Innovation Index Australia

Assessing Australia’s Innovative
Capacity in the 21st Century
Joshua Gans and Scott Stern

(with foreword by Michael E. Porter)
Affiliations: Gans (Melbourne Business School and Intellectual Property

Research Institute of Australia, University of Melbourne); Stern (Kellogg
School of Management, Northwestern University). Contact:
[email protected]. The latest version of this paper will be available at
www.mbs.edu/jgans.
We thank Michael E. Porter, Jeff Furman, Leanne McDonald, Peter Jonson, the
Office of the Treasurer, Jessie Borthwick and workshop participants from the
AIC briefing tour for helpful comments and discussions. Richard Hayes
provided outstanding research assistance. We also thank IPRIA for financial
assistance. Part of this report is drawn from Porter, Stern and COC (1999). All
views expressed are solely those of the authors and do not necessarily
represent those of the above individuals and organisations. Responsibility for
all errors lies with the authors.
27th June, 2003

Foreword
A body of research on the determinants of innovation at the national level began in
1999 with the National Innovation Index Project at the Council on Competitiveness.
This study aimed to diagnose the long-term challenges for sustaining innovation and
competitiveness in the United States. Scott Stern and I identified the centrality of
regional clusters and a strong national innovation infrastructure as key drivers of the
ability of companies to innovate at the global frontier. The Innovation Index Project
has now developed into an ongoing line of research and is an annual component of the
World Economic Forum’s Global Competitiveness Report.
Initially published at the height of the “dot-com” era, our analysis and policy
recommendations contrasted with claims that the Internet and globalization had
eliminated the crucial role of location in innovation. We emphasized that, as open
borders and information technology erode traditional advantages, competitive advantage
would increasingly depend on companies exploiting location-specific advances to
innovate. This message has become more urgent in a less forgiving economic
environment; the viability of companies increasingly depends on their ability to connect
the specific strengths of their local environment with opportunities for global
competitive advantage through innovation.
In this report focused on Australia, Joshua Gans and Scott Stern have completed a
significant extension of earlier studies of innovative capacity at the national level. This
study takes advantage of an updated dataset including a wider range of countries and
more refined empirical measures. The analysis confirms the key findings of prior work,
including the importance of world-class research-oriented universities and the crucial
role played by regional clusters.
These findings, and the policy recommendations that flow from them, should be at
center stage as Australia faces the next competitiveness challenge. Macroeconomic
stability and microeconomic reform have transformed Australia from an adopter to a
producer of global technology. However, the challenge of establishing Australia as a
first-tier innovator remains. Achieving a higher level of innovative capacity requires
attention to all aspects of the innovation system. Australia must ensure the availability
of a world-class pool of technically trained people, and an investment environment that
encourages the deployment of risk capital. Deep and dynamic clusters are central to the
ability of Australian companies to compete on a global level, requiring that policy
continues to encourage vigorous domestic competition and strong protection of
intellectual property. As Gans and Stern point out, historical strengths in agricultural
and life sciences research, complemented by a distinct proclivity among Australian
R&D personnel towards the life sciences, make the potential for cluster development in
these areas particularly promising. A strong system of research-oriented universities and
related institutions for collaboration will be particularly important for Australia to
evolve into a first-tier innovator economy.
Though individual companies are the ultimate engine for innovation, the national
innovation environment has a strong influence on whether companies are able to
develop and commercialize new products and processes at the global technology
frontier. With a highly educated workforce, mature political institutions, and a rich
history of growth and adaptability, Australia has great promise to establish itself as a
source of global innovation. Achieving this objective will require systematic attention to
the drivers of innovative capacity in the Australian context; this report identifies those
drivers and thus the central foundations for such a transition.
Michael E. Porter
Bishop William Lawrence University Professor
Harvard University
Cambridge, Massachusetts
USA
June 2003
Executive Summary
International competitiveness increasingly depends on innovation, especially in

advanced economies. With a decade of structural reforms and with continued
operational improvement in education and infrastructure now a given, Australian
companies are able to rapidly acquire and deploy technology from around the world.
But competitiveness can no longer be sustained by producing standard products using
standard methods. Prosperity flows from the ability of a nation’s companies to create
and then globally commercialise new products and processes, shifting the innovation
frontier as fast as rivals catch up.
This report presents new findings regarding the drivers of global innovation across
advanced nations and provides an assessment of the evolution of the Australian
environment for innovation over the past two decades. Building on the national
innovative capacity framework (Porter and Stern, 1999; Furman, Porter and Stern,
2002), we demonstrate how a nation’s relative performance in producing global
innovation is linked to three factors: (1) the strength of a common innovation
infrastructure; (2) the vitality and innovation orientation of regional clusters and (3) the
quality of linkages between the innovation infrastructure and a nation’s clusters.
A detailed empirical examination of the drivers of global innovation across the OECD
over the past two decades is at the heart of the analysis and subsequent
recommendations. In this regard, three empirical findings stand out. First, no single
factor uniquely determines the ability of a country to produce global innovation;
innovation depends on strength along multiple dimensions. A healthy innovation
environment depends on the quality of human resources, effective public policy, and
innovation-oriented corporate investment. Second, since companies are the ultimate
engine for innovation, vital clusters in which firms compete on the basis of innovation
but cooperate on shared priorities is a crucial to the process of producing global
innovation. Third, by facilitating knowledge transfer and cumulative step-by-step
progress, universities and other “institutions for collaboration” play an especially
important role in determining the innovative capacity of a particular location. Overall,
global innovation is driven by nuanced factors, many of which can, nonetheless, be
enhanced by effective policy interventions.
These findings are at the foundation of assessing Australian innovative capacity. Over
the past quarter century, both public policy and private sector initiatives have
transformed Australia from a classical “imitator” to a second-tier innovator
economy. This improvement is the consequence of policies ensuring macroeconomic
stability and the implementation of microeconomic reforms that have opened Australia
up to global competitive forces. While Australia has improved its innovative capacity
over time, it has not done so as fast as key international competitors. Some have
leapfrogged Australia through sustained policy action. This international perspective
on innovation policy and innovative capacity yields specific insights into Australia’s
relative strengths and specific policy challenges.
Though Australia has enhanced its commitment to innovation policy, establishing

Australia as a first-tier innovator nation requires a systematic upgrade in the Australian
innovation environment. Innovation policy reform in Australia should impact the
innovation infrastructure, the cluster innovation environment, and the strength of
linkage mechanisms. At the broadest level, policy should be focused on training (and
retaining) a world-class innovator workforce, and providing opportunities and
incentives for the deployment of risk capital. At the same time, Australia must address
key imbalances in the resource and investment choices of the public and private sector.
Australia’s historical strengths have led to a nascent capability for innovation
throughout the life and agricultural sciences; the recent global success of the Australian
wine industry reflects the impact of a strong cluster environment on international
competitiveness. While ‘picking winners’ is a recipe for policy failure, Australia can
position itself as a global innovator by allowing labour, capital, and domestic product
markets to reward long-term investments that leverage specific strength areas. As well,
a great deal of the increase in Australian business R&D investment has been inward-
looking, focusing on how to tailor global technology to the Australian context. The
competitiveness of Australian companies, however, will depend on their ability to
develop new-to-the-world technology and processes with global application. Finally, the
Australian university system is an historic strength and nurturing this asset (as well as
other institutions for collaboration) will be crucial for establishing and retaining a
higher level of innovative capacity.
Above all, we caution patience with regard to the application and realisation of the
fruits of innovation policy. Returns on innovative capacity investments only manifest
themselves over time. Addressing weaknesses requires a consistent, long-term strategy
and not periodic bursts of policy initiatives. This commitment must be similar in scope
and duration to the process of microeconomic reform that has resulted in durable
policy institutions such as COAG and the Australian Competition and Consumer
Commission.
Australia currently faces an historic opportunity to redefine its position in terms of

innovation. Undertaking investments and implementing policies to achieve this
objective are essential if Australian companies are going to compete effectively in a
global economy. More importantly, as the central driver of productivity over the long
term, enhancing the Australian innovation environment is crucial for ensuring long
term improvements in national prosperity and welfare.
Contents Page
1 Introduction ................................................ 2
2 The Foundations of Innovative Capacity ...... 7

2.1 The Link Between Innovation and Prosperity.... 7
2.2 Sources of National Innovative Capacity........ 10
2.3 Measuring National Innovative Capacity ........ 19
2.4 Findings on Innovative Capacity................... 26
3 Australian Innovative Capacity.................. 28

3.1 Innovative Capacity Across the World ........... 28
3.2 The Evolution of Australian Innovative Capacity32
3.3 Projecting Australia’s Future ........................ 38
4 Nurturing Australia’s Innovative Capacity . 42

4.1 Invest in the Common Innovation Infrastructure42
4.2 Encourage Cluster-Based Economic Growth ... 45
4.3 Foster Linkages ......................................... 47
4.4 Summary ................................................. 48
5 Final Thoughts........................................... 50
Appendix A: Econometric Methodology .............. 51
Appendix B: US Patents by Australian Organisation

.................................................................. 60
References ......................................................... 61
June, 2003 i
Section 1 Introduction
1 Introduction
During the 1990s, Australia has been an outstanding economic performer

amongst leading economic nations in the world (Figure 1-1). In recent
times, real growth per capita has averaged above 4 percent per year. This
growth has been driven by real advances in productivity, rather than
simply catching up from a low productivity baseline (Figure 1-2).
It is easy to point to several drivers of this success. Relative

macroeconomic stability, a substantial modernisation of the tax system,
the reform of public utilities in key infrastructure areas such as
telecommunications and energy, the strengthening of competition policy,
and the creation of institutional reviews of existing government policies
(e.g., through the Productivity Commission and National Competition
Council) are all contributors to this substantial level of achievement.
Indeed, there is good reason to believe that Australia has only just begun
to feel the impact of these reforms on productivity, and reform-driven
growth can continue at least in the medium term.
Figure 1-1: Real GDP Growth Rates
Source: EIU (2001), OECD (2002), Singapore Statistics (2002).
2
Figure 1-2: Catch-Up?
Source: IMF (2001)
However, over the longer term, the basis for growth and international
competitiveness will increasingly rely on innovation. Across advanced
economies, structural reforms and operational effectiveness are now a
given, and companies can acquire and deploy global technology.
Producing standard products using standard methods will no longer
sustain competitive advantage. Indeed, the prosperity and welfare of
countries will flow from the ability of companies within a location to
create and globally commercialise new products and processes, shifting
the innovation frontier as fast as rivals catch up.
This shift in the basis of international competitiveness poses a new and

difficult challenge for Australia. Relative to other advanced economies,
Australia is a poor performer in terms of global innovation, both in terms
of ideas generated as well as the growth rate of ideas production (Figure
1-3). And it is not difficult to see why. Australian firms employ fewer
potential innovators than other leading nations (Figure 1-4) while capital
expenditure on R&D lags substantially (Figure 1-5). Without basic inputs
in these areas, a nation cannot expect to generate innovative outputs.
The real concern for Australia’s future prosperity lies in innovative

performance. Innovation is the well-spring of economic growth and no
country can live off of the fruits of its natural endowments. Investment
has to be continual and well placed. This requires both governments and
firms to be attentive to long-term issues and avoid temptations to rest on
the laurels of strong near-term economic performance.
3
Figure 1-3: Patents versus Patent Growth
Source: US Patents and Trademarks Office, Author Analysis
Figure 1-4: Scientific Employment
Source: OECD Science, Technology and Industry Scoreboard 2001.
4
Figure 1-5: R&D as a percentage of GDP in 2000
4.50
4.00
3.50
3.00
% of GDP
2.50
2.00
1.50
1.00
0.50
0.00
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Source: OECD Science, Technology and Industry Scoreboard 2001.
These concerns are already showing visible manifestations. The number

of important company failures and corporate relocations are a wake up
call, shaking confidence in Australia’s corporate basis. In addition,
Australia has few clusters or sectors that are well developed and can be
relied upon for future prosperity. While there are some documented
successes such as the wine cluster, potential clusters with the highest level
of promise – such as biotechnology – have not yet delivered meaningful
economy-wide benefits. There is clear pressure from many sectors for
Government to “do something” but there is no clear vision what the next
policy push should be, following on from the successes of
microeconomic reform.
This leads us to the theme of this report. The innovation challenges for
Australia’s future prosperity are connected and require a coordinated
strategy to address them. However, working out what that strategy needs
to be requires a clear understanding of the role of global innovation in
determining future competitiveness, and the specific strengths and
weaknesses of the Australian innovation environment. Our overall
objective is to provide an examination of the drivers of global innovation
in order to shed light on the sources of Australia’s innovation
performance relative to other nations. Rather than a “scoring” exercise,
the chief purpose of this benchmarking is to identify an informed set of
policy options that can facilitate Australia’s future as an innovator
economy.
The report proceeds in three sections. In Section 2, we describe the

national innovative capacity framework, identifying the key drivers of
global innovation and describing a method for evaluating innovative
capacity in a systematic quantitative way. Section 3 provides the main
results from this quantitative assessment. It represents a significant
5
update on prior innovative capacity benchmarking studies (Porter and

Stern, 1999), including several years of additional data, additional
countries, and more refined empirical measures. The results highlight a
number of striking issues for Australia, motivating the policy assessment
in Section 4. Simply put, Australia has made important gains in innovative
capacity throughout the 1990s, but has not yet translated those gains into
first-tier innovator status. The final section offers some concluding
thoughts on the motivations for Australian innovation policy in the
future.
6
Section 2 The Foundations of Innovative Capacity
2 The Foundations of Innovative

