Explaining United Kingdom investment estimates: past, present and future. Jacqui Jones, Louisa Nolan, Andrew Banks, Philip Wales and Darren Morgan

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1 Explaining United Kingdom investment estimates: past, present and future Jacqui Jones, Louisa Nolan, Andrew Banks, Philip Wales and Darren Morgan Section 1: Summary 14 March 2014 The compilation of investment estimates is complex, involving a number of different data sources, methods and processes. As part of its commitment to continuous improvement, the Office for National Statistics (ONS) ensures that sources, methods and processes are regularly reviewed and where appropriate improved, both to maintain the quality of the estimates produced, and to align with international guidance. As part of this continuous improvement programme, new production systems with updated methods for producing investment estimates were introduced in the 2013 United Kingdom (UK) National Accounts (Blue Book 2013). Details of the key methods changes were published in July 2013 and included: Changes to the construction of the current price investment dataset - using assets as the building blocks and processing acquisitions and disposals of capital assets separately. Changes to the apportionment of supply and use balancing adjustments from products to assets. Changes to the construction of the seasonal adjusted chained volume measure investment dataset removing the effects of prices (deflating) using lower level weighted product deflators; deflating and chain linking acquisitions and disposals of capital assets separately; and seasonally adjusting lower level series. In addition to the methods changes, to align with the European System of Accounts 1995 (ESA95), new data sources were included for: 1. investment in artistic originals. 2. the inclusion of an operating surplus mark-up for own-account software. These changes mainly affected the chained volume measures and consequently the underlying estimated price change of investment over the time series. The changes were primarily from: Updating the software deflators from a broad machinery and other equipment deflator to the computer services Services Producer Price Index. Conceptually this is a more appropriate deflator but further analysis is planned. In combination with this, aligned to ESA95, software was reclassified from machinery and other equipment to intangible fixed assets. For total investment between 1997 and 2004, these were the largest contributions to the Blue Book 2013 changes. Updating the dwellings deflator from a general all construction deflator to a specific construction deflator that only included the appropriate dwellings-related prices (new housing, and repair and maintenance), which is conceptually correct for investment in dwellings. For total investment between 2005 and 2013, this was the largest contribution to the Blue Book 2013 changes. Replacing forecasted deflators with actual deflators. For Blue Book 2014 the same methods and processes will be used to compile investment estimates with one exception: the method used to maintain the asset composition post supply and use balancing will be reverted back to the method used in Blue Book This will remove some of the volatility in the series but it should be noted that capital expenditure is by its nature volatile (see Section 6). 1

2 For Blue Book 2014 new data sources and methods will be included to meet the requirements of the European System of Accounts 2010 (ESA10). The key changes are for research and development, weapons and decommissioning (terminal) costs, which are all classified as capital assets in ESA10. Further articles on the impact of ESA10 changes will be published prior to the UK National Accounts publication in September This article is structured as follows: Section 2: Introduction Section 3: Definitions of Gross Fixed Capital Formation (GFCF) and UK business investment Section 4: Process for compiling GFCF and the methods used from Blue Book 2009 to Blue Book This section also highlights the areas that are currently being reviewed and that will be reviewed after Blue Book 2014 Section 5: Impact and explanation of Blue Book 2013 changes Section 6: Blue Book 2013 volatility Section 7: Explanation of the recent weakness in GFCF in comparison with external surveys Section 8: Forthcoming changes for Blue Book 2014 For further information on this article please contact: Section 2: Introduction UK investment estimates are produced by ONS as part of the UK national accounts; and they are a component of the expenditure approach to measuring Gross Domestic Product (GDP). Internationally these investment estimates are known as GFCF and are defined in the European System of Accounts manual (ESA), which is consistent with the System of National Accounts manual (SNA). On a quarterly basis, GFCF estimates are published in the following ONS releases: Business Investment; Second Estimate of GDP; Quarterly National Accounts; and UK Economic Accounts. On an annual basis, GFCF estimates are published in the UK National Accounts (Blue Book) and UK Economic Accounts. As part of its commitment to continuous improvement, ONS periodically reviews and where appropriate improves data sources, methods and processes used for compiling estimates. As part of this commitment, in Blue Book 2013 new production systems were introduced for compiling GFCF, which included improved data sources, methods and processes. Section 3: Defining GFCF and Business Investment The definition of GFCF, GFCF assets and GFCF sectors are laid out in the SNA and ESA manuals. In Europe, National Statistical Institutes (NSIs) are legally required to comply with these definitions. Table 1 summaries the ESA definitions of GFCF, and tangible and intangible fixed assets. The assets and sectors which are included are shown in Table 2. 2

