The Intangible Economy

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March 30, 2007

Why worry about trade

Brad DeLong has got me confused in his recent blog posting - Grasping Reality with Both Hands: Brad DeLong's Semi-Daily Journal: Potential Reasons for Worrying About Outsourcing/Offshoring

You see, trade balances. What we buy equals what we sell, in value. What we buy and what we sell can be goods, services, or property, but it balances. If we have a comparative advantage in nothing--and export nothing--then we necessarily have a comparative disadvantage in nothing--and import nothing. Trade is thus an opportunity for us to move workers out of occupations where we are least and into occupations where we are most productive.

This doesn't mean we shouldn't worry about trade. But it does mean that the right reasons to worry about trade are relatively specific and relatively small in number.

I see four reasons:
* First, we can worry about trade because we can worry about what trade does to our income distribution: perhaps we would be happier with our income distribution and assess ourselves as having a higher level of social welfare if we made some of the things we import at home and didn't make some of the things we export--even though each of our imports and exports makes narrow profit-and-loss getting-and-spending sense.
* Second, we can worry about trade because we worry about what trade does to external benefits from productive activity that boost growth: perhaps we would grow faster and become richer if we made some of the things we import at home and didn't make some of the things we export--because making some things produces increased worker skills and technological knowledge through unpriced, un-accounted for channels.
* Third, we can worry about trade to the extent that it amplifies the ability of our dysfunctional government to dysfunction: the ability to borrow from abroad to cover deficits may diminish the pressure on feckless politicians and their supporters to deal responsibly with fiscal policy.
* Fourth, we can agree that increased trade is good for the nation, yet believe that government has to play an active and aggressive role in providing social insurance and a measure of compensation to those ground exceedingly fine by the mills of globalization--and the rise of

It is not clear which of these reasons is behind Alan Blinder's current worries on outsourcing and offshoring. My worries about outsourcing are mostly (4). I worry somewhat about (2). But (1) and (3) are, I think, not on the agenda. Global outsourcing seems to me at least as likely to improve as to worsen the distribution of income. And the marginal amount of governmental fecklessness produced by access to global capital markets seems to me to be small.

What I don't understand are the three statements in the beginning:

1) "You see, trade balances. What we buy equals what we sell, in value. What we buy and what we sell can be goods, services, or property, but it balances.”
Yes, trade balances – and right now we are selling property to pay for goods and services. That is the age-old formula for bankruptcy (or what Buffet calls the sharecropper economy).

2) “If we have a comparative advantage in nothing--and export nothing--then we necessarily have a comparative disadvantage in nothing--and import nothing.”
Yes, when you have a comparative advantage in nothing you eventually stop importing - and we all know how pleasant an autarkic economy is

3) “Trade is thus an opportunity for us to move workers out of occupations where we are least and into occupations where we are most productive.”
How does it follow that if we have a comparative advantage in nothing, we can move workers into more productive occupations?

Theoretically, it is impossible to have a comparative advantage in nothing – because other countries will put all their resources into those areas (wine or cloth) where they have the comparative advantage, there by opening up some areas for us. Practically, however, countries follow absolute advantage – I’m better than you in both wine and cloth, so I’m going to make both and not bother with your imports.

What Blinder said yesterday was that the occupations we should be moving people into are in the non-traded sectors. Note that Blinder's work has been to show that there are fewer and fewer of this.

That is what worries me.

Posted by Ken Jarboe at 10:02 AM | Comments (1) | TrackBack

Valuing the workforce - not

How many times have we heard the phrase: "our employees are our most valuable assets?" Guess they don't really mean it. Bottom line is that workers are a cog in the machine -- as evidenced by Circuit City's announcement: Circuit City Cuts 3,400 'Overpaid' Workers:

Circuit City fired 3,400 employees in stores across the country yesterday, saying they were making too much money and would be replaced by new hires willing to work for less.

The company said the dismissals had nothing to do with performance but were part of a larger effort to improve the bottom line. The firings represent about 9 percent of the company's in-store workforce of 40,000.

"Retail is very competitive and store operations just have to contain their costs," said Jim Babb, a Circuit City spokesman. "We deeply regret the negative impact that was had on these folks. It was no fault of theirs."

Steven Pearlstein summed it up nicely Attempts to Trim the Fat Merely Cut at the Meat:

But if retail is as competitive as Babb says, you'd think a merchant might want to keep its best salespeople -- you know, the ones who know the most and have records of selling the most. That would be particularly true at stores where customers have lots of questions that need answering -- for example, those at a chain that sells major home appliances, flat-screen TVs and digital cameras.

Let me pull a Jim Cramer here -- SELL NOW. They obviously don't have clue and are grasping at straws.

Opps -- too late. Wall Street has already told us what it thinks. Circuit City dropped over 4% yesterday.

Posted by Ken Jarboe at 08:07 AM | Comments (0) | TrackBack

Needed -- a new trade policy - part 2

Yesterday, Alan Blinder, Jeff Faux and Fred Bergsten debated globalization on the Diane Rehm's show. I use the term "debate" loosely because, as is usual in these situations, they talked past each other.

1) Faux never acknowledged that trade agreements can have a positive effect. Yes Jeff, I agree that the situation is bad. As I've said before, the only good news on the trade deficit is that we are digging the hole at a slower rate. But not negotiating trade opening agreements with places like Korea will keep us in the same situation of still digging the hole. We don't need to completely stop negotiating agreements; we need to negotiate better agreements.

2) Bergsten never acknowledged that re-training is a best a half-hearted solution (if you are not creating jobs) and that wage insurance only works in limited circumstances. The unemployed worker who called in is never going to get back to $28 an hour -- he is not going to get back to where he was in a few years by taking a lower wage job and working his way back up as he learns the general and firm-specific skills. His wage insurance will be a partial subsidy for a few years and when he loses it, he will be worse off. Yes, Fred, trade has positive benefits but you have to be competitive to gain those benefits. And in this new economy of task-based competition, education and skill level alone aren't nearly enough.

3) Blinder went out of his way to re-assert his free trade ideology. But, his solution was the most protectionists of all -- retrain people to go into naturally protected jobs, i.e. in the non-trade sectors of personal services. Yes, Alan, but what happens as there are more and more losers who need to be placed in those fewer and fewer naturally protected jobs? And as our economy retreats into those naturally protected non-trade jobs, how do we earn the income we need to pay for our imports. A natural autarkic economy (which is what you end up with) is not much better than a politically imposed one.

And the discussion completely focused on the wrong thing -- job loss rather than wage competition. Fred completely ignored wage competition and pointed to the low unemployment rate as a measure of success. Alan mentioned it in the beginning as the real point to his analysis of offshoring -- and never brought it up again. Jeff simply asserted that trade increased inequality, but never explained how.

So -- the wise men are all blindly groping around the elephant.

Posted by Ken Jarboe at 07:14 AM | Comments (0) | TrackBack

March 29, 2007

Needed -- a new trade policy

Yesterday, there were a number of trade activities and articles. Lou Dobbs (and others) testified on Capitol Hill at the House Foreign Affairs Committee on Trade, Foreign Policy and the American Worker (something I had an indirect role in bringing about - but that is another story). The Wall Street Journal ran a front page story on how Alan Blinder (and others) are re-evaluating the free trade policy (Pain From Free Trade Spurs Second Thoughts). And Steven Pearlstein's column in the Washington Post (An Opportunity On Trade) outlined a potential Grand Bargain of joining a more effective worker retraining and adjustment policy with continued open markets.

Pearlstein is right when he starts by saying "We're at a crucial moment in U.S. trade policy." But neither his Grand Bargain nor the House hearings get at the core of situation.

