Structural or cyclical? Yes, kind of, maybe says JEC

The Congressional Joint Economic Committee has released its 2012 Joint Economic Report. Besides giving an overview of the state of the economy (and providing a platform for differing partisan views on the economy and current policy), the report had this to say about the structural versus cyclical debate:

It is generally very difficult to distinguish unobserved movements in cyclical components of growth from structural components and especially so when the time period of interest is relatively recent and relatively short. Some recent studies have concluded that much of the sluggish growth is the result of long term trends that were unrelated to the recession, such as the demographic changes in the labor force as the baby boomer generation retires. Even so, cyclical factors remain a significant force in restraining overall economic growth.
. . .
Even if some of the weakness in product demand growth reflects structural factors, the extraordinary size and persistence of the output gap serves as an indication for macroeconomic policymakers that both monetary and fiscal policies should be promoting aggregate U.S. demand, at least over the near term.

In other words, multiple actions are need to address both the structural and cyclical problems. However, the Report falls short of what those actions might be. With the threat of the fiscal cliff overshadowing the Report, one can understand its focus on the macroeconomic and cyclical issues. I wish, however, the Report had looked a little more at ways to attack the structural issues.

New OECD paper on US innovation

A new working paper from the OECD looks at Strengthening Innovation in the United States. According to the abstract:

The US innovation system has many strengths, including world class research universities and firms that thrive in innovation-intensive sectors. However, fissures have begun to appear, notably in the areas of human capital development, the patent system and manufacturing activity, while public investments in R&D and research universities are at risk of being curtailed by budget cuts. Revitalizing the dynamism of innovation has become a priority for US policymakers. To this end, it is important that federal and state governments sustain financial support for knowledge creation. The US workforce’s skills will need to be upgraded, especially in STEM fields, and measures taken to provide more favourable framework conditions for developing advanced manufacturing in the United States. While the recent patent reform is a big step in the right direction, patent reform needs to be taken further by ensuring that the legal standards for granting injunctive relief and damages awards for patent infringement reflect realistic business practices and the relative contributions of patented components of complex technologies.

A couple of other important topics covered by the paper did not get into the abstract. These include strengthening innovation in manufacturing and encouraging entrepreneurship. They also repeat the now standard call for combining agencies in to a national innovation agency.
Most of these recommendation are one we have heard before. I was disappointed that additive manufacturing was not discussed or even acknowledge in the paper. And my take on government re-organization is that we need to start thinking about networks more and formal bureaucratic organizations less (see previous postings). Rather, I support the idea of a Quadrennial Competitiveness Assessment by an independent panel of the National Academies, a Biannual Presidential Competitiveness Strategy that lays out the president’s competitiveness agenda and policy priorities, and an Interagency Competitiveness Task Force (see previous posting).
The discussion of the patent system is the one area that is beyond the current debate. The paper calls for patent reform to take the next step:

Patent reform (America Invents Act) needs to be taken further by ensuring that the legal standards for granting injunctive relief and damages awards for patent infringement reflect realistic business practices and the relative contributions of patented components of complex products.

I think few in Washington are interested in revisiting patent reform at this time. But it is good to try to keep in on the agenda.
I do have another complaint: the introductory section on the health of the innovation enterprise in the US defaults to the standard measures of R&D spending and patents (their Figure 2 in the paper). They do discuss other measures, such as the innovation survey and multifactor productivity. But the highlighting of patents and R&D spending as proxies is still disappointing. I wish we would confront our “drunk under the lightpost” problem directly.

Advice to the UK — look at that IP locked up in bank collateral

I’m finally catching up to some administrative work on the Athena Alliance website — specifically posting an article that appeared a couple of months ago. The article, “Unlocking the Hidden Value of Intangible”, was published last fall in Crossbow Magazine in the UK and is published by the Bow Group which serves as “an intellectual home to Conservatives in the United Kingdom.”
That article looks at the issue of intangible assets and bank loans. Many bank loans already put liens on companies’ intangibles as part of the loan process. But intangibles are sweep up in an “all asset lien.” These intangibles are not specifically counted as collateral and banks rarely even know what is included. Thus, companies do not receive the full funding level for which they could otherwise qualify. The article argues that the Bank of England should institute a program to identify the intangible assets that are part of bank collateral. As part of the Funding for Lending Scheme (FLS), the Bank swaps additional capital for bank loan portfolios. As the Bank assesses the adequacy of collateral it receives from participating banks, it is in a perfect position to identify the intangible assets that are part of that collateral. Based on that review, standards for what is acceptable loan collateral could be developed to explicitly count those now hidden assets.
Given that this issue of Crossbow was timed for the Conservative Party’s annual conference, maybe someone in the British government read the piece. Maybe someone on this side of the pond might as well.

October trade in intangibles – and revisions

Disappointing news from this morning’s BEA trade data. The trade deficit rose by $1.9 billion in October to $42.2 billion from $40.3 billion in September, revised. Economist had expected a deficit of $42.7 billion. One part of the story is that exports dropped by $6.8 billion while imports fell by $4.9 billion. The drop in exports may be a result of a combination of global economic slowing and Superstorm Sandy which closed many east coast ports. Increased imports petroleum goods was the other large part of the story. Both imports and exports of non-petroleum goods were down, resulting in a slight improvement in the non-petroleum goods trade deficit.
The good news is that our surplus in intangibles increased slightly in October by $106 million to $14.5 billion. Exports were up by $191 million while imports grew by $86 million. Both royalty receipts (exports) and royalty payments (imports) were down slightly – with exports down more than imports resulting in a decline in the surplus of $30 million. As in previous months, the surplus in business services increased slightly as exports grew faster than imports. As this data indicates, however, the changes in the intangible trade were negligible — especially compared to the size of the overall deficit.
The really bad news is a surge in the deficit in Advanced Technology Products, which grew by over $2.9 billion. The biggest change was an almost $1.9 billion increase in information & communications technology imports. 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 release also contains a revision in services data for April through September. Royalty receipts (exports) were revised downward and business services were revised upwards. As a result, the royalty surplus was lowered and the business services surplus was raised. Given that the revisions to business services were larger, the total intangibles surplus was revised upward by a total of $651 million over the six month period.
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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.

