How US economy grew US$560b overnight; Revamped GDP calculation includes spending on R&D and production of original artistic and literary works

A larger, more innovative US economy

Robin Bew

The US government has just comprehensively revised its GDP data, leading to some fascinating results. By counting spending on R&D and the production of artistic works such as films as productive investment, the new data show an economy that is US$560bn larger than previously estimated. In effect, a country roughly the size of Sweden has been added to GDP. Investment in intellectual property goes hand in hand with innovation, which suggests that the US is even better equipped than previously thought to flourish in the knowledge economy. However, as my team of analysts notes slightly ruefully, the latest data revisions play havoc with economic forecasts. Look for changes in our US growth and fiscal projections in the near future.

August 1st 2013

New data reshape picture of US economy

Economic growth, especially in Western countries, has been difficult to come by in recent years. But the US government has found a new way to look at companies and what they spend, and the result is a larger US economy than had been previously estimated–by some US$560bn. In effect, a country slightly larger than Sweden has been added to the US economy in a single stroke.

The US Bureau of Economic Analysis (BEA) released its second-quarter GDP estimates on July 31st, but also did something more. Once every 12 months, the government revises the past year’s data, using more up-to-date information. Every five years, it carries out comprehensive revisions, using more complete data, including detailed figures for industries that take years to assemble. In rare cases, the government revises the way it calculates GDP, altering the overall size and shape of the US economy. This week, the government did all of these things, leading to some fascinating results.

Making a place for IP investment

The government’s biggest change was to add new kinds of spending to its GDP calculation. Economies are typically measured by how much is spent–by consumers, businesses and government. Historically, the US government has excluded certain kinds of spending from its estimates of business fixed investment, such as research and development, as well as the cost of producing original entertainment, literary and artistic works. These things were not considered “fixed” investment because they are not long-lasting, aren’t part of a regular production process and can’t be clearly owned. That was the view, at least, until now. The government’s revised view is that R&D and original entertainment works are valuable intellectual property that do, indeed, have lasting value and are an important part of the economy. They are not merely “used up” as inputs into other things, which was the historical view. By adding in spending on these items–the government has estimated this for prior years, not just the current one–the economy suddenly looks bigger than it was, by some US$560bn, or 3.6%. Included in this figure are smaller changes to the way pension benefits are calculated, and to a measure of housing investment. All of this has pushed total US output to US$16.2trn in nominal terms, reinforcing America’s status as the world’s largest economy and opening up a bit more breathing space over fast-closing China.

Why should we care?

Does any of this matter? It important ways, it does. Investment in intellectual property (IP) goes hand-in-hand with innovation, which most economists agree is an important driver of economic growth. IP investment also contributes to improvements in productivity, which raises standards of living. To the extent that the US is now properly accounting for investment in intellectual property, it’s role in the economy can be more carefully evaluated. Nor is the US the only country to think this way; others are expected to adopt this change in coming years.

Other, smaller benefits arise from this. Any aspect of an economy can be judged by determining its share of GDP, which also makes international comparisons easier. Government spending in most European countries, for example, is larger as a share of GDP than in the US, reflecting the continent’s deeper involvement in social programmes. A now-larger US economy means government spending is a smaller share of GDP, which should please conservatives in Congress. The US budget deficit, which was equal to 7% of GDP in 2012, has now been revised down to 6.7%. Public debt as a share of the economy is also a bit smaller. None of this changes the underlying fiscal picture: as the population ages and retires, the budget figures will start to look a lot worse. But for now, increasing the size of GDP makes them look a bit better.

A less severe slump

The broader GDP revisions change our views in other ways. For example, 2012 was a surprisingly good year for the US economy, which we now know expanded by a robust 2.8%–much better than the previous 2.2% and the best single year of growth since 2005. The recession in 2009, it turns out, was not quite as bad as was thought; GDP contracted by 2.8% instead of 3.1%. More sobering is the steady erosion in the growth of US output over the years. Between 1959 and 2002, GDP growth averaged 3.4%. During the last decade, it has averaged a more pedestrian 1.8%.

