Is Canadian R&D Too Risk Averse?

December 28, 2017 SRED

Are Canadian companies running from research and development because of risk?

Innovation in Canada has been under scrutiny by the government, industry, and media in various forms for decades. In this article, we discuss a growing trend among critics of Canada’s research and development (R&D) funding practices, and of the belief that Canadian companies are not taking enough risks in their R&D efforts, and how these criticisms may affect the SR&ED program.

The Naylor Report’s View

In the report published in April 2017, Investing in Canada’s Future: Strengthening the Foundations of Canadian Research (The Naylor Report), David Naylor, former president of the University of Toronto, suggests that Canadian businesses should take more risks in their R&D.¹ The Naylor Report was commissioned by Kirsty Duncan, Minister of Science, in 2016 and is the most comprehensive review of federal government spending on science in 40 years.²

The report states that “current financial pressures are leading Canadian peer review committees to favour proposals using proven techniques, in areas that have been productive in the past, and from more established researchers with proven track records.”³ It notes that “the current climate of risk aversion is partly created by funding shortfalls.”⁴

The Naylor Report recommends that “the Government of Canada should mandate the [fund-] granting councils to encourage and better support high-risk research with the potential for high impact.”⁵ These councils include the Canada Foundation for Innovation (CFI), Canadian Institutes of Health Research (CIHR), the Social Sciences and Humanities Research Council (SSHRC) and the Natural Science and Engineering Research Council (NSERC).

The report also addresses “areas of action” such as “amending funding program criteria to ensure that a meaningful portion of grants goes to riskier projects and providing training to peer reviewers to reduce potential bias against high-risk research.”⁶ The report’s panel recommends looking to other countries and regions for successful models for Canada’s funding agencies and adds that these agencies already “have a mix of programming that offers latitude for riskier research questions to be pursued.”⁷

Beyond the Naylor Report

In August 2017, the Information Technology Association of Canada (ITAC),⁸ a national association for businesses in the information and communications sectors, released a 2018 Pre-Budget Submission to the federal government, Strengthening Canada’s Place in a Digital World.⁹ The submission recommends “increasing risk capital for growing companies” by allowing large firms to fund collaborative R&D with Canadian small and medium businesses through unused SR&ED tax credits.¹⁰

“Risk capital,” otherwise known as “venture capital,” is “capital invested in a project in which there is a substantial element of risk, typically (in) a new or expanding business.”¹¹ Investopedia also describes risk capital as:

Such capital [that] can either earn spectacular returns over a period of time, or it may dwindle to a fraction of the initial amount invested if several ventures prove unsuccessful, so diversification is key for successful investment of risk capital. In the context of venture capital, risk capital may also refer to funds invested in a promising startup.¹²

Essentially, ITAC suggests that Canadian companies need access to the type of funding that would allow them to pursue riskier R&D projects. Although ITAC advocates in favour of the SR&ED tax credit, it has suggested that it is not incentivizing Canadian business to complete riskier R&D endeavours and has previously provided recommendations on how the SR&ED program can be changed to encourage R&D.

The Federal Government’s View

Concerns regarding the culture of risk aversion in Canadian R&D have been previously brought to the attention of the federal government. In 2015, an internal note to then-Finance Minister Joe Oliver, Canadian Business Innovation Landscape, stated Canadian firms were “shunning” innovation, and one of the possible reasons why was “the higher risk aversion of Canadians.”¹³

In July 2016, Navdeep Bains, Minister of Innovation, Science and Economic Development Canada, also told the Globe and Mail newspaper that innovation had “lagged” in Canada. “Eighty-five per cent of the tax policy that we have for benefiting R&D is indirect,” Bains said. “The vast majority is driven by SR&ED. The idea is to really stimulate investments in R&D. […] We’re providing opportunities for businesses but they’re not really stepping up. […] The issue is how come business isn’t investing more in R&D? That’s where our focus is.”¹⁴

The Naylor Report argues for a vigorous “scrutiny” of SR&ED tax credits,¹⁵ and in October 2017 (the time of writing) the federal government was reviewing the SR&ED program. However, it is uncertain what recommendations the government will adhere to.

Conclusion

Whatever the reason for Canadian business’ aversion to risky R&D, it is important to note that funding riskier projects does not automatically lead to R&D success. Although Canada does not have a large global competitor pursuing R&D such as Google or Facebook, there may be good reason for Canadian business’ and funding agencies’ safer approach to R&D.

Canada’s innovation has been affected in the past by the failings of Blackberry¹⁶ and Nortel.¹⁷ These experiences may have had an adverse effect on the enthusiasm at which riskier R&D projects in Canada are initiated and funded. However, diversifying the projects by funding some high risk (but not so much that the risk of failure would be monumental to business and the government) and other, lower risk projects may provide the boost that Canadian innovation needs and may appease critics of Canada’s R&D funding programs (including the SR&ED tax credit).