Vote for the party with a bold innovation policy

This article shows the fragile state of our industrialisation policy.

You could say that, since Independence, this policy has not been based on attracting cuttingedge technology and the transfer of intellectual talent but on a concerted effort to solve the problem of mass unemployment in the late 1970s by resorting to a number of measures such as giving tax perks – including 10-year tax holidays, public land on the cheap and various other monetary incentives provided that the investor guaranteed the creation of jobs.

You may agree that this policy has attracted various cycles of investors since the drive for industrialisation began in the 1960s and our political leaders cheer us up by telling us that, apart from building a tourist infrastructure, we have welcomed investors in the ‘cut, make and trim’ textile industry – largely attracted to Malta because of our comparatively low labour cost.

Such a promising textile industry was not properly capitalised. It was based on the assembly and pressing of garments without any research and development or innovation/design units. As a result, such unique intellectual capital was not transferred to local factories by foreign investors. The obvious consequence of this weak industrialisation policy was that, once wages had increased beyond a certain level, there was a mass exodus and the industrial estates became ghost cities.

Replacement of the textile industry in the late 1980s was followed by attracting other manufacturing units including (but was not limited to) pharmaceuticals, microchip, printing, engineering, some foundries and Playmobil. All these have a common denominator – they do not carry out any R&D studies in Malta. This is an industrialisation policy that is crying out for reform, as competition from other Eastern European countries is intensifying and we risk being exposed to another exodus, as wages are gradually revised upwards. Can the party elected on 4 June take up the challenge and reform our industrialisation policy?

Readers may well ask what the solution is. The answer is that there is so much disruption created in modern manufacturing techniques, including robotics, artificial intelligence, blockchain systems and nanotechnology, that relying solely on the three pillars of tourism, iGaming and financial services is not recommended.

All advanced economies are facing a cultural and educational revolution that means young entrepreneurs are nurtured to explore innovation while their country invests more in attracting overseas talent. The target set by Malta’s government to reach two per cent of GDP in R&D by 2020 is far higher than our current level of around 0.7 per cent – which is reaching a mere €60 million. Other European countries have been keen to attract innovation to their shores and even give exciting incentives, fully approved by the Commission. This year saw the inaugural launch of new “Innovation Box” tax rules in the Netherlands, which was fully approved by the Commission after the OECD put some pressure on the Netherlands to change the old scheme which has been running successfully since 2007.

The old scheme has been providential in attracting many R&D companies to set up base in the Netherlands and claim tax exemptions, reducing the rate of corporate tax to a preferential rate. This means that instead of taxing the full amount of such profits at the general corporate in- come tax rate of 25 per cent, only one-fifth of such profits may be taxed at that rate – in other words, charging an effective tax rate of five per cent. Of course, this year there are new rules to prevent any misuse of the scheme, but the lower tax rates are still available.

The incentive applies to self-developed (meaning in-house) technology and the creation of other intangible assets, such as the know-how for a new product or for a new production process. The new scheme – which has been named “the nexus approach” – separates development expenditure into qualifying expenditure and non-qualifying expenditure. Qualifying expenditure is expenditure exclusively incurred by the development of the intangible fixed asset, with the exception of costs incurred for the outsourcing of R&D to group companies and indirect costs such as accommodation and financing.

Expenses for contract R&D activities carried out by third parties are considered qualifying expenses, as a company is expected to only outsource ‘non-fundamental’ R&D-activities to third parties. Another bonus in this Innovation Box scheme (which has never been introduced in our tax code and does not feature in any party’s manifesto) is the treatment of losses in the start-up period. In my opinion, this is a clever way of attracting multinational companies to set up R&D centres in our country to support a dynamic economy buttressed by cutting-edge technology using the latest AI systems.

Simply put, the Innovation Box allows losses to be generally taxdeductible at the general tax rate of 25 per cent (ours at 35 per cent) not at the reduced effective tax rate of five per cent. The cherry on the cake is that initial losses incurred before business operations have begun are also deductible at a 25 per cent tax rate. It is a part of the complex structure that constitutes an effective ecosystem that supports a culture of successful entrepreneurship.

The basis of a successful industrialisation policy begin is the nurturing of start-ups (both local and those attracted to migrate here). For this purpose, we need a paradigm shift in our mentality to attract foreign direct investment (FDI) that is sustainable and anchored in fundamental research conducted through business accelerators.

Simply throwing money at the local SME scene (or reducing tax to 10 per cent) will not automatically create more members of that Billion Euro Club, whose members in the US are known as ‘unicorns. These start-ups do not exist in isolation. It is true that many of them fail to create success. Sometimes the cause of such failure is the lack of careful nurturing in an ecosystem, which comprises a mosaic between venture capital, angel investors, mentors and the bricks and mortar where the start-ups weave their magic. For many years, locally, we run incubators – which are more about providing bricks and mortar and a place in which to work, and not particularly successful as they still have the connotation of ‘life support’ rather than inculcating the ambition to innovate and do something bigger and better.

The alternative – which has proved successful in the USA – has been the accelerator business model, the origins of which are usually attributed to a vibrant start-up scene. These form part of the much-desired ecosystem that fostered Airbnb & Uber (so called Unicorns now worth billions). Why is it so hard for Malta to start enjoying the success achieved in other innovation centres run by universities such as MIT, Stanford, Oxford, Leiden and others?

Now that we are hosting two new educational institutions – Barts medical school and AUM – we may take heart and try to attract more universities to create a nucleus of talent. Naturally, the future output of graduates from these institutions can either result in a brain drain or, ideally, former students staying here to populate innovation/research centres of international repute. Regrettably, these centres are non-existent locally and, as stated earlier, there is no impetus to sustain cohorts of talented graduates who simultaneously receive seed money, office space and mentoring in exchange for a percentage of equity.

What do such centres do? Broadly speaking, they help ventures define and build their initial products, identify promising customer segments and secure resources, including capital and employees. More specifically, we need accelerator programmes – these are usually of limited-duration, lasting about three to eight months – that help groups of start-ups with the new venture process. They also offer a plethora of networking opportunities, with both peer ventures and mentors, who might be successful entrepreneurs, programme graduates, venture capitalists, angel investors or even corporate executives.

To conclude, this essential innovation reform may sound like a dream that can only be realised if the political party elected in the coming election can do a Saul of Tarsus and see the light of inspiration. Those enjoying the statusquo criticise visionaries like me saying we are armchair critics. Those more of the old school lament that, in reality, our destiny is hampered by limitations due to our size and geographical location – away from the mainland. Surely, we have come a long way since the frugal times when our country was a colony and we earned with pride our ‘A’ rating endowed by credit agencies. This proves us to be a collection of talented and resourceful people. Let us pray that, when the cacophony of electoral slogans and mud-slinging jamboree have died down and calm finally prevails, the man in the street can separate the chaff from the wheat and vote for the party most capable of securing our economic survival.

As always, the electorate gets the government it deserves.