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economy lab

Kevin Van Paassen

Expanded international trade and measures to encourage research and development (R&D) are two themes that are dealt with separately in the budget, but there are some important links between more openness to trade and innovation.

Research and development is costly, and much of Canada's R&D policy framework is built around reducing those costs, most notably in the form of tax credits under the Scientific Research and Experimental Development (SR&ED) Program. Many observers have concluded that the SR&ED has been a costly disappointment: even though public spending under the SR&ED has been high by international standards, Canada still lags in international rankings of R&D and innovation.

The reduction of the SR&ED tax credits and the new emphasis on direct support for R&D is best viewed as an admission of failure on the part of the government and a willingness to experiment with another approach.

It remains to be seen if these experiments will do any better. 'Direct support' amounts to governments providing public money to companies that – in the government's judgment – are best-placed to develop new, profitable products and technologies. It is by no means certain that governments have any particular talent in predicting trends in markets or technology, so there is a non-negligible risk that the money will simply go to those who are well-connected.

But reducing the cost is only one way of encouraging R&D. Another way to tilt the R&D cost-benefit calculus is to increase the payoff. And one of the ways of making innovation more profitable is to increase the size of the market to which the entrepreneur has access.

There is a well-established link between productivity growth and participation in international trade: firms – both Canadian and foreign-owned - with an international exposure have higher productivity, do more R&D and pay higher wages. Even though it is not presented as such, making it easier to gain access to foreign markets may be the most effective innovation measure in the budget.