What the annual GDP revised data tells us

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When BEA released its advanced estimate of GDP last month, it also released its annual revisions. Those revisions go back to 1969 and include more data on Intellectual Property Products (IPP).

First, the revisions. The chart below shows the comparison between the earlier and the most recent data. The level was significantly of in 1Q 2011 and 1Q 2013 and so far off in 2Q 2012 and 3Q 2013 that it missed the trend. Not to be too critical, but this points out that we still have a ways to go in timely data collection.

2015 revisions.png

The more interesting item is the new data on IPP going back to 1969. The chart below shows both the volatility and the somewhat cyclical nature of IPP investment. The same is true for the various components: R&D, software and entertainment, literary, and artistic originals. Interesting that software gets less volatile in the last decade and a half. R&D investment seems to be all over the place. Other than a few spikes, investment in entertainment, literary, and artistic originals has been rather steady.

IPP percent from 1969.png

Software percent from 1969.png

R&D percent from 1969.png

Artistic percent from 1969.png

For more details on the revisions, see The 2015 Annual Revision of the National Income and Product Accounts by Stephanie H. McCulla and Shelly Smith from the August 2015 edition of the Survey of Current Business.

R&D investment up in second estimate of 2Q 2015 GDP

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The U.S. grew faster last quarter than thought according to the second estimate of GDP data released this morning from BEA. In this latest estimate, GDP is up 3.7% in the second quarter of this year. the advanced estimate was of a growth rate of 2.3% (see earlier posting). Economists had expected an upward revision to 3.2% based on new data.

Investment in R&D was revised upwards from 5.2% to 12.2% - which was greater than in the 1st quarter. As a result the entire category of IPP was revised upward as well. However, investment in software was still below the 1Q level and investments in entertainment, literary, and artistic original declined in the 2nd quarter.

IPP parts 2Q15 - 2nd.png

Next Production Revolution - OECD

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And continuing with OECD activities, here is the outline of a new project on the Next Production Revolution:

The objective of the OECD work on the 'Next Production Revolution' in 2015-2016 is to examine and better understand the pathways - both technological and non-technological - of future prospects for growth, innovation and productivity across the economy. The ambition is to better understand the key structural changes in both manufacturing and services that could occur and assess the implications these technological changes and the resulting business dynamics will have for a wide range of policies. The work does not aim to forecast what will happen in the future as this is an impossible task in a world characterised by increasing levels of volatility, uncertainty, and complexity. The aim is rather to formulate robust policy recommendations on how economies can fully benefit from the emerging new opportunities, and prepare for the challenges of the next production revolution.

I should point out that this project shares the basic viewpoint of the recent NAE report on Making Value for America: Embracing the Future of Manufacturing, Technology, and Work (see my earlier posting on Engineers who get it) -- that one of the major factors in the new I-Cubed (Information, Innovation, Intangible) Economy is the fusion of manufacturing and services.

OECD on productivity

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In Monday's posting on OECD's recent report on intellectual property there was a discussion on the role of patents in the diffusion of knowledge. Another recent OECD report from their Future of Productivity project shows just how the process of knowledge flows and technological diffusion is for the economy. The report, its accompanying policy note and the presentation make clear that diffusion is the key productivity issues of today:

Productivity growth of the globally most productive firms remained robust in the 21st century but the gap between those high productivity firms and the rest has been increasing over time. This rising gap raises questions about why seemingly accessible knowledge and technologies do not diffuse to all firms.

Productivity growth.png

According to the report, policies can help rectify the situation:

Three policy areas appear to be of key importance to sustain productivity growth: i) foster innovation at the global frontier and facilitate the diffusion of new technologies to firms at the national frontier; ii) create a market environment where the most productive firms are allowed to thrive, thereby facilitating the more widespread penetration of available technologies; and iii) reduce resource misallocation, particularly skill mismatches.
. . .

Policies to sustain productivity growth include:

• Improvements in public funding and the organisation of basic research, which provide the right incentives for researchers, are crucial for pushing out the global frontier and to compensate for inherent underinvestment in basic research.

