1Q 2015 GDP and investment in intangibles

Some bad news this morning from BEA’s advanced estimate of U.S. 1st quarter GDP. According to this first estimate, GDP grew by only 0.2% in 1Q 2015. The growth in business investment in intellectual property products (IPP) remained at a high level at a 7.8% increase with a positive trendline (see chart). Software investment picked up a little with a 5.8%. R&D slipped somewhat to a still strong level of 12.3%. Investment in entertainment, literary, and artistic originals actually declined by 1.2%. Of course, this is only the advanced estimate, subject to considerable revision.
GDP-IPP 1Q15 - 1st.png

Why trade agreements are so difficult

Last week, the House Ways and Means Committee and Senate Finance Committee took up a new Trade Promotion Authority bill (aka TPA or “fast track”) in the face of hardening battle lines on the subject. The vote to approve the bill was generally party line with Democrats somewhat split and tea-party wing of the GOP raising some concerns (for example that TPP will undercut U.S. immigration law.
Technically the voting was on negotiating authority and trade enforcement measures (see the Bipartisan Congressional Trade Priorities and Accountability Act of 2015 S. 995 and H.R.1890 and H.R.1907 Trade Facilitation and Trade Enforcement Act of 2015). But underlying the debate is the current negotiations over the Trans-Pacific Partnership (TPP) – a potential deal among 12 Asian-Pacific nations. The TPP includes the U.S. and Japan but does not include China. The push for rules for Congressional consideration of trade agreements (TPA/fast track) is seen as a preliminary step toward approval of TPP. It is argued that without these rules, which limit Congressional modifications to the deal, it will be impossible to finalize TPP.
Trade agreements such as TPP (and the rules for negotiating those agreements such as TPA) are highly controversial. Such agreements are also difficult to negotiate. TPP talks basically started in 2005. The broader Doha Round of multilateral trade talks at the World Trade Organization (WTO) started in 2001 and is essentially dead in the water.
Trade agreements have always been difficult and controversial. But the current environment is heightened. As globalization is seen as a factor in stagnating worker income, trade agreements are seen as the mechanism of globalization and therefore a cause for the anxiety. This anxiety is increased by one simple fact: trade agreements are no longer about trade; they are about economic harmonization.
Earlier fast track legislation and trade agreements were more narrow. For example, the Trade Expansion Act of 1962 which authorized Kennedy Round of trade negotiations under the General Agreement on Tariffs and Trade, and the Trade Act of 1974, which authorized the Tokyo Round, were mostly about tariffs. As I have noted before, trade entered a new era in 1994 with the inclusion of TRIMS (Trade Related Investment Measures), TRIPS (Agreement on Trade-Related Aspects of Intellectual Property Rights) and GATS (General Agreement on Trade in Services) in the Uruguay Round. These moved trade negotiations past tariffs and at-the-border issue to internal economic and regulatory policies.
One amendment to the TPA bill in the Senate Finance Committee serves to dramatically illustrate this point. Senator Bob Menendez (D-N.J.) added a section on human trafficking (see stories in the New York Times and the Washington Post). According to the stories, the amendment would deny fast track to any agreement with countries on the State Department’s list of top human traffickers.
A more public debate about economic harmonization has to do with the addition of currency issues in to trade agreements. In Can trade agreements stop currency manipulation? Kemal Derviş of Brookings argues that “trade negotiations are not the right forum for discussing the causes and consequences of current-account imbalances and reaching agreements on macroeconomic-policy coordination; that is what the IMF and the G-20 are for.” Fred Bergsten (Addressing Currency Manipulation Through Trade Agreements) agrees that the IMF would be the best forum to address currency manipulation. However, he argues that “it would be anomalous and unacceptable for such a “21st century trade agreement,” one that seeks to become the new template for global economic accords, to ignore an issue that clearly has greater impact on trade than any other, especially when the International Monetary Fund (IMF) and other institutions have failed to resolve it for so long.” Thus, he believes that adding a currency chapter to the TPP is both appropriate and necessary. In an op-ed in the New York Times earlier this year (“How to Stop Currency Manipulation“) Jared Bernstein echoed this approach. As he noted:

It’s important to recognize that deals like the Trans-Pacific Partnership are not necessarily about “free trade.” They are instead a set of rules; some, like lowering tariffs, lead to freer trade, while others, like expanding patent protections, are more protectionist. Rules governing currency tactics certainly fit the framework.

