September trade in intangibles

Some good economic news this morning on trade. The BEA data shows the trade deficit declining by $2.3 billion in September to $41.5 billion from the revised August deficit of $43.8. August, revised. Economist had expected the deficit to grow to $45 billion. Exports were up by $5.6 billion while imports grew by only $3.4 billion. The growth of both exports and imports is a sign of an improving economy. Much of the overall improvement was due to a decline in the deficit in petroleum goods. Imports of petroleum goods was up slightly, but exports surged. Our non-petroleum goods trade deficit actually increased by a small amount.
Reversing the trend of the last couple of months, our surplus in intangibles increased in September by $892 million to $14.2 billion. Most of that improvement was due to a decline of $831 million in royalty payments (imports) which reflects the end of payments for the broadcast rights to the Summer Olympics. Royalty receipts (exports) were up slightly. As in previous months, the surplus in business services increased slightly as exports grew faster than imports.
Unfortunately, the deficit in Advanced Technology Products grew in September by $431 million. The biggest change was an increase in information & communications technology and aerospace imports. On the other side, biotechnology imports declined. 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.

Getting the innovation mix right – again

Clay Christensen makes a very important point in his essay in Sunday’s New York Times “A Capitalist’s Dilemma, Whoever Wins the Election.” Unfortunately, it is a point that has been made before in a slightly different form over 30 years ago.
Christensen begins by noting that “innovation” is actually made up of three types:
  • Empowering innovations which “transform complicated and costly products available to a few into simpler, cheaper products available to the many.” These are the new products and services that create jobs and new wealth. He cites the Model T, the first personal computers, the transistor radio and online services as examples.
  • Sustaining innovations which “replace old products with new models.” These are the newest version of an existing product. As such, they create few new jobs but “keep our economy vibrant.” They also account for the bulk of what we call innovation. The example he sites is the a Toyota Prius replacing a Camry.
  • Efficiency innovations which “reduce the cost of making and distributing existing products and services.” These innovation generally reduce the number of jobs but may make the companies more internationally competitive (thereby saving some jobs).
Here is the important insight derived from this taxonomy:

Ideally, the three innovations operate in a recurring circle. Empowering innovations are essential for growth because they create new consumption. As long as empowering innovations create more jobs than efficiency innovations eliminate, and as long as the capital that efficiency innovations liberate is invested back into empowering innovations, we keep recessions at bay. The dials on these three innovations are sensitive. But when they are set correctly, the economy is a magnificent machine.
. . .
In the last three recoveries, however, America’s economic engine has emitted sounds we’d never heard before. The 1990 recovery took 15 months, not the typical six, to reach the prerecession peaks of economic performance. After the 2001 recession, it took 39 months to get out of the valley. And now our machine has been grinding for 60 months, trying to hit its prerecession levels — and it’s not clear whether, when or how we’re going to get there. The economic machine is out of balance and losing its horsepower. But why?
The answer is that efficiency innovations are liberating capital, and in the United States this capital is being reinvested into still more efficiency innovations. In contrast, America is generating many fewer empowering innovations than in the past. We need to reset the balance between empowering and efficiency innovations.

Christensen goes on to blame the situation on what he calls “The Doctrine of New Finance” with its emphasis on RONA (return on net assets), ROCE (return on capital employed) and I.R.R. (internal rate of return).
I believe he has a strong point – but am not sure this is such a new problem. Over 30 years ago, Robert Hayes and William Abernathy published in HBR their seminal paper Managing Our Way to Economic Decline. They argued there are three tasks of a manager:
  • Short term–using existing assets as efficiently as possible.
  • Medium Term–replacing labor and other scarce resources with capital equipment
  • Long term–developing new products and processes that open new markets or restructure old ones.
Companies (and economies) fail when they concentrate on the first two tasks and ignore the third.
Translated into Christensen’s innovation terminology, economies fail when they emphasize efficiency (and sustaining) innovation (short and medium term objectives) over empowering innovation (long term objectives).
Luckily, as history has shown, this emphasis can be overcome. Since the publication of the Hayes & Abernathy article in 1980, there has been a wave of empowering innovation. As I’ve pointed out before, we overcame the competitiveness challenges of the 1980’s by meeting them head on. We put in place a number of new government policies and companies engaged in a new wave of innovation. We need the next wave of policies to meet the new competitiveness challenges we face today.
Christensen has outlined a few of his ideas in his article. There are many more that I could come up with. The point is not whether my list or Christensen’s list is the right list. The point is to have a debate that recognizes the real forces underlying the problem. Simply cutting and “letting the economic work” is a recipe for a new round of managing our way to economic decline.

