Killing innovation

Everyone seems to want to “rebalance” the British economy. The word was used 12 times in the last budget and is cited by politicians across the spectrum. But what does it really mean? And is such a thing even possible given the looming spending cuts?

Speaking just after the Conservative party conference last October, George Osborne gave “rebalancing” an ambitious definition: “We have to rebalance this economy to make it less wholly dependent on the success of financial services,” he said. “We need active government support for manufacturing, low carbon energy, pharmaceuticals, aerospace, the creative industries and the other sectors Britain should be excelling in. We need a financial system that enables more long-term investment in productive assets and infrastructure.”

The business secretary Vince Cable, leading Labour figures and several business leaders have said similar things. Yet what do they envisage, in practice? In April’s Prospect, Will Hutton tried to be a bit more specific. Britain must wean itself off its addiction to borrowing on property, reconfigure its industrial and business structure, promote innovation to support its knowledge economy, overhaul its competition and skills institutions, build new markets and create a tax system to reward entrepreneurship.

One place that has already done this successfully is Finland. When the Soviet Union broke up, Finland lost its biggest trading partner. It turned west, joined the EU and, in the face of a recession, started to spend more on research and innovation. Out of that came a new Nokia and a clutch of other world-beating firms. Today it has one of the most successful and hi-tech economies in the world. But when Esko Aho, the prime minister who presided over Finland’s turnaround, was asked to advise the EU on how to replicate his success, the measures he proposed proved too rich for member states and the report was buried. Even our interventionist cousins on the continent could not stomach them.

To get an idea of the scale of change needed, look at innovation in Britain. Arguably, it has been in decline for decades. This is certainly true of investment by companies in R&D; the hard, high-tech stuff critical to success in four of the sectors cited by Osborne—manufacturing, low carbon energy, pharmaceuticals and aerospace. Between 1991 and 2008, high-tech investment by companies declined from 1.0 per cent of GDP to 0.8 per cent. That slippage of 0.2 per cent represents some £2bn a year. Britain, in other words, is becoming a lower-tech country. The 1,000 job cuts recently announced by BAE Systems should make us worry further. By contrast, over those same 18 years, R&D as a percentage of GDP rose in the US, Germany and France. Finland’s spending rose from 1.1 to 2.6 per cent.

This has happened in spite of heavy spending by Labour aimed at stimulating R&D. The research councils that fund university work saw big increases in their budgets, and substantial funds flowed into more market-oriented research (see Jean Seaton, “An academic question” ). There were tax breaks for companies spending on R&D; a Technology Strategy Board (TSB) was created along with the National Endowment for Science Technology and the Arts (Nesta); and the regional development agencies (RDAs) spent substantial sums in this area. Altogether, this spending still adds up to £1-1.5bn a year. Yet so far, despite all the pump-priming, there is no sign of increased spending on R&D by companies. This may not prove that the Brown approach has failed; what it demonstrates is that cultivating a high-tech economy is a long, hard and expensive game for the state to play. And to succeed with ambitious rebalancing, Britain will have to win not only this game, but many others.

But instead of boosting the market-friendly apparatus assembled by Labour in order to support the high-tech sectors, the new government is now dismantling it. Research councils face cuts of up to 20 per cent; the RDAs have been abolished and spending on their functions cut back heavily. The tax breaks for R&D are under review, with free market thinkers at Policy Exchange arguing for huge cutbacks.

Policy development, meanwhile, is focusing on just one item on the Hutton list: a new wave of technology centres modelled on Germany’s Fraunhofer institutes. This initiative has two outstanding backers in the men behind two of Britain’s authentic hi-tech successes: Hermann Hauser, the charismatic Cambridge investor behind ARM, which designs most of the world’s computer chips, and James Dyson, of vacuum cleaner fame. But I have my doubts.

In Germany, the Fraunhofers help bridge the gap between companies and academia, especially in engineering. They attract bright scholars, have expensive kit no one firm would want to buy, and focus on research likely to underpin big new technologies. But outside engineering, what role would these centres play in Britain? Why would the life sciences want them, for example? Even within engineering, Britain lacks Germany’s thick industrial fabric. Our great expertise is in our world-class university departments. Rather than starting something new, wouldn’t it be better to build on them? If we want to make Cambridge a silicon hub, for example, why not invest in facilities to strengthen links between academia and industry? Recruitment would be a lot easier because of the university’s excellent reputation.

In a speech in early September, Vince Cable set out in clear terms the global policy consensus: that it is right to invest in research and innovation, even when cutting government spending overall. The OECD emphasises this is essential for future economic growth, and it is a policy followed by the US, Germany and France. The coalition has not articulated an alternative, and indeed Cable appears to accept the OECD consensus. What seems to have slipped between the cracks, though, is the political will to implement it.

Cuts of 20 per cent in the research councils and TSB will no doubt trigger the abandonment of some sub-disciplines and, without the irrigation of active research, expertise in many fields will rapidly wither. This is certainly not what they did in Finland when their finances were squeezed. It’s not what you do if you want to support high-tech companies in advanced manufacturing. And it’s not what you do if you want to rebalance Britain’s economy.