Moving beyond the correct forum for crafting the rules is the debate over the rules themselves. It is this economic harmonization that is at the core of the clash over TPP and TPA. Proponents argue for TPP saying the rules will benefit the U.S. and that if the U.S. doesn’t write the rules, China will (see “Pass Trade Promotion Authority and enable conclusion of the Trans-Pacific Partnership negotiations“). Opponents don’t like the rules that the U.S. Government seems to be writing (see “The Trans-Pacific Partnership is great for elites. Is it good for anyone else?”). In essence, the clash over TPA/TPP is a continuation of existing debates over domestic policy.
Here is where the issue of content meets the choice of forum. The shift from trade to economic harmonization changes the dynamics of the negotiation process. The old dynamics don’t work. During my Senate staff career, I was involved in the beginning and the end of the Uruguay Round. When we finally passed the implementing legislation, I mused out loud that I thought this would be the last global round of trade negotiations. None of my colleagues agreed – and some of the old hands seemed taken aback at such heresy. They argued that you can only get an agreement by linking everything in a big package. (In diplomacy – this is known as “linkage.”)
Almost three decades later, I still think I am right. Linkage doesn’t work the way it used to. In previous negotiations with a focus on tariff reduction, the dynamic was simple. I’ll reduce my tariffs on steel if you reduce your tariffs on autos. This allowed for a win-win (from economists point of view) situation that pushed for lower and lower tariffs. Everyone agreed that the end point was lower tariffs. The question was how to get there.
In the new talks, it is unclear how the trade-offs work, and in what direction the dynamics points. I’ll lower my tariffs on steel if you increase your copyright protection to 100 years? I’ll allow you to subsidize your aircraft industry if you don’t ban my genetically-modified beef? I’ll decrease my agricultural subsidies if you reduce regulations on investment banking?
We don’t have any agreement on what the end point should be. We have a general idea – “open economies” – but we differ dramatically on what that means and on the specifics. The internal clash over what the rules should be makes it hard to agree with other nations on best policy (i.e. which policy is correct and which is not) when we can’t agree within the nation.
Thus my unease with large multi-issue, multilateral negotiations such at the TPP. I’m not sure we understand the trade-offs any more. And I’m not sure what we really want to accomplish in any one specific area i.e.less regulation on the financial sector or more regulation?. Rather, as I’ve argued before, we may have to approach each of these economic regulatory issues separately – possibly in separate forums, such as the OECD and the G20. Yes, this being a negotiation, there will be linkage. But the complex web of links will not become so great as to bring the entire structure down. And it will allow all parties to clearly focus on a specific issue not the trade-offs — leading, one would hope to a better outcome.
Having said that, the TPP is in process and likely to be finished soon. Given that, there may be a role for an agreement like TPP to serve as an enforcement mechanism for agreements negotiated elsewhere. The negotiating objectives in the TPP legislation already reference a number of other international agreements. The anti-human trafficking section added in the Senate Finance Committee to the TPP legislation is an example of an explicit attempt to use of TPP to enforce an international agreement.
Another explicit attempt to use TPP as an enforcement mechanism can be found in Rep. Sandy Levin’s alternative legislation (Right Track for the Trans-Pacific Partnership Act 2015 – see also the summary). In a critical difference, the Levin substitute explicitly directs the President to “establish strong and enforceable rules, consistent with or building upon Article IV of the Articles of Agreement of the International Monetary Fund.” Article IV requires members to “avoid manipulating exchange rates or the international monetary system in order to prevent effective balance of payments adjustment or to gain an unfair competitive advantage over other members.” As noted earlier, the IMF has not proved to be an effective enforcement mechanism. A trade agreement could be. [Note: Rep. Levin is the Ranking Member of the House Ways and Means Committee. The Levin substitute was not allowed to be considered by House Ways and Means during the mark up. I suspect part of it may show up during the House and Senate floor debates.]
In summary, it is time to look beyond trade agreements as a mechanism for economic harmonization. But I doubt that will happen immediately. I assume that once the TPP is concluded attention will turn to the Transatlantic Trade and Investment Agreement (TTIP). And the debate will continue, just as the economic policy debate will continue domestically.

