This article was published on 13 August 2019
Competitive advantage. Product improvement. New products and services. Valuable IP. Commercial spinoffs. Increased productivity. Opportunities for collaboration and knowledge transfer.
The “plus” column for investing in research and development (R&D) makes a compelling case for businesses to set aside a good chunk of their annual budget.
But it seems many companies – particularly Kiwi companies – find it hard to get past the “minus” column. R&D needs money and there’s an element of risk because the return on investment (ROI) is neither guaranteed nor simple to calculate.
The upshot? New Zealand has one of the lowest rates of total R&D in the OECD, driven by one of the lowest shares of private R&D1.
The corollary is the productivity gap between New Zealand and the OECD average – and it’s estimated that 40 per cent of that gap is attributable to New Zealand’s weak R&D investment2.
Sir Paul Callaghan, Callaghan Innovation’s namesake and source of several guiding tenets, believed that 100 companies led by 100 inspired entrepreneurs could turn this country around. He also believed investing in R&D – along with education, leadership and vision – would play a critical role.
Looking at the data shows we’ve made some progress in recent years. New Zealand’s business expenditure on R&D was $2.1 billion in 2018 – an increase of $548 million (34 percent) on 2016 spending.
Total spending on R&D for all sectors – taking account of business, higher education and government expenditure – was $3.9 billion, representing an increase of $757 million in two years. There’s evidence the increases are real too and not just driven by R&D costs rising: New Zealand now has 23,000 FTE R&D workers, up 17% from 20163.
It’s a shift in the right direction but we’re still falling well short of the Government’s target of R&D spending reaching 2% of GDP (at 1.37 percent of GDP), and lagging behind the likes of Israel (4.25), Korea (4.23), Sweden (3.25), Switzerland (3.37), Japan (3.14), Austria (3.09), the United States (2.74), Norway and the Netherlands (2.03)4.
All of which explains why the Government has developed the R&D Tax Incentive, providing businesses with a 15% tax credit on all eligible R&D spending between $50,000 and $120 million. It helps offset one of those two items sitting in R&D’s minus column: cost.
One of the criticisms levelled at the R&D Tax Incentive is that it doesn’t offer support to young start-ups in those early pre-profit days when they’re working to bring a product or service to market.
But the counter argument is that, instead of the approximately 300 businesses who were assisted by Growth Grants each year, an estimated 2000 to 3000 companies are expected to benefit from the tax credit.
There are also several other grant options in place – including Getting Started, Project and Student Grants – that Callaghan Innovation delivers to support companies at the early stages of their R&D journey.
In addition, while there is limited refundability for loss-making businesses in the first year of the R&D Tax Incentive, the Government has proposed new legislation that, if successful, will deliver broader refundability from the 2020/2021 tax year.
Risk versus reward
The other item sitting in R&D’s minus column – the risk of an uncertain ROI – is more complex. By definition, R&D is uncertain: the aim being to solve unanswered questions or discover something new.
Separating out and calculating the ROI on R&D is also complicated. But the evidence exists to show R&D is a good bet for business.
In 2017, a review of economic studies around the world found the long-term payback on R&D is in the order of 20 percent a year5. A return that is hard to match with any other business investment.
Data collated from World Bank, UNESCO and OECD also shows a strong positive correlation between national spending on research and development (R&D), patent applications and economic growth6.
Then there are the companies that evidence the payoff with their ongoing commitment to R&D. New Zealand’s often touted examples of R&D big spenders like Xero, Fonterra and Fisher & Paykel wouldn’t continue to invest if they weren’t reaping the rewards.
Strong evidence also exists to support tax incentives as a mechanism for growing R&D spending. A working paper from National Bureau of Economic Research that reviewed the empirical evidence on their effectiveness, released earlier this year, found R&D tax credits were effective at increasing business R&D.
“… the tax relief program not only spurred innovation by the firms that were its direct beneficiaries, but it also had positive spillover effects on technologically related firms.”
Another working paper focusing specifically on the UK tax incentive programme to encourage R&D found that aggregated business R&D spending would have been 10 percent lower in the absence of tax relief.
The researchers also found no evidence that firms reclassified existing activities as R&D or expanded relatively inconsequential projects – another concern that has been levelled at the tax credit.
With all that in mind, there’s a strong case to be made for New Zealand businesses to commit to boosting their R&D spend. The R&D Tax Incentive is well-positioned to provide the support that’s needed for Kiwi companies to feel the fear – think of the rewards – and do it anyway.
1, 2 What we know (and don't know) about economic growth, July 2016, MBIE Working Paper 16/01
4 The World Bank Group https://data.worldbank.org/indicator/gb.xpd.rsdv.gd.zs
6 World Bank, UNESCO, OECD http://res.cloudinary.com/yumyoshojin/image/upload/v1484993356/pdf/intellectual-property-2017.pdf
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