Economic competition and trade is shifting from industries to tasks (as the organization of work continues to evolve). That is the point Alan Blinder and other raise (see Blinder's paper in Foreign Affairs- Offshoring: The Next Industrial Revolution?, the Grossman/Rossi-Hansberg paper at last summer's Fed Jackson Hole symposium - The Rise of Offshoring: It’s Not Wine for Cloth Anymore, and Baldwin - Globalisation: the great unbundling(s).

As that shift continues, a trade policy that tries to shift workers from one industry to another is bound to fail unless it deals with the fundamental competition between workers on the task level. And that competition is due to that fact that, as Pearlstein states, "even the best-paid workers in many of the best-behaved countries earn a fraction of the wages of American workers." Yet our entire trade policy is based on moving resources and workers from rising industries and out of declining industries (as evidenced by market winners and losers).

My frustration with the system is unless we deal with the task competition, all the retraining in the world won't help -- because our re-adjustment policy thinks it is shifting workers to new industries (supposedly where there is competitive advantage here so the jobs remain here) while it is actually re-training people into tasks were there may or may not be a US competitive. We will end up repeating the experience of the late 1990's of re-training folks for jobs in the computer industry exactly at the time when those tasks were beginning to come under intense wage competition.

As a result, taxing the winners to pay the losers (the standard solution to the downside of globalization) becomes an ever deepening hole - as there are no industries to shift the losers into, only tasks that continue to be subject to continued wage competition or are in non-traded sectors. And there in lies the second problem. As task competition increases, are the only jobs left for Americans only in non-traded sectors? If so, how do we then earn the income need to pay for our imports?

As Paul Craig Roberts has pointed out in Manufacturing & Technology News :

All advocates of offshored production for U.S. markets fail to explain how the United States can balance its trade and current account deficits when its work force is being redirected into domestic nontradable services. The United States has made it thus far, because the U.S. dollar inherited the reserve currency role after WW II. Although less inclined than previously, foreigners are still willing to accept U.S. dollars for real goods and services. This willingness is threatened by large and persistent U.S. trade and budget deficits.
(Tuesday, March 13, 2007 Volume 14, No. 5 - subscription required)

Obviously, I don't have an answer for how we get out of this box. My real problem is that we don't even seem to acknowledge that we are in the box. Labor and environmental standards (while I support) don't touch the issue. Neither does "new industries" - if most of those new industries consist mostly of tasks which are subject to global wage competition.

My hope is that the Grand Bargain isn't a splitting of hairs -- but a chance to re-evaluation our situation. I know the chances of that happening are slim - but I remain an optimist.

Posted by Ken Jarboe at 06:11 AM | Comments (0) | TrackBack

March 28, 2007

Valuing the workforce - highly

One of the most problematic valuations of an intangible involves the workforce. How can a financial metric capture the skills and knowledge, especially of a highly technical workforce. Partly for that reason, accounting rules explicitly forbid placing a value on an acquired workforce as part of a merger or acquisition -- while explicitly requiring the valuation of other acquired intangible assets.

Valuation experts say they can come up with a number for the workforce - based either on the replacement costs (what it would cost to hire the same set of skills). That, of course, does not take into account the organizational and interpersonal aspects of a team of workers.

Another way is to look at the market valuation. How much is the equities market willing to pay. That approach has its own difficulties -- as the DealBook blog of the New York Times points out (Blackstones Million Workers)

Are Blackstone Group’s employees really worth an average of $50 million apiece? That value, based on reports that the private equity firm could be worth $40 billion in an initial public offering, “could well be the highest bounty ever placed on the heads of office workers,” Breakingviews writes.

The Breakingviews article compares that level to the $10 million or so value placed on AOL and Google at the height of the dot.com bubble and the current $5 million per worker valuation of Moody's, which has a more sustainable business.

As is the case with other equities-based measures of intangibles, it is hard to separate the value from the froth.

Posted by Ken Jarboe at 09:00 AM | Comments (0) | TrackBack

Open source patent process - part 2

Earlier this month, I posted an item about a new Patent Office pilot project to use an open source method for patent information. On Monday I was at a presentation by Beth Noveck from New York Law School who is running the project, called Peer to Patent. The presentation provided additional clarification on the scope of the pilot.

Unlike how some have described it, it is not a Wiki but a much more controlled information gathering and sharing process based on many models – including Nature magazine's open peer review process. Nor is it the open ended post-grant review process that some fear. It is designed specifically to gather and evaluation information on prior-art. It will not deal with issues of the scope of the claims within the patent or about patentability -- although those may be added later.

Essentially, the system is designed so that participants may suggest cases of relevant prior-art, including a detailed description of the relevancy. Participant will then vote to rank the top ten cases, to be forwarded to the patent examiner. One of the evaluation criteria will be if the examiners feel the information is useful.

This pilot will be confined to software patents. Already GE, HP, IBM, Microsoft and Red Hat have signed up to have some portion of their future patent applications go through the process. As an incentive for companies to participate in the project (i.e. waive the requirement for no public comment), PTO will expedite those applications.

The pilot is not a substitute for the proposed patent reform legislation. In fact, for the open review system to work to its highest potential, several changes to current law that are in that legislation will be needed. First is universal publication of patent applications. Right now, the applicant can ask that the application not be made public. Obviously, that would prevent open source review.

Second, a change in the regulation is needed to allow comment. Right now, an outside party may submit prior art to the PTO in the patent examination process – but may not comment on the application or that prior art. Thus, there can be no description of why the prior art is relevant. The applicant can waive this requirement to allow public comment. This is how the pilot program gets around the regulation. Thus, the pilot project is completely voluntary. But for the system to work to its fullest potential, public comments needs to be allowed in all cases.

Third, the fear of being found guilty of willful infringement needs to be reduced. Scientists and company experts might be hesitant to participate, for fear that reviewing applications would be used later as evidence that they had knowledge of some invention beforehand willfully infringed on the patent.

All three of these were in the proposed patent reform legislation from last year.

Noveck would also like a change in the scientific grants process – to have scientists who review grant application also review the patent applications based on that research. My own bet is that the process will attract grad students like flies to honey. It will provide an excellent platform for bright young students to get the early recognition as an expert in their field needed to launch successful career.

IBM is already encouraging its employees to participate. The IBM representative at the presentation said that willful infringement does not apply to reviewing applications – only knowledge of a granted patent. IBM’s participation should reduce that fear of willful infringement.

One thing to watch as the pilot unfolds is its effect on valuations. This could be a big incentive to participate in the program: to get a stronger patent. Those who participate can legitimately claim they have a strong patent with greater certainty and less chance to be challenged later on. As a result of greater certainty, the valuation should be higher. That, in turn, will be a spur to the growing movement to monetize intellectual property.

Posted by Ken Jarboe at 08:27 AM | Comments (0) | TrackBack

What's in a number

What is in a number? Lots of hidden value if that number is 212. According to a story in the Christian Science Monitor (Backstory: In area codes, 212 is the only-est number), phone numbers with the Manhattan area code are selling a prices starting at $250 and ranging as high as $9000 to someone in Los Angeles. The reason:

"If you had to assign a number to the center of the universe in the American mind, that number might as well be 212," says Robert Thompson, a professor of media at Syracuse University in New York. "It's probably one of the most intensely imagined square miles in the nation, and to a degree, in the world."

I think I will stick with my 202 area code. Maybe I should even stock up. You know -- 202, Washington DC, capitol of the free world, same starting number as the White House and the Congress . . .

