June 2009 Archives

I was recently at a conference where Klaus Hoehn, the VP for Advanced Technology and Engineering for John Deere spoke. He made a very interesting off hand comment. He said that Deere was in the business of providing functionality -- and was moving toward providing integrate customer solutions.

His comments recalled to mind a story of innovation in Christensen's The Innovator's Dilemma about steam shovels (see summary). One company was in the business of building bigger shovels with greater power. And the best technology was the cable system. Another company, however, developed the new hydraulic system was not as good as the steam cable system -- but was very suited to narrow spaces. They got in the business not of providing big powerful shovels but of digging narrow trenches (such as for pipe laying or house foundations). Functionality - not a specific product.

The Deere quote is similar to what we keep hearing from a lot of companies. The mass production model (of more and more of the same) is giving way to the customization model. This is a trend we have been talking about for some time -- and that helps define competitiveness in the I-Cubed Economy. But we are just beginning to bring our mindsets around to what it means. Originally, customized manufacturing meant the flexibility to run smaller batches of mass produced goods or to add certain features to a basic product. Hence it was also know as flexible manufacturing.

However, at its heart, customized manufacturing really means providing the customer with a product uniquely suited to their needs. The phrase "just-in-time; just-for-me" has been used to describe this level of customized goods. It is not about the product; it is about the customer.

From that perspective, distinction between manufacturing and services begins to blur. What business am I really in? Is my business making backhoes? Or is my business selling contractors ways to make holes in the ground? With that question comes a change in orientation from making the product better to providing "integrate customer solutions."

The classic case is Rolls-Royce as noted before. The aviation division of Rolls doesn't sell jet engines, they sell thrust in the form of hot air out the back of airplanes. The monitoring and servicing of the engines is as important as their manufacturing. And the servicing works because they designed and built the engines in the first place.

By the way, the same shift is happening in "services" -- at least in some areas. What does the customer need rather than how to I make my particular service faster, better, cheaper. It is really a shift from efficiency (the focus in the industrial age) to customer-focused innovation. (Note: I have to use that clarification of "customer-focused" since most of our view toward innovation is still on making the product the faster, better, cheaper).

That is not to say that faster, better, cheaper is not a factor. But faster, better, cheaper is not any of those if the product really doesn't suit my needs. If what I want to do is travel a mile from my house to my office, a bicycle or a bus may be a better solution than a Ferrari.

The switch in focus from the product (good or service) to the customer needs is a move beyond the age of mass production/mass consumption. The switch is well underway in the economy. Businesses, like Deere, understand this.

So, what are the public policies appropriate to this new era?

There was an interesting piece over in Joff Wild's blog at IAM Magazine about an Ocean Tomo ratings deal with France's state bank. According to the piece:

The Chicago-based merchant banc has agreed a working protocol with Caisse des Dépôts, the development bank owned by the French state, that is expected to lead to the creation in the autumn of the first ratings platform for European patents. This would be an OT/Caisse des Dépôts joint venture based on the ratings platform that Ocean Tomo already has for US patents.

Wild implies that this is a move toward setting up a European IP transactions market. In other words, the joint venture will be a patent analytic service.

I wonder if this might be headed in a different direction. One of Caisse des Dépôts responsibilities is the development of French SMEs -- especially helping to find financing. Could it be that this new patent rating system is the beginning of IP-based lending on behalf of the bank? Given the need to have such a rating system in place to underpin any lending program and given the bank's basic mission, it seem like a logical fit.

Anyone out there have any additional information?

Here is an interesting bit from a recent article by James Fallows interviewing Nouriel Roubini - Dr. Doom Has Some Good News:

"The question is, can the U.S. grow in a non-bubble way?" He asked the question rhetorically, so I turned it back on him. Can it?

"I think we have to ..." He paused. "You know, the potential for our future growth is going to be lower, because of the excesses we've had. Sustainable growth may mean investing slowly in infrastructures for the future, and rebuilding our human capital. Renewable resources. Maybe nanotechnology? We don't know what it's going to be. There are parts of the economy we can expect to lead to a more sustainable and less bubble-like growth. But it's going to be a challenge to find a new growth model. It's not going to be simple." I took this not as pessimism but as realism. (emphasis added).

I have to somewhat disagree. The new growth model has been in front of us for some time -- we have just chosen to ignore it and take the easier path of asset bubbles. That growth model is based on innovation and fueled by intangibles.

As I have noted often (including yesterday), the new model is slowly taking hold. It is a model where there is less consumption of mass produced items and more of customized solutions -- which mistakenly show up in our economic statistics as "services" even though they are based on goods. It is a model where American production of goods (which we currently label "manufacturing") and services are revitalized using knowledge and intangibles -- where our trade accounts return to a sane balance.

Seen from a macroeconomic point of view -- where all consumption is one big aggregate -- Roubini's question makes some sense. Seen from a microeconomic view, however, the answers are more discernable in the structural transformation.

But let us be clear. We are talking a major transformation. The new growth model is not a return to the economy of the 1950's or even the 1980's. It can't be. The days when a young person could finish high school and get a good paying job on the assembly line with almost no skills is gone forever (as a recent New York Times story highlighted). The days when all a business had to worry about was how to increase efficiency are over.

The fact of the transformation is clear. It will happen. Whether the US takes advantage of the transformation to ensure economic prosperity is another matter. The policies we put in place will determine the outcome. To the extent that we stick with the policies of the industrial age, we will not prosper. To the extent that we miss read the transformation using an industrial age mindset (i.e. its all "services"), we will not prosper.

Thus, our first task it to change the mindset - and understand the transformation. By doing so, we will create the new growth model Roubini and other macroeconomists are searching for.

The Knowledge@Warton website has an article Innovation: Sometimes It Takes a Village that summary of a recent conference on innovation networks. The article covers the issues and opportunities of what we generally label "open innovation."

Part of that discussion focused on the importance of collaboration -- and how to manage that collaboration.

Part, however, was focused on a more arms' length approach of what might be characterized as innovation markets -- where a question or challenge is throw out for anyone to try to solve (FYI - the company InnoCentive runs a web-based service to administer this market).

