July trade in intangibles – and revisions

The US trade deficit was essentially unchanged in July, according to data released this morning from the BEA. The July deficit was $42.0 billion compared to June’s (revised) deficit of $41.9 billion. The number is somewhat good news: economists had been expecting a deficit of $44 billion. More worrisome was that both exports and imports we down. Exports dropped by $1.9 billion while imports were down by $1.8 billion. This is confirmation that the economic slowed somewhat in July. The mixed news is that our deficit in petroleum goods & oil declined but our non-petroleum goods deficit increased — with exports of non-petroleum goods dropping while imports rose.
Also mixed news is that our trade surplus in intangibles declined in July by over $290 million. However, that decline was concentrated in royalty payments reflecting the payments for the broadcast rights to the Summer Olympics. The surplus in business services increased slightly as exports grew faster than imports.
The bad news is that our deficit in Advanced Technology Products increased by almost $1 billion in July — reversing June’s decline in the deficit. Almost every category saw a worsening of the trade balance except for information and communications technology (ICT) where imports were down more than the drop in exports. 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.
Today’s data also contains revisions for the first half of 2012. Royalty imports and exports revised downward. Business services exports were revised upwards and imports revised downward, both by significant amounts. As a result, the surplus was revised upwards by over a $1 billion in June and close to that amount in the other months of 2012. It is unclear the reason for the size of the revision, other than it incorporates monthly data which tends to be more comprehensive when it comes to business services.
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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.

And the winner is … design

We now know the value of rectangles and rounded edges. According to a jury in San Jose, they and other features of the iPad and iPhone are worth about $1 billion. That is what Samsung owes Apple in damages for infringing on their patent. But Apple v. Samsung was no ordinary patent case. Setting aside that this was a battle of technological titans, the subject of the patents was extraordinary. Apple argued that the “look and feel” of Samsung’s products copied Apple’s. Apple even led off the trial with designer Christopher Stringer. Samsung tried to argue that Apple’s designs were inspired (aka copied) from others such as Sony.
The implications for the smartphone wars of this decision are not yet known. Some foresee more design patent fights. Some claim that Samsung and other can work around the design issues. Others see a new wave of innovation in smartphone design. What is clear is that design, not just technology, has taken center stage as a competitive advantage in the global marketplace.
Unfortunately, the U.S. may be unilaterally disarming in this coming battle. Or more likely, simply letting a competitive advantage erode. Our technology policy ignores the role of design in sustaining a competitive edge. We seem to simply assume America’s continued preeminence in this area.
As important, we are in danger of failing to learn the lessons from Apple v. Samsung for our innovation policy. Our policies seem to continue to stress the technological gadget part of innovation without coming to grips with the cutting edge functionality of the design that makes the gadget compelling. Likewise our model of innovation is stuck in the linear basic science-to-product mode, ignoring what the practice of design teaches about the process and sources of innovation.
There are two elements of design our innovation policy needs to embrace: how good design creates a competitive advantage, and how the process developed by designers (“design thinking”) can be utilized to improve innovation.
The first part is obvious. Almost a decade ago, the UK Design Council documented that the stock prices of design-intensive companies consistently outperform the market. More recently, they have estimated that every £100 spend on design by these “design alert” companies results in a £225 increase in revenues. In the U.S., there have not been comparable studies. But anecdotal evidence points to the same conclusion. Compelling design wins markets.
The second point is not so obvious. “Design thinking” is a term often misunderstood. It refers to the process used by designers that involves deep customer involvement, iterative design and rapid prototyping. Rather than follow the linear model of innovation, this process brings together multiple inputs to create innovation goods and services. As Tim Brown, president and CEO for the design firm IDEO notes, “Design thinking is a human-centered approach to innovation that draws from the designer’s toolkit to integrate the needs of people, the possibilities of technology, and the requirements for business success.”
Pioneered by IDEO and others, the approach is taught at University of Toronto’s Rotman School of Management, the Stanford Hasso Plattner Institute of Design (the d.school) and the Institute of Design at the Illinois Institute of Technology (IIT), among others.
So, where does design and design thinking fit in our innovation policy? Given that design is a key element of competitive success, it should be right up front. We have various R&D programs. We have numerous programs to support STEM education and university engineering research. We have the SBIR/STTP programs to bring bench science to commercialization. Where are the programs to support research, teaching and utilization of design and design thinking?
They don’t exist.
Let me suggest three easy ways to change that. First, expand the Manufacturing Extension Partnership (MEP) program to specifically include design and design thinking as part of their services. This would be a logical extension of their existing Next Generation Strategy. Second, create a Design Research Center as part of the National Science Foundation’s (NSF) Engineering Research Center (ERC) program. This center would promote research on and teaching of integrated design thinking. Third, expand existing engineering scholarships and fellowships to specifically include the study of and research on design and design thinking.
Apple v. Samsung has demonstrated beyond doubt the competitive advantage of design. If America is to maintain its competitive edge, design and design thinking need to be incorporated into our innovation policy. Failure to do so will result in yet another economic advantage slipping away.

