Employment growth continues in both intangible producing industries and tangible producing industries

July’s employment data shows a return to equal growth in both intangible and tangible producing industries.

The US employment growth machine continued in July with the Bureau of Labor Statistics reporting an unexpectedly high increase in jobs of 528,000. The biggest gains in intangible-producing industries were in Professional and Business Services (up 82,100), Educational & Health Services (up 103,800), and Government (excluding Postal Service) (up 54,800). For tangible-producing industries, the higher level of employment was due primarily to increases in Accommodation & Food Services (up 73,900) and Trade, Transportation & Utilities (up 54,000). Construction & Mining (up 39,000) and Manufacturing (up 30,000) also contributed to the growth.

A couple of months ago I reported that the May data showed a large difference in employment in tangible-producing industries versus intangible-producing industries. That was a change from the previous trend where the two parts of the economy have grown (or declined) at pretty much the same rate (see chart below). The July data shows only a slightly faster employment growth in the intangible-producing industries compared to tangible producing industries. Thus, it looks like the trend of relatively equal growth started at the end of the Great Recession will continue. That being said, we continue to see employment volatility within specific industries.

For more on the categories, see my explanation of the methodology in an earlier posting

GDP bright spot: Knowledge-related business investment in software and R&D

While overall GDP declined slightly in 2Q 2022, knowledge-related business investment in software and R&D continued strong growth. But investment in information processing equipment was lower.

There is (and will be) considerable discussion of this morning’s numbers for US GDP for the 2nd quarter of 2022. BEA’s “Advanced Estimate” shows GDP dropped by 0.2% compared to the first quarter (a decline of 0.9% at an annual rate) – triggering a debate about whether the US is in recession (a two quarter drop in GDP is used by many as the definition of a recession whereas economist use a broader set of indicators).

Contributing to this weakness was the fact that business (non-residential fixed) investment was essentially flat. And investment in information processing equipment (a key knowledge-related sector) declined at an annual rate of 6.4%.

One bright spot: the other knowledge-related areas continued strong growth. Investment in software was up by an annual rate of 8.9% and R&D spending up by 7.5%.

Obviously those two sectors make up only a small fraction of our $25 trillion economy. But the willingness of businesses to continue to increase their investments in software and R&D bodes well for future economic growth.

[Note: I define knowledge-related investment as the combination of investment in Information Processing Equipment, R&D, and Software. The first of these three categories is reported in the GDP data as a subcategory of Non-residential Fixed Investment: Equipment. The latter two are reported as subcategories of Non-residential Fixed Investment: Intellectual Property Products.]

Intangibles trade surplus holds up well in pandemic. Goods deficit explodes.

Yesterday the Bureau of Economic Analysis (BEA) released trade data for April, showing an improvement in the U.S. trade deficit – due to a significant decrease in imports (down by $12.1 billion from March) coupled with a rise in exports (up by $8.5 billion). This month’s release also includes the annual revision of trade data going back to 2015.

Given the updated data and that it has been slightly more than 2 years since the COVID 19 shut down, I thought it was time to take an updated look at how intangibles trade has been affected by the pandemic. The short answer is: not much – unlike the trade in goods which got hammered (see chart below).

As the chart labeled “Trade in Intangibles” shows, intangibles exports, imports and trade balance were basically on the historical trend line. Overall exports grew from $44.9 billion in March 2020 to $53.2 billion in April 2022. Imports rose at a slightly lower level, going from $25.7 billion to $30.6 billion in that timeframe. As a result, the surplus grew from $19.2 billion in March 2020 to $22.6 billion in April 2022 – an improvement of $3.4 billion.

The chart of the components of intangibles trade shows a similar story of continued trend lines for most areas of intangibles trade. The interesting exceptions are Financial Services and Maintenance & Repair Services.

Financial Services grew dramatically in the first part of the pandemic due to a surge in exports. The surge leveled off in the spring of 2021. At the same time, imports rose slightly resulting in a small decrease in the traded surplus in the past few months (see chart below).