Case in point: Twenty years after the Exxon Valdez oil spill in 1989, as many as 80,000 barrels of oil remain on the floor of Prince William Sound because the oil has been frozen by sub-arctic temperatures, making it difficult to pump to the surface. The Oil Spill Recovery Institute, established by Congress after the spill, ran a $20,000 challenge with InnoCentive in 2007 to try to solve the dilemma, which had perpetually stumped the world's oil experts. After three months, a construction engineer from the Midwest came up with the winning answer, surmising that vibrating the oil could keep it in a semi-fluid state, in the same way cement is kept flowing while it is poured into a form. Modify the drilling equipment, vibrate the oil and you'll be able to pump it, he suggested. It worked.

So -- what is the public policy needed to stimulate these innovation networks -- both collaborative and "market"?

Much of our focus on patents recently has been on the substance of the reform proposals. Not getting as much attention is the fact that the budgetary wheels are coming off over at that US Patent and Trademark Office (USPTO). In fact, the situation has gotten so bad that according to a story in Tech Daily, Senate Judiciary Chairman Patrick Leahy and ranking member Jeff Sessions last night introduced a bill to allow USPTO to borrow money from its trademarks operations (a fund that is in surplus) to pay for its patent operations. (FYI - the bill has not yet shown up in the Congressional Record).

And how long can we continue to delay fixing this system?

The BEA released its final numbers for 1st quarter GDP showing that the economy declined by 5.5% January through March. Since BEA already released data indicating the depth of the decline, these numbers are in many ways old news. What is new news, at least to me, is the size of the adjustments. The "Advance" estimate (issued in April) had GDP declining by 6.1%. The "Preliminary" (issue in May) had a drop of 5.7%. Today's "Final" number is 5.5%. According to BEA:

The upward revision to the percent change in real GDP primarily reflected a downward revision to imports and an upward revision to private nonfarm inventory investment that were partly offset by downward revisions to exports and to personal consumption expenditures for services.

So trade (including trade in services) and consumption of service were three of the four reasons for the revisions.

I note that this will not be the last revision to the data. BEA is scheduled to release the 13th comprehensive (or benchmark) revision of the national income and product accounts (NIPAs) at the end of July. More information about the changes is available on their website.

All of this should remind us of the difficulties on measurement in the Intangible Economy -- and the reason we need to support BEA's (and the other statistical agencies') efforts to improve the data. After all, economic data is a key government provided intangible asset.

The House climate change bill looks like it will be moving soon. The House Rules Committee has announced the next steps for a bill that could go to the floor possible as soon as this weekend. The Committee set a deadline of Thursday morning for the submission of proposed amendments. The Committee also released the text of the bill - the American Clean Energy and Security Act of 2009 - that will be considered.

There is a lot in the 1201 page bill that is worth of commentary -- such as the provision requiring a report to Congress (and the media) as to whether India and China have standards as strict as the US, the new energy efficiency standards, the creation of yet another narrow worker adjustment assistance program, the provisions to promote exports of clean energy technologies and protect intellectual property rights, and the actual set up of the emissions rights auctions. Already many of my friends are scrambling to digest the bill's contents. I will wait for their analysis of what is in and what is out and who is up and who is down.

However, I want to draw attention to just one provision. Section 124(d) creates a domestic manufacturing incentive program similar to the provision in the stimulus bill I mentioned earlier. The difference being that the climate change bill uses emission allowances to pay for up to 30% of the cost of the manufacturing facility.

Maybe with such actions we won't end up losing our green technology industries.

Earlier today, I mentioned the fact that our trade deficit in advanced technology goods stems from a failure of trade and innovation policy -- not because we are less innovative. It is the result of an "invent it here; build it there" business model. Well, it looks like we may be going doing the same road with green technology. This morning, the New America Foundation issued a report on the Green Trade Balance. The situation is not good:

Green investment is a major pillar of the president's economic recovery plan. Yet, America's dependence on foreign countries to produce green technologies may undermine this recovery strategy. Using a list of green goods derived from the Organization of Economic Cooperation and Development (OECD) and the Asia-Pacific Economic Cooperation (APEC), we have determined that the United States ran an overall green trade deficit of -$8.9 billion in 2008, including a deficit of -$6.4 billion in the critical category of renewable energy, one of the main targets of the Obama administration's green agenda. The U.S. economy also suffered a significant deficit in the pollution management category. On the positive side, the United States ran modest surpluses in two categories--energy efficiency and a grouping of other environmental goods related to water purification and sustainable agriculture.

If current trends continue, the green trade deficit can be expected to widen further as the administration's agenda increases domestic demand but without sufficient measures to increase domestic production. If the deficit continues to grow, the United States will forego the creation of millions of high-wage, high-skill green manufacturing jobs and lose its potential to be a global producer as well as a consumer of green technologies.

. . .

The trends in America's green trade balance should caution policymakers against over-promising about the jobs and investment we can expect from government spending to support the green economy. If the green recovery is to deliver more jobs and spur more domestic investment, it will need government measures to encourage domestic production as well as domestic consumption.

When the stimulus bill was passed, some policymakers recognized this need (see earlier posting). As I reported then, Sec. 1302. (Credit for Investment in Advanced Energy Facilities) of the tax provisions of the bill created a 30% tax credit for the establishment of an alternative energy manufacturing facility. As my old boss, Senator Jeff Bingaman was quoted in the Wall Street Journal as saying, "Several of us have come to recognize that we've outsourced the very things we're going to need to change the nation's energy mix, and this is a way of encouraging more manufacturing here at home."

The New America Foundation report highlights how urgent that task is.

Some updates on innovation policy:

This week is the annual OECD Ministerial meeting. The overall theme of the meeting is The Crisis and Beyond: For a stronger, cleaner, and fairer world economy. As part of the preparation, OECD has issued a new report: Policy Responses to the Economic Crisis: Investing in Innovation for Long-Term Growth. The report argues that the focus on innovation should increase during the economic crisis, stating that "[T]he crisis should not damage the drivers of long-term growth, but should instead be used as a springboard to accelerate structural shifts towards a stronger, fairer and cleaner economic future." In that vein, they recommend continued support for focused research and public-private partnerships, enacting policies to lower obstacles to entrepreneurship (including addressing the liquidity problems facing start ups and small firms), and continue investments in information technologies and in human capital. The report goes on to describe policies being taken by OECD countries.

Thanks to Intellectual Property Watch for point this out.

- - -
A much more pessimistic view comes from Mike Mandel's recent Business Week cover story The Failed Promise of Innovation in the US. His basic argument is that the innovations of the 1990's have failed to deliver - especially in biotech. I have to say that I find his arguments rather unconvincing. It seems like he desperately wanted all the high tech hype to be real. It wasn't. It couldn't have been. And it won't be in the future. But the failure of reality to live up to the hype does not mean that innovation has failed.

