Advancing Knowledge and the Knowledge Economy

Last week I was at a fascinating conference on Advancing Knowledge and the Knowledge Economy. Held at the National Academy of Science main building here in Washington, it focused on the transformation of knowledge:

Knowledge assumes many forms and behaves in anomalous and unpredictable ways. Unlike the tangible resources of the industrial economy, there is little shared understanding of knowledge as an economic factor despite its immense importance in the global economy. Yet the knowledge-based economy, conventionally measured by the composition of the workforce, is in flux. It is plainly characterized by an explosion of data and codified knowledge, propelled by a revolution in information and communication technologies, but the changes go much deeper.
The generation of knowledge is traditionally conceived as a process internal to single entity. But it is increasingly a product of networked entities, often differently situated yet motivated to find new solutions to specific problems, needs, and circumstances – and, in many cases, to reveal these solutions to others. Enabled by technology, knowledge moves quickly within these networks – across firms, institutions, borders, and distances. While scientific research has long been characterized by unfettered circulation of discoveries and the ability to build instantly on these discoveries, distributed models are gaining importance and becoming essential to the larger fabric of the knowledge-based economy.

Abstracts are available at the conference website; the actual papers and presentations are not yet up, but should be available soon. The website also contains a link to a couple of relevant OECD papers (OECD being one of the major sponsors).
One aspect of knowledge very much in play at the conference was serendipity. Throughout the two days, I picked up little gems of insight and information that were not part of the speaker’s main message. Rather than try to summarize the presentations, I will be posting these tidbits over the next few days.

Underestimating savings

While the account profession continues to resist counting research and training as an investment, there is some slight movement at the level of macroeconomic statistics. Recently, the Bureau of Economic Analysis (BEA) and the National Science Foundation (NSF) announced a new project to look at the issue. The project would create a “satellite account” for the R&D portion of the GDP numbers — including looking at the issue of treating R&D as an investment (i.e. capitalizing the cost over a number of years, similar to what is already done with plant and equipment, rather than expensing it). According to research by BEA economists, our current treatment of R&D as an expense underestimates our national rate of savings by approximately 2 percentage points.
As Michael Mandel points out in a recent column in Business Week, this underestimation distorts our policy debates and focuses attention on the wrong priorities:

The coming debates over tax reform and private accounts for Social Security are going to be framed in terms of the savings rate as well. All the proposals for overhauling the tax system are geared toward putting more of the weight of taxation on consumption, and less on savings and investment. And many supporters of Social Security privatization claim that the current system lowers savings, because Americans rely on the government to fund their retirements rather than putting money away themselves.
In the end, what will propel growth is human capital and innovation. It’s the hidden savings rate that deserves the attention, not the official one.

This mirrors an argument that Baruch Lev has repeatedly made about the expensing of corporate R&D. It has always surprised me that the high-tech community has focused exclusively on the issue of stock opinion and completely ignored the issue of capitalizing of R&D. Part of the problem has been accountants’ concern over the validity of the procedure. The movement by the economists in charge of macroeconomic statistics toward capitalization of R&D in the national accounts may give a new push to the business accounting issues. After all, these folks are hardly a radical bunch. And if they say this is the right thing to do for the national accounts, it is going to be harder for people to say it can’t be done at the firm level.

Inclusion in the Intangible Economy

The Martin Luther King, Jr. Holiday is more than just a day off. It should be a time to reflect on where we are in meeting Dr. King’s Dream and the American goal of an inclusionary society. An inclusionary society is absolutely necessary for the functioning of an intangible economy. As Richard Florida and others have pointed out, creativity thrives where there is diversity and tolerance. In this intangible economy, we can not afford to exclude any human assets.
The intangible economy is also the networked economy. Metcalf’s Law roughly states that the value of a network increases exponentially in relation to the number of participants. The same is true for that network of productive activity we call the economy. By leaving some behind, we impoverish not only those individuals; we also impoverish ourselves. By empowering and embracing others, we also empower ourselves.
Let us continue to keep this in mind, not only today, but always as we strive to build an inclusionary intangible economy.

Trade in intangibles

This morning’s trade figures have some good news and bad news concerning trade in intangibles. For our purposes here, I’m defining trade in intangibles as the sum of “royalties and license fees” and “other private services” (see the official BEA/Census definitions of these two categories below). The good news is that our balance of trade in intangibles is holding steady over the past three years at between $6 and $6.5 billion monthly. Imports of intangibles have steadily increased over the past three years from $7.5 billion to almost $10 billion. But exports have increased as well.
The bad news is that our balance of trade in intangibles is holding steady at between $6 and $6.5 billion monthly. Intangibles are not offsetting our large deficit in goods. If we are to get our trade deficit under control, we have to pay more attention to goods and not rely on the myth that “services (intangibles) will save us.”
As I have often argued, much of the power of intangibles is how they operate within all sectors of the economy – not as a separate sector. We need to harness our intangibles to re-invigorate our goods trade as well as rely on our “intangible trade.”
Intangibles trade 1.gif
BEA/Census Bureau definitions:
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.

