April 2009 Archives

Last week, Lee Rainie, Director of the Pew Internet & American Life Project, gave a talk to senior government managers on "Governing as a social network. Below is his powerpoint presentation. What I found especially interesting was the graphic on how the information ecology has changed. It certainly is a different era.

Two bits on the demise of the magazine Portfolio.

Bruce Nussbaum's take:

The closing of Conde Nast's 2-year old monthly business magazine, Portfolio, proves his point. Portfolio was a lush, expensive paen to an era of big advertising budgets from big corporations spent on mass audiences. This era has been ending since the the technological innovation of web, Google and targeted advertising fused with a quick-quick, multiple tasking, attention-challenged culture of Gen Y. Maybe a decade ago?

Ed Yardeni's take (from his list of 12 Reasons To Be (Economically) Optimistic):

Condé Nast has decided to shutter Portfolio after two years of struggle. The introduction of the glitzy magazine about Wall Street launched in the spring of 2007 marked the end of the bull market. Now its demise may mark the end of the bear market.

An interesting metric of both economics and publishing.

The BEA report this morning that the GDP fell by 6.1% in the 1st quarter of 2009 is not as bad as it seems. Yes, the drop was greater than the 4.6% decline predicted by the Dow Jones Newswires survey of economist. But there are some interesting bits of good news in the data. The main one is that personal consumption actual rose (by an annualized rate of 1.5% 2.2% - contributing a positive 1.5% to the change in GDP) after two quarters of decline. The real killer was a large decrease in private domestic investment, especially fixed non-residential (i.e. business spending). Inventories also declined sharply. Revived consumer demand and low inventories adds up to a potential rebound in business spending.

Also note that this is the "advance" version of the data -- which will be revised as more data (such as the March trade figures) become available. The advance GDP usually gives a good indication of the direction and relative size of the changes to GDP, but the actual number will change.

This morning BEA released its sector by sector breakdown of the 2008 GDP. The analysis confirms some of what we knew about the slowdown, but also reveals some other interesting facts. We knew that the slowdown hit the construction, manufacturing, retail and finance sectors. The BEA data on real value added in 2008 in each of these sectors confirms that. Real value added in construction dropped by 5.6% in 2008. Manufacturing real value added declined by 2.7%, with manufacturing of non-durable goods down by 4.6%. Retail related sectors were down, with transportation and warehousing dropping by 3.7%. Finance and insurance was down by 3.0%.

But here is the interested part. Construction actually started declining much earlier: down 0.5% in 2005, 4.1% in 2006 and a whopping 11.2% in 2007. So 2008 was actually an improvement. And while finance was down, real value added in the real estate sector (including renting and leasing) was actually up 1.8% in 2008 - although that was a slowdown from the 3.3% increase in 2007.

The "information economy" was still growing in 2008. The real value added in the information/communications sector increased by 5.2% in 2007 - again slower growth than the 8.1% increase in 2007. Growth in real value added in professional, scientific and technical services actually increased in 2008 over 2007 - an 8.7% increase in 2008 compared to a 7.1% increase in 2007.

The BEA data also shows that the goods producing part of the private sector slid into recession back in 2007 - when its annual growth in real GDP decline by 0.7%. The decline was, of course, even greater in 2008 - down 3.0%.

What this new data tells me is that the economic slowdown was caused by a variety of factors. It was not simply a lock up of the financial or house markets. There were significant weaknesses, and strengths, baked into the economy. Any sustained recovery will need to be based on correcting those weaknesses and building on the strengths. Including the strengths of the I-Cubed portion of the economy.

Yesterday, President Obama gave a major address to the Annual Meeting of the National Academy of Sciences on his science and technology policy. In the speech he mentioned a number of initiatives his Administration will undertake -- see the Fact Sheet for details. These moves are, in my view, long overdue. Some are new initiatives, such as the "Race to the Top" program to support math and science teachers and the emphasis on clean energy technology. Some, such as increased funding for basic research, will simply bring us back to where we should have been years ago.

While he didn't speak directly about entrepreneurship and broader innovation, his remarks did contain this line:

For we must always remember that somewhere in America there's an entrepreneur seeking a loan to start a business that could transform an industry -- but she hasn't secured it yet.

Speaking of banks and intangible assets (see earlier posting), here is an interesting summary of the debate over how to count bank assets - from the NY Times blog Dealbook - Questioning Wall Street's Favorite Bank Benchmark. The article describes the difference between using "tangible common equity" (TCE) to measure the level of bank capital or the current regulatory definition of "Tier I" capital. A big difference: Tier I includes some intangibles.

On the one side are people like former House Banking Committee Chairman Jim Leach, who is quoted saying "The fact that we even have anything other than T.C.E. is a reflection on judgment, which was deeply lacking." On the other side is Warren Buffett (among others), who is quoted as explaining the flaws of TCE by saying ""Coca-Cola has no tangible common equity, but they've got huge earning power."

For right now, the banking analysts and the markets are focused solely on TCE. In this age of uncertainly, I guess they don't care about intangibles.

For many banks, now comes the time of separating the wheat from the chaff -- in this case valuable intangibles from the froth of "goodwill" created by overpaying for assets. According to today's New York Times:

Companies are taking billions of dollars in losses as they write down the value of assets known as good will -- the amount they overpaid for a business compared with the sum of its parts. As the economy sinks lower and businesses struggle, that good will is going bad.
. . .
Banks wrote down more than $25 billion in good will in 2008, up sharply from $790 million a year earlier, according to data compiled by Frank Schiraldi of Sandler O'Neill & Partners. By the end of the year, banks still had $291 billion worth of good will on their books. An incomplete tally of write-downs from the first quarter showed that banks had taken a $3.5 billion hit to good-will values.

