You can find my next blog at

www.southmountaineconomics.com

I'm taking a hiatus from blogging for about a month. But I will be focusing on innovation and growth.

(If there's any problem with getting to the blog, let me know)

To confirm the rumors: I was not offered a position by Bloomberg.

To my friends at BusinessWeek, both old and new: We had a fantastic run, and I loved working with you all. Sometimes we were good, sometimes we were great, but we always had integrity and soul (yes, that's the word I mean).

To Norm, Josh, and all my BusinessWeek friends who are going over to Bloomberg: Good luck! I know that you are going to build an exciting new magazine. It won't be the same as the old BusinessWeek, but times have changed, and it's time for BusinessWeek to change with them.

As for me? I've got definite plans that I'm not ready to post about yet. I will, however, put up a new email address before closing down shop here. I will continue blogging at a new location, with a hiatus of a month or two.

The headline number for this morning's PPI report was an 0.6% decline in the price of finished goods less food and energy ("core PPI"). In fact, core finished goods PPI has fallen for 4 out of the past 6 months. So if we just look at this number, inflation seems like it isn't a problem,

However, I prefer to look at a different statistic in the PPI report--the PPI for traditional service industries. Never heard of it? You are not alone. Starting a few years ago, the BLS aggressively broadened its coverage of the service sector. In particular, the "traditional service sector" includes everything from telecommunications and web search portals to health care to banking to management consulting to fitness centers.

So now the BLS publishes a PPI for these service sector industries (it's at the back of the report, pp 20-21). I wrote about the service sector PPI on my blog in February, in a post entitled "The PPI says: Service Sector Deflation is Almost Here."

Now, we have a really big divergence in the path of the core finished goods PPI and the service sector PPI. Core goods inflation is collapsing. But services PPI is slowly ticking up.

I think the service sector PPI is a better measure of the underlying inflation rate, because it covers a broader swathe of the economy. So this chart tells us that inflation is slowly starting to recover.

Next week I'm looking forward to speaking at two important innovation-related conferences. On Thursday I will be in Chicago at "Innovating Our Way to Prosperity" put on by The Institute for Work and the Economy. It's obviously a critical topic these days, given the weak state of the job market, and I will be giving a talk on "Moving Beyond America's Innovation Shortfall."

Then on Friday I will be in Philadelpha at the Wharton School, at "Borderless Innovation: Management Practices, Promises and Pitfalls" presented by the Mack Center for Technological Innovation. This trend towards borderless innovation is central for today's global economy, and understanding how it works may be crucial for our future global growth, and our future standard of living. My talk is entitled "Global Innovation: The Big Experiment."

And yes, these two conferences are closely related to each other. In the first conference I will look at the innovation shortfall and its aftermath from the viewpoint of job creation in the U.S., and in the second conference I will focus on global innovation and corporate performance. It's my contention that these two perspectives, while very different, actually come down to the same issue: How can we assure that we get more genuine innovation in the years going forward?

I will likely post my presentations afterwards.

Here's more bad news for jobs.

According to this morning's trade report, the advanced technology trade deficit widened to $18.2 billion in the third quarter, up from $12.9 billion in the second quarter of 2009 (advanced technology products include 10 categories, such as information and communications, biotechnology, and aerospace).

The third quarter ATP deficit, at $18.2 billion, was just below the $18.9 billion of a year ago. I believe that was the record, though, I'm not 100% sure.

Nevertheless, the widening of the ATP trade deficit is not good news for U.S. production jobs, since it means that even as demand for innovative products recovers, the production benefits are primarily being felt overseas. Employment in the computer and electronic products industry, for example, fell at a 10% annual rate in the third quarter.

What about royalties and license fees to produce the new technology--doesn't the U.S. benefit from that? The total trade surplus in royalties and license fees was $14.4 billion in the third quarter, smaller in magnitude than the advanced trade deficit. Given that royalties and license fees include movies and tv shows as well, it's likely that the amount of revenue from licensing the overseas production of advanced technology products was actually substantially less.

...if anyone is interested.

Following my usual practice, I regret to inform you that I've reduced my investments in domestic equities. I think this play still has another unhappy act to run before the (perhaps) happy ending. But is there an intermission?

Over the next week, as I clean up my desk, I'm going to be doing short reviews of books that I have been meaning to write about. Let's start with Profit Power Economics, a fascinating new book which combines corporate strategy and economics. The author, Mia de Kuijper, runs her own strategy advisory firm and has a PhD in Economics from Harvard (she stopped by one day, and we had a fun conversation).