August employment

Mixed news from BLS this morning on the employment situation. The number of jobs went up somewhat by 96,000 in August while the unemployment rate dropped to 8.1%. According to the Wall Street Journal, economists had been expecting a gain of 126,000 jobs with the rate staying at 8.3%. The biggest employment gains were in health care, food services and drinking places, and professional and technical services. Manufacturing dropped by 15,000 due to declines in the auto industry. Interestingly, employment in auto dealers went up. Wholesale and retail trade gained jobs, as did the financial sector. State and local governments continue to be a drag on employment – as they shed 10,000 jobs in August. Federal government employment went up by 3,000.
There were more hopeful signs in part time employment, where the total number of involuntary underemployment declined by 210,000. Both the number of individuals working part time because of slack work and those who could only find part time work declined in August. However, the large drop of 140,000 in those working part time because of slack work could either be due to increased hours or being laid off completely.

Treating the waves as an asset

There was a great story in the Washington Post about what happens when you treat something as an intangible asset. All of a sudden, it has value. And then a case can be made that the value needs to be protected. Such was the case that surfers first made in 2002 about the waves off Rincon, Puerto Rico. The result was the birth of a new way of looking at the environment, according the Post story, “Surfonomics quantifies the worth of waves.”:

Surf­onomics is an offshoot of natural resource economics that seeks to quantify the worth of waves, both in terms of their value to surfers and businesses and their non-market value — or how much people would be willing to pay not to lose them.

In the case of the waves off Rincon, a real estate development was blocked because it would result in damage to the reef. Lose the reef, lose the waves, lose the surfers, and lose the tourist dollars. And it turns out that surfing is big business — worth over $2 billion to the US economy annually. Just the waves off Half Moon Bay, CA generate annual revenues of $23.9 million from visiting surfers and spectators. All of a sudden, those waves are worth protecting.

Pisano on Chandler and organizational innovation

I recently came across an essay by Gary P. Pisano of the Harvard Business School on “The evolution of science-based business: innovating how we innovate.” That subject matter is interesting in and of itself. But what I want to highlight is something different: the set up of his argument. The essay is part a special issue of the journal Industrial and Corporate Change: “Management Innovation-Essays in the Spirit of Alfred D. Chandler, Jr”. What I found compelling was Pisano’s summary of some of Chandler’s core thesis:

2. Chandler’s core propositions
Through his studies of the rise of the modern corporation and managerial capitalism in the United States, Alfred D. Chandler advanced three core propositions: (i) technological innovation and organizational innovation are interdependent; (ii) new forms of business organization and institutional arrangements are invented to solve specific economic problems; and (iii) organizational and institutional innovation is an evolutionary process–nothing guarantees “we get it right” every time. Together, these propositions constitute what might be called a “Chandlerian perspective” on the structure and organization of economic activity.
2.1 The interdependence of technological and organizational innovation
For decades, scholars have tried to understand the forces that influence the rate and direction of inventing activity. [Footnote: See e.g. National Bureau of Economic Research (1962) The Rate and Direction of Inventive Activity.] A subset of the innovation community, starting with the work of Nelson and Winter (1982), has long recognized that the “right” institutional arrangements play a critical role in facilitating technical advance and the diffusion of innovations. This perspective clearly has its roots in Chandler’s historical studies. Technical advances in steam power, steel making, mechanical engineering, and the like may have made railroads and mass production technically feasible, but it was a host of novel organizational and institutional arrangements–administrative hierarchies, professional managers (and business schools to train those manager), formalized capital budgeting systems, accounting and control systems, corporate governance structures that separated ownership and management–that made them economically feasible. Railroads were, in Chandler’s words, “the first modern business enterprise”:

No other business enterprise up to that time had had to govern a large number of men and office scattered over wide geographical areas. Management of such enterprises had to have many salaried managers and had to be organized into functional departments and had to have a continuing flow of internal information if it was to operate at all. (Chandler, 1977: 120).

