I have been asked to talk a little bit about productivity this morning and how we can foster more of it.  I want to start by comparing two recent innovations and how we treat them.

Yo is a smartphone app. Yo does one thing: it lets you send the word “Yo!” to friends on their phone.

MelaFind is a medical device. MelaFind has been described as a “camera with a brain” —optical technology that would scan potential melanomas in multiple spectra and then, using sophisticated algorithms and large datasets, diagnose which were most likely to be cancerous.

Which innovation do you think had an easier time securing funding and regulatory approval? Yo! … of course. Yo didn’t need regulatory approval, nor should of it, but it found a willing capital market ready to latch on to a latest fad – already receiving a stunning $2.5 million of equity injections – for an app that says Yo!

In contrast, MelaFind fought battles to achieve regulatory approval by the Food and Drug Administration in the United States. After initially supporting MelaFind the FDA sent them a “Not Approval letter” raising various questions about MelaFind. Their stock price was immediately halved and they faced years of regulatory approval and legal battles. Eventually MelaFind won and their product was approved.

Who can blame Google's Sergey Brin who recently said that he didn't want to be a health entrepreneur because “It's just a painful business to be in . . . the regulatory burden in the U.S. is so high that I think it would dissuade a lot of entrepreneurs.”

Before you think this is a uniquely American problem, what they do is important and our drug approval processes can be just as arcane. An innovative north Queensland company, QBiotics, is trialling a new cancer drug made from the extracts of blushwood, a plant found in tropical north Queensland. They are conducting their human trials in the US partly because of the cost of human trials here and because of the necessity of getting approval in the much bigger US drug market.

In my view it remains useful to distinguish between the “innovation” undertaken by QBiotics, which has the potential to save millions of lives and spawn an entire new drug industry, and “innovation” like Yo, which, while harmless, is an inane waste of time. I am concerned that in talking of innovation people are too often confusing the two, and even sometimes being overawed by the shiny, bright things of smartphones and the sharing economy and not on the invention of new products or processes, deployed on a large scale that can have a significant impact on society and the economy.

That is not to deny that many more recent innovations like Google and eBay have been massively beneficial. What I am saying is that small-groups of profit seeking entrepreneurs are unlikely to generate the kind of world changing innovations that will drive productivity growth and development. Real and long-lasting innovations are still likely to emerge from the hard-headed work of scientists more interested in truth and knowledge than money.

We don’t need a Silicon Valley in Australia, we need more science degrees.

But first I want to highlight how important innovation is. It is not an end in itself per se, although human inquiry and ingenuity can be a worthwhile pursuit on its own, but its real benefit lies in what it can do to transform our prosperity and economy.

Productivity growth — doing more with the same or fewer inputs — is the long run driver of economic growth, living standards and prosperity. Sure other factors play a part at times, such as higher commodity prices. But as we have seen, these windfalls can disappear as quickly as they rise.

A few years ago Glenn Stevens famously said that in 2005 a shipload of iron ore would buy about 2,200 flat-screen TVs. By 2010, that same shipload of iron ore could buy 22,000 flat-screen TVs. That was both because TV prices fell and because iron ore prices rose by a factor of six. Iron ore prices have fallen, so the picture is not quite as rosy today. By my calculations, a shipload of iron ore today would only buy around 7,000 flat-screen TVs. So we have around a third the wealth in iron ore that we had just five years ago.

Increases in our terms of trade are welcome but they are not sustainable, over the long long run it’s productivity that matters.

Australia is in its 24th year of continuous economic growth. It is the second longest period of uninterrupted growth in recorded world history, only beaten by the Netherlands after they discovered oil in the North Sea. The reason we are able to enjoy this economic growth is because of our productivity. Productivity is the seed of all the fruit that we are lucky enough to reap in this country.

