House of Commons - Trade and Industry

Select Committee on Trade and Industry Written Evidence

APPENDIX 19

Memorandum submitted by The Royal Academy of Engineering

EXECUTIVE SUMMARY

The Royal Academy of Engineering is pleased to respond to the call for evidence by the Trade and Industry Committee on the subject of progress towards the knowledge driven economy. The Academy believes that this is a timely inquiry into a vital topic that underpins the future competitiveness of the UK. In this response, The Academy does not seek to provide a comprehensive overview of the subject area, but rather attempts to draw attention to specific points of particular concern to The Academy.

The UK possesses invaluable resources in the form of human capital and a world class research base. However, the emergence of a swathe of low-cost economies, which are not only providing inexpensive labour for manufacturing and services but are also rapidly increasing investment in education, R&D and technology, has provided the UK with a new and serious challenge. In addition, globalisation and advances in technology are changing the way in which business is conducted. The UK has many of the competencies required to retain and improve its competitive advantage in a knowledge driven economy, but needs to adopt a more focussed approach with a long-term view if it is to achieve this.

First of all, the UK needs to recognise that the failings in its secondary and higher education systems, especially in mathematics, engineering and the physical sciences, represent clear and current threats to the continued supply of personnel essential for future success. Secondly, the UK needs to further enhance its R&D activity, particularly in industry, and to ensure that funding is available for long-term and speculative research. Thirdly, the UK should seek to improve its ability to support innovation and help entrepreneurs to grow their businesses to a sustainable size. Finally, the UK needs to explore opportunities to migrate further up the value chain, for example by strengthening its capabilities for systems integration.

INCREASED COMPETITION FROM LOW-COST ECONOMIES

1.1 The prediction that the UK would face increasing competition from low-cost economies has proved correct. Many UK companies have, for example, chosen to outsource not just low-skill jobs such as call centre operation but also higher skill services eg software engineering to India on account of the abundance of well-educated, English-speaking personnel and the low cost of labour. In fact, 76% of the Indian IT industry total earnings constitute export revenues[96] and, in line with the growth in outsourcing by companies from the UK and elsewhere, the number of knowledge workers in India rose from 6,800 in 1985-86 to 522,000 in 2000-01. [97]In addition, Indian IT industry revenues exhibited a phenomenal Compound Annual Growth Rate of 42.3% between 1994-95 and 2000-01. 95 South Korea has also been extremely successful in rapidly developing advanced technology in the electronics and telecommunications industries, achieved through a combination of high levels of targeted Government investment, low labour costs and a ready supply of well-educated and skilled personnel.

1.2 Furthermore, low cost economies such as India and China are producing large numbers of highly trained engineering and technology graduates, with China alone turning out in the order of 200,000 engineering graduates per year, representing about 44% of Chinese graduates in all subjects. [98]Increasingly, these graduates are taking up opportunities overseas to capitalise on the large salary differential. The prestigious Indian Institutes of Technology are producing graduates and post-graduates of an extremely high calibre whose skills are in demand both within and outside India. Indeed, there are already large numbers of highly qualified software engineers from India currently working in the UK. On the other hand, wages are now increasing in India and market globalisation means these workers are able to exploit international markets without physically having to relocate so the influx of Indian IT personnel may not continue indefinitely. Irrespective, the UK needs to be prepared for the fact that India, China and other countries will continue to generate large number of skilled scientists and engineers in the coming years.

1.3 However, the advancement of economic development in countries such as China, India and South Korea represents not only a threat, but also a new opportunity for the UK. In the longer term, the low cost economies can be expected to migrate further up the value chain, promoting development in these countries and ultimately increasing the global markets for high technology products and services. Low skill operations may be taken on by other lower cost economies and in some cases outsourcing will be replaced by automation, for example Automatic Voice Integration to deal with call centre enquiries. In addition, there is evidence to suggest that countries such as Taiwan and South Korea are prepared to invest heavily in certain types of technology R&D, eg. broadband infrastructure, and to provide capital for establishment of manufacturing plants etc. Consequently, some UK researchers are now approaching these countries as potential sources of finance for specific areas of technology R&D.

