January 2007 Archives

Financial competitiveness - part 3

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James Surowiecki of the New Yorker takes exception to the prevailing wisdom that New York is losing its competitive advantage in issuing IPOs due to over-regulation:

To begin with, many of the world’s biggest I.P.O.s in recent years have been privatizations of state-owned companies in Europe and China, which for political reasons were never likely to happen in the U.S. Also, corporate executives prefer to take their companies public in bull markets, which improves their chances of getting a high price for their shares, and foreign markets have lately done better than the U.S. market. London and Hong Kong are also cheaper than New York: the commissions that investment banks charge to take companies public there can be about half what they are in the U.S. More broadly, globalization—a force that Wall Streeters applaud when it comes to textile plants and call centers—has increased competition. Many foreign exchanges, like Hong Kong’s, are now far more liquid and open, and they also have much tougher regulations (often modelled, ironically enough, on those of the U.S.) than they once did. All this has made investors more willing to invest in them. Their market share has naturally increased as a result, particularly since, even in a global economy, companies prefer to list their shares closer to home.

Once you control for these factors, it becomes hard to find anything other than anecdotal evidence that regulations are doing serious damage to New York’s ability to attract foreign I.P.O.s. More important, it’s far from clear that a decline in foreign I.P.O.s would be a sign of future disaster anyway. After all, what matters to the fundamental health of an economy is its ability to attract capital and investors, not foreign listings. And there is no evidence that America’s attractiveness to investors has diminished. Its share of global stock-market activity in 2005 was actually three points higher than it had been a decade earlier. In the same period, the market capitalizations of the New York exchanges rose almost twice as fast as the market cap of the London Stock Exchange. And, according to the New York report, if you look at the annual growth in equities—which is what Sarbanes-Oxley would presumably be a drag on—you find something unexpected: from 2001 to 2005, the U.S. market grew significantly faster than that of Europe or the U.K. Does that really look like an industry crippled by regulation?

I agree that New York City and the US government need to take a hard look at the competitiveness of our financial markets. But I also agree that we need to get at the root conditions, not perceptions and set answers. Answers will come, but we need to ask the right questions. And right now, it is not clear that the right questions have yet been asked.

A really intangible economy

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For those of you who don't yet know about "Second Life" - here is a wonderful primer from the Christian Science Monitor on the economy in virtual reality - A second income on Second Life.

And by the way, Sweden is seting up a Virtual Embassy in 'Second Life'

Sweden will set up a virtual presence in the popular online world "Second Life" to spread information about the Scandinavian country and attract more young visitors, officials said Monday.

The government-sanctioned "embassy" will provide curious visitors with information about Swedish culture and history, as well as tips about places to visit and visa rules for tourists, Swedish Institute Director Olle Wastberg said.

Sounds a lot like that smart brand management strategy I mentioned yesterday.

Real time brand management

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Over the course of the 20th Century, it became clear that brands and reputation had become so valuable that a new form of business "brand management" has evolved. Brand management has been around for some time -- some claim that brand management starting in the 1930's at P&G. But in more recent years, with the evolution of faster communications, brand management has move into real-time on-line mode, with managers tracking what people are saying about a brand almost the minute by minute. One of the pioneers of this approach is a Washington area company New Media Strategies. A recent story in the Washington Post (Tracking Who's Saying What About Whom) describes the process:

Moira Curran starts her day at the office by skimming several dozen blogs, occasionally firing off instant messages to her co-workers with links to juicy bits of celebrity gossip.

Then she listens to podcasters chatting about the latest episodes of "Grey's Anatomy" or "Lost." In the afternoon, she keeps an eye on soap operas on the television set that hangs above her desk.

About 70 colleagues, scattered across two floors of an Arlington high-rise, spend eight hours a day doing much of the same. Some of them are also playing video games, watching movies and cruising around MySpace.

That's exactly what the clients of New Media Strategies, an online marketing company, pay the employees to do. Companies ranging from movie studios and television networks to automakers and burger chains hire these professional Web surfers to scour the Internet for any mention of their brands. Over the past few years, the "online analysts" have helped the companies track their reputations, found ways to get their products noticed and joined online conversations to help steer them the way clients want them to go.

. . .

Many of the online analysts wear headphones all day and chat with bloggers via instant messages. Their job is to be the clients' eyes and ears online, said Clay Dunn, 28, a brand manager who monitors what is said about video games and movies.

He watches for rumors and alerts his Hollywood clients if online coverage goes awry. Once, for example, backstage photos from a movie set surfaced and spoiled a sneak preview already in the works. Curran, another brand manager who trolls the Web on behalf of television clients, corrects errors published in blogs. If rumors spread that someone's been fired from the cast of HBO's "Entourage," for example, she's there to set the record straight. If an angry viewer bashes a network for a violent scene in a prime-time show, she's there to post a rebuttal. She watches soap operas so she'll be able to chat knowledgably with the rest of the online audience.

This type of brand management grows out of viral marketing - essentially word-of-mouth amplified by advanced communications. This virtual social networking is one of the reasons for the explosive growth in the internet - from blogs to YouTube. Rumors and information no longer spread slowly - they travel around the world with the speed of an electron. Online brand management is one way for companies to keep up with that information flow.

Note that the process is not passive. These brand managers actively intervene in the conversations to set the record straight:

Curran said she is careful to acknowledge her connection to clients when it's required. All online marketers have to walk a fine line when they work the blogosphere. Federal Trade Commission rules require them to identify their roles when they're making a point on behalf of a client, but if they're gossiping about the latest episode of "Desperate Housewives" they can legally be as anonymous as anyone else.

This raises some interesting issues that have surfaced in other venues: how do you judge the information you are getting? Is it one person's personal opinion? Is it planted by the company? By the company's rivals? Is it a paid "statement" or a heartfelt plea? All of these issues have been around for a long time (one might say since humans first learned to communicate). But in the I-Cubed Economy as information flows so much faster, they become even more heightened.

I don't know the answer as to how to deal with this -- efforts at transparency can only go so far. Education and the development of critical thinking is probably our best defense against manipulated information. They used to say, don't believe everything you read in the newspapers. Now, it is don't believe everything you read on the Web.

Ah yes, the more things change . . .

Financial competitiveness - part 2

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As New York City and the Congress look at the competitiveness of US financial services and regulatory "reform" (see earlier posting), I hope they include all voices -- including the customers of those services. One of the major customers is the investor community. And the investor community is not so gung-ho to "reform" the system, especially when it comes to Sarbanes-Oxley, as Business Week reports in Not Everyone Hates SarbOx:

Not so fast, says a growing chorus of investors. Lost amid all the boos over SarbOx, they say, are some major benefits. The biggest: SarbOx and related reforms have produced much more reliable corporate financial statements, which investors rely on when deciding whether to buy or sell shares. For them, SarbOx has been a godsend.

What's more, says Duncan W. Richardson, chief equity investment officer at Eaton Vance (EV ) Management and overseer of $80 billion in stockholdings, even the act's much disparaged requirements for testing internal financial controls could drive gains in corporate productivity and profits. Says Donald J. Peters, a portfolio manager at T. Rowe Price Group (TROW ): "The accounting reforms have been a win."

Earnings will be on investors' minds over the next several weeks as most corporations announce yearend results. The numbers will include results tallied under generally accepted accounting principles and, thanks to a Securities & Exchange Commission regulation adopted during the reform years, they'll also come with reconciliations to any nonstandard or "pro forma" numbers that companies use to try to spin their results. The reconciliations, says Peters, are "extraordinarily" helpful. "It is [now] much easier for me to have a view of the true economics" of a company, he says.

Beefed-up disclosure requirements have also meant that companies now deliver numbers with fewer adjustments for unusual charges and write-offs, which in the past have been used to make earnings look better. Thomson Financial's (TOC ) Earnings Purity Index, which tracks earnings adjusted for such write-offs, shows improvements in each of the past four years. And now earnings reports reflect expenses for incentive stock options, information investors like that wasn't available before the big accounting scandals.

Just as important, executives appear to have a firmer grasp of costs when they talk about operating margins, according to Richardson of Eaton Vance. He credits the improvement to the infamous Section 404 of SarbOx, which requires documented testing of internal controls. "Even not-so-good management teams have good controls now, and that leads to an ability to cut costs," he says.

One of the strengths of the US capital markets is the people from all over the world are still willing to sent their money here. They generally trust the system. Weakening that trust is not a way to strengthen the system.