I was especially interested, however, in his comments on trade and innovation. He take the growing trade deficit as an indicator of a lack of innovation. I disagree. The real reasons for the growing trade deficit are many. But part of it was the innovation business model: invent it here, make it over there. That is a failure of trade policy, economic policy and innovation policy, not innovation per se.

- - -
Then there is the story in today's Wall street Journal In Search of Innovation. They use one of my favorite analogies: the dunk under the light post. "Why are you searching here under the light post when you lost your keys over there," asks the cop? "Because this is where the light is," answers the drunk. The authors point out that much of the search for "innovation" is where the current light is -- rather than where the innovations are. They offers a number of tips for how to broaden the search -- all of which generally fall under the rubric of open innovation.

One other thing I would point out is that there definition of innovation is a broad one -- encompassing new products, services and process. One of the most interesting example is this:

Doctors at the Great Ormond Street Hospital for Children in London, for example, consulted with members of a pit-stop crew from Italy's Ferrari Formula One motor-racing team to explore ways of improving how children were being moved out of heart surgery and into intensive care.

In contrast, Mandel's complaint is about the failed promise of high-technology.

- - -
So let me go back to the light post story. In our search for innovation policy, we have been looking in the usually places where there is light. In this case, in technology policy. But I will reiterated what I have said time and time and time again: technology is not the same as innovation. Business gets that. But government policy makers don't. Until we have a broader definition of innovation policy, we will continue to be like the drunk under the light post -- search for answers in all the wrong places.

There is a lot of misunderstandings about the Intangible Economy (or the "dematerialized" economy or the "weightless" economy or the really misleading "services" economy). One of the greatest misunderstandings is that manufacturing has no role. Or that a national economy can survive without manufacturing. For example, a recent story in the Wall Street Journal on Michigan and the Knowledge Economy: Manufacturing won't support the middle class. The story advocates an abandonment of manufacturing for knowledge industries, which they define as "information, finance, insurance, professional services, health care and education."

There are two fallacies to that argument:
1) that "manufacturing" and "services" are completely separate and unrelated activities
2) that a large nation can export enough "services" from the knowledge industries to pay for the importation of manufactured goods.

Let's start with the first argument. One of the hallmarks of the intangible economy is the fusion of manufacturing and services. As I have noted before, even the very nomenclature manufacturing and services has become misleading. This is highlighted in a new report from the Work Foundation in the UK on Manufacturing and the Knowledge Economy. (Part of their series on the Knowledge Economy.)

The reports make a number of important points about manufacturing:

Modern manufacturing has been reshaped by exactly the same forces driving our transformation into a knowledge based economy. There are two closely related major consequences of these changes.
• Firstly, modern manufacturing invests more heavily in knowledge based intangible assets than services and provides large numbers of knowledge intensive jobs;
• Secondly, the conventional boundaries between manufacturing and services are blurring as manufacturers incorporate high value added services into the production process.

On this second point - the blurring of manufacturing and services, the classic case is Rolls-Royce as I've noted before. But not only is the business model blurring the boundaries, the jobs linkages remain strong. The Work Foundation report references a 2004 report from the EU High-Level Group Report Manufuture Technology Platform - Manufuture: A Vision for 2020. This report notes that for every job in manufacturing there were two jobs in manufacturing related services. They also cite a report to the UK Department of Trade and Industry - A Portrait of Trade in Services - that about 25 per cent of all exports of business services and between 40 and 45 per cent of trade and technical related service exports were generated by manufacturing companies.

And those manufacturing sector jobs are more knowledge intense. The Work Foundation finds that in the UK high to medium high tech manufacturing have the same level as knowledge intensive services -- around 40% of the workforce in both.

In other words, manufacturing and services are not two sides of the same coin - they are parts of the design of the face of the coin. Losing the manufacturing base means losing knowledge-intensive jobs and knowledge intensive value added.

- - -

The second part of the "let-manufacturing-go" is that we can export enough services to pay for imports of goods. That may be partial true for a very small economy -- say Singapore. However, for an economy the size for the United States, the ability to produce goods is vital for our international financial position. While manufacturing may be under 15% of GDP, it makes up a large part of our trade deficit. Even if we were self-sufficient in energy, we would be running a $300 billion trade deficit because of our deficit in manufactured goods.

Our trade surplus in services is so small relative to our deficit in goods -- as illustrated below and in my earlier posting. In addition, we need to be careful in the definition of services - since it included travel, tourism and transportation. The core of what people think of is in just two of the categories: royalties and "other business services". I label these as "intangibles" and publish that data monthly. At current levels, our intangibles surplus (business services and royalties) would have to be 6 times as large as it is now in order to offset our goods deficit.

In addition, trade in intangibles is subject to the same competitiveness pressures as trade in goods. Other nations are expanding their knowledge based service industries as well. In fact, our imports of intangibles grew faster than our exports in 7 of the last 10 years. There is no reason to believe that our exports in these sectors can grow 6 times as large in the near future.

There is one other way to look at the importance of manufacturing to the US economy. Let us undertake a thought experiment as to what would happen if manufacturing output declined. The chart below illustrates the impact on the trade deficit -- using the Federal Reserve's data on industrial production for total consumer goods and durable goods. Let us simply see how much more we would have to import if domestic production declined -- assuming consumption remained at 2008. This does not include any decline in manufacturing exports. If output of durable goods (the smallest US manufacturing sectors) were eliminated, the deficit would increase by 60%, If output of all consumer goods (durable and non-durable) were cut in half, the deficit would double. And if the entire consumer goods manufacturing base disappeared, the deficit would triple.

Now, let's also take away our exports in consumer goods. Here we have to be a little creative with the data since the categories of "consumer goods" for trade data and for industrial production are not the same. For this thought experiment, we will subtract out from the goods balance any exports of what fall into the trade categories of "automotive vehicles" "consumer goods" and "other goods". The impact is even more dramatic.

Bottom line: manufacturing still matters. But it is a different from the past - more sophisticated and knowledge intensive that ever. As such, it is an integral part of the Intangible Economy

This morning the BEA released the data for 1st quarter current accounts. This is a more comprehensive look at our international transaction than the monthly trade figures. It includes income and other financial transactions as well.

