Lesson from Japan

Apropos my earlier posting on part-time work, the Journal is also running a story about the economic effects of using temporary workers – Growing Reliance on Temps Holds Back Japan’s Rebound. One reason Japan’s rebound hasn’t gotten traction: companies’ growing reliance on temporary workers. Part-time and temporary workers are paid less and spend less – thereby dampening domestic demand. And because they are not covered under existing labor force agreements, they also do not automatically benefit from an up turn in the company’s fortunes.

Yet the heavy use of temps also has created an obstacle to the virtuous cycle typically seen in an expanding economy: When companies make better profits they eventually raise wages, which boosts consumer spending — and leads to more corporate profits.

Temps and part time workers don’t necessarily get those wage increases. Thus, consumer spending does not pick up and profits don’t go up.
Something to keep in mind as we see the US going to more of a part-time and free-lance economy.

Innovation in China

Forbes is running a new column about China – from the boots-on-the-ground view of Intel’s deputy general manager for China — China’s Invent-It-Here Syndrome. The statements should be eye-opening:

The Chinese government’s goals are sweeping: to develop, influence or downright own the core intellectual property of the next generation of technologies that will power the global economy. To do this, the government has committed to doubling its spending on research and development so that it reaches 2.5% of China’s gross domestic product by 2010, approaching $100 billion annually. China is also on track to have more research scientists and engineers than any other country by 2015.

But it is not just about increasing R&D (something we failed to do in the last federal budget). It is about creating a mercantilist technology policy.

In the past 18 months, China has officially embarked on a multi-year, multi-faceted plan to transform “made in China” into “invented in China.”
You can read about state economic plans on the Internet, and they sound dry and flat. In China, however, these plans are alive. They imbue every conversation with Chinese technology companies and with Chinese government ministers with urgency. They get written into contracts. (emphasis added)
Here’s how China’s long-term economic plan came alive for me: This past summer, I moved to China for Intel to co-run our sales and marketing operations there. A few weeks into the job, I realized that doing business in China involved much more than winning sales in the world’s only very large and very fast-growing PC market.
For instance, international standards are the glue of the PC and communications industry, ensuring that machines can communicate and work together, no matter where they’re made. Big corporations devote significant time and people power to making sure their ideas are represented on the standards bodies that write these rules.
But in every introductory “ops” review I did in China, all our managers talked about how the “local standards” were a key to Intel’s success in every market. By insisting (as any country can) that products sold in China must adhere to local as well as international standards, China makes sure that Chinese inventions get built into high-tech products sold here. That means there is a Chinese voice in which products succeed or fail in China. And products that succeed in China have a much higher chance of succeeding globally.

OK — and so what is our response? So far, and officially, nothing.
But that does not mean we can’t or shouldn’t do anything. For some of the actions we could take, see Julie Hedlund and Rob Atkinson’s paper The Rise of the New Mercantilists: Unfair Trade Practices in the Innovation Economy. There are many more reactive and proactive steps we can be taking.
Most importantly, we need to understand that other countries are playing a different game. They believe in an active policy to promote economic growth in this new I-Cubed Economy. We may disagree with what they are doing. We may think we have a better way. But until we get into the game with a strategy of our own, we will be left on the sidelines.
And the sidelines is not the place where we want us or the next generation to be.

Coping with the recession – and needing new policies

An interesting new phenomenon is going on in the labor force. In the late Industrial Era, economic downturns were met with the labor market mechanism of layoffs. Workers were not fired (permanently separated) but laid off with the expectation of being called back when the upturn started. This was cyclical unemployment. A number of social institutions grew up to accommodate this process, including unemployment insurance (UI) and union-based unemployment funds. While these policies were developed to cope with firings not temporary layoffs, they operated as a de-facto industrial policy for the large mass production companies that guaranteed the workforce would still be available for recall.
That has changed. The cyclical recessions of the 1950’s, 60’s and 70’s have given way to structural recessions. The 1981-2 recession was the last time that there were wholesale layoffs with the expectation of calling the workers back. In the 1990 recession, outright firings replaced layoffs as companies used the recession to restructure. Rather than sticking around on unemployment, workers take new jobs (or at least look for them) as they believe they will not be re-hired. In essence, the forces of creative destruction were unleashed to move resources from one industry to another, rather than simply move those labor resources into a reserve pool for existing industry.
This shift is one of the reasons for increased economic insecurity and anxiety — as workers found their hard earned skills and tacit knowledge no longer valuable as they switch from industry to industry.
Now a new technique may be emerging in the current “situation.” The Wall Street Journal reports that more companies are cutting hours rather than letting workers go:

In another sign of a weakening job market, employers are cutting hours for more workers to below the 35-hour-per-week threshold for full-time work because of slowing demand, or “slack work,” according to government data.
. . .
Reducing hours is enabling many companies hurt by slowdowns in housing and autos, in particular, to stave off layoffs and retain skilled workers, but the cuts are squeezing earnings for many workers and putting some workers’ benefits at risk.