Likewise, as I have stated earlier, it is not clear that regulatory tightening is the sole or major cause of the problem. As the Wall Street Journal reports - In Call to Deregulate Business, a Global Twist - WSJ.com, the standard answer so far has been blame the regulations:

Yet this position, which has gone largely unchallenged, downplays a different explanation for why U.S. exchanges are under pressure -- the changing nature of global finance. Stock markets around the world have become better and deeper, encouraging companies to seek IPOs in their home market. Trading across borders has become simpler, cutting the prestige and usefulness of a big-country listing everywhere. And private-equity buyouts are a global phenomenon, not a uniquely American one.

Meanwhile, other countries are stiffening their own rules, bringing them closer to the U.S. model.

. . .

There's little doubt U.S. exchanges are facing increasing competition. They're losing out to overseas exchanges for initial public offerings. Many overseas companies are deciding they don't need an American listing. And in the U.S. itself, many companies have decided they're better off private.

Taken alone, the cost of regulation can't explain what's happening to U.S. financial markets, and paring regulations might not alter the outcome, except to give a helping hand to Wall Street.

Jenny Anderson, the New York Times "Insider" columnist, notes About Those Fears of Wall Street’s Decline ... :

Some of these claims make sense. Others do not. For starters, there is a fixation on data showing that initial public offerings are gravitating to London and China. This data seemed problematic: smaller companies are listing in London because there is a market there that boasts of having virtually no regulation, a benchmark the United States should not lower itself to meet.

And larger companies, especially Russian and Chinese ones, are increasingly staying home or going to London to raise capital, which can be attributed to factors like London’s being in a better time zone.

More important, the main reason companies are listing in their home markets is that globalization is not a lofty theory but has truly produced more competitive global markets. That means more companies will choose not to trek halfway around the world to raise money — especially when fees in London are half that of the United States.

By the way, Brad Selzer inadvertently underscores the changing situation of the US financial services sector when he states (in RGE - Yet more evidence that emerging markets cannot create the financial assets their citizens want to hold …):

Indeed one of the big (underreported) stories of the past few years is how savers in emerging markets are increasingly willing to hold their savings in the local banking system in local currencies despite low nominal interest rates (China) or low nominal and negative real interest rates (Russia). It has been better to get low returns in the local bank than to hold (depreciating) dollars.

Foreign investors -- private investors that is -- have also been quite keen to put funds into emerging market financial assets.

That is the basic problem I have with all theories that attribute the uphill flow of capital to financial underdevelopment. Right now, emerging markets don't seem to be having any trouble generating financial assets that their citizens want to hold, or that foreign investors find attractive.

If foreigners are don't need/want to buy what we have to sell, the financial markets are going to lose vis-a-via other markets. That is the essence of competitiveness.

The question of improving US competitiveness in financial services is an important -- and ongoing -- question. One of my earliest research projects was an Office of Technology Assessment study in the 1980's on International Competition in Services - which included banking and financial services (although I didn't work on that part of the study). That report found a combination of regulation, technology and the maturation of foreign markets to be the major drivers behind slipping US competitiveness in financial services. And the policy options included increased international regulatory cooperation.

The OTA study provided a broad look at the issue. We need to continue to take a broad look as we approach the issue. Otherwise, we will have piecemeal changes that may simply make the problem worse.

Prizes for R&D - part 2

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Speaking of prizes for R&D (see yesterday's posting), I just got pre-announcement of a new National Academies study on Innovation Inducement Prizes at the National Science Foundation. The report concludes that prizes have an important role to play in our innovation system and recommends that NSF establish a a pilot program of “several small-scale prizes ($200,000 to $2 million each) in diverse areas that differ regarding prize scope and scale, contest duration, engagement of outside groups, and other features.” In other words, an experiment. Sounds good to me.

Manufacturing legislation

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While the competitiveness agenda is far from front and center in Washington these days, that does not mean it has disappeared completely. At the beginning of this new Congress, Rep. Vernon Ehlers (the former Republican Chair of the House technology subcommittee) introduced the HR 255 ‘‘Manufacturing Technology Competitiveness Act of 2007" -- which was identical to the Manufacturing Technology Competitiveness Act of 2005 that passed the House (but not the Senate) in the last Congress.

One of the elements (that was striped from the bipartisan Senate competitiveness bill introduced in the waning days of the 109th Congress) was a grant programs to the Hollings Manufacturing Extension Partnership (MEP) Centers "to develop projects to solve new or emerging manufacturing problems". Specifically, the grants are for "projects associated with manufacturing extension activities, including supply chain integration and quality management, or extend beyond these traditional areas."

Those are the magic words: "beyond these traditional areas." That phrase would allow the MEP Centers to get into the business of helping companies with innovation -- not just manufacturing processes.

I have long argued that "design" is the new "quality". And that manufacturing and services are fusing. Small companies that are solely manufacturing are going to be less and less able to compete (and create jobs) in an economy of increased automation and globalization. To survive, these companies need an array of technical services and advice in areas such as design, marketing, and servicing.

They know it and MEP knows it. In fact, the MEP Next Generation Strategy states:

With success in the marketplace dependent upon product differentiation, service innovation, and speed to market, MEP is prepared to position manufacturers to compete in this global economy through services that are grounded in business strategy development, advanced marketing techniques, new product development, the integration of supply chains, and increasing the technical and problem solving skills of the workforce.

The grant program in the Ehlers bill is an important tool in implementing the MEP strategy. I know the Democrats will want to craft a new version of the legislation. Let's hope they keep this provision -- and even expand upon it. That would go a long way to helping 21st Century manufacturing thrive in the American I-Cubed Economy.

The shifting sands of economics

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Telling dispatches from Davos:

America no longer owns globalization - International Herald Tribune:

This year's theme at the World Economic Forum annual meeting here — "the shifting power equation" — confirms the view of many participants that power is draining away from the United States to multiple centers as countries from Brazil to China move beyond "emerging" market status to establish themselves as major players on the world scene.

The conference theme also acknowledges the panic in traditional business circles as power shifts from the producer to the consumer thanks to the Internet and the digital distribution revolution.

Far from some kind of conspiracy of the global elite plotting the future as they whisk down the Alpine slopes, Davos is in fact a back-end barometer of their evolving worldview. It does not break new ground but consolidates opinion. It does not generate new trends but codifies them into conventional wisdom. That is its power and its importance.

Just How Good Is Globalization? - WSJ.com:

A new refrain is emerging in Davos this year: Globalization isn't working for everyone. Stagnating wages and rising job insecurity in developed countries are creating popular disenchantment with the free movement of goods, capital and people across borders. If unchecked, popular fears could turn into a political backlash that could lead to protectionism -- or at least make broad free-trade agreements harder to achieve in the future.

You might want to also check out Bruce Nussbaum's blog, which has a running commentary on Davos. This Includes a summary of the Twelve Power Shifts That Are Changing The World - based on the first day's sessions.

The next wave of outsourcing?

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Is Brazil the next wave of outsourcing? It may be according to the Wall Street Journal - Soccer, Samba and Outsourcing?:

With time zones and a culture closer to those of the U.S. than Bangalore or Beijing, small operators such as Mr. Lazarski and multinationals including Accenture Ltd. and IBM are betting that Brazil could quickly become Latin America's major hub for inexpensive corporate support work, and a top-five location world-wide.

But, wait a second. One of the rhetoric points about outsourcing to China and India was all about the time differences. With operations in the US and in Asia a company could run a project 24 hours. IT workers in the US could hand the project off to their Asian counterparts at the end of the day (the beginning of the day over there) and then take it back the next day. This job sharing was said to increase productivity.

I realize that rhetoric generally disappeared awhile ago. But it seems to still linger - including in Washington policy debates. Outsourcing to Brazil should finally kill it off - since this type of outsourcing has nothing what so ever to do with round-the-clock production. It is job competition, not job sharing, plain and simple.

Prizes for R&D

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David Wessel's Capital column in today's Wall Street Journal is about prizes as a research incentive. In the piece, he discusses the standard prizes for invention from solving the navigation problem of longitude to the Netflix $1 million prize for a better algorithm. He also discussed more innovative approaches - the web site InnoCentive and the X-Prize Foundation. What I found fascinating was the evaluation of prizes as incentives, especially the studies of InnoCentive:

One surprise: The further the problem was from a solver's expertise, the more likely he or she was to solve it. It turns out that outsiders look through a completely different lens. Toxicologists were stumped by the significance of pathology observed in a study; within weeks after broadcasting it, a Ph.D. in crystallography offered a solution that hadn't occurred to them.

Thus, prizes have the benefit of opening up the research to new ideas. In a time of heavy specialization and, what some see as strong gatekeepers to research funding, new mechanisms for fresh approaches are needed. Tapping into the intellectual entrepreneurship of the world through prizes seems to be one of the best new mechanisms around. May it continue to flourish and expand.

