Expanding the Creative Class

One of the often cited dangers of our economic trajectory to the I-Cubed Economy is the creation of a society of have and have-nots. Those with the skills/talent/knowledge to succeed will prosper in this “brainwork” economy while those involved in less intellectually challenging (and more physical types) of activities will not. The great middle class, created by well paying manufacturing jobs, will disappear.
But that scenario need not occur. As I have often argued, all jobs require some creativity and level of tacit knowledge. It all depends on how we structure the activity. If we “dumb-down” jobs, we will loss the creative potential of the workers engaged in that activity; if we “smart-up” jobs, we open the door for greater innovation and productivity.
As Richard Florida has said, the next big challenge for the Creative Society is to bring in those millions of workers who are struggling in this economy. Now Florida has written a more extensive discussion of that idea in Newsweek – “The Secret to Future Growth”:

Equally important [to the creative sector] will be the continued expansion of the service economy, where more than 5 million new jobs will be added, including retail salespeople, customer-service representatives, janitors, waiters and landscapers. Because these jobs pay a third of those in the creative economy, and half of those in the declining manufacturing sector, this trend is generally seen as a danger sign, a signal that the labor market is cleaving into two classes: high-skilled, high-paying creative work and much-lower-paying service work. The general consensus is that the only way to raise wages for these jobs would be with massive government intervention.
But a new generation of service companies is discovering that increasing pay and improving working conditions can add significantly to the bottom line. A good example is Best Buy, which employs 90,000 people and is the largest specialty retailer of consumer electronics in the world, with annual sales of some $25 billion. Taking a page from Toyota’s much-lauded management system, employees are encouraged to improve upon the company’s work processes. Small changes suggested on the salesroom floor—a teenage sales rep’s reconception of an Internet phone-calling display, or an immigrant salesperson’s proposal for ways to target advertising and service to non-English-speaking communities—have been implemented across the company, generating millions in added revenue. Best Buy likes to grow from within so motivated employees are able to move quickly from in-store sales to retail management, where pay increases substantially
This retail revolution provides a model for turning service work into stable middle-class jobs. Thriving companies such as Best Buy, Starbucks, Whole Foods, REI, and the Container Store dominate lists of the best places to work. Many of them are increasing pay and benefits and making their work environments more stimulating. At the Container Store, for example, the typical hourly worker earns $29,277 a year, or 50 percent more than the U.S. retail industry average. They’re doing this not out of altruism, but to increase productivity and profit.
Of course there is more to do. The service economy, particularly fast-growing personal-service fields like haircutting and landscaping, is dominated by small and medium-size companies who are unable or unwilling to upgrade pay and working conditions. The “on-ramps” that better-paying service jobs can provide remain too few and far between. The leaders in Davos must understand that economic competitiveness hinges on developing the full creative capabilities of the store clerk and the landscape laborer, as well as the computer scientist and the architect. And they should look beyond the tech sector for models.

Many of these are what I call “tangible service” jobs — jobs that primarily involve the physical manipulation of matter rather than “intangible service” jobs which primarily involve the manipulation of information. There is no reason, however, that physical manipulation of matter needs to be separated from use of information and knowledge, especially tacit knowledge. The Taylorist model of physical production is not necessarily the best.
Already we can see that a number of these jobs are part of the creative economy — depending on how you structure them. For example, a barber might be seen as a traditional service job; a high-priced hair stylist is certainly part of the creative economy. So expanding the creative economy is a much a mindset problem as an economic one. People must realize that the phrase “our employees are our most important asset” is more than a nice slogan — and that it applies to everyone, from the CEO to the janitorial services. Once that mind shift occurs, the creative economy will expand rapidly.

Focus on innovation, rather than invention

John Hagel and John Seely Brown have written a telling critique of our current innovation plans in Business Week – Funding Invention Vs. Managing Innovation

George W. Bush’s proposal to increase federal government R&D spending is revealing on two levels. It suggests a growing sense of urgency about the need for the U.S. to strengthen its innovation capability. At the same time, it provides insight into the mindsets that are making the U.S. more vulnerable to global competition.
While executives of large Western companies and policy-makers of Western governments continue to view innovation through 20th century lenses, entrepreneurial companies in Asia are harnessing the opportunities of the flat world to pursue broader forms of innovation appropriate for the 21st century.
In the West, we still confuse invention with innovation. Even worse, we tend to focus narrowly on breakthrough technology or product invention — that’s what really gets the adrenaline going. Anything else is marginal and uninteresting.

