In the current environment of rapid

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1 Ecoomic & Labour Market Review Vol 1 No 2 February 2007 feature Emma Edworthy Office for Natioal Statistics Gavi Wallis HM Treasury Treatig research ad developmet as a capital asset SUMMARY Treatig research ad developmet as a asset requires a umber of importat steps. The first step is to determie the compoets of research ad developmet expediture to be icluded as ivestmet ad the to traslate those expediture compoets ito a Natioal Accouts compatible format. The secod step is the costructio of appropriate deflators for research ad developmet assets. The fial step requires the estimatio of appropriate depreciatio rates for research ad developmet capital. This article presets work udertake by the Office for Natioal Statistics o these three steps for the UK busiess sector ad also some estimates of the productivity impact of research ad developmet o busiess sector firms. I the curret eviromet of rapid techological chage, research ad developmet (R&D) has proved to be a importat elemet of ecoomic growth. R&D is cosidered oe of a umber of measures of iovatio performace ad various studies have show that ivestmet i R&D is a importat source of productivity growth (for example Griliches, 1981). R&D ivestmet reduces productio costs, as iputs are more effectively trasformed ito outputs, ad it alters output characteristics, thereby providig ew products to the marketplace (Berstei ad Mamueas, 2004). As a result, the promotio of ivestmet i R&D has become a priority withi the EU. I Barceloa, i 2002, EU heads of govermet set a target for EU R&D to reach 3 per cet of gross domestic product (GDP) by 2010, with two-thirds of this comig from busiesses. As a result, may EU coutries set domestic targets, icludig the UK. The UK govermet set a target to icrease R&D expediture to 2.5 per cet of GDP by Total UK R&D curretly stads at 1.78 per cet of GDP (Office for Natioal Statistics (ONS), 2006). The official guidelies for collectig R&D data come from the OECD Frascati Maual. This maual deals exclusively with the measuremet of huma ad fiacial resources devoted to R&D, amely R&D iput data. It provides a platform for iteratioally comparable data o R&D. The maual describes R&D as comprisig creative work udertake o a systematic basis i order to icrease the stock of kowledge, icludig kowledge of ma, culture ad society, ad the use of this stock of kowledge to devise ew applicatios. The maual ackowledges three types of R&D activities: basic research, applied research ad experimetal developmet. Basic research is experimetal or theoretical work udertake primarily to acquire ew kowledge of the uderlyig foudatio of pheomea ad observable facts, without ay particular applicatio or use i view. Applied research is also origial ivestigatio udertake i order to acquire ew kowledge. It is, however, directed primarily towards a specific practical aim or objective. Experimetal developmet is systematic work, drawig o the existig kowledge gais from research ad/or practical experiece, which is directed to producig ew materials, products or devices, to istallig ew processes, systems ad services, or to improvig substatially those already produced or istalled. Although it is widely accepted that expediture o R&D by firms is a meas to improvig their productivity via ew processes ad product iovatios, it is ot recorded by Natioal Accouts i a way that reflects this. R&D is curretly treated as a itermediate iput for busiesses ad curret cosumptio for govermet ad o-profit istitutios. At the Statistical Policy Committee (SPC) i November 2006, Europea Member States came to a coclusio o how to hadle the itroductio of R&D activity as capital formatio i the update of the System of Natioal Accouts (SNA). This 16 Office for Natioal Statistics

2 Ecoomic & Labour Market Review Vol 1 No 2 February 2007 Treatig research ad developmet as a capital asset coclusio will be preseted to the UN Statistics Commissio meetig at the ed of February, whe the SNA revisios will be agreed upo (the SPC expects the Europea view to be accepted). The SPC cocluded that compulsory satellite accouts should be developed i the short to medium term i order to address the substatial coceptual ad measuremet difficulties ivolved with treatig R&D as a asset. It is recommeded that the fial decisio o icludig R&D expediture i core Natioal Accouts should be take oce sufficiet evidece is gaied through experiece i satellite accouts, showig that it ca be measured with appropriate cofidece. I preparatio for revisios to the SNA relatig to R&D, Eurostat have fuded a ONS project to assess the practical ad methodological issues ivolved i capitalisig R&D i Natioal Accouts. This article presets work that has bee completed as part of the project. 