I've done something different with the data. Below is the normal chart of intangibles (royalties and business services). But I've also broken down the data is a slightly different way. The second chart shows the elements of our current account. "Services" have been split into travel/transportation, business services and miscellaneous. Miscellaneous includes the services categories of "Transfers under U.S. military agency sales contracts" and "U.S. government miscellaneous services" and is combined with the financial category of "Unilateral transfers." Royalties are taken out of "services" and combined with income. It seems to me that royalty and license fees are no different than any other income on an investment.

The quarterly intangible trade data simply echoes the monthly date showing a general plateau. The reconfigured current account data tells an interesting story. Of course, it shows the massive change in goods trade due to the economic slowdown. But it also shows that most of the other categories are relatively flat (as can be seen better in the third chart). Income being somewhat volatile during this period as should be expected.

The current account data also shows the magnitude of the hole we are in. None of the other categories come close to making up for our goods deficit (even at the deep recessionary levels).

Clearly we won't be able to fix our international trade and financial situation without dealing with our goods deficit. That is part and parcel of the Intangible Economy.

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

Royalties and License Fees - Transactions with foreign residents involving intangible assets and proprietary rights, such as the use of patents, techniques, processes, formulas, designs, know-how, trademarks, copyrights, franchises, and manufacturing rights. The term "royalties" generally refers to payments for the utilization of copyrights or trademarks, and the term "license fees" generally refers to payments for the use of patents or industrial processes.

Other Private Services - Transactions with affiliated foreigners, for which no identification by type is available, and of transactions with unaffiliated foreigners. (The term "affiliated" refers to a direct investment relationship, which exists when a U.S. person has ownership or control, directly or indirectly, of 10 percent or more of a foreign business enterprise's voting securities or the equivalent, or when a foreign person has a similar interest in a U.S. enterprise.) Transactions with unaffiliated foreigners consist of education services; financial services (includes commissions and other transactions fees associated with the purchase and sale of securities and noninterest income of banks, and excludes investment income); insurance services; telecommunications services (includes transmission services and value-added services); and business, professional, and technical services. Included in the last group are advertising services; computer and data processing services; database and other information services; research, development, and testing services; management, consulting, and public relations services; legal services; construction, engineering, architectural, and mining services; industrial engineering services; installation, maintenance, and repair of equipment; and other services, including medical services and film and tape rentals.

The draft of the Obama Administration's financial plan is circulating this morning, even before the official announcement later today. As expected, the circulating drafts propose a Financial Services Oversight Council to "facilitate information sharing and coordination, identify emerging risks, advise the Federal Reserve ... and provide a forum for resolving jurisdictional disputes between regulators."

That "advise" the Fed on systemic risks part has people concerned. The critique is that the proposal gives the Fed too much power. Yesterday, Senator Mark Warner proposed a more powerful Systemic Risk Council (see the story on the Real Time Economics blog at the WSJ). These statements by Senator Warner, who sits on the Banking Committee, may be the opening shots in the turf wars.

As I've noted before, the networked organizational approach is the correct way to go. Now comes the important process of designing exactly how whatever Council is created will actually work. Let's how the debate that Senator Warner has kicked off is thoughtful and complete.

It has been over a year since my last update on the fashion copyright issue. Over at TechDirt, there is an interesting posting on the backlash - Fashion Designers Realizing New Fashion Copyright Would Cause Serious Harm To Business. As I've noted some time ago, there has been some great work on what is called the "negative space" issue -- areas of innovation that flourish without traditional IP. High fashion is a case in point (for example see The Piracy Paradox: Innovation and Intellectual Property in Fashion Design).

By the way, I wouldn't take the poll on the TechDirt site very seriously. It is hardly an accurate indicator. But the fact that the little guys are pushing back on this makes for a very interesting case study.

Yesterday's Wall Street Journal had a thoughtful piece on Why Technologists Want Fewer Patents. Gordon Crovitz's column used the Supreme Court decision to review the Bilski case on business process patents (see earlier posting) to raise an often overlooked function of the system: the sharing of information:

The Supreme Court may decide that more progress would be made with narrower definitions of what is patentable. A book on the U.S. approach to patents, "Jefferson vs. the Patent Trolls" by Jeffrey Matsuura, makes the key point that "intellectual property rights were not goals in and of themselves, but were instead a mechanism through which society attempted to facilitate creative collaboration."
Thomas Jefferson, the nation's inventor-president, would support patent reform in an era when new information technologies build on themselves. An idea, he observed, is a rare thing whose value increases as it's shared. "No one possesses the less because everyone possesses the whole of it," he wrote. "He who receives an idea from me receives it without lessening me, as he who lights his candle at mine receives light without darkening me."

The very explicit deal embedded in the idea of a patent is disclosure in return for limited protection. Otherwise, the system would work on a process of trade secrets.

It is this collaboration part of the process that gets lost in the debate -- especially by the "patents as a natural property right" crowd. Interestingly Joff Wilds's critique against the article focused on the data on patent applications and litigation costs without ever engaging in the core argument on business process patents.

There might be a typo on the patent application numbers and people do not agree on the size of litigation costs. But Crovitz got the essence of the question right: what is the purpose of patents in fostering innovation . The answer to that question is what the Supreme Court will be grappling with.

A number of books seem to have come out recently about the financial meltdown. Today's New York Times has a review of two. The title of the article - Greed Layered on Greed, Frosted With Recklessness - sums up the story. I have used the analogy of a juggling act perched on the top of a house of cards build on a foundation of quicksand. The quicksand was the overextended mortgages with teaser rates and interest only payments. (For the record, I think it was the adjustable rates that really created the ticking time bomb). The house of cards was the slicing and dicing of the mortgage-backed securities. The juggling act was the interest rate and currency arbitrage going on backed by those securities and the insurance scam know as "credit default swaps."

The book review points out a very important fact. One of the books is Fool's Gold by Gillian Tett. The subtitle of that book is especially telling: How the Bold Dream of a Small Tribe at J. P. Morgan Was Corrupted by Wall Street Greed and Unleashed a Catastrophe. As the review notes:

At the heart of "Fool's Gold" is Ms. Tett's portrait of the high-octane culture at J. P. Morgan in the 1990s. She shows the premium that young hotshots there placed on "innovation" and "creativity," and she also conveys the horror that some of them later felt when they saw that their Frankensteinian brainchild had become a "rapacious scourge," as other firms monkeyed with its genetic code, moving from the world of high-grade corporate lending into the far more hazardous realm of subprime mortgages.

