innovation is not R&D

But is R&D innovation? John Kay explains.

When we talk about innovation, we visualise men and women in white coats with test tubes and microscopes. Outside many university cities around the world there are biotechnology estates established by governments that believe high technology is the key to a competitive future. The funds that governments provide to support innovation are all too often appropriated by large companies that are better at forming committees to pontificate about what the global village will want in the future than they are at assessing what their customers want today. ….

Last month the [UK’s] National Endowment for Science, Technology and the Arts picked up this point. For years research and development scorecards have dutifully recorded how much pharmaceuticals companies spend on the search for new drugs and the expenditure of governments on defence electronics. But a Nesta report, presenting plans for a new innovation index has now recognised that most of the spending that promotes innovation does not take place in science departments. The financial services industry may have been Britain’s most innovative industry in the past two decades – perhaps too innovative – but practically none of the expenditure behind that innovation comes under “R&D”. And the same is true in retailing, media and a host of other innovative industries.

John Kay, “Innovation is not about wearing a white coat”, Financial Times, 16 December 2009.

An ungated version of this column will soon be posted here.

A pilot version of pilot version of NESTA’s Innovation Index can be downloaded here.

Data will be added over the next 12 months, and the Index will be extended to incorporate public sector innovation. NESTA promises then to update the Index each year with new data.

I was excited and eager to learn more, but became very disillusioned by the time I reached page 14 of the pilot report:

The second component is what macroeconomists describe as Total Factor Productivity (TFP). This is the measure of productivity growth that is not accounted for by the growth in factor inputs, such as physical capital or labour quality, and is generally attributed to better ways of doing things, including the broader benefits of technological advances and improved processes. In the approach used in the Innovation Index, in which the private benefits of investments such as R&D are captured separately, TFP includes the spillover benefits of innovation investment.

This methodology shows that between 2000 and 2007, labour productivity grew at an annual average of 2.7 per cent per year. Innovation contributed 1.8 per cent, or approximately two-thirds of the growth experienced.

NESTA, “The Innovation Index: Measuring the UK’s investment in innovation and its effects”, November 2009.

TFP is the residual that is left after regressing output on inputs, i.e. the residual of an aggregate production function. I have discussed all the problems with this methodology in a series of seven thoughts titled “economics as faith”. To locate these posts, type “economics as faith” into the search bar, or click on the “production functions” tag.

The first component of the Index is somewhat better. It consists of adding up all expenditure on R&D (really!), plus all expenditure on design, training, market research, etc. etc.. “However, R&D represents only 11 per cent of the investment in innovation ….” In other words, 89% of all innovation expenditure is excluded from the R&D budgets of private firms. So far, so good. But NESTA then uses “a growth accounting approach … to understand the effect of these [expenditures] on productivity growth.” This requires measures of aggregate productivity, reliance again on “economics as faith”.

I did not look at the third and last component of the Index, “a set of metrics that can be tracked to assess how favourable a climate the UK is for innovation”, so will not comment on that. I also do not know how – or whether – the three components will be combined to form a single index.

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  2. […] only be understood as faith, not science. These posts are titled “economics as faith”; one of them focuses on attempts to measure technical […]