4Q GDP revised downward – and intangible investment upward

This morning BEA published its second estimate of US GDP and revised the economy’s growth rate down to 2.4% from last month’s advanced estimate of 3.2%. According to BEA’s press release, the downward revision was attributed mostly to a lower estimate of personal consumption expenditures. However there was a huge upward revision in the growth in investment in intellectual property products (IPP), i.e. research and development; entertainment, literary, and artistic originals; and software. The advanced estimate had IPP investment growing at 3.2%. The second estimate comes in with a growth rate of 8%.
Not only does this change the number, it changes the story. The advanced estimate had investments in IPP declining somewhat from the 3Q rate of 5.8%. The newest data shows investment in IPP actually accelerating. The BEA statement does not describe why such a big revision. But that is something we need to understand.
IPP percent 4Q13 -2nd.png

Additive Manufacturing as a Disruptive Technology

Last summer I was invited to give a presentation on Additive Manufacturing to the Standing Committee on Defense Materials Manufacturing and Infrastructure (DMMI) of the National Research Council/National Academies. The presentation opened their workshop on affordable, low-volume manufacturing. The material below is a summary of that presentation. The prepublication report on the entire workshop, Limited Affordable Low-Volume Manufacturing: Summary of a Workshop, is available on their website. My presentation slides are also now available.
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Additive manufacturing (aka 3D printing) is a new manufacturing process where materials are deposited (“printed”) layer by layer to create a three dimensional object. As such, additive manufacturing is often viewed as a replacement for traditional manufacturing. However, this is not the appropriate way to frame any economic discussion of additive manufacturing technology. Instead, we need to focus on additive manufacturing as a disruptive technology and put the technology into the context of macro forces at work in the economy.
Let us begin with these macro forces changing the economy:

The rise in the intangible economy. Over the past three decades, there has been a shift in the factors of production away from tangible assets (such as land and capital) to intangible assets (such as knowledge). Knowledge is embedded not just in patents and copyrights but also in workforce skills, social relationships, and organizational processes. This creates a whole new series of factors in production that drive competitiveness. The level of investment in intangibles now exceeds investment in plant and equipment.
The fusion of manufacturing and services. The traditional breakdown of manufacturing and services does not make sense anymore, as they are intertwined. Apple is a prime example with the combination of a product (iPods and iPads) with a service (iTunes). Value-added is no longer found in just the manufacturing process (due to economies of scale) but in the services/knowledge component. That component can be a separate product (after sales service) or is more commonly seen (but often not recognized) as the high level of knowledge embedded in the products.
The change of the innovation process. The generally view of the innovation process is linear: basic research feeding into applied research followed by technology development. While this might have been true in the industrial age, a different view of innovation has emerged in the past decade. Innovation is driven by user needs, with bottom up, design-based thinking approach involving problem solving and rapid prototyping. I see this more as a “stew pot” model where multiple ingredients, including technology, are mixed together — rather than the development and refinement of a specific technology.
The latest step in globalization, “Globalization 4.0”. Globalization 1.0 was characterized by growth in international trade. In Globalization 2.0, the supply chain became global, but production remained specialized in different regions. In Globalization 3.0, the complete economic structure became global, and the focus was on harmonizing the economic rules. In Globalization 4.0, production will be brought back to a very local system, though still within the global context.

Disruptive technologies fit into these changes in the macroeconomic forces. What is a distributive technology? Let me use the example of the steam engine and the railroad. The steam engine was initially designed to be used as a pump based on linear motion. As such, it had limited application. It wasn’t until the pump’s linear motion was converted to rotational motion that steam power became ubiquitous. The result was both locomotion (the railroad) and manufacturing power (the factory). Remember that both railroads and machine production existed before the steam engine (mostly powered by animals). But it was this expanded source of power that disrupted the entire economic structure.
The development of the railroad system continued this disruption with three major impacts:

New markets opened. Railroads transformed local markets into a national market. In part because of price wars due to overbuilding of railroad lines, retail companies (such as Sears) could reach a national customer base.
New industries were created. Building and running the railroads also increased the demand for machine-based manufacturing (for locomotives and railway cars) and new materials (steel).
Management structures changed. Management changes were needed to operate trains across the United States. Alfred Chandler’s book The Visible Hand: the Managerial Revolution in American Business chronicles this shift from family management to professional management. I would argue also that the shift from a “spoils” system to a professional civil service in the public sector was parallel to and driven by the rise of professional management in the private sector.