3 Table 1: ESA definition of GFCF GFCF is: resident producers acquisitions, less disposals, of fixed assets during a given period plus certain additions to the value of non-produced assets realised by the productive activity of producer or institutional units (ESA 1995, para 3.102). Tangible and intangible fixed assets are: outputs from the processes of production that are themselves used repeatedly, or continuously, in processes of production for more than one year (ESA 1995, para ) Table 2: ESA GFCF assets and institutional sectors GFCF assets: New dwellings and significant improvements to dwellings New buildings and other structures and significant improvements to these Machinery and equipment and cultivated assets Transport equipment Intangible assets Costs associated with the transfer of ownership of non-produced assets. GFCF top level institutional sectors: Private non-financial corporations Public non-financial corporations Financial corporations Central government Local government Households Non-profit institutions serving households Current UK compliance with the European National Accounts regulation is on an ESA95 basis but in September 2014 will move to ESA10. The three key changes for GFCF between ESA95 and ESA10 are the capitalisation of research and development, weapons and the inclusion of decommissioning (terminal) costs (see Section 8). It is within this legally binding international guidance that UK official estimates of GFCF are produced and transmitted to Eurostat. Alongside GFCF, ONS produces business investment estimates. In contrast to GFCF there is no international definition of business investment, which means international comparisons cannot be made. There is no European regulatory requirement to produce business investment estimates. In the UK, business investment excludes: expenditure on the following assets: dwellings and the costs associated with the transfer of ownership of non-produced assets e.g. soil, water and land; and investment by the following sectors: Central and Local Government. Section 4: Compiling GFCF: data sources, methods and processes Figure 1 presents an overview of the key stages of the GFCF compilation process. This section goes through each stage in turn looking at the data sources, methods and processes involved. Where 3

4 appropriate it also highlights data sources, methods and processes that are either currently being reviewed or will be reviewed in the future. Figure 1: Overview of the GFCF compilation process 4.1 Stage 1: Building the current price dataset The GFCF current price dataset is built from a number of data sources. Data collected by the ONS quarterly survey of capital expenditure 1 accounts for approximately 50 of total current price GFCF (and 80 of business investment). The survey asks a large sample (27,000) of registered businesses to provide the value of acquisitions and proceeds from disposals of the different assets. In addition to the quarterly survey, data from other government departments (e.g. the Department of the Communities and Local Government (DCLG), Her Majesty s Revenue and Customs (HMRC), Her Majesty s Treasury (HMT)) and public corporations are used to construct the current price dataset. For Blue Book 2013, to meet ESA95 reservation requirements, additional data sources were introduced for artistic originals and the mark-up for own account software The ONS quarterly capital expenditure survey questionnaire is currently being reviewed and developed so it is ESA10 compliant. Following development and testing, the revised questionnaire will be implemented from Quarter 1, Prior to 2010, the ONS quarterly survey of capital expenditure was collected on a Standard Industrial Classification 2003 (SIC03) basis. In 2010, in line with European guidance SIC07 was implemented. Pre-2010 data have been converted to SIC07. 4

5 Combining the different data sources allows the construction of a current price GFCF dataset for the whole economy, broken down by industry, asset and sector on both an acquisitions and disposals basis. Table 3 provides an overview of the Stage 1 methods changes from Blue Book 2009 to It is evident from this table that Blue Book 2013 returned to some of the methods used to build the current price GFCF dataset prior to Blue Book 2011 but processed acquisitions and disposals separately. Table 3: An overview of Stage 1 methods changes from Blue Book 2009 to 2013 Blue Book 2009 and 2010 Blue Books 2011 and 2012 Blue Book 2013 and 2014 Methods used for building the current price GFCF dataset A bottom up approach using assets as the building blocks. Processing on net capital expenditure. A top down approach, which calculated total GFCF first and then the lower level data were derived using historical proportions. Processing on net capital expenditure. A bottom up approach using assets as the building blocks. Processing on acquisitions and disposals separately. 4.2 Stage 2: Benchmarking to the Annual Business Survey (ABS) Since 2011, quarterly GFCF data have been benchmarked to annual capital expenditure data from the ONS annual business survey (60,000 sample) as part of the annual national accounts process. The larger annual survey, with data from audited accounts, is intended as a more reliable source of annual capital expenditure data. Like the quarterly capital expenditure survey the annual business survey requests data on the value of acquisitions and proceeds from the disposal of assets. The annual benchmarking process benchmarks quarterly capital expenditure data to the annual business survey annual totals and then constrains the quarters to sum to the annual business survey totals to keep the quarterly profile as consistent as possible. The ONS annual business survey capital expenditure questions are currently being reviewed and developed so they are ESA10 compliant. Following development and testing the revised questions will be dispatched from A review of the annual business survey benchmarking process is planned. The recommendations from this will be implemented in either Blue Books 2015 or Table 4 provides an overview of the Stage 2 methods changes from Blue Book 2009 to In Blue Book 2013 direct benchmarking for all industries continued to be used as initiated in Blue Book

