Productivity and R&D Expenditures

Archived Topic Box from the 2005 Fifth Annual Benchmark Report

Economic theory points to advances in technology as a principal determinant of long-run productivity growth, and therefore represents a major source of increases in economic growth and living standards over time. Technological change happens through innovation – the complex process whereby research creates novel ideas, new technologies and processes, new products are invented, and old products and ways of doing things are improved. The eventual outcome is better, or cheaper, goods and services that stimulate economic growth.

At the root of technological change is research and development (R&D), a broad concept that includes both the development and integration of new products and the improvement of business practices. Due to the importance of R&D to productivity growth, and productivity growth to economic growth and improving living standards, the link between R&D and productivity has been studied at length. However, difficulties in measuring and defining both variables mean that studies and reports have varied widely in their estimations about how much R&D impacts productivity levels and productivity growth. Some US studies have produced estimates of the impact of R&D on productivity that range from zero net effect, to returns that exceed all other types of investments. Results from US studies strongly suggest that R&D spending has a positive influence on productivity with a rate of return that likely exceeds that of conventional investments.

R&D is generally divided into two categories – public and private. Historically the positive impact of R&D on productivity has been stronger for the private sector than public sector universities and research institutions. However, R&D performed in the public sector has spillover effects on the general level and quality of R&D performed in a society, and therefore, the division between private and public R&D is not entirely clear.

Analysis done by the OECD confirms a positive correlation between R&D expenditures and productivity performance, and explores the varying returns from public vs. private R&D spending in detail. Focusing on the effects of R&D spending on multifactor productivity growth in 16 OECD countries over two decades, the OECD study found that a 1% increase in business R&D generates 0.13% growth in productivity while a similar increase in public R&D spending generated 0.17% productivity growth. While this study underlined that the linkage between public R&D and productivity is significant – and likely outweighs the costs of public research – it also found that the effect of public research was higher in countries with a higher intensity of business R&D, illustrating the essential linkages between the two streams and the importance of the business sector in implementing and commercializing public sector findings.

Of particular importance to a small open economy such as BC where the extent of R&D activities are limited somewhat by the size of the economy and population, is the strong positive correlation between foreign R&D (defined as business R&D performed in other OECD countries) and productivity growth. In the OECD study, this effect was significantly higher than domestic R&D showing that a 1% increase in foreign R&D was associated with a full 0.44% growth in productivity. Significantly, this illustrates the impact of technological spillover effects between nations and the importance of ensuring that domestic firms have the capacity to recognize and adopt foreign technologies just as rapidly and effectively as they do domestic technologies.

Sources: Organisation for Economic Cooperation and Development (2001), R&D and Productivity Growth: Panel Data Analysis of 16 OECD Countries; Nicholson (2003), The Growth Story: Canada's Long-run Economic Performance and Prospects, International Productivity Monitor, Number 7, Fall 2003; Congressional Budget Office (2005), R&D and Productivity Growth: A Background Paper.