The lesson from the steam engine and railroad is that a disruptive technology has two main characteristics:

• it allows for something new (not just an improvement on something already in existence), and
• it has spillover effects that create new activities.

Additive manufacturing is a perfect example of a disruptive technology using this definition.
Additive manufacturing started as something else. It began as a technique for rapid prototyping. As the technology matured, both in the process and in its available, it moved from prototyping to actual production.
It allows for something new:

Manufacturing new shapes that could not be manufactured before. For example, additive manufacturing techniques can create prosthetics that would have been prohibitively expensive using conventional techniques.
Harnessing the new use of materials. Additive manufacturing can combine materials in ways that were not possible before –for example, making a single piece of variable density. Image the possibilities of a baseball bat made with variable density, hard at one end, soft at the other.
Requires new design processes. Once the materials have changed, the design process needs to change as well, and a completely different approach to manufacturing is called for. This is a hallmark of a disruptive technology.

Additive manufacturing fits directly into and reinforces the macro forces discussed above:

Additive manufacturing is based on knowledge, not physical assets. As a result, the manufacturing approaches change: manufacturing can now be accomplished anywhere there is a suitable printer.
The economic structure changes. Manufacturing and service (design/customer problem solving) are now fused together as “production” becomes less about economics of scale and more about customizing the product to meet a specific need.
The innovation model changes. Manufacturing becomes more bottom-up, as designs can be changed at the user end rather than only at a large manufacturing company’s design department.
Additive manufacturing enables Globalization 4.0. Production can now be localized. But this does not necessarily mean home production. However, handling and storage of raw materials can be difficult, so the model may be better suited to a regional production site; for example a local hardware store printing individual screws as the customer needs them.

What does this mean for policy, specifically for defense?

First, it may change the design and function of weapon systems as new production capabilities change the design process.
Second, military readiness issues change as additive manufacturing development creates an ability to produce parts and entire weapon systems on demand and at site.
Third, as control of raw materials becomes more important, key strategic considerations may shifts from control of the production site to the raw materials site.
Fourth, existing mechanisms to control weapons proliferation, such as the International Traffic in Arms Regulations (ITAR), may not be as relevant/effective/enforceable when the design can be sent anywhere in the world and production can be localized.

In summary, spillover effects from additive manufacturing will occur, but we do not know where the technology will lead us. We do know that it will allow us to do things we have not been able to do before. The challenge right now is to monitor and understand how that new capability affects our economic and national security.

A new twist to medical tourism

As readers of this blog know, I’ve posted a number of pieces on medical tourism — the phenomena of patients going abroad for health care treatment. My interest in this activity comes from looking at the health care industry as an engine for economic development. On the one hand, localities believe their health care sector is geographically rooted – it serves the local economy. After all, everyone needs a doctor eventually. On the other hand, some high end health care facilities have always drawn in outside patients (i.e. Mayo Clinic) which are a form of services exports. Medical tourism shows that the trade flow in health care services runs both ways. Patients continue to come to high end U.S. facilities. And U.S. patients seek lower cost services abroad.
But, as a recent Economist article (Médecine avec frontières: Why health care has failed to globalise), the level of trade has not lived up to expectations. And, it may not be the patients who are necessarily moving:

the mere possibility of medical tourism is starting to change health care in unexpected ways. The biggest gains have gone not to patients, insurers or governments, but to hospitals, which have calculated that they could win more business by reversing the trend and going abroad to find patients. America’s Cleveland Clinic will open a branch in Abu Dhabi next year. (It already manages Sheikh Khalifa Medical City, a 750-bed hospital in Abu Dhabi.) Singapore’s Parkway Health has set up hospitals across Asia. India’s Apollo Hospitals, a chain of private hospitals, has a branch in Mauritius.
And though American firms and insurers have mostly stopped scouring the globe for bargains, some have negotiated bulk rates with top-notch hospitals at home. Lowes, a home-improvement firm, offers workers all around the country in need of cardiac care the option of going to the Cleveland Clinic in Ohio. PepsiCo, a food giant, made a deal with Johns Hopkins in Maryland. Other firms are said to be working on similar schemes. The future of medical tourism may be domestic rather than long-haul.