Losing relational capital: the Intuit case?

Intuit seems to be a company with strong Relational Capital – a good reputation and a strong customer base. But recently they have had their share of problems. [In the interest of full disclosure, I use Intuit products TurboTax and Quicken – which I love. But I had a problem with TurboTax this year, as explained below.] Earlier this year, the company apologized for forcing customers to buy an upgrade. But they did so in a way that raised privacy concerns (see Forbes story “Intuit Cries Uncle, Will Reverse TurboTax Deluxe Changes“). Then came the news that TurboTax might have been used to file fraudulent returns (see Washington Post stories “TurboTax resumes processing state returns after fraud reports prompt halt” and “Fraudsters found a new way to steal refunds from TurboTax customers“). Now comes word of a potential class action lawsuit alleging that TurboTax’s lack of security enabled that fraud (see “Potential class-action lawsuit filed against the maker of TurboTax“).
Oh, and by the way, Tax Day saw stories about how the tax software companies such as Intuit are lobbying against tax simplification (see L.A. TimesThe tax-prep industry lobbies hard to keep Tax Day a torture for you” and New York TimesWould You Let the I.R.S. Prepare Your Taxes?“). Intuit came back forcefully with a detailed response (Intuit Statement on Tax Policy).
I can’t speak to the fraud or lobbying issues. But I can speak to the earlier problem of because I am one of the people negatively affected by their action. I bought the software version I have been using for years. Then was told that I needed to purchase an upgrade for $42.30 (which doubled the price). Then I was told that was a mistake and I could get $25 back (not the full amount). Then when I applied for the refund, I was told that it was a limited time offer and time had expired. Why they chose to limit the amount and the time does not make sense. So, not only did they make a mistake, their attempts to rectify it have left me, at least, with a bitter taste.
Not a good way to build Relational Capital. But why does this matter? It matters in two ways. First is how customers respond to their products. I for one will be a more skeptical next year about buying TurboTax. The company will have to show me that I won’t get screwed again. And I am not alone in those feelings. As of the time I am writing this, TurboTax has 2495 “5 star” ratings on Amazon and 2973 “1 star” ratings. Illustrative of the negative is this comment, “I hate being gouged, and I hate weasel word explanations even more.” Granted this was written in December 2014 before TurboTax admitted its mistake. But 5278 readers out of 5378 found the review helpful. And so far I see few if any positive responses to the refund offer.
Second, and possibly more important, is how the reputational damage might play out in other areas. Intuit gets high marks from some for its eventual response to the refund issue (see WSJ: “Crisis of the Week: TurboTax Combats Customer Revolt“). But the fumble may undercut Intuit/TurboTax’s ability to garner a positive public response to the other issues.
So far, any damage has not become apparent. Earlier this week Intuit announced that it expects TurboTax revenue to show an 8% increase. The real test will be how the public reacts to the lawsuits and how customers react next tax season. Intuit understands the importance of Relational Capital. As their latest financial statement (10K) states, “Our business depends on our strong reputation and the value of our brands.” It will be an interesting case to see how they maintain that reputation.

