Productivity and digital capital

There is a new paper out from the Brookings Institution’s Hutchins Center on Fiscal and Monetary Policy that has important implications for how we address lagging productivity. Part of the Hutchins Center’s Productivity Measurement Initiative, the paper by Prasanna Tambe, Lorin M. Hitt, Daniel Rock and Erik Brynjolfsson is called Digital capital and superstar firms.

Building upon previous work, the paper looks at a different categorization of intangible assets labeled “digital capital” consisting of “employee training that is related to new information technologies, firm-specific human capital related to technology systems, and the development and implementation of business processes and other forms of organizational transformation required to support or use new information technologies.” (p. 5) This definition excludes brands and intellectual property, and general human capital (as opposed to the IT related firm-specific human capital).

They find that investment in digital capital accounts for increases in productivity. “Our findings suggest that the higher values the financial markets have assigned to firms with large digital investments in recent years reflect greater digital capital quantities, rather than simply higher prices for existing assets. In other words, they reflect genuine improvements to firms’ productive capacity. In fact, we find that digital capital, if included as a separate factor in firm-level production functions, predicts differences in output and productivity among firms.” (p. 19)

Importantly, most of the value of digital capital is concentrated in a small number of superstar companies.

The combination of these findings has major implications for how to raise productivity: “One interpretation of our findings is that translating organizational innovations into productive capital requires significant investment in organizational re-engineering and skill development. Therefore, even if firms have the appropriate absorptive capacity, knowledge of how to construct digital assets will not automatically generate productive digital capital any more than access to the blueprints of a competitor’s plant will directly lead to productive capacity.” (p. 19)

In other words, laggard companies face daunting obstacles in trying to catch up. Knowledge is not enough and is not easy to translate into action.

In light of that finding, the public policy question is “what can governments do to help?” Clearly, technical assistance is not enough. It may be a necessary condition, but it is not a sufficient one. Investment in organizational and human capital is also required. Government support for investment both areas is somewhat controversial. While funding for general human capital has long been acceptable, funding for firm-specific human capital is less acceptable. And government funding for organizational capital is viewed as questionable. In both cases, government support is seen as using public funds to benefit private interests.

This is not to say that there isn’t already a good deal of government support for specific industries and firms, often through the tax code. I’m just pointing out that the case needs to be made for investments in digital capital. That case rests on the fact that digital capital is a key driver of productivity, which is crucial for continued economic prosperity. Just like R&D spending, there are great public spillovers of investment in digital capital.

In addition, we need to think more about the most effective mechanisms for fostering digital capital. Funding for firm-specific human capital can be relatively straight forward. One example is funding industry-community college partnerships. Funding organizational capital may be much trickier. Current government policies focused on technical assistance. We need creative ways to go beyond this narrow focus. Otherwise, we risk digital equivalent of, as the authors of this paper put it, assuming “access to blueprints of a competitor’s plant will directly lead to productive capacity.”

SEC takes new steps on disclosure – and what should be next

In an earlier posting, I reported on how the SEC has changed its Regulation S-K to require disclosure of information on human capital as part of the MD&A (Management Discussion and Analysis) section of companies’ financial reports. I noted back then that two Democratic members of the SEC voted against the new rule because the changes didn’t go far enough in requiring disclosure on Environmental, Social, and Governance (ESG) issues. As I stated then, this may foreshadow additional action by the SEC in this area.

Now SEC is taking another step with the announcements of a task force on enforcement of disclosures on climate change and ESG and an enhanced focus on climate change risk as part of the agency’s enforcement priority. The Commission is also seeking public input on possible new disclosures on climate change.

This interest in climate change and other ESG issues comes in response to calls from investors in both the US (see “BlackRock Chief Pushes a Big New Climate Goal for the Corporate World“) and in other countries (see “Accounting needs to be stepped up for climate change costs“).

Will increased attention to ESG issues spill over to intangibles? The answer is unclear. The driving interest in the new requirements for disclosure of human capital was focused on ESG issues of diversity and inclusion – not on economic performance such as improving innovation and productivity. And the focus of these efforts seems to be on outputs (i.e. the impact, costs, and risk) rather than inputs (i.e. intangible assets).

The attention to EGS issues is, however, useful in honing in on the guiding principle that the disclosures be consistent, comparable, and reliable. The only way to achieve these goals is for the disclosures to be mandatory. Voluntary disclosures leave information gaps that undercut reliability and do not allow the enforcement of standards of uniformity required for consistency and comparability. The question of mandatory disclosure is one that has bedeviled regulators since the beginning. And is especially of importance when it comes to understanding the impact of intangibles (see my working paper Reporting Intangibles).

One way forward would be for the SEC to build on existing requirements. Specifically, the SEC could allow for an alternative reporting of companies’ sales, general, and administrative costs (SG&A). This alternative would refine the current reporting of SG&A to breakout spending on intangibles from more routine spending. As I described in an earlier posting, SG&A would be divided into four components: R&D, advertising, Maintenance Main SG&A (basically the cost of sales such as office and warehouse rents, customer delivery costs, and sales commissions, and Investment Main SG&A (which would be the residual after subtracting R&D, advertisement and Maintenance Main SG&A ). The assumption is that Investment Main SG&A reflects spending that seeks to build organizational assets. Investment in intangibles would constitute the three categories of R&D, advertising and Investment Main SG&A.

