Examination of Witnesses (Questions 140-159)
NESTA
2 APRIL 2008
Q140 Mr Bailey: I welcome your comment
that scientists write in English. I must admit there have been
occasions when I have not thought that! There is a perception
that this country is good at research but poor at innovation.
How far do you think that is true?
Mr Halkett: Traditionally this
is thought of because of our high research standing based on citations
and our relatively low patent production compared to the rest
of the world. Firstly, I dispute that that defines innovation.
I would say that if you wanted to look at research-based new to
the world innovation, then those metrics become valid. I do not
think that that is necessarily true. It has changed repeatedly
in recent years. The Sainsbury Review did a very good job of recounting
increases, particularly in university licences. There has been
a decrease in university spin-outs but, frankly, it could be argued
that that is probably a good thing in terms of the competitive
advantage of universities, that increases in licences and decline
in spin-outs might be a good idea. In terms of research income
that comes in from the outside, that is all on an upwards trend.
When you are looking at innovation as a whole, where you are thinking
about innovation in services, basing it on those metrics makes
it too simplistic. I think that it is wrong to think that is the
character of the UK.
Mr Bailey: Picking up a couple
of points, I am not clear why you say the increase in licences
but a reduction in spin-outs for universities is a good thing.
Secondly, could I add this? There is also a perception that we
do the research and some foreign competitor somehow pirates that
research and benefits from all the commercial aspects that arise
form it.
Chairman: "Pirate" may
be quite a strong word.
Q141 Mr Bailey: I tried to be a little
colourful.
Mr Halkett: I think the word "pirate"
is interesting. In terms of the spin-outs, the point is that every
institution, every actor, needs to play their best and most appropriate
role in the innovation ecosystem. Are universities best at forming
companies? Probably not. Are universities excellent at generating
world leading knowledge? Yes. Therefore the question would be:
how can that best be turned into economic and social value? Sometimes
that will be through spinning out companies but more often than
not it is likely to be through licensing it to people who know
how to start up companies and know how to then grow those companies
into world class competitors. I am not saying that that does not
happen in universities. There are some notable examples from the
UK and also from the US that everybody knows that have demonstrated
that, but certainly a fixation on the university spin-out as the
main vehicle of knowledge transfer out of universities and into
business I think probably is not sensible. On the idea that knowledge
gets generated here and is exploited elsewhere, whether it is
pirated or not, those are two different questions. Exploited implies
that maybe it is taken up by a major US-based multinational and
actually turned into world leading drugs or some sort of engineering
product. I will deal with that first. Pirating implies the intellectual
property problems in Asia. I suppose that may be what you are
getting at. On the first one, is that a problem? If we have effectively
functioning intellectual property, then if you generated the knowledge,
you should be getting the returns from that knowledge. The innovation
process is extremely costly, of which the initial invention, although
it is critical to it, is only a very small part of the expenditure.
We have a research strand developing at NESTA on growing innovative
companies. We are trying to find out if it is a problem that young,
innovative companies in the UK rather than maybe growing to become
international giants—they are called gorillas in the parlance
of the investment companies—get bought up by large multinationals.
Is that a problem or is that an effectively functioning innovative
ecosystem for a country that is the size of the UK? I think that
is an open question. First, we do not know if it is true yet.
Secondly, when we do find out, the question is: do we care? We
are mainly interested not necessarily in national virility symbols
but in terms of delivering social and economic value to the UK.
The question of knowledge being pirated is a different one. Of
course control over intellectual property and the illegal use
of it is a real problem and is an issue of international concern.
That then takes us into the question of intellectual properly
more generally and you do not want to throw the baby out with
the bath water. If you stiffen the intellectual property laws
too much, then you could certainly end up in a situation where
you are discouraging follow-on invention, which frankly was the
whole purpose of intellectual property in the first place. You
get protection in return for disclosure. Particularly with new
currents of innovation around open innovation, sharing knowledge
and collaboration, you could end up in quite hot water indeed.