In other words, this all started out as a positive innovation that went wrong.

There is another part of the overall story of this financial innovation that often gets missed. The sad fact is that all of these derivative financial instruments were designed to use financial markets to manage (i.e. reduce) risk. They are all elaborate forms of insurance -- such as by making counterbets (futures) or spreading the risk (securitization). Using the market for risk management is a useful undertaking. But, in the end many of these tools not only increased risk, they made it much less understandable and therefore much more dangerous.

There are important lessons to be learned here as we take up financial reform. But the lesson learned should not be to stop innovation in financial markets. That would be folly. The point is to understand when an innovation goes beyond its useful sphere. We generally thing of a rose as a desirable plant. But a rose growing in the middle of a wheat field is probably better characterized as a weed.

Our trick in revamping the financial system is to build a mechanism that can tell the difference between a rose and a weed -- and know when a rose has become a weed.

In a posting last week, I noted that according to preliminary reports, the Obama Administration was not going to propose a super-regulator to oversee the financial system. That did not sit well with some in Congress. But, as I argued, I think it is better to utilize a collaborative network model, rather than the traditional hierarchical bureaucracy.

On Wednesday, the President will formally release the proposal. But already the outline is being reported. For example, today's Washington Post has an op-ed by Tim Geithner and Larry Summers (A New Financial Foundation) giving the highlights of the proposal. The Wall Street Journal has a more in-depth story on the proposal. That story confirms the more networked approach:

Officials say the goal is to distribute power in such a way that gaps in oversight are removed and the opportunities for regulator shopping reduced.
. . .
The plan calls on the Fed to oversee financial institutions, products, or practices that could pose a systemic risk to the economy. It will create a "council" of regulators to monitor this area as well.

The proposal will also seek to the jurisdictional issues between the SEC and the CFTC and will even create a new consumer financial protection agency.

I realize there will be a lot of skepticism about this approach. Already Business Week is running a story Is Obama Flubbing the Financial Fix? But ultimately the network model should be more effective. As I mentioned before, the trick will be designing the incentives and process to make it work in practice - not just on paper. I hope Congress and the regulators spend enough time on that part of the proposal to get it right.

Brad DeLong has an interesting essay at Project Syndicate on The Hidden Purposes of High Finance. One of his points is that high finance gives us the illusion both safety and liquidity. But it is a useful illusion:

It is a fact that we are much happier saving and accumulating, and that we are much more likely to do so when we think that the resources we have saved and accumulated are at hand. It is also true that when we invest our wealth - in Pfizer's intellectual property, factories in Shenzhen, worldwide distribution networks, or shopping malls in Atlanta - it is not, in fact, at hand. Our invested wealth can only be made to appear liquid to any one of us, and only if there is no general shift in our collective desire for liquidity.

That is an interesting point to keep in mind - given recent history.

But there is a much more interesting point in that statement: the inclusion of "Pfizer's intellectual property" and "worldwide distribution networks" in that list of investment. That a noted economist would routinely included these intangible assets shows how far our thinking has come.

A small victory I will grant you. But a victory nonetheless.

On Monday a bipartisan group of Senators, led by Finance Committee Chairman Max Baucus, introduced a bill to make the R&D tax credit permanent -- technically the Research and Experimentation (R&E) tax credit. The bill - S. 1203 the Grow Research Opportunities with Taxcredit's Help Act of 2009 -- would phase out the traditional R&E tax credit and beef up the alternative simplified version created a few years ago. The credit for the simplified version would increases from the current 14% to 20%.

No word from high-tech industries on how they feel on the change. But making the credit permanent is a long over due step -- and something called for in the Obama technology policy. In past years, the credit has simply been temporarily extended because of cost issues (a short term extension counts less in the budget scoring rules). Given the current budget pressures, we will see if the "permanent" part of the bill makes it through the process.

The same problem faces what should be the next step -- adding a worker training/skills enhancement credit. Such an action to turn the R&D tax credit into a knowledge tax credit makes good policy sense. As I've argued before, if we give companies incentives to conduct research or invest in new equipment we should also give companies incentives to invest in their most valuable asset: their workers.

But a knowledge tax credit is expense. While it might be the right thing to do, it will probably fall victim to the budget deficit problem. And that would be a shame.

David Wessel asks an important question in his recent column Stench of Toxic Assets Lingers:

So is it no longer necessary for the government to get toxic assets off banks' books to get credit flowing again? Is bolstering banks' capital a substitute for ridding them of smelly loans and securities?

His answer, we are about to find out. With the programs to buy toxic asset essentially not operating (in part because the banks have no incentives to sell), the next few months will tell. As he notes:

If the economy takes a bad turn, or attitudes toward banks change -- particularly toward banks that weren't deemed healthy enough to give back taxpayer capital -- a mechanism for removing toxic assets may yet prove essential to reaching a happy ending.

Wessel does a great job of explaining why removing toxic assets may be important to the credit system. Let me add one other with respect to intangibles. My fear is that as long as banks are sitting on these assets they will be very hesitant to embrace intangible-backed loans. After all, they are already carrying big load of uncertain in the form of these assets they can't sell, they can't value and they really don't understand. Why should they add more - in the form of intangible assets that they don't understand, don't think they can value and don't know how to sell if necessary.

Creating more certainty about intangibles (understanding/transparency, valuation and markets) is critical to their acceptance in financial markets. But so is dealing with the toxic assets. I fear that until we clear out the toxic, there is simply no room in the banks' uncertainty space for anything else.

According to press reports (Wall Street Journal, Washington Post), the Obama Administration is backing away from earlier plans to create a super-financial regulator. The Post story notes that "The plan now taking form would include the creation of a council to work with the Fed to coordinate oversight of the financial system."

Good. As I noted some time ago, I am very skeptical of the Department of Everything Department approach to financial regulation. I think we went down that path with the Department of Homeland Security -- which was an industrial age response to an information age threat.

Rather than create a new hierarchical structure, we need to empower the network. True, financial regulators don't always play well together -- and financial institutions have been known to "regulator shop" to get the most lenient oversight. But both of those problems can be handled by how you design the network -- the roles, the structure, the rules.

