From the Blogs: Innovation in Britain

In this second of our weekly features, we look at British economists’ debate about the sources of innovation and prosperity.

Last week saw the launch of the UK government’s consultation on a new industrial strategy, and the announcement of a 20% increase in government spending on R&D. There was much questioning in the media and among professional economists of whether the new plans really live up to the scale of the challenge. But on the need for a step-change in the UK’s economic performance there is little doubt.

Labour productivity languishes 30% below that of the US or Germany while rates of spending (public and private) on R&D remain well below the OECD average. This is one of the reasons why the UK ranks just 19th on the Wake Up 2050 rankings. Nor is the problem confined to the UK. In the OECD, while spending on R&D has remained robust, patent issuance (an important indicator of innovation) still hasn’t recovered since the financial crisis (See Chart). This raises two related questions: what drives innovation and why has it slumped?

A debate on this very question had been kicked off shortly before the new industrial strategy was unveiled by an article by Liam Byrne in the Guardian. A former Labour minister best-known for leaving a note saying “There’s no money left” for his Conservative successor in 2010, Byrne, who is working with the Sheffield Political Economy Research Institute to develop new ideas for economic policy, wrote:

“That is why we are seeking to launch a new kind of debate in the hope of finding a new kind of consensus. The sooner we find it, the sooner we can reject once and for all the tired and increasingly flawed orthodoxy of shareholder value and trickle-down economics that took shape with such force nearly 50 years ago.”

This remark prompted a brisk response from Tim Worstall (of the Adam Smith Institute) who rejects several of Byrne’s contentions, but particularly the implicit attack on shareholder capitalism as a source of innovation. As Worstall puts it:

“Increasing income, and/or wealth, is driven by technological advances that lead to greater productivity. And only societies which have had some at least modicum of that shareholder capitalism have ever had that trickle-down which drives the desired result.”

He goes on:

“The Soviet Union managed to increase total factor productivity – the form of productivity increase which actually matters – not one whit in its 70 years. Roughly capitalist and roughly market economies crank it along at 1-2 per cent, year after decade. Just a quick look around the world will show that places that have had shareholder capitalism for decades and more tend to be rich places. Places just getting it are getting richer – and those that don’t have it are still mired in peasant destitution.”

Worstall’s specific defence of shareholder capitalism’s record on innovation prompted a response from Chris Dillow (economist and blogger at Stumbling and Mumbling) who is more sceptical:

“Bart Hobijn and Boyan Jovanovic have pointed out that most of the innovations associated with the IT revolution came from companies that didn’t exist (pdf) in the 70s. The stock market-listed firm is often not so much a generator of innovations as the exploiter of innovations that come from other institutional forms – not just private companies but the state (pdf) or just men tinkering in garages.”

Dillow explains that this might be because shareholder-owned firms are excessively short-termist or that managers believe that their innovations will simply be replicated by other firms. On this point, we should also note an important recent paper from the OECD which shows that although leading firms are still innovating rapidly, there has been a slowdown in the rate of transfer of those innovations to ‘laggard’ firms, which is holding back productivity growth.

The authors believe that regulatory barriers and insider knowledge are increasingly leading to a ‘winner takes all’ dynamic in which leading firms are able to corner markets. These firms are typically large, multinational, capital intensive, rich in patents and profitable (e.g, Apple or Google).

 
That might seem to vindicate the connection between shareholder capitalism and innovation – if it were not for the fact that many of the laggards are shareholder-owned too. As the OECD report points out, there is a growing gap between the leaders and the laggards. In the Financial Times’s Free Lunch newsletter on January 13th, Martin Sandbu pointed to a growing problem of “zombie” companies being kept alive by lax bank lending standards, blocking the process of creative destruction and slowing the diffusion of frontier technologies. He cited a further OECD study earlier this month in support of this view.

 
As Chris Dillow wrote, if shareholder capitalism is a major source of innovation, it has, as he puts it, at the very least, “lost some of its dynamism.” This might also explain the slowdown in patent issuance. Britain’s new industrial strategy is just the latest in many attempts to replace this lost dynamism. Whether it can do remains to be seen.

Edited by Bill Emmott