A glass half full?

| December 8, 2017

Two years on from the launch of Malcolm Turnbull’s National Innovation and Science Initiative in December 2015, the latest Australian Innovation System Report issued by the Department of Industry’s Chief Scientist finds that 48.7% of Australian firms are actively innovating, up from 45% in a year.

The report observes that innovation occurs in all industries and that entrepreneurial attitudes remain positive, but business dynamism has faltered in some respects. The latest data from the Business Longitudinal Analysis Data Environment (BLADE) suggests the number of high-growth firms has fallen in terms of both employment and turnover over the last decade and that spending on research and development by private companies is in long term decline.

The Chief Economist’s annual report has been published since 2010, and this year’s release focuses on the economic impact of high-growth firms and the role innovation plays in their success. There are more than 10,000 high-growth firms in Australia at any given time, although firms with high growth potential are difficult to identify and may only grow strongly for a short time.

The report argues that innovation policy must be reviewed regularly for it to remain relevant, effective and connected, given the pace of economic and technological change today.  However, the two-year anniversary of NISA has passed without the promised second and third waves of investment and reform.

Mark Cully’s perspective

Introducing the report, Chief Economist Mark Cully accepts that Australia is undergoing an economic shift, as the mining boom of the last 15 years draws to its end. While the boom-bust cycle of the past has been avoided, Australia’s economic growth has dwindled due to an population ageing, faltering global trade and the lingering legacy of the global financial crisis, meaning living standards have remained static since 2014.

He remains optimistic, as the nation has proved its ability to innovate and adapt to change in the past.  Australia has produced its fair share of world beating inventions, and new digital technologies, including 3D printing, quantum computing, blockchain and artificial intelligence, offer opportunities for domestic innovators and entrepreneurs to thrive.

Working with supply chain partners, financial backers and academic researchers, Australia’s businesses will be the engine room for innovation-led growth. The 2017 report therefore concentrates on the most dynamic firms to understand and share their approach to encourage more firms to grow more quickly.

The importance of high-growth firms

Innovation should not be confused with mere invention, which is merely one step in the process of putting new ideas into the commercial realm.  Although Australia has traditionally depended on primary industries such as mining and farming, the easing of the mining boom demands the creation of a more sophisticated national economy.  It is innovation which drives long-term productivity growth in the modern world, just as it has underpinned human progress throughout history.

The report substantiates the oft-made claim that innovation helps firms to grow.  It finds that product innovation boosts turnover by an average of 3.3% across all industries, while marketing innovation adds 4% or more.

However, international research shows that employment and sales growth is largely concentrated in a relatively small proportion of high-growth firms (HGFs).  In a similar fashion, Australian HGFs make a disproportionate domestic contribution compared to other firms.

Between 2004–05 and 2011–12, just 9% of Australian firms created almost half the country’s new jobs.  At the same time, 15% of Australia’s firms generated two thirds of the total growth in sales.

Companies with high-growth can be found in all industries, but tend to concentrate in certain sectors. While manufacturing contributed over half the HGFs in 2004-5, ten years later three industries now account for three quarters of the total.

HGFs tend to be younger than other firms, with most of them created less than eight years ago. They also invest more in their future.  Between 2002 and 2013, their median capital expenditure was 65% higher than other companies, and they showed a notably larger increase in annual labour productivity as a result.

The short-term nature of high growth rates reported in international studies is also evident in Australian firms. Most Australian HGFs end their high-growth stage within four years. HGFs are not a particular type of firm therefore, but a phase which some firms experience at an early point in their life cycle.

Australia’s patchy R&D performance

Calls for innovation have been repeated to the point of cliché.  The Commonwealth alone has produced over 60 reports on the topic since the dawn of the new century.  However, despite a torrent of words and rafts of initiatives from both sides of politics, trends for high-growth firms have tailed off rather than accelerated.

The proportions of HGFs in the Australian economy declined from 18.6% in 2005 to 12.5% in 2014, for example, although Australia’s percentage of high-growth firms remains slightly above the OECD average.

The average turnover growth recorded by HGFs has also declined, although sales revenue has grown in absolute terms.  In 2014, the median turnover growth rate of HGFs was 38%, equating to almost $184 million in sales revenue.  That compares to a median growth rate of 68% in 2006, with median annual sales revenue of $116 million.

