Agri-Food 2000 - Melbourne August 16 - 17 "Invention, Innovation and Profitability"

Professor Wolfgang Kasper

Senior Fellow

Centre for Independent Studies - Sydney

About the presenter

The Knowledge Economy -- Nothing New

Discovery, Invention and Innovation

Competition -- The Lifeblood of Innovation

The Enemies of Innovation

Opportunities for Innovators

The Knowledge Economy -- Nothing New

Nowadays, there is much talk of the ‘knowledge economy’ and the ‘new e-economy’, and every rookie journalist gushes about the importance of innovation.

In reality, there is nothing new about the basic fact that the search for, and testing of knowledge, is what drives economic progress and human optimism. Since the earliest beginnings, our forebears have been ‘the Curious Animal’, tinkering with stone tools, experimenting and trying out ideas, failing, rejecting schemes, trying again, and sometimes being lucky in that others accepted a discovery and imitated it.

The only new aspect of our age is the enormous acceleration in innovation and an incomprehensible increase in the complexity of human knowledge. I say ‘incomprehensible’ because no single human mind could possibly hold all this knowledge, and no single person could ever understand how bits and pieces of ever-evolving knowledge are combined to become useful. Individuals with diverse interests and expertise--not governments or other collectives--must therefore be the focus if we want to understand the modern knowledge economy.

Discovery, Invention and Innovation

My assignment this morning is to address the fundamentals of how and why knowledge is explored and tested (and why not), and Ã¢ÂÂÃ¯Â¿Â»Ã¯Â¿Â»Ã¯Â¿Â» how this affects human welfare. Ã¢ÂÂÃ¯Â¿Â»Ã¯Â¿Â»Ã¯Â¿Â»

To start, I have the tedious task of inflicting on you some important definitions…. This is what you get when you invite a professor of economics as a speaker!

First, there is the discovery of how things work in nature: If you soak wild olives in brine, they become edible; if you keep grape juice for a while, it becomes an exhilarating drink; if you add tan bark, it keeps better. Many of these discoveries came about by mere chance, but people have also sought to discover new ideas by systematic, planned effort.

Chance discoveries still occur, for example when Fleming discovered the healing property of mould, or when they analysed what ties the atom together and discovered that much energy could be set free by splitting it. However, much research effort is now undertaken in systematic ways to fill in the gaps and the details of new information: What if we vary the

fertiliser mix, what if we insert a different gene?

Such discoveries are the result of scientific effort (Graph 1). For example, researchers at CSIRO discovered that carbon particles can be bonded to paper under the influence of light.

Taken by themselves, scientific research and such discoveries are economically irrelevant.

Discoveries have to be developed in laboratories. Applied scientists, research agronomists and engineers try to establish the technical feasibility of new knowledge. Does it work? If successful, they make an invention, a functioning bench-top model of how certain inputs are combined to obtain certain outputs. This can result in a patent, but--taken by itself--it is also economically irrelevant.

What really matters economically is whether knowledge is useful and stands the test of commercial feasibility. Entrepreneurs test whether a new idea makes a profit. Do people value a new product sufficiently to justify the costs one has to incur in producing it? People express their valuations with ‘dollar votes’. Only when the answer is affirmative, and the innovator reaps a profit, do we get an innovation, and with it a real contribution to human welfare.

Scientists, engineers and policy makers often fail to understand the complexity and difficulty of entrepreneurial innovation. The public imagination, too, is easily inspired by inventions, but is turned off by the pedestrian, humdrum problems of innovation. Politicians make inspiring speeches about a Very Fast Train from Sydney to Canberra and Melbourne. But will it make a buck? Will sufficient numbers of people abandon their homes, their cars, busses and aircraft and pay a high enough ticket price to justify the expense of the investment by yielding a profit?

Innovation is the hard part! There are numerous cases, such as the afore-mentioned CSIRO discovery, which led to innovations elsewhere. It was Xerox that turned the discovery into the photocopier. To do this, an entrepreneur has to marshal much petty, diffuse commercial knowledge:

How to assemble the product cost effectively? Ã¢ÂÂÃ¯Â¿Â»Ã¯Â¿Â»Ã¯Â¿Â» How to train the skills in production and servicing? Ã¢ÂÂÃ¯Â¿Â»Ã¯Â¿Â»Ã¯Â¿Â» Where to find the inputs and at what cost? Ã¢ÂÂÃ¯Â¿Â»Ã¯Â¿Â»Ã¯Â¿Â» No market is waiting; people have to be made to want a photocopier. Ã¢ÂÂÃ¯Â¿Â»Ã¯Â¿Â»Ã¯Â¿Â»

How to package, market and distribute the machines? Ã¢ÂÂÃ¯Â¿Â»Ã¯Â¿Â»Ã¯Â¿Â» How to ensure that supplies of carbon are out there when the cartridge has to be replenished? Ã¢ÂÂÃ¯Â¿Â»Ã¯Â¿Â»Ã¯Â¿Â»

Click here for Graph 1

The entrepreneurial task is monumental, but often underrated and misunderstood.