A bit of explanation first. In accounting terms, "goodwill" was an amorphous category where you threw all sorts of assets you couldn't figure out. When a company buys another firm, everything in the purchase price above and beyond the "fair value" is categorized as "goodwill". In 2001, the Financial Accounting Standards Board (FASB) issued Statements of Financial Accounting Standards (SFAS) 141 and 142. These required companies to separate out a long list of intangibles assets from "goodwill" and treat them differently. Goodwill therefore includes all of the speculative overpricing of the purchase as well as unidentifiable intangibles.

The definition of "goodwill" is important when reading the Times story. The story states that the goodwill includes "brand name, its customer base and reputation." Not necessarily -- since those were supposed to be pulled out from goodwill under 141/142. The story thus combines two issues: the write down on intangible assets and the write down on the goodwill.

For example, it its 10K filing with the SEC, SunTrust (mentioned in the article) had $7 billion in goodwill and slightly over $1 billion in other intangible assets. Those other intangible assets included "customer relationship." In its 1st Quarter statement, SunTrust took a $715 million write down of its goodwill -- but not of its intangible assets.

In 2008, Macy's took a $5.4 billion goodwill write down (according to its 10 K filing). But it only wrote down about $112 million in intangibles.

So, it is clear that the massive write downs are not due to intangibles loosing value. The write down are companies finally recognizing that they overpaid for previous acquisitions. As an August, 2008 paper by Feng Gu and Baruch Lev (Overpriced Shares, Ill-Advised Acquisitions, and Goodwill Impairment) hypothesize:

the root cause of many goodwill write-offs - managers' public admission of ill-advised corporate acquisitions - is the overpriced shares of buyers at acquisition. Overpriced shares provide managers with strong incentives to invest, and particularly to acquire businesses, even at excessive prices and doubtful strategic fit, in order to buy themselves out of the overpriced share predicament and postpone the inevitable price correction by portraying continued growth.

Business Weeks has released its ranking of the 50 best performing companies. According to the cover story, the companies that doing the best are those who are taking advantage of the economic turmoil, "This year's BusinessWeek 50 is chock-full of companies that changed the rules of engagement in their industries."

Autodesk exemplifies many of the companies in this year's BusinessWeek 50, our 13th annual ranking of the best-performing companies in the Standard & Poor's 500-stock index. While each list invariably includes companies that rode the wave of powerful industry cycles--such as this year's four energy companies--many more, like Autodesk, earned their spot in the BW 50 as innovators. They created products or services dramatically better and cheaper than anything offered by rivals. "These companies are what I call the 'disrupters' of the economy," says Harvard Business School professor Clayton H. Christensen, an innovation expert. Autodesk and its cutting-edge design software, for example, have helped the makers of everything from appliances to cars to prosthetic limbs take on entrenched rivals with greater resources.

At Nucor (NUE) (No. 20), experimental technologies and cutting-edge compensation revolutionized steel manufacturing--and may help explain why the company is holding up despite tough times. IntercontinentalExchange (ICE) (No. 17) and its electronic futures market brought greater price transparency to energy trading, and the company is now blazing a new trail by launching one of the first clearinghouses for complex credit default swaps. Occidental Petroleum (OXY) (No. 43) has relied on advanced technology to wring more production out of its oil fields in Texas and is now doing the same in Libya. Laparoscopic tools from Intuitive Surgical (ISRG) (No. 41) have shortened the recovery period for many surgery patients and could in time dramatically reduce the number of beds the nation's surgical hospitals need.
. . .
In the case of Coca-Cola, that meant finally embracing the change in consumer tastes--and marketing niche brands, such as vitaminwater and its Dasani water, with the same commitment as it does its flagship cola.
. . .
Consider Fastenal, a distributor of nuts, bolts, and 49,000 other tools and parts used by industrial customers. Given the commodity nature of its products, Fastenal works hard to guarantee its costs are the industry's lowest. To encourage employees to act like owners and shave every penny possible out of its cost structure, Fastenal pours 10% of all profits above a preset level each year into bonuses and 401(k) contributions.

As the Business Week 50 list demonstrates, innovation pays off in economic performance. So, where is the public policy to support this range of innovative activity?

One would think that by now we would have a handle on measuring economic activity in the tangible economy. But, it appears that a simple thing like a house can cause an uproar. Take the case of an article in today's Wall Street Journal about a fight between two well known housing experts -- Robert Shiller and Thomas Lawler -- over whose data is correct. As the story points out:

No one has found a precise way to measure changes in house prices. Because no two homes are exactly alike, changes in the price of one won't necessarily be matched even by apparently similar homes nearby, much less those hundreds of miles away. Though some indexes track price changes in the same set of houses over time, those can be distorted by major improvements in some of the houses and deterioration in others. The publicly recorded transaction prices, used to create indexes, often are distorted by incentives given to buyers that aren't tallied in the price.

The latest issue of Intellectual Asset Management (IAM) magazine has an article on the Ten common myths about intangibles value and valuation (subscription required). IAM editor Joff Wild has posted a summary on his blog Ten intangible/IP valuation myths revealed. I will let you read the 10 myths for yourself. I agree with most - but want to focus on Myth #4:

Each intangible should have only one official value. A single intangible may have several very different values at the same time; all of them valid, depending on who owns it and for what purpose it will be exploited.

This characteristic of an intangible (and these folks use the word to really mean IP) makes the valuation highly context specific. I like to use the analogy to the housing market. There are those who want to use a house as shelter; those who want to rent it out; those who want to use it a speculative investment. In that case of a patent, there are those who want to use the patent to create a product and those who want to own the patent to collect royalties. There are also those who want to sell the patent at a later date -- as part of a pool of patents that would be more valuable than a single patent, or after doing further development work on the technology to increase its value, or use the patent for infringement litigation. On top of these categories, we also have defensive ownership. In the housing market, this is buying the lot next to you so no one builds there to block your view.

