November 2006 Archives

his morning, the BEA released the preliminary estimates of 3rd quarter Gross Domestic Product. Last month's advanced estimate was a paltry 1.6%, a number low enough to make many economists worry about a slowdown. But today, we find that the real number is 2.2%. A big difference. The revision was due to fewer imports than expected and a greater accumulation of inventories (neither of which good news in and of themselves but are positive in that they increase the total GDP).

The size of the revision should prompt a moment of reflection about our economic statistics. We often complain that our current statistics don't give us an accurate picture of the I-Cubed Economy. But even long-accepted statistics are not infallible -- as is shown by this revision to a number which we all feel is a pretty good indicator. As we move forward with revamping our economic statistics, let us keep in mind the fallibility of the numbers. As the old saying goes, there are lies, damned lies and statistics.

The mantra of the new economy has been "be first" -- first-mover advantages, be first in market share, be first-to-market. But that isn't how the I-Cubed Economy necessarily works. Servicing customer needs, rather than beating the brains out of the competition, is the real key to success -- as James Surowiecki points out in his latest New Yorker column, In Praise of Third Place:

Fifteen years ago, the video-game industry was ruled by one player, Nintendo. The company had machines in a third of American homes, and it was Japan’s most profitable electronics company. The title of a 1993 book summed up the situation: “Game Over: How Nintendo Conquered the World.” Then the Sony PlayStation arrived, and everything changed. Today, Sony is the dominant force, and its chief rival is not Nintendo but Microsoft, which makes the Xbox. Two weeks ago, the début of Sony’s PlayStation 3 was greeted by crowds of hysterical consumers anxious to get their hands on the new console, billed as the most powerful gaming machine ever. When Nintendo’s new console, the oddly named Wii, appeared, a few days later, there were excellent reviews and expectations of good sales, but no more talk about world conquest. If Sony and Microsoft are the major-party nominees, Nintendo is more like a cool third-party candidate.

As Sony and Microsoft battle over who will own the home entertainment market ("control the living room"), Nintendo took a different tack.

Nintendo has dropped out of this race. The Wii has few bells and whistles and much less processing power than its “competitors,” and it features less impressive graphics. It’s really well suited for just one thing: playing games. But this turns out to be an asset. The Wii’s simplicity means that Nintendo can make money selling consoles, while Sony is reportedly losing more than two hundred and forty dollars on each PlayStation 3 it sells—even though they are selling for almost six hundred dollars. Similarly, because Nintendo is not trying to rule the entire industry, it’s been able to focus on its core competence, which is making entertaining, innovative games. For instance, the Wii features a motion sensor that allows you to, say, hit a tennis ball onscreen by swinging the controller like a tennis racquet. Nintendo’s handheld device, the DS, became astoundingly popular because of simple but brilliant games like Nintendogs, in which users raise virtual puppies. And because Nintendo sells many more of its own games than Sony and Microsoft do, its profit margins are higher, too. Arguably, Nintendo has thrived not despite its fall from the top but because of it.

Strategy is all about thinking through what you are doing - not necessarily following the latest management fad. The same is true for national or local economic strategies. I would venture to say that there are a lot of Nintendo's out there - national and regions how are doing very well by following an older management fad of "sticking to your knitting." That is not to say that they aren't innovative. Today's knitting is nothing like yesterday's. But building on your strengths and shoring up your weaknesses has always a good strategy. And while others fight over who has a larger market share, making sure that you are providing value to your customer will always be a winning strategy.

FYI - this insight from the Wall Street Journal - As Patents Grow More Contentious, Battleground Shifts to High Court:

With the economy increasingly dependent on technological innovation, the Supreme Court is scrutinizing more patent rulings made by a special court that critics say has tilted too far in favor of intellectual-property rights and could be stifling competition.

The high court, which today hears arguments in one of three patent cases on this term's docket, has ruled in recent cases on the side of more flexibility in enforcing such rights. If that trend continues, it could translate into weaker protections for patent holders and promote greater access to inventions.

The Supreme Court's newfound assertiveness on core issues of patent law -- after hearing only a handful of cases in the field over 20-plus years -- comes amid a sharp debate over how to maintain American industry's competitive edge while upholding the protections that reward the risk-taking behind cutting-edge inventions.

In today's economy, for instance, many innovations -- such as software programs, drugs or advanced electronics -- are built on myriad smaller inventions. That has led to disputes between owners of component patents and those who incorporate those pieces into more complex products, leaving federal courts to delineate who owns what.

There are three major patent cases that the Supreme Court will decide before the end of this term in June 2007. These three will go along way to reshaping patent law. But ultimately the Congress needs to step up and pass patent reform legislation. Let us hope the new Congress is up to that task.

Ford Motor Company wants to borrow money. Lots of money. $18 billion to be exact.

Normally, that would not be big news. It would be some news for the corporate bond market. But this is generally routine news.

What is newsworthy about this borrowing is how Ford plans to do it. Rather than sell normal corporate bonds (with a rating at junk bond levels), Ford is selling bonds backed by some of their assets. As the Wall Street Journal reported:

In arranging to borrow as much as $18 billion, Ford Motor Co. is making a massive bet that by pledging its assets as collateral, it can take advantage of buoyant debt markets to help pay for a difficult and costly restructuring.

