Brad Setser on Intangibles

Posted by: Michael Mandel on February 06

Brad Setser does a long and thoughtful post on my cover story. I will have a longer response later, but here are my immediate reactions. Brad writes:

I do not have an informed opinion on the question of whether the national accounts definition of investment is dated, and too narrow. Should some of McDonald’s advertising budget be considered a long-term investment in McDonald’s brand - an investment with a longer half-life than a new PC - rather than just an attempt to sell more burgers today. That would drive up US investment rates. And US savings rates, as both business investment and business savings would rise.

Maybe the US invests (and saves) more than the national income accounts show. I don’t think, though, that mismeasured advertising investment changes the bottom line: the US now saves a lot less than it used to. The US savings rate may not be negative, but it still fall short of what the US needs to finance all the investment the US does.

First reaction: First, Brad writes, that “the US now saves a lot less than it used to.” How does he know this? Yes, that’s what the official data shows, but so much of what Americans spend on future-oriented activities is currently counted as consumption in the national income accounts, or treated as intermediate outputs (see here for an explanation). So that dollar you spent on your kids education is subtracted from the national savings pool. The money that Apple spends on R&D is not added into the national savings pool, even though it belongs there.

The official data show that the national savings rate has fallen from about 21% in the 1950s to about 15% in this decade—or about a 1 percentage point a decade. However, over the same period, unmeasured investments in business intangibles were rising from 4% to about 9% of GDP. If we add those into both the investment and the savings side of the economy, most of the official decline in savings disappears. Remember: The national savings numbers are among the least reliable numbers that the government publishes, because they are a residual.

My second reaction:


Brad writes that: "The US savings rate may not be negative, but it still fall short of what the US needs to finance all the investment the US does."

My response is, so what? It's a truism among trade economists that whether you run a current account deficit or a current account surplus matters less than what you do with the money. In that vein, pessimists have accused the U.S. economy of importing capital in order to fund consumption.

But according to my argument, that's not true. We seem to be importing capital in order to fund an enormous amount in investment in intangibles, including knowledge, training, brand equity and the like. Then U.S. companies are using those investments to maintain their competitive position in the global economy.

It's a virtuous circle, rather than a vicious one. What's more, it has the additional virtue of being consistent with the facts, including the much faster productivity growth in the U.S., that darned unwillingness of the dollar to drop, and the continued high rate of return of U.S. companies overseas.

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Reader Comments

Noels Geert

February 7, 2006 02:53 AM

Sir,

"Unmasking the Economy" seems to me the economic equivalent of Glassman's "Dow 36,000". If we change the accounting, wrong seems right, and imbalances disappear...

But how will you argue away the record US debt levels. Current household debt levels are consistent with levels that trigger the so-called "debt snow-ball"-effect. Households will have to borrow more to pay interest charges... This doesn't seem to fit with your hidden strength story.

So if the US economy were a company today, it would have increasing negative cash flows, record high credit debt levels and the company would be issuing more and more shares to pay for it's financing gap. Who would call this "signs of strength"? The management could then argue that the accounting rules are totally wrong, and that there is a lot of hidden strength.

But that still doesn't seem the most credible story to me. All in all, Brad Setser has the more credible version of the US economic case in my view.

kind regards

Geert Noels
Chief Economist
Petercam
Brussels-Belgium

Brandon

February 7, 2006 02:14 PM

In reference to Geert Noels comment about credit market debt, I am reposting the following link to a chart that shows Total Credit Market Debt as a Percentage of GDP.
http://www.legend-financial.com/content/ourviews_legend2.asp?SPID=19061&LinkID=35757&Title=Articles%20Online%20-%20Med

Our current credit market debt is over 3 times the size of our annual GDP. This is the highest it has ever been. The last time it was even close to as high was during - you guessed it - the Great Depression. We can certainly argue that the US now has a much more dynamic economy, and also argue that it's less relevant because the US now has a floating fiat currency rather than one backed by any real value; however, I think we're a nation living on borrowed money and borrowed time.

Lord

February 7, 2006 02:15 PM

It is a mistake to confuse how US companies are doing with how the US is doing. Large US companies are no more US than most other multinationals, and while they may be doing well internationally, that says little about the US.

David Foster

February 7, 2006 04:21 PM

Geert...debt cannot be evaluated in isolation. A balance sheet has two side, and you have to look at both of them.

In the corporate world, for example, General Electric has increased its long-term debt substantially: $140B at the end of 2002, and $217B for the quarter ending Sept 05. Is anyone alarmed about this? No, because people are confident that the proceeds from the debt have been invested in valuable assets.

Similarly, the issue with government debt is not just how much was issued: it's the question of how effectively the funds were spent and what the future economic impact of that spending will be.