Creating this new measure of intangibles is not without difficulties (for more detail see One Job: Expectations and the Role of Intangible Investments by Michael J. Mauboussin and Dan Callahan of Morgan Stanley and “Should Intangible Investments Be Reported Separately or Commingled with Operating Expenses? New Evidence” by Luminita Enache and Anup Srivastava). However, the SEC could allow this calculation under a “safe-harbor” provision – a process that I have long advocated for that would expand reporting on intangibles.

At first blush the concerns over ESG issues and the disclosure of intangible assets seem rather distant. But they share a common underlying problem: that investors are not getting the information they need to make intelligent investment decisions. I hope the heightened discussion over ESG disclosures will raise awareness of this basic problem. And that the SEC will be able to use the current concerns over companies’ disclosures to make meaningful change on all aspects of the problem.

Tech policy may be next up in Congress – but we need a broader view

Now that the COVID-19 American Rescue Plan has been enacted, speculation is growing that the next big bill will be a technology and competitiveness act. According to the Washington Post, a Chinese-focused technology bill may be replacing an infrastructure bill as the next legislative push. Late last month, Senate Majority Leader Chuck Schumer directed Senate committees to start working on such a package, using last year’s Endless Frontier Act as their starting point.

Since that bill garnered bipartisan support, the thinking is that it would be a good follow-up to the partisan fight on the COVID-19 bill. That support is riding on wave of concern over a rising technological competition from China, the availability of medical supplies during the pandemic, and the current semiconductor shortage.

However, there are a number of approaches that future policy could take. The Endless Frontier Act calls for the reconfiguration of the National Science Foundation (NSF) into a National Science and Technology Foundation (NSTF). However, it is not clear that grafting a large technology development and commercialization organization on to the existing basic science funding agency is the best alternative (as I noted in earlier postings).

An alternative proposal to create a National Technology Foundation (NTF) was recently suggested by the National Security Commission on Artificial Intelligence (see previous posting). The NTF would be separate from but parallel to the NSF. The NTF would focus on technology development and commercialization in a number of key technologies, including AI, biotechnology, quantum computing, semiconductors and advanced hardware, robotics and automated systems, 5G telecommunications, additive manufacturing (aka 3D printing), and energy storage technology.

Another approach is the creation of a number of agency specific DARPA-like entities. The President seems to have already endorsed the creation of a Health Advanced Research Projects Agency (HARPA).

Beyond the question of NSTF, NTF or “X”ARPA, there are a number of other technology policies that the new legislation should consider. For example, both the Endless Frontier Act and the AI Commission call for a regional technology hub program in the Commerce Department. And the AI Commission report contains over 60 specific funding proposals. Then there are a number of specific technology policy bills already introduced, such as the Democracy Technology Act (S. 604) sponsored by Sen Warner and others to create an interagency International Technology Partnership Office at the State Department headed by a Special Ambassador for Technology, with a $5 billion International Technology Partnership Fund to support joint research projects. It is unclear which and how many of these policy proposals will make it into the bill.

It is also unclear whether the new bill will include elements from last year’s America LEADS Act (which Senator Schumer co-sponsored). Included in that bill was a number of manufacturing, research, and technology development proposals such as expanding the Manufacturing USA Institutes program, expanding the Manufacturing Extension Partnership (MEP) program, and expanding the National Security Innovation Capital program and other defense-related critical technology programs. But that bill went beyond science and technology policies to include provision such as sanctions on China, support for continued stationing of US troops in Japan and South Korea, and provide refugee status to resident of Hong Kong and Xinjian province.

What is clear is that the process will be messy and disjointed. I participated as Senate staff in the creation and enactment of the Omnibus Trade and Competitiveness Act of 1988. That bill, as sprawling as it was, was at least guided by the framework and rhetoric of improving US economic competitiveness. As I’ve pointed out, the competitiveness framework has been missing for a number of years. It has been replaced with a “fear-of” driven policy – in this case the fear-of-China.

I understand the importance of the fear-of approach in motivating action. The 1980s it was a fear-of-Japan industrial policy. In 1950s and 60s had a fear-of-Russia industrial policy. One could even argue that Hamilton’s Report on Manufacturing and Henry Clay’s American System were in part a fear-of-Britain industrial policy. But our policy needs to go beyond reaction. We need a way to look systematically at the foundations of our economic competitiveness. Just as monitoring one’s personal heath is better than waiting for a diagnosis and way better than just treating the symptoms, we need a mechanism to go beyond the current problems.

Unfortunately, none of the existing proposals addresses this need. Yes, they contain various study and strategy-creation provisions. But they are narrow in scope. For example, the AI Commission’s recommendation for a Technology Competitiveness Council and a National Technology Strategy is focused on the development of emerging critical technologies – not on the competitiveness of the economy. Similar, the President’s Executive Order on supply chains is focused on issues of resilience and security which will help improve competitiveness – rather than starting with the goal of competitiveness and looking at how supply chains enhance or threaten that goal.