This is not completely unusual. As the Journal goes on to say:

Ford isn't alone in being forced to back its borrowing with hard assets. Earlier this month, General Motors Corp. pledged some equipment assets as collateral for a $1.5 billion loan and arranged earlier in the year for a $4.6 billion secured credit line, which, like a credit card, can be tapped when needed.

What is noteworthy is the mix of assets Ford is using. Its not just hard assets. According to the Washington Post:

Among the other assets Ford was using as collateral are its intellectual property, such as patents or significant trademarks; real estate; and its automotive financing unit, Ford Motor Credit.

A few years ago, bankers would not touch intangibles as collateral. Now I hear from financial advisors and valuation specialist that they are getting more calls about using intangibles as part of a larger loan package (as Ford is doing). I suspect we will see more of the deals in the future. And as the market becomes more familiar and comfortable using intangibles as part of a package, we are likely to see stand-alone type of deals - where the intangible assets are the only collateral used. This is already happening in the securitization arena. Look for this type of financing to spread.

From Forbes and the Reputation Institute comes a listing of one of the most intangible of intangibles:The World's Most Respected Companies.

"Reputation" has become a watchword in the corporate world, and safeguarding a company's image is now a top priority for many CEOs. That's one reason why the Reputation Institute, a New York consulting firm, decided to rate the reputations of the biggest companies in the world. The results may surprise you; only one American company, for example, made it into the top ten worldwide.

The only US company in the top worldwide 10 was Kraft. Other top US companies include Johnson & Johnson, Pepsi, Disney, Home Depot, 3M, Kroger, Target, P&G and Deere.

Patents, patents and even more patents. I came across the following in Business Week a couple of weeks ago - VoIP Patents: Innovation—and Lawsuits:

The Patent & Trademark Office is approving patents aplenty for Internet-based calling. On Nov. 14 alone, it handed out a patent on what IBM calls a "conversations computing system," and granted chipmaker Intel a patent for a computer-based phone "eliminating the need for a telephone set."

Those were among dozens of patents granted on two separate days in November to companies including Texas Instruments, Motorola, and Nokia. In October, the PTO gave an additional 76 patents to the likes of Qualcomm, Nortel, Broadcom, Time Warner's AOL, and NTT DoCoMo of Japan.

In all, the U.S. has to date issued 2,049 patents related to Voice over Internet Protocol (VoIP), a technology that enables low-cost or free calling using the same method that zips e-mail around the Internet.

I think this illustrates the problems of patent thickets, especially in IT: over 2000 VoIP patents and counting. As the article goes on to say:

Chances are, many patent battles will be fought outside the courtroom. Patent holders are likely to use their intellectual property portfolio to extract concessions on cross-licensing deals, where one company may share its VoIP expertise in exchange for use of another company's patented technology, says VoIP expert Jeff Pulver. "It's certainly going to be something somebody could use against somebody."

This also illustrates the differences in technologies. A new drug has a patent (or a few patents) on the chemical composition and on the process. IT has literally thousands of patents on one technology. How to deal with that difference is the major stumbling point for patent reform.

It is also the reason why we need patent reform. Does anyone really think that everyone in the VoIP business (equipment supplier to service supplier) has carefully researched all 2049 patents to make sure they aren't infringing? And that there aren't a bunch more patents out there that may not be called VoIP related, but really are?

It's the Wild West out there -- it really is folks. Time for the Congress to finally step up and deal with the problem.

The man whom some on Wall Street blame for their competitiveness woes is speaking out on financial regulation and competitiveness - Spitzer slams threat to corporate reforms:

In an interview with the Financial Times, the outgoing state attorney-general, who won fame for tackling corruption in the financial services industry, said diluting such reforms would be “counterproductive” and would fail to tackle the reasons US businesses are falling behind.

“The argument that we are failing in competitiveness because of regulations is incomplete,” Mr. Spitzer said. “We’re failing in competitiveness because of failed business models and the lack of smart investment in technology. General Motors is not failing because of regulations but because it hasn’t produced good products.

. . .

Mr. Spitzer said critics who warned that aggressive enforcement hurts competitiveness were ignoring recent history. “The sectors that bore the brunt of my cases are performing extremely well,” he said. “They are more competitive because they understand the importance of ethics.”

Many of the top investment banks and the insurance companies that settled with Mr. Spitzer over allegations of biased stock research, accounting fraud and bid-rigging are having extremely profitable years.

Spitzer's remarks in the Financial Times come on the heels of Secretary Paulson's remarks (see earlier posting) and a special report (and cover story) in the Economist. That report, America's capital markets: Down on the street, gives a précis of the "roll-it-back reformers" objections:

The advocates of reform see plenty of scope for improvement. The problem is not only Sarbanes-Oxley, they argue. Aggressive investigations by Eliot Spitzer forced the financial industry into settlements that curbed innovation as well as sharp practice. Federal regulators, desperate to keep up with the New York attorney-general (and now governor-elect), ran amok. Class-action lawyers have been allowed to wield too much power, and shareholders too little. on

From the tone of the article (and the accompanying opinion piece What's wrong with Wall Street), the Economist isn't buying this as the sole problem:

The bad news for America is in part the result of good news elsewhere. Thanks to financial liberalisation (which America encouraged), New York faces a lot more competition than it used to. Developing countries are getting richer, and their companies and financial markets better governed. Firms that might once have rushed to American exchanges to privatise themselves are instead doing so at home, or at least nearby. London is seen as a natural home for companies from Russia. Chinese firms are turning more to Hong Kong, which is gaining a reputation for capital-raising as well as trading: witness the gargantuan offering by ICBC, a bank, last month. As Asian markets mature, more of the capital there will surely never leave the region: there is little point in Asian companies going to New York to raise cash from Asian savers. Other markets are growing up, making Wall Street less exceptional.

