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.