within regional networks, and in a manner consistent with provincial strategies. This is the model to be emulated across the innovation and R&D policy space.
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