What’s Wrong With This Picture?

In the 2004 election rhetoric we were treated, ad nauseam, to more than we wanted to hear about the state and future of the U.S. economy. Regardless of which side one took, it’s possible that the numbers used to measure the economic performance of the U.S. were all wrong, this according to a piece written by Michael Mandell, Christopher Farrell and Howard Glickman in BusinessWeek.

Consider, for example, that in 1946 Bugsy Siegel and cronies invested $6 million in the Las Vegas Flamingo Hotel. This investment was duly noted by government statisticians and became part of the Gross National Product calculations for that year. Missing in those calculations was the investment made by AT&T in Bell Labs, where the transistor was invented.

Today, the Bureau of Economic Analysis can tell you how much the railroads spend on furniture, which is added to Gross Domestic Product, but the bureau has little idea how much companies invest in innovation, product design and training.

In both of these extremes, something is missing from the analysis; intangibles that can provide future economic returns are not measured in economic output figures as are bricks and mortar.

My favorite vignette of mis-measurement is how we value spending on education. Americans spend more than 7% of GDP on education, compared to 4.6% for Japan. If this money were counted as an investment in the future ability of children to earn a good living and improve their lives and not as consumption, the U.S. personal savings rate for 2005 would be 2.0%, not the -0.5% the official numbers show, according to the BusinessWeek article. Surely the value of education lasts longer than the computer or iPod, which do show in the GDP figures.

Speaking of iPods, our system of measurement fails to account for Apple’s collective creative genius that managed to sell more than 40 million iPods. Last year, Apple spent more than $800 million on research and development (R&D) that is not counted in GDP figures, though each iPod, manufactured in China, is counted twice, making Apple a statistical reseller of imported goods.

These examples point out a fallacy in using conventional economic measurements as a yardstick for the American economy. The statistical systems in place date back to Depression Era accounting when President Franklin Roosevelt assigned the Department of Commerce the chore of coming up with a way to measure national production.

The man behind this early work, Nation Bureau of Economic Research economist Simon Kuznets, later won a Nobel Prize in economics (1971) for his work. He recognized as investment in future production the building of plants and purchase of equipment. But he failed to assign value to investments in education, training and R&D.

These miscalculations are primarily the result of the U.S. becoming a knowledge economy, with innovation and ideas becoming more important than bricks and mortar, one where education and training play an increasingly important role in the future well-being of the country.

In part, these measurement issues help explain why the slowdown in the economy in 2001 may have been more severe than reported – and why the growth we are experiencing now may be better than it measures. In 2001, companies cut back on expenditures for intangibles (not measured) by largely reducing payrolls (measured as job losses). Yet business output and earnings continued positive, leading to a GDP figure that might have been higher than expected.

Today, businesses are spending more on intangibles (not measured as business investment), which understates the performance of the economy.

Rhetoric aside, we could conclude from this discussion that our economy is being positioned for more rapid growth than we might expect, provided we continue to invest in education, training and R&D.