So I am heartened by the idea of a council. I agree with Dan Tarullo's recent statement (Financial Regulation in the Wake of the Crisis) that:

History shows that opportunities for real reform are often short-lived. Momentum can too easily be lost, and the return of better times too easily leads to complacency. If we are to spare the next generation the pain and loss caused by a financial crisis, we must not only learn lessons. We must act on them.

I would submit that one of those lessons is that structure matters as well as regulations.

So I would urge the Administration and the Congress to put as much thought into the set up of that organization as they do to the actual substance of the new regulations. We can't create regulations to foresee every situation. We can, however, set up a structure that can respond quickly. Ultimately, organization is what matters. Let's get the organization right.

Yesterday the House of Representatives overwhelmingly passed the Consumer Assistance to Recycle and Save Act -- otherwise known as "Cash-for-Clunkers." The bill authorizes $4 billion in vouchers (up to $4500 each) to help pay for a new car when trading in an old one. There are requirements of upgrading fuel economy etc. attached.

While I support the idea (it has been used in other countries successfully), I would like to point out that House passage sets up an interesting natural experiment in behavioral economics. According to some analysis, 25 million vehicles might be eligible for the plan and a million might actually take advantage of the vouchers.

Now, if you were one of the million people who might use the vouchers - what are you going to do? The bill has just passed the House. It still has to go through the Senate. And the bill is an authorization - it still needs an appropriation. Then the Secretary of Transportation has to set up the regulations and the dealers have to be certified to participate in the program.

So, you really don't know when the program will actually begin. You need a new car soon. But $4500 is nothing to sneeze at. Do you wait?

Do enough people wait so the net effect is an immediate slowdown in new car sales? Does the program cause a transfer of sales from immediate term to later in the future (when the program is operating)? It would be very interesting if the program had the perverse affect of causing a decline in sales right at the point when increased sales are needed. If so, is there a way to design such a program to prevent this from happening?

There is a dissertation out there for some bright economics graduate student!

BEA's trade data for April released this morning shows a slight increase in the deficit -- up $700 million to $29.2 billion -- even though both imports and exports declined. As both the Wall Street Journal and the New York Times report, the numbers were about what was expected -- reflecting the slowdown in the global economy. The March and April figures, however, reverse the trend since last July of the slowdown resulting in a reduction of the deficit. This may be due to increased imports of oil as prices rise.

Our intangibles trade surplus also moved in the wrong direction - dropping slightly in April by $160 million to $11.68 billion. Exports of both private business services and royalties were down and imports in both categories were up.

The really bad news was that our deficit in Advanced Technology Products surged in April - rising to $4.7 billion. Imports were steady but exports in every area, except biotechnology, dramatically slowed. 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.

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The other release today from BEA contains the revisions for 2006 to the present. The intangibles balance for 2006 was revised downward by $4.4 billion -- or 4.4%. The data for 2007 and 2008 were revised by much smaller amounts -- upward by $900 million (0.6%) and downward by $1.8 billion (1.2%) respectively. I don't know if the relatively large revision for the 2006 data represents simply catching up to better data collection activities. As I noted last year, BEA is undertaking a number of activities to improve the data on intangibles and the knowledge economy.

On the other hand, the difference in the size of the revisions may reflect the delay in the data. The new 2006 data may just now be available and the 2007 and 2008 figures may be subject to larger revisions in the future as new data comes in. The data for the second half of 2008 was already revised earlier this year by roughly $3 billion (see earlier posting). We will have to see what the size of the next set of revisions is to see whether BEA's efforts can reduce the size of the uncertainty in the data.

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.

As those who have been following this blog know, one of the items I track is the unemployment numbers -- specifically the involuntary underemployed. The reason I do so is that this indicator of the labor force is generally under reported. But it is an important measure - especially in the I-Cubed Economy with its very liquid and flexible labor force. Recently, Mary Daly, Bart Hobijn and Joyce Kwok of the Federal Reserve Bank of San Francisco (FRBSF) looked more closely at this indicator and others to try to forecast the direction of unemployment (see Jobless Recovery Redux?). Their findings are not optimistic:

Our analysis generally supports projections that labor market weakness will persist, but our findings offer a basis for even greater pessimism about the outlook for the labor market. Specifically, we suggest that the relatively low level of temporary layoffs and high level of involuntary part-time workers make a jobless recovery similar to the one experienced in 1992 a plausible scenario.

I agree that the data resembles 1992. But I would also argue that the same pattern has existed in every recession since. And it actually pre-dates the 1992 recession. The recession of the early 1980's was the first recession of the I-Cubed Economy where workers were not placed on temporary layoff but permanently fired. Companies and workers were "downsized" rather than laid-off. Involuntary part-time work was the response of people downsized.

This was part of the switch away from the industrial economy. In the industrial economy, temporary lay-offs were the way of buffering the labor force from cyclical downturns. Workers were kept around for the next up turn -- with either union-based or government-based unemployment payments to maintain family income until the recall.

In the I-Cubed Economy, that process has disappeared. Workers have to find new jobs -- often in new industries. Cyclical downturns now lead to structural changes.

Unfortunately, after 20 years we apparently still have not learned that lesson. And our public policies -- such as unemployment insurance and worker training -- have suffered.

So, I'm not sure the FRBSF's analysis points to a slow or fast turn around in the labor market. It does point out that the labor market is different than in the past.

Bruce Nussbaum has a great idea -- make outgoing P&G head A.G. Lafley the nation's Chief Innovation Officer. Bruce is absolutely right that what is needed in the job is someone who can transform organizational culture. Innovation is not about the latest high-tech gadget. It is not about technology policy (although that is a part). Innovation about doing things differently and better. That is an organizational activity -- and Lafley has shown that he can create an innovative culture. He moved P&G from a technology push organization to an organization focused on new ways of working with suppliers, new business processes, and new ways of helping consumers.

So I agree with Bruce -- Lafley for Chief Innovation Officer!

By the way, here is the link to the video of Business Week's interview with Lafley last year.

There is an interesting story in Forbes on how Diversity Helps Your Business--But Not The Way You Think by Katherine Phillips. Professor Phillips is at the Kellogg School of Management at Northwestern University. She argues that the main benefit from diversity in a group does not necessarily come from the minority members bringing in a new perspective. The dynamics are much more subtle - and important:

I recently published research in Personality and Social Psychology Bulletin, with co-authors Katie Liljenquist of Brigham Young University's Marriott School of Management and Margaret Neale of the Stanford Graduate School of Business, that found that members of a social majority are more likely to voice unique perspectives and critically review task-relevant information when there is more social diversity present than when there is not. Moreover, this is true even when the people who are "different" don't express any unique perspectives themselves. Our research suggests that the mere presence of social diversity makes people with independent points of view more willing to voice those points of view, and others more willing to listen.

