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Upton Speech to Royal Society Academy Conference

"How will the Crown's ownership and purchase interests in science and technology evolve as private investment in R & D expands".
Keynote Address to the Royal Society Academy Conference
Rt Hon Simon Upton
9.35 am, 25 November 1999

Before I turn directly to the subject matter you have asked me to address, let me make a few comments about the economic setting in which any future development of R&D will occur.

The title of this address contains the assumption that private sector R&D will expand. We all hope that it will but there is no inevitability about it.

New Zealand has always been a branch-line economy. It was once a branch of an imperial economy that had global reach and gave us expectations of metropolitan status. Today we are a branch of a global economy in which we have no special status beyond inherited linguistic and cultural connections.

The quality, creativity and versatility of our human capital will determine how well we exploit the opportunities available to us. And there are opportunities. But I think it is important to underline to a science-based audience that they aren't all going to be the result of new and unimagined high tech industries that don't yet exist (as some of our more futuristic and swashbuckling commentators might have us believe.

In an increasingly dirty and crowded world, a clean environment in which food can be produced will become increasingly rare. Similarly, a low population density in a temperate developed world setting without many of the unavoidable side-effects of suffocating urbanisation (this isthmus excepted) is going to make New Zealand as a tourist destination distinct from so many places.

Of course there will be new, technology-based industries that will augment the respectable stable already based here. But the brutal point has to be made that there is no particular reason why such businesses will be located here beyond the lifestyle decisions of their proprietors. The same stunning environment and lack of population density that makes the quality of life here so special, is also a symptom of our distance from the centre of things – of our peripherality (if there is such a word).

Yes, I'm aware of the information society, the global village and modern communication technologies. But human beings seem attracted by others of the same species, and it is undeniable that the cultural depth and intellectual ferment we see in more populous places like Europe and North America will provide a melting pot for economic and scientific creativity that we cannot match.

As I have found myself saying over and over again during the recent election campaign, we are living at the last bus stop on the planet and if I hear another person suggest Finland or Ireland as models I will scream. Both sit on the edge of a continent which is home to 300 million of the richest people on the face of the earth. A similar proximity to markets and people underwrites Singapore's future. It seems to me that these countries could get quite a lot of policies wrong and still do very well. The unpalatable truth for New Zealand is that we have much less room for manoeuvre, less rope with which to hang ourselves (in terms of bad management) and no guarantees of maintaining first world living standards just because we were born to them.

It is these facts about the way the real world is rather than policy prescriptions that we have to keep at the front of our minds. While economic liberalisation has, in my view, been vital in giving us a chance to make our way in the world, there is no a priori reason why we will end up getting richer, relatively speaking.

That's why I'm uneasy about the cheerful prescription some would tout that we should just sweep away any government expenditure on things like R&D as a deluded manifestation of over-bearing government, fell the CRIs because private owners would do better things with them and hand back the savings in lower taxes. In a world where people, capital and intellectual property have never been more mobile, I have the uneasy feeling that slightly lower taxes mightn't compensate for the loss of intellectual capital that might ensue. In any case, to assert that the outcome must be better would be to replace empirical analysis with ideology.

Similarly, we can't adopt a cargo cult approach to policies for research and human capital. The idea that, in addition to what we do now, our government could deploy rafts of 'intelligent' subsidies and incentives, tax breaks and other inducements to grow an artificially 'clever' economy seems equally deluded. Richer countries (Australia for starters) will always be able to outbid any schemes we dream up to lure investors. We've lost that race before we start.

The approach that best fits the reality of our situation is a modest one that lies somewhere between the minimalist and hubristic positions. So when you ask me to talk about how the government's purchase and ownership interests in science may evolve, I can only say that they will do so in a way that reflects our particular constraints and challenges as a small, developed economy miles from our markets.

The biggest challenge we have is hanging onto our best people (as it always has been). When I said, at the outset, that the quality of our human capital would determine how well we do as a country, I could be accused of echoing a truism that applies universally. But our geo-political isolation and lack of strategic or locational significance makes that challenge more important for us than almost any other country – unless, that is, we are happy to be a reasonably well-fed but intellectually impoverished bunch of also-rans. And as I've explained, the very thing that makes our need for hugely creative and innovative people so important – our isolation – is the factor that makes it especially hard to keep them.

So what are the implications for the Government's ownership and investment interests in science and research? I shall begin with the ownership interest since I have more to say about that..

The Government owns a portfolio of research institutes – the CRIs. First let me say a word about the state of the CRIs. They are, as a whole, in a strong (though by no means invulnerable) position. Since their establishment seven years ago, the CRIs have been completely refurbished in a physical sense as a result of a very benign ownership policy that has been unique in the public sector.

