How strong is the U.S. economy?

I’ve got an advanced degree in economics, and I’m here to tell you that the official numbers on the U.S. economy are just plain strange. On the one hand, in the fourth quarter of 2005, GDP growth slowed to a crawl. On the other hand, that had little effect on U.S. labor markets, since the ...

By , a professor of international politics at the Fletcher School of Law and Diplomacy at Tufts University and co-host of the Space the Nation podcast.

I've got an advanced degree in economics, and I'm here to tell you that the official numbers on the U.S. economy are just plain strange. On the one hand, in the fourth quarter of 2005, GDP growth slowed to a crawl. On the other hand, that had little effect on U.S. labor markets, since the Bureau of Labor Statistics reported on Friday that the economy has generated more than 200,000 net new jobs a month, and that unemployment is now down to 4.7%. On the one hand, the U.S. trade deficit shows no sign of reversing itself; on the other hand, some economists insist that dark matter is not being counted. On the one hand, European work fewer hours than Americans. On the other hand, it's possible that Americans have more leisure time than Europeans. The latest: Time frets on it's cover that we may be losing our edge. Except that Michael Mandel says on the cover of Business Week that the economy is stronger than conventional statistics indicate (link via longtime reader Don Stadler): [W]hat if we told you that the doomsayers, while not definitively wrong, aren't seeing the whole picture? What if we told you that businesses are investing about $1 trillion a year more than the official numbers show? Or that the savings rate, far from being negative, is actually positive? Or, for that matter, that our deficit with the rest of the world is much smaller than advertised, and that gross domestic product may be growing faster than the latest gloomy numbers show? You'd be pretty surprised, wouldn't you? Well, don't be. Because the economy you thought you knew -- the one all those government statistics purport to measure and make rational and understandable -- actually may be on a stronger footing than you think. Then again, it could be much more volatile than before, with bigger booms and deeper busts. If true, that has major implications for policymakers -- not least Ben Bernanke, who on Feb. 1 succeeded Alan Greenspan as chairman of the Federal Reserve. Everyone knows the U.S. is well down the road to becoming a knowledge economy, one driven by ideas and innovation. What you may not realize is that the government's decades-old system of number collection and crunching captures investments in equipment, buildings, and software, but for the most part misses the growing portion of GDP that is generating the cool, game-changing ideas. "As we've become a more knowledge-based economy," says University of Maryland economist Charles R. Hulten, "our statistics have not shifted to capture the effects." The statistical wizards at the Bureau of Economic Analysis in Washington can whip up a spreadsheet showing how much the railroads spend on furniture ($39 million in 2004, to be exact). But they have no way of tracking the billions of dollars companies spend each year on innovation and product design, brand-building, employee training, or any of the other intangible investments required to compete in today's global economy. That means that the resources put into creating such world-beating innovations as the anticancer drug Avastin, inhaled insulin, Starbuck's, exchange-traded funds, and yes, even the iPod, don't show up in the official numbers.... [O]ver the past seven years the economy has continued to evolve while the numbers we use to capture it have remained the same. Globalization, outsourcing, and the emphasis on innovation and creativity are forcing businesses to shift at a dramatic rate from tangible to intangible investments. Read the whole thing, which gets around to the "dark matter" question as well (also click here to see the Boston Fed paper upon which Mandel got most of his info). Mandel's story does offer an explanation about the fourth quarter numbers: [T]he conventional numbers may be understating the strength of the economy today. The BEA announced on Jan. 27 that growth in the fourth quarter of 2005 was only 1.1%. In part that was because of a smaller-than-expected increase in business capital spending. However, employment at design and management-consulting firms is up sharply in the quarter, suggesting that businesses may be spending on intangibles instead. Indeed, the consumer confidence number for January zoomed to the highest level since 2002, as Americans became more optimistic about finding jobs. In fairness, as Stadler pointed out in the e-mail that triggered this post, it is possible that redefining investment would also make the 2001 downturn look more serious that conventional GDP data suggested -- because there was such a fall-off in R&D spending at the time. So, maybe the economy is much more robust than commonly thought. But there are three caveats to this that I can't quite shake. First, I very much want this to be true, which means that I might be accepting Mandel's suppositions too quickly. Second, I still remember this Stephen Roach op-ed from 2003, which also pointed out the screwiness with existing data -- except that Roach thought the metrics under discussion were being too optimistic about labor productivity gains. Roach and Mandel are focusing on the same productivity figures -- but Mandel thinks it shows that other numbers are screwy, while Roach thinks the productivity figure is inflated. I'm not sure Roach is right either -- but it's worth bearing in mind that inaccuate data can cut both ways in trying to figure out the current economy. Third, even if we're exporting knowledge capital in the form of FDI, we're also importing significant amounts of knowledge capital -- in the form of science and engineering Ph.D. students. What happens when those figures are thrown into the mix?