Yet, for all these different reasons for buying a house, housing prices are generally accepted as valid -- even in periods of extreme volatility such as today.

So let me add Myth #11: Intangibles can't be valued in the market place.

The solution to the valuation problem, it seems to me, is in building up a robust market. And, ironically, building up a robust market requires more attention to disclosure - rather than valuation methodology. If you get the items out to the market - if you let people know they are available for transactions - the market will set a price. It won't be perfect - in fact it is guaranteed to be subject to all sort of irrational and arational behaviors. But if it is transparent and the process is seen as fair, then the price will be legitimate.

And that is the best valuation methodology of all.

I like Tom Brokaw, but in his op-ed piece in Sunday's New York Times (Small-Town Big Spending), he got it backwards. The piece is about what he sees as the redundancies of government services and structures:

Yet Iowa proudly maintains its grid of 99 counties, each with its own distinctive courthouse, many on the National Register of Historic Places -- and some as little as 40 miles away from one another. Each one houses a full complement of clerks, auditors, sheriff's deputies, jailers and commissioners. Is there any reason beyond local pride to maintain such duplication given the economic and population pressures of our time?

This is not a problem unique to the states I have cited. Every state and every region in the country is stuck with some form of anachronistic and expensive local government structure that dates to horse-drawn wagons, family farms and small-town convenience.

If this is a reset, it's time to reorganize our state and local government structures for today's realities rather than cling to the sensibilities of the 20th century.

But the centralization of government structures -- based on economies of scale -- which he advocates is exactly the hallmark of the Industrial Age of the 20th Century. The 21st Century - and the I-Cubed Economy -- will be one of decentralization and localized services, connected in a vast network. Some government services will likely benefit form consolidation on the network. I am betting, however, that there will still be a need for local governmental structures geared toward the crafting of localized solution (sometimes tweaks of generalized best practices) to localized problems.

Last week, Fed Reserve Chair Bernanke gave a speech on Financial Innovation. In that speech he made a very insightful comment:

Regulation should not prevent innovation, rather it should ensure that innovations are sufficiently transparent and understandable to allow consumer choice to drive good market outcomes.

That is good advice for innovation and regulations in general.

And it harkens back to our earlier comments on vetting innovations.

PS -- for an interesting discussion of the speech and innovation in financial services, see James Kwak's blog The Baseline Scenario - Financial Innovation for Beginners.

I have long complained about our confusing, inadequate and antiquated system for training and assisting workers. First of all, we wait until someone loses their jobs before we decide that it might be a good idea to upgrade their skills. For a nation that confesses to believe that "our human capital is our most important asset", such an after the fact as our "re-training" programs have now response is just utterly stupid. It is based on the false notion that somehow the government should not ever intervene in the market -- that helping foster on the job training is a give away to private companies - who should be doing it themselves. Of course, this argument ignores the market failure that the free-rider problem (i.e. why should I spend money on worker training when I can simply hire away you workers after you pay to upgrade their skills). It also ignores the loss in overall economic competitiveness due to a less than world-class trained workforce (the social welfare argument). Image if we eliminated our tornado warning system -- claiming the government shouldn't interfere with Mother Nature and the only job of the government is to clean up the mess afterwards. But that is exactly the mentality we use when dealing with economic tornados.

We need to move to a proactive system - part of which is a knowledge tax credit to encourage more on-the-job training. (See our working paper on Crafting an Obama Innovation Policy)

Second, when we do have a program to help unemployed workers, it is a mishmash of programs. Today's Wall Street Journal is running a story about how Crazy-Quilt Jobless Programs Help Some More Than Others. The story notes the huge discrepancies between the Trade Adjustment Assistance (TAA) program and standard unemployment programs.

The story also illustrates why it is so hard to get workers the support they need:

"A worker who loses a job due to trade is not deserving of a more generous safety net than a worker who loses his job due to other forces, such as technological change," says N. Gregory Mankiw, a professor of economics at Harvard University and former chairman of President George W. Bush's Council of Economic Advisers.

Mankiw's comment echo the standard critique: why should we help workers at all. We should be posing the question the other way around:

A worker who loses a job due to economic forces does not deserve a less generous safety net than a worker who loses his job due to trade.

Once we confront the problem in this correct way, then we can start to solve it.

I know, the issue of cost will come up. It is the standard head fake that critiques use to deflect the issue. But we hear this all the time from the "pennywise and pound foolish" crowd. Time and time again, preventive measures have shown to be less costly than after-the-fact remedies.

Continuous worker training is one of those preventative measure that we should institute. In the mean time, we need to create at least an effective response unemployment program by consolidating and upgrading the programs. We can not afford to let our human capital wither in this crisis if we are to restore economic prosperity. Otherwise, our recover efforts will simply be an effort to re-flate the bubble.

The possible bankruptcy proceeding for GM are highlighting a key intangible asset in the process: the supply chain. As the Financial Times reports (GM seeks provision for its suppliers):

General Motors is prepared to argue that hundreds of its suppliers are "critical vendors" who require timely payments if it seeks bankruptcy protection, setting the stage for what would be the most sweeping attempt ever to win special treatment for such contractors, people close to the matter say.
Companies often request special treatment for a limited number of suppliers as part of bankruptcy petitions.
Bankruptcy experts say GM would stand a good chance of winning protection for more suppliers than is usual because of the large number that provide "just-in-time" car parts to the company.

