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Archive for January, 2010


Is it Time to Start Celebrating?

The fourth quarter GDP growth was reported at 5.7% growth.  Most economists believe this growth was mainly due to inventory rebuilding and government spending.  Both are likely to fall off in this year.  It is not possible to continue government spending at its present rate and once inventories are rebuilt to more normal levels companies will slowtheir production.  The best news for the economy is the election of Scott Brown as Senator from Massachusetts.  This is likely to lead to gridlock in Washington, which will allow businesses to plan for the future without the uncertainty of radical changes in regulations or taxes.  If gridlock does prevail, then the economy will recover but growth will be moderate.  I expect that if the Federal Reserve does not raise interest rate substantially, we will see inflation start to pick up around the fourth quarter of 2010 but no later than sometime 2011.  This combination of moderate growth and increasing inflation will be similar to the stagflation of the 1970s and will not substantially reduce the unemployment rate.  If the Federal Reserve does raise interest rates enough to quell inflation, then we fall into another recession.

Threats

The 800 pound gorilla in the room of the US economy this decade is Medicare and Social Security.  Our nominal federal debt is $12.3 trillion.  This represents a debt to GDP ratio of about 86%.  While this number is large, it was higher after World War II, when it peaked at 120%.  However, at the end of World War II we did not have large unfunded liabilities associated with Medicare and Social Security.  If you include the approximately $60 trillion in unfunded liabilities into the debt to GDP ratio, the ratio is 505.6%.  This is clearly unsustainable.  The effects of the unfunded liabilities are likely to be felt before the end of this decade and will dwarf the financial crisis associated with housing market in 2007-2009.  This will lead either to massive inflation or default on our debt and unsustainable tax rates.

Solutions

If we want the economy to grow and create jobs, we first need to reverse those changes in our laws in regulations that are inhibiting innovation.  Since 2000, we have passed a number of laws and regulations that are killing innovation in the US.  The incredible innovation of the 90s was based on technology start-up companies built on intellectual capital, financial capital, and human capital.  All three of the foundations have been under attack since 2000.  Our patent laws have been weakened reducing the value of intellectual capital.  Sarbanes Oxley has made it impossible to go public reducing financial capital for start-ups and the FASB rules on stock options have made it harder to attract human capital to start-ups.  The Decline and Fall of the American Entrepreneur: How Little Known Laws and Regulations are Killing Innovation, explains these problems in more detail.

Reinvigorating our economy by encouraging innovation will reduce the problems associated with Social Security and Medicare.  It will also make it less painful to restore fiscal discipline to our government.  If we do not do not resolve these issues of innovation, fiscal discipline, and entitlements, the US will suffer a severe economic downturn this decade and the US position as economic, military, and political leader of the world will end.

 

An article in WSJ blogs is more evidence that Sarbanes Oxley has driven the investment banking business overseas.  This has significantly hurt the financial capital to technology startups.  According to the article:

A statue in the City of London of the authors of the 2002 Sarbanes-Oxley U.S. regulatory legislation?

Such a monument is worthy of consideration, joked Lord Levene, chairman of Lloyd’s of London, at a World Economic Forum panel discussion. His point was that tighter accounting and other corporate regulations delivered by the so-called SarbOx law drove business to the U.K. from the U.S. and helped London thrive before the more recent credit crisis.

Please read the full article, A SarbOx Statue in the City of London?

 
Why Investors Need to Pay Attention to the Bilski Decision

A significant portion of the value of stocks is represented by intangible assets.  According to Ocean Tomo, Patent Attribution to Equity Returns , 75% of the value of the S&P 500 is intangible assets.  The Bilski case in front of the Supreme Court could significantly affect the value of these intangible assets.

Bilski is a case about whether certain types of technology are patentable subject matter.  The patent in this case was directed to a financial system for hedging commodities risk.  However, the Supreme Court may use this case to undermine patents related to software and business methods.  If the Court does significantly limit the patentability of software based inventions, the value of the intangible assets of many of these companies will be significantly reduced.  (For more information on the Bilski case see, Bilski, Financial Patents, and the Financial Crisis , and Bilski, Software Patents and Business Method Patents .

