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What Works to support business innovation in the Covid-19 recovery?

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The UK’s relatively poor productivity since the 2008 financial crisis is partly explained by the limited adoption of productivity-enhancing digital technologies and modern management practices. This is a particular problem amongst small and medium-sized enterprises (SMEs).

To better understand how firms are responding to the COVID crisis, Anna Valero and I ran a survey asking about short-term business innovation responses, namely the adoption of new technologies, digital capabilities, management practices and products. A majority of firms have innovated in response to the crisis and most firms expect these innovations to improve workforce productivity and to continue in the future.

A key question for policy is how to encourage firms to carry on innovating in the COVID-19 recovery phase and beyond.

What are the main barriers to innovation?

Figure 1: Barriers to process innovation

Local authority areas with highest and lowest youth claimant count rates

Notes: N=361 (firms that responded to this question).

In our survey economic uncertainty caused by COVID-19 and Brexit, as well as difficulties accessing finance are the two major barriers to investment in innovation. Access to finance is more of an issue for smaller firms.

What does the evidence say about access to finance?

The UK government has already introduced a number of loan guarantee schemes, including the Bounce Back Loan Scheme and the Coronavirus Business Interruption Loan Scheme. In the early months of COVID-19, What Works Growth published a rapid evidence review on what works for access to finance schemes. This found that loan guarantee schemes have a positive effect on firm access to debt finance either in terms of the availability of credit or the cost of borrowing (or both). However, the impact on firm survival is mixed and most of this evidence is from periods of growth.

Figure 2: Potential new government assistance schemes for technology, capability and management practice innovation

Local authority areas with highest and lowest youth claimant count rates

Notes: N=346 (firms that responded to this question) (182 small firms defined as having fewer than 50 employees; and 164 medium/large defined as having 50 or more employees). Firms could select more than one option, so the bars do not sum to 100%.

We asked surveyed firms to select government support programmes that they think would help them innovate in the recovery. New tax incentives are the most cited policy levers across larger and smaller firms, and smaller firms also particularly value grants or vouchers.

What does the evidence tell us about these policies?

In our 2015 review of the evidence, we found more evidence on the effects of such schemes on R&D and patenting rather than on process innovation. Focusing on R&D tax credits, we found that tax credits can positively impact R&D expenditure, although effects are not always positive and may depend on firm size. Small firms are slightly more likely to experience positive benefits. One potential reason for this is that small firms may face greater financial constraints, making them more responsive to changes in tax credits. In addition, programmes that target particular production sectors appear to do slightly worse in terms of increasing R&D expenditure and innovation, compared to those that are ‘sector neutral’.

While the evidence covers R&D rather than process innovation, it suggests that tax credits could be a useful policy to encourage innovation, both at firm and area level. Targeting support at small and medium size enterprises in a way that is ‘sector neutral’ may help improve effectiveness.

There is less evidence to inform the development of grant schemes. Our review found that innovation grants and loans can positively impact innovation, although effects are not always positive. The effects are weaker for intellectual property related outcomes like patents than for (self-reported) measures of process or product innovation suggesting that grants could play a role in supporting such innovation during the recovery.

The lack of evidence is also an issue for informing the development of innovation voucher schemes. The Creative Credit pilot, run in the UK, found vouchers had a positive effect on product and process innovation six months post-treatment. However, effects did not persist after 12 months. If these findings generalise, this suggests that vouchers might help during the economic recovery but are less likely to lead to a long-term step-change in innovation behaviour of businesses.

Arguably financial incentives alone may not be enough to address all the barriers to innovation, and more evidence should be gathered on support packages that go beyond. For example, more holistic packages could offer financial incentives that cover both innovation adoption as well as digital and professional skills programs for the young workforce, which is particularly valued by large firms.

Innovation policy lends itself to experimentation and has been the focus of many policies in the last decade. UKRI, the Catapults, Be the Business and the BEIS Business Basics program are just some of the notable government initiatives to increase learning on business innovation. As a result, some of the difficult work of evaluation has been done – so let us learn from it. Let’s also make sure we actively design evaluation plans for current policy packages, to build evidence on and confidence in what works in times of crises.

In our survey one year on, we will report the effects of pandemic-induced innovation adoption, and how it relates to take up of government assistance. We’ll report on that here; in the meantime please get in touch if you have any questions or comments.