Q142 Mr Bailey: What is your take
on the decision of 3i no longer to invest in technology starts?
Mr Halkett: It is an unfortunate
occurrence for two reasons. The first is the signal that it sends.
The second one is the reality of the fact that 3i has moved out
of that sector. It is not surprising. The British Venture Capital
Association has reported aggregate returns to the very early stage
of investment of -1.5% over time. That does not seem like a good
business to be in, certainly compared to when you are looking
at the high returns from management buy-outs of private equity
further up the spectrum. If you are managing large amounts of
assets, where would you choose to put your money? I think that
that is a problem. One matter we are very keen to point is that
the question of stages of investment is very important here. Early
stage masks a multitude of definitions. In our venture capital
operation at NESTA, we invest in what we call the seed stage,
which is the very earliest pre-revenue stage of the very highest
risk companies. That is a very hard area to work in. We are working
very hard there. We have a well qualified and experienced team
that is trying to demonstrate that you can make commercial returns
in that space, but there are perpetual problems in terms of doing
that. Businesses require different types of support; they require
different types of investment. The decision of 3i is disappointing.
On their behalf, it is clearly rational. Does it represent a problem
for the UK? I would say "yes". Obviously the enterprise
capital funds are meant to be moving into that space to some degree
but we are still witnessing a problem in the sub-£2 million
investment gap. We have some new research that will be coming
out towards the summer that uncovers that.
Q143 Mr Bailey: My next question
was going to be: is this indicative of the venture capital market
failing to invest in product innovation? I think you have partly
answered that. Is there anything else you would like to look at
there?
Mr Halkett: I think that it is
important to recognise that the very early stage of funding being
available is a critical part of any innovation system. The point
is that there are public goods that result from that that do not
reward the private investor directly. It is a very high risk area.
If you think about the returns that can be made from investing
£20 million into a later stage business, the amount of due
diligence, the amount of specialist knowledge that you need is
probably relatively similar to what you need to be investing a
couple of hundred thousand pounds into a very small, high risk
biotech business. There is a question there about allocation of
resources and the way in which people would want to place their
resources if they are an investment company. I think there remains
a strong case for public involvement. What we are trying to find
is what is the most effective way for that to happen because that
has been a difficult story worldwide, not just in the UK, over
the past 20 or 30 years.
Q144 Mr Bailey: How does NESTA ensure
that money it invests in new companies is not tantamount to charitable
giving?
Mr Halkett: We invest around £10
million a year into the earlier stage companies and funds that
invest in early stage companies. We ourselves alone are not going
to transform the UK's early stage investment market. Our goal
is to demonstrate the kinds of returns and models of investment
in terms of business support and in terms of the structure of
funding that we give that will draw other people into the market.
We want to make this commercially attractive. If we do that, then
other people will enter. We invest with a very hard-nosed commercial
approach, but linked to the very early stage of investment, if
you see what I mean. That is the way in which we ensure that we
are not doling out money that effectively becomes grants. As I
said, we have also invested heavily in giving ourselves a fully
qualified and very professional investment team.
Mr Bailey: I will be a little
provocative and ask if there are any funds that you would categorise
as charitable giving?
Q145 Chairman: The Chief Executive
has said there is a danger of public funds degenerating into charitable
giving, for example.
Mr Halkett: There are a couple
of problems with that. The first one is that if funds are given
targets, and particularly if they are targets that may be linked
in recent years, not necessarily any more, around regional development
or with multiple bottom lines or tied to particular universities,
then the chances are that they are going to be looking to meet
somewhat arbitrary targets around numbers and amounts of investment,
rather than the fundamental target of actually delivering good
returns and making good investments. I think that there is a danger
and there might have been some problems with that in the past,
but that is definitely changing. People are hungry to learn how
to make this work. That is where we hope to be able to both theoretically
and practically contribute to that.
Q146 Chairman: You have referred
to a report that your organisation is producing. Tell me the subject
of that report in this context of funding.