As last September's Intangible Asset Finance Society meeting noted (see earlier posting), it is not just the existence of the supply chain that is the asset. What matters is the management of that supply chain and how it can affect your own reputation assets. I hope the bankruptcy court can take the reputation aspects into account as well.

Tis the season for innovation survey's (see earlier posting). Business Week has just posted its list of the World's Most Innovative Companies. Once again, Apple is rated the most innovative company.

The overall findings are somewhat similar to the earlier posting. Companies are cutting back somewhat, but not drastically. The one exception is GM, which has completely dropped off the list. On the other hand, there are over a dozen companies on the list which didn't rate last year, including Volkswagen which went from not rated to 18th on the list.

There is also a greater attention to collaboration. As the story notes: "Some, such as Procter & Gamble (PG) (No. 12) and Vodafone (VOD) (No. 25), are teaming up with outsiders to share costs." As the detailed story on Vodafone tells it, the company is a late comer to the open innovation model. But now it is a strong convert:

The clearest sign of Vodafone's new philosophy can be found on a Web portal called betavine. The site allows anyone from hobbyists to software pros to create and test one another's mobile applications, which can be downloaded on any wireless network, not just Vodafone's. While developers retain intellectual property rights, the British giant gets insight into the latest trends and ensures that new apps are compatible with its network. Vodafone itself used betavine to enlist those enthusiasts to test a software add-on that enables mobile broadband customers to access the Internet via Linux.

InnovationTools.com has released its latest Innovation Climate Survey. The findings might be surprising at first, but not if you think about it for a moment:

Nearly half of the survey respondents (49.0%) reported that the climate for innovation has improved in their organizations. Of this total, just over 20% said it has improved significantly, while another 27% said it has improved slightly. Another one-fourth of innovation practitioners (25.7%) said there has been no change in the climate for innovation in their companies.

We are forging new partnerships with folks we formerly viewed as competitors. They may have a skill set which combined with ours sells not only our product but theirs as well, resulting in clients seeing that we go the extra mile to meet their needs.

This too makes perfect sense upon reflection. In downturns, internal resources are less available - or are allocated in a much more strict manner. When internal resources are scarcer, it makes sense to look outside. In some cases, this outward look may be a completely different behavior for the company. Thus, downturns maybe the time when companies can more easily break the "not-invented-here" syndrome.

This new embrace of collaboration will change the way business operates. Once adopted, it is likely to be a permanent rather than transitory -- once the culture of collaboration takes hold. And, as we noted in our report Virtual Worlds and the Transformation of Business, the tools for collaboration are rapidly evolving. The development of these new tools will help streamline and shorten design and testing of new products, improve training and learning, and provide important new ways to involve consumers in product design, performance, and after-sales support (see earlier posting). The result will be a stronger, more productive economy.

Maybe we should add a C - for collaboration - to the I-Cubed Economy.

One of my consistent themes throughout the discussion of the financial crisis has been dealing with the tide of red ink. As the financial system writes off the bad assets - by selling them to Fed or however -- there is going to be some very large losses.

Now, we see how one of the savviest players - Goldman Sachs - has figured out to deal with the red ink: hide it. Ok, they didn't really hide it - they just dealt with it quietly and then ignored it. Here is how William Cohan explains it in his column today on how Goldman is doing - Big Profits, Big Questions:

Part of the answer lies in a little sleight of hand. One consequence of Goldman's becoming a bank holding company last year was that it had to switch its fiscal year to the calendar year. Previously, Goldman's fiscal year had ended on Nov. 30. Now it ends Dec. 31.
As a result, December 2008 was not included in Goldman's rosy first-quarter 2009 numbers. In that month, Goldman lost a little more than $1 billion, after a $1 billion writedown related to "non-investment-grade credit origination activities" and a further $625 million related to commercial real estate loans and securities. All told, in the last seven months, Goldman has lost $1.5 billion. But that number didn't come up on Monday. How convenient.

Such a move is apparently completely legal. As the Washington Post story (Goldman Revamp Puts Dec. Losses Off Books) relates:

Michael Williams, director of research at Gradient Analytics, which specializes in examining corporate accounting, said companies have a lot of discretion in deciding when to recognize gains and losses.
"It does seem rather remarkable that they ended up with such a large amount of losses in December itself, just in that four-week period," Williams said. "You're just left scratching your head to a large extent about what's underlying the numbers for the month," he said.
Given the scale of the December losses, and considering that March was so strong for the financial markets, it seems possible that Goldman's first-quarter profit would have been a loss if it were still reporting on the old schedule, Williams said.

However, there is a question of whether and when the December numbers should have been released. As the Post notes:

The Goldman spokesman rejected the notion that the firm shifted losses into December. Goldman did not supplement its latest earnings release by showing past results on a comparable basis because its business isn't seasonal "and we didn't think it was material or significant," [Lucas van] Van Praag said.

Only on Wall Street can billion dollar write-offs not be considered "material."

First mark-to-myth. Now the insignificance of billion dollar losses. We now have the answer to what is going to happen to the red ink. It will simply disappear into the ether -- just like all those assets did.

Goodbye financial engineering; hello accounting engineering.

UPDATE: For more on the Goldman, especially the relationship with AIG, see the posting on this morning's New York Times' DealBook blog - Analysts See Weak Spots in Goldman's Results.

Latest on TARP from the Financial Times - Tarp investigator seeks evidence of book fiddling

The official policing the $700bn Tarp fund says he is investigating whether banks have "cooked their books" to secure bail-out money.
Neil Barofsky, special inspector-general for the troubled asset relief programme, told the Financial Times he was seeking evidence of wrongdoing on the part of banks receiving help from the fund, which was designed to ease credit conditions and support distressed industries.
"I hope we don't find a single bank that's cooked their books to try to get money but I don't think that's going to be the case," said Mr Barofsky, who has been dubbed the "Tarp cop".

