The importance of innovation
Productivity doesn’t get talked about much by politicians at the best of times, and certainly not these days. It sounds dry and technical, and far removed from emotive issues like Brexit and the crisis of capitalism. But productivity and populism are more closely linked than meets the eye, and policymakers worried about political turmoil should think more about the economic conditions that contribute to that turmoil.
Productivity in the economy is, ultimately, the main driver of long-run income growth per capita.[1] If voters are unhappy at the real value of their wages or the length of their working week, productivity is at the root of their worries. And productivity is strongly correlated with innovation. One estimate of the contribution of innovation to productivity growth suggested that: ‘…between 2000 and 2008, innovation accounted for 51 per cent of labour productivity growth…’ in the UK.[2]
Not only does higher labour productivity mean higher incomes, but it also enables many people to work fewer hours while maintaining living standards. However, as Chart One shows, comparative levels of labour productivity in the UK are lower than in many other industrialised economies, such as Germany and South Korea. Moving to the four-day week that Labour’s John McDonnell has promised for all workers would mean a significant drop in UK economic output unless it was accompanied by a significant increase in labour productivity.
Chart one: GDP-per-hour worked, 2000 – 2017[3]
Source: OECD
Innovation is, to a-significant degree, driven by research and development (R&D) activity. R&D generates considerable private and social benefits. With the public returns up to three times greater than the private gains that accrue as a result of undertaking R&D.[4] The private gains however are considerable and are strongly associated with higher firm-level productivity:
‘…Firms that persistently invest in R&D have higher productivity (13 per cent higher than those with no R&D spending and 9 per cent more than firms who occasionally invest in R&D)…’.[5]
However, at present, the UK lags behind other industrialised countries in relative R&D expenditure levels and on metrics of innovation such as (Resident) Patent grants.[6] [7] Unpacking why this is the case is a complex activity. However, two factors stand-out as likely causes: relatively low levels of investment and inefficiency in R&D activity in the UK.
Quantity of Patents granted: South Korea and Germany out in front
Chart Two below illustrates the quantity of (Resident) Patents granted annually in Germany, the Netherlands, South Korea, Switzerland and the UK. The dominance of South Korea in particular, is very evident in the international data. South Korea consistently grants the most Patents out of the sample economies.
Chart two: Annual number of (Resident) Patents granted between 2008 – 2017
Source: WIPO
Germany grants the second greatest number each year, as illustrated in Chart two. The UK grants marginally more patents (from among its population) than the Netherlands and Switzerland.
It is to be expected that the larger economies in the sample spend more in absolute terms on patents and have more individuals working in R&D than smaller economies and therefore, overall, produce more Patents. Yet the UK still underperforms on innovation compared to the smaller countries in the sample too, when adjusting for the size of other economies and populations:
- With a population 14.5 million lower and a GDP in 2017 $775 billion smaller than the UK, South Korea saw the granting of around fourteen times more (Resident) Patents than the UK.
- Despite a population nearly four times larger than the Netherlands, the UK only granted 1.2 times more (Resident) Patents than the Dutch in 2017.
Two central reasons for this relative under-performance are explored in more detail below.
Spending on R&D: Korea leads, Germany follows…
When it comes to relative R&D spending, the UK is comfortably and consistently out-spent – as a proportion of GDP – by South Korea and Germany and marginally out-spent by the Netherlands and Switzerland. Chart Three below shows the relative R&D expenditure position of Germany, the Netherlands, South Korea, Switzerland and the UK each year between 2008 and 2017.
Chart three: annual total (public and private) R&D expenditure between 2008 – 2017[8]
Source: OECD and WIPO
Innovation in the UK economy and in turn its productivity, has been held back by this relative under-investment in R&D. The UK’s poor investment is in-part a result of the decline in public spending on R&D over the period 2010 to 2017. As a percentage of GDP, public spending fell from 0.52 per cent of GDP to 0.44 per cent of GDP over that time.[9] While private investment has, broadly, balanced out the fall in public sector investment, it has meant that private money has only maintained overall expenditure rather than helped increase it.
Is the UK bad at translating R&D into economic success?
However, an element of the R&D landscape that is less often touched upon, yet, which is likely to have an important bearing on the quality and effectiveness of R&D and thus the level and quality of innovation in the UK – is the efficiency of R&D expenditure and of those working in R&D in the UK.