Capacity
World class competitiveness and prosperity depends on national innovative

capacity – that is, the ability to develop and commercialise “new-to-the-
world” technologies, products and business organisations.1
2.1 The Link Between Innovation and Prosperity
The prosperity of any economy depends on its productivity, or the value

created by a day of work or a dollar of capital invested. Productivity sets
the wages that a nation can sustain and the returns earned by holders of
capital, the two major contributors to per capita national income. The
central role of technological innovation in productivity improvement,
long-run economic growth, and in determining a nation’s standard of
living is well recognised by both economists and policymakers.2 In the
1 The term “innovative capacity” has been used extensively by prior researchers in the
economics, geography and innovation policy literatures. For example, in the economics
and innovation policy literature, Pavitt (1980), along with co-authors at the Sussex
Policy Research Unit, employed the term in a similar way as used here in the economics
and innovation policy literature. Suarez-Villa (1990, 1993) provides a fuller articulation
of the concept within the geography literature, focusing on the specific linkage between
invention and innovation. See Neely and Hii (1998) for a more detailed discussion of the
origins and definition of innovative capacity in the academic literature. The framework
presented here builds directly on research reported in Porter, Stern and COC (1999) and
Furman, Porter and Stern (2002) and the references cited therein.
2 Bush (1945) provided an early and eloquent rationale for sustained public investment
in the nation’s science and technology base. The centrality of innovation in economic
growth has been appreciated since the seminal contributions of Schumpeter (1943),
Solow (1957) and Abramovitz (1956). Rosenberg, however, was the first to identify how
innovative activity of the macroeconomy was inherently the result of more
microeconomic processes and their interaction with the environment and national
institutions (Rosenberg, 1963; 1982). Building on such early work, Nelson (1990),
among others, focuses on the elements of the national innovation system (most closely
resembling our concept of the common innovation infrastructure described below)
while Porter (1990; 1998) conceptualises the critical importance and workings of clusters
and their role in innovation and competitiveness. Our work also links these more
microeconomic-oriented approaches to the macroeconomic approach employed by
Romer (1990; 1996), who focuses on the relationship between the “ideas” sector of the
economy and the overall process of productivity growth in the economy. For a more
detailed discussion of the motivation for this work and its relationship to prior studies in
7
absence of sustained innovation, the rate of productivity growth in

labour-constrained economics will ultimately fall to zero. Over time, an
even tighter link between innovative capacity and prosperity has emerged,
especially for advanced nations such as Australia. The challenge for
policymakers is to foster an environment where innovation flourishes.
Productivity, contrary to popular usage, is more than just efficiency. It is

equally driven by the value of the products and services a nation can
produce, where value is measured by what customers are willing to pay
for them. Italy, for example, supports high wages and profits in shoes
because of the high value that consumers place on its products, not
because Italian shoe manufacturers produce shoes more cheaply than
others. Moreover, national productivity is an aggregate of the productivity
of each of a nation’s industries, not just those whose products are
exported or technology-intensive. Local industries can either contribute
to or detract from national productivity and play an instrumental role in
influencing the productivity of more visible export industries.
Indeed, in a modern economy, it is not only what a nation produces but

also how it goes about it that matters. Innovation can drive productivity
improvement across all industrial sectors. In this sense, there are no “low
tech” industries—only low technology companies that fail to incorporate
new ideas and methods into their products and processes. Innovation
opportunities are present today in virtually any industry. Although
industries producing enabling technologies such as computers, software,
and communications have received much attention, opportunities to
apply advanced technology are present in fields as disparate as textiles,
machinery, and financial services. For example, the historical success of
Australian agriculture in international markets is due in no small part to
the development and application of advanced technologies specific to the
agricultural sector, including farming techniques guided by computers and
agricultural biotechnology.
Innovation—the transformation of knowledge into new products,

processes, and services—involves more than just science and technology.
It involves discerning and meeting the needs of customers.
Improvements in marketing, distribution, and service are innovations that
can be as important as those generated in laboratories involving new
products and processes. Indeed, some of the most important innovations
today occur in sales and distribution. Consider, for example, the
revolution in small-package delivery that has occurred over the past 15
years— and the resulting U.S. global pre-eminence in this industry.
the economics of technological change, see Stern, Porter, and Furman (1999) and Porter
and Stern (1999).
8
History teaches us that, ultimately, the private sector is the engine for
innovation. The transformation of knowledge and new ideas into wealth-
creating technologies, products, and services is the province of firms, not
governments or universities. Nonetheless, national policy and public
institutions create an environment that can encourage or detract from
firms’ innovative activity. The U.S. pharmaceutical industry, for example,
has benefited greatly from intellectual property laws that encourage
investment in discovering new drugs; by contrast, patent laws in Japan
and pricing laws in France historically discouraged investment in new
medications, resulting in less innovative companies within these nations’
borders. Similarly, Australian leadership in the international wine industry
reflects an effective mix of vigorous domestic competition alongside
public/private cooperation in areas of shared interest, such as basic
research. The foundation of international competitiveness begins at home
with an effective public policy environment and dynamic clusters
competing on the basis of innovation and value enhancement (Porter,
1990; 1998). A higher rate of innovation in one nation does not come at
the expense of others. The ability of firms in one country to create new
ideas can be enhanced by innovations created in others. Raising their
rates of innovation can improve the prosperity and productivity of all
nations, and collectively speed the rate of world economic growth.
Indeed, as many advanced nations face the prospect of declining
population growth, a stepped-up rate of innovation is needed to drive the
faster productivity growth that will be required to sustain healthy
economic growth rates. The studies reported on here do not aim to
designate winners and losers but to measure how countries are
performing relative to their potential, and suggest ways in which the
innovative capacity of all nations can be nurtured.
In summary, the capacity for innovation determines the standard of living

in the global economy. No individual economy can support high wages
and profits by simply producing standard products or services made with
standard techniques. Australia’s future prosperity depends upon:
• Creating high value products and services
• Developing unique products, features and processes
• Staying ahead of technology diffusion
Innovation is more than simply a process of scientific discovery, and goes

beyond simply adopting best practices and technology from other
countries. Instead, innovation requires the identification of new
opportunities for value enhancement and translating nascent
opportunities into commercial practice, both domestically and abroad.
9
2.2 Sources of National Innovative Capacity
Why are some nations so much more innovative than others? This is not
the same as asking why some countries publish more scientific papers
than others, nor is it the same as asking why some countries are able to
achieve higher scores on standardised tests in maths, science, or
engineering. Instead, the answer requires identifying those factors that
influence the ability of a nation’s firms to identify economically valuable
new products, services, and processes and develop them commercially.3
The vitality of innovation in a location is shaped by national innovative

capacity.4 National innovative capacity is a country’s potential -- as both a
political and economic entity -- to produce a stream of commercially
relevant innovations. National innovative capacity is distinct from purely
scientific or technical achievements, and focuses on the economic
application of new technology. Innovative capacity is not simply the
realised level of innovation but aims to measure the fundamental
conditions that create the environment for innovation in a particular
location. Innovative capacity depends in part on past technological
sophistication and the size of the scientific and technical work force, but
also reflects a series of investment and policy choices by government and
private sector that affect the incentives for research, development and
commercialisation activities in a country and their productivity.
Sharp differences in innovative output across locations make clear the

importance of local circumstances in R&D productivity. However, taking
advantage of the local environment for innovation is far from automatic.
Companies based in the same location can and do differ markedly in their
3 History is replete with examples in which scientific or conceptual advances have been
identified in one country but commercially developed in another. The powerful

nineteenth-century German chemical industry, for example, was very much dependent
on the discoveries of a British chemist. In more recent times, it was Japanese companies
that built upon the initial invention of the video cassette recorder (VCR) in 1956 by
Ampex (a U.S. company) and turned the VCR into an overwhelming commercial
success. History also offers numerous examples in which national industries developed
and maintained innovation and international competitive advantage for decades, such as
the American computer and German automobile industries. Australia has been
responsible for a wide range of inventions that have been commercialised by companies
in other countries, ranging from the “black box” flight recorder to the lawnmower. In
each of these cases, innovative and competitive success was supported by a wide range
of supporting circumstances. The continued success of the German chemical industry,
for example, has been underpinned in large part by a highly developed university system
that encourages innovative research partnerships with industry.
4 See footnote 1 for a discussion of the origins and prior uses of the term national
innovative capacity.
10
Figure 2-1: Drivers of National Innovative Capacity
success at innovation. Harnessing the local environment for innovation

requires that companies pursue appropriate strategies and make
appropriate investment choices.
Building on Porter and Stern (1999), we propose a framework for

understanding the drivers of national innovative capacity (also see
Furman, Porter and Stern (2002)). National innovative capacity is
composed of four broad elements that define how location shapes the
ability of a company to innovate at the global frontier (see Figure 2-1).
Although the framework was created for application at the national level,
it can also be employed to evaluate innovative capacity at the regional or
local level.
Figure 2-1 illustrates the Porter-Stern framework. The left-hand side

represents the cross-cutting factors that support innovation throughout
many if not all industries: investments in basic research; investment in
education; a network of universities conducting research and training
scientists, engineers, and others in advanced problem-solving; and
policies that affect the incentives for innovation in any industry. The
diamonds on the right side signify the innovative environment in groups
11
of linked industries termed clusters.5 Clusters are geographically

proximate groups of interconnected companies, industries, and associated
institutions in a particular field, linked by commonalities and
complementarities. It is appropriate to focus on clusters (e.g., information
technology) rather than individual industries (e.g., printers) because there
are powerful spillovers and externalities that connect the competitiveness
and rate of innovation of clusters as a whole. Dotted lines connecting
some cluster diamonds to others indicate that spillovers occur across
clusters as well. For example, innovation in automotive products draws to
some extent on national innovative capacity in the information
technology and advanced material clusters. Because of the importance of
proximity, the focus of innovation in clusters is often at the regional level
in countries with geographically disparate centres of industrial activity
such as Australia and the United States.
Finally, there is also an important reciprocal interaction between the

common innovation infrastructure and cluster-specific circumstances.
Each cluster in the nation draws on the common innovation
infrastructure, but its investments and choices also contribute in some
respects to the development of that common innovation infrastructure.
Biotechnology firms draw on technology and people from university
science departments and schools of medicine, but typically support them
through grants and contract research. The internal research and clinical
testing of biotechnology firms advance the knowledge base in these
institutions. Often through trade associations, biotechnology firms also
participate in specialised training activities that boost the nation’s stock of
skilled talent.
Both the Innovation Index developed in the next section and the policy
implications we draw from it depend on each element of the national
innovative capacity framework. We, therefore, explore each area in
greater detail before turning to the benchmarking analysis.
2.2.1 Common Innovation Infrastructure
A nation’s common innovation infrastructure is the set of crosscutting

factors supporting innovation throughout an entire economy, including
the pool of human and financial resources devoted to scientific and
technological advances, the economy wide public policies bearing on
innovative activity, and the economy’s inherited level of technological
sophistication (Figure 2-2). The foundation of a nation’s common
innovation infrastructure is its cadre of scientists and engineers involved
5 For a discussion, see Porter (1990, 1998).
12
Figure 2-2. The Common Innovation Infrastructure
• Investment in basic research

• Tax policies affecting corporate R&D and investment spending
• Supply of risk capital
• Aggregate level of education in the population
• Pool of talent in science and technology
• Information and communication infrastructure
• Protection of intellectual property
• Openness to international trade and investment
• Overall sophistication of demand
in innovation. Government funding is the mainstay of virtually every

nation’s investment in truly frontier research. Sustained support for
research, particularly university-based research, also tends to augment the
pool of scientists and engineers because research funding often includes
stipends and assistantships that attract young talent.
The set of technically trained personnel and the aggregate level of

education in the population constitute another important cross-cutting
element of national innovative capacity. Certainly, the ability of firms to
develop specialised expertise in designing innovative products and
processes depends critically on the availability of suitably talented
technical employees. While technological work is performed by only a
small subgroup of the labour force, innovative personnel are not
necessarily technical staff. Innovation arises in numerous domains,
including marketing, service, and management. The ability of a nation to
develop individuals with such abilities depends on whether the
educational system provides a high-quality cognitive skill base from which
all firms can draw.
Support for research and education alone, while necessary to support

innovation, is not sufficient. High scores in international mathematics
exams may increase the potential to develop engineers but do not ensure
innovative success. Even the quality of science in a country, as measured
by the number of important publications, is only a weak predictor of
national success in commercial innovation (Stern, Porter and Furman,
1999). Other cross-cutting institutions that enhance the strength of the
common innovation infrastructure upon which clusters can draw are a
strong information infrastructure and an accessible supply of risk capital.
The recent changes wrought by the Internet are ample demonstration
that information technology and the infrastructure to disseminate it can
drive innovation across a wide array of industries in the economy.
Risk capital is a vital lubricant to innovation, especially for the translation

of innovations into commercial products and services. There is a
13
tendency these days to equate risk equity with venture capital, but the
institutional structure for providing risk capital can take different forms in
different nations. In Japan, for example, most risk capital comes from
large corporations. As any nation seeks to improve its supply of risk
capital, it should build on its unique institutional strengths. For Australia,
public policy can encourage renewed energy in corporate venture
investing or providing the context for the long-term rise of a distinct
venture capital sector.
A set of important federal and state policies constitute another element of

the common innovation infrastructure. It is well understood that the
incentive to innovate disappears when firms cannot reap returns on their
investments. As a consequence, policies that protect intellectual property
are essential for creating a pro-innovation environment. Particular
policies associated with innovation, such as patent and copyright laws, are
more important in some industries than others.6 However, one can
distinguish countries with respect to the overall environment ensuring the
appropriability of returns to innovative investments. Other policies—
such as the extent of R&D tax credits, a regulatory environment that
encourages competition, and efficient taxation of capital gains—affect
incentives for innovation across the economy. Policies toward the
openness of the economy to international competition are also an
essential component of the national innovative environment; open
borders encourage upgrading through increased competition and the
inflow of ideas.
A further aspect of the common innovation infrastructure is the overall

