Falling behind in S&T

Two new studies are out on America’s crisis in science and technology: AeA’s (American Electronics Association) Losing the Competitive Advantage?: The Challenge for Science and Technology in the United States and The Task Force on the Future of Innovation’s The Knowledge Economy: Is America Losing Its Competitive Edge (the Task Force is a coalition of science, education, and technology industry leaders). These reports come on the heals of the last year’s EIA report (Electronic Industries Alliance)Technology Industry at an Innovation Crossroads: A Policy Playbook Addressing the Future of the U.S. High-Tech Innovation Economy, and the Council on Competitiveness’s National Innovation Initiative. All of these report point out the declining Federal support for R&D and problems with the K-12 educational systems.
I would like to say I am optimistic that these reports will serve as a call to action. But I’m not. While industry leaders issue report and report, Washington, with a few exceptions, is focused on other issues. And the huge budget deficit (which does not even count war or Social security privatization costs) leaves little room for the traditional response of expanding Federal support for S&T research or education.
For this reason, I continue to call for a new approach to the problem, as outlined in the Commission on the Future of the US Economy. Clearly, we can not stay on our present course and the alternatives we have tried in the past are either not available or insufficient. We need some new thinking — and we need it fast.

When tangibles are intangible

One of the general concerns over the inclusion of intangibles in any accounting or statistical system is that they are hard to measure – unlike tangible assets which can be physically counted. Well, tangible assets often have a very intangible quality to them. Take for example, oil and gas reserves. Most of us would think that an oil companies proven reserves are pretty tangible. But, according to Daniel Yergin, Pulitzer-Prize winning author of Oil:

It is a crucial misunderstanding to think of oil and gas reserves as being similar to inventory or a company’s cash balances. They are not a fixed quantity capable of physical inspection or exact enumeration. Reserve auditors cannot enter the underground warehouse, that is the pore space in a reservoir, and check off the barrels. They cannot correlate and add up reserves to a second decimal place, as they can with revenues and net income.

Yergin was speaking in reference to a new study by his firm, Cambridge Energy Research Associates, on the problems with the way we count petroleum reserves. The study, In Search of Reasonable Certainty: Oil and Gas Reserves Disclosures, argues that the accounting methods for reserves are hopelessly outmoded. According the press release:

The study describes reserves as an approximation — estimates derived from a complex combination of direct evidence, expert interpretation, a variety of scientific methodologies and experience-based assumptions about the future, often stated in terms of probabilities. For the purposes of internal investment decision-making, companies may use probabilistic methods – alongside single-point deterministic estimates — to categorize reserves as either proven (90% chance of ultimate recovery), proven plus probable (50% probability), or possible (10% chance of recovery).
However, the study notes, the 1978 System focuses on proved reserves as defined by a standard of “reasonable certainty” pegged to “direct contact” with an existing well. The report described this measure as suitable for reserves forecasts of individual producing wells, but unsuited to an increasing proportion of the modern oil and gas industry, particularly to larger offshore projects.

Sounds to me like the standard problem of an accounting system that can’t deal with intangibles – in this case the intangibles of expert interpretation.
Now, on the other hand, where are the checks and balances that insure that these “expert interpretations” have anything to do with reality? We continue to get reports of companies modifying their stated reserves. As one critic, retired French engineer Jean Laherrere puts it:

What is needed for reserve definitions is good practice and good rules, to which every country in the world agrees. The problem is that oil and gas companies are not asking for precise rules as they prefer poorly defined rules, which allow them more freedom for reporting, and they want to keep confidential their field estimates. The push must come from the governments or from the banks.

When creating a reporting system that includes intangibles, it is important to balance the need for understanding these new measures with the check to ensure that they are real and not subject to manipulation. As is the case in many areas of understanding intangibles, transparency and disclosure rather than a bottom line number, may be the best solution.

Dueling on the Dollar

Contrasting articles on the future of the dollar and America’s economic fate hit my desk this week. In the Winter 2005 issue of the Wilson Quarterly carried Robert Aliber’s, “The Dollar’s Day of Reckoning” while the March/April 2005 Foreign Affairs had “The Overstretch Myth” by David Levey and Stuart Brown.
In keeping with his title, Ailber see the current account deficit as unsustainable and eventually leading to a $400 billion correction via the currency market. He argues that a sustainable trade deficit would be no more than $200 billion annually, down from the current level of $600 billion.

The United States today is in a position similar to that of Mexico in 1980, Norway in 1987, and Thailand and Mexico in the early 1990’s. These countries paid the interest on their international indebtedness with some of the funds received from the in-flow of new foreign investments. The United States is now doing the same thing. It is engaging in Ponzi finance, and the game will soon be up.