Then again, it may not have the same panache. As the Monitor points out:

The geographic diversity of [number reseller Sal] Pugliese's clientele only seems to validate what New Yorkers have always said: Civilization has a center, and they live in it. But instead of bodily moving to the concrete jungle – an old-fashioned notion in a cyberenabled world – this new generation of aspiring New Yorkers simply obtains the city's area code. With three simple digits, they tap into the glamour of "Sex and the City," Wall Street, Broadway, and P Diddy. They've made it.

Such is the power of intangibles.

Posted by Ken Jarboe at 07:51 AM | Comments (0) | TrackBack

March 27, 2007

User-driven innovation - part 2

To follow on yesterday's posting, there was another interesting point in Fitzgerald's Sunday New York Times piece (How to Improve It? Ask Those Who Use It) on user-driven innovation:

One problem with the user-innovation model is that it can run into intellectual property rights protections. But the potential for creating new companies has led the government of Denmark to establish user-driven innovation as a policy. It found that Danish companies tended not to push for technological innovation, so user innovation may be the way to help them compete more effectively in a global economy.

The Danish government's October 2005 report - User-Driven Innovation - Results and Recommendations highlights not just technology innovation -- but product design. They specifically look at three industries in the US: electronics, medical devices and fashion. The results were seven recommendations:

1. Establishing an interdisciplinary education in user-driven innovation.

It is recommended that an interdisciplinary education be established, uniting academic disciplines necessary to analyse and assess customer needs and customer experiences.

Academic disciplines include psychology, sociology, ethnography and anthropology; disciplines that all relate to people, communities and society. A common deniminator for the disciplines could be human factors. The education may be designed as a superimposed course and could be offered as a graduate or master degree. The programme should be tied to a faculty, whose academic record creates a platform for research and education in human factors and related tool subjects.

2. Research. It is recommended that a university research institute supported by significant government funds that could spear-head research in the areas of human factors and consumer behaviour be established. High-quality research could also support a human resource master degree.

In the academic disciplines that constitute human factors, research constantly gains new insights. It must be expected that research in factors that motivate human behaviour may provide valuable insights. Often research is carried out in the cross section between the various disciplines.

The research institute should be established in a university with a strong record in human factor research.

3. Educational programmes in existing education. It is recommended that a short, yet comprehensive, educational programmes in the area of human factors be established. Innovation is more and more becoming a team-discipline, which necessitates the involvement of various professional skills and cultures. If user-driven innovation is to make a significant impact it is vital that different academic groups have a profound knowledge of human factor disciplines.

4. Life-long training. It is recommended that an extensive life-long learning programme in the area of human factors be established. Public co-financing of new courses in human factors could be tied to the supply of such programmes.

The organisation of life-long learning in human factors should be carried out in close cooperation with regional companies. The regional companies should also co-finance the strengthening of their employees’ skills.

5. Knowledge- and innovation centres. It is recommended that universities and other knowledge institutions in close cooperation with private companies establish knowledge and innovation centres, where interdisciplinary research teams can work with user-driven innovation and new technology in areas of interest to the Danish business community.

Basic research provides the core foundation for the research efforts, but should be supplemented by applied research when fulfilling the full potential of the basic research.

As new technology became a key competitive element, new institues emerged whose core purpose were to make proper use of basic research in natural science. The Academy for Technical Science is one such institute.
The increased focus on customer understanding will be an important source of competitiveness in the future. This is supported by recent developments in leading business clusters around the world. The practical use of human factor knowledge will be a key competitive factor in the future.

This may be approached in a variety of ways. The latest initatives coming out of Stanford are inspiring. Stanford University has set up 3 knowledge and innovation centres; Bio-X, Media-X and d.school. The centres are built on an interdisciplinary approach and aim to strengthen co-operation with the business community with regards to specific innovation projects. Bio-X focuses on biotechnology; however, the research efforts are combined with other research areas. Media-X is primarily focused on media research, but will also involve other research areas. d.school is a design centre which aims to combine design knowledge with customer understanding.

The university provides access to the necessary facilities but leaves it to interdisciplinary teams to compete for research facilities. The university then selects the most promising research projects. The three centers place emphasis on co-operation with private companies on specific innovation projects.

Other US universities have applied a similar approach. CITRIS at Berkeley is currently planning a research- and innovation project with the Alexandra Institute at Aarhus University, which in time will involve the participation of Danish and US companies.

The creation of interdisciplinary knowledge and innovation centres should take into account unique Danish skills and the structure of the Danish business community.

We recommend that a number of knowledge- and innovation centres that combine research on human factors with natural science, technical and commercial disciplines be established. The centres could potentially cover areas such as foods, health, medicine and medical devices, electronics, IT, energy and environmental technologies, fashion and housing. It should be made a condition that research and knowledge building is interdisciplinary and that the centres cover concrete innovation projects with the participation of private companies. To secure a coupling a knowledge building and business demands, the establishment of knowledge and innovation centres requires co-financing from the business community as well as from local authorities.

6. Networking. It is recommended that autonomous network organisations that may promote a networking culture within Danish business clusters be established. This will necessitate a public-private partnership, as public institutions often assume important roles in knowledge networks.

The networks are increasingly important to a company’s knowledge and competence building. Strong networks are thus important factors in economies, where innovation has become the key competitive element.

The analysis confirms that large companies and companies in strong business clusters have a proven track record in the area of user-driven innovation.

The analysis confirms that the Danish networking culture is underdeveloped as compared to the world’s leading business clusters. While this is hardly surprising, it underlines the need for a stronger Danish networking culture. A stronger Danish cluster creation will increase the proliferation of user-driven innovation.

The report highlights specific examples of autonomous international networking organisations. This is in line with several business analyses which shows that the presence of autonomous networking organisations is a precondition for the creation of strong networks.

Companies and knowledge institutions with a commercial interest in network knowledge sharing are not capable of running the network. The risk of a conflict of interest is too large. This also applies to traditional industry organisations, since they are supposed to manage their members’ interests. In Denmark and abroad we find examples of independent network organisations that have been established as public-private partnerships, but there appears to be a demand for additional networks.

7. Networking architects. It is recommended that courses in regional development and cluster creation be offered.
It requires a specific set of skills to successfully run a network. Among other things networks require interpersonal skills, as well as more down-to-earth tools. The increased focus on networks and the emergence of networking organisations underline the need for developing and communicating tools for network facilitators.

The seven recommendations presented above will strengthen the innovation efforts of Danish companies. User-driven innovation is merely one element in the renewal process that companies will have to address across the entire value chain. However, when looking at the markets where Danish companies compete, user-driven innovation remains one of the key factors in increasing competitive powers. A dedicated effort may propel Denmark to become one of the world’s most advanced countries in the area of user-driven innovation.

I was especially pleased to see the attention given to "knowledge centers" such as the Stanford University d.school. Too bad it doesn't get the same attention from policymakers here in the US.

It should be noted that the Danish strategy is not just based on user-driven innovation, but on entrepreneurship (see the July 2005 presentation)

One other organizational part of the Danish strategy is the
Danish User-centered Innovation Lab (DUCI lab) -- a collaboration between faculty at Copenhagen Business School, Aarhus School of Business and Massachusetts Institute of Technology, based at Copenhagen Business School. Supported by both companies and the government, the lab works directly on best practices in user-driven innovation (Erik von Hippel is on the lab's staff).

It remains to be seen whether Denmark will be successful. Fitzgerald notes:

Skeptics argue that Denmark is both small — population, 5.4 million — and a backwater of innovation, and thus has little to lose in trying something new. They might also point out that even in Denmark, Mr. von Hippel’s ideas are up against more conventional forms of user-aided design, such as sending anthropologists to study how people use products in their daily lives. Companies then translate their research into new designs.

I have to say that, however, that those "skeptics" may not know what they are talking about, especially if they describe Denmark as an innovation backwater. Not only is that incorrect, but the latest EU Innovation Scorecard listed Denmark as an innovative leader, while the US was ranked as an innovation follower.

