Is weak copyright good copyright?

A couple of months ago, I was at the NBER Innovation Policy and the Economy seminar. One of the presentations was by Felix Oberholzer-Gee on copyright. His paper, File-Sharing and Copyright, co-authored with Koleman Strumpf, is now available. The paper attempts to answer the question of whether reduced copyright protection (in the form of free filing sharing) has reduced production. To answer this, they set up a series of questions.
First, does file-sharing reduce the sale of copyrighted materials? There have been a number of studies apparently both ways on this question. But the authors answer is, after comparing the data across the studies and examining the methodologies, that file sharing is unrelated to changes in sales.
Second, how important are complementary sources of income, such as concerts? I’ve noted in earlier postings that to survive the business model in music must shift toward live performances as the major source of income. It looks like that is happening. Artists are touring more now and concert ticket prices have risen faster than inflation. Therefore “income from the sale of complements can more than compensate artists for any harm that file sharing might do to their primary activity.” For example, Paul McCartney earned an estimated $65 million from concerts in 2002 and only $4.4 million from recordings and publishing. For The Rolling Stones, the figures were $40 million from concerts and around $3 million from recordings and publishing. With only a couple of rare exceptions, the top 35 earners in 2002 all made more from concerts than recordings and publishing.
Finally, does file-sharing undermine artistic production? Apparently not. They cite figures which show the number of music albums created more than doubled between 2000 and 2007. “Even if file sharing were the reason that sales have fallen, the new technology does not appear to have exacted a toll on the quantity of music produced.” Their conclusion is that “this makes it difficult to argue that weaker copyright protection has had a negative impact on artists’ incentives to be creative.”
As one would expect, the discussion at the meeting provoked a strong defense of strong copyright. One questioner took issue with the Paul McCartney example – stating that he had become wealthy because of the ownership of the rights to his songs, like Yesterday. Thus, they complained that weaker copyright would prevent new bands from following in the Beatles footsteps – young musician would not be able to make a living with music, as the Beatles did in the beginning by playing in clubs in Hamburg.
This response underscores the emotional attachment to the issue – in disregard of both the data presented and other facts. For example, in the McCartney case, he does not own the rights to his own songs – like Yesterday. He has invested in the right to many songs. But Michael Jackson bought the Beatles portfolio years ago. Thus his income from much of the music portfolio McCartney owns comes from his role as an investor, not as a creator.
The reference to the Beatles day’s in Hamburg was especially amusing and completely off target. It displayed a complete lack of understanding on the music business and of what the paper presented. In fact, it makes the author’s point: most musicians when they are starting out make their money by playing live gigs, not through recordings. The Beatles were able to get started by playing live clubs (Hamburg and Liverpool) – not because they had any royalty income from songs, which in some cases they haven’t even written yet. In fact, the Beatles early live gigs were comprised other people’s song as well as some of their own material. Without these “cover” these songs, the Beatles would not have had enough material to play at the clubs and refine their talent. So, in fact, it can be said that the early Beatles – like every other start up band – only survive on other people’s music.
I highlight this one response to make a point. Oberholzer-Gee is trying to pull off a very difficult task: to change the terms of the debate. Rather than focus on copyright as fixed property, he is looking at it as a mechanism to increase consumer choice by stimulating artistic production. And he has come up with a conclusion in the music case, at least, that does not fit with those who argue for ever stricter protection.
Such a conclusion might not hold for all areas of copyright. For example, few authors can make a living through live performances, unlike musicians. And we all understand the problem facing the news business in generating enough revenue to paying people for content.
Nonetheless, I wish Professor Oberholzer-Gee luck in trying to re-frame the debate. After all, he is simply trying to return the copyright (and patent) debate to its original purpose, as expressed in Article I, section 8 of the Constitution: “To promote the Progress of Science and useful Arts.”
(For more of Professor Oberholzer-Gee papers see his website.)