Let's see, does suspending mark-to-market and letting the banks decide what their assets are worth based on their "significant judgment" constitute "cooking the books"?

By the way, to see a good example of the type of thinking that Samuelson doesn't get (see earlier posting), see Bruce Nussbaum's blog -- including this latest posting - Easter Sunday Thoughts on Designing Sustainable, Non-Material Signals of Cool.

An interesting column in today's Washington Post by Robert Samuelson illustrates the problem we are having at coming to grips with the I-Cubed Economy -- because too many people are still in the grip of the 18th Century thinking that defined the Industrial Age. Here is he heart of Samuelson's argument:

Since the dawn of the Industrial Age, this has been simple: produce more with less. ("Productivity," in economic jargon.) Mass markets developed for clothes, cars, computers and much more because declining costs expanded production. Living standards rose. By contrast, the logic of the [Obama] "post-material economy" is just the opposite: Spend more and get less.

Consider global warming. The centerpiece of Obama's agenda is a "cap-and-trade" program. This would be, in effect, a tax on fossil fuels (oil, coal, natural gas). The idea is to raise their prices so that households and businesses use less or switch to costlier "alternative" energy sources such as solar. In general, we would spend more on energy and get less of it.

The story for health care is similar, though the cause is different. We spend more and more for it (now 21 percent of personal consumption, says Brookings economist Gary Burtless) and get, it seems, less and less gain in improved health. This is largely the result of costly new technologies and the unintended consequence of open-ended insurance reimbursement that encourages unneeded tests, procedures and visits to doctors. Expanding health insurance might aggravate the problem. Many of today's uninsured get health care for free or don't need much because they're young (40 percent are between 18 and 34).

Samuelson has never understood the logic of an innovation driven economy -- where less can be more and more can be less. Nor does he appear to understand the basics of the capitalist economic system: that prices set the signals for the allocation of resources.

Let's started with the first quoted paragraph: that it is all about mass production. In the Industrial Age that was true. But we haven't been in the Industrial Age for decades. Even in the late Industrial Age is wasn't about just declining costs - but expanding product choice (something that Alfred Sloan understood when he created GM and Henry Ford had trouble with). Getting more with less is still important. But the "more" is not "more" the way that it was measured in the Industrial Age (as in more stuff). The key word today is really "better."

In the second quoted paragraph, he complains about "costlier" alternative energy sources. Here he fails to understand the dynamics of price signals. The problem with current energy sources is that they underprice the true cost of production by not including externality costs (in the form of pollution, for example). Those cost must be including to get the pricing signals right. As the price for energy reaches its true price, the basic tenet of capitalism is that investment will follow to the area of higher prices, innovation will drive down prices and a new equilibrium will be established. Apparently, Samuelson thinks that this capitalist system can't work in the energy sector and that no innovation (to either increase alternative suppliers or increase efficiency) will occur due to the change in price signals.

One other point. Samuelson complains about "get less" energy. Somehow he forgets what he just said about the whole point of productivity - to use less. Energy is a input to the production process and using less is what will ultimately drive down costs in the entire economy. I wonder, is he concerned that we are getting less computers because they now fit on a microchip rather than take up an entire room?

The same lack of understanding of dynamics of the capitalist system can be said for his analysis of health care. No innovation -- technologically or organizationally -- will occur to change the current cost structure. In fact, it appears from his view that "costly new technologies" are the culprit.

Samuelson's economic view of a static economy -- apparently frozen in the 1950's. While mentioned some technologies in the context of mass production, he goes out of his way to downplay the possibility of innovation:

They've left the impression that somehow magical technological breakthroughs will produce clean energy that is also cheap. Perhaps that will happen; it hasn't yet. They've talked so often about the need to control wasteful health spending that they've implied they've actually found a way of doing so. Perhaps they will, but they haven't yet.

In other words, since it "hasn't happened yet" it never will.

So maybe I should change the title of this posting. It isn't 18th Century thinking; its 12th Century thinking. Things are they way they have always been and always will be.

I think we can do better than that.

The Wall Street Journal is running a video interview with Tom Koulopoulos, author of The Innovation Zone, on how jobs cuts can spur innovation. The thrust of the interview is on how entrepreneurship often gets a spurt as people get laid off. But, as Koulopoulos points out, credit is constrained in this recession. That make the start-up process more difficult.

What I found more interesting, however, was his discussion of the role of small and big businesses. He used the example of the PUMA (see earlier posting). His point was that the combination of Segway and GM is an example of how the system works: GM is reinventing the automobile but Segway is reinventing transportation. It is the Segway type of innovation that change the game.

Koulopoulos make a very important point: the advantage of the US system is that we can quickly scale up an innovation. Small companies provide the innovation; big companies bring it to scale.

So, what are the public policy implications?

The Economist is running an interesting story on patenting locations. The basic thrust of the piece is a critique of the recent IP Solution's report on patenting - labeled the 2008 Global Innovation Study. The Economist takes issue with the study on a couple of grounds:

Intriguing as it is, the study is misleading in several other ways. For a start, it lumps together patents that were applied for in 2008 with those granted that year. Obviously, none of these firms is in the lunatic fringe, so it is not the case that some applications should be ignored. But not all applications are granted patents, so adding the two together is a no-no.

Then there is the issue of how to "base" the results. The study ranks companies by the total number of patents they file or are granted during the year, instead of giving those numbers as a percentage of sales or head count. Admittedly, such quibbles matter less at the corporate level than they do nationally. Even so, they mask the performance of some highly creative smaller firms.

