Revised 2Q 2013 GDP show intangibles down

There is good news and bad news in this morning’s revised 2Q GDP data from BEA. The good news is that the GDP an annual rate of 2.5% rather than the weaker 1.7% reported last month in the advanced estimate (see previous posting). The upward revision was due in part to better than estimated number on the trade deficit. The revision was even larger than the 2.2% revised growth rate that economists had expected.
The bad news concerns the new GDP category of “intellectual property products.” As you recall from my earlier discussions, this category includes research and development; entertainment, literary, and artistic originals; and software. Last month’s advanced estimates showed business investment in this subset of intangible assets growing in the 2Q by a healthy 3.8%. According to today’s data, investment actually declined by 0.9%.
The new data does not break down the three components of this new category. Nor does it give the reason for the large revision. But it is worrisome that this major driver of future economic growth has gone negative.

Algorithmic Economy

Hezekiah Agwara, Philip Auerswald, and Brian Higginbotham at George Mason University recently published an important new paper on “Algorithms and the Changing Frontier“. Given at an NBER conference on The Changing Frontier: Rethinking Science and Innovation Policy, the paper actually covers two topics: a discussion of the algorithmic economy and the role of standards in globalization (in the context of the algorithmic economy).
On the first topic, they lay out an interesting refinement of what a number of us have been discussing as the knowledge economy:

In the science-based (aka New Growth) model, technological distance does not exist; newly discovered recipes add to aggregate knowledge as soon as they are put into practice. In the algorithmic model, search for better recipes is constrained both by technological distance and by the complexity of the production process. Newly discovered recipes that are not easily imitated are the essence of economic differentiation and the basis for above-normal profits; the interoperability of recipes is essential to the functioning of complex supply chains.
In this light, consider the notion, central to the science-based model, that both ideas are “nonrival” and “non-excludable,” economically relevant innovations are characteristically subject to “knowledge spillovers.” In the algorithmic model, the ideas that actually propel growth and development are overwhelmingly uncodified, context dependent, and transferable only at significant cost–which is to say that tacit knowledge dominates, information asymmetries are the norm, and transactions costs are significant.
While knowledge spillovers of the type that are central to the science-based model clearly exist, they are unlikely to be of significant relevance in the practical work of creating the new business entities that drive twenty-first-century global value chains. The reason for this is that most productive knowledge is firm specific and producers far from dominant production clusters must learn to produce through a process of trial and error. Market-driven innovation involves the search for ideas that are rivalrous and excludable (at least temporarily), out of which ventures with proprietary value can be created. The impediments to innovation that matter most are not a lack of appropriability of returns but the everyday battles involved in communicating ideas, building trust, and making deals across geographically disparate regions and diverse economic units (Auerswald, 2008).
. . .
The emphasis of the science-based model on product innovation naturally leads to a view of the economic frontier in which technology adoption or transfer (largely based on technical standards) are the main conduits for global innovation and knowledge stocks are well represented by patents. The algorithmic model begins with the premise that product innovation is impossible without process innovation; the conversion of new or improved products, and the related technical standards, into commercial products of global value requires substantial innovation in production processes. Not all firms are at the boundaries of the production possibilities frontier, and differences in the quality of operational processes could separate firms with largely similar technical capabilities. Symmetric access to product innovations does not suggest a convergence in productivity.

In other words, development of a technology is not enough. While “technologies” (aka ideas/recipes) are nonrival and non-excludable, implementation can (and does) create excludability.
This insight goes beyond the process of technology development. I have always argued that knowledge economy is broader than just science-based. So what is interesting about this discussion is that the insight can (and should) be applied to all knowledge-based innovation — not just science-based. Substitute “business model” for “technology” and “product development” in the above discussion, and ideas remain the same. The key to success in the “knowledge” economy is not simply the creation of knowledge but the ability to utilize that knowledge.
Thus, I would argue that innovation requires a host of other concomitant investments that go well beyond the standard Washington S&T consensus — i.e. fund R&D and innovation will take care of itself. We need a revamped innovation policy that understands this point. We need a new consensus that innovation, not just science, is the real endless frontier.
Just a quick word on the second topic of standards and their place in globalization. The authors find a correlation between acceptance of ISO 9000 and various knowledge-economy measures. They describe three reasons:

