Tomorrow (31 July 2013), the United States will be adding roughly US$400 billion (or the economy the size of South Africa) to its Gross Domestic Product (GDP) – (Singapore and Malaysia have GDPs of about US$250 billion and US$290 billion respectively).
This is only possible because the United States Bureau of Economic Analysis (BEA) will be restating both the size as well as the composition of GDP all the way back to 1929 when it was first recorded.
They will be doing by reclassifying and now including research and development (R&D) and intellectual property (IP) as an investment rather than as an expense which has been the way it has always historically been measured. Therefore the IP of films, books, television shows and music will now be treated as long-term assets.
What is happening?
Gross Domestic Product – GDP – is essentially a measure of performance of an economy and it is the total value of all the goods and services produced in an economy.
Previously, items such as research and development (R&D), intellectual property (IP) and royalties were treated as an expense.
Now with the treatment of the above items as an investment, it means that innovation is going to be measured and recorded. It is also hoped that this will spur further development and innovation in the country.
However, it is useful to note that other developmental items such as brand building, staff development and training, implementation of process improvements such as Six Sigma will still be considered an expense, despite the fact that the implications of these activities go beyond a financial year.
Why is this important?
By reclassifying R&D and IP, the economic value of knowledge that is embedded in various products and services will now form a component of GDP and it will also elevate the level of investment and national income in the process.
This also means that US joins Canada as part of the first group of countries that have adopted the new international standards to measuring GDP. It is expected that the EU will also adopt this new standard, The System of National Accounts 2008, next year in 2014.
What is the impact?
The BEA has not yet indicated what the total impact will be but estimates from a range of analysts including the Financial Times (FT analysis here) have indicated that the US GDP will increase by between 2.2% and 3% as a result of these different measurement criteria.
It is also estimated that under the new measurement base, historic growth of the US from between 1959 to 2007 will be 3.39% per annum compared to 3.32% using the previous measuring system.
Why is the US doing this?
The US generates a significant proportion of its wealth through research and development, patents, copy rights, intellectual property, trademarks and designs and the inclusion of these items in its GDP measurement base will better reflect the total contributions and value-add to the wider economy.
For instance, under the previous measurement base, Appel’s total long term assets (under traditional measurement methodology was only US$15 billion or less than 4% of its total market valuation of US$400 billion. Granted that this difference may not be entirely attributable to R&D or IP, it is still a vast difference and a significant portion of the difference can be linked back to the value the market places on Apple’s research and development, patents and copyrights.
There still remains a level of confusion around how R&D, IP and other related intangibles will be amortised or depreciated.
The BEA has given some indication on the methodology they are likely to adopt:
Pharmaceutical R&D – they will depreciate this by 10%
Computer systems design – 36% depreciation rate
Movies – 9% depreciation
Music – 27% depreciation (essentially the BEA tacitly acknowledges that the value of music is depreciated three times faster than movies?)
Television shows – only longer term TV programmes such as sitcoms or dramas will be considered investments and included to the GDP but reality programmes, news segments or game shows will still be treated under the current methodology and expensed.
Though there remains a certain level of uncertainty, it should be acknowledged that the measurement of intangible investment is a first step towards the longer journey of truly understanding the value innovation delivers to an economy and how factors such as R&D and IP contribute to economic growth. The BEA’s current approach to the valuation seems to be around understanding and estimate the cost it took to create the intangible assets in the first place.
Key personalities and quotes:
Steve Landefeld, director of the Bureau of Economic Analysis, the Commerce Department unit that measures GDP. “We’ve been trying to understand the sources of growth in the GDP. One of the longstanding gaps in the numbers has been the contributions of intangibles — creations in the arts and entertainment, research and development, things like that — and what they contribute to GDP.”
Ben Bernanke – “We will be more likely to promote innovative activity if we are able to measure it more effectively and document its role in economic growth”
Joseph Schumpeter (1883 – 1950) – Schumpeter argued that the innovation and technological change of a nation come from the entrepreneurs, or wild spirits. He coined the word Unternehmergeist, German for entrepreneur-spirit. Mark II was developed when Schumpeter was a professor at Harvard. He asserted that the agents that drive innovation and the economy are large companies which have the resources and capital to invest in research and development.