February 2005 Archives

Two new studies are out on America's crisis in science and technology: AeA's (American Electronics Association) Losing the Competitive Advantage?: The Challenge for Science and Technology in the United States and The Task Force on the Future of Innovation's The Knowledge Economy: Is America Losing Its Competitive Edge (the Task Force is a coalition of science, education, and technology industry leaders). These reports come on the heals of the last year's EIA report (Electronic Industries Alliance)Technology Industry at an Innovation Crossroads: A Policy Playbook Addressing the Future of the U.S. High-Tech Innovation Economy, and the Council on Competitiveness's National Innovation Initiative. All of these report point out the declining Federal support for R&D and problems with the K-12 educational systems.

I would like to say I am optimistic that these reports will serve as a call to action. But I'm not. While industry leaders issue report and report, Washington, with a few exceptions, is focused on other issues. And the huge budget deficit (which does not even count war or Social security privatization costs) leaves little room for the traditional response of expanding Federal support for S&T research or education.

For this reason, I continue to call for a new approach to the problem, as outlined in the Commission on the Future of the US Economy. Clearly, we can not stay on our present course and the alternatives we have tried in the past are either not available or insufficient. We need some new thinking -- and we need it fast.

One of the general concerns over the inclusion of intangibles in any accounting or statistical system is that they are hard to measure - unlike tangible assets which can be physically counted. Well, tangible assets often have a very intangible quality to them. Take for example, oil and gas reserves. Most of us would think that an oil companies proven reserves are pretty tangible. But, according to Daniel Yergin, Pulitzer-Prize winning author of Oil:

It is a crucial misunderstanding to think of oil and gas reserves as being similar to inventory or a company's cash balances. They are not a fixed quantity capable of physical inspection or exact enumeration. Reserve auditors cannot enter the underground warehouse, that is the pore space in a reservoir, and check off the barrels. They cannot correlate and add up reserves to a second decimal place, as they can with revenues and net income.

Yergin was speaking in reference to a new study by his firm, Cambridge Energy Research Associates, on the problems with the way we count petroleum reserves. The study, In Search of Reasonable Certainty: Oil and Gas Reserves Disclosures, argues that the accounting methods for reserves are hopelessly outmoded. According the press release:

The study describes reserves as an approximation -- estimates derived from a complex combination of direct evidence, expert interpretation, a variety of scientific methodologies and experience-based assumptions about the future, often stated in terms of probabilities. For the purposes of internal investment decision-making, companies may use probabilistic methods - alongside single-point deterministic estimates -- to categorize reserves as either proven (90% chance of ultimate recovery), proven plus probable (50% probability), or possible (10% chance of recovery).

However, the study notes, the 1978 System focuses on proved reserves as defined by a standard of "reasonable certainty" pegged to "direct contact" with an existing well. The report described this measure as suitable for reserves forecasts of individual producing wells, but unsuited to an increasing proportion of the modern oil and gas industry, particularly to larger offshore projects.

Sounds to me like the standard problem of an accounting system that can't deal with intangibles - in this case the intangibles of expert interpretation.

Now, on the other hand, where are the checks and balances that insure that these "expert interpretations" have anything to do with reality? We continue to get reports of companies modifying their stated reserves. As one critic, retired French engineer Jean Laherrere puts it:

What is needed for reserve definitions is good practice and good rules, to which every country in the world agrees. The problem is that oil and gas companies are not asking for precise rules as they prefer poorly defined rules, which allow them more freedom for reporting, and they want to keep confidential their field estimates. The push must come from the governments or from the banks.

When creating a reporting system that includes intangibles, it is important to balance the need for understanding these new measures with the check to ensure that they are real and not subject to manipulation. As is the case in many areas of understanding intangibles, transparency and disclosure rather than a bottom line number, may be the best solution.

Contrasting articles on the future of the dollar and America's economic fate hit my desk this week. In the Winter 2005 issue of the Wilson Quarterly carried Robert Aliber's, "The Dollar's Day of Reckoning" while the March/April 2005 Foreign Affairs had "The Overstretch Myth" by David Levey and Stuart Brown.

In keeping with his title, Ailber see the current account deficit as unsustainable and eventually leading to a $400 billion correction via the currency market. He argues that a sustainable trade deficit would be no more than $200 billion annually, down from the current level of $600 billion.

