JEREMY PEAT

Let me get the micro-economist's policy mantra out of the way. The future for the Scottish economy lies up the value chain. In the increasingly competitive global economy - China, India, Vietnam, Brazil, Russia, new entrants to the eurozone, and so on - Scotland cannot and should not attempt to compete internationally via lower-cost production in bulk standard commoditised products. That applies to both manufacturing and the service sector.

"Up the value chain" is the only way forward to success. That, in turn, implies emphasis on enhanced skills, much more research and development application by business, innovation inducing continuing change and dynamic management.

I was reminded of these facts during a couple of discussions recently on the role of higher education in the Scottish economy, both co-incidentally also involving Dr Chris Masters - former chairman of the Scottish Higher Education Funding Council and respected business leader and thinker - and Professor Bernard King - principal of Abertay University, where applied innovation is seen as key to all they do.

The first discussion was at a David Hume Institute seminar; and papers by King and Masters will appear on our website soon. The second was just this past week, with Fiona Hislop MSP, Scotland's new Minister for Education, in the audience.

A renewed debate about higher education and its role in the Scottish economy comes just at the right time. Not only does higher education matter, but there should now be a real opportunity, within the context of the new (minority) government at Holyrood, to think afresh about key issues where devolved policies pertain.

In the move up the value chain, the role of higher education is self-evident. We will not succeed without higher education providing the right skills at the right time and in the right place.

Even more importantly, we will not succeed unless that sector provides the intellectual capital bullets to assist business to innovate and enhance efficiency in higher value-added activities. Just provision of intellectual capital is not enough. The real problem, and hence the real challenge, is the lack of R&D activity - and hence innovation - within Scottish business.

Scotland and its higher education sector are extremely successful in terms of generating top-quality research. The flow of patents and intellectual capital creation is hugely impressive. However, at one and the same time Scotland lags well down the international league tables so far as such key parameters as business R&D spend, business starts and entrepreneurial activity generally are concerned. This dichotomy between research output and innovative activity is at the heart of the dilemma about how Scotland can move up that value chain.

Masters has considered the limited business interest in innovation. To work on this "demand" side his suggestion is to allocate "innovation vouchers" to businesses in Scotland, redeemable by working with Scottish higher education institutions - with the latter clawing back costs later by cashing in the vouchers.

This approach, he argues plausibly, would provide an incentive for Scottish businesses to utilise R&D output. Further, getting to work with the higher education institutions would show businesses how much they could gain from such contacts and encourage further relationships and more innovation.

My view is that this could provide a partial solution and is well worth a try. (At the least the Scottish Executive should study a similar scheme in the Netherlands.) But we also need to look at the incentive mechanisms on the supply side and how - as in Abertay - supply and demand can be better brought together.

On the supply side, the key approach is to allocate research funds to institutions in line with their performance in the research assessment exercise. This periodic exercise is wholly skewed towards identifying research activity of outstanding merit, from a peer group-based, academic excellence perspective.

I agree that a focus on blue-sky thinking is of value. But it should not be the only focus. Some share of research funds should be allocated on the basis of priority for research which might yield economic value. The balance must be a matter of debate, as must the allocative mechanism for identifying what could be of value.

On both the demand and supply sides the plan should be to work with the grain of the market, by adjusting the incentive mechanisms.

Vouchers for business provide them with an incentive to use research skills. An alternative means of allocating some part of overall research funding for higher education institutions should make the latter ponder how best they can work towards research of economic value.

Finally, Abertay has led the way in demonstrating, in the high value-added digital sector, that supply and demand can be massaged together. The business spin-out record is impressive and the benefits to Tayside have been major.

Perhaps the funding council can work up a means of incentivising more higher education and further education institutions to follow down the Abertay track.

Jeremy Peat is director of the David Hume Institute