This morning the BEA released the data for 1st quarter current accounts. This is a more comprehensive look at our international transaction than the monthly trade figures. It includes income and other financial transactions as well.
I’ve done something different with the data. Below is the normal chart of intangibles (royalties and business services). But I’ve also broken down the data is a slightly different way. The second chart shows the elements of our current account. “Services” have been split into travel/transportation, business services and miscellaneous. Miscellaneous includes the services categories of “Transfers under U.S. military agency sales contracts” and “U.S. government miscellaneous services” and is combined with the financial category of “Unilateral transfers.” Royalties are taken out of “services” and combined with income. It seems to me that royalty and license fees are no different than any other income on an investment.
The quarterly intangible trade data simply echoes the monthly date showing a general plateau. The reconfigured current account data tells an interesting story. Of course, it shows the massive change in goods trade due to the economic slowdown. But it also shows that most of the other categories are relatively flat (as can be seen better in the third chart). Income being somewhat volatile during this period as should be expected.
The current account data also shows the magnitude of the hole we are in. None of the other categories come close to making up for our goods deficit (even at the deep recessionary levels).
Clearly we won’t be able to fix our international trade and financial situation without dealing with our goods deficit. That is part and parcel of the Intangible Economy.
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 draft of the Obama Administration’s financial plan is circulating this morning, even before the official announcement later today. As expected, the circulating drafts propose a Financial Services Oversight Council to “facilitate information sharing and coordination, identify emerging risks, advise the Federal Reserve … and provide a forum for resolving jurisdictional disputes between regulators.”
That “advise” the Fed on systemic risks part has people concerned. The critique is that the proposal gives the Fed too much power. Yesterday, Senator Mark Warner proposed a more powerful Systemic Risk Council (see the story on the Real Time Economics blog at the WSJ). These statements by Senator Warner, who sits on the Banking Committee, may be the opening shots in the turf wars.
As I’ve noted before, the networked organizational approach is the correct way to go. Now comes the important process of designing exactly how whatever Council is created will actually work. Let’s how the debate that Senator Warner has kicked off is thoughtful and complete.
It has been over a year since my last update on the fashion copyright issue. Over at TechDirt, there is an interesting posting on the backlash – Fashion Designers Realizing New Fashion Copyright Would Cause Serious Harm To Business. As I’ve noted some time ago, there has been some great work on what is called the “negative space” issue — areas of innovation that flourish without traditional IP. High fashion is a case in point (for example see The Piracy Paradox: Innovation and Intellectual Property in Fashion Design).
By the way, I wouldn’t take the poll on the TechDirt site very seriously. It is hardly an accurate indicator. But the fact that the little guys are pushing back on this makes for a very interesting case study.
Yesterday’s Wall Street Journal had a thoughtful piece on Why Technologists Want Fewer Patents. Gordon Crovitz’s column used the Supreme Court decision to review the Bilski case on business process patents (see earlier posting) to raise an often overlooked function of the system: the sharing of information:
The Supreme Court may decide that more progress would be made with narrower definitions of what is patentable. A book on the U.S. approach to patents, “Jefferson vs. the Patent Trolls” by Jeffrey Matsuura, makes the key point that “intellectual property rights were not goals in and of themselves, but were instead a mechanism through which society attempted to facilitate creative collaboration.”
Thomas Jefferson, the nation’s inventor-president, would support patent reform in an era when new information technologies build on themselves. An idea, he observed, is a rare thing whose value increases as it’s shared. “No one possesses the less because everyone possesses the whole of it,” he wrote. “He who receives an idea from me receives it without lessening me, as he who lights his candle at mine receives light without darkening me.”
The very explicit deal embedded in the idea of a patent is disclosure in return for limited protection. Otherwise, the system would work on a process of trade secrets.
It is this collaboration part of the process that gets lost in the debate — especially by the “patents as a natural property right” crowd. Interestingly Joff Wilds’s critique against the article focused on the data on patent applications and litigation costs without ever engaging in the core argument on business process patents.
There might be a typo on the patent application numbers and people do not agree on the size of litigation costs. But Crovitz got the essence of the question right: what is the purpose of patents in fostering innovation . The answer to that question is what the Supreme Court will be grappling with.
