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Economists revise GDP estimates with investment in intangibles

The US economy will officially become 3 per cent bigger in July as part of a shake-up that will see government statistics take into account 21st century components such as film royalties and spending on research and development. Billions of dollars of intangible assets will enter the gross domestic product of the world’s largest economy in a revision aimed at capturing the changing nature of US output. A brief look at the emerging scenario.

Gross domestic product (GDP) is the market value of all officially recognized final goods and services produced within a country in a given period of time. GDP can be determined in three ways, all of which should, in principle, give the same result. They are the product (or output) approach, the income approach, and the expenditure approach. The most direct of the three is the product approach, which sums the outputs of every class of enterprise to arrive at the total. The production approach is also called Net Product or Value added method. This method consists of three stages:

  1. Estimating the Gross Value of domestic Output out of the many various economic activities
  2. Determining the intermediate consumption, i.e., the cost of material, supplies and services used to produce final goods or services; and finally
  3. Deducting intermediate consumption from Gross Value to obtain the Net Value of Domestic Output.

Both firm-level and national income accounting practice have historically treated expenditure on intangible inputs such as software and R&D as an intermediate expense and not as an investment that is part of GDP.  Now, this exclusion of intangibles is increasingly questioned. Economists in USA pointed that business investment in intangibles is a vital aspect of business activity, and the investments shown below represent a large and growing portion of the overall economy.

    •    Computerized information (mainly computer software)
      • Scientific R&D
      • No-Scientific R&D
        • Cost of development of new motion pictures, films and other forms of entertainment.
        • Investment in new designs
        • Estimation of product development by financial services and insurance firms.
        • Investment in Economic Competencies
          • Spending on strategic planning
          • Spending on redesigning or reconfiguring existing products in existing markets,
          • Investment to retaining market share
          • Investment in brand names
          • Employee training.

 

The rapid expansion and application of technological knowledge in its many forms (research and development, capital-embodied technical change, human competency, and the associated firm-specific co-investments) are key features of recent U.S. economic growth. Accounting practice traditionally excludes the intangibles component of this knowledge capital and, according estimates exclude approximately $1 trillion from conventionally measured non-farm business sector output by the late 1990s and understates the business capital stock by $3.6 trillion.

Can we expect our GDP estimates to be revised likewise?

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Transforming a nation with products

India is at a crossroads today. Gloom has replaced what seemed to be an unending boom just a few years ago. After a decade of rapid growth led by the services sector, the Indian economy has hit a plateau. While services exports continue to grow and create a surplus in services trade, they only constitute 35% of the country’s total exports and are unlikely to compensate for the deep deficit in merchandise trade that stands at 10% of gross domestic product (GDP). This deficit in goods trade is partly attributed to the services-led route of economic development taken by India in the post-liberalization era, in contrast to a manufacturing-led route to development that creates a strong base for goods trade.

From a national policy perspective, excessive dependence on services is akin to putting all one’s eggs in the same basket. For a country of India’s size, diversity, and global aspirations, a more diversified economic basket is an urgent imperative.

The current situation has created a need to nurture and bolster “products” or “goods” industries. But the challenging question is where to begin, and which industry might lead the charge. Given India’s rise to prominence in the last two decades as a software hub, could software products be the ideal place to start?
Unlike manufactured products, software does not need major logistics infrastructure, nor does it depend on inputs other than human capital. Further, software products can be delivered through the cloud.

Therefore, the software product industry holds the potential to circumvent India’s relatively weak position in manufacturing and yet capture a high enough degree of value to address at least some of our economic challenges.

In addition to the direct benefit of a healthy software product industry to the national economy, technology can bring about an order of magnitude improvement in the effectiveness and competitiveness of other sectors, be they industrial or social. Industries as diverse as healthcare and jewellery could benefit from standardized software applications that enhance their competitiveness. Therefore, a competitive software product industry will not only benefit the economy but will have a ripple effect across the society at large.

Though the aspiration for a vibrant software product industry is compelling, international comparisons show that we have much ground to cover. While the number of engineers in the Israeli software industry is only a third of those employed in the Indian product industry (including MNC captives), Israeli start-ups raise almost double the amount of venture capital that Indian start-ups do. Further, we have thrice the number of start-ups as Israel, but Israeli investors managed 40 times the number of exits compared to Indian companies in 2011. So far, India’s software product industry is punching below its weight category and needs a fillip.

In the past we have failed to realize our potential in products. Take telecom as an example. We have created mobile services giants like Airtel but have no telecom product industry to speak of. Our air force is one of the largest in the world and yet we haven’t been able to get the light combat aircraft (LCA) deployed in 30 years. We have somehow not been able to develop a product industry in India.

A challenge as big as this one is unlikely to have a one-shot solution. Yet, a vibrant product industry is unlikely to emerge by chance either. The solution needs to emerge gradually and iteratively, based on a continuous dialogue between software product companies, investors, policy makers and potential customers. Shaping policy, funnelling investments and stimulating the market can potentially steer the software product industry in the right direction.

This article first appeared in the LiveMint