Britain is in danger of slipping between the low-cost manufacturing nations and the high-tech US because of the way Government procures contracts.
A new study by the University of Cambridge's Centre for Business Research criticises the UK Government's programmes designed to help small firms apply for government contracts and urges it to urgently adopt the US model if it does not want to lose out economically.
"As policy makers grapple with how the UK is to compete internationally against increasingly technologically sophisticated, but still low wage cost economies such as China and India, the future role of public sector procurement in the innovation economy assumes a pivotal performance," said report author David Connell.
Mr Connell, a former venture capitalist, criticised the Government's Small Business Research Initiative (SBRI) which advertises public sector contracts to small firms.
Up to 2005 the scheme only ever advertised contracts totalling £2 million a year and few departments participated, Mr Connell said.
"The problem appears to stem both from the perception across many government agencies that innovation is the responsibility only of the private sector, and perhaps the DTI, and from the over-whelming predominance of value for money considerations and risk minimisation in public procurement procedures," he said.
Mr Connell called on Government to adopt a similar scheme to the US Small Business Innovation Research (SBIR) programme in order to combat the problem.
SBIR provides 100 per cent funding plus a small profit for new firms undertaking government research and development projects.
Founded in 1982, the programme offers over 4,000 contracts worth over £1.1 billion every year to small US companies including start-ups and university spin-outs.
Mr Connell said: "The US is the world's most successful economy at building science and technology based industries and its use of procurement, through the SBIR and other mechanisms, has played a key part in that success."
A spokesman for the DTI said the Government welcomed anyone researching the issues that small firms are up against.
"The Government remains committed to the SBRI programme and officials continue to work to implement the programme as effectively as possible.
"We envisage publishing a third set of performance figures this autumn."
The reports findings were welcomed by Richard Zybert, founder of hi-tech server solution firm Zybert Computing, based in Edgbaston.
Dr Zybert, an ex-nuclear physicist who spun out his company from the University of Birmingham, has become increasingly frustrated by the process of UK public sector procurement.
Despite acclaim for his server designs and a £3 million European research contract, he has found it difficult to apply for UK public sector contracts.