Research and development – the creative process of discovering and applying new knowledge – is an integral component of industrial innovation. It is the foundation upon which new products, services and business processes are developed that can increase the productivity and international competitiveness of an economy.
R&D is important for Australia’s economic future. As an advanced, open and high-wage economy, Australia relies on the IP and technology embedded in our industries to compete effectively in global markets.
It is therefore concerning that Australia’s performance is going backwards. The rate of both business and government R&D has declined over the last decade, despite it being a time when technological change is accelerating. This decline is also an Australian problem, as rates have been stable or increasing in our advanced economy peers.
This worrying reality runs counter to the notion that Australia is a knowledge economy, whose future success will be based on exploiting high-tech and high-skill niches in global value chains.
So, what’s going wrong? This Research Note examines the dynamics of Australia’s business R&D performance and focuses on business R&D which accounts for just over half of the national total. It is the form of investment that is ‘closest’ to industry, with only a short distance from invention to implementation.
Our findings in a nutshell? Australia heavily depends on a small number of ‘R&D champion’ industries, meaning the national effort is highly exposed to those industries’ economic performance. Building a broader and more diverse industrial base would help drive stronger and more robust national performance.
Australian businesses undertook $20.6 billion of R&D expenditure in 2021-22. This was the highest annual figure on record, beating a previous high-water mark set in 2013-14. In gross terms, business spending has been on a steady upward trend for the last decade.
However, this aggregate growth masks the decline in the intensity of R&D activities undertaken by business. If we measure it instead in terms of industry value-add – a proxy measure for how much businesses reinvest – we can see that Australia’s intensity is going backwards.
Australia’s business R&D intensity grew during the 1990s and peaked in years of the mining boom when it reached 1.38% of industry value-added and 1.28% of GDP. However, the rate then started to fall, and has been declining ever since. It is now at a meagre 0.93% – is at its lowest level in two decades.
Had Australia maintained our peak rate from the mining boom, business R&D would have been $29.8 billion in last financial year: $9.1 billion or 44% higher than it actually was.
This decline in R&D intensity is somewhat unique to Australia. International benchmarks published by the OECD reveal that our advanced economy peers have powered ahead during the same period.
The R&D intensity of the OECD group has grown from 2.3% to 2.7% of GDP since 2008. Particularly large increases occurred in the UK and US, while France, Germany and Japan all maintained high but steady rates.
This increase in advanced economies is unsurprising, as technological change – in particular digitisation – increases the importance of R&D activity.
By contrast, Australia is the only major OECD economy that reduced its intensity dropping from 2.2% to 1.7% since 2008 and resulting in a fall from 12th to 19th place in the OECD ranking.
The Australian economy’s capacity is declining, while our peer competitors’ is growing. Why is Australia bucking the global trend?
Australia has a distinctive system for supporting business R&D activities that heavily relies on indirect forms of government support.
In 2019, $2.96 billion of government support was given to business R&D. Direct government financing – typically in the form of grants or subsidies – accounted for just under one-fifth of the total.
The bulk of support (84%) comes indirectly through the Research and Development Tax Incentive (RDTI), a program which allows companies to offset eligible R&D expenses against their corporate tax liabilities.
If we look at direct and indirect measures together, government support for business R&D in Australia has increased over the last decade. The effective rate of support rose from 9 to 12% of expenditure during the mining boom, to around 16 to 18% more recently.
So despite the effective rate of government support rising, the rate of business R&D in Australia has gone backwards.
Australia’s business R&D depends on a small number of ‘champion’ industries. Of our nineteen industry divisions, just three - professional scientific & technical services, manufacturing, and finance & insurance – account for 74% of all business investment. R&D.
This is an extremely narrow industrial base, and means the national effort relies largely on the performance of just these three industries.
During our R&D peak, a fourth industry – mining – was also part of the champions group. Its rise then decline explains part of Australia’s trajectory.
As mining investment spiked during the boom, so too did the industry’s R&D. In Australia’s peak year (2011-12), mining contributed $4.1 billion, a quarter of the national total.
But as the boom came off the boil mining investment fell back to more modest levels, bringing R&D expenditure down with it. By 2021-22, mining had fallen by three quarters to only $0.9 billion, and the industry’s intensity collapsed from 4.1% to 0.3% of value-add.
Within a decade, mining has ceased being one of Australia’s R&D powerhouses.
However, there is more to the national decline than just per mining. Because during the last decade, the R&D intensity in Australia’s non-mining industries also fell from 1.19 to 1.07%.
Unpacking the dynamics by industry:
Professional services is the only major industry which is growing its R&D rate, and manufacturing the only one holding. But this hasn’t been enough to offset the declines in intensity in mining and other industries.
Australia will struggle to improve our business R&D performance when the industrial base is so narrow.
Reliance on a few champions has exposed Australia to cyclical effects, such as the boom-and-bust cycle of the mining industry. It has also left Australia dependent on a single industry – professional services – for growth.
The solution is to build a broader industrial base for business R&D in Australia.
A first step would be to assess how it can be increased in technology-intensive industries. There is significant use of technology in the agriculture, utilities, retail, construction, and information sectors; yet the intensity of these industries is consistently low.
The explanation may lie in the qualification rules for the RDTI program, which require that R&D activities discover outcomes that “a competent professional cannot know or determine in advance”, and involves a “systematic progress of work” that proceeds from hypothesis to experiment and observation.
This rule excludes research activities which do not involve a formal process of experimentation, as well as activities designed to reproduce a commercial product or process in a new context for the first time.
In the UK – a country which soared up international R&D rankings in the last decade – the qualification rules for R&D tax credits are more permissive. UK businesses simply have to demonstrate that it “overcame scientific or technological uncertainty”, and does not require a formal experimental process.
A second step would be to consider the supply of research skills to Australian industry. These skills are some of the most acute shortages affecting us. Some 37.5% of businesses which utilise science and mathematics skills report being unable to source skilled professionals, the second-highest reported shortage in Australia today.
Businesses which struggle to recruit and retain a research workforce are less likely to commit to R&D investments.
Third, attention should be paid to the precipitous decline in mining R&D. Mining is currently one of the least R&D intensive industries in Australia, whereas it was one of the highest a decade ago. The industry has demonstrated a capacity for much higher levels of R&D, and addressing the factors behind its decline will do a lot to rebuild national capability.
Indeed, mining R&D offers benefits beyond the industry itself. Many of Australia’s key advances in automation – particularly in robotics, sensing and environment management – were first pioneered in mining, before being more broadly applied in agriculture, manufacturing and transport.
The cross-industry spillovers from mining R&D make it a priority to rebuild its performance for the benefit of other sectors too.
Australia has had stronger R&D performance in the past, and we can do so again. Building a broader and more diverse industrial base would help drive the research needed to underpin our future as a knowledge economy.
Dr Jeffrey Wilson is Ai Group's Director of Research and Economics. He leads our economics team, and provides strategic direction in developing the research program to support our advocacy, service delivery and policy activities. He specialises in international economic policy, with a focus on how trade and investment shape the Australian business environment.