This echoes their earlier comments on how London became a financial center (the subject of an earlier posting). A large part of the story is flow of funds and financial innovation.

Yet, almost everyone (including Governor-elect Spitzer) that some regulatory overhaul is needed. Steps are already being taken to fine-tune Sarbanes-Oxley. As the Economist says:

With regulators soon expected to announce rule changes that will lighten the burden, the battle against Sarbanes-Oxley's excesses looks well on the way to being won. This should mean efforts can be directed elsewhere.

They suggest two areas of reform. The first is shareholder rights:

On the one hand, they have too few rights in their dealings with company boards; they have less power than their British equivalents when it comes to electing directors, for instance. On the other, American shareholders (or rather the lawyers who purport to represent them) wield too much power in securities litigation. Lawsuits brought because of falling share prices make a mockery of both the principle of caveat emptor and the honourable New York tradition of never giving a sucker an even break.

The second is the regulatory structure:

Regulators could also do with an overhaul. Here there are two problems, both serious. First, the Securities and Exchange Commission (SEC) is good at the tough stuff, bringing plenty of “enforcement actions”. But in its zeal to keep pace with crusading state attorneys, who exploit high-profile campaigns to win votes, it has lost sight of its other supposed goal—ensuring that markets run smoothly and efficiently. One way to address this imbalance would be to replace some of the SEC's vast army of lawyers with economists. That would also lead to better cost-benefit analysis of new regulations—an area where the SEC trails behind Britain's Financial Services Authority.

Second, the regulatory structure is too atomised. Too many agencies monitor the markets. There are four separate banking regulators. State and federal regulators tread on each other's toes. The SEC's duties overlap with those of the Federal Reserve, the Commodity Futures Trading Commission (CFTC) and others. Since it no longer makes sense for the increasingly entwined cash and derivatives markets to be policed by separate regulators, a sensible first step towards streamlining would be to merge the CFTC and the SEC.

These sound to me to be good starting points. As Mayor Bloomberg and Senator Schumer have said, To Save New York, Learn From London.

Let's see if the financial community can rally behind these lessons from London. It will be a good test of their newly merged lobbying association - Securities Industry and Financial Markets Association.

Earlier postings on this blog have talking about intellectual property protections for products from a specific region, such as Parma ham, Champagne, etc - called geographical indicators. Now, the Japanese are taking it one step further, according to a story in this morning's Washington Post - Putting the Bite On Pseudo Sushi And Other Insults:

With restaurants around the globe describing themselves as Japanese while actually serving food that is Asian fusion, or just plain bad, the government here announced a plan this month to offer official seals of approval to overseas eateries deemed to be "pure Japanese."

Apparently, they are not the only ones:

the mentality in Japan also echoes a similar movement by several nations -- including Italy and Thailand -- now offering guidelines and reward programs to restaurants abroad to regain a measure of control over their increasingly internationalized cuisines.

The target of these campaigns is the already-established, not-so-cutting-edge-anymore trend toward fusion. Fusion is the long standing practice of combining foods from different places, raised to the level of haute-cuisine. Not everyone is crazy about these combination. Thus, the Japanese government's attempt to protect the purity of the Japanese cuisine from such barbarities as serving sushi and Korean bulgogi (barbequed beef) on the same menu.

However, the story points out that Japanese cuisine may not be so pure:

But some here have expressed caution about the launch of the government approval system, arguing that Japan is a country also notorious for adapting foreign foods to local tastes. Indeed, that rare talent gave birth to Japanese seafood and mayonnaise pizza.

In addition, many so-called Japanese foods have foreign influences or roots. Batter-coated and fried food known as tempura, for instance, was introduced to the Japanese by Portuguese missionaries during the 16th century.

"The question is, what can we really call 'Japanese food'?" said Masuhiro Yamamoto, the Tokyo-based food guru. "Here in Japan, we believe that tonkatsu [fried pork cutlet] is essentially Japanese, but try and tell the French that isn't porc paner."

For now, the tools being used in this quest for purity are guideline and seals-of-approval. That is fine and probably useful to anyone who wants a "pure" experience. However, I think they would do us all a favor if they stuck to "good" rather than "pure." There is enough bad sushi out there to police without worrying about whether it is correct or not.

And "correct" is in the eye of the beholder. After, all if we attempt to enforce strict tradition in all our intangibles, such as cuisine, there would be no innovation what so ever. So, for me, fusion beats purity – at least when it come to sushi.

David Wessel wrote a thoughtful piece in his column "Capital" in yesterday's Wall Street Journal about the economic challenge facing the Democrats in the attempt to address the problem of rising inequity. One of the things he pointed out was the complexity of the problem.

Today's inequality reflects a confluence of forces. Technology is increasing employers' appetite for some skilled workers, while diminishing it for assembly-line workers in auto and textile factories. Imports and outsourcing are doing the same. Schools aren't graduating enough of the workers in short supply, such as engineers. Immigration is contributing to a glut of others, visible wherever day laborers gather hoping for work. Unions are atrophying. Corporate boards, hedge funds and sports teams are increasingly willing to write super-sized paychecks to a chosen few.

