January 2008 Archives

As the Congress debates the stimulus package and the Fed cuts interest rates, the Senate Banking Committee is weighing in with a different tactic. According to a story in this morning's Washington Post (Lawmakers Look to Tactic From S& L Crisis), Committee Chairman Chris Dodd is proposing a means to buy up bad loans:

The Home Owners' Loan Corporation, as it is called, would offer to buy mortgages at steep discounts from mortgage firms and banks and then rework the loans based on the reduced value of the properties, making the payments more manageable for homeowners.

A hearing on the proposal is set for this morning.

I think this is a necessary step. It may not provide an immediate boost to the economy, but it will set the proper long term course. We need to be clear about one thing: this is a credit recession. Getting the credit market back on track is an important feature of any economic plan. We should take a lesson from what happened in the US and Japan at the last real estate bubble. In both cases, interest rates were cut. But the US created the Resolution Trust Corporation, took the financial hits and moved on. The Japanese banks and other financial institution kept the bad loans on their books. The US recovered; a decade of low (sometimes negative) interest rates in Japan were ineffective.

Bottom line: as long as the financial system is clogged with suspect loans, the credit market will be reduced to a dribble and the economy will falter. Take the pain, clean up the system and move on.

It looks like the International Standard Organization (ISO) is taking up the issue of intangible valuations. Last year, at the urging of the German Standards Institute (DIN - Deutsches Institut für Normung), the ISO formed a ISO Project Committee for Brand Valuation:

The project proposal presented to ISO, the International Organization for Standardization, was based on guidelines set down by DIN's Performance Capability and Services Standards Committee in cooperation with Markenverband e. V. - who represents the interests of German trademark holders - and numerous other stakeholders. Their motivation was the introduction of the "International Accounting Standards" which allow, under certain circumstances, the inclusion of brand values in financial statements.

Committee participants include financial and other service providers, and representatives from research organizations and high-profile industrial firms; the active participation of the latter shows the relevancy of the subject.

It is expected that the standard will be published in 2010.

Now DIN is pushing the formation of a similar project for patent valuations - see Developing a patent valuation standard, ISO moves to establish a global standard for patent valuation - Intellectual Asset Management and More on the moves to establish an international standard for patent valuation - Intellectual Asset Management. According to Dr. Alexander J. Wurzer, who is heading up the work at the German Institute:

The International Organization for Standardization, ISO, has published a new work item proposal for the standardization of patent valuation processes. The proposal was initiated by the German Institute for Standardization, DIN, and is based on a publicly available specification PAS 1070 “General Principles of Proper Patent Valuation" (SAB1), published in 2007.
. . .
ISO followed that initiative and will appoint a committee to develop an ISO-standard for patent valuation if all relevant and concerned groups articulate their interest to ISO through their national standardization bodies.

The relevant body in the US is the American National Standards Institute (ANSI). ANSI is going through the formal process of reviewing the proposal (comments are due by today as it turns out and voting by member organizations closes in March). This could be an interesting, but difficult project. The process of setting international standards is fraught with national and international politics on top of the already difficult technical issues. Nor am I sure that ISO is the right organization for setting financial standards. But if an agreed upon standard for valuing intangibles can be found, it will be a major step forward toward regularizing their role in the financial system.

By now, you have seen the news reports that GDP growth dropped dramatically to 0.6% in the 4th quarter of 2007 (see GDP Growth Slowed in 4th Quarter, As Housing Continues Its Drag - WSJ.com, Growth Slowed Drastically in 4th Quarter - New York Times, Economy nearly stalled in 4th quarter; suffers worst year since 2002 - Los Angeles Times, Economic Growth Slows in Last Quarter - washingtonpost.com). Here is what BEA: News Release: Gross Domestic Product:

The deceleration in real GDP growth in the fourth quarter primarily reflected a downturn in inventory investment and decelerations in exports, in PCE [personal consumption expenditures], and in federal government spending that were partly offset by a deceleration in imports and an acceleration in state and local government spending.

Deceleration in exports? So much for the rest of the world picking up the slack.

In a earlier posting this week, I made the point about the need for services to adopt a "customer experience" rather than an efficiency approach to growth. Apropos that comment, a story in today's New York Times on Starbucks -- what some think as ultimate "customer experience" retailer -- caught my eye. The story, Overhaul, Make It a Venti contained this statement from another coffee shop owner:

After going head-to-head with Starbucks for almost 10 years, Mr. Cates, the Broadway Cafe owner, said he no longer worried much about competition from the company. Starbucks, he said, has lost its focus on coffee, noting that the company switched from making espresso by hand to robotic machines that pump out drinks with the push of a button.

“For them, the move to fully automated machines was inevitable, but they lost something,” Mr. Cates said. “If you are a barista, you have to roast your own coffee. It’s a necessity. You cannot compete by selling music or WiFi.”

Much of the rest of the story echoed that theme of Starbucks’ "lost soul", including the efforts of the once-again CEO Howard Schultz to turn things around:

Mr. Schultz has said he wants to refocus on the “customer experience,” recapturing some of the magic of the chain’s early years, when employees — who had heard the term barista before Starbucks came along? — made the drinks by hand and customers were excited by top-notch coffee.

Earlier in the Starbucks’ growth period, I remember being told by company officials that they didn’t mind if there was a Starbucks on every corner because everyone would be different with their own micro-environment. Sounds like they went down the centralized McDonalds approach instead. Whether they can reverse that is unclear. As their competitor from Broadway Café noted, moving to automated espresso machines was “inevitable” as the industrial age growth through economies of scale mentality (which Steve Pearlstein pointed out so well – see the earlier posting) kicks in.

From last night's State of the Union Address:

To keep America competitive into the future, we must trust in the skill of our scientists and engineers and empower them to pursue the breakthroughs of tomorrow. Last year Congress passed legislation supporting the American Competitiveness Initiative, but never followed through with the funding. This funding is essential to keeping our scientific edge. So I ask Congress to double federal support for critical basic research in the physical sciences and ensure America remains the most dynamic nation on earth.

Let's hope Congress and the President can work together this time to fund the bill -- and not get into an exercise of finger pointing. (See earlier posting on how things fell about last year).

Steven Pearlstein gets it - big time. Here is his analysis of the new business model -
Biggest Is Not Best - washingtonpost.com:

as the country slides into recession, we are going to discover that this absurd fixation on scale and growth has made many companies weaker rather than stronger. Newly acquired divisions will be shuttered, spun off and written down. And many more industry leaders are likely to follow Starbucks and Wal-Mart in slowing the pace of organic growth.

What companies in many industries are about to discover is that the competitive sweet spot may not be in being No. 1 or 2 in your category, as General Electric's Jack Welch once famously declared, but in being slightly back in the pack, where it's possible to deliver a more profitable trade-off between price and quality.

Think for a minute about what happens, particularly in the service sector, when companies get big. What do they do? They get more efficient. And how do they get more efficient? By coming up with sophisticated systems that allow them to produce consistent, predictable outcomes in everything they do while using as few and low-paid workers as possible.

