How to build an ideas factory

By Mariana Mazzucato
Published on guardian.co.uk at on Saturday 9 October 2010.

The Tories have told us that they want the UK to become a "factory of ideas", fuelling the economy, and indeed the world, with new products and services. Policy and headlines so far have focused on cuts as the central plank of the economic policy. Little attention has been given to the much needed growth plan that will deliver the promised innovation and prosperity.

With budgets so restricted, transforming the UK into a factory of ideas will depend on carefully targeted investment in those activities that nurture the experimentation necessary for innovation. Innovation is a collective process and depends on systems: the interaction between companies and publicly funded research, education, public infrastructure, venture capital and regional development agencies.

One tangible policy measure agreed is the creation of the green investment bank, which is expected to raise £2bn to kickstart a green technology revolution. Yet Ben Caldecott, Climate Change Capital's head of UK and EU energy and environment policy, said improving the UK's ageing energy infrastructure will "require investment at a scale and speed not seen for a generation".

Leading in the green tech race means attracting the best scientists from around the world. Yet last week we were told that the cuts in research budgets are already causing a brain drain; some of the UK's best scientists – the ideas! – are leaving the UK.

So what could and should be done to improve our competitiveness and prevent economic stagnation? To echo the CBI two weeks ago, it is of course essential to continue investing in the very best early-stage research, human capital formation and the nation's infrastructure. These are the wellspring of innovation and cutting them will damage the "animal spirits" that drive business confidence and stimulate investment.

But, on its own, this will not be sufficient. Industrial policy needs to return after decades of taking the back seat, and part of this policy must be to help financial markets reward rather than penalise innovation – a serious problem even before the current crisis.

Evidence demonstrates that companies who engage in more risky innovation are being penalised by banks with higher interest rates than those being offered to less innovative companies. Any growth policy needs to include new incentives for motivating banks to support these firms, perhaps by subsidising the difference in the rate offered to innovative versus non-innovative companies.

Venture capital has not done enough to nurture companies through to product development, giving priority to making millions from the initial public offering phase (IPO). So rather than hyping up the role of venture capital, policy should promote and support those VC companies that have a record in the formation of new products and services.

Credit ratings also need to be re-examined if we are to ensure that they better reflect the high risk taken on by companies that invest in the long term. Sadly, currently, the ratings tend to overemphasise financial indicators (share price) and underemphasise industrial ones (productivity, innovation) and hence often cause more harm than good.

Financialisation and the focus on short-term profits rather than long-run growth has caused many companies to spend millions repurchasing their shares simply to boost their share price, at the cost of spending on R&D. So policy must favour those companies actively engaged in breaking new ground and inventing the new products and services that have the potential to create growth and new jobs rather than those whose sole concern is boosting their share price.

If growth in the UK is going to be led by the creation of new ideas, these policies along with targeted state investment are key. Thatcher and Reagan's trickle-down policies, which assumed that investment would increase automatically if the rich got richer, did not work. They did not work because the cuts they imposed hurt the animal spirits that deliver the confidence and bravery to experiment with new wild ideas which are uncertain today but the foundation of tomorrow's future. The Tory dream of turning the UK into a hotbed of innovation will require a major change of mindset – and a lot of cash.

Professor Mariana Mazzucato, Economics Director of the ESRC Innogen Centre, is an industrial economist with a particular interest in the economics of innovation and its implications for innovation, growth and economic.
Follow her personal blog, dedicated to thoughts on how investment in innovation, with all the uncertainty and risk taking that it encompasses, can lead to more equitable growth.