sophistication of a country’s consumers. The drive for innovative
products is derived in great measure from the nature of demand in the
domestic economy. In Australia, farmers have acted as a demanding and
early customer for many important technologies arising from government
funded organisations such as the CSIRO as well as biotechnology
companies such as CSL. In this case, it is not so much the size of the
home market in a nation that matters but its character.
Finally, a nation’s common innovation infrastructure also depends on its

level of overall technological development. This harder-to-measure
condition is the result of the accumulated array of learning and
investments over time in the economy.
6 In particular, the strength of IP can impact upon key commercialisation choices (see
Gans, Hsu and Stern, 2002; Gans and Stern, 2003).
14
2.2.2 The Cluster-Specific Innovation Environment
While the common innovation infrastructure sets the basic conditions for
innovation, the development and commercialisation of new technologies
take place disproportionately in clusters — geographic concentrations of
interconnected companies and institutions in a particular field. The
cluster-specific innovation environment is captured in Porter’s
“diamond” framework (Figure 2-3).7 Four attributes of the
microeconomic environment surrounding a cluster bear on its overall
competitiveness and innovative vitality -- the presence of high-quality and
specialised inputs; a local context that encourages investment together
with intense rivalry; pressure and insight gleaned from sophisticated local
demand; and the local presence of high quality related and supporting
industries.
The importance of clusters reflects important externalities in innovation

that are contained in particular geographic areas. Presence within a cluster
offers advantages to firms in perceiving both the need and the
opportunity for innovation. Equally important, however, are the
flexibility and capacity present in clusters to turn new ideas into reality.
Within a cluster, a company can rapidly assemble the components,
machinery, and services necessary for commercialisation. Suppliers of
essential inputs and “lead” buyers become crucial partners in the
innovation process; the relationships necessary for effective innovation
are more easily achieved among participants that are nearby. Reinforcing
these advantages for innovation within clusters is sheer pressure —
competitive pressure, peer pressure, customer pressure and constant
comparison. We focus on clusters (e.g., information technology) rather
than individual industries (e.g., printers), then, because of powerful
spillovers and externalities across discrete industries that are vital to the
rate of innovation.
The innovation environment of a cluster is fundamental to its

competitiveness. For example, the Finnish pulp-and-paper cluster
benefits from the advantages of pressures from demanding domestic
consumers, intense rivalry among local competitors, and local Finnish
process-equipment manufacturers who are world leaders, with companies
such as Kamyr and Sunds leading the world in the commercialisation of
innovative bleaching equipment. Similar examples of cluster vitality in
innovation occur in many fields, from pharmaceuticals in the United
States to semiconductor fabrication in Taiwan.
7 For a more complete exposition of the diamond framework and its role in
understanding the origins of national competitive advantage, see Porter (1990, 1998).
15
Figure 2-3: Porter’s Diamond Framework
Perhaps the single most visible recent cluster in Australia centres on the
wine industry. Though it has only recently emerged as a leading force
international market, the growth of Australia’s wine is the consequence of
decades of investment, from the establishment of the Australian Wine
Research Institute in 1955 to the flurry of institutions for collaboration
on international markets founded over the past decade (see Figures 2-4
and 2-5). Building on unique advantages in terms of natural resources,
and enhancing the value of those resources through research and
innovation, the Australian wine industry epitomises how an effective mix
of domestic competition and public/private cooperation in key areas
facilitates international competitiveness.
16
Figure 2-4
The Australian Wine Cluster

History
1930 1965 1980 1991 to 1998

First oenology Australian Wine Australian Wine New organizations
course at Bureau and Brandy created for education,
Roseworthy established Corporation research, market
Agricultural established information, and export
College promotion
1955 1970 1990
Australian Wine Winemaking Winemaker’s

Research Institute school at Charles Federation of
founded Sturt University Australia
founded established
1950s 1960s 1970s 1980s 1990s

Import of Recruiting of Continued inflow Creation of large Surge in exports
European winery experienced of foreign capital number of new and international
technology foreign investors, and management wineries acquisitions
e.g. Wolf Bass
Source: Michael E. Porter and Örjan Sölvell, The Australian Wine Cluster – Supplement, Harvard Business School Case Study, 2002
Figure 2-5
The Australian Wine Cluster

Recently founded Institutions for Collaboration
Winemakers’ Federation of Australia Cooperative Centre for Viticulture
z Established in 1990 z Established in 1991

z Focus: Public policy representation of companies z Focus: Coordination of research and education
in the wine cluster policy in viticulture
z Funding: Member companies z Funding: other cluster organizations
Australian Wine Export Council Grape and Wine R&D Corporation
z Established in 1992 z Established in 1991 as statutory body

z Focus: Wine export promotion through z Focus: Funding of research and development
international offices in London and San Francisco activities
z Funding: Government; cluster organizations z Funding: Government; statutory levy
Wine Industry Information Service Wine Industry National

Education and Training Council
z Established in 1998 z Established in 1995
z Focus: Information collection, organization, and z Focus: Coordination, integration, and standard
dissemination maintenance for vocational training and education
z Funding: Cluster organizations z Funding: Government; other cluster organizations
Source: Michael E. Porter and Örjan Sölvell, The Australian Wine Cluster – Supplement, Harvard Business School
Case Study, 2002
17
2.2.3 The Quality of Linkages
The quality of the connections between a nation’s common innovation

infrastructure and individual industrial clusters is crucial to innovation. It
is also reciprocal: strong clusters feed the common infrastructure and also
benefit from it. Without strong linkages, upstream scientific and technical
advances can actually diffuse to other countries more quickly than they
can be exploited at home. For example, although early elements of VCR
technology were developed in the United States, it was three companies
in the Japanese consumer electronics cluster that successfully
commercialised this innovation on a global scale in the late 1970s.
A variety of formal and informal organisations and networks — which

we term ‘institutions for collaboration’ — are present in many nations
and link the two areas. In most cases, effective institutions for
collaboration involve participation by the public and private sector.
Consider the National Stem Cell Centre (NSCC). Though funded initially
at the federal level (namely, the Australian Research Council), the NSCC
activities now facilitate interaction between the state and federal
government, university researchers, as well as companies and industry
associations. As with many new technologies, the scientific and
commercial impact of stem cell research depends on an effective legal
environment and public acceptance of potential ethical issues; the NSCC
has taken a leading role in helping to define this debate in the Australian
context. Overall, institutions for collaboration can leverage nascent areas
of strength by (a) enhancing the ability of researchers to exchange
knowledge and build on each others’ discoveries and (b) helping to
establish the legal and institutional framework for effective
commercialisation efforts.
A particularly important linking institution is a nation’s university system.

A strong university sector serves as a key channel by which basic,
fundamental research catalyses the emergence of innovation-oriented
domestic clusters. Conversely, by pressuring universities to conduct
relevant research and produce high-quality students with specific
technical skills, private funding and involvement in the university sector
fosters a link from the clusters to the common innovation infrastructure.
University graduates serve in both the public and private sector,
providing a more informal type of linkage, and many universities receive
both public and private funding, reinforcing linkages between
government initiatives and commercial priorities.
18
2.3 Measuring National Innovative Capacity
This study extends the National Innovative Capacity Project conducted

by Michael E. Porter, Scott Stern and several co-authors over the past
several years. The goal of this project is to document the drivers of global
innovation and provide an empirical foundation for public policy
initiatives in this area. This report updates prior studies in the Project by
using more up-to-date data for a wider range of countries and
incorporating a more refined set of measures.8
Attempts to measure and benchmark innovative outputs have become

common across advanced economies9 The distinctive feature of the
Porter-Stern approach is a clear distinction between innovation output
(specifically, international patenting) and its drivers (infrastructure,
clusters and linkages) as well as a careful determination of the ‘weights’
attached to each innovation capacity driver.10 Each weight is derived
from regression analysis relating the development of new-to-the-world
technologies to drivers of national innovative capacity. This has the
advantage of avoiding an ‘ad hoc’ weighting of potential drivers and
instead using the actual relationship between innovative capacity and
innovation to provide those weights. Thus, measures which historically
have been more important in determining high rates of innovative output
across all countries are weighted more strongly than those which have a
weaker (though still important) impact on innovative capacity. The end
result is a measure of innovative capacity that is measured in per capita
terms to allow for international comparisons as well as a set of weights
that focuses attention on relative changes in resources and policies both
over time and across countries.
8 Prior studies by Porter, Stern, and co-authors have employed two distinct
methodologies for benchmarking innovative capacity. The first methodology employs a

panel data approach and publicly available measures of the innovation environment (see
the Council on Competitiveness (1999) co-authored by Porter and Stern; Furman Porter
and Stern (2002) is an academic publication discussing the key methodological issues in
some detail). Second, over the past two years, data from the Global Competitiveness Report
(GCR) have been employed to provide a “snapshot” of the innovation environment for
over 70 countries at a point in time. While each approach has its advantages, this report
builds upon (and focuses its discussion on) the first approach; please see the GCR for
the results of the second approach.
9 We do not review this voluminous field here. However, good starting points are the
benchmarking programs of the European Union (trendchart.cordis.lu).

10 See Appendix A and Furman, Porter and Stern (2002) for a more thorough discussion
of this methodology and prior research in this area. In particular, our approach builds on
a line of research that includes, among others, Dosi, Pavitt, and Soete (1990) and Eaton
and Kortum (1996).
19
2.3.1 Measuring Innovative Output
In order to obtain the weights for the Innovation Capacity Index, we

must benchmark national innovative capacity in terms of an observable
measure of innovative output. In this study, we use the number of
“international” patents applied for in a given year (and subsequently
granted) for each country in the sample, as captured by the number of
patents granted to inventors of a given country by the United States
Patent and Trademark Office.11,12 While no measure is ideal, measures of
international patenting provide a comparable and consistent measure of
innovation across countries and across time.13
Three important factors drive the decision to use international patents.

First, patenting over countries and time is highly likely to reflect actual
changes in inventive outputs rather than spurious influences, especially in
measuring innovativeness at the world frontier. Patenting captures a sense
of the degree to which a national economy is developing and
commercialising “new to the world” technologies—a necessary
prerequisite for building international competitiveness on the basis of
quality and innovation. In short, international patenting is “the only
observable manifestation of inventive activity with a well-grounded claim
for universality.”14
Second, while international patenting is not a perfect measure, other

measures suffer from greater conceptual or data limitations. Copyrights,
for example, are potentially important indicators of innovative activity,
particularly in industries such as software. However, copyrights vary
greatly in their definitions and importance across countries and over time,
11 As we discuss further below, we include a US dummy to account for the fact that US
patenting abroad may differ from other countries’ patenting in the US. This dummy
variable turns out to be both small in impact and insignificant.
12Our use of patent applications within a given year is a refinement on the initial Porter
and Stern methodology. In their initial studies, they employed the number of patents
granted within a given year and assumed a three year “lag” between application and
grant times. Of course, patent applications and patent grants (three years forward) are
highly correlated, and the use of one or the other measure as the innovation output
measure does not affect the core findings of this study.
13 Other recent measures proposed include citations of patents and academic
publications. As is well known, the latter data can suffer from distortions because of self
citation (see Gans and Stern, 2002, 2003).
14 Trajtenberg (1990) provides a thorough discussion of the role of patents in
understanding innovative activity, stretching back to their use by Schmookler (1966) and
noting their ever-increasing use by scholars in recent years (e.g., Griliches, 1984; 1990;
1994). Our use of international patents also has precedent in prior work comparing
international inventive activity (see Dosi, Pavitt, and Soete, 1990; Eaton and Kortum,
1996).
20
and prove not to be very useful for international comparisons of

aggregate innovative activity. The number of scientific journal articles,
while a precise and standardised measure of innovative output across
countries, is an indicator of more basic activity that is closer to scientific
exploration than to commercial significance. As well, the intensity of
patenting is correlated with other manifestations of innovative activity.
It is important to keep in mind that the Index itself is not the number of
international patents, but rather a weighted sum of the types of measures
described earlier (such as national R&D employment, weighed by their
demonstrated influence on international patenting). Therefore, the Index
reflects the actual resource and policy commitments of a country and not simply a
country’s propensity to patent or its involvement in patent-intensive
industries. The choice of patents as a measure, then, only modestly
influences differences in the weights used in the Index calculation. The
Index captures R&D personnel and funding even in those sectors which
do not rely heavily on patenting. Even though areas such as software are
much less patent-intensive than, say, the life sciences, the employment of
software engineers and R&D expenditures in software is part of the
Index.
A final consideration in selecting international patents as our measure of

innovative output is their connection with commercial significance.
Obtaining a patent in a foreign country is a costly undertaking, which is
only worthwhile for an organisation that anticipates a commercial return
in excess of the substantial costs. This insight is confirmed in a suggestive
way by examining the relationship between international patenting and
more general international economic data. As discussed further in Porter,
Stern and COC (1999), international patenting is strongly correlated with
alternative measures of innovative output such as the number of scientific
journal articles and also with outcome measures such as a country’s
market share in high-technology industries. After controlling for the level
of international patenting, however, more upstream measures (i.e.,
scientific journal articles) do not have a significant relationship with
outcome measures (success in international markets). In other words,
international patenting seems to encompass alternative measures of
innovative output and is also closely associated with patterns of success in
innovation-driven international competition.
Figure 2-6 shows the variation in international patenting across countries

on a per capita basis. Notice that there is considerable international
variation and that Australia ranks towards the low end of leading
countries. The analysis documented below explains this variation as well
as providing a way of predicting how a given nation’s performance might
change in response to changes in policy, patterns of investment, or the
cluster environment.
21
Figure 2-6: Patents per Million of Population, 2000
Source: USPTO.
2.3.2 Calculating the Index
The Index is calculated and evaluated in three stages, summarised in

