The complex realities of the intangible economy

There is a simple (and simplistic) mental model of the intangible economy that many carry around with them — including economists who should know better and journalists and politicians who probably don’t. That model is based on an industrial age concept of the division of labor between thinkers and doers (mental work and physical work). In this model, the US (and other “advanced” nations) are moving up the development ladder while others will take our place. So, the US will think and design things; other like China will make things.
The reality is much more complex. Making and designing are all mixed up. Countries that are supposed to be in one area of the value chain pop up in another. Here are two great examples.
Example #1. The US is supposed to be the world leader in aviation technology. Yet, as reported in this recent Wall Street Journal story Boeing is licensing an Italian helicopter design in order to compete for the next generation of Presidential helicopters which will be manufactured in the US.
Example #2. The US is supposed to be the leader in R&D — the place where American (and other) companies do their work on high end of the value chain. Yet according to NSF’s recent survey of global R&D expenses by US companies, American companies do about 20% of their research elsewhere.
By the way, this off shoring of R&D has been going on for some time — see earlier postings and recent comments on the data by Michael Mandel and Richard Florida.
In the intangible economy, knowledge and intangible assets flow in a global network. There is no hard and fast international division of labor. It is just as important to be able to absorb knowledge as it is to create it. If fact, the two are often necessary compliments. As the Boeing case illustrates, your ability to be near the cutting edge makes it easier to incorporate others knowledge into your own system. This is one of the hallmarks of the open innovation process.
Because of these flows, it is important for public policy to continue to focus on all parts of the production process. To simply narrow our gaze at one area — such as design or R&D — is economic myopia.

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Why humanities matter in the I-Cubed Economy

David Brooks’ column in this morning’s New York Times is a defense of studying the humanities. He talks about the need to hone communications and social skills in this technical age. But he also talks about how a study of the humanities helps you be a better human:

Let me try to explain. Over the past century or so, people have built various systems to help them understand human behavior: economics, political science, game theory and evolutionary psychology. These systems are useful in many circumstances. But none completely explain behavior because deep down people have passions and drives that don’t lend themselves to systemic modeling. They have yearnings and fears that reside in an inner beast you could call The Big Shaggy.
. . .
The observant person goes through life asking: Where did that come from? Why did he or she act that way? The answers are hard to come by because the behavior emanates from somewhere deep inside The Big Shaggy.
Technical knowledge stops at the outer edge. If you spend your life riding the links of the Internet, you probably won’t get too far into The Big Shaggy either, because the fast, effortless prose of blogging (and journalism) lacks the heft to get you deep below.

Brooks is echoing a long standing argument about the need for a balanced education. When I was a freshman in Engineering School at Michigan, we had to take a “Great Books” course. In part this was an attempt to produce an “educated person” not just a technician.
In more recent years, this debate seems to have focused on the broadening of the type of skills needed in this new economy. But that is clearly not enough. Not only does the ability to get below the surface go beyond the technical and scientific skills many associate with the “knowledge economy”, it goes well beyond the social and communications skills that we tout as so necessary.
In 2003, the American Council of Trustees and Alumni and Institute for Effective Governance produced a report Becoming an Educated Person: Toward a Core Curriculum for College students (I assume the title is a takeoff on the classic college orientation book On Becoming an Educated Person). William Bennett’s forward to that report states:

Education is not the same as training. Plato made the distinction between techne (skill) and episteme (knowledge). Becoming an educated person goes beyond the acquisition of a technical skill. It requires an understanding of one’s place in the world–cultural as well as natural–in pursuit of a productive and meaningful life. And it requires historical perspective so that one does not just live, as Edmund Burke said, like “the flies of a summer,” born one day and gone the next, but as part of that “social contract” that binds our generation to those who have come before and to those who are yet to be born.

While I may disagree with some of the educational reform recommendations by Mr. Bennett and others, the point is well taken. In the knowledge economy, it is not enough to cultivate skills — we must also strive to cultivate knowledge.

May employment

This morning BLS on employment announced that employment increased by 431,000 in May. The good news was tempered by the fact that much of this increase was 411,000 temporary Census workers. The unemployment rate declined slightly to 9.7%
Economists had expected much higher employment numbers — ranging from 515,000 by those surveyed by DowJones to 540,000 of those polled by the New York Times.
It is interesting to note that manufacturing employment increased. Manufacturing still faces a large structural employment deficit however.
Another bit of good news in the data is that the number of involuntary underemployed (part-time for economic reasons) also decline. As I noted last month, the rise in involuntary underemployed was troubling – as this is a coincident indicator. It is good to see this heading in the right direction.
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Message to G-20 — increase disclosure of intangibles in the financial system

Tomorrow and Saturday, the Finance ministers of the G20 nations will meet in South Korea. This morning’s Wall Street Journal blog Real Time Economics has the highlights of a pre-meeting interview with Treasury Secretary Geithner — Ten Takeaways From Geithner Before G20 Finance Ministers’ Meeting. One of those ten takeaways is this:

Three areas where there needs to be a global consensus for reform: 1) transparency and disclosure in the financial system, 2) derivatives regulation, 3) capital, liquidity, leverage rules.