International comparative data suggests (see Table One) that UK R&D efforts are relatively inefficient compared to those of the Germany, the Netherlands, South Korea and Switzerland. Therefore, a more efficient ‘system of innovation’ could boost innovation levels in the UK and in-turn the productivity of the UK economy and ultimately improve the standard of living of its citizens.
Table one: efficiency in successful domestic Patent generation
Source: OECD, WIPO and SMF calculations
For each 0.1 per cent of GDP invested in R&D by either the public or private sectors in the UK, South Korea and Germany are-able-to generate significantly more granted (Resident) Patents. This suggests that in South Korea and Germany money invested in R&D delivers greater value i.e. relatively more innovation per unit invested, compared to that spent in the UK.
Every 10,000 people employed in R&D activities in Germany, the Netherlands, South Korea and Switzerland, typically produces more successful Patents than the equivalent 10,000 R&D workers in the UK. Notably, for every 10,000 people working in R&D in South Korea, they are producing nearly 2,000 Patents, significantly out-pacing the second-placed county in the sample by around four to one.
What next for government?
Fixing the ongoing under-investment in and inefficiency of R&D in the UK, and thus the relatively low innovation levels in the UK, requires Government action on multiple fronts:
- The most immediate policy change required is that the Government increases significantly the level of public investment in R&D.
- Improvements in the Intellectual Property Rights (IPRs) regime also need to be made e.g. to make it simpler, cheaper and swifter to get patents submitted and granted.
- The ‘tail’ of firms in the UK not operating at the ‘technological frontier’ need to be brought closer to it. This requires greater leadership and management capacity at the firm-level, a lower cost of capital for businesses to encourage investment in the development and adoption of better processes and new technologies, a review of the effectiveness of the R&D Tax Credit and lower barriers to entry for start-ups to help intensify competition in markets and increase their dynamism.
- In addition to increasing the amounts of basic research being undertaken, the channels for transforming it (whether public or private) into viable commercial propositions need to be strengthened. This means helping the knowledge spread across and between the public and private sectors more easily, encouraging spin-outs from research institutions and larger firms, facilitating clustering and other activities which generate positive spill-overs and the reduction of barriers to research collaboration between firms.
- A robust competition regime which guards against the abuse of IPRs by firms, who use them to ‘push-out’ competitors and hinder the processes of technology transfer and ‘creative destruction’.
- A better designed regulatory environment that encourages innovation by providing firms with the scope to experiment with new ideas, processes and products.
[1] Burda, M. (2018). ‘Aggregate Labor Productivity’, pg 2.
[2] NESTA (2012) cited in BIS. (2014). ‘Innovation, Research and Growth’, pg 25.
[3] GDP per hour worked measures how efficiently labour input is combined with other factors of production and used in the production process. The chart is in constant US$ 2010 prices i.e. 2010 = 100.
[4] Lööf et al (2012) cited in BIS. (2014). ‘Innovation, Research and Growth’, pg 7.
[5] Hall, B. et al (2009); Cefis, E., Ciccarelli, M. (2005); Cefis, E., Orsenigo, L. (2001) and Lööf et al (2012) cited in BIS. (2014). ‘Innovation, Research and Growth’, pgs 6 – 7.
[6] ‘Resident Patents’ are those generated domestically within an economy and applied for and granted domestically by the relevant Patent authorities.
[7] Patents are far from a perfect proxy for innovation, as they are only one type of IPR, among a number. Further, international comparisons are difficult because of varying patenting processes in different countries and thus the time it takes between application and the granting of a patent. In addition, there are indications that patents (a tool to incentivise innovation by granting a monopoly over an invention or process) are now becoming mechanisms for raising barriers to competition, further complicating the usefulness of patents as a proxy measure for innovation. Nevertheless, given the relative paucity of accurate measures of innovation across an economy or in an industry it does remain a useful approximate indicator of the levels and quality of innovative activity.
[8] Due to limitation in the OECD data, R&D expenditure as a percentage of GDP is only available for four years in the time-period illustrated in the Chart. As a result, the time-series data for Switzerland is therefore not as fully comparable as the data for the other countries in the sample.
[9] ONS (2019) cited in Royal Society et al (2019). ‘Investing in UK R&D’, pg 4.
[10] As a result of limitations in the OECD data, the Swiss figures are calculated on-the-basis of four years of data. Those years are: 2008, 2012, 2015 and 2017.