Figure 2-7 (Appendix A provides a more comprehensive discussion of
the methodology). The first stage consists of creating the database of
variables relating to national innovative capacity for our sample of 29
OECD countries from 1980 to 2000. These measures are described in the
box “Distilling Measures of National Innovative Capacity.” This database
is used to perform a time series/cross sectional regression analysis
determining the significant influences on per capita international
patenting and the weights associated with each influence on innovative
capacity.
In the second stage of the analysis, the weights derived in the first stage
are used to calculate a value for the Index for each country in each year
given its actual resource and policy choices. It is in this sense that we refer
to national innovative capacity: the extent of countries’ current and
accumulated resource and policy commitments. The Index calculation
allows us to explore differences in this capacity across countries and in
individual countries over time.
22
Figure 2-7. Calculating the Innovation Index
Stage I
• Create a database for 29 OECD countries from 1980 to 2000
• Employ a time series/cross sectional regression analysis to determine the
significant influences on innovative output and the weight associated with each
influence
Stage II
• Calculate the Innovation Index for each country for each year using the weights
from Stage I
• Evaluate the differences in the Index among countries and changes in the Index
over time
Stage III
• Project the Innovation Index into the future for each country, given the recent
trajectory of its policy and resource commitments
• Evaluate projected shifts in the Index among countries and the influence of
various policy areas
The Index, interpreted literally, is the expected number of international patent

applications per million persons given a country’s current configuration of national
policies and resource commitments. It is important not to interpret the
Innovation Index as a tool to predict the exact number of international
patents that will be granted to a country in any particular year. Instead,
the Index provides an indication of the relative capability of the economy
to produce innovative outputs based on the historical relationship
between the elements of national innovative capacity present in a country
and the outputs of the innovative process.
The third stage of the analysis uses additional statistical modelling to

provide a projection of national innovative capacity into the future, based
on recent historical trends in investment and policy choices. This is a
projection rather than a “forecast” in the sense of being predictive. The
recent trajectories of countries’ resource commitments and policy choices
are extrapolated into the future, and then the weights developed in the
first stage are used to project national innovative capacity in the future.
Hence this exercise provides insight into the potential implications of
“staying the course.” Clearly, the innovative capacities that will actually be
realised in the future depend on both the public and private policy
decisions made in the interim. Our methodology is meant to establish a
baseline for comparative analysis and provide a context for current policy
debates.
23
Distilling Measures of Innovative Capacity

The theoretical framework of Porter and Stern suggests that measures included should reflect
the common innovation infrastructure, the innovation environment in clusters, and the
quality of linkages between these two areas. The Index includes the best available measures
of the strength of each area. No single influence alone, whether it be the quality of scientists
or the strength of international property laws, ensures a healthy stream of innovative output.
When several of these influences improve concurrently, however, national innovative
capacity will tend to rise.
Along some dimensions, particularly those which capture the strength of the common
innovation infrastructure, direct measures are available and are included in the analysis. More
subtle and multi-faceted concepts, such as the cluster-specific innovation environment,
cannot be quantified directly from available and internationally comparable data. This
challenge is addressed by employing an intermediate measure which does not capture the
underlying drivers of national innovative capacity in a particular area but measures an
outcome associated with the strength of those specific drivers. The quality of the innovation
environment within clusters is inherently difficult to measure, for example, as it involves such
areas as the supply of specialised talent and the degree of domestic customer sophistication
in particular fields. However, the amount of collective R&D activity funded by a nation’s
clusters provides an indicator of these more fundamental circumstances.
With the distinction between direct and indirect indicators in mind, we review the specific
variables used in the calculation of the Index and how each relates to national innovative
capacity.
The Quality of the Common Innovation Infrastructure
Aggregate Personnel Employed in Research and Development. A critical determinant

of the underlying innovative capacity of an economy is the overall supply of scientific and
technically trained individuals available. Both private and public entities engage the skills of
these individuals, whose continuing learning builds on their formal training. An intermediate
measure of the more fundamental process by which individuals choose to invest in scientific
and technical skills, the level of personnel employed in R&D-related activities in a nation
reflects the baseline level of human resources which can be utilised for purposes of
innovation across the economy.
Aggregate Expenditures on Research and Development. In addition to human

resources, a strong national innovation infrastructure includes the availability of funding for
innovation-related investments. While the determinants of investment in an individual cluster
will be a function of relevant technological and commercialisation opportunities, the
aggregate level of such investments by both business, non-profit, and public institutions
reflects the overall availability of R&D-directed capital. It is crucial to note that while specific
forms of financing (e.g., venture capital) are often cited as being the most efficient form of
providing capital for innovation, countries have developed a variety of institutions for
delivering a high level of R&D capital, including investment by large corporations and
cooperative R&D (Japan), interlocking cooperative funds centred around small- and medium
sized companies (Northern Italy), and the American venture capital model. Aggregate R&D
expenditure is also an intermediate measure reflecting more fundamental drivers of
investment, not the least of which are national R&D tax policy and the existence of
regulations facilitating capital market institutions such as venture financing.
24
Strength of Protection for Intellectual Property. Of the policies affecting national

innovative capacity, perhaps the most basic is the provision of appropriate rewards for
innovation by private inventors. We measure the extent to which a nation’s policies protect
intellectual property rights through patents, copyrights, and the like. Intellectual property
protection contributes to national innovative capacity in two ways. First, strict defence of
intellectual property encourages domestically based firms to invest in innovative activities
and signals the attractiveness of the country as a site in which to locate innovative activity.
Second, obtaining the benefits of such protection requires public disclosure of information
describing the innovation. In this way, intellectual property protection encourages the
diffusion of knowledge throughout the economy. While a cross-cutting measure, the impact
of legal intellectual property protection is more salient for some clusters than for others. For
example, while the pharmaceutical industry has long depended upon strong patent protection
throughout most of the OECD, emerging areas such as software are still developing
appropriate and effective intellectual property institutions.
Share of Gross Domestic Product Spent on Secondary and Tertiary Education. The
availability of high quality workers, with both technical and non-technical backgrounds, is an
additional and basic element of a nation’s common innovation infrastructure. Investment in
higher education creates a base of highly skilled personnel upon which firms and other
institutions across the economy can draw; in both formal R&D activities and more informal
problem-solving, skilled workers are better able to recognise, choose, and execute
innovation-oriented strategies in the pursuit of competitive advantage. The intensity of
national investment in higher education is therefore a crucial determinant of national
innovative capacity. By sustaining investment in higher education, a country can slowly but
surely upgrade the ability of its workforce to innovate and to commercialize new
technologies at the international frontier.
Gross Domestic Product per Capita. Beyond direct investments and policy choices, a
nation’s common innovation infrastructure is affected by the general level of domestic
customer sophistication and the overall accumulated level of domestic technological
knowledge. These are measured in the Index by gross domestic product (GDP) per capita
adjusted for exchange rate differences. The level of wealth achieved by an economy both
reflects the technological stock upon which innovators draw and influences the degree to
which sophisticated domestic customers exert pressure on firms to upgrade the quality of
their product offerings. It is important to note that GDP per capita ultimately depends on
the accumulated history of public and private choices, investments, and outcomes rather than
short-term economic policies.
Cluster-specific Innovation Environment
Percentage of R&D Expenditures Funded by Private Industry. The degree to which a

nation’s clusters contribute to innovative capacity depends, in large part, on whether the
environment of individual clusters encourages firms to commercialise new products and
processes. While there is no measure of this which is comparable across clusters, time, and
countries, the extent of R&D funding by private firms is a reflection of whether cluster-
specific conditions are conducive to R&D investment. Across clusters, the more favourable
the innovation environment, the higher national private R&D spending will be. Controlling
for total R&D expenditures, then, the percentage of total R&D expenditures funded by
private industry is an intermediate measure of the cumulative innovative activity of a nation’s
25
clusters and an observable manifestation of the more fundamental conditions affecting

innovation in those clusters.
Concentration of Patents Across Broad Technological Areas. As innovative clusters will

be associated with technologies from particular technological areas, we use the relative
concentration of innovative output in chemical, electrical and mechanical USPTO patent
classes to proxy for innovative concentration. This measure of specialisation is too coarse to
identify particular clusters but it does potentially capture the consequences of cluster
dynamics and the relative specialisation of national economies in a particular area.
The Quality of Linkages
Percentage of R&D Performed by Universities. National innovative capacity is

reinforced by strong linkages between clusters and the common innovation infrastructure.
While these linkages take different forms in different national contexts, one commonality
across countries is the leading role that universities play in mediating the relationship
between private industry and elements of the innovation infrastructure. A strong university
sector provides an important conduit through which basic, fundamental research results
serve to catalyse the emergence of innovation-oriented domestic clusters. Conversely, by
placing pressure on universities to conduct relevant research and produce high-quality
students with specific technical skills, private funding and involvement in the university
sector serve to foster a key reverse linkage from the clusters to the common innovation
infrastructure.
Controlling for the overall level of R&D investment, then, the percentage of R&D
performed by universities is an indicator of the strength of linkages. It measures the degree
to which innovative activity, whether funded by companies, government or other
institutions, is centred in institutions which are suited to encouraging interplay between the
different entities that contribute to national innovative capacity. It is important to note,
however, that we cannot capture in the Index the full range and diversity of institutions (e.g.,
research cooperatives in Japan and elsewhere) which have arisen across countries to
contribute to such linkages.
2.4 Findings on Innovative Capacity
The regression analysis reveals a strong and consistent relationship

between each measure of the strength of national innovative capacity and
per capita international patenting. This result is interesting in its own
right: while countries differ in the institutions and mechanisms used to
influence and conduct innovative activity, there is a clear relationship
between a small set of measures of the innovation environment and a key
measure of innovative output which holds across all the countries.
Overall, the measures of the strength of national innovative capacity
explain more than 97 percent of the variation in international patenting,
highlighting the strong relationship between the measures and observed
26
innovative output (see Appendix A for a complete discussion). As

discussed further in Stern, Porter, and Furman (2002), these results are
robust to a variety of alternative specifications. For example, the
qualitative results are the same for a smaller data sample composed solely
of those observations after 1985. Hence, the determinants of innovative
output appear to have been quite consistent over time.
Further, each of the measures identified above proves to be both

statistically significant and quantitatively important in explaining
innovative output at the national level. One of the strongest influences
turns out to be the relative size of the R&D workforce—the pool of
available technical talent. For example, a 20 percent increase in the size of
the R&D workforce in a country would lead to a change in the predicted
value of the Index of just over 14 percent. Both the level of R&D
expenditures and the proportion of funding from industry also play
decisive roles in determining the level of innovative outcome. The results
suggest that increasing the percentage of total R&D expenditure funded
by private industry by 10 percentage points (e.g., by shifting industry’s
share from 50 to 60 percent of total expenditures) increases the level of
innovative capacity by over 13 percent. Although the magnitude of their
effects is somewhat smaller, the other measures, including the strength of
intellectual property and the extent of public funds devoted to education
are of substantial importance as well.
The suggestive but imperfect measure of the strength of linkages—the

share of R&D performed by universities— also turns out to be a
significant but modest contributor to international patenting
performance. GDP per capita is a strong statistical determinant of
international patenting as well, reflecting the importance for innovative
capacity of a strong accumulated knowledge pool and a sophisticated and
demanding domestic customer base.
Finally, working in the opposite direction is a “raising the bar” effect. The
productivity of international patenting (i.e., the number of patents
produced for a given level of innovative resources) is declining over time,
a result consistent with prior studies. Taken together, the statistical
analysis confirms the notion that no single factor is determinative in
creating a favourable innovation environment, and that concurrent
progress is necessary in a variety of areas to substantially upgrade a
nation’s innovative capacity.
27
Section 3 Australian Innovative Capacity
3 Australian Innovative Capacity
In this section, we examine more closely the determinants of Australian