The book examines the strategic implications of what de Kuijper calls "The Transparent Economy." How do companies make money in a world of perfect information, where everyone knows what everyone else is doing, and where competition is absolutely intense? She argues:

Profit power is economic clout--the ability of a company to hold on to the value it itself has created, as well as to extract a share of profits from its competitors, to create incremental value for itself and for its partners in business relationships, and to shape the risks it and others will take on....Being "the best" does not guarantee that your company can hold on to its hard-earned gains. Only profit power does that.

These are not the perfect information markets we learned about in introductory economics, where everyone makes the same profits. You have to have some edge (which she calls "power nodes") to ensure that you are not squeezed out by the competition.

The link between this book and the "The Big Shift" of the previous post should be clear. Hagel and company are concerned that American companies, on average, are losing ground because of intense competition, with some companies doing much better than others. de Kuijper is concerned with how to make sure your company is in the winning camp. (Her reasoning applies to careers as well)

Profit Power Economics is a very stimulating read, whether you are a business manager or someone trying to figure out the best career path. The book is a bit dense in parts, but well worth the trouble.

In recent months, I've repeatedly made the point that the financial crisis was a symptom, not a cause. Innovation was weaker than expected, private sector job growth outside of healthcare was virtually nonexistent, while real wages and real stock values showed little gains from the late 1990s to the end of 2007, when the recession supposedly started. Most distressingly, stock prices for the nation's innovative sectors, biotech/pharma and information technology, showed a sharp plunge in real terms from 1998 to 2007.

Now there's a new report out today from Deloitte's Center for the Edge which provides additional confirmation that the underlying problems extended well beyond the financial sector, and started well before the housing bubble.

Back in June, the Center--led by John Hagel III, John Seely Brown, and Lang Davison--released a report showing that U.S. corporate return on assets has fallen by 75% since 1965. They suggested this decline in corporate performance was driven by the "Big Shift"--a tremendous increase in competitive pressure, combined with the increasingly pervasive digital infrastructure.

At the time, I told Hagel that I didn't want to write about his "Big Shift" until I saw industry data, so I could understand which industries were driving the corporate performance decline. Well, the new report from the Center takes a closer look at nine industries, out of which seven show the same pattern of deteriorating corporate performance.

For example, here's the ROA chart for the tech sector.

As the report says:

And what about innovation? At least as conventionally defined and practiced, innovation may not help the trend. The Technology industry, known for innovation, experienced one of the steepest ROA declines of all the industries we studied. This suggests that while product and technology innovation may be necessary, they also are not sufficient.

There are two industries where corporate performance is still strong, according to Hagel & Co: Aerospace & Defense and Health Care. The report notes:

We do not believe it is an accident that two of the most highly regulated industries in the U.S.—Aerospace & Defense and Health Care—are outliers in a broader trend of performance erosion. The ever-more-powerful digital infrastructure increases the potential for competitive intensity and performance pressures, but public policy shapes the degree to which specific industries feel that pressure

I still have to chew through the report some more. But it's pretty interesting.

This morning's productivity numbers showed a huge gain in output per hour in the third quarter--up at an annual rate of 9.5% in the nonfarm business sector.

But here's something else. If we are to believe these numbers, the biggest financial crisis since the Great Depression has actually produced a productivity gain of 5.1% since the downturn started in the fourth quarter of 2007.

If you think that productivity has risen by 5.1% during the financial crisis, I've got a subprime bond to sell you.

Let me get this straight. We have a collapse of the housing and construction sector, massive layoffs in almost every part of the economy, a sharp downturn in consumer spending, and bank failures on an astonishing scale---and the numbers show an increase in productivity?

It defies common sense.

I suggest two reasons why the numbers are off. First, as in my recent cover, companies are cutting educated workers such as scientists and engineers who are not directly involved in the immediate production process. This means a drop in important but unmeasured intangible investments in R&D, product development, training, and advertising, which are not getting picked up by the GDP statistics.

Second, and this is relevant to the DC conference mentioned in the previous post, the statistics are being greatly distorted by globalization. Let's take a look at the computer purchases and supply, as reported by BEA.

According to the BEA's number, final sales of U.S.-produced computers has *risen* by 3.9% since 07IV, while imports of computers have *fallen* by 1.5%. Over the same stretch, employment in the computer industry has fallen by 12.5%. Being incredibly simple-minded, that would suggest that productivity in the U.S. computer industry has risen by about 19% in the downturn. Not bad, if true!

But there's a problem. According to the BEA's stats, the price of imported computers has fallen by 9.6% since the end of 2007, while the price of computers to consumers has fallen by 22.2%.

That doesn't make sense. It's far more likely, as I argued here, that the import price stats are mismeasured.

