Final estimate of 1Q 2015 GDP and continued R&D concerns

In keeping with economist’s expectations, the third (final) estimate of the 1st quarter GDP showed the economy shrank by only 0.2%. The earlier estimate has shown a decline of 0.7%.
A look at the details reveal a more worrisome fact. Investment in Intellectually Property Products (IPP) slowed down to only 4.9% compared with 10.3% in the 4th quarter of 2014. The reason was that investment in R&D grew by only 2.7% compared to 17.2% in the 4th Q. Investments entertainment, literary, and artistic original were up by 2.4% compared to 5%. On the other hand, investment in software grew by 7.8% compared to 5.1% previously.
The history of revisions to the R&D numbers is also worrisome. The first estimate was of a 12.3% growth rate. The second was almost flat at 1.1%. Now the third estimate is of 2.7%. Such large revisions highlight the danger of relying on preliminary estimates.
IPP parts 1Q15 - 3rd.png

Tech policy primer for Presidential candidates (2)

As I noted in my earlier posting, ITIF has published a version of what it would like to hear from the Presidential candidates. Here is the campaign speech I would like to hear:

America has suffered a devastating economic recession. For too many the economy recovery has yet to take hold. We must do all we can to hasten that recovery. But that recovery must be followed by sustained growth and improved economic competitiveness if we are to expect that rising tide to lift all boats.
Our first task is to make sure the tide continues to rise. Our second is to make sure that the tide does in fact lift all boats. Both of these will require understanding the fundamental changes that are occurring in our economy — and crafting tools that fit this new environment in which we find ourselves.
Let us look more closely one part of that change: the current manufacturing renaissance. More and more, companies are finding it to their benefit to open production facilities in the U.S. as opposed to abroad. But, while manufacturing is coming back to the United States, it is different from the manufacturing that left our shores. It is leaner and smarter — requiring higher levels of workers skills. To keep our competitive edge requires fostering an educational enterprise that can provide the constantly changing skills required in a knowledge- and information-intensive economy.
We now see the fusion of manufacturing and services where companies provide solutions not just products. Customization, speed, and responsiveness to customer needs are the keys to success in this new environment. And as the linkage between goods and services grows, we are seeing international competition in services once thought immune to such challenges.
In confronting these new challenges, we cannot rely on simply repeating the policies of the past. We need a combination both new and old solutions.
For example, basic research helped sustain America’s economy growth in the 20th Century. But basic research is not enough. It is one part of a larger mix that fuels the economy. We moving to a post-scientific economy where, to quote Dr. Christopher Hill, former Vice Provost for Research at George Mason University, “the creation of wealth and jobs based on innovation and new ideas will tend to draw less on the natural sciences and engineering and more on the organizational and social sciences, on the arts, on new business processes, and on meeting consumer needs based on niche production of specialized products and services in which interesting design and appeal to individual tastes matter more than low cost or radical new technologies.”
Education needs to move from the classroom to the living room. Life-long learning should not be a slogan but an ingrained part of everyday activity. And as important as STEM is, our economic future is not solely in the hands of our scientists and engineers. Our future prosperity rest on raising the skills and knowledge level of everyone. Productivity no longer comes just from new machines, but from new ways of organizing work.
So let us be clear. The manufacturing jobs of our father and grandfather are not coming back. But we can create the manufacturing jobs for our children and grandchildren. We cannot — we will not — compete on the basis of a race to the bottom where wages and living standards are lowered to keep jobs from moving elsewhere. We can – and will — compete based on raising the knowledge content of our products — both goods and services. By doing so, we can also raise the living standards for all.
Government can play a major role in raising living standards through increased economic competitiveness via innovation and the development and diffusion of new products. But, innovation policy needs to catch up to the innovation process.
In crafting a new policy, we must recognize three points:
 • the innovation model has changed,
 • it’s all about people and organizations, and
 • technology plays multiple roles.
First, we all need to recognize that the innovation model has changed. It is not the linear process of flowing from basic research to final product that sticks in everyone mind. It is a network process. There are many points on the network where innovation can come from. We have used a number of terms to try to describe parts of the new model: “open innovation,” “user-driven innovation,” and even “design thinking.”
It is also not solely about technology. Technology remains an important component. But, as noted earlier, social innovations, marketing, finance, design and business models are also key sources of innovation as well.
Suffice it to say that innovation policy needs embraced this broader concept.
Second, innovation is about people and organizations. Skills, not just education, are critical. To both improve our competitiveness and provide for a more shared economic prosperity, we need to continually upgrade the skills of our worker and our workforce. Highly skills workers contribution more to, and benefit more from increased productivity and economic growth.
To create more highly skilled workers, we need to fundamentally upgrade our workforce training programs. Too many of these programs are focused on helping worker upgrade their skills only after they lose their jobs. Don’t get me wrong, job re-training for the unemployed is very important. But we need to also focus more on upgrading work skills (and thereby company competitiveness) so they don’t lose their jobs in the first place. Continual training on-the-jobs training need to become the backbone of our worker training programs – not an afterthought.
That said, we need to recognize that there will be times of slower demand where even the most competitive of companies may need to cut back on production. Rather than using these slowdowns as time of cut backs on training, we should embrace them as an opportunity. One way we can do this is by tying the concept of “job sharing” with worker training. Under a job sharing program, workers cut back on their hours (meaning that the company does not have to lay off workers completely) and the government picks up the cost of those lost hours through a program similar to unemployment insurance. This concept has been credited as one of the reasons Germany was able to weather the Great Recession. But we need to take the idea one step further. Rather than simply reduce workers hours, we should use those hours for training. In other words, when companies need to cut back on production, let’s pay workers to spend that slack time in the classroom or on-the-job training.
Besides continually upgrading workers skills, we need to continually upgrade the workforce itself. America has long been the destination of choice for the brightest and most ambitious. We need to make sure that America remains open and welcoming to those who would seek to improve their lives – and thereby enrich and improve ours. Immigrants have fueled the U.S. economy for generations – from the brightest Ph.D.s to the hard working entrepreneur and employee. We need comprehensive immigration reform to make sure that we can continue to rely on this source of economic growth and vitality.
But upgrading skills in not enough. Both tacit and experiential knowledge, not just codified and science-based knowledge, are also important. In order to put those skills and knowledge to proper use, organizational structure comes into play. The old hierarchical systems of the industrial age are no longer adequate or appropriate. New adaptive organizations which encourage innovation are needed. What we use to be called “High Performance Work Organizations” are needed to effectively utilize worker skills and knowledge.
Such organizations also play a large role in ensuring that the benefits of increased competitiveness are widely shared.
Finally, any innovation policy needs to understand that there are multiple roles for technology. Technology can be a driver of innovation, a tool of innovation, and even sometimes not all that that relevant to innovation. As a driver, the creation of new technology is a major source of innovation – the kind we normally think of when we use the word “innovation.”
But technology is also a tool in the innovation process. Technology as innovation tool works in two ways. One is innovation as the absorption and utilization of technology. For example, the iPod contained little new technology. It utilized the technology in a new way. The other is technology as an enabler. This is especially true in the information technology (IT) area, where IT allows for a myriad of new applications and innovations.
Take the analogy of the railroad. The marrying of the steam engine to a carriage on iron rails brought about far reaching changes in many difference areas. The railroads spurred on development of a number of other industries, most notably the steel industry. They changed opened up vast new markets and changed the retail and wholesale industries. They even gave rise to new management practices and the shift from ownership capitalism to managerial capitalism.
And sometimes technology plays a very minor role in innovation, if at all. Which was more important in creating the American suburbs: the automobile, Levittown or the 30 year mortgage? One was technological; one was design; one was financial. All were important. As a nation we need to recognize and promote multiple forms of innovation.
So here are some policies I plan to put forward. The new demand driven model innovation shows that government procurement and regulations can drive innovation. Government as a demanding customer can create the “thin opening wedge” — new products and services that have a specialized use. Once that specialized use is established, the product or service can be refined and adopted to a broader customer base. The demanding customer in fact becomes a co-creator. Smart regulations can serve the same function by creating demanding customers.
Here is another example of how we can expand our thinking on innovation. We have a program to create and fund Engineering Research Centers (ERCs) in a number of areas. We should create one for design thinking. We should expanding the ERC model to funding research on and demonstration of new business methods and organizational mechanisms as part of our “Catalyze Breakthroughs for National Priorities” element of the innovation strategy. And we should fund more organizationally-focused challenges, such as the famous DARPA “Red Balloon” challenge.
These are but few of the types of new policies we will pursue — beyond the status quo and conventional thinking that government should confine itself to basic research, education and infrastructure. That might be uncomfortable for some to hear. But it is where we need to go if we are to restore long term economic prosperity in this highly competitive global economy.

