Business R&D Intensity in Canada and the United States: Does Firm Size Matter?

1. Business R&D Intensity in Canada and the United States:Does Firm Size Matter? Presentation to: The 2008 World Congress on National Accounts and Economic Performance Measures for Nations Arlington VA Daniel Boothby Bernice Lau Thitima Songsakul May 16, 2008

2. Outline • Introduction • Decomposition of Business Expenditures on R&D (BERD) intensity: Five factors to examine • size class distribution of firms; • weight of firm size classes in value added; • R&D intensity for R&D performers in each size class; • R&D incidence of firms performing R&D in each size class; and • ratio of value added by the average performing firm to the average value added of all firms in each size class. • Summary of findings • Directions for further research

3. Introduction • Canada lags other advanced economies in its innovation performance on a number of indicators, such as low BERD intensity. BERD intensity across OECD economies, 2004, (percentage of total GDP) Industry-financed BERD intensity across OECD economies, 2004, (percentage of value added in industry) Source: OECD MSTI (2006/2) Table 24 Source: OECD MSTI (2006/2) Table 34

4. Is smaller firm size the reason for lower R&D intensity? • Smaller firm size in Canada is often mentioned as a possible reason for poor innovation performance and low intensity of business R&D. • Two possibilities: • Canada might have “too many” small businesses; that is, small firms might be more prevalent in Canada than in the U.S. • Small businesses in Canada may do less R&D, while larger Canadian firms do as much R&D as their U.S. counterparts.

5. Objective • Our goals: • Assess whether smaller firms are indeed a significant source of low business R&D intensity. • Describe further measures that can be carried out using existing data and that will explain the relation between firm size and business R&D performance in Canada. • Suggest directions for future research. • We use a formal decomposition to account for the size-related factors that affect aggregate BERD intensity. • R&D intensity, R&D incidence and firm size distribution are factors in the decomposition.

6. Five factors to examine A. the size class distribution of firms ni /n; B. the average-firm value-added weight by size class bvai /bva; C. the R&D intensity for R&D performers in each size class, berdip; D. the percentage of firms performing R&D in each size class (i.e., R&D incidence) nip/ni; and E. the ratio of value added by the average performing firm to the average value added of all firms in each size class bvaip/bvai.

7. A. The size class distribution of firms (ni /n) Number of business enterprises in Canada and the U.S. by employment size class, 2002 • We begin with the relative frequency of firms by size class (ni /n) where “size” is defined by the number of employees. • U.S. and Canadian data on firm size for the entire business sector are available. • There is little U.S.-Canada difference in the distribution of firms by size class. • There is a much larger US.-Canada difference in the employment shares of various firm sizes. Employment shares in Canada and the U.S. by employment size class, 2002 Source: Canada-Statistics Canada (2006a) Table 1a and 5a, U.S.-U.S. SBA (2006) Note: * Zero-employee firms cannot be removed from Canadian LEAP data. For the U.S., there are 13.5 percent of enterprises with zero employment.

8. Average number of employees in each employment size class, Canada and U.S. enterprises, 2002 Source: Calculation based on Canada-Statistics Canada (2006a) Tables 1a & 5a, U.S.-U.S. SBA (2006) Why do firms in the U.S. account for a larger share of business sector employment? • The greater share of employment of U.S. firms with 500+ employees is primarily due to the fact that these firms are bigger in the U.S. than in Canada. • This has implications for value-added shares (another factor of the decomposition): suppose in each country value added per employee is the same for all firm sizes. Then the value-added share in each firm size would be the same as its employment share. Consequently, the largest firms would account for more of the value added in the U.S.

9. Employment and value-added shares in manufacturing sector by employment class size, Canada and U.S. establishments, 1997 Source: Baldwin, Jarmin and Tang (2004) B. The average value added weight (bvai /bva) • No direct measure so we will discuss evidence on value-added shares of establishments (not firms) in manufacturingsince we do not have firms economy-wide. • Small establishments in Canadian manufacturing account for a greater share of employment and value added than those in the U.S. • We have seen employment-share comparisons that would lead us to think that this is true for firms economy-wide. • While small firms dominate in the number of businesses in both countries, they do not dominate in measures of economic weight.