I’m not going to comment on derivatives and capital issues. But the question of increased transparency and disclosure in the financial system has been of theme our Athena Alliance since the publication a number of years ago of our working paper Reporting Intangibles: A Hard Look at Improving Business Information in the US.
In that regard, if Secretary Geithner want to push the G20 for greater transparency, he should start with more disclosure of intangible assets. It is not necessary to take on the entire accounting profession and try to assign a book value to intangibles. Simply requiring more reporting of intangibles would be a major step forward. This could be in the form of the Eccles and Krzus proposal for “One Report.” Even baby steps, such as the OECD recommendation for strengthening the patent marketplace through disclosure of patent licensing and sales information would help (see earlier posting on the problem with royalty data). Or it could be through beefing up the requirements for disclosure of information in the MD&A section of existing corporate financial reports – as recommended in Reporting Intangibles.
The Secretary could put his money where his mouth is and lead by example. First of all, he should convene the relevant regulatory agencies –such as SEC, Department of the Treasury, the Federal Reserve and even the Commerce Department–and establish an advisory committee to make recommendations on ways of providing investors with an improved method for assessing the impact intangibles have on the accuracy of a company’s financial picture. This advisory committee could also review valuation methodologies and look at ways to support and encourage increased research on valuation standards. This should include a review of industry trade associations efforts to adopt guidelines for intellectual asset management and intangible disclosure appropriate to particular industry sectors.
Second, as part of its prudent bank supervision activities, the banking regulators need to understand the role intangible assets play in the financial system. The regulatory agencies can take steps to study and collect information on the role of intangibles in the financial system–and to underscore the risks of ignoring them. As they build knowledge in this area, Treasury, the Federal Reserve and other financial regulatory agencies should ask the financial institutions the following questions:

•   To what extent are lending institutions employing intangible asset as collateral, either explicitly or implicitly?
•   What provisions are there in bank reporting requirements for intangibles?
•   Given that intangible assets can be wrapped up in the catch-all category of a blanket lien on all assets, how can lending institutions determine the value of intangible assets for the purposes of assessing collateral?
•   If intangibles are used explicitly as collateral, what underwriting standards are used and what are the specific valuation standards and loan-to-value ratios?

Third, the Secretary should support the commissioning of a National Academies’ study on intangibles. This was proposed at a June 2008 conference sponsored by the Bureau of Economic Analysis and the National Academies. A broad study of intangibles could include the following components:

•   A survey of efforts in other countries to advance the understanding of intangibles and their role in corporate performance and economic growth, promote financial investments in intangible assets, and foster the utilization of intangibles.
•   An inventory of federally owned intangible assets and an exploration of how to exploit them for economic growth.
•   A list of policy recommendations to accelerate private investment in and management of the types of intangible assets most likely to contribute to growth.

Such steps would put the US at the forefront of the transparency question and set an example for the rest of the G20. And isn’t that what international leadership is supposed to be about?

OECD Innovation Strategy

Last week, the OECD held its 2010 Ministerial meeting and policy forum. The focus of the meetings was on economic recovery and sustained growth. One of the highlights was the release of OECD’s Innovation Strategy — a three year multi-disciplinary effort.
The Key Findings report outlines why it matters:

Innovation has been and must continue to be a major driver of rising living standards. Preliminary estimates for several OECD countries show that firms now invest as much in intangible assets related to innovation (R&D, software, skills, organisational know-how and branding) as they invest in traditional capital such as machinery, equipment and buildings. Such investment accounted for up to 1 percentage point – or around one-quarter – of labour productivity growth in Austria, Finland, Sweden, the United Kingdom and the United States between 1995 and 2006 (Figure 1). Moreover, much multifactor productivity (MFP) growth – that is, the joint productivity of capital and labour – is linked to innovation and improvements in efficiency. Collectively, estimates suggest that investment in intangible assets and MFP growth accounted for between two-thirds and three-quarters of labour productivity growth in OECD countries such as Austria, Finland, Sweden, the United Kingdom and the United States between 1995 and 2006. Innovation was the main driver of growth. Differences in MFP also account for much of the gap between advanced and emerging countries, an indication that innovation is also a key source of future growth for emerging economies.

