GDP revised downward

This morning, BEA released its “third estimate” (what used to be called “final”) data on 1st Quarter GDP. The number has been revised downward to a growth rate of 2.7% – from the advanced estimate of 3.2% and the second estimate of 3%. According to BEA:

The increase in real GDP in the first quarter primarily reflected positive contributions from personal consumption expenditures (PCE), private inventory investment, exports, and nonresidential fixed investment that were partly offset by negative contributions from state and local government spending and residential fixed investment. Imports, which are a subtraction in the calculation of GDP, increased.

Unfortunately, some have gotten the story wrong — concentrating on revisions rather than the change from the previous quarter. While consumer spending was less than previously reported, it was still greater than in the previous quarter. And durable goods sales were actually up by a healthy amount. The slowdown was due to a decline in state and local government spending, a significant increase in the trade deficit and a large decline in housing.
Unfortunately, with at least two of those areas, things are only going to get worse. Latest data on housing is not good. State and local spending is set to decline further and Congress is being blocked from doing anything about it. Trade is still a wild card – since we only have data through April.
The good news is about business investment going up, specifically equipment and software. And capital spending by business seems to be continuing.
However, the GDP number do not measure investments in intangibles assets. So we don’t know about that part of the equation. I know that BEA is working on this, but a measure of intangibles in the GDP is badly needed if we are to understand the direction of the I-Cubed Economy.

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Another reason for close-by manufacturing

In a number of previous posting, I’ve argued that in the I-Cubed Economy manufacturing it tied closely to other production activities, such as product development and services. All of that argues for keeping manufacturing local. Here is another reason — financing (from the Your the Boss blog on the New York Times):

When you source your product from China, and need to wait up to 90 days for each order, you have to carry extra inventory as stock-out protection — another big hit to your cash flow. When you use a domestic supplier, you can turn to FedEx or UPS to solve your problem overnight. That means you don’t have to carry as much extra inventory.
With a long supply chain, an entrepreneur faces tough choices because the company’s cash is tied up with suppliers and customers. With credit still tight, companies can end up struggling to cover the inevitable cash shortfalls that come from growth. Some companies resort to doing things like factoring — borrowing off their accounts receivable at interest rates that can top 20 percent — or bringing in outside investors and private equity money, decisions that cut into either net income or equity.

IP enforcement and intangibles

On Tuesday, the White House released its new 2010 Joint Strategic Plan on Intellectual Property Enforcement (see also the White House blog and the write up in Intellectual Property Watch). The document seeks to lay out a clear message on piracy while sidestepping some of the controversies — for example with this statement on fair use: “Strong intellectual property enforcement efforts should be focused on stopping those stealing the work of others, not those who are appropriately building upon it.”
I applaud the coordinated approach to enforcement. But I would also note that balance is necessary. The following is the recommendation from our December 2008 report Crafting an Obama Innovation Policy:

Strengthening the White House role in reviewing and balancing intellectual property policy as broadly defined. The merits of infinitely expanding and strengthening intellectual property protection–patents, copyrights, trademarks, and trade secrets–to accelerate innovation and promote investment are no longer the articles of faith they were for a generation beginning in 1980. Witness the pending patent reform legislation–most of the provisions of which command broad private sector support–and recent Supreme Court and Federal Circuit Court of Appeals decisions in patent cases involving injunctions, patentable subject matter, obviousness, and willful infringement. But there has been no White House leadership on these issues, contributing to a congressional stalemate on patent reform. Moreover, within the Executive Office of the President there is a growing need for balancing the views of the Office of the U.S. Trade Representative (USTR), which has consistently favored ratcheting up intellectual property protection and enforcement–a stance likely to be reinforced by the new Office of the Intellectual Property Enforcement Coordinator.

Balance is key — since IP is only one part of the broader intangible-asset base that drives economic prosperity. Thus, what we need is not just an IP enforcement policy — but an innovation and competitiveness policy based on intellectual capital and intangible asset.
So if the Administration can produce a joint IP strategy – why can’t it produce a joint innovation strategy? Looking at the IP enforcement strategy, there are a number of like actions that could easily be taken with respect to intangibles. For example, one action in the strategy is to assess U.S. Government resources spent on IP enforcement “through a Budget Data Request (BDR), whereby agencies reported the amount of resources they dedicated to human capital and programs, identified metrics used in measuring intellectual property enforcement successes, and planned and estimated expenditures for future years.” Why can’t we do the same thing for our investments in intangibles?
Another action item in the report is to assess the economic impact of IP-intensive industries. Why not expand that to the impact of intangible-asset investments?
IP enforcement is good. But IP enforcement is one narrow silo of the innovation process. If we are to promote economic prosperity in the I-Cubed Economy we need to be tearing down silos. The IP enforcement strategy shows how actions can be coordinated across government agencies. Let’s now do the same for innovation.

