Friday, 8 February 2013

Can Intangible Investment Explain the UK Productivity Puzzle?

We have a new paper on this. An outline is below and the paper is available from here.  A comment on the interesting post by Hugh Small is below.

Here's the puzzle.

Between 2007 and 2009 UK market sector value added fell by 5.8%. Hours worked fell by 1.9%% and hence productivity fell by 3.9%.

In 2009, hours started to grow again, but output has grown very slowly. Between 2011 and 2012Q3, the latest period for which market sector data are available, hours have grown by 2.3% but market sector value added by 1.3%. Hence productivity has fallen by 1%. Why?

The explanation for the initial fall in productivity is labour hoarding. This seems reasonable.  Firms cut output but keep labour in reserve for the recovery. Productivity, output per worker, falls at first, but then recovers as the firm uses the reserve inputs.

This explanation seems to carry less and less weight for the post 2008 years, for it seems very unlikely that firms are still carrying underutilised workers four years on.  So it must be something else.
 
In this paper we thus examine the role of intangibles. Our starting point is the observation that whilst investment in tangibles, plant/vehicles/buildings has fallen and stayed low, a point perhaps not noticed is that investment in intangibles, specifically R&D and software has risen since the recession (software fell and has then been rising, R&D was flat and then rose). Consider then a firm who has reduced production but maintained investment in intangibles. Its skill level rises, since intangible investment typically requires high qualified workers. Its measured output falls, since the output of e.g. R&D projects might not manifest itself for a few years. Thus labour productivity falls, in a pattern that looks just like labour hoarding.

We also investigate some other mechanisms on TFP, see the paper.  But what do we find on labour productivity?

Our main findings are:
  1. Because intangible investment has been growing but is not counted as value added, measured value added is understated.
  2. In fact, market sector real value added growth since the start of 2011, at 1.3%, is understated by 1.1% (about 0.5%pa);
  3. In terms of the labour productivity puzzle then, true value added is growing faster than measured, 2.4% rather then 1.3%, and since hours growth has been 2.3% over this period, productivity has not been -1% but +0.1%. 
  4. Thus we believe that unmeasured intangibles are part of the explanation, but not all of it. 

For convenience, here is the key diagram on the different behaviour of intangibles and tangibles over the recession


Source: figure 3 of  Goodridge, Haskel and Wallis, 2013, paper available from here.


Hugh Small in an interesting post of Feb 1st 2013, has essentially advanced the same argument.  He correctly points out that the intangible investment is high fraction of GDP and that it is not measured.  He shows some data from the World Bank, on the fraction of GDP accounted for by intangible investment.  I am more familiar with our European project data that can be downloaded for free from www.intan-invest.net with a paper describing it here Corrado, Carol; Jonathan Haskel, Cecilia Jona-Lasinio and Massimiliano Iommi, (2012), "Intangible Capital and Growth in Advanced Economies: Measurement Methods and Comparative Results" Working Paper, June, available at http://www.intan-invest.net.  Figure 5 of that paper shows the fraction of GDP accounted for by the intangible investment we measure (software, R&D, design, investment in artistic originals, branding, training and business process engineering):



There are two points to note.  First, some of this investment is already counted in GDP, notably software with R&D to follow soon.  Second, whilst this is a potential effect on GDP levels, the effect on GDP growth is different. As set out in our paper, the addition to the growth of value added is the growth in real intangible investment (not in GDP) over and above real value added growth, times the share of that investment in overall GDP. That share is about 10%, real intangibles are growing faster than GDP by about 5% and hence the undermeasurement of real GDP is 0.5%.  (0.10 times 0.05). 

So I hope that this piece advances the points made by Small and is a contribution to the understanding of the puzzle.  My conclusion: it's not going to be one big thing, but a string of little things that will add up: Zombie firms for example are likely part of the puzzle too.


28 comments:

  1. Intangible fixed assets are usually capitalised in financial accounts and hence this expenditure should show up in investment.

    Since GDP = C + I + G + (X-M), it is hard to see the exclusion of intangible as a cause of the productivity puzzle.

    ReplyDelete
    Replies
    1. In many companies, intangible investments are written off immediately, partly due to accounting conservatism (will they really be worth anything?) and partly for tax reasons. I think this will increasingly change as intangibles become a higher share of total investment and valuation methods become more established, but my anecdotal experience is that it currently happens more often than not.

      Delete
    2. thanks for the interest. as companies become more like Google and less like Ford, I think these conventions need to change!

      Delete
  2. Sounds like a good partial explanation. I'd be curious whether the increasing tax incentives for R&D expenditure have resulted in a reclassification of borderline activities into R&D (as well as the genuine increase in R&D spending that we'd expect). Certainly there are a number of accounting firms going around showing companies how to do this...in exchange of course for a "reasonable" share of the tax benefit gained.

    This reclassification doesn't in itself have any effect on value added, but it might slightly reduce the size of the effect you've discovered in the paper, to the extent that claimed R&D investment is not true investment. How much of an impact this would have depends on the data source for the investment figures - BERD for example is a survey measure not directly based on tax claims, but one can certainly imagine that firms would respond to the survey in such a way as to remain consistent with the tax claim they had made. In any case, this caveat is probably a small one and I am sure you're right that intangible investment helps explain this puzzle.

