Financial competitiveness – part 3

James Surowiecki of the New Yorker takes exception to the prevailing wisdom that New York is losing its competitive advantage in issuing IPOs due to over-regulation:

To begin with, many of the world’s biggest I.P.O.s in recent years have been privatizations of state-owned companies in Europe and China, which for political reasons were never likely to happen in the U.S. Also, corporate executives prefer to take their companies public in bull markets, which improves their chances of getting a high price for their shares, and foreign markets have lately done better than the U.S. market. London and Hong Kong are also cheaper than New York: the commissions that investment banks charge to take companies public there can be about half what they are in the U.S. More broadly, globalization—a force that Wall Streeters applaud when it comes to textile plants and call centers—has increased competition. Many foreign exchanges, like Hong Kong’s, are now far more liquid and open, and they also have much tougher regulations (often modelled, ironically enough, on those of the U.S.) than they once did. All this has made investors more willing to invest in them. Their market share has naturally increased as a result, particularly since, even in a global economy, companies prefer to list their shares closer to home.
Once you control for these factors, it becomes hard to find anything other than anecdotal evidence that regulations are doing serious damage to New York’s ability to attract foreign I.P.O.s. More important, it’s far from clear that a decline in foreign I.P.O.s would be a sign of future disaster anyway. After all, what matters to the fundamental health of an economy is its ability to attract capital and investors, not foreign listings. And there is no evidence that America’s attractiveness to investors has diminished. Its share of global stock-market activity in 2005 was actually three points higher than it had been a decade earlier. In the same period, the market capitalizations of the New York exchanges rose almost twice as fast as the market cap of the London Stock Exchange. And, according to the New York report, if you look at the annual growth in equities—which is what Sarbanes-Oxley would presumably be a drag on—you find something unexpected: from 2001 to 2005, the U.S. market grew significantly faster than that of Europe or the U.K. Does that really look like an industry crippled by regulation?

I agree that New York City and the US government need to take a hard look at the competitiveness of our financial markets. But I also agree that we need to get at the root conditions, not perceptions and set answers. Answers will come, but we need to ask the right questions. And right now, it is not clear that the right questions have yet been asked.

A really intangible economy

For those of you who don’t yet know about “Second Life” – here is a wonderful primer from the Christian Science Monitor on the economy in virtual reality – A second income on Second Life.

And by the way, Sweden is seting up a Virtual Embassy in ‘Second Life’

Sweden will set up a virtual presence in the popular online world “Second Life” to spread information about the Scandinavian country and attract more young visitors, officials said Monday.
The government-sanctioned “embassy” will provide curious visitors with information about Swedish culture and history, as well as tips about places to visit and visa rules for tourists, Swedish Institute Director Olle Wastberg said.

Sounds a lot like that smart brand management strategy I mentioned yesterday.

Real time brand management

Over the course of the 20th Century, it became clear that brands and reputation had become so valuable that a new form of business “brand management” has evolved. Brand management has been around for some time — some claim that brand management starting in the 1930’s at P&G. But in more recent years, with the evolution of faster communications, brand management has move into real-time on-line mode, with managers tracking what people are saying about a brand almost the minute by minute. One of the pioneers of this approach is a Washington area company New Media Strategies. A recent story in the Washington Post (Tracking Who’s Saying What About Whom) describes the process:

Moira Curran starts her day at the office by skimming several dozen blogs, occasionally firing off instant messages to her co-workers with links to juicy bits of celebrity gossip.
Then she listens to podcasters chatting about the latest episodes of “Grey’s Anatomy” or “Lost.” In the afternoon, she keeps an eye on soap operas on the television set that hangs above her desk.
About 70 colleagues, scattered across two floors of an Arlington high-rise, spend eight hours a day doing much of the same. Some of them are also playing video games, watching movies and cruising around MySpace.
That’s exactly what the clients of New Media Strategies, an online marketing company, pay the employees to do. Companies ranging from movie studios and television networks to automakers and burger chains hire these professional Web surfers to scour the Internet for any mention of their brands. Over the past few years, the “online analysts” have helped the companies track their reputations, found ways to get their products noticed and joined online conversations to help steer them the way clients want them to go.
. . .
Many of the online analysts wear headphones all day and chat with bloggers via instant messages. Their job is to be the clients’ eyes and ears online, said Clay Dunn, 28, a brand manager who monitors what is said about video games and movies.
He watches for rumors and alerts his Hollywood clients if online coverage goes awry. Once, for example, backstage photos from a movie set surfaced and spoiled a sneak preview already in the works.<br
Curran, another brand manager who trolls the Web on behalf of television clients, corrects errors published in blogs. If rumors spread that someone's been fired from the cast of HBO's "Entourage," for example, she's there to set the record straight. If an angry viewer bashes a network for a violent scene in a prime-time show, she's there to post a rebuttal. She watches soap operas so she'll be able to chat knowledgably with the rest of the online audience.

This type of brand management grows out of viral marketing – essentially word-of-mouth amplified by advanced communications. This virtual social networking is one of the reasons for the explosive growth in the internet – from blogs to YouTube. Rumors and information no longer spread slowly – they travel around the world with the speed of an electron. Online brand management is one way for companies to keep up with that information flow.
Note that the process is not passive. These brand managers actively intervene in the conversations to set the record straight:

Curran said she is careful to acknowledge her connection to clients when it’s required. All online marketers have to walk a fine line when they work the blogosphere. Federal Trade Commission rules require them to identify their roles when they’re making a point on behalf of a client, but if they’re gossiping about the latest episode of “Desperate Housewives” they can legally be as anonymous as anyone else.

This raises some interesting issues that have surfaced in other venues: how do you judge the information you are getting? Is it one person’s personal opinion? Is it planted by the company? By the company’s rivals? Is it a paid “statement” or a heartfelt plea? All of these issues have been around for a long time (one might say since humans first learned to communicate). But in the I-Cubed Economy as information flows so much faster, they become even more heightened.
I don’t know the answer as to how to deal with this — efforts at transparency can only go so far. Education and the development of critical thinking is probably our best defense against manipulated information. They used to say, don’t believe everything you read in the newspapers. Now, it is don’t believe everything you read on the Web.
Ah yes, the more things change . . .

Financial competitiveness – part 2

As New York City and the Congress look at the competitiveness of US financial services and regulatory “reform” (see earlier posting), I hope they include all voices — including the customers of those services. One of the major customers is the investor community. And the investor community is not so gung-ho to “reform” the system, especially when it comes to Sarbanes-Oxley, as Business Week reports in Not Everyone Hates SarbOx:

Not so fast, says a growing chorus of investors. Lost amid all the boos over SarbOx, they say, are some major benefits. The biggest: SarbOx and related reforms have produced much more reliable corporate financial statements, which investors rely on when deciding whether to buy or sell shares. For them, SarbOx has been a godsend.
What’s more, says Duncan W. Richardson, chief equity investment officer at Eaton Vance (EV ) Management and overseer of $80 billion in stockholdings, even the act’s much disparaged requirements for testing internal financial controls could drive gains in corporate productivity and profits. Says Donald J. Peters, a portfolio manager at T. Rowe Price Group (TROW ): “The accounting reforms have been a win.”
Earnings will be on investors’ minds over the next several weeks as most corporations announce yearend results. The numbers will include results tallied under generally accepted accounting principles and, thanks to a Securities & Exchange Commission regulation adopted during the reform years, they’ll also come with reconciliations to any nonstandard or “pro forma” numbers that companies use to try to spin their results. The reconciliations, says Peters, are “extraordinarily” helpful. “It is [now] much easier for me to have a view of the true economics” of a company, he says.
Beefed-up disclosure requirements have also meant that companies now deliver numbers with fewer adjustments for unusual charges and write-offs, which in the past have been used to make earnings look better. Thomson Financial’s (TOC ) Earnings Purity Index, which tracks earnings adjusted for such write-offs, shows improvements in each of the past four years. And now earnings reports reflect expenses for incentive stock options, information investors like that wasn’t available before the big accounting scandals.
Just as important, executives appear to have a firmer grasp of costs when they talk about operating margins, according to Richardson of Eaton Vance. He credits the improvement to the infamous Section 404 of SarbOx, which requires documented testing of internal controls. “Even not-so-good management teams have good controls now, and that leads to an ability to cut costs,” he says.

