Author: Richard Jones

The Second Coming of UK Industrial Strategy

I have a longish piece in the Winter issue of the US science policy journal “Issues in Science and Technology”, which aims to place our current debates about industrial strategy in the UK in a longer historical context. This is now online here: The Second Coming of UK Industrial Strategy. Here is the introduction to the article:

The United Kingdom dismantled industrial policies in the 1980s; today it must rebuild them to create a social-industrial complex.

Industrial strategy, as a strand of economic management, was killed forever by the turn to market liberalism in the 1980s. At least, that’s how it seemed in the United Kingdom, where the government of Margaret Thatcher regarded industrial strategy as a central part of the failed post-war consensus that its mission was to overturn. The rhetoric was about uncompetitive industries producing poor-quality products, kept afloat by oceans of taxpayers’ cash. The British automobile industry was the leading exhibit, not at all implausibly, for those of us who remember those dreadful vehicles, perhaps most notoriously exemplified by the Austin Allegro.

Meanwhile, such things as the Anglo-French supersonic passenger aircraft Concorde and the Advanced Gas-cooled Reactor program (the flagship of the state-controlled and -owned civil nuclear industry) were subjected to serious academic critique and deemed technical successes but economic disasters. They exemplified, it was argued, the outcomes of technical overreach in the absence of market discipline. With these grim examples in mind, over the next three decades the British state consciously withdrew from direct sponsorship of technological innovation.

In this new consensus, which coincided with a rapid shift in the shape of the British economy away from manufacturing and toward services, technological innovation was to be left to the market. The role of the state was to support “basic science,” carried out largely in academic contexts. Rather than an industrial strategy, there was a science policy. This focused on the supply side—given a strong academic research base, a supply of trained people, and some support for technology transfer, good science, it was thought, would translate automatically into economic growth and prosperity.

And yet today, the term industrial strategy has once again become speakable. The current Conservative government has published a white paper—a major policy statement—on industrial strategy, and the opposition Labour Party presses it to go further and faster.

This new mood has been a while developing. It began with the 2007-8 financial crisis. The economic recovery following that crisis has been the slowest in a century; a decade on, with historically low productivity growth, stagnant wage growth, and no change to profound regional economic inequalities, coupled with souring politics and the dislocation of the United Kingdom’s withdrawal from the European Union, many people now sense that the UK economic model is broken.

Given this picture, several questions are worth asking. How did we get here? How have views about industrial strategy and science and innovation policy changed, and to what effect? Going forward, what might a modern UK industrial strategy look like? And what might other industrialized nations experiencing similar political and economic challenges learn from these experiences?

Read the rest of the article here.

Making UK Research and Innovation work for the whole UK

The first of April saw the formal launch of UK Research and Innovation, the new body which will be responsible for the bulk of public science and innovation funding in the UK. All seven research councils, the innovation funding agency InnovateUK, and the research arm of the body formerly responsible for university funding in England, to be renamed Research England, have been folded into this single body, with a budget of more than £6 billion a year.

Expectations for this new body are very high. Its formation has been linked to the government’s decision to increase research funding substantially, with extra funding rising to £2.3 billion by 2021/2. This new money is explicitly linked to the need to increase the productivity of the UK economy. The government has also committed to a 10-year target of raising the overall R&D intensity of the economy from its current 1.7% to 2.4% of GDP. As I’ve discussed earlier, this is a very challenging target that will require a major change in behaviour from the UK”s private sector, as well as substantial increases in public sector R&D. UKRI has the task of ensuring that the extra public sector investment is made in ways that maximise increases in private sector R&D. All of this, of course, takes place with the background of Brexit, and the need for the UK to rebuild its business model.

There’s one factor that, unless urgently addressed, will hold UKRI back from its mission of making a significant difference to the UK’s overall productivity problems and raising the economy’s R&D intensity. That is the extraordinary and unhealthy concentration of publicly funded R&D in a relatively small part of the country – London, the Southeast, and East Anglia. Entirely uncoincidentally, these are the parts of the country with the most productive economies already. As the Industrial Strategy Commission (of which I was a member) stressed in its final report last year, unless the UK fixes its gross regional economic disparities it will never be able to prosper.

No-one has done more to bring attention to the UK’s unbalanced R&D geography than Tom Forth; everyone should read his recent article on how we should use the increase in funding to redress the balance. One key point that Tom has stressed is the geographical relationship – or lack of it – between public and private sector research. Industry spends roughly twice as much as the government on research, so reaching the 2.4% R&D intensity target will not be possible without major increases in private sector spending – roughly £14 billion a year, by my estimate. Yet classical economics tells us that firms will always underinvest in R&D, because they are unable to capture the full economic benefit of their spending, much of which “spills over” to benefit the rest of the economy. That’s the logic which convinces even HM Treasury that the state ought to support R&D.

Yet Tom Forth’s work – especially his plots of of public against private R&D spending – shows how badly government spending on R&D is matched to the demand of industry, as measured by where industry actually invests its own money.

R&D funding in the business and non-business sectors (government, higher education and charity), by NUTS2 regions. 2014 figures, by sector of performance, from Eurostat.

My first graph shows how unbalanced the UK’s research landscape is. This shows R&D spending – both private and public – broken down sub-regionally. The first thing that’s obvious is the dominance of three sub-regions – Oxford and its environs, Cambridge and its sub-region, and (part of) London – inner West London. These three subregions – out of a total of 40 in the UK – account for 31% of total UK R&D spending, and an even higher fraction of spending in the government, HE and charity sectors – 41%.

There is a striking difference between these three sub-regions, though, and that is their split between public and private R&D (taking public R&D here to mean R&D carried out in government-owned laboratories, universities and the non-profit sector). Overall in the UK, the value of business R&D stands at 1.89 times the value of public R&D. East Anglia – dominated by Cambridge – does even better than this, with private sector R&D coming in at more than twice public sector R&D. This is a science-based cluster that works, with high levels of public R&D being rewarded at above average rates by private sector R&D.

The Oxford, Berks and Bucks sub-region does slightly less well in converting its very large public investment into private R&D, with a multiplier a little below the national average at 1.72.

The real anomaly, though, is Inner London (West). This single region receives by far the largest amount of public R&D spending of any single region – nearly 20% of the entire public funding for R&D. Yet the rate of return on this, in terms of private sector R&D, is only 0.46, far below the national average.

