Innovation investment: the age of cash and concrete?
UK business investment in innovation looks to have fallen sharply since the 2008 financial crisis. More intriguingly, there are signs of a longer-standing investment problem that started long before 2008.
This week Nesta published research on UK businesses' investment on innovation. The main element of this research is the latest version of Nesta's Innovation Index, which reports innovation investment up to 2009 and its effect on economic growth. Also relevant are the results of Nesta's Investment in Intangible Assets Survey, which asked 1,200 businesses about their innovation investment in 2011, and preliminary findings from analysis of business investment in fixed assets.
The research shows several things:
Firstly, that investment in innovation by UK businesses fell from £128 billion to £124 billion as the recession began (from 2008 to 2009). This is the first fall in nominal terms in intangible investment for many years, and represents a fall of about 7% in real terms.
Secondly, there is some evidence that business investment in innovation has fallen further since the recession began. This more up-to-date picture is more tentative than the Innovation Index itself: it comes from the Investment in Intangible Assets Survey, which asks a sample of 1,200 businesses how much they invested in various intangible assets, how long they expect the assets to be useful for, and other questions. This suggests a further fall of around 14% in real terms between the survey we ran in 2009 and the most recent survey, conducted in 2011. (We have excluded R&D from these figures although it was part of the survey, since most R&D is known to be undertaken by a small number of businesses; this means that even a 1,200-firm survey is very vulnerable to error. If we had included R&D, the real-terms fall would be more like 20%, but this is counter-indicated by a larger survey of R&D conducted by BIS.)
Finally, there are some troubling signs about what was going on before the financial crisis of 2008 hit. Tangible investment by UK businesses fell as a percentage of GDP from the late 1990s onwards, from 15% of GDP in 1998 to 11% in 2007. The tangible investment that did occur was increasingly dominated by investment in buildings (which increased from 32% of investment in fixed assets in 1998 to 43% in 2008) as investment in ICT equipment shrank (from 19% of investment in fixed assets in 1998 to 14% in 2007). And at the same time, businesses appear to have been heaping up cash: cash reserves started climbing in 2000 and by 2004 were higher than any time since the 1960s as a proportion of GDP.
I've heard a few innocent explanations for these figures over the past few months, but none of them quite ring true. One argument is that the economy was simply "dematerialising" - become more dependent on the kind of intangibles we measure in the Innovation Index. But the Index shows that levels of intangible investment as a percentage of GDP have been more or less flat, at about 12% of GDP, since 2000. Another explanation is that the changes reflect IT kit getting cheaper and buildings getting more expensive. While it's true that prices were changing, it seems odd that over a fairly long period businesses would not respond to one factor of production getting cheaper and another getting more expensive, rather than simply buying the same quantities of each. I used to have a dial-up internet connection at home; I'm sure if I had one now it would be very cheap, but I've responded to the falling price of bandwidth by buying more, not by banking the saving. If I and everyone else in the UK had stuck with dial-up, that might raise some questions about our technological boldness. So these figures do still give cause for concern. We're looking at them further and will be saying more later in the year.
So it looks like there is cause for some concern about levels of innovation investment in the UK. This is not intended to be a jeremiad against improvident businesses or poor government policy. Businesses respond to their environments, and both this government and the previous government have taken steps to encourage innovation and technology.
But it does give us pause to ask ourselves: how could things have been different, and what can we do to make the future better? There are likely to be answers here for public policy, for businesses and for our financial system. It's a question we'll be tackling in September, when we launch Plan I, our proposals for how the UK can harness innovation to achieve economic growth. If you'd like to discuss this further, we would like to hear from you.