A pharmaceutical company develops a new cancer drug. A Hollywood studio creates a box-office blockbuster. A song writer records a new hit. On July 31, BEA will begin including the amount of money businesses invest in the production of such intellectual property as part of gross domestic product (GDP).
Why?
The changes reflect updated international guidelines for national economic accounting—the United Nations’ System of National Accounts 2008 (SNA). It’s important that economic measures keep pace with a changing global economy and that GDP statistics from different countries use a common set of guidelines for comparability.
Australia and Canada already implemented some of the changes outlined in the 2008 SNA. The United States is taking steps later this month. Europe is expected to act next year.
Expenditures for research and development (R&D) and for entertainment, literary, and artistic originals have many of the characteristics of other fixed assets—ownership rights can be established, the assets are long-lasting, and they are used repeatedly in the production process. Thus, the SNA recommends that expenditures on the production of these types of intangible assets, or intellectual property, be treated as fixed investment. That’s consistent with the way we treat the production of tangible assets like a new drill press in a factory.
Currently, we count spending on R&D and on the creation of entertainment, literary, and artistic originals as intermediate inputs used up during the production of other goods and services. As a result, the contribution of these important innovative activities to economic growth and productivity is difficult to measure. Right now, these investments don’t show up directly in GDP, although sales of drugs and copies of DVDs, CDs, Blu-ray discs and digital downloads are counted.
By recognizing expenditures on R&D and on entertainment, literary, and artistic originals as investment, the contribution of these components to economic growth can be measured.
BEA already includes some intangible assets as fixed investment, notably software development and mineral exploration. The new expenditures for R&D and for entertainment, literary, and artistic originals will be grouped with expenditures for software into a new investment category called “intellectual property products.”
Pension Plans
BEA will also improve the way we count defined benefit pension plans in the GDP accounts.
Unlike defined contribution plans like 401(k)s, defined benefit pension plans provide a benefit to employees based on factors such as length of service and salary history.
Employers provide these promised benefits to employees through a pension fund. Employers, and in some cases employees, make cash contributions to the fund. In addition, the fund holds financial assets, earns income and capital gains on those assets, and pays out benefits to retirees and beneficiaries.
On July 31, we will switch from a cash accounting method to an accrual accounting method to measure the transactions of defined benefit pension plans. That means we will count the benefits as employees earn them, rather than when employers actually make cash payments to pension plans.
Accrual accounting better reflects the retirement benefits an employee earns while working and improves our measures of compensation by more closely aligning the accrual of retirement benefits with the employee’s work. Accrual accounting is also consistent with business accounting standards, and the SNA recommends that countries adopt this accounting method.
The problem with the current cash accounting approach is that employers sometimes make sporadic cash contributions to the pension funds. This results in volatility in BEA’s measure of compensation that does not accurately reflect the relatively smooth manner in which benefits are earned by the employee.
The new measures for pension income and the expanded coverage of intellectual property are two of the major changes BEA is making to how we measure GDP. To find out more, visit our Web page on the comprehensive revision to GDP.