Innovation raises capital productivity by producing new goods and services and implementing new ways of making and marketing them. A country’s human capital’s creativity determines its economic growth and social cohesion. Governments can nourish innovation through policies that support education, R&D, and social connectivity.
Key Thoughts
- Human capital drives innovation, innovation drives productivity, and productivity drives economic growth.
- Innovation requires a coordination of government policies and organisational action.
- An open economy is a self-organising ecosystem that can be nudged in a desirable direction.
Innovation and Economic Growth
Economic growth was low for most of the past 2,000 years. For the first millennium, there was no per capita growth. During the medieval period, small annual per capita growth resulted in just over a 50% increase in per capita GDP in 1,800 years. The Industrial Revolution accelerated growth. It demonstrated how innovation fuels economic development. Following WWII, growth took off, and per capita GDP doubled in about a quarter of a century. World per capita economic growth is now about 2% per year. In the first quarter of 2024, the seasonally adjusted growth of the Australian economy was 0.1%.
World per Capita Economic GDP Growth
Major contributing factors to the Industrial Revolution were the invention of the factory, steam engine, mechanical loom (economic capital), and the enactment of legalisation enabling the formation of joint stock companies (organisational capital).
The British East India Company, established in 1600, popularised the joint-stock model by demonstrating its Cʹ (capital productivity) advantages. At one point, the company accounted for half the world’s trade in commodities. It was the corporation that changed the world.
The joint stock company was an innovation in risk management and the deployment of human capital. First, it was a new means of financing ventures that restricted an investor’s loss to their capital contribution. Second, it separated ownership from management. Professional managers are usually better at capital creation than investors.
The Industrial Revolution entrepreneurs who foresaw the opportunities created by new technology needed a legal structure, the joint stock company, to fund and manage their vision. The joint stock company was an on-ramp to the Industrial Revolution, which raised capital productivity.
Today, successful innovation is mainly dependent on blending human and organisational capital. Consider the Pfizer Covid-19 vaccine. BioNTech provided the highly skilled human capital to design the vaccine, and Pfizer contributed the organisational capital to clinically test, manufacture, and distribute at scale.
Australia’s Record
In terms of global innovation, Australia ranks 24th. The three most innovative countries are Switzerland, Sweden, and the US. We have no science of technology clusters in the world’s top 25. Switzerland and Sweden both have two , and the US has eight. Clusters in Melbourne and Sydney are ranked 43 and 46, respectively. Australia’s Innovation is below par for a country that consistently ranks in the top 20 as a place to live, work, study and invest. Australia’s productivity problem, which we mentioned in the first Insight posting, can be attributed to its relatively low level of innovation.
Human Capital and Innovation
An organisation’s future is determined by its current capital stock and successful innovation. Its current capital is its launching pad for innovation and the creation of its next generation of capital. In the digital age, innovation is driven primarily by knowledge capital, high-quality human capital complemented by organisational capital. For example, a business can support scientists and engineers with labs and knowledge databases. Alternatively, a business funds market researchers to test different methods of customer engagement.
knowledge capital → innovation → productivity
Technological innovation is driving the demand for highly qualified and experienced personnel worldwide. We might have over eight billion inhabitants, but we need more highly skilled people to manage complex organisations and create their paths to the future.
For many organisations, accelerating productivity requires innovative methods for hiring their needed human capital. The HR manager for a consulting company in a remote US region searched Facebook to find appropriately skilled people who had grown up there. She then enticed them to return home. Another company internally generated more digital skills by offering to reimburse employees triple their university fees if they completed a master’s degree in specific digital skills. Apple has a small HR team dedicated to searching worldwide for typically one new hire per year for its design studio.
Britain led the Industrial Revolution because gradual social change enabled tens of thousands of middle-status entrepreneurs and inventors to combine their skills. The elites in other countries had not relaxed their oppressive social hierarchies. Freedom of association is a critical ingredient for innovation as it enables innovators to find like-minded creatives and collide with potential funders and customers. Fostering these collisions is vital to driving growth through innovation, within society and organisations. Steve Jobs designed the Pixar Animation Studios to facilitate serendipitous meetings between employees and visitors.
