Wool to Weta

By Paul Callaghan

New Zealand will never prosper if we keep relying on our natural resources, says scientist PAUL CALLAGHAN. In this edited extract from his soon-to-be-released book, he outlines an alternative vision for a wealthier country

If you go to the Rangitikei district of the North Island you can go on a tour of stately homes. Many were built in the early 1900s when New Zealand's poor economy went through a rapid growth in prosperity. Newly wealthy families developed delusions of grandeur.

The growth was brought about by the science of thermodynamics and the development of the refrigerator. Refrigerated shipping lifted New Zealand from subsistence trade to relative wealth.

The story of our bedrock, land-based industries is an impressive one. Our science innovation gave us world-class agriculture, so that, by the time I was born, New Zealand had one of the highest per capita incomes in the world. We have become a big international player in agriculture and we are a "superpower" in dairy exports. And of course, our absolute prosperity has increased as we all share the fruits of international science and technology discoveries.

So why has our per capita income relentlessly slipped behind countries we used to better? Why do we work harder for less than the rest of the developed world?

To understand that problem we need to go back to some historical indicators. We export commodities, but the long-term trend for commodities - as graphed by The Economist - shows localised peaks when times are good, but the overall trend is relentlessly down.

Forty years ago our meat exports paid for our pharmaceuticals bill eighteen times over. Now it pays for it four times over. Even in the past few years, while we have enjoyed a commodity boom, that ratio has stayed fairly flat. The long-term prospects are clear: relentless decline.

To match Australia's per-capita prosperity, we would need to lift our GDP by US$30 billion a year. Where might we earn that money?

Ideally we would earn it from additional exports. We are just 0.2 per cent of the world's economy. Our local market is very small, and much of what we want to buy is made offshore. What that means is that our extra productive capacity will need to be directed to exports. Everything we want from offshore, whether pharmaceuticals or iPods, we can buy only if people elsewhere in the world want to exchange their dollars, euros or yuan for our goods, our land or our dollars.

Tourism is now our number one export industry, with manufacturing close behind. Dairying continues to be a great New Zealand success story. Adding US$30 billion per year would mean, on the face of it, multiplying our dairy exports by five, or our tourism by four. Of course there are economic multipliers at work that deliver additional "downstream" benefits for every extra dollar exported. But we do get a measure of the scale of our problem by the ratios I am quoting. And even if we could increase dairying or tourism, there are problems.

I doubt that it would be feasible to double Fonterra's production, let alone increase it by a factor of five, and I doubt whether we would want to quadruple the numbers of tourists visiting New Zealand each year, from 2.5 million to 10 million.

I want to suggest another model for New Zealand export business, and one that has few downsides.

The table (page 15) presents an analysis of some international businesses, in terms of two particular metrics per annum: revenue per employee and profit per employee. Revenue per employee and profit per employee are not perfect indicators of wealth generation, but they are interesting. Of course, one needs to look at the assets of a company to get the full picture. What did it cost to build the asset base to allow that industry to function? In the case of high-tech companies, the asset base is mostly brains and knowledge, whereas for an energy company it may be large-scale construction along with brains or fewer brains, depending on the particular company.

But looking at largely brain-based business, it does seem, overall, that high-technology companies come out quite well. There are several companies, in the United States especially, where $1 million revenue per employee is not uncommon. Of course large revenue will be most interesting, from a wealth-generation perspective, when it arises from a low input value of raw materials or a low input value of supplier product (and a low capital asset base). Examples are the writing of valuable software, the discovery and production of a valuable chemotherapy drug or the turning of silicon from sand into integrated circuit electronics.

In this regard, Samsung, which makes its own chips and consumer electronic products, is close to that ideal. Samsung produces about three-quarters of New Zealand's GDP with 123,000 employees. That's a sobering thought. By contrast, McDonald's, a well-known and presumably profitable business for its owners, has extremely low revenue and profit per employee. McDonald's, like most of New Zealand's economy, is in the low-wage business.

Among New Zealand's top earnings performers, it seems that Meridian Energy (NZ$3.0 million per employee) and Auckland Airport (NZ$1.0 million per employee) also make a large amount per employee, but they have large physical infrastructure as capital assets, and there is a cost to capital.

What is high technology? In short, products that embody relatively intensive research and development (R&D) inputs, either at the final manufacturing stage or through the components used in their production.

So what are our high-technology businesses, the ones that turn ideas into valuable products? These are the companies whose assets are the brains of their team. No dams, no windmills, no runways and airbridges, but talented people who create employment for other talented people, who might have computers, some machine tools, some circuit-manufacturing capability and some plastics-moulding equipment.