The list of ideas is impressive:

Unfortunately, the list of alternatives proposed -- while helpful -- doesn't get us to where we want to go. Yes, I agree with almost all of these. I can quibble with the exact formulation of some of them and disagree with one (raising the capital gains and dividends tax - I have long supported a sliding scale that reduces the tax on long run investments while increasing it on short term).

But there is something missing: the recognition that the nature of the economy has fundamentally changed. Too many of these ideas are based on the industrial era which will be most effective in only a portion of the economy. Yes, many will be effective for the I-Cubed Economy (such as the educational-oriented ones). However, they don't go to the heart of the issue.

Gene Sperling's quote is accurate - we must raise the tide as well as all boats. Where are the programs to raise the tide? Granted that the article was focused on inequality not growth. But the two go hand in hand. There is an ingrained fallacy in other thinking that treats them as separate (and generally as conflicting).

Actions that increase jobs and economic opportunity for all will promote both equality and growth. For example, where are the programs for entrepreneurship and business start-up, especially in the communities-left-behind and communities-at-risk? Where are the programs for on-the-job training, workers can keep their jobs and improve their own market able skills -- rather than wait until they are out on the street? Where are the programs to help small and medium size businesses re-orient their businesses to this new innovation led, design-focused competition.

Those should be a no-brainer for either political party. But the GOP calls them "industrial policy" and complains that they are interference with the mythical automatic workings of the market. Democrats call them "corporate social welfare".

Until both sides stop living in the past - and simply pulling out the same old solution, we won't be able to attack this problem.

The list of idea that the Dems are talking about is a good start (better than the previous do-nothing alternative). But it is only a start. Let's begin talking about the rest of the agenda.

In a couple of earlier postings, I talked about greenhouse gas trading as a new financial innovation. Now, according to Bloomberg.com: News:

Fannie Mae, the biggest U.S. mortgage finance company, won a patent for a system to trade greenhouse gas-reduction credits earned by homeowners, securing a foothold in a $22 billion market while raising concerns that the government-chartered company is overstepping its mission.

Ousted Chief Executive Franklin Raines is listed in the patent as an inventor of a system for verifying cuts in household emissions of carbon dioxide and other greenhouse gases. The patent, granted on Nov. 7 and held jointly with a subsidiary of New York-based Cantor Fitzgerald LP, gives Fannie Mae proprietary control over a method for pooling and selling credits to companies that can't meet emission reduction targets.

However, because of the concern over mission-creep, it is unclear what will happen to the patent:

Corinne Russell, a spokeswoman for the Office of Federal Housing Enterprise Oversight that regulators Fannie Mae, said the agency is reviewing the patent and wouldn't comment further.

It is also unclear what the immediate effect of this business process patent might have on ongoing greenhouse gas exchanges -- especially overseas. Given that this trading market has existed for some time, it will be interesting to see exactly what technique Fannie Mae has patented, whether they will try to enforce their patent, and whether the regulators will let them even try.

The ability of the US financial sector to compete in an ever more global industry has become a hot topic of late (see my earlier posting). At noon today, Treasury Secretary Paulson gave what was billed as a major speech on the Competitiveness of U.S. Capital Markets. In it he asked the key question: "Does the decline in initial public offerings in U.S. capital markets signal potentially broader challenges to our competitiveness?"

His answer was a conditional yes:

Some observers cite the decline of foreign IPOs in the U.S. market as an indicator of the competitiveness of our capital markets. We should go beyond the numbers and examine some of the possible reasons for this decline. Several factors contribute to the recent trends, including public policies in other countries. But several other contributing factors offer a framework to assess our own capital markets. These include:
* The development of markets outside the U.S., particularly in London and Hong Kong – and the ability of U.S. investors to participate in these offerings;
* A legal system in the U.S. that exposes market participants to significant litigation risk;
* A complex and confusing regulatory structure and enforcement environment;
* And new accounting and governance rules which, while necessary, are being implemented in a way that may be creating unnecessary costs and introducing new risks to our economy.

Concerning the rise of markets outside the US, he was positive:

A number of foreign exchanges have also aggressively embraced technology and developed innovative business models that increase efficiencies and reduce costs to investors in their markets. These competitive forces have spurred responses in our country. In the most recent example, the Chicago Mercantile Exchange and Chicago Board of Trade announced plans to merge and offer investors a broader range of exchange-traded derivatives, with the goal of creating efficiencies in technology and operations.

On the legal system, he was less positive. He first mentioned the strength of the US:

A sophisticated legal structure – with property rights, contract law, mechanisms to resolve disputes, and a system for compensating injured parties – is necessary to protect investors, businesses, and consumers.

Simply put, the broken tort system is an Achilles heel for our economy. This is not a political issue, it is a competitiveness issue and it must be addressed in a bipartisan fashion.

But it was the regulatory and accounting systems which were his focus, including Sarbanes-Oxley. Unlike some, he did not put all the blame on Sarbanes-Oxley, but looked at the balance needed to operate the entire system.

Most importantly, he did not advocate any specific short term fix. Instead, he laid out broad principles and announced a Conference on Capital Markets and Economic Competitiveness to be held next year. Those principles include:

First, it is necessary to take a global view. We don't operate in isolation, so it is very important to consider how changes we make affect the ability of our companies to compete globally and how these changes affect our interaction with markets and regulators around the world.

