One of the recommendations that I think of as most important in the Review of the National Innovation System is one that will cost next to nothing. As a result, it costs next to nothing. We spent a fair bit of our time focusing on the question of how we could accellerate innovation in services – when most innovation policy aims at primary and secondary industry. Loosening the definition of research and development for the purposes of the tax concession won’t do, not because it’s not a worthy goal but because its cost would be highly uncertain and it would probably end in tears as a result of negative sum financial innovation – namely financial and accounting tricks designed to capture the benefit of the concession for ‘business as usual’.
The other thing that was on our minds was trying to make the normal processes of government (not the ones associated with innovation) more innovation friendly. I think of this as conjoint with my own interest in regulation review – which was developed for the Victorian Government (pdf) as bringing ‘post-Taylorist’ thinking to the question of regulation review.
These two perspectives came together in an example I used repeatedly in panel discussions – the case of Rismark, which I also raised for the delectation of Troppodillians. The fact was that for the privilege of bringing to the Australian financial markets a highly innovative and worthwhile extension for the market for house finance Rismark had to beat its way through a massive thicket of regulation and established government practice. As I’ve said at several presentatations – if you’re Richard Pratt or BHPBilliton and you want to toss $100 mil or so into a new project, you’ll get ‘project facilitation’ which involves governments going out of their way to try to help you through all the hurdles such projects must jump in terms of approvals, regulations, environmental impact statements and so on.
If you’re a startup doing something really new – particularly in services that are highly regulated – for instance finance or health, you’ll be subject to at least as much regulation, but you won’t have a $100 mil budget, you’ll have a tiny fraction of that to start, market yourself, find the right people, cultivate a new market, fight off jealous incumbents, make the inevitable (usually major) mistakes that most start ups make. And the government? Well it will expect you to jump the regulatory hurdles. Sure enough the odd government minister or MP might give you a pat on the back, but you’re pretty much on your own. Anyway, on several occasions I drew Rismark’s horrendous experience to the attention of the panel and we tried to craft a solution – or at least make some progress on this problem – by proposing the establishment of an Advocate for Government Innovation.
I hadn’t known at the time, but Christopher Joye – Rismark’s founder and CEO – had proposed something similar before we considered it. So I was pleased to see his endorsement of our proposal in this column in The Age today. Worth a read and reproduced below the fold.
Stand aside, regulators, and let the innovators through
December 9, 2008
SINCE the late Trevor Swan’s pioneering research on economic growth in the 1950s (for which the ANU economist was nominated for a Nobel Prize) policymakers have known that productivity is the key to long-term economic prosperity.
Sustained productivity growth depends on our ability to innovate, which is in turn heavily influenced by the quality of our “human capital”.
The Government’s recent Review of the National Innovation System highlighted several concerns about Australia’s innovation potential.
First, there is evidence that after a period of strong productivity growth in the 1990s, Australia’s multi-factor productivity performance has deteriorated to levels below the Organisation for Economic Co-operation and Development average since 2002.
Second, there has been a sustained decline in government investment in science and innovation, which has fallen by more than 25 per cent as a share of GDP since 1993.
Finally, both Australia’s public and private expenditure on education now lags behind the OECD average.
In short, the data suggests that Australian governments have done a poor job of promoting productivity.
One of the review’s recurring findings was that policy needs to evolve to acknowledge that most productivity gains come from the practical application of business innovation. That is, policy needs to be developed to minimise the legal, regulatory and bureaucratic barriers to innovation.
The experience of Rismark International has been used as a cause celebre by a key member of the review, Dr Nicholas Gruen, when it comes to businesses having to defy the odds to commercialise industry-changing innovations without government assistance.
It is precisely these odds that stifle the growth of Australia’s lilliputian venture capital industry. And yet venture funding is vital for oxygenating Joseph Schumpeter’s process of “creative destruction” where entrepreneurial innovation is the key driver of long-term growth.
The most important lesson from the global credit crisis is that the financial system had too much leverage. This is particularly true of the household sector, which in many advanced economies has assumed unsustainably high levels of interest-bearing debt. There is, therefore, an elegantly simple solution to the need to “deleverage”: more equity, with households being able to draw on both external debt and equity when financing property.
There are sound economic reasons as to why this market in “shared equity” finance should exist.
Households get access to zero-interest finance where they share the risks and returns of home ownership with outside investors. By doing so, they can cut their traditional mortgage repayments by 30 per cent or more and reduce their vulnerability to adverse economic shocks.
Investors, on the other hand, get low-cost, highly diversified and very long-dated exposures to a $3.3 trillion asset class that they have never been able to efficiently access before.
One of the reasons Rismark was established is because it became clear that in spite of their creative appearances, large financial institutions really struggle with bringing transformational innovations about.
Consider the $250 billion per annum mortgage industry, in which there has been almost no genuine innovation despite its (historically) large number of participants and immense importance. This is because as organisations become larger, consensus-based decision making and risk aversion tend to predominate.
It is often left to start-ups to prise open new markets and capture the first-mover advantage, which, in the absence of enforceable patent protection, is of questionable value. As Dr Gruen has noted, many innovative companies never get off the ground because of the upfront uncertainties they face. In Rismark’s case, the company needed to raise many millions of dollars of venture capital to fund the costs required to resolve the labyrinth of legal and regulatory conflicts its products confronted with the ATO, ASIC, the ACCC and different state government consumer affairs departments.
Failure at any one of these hurdles would have completely killed the market.
These obstacles existed for the simple reason that Australia’s legal and regulatory system was not created with shared equity finance in mind. For example, there was a risk that investors would be taxed annually by the ATO using artificial estimates of the accrued capital gains rather than when the gains were crystallised on the date the loan was repaid. This would have destroyed investor interest.
For over a year of negotiations ASIC was unclear as to whether shared equity should be regulated like other housing finance products or treated as an investment instrument. If the latter prevailed, lenders would not have been able to offer the products through traditional distribution channels.
After surmounting these and other challenges, Rismark eventually succeeded in successfully launching its shared equity product into every mainland city in March 2007.
Since that time its product has won numerous industry awards and been subject to much local and overseas praise.
One of the government review’s main recommendations was the establishment of an innovation advocate “for those within the public or private sectors who seek to innovate but who are stymied by government culture, practices, structures, or regulation”.
For too long, policy makers have conceived of innovation as the commercialisation of technological breakthroughs, more often than not made by people in white coats.
As a result policy has been costly and focused on but a tiny sector of our economy.
The review gives us the chance of broadening this vision to include the four fifths of the economy accounted for by services.
And the good news is that the most critical contribution governments can make to services innovation won’t cost a cent. They just need to get out of the way.
The Rudd Government should not miss the opportunity to establish an innovation advocate, which could be a bold and world-leading experiment in minimising the legal, regulatory and bureaucratic hurdles that invariably hinder market-based innovation.
Christopher Joye co-authored a report for the 2003 Prime Minister’s Home Ownership Task Force and is the CEO of Rismark International.