They go on to say:

In the 20th century, scale and efficiency became key sources of economic value. Companies spent a lot on R&D and standardized and automated the rest of their operations, constraining opportunities for creativity outside the lab. As competition intensified, companies squeezed their R&D budgets in the quest for cost savings, while still looking for the “silver bullet” that would insulate them from competitive pressures. Given that mindset, it’s understandable that CEOs hammer on the government to spend more to help them find the next breakthrough.
But if we shift our attention from invention to innovation, we begin to see a much broader horizon. Innovation — the ability to create and capture economic value from invention — is what really drives both the economic prosperity of nations and the shareholder value of corporations.
Innovation isn’t just confined to commercialization of new products. It can also build upon creative new practices, processes, relationships, or business models, and even institutional innovations such as open-source computing — invention occurs in all these domains. And while breakthrough innovations can generate significant economic value, sustaining that value requires a capacity for continual incremental innovations.

Agreed, but unfortunately Hagel and Brown offer us only generalizations as solutions:

There’s now an opportunity to connect with creative talent wherever it resides and build relationships that enable all parties to innovate more rapidly and to get better faster by working with each other. Fully exploiting this opportunity will require a fundamental re-think of our approach to mobilizing resources, creating much more scalable pull platforms to support large numbers of participants, in place of the push approaches that constrain our innovation opportunities.
Of course, this is a very different vision from the one embedded in the proposal to increase federal spending on R&D programs. Rather than centralizing spending on a national level, this vision sees the potential created by more distributed approaches to innovation management on a global level. If Western executives don’t embrace this vision more aggressively, they will become increasingly vulnerable to competition from companies that do. No amount of spending on R&D by Washington will save them from this fate. Only a shift in mindset will.

Far be it for me to downplay the need for a mindset shift; I have been calling for a shift in mindset for years. But such a shift also requires a shift in practical actions. This is where the vision falls short. For example, are Hagel and Brown calling for increased offshoring of R&D? Or better mechanisms for small and medium size companies to tap into the knowledge crated in other nations? What would a “distributed approaches to innovation management on a global level” look like? And how does it produce incomes and jobs in the United States?
I realize that these are not questions that they may have the answer to immediately. But they are the type of questions that need to be answered before we buy to much more into “the vision.” It is time to move from generalities to specifics. I hope that is their next article.

Patents and innovative evolution

The normal argument for patents is that the exclusive rights granted by patents are needed to provide the financial incentives required by the innovators. That argument is often juxtaposed with the concern that these exclusive rights are a monopoly power that may impede future innovation.
The latter argument is hinted at in a remark by MIT Finance Professor Andrew W. Lo, a true Wall Street “rocket scientist.” Dr. Lo is the director of the MIT Laboratory for Financial Engineering. Business Week describes his research:

One of his projects is an attempt to incorporate evolutionary psychology and evolutionary dynamics into modern finance with his Adaptive Market Hypothesis (AMH). In essence, AMH argues that investors use trial and error to establish rules of thumb in the markets. Their skills improve as they climb a learning curve, and then, inevitably, they confront changes in the market that render some strategies obsolete. The survivors innovate, and come up with new ways of making money.

In a recent interview with Business Week – Online Extra: “Economists Suffer from Physics Envy”, Dr. Lo made an interesting side comment about patents:

Q: You think Charles Darwin’s ideas about evolution, natural selection, and the like apply to the financial markets?
A: Yes. For instance, the hedge-fund industry is the Galapagos Islands — where Darwin [developed the idea of] evolution — of finance. Because of the lack of patents, speed of innovation, and the ruthlessness of competition, we can see evolution in the hedge-fund industry. It looks nothing like it did five years ago.

In other words, the lack of patent is a factor in the industry’s ability to evolve, i.e. innovate. If Dr. Lo’s Adaptive Market Hypothesis is a specialize version of a “general theory of innovation” (which I think it may be), then we need to think very carefully about how the patent system stands as a barrier to (rather than a facilitator of) innovation.