1 Developig methodology Likig Frascati-based expediture to the SNA I order to capitalise R&D i the Natioal Accouts, Frascati expediture data eeds to be traslated ito a SNA-compatible format. The value of R&D eeded to be capitalised withi the SNA framework is gross output mius itermediate iputs. The first step ivolves covertig Frascati sectors ito SNA sectors. Table 1 is a lik table adapted from Robbis (2006). No-market R&D by covetio is valued by the sum of productio costs. They suggest that, by covetio, all o-market output of goods ad services is cosumed by the govermet sector. They highlight that the sum of outlays as reflected by GERD is ot cosistet with the sum of productio costs i accordace with Natioal Accout priciples. They suggest replacig the figures o capital expediture icluded i GERD with a estimatio of cosumptio of fixed capital (COFC). COFC represets the reductio i the value of the fixed asset used i productio durig the accoutig period resultig from physical deterioratio, ormal obsolescece or ormal accidetal damage. Robbis (2006) idetifies R&D as a o-market good based o its producer, either govermet, uiversities or o-profit istitutios. Ow-accout the SNA rule is to value ow-accout productio usig market prices. Whe a suitable market price caot be used, the secod best optio should be used, that is, the sum of the productio costs. I order to arrive at gross output figures, itermediate cosumptio, capital services ad et value added eed to be summed. Net value added is the sum of compesatio of employees, other taxes o productio Table 2 UK data availability ad imports less subsidies plus et operatig surplus. A bridge table adapted from Peleg (2006) betwee the Frascati Maual ad SNA data o R&D would iclude the followig. I. Output A. Frascati Maual GERD (1) Plus acquisitio of R&D to be used as iput i R&D productio (2) Plus depreciatio of capital goods owed by R&D producers ad used i R&D productio (3) Plus et operatig surplus cotaied i R&D output measured at basic prices (4) Plus other taxes less other subsidies o productio (5) Mius capital expeditures B. R&D output by SNA93 defiitios Equal to GERD + (1) + (2) + (3) + (4) (5) II. Data for preparatio of supply ad use tables Exports ad imports of R&D (1) R&D exports (2) R&D imports Not all the data implied by the above are available for R&D i the UK (operatig surplus, exports ad imports of R&D output). Table 2 gives a idicatio of the UK data available ad the adjustmets eeded to be made to come up with a satisfactory gross output figure. De Haa ad va Horste (2005) suggest three product groups to help traslate gross expediture o R&D (GERD) to the SNA. Market R&D the value should be determied by estimated basic prices. Productio costs should be used if reliable market prices are ot available. Table 1 Lik table Frascati sectors to SNA sectors Frascati Maual SNA Busiess eterprise sector No-fiacial corporatios Fiacial corporatios No-fiacial corporatios Fiacial corporatios Geeral govermet NPISH Busiess Eterprise Research ad Developmet (BERD) survey BERD GOVERD (HERD for public uiversities) No-profit expediture o R&D (HERD for private uiversities) Mius capital expediture for fiacial corporatios Plus expediture for NPISH servig busiess Plus R&D purchased as a itermediate iput to productio of R&D i the corporate sector (icludes cost of ay purchased R&D) Mius capital expediture for o-fiacial corporatios Plus expediture for NPISH servig busiess Plus R&D purchased as a itermediate iput to productio of R&D i the corporate sector (icludes cost of ay purchased R&D) Mius capital expediture icludig those for lad ad structures Mius curret expediture for o-plat machiery ad equipmet, as well as purchased ad ow-accout software (estimated with ratio of equipmet ad software to gross output) Plus capital services Mius capital expediture by NPISH servig busiess Plus capital services /a Govermet sector Private o-profit sector Higher educatio sector Abroad Geeral govermet sector No-profit istitutios servig households (NPISH) Geeral govermet NPISH Rest of the world Mius historical cost depreciatio Plus capital services o structures, equipmet ad software owed by R&D performers ad used to perform R&D i the UK Mius historical cost depreciatio Plus capital services o structures, equipmet ad software owed by R&D performers ad used to perform R&D i the UK Mius paymets for trade i R&D services /a /a /a Office for Natioal Statistics 17

3 Treatig research ad developmet as a capital asset Ecoomic & Labour Market Review Vol 1 No 2 February 2007 Key issues Freely available research ad developmet The decisio o whether or ot to iclude freely available R&D as part of R&D gross fixed capital formatio (GFCF) has proved to be cotroversial. The argumet is focused largely o higher educatio ad govermet sectors. At preset the discussio is lookig at excludig basic research for these two sectors, give that it would seem likely that there is o strategy i place to capture future ecoomic beefits. Busiess eterprises, o the other had, are assumed to have a profit motive ad presumably thik that their basic research will lead to future icome, eve if the results are published. Therefore, they ca be expected to have a strategy i place to exploit the kowledge gaied from their basic research (Aspde, 2006). Sice this article covers oly busiess R&D, it is assumed that freely dissemiated R&D is icluded. The case is also argued that usuccessful R&D is a cost of producig R&D ad is therefore idirectly icorporated ito the market value of R&D assets give they are valued at cost. Therefore, usuccessful R&D would ot have a asset life idepedet of successful R&D i the Natioal Accouts. This would see R&D beig treated i the same way as mieral exploratio, where it is viewed that the returs from the successes are sufficiet overall to pay for failures. Potetial for double coutig There is a potetial difficulty with a overlap with computer software. The Frascati Maual idetifies the followig types of capital expediture: lad ad buildigs istrumets ad equipmet computer software The UK BERD survey asks for data uder lad ad buildigs ad plat ad machiery ad does ot separate out software. Madler ad Peleg (2003) highlight two types of potetial R&D software overlap: R&D may be performed with the aim of developig a software origial the developmet of software may be part of a R&D project Matler ad Peleg (2003) also distiguish betwee two types of products: a asset the software that ca be used repeatedly i productio R&D that is a product i itself, whether regarded as a asset or as itermediate cosumptio Cotrary to this view, de Haa ad Va Horste (2005) assume that R&D fully devoted to the developmet of a ew software origial will geerally costitute a iseparable part of the productio process, with a sigle idetifiable output. Their view ad curret SNA93 says that all R&D with the specific goal of developig a software origial should be idetified as software ad ot as R&D. Whe it is ot possible to separate R&D software developmet withi a R&D project, the that software should ot be recorded as a separate asset. De Haa ad Va Horste (2005) agree with Madler ad Peleg (2003) accoutig recommedatios whe software is developed as a supplemetary tool. If it ca be idetified as such, the the software should be idetified as a separate asset ad the cosumptio of fixed capital of this software should be part of the productio costs of R&D output. The mai issue for ONS is ot so much double coutig withi the software idustry, but the amout of R&D software beig double couted withi other idustries. I BERD, software developmet outside the software idustry is recorded uder the product sold by the compay. This software developmet (if classified as R&D by the compay) will be icluded i their capital expediture figures o the BERD form. This capital expediture should already be couted as part of software expediture i the Natioal Accouts. Developig solutios Estimatig curret price gross fixed capital formatio I order to estimate at cost GFCF, some adjustmet to Frascati-based expediture data eeds to be made. Figure 1 provides a diagrammatic represetatio of how to get from Frascati-based total expediture o R&D to a positio where R&D is capitalised i the Natioal Accouts. Figure 1 idetifies that capitalisig R&D will impact o total Natioal Accouts GFCF ad also o capital cosumptio, with both these havig a impact o measured GDP. Three differet methods are idetified to derive the estimate of capital service flows from other asset classes. This capital service flow is essetially a estimate of the iput of the other capital (mostly tagible capital), used i the R&D process, to the R&D capital stock. I the first model, this iput is proxied by COFC plus a assumed retur o those assets. I the secod ad third models, the capital service flow from the assets used i the R&D process is measured directly. Oe method uses retal rates, the other capital services growth rates. More detail o the methodology for estimatig R&D GFCF usig the three differet approaches is provided i the techical ote at the ed of this article. The expediture data used to calculate GFCF is broke dow ito two clear areas, itramural (curret ad capital) ad extramural. Itramural expeditures are all expeditures for R&D performed withi a statistical uit or sector of the ecoomy durig a specified period, whatever the source of fuds. Extramural expeditures are the amout a uit, orgaisatio or sector reports havig paid, or committed themselves to pay, aother uit, orgaisatio or sector for the performace of R&D durig a specified period. This icludes acquisitio of R&D performed by other uits ad grats give to others for performig R&D. Itramural expediture ca be split further betwee: curret expediture: wages ad salaries icludes all overtime paymets, bouses, redudacies, commissios ad holiday pay ad should be gross other purchases of goods ad services from outside the uit, icludig overseas purchases, ad scietific services should be icluded, provided o R&D is ivolved. Cotractors employed o R&D projects are icluded here capital expediture: lad ad buildigs plat ad machiery Capital expediture should iclude aual gross expediture o fixed assets used i R&D projects. Lad ad buildigs comprises the acquisitio of lad ad buildigs, costs of major improvemets ad modificatios or repairs. For the purpose of calculatig R&D GFCF, both extramural ad itramural expediture are icluded. Extramural expediture will obviously iclude R&D purchased both withi ad outside the UK. 18 Office for Natioal Statistics

4 Ecoomic & Labour Market Review Vol 1 No 2 February 2007 Treatig research ad developmet as a capital asset Figure 1 Capitalisig research ad developmet expediture Curret expediture o R&D (labour costs, etc.) Curret expediture o R&D (labour costs, etc.) Total expediture o R&D (Frascati Maual based) + + R&D GFCF R&D related expediture o other assets (Plat ad machiery, purchased software, etc.) Estimatio Derived estimate of capital service flows from other asset classes* Additio of R&D GFCF R&D related expediture o other assets (plat ad machiery, purchased software, etc.) + Natioal Accouts GFCF Estimatio Natioal Accouts capital stock Capital cosumptio No-R&D related expediture o assets (plat ad machiery, software, etc.) GDP * Ca either be derived as cosumptio of fixed capital COFC (capital cosumptio) plus a ormal retur o capital used, or direct capital services estimates Costat price gross fixed capital formatio: estimatio of idustryspecific deflators To look at the cotributio of R&D expediture to ecoomic growth ad productivity, costat price R&D GFCF is the object of iterest. This requires a suitable deflator i order to covert curret price