The OECD reports outline a broad view of innovation. As they point out, “While R&D remains vitally important, many highly innovative firms do not engage in R&D at all . . . Increasingly, firms in services and manufacturing create value through a wide range of complementary technological and non-technological changes and innovations.” Likewise collaboration (including open innovation and user-driven innovation) has become an important part of the innovation process.
The result is that innovation is both a global and local phenomena. “While firms can access factors of production across the globe, local knowledge and capabilities, including proximity to research and education institutions, continue to matter for innovation.”
Thus, the report concludes:

Such changes in the innovation process present a challenge to existing national policy frameworks. The focus on strengthening public research and on providing incentives for firms to invest in research and development is important, but it is not enough. A more strategic approach to fostering innovation is needed, one which considers the full spectrum of policies to create, diffuse and apply knowledge

In response, the report highlights the following policy principles for innovation:

1. Empowering people to innovate
•  Education and training systems should equip people with the foundations to learn and develop the broad range of skills needed for innovation in all of its forms, and with the flexibility to upgrade skills and adapt to changing market conditions. To foster an innovative workplace, ensure that employment policies facilitate efficient organisational change.
•  Enable consumers to be active participants in the innovation process.
•  Foster an entrepreneurial culture by instilling the skills and attitudes needed for creative enterprise.
2. Unleashing innovations
•  Ensure that framework conditions are sound and supportive of competition, conducive to innovation and are mutually reinforcing.
•  Mobilise private funding for innovation, by fostering well-functioning financial markets and easing access to finance for new firms, in particular for early stages of innovation. Encourage the diffusion of best practices in the reporting of intangible investments and develop market-friendly approaches to support innovation.
•  Foster open markets, a competitive and dynamic business sector and a culture of healthy risktaking and creative activity. Foster innovation in small and medium-sized firms, in particular new and young ones.
3. Creating and applying knowledge
•  Provide sufficient investment in an effective public research system and improve the governance of research institutions. Ensure coherence between multi-level sources of funding for R&D.
•  Ensure that a modern and reliable knowledge infrastructure that supports innovation is in place, accompanied by the regulatory frameworks which support open access to networks and competition in the market. Create a suitable policy and regulatory environment that allows for the responsible development of technologies and their convergence.
•  Facilitate efficient knowledge flows and foster the development of networks and markets which enable the creation, circulation and diffusion of knowledge, along with an effective system of intellectual property rights.
•  Foster innovation in the public sector at all levels of government to enhance the delivery of public services, improve efficiency, coverage and equity, and create positive externalities in the rest of the economy.
4. Applying innovation to address global and social challenges
•  Improve international scientific and technological co-operation and technology transfer, including through the development of international mechanisms to finance innovation and share costs.
•  Provide a predictable policy regime which provides flexibility and incentives to address global challenges through innovation in developed and developing countries, and encourages invention and the adoption of cost-effective technologies.
•  To spur innovation as a tool for development, strengthen the foundations for innovation in low-income countries, including affordable access to modern technologies. Foster entrepreneurship throughout the economy, and enable entrepreneurs to experiment, invest and expand creative economic activities, particularly around agriculture.
5. Improving the governance and measurement of policies for innovation
•  Ensure policy coherence by treating innovation as a central component of government policy, with strong leadership at the highest political levels. Enable regional and local actors to foster innovation, while ensuring co-ordination across regions and with national efforts. Foster evidence-based decision making and policy accountability by recognising measurement as central to the innovation agenda.

Many of these recommendations are things we have heard before. Not everyone will agree with each point. But having a full discussion of them in the full context of innovation policy is very useful. A couple of the specifics are ideas near and dear to my heart including:

Well-functioning venture capital markets and the securitisation of innovation-related assets (e.g. intellectual property) are key sources of finance for many innovative start-ups and need to be developed further.

and

Ensuring that information on intellectual assets (e.g. R&D, patents, software, databases, organisational capital) is consistent and comparable over time and across companies would help investors to better assess future earnings and the risks associated with different investment opportunities. This can help make financial markets more efficient and improve firms’ ability to secure funding at lower cost. Governments can assist in efforts to promote identification and dissemination of best practices in reporting. Given the wide range of intellectual assets held by firms in different industries, and the comparatively early stage of development of reporting frameworks, the approach to improved disclosure should remain principles-based.

