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Canada makes major changes to its government support strategy for fostering business innovation

In its March 2012 Federal Budget, the Government of Canada announced a new approach to supporting innovation that it believes focuses resources on private sector needs. The rationale for the changes proposed rests in the advice tendered in 2011 by an Expert Panel which, in turn, was based upon data analysis and an extensive consultation process.  This blog will examine the rationale behind the changes and highlight those elements where change has been the most extreme.

by Allan Martel
Innovation consultant 

July 18th, 2012

There have been several studies that have documented that business innovation in Canada lags behind that of other highly-developed economies. The 2012 Budget document includes the following information: “Despite strong policy fundamentals to support innovation in Canada, Canadian businesses do not take full advantage. Canada continues to lag behind peer countries in terms of overall innovation performance, including private sector investment in research and development (R&D), and the commercialization of research into products and processes that create high-value jobs and economic growth.

As demonstrated by Chart 3.1.2, Canada’s private sector has historically lagged in terms of business investments in research relative to the size of our economy. This trend has persisted despite Canada’s strong post-secondary research performance in recent years. While the business sectors in the United States and across OECD countries are increasing their relative investments in research and development in order to improve their competitive positions, Canada’s business sector has seen a declining trend over the past decade. It is important that Canadian businesses begin to address this gap in order to drive the innovation that leads to success in a competitive global marketplace.

Business investment in R&D in Canada lags competitors

Chart 3.1.2 Business Investment in R&D as a Share of the Economy, 1981–2008

Despite strong policy fundamentals to support innovation in Canada, Canadian businesses do not take full advantage. Canada continues to lag behind peer countries in terms of overall innovation performance, including private sector investment in research and development (R&D), and the commercialization of research into products and processes that create high-value jobs and economic growth.

During its consultations in 2011, the Expert Panel heard frequently that government needed to refocus on helping firms to grow, particularly small and medium-sized businesses (SMEs).  They also heard that innovation support was too narrowly focused on R&D; and that programming needed to be more outcome-oriented, visible and easy to access.

Expert Panel Recommendations to Foster Business Innovation in Canada

The Expert Panel recommended substantial, indeed often sweeping, changes to Canada’s Innovation Policies and Programs:

The Industrial Research and Innovation Council was recommended as “the centrepiece of the federal government's efforts to help entrepreneurs bring their innovative ideas to the marketplace and grow their companies into internationally successful businesses.”

More specifically:

  • Delivery of an expanded Industrial Research Assistance Program (IRAP) (formerly delivered through the National Research Council) (NRC) including a pilot commercialisation vouchers program connecting SMEs to providers of commercialization support and the development of an innovation talent strategy
  • Oversight for business-oriented collaborative research institutes
  • NRC Institutes that are business-oriented would become independent collaborative research organizations
  • NRC Institutes that perform primarily fundamental research would become university affiliates
  • NRC Institutes with core public policy mandates would be transferred to the most relevant department or agency


Risk Capital
 was also addressed with government urged to establish risk capital funds to facilitate funds access for high growth potential, innovation-based firms.

The panel also recommended the evolution of the then pilot Canadian Innovation Commercialisation Program (CICP) into a larger effective Public Sector Procurement instrument, and  urged that the existing Scientific Research and Experimental Development (SR&ED) Tax Credit be simplified such that the focus for SMEs would be labour costs only.

  • The SR&ED Tax Credit was the cornerstone of Canada’s innovation strategy and the Panel recommended several improvements to simplify applications and scaling back of certain benefits with the resulting savings channeled into the direct expenditure support initiatives described above.


In summary, the Expert Panel found that:

  • Canadian businesses find the Scientific Research and Experimental Development tax incentive program to be complex, with an approval process that can be unpredictable and costly.
  • Relative to peer countries, Canada has an over-reliance on tax incentives in the mix of federal support for business research and development compared to direct expenditures that support innovative firms and public-private research collaborations.
  • The numerous federal programs that promote business innovation can be difficult for companies to navigate, and may create inefficiencies.
  • Canada lags behind peer countries in leveraging government procurement to promote private sector innovation.
  • Unlike peer countries, Canada lacks an organization with the capacity to act as a central hub for business-driven research.
  • Canada’s risk capital sector needs further development to effectively support the growth of innovative companies.
  • Canada needs a stronger “whole-of-government” approach to innovation.


In its March 2012 Federal Budget, the Government of Canada responded to the Expert Panel Recommendations as follows:

Key Recommendations of Budget 2012 - Innovation Canada: A Call to Action

  • Shift resources from indirect support through the Scientific Research and Experimental Development (SR&ED) tax incentive program to direct forms of support, including the Industrial Research Assistance Program.
  • Streamline the Government’s support for business innovation.
  • Simplify the SR&ED tax incentive program and improve cost-effectiveness, predictability and accountability.
  • Make business innovation one of the core objectives of procurement.
  • Refocus the institutes of the National Research Council on demand-driven applied research.
  • Help high-growth innovative firms access risk capital.
  • Establish a clear federal voice for innovation.


These changes signal a new approach for the support of innovation in Canada, one which looks to pursue active business-led initiatives to focus resources on private sector needs. 

The March 2012 Budget marked the first indication in the shift in innovation policy through the announcement of $1.1 billion CAD (€882 million) over five years for research and development support and through making $500 million CAD (€401 million) available for venture capital.