While most government departments and crown entities have been under pressure to realise surplus assets and return savings and/or dividends to the Crown, CRIs have been allowed to reinvest any gains or profits. By stating explicitly that the Crown was not only a long term owner of CRIs, but that it wished to deepen and expand their capacity, we gave CRIs a stable medium term climate in which they could refurbish themselves.

Over the last seven years, the net increase (after depreciation) in CRI fixed assets has been $59 million. This investment was necessary to recapitalise the physical asset base of the CRIs, which had been allowed to run down in the years prior to their establishment. Not only have the CRIs been able to replace worn out plant and equipment, but they have been able to purchase more sophisticated equipment and build new state of the art facilities. To achieve this reinvestment, the CRIs have had to become more efficient and generate their own profits that the Crown has been prepared to see them retain.

Those retained earnings total $120 million. The CRIs start the new millennium with $44 million cash sitting on their balance sheets and capital expenditure plans of $137 million over the next three years. That sort of position was unimaginable 7 years ago. While the funding and governance arrangements of other institutions like the universities have left their research assets vulnerable, I believe the CRI formula has given them the space and the resources to underwrite at least this fraction of New Zealand's intellectual capital. I make no apology for having taken the view that if the government is going to own something, it might as well do it properly.

The question remains, how should the Government examine its ownership interest from here on now that the refurbishing and rebuilding stage is largely complete? To those who might be tempted to argue that we should sell the CRIs, I would advance the view – heretical in some quarters – that to do so would almost guarantee the rapid export of valuable intellectual property and bright people.

There is no reason why the best intellectual property should be owned here, less so exploited here unless its characteristics were purely local in application. Equally, it would be foolhardy to think that politically motivated owners could create (let alone execute) significant commercial opportunities based on the intellectual capital contained in the CRIs. Governments, in my view, are bad owners of businesses and shouldn't pretend otherwise.

So what is it that we can own successfully? I think the answer lies in viewing CRIs as pools of high calibre intellectual capability from which we seek to leverage public and private advantage. Notwithstanding my reference to the physical and financial strengths of the CRIs, their only real asset is the people who work in them. And those people will only stay there if the work is interesting, the equipment good and it is reputation-enhancing to do so.

This remains the unfinished business of the CRIs. While the physical fabric is now in generally good order, the rewards for those who work there will have to rise if the gap between local salaries and international opportunities is not to cause a haemorrhage of skills. Some progress has been made, but it will be vital for CRIs to improve their profitability to keep their best staff. The quantum of public funding and the prices accepted by the Foundation will be an important element, but for most CRIs the level of private sector investment will be crucial.

So will the way it is pursued. It has from the outset been intended that CRIs should be run in an orthodox commercial manner so that it is easy to do business with them. But it has also been the owner's policy that they should leave it to those external investors to take the commercial risks and create the new industries.

This does not imply a static, handmaiden relationship between CRIs and industry. Rather, they should be focussed on the knowledge base that supports commercial activity in the key sectors. The relationship is not without consequences for the human capital base of the institutes. While there will be many core competencies that will be maintained over lengthy periods, research at the commercial interface will see teams come and go. It has to be expected that as private research investors leverage CRI skills and knowledge, some researchers will move into industry. It should be an organic process with the CRI constantly re-positioning in new and emerging fields. In the process, CRIs should be securing a future share of the revenue streams that flow from their contribution to the innovation process. But they shouldn't seek to become developers and producers themselves.

Seeing CRIs as publicly owned repositories of skills, and catalysts for the privately-led commercialisation of knowledge wholly or partially funded by taxpayers, means that CRI boards have to be very careful to see that the interests of managers are closely aligned with the owner's interests. This is where the commercial model provides limited guidance to managers.

Private sector owners with a profit maximising (and dividend enhancing) objective will ordinarily seek to grow the business provided that growth enhances shareholder wealth. CRI managers, by contrast, are not charged with growing the business. Opportunities that might normally be developed in-house will be deliberately left to others to generate outside the CRI. The financial returns of this strategy may be lower but the 'dividend' is being taken in the wider economy. Boards will need to see that management aren't building empires at the expense of much faster growing and dynamic commercial development by private entrepreneurs.

Over the last 2 – 3 years I have witnessed a sea change in commercial attitudes to R&D in many traditional sectors of the economy. It has been matched by a much more proactive approach by CRIs to galvanising research partnerships with the private sector. While it will be 5 – 10 years before a large number of spin-offs are seen, the investment proposals I am aware of make it likely that the directions taken by many CRIs will transform their skill bases, as well as their commercial and international connections.

