UK: A TRUE TEST FOR POLICY - INDUSTRIAL PERFORMANCE. - Lack of finance for innovation is a critical factor in the UK's performance.

by Roger Eglin
Last Updated: 31 Aug 2010

Lack of finance for innovation is a critical factor in the UK's performance.

Recently The Sunday Times carried a story about a confidential industry report prepared for the President of the Board of Trade, Michael Heseltine. Its message was dispiriting. Though the performance of UK industry was improving relative to its competitors, the gap remained wide. With poor management, indifferent products and inadequate investment in new technology, it would take decades to overcome the problems.

There is growing evidence to suggest that until Britain gets over the handicaps of a poorly educated labour force and dispiritingly low rate of innovation, the competition will remain ahead. Skill shortages and inadequate innovation feed off each other. A recent report comparing educational attainment in the leading industrial countries emphasises how handicapped UK industry is when it comes to introducing new investment. Productivity levels, says the report, which was prepared for the DTI by the National Institute of Economic and Social Research, are on average 20% lower than in Germany. Workers there are typically more capable than their British counterparts of switching flexibly between different tasks and of consistently achieving high standards of output. Compared with their UK rivals they had greater ability to implement new technology and to compete successfully in high value-added areas of production.

The report revealed how company performance was undermined by lack of skill. Higher level technicians and middle managers in Britain are more often involved in trouble-shooting than their counterparts in France or Germany.

Successful innovation depends not simply on research but on getting products to market quickly. Indifferent performance in bringing products to market undermines profitability which in turn means fewer resources are available for product development, marketing and training. Trapped in this spiral of decline, many UK companies have no future.

A new book, The Second Culture - British Science in Crisis, suggests that the poor record of innovation is pervasive (see page p60). After pointing out that industrial exploitation of science is hampered in the UK because management is not much better educated than its workforce and cannot - as many foreign managers can - grasp the technical issues involved in decision-making, the book's author, Clive Rassam, stresses that the availability of financing is a critical issue. He quotes executives such as Derek Roberts, a former technical director of GEC and Plessey, who blames the short-termism of the City. A former colleague of Roberts, Nigel Horne, believes the poor financial environment is the problem: 'What's wrong here is that the banking system and the financial system don't encourage risk-taking of any kind.'

While the evidence from the venture capital business certainly suggests that the financial community is wary of innovation, the real question is why? I suspect that the issue is not a reluctance to fund innovation per se but the difficulty financiers have in finding projects where the risk/reward ratio is acceptable. Big pharmaceutical firms are prodigious spenders on research and development. Yet none of them experience much difficulty in funding it. They are big enough to absorb the odd failure. They are very profitable. Unfortunately the same comment cannot be made about their manufacturing contemporaries in Britain. Set against rival economies such as Germany, Japan or America, Britain has fewer world-class firms making outstanding profits. Bank of England figures show that industrial profitability is 40% lower than in other major economies.

Dr Walter Eltis, Michael Heseltine's economic adviser, argued in a recent study, The Financial Foundations of Industrial Success, that the financial community's supposed short-termism and aversion to innovation is based on rational investment considerations. Poor industrial profitability means investment is riskier here. 'Where investments are risky, as they are in all cases involving research and development, investors require an above average return to compensate for the greater dispersion of possible outcomes. 'With far higher profitability, much more can go wrong with French, German, Japanese and US businesses and still leave an adequate margin to cover interest.' This is not the case in Britain, Eltis points out. Finance quickly becomes a problem as things go wrong; banks are reluctant to renew loans; and profits and dividends are threatened. Shares prices fall and the company slips into decline or is taken over. It is a familiar British scenario.

The fact that Eltis was one of the main influences behind the DTI report, explains why it was so gloomy. There are no simple panaceas. But the test of any industrial policy the Government develops, or the Opposition proposes, should be what it contributes to the restoration of corporate profitability. Controlling inflation should help re-store the real return on investment. The fact that many firms cannot afford to spend on training or investment, or banks to lend on poor risks, suggests the Government should consider giving more help with training (see also Europe, p18) and cheaper loans or tax breaks for industrial investment. But it is no good complaining about short-termism and lack of support for innovation without appreciating the real issues behind it: until UK industry can afford self-improvement, the economy is in trouble.

Roger Eglin is associate business editor of The Sunday Times.

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