Working down the list, we find 9 sub-regions with respectable levels of total R&D. These include Bristol, Hampshire, Derby, Bedford, Surrey and the West Midlands, Worcestershire and Cheshire. With the exception of East Scotland, all these sub-regions are characterised by above average ratios of private to public sector R&D. Two sub-regions stand out for significant private sector R&D and almost no public sector activity – Cheshire, with its historic concentration of chemical and pharmaceutical industries, and Warwickshire, Herefordshire and Worcestershire.

Then we come to the long tail, with much lower investment in R&D, either public or private. All of Wales, Northern Ireland, the North of Engand, Southwest England beyond Bristol, outer east and southeast London and Kent, Lincolnshire – this is pretty much a map of left-behind Britain.

This brings us to the question: why should we worry about regional disparities in R&D? Let’s put aside for the moment any question of fairness – what it comes back to is productivity. If we plot R&D intensity against regional GDP, we find quite a respectable correlation. (Slightly to my surprise, the correlation is strongest if you plot total R&D – both public and private, rather than just business R&D. I’ve ommitted London entirely as it is such an outlier on both measures).

Sub-regional GDP per capita against total R&D (public and private) per capita. 2014 data, from Eurostat.

Of course, the relationship is not a straightforward one: higher R&D intensities are associated with the presence of high-productivity firms at the technology frontier, there may be a more general effect of higher skill levels associated with regions with higher R&D, and there may well be other factors, direct and indirect, at play too. We can also see outliers. NE Scotland has very high productivity but mid-level R&D investment, not doubt because of the importance of the oil industry, while East Anglia has relatively low productivity given the very high levels of R&D. I suspect the latter is associated with the relatively concentrated nature of the Cambridge cluster, whose effect doesn’t really penetrate far into a large and relatively poor rural and coastal hinterland.

As the Industrial Strategy Commission argued, just as a matter of arithmetic averages, we cannot expect the productivity of the country as a whole to grow if such a large fraction is structurally lagging. So what should we do? Different places demand different approaches, and Tom Forth has some suggestions.

On London, I agree with Tom – the over-investment of public R&D in London is a grotesque misallocation of public resources, but the realities of political economy mean it’s likely to stay that way. At the least, we certainly need to stop building new institutions there. One thing the data does highlight, though, is how concentrated even within London the investment is, so initiatives like UCL East, aiming to spread the benefits of the investment to less favoured parts of the capital, are to be welcomed.

The eight sub-regions with high private sector R&D and public underinvestment offer a clear rationale for further public investment. One needs to be aware of the arbitrary nature of these sub-regional boundaries – the strength of the Cheshire cluster is a very good reason to have a strong Chemistry department in the University of Liverpool, for example – but these regions are likely to provide some very strong investment cases for following the private sector money to support existing clusters.

I somewhat disagree with Tom on the case of Oxford and Cambridge (and here of course my biases may be showing). Tom believes that funding should be frozen in these places until they agree to allow more growth. As far as Cambridge is concerned, I’m not sure this is quite right – there seems to be a huge amount of growth happening in that city at the moment, with significant numbers of new-build apartments going up in the city, and a string of new suburbs like Eddington being built around its fringes, complete with new schools and supermarkets. The issue here is the completely inadequate transport infrastructure to get into and around the city; it’s these infrastructure problems that are stopping the further growth of what is the UK’s most successful science-based cluster, and are stopping the spread of its benefits to its less prosperous hinterland.

But this leaves the bigger problem – how can public R&D investments be used to raise productivity and economic growth in what is the majority of the country, where levels of R&D investment, both public and private, are far too small? It’s easy to imagine arbitrary and ill-thought through investments imposed on regions with no understanding of the potential their economic history and current industrial base will support. But for a counter-example, in my own city, Sheffield, I think there has been a well thought through policy based on promoting advanced manufacturing through investments in translational research and skills, which is bearing fruit through the twin routes of the attraction of inward investment from firms at the technological frontier and improving the performance of the existing business base.

Where does this leave the new organisation, UK Research and Innovation, whose job should be to rectify these issues? It’s not going to be easy, given that the cultures of the organisations UKRI are being built from have been positively opposed to place-based policy. The research councils have focused on “research excellence” as the sole criterion for funding, while the policy of InnovateUK has been to be led by industry. But “place-blind” policies inevitably lead to research concentration, though the well-known Matthew effect. I know that EPSRC at least has been seriously grappling with these issues in the last couple of years, while there is real expertise in Research England on the economic potential of universities in their cities and regions, so there is something to build on.

The early actions of the new organisation are not encouraging. The move back from Swindon to London is a retrograde step, suggesting that UKRI’s first priority is keeping ministers happy and keeping ahead of Whitehall office politics. When the Technology Strategy Board (the predecessor organisation to InnovateUK) was first set up as a free-standing funding agency, it was moved out of London to Swindon to emphasise that it served business, not Whitehall, and it was the better for it.

Moreover, the main board of UKRI is conspicuous for its lack of geographical diversity – out of 16 members, just one – Aberdeen’s Ian Diamond – is from outside London and the southeast. Allowing this situation to arise was a telling and worrying oversight.

One urgent concrete step UKRI should take is to create a high-level advisory board to hold its feet to the fire on a plan to rebalance R&D expenditure across the country. UKRI is to produce a strategy within the next month or two, and it is to be hoped that addressing the regional balance issue forms a central part of this strategy. This board should include senior representatives from the Devolved Administrations, and economic development leads from the metro mayors’ offices and combined authorities in the regions of England. At an operational level, UKRI needs to get its staff out of their London home, perhaps with regional specialists seconded to economic development units in the regions and nations.

The stakes here are high. UKRI has been set up with great expectations – the substantial injection of extra research spending, the 2.4% R&D target are signals that the government expects UKRI to deliver. If it does not produce tangible, positive effects on the wider economy – across the whole of the UK – UKRI will rightfully be judged to have failed – it will have failed the country, and it will have failed UK science. Let’s hope it can rise to the challenge.

Reaching the 2.4% R&D intensity target

I had a rather difficult and snowy journey to London yesterday to give evidence to the House of Commons Business, Energy and Industrial Select Committee (video here, from 11.10). The subject was Industrial Strategy, and I was there as a member of the Industrial Strategy Commission, whose final report was published last November.

