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Putting productivity at the heart of university-led investment zones

In this blog for The Productivity Institute, Nigel Driffield and Sam Roseveare from the University of Warwick analyse the key questions that need to be addressed to maximise the benefits of the UK’s new investment zones and how productivity factors into these questions.

The recent UK government budget (March 2023) unveiled the creation of university-led investment zones, to the excitement of the economic development community. Building on the initial innovation accelerators that are about to be trialled in the West Midlands, Greater Manchester and Glasgow, which seek to align university research with local priorities, the next phase seeks to use fiscal intervention in the form of tax relief and other investment incentives. An implicit assumption of these actions is that they will help locations to attract investment, with research at the research-intensive universities being a vital part of the regions’ value proposition to attract internationally mobile capital. The proposition on the table is that tax relief and other investment incentives linked to research in leading universities will crowd in investment and boost productivity by aligning financial and human capital with research and knowledge transfer activities.

We should start off by saying that, broadly speaking, we think this is a welcome initiative. Spread across eight large metropolitan areas of the UK, and seeking to align university-led innovation with regional priorities in terms of industrial development, innovation and productivity growth, the proposed policies are likely to place the needs of the location at the heart of the priorities, with the decisions in the hands of locally elected leaders.

However, the creation of these new investment zones also raises a number of related policy questions that need to be dealt with at the local level:

    1. Do locations prioritise existing areas of strength with above average productivity, or seek to catalyse new, potentially high growth areas by leveraging research and frontier technologies? If the former, we might expect place-based innovation policy to encourage more general interactions between businesses and universities – potentially strengthening sites that are already internationally competitive. If the latter, then the challenges are likely to be around scaling-up nascent activity.
    2. Do the zones play to the research strengths of the universities involved, or do they focus on their other activities? As noted above, leveraging research could catalyse the creation of high growth sectors, but universities also play a role in attracting inward investors and angel investors, in skills development, as well as supporting business development – particularly with the SME sector.
    3. Do locations seek to crowd in new investment, or seek to nurture investment that is already there? Prioritising new investment is likely to meet the government’s short-term objectives for increased direct investment, but well-designed interventions that nurture existing investment could enhance resilience, potentially leading to productivity gains and other innovations over the medium to longer term.
    4. Do locations put the emphasis on the creation of knowledge, which can be exploited internationally, or focus on the supply and demand of skills immediately? If the former, there is an increased risk that the benefits of intangible capital will be realised elsewhere – but a focus on immediate skills gaps in sectors with low or stagnating productivity is unlikely to lead to sustained activity.

Answering these questions is critical to maximising the benefits of the investment zones. Finding the answers is not trivial and, as ever, there are trade-offs, as one cannot do or achieve everything all at once (despite recent successes at the Oscars).

Is there a framework by which one can better inform such decisions if productivity is placed at the heart of deciding how to implement the investment zones? While productivity is not an end in itself, a better understanding of the drivers of productivity (such as capital investment, innovation and skills can help to maximise the benefits of such zones through attracting mobile capital – be it foreign investment, or investment from elsewhere in the UK.

To start with the latter, the only rationale for moving investment from one part of the UK to another is that the beneficial effects in one place are greater than elsewhere, perhaps due to differences in scale, spillovers, or absorptive capacity. However, the marginal gains from such shifts are likely to be very small for the UK.

So, the emphasis needs to be on attracting or stimulating new investment that otherwise would not happen. Foreign investment is often seen as the “easier option” here, in that it is typically easier to attract new investment in than to stimulate this endogenously from the indigenous sector. Given this we suggest that decision makers in these locations, typically the Mayoral Combined Authorities (MCAs), and by extension universities, need to understand firm strategies and what motivates their investment behaviours, so that the local policy makers can then develop a strategy for maximising the beneficial effects of this in terms of productivity spillovers.

The figure offers a schematic that demonstrates the mechanisms by which inward investment generates productivity growth through externalities. Along with the direct effects, this puts productivity at the centre of investment zones decisions and, more specifically, helps answer the four questions that were posed above. Firstly, it highlights the relationships between FDI and the drivers of productivity, for example in terms of ownership structures, and in turn the incentives to engage in knowledge transfer between the parent company and the affiliate. Secondly, this highlights the importance of local absorptive capacity, including local university capacity in assimilating this knowledge and facilitating development in the indigenous sector, combining to generate spillovers in productivity.

If one seeks to build on existing strengths, then the emphasis needs to be on working with existing businesses and addressing the market failures and other barriers that have hitherto prevented better cooperation between business and research at the local level. The answers here focus on local institutions filling gaps in supply chains, and industrial strategy identifying, for example, missing links in supply chains. This is why recent debates, such as those concerning giga factories or green tech, for example, become so crucial. One advantage of these initiates is that it will encourage local policy makers, business and universities to view investments in green tech not merely as investment opportunities in their own right, but as facilitators of other activities and investment opportunities as new sectors emerge from these collaborations.

Seeking to develop relationships in new areas will rely on attracting investment both from abroad but also potentially from elsewhere in the UK. It is crucial to understand what the potential investor is seeking and how quickly collaborations between local higher education, further education and the private sector can fill any gaps, particularly skills gaps. This requires an understanding that education and training is, at least in part, a public good, and that sectors as a whole need collaboration rather than competition over skilled labour.

[1] Taken from Sumon Kumar Bhaumik, Nigel Driffield, Meng Song, and Priit Vahter, ‘Spillovers from FDI in emerging market economies’, in The Oxford Handbook of Management in Emerging Markets, ed. Robert Grosse, Klaus E. Meyer, Oxford University Press, 2018

Answering the third and fourth questions on the motivations for investment requires a recognition that there is an inherent trade off when seeking to attract investment. Typically, investment in a given location is motivated by one of two factors: either locations attract investment due to lower costs; or they attract investment because of greater prospects for innovation and, therefore, productivity growth. The challenge with the former is how to ensure that one is not simply involved in a race to the bottom in terms of labour costs. The challenge with the latter is how access to knowledge can be scaled to move beyond blue skies research and into activities that benefit the wider economy, rather than frontier technology that is then exploited elsewhere.

Put simply, one of these strategies creates jobs, while the other creates productivity. In formulating plans for investment zones, the answer to this question, in terms of prioritising activity, will need to be at the forefront of decision makers minds.