INVESTING IN INDUSTRIAL INNOVATION Delivering scale, focus and certainty in government support for Innovation

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EXECUTIVE SUMMARY Invest in Industrial Innovation Even small amounts of public funding can stimulate significant private investment.

1. Double funding for industrial innovation by 2020 Boosting funding (including for InnovateUK and R&D tax credits) would enhance the UK’s ability to design, develop and commercialise industrial innovation in the UK

2. Prioritise and focus to give scarce resource greater impact Rather than spread funding too thinly, invest in critical mass to strengthen research excellence, and to develop and commercialise complex industrial innovation

3. Deliver long-term certainty to attract long-term investment Providing longer-term certainty on innovation funding streams would strengthen our global reputation and encourage longer-term investment in innovation in the UK

THE UK’S INNOVATION GAP

£7.3 bn Additional UK government funding for R&D in 2015 in order to match the average level of R&D support (as a % of GDP) in the US, Germany, Finland, France, Korea, Sweden and Switzerland

“The UK’s overall innovation performance is worryingly mediocre. Some of this can be attributed to the private sector. However the public sector has a critical role in enabling, encouraging and actively leading innovation. The UK government could do a lot better in this respect by being bolder, more coherent, more strategic and more dynamic…. To genuinely improve economic prospects, a fundamental shift in governments’ approach to innovation is required.” Tera Allas Former Director General, Strategic Advice, Science & Innovation, BIS

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01 UNDERINVESTING IN INNOVATION AND GROWTH Investment in science and innovation are critical to economic growth and the long term development of our economy. The UK’s growth depends on its ability to innovate: Investment in innovation strengthens our global competitiveness, generates well-paid jobs and helps develop high-tech exports. Yet despite pockets of global excellence, the UK is worryingly mediocre at innovation. It’s not a neutral playing field. Other nations back their nation’s innovation with the scale, focus and certainty in public sector support necessary to stimulate long-term private sector investment. Industrial Strategies in the UK have shown the UK can attract global investment. We need to build o this progress, not rest on our laurels. The UK needs a fundamental shift in our approach to increasing investment in innovation, and therefore in our long-term competitiveness and growth. Research conducted by BIS’ former chief economist Tera Allas 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). It also found the 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. Box 1 Key stats on the UK’s attractiveness for investment in manufacturing innovation Overall underinvestment: th  UK 24 in OECD for Government outlays on R&D, as % of GDP. 

th

UK 24 in OECD for SME investment in R&D, as % of business investment in R&D

Uncompetitive tax support: th  14 in the OECD and G20 for tax support for R&D, 

28 for tax support for innovative machinery



41 for support for new manufacturing facilities,

th

st

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Critical shortage of Engineers:  UK needs over 80,000 graduate engineers each year, but producing only 22,000. 

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th

UK ranks 24 in the OECD for engineers as a percentage of all graduates.

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UNDERINVETING IN INNOVATION AND GROWTH

The UK’s current strength in the high-end manufacturing sectors ADS represents is built upon historic investment in innovation. More recently, the UK has lost its competitive advantage in innovation, reducing the UK’s global attractiveness to investors. In particular, as targeted investment by other nations’ governments through effective industrial strategies, coupled with a limited response by successive UK governments. It’s not a level playing field. Other nations back their industries towards technology demonstrators. Large companies are multinational and will follow the support. ATI funding has shown that the UK can attract multinationals to invest here. We need to keep the momentum, not rest on our laurels. Industrial Strategy has helped to better join up the supply chain, from widget supplier through to market. Innovation Strategy need to do the same for the innovation value chain. What the UK needs now is an Innovation Strategy matched by an Innovation Strategy.

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02 INVEST IN SCALE The UK is truly world-class in many aspects of our innovative capability, and we have many of the right support mechanisms in place to encourage and attract business investment in innovation in the UK. Indeed, the current government, building on work from the last government, has made significant progress in improving the attractiveness of the UK to mobile R&D investment (Table 1 list some of these schemes). Recent improvements include establishing the Catapults, introducing the above-theline R&D tax credit and setting up the Aerospace Technology Institute through the Aerospace Growth Partnership. Each of these initiatives have, as set out below, changed global perceptions of the UK as a place to invest. Table 1. Innovation funding in the UK Department

Innovation Support 

R&D Tax Credits (Large and Small Company Schemes);