One of the questions I was asked was about the government’s new target of achieving an overall R&D intensity of 2.4% of GDP by 2027, as set out in its recent Industrial Strategy White Paper. Given that our starting point is about 1.7%, where it has been stuck for many years, was this target achievable? I replied a little non-committally. I’d reminded the committee about the long term fall in the UK’s R&D intensity since 1980, and the failure of what I’ve called “supply side innovation policy”, as I discussed at length in my paper The UK’s innovation deficit and how to repair it, which also highlights earlier governments’ failure to meet similar targets in the past. But it’s worth looking in more detail at the scale of the ambition here. My plot shows actual R&D spending up to 2015, and then the growth that would be required to achieve a 2.4% target.


R&D expenditure in the UK, adjusted for inflation. Data points show actual expenditure up to 2015 (source: ONS GERD statistics, March 2017 release), the lines are the projections of the growth that would be required to meet a target of 2.4% by 2027. Solid lines assume that GDP grows according to the latest predictions of the Office of Budgetary Responsibility up to 2022, and then at 1.6% pa thereafter. Dotted lines assume no growth in GDP at all.

One obvious point (and drawback) about expressing the target as a percentage of GDP is the worse the economy does, the less demanding the target is. I’ve taken account of this effect by modelling two scenarios. In the first one, I’ve assumed the rates of growth predicted out to 2022 by the Office of Budgetary Responsibility in their latest forecasts. These are not particularly optimistic, predicting annual growth rates in the range 1.3% – 1.8%; after 2022 I’ve assumed a constant growth rate of 1.6%, their final forecast value. In the second, I’ve assumed no growth in GDP at all. One hopes that this is a lower bound. In both cases, I’ve assumed that the overall balance between public and private sector funding for R&D remains the same.

Assuming the modest growth scenario, this means that total R&D spending needs to increase by £22 billion (41%) between 2015 and 2027, from £32 billion to £54 billion . To put this into perspective, between 2004 and 2015 spending increased by £6.6 billion (26%) in the 11 years from 2004 to 2015.

Some of this spending is directly controlled by the government. My plot splits the spending by where the research is carried out – in 2015, research in government and research council laboratories and in the universities amounted to one third of the total – £10.7 billion. This would need to increase by £7.4 billion.

As the plot shows, the government’s part of R&D has been essentially flat since 2004. The government has announced in the Autumn budget R&D increases amounting to £2.3 billion by 2021-2022. This is significant, but not enough – it would need to be more like £3.5 billion to meet the trajectory to the target. There is of course an issue about whether the research capacity of the UK is sufficient to absorb sums of this magnitude, and indeed whether we have the ability to make sensible choices about spending it.

But most of the spending is not in the control of the government – it happens in businesses. This needs to rise by about £14 billion, from £21 billion to £35 billion.

How could that happen? Graham Reid has set this out in an excellent article. There are essentially three options: existing businesses could increase their R&D, entirely new R&D intensive businesses could be created, and overseas companies could be persuaded to locate R&D facilities in the UK.

How can the government influence these decisions? One way is through direct subsidy, and it is perhaps not widely enough appreciated how much the government already does this. The R&D tax credit is essentially an indiscriminate subsidy for private sector R&D, whose value currently amounts to £2.9 billion. Importantly, this does not form part of the science budget. More targeted subsidies for private sector R&D come through collaborative research sponsored through InnovateUK (and, for the moment at least, the EU’s Framework Programme). In addition, private sector R&D can be supported indirectly through the provision of translational R&D centres whose costs are shared between government and industry, like Germany’s Fraunhofer Institutes. The UK’s Catapult Centres are an attempt to fill this gap, though on a scale that is as yet much too small.

Business R&D did slowly increase in real terms between 2004 and 2015. It is important to realise, though, that these gradual shifts in the aggregate figure conceal some quite big swings at a sector level.


R&D expenditure in selected sectors, from the November 2017 ONS BERD release. Figures have been adjusted to 2016 constant £s using GDP deflators.

This is illustrated in my second plot, showing inflation corrected business R&D spend from selected sectors. This shows the dramatic fall in pharmaceutical R&D – more than £1 billion, or 22% – from its 2011 peak, and the even more dramatic increase in automotive R&D – £2.5 billion, or 274%, from its 2006 low point. We need to understand what’s behind these swings in order to design policy to support R&D in each sector.

So, is the 2.4% target achievable? Possibly, and it’s certainly worth trying. But I don’t think we know how to do it now. The challenge to industrial strategy and science and innovation policy is to change that.

Technological innovation in the linear age

We’re living in an age where technology is accelerating exponentially, but people’s habits of thought are stuck in an age where progress was only linear. This is the conventional wisdom of the futurists and the Davos-going classes – but it’s wrong. It may have been useful to say this 30 years ago: then we were just starting on an astonishing quarter century of year-on-year, exponential increases in computing power. In fact, the conventional wisdom is doubly wrong – now that that exponential growth in computing power has come to an end, those people who lived through that atypical period are perhaps the least well equipped to deal with what comes next. The exponential age of computing power that the combination of Moore’s law and Dennard scaling gave us, came to an end in the mid-2000’s, but technological progress will continue. But the character of that progress is different – dare I say it, it’s going to be less exponential, more linear. Now, if you need more computer power, you aren’t going to be able to wait for a year or two for Moore’s law to do its work; you’re much more likely to add another core to your CPU, another server to your datacenter. This transition is going to have big implications for business and our economy, which I don’t see being taken very seriously yet.

Just how much faster have computers got? According to the standard textbook on computer architecture, a high-end microprocessor today has nearly 50,000 times the performance of a 1978 mini-computer, at perhaps 0.25% of the cost. But the rate of increase in computing power hasn’t been uniform. A remarkable plot in this book – Computer Architecture: A Quantitative Approach (6th edn) by John Hennessy & David Patterson – makes this clear.

In the early stages of the microprocessor revolution, between 1978 and 1986, computing power was increasing at a very healthy 25% a year – a doubling time of 3 years. It was around 1986 that the rate of change really took off – between 1986 and 2003 computer power increased at an astonishing 52% a year, a doubling time of just a year and a half.