Intangibles and investing

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This week's cover story at Business Week - Beyond The Green Corporation hits the proverbial nail squarely on the head:

Corporations disclose the value of physical assets and investments in equipment and property. But U.S. regulators don't require them to quantify environmental, social, or labor practices. Accountants call such squishy factors "intangibles." These items aren't found on a corporate balance sheet, yet can be powerful indicators of future performance.

One intangible that is growing in importance is "sustainability" -- what companies are doing to preserve the environment. These actions are generally seen as PR and "do goodism" that make it difficult for companies to justify to stockholders. That may be changing:

new sets of metrics, which Innovest and others designed to measure sustainability efforts, have helped convince CEOs and boards that they pay off. Few Wall Street analysts, for example, have tried to assess how much damage Wal-Mart's reputation for poor labor and environmental practices did to the stock price. But New York's Communications Consulting Worldwide (CCW), which studies issues such as reputation, puts it in stark dollars and cents. CCW calculates that if Wal-Mart had a reputation like that of rival Target Corp. (TGT), its stock would be worth 8.4% more, adding $16 billion in market capitalization.

In addition to making sustainability a bottom-line activity, putting a value on these intangibles is a major step forward. As I pointed out in my white paper, Reporting Intangibles:

Our business reporting system is, in many ways, not even adequate for the Industrial Age, let alone the Information Age. As a consequence, business, investment and economic policy decisions are being made “in the dark” (to quote the title of a recent study).

Fixing that problem will take a multi-prong approach. Better valuation measures of intangibles are one part. Better non-financial measures is another (for example, see the Enhanced Analytics Initiative and the Enhanced Business Reporting Consortium). But greater disclosure of qualitative factors is also needed. Some intangibles will always remain qualitative. Finding ways to communicate that qualitative information in a cross-comparable fashion (so that investors can compare different options) is important. Until then, intangibles will remain murky and hidden -- and in the dark.

[In the interest of full disclosure: the work of CCW on intangibles is carried out with Predictiv, LLC - one of whose principals (Jon Low) is a member of the Athena Alliance Board.]

An innovation-led energy strategy


In my comments on the State of the Union, I complained that a focus simply on substituting alternative fuels for gasoline would do much to help spark the new generation of technological advances. We need a broader innovation-led strategy. A good start toward that strategy is outlined by my friend Joel Yudken in his recent piece Funding An Energy Alternative:

Making energy security a major national goal, accompanied by the appropriate regulatory, fiscal and budgetary policies, would create a powerful “force field” influencing innumerable decisions about energy investments and use throughout the economy. Greatly increasing demand for new energy products and processes would send strong market signals, stimulating private sector investments in R&D, innovation, production and services in a wide range of industrial sectors. It also could foster new regional industrial clusters built around emerging advanced energy technologies, creating new products for both domestic and export markets. Most importantly, many new jobs and occupational opportunities for American workers would be created.

Achieving these gains would first require a major regulatory driver, such as a nationwide greenhouse gas emissions cap and trade program or carbon taxes, that induces industries and consumers to be more energy efficient and reduce their use of imported, high-emissions energy sources. Although controversial, it is possible to craft a politically salable program with only modest short-term impacts on prices and jobs. Such a policy is contingent on commitments from developing nations—especially China and India—to make comparable emissions cuts, and raise large amounts of revenue (e.g., through emissions permit allocations or auctions) available to help businesses, workers and consumers make the transition to an energy secure future.

We would also need accompanying policies designed to stimulate the spread of advanced energy innovations, minimize economic losses and foster new economic opportunities for workers and businesses. These include:
* Large-scale investments in R&D and innovation, including a strategic national energy R&D initiative, coordinating advanced energy research, technology and commercialization programs across federal agencies and support for U.S.-based industrial R&D consortia for advanced energy technology.
* Measures which create demand for energy efficient and “clean energy” technologies, such as more stringent energy standards applied to government buildings, transportation fleets and procurement of goods and services, tax credits, financial incentives and standards that encourage widespread industrial and consumer use of energy efficient and clean energy products and energy services to help small manufacturers and businesses meet energy efficient standards."
* Coordinated regional economic and workforce development programs, including federal and state partnerships with business, labor and community organizations to generate new opportunities for U.S. businesses and workers in emerging energy sectors, especially in economically distressed areas, “smart” urban growth strategies, including investments in mass transit infrastructures and an education and workforce development initiative to train the high-skilled workforce needed by the emerging energy sectors.
* Measures promoting a diversity of energy options, including expanded use of renewables for electricity generation, lighting, heating and cooling and advanced technology vehicles and fuels (e.g., ethanol). Investments in “clean” coal and carbon sequestration and advanced, safer forms of nuclear power also should be considered.
* Assistance to ensure low-income households have access to affordable, and reliable energy, with an emphasis on offsetting increased energy prices from climate policies and helping low-income households become more energy efficient.

Energy can be a sector that leads a new innovative wave. Or it can be a lag, something that we have to deal with in a marginal fashion just to get through. Bold and comprehensive plans are needed, such as the program outlined. The President has opened the door, ever so slightly. Let's see if the Congress (on both sides of the aisle) can march through.

Dynamics and insecurity

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Yesterday's Washington Post has an unintentional juxtaposition of stories that illustrated one of the themes from last night's State of the Union ritual: the competing views of economic dynamism and economic insecurity

On the op-ed page was a defense of dynamism, specifically job churn by Treasury Secretary Robert Kimmitt. In the heath section was a special report on work and stress.

Secretary Kimmitt's piece is well argued discussion of why job turnover is not necessarily bad. I agree that economic dynamism is good (if fact I have argued that our understanding of economic growth should be based more on disequilibrium not equilibrium theory). However, he fails to differentiate between voluntary job separation (economic opportunity) and involuntary job separation (economic insecurity). Both play their role in economic dynamism. But Kimmitt downplays the involuntary part and completely ignores its consequences.

One of those consequences is increased stress. Here too there are goods and bads. Some stress is helpful. It is good to go beyond one's comfort zone. That is also good for the economy - especially an I-Cubed Economy based on creativity and innovation. But too much stress is depilating - again especially in an I-Cubed Economy where so much of the process requires mental acuity. Andy Grove may have entitled his book Only the Paranoid Survive. But that is not a generally recommended approach to economic success. And an economic system that creates insecurity in the name of dynamism does little in the end to promote that dynamism if it raises stress levels to problematic levels.

Like so many other thing, key is getting the balance right. So Secretary Kimmitt, I understand your call for policies that preserve the dynamism that fosters our economic opportunity. But where are the policies that address our economic insecurity.

And don't just tell me that we can't have one without the other. That is soooooo 20th Century. To use the cliché - maybe we need to think outside the box.

The incredible shrinking competitiveness agenda

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A year ago, economic competitiveness was a hot topic. Various bills had been introduced in the Congress and the President's State of the Union address unveiled a new American Competitiveness Initiative. Forget the fact that these proposals were narrow in scope -- at least people were talking about the issue.

Fast forward to today. Competitiveness is almost completely missing in action. The President's 2007 State of the Union Policy Initiatives have reduced his American Competitiveness Initiative to an adjunct to the reauthorization of the No Child Left Behind. (Since it was heavily focused on math & science education anyway, this doe not surprise me. But it does worry me.) The rest of the President's economic focus was old line economics; less government, balance the budget, lower taxes, control entitlements, etc.

One could argue that the energy and health care initiatives in the State of the Union address major competitiveness issues. I can buy part of that. Dealing with soaring health care costs is an important part of increasing our competitiveness. But cutting gasoline use is hardly the major leap forward in technological progress that could be used to spur economic competitiveness in energy-intensive areas.

The Democrats were only a little better in their pre-State of the Union address last week. In addition to talking about math and science education in the context of No Child Left Behind, Speaker Pelosi at least mentioned doubling federal funding for basic R&D in the physical sciences, expanding the R&D tax credit and fostering greater deployment of broadband. But that is not even close to the rudimentary innovation and competitiveness agenda left over from last year.

Jim Webb's response does address the issue of economic insecurity head on:

Wages and salaries for our workers are at all-time lows as a percentage of national wealth, even though the productivity of American workers is the highest in the world. Medical costs have skyrocketed. College tuition rates are off the charts. Our manufacturing base is being dismantled and sent overseas. Good American jobs are being sent along with them.

In short, the middle class of this country, our historic backbone and our best hope for a strong society in the future, is losing its place at the table. Our workers know this, through painful experience. Our white-collar professionals are beginning to understand it, as their jobs start disappearing also. And they expect, rightly, that in this age of globalization, their government has a duty to insist that their concerns be dealt with fairly in the international marketplace.

Unfortunately, the Senator doesn't lay out an agenda to deal with the issue, other than to say "we're working on it."