One of the strengths of the US capital markets is the people from all over the world are still willing to sent their money here. They generally trust the system. Weakening that trust is not a way to strengthen the system.
Likewise, as I have stated earlier, it is not clear that regulatory tightening is the sole or major cause of the problem. As the Wall Street Journal reports – In Call to Deregulate Business, a Global Twist – WSJ.com, the standard answer so far has been blame the regulations:

Yet this position, which has gone largely unchallenged, downplays a different explanation for why U.S. exchanges are under pressure — the changing nature of global finance. Stock markets around the world have become better and deeper, encouraging companies to seek IPOs in their home market. Trading across borders has become simpler, cutting the prestige and usefulness of a big-country listing everywhere. And private-equity buyouts are a global phenomenon, not a uniquely American one.
Meanwhile, other countries are stiffening their own rules, bringing them closer to the U.S. model.
. . .
There’s little doubt U.S. exchanges are facing increasing competition. They’re losing out to overseas exchanges for initial public offerings. Many overseas companies are deciding they don’t need an American listing. And in the U.S. itself, many companies have decided they’re better off private.
Taken alone, the cost of regulation can’t explain what’s happening to U.S. financial markets, and paring regulations might not alter the outcome, except to give a helping hand to Wall Street.

Jenny Anderson, the New York Times “Insider” columnist, notes About Those Fears of Wall Street’s Decline … :

Some of these claims make sense. Others do not. For starters, there is a fixation on data showing that initial public offerings are gravitating to London and China. This data seemed problematic: smaller companies are listing in London because there is a market there that boasts of having virtually no regulation, a benchmark the United States should not lower itself to meet.
And larger companies, especially Russian and Chinese ones, are increasingly staying home or going to London to raise capital, which can be attributed to factors like London’s being in a better time zone.
More important, the main reason companies are listing in their home markets is that globalization is not a lofty theory but has truly produced more competitive global markets. That means more companies will choose not to trek halfway around the world to raise money — especially when fees in London are half that of the United States.

By the way, Brad Selzer inadvertently underscores the changing situation of the US financial services sector when he states (in RGE – Yet more evidence that emerging markets cannot create the financial assets their citizens want to hold …):

Indeed one of the big (underreported) stories of the past few years is how savers in emerging markets are increasingly willing to hold their savings in the local banking system in local currencies despite low nominal interest rates (China) or low nominal and negative real interest rates (Russia). It has been better to get low returns in the local bank than to hold (depreciating) dollars.
Foreign investors — private investors that is — have also been quite keen to put funds into emerging market financial assets.
That is the basic problem I have with all theories that attribute the uphill flow of capital to financial underdevelopment. Right now, emerging markets don’t seem to be having any trouble generating financial assets that their citizens want to hold, or that foreign investors find attractive.

If foreigners are don’t need/want to buy what we have to sell, the financial markets are going to lose vis-a-via other markets. That is the essence of competitiveness.
The question of improving US competitiveness in financial services is an important — and ongoing — question. One of my earliest research projects was an Office of Technology Assessment study in the 1980’s on International Competition in Services – which included banking and financial services (although I didn’t work on that part of the study). That report found a combination of regulation, technology and the maturation of foreign markets to be the major drivers behind slipping US competitiveness in financial services. And the policy options included increased international regulatory cooperation.
The OTA study provided a broad look at the issue. We need to continue to take a broad look as we approach the issue. Otherwise, we will have piecemeal changes that may simply make the problem worse.