The United States today is in a position similar to that of Mexico in 1980, Norway in 1987, and Thailand and Mexico in the early 1990's. These countries paid the interest on their international indebtedness with some of the funds received from the in-flow of new foreign investments. The United States is now doing the same thing. It is engaging in Ponzi finance, and the game will soon be up.

By the end of 2004, America's net international indebtedness had increased by some $500 billion for the year, reaching $3 trillion. Its international indebtedness has been increasing at an annual rate of 16 percent, while its GDP has been growing at a six percent rate. In the long run, international indebtedness simply cannot increase more rapidly than GDP. If it did, foreigners would, in theory, eventually end up owning all the assets and securities in the United States. As a practical matter, policy adjustments or the market will ensure that this does not happen.

He sees little likelihood that this adjustment process will be of "soft landing" variety, which would require a steady, rather than a precipitous, decline in foreign demand for US dollar securities of about $100 billion a year for the next few years.

On the other side, Levey and Brown see an American economy that is continuing to lead:

Despite the persistence and pervasiveness of this doomsday prophecy, U.S. hegemony is in reality solidly grounded: it rests on an economy that is continually extending its lead in the innovation and application of new technology, ensuring its continued appeal for foreign central banks and private investors. The dollar's role as the global monetary standard is not threatened, and the risk to U.S. financial stability posed by large foreign liabilities has been exaggerated. To be sure, the economy will at some point have to adjust to a decline in the dollar and a rise in interest rates. But these trends will at worst slow the growth of U.S. consumers' standard of living, not undermine the United States' role as global pacesetter. If anything, the world's appetite for U.S. assets bolsters U.S. predominance rather than undermines it.

They dismiss any comparison with recent debt crisis in other countries:

There are key differences, however, between those emerging-market cases and the current condition of the global hegemony. The United States' external liabilities are denominated in its own currency, which remains the global monetary standard, and its economy remains on the frontier of global technological innovation, attracting foreign capital as well as immigrant labor with its rapid growth and the high returns it generates for investors.

Interestingly, both sides see similar consequences of a hard landing.

Aliber:

The decline in the trade deficit must be matched by a comparable increase in annual savings (and therefore slower growth in American's consumption) and in U.S. production of trade-able goods. While the longer-term results will be positive, the process of achieving them may be extremely painful, including rising rates of inflation, interest, and unemployment, and possibly a severe economic recession.

Levey and Brown:

But even if such a sharp break occurs--which is less likely than a gradual adjustment of exchange rates and interest rates--market-based adjustments will mitigate the consequences. Responding to a relative price decline in U.S. assets and likely Federal Reserve action to raise interest rates, U.S. investors (arguably accompanied by bargain-hunting foreign investors) would repatriate some of their $4 trillion in foreign holdings in order to buy (now undervalued) assets, tempering the price decline for domestic stocks and bonds. A significant repatriation of funds would thus slow the pace of the dollar decline and the rise in rates. The ensuing recession, combined with the cheaper dollar, would eventually combine to improve the trade balance. Although the period of global rebalancing would be painful for U.S. consumers and workers, it would be even harder on the European and Japanese economies, with their propensity for deflation and stagnation. Such a transitory adjustment would be unpleasant, but it would not undermine the economic foundations of U.S. hegemony.

So what has this got to do with intangibles? Well, in today's financial system, money is the ultimate intangible. No longer backed by precious metals, money is just as valuable as we collectively believe it to be. And that collective belief in the value of the dollar changes (such as this week's turmoil in the currency markets due to the rumor that South Korea's central bank was reducing its reverses of dollars and buying other currencies).

More to the point, the key difference between the two sides hinges on American's intangible asset of what might be called "investment desirability." Levey and Brown see no reason why foreign investors won't continue to see the U.S. as the best place to invest; Aliber sees no reason to believe that foreign investors will continue to view us as a special case immune from the laws of economics.

Levey and Brown not only make the case that the U.S. will remain a desirable location for investment, they point out the lack of alternatives. The euro-zone, they argue, is in no economic position to challenge the U.S. In their view, the only thing that can end the U.S. position is the Pogo-scenario (we have met the enemy and they are us):

Only one development could upset this optimistic prognosis: an end to the technological dynamism, openness to trade, and flexibility that have powered the U.S. economy. The biggest threat to U.S. hegemony, accordingly, stems not from the sentiments of foreign investors, but from protectionism and isolationism at home.

