Don't Look a $400 Billion Gift Horse in the Mouth

…unless you live in Troy

Well into its adolescence or awkward 20-somethings, the Knowledge Economy just got its birth certificate of sorts.  To a rather fumbling thud, the Bureau of Economic Analysis (BEA) decided to include research and development into the calculation of GDP in their March 2013 Comprehensive Revision of the National Income and Product Accounts reported this past week.  This nearly 3% upward revision comes at a time when the economic headwinds of sequestration - notably the shrinkage of the defense sector - is placing considerable and growing drag on the economy.  If timing is everything, than the BEA's announcement is nothing.

Now to be clear, the headline value of this week's announcement is two decades late but still important.  The fact that we've failed to account for the engine of economic expansion - the genuine innovation of products and services that have marked the past expansion cycles - is moronic.  The fact that economists officially have waited until 2013 to decide that their 1805 GAAP Accounting logic derived from France has failed to describe our economic condition is an indictment on academic and professional economists and their comprehensive anticipatory ineptitude.  While they can precisely describe partial past conditions that conform to their limited assumptions with better than random accuracy, they have failed entirely in their ability to anticipate or respond to forward-looking considerations and risks.

There's no small bit of trouble with the BEA's late arrival into modernity.  Research and development is expensed under GAAP accounting into oblivion.  In taxation, the nuance of the In-Process Research and Experimentation Tax Credit (the IRS' most abused tax shelter that it is "incapable" of policing) is the subject of billions of dollars of tax fraud each year.  Politically desirable as the pork that every good Congressional representative can bring home to the district, this $76 billion dollar loop-hole doesn't support economic expansion.  Rather it shrinks legitimate tax collection and defrauds the taxpayer for the benefit of abusing corporations and their interest holders.  In banking, Fed Chairman Ben Bernanke is "not aware" of the use of intangibles (the by-product of research and development) as collateral despite the Federal Reserve's own 2007 report in which they estimated that there are over $3 trillion in borrower assets that are not counted in bank collateral assessments.  In short, we can have our little welcome to the Brave New World economics party but, beware.

I hate to break some news to you but I'm the Cassandra to the BEA's Trojan Horse.  And if you don't know this metaphor, go back and read the account of the fall of Troy.  Cursed by Apollo with the "gift" of prophecy, this daughter of King Priam knew that the horse left by the Greeks was the harbinger of the downfall of Troy but her warnings were unheeded.  In the U.S., we'd scarcely recognize research and development if it were a snake biting our face.  Since the 1970's we've used R&D as a mechanism to flow federal and state support to universities due to our social apathy towards funding education; we've inefficiently underwritten R&D to accommodate state-sponsored enterprise through our statutory agencies; and, we've built a highly inefficient corporate tax regime that allows venture capital to pour cash into enterprises and harvest tax losses in over 80% of the failed endeavors.  Real R&D - the stuff that actually makes the world a better place; that brings new products and services to the world - is endangered on the best of days and bordering on extinction.  Basic research - the kind that made solid rocket fuel, that suspended magnetic signals in tape, that figured out dyes on fabric, that understood the chemistry of the elements that describe our world - is barely present.  While we nuance the edges of consumer electronics to jam more video processing into smaller devices so that we can have a virtual world, the real world is more illusive today than it was 100 years ago.  

                                                                                                     

The social schemes of Natural Philosophy enabled a world of inquiry and debate.  Great societies learned how to disagree with reasoned arguments using more than 140 characters to communicate a thought.  Hash tags and contractions did not navigate the oceans or plumb the depths of space.  In our make-believe world, we pretend that Boston's carnage was a new phenomenon.  How quickly we forget Northern Ireland, Spain, and Germany!  Within my lifetime, terror hasn't emerged on the scene.  In point of fact, it is the innovation of the marketing of terror which has been refined to an art form!  London wasn't safer because of police action.  London became safer because the citizens of London were unwilling to be cowed by terror and reopened pubs and restaurants in the face of carnage.  New York didn't become safer because of end of violence - it became safer by a public that would not relent to the dereliction of the city in the 70s and 80s.  See, even when it comes to social innovation, we're innovating less today than just 30 years ago.  And when it comes to that $400 billion - it gets really messy.

Our R&D and "innovation" in the majority are proxies for legal costs and capital markets inefficiencies.  When Apple and Google buy "innovation" from Nortel or Motorola, they're not making new products.  They're making sure that extortionists cannot hold them hostage in patent lawsuits.  When a government contractor selling satellites misrepresents their ownership of technology and falsifies an indemnity for this lie, it is the government and the taxpayer that loses.  Our GDP, buoyed by innovation risk management does not grow our economy - it memorializes our demise.

 

Equo ne credite, Teucri. Quidquid id est, timeo Danaos et dona ferentes. 

Virgil's Aeneid, Book II.

We the People should count innovation and celebrate the inquiry into the unknown, undeciphered, and forgotten.  We should not mislabel our litigious and capital inefficiencies as innovation.