Intangibles, Innovation & Growth; Theory and Evidence Jonathan Haskel Imperial College Business School, Imperial College London COINVEST Sofia seminar, July 2010 COINVEST is a European Commission Framework 7 project funded under the Socio-economic Sciences and Humanities theme:

Objective: better understanding of growth and innovation What drives growth and innovation? –Henry Ford economy: machines = “tangible capital” –iPhone economy: knowledge = “intangible capital” What “intangible capital” is behind the iPhone? –Some R&D –But also: design, software, marketing, business organisation etc. So what has COINVEST done? –Measured wider set of intangible assets across 7 countries for the market sector –Integrated such measures with National Accounts –Calculated effects of intangible investment on productivity and growth –Backed with micro studies To understand why this is new, some history behind intangible studies Innovation for the iPhone era: summary of COINVEST project

The intangibles agenda What drives growth? –Using more of existing factors = factor accumulation –Using existing factors better or developing new ones = new ideas = innovation Traditional approach –Account for output by Factor accumulation: in practice tangible factors Labour quality Innovation = the residual: that is, the increase in output that cannot be explained by increases in tangible inputs

The intangibles agenda, 2 Strength of growth accounting framework –Conditional on assumptions, consistent account of growth –Linked with core economic and national accounting measures, e.g. GDP –Link with economic theory means provides framework for evaluating where private and social returns differ = policy framework –Very successful in understanding the ICT revolution Weakness of framework –Relies on strong (?) assumptions –Measurement issues formidable –Account of innovation in the traditional approach (output, tangible capital, labour quality) not strong: Has to be freely available knowledge Policy makers and non-economists find residual approach unsatisfactory

The intangibles agenda, 3 Dissatisfaction with the residual moved innovation focus to –Patents –Innovation surveys and innovation indicators –Innovation scoreboards Growth accounting focus became –IT revolution –R&D Innovation literature became rather disparate… Many IT papers very much in growth accounting framework –Backed by theory, strong measurement focus: core questions (did IT earn normal market returns?) Much other innovation work –Patents work v detailed but Subset of innovation Citations data noisy Changes in registration methods affect time series –Innovation survey work wider than just R&D, but Disconnected with other measures e.g. problems with time series Hanging over this is feeling that innovation process has changed –Strongly related to IT, but broader e.g. organisational change –User innovation –Open innovation: companies innovating without patents –Innovative sectors are retailing, banking, airlines

The intangibles agenda, 4 The Corrado, Hulten, Sichel approach: extend the boundaries of growth accounting to more intangible assets besides R&D –Software –Innovative property R&D Design Financial services product development –Economic competencies Marketing Training Firm organisational capital Timely because –Fits with idea that innovation is more than just a residual –Fits the ICT revolution intuition that implementing ICT needs co- investment in branding, new organisations etc. –Keeps the discipline of outputs and inputs –Fits with the broader innovation idea…

Innovation in the modern era The iPhone: –R&D and patents. But: –Software, Design, Marketing and reputation, Low cost airlines –No R&D, no patents. But: –Software, branding, business process Financial services –No R&D, no patents. But: –Non R&D product development, software, branding, business process, training

Intangibles: some strengths Intangibles framework passes tests of –these innovations in the framework, including spillovers (important in banking and airlines) –Integrated with price and quantity systems –Can evaluate policies e.g. policy suggestion tax credit for software? –Helps with Europe2020 measurement ambitions

Intangibles: more data needed on: Intangibles framework needs assumptions on: –List of assets and how to measure their spending Most existing surveys not set up to measure We think own-account very important so needs detailed questionnaires e.g. time allocation in OECD software method –Intangible asset and user cost deflators Intangibles often not traded, no observable asset or user cost prices –Incorporation into growth accounting Needs assumptions on depreciation and competition

Intangibles: the to do list Micro questionnaires –New ONS questionnaire, extends R&D survey (slides below) Intangible depreciation –Evidence from new ONS questionnaire (slides below) Intangible asset prices –New work on inferring intangible prices from downstream industries (joint work in progress with Carol Corrado and Peter Goodridge) Policy analysis (slides below) –Do intangibles close the productivity gap? –The role of public sector R&D –Cross country studies of policy indicators and intangibles