R&D GFCF ito costat price GFCF. The major problem associated with costructig a deflator for R&D is that it is a very heterogeeous product. By defiitio, every project is differet. Give that the majority of R&D is carried out o ow-accout, this makes it hard, if ot impossible, to calculate a market (output) price. As a result, the ext best solutio would appear to be the use of iput prices. The use of iput-based idices to estimate output volumes may well seem iappropriate, but there are may other areas withi Natioal Accouts where they are used whe a better alterative is ot available. Idustry-specific deflators for busiess R&D have bee estimated usig iput prices for the followig types of iput: wages ad salaries other curret expediture lad ad buildigs plat ad machiery R&D cost compoets ad appropriate weights are used to calculate a simple weighted idex ad a divisia idex. Camero (1996) argues that a divisia idex is theoretically ad empirically better at capturig chages i the cost of R&D tha fixed weighted idices such as the Laspeyres or Paasche idices. Table 3 shows data sources available for the UK for estimatig iput-based deflators for UK R&D. The availability of data Table 3 Deflator data sources R&D compoet Proxied by Source Wages ad salaries Other curret expediture (materials, etc.) Capital Idex of earigs of sciece ad techology professioals Idex of average earigs of techicias Idex of average earigs of admiistrative occupatios PPI (iput) materials ad fuels purchased by maufacturig excludig food, beverages, tobacco ad petroleum Separate idex for plat ad machiery, ad lad ad buildigs sources determies the exact methodology that ca be used whe estimatig iputbased price idices. The UK Busiess Eterprise Research ad Developmet (BERD) survey form asks for firms to break dow their average employmet o R&D (umber of full-time equivalets) ito three areas: scietists ad egieers professioal scietists or egieers egaged i the coceptio or creatio of ew kowledge, products, methods ad systems Aual Survey of Hours ad Earigs (ASHE) ASHE Producer price idices Natioal Accouts capital stock deflators Office for Natioal Statistics 19

5 Treatig research ad developmet as a capital asset Ecoomic & Labour Market Review Vol 1 No 2 February 2007 techicias qualified persoel who participate i R&D projects by performig scietific ad techical tasks, ormally uder the supervisio of professioal scietists ad egieers other supportig staff iclude skilled ad uskilled craftsme, secretarial ad clerical staff participatig i R&D projects or directly associated with such projects Wage iformatio for these three occupatioal areas, i the form of gross weekly wages, is available from the Aual Survey of Hours ad Earigs (ASHE). Data from ASHE are classified by stadard occupatioal classificatio (SOC) ad are available for 1997 to 2004 for the followig occupatios: sciece ad techology professioals techicias admiistrative occupatios A simple weightig techique was used to create a deflator for wages ad salaries ad also a divisia idex for compariso. Iitially, a price idex was calculated for each of the three employmet areas, scietists, techicias ad other workers ad the the weights were applied to these idices: E s E t E o Ws ; W t ; W o E T E T E T where: W s : weight for scietists ad egieers W t : weight for techicias W o : weight for other workers E T : total Frascati-based expediture o salaries ad wages E s : Frascati-based expediture o scietists ad egieers E t : Frascati-based expediture o techicias E o : Frascati-based expediture o other workers The deflator for salaries ad wages was the calculated as: P WS P s W s + P t W t + P o W o where P s, P t, ad P o are the price idices for scietists ad egieers, techicias ad other workers. For other curret expediture, the producer price idex (PPI) for materials ad fuels purchased by maufacturers excludig food, beverages, tobacco ad petroleum products was used. For the capital iput to R&D, existig deflators from the Natioal Accouts were used. A aggregate R&D deflator for each of the 33 idustries represeted i BERD was estimated usig the simple weightig techique ad also as a divisia idex for compariso. Estimatig depreciatio rates for research ad developmet capital I calculatig a R&D capital stock, evidece supports the use of the perpetual ivetory method (PIM). The gross stock of R&D is the the measure of the cumulative value of past ivestmet still i existece. The et capital stock would be equal to the gross stock less the accumulated depreciatio o assets i the gross stock. Depreciatio rates ca be based o asset lives or they ca be estimated usig ecoometric methods. Whereas some research treats R&D as a permaet part of the capital stock oce added, the cosesus thikig is that, oce R&D capital has etered the capital stock, it is gradually removed by depreciatio (cosumptio of fixed capital). The empirical evidece o depreciatio rates for R&D assets is limited. The research that has bee carried out has either estimated depreciatio rates usig ecoometric models (for example, Berstei ad Mamueas, 2004) or usig a patet reewal method (for example, Pakes ad Schakerma, 1979). The little evidece that has emerged from both types of aalysis has o the whole produced a commo message that idustrial kowledge depreciates faster tha physical capital. Masfield (1979), Pakes ad Schakerma (1979) suggest there is little kowledge capital left after te years. Berstei ad Mamueas (2004) estimate that R&D capital depreciates at two to seve times