Tech policy primer for Presidential candidates (1)

Yesterday, my friends over at the Information Technology and Innovation Foundation (ITIF) released a new report on Tech Policy 2016: What Presidential Candidates Should Be Talking About. The report is written as a memo for a draft speech (a device I’ve use as well – see companion posting) and lays out a number of specific policy proposals. Not surprising the proposals focus on economic growth, productivity, innovation and the role of information technology. A summary of the proposals is provided at the beginning of the report:

1. Foster innovation.
• Increase federal funding for science and engineering research by $30 billion a year.
• Expand the R&D tax credit so it is more competitive with other countries, and tax income from innovation at a lower rate.
• Establish a National Innovation Foundation akin to the National Science Foundation (NSF).
• Increase federal support for STEM education while rewarding universities for graduating more STEM students.
• Create a national system of “manufacturing universities.”
• Expand H-1B visas, green cards, and citizenship for foreign-born scientists and engineers.
• Charge every federal agency with crafting and implementing an innovation strategy.
• Pass the Startup Act to promote entrepreneurship.
• Create a White House Office of Innovation Review.
• Ensure laws and regulations enable disruption rather than protect the status quo.
• Create an interagency taskforce to combat corporate short-termism.
• Revise the 1996 Telecommunications Act to enable broadband innovation.
• Establish a “flexicurity”system to help workers acquire skills for new jobs.
2. Boost productivity.
• Bring back the investment tax credit for new machinery and equipment and worker training.
• Accelerate IT adoption throughout the public and private sectors.
• Raise the minimum wage to $10, and index it to per-capita GDP growth.
• Close the digital divide by helping people pay for computers and broadband.
• Expand funding for surface transportation by at least $30 billion per year.
3. Compete globally.
• Lower the corporate tax rate to no more than 25 percent, and adopt a territorial system.
• Strengthen the innovative capacity of U.S. firms that do business internationally, in part by expanding financing for scaling innovations.
• Put trade enforcement at the center of U.S. foreign policy, and increase resources for it.
• Confront China by raising the cost of unfairly distorting trade investments.
• Create a National Industrial Intelligence Council to assess competitive challenges.
• Restructure the World Trade Organization (WTO) to be more effective in fighting mercantilism.
• Fight currency manipulation

