September trade in intangibles

The September trade data released this morning showed a slight improvement. The monthly trade deficit declined to $44.0 billion from $46.5 billion in August. This was slightly better than the $45 billion analysts had predicted. The good news was that exports increased and imports declined. As the chart below shows, the deficit in petroleum goods was generally unchanged (down $400 million) while the deficit in non-petroleum goods declined by $2 billion.
Our intangibles trade surplus was basically unchanged as well, rising ever so slightly by $70 million. Exports and imports of private services both increased — as did royalty payments coming in (exports) and royalty payments going out (imports).
However, our deficit in Advanced Technology Products grew in September. Exports grew by over $1 billion but imports increased by over $1.3 billion. The result was another record setting deficit as September was the worst monthly deficit since the government started publishing data specifically on Advanced Technology Products. June, August and now September have all set records. Aerospace exports picked back up slightly from last month — but so did imports. Electronics saw a reversal with exports dropping and imports increasing. In fact, imports increased in every category except biotechnology and flexible manufacturing. The last monthly surplus in Advanced Technology Products was in June 2002 and the last sustained series of monthly surpluses were in the first half of 2001.
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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.

A test for health care and economic competitiveness

Health care costs have long been identified as a issue for economic competitiveness. For decades analysts have pointed to both the high cost of care and the high cost of health insurance as an economic drag, especially for small businesses. One of the elements of the new health care law was meant to ease that cost by creating a new marketplace — called health insurance exchanges — where small businesses can buy health insurance.
Now, here is where it gets interesting. The health care law essentially leaves it up to the states to administer these exchanges. Last Tuesday, a number of conservatives won governorships — many with the very explicit promise to scale back or eviscerate the law.
The result will be a natural experiment with the heath care system. A story in today’s Washington Post underscores the point:

The result, analysts say, is that two models are likely to appear: Democratic governors and legislatures are likely to emphasize vigorous regulation and government oversight, while Republican state leaders are likely to put greater stock in privatization and other free-market approaches.

Here is where the natural experiment come in. There will be a measurable outcome of each of these approaches: the impact of the system on the state’s businesses and economic competitiveness. So we will see.

Biotech grants announced

One section of the heath care legislation passed last spring was a programs of grants and tax credits to biotech firms for high-risk research — the Qualifying Therapeutic Discovery Project Program. In an interesting arrangement, the program was administered by NIH and the IRS. As the fact sheet notes, the program is targeted at “projects that show significant potential to produce new therapies, address unmet medical needs, reduce the long‐term growth of health care costs and advance the goal of curing cancer within the next 30 years.”
The IRS has now published a list of the winners. Over 4600 projects were funded. However, it is unclear how much impact the program will have. As a story in the Washington Post reports:

But with so many companies applying for a share of the money, many firms got much smaller allotments than requested and said the financial boost won’t go as far as they had initially hoped.

Still the program is a step forward. The program was designed to specifically help the smaller companies and start-ups. It was also designed to promote economic competitiveness — as the fact sheet notes:

In addition to supporting biomedical research to find life‐saving treatments, the credit’s allocation will also take into consideration which projects show the greatest potential to create and sustain high‐quality, high‐paying jobs in the United States, and to advance our competitiveness in the fields of life, biological, and medical sciences. Today, the biotechnology industry employs 1.3 million workers, and the industry continues to be a key growth engine for our economy.

The incoming GOP majority in the House has made no secret of its intent to prevent implementation of the health care act. I would hope they would take a close look at this particular part of the law — and support it. There should be an evaluation of how the programs was implemented. And Congress should then support a second round of funding.

October employment

This morning’s BLS data on employment for October showed some good news. While the unemployment rate remained steady at 9.6%, employment grew by 151,000 jobs. Economist had expected only 60,000 new jobs.
A disturbing note however was the fact that the number of employed persons actually dropped in the household survey. The employment rate is calculated using the household survey and the number of jobs created is calculated from the establishment survey. This is not the first time the two surveys are not completely in sync. The difference highlights the uncertain nature of the labor market right now.
Another piece of good news is that both the number of involuntary underemployed (part-time for economic reasons) and the number of workers involuntarily underemployed because of slack work declined in October. The number of workers who could only find part time work rose slightly, however. And the number of voluntary underemployed declined slightly. As the chart below shows, involuntary underemployed and slack work remain at high level.
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The meaning of Tuesday

The electioneering has stopped — and the speculation has begun!
With the election behind us, the world of politicians, pundits and bloggers has turned to what it all means — and speculation on what will occur as a result. I’m going to forgo the analysis of what it means — that is subject to as many interpretations as there are points of view. I’m not sure that I even want to try to speculate on what will occur. But here goes.
First of all, all most everyone agrees that the likelihood of political gridlock is high. There are some who hold out hope for compromise leading to positive action. I think that is likely only on marginal matters. Both sides will want to avoid the government shutdowns of the 1990’s. But coming up with a budget that both sides can live with will be a test. I would point out that Congress has still not passed the appropriations for FY 2011 — which started in October. The lame duck may simply pass another continuing resolution and push the whole mess off to the new Congress.
The budget will be item number one on the agenda. The new House GOP majority is pledged to cut spending. But, as David Wessel points out in his WSJ column today:

as Republican spending cutters move from wooing voters to legislating, they confront two realities: Cutting government spending in general is popular; specific, substantial spending cuts are not. And bringing down the deficit by spending cuts alone, particularly cuts in annually appropriated domestic spending, is, well, arithmetically challenging.

