The age of innovation: Has the time come for the paradigm shift in innovation policy?

By Ema Talam

The United Kingdom is classified as Innovation Leader in the latest European Innovation Scoreboard. Although it excels in performance compared to the European Union average in 2017 on various indicators used (e.g. International scientific co-publications, Innovative SMEs collaborating with others, Foreign doctorate students, etc.), it stands out that the United Kingdom performs very poorly compared to the EU average  on the following indicators: R&D expenditure in the public sector and R&D expenditure in the business sector (the percentages for the UK are 67.0% and 85.1% of the EU average in 2017, respectively) (European Commission, 2018).

Businesses in the UK are the main contributors to the total R&D expenditure and this contribution has increased from 2005 on wards. Hodges (2018) points out: “Focusing on civil (non-defence related) R&D, in 2016 53% of all R&D performed in the UK was funded by businesses, 8% by higher education institutions or funding councils, and 17% by government, including the research councils”.

Increasingly, the majority of funding for R&D performed by businesses comes from businesses themselves—the share was 63.0% in 2010 and was 10 percentage point higher in 2016. The government funding for R&D performed by businesses decreased by 2.1 percentage point from 2013 until 2016 (from 9.9% to 7.8%) (Hogdes, 2018).  Research and development also becomes important in the context of Brexit. Dhingra et al. (2017) recognise lower research and development as one the factors that can lead to productivity and welfare losses in the event of Brexit.

The importance of innovation for growth is often emphasised (Van Reenen, 2011). Furthermore, my previous blogs 1, 2, 3 gave detailed accounts on the links between innovation, productivity and exporting. Although not the sole determinant of innovation, the role of research and development (R&D) can be significant in the process of innovation of a firm (OECD/Eurostat, 2005; What Works Centre for Local Economic Growth, 2015a; What Works Centre for Local Economic Growth, 2015b).

Due to the presence of market failures, governments use different instruments to increase private R&D spending by firms and commonly used ones are R&D tax credits and R&D subsidies. When it comes to R&D tax credits, firms make their own innovation choices, while in the case of R&D subsidies, policymakers are the ones who choose to whom the subsidy will be granted (What Works Centre for Local Economic Growth, 2015a; Dechezlepretre et al., 2016). Numerous studies have dealt with the issue of effectiveness of R&D tax credits and R&D subsidies on increasing R&D investment, innovation or economic performance of a firm.

Some empirical evidences suggest that R&D tax credits have been effective in increasing R&D investment, innovation and improving economic outcomes of a firm (Czarnitzki et al., 2011; What Works Centre for Local Economic Growth, 2015a; Dechezlepretre et al., 2016). For example, Dechezlepretre et al. (2016), using UK data, show that R&D tax credits had positive impact on innovation (i.e. patents), productivity, sales and employment. The effectiveness of R&D tax credits is shown to be different in different industries and sectors the firms are operating in (i.e. differences in the effectiveness are found between high- and low-tech industries), the size of firms (i.e. predominantly, the effect is larger for SMEs) and the age of a firm (i.e. R&D tax credits are more effective for young compared to older firms) (Castellacci and Lie, 2015; What Works Centre for Local Economic Growth, 2015a; Dechezlepretre et al., 2016). Evidence also shows that the impact of R&D tax credits is larger in the long-run (Bloom et al., 2002).

The impact of R&D grants, loans and subsidies on R&D expenditure, innovation and economic outcomes is inconclusive (What Works Centre for Local Economic Growth, 2015b). However, the study by Benavente et al. (2007) on Chile, found the positive impact of R&D subsidies on: process innovation, employment, sales and exports. Furthermore, the analysis by Dimos and Pugh (2016) shows that R&D subsidies have a positive, but small effect on private R&D. In particular, they state that: “findings reject crowding out of private investment by public subsidy but reveal no evidence of substantial additionality” (Dimos and Pugh, 2016, p. 811).

Latest thinking on innovation policy suggests that, in order to achieve smart, inclusive and sustainable economic growth, the focus of government intervention should not be on fixing market failures. Instead, Kattel and Mazzucato (2018) point out to the importance of mission-oriented policies and state: “The role of the public sector here is not just about de-risking, and levelling the playing field, but tilting the playing field in the direction of the desired goals—creating and shaping markets which increase the expectations of business around future growth opportunities, thus driving private investment.” (p. 2). In this case, quantity or rate of innovation are believed to be the second-order issues, while quality and direction of innovations emerge as the top priorities. According to the authors, putting missions at the heart of innovation policy can be used to address numerous challenges and problems that today’s societies are facing. Public investments centred around particular mission can create new markets and shape the existing ones. Mission-oriented policies, according to the authors, are gaining on popularity again.

Innovation matters. Due to its economy-wide impact, governments use different measures to support innovation. Approaches aimed at fixing market failures, such as R&D tax credits and R&D subsidies, generally showed to be effective, although sometimes having only small effects. However, throughout the history, there were also evidences of successful mission-oriented policies that re-shaped the whole societies. Given the stated, the real question is: Has the time come for the paradigm shift in innovation policy?

References – Innovation policy blog – v249 are here