Mr Halkett: We are doing a couple
of things. We have a piece of work under way which looks at the
equity structure of successful innovative businesses over time,
over the course of their development: to what extent was early
stage funding important; to what extent any type of grant type
funding was important; but also angel investment and the rest.
We understand what we call their equity fingerprint through that
time. The second thing we are doing is a quantitative analysis
of the sub-£2 million investment area. Crucially, that is
because the BDCA in particular qualifies early stage as sub-£10
million. You could understand that even if early stage potentially
is going up in that definition, you still would not be supporting
the very earliest stage of innovative businesses. We are looking
at the specific niche in which NESTA operates, and we are finding
a decline in investment in that space over recent years.
Q147 Chairman: Will you be bringing
forward proposals to put that right or is it just a piece of analysis?
Mr Halkett: At the current stage,
it is a piece of analysis but of course we will be developing
proposals to put it right because that is why we exist.
Q148 Mr Weir: Your evidence suggests
that traditional innovation measures are heavily biased towards
R&D and patent intensive industry such as aerospace or pharmaceuticals.
What impact do you think this has had on policy making in this
area?
Mr Halkett: I am normally a big
fan of evidence-based policy. That is something that is quite
often lacking and it is to be encouraged. The problem we have
is that if you depend on evidence constantly and singly and it
is the wrong evidence, because then we are chasing the figure.
There was a Chief Economist at the Bank of England called Charles
Goodhart, who developed something called Goodhart's law, which
was that once an indicator has been established as the basis for
a target, it loses all meaning because people chase the indicator.
You can see some of this, although I am not an expert in health,
with waiting list times where suddenly that was a useful indicator
of the health of the system but then became the target in itself.
You see that with patent applications, with patents granted and
with R&D spend. They are useful indicators as a health check
of parts of the innovation system, but if we actually establish
those as the only targets that we have, and over the past couple
of decades they have consistently been the only reported ones,
then of course policy is built to try to stimulate to meet those
targets because that is a better story to be able to tell. In
the Innovation Nation White Paper we have been asked to
produce a new innovation index that balances this more effectively
and it provides a more balanced appreciation of the UK's economy
and social and innovation system there. We will be making sure
that we at least embed those indicators in a package of other
ones that are relevant to other sectors as well, so that hopefully
then, if you are following the evidence, as a policy maker, what
you will actually be doing is hopefully also improving innovation.
Q149 Mr Weir: What are the outcomes
from that? Presumably patents are used because they have a definite
outcome: this research and innovation has produced a patent and
presumably it will produce profit at some point in the future.
Is it your argument that innovation is wider than just simply
new products, in effect?
Mr Halkett: Absolutely, and to
reinforce the point, patents are a very useful measure for a very
small but particular sector of the economy. I do not want to say
that they are not useful; they just cannot bear the weight that
is currently put upon them. For instance, patents currently only
apply to products; they only apply to new to the world inventions
of those products, not new applications of older technologies.
The other thing about them is that patent application is not really
a great indication of success. Patents granted can be, but more
import would be an indication of patent citation or patent value.
We know from research that has been done in the past that the
vast amount of value from patents is delivered by a very, very
small proportion of those patents. Just to look at those in particular,
they do not work in the services industries; you cannot do a business
model or a business process patent in the UK like you can in the
US, although I am not advocating that. For instance, what you
are really looking at there is probably a useful indicator, but
then only a partial indicator for a relatively small section of
the UK population. It would, for instance, be useful for the pharmaceutical
industry. I would not want to challenge it enormously there, but
other indications of innovation would be important in those industries
as well.
Q150 Mr Weir: What would be these
other indicators? Presumably anybody looking to invest is looking
for an indicator that will show an outcome rather than just to
invest in innovation; they want to see something with an outcome
to it. What indicators would you be looking for?
Mr Halkett: There are a few sectors
where it is relatively obvious. If you are looking, for instance,
at the health of the creative industries, then you would be looking
at copyright and design applications more than at patents.