Future economic growth

Yesterday, the head of the CBO, Doug Elmendorf, testifed on state of the economy. That assessment was generally somber

In the Congressional Budget Office’s (CBO’s) judgment, the economy will stop contracting and resume growing during the second half of this year, but the hardships caused by the recession will persist for some time. The growth in output later this year and next year is likely to be sufficiently weak that the unemployment rate will probably continue to rise into the second half of next year and peak above 10 percent. Economic growth over time will ultimately bring the unemployment rate back down to the neighborhood of 5 percent seen before this downturn began, but that process is likely to take several years.

As the Wall Street Journal noted:

The CBO’s most recent forecast shows that the economy’s output gap — the difference between its actual and potential output — will average 7% of gross domestic product (about $1 trillion) this year and next year. And that output gap will not close until 2013.

The concept of an output gap is a standard macroeconomic notion. It is how fast the economy can grow, given a certain level of increased capital and labor inputs (more machines & more people) and increased productivity (working smarter). In an earlier posting last November I discussed the fact that an underlying premise of the Obama economic stimulus package was transformation. Given that, I’m not sure what the longer term potential economic output really is. Rather than highlight the gap, let’s focus on the actual output levels – and think more about what a transformed economy means in terms raising that actual level of output.

Good financial innovation

In this time of financial melt down and lock up, it is only natural to think of the bad side of financial innovation. We are so concerned with the downside right now that policy makers are seriously considering a financial consumer product safety organization (see my earlier posting and a recent story in the Washington Post).
But Melinda Gates, writing in Newsweek – Helping the Poor Save Money, highlights some good financial innovation:

The success of microloans has opened new opportunities for many poor people and has been a crucial factor in reducing poverty. But loans are not enough. Savings accounts could help people in the developing world weather unexpected events, accumulate money to invest in education, increase their productivity and income, and build their financial security. Fortunately, this is a moment of opportunity. Innovation and new policy ideas are uniting in ways that will lower the cost of savings and bring safe financial services to the doorsteps of the poor.

She goes on to specifically cite agent banking and mobile phone cash-transfer services.
We need to keep this in mind as we think about innovation — of all kinds. Remember, innovation is neither good nor bad – nor is it neutral.

Buying the brand – not the concept

I’ve posted a number of entries calling on someone to buy the Saturn franchise as part of a deal to save GM. It looks like that may occur — but in a manner that undercuts the brands strongest intangible assets. According to a story in today’s Washington Post, A Foreign Buyer Could Put Saturn’s Image Into Orbit:

A few potential buyers are considering tapping Saturn’s strong dealer network to distribute vehicles made by foreign manufacturers into the United States. Such a move would transform a brand that was designed to reinvent how Americans built and sold cars.

This is apparently based on the analysis that the dealer network is Saturn’s most important intangible asset. However, that analysis overlooks the tight interconnection between intangible assets. As the Post story goes on to note:

Thomas A. Kochan, an MIT professor who wrote a book about Saturn, said a foreign partnership faces tall hurdles.
“They’re kidding themselves if they think dealers themselves can sustain the brand,” he said. “This was a tightly integrated model. People related to Saturn because of the aura of the company as an American company.”
. . .
For a while Saturn successfully competed with Japanese rivals. Thanks to its unique dealer arrangement, it introduced “no haggle, no hassle” car buying, in which people paid the posted sticker price.
The company prided itself on a collaborative culture, where dealers and workers regularly gave input into the products. The union relaxed work rules that had pigeonholed workers into one kind of job. Instead of pensions, employees got 401(k)s. Raises were based on performance, not negotiations.
“The sad part is that they didn’t learn very much from it,” Kochan said. “They didn’t stay committed to the organization once initial champions retired.”

That lack of commitment is what helped turn Saturn from a pioneer in reviving American competitiveness to just another brand (and one that everyone is telling GM to ditch).
The new buyers need to understand that Saturn will only survive as a complete concept. Unless the package is revived, the enterprise will simply continue its downward slide. As my friend Nir Kossovsky likes to say, “intangibles are like the stones of a Roman arch where the loss of any one stone could cause catastrophic collapse.”
Unfortunately, it looks like the potential buyers are attempting to buy a couple of the stones – and are running the risk of collapsing what is left of the arch. Isn’t there any body out there interested in rebuilding the structure?