Patent Box



InnovateUK: Catapult Centre, Catalyst, Innovation Voucher, KTNs, KTPs, SBRI



Industrial Strategies: Aerospace Technology Institute; National Aerospace Technology Exploitation Programme; Defence Solutions Centre



Eight Great Technologies



Low Carbon Innovation



Office for Low Emission Vehicles

MoD



Centre for Defence Enterprise; Defence Science & Technology Laboratory

Research Councils



Rainbow Seed Fund



Follow-On Fund



Collaborative R&D



HEIF, RGF, AMSCI

HM Treasury

BIS

DECC

Other

Collaborative

R&D,

Demonstrator,

Source: Allas (2014)

Yet in aggregate, these schemes do not provide enough scale, focus or certainty to sustains our technological advantages.

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2.1

DELIVER SCALE, FOCUS AND CERTAINTY

A little goes a long way

Although the balance of support between basic and applied research in any country will depend on its particular mix of policies, the UK typically spends significantly more on supporting basic research than applied research. Chart 1. UK government’s balance of funding heavily weighted to basic research

Source: EEF, HM Treasury, research-in-germany.de, research.fi

UK innovation policy under successive Governments has not fully recognised the different R&D models under which the UK’s high tech industries operate. This has led to funding streams generally favouring an R&D model tilted towards basic research over the model required by the engineering industries – with a proportionally large investment in development. Chart 2. UK government’s balance of funding heavily weighted to basic research

Source: EEF, Office of Budget Responsibility

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DELIVER SCALE, FOCUS AND CERTAINTY

The imbalance of annual funding between Research Councils – c.£3bn – and InnovateUK – approximately £600m – demonstrates this. Currently, the UK spends 3x – 4x more on Research Councils relative to InnovateUK. This means that the UK government limited R&D grants and funding are far more likely to support research-intensive innovation and provide insufficient support to industries with development-intensive innovation models. Chart 2 shows this imbalance in more detail within the UK. The Science budget is currently about £5.7bn per year, while spending on industrial innovation is just under £2bn (as the Patent Box will soon be scrapped). But it is not about Science versus Technology funding To make best use of our fantastic science base, more needs to be invested into the technology base to pull science through (i.e. InnovateUK, Catapults, ATI, etc). It’s about balance, and not a zero sum game. R&D support needs to join up at every stage, from basic research through to commercialisation, enabling companies to bring more products and services to market. Table 2. UK spends less on Industrial Innovation Country

Innovation Body

UK

Budget (£mn)

% of GDP

InnovateUK

440

0.03

Germany

Fraunhofer Institutes

1600

0.07

Finland

TEKES

490

0.29

Source: BIS, Eurostat, funding bodies’ websites

As Table 2 shows, however, what the UK does spend on the applied research, development and demonstrator elements of industrial innovation through InnovateUK is both absolutely and relatively smaller than similar competitor countries. Filling the innovation gap The OECD data in Chart 2 shows that higher government funding for R&D is positively associated with higher private investment in R&D. Yet, the UK significantly underinvests relative to our closest competitors. In 2013, the UK government financing of R&D was just 0.4% of GDP. In contrast, governments in our main competitors in the US (0.9%), Germany (0.8%), France (0.8%), Finland (0.9%) and South Korea (1.0%), each funded significantly more innovation than the UK. Even the Eurozone managed to fund more R&D (0.7% of GDP) than the UK. If the UK matched the average levels of our competitors, in terms of R&D financed by government as a % of GDP, the UK would have to spend an additional £7.3 bn in funding innovation in 2015. Given the state of the public finances, finding this level of additional of additional spending in the 2015/16 fiscal year would prove difficult.

