Innovation strategy: economic evidence paper

3. Government's Role in Promoting Innovation

3.1 The Rationale for Government Intervention 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 benefits of innovation activity tend to 'spill over' to other organisations through adoption and further development of those innovations, further increasing productivity and output across the whole economy.

Additionally, businesses are often unwilling to invest in R&D activities because they are risky by nature, especially for technologies in the earliest stages of development. Because of this, smaller businesses which are less able to suffer the loss of a failed R&D project may simply not undertake any R&D activity, again resulting in sub-optimal levels of investment.

A review of existing evidence by the Research and Development Corporation Europe (RAND Europe^[25]) found that there may be even greater benefits from innovation across society including impacts on culture, public engagement, social cohesion and environment, although these are difficult to measure. Thus, firms taking decisions to invest in innovation on the basis of benefits accruing to their business only will tend to underinvest.

Finally, there is a role for government in providing the basic infrastructure for innovation to thrive, from digital infrastructure to skills programmes to funding for basic research.

3.2 The Innovation Support Landscape in Scotland

The innovation support landscape in Scotland is complex. It includes grants and wider non-financial support for innovation and around 90 innovation initiatives across the Scottish Government and enterprise and skills agencies, with estimated funding of around £480m in 2018-19. This rises to around 500 initiatives when including innovation funds run by other organisations, such as the UK Government, EU, and third sector.

Source: Enterprise and Skills Strategic Board Innovation Review

As illustrated in the diagram above, innovation support spending is heavily skewed towards the earlier 'concept' stage of the innovation journey. A large portion of this (around £284m in 2018/19) is research funding for higher education institutions which, while potentially contributing towards innovation, has broader objectives. Even excluding this funding, there is around £200m per annum of innovation support from the Scottish Government and the enterprise and skills agencies^[26]. Additionally, of the 49 initiatives across the enterprise and skills system, 85% of funds are administered by agencies, with 16 of the funds spending £100,000 or less in 2018/19.^[27]

In light of this complex landscape, in September 2021 the Enterprise and Skills Strategic Board undertook a high-level review of innovation support in Scotland. As part of this, the Scottish Government Enterprise and Skills Analytical Unit drew together existing evidence on the range of different innovation support initiatives and mapped these against the established innovation framework set out by ministers. A table of this mapping is shown overleaf.

Source: Enterprise and Skills Strategic Board Innovation Review

Key: Lead organisation:

Scottish Funding Council (SFC)

Highlands & Islands Enterprise (HIE)

Scottish Enterprise (SE)

Scottish Government (SG)

The following key themes emerged from the Enterprise and Skills Board's Innovation review:

• Strategy and promotion: there is a need for a clear overarching strategy for innovation in Scotland which drives where funding is targeted and this needs to be accompanied by clear branding which businesses can easily recognise.
• Complexity: over time a substantial number of small innovation funds have been established, many of which are trying to achieve common objectives. These are often designed around the administrative arrangements for service providers rather than the needs of the end user.
• Flexibility: greater flexibility is required as often support is targeted at particular sectors, potentially limiting viable proposals from businesses in other parts of the economy.
• Coordination: there is scope for much greater coordination to maximise the impact from Scotland's investment in innovation, as most initiatives currently exist in isolation.
• Collaboration and knowledge transfer: existing networks and groups, such as the Innovation Forum, could be utilised to foster greater collaboration between funding organisations and a step-change is required in knowledge transfer between research organisations and Scottish businesses.
• Language and accessibility: innovation often means different things to different people, and this can act to limit the ability of firms to access the right support at the right time.

3.3 Effectiveness of Innovation Policy Interventions

Recent work by the Scottish Government Enterprise and Skills Analytical unit concluded that 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 the lack of evidence makes it difficult to judge which initiatives are having the greatest impact on the Scottish economy.

We can however draw on international evidence to consider which types of policy interventions are most effective in stimulating innovation. Recent research from Bloom, Van Reenan and Williams^[28] synthesized a wide body of evidence to produce a 'toolkit' for policymakers which ranks the effectiveness of innovation policy levers in terms of the quality and implications of the available evidence and the policies' overall impact from a social cost-benefit perspective. Policies were also scored in terms of their speed and likely distributional effects (Figure 12).

The evidence reviewed suggests that, in the short run, R&D tax credits along with direct public funding are the most effective while, over the longer term, increasing the supply of human capital (for example, through expanding university admissions in the areas of science, technology, engineering, and mathematics) is more effective. Encouraging skilled immigration was seen to have significant effects even in the short run. Competition and open trade policies were deemed likely to have benefits that are more modest for innovation, but as they are relatively less costly in financial terms, also score highly.

Source: Bloom, Van Reenen and Williams, A Toolkit of Policies to Promote Innovation