Australia needs to diversify its economy, not just its trading partners

Australia is clearly feeling the pain of geopolitical tensions. It will likely feel more.

Canberra's main solution to this challenge is redoubling efforts to diversify Australia's export markets overseas.

But if Canberra wants long term economic resilience, it would embrace the domestic reforms necessary to diversify its economy too.

The urge to merely diversify trading partners is an understandable one considering China, as Australia's largest trading partner, accounts for a third of all Australian exports.

China was the top market for 14 of Australia's top 30 goods exports in 2019 - far more than any other country. China also plays a large role in Australia's imports too.

A British research institute recently determined that among the Five Eyes nations comprised of Australia, United States, United Kingdom, Canada, and New Zealand, it is Australia that is the most dependent on the import of Chinese goods - particularly "strategic" goods ranging from medical equipment and pharmaceutical goods to processed aluminium and steel.

But in light of unprecedented tensions with its largest trading partner and potentially the worst economic climate in nearly a century, Canberra more recently has sought to diversify its trading partners with a heavy focus on bolstering ties with other Indo-Pacific countries like India and Singapore.

Yet in the same way that Australia should avoid relying too heavily on one trading partner, Australia should also not rely too heavily on one trading practice.

With mining and energy exports accounting for 58 per cent of Australia's exports in 2018-2019, Australia is arguably more over-exposed by its reliance on exporting natural resources than it is on a single trading partner.

More worrying than Australia's over-reliance on natural resource exports is the fact that such an over-reliance has gone unchanged from a decade earlier, when it accounted for 56.3 per cent of Australian exports.

This not only defies global trends, but it defies where the global economy is headed. In the future global economy, trade in services that will become paramount, knowledge-intensive and automated processes will dominate value creation, and businesses will require flexibility and resilience.

The future global economy will require innovation - the sort that Australia has not embraced.

Suggesting "we need to innovate" has itself become a cottage industry in Australia, allowing countless reports to be published with big headlines but ultimately little impact.

Today, Australia's spending of 1.78 per cent of its GDP on R&D ranks it 21st in the OECD.

And while the innovative nations - like Israel, Germany, South Korea, and the United States - spend more on R&D than Australia and have increased their spending on it in recent years, Australia has seen total R&D spending as a percentage of GDP decrease in every year of the last decade.

Perhaps even more worryingly, in global rankings of economic complexity - a measure generally correlated with future economic growth - Australia has fallen behind countries like Uzbekistan, Guatemala and Botswana to place 87th.

In total, this indicates a lack of economic resilience that is integral to successfully navigate a global recession and a more contentious geopolitical environment in the near term - let alone achieving competitiveness in the global economy in the long term.

And unfortunately, the time until the realisation of this long term scenario has been accelerated by the global pandemic.

At the same time that Canberra considers further cuts and condones uncertainty surrounding the R&D Tax Incentive (RDTI), Germany has established a direct RDTI and, in April 2020, announced that the the incentive would be expanded in response to the COVID-19 pandemic and ensuing economic downturn.

Meanwhile, simply mentioning "the R&D Tax Incentive", "patent box", or "visa regulations" can lead to exasperated looks in Canberra. While some are inclined to give up on these long-debated issues, it is critical to resolve them as quickly as possible.

As long-running and convoluted as the debate on RDTI may seem, the primary challenge needing to be addressed is quite simple: the program needs both commitment and stability.

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The Australian government must commit to a set number of years in which it will not only maintain the RDTI but also not alter it. It's a similar story with patent boxes.

The continued absence of a patent box remains an unnecessary headwind for Australian innovation.

Home-grown champion CSL have made clear it would have reconsidered its 2014 decision to build a A$500 million plant with 500 innovative jobs in Switzerland had an Australian patent box been available.

And with visa regulations, Australia can actually benefit from the Trump administration's severe crackdown on immigration of all kinds - which has already been a boon to Canada's skilled migration regime.

There are simply too many jobs in innovative firms and not enough qualified candidates to fill them.

Innovative firms in Australia have made clear to Canberra they will not stay in an environment where skills-based visas are limited, cumbersome and inefficient.

Beyond tired debates on specific issues related to innovation that need fresh looks, just as pressing is the need for Canberra to understand at a fundamental level what Australia needs to be more innovative.

Australia has world-renowned research but it is famously ranked near the bottom of the developed world in the commercialisation of that research.

Anchor firms and venture capital are integral to supercharging commercialisation.

It is politically inconvenient but nonetheless true that Australia should endeavour to both court as well as maintain support for multinational anchor firms and foreign venture capital firms, particularly from the United States and Europe.

In addition to helping Australia commercialise its innovations - particularly those of small and medium enterprises - they would also integrate Australia into innovative networks in the United States and Europe and introduce new skillsets.

State and territorial governments in Australia often complain their hands are tied regarding these challenges.

But state and territorial governments can become more adept at using creative incentives for attracting significant investors in innovation into Australia.

Stamp duty fees, for example, could be waived in an agreement that would assure long-term investment and presence in Australia.

Nearly three decades of a recession-free economy hid a less than promising economic picture in Australia.

Australia can either rely on past success while falling further behind in global competitiveness or make the necessary policy changes to make it more resilient.