Evaluation of Research and Development (R&D) Expenditures, Firm Survival, Firm Growth and Employment: UK Evidence in the OECD Context

The latest strategy paper by the Department for Business Innovation and Skills states that innovation is the "main pathway to sustainable economic growth, higher real incomes and greater wellbeing in the long run" (BIS, 2011). Similar assessments are made in the latest consultation document published by HM Treasury in June 2011. The latter also indicates that the government is committed to maintain the R&D Tax Credits scheme and make it more accessible to small firms and start-ups.

These policy initiatives are unfolding against a background of tighter credit markets in the wake of the financial crisis. Recent surveys indicate that company managers and R&D directors tend to be more strategic in their decisions concerning innovation processes and portfolios. Fiscal constraints caused by the crisis have also led to higher public and government expectations that public spending priorities should be justified on the basis of beneficial outcomes.

Given this environment, it is essential to strengthen the evidence base on how incentive schemes affect R&D expenditures by firms, how R&D effort may affect firm survival and performance, how these effects vary between UK firms and industries, how the UK evidence compares with synthesized OECD evidence. The proposed research aims to address these questions in three stages.

In stage 1, we conduct meta-analysis to establish whether or not R&D expenditures are effective in stimulating growth and employment. The evidence base for meta-analysis will consist of estimates reported by all empirical studies that investigate the effects of firm-level innovation on firm survival, growth and employment in OECD countries from 1990 to2012. The meta-analysis will enable us to synthesize the overall effect, while accounting for the sources of variation between primary findings, firm/industry characteristics, study design characteristics, and period/geographical dimensions. It will also enable us to compare the findings form UK data with the synthesized evidence based on data from OECD countries.

In stage 2, we will investigate the effects of R&D Tax Credits on firms' R&D expenditures. Unlike the existing literature that estimates cost elasticities of R&D expenditures, we will use matching difference-in-difference methods to investigate the effects of the incentive scheme on R&D efforts of beneficiary ('treated') firms relative to others ('un-treated'). It will also allow for establishing whether it has 'picked up winners' by inducing already R&D-active firms to make more use of the incentive. The findings will have significant implications for public policy and for public perceptions and expectations-formation.

In stage 3, we investigate the effects of R&D expenditures on firm performance in terms of survival, growth and employment creation. To investigate UK firm survival, we use hazard rate models to estimate the probability of firms going out of business over time. To investigate the effects of R&D expenditures on growth and employment creation, we use dynamic panel-data methods that allow for consistent estimation. In all performance estimations, we will control for firm, location, and industry characteristics that are included in the existing literature; but also liquidity constraints that are not investigated in the wake of the recent credit crunch.

Overall, the proposed research is about finding out what works or does not in the overall policy cycle of R&D and firm performance - from policy intervention through intermediate target to ultimate target. It is also about finding out what explains success or failure - and how the UK evidence compares to the synthesized OECD evidence. Therefore, our findings will strengthen the evidence base for evidence-informed public policy and the existing literature.

Beneficiaries

While developing this project, we have consulted with six representatives of potential stakeholders. Our aim was to elicit their views on how the research question can be made policy- and practice-relevant and what aspects of the innovation-performance relationship should be prioritized for investigation. The stakeholders we have consulted are:

Public sector: The Department for Business, Innovation and Skills (BIS); and the Office for National Statistics (ONS).

Private sector: The Confederation of British Industry (CBI); and the Northern Trust Corporation.

Third sector: National Endowment for Science, Technology and the Arts (NESTA); and the Secure Data Service of UK Data Archive (SDS).

Consultations with our stakeholders have enabled us to identify other potential stakeholders, which include: The Technology Strategy Board (UK), the Trades Union Congress (TUC), the South East England Development Agency (SEEDA); and the Europe INNOVA unit of DG-Enterprise of the European Commission.

This experience led us to adopt a snow-balling approach to maximising stakeholder engagement. The approach is informed by the systematic review methodology and consists of expanding the stakeholder engagement as the research project unfolds. The expansion will be driven partly by recommendations from existing stakeholders and partly through discovery of new organisations or entities as we gather more information about the stakeholder landscape. We will keep a record of the snow-balling process and report the number of stakeholders we engaged over time.

The snow-balling exercise will also benefit from inputs by members of the Project Advisory Board. The latter will include representatives from BIS, ONS, SDS, and NESTA; and two academic peers: Professor Sushanta Mallick of Queen Mary, London and Professor Tom Stanley of Hendrix College in the US.


Benefits

The proposed research will benefit a wide range of stakeholders, including the general public. This is due to the nature of the research topic, which has significant implications for jobs, welfare, firm competitiveness, quality of life, and effective public policy. The potential benefits are explained below.

R&D Tax Credits is a public policy intervention based on the premise that innovation has positive externalities. This quality justifies subsidization because the level of R&D effort by firms may remain less than optimal if it is determined by market forces only.

Our policy evaluation analysis will enable us to establish whether the scheme leads to higher R&D effort by comparable firms or it does tend to 'pick-up winners'. In other words, does it address the externality problem? Or, does it just induce firms that already spend more on R&D to use the scheme more heavily than others? The answer to this question has significant implications for welfare-maximization objective of the public policy.

In addition, our research will shed light on whether the R&D effort affects wealth and job creation; and how this effect may vary between firms, industries, types of R&D expenditures, geographical regions and liquidity constraints exacerbated by the recent credit crunch. These findings will enhance the scope for better-informed decision making by policy makers, employees, institutions specialized in the economics and management of innovation, financial institutions, and investors.

With enhanced information on the innovation-performance relationship, policy-makers will be able to fine-tune the policy to maximise welfare; employees will form better expectations about innovation's effect on employment and wages; research and advocacy organisations will be able to extend their research into controversial issues; and the cost of capital for R&D expenditures will be less distorted by asymmetric information between firms and financial institutions/investors.