The United Kingdom, once a global leader in innovation, has seen its ranking slip in recent years.
According to the World Intellectual Property Organization’s (WIPO) Global Innovation Index, the UK’s position has declined from fourth to fifth. While this remains a promising rating, the WIPO data provide insight into the UK economy’s weaknesses and areas most in need of improvement. These insights can help improve policy to make the UK more innovative and globally competitive.
The UK’s most significant weakness, according to WIPO, is its Gross Fixed Capital Formation (GFCF). WIPO ranks the UK’s GFCF 107 among the 133 included countries. The UK also has the weakest GFCF performance among G7 countries.
GFCF, which represents investment in long-term physical and intellectual capital, is critical for economic growth. However, it remains poorly understood, and this misunderstanding has led to underinvestment, especially in the intangible assets that are key to the modern economy.
Understanding GFCF: More than just physical capital
GFCF is often associated with spending on physical assets like machinery, buildings, and infrastructure. However, it also includes investment in intangible assets, specifically intellectual property products (IPP), such as Research and Development (R&D), mineral exploration, software, and databases. In the UK, overall GFCF has remained stagnant for nearly three decades. And in recent years, there has been a decline in IPP’s share of GFCF in favour of physical capital (See figure below, based on recent ONS data).
The distinction between physical capital and IPP becomes especially relevant in periods of economic downturn. During the financial crisis and the Covid-19 pandemic, for instance, physical capital investment dropped sharply, while IPP investment slightly increased. But in the recovery periods, physical investment surged while IPP investment fell behind. This trend is especially concerning now, as IPP investment continues to decline relative to physical capital.
A call for IPP investment
While physical capital is vital to an economy, intangible assets like IPP are critical to driving long-term economic growth for two main reasons.
First, IPP is needed to fuel the UK’s services driven economy. Intangible products created in service sectors like finance, consulting, and software development fuel the majority of the UK’s economic output. Without sufficient investment in intangibles, these sectors risk losing their competitive edge.
Second, IPP boosts the productivity of physical capital by making manufacturing processes, energy systems, telecommunications networks, and transportation infrastructure more efficient (Neves et al., 2021; Mezzanotti & Simcoe, 2023). The synergy between physical and intangible investments is especially crucial now. In its Industrial Strategy Green Paper, the Government has signalled its desire to expand the UK’s productive capacity in sectors which demand high levels of physical capital productivity, including advanced manufacturing, green energy, and defence. To improve these sectors’ productive capacity and integrate them into the broader economy, physical and intellectual capital must work in tandem.
A balance approach to investment
To reverse the decline in IPP investment, the UK must prioritise both private and public investment in research and development (R&D). R&D investment leads to the generation of new, more innovative ideas, technology, software, systems, and other IPP. This IPP in turn creates a more active service sector and more productive physical capital.
However, private R&D investment in the UK has slowed, even as it continues to grow globally. In 2022, UK business investment in R&D fell by 0.4%, while international investment rose by 5%, with even higher growth in countries such as the US, Japan and South Korea. Additionally, the percentage of UK businesses actively engaged in innovation dropped from 45% in 2018-20 to 36% in 2020-22, marking the lowest level in over a decade. This decline raises concerns about the UK’s competitiveness in the global innovation landscape.
The recent slowdown in private R&D and innovation comes as government R&D investment has seen significant growth in recent years and has been placed at the heart of the country’s economic growth strategy, as outlined by the Chancellor in the new government’s first budget. Public R&D spending provides a cost-effective way to stimulate private sector investment. NCUB analysis shows that every pound of public R&D investment generates £3 to £4 of long-term business investment in R&D.
The Government’s new Industrial Strategy is a promising step toward reinforcing the UK’s position as an economic powerhouse. This strategy should be used to foster an environment that encourages essential research, innovation, and collaboration around both physical and intellectual assets. The UK’s strength in the eight priority sectors lies in businesses investing in R&D to generate ideas, expertise, and intellectual property that advance manufacturing and business capabilities and builds a competitive edge.
A balanced approach to investment calls for a step change in private R&D investment and its translation into tangible innovation outcomes. Achieving this, requires a new vision for R&D and innovation, with committed collaboration among businesses, universities, and the government – working together as partners in the R&D ecosystem. By fostering an environment conducive to innovation and collaboration, the UK can position itself as a leader in R&D, driving economic prosperity and societal progress.
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