It might be the proverbial warning shot across the bow. The U.S. economy shrank by 0.1% in the last three months (fourth quarter – 4Q) of 2012 according to news from BEA this morning. The major problem: a 22.2% drop in defense spending. The second problem: a 5.7% decline in exports including a 0.1% decline in services exports. A draw down of inventories also contributed to the decline — although since sales we up, those inventories will need to be replenished in the coming months. The good news was that nonresidential fixed investment (i.e. business spending) grew by 8.4% compared to a 1.8% decline in the third quarter (3Q) of 2012. The 3Q decline was due to a 2.6% drop in investment in equipment and software. That turned around to a healthy 12.4% increase equipment and software investment in 4Q.
The government-cuts induced economic decline should give lawmakers pause about the upcoming funding cliff known as sequester. Stories out of Capital Hill have been that the sequester will happen — at least for a couple of months. We will see if today’s news changes that.
One other point. As I’ve mentioned before, the data has a basic problem in that it does not give us any guidance on investment in intangibles other than software. So we do not know whether companies have increased or decreased their investments in important areas such as human and organizational capital.
BEA has plans for a major revision in the GDP calculations next year. Two big changes will help make the GDP data more accurate: capitalization of research and development (R&D) and capitalization of entertainment, literary, and artistic originals (movies, music, books, art work, etc.). Currently, both R&D and the cost of creating entertainment, literary, and artistic originals are treated as a direct expense. Under the new system, they will be treated as investments, as they should be since they have long paybacks not just immediate returns.
As part of this shift, investments in these items will be specifically captured in the nonresidential fixed investment data. There will be separate data for software (now a subcategory of equipment), R&D, and entertainment, literary, and artistic originals. This should allow us to get a better picture of the I-Cubed Economy.
Final note: the BEA data on GDP is the “advanced estimates” subject to potentially large revisions. The next revision will be released on February 28.
Devashree Saha and Mark Muro, Create a Nationwide Network of Advanced Innovation Hubs
Bruce Katz and Peter Hamp, Create a ‘Race to the Shop’ Competition for Advanced Manufacturing
Rob Atkinson and Stephen Ezell, Support the Designation of 20 U.S. ‘Manufacturing Universities’
Trends in Technology-Based Economic Development: Local, State and Federal Action in 2012
William B. Bonvillian, “Reinventing American Manufacturing: The Role of Innovation”
“The tech debate blasts off (a linkfest)”
Bloom et al. Management in America
(findings from a new Census survey)
This morning’s trade numbers from BEA come as a bit of a shocker. The deficit jumped by $6.6 billion in November to $48.7 billion. The increase was due to a surge in imports, up $8.4 billion. Exports grew by $1.7 billion. This was in complete opposite to economists’ expectations of a slightly shrinking deficit. According to Bloomberg, economists had expected a trade deficit of $41.3 billion (with estimates ranging from $39.8 billion to $45 billion). The surge was lead by a $4.6 billion increase in consumer goods imports. Declines in oil prices actually help moderate the rise in the deficit. As the chart below shows, our deficit in petroleum goods actually decline in November.
A not quite so bad story can be told about our trade in intangibles. Imports of business services and royalty payments (imports) where both up while royalty receipts (exports) and export of business services were down. As a result, our surplus in intangibles dropped by slightly $106 million to $14.4 billion.
The general bad news was mirrored in the $1.7 billion increase in the deficit in Advanced Technology Products. Similar to last month, the biggest change was a $2.1 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.
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.
Some decent news this morning about the U.S. employment situation from the BLS. Nonfarm payroll employment was up by 155,000 and the unemployment rate was unchanged at 7.8%. This was slightly below what economists had estimated (160,000 jobs and a 7.7% unemployment rate). The other piece of decent news was that November’s job number was revised upwards.
And the number of involuntary underemployed (part time for economic reasons) fell slightly. But, as the charts below show, both the total number of involuntary underemployment and the percentage of involuntary underemployed remains at historically high levels. Is this the new normal? If so, it is a waste of human capital.
The recent deal by Avis to buy Zip Car has generated a lot of commentary. Wired thinks the deal is great. Steven Pearlstein thinks it will be the death of the Zip Car model. Brad Tuttle at TIME has taken a “let’s wait and see” approach. Tuttle does point out the benefits to both Zip Car and Avis. Avis get an easy entry into the growing market of car sharing. It is a market that some think may disrupt Avis’ existing business model — but may be more complimentary than competitive (long term rental for vacation and business travel versus short term immediate trips).
