Australia, like many other developed economies, has been in a productivity rut for several decades. There is no silver bullet that will restore productivity growth in our complex, largely services dominated economy. Real productivity growth requires producing more outputs with less inputs.

Knowledge is the key to productivity growth. Unlike a worker’s time, or a machine, or a piece of land, knowledge can be used again and again. If anything, rather than being exhausted by use, knowledge tends to grow with use.

Since the late 1990s, Australian governments have declared an ambition to be the “knowledge nation”. However, at 1.66 per cent of GDP in 2022, Australia’s investment in research and development (R&D) has been shrinking since it peaked at 2.24 per cent in 2009. Current R&D investment is well below the OECD average of 2.7 per cent of GDP.

Australia has long been a laggard in R&D investment due, in large part, to low levels of business investment. In 1993, business R&D investment was only 0.64 per cent of GDP. While this rose to 1.37 per cent in 2009, likely reflecting rising investment in mining R&D, it fell again to 0.88 per cent in 2022.

The R&D Tax Incentive (RDTI), despite being continually reviewed, revised and costing government some $3.5 billion in 2024, has failed to boost investment. Increasing business investment in R&D will be essential if the Australian economy is to diversify to improve long-term economic security. A lack of investment in experimental development was flagged in the Strategic Examination of R&D Discussion Paper as the biggest gap in Australia’s R&D system.

The Commonwealth Government’s upcoming Economic Reform Roundtable, dubbed the “productivity summit”, is looking to boost productivity growth. Examining how the RDTI might be improved and directing more funding towards basic R&D should be a priority.

The importance of basic R&D

Even if business could be induced to invest more in experimental development, the requisite foundation for this investment is at risk. Government investment in R&D has fallen from 0.41 per cent of GDP in 1993 to 0.16 per cent in 2022.

Over the last decade, a rising share of this funding is going to applied research, such as through the Medical Research Futures Fund (MRFF), while funding for the Australian Research Council (ARC) has fallen steadily. Australia’s basic R&D funding has increasingly relied on the international student market to fund university research, with higher education’s investment in R&D rising from 0.38 per cent of GDP in 1993 to peak at 0.64 per cent in 2020.

However, this source of basic R&D funding has shrunk due to COVID-19, restrictive caps on international students and universities increasingly cross-subsidising domestic students with the fees of international students under the Job Ready Graduate funding arrangements.

This outlook for basic R&D is grim. Yet, absent such investment, experimental development will not be able to thrive.

Basic R&D provides the foundational knowledge for developing new products and processes. It is also foundational in a higher education system that trains knowledge workers, whether applying home-grown or imported knowledge. To be across cutting-edge research, we need to be part of the international research community, which requires a long-term commitment to investment to develop, attract and retain exceptional researchers.

The importance of higher education and Australian research to the productivity growth of the 1990s is underappreciated. Part of the growth reflected catch-up, where Australian firms adopted technologies from abroad. But this adoption was enabled by the expansion of higher education in the previous decades when Whitlam expanded access to universities by removing fees.

Firms were also motivated by the much more competitive environment resulting from the National Competition Policy, greater openness to trade and capital markets, and the dismantling of agricultural regulations.

It was Australian economic research in universities over previous decades that underpinned these reforms. It was social research that pointed to the need for structural adjustment support to help those impacted by the transition – an investment sorely lacking in the United States. This combination illustrates the role that basic social science research, as well as STEM research, plays in expanding the knowledge base.

An opportunity to fund basic R&D while also stimulating business investment

Ahead of the Economic Reform Roundtable, tax reform has finally been put on the agenda. Business groups have been calling for lower corporate tax rates, but engagement in base erosion and profit-shifting means that the effective corporate tax rate varies widely between companies.

The Strategic Examination of R&D has opened the way to rethink (yet again) the RDTI, as well as the broader R&D landscape. I provided the Australian Academy of Science with some analysis as part of their proposal to provide more secure, long-term funding for basic research that would also improve the incentives for business to invest in experimental development.

To match the OECD average R&D funding of 2.7 per cent of GDP, Australia requires more public funding of basic research, as well as a better way to stimulate business investment. A target of 0.2 per cent of GDP dedicated to basic research would roughly double the current government investment (assuming around 40 per cent of the current spend is on applied rather than basic research).

This commitment would only be credible if there is a clear funding mechanism, such as a dedicated levy on business income. Alternatively, a Future Fund along the lines of the MRFF could be established, but given the structural budget deficit, a “pay-as-you-go” system is more feasible. The architecture of the ARC could be used to ensure that funding is competitive and plays to Australia’s strengths.

Estimates using the ATO business data for 2021-22 suggest an annual levy of 0.2 per cent on business income for businesses with a turnover greater than $100 million would raise sufficient revenue to fund basic R&D to 0.2 per cent of GDP. A levy of 0.25 per cent would be sufficient to allow firms to deduct their currently RDTI-eligible R&D expenditure from their levy (a 100 per cent discount) and still collect enough revenue to fund basic R&D at 0.2 per cent of GDP.

A direct deduction of expenditure from the levy would provide a stronger financial incentive for firms to invest in R&D than the current RDTI 140 per cent deductibility. As a basic R&D levy would raise taxes on firms, this reform would be best paired with reducing corporate tax rates. The Productivity Commission proposal to tax cash flow at 5 per cent and reduce the corporate tax rate to 20 per cent for firms below a billion dollar turnover threshold lowers the value of the current RDTI, so reform to this incentive must be part of the mix. Given there would be fiscal savings from reducing the current RDTI, and from swapping some government R&D funding from general revenue, the estimates are only indicative. Treasury could be tasked with providing a detailed analysis of the fiscal and business cost of different combinations of levy, levy discounts and corporate taxes.

With the Trump administration cutting significant funding for basic research, Australia should step up. We can still be the knowledge nation – but only if we are willing to play the long game.

Dr Jenny Gordon is an Honorary Professor at POLIS: the Centre for Social Policy Research at the Australian National University and a non-resident fellow at the Lowy Institute. She was the Chief Economist at DFAT from 2019 to 2021, and was previously Chief Economist at Nous Group, and spent 10 years as Principal Adviser (Research) at the Productivity Commission. She has a PhD in Economics from Harvard University.

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