Charles Krakoff

I was recently in Pyongyang, at the invitation of the Korean Association for Economic Development, to participate in a two-day conference on special economic zones, co-sponsored by the University of British Columbia. It was one of the most surreal experiences of my life, which I am still trying to process. Members of our group who have previously visited the country say they perceived more openness and less fear among the people than in the past, but it remains a highly regimented society. Visible signs of commerce are completely absent. The only billboards show pictures of the Great Leader and Dear Leader or revolutionary slogans accompanying images of ferocious soldiers bayoneting the imperialists. Not a corporate logo in sight. Shops – the people do have to buy necessities and the occasional small luxury – are utilitarian, and their signage, though I can’t read Korean, is drab and functional: “Bread.” “Clothing.” “Furniture.” It may be the only country in the world without Coca-Cola.

Our hosts have asked me to return, to visit their zones and provide some advice, but they are not willing to pay anything close to my normal consulting fees. One thing they will have to learn as they try to engage with the outside world and attract foreign investment – if indeed that is what they do intend – is that foreign experts (I modestly include myself in that category) expect to be paid. It’s not as if the North Koreans are starved for funds or foreign exchange. The fleet of spanking new Mercedes S-Class sedans and SUVs that chauffered our group around the city, the big bottles of cognac and 18-year-old Scotch in the state-owned restaurants we were invited to, where the elite go to enjoy themselves, not to mention North Korea’s nuclear weapons program, are proof of that. Of course, to the degree that the country can rejoin the international community on less confrontational terms, it can go down the path well trodden by developing countries in Africa, Asia, and Latin America and ask for assistance from international donors to pay for my services.

Two weeks ago I was interviewed about my experiences on The Manzella Report, an international business news and opinion magazine that publishes interviews on YouTube. You can view the interview here: Are the North Koreans Ready for Change?

Like the North Koreans, I too may not be ready for prime time, but I am working on it.

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President Obama received a lot of outraged criticism from the right during the 2012 campaign for his remark, “You didn’t build that.” What he meant, though he uncharacteristically said it in a fairly clumsy way, was that for every proudly self-made entrepreneur there is a huge web of supporting institutions and infrastructure built by the government. These essential supports include the obvious – the courts, the Interstate highway system, police and fire departments, etc. – but also a tremendous array of investments undertaken by national governments, many of which have provided a platform on which entrepreneurs can build. A recent article in The Economist, reviewing a new book entitled “The Entrepreneurial State,” by Mariana Mazzucato of Sussex University in England, makes this explicit. And nowhere is this investment activity more influential than the United States, supposedly the cradle of unbridled individual enterprise.

Beneficiaries of these investments include Apple: “The armed forces pioneered the Internet, GPS positioning and voice-activated ‘virtual assistants.’ They also provided much of the early funding for Silicon Valley. Academic scientists in publicly funded universities and labs developed the touchscreen and the HTML language. An obscure government body even lent Apple $500,000 before it went public.” They also include Google, which received early funding from the National Science Foundation. Pharmaceutical and biotechnology companies benefit from the $30 billion in annual funding for biomedical research from the National Institutes of Health.

As Ms. Mazzucato argues, “The entrepreneurial state does far more than just make up for the private sector’s shortcomings: through the big bets it makes on new technologies, such as aircraft or the internet, it creates and shapes the markets of the future. At its best the state is nothing less than the ultimate Schumpeterian innovator—generating the gales of creative destruction that provide strong tailwinds for private firms like Apple.”

There are reasons to be skeptical of some government investments. The Solyndra debacle, in which the Federal government provided $500 million in loan guarantees to a California manufacturer of solar panels, which promptly went bust in the face of low-cost competition from China, is a cautionary example of the dangers of bureaucrats playing at being venture capitalists. But the rallying cry of the Tea Party – the Randian (Ayn and Paul) notion that the state is essentially a parasite feeding on the efforts of bold and visionary individual entrepreneurs – is a pure fairy tale.

The Economist article asks “why are some states successful entrepreneurs while others are failures?” and it provides an answer:  “Successful states are obsessed by competition; they make scientists compete for research grants, and businesses compete for start-up funds—and leave the decisions to experts, rather than politicians or bureaucrats. They also foster networks of innovation that stretch from universities to profit-maximizing companies, keeping their own role to a minimum.” This sounds much like the blueprint for Silicon Valley, or any other successful technology-based industrial cluster.

