Funding Dilemma for Midrange Companies Harms Competitiveness

Medium-sized companies, also known as “midrange companies”, in Germany are at a significant disadvantage when it comes to receiving research funding from the federal government and the EU. As a result, many good ideas for a new product or a process innovation developed by these companies are left on the shelf and not pursued. This is due, firstly, to the fact that businesses do not have access to research funding and, secondly, to the fact that companies have been unable to raise sufficient financial resources from internal or external sources via capital markets. This has serious consequences. Not only are opportunities to innovate and to compete with international companies being wasted, new and innovative jobs are being created in other countries and not in Germany. It is therefore time to rethink current approaches to R&D and place stronger emphasis on tax incentives for research activities, with a particular focus also on midrange companies. This is the result of a study conducted by the Centre for European Economic Research (ZEW), Mannheim, on behalf of the Mechanical Engineering Industry Association (VDMA).

Over the past ten years, medium-sized companies in Germany have reduced their engagement in innovation activities considerably. This development was especially pronounced among companies with 1,000 employees or less, with a recorded drop of ten to 14 percentage points. During the same period, there was a significant decrease in the share of companies investing in research and development (R&D), with medium-sized companies particularly affected.

A ZEW study has, however, shown that the same group of companies that experienced a drop in innovation and R&D activity also received less research funding from the federal government and the EU. According to the ZEW study, small and medium-sized enterprises (SMEs) with 50 to 249 employees, and, above all, midrange companies with up to 3,000 employees have a significantly reduced likelihood of receiving research funding from the government or the EU than companies with more than 3,000 employees.

Midrange companies contribute significantly to the strength of the German economy

The instruments currently used in research funding schemes do not appear to be suited to the planning processes and structures of mid-sized businesses, who are at the same time also excluded from accessing funding methods typically available to small businesses. “This funding dilemma faced by midrange companies is a highly controversial issue, since they contribute significantly to the strength of the German economy with new jobs and value-added. The fact that their needs are not being taken into account is damaging to the competitiveness of the German economy as a whole,” explains Professor Bettina Peters, deputy head of the ZEW Research Department “Economics of Innovation and Industrial Dynamics”.

The contribution of midrange companies towards economic output and employment is clearly evident in the mechanical engineering sector, for example. Around 30 per cent of the one million people employed in this sector work in companies with 250 to 1,000 employees. Every year, turnover generated by companies in this size category amounts to around 75 billion euros, which represents approximately 30 per cent of the sector’s total turnover. “We innovate and produce – creating the foundation for a positive future for people,” says Hartmut Rauen, deputy executive director of VDMA.

Creating tax incentives for research funding is of crucial importance

But how should funding programmes be designed to better take into account the needs of midrange companies and to stimulate involvement in innovation and R&D activities? According to the ZEW researchers, creating tax incentives for research funding would be the best solution at the national level. This type of funding scheme has been proposed in the coalition agreement of the Grand Coalition. However, this proposal focuses specifically on SMEs. “As a representative of industrial SMEs including midrange companies, we are hoping that if the promises made in the coalition agreement become law this will lead to tax incentives for research activities that will really help to advance the country as a whole. Critical for the success of such incentives, in our view, will be resolving the funding dilemma faced by midrange companies,” says Hartmut Rauen from VDMA.

Key to this development is the design of a potential funding instrument. In the ZEW study, researchers calculated various models for a potential tax incentive to encourage R&D, ranging from raising the size threshold for eligible firms to a cap on R&D expenditure eligible for funding or tiered funding rates. In order to reach midrange companies as well as SMEs, the ZEW researchers came to the conclusion that, in the case of limited budget resources, the most suitable model involves non-selective, capped funding open to all firms, a solution which is also used in many other OECD countries. At a funding rate of 20 per cent and tax-deductible R&D personnel expenditure capped at 20 million euros, the German government would have to invest around two billion euros a year. In this model, all companies, even large ones, would be entitled to funding up to the fixed cap amount, otherwise it would be accused of discrimination on the basis of EU state aid rules. The model also has the advantage of reaching a large number of midrange companies with a significant leverage effect given that, according to ZEW findings, around 95 per cent of the companies conducting R&D record R&D expenditure of no more than 20 million euros.

Tax incentives for R&D stimulate research and innovation in companies

However, the federal government must decide not only who gets to enjoy the benefits of these tax incentives, but also how these are to be implemented from an administrative point of view. “The funding must follow a clear set of rules and should be straightforward to administer – from both the perspective of the public authorities involved and the companies seeking funding,” says Dr. Ralph Wiechers, head of taxation at VDMA. “What we don’t need are complicated evaluations and disputes over the delimitation of such funding during tax audits.”

Even if introducing tax incentives for R&D comes at a cost to the state, it ultimately pays off. Numerous evaluation studies carried out in other countries have found that tax incentives are an effective instrument for stimulating research and innovation in companies.

For more information please contact:

Prof. Dr. Bettina Peters (ZEW), Phone +49 (0)621/1235-174, E-mail bettina.peters@zew.de

Dr. Georg Licht (ZEW), Phone +49 (0)621/1235-177, E-mail georg.licht@zew.de

Stefan Röger (VDMA), Phone +49 (0)30/3069 4613, E-mail stefan.roeger@vdma.org