Some results Some macro results –Investment in intangibles –Effects on growth –Cross-country comparisons Some micro results –New questionaires

Tangible and Intangible Investment, 2006 (% market sector GDP, COINVEST + other countries)

Investment by intangible asset (share in GDP, 2005 selected countries)

Growth accounting (selected countries, )

Source: Hao et al. (2009) for Germany, France, Italy and Spain; CHS (2009) for the US, Marrano et al. (2009) for the UK, Jalava et al. (2007) for Finland, Fukao et al. (2009) for Japan, Edquist (2009) for Sweden, Van Rooijen- Horsten et al. (2008) for the Netherlands and Barnes and McClure (2009) for Australia. GDP per capita is from the Total Economy Database of The Conference Board.

Source: Hao et al. (2009) for Germany, France, Italy and Spain; CHS (2009) for the US, Marrano et al. (2009) for the UK, Jalava et al. (2007) for Finland, Fukao et al. (2009) for Japan, Edquist (2009) for Sweden, Van Rooijen-Horsten et al. (2008) for the Netherlands and Barnes and McClure (2009) for Australia. R&D as a share of governmetn budget is from Eurostat.

Development of micro evidence Main micro data on intangible investment –Software (purchased) from purchase inquiries –R&D from R&D surveys We want to be broader than this –EU innovation surveys Some ask intangible spending questions But mostly poorly drafted and answered –UK effort: to extend the UK R&D survey

UK Intangible Investment Survey Survey –Conducted by ONS in October 2009 –Voluntary postal survey of 2,004 UK companies with ten or more employees across the production and service sectors. Response rate 42% –Stratified by industry and employment –Linkable via business register Questions –Firms’ spending on main intangible assets: R&D, software, training, branding, design, organisation or business process improvement Own account and Bought in –Life lengths Priorities –Ask for own account data –Linked to business register

Layout of questionnaire Assets divided into sections

Each section has a filter question which defines the asset with examples

Then asks purchased and own- account

Finally life lengths

% of respondent firms conducting intangible investment by asset category Confirms: non-R&D intangible spending is much more widespread than R&D spend

Total expenditure by category (£m), weighted to give estimates of UK totals Observe importance of in-house spending

Average benefit lives by asset (years) Findings –All are > 1 year –If we include time to development and implement, R&D is longer

Summary Intangible investments are structured way of thinking about growth and innovation Becoming part of measurement systems anyway –Software treated as investment –R&D to be so treated Need new questionnaires: some being developed

Spares

Thursday, September 17, Is knowledge becoming more “important” in the Economy? Computers, iPods, etc. it feels like it! Can we be more precise? How do we think about growth? Proximate causes and ultimate causes Proximate: Ryanair. Machines and workers. How do you get more? Either: Duplicate: more planes, more crew. Innovate: more ideas So proximate drivers of growth are: More capital (planes) More labour (crew, check in) More ideas (fast boarding, arranging rostering) Ultimate drivers are determinants of these Corruption and appropriation Schooling investment etc. Accounting for knowledge in growth

Thursday, September 17, Measurement We need to measure the contribution of the quality adjusted stock of capital and labour Capital: computers, better planes Labour: better educated Measuring ideas is very hard. So do this as a residual i.e. Ideas contribution = output growth minus labour and capital input growth OR: output growth = contribution of labour and capital input growth + ideas contribution (total factor productivity) How much are these relative contributions? Start by looking at developing countries So, what drives growth? Capital, labour, ideas?

Thursday, September 17, How exactly do we do the calculation? Growth accounting Start with a very stylised model of production Features breaks out contribution of ideas, labour, capital diminishing marginal returns constant returns to scale Easy form for growth rates (changes in ln) Output = TFP  Capital Stock a  Labor Hours (1-a) % ch in output = % change in TFP + a*(% change in Capital Stock) +(1-a)*(% change in Labor Hours)

Three sector model Lesson: a. GDP rises b. international productivity comparisons change

Sources of growth with intangibles Excluding intang: Including intang: Lessons: a. productivity growth changes b. TFPG changes c. “innovation” changes