By the end of 2004, America’s net international indebtedness had increased by some $500 billion for the year, reaching $3 trillion. Its international indebtedness has been increasing at an annual rate of 16 percent, while its GDP has been growing at a six percent rate. In the long run, international indebtedness simply cannot increase more rapidly than GDP. If it did, foreigners would, in theory, eventually end up owning all the assets and securities in the United States. As a practical matter, policy adjustments or the market will ensure that this does not happen.

He sees little likelihood that this adjustment process will be of “soft landing” variety, which would require a steady, rather than a precipitous, decline in foreign demand for US dollar securities of about $100 billion a year for the next few years.
On the other side, Levey and Brown see an American economy that is continuing to lead:

Despite the persistence and pervasiveness of this doomsday prophecy, U.S. hegemony is in reality solidly grounded: it rests on an economy that is continually extending its lead in the innovation and application of new technology, ensuring its continued appeal for foreign central banks and private investors. The dollar’s role as the global monetary standard is not threatened, and the risk to U.S. financial stability posed by large foreign liabilities has been exaggerated. To be sure, the economy will at some point have to adjust to a decline in the dollar and a rise in interest rates. But these trends will at worst slow the growth of U.S. consumers’ standard of living, not undermine the United States’ role as global pacesetter. If anything, the world’s appetite for U.S. assets bolsters U.S. predominance rather than undermines it.

They dismiss any comparison with recent debt crisis in other countries:

There are key differences, however, between those emerging-market cases and the current condition of the global hegemony. The United States’ external liabilities are denominated in its own currency, which remains the global monetary standard, and its economy remains on the frontier of global technological innovation, attracting foreign capital as well as immigrant labor with its rapid growth and the high returns it generates for investors.

Interestingly, both sides see similar consequences of a hard landing.

The decline in the trade deficit must be matched by a comparable increase in annual savings (and therefore slower growth in American’s consumption) and in U.S. production of trade-able goods. While the longer-term results will be positive, the process of achieving them may be extremely painful, including rising rates of inflation, interest, and unemployment, and possibly a severe economic recession.

Levey and Brown:

But even if such a sharp break occurs–which is less likely than a gradual adjustment of exchange rates and interest rates–market-based adjustments will mitigate the consequences. Responding to a relative price decline in U.S. assets and likely Federal Reserve action to raise interest rates, U.S. investors (arguably accompanied by bargain-hunting foreign investors) would repatriate some of their $4 trillion in foreign holdings in order to buy (now undervalued) assets, tempering the price decline for domestic stocks and bonds. A significant repatriation of funds would thus slow the pace of the dollar decline and the rise in rates. The ensuing recession, combined with the cheaper dollar, would eventually combine to improve the trade balance. Although the period of global rebalancing would be painful for U.S. consumers and workers, it would be even harder on the European and Japanese economies, with their propensity for deflation and stagnation. Such a transitory adjustment would be unpleasant, but it would not undermine the economic foundations of U.S. hegemony.

So what has this got to do with intangibles? Well, in today’s financial system, money is the ultimate intangible. No longer backed by precious metals, money is just as valuable as we collectively believe it to be. And that collective belief in the value of the dollar changes (such as this week’s turmoil in the currency markets due to the rumor that South Korea’s central bank was reducing its reverses of dollars and buying other currencies).
More to the point, the key difference between the two sides hinges on American’s intangible asset of what might be called “investment desirability.” Levey and Brown see no reason why foreign investors won’t continue to see the U.S. as the best place to invest; Aliber sees no reason to believe that foreign investors will continue to view us as a special case immune from the laws of economics.
Levey and Brown not only make the case that the U.S. will remain a desirable location for investment, they point out the lack of alternatives. The euro-zone, they argue, is in no economic position to challenge the U.S. In their view, the only thing that can end the U.S. position is the Pogo-scenario (we have met the enemy and they are us):

Only one development could upset this optimistic prognosis: an end to the technological dynamism, openness to trade, and flexibility that have powered the U.S. economy. The biggest threat to U.S. hegemony, accordingly, stems not from the sentiments of foreign investors, but from protectionism and isolationism at home.