Good start in recognizing the problem. But more, much more needs to be done before the American people will believe that the Democrats really have an alternative.

There is hope. The Congressional session is brand new - so there is still plenty of time for economic competitiveness and innovation to rise to the attention of lawmakers. There is also time for a broad debate on our economic challenges. That debate started in the last Congress. Let us continue that debate.

Productivity slowdown

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The Conference Board released a report today that U.S. Labor Productivity Growth in 2006 was the Lowest in More than a Decade. Much of the concern was about a slowdown in the impact of information technology:

According to Dr. Bart van Ark, Director of International Economic Research at The Conference Board: "Over the past decade, information and communication technology has been a key driver of global productivity growth, but with these latest numbers one begins to wonder whether ICT's contribution has peaked. The significant fall in U.S. productivity growth is unlikely to be purely cyclical, and the modest European revival of productivity also points to the limited impact of technological change and patchy liberalization of product and labor markets in many countries."

However, according to the report, the "lull" in productivity could also be due to a transition phase to a second wave of ICT-driven productivity growth still to come.

Gail Fosler, Executive Vice President and Chief Economist of The Conference Board, said: "Today's business models have reached a certain level of technology saturation, and incentives for creating a second wave of applications are weak. But there are many industries, in particular in services, in which the potential for more productive technology use seems large. Future productivity gains may be waiting for a new generation of business applications."

More than just investment in new ICT will be required to capture this new productivity. Organizational changes will be needed as well. To quote Erik Brynjolfsson and Lorin Hitt "Computing Productivity: Firm-Level Evidence":

The results suggest that the observed contribution of computerization is accompanied by relatively large and time-consuming investments in complementary inputs, such as organizational capital, that may be omitted in conventional calculations of productivity.

The current policy debate in Washington is beginning to address the ICT investment issue. That is good. But where is the debate on ways to help investment in (and understanding of) those complementary inputs such as organization capital?

Declining US Brand

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And the bad news on US brand power continues. From the latest BBC poll - 'Listen more' is world's message to US:

The global image of the US has significantly deteriorated over the past 12 months, as the chaos in Iraq has deepened. And in 18 of the countries that were involved in previous polls, the slide in America's standing has steepened.

. . .

Comparable surveys suggest that there is still strong support around the world for the values enshrined in US society. But it looks as though America itself is seen to be living up to those values less and less.

As a result, America's soft power - its ability to influence people in other countries by the force of example and by the perceived legitimacy of its policies - is weakening.

And in a turbulent, globalising world, where the US - rightly or wrongly - is associated by many with the disruptive effects of globalisation, soft power matters more than ever. It is a resource that once squandered is very difficult to build-up again.

Enough said.

Financial competitiveness

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Yesterday, Mayor Bloomberg and Senator Schumer released their McKInsey report on the competitiveness of New York as a financial center.

The report is a mix of national and local policies. As the New York Times reports - U.S. Financial Sector Is Losing Its Edge, Report Says, the national policies focused on regulation, legal litigation and talent:

The committee’s primary recommendations echo those of a similar report released in November, focusing on easing or eliminating provisions of the Sarbanes-Oxley Act for small and foreign companies — some steps that the Securities and Exchange Commission is currently undertaking — and curbing securities-related litigation. The latest report is one in a series commissioned in the public and private sectors voicing concern that the United States is falling behind because of a burdensome legal and regulatory environment.

The report adds some new dimensions to the debate, however, making recommendations to ease immigration restrictions facing skilled professionals from other countries, urging convergence on international accounting standards and recommending the adoption of Basel II, an international accord on capital standards, without increasing capital requirements as some United States banking regulators have suggested.

The local agenda was more traditionally economic development oriented. The main recommendation was to establish a public/private joint venture with highly visible leaders focused exclusively on financial services competitiveness, with the agenda of:
• More actively managing attraction and retention for financial services.
• Establishing a world-class center for applied global finance.
• Potentially creating a special international financial services zone.
• Enhancing New York’s ability to promote its financial services profile and its agenda as a leading financial center.

This last suggestion goes to the health of New York's financial cluster. Part of the report's analysis addresses the innovation aspects of the cluster. It comes to an interesting finding:

The senior executives surveyed felt that, broadly speaking, New York was significantly more innovative than London. Considering innovation across all industries, 47 percent of respondents thought New York was more innovative than London, whereas only 15 percent viewed London more favorably. Clearly, innovation is a key advantage for New York in attracting a talented workforce.

However, as addressed in the previous chapter, London’s leadership in derivatives has helped promote innovation there and, when combined with the ease with which talent can move to the UK, it’s easy to see why London might be catching up to New York.

Survey data support this supposition: when asked about innovation in financial services specifically, 49 percent of respondents thought New York was more innovative, but 25 percent put London ahead, suggesting that London might be closing the gap with New York this sector. Some interviewees suggested another important reason why London might be catching up: the legal risks associated with being a business trailblazer are starting to undermine America’s entrepreneurial culture, which in turn damages its traditional leadership innovation. Given the risks associated with experimentation financial services, it would make sense for some of the more cutting-edge activity to move overseas.

One area was missing - what the private sector should do to help itself. The focus of the report was on government action. It did include rhetoric about the need for business to lead -- and the call for a public-private partnership was in keeping with the spirit of that rhetoric. But clearly the firms themselves need to confront these challenges. As I have noted before, fees in New York are apparently higher than in London.

Some, as the Washington Post reports:

are skeptical of the notion that the United States is losing its financial edge. "Financial regulation may scare some businesses away, but for many investors, it offers an extra measure of protection that makes it a competitive plus," said Amy Borrus, deputy director of the Council of Institutional Investors. "At a time when Wall Street firms are doling out platinum-plated bonuses, it's hard to believe New York could be losing its ability to attract and keep skilled financial professionals."

And I will note that the section on talent was focused on getting people to come to New York (and the US) i.e. immigration - not on how to discover and nurture home grown talent.

All in all a good start to the process - but not the end point. These recommendations should be the beginning of further discussion and analysis.

Manufacturing in the US

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Speaking of distributed production, here is evidence from the Wall Street Journal that the US still have some manufacturing capability - For Some Manufacturers, There Are Benefits to Keeping Production at Home:

It has long been an axiom that U.S.-made consumer goods such as TV sets and kitchen appliances can't compete in a world where cheaper labor can be found elsewhere. Like many axioms, though, it isn't entirely true.

Recent data from the Federal Reserve contained some surprises for anyone who thought U.S. companies don't make things for American consumers anymore. In its monthly update on factory output, the Fed reported that U.S. production of audio and video equipment surged about 2% in December and was up 23% for all of 2006.

That is a significant change from several years ago, when the numbers were negative as U.S. production moved overseas. Even output of appliances, though down for 2006, popped 5% in December.

The shift doesn't necessarily represent a renaissance. More likely, it reflects the fact that much of what can go abroad already has, leaving behind what can and should be made in the U.S. One area of strength: high-end goods like top-of-the-line $6,000 Sony Grand WEGA TV sets and $15,000 Sub-Zero PRO 48 refrigerators, which appeal to the affluent folks who have been driving much of the growth in U.S. consumer spending.
"It's the very high-end products," says Daniel Meckstroth, chief economist at Manufacturers Alliance, a trade group. "Manufacturers who have niche markets in high-end products have a very good outlook."

Such manufacturers account for only a tiny fraction of U.S. output and employment. Still, the numbers illustrate an important point about the physical and strategic limits of globalization: In just about any possible future, there will always be some business that is better done close to the customer. The obvious examples are home building and services such as restaurants, but the logic also can apply to certain types of manufacturing.

"If the thing being sold to the U.S. market is locally customized, delicate, or very large, chances are it'll continue to be produced in the U.S.," says Bruce Greenwald, professor of business and economics at Columbia University in New York. The same, he says, is true "if the manufacturing process itself involves almost no labor, like medical testing or like some very automated electronic-component manufacturing plants, chemical plants and metal-fabricating plants."

But continuing to have manufacturing base in the US isn't the same as higher manufacturing employment:

Across the manufacturing sector, the picture is similar: To stay competitive, companies are doing everything they can to boost productivity -- that is, make more stuff with fewer people. "Manufacturing in the U.S. is headed toward plants that have no people in them," Prof. Greenwald says.

That is bad news for factory workers who must retrain or be cast aside. It could be better for the U.S. economy as a whole. The more the U.S. can produce for each hour worked, the wealthier the average American becomes. If, for example, output per hour rises an annual rate of 3%, the average inflation-adjusted wage will more than triple over 40 years.

"Manufacturing is contributing to the welfare of the economy in terms of standard of living, but it's not generating net new jobs," says Mr. Meckstroth. "The electronics sector is one of the areas where that's most visible."