A number of books seem to have come out recently about the financial meltdown. Today’s New York Times has a review of two. The title of the article – Greed Layered on Greed, Frosted With Recklessness – sums up the story. I have used the analogy of a juggling act perched on the top of a house of cards build on a foundation of quicksand. The quicksand was the overextended mortgages with teaser rates and interest only payments. (For the record, I think it was the adjustable rates that really created the ticking time bomb). The house of cards was the slicing and dicing of the mortgage-backed securities. The juggling act was the interest rate and currency arbitrage going on backed by those securities and the insurance scam know as “credit default swaps.”
The book review points out a very important fact. One of the books is Fool’s Gold by Gillian Tett. The subtitle of that book is especially telling: How the Bold Dream of a Small Tribe at J. P. Morgan Was Corrupted by Wall Street Greed and Unleashed a Catastrophe. As the review notes:
At the heart of “Fool’s Gold” is Ms. Tett’s portrait of the high-octane culture at J. P. Morgan in the 1990s. She shows the premium that young hotshots there placed on “innovation” and “creativity,” and she also conveys the horror that some of them later felt when they saw that their Frankensteinian brainchild had become a “rapacious scourge,” as other firms monkeyed with its genetic code, moving from the world of high-grade corporate lending into the far more hazardous realm of subprime mortgages.
In other words, this all started out as a positive innovation that went wrong.
There is another part of the overall story of this financial innovation that often gets missed. The sad fact is that all of these derivative financial instruments were designed to use financial markets to manage (i.e. reduce) risk. They are all elaborate forms of insurance — such as by making counterbets (futures) or spreading the risk (securitization). Using the market for risk management is a useful undertaking. But, in the end many of these tools not only increased risk, they made it much less understandable and therefore much more dangerous.
There are important lessons to be learned here as we take up financial reform. But the lesson learned should not be to stop innovation in financial markets. That would be folly. The point is to understand when an innovation goes beyond its useful sphere. We generally thing of a rose as a desirable plant. But a rose growing in the middle of a wheat field is probably better characterized as a weed.
Our trick in revamping the financial system is to build a mechanism that can tell the difference between a rose and a weed — and know when a rose has become a weed.
In a posting last week, I noted that according to preliminary reports, the Obama Administration was not going to propose a super-regulator to oversee the financial system. That did not sit well with some in Congress. But, as I argued, I think it is better to utilize a collaborative network model, rather than the traditional hierarchical bureaucracy.
On Wednesday, the President will formally release the proposal. But already the outline is being reported. For example, today’s Washington Post has an op-ed by Tim Geithner and Larry Summers (A New Financial Foundation) giving the highlights of the proposal. The Wall Street Journal has a more in-depth story on the proposal. That story confirms the more networked approach:
Officials say the goal is to distribute power in such a way that gaps in oversight are removed and the opportunities for regulator shopping reduced.
. . .
The plan calls on the Fed to oversee financial institutions, products, or practices that could pose a systemic risk to the economy. It will create a “council” of regulators to monitor this area as well.
The proposal will also seek to the jurisdictional issues between the SEC and the CFTC and will even create a new consumer financial protection agency.
I realize there will be a lot of skepticism about this approach. Already Business Week is running a story Is Obama Flubbing the Financial Fix? But ultimately the network model should be more effective. As I mentioned before, the trick will be designing the incentives and process to make it work in practice – not just on paper. I hope Congress and the regulators spend enough time on that part of the proposal to get it right.
Brad DeLong has an interesting essay at Project Syndicate on The Hidden Purposes of High Finance. One of his points is that high finance gives us the illusion both safety and liquidity. But it is a useful illusion:
It is a fact that we are much happier saving and accumulating, and that we are much more likely to do so when we think that the resources we have saved and accumulated are at hand. It is also true that when we invest our wealth – in Pfizer’s intellectual property, factories in Shenzhen, worldwide distribution networks, or shopping malls in Atlanta – it is not, in fact, at hand. Our invested wealth can only be made to appear liquid to any one of us, and only if there is no general shift in our collective desire for liquidity.