As useful as these revisions are, they play havoc with forecasts. The Economist Intelligence Unit had been expecting the US economy to grow by just under 2% in 2013. The new data show that growth in the first quarter was much weaker than previously thought, no doubt because of a series of tax hikes and spending cuts. As a result of this slow start to the year, we are cutting our 2013 GDP forecast to something closer to 1.5%. Although this is well down on last year’s now-sterling 2.8%, we expect continuing improvements in the economy in the second half of this year, setting the stage for a better 2014. Unless and until, of course, the government decides to revise its figures again.

PUBLISHED AUGUST 03, 2013

How US economy grew US$560b overnight

Revamped GDP calculation includes spending on R&D and production of original artistic and literary works

ANNA TEO

ANNA@SPH.COM.SG

THE US economy is much bigger and a bit healthier than earlier thought, following a big revamp in the way US gross domestic product (GDP) is computed.

With the data revision – which adds, for the first time, spending on research and development as well as the production of original artistic and literary works to GDP calculation – the US economy has, overnight, grown by some US$560 billion.

“In effect, a country slightly larger than Sweden has been added to the US economy in a single stroke,” The Economist Intelligence Unit (EIU)’s chief economist, Robin Bew, noted.

Total US output is now estimated at US$16.2 trillion in nominal terms, or about 3.6 per cent bigger than before, strengthening America’s lead as the world’s largest economy.

Apart from annual revisions of its GDP figures with updated information, the Bureau of Economic Analysis (BEA) carries out a comprehensive review of the US National Income and Product Accounts every five years. This time, the revamp includes a change in the way it computes GDP, resulting in a new set of growth figures for the period from 1929 to date.

Notably, US growth last year was a relatively robust 2.8 per cent, after a significant 0.6 point uptick. This makes 2012 growth the strongest in seven years.

The revised figures also show that the great recession of 2007-2009 was less severe than previously thought, with the economy shrinking at an average 2.9 per cent annual pace, rather than the reported 3.2 per cent contraction.

Post-recession recovery has also been slightly stronger: According to the revised data, the economy grew at an average annual rate of 2.2 per cent between the second quarter of 2009 and the first quarter of 2013, compared with a previously published 2.1 per cent pace.

Average annual US GDP growth between 2007 and 2009 has now been revised up by 0.2 percentage point, to 0.8 per cent.

The BEA’s new GDP calculation also includes small changes to the way pension benefits are calculated, and to a measure of housing investment.

But the biggest changes are in the measurement of the “knowledge economy” or intellectual property – spending on R&D and the production of artistic works such as films, which now count as fixed productive investment.

Previously, such spending were treated as intermediate inputs. The BEA says the change reflects the growing importance of intellectual property products in business and productivity.

Said Mr Bew: “Economies are typically measured by how much is spent – by consumers, businesses and government. Historically, the US government has excluded certain kinds of spending from its estimates of business fixed investment, such as R&D, as well as the cost of producing original entertainment, literary and artistic works. These things were not considered ‘fixed’ investment because they are not long-lasting, aren’t part of a regular production process and can’t be clearly owned. That was the view, at least, until now. The government’s revised view is that R&D and original entertainment works are valuable intellectual property that do, indeed, have lasting value and are an important part of the economy. They are not merely ‘used up’ as inputs into other things.”

And the rethink about R&D “spending” is particularly impactful, adding US$396.7 billion, or 2.5 per cent, to US GDP for 2012.

While the data changes will see economists revisiting their growth forecasts for America, the US GDP revamp is significant in more ways than one.

“Investment in intellectual property (IP) goes hand-in-hand with innovation,” said Mr Bew.

“IP investment also contributes to improvements in productivity, which raises standards of living. To the extent that the US is now properly accounting for investment in intellectual property, its role in the economy can be more carefully evaluated. (It also) suggests that the US is even better equipped than previously thought to flourish in the knowledge economy.”

And other countries can be expected to eventually adopt the changes in compiling their GDP data as well.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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