5Beyond UKRI—wider balance
128.UKRI investment in research and innovation will be a cornerstone of total R&D spending in the UK. However, there are other significant roles played by the Government. Departments other than UKRI are also responsible for innovation support and direct R&D spending, and there is wider public procurement that might drive innovation. Giving more emphasis to increasing demand for innovation by encouraging customer (i.e. Government) funding, rather than focusing on ‘technology push’ from university research, represents a potential shift in policy focus.197 The Government also has a supportive role shaping the wider investment landscape, through rules and incentives that encourage firms to invest and undertake innovative practices. In this Chapter we explore the role for coordinating innovation across Government, specific support through the Small Business Research Initiative and other public procurement, financial incentives such as R&D tax credits, and regulation of longer-term investments or patient capital.
Wider support for innovation across Government
129.In both written and oral evidence the Campaign for Science and Engineering (CaSE) drew our attention to work they had undertaken cataloguing a list of Government backed sites or webpages detailing innovation support.198 They suggested that whilst “there is a lot of good innovation support, infrastructure and incentives in the UK [ … ] the UK does not effectively showcase or communicate the UK offer domestically or internationally.”199 This led to the recommendation that a ‘one-stop shop’ be created to gather this information from across Government:
Government [should] create a digital ‘shop window’ that showcases in one place the many different incentives, funding, and initiatives for UK research and innovation support, providing sufficient resource for it to be maintained. This one link could then be easily shared to direct people to the array of support available. This is not just a communications challenge, but also should spur functional improvement and join up across different parts of national and local government systems, messages, portals and opportunities. This could be an opportunity to use SBRI to procure an innovative solution to the challenge.200
130.It is further recommended that this be part of a wider work programme to clarify and effectively communicate the UK offer at the top level, using differentiated and targeted communications to reach key audiences.201 Whilst efficient firms may not struggle to navigate these alternative finance and support routes, it seemed likely that the additional complications would disproportionately affect and disincentivise small and medium enterprises.
131.When this was raised with the then Minister, he agreed that there might be a possibility of creating a “more effective one-stop shop”.202 Following our evidence sessions, the CBI also stated support for a “digital one-stop shop” outlining the range of innovation support that business can access.203
132.There are a myriad of funding sources for research and innovation, many of them provided by UKRI. However, Government departments outside of UKRI, notably the NHS and the Ministry of Defence, invest a significant amount in R&D. The Government needs to make it as easy as possible for businesses to locate and access these opportunities.
133.The Government should conduct a review of all the funding streams and opportunities for R&D support advertised across Government. It should create a central linking point or web portal for access, and consider how this is advertised, particularly to SMEs.
Existing Government demand for R&D
134.Latest ONS data for 2017 shows that the UK Government’s expenditure on science, engineering and technology (SET) relating to research and development was £12.2 billion in 2017, representing 0.59% of GDP.204 Within this, civil departments represented 30% and the Ministry of Defence 13%.205 Dr Sarah Main of CaSE summarised this when saying “we know that UKRI is responsible for about 70% of public R&D spend. Other Government Departments are responsible for the other 30%. Defence and the NHS are significant players in that, but many Departments are responsible.”206
135.The importance of this investment had been recognised previously. The NAO’s analysis of cross-Government funding of R&D in 2017, for example, recommended that BEIS begin work on identifying areas of research that needed strategic leadership and co-ordination,207 and elements of this appear to have informed the Industrial Strategy through the ‘Grand Challenges’ and Challenge Funds. But departments will continue to undertake their own investment and this should not be overlooked in the systematic approach the Government should be taking to reach its R&D target. BEIS director Jenny Dibden recognised this but also suggested that the creation of UKRI provided a greater opportunity for coordination, saying it was:
absolutely right that other Departments have them, but there is something about the creation of UKRI and the fact that Innovate delivers on its behalf, which means you can begin to get more coherence, and that is absolutely a question we are looking at as part of the 2.4% road map.208
136.The Government strategy for reaching 2.4% R&D investment, which we hope will be illustrated in the promised roadmap, should highlight the cross-Government R&D investment that is undertaken, particularly by large departments such as the NHS and Defence. The roadmap should include detail on UKRI’s role in coordinating this investment. The creation of UKRI represents an opportunity for it to operate as the ultimate steward of this system.
