Canada’s Innovation Gap: A Warning Sign for Economic Prosperity and National Security

In the hyper-competitive global economy, business investment in research and development (R&D) is crucial because it drives technological innovation, which is a key factor in any country’s economic prosperity and national security. Yet Canada’s levels of business R&D are far off the pace in technologically advanced, globally traded sectors of the economy.

A recent analysis paints a stark picture, revealing yawning chasms, not just between Canada and the United States but also between Canada and the size-adjusted global averages for business R&D in nine advanced sectors. In 2021, U.S. firms spent almost 103 times more than their Canadian counterparts on R&D in these sectors, despite U.S. GDP being just 11.7 times larger than Canada’s. Worse, Canada was below the global average by a factor of almost five. Such disparities should serve as a clarion call for Canada to reevaluate the R&D incentives it provides firms.

Using data from the EU Industrial R&D Investment Scoreboard—a dataset covering 90 percent of the world’s private sector R&D spending—ITIF assessed Canada’s levels of industrial specialization relative to the global average in nine technologically advanced, globally traded sectors: aerospace and defense, electronic and electrical equipment, general industrials, industrial engineering, pharmaceutical and biotechnology, software and computer services, technology and hardware equipment, alternative energy, and automobiles and parts.

Canada was below par by a factor of two or more in all nine sectors. Its strongest showing came in aerospace and defense, where its firms invested just 45 percent of the global average for business R&D, followed by software and computer services (41 percent of the global average), then automobiles and auto parts (27 percent), then pharmaceuticals and biotechnology (18 percent). In no other advanced sector did Canadian firms register higher than 10 percent of the global average for business R&D.

Meanwhile, U.S. firms invested more than the global average in five of the nine advanced sectors and less than the global average in four. Although, firms in America’s worst-performing sector for business R&D (alternative energy) still invested more in relative terms than firms in Canada’s best-performing sector (47 percent of the global average versus 45 percent).

While the United States maintains a more competitive position in R&D than Canada, its firms’ size-adjusted R&D spending was declining or stagnant in seven of the nine sectors ITIF analyzed, compared to five out of nine in Canada. This underscores both nations’ urgent need to bolster R&D investments to remain globally competitive.

While there are numerous steps nations can take to support R&D-intensive firms, the most straightforward thing Canadian policymakers can do is enhance R&D tax credits. As things currently stand, Canada’s R&D tax subsidy rate slightly exceeds the median for OECD and BRIC countries, while the United States has allowed itself to slip far behind the pace.

To become more competitive, Canada should consider replacing its Scientific Research and Experimental Development (SR&ED) tax credit with something more akin to the U.S. Alternative Simplified Credit (ASC). This would entail limiting the credit to expenditures above 50 percent of base period spending and doubling the credit rate. These changes will incentivize companies to invest more substantially in R&D, fostering a culture of innovation. (For its part, the United States should at least double its ASC rate from 14 to 28 percent.)

Provincial governments in Canada should increase the incentives they provide, too. A concerted effort is required at all levels to nurture a policy environment conducive to innovation.

R&D expenditures, especially in advanced traded sectors, are a linchpin of a nation’s competitiveness in the global economy. Canadian firms have a long road ahead to catch up with the global average in R&D spending, while U.S. firms face their own challenges. However, the urgency of the situation demands swift action.