In other words, having a diverse group gives all members permission to speak their mind -- thereby avoiding "groupthink." As she notes:

We are more thoughtful, and we recognize and utilize more of the information that we have at our disposal, when diversity is present. That is diversity's true value.

An important lesson for the I-Cubed Economy.

In an earlier posting, I noted that the Obama Administration's tax proposals go after the issue of foreign tax havens for intangible revenues. But this is not just an international taxation issue. As we pointed out in our report Intangible Asset Monetization: The Promise and the Reality, certain states have tax policies that make them advantageous as what some would consider to be domestic tax havens. The issue is whether states can collect taxes from companies doing business in their jurisdiction but not physically located there. The issue is more common with respect to income from online and catalog sales in other states. But it also applies to royalty income as well (especially common has been franchise income) through the use of Passive Investment Companies. Such a company holds the intangible asset, such as the trademark/brand/franchise agreement is a low or no corporate income tax state. Thus all royalties are earned in that state and are not subject corporate income tax in the state where the service supplied or product sold.

However, as we pointed out in the report, states have been taking actions to nullify this tax situation. Some recent court ruling may extend that trend, as pointed out in a recent the Business week story Chasing Tax Revenue Across State Lines. Earlier this year, the Massachusetts Supreme Judicial Court issued two rulings involving Capitol One Bank and Geoffrey, Inc (Toys-R-Us) requiring that they Massachusetts income-based excise tax based on sales to Massachusetts residents. In the Geoffrey case, the court specifically cited and upheld the Massachusetts requiring companies to pay tax on receipts coming from intangible assets - which "generally includes, but is not limited to, copyrights, patents, trademarks, trade names, trade secrets, service marks, and know-how." The New York Supreme Court also upheld a case earlier this year whereby Amazon.com was required to pay New York sales tax on purchases made by residents of that state.

The issue may be headed to the US Supreme Court - according to the Business Week story Capital One has filed an appeal. But it is unclear whether the Court will take up the case or not. If the Court takes it up, we may have closure on the issue. And even if it doesn't, letting the Massachusetts ruling stand will say volumes.

From the Financial Times coverage of the European Parliamentary elections (Resounding victory for Europe's centre-right):

Europe's centre-right parties on Monday celebrated a resounding election victory that underlined the resilience of the European model of welfare state capitalism in the face of the worst recession since the 1930s.

Interesting. Isn't that European model of the welfare state what conservatives in the US point to when they want to highlight the horrors of "socialism"?

As the story goes on to note:

One reason is that centre-right leaders, alert to the risk of being portrayed as defenders of a heartless or irresponsible capitalist system, have sought to protect citizens against the worst effects of the recession by preserving jobs where possible and letting the welfare state take care of those in need.
Unemployment benefits, access to medical care and other forms of social expenditure, which come into effect automatically during a recession, form a large part of the €400bn fiscal stimulus that EU policymakers claim to have been implementing over the past six months.

Right wing politicians spending roughly $550 billion and "letting the welfare state take care of those in need"? I guess it all depends on which side of the pond you are on.

Of course, there is a debate as to how much to actually read into this election. During my recent trip to Europe, there didn't seem to be a great voter interest. In fact, voter turnout was at a record low.

The low turnout was a boon to what might be called by some "fringe" parties. One of those is the Swedish Pirate Party which won one seat (see the IAM Blog). The Pirate Party is dedicated to eliminating patents and fundamentally changing copyright. While one seat does not give it much political clout, it does give them a platform and a voice -- which should make for some interesting debates on IP policy in the future.

In a number of earlier postings, I have call for some one to take over and resurrect the Saturn car company. Word has come this morning that Penske Automotive is buying Saturn from GM.

The quotes from Penske are heartening. As the Washington Post reports:

"Saturn has a passionate customer base and outstanding dealer network," said Roger Penske, chairman of Penske and its famed racing team, in a statement. "For nearly 20 years Saturn has focused on treating the customer right. We share that philosophy, and we want to build on those strengths."

In the short term, GM will continue to build Saturn vehicles. What happens in the long term, however, is key. Penske will need to create the same type of philosophy on the product side as that which he brags about on the sales side. We will see whether Penske can build a manufacturing company for the I-Cubed Economy - or simply a marketing firm.

Today jobs data from BLS showed a large increase in the unemployment rate from 8.9% to 9.4% in May. However, as the media is reporting there is good news in the data. According to the Wall Street Journal, "Nonfarm payrolls slid 345,000 in May, the U.S. Labor Department said Friday, well below the 525,000 decline economists in a Dow Jones Newswires survey had expected." The New York Times noted that "Economists said the figures showed the government's efforts to prop up the economy were beginning to have an effect."

I'm not sure that the absence of horrible news is really good news. But, I do see one of those famous (infamous?) "green shoots" in the data on involuntary underemployed (part time for economic reasons). That number has been relatively stable for the past three months at around 9 million underemployed. Not great news, but possibly an indicator of a bottom.

Yesterday David Brooks did a column in the New York Times on the auto industry. He got the big picture question right -- but made a number of statements that undermine his position. He was right in that GM needs a cultural change. It is about organization - which is why I liked the original mission of Saturn.

But I found some of his comments absolutely puzzling. He states that "First, the Obama plan will reduce the influence of commercial outsiders. The best place for fresh thinking could come from outside private investors." What? For the past few decades the role of activist investors has been to push short term payoffs - at the expense of long term thinking and innovation. Yes, fresh thinking "could" come from private investors. But, then again, if they had wings pigs could fly.

Next he critiques the role of the unions as part of the ancien régime. True, the unions resisted change in the past. But that was the organizational role they were forced into. In their new role as part owners, they will have to behave differently. In addition, there will be no chance for organizational change if the unions don't buy into the process in the very beginning. Decades of research on organizational change have shown that. Apparently Brooks hasn't bothered to look into the topic.

I could go on - but there is little point. Organizational change will be hard enough - for GM and other companies like it. But organizational change is the price of survival in the I-Cubed Economy. Too bad that too many people think that organizational can be imposed from the top down -- and simply mean firing a bunch of workers and giving big bonuses to the executives.

