Can the R&D Tax Credit Counteract Deindustrialization?

During the past 25 years, employment in manufacturing as a share of total employment has fallen dramatically in the United States and other advanced economies – a phenomenon widely referred to as “deindustrialization.” In fact, since 2000 alone, over 5 million manufacturing jobs have been lost. Indeed, the well-reported growth in employment in the service sector and the relative decline in employment in manufacturing industries implies to some a decrease in our industrial capacity. But precisely how can deindustrialization be defined? Does the shift to a service economy imply the erosion of an industrial base? Or is deindustrialization the result of national policies that did not anticipate the full extent and impact of the phenomenon of innovation and globalisation?

At its most basic level, deindustrialization is generally defined as the relative decline of the manufacturing sector. However, the challenge of industrialization in the 21st century differs in several ways from the experiences of developed countries when they initially industrialized in the 19th century, as well as developing countries that rapidly industrialized in the twentieth century.  One important difference is that many countries have in fact experienced deindustrialization in recent times. The challenge of industrialization in the 21st century is thus, in reality for many countries, actually a challenge of ‘reindustrialization’.

In response to this, a recent study from the Massachusetts Institute of Technology (MIT) suggests that efforts be made to maintain, and rebuild, the country’s manufacturing base. The researchers also call for efforts to be made to develop the country’s capacity for innovation, which they see as being closely interconnected with manufacturing. Likewise, the concept of creative destruction – the process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one – in developing countries highlights the role of economic policies.  A policy targeted at leveraging the innovative potential of the economy has shown to favor the rise of developing economies. In contrast, in the deficiency of economic policy – when the distribution of resources is surrendered to the market – or when economic policy is unsuitable, substitution activities have not been enough to compensate for the lost jobs and revenues.

In specific, policies targeted at increasing national research and development (R&D) activities are now a crucial component of national tactics to surge productivity, long run economic growth and international competitiveness in majority of OECD countries. The rationalization behind this objective depends on on two contentions. First, investment in R&D is a vital driver of long run productivity development. Second, deprived of government support firms will have an inclination to under invest in R&D comparative to the social optimum. To inspire higher rates of R&D, governments employ a assortment of policy instruments. Incentives delivered through the tax system are one of the most prevalent policy instruments which have swiftly gained widespread support.

Ultimately, the notion that R&D makes a big contribution to industrial innovation and competitiveness is prevalent among economists and politicians. The R&D Tax Credit offered in the United States, in particular, can provide companies with a legislative platform to allow them to offset the cost of innovation. Undeniably, innovation is a key driver in helping companies within the manufacturing sector deliver on strategic goals by setting the right products to market with speed and establishing significant competitive differentiation. However, the R&D tax credit isn’t limited to just the manufacturing sector – in fact, the credit is purposely broad to reward companies for increasing spending on R&D within the U.S. Fundamentally, the R&D credit is available to businesses that create new, improved, or technologically advanced products, processes, principles, methodologies, or materials.

Thus, as noted above, deindustrialization is not necessarily a symptom of the failure of a country’s manufacturing sector or, for that matter, of the economy. On the contrary, deindustrialization is simply the natural outcome of economic development. However, economic policies can play a large role in how a country responds to the notion of deindustrialization, or ‘reindustrialization’. In specific, the R&D tax credit offers an opportunity for firms to leverage the role of innovation and is a vital competitive factor for companies as it lowers the effective tax rate and can refuel R&D efforts through increased cash flow. Ultimately, the R&D tax incentive is an economic policy that is aimed at increasing the innovative potential of the economy. As divulged earlier, the existence of such policies can offset the threats deindustrialization and favour the emergence of growth in an economy.


If you would like to discuss the R&D Tax Credit further, please do not hesitate to contact one of Swanson Reed’s offices today.

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