Levelling up and R&D – the case for innovation deals

The UK has a profound problem of regional disparities in productivity performance, with second tier cities that underperform compared to expectations based on their size, and deindustrialised towns and urban areas that have failed to find productive new economic roles. Productivity growth arises from innovation, taking that term in its widest sense, and formal research and development (R&D) is one underpinning of innovation, so it’s worth asking whether there is a link between geographical disparities in R&D intensity and regional economic underperformance.

The distribution of research and development investment in the UK – especially in the public sector – is currently highly skewed to the prosperous Greater South-East. London, together with the two subregions containing Oxford and Cambridge, account for 46% of all public and charitable spending on R&D, with 21% of the UK’s population. We know that there are substantial spillovers from public and private R&D; econometric estimates suggests that a 10% rise in public R&D would raise private total factor productivity growth by 0.03 percentage points per annum, with an estimated return on public R&D of 20% per annum, so a correlation between regional R&D intensity and productivity might be expected. But does it matter where the R&D is done?

R&D matters not just for the knowledge it generates and the inventions it produces, but in the capacity of firms to absorb new technology. It’s certainly possible to innovate without formal R&D – through the development of new business models, or through the acquisition of new equipment. But in the UK R&D still takes the largest share of firms’ innovation expenditure.

One key justification for public support of R&D is that firms are unable to capture the whole benefit of the research they undertake – there are “spillover” benefits to other firms that are able to copy the innovations of the leaders. The geographical aspect of these spillovers is captured in the importance of clusters, recognised in economic writing since the time of Alfred Marshall. A successful regional cluster draws on a set of collective resources and knowledge, much of it tacit, that drives innovations in both products and processes.

This set of collective resources has been called by US researchers Pisano & Shih the “industrial commons”. A successful industrial commons is rooted in large anchor companies & institutions, together with networks of supplying companies; it is characterized by both informal knowledge networks and formal institutions for R&D, training and skills. International examples include advanced manufacturing in Lombardy, Italy, ICT hardware in Hsinchu, Taiwan, and in the UK, biotechnology in Cambridge. A goal of regional economic policy should be to consciously attempt to rebuild the industrial commons in places where de-industrialisation has caused them to wither.

Public R&D in the UK is carried out in universities, and increasingly, in specialist research institutes such as the Crick Institute in London. In comparison to other developed nations, one type of institution that is relatively lacking in the UK are translational and applied research institutes such as the Fraunhofer Institutes in Germany, IMEC in Belgium and the Industrial Technology Research Institute in Taiwan. Such institutes may focus more on industry engagement, process innovation, the wider diffusion of existing innovations, and in skills development than is possible in institutions more focused on basic research, and they can play an important role in nucleating and developing an innovation ecosystem of the kind that can anchor an industrial commons.

Recent policy developments in the UK do give encouraging signs that some of these issues are being recognised. The UK’s Innovation Strategy, published in July 2021, stated that “we need to ensure more places in the UK host world-leading and globally connected innovation clusters, creating more jobs, growth and productivity in those areas”, while the October 2021 Comprehensive Spending Review announced a £5.2 billion increase in government R&D spending from FY 20/21 to 24/25, and made the important commitment that “the government will ensure that an increased share of the record increase in government spending on R&D over the SR21 period is invested outside the Greater South East”.

Further details for how this increase will be delivered are expected in the imminent “Levelling Up” White Paper. One possibility, signalled in the Budget, is that the Catapult Network might play an important role. These centres represent a recent UK initiative to create the kind of translational and applied research institutes discussed above; it would be valuable to develop these further in a way which more explicitly recognizes their potential for regional development.

The White Paper is being driven by the newly renamed Department of Levelling Up, Housing and Communities, but it will need support across the whole government, including not just the Department of Business, Energy and Industrial Strategy, but in other departments that have received substantial increases in their R&D budgets, especially Defence and Health and Social Care.

For increased R&D spending to have a material effect on the UK’s regional productivity imbalances, it will be important to avoid two pitfalls. The first is to recognise the importance of scale. Too often previous attempts to boost innovation in the regions – for example, by the English Regional Development Agencies in the 2000’s – have been worthwhile in themselves, but implemented at a scale too small to make a material difference to regional economies.

For example, the three Northern RDAs spent £157m on innovation in the three years of the 2004 spending review period – while government and HE R&D spending over the same period was £20.3 billion in total, of which £4 billion was in the North.

To make a material impact on regional inequality of R&D spending, the resources deployed need to be at least an order of magnitude bigger; a crude calculation shows that to level up per capita public spending on R&D across the UK to the levels currently achieved in the Greater Southeast, additional annual spending of more than £4 billion would be needed. If the government is serious about devoting a significant share of the £5.2 billion R&D uplift to “levelling up”, the possibility now exists to make a real change, without jeopardising the existing excellence of R&D clusters in the Greater SE.

The second is to ensure that spending priorities aren’t defined entirely “top-down”, from Whitehall or Swindon. To be effective in driving productivity growth, government spending on R&D must be deployed in a way that maximises its effect to “crowd in” private sector investment. This needs to be done in a way that works with the grain of local economies, building on the existing business base and complementing their existing assets and endowments. This will need local knowledge that it is unreasonable to expect national agencies to possess.

The current geographical imbalances in R&D spending across the UK are of long-standing, and they won’t change without a significant change in the way funding is allocated. One way of doing this would be simply to devolve government R&D funding to cities, regions and nations to make their own decisions in the light of their knowledge of local economies.

There are potential objections to this approach. Given the very patchy nature of devolution across the UK – and especially in England – places may lack institutions with the analytical capacity and the legitimacy to set priorities and make good funding decisions. There’s a further risk that a lack of coordination, between different regions and cities, and between cities and central government agencies, leads to duplication, unhelpful competition and lack of coherence with national policy and priorities.

The idea of an “innovation deal” provides a way forward that answers these potential objections. In an innovation deal, cities and regions would develop a strong institution to implement an evidence-based local innovation strategy. Such an agency should be based on a coalition of private sector actors, local government (e.g. Mayoral Combined Authorities) and regional R&D assets, and would give central government and its agencies confidence that there was a trusted local partner that would take responsibility for implementing an innovation strategy and developing the region’s innovation ecosystem.

These agencies would give a robust mechanism whereby central government and cities and regions could work together to co-create a set of priorities for those new investments, many of which would be focused on translational research and skills development, that would both be most effective for improving regional productivity, while at the same time supporting national innovation priorities, such as the 2050 Net Zero target and a drive to reduce inequalities in health outcomes across the nation.

In Greater Manchester, a private sector led partnership of business, the Mayoral Combined Authority, and universities has come together to create “Innovation GM”, with an invitation to central government to work with them to make R&D led levelling-up of regional productivity a reality. Other cities and regions are engaged in similar initiatives, so there is now a chance to inject a new, place-led, dimension into innovation policy.

The substantial uplift in R&D funding announced in the October 2021 budget, together with the commitment to spend more of this uplift outside the Greater Southeast, offers a once-in-a-generation chance to make a material difference to the UK’s persistent imbalances in R&D spending. Innovation deals with cities and regions offer mechanisms for maximising the impact of this spending uplift on regional productivity.

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