The most important intangible asset of most companies is their patents.  The nadir in this country’s legal atmosphere for patents occurred in the 1970s.  It is not surprising that the chart above shows 1975 as the year when companies had the lowest percentage of their value represented by intangible assets.   According to the book, The Invisible Edge , the FTC & DOJ used antitrust law to force US companies to give away the technology associated with over 50,000 patents.  The result was the U.S. transferred its cutting edge technology to Japan and many U.S. companies found themselves unable to compete with the Japanese.  The book cites a MITI study that substantiates that most Japanese companies took advantage of this traitorous policy by the U.S. government to catch up with U.S. companies technologically.  This policy also resulted in reduced research and development spending. 

 
Grant Thorton on the IPO Crisis

Grant Thornton has prepare a paper entitled Market Structure is Causing the IPO Crisis .  Here is my understanding oftheir position.  The IPO market, especially for small IPOs started to decline before Sarbanes Oxley.  The Manning Rule and Order Handling Rule and decimalization decreased the margin for handling illiquid securities by brokerage houses.  Finally, online brokerage accounts have killed quality research and encouraged speculation.

The things that effect the IPO market are the cost of going public, the return for going public, the alternatives to going public, and the willingness of an investment bank to take you public (might be part of the cost).  While not stated explicitly in the report, they seem to imply that there is little incentive for investment banks to take small companies public or to create a market in their securities after the fact.  If true, I think this would contribute to the IPO downturn, but I do not think they have stated their case very strongly.

 
U.S. Falls to 8th in Economic Freedom

It is a sad day in U.S. history.  According the Heritage Foundation and Wall Street Journal’s 2010 Index of Economic Freedom the U.S. has fallen to eighth.  The U.S. is behind Canada, Ireland, Australia, Singapore, etc.  According to the report the U.S. fell further in the index than almost any other country.  Please read the full report. http://www.heritage.org/Index/ My only complaint with the report is that they do not rank countries according to their protection of intellectual property.  I think this would be a valuable addition.

 
KSR: Supreme Ignorance by Supreme Court

Under the KSR decision (KSR Int’l Co. v. Teleflex Inc., 550 U.S. 398, 416 (2007)) by the Supreme Court nothing is patentable under the sun, unless you believe in black magic.  The Supreme Court in the Bilski (http://hallingblog.com/2009/11/10/bilski-case-reveals-supremes-ignorance/) oral arguments proved that the justices do not have the competence of a first year patent law associate.  KSR shows that the justices do not understand basic physics. 

See if you can spot the errors in physics in the following statements.  “The combination of familiar elements according to known methods is likely to be obvious when it does no more than yield predictable results.” KSR Int’l Co. v. Teleflex Inc., 550 U.S. 398, 416 (2007).  “A court must ask whether the improvement is more than the predictable use of prior art elements according to their established functions.” Id. at 417.  While the Supreme Court’s writing is not the model of clarity, the Court thinks these statements are equivalent.  The Court is saying that a patent for an invention made of known elements (prior art elements, familiar elements) and connections (according to known methods) is likely to not be patentable. 

Every real invention is a combination of known elements, unless you can violate the conservation of matter and energy – black magic.  The fact that the Supreme Court does not know this basic application of the laws of physics demonstrates that it is incompetent to rule on patent matters.  Another flaw in their logic is that if an inventor filed for a patent with an element that was completely new, then the Patent Office would reject the application, appropriately, as failing to clearly and distinctly claim their invention under 35 USC 112, second paragraph.  The fact that the Supreme Court does not understand the legal contradictions of their opinion, demonstrates that they do not understand the basics of patent law. 

 

According to the Brenner Banner article Where Have All the Public Companies Gone, since, 1997  ”the number of listings (of public companies) has declined by almost 40%. This is especially remarkable as listings on other global stock exchanges have increased: the number of listed companies in Hong Kong has almost doubled.”  The article states that Grant Thornton says this is not due to Sarbanes Oxley, but the advent of online trading.  I do not find this credible.  Online trading should effect all the other stock exchange also.

 
Book Review By Pat Choate: Understanding How to Get the U.S. Economy Moving Again

This is a copy of Pat Choate’s review of The Decline and Fall of the American Entrepreneur: How Little Known Laws and Regulations are Killing Innovation.  Dr. Pat Choate, economist, former Vice Presidential running mate of Ross Perot 1996, Director of the Manufacturing Policy Institute, Phd. Economics University of Oklahoma.

