A nation of innovation

When I was growing up the north east was the UK’s industrial powerhouse. Quite literally: the coal which fed the power stations which fuelled our industry was beneath our feet. Across Newcastle, the end of the school year would see thousands of school leavers walking straight into apprenticeships in the shipyards or the factories.  At the Armstrong site in Elswick in my constituency 23,000 were employed during its heyday in the early 1900s, Swan Hunters in Wallsend employed 11,500 shipbuilders in the 1970s.

Those days are gone and with them the structure of employment in the region. The north east is still a manufacturing centre, but automation and huge productivity gains mean that manufacturing is no longer the leading employer in the region. That title has passed to the public sector where one quarter of the region’s workforce are employed. The government’s current targeting of public sector employment is hitting the region hard.

A one nation economy requires jobs, good jobs; not minimum wage or dead-end jobs but the sort of productive and well-remunerated employment that young people want to aspire to and will help close the income inequality gap which has widened so much since the sixties.

Government needs to nurture the businesses who will provide these jobs. We are often told to focus on building UK Googles and Facebooks. The UK economy would certainly benefit from new media giants – as long as they pay their taxes – but let us not forget that for every £700,000 of sales revenue Google employs one person whilst Rolls Royce employs three.

So while we want new media giants we need a range of growing innovative companies in different sectors, including manufacturing, to provide the good quality secure and flexible jobs that a fairer, more productive economy needs.

Napoleon called us a nation of shop keepers – he meant it as an insult, we took it as a compliment. Now we need to become a nation of innovative businesses. A whole nation of innovative businesses that is. Not a cluster in east London and another on the M11, but a nation where a new, innovative, business could be started over a coffee in any city.

Unlocking the small business innovation potential is the achievement which I believe would do the most to guarantee our economic prosperity in the future. And if we have the right approach to skills, risk and reward it will also contribute to a more equal society.

Innovation is not necessarily a force for a fairer society. It is important to remember that the first industrial revolution actually led to increased inequality as crafts jobs were lost and industrial magnates made fortunes they did not share. Economists William Lazonick and Mariana Mazzucato showed in a recent paper how the rewards of innovation are not always fairly shared by those who take the risks, especially employees. [1]

We are on the brink of another industrial revolution, as we deal with the carbon legacy of the last one and emerging markets industrialise. We need to make sure that the rewards of this revolution’s innovations are distributed more fairly than the last, by democratising our science talent base and enabling small and medium sized enterprises (SMEs) to take advantage of the opportunities on offer.

SMEs account for almost half of UK economic output and almost 60 per cent of private sector employment. There are 4.8 million SMEs [2] in the UK and 1.6 million[3] on job-seekers allowance. If only one third of  SMEs took on one more person the battle against unemployment would be won. That’s why Labour set up a small business taskforce to look at how we can create the best environment for SMEs to start, grow and develop through every stage of their business life cycle

Now most economic literature agrees that innovation is a critical driver of growth. One study analysed by the Harvard Business School professor Josh Lerner in his book Boulevard of Broken Dreams estimated that 80 per cent of growth is due to innovation – that is innovation in the broadest sense, covering new processes, business models and materials as well as products. NESTA more recently put the figure at 63 per cent.

Unlocking the innovation potential of small businesses in a fair and equitable way will not be the result of any one policy. There are many different factors that need to be addressed, from the perception of business and innovation in our culture to the relationship between universities and small and medium enterprises. Perhaps most importantly the financial environment needs to be considered.

I want to focus on three potential ways to improve the financing of small, innovative businesses, through commercial bank lending, procurement and public investment.

Despite many, many warm and occasional angry words on the subject, this government has not succeeded in significantly improving bank lending to small businesses. Indeed there is considerable evidence, both anecdotal and quantitative, that lending to small businesses has declined as banks become more risk averse and seek to rebuild their balance sheets. Businesses in my constituency complain that they have been forced from existing loans onto new overdrafts at higher rates which are then counted as ‘new’ lending. The most recent figures from the Bank of England show that lending to businesses has contracted in nine out of the past 12 months and fallen by more than £13bn over this period, while the ITEM (Independent Treasury Economic Model) club has predicted that bank lending is falling to its lowest level since 2006.

Nick Tott’s recent report for Labour’s policy review – The Case for a British Investment Bank’ – gives a detailed analysis of the small business lending failure. One of the key challenges is knowledge and support – understanding the small business and supporting it as it grows.

Banks may lend to businesses they know well in recognised market segments with plenty of fixed assets. When it comes to markets with which they are less familiar they turn the business away. New innovative businesses often add technology risk to the mix, engineering businesses require significant capital investment. What these businesses need is finance which is knowledgeable and patient, and that is all too rare.

Knowledgeable finance not only provides money but support, helping upskill small businesses to meet the demands that growth places on them. For example, fast growing SMEs have a great need for skilled, innovative people but do not have large human resources departments to help attract, retain and manage them.

Equally as our own economy bumps along somewhere between recession and sluggish recovery, growth opportunities are increasingly likely to be found abroad but many SMEs do not have the right overseas contacts or knowledge to exploit them, or the influence to win a place on a prime ministerial trade mission.