This pace of advance was checked in 2004. The rapid advance had come about from the combination of two mutually reinforcing factors. The well-known Moore’s law dictated the pace at which the transistors in microprocessors were miniaturised. More transistors per chip gives you more computing power. But there was a less well-known factor reinforcing this – Dennard scaling – which says that smaller transistors allow your computer to run faster. It was this second factor, Dennard scaling, which broke down around 2004, as I discussed in a post last year.

With Moore’s law in operation, but Dennard scaling at an end, between 2003 and 2011, computer power counted to grow, but at the slower rate of 23% – back to a 3 year doubling time. But after 2011, according to Hennessy and Patterson, the growth rate slowed further – down to 3.5% a year since 2015. In principle, this corresponds to a doubling time of 20 years – but, as we’ll see, we’re unlikely to see this happen.

This is a generational change in the environment for technological innovation, and as I discussed in my previous post, I’m surprised that it’s economic implications aren’t being discussed more. There have been signs of this stagnation in everyday life – I think people are much more likely to think twice about replacing their four year old lap-top, say, than they were a decade ago, as the benefits of these upgrades get less obvious. But the stagnation has also been disguised by the growth of cloud computing.

The impressive feats of pattern recognition that allow applications like Alexa and Siri to recognise and respond to voice commands provide a good example of the way personal computing devices give the user the impression of great computer power, when in fact the intensive computation that these applications rely on take place, not in the user’s device, but “in the cloud”. What “in the cloud’ means, of course, is that the computation is carried out by the warehouse scale computers that make up the cloud providers’ server farms.

The end of the era of exponential growth in computing power does not, of course, mean the end of innovation in computing. Rather than relying on single, general purpose CPUs to carry out many different tasks, we’ll see many more integrated circuits built with bespoke architectures optimised for specific purposes. The very powerful graphics processing units that were driven by the need to drive higher quality video displays, but which have proved well-suited to the highly parallel computing needs of machine learning are one example. And without automatic speed gains from progress in hardware, there’ll need to be much more attention given to software optimisation.

What will the economic implications be of moving into this new era? The economics of producing microprocessors will change. The cost of CPUs at the moment is dominated by the amortisation of the huge capital cost of the plant needed to make them. Older plants, whose capital costs are already written off, will find their lives being prolonged, so the cost of CPUs a generation or two behind the leading edge will plummet. This collapse in price of CPUs will be a big driver for the “internet of things”. And it will lead to the final end of Moore’s law, as the cost of new generations becomes prohibitive, squeezed between the collapse in price of less advanced processors and the diminishing returns in performance for new generations.

In considering the applications of computers, habits learnt in earlier times will need to be rethought. In the golden age of technological acceleration, between 1986 and 2003, if one had a business plan that looked plausible in principle but that relied on more computer speed than was currently available, one could argue that another few cycles of Moore’s law would soon sort out that difficulty. At the rates of technological progress in computing prevailing then, you’d only need to wait five years or so for the available computing power to increase by a factor of ten.

That’s not going to be the case now. A technology that is limited by the availability of local computing power – as opposed to computer power in the cloud – will only be able to surmount that hurdle by adding more processors, or by waiting for essentially linear growth in computer power. One example of an emerging technology that might fall into this category would be truly autonomous self-driving vehicles, though I don’t know myself whether this is the case.

The more general macro-economic implications are even less certain. One might be tempted to associate the marked slowing in productivity growth that the developed world saw in the mid-2000’s with the breakdown in Dennard scaling and the end of the fastest period of growth in computer power, but I’m not confident that this stacks up, given the widespread rollout of existing technology, coupled with much greater connectivity through broadband and mobile that was happening at that time. That roll-out, of course, has still got further to go.

This paper – by Neil Thompson – does attempt to quantify the productivity hit to ICT using firms caused by the end of Dennard scaling in 2004, finding a permanent hit to total factor productivity of between 0.5 and 0.7 percentage points for those firms that were unable to adapt their software to the new multicore architectures introduced at the time.

What of the future? It seems inconceivable that the end of the biggest driving force in technological progress over the last forty years would not have some significant macroeconomic impact, but I have seen little or no discussion of this from economists (if any readers know different, I would be very interested to hear about it). This seems to be a significant oversight.

Of course, it is the nature of all periods of exponential growth in particular technologies to come to an end, when they run up against physical or economic limits. What guarantees continued economic growth is the appearance of entirely new technologies. Steam power grew in efficiency exponentially through much of the 19th century, and when that growth levelled out (due to the physical limits of Carnot’s law) new technologies – the internal combustion engine and electric motors – came into play to drive growth further. So what new technologies might take over from silicon CMOS based integrated circuits to drive growth from here?

To restrict the discussion to computing, there are at least two ways of trying to look to the future. We can look at those areas where the laws of physics permit further progress, and the economic demand to drive that progress is present. One obvious deficiency of our current computing technology is its energy efficiency – or lack of it. There is a fundamental physical limit on the energy consumption of computing – the Landauer limit – and we’re currently orders of magnitude away from that. So there’s plenty of room at the bottom here, as it were – and as I discussed in my earlier post, if we are to increase the available computing power of the world simply by building more data centres using today’s technology before long this will be using a significant fraction of the world’s energy needs. So much lower power computing is both physically possible and economically (and environmentally) needed.

We can also look at those technologies that currently exist only in the laboratory, but which look like they have a fighting chance of moving into commercial scales sometime soon. Here the obvious candidate is quantum computing; there really does seem to be a groundswell of informed opinion that quantum computing’s time has come. In physics labs around the world there’s a real wave of excitement at that point where condensed matter physics met nanotechnology, in the superconducting properties of nanowires, for example. Experimentalists are chasing the predicted existence of a whole zoo of quasi-particles (that is quantised collective excitations) with interesting properties, with topics such as topological insulators and Majorana fermion states now enormously fashionable. The fact that companies such as Google and Microsoft have been hoovering up the world’s leading research groups in this area give further cause to suspect that something might be going on.

The consensus about quantum computing among experts that I’ve spoken to is that this isn’t going to lead soon to new platforms for general purpose computing (not least because the leading candidate technologies still need liquid helium temperatures), but that it may give users a competitive edge in specialised uses such as large database searches and cryptography. We shall see (though one might want to hesitate before making big long-term bets which rely on current methods of cryptography remaining unbreakable – some cryptocurrencies, for example).