Innovative Capacity. Prior to doing so, it is instructive to place Australia’s
performance in a global context.
3.1 Innovative Capacity Across the World
In terms of innovative output, compared with other leading economic

nations, Australia has been historically a weak performer (Figure 3-1).
However, during the 1990s, there has been noticeable growth in Australia’s
performance. What concerns us here, however, is the identification of the
causes of Australia’s historic performance and assessment of areas for policy
concern going forward.
To understand this, we turn to the Innovation Index. Figure 3-2 depicts the
Index value for each country over time. The Index, interpreted literally, is the
expected number of international patent applications per million persons given a country’s
current configuration of national policies and resource commitments. It is important not
to interpret the Innovation Index as a tool to predict the exact number of
international patents that will be granted to a country in any particular year.
Instead, the Index provides an indication of the relative capability of the
economy to produce innovative outputs based on the historical relationship
between the elements of national innovative capacity present in a country and
the outputs of the innovative process.
The Index yields a number of interesting findings. Over the three decades
examined, countries fall into three relatively stable groups in terms of
innovative capacity (see Figures 3-2 and 3-3). The United States and
Switzerland consistently appear at the top of the Index, and were joined there
in the 1980s by Japan and Sweden. These countries constitute the innovator
group. A second group of countries, including the remaining Scandinavian
countries, constitute a middle group. This group now includes Australia. The
third group, including Italy, New Zealand and Spain, lag behind the rest of
the OECD over the full sample. There are quite substantial differences across
the groups in terms of the value of the Index. Predicted per capita innovative
capacity for the top group is more than 5 times the level of capacity attributed
to countries in the lowest tier.
28
Figure 3-1: Patenting Across Leading Economic Nations
Source: USPTO
Figure 3-2 The Innovation Index for Selected Countries
250
200 Australia
Denmark
France
Germany
150
Italy
Japan
New Zealand
S Korea
100
Sweden
Switzerland
UK
50 USA
0
1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
From 1980 to 1989, the Index is based on data for West Germany only
29
Figure 3-3: Innovation Index Rankings
Country 1980 Rank 1980 Country 1985 Rank 1985 Country 1990 Rank 1990
Innovation Index Innovation Index Innovation Index
USA 1 145.4 USA 1 205.7 USA 1 150.7
Switzerland 2 116.8 Japan 2 132.2 Switzerland 2 146.4
Sweden 3 85.4 Switzerland 3 103.7 Japan 3 138.0
Germany 4 74.8 Sweden 4 103.6 Sweden 4 93.5
Japan 5 68.6 Germany 5 72.5 Germany 5 80.5
Netherlands 6 55.8 Canada 6 65.6 Finland 6 57.0
UK 7 54.6 Netherlands 7 48.8 Canada 7 53.2
France 8 50.4 France 8 46.9 France 8 52.9
Canada 9 49.5 Norway 9 45.6 Netherlands 9 47.8
Norway 10 31.8 UK 10 45.5 Denmark 10 46.5
Hungary 11 31.8 Finland 11 42.5 UK 11 41.9
Belgium 12 28.5 Belgium 12 40.3 Belgium 12 41.8
Finland 13 28.2 Denmark 13 36.7 Norway 13 38.7
Denmark 14 24.5 Australia 14 27.5 Australia 14 29.7
Austria 15 24.4 Austria 15 24.9 Austria 15 27.9
Australia 16 20.6 Hungary 16 23.0 Italy 16 20.4
Italy 17 12.5 Italy 17 16.4 Iceland 17 15.5
Iceland 18 10.5 Iceland 18 13.8 S Korea 18 12.3
New Zealand 19 9.1 New Zealand 19 8.5 Hungary 19 11.2
Ireland 20 4.9 Ireland 20 6.0 Ireland 20 9.8
Spain 21 3.2 S Korea 21 4.3 New Zealand 21 8.2
Portugal 22 0.8 Spain 22 3.4 Spain 22 7.3
S Korea 23 0.6 Portugal 23 1.2 Portugal 23 3.1
Greece 24 0.5 Greece 24 0.9 Greece 24 1.6
Turkey 25 0.4 Turkey 25 0.5 Turkey 25 0.3
30
1995 2000
Country Rank 1995 Innovation Index Country Rank 2000 Innovation Index
Japan 1 188.1 USA 1 214.4
Switzerland 2 176.9 Sweden 2 184.9
USA 3 170.5 Finland 3 173.1
Sweden 4 150.0 Japan 4 171.6
Germany 5 107.8 Switzerland 5 149.7
Finland 6 84.2 Iceland 6 130.7
Denmark 7 83.1 Denmark 7 116.3
France 8 80.5 Germany 8 109.5
Canada 9 71.2 Canada 9 81.4
Norway 10 67.6 UK 10 79.4
Netherlands 11 61.5 France 11 77.6
Belgium 12 60.3 Norway 12 75.1
UK 13 53.5 Belgium 13 75.1
Australia 14 46.0 Netherlands 14 68.7
Austria 15 44.7 Ireland 15 62.3
Iceland 16 38.1 Austria 16 52.4
S Korea 17 35.9 Australia 17 50.9
Ireland 18 33.4 S Korea 18 42.3
Italy 19 17.1 Italy 19 19.7
New Zealand 20 14.3 Spain 20 17.3
Czech Rep 21 13.2 New Zealand 21 14.9
Spain 22 11.1 Czech Rep 22 14.5
Portugal 23 4.9 Greece 23 12.0
Slovak Rep 24 4.4 Portugal 24 11.1
Greece 25 4.2 Hungary 25 5.4
Hungary 26 3.3 Slovak Rep 26 3.5
Poland 27 2.4 Poland 27 3.5
Mexico 28 0.5 Turkey 28 1.4
Turkey 29 0.4 Mexico 29 1.2
31
An important finding from the analysis is that the relative advantage of

leader countries has been declining over time. As can be seen in Figure
3-3, not only has the top tier expanded to include Japan, and Sweden, but
some middle tier countries, such as Iceland and Finland, have made
major gains in innovative capacity. Moreover, this convergence seems to
be built on fundamentals rather than transient changes. Consider the case
of Germany, where innovative capacity grew strongly throughout the
1980s. Despite a drop-off resulting from reunification with the East
beginning in 1990, Germany maintained a relatively high level of
innovative capacity throughout the 1990s. Indeed, looking across the
OECD, there seems to have been a slow but steady closing of the gap
between the innovation leaders and nations with historically lower levels
of innovative capacity.
It is important to note, however, that some important countries, most

notably Italy and Canada have at best remained constant in their
innovative capacity. Finally, the Netherlands has seen an alarming fall off
in its innovative capacity. Compared to other economies that have been
able to achieve relatively strong improvement, then, these countries have
eroded their relative innovative capacity over the past quarter century by
neglecting investments in common innovation infrastructure and in
supportive cluster innovation environments.
3.2 The Evolution of Australian Innovative Capacity
Over the past twenty years, Australia has substantially enhanced its
innovative capacity (Figure 3-3 compares Australia to a group of leading
countries, while Figure 3-4 presents Australia’s performance in isolation).
During the 1980s, Australia’s positioning could be characterised as a
“classical” imitator economy – productivity improvements were primarily
driven by the ability to import technology and ideas developed elsewhere.
Over the past decade, Australia has more than doubled its level of
innovative capacity (relative to its levels in the early 1980s) and
transformed itself into a second-tier innovator economy (though
somewhat at the lower end of this group).
As a consequence of these improvements, Australia no longer simply

relies on the fruits of innovations seeded elsewhere. Australia has
achieved an innovation environment that allows it to be a solid though
not leading contributor to global innovation. However, rather than
continuing the upward trajectory observed during the early 1990s,
innovative capacity in Australia over the past half decade has remained
stable. Given that both advanced and emerging economies throughout
the world are investing substantially in innovative capacity, stability in the
Australian context raises the risk of falling back in relative terms.
32
Figure 3-4: Evolution of Australia’s Innovative Capacity
Australia Innovation Index
60
50
40
Innovation Index
30
20
10
0
1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
Year
The evolution of Australian innovative capacity can be assessed more

carefully by considering the movement over time in each of the drivers of
innovative capacity. Figure 3-5 presents each the changes over time in
each of the measures used in the benchmarking analysis.
Figure 3-5: Drivers of Australia’s Innovative Capacity
Common Innovation Infrastructure
Real R&D Expenditure in Year 2000 USD
8000
7000
6000
5000
Millions
4000
3000
2000
1000
0
1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
33
R&D personnel per million people
6000
5000
R&D personnel per million people

4000
3000
2000
1000
0
1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
Education share of GDP
4.50
4.00
3.50
%
3.00
2.50
2.00
1.50
1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998
IP protection
10.00
9.00
8.00
7.00
6.00
5.00
4.00
3.00
1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
34
Cluster-Specific Environment
R&D funded by industry (%)
60.0
50.0
40.0
30.0
20.0
10.0
0.0
1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
Quality of Linkages
R&D performed by universities (%)
30.00
29.00
28.00
27.00
26.00
25.00
24.00
23.00
22.00
1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
Prior to 1980, Australia was an imitator economy. Despite a reasonable

standard of living, the national economy was characterised by a low level
of R&D expenditures and a relatively small share of these expenditures
were funded by the private sectors. From an historical perspective,
Australia has maintained a high share of national income devoted to
higher education and university R&D performance. Indeed, these
investments in a research-oriented educational sector were the stepping
stones upon which the improvement in Australian innovative capacity
was founded.
35
Australia experienced its first phase shift in innovative capacity between

1980 and 1991. While this took some years to be reflected in improved
international patenting (a phenomena common to many economies
improving their innovation environment), steady increases in R&D
expenditures with maintenance of educational levels lead to a steady but
higher level of innovative capacity than in previous decades. An
important driver for this was important improvements in Australia’s
economic productivity (as reflect in real GDP per capita growth) that
resulted from sound macroeconomic policy and key microeconomic
reforms.
The growth in Australian innovative capacity accelerated between 1991

and 1996. This improvement in the fundamentals of the Australian
innovation environment was driven by a combination of interrelated
factors. First, Australia experienced steady growth in R&D expenditures,
GDP per capita and private sector R&D funding. Each of these drivers
was an important consequence of key reforms to Australia’s competition
policy, increasing openness and other factors making Australia an
attractive location for foreign investment. Further, though it is difficult to
transform the R&D workforce of a national economy in the short term,
the early 1990s saw a surge in Australian employment of research
personnel. Finally, proactive policy change in intellectual property
protection and other areas improved the perception of how conducive
the Australian environment was for innovation. Together, a record of
sound macroeconomic policy, microeconomic reform and openness, and
an enhanced R&D workforce all contributed to Australia’s ability to
achieve second-tier innovator status by the mid-1990s. Finally, since
1996, by and large, growth in Australia’s innovative capacity has levelled
off. On one level, year-to-year fluctuations reflect short-term changes in
the global economic environment (such as exchange rate variation and
fluctuations in economic growth rates). However, at a more fundamental
level, the acceleration in Australia’s innovative capacity during the early
1990s has, to some extent, stabilised. Moreover, this stagnation in the
growth of innovative capacity reflects a deteriorating environment on two
bulwarks of the Australian system: higher education expenditures and a
high level of university research performance. Since 1997, there has been
a downward trend in both of these variables; in contrast, in most other
advanced economies, these are exactly the measures where policy
attention has been the most intense.15
15 This is despite government initiatives like the Backing Australia’s Ability set of
programs. While some of these are designed to put in place long-term institutions to
attract core researchers to Australian universities (i.e., the Federation Fellowships
program) others have been highly specific projects for particular high technology areas.
Consequently, the set of projects does not appear to have built into a persistent cycle of
growth in innovative capacity. See West (2001) for a background analysis.
36
At the same time, Australia’s recent stability reflects its status as a second-
tier innovator. Whereas achieving second-tier innovator status was
accomplished by upgrading on well-defined dimensions such as
improvements in intellectual property policy, the key challenges facing
Australia today rely on coupling the different aspects of the innovation
system together in a more coordinated fashion.
For example, consider the “imbalance” between Australia’s unique

strengths in terms of R&D personnel and its sectoral distribution of
R&D funding. Figure 3-6 (compiled by the Allen Consulting Group)
compares the distribution of Australian graduates across broad sectors
compared with other countries. Whereas engineering graduates are the
principal component of R&D manpower in most countries, Australia
stands by itself as the only country where life sciences graduates dominate
all other sectors. This difference in the composition of new entrants to
the R&D workforce reflects an historical commitment to world-class life
sciences university research and substantial investments in teaching
capacity and effective curricula. However, the sectoral composition of
R&D expenditures paints a quite different picture, particularly with
regards to innovation and commercialisation activities (Figure 3-7). R&D
expenditures are focused in the areas of engineering and software, and
the overwhelming majority of investment is by the private sector. In
Figure 3-6
37
Figure 3-7
contrast, only a tiny fraction of private R&D investment is located in

those sectoral areas more closely related to Australia’s historical
advantages and investments, such as agriculture and life sciences.
Policymakers may have been to ignore such imbalances during the period
where Australia was developing its baseline innovation capabilities.
However, the persistent mismatch between capital and labour
investments may now be impinging on R&D productivity. Public sector
investments are not effectively commercialised, while private sector R&D
cannot draw upon local knowledge for global advantage. Enhancements
to Australian innovative capacity going forward must be premised on a
closer connection between public and private sector priorities. While
Australia has improved its common innovation infrastructure and cluster-
specific environment, Australia’s challenge today is to reverse the decline
of institutions central to the quality of innovation linkages across the
economy and it must connect the investments in public sector basic
research more closely with the innovation priorities of Australian clusters
with an opportunity for global competitiveness.
3.3 Projecting Australia’s Future
Finally, we use the Innovation Index formula to calculate the projected

evolution of innovative capacity going forward, based on historical trends
in investment and policy choices. In particular, for each country, we
38
extrapolate each driver of innovative capacity to its level in 2005,

assuming that the trend from 1990-2000 continues until 2005. We
emphasise that rather than being a prediction, this calculation represents a
projection of the likely evolution of innovative capacity in the absence of
a shift in priorities, investments, or policies.
While such forecasts are inherently difficult, our projects indicate several
interesting trends. Figure 3-8 lists the Innovation Index and country
rankings for 2005. For Australia, the index level grows grow but the
relative rank remains flat. While personnel employed in R&D activities
are projected to continue to grow, this enhancement is offset by the
projection of a continuing decline in the share of national income
devoted to higher education. A low rate of growth is a cause for concern
insofar as other leading nations are investing more intensively in various
facets of innovative capacity. For instance, while Australia is expected to
still outrank New Zealand in 2005, that country is predicted to nearly
double its innovative capacity rating between 2000 and 2005, in part
because of its sustained investments in education and a supportive
environment for industrial innovation.
Past efforts that have placed Australia as a second-tier innovator may be

squandered as the innovative capacity of other second tier innovators
continues to grow while Australia remains at a constant level. For
example, Iceland, Finland and Denmark (whose 1980 innovative capacity
levels were quite similar to Australia) are predicted to achieve first-tier
innovator status over the next few years. The performance of Iceland, in
particular, is striking; as recently as 1995, Australia and Iceland recorded a
similar level of innovative capacity, but a gap between these two countries
has grown since that time.16
As a comparison, the United States is also projected to face a decline in

its innovative capacity, though the reasons are somewhat different. For
the U.S., deterioration in innovative capacity is linked to the declining size
of its R&D workforce and a very high rate of variation in its level of
R&D investment activities. Long-term improvements in innovative
capacity are facilitated by a self-sustaining and steady growth path rather
than sporadic bursts of investment and policy activity. Indeed, though the
long-term consequences are not yet clear, the backlash from the 1990s
technology boom may undermine US leadership in innovative capacity in
the future.
16This performance is in part due to Iceland’s status within our dataset as an emerging
nation. Removing this reduces Iceland’s relative rank in recent times; although its
improvement remains dramatic.
39
Figure 3-8: The Predicted Innovation Index in 2005
2005 2005 Innovation