However, the Economist brushes lightly over the real issue: does patenting equal innovation? According to the story:

The correlation between such [international] patenting and innovation is remarkably robust, according to various studies. More intriguing still, the correlation holds true not only at the national level, but also at the level of the firm.

I would like to see those studies - because I have not seen such a tight correlation. I worry that such correlations are the result of self-reference -- "innovation" is defined mainly by the number of patents, therefore the number of patents is highly correlated with "innovation."

Likewise, patenting strategies differ by industry -- a fact we are constantly reminded of in the patent reform debate. Some industries patent less than others. This does not necessarily mean they are less innovative.

Patents are a important measure. But patents are, as the Economist pointed out, a problematic proxy for innovation. Too bad the Economist didn't explore that part of the story better. Or add their voice to the call for better measures of innovation.

This morning, the US monthly trade deficit shrunk by a dramatically unexpected $10 billion (see earlier posting). Yet, from what I can tell, the news media has essentially ignored the story. Any mention of it by the Wall Street Journal, Washington Post, CNBC is buried on their websites - either as an obscure wire story or at the end of the story on weekly jobless claims. The Wall Street Journal seems to think that Karl Rove calling President Obama "divisive" is more news worthy.

Apparently, we have reached a point in the economy where trade doesn't matter any more. Interesting.

UPDATE: The one exception I can find to this general lack of coverage of the trade data is AP Economics Writer Martin Crutsinger's excellent story (available on WTOP).

UPDATE 2: THe Wall Street Journal's Real Time Economics blog is running a "Economists React" discussion about the trade data.

This morning's BEA trade data shows that our trade deficit declined dramatically in February - down over $10 billion to $26.0 billion. Exports grew by $2.0 billion while import dropped by $8.2 billion. The rise in exports is extremely good news - as it points to a healthier trade balance long term. Notably, goods exports accounted for all of the improvement. The biggest jumps in exports were in a diverse set of industries: soybeans; steelmaking materials; chemicals; semiconductors; telecommunications equipment; pharmaceuticals; artwork; and, gem diamonds.

That leads us to our not so good news: the intangibles balance was essentially unchanged -- as trade in all categories (export and imports; royalties and business services) all declined.

Our deficit in Advanced Technology Products also continued to decline, dropping to $1.5 billion in February as exports grew and imports dropped. 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.

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.

There is a lot of economic opportunity in going green, aside from the environmental reasons. But if green technology is to be an driver of economic growth, it has to be exportable. Locally rooted activities, such as retrofitting of building, are important -- but do not generate an inflow of revenues to offset our current large outflows. To help bring our trade flows back into balance, we need to be internationally competitive in exportable green technologies.

Building that competitive position should not be taken for granted. Other nations are embarking on the same goal. And, as Michael Porter taught us, certain local factors (such as a sophisticated customer base) enhance a nation's competitiveness in certain industries. Such is the case in green. For example, the New York Times recently reported that China may have a competitive advantage in electric vehicles:

Electric cars have several practical advantages in China. Intercity driving is rare. Commutes are fairly short and frequently at low speeds because of traffic jams. So the limitations of all-electric cars -- the latest models in China have a top speed of 60 miles an hour and a range of 120 miles between charges -- are less of a problem.

That matching of a large domestic market with the current characteristics of the technology given the Chinese an advantage in introducing electric cars quickly -- and building on that experience to enter other markets (such as the US) with a superior product.

A new article in Knowledge@Wharton - Going Green: Why Germany Has the Inside Track to Lead a New Industrial Revolution - makes the same claim for Germany in renewable energy:

In 2008, even as Americans argue over whether renewable energy is a fantasy, Germany generated 14.2% of its electrical power from renewable resources. Already a leading player in so-called clean technology -- the mix of environmentally benign power generation and environmentally friendly technologies -- Germany may become the epicenter of the world's next industrial revolution: the triumph of clean, cheap, sustainable electricity.

So here is a plausible scenario for the future: the US gets its electric cars from China and its renewable energy production equipment (solar; wind) from Germany. And our trade balance continues to run a large negative - even after we reduce oil imports.

We need to do better.

Here is an interesting story from last weekend's Wall Street Journal - The Scariest Monster of All Sues for Trademark Infringement:

When Christina and Patrick Vitagliano dreamed up their Monster Mini Golf franchises -- 18-hole, indoor putting greens straddled by glow-in-the-dark statues of ghouls and gargoyles -- they never imagined that a California maker of high-end audio cables would object.
But Monster Cable Products Inc., which holds more than 70 trademarks on the word monster, challenged the Vitaglianos' trademark applications. It filed a federal lawsuit against their company in California and demanded the Rhode Island couple surrender the name and pay at least $80,000 for the right to use it.

Apparently, Monster Cable has been actively going after other companies who uses the word "monster":

Over the years, it has gone after purveyors of monster-branded auto transmissions, slot machines, glue, carpet-cleaning machines and an energy drink, as well as a woman who sells "Junk Food Monster" kids' T-shirts that promote good eating habits. It sued Monster.com over the job-hunting Web site's name and Walt Disney Co. over products tied to the film "Monsters Inc." It opposed the Boston Red Sox trademark applications for seats and hot dogs named for the Green Monster, the legendary left-field wall in Fenway Park. All in all, Monster Cable says it has fought about 190 monster battles at the U.S. Patent and Trademark Office and filed around 30 monster lawsuits in federal courts.