• Rising international connectedness and the key role of multi-national enterprises in driving frontier R&D imply a greater need for global mechanisms to co-ordinate investment in basic research and related policies, such as R&D tax incentives, corporate taxation and IPR regimes.

• Productivity growth via the diffusion of innovations at the global frontier to national frontier firms is facilitated by trade openness, participation in global value chains (GVCs) and the international mobility of skilled workers. Rising GVC participation magnifies the benefits from lifting barriers to international trade and from easing services regulation.

• Well-functioning product, labour and risk capital markets as well as policies that do not trap resources in inefficient firms - including efficient judicial systems and bankruptcy laws that do not excessively penalize failure - help firms at the national frontier to achieve a sufficient scale, enter global markets and benefit from innovations at the global frontier.

• A competitive and open business environment that favours the adoption of superior managerial practices and does not give incentives for maintaining inefficient business structures (e.g. via inheritance tax exemptions that may prolong the existence of poorly managed family-owned firms) facilitates within-firm productivity improvements. Stronger competition also enables the diffusion of existing technologies to laggards, which underpins their catch-up to the national frontier.

• Innovation policies, including R&D fiscal incentives, collaboration between firms and universities and IPR protection, should be designed to ensure that they do not excessively favour applied vs basic research and incumbents vs young firms.

• Framework policies that reduce barriers to firm entry and exit and improve the efficiency of matching in labour markets can improve productivity performance by reducing skill mismatch.

• Reforms to policies that restrict worker mobility and amplify skill mismatch - e.g. high transaction costs on buying property and stringent planning regulations - and funding for lifelong learning will become increasingly necessary, to combat slowing growth and rising inequality.

This report builds on OECD's earlier work on knowledge-based capital (KBC, aka intangible assets). As such, the report highlights the importance of investments in KBCs. But it is not just what companies spend on intangibles that is important. The report notes that "it is likely that the competitive advantage of GF [Global Frontier] firms arises not only from their investments in KBC, but how they tacitly combine different types of intangibles - e.g. computerized information; innovative property and economic competencies - in the production process." The key role that tacit knowledge plays makes the task of knowledge diffusion that much more difficult.

A number of the policy recommendations explicitly attempt to foster the flow of tacit knowledge. Openness of the economy is one such policy. As the report notes, "Exposure to trade and FDI entails exposure to knowledge and know-how of the "best" foreign and domestic firms." Another such facet of openness is the flow of people, especially brain circulation, "which might stimulate knowledge flows, collaboration and ultimately high impact research."

The report ends with an outline for future research. One project will look at "the sources of the cross-country differences in aggregate productivity." In that regard, it would be useful to look more carefully at what specific investment in which specific intangible assets make the most difference. As I've noted in an earlier posting, data shows that the countries differ greatly in the productivity growth they get from their investments in intangibles. Work by Carol Corrado, Jonathan Haskel, Cecilia Jona-Lasinio and Massimiliano Iommi, "Intangible Capital and Growth in Advanced Economies: Measurement Methods and Comparative Results" shows Finland, Ireland and even Slovenia get greater productivity growth from their investments in intangible capital than the U.S.

Intangible v MFP - Corrado 2012.png

I hope the new OECD research effort will take a closer look at this phenomenon.

Thoughts on tech displacement

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There's a new paper out by Joel Mokyr, Chris Vickers, and Nicolas L. Ziebarth on "The History of Technological Anxiety and the Future of Economic Growth: Is This Time Different?" The paper looks at three forms of anxiety over technology:
First, one of the most common concerns is that technological progress will cause widespread substitution of machines for labor, which in turn could lead to technological unemployment and a further increase in inequality in the short run, even if the long-run effects are beneficial. Second, there has been anxiety over the moral implications of technological process for human welfare, broadly defined. In the case of the Industrial Revolution, the worry was about the dehumanizing effects of work, particularly the routinized nature of factory labor.
. . .
A third concern cuts in the opposite direction, suggesting that the epoch of major technological progress is behind us

While the discussion of all three is interesting, I found the comments on the first issue of tech displacement to be the most insightful. Mokyr et al. make a key point about the gains and costs of technological progress:
While the predictions of widespread technological unemployment were, by and large, wrong, we should not trivialize the costs borne by the many who were actually displaced. It is true that, in the long run, wages for laborers increased to reflect dramatically increased productivity. It is also true that, for the Industrial Revolution, by many estimates it took longer than an average working lifetime to do so, and in the long run, we are all dead.
These distributive aspects of the change are at the heart of most of the anxieties.