    ReplyDelete
  3. Doesn't really explain why productivity in the UK specifically is falling. Investment in intangibles surely isn't unique to the UK.

    ReplyDelete
    Replies
    1. ONS says that the 'productivity puzzle' is visible in other EU States but in UK it is more pronounced. Possible explanation: UK private sector is smarter, knows that intangible investments not measured by GDP have high returns.

      Delete
    2. Agreed, next paper is too look across Europe! Thanks for your interest, BTW, we do everything in terms of hours so hope to control for the increase in part time work that you have written about. (insofar as hours are well measured of course). many thanks for your interest, Jonathan

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  4. Living in the South Midlands, this feels sort of right.

    Car production in mass car plants is struggling. Small scale production of luxury cars; aston-martin, jaguar, etc, is doing ok.

    Designers, draftsman, etc, are in strong demand, designing cars that will be built in China, Malaysia, etc.

    ReplyDelete
  5. Dear prof. Haskel,
    could it be a possible explanation the increse in regulation and burocracy imposed by public authorities but also by internal controls? I see so much of my time at work wasted in filling forms, reports and tons of paper that for sure cannot add any value save for paper factories. Cheers,

    Riccardo.
    Milan, Italy

    ReplyDelete
    Replies
    1. Dear Riccardo, thanks, and sorry for the long delay, I have been away. That increase would certainly lower productivity, but we don't measure it. Yours, Jonathan

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  7. This is an interesting topic.

    Value added is, operationally at least, sales less the bought-in revenue costs of materials and services from outside suppliers.

    A number of implications flow from this definition:

    1. There must be a sale for Gross Value Added to arise. Hence self-constructed assets, whether tangible or intangible, should not be measured in GVA, at least according to the definition.

    2. If self-constructed fixed assets are treated as revenue expenditure then GVA may be understated only by the bought-in material cost in the self-constructed asset. The labour component in the asset, which is likely to be large in intangibles, will have no effect on the GVA measurement. So the effect on GVA if immediate write off is used is likely to be small.

    3. If self-constructed fixed assets are treated as capital expenditure then GVA, using the definition, GVA does not arise - without a sale to another firm there can be no GVA

    4. If a firm producing capital goods sells to another UK firm, whether intangible or tangible, then GVA does arise provided the buying firm capitalises the purchasee. In my view, such assets should be capitalised and I am not persuaded that immediate write off is the norm, even when prudence is applied. Assuming that capital purchases, whether of tangible or intangible assets, are capitalised and are so treated in the national accounts, then the growth in traded inntangibles can not account for the productivity puzzle

    5. If a firm producing capital goods sells to another UK firm then the transaction will not be counted in GVA if the buying firm writes it off immediately as revenue expenditure. Instead it will be cancelled as intermediate consumption on consolidation in the national accounts. Immediate write off a purchased fixed asset is generally not permitted by accounting standards (even if intangible). I would hope ONS would detect and unpick such erroneous accounting treatment when it assembles the national accounts.

    In short, I am not persuaded that the growth in intangibles accounts for much of the productivity puzzle. I am also wary that challenging the accuracy of the numerator in the productivity calculation. ie GDP, may suit some political agendas.

    ReplyDelete
    Replies
    1. PaintingWithNumbers (above) says that 'there must be a sale for gross value added to arise'. If that were true then the international bodies have made a mistake in deciding to include R&D in GDP expenditure as fixed asset creation from 2014. Going to PWN's last sentence, this decision can only be explained by a consensus that the numerator is wrong, because R&D has been significant for a while. Challenging or defending the numerator will certainly suit political agendas, and that fact it is reassuring evidence that policy is sometimes based on numbers.

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    2. @Hugh

      But R & D (usually) has no market value, so where is the GVA?

      I am not against counting such items in GVA. My point is that doing so breaches the definition of GVA.

      I believe China already counts self-constructed assets in GVA. It treats such expenditure as if a firm sold such an asset to itself.

      I would be very happy to have GVA redefined so that self-constructed fixed assets are included. If this were to happen then I hope it would impact on corporate reporting. A corporate GVA statement along these lines would better assist society to evaluate the role and contribution that companies may (or may not) make to the public good.

      I am all for basing policy on evidence and numbers. The problems start when ideologues try to re-write definitions or manipulate numbers. Restating the recent stagnant GDP figures upwards would almost certainly suit the current government and its acolytes.

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    3. @PNW The restatement upwards described in Prof. Haskel's paper begins before the current government came to power. see www.matureeconomy.org

      Delete
    4. @Hugh

      I know, but the economy was growing then anyway.

      The economy has since stagnated under the current government's watch. Restating upwards, which would show the economy as not stagnating after the election and under the current government's watch, would be politically advantageous to them. This why I am wary

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    5. Yes, you could claim on the basis of the "official" figures that there were green shoots of recovery in 2009/10 which died out out as government policy began to bite leading to 'flatlining' in 2012. There may be lessons about the economy to be drawn from the discrepancy though, and it would be shame if it was just used by parties to beat each other over the head with. BTW your earlier comment about China sounds interesting. Source?

      Delete
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