One way or another, routine manufacturing jobs are decreasing - either through automation or outsourcing. Manufacturing has a future in America. It's just not a future that looks like the past. We need to be discovering what the high-skilled, non-routine tasks that can produce the I-Cubed Economy's middle class - just the way that factory jobs created the middle class in the Industrial Era. Trying to return to that era won't work. But neither will the laissez faire approach of "let's all become computer programmers". We need to think differently.

Trade and currencies

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Last week in my posting on the Future of Globalization I mentioned the Economist story about the unbundling of work tasks as the new paradigm of trade. I also mentioned that our thinking about economic policy has not caught up with this shift. Friday's New York Times illustrates the point in "Trade Deficit Stubbornly Defies the Dollar’s Slide":

But new factors arising from the increased globalization of production seem to be making the trade adjustment particularly slow. For instance, by moving more production out of Europe, into dollar-pegged regions like China and elsewhere in Asia, European companies have created natural hedges against a strong euro.

“With globalization, we now have a large network of plants all over the world,” said Anton Börner, president of BGA, an association of German wholesalers and exporters based in Berlin. “So we are not as affected by changes in a single currency.”

Hugo Boss, one of Joseph Abboud’s main competitors, is based in the southern German town of Metzingen. But it also stitches garments at a factory in Cleveland and buys raw materials from Asia, where most of its transactions are in dollars or dollar-linked currencies.

Our mental model of what drives trade is still an image of finished goods crossing borders (wine and wool). Currency changes affect that (and therefore may eventually affect some of trade with China). But there is the natural currency hedging that companies have created with their distributed production. And it is often based on dollars anyway.

As bits and pieces of the production process are distributed to different places, currency changes become less effective. So the cost of the Italian designer of your new suit or dress goes up a little, but the production costs in Taiwan stay the same and the transportation costs (based on the cost of oil in dollars) goes down. Currencies still matter. But it may take larger shifts to affect prices and cost, and therefore the location of production.

Just a small example of how the global rules of the game may be shifting.

Future of Globalization

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A couple of new articles have hit the news stands on globalization today, both of which raise questions about the future. The first is actually a couple of pieces in the Economist. In a special report, Trade's victims: In the shadow of prosperity, they discuss one of the dark sides of the new globalization:

In the 21st century competition between firms and industries, such as Galax's furniture factories and their Chinese rivals, is becoming less important than competition between individual tasks within firms in different countries. Whether he is employed in a furniture company or a hospital, the American data-processor will be competing against someone from Bangalore. Rather than affecting entire industries, or whole factories, global competition will affect individual jobs—skilled as much as unskilled.

Such a shift helps explain the popular nervousness about globalisation. Many more workers are worried that their jobs will be at risk. That, in turn, increases the political appeal of assisting trade's losers. But it also makes those losers even harder to identify. And it undermines at least one reason for offering them special help. When trade-displaced workers were older, less educated and hence less easily re-employable than others, helping to retrain them improved the economy's efficiency. But as potential job losses from trade shift up the skill ladder and across industries, those displaced by trade will look much like the rest of the workforce.

The companion article The great unbundling: Does economics need a new theory of offshoring? goes into greater depth on this shift. It explores the recent work by Gene Grossman and Esteban Rossi-Hansberg of Princeton University and by Richard Baldwin, of the Graduate Institute of International Studies in Geneva:

The new breed of models paint globalisation with a much finer brush. (It is high-resolution globalisation, Mr Baldwin says.) International competition plays out not just at the level of the industry, or even the firm, but right down at the level of individual tasks—assembly, packaging, data entry—that cut across whole sectors of the economy. Moreover, in a break with most traditional models, the new theories do not take the tradability of things as a given. For Messrs Grossman and Rossi-Hansberg, the ease of trading a particular task is a matter of degree not kind; and it is a variable, not a constant. Hence tasks that seem safe from foreign competition today may not be so tomorrow. Finally, the tradability of a task might bear no relation to the amount of skill it requires. As a result, the victims of globalisation are harder to identify and the salves harder to apply.

As I have long argued, the nature of trade has changed. These new models come much closer to describing what is really going on (such as the cross-national production strategies that our friends at the Berkeley Roundtable on the International Economy (BRIE) have been talking about for years).

The second article is in the latest issue of Foreign Affairs: Has Globalization Passed Its Peak? Written by Rawi Abdelal and Adam Segal, it is a standard "we all know globalization is good but we face challenges" type of piece. I am usually skeptical of this approach but I did find their analysis of the current situation of interest:

In retrospect, signs of the current slowdown in globalization have been obvious for some time. Major participants in the process have always had very different ideas about how the integration should occur. As a result, what often looked like a single, steady process turns out to have been conducted along two, sometimes contradictory tracks.

On one side of the ideological split stood the United States. Washington's approach to globalization has long been ad hoc, meaning that it has relied on the preponderant power of the U.S. Treasury and of private U.S. firms to strike bilateral deals directly with other countries. U.S. policymakers tend to be skeptical of global rules and international organizations, favoring individual and specific trade and investment treaties instead. Admittedly, the United States has offered modest support for international organizations at times, but never at the expense of its own preeminent role in the world economy. This approach has been effective from the United States' perspective, as it has placed the country firmly at the center of global markets.

European policymakers, meanwhile, have favored a different tack, trying to drive globalization by creating new overarching rules for the world economy and by empowering international organizations such as the European Union (EU), the Organization for Economic Cooperation and Development (OECD), the International Monetary Fund (IMF), and the World Trade Organization (WTO). The European doctrine of managed globalization envisions a world of multilateral rules that will supersede U.S. power. Over the years, the EU alone has compiled over 80,000 pages of regulations to ensure the interdependence of its members -- the greatest body of such rules ever produced.

These two very different visions of how globalization should progress have never been harmonized, and this conflict has weakened the foundations of globalization in recent years.

I would also have to argue with their argument that the go-it-alone path of the US has been to our benefit. With our huge trade deficit and shift of productive capacity offshore, I'm not sure that qualifies as an "effective" policy.

But I do agree that the inability to come up with rules for globalization is a major challenge. Economic integration without rules is not integration - it is a jungle. We learned that in the US with the shift from local to national markets.

The other challenge is outlined by the shifting paradigm. The nature of trade has changed, but we are still trying to write the rules for the old game. The sooner we understand both the upside and the downside of the new game, the better. Because right now, I don't think policymakers do. And they rules they are trying to write aren't necessarily that relevant any more.

Competing for IPOs

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Yesterday, the Treasury Department reiterated its earlier statements that the Secretary would hold a conference on the competitiveness of US Capital markets. According to Robert Steel, Treasury's undersecretary for domestic finance:

the conference would focus on regulation, the accounting industry and legal and corporate governance. Mr. Steel said Treasury officials want to explore such subjects as "what's the right regulatory regimen for the economy."

As I've commented in a number of earlier posting, much of the focus has been on competition from London. However, the New York Times reported earlier this week, (Hong Kong and Shanghai Duel for Financial Capital), that Hong Kong is already number two after London.


So why all the attention on only London? And why on regulations only? Part of the rise of London and Hong Kong is that's where the money is.

Let's hope that the Treasury summit on competitiveness can incorporate the industry's deregulation agenda -- and move beyond it. Simply saying "get government off our backs" isn't going to solve the problem. Part of the issue may also be to get government to stop protecting the industry from competition. Remember, the Big Bang in London resulted in lower underwriting fees (two to three percent lower than New York apparently).

The conference needs to also address macro issues, such as the short-term nature of the markets in the face of the need for long-term patient capital and the rise of intangibles as a new asset class.

Done right, it should be a very interesting meeting.

The value of diversity

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Shankar Vedantam's column in Monday's Washington Post reported on the latest findings on the value of diversity - In Boardrooms and in Courtrooms, Diversity Makes a Difference

When the Rev. Martin Luther King Jr. called on America to open the doors of opportunity to people of color, the civil rights leader was making a moral argument.

Cedric Herring recently decided to take things one step further. Given that discussions about morality are often divisive, the sociologist decided to take a more scientific approach. In other words, beyond the question of whether diversity is a good thing, is there evidence that it makes a difference?

Herring has just completed his study. He found that companies that are more diverse have more customers, a larger share of their markets and greater profitability. In fact, when Herring puts his numbers on a graph, he finds a linear relationship between diversity and business success, meaning that as diversity increases, those business indicators increase in step.

. . .

Herring, who works at the University of Illinois at Chicago, says he agrees with advocates who have long argued that workers with different backgrounds make companies more responsive to customers. This model suggests that racial diversity is a marker for diverse ideas, attitudes and life experiences, and that having a range of perspectives can alert a company to threats and opportunities.