Expectations and the employment numbers

The December employment numbers came out this morning, and the Yahoo News website had the following two headlines:

December Job Gains Less Than Expected – Reuters
December Hiring Helps Fuel Job Growth – AP

The facts related by both stories were the same. Payrolls were up by 157,000 but economists had predicted 175,000. There were 2.2 million new jobs in 2004 compared to a loss of 61,000 in 2003. The unemployment rate was unchanged.
Is this just one reporter looking at the negative and one at the positive? Or is there more to the discrepancy?
To me, the difference highlights two of the key features of the intangible economy: the role of expectations and the importance of uncertainty. In this age of information, we are bombarded with facts. And at the same time we are increasingly told what these facts mean ahead of time.
Companies that the maybe very profitable, but not as profitable as was expected, are punished by Wall Street. Movies that don’t open to the anticipated box office numbers are bombs. Presidential candidates that don’t garner the projected number of votes are considered losers (even if they finish first). Predictions, not facts, set the tone.
Management of expectations has become a way of live in every field: business, politics, and entertainment.
Unfortunately, the predictions, upon which those expectations are based, are not always correct. As Justin Lahart writes in today’s Wall Street Journal:

Nobody seems to have a clue on how today’s jobs report will come in. Maybe that isn’t such a bad thing.
Cluelessness and economic forecasting aren’t necessarily strange bedfellows, and lately this has been particularly true of the monthly employment report. Over the past year the forecast for the monthly change in nonfarm payrolls has missed the reported change by an average of 110,000, according to Lehman Brothers.

Part of our information/fact driven economy is a demand for precision. That precision can not always be met, especially in the squishy area of intangibles. During our work on looking at how companies report intangible assets, we talked to experts in valuation methodologies. One of them made the most striking comment: “We can value a company’s intangible assets, like their workforce. But if we are within plus or minus 20 percent, we thing we have done a good job. That drives the auditors absolutely crazy.”
Intangibles means uncertain. And as uncertainty collides with expectations, the result will be more confusion and conflicting headlines like this morning. As we move into the intangible economy we will need to learn to put up with a certain degree of cluelessness.

Europe’s innovation strategy

Two pieces in today’s Financial Times of London caught my eye. Both having to do with how Europe is positioning itself to cope with this new economic situation. The first is a comment by the new EU industry commissioner Gunter Verheugen on competition policy (what we call anti-trust policy). While competition policy is not in his commission portfolio (Neelie Kroes is the new competition commissioner, replacing Mario Monti), Mr. Verheugen’s statements may be taken as a possible shift in EU direction toward less stringent anti-trust enforcement:

He told Le Monde, the French newspaper: “We have to discuss the manner in which we deal with mergers, in the general interest of Europe.

Insofar as these help the creation of European champions, I am clearly in favour [of such discussions].”

. . .

Mr. Verheugen hinted that Neelie Kroes, the new competition commissioner, backed his views.

“Neelie Kroes, has a very good understanding of business. I have the feeling that she is not, in principle, opposed to the emergence of big companies, provided they exist not thanks to subsidies but their position in the market.”

The second piece was a story about a French initiative to open its industrial innovation funding to companies from other European countries.
These two pieces raise an interesting point about Europe’s (and the US’s) innovation strategy.
With the recent criticism (see the Kohn report) of the failure of the EU to meet the goals of the Lisbon Strategy to become the world’s leading information economy, it is clear that there some in Europe who are interested in jump-starting the process. The question is whether creation of large “European champions” and large-scale government funded R&D are the way to spark innovation.
Government funding (and incentives) for innovation is clearly important. This point was rightfully hammered on in the recent National Innovation Initiative report by the Council on Competitiveness. However, large scale funding projects is but one of many elements in an innovation strategy. Vigorous competition is another — and creation of “champions” may not be the best way to promote that competition.
In fact, one of the key elements of a healthy, robust National Innovation System may be the mix of large and small companies. In the industrial age, big was better as economies of scale ruled. Large companies and massive research projects build on the economic of scope and scale. One of the paradoxes of the intangible economy is the simultaneous need for large and small, centralized and decentralized organization. We talk a lot about the small, fast moving virtual companies as the model for the future. Yet it is the large companies with their brand power and marketing ability who often come away with the greatest economic gains.
Thus, a strategy of creating large champions and pouring money into their research project is an idea whose time has come and gone.

Jobs in the intangible economy

Today’s Christian Science Monitor includes a look ahead, include a story on the future of jobs.  According to Dan Pink (echoing comments by Frank Levy and others):

Jobs that depend on routines, jobs that are basically following a set of rules, jobs that you can essentially reduce to a recipe – basic accounting, basic legal research, basic computer programming – those jobs, which used to be the pathway to the middle class, are either being outsourced or automated.

