R&D: Is the road to prosperity through public support?

R&D: Is the road to prosperity through public support?

Zak blog websiteBy Zakaria Ismail, Place Research Analyst, NCUB

Conversations around public R&D expenditure have been prevalent in policy discussions, reports and blogs over the past few decades. Should we be spending more? If so, where should the money go? In which sectors? Where in the country should it be targeted? Will private R&D spend increase as a result?

In light of the COVID-19 pandemic, and the subsequent economic recession that many predict will occur post-lockdown, research and innovation has been highlighted as being vital to both economic recovery and future prosperity.

The government’s roadmap for research and development in the UK makes such a case. Published in July 2020, the document states that the government will test in detail how to increase investment in R&D and make the UK world-class at securing the economic and social benefits from research. Achieving this will include support for entrepreneurs and start-ups (which will be expected to increase the scaling up of R&D intensive firms via the flow of capital), attracting and retaining talented people, and ensuring that R&D systems make the fullest contribution to the place-based levelling up agenda.

The goal is clear: to significantly increase the level of public R&D expenditure in the future in order to increase GDP, jobs, and general economic prosperity. However, as the level of public expenditure on R&D rises, there are two particularly important questions to ask, the first being:

1. How should R&D spending be allocated?

Scenarios related to the first question were explored in a recent report released by the government. ‘Macroeconomic modelling of the 2.4% target’ assessed the impact of raising the share of R&D expenditure to 2.4 per cent of GDP by 2027 on GDP, productivity and employment.

The authors of the modelling used the E3ME model for their analysis which is maintained by Cambridge Econometrics and is based on post-Keynesian economic theory (meaning that the model does not assume optimal use of available resources).

The report also explored the different ways in which the R&D target might be met, including whether or not foreign direct investment (FDI) increases as a result of increased public funding, the share of both public and private funding, the relationship between regional expenditure and economic prosperity and the proportion of additional spending in different sectors. Scenarios in which external factors may influence R&D were also explored. These included the introduction of tax incentives, digitalisation and the electrification of transport.

The main discovery from every scenario that involved an increase in R&D expenditure, was that a greater level of spending on R&D leads to increases in GDP, employment and productivity. Unsurprisingly, increases are also greater when the R&D expenditure continues to grow after 2027, compared to expenditure remaining constant after 2027. The report also concluded that increasing the level of foreign R&D expenditure has virtually the same positive impact on domestic increases in R&D expenditure, and it is more important for the R&D to take place than to look at where the funding is coming from.

Regional variations in growth related to increased funding

There were two scenarios that differed with respect to increases in funding: economic prosperity grew faster outside the Golden Triangle versus in the South East ‘Golden Triangle’ . The results show that the increases in GDP, productivity and employment were greater when R&D funding was increased outside the Golden Triangle. NESTA’s recent report, ‘The Missing £4 Billion’ has stated the need for the regional devolution of innovation funding, and results from both reports will further bolster the argument to remedy the UK’s geographical inequalities in public R&D spending.

A trade-focused sector that operates in global markets, it was also noted there was a higher potential return when R&D expenditure grew faster in manufacturing than in other sectors. The prevalence of the manufacturing sector outside of the South East was the reason provided for the greater outcome when increasing funding outside the Golden Triangle. In general, R&D spend grew slightly faster in sectors with an already large R&D share compared with those with a smaller R&D share, in both the short and long run.

Other incentives and their impact on R&D spending

When exploring the effect of offering direct financial incentives in the form of tax credits to boost R&D expenditure levels, an insignificant level of change was observed. Digitalisation, or focusing on specific technologies, without increasing R&D expenditure directly, had a modest positive effect, with the largest positive effect in sectors in which the UK is already a large net importer of goods.

Another pertinent question to be asked prior to any increase in public spending on R&D:

2. Will increases in public spending generate those in the private sector to act in kind?

A report commissioned by BEIS to deepen understanding of the impact of public R&D funding on private R&D investment was published in July 2020. With research undertaken by Oxford Economics, the approach sought to identify the extent to which public R&D leads to private R&D. A causal link from one to the other was sought, as opposed to simply looking at a correlation between the two.

There were two ways in which public support was considered to stimulate private investment in R&D:

- By reducing costs and risks that firms face in undertaking research
- By making new discoveries that stimulate private research in related fields

The best estimate of the “leverage rate” suggested that a 1 percent increase in public R&D investment leads to an increase in private R&D investment between 0.23 and 0.38 percent, beginning within the year that the public investment occurs. Like the previous report, indirect support via R&D tax credits brought no firm conclusions. The same was true when comparing funding being made to businesses or funding being made to universities and research councils.

The results and conclusions from both reports have a key theme: increasing public spending on R&D, with private spending increasing as a result, will boost GDP, productivity and employment. Subsequent questions will be asked, primarily on how and where the money will be spent, and these questions will be a key aspect of any future increase in expenditure. But they don’t take away from the critical importance of not just meeting the 2.4% target, but exceeding it beyond 2027.

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