the rate of physical capital. Berstei ad Mamueas (2004) cosider R&D depreciatio withi the cotext of itertemporal cost miimisatio, where depreciatio rates are estimated simultaeously with other parameters characterisig the overall structure of productio. They characterise R&D depreciatio as a geometric or decliig balace form. A geometric patter is a specific type of accelerated patter. A accelerated patter assumes higher depreciatio i the early years of a asset s service life tha i the later years. This compares with a straight-lie depreciatio patter that sees equal depreciatio over the life of the asset. The justificatio for this comes from a series of papers by Griliches (1979, 1990 ad 1995). Griliches gives two mai justificatios for this: there is approximately a cotemporaeous lik betwee R&D ad the services emaatig from this ivestmet through iovatio ad ivetio typically, iovatio ad ivetio are short-lived, ad replaced at a rapid rate These imply that efficiecy declies relatively fast i the early part of the service life of R&D ivestmet, ad therefore R&D depreciatio approximates decliig balace. Nadiri ad Prucha (1996) estimate a geometric depreciatio rate of 12 per cet for the US maufacturig sector. They estimated a model of factor demad that allowed for estimatig joitly the depreciatio rates of both physical ad R&D capital for the US total maufacturig sector. Their 12 per cet estimate of depreciatio is very close to the ad hoc assumptio usually used as a startig poit i most empirical aalysis, 15 per cet. They used oly gross ivestmet data to geerate estimates of the depreciatio rates as well as cosistet series for the stocks of R&D capital. The 12 per cet estimate is ot too dissimilar to studies that use R&D capital stocks as a iput i the productio fuctio, Griliches (1980) ad Berstei ad Nadiri (1988, 1991). O average, the estimates for depreciatio rates of R&D stock i empirical literature rage from 10 to 25 per cet, though these ted to be for certai sectors of the ecoomy. This correspods to a average service life of about five to te years. Here, a depreciatio rate for the busiess sector is estimated usig ecoometric methods. The method will be to look at the impact past R&D has o output (gross value added at market prices) to assess the rate of depreciatio. That is, if R&D udertake five years ago has, o average, zero impact o value added today, the the life legth mea of R&D ca be deduced as beig five years. The followig equatio was estimated: GVA t α s C t s + N t + K t S1...T where GVA t is the chage i gross value added from time t to time t 1, C t is ivestmet i R&D, K t is other capital iputs ad N t is labour iput. Clearly there are various ecoometric issues surroudig the estimatio of the equatio above but these will ot be discussed here. 20 Office for Natioal Statistics

6 Ecoomic & Labour Market Review Vol 1 No 2 February 2007 Treatig research ad developmet as a capital asset Estimatig research ad developmet capital stock With costat price R&D GFCF ad a estimated depreciatio rate, it is easy to estimate the R&D capital stock. The PIM is used to calculate the R&D capital stock with a assumptio of geometric depreciatio, ad the methodology of Guellec ad Va Pottelsberghe (2004) is used for calculatig the et R&D capital stock i the iitial year. Details are provided i the techical ote at the ed of this article. UK data sources Busiess Eterprise Research ad Developmet (BERD) The BERD survey is a aual survey desiged to measure R&D expediture ad employmet i the UK. Sice 1995, it has used a stratified radom sample, stratified by product group ad employmet sizebads, where sizebad 1 (400+) is sampled 1:1, sizebad 2 ( ) is sampled roughly 1:5 ad sizebad 3 (0 99) beig sampled roughly 1:20. These samplig fractios were reduced i 1998 as 400 more forms were made available for samplig. I the first stage of the samplig procedure, the largest 400 firms are chose ad i the 2003 survey this correspoded to those eterprises doig more tha 2.6 millio of R&D. These compaies have either bee idetified from previous returs or from oe of the other data sources. These 400 firms are the set a log form (a log form is simply a survey form that has a larger umber of questios tha a short form). There are a umber of sources that cotribute towards the samplig frame for the BERD. The Aual Busiess Iquiry survey asks a filter questio about whether or ot a firm egages i R&D. The Departmet of Trade ad Idustry ad Scottish Executive provide ONS with R&D iformatio o compaies. Fially, the press is used to idetify firms that are coductig R&D ad these are added to the samplig frame. For those firms ot receivig a log form, they are broke dow ito the remaiig two employmet sizebads metioed above. Eterprises are the selected radomly from each sizebad usig the samplig fractios applicable to that bad. Those idetified are the set a short form. For o-selected firms, data is imputed o the basis that these eterprises have the same R&D to employmet ratio as selected reportig uits i their class. Aual Respodets Database (ARD) The other mai source used is the ARD. This is a data set that combies iformatio from ONS busiess surveys over time ad cotais a variety of useful variables, such as turover ad employmet. Robjohs (2006) provides further detail o this data set, how it ca be liked to other surveys such as the BERD, ad recet developmets. Natioal Accouts data For the tagible capital used i the R&D process, data o life-legth meas ad deflators is available