137.While departments should be free to invest in areas of individual importance, UKRI should maintain a strategic overview of potential synergies with UKRI funding and the impact on skills and infrastructure that this creates. It should also analyse the potential impact of this cross-Government funding on dimensions of balance such as regional concentration of spending that we have addressed in this inquiry.
The Small Business Research Initiative (SBRI)
138.Whilst the Government should not overlook the existing demand for innovation by departments discussed in the previous section, there are additional mechanisms through which demand for innovation could be stimulated. The main example identified in our inquiry was the SBRI, a programme aimed at helping small businesses take advantage of procurement contracts that the Government is offering, helping innovators to demonstrate and develop their new technologies and Government organisations to solve challenges by connecting them with innovative businesses.209
139.The Dowling Review singled out SBRI as an important mechanism for encouraging collaboration,210 and this was endorsed by the Government’s response to the Dowling Review in 2016.211 However, David Connell led an independent review of SBRI that reported in November 2017, which found that these endorsements were not reflected in practice.212 The use and method of implementation of SBRI varied widely across Government, highlighted by the fact that in 2015–16 funding through the scheme fell to only £63 million, a 25% reduction compared to the previous year’s peak. The review made several recommendations on how to make better use of the opportunity presented by SBRI, including:
- the establishment of a central SBRI fund into which public sector organisations could bid to fund a programme of SBRI competitions, to reach around £250m per annum within six years;
- the establishment of a ‘National SBRI Fund Board’, comprising public and private sector representatives, to oversee the central SBRI fund, set funding conditions and guidelines for SBRI programmes and review departmental or agency programme proposals; and
- the introduction of a third phase of funding for a small number of projects, combined with a drive to ensure that funding for first and second phase projects meet guidelines (£50,000–100,000 for Phase 1 and £250,000–1m for Phase 2).213
140.The main Government response to the recommendations has been the creation of the GovTech Catalyst Fund, designed to “incentivise Britain’s tech firms to come up with innovative solutions to improve public services”; it currently has four challenges, including tracking waste and cutting traffic congestion.214
141.This fund is significantly smaller than the Connell Review recommendations, standing at only £20 million. Professor Sir Mark Walport noted that “skills to procure innovation through SBRI are a scarce commodity, unfortunately”, although through things like the GovTech Catalyst fund, “the Government are exploring ways to expand it”.215 Jenny Dibden of BEIS agreed that “it is small, but it demonstrates to people that it can work. There has been a huge amount of interest from a whole range of public sector organisations in receiving this money”.216 The then Minister agreed that the GovTech fund was essentially “testing the recommendation for a central fund”.217
142.We have previously addressed these issues in our Quantum Technologies Report.218 We now re-iterate those conclusions, as follows.
143.We agree with the Connell Review that the Small Business Research Initiative has a “unique and valuable role to play in the innovation and procurement landscape”, supporting UK businesses in developing innovative new products while enabling public sector bodies to source innovative solutions to the challenges they face. However, the Government’s response to the Connell Review so far is limited.
144.The GovTech Catalyst only supports public bodies in sourcing digital technology solutions and the three-year, £20m GovTech Fund is significantly smaller than the £250m that the Connell Review recommended to be spent per annum through SBRI, or the £200m target the Government had for SBRI spending in 2014–15, and should not be viewed as a replacement. We recommend that the Government fully adopts the recommendations of the Connell Review, and establishes a central SBRI fund with a National Board to oversee its delivery as part of the 2020 Spending Review.
145.The Government should consider using the SBRI to procure the web portal for innovation support detailed in the recommendation at paragraph 133, allowing external experts and potential users to create an intuitive directory and system for coordinating future innovation support schemes.