Finally, one should not forget that information and computing isn’t the only place where innovation takes place – a huge amount of economic growth was driven be technological change before computers were invented, and perhaps new non-information based innovation might drive another future wave of economic growth.

For now, what we can say is that the age of exponential growth of computer power is over. It gave us an extraordinary 40 years, but in our world all exponentials come to an end, and we’re now firmly in the final stage of the s-curve. So, until the next thing comes along, welcome to the linear age of innovation.

An intangible economy in a material world

Thirty years ago, Kodak dominated the business of making photographs. It made cameras, sold film, and employed 140,000 people. Now Instagram handles many more images than Kodak ever did, but when it was sold to Facebook in 2012, it employed 13 people. This striking comparison was made by Jaron Lanier in his book “You are not a gadget”, to stress the transition we have made to world in which value is increasingly created, not from plant and factories and manufacturing equipment, but from software, from brands, from business processes – in short, from intangibles. The rise of the intangible economy is the theme of a new book by Jonathan Haskel and Stian Westlake, “Capitalism without Capital”. This is a marvellously clear exposition of what makes investment in intangibles different from investment in the physical capital of plant and factories.

These differences are summed up in a snappily alliterative four S’s. Intangible assets are scalable: having developed a slick business process for selling over-priced coffee, Starbucks could very rapidly expand all over the world. The costs of developing intangible assets are sunk – having spent a lot of money building a brand, if the business doesn’t work out it’s much more difficult to recover much of those costs than it would be to sell a fleet of vans. And intangibles have spillovers – despite best efforts to protect intellectual property and keep the results secret, the new knowledge developed in a company’s research programme inevitably leaks out, benefitting other companies and society at large in ways that the originating firm can’t benefit from. And intangibles demonstrate synergies – the value of many ideas together is usually greater – often very much greater – than the sum of the parts.

These characteristics are a challenge to our conventional way of thinking about how economies work. Haskel and Westlake convincingly argue that these new characteristics could help explain some puzzling and unsatisfactory characteristics of our economy now – the stagnation we’re seeing in productivity growth, and the growth of inequality.

But how has this situation arisen? To what extent is the growth of the intangible economy inevitable, and how much arises from political and economic choices our society has made?

Let’s return to the comparison between Kodak and Instagram that Jaron Lanier makes – a comparison which I think is fundamentally flawed. The impact of mass digitisation of images is obvious to everyone who has a smartphone. But just because the images are digital, doesn’t mean they don’t need physical substrates, to capture the images, store and display them. Instagram may be a company based entirely on intangible assets, but it couldn’t exist without a massive material base. The smartphones themselves are physical artefacts of enormous sophistication, the product of supply chains of great complexity, with materials and components being made in many factories, that themselves use much expensive, sophisticated and very physical plant. Any while we might think of the “cloud” as some disembodied place where the photographs live, the cloud is, as someone said, just someone else’s computer – or more accurately, someone else’s giant, energy-hogging, server farm.

Much of the intangible economy only has value inasmuch as it is embodied in physical products. This, of course, has always been true. The price of an expensive clock made by an 18th century craftsman embodied the skill and knowledge of the craftsmen who made it, itself built up through their investments in learning the trade, the networks of expertise in which so much tacit knowledge was embedded, the value of the brand that the maker had built up. So what’s changed? We still live in a material world, and these intangible investments, important as they are, are still largely realised in physical objects.

It seems to me that the key difference isn’t so much that an intangible economy has grown in place of a material economy, it’s that we’ve moved to a situation in which the relative contributions of the material and the intangible have become much more separable. Airbnb isn’t an entirely ethereal operation; you might book your night away though a slick app, but it’s still bricks and mortar that you stay in. The difference between Airbnb and a hotel chain lies in the way ownership and management of the accommodation is separated from the booking and rating systems. How much this unbundling is inevitable, and how much is the result of political choices? This is the crucial question we need to answer if we are to design policies that will allow our economies and societies to flourish in this new environment.

These questions are dealt with early on in Haskel and Westlake’s book, but I think they deserve more analysis. One factor that Haskel and Westlake correctly point to is simply the continuing decrease in the cost of material stuff as a result of material innovation. This inevitably increases the relative value of services – delivered by humans – relative to material goods, a trend known as Baumol’s cost disease (a very unfortunate and misleading name, as I’ve discussed elsewhere). I think this has to be right, and it surely is an irreversible continuing trend.

But two other factors seem important too – both discussed by Haskel and Westlake, but without drawing out their full implications. One is the way the ICT industry has evolved, in a way that emphasises commodification of components and open standards. This has almost certainly been beneficial, and without it the platform companies that have depended on this huge material base would not have been able to arise and thrive in the same way. Was it inevitable that things turned out this way? I’m not sure, and it’s not obvious to me that if or when a new wave of ICT innovation arises (Majorana fermion based quantum computing, maybe?), to restart the now stuttering growth of computing power, this would unfold in the same way.

The other is the post-1980s business trend to “unbundling the corporation”. We’ve seen a systematic process by which the large, vertically integrated, corporations of the post-war period have outsourced and contracted out many of their functions. This process has been important in making intangible investments visible – in the days of the corporation, many activities (organisational development, staff training, brand building, R&D) were carried out within the firm, essentially outside the market economy – their contributions to the balance sheet being recognised only in that giant accounting fudge factor/balancing item, “goodwill”. As these functions become outsourced, they produce new, highly visible enterprises that specialise entirely in these intangible investments – management consultants, design houses, brand consultants and the like.

This process became supercharged as a result of the wave of globalisation we have just been through. The idea that one could unbundle the intangible and the material has developed in a context where manufacturing, also, could be outsourced to low-cost countries – particularly China. Companies now can do the market research and design to make a new product, outsource its manufacture, and then market it back in the UK. In this way the parts of the value of the product ascribed to the design and marketing can be separated from the value added by manufacturing. I’d argue that this has been a powerful driver of the intangible economy, as we’ve seen it in the developed world. But it may well be a transient.

On the one hand, the advantages of low-cost labour that drove the wave of manufacturing outsourcing will be eroded, both by a tightening labour market in far Eastern economies as they become more prosperous, and by a relative decline in the importance in the contribution of labour to the cost of manufacturing as automation proceeds. On the other hand, the natural tendency of those doing the manufacturing is to attempt to move to capture more of the value by doing their own design and marketing. In smartphones, for example, this road has already been travelled by Korean manufacturer Samsung, and we see Chinese companies like Xiami rapidly moving in the same direction, potentially eroding the margins of that champion of the intangible economy, Apple.

