Riding the Rising Tide

Earlier this week, ASTRA (the Alliance for Science & Technology Research in America) released its report – Riding the Rising Tide: A 21st Century Strategy for U.S. Competitiveness and Prosperity. The report is really a call for the various Presidential campaigns to take the issue of competitiveness seriously. It echoes and builds upon the now familiar concern about the lack of an innovation strategy in the US. The ASTRA report offers a 14 point plan:

The Congress and the Administration should fulfill the physical sciences and engineering R&D commitments made in the American Competitiveness Initiative (ACI). However, to ensure that funding expands beyond increases in inflation, the timetable for these investments should be accelerated. In addition, investment should be increased beyond the ACI recipient agencies.
The Federal government should increase and stabilize funding for applied research and advancing promising, high-risk technologies with substantial economic potential to bring them to a stage of maturity that is attractive for private sector investment. This includes funding for the new Technology Innovation Program (TIP) and other programs that meet this objective.
In addition, the approach to SBIR funding should be reviewed to determine how this program could maximize its ability to contribute to the U.S. innovation base.
A large share of Federal R&D investment should focus on the leading edge of science and technology, especially in fields expected to have revolutionary impacts, such as nanotechnology, biotechnology, and high-performance computing.
The Federal government should increase R&D to support the U.S. service economy, including support for services innovation, productivity, efficiency, competitiveness, and technical workforce development.
While investigator-driven research remains the cornerstone of Federally-supported academic R&D, the Federal government should increase attention to emerging opportunities for interdisciplinary and multidisciplinary research, including a focus on centers of research excellence where rapid development of innovations requires this type of collaboration. This includes reaching out to academic institutions in geographic regions in which the potential for innovative capacity exists—such as high quality research and researchers—but needs further nurturing.
To ensure that the US. reaps the benefits of Federal R&D investments, the Federal government should examine what incentives can be put in place to enable adequate returns from public R&D to be captured domestically For example, the U.S. should consider devoting a small part of the Federal research portfolio to investments in applied research,
technology prototyping, demonstration, testing, pilot-scale production and other precompetitive activities to increase the likelihood of eventual commercialization on our shores.
The U.S. needs to examine whether prevailing skill levels are adequate for an innovation based economy, and for our success in the growing global “trade in tasks” in which routine knowledge work is easy to ship offshore.
The U.S. should provide better and more detailed information on the nation’s need for scientists, engineers and information technology workers. The National Science Foundation should: encourage employers to better articulate their current and prospective STEM workforce needs, and the types of skills and disciplines needed; ensure students and workers understand what these specific skills and disciplines are; as well as encourage a significant shortening of the feedback loop between employers and their needs, and the responses by education and training institutions. This includes providing career information and nurturing to groups underrepresented in STEM—such as minorities and women—to increase their knowledge of opportunities in STEM education and careers.
The Federal government should encourage university educators to broaden the skill sets of U.S. scientists, engineers and information technology workers. University educators should ensure that scientists, engineers and IT professionals have: global and cultural awareness;
knowledge that helps them understand business, markets, marketing and customers; the ability to work as a member of and communicate effectively in teams of diverse disciplines; some understanding of business finance such as cost-benefit and return on investment concerns; as well as project management abilities.
The U.S. should strengthen efforts to attract top foreign students and PH.D.-level professionals in science, engineering and technology. This includes developing a national strategic plan for recruiting top international students, scientists, engineers and technologists, and evaluating the U.S. immigration system to remove barriers to these talented individuals migrating to the U.S.
The next President should launch a White House level initiative to perform a comprehensive review of U.S. laws and regulations relating to the business climate for innovation. This would include regulations promoting human health and safety, standards for environmental protection, as well as tax, trade and antitrust policies, to determine whether changes are needed to meet the nation’s public policy goals while, at the same time, promoting innovation and competitiveness.
The Federal government should lead efforts to determine where the priorities are, and to begin the process of developing some high level indicators around the key drivers of innovation that are known and recognized.
The U.S. must create—and provide meaningful financial resources to—institutions within the Federal government capable of performing high quality analysis of U.S. and foreign innovation systems, and formulating a Federal innovation policy and investment agenda commensurate with the new economic realities and 21st century competitiveness challenges.

What I especially like about these points is that they incorporate but go beyond the current calls for more R&D funding and more attention to STEM (science, technology, engineering and mathematics) education. For example, the report discusses the range of innovation relevant skills needed in the US economy and highlights the need for STEM workers to have a broad skills set.
The last three recommendations are of particular interest to me. The report calls for greater efforts to understand the innovation ecosystem. We need to understand that the nature of innovations has changed in the I-Cubed Economy. It is no longer a linear process that begins with men in white coats in labs. Innovation is a complex set of interactions — truly an ecosystem. By calling for better measures, increased analytical capabilities and new ways of thinking about innovation, the report sets a direction for innovation policy.
Now if the policymakers will only follow ASTRA’s lead.