But the authors make a more important point as to the dynamics of the process:
More importantly, technological progress also took the form of product innovation, and thus created entirely new sectors for the economy (emphasis in original).

Essentially, the dynamic is a race between productivity and demand with job creation trying to offset job displacement. The linkage between the job displacement effects of innovation via productivity increases and the job creation aspects of innovation and productivity works in three ways. The standard way economists explain the dynamic is the classical balance between supply and demand. As David Autor notes in his new paper "Why Are There Still So Many Jobs? The History and Future of Workplace Automation"
Automation does indeed substitute for labor--as it is typically intended to do. However, automation also complements labor, raises output in ways that lead to higher demand for labor, and interacts with adjustments in labor supply.
In other words, if productivity reduces prices (as opposed to increasing either profits or leisure, i.e. less labor needed for same output), economic theory tells us that sales should increase. That demand for greater production will offset the need for fewer workers per unit of output.

The second way linkage is how process innovation both increases productivity and enables product innovation. The definition of a disruptive technology is that it allows you to do things that you couldn't do before. Case in point is additive manufacturing aka 3D printing (see my 2014 report Additive Manufacturing as a Disruptive Technology). Additive manufacturing allow production of items that could not be made in conventional processes. This leads to product innovation in areas as disparate as medical devices and fashion.

An example from the early days of the Industrial Revolution is hog lard rendering. Steve Gordon points out (in "From Slaughterhouse to Soap-Boiler: Cincinnati's Meat Packing Industry, Changing Technologies, and the Rise of Mass Production, 1825-1870"), "Not until the 1830s, with improvements in factory technology and the opening of new markets, did animal wastes become commercially profitable."

As the process of rendering of hog lard became refined, the use of the product for high quality soaps and candles increased, displacing home-made products. But there were spins off products as well. According to Charles Morris (The Dawn of Innovation: The First American Industrial Revolution):
Mastery of the chemistry of lard facilitated the production of pure glycerine for a host of applications. It was important to tanners, a useful solvent, and widely used in the production of pharmaceuticals and food.
Changes in production processes open up new opportunities in product innovation and increased demand beyond the original product.

The third linkage is the non-linkage. Product innovation can occur independently from productivity increases. So far, the history of technological progress since the Industrial Revolution has been one of enough product innovation to create new jobs. It is this third dynamic of the independence of labor-creating product and labor-reducing process innovation which partially ties back to the third anxiety outlined by Mokyr et al. Will we have the new product (goods and services) development to continue to fulfill the promise of new jobs and new types of jobs? If the future of production is "just-in-time and just-for-me", will this customization be enough to keep the dynamic going of net job creation?

For now, the dynamic seems to be working. As Peter Thiel famously said, "we wanted flying cars instead we got 140 characters." Frankly I think we are better off with the 140 characters. And if you think there is an airspace problem with drones, image 250 million cars and truck flying around overhead. But the key question is this: which is enough to create jobs? Flying cars built in automated factories does little to increase net employment. If you take "140 characters" has short hand for "apps" in general, then 140 characters wins. Estimates are that the app economy has generated 750,000 jobs as of 2013.

As they say in the financial advice disclaimer however, "past performance is no guarantee of future results". The balance between job displacement and job creation is not written in stone. Public policy can help maintain the balance. But only if we recognize that a positive economic outcome is not a preordained outcome.

    Note: the views expressed here are solely those of the author and do not necessarily represent those of Athena Alliance.

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