We have a handful of such companies in the $100 to $200 million per year revenue category. These include Rakon with global positioning systems (GPS) on a chip, Fisher & Paykel Healthcare with hospital technology, Tait Electronics with radio communications equipment, HumanWare with technologies for the blind and Gallaghers with security equipment and electric fencing.

None of them beats Fonterra in terms of revenue per employee (around $300,000 per annum), but let's consider for a moment their big advantage. Rakon, Fisher & Paykel Healthcare, Navman, Gallaghers, Alphatech, Vega Industries, HumanWare, Weta Workshop and Weta Digital all needed no new resources to start except brains and market understanding. Unlike Fonterra (or Meridian Energy), they need practically no land. They incur no significant costs of transport across the world, because their products are worth tens of thousands of dollars per kilogram or, better still, weightless.

They consume little energy. They do not emit significant greenhouse gases or dump nitrates in our lakes. The Resource Management Act is no bother to them at all, and, as their products are valuable, they are perfectly happy with a high New Zealand dollar value. And these businesses reside in perfectly attractive buildings and surroundings. In short, they are sustainable, environmentally and socially benign and there is no limit to the numbers of such companies which we might enjoy, except to the degree that our brains and enterprise make such businesses possible.

Clearly New Zealand would benefit if many more such "knowledge businesses" were to form, but what can we do to seed that process?

The reason that each of these companies started is not widely understood. Anecdotal evidence suggests the role of inspired individual entrepreneurs, few of whom came from a formal, research-based scientific background, but all of whom have extensively employed high-level R&D capability.

How do we generate more? I don't think that it is sufficient for us merely to create a macro-economic environment conducive to business, and especially export business, and then to hope that seed nuclei will form. My interest is in expanding the seeding process and helping companies take the first steps to market.

One obvious place to look for such seeds is in the large body of publicly funded scientific research, especially in those areas of science where commercial opportunities abound. Our prior success stories suggest that physical sciences may be our best hope.

I am speaking here of spin-out companies. Examples of such recent spin-offs are: Southern Photonics Ltd (optical pulse analysers) from the University of Auckland, Whisper Tech Ltd (Stirling cycle engines) from the University of Canterbury, Magritek Ltd (magnetic resonance technology) from Victoria University and Massey University, Australo Ltd (nanomanipulation of DNA), which has grown out of prior University of Otago research, and Photonic Innovation Ltd (laser detection of gases), also from the University of Otago. In the biotechnology sector, we have Proacta, a United States company which has commercialised cancer drug intellectual property of the University of Auckland and Protemix, a University of Auckland spin-out company developing drugs to treat diabetic heart failure. Both show considerable promise, but have not yet generated a significant income stream. Therein lies an interesting issue.

New Zealand's Growth and Innovation Framework (GIF), established by the government in 2002, identified four sectors, including creative design, information and communications technology (ICT) and biotechnology, worth focusing on. Later economic strategies highlighted these and other candidates.

This sort of "guessing where our talents lie" is inherently dubious. It is true that ICT is indeed an area of high technology where we can get to market quickly and where we have shown that we can be successful. But consider for a moment the case for biotechnology. The government-funded Foundation for Research, Science and Technology (FRST) particularly targeted biotechnology as an area for R&D investment.

Biotechnology is an ill-defined descriptor, encompassing pharmaceutical development, genetic engineering and human reproductive technologies at the most valuable end of the spectrum to new methods of food and beverage processing or technologies which assist agriculture at the other end. Clearly New Zealand has some natural advantages in agriculture, horticulture and certain food industries, so that technologies aimed at enhancing their performance can produce real benefits. But for the rest, for the high-value activities, biotechnology is one of the most difficult areas in which to get products to market and to generate income streams.

With biotechnology it is often hard to find a way to turn ideas into real products, to deal with complex regulatory requirements and to develop sufficient scale. While we are clearly good at agriculture, the assumption that this will translate into other areas of biotechnology is an heroic act of faith.

While we have not been particularly effective at turning scientific intellectual property into business, especially in the more valuable aspects of biotechnology, in contrast we seem to be good at doing it in another high-value area, the so-called physical platform technologies. Given our capability in physical sciences and engineering, I think that we could generate many more start-ups of the Rakon/Navman variety, and if a fraction of them succeed we may do far better than via the biotechnology route favoured by government.

One of our main funding instruments for building a platform for high-technology spin-outs has been the New Economy Research Fund (NERF). A report on this fund, commissioned by the Ministry of Research, Science and Technology and undertaken by United States firm Abt Associates in 2006, suggests that New Zealand disproportionately invests in biotechnology yet the outcomes, in science, intellectual property and business activity, have been significantly poorer than those for physical sciences and engineering.