New research from psychology, however, suggests that this information model might only partially explain diversity's impact. Something more subtle -- and intriguing -- also seems to happen when people of color join groups that were formerly all white: The entire group starts to think in new ways. Minorities, in other words, not only bring new perspectives to the table but also seem to catalyze new thinking among others.

Another view of the importance of diversity comes from John Hagel, who looks at Scott Pages's new book The Difference: How the Power of Diversity Creates Better Groups, Firms, Schools, and Societies. Hagel points out that one of the keys elements of diversity is friction:

Diversity aids problem-solving enormously, but it also generates significant friction. We have come to believe in the business world that friction is bad but, in fact, certain forms of friction are essential to innovation. Even in the absence of diversity in fundamental preferences, people with diverse perspectives and tools and the best of intentions are naturally going to clash over potential solutions to problems that they believe are important before they converge around an answer.

I have long argued that diversity is an important part of the I-Cubed Economy. In an era where creativity and new ideas play a key role in economic prosperity, insular thinking is a detriment. The United States has been blessed with an abundance of diversity (and the friction that goes along with it). Our task is to constructively manage that friction and build upon the strength of that diversity. Those who would build walls - internal or external - may think that they are "protecting the American way of life." In reality, they are undermining our very life blood - the intangibles that make the American way of life what it is. They are also undermining our ability to compete and our future economic prosperity.

Let us then embrace and celebrate our diversity. For it is what makes us a great and prosperous nation.

NY Fed head on globalization

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Yesterday, Tim Geithner, President of the Federal Reserve Bank of New York, gave a speech on the Developments in the Global Economy and Implications for the United States. It was a speech the Wall Street Journal called "one of his strongest warnings yet on threats facing the U.S. economy, citing the budget deficit, fixed exchange rates and growing inequality." He began with an analysis of the factors at play:

Rapid technological innovation and greater economic integration have brought stronger growth and higher levels of productivity. The acceleration in productivity growth that occurred in the United States in the second half of the last decade seems likely to remain intact. And productivity growth is accelerating outside the United States, most strikingly in some of the large emerging economies.

Financial innovation and greater integration of national financial systems has contributed to the strength of real economic activity by improving the allocation of resources within and among economies. Improvements to risk management and to capital cushions are likely to have made the financial system more stable and more resilient.

And macroeconomic policy has improved around the world. The increase in monetary policy credibility in a broad range of countries has produced lower rates of inflation and more stability in inflation expectations. Greater public confidence in monetary policy was critical to laying the foundation for the improvements in real economic performance, by providing a stable foundation for long-term investment decisions.

And rapid growth in the major emerging market economies, together with the substantial earnings of energy-producing and commodity-exporting countries, have produced a substantial increase in wealth and savings relative to perceived investment opportunities. In a world where capital can now flow much more freely across national borders, a significant portion of these savings has moved across national borders.

These are powerful and fundamental forces, and they certainly help explain the broad reduction in risk premiums and the substantial demand for credit risk and financial assets.

There are other factors at work as well, however, that have less favorable implications. Part of this recent dynamic in financial markets is a consequence of the present state of the international monetary system, in which a substantial part of the world economy runs exchange rate regimes tied in some way to the dollar. This has entailed a sustained period of very substantial official accumulation of dollar reserves, putting downward pressure on U.S. interest rates and upward pressure on U.S. asset prices.

He then goes on to talk about the importance of both the budget and trade deficits. More important to my mind is that he disputes the standard proposals for coping with the growing concerns over globalization:

The political challenge of sustaining support for the process of integration may be the most important economic challenge of our time. To paraphrase Lawrence Summers, it is not enough to explain that globalization is inevitable and that policies that look politically attractive as a response to economic anxiety will only hurt the economy as a whole. Nor is it a politically effective strategy to state simply that economic integration is a necessary and powerful force in raising average incomes, or that technological change may be more important than trade or immigration as an explanation for slower growth in real wages for many Americans.

Raising the quality of education and exploring ways to improve the safety net are a necessary part of the solution to this challenge. But these reforms will have a long fuse and they may not yield the hoped-for increase in support. Trade does not appear to be more popular in countries with more generous safety nets, universal health care and highly subsidized higher education than it is today in the United States.

Rather, he stressed the need to face the reality that overall insecurity has increased:

The political challenges of sustaining support for global economic integration and fiscal sustainability will be more difficult in the United States because of what has happened to the distribution of income and economic insecurity. Several broad economic forces substantially complicate an already difficult set of political challenges: the long-term increase in income inequality, the slow pace of growth in real wages for the middle quintiles of the population, the increase in the volatility of income that is a reflection of the greater flexibility of the U.S. economy, and the greater exposure of households to the risk in financing retirement and the burden of paying for health care.

Unfortunately, he doesn't outline a direction to deal with those issues. At least his speech has acknowledged them. Let us see if other policymakers see this as their cue to broaden the discussion.

US strategy session on Design with India

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Last year, the Confederation of Indian Industries (CII) and the Indian National Institute of Design (NID) held a major conference on Design with India. (See also my earlier entry on the Business Week summary of the conference.)

The CII has just announced a follow on strategy session in New York on Feb. 5.

The ultimate objective for organizing a series of strategy sessions around the world is to identify an international panel of innovators and thought leaders, who will act as a think tank for inspiring people centered innovation in India and for integrating the creative talent and cultural resources of India with the global economy.

The session will start with a keynote address by my friend Clyde Prestowitz, Founder and President of the Economic Strategy Institute and author of the book, Three Billion New Capitalists: The Great Shift of Wealth and Power to the East. Should be an interesting meeting.

Brand mistakes

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Talk about not knowing your brand. Here is the latest howler - Have you seen Nepal? Not really, Peru says:

Royal Nepal Airlines has apologized to Peru after mistakenly using a photo of the Inca ruins of Machu Picchu to promote tourism in Nepal.

Peru's foreign ministry said in a statement on Wednesday the flagship carrier of the Himalayan kingdom, about half way around the world from the Andean country, had put the picture of Peru's tourism icon, Machu Picchu, on a poster under a slogan "Have you seen Nepal?"

Mountains, ruins -- they all look alike.

Cisco and Apple

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Cisco Files Suit Against Apple Over iPhone Trademark. Apparently, Cisco holds the trademark for iPhone - and Apple went ahead with using the name even though it had been in discussions with Cisco.

According to the Los Angeles Times:

Until Monday night, the two companies were negotiating over the name. Cisco, which acquired the name when it bought another company, was willing to "share," Cisco spokeswoman Terry Anderson said.

. . .

For the last several years, Apple has been asking Cisco about the iPhone name, Cisco said.

Anderson said the networking company was not looking for money and recognized the hard work of the Apple team. But Cisco is looking for a "collaboration and joint development with Apple" to ensure that Apple's phone works with Cisco's networking gear.

Incredible. There is an argument (mostly from the small inventors) that the big companies don't really care whether they infringe upon some one else's IP. If they want to do it, they just do it regardless. If the story about Apple is correct - it lends some credibility to that view.

I'm all for challenging non-valid and questionable IP. I am also in favor of limiting what types of ideas and knowledge can be considered personal property. But when there is a valid IP, it needs to be enforced. It really is the wild West out there!

Understanding innovation

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Do you still think that innovation is about guys & girls in lab coats and geeks run wild? Is you view of economic growth based on the linear model of research to development to product design to manufacturing? If so, you need to check out at least a few of the Harvard Business School's 25 most popular articles. According to The Business Innovation Insider, at least 5 of the top 25 are about innovation. One of my favorites is #12: How Kayak Users Built a New Industry -- about user-driven innovation. If you want to understand the innovation part of the I-Cubed Economy, read this article.

Innovative Apple?

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The Morning Brief from the Wall Street Journal captured the essence of the latest tech buzz: "iPhone Is Innovative, But Will It Dominate?" Unlike the iPod, the iPhone is entering a crowded market. As a result, many wonder if the it is enough of a "re-invention of the phone" (as Steve Jobs claims) to make a difference.

I have a slightly different take. One has to start with the reason for the iPod success. Yes, design and techie coolness were important. But as important was the intangible service side of the product. Up until the iPod, the downloading of music was a some what risky business. Am I doing something illegal? Ok, I know what you are saying "the geeks and kids didn't really care about that." True. But their parents and mainstream America did. Can you imagine President Bush getting a gift for Christmas that RIAA all about piracy?

What iPod did was make downloading of music safe. Thus, I believe that the exclusive tie into iTunes is as much, if not more, important to the success of iPod as the technology and the design. Business model -- not cutting edge tech -- was the key.

