HUP: The Growth of Investment in Research and Development is Imperative, We Propose Increasing Subsidies to the EU Average Level

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Almost a quarter, precisely 23 percent of all R&D investments in the business sector amounting to 120 million euros during 2022 were related to investments in the computer programming sector and related activities. While these investments stagnated at the level of the European Union, in Croatia, R&D investments in 2022 increased to 1.43 percent of GDP thanks to an increase in private sector investments in R&D (by 0.20 percentage points to 0.78 percent of GDP), states the weekly macroeconomic analysis of the Croatian Employers’ Association HUP Fokus, signed by their chief economist Hrvoje Stojić.

In the decade from 2012 to 2022, Croatia was among the three EU member states with the fastest increase in R&D investments by 0.69 percentage points of GDP. Although the investment statistics are improving, the level of investment is not sufficient. Thus, investments from the state and higher education institutions amounted to 0.25 percent of GDP, or 0.4 percent of GDP, which is equal to or slightly below the EU average, while investments from the business sector are half the EU average and even three times lower compared to the most successful EU members.

– Knowing that this type of investment in innovation generates as much as 7-8 dollars for every dollar invested (Bank of America), in this week’s HUP Fokus, we provide recommendations for encouraging investments from the business sector in R&D to accelerate economic productivity growth and stronger integration into global value chains, ultimately increasing exports in the field of high technologies. If we want our investments to change the structure of the economy, then it is necessary to invest in innovations, patents, research, and development, and for that, effective innovation management mechanisms are needed to enable more efficient implementation of programs funded by the European Union funds – writes Stojić.

A significant opportunity is opened by the Smart Specialization Strategy (S3), which allows for the announcement of open innovation calls for subsidizing research and development projects (IRI) of Croatian companies and scientific institutes. With improved access to combined funds from the NPOO program, ESI funds, and the state budget, the potential total investments by 2027 amount to 340 million euros. Targeted competitions would promote the development of internationally competitive products and technological solutions with higher added value, which is a step forward compared to previous solutions for individual users unprepared for market competition.

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The expected strengthening of cooperation between the academic and business sectors favors small, innovative start-up companies targeting the global market. In this context, the focus of the ICT sector is potentially shifting from renting people on projects and working on demand for foreign software developers and platforms to their own products and intellectual property, which helps attract more technologically advanced and higher quality domestic and foreign investments. This finally increases the resilience of domestic IT companies to downturn phases of the cycle and facilitates talent retention in Croatia.

The S3 platform is also a basis for projects transforming our less developed regions, financed from the allocated Integrated Territorial Program (ITP). It would play a significant role if companies, rather than (scientific) institutes, were the holders of IRI and ITP projects, as this would allow us to utilize the transformational effect of available funds. The average subsidy rate for investments in R&D in Croatia since 2019 is 0.07 percent for large companies and 0.04 percent for small and medium-sized enterprises. It is significantly lower than the average of the CEE region, EU-27 area, and especially the OECD average, as it is two to two and a half times lower for large companies and up to four to five times lower for small and medium-sized enterprises. Therefore, the state could significantly more generously assist the development of new technologies through tax incentives.

In neighboring Slovenia, the average subsidy rate of 0.21 percent for all types of companies is at the OECD average and slightly above the EU-27 average, as well as the CEE region. Slovenia thus grants a 100 percent incentive for investments in R&D up to a maximum of 63 percent of the tax base in the first year, with the remainder in the following four years.

The highest tax incentives for R&D in the EU are provided by Portugal (0.39 percent), Poland, and France (0.36 percent). Portugal recognizes 32.5 percent of the R&D cost for large companies, and the rate increases by 15 percent for small and medium-sized enterprises that do not benefit from the incremental rate of 50 percent. The incremental rate represents 50 percent of the difference between the R&D cost in the tax year and the average amount of R&D costs in the last two years, up to a level of 1.5 million euros.

In Poland, the deduction depends on the size of the company and the type of eligible costs in six categories – salaries and social contributions, purchase of goods and raw materials, expertise/research purchased from scientific institutions, research equipment, depreciation of intangible and fixed assets excluding vehicles, buildings, and construction works, costs of intellectual property protection. As early as 2018, the deduction in income tax was increased from 50 percent and 30 percent (depending on the category of eligible costs and the size of the company) to one hundred percent.

In other words, companies can save 19 zloty on 100 zloty of qualified R&D costs. In 2022, existing deductions in income taxes were increased from one hundred percent to two hundred percent of qualified costs incurred on employees covering the cost of personnel that companies hire for research and development purposes. In a potential redesign of subsidies that, according to our recommendations, should reach or even exceed the EU/OECD averages, it is certainly necessary to examine to what extent more generous support for R&D for small and medium-sized enterprises (compared to large companies), as has been the case in several EU members (France, Netherlands, Belgium) and several OECD members that are not EU members, positively affects the supply side of the economy.

Along with designing progressive tax practices, in the context of defense against cyber attacks, HUP-ICT proposes the introduction of tax reliefs/incentives or certain stimuli for companies investing in skills related to cybersecurity. HUP ICT also proposes the establishment of a so-called ‘sandbox’, or Innovation sandbox, a regulatory and legal digital environment with pre-installed software and hardware capabilities, which will allow all start-up companies, regardless of the sector, to test their business ideas before market entry, as well as in later stages of development.

This is particularly important for the artificial intelligence (AI) sector, where HW (GPUs) is essential. It is an extremely expensive system that start-up companies cannot afford. Relevant analysts estimate that AI technologies will increase productivity growth in developed economies by 1.4-2.7 percent annually over the next decade. Such productivity shifts significantly impact the growth of real economic output and reduce the costs of many goods and services. It is estimated that the largest part of productivity growth arises from business automation and acceleration of technological innovations.

Investments in R&D can increase the share of high-tech exports in Croatia’s total exports in the medium term, considering that the current result is only 41.8 percent of the EU average (7.4 percent compared to 17.7 percent) and even three and a half times smaller compared to the most successful EU members. The level of investment in R&D also positively correlates with the share of employees in high-tech sectors and the share of innovative companies in the economy. The ultimate goal is to accelerate productivity growth so that the forecasts of the European Commission do not materialize, which predict that we will lag behind the CEE region in the coming years.

In addition to investments in technology, on the path to convergence with EU standards, reforms need to be implemented in a number of other areas, particularly in the education system, where despite costs higher than the EU average, we have poorer educational outcomes in mathematics and face efficiency issues. In this sense, it is essential to raise quality through a more objective assessment system, increase teacher rewards while simultaneously reducing the number of employees in the education system.

Moreover, curricula should be adapted to the needs of the sectors we highlight as priorities in the Smart Specialization Strategy: personalized health care, smart and clean energy, smart and green transport, security and dual-use, sustainable and circular food, customized and integrated wood products, and the latest area, digital products and platforms. In the Aliens Act, HUP ICT emphasizes the need to regulate the use of the ‘EU Blue Card’ for ICT professionals without completed higher education as well as simpler family reunification procedures, states the analysis.