Country Rank Index
Sweden 1 258.0
Iceland 2 208.9
USA 3 204.9
Finland 4 198.8
Japan 5 186.3
Denmark 6 181.4
Switzerland 7 156.0
Norway 8 97.8
Germany 9 97.1
France 10 93.5
Ireland 11 91.1
Canada 12 84.8
Netherlands 13 84.2
UK 14 84.0
Belgium 15 81.4
S Korea 16 73.7
Australia 17 63.9
Austria 18 60.8
New Zealand 19 29.0
Greece 20 19.0
Spain 21 16.3
Czech Republic 22 15.3
Italy 23 14.9
Portugal 24 14.4
Slovak Republic 25 6.1
Poland 26 4.4
Hungary 27 2.3
Turkey 28 1.4
Mexico 29 1.4
As well, regional effects seem to be increasingly important in driving

enhancements to innovative capacity. As a group, the Scandinavian
nations are experiencing the highest growth rates in innovative capacity, a
fact which has had a marked impact on patterns of international
competitiveness and prosperity. Rather than luck or circumstance, the rise
of companies such as Nokia reflects steady improvements in education,
R&D resources and policy in Finland and the other Scandinavian
countries.
In contrast, Australia is less connected to the innovative efforts of its

neighbours. For example, while several East Asian nations such as
Singapore and Taiwan have substantially enhanced their innovative
capacity over the past decade, the key clusters in these countries are quite
40
different than leading Australian clusters. Enhanced investments in the

common innovation infrastructure, the innovation environment for
clusters, and linkage mechanisms will be required for Australia to
improve its innovative capacity position over the medium term.
41
Section 4 Nurturing Australia’s Innovative Capacity
4 Nurturing Australia’s Innovative

Capacity
Our analysis of Australia’s innovative capacity indicates that macroeconomic

stability, improved competitiveness in terms cost and quality, the
diversification of Australian industry away from traditional sectors and the
prime examples of burgeoning clusters (e.g., wine and biotechnology) have
combined to provide a sound basis for future development and innovative
potential. The key question is how to build upon this capacity to turn Australia a
world class innovator?
Here we outline an innovation policy agenda for Australia that is informed by

our analysis of innovative capacity across countries. Our purpose here is to
provide some principles and examples that can illustrate how Australia might
move forward rather than specific policy proposals per se.
4.1 Invest in the Common Innovation Infrastructure
The backbone of an effective innovation system is the national innovation

infrastructure. In the absence of a well-trained pool of scientists, engineers,
and entrepreneurs, or effective public policy towards areas such as intellectual
property, the prospects for innovation-driven growth are low. As well,
innovative capacity is especially sensitive to one or two areas of specific
weakness; as a result, investments in the innovation infrastructure should be
balanced along multiple dimensions, from investments in basic research
towards the facilitation of openness to international competition and
investment. With this in mind, the analysis suggests a few key priorities for
Australian innovation policy going forward.
4.1.1 Human Capital
First, and perhaps most importantly, Australia must expand its efforts to
develop an effective pool of trained innovators, including trained scientists
and engineers as well as encouraging entrepreneurship and managerial
training. While there has been a substantial growth in the number of scientists
and engineers in Australia over the past decade, Australia still lags behind
leading innovator economies, such as Japan, Finland, and the United
Kingdom.
The decade-long decline in the share of expenditures devoted to higher

education is particularly troubling in this regard. Had Australia maintained its
historic share of expenditure on education, its innovation index in 2000
42
would have been over 16 percent higher. Such an improvement was predicted to
shift Australia from the lower portion of second-tier innovators to the middle
of this grouping.
Several specific initiatives can help Australia achieve growth over time in the
proportion of the workforce with strong science and engineering
backgrounds or who possess the strong problem-solving skills so crucial for
innovation. First, though Australia is geographically remote, talented
scientists, engineers and innovators increasingly compete in a global labour
market. The “brain drain” of top R&D personnel needs to be arrested. The
Federation Fellowships are a very positive step in this direction, and there is a
strong case for encouraging those with scientific and technical backgrounds
to remain in Australia on a broader scale. Such a policy might include specific
tax incentives and educational subsidies (which we discuss further below). As
well, by international standards, the wages for scientists and engineers whose
compensation is under the authority of the government (e.g., most university
and government laboratory researchers) is relatively low; given this
imbalance, upgrading wages for government-funded researchers will place
upward pressure on the relative wages for all Australian scientists and
engineers.
Second, while scholarships encouraging postgraduate studies within Australia

are an effective inducement, these programs may be enhanced in order to
provide a more systematic foundation for global innovation. Specifically,
while the Australian university system is excellent in many regards, the best
scientific and engineering program for a particular student may often be
international. In order for Australian companies and industry to produce
global innovation, Australian researchers should be encouraged to received
world-class training, whether this occurs at home or abroad. Top
undergraduates should be encouraged to pursue graduate studies, but,
particularly in those broad skill areas that contribute to cluster development,
incentive programs should not be limited to Australian universities. An
explicit focus on international training for scientists, engineers, and
innovators has been a longstanding hallmark of the Finnish policy
environment, and is often credited with helping Finland to develop an R&D
personnel base that has allowed companies like Nokia to emerge on a global
scale.
Third, substantial educational investment across society needs to be secured

and enhanced. Development of universal problem-solving skills, maintenance
of access to higher education and an improved commitment to postgraduate
educational opportunities all have historically assisted in fostering the skills
required for cluster development.
4.1.2 Risk Capital
Innovation carries a substantial level of risk relative to other investments, and

the fruits of innovative investments are often only realised long after
investments have been made. Therefore, for companies to take advantage of
43
new technology and innovation prospects, the investment environment must

be friendly to risky and long-term investment opportunities.
There are two policy priorities in this area. First, Australia must continue
upgrading the effectiveness of its intellectual property system (and the
business, legal and regulatory environment more generally). Given the
substantial technical and market uncertainty associated with innovation, legal
and/or regulatory uncertainty is an unnecessary and inefficient tax on
corporate investment activities. While the precise scope of patent law and
regulatory intervention may be debated, uncertainty about the scope of patent
law or the extent of regulation reduces the ability to enforce policy once
decided and discourages innovative investment.
Second, while an aggressive program of tax incentives seems to have been

important in spurring Australian business R&D investment in the first half of
the 1990s, business R&D investment has levelled off after a modest
reduction in the tax incentives. In terms of generosity, Australia compares
favourably with many (though not all) other nations in terms of R&D tax
incentives. However, an effective R&D tax incentive system should attempt
to maximise the benefits for each dollar of lost tax revenue. As such, ensuring
a healthy supply of risk capital for innovation will benefit from a much more
targeted tax incentive program. Similar to the recommendations of the
Federation of Australian Scientific and Technological Societies (FAST), our
analysis supports the idea of a “sliding scale” for tax incentives with higher
tax incentives for those companies operating at a higher level of innovation
investment intensity. As well, tax incentives should favour those companies
who are undertaking cooperative research with universities, consortia or
government-sponsored research centres. Targeted R&D tax incentives are
likely to raise the effectiveness of this tax subsidy per unit of tax dollar
foregone, and encourage innovation investment in areas that are most likely
to result in global advantage for Australian industry.
4.1.3 Cumulativeness
Cumulative research is at the very heart of the process by which science and
innovation investments contribute to the long-term growth of the economy.
Rather than the technology or process developed by any one company at a
point in time, economic growth and prosperity result from step-by-step
progress by many innovators over time. Though the cumulativeness of
research is often assumed by many policy analysts, policy plays a key role in
determining the degree of cumulativeness across innovations.
Two issues stand out in this regard. First, for many companies, trade secrecy
is a key mechanism for ensuring an economic return from innovation. While
secrecy may be in the interest of an individual firm, secrecy reduces the
powerful externalities and spillovers at the heart of innovation-driven
regional economic growth. Enhancement to the intellectual property system
to encourage the disclosure of new technologies and inventions, as well as
facilitating standard-setting bodies that coordinate technical interfaces, can be
44
effective elements in enhancing the degree of spillovers among companies

and researchers within Australia.
Second, while the hallmark of scientific research is openness and disclosure,

secrecy issues are playing an increasing role in scientific research projects with
potential commercial application. Both government policy and scientific
research societies must provide clear guidelines for ensuring that
government-funded scientific research projects are adequately disclosed. This
disclosure process should involve both timely publication of research papers
reporting results as well as rules to provide access to materials or equipment
required to build on prior research.
4.1.4 Innovation Policy
Finally, while the principal elements of national innovation policy largely

reflect international “best practice,” Australia must continue to expand its
effort at establishing open markets, vigorous antitrust enforcement that
supports innovative investment, and provide effective protection for
intellectual property. As emphasised earlier, effective improvements in the
Australian innovation infrastructure require balanced upgrading on multiple
dimensions; areas of past strength should not be neglected when other areas
become the focus of policy attention.
4.2 Encourage Cluster-Based Economic Growth
Cluster development is a key driver of innovative capacity, and crucial if

Australia is to raise its innovative capacity to a world-class level. In the
absence of domestic firms from interrelated industrial areas engaging in
vigorous, innovation-based competition, the likelihood of any given firm
achieving global leadership through innovation is remote. Moreover, an
innovation-oriented cluster environment able to compete on global markets
must have its foundations in the unique strengths and capabilities of the local
economy. From the textile cluster in Northern Italy to the electronics clusters
in Japan and Finland, traditional sectors serve as the foundation for clusters
with global impact.
Policy towards cluster development must trade off two criteria. First, though
clusters are a key element to innovation-driven growth, it is important to
emphasise that appropriate government intervention must avoid picking
winners. Successful cluster development must evolve according to market
signals and individual firms should be protected against the pressure of
competition from domestic or foreign firms. Conversely, the number of
clusters in a particular location which can compete globally is limited by the
size of the region and the stage of economic development. For small or
medium-sized countries, most firms able to compete on a global scale will be
drawn from a small number of key clusters. For example, Taiwanese success
in the semiconductor industry reflects a deep electronics cluster, with little
45
diversification to other high technology areas such as biotechnology. While

the government must avoid picking winners, it must also avoid imposing
diversification.
Effective public policy must incorporate both of these criteria. First, and
perhaps most importantly, the foundations of dynamic clusters lay in the
ability of investors and companies (both domestic and foreign) to direct
financial and human resources towards those opportunities which can yield
global competitive advantage. As a result, government-imposed barriers to
entry or excessive regulation can hinder effective cluster development. As
well, clusters can only nurture firms with the potential for global leadership
by subjecting those firms to vigorous domestic competition; vigorous yet
sophisticated antitrust enforcement ensures that no firm exploits market
power at the expense of industry development.
Beyond providing a strong microeconomic environment from which clusters

emerge, government can exert leadership and provide incentives for
public/private partnerships through the establishment of institutions for
collaboration. From basic research consortia to organised export groups,
government can facilitate the process by which firms – competing vigorously
in domestic and international markets on the basis of innovation – can
nonetheless cooperate on shared priorities.
The logic of dynamic cluster development holds additional implications for

Australian managers, investors and other stakeholders in Australian economic
development. Though operational challenges and near-term tactical concerns
often dominate managerial time and attention, global competitive advantage
requires from strategic positioning within clusters that have the potential for
world-class competitiveness.
The analysis in Section 3 offered some preliminary (though by no means

definitive) evidence bearing on these choices. Relative to first-tier innovator
economies, Australian innovation resources are out of balance. Despite
unique historical strengths in life sciences, agriculture and mining, the
majority of R&D investment by Australian companies is in the area of
information technology. Moreover, the vast majority of these information
technology investments are inward-looking, focusing on how to tailor global
technology to the Australian context. Though such investments are clearly
important and make sense when viewed in isolation, adaptation of global
technologies to the local economy does not provide a basis for sustainable
global advantage. Instead, Australia’s historical advantages lie in the
exploitation of natural resources and the development of a first-class
university research system, with particular strength in the areas of agriculture
and life science research. Though still at an early stage, the foundations for
dynamic cluster development in these areas seems to be strong, particularly
when compared to potential international competitors.
At the same time, for investors to nurture the development of Australian

companies with the potential for global competitive advantage requires
assessing the unique advantages of the Australian environment. In this
46
regard, public R&D funds are most effective when spurring

complementary follow-on private sector research and commercialisation
investments.17 Recent initiatives by firms within Australia’s fledgling venture
capital sector to focus on areas such as biotechnology reflect private sector
leadership in spurring the exploitation of unique Australian capabilities. In
other words, the choices of policymakers, managers, investors, and other
stakeholders impact not only the near-term dynamics of an individual firm or
program but can spur the development of dynamic clusters competing
globally on the basis of innovation.
4.3 Foster Linkages
Though Australia’s university system is an historical source of strength,