Three discussions on the changing economy

Over the past few weeks there have been a number of meetings and conferences on the economy. Here are videos of three I found most interesting.
Making Sense of the Information Economy: A Mixed Record? is one session of a larger conference on What’s Wrong with the Economy–and with Economics? put on by The New York Review of Books. Most of the other sessions deal with the state of the economics profession. This session deals with a particular part of the economy. I was particularly interested in Shoshana Zuboff’s overview of what she calls the “advocacy capitalism” versus “surveillance capitalism” forms of the digital economy and society — including how this affects the relationship between buyer and seller.
The Hutchins Center Explains: Productivity slowdown was a meeting at the Brookings Institution of three noted economic experts on productivity. The problem is that they (and other economist) can really explain changes in productivity. Martin Baily offers a myriad of possible factors, including conflicting theories of the rate of innovation. Of special interest to me was Harry Holzer’s call for “incentives and assistance for employers to go ‘higher road’.” While this was mentioned just in passing, resurrecting the notion that high performance organizational structures matters is a good idea. [For more, see my earlier paper Time to Get Serious About Workplace Change.]
Then there was last week’s Institute for New Economic Thinking conference New Economic Thinking: Liberté, Égalité, Fragilité. The opening plenary on economics and inequality is available on-line [note that the event does not start until 23 minutes into the video and the panel discussion with Angel Gurria, Thomas Piketty and Joseph Stiglitz does not start until 55 minutes into the video]. Papers and presentations are also available. Angel Gurria’s (Secretary General of the OECD) discussion of how inequality hurts economic growth was especially of interest. I was also interested in Andy Wyckoff’s presentation “Innovation & Inequality: Exploring the Role of KBC and Business Dynamics” [note: KBC stands for Knowledge-Based Capital aka intangible assets].
Happy viewing.

Customer data is an asset – or it is?

By now you probably know that RadioShack is going through bankruptcy proceedings and closing stores. Last week, the bankruptcy court approved a plan to sell the company to the hedge fund Standard General who would co-locate the remaining stores with Sprint stores. (The sale is actually to the General Wireless subsidiary of Standard General). But, as the Wall Street Journal reports, General Wireless/Standard General appear to only be getting the stores and the workers:

The new RadioShack has only temporary rights to its name and certain patents as it gets back on its feet. Unless Standard General comes up with more money, RadioShack might need a new name after six months.
Rival bidder Salus has first claim on the RadioShack intellectual property, including the trademark, patents and customer lists.
Owed $150 million, Salus will get only partial payment out of the sale to Standard General. The intellectual property could be sold separately, and it could be sold to Standard General. However, Salus is in active talks with other potential buyers of RadioShack’s intellectual-property, valuation adviser David Peress, of Hilco Streambank, said in court. [Hilco Streambank is handling the sale of the intangible assets.]

Now, here is where it get really interesting. Some of those intangible assets may not be assets after all. Specifically, customer lists may be subject to privacy laws that restrict their transfer to another owner. According to stories in the Washington Post and Bloomberg Business, the Attorney Generals of Texas and Tennessee have raised the possibility of filing suit to stop RadioShack from selling its customer lists. And, according to AdAge, the New York Attorney General is looking at the case. They argue that RadioShack made an explicit promise when it collected the data to not sell their customer lists. Since the sale of the lists would violate the company’s privacy policies, they argue that it also violates state law.
These lawsuits might be a bit of a stretch. What the stories don’t point out is that there is already a process to deal with these cases. The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 contains a specific set of provisions known as the Consumer Privacy Ombudsman provisions. This part of the bankruptcy code describes what type of data/information is or is not considered protected under privacy restrictions. It also sets up a process to appoint a Consumer Privacy Ombudsman to report to the court as to what data is protected, what may or may not be sold and under what conditions. For example, in one case, the buyer was required to contact those on the list and allow them to be removed (an “opt out” process). The goal of these provisions is to balance the traditional mission of a bankruptcy court to maximize repayment to the debtor (by maximizing the sale of all assets) with individual’s privacy rights. [See here for a more detailed explanation of the law.]
The ruling by the Ombudsman can be complicated by the lack of a standard privacy clause. Some companies, such as Google and Facebook, have clauses in their privacy policies explicitly allowing the transfer of customer data in cases of an ownership change or asset sale. However, even in these cases questions can remain, such as which version of the company’s privacy policy applies: the policy when the data was first collected or the most recent policy? And who collected the data: the parent company or an independent franchisee?
It remains to be seen what will ultimately happen to RadioShack’s intangible assets. In the RadioShack case, the appointed Ombudsman has told the court that the lists are not yet being sold. Therefore she does not have a report for the court at this time. Obviously the Ombudsman needs to know the terms of any deal before making findings and recommendations.
But regardless of the final outcome, the case raises interesting questions about how these assets are restricted and how they may or may not be utilized. One more factor to take into account when managing your intangible assets.