Much innovation does not derive from inventions, let alone scientific discoveries. Normally, innovations have less inspiring sources: New capital goods require that production is done differently. The success of a competitor inspires copycatting (a less vulgar term is technical diffusion). New competitors or changes in input costs require process innovations. A competitive move by a rival requires a product innovation. Feedback from demanding clients requires innovative improvements (Graph 1).

Competition -- The Lifeblood of Innovation

Please note how often I used the word ‘competition’! This is the lifeblood of innovation. And the enemies of competing are the enemies of innovation and economic growth.

How do people become entrepreneurs and why do they compete? Sometimes, people are driven by deep, innate instincts to take risks. More often than not, an innovation makes a loss and has to be abandoned. Red ink is an essential part of the process of separating the valued innovations, from those ideas that we do not value highly enough.

Suppliers typically risk product innovations hoping to gain a market niche and process innovations to save costs and gain a price advantage. They do so because they rival with other suppliers. They continually search and test useful knowledge, incurring costs and facing risks, because they want to place themselves in an advantageous position from which to strike deals with intending buyers.

Beforehand, they cannot know whether they incur the knowledge search costs in vain and they have to overcome the fear of failure. They do so only in the hope of a profit. This is a selfish motivation, but look at the by-product: more affluent, safer, healthier, better-entertained, longer lives for billions of people!

Buyers also compete. They rival with each other and incur search costs: Where can I get the best deal? Does the new product suit me? Do I get more satisfaction from a new product? Vigorous innovation depends greatly on interested, critical and demanding buyers.

As long as Australians were beer drinkers, the wine industry had little chance to get beyond selling rough ‘Kangaroo Red’. And as long as it was bad form in restaurants to complain about a bad meal, Australian restaurants were unable to rival French standards, where being a knowledgable, demanding and paying client of haute cuisine is a national sport!

The future success of much Australian agribusiness will depend on knowledgeable and demanding customers--and on the readiness, or otherwise, of producers to listen to complaints and suggestions, in short on a genuine readiness to compete. Monopolists, who always have a stock answer why the customer is wrong, learn little and will go out of business!

Much can be gained by organising feedback from customers. Honda originally made poor motor cycles. They gave long warranties and recorded and analysed every fault. Dissatisfied customers made them into the quality marque they now are!

There is one more point worth making here. Entrepreneurs frequently depend for their innovation success on the presence of other entrepreneurs. The innovators that improve the microchip are successful because of the presence of innovators in the design and marketing of software, entrepreneurs who use the hard- and software in a myriad of untested applications, people who design systems of logistics, accounting and service support -- an incomprehensibly complex web of entrepreneurs have ‘swarmed’ on the world stage since the 1980s and have created mutually the conditions of their success!

The Enemies of Innovation

Innovative entrepreneurship is always risky, and there are always excuses to postpone the costly testing of a new idea. We know that some communities produce more successful entrepreneurship than others. We also know that entrepreneurship is not a community-wide genetic trait. Migrants from static, innovation-shy societies to other jurisdictions are often very enterprising and successful.

The explanation lies in great differences in institutions, ie. the rules under which the game of competing and innovating is coordinated. Experience has shown that economic and technical innovation depends on secure property rights, the freedom of contract and the suppression of political discrimination between citizens.

Where successful entrepreneurs have to fear expropriation, as historically in China, you may get admirable inventions, but little wealth-creating innovation. Secure property rights extend to the ownership of one’s labour and knowledge. Slaves do not innovate, nor do form-filling, over-regulated slaves of the modern state. And if private property is protected as poorly as, for example, by Australia’s opportunistic, ever-changing superannuation legislation and is subjected to double and triple taxation of savings, you get deficient private capital formation.

The Wik decision was not a good way of protecting private property rights either. And welfare states that confiscate a lot of private income and wealth to redistribute to others, such as Australia, cannot pretend to be good protectors of private property. In the late 1990s, as much as a quarter of the domestic product is redistributed by coercive taxes and welfare handouts.