1)”ISO certification eases entry into production and distribution networks on a global scale because it signals a willingness and a capability for low-transactions cost integration into global production networks.”
2) “. . . the process of completing ISO certification serves as a learning tool that materially improves productive efficiency . . .”
3) “ISO certification increases functional compatibility and interoperability according to global norms, and thus eases adoption of platform technologies, or general-purpose technologies.”

Thus standards are an important part of spreading the algorithmic economy.

Sharing Economy as part of I-Cubed shift

There is a recent report out on a new model for the economy: World Economic Forum YGL Sharing Economy Working Group Position Paper. According to the report, the Sharing Economy (aka Collaborative Consumption) is part of the movement from an “asset heavy” to an “asset light” lifestyle where temporary use (rental, like-exchange, gifting) replaces ownership. As the report notes:

When combined with the power of new technologies, particularly mobile platforms in today’s global village, collaborative models of consumption, production and marketplace creation – such as Airbnb, Etsy, TaskRabbit, RelayRides and many others – stand to reinvent and redefine these timeless behaviors on a scale and in ways never possible before.

From my perspective, the Sharing Economy is part and parcel of the I-Cubed (Information-Innovation-Intangible) Economy. It is a business model growing out of shift from emphasis on products to solving customer needs and the resulting fusion of products and services (see some previous postings). I would note that the “asset light” part of the description refers only to tangible assets. The Sharing Economy is actually intangible asset heavy. For example, it requires high levels of key intangibles such as trust and reputation. And it has a much deeper social and community aspect to it as well. It also needs careful review of government policies to succeed.
The report outlines factors that make sharing a success:

Generally speaking, collaborative consumption businesses work best when they meet certain criteria:
• It is important for the asset to become “liquid,” i.e. easy to share and/ or distribute; this is typically the case for spaces and skills.
• It is also particularly good when the asset has high idling capacity, i.e. low frequency of use, such as cars or spare spaces (commercial and residential).
• Assets that are correlated with a high percentage of income outlay or are expensive to own outright, such as solar panels and luxury goods, due to potential cost savings and/or income limitations.
• Assets that quickly become obsolete, such as baby goods and maternity related clothing and products.
• Assets that have no demand or supply limitations, or whose value increases because of the fact it is shared (such as travel experiences), are other hallmarks of this space.

It is important to note that consignment shops and flea markets have been dealing in the re-use of goods for years. What had changed is not the resale of goods but the deliberate temporary use of those goods. As a result, there is a shift in the business model as noted above. The report gives an example of this:

Traditional car manufacturers have partnered with car sharing companies (GM and RelayRides) and developed their own car sharing initiatives (BMW, Daimler), while ride sharing services can work with taxi cab companies to maximize utilization of unused cabs (Uber). They have begun to look at a future in which customers are more interested in having access to “mobility services” than owning a car, and developing offerings accordingly.

The report notes the legal, regulatory and policy issues involved:

Many existing public policies and laws can help or hinder the sharing economy. Equally important, many policies drafted in the ownership era are silent about sharing – creating a “gray area” in which activities are neither legal nor illegal. Today the most contentious issues focus on taxation, insurance, zoning and licensing, and consumer protection (including personal data) issues.