Q151 Mr Weir: Does that not amount
to much the same thing? A copyright and a patent are different
ways of giving protection for an innovation, are they not?
Mr Halkett: I think that is right.
That is one of the most straightforward ways in which the indicators
can be improved, if we just gave equal weight to the idea that
copyright, which is relevant to the 7.5% or so of the UK economy
that is based on creative industries, is perhaps the indicator
of choice when compared to patents maybe that are important to
high-tech manufacturing, which represent around 2.5% of the economy.
The problem comes when we look at the health of the whole of the
economy based on the patents or the R&D statistic alone.
Q152 Chairman: Copyright protects
brand value as well, though, does it not?
Mr Halkett: Yes.
Q153 Chairman: It is much wider than
just the narrow creative sector?
Mr Halkett: It is, but again it
is a question of the most appropriate indicator there as well.
In other sectors you would see it as well. For instance, we have
work underway, and we have been doing this in partnership with
BERR but also some of our own work, on the question of innovation
in services. If you look at the companies in the services sector
that are most innovative, a very important indicator of that is
the level of management training that those businesses have, particularly
their ability to understand innovation, deploy information and
communications technology and think in a way that is conducive
to innovation. They produce very few patents. Of their innovation
expenditure that they self-identify in services, less than 20%
qualifies as research and development. For instance, you would
have some idea of a health check of the innovation capability
of the services sector if you did understand that level of management
capability. These all need to be refined. The question is: how
do we improve on the existing indicators that we have? A sectoral
approach is going to be important. We need to look at the relevance
of the different regions because of industrial structure and demographic
structure in different regions. We need to be thinking about the
flow of talent. Clearly skill levels are very important to innovation,
but they are important in different ways for different sectors.
We need to strike a balance between over-complicating what is
currently too simple a system but also not ending up back where
we are right now, where we have unsatisfactory proxy indicators
for the whole of the economy.
Q154 Mr Weir: I think I understand
all that. How do you get across to an investor the idea of investing
in innovation in, say, a service industry? Anybody investing in
manufacturing and the creative industries can see an outcome,
apart from the copyright or whatever. What you are saying seems
very ethereal, that there is innovation within the service business.
How do you measure it and put it in a way that investors can understand
that they are investing in something that will be taken forward
and provide profit in the future?
Mr Halkett: Investors tend to
have a strong understanding of innovation in services because
they are very close to the business, because they look at businesses
individually; they understand those businesses and they are not
trying to aggregate them too much. The problem we have, in terms
of innovation indicators and metrics, is on the national or the
regional level when we are looking at whole swathes of the economy.
For instance, we look at the UK's pharmaceutical sector which
invests 14% of its revenues in research and development, which
is a very high level globally and it is also a leading sector.
There is a link there and so it is appropriate for that area.
Investors in those businesses would understand that. The Government
understands that as well. The problem, of course, is that it only
represents about 6% of the economy and therefore its actual impact
on the overall innovation statistics is less than perhaps it could
be. What we need to look at is understanding how innovation happens
in these different sectors and then we will be able to develop
indicators based upon that. A classic is in the public sector
where currently we do not really measure innovation at all. In
the report Hidden Innovation that we produced, one of the
classic examples we came across was genetic testing in the NHS.
Over a decade, we produced around 300 new genetic tests in the
NHS; none were produced in the traditional way; none generated
patents; none were based on venture capital funding, but those
deliver important social value to the UK and sometimes economic
value as well. It is a question of knowing what we are looking
for and that is what we are going to undertake.
Q155 Mr Weir: This takes us back
to where we started. We had Sir John Rose of Rolls-Royce before
us previously. He suggested that aerospace R&D spending was
under-supported in the UK. Would you agree with that statement?
