Making a measure for all innovation

By Paul Jensen and Elizabeth Webster

The Age
9 May 2007, p. 14

Industry needs an authoritative index of innovation, write Paul Jensen and Elizabeth Webster.

Innovation is one of those concepts that everyone from economists to business strategists, and politicians to policymakers embraces with vigour.

Almost without reservation, people accept that being innovative is the most important pathway for individuals, firms and nations to secure prosperity. But what actually is innovation and how do we measure it?

A recent plethora of international innovation scoreboards has highlighted one important thing we still can't agree on how to measure innovation.

And until we do so, we can't establish a reasonable benchmark for comparison. This necessitates developing a methodology similar to the well-established methodologies associated with the measurement of price changes over time (the consumer price index).

One recent study developed by IBM and the Melbourne Institute of Applied Economic and Social Research attempts to tackle this issue head on.

Starting from the basic proposition that innovation refers to the introduction of new and improved products and processes, two obvious difficulties arise. First, we have to tackle the issue of what is new. Is it just the launch of new-to-the-world products such as Sonys PlayStation, or should it also account for imitative products such as the PlayStations rival, Microsofts Xbox?

From an economic perspective, new-to-the-firm innovations are just as important as new-to-the-world innovations since they typically offer consumers greater product choice and cheaper prices. In other words, innovation is an important as invention.

Another complication arises from a secondary characteristic of the definition of innovation: when do we acknowledge that something is an improvement over previous alternatives?

Assuming a product doesnt catch on, should we still count it as an innovation? And what process? Looking at research and development, innovation is actually akin to a dynamic process rather than a single point in time.

Of paramount importance here are process innovations (or product ingredients such as Coca-Colas formula) that companies may prefer to protect. If we dont know that these innovations actually occur, how can we possibly account for them?

IBM and the Melbourne Institute have developed a method for measuring innovation in a broad way without sacrificing objectivity. The result is an index of the rate of change of innovative activity in Australian industry that adopts a multi-indicator approach.

It includes objective data on all forms of intellectual property (patent, trademarks and designs), R&D expenditure and employment, and a survey-based evaluation of organisation and market innovation within Australian businesses. In addition, it includes a measure of labour productivity to capture those innovations we do not otherwise directly observe.

Since all the components of the index are included as intensity measures rather than absolute measures that is, we include patent applications per person employed, rather than simply the absolute number of patent applications observed in a year the IBM-Melbourne Institutes Innovation Index of Australian Industry captures the level of innovative activity over and above any growth in the economy over a 16-year period, from 1990 to 2005.

One of the headline observations from the index is that over the entire period of analysis, the rate of change of innovative activity in Australian industry has increased by an average of 1.6 per cent a year. Given the way this index is constructed, this result implies that this is growth over and above the observed GDP growth since 1990. However, the bad news is that in the last year of the study (2005), the rate of innovative activity fell by 2.6 per cent. After a period of growth, our innovative activity has fallen quite a distance.

Dr Paul Jensen and Dr Elizabeth Webster are with the Melbourne Institute of Applied Economic and Social Research