Thus, I am renewing my call for a new push for how we address the competitiveness issue. One way is to reinstate the Competitiveness Policy Council (CPC). Created in the 1988 Trade and Competitiveness Act, the CPC was defunded in the 1990’s as part of a GOP budget cutting exercise. During its life time, the CPC published a number of good reports — but never seemed to get much political traction. [In full disclosure, I wrote the legislation for the CPC and helped get it up and operating back when I served on Senate staff — so its demise was rather painful to me].

A more aggressive approach was outline over a decade ago by the Center for American Progress. The CAP proposal calls for:

• A Quadrennial Competitiveness Assessment by an independent panel of the National Academies whose objectives are to collect input and information from many sources and perform a horizon scan that identifies long-term competitiveness challenges and opportunities
• A Biannual Presidential Competitiveness Strategy that lays out the president’s competitiveness agenda and policy priorities, and captures the attention and buy-in of cabinet principals
• An Interagency Competitiveness Task Force led by a new deputy at the National Economic Council that develops the biannual strategy, oversees White House coordination of competitiveness initiatives, and monitors their implementation by agencies
• A Presidential Competitiveness Advisory Panel of business and labor leaders, academics, and other experts who assist the administration in developing policy details.

I realize that it seems like this was tried (and failed) back in the Obama Administration with the President’s Council on Jobs and Competitiveness. But I would argue that the “Competitiveness” part of the title was basically ignored. Even the Council referred to itself as the “Jobs Council.”

Regardless of what mechanism is used, we need to refocus the discussion on broader issues of “Build Back Better” and competitiveness, not just critical technologies. Unfortunately, I doubt the coming technology package will contain this broader view. That will be a missed opportunity.

Commission report on AI includes broader tech policy recommendations

Last week the National Security Commission on Artificial Intelligence issued its Final Report. Established by Section 1051 of the John S. McCain National Defense Authorization Act for Fiscal Year 2019 to take a very broad look at Artificial Intelligence (AI). https://www.nscai.gov/

There are lots and lots and lots of AI-specific information, findings, and recommendations (including 60+ specific funding recommendations). While the vast majority of the report focuses on AI (as it should), the 756-page report includes a number of important broader technology policy recommendations that could easily be overlooked. These provisions are important for the development of AI, but affect technologies in general.

One of the biggest items is the report’s call for the creation of a National Technology Foundation (NTF) with budget starting at $1 billion for FY2022 and ramping up to $20 billion by FY 2026 (for a total five-year budget of $51 billion). In contrast, the FY2021 budget for NSF was almost $8.5 billion. Unlike other proposals, the National Technology Foundation would be separate but parallel to NSF. The NTF would focus on technology development and commercialization in a number of key technologies, including AI, biotechnology, quantum computing, semiconductors and advanced hardware, robotics and automated systems, 5G telecommunications, additive manufacturing (aka 3D printing), and energy storage technology.

In a similar vein, the report notes that there is no agreement as to which technologies are considered critical, and therefore no way to prioritize governmental strategy and actions. The report calls for “a single, authoritative list of technologies and sectors which are key to overall U.S. competitiveness, along with detailed implementation plans for each to ensure long-term U.S. leadership.”

The report recommends creation of a National Network for Regional Innovation in Emerging Technologies, with a budget of $200 million for FY2022 – FY2026. This network would coordinate and fund the creation of Technology Research Centers in each designated Regional Innovation Cluster to facilitate industry-academia-government collaboration on critical technologies.

The report also recommends modernizing export controls, reforming investment screening (through CFIUS), amending the Foreign Agents Registration Act to better protect critical technologies, and expanding STEM-oriented immigration. In addition, they recommend the creation of a University Affiliated Research Center focused on research integrity and research security.

To promote greater international cooperation, the report recommends the creation of an Under Secretary for Science, Research and Technology and the creation of an Emerging Technology Fund at the State Department to support “digital foreign assistance, digital development projects, emerging technology programs, and other related initiatives of the Department of State and the United States Agency for International Development.”

Finally, the report recommends expanding the loan authority of the U.S. International Development Finance Corporation (DFC) to include funding of domestic industrial base capabilities supporting critical technologies. Specifically, the recommendation is to delegate authority under Title III of the Defense Production Act to the DFC.

As I said, there is a lot in this report. Even if the report had limited itself to just AI-specific recommendations, this would be a pathbreaking set of recommendations. Importantly the commission recognized that our AI strategy must exist in the context of a larger technology strategy. Adding these broader technology policy recommendations strengthens the overall impact on AI development. In doing so it goes above and beyond in setting the direction for technology policy for years to come.

The report lays out an ambitious agenda for policymakers. I hope that they will embrace the broader recommendations and not just cherry-pick some of the AI specific ones. Embedded in this report is an important set of ideas that offer the opportunity to dramatically move technology policy in the right direction. Policymakers need to seize this opportunity.