Where is Frodo?

Hobbits seem to have taken center stage in budget debate — or at least a cameo. First, on Tuesday, the Wall Street Journal made reference to hobbits – basically accusing tea-partiers of living in a Tolkien-like fantasy world. Here is what the Wall Street Journal’s editorial (The GOP’s Reality Test) said:

But what none of these critics have is an alternative strategy for achieving anything nearly as fiscally or politically beneficial as Mr. Boehner’s plan. The idea seems to be that if the House GOP refuses to raise the debt ceiling, a default crisis or gradual government shutdown will ensue, and the public will turn en masse against . . . Barack Obama. The Republican House that failed to raise the debt ceiling would somehow escape all blame. Then Democrats would have no choice but to pass a balanced-budget amendment and reform entitlements, and the tea-party Hobbits could return to Middle Earth having defeated Mordor.
This is the kind of crack political thinking that turned Sharron Angle and Christine O’Donnell into GOP Senate nominees. The reality is that the debt limit will be raised one way or another, and the only issue now is with how much fiscal reform and what political fallout.

Then yesterday Senator John McCain quoted those lines on the floor of the US Senate. Next, Senator Rand Paul (and others) shot back about how the Hobbits were the heroes of the story (see Politico and Washington Post – which has a video of McCain).
As far as misplaced cultural reference go, this one seems to be right up there. The tea-partiers are correct that the Hobbits are the heroes of the Tolkien mythology. But there is a catch. In general, Hobbits are portrayed by Tolkien as an insular people. Bilbo and Frodo Baggins are seen by their neighbors as strange because they are friends with elves and a wizard. Through the stories there are references to the hobbits desire to just return to the Shire and lock out the rest of the big bad world. Frodo and the others (like Bilbo earlier) only become heroes when they leave the comforts of the Shire and leave behind the insular thinking of their fellow countrymen. They become leaders in the outside world — but are still viewed with a little suspicion back home.
So if the tea-partiers are Hobbits, where is the Frodo Baggins? Where is the quiet leader willing to take up the quest and do the right thing — regardless of what his fellow Hobbits (tea-partiers) may think. Where is the tea-party leader willing to join with the others (as Fordo and friends joined with elves, dwarfs and men) to create a responsible solution to our economic and debt issues?
The tea-partiers may be Hobbits. But Frodo, Sam, Pippen and Merry, the heroes of the story, seem to be nowhere to be found.

2Q 2011 GDP

The advanced estimated of US GDP for the 2nd quarter of 2011 is out — and the numbers are bad. GDP in the quarter grew by only 1.3% — which was only slightly better than the 0.4% growth in the 1st quarter [earlier estimates for 1Q growth were as high as 1.9%]. According to the Wall Street Journal, economists had expected a 1.8% increase in the 2nd quarter. Consumer spending was essentially flat (goods down, services up). Private investment was up slightly by 1.7%, led by a 2.7% increase in information processing equipment and software. Sadly, it says a lot when one of the quarter’s most robust areas of growth is up by only 2.7%. Ironically (at least ironically given the current budget debates), the economy got a slight boost from federal government spending in the 2nd quarter, as defense spending rose. But that was more than offset by a decline in spending by state and local governments.
This may not count as a recession by some definitions. But it is certainly a slowdown. And it looks like the Congress is poised to make matters even worse — ala 1937 if not 1929.

More on patents and M&A

Here is yet another example of the new found focus on patents in the mobile telephone industry. From Bloomberg — InterDigital Gains 50% With Apple-Google Patent Rush:

The company [InterDigital] has rallied more than 70 percent since saying it hired Evercore Partners Inc. and Barclays Plc to “explore and evaluate potential strategic alternatives” that may include a sale, according to the company’s statement on July 19.
“We have seen the value of intellectual property rise substantially as major players in the mobile industry increasingly understand the strategic and economic value of this type of asset,” Terry Clontz, chairman of InterDigital’s board of directors, said in the statement.

And the beat goes on.