The Fed and intangibles

On his New York Times Blog, Floyd Norris explains what the Fed did yesterday when it announced a new “term auction facility”:

The Fed will lend money to banks based on almost any asset they own, even ones that are not liquid at all. That will include some of the more exotic loans and securities out there.
Investors, it appears, love it. The stock market opened sharply higher, reducing the losses that came yesterday after the Fed cut interest rates, but not by enough to satisfy Wall Street. This move is taken as evidence that central banks are determined to rescue the system, whatever it takes.
How much will the Fed lend against illiquid assets? It has a public list, already in use in discount window lending. You will note that it allows the lending of up to 85 percent of the face value of AAA-rated collateralized mortgage obligations, if there is no observable market value. There are some C.M.O.’s out there that have not yet been downgraded but that might not bring that much in a sale.
I’d love to see which assets are pledged, and how much the Fed lends against them. But the Fed won’t disclose those facts. Nor will it let us know which banks borrow using the new facility.

Intangible are not included on the current list of assets, however. The Fed will lend against Commercial and Agricultural Loans, Commercial Real Estate Loans, Construction Real Estate Loans, Family Residential Mortgages, Home Equity Loans, Consumer Loans- Autos, Private Banking, Installment, Etc., Consumer Loans- Credit Card Receivables, Student Loans, SubPrime Credit Card Receivables and Asset-Back Securities. It will be interesting to see if anyone asks them to lend against an intangible-backed loan.

October trade in intangibles

In a reversal of the trend for the past few months, this morning’s BEA trade data shows an increase in the deficit by $0.7 billion to $57.82 billion in October. The deficit for September was also revised upwards, meaning the deficit actually increased in that month rather than decreased as previously reported. Much of the increased deficit was due to oil. As the Wall Street Journal reports:

The U.S. bill for crude oil imports was $22.92 billion, up from $20.38 billion in September. The average price per barrel increased $3.98 to a record $72.49 from $68.51. Crude import volumes rose to 316.18 million barrels from 297.50 million.

The New York Times points out that imports from China also played a major role:

The deficit with China jumped 9.1 percent to $25.9 billion, a record for a single month.
The rise reflected record imports from China, led by large gains in shipments of toys and games and televisions as retailers stocked their shelves for Christmas. The demand for Chinese imports is still surging despite a string of high-profile recalls of Chinese products from toys with lead paint to defective tires and tainted toothpaste.

The good news is that our intangible trade balance improved by $90 million in October to a surplus of $10.21 billion. The increase was due to royalty receipts and exports of business services growing faster than royalty payments and imports of business services.
The other story on our intangibles trade is the revisions of the data for the past six months. The revised data does not change the overall trend. But it does show constantly higher figures for business service imports and exports and for royalty receipts (exports). Curiously, royalty payments (imports) were consistently lowered in the revisions. In other words, the earlier data appears to systematically underestimate trade in business services and royalty receipts while overestimating royalty payments. This highlights the continued difficulties of measuring trade in the I-Cubed Economy.
The deficit in Advanced Technology Products increased dramatically in October by $1.5 billion, reaching a record monthly deficit of $6.667 billion. This came in spite of a $1.4 billion improvement in aerospace trade as exports surged by almost $1.9 billion. That improvement was overshadowed by increased imports of information and communications technology (ICT), life sciences and opto-electronics. Imports of ICT alone increased by $1.6 billion. 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-Oct07.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 Fed cuts interest rates and the Dow drops almost 300 points. I guess Wall Street really is fueled by that most intangible of intangibles – expectations. To quote Keynes:

Even apart from the instability due to speculation, there is the instability due to the characteristic of human nature that a large proportion of our positive activities depend on spontaneous optimism rather than mathematical expectations, whether moral or hedonistic or economic. Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as the result of animal spirits – a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities. (The General Theory of Employment Interest and Money, pp. 161-162).

Global Innovation 1000

The latest Booz Allen Hamilton innovation report is out — The Customer Connection: The Global ­­­Innovation 1000 — and the results sound familiar:

In 2006, as in the two previous years of our annual study of the Booz Allen Hamilton Global Innovation 1000 — the 1,000 publicly held companies around the world that spent the most on research and development — overall corporate revenues among these companies increased 10 percent. Once again, their overall spending on research and development also rose, to US$447 billion this year. And as in years past, we found no statistically significant connection between the amount of money a company spent on innovation and its financial performance.

