Rebuilding the UK’s innovation economy

Three steps could be taken immediately by the present or a future UK government

Richard JonesThe weak link in the UK’s innovation economy is that too little is spent by the private sector on research and development.  As a fraction of GDP, this spending now stands at 1.09%, compared to Germany, say, at 1.94%.   The UK’s investment is dwarfed to an even greater extent by more recently industrialised countries, like Korea at 3.09% of GDP, and in 2009 was overtaken by China, whose business R&D intensity now stands at 1.4%, about the same as France.

Private-sector industrial R&D matters, because it is the way in which skilled people and resources are systematically mobilised to use the results of the research base to create new products and services.  Of course, much innovation takes place without formal R&D.  Social innovations can be hugely valuable, and in the digital sector there are very low barriers to entry.  But, if you want to innovate in the material or biological worlds (by, for example, developing new drugs or new energy sources) you need the sustained, capital-intensive and long-term effort that R&D entails.

My earlier SPERI paper – the UK’s innovation deficit and how to repair it – argued that this lack of private-sector research and development was a symptom of a bigger picture of short-termism and under-investment, underlying the UK economy’s long-term problems.  What should the UK government, or future government, do now to address our innovation problem?  I suggest three steps.

1.  Stop making things worse 

Firstly, we should recognise the damage that has been done to the country’s innovative capacity by the structural shortcomings of our economy and stop making things worse.  R&D capacity – including private-sector R&D – is a national asset, and we should try and correct the perverse incentives that lead to its destruction.  The recent attempted takeover of AstraZeneca by Pfizer, driven largely by tax engineering, did at least give some political prominence to this issue.  Rebuilding our innovation economy, then, is an integral part of the broader task of rebalancing our model of capitalism to encourage long-term value creation and discourage short-term value-extraction.

2.  Recognise and maintain our strengths

Secondly, we should build on what we have that is positive.  The UK’s academic research base is highly competitive and cost-efficient, and has become increasingly connected with industry through collaborative and contract research (up 45% in real terms in the last ten years).  Universities now have very effective and focused technology-transfer operations that make the most of their intellectual property through spin-outs and licensing.  But this ‘supply-side’ science policy isn’t enough; driving academic scientists to be more collaborative with applied researchers in the private sector yields diminishing returns, if the private sector doesn’t have the R&D capacity to collaborate with.

3.  Build capacity

Thirdly, we need therefore actively to build capacity in industrial R&D and at the same time to develop the absorptive capacity of the economy for new technology.

Industrial R&D capacity is positively correlated with government spending on science – old arguments that state spending on research ‘crowds out’ private-sector research spending, implausible to start with, have been discredited by econometric studies. Multinationals are strongly influenced in their choice of location for R&D facilities by the strength of the science and skills base; indeed, the UK has an anomalously high proportion of industrial R&D carried out and funded by overseas companies.

In addition to general support for the science base, recent governments have moved to fund more translational, applied research in collaboration with industry, through agencies such as Innovate UK and institutions such as the Catapult Centres.  As Hermann Hauser’s recent review argues, this has been successful so far and should be supported further.  But it’s an approach that works best in sectors that are already strong in the UK, such as aerospace.  By stressing that they are ‘business-led’, these initiatives have a tendency to support the existing business base, rather than building additional new capacity.  That’s where our best efforts need to turn to now.

Yet, as soon as one talks about governments seeking to build industrial capacity, one faces the charge of attempting to ‘pick winners’.  The point, though, is not so much to pick winners, but to identify the problems that we know we will need new technology to overcome.  These are problems that governments cannot avoid addressing, in respect of which they are already committed (explicitly or implicitly) to spending enormous sums of money.

We need to address the returning spectre of infectious diseases, as microbes develop resistance to our existing antibiotics.  The market is not delivering the new antibiotics and vaccines we need.  We also know that our ageing society will face huge human and social costs as incurable neurodegenerative diseases like Alzheimers become even more common.  Social, technical and medical innovations are urgently needed to deal with this.

We need to decarbonise our energy supply, but the existing low-carbon alternatives are just too expensive.  Even the so-called ‘climate realists’, who believe that the potential impacts of climate change have been overstated, agree that we should be carrying out more energy R&D.  Over the last 30 years, energy research has eroded to a degree that isn’t widely recognised.  Our liberalised energy markets can’t deliver the R&D we need to give us cheap solar energy and cheap nuclear power, at scale, so we can get the economics of low-carbon energy to work for us.

What is needed here is directed R&D focused on delivering products.  For some of these products – for pharmaceutical and medical innovations – the government will be the main customer, as well as being the direct financial beneficiary of savings in areas like the social care budget.  In the case of energy, the costs are imposed on future customers through long-term guaranteed prices, for example for nuclear power.  The government should use its power as the purchaser or guarantor to make sure new technologies are developed from which the UK can capture significant value.

The erosion of the UK’s capacity to technologically innovate was not inevitable.  It was the unintended consequence of a series of political and policy choices over decades.  We must now reverse this loss of capacity.  This needs to be done as part of a broader rethinking of the variety of capitalism on which the UK economy is currently based.  Without this wider rethinking, we will be condemned to continue on our current trajectory of very poor productivity growth, poor trade performance and, ultimately, loss of national sovereignty.