Innovation strategy: economic evidence paper

Executive Summary

Introduction

• This economic evidence paper provides a summary of the theory and selected evidence on the role of innovation and its drivers in generating economic growth and Scotland's innovation performance to provide context for and inform the development of Scotland's innovation strategy.
• In particular, it sets out the aspects of innovation in which Scotland currently performs well and those where it can further improve upon; identifies the sectors in which Scotland has the potential to be world-leading which can be supported through the strategy; and identifies a set of indicators (a "scorecard") for tracking Scotland's innovation performance over time to assess whether the strategy is meeting its core objective to make Scotland one of the most innovative small nations in the world.

Drivers of Innovation

• There are many factors that can influence the rate of innovation in an economy and the gains to economic growth that it brings. Key drivers of innovation include: private and public investment in research and development (R&D); organisational and management structures and practices; human capital; culture and ecosystem, both at the firm and industry level; entrepreneurship; inward investment and exporting.
• There is scope in Scotland to further improve on its strong business management practices and to build capacity for innovation and productivity enhancing business models. This includes policies to further encourage a culture of entrepreneurship within the existing business base by building experimental and innovative capacity, and facilitating peer to peer learning between businesses.
• There is a need to tackle a wide range of barriers to businesses adopting and making the most effective use of existing technologies. This will go a long way in improving both the productivity performance and innovative potential of many businesses.

Government's Role in Promoting Innovation

• If left solely to the market, economic theory suggests market failure will arise whereby investment in innovation activities will be at sub-optimal levels, providing a rationale for government intervention to encourage and support innovation.This is primarily because the benefits of innovation activity do not accrue solely to the business undertaking the innovation, in other words there is a positive externality.
• The innovation support landscape in Scotland is complex with around 90 innovation initiatives across the Scottish Government and enterprise and skills agencies, rising to around 500 initiatives when including innovation funds run by other organisations. Innovation support spending is heavily skewed towards the earlier 'concept' stage of the innovation journey.
• Innovation policy impacts are difficult to track, given the non-linear nature of innovation and sometimes lengthy timescales involved. There is currently limited evidence on the impacts of innovation activities within Scottish Government and its agencies. This does not necessarily mean that these initiatives are not achieving benefits, but this the lack of evidence makes it difficult to judge which initiatives are having the greatest impact on the Scottish economy.International evidence suggests that in the short run, R&D tax credits and direct public funding are likely to be the most effective policy levers to stimulate innovation while, over the longer term, increasing the supply of human capital is likely to be more effective. Encouraging skilled immigration is also seen to be effective even in the short run. Competition and open trade policies are likely to have more modest benefits but incur no direct cost to government. Inward investment has also been found to boost innovation through increased R&D spend and, respectively, competition and demonstration effects.

Scotland's Recent Innovation Performance

• Scotland has a mixed performance on the international stage in terms of innovation, with areas of strength such as higher education and business spending on research and development, but also some challenges including government spending on R&D, the proportion of firms innovating and in terms of innovation outputs including patent and trademark applications.
• In 2020, Scotland ranked top among the OECD countries for HERD spend as a percentage of GDP, Scotland's BERD spend as a share of GDP was above the EU average but below the OECD average, and Scotland's GovERD as a share of GDP was lower than both the EU and OECD averages.[1]
• Scotland underperforms both the UK and the EU average in terms of the proportion of businesses that are innovation active. When ranked against the UK and EU-27 countries, Scotland ranked 19th in 2018-20, placing it in the middle of the third quartile.
• Scotland's broader innovation system is classed as strong when compared internationally and has improved over time. Relative to the EU average, Scotland has notable strengths in tertiary education, lifelong learning, digital skills, scientific publications and innovative SMEs collaborating. However, weaknesses remain in employment of ICT specialists, employment in innovative enterprises and trademark and design applications.

Scotland's Sectoral Innovation Strengths

• A range of evidence was considered to identify sectors in which Scotland currently excels and has the potential for further growth at three tiers: business capabilities; the application of innovation into business; and higher education sector capabilities.
• The analysis was constrained by the lack of sufficiently disaggregated sectoral data, the lack of data on emerging sectors that are not yet an established part of Scotland's economy and the lack of sectoral data on higher education sector capabilities. Despite these limitations, the analysis provides some interesting insights on Scotland's sectoral strengths at a broader level.
• While the areas of strength that emerged in each strand of the analysis differed somewhat, a number of broad sectors showed strength across the tiers. These were: Scientific R&D (part of life sciences); Computing / ICT; Business Services; Professional Services; Architectural, engineering and technical activities; Health; Energy; Emerging technologies (including fin tech, health tech and nanotechnologies) and Space.
• Given the data limitations which required this analysis to focus on broad sectors and the fact that many new disruptive and radical innovations are not happening within specific sectors but rather across sectors. To identify more specific areas where Scotland has the potential to be world-leading, it will be necessary to supplement this analysis with expert advice from key innovation and industry academics and other stakeholders.

Innovation Scorecard Indicators

As actions to grow and scale Scotland's innovation ecosystem over the next 10 years proceed there is a need to track performance on a number of key metrics to allow assessment of progress towards the ambition to become one of the most innovative small nations in the world.

It is proposed that this will be undertaken through an Innovation Scorecard which will track Scotland's innovation performance over time on a set of key indicators against other benchmark geographies: ideally these will be international comparators, but it must be recognised that some relevant indicators only permit comparison across UK nations and regions.

Scottish Government analysts developed a set of metrics, drawing upon commonly used data and considering existing UN and EU measurement frameworks, refining this through consultation with academic experts, NESTA and the Innovation Strategy Steering Group.

The Scorecard metrics aligns to the elements of the Innovation Ecosystem, ensuring we monitor the health of the system at each stage of each process to demonstrate Scotland's performance at different stages in the innovation journey, specifically tracking progress at three stages in the innovation system defined as the concept, convert and commercialise stages as well as tracking investment and the adoption of innovation.

Summary of Scorecard

Concept

• Patent citations
• Academic income from business and community interactions

Convert

• Early-stage risk capital (under £10 million)
• BERD jobs

Commercialise

• High growth firms
• Later-stage investment

Adoption and diffusion

• Innovation active businesses

Investment

• Gross expenditure on R&D (which comprises)
• Business expenditure on R&D
• Higher education expenditure on R&D and
• Government expenditure on R&D

Although it is important to recognise that there are often lengthy time lags until economic impacts emerge from new innovations, and that there is a need to factor in time to implement and deliver a new strategy, the Scorecard will provide a useful snapshot of the health of the Scottish innovation system over time.