Will the National Innovation and Science Agenda deliver Australia a world class National Innovation System?

The Prime Minister’s announcement on Monday 7 December of a National Innovation and Science Agenda is a welcome development. However, the challenge will be for the government to turnaround our National Innovation System (NIS) which has been steadily in decline for some time.

As outlined in the Prime Minister’s statement, Australia has many world class businesses, universities and research organisations. However, Australia ranks at the bottom of the OECD group of advanced nations in relation to university-industry collaboration. We also lag in terms of our spending on R&D. For example, Australia spends around 2.13% of GDP on R&D compared to the OECD average of 2.63%. As a benchmark South Korea spends 4.15% of GDP on R&D.

In the Prime Minister’s statement it was noted that enrolments in the fields of science, maths and computing at Australian high schools is declining. To this it can be added that Australia has an average of 8.6 R&D personnel per 1,000 people employed. This compares to Singapore with 10.7 people, Denmark with 14.9 people and Finland with 15.7 people.

These “inputs” to our NIS result in “outputs” such as patents, high-tech exports and the generation of royalties and licence fees for Australian originated intellectual property (IP). Here we also lag the world’s leaders. The most significant performance gaps exist in the areas of triadic patent families (e.g. patents lodged in the US, EU and Japanese patents offices), venture capital deals, high & mid-tech output, fee receipts from IP rights, high-tech exports and R&D by businesses.

A wide-ranging and ambitious agenda but is it enough?

The innovation statement is a wide-ranging and ambitious agenda focused on four key areas.

The first – labelled “Taking the Leap” – is aimed at generating more high-impact start-ups and fast-growing “Gazelle” firms. It addresses at least 10 areas that relate mostly to changes to taxation and company regulation. These initiatives are designed to assist entrepreneurial firms to access venture capital and address commercial risk.

The second – “Working Together” – seeks to increase the level of collaboration between the nation’s universities and other publicly funded research centres, and industry. It targets 9 areas primarily relating to research funding and performance measurements for universities. However, it also contains initiatives to help foster innovation in agribusiness and regional Australia. There are additional programs to build capacity in computing technology and cyber security, as well as strengthening linkages with international centres of innovation.

The third – “Best and brightest” – targets education and immigration programs in an attempt to increase the number of science, technology, engineering and maths (STEM) workers in Australia. This aims to increase the level of information communications technology (ICT) activity within the school curriculum. It also hopes to encourage more women to take up ICT courses and careers. There will also be a new class of visa designed to attract people with STEM and ICT qualifications.

Finally, there is “Leading by example”, that aims to enhance the NIS through investments in e-Government programs and adjustments to government procurement policies.

Arresting the steady decline in Australia’s NIS is an important and long overdue government initiative. However, as Professor Mark Dodgson recently outlined in “The Conversation” the $1.1 billion earmarked for this innovation initiative does little more than “get us back to square one”. The funding provided to this important program is modest compared to what is needed. He quite rightly observes that:

“The Innovation Agenda’s position on insolvency laws and tax investments in startups will begin to help, but unless large firms, particularly overseas multinationals, seriously and consistently invest in innovation here, a key piece of the puzzle is missing.”

This is important. On 18 November I was invited to attend the Business Council of Australia’s round table discussion on how to enhance industry-research collaboration. Much was said about the need for universities to become more closely engaged with industry. There was also a strong call for STEM students to work within business prior to their graduation and be encouraged to start-up their own innovative ventures.

The creation of strategies to address the needs of start-ups, small firms seeking growth, and how to move from R&D to commercialisation were all highlighted. However, there was also a recognition that many large firms, particularly foreign owned multinationals, do very little fundamental R&D in Australia. The pipeline for STEM graduates into industry and the willingness of many large firms to serve a “Keystone” role in local business ecosystems is currently missing.

Is there too much hope placed on start-ups?

The innovation statement places a lot of attention on start-up ventures as a cure for our ailing NIS. However, while start-up activity is important it is only a small part of the overall innovation architecture in Australia.

In terms of start-up activity Australia actually performs very well at the international level. According to the World Bank’s annual Doing Business survey, in 2016 Australia was ranked 11th out of 189 nations in terms of the ease of starting up a new business. This is a decline over the 2015 period when we ranked 10th, but it is still well above the OECD average for advanced economies.

The Global Entrepreneurship Monitor (GEM) suggests that Australia’s rate of new venture creation is amongst the highest of all developed economies. In terms of business start-ups Australia ranks closely with the United States and Canada.

As the GEM report states:

“The Australian culture seems to support and encourage entrepreneurship. Evidence points to both positive attitudes towards entrepreneurship and the relatively high, affirmative media attention presenting successful role models for prospective entrepreneurs. Furthermore, Australia also ranks above average in regard to employee entrepreneurial activity in established firms.”

Australia does not seem to lack an appetite for enterprise within the general population or broader workforce. The rebound in new business creation within Australia in the years following the Global Financial Crisis (GFC) is evidence of this.

I recently wrote in “The Conversation” of the value of public policy that emphasised start-ups. In doing so I highlighted the advice by leading entrepreneurship academics to avoid trying to “replicate Silicon Valley” and their view that encouraging start-ups is generally “lousy public policy”. Nevertheless we can expect to hear a lot of talk about start-ups over the next 12 months.

If they can survive their early years, high growth “Gazelle” start-ups can generate above average levels of job creation. However, such firms represent only a small proportion of the nation’s businesses (approx. 1%) and around 3% of all start-up firms. They are also highly risky and predicting their success or failure is difficult.

