Innovation and the UK's knowledge economy

Vince Cable talks about creating a a successful knowledge-based economy.

My starting point is that our objective in policy must be to create a successful, knowledge-based economy which rests on innovation and a highly skilled labour force. That is what my own job is about. I am delighted to participate in this event, having been greatly encouraged by the work of Mariana Mazzucato.

It is unfashionable but essential to remind people – as she does - of the real achievements of state-sponsored innovation. An accurate history of the state’s role in technological progress is one we urgently needed. It really is important to acknowledge the public investment without which railways, aviation, nuclear power, pharmaceuticals, space exploration, computer science and the internet could never have got going as quickly or at scale. Current moves into green technologies, robotics, personalised medicine and “smart cities” are just as reliant on public investment or other support today. As Mariana points out in The Entrepreneurial State, Medical Research Council-sponsored projects during the 1970s, which led to the discovery of monoclonal antibodies, are now responsible for around a third of all new drug treatments.

Some dangerous myths have proliferated. You will have probably have heard the Ronald Reagan quote: “The most terrifying words in the English language are: I’m from the government and I’m here to help”. It is often used to buttress ideological preferences against state intervention. But he was also the president responsible for the Small Business Innovation Research programme, which we have sought to emulate here; the Orphan Drug Act, a shot in the arm for the biotech industry; not to mention Star Wars which has done wonders for technological innovation even if the Evil Empire dissolved without a laser gun being fired in anger.

And that example illustrates the need to recognise the limits, also, to the role of the state as innovator and entrepreneur. The Soviet Union is no longer with us in large part because an overbearing, centralised state suffocated rather than encouraged innovation. Innovation needs a mixed economy: profit seeking entrepreneurs as well as an entrepreneurial state. And we need to be hard headed rather than over romantic about the entrepreneurial state. Private businesses lose their own money. Government loses money that has an opportunity cost in poorer public finances and higher tax. Concorde and older generation nuclear fusion, such as the Zeta reactor, are testament to the government’s ability to make expensive mistakes. But even here, there were spin-outs and spill-overs which helped to drive innovation in unforeseen ways – a better toolkit for capturing and valuing these effects is something I know you will discuss this week, and is a conversation I welcome.

Government response to date

Today, as we continue the broader work of economic recovery and rebalancing, our mission is to establish the UK as a leading knowledge economy. But critical as it is to have a healthy, profitable private sector, it will not, on its own, generate large scale innovation in areas where there are higher risks and wider benefits. That requires a commitment to public investment in science and innovation, albeit with the caveat I have set out above; we need mechanisms to ensure that public investment is properly evaluated for its prospective returns. A new BIS report released today analyses traditional and emerging barriers to innovation in those sectors with dedicated industrial strategies, to better help us understand where public investment can make a difference.

While we have made progress, I recognise, of course, that Professor Mazzucato has criticised aspects of Coalition policy (I do myself on occasion). Yet there is much common ground between her position and the one staked out by my team in BIS. We are acutely aware of the other areas where we are only just making a serious dent, like the funding gap facing smaller business undertaking cutting-edge R&D – the so-called “valley of death”; the Business Bank is beginning to address this issue. We have given considerable thought to the processes through which innovation occurs in practice – which prompted me to launch the Catapult centres early in our administration, funding a practical link between new science and commercial innovation and drawing on the German Fraunhofer model.

Common ground is also evident in our emphasis on planning for the long-term, epitomised by the industrial strategy – a partnership with business whose commitments go much further than narrowly “addressing market failures”. Here, it is vital that we look beyond party point scoring and beyond the time frame of single parliaments so that business has the confidence to innovate on the back of the technology push we are giving.

This administration has done much in recognition of the role of public funding – in last year’s spending round we committed to increasing science capital funding in real terms from £0.6 billion in 2012 to 2013 to £1.1 billion in 2015 to 2016. We are protecting the £4.6 billion per annum funding for science and research programmes in cash terms during the current spending review period. We also set a long-term capital budget for science into the next Parliament, which will grow in line with inflation to 2020 to 2021, and we have increased the budget of the Technology Strategy Board in the next Spending Round by £185 million, taking it to more than £500 million.