Trade in Maintenance & Repair Services shows the opposite trend (chart below). The traded balance dropped precipitously as exports plummeted at the beginning of the pandemic. This illustrates the category’s close relationship with goods trade and reflects the physical lockdowns during at the beginning of the pandemic. Exports began to recover in the spring of 2021, matching the slight rise in imports. As a result, the trade balance has generally held steady since then. Unfortunately, trade in this is category of intangibles is relatively small so any improvement contributes little to the overall intangibles trade surplus.

In general, this most recent data is in line with my earlier analysis that the pandemic is not having a significant impact on trade in intangible.

However, neither is the pandemic a catalyst for improving performance. Case in point: the pandemic seems to have had little impact on our trade deficit in Insurance Services. But that is not good news as the trendline continues to go straight down with imports climbing and exports declining slightly over the past few years.

In addition, our surplus in Intellectual Property seems stuck at a lower level as payments out (imports) grew at about the same as revenues received (exports). As I noted back in December of 2019, the trade surplus in IP products has been declining for almost a decade as revenues (export) have remain essentially flat while payments (imports) have grown.

NOTE: As part of its 2020 annual revision, BEA has updated the categories it uses to collect services trade data. As mentioned above, this includes creating a new category called Personal, Cultural, and Recreational Services. This category consists of the following subcategories (some of which were previously included in the Intellectual Property and Business Services categories:

  • Audiovisual services, which covers production of audiovisual content, end-user rights to use audiovisual content, and outright sales and purchases of audiovisual originals
  • Artistic-related services, which includes the services provided by performing artists, authors, composers, and other visual artists; set, costume, and lighting design; presentation and promotion of performing arts and other live entertainment events; and fees to artists and athletes for performances, sporting events, and similar events
  • Other personal, cultural, and recreational services, which includes services such as education services delivered online, remotely provided telemedicine services, and services associated with museum and other cultural, sporting gambling, and recreational activities, except those acquired by customers traveling outside their country of residence

BEA also created a new category called Construction Services separating the data out from the existing Business Services category. Since this category seems to cover physical construction activities, I have decided not to include it as an intangible creating activity, similar to how we treat the Travel and Transportation categories. For more information, see the BEA article “Preview of the 2020 Annual Update of the International Economic Accounts

Employment growth in intangible producing industries outpaces tangible industries

Two thirds of May’s employment increase came in intangible producing industries.

Employment grew by a heathy 390,000 in May, according to the latest data from the Bureau of Labor Statistics. The increase was better than expected and comes after a significate increase in employment of 436,000 in April. The biggest gains in intangible-producing industries were in Professional and Business Services (up 76,000), Educational & Health Services (up 66,900), and Government (excluding Postal Service) (up 60,800). For tangible-producing industries, the higher level of employment was due primarily to increases in Accommodation & Food Services (up 67,500) and Construction & Mining (up 41,000).

The large difference in employment in tangible-producing industries versus intangible-producing industries is a change from the previous trend. Since the end of the Great Recession, the two parts of the economy have grown (or declined) at pretty much the same rate (see chart below). It remains to be seen if this faster growth in intangible-producing industries will continue (signaling a greater restructuring of the economy) or whether we have reached an equilibrium point.

For more on the categories, see my explanation of the methodology in an earlier posting https://intangibleeconomy.wordpress.com/2020/06/11/which-jobs-got-hit-in-the-covid-crash-tangible-versus-intangible/

GDP data looks bad on the surface but shows continued strong growth in knowledge-related business investment

Business investment in knowledge-related areas of information processing equipment, software, and R&D increased in 1Q22 and all other nonresidential fixed private investment rebounded after declining in the latter half of last year.

On the surface, this morning’s numbers for US GDP for the 1st quarter of 2022 are troubling with GDP dropping by 1.4%. But there is better news below the surface.

Business (non-residential fixed) investment in knowledge-related areas continued its strong growth – up at an annual rate of 12.5%. This grow was due to a 20.7% increase in information processing equipment. Investment in software was up by an annual rate of 9.4% and R&D spending up by 6.1%. Total business investment in all other areas rose by rose at an annual rate of 3.7% — driven in large part by a rebound in investment in industrial equipment and a smaller drop in investment in transportation equipment.