In other words, just throwing money at innovation doesn’t work. But the B-A-H report talks about what does work: listening to your customers:

We also compiled a list of high-leverage innovators, as we did last year. These were the companies that, compared to other companies in 2006, got a significantly bigger performance bang for their R&D buck. The high-leverage innovators consistently achieve better sustained financial performance than their industry peers while spending less on R&D. We’ve spoken to executives at a number of these companies, including Black & Decker. When listing the reasons for their success, they all mention two key factors. The first is strategic alignment: They work hard to align their innovation strategies closely to overall corporate strategy. The second is customer focus: They all have processes in place to pay close attention to their customers in every phase of the innovation value chain, from idea generation to product development to marketing.

The study breaks these innovation strategies into three types:

Need Seekers: These companies actively engage current and potential customers to shape new products, services, and processes; they strive to be first to market with those products.
Market Readers: These companies watch their markets carefully, but they maintain a more cautious approach, focusing largely on creating value through incremen­­tal change.
Technology Drivers: These companies follow the direction suggested by their technological capabilities, leveraging their investment in research and development to drive breakthrough innovation and incremental change, often seeking to solve the unarticulated needs of their customers.

The report goes on to describe each of these three strategies and give an example of a company in each category. Unfortunately, the report does not give the breakdown by strategy of all 110 companies listed as “high leverage innovators.” It would be interesting to see which companies are following which strategy – and if they clustered by industry.
In any event, the report is yet another piece of evidence of what some of us have been saying for some time: innovation isn’t just about technology and it isn’t just about R&D spending. The companies get that. Maybe some day the policymakers will as well.

Tranches and tranches – and safety of intangibles

In an earlier posting on the subprime mess, I noted in passing that part of the problem was the tranche system of dividing loans up into groups by risk. This tranche system was supposed to isolate risk, but seems to have failed miserably — which I never completely understood. Last week, Steven Pearlstein enlightened me (and everyone else) in his column It’s Not 1929, but It’s the Biggest Mess Since:

In the simple version, each investor owned a small percentage of the entire package and got the same yield as all the other investors. Then someone figured out that you could do a bigger business by selling them off in tranches corresponding to different levels of credit risk. Under this arrangement, if any of the mortgages in the pool defaulted, the riskiest tranche would absorb all the losses until its entire investment was wiped out, followed by the next riskiest and the next.
With these tranches, mortgage debt could be divided among classes of investors. The riskiest tranches — those with the lowest credit ratings — were sold to hedge funds and junk bond funds whose investors wanted the higher yields that went with the higher risk. The safest ones, offering lower yields and Treasury-like AAA ratings, were snapped up by risk-averse pension funds and money market funds. The least sought-after tranches were those in the middle, the “mezzanine” tranches, which offered middling yields for supposedly moderate risks.
Stick with me now, because this is where it gets interesting. For it is at this point that the banks got the bright idea of buying up a bunch of mezzanine tranches from various pools. Then, using fancy computer models, they convinced themselves and the rating agencies that by repeating the same “tranching” process, they could use these mezzanine-rated assets to create a new set of securities — some of them junk, some mezzanine, but the bulk of them with the AAA ratings more investors desired.

The problem being that these new second level tranches really weren’t AAA quality. They might be the top tier of the second tier – but they were still second tier. Pearlstein argues that this tranches of tranches created so much leverage that could not be sustained:

If all this sounds like a financial house of cards, that’s because it is. And it is about to come crashing down, with serious consequences not only for banks and investors but for the economy as a whole.

Tranches of tranches were just on part of the leveraging. As I mentioned earlier, the banks were using these CDO’s (collateralized debt instruments obligations) for interest rate arbitrage in offbook SIVs (Special Investment Vehicles). So what was originally designed as a relatively safe investment product (bonds backed by a steady stream of revenues placed in a separate entity to protect against bankruptcy or other financial problems of the parent entity) became a leveraged speculation play.
So, how does the market recover from what is quickly becoming, as the Wall Street Journal puts it, “comparable to some of the biggest financial disasters of the past half-century”? Both parts of the problem — the housing bubble that caused the value of underlying assets to decline and the overleverage — need to be addressed. Right now, most eyes seem to be on the housing part of the crisis. A few are looking at the financing part, specifically the role of the rating agencies. But sooner or later the leveraging issues will attract more attention.
When that happens it will be important to get the regulations right – not just shut down the system. That will also be the time to see if we can improve the process for financing using intangible assets. It will not be everyone’s nature reaction (which will be to reign in “exotic” loans). As the Journal article points out, these instruments so complicated that “coming up with a value for a CDO entails analyzing more than 100 separate securities, each of which contains several thousand individual loans — a feat that, if done on any scale, can require millions of dollars in computing power alone.” Even the traditional vulture investors are staying away.
We can make the case for intangible lending, but it will not be easy. In part, we will have to build in safeguards up front and return to simplified mechanisms. That will be moving in the opposite direction of the trend in financial engineering. But the current market is likely to reward those who can create a simple, transparent investment vehicle. People still want to invest. They just need to feel safe in doing so. So, making investments in intangible safe has to be our goal right now. It is as straightforward as that.