To be successful it has to come form both the top and the bottom - and meet in the middle. When Brooks worries that the new plan will create an "ever-thickening set of relationships" among stakeholders, some of us who have studies organizational change draw the conclusion that this might actually work.

There are lots of reasons why the "new" GM might fail -- and might fail to carry out the needed organizational change. But they are not necessarily the one's pundits seem to be worried about.

As expected, the Supreme Court will be taking a look at business process patents. As the New York Times reports, the Supreme Court decided yesterday to review the Appeals Court ruling in re Bilski on the patentability of business processes. Needless to say, this is a big deal (for more back ground, see earlier postings). Those who support business process patent strongly pushed for the review, as the Appeals Court limited such patents. But the fact that the Court agreed to review the case does not necessarily mean that the Justices are leaning toward overturning the case. This Court has been more than willing to step into the policy vacuum created by Congress's inability to deal with patent reform.

One other wildcard. By the time the case is heard, the Court will likely have a new Justice. The reviews of Judge Sonia Sotomayor experience with patent law has been mixed. Some view her experience as limited, especially as an appeals court judge. Others point to her earlier years as commercial lawyer where she had a number of IP cases. It will be interesting to see if any of this comes up in the confirmation hearings.

Speaking of the future of the auto industry, Andy Gibbs (formerly) of Patent Cafe did an analysis of the patents of 5 top car makers: GM, Ford, Chrysler, Toyota and VW . The report, Automaker Patent Assets Intelligence Report, is now available. Also available is a summary article of the report at IP Frontline. The study finds the US companies have the best average technology patent quality scores and the best management processes. However, VW had the strongest patent position from a legal enforceability perspective.

However, and maybe more importantly, Toyota leads in green technology. Toyota had more than 29% of its portfolio focused on green technology patents (1,768). Ford was second with 26% (1,674 green tech patents). GM had only 907 green tech patents -- a figure that does not bode well for future competitiveness. Chrysler did also poorly on green tech. But they are expected to pick up technology form Fiat, which was not rated. GM does have 42% of its patent portfolio made up of grade A or B quality patents -- which does suggest strength in potential licensing revenues.

While I have my concerns about patents as a measure of innovation and future competitiveness, such an analysis has its uses. I specifically point to the potential for licensing revenues. I hope the Administration's auto task force took that into account.

One final note on the report. It ends with a section on open innovation and the fact that the car companies, especially GM have been moving toward more research on motor vehicle electronics:

PatentCafe's analysis found that Google already has nearly four dozen patents and applications that mention, and possibly target motor vehicle communications systems, including: "Vehicle Information Systems And Methods"; "Visually-oriented Driving Directions In Digital Mapping System"; and "System For Automatically Integrating A Digital Map System".
Is R&D investment by automakers in such non-core technologies wise, especially considering Google's position as a first-mover and technology leader in this area? Or, is investment into in-vehicle information systems "too little - too late"?
Tomorrow's automakers must return to their core vehicle assembly capabilities, but expand their Open Innovation networks with new suppliers that are maniacally focused on dominating their respective technologies (such as Google). Open Innovation lowers R&D investment, can help automakers focus on their core competence as high quality, low cost auto assemblers, and places more dependence on partners that can more efficiently respond to dynamically changing consumer demands with fast innovation cycle technologies.

Good point.

I have been traveling last week and this - which is why there were so few posts. One of my stops has been Turin, home of Fiat. So I have been following the recent developments in the saga of the US auto industry -- including the pending GM bankruptcy and is selling off of the European operations to a newcomer (Magna). (Interestingly, talk at dinner with the Italians contained nothing about Magna having beat out Fiat for Opel and much about the latest Berlusconi scandal.)

While I support the Administration's action with respect to Chrysler and GM, I think some of the supporters of those actions are in for a surprise. They are, I fear, hoping for a return to the good old days. In that respect, they are sadly mistaken. It is not clear to me that any of us fully understand what is occurring in the auto industry. The problem with our approach struck me as I was reading a recent article in the New York Times on the auto industry - Industry Fears U.S. May Quit New Car Habit. The article talks about the concern that auto sales will not return to pre-recession levels. The failure of sales to rebound sufficiently will put an additional financial burden on the US taxpayers -- as the size of the bailout is calculated on the forecast of future costs and revenues.

According to the article, some think the market will rebound to the benefit of the industry:

If sales do pick up, carmakers eventually could be more profitable than they have ever been because of all the costs they have shed, said David Cole, chairman of the Center for Automotive Research in Ann Arbor, Mich.
"After you rebound from this artificial low in demand, wow," Mr. Cole said of the potential for auto sales and profits.

That statement -- especially the description of the current situation as one of "artificial low demand" -- worries me. For reasons of both innovation and macroeconomics, I thing we need to be very careful in assuming demand is artificially low. That is the point of the NY Times article.

However, this is a complicated story - of both innovation and macro economics. It is a story that the article gets only partially right. The article focuses on people doing without cars completely. It cites increases in car sharing usage (such as ZipCar) and people simply doing with out a car. That is the part of the story it got right -- the story of social innovation. The other part of the innovation story is the switch in core automotive technology (see earlier postings).

Coupled to that is the macroeconomic story. That story has to do with people not buying a second car or holding on to their used cars longer. The decision to trade in an used car or to buy that second car is in large part a function of credit. If credit is easy, there is a greater incentive (or at least less of a barrier) to buying that new car. When credit is tight, people think twice about whether they need that second car -- and whether they can get a few more years out of their old one.

All these forces mitigate against a return to the pre-recession levels of auto sales. To believe auto industry optimistic projections you have to believe that social innovations such as car sharing will have little impact on the market. You have to believe that the shift in core technology will leave the incumbent manufactures in their current dominate position. And you have to believe that central banks will re-inflate credit back to the point where it is cheap to buy a new car frequently.

Not likely.

I think this quote from the Washington Post article After Many Tuneups, A Historic Overhaul is more realistic:

"It's certainly an inflection point. This is an historic transformation," said David McCurdy, president of the Alliance of Automobile Manufacturers who helped negotiate the new fuel standards. "We'll look back in a number of years and realize it was a significant point of change."

That point of change includes coping with oversupply, a new level of sustainable demand and technological and social innovation. The sooner the automakers - and their analysis/supporter - realize that, the better.