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Can Britain build an innovation economy?

Credit: Oli Scarff/Getty Images

June 20, 2018   4 mins

In an era of increasing globalisation being competitive is key. And in the UK – with the potential negative trade impact of leaving the EU – this is more important than ever. Though the economy continues to grow, productivity is once again falling – with the level only just about where it was before the financial crisis of a decade ago.

Germany remains some 30% more productive than the UK; France and the US some 25%. This is in part because business investment has stalled, not helped by a retrenchment of public sector capital spending in the years following the crisis. Without investment, innovation atrophies, and with it growth.

R&D expenditure in the UK stands at a paltry 1.67% of GDP – below the European average of just over 2%, and well below world leaders Israel and Japan, both of whom spend over 4%. And within this total R&D, government spends just £10 billion per annum, or a disappointing 0.6% of GDP.

The latest industrial strategy pledges to increase the total spend to 2.4% by 2027 – clearly indicating that the Government sees innovation as a ‘public good’ – but whether that can be achieved remains to be seen.

The worry is that individual companies would not, if left to themselves, make the level of investment needed to boost the economy as a whole. Businesses take a narrow definition of benefits, they do not price in any positive ‘spillover’ effects (seemingly unconnected benefits) or ‘externalities’ (benefits to others) that flow to the rest of the economy as a result of investment.

If the market is failing to innovate adequately, to the detriment of the economy, does that mean that state intervention is justified? In my mind the answer is a resounding: yes! The dilemma, of course, is how best to intervene.

Germany remains some 30% more productive than the UK; France and the US some 25%

The ideal, surely, would be to change market incentives by putting more emphasis on long-term returns. But that would require changing accepted norms and cultures. Even though R&D spending should increase innovation, efficiency and productivity, such benefits take time. In the short term, profits are cut – and that isn’t always favoured by institutional investors.

Perhaps it would be better to just alter the fiscal framework, or increase government subsidies. But that requires an understanding of ‘additionality’ – in other words, whether the desired outcomes would have happened anyway, meaning that taxpayers’ money is wasted. Was it worth, for example, the UK government introducing in 2013 a low tax ‘patent box’ to encourage companies (like big pharma) to invest in R&D and commercialise their patents, or would firms have invested in the UK anyway? A better focus for taxpayer investment might be small and medium size businesses where the need is likely to be greater and the impact wider.

That implies, however, that government knows best, and there’s not much evidence that it has been particularly successful at picking winners so far

Or perhaps greater competition is the answer. Large monopolies, or oligopolies, enjoying high profits have little incentive to invest. While on the other hand, the difference innovation can make for a competitive firm can be significant. Research clearly shows a positive relationship between competition and innovation.1.

This all suggests that a mix of better conditions for innovation, and a series of targeted but properly costed and evaluated interventions may help boost the UK’s lagging productivity – and with it, all important economic growth.

The UK has done a number of things already. The Technology Strategy Board, now Innovate UK, emerged from the first innovation strategy produced in the early 2000s. In 2016-17 it provided some £560 million worth of project funding, and also attracted large private funding, to assist collaborative research in areas such as emerging and enabling technologies, life sciences, scientific instruments and manufacturing and materials.

There is now also a £725 million Industrial Strategy Challenge Fund focused on innovation, announced in the 2017 Industrial Strategy White Paper, and ten ‘catapults’ which are not-for-profit centres aimed at promoting innovation by connecting businesses with universities and other research organisations.

These are positive steps, but more needs to be done and the sums are still small. Academics like Mariana Mazzucato would argue that an obsession with limiting state intervention to correcting market failure is misplaced. Instead, the state should be actively shaping markets.

That implies, however, that government knows best, and there’s not much evidence that it has been particularly successful at picking winners so far. Current suggestions for a National Investment Bank, for example, would only make sense if it functions at arm’s length from politicians, and it is staffed by experts with banking and commercial skills.

But as Mazzucato suggests, “building dynamic public-private partnerships” to drive innovation makes sense, particularly if that partnership shares the risks and profits. Sadly, the UK is behind the curve. It missed out on developing a sovereign wealth fund, for example, as Norway did so successfully with the oil and gas proceeds when they were at their height in the 1970s and 1980s.

To that end, taking a strategic stake in firms as Mazzucato proposes, and investing in innovation though the process, may indeed be the way forward. Perhaps the UK should take a leaf out of France’s book. The most state-controlled country in Western Europe is, under Macron’s Presidency, about to sell off state shares in companies, partly to raise funds for – you guessed it – a €10 billion Innovation Fund.

  1. See for example Richard Bundell et al., ‘Market Share, Market Value and Innovation in a Panel of British Manufacturing Firms’, The Review of Economic Studies, 1999; Paul Geroski, ‘Innovation, Technological Opportunity and Market Structure’, Oxford Economic Papers, 1990

Vicky Pryce is a board member at CEBR and a former joint head of the UK Government Economic Service. Her books include ‘Why Women need Quotas’, Biteback 2015.


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