Obviously, this continued business investment bodes well for future growth.

[Note: I define knowledge-related investment as the combination of investment in Information Processing Equipment, R&D, and Software. The first of these three categories is reported in the GDP data as a subcategory of Non-residential Fixed Investment: Equipment. The latter two are reported as subcategories of Non-residential Fixed Investment: Intellectual Property Products.]

What does new SEC disclosures on climate mean for intangibles?

Earlier today, the Securities and Exchange Commission (SEC) released draft new regulations on how companies should report information on climate change (see SEC Fact Sheet and article in The Hill). The new rule would enhance and standardize disclosure on both the impact of climate change on the company and the extend that the company is contributing to climate change.

The new rules are part of the general trend to enhanced disclosure on Environmental, Social, and Governance (ESG) issues. The SEC took an earlier step in 2020 toward enhanced disclosure when they finalized a rule amending Regulation S-K to require disclosure of information on a company’s human capital (see earlier posting.)

As important as these new disclosures are, I am not sure that the ESG movement will necessarily get us to where we need to be. As I noted in an earlier posting, the driving interest in the new requirements for disclosure of human capital was focused on ESG issues of diversity and inclusion – not on economic performance such as improving innovation and productivity. And the focus of these efforts seems to be on outputs (i.e., the impact, costs, and risk) rather than inputs (i.e., intangible assets). Likewise, the climate change disclosures focus on the interaction between companies and the natural environment.

The attention to EGS issues is useful to the broader debate on intangible to the extent it hones in on the guiding principle of standardization: that the disclosures be consistent, comparable, and reliable. The only way to achieve these goals is for the disclosures to be mandatory. Voluntary disclosures leave information gaps that undercut reliability and do not allow the enforcement of standards of uniformity required for consistency and comparability. The question of mandatory disclosure is one that has bedeviled regulators since the beginning. Remember that there was a time when the disclosure of even basic financial data such as revenues, expenses and profits was opposed on the grounds it was proprietary. But as I noted back in 2005 in our paper on Reporting Intangibles, without such information investors and managers are flying blind.

The new rules will be out for public comment. I suspect there will be a great deal of discussion. To the extent that we can untangle the issues of mandatory disclosure from that of climate change policy, it should provide some insight as to how to proceed with additional disclosure on information on intangibles.

Is spending on intangibles always an investment?

Question: Are expenditures on intangibles an operating expense or an investment? Answer: Yes, but it requires confronting the Red Queen problem.

When we seek to measure intangibles, we invertible look at company (and national economy) spending as a metric. But not all expenditures are the same. A key concept in accounting and management is the separation of expenditures into operating expenses and investments. For the most part, intangibles are treated by account standards as expenses. Such a framework is, however, controversial. There is a long history of arguing that intangibles should be treated as an investment rather than an expense.

The logic behind this argument is straightforward: expenses are negative and should be minimized; investments are positive and should be encouraged. Treating intangibles as an expense leads to bad results. For example, almost every business leader mouths the line that “our employees are our most valuable asset.” Yet reduction in labor costs is a standard means of reducing operating costs, which can sometimes lead to disastrous outcomes. Thus, it is important for managers to view intangibles as an asset.

But are all expenditures on intangibles really investments? The latest article by Michael J. Mauboussin and Dan Callahan at Morgan Stanley (“Underestimating the Red Queen: Measuring Growth and Maintenance Investments”) explores the difference between company spending for growth and spending for maintenance (i.e., operational activities). They conclude that “SG&A [selling, general, and administrative expenditures] and capital expenditures have an investment component that drives future earnings growth and a maintenance component that is necessary to sustain the current operations.”

Similarly, Matthias Regier and Ethan Rouen (“The Stock Market Valuation of Human Capital Creation”) point out that while personnel expenses are treated in accounting as an operating expense, they include both day-to-day expenses and investments in human capital. And Vijay Govindarajan et. al (“It’s Time to Stop Treating R&D as a Discretionary Expenditure”) argue that “a significant component of digital companies’ R&D costs are necessary operating expenses whose curtailment might stop the companies’ operations.”