6 Table 4: An overview of Stage 2 methods changes from Blue Book 2009 to 2013 Blue Book 2009 and 2010 Blue Books 2011 and 2012 Blue Book 2013 and 2014 Annual benchmarking methods Periodic benchmarking to the ONS annual business survey for specific industries. Benchmarking directly to ONS annual business survey capital expenditure data. Benchmarking directly to ONS annual business survey capital expenditure data. 4.3 Stage 3: Supply and Use balancing Supply and use balancing is undertaken to fully reconcile the three measures of GDP: production, income and expenditure at a detailed level (114 products by 114 industries). In this process, the supply of products is reconciled to the demand for products to the nearest million; and the inputs to industries are reconciled to the outputs from industries. Detailed indicators, only available with a lag of 1-2 years, are used (e.g. ONS annual business survey industry supply and purchases data; HMRC profits data; Government expenditure data) to assist the reconciliation process. This link provides an overview of supply and use in the format of an infographic. As part of the supply and use balancing process, the supply of GFCF products e.g. office furniture, are balanced to the demand for GFCF products across the whole economy. To do this GFCF current price assets are converted to detailed products using a set of historical weights from the ONS annual business spending on capital items survey. Following the supply and use balancing process annual net GFCF product level data needs to be converted back to GFCF assets on an acquisitions and disposals basis. This is done using historical weights from the ONS annual business spend on capital items survey. As GFCF data are published annually and quarterly, the supply and use balanced GFCF product series needs to be converted into annual and quarterly asset level breakdowns. In Blue Book 2013, the approach was significantly changed with pre-supply and use product level GFCF data benched to post-supply and use product totals. These were re-aggregated to assets using the historic weights. This was in contrast to previous Blue Books that used a top-down approach starting with total GFCF (see Table 5). At the end of this stage, we have data available on a current price, non-seasonally adjusted basis. 6

7 A review of the method used to compile the annual and quarterly GFCF series following supply and use balancing has been completed. To maintain the general GFCF asset composition following supply and use balancing in Blue Book 2014, the apportionment of supply and use balancing adjustments will use a top-down approach starting with total GFCF. This will reduce some of the volatility in the series. Development and testing to improve and make ESA10 compliant the ONS annual business spend on capital items survey questionnaire is now complete. The revised questionnaire will be dispatched from It is planned to review the process of deriving products from the GFCF current price assets for supply and use balancing; and the process of compiling GFCF acquisitions and disposals data from the supply and use balanced net product level data. It is anticipated that these reviews will commence when data are available from the revised ONS annual business spend on capital items survey questionnaire. Table 5: An overview of Stage 3 methods changes from Blue Book 2009 to 2013 Blue Book 2009 and 2010 Blue Books 2011 and 2012 Blue Book 2013 and 2014 Deriving GFCF products for supply and use Historical weights from the ONS business spend on capital items survey No change No change Deriving GFCF acquisitions and disposals from net expenditure following supply and use Historical weights from the ONS business spend on capital items survey No change No change Maintaining the asset composition post supply and use balancing Pre-supply and use asset level weights were applied to the quarterly series using a top down approach. Pre-supply and use asset level weights were applied to the quarterly series using a top down approach. For Blue Book 2013, presupply and use product level series benched to supply and use series and re-aggregated. Blue Book 2014 will return to the methods used prior to Blue Book

8 4.4 Stage 4: Building the chained volume measures dataset To build the chained volume measure dataset GFCF acquisitions and disposals asset data are deflated, chain linked and then seasonally adjusted (see Figure 2). Figure 2: Building the net chained volume measures dataset Net Capital Expenditure Current Price and Chained Volume Measures by Asset, Sector and Industry Seasonally Adjust Current Price (Assets by Sector) Seasonally Adjust Volume Data (Assets by Sector) Seasonally Adjust Volume Data (Assets by Sector) Seasonally Adjust Current Price (Assets by Sector) Chain Linking Chain Linking Aggregate to published Asset and Sector Levels Aggregate to published Asset and Sector Levels Aggregate to published Asset and Sector Levels Aggregate to published Asset and Sector Levels Deflate Current Price Deflate Current Price Acquisitions by Assets, Sectors and Industries Disposals by Assets, Sectors and Industries GFCF Current Price Industry and Product Source data + Annual Supply & Use Balancing Adjustments 4.4.1: Deflation Annual and quarterly GFCF asset, sector and industry level breakdowns are first deflated. For Blue Book 2013, this was carried out separately on the acquisitions and disposals series, which allows for the potential differences in the product and asset weights of each series and avoids the problem of processing negative net values. 8

