Macro Roundup

The U.S. is set to count investment in movies, books, and ideas as part of the gross domestic product. It’s about time

On July 31, the U.S. Bureau of Economic Analysis will rewrite history on a grand scale by restating the size and composition of the gross domestic product, all the way back to the first year it was recorded, 1929. The biggest change will be the reclassification—nay, the elevation—of research and development. R&D will no longer be treated as a mere expense, like the electricity bill or food for the company cafeteria. It will be categorized on the government’s books as an investment, akin to constructing a factory or digging a mine. In another victory for intellectual property, original works of art such as films, music, and books will be treated for the first time as long-lived assets.

It’s a great idea, if late. The BEA has the 20th century economy down cold. It can tell you about personal income trends in Anchorage, Alaska, or America’s annual output of rubber products and plastics. Now the agency is putting more attention on R&D—the lifeblood of the 21st century economy—by moving it from an experimental “satellite” account into the heart of measured GDP.

GDP is the main yardstick of macroeconomics—the sum total of all goods and services produced in the country. Business R&D was never counted in that total. It was considered an expense, an “intermediate input,” that ate into profit. Intangible investments such as R&D and the creation of artistic originals have been like physicists’ dark matter: influential but invisible. As Federal Reserve Chairman Ben Bernanke said in a 2011 speech, “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.”

The effect of the revision will be immediate. Measured GDP will get a one-time boost of about 2.7 percent when the government starts counting R&D and artistic creation as investments. (New Mexico and Maryland will get the biggest lifts.) The future growth rate will probably be fractionally higher, too. With R&D treated as an investment, measured economic growth from 1959 to 2007 would have been 3.39 percent annually instead of 3.32 percent, the BEA estimates.

Of course, it’s hard to work up much excitement over an upward revision in historical GDP figures. It’s like being told that you’re happier than you thought you were: unconvincing. The “comprehensive revision” won’t raise wages or put anyone back to work. Then again, that’s not the BEA’s job.

Intangible investment is far from a faddish new idea. In 1908 the sociologist and economist Thorstein Veblen used the phrase to encompass everything from advertising to design. A century before the iPad’s launch, he wrote of companies that give their goods “a more elegant finish for the sake of a readier sale, beyond what would conduce to their brute serviceability.” In the 1930s and 1940s, economist Joseph Schumpeter made intangibles the centerpiece of his theory that economies grow through innovation. Businesses, he observed, innovated to differentiate their products so they could charge higher prices.

Economic theory was ahead of accounting practice. Stage 1 for recognition of intangibles was the reclassification in 1999 of software development as an investment. That was appropriate, since a big software installation can last longer than the sturdiest piece of factory equipment. The second stage is part of a change agreed to through a United Nations working group in 2008. Australia and Canada have already made the switch, and Europe will do so in 2014.

Thanks in part to the power of ideas, the nine or 10 most valuable companies in the world are headquartered in the U.S. (It’s nine on days when PetroChina edges ahead of Wells Fargo.) Only three—General Electric, ExxonMobil, and Chevron—are in the world’s top 10 for tangible fixed capital, according to data compiled by Bloomberg.

If all forms of intangible investment were officially recorded, they would exceed investment in bricks, mortar, and machines, according to estimates by economists Carol Corrado of the Conference Board and Charles Hulten of the University of Maryland. Intangibles include brand-building, worker training, and the development of advanced organizational practices like total quality management, which meet the definition of an investment because they create assets that will produce revenue a year or more in the future, says Hulten. Those, however, will continue to be treated by the government as expenses. Brent Moulton, the BEA’s associate director for national economic accounts, says their investment nature can’t yet be measured accurately enough to use as official data.

That underscores the limits of trying to come up with a single statistical measure of the nation’s economic activity. Government statisticians have to make some heroic assumptions and generalizations to incorporate intangibles like R&D and works of art. Not knowing their true worth, the BEA assigns value to them by estimating the cost to create them. It thus undervalues Hollywood blockbusters and overvalues big-budget flops, assuming that the errors will cancel out in the long run.

Then there’s the challenge of calculating depreciation. Ideas don’t rust like machines, but they do lose value to their creators as they are copied or superseded. The BEA assigns an annual depreciation rate of 10 percent to pharmaceutical R&D assets, vs. 36 percent for computer systems design; 9 percent for movies, but 27 percent for music. In a priceless footnote, it writes: “Long-lived television programs include situation comedies and drama programs. Other types of television programs, including news programs, sporting events, game shows, soap operas, and reality programming, have much shorter service lives and will not be capitalized.”

So Under the Dome is an investment but America’s Got Talent isn’t. You can see how quickly a good economic theory slides into guesstimation and value judgments. And measuring intangible investment is only a first step toward figuring out how much that investment contributes to economic growth. Robert Atkinson, president of the Information Technology & Innovation Foundation think tank, criticizes “intangible-capital fundamentalists” who, he says, unreasonably dismiss the contribution to growth of investment in tangible high-tech equipment.

No one said this would be easy. Steering a $16 trillion economy with the aid of historical GDP data is like driving a car while looking in the rearview mirror. But if that’s what policymakers must do—and it is—they need to make sure that the view to the rear is as clear as possible. That’s the purpose of recognizing R&D and artistic originals as investments, and bringing the national accounts more closely in line with the way the economy works and businesspeople think. Is it perfect? No. But better to be imprecisely correct than precisely incorrect.