This is a break from the standard (and implicit) view that conceptually treats all intangibles as an investment leading to growth (through productivity and/or innovation) and that accounting treatment of intangibles as an expense is always wrong. By recognizing that some intangible expenditures are needed just to sustain on-going operations, Mauboussin and Callahan have introduced the “Red Queen” problem to our view of intangibles: “it takes all the running you can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that!” [says the Red Queen in Through the Looking-Glass and What Alice Found There].

It is important to note that the Red Queen problem is especially acute in industries with high technological obsolescence. As Mauboussin and Callahan note, “the costs for companies in certain industries addressing climate change, or for automobile manufacturers migrating from internal combustion engines to electric vehicles, are potentially massive. These costs are necessary to maintain market position, sales, and competitiveness.”

Teasing out the growth versus operating expenditures may be harder than it seems. Even for tangible assets, understanding the difference between operating expenses (maintenance, repair & replacement) and investment can be tricky. For example, accounting considers equipment maintenance as an operating expense whereas replacement is an investment (to be depreciated subject to accelerated depreciation for tax purposes) even if it is simply to continue the current level of operations. Buying an additional new piece of equipment would clearly be a growth-related investment. But replacing a piece of equipment with an ungraded version may or may not be an investment.

Thus, something can be treated by accounting as an asset and depreciated as investment but be absolutely necessary for production. In fact, most of the intangibles that accountants would consider assets are of this operational type, including licenses, current customer lists, databases, patents on existing products, etc. While these items create a competitive advantage, they do so by creating a moat or ring-wall around existing operations. They do not necessarily, in and of themselves, promote growth.

Mauboussin and Callahan do not solve the Red Queen problem but they offer a direction. They reference work by Enache and Srivastava (“Should Intangible Investments Be Reported Separately or Commingled with Operating Expenses? New Evidence”) on using company SG&A disclosures to measure intangibles (as also cited in their earlier article “One Job: Expectations and the Role of Intangible Investments”). (See also my two earlier postings.) This approach separates SG&A in to operating or investment by category. For example, office rent and delivery costs are part of operating expenses whereas worker training is part of investment.

They do not, however, go the next step to look at the allocation into the two types of expenditures within SG&A categories. For example, all of R&D is allocated to investment whereas, as noted earlier, some R&D expenditures may be more of an operational expense. Likewise, worker training is classified as investment even though some might be better classified as keeping up or as part of worker “on-boarding” activities. 

This is not a minor problem. Obviously, right now any division within a SG&A category between operating expense and investment seems — and probably is — a little arbitrary and subjective.

And using the SG&A data has a technical problem. The R&D and advertising portions of SG&A are measured directly. The other parts (“Main SG&A”) are calculated. “Maintenance Main SG&A” (operating expenses) is estimated using revenues and “Investment Main SG&A” is calculated by subtracting out R&D, advertising and estimated operating expenses from total SG&A. Total investment expenditures is then calculated by adding Investment Main SG&A, R&D and advertising. In other words, investment expenditures are R&D, advertising, and everything else that is not an operating expense. As a result, this methodology cannot tell us how much of Investment Main SG&A is, for example, worker training or how much is for organizational development. In fact, it cannot even tell us what activities are part of the investment SG&A (other than R&D and advertisement). As Enache and Srivastava note, “its [SG&A] constituent items cannot be identified.”

Even if we were able to clearly articulate the level of expenditure in each component of intangibles, we would not necessarily know what is the optimal level of spending on moving forward (growth) or keeping pace (supporting operations). As Mauboussin and Callahan note, “A company with a competitor that has spent the money to provide a better good or service has little choice but to match the competitor’s outlays.” This is a chicken and egg problem. Which came first, my spending to foster growth matched by my competitor’s spending to keep up (the egg) or my competitor’s spending to break new ground forcing me to spend simply to keep up (the chicken)?

Clearly more works need to be done, both conceptually and in data collection.

However, it starts with recognizing the Red Queen Problem. By interjecting that into the debate, Mauboussin and Callahan have substantially increased our understanding of investment in intangibles.