Of course, I would have liked to see the recommendations go beyond disclosure to activities the government could assist in better management of intangible assets as well, such as the Scottish Intellectual Asset Centre and my proposal to expand the Manufacturing Extension Partnerships (see also earlier posting). But that is a topic for future work.
The OECD reports ends with a road map for “the way forward”:

In this broader approach to innovation, it is particularly important to balance policies aimed at the creation of new knowledge and innovations with those aimed at fostering its uptake and diffusion in the economy. Policy actions also need to reflect the changing nature of innovation. This implies an emphasis on the following areas:
•  A more strategic focus on the role of policies for innovation in delivering stronger, cleaner and fairer growth.
•  Broadening policies to foster innovation beyond science and technology in recognition of the fact that innovation involves a wide range of investments in intangible assets and actors.
•  Education and training policies adapted to the needs of society today
to empower people throughout society to be creative, engage in innovation and benefit from its outcomes.
•  Greater policy attention to the creation and growth of new firms and their role in creating breakthrough innovations and new jobs.
•  Improved mechanisms to foster the diffusion and application of knowledge through well-functioning networks and markets.
•  New approaches and governance mechanisms for international cooperation in science and technology to help address global challenges and share costs and risks.
•  Frameworks for measuring the broader, more networked concept of innovation and its impacts to guide policy making.

More than anything else, this outline of a broad strategic view is a major contribution to the policy debate. The Economist summary of the meetings is especially telling:

Windy talk about innovation is mind-numbingly abundant. Unusually, however, the grandees taking part in a conference in Paris this week organised by the OECD received some pointed advice. The rich-country think-tank has unveiled a thoughtful new report on how governments can do better at spurring and measuring innovation.
The grandees were also unusually attentive. Many governments are facing not only slow economic growth but also big deficits and heavy debts. At the same time, problems such as global warming and rising prices for natural resources demand their attention. Innovation, the OECD argues, offers a way out.

Let us hope that they took the larger message – of needing a broad innovation strategy — to heart. Otherwise, piecemeal actions won’t get us to where we need to be.
The full report – The OECD Innovation Strategy: Getting a Head Start on Tomorrow – is available for purchase online; the Executive Summary can be downloaded for free. A companion report – Measuring Innovation: A New Perspective is also available for purchase online.
Below is a video of Andrew Wykoff, Head of OCED’s Directorate for Science, Technology and Industry, describing the importance of innovation.
Other video clips from the policy forum are available online.

Re-authorizing AMERICA Competes Act

After some political drama, the House passed the H.R. 5116, America COMPETES Reauthorization Act of 2010 on Friday (see House S&T Committee press release). The bill reauthorizes various federal R&D programs and STEM education programs. It also enacts many of the Obama technology initiatives including setting up an interagency task force at OSTP and requiring a manufacturing strategy, creating a new prize mechanism in NSF, establishing the Regional Innovation Initiative and creates Energy Innovation Hubs.
I am especially interested in two provisions. The first is a provision to get the MEP Centers into the product development game. Labeled the Innovative Services Initiative, this provision allows the Secretary to set up programs in MEP to assist SME in “accelerating the domestic commercialization of new product technologies.” I would have liked the language to say “shall” set up the program rather than “may” — but it is still a step forward.
The second is the creation of a program of loan guarantees for projects that “reequips, expands, or establishes a manufacturing facility in the United States to (1) use an innovative technology or an innovative process in manufacturing; or (2) manufacture an innovative technology product or an integral component of such product.” The program also uses MEP Centers as an outreach mechanism for the loan guarantees.
I am especially pleased that the program allows for companies to qualify for using innovative technologies or processes. Other programs, such as the Innovation Ohio Loan Fund for example, are focused on the development of new technology. Use, however, is just as important.
Needless to say, much more needs to be done to create innovation strategy of America. But passage of this bill is a good step. It is too bad it took so long.

Protecting the brand

Here are two interesting news stories about company brands. A story in this morning’s Washington Post – Political ads are tough sell for image-conscious corporations – describes how companies are being careful not to associate their brand with any particular political activity even after the Supreme Court ruling allowing for unlimited corporate political spending:

Many corporate executives don’t want to wade into partisan political campaigns. But other companies have told their advisers and GOP fundraisers that they are interested in helping finance ads to spotlight proposed regulations and lawmakers they don’t like. These companies include firms on Wall Street and in the energy sector opposed to stricter regulations as well as fast-food franchise owners fearful of being forced to unionize their shops.
They just don’t want to be singled out — or have their corporate logo attached

The second story is from the New York Times — Venting Online, Consumers Can Find Themselves in Court — on how companies are suing for what they consider defamatory remarks. The issue is what are called SLAPP suits (strategic lawsuit against public participation) where individuals or organizations try to silence opposition through lawsuits. [Full disclosure: I was once involved in an organization that was the target of a SLAPP suit]. But the story points out that such tactics are being used by companies to counter negative on-line postings.
Neither of these are new tactics: corporations have long been sensitive to how their brand is used and companies have been suing critics forever. But the juxtaposition of these stories reminds us that brands and reputation are valuable assets — and that companies recognize the need to protect them.