Many of these I agree strongly with and have advocated for a number of years. For example, I strong support an investment tax credit for worker training (especially on-the-job training for incumbent workers). Some I don’t think go far enough. For example I would like to see funding for design (“d-schools”) in addition to “manufacturing universities.” On some, such as revising the 1996 Telecommunications Act, I have no opinion.
Some of the proposals I am skeptical of, such as a White House Office of Innovation Review with the power to review regulations. A number of years ago I worked on legislation to require Competitiveness Impact Statements as part of regulations. This became law as part of the Omnibus Trade and Competitiveness Act of 1988 (Section 5421). Back then we were very concerned that this would quickly become just a means of cutting regulations. For that reason, the provision was limited to legislative proposals, conferred no right of private action and sunsetted after 6 years. I have the same worry about this new proposed office, which seems based on a bias that regulation only “hinder innovation” (to use the ITIF report’s wording). As I have noted before, regulation can have a positive and well as negative effect on innovation.
I also think that the list leaves out important policy recommendations, such as using intangible assets to finance innovation. For this reason I am posting a companion piece laying out my version of the speech (based on previous postings).
Having said that, I believe the ITIF is a good list for the next President (and the next Congress) to consider. Enactment of even part of this agenda would push us in the right direction.
PS: as a proud alumnus of the University of Michigan I cannot support or endorse the proposed second sentence of the opening of the proposed ITIF speech.

The patent registry problem

Over the years we have published a number of reports on the monetization of intangibles assets, especially patents. (See “Commercialization of University Research – Using Intangible Asset Financing”, “Intangible Assets in Capital Markets”, “Intangible Assets: Innovative Financing for Innovation”, Intangible Asset Monetization: The Promise and the Reality and Maximizing Intellectual Property and Intangible Assets: Case Studies in Intangible Asset Finance.) One of the barriers identified in those reports has been the difficulty in determining exactly who owns the asset.
A new paper Who Owns the World’s Patents? takes a fresh look at the problem. And the finding are not good:

The most basic information about this emerging asset class [patents], information as to ownership, is deeply
uncertain and inaccurate.
Various estimates from very well informed sources – including an assessment made by Yo Takagi, an Assistant Director-General at WIPO, on the basis of WIPO’s technical assistance projects, and David Kappos, former Undersecretary of Commerce for Intellectual Property and Director of the US Patent and Trademark Office – suggest that as much as 25% of the world’s patent ownership data may be inaccurate.
. . .
These inaccuracies in the global patent record have significant and far-reaching consequences. The resulting inefficiencies, elevated costs and risk uncertainties create huge cost barriers to innovation, barring meaningful entry to all but the richest, most powerful corporates, depress the market for licensing transactions and increase the risk of litigation.

To address that problem ORoPO (Open Register of Patent Ownership) is creating a open, voluntary global patent database.
As we pointed out, the inability to verify who exactly owns a patent and who has a lien against that patent are barriers to fully using patents as debt collateral. ORoPO seems to be going after the first half of the problem. It does not seem to recognize the second. But the issue of prior liens is a serious as ownership. Imaging trying to get a loan when the bank can’t tell whether someone else has first call on the collateral.
Thus, I wish ORoPO the best in setting up their system. I also hope they will extend it to not just who controls the title to the asset but to any encumbrances on that title as well. Both are needed for a functioning market.
UPDATE: one of the points I failed to mention earlier is that such a registry also serves as a guide to technical expertise. By searching patents, one can find those individuals, companies and organizations that have specific technical knowledge that can be tapped via a patent license, a consulting contract and/or a collaborative agreement. See this IAM video on the subject.

Trade bill passes Congress; "trade" deal doesn't

Last week, the House of Representatives passed a trade bill while not passing a “trade” bill. The trade bill is H.R.1295 – Trade Preferences Extension Act of 2015. That bill pass the House on Thursday, June 11. Or to be completely accurate, the House passed an amendment to the Senate amendment to the bill. But since the two amendments are almost the same (differing in the budgetary offsets needed to pay for the bill), the bill is all but done difference should be easy to resolve but may get caught up in further maneuvering.
The next day, Friday June 12, The House failed to advance H.R.1314 – Trade Act of 2015. In a convoluted parliamentary maneuver, the House approved part of the bill (technically the Senate amendment) while rejecting another part of the bill. Because of the way the voting was structured, this had the result of putting the bill in a legislative limbo.
I call this second bill a “trade” bill in quotations because it is fundamentally different from a trade bill.
First, the superficial differences. The Trade Preferences Extension Act reauthorizes some specific trade agreements. It extends the African Growth and Opportunity Act which grants lower tariffs and other trade preferences to sub-Saharan Africa and extends the preferential duty treatment program for Haiti. It reauthorizes the Generalized System of Preferences, which is a wider set of tariff breaks for certain developing countries. It also makes a number of modifications to the U.S. tariffs on specific products (such as “Recreational performance outerwear containing 70 percent or more by weight of silk or silk waste”).
The Trade Act of 2015 is more a procedural bill consisting of two parts. One part establishes Trade Promotion Authority (TPA) which grants the President negotiating authority and sets up a “fast track” process for Congressional consideration of agreements reached under that negotiating authority. Under fast track, Congress must vote up or down on the agreement within a certain time – no amendments or filibuster. The other part reauthorizes the Trade Adjustment Assistance (TAA) program to help workers and companies negatively affected by trade agreements.
These are superficial differences because the TPA negotiating authority is more than a simply procedural matter. It is essentially a proxy for the already ongoing Trans-Pacific Partnership (TPP) trade negotiations, and to a lesser extent the Transatlantic Trade and Investment Partnership (T-TIP). Stopping TPA means stopping TPP. Voting for TPA essentially means voting for TPP.
But there is a more fundamental difference between the two bills. The Trade Preferences Extension Act is, at its heart, an old fashioned tariff bill. For the most part the preferences extended under the various programs are in the form of lower tariffs. The Trade Act of 2015 goes well beyond tariffs. As Larry Summers pointed out in a Washington Post op-ed:

The world’s remaining tariff and quota barriers are small and, where present, less reflections of the triumph of protectionist interests and more a result of deep cultural values such as the Japanese attachment to rice farming. What we call trade agreements are in fact agreements on the protection of investments and the achievement of regulatory harmonization and establishment of standards in areas such as intellectual property.

This is a point I have noted numerous times before (see earlier postings). And it is what makes “trade” agreements so difficult. 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 within the U.S. 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. For example, the U.S. is in the middle of a fierce debate over patents (aka intellectual property rights – IPR). Given that debate, what set of rules on IPR are we trying to include in trade agreements? These internal clashes over what the rules should be makes it that much more difficult to agree with other nations on what the international best policy should be.
I’m not sure what will happen to the “trade” bill. As of this writing, the Speaker of the House has scheduled a re-vote this week on the part that failed. But that might not be the only parliamentary strategy in play. Suffice it to say that even if the “trade” bill passes, it will not be the end of the debate. And we should all recognize that this debate is no longer about trade in the way we used to think about it.
UPDATE: On Tuesday June 16 the House passed a resolution (as part of an unrelated matter) to postpone the re-vote. The Speaker now can bring up the re-vote anytime between now and July 30. Other parliamentary actions are possible as well.

Another example of the fusion of manufacturing and services – and policy recommendations

As I have noted many times in this blog, one of the hallmarks of the emerging Intangible Economy is the fusion of manufacturing and services. Intangibles (mislabeled as “services”) are key inputs to the manufacturing process. And more and more companies provide solutions (that look like “services”) not just products.
Here is another example of this strategy (which MIT Professor Michael Cusumano called an “enduring” strategy) from a piece in today’s New York Times on “A Futurist Looks at Where Cars Are Going”. In an interview, Eric Larsen, head of research in society and technology at Mercedes-Benz Research and Development, notes:

We have a business called Boost, where minivans drive children after school. They are like school buses, but door to door, and parents can track them with a phone app. They have a concierge as well as a driver, because the driver can’t leave the bus and walk the kid right to the door. A 7-year-old needs that. In this case, we’re selling a mobility service rather than a product.(emphasis added)

By the way, he still sees a demand for cars as products, with American’s buying cars for transportation (especially in the suburbs) and as status symbols.
The importance of this trend however continues to be overlooked by policymakers. About a year ago the National Academy of Engineering (NAE) – the sister organization to the National Academy of Science – issued a report, Making Value for America: Embracing the Future of Manufacturing, Technology, and Work, clearly focuses on how manufacturing is changing. Given the importance to understanding this trend to our economic future, let me repeat below what I said about the report when it first came out.
– – –
Engineers who get it: understanding the new production system beyond manufacturing v. services

The Changing Nature of Production

The reports lays out its framework right at the beginning:

Business and policy leaders need a holistic understanding of the value chain in order to take effective action in response to the changing manufacturing and high-tech sectors. To systematically identify and successfully address customers’ needs and capture higher returns, businesses must draw on in-house capabilities and external partners to carry out a set of interlinking activities spanning economic sectors. For example, in order to sell cars, automotive companies engage in research, product development, supply chain logistics, production, and sales, as well as pre- and postsale customer services such as maintenance, financing, and information and entertainment capabilities.

While companies have always been involved in a range of activities that cross economic sectors, it is increasingly difficult to recognize clear dividing lines between manufacturing, the production of software, and the provision of services in a company’s product offerings. The service content provided by manufacturers has grown in importance, accounting for a larger proportion of total revenues in many industries. At the same time, companies primarily known for software and services have branched into providing manufactured products. (emphasis added)

The report goes on to emphasize the point:

While companies have always been involved in activities that cross economic sectors, it is increasingly difficult to meaningfully categorize companies along manufacturing value chains as providing mainly goods or services. Many companies that traditionally focused on producing and selling goods have developed service-type business models. For example, Rolls-Royce offers a “power by the hour” service that lets customers rent the use of a jet engine rather than purchasing one. Rolls-Royce retains ownership of the engines, monitors their real-time performance, and manages their maintenance and replacement. Such service content has grown in importance among manufacturers. Deloitte Research (2006) found that the fraction of manufacturers’ revenues generated by services has grown to approximately 20 percent in the medical device, industrial product, and telecommunication equipment industries and as high as 37 percent in automotive and 47 percent in aerospace. Service content is even more pronounced among many of the world’s largest manufacturers, whose main offering is defined by after-sale services.

