Digital advancement means we're measuring the economy wrong

When accountants work out how much UK business is investing in the future, it's stuck in a world of depreciated assets – ignoring the huge changes brought about by cloud and software as a service

It’s a favoured cliché of business that you can only manage what you measure. While entirely true and obvious, this does gloss over the point that how you measure matters as much as what you measure.

Furthermore, you have to understand the details yourself – that is, understand what it is that you are measuring rather than what it is you might think you are.

For example, current national accounting – GDP, investment, etc – entirely misses the effect of cloud computing or software as a service (SaaS), for example. Given the size of the sector and its importance in the tech world, that’s rather a large hole in more general understanding of events.

All of which brings us to something that Friedrich Hayek said. His Nobel lecture, “The pretence of knowledge”, had the underlying point that any central group or body can never have enough information to be able to manage the economy in any detail.

His conclusion is to just get the general setup right and then leave well alone. We can savour this point with a specific example from the computing industry of today.

Business investment

The Times tells us there are worries about the level of business investment in the UK. The UK only spends 14.6% of GDP on business investment, the lowest in the Organisation for Economic Cooperation and Development (OECD). Even Greece spends more than us, at 15.8%. This is a terror, it seems, and something must be done.

Think about this: GDP is the output, and investment is the input. If we’re gaining a higher output for less input, then we’re being more efficient and more productive, which doesn’t sound like something to worry about. But perhaps that’s not enough.

Another idea might be that we’re a more mature – much the same as saying we’re a richer – society. China, for example, has investment up at 40% and 50% of GDP. However, China is building a society beyond the rural environment for the first time in centuries. It’s great that it’s doing so, but doing in 30 years what took the UK 300 years is going to require heavy investment.

In 1978, China had roughly the same GDP per capita (after accounting for inflation) as England did in 1600. Now it’s at about 1955 to 1960 levels for the UK. You’ve got to spend an awful lot on investing to gain such growth. So, it’s not necessarily true that a lower investment-to-GDP ratio is a bad thing.

But on to Hayek’s point. We don’t know that this low UK investment number is correct – in fact, we can prove that it isn’t.

To change statistics slightly, business software investment for the UK is some 1.8 % of GDP. It’s not changed all that much in recent years, which is odd because we’re in the middle of a technological revolution. We just can’t see it in the GDP numbers, as at least one Nobel Laureate, Bob Solow, has been pointing it out for decades.

Beyond the 12-month barrier

But what’s our definition of investment? In GDP accounting, things that are depreciated are investments, things that aren’t are not – at which point the computer industry could tell the economists a few things.

Consider, for example, Microsoft Windows. It was common to purchase multiyear user licences to cover a site or a number of seats. It is more common now to be paying a subscription on a monthly or even annual basis. But see what has happened? We’ve moved our software expenditure beyond the 12-month barrier.

If you trap a friendly accountant, or tie down an unfriendly one, they’ll explain the 12-month importance. Something that the business buys, which will then be used for more than a year, we depreciate that in the corporate accounts.

At the end of year one, we know it still has some value and use, therefore we don’t say it’s worth nothing. It has lost some of its value and depreciated, but not all of such value that we’ve paid for. Something that will be used up in the year of purchase is written off immediately. Pencils are current, same-year spending – mainframes are investment.

This is where we derive our business investment numbers for GDP. We add up the stuff that companies have bought that they’re then going to depreciate. That’s how we arrive at our total national number.

So perhaps Windows wasn’t the right example – Office, then? Moving from a multiyear licence to an Office 365 subscription moves the spending from investment to current spending. With cloud computing, we’re no longer buying a server, warehouse, connections, that we then depreciate. We’re renting them by the hour as we use them. 

As for software as a service, the entire point of SaaS is that we’re not investing, we’re simply paying for what we want when we want it. It all becomes current spending.

Now think back to that figure of 1.8% of GDP. In the UK’s current GDP of perhaps £2tn that’s around £36bn. The size of the UK’s SaaS market is larger than that – especially once you add in cloud computing.

So our national accounts are saying that business software investment is one number, and yet this technological change over to “buy it as you need it” means that we’re spending perhaps double this amount.

Suddenly Hayek’s point has more of a meaning – we’re not measuring what we think we’re measuring. We’re using business investment as a proxy for how asking much is business spending on the future, but we’re doing so by measuring what business depreciates. This isn’t the same thing and technological change is making it less useful as a proxy.

The more we move to the latest technological stage – which is point of our investing in anything as this is what increases productivity – the less accurate our measure of how much we’re doing to greet that brave new dawn. becomes

It’s not necessary to go on to believe in Hayek’s laissez-faire world. But it is useful to recognise that the way we measure the current state of the world we’re trying to manage is becoming increasingly inaccurate. And it’s doing so precisely because of the manner that technology is changing.

This is amusing in a way, because the thing that we’re trying to measure is how much effort we’re putting into advancing the technology that we’re using, which is also the very thing in which the advance is causing the error.

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