David Tognotti, Monster Cable's general manager and an attorney, says the company considers "Monster" a famous mark -- on a par with Barbie dolls or Camel cigarettes. "We're protecting our mark as if it's a famous mark," he said in an interview in Monster Cable's headquarters, where the walls are lined with framed copies of the company's trademarks and patents.
Mr. Tognotti cited a chapter on famous marks in the law book "McCarthy on Trademarks and Unfair Competition" by J. Thomas McCarthy, a noted expert in the field.
But in an interview, Prof. McCarthy expressed doubt that Monster Cable possesses a famous mark. He said such determinations are made by courts. Mr. Tognotti acknowledges Monster Cable hasn't obtained such a court ruling.

In any event, it sounds like this issue is going to go on for awhile. It will be interesting to see if other companies pick up on trademark litigation as a business model for enhancing their revenues.

GM and Segway announced this morning an enclosed two wheel vehicle for urban driving - the PUMA (Personal Urban Mobility and Accessibility). Apropos my earlier comment of technology versus process innovation, I don't think the PUMA will save GM. Much more innovation - defined as a new way of thinking" will be needed at GM.

However, the PUMA is more than just a new technology. In fact, it seems to me to be more of a repackaging of the existing Segway technology -- although I am sure there are some technological refinements as well. The original Segway never became the game-changing technology that it was hyped to be. Part of the problem with the original scooter design is that it was caught in between concepts -- it didn't really belong on the roads but was a problem on sidewalks as well. The new PUMA is clearly a road vehicle, so it may be a better fit to the urban market.

On the other hand, it may just be more of a general marketing tool. As the Wall Street Journal notes, "The struggling auto maker, surviving on a government lifeline, is looking to generate enthusiasm for its increasingly uncertain future ahead of the New York auto show this week."

In any event, don't look to see a few these tooling around your streets anytime soon. While this is just the type of thing early technology adopters can't refuse, it is still a prototype. Production won't begin, according to press reports, until at least 2012.

What exactly is innovation? Is it new technologies? That is the most common image that comes to mind when the word is used. Or is it new ways of doing things? That is a broader, but also more ambiguous, definition. Or is it both new outcomes and new processes?

Keep those two definitions in mind over the next few months when you hear arguments about the DOD budget. The Defense Department's budget may seem to be a strange place to be holding a debate over innovation. But, I believe the competing definitions will implicitly underpin much of the discussion over the Pentagon's funding

Here is the background. Yesterday, Defense Secretary Robert Gates announced the new FY 2010 budget, with a new set of spending priorities. Cut were a number of high tech weapons systems, including the Navy's DDG 1000 stealth destroyer, the Air Force's F-22 and the Army's Future Combat Systems. That is likely to cause a number of people to complain that Gates is anti-innovation (meaning anti-high tech). Already, there were complaints about the cuts (for more see stories in the Wall Street Journal and Washington Post).

Gate had earlier signaled his intension in an article in Foreign Affairs -- A Balanced Strategy: Reprogramming the Pentagon for a New Age. This reprogramming is twofold: strategy and operations. In the strategy, Gates is seeking to redefine the military mission:

we must not be so preoccupied with preparing for future conventional and strategic conflicts that we neglect to provide all the capabilities necessary to fight and win conflicts such as those the United States is in today.

With respect to operations, Gates noted that in combating the insurgency in Iraqi:

For every heroic and resourceful innovation by troops and commanders on the battlefield, there was some institutional shortcoming at the Pentagon they had to overcome.

In other words, Gates is trying to get the Pentagon to act in new ways - to do things differently. That is a path others have tried before. In this case, Gates believes that innovation means moving away from some of the high-tech areas. That sets up the clash between innovation (conventionally defined) and innovation (broadly defined).

There will be lots of defenders of the conventional approach to innovation at DOD -- more high tech weapons systems (something that might be labeled status-quo innovation). We will see how many advocates there are for new ways of doing things.

A widely recognized issue with the management and financial recognition of intangibles is valuation. Not only does the nature of some intangibles make valuation problematic (e.g. worker tacit knowledge) but when intangible are traded (e.g. patents) they are traded in thin markets. The thinness of the market makes it hard to set a general market price. There are other valuation techniques, including a cost approach or an income approach. But having numerous valuation techniques may be part of the problem. How do investors know what technique is being use and what are the inputs to the model?

The recent FASB actions on valuing illiquid financial assets may be of relevance in this regard (see earlier posting). When FASB modifies the mark-to-market rules for these assets, it stated that greater disclosure would be required. That includes, supposedly, disclosure about the valuation methods.

This FASB requirement may have set up a natural experiment for us. I would guess that banks will use a variety of models - and assumption going into those models. In our earlier paper, Intangible Asset Monetization, we called for a joint FASB/SEC task force to review the valuation methodologies. Here is the real-world data that such a task force would need.

SEC should be doing part of this already. A year ago, the SEC issued guidance to companies on what they should disclose about their valuation techniques in the Management's Discussion and Analysis (MD&A) section of their financial reports. I don't know if SEC has yet done a follow up to determine whether companies are complying with that guidance -- and more importantly, what they are saying.

Follow up on analysis of that guidance, along with setting up a proactive process for evaluating the news disclosure requirement, would go a long way to laying the groundwork for a standardized methodology.

At the very least, it would signal that the regulators are serious about disclosure. And given the nature of some intangibles, what may be the most important action is more disclosure, disclosure and disclosure.

This morning's jobs data from BLS showed another leap upward in March as the unemployment rate rose to 8.5%. Payrolls fell by 663,000 and the number of unemployed rose to over 13 million. The number of involuntary underemployed (part time for economic reasons) also rose by 423,000 to over 9 million. Payroll declines were generally across the board. The only sectors of employment growth were health care and the Federal government.

According to the Wall Street Journal, the numbers "largely matching Wall Street expectations, according to a Dow Jones Newswires survey."