I agree that the Pogo-scenario is the most likely cause of an unraveling of the U.S.'s global financial position. The danger is that we undermine our advantages to such an extent that foreigners no longer see the U.S. as a special place to invest - but simply one of many. But I disagree that the triggers will be protectionism and isolationism. Rather, it will be complacency and indifference.

Unfortunately, the signs of complacency and indifference are all around us: the increased difficult of foreigners (scientists, businessmen and yes, investors) to get into the U.S. because of increased concerns over homeland security; the rising budget deficit that the Administration and Congress are unable and unwilling to confront; the picking away at our National Innovation System (as recently documented by the Council on Competitiveness report) while we focus attention of side issues such as tort reform; our blase indifference to the continued trade deficit (including Levey and Brown's repetition of the argument that the trade deficit is a sign of strength not weakness); and, a foreign policy that continues to treat the Made in America brand as something that will last forever.

Yes, the danger is that we will shoot ourselves in the foot. But it will be by doing nothing in the face of serious challenges. Thus, in the end I come down on Professor Aliber's side. We face some serious challenges, as the recent GAO report points out. Yet, we seem stuck in ostrich mode. The Levey and Brown argument just strikes me as too much a "what me worry" approach similar to what we have heard in the past. Some times, a little worry is good. In warning us off from "would-be Cassandras," Messrs. Levey and Brown should remember that Cassandra's curse was to always be right (but never be believed).

One side note: the Levey and Brown article also refers to the recent work on investment in intangibles argue that "the size and growth rate of the U.S. economy have been seriously underestimated." It is true that not including intangibles in the national system of accounts has the effect of misrepresenting the size of the economy. (See my January 18 entry on "Underestimating Savings".) However, I would be very leery of then making the jump, as they do, that this proves that we do not have a national savings problem. The BEA work that I referred to does show an underestimation of savings. But the trend is still downward. And it is that trend, not necessarily the raw number that we need to worry about.

Last night, the AP released its poll of consumer's preference for American goods in nine countries. The results contain some mixed news. Most Europeans prefer not to buy US goods, if the price and quality were similar. In most cases, their preferences for US goods has declined slightly since the last survey was taken in December of 2001 (after 9-11 and before the Iraqi war) - except for the case of the French who disliked our goods as much now as they did before. On the other hand, the Mexicans prefer American goods and the South Koreans appear to be ambivalent. And in Britian, France, and Italy, younger consumers are more likely to prefer US goods than older consumers. Not suprisingly, 93% of Americans would rather buy American products if the price and quality were the same.

Steven Pearlstein's column in today's Washington Post is an absolute gem. He describes how concern over lawsuits on who owns a business/ad idea is stifling innovation. And these are not even patented business process ideas! Another case of IPR gone wild.

For more, see Pearlstein's Live Online extended discussion on the topic.

Earlier this month, the Government Accountability Office (GAO - formerly known as the General Accounting Office) released its report 21st Century Challenges: Reexamining the Base of the Federal Government. The report is worth a careful read by anyone interested in the future of the US.

Testifying before the Senate Homeland Security and Governmental Affairs Committee last week, David Walker, Comptroller General of the United States, stressed the report's findings that

our nation is on an unsustainable fiscal path. Longterm budget simulations by GAO, the Congressional Budget Office (CBO), and others show that, over the long term we face a large and growing structural deficit due primarily to known demographic trends and rising health care costs. Continuing on this unsustainable fiscal path will gradually erode, if not suddenly damage, our economy, our standard of living, and ultimately our national security.

That is a sobering enough statement. But both the report and Mr. Walker's testimony delved much deeper into the forces shaping our fiscal future and the challenges ahead. As Mr. Walker stated,

Our recent entry into a new century has helped to remind us of how much has changed in the past several decades-whether it be rapid shifts in the aging of our population, the globalization of economic transactions, the significant advances in technology, and changing security threats. If government is to effectively address these trends, it cannot accept its existing programs, policies and activities as "givens." Outmoded commitments and operations can constitute an encumbrance on the present and future that can erode the capacity of the nation to better align its government with the needs and demands of a changing world and society.

