The GDP Mirage

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A Coming Revival?

Measuring intangible investments such as business R&D and worker training isn't easy—which is one reason why government statisticians haven't yet done it. But including such expenditures could make a big difference in the way companies, investors, and others understand the economy. Let's do a back-of-the-envelope calculation. In the four quarters ended last June, business spending on tangible investments—equipment and structures—as reported by the BEA dropped by about 20%. If intangible investments had dropped at the same rate, it might have knocked an additional 1.5 percentage points off the -3.8% GDP growth rate. If intangibles fell by only 15%, that might have taken 1 percentage points off GDP growth. (These calculations require making heroic assumptions about price changes and other difficult-to-observe figures, so they should be treated as very rough estimates.)

Since manufacturers are still cutting nonproduction workers, there's a high likelihood that intangible investment was still plunging in the third quarter. That suggests GDP and productivity growth in the third quarter could be overstated by one percentage point, and perhaps more.

Will intangible investments revive soon? Albert of Klein Hersh notes that some companies are starting to hire biologists again. "It's the beginning stages of commitment to discovery," he says. But that uptick is likely to be negated by two massive mergers in the pharma sector, which will result in huge layoffs and cuts in R&D spending. The hookup of Pfizer (PFE) and Wyeth closed on Oct. 15, and the merger of Merck (MRK) and Schering-Plough (SGP) is expected to close sometime in the fourth quarter.

Another major trend that will affect intangible investment in the U.S.: outsourcing of R&D to China, India, and other countries. "Companies want us to recruit foreign nationals from the U.S. to work overseas," says Albert. In effect, more and more of the global R&D dollar is being spent abroad, so imports of R&D are increasing.

This shift in intangible investment is also not well tracked by the GDP statistics, although it obviously will depress employment of scientists and engineers in the U.S. But the economic impacts are murky. Corporate executives have argued that shifting R&D to China and India benefits the U.S. by improving the efficiency of the research process. If you can pay two trained scientists in China the same amount as one in the U.S., they say, you can get twice as much research output. But if U.S.-based companies are doing their research and product development overseas and their production there as well, it's tough to see how ordinary workers in the U.S. will gain.

But that's another story. For now, it's enough to note that the difficult environment for knowledge workers means the GDP statistics are sending too rosy a message about the economy. And as the old saying goes: "If you can't measure it, you can't manage it." Until that situation improves, it's going to be difficult to know if the U.S. is really on the road to recovery.

With Peter Coy in New York

Mandel is chief economist for BusinessWeek.

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