Incentives and innovation: The missing link

Innovation is one of those concepts that attracts almost universal agreement. Every strategy document mentions it. Every political speech celebrates it. Every business conference places it at the centre of discussions about the future. Yet when we examine how capital is actually allocated within an economy, innovation often becomes the exception rather than the rule. Incentives, not aspirations, determine behaviour, and economies ultimately invest in whatever offers the most attractive combination of return, certainty and risk. 

That is perhaps the most important lesson emerging from the latest European Innovation Scoreboard and the accompanying data on public investment in research and development. Europe continues to improve its innovation performance, having increased its overall innovation capacity by 12.6 percentage points since 2018. At the same time, the pace of improvement has begun to slow, prompting renewed concern about productivity, competitiveness and the ability of European firms to scale. The European Commission is increasingly framing innovation not as an isolated research policy but as the foundation of economic security, industrial resilience and long-term prosperity. 

Malta should pay particular attention to this shift because it mirrors many of the questions we have been asking about our own economic model. The challenge is no longer whether Malta can generate activity. It is whether that activity is increasingly generating productivity. Innovation sits at the very heart of that transition because productivity growth ultimately depends on discovering new ways of creating more value with the same resources. 

The difficulty is that innovation rarely wins the competition for capital. 

Economists often speak about market failures in innovation. The phrase is technically correct but somewhat misleading because it suggests that markets are malfunctioning. In reality, markets are behaving exactly as incentives encourage them to behave. If lending against property offers predictable returns, tangible collateral and relatively low risk, while financing an innovative technology company involves uncertainty, longer investment horizons and intangible assets, it should surprise nobody that capital overwhelmingly prefers the first option. Banks are not making irrational decisions. They are responding to the incentives embedded within the financial system. 

This is why discussions about innovation frequently become detached from economic reality. We celebrate entrepreneurs for taking risks while simultaneously designing financial systems that reward avoiding them. We encourage startups to innovate but expect them to provide collateral that, almost by definition, innovative firms do not possess. We ask banks to finance transformation while measuring success through conventional lending metrics. We then express disappointment when the flow of capital follows the path of least resistance. 

Innovation is therefore not primarily a technology problem. It is a returns problem. 

Every economy allocates resources towards the activities that generate the highest risk-adjusted returns. If property consistently delivers attractive and relatively certain returns, capital will continue flowing towards land and buildings. If speculative investment appears safer than research, research will remain underfunded. If expanding existing business models offers greater certainty than creating entirely new ones, incrementalism will consistently outperform disruption. This is where Malta finds itself today. 

Over recent years we have discussed productivity, education, infrastructure, carrying capacity and the need to prepare for the economy envisaged in Vision 2050. These are not separate debates. They are all different expressions of the same structural question. How do we shift incentives away from expanding yesterday’s economy towards building tomorrow’s? 

The European Innovation Scoreboard offers a useful reminder that innovation ecosystems are far broader than research laboratories. Countries that perform strongly combine excellent research systems, access to finance, firm investment, collaboration between business and academia, intellectual property creation and strong commercialisation pathways. Innovation is not a single policy intervention. It is an ecosystem in which incentives consistently reinforce each other. 

Malta’s position as a moderate innovator should therefore not simply be viewed as a ranking. It should be interpreted as evidence that the innovation ecosystem remains incomplete. Encouragingly, Malta recorded one of the strongest annual improvements in the 2025 scoreboard. That demonstrates that progress is possible. The challenge now is ensuring that this improvement becomes structural rather than cyclical. 

This inevitably brings us to the banking sector. 

Banks occupy a unique position within any economy because they do far more than intermediate savings. Through their lending decisions they shape the productive structure of the economy itself. Every loan is effectively a vote about what type of economy should expand. When the overwhelming majority of lending supports property, construction and asset-backed activities, the financial system is not simply responding to demand. It is reinforcing the economic model that generated that demand in the first place. 

This is not an argument that banks should stop financing property. Real estate remains an essential component of every modern economy. The issue is one of balance. If virtually every entrepreneur with tangible collateral can secure financing while businesses built around intellectual property, software, deep technology or research struggle to access growth capital, then the economy gradually becomes locked into a development model where physical assets consistently outperform productive ideas. 

That is precisely why public institutions matter. 

The Malta Development Bank was never intended to become another commercial lender. Its purpose is to intervene precisely where markets, acting rationally, choose not to go. Development banks exist because innovation frequently generates substantial social returns that exceed private returns. A successful technology company creates knowledge spillovers, highly skilled employment, export opportunities and productivity gains that benefit the wider economy, yet these wider benefits are rarely reflected in the commercial lending decision of an individual bank. 

This is why I believe the Malta Development Bank now needs to become significantly more innovation aggressive. 

Its mission should increasingly extend beyond correcting isolated market failures towards actively shaping markets. Instead of asking how innovative businesses can fit within traditional lending criteria, it should ask how financial products can be redesigned around the realities of innovative firms. Revenue-based finance, co-investment vehicles, innovation guarantees, venture debt and scale-up finance should become mainstream rather than exceptional. 

Government also has an important role to play. 

Across the EU, public investment in research and development reached €130.2 billion in 2025, equivalent to 0.69% of GDP. Over the past decade this investment increased by more than 60%, reflecting a growing recognition that research and innovation are becoming central to competitiveness. Malta, however, remains among the countries allocating the lowest public resources to R&D both as a share of GDP and on a per-capita basis. 

This matters not simply because of the amount being spent but because of the signal it sends. Public investment shapes expectations. When governments consistently prioritise research, commercialisation and industrial technology, they reduce uncertainty for private investors and encourage complementary investment from business. Innovation ecosystems emerge when public and private incentives move in the same direction. 

Ultimately, innovation is less about inventing new technologies than about redesigning incentives. 

Countries rarely become innovation leaders because they ask entrepreneurs to take greater risks. They become innovation leaders because they create environments where taking those risks becomes economically rational. They reduce the gap between private returns and public benefits. They ensure that talent finds capital, that research finds markets and that ambitious ideas are not constrained by financial structures designed for a different economy. 

Malta has now reached a stage in its development where this conversation can no longer remain peripheral. Innovation is not another policy objective sitting alongside productivity. It is productivity.