Large and Growing Long-term Fiscal Imbalance-The U.S. government's long-term financial condition and fiscal outlook present enormous challenges to the nation's ability to respond to forces that shape American society, the United States' place in the world, and the role of the federal government. The short-term deficits are but a prelude to a projected worsening long-term fiscal outlook driven largely by known demographic trends and rising health care costs.
Evolving National and Homeland Security Policies-The dissolution of the Soviet Union in 1991 and the emergence of the more diffuse threats posed by terrorism to the nation's national and homeland security have led to major shifts in strategic threats. While these new security concerns are already prompting changes in defense postures and international relationships, preparedness and responses to these new threats also carry wide ranging and unprecedented implications for domestic policies, programs, and infrastructures.
Increasing Global Interdependence-The rapid increase in the movement of economic and financial goods, people, and information has prompted more widespread realization that the nation is no longer self-contained, either in its problems or their solutions. The growing interdependence of nations, while carrying clear economic and social benefits, also places new challenges on the national agenda and tasks policymakers to recognize the need to work in partnerships across boundaries to achieve vital national goals.
The Changing Economy-The shift to a knowledge-based economy and the adoption of new technology has created the potential for higher productivity but posed new challenges associated with sustaining the investment in human capital and research and development that is so vital to continued growth. While the sustainability of U.S. economic growth has been aided by trade liberalization and increased market competition in key sectors, the sustainability of growth over the longer term will require a reversal of the declining national savings rate that is so vital to fueling capital investment and productivity growth.
Demographic Shifts-An aging and more diverse population will prompt higher spending on federal retirement and health programs. Unless there is strength in the underlying sources of productivity-education, technology and research and development-low labor force growth will lead to slower economic growth and federal revenue growth over the longer term. As labor becomes ever more scarce, a greater share of the work force will be comprised of foreign-born workers, women, and minorities with broad-scale implications for education, training, child care, and immigration policies.
Science and Technology Advances-Rapid changes in science and technology present great opportunities to improve the quality of life and the economy, whether it be finding new sources of energy, curing diseases, or enhancing the nation's information and communications capacities. However, technologies raise their own unique vulnerabilities, risks, and privacy and equity concerns that must be addressed by policymakers.
Quality of Life Trends-Large segments of the population enjoy greater economic prosperity than ever before, and the well being of many Americans has improved dramatically thanks to breakthroughs in health care and improvements in environmental protection. However, these improvements have not been evenly distributed across the nation, as more than 40 million Americans lacking health insurance demonstrate. Prosperity has prompted its own stresses, as population growth and sprawl create demand for new transportation and communication infrastructure.
Diverse Governance Structures and Tools-To deliver on the public's needs and wants, the nation's system will be pressed to adapt its existing policy-making processes and management systems. The governance structures and management processes that emerge will be shaped by the above forces (e.g., increasing interdependency, scientific and technological changes, and security threats), and will depend on having sufficient foresight, a continuous reexamination and updating of priorities, ongoing oversight, and reliable and results-oriented national performance indicators.

These forces are similar to the challenges that we have outline before and that form the core charter for the proposed Commission on the Future of the US Economy (see the Athena Alliance website). If anything, the GAO report down plays the economic ordeal that may confront us as we grapple with the shift to an Intangibles Economy.

Reading through the GAO report only heightens our conclusion that we need the Commission to craft a set of bipartisan solutions - now more than ever.

In this era of sharp political divisions, it is heartening to see the occasional outburst of bipartisanship. One of those rare events occurred today with the launch of the Congressional Saving and Ownership Caucus. On the Senate side, the Caucus is co-chaired by Senators Rick Santorum (R-PA) and Kent Conrad (D-ND). The House Caucus is headed by Representatives Jim Cooper (D-TN), Phil English (R-PA), Harold Ford, Jr. (D-TN) and Thomas E. Petri (R-WI).

The caucus is an offshoot of the work of the New America Foundation's Asset Building Program. Earlier this month, New America released their outline of programs for an Ownership Society. These recommendations mostly focused on building financial assets (hence the tie-in with a Congressional Caucus focused on savings) and include their signature recommendation of creating children's savings accounts at birth (similar to the British Child Trust Fund).

Beyond strictly financial assets, the recommendations also include programs for homeownership and saving for educational purposes. In addition to education programs (which clearly fall under the category of investments in intangible assets), there are a few other ideas for what we would consider intangible assets. These include recommendations for strengthening financial literacy, increased R&D in the financial sector to meet the needs of the "unbanked," and supporting microenterprise development.