He goes on to say:

An accountant who’s just doing basic accounting work is toast. But you can imagine accountants morphing to become broader, financial-life planners, and understanding where their clients are coming from, understanding their true needs, not just crunching numbers, because foreigners can do [that] cheaper, and computers can do it better. [But computers] can’t understand someone’s dreams; they can’t design a compelling experience.

This illustrates the changing nature of the economy. The ability to innovate and to “design a compelling experience” are the important intangible assets. Routine activities — no matter how technically sophisticated or important — will gravitate to the cheapest workforce or be automated. Key to non-routine activities is a person’s tacit knowledge as well as problem solving abilities. A story in Business Week last March put it succinctly:

As valuable as education is, technical knowledge alone won’t cut it, because workers in other countries read the same textbooks. For many good jobs, in fact, education isn’t as useful as specialized local knowledge. Lin Stiles, a headhunter in New London, N.H. says that demand is hot for plant managers who can improve a factory’s efficiency. A fancy degree isn’t necessary. Says Stiles: "We frequently do not have college requirements even for a vice-president for operations."

In the end, the intangible economy is very, very different from the industrial economy’s never ending quest for standardization and optimization of routine activities.

Welcome to the Intangible Economy

Welcome to The Intangible Economy, Athena Alliance’s weblog of insights and information on the I-Cubed (Information, Innovation, Intangible) Economy.
The I-Cubed Economy is upon us. As I have argued elsewhere, the global economic situation has changed. Twenty years ago, the concern in the US was over global competition in goods and the loss of domestic manufacturing firms. Now we face a new challenge brought about by the fusion of manufacturing and services and the opening up to international competition of services sectors once thought to be immune to this competition. Then, the issues were quality and productivity; now they are the need for increased customization, speed and responsiveness to customer needs. Then, the concern was over creating a flexible and educated workforce; now, in addition to those concerns, we must foster an educational enterprise with the constantly changing types of education and skills required in a knowledge and information intensive economy. Then, the challenge was the cost of capitol; now the challenge is to unlock the value of underutilized knowledge assets and to insure the efficiency and stability of the global financial system. Then, the problem was how to raise policy awareness of the importance of international trade; now the problem is how to craft policy for an increasingly globalized and interconnected economy. Then, our focus was on individual firms and industries; now we must face the challenges of sustaining networks of firms and adopting new of business models. Finally the speed with which all of these problems and challenges arise has increased.
Information, knowledge and other intangibles now power economic prosperity and wealth creation. Intangible assets – worker skills and know-how, informal relationships that feed creativity and new ideas, high-performance work organizations, formal intellectual property, brand names – are the new keys to competitive advantage. The I-Cubed Economy is one of relentless change and competition. We are on a new treadmill. While the industrial economy demanded higher and higher levels of productivity to continue to drive costs down, this new economy demands more and more innovation. Intangibles and information drive our innovation process, which is a combination of formal research and informal creativity. These elements combine to produce the productivity and improvement gains needed to maintain prosperity.
One feature of the I-Cubed Economy is that portion which made up purely of intangibles. It has been estimated that the size of investment in intangibles in the US is over $1 trillion. But intangibles are part and parcel of the overall economy. They can not be separated out and treated as distinct economic sector. As a myriad new information and technologies sweep across the domestic and international economy, all sectors and industry, as well as the suppliers of financial, technological and human capital, need to develop their intangible capabilities and resources.
In this Intangible Economy, the rules have changed. But public policy has not caught up with this new economic environment. Governments are struggling with ways to utilize information, foster the development of intangibles and promote innovation and competitiveness. Policy makers are grappling with the urgent need to frame policy questions in light of the changing economic situation. Issues of developing and managing intangibles underlie discussions on a variety of subjects, such as intellectual property rights, education and training policy, economic development, technology policy, and trade policy. Crafting new policies in these areas will require infusing a better understanding of intangibles and the information economy into the public debate.
We also need to go beyond existing solutions. Our current economic theory and policy is a product of the industrial age of mass consumption, mass production. We need to develop new ways of thinking about economic activity, different means of promoting and organizing economic opportunities and activities, and different economic policies and programs.
But, understanding is not enough. We must also enlarge the repertoire of strategies, mechanisms, tools, and capabilities that individuals, firms, and communities can use to shape their own positive economic futures, with special attention to those in danger of being left behind.
American firms and workers lead the world in creating and using intangible assets. But, the increasing global competition means that we must continue to develop our intangible economy. No American need be left behind in the new economy as in this new era of intangible-based global competition.
It is our hope that this discussion will provoke thought – and comments – as we grapple with this new economic reality.
We also invite you to view our papers and the summaries of our policy forum on the Intangible Economy (co-hosted with the Wilson Center) at the main Athena Alliance website.