CoInvest – intangible investments in Europe

In yesterday’s posting I made reference to a paper by Chuck Hulten, et al. on company investments in intangibles. That paper was written as part of a European research project on Competitiveness, Innovation and Intangible Investment in Europe (COINVEST):

The project aims to understand the contribution of intangible investments to innovation, competitiveness, growth and productivity in Europe. Such a project is vital to help European Union (EU) policy formation and to deepen understanding of some of the most crucial questions facing EU economic policy. The reason is simple. Currently, (almost all) intangible investments are either not measured, or are treated as an intermediate input into production so they are assumed to produce no durable assets for firms or economies. Does this matter? In practice, most knowledge investments involve intangible spending. The Lisbon Agenda aims to make the European Union “the most competitive and dynamic knowledge-driven economy by 2010”. Thus, we are in the position of having little data or measurements to back this policy aspiration. This project will set out a method and collect the data required. Some knowledge investment is counted as such in the key economic measures such as GDP (eg software). However, R&D and other knowledge investment (like investment in human capital via training, investment in reputation capital, investment in organisational capital etc.) are all treated as day-to-day expenses, not investment. Thus, under current conventions, investment and GDP in an economy whose businesses spend one euro more on almost all knowledge investment is the same as an economy whose businesses turn up their air-conditioning. Using a team of experts in this field, the project will collect data on a wide range of knowledge investment, at macro and micro levels, incorporate these into macro and micro performance measures and thus greatly improve our understanding of knowledge-driven economies and firms and policy.

The project has produced a number of interesting reports and papers — mostly on the data issue. The research is wrapping up with a policy briefing in mid-July and a dissemination event in September. I’m looking forward to seeing their final results.

Intangible values

Joff Wild over at IAM blog has a piece on OceanTomo’s new report on intangible valuation. According to OceanTomo, “In 2009, the implied intangible asset value of the S&P 500 reached 81%, an all-time high for the years covered by the firm’s research, which extends back to 1975.” As Joff points out in his piece, some of these claims of 70% plus intangible valuation have been challenged.
OceanTomo did provide Joff with the following explanation of their methodology:

INTANGIBLE BOOK VALUE METHODOLOGY
Intangible book value is calculated by subtracting the tangible book value from the market capitalization of a given company or index. In practice, companies report tangible book value per share, number of shares outstanding, and market capitalization. Therefore, intangible book value can be calculated by subtracting the market capitalization from the tangible book value per share multiplied by the number of shares outstanding.
It is expedient to do the calculation on a per share basis, as we have done here, and simply subtract the tangible book value per share from the market price. There are modest discrepancies between the two numbers due to differences in setting shares outstanding on a company by company basis. However, the discrepancy is rarely a few percentage points which are within the error needed for most purposes.

While I appreciate the attempts by OceanTomo to put a value on intangible assets, I remain concerned and skeptical of this methodology. The difference between tangible book value and market capitalization certainly contains the intangible asset value. But it also contains a lot more. For one thing, it including the difference between the market’s valuation of the physical and financial capital and the official book value of those assets (note the whole mark-to-market controversy in accounting). It also contains what some call the market froth — or the irrational exuberance. That fact works both ways — inflating the market value of the stock and deflating it as well. When the stock market tumbled recently, billions of intangible value did not simply disappear – did it?
Thus I am skeptical of using market capitalization to tell us anything of intangible company value – except for where the psychology of the market may be. For example, in 2008 — according to the Federal Reserve Board’s Flow of Funds Account — the total net worth of US non-farm, non-financial corporations was $14.2958 trillion — tangible assets of $14.2249 trillion (real estate, equipment and software, inventories — at market value or replacement cost), financial assets of $13.5006 trillion, and $13.4297 trillion in liabilities. The market value of equities outstanding for these non-farm, non-financial corporations was only $10.0364 trillion — for a equities/net worth ratio of 70.2% Does this mean that intangibles had a net worth of negative $4.2 trillion?
I would rather refer you to the work of Charles Hulten and colleagues who looks at expenditures on intangibles as investments and then modifies the balance sheets value accordingly. By this measure, intangibles are still important:

For pharmaceutical firms, intangible assets account for 39% of total assets for German firms and 54% for American firms. R&D capital accounts for 24% of total assets in German pharmaceutical firms and accounts for 39% of total assets in American pharmaceutical firms. Organizational capital accounts for 15% of total assets in both German and American pharmaceutical firms. For IT firms, intangible assets account for 38% of total assets for German firms and 43% for American firms. R&D capital accounts for 29% of total assets in German IT firms and accounts for 26% of total assets in American IT firms. Organizational capital accounts for 9% of total assets in German IT firms and 17 in American IT firms.

Those strike me as much more plausible numbers. I especially like the industry-specific calculations given the variation among industries in their intangible asset intensity.
So – yes intangibles are a major part of company value. But let’s be careful to not fall into the trap of over-hype. The concept of intangible assets and intellectual capital is already beginning to take root — even in policy debate (i.e. the reference to intellectual capital in the Obama Administration’s manufacturing policy). Let’s make sure we build further understanding of and confidence in intangibles based on solid ground.