December – and 2005 – trade in intangibles

The US ran a record trade deficit of $725.8 billion in 2005, $108.2 billion more than the 2004 deficit of $617.6 billion. News on intangibles trade was more mixed. The good news is that the intangibles surplus for the year increased to $92.4 billion – the highest it has been. However, revisions in this morning’s BEA trade data show that our balance of trade in intangibles actually declined in November, while increasing by only $22 million in December — essential flat at a surplus of $6.9 billion monthly. The monthly intangibles surplus is still below the peak surplus of almost $7.5 billion in December 2004.
And while our annual intangibles surplus has almost doubled since 1992, the current rate of growth in export is slightly lower than the growth rate in imports. This means that we can not count on a rapidly growing surplus in intangibles to offset the rest of our trade deficit.
The deficit in Advanced Technology Products narrowed in December to $3.2 billion, as exports grew while imports were basically unchanged. However, the total deficit grew from $36.9 billion in 2004 to $44.4 billion in 2005. 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.

Intangibles trade-Dec05.gif
Intangibles trade-2005.gif

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 evolving music industry

As recording technology has changed, the 45 record single was replaced by the LP album, which was replace by the CD. Which is now being replaced by — you guess it, the single. As the Washington Post reports, Downloads Make Singles a Hit Again:

As iPods and other MP3 players outsell CD players, sales of downloaded singles are booming accordingly: Though sales of full-length albums were down 7.2 percent last year, the digital singles market grew by 150 percent, with 352.7 million individual songs sold online, according to Nielsen SoundScan. It was by far the highest figure for singles sales in any format since 1973, the first year for which Recording Industry Association of America shipment data are available for singles. In late December 2005, weekly singles sales topped CD sales for the first time, as American consumers — many of them flush with holiday gift cards and loading new MP3 players — purchased 19.9 million digital tracks but just 16.8 million albums, according to Nielsen SoundScan.
And that’s to say nothing of the $600 million (and growing) ring tone business in the United States.

Ironically, not to long ago, as the story relates, the single was seen as a dinasour:

By 2002, so few individual hits were being released commercially that the National Association of Recording Merchandisers launched a “Save the Single” campaign. But it didn’t help — at least not that year: In 2002, singles accounted for less than 7 percent of music sales, with only 12.2 million singles sold, according to Nielsen SoundScan. Billboard reported that it was “believed to be the lowest number since the single was in its infancy in the early 1950s.”

Some are not happy with this revolution (in both the current and original sense of that word). The Post sotry quotes Charles Goldstuck, president of BMG North America,

“The challenge for the industry is to find some balance between singles sales and album sales. We want to create an artist experience, not a singles experience.”

Others agree:

Says artist manager Jim Guerinot, whose clients include pop singer Gwen Stefani and the rock bands Nine Inch Nails and Hot Hot Heat: “While somebody might view a scene from a play as being really well done, well performed and well written, most artists would prefer to have you watch the entire play. Musicians put their music out in a long-form format, complete with artwork, and their preference would be for you to experience their work that way.”

But there is an alternative way savor the artistic experience. It is called “the concert.” Maybe that is way people still go to hear live music performances. And why they will continue to be a big part of the business model in the music industry.

Budget and investment in creativity

There are a number of areas that are not included the OMB analysis of Federal investments (see earlier posting) which need to be addressed if we are to have a complete picture of our investments in intangible assets. One of those is funding for the arts and humanities (others include standard setting activities, organizational capacity building & technical assistance such as USDA extension service and the Manufacturing Extension Partnership, export promotion activities and government information creation, such as the statistical agencies, the weather service, etc.).
For arts and humanities, the funding picture is mixed. According to the Washington Post, Small Gains for Cultural Programs in Bush Budget Plan:

The small increases for cultural institutions and federal agencies presented yesterday in President Bush’s 2007 budget request to Congress will curtail any expansion in new programs.
The modest boost will most likely offset inflation but not give enough cushion to try new things. On the other hand, none of the agencies received sizable cuts.

In a tight budget, this is understandable. But, placed against the need face up to our new competitiveness challenges, the funding level takes on a different light. Americans for the Arts President and CEO Robert L. Lynch got it exactly right in his comments:

Rather than zeroing out the Department of Education’s arts education programs, President Bush should ask for an increase. His State of the Union address recognized that we need to prepare a 21st-century workforce by fostering talent and creativity. While his American Competitiveness Initiative would substantially increase investments in math and science education, we also believe that one of the best ways to nurture creativity is to have children learn and actively participate in the arts. Studies show that students who participate in the arts are not only more likely to participate in a math and science fair but also out-perform their peers on the SATs by 87 points.

