Innovation is highly important to the competitiveness and productivity levels of advanced capitalist economies. It has long been recognized that innovation is a key motor of economic change, as it stimulates intense forms of competition. New products command a premium price, and as others seek to replicate those innovations to improve their own products, those innovations diffuse widely into the economy, increasing general well-being. Innovation is partly about new products, but more importantly, innovation concerns building capacity to make profitable changes more effectively, encompassing changes in production technologies and techniques as well as new product introduction. More recently, this link between innovation capacity and competitiveness has been made explicit: there has been a realization that long term business competitiveness requires effective innovators as well as innovations.
The UK's long term productivity problem is partly a result of a dearth of UK innovation. UK Governments have long been concerned with increasing the amount performed by UK businesses.
Historically, governments have tried two approaches to policy, creating innovative businesses and funding innovation in existing businesses. Although these policies have led to the existence of a number of very innovative firms, but the overall economic benefits have been disappointing. In particular, these approaches have failed to benefit firms not in direct receipt of funds, especially small firms (SMEs), and they have not encouraged significantly more innovation, dynamism or spin-offs.
Contemporary policy thinking has moved away from the more interventionist approaches towards a more market-focused perspective on supporting innovation, to intervene only to overcome identifiable market failures. The uncertain nature of innovation means that it is particularly prone to these failures, especially in the areas of pricing knowledge, estimating returns to innovation and the opportunity cost of failure to innovate: policies in response include LINK, Smart and Foresight.