The New America issue brief also includes ideas on protecting assets, such as curbing predatory lending, and for strengthening the Community Reinvestment Act (CRA) to improve low-income lending. I wish it had taken the next step and included programs to protect credit ratings - a key intangible asset of both individuals and businesses. Issues concerning identify thief as well as the role of credit rating agencies (as discussed in an earlier posting) would be fruitful areas for further work. It would also be of interest to look at how the CRA could be used to promote the development of intangible assets for low-income individuals and in low-income communities.

The other area that I think needs further elaboration is in the educational programs. These programs, including the educational savings accounts (Section 529 savings plans), are geared to formal education, especially college. In an intangible economy, we need to boost continuous learning, not just static earning of a degree. We need to find a way to craft the rules for these educational programs to allow them to be used for broad learning activities, without opening the programs up to the huge array of potential abuses. Clearly this is an area that will require a lot more work.

In the meantime, the creation of the Savings Caucus is to be applauded. At today's press conference, Caucus chairs delicately side-stepped the hot button "savings" issue of Social Security. It remains to be seen whether the Caucus, launched with high hopes today, can avoid floundering on the hard political rocks of Social Security. Let us hope so.

Coincidently, I got an advertisement for a new journal after I wrote yesterday's posting on the value of the "US" brand. The journal is Place Branding and has a strong international focus. We have long believe that how others perceive a location (its "brand") is an important intangible assets (see my paper on Building on Local Information Assets and the paper by MaryAnn Feldman on Constructing Jurisdictional Advantage on our website. It is interesting to note that this concept has now reached critical mass to entice a commercial publisher into the field.

As has been discussed before in these postings, one of this nation's most important intangible assets is the "US" brand. But, that brand is under continuing downward pressure. According to a story in today's New York Times, "U.S. Companies Rethinking Their Marketing in Europe":

For years, American corporations and the European companies that do business with them have faced anti-American sentiments from Europeans. But with the war continuing in Iraq and discomfort growing over United States dominance, the companies have been forced to further adjust how they do business in Europe.

32 percent of Europeans polled in January said they were less likely to purchase products made by companies in the United States because of disagreements with American culture. The Coca-Cola brand, for example, was "trusted" by 69 percent of respondents in the United States but by only 45 percent in Europe and 46 percent in Canada. Procter & Gamble products, which include Vicks, Folgers, Charmin, Clairol and Pampers brands, were trusted by 74 percent of Americans but only 44 percent of Europeans.

I'm not particularly alarmed by this latest "trust" survey. Anti-Americanism in Europe waxes and wanes with the political and cultural winds, taking the value of the "US" brand with it. And, as I used to tell my international business students, a good international marketing strategy balances between localizing your product and building a global cachet (like Levi's or Coke).

However, we can not be blind or sanguine about the effects of our international actions on our international commerce (and brand valuation). Right now, the hottest selling book in Turkey portrays a US invasion of that country. According to the Christian Science Monitor, even the authors of the book see it as more than a novel:

The book is clearly sold as fiction, but its premise has entered Turkey's public discourse in a way that sometimes seems to blur the line between fantasy and reality.
. . .
[Co-author Burak] Turna does not see the book as fiction. "From our point of view, it's a philosophical and scientific calculation," he says. "It's more than a novel."

Last summer, I wrote a piece for Rural Matters on "Building on Local Information Assets" (available at the Athena Alliance website). In that article I argued that rural areas have important local intangible assets upon which they can build economic development. Tourism is obviously one. But even I was taken aback when I heard a news item on the radio that wildlife-watching was an $85 billion industry (according to National Wildlife magazine).

And apparently growing. According to the 2001 National Survey of Fishing, Hunting, & Wildlife-Associated Recreation by the U.S. Fish & Wildlife Service, wildlife watching was a $40 billion industry. Adding in hunting and fishing brings the total to $110 billion annually.

That is a lot of spending on an intangible. It is about as big as the $110 billion in 2004 expenditures for computer hardware industry, about a third the size of the $326 billion in personal consumption in 2004 of clothing and about a quarter the size of the $450 billion in personal consumption in 2004 of autos and auto parts. [From BEA release of January 28, 2005 "Gross Domestic Product: Fourth Quarter 2004 (Advance)"]

As Jason Henderson of the Kansas City Fed wrote last April in The Main Street Economist:

Nature has always been a strong foundation for rural America . Now, wildlife recreation appears to be the newest opportunity. The industry may not be the answer for every rural community, but those with entertainment and wildlife may be able to leverage Mother Nature to spark new growth.

