Macroeconomic modelling of the 2.4% R&D target

James Tooze reflects on recent analysis of reaching the Government’s R&D target.

Alongside the publication of the Government’s R&D roadmap, BEIS published a macroeconomic analysis paper focused on the target to increase research intensity to 2.4% by 2027. The paper outlines a number of scenarios by which the UK could, in theory, attempt to reach this target and the effects it would have. The economic model takes process innovation and product innovation into account, while also assessing the spillover benefits from innovation. You can read the full paper here but I will pick some of the findings from the report and discuss the potential consequences of the conclusions.

More R&D drives economic growth and productivity

We have long argued at CaSE that long-term investment in R&D will lead to positive economic outcomes for the entire country. The Government has recognised this, with a huge boost to public investment in R&D up to 2024/25. In every scenario that the paper used as part of the economic modelling, UK GDP grew when compared to a reference case where R&D investment remained flat. In absolute terms by 2027, R&D investment could add £30bn to the UK economy and create 80,000 new jobs. It is unclear, however, whether this accounts for the current economic difficulties in wake of the Covid-19 pandemic.

The report noted, importantly, that there is a time lag associated with this growth. This means that a concerted effort is required to receive the greatest benefits from research, whether that be allowing time for diffusion of new technologies, boosts in trade performance or increases in investment from across all sectors. The report shows that if the UK were to continue with a drive to increase research intensity to 3% by 2040, UK GDP could increase by £180bn and create over 900,000 jobs. This is why the Government’s commitment to increase public investment in R&D can only be maximized by being part of a long-term plan. This includes the spillover benefits of research and innovation, where the fruits of R&D are felt beyond the sector carrying out the work and benefit all those across the UK.

Continued R&D funding more important than where the investment comes from

The paper outlines a number of models that analyse different scenarios where particular sectors or organisations play a more significant role in the uplift in research investment. Models of other policy interventions, such as using more public sector investment to increase R&D tax credits, were also tested. The models conclude that in the medium and longer-terms, all scenarios lead to economic growth but no one particular scenario is significantly better than the others.

One of the scenarios that is modelled in the paper is where the UK greatly increases the amount of Foreign Direct Investment (FDI) as a proportion of the increase in R&D investment. FDI is an important part of the UK’s current R&D investment portfolio but has stagnated in recent years. The growth of firms contracted to perform R&D in the UK by other private firms located overseas has become incredibly important to the UK. In an increasingly globally competitive landscape, combined with the economic difficulties arising from the current pandemic the UK has to fight hard to keep much of this investment. The economic model does show, however, that the origin of the investment is not as important as ensuring the investment is maintained.

Although it may be easier to have a scenario where the Government could focus its efforts for the maximum benefit, showing there is no ‘right’ way to ensure research drives economic growth means the UK can use its strengths and be strategic about the investments it makes. It is often said that the balance of private and public investment in research should be roughly 2:1, although the UK’s ratio is currently closer to 3:1. Perhaps more important than having a 2:1 ratio is having an understanding of how to maximise and expand the UK’s research portfolio that gives the UK the best chance to succeed.

Investing in R&D can drive economic growth across the country

One of the most interesting scenarios that the report outlines is the location of increases to R&D investment up to 2027. The scenario models an outcome where the largest increases are made within London and the South East, and the alternative model where the majority of investment occurs outside of the so-called ‘Golden Triangle’. The model shows that greater growth in funding outside the Golden Triangle, unsurprisingly, leads to greater economic growth in all other UK regions than the reference case. There are a number of caveats to this outcome that need to be considered.

It is incredibly important to note, however, that the economic model used is not able to take research capacity into account, including the ability for regions to absorb large increases in research investment. Supporting each region to be the best it can be, rather than seeking to recreate successes from other areas of the country, has been key feedback from across the UK as part of our Power of Place report. That’s why we have called on the Government to support research excellence, regardless of size across the UK and our ask was picked up in the Government’s roadmap.