This new mechanism highlights one positive aspect. Employers recognized the value of workers and are trying to find ways to keep them. On the downside, it may retain skilled workers in the short run but could dramatically increase the economic pressure on these workers — pressure some believe is already large and growing (due to the housing problem).
It also highlights the crying need for new government policies. As I mentioned earlier, UI and union-funds helped ease the difficulties of layoffs associated with cyclical unemployment. For structural unemployment, there are programs on the books — retaining etc. But those programs are structurally inadequate and flawed as well as grossly under funded.
For this new involuntary part time economy, we don’t have a clue. What is the appropriate economic policy to help the “slack” worker? Do we help the worker directly or would an expansion of the Earn Income Tax Credit help cope with the loss of income effect of slack work? Do we treat this as a labor market issue? Or do we treat it as an issue of the working poor? Or more accurately, as an issue of the loss of income of the working middle class on in danger of becoming poor? And how do we figure in the issue of the free-lance economy and the voluntary part-time workforce?
Welcome to a new I-Cubed Economy.

History of a financial scandal – the Match King

As we try to sort through the (ongoing?) financial meltdown, a little bit of history is always helpful. In that vein, the Economist has a review of a new book on an earlier financial crisis — Fraud and financial innovation: The match king:

A forthcoming book “The Match King” by Frank Partnoy, professor of law at the University of San Diego, will argue that the line of many of today’s most dazzling financial innovations can be traced directly back to Kreuger. So can America’s landmark Depression-era securities and accounting laws, which still shape the world of finance. So, too, can some of the most famous instances where those laws have been breached, such as the case of Enron, the collapsed American energy company.
Long before modern financiers created a market in asset-backed securities (the source of this year’s turmoil) Kreuger was a master of the art. Effectively, the securities he sold to investors provided loans for governments secured against assets that he himself controlled. The assets were held offshore, which today’s tax planners would welcome, and mostly off-balance sheet, the custom at Enron and many of the banks that have suffered this year.

The Economist explains how this was done, and why it fell apart:

After secretly acquiring factories around Europe during the years of post-war Depression in the early 1920s, from 1925 onwards Kreuger began offering a bargain to penniless governments that many found hard to refuse. Kreuger would, he said (usually with great secrecy), lend money to countries that provided him with a national monopoly on match production. His monopoly and skilled marketing would increase sales (Kreuger was a first-rate salesman, too: he is said to have propagated the myth that it is unlucky to light three cigarettes from the same match). Governments taxed matches, so the higher sales would raise tax revenues used to repay the loans. It was, boasted Kreuger, an almost foolproof business plan: the loans were secured against revenues that he controlled; the monopolies, meanwhile, ensured generous returns.
. . .
But despite the apparently flawless business model, match monopolies, it turned out, were not all that profitable. In order to offer spectacular returns, Kreuger paid dividends out of capital, not earnings. He was, in effect, operating a giant pyramid scheme, reliant on confidence to maintain a steady inflow of cash.

Key to pulling this off was a lack of transparency (or, as economists label it, asymmetric information):

Like other free-wheeling entrepreneurs, Kreuger did not disguise his contempt for accounting norms. In a rare interview in 1929, he told Isaac Marcosson of New York’s influential Saturday Evening Post that the key to his success was “silence, more silence, and even more silence”. (In a sycophantic letter to him found in Vadstena, Marcosson writes, “I regard it as a great privilege to be your Boswell.”) Secrecy, and his extensive network of paid informers around Europe, served him well; not only did it keep investors in the dark, but also enabled him to do deals with rival governments, such as republican France and fascist Italy, who loathed each other.

The point here should be clear – the more information out to the marketplace, the better. As I noted in our earlier paper, Reporting Intangibles, better disclosure is needed, especially of intangibles. History continues to teach us that lesson; we continue to ignore it.

Will Buffett insure intangibles?

Warren Buffett is moving into the bond-insurance business. According to a story in the Wall Street Journal:

Warren Buffett, seizing a chance to profit from turmoil in the nation’s credit markets, is starting up a bond insurer that aims to make it cheaper for local governments to borrow and promises to be a tough competitor for the industry’s embattled incumbents.
The billionaire investor’s Berkshire Hathaway Assurance Corp., set to open for business today in New York state, will guarantee the bonds that cities, counties and states use to finance sewer systems, schools, hospitals and other public projects.

Give that he is already known for looking for assets that generate strong cash flow, will he look to the securitization of trademarks and other intangibles (backed by franchise fees)? Probably not right away, according to the Washington Post:

He said the company would stay away from insuring complicated structured products such as bonds backed by mortgages and credit card receipts.