Our ability to grow more food on less land with fewer workers lets others in our hospitals care for our sick, lets others teach our children, a few of us to create works of art and even fewer of us to travel around the country giving speeches like I am today. In the early decades of the 20th century, agriculture accounted for around one-quarter of our total employment in Australia and produced just under one-third of our GDP. The Food and Agriculture Organization shows that wheat yields in developing countries have increased from around 800 kilograms per hectare in 1960 to in excess of 2,500 kilograms today. We have always had a problem feeding the world, but that has been made massively easier through better productivity. A culture without a productive economy has never produced high works of art and the more productive the economy the more resources are available to spend on the things in life that are not free but are the best things—our children, our art, our health. None of them are free.

The basic productivity story in Australia is straightforward. Today Australians produce twice as much in goods and services for each hour they work compared with around 40 years ago. But although our long run story has been good, the past decade has not.

Labour productivity in the market sector has grown at just under 2 per cent a year over the past decade. This doesn’t seem too bad. But you have to remember that Australia has had the largest capital investment boom in its history.

When we look at multifactor productivity — which takes out the impact of capital deepening — the story is pretty bad.

Multifactor productivity in the market sector has grown at negative 0.2 percentage points a year over the past decade (2003-04 to 2013-14).

The long run average growth is 0.7 percentage points a year (1973-74 to 2013-14).

So instead of doing more with less, in Australia we’re now doing less with more.

This is costing us right now. If in the next decade GDP per capita grew at its long run average, each Australian on average would see an increase in their income of $6300 (in real terms) than if it continues to grow at the rate over the past decade.

Productivity figures give you the helicopter view of what’s happening to national productivity. They are the outcome of millions of decisions taken by businesses and workers, and governments across the country every week.  But they don’t explain anything. They are just a signpost.

So what’s driving our poor productivity performance over the past decade? Part of the fall is due to some measurement issues. High investment combined with resource depletion in some part of mining leading to falls in measured productivity — basically the mining of more marginal resources.

Also, as the mining industry continues its shift from its investment phase to its production phase we can expect to see some pickup in productivity.

Another factor pushing down our productivity in the electricity, gas and water sector has been a move to higher cost production technologies across many utility services in order to provide better environmental outcomes and meet increased reliability standards.

So the Government’s efforts to reduce the Renewable Energy Target and get rid of the carbon tax will help keep energy costs from rising as fast as they have been, which will help business profitability.

These factors account for some of the decline – but not all of it.

Many private and government agencies have been highlighting the costs imposed on business from red and green tape – such as government approvals processes, zoning and planning regulations, costs imposed in small business in terms of time and money in trying to keep up with an ever growing paper burden by different commonwealth and state regulators and so on.

Labour market regulations imposed by the previous government are also becoming a problem — cutting into productivity growth, jobs growth and living standards.

To take just one example of how a few poor policies by the Australian government affecting one sector can do a lot of damage to productivity in a short time consider the former Government’s changes to coastal shipping regulations. These changes to shipping labour and cabotage arrangements were found by the Productivity Commission to substantially push up costs of coastal trading services and reduce competition. I have been told that because of these restrictions it is now cheaper to import sugar from Brazil to Melbourne, than from North Queensland to Melbourne.

Innovation and productivity are inextricably linked. Doing things better (process innovation) and producing new and better products (product innovation) underpin productivity.

There are three policy “planks” for driving and stimulating innovation — incentives, flexibility and capabilities.

In emphasising the crucial role of competition as providing the first of these planks — incentives — the Chairman of the Commission Gary Banks observed:

International evidence suggests that it is market competition, rather than government assistance, that is the main driver of innovation and its diffusion throughout an economy. 

Or as Abraham Lincoln more eloquently put it, more innovation occurs when we add “the fuel of interest to the fire of genius.”

The principal way our system seeks to add the fuel of interest is through our R&D tax incentives. These are often seen as a way to compensate firms for the external or “spillover” benefits they provide to the wider economy. While that is true, they are also a means of correcting the internal distortions created by our asymmetric tax system. Our system taxes profits as soon as they are made but requires companies to defer losses rather than receive an immediate refund. These losses lose value over time, due to inflation, and some companies may never realise their value if they go bust in the meantime.