10. R&D intensity by size class, Canadian1 and U.S.2 enterprises, 2002 • Source: Canada-Statistics Canada IRD 2005 Intentions (2006b) Table 15, U.S.- NSF RDI 2002 (2006) Tables 14 & 27 • Notes: • Canadian figures are measured as current intramural R&D expenditures (from all funding sources) as a percentage of performing company revenue. • U.S. figures are measured as industrial R&D by company and non-federal funds, as a percentage of net domestic sales. • 5-49 for the U.S. C. R&D intensity for R&D performers in each size class (berdip) • The biggest Canada-U.S. differences in R&D intensity for performers are for large firms, not small firms. • There is a pattern of overall higher intensity in all size classes in the U.S. • We need to be careful—neither numerator nor denominator are the same for the U.S. and Canada.

11. R&D incidence by size class, Canadian and U.S. enterprises, 2002 Source: Canada-Statistics Canada IRD 2005 Intentions (2006b) Table 1.8 and Business Dynamics in Canada (2006) Table 1a, U.S.-NSF RDI 2002 (2006) Table 14, U.S. SBA (2006) Note: *5-99 for the U.S. Canadian data from IRD exclude firms with zero employees, but LEAP data include them. Therefore, the R&D incidence for the small size group here is underestimated. D. R&D incidence (ni p/ni) • The smallest size class shows much lower R&D incidence than larger enterprises in both countries. • However, Canadian small firms are not lagging their U.S. counterparts in terms of R&D incidence. • In fact, these results show very similar incidence of R&D in Canada and the U.S. in all size classes.

12. Average number of employees per enterprise, performing firms versus all firms, U.S., 2002 Source: Calculation based on data from NSF RDI 2002 (2006) Tables 5 & 39, and U.S. SBA (2006) E. The ratio of value added by the average performing firm to the average value added of all firms (bvaip/bvai) • There is little difference in the number of employees in performing and non-performing firms in the U.S. – at most performing firms have 10% more employees. • Thus large productivity differences would be required for bvaip/bvai to be large. As a guesstimate, we think it is unlikely that this factor will be greater than 1.5 in any size class in Canada or the U.S.

13. Summary of findings: firm size and Canada-U.S. BERD intensity gap • Small firms are not more prevalent in Canada. • Greater prevalence of small firms cannot contribute to the gap. • Value-added share of large firms is bigger in the U.S. • This is likely to contribute to the gap, but it takes large changes in the value-added shares of size classes to have much of an impact on overall BERD intensity. • BERD intensity tends to be lower in Canada than in the U.S., more so for large firms. • Small firms have little to do with the reasons for the BERD intensity gap.

14. Summary of findings: firm size and Canada-U.S. BERD intensity gap (cont’d) • There are only small differences between Canada and the U.S. in the percentage of firms in each size class that perform R&D. • Differences in R&D incidence cannot contribute significantly to the gap. • The ratio of value added by the average R&D performer to the average firm is not likely to differ much among size classes nor between Canada and the U.S. • Little impact of differences in this ratio on this gap.

15. Share of total business R&D by size class, Canada1 and the U.S.2, 2002 Share of performing firms by size class, Canada and the U.S., 2002 • Sources: Canada-Statistics Canada IRD 2004 Intentions (2005) Tables 1.8 &17, U.S.-NSF RDI (2006). • Notes: • For Canada R&D is total intramural R&D including capital expenditures. • For the U.S. R&D is total industrial R&D funds. • 5 to 49 for the U.S. Small firms are not responsible for low R&D intensity in Canada • The R&D share of all firm size classes except the largest (5000+ employees) is much bigger in Canada than in the U.S. • Lower intensity for very large firms in Canada relative to the U.S. may contribute to low BERD intensity. 3

16. Directions for further research—Data development • Linking the establishments reporting in the Census of Manufacturers and the companies reporting in the Research and Development in Canadian Industry (RDCI) Survey to the firms of LEAP or of the Business Register. This would allow direct computation of R&D incidence, intensity, the relative value added of performers and all firms within a size class and the value-added share of a size class. • Other projects would be to link LEAP and the RDCI to provide better information on R&D incidence and to use LEAP to provide a finer division of large firms by size class. • In the long term, a longitudinal, integrated data set on business strategies, R&D activities, value-added and employment would be a valuable asset for researchers.

17. Directions for further research—Broad directions • If very large firms are in fact multinational firms, a better understanding of how multinationals choose where to conduct R&D activities would be useful. • From the RDCI survey, about 15% of Canadian BERD is funded by foreign sources. Are these research mandates from multinational parents? • If so, is this large part of Canada’s already low BERD at risk from emerging economies?

18. Conclusion • In our view, we have ruled out small firms as an important factor in the BERD intensity gap between Canada and the U.S. If firm size plays a role in the gap at all, it is differences in the presence of very large firms that may matter. Our suggestions for research directions are aimed at better understanding the role of these firms in BERD intensity.