In our current budget-cutting environment, these essential investments are under threat. According to a recent article in The Huffington Post, sequestration will cost the NIH 5% of its budget, or $1.7 billion, forcing the cancellation of 700 competitive research grants in the current Federal budget year. Similarly, the National Science Foundation is expected to issue 1,000 fewer research grants this year as a result of sequestration.

According to a statement by the Congressional Budget Office, the Federal Highway Trust Fund, which is funded by taxes on gasoline and diesel and which provides a substantial portion of the money states use to maintain state and national roads, is essentially insolvent and will run out of money completely by 2015. The only way to avoid this would be to cut transportation funding by 92% or raise the Federal gasoline tax by 50 cents a gallon, and it’s hard to imagine the Republican-controlled House of Representatives going along with the latter.

In the current political environment, much of the public investment that enables American businesses to innovate and prosper is under threat, mainly from ideologues who refuse to recognize the essential role that government initiative and funds have played since the founding of the Republic, from the Erie Canal to the interstate highway system, to nanotechnology research.

It is worth considering these facts in the context of the current legal battle between Verizon and the Federal Communications Commission. Verizon is challenging a net-neutrality order adopted by the FCC in 2010, which states that internet service providers (ISPs) cannot block lawful content and mobile broadband providers cannot block lawful websites. Verizon contends that the order violates its First Amendment rights. More to the point, Verizon and its competitors, including Comcast and AT&T, maintain that they spent billions of dollars to build their networks and should be able to grant or deny access as they please, or charge different customers different rates for transmitting on their networks. This is a spurious argument. The broadband companies are “common carriers,” a term that applies not only to telecoms companies but also to airlines, railroads, and trucking companies: they offer their services to the general public under a license or authority granted by a public regulatory body. Common carriers are subject to licensing requirements because they are using a public resource: radio spectrum, rights of way, public roads, or air traffic control systems, without which they would be unable to operate. In the case of the telecoms company, they are also using a resource – the Internet – that was developed by DARPA, the U.S. Defense Advanced Research Projects Agency.

The Internet and the public airwaves are not the property of those companies to use as they please, free from any oversight or interference. It is time to tell them, “No, you didn’t build that.”

 

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Outgoing WTO Director-General Pascal Lamy has recently criticized EU-US and transpacific trade talks, which have the potential to create the world’s two largest free trade areas and measurably increase prosperity and growth for hundreds of millions, if not billions, of people. He has a point. Several, actually. Regional trade agreements, though they may possibly serve as stepping-stones to global agreements, can also reduce the urgency with which their members approach global trade negotiations in the WTO framework. A transpacific or transatlantic trade agreement, in addition to excluding China, which already sees hostile intent in the transpacific talks, would also leave out some of the world’s most vulnerable economies and people, especially in Africa and South Asia. Lamy also expressed doubt that either of these incipient trade agreements would address agricultural subsidies, which are the most important trade distortion of all.

All true. And yet, given the paralysis affecting the Doha Round WTO trade talks, now in their 13th year, big regional agreements may be the best deal we can get. According to a study by the European Centre for International Political Economy, a transatlantic zero-tariff agreement, reducing existing tariffs from their current levels of three to five percent to zero, would add between 0.99 and 1.33 percent to U.S. GDP. Eliminating non-tariff trade barriers such as subsidies, and harmonizing product safety and drug approval standards, could add even more. The benefits from a transpacific agreement, which could cover forty percent of global trade if Japan’s efforts to join the agreement bear fruit, could be similar. And the wonderful thing about trade is that one party’s gains are not another’s losses. These agreements could raise everyone’s prosperity.

But relatively trivial disagreements could easily stall both sets of talks or derail them entirely. France has insisted that any trade agreement would have to allow it to continue to lavish subsidies on the French film industry. Japan, whose Liberal Democratic Party owes much of its support to wealthy farmers, insists that it should be allowed to protect its producers of rice, wheat, beef, and soy from imports. Japan has long imposed non-tariff barriers against a wide range of products, including skis, claiming the imported variety are unsuitable for Japan’s unique snow conditions. Such practices are not unknown in France either. At one point, all imported videocassette recorders and players had to be inspected in the customs shed in the city of Poitiers.

