How important are intangibles in accounting for productivity growth?

1. I was asked today: if intangible capital deepening slows, is that a big effect on productivity growth?  This is part of a broader question; what's the relative importance of intangible assets in accounting for productivity growth (value added per hour growth)?

2. Growth accounting allows a decompositition of labour productivity growth into the contributions of:  

a. reallocation = workers moving between industries of different productivity levels 

b. labour composition = increased skills, age and experience

c.  ICT capital deepening = increased ICT capital (computers, comms equip) per hour 

d.  NonICT capital deepening = increased NonICT capital (buildings, vehicles, non-ICT plant) per hour 

e.  Intangible capital deepening = increased intangible capital (R&D, software, artistic originals, design, marketing, business process, training) per hour 

f. TFP = increased total factor productivity (what's left over, which increased efficiency plus mismeasurement etc.)

Here are some results from our EUKLEMS-INTANProd database, in hopefully obvious notation.  Countries are US, UK, EU (France, Germany, Spain, Italy, Denmark, Holland, Austria, Sweden, Finland). Industries are all ommiting A (agriculture), OPQ (defence, education, health), B (mining), D-E (gas, electricity, water), F (construction).  All these are not well measured, and/or mostly public sector. 

As the results show, intangible capital deepening is much the most important contributor to labour productivity growth in the 2011-19 period (tangible capital deepening contributions is the sum of ICT and NonICT, which is still lower than the intangible contribution).

Table:  of contributions

 

And a picture

As we saw in a recent blog the employment rights bill will very likely lower intangible investment. That will lower intangible capital deepening, other things equal.  This then is a policy measure lowering the major source of UK productivity growth.  Not a good policy if you want growth to increase. 

What has happened to R* recently?

 The 2025 Brookings Papers conference had a sesssion on this.  

The slides from Lukasz Rachel and the discussants are available. 

The discussant Adrien Auclert makes some very nice points. I picked up on some.

First, the framework.  R* is the price that balances demand for capital for use in production by firms with the supply of savings by consumers.  But terminology is hard here: the savings by consumers causes them to build up wealth, which is in part demand for durable assets (e.g. a house).  So wealth accumulation is asset demand which is capital supply.   And the demand for the use of capital is by firms and governments to produce goods/svcs, and they issue claims on the owernship of such assets e.g. shares (and for government, government debt).  So the value of assets issued by firms and government is asset supply or capital demand.  This is nicely illustrated by his graph which highlights the demand/supply nomenclature 

Thus he talks nicely about forces that raise asset supply which raise r*

And forces that raise asset demand, which lower r* 

He summarises the main finding of the paper as being that asset demand has won

with the main drivers falling productivity, rising aging and rising risk

Here is the prediction for the future

most of these are putting upward pressure on r*, but intangibles are lowering. why? this is because in his model more intangibles offset competition and innovation and so lower productivity.  

Thus we have

1. business as usual, small and gentle fall in r*

2. more productivity growth, r* rises. 

A portrait of UK R&D

 Getting a handle on innovation support is hard with many schemes, funding etc.  Just looking at R&D, here is some data from Cambridge UK Innovation Report, 2025, using the latest 2022 data.

1.  Spending on R&D, excluding tax credits looks like this: where the Sankey diagram nicely shows the potential difference between an intangible asset that can be financed in one area and have the performed investment be in another place: 

(btw, within UKRI are a number of other institutions; research councils (competitive grants allocation, about 50% of the money: innovateUK(working with companies to derisk innovation, catapult centres etc. about 20% of the money).  HEFCE/Research England give out REF-based money to universities.  See here,). 

.  

2.  What does business spend the R&D money on (notice these are products and not industries)?  Notice the massive figure on software development; and notice too the seperate line for computer programming and info services.  The days of R&D being mostly pharma and transport are over. 

3. Finally, notice too that government support for R&D can also be tax credits.  They are much more than direct funding as the below shows:

4. and the figures for tax credits are very large; £7.5bn in 2022-3 "For the 2022–23 tax year, UK businesses claimed a total of £7.5 billion in R&D tax relief support. This figure is more than twice the £2.6 billion of direct support to business R&D provided by the government and UKRI in 2022" 

By size "In terms of R&D tax credit claims by firm size in the UK, in the 2022–23 tax year:[2] • 67% (US$5 billion) were claimed by small and medium enterprises • 33% (£2.5 billion) were claimed by large firms." 

 

Did persisently low interest rates post GFC lower productivity growth?

Many allege that the long run of low interest rates post global financial crisis lowered productivity growth via zombie firms.  These low productivity firms survived more than they should have done and hence productivity growth stalled.  

An alternative view is that low productivity growth, for other reasons, lowered r* and hence interest rates.  

A paper "Aggregate productivity decompositions using structural business surveys: Evidence from the UK by Russell Black, Rebecca Riley and Garry Young", available here sheds a bit of light on this for the UK.

It uses UK company data to decompose productivity growth into that 

a. within surviving companies

b. reallocation of market share between surviving companies

c. the net effect of exit and entry.

One might think that the zombie firms view would say that the net entry/exit effect would be less as fewer low productivity firms exit.  

Their chart shows this isn't the case.

1. Using various different methods the change in the net entry effect, see middle panel is very small, a slight fall.

2. instead, the fall in productivity growth is due more or less equally to falling within firm growth and falling between firm reallocation.  The latter might be a zombie phenominon, but it isn't clearly so.

Update, with some numbers
1. using the Foster. Halitwanger, Krizan decomp, the 5 year interval, 99-07, within effect is 1.95%, net entry 0.22% (total LPG is 1.4).  The same data, 2011-19 are 0.61%, 0.08% (-0.32%).  

2. so the net entry effect has slowed, but it's 8% of the slowdown.  The change in within effects are 80% of the slowdown.

Thinking on the margin, or economic thinking as a system, again

 As we often say in class, economics is about thinking on the margin.  Statement "tobacco taxes rose, but my friend carried on smoking, so economics is rubbish". No.  Your friend might be inframarginal.  It's very likely that for a person on the margin, they will stop smoking.

Another way to say this is that economic thinking is systems thinking. Don't just think about the consequences for your friend, but for the system as a whole.  And the system as a whole will be influenced by marginal smokers. 

Here's an application of that.  

1. The Earned Income Tax Credit subsides workers on a low wage and is much more generous for workers with children.  See the discussion in Leigh, https://docs.iza.org/dp4960.pdf. 

2. What happens when it is introduced? One non-marginal model is to say: well, if more workers with children work, that raises supply and lowers the wage of low paid workers with children.

3. The marginal argument is different.  If the supply of labour rises, then wages will fall for all marginal workers, those with and without children.  

4. what does the paper find? 

"Although the EITC has a much larger effect on the labor force participation of workers with children than those without, the wage effect appears to be similar for workers with and without children. This suggests that what matters is the average EITC rate in a labor market, not an employee’s own EITC rate."

So when someone tells you how beneficial tax credits are, think of the system.  Subsidising firms to pay low wages has systemmatic effects.

Rates of return, net present values and cost-benefit ratios

 1. suppose the government spends £x on some investment, say a road or R&D.  What is the rate of eturn/ 

2. Following some excellent notes from the OBR, we have that the IRR of that spend is the discount rates that solves the equation

 

 that, is the rate of return that sets this number to zero.

3. the Benefit from spending on some investment is more GDP.   That increase in GDP is dY/dK.=alphaY/K where alpha is the elasticity of output with respect to capital.  If Y/K is constant and we imagine spending £1 investment we have 

which says that the IRR is the marginal product of the project less the depreciation rate.  Or, the marginal product of the product is the gross rate of return.