More credit worries

Oh boy, this doesn’t look good — Surge in Auto-Loan Delinquencies Is Latest Trouble for the Economy – WSJ.com. Why is this bad? As the story explains:

Car loans differ from home loans in one crucial way. During 2004-06, many home loans were made to speculators on the assumption that the underlying asset — the home — was sure to keep rising in value. Many people, inspired by fervor in the market, took out home loans that in retrospect they had little hope of paying back.
By contrast, everyone understands that the car behind a car loan is an asset destined to lose value. The typical delinquent borrower in a car loan isn’t a speculator but someone who became unable to make what previously seemed like a manageable payment. That is why car delinquencies are closely linked to the health of the economy.

Not good. Not good at all.

Fixing the subprime mess

It looks like Treasury Secretary Paulson has beat back the laissez faire skeptics (the inheritors of Hoover’s Treasury Sec Andrew Mellon whose response to the Great Depression was to let the economy “purge them all”) and has won Presidential support for his plan to help subprime mortgage borrowers (see Bush to Unveil Aid to Homeowners – WSJ.com, Lenders Agree to Freeze Rates on Some Loans – New York Times, Bush mortgage plan would freeze rates – Los Angeles Times, Bush Wins Agreement To Freeze Mortgages – washingtonpost.com).
Great, you say. But what has this got to do with intangibles? Simply this: if we can’t get a handle on the home mortgage lending problem (one of the most tangible of tangible assets), how are we ever going to expand lending on intangibles? The problem is systemic to the financial system right now. As WSJ columnist David Wessel points out:

For years, banks and investors lent freely. They took big risks for surprisingly little reward (known as “low risk premiums” in the patois of the trade). Now, they’re shunning risk. Big banks are reluctant to lend even to each other for more than a few days, and are hoarding cash.
. . .
Leverage is defined as the factor by which a lever multiplies a force. In economics and finance, leverage allows the bold to borrow to make bets that can pay off handsomely when times are good. But leverage magnifies losses when things go bad. So borrowing binges are followed by periods of deleveraging in which lenders and investors borrow less and take fewer risks. Economists dub the recent decades in which recessions were scarce and inflation calm the Great Moderation. That seems to be giving way to the Grand Deleveraging.
At best, the economy has a hangover, and will feel better in a couple of months. But this may be more like a case of mono, an ailment in which the patient doesn’t return to normal vigor for a lot longer.

Until we get through the Great Deleveraging, advances in monetization of intangibles may be on hold. But we may be in a position to put in place the infrastructure and the public policies needed for the next expansion — learning from the problems of today.
It is often said that it is too late to fix the roof when it is raining. But the rain shows you where the hidden leaks are. You just need to be prepared to get out the ladder as soon as the rain stops.

Economic anxiety

Bob Reich has a simple answer to the question of why rising economic anxiety — It’s the Economy, Stupid — But Not Just the Slowdown:

The real reason is middle-class families have exhausted the coping mechanisms they’ve used for over three decades to get by on median wages that are barely higher than they were in 1970, adjusted for inflation.

The first was the two-earner household as more women moved into the labor market. The second was working longer hours. The third was the ATM machine known as rising home equity. Having gone through these three ways of maintaining family income that masked the effects of stagnate wages, the real economic question is what to do next. How to we get wages back on the growth track that created the great American middle-class? And how do we do it in the face of the new circumstances of the global I-Cubed Economy?
Unfortunately, the answers to those questions are few and far between. Pabulum, nostrums, nostalgia and rhetoric is in great supply. But real answers are rare.

New IP proposals in WTO

From Intellectual Property Watch comes this update – Members Seek To Raise TRIPs Amendments In WTO Negotiations:

World Trade Organization members seeking changes to international rules on trade and intellectual property rights moved this week to include the debate on their proposals in an upcoming deadline for the broader trade negotiations at the WTO. But opponents continued to resist moving the issues to negotiation.
At issue is a proposal to raise the level of trade protection for geographical indications (distinctive products named for places) on a variety of products to the level already enjoyed by wines and spirits, and a separate proposal to require the disclosure of the origin of biological resources and traditional knowledge in patent applications.

It continues to be unclear whether the Doha Round of trade negotiations will ever be concluded. The IP issues are not the major hold ups. By themselves, it doesn’t look like these proposals are necessarily going to go anywhere. But the dynamics of these negotiations are such that the IP proposals could become trading chips for other issues. And, as the IP Watch story points out, they are being raised in the context of an overarching “single undertaking” negotiation. So, while not yet becoming the tail that wags the dog, IP issues are still in play in the negotiations.