Tuesday, April 23, 2013

The New Way to Measure GDP

A couple people have asked about the new revisions being made in terms of how we measure GDP.  I investigated this and let me just say


I had to go through this monster of a document to find the answer and see if;

1.  the changes are economically and "accountingly" accurate/correct/called-for/legitimate
2.  determine if the impetus for these changes was malicious or well-intended

and after much debating, theorizing and thinking through I think I have your answer.

In short, the changes made (specifically to the R&D) are incorrect in that they double count R&D into the GDP.  However, I do not believe these changes were malicious, but were rather logical and theoretical errors made on the part of the economist and accountant "theoreticians."

The longer version...well....why don't you pour yourself a martini first and find a comfy chair before I delve into it?

You back?

Good, OK, let's begin.

First, I found the subsection of the study that specifically addresses R&D and I have it posted here:

most of this is gobbledygook so let me translate this into English for you.

The red section is basically the UN saying that the value of R&D and all of its future economic benefits should be considered in the SNA or "new GDP measure."  This assertion is true.  The benefits that are derived from R&D SHOULD be included in any measure of economic production for it DOES affect economic production. So so far we have no disagreement with the economists at the UN.

However, we get in into trouble with the green highlighted area.  Here the UN is calling for a way to go about achieving their goal of accounting for or measuring R&D in the new GDP measure.  They don't go into details, merely suggesting new methodologies and techniques to measure this, but here is where they're wrong.

R&D is already accounted for and measured currently in GDP.

The reason why is that all expenditures on R&D are transacted and accounted for.  Maybe not obviously, but every bit of economic production and benefit of R&D DOES end up in the current measure of GDP.

Let me explain why.

When a company, government or other institution spends money on R&D it spends it on two things:

Materials and labor.

Any money spent on materials is immediately accounted for in GDP in that the suppliers of said materials record this as sales.  So just because Apple is developing a new lithium battery doesn't mean all the money it spent on lithium doesn't make it into GDP.  It does via the lithium company producing and selling Apple its lithium. 

That is your first instance of double accounting.

Labor, however, is a bit more ambiguous and the double accounting is not as apparent.  All the money spent on scientists, support staff, and maintenance staff in the R&D lab does not immediately result in the production of a good or service.  Not recordable at that moment anyway.  At this point, however, you may be tempted to make the argument that:

"Well, those people will take their salaries and buys stuff, those transactions of which would end up in GDP."

and think you have found the "double accounting error." 

But, while true, it's Keynesian.  It doesn't account for the fact the value of their labor and expertise in developing a "new lithium battery" is still not accounted for.  For example the scientist who takes his money and buys the Hogan's Heroes DVD set did not MAKE the Hogan's Heroes DVD set.  That is the production of somebody else.  Ergo the labor he expended at the lab is still not making it into GDP.

Inevitably though, the scientist's labor WILL make it into our current measure of GDP in the future when the product or service his labor was used to develop is sold on the free market.

This is an important point to explore further because I believe it is here where the UN economists are goofing up.

Two things happen when this product is sold.

One, a transaction.  This means the transaction will be recorded in GDP.

Two, the scientist's labor is finally valued.  It has a price tag put on it.

The reason why is that when a product or service is sold, you are now attaching a value in terms of dollars AND making a transaction.  So when somebody buys the latest Apple device the price they pay is NOT just for the materials, and NOT just the labor that went into assembling it, but ALSO for the labor in the R&D lab that was expended developing it's latest doo-dad or feature.  Naturally, this is why people are willing to pay a higher price for an IPhone 63 vs. an IPhone 47.  That premium IS the market value of the R&D AND IS ACCOUNTED FOR.

Now, admittedly I did not read through all 800 pages of the UN's SNA publication.  And I could have misinterpreted the writing, reason or rationale of the economists who wrote it.  But as it stands right now, my understanding of this new measure of GDP is flawed and will overstate the level of genuine economic production and wealth in the country.

I VERY MUCH WELCOME any criticisms or corrections from any economists who are more specialized than I am in accounting theory, NIPA accounts, etc. etc.

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