I’ve got an advanced degree in economics, and I’m here to tell you that the official numbers on the U.S. economy are just plain strange. On the one hand, in the fourth quarter of 2005, GDP growth slowed to a crawl. On the other hand, that had little effect on U.S. labor markets, since the Bureau of Labor Statistics reported on Friday that the economy has generated more than 200,000 net new jobs a month, and that unemployment is now down to 4.7%. On the one hand, the U.S. trade deficit shows no sign of reversing itself; on the other hand, some economists insist that dark matter is not being counted. On the one hand, European work fewer hours than Americans. On the other hand, it’s possible that Americans have more leisure time than Europeans. The latest: Time frets on it’s cover that we may be losing our edge. Except that Michael Mandel says on the cover of Business Week that the economy is stronger than conventional statistics indicate (link via longtime reader Don Stadler):

[W]hat if we told you that the doomsayers, while not definitively wrong, aren’t seeing the whole picture? What if we told you that businesses are investing about $1 trillion a year more than the official numbers show? Or that the savings rate, far from being negative, is actually positive? Or, for that matter, that our deficit with the rest of the world is much smaller than advertised, and that gross domestic product may be growing faster than the latest gloomy numbers show? You’d be pretty surprised, wouldn’t you? Well, don’t be. Because the economy you thought you knew — the one all those government statistics purport to measure and make rational and understandable — actually may be on a stronger footing than you think. Then again, it could be much more volatile than before, with bigger booms and deeper busts. If true, that has major implications for policymakers — not least Ben Bernanke, who on Feb. 1 succeeded Alan Greenspan as chairman of the Federal Reserve. Everyone knows the U.S. is well down the road to becoming a knowledge economy, one driven by ideas and innovation. What you may not realize is that the government’s decades-old system of number collection and crunching captures investments in equipment, buildings, and software, but for the most part misses the growing portion of GDP that is generating the cool, game-changing ideas. “As we’ve become a more knowledge-based economy,” says University of Maryland economist Charles R. Hulten, “our statistics have not shifted to capture the effects.” The statistical wizards at the Bureau of Economic Analysis in Washington can whip up a spreadsheet showing how much the railroads spend on furniture ($39 million in 2004, to be exact). But they have no way of tracking the billions of dollars companies spend each year on innovation and product design, brand-building, employee training, or any of the other intangible investments required to compete in today’s global economy. That means that the resources put into creating such world-beating innovations as the anticancer drug Avastin, inhaled insulin, Starbuck’s, exchange-traded funds, and yes, even the iPod, don’t show up in the official numbers…. [O]ver the past seven years the economy has continued to evolve while the numbers we use to capture it have remained the same. Globalization, outsourcing, and the emphasis on innovation and creativity are forcing businesses to shift at a dramatic rate from tangible to intangible investments.

Read the whole thing, which gets around to the “dark matter” question as well (also click here to see the Boston Fed paper upon which Mandel got most of his info). Mandel’s story does offer an explanation about the fourth quarter numbers:

[T]he conventional numbers may be understating the strength of the economy today. The BEA announced on Jan. 27 that growth in the fourth quarter of 2005 was only 1.1%. In part that was because of a smaller-than-expected increase in business capital spending. However, employment at design and management-consulting firms is up sharply in the quarter, suggesting that businesses may be spending on intangibles instead. Indeed, the consumer confidence number for January zoomed to the highest level since 2002, as Americans became more optimistic about finding jobs.

In fairness, as Stadler pointed out in the e-mail that triggered this post, it is possible that redefining investment would also make the 2001 downturn look more serious that conventional GDP data suggested — because there was such a fall-off in R&D spending at the time. So, maybe the economy is much more robust than commonly thought. But there are three caveats to this that I can’t quite shake. First, I very much want this to be true, which means that I might be accepting Mandel’s suppositions too quickly. Second, I still remember this Stephen Roach op-ed from 2003, which also pointed out the screwiness with existing data — except that Roach thought the metrics under discussion were being too optimistic about labor productivity gains. Roach and Mandel are focusing on the same productivity figures — but Mandel thinks it shows that other numbers are screwy, while Roach thinks the productivity figure is inflated. I’m not sure Roach is right either — but it’s worth bearing in mind that inaccuate data can cut both ways in trying to figure out the current economy. Third, even if we’re exporting knowledge capital in the form of FDI, we’re also importing significant amounts of knowledge capital — in the form of science and engineering Ph.D. students. What happens when those figures are thrown into the mix?

Daniel W. Drezner is a professor of international politics at the Fletcher School of Law and Diplomacy at Tufts University and co-host of the Space the Nation podcast. Twitter: @dandrezner

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