GDP: Add 3% and Some Bad Accounting

Via Mark Thoma, the Financial Times reports on the expected changes to US GDP accounting rules that are likely to raise the GDP level by 3% when they are implemented in July. I am not an expert on all the technical aspects of measuring GDP (I always hope that whomever is dealing with this is doing an excellent job) but this change reminds us of a fundamental issue with macroeconomic statistics: the lack of good data on NDP (Net Domestic Product), a variable that should be much more relevant than GDP to measure economic performance or welfare or activity.

What the future accounting rules will do is to reclassify certain business expenditures (such as R&D) as investment instead of an intermediate input that enters the production function. Why is this relevant? When a business expenditure is simply accounted as part of the production process (as a cost), it only enters in GDP through the value of the final good – to avoid double counting. But when a business expenditure is counted as a capital good it will show up twice in GDP. When it is produced it will show up as investment (a component of GDP). But then, as the asset is used and contributes to the production of the final good, the value it generates is incorporated into the value of the final good. We are doing bad accounting here as the cost to the business (which is captured by the depreciation of the asset) will never show up with a minus sign in the calculation of GDP because GDP is a gross measure of production and not a net measure of production.

So if something that was considered a regular business expense (such as R&D) is now included as a capital expenditure it will simply raise the level of GDP. If we calculate NDP (net domestic product) there should be no change in the long-term — although the profile will look different as in one case, when it is assumed to be a business expenditure, we are simply depreciating the good fully in one year.

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