Asking the right economic questions

Yesterday, the Senate Commerce Committee held a hearing several nominations. The transportation folks were focused on J. Randolph Babbitt, nominated to be FAA Administrator and John Porcari, nominated to be DOT Deputy Secretary. Techies wanted to hear from Aneesh Chopra, nominated to be Chief Technology Officer and Associate Director for Technology at OSTP and Larry Strickling, nominated to head NTIA. But also in that mix was Rebecca Blank to be Commerce Under Secretary for Economic Affairs. This is an important and often overlooked position – one that is critical to our innovation and intangibles agenda. The previous Under Secretary, Cynthia Glassman, was instrumental in pushing for better understanding of intangibles (see her remarks at our December 2007 conference).
Thus, it is important that the Under Secretary ask the right questions. In her testimony before the Committee, Dr. Blank got it right:

Particularly in the current economic environment, as we deal with the worst recession in the past 60 years, good economic analysis is in high demand. I look forward to taking on some questions that are particularly relevant to the Department of Commerce and its interests; questions such as “How is the current recession leading to restructuring in manufacturing industries in the U.S. and abroad and what are the implications for jobs, productivity, and profits among U.S. manufacturers?” “Is the U.S. as competitive as it should be? Which industries are leading in productivity, innovation, and competitiveness in the U.S., as we come out of the current recession?” or “What would rapid growth in environmentally-focused products mean in terms of industry and job expansion?”

That sounds like a good start. As the head of our economics statistical system, I hope she continues the work of her predecessor – with the focus innovation and intangibles.

Building intangibles – block at a time

Mary Adams has a great presentation that shows the interrelations between various types of intangible assets (human capital, structural capital, relationship capital) and how it can be build block at a time. Check it out:

Obama’s get it – the importance of the arts

About a year and a half ago, I praised then-Presidential candidate Mike Huckabee for making the case that arts and music instruction was just as important for creativity and economic competitiveness as math and science. While I did not support his candidacy, I thought he was on the right track on this one.
Now comes a comment regarding my candidate in that race, who, by the way, won. First Lady Michelle Obama was in New York yesterday to promote the arts. According to today’s New York Times, she made the following remark:

“My husband and I believe strongly that arts education is essential for building innovative thinkers who will be our nation’s leaders of tomorrow,” said Mrs. Obama, who introduced a performance by a multiracial cast of young dancers.

For me, that emphasis on the link between innovation/creativity and the arts is one of the most important – and most overlooked – factors. Yes, art for art’s sake is good. Arts help define what it means to be human — and raise the level of our collective humanity.
But there is also a hard nosed economic bottom line to the arts. In most cases, arts advocates try to make this case in terms of the economic contribution of the arts. The arts are big business – as study after study have shown. As a report from the National Governors Association (NGA) Arts & the Economy: Using Arts and Culture to Stimulate State Economic Development explains:

Arts and culture-related industries, also known as “creative industries,” provide direct economic benefits to states and communities: They create jobs, attract investments, generate tax revenues, and stimulate local economies through tourism and consumer purchases.

But that is an incomplete case. As the very next sentence in that NGA report states:

These industries also provide an array of other benefits, such as infusing other industries with creative insight for their products and services and preparing workers to participate in the contemporary workforce.

Just as math is a foundational skill, so are the arts. As Huckabee was quoted as saying in my earlier posting, “If you don’t stimulate both sides of a human’s brain, you’re simply generating half the capacity.”
Last November, the British Arts and Humanities Research Council and their National Endowment for Science, Technology and the Arts (NESTA) put out a report on Arts and Humanities Research and Innovation. That report took a unique (and somewhat radical) view of innovation:

Traditional understandings of innovation emphasise the importance of science and technology research. In contrast, this paper investigates the role that arts and humanities research plays in the innovation system.