Some commercial banks are developing programmes to bridge the gap. One such is Santander’s ‘Breakthrough’ programme which aims to help the UK’s fastest growing SMEs achieve their full potential through intensive, hands-on support. So the bank funds business workshops with successful companies, networking conferences and international trade missions as well as internships to match university graduates with small businesses.

And of course it provides finance, £150m from Santander and £50m from the regional growth fund. One year in, Santander Breakthrough report they have invested £5m in four companies, created over 200 new jobs, taken 30 SMEs on three trade missions (including one all women trip to the US) and are offering 500 internships through 65 Universities.

Feedback from the small businesses on the programme is universally positive, in contrast to the criticism I hear all too often in my surgeries. It is early days but such programmes would seem to suggest that when the right incentives are in place, and the will is there, high street banks can make a difference.

The Santander Breakthrough program is clearly having some success but it lacks scale and, critically, businesses need to have revenue of £500,000 to reap most of the benefits. It is not going to help start-ups that have yet to make their first big sale.

But there is a programme designed to do exactly that – and Labour introduced it. The Small Business Research Initiative (SBRI) is based on a long running, highly successful US programme which helps smaller businesses develop new technologies for public sector customers.

A public organisation identifies a specific challenge and in an open competition small businesses submit their ideas for innovative solutions. Those showing promise are awarded initial development contracts up to £100,000. After assessing the results, the most successful may be awarded a further contract worth up to £1m to develop the product to commercial viability.

In one example a Scottish company developed software to translate sign language into text to help hearing impaired people use smart phones. The device camera captures a video stream which is then processed by the software to recognise sequences of user gestures through a locally stored ‘library’ of core concepts or words. These are then assembled into sentences, which are outputted as text in real time.

With fewer than 10 employees but £150,000 of SBRI phase 2 funding, Technabling Ltd is now working to extend the image recognition technology to capture the whole of British sign language enabling a fully fledged, affordable product which could transform the way the way 100,000 British Sign Language users communicate with other people. ‘Assistive technology’ is a growing field bringing technology to the assistance of those who need it most.

SBRI offers many advantages to Technabling Ltd compared with conventional grants programmes, which can only fund a proportion of total costs. SBRI provides 100 per cent funded procurement contracts and the funding goes directly to the small business; it is linked to a real customer need, and it provides a track record for subsequent customers and investors. For public sector customers, the phased approach helps to manage the risk so evident in many public IT procurement programmes.

But despite its popularity with SMEs total SBRI spend is still only around £20m per annum. Taking into account the relative size of the UK economy, this is about one tenth of US spend on its equivalent program and is less than a tenth of the amount Eric Pickles planned to spend promoting weekly bin collections. There have been calls to expand this and Labour is looking at this as part of our policy review. We are clear that we need to have the right programmes and institutions that can help unlock the innovation potential at different stages of the business cycle.

So getting commercial lending right and driving innovative procurement through schemes like SBRI could help make knowledgeable and patient finance more available. Success breeds success and a vibrant environment of growing, innovative small businesses will encourage tech entrepreneurs and academics to take their ideas to market. But innovation needs to spread beyond those who are already in the sector. It needs a public face and a way of engaging people more directly in the highs – and lows – of the innovation process.

Part of this should be through our culture and the media – sharing more of the stories of the great small innovative businesses across the country. But some have made proposals for how high street savings and investments schemes could play a greater role in promoting innovation. One existing scheme is the Individual Savings Account (ISA) which uses tax benefits to encourage savings and investment in certain types of stocks and shares.

In France however an ISA-type product is used to encourage innovation.  The Fonds Commun de Placement dans l’Innovation (FCPI) scheme raises investment funds from the general public to  finance innovative technology  companies in France and abroad. This has proved very successful in raising funds – over €6 billion since 1997. By the end of 2010, FCPIs had invested in over 1,150 companies through 300 funds run by nearly 40 asset  management companies.  Comprehensive analysis of the data available indicates that FCPI funds have had a demonstrably positive effect on their target market of innovative SMEs.

One sector of our economy which is characterised by small growing companies is biotech. Their industry group, the BioIndustry Association (BIA) is calling for a form of innovation ISA – Citizens’ Innovation Funds (CIFs) which, they argue, would ‘provide a practical way of unlocking the patriotic  potential of a large number  of Britons to support the  innovative businesses which  are essential for our nation’s  economic future’.  Their analysis suggests that the costs of the tax relief would be returned to the treasury within three years through increased corporation tax, employee income tax and national insurance tax receipts, but detailed modelling would be required before this could be confirmed.

Investment in innovation is risky. As the advertisements say ‘investments can go down as well as up and you could get back less than you have paid in’. But investment in innovation is also exciting and productive, leading to new applications and medicines, better ways of communicating and cleaner sources of energy, which touch all of our lives. If the risks are clearly communicated and managed through appropriate investment vehicles, knowledgeable and patient finance and supportive procurement programmes, many more British businesses and individuals might be inspired to share in the adventure. Investment in innovation is wealth creating. We need to expand the opportunities to share in that wealth and build a nation of innovation.