Australia must upgrade its institutions that link the common innovation
infrastructure to individual regional clusters. In many respects, enhancing the
effectiveness of linkages is perhaps the most difficult area of innovation
policy, as many of the most important functions served by linkages and even
the institutions themselves depend on informal mechanisms and governance
structures. For example, effective industry association boards tend to be
those that are self-organised (rather than imposed by the government) and
much of the knowledge flows facilitated by universities occurs through
informal exchanges and networks. With these challenges in mind, we
highlight a few specific areas for policy concern in this area.
First, universities must continue to upgrade their role as key linkages in the
Australian innovation system. In leading innovator economies, the university
system provides required training for a technically skilled labour force. It also
undertakes “basic” research investments that serve as the foundation for a
country’s industrial clusters. Finally, by serving as a neutral broker within and
among companies themselves, universities serve to serve as a knowledge hub
through which spillovers are achieved. Though Australian universities have
been historically isolated from industry and national innovation policy
initiatives (relative to the US), they are today playing a key role in one of
Australia’s most promising clusters, the life sciences.
17 For example, Zmood Innovations – a Melbourne-based start-up company developing

applications of Micro Systems Technology to printing systems, identification systems and
medical diagnostic devices – has found new opportunities for domestic and offshore R&D
precisely because of the development of complementary inputs. Their technology has
potential applications in electronic systems as well as biosensors and other applications in
medical devices. This start-up has been spurred on by two developments: First, another
private company – MiniFAB – has invested in clean room facilities which are absolutely
essential for start-ups like Zmood Innovations to use to fabricate working models of their
devices. Second, the government has coordinated the Australian Synchrotron project; a key
infrastructure development for scientific and technological applications in the fields of nano-
and micro systems technology.
47
During the last several years, a number of excellent initiatives to enhance

research grants encouraging linkage between industry and universities, as well
as establishing Cooperative Research Centres to promote R&D performed by
universities, have been implemented. While the broad outlines of these
programs are excellent, there has been a tendency to micro-manage the
process of funds disbursement and use.
R&D tax incentives may serve as a more decentralised solution. For example,
a direct incentive for companies to engage universities in the research process
would be to offer a greatly enhanced R&D tax credit for company funding of
university research. In so doing, the process of interaction between
universities and industries would be induced directly, and might focus
industry attention on the potential benefits of working with university
researchers. As well, joint research projects with universities are more likely
to satisfy the criteria that the investments eligible for the credit themselves be
truly innovative.
In addition to universities, Australia must encourage the development of

other linkage mechanisms. For example, though often viewed simply as an
investment fund, the fledgling Australian venture capital industry should
explicitly seek out a linkage role in order to be successful. In the United
States, venture capital serves not only as a source of funds but as a source of
specialised expertise in managing the commercialisation of new technology
and a network to enhance the commercial and social impact of a given
innovation. As well, more active involvement by industry associations can
play a critical role in raising the bar with aggressive quality standards as well
as openness to new technologies.
4.4 Summary
In a global economy, innovation-based competitiveness provides a more

stable foundation for productivity growth than the traditional emphasis on
low-cost production. Having secured a position as a leading user of global
technology and creating an environment of political stability and regional
leadership, Australia has an historic opportunity to pursue policies and
investments to establish itself as a leading innovator nation. Australia must
build upon a foundation of openness to international competition and the
protection of intellectual property rights. However, Australia needs to focus
upon the areas that appear to have become neglected over the past two
decades. In particular, Australia should significantly increase its investment in
order to:
• Ensure a world-class pool of trained innovators by maintaining a high

level of university excellence and providing incentives for students to
pursue science and engineering careers
48
• Provide incentives and opportunities for the deployment of risk

capital
• Facilitate innovation as a cumulative step-by-step process
• Continue to open up Australia to international competition and

investment and upgrading the effectiveness of intellectual property
protection
• Maintain a vigorous yet sophisticated approach to antitrust

enforcement
• Reduce barriers to entry and excessive regulation that hinder effective

cluster development
• Build innovation-driven dynamic clusters based on unique strengths

and capabilities
• Enhance the university system so that is responsive to the science and

technology requirements of emerging cluster areas
• Encourage the establishment and growth of institutions for

collaboration within and across industrial areas.
Australia’s innovation policy must be cohesive in order to create a favourable

environment for private sector innovation. Rather than micro-management
of individual projects or short-term schemes that do not necessarily fit within
the overall plan, innovation policy must be consistent and allow markets and
investors to ultimately choose where to deploy resources and capital for
global innovation. Indeed, in the Australian context, high-technology
investments may not be in what are conventionally regarded as high-
technology industries, as Australia’s key strengths build on historical
advantages in primary industries. Ultimately, policy should not be judged on
whether a particular company or industry flourishes but on whether, taken as
a whole, Australian firms are increasingly able to develop and commercialise
innovation for global competitive advantage and as a source of prosperity for
Australia going forward.
49
Section 5 Final Thoughts
5 Final Thoughts
At present, the bulk of the world’s innovations are developed and

commercialised by a relatively small number of top tier innovator
economies. These nations have put themselves in that position through
commitments to enhance and sustain innovative capacity within their
country. In some cases, such as for the United States and Switzerland, top
tier innovators have reaped the benefits of that position for decades.
Other countries’ emergence is more recent. For example, building on a
decade of systematic policies to enhance innovative capacity, Finland has
become a global leader in telecommunications innovation, simultaneously
serving as the foundation for the competitiveness of companies such as
Nokia and bestowing an important gift on other citizens throughout the
world who benefit from that innovation as consumers.
Some have claimed that, as a relatively small and geographically remote

economy, Australia need not invest in innovation but simply be content
to adopt the best of global technology. We disagree. It is Australia’s duty
as a leading member of the world community to itself become an active
contributor to the world’s knowledge pool. As a prosperous nation, our
payment for innovations developed by companies in other countries
should be a reciprocal contribution ourselves. While individual companies
invest in innovation to serve the interests of their investors and
stakeholders, government investment in the innovation environment can
be premised on ensuring Australia’s appropriate place in the community
of nations.
The role of the government is to ensure that the basis exists in Australia’s
innovative capacity by investing heavily on the three dimensions
identified in this report – a common innovation infrastructure, the
cluster-specific environment and the quality of linkages. We should not
expect that Australia will become a leading innovator across all industrial
area; instead, Australian strength in a few key areas can serve as the basis
for international competitiveness and the source of Australian new-to-
the-world innovation. Achieving this goal requires building on Australia’s
many areas of strength and undertaking proactive investments to address
key areas of concern, from human capital development to the university-
industry interface.
50
Section 0 Appendix A: Econometric Methodology
Appendix A: Econometric Methodology
This Appendix provides a brief, more technical review of the procedures

underlying the calculation of the Index and includes the results from our
regression analysis. We proceed by reviewing the procedures associated with
each of the four stages of the analysis.
Stage I: Developing a Statistical Model of National

Innovative Capacity
The first stage consists of creating the database of variables relating to

national innovative capacity for our sample of 29 OECD countries from
1980 to 2000. This database is used to perform a time series/cross sectional
regression analysis determining the significant influences on per capita
international patenting and the weights associated with each influence.
Variables, definitions, and sources are listed in Table A-1. Table A-2 lists the
29 countries in the primary sample. Finally, Table A-3 provides some
summary statistics.
Data choices are discussed in Furman et.al. (2002). Importantly, the data
draws on several public sources, including the most recently available data
from the OECD Main Science and Technology Statistics, the World Bank, and the
National Science Foundation (NSF) Science & Engineering Indicators. Where
appropriate, we interpolated missing values for individual variables by
constructing trends between the data points available. For example, several
countries only report educational expenditure data once every other year; for
missing years, our analysis employs the average of the years just preceding
and following. The primary measure of innovative output employed in the
Index is international patent output. The data are provided by the United
States Patent & Trademark Office. For all countries except the United States,
the number of patents is defined as the number of patents granted in the
United States. Since nearly all U.S.-filed patents by foreign companies are also
patented in the country of origin, we believe that international patents
provide a useful metric of a country’s commercially significant international
patenting activity. For the United States, we use the number of patents
granted to establishments (non-individuals) in the United States. To account
for the fact that U.S. patenting may follow a different pattern than foreign
patenting in the United States, we include a dummy variable for the United
States in the regression analysis (the coefficient is however statistically
insignificant). It is crucial to recall that patenting rates are used only to
calculate and assign weights to the variables in the Index. The Index itself is
based on the weighted sum of the actual components of national innovative
capacity described in Section 2 and in Table B-1.
51
Table A-1: Variables & Definitions
VARIABLE FULL VARIABLE DEFINITION SOURCE

NAME
INNOVATION OUTPUT
PATENTS j,t International Patents For non US countries, USPTO patent
Granted by Year of patents granted by the database
Application USPTO. For the US, patents
granted by the USPTO to
corporations or
governments. To ensure this
asymmetry does not affect
the results we include a US
dummy variable in the
regressions.
QUALITY OF THE COMMON INNOVATION INFRASTRUCTURE
FTE R&D PERSj,t Aggregate Personnel Full time equivalent R&D OECD Science &
Employed in R&D personnel in all sectors Technology
Indicators
R&D $j,t Aggregate Total R&D expenditures in OECD Science &
Expenditure on R&D Year 2000 millions of US$ Technology
Indicators
IPj,t Strength of Protection Average survey response by IMD World
for Intellectual executives on a 1-10 scale Competitiveness
Property regarding relative strength Report
of intellectual property
ED SHAREj,t Share of GDP Spent Public spending on World Bank,
on Secondary and secondary and tertiary OECD Education
Tertiary Education education divided by GDP at a Glance
GDP/POPj,t GDP Per Capita Gross Domestic Product per Penn World
capita, constant price, chain Tables GDP &
series, US$ population series.
GDPj,t GDP Gross Domestic Product Penn World
constant price, chain series, Tables
US$
CLUSTER-SPECIFIC INNOVATION ENVIRONMENT
PRIVATE R&D Percentage of R&D R&D expenditures funded OECD Science &
FUNDINGj,t Funded by Private by industry divided by total Technology
Industry R&D expenditures Indicators
SPECIALISATIONj,t E-G concentration Relative concentration of Computation from
index, excluding the innovative output in USPTO data
US chemical, electrical and
mechanical USPTO patent
classes
QUALITY OF LINKAGES
UNIV R&D PERFj,t Percentage of R&D R&D expenditures OECD Science &
Performed by performed by universities Technology
Universities divided by total R&D Indicators
expenditures
52
Table A-2: Sample Countries (1980-2000)
REGRESSION DATA FROM 1980-1998

INDEX CALCULATIONS FROM 1980-2000
Australia Finland Ireland Norway Sweden
Austria France Italy Poland Switzerland
Belgium Germany* Japan Portugal Turkey
Canada Greece Mexico Slovak Republic United Kingdom
Czech Republic Hungary Netherlands South Korea United States
Denmark Iceland New Zealand Spain
Czech Republic, Mexico and Poland have index calculations from 1993, Slovak Republic from 1995
* Prior to 1990, figures are for West Germany only; after 1990 results include all Federal states
Table A-3: Means & Standard Deviations
VARIABLE Observations Mean Standard Deviation

INNOVATION OUTPUT
PATENTS 525 3113 9301
FTE R&D PERS 512 170431 356016
R&D $ 507 13343 32652
IP 277 6.22 1.29
ED SHARE 499 3.09 1.02
GDP/POP 525 16418 5652
GDP 525 661 1256
PRIVATE R&D FUNDING 508 47.8 17.1
SPECIALISATION 523 0.152 0.126
QUALITY OF LINKAGES
UNIV R&D PERF 516 25.4 12.5
An interactive dummy variable is also included to account for the low

innovation base of several of the emerging countries. The coefficient is
significant and is an area for future development.
The statistical model draws heavily on a rich and long empirical literature in
economics and technology policy (Dosi, Pavitt, and Soette, 1990; Romer,
1990; Jones, 1998). Consistent with that literature, we choose a functional
form that emphasizes the interaction among elements of national innovative
capacity, namely a log-log specification between international patent
production and the elements of national innovative capacity:
53
Table A-4: Innovation Index Regression Model
Dependent variable = L PATENTS

Coefficient (Std Error)
0.70
L FTE R&D PERS
(0.10)
0.64
L R&D $
(0.08)
0.066
IP
(0.037)
0.13
ED SHARE
(0.02)
0.79
L GDP/POP
(0.18)
-0.21
L GDP
(0.07)
0.014
PRIVATE R&D FUNDING
(0.002)
0.38
SPECIALISATION
(0.27)
QUALITY OF LINKAGES
0.010
UNIV R&D PERF
(0.004)
CONTROL VARIABLES
0.12
US DUMMY
(0.09)
0.027
EMERGE DUMMY
(0.011)
YEAR EFFECTS Significant
REGRESSION STATISTICS
R SQUARED 0.972
NUMBER OF OBSERVATIONS 525
LPATENTS j ,t = β 0 + β t YEAR t + βUSA USDUMMY j + β EMERGE EMERGE j *(YEAR − 1978) +

β FTE LFTERESEARCHERS j ,t + β R & D $ LR&D$ + β IP IPj ,t + β EDSHARE EDSHARE j ,t +
β GDP / POP LGDP / POPj ,t + β GDP LGDP + β SPEC SPEC j ,t + β PRIVATER & D PRIVATER&D j ,t +
βUNIVR & D UNIVR&D j ,t + ε j ,t
This specification is inspired by 4.4 of Furman et.al. (2002). It has several

desirable features. First, most of the variables are in log form, allowing for
natural interpretation of the estimates in terms of elasticities. This reduces the
sensitivity of the results to outliers and ensures consistency with nearly all
earlier empirical research (see Jones, 1998, for a simple explanation of the
advantages of this framework). Note that the variables expressed as ratios are
54
included as levels, also consistent with an elasticity interpretation. Second,

under such a functional form, different elements of national innovative
capacity are assumed to be complementary with one another. For example,
under this specification and assuming that the coefficients on each of the
coefficients is positive, the marginal productivity of increasing R&D funding
will be increasing in the share of GDP devoted to higher education. Third, by
using patents granted by date of application we do not need to impose a lag
between the components of national innovative capacity and the measure of
innovative output, international patenting.
Table A-4 reports the results from the principal regression. The coefficients
on the variables are significant at the 10% level with the exception of the US
DUMMY and SPECIALISATION. Consistent with prior research, the time
dummies largely decline over time, suggesting a substantial “raising the bar”
effect over the past 20 years (see Jones, 1998, for a discussion of declining
worldwide research productivity).
Stage II: Calculating the Index
In Stage II, the Innovation Index was calculated using the results of the
regression analysis in Stage I. The Index for a given country in a given year is
derived from the predicted value for that country based on its regressors.
This predicted value is then exponentiated (since the regression is log-log)
and divided by the population of the country:
exp( X′j,t β)
Innovation Index j,t =
POPj,t
To make our results comparable across countries, we included the U.S.

