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Role of Innovation in Economic Growth in a New Zealand Context

Page updated 5 Nov 2010

Speech delivered by Struan Little, Deputy Secretary to the Treasury at the New Zealand Association of Scientists Annual Conference on 21 October 2010, Wellington.

Good morning.

My name is Struan Little and I am the Deputy Secretary, Dynamic Economy, at the New Zealand Treasury.  My responsibilities include providing advice to the Government on research, science and innovation. 

Looking at the list of distinguished speakers who will address us today, and the diverse range of backgrounds being brought together to focus on the subject before us, can I say what a pleasure it is to be here on behalf of the Treasury.

Today I’m going to be talking, essentially, about two things:  first that innovation is profoundly important for New Zealand’s economic performance and growth and, secondly, that to gain greater economic dividends from science, research and innovation, we need to get much more fusion and synergy between our scientists and firms. 

I want to set the scene by first talking about New Zealand’s relative economic performance since the 1970s.

Figure 1: Real GDP per capita for Australia, New Zealand and OECD(1)
                 At 2000 PPP(2) prices, 1972-2009, Base: OECD 2000(=100)
Figure 1: Real GDP per capita for Australia, New Zealand and OECD
1. Organisation for Economic Co-operation and Development.
2. Purchasing power parity.
Source: Statistics New Zealand, Australian Bureau of Statistics and OECD Factbook 2010.

In 2009, New Zealand’s gross domestic product per person stood around 15 per cent below the average for the relatively rich, developed societies in the Organisation for Economic Co-operation and Development (OECD), which put us in 22nd place in the, then 30-member, OECD:  that’s a significant relative decline from being around 15 per cent above the average of the smaller, and richer, OECD during the early 1970s, when we ranked eighth out of 24 member countries.  New Zealand’s per capita income gap with Australia emerged during the mid 1970s and has generally widened since – our GDP per capita is now about 26 per cent less than Australia’s (Statistics New Zealand, September 2010).

To close the income gap with the richer OECD countries, our economy would have to grow faster than their’s for a long period.  As far as closing the gap with Australia, New Zealand’s average annual growth in GDP per capita would need to outpace Australia’s by about two per cent a year over 15 years.   That’s quite a challenge.

So what will drive this economic growth?   In simple terms there are two things that drive economic growth.  

There’s working harder:  New Zealand is already quite good at that.  We work more hours per person than the OECD average and countries like Australia and the US. 

And there’s working smarter:  getting more output from each hour worked.  Over the past 200 years, income per head in the developed world grew about 19 times.  The economic evidence suggests that most, if not all, of this income growth came from improvements in productivity rather than increases in hours worked per person.  

New Zealand has been poor at this.  An hour worked in New Zealand produces about 30 per cent less value-added than an hour worked in Australia - despite the fact that the rate of productivity growth across the other side of the Tasman has been slowing in recent years (OECD, 2010).

So, broadly, to lift economic growth New Zealand needs to work smarter: to get more output from each hour worked.  On its own, just working harder isn’t going to be enough.

How can we work smarter?   Well, we know from analysis done by the OECD that between 25 and 45 per cent of productivity gains come from innovation.   Most of the huge rise in living standards in the developed world over the last 2 centuries has come about through technological breakthroughs based on increased knowledge.  So it’s crucial that we deepen our understanding of how innovation happens and get much, much better at it so the economy can deliver the higher living standards we’re aiming for. 

So what drives innovation?  Science is one critical input, but the story of how innovations arise is much more complex than putting resources into basic research to get new technologies downstream.  Innovation and working smarter is all about getting new ideas flowing into the creation of new products, new and improved processes and technologies and softer changes like new business models or novel methods of marketing and distribution. 

Most innovation takes place in firms, and often this is through new ideas being generated on the shop floor, among users of systems and responding to end-users.   Firms need to innovate to compete and grow, and in the process come up with new products and processes and improvements in productive efficiency.

How good are we at innovation?  Statistics New Zealand surveys suggest that New Zealand firms have levels of product, operational and marketing innovation that compare reasonably well with other small OECD countries (Statistics New Zealand, 2008).  Another indicator, the IBM - University of Auckland’s Innovation Index, found that New Zealand’s rate of innovative activity rose by 13 per cent between 1998 and 2000 but then remained virtually flat for the next seven years before falling sharply in 2008.  In contrast, the same index for Australia rose more than 25 per cent in the same period (IBM New Zealand and University of Auckland Business School, 2010).  These figures indicate that there’s plenty of potential for lifting our innovation performance.