Maybe Denmark is an innovation leader because of its innovation strategy that embraces bottom-up innovation? Maybe the US should think about that? Just maybe . . .

Posted by Ken Jarboe at 08:36 AM | Comments (0) | TrackBack

March 26, 2007

Update - anti-trust v. IPR

Update --
Ruling May Be End for Vonage - washingtonpost.com:

A federal judge yesterday [Friday] dealt a potentially fatal blow to Vonage Holdings, the Internet-phone service that offers one of the few alternatives to traditional carriers, by ordering it to stop using a technology that connects its network to the public telephone system.

The injunction does not take effect immediately. The judge ordered a hearing in two week's on Vonage's request for a stay. And Vonage says it is proceeding with a work-around. I also think it is possible that this will go to at least one level of appeals to see if the ruling conforms to Supreme Court decision in the eBay case on requirements for an injunction.

So, there is still a long way to go on in this case. As I mentioned earlier, this case highlights the tension between anti-trust/competition policy and IPR. Round one goes to IPR.

Posted by Ken Jarboe at 08:54 AM | Comments (0) | TrackBack

User-driven innovation - part 1

Sunday's New York Times had an interesting piece by Michael Fitzgerald on user-driven innovation and the work of Erik von Hippel at MIT - How to Improve It? Ask Those Who Use It:

Mr. von Hippel is the leading advocate of the value of letting users of products modify them or improve them, because they may come up with changes that manufacturers never considered. He thinks that this could help companies develop products more quickly and inexpensively than with their internal design teams.

“It could drive manufacturers out of the design space,” Mr. von Hippel says.

It is a difficult idea for research and development departments to accept, but one of his studies found that 82 percent of new capabilities for scientific instruments like electron microscopes were developed by users.

As I have written earlier about bottom up innovation and Von Hippel's work, it raises some important ideas about our innovation system. Most of his ideas I agree with. However, I have to disagree with the though that user-driven innovation will "drive manufacturers out of the design space." If anything, it will do the opposite - as those companies without extensive design will be forced to seek out user-driven innovation and incorporate it into their products. A story in the Washington Post from a couple of years ago (Tapping Into Tinkering) pointed out how user modification of products is an established part of the US innovation system:

Fans of the TiVo digital video recorder have discovered how to break it open and install a larger hard drive. Early users of the Roomba, a robot vacuum cleaner, are rewiring it to serve as a "mobile security robot." Owners of the new Sony PlayStation Portable have figured out how to use the game machine to surf the Internet and exchange instant messages.
. . .
Sometimes, tinkerers become a consumer electronics maker's unofficial research-and-development team, with innovations winding up as built-in features down the line.

TiVo's most ardent fans came up with a way to record TV shows by sending commands via the Internet long before the company got around to officially offering that feature.

And before the iPod was the ubiquitous gadget it is today, early users of Apple's digital music player enabled it to store addresses and text files -- a feature the company now promotes.

Customers also came up with the idea of recording their own talk and music shows and making them downloadable for the iPod -- a phenomenon called "podcasting" that has become so popular that Apple recently rolled out software to streamline the process.

Americans have always liked to fiddle with things, from building better ham radios to juicing up car engines in the driveway. The urge fuels a multibillion-dollar industry in after-market auto parts, and automakers keep a close eye on how enthusiasts find new ways to use their products. Mitsubishi Motors, for example, sponsors teams that modify its Lancer Evolution performance car for auto shows.

Companies that let others seize that innovation are not going to survive. Or they will become simply contract manufacturers surviving in low wage locations. So the net effect will be an increase in design intensity of US firms.

And that would be a good thing.

(More tomorrow on a country that has embraced user-oriented innovation as a national policy).

Posted by Ken Jarboe at 08:22 AM | Comments (0) | TrackBack

March 23, 2007

Defending financial innovation

David Leonhardt defends financial innovation (Once Again, Debt Is Miscast as the Villain - New York Times):

But whatever happens, it’s important to remember that the mortgage market is following a classic cycle that nearly every other form of consumer credit has also followed. When somebody comes up with an innovation, be it consumer loans, credit cards or creative mortgages, it inevitably leads to an explosion of borrowing that includes a good amount of excess and downright abuse. After the abuse is cleaned up, though, most families end up better off.

I hope we will keep that thought in mind as we go through the normal orgy of outrage and blame-finding -- which has already started (see Senate Questioning on Mortgages Puts Regulators on the Defensive - New York Times and Fed Faulted For Inaction On Mortgages - washingtonpost.com

Posted by Ken Jarboe at 09:37 AM | Comments (0) | TrackBack

China and technology

The Wall Street Journal has discovered an interesting idea -- Soon Made in China: High-Tech Products:

China is demonstrating a surprising ability to parlay its dominance in low-end manufacturing into a new strength in producing sophisticated high-tech goods.
Already the place where many of the world's computers and mobile phones are put together, it is expected to become home to a multibillion-dollar integrated-circuit plant run by Intel Corp., the world's biggest maker of computer chips.
The speed at which China is moving into more-complex manufacturing is a sign that its transition from a low-wage economy making cheap goods to a high-wage economy producing valuable ones may not be as difficult as once thought.
. . .
The electronics business is one of the main areas in which the transformation of Chinese manufacturing is taking place, and foreign investment is crucial for those changes. This deal also illustrates the force behind that transformation: The critical mass that China has built up in the labor-intensive, but relatively simple, assembly and manufacturing of many products is now allowing it to attract higher-value parts of those businesses.
. . .
The pattern in electronics is also seen in other industries. Chinese steelmakers have recently begun producing types of high-end processed steel that previously had to be imported. The car business has gone from near-total reliance on imported parts to heavy use of components made and designed at home.

So -- tell us something new. Many of us have been talking about the Chinese technological evolution for years. I am constantly surprised that people are surprised. There are many challenges facing the Chinese economy. But there is little reason to believe that they don't have the ability to transform from a low cost to a high-value added producer.

Posted by Ken Jarboe at 09:33 AM | Comments (0) | TrackBack

March 22, 2007

Thoughts on copyright

From James Boyle -- FT.com / Comment & analysis / Comment - Rocks in the web’s safe harbours:

When we are dealing with intellectual property, how do we know who is a trespasser and who is a greedy landowner trying to enclose the public right of way? First lesson, analogies to physical property – like the one I just used – are dangerous. Most of these disputes are about whether a new market, enabled by technology, should lie inside or outside the scope of the artificial monopoly conferred by the intellectual property right. Because these rights are created for a purpose – to foster and disseminate science, innovation and culture – there are inevitable “should” questions involved.

From Walt Mossberg -- Personal Technology - WSJ.com

I am not a lawyer, and I have no idea how this lawsuit will wind up. I suspect it is mainly a bargaining tactic by Viacom. But I know one thing: This fight isn't primarily about consumers and their rights, and its outcome won't necessarily make things better for Internet users.

. . .

Most honest people wouldn't consider it piracy to buy a CD, copy it to a computer and email one of the song files to a spouse or friend. But the record industry, backed by the laws it essentially wrote, does. Most honest people wouldn't think that uploading to YouTube a two-minute TV clip, which they paid their cable company to receive, is piracy. But Viacom, backed by the laws its industry essentially wrote, is demanding that Google remove all such clips.

. . .

As a nonlawyer, I think these clips seem like "fair use," an old copyright concept that seems to have weakened under the advent of the new laws. Under fair use, as most nonlawyers have understood it, you could quote this sentence in another publication without permission, though you'd need the permission of the newspaper to reprint the entire column or a large part of it. A two-minute portion of a 30-minute TV show seems like the same thing to me.