In the restaurant business, for example, the big chains spend lots of time and money coming up with demographic and financial parameters for locating outlets. They hire executive chefs who whip up industrial-style recipes for menu items that they test on focus groups and can be replicated by line chefs with little experience and culinary flair. They come up with standard prototypes for how the restaurants will be laid out, how they'll be decorated and equipped, what plates, uniforms, napkins and menus they'll use. They purchase a computer system that not only takes care of processing meal orders and keeping track of the money and reordering food from the central warehouse, but also identifies any store or shift or employee producing results that are outside the desired norms. They even come up with the standard responses the hostesses and waiters use in greeting customers and handling complaints.

In the end, what you wind up with is a company that has a small corporate headquarters full of highly-paid people who design and refine these systems. At the restaurant level there are large numbers of low-skilled workers who are easily replaced and paid relatively low wages for essentially showing up and following the standard procedures. Together they create a giant company with lots of scale efficiencies producing a predictable product at a competitive price that appeals to large numbers of consumers.

The first is that these companies are coming close to having saturated the U.S. market. There's not much more cost they can squeeze out, so they can't stimulate additional demand through price cuts. And as a result of their relentless expansion over the past two decades, there are no new regions to enter.

At the same time, I sense there's a growing backlash against these models from customers who are dissatisfied with formulaic products and lackluster service. This backlash has provided an opening for competitors offering something different and better, even if it is more expensive.

This is the challenge facing Starbucks and Wal-Mart. And it lies behind the recent success of former "niche" players such as Whole Foods, JetBlue, Coach and boutique hotels such as those run by the Kimpton Group. Indeed, these "middle-tier" companies are so focused on growth that, ironically, they have wound up adopting many of the same characteristics as the industry giants.

But the other reason I see an opening for mid-tier companies is that the good ones are better able to attract employees who have the creativity and initiative key to success in service industries. Those kinds of employees attach high value to autonomy and independence and don't work particularly well in organizations where regimentation is built into the corporate DNA. And because the focus at these companies isn't driving growth by driving down costs, they are able to offer more attractive compensation packages, particularly in the area of incentive pay.

You have already seen this phenomenon in advertising, finance and the law, where many of the brightest people are gravitating to boutique firms. And if I'm right, you are going to soon find it in mid-size retail chains that employ knowledgeable sales people rather than clueless clerks, and health insurers that assign a nurse practitioner with a name and phone number to every customer to handle everything from choosing a doctor to correcting a billing error.

So, what to do in a recession? If you follow this mid-tier strategy, refine your innovation. Rather than chasing even greater levels of efficiency and economies of scale, look at ways to improve your "customer experience." And that doesn't mean adding tablecloths to your coffee bar. It means looking carefully at the reasons why your customers are your customers. Just as companies are beginning to involve their customers in product development, service companies are going to have to reach out to their clients.

In the I-Cubed Economy, production will become a joint venture - not a one-directional transfer transaction. That doesn't mean that mass produced goods and services will completely disappear. I will still want to buy a mass produced light bulb and probably ride mass transit. But customization - "just in time, just for me" - is the new production paradigm. As Pearlstein points out, this future may belong to the mid-tier companies: small enough to move rapidly and big enough to carry it off.

In his column today, Two Cheers for Wall St. - New York Times, David Brooks is peddling something call the Ecology Narrative of innovation on Wall Street. It goes like this:

When a new instrument enters the market, it takes a while before people understand and institutionalize it. Whether the product is high-yield bonds or mortgage-backed securities, there’s a tendency to get carried away.

In the first stage of this adolescence, investors look around and see everybody else making money off some new instrument. As Nicholas Bloom of Stanford notes: “They assume they are fine because they see everyone else buying it.” Individual bankers have a special incentive to get in on the ride because their yearly bonus is determined by how they do in the short term.

Then there’s a moment when people realize how stupid they have been. They’ve bought a pile of subprime mortgages without really knowing what they’ve purchased. The ratings agencies suddenly don’t look so reliable. The cycle of overconfidence becomes a cycle of underconfidence because nobody knows who is holding worthless paper.

Then, finally, maturity sets in. Those who have lost great gobs of money get fired. People still find the new product useful, but within parameters and with greater safeguards.

The lesson of the Ecology Narrative is that, in most cases, the market corrects itself. Maybe this year banks will change their pay structure so there’s not so much emphasis on short-term results. Maybe companies will change their boards to improve scrutiny over complex new instruments. In short, markets adapt.

There is some truth to this. But he misses a couple of key points. First, he sets this Ecology Narrative as a counterpoint the Greed Narrative:

The financial markets are dominated by absurdly overpaid zillionaires. They invent complex financial instruments, like globally securitized subprime mortgages that few really understand. They dump these things onto the unsuspecting, sending destabilizing waves of money sloshing around the globe. Economies melt down. Regular people lose jobs and savings. Meanwhile, the financial insiders still get their obscene bonuses, rain or shine.

This Greed Narrative is, of course, a strawman caricature. Brooks does this for a very simply reason: the Greed Narrative requires government intervention and the Ecology Narrative is self-correcting. Political point made.

In truth, both of these narratives are at work. They are not opposites. And both require a role for government. Governments have always played the role of stepping in and limiting and correcting the abuses of the capitalist system. Stemming those abuses is the genius of modern capitalism.

In the Ecology Narrative, regulation also plays a role in stemming not the just the abuses, but also the "adolescent" over exuberance. Regulation helps the markets adapt and regulations build the firewalls that prevent that adolescent from burning down the entire house. If the current meltdown turns out to be worse than we originally thought, it will be because we didn't have the regulatory systems in place to prevent the meltdown from spreading – the dreaded “contagion”.

As Brooks points out, there is the balance between innovation and creativity. To survive, any ecology system has to have mechanisms in place that make sure that bad innovations don’t completely imperil the system. In the case of financial markets, we have learned that government regulation is part of the ecosystem, playing that key role.

In creating policy for the I-Cubed Economy, we need to put out brainpower to work getting the regulations right. Not simply writing them off.

Update: I just ran into this recent quote from Stephen Roach in The Globalist:

The Fed's seemingly open-ended support of unfettered and unregulated financial innovation facilitated a derivatives-based revolution that turned out to have been a good deal riskier than the Greenspan libertarian mantra ever presumed.

Interesting.

Speaking of stimulus and recessions, Bruce Nussbaum has some advice on 10 Worst Innovation Mistakes In A Recession. They include firing talent, cutting R&D and stopping growth. Most of these boil down to warning against the standard response: retrenchment. Roger Martin makes a similar point in a recent interview: the key is to position the organization for a return to growth.

The same is true for public policy. Let us use this time to examine where the problems are and create economic policies for long term growth in the I-Cubed Economy. And by the way, that also means getting out of the current just-cut-taxes mindset. Government has a role to play - we need to acknowledge that positive role and move on.

This morning, my friend Steve Clemons over at the New America Foundation hosted a forum with the economic advisors of some of the Presidential candidates: As the Economy Screams. Video is available at the website.

On Friday, the Department of Commerce released the report of the Advisory Committee on Measuring Innovation in the 21st Century Economy. The report offered a number of recommendations for government actions to improve innovation statistics. They also called on business to "create, expand and assess firm and industry-level measures of innovation and develop best practices for innovation management and accounting."