One key driver that might reverse the separation of the material from the intangible is the realisation that this unbundling comes with a cost. The importance of transaction costs in Coase’s theory of the firm is highlighted in Haskel and Westlake’s book, in a very interesting chapter which considers the best form of organisation for a firm operating in the intangible economy. Some argue that a lowering of transaction costs through the application of IT renders the firm more or less redundant, and we should, and will, move to a world where everyone is an independent entrepreneur, contracting out their skills to the highest bidder. As Haskel and Westlake point out, this hasn’t happened; organisations are still important, even in the intangible economy, and organisations need management, though the types of organisation and styles of managements that work best may have evolved. And, power matters, and big organisations can exert power and influence political systems in ways that little ones can not.

One type of friction that I think is particularly important relates to knowledge. The turn to market liberalism has been accompanied by a reification of intellectual property which I think is problematic. This is because the drive to consider chunks of protectable IP – patents – as tradable assets with an easily discoverable market value doesn’t really account for the synergies that Haskel and Westlake correctly identify as central to intangible assets. A single patent rarely has much value on its own – it gets its value as part of a bigger system of knowledge, some of it in the form of other patents, but much more of it as tacit knowledge held in individuals and networks.

The business of manufacturing itself is often the anchor for those knowledge networks. For an example of this, I’ve written elsewhere about the way in which the UK’s early academic lead in organic electronics didn’t translate into a business at scale, despite a strong IP position. The synergies with the many other aspects of the display industry, with its manufacturers and material suppliers already firmly located in the far east, were too powerful.

The unbundling strategy has its limits, and so too, perhaps, does the process of separating the intangible from the material. What is clear is that the way our economy currently deals with intangibles has led to wider problems, as Haskel and Westlake’s book makes clear. Intangible investments, for example into the R&D that underlies the new technologies that drive economic growth, do have special characteristics – spillovers and synergies – which lead our economies to underinvest in them, and that underinvestment must surely be a big driver of our current economic and political woes.

“Capitalism without Capital” really is as good as everyone is saying – it’s clear in its analysis, enormously helpful in clarifying assumptions and definitions that are often left unstated, and full of fascinating insights. It’s also rather a radical book, in an understated way. It’s difficult to read it without concluding that our current variety of capitalism isn’t working for us in the conditions we now find ourselves in, with growing inequality, stuttering innovation and stagnating economies. The remedies for this situation that the book proposes are difficult to disagree with; what I’m not sure about is whether they are far-reaching enough to make much difference.

Industrial strategy roundup

Last week saw the launch of the final report of the Industrial Strategy Commission, of which I’m a member. The full report (running to more than 100 pages) can be found here: Industrial Strategy Commission: Final report and executive summary. For a briefer, personal perspective, I wrote a piece for the Guardian website, concentrating on the aspects relating to science and innovation: The UK has the most regionally unbalanced economy in Europe. Time for change.

Our aim in doing this piece of work was to influence government policy, and that’s influenced the pace and timing of our work. The UK’s productivity problems have been in the news, following the Office of Budgetary Responsibility’s recognition that a return to pre-crisis levels of productivity growth is not happening any time soon. Both major political parties are now committed to the principle of industrial strategy; the current government will publish firm proposals in a White Paper, expected within the next few weeks. Naturally, we hope to influence those proposals, and to that end we’ve engaged over the summer with officials in BEIS and the Treasury.

Our formal launch event took place last week, hosted by the Resolution Foundation. The Business Secretary, Greg Clark, spoke at the event, an encouraging sign that our attempts to influence the policy process might have had some success. Even more encouragingly, the Minister said that he’d read the whole report.


The launch of the final report of the Industrial Strategy Commission, at the Resolution Foundation, London. From L to R, Lord David Willetts (Former Science Minister and chair of the Resolution Foundation), Diane Coyle (Member of the Industrial Strategy Commission), Dame Kate Barker (Chair of the Industrial Strategy Commission), Torsten Bell (Director of the Resolution Foundation), Greg Clark (Secretary of State for Business, Energy and Industrial Strategy), Richard Jones (Member of the Industrial Strategy Commission). Photo: Ruth Arnold.

Our aim was to help build a consensus across the political divide about industrial strategy – one strong conclusion we reached is that strategy will only be effective if it is applied consistently over the long term, beyond the normal political cycle. So it was good to see generally positive coverage in the press, from different political perspectives.

The Guardian focused on our recommendations about infrastructure: Tackle UK’s north-south divide with pledge on infrastructure, say experts. The Daily Telegraph, meanwhile, focused on productivity: Short-termism risks paralysing the UK’s industrial strategy, report warns: “Productivity was a major concern of the report, particularly the disparity between London and the rest of the UK…. Targeted investment to support high-value and technologically led industries was the best way to boost regional productivity, by generating clusters of research and development organisations outside of the London and the South-East, the report suggested.”

The Independent headlined its report with our infrastructure recommendation: UK citizens should be entitled to ‘universal basic infrastructure’, says independent commission. It also highlighted some innovation recommendations: “The state should use its purchasing power to create new markets and drive innovation in healthcare and technology to tackle climate change, the commission said”

Even the far-left paper the Morning Star was approving, though they wrongly reported that our commission had been set up by government (in fact, we are entirely independent, supported only by the Universities of Sheffield and Manchester). Naturally, they focused on our diagnoses of the current weaknesses of the UK economy, quoting comments on our work from Greg Clark’s Labour Party shadow, Rebecca Long Bailey: Use Autumn Statement to address long-term weaknesses in our economy, says Rebecca Long Bailey.

In the more specialist press, Research Fortnight concentrated on our recommendations for government structures, particularly the role of UKRI, the new umbrella organisation for research councils and funding agencies: Treasury should own industrial strategy, academics say.

There are a couple of other personal perspectives on the report from members of the commission. My Sheffield colleague Craig Berry focuses on the need for institutional reform in his blogpost Industrial strategy: here come the British, while Manchester’s Andy Westwood focuses on the regional dimensions of education policy (or lack of them, at present) in the Times Higher: Industrial Strategy Commission: it is time to address UK’s major regional inequalities.

