1. 1 Economics and Business Exchange Supported by Deloitte.

2. 2 Incentivising innovation ippr economics and business exchange 13 November 2005 Chiara Criscuolo Centre for Economic Performance, LSE

3. 3 Why are we interested in innovation? Technological knowledge is a driver of productivity Not the only one driver: –Organisational knowledge –Skills –Physical Capital, ICT “Productivity isn’t everything, but in the long run it is almost everything” (Paul Krugman) Productivity growth drives growth of real wages Productivity growth can be used to finance government expenditure

4. 4 A simplified scheme Knowledge R&D Modified Figure 1 Griliches and Pakes NBER WP561 1980 Productivity

5. 5 A simplified scheme Knowledge R&D Non-R&D Expenditure In knowledge Self- reported Innovation Patents Productivity Knowledge Flows competition costs Skills Basic ScienceKnowledge base

6. 6 How does the UK measure up? UK Productivity Gap, 1990-2001, Market Sector (UK=100) Source: O’Mahony (2004)

7. 7 UK Productivity Gap, 1999 (UK=100) Source: O’Mahony and de Boer (2002)

8. 8 INNOVATION OUTPUT: Patents Share of countries in “triadic” patent families Source: OECD

9. 9 Other innovation measures Alternative innovation measures. Source: Community Innovation Survey, based on Oslo manual Only comparable information for some EU countries Source: IFS

10. 10 UK R&D stagnant over medium run R&D to GDP 1991-2003,G7 Source: SET, 2005; http://www.ost.gov.uk/setstats/7.htm R&D intensity has stagnated since 1991 and fallen behind other countries Not just de-industrialization: within sector

11. 11 Broader measures of investment in knowledge (as % of GDP 2002)

12. 12 A simplified scheme Knowledge R&D Non-R&D Expenditure In knowledge Self- reported Innovation Patents Productivity Knowledge Flows competition costs Skills Basic Science Knowledge base

13. 13 Other innovation inputs: Knowledge Spillovers Hard to find cross-country evidence on knowledge spillovers Possible proxies: –FDI/Presence of foreign affiliates –Trade openness of the country –Patent citations –Mobility of workers –Cooperation Between Businesses Between Businesses and the science base UK seems to do quite well on all of these proxies

14. 14 Innovation Policies Correct for market failures (e.g. in financing R&D) –R&D Tax credit system –Loan guarantees –Banking system/venture capital (?) Correct for externalities –Knowledge Spillovers Role of foreign presence (embeddedness) Role of foreign sourcing (intra and extra firm) Absorptive capacity Make the country more conducive to innovation: –Supporting basic scientific research –commercialisation of inventions –University-business links (Lambert) –Increasing supply of skills –Entry of new firm and growth of better firms –Competition

15. 15 R&D tax credits Many other countries with R&D tax credits…actually UK system quite generous UK adopted in 2000, first for SMEs now for all firms Current cost about £430m p.a. Good econometric evidence that R&D does react to changes in its tax-price (Hall and Van Reenen, 2000) But why no pick-up (even a fall in 2004)? –Slow response; takes about 10 years for most of effect to be felt –… still need to evaluate and do a proper cost benefit all R&D subsidies increases wages of (high income) R&D workers (Goolsbee, 1999) the UK R&D intensity gap: smaller proportion of firms doing R&D at all (firms that do are as R&D intensive as firms abroad)

16. 16 Innovation support programs Overcome credit constraint and high uncertainty (especially for SMEs) Loan guarantee SMART SPUR Increase knowledge flows and collaboration LINK and Collaborative R&D (between businesses and between businesses and research institutions) Knowledge Transfer Partnerships Faraday Partnerships and Knowledge Transfer networks MANY others: business link webpage : 2667 listings in the support directory for starting up and developing a business

17. 17 Issues with Innovation Support schemes Policy evaluation widespread in education or labour market programs Existing evaluations of DTI schemes that support innovation is very scarce and is lumped together with other schemes (e.g. Regional Selective Assistance) Econometric Methodology and data linking allow evaluation of innovation support programs

