A Case for Innovative Economic Leadership

• GFC Implications
• Strengthening Innovation Support

Outline

Professor Roy Green (University of Technology, Sydney) suggested that Australian firms need to upgrade their ability to innovate out of the severe 2009 economic downturn, and that governments should consider such long term needs in determining their short term responses to the economic crisis ('Innovation the key to recovery', The Australian, 1/4/09)

Outline: Short term gains must be linked with longer term strategies. Without agreement on causes of the GFC, there can be no solution. At present all that is agreed is that government intervention is the answer, and theories of capitalism as a self-adjusting mechanism are challenged. The first response to crisis was based on monetary analysis (involving de-leveraging, lower interest rates, recapitalizing banks). It then became obvious that countries were caught in a liquidity trap like Keynes had identified (ie that the problem was not a lack of credit but of effective final demand). Governments shifted emphasis to short term fiscal stimulus - on the grounds that markets would take too long to restore themselves. However problems facing the world's economies are deeper than financial imbalances and demand deficiency. There is a structural crisis of over-production promoted by over-expansion of credit, and a shift in the distribution of income from wages to profits. Thus short-term stimulus measures need to be linked to building longer-term capacity for innovation and entrepreneurship - so that enterprises can lead recovery. Schumpeter's analysis of creative destruction provides best guidance. Firms now have to create own momentum via innovation, not ride others' waves. Firms need to adapt to markets, and ensure that markets lock into their innovations. This would allow rapid growth even in difficult times. However Australia's productivity growth, boosted by 1990s reforms, has faded. 2008 review of national innovation system showed that revival of productivity / competitiveness depends on knowledge and innovation. Government innovation policy should not focus only on R&D - because 2/3 of firms' innovation spending is not R&D. Management and leadership are key factors. Federal Government has started moving in this direction with its: Enterprise Connect business advisory services; a 'researchers in business' schemes; and specialized innovation centres. This could be extended for more targeted management / innovation capacity in workplaces - and be a cost-effective way of using fiscal stimulus with longer-term benefits.

Somewhat similar suggestions were offered on behalf of the Licensing Executives Society (eg see Stimulus packages going to wrong spots: attorney, 2/4/09).

The purpose of this document is to propose mechanisms for speeding a transition to a situation in which firms are more able to innovate out of economic downturns.

In brief it will be suggested below that:

• Professor Green's constructive proposal is made more important by the fact that the global financial crisis (GFC) is exposing, and was partly caused by, poorly-understood structural defects in the world's economy that make it unlikely that sustainable recovery will involve merely reviving pre-GFC economic functions;
• the need to develop innovative capabilities in Australian firms and regional economies has been recognised for two decades, but progress has been slow - arguably because innovation systems were developed that were politically-driven (ie perceived to be a 'good thing' by influential interest groups) rather than being market-driven (ie meeting the needs of customers);
• Australia's productivity growth has been hampered by the lack of balance between the strict emphasis on exposing firms / individuals to competition and the amateurish effort to enhance their ability to compete successfully in high value-added activities (eg through effective innovation systems);
• better means to develop economy-wide innovation support capabilities are probably available, but require new approaches to economic leadership.

Implications of the Global Financial Crisis (GFC)

Professor Green's article presented a constructive account of how the GFC has appeared and how governments have responded in countries that are like Australia.

However this is only a partial view as there are causal factors and policy implications in (say) continental Europe, East Asia and emerging economies that are significantly different - and these differences have received little attention. An attempt to draw upon information related to significant non-Anglo-zone economies as well is in GFC: The Second Test of Globalization.

Of particular relevance is that there is more to the problem of financial imbalances and a cyclical demand deficiency than the article suggested. There is a critical international dimension related to  economic strategies that have been the basis of East Asian economic 'miracles' (that are macroeconomically-unbalanced because of structural demand-deficits). These have contributed to the financial imbalances that have long put economic growth at risk (see Structural Incompatibility Puts Global Growth at Risk, 2003), and also to the emergence of the GFC (see Financial Imbalances in Global Financial Instability: A Many Sided Story).

There is increased recognition by many analysts of the importance of these financial imbalances and the problem was even referred to indirectly by US President Obama when he spoke of the inability of the world's economy to rely on the US to provide unlimited future demand. However the imbalance issue was not addressed through the G20 summit (see Announcing 'Peace for our Time'). The bottom line is that:

• recovery from the GFC is not likely through demand stimulation in countries like Australia (especially the US) that have been relied upon to provide the excess demand to counterbalance the demand deficits in countries with export-oriented strategies (like Japan, China, Germany); and
• for complex cultural reasons, East Asian economic models probably can't be adapted to succeed in a new environment which lacks strong external demand and financial systems (see Are East Asian Economic Models Sustainable?).

Thus (though the possibility is as yet virtually unknown to financial markets and economic analysts) there can probably not be any sustainable economic recovery which merely restores past economic activity. Increasing the ability of firms to find / create new opportunities that Professor Green drew attention to is likely to be critically important. .

The present writer's (undoubtedly inadequate) general speculations about Australia's response to the GFC are in Managing Australia's Economic Crisis. This refers to significantly boosting economic supply capabilities.

