Ellen R. McGrattan and Edward C. Prescott write,
In 2008, only a small part of all intangible investment was included in the measure of GDP from the Bureau of Economic Analysis (BEA). As a result, the fact that labor productivity rose between 2008 and 2009 is not inconsistent with theoretical predictions. The intuition is simple: during a downturn, measured labor productivity rises if we significantly underestimate the drop in total output. We underestimate the drop in total output if there are large unmeasured investments.
Pointer from Mark Thoma. Recall that Jones once tweeted that most workers do not make widgets. Instead they help to build organizational capital.
The authors, who were let go by the Minneapolis Fed several months ago in what was widely viewed as a “purge,” go on to point out that the Commerce Department recently decided to incorporate investment in intellectual property into its measure of investment, and that in recent decades this category accounts for about 1/3 of all investment. They point out that the government does not include other forms of intangible investment, including “advertising, marketing, and organizational capital.”
On the input side, we measure Garett Jones workers. However, on the output side, we tend not to count what they produce. This creates a mis-measured economy. When firms are undertaking a lot of intangible investment, measured productivity is understated. When they cut back in intangible investment, measured productivity growth is overstated.
I think, though, that in order to explain the reduction in intangible investment, you have to tell a PSST story. That is, I do not think that there was an economy-wide “shock” that reduced productivity. I think that there were firms that came to the realization that the outlook did not warrant continued intangible investment. Think of bookstores, newspapers, and other victims of creative destruction.
Purge? What a shame that the Prescott kid never panned out.
In defense of the establishment (now *that* is something I never expected to write), how does one make an objective measurement of change in most of those intangible forms of capital? I am not sure how an auditor or analyst should measure the output of someone focusing on marketing or institutional capital. We might agree that those are valuable and important things to work on, but without repeatable measures of value, how do we measure productivity? Should we just note that they are important, but throw our hands in the air when it comes to measurement?
Expanding a bit on Michael P comment, above …
There is a standard joke among accounting majors at B-school that goes something like this …
A wealthy businessman wants to hire an accountant for his firm, and obviously wants to hire the best accountant he can get. He has 3 candidate applicants for the job. He decides to pose the following test question to each candidate: “What is 2 plus 2?”
The first 2 candidates, after doing some scribbling and punching entries into their hand-held calculators respond, “Sir, 2 plus 2 equals 4!”. He thanks them for their answer and dismisses them with a “Thanks, I’ll be in touch.”
The third candidate enters, and he poses the question to her, “What is 2 plus 2?”
To which she (very quickly) responds, “Anything you WANT it to be, sir!”
The businessman hires the third candidate on the spot!
Now, it strikes me that “incorporating” intangibles into GDP models and results is an exercise in answering the question, “What is GDP?”, with “Anything you WANT it to be!”, and I don’t see that as an improvement in the usefulness of the metric.
Arnold, you are correct that GDP “mis-measures” the economy. Your previous statements that “the U.S. economy is not just a GDP factory” is the most concise, relevant and telling statement I’ve ever heard/read that GDP “mis-measures” the economy. In the exact same sense – and for the exact same reasons – accounting reports released under GAAP accounting rules “mis-measure” the value of a company/firm. (See the justification for the GAAP Objectivity Principle.)
My point being, neither GAAP nor, by extension, GDP (derived from aggregated GAAP data) metrics were ever intended to be an accurate representation of the value of the firm or the larger economy. Indeed, they were only intended and designed to be a representation-of-value metric that is repeatable, comparable, objectively verifiable, and traceable.
Adding other “intangibles” to the GDP metric (as Commerce has already done) DOES NOT improve the accuracy of the metric – as you note, government GDP numbers do not include other intangibles such as “advertising, marketing, and organizational capital”. The GDP metric also doesn’t include other forms of wishful thinking either.
Unfortunately, the the incorporation of these new “intangibles” in the Commerce Department GDP metric – while NOT improving accuracy – merely destroys the repeatable, comparable, objectively verifiable and traceable usefulness the metric once had. They may as well add a dollar-valued “Wishful thinking” sub-category to the Investment spending component of GDP as well – you know, so the question, “What is GDP?” can always be answered with “Whatever you WANT it to be!”