Encouraging R&D - forget about it!

One aspect of Australia’s international performance over which commentators occasionally wring their hands, is this country’s apparently poor showing in spending on research and development by the private sector. No spending on research and development means no advanced industries, or so the theory goes.

The Federal Government has, over the years, tried to act on these concerns by granting various tax breaks and was recently trumpeting the fact that tax concessions given to R&D in 2001 had led to a surge in spending on this activity.

Perhaps. But as already noted by other On Line Opinion commentators, there is good reason to believe that the bulk of tax concessions on R&D are a waste of money, with a lot to be said for direct grants to R&D projects. (In fact, government policy seems to be swinging around to this point - it just has a way to go.)

But whatever the government’s policy, it is now broadly recognised that international comparisons of private spending on research and development are of little use by themselves. They don’t mean anything. The amount of money spent on R&D by a particular country is little more than a reflection of that country’s industrial structure, not the cause of it.

To explain. The OECD occasionally publishes international comparisons, with one such comparison being the amount of money spent on research and development as a percentage of gross domestic expenditure. In the latest figures, which are now five years old, Australia is about half way down the list with a score of 1.64 per cent - below Luxembourg (1.75) and a little above Norway (1.61), but well below the leader, Sweden which is a shade below 4 per cent.

This could obviously be better, but essentially all the list is telling us is that those countries have different industries. As a comparison we could look at figures for spending on exploration and mining. Those figures do not seem to be collected but if they were collected and ranked by countries, Australia and Canada would come out near the top. However, all that ranking tells us is that both countries have large hinterlands, with plenty of minerals and not much settlement (native groups aside) to prevent cheap extraction.

Sweden, Finland and Switzerland would be somewhere near the bottom in spending on mineral exploration as Finland and Switzerland, in particular, have few mineral resources.

In contrast, Sweden tops the list of R&D per capita as it has industries which, by their nature, require a lot of spending on development just to stay in the game. Innovative mid-tech companies in Australia - companies that make, say, poker machines or smart parking meters - are unlikely to invest more than 10 per cent of revenue back into research and development. One of Sweden’s main industries, in contrast, is telecommunications, which has a high reinvestment rate. Ericsson is known to put 24.9 per cent of its revenue into research and development. As Sweden is also home to the likes of Saab and Electrolux it is little wonder that the R&D rate is high.

Australia may not have an Ericsson or a Saab, but it does have internationally known swim wear companies - design of clothing is unlikely to count as R&D but maybe it should - as well as companies that make farm equipment for dry soils, or race track equipment. And who could forget the Wiggles - the entertainment group for very young children - which has become an international franchise.

These enterprises may be industries that spend more on marketing than high tech research and development (the Wiggles probably don’t claim much for R&D) because that is the way those particular industries operate.

In a recent report by the Productivity Commission, Public Support for Science and Innovation, March 2007, the commission adjusted the OECD R&D tables for industry structure to find that Australia’s private research effort is in fact, tolerably close to the OECD average - where that average is well up the list. The adjusted figures probably don’t tell us much, but the commission rightly concluded that there was no urgent problem that needed fixing.

All that said, Australia would also like its own Ericsson or Saab, or even an IKEA (also Swedish based), as a further broadening of the economy and, of course, as something we can tell international investors about. Sadly, those hard-nosed investors will be less impressed by The Wiggles than by an international telecommunications company.

So how do we get a Saab or an Ericsson? The answer is with difficulty, but certainly not by forcing matters, and probably not in well established industries. Ericsson was founded not long after Alexander Graham Bell invented telephones and Saab started in the 1930s as a supplier of airplanes to the Swedish military. Australia’s own Commonwealth Aircraft Corporation started not long after Saab, incidentally, and although it made trainer aircraft in the 1940s and helicopters under licence in the 1970s, and still makes aircraft components (the company has long been foreign owned) it never kicked off in the same way as Saab.

There is no one answer as to why Saab worked and CAC did not, but Sweden already had a well established armaments industry, with designers and skilled technicians to hand, not to mention ready customers (Europe) near by. In contrast, Australia’s natural advantages, and opportunities were in mining, and farming, so that is where the capital and talent went.

Mining is no longer the brave new world that it was, and farms hardly require anyone to run them, so there is hope yet. However, AussieSaab is unlikely to mushroom out of an established company - it has to come from left field - so there would seem to be little point in boosting research through concessions given mainly to well established companies.

This is mostly what the major, existing tax concessions for research and development do. Taxpaying companies can claim 125 per cent of money spent on R&D, with that concession representing about 60 per cent of the $420 million foregone in various tax programs designed to encourage innovation.

Another program that is unlikely to bring forth a down under Saab or Microsoft is a 175 per cent premium tax concession, granted by the Government for a company that makes a greater than usual effort in R&D. There is also a R&D tax offset for small companies and a grant program, listed along with the tax concessions, called the Commercial Ready program.

The Department of Industry Tourism and Resources recently produced a weighty report How R&D Assistance Influences Company Behaviour which found, through surveys, that the concessions helped business by permitting them to speed up product development and giving projects a larger budget.

All worthy results but, I suspect, in the end of little use. R&D is a serious business and if private companies have to be pushed into action on this front, or take tax into account in making the decision to invest in R&D, then they are probably on the way out anyway.

In any case, apart from the potentially useful tax offset and commercial ready program, the concessions simply permit established companies to avoid some of their tax. Best to give everyone a tax cut and hope that someone out there intends to start AussieSaab.

Post script. As this article was in the process of being put up on On Line Opinion's site, the Australian Bureau of Statistics released a new set of figures for private spending on research and development. These figures indicate that spending on R&D has been increasing at a rate of 12 per cent a year. That is nice but there are several possibilities. One is that the various tax concessions available have made businesses more willing to declare spending on R&D, another is that R&D spending is rising world wide, and yet another is that the structure or composition of Australian industry is changing. Or perhaps all three. The figures mean little by themselves.