Mirroring the Committee's recommendations, the Secretary of Commerce promised action in five areas:
&bull BEA and BLS would work on an improve framework for measuring productivity in high-technology and services industries.
&bull BEA will put together a supplemental account that will track and measure intangibles - specifically intellectual property and human capital - as investments rather than expenses.
&bull BEA will work with NSF to refine measures of innovation inputs such as licensing fees and training of technology workers - going beyond current measures of R&D spending and the number of scientists and engineers.
&bull Commerce will work with other agencies and Congress to look at ways to improve the interagency sharing of information.
&bull Commerce will host at least 4 forums on innovation around the country.

Of particular interest to me was the inclusion of intangibles. The creation of a supplemental account on intangibles will have a dual impact. First, it will raise awareness of the economic importance of intangibles. It will also attack some of the issue of measurement and valuation and help set standards in these areas which should be of value in business and financial reporting as well.

I was also pleased to see the tone of the report: that we are still learning about the innovation process and that innovation itself is dynamic and not necessarily quantifiable. It also recognized that the ultimate goal is the facilitation of innovation -- not just better measurement. The report outlines a number of areas where additional research on innovation measurement is needed.

It is important to stress this last point about our lack of knowledge about the innovation process. This lack of knowledge will, I believe, become more telling as we try to answer some of the research questions. We will need to expand our models of innovation and break away from the old linear model that assumes R&D is the source of all innovation. While we are getting there - especially in the business sector, there are still remnants in our thinking.

For example, at the press conference on Friday to announce the report, references were still made equating "highly educated" and "smart" people" with "human capital." Yes, highly educated and smart people are important. But smart and highly educated are not necessarily the same thing. We also know that innovation comes from many sources - not just smart people. Ordinary front-line workers are often times a great source of innovation - as they know their jobs better than anyone else. So as we try to measure human capital, and foster its development, we need to think of mechanisms beyond those geared to “smart” people.

I am also somewhat disappointed that the Committee dismissed the idea of surveys based on OECD's Oslo Manual, which serves as the basis for the EU Community Innovation Survey and other nations’ innovation metrics. These were considered as too costly and suffering from response rate problems. The Committee is recommending number of steps that would constitute a major overhaul of the National Income and Products Accounts (NIPA) and rightfully seems to feel that the undertakings proposed is fairly ambitious undertaking without adding costs.

I somewhat understand. Our statistical system is not one that is flush with resources. In fact, it is often starved of the needed funds to make important improvements or even to carry out its basic mission. The Committee recommendations will require a commitment of resources that may be difficult to obtain. And there are cost and data issues associated with the existing Oslo Manual based surveys that could make them that much more difficult to implement.

But I still think the Oslo Manual approach should be considered in the future as they are the broadest set of direct measures of innovation available. The report does allow for this possibility, couched in the discussion of what businesses could do to collect better data and where additional research is needed.

All in all, the report is a great start to creating an innovation policy in the US. Now we need to implement its recommendations and take the next steps.

Here is a crazy thought: can Warren Buffett play in today's credit market meltdown the role that JP Morgan once played in the stock market? No, I'm not suggesting that Buffett can stem a loss-of-confidence based stock price slide like Morgan did. But Buffett may be able to restore some confidence to the credit markets - specifically to the asset-back securities markets, and by extension to the rest of the markets and the economy as a whole.

Let me explain. One of the structural causes of the current economic "situation" is the melt down in the asset-backed securities market, triggered in the subprime market. Once subprimes started to fall apart, it became clear that the rest of the market was also on shaky ground due to the slicing and dicing of the securities known as Collateralized Debt Obligations (CDOs). The collapse of the CDOs is taking the monoline bond insurance companies down with it. The result is not only a large capital loss but a dramatic tightening of credit with no one able to provide the bond insurance.

Into this gap steps Mr. Buffett. As I noted earlier, Berkshire Hathaway Assurance Corp is now guaranteeing state and municipal bonds in New York. That is an opening for Buffett to get into the business in a larger way. But, you can be sure that he is going to set some rather strict standards for what gets backed. Those criteria could quickly become the proverbial gold-standard for the industry. With such standards in place, investors may be willing to come back into the water again.

By the way, it is interesting to keep in mind how Berkshire Hathaway got into this business. It was a call from New York State Insurance Commissioner Eric Dinallo with the suggestion because the state needed someone to back the state and municipal bonds in order to maintain those bond's top ratings (see A Regulator Not Stymied by Red Tape - New York Times). A perfect example of government and market working together (in what some might call "industrial policy").

With the financial markets in trouble and the Fed slashing interest rates, the drumbeat for an economic stimulus packing is reaching a fevered pitch. So far, the consensus has coalesced around Larry Summer's three T principles: timely, targeted and temporary. Usually, this makes good economic and political sense. Politically, it avoids a long-drawn out debate over economic fundamentals - in this case, over the potential showstopper on extending the Bush tax cuts. If everyone agrees not to raise structural issues, a package can be passed quickly (although that is not preventing last minute wrangling - see Joint Economic Push Is Both Parties' Goal - WSJ.com). In "normal" times, such a 3-T approach would also make economic sense. If this were a cyclical downturn, the standard Keynesian economic stimulus of pumping up demand would be appropriate.

By the way, I'm not sure that one of my favorite stimulus elements will make it into the package. As I noted earlier, the number of involuntary part time workers is increasing as well as unemployed. Few of the proposals will help the worker whose hours have been reduced. The answer to that problem is a reducing or "holiday" in payroll taxes. With a cut in the amount of withholding for payroll taxes, all workers, including part time, would get an immediate boost. There is a downside to this mechanism, however. As the CBO report points out, such a payroll tax holiday is more difficult to administer compared to other options. I would argue that such a difficulty is worth the effort if the appropriate target is reached. And in this case, not dealing with the increase in part time workers constitutes missing the target.

But here is the biggest worry: what if this is not a cyclical downturn or a correction? What if the problems are structural? That is the worry. We may find that the stimulus package falls far short of what is needed. Will there be anything in the stimulus package to help homeowners facing default? How about dealing with the long term structural problem of households using rising home equity to finance living standards? What about the shift in income patterns and the stagnation of incomes for many workers? The rising prices of oil and the fall of the dollar? The continued growth of the trade and budget deficits?

And what about the major structural issues facing the I-Cubed Economy: the changing nature of the production process? None of the stimulus discussions will even begin to get at these matters.

Yes, I agree, something needs to be done quickly to stimulate the economy. And the discussions over the structural issues will take more time. But if we don't take this opportunity to start those discussions, we may find that they never get started. Nothing jump starts the discussion like a crisis.

According to the Financial Times, there is now

a different Silicon Valley boom. This one is sucking in talent from some of the industries that have dominated the region over the past decade, such as the internet, software and systems. It is driven by the same belief in unbounded opportunity that fuelled the rise of the internet.

Under the banner of “clean technology,” this latest Valley obsession spans a wide range of technologies and industries. These include alternative energy sources such as solar power and ethanol; technologies geared to energy management and conservation; and new materials and industrial processes with varied environmental benefits.

Industrial processes? Hardware, like solar technology? Materials? This is the "service" economy?

No, it is one more manifestation of the I-Cubed Economy. Information, innovation and intangibles are key factors in every industry -- whether providing IT services or developing new energy efficient industrial processes or solar hardware. The manufacturing/services dichotomy is a dead as the dodo. It has outlived its usefulness and should be retired.

Time to start thinking about the sectors or economy activity (energy, transportation, food, shelter, entertainment etc.) -- and stop think about the process (manufacturing or service).

