An Innovation Index Based on Knowledge Capital Investment

An Innovation Index Based on Knowledge Capital Investment: Definition and Results for the UK Market Sector Tony Clayton, Mariela Dal Borgo, Jonathan Haskel j. haskel@ic. ac. uk www. ceriba. org. uk Sheffield, 2008

Popular discussion: the transformation of the economy • The new/knowledge economy – Technology changes • Software, hardware, ICT – Trade changes • Move to knowledge-intensive activities • Rise of the service sector • Innovation as a key economic driver – DIUS “Innovation Nation” White Paper: commission an “innovation index”

Where do we see Innov/New Economy in the macro statistics? • The New Economy – GDP growth: stable – Labour prod growth/TFP growth: stable/slowdown – Investment shares: stable • Innovation – Most think of R&D (input) or TFP (output) – Some innovation-type spending measured and capitalised e. g. software – Most treated as an intermediate • R&D • Apple – Relegated to TFP – Limits what Economists can say about innovation

LPG and TFPG in the UK Note: LPG=Cap deep + human cap deep + TFPG

Our main claim • Innovation and the New Economy – needs better measures of innovative investment – Incorporated into National Accounts • Some new economy is about investment in tangible assets – Computer hardware – Telecoms equipment – Tangible investment: included in GDP • But some about – investment in intangible “knowledge” assets – Broader than R&D • Computerised information: software, databases • Creative property: scientific R&D, non-sci R&D (e. g. design) • Firm competencies: training, branding, organisational capital

Research programme • Settle on list of intangible assets • Measure investment in them • Incorporate into National Accounts so consistent with GDP and explain growth • Hopefully gives – Better GDP measure – Better account of drivers of GDP – Better account of innovation

• Current method The i. Pod – Inputs: Count scientific R&D only. – Output/value added: • No effect by assumption: all R&D used up in a year, no enduring asset created, so only an intermediate • Intangibles approach – Inputs: • Upstream: more than just R&D – Upstream spending also on design, software • Downstream: need associated coinvestment – Marketing, organisational change – Output/value added • Rises: spending is an enduring knowledge asset so its investment • Shows up as innovation spending on intangible assets

How does the i. Pod show up in (US) National Accounts? • i. Pod: Designed in California, made in China • Apple – nominal value added = • Sales – value of imports – (design+marketing+R&D) – (Industry classification may be wholesaler) – Real value added: depends on deflators – Innovation effect of i. Pod: TFP growth if real value added rises • Alternative model – Apple builds knowledge capital asset by investing in R&D but also design, marketing – Real GDP rises with more investment – Innnovation measured by more knowledge investment and (maybe) increased TFPG

Growth and innovation accounting, outline • • 1. Data on invest in intang assets 2. Deflate and build real intang asset stocks 3. Recalculate GDP and factor shares to include intang 4. Build Hall/Jorgenson capital services to add assets together • 5. Build labour quality adjustment • 6. Calculate LPG, capital and labour deepening, TFPG • 7. Innovation – accounting is spending on intang assets – Index is share-weighted knowledge capital growth plus TFPG

Questions we can answer 1. 2. 3. 4. 5. 6. Is investment increasingly in know assets? Is GDP or GDP growth understated? What has happened to investment? What has happened to the capital share? What has happened to Y/L growth? What are the contributions of labour, tangible capital, knowledge/intangible capital and TFP to growth? 7. What does innovation look like 1. What intangible assets are being spend on? 2. What is the contribution to growth?

Other work • Corrado, Hulten and Sichel (CHS) for the US • Findings interesting: – Increasing importance of investment in intangible assets – Y and I/Y understated – Capital share has been rising – Labour prod growth understated (although mid 90 s acceleration similar) – TFP growth has accelerated, but less TFP growth than before • Giorgio Morrano, Haskel, Wallis for UK • Van Ark, Manole, Hao for. EU countries

Results • GHW paper, May 07 – Followed CHS method – Growth a/c for whole market sector • CDH paper, Sept 08 – 6 market sector industries – Improved design data using OECD software methodology

Summary of results • Innovation accounting – 1997: Tang invest = £ 81 bn, knwlg invest = £ 76 bn – 2005: Tang invest = £ 96 bn, knwlg invest = £ 117 bn • Of which R&D = 7%, software = 14%, training = 25% • Innovation index – 2000 -05 mkt sector lab prod. growth= 2. 74 pppa, • Contrib of knowledge capital= 1. 24 pppa. • Contrib of mfring knowledge capital = 0. 75 pppa

Algebra of including intangibles Excluding intang: Including intang:

Details of g a/c method 1. Collect nominal investment in intangibles time series • • • What investment measures? Availability of data over time e. g. training Measures for market sector only: some interp needed 2. Deflate to get real investment series • • Choice of deflator. Use mkt sector deflator Software and hardware: • • Soft: purchased and own account (own a/c pro’y adjust) Hardware