Those cuts may hit programs important to restoring our economic competitiveness — such as research funding (see NY Times story). And Congress was never able to reauthorize the America COMPETES Act (passed by a large bipartisan majority in 2007) because of a dispute over the funding levels and some of the programs.
Of course, there are those who think gridlock is just fine. They subscribe to the idea that government is always and everywhere the problem. If government simply comes to a halt, then the economy will work itself out. Needless to say, I disagree with that view. And I think the events of the past two years have only reinforced my beliefs.
But above and beyond the financial collapse and the enduring Great Recession, I believe there are major steps that the government needs to take to foster innovation and the utilization of intangible assets — as I have written about extensively in this blog (see this earlier posting for example). Those needed actions are unlikely in an environment of gridlock.
But we will see. I am hopeful that there are some areas where everyone can agree — such as expanding the scope of the MEP program to include innovation in new business methods and product development and to include services for improved intangible asset management. There are a number of other programs that both sides of the aisle should be able to support (see our working paper Crafting an Obama Innovation Strategy and our policy brief Intellectual Capital and Revitalizing Manufacturing).
One final heads up. Two early indicators of where we may be heading will come up this spring. The first is the FY 2011 appropriations – as I mentioned earlier. The second may be more important: the federal debt ceiling. Sometime before summer, the government will need to raise the debt ceiling. If it does not, the government will be unable to borrow additional funds and will not be able to make interest payments. Technically, the US government will then be in default. The consequences for financial markets are likely to be chaos. We faced such as situation back in the 1990’s when the GOP controlled Congress refused to vote to increase the debt ceiling. After some nail-baiting maneuvers by the Treasury to stave off default, a compromise was reached. Whether such a compromise is possible in today’s political climate remains to be seen.

IP and tax strategies – the case of Google

Over the years, I have posted a number of pieces on taxation of royalties and the shift of IP to low tax countries. A story in the Washington Post shows how Google uses this mechanism:

Income shifting commonly begins when companies such as Google sell or license the foreign rights to intellectual property developed in the United States to a subsidiary in a low-tax country. That means foreign profits based on the technology get attributed to the offshore unit, not the parent. Under U.S. tax rules, subsidiaries must pay “arm’s length” prices for the rights – or the amount an unrelated company would.
Because the payments contribute to taxable income, the parent company has an incentive to set them as low as possible. Cutting the foreign subsidiary’s expenses effectively shifts profits overseas.
. . .
Allocating the revenue to Ireland helps Google avoid income taxes in the United States, where most of its technology was developed. The arrangement also reduces the company’s liabilities in relatively high-tax European countries where many of its customers are located.

According to the story, the tax strategy Google uses is even more complicated, with profits following to another Irish company, then to a Netherlands subsidiary and then to Bermuda.
Earlier this year, a group called Business and Investors Against Tax Haven Abuse recommended a number of step to deal with the problem (see also New York Times article). The report specifically includes a recommendation on the transfer of IP:

Block All Transfers of Intellectual Property Designed to Evade Taxes.
Revenue: Closing this loophole would add $10 billion to the Federal Treasury each year or $100 billion over ten years. Shifting intellectual property to low or no-tax jurisdictions is one of the biggest abuses of tax havens. During early stages of product development, firms in the technology and pharmaceutical industry would often retain their patents in the United States, so that costly research and development could be expensed and used to offset other earnings. As products approached commercialization, valuable patents would be registered in a tax haven, allowing companies to evade most, if not all, of the profits associated with the product.
Status: The International Tax Competition Act of 2010 would tax all revenue pertaining to
patent use for products sold within the United States, regardless of where the patent is
physically registered.

The other way of approaching this issue is through transfer pricing. As we discussed in our earlier report Intangible Asset Monetization: The Promise and the Reality, when a company sells the intellectual property to subsidiaries located in another country, the key is whether that “sale” is a fair market value and therefore the appropriately taxed. In the Google case cited in the Washington Post story, they negotiated a transfer price agreement with the IRS in 2006. Back in February, the Obama Administration proposed strengthening the rules on transfer pricing (see earlier posting). Nothing came of the proposal. And it is doubtful, at least in my mind, that the new Congress will take up the issue.
In the meantime, expect to see more companies adopt the Google approach.