Innovation, research and the UK’s productivity crisis

Richard Jones  - Associate Fellow of SPERI, Professor of Physics and Pro-Vice-Chancellor for Research and Innovation, University of Sheffield

There are a couple of special factors that have affected the UK economy in the last decade that we need to be aware of.  The production of North Sea oil peaked in 1999.   The oil and gas industry has been a major contributor to the UK’s economic growth, but as the oil runs out the productivity of that sector is inevitably falling.  Between 2000 and 2008, the productivity of the financial services sector also rose rapidly.  This rise similarly went into reverse in the aftermath of the financial crisis, which revealed that much of the apparent profitability of the banking sector arose as a result of the implicit guarantees given by the tax-payer to underwrite its increasing appetite for risk.  In the stricter post-crisis regulatory environment, productivity growth in this sector will (and should) remain subdued.

In short, declining North Sea oil and the continuing effects of the financial crisis on the financial services industry provide ongoing headwinds to productivity growth.  This means that productivity in other sectors will have grow even faster to compensate – if our economy is to return to health.

Innovation in the sense used by economists, in the context of ‘total factor productivity’, encompasses much more than just the development of new products and improved processes through formal research and development.  It includes learning-by-doing, adoption of best practices from elsewhere, user-inspired innovation and social innovation.  But research and development nevertheless remains important, and Haskel’s work quantifies the contribution an increase in research and development could make to the economy’s overall productivity growth, which is material.

We need to be conscious that the R&D intensity of the UK economy has been declining for decades: in 30 years we have gone from being one of the most R&D intensive economies in the world to one of the least, having been surpassed on that measure first by Korea, and more recently China.  The consequences of this decline have now come home to roost.

A solution to our productivity problem must involve an improvement in our overall R&D performance.  This needs to involve both the public and private sectors; stagnating business R&D has been a major part of the UK’s problem, and the fact that more than half of that business R&D is funded from abroad means that it is very sensitive to the state of the publicly funded research base.

Given how critical our productivity problem is, it should be unthinkable to be reducing the public resources going into research and development now.  Instead, we should be using the excellent research base we have in the UK’s universities, which has already demonstrated its willingness and ability to work with the private sector for the benefit of our wider economy and society, to rebuild our innovation economy.  This effort needs to balance the continuing need for long-term discovery science to secure our future, with some serious and focused efforts to develop the new technologies we know we need, in areas such as affordable low-carbon energy and new healthcare technologies for an ageing population, and continuing work to unlock the economic benefits of research.

The alternative course, of continuing on our current path of stagnating productivity and stagnating innovation, isn’t inevitable.  It would be a choice, a costly choice for the whole country, and it’s a choice we shouldn’t make.

A longer version of this piece, with full references and supporting statistics, can be found on Richard Jones’s Soft Machines blog