from the Natioal Accouts. Give a life-legth mea for each type of tagible capital asset, the depreciatio rate ca be calculated as follows: δ d/t where d is called the decliig balace rate ad T is the life-legth mea. d will differ across asset types, ad the decliig balace rates for differet asset types ca be foud i Wallis (2005). Whe d2, as it does for itagibles such as R&D, there is what is referred to as the double decliig balace method. Capital services data The estimates of capital services growth ad retals are based o Wallis (2005). Some aggregatio was required to get from the 57 idustries at which capital services estimates are published to the required 33 R&D product groups. Updates to the capital services estimates i Wallis (2005) will be published i a forthcomig issue of Ecoomic & Labour Market Review. Table 4 Busiess ivestmet i R&D billio UK estimates Busiess ivestmet i R&D ad the R&D capital stock Table 4 shows estimates for GFCF usig three differet methodologies ad compares them with the curret R&D expediturebased measure as published i ONS (2006), Research ad Developmet i UK Busiesses (MA14). Table 4 shows that all three methods give GFCF above the MA14 estimate of total R&D expediture. This meas that the flow from the other capital assets beig used as part of the R&D process, plat ad machiery, ad lad ad buildig, is greater tha the expediture o these assets. This reflects the fact that ivestmet i the stock of these assets is greater tha the depreciatio of the stock, that is, there is a icreasig stock of other assets that are beig used i the R&D process. The mai thig to ote from Table 4 is that the results from the three methods are quite similar. This meas that despite methods 2 ad 3 beig preferable o theoretical grouds, as they directly measure capital services flows, usig method 1 would give robust estimates. It is expected that some coutries would ot have the required capital services data to implemet methods 2 or 3. Research ad developmet deflator Figure 2 shows the estimated deflator for busiess sector R&D agaist the UK GDP deflator. A GDP deflator is commoly used i empirical studies as a proxy for a R&D deflator. It is clear from Figure 2 that the two differ quite a bit, suggestig that the GDP deflator is ot a good proxy. Idustryspecific deflators were also produced ad these showed sigificat differeces betwee idustries. Year MA14: total Method 1 Method 2 Method 3 R&D expediture Source: MA14 (ONS, 2006), methods 1, 2 ad 3 are authors ow calculatios Office for Natioal Statistics 21

7 Treatig research ad developmet as a capital asset Ecoomic & Labour Market Review Vol 1 No 2 February 2007 Figure 2 GDP deflator ad estimated R&D deflator Idex ( ) GDP deflator Research ad developmet depreciatio rate Prelimiary results are based o a pael of idustry data for the period 1998 to From this idustry-level pael, a busiess sector depreciatio rate was estimated. I future it is plaed to use a firm-level pael to estimate idustry-specific depreciatio rates. Table 5 shows the results of the chose regressio specificatio. As the fourth lag of R&D ivestmet is isigificat, the results suggest a life legth mea for UK R&D of four years. If a decliig balace rate of two is assumed ad the formula for depreciatio discussed already (δ d/t) is used, this implies a depreciatio rate for UK R&D of 50 per cet, a rate much higher tha those rates preseted i the empirical studies discussed above. Although these results are prelimiary, they do suggest that the approach could provide sesible estimates of depreciatio for R&D capital followig further developmet ad ivestigatio. It should also be oted that this is a busiess sector depreciatio rate ad there could be substatial idustry variatios. Research ad developmet capital stock Table 6 shows estimates of busiess sector R&D capital stock whe a depreciatio rate of 15 per cet is used (the most commoly assumed depreciatio rate i R&D deflator empirical studies). Table 7 shows estimates of UK busiess sector R&D capital stock usig a 50 per cet depreciatio rate, as estimated above. Clearly, the impact of usig differet depreciatio rates is very large. Cotributio of research ad developmet to productivity growth After capitalisig R&D, it is importat to look at the impact this would have o productivity, as this ca be used to help justify its treatmet as a asset. The retur of R&D ivestmet was estimated usig a firm-level pael created by mergig BERD ad ARD data for the period 1998 to The fial data set used i the productivity aalysis cotaied 16,095 firms. The startig poit was a model commo to a lot of empirical studies of the R&D cotributios to productivity growth, a exteded Cobb-Douglas productio fuctio icludig time treds ad firm specific effects: Y AN α1 K α2 K α3 E T R Table 5 Regressio results for depreciatio estimatio where Y is a measure of value added, K T is capital iput (excludig R&D capital), N is labour, K R is R&D capital, A is a parameter represetig spillovers (proxied by the sum of R&D withi the idustry) ad E is a error term. Takig logs ad addig both Depedet variable: chage i gross value added Lag of R&D expediture Coefficiet Stadard error t-value Lag Lag Lag Lag Lag Table 6 Busiess R&D capital stock, 15 per cet depreciatio billio Year Method 1 Method 2 Method Source: Authors ow calculatios Table 7 Busiess R&D capital stock, 50 per cet depreciatio billio Year Method 1 Method 2 Method Source: Authors ow calculatios a firm idex i ad a time subscript t, the equatio becomes: Y it a + α 1 it + α 2 k T,it + α 3 k R,it + e it A simple regressio (equatio 1 i Table 8) gives a estimated elasticity of per cet o R&D capital. This implies that a 10 per cet icrease i R&D capital is associated with a icrease i productivity of 0.95 per cet. The simple regressio aalysis was exteded to allow for differet dummies, icludig iteractio dummies, to accout for a distictio betwee services ad maufacturig idustries ad to accout for foreig owership (US, Japa ad Europe). Equatios 2 to 6 i Table 8 show the resultig estimated regressios. Equatio 2 shows that there is a average differece betwee services ad maufacturig productivity, with services more productive. Equatio 3 shows the results of icludig a iteractio dummy for services ad the R&D capital stock. The result suggests that a icrease i R&D capital stock leads to a bigger icrease i productivity for services tha for maufacturig although the differece is ot statistically sigificat at covetioal levels. 22 Office for Natioal Statistics

8 Ecoomic & Labour Market Review Vol 1 No 2 February 2007 Treatig research ad developmet as a capital asset Table 8 Regressio results for productivity impacts of R&D Equatio N K T K R Services UK US Japa EU Fraumei B (1997) The measuremet of depreciatio i the US Natioal Icome ad Produce Accouts, Survey of Curret Busiess, July Spillovers 0.64*** (26) 2 Services dummy 0.69*** (29) 0.33*** (21) 0.29*** (18) 0.095*** (8.76) 0.061*** (6.35) 0.12*** (2.75) /a /a /a /a /a /a /a /a /a Griliches Z (1979) Issues i Assessig the cotributio of R&D to productivity growth, The Bell Joural of Ecoomics 10, pp Iteractive services dummy 0.69*** (29) 4 Coutry dummies 0.67*** (28) 5 Coutry dummies 0.67*** (28) 6 Iteractive coutry dummies 0.67*** (28) 0.29*** (18.4) 0.32*** (20.7) 0.32*** (20.7) 0.32*** (20.7) 0.061*** (6.15) 0.066*** (7.12) 0.066*** (7.12) 0.05*** (4.2) (1.85) /a /a /a /a /a /a /a /a /a /a 0.20*** (4.94) /a 0.25*** (4.75) 0.32*** (5.87) 0.39*** (5.70) 0.12 (1.27) (1.72) 0.08 (1.42) (1.52) Griliches Z (1981) R&D patets ad productivity, NBER, The Uiversity of Chicago Press. Griliches Z ad Mairesse J (1981) Productivity ad R&D at the firm level, i: Z Griliches (ed.) R&D, patets ad productivity, The Uiversity of Chicago Press. Note: t-value i paretheses, *** sigificat at 1 per cet level, ** sigificat at the 5 per cet level. Griliches Z (1992) The search for R&D spillovers, NBER Workig Paper No. W3768. Takig accout of firm owership suggests that UK firms add more to productivity. The base i this regressio is all firms ot UK-, US-, Japa- or EU-owed. Fially it appears that UK-owed firms ad US firms have a additioal effect from a icrease i the R&D capital stock o productivity over ad above other coutries. Coclusios ad future work This article has addressed several issues ivolved i the capitalisatio of R&D for the UK Natioal Accouts. Three separate methods were preseted for calculatig R&D GFCF. The results preseted i Table 4 show that estimates are robust to the three methods. The estimate for a busiess sector R&Dspecific deflator showed that the use of a GDP deflator i R&D capitalisatio calculatios is ot a accurate proxy. Prelimiary results imply a depreciatio rate for UK busiess R&D of 50 per cet. This is a somewhat higher rate of retur to UK R&D tha that estimated i empirical studies to date. However, these results are oly prelimiary ad more empirical ecoometric aalysis is eeded i this area. The most otable thig that comes out of work that has bee completed so far is that, ot oly is calculatig depreciatio rates the most difficult elemet, but also that the estimated R&D capital stock is more sesitive to the depreciatio rate tha it is to chages i the way R&D GFCF ad R&D deflators are calculated. Estimatig a whole ecoomy life legth mea usig idustryspecific data implied a depreciatio rate of 50 per cet. However, the ecoometric issues surroudig this early stage estimatio are ackowledged. Firm-level data gave a estimated elasticity of per cet o R&D capital. This implies that a 10 per cet icrease i R&D capital stock is associated with a icrease i productivity of 0.95 per cet. Note 1. This article presets the curret stage of a ogoig project joitly fuded by ONS ad Eurostat. As such, its cotet is work i progress ad we would welcome commets ad suggestios. All the aalysis preseted here was carried out before the latest ONS BERD data revisios. The statistical data preseted here is Crow Copyright ad is reproduced with the permissio of the Cotroller of HMSO ad the Quee s Priter for Scotlad. Opiios expressed here are those of the authors ad do ot ecessarily represet the views of HM Govermet. A loger, more techical, versio of this article will be available i a forthcomig issue of Statistika Joural for Ecoomy ad Statistics. Cotact [email protected] Refereces Aspde C (2005) Update to the 1993 SNA. Berstei J I ad Mamueas T P (2004) R&D depreciatio, stocks, user costs ad productivity growth for US kowledge itesive idustries. Camero G (1996) O the measuremet of real R&D Divisia price idices for UK Busiess Eterprise R&D at uk/users/camero/papers/defl.pdf De Ha M ad Va Rooije-Horste M. (2005) Measurig output ad capital formatio i ope ecoomies, Statistics Netherlads. Guellec D ad Va Pottelsberghe B (2004) From R&D to Productivity Growth: Do the Istitutioal settigs ad the source of fuds of R&D matter?, Oxford Bulleti of Ecoomics & Statistics 66(3), pp Hall R E ad Jorgeso D W (1967) Tax Policy ad Ivestmet Behaviour, America Ecoomic Review 57(3), pp