9 For Blue Book 2013, the majority of the deflators used in the deflation process were Producer Price Indices (PPIs), Services Producer Price Indices (SPPIs), Construction prices, and Import Price indices; GDP implied deflators were used when PPIs were unavailable. Asset level deflators were derived by weighting product level e.g. PPIs and SPPIs using weights from the ONS business spend on capital items survey. Section 5 provides further information on the impact from these deflators. As part of its commitment to continuous improvement ONS has established a deflation team to review, develop and improve deflators throughout national accounts. The external contract for the construction price indices has recently been retendered and the new contractor is currently reviewing the methods used to collect the data and construct the price indices. ONS is planning a seminar in May 2014 to provide an opportunity for users to discuss any proposed data and methods changes : Chain linking Following deflation of the asset and sector acquisitions and disposals the data are chain linked. Prior to Blue Book 2013, chain linking was often problematic as it was carried out on the net expenditure series, which often contained negatives (i.e. disposals were greater than acquisitions). This issue was removed for Blue Book 2013 by chain linking acquisitions and disposals separately : Seasonal adjustment In Blue Book 2013, GFCF data were seasonally adjusted separately for acquisitions and disposals at an asset by sector level; this breakdown was then aggregated to create seasonally adjusted GFCF in both constant and current prices. 9

10 Table 6: An overview of Stage 4 methods changes from Blue Book 2009 to 2013 Blue Book 2009 and 2010 Blue Books 2011 and 2012 Blue Book 2013 and 2014 Deflation Deflating net capital expenditure at an asset and industry level. Deflating net capital expenditure at a total GFCF and industry level. Deflating acquisitions and disposals separately at an asset and sector level. Used PPI weights calculated in 1998 using business spending on capital items survey information. Broad implied deflators used with PPI forecasts for the latest periods. Fuller set of PPIs, construction prices and GDP implied deflators used. Latest Business Spending on Capital Items Survey used to weight deflators. Chain linking Chain linking net capital expenditure at an asset and industry level. Chain linking net capital expenditure at a total GFCF and industry level. Chain linking acquisitions and disposals separately at an asset and sector level. Seasonal adjustment Seasonally adjusted at a level, which resulted in approximately 100 series being seasonally adjusted. Seasonally adjusted at the sector and high level asset level. Seasonally adjusted at a level, which resulted in approximately 1,500 series being seasonally adjusted. Seasonally adjusted net capital expenditure. Seasonally adjusted net capital expenditure. Lower level data prorated/benched to higher level totals. Seasonally adjusted acquisitions and disposals separately. 4.5 Stage 6: GDP balancing GDP balancing is the process by which the output, expenditure and income measures of GDP are confronted to produce the best estimate. This can result in GDP balancing adjustments being made to specific GDP components such as GFCF. Section 5: The impact and explanation of Blue Book 2013 changes This section looks at the impact of the Blue Book 2013 data sources, methods and process changes (see Section 4) to GFCF and business investment estimates. 5.1 The impact of Blue Book 2013 GFCF changes In Blue Books 2009 to 2012 the relationship between GFCF current price (CP) and chained volume measures (CVMs) was very similar (see Figures 3 and 4). To look at the underlying estimated price 10

11 change an implied deflator can be calculated by dividing the current price data by the chained volume measure data and multiplying by 100. Looking at the GFCF implied deflators in Blue Book 2009 to 2012 (see Figure 5) you can see that there was little variation in estimated prices from 1997 onwards. Figure 3: Total GFCF (current price) Blue Book 2009 to Blue Book 2013 ( million) Figure 4: Total GFCF (chained volume measures) Blue Book 2009 to Blue Book 2013 ( million) BB09 BB10 BB11 BB12 BB BB09 BB10 BB11 BB12 BB Source: ONS Figure 5: Total GFCF implied deflator Blue Book 2009 to Blue Book Total GFCF (BB09) Total GFCF (BB10) Total GFCF (BB11) Total GFCF (BB12) Total GFCF (BB13) Source: ONS As outlined in Section 4, the methods used to construct GFCF in Blue Book 2013 saw a return to building the GFCF current price dataset using assets as the building blocks (as was done prior to Blue Book 2011) so that the contributions from different assets were better reflected in the estimates. It 11