Steven Johnson: Scientist and Author: “If you look at history, innovation doesn’t come just from giving people incentives; it comes from creating environments where their ideas can connect.”
An open economy is a self-organising ecosystem because it facilitates freedom of association. New capital creation activities can organically emerge as people, organisations, and ideas freely intersect and form new ventures. Ideally, a government’s economic development policy has processes for nudging self-organisation in the desired direction.
Many are excited by AI’s innovation potential, particularly its use in products such as ChatGTP, which is based on large language models (LLM). To seize this opportunity, enterprises must invest in human capital that understands how to deploy and exploit LLMs. The biggest challenge for raising productivity via an LLM will be finding people with the necessary skills and business know-how.
Mindsets and Innovation
Innovation is influenced by three types of mindsets, as shown in the following figure. The notion that a market economy continually destroys the old to create the new. Creative destruction has been the accepted wisdom for about 80 years. Amazon is blamed for creatively destroying much of the capital of brick-and-mortar retail. Not surprisingly, this framing nourishes a perspective that views the destruction of the old as undesirable. It can encourage resistance and preservation of the status quo.
Creativity and Capital Productivity Growth
A preferred alternative framing of creative construction emphasises that something novel has emerged. Leaders must stress that we live in a capital creation economy that is constructively growing the stock of capital for the benefit of all, particularly when there is a fair distribution of the rewards. As citizens of one of the most egalitarian countries, Australians have much to gain from a pro-innovation creative construction mindset.
Barry Jones Former Australian Minister for Science: “Failure to act appears to favour the present but it certainly prejudices the future.”
The creative hindrance mindset is a major brake on innovation. When threatened by innovation, vested interests attempt to divert and delay. They are rich in financial resources and social capital. Unsurprisingly, the fossil fuel industry is a creative hindrance to the renewable energy transition. It has used its social capital (e.g., political connections) to maintain the growth of subsidies globally. In Australia, fossil fuel subsidies in 2023 increased to AUD 57.1 billion, up from AUD 55.3 billion in 2022. Creative hindrance props up the past rather than funds the future. In organisations, inertia is a subtle form of creative hindrance, but it has the same effect. Many executives have blinkers that result in preserving the status quo rather than seeing the potential of innovations. Jennifer Mueller has some sound advice on how to foster creative change.
Political and organisational leaders must continually frame innovation as creative construction and aggressively sideline creative hindrance. To change mindsets, allocation of all types of capital should demonstrate favouring the future.
Monetary Policy and Innovation
Recent research indicates that interest rate increases, as we have had in Australia recently, reduce investment in innovation. A tighter monetary policy makes it harder to attract customers for new products and reduces the incentives for riskier cutting-edge innovations. As a result, long-term productivity drops. Moreover, innovation often reduces costs. Consequently, unless there is a countervailing policy, interest rate increases retard innovation. Conventional monetary policy, by slowing innovation, maintains the momentum of inflation.
Rather than cut innovation investment when interest rates rise, a contrarian strategy would maintain current levels of R&D. Hence, a pipeline of new products is ready to take advantage of monetary policy easing. Governments that cut R&D spending can prolong inflation.
Australia and Innovation
Recall that the causal chain described previously states:
knowledge capital → innovation → productivity
The root cause of low productivity is a lack of knowledge capital – highly educated and experienced human capital supported by appropriate organisational capital. We can rewrite the equation as:
(human capital + organisational capital) → innovation → productivity
Increasing Australia’s productivity requires developing well-educated human capital and equipping it with appropriate labs, software, and databases to leverage human skills to drive innovation. We must complement these actions by nurturing environments where innovators and entrepreneurs can interact to self-organise the future.
As a democracy with freedom of association, Australian organisations must lead in improving productivity. They have more flexibility for action than governments and can collectively influence governments to enact policies that support human capital growth to propel innovation. An innovative society does not wait for governments to fix problems. It takes solutions to governments.
Critical Reflections
- Are you actively partnering with local educational institutions to raise the quality of their graduating human capital?
- What organisational capital do you need to leverage the human talent of your internal innovators?
- Are you tracking changes in legislation and regulation that will require you to innovate or will facilitate your innovation?
- Are you participating in your industry’s innovation council or similar body?