Madler P ad Peleg S (2003) R&D software, Paper preseted at secod meetig of the Caberra II Group, OECD (Paris). Masfield E (1987) Price idices for R&D iputs, , Maagemet Sciece 33(1), pp Nadiri M I ad Prucha I R (1993) Estimatio of the depreciatio of physical ad R&D capital i the US total maufacturig sector, NBER Workig Paper No. W4591. Office for Natioal Statistics (2006) Research & Developmet i UK Busiesses (MA14) at commerce/ma14_2004.pdf Orgaisatio for Ecoomic Co-operatio ad Developmet (2001) Measuremet of capital stocks, cosumptio of fixed capital ad capital services. Orgaisatio for Ecoomic Co-operatio ad Developmet (2002) Frascati Maual: Proposed stadard practice for surveys o Research ad experimetal developmet. Pakes A ad Schakerma M (1979) The rate of obsolescece of kowledge, research gestatio lags, ad the private rate of retur to research resources, NBER Workig Paper No. W346. Peleg S (2006) Harmoizatio betwee R&D Statistics ad the Natioal Accouts, Paper preseted at the NESTI/Caberra II meetig i Berli, Germay, May 31 to Jue 1. Office for Natioal Statistics 23

9 Treatig research ad developmet as a capital asset Ecoomic & Labour Market Review Vol 1 No 2 February 2007 Robbis C A (2006) Likig Frascati-based R&D Spedig to the System of Natioal Accouts, Bureau of Ecoomic Aalysis Workig Paper, WP ad at gov/bea/papers/robbis_06_sna_fras.pdf Robjohs J (2006) ARD2: the ew Aual Respodet Database, Ecoomic Treds 630, pp43 51 ad at article.asp?id1556 Rogers M (2006) Estimatig the impact of R&D o productivity usig the BERD-ARD data at Wallis G (2005) Estimates of the volume of capital services, Ecoomic Treds 624, pp42 51 ad at article.asp?id1297 Techical ote Methods for estimatig R&D gross fixed capital formatio Method 1: Cosumptio of fixed capital (COFC) plus a assumed retur I method 1, the estimate of R&D GFCF is calculated as the followig: GFCF t CP CP CP ( C t + I at ) I at + COFC at + R at a a a a where C t is curret expediture o R&D, I CP is curret price ivestmet i the asset type a beig at used i the R&D process (usig UK data oly two asset types ca be idetified lad ad buildigs, ad plat ad machiery), COFC at is the cosumptio of asset type a beig used i the R&D productio process ad R at is the assumed retur o asset type a beig used i the productio process. COFC i time t for a asset of type a is give by the followig: COFC at K. at δ a where K at is the et stock of asset type a at time t ad δ a is the rate of depreciatio of asset a. To calculate a et stock for each asset type, the perpetual ivetory method (PIM) was used. A geometric PIM was used to calculate et stock as follows: K at (1 δ a,t τ ) τ. I a,t τ τ0 where I is costat price ivestmet i asset a. I costructig this PIM the followig assumptio was made about the et capital stock i the iitial year, assumig a steady state: K a0 I a0 / δ a Fially for this model, a estimate of R at is eeded. The Australia Bureau of Statistics assumptio that the rate of retur o capital used i the R&D process is 5 per cet was used: R at K at Method 2: Capital services estimated usig retals I method 2, the estimate of R&D GFCF is calculated as the followig: GFCF t CP CP CP ( C t + I at ) I at + CS at a a a where variables are as defied above ad CS at is the capital service flow at time t from the asset type a beig used as part of the R&D process. Capital services refer to the flow of productive services from the stock of capital. Capital services estimates recogise that the same stock of capital may be used more or less efficietly. For method 2 CS at is calculated as the real level of capital services: CS at K at. r at where r at is the retal for asset a at time t. The retal is calculated usig the Hall-Jorgeso (Hall ad Jorgeso, 1967) formula for the cost of capital i discrete time t: r at T at [δ a. P at + R t P a,t 1 (P at P a,t 1 )] where P at is the price of a asset of type a at time t, δ a is the rate of depreciatio, ad R t is the rate of retur. T at is the tax adjustmet factor which is give by the followig: T at [ 1 u t D at] 1 u t 24 Office for Natioal Statistics

10 Ecoomic & Labour Market Review Vol 1 No 2 February 2007 Treatig research ad developmet as a capital asset where u t is the corporatio tax rate ad D at is the preset value of depreciatio allowaces as a proportio of the price of asset type a. Method 3: Capital services estimated usig capital services growth rates I method 3, the estimate of R&D GFCF is calculated as the followig: GFCF t CP CP CP ( C t + I at ) I at + CS at a a a This is as i method 2. Here, however, CS at is calculated usig a differet method. I the iitial year, the capital services iput to R&D is estimated usig the real level of capital services as i method 2: CS a0 K a0. r a0 Subsequet years are calculated as follows: CS at+1 CS at. g at for t 1,2,... where g at is the growth rate of capital services for asset a at time t. Estimatig research ad developmet capital stock A geometric PIM was used to calculate the R&D et capital stock as follows: RD t (1 δ t τ ) τ. GFCF t τ τ0 where RD t is the R&D capital stock at time t, GFCF t is costat price R&D GFCF at time t ad δ is the depreciatio rate of R&D (costat over time). The methodology of Guellec ad Va Pottelsberghe (2004) is used to calculate R&D et capital stock i the iitial year, RD 0. Guellec ad Va Pottelsberghe (2004) assume a costat aual rate of growth of past ivestmet: RD 0 with λ GFCF 0 1 λ(1 δ) η where η is the mea aual rate of growth of GFCF t. Office for Natioal Statistics 25