New Zealand needs to lift its investment in research, development and business innovation and make operating conditions for businesses more favourable to become more competitive internationally, a new report says.

Prime Minister John Key and Science and Innovation Minister Steven Joyce launched the second Business Growth Agenda progress report, on building innovation, in Wellington on Tuesday.

The report, from the new Ministry of Business, Innovation and Employment, says while New Zealanders are "great at coming up with smart ideas", the country needs to get better at translating those ideas into commercially successful products.

New Zealand spends 1.3 per cent of GDP on research and development (R&D), while the OECD average is 2.4 per cent.

Business expenditure on R&D was 0.54 per cent of GDP in 2010, well below the OECD average of 1.62 per cent, while government funding was 0.59 per cent of GDP - compared to the OECD average of 0.73 per cent.

The government has budgeted $1.25 billion for research and innovation in 2012/13, rising to around $1.3b in 2014/15.

The report says New Zealand faces "significant challenges" in raising its business R&D output - including that half of all business R&D around the world occurs in three industries: motor vehicles, electrical equipment and pharmaceuticals - which New Zealand has a relatively low share of.

"Further, the bulk of business R&D effort internationally is undertaken by a relatively small number of very large firms, and few New Zealand businesses are at that scale," it says.

"New Zealand is also some distance from international markets and Kiwi businesses tend to over rely on bank debt and internal sources of capital which can restrict funding for R&D."

The report says the government can help by creating the right business conditions, along with setting competitive tax rates and prudent fiscal and monetary policy "to give firms the confidence to invest further in innovation".

It praised the government's commitment of $166 million over the next four years to establish a new Advanced Technology Institute (ATI), to help high-tech firms become more competitive and connected to innovation and business development experts.