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The numbers do not always add up

July 18th, 2008 · No Comments

The US, the place of origin of the housing and credit market that now haunt other economies and markets, turns out to be surprisingly resilient. There are a number of explanations possible, not least of which comes from the ‘knowledge economy’. 

All the mayhem that you can read on a daily basis in the media (and here) has not got the US economy under, at least for now. This is remarkable, as the problems are very serious. We would say, the economic problems have not been this serious since the 1930s.

However, the US economy still grew by an adjusted 1% on yearly basis in the last quarter. Instead, quite a few of the European economies are actually probably already in a recession, like Germany.

There are conventional explanations, and a (somewhat) unconventional one. First the conventional ones.

1) The fall of the US dollar. Exports are booming, and where almost completely responsible for that 1% growth. The mirror image of that is that the euro zone is suffering from an expensive currency, both Germany’s and France’s exports are down.

2) Swift policy reaction. After initial dithering (as the Fed under Greenspan had denied a housing bubble even existed for years), monetary policy was rapidly eased (and all sorts of additional unconventional measures taken). Add to that the fiscal stimulus package (there might be another one in the making) and you see what we mean.

One of the great virtues of the US economy is it’s propensity to adapt. And perhaps even more importantly, adapt fast. It’s a rougher form of capitalism than the more genteel European one, adapting fast almost seems to be in the genetic make-up of being American.

This is a particular advantage in an age of globalization, which puts a premium on the ability to rapidly redirect resources to more competitive uses.

3) Intangibles. Speaking about resources, it’s pretty well known that both accountancy on the level of firms, and perhaps even more so the accounting of economic activity at large, have significant problems with the measurement of so called ‘intangibles’.

One example will illustrate what we’re talking about. Apple’s shiny new iPhone will probably designed and developed in the US, but manufactured in China. According to macro-economic accounting, this makes Apple, one of the most innovative companies in the world, a re-seller of imported goods.

See the problem? Something is wrong here. Those expenditures on innovation and marketing create, to quote another specialist in the field, Charles Leadbeater, value out of thin air. And lots of value, whole new markets (computers, iPods, etc.).

One could argue that spending related to intangibles like research and development, brand building, marketing, employee training, all things related to the creation of knowledge, are of crucial and increasing importance for economic success, especially in advanced economies (and there is a wealth of solid evidence in support of that).

However, macro-economic accounting doesn’t treat it as investments. It is much more difficult to measure than good old capital expenditures. So companies investments in PC’s count, that in software (which is more significant even in sheer size, and probably significantly more durable) doesn’t.

Build a hotel, and it’s investment, build a lab, say that of Apple, or the famous Bell labs of AT&T, or the Palo Alto one of Xerox, and it doesn’t, no matter that these labs have invented stuff like the transistor, the iPod, the computer mouse, the copy machine, and a whole host of other stuff.

And since America’s economy is particularly good at this sort of stuff, research and marketing, but if the national accounts treat Apple as a reseller of important goods, you wouldn’t know. So the most important sources of America’s wealth and future wealth do not get reported in the national accounts.

It’s not much different on a company level, by the way. You might not realize because of today’s rather depressed share prices, but there is a significant gap between the book value of a company (basically it’s assets combined) and the market value resulting from the combined value of the outstanding shares.

That gap is, well, filled with knowledge. But knowledge is difficult to measure. At least on a firm level, accountants have found ways of approximation. Brand value, an important intangible, is measured by ‘goodwill’, for instance.

But even on a firm level things are rather complicated. The combined assets of, say, Microsoft, would only amount to a fraction of it’s $240B market cap. The rest is, well, intangibles..

Knowledge intensive companies need a new way of accounting, but because of their crucial (and increasing) importance to economies, the changes in the national accounts are even more urgent. These do underestimate the vibrance of the underlying economy to a significant (and growing) extent.

But, just because knowledge products and processes are so hard to quantify, this process doesn’t have easy solutions, and certainly not the acurate ones accountants are usually so fond off.

Tags: Opinion · The Markets