12 also returned to the method of using data from the ONS business spending on capital items survey to weight the deflators. For the first time: As recognised internationally, the compilation of GFCF included processing acquisitions and disposals separately, rather than compiling on the net position. This also avoids the issue of being unable to chain link due to negative values. The pre-supply and use net product series were benched to the post-supply and use balanced net product series and then re-aggregated to the assets. Benching the low level net product series, which can be negative, introduced increased quarterly volatility in Blue Book 2013 A fuller set of PPIs, SPPIs and IPIs were used and where not available GDP implied deflators were used, consistent with use across National Accounts. Seasonal adjustment was carried out on lower level acquisition and disposal series. Aligned to ESA95, Blue Book 2013 also included improvements to the measurement and estimation of investment in artistic originals and inclusion of an operating surplus mark-up for own account software; and software was reclassified from machinery and other equipment to intangible fixed assets. Using these methods the current price series remained similar to previous Blue Books (see Figure 3). However, there were level shifts in the CVM series (see Figure 4) and consequently the implied deflator (see Figure 5). The key reasons for these changes were: Changes in GFCF asset shares: increased shares of dwellings and intangible fixed assets and decreased shares of machinery and other equipment, which had an impact across the GFCF time series. The use of a specific SPPI for deflating software, instead of a broad machinery and other equipment deflator, which had an impact mainly from 1997 to The use of deflators specific to the dwellings assets (new housing and repair and maintenance) instead of a deflator for all construction, which had a significant impact from The explanation of Blue Book 2013 GFCF changes The deflation process was the primary reason for the impact on previously published data. There are two components to this: (a) the relative share of the assets to total GFCF; and (b) specific asset deflators. With regard to changes in asset shares, there were three key changes between Blue Book 2012 and 2013 (see Annex A): 1. A decrease in the asset share of machinery and other equipment, from the reclassification of software to intangible fixed assets. 2. An increase in the asset share of intangible fixed assets, from the reclassification of software and the inclusion of artistic originals and a mark-up for own account software. 3. An increase in the asset share of dwellings, particularly between 1997 and However, these do not fully explain the change in the GFCF implied deflator. To demonstrate this Figure 6 shows the GFCF Blue Book 2012 implied deflator (blue line) compared with an estimated implied deflator if Blue Book 2012 asset shares were used but with Blue Book 2013 deflators (dark red line) and an estimated implied deflator if Blue Book 2012 deflators were used with Blue Book 2013 asset shares. You can see from Figure 6 that there is greater variation from the Blue Book 2012 implied deflator (blue line) when asset deflators are changed to the Blue Book 2013 deflators (dark 12

13 red line). This indicates that at a headline level, Blue Book 2013 deflators had a greater impact on the change in the implied deflator than the Blue Book 2013 asset shares collectively. Figure 6: The impact on the Blue Book 2012 GFCF implied deflator of changing to Blue Book 2013 asset shares and deflators = GFCF deflator (Blue Book 2012) Latest shares, Blue Book 2012 asset deflators BB12 shares, latest asset deflators Source: ONS Two primary changes in the GFCF deflators that made the largest contributions to the change in the Blue Book 2013 GFCF implied deflator were: Between 1997 and 2004, the largest contribution to the GFCF implied deflator change was from the use of an updated software deflator. Between 2005 and 2013, the largest contribution to the GFCF implied deflator change was from the use of an updated dwellings deflator GFCF changes from the updated software deflator In Blue Book 2013, between 1997 and 2004 the largest contribution to the GFCF implied deflator change was from the use of an updated software deflator. On average, investment in software accounts for around 10 of current price GFCF and on average around 79 of GFCF intangible fixed assets. Prior to Blue Book 2013, investment in software was deflated using a broad machinery and other equipment deflator (the blue line in Figure 7). In Blue Book 2013, to align with ESA95, software was reclassified to intangible fixed assets. The deflator for software was also updated from a broad machinery and other equipment deflator to the computer services SPPI (black line in Figure 7). Figure 8 shows the Blue Book 2012 and Blue Book 2013 GFCF implied deflators (solid blue and solid black lines respectively), alongside an Blue Book 2013 GFCF implied deflator using the Blue Book 2012 software deflator (dotted black line). The difference between the dotted black line and solid black line shows the estimated effect to the GFCF Blue Book 2013 implied deflator if the Blue Book 2012 software deflator was used. 13

14 Figure 7: Current and previous price indices used to deflate software (10 of GFCF) Figure 8: Impact on GFCF implied deflator from changing the software deflator = = BB12 other machinery BB13 software Source: ONS GFCF deflator (Blue Book 2012) GFCF deflator (latest) Latest GFCF deflator using old software deflator After Blue Book 2014, the use of the computer services SPPI used as the GFCF software deflator will be reviewed. Its current use is based on the fact that it is an official SPPI compiled in accordance with Eurostat guidance and is conceptually better than a broad machinery and other equipment deflator for deflating the software asset International perspective Figure 9 shows the UK computer services SPPI (red line) compared with other countries. The UK computer services SPPI sits in the middle of other European SPPIs; in contrast the United States (blue line) has a different price profile with declining prices over the same period; this is derived by quality adjusting the PPI (Byrne et al., 2013). Unlike the UK equivalent, the US software publishers PPI is higher before the 2010 reference year and thereafter lower. 14

15 2007Q1 2007Q3 2008Q1 2008Q3 2009Q1 2009Q3 2010Q1 2010Q3 2011Q1 2011Q3 2012Q1 2012Q3 2013Q1 2013Q3 Figure 9: International comparison of computer services SPPI and PPIs 1 (2010=100) Denmark 105 Spain 100 France 95 Norway 90 EU28 85 United Kingdom 80 US Purchased The US price index is a software publishers PPI Source: Eurostat, ONS, US Bureau of Economic Analysis, and US Bureau of Labor Statistics As part of the review of the use of the computer services SPPI ONS plans to investigate the deflation of software in other countries. The first step in this process has been to review the implied intangible fixed assets in other countries (see Figure 10). What is interesting to note from this is that up until 2009 the UK deflator is broadly consistent with those used in the EU17. In contrast the Netherlands, France and the US have different price evolutions. This maybe partly explained by the shares of products included in intangible fixed assets; and for the US that they have already moved onto an SNA08 basis, which includes the capitalisation of research and development in intangible fixed assets. Figure 10: International comparison of implied intangible fixed assets deflators European Union (27 countries) Euro area (17 countries) France Germany Netherlands United Kingdom United States Source: OECD and Eurostat 15