Why locating design and manufacturing together matters

One of the tenets of the industrial age was that activities could be separated and specialized. Researchers researched, engineers engineered, managers managed, and workers worked. The parts didn’t need a lot of communications between them. In fact, the old saying about product design was it was “throw over the transom” between departments [for those of you who don’t know the expression, the transom is the window over a door — the saying means you didn’t even have to open the door to pass the design along]. As advances in technology moved along, it became earlier to break up product design from production. This created the idea of an international division of labor that mimicked the company’s division of labor. Production was moved to low labor cost locations. Advanced nations would specialize in research, design and other higher value-added activities.
However, it never completely worked that way in reality. As Gary Pisano and Willy Shih of the Harvard Business School [and many others] pointed out, those higher valued-added activities have followed production offshore (see earlier postings). Turns out that the linkages between production and other parts of the value chain are stronger that we thought. For example, I have mentioned numerous times before that companies which make the product have strong service value (resulting in a fusion of goods and services). A recent article in The Atlantic (“The Insourcing Boom”) succinctly describes one of the linkages:

GE is rediscovering that how you run the factory is a technology in and of itself. Your factory is really a laboratory–and the R&D that can happen there, if you pay attention, is worth a lot more to the bottom line than the cost savings of cheap labor in someone else’s factory.

The article gives a clear example from GE’s GeoSpring water heater of how this works:

The GeoSpring suffered from an advanced-technology version of “IKEA Syndrome.” It was so hard to assemble that no one in the big room wanted to make it. Instead they redesigned it. The team eliminated 1 out of every 5 parts. It cut the cost of the materials by 25 percent. It eliminated the tangle of tubing that couldn’t be easily welded. By considering the workers who would have to put the water heater together–in fact, by having those workers right at the table, looking at the design as it was drawn–the team cut the work hours necessary to assemble the water heater from 10 hours in China to two hours in Louisville.
. . .
So a funny thing happened to the GeoSpring on the way from the cheap Chinese factory to the expensive Kentucky factory: The material cost went down. The labor required to make it went down. The quality went up. Even the energy efficiency went up.
GE wasn’t just able to hold the retail sticker to the “China price.” It beat that price by nearly 20 percent. The China-made GeoSpring retailed for $1,599. The Louisville-made GeoSpring retails for $1,299.
Time-to-market has also improved, greatly. It used to take five weeks to get the GeoSpring water heaters from the factory to U.S. retailers–four weeks on the boat from China and one week dockside to clear customs. Today, the water heaters–and the dishwashers and refrigerators–move straight from the manufacturing buildings to Appliance Park’s warehouse out back, from which they can be delivered to Lowe’s and Home Depot. Total time from factory to warehouse: 30 minutes.

As the I-Cubed Economy develops we are seeing an interesting phenomenon: linkages are becoming tighter and more important. While it is possible to have engineer and production workers half a globe away, it is better to have them next door. The same, I would guess, can be said for many parts of the production process. As a result, expect to see a new economic landscape emerge – very different from that we have lived with in the past.

November employment

November’s employment data from BLS showed an increase of 146,000 jobs with the unemployment rate dropping to 7.7%. Economists had warned that the numbers might be a little strange, in large part because of Hurricane Sandy. But that does not seem to have been the case [economists has estimated that only 80,000 new jobs with unemployment rate 7.9%]. Notably, employment went up in professional and business services, as well as retail trade, and health care. Employment in information industries was also up, with the category of “motion picture and sound recording” contributing all most all of the growth.
Involuntary underemployment in November continued the pattern from October. The total number of involuntary underemployment dropped again in November by 158,000 after declining by 257,000 in October. The number of individuals working part time because of slack work also continued its decline by 117,000 but while the number of those who could only find part time work rose slightly by 27,000. 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.

About that knowledge tax credit

Last night, Senator Marco Rubio (R-FL) was honored with the Jack Kemp Foundation’s Leadership Award. In his speech, Senator Rubio touched on a theme that I have supported for a number of years:

our tax code should reward investment in education. If you invest in a business by buying a machine, you get a tax credit for the cost. If there is a tax credit for investing in equipment, shouldn’t there be a tax credit for investing in people?

As I noted in The Economists’ Voice last year (see earlier posting),

One policy change would be to turn the R&D tax credit into a broader knowledge tax credit. A knowledge tax credit would apply to company expenditures on worker training and education — just like the R&D tax credit applies to expenditures on research activities. In only make sense that boosting worker skill levels is a necessary compliment to any activities to raise innovation and productivity. After all, innovation doesn’t come solely from the lab any more.
It also makes sense to pair the knowledge tax credit with any efforts to incentivize increased investment in plant and equipment. If we give companies incentives to conduct research or invest in new equipment we should also give companies incentives to invest in their most valuable asset: their workers.

It is becoming clear that a major tax reform effort will be undertaken in the next few years (once we get past the immediate fiscal crisis). The knowledge tax credit need to be part of that effort.