South-Westerns' Economic News Summaries
GDP Measures Subject to R&D
Topic National Income Accounting
Key Words

Investment Spending and GDP

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Reference ID: A144248911
News Story

Recent evidence suggests that GDP figures leave something to be desired when it comes to measuring how much the American economy produces and who gets what share of the pie. Basically, GDP calculations include the value of all goods and services produced in the U.S. in a given year--often referred to as national income. The Bureau of Economic Analysis, the agency that calculates and reports GDP statistics each quarter, also breaks out how much of national income goes into company profits and how much goes to workers in the form of wages and salaries.

The BEA's research now indicates that current methods for calculating GDP undercounts the dollar returns that R&D generates. Studies by two prominent researchers at the Federal Reserve confirm the BEA's findings. The "Research" in R&D is defined as an activity aimed at discovering new knowledge in hopes that such knowledge will be useful in creating a new product, process, or service, or improving a present product, process, or service. "Development" translates research into a new or improved product, process, or service that a firm can use or sell.. Currently, U.S. companies spend approximately $300 billion each year on R&D--big money in anyone's book.

As a result of their study, the Bureau of Economic Analysis will produce and publish an experimental GDP account that will parallel the standard quarterly report, except for one change: research and development will be counted as capital-an asset-- instead of as an expense. Consider the logic of the process. If a firm is making and selling a dress, the cloth and thread that go into the dress are an expense that will be subtracted from the sales price to determine the profit. The automated sewing machine that made the dress is considered capital investment because, once installed, it will make dress after dress, generating a revenue stream. Business investments are often funded from firms' retained earnings to generate more earnings. Similarly, the R&D from producing, say, a new medicine, will generate revenue to the firm for years to come. The BEA is simply recognizing research and development in the same way that they have recognized other investments in the past. The experimental measure of GDP will thus see R&D as capital investment and count it as a profitable contribution to GDP instead of being expensed.

Two Fed economists agree with the bureau's thinking. Carol A. Corrado and Daniel E. Sichel, along with an outside collaborator, University of Maryland economist Charles R. Hulten, would even go further. They would do more than just reclassify R&D. This team says that other intangibles--like advertising used to establish a name brand that improves sales, or a retail chain's outlays to adapt existing technology to the firm's advantage--should also be reclassified as investment rather than expenses.

The new experimental measure, scheduled for its debut in September, will no doubt gain much attention from economy watchers.

Questions
1.

Discuss the difference between the expenditure approach to GDP and the income approach to GDP.

2. How will the experimental measure being consider by the Bureau of Economic Analysis change the breakdown or allocations in the income approach to GDP?
Source Louis Uchitelle, "Seizing Intangibles for the G.D.P The New York Times Online, April 9, 2006.
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