Anyone who has read Henry Hazlitt’s classic Economics In One Lesson knows the importance of thinking beyond the short-term impact of a particular decision. Gene Epstein’s latest “Economic Beat” column in Barron’s documents a pending change in the calculation of gross domestic product that should do a better job of incorporating long-term economic activity.
SPEAKING OF INVESTMENT, the Bureau of Economic Analysis has announced that it will add spending on research and development to the investment portion of GDP when it releases its annual revision of the historical data in July. The decision makes sense — so much so, in fact, that it raises questions about whether GDP as calculated by the BEA sufficiently captures investment activity.
A huge share of GDP is devoted to providing for the needs of consumers within a given year. This includes not just retail and wholesale outlets, but most farming and much of manufacturing, not to mention the transportation sector that gets the goods to consumers. There are also the services of hairdressers, masseurs, counselors, and taxi drivers. But there is a great deal of economic activity that takes the form of providing for consumer needs over the long term.
The private-sector’s investment portion of GDP includes the construction and renovation of single-family homes and apartment buildings (“residential investment”); the accumulation of inventories; the building of “structures” in the form of offices, stores, hotels, and factories; the production of equipment — including machinery, computers, and desks — and the creation of computer software.
What all these things have in common is that they capture economic activity that is mainly geared to satisfying consumer demand beyond a year’s time. True, once a house is built, it starts providing sheltering services in the very first year it is occupied. But the economic benefit comes overwhelmingly from the many years it will be providing this service. Inventory building also looks to the future, although at times over a period of months. But whether or not equipment is part of investment turns on its service life lasting beyond a single year. Thus, personal computers represent investment in equipment, but pens and pencils don’t.
That’s why adding research and development to investment makes sense. Spending on R&D by business, nonprofits, and government is essentially the attempt to develop new and better products in a whole range of industries, from pharmaceuticals to autos to aerospace. R&D is therefore a clear example of economic activity with an eye on the future.
