The GDP Mirage

This week Michael Mandel, chief economist at BusinessWeek, reports on “The GDP Mirage”.

What is it?

GDP is a measure of all the goods & services produced by the U.S. economy. We use it as a benchmark. The change in GDP is what we are referring to when we discuss the perennial question, “how’s the economy?”

On October 29, The Bureau of Economic Analysis reported that GDP rose 3.5% in the third quarter of 2009. That’s quite a number! Especially when you consider we haven’t seen any numbers like that since Q2 of 2007, over two years ago.

Most media outlets and pundits are reporting that the recession is over. Mandel disagrees. How dare he issue such a contrarian viewpoint when we are all looking for good news? Because he’s probably right. Mandel’s argument is that the GDP as it is currently measured fails to track intangibles which are a necessary ingredient of the economy in 2009.

The intangibles he mentions are R&D, product design and worker training. Certainly those sound important to me. We would never have gotten to this stage of development if companies hadn’t spent on these things in the past!

So, why are the companies cutting these important intangibles?

The accounting system as it stands recognizes these categories as expenses, not investment. When a company wants to boost the bottom line, they cut expenses to look better to investors, creditors and everyone else. Since 1999 software has been categorized as an investment. In 2013 R&D will be an investment. But what happens before 2013?

Mandel is especially concerned about the reduction in employment of scientists and engineers, which has fallen 6.3% in the last year as compared to general employment, which has fallen 4.1%. Surely highly educated knowledge workers are important in the information age, are they not?

I keep hearing about how past recessions have given birth to new companies and innovation. It is possible the same results may not come out of this recession if companies are not investing. Mandel points out new product development is down, and the more highly educated workers are the first to be let go. In the past the U.S. has done very well investing in workers and spending on worker training. But now with huge cutbacks, will the U.S. worker maintain the same level of output?

BusinessWeek did some back-of-the-envelope calculations, and predicts that intangible investments are still decreasing.

We all know about the ominous outsourcing of R&D to China and India. It started with call centers. And now has moved up the chain to the really important development. It’s the big sucking sound Ross Perot used to talk about, now in a different part of the world.

If U.S. companies are getting more bang for their R&D buck by spending in foreign countries I suppose that’s not so bad. But the outsourcing of such a great range of jobs will help to keep unemployment high for a long time. What about those unemployed scientists?

Baseball statistics show us that what we track has a chance of improving. In fact, sometimes people will go to any length to achieve their numbers (Enron, anyone? McGwire and Sosa?) Sounds like we need to speed up directions to the BEA about what to track in GDP. Mandel states that the BEA does a good job with the numbers they have, but they “are using 20th century tools to track a 21st century economy”.

My opinion is Mandel is right. In a global information age, knowledge can be more important that property, plant and equipment. After all, what would you rather have, a dusty old building, or the knowledge of how to build a new and better one, on time and under budget?