As I have long argued, we need to expand our vision of competitiveness to embrace creativity and a broader view of innovation. That is the next wave of competition — and our policy makers still don’t see it coming.

Quick take on the budget

The President’s budget, released this morning, is an “on the one hand and on the other hand” affair. The President has vowed to cut discretionary spending and make the tax cuts permanent. But he also has proposed a new science and education initiative (American Competitiveness Initiative).
A broad view of these areas can be found in Chapter 6 of the Analytical Perspectives where OMB publishes special budget “crosscuts”, including an analysis of Federal investments. That category includes not only physical investments, but also the conduct of research and development and the conduct of education and training. Here is what budget has to say about these latter two categories:

Conduct of research and development. Outlays for the conduct of research and development are estimated to be $130.7 billion in 2007. These outlays are devoted to increasing basic scientific knowledge and promoting research and development. They increase the Nation’s security, improve the productivity of capital and labor for both public and private purposes, and enhance the quality of life. More than half of these outlays, an estimated $76.8 billion, are for national defense. Physical investment for research and development facilities and equipment is included in the physical investment category. Nondefense outlays for the conduct of research and development are estimated to be $53.9 billion in 2007. These are largely for the National Aeronautics and Space Administration, the National Science Foundation, the National Institutes of Health, and research for nuclear and non-nuclear energy programs. A more complete and detailed discussion of research and development funding appears in Chapter 5, “Research and Development,” in this volume.
Conduct of education and training. Outlays for the conduct of education and training are estimated to be $85.5 billion in 2007. These outlays add to the stock of human capital by developing a more skilled and productive labor force. Grants to State and local governments for this category are estimated to be $52.6 billion in 2007, more than three-fifths of the total. They include education programs for the disadvantaged and individuals with disabilities, other education programs, training programs in the Department of Labor, and Head Start. Direct Federal education and training outlays are estimated to be $32.9 billion in 2007. Programs in this category are primarily aid or higher education through student financial assistance, loan subsidies, the veterans GI bill, and health training rograms. The decline from 2006 to 2007 results in part from upward reestimates of $11.4 billion in 2006 in loan subsidies for loans made in earlier years.
This category does not include outlays for education and training of Federal civilian and military employees. Outlays for education and training that are for physical investment and for research and development are in the categories for physical investment and the conduct of research and development.

The numbers are as follows (in billions):
Conduct of research and development: $119.8 (FY 2005) – – – $127.4 (FY2006) – – – $130.7 (FY 2007)
National defense: $70.6 (FY 2005) – – – $75.6 (FY2006) – – – $76.8 (FY 2007)
Nondefense: $49.2 (FY 2005) – – – $51.8 (FY2006) – – – $53.9 (FY 2007)
Conduct of education and training: $94.7(FY 2005) – – – $104.2 (FY2006) – – – $85.5 (FY2007)
Grants to State and local governments: $51.6(FY 2005) – – – $53.7 (FY2006) – – – $52.6 (FY2007)
Direct Federal: $43.2(FY 2005) – – – $50.5 (FY2006) – – – $32.9 (FY2007)
So education and training is below the FY 2005 level while research and development is up.
But, like every thing else, the Devil is in details. In the Education Department’s budget, the following new programs get funded as part of the American Competitiveness Initiative:
Math Now for Elementary Schools Students: $125 million
Math Now for Secondary School Students: $125 million
Advanced Placement: $122 million (up from $32 million last year)
National Mathematics Panel: $10 million
Evaluation of Mathematics and Science Education Programs: $5 million
Adjunct Teacher Corps: $25 million
At the same time, the budget cuts almost $1.2 billion from vocational education and the overall department budget declines by $2 billion.
Likewise on the science and technology side, the National Science Foundation’s budget goes up by almost $500 million in budget authority (around a $100 million in actual outlays in FY 2007). But the budget calls for the elimination of the Advanced Technology Program and a 2/3 cut in funding for the Manufacturing Extension Partnership.
In sum, add little on this side and take a little from over here.
P.S. – just a cautionary note. This is the opening of the complicated budget dance. This can, and most likely will, change before we are through.