I agree that the Pogo-scenario is the most likely cause of an unraveling of the U.S.’s global financial position. The danger is that we undermine our advantages to such an extent that foreigners no longer see the U.S. as a special place to invest – but simply one of many. But I disagree that the triggers will be protectionism and isolationism. Rather, it will be complacency and indifference.
Unfortunately, the signs of complacency and indifference are all around us: the increased difficult of foreigners (scientists, businessmen and yes, investors) to get into the U.S. because of increased concerns over homeland security; the rising budget deficit that the Administration and Congress are unable and unwilling to confront; the picking away at our National Innovation System (as recently documented by the Council on Competitiveness report) while we focus attention of side issues such as tort reform; our blase indifference to the continued trade deficit (including Levey and Brown’s repetition of the argument that the trade deficit is a sign of strength not weakness); and, a foreign policy that continues to treat the Made in America brand as something that will last forever.
Yes, the danger is that we will shoot ourselves in the foot. But it will be by doing nothing in the face of serious challenges. Thus, in the end I come down on Professor Aliber’s side. We face some serious challenges, as the recent GAO report points out. Yet, we seem stuck in ostrich mode. The Levey and Brown argument just strikes me as too much a “what me worry” approach similar to what we have heard in the past. Some times, a little worry is good. In warning us off from “would-be Cassandras,” Messrs. Levey and Brown should remember that Cassandra’s curse was to always be right (but never be believed).
One side note: the Levey and Brown article also refers to the recent work on investment in intangibles argue that “the size and growth rate of the U.S. economy have been seriously underestimated.” It is true that not including intangibles in the national system of accounts has the effect of misrepresenting the size of the economy. (See my January 18 entry on “Underestimating Savings“.) However, I would be very leery of then making the jump, as they do, that this proves that we do not have a national savings problem. The BEA work that I referred to does show an underestimation of savings. But the trend is still downward. And it is that trend, not necessarily the raw number that we need to worry about.

Managing the US Brand

Last night, the AP released its poll of consumer’s preference for American goods in nine countries. The results contain some mixed news. Most Europeans prefer not to buy US goods, if the price and quality were similar. In most cases, their preferences for US goods has declined slightly since the last survey was taken in December of 2001 (after 9-11 and before the Iraqi war) – except for the case of the French who disliked our goods as much now as they did before. On the other hand, the Mexicans prefer American goods and the South Koreans appear to be ambivalent. And in Britian, France, and Italy, younger consumers are more likely to prefer US goods than older consumers. Not suprisingly, 93% of Americans would rather buy American products if the price and quality were the same.

Stifling innovation through intellectual property rights

Steven Pearlstein’s column in today’s Washington Post is an absolute gem. He describes how concern over lawsuits on who owns a business/ad idea is stifling innovation. And these are not even patented business process ideas! Another case of IPR gone wild.
For more, see Pearlstein’s Live Online extended discussion on the topic.

GAO looks at a bleak future

Earlier this month, the Government Accountability Office (GAO – formerly known as the General Accounting Office) released its report 21st Century Challenges: Reexamining the Base of the Federal Government. The report is worth a careful read by anyone interested in the future of the US.
Testifying before the Senate Homeland Security and Governmental Affairs Committee last week, David Walker, Comptroller General of the United States, stressed the report’s findings that

our nation is on an unsustainable fiscal path. Longterm budget simulations by GAO, the Congressional Budget Office (CBO), and others show that, over the long term we face a large and growing structural deficit due primarily to known demographic trends and rising health care costs. Continuing on this unsustainable fiscal path will gradually erode, if not suddenly damage, our economy, our standard of living, and ultimately our national security.

That is a sobering enough statement. But both the report and Mr. Walker’s testimony delved much deeper into the forces shaping our fiscal future and the challenges ahead. As Mr. Walker stated,

Our recent entry into a new century has helped to remind us of how much has changed in the past several decades-whether it be rapid shifts in the aging of our population, the globalization of economic transactions, the significant advances in technology, and changing security threats. If government is to effectively address these trends, it cannot accept its existing programs, policies and activities as “givens.” Outmoded commitments and operations can constitute an encumbrance on the present and future that can erode the capacity of the nation to better align its government with the needs and demands of a changing world and society.

The report looks at 8 “Forces Shaping the United States and Its Place in the World”:

Large and Growing Long-term Fiscal Imbalance-The U.S. government’s long-term financial condition and fiscal outlook present enormous challenges to the nation’s ability to respond to forces that shape American society, the United States’ place in the world, and the role of the federal government. The short-term deficits are but a prelude to a projected worsening long-term fiscal outlook driven largely by known demographic trends and rising health care costs.
Evolving National and Homeland Security Policies-The dissolution of the Soviet Union in 1991 and the emergence of the more diffuse threats posed by terrorism to the nation’s national and homeland security have led to major shifts in strategic threats. While these new security concerns are already prompting changes in defense postures and international relationships, preparedness and responses to these new threats also carry wide ranging and unprecedented implications for domestic policies, programs, and infrastructures.
Increasing Global Interdependence-The rapid increase in the movement of economic and financial goods, people, and information has prompted more widespread realization that the nation is no longer self-contained, either in its problems or their solutions. The growing interdependence of nations, while carrying clear economic and social benefits, also places new challenges on the national agenda and tasks policymakers to recognize the need to work in partnerships across boundaries to achieve vital national goals.
The Changing Economy-The shift to a knowledge-based economy and the adoption of new technology has created the potential for higher productivity but posed new challenges associated with sustaining the investment in human capital and research and development that is so vital to continued growth. While the sustainability of U.S. economic growth has been aided by trade liberalization and increased market competition in key sectors, the sustainability of growth over the longer term will require a reversal of the declining national savings rate that is so vital to fueling capital investment and productivity growth.
Demographic Shifts-An aging and more diverse population will prompt higher spending on federal retirement and health programs. Unless there is strength in the underlying sources of productivity-education, technology and research and development-low labor force growth will lead to slower economic growth and federal revenue growth over the longer term. As labor becomes ever more scarce, a greater share of the work force will be comprised of foreign-born workers, women, and minorities with broad-scale implications for education, training, child care, and immigration policies.
Science and Technology Advances-Rapid changes in science and technology present great opportunities to improve the quality of life and the economy, whether it be finding new sources of energy, curing diseases, or enhancing the nation’s information and communications capacities. However, technologies raise their own unique vulnerabilities, risks, and privacy and equity concerns that must be addressed by policymakers.
Quality of Life Trends-Large segments of the population enjoy greater economic prosperity than ever before, and the well being of many Americans has improved dramatically thanks to breakthroughs in health care and improvements in environmental protection. However, these improvements have not been evenly distributed across the nation, as more than 40 million Americans lacking health insurance demonstrate. Prosperity has prompted its own stresses, as population growth and sprawl create demand for new transportation and communication infrastructure.
Diverse Governance Structures and Tools-To deliver on the public’s needs and wants, the nation’s system will be pressed to adapt its existing policy-making processes and management systems. The governance structures and management processes that emerge will be shaped by the above forces (e.g., increasing interdependency, scientific and technological changes, and security threats), and will depend on having sufficient foresight, a continuous reexamination and updating of priorities, ongoing oversight, and reliable and results-oriented national performance indicators.

These forces are similar to the challenges that we have outline before and that form the core charter for the proposed Commission on the Future of the US Economy (see the Athena Alliance website). If anything, the GAO report down plays the economic ordeal that may confront us as we grapple with the shift to an Intangibles Economy.
Reading through the GAO report only heightens our conclusion that we need the Commission to craft a set of bipartisan solutions – now more than ever.

Congressional Savings Caucus

In this era of sharp political divisions, it is heartening to see the occasional outburst of bipartisanship. One of those rare events occurred today with the launch of the Congressional Saving and Ownership Caucus. On the Senate side, the Caucus is co-chaired by Senators Rick Santorum (R-PA) and Kent Conrad (D-ND). The House Caucus is headed by Representatives Jim Cooper (D-TN), Phil English (R-PA), Harold Ford, Jr. (D-TN) and Thomas E. Petri (R-WI).
The caucus is an offshoot of the work of the New America Foundation’s Asset Building Program. Earlier this month, New America released their outline of programs for an Ownership Society. These recommendations mostly focused on building financial assets (hence the tie-in with a Congressional Caucus focused on savings) and include their signature recommendation of creating children’s savings accounts at birth (similar to the British Child Trust Fund).
Beyond strictly financial assets, the recommendations also include programs for homeownership and saving for educational purposes. In addition to education programs (which clearly fall under the category of investments in intangible assets), there are a few other ideas for what we would consider intangible assets. These include recommendations for strengthening financial literacy, increased R&D in the financial sector to meet the needs of the “unbanked,” and supporting microenterprise development.
The New America issue brief also includes ideas on protecting assets, such as curbing predatory lending, and for strengthening the Community Reinvestment Act (CRA) to improve low-income lending. I wish it had taken the next step and included programs to protect credit ratings – a key intangible asset of both individuals and businesses. Issues concerning identify thief as well as the role of credit rating agencies (as discussed in an earlier posting) would be fruitful areas for further work. It would also be of interest to look at how the CRA could be used to promote the development of intangible assets for low-income individuals and in low-income communities.
The other area that I think needs further elaboration is in the educational programs. These programs, including the educational savings accounts (Section 529 savings plans), are geared to formal education, especially college. In an intangible economy, we need to boost continuous learning, not just static earning of a degree. We need to find a way to craft the rules for these educational programs to allow them to be used for broad learning activities, without opening the programs up to the huge array of potential abuses. Clearly this is an area that will require a lot more work.
In the meantime, the creation of the Savings Caucus is to be applauded. At today’s press conference, Caucus chairs delicately side-stepped the hot button “savings” issue of Social Security. It remains to be seen whether the Caucus, launched with high hopes today, can avoid floundering on the hard political rocks of Social Security. Let us hope so.