One specific set of recommendations for government I found especially interesting – and problematic. That is the use of government assets in the sharing economy. I have long advocated better use of government intangible assets (see previous posting on government investments in intangible assets). But the examples given here are about use of tangible assets, specifically space and vehicles.
Space is less problematic as there is a history of public/private partnerships (PPP’s) in real estate development. Although there is also a history of criticism of such arrangements, there are ways of ensuring public benefit and avoiding private capture. Government rental of other assets, such as vehicles, raises the question of pricing and unfair competition by government entities. Governments can often price well below what a private sector could. For example, since the government already has its fleet of cars it could price a car sharing service at marginal costs which are lower than a private company could charge.
Of course, the long term answer to that might be for the government to get rid of its fleet and participate as a customer in a car sharing service. That gets into a whole other area of the outsourcing of government activities.
Such issues of pricing and outsourcing are not new (I was involved in legislation on pricing, access and competition with government entities back in the 1980s). But they do need to be added to the list of government policies to be reviewed.
The report astutely recognizes that there may not be a one-size-fits-all answer to these issue. Thus, they recommend local government set up Sharing Economy Working Groups to address these issues. I would take that a step further and recommend that the federal government also set up such a working group with two separate but interrelated tasks: 1) review federal policies concerning the development of the Sharing Economy market and 2) review internal government management policies and procedures concerning the ability of the federal government to participate in the Sharing Economy.
This latter part also has a dual role. The federal government may be able to reduce costs and improve efficiency through sharing. The participation of the federal government may also help jump start the development of the Sharing Economy in certain locations. Government procurement has always been an important factor in promoting or inhibiting innovation. Making sure it gets used to promote innovation in this case would be of benefit to us all.

Before there were trolls, there were sharks

With all the news about patent trolls, you may find this bit of history interesting — from Patent Alchemy: The Market for Technology in U.S. History. Apparently, in the 19th Century, a similar phenomena occurred – labeled sharks:

The best known examples of such predators targeted railroads and farmers. In the case of railroads, a shark named Thomas Sayles bought rights to three overlapping patents for “double-acting” brakes that had been issued initially to three different sets of inventors. Whenever a railroad licensed one of the patents, Sayles would sue it for infringing on the other two. In response to these and other, less notorious claims, the railroads banded together in trade associations to take joint legal action. Battling Sayles all the way to the U.S. Supreme Court, they won an important victory in 1878 in which the Court effectively limited the amount that sharks could extract by ruling that infringers were liable only for the incremental benefits they garnered from using a particular invention over possible substitutes.
In the cases involving agriculture, the outcome was mixed. During the 1870s and ’80s western farmers were deluged with threats of legal action if they refused to pay licensing fees for a range of devices they were using–from barbed wire to milk cans to plows to drivewells (basically, pumps attached to pipes driven into the earth with a sledge hammer.) These cases seem to have flourished because there was uncertainty about the value and legitimacy of many of the patents on such devices, and because farmers in the more remote parts of the country were still prey to the kinds of unscrupulous itinerant agents described above. Like the railroads, farmers banded together in associations to fight the harassment in court. In the case of drivewells, farmers eventually managed to get the offending patent invalidated. In other cases, for example barbed wire, they repeatedly lost in the courts. Nonetheless, the farmers’ increasingly well-organized opposition took its toll on the sharks’ business–first, by raising the litigation costs involved in enforcing patent rights, and second, by changing the political environment in ways that discouraged local officials from aiding patent owners. By the time the Populist movement swept through the region in the 1890s, the problem had significantly abated.

The paper does not mention one of the later and important anti-patent activities, however. I’m referring to the fight by Henry Ford to break the Shelden patent on the automobile (actually on the internal combustion engine) and overturn the Association of Licensed Automobile Manufacturers. (See Monopoly on Wheels: Henry Ford and the Selden Automobile Patent.) Had that patent not been thrown out, it is unclear that the auto industry would have developed into a mass consumption industry as it did.
Does all this sound familiar?

