Look to the intangibles

By Jonathan Haskel and Stian Westlake

Jonathan Haskel is a professor of economics at Imperial College, and Stian Westlake is executive director of policy and research at Nesta.

“The structure of the British capital markets has contributed to corporate goals that do not support investment and innovation”. -Michael Porter, "The Competitive Advantage of Nations" (1990)

“Deep-seated short-term attitudes… have led us to invest less than we might in technology and advanced means of production”. - Michael Heseltine, speech in Parliament (1993)

“All corporate Britain is infected by the same bias: …under-investment and lack of innovation”. – Will Hutton, The Observer (2011)

“If Britain is to remain a G20 economy, it must start investing like one.” – The Economist (2013)

BRITISH businesses have always underinvested, haven’t they? Experts from Michael Porter to Michael Heseltine to Will Hutton all agree. The idea is so old and so widespread as to be received wisdom

But is this truism really true? Over the last decade, researchers have gradually reached a surprising conclusion: when you take into account intangible investments, such as software development, product design and training, British businesses aren’t investment laggards after all.

Let’s first of all consider the case against UK plc. Exhibit A is our levels of private-sector fixed capital formation—the amount British firms invest each year in physical assets like machinery, buildings, computers and vehicles. This is lower than that of most other rich countries: it’s 13% lower than Germany, and 10% lower than France, relative to the size of the private sector. The second problem is business research & development (R&D): UK plc does less than businesses in France, Germany or Scandinavia, not to mention the US.

Combining these data seems to confirm the worst fears British business’s critics: we lag severely behind most of our major competitors. It’s perhaps unsurprising that they propose increased capital allowances, state investment banks, and wholesale changes in corporate governance and management.

But wait a minute. Not every investment that a company makes is into something you can stub your toe on. The fears over Britain’s R&D levels are of course an admission of that. Some investments are, in economist’s jargon, “intangible”. But although you can’t touch them, they still involve spending money now in the hope of a benefit in the future. Whenever a business trains a worker, designs a new service, builds a database or produces something copyrighted, it is investing. So just measuring physical kit and R&D gives only an incomplete picture.

Starting in the last decade, macroeconomists and statisticians have made a concerted effort to understand the scale of these intangible investments. The concepts were set out in a 2006 paper by US economists Carol Corrado, Charles Hulten and Dan Sichel. Subsequent work by others (including one of the authors of this piece) extended this work, initially to the UK, and then, with the backing of the EU and the OECD, to a much wider range of rich countries.

The results are striking, especially in light of British investment pessimism. The UK turns out to be one of the leading investors in non-R&D intangible assets: things like product and service design, organisational investment and branding and marketing. This is perhaps unsurprising given the size of its services sectors: service industries typically invest more in other intangibles than on physical capital or R&D.

When we look at all forms of business investment together, the UK’s edge in intangibles changes its relative performance entirely. Far from being a laggard, it does rather well, demonstrating a higher level of total business investment than countries with widely admired economies, such as Germany and Finland.

“Why hasn’t the UK economy performed better, then?”, some might ask. “Better than what?” would be a fair reply. A London School of Economics assessment of British economic performance from 1997 to 2010 showed the UK’s productivity growth over the period was better than most other rich countries even taking into account the effect of the 2008 financial crisis.

There is no cause for complacency about the British economy. Aggregate demand remains low, which has led to low investment levels since 2008. Britain has well documented problems with skills and public infrastructure. And as in much of the world, inequality has risen greatly. But whatever problems we have, UK plc’s long-term unwillingness to invest doesn’t seem to be one of them.