(thanks to John Chester, the afternoon host at WGMS - Classical 103.5 for passing on this news item)

The December trade figures came out this morning and show that our balance of trade in intangibles holding steady at slightly over $6.5 billion monthly. Both export and import have steadily increased. For the year, our intangibles balance is $76.4 billion up slightly from $76.2 billion in 2003 and $73.9 billion in 2002.

(As discussed last month, we are defining trade in intangibles as the sum of "royalties and license fees" and "other private services" - see the official BEA/Census definitions of these two categories below).

The overall trade deficit improved somewhat in December with a total trade deficit of $56.4 billion compared to the November deficit of $59.3 billion. But, the 2004 deficit was a record $617.7 billion, up significantly from the 2003 deficit of $496.5 billion.

I repeat what I said last month: intangibles are not, and can not, offset our huge and growing deficit in goods. While we are an intangible economy, trade in pure intangible will not save us. The power of intangibles is how they operate within all sectors of the economy, not as a separate sector. We need to harness our intangibles to re-invigorate our goods trade if we are to get our dangerous trade deficit under control.

BEA/Census Bureau definitions:

Royalties and License Fees - Transactions with foreign residents involving intangible assets and proprietary rights, such as the use of patents, techniques, processes, formulas, designs, know-how, trademarks, copyrights, franchises, and manufacturing rights. The term "royalties" generally refers to payments for the utilization of copyrights or trademarks, and the term "license fees" generally refers to payments for the use of patents or industrial processes.

Other Private Services - Transactions with affiliated foreigners, for which no identification by type is available, and of transactions with unaffiliated foreigners. (The term "affiliated" refers to a direct investment relationship, which exists when a U.S. person has ownership or control, directly or indirectly, of 10 percent or more of a foreign business enterprise's voting securities or the equivalent, or when a foreign person has a similar interest in a U.S. enterprise.) Transactions with unaffiliated foreigners consist of education services; financial services (includes commissions and other transactions fees associated with the purchase and sale of securities and noninterest income of banks, and excludes investment income); insurance services; telecommunications services (includes transmission services and value-added services); and business, professional, and technical services. Included in the last group are advertising services; computer and data processing services; database and other information services; research, development, and testing services; management, consulting, and public relations services; legal services; construction, engineering, architectural, and mining services; industrial engineering services; installation, maintenance, and repair of equipment; and other services, including medical services and film and tape rentals.

One of the last unregulated parts of the financial markets is the operation of credit rating agencies. Yesterday, the heads of the major companies got a grilling from the Senate Banking Committee. The problems were summed up in a Washington Post investigative series last fall (Gatekeepers: Power of Credit Raters):

Dozens of current and former rating officials, financial advisers and Wall Street traders and investors interviewed by The Washington Post say the rating system has proved vulnerable to subjective judgment, manipulation and pressure from borrowers. They say the big three are so dominant they can keep their rating processes secret, force clients to pay higher fees and fend off complaints about their mistakes.

A third of corporate practitioners believe the ratings on their organization's debt are inaccurate. Only 42 percent of corporate practitioners from organizations with rated debt believe that changes in their organization’s financials are reflected in their ratings in a timely manner.

Three out of five organizations believe the ratings that they use for investment decisions are accurate. Only 38 percent of the same organizations believe the ratings that they use for investment decisions are timely.

While the rating agencies maintain that their methodologies are publicly available, critics complain that process is non-transparent. Each credit report does contain a rationale section describing the key factors in the rating decision. And there some information available on the rating agencies' websites. But it appears to be general in nature. As S&P's 2001 report Rating Methodology: Evaluating the Issuer states:

Bear in mind that ratings represent an art as much as a science. A rating is, in the end, an opinion. Indeed, it is critical to understand that the rating process is not limited to the examination of various financial measures. Proper assessment of debt protection levels requires a broader framework, involving a thorough review of business fundamentals, including judgments about the company's competitive position and evaluation of management and its strategies. Clearly, such judgments are highly subjective; indeed, subjectivity is at the heart of every rating.

There have been a number of studies as to how stock analysts make their decisions and the role of intangible assets. However, there seem to be few studies as to what the debt analysts look at. Sounds like a fruitful area for future research.