Method contd 3. Build real capital stock using perpetual invent method • • Starting point (1970=0) Depreciation rates: use CHS rates. Experiment. Adjustment for annual data (assumes investment comes on stream in mid-point of year) Assets: – Tang: buildings, plant, vehicles, computers – Intang: see below, main are software, R&D, advertising, training

Method contd 4. Re-calculate market sector GVA to include intangibles • Adjusted Nominal GVA – • Unadjusted nominal m. sector GVA + nominal investment Adjusted Real GVA growth – – Weighted growth in real market sector GVA + weighted growth in real investment Weights are shares of nominal market sector GVA and nominal investment in unadjusted market sector GVA 5. Adjust operating surplus of m. sector GVA – – Adj op surpl =adjusted GVA – m. sector labour compensation Mixed income: allocated prorata (note Bof. Eng, to wages)

Method contd 6. Build Hall/Jorgenson VICS measures • Rental rates and rate of return assume: – equalised rates of return across all assets – rental rates times stock = – Tax adjustment • • Generate VICS for each asset as share of asset in payments in times real asset growth rate Generate economy-wide VICS summing VICS for each asset

Method, contd. 7. Build quality-adjusted labour index • Bof. E index adjusts hours for – Education – Gender – Age 8. Do growth accounting

Types of intangible, details A. Computerized information • Computer software (bought in, own account) • Computer databases B. Scientific and creative property • Science and Eng R&D spending, usually leading to a patent/licence • Mineral exploration (mostly R&D in oil and minerals) • Artistic originals (mostly R&D in creating artistic originals) • Other product development, design, research, usually not leading to a patent/licence (I. e. non-scientific R&D spend) – product devel costs in fin svcs – architect and eng design – R&D in soc sci and humanities C. Economic competencies • Brand equity (to develop reputation capital via branding or trademarks) • Firm-specific human capital • Organizational structure (organisational capital)

A. Computerized information

B. Scientific and creative property

C. Economic competencies

Industries

Tan and intang invest by ind

Intan investment by type (% total)

Intan investment by ind (% ind. VA)

Mkt sector intang invest, by asset type

Decomposition of ALP

Innovation index

Future work: extended survey

Initial feedback from summer pilot • ‘Extended R&D’ survey – Firms understand technical/non-technical innovation input – Important who we talk to, need more than one contact – ‘Boundary of firm’ issues – with MNEs – Some industry differences in approach – Hard areas • Own account organisational capital • Training – including ‘opportunity cost’

Extra slides

GHW Results for 2004

Intangible investment by asset type, % of MGVA UK US

Invest share of MGVA UK US

LPG and TFPG Existing National Accounts Including all intangibles

Spares

Output concepts in the National Accounts

Output with different treatment of intangibles

Treatment of intangibles in national accounts

Should intangibles/knowledge assets be included in investment? • Definition of investment: – Spending today to create an asset that generates income in the future • Examples: – R&D: creates scientific knowledge stock, future returns – Software: creates computerised knowledge, future returns – Training: creates knowledge in workforce, future returns

Practical problems • Definitions: do intangibles generate an asset for the firm? – Brands, yes – Workforce training, belongs to workers • Measurement of intangible expenditure – Own account/purchased e. g. software – Valuation of intangibles e. g. brand names, organisational capita • How much expenditure is investment? – Advertising: long term brand building versus short term publicity • Redefining national accounts – Intangible investment is income to firms – So labour share of output changes

Our key argument to measure innovation • Imagine an economy with no innovation • How could we get more output? – Lay on another plane and another crew – Deepening physical capital and labour = duplication • How would we get more output from innovation? – Faster boarding, turnaround: better software – Deepening knowledge capital = innovation • Summary: innovation is – extra output over and above that from use of additional physical capital and labour – Or, the extra output from use of new knowledge capital – Implications for measurement • Measure growth in output (GDP), and in inputs: physical capital, knowledge capital, labour • Innovation accounts are data on knowledge investment • Innovation index is contribution of knowledge investment to output growth

What our measure is and is not • Output – output of more goods and services. – Not number of inventions or ideas – GDP as currently measured does not fully capture this • Inputs – knowledge capital • Needs investment e. g. R&D • Comes for free e. g. imitating – knowledge capital investment is more than just R&D • R&D, software, design, firm-funded training, organisational capital • Investment is not just purchases from the “creative inds” since in house too. So covers hidden innovation • Inputs to outputs – Needs assumptions on life lengths of knowledge stock, deflators • Relation to other innovation definitions, see paper

Intangibles and innovation • Axioms – Innovation is the implementation of something new – It needs investment (unless pure spillover) • Consistent framework: accounting for intangibles – Activity • Innovation needs investment in knowledge • Knowledge investment is more than just R&D, the creative industries, an intermediate input • Knowledge investment produces knowledge or “intangible” assets – Impact • Investment raises value added • Service flow from kn assets contributes to growth