October employment

The October employment data is out from BLS and the news is much better than expected. The economy added 171,000 net new jobs with the unemployment rate edging up a tenth of a percent to 7.9% (in part because more people were looking for jobs). Economists had expected a net job gain of 125,000 and a rate of 7.9%. As importantly, the data for the past two months were revised upwards. September now shows a gain of of 148,000 jobs rather than 114,000 and August was revised upward to 192,000 from 142,000. Professional & business services, health care, and retail trade were the biggest gainers in October while leisure & hospitality and specialty trade contractors also grew. Overall construction jobs were up were slightly as was manufacturing employment.
The total number of involuntary underemployment dropped by 257,000 — which was especially good news after last month’s big increase. The number of individuals working part time because of slack work dropped by 294,000 while the number of those who could only find part time work rose slightly by 37,000. The decrease in slack work may indicate an increase in demand. As the chart below shows, involuntary underemployment, including slack work, remains well above pre-Great Recession level – although the trend line is down for slack work.

The lessons of Circuit City

Last Friday’s posting made a passing reference to Circuit City. In numerious previous postings, I have held up the now-bankrupt Circuit City electronics retail chain as the example of how not to foster your intangible assets. Now comes an article on the HBR blog by Alan C. Wurtzel on “What Circuit City Learned About Valuing Employees.” Wurtzel is the son of Circuit City founder Sam Wurtzel.
Wurtzel describes how his father became a devote of Douglas McGregor’s “Theory Y” of management. McGregor’s Theory Y argued that workers should be treated as valuable assets — in contrast to what McGregor called Theory X which treated workers as simply cost. According to Wurtzel, the difference between the two is what doomed Circuit City:

Between 1949, when it was founded, and 2000, Circuit City became the largest and most profitable independent retailer of consumer electronics in the country in part because it valued its employees and helped them to grow. However, in the last nine years of the company’s life, new management increasingly relied on Theory X. Yes, the environment was challenging and other mistakes were made. But perhaps the biggest one was to treat staff as disposable economic units. In any business, especially one dealing with the public, employee morale is crucial. When workers are treated as cogs in a machine instead of flesh-and-blood human beings, they naturally fail to give their best efforts. When that happens, sales and margins decline, turnover increases and profits plummet.

Wurtzel goes on to make another important point:

Today, most modern companies use Theory Y policies to attract, retain and motivate staff. They invest heavily in orientation, training, and professional development; their management is interactive and open management; and their performance reviews are as McGregor wanted them to be. At the same time, technology has the potential to take us back to Theory X. Employers can now measure productivity to the split second. Call centers, for example, know how many calls an operator handles per hour, the average time per call and how many sales were made or disputes resolved. UPS can prescribe routes for its drivers, tell how long they spend at each stop and track them through GPS. Any job that regularly requires the employee to use a computer lends itself to the same sort of individual productivity analysis.

These conflicting tendencies — cost versus asset — may well be one of the defining characteristics of the workplace in the I-Cubed Economy.
UPDATE PS: The article by Wurtzel, who also served as CEO of Circuit City until 1986, is a shorten version of his new book: Good to Great to Gone. The title is a take off of the 2001 book Good to Great that touted Circuit City’s successes.