Knowledge Goods Matter to Economic Growth, But When Will Policy Catch-Up?

Knowledge goods and services drive innovation and economic growth. Robert Solow, Gary Becker, Paul Romer, and other scholars have provided important contributions to these areas of study. The outputs of exceedingly productive industries—ones that rely heavily on knowledge, human capital, and intellectual property—are the most valuable assets to increase standards of living and levels of economic development.  The latest report from McKinsey’s Global Institute brings the evaluation of knowledge goods, services, and human capital to a global scale. The report quantifies—in totality—the network of global trade, flows of commerce, and people in the digital age across 195 countries:

Flows of goods, services, and finance reached $26 trillion in 2012, or 36 percent of global GDP, 1.5 times the level in 1990. Now, one in three goods crosses national borders, and more than one-third of financial investments are international transactions. In the next decade, global flows could triple, powered by rising prosperity and participation in the emerging world and by the spread of the Internet and digital technologies. Our scenarios show that global flows could reach $54 trillion to $85 trillion by 2025, more than double or triple their current scale. 

Those are some nice, big numbers. Aside from the composite figures, Neil Irwin at The New York Times makes a particularly compelling point about the McKinsey study:

Economists have a habit of looking at the world in terms of aggregates. The trade deficit numbers that the United States government releases each month treat an American company buying engineering services from a French consulting firm the same as it does an American buying a bottle of French wine. But the impact on the economy and society is very different — the wine represents a story of simple commercial transactions in which people in one country buy goods and services from people in another. But it is those complex, long-lasting and knowledge-intensive forms of international connection that are increasing the fastest. 

Exactly. Much like how Wall Streets analysts tend to favor valuing company performance based on quarterly returns, economists (and politicians) live for quarterly GDP and monthly employment reports. Of course, these reports are important barometers of economic performance. But it’s important to see the forest from the trees. Evaluating the economy’s performance over a few reports can lead to oversights in the important structural changes taking place in the broader economy.

For example, McKinsey’s report finds that trade in knowledge-intensive goods such as aerospace and pharmaceuticals increased nearly 8 percent annually from 2002-2012, in contrast to 6 percent for both capital-intensive but lower-tech goods. Labor-intensive goods see lower growth rates than those products. Similarly, our previous research estimated the contribution of IP-intensive industries (those that spend greater than the national average on R&D per employee) to previous U.S. FTAs. These FTAs boosted manufacturing exports in IP-intensive industries by 10.9 percent (pharmaceuticals and medicines by 15 percent), compared to an average of 7.3 percent in all industries and just 3 percent in non-IP-intensive industries. These figures alone make you wonder why there should be question over whether we pass the Trans-Pacific Partnership or the Trans-Atlantic Trade and Investment Partnership.

The knowledge-intensive industries highly touted and covered in the McKinsey report rely heavily on R&D expenditures and human capital as the principal inputs for innovation-driven growth. Our policy goals in education, innovation funding, tax, and trade must align with these economic strengths and positive growth areas of our economy.