One input to firms’ innovation is research and development (R&D), but they are not the same thing.  While business R&D is a vital part, firms that innovate do not necessarily conduct R&D - only eight per cent of all businesses in New Zealand perform R&D compared with much higher rates, 46 per cent, performing wider innovation, and this disparity exists in all sizes of firms (Statistics New Zealand, June 2010).

Figure 2: Research and development(1) and innovation activity(2)
                  By business size, Financial year at August 2009
Figure 2: Research and development and innovation activity
1. Results are for the last financial year at August 2009.
2. Results are for the last two financial years at August 2009.
Source: Statistics New Zealand, June 2010.

While firms are at the centre of the innovation process, government has a big role to play.  The most important and most effective role for government is improving the policy settings that have a pervasive impact on firms’ ability to perform: by maintaining a stable macro environment, by cutting back on poor regulation, by boosting competition, by addressing the taxes that are the most negative for growth, by investing in infrastructure, and by making the public sector more efficient. That provides us with the base, for ensuring the systems and incentives are in place that allow innovation to occur.

Secondly, R&D is an important part of the innovation system – so government has to make the most of its public investment in science to yield benefits to New Zealand. This is especially so now, when fiscal conditions are extremely tight.  To get economic impact we particularly need the output from the science system to be applied in the economy by firms – the wider the better.  In saying this, I recognise that science also contributes to other important outcomes for New Zealand, including environmental, health and social. That said, being from Treasury, I tend to use an economic lens.

How are we doing in getting economic impact from our public investment in science?  There’s no doubt that New Zealand produces very good science, and leads the world in some areas.  We have a strong research base – for example, we are placed ninth out of 23 OECD countries in terms of the number of science and engineering articles published per one million inhabitants (OECD (2006).   We also rank sixth out of 28 OECD countries for the number of R&D personnel per 1,000 people employed (OECD, 2010).  But when it comes to converting this knowledge into commercial opportunities and higher value we do not do as well; this was confirmed by the OECD which has highlighted that technology diffusion and adoption is a weakness for New Zealand (OECD, 2007).

What is key is getting science connected with business, so science can give business a hand-up to solve problems entrepreneurs are grappling with and to realise opportunities they have glimpsed.  As important – or even more important - out of this synergy can come unanticipated developments for novel products or processes, opening up completely new products, applications and markets.

A case in point is the development of the electric fence.

It was Bill Gallagher who first developed the first electric fence and supplied it to New Zealand farmers.  These fences were battery powered and did a reasonable job, but their usefulness was limited because, if grass touched the wire, the voltage would drop and the animals could just walk through.  What led to the electric fence industry taking off was the invention of unshortable electric fence technology by a public sector scientist working at Ruakura.   The new reliable fences, powered from the mains supply, utilised a high current in short bursts which were safe for both livestock and people.  Since then, Gallagher’s commercialisation of the improved technology has revolutionised farm grazing around the globe and unforeseen, diverse applications have arisen – from corralling big-game animals to electrical and alarmed security fences to keep people in or intruders out.

Of course, impacts can also be unforeseen.  A rich source of unforeseen applications arises when researchers and users get together and share their ideas and perspectives.

An example is the “camera pill” - a disposable pill-sized camera that passes straight through the digestive tract, continuously broadcasting pictures of the intestine to an external receiver.  This was invented by a guided missile designer in Israel who got the idea after talking with a gastroenterologist who was suffering from undiagnosed stomach pain.   This story also illustrates the benefits of being connected internationally.   The concept of a camera pill was actually being developed independently in Israel and Britain.  These two groups of scientists later got together and successfully collaborated to develop the technology.

So getting users and scientists to talk to each other, to understand each other’s perspectives and feed off each other’s ideas, will be an important part of getting our innovation system humming. While this is already happening to some extent, we think there is room for improvement. 

Survey results show that ‘existing staff’ and ‘customers’ were the most common sources of information that businesses used for the purposes of innovation.  Less than 10 percent of businesses rated either ‘universities or polytechnics’ or ‘Crown research institutes (CRIs), other research institutes, or research associations’ as important sources of information.

Figure 3: Sources of information for innovating businesses 
                   Last two financial years at August 2007 and 2009
Figure 3: Sources of information for innovating businesses
Source: Statistics New Zealand, June 2010.

The picture is much more varied at the industry level.

In the education and training industry, 22 percent of businesses rated ‘universities or polytechnics’ as important sources of information of innovation, but only one percent in the retail trade industry did so.

In the primary sector, 23 percent of businesses in the agriculture, forestry, and fishing industry rated ‘CRIs, other research institutes, or research associations’ as important sources (Statistics New Zealand, 2010).