Finally, Andy Westwood wrote a telling piece on the process itself, which resonated very strongly with all the Commission members: Why we wonk – a case study.

Should economists have seen the productivity crisis coming?

The UK’s post-financial crisis stagnation in productivity finally hit the headlines this month. Before the financial crisis, productivity grew at a steady 2.2% a year, but since 2009 growth has averaged only 0.3%. The Office of Budgetary Responsibility, in common with other economic forecasters, have confidently predicted the return of 2.2% growth every year since 2010, and every year they have been disappointed. This year, the OBR has finally faced up to reality – in its 2017 Forecast Evaluation Report, it highlights the failure of productivity growth to recover. The political consequences are severe – lower forecast growth means that there is less scope to relax austerity in public spending, and there is little hope that the current unprecedented stagnation in wage growth will recover.

Are the economists to blame for not seeing this coming? Aditya Chakrabortty thinks so, writing in a recent Guardian article: “A few days ago, the officials paid by the British public to make sure the chancellor’s maths add up admitted they had got their sums badly wrong…. The OBR assumed that post-crash Britain would return to normal and that normal meant Britain’s bubble economy in the mid-2000s. This belief has been rife across our economic establishment.”

The Oxford economist Simon Wren-Lewis has come to the defense of his profession. Explaining the OBR’s position, he writes “Until the GFC, macro forecasters in the UK had not had to think about technical progress and how it became embodied in improvements in labour productivity, because the trend seemed remarkably stable. So when UK productivity growth appeared to come to a halt after the GFC, forecasters were largely in the dark.”

I think this is enormously unconvincing. Economists are unanimous about the importance of productivity growth as the key driver of the economy, and agree that technological progress (sufficiently widely defined) is the key source of that productivity growth. Why, then, should macro forecasters not feel the need to think about technical progress? As a general point, I think that (many) economists should pay much more attention both to the institutions in which innovation takes place (for example, see my critique of Robert Gordon’s book) and to the particular features of the defining technologies of the moment (for example, the post-2004 slowdown in the rate of growth of computer power).

The specific argument here is that the steadiness of the productivity growth trend before the crisis justified the assumption that this trend would be resumed. But this assumption only holds if there was no reason to think anything fundamental in the economy had changed. It should have been clear, though, that the UK economy had indeed changed in the years running up to 2007, and that these changes were in a direction that should have at least raised questions about the sustainability of the pre-crisis productivity trend.

These changes in the economy – summed up as a move to greater financialisation – were what caused the crisis in the first place. But, together with broader ideological shifts connected with the turn to market liberalism, they also undermined the capacity of the economy to innovate.

Our current productivity stagnation undoubtedly has more than one cause. Simon Wren-Lewis, in his discussion of the problem, has focused on the effect of bad macroeconomic policy. It seems entirely plausible that bad policy has made the short-term hit to growth worse than it needed to be. But a decade on from the crisis, we’re not looking at a short-term hit anymore – stagnation is the new normal. My 2016 paper “Innovation, research and the UK’s productivity crisis” discusses in detail the deeper causes of the problem.

One important aspect is the declining research and development intensity of the UK economy. The R&D intensity of the UK economy fell from more than 2% in the early 80’s to a low point of 1.55% in 2004. This was at a time when other countries – particularly the fast-developing countries of the far-east – were significantly increasing their R&D intensities. The decline was particularly striking in business R&D and the applied research carried out in government laboratories; for details of the decline see my own 2013 paper “The UK’s innovation deficit and how to repair it”.

What should have made this change particularly obvious is that it was, at least in part, the result of conscious policy. The historian of science Jon Agar wrote about Margaret Thatcher’s science policy in a recent article
“The curious history of curiosity driven research”. Thatcher and her advisors believed that the government should not be in the business of funding near-market research, and that if the state stepped back from these activities, private industry would step up and fill the gap: “The critical point was that Guise [Thatcher’s science policy advisor] and Thatcher regarded state intervention as deeply undesirable, and this included public funding for near-market research. The ideological desire to remove the state’s role from funding much applied research was the obverse of the new enthusiasm for ‘curiosity-driven research’.”

But stepping back from applied research by the state coincided with a new emphasis on “shareholder value” in public companies, which led industry to cut back on long-term investments with uncertain returns, such as R&D.

Much of this outcome was predictable in economic theory, which predicts that private sector actors will underinvest in R&D due to their inability to capture all of its benefits. Economists’ understanding of innovation and technological change is not yet good enough to quantify the effects of these developments. But, given that, as a result of policy changes, the UK had dismantled a good part of its infrastructure for innovation, a permanent decrease in its potential for productivity growth should not have been entirely unexpected.

The Office of Budgetary Responsibility’s Chart of Despond. From the press conference slides for the October 2017 Forecast Evaluation Report.

The second coming of industrial strategy

A month or so ago I was asked to do the after-dinner speech at the annual plenary meeting of the advisory bodies for the EPSRC (the UK’s government funding body for engineering and the physical sciences). My brief was to discuss what opportunities and pitfalls there might be for the UK Engineering and Physical Sciences community from the new prominence of industrial strategy in UK political discourse, and especially the regional economic growth agenda. Following some requests, here’s the text of my speech.

Thanks for asking me to talk a little bit about industrial strategy and the role of Universities in driving regional economic growth.

Let me start by talking about industrial strategy. This is an important part of the wider political landscape we’re dealing with at the moment, so it is worth giving it some thought.

If there’s a single signal of why it matters to us now, it’s the Industrial Strategy Challenge Fund – in last years Autumn Statement – a very welcome and quite substantial increase in the science budget – but tied in a very explicit way to industrial strategy.

What is that industrial strategy to which it is tied? We don’t know yet. We had a Green Paper in February – (a “very green” green paper, it was described as, which is civil service speak for being a bit half-baked). And we’re expecting a White Paper in “autumn” this year. i.e. before Christmas. I’ll come back to what I think it should be in a moment, but first… Continue reading “The second coming of industrial strategy”

The Life Sciences should not have an Industrial Strategy

The UK government has published the first outcome of the Industrial Strategy “sector deals” announced in the spring’s Industrial Strategy Green Paper. The Life Sciences Industrial Strategy was headed by Sir John Bell; the area is of undoubted importance for the UK, and the document has some very sensible recommendations. But there’s a bigger problem here – the life sciences aren’t an industry, they’re a science area. You wouldn’t describe your policies for the aerospace industry as a Materials Science Industrial Strategy or a Fluid Dynamics Industrial Strategy – industry policy should be driven by and framed in terms of the demand for innovation, not by the science areas which contribute to it.