We need to do more

But I want to advance the economic argument today, in order to make the case that we need to do more. As any academic will tell you – and there are plenty of you here today – a sound argument needs premises that justify its conclusion. So let me set out 4.

My first premise is that science and innovation are critical to economic growth and the long term development of our economy. Of the productivity growth that took place in the UK between 2000 and 2008, one third (32%) was attributable to changes in technology resulting from science and innovation. Innovative firms are also more resilient and more likely to export and as I set out 2 weeks ago, there is a serious export challenge facing the UK.

Innovation is a critical driver of productivity, an area in which the UK has what some would call a “puzzle”, but which I would call a serious imbalance. UK productivity is around 16% off its pre-crisis trend and the Office for Budget Responsibility sees the outlook for productivity growth as the key uncertainty for the economic outlook. But fascination with this puzzle risks obscuring a broader trend of structurally and comparatively lower productivity than our competitors, and this is where the importance of innovation is clear. Around 2 thirds of our productivity lag with the US can be attributed to weaker innovation and ways of working. Looking across countries and across sectors, firms that persistently invest in R&D have higher productivity – 13% higher than those with no R&D spending and 9% more than firms who occasionally invest in R&D.

Innovation also underpins business resilience. A study of the Community Innovation Survey found that failure rates among non-innovators were higher than those among innovating firms. From a cohort, 88% of innovating firms survived after 8 years compared to 78% of non-innovators.

Finally, innovation plays an important role in our export ambitions. SMEs which have a track record of innovation are more likely to export, more likely to export successfully, and more likely to generate growth from exporting than non-innovating firms. For firms of all sizes there is a strong positive association between innovation, exporting and productivity. In particular, R&D and innovation-intensive sectors such as finance, business services, pharmaceuticals and aerospace are sectors in which we also have significant comparative advantage.

The second premise is that if we consistently invest less in our science and innovation capabilities than our competitors, we cannot expect to sustain the UK as a world leader in knowledge-based activity. It’s worth recognising here that our world class research base continues to outperform. The UK research base continues to produce a large output for its moderate size, with a sustained track record of high quality research. With just 4% of the world’s researchers, we account for 6% of world articles, 12% of citations (a key measure of research excellence) and 16% of the most highly cited articles.

But the UK’s total investment in R&D – both public and private – has been relatively static at around 1.8% of GDP since the early 1990s and stood at 1.7% of GDP in 2012, the last year for which we have data. In contrast, the US alone spends around £250 billionn (2.8% of GDP) on R&D per annum. China increased its R&D by 28% in 2009 and 15% in 2010, to roughly £125 billion (1.8% of GDP), and South Korea doubled its expenditure between 2003 and 2011 to around £35 billion (4.0% of GDP). France and Germany have consistently invested substantially more than 2% of their GDP in R&D, with aspirations to increase this to 3% or more. Public sector support for innovation is harder to compare, but such data as exist suggest that UK funding is at the lower end of the scale.

Moreover, if we look at innovation support specifically (as opposed to wider research), as a share of GDP, Finland spends almost 10 times as much per capita on TEKES, its Technology Strategy Board equivalent, than we do. We so far invest in our Catapults less than a tenth of what Germany spends on its Fraunhofer Institutes and what France has committed to its equivalent Institut Research and Technologies (£135 million vs £1.6 billion and £2 billion), though this is from a standing start 3 years ago and will increase.

In a globally competitive environment, this comparatively weak performance risks jeopardising the breadth and depth of science and innovation excellence required to underpin our industrial success and the capacity of our firms to absorb and apply new knowledge and ideas. BIS research conducted by our former chief economist Tera Allas earlier this year found that a level of total R&D expenditure which is consistent with securing future economic success is likely to be closer to the 2.9% of GDP average of our comparators (including Germany, France, Finland, Austria, the US, Canada, Japan and Korea). Tackling this gap is a motivation behind the Chancellor’s decision to improve the R&D tax credit.