At the same time, companies primarily known for software and online services have branched into designing and producing manufactured goods. Amazon, for example, established a hardware team that developed the Kindle e-reader and Fire TV digital media player, and is developing a smartphone to more effectively deliver its offerings to customers. Google is partnering with contract manufacturers to produce wearable technology products such as Google Glass.

Apple is a case in point. The report lays out the Apple value added chain which runs from raw materials to content. Many companies, from Corning to the New York Times play a role in that value chain. But Apple itself has a major role in assembly & sale of products, software and on-line services. Is Apple a hardware, software or IT services company?

The report demonstrates how different locations and divisions of other major companies can be classified across the manufacturing/services divide. For example, Ford Motor Company is a manufacturer headquartered in Dearborn, MI. It has a wholesale trade business in Livonia, MI. There are numerous retail trade dealerships (with a tight connection to that division of Ford). There are various professional and technical services parts to Ford ranging from R&D to engineering to software development to marketing. Finally, there is an automotive repair division in Wayne, MI. The report highlights similar structures for GE and Procter & Gamble.

Hence the report’s emphasis on a value chain approach. I would argue that it is more a “changing factors of production” and a “serve the customer needs” approach. Intangible factors of production and thus of competitive advantage are noticeable in all areas of the values chain and might be considered “services” if they were done by a separate organization: R&D, product design, supplier relations & supply chain management, marketing & brand management, customer relations, etc. It is next to impossible to separate out the “service” from the “manufacturing” in the inputs, in the throughputs (aka, processes) or in the outputs.

Likewise the end goal has shifted from simply efficient production to meeting customer needs. This is reflected in the report’s core concept of “making value.”

Although it is not yet in widespread use, the concept of making value is a particularly effective way of examining the success and failure of individuals, businesses, communities, and nations. Making value is the process of using ingenuity to convert resources into a good, service, or process that contributes additional value for a person or society. While value creation is often used to refer to the ability to provide things of worth for the customer or user, making value is used here to emphasize the entire system of activities that is necessary to conceive, produce, and deliver these things–especially the design and production processes that often receive less attention in discussions of value creation. (emphasis in original)

It is important to stress that “making value” is about serving customer needs, not about optimizing the value chain for a particular good or service.

This “making value” framework builds upon, but is a break from, earlier STEM/R&D focused reports. Interesting that the focus of the project evolved from Making Things: 21st Century Manufacturing and Design (title of an NAE forum in 2010 – see earlier posting) to Making Value: Integrating Manufacturing, Design, and Innovation to Thrive in the Changing Global Economy (title of a 2012 NAE forum – see earlier posting).

But even the report shows how difficult it is to shed the old vocabulary. To be clear, the report should use the term “production system” or “production value chain” rather than “manufacturing.”

Driving Factors

The report sees three factors driving this change: globalization, advances in computing and automation (digitization) and improved production processes such as lean manufacturing. The result of these forces, they argue, is major change in the nature of work. This shows up as a reduction in the number of front-line manufacturing production workers and a shift in required worker skills.

Much has been said by many reports and studies about globalization and digitization. This report’s inclusion of organizational and process changes is an important and refreshing addition to the mix.

The report contains a entire chapter on the opportunities presented by digital technologies. As they state,

The challenges presented by increasing competition and the changing nature of work, and the opportunities presented by digital technologies, will require US companies and communities to strengthen their ability to innovate and create value.

This is a useful expansion of the earlier chapter on the forces of change. I wish however the report had gone into as much depth on the issues of globalization and the changing nature of work. Each of these topics could have used a chapter as well.

I would have also added another factor to the mix: the increasing importance of intangibles as a factor of production. Business models have shifted from economies of scale to customization. Part of that is due to digitization. But digitization alone was not responsible for the shift in business models. Companies are seeking to differentiate themselves more and compete less on price based. This differentiation has natural focused on customization and better meeting customer needs. The new focus necessarily relies more on knowledge and intangible assets, such as relationships and customer data.

This shift to more knowledge and intangible asset input is directly reflected in the change in worker skills needed. The issue is more just tech skills, however. The report touches lightly on this topic:

It is not enough, for instance, for an IT worker to be proficient in technical issues; because of the ever more integrated and collaborative nature of jobs and companies, employers would like their IT workers to understand the analytical and business development side of their jobs as well, and such employees are much harder to find than workers who can do just one or the other …

They do make one important statement with respect to skills:

The shift in the skills needed for production jobs is indicative of a larger transformation across all aspects of the value chain and all sectors of the US economy.


The report offers a dense array of recommendations that reflect this different view. For example, there is more attention to the issues of business models. The recommendations are grouped around five points to create a “value creation ecosystem”:
(1) widespread adoption of best business practices,
(2) an innovative workforce,
(3) local innovation networks,
(4) flow of capital investments, and
(5) infrastructure that enables value creation.

Of special interest to me is their concluding discussion of “federal programs that monitor the condition of various activities in US-based manufacturing and high-tech service value chains.”

