Arrested development: why are Aussie private sector R&D budgets so abysmal?

We desperately need to keep fledgling tech startups in Australia for the sake of our economy, job market, and chances at building a world-leading startup ecosystem. But with poor government support and vanishing private sector R&D investment, what hope do we have of retaining them?

The Australian government invests 1.79% of GDP in Research & Development.

The OECD average is 2.681%.

Under the current government, this is something we can’t easily control. But perhaps because of this fairly dismal example, private-sector decision makers are doing no better.

Business expenditure on R&D, aka BERD, was just 0.9% of GDP

The creaky old wheels of our commodities-based economy are finally turning towards knowledge, innovation, and invention. We need R&D to get us there. So why are we penny pinching on an opportunity that could help us build the next strong, sustainable era of our economy? 

If it ain’t broke

One factor is our historical underinvestment in R&D. We’re known for more of an “if it ain’t broke, don’t fix it mentality” than a “what if we tried this instead?” one. 

Australian innovation has relied on the government’s R&D tax incentive scheme since 2011. The scheme isn’t too different from schemes in other countries. It does generate worthwhile research and help startups get off the ground. But the statistics suggest it’s failed to deliver higher value to our economy.

Australia’s R&D expenditure as a percentage of GDP declined from 2.18% in 2010 to 1.79% in 2017. We weren’t at the ten-year OECD average of 2.34% to begin with, and we’re certainly not now.

For what are probably complex and numerous cultural reasons, Australia doesn’t share the relentless business drive of the Americans or the savage industrialism of the UK. It has relied comfortably on natural resources and the fruits of agricultural labour rather than investing in boosting our brain power.

We are also a big country with a small population. It’s much harder to generate the critical mass of researchers and businesses needed to drive innovation.

What also didn’t help was the 2018 R&D tax incentive switcharoo. 

In 2017, the Australian Tax Office warned businesses it would audit corporate R&D tax incentives claims amid suspicions they were being made on not-strictly R&D work. It made changes the following year that left Australian businesses liable for millions of dollars in repayment fees and penalties, disqualified them from future incentives, and made it almost impossible for new businesses to qualify. 

Airtasker was hit hard by this, as well as analytics startup Digivizer. Not only did they have to find the money to repay the government. They lost confidence in a system designed to help them that ended up penalising them. 

Airtasker’s “crime” was to claim relief on R&D projects that looked at combining two separate software languages, and developing algorithms that helped moderate content and detect bad user behaviour on the platform. 

Cofounder Tim Fung said: “We’re fortunate that… the scale that we are now at means we are somewhat able to absorb the repayment, but certainly if you’re a company growing at 25% a year, you would definitely not be able to pay it back.”

The whole thing showed a fundamental lack of understanding at the ATO about what software companies actually do. The regulations seemed to require companies to prove activity “more akin to scientific laboratory experiments” than the modern iteration of researching and developing.

Airtree Ventures cofounder Daniel Petre called it “a clusterfuck”.  

It would be great to say things have improved since 2018. 

But changes to Canberra’s R&D Tax Incentives scheme in 2021 – intended to reward companies with higher R&D spends – will actually lower incentives for SMEs because of how it interacts with decreases in SME tax rates. 

SMEs currently get R&D tax credits of 43.5%. The new system means they’ll get the corporate tax rate of 25% plus 18.5%, which progressively reduces the benefit as corporate tax cuts take effect. Lowering the corporate tax rate will help SMEs generally, but will punish those (e.g. SaaS companies) engaging extensively in R&D. 

We desperately need to keep these startups in Australia for the sake of our economy, job market, and chances at building a world-leading startup ecosystem. But the whole thing is kind of a disaster.

Tim Fung said: “We hire software engineers in Australia and are creating jobs in that regard, but certainly if the incentives exist elsewhere to do that more economically, we have to think about that.”

Seeding innovation 

17% of Australian businesses fail because they didn’t do enough homework on their market or industry. Without proper funding for market research, what hope did they have?

R&D investment can be the difference between a seed stage startup succeeding or dying.

Without expensive, attack-dog accounting teams, startups struggle to navigate the space. Rebates are great if you can qualify for them, but having to wait a year for them just doesn’t work for seed stage cash flow.

In securing private funding, there’s a chicken-and-egg problem: startups need R&D funding to be successful, but they can’t get R&D funding before they’ve proven they can be successful. 

Perhaps if R&D offsets were reimbursed quarterly rather than annually, cash flow could be improved, and testing, developing, and proving models could be invested in more efficiently.

Developing solutions 

Despite all, Australia now ranks 10th in the world for research output. 

The government has established 9 “national research priorities”, namely: food, soil and water, transport, cybersecurity, energy, resources, advanced manufacturing, environmental change, and health.

It’s also updating the list of “Critical Technologies in the National Interest”, some of which include AI, gene technology and vaccines, energy and environment, and robotics and space, and investing AUD $1 billion in them. 

But it’s corporations that have a chance to make a seachange here.

Uniting with our world-class universities and think tanks to boost ‘tech transfer’ is one pathway. One of the reasons Tel Aviv leads the world in startup success is because of the intimate relationships between corporate, academic, and military, giving Israel a huge knowledge commercialisation edge. 

A forward-thinking solution is innovation vouchers. Having seen success in the Netherlands and the UK, they provide conditional R&D funding, redeemable through working with a university or other publicly-funded research institution only. 

The impact of our declining manufacturing sector is already being realised. The mixing of inventive genius with business brilliance is indispensable if we want to compete with other advanced economies. 

We can’t keep relying on (or blaming) the government. Government policy will always be a benchmark to what the private sector spends. But the private sector is big and scary enough to prioritise R&D regardless. 

As the law of accelerated returns tells us, growth in knowledge and understanding is always exponential. The longer we languish, the more we fall behind.

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