So where is the revolutionary new business model in the iPhone? I see tech; I see design; I don't see business model. Without the business model, I don't see the iPhone dominating a crowded space.

I may be wrong. As I have preached often in this blog, design and brand are important. In the iPhone, we have a natural experiment of these two concepts. We will see if they are important enough.

November trade in intangibles

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This morning's BEA trade data was relatively good as the overall deficit declined by $0.6 billion to $58.2 billion. I say relatively good as the deficit did not grow but remained essential unchanged. We are simply digging a hole at the same rate as last month. Once again, a decline in our energy bill was the bulk of the good news.

On the intangibles side, the surplus also remains essentially unchanged, increasing by a mere $67 million in November. Income from royalties (exports) increased slightly while royalties paid out (imports) remain flat. Exports of private services increased. Imports of private services also increased, but not as much as exports.

The deficit in Advanced Technology Products also improved slightly, declining by $370 million. This is a welcome change from last few months' increases. However, the deficit remains are about $4.5 billion.

All in all, an OK report. Nothing to write home about.

Intangibles trade-Nov06.gif

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.

Latest Supreme Court patent ruling

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This afternoon, the Supreme Court ruled in MedImmune v. Genentech in favor of MedImmune's request to challenge the validity of Genentech's patent in court. As the AP reports:

The decision "opens the courthouse door and lets people come in and possibly allows them to challenge, but it also leaves many questions unanswered," said Washington attorney George C. Best. The outcome, he said, will depend on how lower courts interpret MedImmune's contract with Genentech.

The Bush administration supported MedImmune, telling the Supreme Court that invalid patents can hurt efficient licensing, hinder competition and undermine incentives for innovation.

Corporations that are major patent holders backed Genentech, saying that creating a unilateral right for a licensee like MedImmune to challenge a licensed patent will destabilize thousands of existing patent settlements and license agreements.

While Tuesday's ruling focused on legal procedure, during arguments in a patent case in November several justices expressed broader skepticism about the current standard for granting patents and seemed to signal a willingness to make them harder to obtain. That case focuses on whether an invention is obvious and therefore ineligible for a patent.

Bottom line is that Court continues to rule that our patent system is seriously flawed and overrun with questionable claims. And they are making clear that if the Congress doesn't sort out the mess, the courts will.

The education agenda

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One of the items I forgot to include in my earlier listings of Congress's innovation/competitiveness agenda was education. And it will be an important part of the agenda: the No Child Left Behind Act is up for renewal this year. Congressional leaders (specifically Senator Kennedy, Chair of the Senate Health, Education, Labor and Pensions Committee and Congressman Miller, Chair of the House Committee on Education and Labor) met with the President yesterday. According to the New York Times, the meeting was amiable but differences over issues such as funding still remain.

I would hope that Congress would use the opportunity of the law's reauthorization to carry out a more fundamental look at education. As the recent TIME cover story described the problem, it is time to redesign the system. The recent report by the Commission on the Skills of the American Workforce (see earlier posting) did a good job of laying out the issue. That report should spark a broader debate on educational reform - including testing and standards under No Child Left Behind and all of the subjects that have been dropped from the class room.

In a report late last year, the Conference Board pointed out that the I-Cubed Economy requires students to have a multitude of skills:

Basic Knowledge /Skills

English Language (spoken)
Reading Comprehension (in English)
Writing in English (grammar, spelling, etc.)
Foreign Languages

Applied Skills

Critical Thinking/Problem Solving—Exercise sound reasoning and analytical thinking; use knowledge, facts, and data to solve workplace problems; apply math and science concepts to problem solving.
Oral Communications—Articulate thoughts, ideas clearly and effectively; have public speaking skills.
Written Communications—Write memos, letters and complex technical reports clearly and effectively.
Teamwork/Collaboration—Build collaborative relationships with colleagues and customers; be able to work with diverse teams, negotiate and manage conflicts.
Diversity—Learn from and work collaboratively with individuals representing diverse cultures, races, ages, gender, religions, lifestyles, and viewpoints.
Information Technology Application—Select and use appropriate technology to accomplish a given task, apply computing skills to problem-solving.
Leadership—Leverage the strengths of others to achieve common goals; use interpersonal skills to coach and develop others.
Creativity/Innovation—Demonstrate originality and inventiveness in work; communicate new ideas to others; integrate knowledge across different disciplines.
Lifelong Learning/Self Direction—Be able to continuously acquire new knowledge and skills; monitor one’s own learning needs; be able to learn from one’s mistakes.
Professionalism/Work Ethic—Demonstrate personal accountability, effective work habits, e.g., punctuality, working productively with others, and time and workload management.
Ethics/Social Responsibility—Demonstrate integrity and ethical behavior; act responsibly
with the interests of the larger community in mind.

If our educational system isn't giving our children those skills, it will guarantee that they are left behind. A law that purports to make sure no child is left behind needs to live up to its billing by including all the skills needed. Otherwise it is just empty rhetoric. And right now, according to the Conference Board (and others) our educational system doesn't seem to be doing the job.

This year we may have a chance to change that.

A New Urban Policy

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Yesterday, I mention the Brookings Institution's Urban Market Initiative. That program is one of the projects of Living Cities. Living Cities is a consortium of major foundations and financial institutions.

Living Cities rebuilds and revitalizes neighborhoods, improving the lives of the people who reside there by securing adequate housing, education, employment and shopping, safe streets and transportation. This generates more investment and enterprise. As cities provide more opportunities for their residents, they create greater opportunities to sustain America’s economic leadership in the decades to come.

Last November, Living Cities published a white paper on a New Urban Policy. Coming right before the election, this statement didn't get the attention it deserves. The paper outlines the framework for a National Urban Enterprise Act of 2007.
1. Lay out a vision of the federal role in urban policy;
2. Ensure consistency in federal funding;
3. Provide flexibility in the use of federal funds;
4. Enact a new competitive challenge grant;
5. Endorse requirements for performance measures;
6. Create a mechanism to assess all federal programs’ effects on cities; and
7. Establish a White House Conference on Cities.

The basis for this framework is to strengthen the ability of urban areas to use public-private partnership to leverage private investment dollars. The proposal calls on the Administration and Congress to maintain a consistent level of funding for urban economic development:

Nothing is more destructive to community economic development efforts than the lack of consistency in federal funds. Though federal dollars are often a small fraction of total project costs, they are usually the funds that get projects started. Major economic-development projects typically take ten years. It is very difficult for local decision makers to make plans over that length of time without confidence in the consistency of federal commitments. The annual uncertainty regarding federal housing and community development funds sets off a cascade of negative effects.

One of the other proposals is support for the President's Economic Development Challenge Fund. But unlike the Administration's position, which would reduce CDBG funding to pay for the new program, Living Cities is calling for $200 million in new funding.
Given the budget cutting that is needed to deal with the Federal deficit, I'm not sure that calls for new funding will get very far in the new Congress. But the call for a new urban policy and consistent funding for economic development should be listened to. Revitalized urban areas are a corner stone of the I-Cubed Economy. And Living Cities should be commended for attempting to make urban policy a national priority.

The Financial Times is reporting this morning that a trade deal may be in the works:

Negotiations between the US and the European Union have revived hopes that a deal can be struck on the stalled Doha round of world trade talks by the end of the month, according to EU and American officials.
Top US and EU negotiators have told the Financial Times they hope to achieve a breakthrough in the coming weeks, paving the way for an agreement with Brazil and India at the World Economic Forum in Davos this month.
. . .
Mr Bush and José Manuel Barroso, European Commission president, are expected to back the drive for a deal when they meet today at the White House.

This is not the first time that we have seen the resurrection of the Doha Round. And it is unclear whether this is a resurfacing of the Doha-lite suggestion (see my posting last year) which was heavy on manufacturing and services trade and light on agriculture.

Should this latest news of a breakthrough be true, it will come at the last minute before the President's trade negotiating authority expires. It also makes the Congressional agenda on the innovation/competitiveness issues much more interesting. Twenty years ago, the renewal of trade negotiating authority was the engine that drove passage of the 1988 Trade and Competitiveness Act. That legislation set in place the direction for our competitiveness policy (and many of the specific programs) up to the present day.

I'm not sure that legislation to implement a Doha Round agreement would have the same effect. Implementing legislation is complicated as it is, without having to carry the burden of a number of subsidiary policies. Those subsidiary policies, however, might be the only way that a trade agreement would pass Congress. For example, it is very clear that an expansion of trade adjustment assistance would be required. It is unclear whether expansion of math and science education or patent reform (two major components of the current competitiveness agenda) would be part of the deal.

Likewise, the Doha Round does not incorporate a number of the new globalization issues (see my 2001 paper After Doha: What The WTO Is Not Talking About).