The key here is “complicated structured products.” To some extent, intangible-asset backed securitization is transparent and uncomplicated. Of course, there are still all the questions about the value of the underlying asset. The problem with mortgage backed securities is not just the complicated structure but the uncertainly over the ability of borrowers to repay the loans. Figuring out that risk is the job of the bond insurer – which is what Buffett is going to have to do. So without all the traunches and CDO, straightforward bonds backed by franchise fees or patent royalties might be an attractive business – even for Warren Buffett.

While you were gone . . .

A few tidbits from the last couple of weeks in the Intangible Economy:
From our friends at Circuit City — remember, the company who decided that it was a good strategy to sack the most experienced workers — came this pre-Christmas story (Circuit City’s Shares Tumble After Loss Widens – washingtonpost.com):

Circuit City laid off 3,400 workers in March to replace them with lower-paid new hires. This week, it announced the approval of millions of dollars in cash incentives to retain its top talent after the departure of several key executives over the past year. Executive vice presidents could claim retention awards of $1 million each, and senior vice presidents could get $600,000, provided they stay with the company until 2011, according to a filing with the Securities and Exchange Commission.

At least some folks on Wall Street understood — according to the Post “The bonuses didn’t sit well with Merrill Lynch analyst Danielle Fox, who questioned whether Circuit City should instead focus on incentives for the people who sell its products in stores.”
Moral of the story (from Circuit City’s point of view): Executive VPs good; real workers bad. Not!
– – –
More on the Internet gambling offset. In an earlier posting, I noted that the US has settled its Internet gambling trade dispute with Canada and the EU with “concessions” in warehousing services, technical testing services, research and development services and postal services. Just before Christmas cam word that the WTO has awarded the original complainant, Antigua, concessions in IPR. According to the International Herald Tribune:

In an unusual ruling Friday at the World Trade Organization, the tiny Caribbean nation of Antigua won the right to violate copyright protections on goods like films and music from the United States – worth up to $21 million – as part of a dispute between the two countries over online gambling.
The award comes after a WTO decision that Washington had wrongly blocked online gaming operators on the island from the American market at the same time it permitted online wagering on horse racing.
Antigua and Barbuda had claimed annual damages of $3.44 billion. That makes the relatively small amount awarded Friday, $21 million, something of a setback for Antigua, which had been struggling to preserve its booming gambling industry. The United States had claimed that its behavior had caused only $500,000 damage to the Antiguan economy.
Yet the ruling is significant in that it grants a rare form of compensation: the right of one country, in this case, Antigua, to violate intellectual property laws of another – the United States – by allowing them to distribute copies of American music, movie and software products, among other items.

Does this mean that Antigua will become the free music, movie and software haven? Will tourists flock to the beaches to pick up “legal” bootlegged copies of new movies? Unclear. Here is what USTR – Statement on Internet Gambling says:

The United States is concerned, however, that the Arbitrator agreed with Antigua’s request to suspend WTO concessions not just with respect to services, but also with respect to intellectual property rights (IPR). Any authorization pursuant to the award would be strictly limited to Antigua; every other WTO Member remains obliged to protect U.S. IPR under WTO rules, including enforcement against any IPR-infringing goods. Moreover, even with respect to Antigua, it would establish a harmful precedent for a WTO Member to affirmatively authorize what would otherwise be considered acts of piracy, counterfeiting, or other forms of IPR infringement. Furthermore, to do so would undermine Antigua’s claimed intentions of becoming a leader in legitimate electronic commerce, and would severely discourage foreign investment in the Antiguan economy.

So, this one is far from over. But it does set the precedent that IPR is not an ironclad right. It is a government granted right. And like any other government granted right, it can be granted or withdrawn as the government sees fit. It this case, the WTO recognizes IPR as just another trade law. Interesting.
– – –
Finally, there is this recent story in Business Week summarizing The State of Innovation:

This year, surveys from three leading consultancies—Boston Consulting Group, McKinsey & Company, and Booz Allen Hamilton—show innovation remains a high priority for most corporate leaders around the world. There’s consensus across industries that innovation is a key growth driver. Unfortunately, the surveys also reflect a broad belief that most companies don’t have the leadership, systems, or tools to successfully and consistently innovate.

The story is a good highlight of the three reports (many of which have been mentioned in this blog) — and worth the read. The conclusions are not uplifting, however. Innovation is in danger of becoming a buzzword (see the latest IBM “Innovation Man” ads that play on this trend). Every CEO spouts the same rhetoric. But it is unclear that they understand beyond the rhetoric. And with a looming economic slowdown, we will see how many are willing to put their money (and other resources) behind the words. When business slows, innovation can come to the fore as a means of moving ahead (especially when resistance to change maybe lower). Or, it can be the first “extraneous” expense to be cut. We will see which mindset actually rules.
Such is the challenge facing the I-Cubed Economy in 2008. Happy New Year.