Naturally, this makes the market economy dysfunctional and creates strong disincentives against innovation and wealth creation.

Where individuals are not free to contract with whom they choose to or where the courts fail to enforce contract fulfilment in reliable, cheap and transparent ways, innovation is absent or poor.

Where political intervention creates economic privileges, for example tariff protection for selected producers, restrictive licensing, or exclusive public purchasing, many potential entrepreneurs will never even go into the starting blocks. Australian parliaments, at local, State and federal levels, have created numerous privileges and restrictions that raise the costs of innovating.

For much of the 20th century, Australians worked hard and saved much, but got little economic growth out of new ideas. Industrial profits came from lobbying and tax schemes, and not from real innovation. Many inventors had to take their ideas to America, Taiwan, Korea or elsewhere to avoid the distortions and complicated regulations.

Entrepreneurs with good technical know how and skills do not normally have a taste for bureaucratic processes and political lobbying. They do not have the patience to cope with discriminatory labour-market regulations and politically tolerated restrictive labour cartels. This is why Xerox could never have become an Aussie blue chip company.

International and historic experience shows that entrepreneurs require simple, stable, reliably enforceable rules, prohibitions of thuggery, fraud and negligence. Innovators certainly need universal rules on health, safety, environmental protection, which are easy to understand and follow. But they are defeated in political environments where the rules change continually, where administrations make up the rules arbitrarily as they go along, where ignorant parliamentarians prescribe specific outcomes and processes: You must produce orange juice or garlic to this clean-food standard or that. You must not plant this strand of wheat or that gene-modified soybean seed.

To put it bluntly: the biggest enemies of innovation in this country are parliaments and administrations. The Commonwealth legislature alone has promulgated over 40 000 pages of new legislation during the 1990s, more than the aggregate from 1901 to 1990. We had a new Workplace Relations law of over 300 pages! No small entrepreneur, like the Greek fish shop owner, could ever hope to understand such confounded legislation. No wonder it failed the test on the water front and in the mines.

Most of the new statutes and regulations are written by ignorant control maniacs and serve well-connected interest groups, but hinder the small entrepreneur and the start-up firm. On top of this, we have State regulations, as well as local councils which are frequently run in the interest of the local trades and labour council or the real estate developers, but not the job-creating competitors and the citizens. I know of someone who tried to start a prawn farm on the NSW South Coast; he gave up after a year when he had to fill in the 23rd application form for some ‘authority’.

The full consequences of regulations are rarely appreciated by those who impose them. They may have wanted to protect workers by decreeing or negotiating one-shift conditions and ‘rostered days off’. But they failed to foresee that capital-intensive processing jobs moved offshore where the capital stock could work round-the-clock, seven days a week, the only way to make a profit. This is an unintended side effect. Or they provided for generous workers compo. It was not a great help to those whose jobs got destroyed by the on-costs. The more regulations are piled up, the more unintended consequences hurt innovation and enterprise, and the more sclerotic the economy becomes.

Other enemies of innovation in this country are the courts. A new generation of judges seems bent on shifting from the cultivation of the law--simple and reliable rules--to engineering specific outcomes that the elites desire: social justice, high environmental standards, clean food standards (which Asian customers cannot afford), etc. Economic consequences, let alone entrepreneurial confidence, are rarely a judge’s concern.

In addition, there are of course established producers with good political connections who try to prevent new competitors. There are labour cartels that impede competition among workers, new forms of training and apprenticeships, which suit changing conditions and new activities. There is the ‘envy industry’, and the usual contingent of enemies of progress--ranging from people who think wealth creation is sinful to those who assume that the environment is safeguarded if we remain poor and under-employed!

One trap not to fall into is to rely on central bureaucracies and political handouts for innovation. Successful innovation in the modern world is driven by competition and markets. The notion that, somehow, a government-financed committee or authority should specialise in innovating--so that the others can shirk the costs and risks of innovation--is welcome to those too risk-averse and too lazy to compete.

It suits ambitious political self-promoters, industry ministers and political parties in search of donations, but industry policy by subsidising selective innovations has been a worldwide failure. The only exception is the case of backward countries--such as Japan in the 1950s and the East Asian New Industrial Countries more recently--who can emulate what has worked elsewhere and undercut established manufacturers with lower costs. Australia is not in that position.

