Answering the $64,000 question: Closing the income gap with Australia by 2025: First Report and Recommendations
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Policies we recommend should not be adopted

Greater research and development support

Many submitters argued that substantial increases in government financial support for research and development should be an important component in any successful strategy to close the income gap. Those who argue along these lines tend to highlight the relatively low share of GDP spent on research and development (R&D) in New Zealand - on the most recent data, only 7 of the 30 OECD countries had a lower share of spending on R&D than New Zealand. It is often noted that our R&D spending is, as a share of GDP, 23rd in the OECD, and that our GDP per head is 22nd in the OECD. The suggestion is that low R&D spending has, in some sense, caused the continuing economic underperformance.

But on many dimensions the picture is not that clear cut. All but one of the countries where more is spent on R&D than in New Zealand has higher GDP per capita than New Zealand. But is high ongoing spending on R&D resulting in higher incomes or is it the other way round? If we look at economic growth in the ten years prior to the recent recession, of the 10 countries spending more on R&D than the OECD average, only four had faster GDP per capita growth than New Zealand. Six countries spent less on R&D and most grew more rapidly than New Zealand. The countries spending less on R&D mostly have lower incomes than we do - they too no doubt are aspiring to improve their overall economic performance, closing their gaps to the rest of the OECD. It is at least possible that higher spending on R&D is a reflection of an economy's success, and part of the process of maintaining the capabilities within firms that helped make their homelands successful high income countries, rather than being a direct cause of that success. A company like Nokia needs to spend heavily on research and product development to maintain its position in a constantly changing market.

It is also well-recognised that, as a share of GDP, New Zealand government spending on R&D (through universities, Crown Research Institutes and other mechanisms) is not obviously anomalous - indeed, it is higher as a share of GDP than in a number of countries with materially higher incomes (including the United States, the United Kingdom, and Canada).

To the extent that there is a gap to be better understood, it relates to private sector R&D spending, which is materially lower (as a share of GDP) than in most OECD countries. Some research work suggests that New Zealand's rate of research and development spending is not unexpected given the current industry structure of the economy[41]. But, of course, that may be to beg the question: the point of the 2025 goal is that we want the New Zealand economy to look different than it does now, not just to explain why it is how it is today.

The private sector can be expected to invest - and invest heavily - in R&D when it expects there to be a large pay-off, and where the firms doing the investment can capture many or most of the gains. Intellectual property laws are an important component of ensuring that people thinking of doing research can secure enough of the gains to make such spending worthwhile. Many New Zealand firms invest heavily in research and development to develop and expand their product range.

For firms, research and development spending is one component of the overall process of innovation that enables firms to adapt and grow, staying a step or more ahead of competitors from around the world. But it is only one component - and even in-house or contracted research is only one way of positioning a firm at the leading edge of technology. Licensing arrangements, joint ventures with foreign investors, and foreign direct investment itself are also ways of enabling New Zealand to benefit from technological advances. As just one example, most banks here are Australian-owned, but whether their formal research and development spending is physically done in Australia on the one hand or New Zealand on the other doesn't affect the ability of New Zealand firms and businesses to benefit from the product innovations and technological advances the Australian bank operations here introduce as a result of the parent banks' R&D spending[42].

In understanding the research and development situation in New Zealand, it is also worth considering some data compiled by the OECD on the number of researchers doing R&D. On those figures, New Zealand has the fourth largest proportion of the workforce doing R&D (in fulltime equivalent terms) of any of the 30 OECD countries. How these figures are reconciled with the spending figures is not entirely clear, although one possibility is that our researchers may have relatively little capital to work with by comparison with researchers in other richer countries. It certainly doesn't suggest the lack of a skill base or a lack of willingness to do remunerative research.

Figure 20: Researchers (per thousand people employed, full-time equivalent, engaged in R&D)
Figure 20: Researchers (per thousand people employed, full-time equivalent, engaged in R&D).
Source: OECD

The Taskforce recognises that there is an important role for government in funding some components of scientific research, in particular the so-called “basic research” that does not necessarily lead directly to patentable or marketable products. In those areas, it may not be possible for private investors to capture a sufficient proportion of any gains. The government sector, broadly defined, owns a large proportion of the assets in New Zealand and provides directly a lot of the services. One would expect the owners to be doing, or paying for, the research and development spending required in support of those state-owned or provided activities. But without market disciplines it is an open question whether the right incentives are in place to encourage them to do so adequately.

There may also be a limited number of areas where additional research spending would benefit a wide variety of parties, but where it might be either extremely difficult to coordinate all the potential beneficiaries, or to limit the use of any resulting research advances primarily to those who have contributed to the cost. Without some government facilitation and/or funding, an inappropriately low level of spending would be likely. To some extent these cases are provided for in the Commodity Levies Act, which enables participants in a single industry to agree on an industry levy (ie not involving government funding) to fund generic research and development spending. In a New Zealand context, bee research (potentially benefiting all agricultural, horticultural and viticultural producers) might be a rare example of something that is best funded from central government.

Whatever research and development spending the government does or funds needs to be managed extremely well. Resources are scarce, and the research capabilities of New Zealand universities and CRIs, for example, are extremely valuable assets. It is important that they are managed, and harnessed, to generate best long-run value for the economy as a whole. We note that the Government has appointed a taskforce to review the Crown Research Institute model and we look forward to the insights that will no doubt be contained in their report.

The Taskforce is not convinced that there is a compelling case for more government spending on research and development, through whatever means. We regard as unproven the case for the sort of joint government and private sector funding recently announced for research and development in the kiwifruit industry. It is not clear to us that a compelling analysis has been undertaken identifying why private sector growers and marketers should not bear the full cost of the research themselves, through established administrative or innovative new market-based coordination mechanisms. The appropriate test is not whether the private sector parties doing the spending would capture all the benefits of research - lots of innovations and inventions paid for by one firm spark competitors to do something similar, reducing the potential benefits to the initial innovator. We still benefit today from the invention of the telephone: the initial patent having long expired, the descendants of Alexander Graham Bell do not.

More generally, we would not favour the re-establishment of a research and development tax credit[43]. The priority for economic reform should be on improving the overall climate for wealth creation. When people or firms find that the barriers in the way of innovation have lessened and the rewards from taking risk have improved, they are more likely to invest in building businesses, and all that goes with that. A better regulatory environment, materially lower marginal tax rates and a lower cost of capital are much more likely to lift overall economic performance and, probably, private sector research and development spending too, than targeted tax credits or similar spending. In a transformed economy in which more profitable opportunities exist, we would expect to see high rates of investment spending and higher rates of research and development spending. But we get both in the best and most efficient way by creating the right overall climate for business, not by targeted subsidies and specific incentives.

A new government financial institution

Some have argued that there are gaps in the market for finance, constraining growth and development, and that smart government institutions and initiatives could usefully help fill those gaps. We are sceptical.

The best single contribution governments can make to ensure the ready, and efficiently priced, availability of debt and equity finance is to look after the rules of the game. Clear enforceable and transferable property rights, money that holds its value, and a banking system where it is clear that the risks will be borne by the owners of the banks and their creditors, not by the Crown, are the key components of what governments can and should do. Taking direct debt or equity exposure to chosen companies and sectors has little to commend it in almost all circumstances.

Some have argued for the creation of a “new DFC”, or an expanded mandate for Kiwibank, or for an expanded scale of funding for the Venture Investment Fund. Some have also argued for guarantees for small business funding. Our overall approach to these options is as follows:

Notes

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