The quasi-good news is that the number of workers unemployed less than 5 weeks is dropping. The really bad news is that the number of workers unemployed over 14 weeks is steadily growing. So, more people can find a job right away - but those that don't are out of work longer.

Here is a great juxtaposition, from yesterday's Wall Street Journal:

Story #1 Regulators Agree to Create Stricter Capital Requirements for Banks:

A group of U.S. and foreign bank regulators has agreed to move towards creating stricter capital requirements for banks around the world, marking a reversal from a push just a few years ago to give financial institutions more flexibility in how they calculate reserves.

Story #2 FASB Eases 'Mark-to-Market' Rules

The Financial Accounting Standards Board revised the rules to allow companies to use their judgment to a greater extent in determining the "fair value" of their assets. The board also made it easier for companies to avoid having to take impairment charges against earnings when they suffer losses on their investments.

Intellectual Property Watch is reporting that compromise US patent reform legislation cleared the Senate Judiciary Committee today:

The measure (S 515) is the latest attempt by Senate Judiciary Committee Chairman Patrick Leahy (Democrat, Vermont) and other lawmakers to push through changes to the US patent system, and it appears to have wide support across industry sectors.

Nevertheless, the amended version of the bill, which Leahy called a "very delicate compromise," faces continuing strong opposition from some lawmakers and leaves several controversial issues still unresolved.

So this may be the beginning of end.

Earlier today, FASB announced that it was modifying the mark-to-market rules. Final guidance will come out in a week or so. (You can also listen to the announcement on line.) According to Bloomberg, "Changes to fair-value, or mark-to-market accounting, approved by FASB today allow companies to use 'significant' judgment in gauging prices of some investments on their books, including mortgage-backed securities."

If banks can now use "significant" judgment and internal valuation models for financial assets, why can't companies use significant judgment and internal valuation models for all intangibles?

Now, FASB will require greater disclosure of valuation methods and on cost data. That is good news. But, again, what about the valuation methods of their intangibles, such as for their patents?

Seems to me if you can do one, you should be able to do the other.

James Surowiecki has an interesting piece in The Guardian - How the bandwagon wrecked the wisdom of market crowds, in which he comments on how the market participants took excessive risk:

So what drove these bets? First, at most companies the link between pay and performance, risk and reward, was severed - or, to be more accurate, the link between pay and long-term performance was nonexistent. Crowds are wise when the individuals in them have an incentive to get the right answer. On Wall Street, though, the enormous amounts of money that one could make in the short term meant that the long-term consequences of failure mattered much less than they once did. Similarly, the fact that mortgages were packaged and sold as securities to outside investors changed incentives dramatically. Mortgage brokers were rewarded not on the ultimate performance of the mortgages, but on how many deals they made. As a result, it's not surprising they were not interested in meaningfully evaluating potential borrowers' riskiness.

The problem was compounded by what you might call the outsourcing of responsibility. Again, markets work best when people in them are thinking for themselves. But during the bubble, an enormous amount of authority was given to the ratings agencies, whose evaluations of housing assets had a tremendous impact on the securities that investors chose to buy and the interest rates they were willing to accept. These agencies were either lacking or uninterested in the kind of granular information that would have allowed them to offer meaningful judgments about the assets, and relied too often on broad analyses and historical trends to make their judgments.

Still, that doesn't quite explain why seemingly savvy investors, who knew that the rating agencies had conflicts of interest, simply went along with their judgments. To explain that, I think you have to accept something that isn't necessarily easy to believe, which is that Wall Street to some extent drank its own Kool-Aid.

. . .

We often take our cues from those around us, and in times of uncertainty - whether good or bad - we tend to herd together. The key to a group making wise decisions is that its members be diverse in their opinions and relatively independent of each other. But this impulse toward imitation - or what sociologists call "social learning" - can make that difficult. It isn't simply that we are mimics. It's that the people around us often do have good information. They often have come up with good answers. So there is a powerful bandwagon tendency in humans generally, and in markets specifically; and during this bubble it exerted a powerful influence.

We used to call that herd behavior Groupthink. When The Wisdom of the Crowd first came out, I remember wondering what would happen when it collided with Groupthink. Now we know, at least in this case. Groupthink won.

A new story at Strategy+Business makes the interesting claim:

Companies that are not in financial services are sitting on as much as US$950 billion of excess working capital on their balance sheets, untapped and wasted, according to a Booz & Company analysis of North American stock exchange-listed businesses with annual revenue of more than $1 billion. All this potentially available cash is tied up in a vast array of receivables, payables, and inventory that is being neglected or that could be better handled.

Receivables, payables, and inventory are all assets that, with the proper management, can be turned into better cash flow.

If there is almost a trillion dollars lock up in those well-known forms of assets, how much more might there be locked up in intangibles?

A new accounting rule set to be approved this week will relax mark-to-market rules for banks sitting on billions of dollars in toxic assets, making it more attractive to keep the assets on their books. Yet those changes may undermine a larger U.S. Treasury plan to rid the banks of those same assets, bankers and accounting experts say.
The Financial Accounting Standards Board is proposing significant changes to its mark-to-market rules, allowing banks to set their own values for certain hard-to-value troubled mortgages, corporate loans and consumer loans. The new proposal, called FAS 157-e, is scheduled for a vote this Thursday.
The change was meant to assist U.S. banks after bankers complained current mark-to-market accounting rules forced them to undervalue their assets, by setting prices at deeply discounted, fire-sale values.
Once the new accounting rule takes effect, banks will have new incentive to keep the assets directly on their books, say bankers. That is because the rule states that banks can use their own judgment on asset values as long as there are no willing bidders to set a market price.