But when I look at these results what strikes me most is the potential for a much greater flow of information between our public research organisations and firms – and I can’t help thinking, what great ideas we could be missing out on?  I hope that’s a thought you’ll take away too.

There have been wide ranging changes in the science sector in the past year aimed at supporting economic growth.  These include: 

  • Early next year will see the amalgamation of the Ministry of Research, Science & Technology and the Foundation for Research, Science and Technology into the new Ministry of Science and Innovation (MSI).  This will bring policy making and funding together, remove some fragmentation in the system and give the sector a single and stronger lead agency;  
  • The Taskforce set up a year ago to examine how the Crown Research Institutes can best deliver on national priorities and contribute to economic growth, has reported.  The process of implementing its recommendations is underway;
  • Business R&D has been growing in recent years from a low base.  Although our business R&D is relatively low by international standards this can be largely explained by our industry structures, firm size and distance to market.  But given that a large body of empirical evidence suggests that business R&D has a significant impact on economic growth – encouraging it is important.  Budget 2010 made provision for four initiatives to boost business R&D and improve technology transfer and commercialisation from publicly funded research to firms (technology development grants, technology transfer vouchers, the national network of commercialisation centres initiative, and technology transfer initiatives); and
  • In the tertiary education sector there have been changes to the PBRF evaluation process to ensure that excellence in applied and commercial research is properly rewarded.   

So where do we go from here?

We need to ensure we get the best out of these substantial changes in the science system.  The new MSI will need to live up to its name and ensure that innovation is as centre stage as science policy.  It will probably mean some shift of focus and funding from ‘blue skies’ and basic research to applied research of relevance to firms.  And to apply energy and drive to getting a step-change in collaboration and knowledge transfer both in the science sector and between the science sector and firms. 

New Zealand only produces a very small percentage of global knowledge, so we have to be smart technology adopters.  To do this we need to be deeply connected with the global innovation system.  We already have many good linkages with international science, but I think we can do even more. We need our public research organisations not only to be excellent at keeping abreast of leading edge science and emerging technology, but also to excel at adapting it for New Zealand settings and turning it into commercial opportunities for our firms.     

We need to ensure that the CRI reforms help to maximise the economic benefit from CRI research, and to get this we need New Zealand firms to be able to turn these findings into profits.   We need CRIs to forge partnerships with the private sector to help CRIs plan their research more in line with the needs of industry, and give the private sector an early insight into potential investment opportunities.  It’s vital too that CRIs put a much greater emphasis on transferring the knowledge and technologies they generate to New Zealand businesses.  The new arrangements for funding and monitoring CRIs will help cement this in.

The new business R&D incentives and commercialisation initiatives are underway – we need to ensure that they are evaluated properly and learn from our experience of them in practice.    We want to facilitate Commercialisation Centres to build up scale, expertise and networks so that they become excellent at commercialising bright ideas.  And it’s Treasury’s view that further incentives for business R&D are worth considering, but these will need to be within the bounds of our fiscal constraints.

We must also build up a stronger focus, not just on commercialisation and technology push, but knowledge transfer more generally. To capitalise on our innovation potential, we have to ensure that the flow of ideas is genuinely two way - not just from public research organisations to firms but from firms to scientists, scientists to scientists and, where possible, from firms to firms.  Building stronger networks, with highly mobile researchers with strong links to industry will be part of this, as well as accessing and adapting the best ideas from abroad.

In closing, I want to leave you with the message that New Zealand’s future economic performance will depend on innovation.  Research is one important input to this, but it is firms that take up and apply research for economic benefit for New Zealand.  To get the best out of our science system, the flow of ideas between the science system and firms needs to be strong and genuinely two-way.

Thank you. I wish you well for the rest of the conference.

References

IBM New Zealand and University of Auckland Business School, “Innovation Index of New Zealand 2010,” IBM New Zealand and University of Auckland Business School, University of Auckland, 2010.

OECD, “Science, Technology and Industry Outlook 2006,” OECD 2006, Table 38.

OECD, “OECD Reviews of Innovation Policy – New Zealand,” OECD 2007.

OECD, Estimates of labour productivity levels 2009, OECD database, 2010.

OECD, “Main Science and Technology Indicators,” OECD, 2010, Vol 2010/1, Table 10.

Statistics New Zealand, “Innovation in New Zealand: 2009,” Statistics New Zealand, June 2010.

Statistics New Zealand, “Comparing the Income Gap between Australia and New Zealand: A 2025 Taskforce analytical report 2010 update,” Statistics New Zealand, September 2010.

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