I do not review books on the Net unless I find them well-written and especially informative, which certainly applies to Dale B. Halling’s The Decline and Fall of the American Entrepreneur.

Nonetheless, I do have a criticism directed towards the publisher. My copy did not contain a vita of the author, which in this case is a major omission. Mr. Halling is a physicist, lawyer and an expert on patents and entrepreneurship, all of which comes through in his book. This author delivers the goods. A vita in subsequent printings would be useful.

Mr. Halling combines two topics — the impediments to entrepreneurship that have been created by the U.S. government as an unintended consequence of its pursuit of other goals and the systemic weakening of the U.S. patent system by the U.S. Supreme Court and the Congress.

The resulting technological stagnation is a major reason the U.S. has gone from producing 25 percent of the World’s Gross Product in the mid 1990s to about 20 percent today. The loss is significant – about $3 trillion of U.S. GDP in 2009 alone.

He demonstrates in clear terms the linkages between economic growth, productivity, and income. And he lays out how technological advancement has always been the American advantage in global competition, an advantage that the U.S. is squandering.

He explains how the Sarbanes Oxley Act cut off the waves of venture investment that did so much to stimulate U.S. growth in the 1980s and 1990s, and he also explains how shifts in accounting rules as per stock options directed many of our most creative people into less than innovative activities.

His final chapter contains some straight forward recommendations that involve no direct-cost regulatory changes that would once again stimulate more innovation, investment and job creation in America. Amazingly, Congress is now considering a so-called “patent reform” legislation that would further diminish U.S. innovation. The author convincingly explains how this would damage U.S. innovation. He also explains the consequences of recent Supreme Court decisions on patent law. My observation is that the Roberts Court is the most anti-patent set of Justices in U.S. history. Once Congress understands what the Court has done, their decisions need to legislatively overturned.

In sum, this is well-written, jargon-free, 137-page book that is a quick read. It evidences smart and practical thinking by an author with real world experience. I highly recommend it.

 

Terratec’s AggreScreed was named one the top innovations by the magazine Equipment World .  The AggreScreed allows a contractor to lay a gravel road of a set depth without the cost and time of placing survey stakes.  This invention saves contractors time and money by eliminating survey costs, reducing wasted aggregate, and eliminating rework.  This is exactly the sort of technological innovation for which the patent system was designed.  Unfortunately, it took Terratec around four years to obtain its patent.  This in not untypical and it points out that the US patent system is broken, but not for the reasons suggested by those people pushing patent reform.  The Patent Office is hopelessly backlogged but Congress will not fully fund it.  The Supreme Court’s recent decision have increased the uncertainty over whether a patent will be held valid or approved by the patent office.  We need real patent reform that provides the Patent Office the funding they need to do their vital job and provides an objective standard for which inventions are patentable.

 
A Modest Proposal for Academic Economists

In one of my earlier posts, Patent Quality Non-Sense , I pointed out that the R&D (Research and Development) per patent ratio, GDP per patent ratio, and number of citations per patent have all increased over the last fifty years.  These were all statistically significant changes.  Based on this evidence I concluded that the quality of patents (or threshold for obtaining a patent) has increased over the last fifty years.

I was fortunate enough to have an academic economist send me a message pointing out that there were several papers by academic economists that have been debating why the R&D per patent and GDP per patent ratio have been increasing.  One of these papers suggested the reason for this phenomena was that as technologies are explored they become mined out – the cost of obtaining a new invention keep increasing.  Of course this issue had been explored in the 1950s by the famous economist, Jacob Schmookler, in his book “Inventions and Economic Growth.”  Professor Schmookler showed that across multiple industries the amount of R&D per patent was essentially the same.  See figure 2, page 46, figure 22, page 138, figure 23, page 139. 

 

Since these industries included both new industries and mature

 

There has been a lot of discussion about whether the Venture Capital Model is dying. Some suggest that there is just too much money in venture capital other suggest that it is just a cyclical downturn. However, the evidence does not support this.  Click here to see the video

 

There is a great post in IPBiz, “Mentioning Innovation with Mentioning Patents“, how CBS Sunday Morning had a whole show about the lack of innovation but never discussed patents or inventors.

One of my colleagues is always pointing out the people who use the word innovation discuss it in a disembodied way.  They never discuss inventors or patents.  Specifically, he states:

Say yes to inventors. Say no to “ignore-&-evasion”.