16 GFCF changes from the updated dwellings deflator Between 2005 and 2013, the primary contributing factor to the change in the Blue Book 2013 GFCF implied deflator was the change to the dwellings deflator. In Blue Book 2012, implied GDP construction deflators were used as the GFCF dwellings deflators, these included all construction work, not just new dwellings and repair and maintenance to dwellings. In Blue Book 2013, ONS construction output price indices were used for new dwellings (50) and repair and maintenance (50), which is conceptually consistent with the dwellings asset. Figure 11 shows the effect of this change between Blue Book 2012 and Blue Book Figure 12 shows the difference between the deflators used in Blue Book 2013 (black and dotted black lines) and those used in Blue Book 2012 (blue line). Figure 11: Blue Book 2012 implied dwellings deflator and Blue Book 2013 dwellings deflator Source: ONS 2005 = 100 Weighted underlying series (BB13) Implied dwellings deflator (BB12) Figure 12: Construction price indices =100 new private housing repair and maintenance, private housing all construction work Figure 13 shows the GFCF deflators for Blue Book 2013 and Blue Book 2012, as well as a series showing what the Blue Book 2013 GFCF series would have looked like if the Blue Book 2012 dwellings deflator had been used (dotted black line); this highlights the impact of changing the dwellings deflation methodology. 16

17 Figure 13: Impact of changing the dwellings deflator on the Blue Book 2013 GFCF implied deflator = GFCF deflator (BB12) GFCF deflator (BB13) BB13 GFCF series with old dwellings deflator Source: ONS The change in the dwellings deflator, and to some degree the increased asset share of dwellings particularly between 1997 and 2001, are the primary reasons for the change in the overall GFCF implied deflator in Blue Book A dwellings weight of approximately 25 implies that, all else being equal, the change in dwellings deflation would account for approximately 90 of the change in the GFCF deflator between 2005 and Other smaller contributing factors to the change in the GFCF implied deflator in Blue Book 2013 were: The use of updated weights from the reinstated ONS business spending on capital items survey to weight the combinations of lower level price series to represent the proportion of spending on individual products in each asset. Deflating and chain linking acquisitions and disposals separately. Deflating separately on acquisitions and disposals also helps from a chain linking perspective where it can be problematic to chain link negative values, which can be present in the net expenditure series. 5.3 The impact of Blue Book 2013 business investment changes Prior to Blue Book 2013, the business investment estimates saw a relationship similar to that of GFCF between current price (see Figure 14) and chained volume measures (see Figure 15). The implied deflator (see Figure 16) showed limited variation in prices from 1997 onwards. 17

18 1997 Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q1 Figure 14: Total business investment (current price, seasonally adjusted) consistent with Blue Book 2011 to Blue Book 2013 ( million) Figure 15: Total business investment (chained volume measures, seasonally adjusted) consistent with Blue Book 2011 to Blue Book 2013 ( million) Blue Book 2011 Blue Book 2012 Blue Book Blue Book 2011 Blue Book 2012 Blue Book 2013 Source: ONS Figure 16: Total business investment implied deflator = Blue Book 2011 Blue Book 2012 Blue Book Source: ONS The impact of the Blue Book 2013 changes was more pronounced for the business Investment implied deflator (see Figure 16) compared with the GFCF implied deflator (see Figure 5). This was primarily because of the composition of business investment (it excludes dwellings, and capital expenditure by central and local government). This meant that the effects of the changing asset shares, updated deflators (excluding dwellings), and the inclusion of artistic originals and mark-up 18

19 for own-account software had a larger impact compared with GFCF, where the change was dominated by the change to the dwellings deflator. 5.4 The explanation of Blue Book 2013 business investment changes As with the changes to GFCF, the deflation process was also the primary reason for the changes in business investment consistent with Blue Book However, unlike GFCF, the contributing factors to the change in the business investment implied deflator were from both the change in asset shares and change to deflators (see Figure 17). Figure 17: : The impact on the implied business investment deflator (consistent with Blue Book 2012) of changing to Blue Book 2013 consistent asset shares and deflators = Business investment deflator (Blue Book 2012) Latest asset shares, Blue Book 2012 asset deflators Blue Book 2012 asset shares, latest asset deflators Source: ONS From an asset shares perspective, the primary contributing factors to the change in the business investment implied deflator was from the reclassification of software from machinery and other equipment to intangible fixed assets and the inclusion of artistic originals and a mark-up for own account software in intangible fixed assets. In combination with this the software deflator was changed from a broad machinery and other equipment deflator to a specific computer services SPPI. All else being equal, these changes accounted for approximately two thirds of the change in the business investment implied deflator from 1997 to 2004 (see section 5.4.1) From 2005 to 2013, the largest contribution to the business investment implied deflator change was from the replacement of forecast deflators with actual deflators. It is estimated that this accounted 19