I have additional comments with Mike's original post on the story.

Geert Noels

February 7, 2006 04:55 PM

Concerning David Foster's remark on debt

Fair point about relating debt to the asset side of the balance sheet. But the ratio debt/assets has been strongly deteriorating (Household debt to Asset ratio was 8.5 in the 50ies, 11.4 in the 60-ies, 12.5 in the 70ies, 13.5 in the 80ies, 14.5in the 90-ies, and currently stands at 17.5 Q3 2005).

Another point is that the value of the assets has been inflated due to debt-driven demand. Or to put it differently, only non-correlated assets are a good hedge for debt. If the assets are correlated with the debt, their value could strongly decrease when the debt problem arises. This was for instance the case with European telco's. Apparently healthy debt/asset ratios, until the value of the assests dwindled afteer 2000...

Also, I don't think that all this debt of US households has been used for "wise investments". It has been spent on consumption, and is a good reflection of the consumption-obesitas of the US economy in my view.

David Foster

February 7, 2006 07:56 PM

Geert...but suppose that part of the debt incurred by a family is to send their kid(s) to college? Doesn't the education obtained (assuming wise choice of coursework) represent an *asset*, both to the (extended) family and to the nation as a whole? Won't it generate future wealth, just as a machine tool would? This is, of course, a big part of Mike's whole point: the need to consider the value of intangible assets. I've entered some caveats on specifics, but the overall point is, I think, a correct one.

And I can't resist pointing out that (according to a recent issue of The Economist, IIRC) the US spends considerably more (as a % of GDP) on education than do most European nations.

brad setser

February 7, 2006 11:57 PM

We in the US also spend considerably more than most European countries on health care, and, in return, get results that are, on average, not as good. College education certainly costs less in Europe (I spent four years exploiting this fact), in part because faculty salaries are a lot lower and in part because the government is in a lot of ways a monopoly buyer. I suspect Europe gets a bit less too. But, even so, the financial service firms in the UK don't seem to have any more trouble finding "talent" than financial service firms in the US. For example, I don't think anyone holds my low cost European education against me (at least not anymore). All this is to say that spending on education is not necessary perfectly correlated with results, in the same way that health care spending is not perfectly correlated with results -- tho in this case, i suspect the final balance will be US spends more and gets more. The question is how much more.

Tom Hoffmann

February 8, 2006 12:36 PM

I don't understand why both rent and mortagage payments are considered expense items. The number one "investment" goal for the American dream is to own a home.

Mike Mandel

February 8, 2006 01:00 PM

Tom,

The bottom line is that spending on home construction and renovation *is* counted as investment in the national income accounts, but education isn't.

Mike Mandel

February 8, 2006 01:07 PM

Hi Brad,

You are right about education..as I acknowledge in the story, getting the right measure of real output is not a trivial task.

As for medical care--I can make a reasonable argument that the portion of medical spending devoted to children's health should be counted as investment in their future capabilities as workers. For example, take a look at David Weil's paper on "Accounting for the Effect of Health on Economic Growth" (http://www.nber.org/papers/w11455). He found that "the share of cross-country variance in log income per worker explained by variation in health is 22.6%, roughly the same as the share accounted for by human capital from education, and larger than the share accounted for by physical capital."

However, I decided that for this article, putting in medical spending as an investment would blow everyone's circuits.

Michael Storm

February 8, 2006 02:51 PM

I will offer a simple example:

- guy leaves firm
- guy spends savings on start-up
- guy sells start-up for $50M.


This is the US economy - complete with negative savings rate and massive capital gains (and WEALTH).

It is exactly what is rational from the perspective of how our tax system is set-up. Thus, the smartest individuals minimize savings AND income in favour of entreprenurship.

Mr. Setser doesn't understand "dark matter" because it is not in text books and he does not seem to be exposed to the real world economy. A classic investment style is "you give me the capital and I take a 25% GP position for my management". Thus in this transaction a manager just created an "asset" worth 1/5 of the capital. Again here, often fund employees take "income" in the form of "equity units" -- NO INCOME, NEG SAVINGS, MASSIVE WEALTH.

Seems obvious...

Sushant Sinha

February 9, 2006 12:45 AM

Basically, I liked the argument that you made: the normal economic measures do not actually reflect the strength of a society. There are intangible assets that we are not measuring correctly, like investment in education and R&D. I actually never agree that the strength of a society can be measured just by broad metrics GDP, GNI or national savings. It depends on the broad value system, judicial system, political system, and investment in constructive assets. Some of these are well measured by many metrics used by political scientists or by welfare economists arguing for human development metrics. These metrics may make a society happy and productive, but may not directly transform into wealth. No one really knows how these metrics (including investment) actually transform into wealth. So, my question is : Should we speculate these transformations into a single dimension of wealth or let judge a society by all these multi-dimensional metrics?
It may be possible that some of them actually easily transform to wealth. For example, R&D may actually produce lot of wealth. But, there is still uncertainity and shouldn't we leave them to be reflected in GDP growth?