R&D spending by Australian firms has declined as a percentage of GDP since 2008–09, after strong growth in the previous decade. Although the slide in mining investment is largely responsible, manufacturing investment has also waned at a time when firms are being urged to develop modern ‘Industry 4.0‘ approaches. While Australian R&D spending remains slightly above the OECD average of 2% of GDP, it still lags well behind Germany and other top performers.

SMEs lead the way

The report found that most high-growth firms are SMEs, rather than larger firms, a proportion which has steadily increased from 69% in 2005 to 85% in 2015.  An R&D Tax Incentive was introduced in 2011 for firms turning over less than $20 million, replacing the previous R&D Tax Concession, and has played its part in encouraging investment.  SMEs now receive an after-tax benefit of at least 13.5 cents in the dollar, increasing to 43.5 cents in some cases, for eligible R&D investments, compared to just 7.5 cents under the previous scheme.

Repercussions and policy directions

Arguments rage about whether investment in modern technology will create or destroy jobs in the long term.  The Chief Economist’s report suggests that R&D investment boosts turnover, labour productivity and wages across all industries, but tends to reduce employment growth as people are replaced by machines and algorithms.  These effects, both good and bad, have become more pronounced over time, although they vary across firms and industries.

The disproportionate economic contribution of HGFs has piqued the interest of governments around the world, but research suggests that HGFs are difficult to target, as firms with potential are difficult to identify and those that grow may not maintain their performance for long.  Despite these caveats, a range of ‘no regrets’ policies can be pursued by Federal and State governments to prepare the ground for HGFs to bloom.

Increasing the depth, breadth and relevance of skills available to businesses should strengthen Australia’s ability to innovate and make the workforce more capable of capitalising on future opportunities, for example, and the government has stressed the importance of STEM in education as a result.

Poor relations between industry and academia are often blamed for Australia’s failure to commercialise its well-funded public research and compared unfavourably to Germany and other countries. This lack of collaboration has been lamented for many years, but remains stubbornly difficult to remedy, despite no shortage of government efforts.

Competition policy and commercial regulation can also help or hinder innovation, not least the digital disruption of traditional incumbents.  Australia ranks well in the numbers of start-ups in the country, but business dynamism is declining, implying a weakening rather than a strengthening of competition overall. Regulatory reform could reduce barriers to labour mobility and business entry and exit, for example, and improve the operation of intellectual property.

The apparent success of the R&D tax incentive shows that targeted measures can have a demonstrable and positive effect on outcomes, but more can still be done.  SMEs looking to innovate can still struggle to gain access to the finance they need, and addressing such issues by specific measures while maintaining macroeconomic stability will help drive growth across the whole economy.

Turnbull’s ‘Ideas Boom’ falls flat?

Craig Laundy, the Assistant Minister for Industry, Innovation and Science, welcomed the Chief Economist’s report and said it underlined the importance of the government’s innovation and science agenda to boost domestic productivity and international competitiveness. He stressed that “The Australian Government is working to ensure we have the right conditions to ensure high-growth firms can continue to thrive”, but others are less sanguine about the government’s commitment to innovation.

Malcolm Turnbull’s early zeal for a technology-driven economic transformation failed to resonate with a skeptical, if not fearful, electorate at the last Federal election, and the ‘ideas boom’ which formed the centrepiece of his early appeal has duly slipped from the political limelight. Two years after the 24-project, $1.1 billion National Innovation and Science Agenda was unveiled with much fanfare, Labor and innovation pressure groups are criticising the lack of follow-up reforms.

No less than four ministers have taken their turn handling the programme. There have certainly been some gains, with Ministers Cash and Laundy noting that venture capital fundraising reached a record $1.32 billion in 2016-17, more than double the previous year, while total investment increased by a quarter. The amount of committed capital in Early Stage Venture Capital Limited Partnerships also increased from $620 million in 2015-16 to more than $1 billion in 2016-17, and in its first year the angel investors tax measures generated an estimated $280 million for Australian start-ups.

However, Labor’s Ed Husic has called for further measures, including the legalisation of equity crowdfunding by private companies and a u-turn on restrictions to the 457 visa scheme. While Industry Minister Arthur Sinodinos told Senate Estimates in March that NISA 2.0 and 3.0 were planned – with 2.0 to be delivered in May 2017 – no further waves of projects or reforms have been forthcoming.

Plans for a Federal space agency were revealed in September, offering hope the government remains willing to substantiate its rhetoric with action, and ambitious firms will hope existing measures are finetuned and new ones instigated to maintain Australian momentum.

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