FOURTH INDUSTRIAL REVOLUTION: a new policy blueprint

03 May 2019

In a time of rapidly changing industry with potentially huge consequences for society, governments face a dilemma of how to incentivise entrepreneurship and innovation while ensuring that innovation benefits society as a whole.

According to research by Hans Gersbach, Ulrich Schetter and Maik T. Schneider published in the May 2019 issue of The Economic Journal, innovative entrepreneurship and inclusive growth can be reconciled when governments invest in science and increase the tax rates of both labour and profit taxes while preserving the relative proportionality of the two.

Their study considers new policies to adapt to the 4th industrial revolution where breakthroughs in technology are expected to yield major improvements in our lives but potentially threaten jobs and bring dramatic societal changes.

Science is a pivotal factor of the 4th industrial revolution – one of the most promising yet threatening developments of our times – and governments in the developed world plan to invest heavily in scientific research to place their economies in a leading position to harness the gains of the innovation that will accompany it. The UK government, for example, announced investments of £500 million in scientific research in artificial intelligence and robotics. However, the private sector accounts for a large share of marketable innovations, and governments hope that entrepreneurs will draw on the results of scientific research in setting up new innovative businesses.

The authors argue that the largest economic gains could be achieved by having relatively low profit tax rates for businesses and relatively high labour tax rates. This would encourage skilled individuals to create an innovative start-up rather than working as an employee, allowing science to more effectively translate into economic prosperity.

However, as a consequence of this, governments see themselves confronted with the dilemma of how they can incentivise entrepreneurship and innovation in the private sector while ensuring that innovation benefits society as a whole. As the 4th industrial revolution is underway, advancements in artificial intelligence, machine learning, and robotics are projected to affect up to 50% of jobs, disproportionately low-skilled.1

The authors argue that an innovative and inclusive society can be achieved when governments invest in science and increase the tax rates of both labour and profit taxes, maintaining the relative proportionality of the two:  Maintaining the proportionality preserves the incentives for entrepreneurship. The higher level of both tax rates would provide funds to compensate those who would otherwise lose out from the technological changes. Such a scheme can take several concrete forms with one example, among others, being the much-debated universal basic income.

When designing policy, these benefits of an increase in the general tax level have to be weighed against the efficiency of public institutions in redistributing funds. Similarly, a potentially growing shadow economy and international tax competition impose restrictions on redistributive policies. Yet the anticipated distributional implications of the 4th industrial revolution require us to rethink growth-policies to ensure that societies as a whole participate in the gains from innovation and to sustain growth and prosperity for future generations. Rethinking science and tax policies is a promising starting point for future debates on this issue.

TAXATION, INNOVATION AND ENTREPRENEURSHIP’ by Hans Gersbach, Ulrich Schetter and Maik T. Schneider is published in the May 2019 issue of The Economic Journal

1. See e.g. Frey, C. B., and Osborne, M. A. (2013). The Future of Employment: How Susceptible Are Jobs to Polarization? Oxford Martin School Working Paper and Brynjolfsson, E. and Mitchell, T. (2017). What Can Machine Learning Do? Workforce Implications. Science 358(6370): 1530-1534.

Hans Gersbach

Professor of Macroeconomics | Innovation and Policy at ETH Zurich

Ulrich Schetter

Postdoctoral Researcher at the SIAW Institute at the University of St. Gallen and an Associate at the Center for International Development at Harvard University

Maik T. Schneider

Associate Professor (Senior Lecturer) in Economics at the University of Bath