Worse, there has been an "investing in predetermined boxes" approach to New Zealand's funding of scientific research, based on a presumption that our small size requires us to focus our investment effort - focused of course where public servants deem that we might be successful. The biotechnology gamble appears to be based on an observation that we are good at farming.

In my view we should invest in platforms where we have capability and talent, and, being the small country that we are, we would be most unwise to plan in advance where these capabilities and talents are likely to arise. No public servant has the prescience needed to make pre-selected allocations or to micro-manage our research.

I am not advocating spending less on biotech research. But I am suggesting that we shouldn't apply blinkers, that we do have a track record of producing great businesses out of physical sciences and engineering and that we have the potential to do a great deal more. Most importantly, we should realise that we probably won't get results on the cheap. We invest less per capita in R&D than the OECD average, and our industry research investment rate is extremely poor.

Despite that, our per capita rate of science publication is high, on a par with the best in the world. But where we perform badly is in the generation of intellectual property per capita (NZ has 0.03 US patents per annum per 1000 population compared with 0.15 for Finland and 0.26 for the US). Why is that? Perhaps in part it reflects the nature of business in New Zealand, and in particular the low-technology character of much of our manufacturing. But I also believe that it is because of the lack of an enterprise culture among many of our scientists.

For example, in some Crown research institutes (CRIs), boards and management are loath to share the benefits of intellectual property with research staff. By contrast, there are fewer excuses for poor performance in the universities. Staff are entitled to a one-third share of benefit.

Being a scientist, I naturally look to science to contribute to New Zealand's economic development. But at the same time, a degree of caution is needed. While science and technology have driven improvements in prosperity and quality of life in a global sense, there is no guarantee that a small country will be able to commercialise the scientific research carried out within its confines. Further, when we look at our own successful high-technology companies, we find that many emerged through the genius of entrepreneurs rather than as outcomes of home-grown science research.

In many cases, the science that underpins our successful businesses was developed abroad, as in the case of the chip technology of Rakon. Examining our successes, we see that the fundamental driver is entrepreneurial vision coupled with effective innovation.

Good-quality science research is not a necessary condition for successful high-technology commercialisation and most certainly it is not a sufficient condition. However, scientific research, when carried out with intent to innovate and with a keen awareness of commercial potential, brings three major benefits to an economy.

First and foremost it provides a source of skilled employees for the high-technology sector. Secondly, it provides a source of intellectual property and potential seeds for innovation. Thirdly, it raises the significance of science and technology in the country and increases the motivation for the young to pursue an education in science and engineering.

But the drive for innovation, and the ability to learn from markets, as well as underlying scientific and technical skills will be the key determinants of whether new science-based businesses can emerge.

I have argued here against an attempt to pick winners, against the belief that because New Zealand is small we must necessarily focus our ambitions within the science and technology sector. The crucial determinant of funding direction, for economically focused tools such as NERF, should be the quality of the proposals, the science excellence, the potential for innovation and the entrepreneurial capabilities of the team.

Frankly, New Zealand science needs to do a whole lot better. That is where Centres of Research Excellence can contribute. One of these, the MacDiarmid Institute for Advanced Materials and Nanotechnology, was founded in 2002 and is a partnership involving scientists from across New Zealand. We have tried in the MacDiarmid Institute to create a culture of entrepreneurship among our graduate students.

Among this group we have outstanding human research capability in physical sciences and engineering. Our challenge is to turn that capability into manufacturing industry, to get people to "make things that the market wants".

We have to fire up our young scientists so that they see starting their own business, or joining a start-up team, as the most exciting prospect for working in New Zealand.

Part of our culture change will be to encourage a marriage of physical sciences and engineering. Ultimately, when we come to make products to sell to the world, we will need the skills of the engineers and designers. And New Zealand performs badly in this regard. We have a disjoint between engineering and physical science that borders on hostility in places. We have far too few students enrolling in engineering courses in our universities and far too few learning the necessary maths and physics at high school.

But the solution, I believe, lies in the hands of the present science and engineering generation. When we create the exciting high-paying jobs in the New Zealand high-technology sector, smart kids will cotton on fast.

My personal journey from science into entrepreneurship is quite recent. It grew out of geophysics research funded under a global climate change programme of the Foundation for Research, Science and Technology. We had started by developing robust, cheap, portable magnetic resonance spectrometers that could be used in Antarctica to measure the brine content of sea ice, but that work led to international interest in the use of these spectrometers for university teaching purposes, and then to their use in analytical research environments.