DEVELOPMENT OF NEW PRODUCTS, PROCESSES AND SERVICES

2.1 The efficient development of new products, processes and services requires thriving and innovative R&D activity. UK science and engineering R&D has received welcome boosts in funding and support under the current Government. That said, the overall UK gross domestic expenditure on R&D as a percentage of GDP is, at 1.9%, significantly lower than the OECD average of 2.33% and is also growing more slowly than the OECD average. [99]Importantly, only 46.2% of this R&D expenditure was financed by business enterprise in the UK in 2001, contrasting with an OECD average of 63.6% and much higher business investment levels of 68.3% in the US and 73% in Japan. 98

2.2 The UK Government has responded to this problem by introducing a number of measures to promote business expenditure on R&D. The establishment of R&D Tax Credits, publication of the R&D Scoreboard and development of a panoply of schemes to facilitate business-university collaboration and support small to medium sized enterprises have all had a positive impact. Additionally, Regional Development Agencies have played an important role in stimulating economic growth and R&D investment at a local level and clusters in areas such as Cambridge have become effective hot-spots for development of new products and services, notably in biotechnology and computing.

2.3 However, there are still multiple challenges to be addressed. The increasingly commercial attitude of universities has in some cases created a tension in collaborations with businesses over issues such as intellectual property rights. It will also be important to ensure that the move towards full economic costing, which may be welcome in principle, does not deter businesses from working with universities. In addition, there seems to be a shortage of skilled senior management to help inventors and start-ups to progress their enterprises beyond the initial stages into a more sustainable operation. Interestingly, it has been observed that there is little UK research into technology management with few dedicated Chairs at UK universities. The Government appears to be keen to address such problems, having undertaken an Innovation Review and a review of business-university collaboration, headed by Richard Lambert, and The Academy awaits the findings of these with interest.

2.4 The exceptionally high UK industry spend on acquisitions relative to investment in R&D and capital expenditure also merits further attention in view of the negative correlation between major acquisition and company performance. [100]Moreover, these high levels of acquisitions activity exacerbate the increasing mismatch between, on the one hand, the average lifetime of a company before merger, acquisition or major change in business direction and, on the other, the average timescale for conversion of a technology into a product or service. Consequently, companies have become progressively more reluctant to embark on long-term or speculative research even if it could ultimately give rise to genuinely revolutionary technologies and products.

2.5 It is particularly important that the UK grasps opportunities provided by new technologies to re-engineer the way in which services are delivered and to create new services. There is an impression that the UK Government has not been able to articulate or enable the bold visions being adopted by other countries such as Japan, especially in the application of technology to fields such as health and education. Japan recently announced the second phase of their national IT strategy, "e-Japan Strategy II", which shifts the focus from building IT infrastructure to the use of this infrastructure to advance areas such as medicine, finance and government service, and the development of an associated IT social infrastructure to facilitate effective uptake of these new services. Whilst the Japanese strategy seeks to create innovation in service provision and address the dynamics of the market, the UK's efforts have been mainly restricted to construction of the physical infrastructure of the digital economy.

2.6 The UK has also not done enough to facilitate the development of terminals and other user interfaces that will make it simple and enjoyable for the mass population to connect with the digital era. Standards need to be developed in all these areas for an open digital economy to prosper. Asian economies, such as Japan and South Korea, are well-placed to innovate right across the value chain, having strong national players (eg. Fujitsu and Samsung) who have technology capabilities spanning from terminals through to networks and software. Indeed, it has been suggested that successful exploitation of research and knowledge depends on the presence of a complete "food chain" or "ecosystem"— in this regard the UK may be at a disadvantage due to the weakness of manufacturing and paucity of early-adoption users in many sectors.

2.7 Overall, there are likely to be many new opportunities for knowledge-based services and products and the UK must position itself in such a way that it can respond rapidly and effectively. There has been a growth in the market for technology for personal use, reflected in the widespread uptake of mobile telephones and laptop computers, and tools such as navigation and media access services can be expected to become commonplace in the future. The built environment will also gradually become "smart", with myriads of sensors and data storage, communications and processing devices built into construction materials, furniture, fabrics, devices and clothing. Embedded software systems are already estimated to be ten times as prevalent as personal computers worldwide and this figure can be expected to rise extremely rapidly. The increasing adoption of interactive TV services by the public is also likely to provide opportunities for new services and products.