Amid good news, caution that January employment growth rate slows in intangible producing industries

January’s employment growth looks, unexpectedly, a lot like December. Economists and policy makers had feared the Omicron virus surge had put a damper on job growth. But nonfarm payroll employment grew by 467,000 in January. Economists had forecast an increase of only 150,000.

While this is good news, there are some continuing concerns, arguably minor. Intangible producing industries grew by 185,400 – but that was less than the growth in December of 214,400. The slower growth was due to a slight slowdown in growth in Arts, Entertainment, & Recreation and in Educational & Health Services. Employment in Government and the Information sector was up slight compared to December. Professional and Business Services had the largest growth of 87,300 – which was about the same as in December but much less than in October and November.

Employment in tangible producing industries grew by 281,900, driven by increases of 132,000 in Trade, Transportation & Utilities and 130,800 in Accommodation & Food Services. This is a pickup in growth in Trade, Transportation & Utilities, but roughly the same amount of job growth as in the previous month for Accommodation & Food Services. The number of jobs in Construction & Mining and in Telecommunications actually declined.

Employment increased but at a slower rate in Personal & Laundry Services, Repair & Maintenance, Manufacturing, and Financial. Tangible Business Services saw a slight increase in employment compared to a decline in December.

As I have noted in earlier postings, the labor market seems to have settled back into the post-Great Recession, pre-pandemic pattern of relatively equal growth in tangible-producing versus intangible-producing industries – but at a slower rate. The COVID-19 pandemic has done little to disrupt to dramatic shift in the tangible-intangible structural balance that emerged after the Great Recession.

For more on the categories, see my explanation of the methodology in an earlier posting.

Intangible investments, tangible wealth

In the intangible economy, wealth is still mostly tangible and rising equity and real estate values are drivers of increased global wealth – not savings and investment.

Late last year McKinsey Global Institute (MGI) put out a report on The rise and rise of the global balance sheet: How productively are we using our wealth? which revealed an interesting feature of the intangible economy: while investment is increasingly in intangibles, wealth is overwhelmingly tangible. Intangible account for only 4% of real global assets as of 2020. Real estate (land and structures) account for 68%. The remainder is made up of other tangible assets such as infrastructure, machinery & equipment, and inventory.

Looking more broadly at the global balance sheet, the value of these real (aka non-financial) assets account for roughly a third of total global assets. The other two-thirds of wealth are financial assets held by financial corporations (the financial sector) and financial assets held by households, governments, and nonfinancial corporations (the financial system). Analysis of the growth in these global assets reveals a worrisome fact. Over the past two decades asset growth has been largely due to rising prices (valuation) for equities and real estate. Increased savings and investment account for just over a quarter in wealth creation.

I have two take-ways from this report. My main take-away is about the difficulty of measuring the value of intangible assets as assets. The report uses data from existing System of National Accounts framework. In the US data, the only intangibles included are intellectual property products which include only software, research & development, and entertainment, literary & artistic originals.

It should be noted that the authors of the report are well aware of the importance of intangibles as a factor in production (see MGI report Getting tangible about intangibles: The future of growth and productivity?.  For comparability’s sake they used the globally accepted framework.

However, as part of their sensitivity analysis, they modified the treatment of intangibles. They first expanded the list to include additional intangibles from the INTAN-Invest project database such as organizational capital, training, and brand investments. Adding these doubles the value of intangibles. Next, they removing the standard accounting practice of depreciating IP on a 5-year schedule. This quadruples the value of intangibles.

Admittedly, these modifications result in only minor changes in the relative size of intangible assets compared with total. But they do illustrate the difficulty in using intangibles as a store of value.

[Note there are other frameworks as well. For example, World Bank’s Changing Wealth of Nations series https://www.worldbank.org/en/publication/changing-wealth-of-nations includes human and natural capital in its analysis. It should be pointed out however that measuring human capital and natural capital is a work in progress.]

