Ottawa’s ‘innovation budget’ unlikely to spark innovation

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Appeared in the Winnipeg Free Press, April 6, 2017

There’s no doubt that a key theme of the recent federal budget was innovation. Indeed, the word “innovation” appears 261 times in the 280-page budget document. While innovation is certainly an important driver of economic growth and prosperity, Ottawa’s current approach—doling out public funds to favoured industries and companies—is unlikely to spark innovation and may in fact hinder it.

For instance, the government plans to spend $950 million over five years for the formation of “superclusters” to help create the next Silicon Valley. How precisely this will be accomplished is unclear, but the government has anointed particular industries—such as agri-food and clean technology—as the most likely originators of coming innovation.

The problem with trying to pick winners is that no one really knows what sectors will drive growth-enhancing innovation. Ironically, this is a point Finance Minister Bill Morneau recognized in his budget speech when he noted that a few decades ago no one would have imagined how much mobile computing would change the way we live.

Critically, handing out taxpayer money to the government’s favoured industries takes resources away from other areas of the economy that could in fact be the source of future innovation.

The budget contains other hand-outs to businesses in the name of innovation. For instance, $400 million for a new government-sponsored venture capital fund and $1.4 billion in new available financing for businesses involved in clean technology.

While Ottawa hopes the private sector contributes financing for the venture capital fund, the auditor general recently found that a similar fund, created by the Harper Tories, failed to attract private investors due to low returns and high management fees. Moreover, evidence shows that government-sponsored venture capital initiatives tend to underperform compared to initiatives funded by the private sector.

More broadly, it’s concerning to see the government announce new spending on innovation when there’s no indication that the considerable resources currently spent are effective. Ottawa currently spends $23 billion each year on 147 separate programs and special tax breaks aimed at innovation and skills training. But as a recent study found, the government has not properly measured whether 90 per cent of this spending is achieving the stated goals.

Also concerning, the government has brought back the Labour-Sponsored Venture Capital Corporation Tax Credit, a failed policy that is counterproductive to innovation. Again, the evidence shows this tax credit, which costs $150 million each year, displaces more effective private venture capital funding and lowers the level of overall capital available to Canadian entrepreneurs.

Rather than try to pick winners (and losers), the government should instead foster an economic environment that encourages innovation and entrepreneurship broadly. This can be achieved in two important ways.

Firstly, reduce regulations that protect industries and certain businesses from competition. When competitive pressures are lacking, there’s less incentive to innovate, whether the desire is to protect or gain market share. Indeed, research shows that regulations restricting competition slow the introduction of innovative technologies and practices.

Secondly, ensure entrepreneurs are rewarded for taking risks on unproven ideas. Unfortunately, the federal government’s record on this front is not positive, as it has raised the top marginal tax rate on personal income—a policy that research shows will adversely affect entrepreneurship by changing the risks and rewards associated with it. In other words, by raising the top tax rate, the federal government is discouraging the very people most likely to innovate.

If the government is serious about encouraging innovation, it should take steps to eliminate counterproductive policies and increase the rewards of innovative endeavours.

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