Public procurement
146.The SBRI is potentially an important tool, but as the Royal Academy of Engineering (RAEng) said, “it is important not to reduce public procurement to SBRI: procurement can be used beyond research and beyond small businesses”.219 The RAEng pointed to MoD projects and the Highways England Innovation Fund as important examples of procurement beyond SBRI.220
147.The Industrial Strategy Green Paper highlighted that the public sector as a whole spent around £268 billion per year on procurement, equivalent to around 14% of GDP.221 The CBI agreed that this was an “important lever” for driving innovation and that with “government being such a powerful buyer in the UK economy, its actions can stimulate demand for new technologies, creating marketplaces that induce the development of innovative new products and services.”222 How to make this public procurement more ‘innovation-friendly’ was a key challenge, and the diversity of procurement opportunities might be glossed over in the search for one-size-fits-all models.223
148.However, the CBI surveys showed that only 5% of businesses agreed that current public procurement processes in the UK incentivised innovation. This was supported by RAEng who were concerned that whilst procurement had the potential to have a “disproportionately transformative effect on UK companies”, procurement processes were a “significant barrier to increased R&D investment” due to the “focus on achieving the lowest cost, failure to develop collaborative relationships, restrictive rules on IP and the absence of incentives for companies to take risk and propose novel approaches”.224 They suggested the Government had “long recognised an unresolved challenge”, a view supported by Professor Sir Mark Walport of UKRI.225
149.Felicity Burch of the CBI called for “a bigger, more strategic approach” to procurement:
You need the Government Departments pulling together to deliver better procurement outcomes and more innovation through procurement [ … ] The issue is whether SBRI is the right tool. Even £200 million will not be enough really to shift the dial on the UK landscape [ … ] The Government need to take a more holistic look at their procurement practices. SBRI is probably part of it, but they should look at how they support research and innovation more generally. Departmental expenditure on R&D needs to be part of that mix. Potentially, it would be the bigger shift.226
150.The then Minister acknowledged the potential of procurement, stating:
I see huge opportunities in looking at where, through public procurement, we can deliver potential opportunities for co-investment in future R&D. It has been tried before; it has not always been so successful, and I am trying to understand why.227
This analysis will be difficult given the quality of Government procurement data is relatively poor, as highlighted by the Institute for Government.228 This illustrates an ongoing concern that we addressed in our Digital Government inquiry, which looked at how well the Government and its agencies deployed their datasets to maximise their value for money, effectiveness and delivery, and how well ‘open data’ arrangements were operating.229
151.The Industrial Strategy rightly recognises the power of public procurement as a demand-side driver of potential R&D spending. However, there does not appear to be any further development of the strategy to exploit this potential, despite it being a long-recognised issue.
152.Alongside increasing the size and reach of SBRI, the Government should produce a procurement strategy and communications plan for addressing businesses that specifically identifies innovation opportunities and promotes innovation-friendly practices across all types of procurement. It should address barriers currently perceived by the business community, such as treatment of risk and intellectual property. The benefits of a central portal that collates procurement opportunities from across Government should be pursued.
R&D tax credits
153.R&D tax credits are a tax relief designed to encourage greater R&D spending. There are currently two schemes for claiming relief, the SME Scheme, aimed at small and medium-sized enterprises, and the Research and Development Expenditure Credits scheme (RDEC) for larger companies, resulting in either a corporation tax reduction or a cash credit for loss-making firms.230
154.The latest HMRC Evaluation of R&D Tax Credits is from 2015 and estimates that for every pound spent on R&D tax credits, between £1.53 and £2.35 is additionally spent on R&D by UK companies, which appears in line with previous international studies.231 Many of the written submissions to our inquiry quoted this evidence in their support for R&D tax credits.232 The CBI explained that the system was “hugely valued” and that “in CBI surveys access to tax credits is one of the areas where businesses are most likely to rate the UK as world class”.233
155.Despite this support, there were still suggestions for potential improvements. Submissions by Oxford University and the Russell Group highlighted that the system could be simplified, for example by making all company sponsorship of university research eligible for credit.234 CaSE suggested that the definition of R&D for tax purposes needed to be updated as it was “currently too focused on physical products”; suggestions included the “purchase of data for research purposes and digital infrastructure to support R&D within the definition, as some other countries have done already.”235 Felicity Burch of the CBI suggested that “the R&D tax credit does not currently include the use of algorithms in research, but for a lot of businesses that is a new and growing area and could open up opportunities for the sector”.236
156.However, we recognise that many of the organisations that support the tax credit system are those who currently benefit from the scheme, or those who could benefit in future. At the same time tax credits may be more important for international tax competition, for retaining R&D intensive firms in the UK or attracting new R&D investment, than for any intrinsic effectiveness in driving innovation. As a tax incentive it may also encourage gaming—a HMRC-HMT consultation in to preventing abuse of the R&D tax relief for SMEs ran from March to May 2019 and may be legislated for in the Finance Bill 2019–20.237
157.David Connell was more sceptical about the impact of R&D tax credit spending, suggesting that “the Government subsidy seems merely to have substituted for aggregate spending from company generated funds”.238 His evidence cited the UK’s business R&D intensity, which was around 1.1% of GDP in 1999–2000 and at a similar level in 2015–16, despite more than £20bn being spent through the scheme, and he noted that industrial competitors such as Germany, Finland and Sweden have no such tax credits but maintain high levels of R&D. Analysis by the Institute for Public Policy Research, which built on HMRC’s findings but incorporated methods used by the Irish Department of Finance, estimated that “between 57 and 80 per cent of R&D tax credits are deadweight, subsidising spending which would have happened anyway, at an annual cost of £1.8–1.9 billion.”239 The Academy of Social Sciences suggested that this analysis should encourage further work on how to stimulate private investment.240
158.David Connell suggested several possible improvements to the system, including making the credit applicable to only increases in R&D spend, and attempting to pay the credit as a voucher, which could be redeemed for development contracts with universities, independent research organisations or (other) SMEs.241 These vouchers had the potential to be designed as regionally-specific to further encourage regional re-balancing in line with Government priorities.