"...A different way to evaluate the adequacy of infrastructure is to look at the value of all public capital in place, adjusted for depreciation. That so-called capital stock has trended down as a share of GDP in most big countries, and particularly so in the U.S., according to the International Monetary Fund. That suggests annual capital spending is not keeping up with economic growth and normal wear and tear....Yet measuring the impact of public capital is no easy matter. The CBO believes that, on average, the return on federal investment is only about half that of private investment. Partly, that’s because some public works have purposes other than raising economic output: monuments boost national pride, medical research improves the quality of life and bike paths reduce pollution. But it’s also because some federal investments are poorly targeted, and in some cases reduce private, state or local investment...."

Write to Greg Ip at greg.ip@wsj.com

So for the foreseeable future, the U.S. will have to get by with constrained infrastructure budgets, badly targeted.

Both Republicans and Democrats have backed various infrastructure-bank proposals since 2007, but they haven’t gone anywhere. That’s because lawmakers’ political priority is to shore up the Highway Trust Fund, which is running out of money and about to expire unless reauthorized by Congress.

In the U.S., the equivalent idea is a “national infrastructure bank.” The federal government would seed the bank with capital, with which it would then extend loans or loan guarantees to state, local and private borrowers. A professional staff would choose projects based on economic and technical merits, the contribution to national and regional growth, job creation and environmental benefit.

There are ways around such constraints. In 2010, Britain drew up a national infrastructure plan that prioritizes projects that maximize economic value, for example because they complement a regional transport network or better utilize an existing asset. Canada has set up a government corporation to evaluate and fund “public-private partnerships.”

But no such system exists. The existing system tends to favor new projects even when a maturing economy with denser cities would favor rehabilitating existing infrastructure or using it more efficiently, such as with electronic tolls, congestion pricing and even apps that find free parking spots.

The ideal approach to federal investment would be to rank all possible projects by their return, both monetary, such as user fees, and nonmonetary, such as less time spent in traffic. Those with the highest return get funded first.

Yet measuring the impact of public capital is no easy matter. The CBO believes that, on average, the return on federal investment is only about half that of private investment. Partly, that’s because some public works have purposes other than raising economic output: monuments boost national pride, medical research improves the quality of life and bike paths reduce pollution. But it’s also because some federal investments are poorly targeted, and in some cases reduce private, state or local investment.

But that comes with a caveat: the investment has to be efficient.

Federal investment has been squeezed from all sides: caps on discretionary spending, competition from costly social-benefit programs, and reluctance to raise gasoline or other taxes. That leaves borrowing. With interest rates so low, the IMF thinks debt-financed investment could virtually pay for itself by boosting demand in the short run and productivity in the long run.

A different way to evaluate the adequacy of infrastructure is to look at the value of all public capital in place, adjusted for depreciation. That so-called capital stock has trended down as a share of GDP in most big countries, and particularly so in the U.S., according to the International Monetary Fund. That suggests annual capital spending is not keeping up with economic growth and normal wear and tear.

This doesn’t automatically indicate underfunding, since the country’s needs change over time. The Interstate highway system, for example, only needs to be built once.

On a number of criteria, infrastructure spending has slipped. State, local and federal investment in transportation and water infrastructure has gradually declined from close to 3% of GDP in the early 1960s to 2.4% in 2014, according to the Congressional Budget Office.

Such arbitrary constraints are endemic. Investment in Amtrak’s profitable Northeast Corridor line is compromised by the railway’s congressional mandate to also operate money-losing long-distance routes. New York’s LaGuardia and John F. Kennedy airports, despised by travelers as outdated, inconvenient and unpleasant, are profitable enough to have justified an overhaul years ago. But their owner, the Port Authority of New York and New Jersey, had to plow $8 billion into rebuilding the World Trade Center site.

The Hamilton Project, a think tank, notes that federal spending per 1,000 miles traveled per vehicle varies from $12 in Georgia to $98 in Alaska. A similar number of miles were driven in Tennessee and New Jersey, but Tennessee received 42% more federal funding.

For example, the federal government sends money to the states for highways based on a formula linked to the gasoline tax each state contributes to the Highway Trust Fund, which is not necessarily correlated with what roads get used most.

“Outside of a few very small new programs, it is nobody’s job in Washington to figure out which roads or bridges we should invest in,” says Aaron Klein of the Bipartisan Policy Center, a think tank. “It is a decentralized structure where state and local authorities are highly empowered.”

Federal infrastructure investment is not directed to the projects with the biggest payoff in productivity, safety or environmental protection. Inadequate funding, badly targeted, is a recipe for undermining the country’s long-term economic potential. Bridges raise productivity; bridges to nowhere don’t.

Lost in the debate over the quantity of federal investment, however, is an equally pressing problem: the quality of such spending.

Amtrak’s deadly derailment last week has again re-awakened concerns that the U.S. spends too little on highways, railroads and other public infrastructure.

Updated May 20, 2015 5:55 p.m. ET

By Greg Ip

Federal investment on infrastructure projects is poorly targeted to where it boosts productivity the most

Quality, Not Just Quantity, of Infrastructure Needs Attention

Ip, Greg, "Quality, Not Just Quantity, of Infrastructure Needs Attention,"The Wall Street Journal, May 20, 2015. Available at:http://www.wsj.com/articles/quality-not-just-quantity-of-infrastructure-needs-attention-1432138724