Policy tweaks can push private sector R&D

Non-restrictive, investment-friendly policies will attract private investment to help India realise its innovation potential.

A few days ago, Apple Inc. established a wholly-owned subsidiary for research and development in India. While the company has conducted R&D in the United States, China, Germany, and Israel, it did not previously have a research base in India. This move is, undoubtedly, a welcome one. However, this initiative should not remain just one of the country’s few major industry R&D initiatives. India needs the private sector to play a much larger role in driving its technological advancement.

Currently, India underperforms in innovation. For instance, the country’s share in high-tech exports in its manufacturing basket is 12 per cent, a low share compared to 23 per cent, 22 per cent, and 39 per cent in China, Israel, and Vietnam, respectively. This underperformance is not due to government neglect – government spending is in line with the income levels in the country. The primary concern is India’s in-house industry R&D, which contributes a mere 36.4 per cent to the gross expenditure on R&D,
compared to 77 per cent in China and 75 per cent in the US.

Thus, to increase India’s technological power, it is crucial to understand why Indian firms fall short in innovation. For instance, it is noted that Indian firms find it difficult to raise resources. Private investment as a share of India’s GDP has declined. High tax rates and uncertainty stemming from sources such as lack of precision in the tax code and frequent tax changes act as disincentives for investment. The existing mechanisms to hedge against tax certainty and facilitate investments have not been effective. Of the 1,659 Advance Pricing Agreement applications, only 516 have been signed, mostly unilateral, which provides less certainty. Since introducing the new model Bilateral Investment Treaty (BIT) in 2015, India has signed only four new BITs and terminated older BITs with 77 countries, prompting the standing committee on external affairs to remark that “it was not commensurate with the growth of India’s interest in this domain and our rising stature in global affairs.”

Another key ingredient to foster innovation is talent. India does well in screening top talent but fails to retain this talent. A recent study found that the higher a student’s rank is in the IIT JEE exam, the higher the likelihood of the student emigrating. Top-notch talent in an economy needs to be complemented by a large enough skilled labour force. However, India’s labour productivity is low, i.e., one-ninth, one-fifth, and one-half that of the US, South Korea, and China, respectively.

Additionally, an ecosystem that is conducive to firm scalability fosters innovation by helping the firms envision larger markets, incentivising them to bear the fixed costs of innovation. However, restrictive regulations and protectionist policies such as high tariff and non-tariff barriers have reduced the scope of Indian firms’ access to cheaper inputs, being part of global value chains, and scale-up.

Given that the societal benefits of R&D surpass the private benefits, there is a case for governments to finance R&D. However, India has progressively reduced R&D tax incentives from 200% in 2016-17 to 100% in 2020-21. Further, India lacks high-quality research universities. The R&D funding to academia in India is just 5% compared to 30% in the US.

Identifying leverage points

So, how do we go about from here? The factors identified above impact innovation, but they also influence each other. For instance, academia can impact the quality of the workforce, which will have a bearing on the corporations and, in turn, can impact academia and the overall R&D system. A one-dimensional analysis of the challenge might not be enough to solve this deep and connected problem. As part of an analysis conducted for the 1991 project, we deployed the tools of complexity to locate all interrelationships that impinge on firm-level innovation.

The complexity analysis helped us identify three leverage points: corporations, universities, and R&D systems. Prioritising these domains would lead to significant gains in innovation.

The government must create an enabling policy environment that attracts investments and facilitates the scaling up of corporations. Reducing tax rates and enhancing tax certainty through improved capacity for concluding APAs and BITs can help. The government should also remove restrictive labour legislation that is out of step with current realities.

Universities in India need to tap the intellectual capital of top talent outside the country. Special fellowships or monetary incentives, similar to those employed by China, might not be sufficient to persuade individuals to move to India permanently. The most viable approach would be facilitating collaboration between Indian researchers abroad and those in India. It could be achieved through joint research programmes and by establishing hubs of excellence in geopolitically favourable and livable locations such as Dubai, Singapore, or Melbourne. Additionally, the government must prioritise setting up new universities and accelerating foreign universities’ participation by simplifying the regulatory approval process. It will increase competition and, consequently, increase India’s innovation potential.

In addition to the above measures, the government could explore enhancing R&D tax incentives and collaborating with geopolitically favourable partners like the Quad countries to enable technology transfers.

Focusing on the above policy ingredients, identified through considering system linkages, would go a long way in enabling private sector R&D, which could help India transition to a more innovative and advanced industrial landscape.

(The writers are researchers at the Takshashila Institution)