On Weds, the Supreme Court heard arguments in yet another patent case, this time on how far down the supply chain royalties go. As the International Herald Tribune explains:

At issue is whether LG can enforce its memory-technology patents against both Intel and the computer makers that install Intel's chips in their machines. Quanta, the world's largest maker of notebook computers, said it could not be forced to pay royalties on three LG patents because Intel already has paid.

Quanta Computer Inc. of Taiwan, argued that LG was demanding more than patent law allowed. The license to Intel exhausted the patent claims, the company contended. Since the chips have no use other than as a computer component, it would make no sense to license their sale but forbid installing them in computers, it said.

Several justices seemed to agree. "What you are trying to do is expand what you get," Chief Justice John Roberts told LG's attorney, Carter Phillips. "And the reason that troubles me is because if you had imposed a condition on the sale, Intel wouldn't have paid you as much."

The final decision probably won't come out until summer.

David Wessel's Capital column in the Wall Street Journal today is about the bursting of the financial sector's pay bubble:

First came the bursting of the tech-stock bubble, now the bursting of the housing bubble. The bursting of a bubble in finance -- and the pay of those who helped make the tech and housing bubbles possible -- can't be far behind.

But the column isn't really about punishing the high-fliers. It is about whether we need that much brain power going into financial services:

Modern finance is, truly, as powerful and innovative as modern science. More people own homes -- many of them still making their mortgage payments -- because mortgages were turned into securities sold around the globe. More workers enjoy stable jobs because finance shields their employers from the ups and downs of commodity prices. More genius inventors see dreams realized because of venture capital. More consumers get better, cheaper insurance or fatter retirement checks because of Wall Street wizardry.

But financial innovation is like splitting the atom: Nuclear power offers energy without greenhouse gases, but nuclear weapons can blow up the planet. It all depends on how wisely it is used. Helping promising companies raise capital? Vital to U.S. prosperity. Devising, selling and trading mortgage-backed securities so complex that no one, even those Harvard grads, can fully understand them? Could be a waste of talent and energy.

Yes, the Harvard-trained physician who helps venture capitalists pick among competing cures for cancer may help millions instead of the hundreds of patients he or she might have treated directly. But tens of billions of dollars of losses in new-fangled investments at the largest U.S. financial institutions -- and the belated realization that some of those Ph.D.-wielding, computer-enhanced geniuses were overconfident in the extreme -- strongly suggests some of the brainpower drawn to Wall Street would have been more productively employed elsewhere in the economy.

And it looks like many of those folks will get the chance to find out if that is so.

I'm glad to see that he is differentiating between true financial innovation and extracurricular financial engineering -- the needed and the froth (see my earlier posting). I'm not sure, however, that a downturn that forces folks out of finance will only reduce the froth - and not also prevent real (and needed) financial innovations. I'm also not sure that all these "overconfident" "Ph.D.-wielding, computer-enhanced geniuses" which will be switching to other fields will necessarily increase the productivity of those other areas. To be productive in these creative fields, people need to be passionate about what they are doing. Taking a job in a different industry after being kick out of Wall Street is not necessarily the formula for passion. Let us hope all the (soon to be?) released brain power really does go to productive uses.

In keeping with what is developing as an IP theme this week, let me point out a story from the Boston Globe last month -- Creative vigilantes. I commented on the concepts of negative spaces in protecting intellectual property in earlier postings on fashion and magic. The Boston Global expands this into comedy -- in an interesting way:

Last February, Joe Rogan, the beefy host of the gross-out extravaganza "Fear Factor," got on the stage at the Los Angeles club The Comedy Store and unleashed a tirade against the comedian Carlos Mencia, who sat beside him on a stool, angrily protesting. According to Rogan, Mencia had been stealing other comedians' material for years, and the only way to stop him was by making his habits widely known. This Rogan did his best to achieve; shortly thereafter, he posted a video of the exchange - liberally peppered with indecencies and spliced with supporting material - on his website. From there it spread quickly over the Internet.
. . .
In something as simple as the public outcry of a Hollywood jokester, [Christopher] Sprigman, an associate professor of law at the University of Virginia, sees an approach that he hopes could put the lie to this thinking, and turn the heads of lawmakers. He sees a comedian enforcing respect for originality without resorting to legislation, lawyers, or the courts. He sees intellectual property being protected - not by the strong arm of the government, but by way of the very technologies that have incited stronger laws in the first place.
"People usually talk about how the Internet destroys intellectual property," says Sprigman. "But here the Internet enforces intellectual property. It helps to protect creativity by shaming pirates."

The story goes on to talk about the negative space issue - where lack of legal IP protection either helps the industry (the fashion advances through copying argument) or where other mechanisms are more effective (peer pressure in the magic industry).

The entire area of negative space is opening up a fascinating debate about the nature of innovation. What incentives are needed - and in what circumstances? Clearly, there is no one-size-fits-all solution to the innovation question. What works in one area may not work in another. And what is deadly in one area may be absolutely critical in another.

We need an innovation policy that can tell the difference.

From this morning's Wall Street Journal - Intel's Profit Surges 51%, but Outlook Is Cautious:

Intel Corp. posted a 51% surge in fourth-quarter profit but sounded a cautious note about business conditions in the first quarter and the rest of the year.
The forecast by the giant chip maker, whose results are seen as a gauge for global technology demand, sent its shares down more than 14% in after-hours trading.

Profits up 51%; stock price down 14%. What is going on? Confidence in the future direction. As the story points out:

But with the widely reported jitters about economic conditions, mainly in the U.S., the company is watching out for signs of a slowdown. John Lau, an analyst at Jefferies & Co., noted that Intel's first-quarter forecast points to a 10% decline in revenue compared with the fourth period, where revenue typically falls 7% to 9% because of seasonal factors. "It certainly doesn't give us a good feeling that it would be better-than-normal seasonality," he said.

So the fact that the revenue forecast is 1% to 3% lower than what might be normally expected is taken as a sign that the bottom may be falling out.

And how do you factor that intangible in to your calculations?

Speaking of patents, there was this story the other day - Companies to Share Eco-Friendly Patents - WSJ.com:

Multinational companies including International Business Machines Corp., Sony Corp., Pitney Bowes Inc. and Nokia Corp. will unveil today what they call a patent-sharing plan for companies to donate intellectual property that improves the environment.

The project, dubbed the "Eco-Patent Commons," builds on the experience of the open-source software movement in which programmers around the world freely share their computer programs, said David Kappos, IBM's assistant general counsel for patent law, who helped design the system. He said that "the advantage of using this commons approach is efficiency, scale and visibility."

The commons will be administered by the World Business Council for Sustainable Development, a Geneva-based group that includes some 200 of the world's biggest companies.

Intellectual property rights to technology that solves environmental problems have been a contentious issue in negotiations over the Kyoto Protocol -- which attempts to combat global warming -- with U.S. negotiators resisting proposals to force companies to give away technology. John Coequyt, energy policy specialist with the Washington office of Greenpeace, an environmental group, said that the commons is "potentially a way to solve the problem by voluntary action."

Patent pools are a long standing and effective mechanism for spurring innovation. Almost ninety years ago, then Assistant Secretary of the Navy, Franklin D. Roosevelt helped consolidate radio patents into a pool to further development of that technology, which was seen as critical during World War I. A report by the USPTO done in 2000 showed that patent pools could be especially helpful today in biotechnology.