Mr Halkett: He is more of a specialist
on the aerospace industry. On the question of R&D support,
there is evidence but it is scarce that a 10% reduction in the
cost of research and development through whatever means but potentially
by government subsidy, through something like an R&D tax credit,
over time leads to a 10% increase in R&D, but we would expect
that because companies are rational. There is very little rigorous
evidence currently of the link between research and development
and innovation, as opposed to just increasing R&D spending
and the link between it directly and productivity growth over
the long term. Would aerospace like additional support for its
research and development activities? Yes. Would that in my opinion
directly increase the innovation performance of the UK? I think
that is a question that is still out there. Knowledge moves quickly;
companies move quickly; people move quickly. Investing on a national
level on something like that with the idea that it will improve
your innovation performance is an interesting question. Whether
R&D tax credits or support for R&D is actually just a
part of international tax competition attracting large companies
that we prefer to have rather than other people have is another
matter. That is a judgement that goes beyond the realm of innovation
policy. If you are looking specifically at innovation, there is
more work to be done to suggest that large-scale support for research
and development increases the innovation that matters to the UK
economy.
Q156 Mr Wright: If we briefly turn
to regional policy, the Lambert Report identified an increased
role for regions as a key part of innovation policy. The evidence
that we have received suggests clearly that companies find dealing
with different funding bodies in different areas frustrating.
Do you think we have the balance right between promoting regional
clusters and recognising that companies do not necessarily follow
administrative boundaries?
Mr Halkett: I think this is work
in progress. We have two findings from our research that are important
here. The first is that we need increasing regional tailoring
of innovation policies. One size does not fit all; it certainly
does not work nationally. We produced a series of reports at the
end of last year, one on innovation in the city, one on regional
innovation coalitions and one on what we called rural innovation.
They all demonstrated that, whilst you should have a national
standard of policy, it needed to be able to be tailored for local
and regional industrial and demographic structures and priorities.
The default that we have gone into is that because we have aimed
at entirely national policies that cannot really be tailored,
we have ended up with an innovation policy that not just favours
science and high-tech manufacturing, but basically favours the
greater South-East above and beyond the rest of the UK. That is
because it is an easy default to go to. The first finding is that
it is very important to have a level of regional devolution to
ensure that capacity. The other finding is exactly what you found,
which is that people are currently unsatisfied with the capability
at the regional level to deliver a very high standard of innovation
policy and innovation support, particularly when there are problems
with cross-administrative boundaries. You certainly see that many
organisations, for instance say around the Cambridge area, would
have much closer relationships with London than they would maybe
with Ely, and yet Ely is covered by the same development agency
and London is not. That clearly is a bit of a problem. RDAs may
not be moving as fast as we would like but they are moving in
this regard. The best example and the one that we are closest
to is the Northern Way, the collaboration between Yorkshire and
Humberside, between the NorthEast and the Northwest Development
Agencies, where they are working upon pan-northern issues collaboratively:
research into transport linkages, innovation support, business
support, things that actually work across. Of course part of that
is trying to establish the M62 corridor as a strong economic independent
entity and perhaps a rival pull to the South-East, but it also
I think represents quite a forward-looking and intelligent step
when it comes to thinking about the realities of innovation policy.
Q157 Mr Wright: With regard to the
RDAs, in your evidence you mention the fact that in terms of the
priority areas eight of the nine RDAs include biotechnology or
health sciences. All right, competition is fine between the areas.
Do you think that should be led by the Government to say it is
for each RDA to say what area should be looked at? Clearly, they
are the builders ultimately of the priority areas. The competition
is going to be strong and you are duplicating a lot of the public
expenditure.
Mr Halkett: To an extent over
the past decade this has been a necessary evil. In return for
the development of regional autonomy and regional interests, you
have regional `boosterism' as well. Of course everybody wants
to jump on the biotech bandwagon and say that their area is going
to be world leading. Equally clearly, that is absolutely not true.