Second, our regulatory structure should be more agile and responsive to changes in today's marketplace.

Third, to stand the test of time, rules should be embedded in sound principles.

Fourth, regulators should take a risk-based approach to regulation, weighing the cost to shareholders against the benefits.

Fifth, our enforcement regime should punish and deter wrongdoing and encourage good behavior without hindering responsible risk-taking and innovation.

And, lastly, the best way our business leaders can protect the integrity and competitiveness of our markets is to exert moral leadership, where the threshold question is, "Is this right?" not "Do the rules allow us to do this?"

As we move deeper into the I-Cubed Economy, intangible assets will become more and more important in the financial markets (which is the subject of an ongoing Athena Alliance research project). The conference will need to confront this new reality if it is to be anything more than a look back at the past.

The Secretary has laid out a path. It is up to the rest of the financial community to follow.

Last week, I posted a description of a recent Swiss study on informal innovation. Using the same data from the Swiss Innovation Survey, Heinz Hollenstein look at the behavior of companies seeking foreign R&D. He identified four strategies:

• Strategy 1: Firms pursuing a broad-based foreign R&D strategy in terms of motives, with tapping into knowledge available at foreign universities and embodied in specialists as the core elements;
• Strategy 2: Firms strongly embedded in networks of highly innovative companies and transferring a substantial part of the knowledge obtained abroad to the domestic headquarter;
• Strategy 3: Firms pursuing a strongly focused strategy, with foreign R&D almost exclusively used as a means to extend local markets;
• Strategy 4: Firms pursuing, in terms of motives, a rather narrow-based foreign R&D strategy that aims at reducing R&D costs and gaining access to highly skilled personnel.

His findings:

Foreign R&D still is based to a very significant extent on the traditional efficiency- and market-seeking motives: clusters 3 and 4, which primarily reflect these types of motives, dominate foreign R&D activities, at least in terms of employment (65% of employment). However, knowledge-seeking, which is a core ingredient of the other two foreign R&D strategies, has become a very important driver of the internationalisation of R&D in the Swiss economy: 51% of firms (although only 35% of employment) pursue these two types of foreign R&D strategies.

Given that the Swiss economy and Swiss companies are highly internationalized, it is interesting the extent to which companies’ foreign R&D strategy are still relatively traditional. However, the growth in the more knowledge-seeking strategies portents a coming shift.

This is the subject of a number of on-going studies (most notably by my colleague Hal Salzman at the Urban Institute). It will also be the subject of a conference next year at the National Academy, which Athena Alliance is a co-sponsor. More on that as details become available.

Two Swiss academics - Marcel Bogers and Stéphane Lhuillery - have taken a close look at their nation's 2000-2002 innovation survey and have teased out a measurement of informal innovation. Informal innovation is that which does not come from formal R&D. As they define it, informal innovation includes "marketing, design and engineering capabilities, training and learning (e.g., by doing), monitoring external sources of innovation, development new production facilities, acquiring of new technologies and technical information or know-how, and organizational investment and change" and is "generally embodied in people and organizations." This is the type of innovation that often does not get captured in standard OECD innovation surveys -- and is completely overlook in the US tech-centric discussion of innovation policy. [In fairness to the work of the OECD, this paper seems to be focused on the previous generation of the OECD innovation surveys. The 3rd Edition of the Oslo Manual on innovation does a much better job at looking at marketing and organizational innovations.]

The paper's findings are very interesting:

Our results show that around half of all the (innovative) firms in the sample could be considered as being informal innovators, in line with our definition. In particular, service firms were confirmed to be mostly involved in this informal innovation whereas high-tech firms are less likely to be (exclusively) involved in non-R&D innovation. Furthermore, we show that non-R&D innovation is associated to product innovation as well as process innovation. The process innovation side is contended to rely on learning-by-doing or learning-by-using. Non-R&D (innovative) firms account here for more than one third of the total reduction of production costs due to process innovation, which in particular holds for smaller firms and service industries. Non-R&D innovations are thus important substitutes for R&D-based innovation. These results show that a large part of the economy is not considered by Science and Technology (S&T) policy makers, as they focus on one side of the knowledge production in enterprises.

The importance of informal innovation has recognized for quite some time. Nobel-prize winner Ken Arrow pointed out the role of "learning-by-doing" back in 1962. Subsequently over the past 40 years, we have heard discussions of "learning-by-using" and "customer-driven" innovation.

These are the areas upon which we need to build our broader national innovation policy. Unfortunately, they are also the areas which are the most difficult to affect with public policy. Funding R&D and training more scientist and engineers is easy. Finding ways to spur informal innovation is hard.

But that is exactly what we must do.

Beginning with the ugly. The latest issue of the Economist has a story on the struggles and pitfalls of National branding: A new sort of beauty contest:

For 15 years you have tried to make the world aware of your newly born country. It is huge—the size of western Europe—rich in natural resources, modernising fast. But progress is frustratingly slow. Then a pestilential foreign comedian makes you (in)famous overnight, for grotesque but fictional squalor, cruelty and vulgarity. Should you be pleased, cross or both?

That is the puzzle facing Kazakhstan, thanks to “Borat!: Cultural Learnings of America for Make Benefit Glorious Nation of Kazakhstan”, a new film that has proved a surprise box-office hit in America. A mock documentary, it portrays Borat, a lecherous, racist Kazakh (but actually a British comedian) visiting America, with assorted misapprehensions on both sides that are comical or tasteless depending on your viewpoint. Kazakh officials are now grimly trying to show they share the joke; Russia says it will ban the “humiliating” film.