Groupon accounting under scrutiny

I hope it is not as I feared. According to a story in the Wall Street Journal, the SEC is taking a look at Groupon accounting claims. In an earlier posting, I raised the concern that Groupon creative accounting will trigger a backlash against real improvements in accounting for intangibles. My fear is that we all will get tarred with the same brush Рto use an old, but apt, clich̩. As the Journal story notes:

John Coffee, a professor at the law school at Columbia University, said the SEC has become more cautious about using nontraditional metrics after the dot-com bubble and subsequent bust. “The more we get into a bubble, the more we have analysts wanting to use numbers giving a sense of momentum,” said Mr. Coffee. “In social media, there are signs of a bubble and that creates some nervousness at the commission.”

Heightening that nervousness with possible bubble-feeding metrics is just what we don’t need right now — when we may be making real progress on accounting for intangibles.

Whither the auto industry

On the surface, this looks like dueling headlines:
Wall Street Journal: Car Makers Help Drive Economic Recovery
New York Times: The Auto Industry, Stuck in the Slow Lane
But a closer look reveals more of an agreement. According to the optimistic Journal story:

A resurgent auto industry has weathered the supply-chain hitches that stifled production during the spring and is poised to double the pace of U.S. growth in the third quarter, according to some estimates. But that may not be enough to help beleaguered consumers and businesses get a flagging recovery back on track.

Form the pessimistic Times story:

A report released on Wednesday by AlixPartners, a business consulting firm, projects modest sales growth for the foreseeable future.
. . .
American automakers have already regained their profits. And future sales will be fueled by population growth in the United States as well as growing demand in developing markets.

But, in both cases, a more pessimistic view persists. The reason may be a strong dose of reality. As the Times story notes:

John Hoffecker, managing director at AlixPartners, said the level of sales before the recession was unsustainable.
“Many people were thinking that was the norm,” Mr. Hoffecker said. “And our view was that it was not actual demand.”

I tend to agree. We cannot sustain future economic prosperity by trying to return to the economic structure of the past. New industries will emerge; manufacturing will reinvent itself. and if it doesn’t, we well all be left behind – for we need a strong manufacturing sector, but not the manufacturing sectors of the now-past industrial age.

Why manufacturing processes matter

Here is an interesting insight from MIT’s Technology Review that show why having a manufacturing base in the US matters. The article “Location Matters in Manufacturing” discusses finding by Professor Erica Fuchs that the shift of manufacturing to East Asia in optoelectronic and advanced materials areas caused new technologies to abandoned because they did not fit into the outsourced East Asian manufacturing processes. And those processes drive the industry: “surprisingly, says Fuchs, she found that manufacturing variables were far more significant than consumer preferences in determining the economic viability of the automotive technologies.”
Fuchs is looking into follow up question — can new companies in the US and other developed countries use these new technologies to compete against the incumbents? That, I believe, depends on if we have a robust innovation policy here in the US. If we can craft policies to effectively support these new companies build around these new technologies, then we might be able to harness the process of creative destruction. But if we don’t, we are likely to get the destruction without the creative part.

The IP marketplace

Keith McDowell has written a rundown of the intellectual property marketplace on his blog Go Forth and Innovate! — complete with a listing of various players and IP market platforms. This is a good place for anyone who want a overview.
Unfortunately, he falls into the normal trap of equating IP with “innovation.” Contrary to his phraseology, he is not writing about the “innovation marketplace” — but a very narrows subset of it. And while his supposed focus is on universities and innovation, he talks solely about technology transfer in the form of buying and selling IP. No discussion of all of the other forms of knowledge transfer and the important role of universities in that person to person process. Nor does the word “start-up” appear except in the context of start-ups as buyers of university IP. No discussion of the important role of universities as facilitators of start-ups.
I really don’t mean to pick on Dr. McDowell. He is an experienced technology transfer executive with much to teach us. But his comments reinforce an outdated and misguided paradigm. Yes, transfer of university IP is important. But let us not mistake that for the innovation marketplace.