Knowledge-building and development

I’m catching up on an item from IP Watch last month on the importance of knowledge-building for development:

The widening gap in scientific and technological capabilities between some developing countries suffering persistent poverty and rich industrialised countries brings to question why some countries are catching up with richer countries, while others are not. Two key factors for success and innovation are knowledge building and the role of the state as a facilitator, according to UN officials.
The views were put forth in a book launched at a side event to the 13th United Nations Commission on Science and Technology for Development in late May. The roundtable, organised by the International Centre for Trade and sustainable Development (ICTSD) on 20 May, aimed to prompt discussions on the results of the book and their relevance for policy discussions on innovation in international fora.
The authors found that rich countries built strong institutions as a complement to their production systems. That allowed them to build up strong production and the exportation of high quality goods and services, a path followed by emerging economies. However, poor countries continued to produce raw materials for the richer countries. Central to the production activities of all countries that became rich is a set of industrial and innovation policies, they said.
The book entitled “Latecomer Development: Innovation and Knowledge for Economic Growth” is authored by Banji Oyelaran-Oyeyinka, director of the Monitoring & Research Division of the United Nations Human Settlements Programme, and Padmashree Gehl Sampath, economic affairs officer in the Policy and Capacity Building Branch of the UN Conference on Trade and Development (UNCTAD).

The book was actually published last year. According to its abstract:

The most important issue for development centres on the debate about the centrality of knowledge, technology and innovation to the process of economic development. While this much is broadly agreed, what is at issue is the precise mechanics of overcoming economic development challenges in different contexts. At the heart of it all is about how economies at different levels deploy the unending streams of information and knowledge to developmental ends. In time, the notion of income convergence between the poorer South and the wealthy North has proved a mirage, while a new economic divide has in fact occurred within the South itself, and as well, between regions and within regions. The debate relating to latecomers is thus framed in discussions about regions and countries that arrive late to mastering industrialization in achieving economic prosperity through the use of knowledge. In other words, a new divide has emerged among the latecomers themselves, and with it, greater conceptual complexity in the ways of our understanding of the divergent ways of economic development. We have thus separated “fast followers” and new “late comers”.

In the powerpoint from the May briefing, they identify “frontier” countries as US, Japan, Denmark, Germany, Sweden, Norway and Israel. Fast followers are South Africa, Malaysia, Brazil, Mexico and Russia. Those moving from fast followers to frontier are Hong Kong, South Korea and Singapore. Interestingly they place India and China as moving from late comers to fast followers.
The briefing also makes the point that “Innovation is not about R&D, it’s the use of knowledge in application.” However, they seem stuck in the standard model of technological catch-up driven by traditional science-based research.
That is my one critique of the work. While they identify knowledge as the key driver, they do not explore the various types and roles of knowledge — including knowledge as business methods and the importance of knowledge absorptions as well as creation.
So, a useful piece of work. But clearly much more needs to be done in understanding the link between knowledge and international economic development.

Future job demand and wages

Here are two reports on the future of jobs in the US. A report from the Georgetown University Center on Education and the Workforce entitled Help Wanted projects a serious shortfall in qualified workers:

by 2018, we will need 22 million new college degrees–but will fall short of that number by at least 3 million postsecondary degrees, Associate’s or better. In addition, we will need at least 4.7 million new workers with postsecondary certificates.

A report from the Hamilton Project — The Polarization of Job Opportunities in the U.S. Labor Market — makes the following points:

•  Employment growth is polarizing, with job opportunities concentrated in relatively high-skill, high-wage jobs and low-skill, low-wage jobs.
•  This employment polarization is widespread across industrialized economies; it is not a uniquely American phenomenon.
•  The key contributors to job polarization are the automation of routine work and, to a smaller extent, the international integration of labor markets through trade and, more recently, offshoring.
•  The Great Recession has quantitatively but not qualitatively changed the trend toward employment polarization in the U.S. labor market. Employment losses during the recession have been far more severe in middle-skilled white- and blue-collar jobs than in either high-skill, white-collar jobs or in low-skill service occupations.
•  As is well known, the earnings of college-educated workers relative to high school-educated workers have risen steadily for almost three decades.
•  Less widely discussed is that the rise in the relative earnings of college graduates are due both to rising real earnings for college workers and falling real earnings for noncollege workers–particularly noncollege males.
•  Gains in educational attainment have not generally kept pace with rising educational returns, particularly for males. And the slowing pace of educational attainment has contributed to the rising college versus high school earnings gap.

Both the skills/education gap and the polarization of wages are serious problems facing the I-Cubed Economy. In my view, they will not be solved through our conventional educational and labor market policies. Those policies continues to be geared toward the labor markets of the industrial age. For example, we provide government support for unemployment insurance and re-training once people lose their jobs. But we have few programs to upgrade workers’ skills and keep them competitive so they don’t lose their jobs in the first place. That is way I’ve been advocating a knowledge tax credit.
The knowledge tax credit is just one example of how we need to change our thinking on public policy. I am sure that others can come up with dozens of other ideas. As these two reports indicate, however, we need to do this re-thinking now. Otherwise, the problems will simply continue to grow.