The Australian Business Foundation’s research contributes to a growing body of international evidence that innovation is crucial to high and sustainable rates of economic growth. But what exactly are the elements of a successful innovation system, and how can Australia initiate and manage one?  These questions were addressed by Professor Jonathan West and Professor Keith Smith in their joint presentation hosted at Macquarie Bank on 27 October 2005.

In his introductory remarks, Mr Daniel Phillips (Executive Director, Investment Banking Group, Macquarie Bank) observed that successful innovators are those who:

• employ outstanding people;
• engage in continual product innovation; and
• pick niches that allow for global expansion.

Professor West began by pointing out that innovation debates tend to oscillate around two poles: one focuses on microeconomic reform and employing labour more intensively, while the other stresses the importance of high-tech industries and the ability to commercialize inventions. Neither of these are sufficiently explanatory. Moreover, the innovation problem is often framed incorrectly, as either:

• how to commercialize science and research; or
• how to build new high-tech industries, like information and communications technology (ICT), biotechnology or nano-technology.

Professors West and Smith suggest an alternative view, which neither underestimates the technological basis of productivity gains, nor places undue emphasis on high-tech industries (which constitute only 3% of total industries in Australia).  Furthermore, they identify three particular problems with Australian innovation: 

• the erosion of our scientific and technological capacities;
• our failure to commercialize science and research well; and
• most seriously, the poor innovation performance of the 97% of Australian businesses that are not high-tech.

Therefore, the critical issue to address is how to make the bulk of mainstream Australian business more innovation-driven, and therefore able to contribute more to Australia’s productivity performance.

Professor Keith Smith picked up the presentation by commenting on the characteristics of innovation.  He outlined the chief characteristics of innovative activity. He remarked that productivity should not be defined simply as working harder with existing assets; rather, it is necessary to understand the underlying determinants of productivity, and how innovation affects the economic development of firms and nations.  

Professor Smith went on to discuss the key characteristics of innovation as follows:

Innovation is not linear: Innovation is rarely based on science or research and development (R&D); it usually consists of firms drawing on their own and others’ knowledge to develop new concepts for products or services. R&D can help this problem solving. Innovation capabilities are cumulative, and involve substantial investments in tangible and intangible assets (e.g. real capital goods, training, design capabilities, market research, etc.).

Innovation is pervasive: Innovation occurs across all sectors. The high-tech sector does not drive productivity and the rate of economic growth. Service industries and the public sector have high levels of product and process innovation.

Innovation involves both continuous and discontinuous technological change: Large-scale shifts are rare, but discontinuous change within sectors is not. That is, it is more common to observe series of waves of technological innovation within sectors, than seismic shifts (e.g. from manual to electronic typewriters, to word processes to personal computers).  Small, incremental changes can have monumental effects on productivity and economic development.

Innovation is uncertain:  Innovation entails technical and market unknowns, the prime movers behind a given innovation don’t always succeed, and the best technology doesn’t always prevail. 

Innovation is collaborative:  Innovation normally involves parties external to the innovative company. It often involves public-private interaction, with the public sector investing in the development of core technologies, and significant streams of knowledge flow from a nation’s ‘knowledge infrastructure’ (universities, research institutes, etc.) to firms.

Innovation occurs within national systems of innovation:  Firms innovate within the context of a nation’s regulatory, institutional, political and cultural systems, as well as its different technological and industrial specializations, infrastructure and learning systems.

Professor Smith also covered the incidence and intensity of innovation in Australia.  Having discussed the critical components of innovation systems, Professor Smith presented data on how these related to Australia. The specific features of Australian innovation emphasized by Professor Smith were as follows:

• Based on the ABS Innovation Survey, 35% of firms across all industries are innovators; that is, they have introduced new products, processes or forms of business organization in the last three years.
• Innovation is not confined to technologically innovative sectors. The manufacturing sector is dominated by high growth, low-tech industries.
• Expenditures on innovative inputs other than R&D are twice that of business expenditure on R&D.
• Economic uncertainty and financial costs are reported as significant obstacles to innovation by innovative firms.
• Innovative firms are also firms that collaborate with external parties.
• Australia’s relatively low business investment in R&D (i.e. low compared to other OECD countries) reflects its concentration of foreign-owned multinational corporations and the specialization of its industrial base.

• Australia possesses a low-tech but innovative industrial structure.
• Australia’s innovative firms exhibit high levels of collaboration with other firms and with public research institutions.
• There is consequently a crucial role for Australia’s knowledge infrastructure (e.g. universities).
• Financial uncertainty is a serious obstacle to investment in innovation.
• A significant problem exists in growing innovation-based firms.

Professor West commented on the difficulties posed by uncertainty and foreign ownership.  He addressed the policy challenges posed by managing the risks of innovation. They key arguments he raised were as follows:

• Free markets for knowledge and labour tend to result in inadequate investments in knowledge, as they limit the ability of investors to appropriate the returns on such investments.
• Australia’s superannuation funds could be used to finance innovation.
• Innovation has become more complex, therefore demanding ever more resources and entailing ever higher degrees of risk. The greater the risk, the broader the base over which that risk must be diversified. For example, low-risk ventures like barber shops are usually funded by family and friends; businesses that use higher-risk technology, such as ICT enterprises, need access to venture capital; and enterprises that carry the deepest and broadest risks, like commercial aircraft manufacture, are likely to be underwritten by government.
• Frontier technologies, such as those in pharmaceuticals and life sciences can entail severe risk (given the large number of trials and projects and the high costs involved) against the probability of bringing even one successful product to market. Professor West contends that only governments are in a position to underwrite such risks, as in the USA with biotech industries and in Europe with commercial aviation.
• Another critical challenge is how to prevent the value of innovative activity from leaking to overseas investors. The value of innovation is increasingly not captured in wages, so merely attracting foreign-owned companies will not secure for Australia the value, the technology transfer and the capabilities from investment in innovation. In order to capture the value of innovation, Australia needs to own growth companies. Local entrepreneurship and long-term equity ownership are essential.
• Australia must have policy settings both to appropriate returns from investment in innovation (i.e. capture the upside) and to survive the downside by the effective management and diversification of risk, particularly by having the right vehicle for dealing with risk.