If we assume that import computer prices really fell at the same rate as domestic consumption, that would mean import growth is really faster, and domestic output growth is slower, as is productivity growth. By my back of the envelope calculation, the effect on computer industry productivity growth is potentially huge (I'll give the details later after I have had a chance to check them). This sort of calculation extends to the rest of the economy, though less dramatically.

So for these two reasons, I am quite skeptical of the proposition that the financial crisis has increased output per hour.

I'm about to go down to DC to attend this conference (I'm giving the after-dinner remarks as well)

Measurement Issues Arising from the Growth of Globalization

This is a very important conference as we try to figure what is *really* going on in the U.S. economy. I'll be writing more about it.

This morning Warren Buffet's company Berkshire Hathaway announced that it was buying Burlington Northern Santa Fe in a deal valued at $44 billion. In the announcement, Buffett called the purchase an "all-in wager on the economic future of the United States."

Is Buffett right that a bet on Burlington Northern is a bet on the economic future of the U.S.? Because if Buffett is right, we've got real problems.

Let's take a look at what Burlington Northern carries. Its major freight revenues (as of 2008) come from coal (23% of revenues); agricultural products (20%); international intermodal shipments of consumer products, which is probably mostly imports (16%); construction and building products (14%); and petroleum products (4%).

In essence, Buffett is betting that the next ten years will look a lot like the last ten: A lot of growth in imports, construction, energy and agricultural products. If he thought that innovation was going to be the driver of the next ten years--biotech, energy, and infotech--he wouldn't be buying Burlington Northern.

I'm not saying that Buffett is wrong. His skepticism about the tech sector in the late 1990s, and innovation in general, turned out to be right on the mark. Berkshire Hathaway stock over the past decade has risen by 84%, whil the S&P 500 is down by 18%.

But his "all-in wager on the economic future of the United States" paints a remarkably gloomy picture of where we are heading.

Ford's 3rd quarter earnings report, released this morning, showed a surprisingly large net income of almost $1 billion. The company reported that it:

...reduced its Automotive structural costs by $1 billion in the quarter, largely driven by lower manufacturing and engineering costs, which included benefits from improved productivity, personnel reduction actions primarily in North America and Europe, and progress on implementing its common global platforms and product development processes.

So this leaves two questions: First, how much of these cost reductions came from cuts in intangible investments such as engineering, research and development?

The answer is: The earnings report doesn't tell us. R&D and product development are not broken out separately on a quarterly basis, even though Ford has had an enormous budget for these items ($7.3 billion in 2008, according to the 10K).

Second, is engineering, research and development money being shifted to Ford's overseas operations? Once again, the earnings report is mute on this point. The 10K says

We maintain extensive engineering, research and design centers for these purposes, include large centers in Dearborn, Michigan; Dunton, England; Gothenburg, Sweden; and Aachen and Merkenich, Germany

As Ford makes "progress on implementing its common global platforms and product development processes," it would be good to know the size of the ER&D spending cuts and where they are hitting.

One of my favorite commenters, Ajay, writes:

Wow, when the chief economist at Businessweek is capable of writing a sentence like "if U.S.-based companies are doing their research and product development overseas and their production there as well, it's tough to see how ordinary workers in the U.S. will gain," it's easy to see why this magazine was recently sold off for almost nothing, around $5 million, or around $15k per employee as one article estimated. The ordinary worker gains because they can buy goods for cheaper, it's that simple.

Actually, it's not that simple. If one nation improves its capabilities while others stand still, there's nothing about the arithmetic of trade that requires that all nations benefit.

The simplest way to see this is to think about oil. Suppose that a very cheap substitute for oil was discovered in the U.S. Clearly U.S. standard of living would rise, and overall the average global standard of living would rise--but the standard of living in the oil producing countries of the Mideast would fall dramatically.

The parallel here--if China improves its R&D capabilities while the U.S. stands still, there is *nothing* about the arithmetic of trade in a multinational world that requires that Americans will benefit. Nothing.

I stand ready for people to argue with me.

P.S. Hopefully I'm not to blame for BW's sale!

Added November 3: Novartis announced that it is going to invest $1 billion over the next 5 years for a new R&D facility in China. Just a few days earlier, the company announced that overall R&D expenditures were down by 6% over the previous year. You draw your own conclusion about the future path of spending.

Posting for Michael, who’s traveling:

If you care about R&D, product design, worker training, or any of that other good stuff, you might want to look at my new cover story. I’ll be adding to this over the weekend.

Here's a bit of a good news-bad news chart.

The rate of job cuts for production workers in manufacturing has slowed dramatically in the past few months, as companies start to rebuild inventories.

However, they are still aggressively slicing their nonproduction workers--engineers, managers, sales staff, and the like. Over the last three months, employment of manufacturing nonprod workers is falling at a 7.6% annual pace, compared to a 4.2% pace for production workers.