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The Australian Government has signalled what it sees as the need for all sectors of the economy to be more innovative. Reviews have been commissioned that indicate how this agenda might be accomplished, including the development of greater links between higher education and industry. In this article, Australia's research expenditure by sector is compared with nine other advanced economies. The funding arrangements and performance of the higher education sector are then considered in some detail. A number of policy changes are recommended for higher education, including a need for greater funding of information technology, engineering and technology and full funding of project research. [ABSTRACT FROM AUTHOR]