As the report implicitly states, the policy questions are not about picking a certain part of the value chain to specialize in, i.e. the old manufacturing versus services debate. Rather, policy issues revolve around finding ways to strengthen all elements in the “making value” process. One of the recommendations specifically states:

The United States needs to encourage new business creation across the value chain to stimulate innovation and job creation. (emphasis added)

I wish the report had highlighted this important point a little more.

Some of the policy ideas are not new. But many of the recommendations are new or new twists on old recommendations. The focus on best business practice brings the policy discussion back to issues of lean manufacturing and associated principles – something that the Baldrige Award is supposed to promote. It also refocuses on the idea of spreading best practices. Specific recommendations include urging companies to examine their business models “to search for missed opportunities to leverage distributed tools and coordinate manufacturing and product lifecycle services.” They also urge companies to implement best practices (including such as Lean Production and researchers to study and find effective ways to teach best practices.

Importantly, the report promotes the concept of design thinking:

An iterative process of understanding customer experiences, building and trying out a prototype, improving the solution, and applying lessons learned to the next innovation are all critical to maintaining a competitive advantage.

While there is no specific recommendation on design thinking, it should fall under the general heading of promoting best practices. I have long argued that to foster design thinking, we should fund five colleges or universities to create design schools (d.schools) similar to the Stanford (Hasso Plattner Institute of Design). The proposal builds upon the “manufacturing universities” proposal to grant 25 universities $5 million each per year for four years to revamp their engineering teaching and research activities toward manufacturing and engage in greater joint industry-university research projects. At $5 million per year for five schools, the total budget for creating new design schools would be $25 million. (See also earlier postings.)

The workforce recommendations look at much more than technical STEM education.

Critical thinking and creativity are as important as technical skills. It is not enough to learn facts and procedures by rote; students need to learn to evaluate a situation by asking questions, observing, collecting further information, and subjecting the collected data to a thoughtful analysis to identify mistakes and weaknesses and come up with alternative possibilities. Creative critical thinkers constantly probe and evolve their own interpretations and ideas.

Many of the recommendations focus on improving the education system, including closer ties between businesses, local school districts, labor, community colleges, and universities and for more focus on “team-based engineering design experiences and learn to use emerging digital and distributed tools.” They also support national skills certifications and efforts to improve education cost-effectiveness.

The report goes well beyond education to address issues of teams and diversity. They specifically call on business to recruit a more diverse workforce, universities and community colleges to improve inclusion of traditionally underrepresented groups and Congress to reform immigration policy. Other than the mention of team-based experiences in college, there appear to be few any specific recommendation on teams per se. I would add however that helping companies understand the importance of and build teams is part of promoting best practices.

I especially like their call for more employer based training:

Despite the sizable returns employers can receive from training programs, both employers and employees report that the current level of employee training, especially in small businesses, is not adequate …

Thus one of their recommendations is that “Businesses should establish training programs to prepare workers for modernized operations and invest in advancing the education of their low- and middle-skilled workforce.” Interestingly, this is part of the best practices set of recommendations. That the report believes worker training is a best practice speaks volumes.

Another workforce recommendation is that “Congress and state legislatures should create incentives for businesses to invest and be involved in education programs.” This includes tax credits or other incentives. While the report mentions continuing workplace education, they only specifically mention incentives for programs for students and displaced workers. I would go beyond this to explicitly include tax credits for on-the-job training for the existing workforce aka a knowledge tax credit. The best program for a displaced worker it to upgrade their skills so they are either less likely to lose their job and/or more likely to quickly get a new one.

Concerning developing local innovation networks, their recommendations are a mixed bag. They call for more research on understanding the declining rate of new business creation. They urge local stakeholders to work together to create networks and for metro area and state governments to do a better job coordinating efforts both internally and geographically. They reiterate their recommendation for on spreading best practices, specifically as part of the Advanced Manufacturing National Program Office. They call on the SBA to “continue to help more young businesses become globally competitive” including connecting with local innovation network.

The discussion of capital investment addresses the long-standing concern about short-term investment and the issue of capital for start-ups. They specifically recommend that Congress should modify the capital gains tax rates to incentivize holding stocks for five years, ten years, and longer and make the R&D tax credit permanent. They also recommend the “Federal agencies should facilitate industry and government cooperation to identify shared opportunities to invest in precompetitive research in long-term, capital-intensive fields.” These recommendations are fine as far as they go but I would have liked to see more discussion of innovative financing tools for start-ups. I would have also added proposals to better utilize intellectual property (IP) in the lending process. Specifically, the Small Business Administration (SBA) and U.S. Patent and Trademark Office (USPTO) should convene a working group of lenders, regulators and other interested parties to develop a common template to be used when describing and valuing IP and intangible assets used implicitly or explicitly as collateral. The Intellectual Property Office in the United Kingdom (UK IPO) is already undertaking such an activity. Any U.S. effort should communicate, and to the extent possible coordinate, with that activity. (See also earlier postings).

The infrastructure recommendations covers information, communications and computing as well as the traditional categories of transportation, water, waste and energy. Their recommendations focus on investing in a world-leading wireless infrastructure and access to a world-leading infrastructure for high-performance computing. Nothing, unfortunately on traditional infrastructure. I would have liked to have seen a discussion of ideas such as the National Infrastructure Bank.

Finally the report looks at the problem that has been at the heart of my work: both statistics and Federal programs are not in-line with this new economic structure. On statistics, they recommend that

Federal agencies should develop methods of accounting for the complex relationships between manufacturing, services, and information and consider multiple ways of collecting and organizing national statistics.

