New Zealand needs to get its national act together on innovation if it is ever to overcome its longstanding problem of being a productivity laggard among small advanced economies — with accordingly stunted incomes.
That is the central conclusion of the Productivity Commission's latest opus, the draft report on its inquiry into frontier firms. In this context, "frontier" means being in the top 10 per cent, say, of firms ranked by productivity.
For the past 25 years or more, it says, New Zealand's gross domestic product per capita has remained around 70 per cent of the level prevailing among countries in the top half of the OECD. That includes Australia, which helps explain why so many Kiwis now live there.
At the same time, exports are a relatively low share of the economy and heavily concentrated, with just 33 firms accounting for more than half of all exports in 2019.
The commission argues that both of these troubling stylised facts can be explained, at least in part, by the state of the innovation "ecosystem".
It is fragmented, lacks strategic focus and is badly underfunded both by the Government and the private sector.
"Innovative, knowledge-intensive, specialised products typically have large upfront development costs followed by low marginal costs once the product is fully developed," it says. This pattern creates strong economies of scale, and to achieve that scale in the case of small advanced economies like New Zealand requires exporting.
"This is why established New Zealand companies like Fisher & Paykel Healthcare, Zespri and Xero (and a new tranche of companies such as Pushpay and Volpara Health) rely predominantly on exports for their revenue."
That is not to deny the importance of lifting productivity in domestically focused sectors; they are the lion's share of the economy and they are a key source of inputs to the export sector. Many of the conditions that favour innovation in exporting, such as support for R&D and the supply of skilled workers, are also likely to favour innovation in some domestic firms, the commission says.
There is a range of things the Government does to foster innovation, and needs to do better, including:
• Incentivising business R&D, which is low by international standards, through grants and tax credits
• Funding research in universities and Crown research institutes
• Helping firms enter foreign markets, including providing market intelligence
The report calls for closer and continuing engagement between the Government, the private sector and research and educational institutions to identify what policies are likely to have the most impact on innovation in specific areas of the economy.
And, given limited resources, it argues for much more selectivity and focus in deciding where to target assistance.
Focus does not mean "picking winners", it hastens to say. "Rather it is about employing ongoing adaptive collaborative processes to elicit information from firms about emerging innovation and so identify appropriate collaboration that will get the ball rolling faster and overcome bottlenecks and barriers."
Economist David Skilling, whose work on small advanced economies the commission has drawn on, advocates focusing resources on strategic clusters where New Zealand has some comparative advantage, like the primary sector, or where the disadvantage of remoteness is less of a problem, like weightless exports.
"The risk of a level playing field approach that 'lets a thousand flowers bloom' is that it yields a thousand dead flowers, because firms do not have the topsoil of a surrounding cluster in which to grow to become frontier firms," he said.
One of the structural weaknesses the inquiry identified is that compared with other small advanced economies, links between New Zealand firms and researchers in universities and research institutions have been very weak. The fact that firms do relatively little R&D, by international standards, is part of the reason.
But it also reflects, the commission concludes, perverse incentives in the way the Government funds academic research.
The main way research is funded is the Performance-based Research Fund. Its emphasis on "world class" research, the commission was told, encourages researchers to seek publication in highly regarded international journals, which are relatively uninterested in publishing research on New Zealand-specific topics or on applied, rather than "pure", research.
The universities also drew fire for failing to supply graduates with the skills business is looking for.
Researchers, for their part, report that the mechanisms for allocating funding are too competitive, bureaucratic and short-term.
Another strong theme to emerge from the commission's consultations was that the "plethora of government supports for innovation is siloed, fragmented, cluttered and confusing. The commission was told some firms find it so difficult to navigate they give up on seeking assistance." In 2019 the Government put out a draft research, development and innovation strategy, with the objective of New Zealand becoming a "global innovation hub" by 2027. No decisions on implementing this strategy have been taken.
The danger is that it joins a stack of past initiatives with similar lofty goals. Remember the Knowledge Wave? Or the Growth and Innovation Framework of 2002? Or the Business Growth Agenda of 2012?
"New Zealand has a history of small-scale, sector-focused initiatives that often fade away without any clear idea of what they have achieved," the commission says. Or, it might have added, without any clear idea of why they failed.
The current initiatives, rather than being transformational, run the risk of a similar fate without a substantial increase in funding.
"If New Zealand is to achieve innovation-driven success on the scale of comparator [small advanced economies] it must be similarly bold in identifying the most promising areas for focus and in allocating substantial resources to those areas over a sustained period of time."
A repeat of what Skilling calls a "sub-therapeutic dose" of resources will achieve little or nothing.
Submissions on the draft report's findings and recommendations close on February 5.