Prizes for R&D – part 2

Speaking of prizes for R&D (see yesterday’s posting), I just got pre-announcement of a new National Academies study on Innovation Inducement Prizes at the National Science Foundation. The report concludes that prizes have an important role to play in our innovation system and recommends that NSF establish a a pilot program of “several small-scale prizes ($200,000 to $2 million each) in diverse areas that differ regarding prize scope and scale, contest duration, engagement of outside groups, and other features.” In other words, an experiment. Sounds good to me.

Manufacturing legislation

While the competitiveness agenda is far from front and center in Washington these days, that does not mean it has disappeared completely. At the beginning of this new Congress, Rep. Vernon Ehlers (the former Republican Chair of the House technology subcommittee) introduced the HR 255 ‘‘Manufacturing Technology Competitiveness Act of 2007” — which was identical to the Manufacturing Technology Competitiveness Act of 2005 that passed the House (but not the Senate) in the last Congress.
One of the elements (that was striped from the bipartisan Senate competitiveness bill introduced in the waning days of the 109th Congress) was a grant programs to the Hollings Manufacturing Extension Partnership (MEP) Centers “to develop projects to solve new or emerging manufacturing problems”. Specifically, the grants are for “projects associated with manufacturing extension activities, including supply chain integration and quality management, or extend beyond these traditional areas.”
Those are the magic words: “beyond these traditional areas.” That phrase would allow the MEP Centers to get into the business of helping companies with innovation — not just manufacturing processes.
I have long argued that “design” is the new “quality”. And that manufacturing and services are fusing. Small companies that are solely manufacturing are going to be less and less able to compete (and create jobs) in an economy of increased automation and globalization. To survive, these companies need an array of technical services and advice in areas such as design, marketing, and servicing.
They know it and MEP knows it. In fact, the MEP Next Generation Strategy states:

With success in the marketplace dependent upon product differentiation, service innovation, and speed to market, MEP is prepared to position manufacturers to compete in this global economy through services that are grounded in business strategy development, advanced marketing techniques, new product development, the integration of supply chains, and increasing the technical and problem solving skills of the workforce.

The grant program in the Ehlers bill is an important tool in implementing the MEP strategy. I know the Democrats will want to craft a new version of the legislation. Let’s hope they keep this provision — and even expand upon it. That would go a long way to helping 21st Century manufacturing thrive in the American I-Cubed Economy.

The shifting sands of economics

Telling dispatches from Davos:
America no longer owns globalization – International Herald Tribune:

This year’s theme at the World Economic Forum annual meeting here — “the shifting power equation” — confirms the view of many participants that power is draining away from the United States to multiple centers as countries from Brazil to China move beyond “emerging” market status to establish themselves as major players on the world scene.
The conference theme also acknowledges the panic in traditional business circles as power shifts from the producer to the consumer thanks to the Internet and the digital distribution revolution.
Far from some kind of conspiracy of the global elite plotting the future as they whisk down the Alpine slopes, Davos is in fact a back-end barometer of their evolving worldview. It does not break new ground but consolidates opinion. It does not generate new trends but codifies them into conventional wisdom. That is its power and its importance.

Just How Good Is Globalization? – WSJ.com:

A new refrain is emerging in Davos this year: Globalization isn’t working for everyone. Stagnating wages and rising job insecurity in developed countries are creating popular disenchantment with the free movement of goods, capital and people across borders. If unchecked, popular fears could turn into a political backlash that could lead to protectionism — or at least make broad free-trade agreements harder to achieve in the future.

You might want to also check out Bruce Nussbaum’s blog, which has a running commentary on Davos. This Includes a summary of the Twelve Power Shifts That Are Changing The World – based on the first day’s sessions.