The full-truth word is “invention”, not inno-evasion.

He makes excellent points – at least on how the word innovation has been perverted.

 
96% of Americans Believe Innovation is Critical

According to the BBC article “Governments stifle hi-tech innovation, says trade group” , American believe innovation is critical to the US’s success as a world economic leader.  The article states:

The weakening financial markets meant that in 2009 America was overtaken as the most competitive economy by Switzerland.

As regular readers of this blog know, In my opinion since 2000 we have passed a number of laws and regulations that are killing innovation in the US.  The incredible innovation of the 90s was based on technology start-up companies built on intellectual capital, financial capital, and human capital.  All three of the pillars have been under attack since 2000.  Our patent laws have been weakened reducing the value of intellectual capital.  Sarbanes Oxley has made it impossible to go public reducing financial capital for start-ups and the FASB rules on stock options have made it harder to attract human capital to start-ups.  The Decline and Fall of the American Entrepreneur: How Little Known Laws and Regulations are Killing Innovation, explains these problems in more detail.

 

According to the Wall Street Journal Article Big Business Creates Jobs Too, “ignoring the important role that big business plays in job creation is a short-sighted mistake.”  The author also states

It is actually within large companies that an entrepreneur can find, already in existence, much of what it takes to insure a venture’s success. This includes the capital required to fund startup costs, the marketing presence to create a near-instant reach to customers, and the standing required to gain trust of both vendors and customers.

While it is true that large companies innovate, on a per employee basis they are much less innovative see SBA report on point.  In addition, the reason for our economic woes are not that the government has failed implement policies that support large companies, but that it has implemented polices that inhibit technology start-ups.  Only technological innovation results in real per capita increase income.  The Wall Street Journal article is misleading at best.

Unfortunately, since 2000 we have passed a number of laws and regulations that are killing innovation in the US.  The incredible innovation of the 90s was based on technology start-up companies built on intellectual capital, financial capital, and human capital.  All three of the pillars have been under attack since 2000.  Our patent laws have been weakened reducing the value of intellectual capital.  Sarbanes Oxley has made it impossible to go public reducing financial capital for start-ups and the FASB rules on stock options have made it harder to attract human capital to start-ups.  The Decline and Fall of the American Entrepreneur: How Little Known Laws and Regulations are Killing Innovation, explains these problems in more detail.

 
Do Individual Inventors and Start-ups Invent Anything Important?

According to the SBA report An Analysis of Small Business Patens by Industry and Firm Size,

Small firms have three times as many patents in emerging technologies as would be expected based on the overall percentage of patents for which they are responsible.  Specifically, small firms account for just 8 percent of all patents in the database (firms with 15+ patents), but 24 percent of the patents of U.S. firms in the emerging technology clusters.

In addition, the report states that small firms tend to patent in different areas of emerging technology than large firms.

But are small firms patents of high quality?  The report states:

Small firm patents outperform large firm patents on a number of impact metrics including growth, citation impact, patent originality, and patent generality. These metrics have been used for decades to measure the innovativeness of firms, labs, and agencies. The metrics have been validated and shown to correlate with increases in sales, profits, stock prices, inventor awards, and other positive outcomes. This suggests that the patents of small firms in general are likely to be more technologically important than those of large firms.

In addition, firms with fewer employees out patent firms per employee with more employees across all cross section firms.  Specifically,

Small firms obtain many more patents per employee than do large firms. This result is quantified to show that this is not a small-firm large-firm phenomenon, but is actually a firm size issue at all levels. In particular, even within the small firm domain, companies with fewer than 25 employees will have a higher patent-to-employee ratio on average than firms with 50 employees, which will in turn have a higher patent-to-employee ratio than firms with 100 employees, and so on.

Despite the fact that small firms and individual inventors are key drivers for technological innovation, Congress and the Supreme Court are trying to make our patent system less accessible for small inventors.  For instance, Congress is trying to change the patent laws from first-to-invent to a first-to-file system.  This would be similar to Europe’s system, which has proven to be very unfriendly to independent inventor and small firms.  The Supreme Court has made it harder for inventors to obtain an injunction (eBay decision) if their patent is violated and made it more uncertain and expensive to obtain a patent and uphold it validity (KSR decision).

 

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