A similar pattern repeated itself in other capital-intensive businesses. Advances in the application of mechanical and electrical power to production (and later chemicals) made mass production technical feasible, but again, without access to capital (made possible by the development of more sophisticated capital markets) and creation of administrative structures to coordinate the diverse activities of these large-scale enterprises, mass production would not have been economically possible. After reading Chandler, it is hard to think about technological innovation as anything but tightly intertwined with organizational and institutional innovation.
2.2 Organizational and institutional innovation as the product of human invention
Today, it is easy to take for granted such things as separation of ownership from management, hierarchical organizations, multibusiness corporations, capital markets, accounting and control systems, and other scaffolding of modern economies, as if they were somehow “natural.” Chandler teaches us that there is nothing natural about them. They were inventions. Indeed, virtually every aspect of the business world around us–every organizational form, every management technique, every formal and informal institutional arrangement, every principle of management, and every management function–is the product of human invention. Chandler also helps us understand that often–but not always–these inventions were made in response to very specific economic problems. As noted above, mass production required large infusions of capital. The traditional owner-manager company, institutionally, was not up to that economic task. To raise the requisite amounts of capital required capital markets, and a separation of owners (investors) from managers. The rise of professional management as an occupation was an invention to deal with the need to run these complex enterprises. Business schools were invented to supply such professionals. Other elements of the US system of higher education, particularly engineering focused schools like MIT, also played a critical role in supplying managerial talent for complex enterprises.
2.3 Organizational and institutional innovation as an evolutionary process
The first two points above provide a false impression that economic need and organizational/ institutional innovation mesh tightly. But Chandler teaches us that such a strict functionalist interpretation is flawed. Economic needs arise, but the response of organizations is slow, uneven, and not always perfect. The rise of the modern corporation itself was a constellation of innovations that spanned multiple decades, if not much of the 20th century. Norms about the roles and responsibilities of management, particularly their fiduciary duty to shareholders, probably evolved more in the last two decades of the 20th century than they did during the first eight. Not all organizations responded immediately. Even within the US national context, some responded with a lag and others not at all. The differences get even larger as one moves across international contexts. The notion that novel institutions and organizations always arise to enhance economic efficiency does not stand the test of historical analysis. Business trusts were also an organizational innovation of the late 19th century. It would be hard to argue that these were in any way motivated by a desire to increase economic efficiency, or that they had had any positive impact on efficiency. It took another institutional innovation–antitrust law–to rectify the problem.
Chandler’s analysis covered a period of great economic, technological, and social change in American industry. The propositions above help to explain the way institutions–particularly business organizations and markets–evolved to adapt to the challenges created by these changes. In short, a Chandlerian explanation for US economic success in the 20th century would place a great deal of weight on the country’s superior ability to invent, adopt and adapt innovative organizational structures and practices. Looking at the 21st century through a Chandlerian lens puts organizational and institutional innovation sharply into focus.
There are many potential transformative forces shaping business organization in the 21st century. The one I would like to focus on in the remainder of this essay concerns science, and in particular, the way in which business participates in and shapes science. Recent decades have witnessed intensive organizational experimentation in the way science is generated, diffused, and commercialized. Advances in the sciences of life, energy, and materials offer huge promise both to drive economic growth and improve welfare. Yet, to believe that promise will be realized without organizational and institutional innovation would be to ignore the lessons of Chandler.

Let me paraphrase that last statement: one of lessons of Chandler is that organizational and institutional innovation matter. Unfortunately, this is a lesson that innovation policy often misses. Policy tends for focus on the technological to the exclusion of all other forms of innovation. In our working paper Rethinking Innovation Policy (and numerous postings this and this), we noted that “Innovation policy needs to catch up to the innovation process.” Chandler, as Pisano points out, has described some of the important aspects of the innovation process. Now we have to match our policy to that process.
Tip of the hat to William Miller’s posting on the IC Knowledge Center for bringing this paper (in a different context) to my attention.