What made America great was her unsurpassed ability to innovate. Equally important was also her ability to rapidly adapt to the change that this innovation fostered. For decades the combination has been a self reinforcing growth dynamic with innovation offering a continuously improving standard of living and higher corporate productivity levels, which the US quickly embraced and adapted to.

This in turn financed further innovation. No country in the world could match the American culture that flourished on technology advancements in all areas of human endeavor. However, something serious and major has changed across America. Daily, more and more are becoming acutely aware of this, but few grasp exactly what it is. It is called Creative Destruction.

It turns out that what made America great is now killing her!

Our political leaders are presently addressing what they perceive as an intractable cyclical recovery problem when in fact it is a structural problem that is secular in nature. Like generals fighting the last war with outdated perceptions, we face a new and daunting challenge. A challenge that needs to be addressed with the urgency and scope of a Marshall plan that saved Europe from the ravages of a different type of destruction. We need a modern US centric Marshall plan focused on growth, but orders of magnitude larger than the one in the 1940’s. A plan even more brash than Kennedy’s plan in the 60’s to put a man of the moon by the end of the decade. America needs to again think and act boldly. First however, we need to see the enemy. As the great philosopher Pogo said: “I saw the enemy and it was I”.

THE PROBLEM IS NOT CYCLICAL, IT IS SECULAR.

The dotcom bubble ushered in a change in America that is still reverberating through the nation and around the globe. The Internet unleashed productivity opportunities of unprecedented proportions in addition to new business models, new ways of doing business and completely new and never before realized markets. Ten years ago there was no such position as a Web Master; having a home PC was primarily for doing word processing and creating spreadsheets; Apple made MACs; and ordering on-line was a quaint experiment for risk takers. The changes in ten short years are so broad based that a whole article would be required to even frame the magnitude of the changes. What needs to be understood is that this is precisely what is destroying America. Let me explain.

The process of Creative Destruction is the essential fact of capitalism. It is what capitalism consists in and what every capitalist concern must survive within. America as the birth place of modern capitalism was rooted in a clear understanding of this process and the indisputable reality of survival of the fittest.

“CREATIVE DESTRUCTION: … the competition from the new commodity, the new technology, the new source of supply, the new type of organization – competition which commands a decisive cost or quality advantage and which strikes not at the margins of the profits and the outputs of the existing firms but at their foundations and their very lives”.

Joseph A. Schumpeter

From Capitalism, Socialism and Democracy (New York: Harper, 1975) [orig. pub. 1942], pp. 82-85:

In 1997 prior to the ‘go-go’ Dotcom era unfolding, America’s unemployment was less than half of what it is today at 4.7%. At that time the US added 3 Million net jobs which reflected the creation of 33.4 Million new positions while obsolescing or cutting 30.4 Million old positions. Job losses occurred in old vocations such as typists, secretaries, filing clerks, switchboard operators etc. Hired were new occupations such as C++ programmers, web masters, database managers, network analysts etc.

As the chart above illustrates however, the additions have fallen off precipitously while the job losses have stayed relatively flat. In 2009 job losses were 31.0M and only slightly larger than 1997 which would be expected with further internet application development. New job creation however was only 24.7M which is dramatically lower than the 33.4 in 1997.

The result is 40.8M people on food stamps in the US, as seen below.

This net creative destruction chart reflects closely the US economic output gap.

Employment levels at 58.5% are now near 30 year lows and do not show any signs of significant improvement. This is despite nearly $13T in artificial stimulus to restart an economy that appears to refuse to restart or unarguably is minimally a ‘jobless recovery’.

Once again Tyler Durden and the folks at Zero Hedge did an excellent analysis of the July unemployment numbers by correctly adjusting for shifts in workforce participation. It is surprising that no one other than Zero Hedge understands how to properly assess the monthly labor rate. Their analysis, using government BLS numbers, is shown below and reflects an unemployment rate of 14.7% adjusted for workforce participation.

Is it any wonder Christina Romer as head of Obama’s Council of Economic Advisors resigned the day before the July Non-Farm Payroll numbers were released, when she once again would have had to spin and justify the unemployment rate to the media?

ITS STRUCTURAL, NOT THE FAMILIAR CYCLICAL BUSINESS CYCLE

All the preceding graphics have been labeled with a December 1999 vertical bar. In every instance it shows a major cusp occurring near that point in time. The dotcom market bubble finally popped 3-4 months later. There are anomalies that create some distortions after this period, such as the explosion in both the residential and commercial real estate sectors that temporarily fostered massive hiring from brokers, agents, contractors, trades personnel, developers, etc. Much of this has subsequently been pulled back.

WHAT HAPPENED?

The short answer is the US is no longer innovating fast enough. Innovation needs to sustain its exponential growth to absorb the creative destruction job losses. It no longer can. Mathematicians would have argued some time ago this was a certainty to happen, but precisely when this would occur however was the unknown.

We have been cutting Research and Development expenditures in the US dramatically. I warned of this in 2009 in my article: America, Innovate or Die! It has only gotten worse since. Corporations may be reflecting minor cuts on their balance sheets in this area but it obscures the fact that the money is increasingly being re-allocated and spent offshore. Jobs and innovation follow R&D.

