Business R&D is the weak link in the UK’s innovation system

What’s wrong with the UK’s innovation system is not that we don’t have a strong science base, or even that there isn’t the will to connect the science base to the companies and entrepreneurs who might want to use its outputs. The problem is that our economy isn’t assigning enough resource to pulling through the fruits of the science base into technological innovations, the innovation that will create new products and services, bring economic growth, and help solve some of the biggest social problems we face. The primary symptom of the problem is the UK’s very poor performance at business funded research and development R&D. This is the weak link in the UK’s national innovation system, and it is part of a bigger picture of short-termism and under-investment which underlie the UK economy’s serious long-term problems.

For context, it’s worth highlighting two particular features of the UK economy. The first is its very poor productivity growth: currently on one measure (annualised 6 year growth in productivity) we’re seeing the worst peace-time performance for the last 150 years. Without productivity growth, there will be no growth in average living standards, and that’s going to lead to an increasingly sour political scene.

The second is the huge current account deficit, which at 5.4% of GDP is worse than in the crisis years of the mid-1970s. Now, as then, the UK is unable to pay its way in the world. Unlike the 1970’s, though, there’s no immediate political crisis, no humiliating appeals to the IMF for a bail-out. This time round, overseas investors are happy to finance this deficit by buying UK assets. But this isn’t cost-free. An influx of overseas capital is what is currently driving a price bubble for domestic and commercial property in London, severely unbalancing the economy and leading to a growing gulf between the capital and the regions. The assets being bought include the nation’s key infrastructure in energy and transport; there will be an inevitable loss of control and sovereignty as more of this infrastructure falls into overseas ownership. Chinese money will be paying for any new generation of nuclear power stations that will be built; that will give the UK very little leverage in insisting that some of that investment is spent to create jobs in the UK, and it will be paid for by what will effectively be a tax on everyone’s electricity bills, guaranteed for 35 years.

These are long-term problems, and so is the decline in business R&D intensity. The last thirty years has seen this drop from 1.48% in 1981, to 1.09% now (measured as a percentage of GDP), as I discussed at length in my paper “The UK’s innovation deficit and how to repair it”. This compares poorly to developed competitors like Germany, where business R&D accounts for 1.94% of GDP, and it’s dwarfed by the investment of more recently industrialised countries, like Korea, at 3.09% of GDP. We hear a lot about the “global race” and the need to compete with rapidly growing countries such as China in high value added, technologically innovative products. We can judge how well this is going by noting that our business R&D intensity was overtaken by China in 2009. China’s 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. Can you innovate without R&D? Of course you can – social innovations can be hugely valuable, and in the digital sector there are very low barriers to entry. A couple of people can create a new app, digital service or e-commerce application, at relatively low cost. But, as I’ve discussed before, this isn’t true in the material and biological realms. If you want to develop new drugs, or develop new energy sources, you need the sustained capital intensive, long-term, and frankly expensive effort that R&D entails.

The old world of R&D was dominated by big companies – the likes of GEC and ICI. Neither company was without its faults, but their loss a decade ago took out big chunks of our innovative capacity. They died as a result of an emphasis on doing deals rather than building businesses, in pursuit of short-term returns for shareholders. Now there are just 2 UK companies in the top 100 world companies for R&D, GSK and AstraZeneca. AstraZeneca remains independent, for the moment, following the recent abortive takeover bid from the US company Pfizer. One good thing that came from that episode is that the issue of R&D capacity as a national asset got some political prominence. I don’t think, though, that enough people recognised the larger context here of the long-term decline of business R&D in the UK.

If the old world of corporate R&D is dying, the new world has yet to be born. In one popular vision of that new world, R&D is carried out not by monolithic corporations but by nimble spin-outs supported by venture capital. There’ve been some important companies that have come out of this route. The problem, though is one of scale . The model isn’t working at anything like the level that would make a difference to the national economy. In 2012, the total funds from Venture Capital going into pharma and biotech were just £46 million. Compare this to the £727 million by which total pharma industrial R&D fell in that year. Why are the amounts going in so small? Is this a failure of our capital markets? The answer is simpler than that – the financial rewards from VC investment in new technology are too small to justify the risk. In the UK, technology focused venture capital is overshadowed by a much larger, and more lucrative, private equity sector focused largely on less technology-intensive sectors such as retail.

Our model of capitalism – highly financialised and driven by maximising short-term shareholder value – doesn’t seem to be able to support R&D. And yet we need R&D to mobilise resources to solve big problems. This can’t be done by academia, because they aren’t close enough to markets and they aren’t focused enough on meeting the needs of those markets. But it can’t be done by the small start-ups that can write a new app or e-commerce application either, as they can’t mobilise the resources needed on long enough timescales. Of course, business R&D isn’t the only thing that matters in driving the technological innovation that leads to economic growth; skilled people and demanding customers can be major drivers for companies to adopt and adapt new technologies and methods that originate elsewhere, if the necessary investment for that can be found. But R&D is necessarily long-term, so it’s the first victim of the short-termism that blights our economy.

The problem is clear – but what should we do about it? My next post will have some suggestions.