My third premise, building on the second, is that, alongside tax incentives for R&D, public investment is also part of the solution to our chronic private sector underinvestment. Business expenditure on R&D (BERD) grew 8% in real terms between 2001 and 2012, but – as a share of total output – it has flat-lined since 2007 at around 1.1%. It remains to be seen how far tax credits alleviate that deficiency but there is still a case for strong public investment. Rather than “crowding out”, the literature offers strong evidence that public investment in science and innovation “crowds in” private investment.

While the causal links are complex and path-dependent, the pattern of spending across OECD countries shows a marked correlation between public and private investment in R&D. There is potential for public investment to drive virtuous circles of private investment and innovation, as quality of research attracts international talent which in turn attracts global companies – all of which results in further advances in both new knowledge and exploitation. This is corroborated by recent research by Alan Hughes and Jonathan Haskel, which concluded that “in terms of willingness to pay, public research funding leverages complementary funding from private and other sources.”

The fourth premise is that what we’ve done so far has worked. This is an argument about needing more of what’s proven, rather than a speculative punt on a new idea. For example, we know that innovation support increases firms’ survival probability by around 3% over a decade. A second report we have released today synthesizes the evidence on the returns to government investment in science and innovation. It confirms that social returns are significant – normally 2 or 3 times greater than their private benefits, and persisting long into the future. Every one pound we spend delivers an average social rate of return – i.e. a return to wider society beyond the agent spending the money – of between 20 and 50 pence per year in perpetuity. Technology Strategy Board investment to support business-led innovation has generated a return to the economy of between 3 and 9 pounds of additional value (Gross Value Added) for each pound of public money invested. At these rates, investment in UK science and innovation will pay for itself many times over through expansion of our capacity to exploit technologies developed elsewhere, through economic growth and attracting business investment, and from improvements in living standards.

The conclusion, then, is that we need to do more on both science and innovation, recognising: their importance to the economy; our vulnerable competitive position; the need to catalyse private sector investment; and the fact that we know public investment delivers a return. But one of the other lessons from experience is that while money is a necessary condition, it is not sufficient. The delivery vehicle also matters. Independent, technically competent institutions like the Technology Strategy Board make good use of public money; not the same as ministers spending money on the latest wheeze.

Doing more – new announcements

I am therefore pleased to be able to announce not 1 but 3 new demonstrations of the government’s commitment to nurturing and sustaining the UK’s world class science capability.

The first is a significant new investment via the Engineering and Physical Sciences Research Council. The EPSRC is launching 2 programmes with industry partners worth £30 million in total – involving 11 universities and 30 businesses, from SMEs to Rolls-Royce, Tata Steel and GKN.

One programme is concerned with developing quieter, more powerful and more efficient aero engines through advancements in structural metals; it reflects one of the priorities of the Aerospace Technology Institute, created as a result of our industrial strategy. The second programme covers further research on non-destructive evaluation: spotting defects before they develop in critical infrastructure, so that we can keep the lights on and our buildings safe.

Secondly, I can announce that UK researchers will be granted access to a “virtual library” of stalled pharmaceutical compounds through a new partnership between the Medical Research Council and 7 global drug companies. These compounds are valuable to academic researchers, who can use them to understand how a disease takes hold in the body and how it might be stopped or slowed down. Re-purposing abandoned compounds could lead to the development of new medicines for many debilitating conditions – such as chronic cough, where a collaboration between AstraZeneca and the MRC is already bearing fruit.

Finally, tomorrow will see my colleague, George Freeman, opening an £11.5 million building in Norwich enabling businesses to interact with the best scientific and research minds in areas such as food, health and energy. The new Centrum building is at the heart of innovation and enterprise at the Norwich Research Park, a leading campus of bioscience innovation that is undergoing expansion to bring jobs and major investment to the region.

But these science interventions, while critically important, do not go far enough. They do not address the UK’s underinvestment in innovation and they do not reflect the scale of the step-change we need to make.

Of course we are fiscally constrained and this is not the place to go into tax and spending priorities, suffice it to say that a doubling of innovation spend is what a serious commitment to innovation means. It was this kind of commitment in the aerospace sector, via the Aerospace Growth Partnership, which retrieved a sector at risk of drifting away.