So began the export company Magritek, and a stream of new products based on magnetic resonance technologies. The company took off because we had a brilliant and unconventional young entrepreneur with a PhD in magnetic resonance who could act as CEO. I can't be certain that Magritek will make it, but it is performing, with revenue of around $1 million per annum, nine employees and minimal asset base.

So how do we boost the high-technology sector in New Zealand? First, and foremost we should do the easy things. We should discard the myth that because are good at farming, our best high-technology future lies necessarily in biotechnology. Our best high-technology future will lie where our skills, our talents and our enterprise are apparent.

The Foundation for Research, Science and Technology needs to disentangle the process of encouraging wealth generation from the process of maintaining stability of funding for Crown research institutes. The NERF fund in particular needs to be freed up to all-comers, with funds being allocated where the science, engineering and enterprise capability is exhibited, and not in pre-labelled packages invented by FRST officials. We should be prepared to be surprised, to find talent in unexpected places and in unexpected science platforms.

We need an injection of new public funding in research. We cannot expect to reach the technology-based economic performance of countries we aspire to equal when we invest in R&D at a much lower rate, both in business investment and in government investment.

Whatever route is chosen, such additional funding will need to seek ingenuity, intelligence, enterprise and commercialisation intent.

More funding and more effective investment instruments are relatively easy to achieve. What is harder to achieve is a culture in which scientific and technological enterprise is valued, where business seeks to innovate, where scientists regard business as a valid outlet for their talents and where children aspire to be scientists, technologists and engineers.

We need our universities and institutes to champion world-class New Zealand science research where only the best will do, attracting the world's best to New Zealand, and enabling New Zealanders to be world-class scientists working in New Zealand. We need to build a science platform that is internationally connected, wealth generating and a focal point for society, raising the status of science in New Zealand.

And most importantly, perhaps, we need to educate a new generation of scientists who are excellent, entrepreneurial, communicative and socially aware, a generation who wish to stay in and contribute to New Zealand.

We need to build active links with the Kiwi diaspora, along the lines of the important work carried out by Stephen Tindall and the Kea network. New Zealand has an opportunity to recruit new migrants and returning Kiwis of exceptional enterprise and scientific/technological talent, in a world that looks increasingly tense and unstable.

To be successful we need to be viewed internationally as more than a "farm and theme park". A major cultural shift towards greater emphasis on science and technology may generate new high-technology enterprises through this multiplier effect. Perhaps even more important is creating urban environments in which people of talent and enterprise will want to live.

We need to acknowledge the heroes of New Zealand's high-technology sector, such as Neville Jordan who built microwave communications company MAS Technologies from scratch. It was the first New Zealand enterprise listed on the NASDAQ. Jordan sold it at premium value and went on to found a New Zealand venture capital company, Endeavour Ltd. We need to tell the stories of Peter Maire, Gary Paykel, Rod Drury, Ken Stevens, Russell Smith and Angus Tait, amongst others.

The kids know about Weta and the Jackson studios. But they don't know the stories of the remarkable individuals who began our high-technology sector.

We need to remember that small countries can do astonishing things. Finland, with a population of four million, produces Nokia cellphones. Sweden, with a population of nine million, makes Saab jets, Volvo motorcars and Ericsson cellphones. It manufactures pharmaceuticals and, in Ikea, sells kitset furniture to the world. One single family, the Wallenbergs, donates $200 million a year, mostly to science research. That's five times our Marsden fund. Sweden runs the Nobel Prizes; the Swedes decide who get the top prizes in science for the world. That's pretty impressive.

Swedes aren't any better educated than us. They aren't more ambitious than us. It's just that they expect to innovate with science, while we see ourselves differently. We overachieve brilliantly in sport, but we underachieve in creating large sustainable businesses that can ensure our prosperity.

It doesn't have to be that way. We have the capacity to do a lot better. We have the brains, the education system, the inventiveness. But we do need to resist our occasional little-mindedness, our parochialism, our tendency to divide amongst ourselves, our tendency to be suspicious of each other.

We have business suspicious of government, engineering suspicious of science, Wellington resenting Auckland, the University of Auckland pretending the other universities don't exist, CRIs jealously protecting research grants from universities, the Ministry of Research, Science and Technology disjointed from the Ministry of Education, the Foundation for Research, Science and Technology disconnected from the Tertiary Education Commission. We just can't afford it.

We live in a wonderful but small country. Our population is no bigger than Manchester or Philadelphia, but no smaller than Finland - where people seem a whole lot better at co-operation. My plea is that we believe in ourselves and work hard to discover the business models that work for us.

My plea is for a "New Zealand Incorporated" perspective, where we build links with our talented diaspora and all the other fellow-travellers in the great Global Village who love this country.

- NZ Herald

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