Obviously, those whose research is intimately linked with classic public good research of, say, an environmental nature will have a different development path from those CRIs that service fast-developing areas of industrial and service sector activity. But from an ownership perspective we will only know that we've got it right if their science output is able to draw on a deeper, stronger human skill base than it does today. I know that's difficult to measure, but it is where ownership monitoring has, in my view, to be concentrated along with ensuring that there is a constant leveraging and application of new knowledge by private sector companies.

I accept that once private interests have invested in developing commercial applications that have emerged from CRIs, there is no guarantee that all the benefits will be captured in New Zealand. That's the way the global marketplace works. But if the quality of the CRIs' capability is maintained and the institutes can capture a share of the intellectual property that others generate from their work, they should be an on-going magnet for domestic and off-shore investment and, along the way, a reason for firms to locate here.

Let me turn briefly to the purchase side of the equation. This is, to my mind, much more straightforward. As the private sector becomes more technically and scientifically literate, the government's role as a purchaser can become less interventionist. To be frank, I think we must view the Foresight process as transitional. It has involved a large amount of consultation with huge numbers of industry sectors that have little previous track record of strategic thinking let alone investment in R&D. The exercise of engaging them may have been as valuable as the research dollars that will be spent as a result. For the first time, many industry sectors are wanting to drive their own research agendas. The risk, of course, is that once the opportunities are well understood, that energy and interest will be expended on lobbying for funds. Indeed, that seems to me to be the risk that the new system runs. While new strategic portfolios will bring much publicly-funded research closer to those who can make use of its results, the risk is that money will be spent on the basis of who can bring political pressure to bear rather than the capacity of the research to open doors that would otherwise have remained closed.

I am prepared to accept that a more collaborative and negotiated approach to spending public research dollars may be needed to change private sector attitudes. But once evidence of increasing private sector R&D is clear, I believe we should rely principally on the CRI and university interface with the private sector to determine priorities.

The Government should do what it does best, and that is funding truly high quality, long term, blue skies work (and, of course, research related to solving problems that only the public sector can sensibly tackle such as climate change or hazard mitigation). In an ideal world, the private sector's investment in R&D would be so strong that as much as 60% of the annual PGSF could be switched to the sort of work supported by the Marsden Fund.

My conclusion, after 15 years in the science policy debate field, is that governments are poorly informed purchasers of research. That was the reason I insisted on NSOF as an explicit admission of inevitable purchaser 'failure'. It is vital that NSOF, or some similar mechanism, is retained, and I categorically reject the view that it should be viewed as an 'ownership' device. It is there to counteract the myopia that will inevitably afflict a central purchaser.

Theories of knowledge applied to economic activity have, in recent years, provided much empirical support for the beneficial consequences of the 'invisible hand' posited by classical economists. In short, markets are now understood as highly effective social institutions for generating and assimilating widely dispersed knowledge. In my view, the invisible hand of discovery in research institutions is an equally potent force.

While those who allocate public research dollars should be sure that merit and rigour are beyond question, they should be suitably modest about the extent to which they can influence the outcomes of research or indeed determine priorities beyond very broad areas of national or regional significance. Bureaucratic crystal ball gazing will rarely generate more knowledge than the serendipitous investigations of really first class scientists. The bulk of our public science investment should be seen as an unashamed investment in the knowledge base of our society.

That is not where we are now, and key sectors of the economy are still heavily dependent on publicly directed priorities. The aim should be to have the productive sector take over the direction of commercially related research so that more public dollars can be spent on the sorts of research that only governments (or private philanthropic institutions) will ever fund.

It goes without saying that this is a prescription for public science funding that demands a minimum of political activism beyond persuading taxpayers and Parliament of the value of marshalling public resources to augment our knowledge base. That has certainly been my approach over the years I have been a science minister. I can honestly say that I have never once sought to influence the allocation decisions of the government's funding agencies and I don't believe any minister ever should.

Similarly, I have never directed a CRI about the sort of research it should pursue. I have, as the CRI Act demands, asked Boards to justify their activities as being of benefit to New Zealand. But in practice, I have interpreted that as being any activity that maintains the skill base of the institution and its continued availability to New Zealand users – not my view of what research is or isn't good for people.

I have been, with some success, an advocate for higher public investment in science. Of all the investments we make on behalf of taxpayers, it is one of the most benign. Let us hope that all political parties take that view and, more importantly, take the trouble to understand the importance of science to maintaining our standing as a first world nation.

Thank you.

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