That is an interesting point to keep in mind – given recent history.
But there is a much more interesting point in that statement: the inclusion of “Pfizer’s intellectual property” and “worldwide distribution networks” in that list of investment. That a noted economist would routinely included these intangible assets shows how far our thinking has come.
A small victory I will grant you. But a victory nonetheless.
On Monday a bipartisan group of Senators, led by Finance Committee Chairman Max Baucus, introduced a bill to make the R&D tax credit permanent — technically the Research and Experimentation (R&E) tax credit. The bill – S. 1203 the Grow Research Opportunities with Taxcredit’s Help Act of 2009 — would phase out the traditional R&E tax credit and beef up the alternative simplified version created a few years ago. The credit for the simplified version would increases from the current 14% to 20%.
No word from high-tech industries on how they feel on the change. But making the credit permanent is a long over due step — and something called for in the Obama technology policy. In past years, the credit has simply been temporarily extended because of cost issues (a short term extension counts less in the budget scoring rules). Given the current budget pressures, we will see if the “permanent” part of the bill makes it through the process.
The same problem faces what should be the next step — adding a worker training/skills enhancement credit. Such an action to turn the R&D tax credit into a knowledge tax credit makes good policy sense. As I’ve argued before, if we give companies incentives to conduct research or invest in new equipment we should also give companies incentives to invest in their most valuable asset: their workers.
But a knowledge tax credit is expense. While it might be the right thing to do, it will probably fall victim to the budget deficit problem. And that would be a shame.
David Wessel asks an important question in his recent column Stench of Toxic Assets Lingers:
So is it no longer necessary for the government to get toxic assets off banks’ books to get credit flowing again? Is bolstering banks’ capital a substitute for ridding them of smelly loans and securities?
His answer, we are about to find out. With the programs to buy toxic asset essentially not operating (in part because the banks have no incentives to sell), the next few months will tell. As he notes:
If the economy takes a bad turn, or attitudes toward banks change — particularly toward banks that weren’t deemed healthy enough to give back taxpayer capital — a mechanism for removing toxic assets may yet prove essential to reaching a happy ending.
Wessel does a great job of explaining why removing toxic assets may be important to the credit system. Let me add one other with respect to intangibles. My fear is that as long as banks are sitting on these assets they will be very hesitant to embrace intangible-backed loans. After all, they are already carrying big load of uncertain in the form of these assets they can’t sell, they can’t value and they really don’t understand. Why should they add more – in the form of intangible assets that they don’t understand, don’t think they can value and don’t know how to sell if necessary.
Creating more certainty about intangibles (understanding/transparency, valuation and markets) is critical to their acceptance in financial markets. But so is dealing with the toxic assets. I fear that until we clear out the toxic, there is simply no room in the banks’ uncertainty space for anything else.
According to press reports (Wall Street Journal, Washington Post), the Obama Administration is backing away from earlier plans to create a super-financial regulator. The Post story notes that “The plan now taking form would include the creation of a council to work with the Fed to coordinate oversight of the financial system.”
Good. As I noted some time ago, I am very skeptical of the Department of Everything Department approach to financial regulation. I think we went down that path with the Department of Homeland Security — which was an industrial age response to an information age threat.
Rather than create a new hierarchical structure, we need to empower the network. True, financial regulators don’t always play well together — and financial institutions have been known to “regulator shop” to get the most lenient oversight. But both of those problems can be handled by how you design the network — the roles, the structure, the rules.
So I am heartened by the idea of a council. I agree with Dan Tarullo’s recent statement (Financial Regulation in the Wake of the Crisis) that:
History shows that opportunities for real reform are often short-lived. Momentum can too easily be lost, and the return of better times too easily leads to complacency. If we are to spare the next generation the pain and loss caused by a financial crisis, we must not only learn lessons. We must act on them.
I would submit that one of those lessons is that structure matters as well as regulations.
So I would urge the Administration and the Congress to put as much thought into the set up of that organization as they do to the actual substance of the new regulations. We can’t create regulations to foresee every situation. We can, however, set up a structure that can respond quickly. Ultimately, organization is what matters. Let’s get the organization right.