[Not yet having seen Borat - it is on the Thanksgiving movie fest list - I am given to understand that it makes as much fun of America as of Kazakhstan]

According to the story, experts on national branding are divided as to how Kazakhstan should respond: lie low or make lemonade of out lemons. In any event, national branding is a difficult task if all one has is image. As the Economist states, "nor can money spent on glitz and schmooze easily make up for dire political realities, such as a bad record on free speech, or an amnesiac approach to history." Like any brand, there has to be more substance under the perception.

Part of the process of national branding has to go hand in hand with an underlying economic strategy. In the private sector, this is known as leveraging the brand - moving into related products and services. You hook the customer on one level and then offer more. An example of a nation doing this is an article in the same edition of the Economics on Marketing New Zealand: From fantasy worlds to food:

New Zealand famously promoted itself as a tourist destination using the dramatic landscapes seen in “The Lord of the Rings” films. Now that the magic has faded, it has started emphasising its food and wines in addition to its natural beauty. One approach is to reach out to potential visitors in other foodie hubs. At last year's “Maori Art Meets America” event in San Francisco, New Zealand pinot noirs, breads, meats and cheeses were served. “All this helps grow the food and wine sector tremendously,” says George Hickton of Tourism New Zealand. Michael Hall, professor of tourism at the University of Canterbury, predicts that saffron, walnuts, truffles and olive oils will be the next Kiwi foods to be marketed abroad in an effort to develop food tourism.

In this case, New Zealand is actually going back to an older marketing strategy of pure air/water and pure food, updated to use the recent spotlight of the movies.

And finally, brand loyalties change - even for countries. According to the Economist:

The American administration is also spending heavily on public diplomacy. But apparently to less effect. Polls show unparalleled hostility around the world not just to the administration but to the country itself. “America spent 300 years building a powerful, rich, globally adored brand,” says Mr. Anholt [Simon Anholt, a branding specialist and author of the forthcoming Competitive Identity: The New Brand Management for Nations, Cities and Regions]. “It is leaking away very quickly.”

As I've remarked before, time to do something about that.

Last month, I posted an item about the competitive position of US financial markets. New York seems to be losing out in the IPO race and Mayor Bloomberg has commissioned a study on how to restore the US position. In my posting, I hoped that the study would do more than just repeat the standard line about less regulation and looser oversight. It appears that the New York Times shares my concerns, based on Sunday's editorial The Corporate End Run:

United States markets lost their dominance of initial stock offerings for numerous reasons that had little to do with regulation. Some of last year’s biggest deals were Chinese and French privatizations. Markets elsewhere are bigger and more liquid than they once were. There are also intangibles, such as America’s recent unpopularity, increased barriers for visa seekers and extraordinary budget and trade deficits, which might make an issuer think twice about a dollar-denominated stock.

The London Stock Exchange, one of the leading beneficiaries of the American decline, commissioned a study showing that underwriting fees in London are just 3 percent to 4 percent of a transaction, compared with an average of 6.5 percent to 7 percent in the United States.

When workers confront globalization, they are told to adapt, take their pink slips and go to night school. It is the harsh downside of an integrated world economy that has on balance significantly enriched the country. When financiers feel the pinch from competition in Hong Kong and London, they run to the Bush administration for rule changes.

America’s investor protections and corporate regulations have made it a nation of share owners, with almost 57 million American households owning stocks either directly or through mutual funds. The Securities and Exchange Commission has already signaled that it will smooth the implementation of Sarbanes-Oxley, especially for smaller companies. And abuses of the private litigation system like pay-to-play should be stopped. There is room for reform. But over all, the system is working. It may need tweaks, but it does not need a revamping.

London fees are twice what they are in the US? Mr. financial entrepreneur, call your office -- there is market opportunity here (and it doesn't have anything to do with regulation).

Is an actor's real name protected under intellectual property rights? A case in Wisconsin may answer that question, according to the Washington Post -- Andy of Mayberry, Wisconsin?:

The star of "The Andy Griffith Show," who as Andy Taylor portrayed the sheriff of the fictional North Carolina town of Mayberry, has sued a Wisconsin man who unsuccessfully ran for the Grant County post after legally changing his name to Andrew Jackson Griffith.

The lawsuit, filed Nov. 3 in U.S. District Court in Madison, alleges that William Harold Fenrick, 42, violated trademark and copyright laws, as well as the privacy of actor Andy Samuel Griffith, when he used his new name to promote his candidacy for sheriff in southwestern Wisconsin.

The lawsuit says the former Fenrick changed his name for the "sole purpose of taking advantage of Griffith's notoriety in an attempt to gain votes." It asks the court to order him to go back to his original name.

We will have to keep an eye on this. The way things are going, it may make it all the way to the Supreme Court.

After last month's horrendous trade numbers, this morning's BEA trade data comes as a welcome relief. The overall deficit declined by $4.7 billion to $64.3 billion as imports declined and oil prices fell.

But, while this is good news, it is not great news. It just means that we are just digging ourselves into a deep hole at a slower rate.

Our trade in intangibles is helping to stem the tide - but not by very much. The intangibles surplus rose almost insignificantly by $44 million to $8.16 billion in September. The monthly surplus is still below what it was earlier this year. Imports and exports grew at about the same rate.

