Competing in the Global Economy – The Innovation Challenge

However if the economic models that support claims of short-termism are true then all
firms – wherever located – should have similar problems in trying to communicate the
benefits of potential projects to investors. Some argue that other national innovation
systems – e.g. Germany – allow better information flow between investor and firm
because of their different system of corporate governance (with Bank representatives
sitting on company boards for example). But even under these systems, firms still
report difficulties 116 . Nor does it explain why countries like the US, with apparently
similar financial systems to the UK, deliver higher levels of R&D spend.
Although firms rate financing constraints as a significant barrier to innovation 117 the
most recent CBR research suggests that when firms seek external finance they
generally get it – and usually from banks 118 . Innovators are as likely to receive finance
as non-innovators. Only 10% of the CBR firms were unsuccessful in obtaining external
finance although older and larger firms tend to be more successful than smaller
firms 118 . This should not come as a surprise since we would expect firms with a track
record to be more successful. In general terms then, whilst UK firms may under invest
in innovation related activities, it is unlikely that access to finance is the main reason 120 .
Given the levels of uncertainty involved in the innovation process it is likely that, on
occasion, investors take a cautious attitude to investments in innovative firms. This is
reasonable. The issue for Government is simply whether the problem is particularly
worse in the UK and whether it can improve upon the status quo.
Looking at the supply of finance it is difficult to argue that, generally, there is a
shortage of finance for innovation. UK capital markets are well developed and equity
markets are extremely strong. With a market capitalisation of £1523 billion the London
Stock Exchange is one of the largest in the world. Apart from it, which tends to focus
on the needs of larger firms, the UK also has secondary markets, such as AIM and
OFEX, and private equity which acts as source of finance for smaller firms. The UK
private equity industry continues to be the largest and most developed in Europe,
accounting for 29% of total annual European Equity investment in 2001. The next
largest industries are Germany (18%) and France (13%) 121 .
Private equity
Private equity means the equity financing of unquoted companies at many stages in the life of
a company from start up to expansion or even management buy outs or buy ins of established
companies. Venture capital is a sub-set of private equity.
Source: BVCA
116 Firms in Germany do report difficulties in getting long-term partners to finance R&D and the acquisition of intangible assets. This may
be due to the absence of instruments to spread risk, such as well developed equity markets. For example see the chapter on Germany
in Technological Innovation and Economic Performance Edited by Benn Steil, David G Victor and Richard R Nelson. Princeton (2002).
117 For example, the second Community Innovation Survey showed that 10% of UK firms reported that they lacked appropriate sources
of capital or that the cost of finance was a constraint on innovation. This figure was around twice the European average, and financial
constraints disproportionately affected higher technology businesses. According to the CBR survey economic factors – such as costs
of finance or length of payback period – tend to rank mostly highly as barriers to innovation.
118 Cosh A and A Hughes, Enterprise Challenged: Policy and Performance in the British SME Sector 1999-2002, ESRC Centre for
Business Research, University of Cambridge (2003).
119 For SMEs, CBR show that the most important source of finance is banks. 79% of firms seeking finance do so from banks with less
than 10% of firms seeking finance from all other sources apart from HP/leasing businesses. Their analysis of failure rates showed
that whilst a statistically significant proportion of bank finance applications failed, this was not surprising given the volume of bank
finance relative to other sources. Taking account of this, CBR show that failure rates are higher for venture capital. Firms of different
sizes also have different patterns of financing. Venture capital is more likely to be sought by larger firms. Micro firms are more likely
to seek finance from banks and are more likely to fail to obtain it.
120 Researchers have also used R&D data to test for the existence of financial constraints. If firms are financially constrained, because of
imperfections in capital markets, they would be unable to attract sufficient external funds and would be reliant on internal funds to
finance investment in R&D and this should result in the level of R&D spending being sensitive to changes in internal finance. Overall
the results of empirical studies are inconclusive. See Becker B and N Pain, What Determines Industrial R&D Expenditure in the UK?
National Institute of Economic and Social Research, working paper (2002).
121 British Venture Capital Association, The economic impact of VCTs (2003).
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