159.The Government has spent more than £20bn through the R&D tax credit scheme. It is popular and widely supported, but often this support is from those who have benefited from its generosity or focus on the quantity rather than quality of support. We welcome the Treasury consultation aimed at preventing abuse of the system.
160.The Treasury and HMRC should undertake updated analysis of the tax credit system which addresses the issue of deadweight spending and reassesses current estimates of additionality of R&D spending by business. This analysis should also evaluate the benefit of other potential changes to the scheme to encourage additionality of spending, and methods of targeting credit for regional or sectoral priorities, to encourage alignment with the goals of the Industrial Strategy.
Patient capital
161.As described by the Financial Conduct Authority (FCA), ‘patient capital’ refers to a broad range of alternative investment assets intended to deliver long-term returns, including infrastructure, real estate, private debt or equity, and venture capital.242 The Government’s Patient Capital Review specifically sought to address the issues of financing growth in innovative firms.243 Their consultation identified a range of indicators suggesting that the UK is lagging behind its potential in the longer-term process of scaling up successful start-ups.244 Whilst venture capital investment in the UK is currently valued at around £4 billion per year, if the UK achieved the same level of investment as the USA relative to GDP, it would be around another £4 billion per year higher.
162.The review identified a number of causes for the lack of effective patient capital investment in the UK. One root cause was the UK’s historically thin market for patient investment, stemming from a lack of critical mass in parts of the market. On the demand side there may be a lack of serial entrepreneurs and inconsistency in the success of University spin outs.
163.Following the publication of the Government’s patient capital consultation, we wrote to the then Chancellor in September 2017, ahead of the first Autumn Budget. In this letter we agreed with the identification of pension funds as a potential untapped source of capital, with the UK defined-benefit pension funds holding around £1.3 trillion in assets but a low level of investment in patient capital, potentially as a result of perceived over-interpretation of the legal responsibility of pension fund trustees to act ‘prudently’.245
164.At Budget 2018, the Government published an update to the consultation246 which outlined its progress on implementing the patient capital action plan, and new measures were announced to support defined contribution (DC) pension schemes to invest in patient capital:247
- “through the British Business Bank, the government will support pension funds to invest in growing UK businesses. Several of the largest defined contribution pension providers in the UK have committed to work with the British Business Bank to explore options for pooled investment in patient capital”;
- “the FCA will publish a discussion paper by the end of 2018 to explore how effectively the UK’s existing fund regime enables investment in patient capital”; and
- “the FCA will consult by the end of 2018 on updating the permitted links framework to allow unit-linked pension funds to invest in an appropriate range of patient capital assets”.
165.The British Business Bank launched the British Patient Capital248 programme in 2018 to invest in commercially viable venture capital funds. It began with an initial £400 million seed finance, and an aim of investing £2.5 billion over the next decade, leveraging further private investment to create a £7.5 billion fund. This investment should help venture capital funds improve the breadth and depth of their experience. The FCA discussion249 and consultation250 papers have been published, with final rules (and attendant enhanced risk warnings) intended for publication in late 2019.