There are a number of forms of patent pools (see Knowledge Ecology International - Survey of Patent Pools Demonstrates Variety of Purposes and Management Structures). Yet there is not a lot of discussion of patent pools as a tool of technology and innovation policy. There should be.

Maybe this latest pool will not only help facilitate eco-innovation, but also raise the profile of patent pools and cause others to think of expanding their uses in other industries.

Believe it or not, patent reform has raised a great deal of passion. Both side argue that if their position is not adopted, innovation and the US economy will come crashing to a halt. Or, more correctly, they argue that if the other side’s position is adopted, the system be destroyed. (A tame version of this is John Markoff's recent New York Times column Two Views of Innovation, Colliding in Washington.)

One of the major concerns is that of the small inventor/small company. They fear that the patent system is already stacked against them and that the patent reform proposals will just make matters worse. That fear seems to stem from the fact that big companies can outspend them and outlast them in court cases. Without the weapons of triple damages and automatic injunctive relief, they fear that they can not stand up to the big boys and protect their patents. The post-grant review process is seen as just another way for the big boys to string out the process and force the little guy out of the game by raising the costs.

Whether or not you believe these fears are justified and that the proposed changes will make matters worse is almost irrelevant to the political debate. These fears exist and should be addressed.

One way of doing so is by raising the possibility of patent litigation insurance. Such insurance covers the cost of bringing an infringement case. This is different from patent liability insurance. A workable insurance system—covering both the cost of bring litigation and the cost of potential liability—might be able to serve as a replacement for the defensive patent syndrome.

Here we can take a lesson from Europe. The Danish Patent and Trademark Office has long encouraged the creation of a patent litigation insurance system for small business. As a first step, the Danish insurance company Dahlberg joined with and SAMIAN Underwriting Agencies to offer an enforcement policy beginning in December of 2007: PatentEnforcer (TM). This is first-party coverage to offset the cost to small and medium size enterprises (SMEs) of bringing a patent infringement case.

Let me suggest the following: as part of the patent reform legislation, Congress should require the USPTO and the SBA to conduct a review of the patent insurance system. That review should specifically study on the feasibility of offering patent litigation insurance (possibly through SBA).

I don't know if this will actual lower the temperature of the rhetoric on patent reform. But regardless, a review of patent insurance would be a useful step in strengthening our innovation system.

The House GOP leadership has a new report out on the problems with government. Called The Little Book of Big Government, one section deals with what they consider unwarranted expansion of federal crimes and encroachment on our liberty. Here is one of the examples:

Smokey the Bear: You can be punished with up to six months in prison under federal law for the unauthorized use of the image of “Smokey the Bear” or “Woodsy Owl.” (18 U.S.C.
711 and 18 U.S.C. 711a)

Interesting. As I remember it, federal law (18 U.S.C. 2319) provides jail time for copyright violations.

So, violate the copyright on Smoke the Bear, get 6 months in jail. Violate the copyright on Mickey Mouse, get 10 years in jail.

They are right -- this sounds all wrong.

In an earlier posting a couple of month ago, I noted some website that have information on the position of the Presidential candidates on technology issues.

Now the ASTRA website USInnovation has a section that is tracking the 2008 Presidential campaign. The site also contains useful information about each of the candidates' position on technology issues. Unfortunately, right now the site is confusing in that regard. In order to get that information, you have to click on the candidate's name -- which are listed on the bottom of the website. Nowhere on the site does it tell you that technology policy information is available if you do this.

I am told that this is in process of being fixed. So, for now, go to the site. Scroll down to the bottom of the page. Click on the candidate's name.

Wolfgang Munchau has an interesting take on the current financial mess in his recent Financial Times column The credit revolution looks to the long-term:

So what about the long-term prospects of securitised credit? In A Short History of Financial Euphoria, John Kenneth Galbraith made the depressing claim that finance does not lend itself to innovation, full stop. What masquerades as innovation, he said, boils down to nothing more than credit secured on some asset. You can repackage it, slice it horizontally or vertically, repackage it, call it a different name, but at the end of the day, somebody owes money to somebody else. If this market booms, you can bet your securitised dollar that this is due to exuberance. This is worth discussing in some detail.

The macroeconomic function of a modern financial market is to provide liquidity, pool information and share risk. During the credit boom, proponents argued that products such as collateralised debt obligations would help distribute credit risk through the economy. While that was technically correct, they distributed it in a perverse way. Instead of channelling risk to those best able to absorb it, they channelled it to those who amplified it the most – banks.

Nor did the pooling of information work according to plan. Most of the credit market products are notoriously opaque. And the liquidity argument appears to have worked only during periods of exuberance. We must therefore conclude that the securitised markets, as they have been operating until today, could not have brought many macroeconomic benefits. Since boom-bust episodes are hugely damaging to an economy, the net macroeconomic effect of the modern credit market may well have been negative until now, and be about to get more so as this year progresses.

But I still suspect that Galbraith is wrong in the long-term. A properly functioning financial market with proper risk-sharing and information flows should be positive. Without it, there would be less finance for venture capital and private equity. Nor is there anything wrong in principle with the idea of a subprime mortgage, a product that allows poor families without a credit record to finance their homes, as long as all sides in the transaction understand the risks in full and as long as the mortgage distributor shares some responsibility in case of default.

While none of these conditions existed during the credit boom, these problems are fixable.

I have to agree with 90% of this. I am especially heartened with his conclusion that the problems are fixable. The real problem in the current melt-down has been the repackaging of debt (as I've noted in earlier postings). But, while Galbraith was correct that much of the "innovation" is re-slicing of the same baloney, there is some true innovation out there (again as I've noted occasionally on this blog). Case in point is the vast expansion of the asset classes used as collateral. That is true innovation. One can always find historical evidence that almost everything under the sun was once used as collateral for a loan (including a pound of flesh). My own research on the monetization of intangible assets pointed out to me that patents were used to back loans since the late 1800's. But the regularization of certain classes of assets at part of the credit markets is the real innovation. The ubiquity of the 30 year fixed rate mortgage in the US is a true innovation. 60 years ago, the idea of lending to students on the promise of future income would have been absurd to many. Auto loans, accounts receivable, credit card receivables -- all of these are credit market innovations. A little over a decade ago, a crusty old local banker in my neighborhood refused to provide mortgages for condo's ("where's the dirt").

So, I am happy to hear that the current problems are fixable. That gives us plenty of room for a new boom. In part, that boom will be fueled by new asset classes (such as intangibles and intellectual property). As Bill Gross, Managing Director of PIMCO Bonds says in his latest Investment Outlook: "Pyramids Crumbling":

Financial innovation will inevitably march forward, if not in distinctly new forms, then into new asset markets . . .

However, Munchau's point is that these true financial innovations will not trigger the type of boom that we have seen recently. He may be right. True long term financial innovations may be more incremental in their impact, rather than create a huge (and unsustainable) boom. It may be the slicing and dicing that creates the exponential changes.

I'm not sure that there is anyway to prevent that - at least come of that. With a new financial innovation, there may just be a layer of froth. What really worries me is that any growth founded on true innovation will quickly turn into a bubble. That seems to be the history.