But why should I have to guess about that? What consumers need is real clarity on the whole issue of what is or isn't permissible use of the digital content they have legally obtained. And that can come only from Congress. Congress is the real villain here, for having failed to pass a modern copyright law that protects average consumers, not just big content companies.

We need a new digital copyright law that would draw a line between modest sharing of a few songs or video clips and the real piracy of mass distribution. We need a new law that would define fair use for the digital era and lay out clearly the rights of consumers who pay for digital content, as well as the rights and responsibilities of Internet companies.

Add copyright to the growing list of things Congress needs to act on in order to catch up to the I-Cubed Economy -- right after they finally deal with patents.

Posted by Ken Jarboe at 09:06 AM | Comments (0) | TrackBack

Financial competitiveness - part 5

From the New York Times' financial industry blog DealBook Big Ben Versus the Big Apple: Another Take come this insight on our financial competitiveness:

In comparing Wall Street now to the Wall Street of the dotcom boom, people often forget one issue: The wealth then grew largely from a slew of stock offerings that should never have happened. What happened then in New York is taking place now in the foreign exchanges, according to Jeffrey Garten, a professor of international economics at Yale:
"When you analyze why London is getting more than its share of IPOs, you realize that a lot of them really should not be listed in the U.S., given our tradition of investor protection. Many come from emerging markets, particularly Russia and China. By any standards, they lack accounting rigor and transparency."

This reminds me of the classical study of industrial policy using the case of the NE fishing industry. The industry set its benchmark as the high point during WWII when meat was scarce and the demand for fish artificially high. Sometimes the industry just doesn't understand the situation.

By the way, the DealBook has published a number of items on the health of the financial markets.

Posted by Ken Jarboe at 08:02 AM | Comments (0) | TrackBack

March 21, 2007

Did you know

This presentation is making the rounds in the blogsphere and elsewhere. While I would take some of the predictions at the end with a large grain of salt, it has some thought provoking statements.

Posted by Ken Jarboe at 01:44 PM | Comments (0) | TrackBack

Asset or liability

The Conrad Black trial (see Washington Post, the WSJ and the New York Times) has drawn attention to a little publicly known but widely used intangible -- the non-compete agreement. In most cases, companies require workers to sign an agreement stating that they will not go to work for a competitor during a certain period of time. It is a way for a company to protect "its" intellectual property that resides in the skills and tacit knowledge of the workers. The concept raises interesting questions as to who really owns the IP -- the worker or the company.

It also raises questions about the transfer of knowledge. California does not enforce non-compete agreements - claiming that they are an illegal restriction of trade. The case can be made that this feature was an important part of the growth of Silicon Valley, because it allowed workers to leave one company to quickly start another. Image an alternative history where in 1957, William Shockley could have prevented 8 engineers from leaving Shockley Semiconductor to form Fairchild Semiconductor. Company hopping and spin-offs of spin-offs are a way of life in Silicon Valley - non-compete agreement literally notwithstanding.

But for the rest of the world, non-compete agreements are standard operating procedure. The Lord Black trial highlights the reverse aspect of non-competes: the non-compete payment. Payments are given to key employees to prevent them from working or setting up a competitor. Black and others are accused of fraud for arranging, without Board approval or understanding, for non-compete payments when they left the company. The prosecution likens this to extortion.

A 2004 Washington Post story on Fairchild's former CEO sheds some more light on the practice:

Noncompete payments are commonly made to employees with critical knowledge of a subsidiary's operations or customers, said John F. Olson, a corporate lawyer at the firm Gibson, Dunn & Crutcher LLP. Speaking generally, Olson said they are not typically awarded to chief executives who are primarily investors, financiers or turnaround specialists. He added that they can be used as inducements to get executives or major shareholders to go along with a deal.

"The burden of proof is really on the board to explain why that money belongs to the executives and not to Fairchild's shareholders," said Nell Minow of the Corporate Library.

John C. Coffee, a professor at Columbia Law School specializing in corporate law, said that, as a general matter, non-compete payments to chief executives or controlling shareholders when a subsidiary is sold can be a means of diverting to those individuals money that should go to all the shareholders as part of the sale price.

- - -

For those of us interested in how intangibles show up on the balance sheet, this is a good reminder that assets can be liabilities as well.

And for those of us who are interested in political economy, it is a reminder of the split between executives and workers. Workers sign non-compete agreements that require they give up certain intellectual property rights as a condition of employment; executives sign non-compete agreements requiring the company pay them for those intellectual property rights.

Very interesting.

Posted by Ken Jarboe at 09:15 AM | Comments (0) | TrackBack

March 20, 2007

Losing talent

Speaking of wasted brain power (see yesterday's posting), the most recent In The Lead column in the Wall Street Journal looks at how Managers Lose Talent When They Neglect To Coach Their Staffs:

Rather than worry so much about the war for talent in today's tight job market, executives ought to focus on the waste of talent in their ranks. Many don't spend nearly enough time making sure the people under them learn and grow on the job.
. . .
A key differential between a staffer who feels like a valuable part of a company and one who is disengaged is the quality of leadership in their workplace. Most engaged employees work for managers who spend a big chunk of their time helping their subordinates succeed. Managers who focus on talent assign their employees to jobs that play to their strengths, make sure they have the resources they need to perform well, respect their opinions and push them to advance.

The piece goes on to talk about the need to develop talent -- including helping people grow into their jobs. In this day of job hopping and quick layoffs, the concept of growing talent may seem like a left over from the era of large hierarchical organizations and life-time employment. But it shouldn't be.

In the I-Cubed Economy, on-the-job training is key to any organization's success and sustainability. That training includes all facets of the workforce, not just technical skills. Skill development and energizing the workforce is a major task of a manager - which is often overlooked in the day-to-day crunch. But a good manager wouldn't let the organization waste a lot of money and resources just to get the daily job done. And wasting talent is just as bad as wasting money. It is just more invisible (which points out the need for better internal information on intangibles -- but that is another story).

The good managers get it and work on developing their internal talent. And the bad ones -- end up as models for Dilbert cartoons.

Posted by Ken Jarboe at 11:04 AM | Comments (0) | TrackBack

March 19, 2007

Illiteracy and un-economic development

I have been involved with economic development in the District of Columbia for a number of years. With all the technology and economic boom in the Washington area, DC itself is something of the hole in the middle of the doughnut. There has been a construction boon in the District -- but the technology companies (and others) are locating in the suburbs. This is, ironically, in part a consequence of the construction boom -- as more and more A-space office building are built and rents reach the level that only high priced lawyers, lobbyist and first-tier defense contractors can afford. As property values continue to rise, small guys can't afford either the rent or the property taxes (if they were lucky enough to have bought years ago).

The other part of the problem has been worker skills. DC is in the middle of a political battle over the schools -- with the Mayor seeking direct control and the elected School Board fighting back. Both sides agree that DC public schools have failed DC children and that something needs to be done now.

But the school issue is for future generations. What about the workforce here and now? On that score, DC is about to get some devastating news. According to a story in today's Washington Post (Illiteracy Aid Found To Lag In District):

Only 8 percent of District residents with the lowest literacy skills get the remedial assistance they need, according to a new report by the State Education Agency.
. . .
The State of Adult Literacy Report, scheduled to be delivered to the mayor and D.C. Council members today, found that nearly 36 percent, or 170,000, of the District's residents are functionally illiterate, compared with 21 percent nationally.

The news is even worse in some areas. In the poorest Wards, the literacy rate is almost 50%.

The economic consequences are terrible:

The D.C. Chamber of Commerce, which contributed to the report, said the District lost up to $107 million in taxes annually between 2000 and 2005 because of a lack of qualified job applicants.

