2Q 2012 GDP – and waiting for better measures

News from BEA this morning is that the economy slowed in the April-June period. GDP grew by only 1.5% in the second quarter, compared with 2% in the first quarter and 4.1% in 4Q 2011. The 2Q 2012 growth rate was basically in line with economists’ forecast of 1.3% (according to the Wall Street Journal).
Declining spending by Federal, state and local governments continues to be a drag on GDP growth, although not as large as in earlier periods. Consumer spending increased, but at a slower rate. Spending on durable goods actually declined. Nonresidential fixed investment (i.e. business spending) grew at slower rate as well — up 5.3% compared to a 7.5% increase in 1Q 2012. The good news is that equipment and software increased by 7.2% compared to an increase of 5.4% in the previous quarter. And, as I have noted before, the data has a basic problem in that it does not give us any guidance on investment in intangibles other than software. So we do not know whether companies have increased or decreased their investments in important areas such as human and organizational capital.
That is about to change — at least a little bit. BEA has plans for a major revision in the GDP calculations next year. Two big changes will help make the GDP data more accurate: capitalization of research and development (R&D)and capitalization of entertainment, literary, and artistic originals (movies, music, books, art work, etc.) Currently, both R&D and the cost of creating entertainment, literary, and artistic originals are treated as a direct expense. Under the new system, they will be treated as investments, as they should be since they have long paybacks not just immediate returns.
As part of this shift, investments in these items with be specifically captured in the nonresidential fixed investment data. There will be separate data for software (now a subcategory of equipment), R&D, and entertainment, literary, and artistic originals. This should allow us to get a better picture of the I-Cubed Economy.
It might also help economist better forecast future growth. Right now, the predictions are constrained by the industrial age thinking and metrics. Take for example this quote from a recent Wall Street Journal comment on another piece of data: “New orders for nondefense capital goods excluding aircraft–which many economists consider a proxy for business investment–fell 1.4% in June from a month earlier.” (emphasis added)
But business investments in tangibles is smaller than investment in intangibles and between 60% to 80% of company value in their intangible assets. Given that, why would a measure of only a fraction of business investment – and in a category that is shrinking in importance as a value driver – be an accurate indicator of the health of the economy. Yes, investment in plant and equipment is important just as a manufacturing base is important. But investments in intangibles are just as, if not more, important — including for the manufacturing base. And we aren’t reporting those investment in intangibles in our GDP data. That is like trying to drive a car with most of the windows covered. It can be done – kind of. But it is very dangerous.
Likewise, not having correct data about our Information-Innovation-Intangibles Economy is dangerous for policy making. The new BEA changes will help. But they are only a step in the right direction.
Final note: the BEA data on GDP is the “advanced estimates” subject to potentially large revisions. The next revision will be released on August 29.

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