1. 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

2. 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”

3. 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

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

5. 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

6. 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

7. The iPod Current method –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

8. How does the iPod show up in (US) National Accounts? iPod: 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 iPod: 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

9. 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

10. Questions we can answer 1.Is investment increasingly in know assets? 2.Is GDP or GDP growth understated? 3.What has happened to investment? 4.What has happened to the capital share? 5.What has happened to Y/L growth? 6.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?

11. 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 90s acceleration similar) –TFP growth has accelerated, but less TFP growth than before Giorgio Morrano, Haskel, Wallis for UK Van Ark, Manole, Hao forEU countries

12. 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

13. Summary of results Innovation accounting –1997: Tang invest = £81bn, knwlg invest = £76bn –2005: Tang invest = £96bn, knwlg invest = £117bn 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 = 0.75pppa

14. Algebra of including intangibles Excluding intang: Including intang:

15. 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

16. 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

17. 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 BofEng, to wages)

18. 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

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

20. 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)

21. A. Computerized information

22. B. Scientific and creative property

23. C. Economic competencies

24. Industries

25. Tan and intang invest by ind

26. Intan investment by type (% total)

27. Intan investment by ind (% indVA)

28. Mkt sector intang invest, by asset type

29. Decomposition of ALP

30. Innovation index

31. Future work: extended survey

32. 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’

33. Extra slides

34. GHW Results for 2004

35. Intangible investment by asset type, % of MGVA UK US

36. Invest share of MGVA US UK

37. LPG and TFPG Existing National AccountsIncluding all intangibles

38. Spares

39. Output concepts in the National Accounts

40. Output with different treatment of intangibles

41. Treatment of intangibles in national accounts

42. 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

43. 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 capital 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

44. 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

45. 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

46. 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