The "fundamental problem" is that New Zealand's commodity-based economy produces an average income per person, in real purchasing power, of only 84 per cent of the Western average and just 77 per cent of the average across the Tasman.
To close that gap, says Andrew Grant of McKinsey and Company, requires higher productivity. And the key to productivity is smarter technology.
But, in the first major Knowledge Wave Trust report since last year's conference, McKinsey concludes that New Zealand's technological efforts are woeful.
"New Zealand has a public sector-dominated research industry whose inherent weaknesses have been exacerbated by a lack of clear and consistent strategic direction, weak funding allocation mechanisms and a fragmented research sector."
McKinsey recommends a massive boost in state research spending, and tax breaks and loans to induce an even bigger increase in business research.
The diagnosis 1. No strategy: The report says New Zealand lacks "a clear and consistent innovation strategy".
In 1999-2000, the Government and universities between them spent $114 million on research in pastoral industries; $87.5 million on horticulture, food and beverages; $41 million on forest products; $10 million on fisheries; $44 million on manufacturing and construction; $17 million on energy; $2 million on transport; $11 million on tourism and commercial services; $38 million on computing and communications; $147 million on the environment; $112 million on social and cultural research; $66 million on health; $67 million on fundamental research; and $10 million on other areas.
"It's confetti politics - a little bit going to everyone," says Grant. "When you are small, trying to do too many things averagely is a recipe for disaster. You have to do a few things well."
The Government said in February that three sectors would have priority: biotechnology, information and communications technologies (ICT) and creative industries.
But the report says Australia, Canada, Singapore, Finland and Israel are all targeting biotech and ICT too - with far more money than New Zealand has.
2. Fragmentation: Public research spending is split among eight universities, nine Crown research institutes and hundreds of companies and private researchers.
Biotech research is done at eight of the nine Crown research institutes. The biggest, AgResearch, effectively competes with our biggest company, Fonterra, in genetic research on cows.
"If you look at some of the large East Coast and West Coast laboratories in the US, they are equivalent to the entire New Zealand R & D system," Grant says.
"That actually is the market. That is what we are up against. When you hold that mirror up to what we have, we look desperately fragmented.
"We have created entities that are far, far too small. We are not even talking about creating an All Black team - going from a club competition to a provincial competition would be helpful to start."
3. Poor quality control: Only Marsden Fund grants for basic research and Health Research Council grants are allocated using international "peer reviewers".
The Foundation for Research, Science and Technology uses "reference groups", usually drawn from relevant researchers and businesses within New Zealand. It said last December that it "has not undertaken on-site assessments for several years" and has "no milestone monitoring, review and follow-up on contracts".
McKinsey says the foundation "lacks sufficient resources effectively to manage the nation's R & D investment". It spends only 2 per cent of its research funds on managing the research, compared with global benchmarks of about 5 per cent.
4. Low investment: Both the Government and business invest less in research and development (R & D) than most of the 30 developed countries in the Organisation for Economic Co-operation and Development (OECD).
In 1999-2000, the Government invested 0.58 per cent of the national income in R & D, compared with an OECD average of 0.68 per cent. This year, Government spending is down to 0.54 per cent.
Business R & D investment was only 0.32 per cent of the national income, compared with an OECD average of 1.4.
"New Zealand is not a little bit off the pace. We are way off the pace," Grant says.
5. Low basic research: The two basic research funds (Marsden Fund and New Economy Research Fund) plus university research, scholarships and fellowships all add up to only 31 per cent of Government research spending, compared with an OECD average of 40 per cent.
This year there were 801 applications for Marsden grants, but the budget let only 86 be funded. That 11 per cent success rate compares with 21 per cent in Australia and 31 in the US for similar funds.
"New Zealand is spending much less on basic research than its global competitors," the report says. "This potentially limits New Zealand's ability to create a solid innovation pipeline that feeds its [economic] growth."
6. Weak global links: New Zealand's rate of international collaboration in authoring scientific papers is above the world average. But McKinsey says we have failed to establish other links such as:
* Canada is creating 2000 research professorships by 2005 to attract expatriate and other researchers.
* Singapore has lured top US universities such as Johns Hopkins to build research-based campuses in Singapore.
* Israel has created bi-national research foundations, including one where the US and Israel each paid US$55 million ($117 million) into a fund and use the interest and the proceeds from selling shares in earlier projects to invest about US$12 million ($26 million) a year injoint commercial R & D projects.