My second take-away is more of a macroeconomic concern about the relatively small contribution of saving and investment to overall wealth creation. To the extent that additional wealth created by rising asset prices is channeled back into the economy in the form of savings and investment, this can be a positive spur to economic growth. However, this is not necessarily what happens. As the report states, the process could “encourage investors to seek asset price increases rather than more traditional benefits from operating assets.” In other words, create an asset bubble.

The report discusses to role of low real interest rates, among other factors, in fostering this situation. If we are moving to an era of higher interest rates (as it appears that we are), the future growth of the economy may be more fragile than we thought.

For this, and other, reasons, the report concludes that we need to find “alternative long-term stores of value.” However, it also lays out the case as to why it is difficult for intangibles to play that role:

“Although intangibles have attracted plenty of investment, they have not served as a long-term store of value at scale. Measured using current assumptions for their value rather than the broader societal value they might bring, they constitute only a tiny part of total net worth. But these assumptions and the amount of private value intangibles can hold depend on the economic and competitive context. Most intangibles can be scaled at near zero marginal cost and are not “used up” in production. That means the returns on intangibles investments can flow to a variety of stakeholders. At one extreme, if competition is strong and IP protection light, all value of intangibles investment will quickly pass to consumers as customer surplus, increasing real income and standards of living for all but not serving as a long-term store of value for those making the investment. At the other extreme, the policy and competitive environment could allow companies investing in intangibles to protect—and scale—the value of those investments ad infinitum, through IP protection, protection of trade secrets, sustained advantages of scale, barriers to entry, or not containing monopoly power. In such a setting, intangibles investments could become long-term stores of value for savers and increase the value of their investments over time, but at the expense of competition and consumers. What policy mix is needed to extract more value and return from intangibles investment and yet also preserve customer surplus and strong competition? And what might then be the right way to measure intangibles at a company and societal level?”

For all these reasons, I am beginning to believe that we need to modify our view intangibles. We need view intangibles as an “asset” in the sense of something useful (using the Merriam-Webster’s definition of an asset as an advantage or a resource) – not an asset as in a store of value. In other words, focus on intangibles as input to the production process. As such, we need to focus measurement on investment metrics, rather than valuations.

More on this to come.

BEA data shows strong growth in knowledge-related business investment in 4Q 2021

Growth was led by increased investment in information processing equipment but all other nonresidential fixed private investment actually declined, with investment in transportation equipment taking a big hit.

This morning’s numbers for US GDP for the 4th quarter of 2021 and-year-2021-advance-estimate are looking good. According to BEA, GDP rose at an annual rate of 6.9% in 4Q and by 5.7% for the year.

Business (non-residential fixed) investment in knowledge-related areas grew at an annual rate of 14.2%. This grow was due to a 22.7% increase in information processing equipment (which had declined in the previous two quarters). Investment in software was up by an annual rate of 12.2% and R&D spending up by 6.5%.

Total business investment in all other areas declined by an annual rate of 14.6% — driven in large part by a drop in investment in transportation equipment of 45.3%. Investments in non-residential structures and in “other equipment” were down by 11.9% and 11.7% respectively. Investments in non-residential structures have declined in 8 of the past 9 quarters (1Q 2021 being the one exception). The continuing declines in investments in non-residential structures and transportation equipment are especially worrisome.

In my earlier posting on 3Q 2021 I expressed concern that the decline in investment in information processing equipment in 2Q 2021 and 3Q 2021 may be a reflection of the ongoing semiconductor shortage. Hopefully the rise in investment in information processing equipment in 4Q 2021 is due to steps to alleviate that shortage.

As I also noted in last quarter’s posting, knowledge related business investments did not suffer as great a cutback as other business investments in the COVID-19 slowdown and have been growing since 2Q20. They now account for 59% of total business investment (up from 50% in 3Q19). Looking at only the two digital-related investments of information processing equipment and software, this subcategory makes up 42% of business investments.

[Note: I define knowledge-related investment as the combination of investment in Information Processing Equipment, R&D, and Software. The first of these three categories is reported in the GDP data as a subcategory of Non-residential Fixed Investment: Equipment. The latter two are reported as subcategories of Non-residential Fixed Investment: Intellectual Property Products.]