INTRODUCTION OF ELECTRONIC COMMERCE

3.1 E-commerce has been so comprehensively embraced that it is now very much part of business as usual, as reflected by the frequent omission of the "e-" prefix. The drivers promoting e-commerce include access to a larger customer base, lower costs, increased speed, and improved customer service. For the customer, the key benefits conferred are wider choice, lower costs and increased flexibility. Developments in web technology have made it easier for companies to work together on an international scale, thereby increasing the effectiveness of e-commerce and the evolution of the Semantic Web[101] should add further value. One consequence of the increased prevalence of e-commerce is likely to be the standardisation of business processes, since companies will have to comply with the systems of their major suppliers and customers. In the short time, this may entail a drop in efficiency, but should lead to better services in the long term.

3.2 Research by the University of Surrey School of Management suggests that e-commerce has been particularly helpful for some small and medium sized enterprises, allowing them to overcome geographic limitations and offering them access to global markets for their products and services. Conversely, overseas competitors are granted access to the UK market via the same technology, in effect creating a more level international playing field. Thus, while e-commerce may act as an amplifier for companies with pre-existing service or product advantages, it is unlikely to grant a specific advantage to most sectors of UK industry. Many UK financial companies have, however, been able to capitalise on the introduction of e-commerce due to the fact that they already have a global, or at least European, presence.

3.3 It is estimated that 63% of UK businesses are now online and approximately 49% of homes were reported to have internet access in 2002. [102]Nevertheless, there is concern that these figures are now growing slowly, with progress in e-commerce hampered by both doubts over security and privacy and inadequacies in the UK infrastructure. In particular, the protracted roll-out of broadband continues to hinder the UK's progress, as does the fact that the standard speed of UK broadband is 512kbps which is at the low end of the range used by international competitors. Other aspects of the UK infrastructure also impede e-commerce. For example, the widely acknowledged deficiencies of the UK transport network mean that people and goods are frequently delayed, resulting in a significant loss of efficiency in the delivery of goods ordered over the Internet.

DEVELOPMENT OF SCIENCE AND KNOWLEDGE BASES

4.1 It is self-evident that the UK needs a robust and effective education system if it is to compete successfully in the knowledge driven economy. However, serious questions exist over the current and future capabilities of the UK to provide a reliable stream of appropriately skilled and educated personnel. For example, the standards of mathematics and physical science teaching in secondary schools provide grave cause for concern. One in three mathematics, physics and chemistry teachers are aged over 50. [103]Unfortunately, there has been a longstanding recruitment problem in these subjects and of those now entering the profession, many do not have undergraduate degrees, or even A-levels, in the subject they will be teaching. Indeed, 26% of full-time mathematics teachers have no qualification in the subject. 102

4.2 The situation is no less disturbing at the university level. Many engineering and physical science departments are facing a demographic time-bomb caused by growing numbers of staff approaching retirement age and decreasing numbers of graduates wishing to pursue academic careers. Statistics produced by the Higher Education Funding Council for England in 2002 revealed that an increase in recruitment rates of up to 36% by 2010 was needed just to maintain current staffing levels in UK engineering departments. [104]In practice, many departments are already struggling to attract new staff and 46 engineering and technology departments succumbed to closure between 1996-07 and 2000-01. 103

4.3 The appeal of engineering as a career has declined alarmingly in past years: engineering attracted only 5.2% market share of all accepted domestic higher education applicants in 2001 compared with 10.7% in 1991, despite a substantial overall expansion in higher education. 103 Fortunately, IT and bioscience courses appear to be continuing to enjoy healthy levels of interest, but the dwindling supply of engineers and physical scientists could profoundly obstruct the UK's progression towards the knowledge based economy. Furthermore, the introduction of student financial contributions for undergraduate courses, particularly if adjusted to account for the relative costs of the subject, could provide yet a further disincentive to study unavoidably expensive subjects such as engineering. Similarly, there are concerns that students opting to spend a year in industry may have to pay fees during this training, which would impact on the uptake of this excellent opportunity to develop the skills of undergraduates.