March employment in tangible and intangible industries

Today’s job numbers from BLS are only somewhat ok. Employment is up by 126,000 in March with the unemployment rate staying a 5.5%. Economists had expected an increase of 245,000 jobs.
Employment in tangible producing industries grew by a meager 25,700 in March. Employment in Manufacturing, Construction & Mining and Tangible Business Services all declined. Intangible producing industries added 100,400 jobs with most of that gain in Educational & Health Services. (See tables below.)
As the charts below shows, U.S. employment in tangible producing industries and intangible producing industries is just about equal. Up until March, employment in tangible producing industries had been growing slightly faster than in intangible producing industries.
For more background on this data, see my earlier posting.
Mar 2015 tangible & intangible employment.png
Mar 2015 parts.png

Update on new trade data process

As part of this morning’s trade data release, BEA announced that it and Census would be releasing an advanced estimate of trade data to be incorporated into (and improve the accuracy of) the advanced estimate of GDP (see BEA’s blog announcement)). The advance estimate of the June trade data will be release July 30 (the same day as the 2nd quarter GDP advanced estimate) with the regular report released on August 5. Note that the regular report will still be subject to the standard revisions (the next month and after 6 months).

February trade in intangibles

Good new this morning on trade. According to data from BEA, the U.S. trade deficit dropped by $7.2 billion in February to $35.4 billion. The bad news is that exports were down $3.0 billion and imports were down $10.2 billion. The slowdown in trade may be attributable to the bad weather and a West Coast dock strike. Interestingly, our deficit in petroleum products also dropped, due to falling oil prices.
However, our surplus in pure intangibles declined again slightly in February after a drop in January. Exports were down while imports were up. The surpluses in maintenance & repair services grew with an increase in export and a decline in imports. The surplus in financial services did just the opposite, declining as exports went down and imports up. The deficit in insurance services improved slightly. Net revenues from the use of intellectual property dropped slightly as revenues from foreign sources (exports) were up but charges for the use of intellectual property paid out to foreign sources (imports) increased more. The surplus in business services continued to grow a long string of declines last year.
Our Advanced Technology deficit once again improved in February to $3.1 billion. And once again the improvement was due improvement in the Information and Communications Technology (ICT) deficit as imports dropped by $2.3 billion even though exports were down $1 billion.
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 $11.8 billion in February compared with $9.9 billion in January. Again, much of this was due to the lower ICT imports.
Intangibles trade-Feb15.png
Intangibles and goods-Feb15.png
Intangibles trade parts-Feb15.png
Oil goods intangibles-Feb15.png

Note: I am now reporting the trade data using the new BEA classifications for services trade, which breaks services into more categories. In the past, the intangible trade data was the sum of Royalties and License Fees and Other Private Services. Under the new classification system, intangibles trade data is the sum of the following items: maintenance and repair services n.i.e. (not included elsewhere); insurance services; financial services; charges for the use of intellectual property n.i.e.; telecommunications, computer, and information services; other business services.

Charges for the use of intellectual property n.i.e. is simply a renaming of Royalties and License Fees. This includes 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.

Maintenance and repair services n.i.e., financial services, and insurance services, were previously included in Other Private Services. Telecommunications, computer, and information services is a combination of those two items (telecommunications and computer & information services) that were also previously included in Other Private Services. Three categories previously in Other Private Services — education-related and health-related travel and the expenditures on goods and services by border, seasonal, and other short-term workers — were removed and reclassified to travel. The new category of other business services is a continuation of the older category Other Private Services with those components removed.

Thus, other business services includes categories such as advertising services; research, development, and testing services; management, consulting, and public relations services; legal services; construction, engineering, architectural, and mining services; and industrial engineering services. It also includes personal, cultural, and recreational services which includes fees related to the production of motion pictures, radio and television programs, and musical recordings; payments or receipts for renting audiovisual and related products, downloaded recordings and manuscripts; telemedicine; online education; and receipts or payments for cultural, sporting, and performing arts activities.

For more information on the changes, see the March 2014 Survey of Current Business article, “The Comprehensive Restructuring of the International Economic Accounts: Changes in Definitions, Classifications, and Presentations.”