The deficit in Advanced Technology Products increased to $4.2 billion as imports outpaced exports, mainly due to an increase in aerospace imports.

Bottom line: pretty much of a status quo report. A little better, but nothing dramatic.

Note: we define trade in intangibles as the sum of "royalties and license fees" and "other private services". The BEA/Census Bureau definitions of those categories are as follows:

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.

The election is over (finally - I was involved in some local DC races and slept in this morning). But Congress is not done for the year. The House and Senate reconvene tomorrow (Thursday Nov 9). Facing the lame-duck session are a number of left-over items. Foremost is the funding of the US government. Only a few appropriations bill have been enacted into law - the rest of the government is running on what is called a continuing resolution that expires shortly. So Congress will need to quickly get to work on an overall spending bill.

But also something that should be on the agenda is the competitiveness legislation. Just before they left town, the Senate leaders Frist and Reid introduced S. 3936 - A bill to invest in innovation and education to improve the competitiveness of the United States in the global economy.

Chances that this piece of legislation will become law this year are slim. There are too many details to be worked out - especially with the some-to-be Democratic House. But a discussion of the issue on the floor of the Senate and passage of the bill there would be a good set up for next year's agenda.

Now NTP Inc. is going after Palm -- Palm hit by patent suit

Patent holding company NTP Inc. said on Monday it filed a patent infringement lawsuit against Palm Inc., maker of the Treo mobile phone, in a U.S. court, sending Palm shares down more than 7 percent.

The suit alleges that Palm's products and services infringed NTP's patents and seeks recovery of monetary damages resulting from Palm's direct and indirect infringement, the intellectual property firm said in a statement.

Specifically, NTP said it is targeting services and systems primarily used or adapted for use in e-mail systems with radio frequency communications to mobile processors and related services.

A Palm spokeswoman was not immediately available for comment.

NTP said it would prefer to resolve the issue via a negotiated license agreement.

About a $612.5 million agreement? And are these the patents which were already invalidated?
Will Palm be able to fight back in court or is the 7% hit on their stock price already too painful. And how will the e-Bay case that limits the injunctive relief mechanism affect any trial or negotiation strategy?

If this isn't taken by Congress as a real wake up call to fix the patent problem, then nothing is.

From the latest Business Week - Andy Grove's Wish List for Congress

Q: What laws need changing?
A: Intellectual property law, for one. Patent as well as trademark law. You have to ask, "Are these the laws—if we didn't have any laws—are these the ones we would or should have?" I don't think if you did that you'd get a yes answer today.

Interesting. But, then again, Grove has been calling for patent and IPR reform for years. Maybe in the next Congress (people keep telling me that we are getting close).

The Wall Street Journal story this morning has an interesting anecdote on how productivity is shifting:

Instead of spending on information technology alone, businesses are focusing more on improving their operations -- investing in things like better warehouses, machines and logistics. Some of that investment helps them get more mileage out of previous advances in information technology. The flexibility of U.S. labor, product and capital markets also play a role by making it easier for companies to adapt and get the money they need to do so.

Take, for example, UPS. Together with an upgrade of its information systems, it is changing the way it packs trucks and plans routes. Among other things, this allows its drivers to avoid left turns, which burn up extra gas.

A perfect example of how technological innovation (IT) and non-technological innovation (different routes) combine to improve productivity.

This morning's weak employment numbers - only 92,000 new jobs - underscores the fragile nature of our economic growth. Manufacturing and construction declined while services continued to pick up the slack. Combined with yesterday's weaker productivity numbers and the earlier reports of a slower GDP, today's figures point more to a slowdown in the short run. Interestingly, some are looking at the upward revisions to the previous month's job numbers as in indicator of a more robust economy. I would caution that over 30,000 of that job increase was in local education (that is the seasonally adjusted number - the real number was over 400,000) and 26,000 was in food service and drinking establishments.

Rather than focus on the short term, however, my concern is more the long term. Here the employment numbers are equally worrisome. According to the BLS, the top growing sectors (in terms of significant growth over and above other sectors) are food service and drinking establishments, nursing and residential care facilities, and hospitals. These are not tradable services (setting aside that fact that foreign tourists do patronize our bars and restaurants and the fact that top hospitals do attract some foreign patients). We need to be growing our tradable intangible services as much as these non-tradable tangible services.

From Bruce Nussbaum - Productivity Numbers Are Bad--Are We Spending Too Much On R&D And Not Enough On Innovation?:

The latest batch of numbers on productivity growth are awful and this bodes ill for the future if they continue. I know the conventional wisdom is that private spending for R&D is falling and that causes productivity to fall as well.

But invention is not innovation and spending on R&D is no guarantee that you will get the kind of innovation that generates revenue growth, profits, wealth and jobs. Many corporations are trimming their R&D--outsourcing much of it to networks of scientists and engineers--and boosting their innovation hit rates.

Amen on that point. I think we need to keep the productivity statistics. But can we get some innovation statistics as well - so we can look at the productivity numbers in some sort of context?

Earlier this week, I was at a conference organized by the New America Foundation on Back to the Economy: Confronting America's Growth Challenges (video of the conference is available). The conference was part of their new Economic Growth Project.