The idea of particularly generating a biotech cluster essentially
out of thin air is not really going to work. There is almost no
evidence globally that you can create clusters. You can certainly
build, stimulate and grow them; you can certainly take good ones
to great ones, but the idea of literally creating one is extremely
difficult. I would say: yes, there has been a problem. We talk
about the question of intelligent competition. This is a fine
balance. Can you have central government direct that is going
to be the champion for biotech within the UK? That is a problematic
area but if you look at it, it is quite clear that there are a
few front runners. Obviously there is the area around Cambridge;
the area between Glasgow and Edinburgh; and a couple of other
pockets. Obviously we had the news story this morning about the
embryos from the North East. There are ways in which these are
going to work together. The point is that when we look at globalisation
and at the rise and rise of other centres of excellence, at the
fact that people and knowledge are moving faster and faster, the
chances are that the currently excellent places are going to become
more excellent and therefore there are going to be fewer of them.
The leading scientists and researchers will literally move there
to work with the best in the field. As an aside, we will also
see the same in the services industry. You see the ever growing
rise of London as a financial services centre. Clearly there is
a bit of a clustering effect going on there and it is to the detriment
of other people. When we are looking at this, I think we are clearly
moving to a world where the UK will have a couple of globally
competitive areas in something like the biosciences and, yes,
there will be other areas but they have to recognise their position
as feeders into those national centres. I would prefer for those
to emerge rather than be chosen but government chooses all the
time. Apart from the paranoia we have about "well, I am not
picking winners, but ... " as we always hear in ministerial
speeches, the point is that governments the world over pick winners
all of the time. If we look at the vast increase in health care
spending by the US Government, theoretically the home of the free
market, it is up to about $29 billion a year now through the national
institutes of health. Then suddenly you are noticing that countries
all over are essentially picking winners. They are picking sectors,
they are not picking firms. I think that is a more intelligent
way to go. Should there be a government committee that sits there
and makes some sort of decision and then awards a bioscience excellence
centre to Cambridge? That would not make an awful lot of sense,
I do not think, but certainly there are going to be choices made.
The idea of almost arbitrarily going against that tide to boost
other areas seems nonsensical.
Q158 Mr Wright: Briefly, do you consider
that in, say, five years' time eight out of the nine RDAs that
have been given a priority area would be reduced down to four
perhaps or five because they will recognise that they cannot keep
pace with areas such as Cambridge?
Mr Halkett: I would strongly hope
that that would be the case and that they would choose to focus
on other areas of their clear strengths. Those strengths are distributed
across the UK. Each region has its own particular strengths it
can build on. There is a glamour attached to a minister wrapping
himself around the latest biotech piece of machinery that they
want to announce and everybody wants the person to go to that
area and wants to work in that space. I think what we want to
see is a more intelligent approach to that. However, that will
depend on a very proactive and realistic approach from regional
development agencies and from city councils.
Chairman: We are really enjoying
this evidence session, as I thought we would. We are not half-way
through our questions, so can we go through our menu of questions
and try to avoid detailed expositions. We can come back to this
at a later date and explore things in more detail. I am afraid
it is frustrating but can we move on faster?
Q159 Mr Wright: Turning to government
and policy, how would you assess the Enterprise and Innovation
White Papers?
Mr Halkett: We were involved in
the development of both. We were particularly close and DIUS is
our sponsoring department and therefore we were involved in the
development of Innovation Nation. I was very pleased with
how it turned out. I think that it sets a clear intellectual leadership
centre in the UK Government. I think that globally it has been
recognised as quite a step forward. In particular, if you look
at the contents page, there is a chapter on demand, which is very
unusual in international innovation strategies. Innovation in
public services is attracting a lot of international attention.
I have been getting international comments on it. Those are the
areas where people are focusing. I think it has done that very
well. The point is that it is going to be very challenging to
implement. What we are looking at now is DIUS having to work an
awful lot through other government departments to achieve its
goals. That is critical. We have made the comment that we think
non-innovation policy is almost more important than innovation
policy when you are considering innovation performance and therefore
it is a necessary evil. That is an interesting challenge for the
structure of a department. I thought the enterprise strategy was
a good start and they have made it quite clear that this is the
beginning of a real focus on the enterprise agenda. I look forward
to working with them further on that.
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