20 for over half (52) of the difference between the Blue Book 2013 and Blue Book 2012 implied business investment deflator growths (see section 5.4.2) Business Investment changes from the updated software deflator On average, investment in software accounts for around 18 of current price business investment (compared with 10 of current price GFCF) and on average 79 of intangible fixed assets. Prior to Blue Book 2013, investment in software was deflated using a broad machinery and other equipment deflator (the blue line in Figure 18); in Blue Book 2013 it was deflated using the SPPI for computer services (black line in Figure 18). Figure 19 shows the business investment implied deflators consistent with Blue Book 2012 (solid blue line) and Blue Book 2013 (solid black line), alongside a series that shows what the implied business investment deflator would have looked like if the previous software deflator had been used (the broad machinery and other equipment deflator). Here you can see that for business investment the change in the software deflator had a larger impact to business investment compared with the impact on GFCF (see Figure 8). Approximately two thirds of the change in the business investment implied deflator between 1997 and 2005 can be explained by the reclassification of software and the change in the software deflator. After 2005 there was a negligible impact on the business investment series. Figure 18: Current and previous price indices used to deflate software (18 of business investment) Figure 19: Impact of changing software deflator = = BB12 other machinery BB13 software Business investment (Implied deflator BB13) Blue Book 2013 non-dwellings GFCF (using old software deflator) BB12 implied business investment def Source: ONS As mentioned in section 5.2.1, after Blue Book 2014, the use of the computer services SPPI used as the GFCF software deflator will be reviewed. Its current use is based on the fact that it is an official SPPI compiled in accordance with Eurostat guidance and is conceptually better than a broad machinery and other equipment deflator for deflating the software asset. 20

21 Figure 20 and Table 7 summarise the changes in business investment asset shares and price evolution. Figure 20 shows the implied business investment deflator alongside the asset deflators for business investment. Table 7 provides a summary of Blue Book 2013 business investment asset shares and average annual growth between 1997 to 2005 and 2005 to These indicate that buildings and other structures saw higher average annual price growth between 1997 and 2005 compared with other assets. This was a contributing factor to the change in the business investment implied deflator between these years. The gradient of the Blue Book 2013 business investment implied deflator slope is therefore mostly explained by the asset share and rising prices in buildings and other structures; this was also evident in previous Blue Books but offset by the previous software deflator. Figure 20: The business investment implied deflator (consistent with Blue Book 2013) and asset implied deflators Table 7: Business investment asset shares and average annual implied deflator growths = Business investment Transport equipment (13) Other machinery and equipment (38) Other buildings and structures (29) Intangible assets (20) Asset name Buildings and other structures Machinery and equipment Transport equipment Intangible assets Total business investment Asset share of business investment Average annual growth between Average annual growth between Source: ONS Changes from the replacement of forecasted deflators The compilation of GFCF and business investment in Blue Book 2012 did not include actual deflators for the most recent periods (Q1, 2011 onwards). Although this method did not directly impact the years prior to Q1, 2011 the lower growth in the later periods in Blue Book 2012 did impact on the growth of the entire series. For the period between Q and Q4 2012, forecasting the Blue Book 2012 business investment implied deflator from Q accounted for over half (52) of the difference between the Blue Book 2013 and Blue Book 2012 implied deflator growths. Figure 21 shows the impact of replacing the Blue Book 2012 forecast method with the Blue Book 2013 implied deflator growths from Q

22 Figure 21: The impact of forecasting on the business investment implied deflator = Source: ONS BB13 implied deflator BB12 implied deflator BB12 implied deflator + BB13 growth from Q Other smaller contributing factors to the change in the business investment implied deflator were: The use of updated weights from the reinstated ONS business spending on capital items survey to weight the combinations of lower level price series to represent the proportion of spending on individual products in each asset. Deflating and chain linking acquisitions and disposals separately. Deflating separately on acquisitions and disposals also helps from a chain linking perspective where it can be problematic to chain link negative values, which can be present in the net expenditure series. Section 6: Blue Book 2013 volatility As discussed in the GFCF article published in July 2013, the pre-supply and use net product series were benched to the post-supply and use balanced net product series and then re-aggregated to the assets. Benching the low level net product series, which can be negative, introduced increased quarterly volatility in Blue Book 2013 compared with Blue Book 2012 (see Figure 22). 22