Many of the conference speakers concentrated on whether the US faced a recession. The general mood was optimistic, with some pessimists thrown in for spice. A couple of the speakers actually took up the challenge of thinking long term - beyond the conventional ideas. Michael Mandel talked about the problem of mis-measuring the knowledge economy (with only a passing reference to the "dark matter" issue).

I agree with most of what Mike said. However, even if we get the measures right, it will still not be enough. Treating R&D as and investment in GDP does result in a boost of the savings rate and productivity. But, it does not change the negative trend line. We need to really understand what really drives economic growth.

We know that intangible assets and knowledge are the new key factors of production - and are important in and of themselves. Yet, we are not clear what that means. The shift in production to other nations is not just an indication of lower costs, but also of the availability of those production factors in abroad (design in China; business services in India).

Let’s look at what those factors are. R&D is important. But innovation is not just new technology; it is new ways of thinking about things and new ways of doing things. Education is important. But it is the skills and knowledge that companies need – communications skills; interpersonal skills; creativity – are different from what is pushed by our educational policy. And no one is looking at the issue of transferring the tacit knowledge which accounts for much of our human capital.

A key insight, for me, came from an almost throw-away comment by Bernard Schwartz. He pointed out how the Washington and economist’s view of investment differs from the businessman’s view. The economists look at the size of the number. But, businessmen look at how much (or how little) they have to invest to get the job done. They don’t need to make as big an investment as before in things like plant and equipment. In addition, the velocity of investment has increased.

In other words, the productivity of investment has increased. Investment policy hasn’t caught up with this shift. I would make the analogy with what happened in computers. We get more computers for less money. With increase productivity in investment, we may be getting more output for less investment.

So, while most of the speakers talked about increasing investments in education and R&D, they didn’t take the next step. No one followed on Schwartz’s comment: that the nature of the business investments has changed. The same is true with investments in skills, knowledge and innovation investments. For example, we look at formal education investments. What about investments in specific technical course or investment in a mentor relationship? Those could have a much larger impact for much lower costs than traditional education.

Thus, the concern over absolute numbers of investment in R&D, education and infrastructure may or may not be relevant. There is investment and there is investment. The infamous proposed “bridge to nowhere” in Alaska was an infrastructure investment. Yet, all of the government and private sector spending on Y2K is viewed as an expense, whereas in truth it was an investment – in the Indian computer/business service industry.

So, what are the key policy levers? I think they are the same as before – but applied differently. We need public investments in broad innovation activities and investment in new types of educational activities. The policy is correct; the targets have changed.

On the macro level, Robert Shapiro laid out the crux of the problem. The traditional macro economic links have been broken. The old formula was to manage demand to output under the theory that increased output led to increased domestic employment. The other part of the job was to increase productivity (in part by lowering business cost pressures) which led to an increase in wages.

Can these linkages be re-established? Should they? Or should we look for other policy levers that go at wages and employment?

In his remarks, Jeff Faux suggested that during the next recession, the public sector should learn from how the private sector responses. The private sector uses recessions to restructure. We should use the recession to restructure the system. I agree that we need to restructure – but I hope we don’t have to go through a recession to get there.

Innovation can happen anywhere - even in old traditional industries, like playground equipment. For example, see the Business Week story Serious Playgrounds:

With an immersive, high-tech world of video games, cartoons-on-demand, and online social networking at their fingertips, the youth of today are spending less time recreating in the great outdoors. The seesaws, swing sets, and jungle gyms languishing in the playgrounds of yesteryear can't compete for the attention of this budding, screen-wired generation.

But all hope is not lost, say some promising new minds in the resurging play equipment manufacturing industry. From high-end designers to proactive nonprofits, a variety of fresh voices in the field are working to give little Johnny compelling reasons to come out and play.

Some of these new playground cost more than some people houses, up to a million dollars - so I'm not sure they will be showing up in the park next door any time soon. But they are based on an important concept in innovation - listening to the user:

A San Francisco-based play-structure designer and self-proclaimed child at heart, Barbara Butler turns kid fantasy into backyard reality on a daily basis—for a pretty penny. For about $4,000 to upward of $240,000, Butler and her team of "play professionals" will custom-build the fort, castle, tree house, or playground of your child's dreams. Before she gets to work, she always sits down and listens attentively to the children's own ideas and looks over their fantastical sketches—to her, valuable blueprints.

These new playgrounds are competing head-to-head with the latest technological gadgets. But they are doing it without trying to out-tech the tech:

According to Susan Solomon, author of American Playgrounds: Revitalizing Community Space (UP of New England, 2005), the playgrounds of today lose out to tech-toy recreation because they fail to provide challenges. "You don't want to advocate that kids get hurt, but you want to advocate that there's a small possibility of risk," says Solomon. "Risk is important to kids because that's how they learn. Rather than deal with risk, Americans want to eliminate it."

Her book highlights a number of innovative play spaces in the country where challenging activities and natural, tactile experiences were the focus of design rather than cookie-cutter plastic tubes and ball pits. One such example was the Children's Garden of Enchantment in San Francisco's de Young Museum, a space designed by landscape architect Walter Hood for the museum's October, 2005, reopening.

Young visitors to the garden find sensory activities that encourage a connection between imagination and the natural world, such as a fog field, native floral arrangements, and scalable sculptures. "Childhood recreation shouldn't be dictated by equipment," Hood says.

As I've stress before, innovation is not about the latest gadget. Innovation is about creative problem solving and giving the user something better.

Can we get a National Innovation policy that recognizes this fact?