CHILE KNOWS IT NEEDS MORE INNOVATION

UNCLAS SANTIAGO 002411

SIPDIS

SIPDIS

E.O. 12958: N/A
TAGS: ECON EFIN PGOV KIPR EIND ETRD CI
SUBJECT: CHILE KNOWS IT NEEDS MORE INNOVATION


1. SUMMARY. Despite President Bachelet's declaration that
innovation would be one of the pillars of her administration,
budgets for research and development remain precariously low
in Chile -- only seven tenths of one percent of GDP. A
ministerial commission tasked with identifying innovative
sectors and ways to promote them has drafted legislation for
tax breaks it hopes will increase private sector spending on
innovation and bring new technology to Chile. END SUMMARY.


2. Soon after taking office in March, President Bachelet set
up the Council on Competitiveness and Innovation to seek
concrete ways to identify and incentivize knowledge-based
sectors of the economy. Chile's export-oriented economy
remains dependent on primary products -- copper alone
represented nearly 50 percent of the value of Chile's exports
in 2005. There is very little value added in Chile's economy
and this presidential council was tasked with finding ways to
change that. It is composed of representatives from five
ministries -- Finance, Economy, Education, Agriculture and
Public Works -- and is headed by former Finance Minister
Nicolas Eyzaguirre.


3. Talk of innovation is new for Chile, it began with
Bachelet. She has asked the Council on Competitiveness to
recommend nine sectors and industries (e.g. biotech),which
the GOC will seek to foster. Also to that end, the Council
has drafted legislation to encourage greater private sector
spending on research and development. Currently, there is
almost no private sector spending on innovation. Part of
that may be due to Chile's poor track record on protecting
intellectual property rights (IPR). GOC officials say they
appreciate the interplay between protecting IPR and promoting
innovation. Some at least are aware that a lack of a clear
GOC policy on IPR protection could be a hindrance. A member
of the Council told Senior EconOff he had been unaware of
U.S. and EU concerns over IPR protection in Chile. He agreed
the GOC lacked a clear policy and said he would seek to have
the Council discuss it.


4. The Ministry of Finance has the lead in drafting tax
legislation and recently presented two proposals to
congressional committees. The first is a tax reform intended
to incentivize research. Through a 35 percent tax credit and
then a 65 percent deduction allowed against the corporate tax
rate, the GOC would pick up the tab for about 50 percent of a
private company's spending on research and development.
Currently, there is virtually no tax incentive for spending
on research. The second draft would set the
import/withholding tax on software at a uniform 15 percent.
A number of taxes are applied against imported software now,
with the total hit ranging up to an added 35 percent in
costs. The net result has been reluctance on the part of
Chilean companies to buy the tailored software they need.


5. Spending on innovation in Chile is abysmally low. An
advisor with the Ministry of Finance, who serves on the
Council on Competitiveness and Innovation, told Senior
EconOff that only seven tenths of one percent of Chile's GDP
is spent on research and development. Bachelet's goal is to
raise that spending level to 1 percent of GDP by 2010. Even
at 1 percent, as Santiago's leading newspaper editorialized
November 20, this level would lag far behind countries such
as Ireland, Singapore and New Zealand. Worse than current
spending levels in the eyes of the Ministry of Finance
advisor, of the money currently spent on research and
development, two thirds of it is public sector money.
Chilean private companies spent only three tenths of one
percent of GDP on research in 2005, or about USD 350 million.
There is also no evidence that the public sector money spent
on innovation led to any economic growth or job creation.


6. If the Chilean private sector is not spending enough money
on research and development, foreign investors are not
spending money on it at all. Though Chile might still be
able to attract respectable levels of foreign direct
investment (FDI) -- however, the total level in 2005 showed a
big drop-off compared to 2004 -- most of the FDI goes to a
few basic sectors. Over 80 percent of the investment that
has entered Chile in 2006 has gone to the mining, water, gas
and electricity sectors. Moreover, much of that FDI has gone
into mergers and acquisitions, not into creating new
infrastructure or jobs.


7. COMMENT. To its credit, the Bachelet administration has
realized it must develop concrete incentives to get companies
to spend on research and development. Putting the onus of
identifying promising industrial clusters on a ministerial
commission smacks of state interventionism, but it is at
least an effort to determine where Chile's might be able to
develop a comparative advantage. If Chile really wants to
overcome its reliance on primary product exports and more
importantly, update its conservative business culture, it
will likely have to do more than tinker with tax rate
margins. It will need to articulate publicly a clear policy
direction on innovation, including IPR, and stick to it over
the long term.
KELLY