The second irony of this situation is that the Washington region is one of the most educated areas in the country. DC itself is home to a number of major universities (Georgetown, George Washington, Howard, American, Catholic, etc), with others nearby (Maryland, George Mason, Johns Hopkins).

The new Mayor likes to say that Washington should be a world-class city. But it won't be without a world-class workforce. And that workforce has to encompass both the top and bottom levels. Right now, raising the bottom needs to be our focus. In the I-Cubed Economy, there is no excuse for functional illiteracy. As the slogan of the United Negro College Fund goes, "A mind is a terrible thing to waste." Brain power is our most important asset. We can't afford to lose any of those minds -- in DC or elsewhere.

Posted by Ken Jarboe at 08:05 AM | Comments (0) | TrackBack

March 16, 2007

Fleeting - and faked - reputation

Reputation can be one of the most enduring - and the most fleeting - of intangibles. It is also one of the easiest to fake. The "confidence game" has been practices for all of human history. And it is part of the Internet system, as we are all aware every time we check our e-mail. In the digital age, the con has taken a new twist on an old game - use the victims strengthens against themselves - as the Washington Post explains (The Ol' Bait and Click):

But users have repeatedly found ways to inflate or wholly fabricate their reputations. The online encyclopedia, Wikipedia, was thrown into turmoil late last month after users learned that one of the site's major editors was not a tenured university religion professor as he claimed in his online profile but a 24-year-old college dropout. At Amazon, a computer glitch three years ago inadvertently exposed the real names of reviewers writing under pseudonyms. Some turned out not to be disinterested literary judges but authors giving their own books glowing reviews to boost sales.

The scams take countless and ever more ingenious forms. These include intimidating other users who give negative ratings by threatening to retaliate with negative feedback of their own. Some con artists also create false secondary accounts, known as "sock puppets," that a cheat can use to give himself fake positive feedback. It also includes piling up legitimate positive reviews and then closing in for the kill as an eBay seller from New Jersey called "malkilots" did to nearly three dozen would-be camera buyers, including the bidder from Georgia.

According to the story, "malkilots" sold hundreds of $20 memory cards to gain an excellent reputation, then switch to selling expensive camera's that never arrived. And this was not an isolated instance:

John Morgan, a business professor at the University of California at Berkeley, said his research found that 526 eBay sellers posted more than 6,500 listings on the site during the second half of 2005 for low-priced or seemingly valueless items in an apparent bid to inflate their feedback reputations.

"Such a listing makes no economic sense unless the seller is trying to increase his feedback rating," he said.

Morgan and co-author Jennifer Brown found one vendor called "thelandseller" who posted 304 such listings -- offering to sell a riddle in return for a penny and positive feedback. Then, with his inflated rating, "thelandseller" went on to try selling several undeveloped pieces of property in the southern United States whose starting bid prices were in the thousands of dollars.

With the amplifying power of advanced information and communications technology, a simple con can rake in a lot. And with "reputation systems" replacing face-to-face interactions, the game gets much more technical. It also creates new demand for "reputation protectors":

While sites like eBay and Amazon use ratings to help conduct commerce, a new start-up called Rapleaf is a general Web site devoted to tracking people's reputations and trustworthiness on and off the Internet. Auren Hoffman, Rapleaf's chief executive, said the site weaves together different types of information about individuals, making it more difficult for cheats to game his system. But he expects them to keep trying.

"Fraudsters get more sophisticated," he said. "It's always an arms race."

That should be a warning to others who are setting up on-line exchanges. For example, the Patent Office is already working on ways to protect the integrity of their pilot open patent review system (see earlier posting). I hope they build in a strong reputation checking system. With the stakes in patent claims growing higher, the incentives to con the system will only increase.

Posted by Ken Jarboe at 08:42 AM | Comments (0) | TrackBack

March 15, 2007

Are tractors high tech?

Some of you might recall that in my last posting on the intangible trade numbers, I briefly mentioned an odd note in the advanced technology numbers. The numbers for advanced technology exports, specifically in aerospace technology and in information and communications technology, were down. Yet, the capitol goods account shows an increase in exports of civilian aircraft and computers. Part of the answer is in the definition of advanced technology produced. As a recent New York Times story (Catching a Wave of High-Tech Exports) points out, a number of exports we don't normally thing of as high-tech really are. Take for example tractors:

Ask people in Waterloo, Iowa. There, at a factory, thousands of workers are building high-tech John Deere tractors that are equipped with satellite-tracking technology and are intended for export to China, India, Central Europe and the former Soviet republics in Central Asia, among other destinations. Foreign sales of these tractors have doubled in the last five years. “There are more lines of computer code in these tractors than there is in the space shuttle,” says Dave Everitt, president of the North America, Australian and Asian regions of the agricultural division of & Company">Deere & Company.

Although the cheaper dollar has helped, particularly in sales to Western Europe, the tractors are selling because they can be guided precisely by satellite and because of an “intelligent power” system that can provide extra horsepower when needed while still meeting emission requirements. “We are not competing on cost. We are not competing on volume,” Mr. Everitt says. “We are competing on providing value to the customer.”

Deere makes midrange tractors in Brazil, China, Germany, India and Mexico, but the larger, more sophisticated ones are made in the United States.

I have always been concerned that we throw around the label "high-tech" rather carelessly -- especially when we label sectors. Thus, the steel industry and the automotive industry back in the 1980's were considered low-tech, sunset industries not worth saving. The future was in high-tech industries like semiconductors. But, change the label from "steel" to "metallurgical materials" and you can see that there is a portion of the industry that can be innovative, cutting edge.

We need to recognize that any industry can be high-tech. It is just a matter of how much innovation and knowledge creation we push in that area. Years ago, I tried telling people about the new research in radio waves. Forget about it, I was told. Radio was an old technology. Substitute the word "wireless" for "radio" - and your whole perspective changes. And that isn't even touching upon the new radio-frequency identification (RFID) technologies.

Point being, let's not right off any sectors or industries. Innovation and creativity is everywhere. Our national innovation policy needs to recognize that fact.

Posted by Ken Jarboe at 08:39 AM | Comments (0) | TrackBack

March 14, 2007

Location, location - and the need for new thinking

Yesterday's New York Times nicely sums up the recent Halliburton announcement in The Death of Geography? :

A handshake can still trump a videoconference. The energy services giant Halliburton announced on Sunday that it will move its corporate headquarters and its chief executive, David Lesar, from the old boomtown of Houston (Texas) to the rising boomtown of Dubai (United Arab Emirates). The move sends the message that even in the new economy, some of the old rules still apply, including that location matters.
. . .
The company will remain incorporated in Delaware, other executive officers will stay put in Houston, and, the company insists, there will be no tax benefits from its move. Halliburton — which is spinning off its embattled military contracting subsidiary — says it wants to focus on energy. And as the saying goes, it’s going where the oil is.

That stands in conflict with the popular notion that the wired world has made geography irrelevant. But all the Blackberry devices and Internet phone calls in the world can’t make up for in-person interactions. That’s not just for old-economy companies like Halliburton either. Silicon Valley continues to act as a leading incubator for high-tech start-ups. Once you have a critical mass of software engineers and venture capitalists attending the same happy hours, a certain ferment takes place. News spreads fast in person, not just on MySpace. As a result, a city with a strong concentration of companies and a trained labor force — like New York in finance — can maintain its position within an industry.