Medical tourism – to Europe

Over the years, I’ve written a number of pieces on medical tourism. Here is a new twist from a story in the New York Times on “The Growing Popularity of Having Surgery Overseas“:

While five years ago most American patients who went abroad for cheaper care went to countries like India and Thailand and over the border to Mexico, many are now going to Europe, where care at top hospitals frequently costs a fraction of what is charged in the United States. There are private facilitators who help make the arrangements, pairing patients with doctors and hospitals and arranging travel plans.
In the last few years, governments and hospitals in Europe have entered the field and are now promoting their services.

At one point a number of years ago, medical services were something that the US sold to the rest of the world — especially the wealthy from abroad who could afford a trip to the Mayo Clinic, for example. Now we may be on the verge of importing medical services in the form of more American going to Europe for treatment.
The story also point out an interesting dysfunction of the U.S. health care market:

Medical tourism, it turns out, does not have to be international. (Medicare does not currently cover joint replacements outside the United States.) Some economists point out that health plans in New York City, a relatively expensive market, could save money by sending their patients to Buffalo in limousines.

What will this all mean for attempts by many localities to use health care as the driver of economic development? One answer, find ways to keep cost down and quality up and you become the destination of choice.

Some thoughts on Jeff Bezos and the Washington Post

Lots of ink has been spilled and bandwidth used to discuss the sale of the Washington Post to Amazon founder Jeff Bezos. I have just one thought to add to the discussion. For all the talk of Jeff Bezos as “innovator”, we can easily lose sight of his other real strength – leverage. The Amazon predictive analytics tools are truly innovative. But it has been Bezos’ ability to build upon his innovations that has set him apart.
Bezos built up a system to sell books online based on price arbitrage. He recognized that the large differential between publisher’s wholesale prices and bookstores retail provided an entrepreneurial opportunity. However, it was the fulfillment process that turned the opportunity into reality and made online sales possible.
Remember Tom Freidman’s 1999 prediction that Amazon would never generate profits because anyone could replicate their business model from a spare bedroom? Well, Freidman was right in the broad sense that the .com retailers were overhyped. But he was wrong about the ability to replicate the Amazon model. He saw it as simply price arbitrage. In reality it was customer service and logistics.
Bezos genius was to then leverage this infrastructure from selling books to selling anything. This set up the 21st Century battle to be the dominate online platform with eBay (who has come at a similar point from its more distributed model as befits its history).
What does this mean for the Washington Post? Look more for opportunities to leverage the Post’s journalistic assets rather than radical “innovation.” There are a couple of possible examples. The conventional route would be to expand into more in depth analysis – similar to the Economist’s special reports and more proprietary publications. (Interestingly, the Washington Post Company is not selling some of its other publication, such as Slate, which would have provided a natural linkage).
The other would be to tap into the recent interest in political intelligence for economic reasons. The establishment of Bloomberg Government is a possible model. One can envision a sister organization to the paper tapping into those journalistic assets.
As a recent BusinessWeek story notes, Bezos loves content. So look for innovation that actually is leverage of content in new ways. And that will be innovation indeed.

June trade in intangibles

This morning’s trade data from BEA was something of a shocker: the deficit fell by $9.9 billion to $34.2 billion in June. Economist had been expecting a deficit of $43.5 billion. Exports were up by $4.1 billion while imports were down by $5.8 billion — a good combination. Part of the improvement was due to lower imports of petroleum goods. But imports of non-petroleum goods were also down and exports up. The better than expected news means that GDP estimates for the 2nd quarter are likely to be revised upward from the initial estimate of 1.7% (see earlier posting).
Our surplus in pure intangibles trade more of a mixed bag. Exports of business services dropped slightly but imports dropped more resulting in a slight increase in the surplus. Royalty receipts (exports) rose slightly more than royalty payments (imports). As a result, the intangibles surplus basically remained the same, up by only $38 million in June to $15.8 billion
After surging for the last couple of months, our deficit in Advanced Technology showed a dramatic drop to $3.4 billion in June from almost $7.2 billion in May. Almost every category showed improvement with the most dramatic in information and communications technology, where imports dropped by $1 billion and exports increased by by almost $900 million. Exports of aerospace grew by almost a $1 billion as well. 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.
Advanced Technology goods also represent trade in intangibles. These goods are competitive because their value is based on knowledge and other intangibles. While not a perfect measure, Advanced Technology goods serve as an approximation of our trade in embedded intangibles. Adding the pure and embedded intangibles reveals an overall surplus of $12.5 billion
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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.