23 1997 Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q3 Figure 22: Comparison of Blue Book 2012 and Blue Book 2013 current price GFCF series ( millions) = BB12 CP SA BB13 CP SA 0 Source: ONS Further analysis and comparison of methods has been carried out on the quarterly compilation process to ensure the most appropriate methods are maintained. Following this it has been agreed that for Blue Book 2014 the pre-supply and use asset level weights will be applied to total GFCF and apportioned to the quarterly series by pro rata across the asset, sector and industry breakdowns thus reducing quarterly volatility but not removing it as the underlying source data are intrinsically volatile. 6.1: Volatility of capital expenditure source data At an individual business level capital expenditure is volatile as businesses rarely acquire and dispose of capital assets on the same basis each quarter. The quarterly capital expenditure survey utilises stratified random sampling, with strata constructed using employment size bands within industry groupings. The employment size bands are shown in Table 8. One way to analyse the effect of volatility in the capital expenditure survey data is to look at the fully enumerated stratum, where all businesses are selected every quarter. This stratum comprises the largest businesses in the sample. If the volatility is mainly due to the fully enumerated business stratum, then the volatility is likely to be genuine population volatility. In contrast, if the volatility is mainly due to sampled businesses, then the volatility could be due to population volatility or sampling error. 23

24 2011 Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q3 Table 8: The quarterly capital expenditure survey sampling strata Size band Employment size Type of sampling Size band 1 0 to 19 employment Not sampled, estimated by using size bands 2-4 Size band 2 20 to 49 employment Sampled or fully enumerated depending on industry Size band 3 50 to 99 employment Sampled or fully enumerated depending on industry Size band to 299 employment Sampled or fully enumerated depending on industry Size band employment Fully enumerated Figure 23 below shows the capital expenditure of acquisitions for the fully enumerated stratum (size band 5) and sampled businesses; and Figures 24 the corresponding disposal series. Figure 23: Capital expenditure of acquisitions for the fully enumerated and sampled strata ( thousands, current price, not seasonally adjusted) Figure 24: Capital expenditure of disposals for the fully enumerated and sampled strata ( thousands, current price, not seasonally adjusted) 30,000,000 2,500,000 25,000,000 20,000,000 15,000,000 10,000,000 5,000,000 2,000,000 1,500,000 1,000, , Source: ONS fully enumerated (300+ emp) sampled (<300 emp) fully enumerated (300+ emp) sampled (<300 emp) From Figures 23 and 24, you can see that much of the period-on-period volatility comes from the fully enumerated businesses, rather than the sampled bands; particularly for total disposals. This implies that the volatility in quarterly capital expenditure survey estimates are due to genuine 24

25 variability in the population, rather than sampling variance; and that improvements to sample design and estimation are unlikely to result in large reductions to the volatility. It should be noted that, while fully enumerated businesses are all sampled, not all will respond - this is dealt with either using imputation (for sizeband 5) or estimation (for all other sizebands). Where estimation is used, this can result in sampling variability even from fully enumerated strata, but the best way to reduce this is likely to be through imputation rather than estimation methods. Section 7: Explanation of the recent weakness in GFCF in comparison with external surveys In between the annual Blue Book publications, GFCF quarterly data are compiled from unbenchmarked quarterly data. The data are on an acquisitions and disposals basis and the published official estimates are on a net capital expenditure basis (acquisitions minus disposals). In contrast external private surveys collect data on acquisitions or intentions to acquire only and do not show the net position. There are also other differences in relation to coverage, the type of data collected and the reference period. It has been suggested that net investment was relatively weak through 2012 and 2013, compared with the growth in other sectors of the economy. However, it should be noted that in 2012 and 2013, growth in the acquisition of assets was relatively strong. The net level investment was weaker, because it was offset by increasing disposals of assets. These grew more strongly than acquisitions in 2012, and remained at a high level in 2013 (see Table 9). Table 9: Total quarterly capital expenditure survey data (current prices, not seasonally adjusted) million year acquisitions disposals net Source: ONS 25

26 Disposals are recorded when: assets are sold to other businesses / institutional sectors to be used in their production processes (GFCF) assets are sold to e.g. the household sector, for non-production purposes (final consumption expenditure) assets are scrapped (inventories) assets are sold to non-uk-based recipients (trade) The quarterly capital expenditure survey does not collect information about the final destination of disposals. In terms of the relationship between acquisitions and disposals Figure 25 shows that these are variable overtime. Disposals have increased significantly in relationship to acquisitions in 2012 and Figure 25: Relationship between acquisitions and disposals of capital assets disposals / acquisitions Source: ONS Section 8: Forthcoming changes for Blue Book 2014 A considerable amount of evaluation has been undertaken on the GFCF series to ensure that the most appropriate methods are used for Blue Book For Blue Book 2014 there will only be one non-esa related change to the methods for compiling GFCF: returning to the method used pre Blue Book 2013 to apportion supply and use balancing adjustments to the quarterly GFCF series, which will reduce some of the volatility seen in the Blue Book 2013 GFCF series. Blue Book 2014 will also see the introduction of ESA10 changes. Specifically for GFCF this will include the capitalisation of research and development; weapons; and terminal costs. Further information on the impact of these changes will be published in the summer. 26