Such an analysis would, I believe, go a long way to helping us break free from the existing out-dated view of the economy. Statistics are a window through which we see the world. But yet our current statistical system is more like looking through the rear view mirror. We need better metrics upon which to base our policies.

On policy, the report recommends that

Federal programs that contribute to innovation should be directed and optimized as appropriate to assist software and service providers as well as manufacturers. Federal programs to revitalize manufacturing in the United States, such as the Advanced Manufacturing National Program Office (AMNPO), the Manufacturing Extension Partnership, and the Advanced Manufacturing Partnership, should not lose sight of the importance of software and service providers.

Of the many recommendations in the report, if these two recommendations alone are embraced by the policy community then the NAE will have secured a breakthrough in the policy debate. As I argued in my report Rethinking Innovation Policy – Reposing to an RFI:

First, we should recognize that the barriers between “manufacturing” and “services” are eroding. Service activities are increasingly linked manufacturing activities. In fact, companies such as the German Mittelständler companies are successfully competing in “old” industries based on that linkage. They offer knowledge — not low cost. Knowledge is what gives them a superior product and knowledge is what makes their services so valuable. But is it not just generic knowledge. They are selling their knowledge as a means to create solutions for their customers. Their customers want the knowledge to be specifically applied to them – not some abstract concepts. That is the “service” part of the equation. So, all of the activities described above for helping manufacturing should recognize that these manufacturing companies are already in the “service” business.
Next, it should be recognized that all of the activities described above for helping manufacturing also apply to services. Service industries are becoming more knowledge-intensive and need to understand and better their intangible assets. MEP could be further expanded to a offer assistance to service providers — just as the Baldrige Award was opened up to service businesses. Promoting innovative service delivery activities the government procurement process and through the establishment of demonstration and technology diffusion programs is also just as important as in manufacturing. Likewise, research on the organizational and business model aspects of service delivery should be undertaken.
The bottom line answer to both questions [raised by the RFI] is as follows: our goal should be to help American companies make the transformation to a more knowledge-intensive, information-fueled innovative production process — in all sectors and in all industries. Some of those industries will be labeled “manufacturing.” Some will be labeled “services.” Some will be a combination of both. What we label it is less important than the action we take to help make the undertaking of these activities here in America as productive, competitive and wage/job creating as possible.

– – –
When the report came out, the NAE committee promised it would be undertaking efforts to educate policymakers, business leaders and others as to the importance of the framework and recommendations. These efforts are especially needed now a more and more attention is turned to our manufacturing strategy and its role in addressing issues of middle-class economic and inequality. I continue to wish the committee all the best in these efforts.

Hotels go "asset-lite"

A piece in today’s Washington Post on hotels caught my eye this morning. The story describes part of Hilton’s latest business:

Hilton and some of its dominant rivals, including Bethesda-based Marriott International and Starwood, benefit from a business model in which they manage hotels for someone else at a negotiated price. That model, known as asset light, tends to produce high profit margins because others own the real estate.

In other words, hotel chains (which one would think are tangible heavy) have become intangible companies.
This trend has actually been going on for some years. As the Economist noted almost 5 years ago:

Marriott, a big American hotel group, started to sell its property in the late 1970s and today owns only six of the 3,400 hotels that bear its brands. InterContinental, a British-based firm that is another big believer in being asset-light, owns only 15 hotels, manages 628 and has its brands woven into the towels of a further 3,800 franchised operations.

And HVS, a hospitality industry consulting service, commented back in 2007 that:

We have seen an exceptional level of transactions in the last five years, together with many changes in hotel ownership and the evolution of new management structures in the hospitality industry. There are two primary reasons that have triggered a frenzy selling: firstly, the real estate cycle; it taught hotel companies the lesson of an “asset light” strategy; and secondly, the split between hotel ownership and hotel operations. Companies are increasingly adopting a strategy of selling owned properties and concentrating on the core business of managing hotels, as they continue to recover from real estate cycles.

It is clear from these stories that the strategy of “going intangible” has going on for some time. Intangible assets have always been important in the hotel industry. Brands, quality of services and management systems that promote staff productivity are all important. Reservation systems and pricing strategies that maximize revenues and occupancy rates are also key to profitability.
In many ways, this trend matches the evolution in many other industries. Manufacturing companies has discovered valued-added in intangible-based services – leading to a fusion of manufacturing and services. So services industries have also found a way to leverage their intangibles. With the rise of shared-economy competitors such as Airbnb (the ultimate asset light hotel chain), the growth in the intangibles strategy is likely to continue.