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02

DELIVER SCALE, FOCUS AND CERTAINTY

However, by 2020, the government’s ambition should be to double the support for industrial innovation, in particular by doubling the budget for InnovateUK and the R&D tax credits. Chart 3. Additional Government funding for innovation linked with higher private R&D investment Private & 3rd sector financed R&D, as % of GDP

4.0 Japan 3.5 South Korea 3.0 2.5 Germany

2.0

US

Austria

1.5 UK 1.0 0.5 0.0 0.0

0.2

0.4

0.6

0.8

1.0

1.2

Gov't financed R&D, as % of GDP Source: OECD and ADS

Raise R&D tax credits to EU maximum Previously the EU maximum for R&D tax credits had been 35% relief for SMEs (including Midcaps) and 25% for large companies. While the UK’s SME scheme had approached the levels of that cap, the large companies credit did not reach the maximum. In May 2014, the European Commission amended the State Aid rules for supporting R&D and innovation to allow up to 70% of the eligible costs for SMEs and Midcaps and up to 60% of eligible costs for larger companies. Table 3. UK spends less on Industrial Innovation EU maximum Country relief SME SME (loss making)

Large companies (Above the line

70% (up from 35%)

60% (up from 25%)

UK R&D tax relief Official rate as a % of eligible costs 225% (super deduction)

25%

14.5% (cash credit of super deduction)

32.6%

11% (gross)

8.8% (net)

Source: HMRC, PWC and European Commission , Eurostat, funding bodies’ websites

The UK could double the value of the SME R&D tax relief – at a cost of £600mn per year – and still not breach EU State Aid rules. A doubling of the large companies above the line relief would cost the

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DELIVER SCALE, FOCUS AND CERTAINTY

Exchequer an additional £1.5bn per year and still leave significant scope to raise the credit within the allowable state aid limits.

2.2

Prioritise & focus to deliver bigger impact

Not only does the UK provide lower levels of government support for innovation than our key competitors, the funding the UK does provide is spread across seven different departments, bodies 2 and agencies via 30 major initiatives. Recent analysis has therefore shown that specific initiatives do not provide sufficient scale or critical mass, meaning the full benefits are not exploited. Funding is spread to thinly to attract critical mass Despite the advantages afforded to UK manufacturing in the past through the competitive research system under the Haldane Principle, the fragmented funding streams through which universities apply do not provide sufficient critical mass and are unaligned to the UK’s new Growth Partnerships. Due to such localised decision making, research is taking place at a sub-critical level across many universities, with many institutions’ research priorities overlapping. Individual, localised research proposals from UK universities are often effective at attaining EU funding; however, further external investment into stovepiped research programmes reinforces the UK’s fragmented research capability. A failure to act with one voice through central research hubs leaves the UK unable to leverage and spend EU funding as effectively as is possible. As funding is spread too thinly, the UK risks duplicating funding on research and weakening research outcomes that could have been considerably strengthened through aggregated funding, from a large number of low-funded programmes to a select, well-funded development-focussed few. Duplicated research further serves to hamper exploitation and will miss opportunities to attract global investment. Hermann Hauser’s original rationale for the Catupult Centres was to address the UK’s traditional 3 weakness of spreading funding too thinly across the UK. Target Green R&D supported, not Green taxes raised Currently the Government judges its environmental credentials by measuring and increasing the % of revenues raised from environmental taxes (as defined by HM Treasury). However this metric of environmental progress simply encourages Government to add further costs to UK businesses. The Government should instead target green R&D supported as a percentage of GDP. This would have the benefit of stimulating innovation and environmental technologies in the UK, while minimising the desire to further raise environmental taxes.

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Deliver long-term certainty to attract long-term investment

The introduction of 11 sectoral Industrial Strategies has helped how multinational companies and other countries view the UK as a location for long-term investment. The strategies have been 2 3

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Allas (2014). Hauser (2014).

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DELIVER SCALE, FOCUS AND CERTAINTY

developed in partnership with industry, setting out long-term innovation, skills and supply chain priorities and funding to ensure the UK is able to build up on its current global strengths. For the civil aerospace sector, the Aerospace Growth Partnership (AGP) has set up the Aerospace Technology Institute (ATI), a joint Industry-Government seven-year, £2bn commitment to fund collaborative R&D projects; the National Aerospace Technology Exploitation Programme (NATEP), funded via the Advanced Manufacturing Supply Chain Initiative mentioned above, to help SMEs commercialised technologies; and will fun 500 MSc bursaries. Commenting on the AGP while opening a new R&D facility in Filton, the CEO of Airbus, Fabrice Bregier, noted, “What I have seen with the AGP & ATI has truly drawn the eyes of Airbus” The pace with which the UK has been able to put in place long-term funding commitment has fundamentally changed global perceptions of the UK’s competitiveness. Increasing and focusing the support for industrial innovation must therefore by matched by long-term certainty. This would give businesses the confidence to invest in innovation in the UK.

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