The French stance on film industry protection, surprisingly, has come in for more criticism from other EU members fearful of scuppering an immensely valuable deal than from the U.S. and its film industry, which seem fairly relaxed about the whole thing. In a country that has given its highest civilian honor to both Jerry Lewis and Sylvester Stallone, Hollywood has nothing to worry about no matter how much public money French film producers receive. Japanese farmers and their political supporters are, clearly, trying their luck demanding so many exemptions. Kobe and Wagyu beef notwithstanding, none of the products for which Japan is seeking protection has the iconic cultural status of rice, which is tightly bound to Japan’s sense of nationhood. Each year the Emperor conducts special public rituals of sowing, planting, harvesting and giving thanks for rice, while the ceremonies for enthroning a new Emperor include private rites in which he eats specially cultivated sacred rice in an act of communion with his ancestor, the Sun Goddess Amaterasu-ōmikami.

So here is a modest proposal. Each country gets a free pass to protect or subsidize one thing, regardless of fairness or logic. If the French want to give their money to cineastes in the form of subsidies rather than fork out 10 Euros to go see their films, fine. If Mrs. Watanabe wants to buy Japanese rice at a price some 700 percent higher than what she would pay for Thai or American rice, let her. It may not, strictly speaking, be fair to American rice farmers, but it is no more unfair than the subsidies those same farmers get from the U.S. Government (see my recent post on the farm bill), which apparently are legal under current international trade rules. The same rule, of course, would mean that the U.S. would have to choose just one thing to protect or unfairly subsidize. Arkansas rice or cotton growers? Florida sugarcane growers? New England dairy farmers? Archer Daniels Midland? Solar panel manufacturers? And once the choice is made, it’s made. No switching around based on election-year vote counting, depending on who is doing the counting.

On second thought, this is far too reasonable a proposition. It’ll never fly.

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In principle, the decision by House Republicans to strip the food stamp program out of the current farm bill is not a bad thing. In practice, it may not be so bad either.

For the past 40 years or so, agricultural subsidies and supplemental nutrition programs (food stamps) for poor people have been joined at the hip, the idea being that combining the two, otherwise unrelated, initiatives could help win bipartisan support for an omnibus bill that contained something for every constituency: farmers, agribusiness, advocates for the poor, etc. The problem with such an approach is that it embodied the worst of interest-group politics, legislative back scratching, and pork barrel giveaways. No liberal legislator would vote against subsidies for rich sugar or cotton or tobacco farmers for example, if it meant cuts to the food stamp program. No Florida conservative would vote to cut food stamps if it also meant cuts to subsidies for his or her rich, sugar-growing constituents. Everyone got pretty much everything they wanted, and no serious policy debate ever occurred. So separating the two makes profound sense. But encouraging a serious policy debate is the last thing on House Republicans’ minds.

In drafting and voting on a pure farm bill, House Republicans have laid bare their hypocrisy by showing, in black and white, the hollowness of their claims to budget-cutting rigor. It turns out that it’s not government spending per se they object to: as long as it benefits the wealthy, they are quite okay with it. Indeed, in drafting the new farm bill the House Republicans rejected all calls to cap or eliminate subsidies to wealthy individuals and corporations. [click to continue…]

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For all its faults, the pharmaceutical industry remains one area in which the United States is still a competitive world leader. But without drastic changes in the way the FDA regulates the industry, this advantage may not last.

Back in the early 1980s I worked for one of the major airlines, a company you have probably heard of, even though it hasn’t flown in over a decade. This was shortly after President Jimmy Carter had deregulated the airline industry. My employer, a pioneer in commercial flight, had grown accustomed to doing business in a certain way and lacked the foresight and skill to adapt to the new environment. Prior to deregulation, airlines needed to have lots of lawyers, whose main job it was to lobby the federal government to get and keep valuable landing slots at major airports. Once you had those, you could count on a steady stream of profits, since the Civil Aeronautics Board limited competition on most routes, thus ensuring high load factors, and also set fares the airlines were allowed to charge. Overnight, things changed 180 degrees, and airlines had to pay attention to things like customer service and efficiency. My employer failed to make the cut.

We may be seeing the opposite phenomenon in the pharmaceutical industry. According to a recent report by KPMG, industry returns on R&D spending have fallen from 18% in 1990 to 10% in 2010, and annual growth in R&D spending has slowed from an average 10% between 1999 and 2006 to just 1% since 2007. Pharmaceutical companies may be turning to lawyers and the regulators to make up the difference. [click to continue…]

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