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Firm innovation in the post-pandemic world

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We know that innovation by firms is a key driver of economic growth. One of the few silver linings of the pandemic has been that many firms have innovated in response. According to recent research by the Centre for Economic Performance, nearly two-thirds of surveyed firms adopted new digital technologies and management practices, more than a third developed new digital capabilities (for example, e-commerce, advanced analytics, and cyber security), and half introduced innovations to their products and services. If this shift to being more innovative becomes permanent, it should help UK businesses become more competitive.

The government plans a further boost with the recently published UK Innovation Strategy, setting out a long-term plan to support innovation-led growth. What does the impact evaluation evidence say on how it might do this and what is the role of local government?

Improving finance for innovation

One way in which government intends to support innovation-led growth is by improving access to finance through loans and loans guarantees, improving the information quality, and providing incentives to lenders.

Whilst not specific to innovation, our access to finance evidence review considers what the impact evaluation evidence tells us about the likely effectiveness of such an approach. Access to finance interventions improve access to debt finance either by increasing loan availability or lowering the borrowing cost. However, the effect on access to equity finance is more mixed and there is some evidence that loan guarantees policies can increase default risk. To the extent that innovation relies on debt finance – for example to buy new capital equipment – this is good news. For riskier innovation projects that rely on equity finance to share risks and adequately reward investors the findings are less positive.

Even if innovation increases, will this generate innovation-led growth? Here, the evidence is less positive. Support can improve firm performance (e.g. employment and sales), with most evaluations finding a positive impact on at least one aspect of firm performance. But when a specific aspect is considered, typically only half the evaluations find a positive effect. This might suggest that targeting particular outcomes can be hard, and that innovation may spur economic growth in subtler ways and in the longer term.

A more direct approach is the use of R&D grants, loans and subsidies and there is evidence that these interventions have impacts on R&D expenditure, innovation activities and firm performance, although these are not always positive and outcomes tend to increase more in small and medium-sized firms. One example, the Creative Credit Programme, aimed to help UK SMEs overcome innovation barriers and develop collaborative relationships with creative industries partners. The programme had positive short-term impacts on firm innovation behaviour and more modest impacts on firm performance, although the effects were not sustained in the medium-term. This highlights the challenges there can be in getting innovation behaviour to stick. Promoting innovation-led growth also requires solid business networks, managerial capabilities to identify opportunities and market signals to encourage investment in innovative activities. Failing to change the innovation behaviour of firms may lead to temporary attempts to innovate but this is not enough to drive sustained economic growth.

Building networks

The strategy emphasises the importance of networks between businesses and research institutions at the local level. Although there is a lack of evidence, these interventions may yield promising results. Whilst this is not something we have an evidence review or toolkit on, there is some research on this topic. For example, the Dutch innovation voucher was successful in improving the interaction between SMEs and public research institutes and the evaluation was clear that most projects would not have been conducted in the absence of the programme.

Furthermore, policies to encourage collaborative behaviours between universities, the public sector, and enterprises may also help them innovate. Our co-location toolkit looks at evaluations of interventions that encourage co-location of researchers (for example, science parks, provision of key infrastructure and building-level co-location). The reviewed evidence shows that co-location improves quality of research, spillovers between researchers and commercial sectors, and spurs firm innovation. For example, one study finds that firms’ patent applications are positively associated with the number of companies located within walking distance to the Cambridge Science Park. Another that considers the relationship between science parks and the commercialisation of new products and services in the UK concludes that firms located in science parks have more new patents, new products and new services than other firms, although it may be that more innovative firms choose to locate in these sites. Lastly, evidence from our university spin-off toolkit shows that university-industry partnerships may have a positive effects on spin-offs. 

Innovation – critical but challenging to deliver

Innovation is a key driver of economic growth. However, the evidence shows that interventions do not always translate into long-term changes in innovation behaviours and firm performance. This suggests delivering a more innovative economy may be challenging even with the strategy in place.

In addition, some businesses do not innovate due to risk aversion, inertia, or lack of knowledge about how to improve products or processes but there is little discussion of this in the strategy. So, changing long-term innovation behaviour may require further actions on managerial capabilities, workers’ skills, and awareness of innovation benefits.

Although the innovation strategy sets a roadmap for local governments, the appropriate policy mix may vary according to local strengths, capabilities, and supply and demand factors that explain underinvestment in innovation. Even when the implementation is local, coordination across stakeholders organisations and government levels is important to get a broader vision of the innovation system, prioritise interventions, and understand which market failures can be addressed at the local and national level.

We hope that this quick review of the evidence on innovation is helpful. There is a lot more detail on our website and we are always happy to discuss innovation further, just get in touch!