DON'T BOTHER THEM WITH REALITY:

Why The Economy Is A Lot Stronger Than You Think: In a knowledge-based world, the traditional measures don't tell the story. Intangibles like R&D are tracked poorly, if at all. Factor them in and everything changes (Michael Mandel, with Steve Hamm in New York and Christopher J. Farrell in St. Paul, Minn., 2/13/06, Business Week)

You read this magazine religiously, watch CNBC while dressing for work, scan the Web for economic reports. You've heard, over and over, about the underlying problems with the U.S. economy -- the paltry investment rate, the yawning current account deficit, the pathetic amount Americans salt away. And you know what the experts are saying: that the U.S. faces a perilous economic future unless we cut back on spending and change our profligate ways.

But what if we told you that the doomsayers, while not definitively wrong, aren't seeing the whole picture? What if we told you that businesses are investing about $1 trillion a year more than the official numbers show? Or that the savings rate, far from being negative, is actually positive? Or, for that matter, that our deficit with the rest of the world is much smaller than advertised, and that gross domestic product may be growing faster than the latest gloomy numbers show? You'd be pretty surprised, wouldn't you?

Well, don't be. [...]

Everyone knows the U.S. is well down the road to becoming a knowledge economy, one driven by ideas and innovation. What you may not realize is that the government's decades-old system of number collection and crunching captures investments in equipment, buildings, and software, but for the most part misses the growing portion of GDP that is generating the cool, game-changing ideas. "As we've become a more knowledge-based economy," says University of Maryland economist Charles R. Hulten, "our statistics have not shifted to capture the effects." [...]

According to BusinessWeek's calculations, the top 10 biggest U.S. corporations that report their R&D outlays -- a list that includes ExxonMobil (XOM ), Procter & Gamble (PG ), General Electric (GE ), Microsoft (MSFT ), and Intel (INTC ) -- have boosted R&D spending by 42%, or almost $11 billion, since 2000. Yet over the same period, they have only increased capital spending by a meager 2%, or less than $1 billion. So all together, these giants have actually increased their future-oriented investment by roughly $12 billion -- most of which doesn't show up in the BEA numbers.

This shift to intangibles looks all the more remarkable when we look a bit further back. P&G, for example, has boosted its spending on R&D, which doesn't count as investment in the GDP statistics, by 39% since 1996. By contrast, the company's capital budget, which does factor into GDP, is no bigger today than it was back then. The same is true at spicemaker McCormick & Co. (MKC ), where capital spending is basically flat compared to 1996 but R&D outlays to create new products have tripled over the same period.

Want to see how this works? Grab your iPod, flip it over, and read the script at the bottom. It says: "Designed by Apple in California. Assembled in China." Where the gizmo is made is immaterial to its popularity. It is great design, technical innovation, and savvy marketing that have helped Apple Computer sell more than 40 million iPods. Yet the folks at the BEA don't count what Apple spends on R&D and brand development, which totaled at least $800 million in 2005. Rather, they count each iPod twice: when it arrives from China, and when it sells. That, in effect, reduces Apple -- one of the world's greatest innovators -- to a reseller of imported goods. [...]

The same intangible investments not counted in GDP, such as business knowhow and brand equity, are for the most part left out of foreign trade stats, too. Also largely ignored is the mass influx of trained workers into the U.S. They represent an immense contribution of human capital to the economy that the U.S. gets free of charge, which can substantially balance out the trade deficit of goods and services. "I don't know that the trade deficit really tells you where you are in the global economy," says Gary L. Ellis, chief financial officer of Medtronic Inc., a world leader in medical devices such as implantable defibrillators. "We're exporting a lot of knowledge." [....]

There's no doubt that the statistical problems are formidable, but it's also certain that the conventional trade statistics are missing a big portion of the knowledge flows that create value these days. Suppose we assume that U.S. multinationals can earn an extra percentage point of return on their foreign investments by being able to use business intangibles exported from the U.S. Then a rough estimate of the value of the unmeasured exports of knowledge is anywhere from $25 billion to $100 billion per year, depending on what assumptions are used.

And let's not forget about immigrants. The workers who move to the U.S. each year bring with them a mother lode of education and skills -- human capital -- for free. One celebrated example is Jonathan Ive, the man who designed the iPod and iMac. Ive was born in England and educated at Newcastle Polytechnic University of Northumbria before joining Apple Computer Inc. in California in 1992.

A few sure signs someone has their head up their economic rumpus, they're worried about: (1) inflation; (2) our savings rate; (3) the trade deficit; (4) our falling behind in R&D; (5) the economic effects of immigration.

Posted by Orrin Judd at February 21, 2006 5:27 PM