Here we come to the role of financial regulation. Unfortunately, the political economy of such regulation is usually reactive. Not because the regulation is inherently reactive, but because the politics makes it reactive. During the boom, laissez faire advocates put up a strong fight against any government "interference" -- usually by pointing to how well everything is going and warning not to "kill the goose that laid the golden egg." (Ironically, having pre-empted any proactive government actions, they can then claim that government is only reactive and non-innovative.)

I don't know if the next wave of financial innovation (based on intangible assets) will follow this same course. But there may be a chance now to get ahead of the curve and put in place sensible policies and regulations that promote the use of intangible assets as an asset class while trying to head off any speculative bubble. That may not be possible. At least it is worth a try.

Now this is very worrisome -- FT.com / World - Moody’s says spending threatens US rating:

Steven Hess, Moody’s lead analyst for the US, told the Financial Times that in order to protect the country’s top rating, future administrations would have to rein in healthcare and social security costs.

“If no policy changes are made, in 10 years from now we would have to look very seriously at whether the US is still a triple-A credit,” he said.

According to this morning's BEA trade data, the trade deficit rose sharply in November to $63.1 billion, a jump of $5.3 billion over the October revised number. Imports rose $6 billion while exports rose only $0.6 billion. While exports reached record levels, apparently the decline in the dollar was not enough to boost exports to the levels needed to offset higher oil prices.

As worrisome, our intangible trade balance in November stayed exactly flat at $10.21 billion. A slight $30 million increase in our net royalty payments (surplus) was offset by $30 million decrease in our business services surplus. Our net royalty payments have been growing slowly but relatively steadily throughout the year. However, our surplus in business services has been essential flat over the past year – fluctuating between $6.4 and $6.7 billion monthly.

The deficit in Advanced Technology Products improves slightly in November to $6.4 billion – after October’s record monthly deficit of almost $6.7 billion. The November deficit is still the second largest in history. Surprisingly, both imports and exports declined. November exports and imports were down in key sectors such as aerospace, biotechnology, electronics and information and communications technology (ICT). The last monthly surplus in Advanced Technology Products was in June 2002 and the last sustained series of monthly surpluses were in the first half of 2001.

Needless to say, the trade numbers are not good news. In the short run, the deficit will be a drag on growth, as Wall Street Journal notes:

The November deficit exceeded Wall Street expectations. The median estimate of eight economists surveyed by Dow Jones Newswires was a $59.75 billion shortfall.
It is unlikely the economy will get the support from trade during the fourth quarter that it received in the third quarter. Gross domestic product July through September grew a stunning 4.9%; of that, the trade component of GDP contributed a sizable 1.38 percentage points. But the available fourth-quarter data show the trade deficit widening in October and in November. The $63.12 billion deficit in November was the largest since $64.15 billion in September 2005.

Analysts predict further increases in the deficit with China in the months to come as U.S. demand has been unfazed by a string of high-profile recalls of a number of Chinese products, everything from tainted toothpaste to toys with lead paint. China reported Thursday that its trade surplus through December with the world rose by 47.7 percent to a record of $262.2 billion with the December surplus coming in at $22.7 billion, up 9.5 percent from a year ago.

data on Friday suggested that [Chinese] policies to rein in exports are starting to bear fruit.
The [Chinese] surplus for December alone came in at $22.7 billion, below forecasts of $24.5 billion and well down on October's record $27.1 billion, while imports grew faster than exports for the third month in a row.

Short term worries aside, I am concerned over the long term trends, especially in business services. This is an area where the US is supposed to have a competitive advantage. Yet our trade surplus is not growing.

Not good in the short term and not so hot in the long term either.

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.

Apropos my posting earlier this week on whether trade or technology affects wages, here is the counter argument - Blue-Collar Blues: Is Trade to Blame for Rising US Income Inequality? -- Robert Z. Lawrence, Peter G. Peterson Institute for International Economics:

International trade accounts for only a small share of growing income inequality and labor-market displacement in the United States. Lawrence deconstructs the gap in real blue-collar wages and labor productivity growth between 1981 and 2006 and estimates how much higher these wages might have been had income growth been distributed proportionately and how much of the gap is due to measurement and technical factors about which little can be done.

The Washington Post is running a story today about how commercial companies - including the TV networks - are using photographs without permission -- Hey, Isn't That . . . :

Under the banner of "intellectual property," record labels warn you not to bootleg their songs. Hollywood studios warn you not to download their movies. Intellectual property has lately seemed the concern of corporations trying to protect the artist from the grabby public.

But in an increasingly user-generated world where the public is the artist, sometimes it's the big boys who get grabby. And the questions that arise are about ownership, but they are also about fairness, and changing culture, and ultimately, the search for authenticity.

As the story goes on to say, some of the images are protected under Creative Commons, which allows use if attribution is given, but may or may not prohibit commercial use. (For the record, this blog is covered under Creative Commons - free use with attribution but no commercial use.) But as they point out:

In some ways the more interesting question for this corporate breed of photonapping isn't "Is it legal?" but rather, "Why does it sting so badly?"

The answer of course is that the corporations are doing the same thing that they blame others for doing (and often for the same reasons). In a number of the cases presented, it appears to be individuals used material off the internet without thinking about the copyright issues. If it is out there, it must be ok, right?

All of which points to a need for both better understanding and education of intellectual property -- and not just in the "lock it all up" mode of some -- and a better set of rules. Hats off to Creative Commons for their work in raising awareness of the issues and their innovative approaches to the protection/utilization balance.

Dani Rodrik makes a great point on his blog about Trade and wages:

I have often read or heard the assertion that there is no respectable work by economists that attributes an important part of rising inequality in the U.S. to international trade, with the implication being that it's all (or mostly) due to skill-biased technological change. Greg Mankiw has made this argument in the past, and Alan Blinder implies as much in his recent NYT article.
I have never understood why the work of Rob Feenstra and Gordon Hanson is overlooked in this context. These two are among the very best empirical trade economists today (and Feenstra is the author of the most widely used graduate-level textbook in trade). In a series of papers, they have argued that outsourcing and global production sharing act just like skill-biased technological change, and they have played an important role in shaping wage inequality. Their empirical work is careful and driven by a compelling theoretical model of within-industry specialization.

Rodrik points to their paper Global Production Sharing and Rising Inequality: A Survey of Trade and Wages, which concludes:

While there is abundant evidence of skill-biased technological change, it also appears that international trade, in the form of foreign outsourcing, contributes to skill upgrading and increases in the skilled-unskilled wage gap.

To some of us, that conclusion makes perfect sense. Not only are the both of these forces at work, they are interrelated and come from the same source. As Levy has pointed out, if your job can be routinized, it can either be automated or done by someone in a lower wage area following instructions.

But that is just the beginning. The next wave of technology-trade interaction is coming as the higher level conceptual jobs gain in other locations.

There is a new state competitiveness index out, this one from the Beacon Hill Institute of Suffolk University. More sophisticated than some, it still contains a few questionable (ideological?) items and its own flaws. For example, union membership and size of state government are taken as competitive negatives. I would question that. In some cases, this results in a strange outcome. For example, my old home state of Michigan ranks 39th in “employer firm births per 100,000 population” – a key indicator in their business incubation subindex. (Interestingly, I don’t know if that is a net (births minus deaths) or a gross (only births) number – arguments can be made for including either). However, Michigan ranks 43rd in unionized workforce. That somehow drags the state down to 48th place in the business incubation subindex (even though all the others components are at 38th or 39th place). The impact of the unionization component is also heavy for Maryland – which ranks high on many of the incubator indicators (and is generally recognized as doing a good job in promoting firm creation – 11th in firm births).

