DEVELOPING RESEARCH SPENDING

Since 1980, the UK has invested a lower share of GDP than most other industrialised countries; and GDP per worker has been lower too. For every £100 invested per worker in the UK, Germany has invested over £140, the US and France around £150 and Japan £16

Thus chancellor of the exchequer, Gordon Brown, introduced three measures, in last week’s budget with the aim of encouraging greater research and development and plant expenditure.

First, he cut the main rate of corporation tax from 33% to 31%, its lowest ever level, and the lower rate, for companies generating profits under £300,000, from 23% to 21%, both taking effect as of April 1997.

Second, Brown abolished tax credits on dividend payments to pension funds. This approach aims to discourage short-termism where UK companies put investors’ demands before those of internal investment.

Third, he doubled first-year capital allowances to 50% for smaller businesses, although they will revert to 25% in subsequent budgets. Brown argued that this provided an incentive for upgrades at a time when the UK economy was strong, rather than offering a sticking-plaster solution during a downturn.

The latest UK R&D Scoreboard, published two weeks ago, highlighted for Brown that something needed to be done. Britain was placed joint bottom (with Italy) of a ranking of R&D expenditure relative to sales in G7 countries. Only 2.3% of an average UK firm’s turnover is spent on R&D compared with 4.3% in the US, 4.6% in Germany, and a massive 10.8% in table leader Canada, the report states. Further, the figures suggest national problems in engineering, where the UK dedicates 1.9% of sales to R&D compared to a global average of 4.0%, and electronic and electrical equipment, with a British 3.1% spend against a 6.2% world average.

So has Brown come up with the right solution? Reactions from industry and investors have been mixed. Some firms question whether or not the Department of Trade and Industry figures compare like with like – and, to be fair, they have a point. UK accounting regulations are tougher than most international equivalents in defining R&D, limiting British firms to declarations of pure research work.

However, greater controversy has surrounded the abolition of tax credits on dividends, even though most pension funds anticipated the move and had already discounted share prices. In research commissioned by the funds from City University, M Ameziane Lasfer and Richard Taffler concluded that, based on their comparison of PLC firms’ R&D funding levels with general corporate activity, `companies that pay dividends are more likely to invest in R&D and their R&D expenditure is significantly higher than that of those that do not pay dividends’.

The two academics also noted that dividend payers did not reduce R&D expenditure during the 1991-92 recession, even though profitability was in free fall. In this context, the funds are reiterating their belief that the abolition of credits is more about filling the Treasury’s coffers than encouraging investment.

On the corporate side, Brown’s decision also got an irritated response. One senior UK industrialist said he would not be surprised if institutions were to have `a quiet word’ with companies suggesting that some form of `compensation’ (that is, increased dividends) would be in order. Other people point out that, as the abolition has already been discounted from share prices, consequent reductions in market capitalisation have reduced the amount of capital they can raise.

Companies must face the loss of pension tax credits in the longer term. Many larger players are enjoying `holidays’ from employer contributions because surpluses have built up thanks to the strength of the London Stock Exchange.

However, just how long these surpluses will last is a moot point; forget the possibility of a stock market crash, the truth is that pensioners are living longer. One factor remains constant: few major companies believe that higher dividends and renewed pension contributions will be automatically offset by the corporation tax cuts.

The big question is if Brown’s plan is largely just a sideshow. An increasing number of senior industrialists are coming to this view and Allen Yurko, chief executive of Siebe, one of the UK’s leading R&D investors, is one of those following a different track. Commenting before the budget, he said he supported the idea of a UK scoreboard that exists to encourage the market, because whatever fiscal measures are taken by the Treasury, they are secondary to the fact that `in today’s world, the willingness and ability to innovate are central to profitability. I do not think that if you are serious about the marketplace, you gear that willingness wholly to what tax incentives are or are not available from Government. The economics of R&D are about having a business in five years’ time and shareholders increasingly understand that.’

Indeed, Yurko argues that the UK’s problem may not be so much in the amount that larger firms are willing to invest, as in the supporting infrastructure. `Some people might think that because Siebe is high up the list that we will say most other companies are underspending. Well, I wouldn’t say that, but what does concern me is that the UK lacks the smaller sunrise companies seen in other countries that feed innovations into the mainstream.’

Tony Blair has made similar observations, but support for this kind of firm was very much on the margins of last week’s budget – the cuts in corporation tax aside. Perhaps tax incentives are not the best mechanism to encourage such firms, and perhaps, until something does happen in this area, the jury on Government R&D policy should be allowed to deliberate. Provided, of course, that industry does not have to wait too long.

{{UK top 10 investors in engineering sector

Company Spend (£m) % of sales

Rolls-Royce 199.0 4.6British Aerospace 156.0 2.4Siebe 145.0 5.6Smiths Industries 50.0 5.0Vickers 41.3 3.4TI Group 37.4 2.1British Steel 35.0 0.5Johnson Matthey 26.4 1.0BBA 18.6 1.7Morgan Crucible 13.7 1.5

UK top 10 investors in engineering, vehicles sector

Company Spend (£m) % of sales

Lucas Varity 106.8 4.0GKN 94.0 3.3T&N 53.0 2.7BSG International 13.9 1.4Laird 12.2 1.2Avon Rubber 8.2 2.4Adwest 4.1 1.8First Technology 2.1 5.4Syltone 1.3 1.9Trinity 1.0 0.4

UK top 10 investors in electronic and electrical equipment sector

Company Spend (£m) % of sales

GEC 432.0 6.9Racal Electronics 70.8 6.7BICC 30.0 0.7Bowthorpe 23.5 4.5Anite 17.4 6.6Fairey 12.4 5.0Oxford Instruments 10.4 7.1Ultra Electronics 9.6 7.8Eurotherm 9.3 4.5Peek 8.8 5.4

Source: (all tables and graphs) Company Reporting/DTI

Note: These tables exclude UK subsidiaries of foreign-owned firms}}