DUMMY coefficient in the calculation. The issue of its inclusion or exclusion
remains an area for closer examination in the future. We also included the
SPECIALISATION and interactive EMERGE dummy variable. While
refinement of these measures is an interesting area for future work, their
inclusion or exclusion is not crucial for our key results concerning Australian
innovative capacity.
Table A-5 provides the Index value for each country for each year. The
Index, interpreted literally, is the expected number of international patents per million
persons given a country’s current configuration of national policies and resource
commitments. It is important not to interpret the Innovation Index as a tool to
predict the exact number of international patents that will be granted to a
country in any particular year. Instead, the Index provides an indication of
the relative capability of the economy to produce innovative outputs based
on the historical relationship between the elements of national innovative
capacity present in a country and the outputs of the innovative process.
55
Stage III: Projecting the Index into the Future
The third stage of the analysis began by modelling the future evolution of
each element of national innovative capacity for each country. For the policy
measure of intellectual property protection, we assumed that the policy
environment was maintained at its 2000 level. For the other variables, the
projected value was set equal to its value for the last observed year (in most
cases, 2000) plus an increment which depended on the trajectory of the
variable in the country between 1991 and 2000. For the ratios such as
education as a share of GDP, % of R&D performed by universities and %
financed by industry we regressed each variable against a first order time term
and used the resulting slope to project future changes from the last observed
level. For the other variables, we regressed each variable on a first and second
order time term, and then assumed that the resulting coefficients could be
used to project future changes from the last observed level. This procedure
can result in extreme values based on imprecise estimates, so we were careful
to check our results against this possibility. Once these projected regressors
were derived, the Index was recalculated following the procedure described in
Stage II.
56
Table A-5: Historical Innovation Index 1980-2000
Year Australia Austria Belgium Canada Czech Denmark

Republic
1980 20.6 24.4 28.5 49.5 24.5
1981 21.2 23.5 31.2 60.3 23.6
1982 20.9 21.6 31.9 57.3 23.7
1983 24.1 24.4 37.8 60.0 29.1
1984 25.4 22.3 36.1 57.1 30.6
1985 27.5 24.9 40.3 65.6 36.7
1986 27.4 27.7 42.6 59.8 40.7
1987 26.6 28.4 40.7 56.3 42.5
1988 27.6 27.5 37.4 54.2 41.5
1989 31.6 31.2 45.6 60.2 44.9
1990 29.7 27.9 41.8 53.2 46.5
1991 31.6 29.8 42.0 54.6 45.9
1992 32.5 28.9 37.0 52.2 46.8
1993 38.8 36.3 49.9 64.9 14.0 63.9
1994 45.8 42.6 56.9 73.9 18.1 72.3
1995 46.0 44.7 60.3 71.2 13.2 83.1
1996 52.8 46.9 60.7 73.7 13.4 96.1
1997 47.3 43.3 57.2 69.3 13.5 93.7
1998 43.0 48.6 60.4 65.8 15.4 103.6
1999 50.6 51.2 68.0 74.8 14.4 119.2
2000 50.9 52.4 75.1 81.4 14.5 116.3
Year Finland France Germany Greece Hungary Iceland

1980 28.2 50.4 74.8 0.5 31.8 10.5
1981 29.5 48.5 68.2 0.5 30.8 10.3
1982 29.5 44.9 60.9 0.6 27.1 11.1
1983 34.0 47.9 68.4 0.8 26.6 10.6
1984 36.0 44.5 64.8 0.8 23.4 11.8
1985 42.5 46.9 72.5 0.9 23.0 13.8
1986 46.5 47.7 78.7 1.0 22.2 14.9
1987 50.7 47.7 83.0 1.1 21.3 17.9
1988 53.7 46.4 77.2 1.2 17.2 19.9
1989 63.6 54.0 86.3 1.5 10.7 17.2
1990 57.0 52.9 80.5 1.6 11.2 15.5
1991 58.2 48.3 93.4 1.7 6.2 24.4
1992 51.3 53.5 88.3 2.0 5.2 19.8
1993 55.5 71.6 106.0 2.9 6.0 29.5
1994 66.3 78.2 108.3 3.9 4.8 26.6
1995 84.2 80.5 107.8 4.2 3.3 38.1
1996 98.6 82.6 105.8 5.3 3.0 57.6
1997 103.5 71.5 96.8 6.2 3.2 65.9
1998 121.2 75.3 99.2 7.0 3.3 90.1
1999 158.7 80.1 112.1 9.6 4.0 117.5
2000 173.1 77.6 109.5 12.0 5.4 130.7
* For 1980-1989, the index value is for West Germany only.
57
Year Ireland Italy Japan Mexico Netherlands New

Zealand
1980 4.9 12.5 68.6 55.8 9.1
1981 4.5 13.2 92.0 48.0 9.3
1982 4.1 12.0 82.6 44.7 8.0
1983 4.7 13.7 107.8 47.4 8.3
1984 4.8 12.9 116.4 41.5 8.0
1985 6.0 16.4 132.2 48.8 8.5
1986 6.9 17.3 132.4 53.7 8.7
1987 7.5 19.0 135.1 55.7 8.8
1988 6.8 19.2 131.4 47.1 7.9
1989 8.2 19.1 134.0 49.0 8.5
1990 9.8 20.4 138.0 47.8 8.2
1991 12.1 20.0 147.2 43.4 6.6
1992 14.6 18.9 135.3 39.1 6.7
1993 17.8 19.8 182.1 0.4 48.8 11.4
1994 27.8 19.3 197.2 0.7 55.3 11.8
1995 33.4 17.1 188.1 0.5 61.5 14.3
1996 36.3 19.7 172.8 0.6 66.6 17.2
1997 42.3 19.2 161.6 0.7 57.6 19.1
1998 42.9 20.4 142.9 0.8 60.5 15.5
1999 50.4 20.2 167.4 0.9 67.1 16.8
2000 62.3 19.7 171.6 1.2 68.7 14.9
Year Norway Poland Portugal Slovak South Spain

Republic Korea
1980 31.8 0.8 0.6 3.2
1981 32.3 0.8 0.8 2.8
1982 30.4 0.9 1.7 2.8
1983 35.2 1.0 2.3 2.9
1984 37.1 0.9 3.2 3.1
1985 45.6 1.2 4.3 3.4
1986 47.4 1.3 5.0 4.2
1987 47.0 1.5 5.9 4.6
1988 45.0 1.8 7.7 5.4
1989 44.6 2.0 10.7 6.2
1990 38.7 3.1 12.3 7.3
1991 38.9 2.4 14.3 8.5
1992 41.9 3.2 16.8 8.3
1993 51.0 2.1 3.8 22.7 9.3
1994 65.1 2.0 4.3 28.2 10.1
1995 67.6 2.4 4.9 4.4 35.9 11.1
1996 74.0 3.3 5.8 5.6 41.0 12.2
1997 71.9 3.2 5.9 5.1 36.6 11.5
1998 68.9 3.3 7.4 4.0 22.5 13.9
1999 75.4 3.9 9.5 3.6 29.9 15.3
2000 75.1 3.5 11.1 3.5 42.3 17.3
58
Year Sweden Switzerland Turkey United United

Kingdom States
1980 85.4 116.8 0.4 54.6 145.4
1981 87.4 106.7 0.4 56.1 157.2
1982 78.8 94.2 0.4 47.4 146.2
1983 85.6 101.9 0.5 48.0 173.9
1984 92.2 97.2 0.5 43.4 186.4
1985 103.6 103.7 0.5 45.5 205.7
1986 107.1 132.1 0.5 45.7 182.0
1987 106.5 133.2 0.5 45.0 156.8
1988 101.0 130.6 0.4 46.8 150.6
1989 106.8 152.4 0.3 45.7 154.0
1990 93.5 146.4 0.3 41.9 150.7
1991 94.3 138.6 0.4 38.0 152.0
1992 88.8 127.2 0.4 36.1 131.5
1993 107.5 159.5 0.4 44.1 170.9
1994 124.6 176.0 0.4 51.8 179.9
1995 150.0 176.9 0.4 53.5 170.5
1996 178.0 180.5 0.7 54.4 180.9
1997 153.8 154.6 1.0 57.4 180.2
1998 166.1 152.8 0.8 62.6 180.4
1999 194.3 155.4 0.9 72.7 197.5
2000 184.9 149.7 1.4 79.4 214.4
59
Section 0 Appendix B: US Patents by Australian Organisation
Appendix B: US Patents by Australian

Organisation
Organization Patents Issued from 1997 to 2001

1 COMMONWEALTH SCIENTIFIC AND IND. RES. ORG. 153
2 SILVERBROOK RESEARCH PTY. LTD 127
3 CANON KABUSHIKI KAISHA 56
4 UNIVERSITY OF QUEENSLAND 42
5 EASTMAN KODAK COMPANY 36
5 UNIVERSITY OF MELBOURNE 36
7 ORBITAL ENGINE COMPANY (AUSTRALIA) PTY. LTD. 34
8 ISHIKAWAJIMA-HARIMA HEAVY INDUSTRIES CO., LTD. 31
9 UNIVERSITY OF SYDNEY 29
10 RESMED LIMITED, AN AUSTRALIAN COMPANY 28
11 AUSTRALIAN NATIONAL UNIVERSITY 19
12 CANON INFORMATION SYSTEMS RES. (AUS) PTY LTD. 18
12 TECHNOLOGICAL RESOURCES PTY, LTD. 18
14 AMRAD CORPORATION LIMITED 17
14 LUDWIG INSTITUTE FOR CANCER RESEARCH 17
16 BIOTECH AUSTRALIA PTY LIMITED 16
16 TELSTRA CORPORATION LIMITED 16
18 COMALCO ALUMINUM LIMITED 15
19 GENE SHEARS PTY. LIMITED 14
20 AUSTRALIAN MEMBRANE AND BIOTECH. RES. INST. 13
20 USF FILTRATION AND SEPARATIONS GROUP INC. 13
22 BHP STEEL (JLA) PTY. LTD. 12
22 SOLA INTERNATIONAL HOLDINGS LTD. 12
22 UNISEARCH LIMITED 12
25 COCHLEAR LIMITED 11
25 IMMULOGIC PHARMACEUTICAL CORP. 11
25 SRP 687 PTY LTD 11
25 WOMEN'S AND CHILDREN'S HOSPITAL 11
– Note: Shading indicates universities and research institutions

Source: US Patent and Trademark Office (www.uspto.gov). Author’s analysis
60
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Assessing Australia’s Innovative

Capacity in the 21st Century

Joshua Gans and Scott Stern

Affiliations: Gans (Melbourne Business School and Intellectual Property

27th June, 2003

International competitiveness increasingly depends on innovation, especially in

Though Australia has enhanced its commitment to innovation policy, establishing

Australia currently faces an historic opportunity to redefine its position in terms of

2 The Foundations of Innovative Capacity ...... 7

2.2 Sources of National Innovative Capacity........ 10

2.3 Measuring National Innovative Capacity ........ 19

2.4 Findings on Innovative Capacity................... 26

3 Australian Innovative Capacity.................. 28

3.2 The Evolution of Australian Innovative Capacity32

3.3 Projecting Australia’s Future ........................ 38

4 Nurturing Australia’s Innovative Capacity . 42

4.2 Encourage Cluster-Based Economic Growth ... 45

4.3 Foster Linkages ......................................... 47

4.4 Summary ................................................. 48

Appendix A: Econometric Methodology .............. 51

Appendix B: US Patents by Australian Organisation

During the 1990s, Australia has been an outstanding economic performer

It is easy to point to several drivers of this success. Relative

Figure 1-1: Real GDP Growth Rates

Source: EIU (2001), OECD (2002), Singapore Statistics (2002).

Figure 1-2: Catch-Up?

Source: IMF (2001)

This shift in the basis of international competitiveness poses a new and

The real concern for Australia’s future prosperity lies in innovative

Figure 1-3: Patents versus Patent Growth

Source: US Patents and Trademarks Office, Author Analysis

Figure 1-4: Scientific Employment

Source: OECD Science, Technology and Industry Scoreboard 2001.

Figure 1-5: R&D as a percentage of GDP in 2000

These concerns are already showing visible manifestations. The number

The report proceeds in three sections. In Section 2, we describe the

update on prior innovative capacity benchmarking studies (Porter and

2 The Foundations of Innovative

World class competitiveness and prosperity depends on national innovative

2.1 The Link Between Innovation and Prosperity

The prosperity of any economy depends on its productivity, or the value

absence of sustained innovation, the rate of productivity growth in

Productivity, contrary to popular usage, is more than just efficiency. It is

Indeed, in a modern economy, it is not only what a nation produces but

Innovation—the transformation of knowledge into new products,

In summary, the capacity for innovation determines the standard of living

• Creating high value products and services

• Developing unique products, features and processes

• Staying ahead of technology diffusion

Innovation is more than simply a process of scientific discovery, and goes

2.2 Sources of National Innovative Capacity

The vitality of innovation in a location is shaped by national innovative

Sharp differences in innovative output across locations make clear the

identified in one country but commercially developed in another. The powerful

Figure 2-1: Drivers of National Innovative Capacity

success at innovation. Harnessing the local environment for innovation

Building on Porter and Stern (1999), we propose a framework for

Figure 2-1 illustrates the Porter-Stern framework. The left-hand side

of linked industries termed clusters.5 Clusters are geographically