Changing how ITC deals with patents in Section 337

In the latest twist on the Samsung/Apple patent wars, the Obama Administration — specifically US Trade Representative Michael Froman — vetoed an International Trade Commission (ITC) order banning the importation of some Apple products (see Froman’s letter). It remains to be seen whether this action is likely to have a major impact on future cases. This could be a one-off action or it could set a trend (for example, see various opinions from the WSJ to ComputerWorld). It does illustrate that the ITC has become a major venue for patent infringement litigation. And the heightened attention to the ITC’s role is a positive development in and of itself.
The ITC’s jurisdiction stems from its Section 337 authority to treat patent infringement as an unfair trade practice and bar importation of the of offending good (see ITC’s Summary of Statutory Provision Related to Import Relief). Since the remedy is exclusion of the product from the U.S Market, this power is parallel to the old practice of the courts to impose an immediate injunction on the sale of the product. The Supreme Court found this policy of mandatory injunction problematic in the E-Bay vs. MercExchange case (see earlier posting). A similar result is needed for Section 337.
In other words, the issue is not with the ITC or USTR and their decisions in this case. The issue should be the appropriateness of the underlying statute.
Suggestions have been made on changing the ITC role (see “The Topsy-Turvy ITC”), such as “(1) removing ITC jurisdiction over U.S.-based parties, even if they manufacture products overseas, (2) removing ITC jurisdiction over cases in which a remedy is otherwise reasonably available in the U.S. courts, and (3) limiting the availability of exclusion orders involving standards-essential patents along the lines recently proposed by the FTC and others.” Some have even called for repealing Section 337. I propose we look at a more radical and different approach. Let’s treat patent infringement similar to dumping or subsidies.
Trade law is well established to deal with dumping and subsidies. The remedy is monetary in the form of tariffs and countervailing duties (CVD). Why can’t a monetary remedy similar to a CVD be assessed in a patent infringement case? I realize that this would separate patent infringement cases from the rest of Section 337. There may be good reasons an unfair trade practice (“standard”) 337 case can only be enforced through exclusion. But in the case of patents, the point should be monetary compensation, not automatic injunction.
I also realize this would put a new burden on the ITC of determining the appropriate level of the CVD. A solution would be to break up the process as is now done in CVD cases between Commerce and ITC. Of course, it would be key to make sure that the funds go to the plaintiffs not the U.S. Treasury since the purpose is to recompense the plaintiff for the lost income from the infringement. I do understand this might have some WTO issues (as evidenced by the problems with the Continued Dumping and Subsidy Offset Act of 2000). But regardless of the technical difficulties, shifting from a death sentence approach to a graduated response might help ease the litigation problems – both at the ITC and in the patent wars in general.
By the way, if you think that the ITC patent battles only cover high-tech, think again. Here is a recent ITC notice on a case involving alleged patent infringement on “certain muzzle-loading firearms and components.

July employment data

As you have probably read in numerous places, the July employment data from BLS was lack luster. Employment rose by 162,000, which was less than expected. And unemployment rate dropped slightly to 7.4% but only because fewer people were looking for work.
One of my key trends to watch is that of the involuntary underemployed (part-time for economic reasons) — which represents a waste of human capital. The total number of involuntary underemployed declined very slightly in July – basically status quo. But the components shifted. Those who could only find part-time work increased while those on slack work declined. However, the number of involuntary underemployed spiked at the onset of the Great Recession and has stayed at a historically high rate with only a slight downward trend (as the chart below shows). If this is the “new normal” then we need to worry about whether we are permanently under-utilizing our human capital.

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