The Bush Administration released its FY 2006 budget yesterday. Budgets are all about priorities as reflected in resource allocations. As such, this budget will be parsed, dissected and analyzed in a hundred different ways over the next few days, weeks and months. Part of the priority mix is the trade off between immediate consumption and longer term investment. One of the ways we should look at the budget, therefore, is how it allocates funds for long-term investments, especially the development of intangible assets. The US government does not split out such investments in a separate capital budget and a full detailed analysis of Federal investments in intangibles is beyond my scope at this point. But there is an existing background analysis on investments already prepared by the Office of Management and Budget (OMB) which offers some tantalizing glimpses. Section 6 ("Federal Investments") of OMB's Analytical Perspectives, Budget of the United States Government, Fiscal Year 2006 discusses physical capital investments, the conduct of R&D and the conduct of education and training.

According to this analysis, Federal investment in the conduct of research and development will increase slightly from $122.4 billion to $124.9 billion. Defense R&D makes up the majority, increasing from $71.4 billion to $73.5 billion; non-defense R&D goes from $51.1 billion to $51.4 billion

Note: By another measure in Section 5 of the Analytical Perspective, scientific investment will decline. The Federal Science and Technology budget (which does not count funding for defense development, testing, and evaluation) is down by roughly 1% from $61.7 billion to $60.8 billion.

Investment in the conduct of education and training declines dramatically from $92.9 billion in FY 2005 to $86.7 billion in FY 2006. According to Administration officials (as quoted in the Wall Street Journal) this decline is actually a savings due to program consolidation, not a cut in actual services delivered. Needless to say, critics disagree.

The budget analysis also includes a summary of spending on government statistics (section 4 of the Analytical Perspectives). The FY 2006 budget shows small increases for most of the statistical agencies. No agency was cut.

So, by this very rough cut, the Federal investment in intangible assets is $211.6 billion (down from $215.3 billion in FY 2005). And add in roughly $2.3 billion for statistics.

These numbers, however, are only imperfect measures of Federal investments. They do not include other spending on intangible assets, such as arts & humanities funding, other government information creation activities such as the weather service and the Library of Congress, the government standard setting activities, training of government personnel (including non-combat related military training), organizational capacity building & technical assistance programs, export promotion activities and funding, agricultural brand promotion (marketing boards), and government sponsored awards, such as the Baldrige Quality Award. While they do include the subsidy value of direct loans and loan guarantees for education, they don't include tax expenditures, such as the R&D tax credit (valued at $4.2 billion in FY 2006) and the tuition tax credit ($5.3 billion in FY 2006).

By contrast, OMB calculates major public investment in physical capital at $183.5 billion.

In addition, the Corporation for Enterprise Development has estimated that other assets building programs (homeownership, retirement savings, savings and investment, and small business development) make up another $335 billion (in FY 2003) of Federal funds. (See their 2004 report Hidden in Plain Sight.) All most all of this comes in the form of tax expenditures and never shows up in the budget.

Given the amount of these funds, maybe it is time to take a closer look at our investment budget. I understand that there are budget process issues with creating a separate capital budget. The most salient concern is over the political games that can be played: every program will be categorized as an investment in order to take it off-budget and to protect it politically. However, that concern should not prevent us from doing a better job of analysis. We can create a standard set of expenditure categories that we all can agree are investments in intangibles. Using that set we can get a better handle on what we are investing in and where that investment is going.

Anyone out there interested in taking this on?

A California kindergarten teacher is now $15.6 million richer due to a previously unknown intangible asset: his photo. As a story in the LA Times relates, it turns out that this gentleman was a former model and actor who

happened to come face to face with himself on a label for Nestle's Taster's Choice.

"What am I doing on this jar?" he thought as he looked at the picture of a clearly satisfied coffee drinker peering into his cup.

Then he remembered: In 1986, he had posed for a photographer on assignment for Nestle. He was paid a modest amount for his time and assumed that nothing ever came of the two-hour shoot.

Before you start yelling about frivolous lawsuits, think about this. Apparently, Nestle first tried to claim that he had been paid in full for the photo shoot and then tried to claim it wasn't even him. My guess is that their stonewalling significantly upped the price tag.

Moral of the story: your intangible assets may be worth only what a court says they are worth.

Reinventing High School was topic of an editorial yesterday in the New York Times. The piece praised various efforts to change the current system of secondary education. As they pointed out:

The American high school is a big part of the problem. Developed a century ago, the standard factory-style high school was conceived as a combination holding area and sorting device that would send roughly one-fifth of its students on to college while moving the rest directly into low-skill jobs. It has no tools to rescue the students who arrive unable to read at grade level but are in need of the academic grounding that will qualify them for 21st-century employment.