Just as research is the keystone to science and technology, so should it be for arts and humanities. We often label this activity “scholarship” rather than “research.” Yet, as the NESTA report points out, it should be viewed in the same light:

As shown in this paper, the arts and humanities make vital contributions to the innovation system, even though some arts and humanities researchers may not perceive themselves as part of this system, and may resent attempts to assess the relevance of their work in this way.
. . .
Arts and humanities researchers have often taken a robustly independent line in this area, and there is generally less of a tradition of societal problem-orientation than found in other disciplines. Yet we have seen how the arts and humanities already offer new and innovative approaches that can have profound effects on society. The arts and humanities have the critical and analytical capacity to challenge assumptions
and ways of working, while providing a sense of the historical context, traditions and cultural setting in which society and the economy function.

This is a line of think we need to pursue in this country as well. Maybe the First Lady’s comments will help lead us in that direction.

BEA budget includes innovation measures

The Administration’s FY 2010 budget proposal includes funding for work on including innovation data in the GDP. For more on this see the Athena Alliance report Frameworks for Measuring Innovation: Initial Approaches, the STPI background paper Measuring Innovation and Intangibles: A Business Perspective and the BEA article “Toward Better Measurement of Innovation and Intangibles.”
From the BEA’s Congressional Justification briefing:

GDP Innovation Account
Background: All countries acknowledge that business investment in tangible assets as a major contributor to economic activity. In the U.S., they are thought by experts to be fully equal to investment in intangible assets. No country has yet included a comprehensive estimate of business investment in intangible assets in the GDP, yet such investments are increasingly the drivers of economic growth. BEA will expand its 2009 R&D initiative with this broader innovation account, resulting from the Secretary’s Advisory Committee on Measuring Innovation in the 21st Century. Building on its work with the National Science Foundation (NSF) measuring R&D, BEA will develop estimates of investments in innovative activities. Working with NSF, BEA produced the first U.S. R&D account in 2006 and is prepared to develop that further with this initiative.
As BEA confronts the challenges of measuring a dynamic and ever-changing economy, there are gaps in the economic statistics BEA produces that must be filled. To more effectively and comprehensively measure the 21st century economy, BEA must build on its development of the R&D satellite account and significantly improve its measures of broader innovative economic activities. Investments in innovation, or knowledge-based activities, are thought to be important engines of economic growth. Yet very little is understood about their role in the economy. Much of the growth that the U.S. economy has experienced in the last ten years is not captured by traditional economic measures–many economists believe that as much as 40 percent of that unexplained growth can be accounted for by knowledge-based activities. Understanding the role of these activities in the economy is critical to accurately measuring and encouraging a strong U.S. economy.
Proposal: Early results from BEA’s work on R&D suggest that investments in R&D account for roughly 1/5 of the contribution of knowledge-based activities to economic growth. This new initiative will expand on the R&D statistics BEA has been developing, and will fully research, identify, and quantify the other components of innovation and their contribution to growth. BEA will develop an innovation account that estimates investments in human capital, the design and development of new goods and services, and improved business processes. BEA proposes the following specific products:

• Work with NSF to develop a framework and prototype estimates of investments in innovative activities by the end of FY 2010. BEA will work with the NSF to develop measures of innovation activities that reach beyond the scientific R&D statistics that are currently provided by NSF and have been incorporated into BEA’s R&D satellite account. These innovative activities–including important intangibles like new product development and firm-specific training–are thought to be important contributors to economic growth.
• Work with NSF and Census to develop detailed estimates of innovation-related intermediate inputs in FY 2011. In understanding the contributions of R&D to economic growth, it is important to not only measure the uses of R&D by industry, but to understand the inputs into R&D. These inputs, ranging from IT equipment to scientists and engineers, are critical to understanding the sources of R&D’s own contributions to growth and in designing public policies to encourage innovation and growth.
• Work with BLS to develop aggregate and industry-level measures of the contributions of investments in innovation total factor productivity. BEA’s work on R&D has demonstrated that there are important differences across industries with respect to investment in R&D and the contribution of those investments to overall total factor productivity. Because these differences are also likely to exist for the broader classes of innovative activity, BEA will develop industry-level estimates of innovative investments that will facilitate measurement of individual industries’ contributions to economic growth.
• Work with NSF and Census to publish innovation statistics on firm and establishment-level data. BEA will publish innovation statistics based on data on firms as well as establishments to provide more comprehensive estimates of employment in innovation occupations.