The Financial Times in the UK featured this global analysis to the right, which to the best of my knowledge never saw the light of day in any US publication. The rate of growth in research papers in the US is not keeping up.

Total researcher share is shrinking and falling further behind as the chart below demonstrates.

Even more alarming is the number of US patents being filed. Other than IBM and Microsoft the numbers are stunningly small. It needs to be fully appreciated that both IBM and Microsoft now have large numbers of major world class research facilities outside the US and the US filings numbers below are likely reflecting this (see America, Innovate or Die!).

“The numbers of engineering graduates in China and India far outpace that of the United States. In China, it is 600,000; in India, 350,000; in the United States, 70,000, and many of these are foreign students who, more likely than not, will be returning to their home countries.”

Senator Edward Kennedy -- 10-25-05

Testimony - Senate Record

Let me relate a personal story if I may. In the early 90’s I was a Vice President of Engineering for a S&P 500 corporation in Massachusetts. This engineering facility in Massachusetts consisted of over 900 engineers supporting an enterprise with 28 facilities and over 10,000 employees. Today it is all gone. The towns in the immediate area of this enterprise also had major facilities of two other S&P 500 corporations. They are also both gone. There were companies in Massachusetts at that time by the name of DEC, Data General, Prime, Wang to name but four, that employed hundreds of thousands of highly skilled personnel. They are likewise gone. So where are the jobs to replace them?

Communities in this area now reflect those who have temporarily found jobs as a result of the over building of retail stores and malls during the last ten years in almost every available piece of land that could conceivably be built on. I walked into yet another Home Depot and found one of my former employees working in the electrical department who happened in the ‘90s to be one of the world’s best power supply design engineers. He told me there was one other with him from his old department. Both as I recall had Master’s degrees in electrical engineering.

The new technology in the area is now Bio-Tech. These new Bio-Technology corporations however only employ in the 5 and 10 thousand range of employees. Not the 100s of thousands that the four corporations I mentioned above once did. These Bio-Tech players additionally have an extremely high percentage of Master’s and PhD level employees. What about the high school and/or college grads? Few need apply. I personally see this demographic lined up for Dunkin Donuts application forms each morning while relaxing after my morning jog. More also out of work PhDs due to reduced teaching positions is not the solution. This is the state of affairs in R&D that our politicians don’t see nor fully comprehend.

IS IT GOING TO CHANGE?

I told you the above personal story as a way of leading into one of my primary goals in the early 90s as VP of Engineering of this particular operation. It was something called Cycle Time reduction. This is the process of shortening the time to market of products from concept to revenue generation. The chart to the right shows a graphical representation of this.

We were so successful at reducing this through computerization such as the implementation of CAAD-CAM-CIM, JIT, Kanban, TQM and a host of other acronyms that we were at levels approaching 80% of the following years revenue being forecasted to be derived from products still on the engineering concept boards. Margins and room for error were absolutely razor thin. The strategy was like the old three legged race at the community picnic. The faster some tried to run the more they tripped themselves up. It was a strategy where speeding up the process left unprepared competitors with a fatal competitive disadvantage. The fight for market share was intense. Though I had moved on, when the internet arrived and supply chain management was reinvented and overlayed onto the previous advancements, the enterprise was rapidly shuttered and moved to the far east. It is one, of no doubt, thousands of similar stories in America. America’s ability to innovate and adjust to that innovation killed this American based organizational unit. The highly skilled, intense and motivated employees innovated themselves out of a job.

THE LESSON IS THIS

America used the rate of innovation as a foundation for its competitive advantage. Like the tortoise and hare however, the US can no longer maintain this rate and hence the advantage has temporarily shifted to the previous followers who are presently less impacted. America must once again innovate and change but now in a manner more fitting for the realities of this new decade.

The product today is no longer the widget that comes off a manufacturing line and is stuffed into a box to be shipped to distribution centers for sale. The product today with short product life cycles and hundreds of new products is Intellectual Capital. Intellectual Capital is the knowledge of knowing how to do something. How to design and build something – not the actual ‘doing of it’. Until America forces corporations to account for Intellectual Property properly, the multi-nationals will continue to fully exploit this tax loophole. Even worse, America’s innovation will continue to be used against her. The cost of manufactured products today are less and less in labor & production and increasingly in materials and innovation. Capital is likewise shifting to be more intellectual versus financial. A major overhaul of accounting standards must be driven by our legislators or it will not be changed. It is not to the multi-nationals advantage to allow such a debate and shift to occur.

Unfortunately our law makers allowed this American asset to leave the US unrestricted, untaxed and without recourse. It was America who knew how to design and build a PC. It is fine for the product to be built where it is cheapest as part of free trade, but only when the cost of the knowledge or Intellectual property is priced in. Amortization of research & development must include the Intellectual property value as well. The Intellectual Capital was an American asset, not a corporate asset which left. Massive royalties should now be flowing to the US taxpayer today which would offset many state and local services cuts. Instead we are left with underfunded corporate legacy pension plans that the government in the years to come will no doubt pick up the tab for by likely hyperinflating the currency. Though it is too late to revisit the horrendous US failure of public policy in the past, it is not too late to prepare for tomorrow.