In its detailed policies, there is much to agree with in the Life Sciences Industrial Strategy. There’s no question that the UK has a strong base in the life sciences, that this is a source of comparative advantage, and that this capacity should be preserved and strengthened. New industrial clusters in medical technology should be developed (especially outside the existing concentration of biomedical life sciences between London, Oxford and Cambridge), and the data the health system generates is an enormously powerful resource that should be exploited more (but with great care and sensitivity). And who could disagree with the proposition that the Home Office should be suppressed (they’re too diplomatic to put it quite like that, of course). There are some less good ideas too, with demands for more distorting tax breaks. The proposal to widen the scope of the “patent box” to include other types of intellectual property is a particularly bad idea, which would take what’s already a very poor piece of public policy and make it worse.

The headline recommendation is politically opportunistic, potentially positive, but not completely thought through in its current form. This is for a “Health Advanced Research Program”, in analogy to the US defense research agency DARPA. It’s politically astute in that it appeals to the current bout of DARPA envy amongst British policy makers (and it’s got a good acronym). As I’ve discussed before, I’m not convinced that this enthusiasm is underpinned by enough understanding of the way DARPA actually operates and the way it sits as one relatively small part in the wider USA innovation system.

One key issue is the question of how to define the problems, and being clear about who owns those problems. Part of DARPA’s success comes from the close connection to the people who own the problems the agency is trying to solve, who in DARPA’s case, are in the USA’s military. This clarity is not yet present in the “HARP” proposal. For healthcare, the key owners of the problems are the NHS, and the local authorities responsible for social care. Industry is important, both as potential providers of solutions, and as beneficiaries of the new business opportunities that the innovations should give rise to, but they don’t own the problems.

The strategy does indeed suggest that the key USP of HARP should be the involvement of the NHS, who, it is envisaged, will provide patient data and opportunities for piloting the resulting technology. The difficulty this leaves unsolved is one that the strategy itself correctly identifies – “Evidence demonstrates that access to and diffusion of products in the NHS is often slower than in some comparable countries. This environment risks creating a negative impression in boardrooms around the world with trials being diverted to geographies deemed more likely to use products. Partnership with industry through this strategy and a subsequent sector deal will be challenging unless there are clear signals that innovation will be encouraged and rewarded, and the challenge of adoption of new innovation at pace and scale is resolved.” The NHS is, as currently configured, structurally inimical to innovation.

How could you frame an industrial strategy in this general area? You could define it in terms of conventional industry sectors. For healthcare, this would include those sectors which develop and supply products – including pharmaceuticals and biotechnology, and the broader area of medical technology, including tools and devices, diagnostics and digital healthcare. Equally, it should include those sectors that actually deliver health and social care, which after all form a large part of the economy, albeit one that remains in large part outside the market. These include social care – a very large sector, which has low productivity and is problematic in some other ways, as well as hospitals and primary care. The interests of these sectors don’t always point in the same direction, as one can see from the constant tussles between NICE and the NHS and pharmaceuticals companies about drug pricing and availability.

Although in reality the Life Sciences strategy does largely read as a sector strategy for the pharmaceuticals and biotechnology sector, calling it a Life Sciences strategy does frame it in terms of the underpinning science. And in this sense Life Sciences is not a great term, being at once too inclusive and not inclusive enough.

What the strategy means by “Life Sciences” is essentially the high status science of biomedical research. But life sciences – biology – doesn’t just include those bits of biology that are relevant to human disease. That would cover the cell biology and physiology of the human organism itself, together with the biology of those organisms that are studied as more experimentally tractable models for humans – whether that’s mice or zebra-fish. And it includes the biology of human parasites and pathogens. What is left out in this narrow definition of “Life Sciences” are those aspects of biology that have other applications – in agriculture, for plant science and animal health, in industrial biotechnology, in environmental science and ecology. And of course we should not be afraid to stress that we should study biology because it is fascinating in its own right and yields insights into some of the biggest outstanding scientific issues that there are – how life started, whether other types of life are possible.

But the focus in “Life Sciences” on high status biomedical research is also too exclusive. Other areas of science and technology are important for healthcare, and are underemphasised in academia. These include engineering and nano-science, data science and IT, and, perhaps above all, the social science of public health and health economics.

The issue, then, is that by calling itself a “Life Sciences” strategy, it gives primacy neither to the relevant industry sectors, nor to the fundamental problem of caring for sick people. I think the ultimate goal here is the big problem of providing affordable health and social care with dignity for the whole UK population, in the context of the changing age profile of the country. The key organisations here are the NHS and the deliverers of social care, and the priority needs to be on enabling those organisations to become more innovative. This will certainly generate opportunities for key industrial sectors like pharmaceuticals and medical technology; improving the connections between the research base, industry, and the clinic remains just as important. But framing the problem right will change some of our priorities.

Climbing stories, climbing fictions

I call myself a rock climber, and sometimes I manage to do some climbing too. This summer I’ve been out a few times with a new climbing partner, Mike. Mike’s a writer – M. John Harrison – whose most famous work is the science fiction trilogy Light, Nova Swing and Empty Space. I’ve written about these brilliant books before. But it’s another novel of his that these climbing trips have brought to mind – his 1989 novel “Climbers”.

“Climbers” is a beautifully written book, formally clever and an utterly perfect evocation of a certain time and place, a certain milieu – the Peak District climbing scene in the late 70’s and early 80’s. This I know, because I was there – at least, as a youth learning to climb myself, I was on the fringes of this scene.

This is how it happened. 1979 was the year I left school. That summer, my friend and climbing companion, Mark, having been expelled from school (the reasons for which are another story), had moved to the Peak District. His parents had divorced, and he went with his mother, first to a mobile home outside Chesterfield, then to the village of Tideswell. I visited him there, staying in his mother’s tiny cottage and hitching to the crags, Mark in a greatcoat, with their Jack Russell sticking its head out of his rucksack, an ancient Karrimor Pinnacle that he’d stolen from school. Continue reading “Climbing stories, climbing fictions”