October 2, 2006: Volume 7, Issue 77 
 
1. SURF'S UP: Try And Keep Up -- By Tobin Smith 
 
So, how big is the U.S. economy? And how much do we invest each year versus
what we consume? 
 
If you listened to the radical left or radical right, you would think our
economy was about to run out of "capital" because our "national savings rate"
was so darned low. 
 
Well, the state of our nation's "capital" was a LOT better off than some people
could fathom, especially due to the insane, arcane way we measure national
savings. 
 
I've been telling you that for a while now. Now I have proof. 
 
In a preliminary study released last week, the Bureau of Economic Analysis said
that research and development investment, or R&D, accounted for 4.5% of growth
in real GDP between 1959 and 2002.  
 
How big is that? Investment in bricks and mortar was just above 2%. 
 
Here's the insane part. Currently the hundreds of billions of dollars that
businesses spend each year on research and development (R&D) are not counted
toward economic growth -- i.e. they are NOT an investment; instead, they are an
expense.  
 
Say you are a company that has $1 billion of sales and spends $100 million on
research and development projects. With the current approach to accounting,
this investment in people, equipment and everything else is an "intermediate"
expense. That makes the expense deductible off one's tax bill. 
 
But treating R&D as an investment would make the U.S. economy 3% BIGGER and our
"national savings rate" 2%-3% HIGHER. 
 
Why is this a good idea? 
 
Because research and development is the lifeblood of our economic system, yet
we don't value it as such. And also because we are clearly understating the
amount of capital we put to work each year in our economy by such arcane
measurement systems. 
 
In most countries, the return on equity capital at the corporate level is very
low -- lower than what investors can get in the risk-free bond market. The best
example is Japan, with an average return on equity at the corporate level of
less than 3%.  
 
In the U.S. we average well above 8% -- it's why we are capital importers
rather than exporters -- capital invested in U.S. companies returns a higher
rate of growth. 
 
One of the key reasons for our ultra-high rate of return on equity is the
ultra-high rate of return on our world-leading amount of research and
development. 
 
The higher the rate of R&D investment, the higher the growth rate of our
economy.  
 
The same is true for productivity investments. When we invest in a new RFID
system for our supply chain, we book that investment as, well, an investment.
The return on that investment is measured in dollars saved. 
 
When we spend $50 million of time, products and people figuring out the next
iPod, the return on that investment is measured in profits generated. 
 
The Bureau of Economic Analysis says it will continue to expense R&D investment
till 2012 -- for what reason, I cannot fathom. 
 
But you should know that when you hear about our "unsustainably low" national
savings rate or the "chokingly large current account deficit," there is so much
positive data left out of these numbers that the figures are laughable. 
 
Toby