Christopher

February 9, 2006 09:20 AM

The Development Gateway (World Bank spin-off primarily focussing on IT for Development) has posted an interesting set of resources. They link to several techniques that are being developed to measure the types of intangibles associated with the Knowledge Economy.
This link should work:
http://topics.developmentgateway.org/knowledge/highlights/default/showMore.do
If not, try this one:
http://topics.developmentgateway.org/knowledge/rc/BrowseContent.do~source=RCContentUser~folderId=3216

Nobody

February 14, 2006 01:12 PM

One note: if you're going to start counting education and health care as investments or assets now, be sure to go back and include them in historical comparisons too.

Steven M

February 15, 2006 03:45 PM

Hi. This is one of Brad's loyal followers, having made the jump from his blog to this one. Thanks for having us over. :)

I see a few problems with the premise of this article, and the resulting discussion. For one, it seems like we are comparing apples to oranges to kumquats.

Yes, the rise of knowledge-based industries MAY be good for the US in the long run. It is also possible that the utter deterioration of our manufacturing industries may be a bad thing. The real problem is that no one in the US is paying any attention to which view is correct, or governing their actions accordingly, and it has been years since anyone here did.

Mr. Mandel, you say that the rise of knowledge-based activity is the real strength of the US economy. Presumably, the accompanying decline of our manufacturing industries is therefore no cause for alarm. Yet there are hundreds of intelligent talented Americans trying to make GM and Ford sell more cars. Their efforts are not succeeding, and instead those companies are declining and laying off thousands of workers.

Presumably, you would attribute this to the unseen hand of market forces, and say that in the long run it is positive, because our economy is undergoing a transition. Yet no one actually decided to make those layoffs occur; they are not due to increasing productivity, but rather due to declining business. What if (hypothetically) I could show you it is in fact not positive, and it would result in less opportunities and lower living standards? Would you then urge government action?

Of course not, because you would then credit the "unseen hand" of the market as having reduced inefficient businesses, in favor of more competitive and efficient ones. Yet it is precisely that process, and that "unseen hand," which I and other globalization doubters see as a problem.

Yes, some individual industries needed to be moved overseas, to attain greater efficiency. Yet even if there were good reasons to outsource each individual industry, the cumulative effect of that would be that eventually no good jobs would be left here. That concern can be addressed only outside the discussion of what is more efficient. At some point, we must assert the importance of national concerns, and what jobs exist for our own society, regardless of the economic reasons. That is true even if the industries are inefficient and EVEN if they always will be.

That is one of the obligations of any nation. Every citizen in a society, whatever their class, has some obligation to see that ,some business goes to domestic industries here, if that citizen does get any benefits from living here.

You would argue that such thinking is outmoded, as new industries are arising, which will bring new efficiency, and ultimately create good jobs for all across the US. The real problem is that no one is actually watching whether that is really happening, and no one is changing their economic plans or decisions based on that. This includes yourself.

It is precisely these national concerns, over and above any consideration of what is more efficient and competitive, which form the concerns of globalization opponents. In previous eras, industries might rise and fall, but the new industries, remained here, just like the ones they replaced. This is the first time in American history that that is not the case to such a large degree.

We don't object to economic transitions . We just want to make sure that someone is paying attention to the basic, existential concerns of our society, (in addition to the valid concerns of economic progress and efficiency). So far, no one seems to be paying attention to those concerns. We hope that someone will. This is one of the reasons that we continue to promote this type of analysis, viewpoint and discussion.

I appreciate your interesting article, and the opportunity which your insights have given all of us to lay some of these concerns on the table. Thanks very much.

Steven M

Jon

February 27, 2006 12:27 PM

Why should advertising and brand building be considered "investment"? If McDonald's spends $1 billion to convince people to go there instead of Burger King, what improvement in our ability to produce something has been generated?

John Konop

May 29, 2006 08:57 PM

Mike,

The last time I posted on your blog about this topic you question the 31% of consumer spending,American families using their homes as a credit cards or ATM MACHINE. This makes the saving rate issue more alarming.

http://www.hoisingtonmgt.com/HIM2005Q3_NP.pdf

AS always look forward to your opinion. Thanks jk

Thank you for your interest. This blog is no longer active.

 

About

Michael Mandel, BW's award-winning chief economist, provides his unique perspective on the hot economic issues of the day. From globalization to the future of work to the ups and downs of the financial markets, Mandel-named 2006 economic journalist of the year by the World Leadership Forum-offers cutting edge analysis and commentary.

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