Others also discover patents

It looks like the size of recent patent portfolio valuations has caught the eye of more than investment bankers (see earlier posting).
Activist shareholders may now also be getting into the game. According the the NY Times DealBook blog, Carl Icahn is telling Motorola Mobility to sell off its patents — which he apparently estimates have a higher value than the $4.5 billion paid for the Nortel patents.
Anybody have a sense of whether these valuations are real — or are we talking possible bubble here?

Have investment banks discovered patents?

Here is a little tidbit from a story today in the Wall Street Journal – Kodak Considers Options for Digital-Imaging Patents:

Kodak declined to comment on the process of its patent sale or the value of the portfolio. The company has retained Lazard as an adviser. Lazard also advised Nortel on its patent sale.

One estimate cited in the story is that the part of Kodak’s patent portfolio for sale is worth $2 billion. With numbers like that, no wonder the big boys of investment banking are getting involved.

More on tax reform

In yesterday’s posting, I cited Rob Atkinson’s new report on tax reform. In that report, he argues that there is no evidence of the claim that tax incentives automatically lead to unproductive over investments in the favored sectors. For example, some investment tax credits may actually boost productivity because of an underlying under investment in certain productivity raising activities. I am prepared to admit that some tax incentives lead to economic distortions. For example, I’m not sure the mortgage tax deduction for second homes leading to greater vacation home production is the most productive use of capital. But I do agree that there is knee-jerk assumption about differential treatment in the tax code.
Atkinson points to a recent report by the President’s Economic Recovery Advisory Board (PERAB), Report on Tax Reform Options. That report asserts “Because certain assets and investments are tax favored, tax considerations drive overinvestment in those assets at the expense of more economically productive investments.”
I ran into an example of this thinking specifically with respect to intangibles in the previous Administration’s Treasury Department’s 2007 report on tax reform (see earlier posting). That paper claims that we may be overinvesting in intangibles, especially human capital, because of favorable tax treatment. This is because investments in intangibles are immediately expensed whereas investments in physical assets are depreciated over their useful lives. Frankly, I find that idea that somehow we are overinvesting in intangible assets to be laughable. If the tax code gives intangibles an advantage, then it is a unintended benefit that we should exploit not eliminate.
The PERAB seems to accept this claim, without actually making it. In their discussion of expensing of plant and equipment, they buy implicitly into the notion that investments in intangibles is favored by the tax code:

Providing expensing for physical capital would also eliminate the differential tax treatment between investments in physical capital, which are currently deducted over many years, and investments in certain intangible capital (like research
and development, or advertising), which businesses can currently deduct immediately.

PERAB does not, at least, make the mistake of then claiming that we are overinvesting in intangibles. While business investment in intangibles has increased over the past few decades, both absolute and relative to physical capital, it is not at all clear that we are overinvesting. In some areas, such as basic research and worker training, I believe it is clear that we are underinvesting.
For this reason, I would propose a principle for reform which turns the differential tax treatment on its head. We need to make sure that treats investments in intangible assets at least as well in tangible assets. The tax code should not distort investment decisions by skewing it toward physical assets.
Last year’s tax deal gives a perfect example of how this bias against intangibles works. In the stimulus bill (sec. 144(a)(12)(C)), there was a minor change to allow the use of industrial development bonds (IBDs) to finance facilities manufacturing intangible property. Before this change, only traditional factories were eligible for this program. The change would allow local government to support new facilities for software development or bio-tech research facilities, for example, as well. That expired at the end of 2010 — and was not included in the tax deal. This simply act of putting physical and intangible investments on the same footing was forgotten and ignored.
This example of ignoring intangibles is all too common in the tax code. Yes, intangibles are expensed. But I doubt that causes any CEO to say to themselves, “I’m going to increase my training budget and not buy that new machine because I get a bigger tax break from spending on training.”
We need to look at how investment decision really get made – and adjust our tax code accordingly. And one of the adjustments we need to make is ensuring that the tax code fosters, not discourages, investments in intangible assets. After all, intangibles are the fuel that runs this new knowledge economy.