18. 18 Role of foreign presence/sourcing and global engagement Evidence that Multinationals and globally engaged firms are more innovative –Both because they invest more in R&D –They learn from their headquarters/other firms in the group (Criscuolo et al., 2005 and Brastetter, 2004) Role of International trade for learning –Learning by importing (evidence MacGarvie, 2004) –Learning by exporting (mixed evidence) Role of foreign affiliates as a source of knowledge spillovers –Evidence shows that knowledge spillovers are along the value chain (vertical) Role of domestic multinational as a source of knowledge spillovers –Reverse technology transfer/Technological sourcing (Griffith, Harrison, Van Reenen, 2004)

19. 19 Role of foreign affiliates Knowledge spillovers Increase competition Issues: –They come but they need to stay: reasons for location Lower costs Acces to skilled labour/science base Proximity to market –How much knowledge spillovers do UK firms get from foreign affiliates (FA)? evidence that FA source more knowledge from abroad but not more likely to transfer technology to the local economy as compared to local firms (Cassiman and Veugelers, 2004). –How to increase “Embeddedness”? –What is the role of UK multinationals? They are likely to be more embedded…(interesting issue for research)

20. 20 Role of foreign sourcing One important type of International technology transfer is “technology sourcing” hypothesis firms obtain international R&D spillovers by locating their inventors/R&D labs close to leading edge research Question: Do UK firms with stronger inventor presence in the US benefit disproportionately from US R&D efforts? UK behind the US (frontier) but a lot of historical linkages Answer: Griffith, Harrison and Van Reenen find that UK firms benefit more from US R&D spillovers if they have strong US inventor presence Policy relevance: –EU policy makers attempted to “repatriate” R&D labs away from US (Lisbon Agenda) –More generally: is it nationality or location of R&D that matter? Is there a trade-off between the two?

21. 21 Other issues: Role of basic science UK does well in elite science **More papers per head and citations per head than main competitors Papers and citations per head (UK=100), average over 1998-2003 Source: Evidence Ltd. Thomson ISI (2004)

22. 22 Why doesn’t this translate in innovation? Do universities have the right incentives? –E.g. evaluation and funding based on RAE performance –Incentivising commercialisation of inventions by universities (Higher education innovation fund) : trade-off: knowledge is a public good… –Collaboration with businesses

23. 23 Other issues: Role of competition, regulation and firm turnover Competition Important driver of innovation and productivity (e.g. Blundell, Griffith, Van Reneen, 1999, Bloom et al., 2004) UK position seems strong on OECD Indicators Schumpeterian theory of creative destruction stresses the positive role of firms’ turnover and in particular of firm entry Cross-country evidence shows that UK has quite high turnover but that the rate of growth of high productivity firms is low…

24. 24 Policies to Raise Innovation and Productivity Innovation inputs (e.g. R&D) Cooperation Human capital –“policy complementarity”: effect on productivity and inequality –technical Skills/Managerial skills Global engagement: trade/inward FDI/outward sourcing Competition/Regulation Much of policy framework in UK is “right” from economic perspective: emphasis on skills, tough competition, openness to trade and FDI, support for R&D Delivery. Need for rigorous evaluation (e.g. education reforms, R&D policy)

25. 25 What NOT to do Large state-directed “grand projet” Aggressive attempts to “repatriate” R&D from US (Griffith, Harrision, Van Reenen, 2004) Create greater uncertainty through tinkering with small tax schemes. Evidence that investment responses retarded by micro-uncertainty (on the increase in US and UK as macro-uncertainty has declined). Slows down reallocation which drives aggregate productivity Use R&D policy as a way of creating equality between regions of the country: need to concentrate resources where they can be best used (“pick winners”)

26. 26 Conclusions UK continues to have a longstanding productivity gap with US (and France/Germany) Some improvement in recent years at closing the gap with EU – and has kept up with US even in the “miracle” period post 1995 Policies to address the gap: –We concentrates on R&D/innovation –Skills –Managerial practices –Competition –Infrastructure Need for evaluation …..although long-term nature of evaluation must be recognised Not a single answer

27. 27 Thank you For references and further reading Contact: c.criscuolo@lse.ac.uk

28. 28 Economics and Business Exchange Supported by Deloitte.