May employment in tangible and intangible industries

Good economic news this morning in the form of May’s employment data from BLS. Payrolls rose by 280,000 net new job, which was better than expected. Economists had forecast an increase of 226,000 jobs. The unemployment rate ticking up slightly to 5.5% because of more people looking for work.
Employment in tangible producing industries grew by 101,900 in May. Trade, Transportation & Utilities and Accommodation & Food Service were the biggest gainers. Intangible producing industries added 179,200 jobs with most of that gain in Professional & Business Services and Educational & Health Services had the overall largest gain but Arts, Entertainment & Recreation saw the biggest percentage jump.
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. Note that later this month I will be publishing a more refined version of this analysis based on more detailed industry level data. This may change the analysis somewhat.
May 2015 parts.png
May 2015 tangible & intangible employment.png

Digging deeper into intangible trade data – April and annual revisions

This morning BEA came out with the April trade data and its revisions for the last few years. That data contain goods news – and, with the revision, offered an opportunity/excuse to dig deeper into components of trade in intangibles.
The major news was a large drop by $9.7 billion) in the deficit to $40.9 billion. economists had forecast decline to $44 billion. Exports grew by $1.9 billion while imports fell by $7.8 billion. However, this drop in imports maybe more of a correction after March’s increase due to ending of the west coast dock strikes. Still it is good news with the deficit in both petroleum goods and non-petroleum goods declining. The deficit in petroleum goods has been on a steady track of improvement for the past four years (see chart below).
Oil goods intangibles-Apr15.png
Trade in intangibles also improved with the surplus rising slightly to $15.5 billion as export grew more than imports. The surpluses in maintenance & repair services continued to grow with exports up and imports down slightly. The surplus in financial services also grew as exports rose more than imports. The deficit in insurance services improved slightly. However the small surplus in telecommunications services declined slightly. The surplus in business services continued to grow. Net revenues from the use of intellectual property increased slightly as revenues from foreign sources (exports) were up more than charges for the use of intellectual property paid out to foreign sources (imports).
Our Advanced Technology deficit was essentially unchanged at $6.4 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 $9.1 billion in compared with $9.0 billion in March.
Intangibles trade-Apr15.png
Intangibles and goods-Apr15.png
Intangibles trade parts-Apr15.png
Today’s data also includes revision going back to 2012. For the most part, these revisions had little impact on the overall trends. However, the revisions show a more positive trend for telecommunications, computer and information services with exports revised upwards. Revenues from intellectual property (exports) were revised downward resulting in a lower surplus. Exports of financial services for the last 6 month were also revised downward.
These revisions also give us the opportunity to look at trends in each of the components in greater detail. Maintenance & repair services is the smallest component but contributes more to the surplus than some other industries. As the chart below shows, the surplus in this area has been growing rapidly lately as exports continue to increase while imports have flatten out. Maintenance & repair services still have only a modest overall surplus of $1.4 billion.
Maintenance and repair services-Apr15.png
The two largest industries (by total trade – exports plus imports) are business services and intellectual property. Intellectual property is also the largest positive contributor to the overall trade balance with a surplus of $7.3 billion. In the past five years, the growth in exports (payments received) has slowed down somwhat. As a result, the surplus has been essential flat.
While large in total trade, business services have a surplus of only $3.4 billion. Both imports and exports have grown steadily. In the past year, exports have risen enough to result in a boost in the surplus after a couple of years of stagnation and decline.
Business services-Apr15.png
Financial services has the second highest level of contribution to the trade balance with a surplus of $5.8 billion while being the third largest in total trade. Exports have surged while imports have grown only slowly.
Financial services-Apr15.png
Insurance services and telecommunications, computer & information services are roughly the same size in total trade (well behind financial services). However, telecommunications, computer & information services trade is basically balanced with a small surplus of $237 million while insurance services runs a large deficit of $2.6 billion. That deficit has slowly improved over the decade after reaching its low point in November 2008. Since then imports have steadily decline while exports have rising slightly.
Insurance services-Apr15.png
As the chart below show, telecommunications, computer & information services had been running a deficit for a number of years. The industry began showing surpluses in late 2012. The overall trend recently has been positive with exports growing and imports remaining flat (and even declining slightly).
In summary, financial services and revenue from intellectual property account for the vast majority of our intangible surplus. Financial services exports are healthy but revenues from intellectual property has stagnated. Business services also contribute positively but imports remain strong limiting the growth in the surplus. The deficit in insurance services remains a drag on the economy but has improved over the past few years. Trade in telecommunications, computer & information services is basically balanced with a slight surplus after years of small deficits. The overall trend seems to be positive, but one would think that the United States would have a larger surplus in this advanced technology areas. Maintenance & repair services also contribute to the surplus but are small compared to the other areas.
The overall picture is positive, with some concerns. A significant drivers of the growth in the surplus seems to be financial services exports. Given the troubles seen in this area over the past few years, one wonders whether this growth is simply catch up, due to declines elsewhere, or simply just a slightly lower trajectory than before the Great Recession. In any event, it is unclear whether that increase in exports can continue.
Another worrisome trend in the recent slowdown in IP revenues and the stagnation of the balance since mid-2011. It is unclear why this is occurring but it marks a significant difference from the pre-Great Recession period. Better understanding of this trend is needed to be able to make the appropriate policy choices.
Note: The detailed trade data use the new BEA classifications for services trade (see the March 2014 Survey of Current Business article, “The Comprehensive Restructuring of the International Economic Accounts: Changes in Definitions, Classifications, and Presentations.”).
Charges for the use of intellectual property is a somewhat broader category than under the previous classification and includes all 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 were previously included in Other Private Services and are now broken out as a separate category. However, cleaning of transport equipment is included in transport services, construction repairs and maintenance are included under construction, and maintenance and repairs of computers are included under computer services.
Financial services includes: securities, underwriting & related services; financial management, financial advisory and custody services; credit card and other credit-related services; and securities lending, electronic funds transfer and other services.
Insurance services includes direct insurance, reinsurance and auxiliary insurance 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 categorized as 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 and are not included as intangibles for the purpose of this analysis.
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.