This work is part of a $4.5 million new Navigating the 21st Century Economy statistically initiative that also includes better data on energy usage and retirement incomes.

Intangible tax proposal – further thoughts

Having had a few days to ruminate, I have some further thoughts on the President’s tax proposal on transfer of intangible assets (see earlier posting). Looking over the proposals in more detail, it became clear that it contain three separate proposals: an expansion of the definition of intangibles; dealing with the issue of transfer of multiple intangible properties; and, a valuation issue.
Let me deal with them in reverse order. The last proposal calls for the valuation of the intangible “at its highest and best use, as it would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts.” In other words, a market transaction. Generally, there are three accepted methods of valuation: the market approach, the cost approach, and the income approach. Under current law, the income approach is used — specifically Section 367(d)(2)(A) of the Internal Revenue Code requires the treating the transaction as “receiving amounts which reasonably reflect the amounts which would have been received annually in the form of such payments over the useful life of such property.”
If this provision becomes law, it will be interesting to see how it is implemented. It will have to be based on the use of comparable sales – which will make it interesting to define the comps.
On this, let me propose a slightly different idea. In Medieval Denmark, the King levied tolls on ships passing through the Øresund (the channel connecting the Baltic and the North Sea between the modern border of Denmark and Sweden). Tolls were collected at Elsinore (better known in literature as Hamlet’s castle). The method of valuation was a simple self-declaration. But the King reserved the right to purchase any and all of the cargo at the stated valuation. Such methods of market checks on self-valuation are rare, but not unheard of. (For a discussion of this method of self-valuation see Sound taxation? On the use of self-declared value). Such a method may not be practical when assessing the valuation of intangible for international transfer pricing tax purposes — but it is worth further exploration.
The second proposal goes to the power of the IRS Commissioner under Section 482 to place his/her own value on a transfer whenever “necessary in order to prevent evasion of taxes or clearly to reflect the income of any of such organizations, trades, or businesses.” The proposal would allow the Commissioner to value the intangible on an aggregate basis. This appears to go after the well-know issue that portfolios on intangibles are more valuable than the individual items taken separately. This issue is also tied to the market valuation issue — as the current rules of using income appear to require tying the income to each specific intangible.
The last proposal is the most interesting. It would expand the definition of intangibles include workforce in place, goodwill and going concern value. It is also, at least to me, attacking a very different issue than the other two. Those three intangibles are essentially “whole-enterprise” assets. They can not be split off from the enterprise. As such, they are generally not transferred from entity to another as individual components like a patent or a trademark could be.
Thus, the issue of international transfer pricing is different in this case. It is about transferring control of the enterprise to a foreign owner. This is a slightly different “loophole” the IRS has been going after. Beginning 2007, the IRS has defined workforce in place as an intangible asset for purposes of what is called Section 936 Exit Strategies (see Industry Director Directive on Section 936 Exit Strategies # 1 and Industry Director Directive on Section 936 Exit Strategies # 2). These are specific transactions having to do with the restructuring of companies who had gained tax credits for operating in Puerto Rico as those credits have been phased out. The classification of workforce in place as an intangible asset made such a transfer a taxable event. Not surprisingly, this is view as a very controversial move. (For more information see the KPMG write up The Transfer of Workforce in Place to a Foreign Corporation.) It appears that this latest proposal is an extension of that same principle — that all asset transfers should be subject to taxation — to all transactions.
As such, this may the politically most difficult – but the least directly tied to the issue of the transfer of intangibles to tax havens. We will see how the politics of the various proposals plays out.