166.The evidence we received appeared broadly supportive of the Patient Capital Review analysis and recommendations,251 with the BioIndustry Association in particular urging us to encourage the Government to act quickly to increase private investment by pension funds.252 Universities UK suggested in their submission that the Patient Capital investment fund was a “positive step in the right direction”, but what was needed now was a “coherent framework that sets out a strategy on stimulation of private investment in R&D”.253 The Academy of Medical Sciences called the establishment of British Patient Capital a “highly positive step”, but stressed it was “vital” that investment was delivered across the whole country, as venture capital remains “extremely elusive outside of the South East of England”.254
167.David Connell also suggested that there was a requirement for non-dilutive finance for start-ups “to help prevent successful entrepreneurs being forced by financial investors into early trade sales, with the resulting truncation of growth in UK based operations”, adding that recent patient capital measures did not appear to address this.255
168.The Patient Capital Review was a welcome step by the Government to identify important issues in the demand and supply of long-term capital. We welcome the subsequent work to help clarify the guidance for investors so as to make patient capital more accessible to pension funds, which we have previously also identified as a significant potential source of funding. However, such clarification may be insufficient to entice investors towards new assets and investments if they still perceive they are at a disadvantage due to information asymmetry and lack of experience. We hope that the launch of British Patient Capital and the work on pooled investment vehicles will address this issue. We also hope additional influence over dimensions of balance, such as regional concentration of funding, can further be addressed by this investment.
169.We recommend that the Government act quickly on the recommendations of the FCA review of regulations relating to patient capital and permitted links, and publish a further update at Budget 2020 that details the additional pension fund investment that has been stimulated by these rule changes. Further review should be considered if there has not been a step change, maintaining a commitment to exploiting the considerable funding potentially available through both defined-contribution and defined benefit pension schemes.
198 Campaign for Science and Engineering, What Government support is available for research and innovation?, Sept 2018
203 Confederation of British Industry, UK will not reach the Government’s R&D spending target until 2053, 14 May 2019
205 Ibid
207 NAO Cross-government funding of research and development Nov 2017
209 The SBRI (delivered by Innovate UK) is a two-stage, contract-based programme to fund the development of innovative technology solutions to meet government needs - either for departments’ own requirements or to meet policy challenges. Phase 1 contracts are worth £50–100,00 and Phase 2 £250,000 to £1 million, with project costs 100% funded.
210 BEIS Dowling Review of Business-University Research Collaborations July 2015, recommendation 29
213 BEIS Leveraging public procurement to grow the innovation economy Nov 2017 pp14–17
214 Government Digital Service GovTech Catalyst information
218 Science and Technology Committee, Twelfth Report of Session 2017–19, Quantum Technologies, HC 820
221 BEIS, Building our Industrial Strategy, Jan 2017
223 Uyarra & Flanagan (2010) Understanding the innovation impacts of public procurement, European Planning Studies, 18:1, 123–143
224 Royal Academy of Engineering (BER 0061) para 35
228 Institute for Government, Government Procurement: the scale and nature of contracting in the UK
229 Science and Technology Committee Digital Government inquiry launched
230 Relevant rates and qualification criteria for the different schemes are detailed on the Government R&D tax reliefs
231 HMRC, Evaluation of Research and Development Tax Credit, March 2015
232 UCL (BER0014); BioIndustry Association (BER0030); UK Research and Innovation (BER0063); Royal Society of Biology (BER0076)
237 HMT & HMRC, Preventing abuse of the R&D tax relief for SMEs: consultation, March 2019
239 IPPR Commission on Economic Justice, Industrial Strategy: Steering structural change in the UK economy, November 2017, p 4
242 Financial Conduct Authority, Patient Capital and Authorised Funds, Dec 2018
243 HM Treasury, Patient Capital Review, Jan 2017
244 HMT Financing growth in innovative firms pp 11–12;namely a proportionally lower number of young large listed companies, a lower proportion of R&D being performed by younger companies, a lower number of “unicorn” firms” (a private company valued at more than $1 billion (US), fewer firms growing to scale, and a tendency for UK investors to exit at a relatively early stage, reducing firms’ ability to scale up.
247 HMT Budget 2018 para 4.43
249 Financial Conduct Authority, Patient Capital and Authorised Funds, Dec 2018
250 Financial Conduct Authority, Consultation on proposed amendment of COBS 21.3 permitted links rules, Dec 2018
Published: 12 September 2019