In other words, the trade flows may be changing from health care imports (U.S. patients going abroad) to exports (U.S. hospital selling services to foreign patients in their home or third party countries). It is also the case of that dynamic economic force of import substitution as more U.S. patients opt for the local rather than the foreign product.

The problem of GDP

Diane Coyle has written an excellent summary of the problems of measuring economic activity in the Information-Innovation-Intangible (I-Cubed) Economy. Her piece in Foreign Affairs, “Beyond GDP”, is an excerpt from her new book GDP: A Brief but Affectionate History. Below are some excerpts from the excerpt that talk specifically about issues related to intangibles. For those interested in the other GDP related issues, I recommend the full article and book.
On the problem of getting the measures right:

In particular, economists will have to grapple with three issues. The first is economic complexity, driven by innovation, the constant introduction of new products and services, and the increasing globalization of production chains. The second is the increasing share in advanced economies of services and intangibles, including online activities with no price. The third is the urgent question of sustainability — whether the depletion of resources and assets now will undermine potential future GDP growth.
. . .
In 1998, the United States offered 185 television channels, 141 over-the-counter painkillers, and 87 brands of soft drink. In 1970, there were five TV channels, five painkillers, and 20 types of soft drink. Even more striking, whereas there were 400 types of computers and nearly five million websites in 1998, there were zero just decades earlier. All this is a great thing: variety through constant innovation could be considered one of the key indicators of economic development. It is surprisingly hard, though, to find economic statistics that take into account the number of different products available.
. . .
This points to a second serious issue for GDP as a measure of the economy. Each year, the economy consists of more that is immaterial, which makes measuring productivity hard. It is relatively straightforward to keep tabs on economic output per worker when you can count the number of cars or refrigerators or nails or microwave meals being shipped from factories. But how do you measure the output of nurses, accountants, garden designers, musicians, software developers, health care assistants, and the like? The only way is to count how many of them there are and how many customers they provide with a service. But that entirely overlooks the quality of the service they provide, which, in their industries, is more important than quantity.
. . .
A related issue is how to count the value of an intangible product or service, the purely digital items such as search engines, apps, crowd-sourced encyclopedias, and so on. These often have a price of zero and, with no market price, are not captured in GDP statistics.

On the problem of depreciation of intangibles:

GDP statistics do include a measure of the depreciation of physical assets (“capital consumption”). The physical stock of capital (machines, transportation equipment, buildings) must grow by more than what is needed to make up for depreciation, for a growing economy. Producers also need to make additional investments to keep pace with growth in the population if consumption per person is to remain stable, which is what matters more than the total size of GDP. In addition, if innovation — technical progress — is taken into account, it is surely important to include some indicator of the research effort required to innovate.
The latest international national accounting standard, SNA2008, has tried to address the problem. The United States is the first country seriously to put into practice its suggested improvements, which include counting spending on research and development — and an estimate of the investment in “artistic originals” such as Hollywood movies and music — as investment rather than a business cost. The United States’ GDP saw a one-time jump of more than two percent in 2007 thanks to the new methodology. An even bigger increase of 3.4 percent was announced in mid-2013 partly due to this change.
. . .
If policymakers are to take seriously the environmental impact of growth — and the extent to which current growth comes at the expense of future growth — natural depreciation needs to be included in GDP alongside the depreciation of machines and roads.
. . .
As if depreciation of natural assets weren’t complicated enough, there is yet another kind of asset to consider: human capital, or how able people are to make use of the other assets they have at their disposal. Human capital depends on education and practical training and ability to create and innovate. Related to human capital is social capital, a hard-to-define concept that tries to capture how well people are able to organize collectively through political and other institutions. It is hard to measure, but it clearly affects economic growth. To give just one example out of many, former colonies that inherited the English legal framework have grown faster and have higher incomes per capita now than those that inherited the French legal framework. Legal traditions would appear to be one factor contributing to social capital.
Investment in human and social capital is not really measured in conventional statistics, although spending on some inputs, such as education expenditure, is. This is understandable, given that the concepts are hard to pin down in the first place, but they do matter. A country should not regret forgoing some increase in GDP this year for the sake of investments that will contribute to its population’s ability to work, build, and invent later.

