When investment becomes consumption

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. Michael Mandel, Chief Economist Business Week

The siren's song of the new economy, which I had thought silenced by the partial deflation of the Tech Bubble, can still be heard while reading the pages of Business Week. According to their Chief Economist, Michael Mandel, the Economy is a lot stronger than you think, because "we're becoming a more knowledge based economy" but not accounting for the knowledge based investment. I wonder what people used to do 100 years ago, without knowledge or ideas or any of those new fangled contraptions we recently invented.

To be fair to Mr. Mandel, back before I came to believe in history, I too found new economy theories seductive. The idea that man is much smarter now than he was before is, after all, a seductive idea. The idea that I am smarter or better looking than my neighbor is equally seductive. Unfortunately, just because an idea makes one feel good does not mean it is true, indeed, these are the ideas about which, I feel, one should be most skeptical.

The primary mistake, in my view, of the new economists, is to fall into Fukayma's End of History trap - to think that man has made some great evolutionary leap forward in the current generation. This, by the way, is a very old idea. Once one takes this assumption as dogma, one can deduce all sorts of, what I believe to be, silly ideas.

Some of you might be wondering what I mean by coming to believe in history - surely everyone believes in history? Maybe I'm the exception but I don't think I did, although I could answer an assortment of questions on the topic.

There is a difference, I believe, between the ability to regurgitate "1776" when asked for the date of the signing of the Declaration of Independence and imagining the reality of a bunch of guys, quite similar to you or I in most respects, boldly signing a document of radical ideas at risk of life and liberty.

To believe in history is to come to the view that Thomas Jefferson and George Washington (and Julius Caesar and Cicero for that matter) were just as real as Tiger Woods or President Bush. I choose the two current era examples to pick people of whom many would know and yet with whom few have met, similar to the historical examples. Just like the President and Mr. Woods, Jefferson, Washington and Cicero ate, slept, loved, lost, laughed, cried and thought. They lived, just as we live, in the same material universe. They used their ideas, just as we do, to carve out a life in this world.

To believe in history is to put flesh on the bones of the historical record, if you will. To believe in history is to imagine minds capable of writing, reading and understanding Shakespeare (or Sophocles for that matter) long before you or I or our parents even walked the earth. Once you do that, I argue, the new economy arguments will be seen in a new light. Let's revisit the opening excerpt:

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.

Is Mr. Mandel arguing that the US was not a knowledge based economy until just recently? Is the US only now generating cool, game changing ideas? Let me throw out a few names and let's imagine they are not merely the answers to game show trivia questions but real people, Thomas Edison, Nicola Tesla, Marie Curie, and Henry Bessemer. I think light bulbs, alternating current, radium and cheap steel were pretty cool, game changing ideas, certainly the historical record describes them as such.

This brings us to the crux of the matter, the practical effects. Inadequate accounting for knowledge based, as opposed to physical capital, investment is the basis of Mr. Mandel's argument
that the economy is stronger than we think. Yet, investment per se, doesn't drive the economy over the long term, rather it is investment that produces returns.

If, instead of assuming that modern man is inherently more clever than his ancestors, Mr. Mandel had put some flesh on the bones of his own idea, he might not be so sanguine about the future. To wit, let's grant that the BEA doesn't count billions of dollars of "knowledge based" investment. The BEA does, however, count profits. To the extent profits or returns are counted with reasonable accuracy, but investment is undercounted by a large margin, then return on investment in this country is far lower than we thought. You know, he might be on to something after all.

In the end all of this spending on intangibles might end up being just that. Investment that generates no returns is just consumption, just ask any owners of the now defunct "B to B" companies.