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In recent months, we've seen glimmers of hope that Canada's long-dormant business capital investment is starting to pick up – considered a critical element to spurring the country's next phase of economic growth and addressing its chronic productivity underperformance. But sadly, a key missing piece of the productivity puzzle – research and development – is being left behind.

A new report from Statistics Canada says Canadian companies expect to spend $15.4-billion of R&D this year – down 0.9 per cent from last year. It's the third straight year in which R&D spending has declined, cutting more than $1.1-billion from corporate Canada's R&D budgets. Businesses' R&D spending is now no higher than it was in 2005; if you exclude wages from that equation, R&D is down 16 per cent in the past decade.

Clearly, this is no recipe for the kind of innovation culture that lifts productivity, expands economic capacity and drives international competitiveness. Given that pretty much everyone agrees more innovation is desirable, yet corporate Canada isn't increasing its investments in innovation, we have to wonder what the problem is here.

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It's not that Canadian businesses, in general, don't have the money. Collectively, they have more than $600-billion in cash in their piggy banks. Last year, operating profits nationally increased by nearly $14-billion (4.4 per cent); profits in the first quarter of this year were up more than 12 per cent from a year earlier. (Statscan will release second-quarter data later this month, but earnings reports from companies that trade on the Toronto Stock Exchange suggest continued strong profit growth.)

And there are indications that companies have started to loosen the purse strings, as economic prospects gradually improve. Statscan reported early this year that businesses intended to increase their spending on construction, machinery and equipment this year, albeit by a modest 1.4 per cent. Since then, the Bank of Canada's Business Outlook Survey has shown a growing proportion of companies in each of the past two quarters that indicate they plan to increase their investment in machinery and equipment. Meanwhile, permits for non-residential construction are surging; in June, they were up more than 40 per cent from a year earlier.

Investment in upgraded machinery and equipment and expanded facilities certainly play an important role in productivity improvements. Still, for an economy that is struggling to remain competitive in many export markets, the absence of R&D investment is troubling.

If we look at the composition of Canada's R&D picture, we get a better idea where the problem lies. While R&D spending has expanded rapidly in Canada's booming energy sector, it has been in a prolonged slump in manufacturing – mirroring the downturn in the sector in general. Annual manufacturing R&D has declined 22 per cent since 2001. Back then, manufacturers were responsible for more than two-thirds of all of Canada's R&D spending; now it's just 46 per cent.

There's a bitter irony that the sector that most badly needs to innovate – to regain the ground lost to aggressive, low-cost international competition – is the one area where R&D investment is sputtering the worst. The country's manufacturers are falling into a vicious circle: As business erodes, they scale back spending on such costly luxuries as R&D, which leaves them further behind the innovation curve, which makes them less competitive in the global market, which further erodes their business.

If Canada's manufacturing sector is ever going to get back in the game, this can't continue. For starters, Ottawa needs to treat this as an economic policy priority; it needs to get moving on its overhaul of its science, technology and innovation strategy – something it has been kicking around for a few years now, and on which it held public consultations earlier this year – and provide meaningful incentives to accelerate private-sector R&D investment.

An export-intensive economy, operating in a world where trade is no longer growing as it once was, simply can't afford to neglect these investments – especially when it comes to manufacturing.

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