However, The Economist asks the question, "Does the location of a company's headquarters matter any more?" They cite a number of examples where companies have split up their operations:

Wall Street banks have started shipping senior people from New York across the Atlantic in a nod to London's growing financial clout. Nokia, Finland's mobile-phone giant, has splintered its top ranks in the opposite direction: four members of its 11-strong senior management team, including the chief financial officer, are based in New York state.
. . .
In October John Paterson, IBM's chief procurement officer, moved to Shenzhen, China, the first time the head of a company-wide function at the firm has been based outside America.
. . .
The boss of Lenovo, a computer firm, lives in Singapore, for instance, but its principal operations are in China and America.

None of this is contradictory. There is a new phenomena in the workplace in which tasks are broken up and production takes place in distance and distinct locations. These new forms of work organization has been steadily growing – starting with early cross-national production strategies (see early work at BRIE) to the offshoring of IT and other technical tasks. As the Economist now points out, it has reached managerial tasks.

But as the Economist also points out, location of those tasks still matters. That is why the New York Times editorial is still correct. Places like New York or London will still be centers of finance. And many companies may want to have part of their financing operations there.

The real trick is how to manage the far-flung company operations. How does it work to have the CEO in one location, the CFO in another and the CIO in yet a third?

The other trick is what this means for public policy. Economists are slowly coming around to the idea that this unbundling of tasks changes trade policy. As Grossman and Rossi-Hansberg argue:

Our understanding of the effects of international integration on prices, production patterns, and factor income comes primarily from analyzing models in which goods—sometimes used as intermediate inputs, but often serving final consumer demand—are produced entirely in one locations. But times are a-changin’. Revolutionary progress in communications and information technologies has enabled an historic (and ongoing) break-up of the production process. Countries like England and Portugal still produce some goods from start to finish, but increasingly they participate in global supply chains in which the many tasks required to manufacture complex industrial goods (or, increasingly, to provide knowledge-intensive services) are performed in several, disparate locations. To better understand the implications of these trends, we need a new paradigm for studying international trade that emphasizes not only the exchange of complete goods, but also trade in specific tasks …

(See also Richard Baldwin, Globalisation: the great unbundling(s))

We at Athena Alliance have long called for this new paradigm of trade in the I-Cubed (Information-Innovation-Intangible) Economy. In 2004, we proposed the creation of a Commission on the Future of the US Economy. The charge of this Commission was to look at these emerging new challenges and craft new policy solution that go beyond trade to the entire structure of our economy.

That may sound like a huge undertaking – but it has been done successfully in the part. Twenty years ago, the President’s Commission on Industrial Competitiveness (aka the Young Commission) set our economic agenda on the course of addressing our competitiveness challenges. We need this new Commission to do the same. The challenges may be different, but the urgency is alike.

Not only are times a-changin', but time's a-wastin'. We need this Commission, now.

Posted by Ken Jarboe at 10:57 AM | Comments (0) | TrackBack

Not all innovation is good

That is the lesson that Steven Pearlstein conveys in his column today - 'No Money Down' Falls Flat). Pearlstein looks at the sub-prime mortgage industry, including the following "innovations":

(a) The "balloon mortgage," in which the borrower pays only interest for 10 years before a big lump-sum payment is due.
(b) The "liar loan," in which the borrower is asked merely to state his annual income, without presenting any documentation.
(c) The "option ARM" loan, in which the borrower can pay less than the agreed-upon interest and principal payment, simply by adding to the outstanding balance of the loan.
(d) The "piggyback loan," in which a combination of a first and second mortgage eliminates the need for any down payment.
(e) The "teaser loan," which qualifies a borrower for a loan based on an artificially low initial interest rate, even though he or she doesn't have sufficient income to make the monthly payments when the interest rate is reset in two years.
(f) The "stretch loan," in which the borrower has to commit more than 50 percent of gross income to make the monthly payments.

His argument is that these risky types of loans got even riskier when they were combined with the securitization of mortgages - which pushed the risk acceptance further and further up the ownership chain. The result has been a disconnect between the understanding of the risk and the purchase of the risk. Mortgage brokers and bankers have greater incentives to write more and riskier loans (since they bear none of the risk and all of the incomes from the fees). And hedge funds, seeking higher returns, have more incentive to buy the riskiest (and highest yielding) portion of the mortgage backed bonds.

I think Pearlstein has a point - but I'm not sure I would blame the innovations. What we have is a huge market failure and the danger of a completely unregulated market -- that is was it is because there are no regulations on the buyers (hedge funds) and few restrictions on the sellers. Securitization is supposed to be a way of spreading, and thereby reducing, risk; it ended up, according to Pearlstein, as a mechanism for increasing risk.

We also have to recognize, and give credit to, the fact that mortgage innovations have allowed millions to become homeowners -- starting with that risky idea over half a century ago called the 30 year mortgage (an idea so risky it required the creation of government-sponsored middlemen, Fannie Mae and Freddie Mac).

Having said that, I think the Pearlstein lesson is still valid. Innovation is not necessarily positive - and many innovations have a downside. Now what we need is an innovation in public policy to correct the problems.

Posted by Ken Jarboe at 08:34 AM | Comments (0) | TrackBack

March 13, 2007

Competitiveness or anti-regulation - part 2

As I remarked yesterday, I am concerned that this week's "financial markets competitiveness" activities are focusing too much on the anti-regulation agenda. That concern was heightened by a report in this morning's New York Times about the private kick-off dinner last night - (Bush Aides and Business Meet on Shift in Regulation):

Senior Bush administration officials began a series of high-level discussions on Monday with top executives from Wall Street, corporations and the major accounting firms. Many of the executives have urged the rollback of laws passed in the wake of the Enron and WorldCom scandals as well as limits to liability from government and shareholder lawsuits.

Yes, a look at regulations is probably necessary. But, as a story in the Houston Chronicle (Business interests' push to ease rules at hearing) points out:

Wall Street powerhouse Goldman Sachs took issue with the business campaign's premise.
"The regulatory climate does matter. ... Nonetheless, we do not think this is the main problem," Goldman Sachs said in a recent research paper. "Instead we see the growth of capital markets outside the U.S. as a natural consequence of economic growth and market maturation elsewhere. The U.S. has in fact been losing market share for several decades."

The real problem, as one analyst told me, is complacency. Our financial markets have gotten used to being the top dog and gotten complacent. That complacency is reflected in our regulatory approach, but also in the operations of Wall Street itself.

The last point is highlighted by research showing that Wall Street fees are higher than in other markets. To its credit, the Chamber of Commerce's Commission on the Regulation of US Financial Markets in the 21st Century included a discussion of fees:

1. Direct Costs of Issuing Equity
The fees involved in raising capital account for a portion of the direct costs of raising such capital. These fees include investment banking fees, legal and accounting charges, exchange listing fees, and printing costs. These fees tend to be higher in the United States than in other jurisdictions. For example, gross spreads, or the percentage of the issue price that the syndicate receives, are commonly the largest cost component of an IPO. Torstilla (2003) finds median gross spreads in equity IPOs of 7.0% in the United States compared with 4.0% in Europe.
2. Indirect Costs of Issuing Equity
The direct costs for raising capital represent only a portion of the total costs. Underpricing of IPOs is also an important component of the total cost. This occurs when a new stock issue is priced below the price that prevails in the market once the stock starts trading. Underpricing costs are roughly comparable between the United States and Europe, although they vary considerably from company to company and from time period to time period. Ritter (2003) found that average underpricing was similar in the United Kingdom and highest in the United States. Using more recent data, covering the low-volume time period from January 2003 to June 2005, Oxera (2006) found underpricing lowest on Euronext and highest on the United Kingdom (UK) Alternative Investment Market (AIM) with the U.S. markets in between.
On the other hand, there is evidence that the United States still has a cost of capital advantage over other countries. Foreign firms cross-listed in the United States continue to command a premium over firms that are not cross-listed, although the premium has declined over the last decade.

