Silicon Valley shows the way to start-up future

Malcolm Turnbull’s elevation to the prime ministership has prompted a spring cleaning of the government’s image — out with the hardhats, in with the smartphones. Whether Turnbull is a more successful innovation prime minister than Tony Abbott was an infrastructure one will begin to emerge on Monday with the release of the government’s innovation statement.

Expect rhetoric about the importance of an agile and dynamic economy, dollops of public funding for promising start-ups and perhaps a tax break or two designed to encourage and attract increasingly footloose entrepreneurs. But it’s far from clear the benefits of such laudable efforts will outweigh the extra complexity and the cost of having higher other taxes to pay for them.

None of this is to dismiss the importance of innovation. On the contrary, innovations are the “gales of creative destruction”, to borrow Joseph Schumpeter’s ­famous phrase, that have so boosted our living standards.

“It is not (textbook) competi­tion which counts but the competition from the new commodity, the new technology, the new source of supply, the new type of organisation — competition which commands a decisive cost or quality advantage and which strikes not at the profit margins and outputs of the existing firms but at their foundations and their very lives,” he wrote in the 1942 classic Capitalism, Socialism and Democracy.

In other words, we should be more concerned with creating an environment where innovative businesses capable of wiping out ANZ and Westpac can develop rather than promoting (cosy) competition between the two banks.

That may not be so far away. Across town from the headquarters of Sydney’s banking ­giants is Stone & Chalk, a three-month-old not-for-profit “fintech” hub, a place providing — for a fee of a few hundred dollars a month — training and office space for 180 start-up entrepreneurs, investigating how to disrupt the huge profits underpinning a vast array of financial services.

“Australia is very well positioned to create disruptive technology in this area given our large finance sector and local expertise,” says Alex Scandurra, its chief executive, who oversees 55 staff. Start-up isn’t just a buzzword, he says. “They are technology companies with an original idea that have large-scale potential.”

Whatever they are called, governments everywhere, mesmerised by their success (and potentially taxable revenues) want to encourage them. In barely five years, Uber’s market capitalisation has soared from nothing to more than $US60 billion ($82bn), more than industrial giants Ford and General Motors, founded a century earlier. The Singapore government, for instance, now gives matching grants of up to $S50,000 ($51,000) to its budding tech entrepreneurs.

While focus on start-ups has surged under Turnbull, whose success founding Ozemail in the 1990s reveals a genuine interest and appreciation, government policy isn’t inhibiting their development. There is no crisis demanding action.

Fishburners, a less specialised start-up hub in Sydney’s Ultimo founded four years ago by a consortium of large companies including Google and News Corp, is “incubating” about 175 proto-firms. “There are more start-ups on Harris Street than in any other street in Australia, and the 2007 postcode (Ultimo) has by far the densest concentration,” says Murray Hurps, its general manager, pointing to early successes in goCatch, 99dresses, and DesignCrowd.

Released yesterday, an annual survey of the Australian start-up scene called Startup Muster showed growth of more than 55 per cent to more than 600 in the number of “validated” enterprises, many of which are generating hundreds of thousands of dollars a year in turnover. Sydney hosts almost half of them, Melbourne only 17 per cent.

At the same time, available seed funding has exploded from barely $100 million back in 2012 to about $1bn this year, thanks to a growing array of specialist venture capital funds based in Australia such as Airtree, Brandon Capital, Square Peg, Blackbird, and Blue Sky.

Despite dramatic growth, Australia could be more innovative. It is ranked 17th in the world ­according to Cornell University’s Global Innovation Index — slightly behind Canada and New Zealand. Switzerland, Britain and Sweden are on top.

“My advice to people would be take a chill pill and relax; Rome wasn’t built in a day,” says Daniel Petre, co-founder of Airtree, anticipating Monday’s policy announcement. “The first thing to understand is we aren’t going to be Israel or the US and it would be naive to think doing what they do will necessarily work here.”

Petre, who has more than 30 years’ experience in the technology industry including eight working closely with Bill Gates at Microsoft in the US, points to deep-seated cultural and structural impediments to greater levels of homegrown innovation.

“Many of our industries are either formally or informally oligopolies, where massive players make it hard for genuine competition and they engage in little genuine knowledge R&D,” Petre says. “Government should be open to co-investing — because then there’s a market test — but they should not be in the business of allocating funds to start-ups.”

Hurps says sourcing of skilled computer coders increasingly is becoming more of a problem. “You can’t create these skills overnight and it’s hard to get them into the country,” he says, hoping for changes to immigration that make their entry easier.

From South Australia’s failed Multifunction Polis in the early 1990s to the Rudd government’s Green Car Innovation fund, the Australian government has a poor track record at nurturing viable new industries, let alone hi-tech ones. The Abbott government had to shut down Labor’s expanded, and failed, Innovation Investment Fund.

“It’s predictable that start-ups will want something from government but you can’t ask a patient how to treat them,” says Hurps.

Tax changes that favour some classes of entrepreneurs over others are likelier to appear in Monday’s announcement than large direct investments in start-ups. But this will be, in essence, more of the same: the number of firms and their expenditure on qualifying R&D tax concessions (which cost about $2.5bn a year in forgone revenue) has soared in the past decade to 12,000, with seemingly little impact on Australia’s levels of productivity or innovation.

“R&D tax incentives have not shifted the productivity or investment dial in the past,” Productivity Commission chief Peter Harris said recently in Melbourne, calling for a “more hard-headed and less wishful” attitude to assessing “which incentives are most likely to motivate investment and translate into genuine improvement in national income”.

Indeed, it’s possible the concessions do not encourage genuine, knowledge-based R&D and instead are simply a way for large companies to have taxpayers subsidise the cost of their expenditures on physical infrastructure they would have made anyway.

Indeed, according to tax office data, of the $4.4bn in qualifying R&D expenditures made in 2013, businesses in the professional, scientific and technical services industry spent only $486m. The telco sector spent $170m. Fifteen banks spent $587m, miners $847m and supermarkets managed to spend $26m on R&D.

It’s unlikely the innovation statement will address the real inhibitors of innovation, such as the size of government and legislators’ growing ignorance of business, the morass of state and federal regulations that stifle competition.

“As modern economies developed, a welter of regulations by local, regional and central governments erected barriers to new products and facilities to produce them, quite possibly doing more harm than good,” Edmund Phelps writes in his 2013 analysis of flagging entrepreneurialism, Mass Flourishing.

The winner of the 2006 Nobel prize in economics, Phelps says creeping corporatism — implicit and explicit links between government and business — is the biggest enemy of innovation. Indeed, the modern labour markets encourage the best and brightest to enter inherently or largely parasitic industries that subtract from economic welfare — the law, the political class and expanding ­bureaucracy, and swathes of financial services, for instance.

State and federal government would have more success encouraging innovation by simply expediting the recommendations of the Harper review into competi­tion, which make corporatism more difficult.