Still, wrapping up the Doha Round (one way or another) would be a step forward. We could then start talking about the rest of the agenda.

Using alternative financial data

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Last month, the Brookings Institution and Political & Economic Research Council released a report Give Credit Where Credit is Due focused on ways credit scoring could be extended to those with meager credit histories. Bookings will hold a press conference/panel discussion on the report tomorrow. The findings were straight forward:

Mainstream lenders can use "alternative" or "nontraditional" data, including payment obligations such as rent, gas, electric, insurance, and other recurring obligations, to evaluate the risk profile of a potential borrower.

If adopted by credit rating agencies, the result will be an extension of financial resources (in the form of credit) to millions of Americans not in the financial mainstream. Missing, however, appears to be any recognition of the importance of intangibles - human capital, education, reputation - as a factor of creditworthiness. This point has even been acknowledged by one of the leading thinkers on building assets as a means of poverty reduction, Hernando DeSoto (see my earlier posting on DeSoto). These are the type of factors that credit officers (and local bankers) used to incorporate into their lending judgments. They are difficult to quantify and put into the mathematical credit score models. As the report points out, "objective" data gathered and analyzed by external organizations (credit bureaus) have supplanted subjective judgments, in large part due to the 1970 Fair Credit Reporting Act. While this has improved the process by reducing credit risks, it has left many out of the mainstream. Use of alternative data can improve the situation. But it is also important to look at how intangibles can be factored in to the decision in an unbiased fashion. We know that these intangibles have not disappeared completely from the decision process. Regularizing their input into the credit process would be a giant step forward.

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This report is part of the Brookings' Urban Markets Initiative. That project looks at new ways to use information to uncover and promote urban markets:

Imagine putting on a pair of glasses for the first time. All of a sudden, it is as if you have “new eyes”. The buildings and trees around you come into precise focus—every treetop leaf, every window, the print on that tiny sign in the window a block away, the smile of an infant in a stroller down the street. And with all the new information, you need to learn new ways to navigate, understand and manage what seems like a new world around you.

This is the predicament of America’s urban markets—most investors just don’t have the “new eyes” to clearly see the economic value in these markets. Urban neighborhoods have treasures that are too often unseen, including concentrations of retail spending power double or even triple those of nearby, affluent suburbs. But because the right information tools do not exist to demonstrate this potential, urban neighborhoods are invisible. Without the right tools and models to identify the resources and market potential of urban neighborhoods, investors pass them over.

The project has already produced a number of “new eyes” reports, including a September study in the urban informal economy: Measuring the Informal Economy - One Neighborhood at a Time.

Given the importance of information in the I-Cubed Economy, I can not say enough about this “new eyes” approach. I just wish it was extended to other issue areas as well.

New market indices

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Late last year, OceanTomo (who labels itself as an Intellectual Capital Merchant Banc) launched the Ocean Tomo 300™ Patent Index. The OT 300 is listed on the American Stock Exchange under the symbol OTPAT and traded as an exchanged traded fund (ETF) under the symbol OTP. According to OceanTomo's test, the OT300 has out preformed the general market indices in 10 years of back testing, and continues to outperform the general market in real time.

This index joins a growing number of other measures for tracking stock performance of I-Cubed companies. Sanjay Dalal over at the blog Creativity and Innovation has created a stock market index bases on the Business Week's annual survey of top innovative companies. The Innovation Index lists 20 North American companies that are publicly traded. While not a publicly traded index like the OceanTomo 300, this is a useful measure of how the innovative economy is doing. As of yesterday, this Index was up 3%.

A few years ago, the UK Design Council came up with there own Design Index, which outperforms the FTSE 100.

These new measures are but one part of the increased recognition of intangibles assets by the financial community. Activities to monetize intangible assets has increased dramatically in the past few years (see my earlier posting on Ford). These activities will only increase as the I-Cubed Economy continues to expand.

Congressional agenda

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The new 110th Congress convenes today at noon. On the Senate side, it will mostly be procedural - adopting the rules, appoint Committee Chairs and members, etc. In an unusual move, the Democrats and Republicans will meet in a joint caucus before hand to try to set a cooperative tone.

On the House side, the plan is for quick action on a number of issues. Speaker-to-be Pelosi has promised a "first 100 hours" strategy. As the Washington Post describes it:

Today, the House will take up an ethics package. Tomorrow, new budget controls. On Tuesday, the House will enact most of the security recommendations of the bipartisan commission that examined the Sept. 11, 2001, terrorist attacks. On Wednesday, the minimum wage goes up. On Thursday, it's federal funding for stem cell research, and on Friday, Democrats intend to give the government the authority to negotiate drug prices for Medicare. On Jan. 17, interest rates for student borrowers will be slashed, and on Jan. 18, tax breaks for Big Oil will go by the wayside, making room for alternative energy research.

Not included in that rush are a number of competitiveness and innovation agenda items that are sure to come up later in the Congressional session. The big three that were already teed up last year are:
   • funding for R&D and math/science education;
   • immigration, including H-1-B visas for high skilled workers; and
   • patent reform.

On the R&D/math & science issue, late last year then GOP Senate Leader Frist and Dem Leader Reid introduced a bipartisan bill to implement a number of suggestions of the National Academy of Sciences' Rising Above the Gathering Storm and the Council on Competitiveness' National Innovation Initiative reports (see my early posting). There are some glitches in that bill, such as the abolition of the Technology Administration in the Commerce Department. But I would expect that the Senate could take up the issue for a full scale debate early in the session.

On the immigration issue, things are not so harmonious. Expect new studies on all sides. Yesterday, a new study on the contributions of immigrants to technology entrepreneurship was released. According to news reports:

The report, based on telephone surveys with 2,054 companies and projections by researchers at the University of California at Berkeley and at Duke University, found that immigrants -- mostly from India and China -- helped start hundreds of companies with estimated sales of nearly $50 billion.
On the other side, the Center for Immigrations Studies is said to be preparing its own new report on how high-tech immigrates push down wages. According to these same news reports:
Jessica M. Vaughan, an analyst at the Center for Immigration Studies, said an increase in the [H-1-B] cap would amount to "a subsidy for business because it allows them to bring cheaper labor from overseas."

The fight over patent reform has shaped up to be a multi-sided battlefield. Some groups argue for patent reform, but can't agree on what should be done. The biggest split is between the IT industry and bio-pharma, which stalled legislative action in the last Congress. Added to that are those who want no changes, including some vocal (but apparently self-appointed) representatives of the small inventors. And then there is the Supreme Court, which is not waiting for Congress to act before wading into the fray. With all this pushing and shoving going on, it is not clear what will emerge.

That something needs to emerge this year is, to me at least, clear from the latest lawsuits. By now you have probably heard about the latest technology patent suit - this one concerning video over the Internet. What I find interesting is not the suit itself, but the reaction to it. Typical was this comment in the New York Times:

Legal experts said it was difficult to handicap Intertainer’s claims. “There are so many of these lawsuits nowadays,” said Eric Goldman, director the High-Tech Law Institute at Santa Clara University School of Law. “It is hard to figure out which ones are a serious threat and which ones are not.”
Mr. Goldman also said it was unclear what specific technology or service was covered by the Intertainer patent.
“I have the same problem with this patent as so many of the patents of the dot-com boom days: I don’t know what it means,” Mr. Goldman said.

Regardless of where you stand on the issue, I think it is clear that having a patent system that people don't know what it means can't be a good thing for the American economy. Fixing the broken patent system needs to be one of Congress' top priorities.

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Of course, as anyone who reads this blog with any regularity knows, I firmly believe that other actions are needed as well. Much is missing from the top three innovation items - and from the Democrats' stated economy agenda. For example, there is still no recognition in our "innovation" policy that innovation is much more than new technological gadgets. Our definition of innovation needs to be greatly expanded to foster all forms of innovation and innovation in all sectors of the economy. Likewise, we still don't appreciate the role design plays in economic competitiveness - and don't understand how public policy can help in that arena. And we still don't have a labor policy that treats workers as knowledge assets, rather then interchangeable parts in a huge industrial machine. We need to change our mindset on how we approach the I-Cubed Economy, before we can change our policies.

Two years ago, at the beginning of the 109th Congress, Government Accountability Office (GAO) released a report entitled The 21st Century Challenges: Reexamining the Base of the Federal Government. At that time, I highlighted some of the key issues, including the changing economy.

As new 100th Congress starts its work, let me renew my call for a Commission on the Future of the American Economy to take a new and fundamental look at our new situation. As I've stated before, the competitiveness challenges we face today are different from those of the 1980's. Let us recognize those new challenges - and craft new solutions.

    Note: the views expressed here are solely those of the author and do not necessarily represent those of Athena Alliance.

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