Sunday, April 09, 2006

Intangible Investment

An article in today's NY Times points out that it is often hard to distinguish between a dollar spent by a firm as a current business expense and a dollar spent on intangible investment, such as research and development.

The approximately $300 billion spent each year on R & D is a big concern of the bureau's economists. Until now, it has been counted as an expense, reducing the profit total within the G.D.P. Starting in September, however, the bureau will publish an experimental G.D.P. account that parallels the standard quarterly report, except for one change: R & D will be counted as capital investment rather than as an expense.

There is logic in this change. Consider the process of making and selling a dress. The cloth and thread--the raw materials--that go into the dress are an expense that must be subtracted from the sales price of the dress, once it is sold, to arrive at a profit. The automated sewing machine that makes the dress, on the other hand, is counted in the G.D.P. accounts as a capital investment because, once installed, it makes dress after dress, generating a stream of revenue. It is an investment drawn from retained earnings to generate more earnings.

Similarly, the research and development that made Prozac possible generates revenue for years, just as the sewing machine does for the dressmaker. Successful research and development yields long-term returns, and the bureau's experimental G.D.P. acknowledges as much, by classifying R & D as capital investment in the satellite account. Capital investment, in turn, counts as a contribution to profit in the
The article does not emphasize the distinction between Gross and Net measures of the economy's output, but this distinction seems important. Shifting a dollar of R&D from the category of current expense to the category of capital investment will raise Gross measures, but it will have a smaller effect on Net measures. Net measures subtract depreciation of past investment, so if investment is increased by a change in definition, then the depreciation of past investment will have to be increased as well.

The article points out that there are many other types of spending that could also be recategorized as investment:

[This] would include various intangibles, like advertising when it is used to establish a brand name that permanently lifts sales, and a retail chain's outlays to adapt existing technology to the chain's needs, as Wal-Mart did in designing a superefficient inventory control system. Such intangibles now approach $250 billion a year, up from only $11 billion in the 1970's.
Not mentioned in the article is the treatment of educational expenditure. Your tuition at Harvard is counted as consumption, not investment. (So I hope you are enjoying yourself.) If we treated it as investment, GDP would not change, but the measured allocation of GDP among the components of expenditure would change.

The article suggests that intangible investment is growing in importance over time. That might well be true. If so, it means that national saving as a percentage of GDP is higher than we thought, and the true trends are different than those we see in the standard data. Those worry-warts (like me) who lament the fact that national saving is near historic lows may have less reason to worry than we thought.