R&D Tax Incentives in BiH: Is it time for tech industry to put them on the advocacy agenda?

This article was originally published on my Medium page (March 16, 2019).

I read the IT Manifesto published by Bit Alliance recently. I am incredibly happy to see how the software industry is progressing in organizing itself and articulating its interests and needs in a structured and policy-relevant manner.

A number of set strategic goals is related to human capital development (education and skills development), what is expected having in mind that lack of talent (i.e. skilled workforce supply) and poor education outcomes are main obstacles and concerns that the industry is facing. It is a stumbling stone for the industry and immediate and extensive policy reaction is necessary for the industry to release its full potential and prevent/reduce financial losses and opportunity costs associated with the lack of talent. The second reason why this is one of the main concerns for the industry is the setup of the industry itself: as said in the document, but also recognized in earlier research reports, majority of the industry is concentrated in the niche of outsourcing where the supply of workforce is the main and almost only pillar of the growth.

I am also happy to see that one of the strategic goals is to put an accent on R&D in IT industry. However, my general impression is that innovation is being a neglected topic in the discourse on BiH software industry (and high-tech industry in general) and a little research effort was put to explore and mainstream innovation-related topic(s) among policy makers and professionals. Even if discussed, it is usually concentrated around establishing links between academia and the industry, and strengthening capacities of public universities and research organizations to deliver R&D. Some other policy solutions and measures remain unexplored and unthematized.

Innovation, along with talent nurturing, in my opinion should be a backbone of tech industries in BiH — these two combined will make the industry more sophisticated, resilient, agile and diversified. That is a part of the discussion on what is the long-term vision of the industry beyond satisfying current demand for workforce and lowering wage-pressure? Should the industry put all (or majority of) eggs in the basket of the outsourcing niche?

Recent shocks and decline of Indian IT outsourcing industry is a good reason for rethinking outsourcing and low-end service provision as a viable long-term development strategy for the industry. Although Indian and BiH software industry cannot be compared due to many reasons, there are some more ‘universal’ issues with outsourcing: outsourcing activities are highly sensitive to external shocks (e.g. emergence of new outsourcing markets, rising of protectionist economic policies, changes in technologies and automatization, etc.), they usually rest on low-end projects, require lower skillset and contribute less to employees’ self-development, and rely less on innovative behaviour of companies and employees, among others. Outsourcing allows companies in developing countries and emerging markets to experience fast growth — usually competing on international market by low costs, foreign language capabilities of workforce and decent quality of services / outputs — but at the cost of stable and diversified development path.

To prevent such path-dependency, which would lock-in the industry in outsourcing niche, more focus should be put on innovation and innovation-enhancing policy measures. Said differently, high-tech industries should advocate for innovation policy mix that would help their companies to build-up capabilities to produce their own high-quality, competitive and exportable products. This is the focus of the academic research I am conducting (working title: The role of innovation policy in building and sustaining comparative advantage: The case of Software Industry in Bosnia and Herzegovina) and planning to finalize and publish in the third quartal of this year, thus formulating initial policy recommendations based on the sound evidence (I hope the software industry will find them useful).

However, although the question of proper innovation policy mix is very complex, especially in a country such as Bosnia and Herzegovina, I strongly believe that so-called R&D tax incentives, introduced in majority of OECD and EU countries, could be one of the policy instruments to be advocated for as soon as possible. Majority of country-level and comparative studies and cases I reviewed (40+ studies) provide strong evidence that R&D tax incentives are effective measure to encourage private investment in R&D and stimulate companies to be more oriented toward innovations. In essence, the main objective of R&D tax incentives is to reduce costs and risks of doing R&D by reducing taxes on all or particular qualified R&D expenditures (wages and other consumables used in the R&D process). This policy instrument provides support in a transparent manner, offering equal participation and benefits for all businesses aligned with the set terms and criteria. Furthermore, tax incentives do not alter or distort the choice of the company regarding the aims and design of R&D activity as it could be the case with project-based granting or procurement approach. It not surprising therefore, that R&D tax incentives became attractive to governments and have been increasingly used policy instrument during the past two and half decades. R&D tax incentives significantly substituted direct measures (e.g. R&D grants) in many countries and have become more and more generous in past years. I will try to better explain and contextualise this measure in the upcoming weeks in the form of a blog post or a policy brief.

To prevent to be misunderstood, I would like to emphasize that for me this is not a matter of choice between different setups and development paths of the industry. I see a great potential in innovation-promoting policies for the industry to diversify and become more resilient on changes and shocks. Outsourcing and providing IT services, on one side, and own-product development, on the other, are rather complementary than mutually exclusive choices. If R&D tax incentives are available, IT companies would be encouraged to invest into R&D and experimental activities (and to allocate more staff on such activities), to invest into ideas incubation (e.g. start-ups) and development of cutting-edge solutions. All mentioned bring significant risks and uncertainty for companies, and therefore R&D tax incentives would amortize potential risks to some extent.

The software industry is our golden ticket to train of the fourth industrial revolution and way to reduce digital gap between BiH and developed countries. Therefore, the software industry has a legitimacy (i.e. economic justification) to demand more from the government, to insist on better and stimulating policy framework, because any investment in IT sector will positively affect other industries and society as a whole in BiH as well. I believe that innovation policy and R&D measures should be high on that agenda, and R&D tax incentives, as widely adopted and proven policy instrument, should be one of the policy advocacy priorities.

Bit Alliance’s IT Manifesto is a great step toward that.

*Post reflects my own opinions and cannot be associated with institutions and organizations I am affiliated with.

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