No matter how hard localities try, the best-designed high schools in the world will still fail unless the states and the federal government finally bite the bullet on teacher training. That means doing what it takes to remake the teacher corps, even if it means withholding federal dollars from diploma mills pretending to be colleges of education, forcing out unqualified teachers and changing the age-old practice of funneling the least-prepared teachers into the weakest schools.

We need a re-design of the entire system stressing both the new skills needed for the intangible economy and the importance of continuous learning. Well-designed high schools can do this. There are some great examples in the report from the Partnership for 21st Century Skills, "Learning for the 21st Century". The report makes a strong case for re-design of the educational enterprise:

Today's education system faces irrelevancy unless we bridge the gap between how student live and how they learn.

Key is understanding how people learn. The Partnership is not the only group undertaking such efforts. For example, the Federation of American Scientists is spearheading a Learning Federation to undertake fundamental research on learning science and technology. The Digital Opportunity Investment Trust (DO-IT) is seeking legislation to channel funds from auctions of unused, publicly-owned telecommunications spectrum into an educational trust fund that will help transform education, training and lifelong learning.

Many of these efforts seek greater use of information technology in the education process. I have some concerns about the potential over-reliance on technology as a fix to our educational problems. But more importantly, these projects are actively seeking a new model of education. To my mind, finding that model is key. We aren't there yet. We still see education as something that most people do in childhood (roughtly from ages 5 to 18) and some do for a few more years in college.

We need to expand the view to one where education in childhood creates the foundation for learning that continues throughout a person's life. Yes, we all agree at the level of rhetoric on this new view. But deep down, the practical understanding of what this means and the mechanisms for doing this are lacking. For example, we still measure the health of the educational system on how many people "finish" a certain degree program (8th grade, high school, college) - thereby reinforcing the notion that education is something to go through and be done with.

The educational process is still back in days of measuring fixed output, similar to when manufacturing measured quality at the output stage (how many errors) rather in the current processes of kaizen (continuous improvement - which, I am told, comes from the combination of the Japanese words Kai - school and Zen - wisdom). When we can develop a metric for how many people learned a new skill last year (or some such measure of kaizen - "school wisdom"), and measure our education system on these factors, then I will believe we have truly made the transition to a learning system for the intangible economy.

The New York Times has a story this morning on the teaching of evolution that I find very disturbing. According to this report, biology teachers are routinely skipping over evolution for fear of "getting in trouble."

Teaching guides and textbooks may meet the approval of biologists, but superintendents or principals discourage teachers from discussing it. Or teachers themselves avoid the topic, fearing protests from fundamentalists in their communities.

Even where evolution is taught, teachers may be hesitant to give it full weight. Ron Bier, a biology teacher at Oberlin High School in Oberlin, Ohio, said that evolution underlies many of the central ideas of biology and that it is crucial for students to understand it. But he avoids controversy, he said, by teaching it not as "a unit," but by introducing the concept here and there throughout the year. "I put out my little bits and pieces wherever I can," he said.

These findings set the United States apart from all other industrialized nations, said Dr. Jon Miller, director of the Center for Biomedical Communications at Northwestern University, who has studied public attitudes toward science. Americans, he said, have been evenly divided for years on the question of evolution, with about 45 percent accepting it, 45 percent rejecting it and the rest undecided.
In other industrialized countries, Dr. Miller said, 80 percent or more typically accept evolution, most of the others say they are not sure and very few people reject the idea outright.
"In Japan, something like 96 percent accept evolution," he said. Even in socially conservative, predominantly Catholic countries like Poland, perhaps 75 percent of people surveyed accept evolution, he said.

But several experts say scientists are feeling increasing pressure to make their case, in part, Dr. Miller said, because scriptural literalists are moving beyond evolution to challenge the teaching of geology and physics on issues like the age of the earth and the origin of the universe.
"They have now decided the Big Bang has to be wrong," he said. "There are now a lot of people who are insisting that that be called only a theory without evidence and so on, and now the physicists are getting mad about this."

two popes, Pius XII in 1950 and John Paul II in 1996, have endorsed the idea that evolution and religion can coexist. "I have yet to meet a Catholic school teacher who skips evolution," Dr. Scott [Dr. Eugenie Scott, executive director of the National Center for Science Education] said.