The prescription 1. Prioritise research: "For New Zealand to achieve its goal of returning to the top half of the OECD world, R & D must be a 'first-order' national strategic priority that receives the same focus and attention that Governments have traditionally given to health, education and taxation policy," McKinsey says.
It recommends a top-level "innovation leadership committee" of cabinet ministers, business leaders and national and overseas experts to allocate research funds to strategic priorities.
2. Innovation strategy: The report says New Zealand should "focus its innovation activity on those slivers where it has sufficient scale and research skills to be a top global player".
"For example, within biotechnology, focus should be on maintaining a global lead in agriculture through investment targeted at the cutting edge of agbiotechnology."
In Grant's words: "It's not just for the startups. It's for forestry, agriculture, fishing. It's how you use ICT and biotech to actually teach those dinosaurs to dance."
3. Clusters: McKinsey advocates consolidating New Zealand's research effort into clusters with "critical mass".
Grant cites evidence from Silicon Valley's Stanford University that you need 100 scientists working in the same area of science in one place to get the kind of vigorous "intellectual discourse" that promotes new thinking.
The report does not advocate merging universities and research institutes directly, but says this should achieved by making all funding "contestable" - removing even the 10 per cent that crown research institutes get as a base grant.
It praises the new process where universities had to compete for funding worth a total of $15 million a year for five "centres of research excellence" . Two or three more centres will be chosen in November.
The report suggests holding similar tenders for centres of excellence across the whole R & D sector and giving them up to 30 per cent of the state R & D budget.
4. Peer review: McKinsey proposes using international peer review to allocate funding for all basic and strategic research.
This would avoid the "political gaming" that may occur when New Zealanders sit in judgment of their own colleagues, and ensure that research does not duplicate work being done elsewhere.
To pay for this, it recommends raising the foundation budget for managing research grants.
5. More investment: The report says the only way to lift productivity above the OECD average is to invest at least the OECD average on R & D - in actual dollars, not just as a proportion of our (low) incomes.
That means raising state research spending from an average of $245 a year for every person in the country at current growth rates to $413 a person by 2010, and multiplying business research spending from $136 to $838 a head.
In kiwi dollars, it means trebling Government research spending from this year's $677 million to $2 billion a year, and inducing business to lift its research spending by an order of magnitude, from around $400 million to $4 billion a year, by 2010.
"We have to take an investment mindset rather than an expenditure mindset," Grant says.
He suggests following Quebec's example and ploughing some of the NZ superannuation fund into R & D.
6. More basic research: McKinsey says 40 per cent of Government research funding should go into basic research to build science skills and "fuel the pipeline" of future technologies. Universities, which won 66 of this year's 86 Marsden grants, would probably get most of this.
7. Incentives: The report challenges the country's top 100 companies to develop corporate technology strategies to increase their global competitiveness.
But it says the required tenfold leap in business R & D will never happen unless taxpayers also help with grants and tax incentives.
It recommends expanding research consortiums - where the Government matches money invested by businesses and research bodies - from $22.5 million this year to cover the entire category of research for industry, including agriculture and forestry, which totalled $171 million this year.
This is the model in Israel and Finland, where the Government gets its money back with a dividend if the research pays off. In effect, it would mean that industry, not the state, drives applied research.
On top of this, McKinsey recommends short-term tax credits based on future earnings for startup companies which may be too new for state co-funding.
It praises a British scheme giving a 24 per cent tax credit on R & D spending by small businesses which are not yet profitable.
This costs the Government nothing initially, as loss-making companies do not pay taxes anyway. But it encourages investment in startups by letting them build up credits against taxes on future profits, enabling investors to recover their money sooner.
"We have to match the market," Grant says. "We do not have the intrinsic advantages that we would need to be able to outperform Australia. If you not going toe to toe with them in these sorts of incentives, you are just not attracting the R & D that you need."
8. Strengthen global links: The report recommends Canadian-style research professorships to attract Kiwis and others from overseas, and encouraging local researchers to take temporary posts overseas with guaranteed jobs when they come home. It also endorses Israeli-style bi-national research funds.
Herald features:
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Global Kiwis
Proud to be a Kiwi
Our turn
The jobs challenge
Common core values
Related links:
The Government's innovation strategy