Maryland is also penalized because it has a low level of foreign direct investment – which is taken of a surrogate for a more closed economy. That is another assumption that is highly questionable.

In addition, almost every one else, technology is given center stage rather than innovation. And technology is measured by the same flawed indictors of R&D funding, STEM workforce and patents. (To be fair, everyone else uses these as well – in part because we have nothing better). Curiously, even with this, the so-called high-tech states don’t necessarily come out on top.

All in all, a good attempt. But I am still waiting for the definitive study (which may be a chimera after all).

Apropos my earlier posting on part-time work, the Journal is also running a story about the economic effects of using temporary workers - Growing Reliance on Temps Holds Back Japan's Rebound. One reason Japan's rebound hasn't gotten traction: companies' growing reliance on temporary workers. Part-time and temporary workers are paid less and spend less - thereby dampening domestic demand. And because they are not covered under existing labor force agreements, they also do not automatically benefit from an up turn in the company's fortunes.

Yet the heavy use of temps also has created an obstacle to the virtuous cycle typically seen in an expanding economy: When companies make better profits they eventually raise wages, which boosts consumer spending -- and leads to more corporate profits.

Something to keep in mind as we see the US going to more of a part-time and free-lance economy.

Forbes is running a new column about China - from the boots-on-the-ground view of Intel's deputy general manager for China -- China's Invent-It-Here Syndrome. The statements should be eye-opening:

The Chinese government's goals are sweeping: to develop, influence or downright own the core intellectual property of the next generation of technologies that will power the global economy. To do this, the government has committed to doubling its spending on research and development so that it reaches 2.5% of China's gross domestic product by 2010, approaching $100 billion annually. China is also on track to have more research scientists and engineers than any other country by 2015.

But it is not just about increasing R&D (something we failed to do in the last federal budget). It is about creating a mercantilist technology policy.

In the past 18 months, China has officially embarked on a multi-year, multi-faceted plan to transform "made in China" into "invented in China."

You can read about state economic plans on the Internet, and they sound dry and flat. In China, however, these plans are alive. They imbue every conversation with Chinese technology companies and with Chinese government ministers with urgency. They get written into contracts. (emphasis added)

Here's how China's long-term economic plan came alive for me: This past summer, I moved to China for Intel to co-run our sales and marketing operations there. A few weeks into the job, I realized that doing business in China involved much more than winning sales in the world's only very large and very fast-growing PC market.

For instance, international standards are the glue of the PC and communications industry, ensuring that machines can communicate and work together, no matter where they're made. Big corporations devote significant time and people power to making sure their ideas are represented on the standards bodies that write these rules.

But in every introductory "ops" review I did in China, all our managers talked about how the "local standards" were a key to Intel's success in every market. By insisting (as any country can) that products sold in China must adhere to local as well as international standards, China makes sure that Chinese inventions get built into high-tech products sold here. That means there is a Chinese voice in which products succeed or fail in China. And products that succeed in China have a much higher chance of succeeding globally.

OK -- and so what is our response? So far, and officially, nothing.

But that does not mean we can’t or shouldn’t do anything. For some of the actions we could take, see Julie Hedlund and Rob Atkinson's paper The Rise of the New Mercantilists: Unfair Trade Practices in the Innovation Economy. There are many more reactive and proactive steps we can be taking.

Most importantly, we need to understand that other countries are playing a different game. They believe in an active policy to promote economic growth in this new I-Cubed Economy. We may disagree with what they are doing. We may think we have a better way. But until we get into the game with a strategy of our own, we will be left on the sidelines.

And the sidelines is not the place where we want us or the next generation to be.

An interesting new phenomenon is going on in the labor force. In the late Industrial Era, economic downturns were met with the labor market mechanism of layoffs. Workers were not fired (permanently separated) but laid off with the expectation of being called back when the upturn started. This was cyclical unemployment. A number of social institutions grew up to accommodate this process, including unemployment insurance (UI) and union-based unemployment funds. While these policies were developed to cope with firings not temporary layoffs, they operated as a de-facto industrial policy for the large mass production companies that guaranteed the workforce would still be available for recall.

That has changed. The cyclical recessions of the 1950’s, 60’s and 70’s have given way to structural recessions. The 1981-2 recession was the last time that there were wholesale layoffs with the expectation of calling the workers back. In the 1990 recession, outright firings replaced layoffs as companies used the recession to restructure. Rather than sticking around on unemployment, workers take new jobs (or at least look for them) as they believe they will not be re-hired. In essence, the forces of creative destruction were unleashed to move resources from one industry to another, rather than simply move those labor resources into a reserve pool for existing industry.

This shift is one of the reasons for increased economic insecurity and anxiety -- as workers found their hard earned skills and tacit knowledge no longer valuable as they switch from industry to industry.

Now a new technique may be emerging in the current "situation." The Wall Street Journal reports that more companies are cutting hours rather than letting workers go:

In another sign of a weakening job market, employers are cutting hours for more workers to below the 35-hour-per-week threshold for full-time work because of slowing demand, or "slack work," according to government data.
. . .
Reducing hours is enabling many companies hurt by slowdowns in housing and autos, in particular, to stave off layoffs and retain skilled workers, but the cuts are squeezing earnings for many workers and putting some workers' benefits at risk.

It also highlights the crying need for new government policies. As I mentioned earlier, UI and union-funds helped ease the difficulties of layoffs associated with cyclical unemployment. For structural unemployment, there are programs on the books -- retaining etc. But those programs are structurally inadequate and flawed as well as grossly under funded.

For this new involuntary part time economy, we don't have a clue. What is the appropriate economic policy to help the "slack" worker? Do we help the worker directly or would an expansion of the Earn Income Tax Credit help cope with the loss of income effect of slack work? Do we treat this as a labor market issue? Or do we treat it as an issue of the working poor? Or more accurately, as an issue of the loss of income of the working middle class on in danger of becoming poor? And how do we figure in the issue of the free-lance economy and the voluntary part-time workforce?

Welcome to a new I-Cubed Economy.

As we try to sort through the (ongoing?) financial meltdown, a little bit of history is always helpful. In that vein, the Economist has a review of a new book on an earlier financial crisis -- Fraud and financial innovation: The match king:

A forthcoming book “The Match King” by Frank Partnoy, professor of law at the University of San Diego, will argue that the line of many of today's most dazzling financial innovations can be traced directly back to Kreuger. So can America's landmark Depression-era securities and accounting laws, which still shape the world of finance. So, too, can some of the most famous instances where those laws have been breached, such as the case of Enron, the collapsed American energy company.

Long before modern financiers created a market in asset-backed securities (the source of this year's turmoil) Kreuger was a master of the art. Effectively, the securities he sold to investors provided loans for governments secured against assets that he himself controlled. The assets were held offshore, which today's tax planners would welcome, and mostly off-balance sheet, the custom at Enron and many of the banks that have suffered this year.