The annual Technology Strategy Board budget is approximately 0.03% of GDP, or £500 million. Doubling annual innovation spend could bring its resources closer to £1 billion. It would enable the Catapult network to be deepened and widened and lift some of the crippling barriers to private funding (like the 25% success rate on Smart fund applications). It would also enable the Catapults to leverage in greater private funding – the Catapult model requires public funding to be matched by the private sector one for one, which means substantial bang for every buck of extra public funding. I have asked Herman Hauser to review the future scope and scale of the Catapult Network, but for example, a further £500 million of public investment could mean at least a £1 billion more of innovation spend every year across the UK. This would close some of the gap on our competitors, moving us closer towards that important figure of 2.9% of GDP spend I mentioned earlier as being the indicative level necessary for the UK’s future economic success. Moreover, the partnerships we are building between the public and private sectors via initiatives like the Catapults will mean that additional funding will be spent where it is definitely needed, not where government thinks it is.

I believe that this target is the logical conclusion of the argument I have made today, and is consistent with much of what I’ve been arguing for over the past 4 years: the need for long-term planning and commitment, and the need to create certainty. I want there to be no doubt in the minds of overseas investors, of world-class scientists, of budding entrepreneurs, that the UK is the best place in the world for them to invest, research, collaborate and start a business.

Long-termism and access to finance

The same arguments about long-term planning and commitment to innovation apply equally to the private sector. Mariana’s work has pointed to the threat to innovation posed by short-termism and “financialisation” – the same issues I commissioned John Kay to study and which I have sought to tackle in terms of UK equity markets. What is needed in both cases is a longer-term, more committed approach, which requires a change of attitude and behaviour in the boardrooms of companies and investors.

In particular, the need for a more patient, longer-term approach which combines the resources of public and private is evident in the case of access to finance for new and innovative firms. Finance constraints are an issue for companies in all sectors – and have certainly been exacerbated since the financial crisis – but the challenges for innovative firms are arguably most acute. The riskiness of new technologies; the lack of fixed assets against which to secure finance; the need for long-term investment and the fact that benefits accrue to society as well as private investors all conspire to deprive innovative firms of the capital they need. The government has an indisputable role to play in helping firms to bridge this “valley of death”.

Through government funding, we are attracting private sector investment into the early-stage market. For example, the British Business Bank has begun to intervene through a VC Catalyst Fund, providing up to £125 million of public investment to help VC funds achieve a first closing and support high-growth companies.

We are investing £170 million in SMEs alongside £230 million of private sector investment through the Enterprise Capital Funds, now incorporated into the British Business Bank. More than 20% of ECF portfolio companies have also received Technology Strategy Board funding – high-growth firms like OR Productivity, which is developing robotics for use in operating theatres. We expect this proportion to increase significantly.

There are other significant initiatives. The Technology Strategy Board’s Venturefest events helps innovative companies connect with investors and, along with public and private sector partners, the TSB is working on a new online platform to showcase the most exciting high-growth companies to potential investors. This is in addition to the schemes already in operation, such as the £180 million Biomedical Catalyst, which supports UK academics and businesses on the vital first step in exploring the market potential of their early-stage scientific ideas, bridging the ‘valley of death’.

But we know that there’s more to do. My department is preparing a science and innovation strategy for publication this Autumn. Finance for innovation will be one of its main subjects and I’m sure the discussions throughout the rest of this conference will give my team great food for thought.

Conclusion

In sum, the case for public support for science and innovation is, to me, unequivocal. Science and innovation requires patience and grants have the capacity to promote long term support (though grants can in practice be very short term too). Mariana has illustrated how venture capital arrived only 20 years after key public investments were made in biotech, nanotech and for the technologies underpinning the internet. For a single field of medicine, the Wellcome Trust assumes the lag between public and charitable R&D spending on cardiovascular research and measurable health gains to be 17 years.

Which brings me back to part of my opening argument. Investments made today are for the sake of breakthroughs whose effects are felt by the next generation or the one after that. There are, of course, many competing claims for public money – but continued support for science and innovation is among the most compelling and, arguably, the most selfless.

Failing to support our researchers and innovators would be the most short-sighted decision of all – and we shouldn’t hesitate to remind people of that at every opportunity.