I wish the report had gone into greater depth about what Wall Street itself needs to do to maintain its own competitiveness. This may be a case where (to misquote Shakespeare) the fault lies not in others (i.e. Washington) but in ourselves (i.e. Wall Street).

Posted by Ken Jarboe at 10:24 AM | Comments (0) | TrackBack

Business drivers, performance measures and financial markets

As I mentioned in yesterday's posting on the report of the Commission on the Regulation of US Financial Markets in the 21st Century, one of the recommendations is to eliminate quarterly earnings guidance by companies. Part of that recommendation touted the need for moving toward better measures of both business drivers and performance -- and mentions the work by the CFA Institute. As one Chamber official told me, the current emphasis on a single number (earnings per share as measured to the penny) lead to a simplistic conversation between investment analysts and business executives on whether the company hit the number.

The problem, however, as the Chamber official admitted, is not just the emphasis on a single number but also on the short-term focus. The study took no position on ideas to shift the focus, such as eliminate the underlying requirement for quarterly earnings statements. But it does raise the question of whether new incentives and new measures are needed.

How to move away from the short term focus was the subject of a report last year by the by the CFA Centre for Financial Market Integrity and the Business Roundtable Institute for Corporate Ethics - Breaking the Short-Term Cycle. In that report, 76% of the CFA Institute's membership (which includes analysts and asset managers) thought companies should move away from quarterly earnings guidance. And of that group, 96% said companies should provide more information on long-term drivers of the business.

Looking at alternative measures was the subject of our earlier Athena Alliance white paper: Reporting Intangibles. It is not a simple matter coming up with a set of measures which give analysts (and investors) a good cross-industry comparison. Each industry, and in some cases each company, have particular measures that are more relevant than others. That is why earnings per share is such a powerful tool.

But earnings per share has never been a prospective measure. It tells you how the company did last quarter, not what it is going to do. In some ways, it is like trying to predict what to wear based on yesterday's weather. Granted, we expect company performance to be less volatile than the weather – and that may be the catch. Because we expect steady improvement quarter to quarter, companies may be more risk-adverse than they would normally be. Extraordinary actions can be removed from (or otherwise accounted for in) the quarterly number; it is still a measure of stability as much as growth.

To get a better picture of the future prospects of a company, these other measures are critical. Our report highlights the Management’s Discussion and Analysis (MD&A) statement required as part of annual corporate filings. Under SEC requirements, the MD&A sections now can be used for an extensive analysis of both business drivers and non-financial performance measures. Last November, the Enhanced Business Reporting Consortium released version 2.1 of its reporting framework for structuring the MD&A. (See the 2005 version 1.0 for an explanation.)

That framework breaks the discussion down into four major areas: Business Landscape; Strategy; Resources and Processes; and, Performance. Much of what I consider intangibles are captured in the Resources category, which they further disaggregate into: Monetary capital, Physical capital, Relationship (Social) capital, Organizational (Structural) capital and Human capital. While I can quibble with some elements of this framework (and in some ways think the version 1.0 was better), it is a major step forward in creating a cross-company platform for analysis.

Chamber officials tell me that they will be following up with more work in the area of alternative measures. Our report and the new Enhanced Business Reporting Consortium framework should give them a good head start in their activities.

Posted by Ken Jarboe at 09:11 AM | Comments (0) | TrackBack

March 12, 2007

Chamber's financial markets study

In follow up to the earlier posting, the Wall Street Journal has a preview of the report of the Commission on the Regulation of US Financial Markets in the 21st Century - "Panel Urges Steps To Boost Allure Of U.S. Markets":

But unlike some of the earlier studies, the commission's report makes six fairly narrow recommendations that it says could be implemented within a year. Some of the recommendations would require congressional action, but others could be acted on by regulators or corporate executives.

The six recommendations are: changing the SEC's structure and approach to regulation; giving the agency more authority to exempt certain companies from adhering to the Sarbanes-Oxley corporate-reform law; promoting international discussion to prevent the type of litigation that led to the 2002 collapse of Arthur Andersen, one of the nation's biggest auditing firms; eliminating quarterly earnings estimates; making retirement savings accounts more easily available to workers; and making those accounts more portable when workers change jobs.

The full report is available on the Chamber's website here.

The focus on issue beyond regulatory reform is welcome news, including the need for innovative savings plans and portable pension (an issue I worked on 20 years ago). I am especially heartened to see the recommendation on quarterly earnings statements. I don't know if this is the best option, but it raises the problem of the short term focus on the financial markets. We desperately need that broader discussion. It has long been suggested that the focus on short-term earnings has been a detriment to innovation and risk taking in US companies. It is past time to look into the issue in greater detail.

Posted by Ken Jarboe at 09:53 AM | Comments (0) | TrackBack

Competitiveness or anti-regulation

The competitiveness issue takes center stage in Washington this week, but it comes in the guise of an anti-regulation backlash. Tomorrow is the Treasury Department's big confab on the competitiveness of US Financial Markets. Since the early reports on the issue blame over-regulation for much of the problem, we can guess what the discussion will focus on. Then on Wednesday, the US Chamber of Commerce will hold a day long forum and release the report from their Commission on the Regulation of US Financial Markets in the 21st Century. The title of the group explains its focus.

As I have written before (see here, here, here, here and here), this focus on regulation and the definition of the woes of the US financial markets may not be correct. Linda Chatman Thomsen, the head of SEC enforcement, discussed the various reports and alternatives explanations of the state of the financial markets in a speech recently. As she noted, "there is substantial evidence that financial markets succeed because of strong enforcement and regulation not in spite of it."
(See also this morning's Washington Post - "Businesses Prepare to Mount a Concerted Attack on Regulation" and the view from the right "Red tape drives firms overseas" - The Washington Times.)

Back in November of last year, when I first heard of the Treasury Department’s conference, I noted that there are a number of items which should be on the agenda beyond simply regulatory "reform". The framework of the meeting is broad enough to incorporate these other factors. We will see if the participants can bring an overarching perspective to bear. Likewise, the Chamber of Commerce's forum is big enough to expand the discussion.

Otherwise, if the definition of competitiveness simply becomes anti-regulation, the entire competitiveness agenda could suffer. And nothing of real value to helping the competitiveness of the US financial markets will be accomplished. That would be a wasted opportunity.

Posted by Ken Jarboe at 08:20 AM | Comments (0) | TrackBack

March 09, 2007

January - and revised 2006 - trade in intangibles

Today was a kind of "double-witching hour", with both trade and employment data coming out. Employment growth was somewhat weak, with only 97,000 new jobs. But, this morning's overall BEA trade data is good – the monthly deficit is down.

However, the news on our trade in intangibles is not so good. First, our monthly surplus in January was essentially unchanged compared with December. Revenues from and payment of royalties were down while both exports and imports of private services were up.

The other not-so-good news was that last year’s figures were off by almost $1.4 billion – to the negative. This month’s revisions to the 2006 data show that our exports of private services were constantly overstated and our royalty payments (imports) constantly understated. As a result the revised intangibles surplus for 2006 was $98.3 billion rather than $99.7 billion. That is an error of only 1.5% - so in the greater scheme of things, it is not a major change. But, I always like to see revisions that show a better trade position rather than a worse one.

On the really bad news front, the Advanced Technology Products (ATP) deficit took a nose dive – back to the levels of recent months before December’s marked improvement. The January ATP deficit was almost $4.7 billion (compared with $2.2 billion in December, $4.5 billion in November and $4.8 billion in October. The January shift was due to declines in exports in aerospace technology and in information and communications technology. [Interestingly, the capitol goods account shows an increase in exports of civilian aircraft and computers.]

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.

Posted by Ken Jarboe at 10:49 AM |