For both companies, what the deal really brings is access to each others’ intangible assets. Avis get the new business model and customer base (at a hefty premium). According to Zip Car’s latest 10-Q filing, the company had total assets of $429.6 million as of September 31 2012. Of that $107.4 million is goodwill and $3.6 million are booked intangible assets (both from various acquisitions). Specific acquired intangibles include noncompete agreements, trade names, member relationship, reservation systems & technologies and rights to parking spaces. Avis is paying approximately $500 million — meaning there is an additional $70.4 million in unbooked intangibles and goodwill that Avis is buying. So 25% of Zip Car’s booked value is in intangibles and 36% of the value of the deal is due to intangible. In contrast, Zip Car’s property and equipment (tangible assets) amount to $175.8 million constitute 35% of the deal. The rest is financial assets held by the company.
Zip Car gets, as Tuttle and the Seeking Alpha blog point out, greater negotiation power with suppliers — including car manufacturers and insurance companies. Zip Car also gets an entry into the business market that they are beginning to target (Z4B).
Time will tell if the acquisition works out. But one think is clear: its’ all about the intangibles.
Over the years, I have written a fair amount about the issue of transfer pricing and intangibles. Transfer pricing is one of those important but highly technical issues that proves the old saying “the devil is in the details.” To help people better understand the issue, I am pleased to announce that the International Management Forum is offering two distance learning courses on transfer pricing.
The first course is a general course on Transfer Pricing. This course will cover a multitude of topics, including: Business Restructuring and Valuation, Transfer Pricing Legislation and Guidelines, Documentation Requirements per region and per country, Transfer Pricing Project and Risk management, Transfer Pricing (pre-) Controversy Management, Design and Development of a Transfer Pricing Policy, Types of Intercompany Transactions, and Intellectual Property and Customs. You can get more information and register for the course at this website.
The second course is a more specific course on Transfer Pricing and Intellectual Property. The issue of transfer pricing and intangibles is one of the hot topics in taxation. As I have noted, the issue has been included in the last couple of budget submissions by the Obama Administration and has been the subject of U.S. Senate hearings. The OECD is undertaking a major project to provide guidance on the definition, identification and valuation of intangibles in the transfer pricing process. Last summer the OECD released a discussion draft on transfer pricing of intangibles and is currently reviewing comments.
This course will look at the current state of play in this evolving topic. It will provide framework to capture the various characteristics of IP, look at the methods that have been provided by the OECD to establish arm’s length pricing or valuation of intra-group transactions of IP, and provide practical ways of implementing of these methods. For more information or to register, go to this website.
Both courses are conducted through distance learning techniques and qualify for CPE credits. Course instructors are praticing professionals from Transfer Pricing Associates and its network partners.
(Note: Athena Alliance is a paid promotional partner for these courses. Athena Alliance does not control the content or the delivery of the course materials and the views expressed by the materials or instructors in these course do not necessarily represent those of Athena Alliance.)
Round 1 of the fiscal cliff regarding the automatic tax increases is over; Round 2 on spending is about to begin. As we go into Round 2 we should keep in mind the importance of government investment in activities that lay the ground work for economic growth, especially intangible assets. William Janeway gets it exactly right in his recent piece in the LA Times “Venture capital didn’t build that:”
Over some 250 years, economic growth has been driven by successive processes of trial and error and error and error: upstream exercises in research and invention, and downstream experiments in exploiting the new economic space opened by innovation. Each of these activities necessarily generates much waste along the way, such as dead-end research programs, useless inventions and failed commercial ventures. In between, the innovations that have repeatedly transformed the architecture of the market economy, from canals to the Internet, have required massive investments to construct networks whose value in use could not be imagined at the outset of deployment.
At every stage, the innovation economy depends on sources of funding decoupled from concern for economic return. As economists have long recognized, such funding will not be delivered by competitive markets. Only an active state in pursuit of politically legitimate missions — national development, national security, conquering disease — can play the required role.
Thus, from the Erie Canal to the Internet by way of the transcontinental railroads and the Interstate Highway System, the American state has played a strategic role in the deployment of the transformational technologies that have created a succession of “new economies.” In disregard of this history, forces have been at work for a generation to delegitimize the state as an economic actor — even as the next new economy can already be defined in broad strokes.
I would add to that list the following: public education (both K-12 and public universities), R&D funding (including physical, biological and social sciences), worker training and development, business assistance and development (including the MEP program), data collection and dissemination (aka the government statistic agencies) and other investments in intangible assets.
Over the next couple of months we will be hearing a lot about government spending. I hope we keep in mind a rule form business: “you need to spend money (invest) in order to make money.” The same is true for economic growth. Public investment in the factors of growth is absolutely vital to the future economic prosperity of the Untied States. Let us hope that we will not be, to use a cliche, “penny wise and pound foolish.”
Happy New Year.