Increasing R&D subsidies and tax incentives pays off, but support must be targeted carefully
A new study published on 13 January shows that the most effective support policy for research and development is to allocate subsidies to businesses with high R&D productivity or innovation capacity. Uniformly targeted subsidies – which in practical innovation policy are similar to R&D tax incentives – also bring about substantial growth, albeit to a lesser extent than selectively targeted innovation subsidies.
The study suggests that increasing subsidies and tax incentives for research and development is proper policy in Finland. When it comes to direct R&D subsidies, efforts should be made to develop ways to assess the innovation capacity of businesses so that subsidies can be allocated effectively.
Understanding the overall economic impact of business subsidies is essential for planning effective support policy and implementing business policy measures. Successful innovation policy can accelerate economic growth and improve competitiveness.
The report by researchers from the Research Institute of the Finnish Economy ETLA and the VATT Institute for Economic Research, titled ‘Innovation, reallocation and growth in the 21st century’, offers new insight on the impact of business subsidies on economic growth and the welfare of businesses. Relatively few studies of this type have been conducted around the world, and this is the first study conducted using Finnish data.
The project examined policies in which subsidies are targeted to businesses uniformly regardless of R&D productivity and more selectively targeted policies in which subsidies are allocated based on R&D productivity. Implementing a selectively targeted policy means that the officials making decisions on R&D subsidies must be able to distinguish between businesses with a high and low innovation capacity.
“By nature, uniformly targeted subsidies are similar to neutral R&D tax subsidies that are not allocated to specific types of businesses or projects. Selectively targeted subsidies, on the other hand, are similar to direct subsidies. The recipients of subsidies must be selected on a case-by-case basis following an assessment of their innovation capabilities; subsidies cannot be allocated based on the general information available for taxation,” says ETLA Research Director Heli Koski.
A key finding of the study was that the most effective solution would be a selective innovation policy that allocates R&D subsidies to businesses with high R&D productivity or innovation capacity. A selective subsidy policy would cause low-productivity R&D companies to exit the market. As a result, their resources could be put to more productive use in higher-productivity companies.
Uniformly targeted support also leads to a significant growth in the welfare of businesses, but to a lesser extent than selective subsidies. This means that, in general, increasing the amount of R&D subsidies and tax incentives is proper policy in Finland.
“In practice, it is impossible to allocate R&D subsidies based entirely on the innovation capability of businesses. However, our results on the benefits of uniformly targeted subsidies show that even imperfectly targeted R&D subsidies and tax incentives are proper policy in Finland,” says Research Director Heli Koski.
The research team proposes that, in practice, the innovation capabilities of businesses could be assessed based on the number of new products produced over a certain period of time, while also taking into account further innovation that enhances the quality of products or does not, at least not immediately, lead to the creation of new products. Especially in the case of young businesses, it would also be important to be able to assess the company’s future capacity to innovate and the quality of future innovations.
The publication was conducted as part of the implementation of the 2021 Government Plan for Analysis, Assessment and Research.
Heli Koski, Research Director, ETLA, tel. +358 50 466 3214, [email protected]
Elias Einiö, Heli Koski, Tero Kuusi and Markku Lehmus (2022) Innovation, reallocation and growth in the 21st century, Prime Minister's Office.