4.4 Many heads of engineering departments have also observed a marked rise in the numbers of foreign students, including those from low cost economies, studying at UK universities both as undergraduates and post-graduate on science, technology and business courses. Although the UK benefits from their input and skills while they are in the UK, many later return to their home countries (or take up positions in other countries, especially the US). It is imperative that the UK avoids drifting into a position of reliance on short-term visitors from overseas to compensate for the deterioration of the UK's own skills and personnel base.

4.5 Industry, meanwhile, has been afflicted by global companies responding to unfavourable economic conditions by retrenching their UK activities to their home bases, or in favour of locations where they see the greatest market opportunities, eg China. In the telecommunications industry, the UK has lost major R&D capabilities as companies such as Alcatel and Nortel have closed or scaled back their UK R&D operations. Similar problems are seen in the chemicals industry where the loss of UK research bases for companies such as Shell, BP and ICI have collectively had a serious effect on UK R&D in this sector. Even if companies do re-establish R&D operations in the UK when the economic conditions change, it will not be trivial to regenerate the domestic skills and knowledge base needed to support these activities.

4.6 It is worth noting that the UK is also encountering competition from higher cost economies that may offer more favourable fiscal environments. Dow chemicals, for example, are reported to have recently selected Switzerland as their preferred location for their European laboratory. There may therefore be an argument for investigating the feasibility and potential benefits of further tax incentives to encourage multinational enterprises to set up or maintain research facilities in the UK.

4.7 Moreover, it is vital to ensure that enthusiasm for new technologies does not overshadow the need to maintain investment in the UK's existing technology base. The emergence of a new technology can spark radical development in notionally unrelated and "mature" technologies, prompting a paradigm shift in their market opportunities. The UK must therefore sustain its investment in R&D in areas where it has established a niche expertise or technological advantage. For example, the UK nuclear industry has been in steep decline for several years and, despite the fact that the Government wishes to keep open the option of nuclear energy as a source of low carbon energy generation for the future, the skills and knowledge base which formerly afforded the UK an international advantage has been all but terminally eroded.

4.8 The UK has a wide range of funding routes for R&D, including multiple Government departments and agencies, charities, EU Framework Programmes, Regional Development Agencies and Industry. In light of the finite resources available, there is a strong argument to be made for developing a more coordinated national approach to R&D funding for the development of new technologies. Clearly, caution must be exercised to avoid any stifling of innovation, but an integrated strategy addressing national priorities for both the public and private sector could make a powerful contribution to strengthening the UK's global competitive advantage. This would require debate at a national level and agreement over who to consult and how to define the process for establishment of research priorities.

4.9 The Government also needs to ensure that its channels for funding research are operating effectively. The various Government initiatives to improve the effectiveness of business-university collaboration have had a positive impact on knowledge transfer and the quality and relevance of university research and graduate skills. However, academics frequently complain that collaboration with industry is not given sufficient recognition, for example by reviewers of grant proposals or in the Research Assessment Exercise. In addition, it continues to be difficult to attract funding for multi-disciplinary research proposals. Although these problems are recognised by the Government, adequate solutions have not been implemented to date. The UK Government should also consider supporting applications to the EU Framework Problems by providing initial funding or assisting in the preparation of proposals, as routinely occurs in other EU countries. Additionally, there is an argument that better alignment of the UK and the EU funded programmes would enable the UK to leverage more efficiently the European funding available.

4.10 Finally, the web itself has rapidly become an indispensable part of the international knowledge base, but there is a conspicuous absence of adequate search tools for extracting information from the burgeoning number of web sites. Future developments in artificial intelligence are likely to overcome the difficult technical challenge of prioritising the sites for the needs of users. Meanwhile, both technological and political solutions need to be uncovered to combat the scourge of junk mail and computer viruses, which threaten the progress of the IT-enabled knowledge economy. In both these cases, it is in the UK's interest to be at the forefront of developing or implementing responses to these problems, since resolution of these challenges could grant the UK a significant competitive edge in a knowledge driven economy.

Mr P Greenish CBE

Chief Executive

The Royal Academy of Engineering

24 November 2003