Research undertaken into firm dynamics and employment growth suggests that job creation is largely coming from a few small young firms. Only some 2% to 9% of start-ups will grow above 10 employees and most firms don’t grow at all beyond that point.

The majority of Australia’s small to medium enterprises (SMEs) are not growth oriented. These small business owners are often dismissed as “lifestyle entrepreneurs” or in a derogatory manner “muppets”. However, the decision to cap the growth of a business once it has become sustainable is actually a very rational one.

Growth is a risky strategy and sensible owner-managers will approach it with caution. Modest, sustainable growth that can be funded from retained earnings and manageable levels of debt financing is usually a better option for most SMEs. Even those with innovations to commercialise.

Stimulating investment in innovation

The innovation statement has a lot to say about initiatives to help start-up and early stage businesses gain more access to financing.

The use of venture capital to help high growth potential businesses “scale up” is a relatively niche area of the overall business financing architecture within a nation’s NIS. Venture capital financing has had a relatively patchy track record both in Australia and the United States over the past 25 years.

For start-up and early stage ventures the most likely form of venture financing is from informal investors and “Business Angels”. However, such investors are typically difficult to find and rather shy about disclosing their investment portfolios.

The government’s plan is to stimulate this type of financing by making it easier to access crowd-funding for entrepreneurial ventures. This will take the form of the Crowd-sourced equity funding (CSEF) scheme. Small firms with less than $5 million in turnover and assets will be able to raise up to $5 million per year from the general public and there will be a relaxation of the standard corporate governance requirements (e.g. holding AGMs, producing audited financial statements and shareholder reports) for a period of up to 5 years.

Other initiatives designed to stimulate more funding for entrepreneurial ventures include changes to the Venture Capital Limited Partnerships (VCLPs), the transfer of losses from one venture to the next, changes to the insolvency laws to create “safe harbours” for directors who get into financial trouble, the inclusion of depreciation for intangible assets, reforms to the employee share schemes (ESS), and concessional tax treatments for investors in start-ups.

Most of these reforms have been on the wish list of the venture capital lobby for some time. For example, a report from Australian Venture Capital Ltd (AVCAL) to the federal government in 2012 called for changes to VCLPs and Early Stage (ESVCLP) programs, plus ESS taxation requirements among other things. The reforms to insolvency have been part of an ongoing discussion for many years dating back as far as 2008.

In general these initiatives seem to offer some value for enhancing the level of financing for entrepreneurial start-ups and early stage ventures. However, such businesses are inherently high risk and investors should recognise this. Government regulatory authorities will also need to be well prepared to ensure that the system is not abused.

Changing the university-industry nexus

The innovation statement also signals a number of important changes to how universities will be funded and performance managed. These are designed to encourage greater engagement between the universities and industry.

The Australian Research Council’s (ARC) Linkage Grant program that funds collaborative research between universities and industry will shift from the current once a year application cycle to one of continuous applications. This scheme previously offered two rounds a year and the reduction to one round a year was a severe blow to engaging industry partners who found this too inflexible. The continuous cycle is therefore welcome.

Another welcome change is the introduction of performance metrics for universities to measure the impact and engagement they are having with industry. At this stage the details of how this will work are unclear, but it will be based on the work already completed by the Australian Academy of Technological Sciences and Engineering (AATSE) in their report “Research Engagement for Australia”. This proposes a new set of metrics that measure the volume, intensity and productivity of how universities engage with industry.

Proposed research engagement metrics include competitive grants with clear industry collaboration (e.g. ARC Linkage, NHMRC Development Grants, NHMRC Partnership Grants), other public sector and industry income, CRC income and income from the commercialisation of research. However, it has also been suggested that consultancy income, short-course or executive training income, and the number of academics on company boards or government committees be counted.

All of these initiatives have some merit but it will require some significant changes of culture and structure within our universities to implement them.

Building a forest not a plantation

Overall the challenge facing Australia is how to reshape our national economy and make it ready and relevant for the 21st Century. Historically our economic growth has been built on the export of low value added commodities. For much of the past 25 years we have enjoyed the benefits of the rise of China. This has seen iron ore, coal and gold as our top three most valuable exports.

However, our fourth most important export has been education services. This is a reflection of the quality of the Australian education system, in particular our university sector. With China’s growth rate slowing the forecasts for Australia’s economic growth are subdued.

According to the Reserve Bank of Australia the outlook for the Australian economy is still positive. However, they are somewhat unclear about where the growth is to come from. Household and business services, food, arts, recreation, health care, education and training, were all identified as potential areas for growth.

Yet Australia still needs to make things and as I have written in past articles in “The Conversation”, it does matter that we have a manufacturing sector that is world class. We should encourage high growth start-ups and assist entrepreneurial firms to scale up. Our universities should also cease their obsession with publishing in a narrow range of approved journals and recognise the value of industry engagement.

Our large firms should be given incentives to increase their rate of investment in R&D, and serve as “Keystones” or focal points for sustainable industry clusters. There must also be attention given to the “ordinary” SMEs that comprise around 98.7% of the 2 million businesses in Australia. Such firms employ just over 70% of the workforce and contribute about 58% of the industry value added. Helping to stimulate growth amongst these existing firms is also important. A process known as “economic gardening”.

In general we need to build a healthy and sustainable business ecosystem that is like a forest with all types and sizes of businesses. We should not be designing a plantation with the emphasis on a single type of business. Innovation and growth can come from low, medium and high-tech sectors. Many of the best entrepreneurs never graduated from university.

The development of Australia’s NIS and the impact that this will have on our future economic growth is critical. It is of such national importance that it should not be permitted to become a victim of political point scoring. A long term, bipartisan approach is required.