R&D Part of the Productivity Puzzle

26 April 2017

New Zealand’s relatively low rate of productivity growth, compared to OECD countries, has long been a core problem, holding us back from becoming a more prosperous economy for everyone.  Aside from all the statistics we hear in the news periodically, productivity is perhaps the most important component for growing our economy in a way that can improve our standards of living, wages and ability to compete and thrive in export markets. 

Continuing a strategy that relies too heavily on commodity exports and low value tourism simply will not get our country to where we want it to be in terms of incomes and sustainable growth - work needs to be done fundamentally around how to create conditions where more high-value businesses can thrive, both in main centres and our regions, and particularly manufacturers and exporters.

Within manufacturing, there are simple changes than can be made to get us moving in the right direction – better support for Research & Development (R&D), and Accelerated Depreciation to support businesses in keeping up with the latest technology in plant and equipment. 

There is a strong link between R&D and productivity, allowing companies to create higher value products, as well as to develop more efficient processes and new ways of production.   There are also productivity and innovation benefits of co-locating R&D and production activities – keeping manufacturing activity on-shore has benefits wider than the jobs and growth it supports.

New Zealand lags behind most of our competitors in terms of business R&D spending, and in the support Government contributes.  Our total R&D as a percentage of GDP sits at 1.28% in 2016 (with business spending making up 0.64%, Government 0.26% and higher education 0.38%).  This is significantly lower than the OECD average of 2.4% of GDP.  Still, manufacturing is already a large contributor to business R&D spending, making up over 40% of total private sector R&D spend.

R&D tax credits are a common policy tool used around the world to incentivise and support R&D activities. Many of our direct competitors use R&D tax credits or other forms of incentives, such as Australia, Canada, China, Ireland, Japan and the United States.  New Zealand used to have a system of R&D tax credits in place, but these were removed and replaced by a grant system, though some tax credits have been made available for start-ups.

The current grants programme for New Zealand simply doesn’t work. Well, it works for large companies with high R&D expenditure – they continue to get a 20% tax credit on their R&D spend for a maximum of 5 years. The system for Callaghan Innovation Project Grants, however, designed for smaller companies, is viewed as far too cumbersome by most manufacturers to be worth applying. There is a good reason why most countries opt for the much simpler system of R&D tax credits.

The other side of this equation is businesses simply being able to invest in new plant, equipment and technology to improve their own productivity – with the rapid pace of change in technology in manufacturing, this is more critical than ever.

A simple change is to introduce accelerated depreciation for investment in productivity improvement. Manufacturers need to innovate to increase productivity, and apart from process innovation, that means upgrading productive plant and equipment.  Current tax rules were written when manufacturers could afford to run machinery for 20 years or more before replacing it – that is simply no longer the case. And what we are asking for is not a change in the total tax payable, just in the timing of it.  Once again, this kind of tax treatment of productive equipment investment is relatively commonplace among the countries our exports compete with. 

Both R&D tax credits and accelerated depreciation are solid starting points for helping move our economy in a more productive and sustainable direction – keeping up with innovation and technology is the only way the productive parts of our economy, like manufacturing, can keep up with our competitors into the future.  If we want a prosperous country, we cannot be left behind.