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February 14, 2006
Economic Misconceptions from the Columbia Journalism Review
Gal Beckerman of the Columbia Journalism Review is not happy at all with my cover story on intangibles. Unfortunately, in objecting to my story, Beckerman falls into a simple economic misconception, writing:
R&D is already factored into GDP. Companies research and develop better products. Gross domestic consumers buy more of these products. So, presto! ...... same old GDP number.
That may sound plausible, but it's simply not right. First, note that the same flawed argument can be applied to investment in physical equipment as well. After all, if Intel invests $3 billion in a new factory, say, to produce better and cheaper microprocessors, consumers get the benefits through their purchases of computers. Why bother to add the $3 billion investment into GDP?
The answer should be obvious. The factory is a long-lived investment which provides returns not just this year, but years into the future. That's why Intel's investment gets added into GDP, separate from the value of today's production of microprocessors.
Similarly, R&D is a long-lived investment, which pays off for years to come. There's an asset created, the stock of knowledge, which didn't exist before.
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It's a matter of timing. Take an individual corporation as a microcosm of the economy: you *could* evaluate results based on cash flow alone..so that the year you build a new $500 million plant, you would have awful negative free cash flow--leading to alarm and despondency if this were the only metric and were interpreted naively, followed by irrational exuberance in future years when no cost for the plant is being borne--until it starts wearing out. Or you could use accrual accounting, capitalize the plant, and depreciate it as it is used.
A free-cash-flow-only analysis which looks at current period only will tend to systematically understate profits in a time of rapid growth.
Posted by: David Foster at February 14, 2006 02:11 PM
On another thread, "Nobody" pointed out that if we are to include R&D and education as investments now, we should refigure for having done so in previous years. While I may agree with Mike's assessment that we should include these, I have to agree with that poster as well. The knowledge that went into creating that Intel factory in Ireland may well deserve to be counted, but so should the steel production processes from the early 1900's that wound up in the hands of Japan. Grove or Carnegie, knowledge is knowledge and we should fairly count it historically and not just "suddenly".
Posted by: Brandon at February 15, 2006 08:30 AM
Nice post. I just linked (over at Angrybear) to something from the New Economist who noted research by Mark Rogers as to why business R&D investment in the UK is so low.
Posted by: pgl at February 16, 2006 09:06 AM
Please help me understand. What exactly is unmeasured contribution of R&D to GDP. Let's assume a researcher makes $80K a year (so he adds this amount to national income. But his addition to the economy's stock of knowledge is worth $100K. Is the difference between these two numbers (i.e. $20K) the unmeasured contribution tot GDP?
If so, I would not agree. Compare it to consumer surplus. When a consumer buys an iPod for, say, $250, while he values it $300, the $50 consumer surplus is not added to GDP. And righlty so, I think.
Posted by: mathijs at February 16, 2006 03:15 PM