The shift in innovation strategy now focuses on improved support for high-growth firms, research collaboration, procurement instruments, applied research and risk financing.  As outlined in the Budget documents Chapter 3.1, the specific initiatives contained in the March 2012 Budget include:

  • Doubling the contribution budget of the Industrial Research Assistance Program to better support research and development by small and medium-sized companies.
  • Supporting private and public research collaboration through internships for graduate students and funding for business-led research and development.
  • Supporting innovation through procurement by connecting small and medium-sized companies with federal departments and agencies to build their capacity to compete in the marketplace.
  • Refocusing the National Research Council on demand-driven business-oriented research that will help Canadian businesses develop innovative products and services through converting their existing Institutes to collaborative research centres.  The Government did not accept the Expert Panel recommendation to move these centres out from under the NRC.
  • Helping high-growth firms access risk capital by committing significant funds to lever increased private sector investments in early-stage risk capital and to support the creation of large-scale venture capital funds led by the private sector.
  • Streamlining and improving the SR&ED tax incentive program by removing capital from the expenditure base, making it more cost-effective through design improvements and a measured rate reduction, and providing greater predictability through administrative improvements.
  • Finally, this Budget contained extensive and wide-ranging cuts to federal government sponsored labs R&D allocations, averaging 5 to 10% with the heaviest impacts to defence and environment labs.


Opinion

The shift to subsidies and away from tax breaks doesn’t sit well with many business groups.

“They seem to be taking the subsidy approach of winner-picking by bureaucrats,” said Catherine Swift, chief executive of the Canadian Federation of Independent Business. “That’s always been a fiasco. We throw money down the toilet.”

“The government will be hard pressed to show how outcomes will be improved in business R&D if they’re spending less money,” said Jayson Myers, chief executive of the Canadian Manufacturers and Exporters.

In my personal opinion, these are, on balance, welcome changes and it is important to note that these shifts represent only the Stage One response to the Expert Panel by government, with further changes anticipated in the 2013 Budget. 

There are challenges in implementing this plan, some operational, some more strategic. 

On the operational side, doubling the IRAP budget has occurred in the past resulting in a somewhat mad scramble to ramp up activities to take advantage of allocated available funds.  This is aggravated by the fact that IRAP funding is only for two years, not particularly helpful for longer term innovation projects.

Of more concern is the trend evident between 2003 and 2005 among the fastest-growing SMEs in Canada (gazelles) to bypass IRAP because of lengthy or complicated application processes and seek Venture Capital (VC) funds instead insofar as these funds remained available.  Over the last few years, IRAP has moved to support larger projects in an environment of a chronic shortage of VC funding.

The Canadian Foundation for Innovation (CFI) has received $500 million CAD (€401 million) in support of its successful and worthwhile programming over the next five years.

The Internship program has been doubled – but for only two years, perhaps signaling a future program evaluation before further funding is committed.

The procurement initiative will need careful legislative drafting and I don’t expect significant results from this initiative, but the addition of a military procurement component is promising.

Refocusing the NRC Research Institutes will be an extremely challenging task.  This is true on many levels, not the least of which is the geographic distribution of the current Institutes, at times misaligned with core Canadian industrial capacity. 

The government decided to retain the NRC Institutes within NRC but no longer focused primarily on basic research, instead redesigned as collaborative research centres with a mandate of a closer industrial focus for their core technologies.  As such, they have all been given targets to increase the level of private sector funding and collaboration over the next two to five years.   The research centres are currently planning their new activities but history indicates that this model rarely creates sustainable entities in Canada. 

Finally, these Institutes are currently staffed almost exclusively with research scientists performing generally excellent basic research who may or may not be able to make the transition from longer-term research projects to a more market-focused and shorter – term innovation focused agenda.  Additionally, where will the shortfall in basic research be made up, if at all?

The Venture Capital initiatives are both timely and appropriate for the Canadian risk financing marketplace where significant intellectual property has been lost through foreign venture capital support to promising Canadian innovation – based SMEs.

Canada has had a chronic shortage of “valley of death” (post - early-stage after proof of concept) VC funding and this issue should be addressed specifically in the program design. 

The $400 million CAD (€321 million) split over two years allocated in the 2012 Budget is a drop in the bucket relative to actual VC funding demand in Canada.

There is substantial evidence suggesting that the right combination of VC and IRAP financing can create sustainable gazelles.  The data are clear but not necessarily well understood in the critical policy and program design centres of the Government of Canada.

The SR&ED Tax Credit changes will have a potentially dramatic effect on how innovation is pursued within Canadian firms, particularly SMEs, as the limiting of eligible expenses to salaries will make critical equipment acquisitions all the more difficult. 

The overall reduction in the SR&ED Tax Credit budget might also affect negatively larger Canadian firms which have used these funds to support innovation – related equipment purchases and other non-labour costs. 

In conclusion, this Budget represents a major shift in Canada’s policy approach towards fostering business innovation.  It moves from largely a tax-credit – based system to an approach with slightly more focus on direct financial support.

The net change of reductions in SR&ED is large and ongoing each year whereas new industry support elements are only for 2 years. As a result there is a net reduction of direct support to industry.

It remains to be seen whether the Government’s decision to ignore the Expert Panel’s recommendation to create a new overarching competitiveness agency and instead to continue IRAP program delivery and to pursue the transition from Research Institutes to collaborative research centres within the National Research Council will prove to be the right choice. 

European observers should track the effort to redefine the role and mandate of the NRC to see if old dogs can be taught new tricks after all.