Economic complexity is the answer to Pyne’s innovation problem

Industry, Innovation and Science Minister Christopher Pyne says he will release his ‘inner revolutionary’ to help make Australia’s economy more innovative. Mick Tsikas/AAP

Australian Prime Minister Malcolm Turnbull has tasked new Innovation, Industry and Science Minister Christopher Pyne with making Australia’s economy more innovative.

The purpose of industry policy is to ensure Australia is prosperous, both now and in the future. But a nation’s potential to create prosperity is a direct function of its economic complexity.

Countries with high economic complexity have a highly diverse portfolio of firms all producing and exporting offerings few other nations are able to produce. These offerings require a multitude of inputs, a high share of which are sourced in country since they also have high economic complexity.

In this environment system integrators tend to have higher economic complexity than the producers of the components that make up the system; producers of production equipment tend to have higher economic complexity than the producers using this capital equipment; and producers of physical goods tend to have higher economic complexity than the providers of the necessary input services.

This explains why manufacturing is critical for the creation of prosperity in any nation and why prosperous nations, as a consequence of their high economic complexity, have a large share of systems integrators and advanced manufacturers in their economy (for example Japan, Germany, Switzerland, Sweden).

Against this backdrop it is very worrying that Australia’s economic complexity has declined over the last 25 years - it ranked 53 among all countries in 2012. The top three were Japan, Switzerland and Sweden.

The worry is magnified when you consider the automotive sector – the highest current contributor to Australia’s economic complexity –- will disappear over the coming two years. This is likely to lower Australia’s economic complexity by a further 5-15%, while at the same time reducing the share of manufacturing in Australia’s economy to below 5% (compared to Switzerland’s 20%).

So how can Australia use its industrial, innovation and science policy to increase its economic complexity?

1. Choose areas of comparative advantage

This means focusing on sectors like mining equipment, technology and services – a A$90bn industry with A$15bn in exports. The objective here must be to accelerate the export oriented and science and technology based growth of this industry with a realistic objective of doubling exports to A$30bn in five years. Other target sectors could include agricultural equipment, technology and services; medical equipment, technology and services; and sophisticated defence equipment, technology and services.

2. Focus on increasing the value add to raw material production

This would mean learning from the failure to capture sustainable prosperity from the mining boom through the lack of value add, and the late development of the mining engineering, technology and services industry.

We should not repeat the mistakes of the mining boom with the Asia food boom. This means driving high value add food production like science-based foods (e.g. gluten free bread, lactose free milk, fortified products) and luxury food products (e.g. selected spirits, wines, cheese, seafood). Both of these will also require a highly competent packaging industry.

Other sectors that fall under this heading would be the cellulose value chain (e.g. engineered timber products, high value chemicals, composite and fibre materials), and high value add products originating from minerals (e.g. spherical graphite, metal powders for additive manufacturing use, specialised alloys).

*3. Develop tomorrow’s industries based on our comparative advantages in research *

Examples here would be high-value chemicals from seaweed; advanced fibre material based production; advanced health and care solutions; advanced solutions for real life robotics applications; quantum computing; cell factory solutions.

4. Prepare for ‘industrial euthanasia’

Manage the transition out of yesterday’s industries into tomorrow’s highly service-based advanced manufacturing. In this world most manufacturing activities will take place in a virtual space with many of the key enabling technologies and their associate production systems spread across the whole manufacturing activity system. This has major implications for both productivity improvements as well as the role of people in these manufacturing activities.

For most firms the productivity improvements will outstrip the underlying demand growth. This means tomorrow’s demand can be satisfied with fewer employees, unless we dramatically grow the number of firms and move into domains where the market growth is high.

5. Ensure major government projects are not bought off-the-shelf

Instead, they should include a component of solving problems never before solved. Doing this in-country maximises the spillover effects, and as a result is important for growing economic complexity.

6. Align labour market flexibility with structural change in the economy

The shift in activities will generate very large skill gaps, meaning firms will need to vary their labour costs via new contractual arrangements with employees (more part-time work, more flexible work). These changes need to be managed with respect for the individuals concerned, recognising that the responsibility to maintain labour market relevance rests both on the employer and the individual.

A successful new industry, innovation and science policy is imperative, not only to secure our future prosperity, but also to address the already visibly declining ability to generate prosperity in our nation.