On the issue of technology displacement:

Productivity, in turn, might not be as important a measure as it once seemed. As the tech guru Kevin Kelly has written, “Generally any task that can be measured by the metrics of productivity — output per hour — is a task we want automation to do. In short, productivity is for robots. Humans excel at wasting time, experimenting, playing, creating, and exploring.” Kelly is comfortable with the idea of robots doing more work for us. Some are not. In response to Race Against the Machine by Erik Brynjolfsson, an MIT economics professor, and Andrew McAfee, principal research scientist at MIT’s Center for Digital Business, Paul Krugman took to his New York Times column to write, “What’s striking about their examples is that many of the jobs being displaced are high-skill and high-wage; the downside of technology isn’t limited to menial workers. Still, can innovation and progress really hurt large numbers of workers, maybe even workers in general? I often encounter assertions that this can’t happen. But the truth is that it can, and serious economists have been aware of this possibility for almost two centuries.” Krugman is right. During the Industrial Revolution, new looms and mills disadvantaged skilled craft workers.
When it comes to automation and job displacement, we tend to dislike productivity increases. Yet the bots of today will eventually have the same effects on the economy as steam-powered mills in the nineteenth century. Robots are a new kind of capital equipment, and their value will initially go to the owners of that capital. Over time, however, each working person will benefit from more capital with which to do his or her job, just as a weaver could produce more with a mechanical loom than with a handloom in his cottage. And that will translate directly into higher labor productivity and — if workers acquire the necessary skills and society can manage income inequality — higher wages for all. For now, increased income inequality has accompanied productivity increases linked to digital technologies, indicating that the gains have not been widely shared, but there is no reason to think that they necessarily couldn’t.

She does end with a somewhat optimistic note:

At present, we are in a statistical fog, without the information needed about either the negative aspects of growth when it is unsustainable and when it depletes the natural and other assets available for the future, or the positive aspects, when it delivers innovations and creativity. GDP, for all its flaws, is still a bright light shining through the mist.

And that is why I strongly support all the efforts at better measurement.

January employment

The BLS reported this morning that the unemployment rate in January held basically steady at 6.6%, compared to 6.7% in December. But payroll employment was up by a somewhat lackluster 113,000 jobs — economists had forecast an increase in payrolls of 189,000.
The number of involuntary underemployed (part time for economic reasons) in non-agricultural industries, however, dropped by 520,000 – almost all of that drop was in the category of slack work. The number of those who could only find part time work remained basically the same. The drop in slack work could mean that companies are beginning to increase production or they are laying people off. The average weekly hours worked did not change in January. And the number of part time for non-economic reasons increased. Involuntary underemployment is still well above pre-Great Recession levels.
Involuntary underemployed Jan 2014.png

December trade in intangibles – and 2013

This morning’s data from BEA on the U.S. trade balance is not welcome news. The trade deficit grew in December by $4.1 billion to $38.7 billion. Exports down by $3.5 billion while imports were up $0.6 billion. As the chart below shows, the deficits worsened in both petroleum and non-petroleum goods. Economists had expected a deficit of only $35.9 billion
Nor was the news good for our trade in pure intangibles. Because of a drop in exports of business services, our surplus in pure intangibles declined slightly in December. Imports of business services continued to grow. Royalty receipts (exports) rose faster than royalty payments (imports), so the surplus in royalties was up slightly.
However, our deficit in Advanced Technology improved dramatically in December, dropping by almost $3.3 billion to $6.0 billion. The improvement was due in large part to a $2.4 billion drop information and communications technology imports.
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 shows an overall surplus of $10.3 billion in December, compared to $7 billion in November.
For the year, our surplus in pure intangibles rose to $190.8 billion — an increase of almost 7.5% over 2012. Exports of business services continued to increase in 2013 while imports declined slightly. Royalty receipts (exports) rose faster than royalty payments (imports).
Intangibles trade-Dec13.png
Intangibles and goods-Dec13.png
Oil goods intangibles-Dec13.png
Intangibles trade-2013.png
Intangibles and goods-2013.png

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.