Let’s get real about Canada’s lack of investment in R&D

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New data from Statistics Canada are a reminder that Canada’s productivity problems are built from the ground up.

On Wednesday, Statscan released preliminary findings from its annual survey of research and development spending. The numbers weren’t great. But then, they rarely are.

The early results indicated that private-sector R&D spending grew just 0.5 per cent in 2022. When you consider that inflation averaged nearly 7 per cent in the year, that represents a considerable decline in R&D in real terms.

Companies have indicated that they intend to increase their spending by a much more respectable 4.7 per cent in 2023. Still, after inflation (which is expected to average about 3.5 per cent this year), real R&D investment has been contracting during a two-year period in which businesses have faced persistent capacity pressures and extremely tight labour supplies. And in a time when the country has committed to a green transition, backed up by a rising price for carbon.

These conditions provide oodles of incentive for businesses to invest in productivity-enhancing improvements. R&D is the very bedrock of innovation and productivity growth. And yet, most discouragingly, Statscan’s survey found that “Fewer than 2 per cent of businesses in Canada incorporate research and development as part of their business strategy to address economic challenges and opportunities.”

Wow. Fewer than 2 per cent?

This remarkable apathy toward R&D is a symptom of a broader lack of interest in productivity-enhancing investments. Real spending on machinery and equipment (i.e. adjusted for inflation) fell nearly 8 per cent in the fourth quarter of last year, its second straight quarterly decline. Spending for 2022 remained below prepandemic levels, for the third straight year.

Meanwhile, private-sector employment is up 5 per cent from its level prior to the pandemic, and nearly 11 per cent since the beginning of 2021. Throughout the economy’s strong recovery from the COVID-19 recession, as demand grew rapidly, businesses consistently demonstrated a preference to expand their labour to meet that demand, rather than their capital stock.

As the Statscan survey suggests, the vast majority would rather hire than innovate. Even in an economy with acute skills shortages and fast-rising wages.

Starved of these tools for growth, it’s no surprise that productivity is stagnating. Labour productivity – measured by the amount of gross domestic product per worker – has fallen in nine of the past 10 quarters, and is now below prepandemic levels. As businesses have hired more and more staff during the recovery, each staffer has produced less and less.

The lack of productivity growth, and investment in it, has become a pressing concern in the fight against inflation.

The Bank of Canada – which has aggressively raised interest rates to quell inflation – has repeatedly expressed its concern that wages have been growing at between 4 per cent and 5 per cent a year, while productivity has been moving backward. Wage growth can be sustainable if productivity is expanding to justify it; if the productivity isn’t there, it’s inflationary.

The rule of thumb is that if you add the inflation rate plus the productivity growth rate, you get a sustainable rate of wage growth. If the Bank of Canada wants inflation at its 2-per-cent target, productivity would have to grow 2 per cent to 3 per cent annually to support those wage gains. Last year, labour productivity fell 1.5 per cent.

Clearly, something has to give. Either we live with higher inflation (not a popular choice), we accept lower wage growth (see above, re: popularity) or we accelerate productivity to support higher wages.

Certainly, in the long run, that third choice is best. Productivity growth feeds sustainable income growth, raises economic capacity and wealth, supports a rising standard of living. In its absence, wage growth stagnates, business growth stalls and the economy overall struggles.

At the foundations of healthy productivity is a strong culture of research and development. This is where innovations emerge to drive new systems and processes that generate more output with fewer human hands.

But Canada doesn’t have a strong R&D culture. We spent 1.6 per cent of GDP on R&D last year, well below the OECD average of 2.7 per cent, less than half what the United States spends. The tepid numbers in Statscan’s survey are just the latest manifestation of our national indifference to laying this vital groundwork.

If there is any cause for hope within the Statscan data, it lies in the R&D trend in the services sector of the economy, which accounts for about 70 per cent of Canada’s GDP. Growth in R&D spending among services-producing businesses has averaged 7 per cent annually over the past five years; after a lull in 2022, spending intentions are poised for 6-per-cent growth in 2023. By contrast, manufacturing R&D hasn’t grown at all since 2018, although the survey points to a 4.7-per-cent increase this year.

Perhaps the improvement in R&D intentions this year are a sign that the private sector is finally coming to terms with the intense labour shortages that have tied the hands of so many businesses, as well as the pressures they face in the green transition if they don’t change their ways. Maybe companies are beginning to recognize that their addiction to hiring is no longer the best answer. We can hope.

 

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