Strengthening Innovation Support

Stronger innovation systems are not the only way in which firms' abilities to find / exploit new opportunities could be enhanced. For example, there might be advantages in increased flexibility through better systems for enterprise bargaining and less intrusive regulation through developing ways of addressing social / environmental difficulties with less reliance on government intervention.

However the challenge of creating strong market-focused systems to support innovation by firms in larger cities and to extend this to firms in other regions is a good way of considering the challenge of accelerating the development of high value-added economic production capabilities generally.

Why pursue productivity? The suggestion here about seeking high value-added economic activities might seem obvious, but it is not as obvious in the GFC environment as it might have been some years ago.

The pursuit of financial gains (eg profits) through complex institutional arrangements was a major factor in the emergence of the GFC.  A much stronger role for government is seen as the antidote. However this is not likely to be durable, because governments will be no more able to pick winners in future than they have been in the past - because of their structural inability to get the information needed to do so.

However there is another profound (but virtually unknown) challenge to the notion of pursuing financial productivity - and this arises from the economic models that have been used in East Asia where production is coordinated by social relationships amongst elites - with little regard to financial returns. This is seen (by Asian nationalists) as the basis for quite different methods for organising economies and of financial systems which are unlike those used in Western societies. However such alternatives to the pursuit of capitalist profits are also unlikely to be durable for reasons suggested in China: After the Bubble

There is nothing new about innovation support systems. The present writer produced one of the earliest reports on upgrading innovation capabilities in Australia (Towards a Strategy for Technological Development in Queensland, Premier's Department, 1983, unpublished). This identified the fact that such systems had been effective in some of the world's more dynamic economic regions since about 1970. It also revealed that a lack of commercial competency and organization (rather than any shortage of R&D, education or technical skills) was the major obstacle to innovation in Australia,

However, despite the strong in-principle political support that has been given to boosting innovation capabilities in Australia, progress has been very slow (perhaps even negative) because politically-driven rather than market-driven methods have been used (see Smart State: Aiming at the Wrong Target for indicators, and The Economic Futility of 'Backing Australia's Ability 2' for a more general discussion). The political system responded to the strongest established  lobby groups (ie those involved in science and technology) and almost nothing was done to reduce the more important constraints (ie commercial capabilities and organisation).

As Professor Green noted, (a) the capability of firms to profit from innovation is important to an economy's productivity; (b) Australia's productivity growth has been slowing; and (c) there is much more to effective innovation than R&D (eg the internal management competencies that his article referenced, as well as many external commercial / production / legal / financial / logistic / etc support services).

One reason for limited progress in boosting productivity is arguably that strategy for boosting the supply side of the economy has been unbalanced. Emphasis has been placed on requiring individuals / firms to compete without doing enough to ensure that they had the systemic support needed to compete successfully in high value-added activities (see Defects in Economic Tactics, Strategy and Outcomes, 2000)

Government policies to increase competitive capabilities have focused on providing inputs to the economic system (eg education / training / research / innovation support services to individual firms such as those Professor Green's article referenced). Unfortunately, because they are not market-responsive and crowd-out the emergence of embryonic market-based arrangements, government-promoted 'assistance' services to individual firms to fill perceived market gaps are a major obstacle to the development of the market-based services which must exist if thousands of (rather than a few) firms are to go down that route (ie government 'assistance' services are the opposite of economic development), A superior approach would be to stimulate  such support services within the market economy, and thus (a) increase the ability of large numbers of firms to profit from innovation; and thus (b) generate a strong demand and productive sense of direction for economic inputs such as advanced education, training and R&D.

Methods to accelerate the development of market-based innovation support capabilities are arguably available through stimulating multifunctional enterprising responses to major new opportunities (eg see Changing the Economic System Directly). This, however, requires rethinking the nature of effective 'economic' leadership. Because of the pressures that they are subject to, politically-accountable entities tend to reflect understandings that are widely accepted within the community. They are thus intrinsically unable to take the lead in promoting changes whose economic value depends on the fact that they are not yet widely understood (see Economic solutions are beyond politics, 1995).

A practical means to accelerate the development of economic functions such as an innovation system which is based on reasonably-successful past market-driven experiments is speculated in Developing a Regional Industry Cluster (2000). A process to boot-strap the development of a more commercially-relevant innovation system (by building off existing capabilities through adding value to particular opportunities) was suggested in 1998 by a Technology Task Force of Queensland's Institution of Engineers. Protocols for private-public partnerships that were developed in the US in the 1990s (eg the Silicon Valley Joint Venture Network Association) might also be worth considering.

Though attempts to accelerate learning within the real market economy must be inadequate if undertaken by democratically accountable entities, there would be great value in requiring democratic endorsement of the protocols that would be used in such processes to protect the community interest. This would be like governments determining the rules under which companies operate even those such entities tend to be unsuccessful in a competitive environment if subjected to direct political control.

Finally, as Australia's states are the primary level of government that has had nominal responsibility for economic development, there might be value in changes in the national tax system and revenue-sharing systems. At present those systems gives states neither financial rewards for real success nor financial penalties if they merely pretend to take that responsibility seriously, because: (a) state revenues tend to be based on the value of economic transactions, rather than on the economic value-added which determined business profitability, employee remuneration and the federal-government's main tax bases; and (b) revenue sharing arrangements compensate states whose defective economic strategies produce a weak tax base (see Providing Incentives for Economic Development).