The Economist explains how this was done, and why it fell apart:

After secretly acquiring factories around Europe during the years of post-war Depression in the early 1920s, from 1925 onwards Kreuger began offering a bargain to penniless governments that many found hard to refuse. Kreuger would, he said (usually with great secrecy), lend money to countries that provided him with a national monopoly on match production. His monopoly and skilled marketing would increase sales (Kreuger was a first-rate salesman, too: he is said to have propagated the myth that it is unlucky to light three cigarettes from the same match). Governments taxed matches, so the higher sales would raise tax revenues used to repay the loans. It was, boasted Kreuger, an almost foolproof business plan: the loans were secured against revenues that he controlled; the monopolies, meanwhile, ensured generous returns.
. . .
But despite the apparently flawless business model, match monopolies, it turned out, were not all that profitable. In order to offer spectacular returns, Kreuger paid dividends out of capital, not earnings. He was, in effect, operating a giant pyramid scheme, reliant on confidence to maintain a steady inflow of cash.

Like other free-wheeling entrepreneurs, Kreuger did not disguise his contempt for accounting norms. In a rare interview in 1929, he told Isaac Marcosson of New York's influential Saturday Evening Post that the key to his success was “silence, more silence, and even more silence”. (In a sycophantic letter to him found in Vadstena, Marcosson writes, “I regard it as a great privilege to be your Boswell.”) Secrecy, and his extensive network of paid informers around Europe, served him well; not only did it keep investors in the dark, but also enabled him to do deals with rival governments, such as republican France and fascist Italy, who loathed each other.

The point here should be clear - the more information out to the marketplace, the better. As I noted in our earlier paper, Reporting Intangibles, better disclosure is needed, especially of intangibles. History continues to teach us that lesson; we continue to ignore it.

Warren Buffett is moving into the bond-insurance business. According to a story in the Wall Street Journal:

Warren Buffett, seizing a chance to profit from turmoil in the nation's credit markets, is starting up a bond insurer that aims to make it cheaper for local governments to borrow and promises to be a tough competitor for the industry's embattled incumbents.
The billionaire investor's Berkshire Hathaway Assurance Corp., set to open for business today in New York state, will guarantee the bonds that cities, counties and states use to finance sewer systems, schools, hospitals and other public projects.

Give that he is already known for looking for assets that generate strong cash flow, will he look to the securitization of trademarks and other intangibles (backed by franchise fees)? Probably not right away, according to the Washington Post:

He said the company would stay away from insuring complicated structured products such as bonds backed by mortgages and credit card receipts.

The key here is "complicated structured products." To some extent, intangible-asset backed securitization is transparent and uncomplicated. Of course, there are still all the questions about the value of the underlying asset. The problem with mortgage backed securities is not just the complicated structure but the uncertainly over the ability of borrowers to repay the loans. Figuring out that risk is the job of the bond insurer - which is what Buffett is going to have to do. So without all the traunches and CDO, straightforward bonds backed by franchise fees or patent royalties might be an attractive business - even for Warren Buffett.

A few tidbits from the last couple of weeks in the Intangible Economy:

From our friends at Circuit City -- remember, the company who decided that it was a good strategy to sack the most experienced workers -- came this pre-Christmas story (Circuit City's Shares Tumble After Loss Widens - washingtonpost.com):

Circuit City laid off 3,400 workers in March to replace them with lower-paid new hires. This week, it announced the approval of millions of dollars in cash incentives to retain its top talent after the departure of several key executives over the past year. Executive vice presidents could claim retention awards of $1 million each, and senior vice presidents could get $600,000, provided they stay with the company until 2011, according to a filing with the Securities and Exchange Commission.

At least some folks on Wall Street understood -- according to the Post "The bonuses didn't sit well with Merrill Lynch analyst Danielle Fox, who questioned whether Circuit City should instead focus on incentives for the people who sell its products in stores."

Moral of the story (from Circuit City's point of view): Executive VPs good; real workers bad. Not!

More on the Internet gambling offset. In an earlier posting, I noted that the US has settled its Internet gambling trade dispute with Canada and the EU with "concessions" in warehousing services, technical testing services, research and development services and postal services. Just before Christmas cam word that the WTO has awarded the original complainant, Antigua, concessions in IPR. According to the International Herald Tribune:

In an unusual ruling Friday at the World Trade Organization, the tiny Caribbean nation of Antigua won the right to violate copyright protections on goods like films and music from the United States - worth up to $21 million - as part of a dispute between the two countries over online gambling.

The award comes after a WTO decision that Washington had wrongly blocked online gaming operators on the island from the American market at the same time it permitted online wagering on horse racing.

Antigua and Barbuda had claimed annual damages of $3.44 billion. That makes the relatively small amount awarded Friday, $21 million, something of a setback for Antigua, which had been struggling to preserve its booming gambling industry. The United States had claimed that its behavior had caused only $500,000 damage to the Antiguan economy.

Yet the ruling is significant in that it grants a rare form of compensation: the right of one country, in this case, Antigua, to violate intellectual property laws of another - the United States - by allowing them to distribute copies of American music, movie and software products, among other items.

Does this mean that Antigua will become the free music, movie and software haven? Will tourists flock to the beaches to pick up "legal" bootlegged copies of new movies? Unclear. Here is what USTR - Statement on Internet Gambling says:

The United States is concerned, however, that the Arbitrator agreed with Antigua’s request to suspend WTO concessions not just with respect to services, but also with respect to intellectual property rights (IPR). Any authorization pursuant to the award would be strictly limited to Antigua; every other WTO Member remains obliged to protect U.S. IPR under WTO rules, including enforcement against any IPR-infringing goods. Moreover, even with respect to Antigua, it would establish a harmful precedent for a WTO Member to affirmatively authorize what would otherwise be considered acts of piracy, counterfeiting, or other forms of IPR infringement. Furthermore, to do so would undermine Antigua’s claimed intentions of becoming a leader in legitimate electronic commerce, and would severely discourage foreign investment in the Antiguan economy.

So, this one is far from over. But it does set the precedent that IPR is not an ironclad right. It is a government granted right. And like any other government granted right, it can be granted or withdrawn as the government sees fit. It this case, the WTO recognizes IPR as just another trade law. Interesting.

Finally, there is this recent story in Business Week summarizing The State of Innovation:

This year, surveys from three leading consultancies—Boston Consulting Group, McKinsey & Company, and Booz Allen Hamilton—show innovation remains a high priority for most corporate leaders around the world. There's consensus across industries that innovation is a key growth driver. Unfortunately, the surveys also reflect a broad belief that most companies don't have the leadership, systems, or tools to successfully and consistently innovate.

The story is a good highlight of the three reports (many of which have been mentioned in this blog) -- and worth the read. The conclusions are not uplifting, however. Innovation is in danger of becoming a buzzword (see the latest IBM "Innovation Man" ads that play on this trend). Every CEO spouts the same rhetoric. But it is unclear that they understand beyond the rhetoric. And with a looming economic slowdown, we will see how many are willing to put their money (and other resources) behind the words. When business slows, innovation can come to the fore as a means of moving ahead (especially when resistance to change maybe lower). Or, it can be the first "extraneous" expense to be cut. We will see which mindset actually rules.

Such is the challenge facing the I-Cubed Economy in 2008. Happy New Year.