A STARTING POINT FOR CHANGE – Gordon’s Top Ten

As I said in the beginning the US needs a bold new “Marshall” plan to fight the new destruction of creative destruction. Here is a starting point for public debate:

1 – If we can spend $165B bailing out AIG, then we can spend $100B (4 years of college @ 50K/year X 500,000 students) and guarantee everyone in America a college education to compete in the 21st century. Parents will start to spend immediately instead of presently being almost financially paralyzed with skyrocketing education costs.

2- Obama says we need to be leaders in Energy. OK. Where are the programs? Where are the 50,000 new university teaching and research positions ( 50,000 X 75K = $3.8B)? At $3.8B this is a rounding error compared to the banks TARP program.

3- 99% of all jobs in America are created by small business with less than 500 employees. Stop treating them like they are last on the ‘to help’ list after the banks, financial institutions and S&P 500 but first on the taxation list. S&P 500 paid almost net zero taxes, reduced US hiring, yet received the bulk of the governments bailouts. Small business is the golden goose that every administration seems determine to cook. What has the government done for small business other than burden them with Obamacare and the potential removal of the Bush tax cuts (most small business are directly affected proprietorships)? If you can’t immediately recite what the government has done to help small business as THE US employer (versus what they have done for the bank and financial lobby), then you understand the problem.

4- The number of Government employees, in addition to their salaries and benefits (federal, state & local) can best be described as out of control. According to a new study from the Heritage Foundation, U.S. government workers earn 30 to 40 percent more money than their private sector counterparts on average. So, in essence, the ‘servants’ make substantially more money than the taxpayers who employ them. Isn’t the system great? In fact, according to the study, if you add in retirement and health care benefits, the average federal employee now earns nearly twice as much as the average private sector employee.

5- Make Social Security and Medicare financially sound so Americas can believe and budget that it will be there for them. The public will spend and invest if they know they have a nest egg that really exists. The government is fooling no one. Kids learn that Social Security and Medicare is unfunded before their college freshman year today.

The stark reality of the shift from defined benefits to contributory benefits over the last decade is just now sinking in with the US consumer. They now have no retirement like their parents had. Retirement savings is something when added to college costs is leaving them frightened. Worried people don't spend money and when the economy is 70% consumer spending you have an economic crisis. Political denial and the government attempting to paper it over with policies of extend and pretend are misplaced and will make the inevitability even more difficult to effectively address.

6- When did the American people decide to fund military operations in over 130 countries around the world? With 40.8M people on food stamps, something is seriously out of balance here but there is no public debate thought to be required by either party.

7- The US has no full scale strategic growth programs being initiated by the present administration. We have only financial stimulus or austerity programs. There is a big difference that seems wasted on Washington.

8- Washington and the lobbyists that control it have taken control of our government. Obama campaigned to stop earmarks which ranged in the area of approximately 10,000 annually prior to his presidency. In his first year they increased to the 11,000 range. This is not the change he promised as more pork increasingly flows.

9- For those that actually read it, Obamacare is not a solution for healthcare. It is a stealth income tax we will all soon get hit with. The Dodd-Frank Act is not a fix to what caused the 2008 financial crisis but rather is the most dramatic shift in centralized US government planning and control since the 1930’s. Both these bills were over 2000 pages compared to landmark bills historically being 25 – 45 pages. Indications are that few of our elected representatives actually read either of these documents. They simply voted party lines. As Sarbanes-Oxley dictates, CEOs must sign their corporate 10-Q reports to the government and are liable for it. It is a felony not to. Every elected official should also sign that he or she has personally read the entire act prior to being allowed to vote on it or it likewise will be a felony.

10- The Supreme Court recently over-turned major elements of the Campaign Contribution Reform bill. Washington and the media have now gone completely mute on this subject as politicians scramble for mid-term campaign money for media expense coverage. Maybe our elected officials should vote with the same urgency on this matter as they are presently on giving billions of ‘candy’ away almost daily to every financial disruption, state budget problem, unemployment benefit problem or sign of increasing housing default and foreclosure rates during this run up to the fall elections.

I could go on, but I think you get the message. America is afraid to be bold! We have no strategy, no plan, no funding and no leadership! In my days as a VP of Engineering you were fired for just one of these shortfalls.

Maybe we the public need to start doing some firing!

“The biggest political change in my lifetime is that Americans no longer assume that their children will have it better than they did. This is a huge break with the past, with assumptions and traditions that shaped us.”

Peggy Noonan: America Is at Risk of Boiling Over

Feature Wall Street Journal Op-Ed article - 08-07-10

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Gordon T Long

Tipping Points

Mr. Long is a former senior group executive with two Fortune 500 international corporations, a principal in a high tech public start-up and founder of a private venture capital fund. He is presently involved in private equity placements internationally along with proprietary trading involving the development & application of Chaos Theory and Mandelbrot Generator algorithms.