These issues are likely to impact small companies more than large ones because small companies have less ability to offset losses against profits from other areas of their business, and small companies are more likely to go out of business. That is why the government has sought to concentrate the value of R&D tax concessions to smaller companies over larger ones.

The Government has also controversially made the decision to reduce the rate of offset by 1.5 percentage points. This has proven to be a necessary saving in a budget that is still more than $30 billion in deficit. 

The Government, however, is conducting a review of the R&D tax concession framework through the tax discussion white paper. I recognise the work of Adam Rogers from Swanson Reed who has been working on developing a patent box policy, which is promising. While such policies have had some issues overseas we need to encourage new ideas like this in public policy. We have no hope for an innovative economy if we can’t be innovative on innovation policy.

I also note that I am a member of the Senate Economics Committee and we will be ramping up work on an inquiry into innovation in Australia in coming months. That inquiry held hearings in Newcastle and Sydney and we have received over 170 submissions and we are due to report in October.

Of course, a patent box policy will only be effective if our underlying patent and intellectual property system has integrity.

Another factor affecting incentives to innovate is ensuring that we have good R&D tax incentives and appropriate policies in the area of intellectual property. I share some of the concerns of US economist Alex Tabarrok who has highlighted the loosening of patent requirements that has allowed an explosion of patents, and for companies to concentrate more on acquiring than developing new ideas. I note that New Zealand banned patents in the software industry in 2010 altogether. 

The other planks of innovation policy I mentioned earlier— flexibility and capabilities — are also crucial. We need firms and workers that have the flexibility to adapt to the opportunities and challenges that the world throws at us. They also need the capabilities, both in terms of human and physical capital to do this.

The role for Government in this is large. High quality education and training that is responsive and demand driven and teaches the skills that businesses want from their staff is important.

This Government has invested more than $9 billion this year alone in science, research and innovation including almost $70 million in additional funding for Australia’s leading scientific research organisations to build world-class infrastructure that will create stronger connections between research and industry.

The Government is currently finalising its national Science, Technology, Engineering and Mathematics (STEM) plan which will achieve tangible outcomes across the country for decades to come. 

•           Announced as part of the Government’s Industry Innovation and Competitiveness Agenda, this $12 million investment will improve the focus on STEM subjects in primary and secondary schools across the country.

•           The funding will invest over $7 million to provide innovative mathematics resources for teachers and students, provide over $3 million for greater exposure to computer coding across different year levels and contribute $500,000 for an innovation-focused ‘Pathways in Technology Early College High School’ (P-TECH) pilot programme to help develop the next generation of innovators and graduates.

The Government will also seek to address Australia’s deficit in links between research and commercialisation through the establishment of Industry Growth Centres. Sometimes we are too negative about our innovation system. Australia has more than 4000 researchers per million people, putting us 8^th in the world on this measure, ahead of countries like South Korea, Germany and the United Kingdom.

What we are less good at though is turning that research into commercial outcomes. On OECD analysis Australia ranks 32^nd out of 33 countries on business to research collaboration for small to medium sized firms, and last for large firms.

We won’t be able to seek to address such an issue with an economy-wide approach but we can seek to concentrate on those areas we know we have a natural advantage in. In other words we can back our strengths.

That is why we are establishing five key Industry Growth Centres to focus on areas where Australia excels. These include:

-          Food and agribusiness

-          Mining, equipment, technology and services

-          Medical technologies and pharmaceuticals

-          Advanced manufacturing

-          Oil, gas and energy resources

This initiative will enable national action on key issues by encouraging collaboration and commercialisation of new products, enhancing management and workforce skills, identifying opportunities to reduce regulatory burden and improving capabilities to engage with international markets and global supply chains.

I started off by talking about the regulatory burdens involved in getting pharmaceuticals approved in Australia. That is one of the key areas the government wants to focus on. If we can reduce the barriers to commercialisation and encourage a commercial outlook we can come up with the good ideas as well as bring greater productivity and prosperity to Australia.