If some industry-government committee tells you that they can pick winners, ask yourself what incentives they have to do so. The profit motive is lacking and the necessary combination of complex technical and commercial knowledge for something as complicated as even producing and marketing a pencil cannot be assembled around a table. The lesson of the Soviet Union must be heeded: They managed a few simple priority tasks such as launching the Sputnik, but the complex business of getting fresh vegetables into the shops eluded them!

Australia has had its share of ‘picking winners’ policies, and careers in promoting inspiring causes (Think of the Multi-function Polis!), but the real innovations have come from competing entrepreneurs, for example in the wine industry, mining and transport.

Opportunities for Innovators

We must not allow ourselves the luxury of being deterred. To the contrary, we should be inspired by our numerous comparative advantages that can help innovators to succeed:

Australian’s natural resource endowment is abundant and diverse. Resource exploitation requires the energetic use of costly rough-country technology, as well as care with a brittle environment.

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The ‘tyranny of distance’ is no more. Transport and communications costs have been plummeting, and Australians have become expert at exploiting distance-bridging technology, from the Internet to parcel delivery services. However, we need genuine competition in road, rail and air transport, an open waterfront and open shipping and open skies.

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The population, while aging, is still rather youthful, compared to Europe or Japan. Australians still have a some can-do optimism. Ã¢ÂÂÃ¯Â¿Â»Ã¯Â¿Â»Ã¯Â¿Â»

Australian education is not brilliant, but OK. We have much of the practical human capital that countries further north still lack. Ã¢ÂÂÃ¯Â¿Â»Ã¯Â¿Â»Ã¯Â¿Â»

In the era of globalisation the practice of well-known and time-tested British law and the knowledge of the world language English, are an enormous advantages. Australians also now have good access to other cultures thanks to past immigration. The children of migrants are confident and go getting and part of the exciting multi-ethnic cross-fertilisation that will generate novel ideas and not only in restaurants.

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The reforms of the Hawke-Keating era have made capital markets flexible and responsive. Innovators now find it easier to convince bank managers of the merits of a new idea.

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We now have little option but to engage in enterprise and innovation. If we allow the enemies

of innovation to dictate policy and stop the process, we will fall ‘off the bicycle’, and we would do so very quickly because--different from large countries in North America and Europe--we are frontline states vis ÃÂ  vis the dynamic new industrial countries of Asia. They are competitors, but they also offer rapidly growing markets, we listen to their demands and keep to the forefront of development.

Exploiting knowledge offers something even more important than prosperity and jobs: competing and innovating breeds confidence and optimism. Australians were very creative and innovative throughout the 19th century, and can-do optimism and self-reliance became an admired national trait. Through much of the 20th century, governments have promised more security and many have become less free and less go getting.

For me, the big question is: Do we want to aspire to a repetitive, unenterprising, collectively led existence? Or do we want the 21st century to be free, enterprising, optimistic and satisfying, even if that entails the discomforts of competing and the odd commercial failure?

Wolfgang Kasper is a Senior Fellow of the Centre of Independent Studies (CIS), a Sydney-based free-market think tank. Prior to leaving the University of New South Wales as an Emeritus Professor, he was the foundation Professor of Economics at the University’s College on the Australian Defence Force Academy campus in Canberra.

He spent his formative years in post-war West Germany and Switzerland. In the second half of the 1960s, he wrote his doctoral thesis in international finance and worked on the staff of the German Council of Economic Advisers and the Kiel Institute of World Economics. In the early 1970s, he served as an Adviser to the Malaysian Minister of Finance and later worked at the Australian National University, as well as the Reserve Bank of Australia.

Kasper has a long record of research and consulting for governments and businesses in industry economics, technical and organisational innovation, economic development, institutional evolution, international trade and finance, both in mature economies and in East Asian and Pacific countries. He is known for his defence of free markets in occasional articles for papers such as "The Australian", "The Australian Financial Review", "The Wall Street Journal", "Neue ZÃÂ¼rcher Zeitung", and "Welt am Sonntag".

Kasper was elected a member of the Mont PÃÂ¨lerin Society, an international academy, serves on the Academic Advisory Council of the Centre for Independent Studies, and is a member of the Board of Management of the International Schumpeter Society, an international association concerned with innovation.

Prof. W. Kasper, 'Point of View', 7 The Point, Tura Beach 2548, Australia. Tel. /fax: [+61]-2-6495 0390 Ã¢ÂÂ¢ e-mail: kasper@asitis.net.au or wkasper@cis.org.au



