Innovation is the Issue

Peter Carre | September 25, 2017

The recent GAP Summit highlighted innovation as the key to growing mid-sized business, just as it is to success in the wider Australian economy.

The process for harnessing innovation itself is not easy to define, with all of its various components, but it has an intrinsic order and architecture that can be detected, excavated and explored in order to make the most of our national resources.  We need not aim to map out this development in detail, but rather to lead an agile reconnaissance over the landscapes that lie hidden within the various pockets of resources in this country.  All agree that Australian mid-sized businesses need to improve productivity to improve themselves, fund growth and be competitive. It is not deregulation or re-regulation that will do that.  It’s time to turn to a different driver of productivity advance: innovation.

The problem is that Australia now has almost two decades of experience trying to improve innovation, with little success.  Unfortunately, the evidence compels us to accept that in spite of the expenditure of many hundreds of millions of taxpayers’ dollars, Australian business today is no more innovative than it was 30 years ago:  We don’t export a higher proportion of high-value goods, the proportion of our stock market comprised of technology companies hasn’t grown, our companies introduce fewer new products and services than those of other countries, even in the same industries, and our businesses have significantly lower R&D/Sales ratios to that of comparable economies. Why?

The answer is that policy makers have ignored what economists know about how innovation actually happens in a modern economy. Instead, they’ve tried push universities and research centres to become commercial sources of revenue.  That hasn’t worked, and that’s not how it actually works, although it might be one by-product that results from sensible policies to promote innovation. We need to provide certainty for innovation.

Since about 1980, innovation has been the most lively field of research within economics.  Economists have long recognised that innovation is the critical dimension of productivity improvement, and that productivity is the vital basis for sustainable prosperity.  Within economics, a relatively new field known as ‘Innovation Studies’, linked with ‘New Growth Theory’, focuses on why some countries and regions are more innovative than others, and what governments might do to improve their performance.

What we’ve learned in this research contradicts conventional wisdom about innovation as an economic process, and also contradicts several key assumptions that underlie most Australian government policy for innovation.  Most people think of innovation as being about high-tech, for example, and much of Australian Government policy has been directed to commercialising science to create new high-tech industries.  Indeed, development of an ‘innovation policy’ by most OECD governments, followed by most Australian governments, has formed a pattern something like this:

First, select a list of leading-edge technologies; the usual suspects are information technology, biotechnology, and nanotechnology.

Once the list is compiled, either invest directly in research and development in these fields or provide incentives (particularly tax concessions) for firms to do so.

Then provide inducements for researchers to commercialise their discoveries.

With sufficient patience, a new industry supposedly results.

But, the first important finding of recent economic research is that innovation is not concentrated in high-tech sectors.  Statistical studies show that all sectors of the economy innovate, and that innovation is widely dispersed across the economy.  Innovation is not monopolised by a few supposedly leading sectors, with others dragging along behind. This is great news for Australian mid-sized business because it means that to become an innovation-based economy we don’t have to create new high-tech industries out of thin air.  In fact, in no country do high-tech industries make up more than about 3 per cent of the economy. What we do need is to add innovation capability to our existing

industries, especially in the mid-sized business sector.

The second important finding of economists working in this area is that within individual sectors, innovation is very concentrated.  The typical pattern is that a few individuals or firms innovate, and the rest copy.  Innovation is about entrepreneurship—both within existing companies and in new ones. This is also good news for Australian mid-sized businesses because it means that we don’t need to change our culture, to make it more change-embracing or innovative.  Our rate of entrepreneurship, of new firm creation, is roughly equivalent to that of comparable nations.  What we do have to do is focus on helping, or at least getting out of the way of, our few innovators and focusing their efforts.  Others will join the parade.

A third important finding is that innovation rarely begins with a ‘discovery’, perhaps made by some boffin in a lab, that is subsequently commercialised.  Rather, what usually happens is that customers actually tell companies what they need, or firms recognise an unexpressed opportunity, and then companies try to figure out how to make money supplying that need.  To put it in simple economics terms, we have focused on the supply side of the market, trying to get business or consumers to use our new hi-tech or scientific discoveries rather than focusing on the demand side of the equation. We need to ask more what business or industry wants and see what is on our shelves already (in universities, research institutes, or companies) that can be used or adapted to fill that need or how to provide services in the way customers actually want them. Then we can unleash our scientists, our technologists, our business model thinkers and our entrepreneurs to address these.

This is very important for Australia because it means that we’re unlikely to start an industry with science.  The science can be important, but it doesn’t start the process; it comes in after a customer need is identified.  The implication is that Australia is much more likely to succeed in areas in which we already have strong industries and companies—that already know and understand customers—than in brand new ones.  We should focus first on adding innovation to our existing mid-sized businesses rather than creating new ones.  Mining and resources come to mind, as well as agriculture, pockets of sophisticated manufacturing, tourism expertise and assets, energy, and educational exports assets.  Financial services is possibly another, however that industry is so globalised that it may be difficult to keep up with innovation..  Undoubtedly there will be others.

Fourth, it turns out that innovation is much riskier, economically speaking, than we’d thought, and that a disproportionate part of the value of innovation is captured by those willing to bear this risk.  In effect, the people who finance innovation gain much of its benefit. This is also important for Australia.  With close to 2 trillion dollars in privately managed investment capital now in Australia, we have more than ample capital to support our innovation needs.  A tiny percent of this money devoted to innovation would more than supply our needs.  Of course, competing with franked dividends and property for that capital has been problematic.  So we need to change our approach.  The mid-sized businesses who provide a compelling case for those dollars can and will reap the benefit.