# Presentation: 174189

## The U.S.R&D Satellite Account:Measurement Issues and R&D Satellite Account Methodology

**Sumiye Okubo **
**R&D Conference**
**December 13, 2006**

**Notes:**
Good morning everyone.  Welcome of the R&D Satellite Account conference.  We would like to get as much participation from everyone as possible today.

## Goals of Conference

- Solicit advice on conceptual framework and estimation methods
- To extend 2006 R&D satellite account methodology to improve 2007 estimates
- To improve framework and data sources in order to incorporate R&D into the national accounts over the next five years
- Several thorny issues

**Notes:**
We have a number of issues that we need to address as we work towards incorporating R&D into the national economic accounts. 
For 2007, our plan to produce a prototype industry R&D SA requires that we develop a framework and determining what data are needed to estimate the account. 
We also want to look at the income side more closely than we did for the 2006 version, and work towards an internally consistent set of accounts, in terms of rates of return, prices, depreciation, etc. in the coming year.
In addition, we need to include trade in the R&D SA – the imported R&D services minus exported R&D services.
We need to develop a roadmap on how to include R&D into the regional and international accounts.
We would like advice on how to resolve the thorny conceptual and methodological issues related to incorporating R&D into the core accounts.

## Purpose of R&D Satellite Account

- Treat R&D as investment
- R&D creates a future stream of benefits
- Appropriable R&D has the qualities of an economic asset
- Part of BEA program to improve    measures of intangibles in national accounts

**Notes:**
Although many of you are already familiar with the 2006 R&D SA, I will provide a very brief summary of how we estimated the R&D SA, review some of the results, and then outline the issues we need to address in order to accomplish our goal of incorporating R&D into the core accounts.
This project is part of the BEA program to improve measures of intangibles in the national accounts and adapt its measures of economic activity to changes in the structure of the economy.
Progress on Intangible Investment in BEA’s accounts 
Software treated as investment 1999
R&D treated as investment
BEA satellite accounts, 1994, 2002, 2005 – the 2006 R&D SA extends our earlier work.
BEA has begun work to produce prototype estimates of Education, human capital, and medical care

## Changes in National Accounts

- Capitalizing R&D expands scope and rearranges the accounts:
- R&D expenditures funded by business reclassified from intermediate inputs to business investment, and business income rises
- R&D expenditures funded by Nonprofits and Government transferred from consumption to investment
- Services of nonprofit and government R&D capital increase

**Notes:**
To quickly summarize the changes in the national accounts in capitalizing R&D:
Reclassify business R&D from intermediate input to business investment, GDP rises and business income rises.
Transfer nonprofit and government R&D from consumption to investment, increase GDP by R&D CFC.
Increase current measure of GDI by increase in services of nonprofit and government R&D capital.

## Overview of Estimation Method for R&D Stocks

- Sum input costs
- Include a charge for depreciation of fixed assets
- Assign investment to owning sector using funder information
- Deflate nominal investment
- Create capital stocks with perpetual inventory method

**Notes:**
The estimates of R&D stocks presented in this paper are prepared by 
Remove any capital expenditures from the data to avoid double counting    
 summing the input costs, 
 adjusting these expenditures to include the depreciation cost for the use of structures, equipment, and software for R&D investment 
 assigning the investment to the owning sector based on information about the funder. Because existing R&D survey data are insufficient to completely identify ownership, BEA has two immediate choices, the funder and performer perspectives. In this satellite account, BEA adopted the funder perspective to represent ownership. This reflects the view that the funder of R&D usually gains the direct economic benefits.  
The costs were deflated to develop real (price-adjusted) R&D investment, 
 cumulating this investment into a capital stock with an annual depreciation rate, using the perpetual inventory method, 
We developed alternative scenarios to adjust for know characteristics of R&D – high rates of return, declining prices of products incorporating R&D, shorter service lives; 
 We then estimated the changes on investment and savings, on growth, on profits or gross operating surplus, and on government and nonprofits. 

## Impact on Investment and Saving

- Capitalizing R&D raised
- Current dollar gross private domestic investment by 11 percent in 2002
- Adjusted national savings rate 2 percentage points, from 14 percent to 16 percent in 2002

## Impact on Growth

- Capitalizing R&D increases current GDP by 2 1⁄2 percent and real GDP growth by a tenth of a percentage point
- R&D investment accounts for 41⁄2 percent of real GDP growth between 1959-2002
- R&D investment accounted for 61⁄2 percent of real GDP growth between 1995-2002

**Notes:**
Treating R&D as a business investment, rather than an expense, has a substantial impact on the measure of GDP and its components.
Capitalizing R&D increases current dollar GDP by an average 2 1/2 percent for the US, and the growth rate of real GDP by 0.1 percentage point.  This increase is similar to those obtained by other countries, such as Israel, Canada, Netherlands, and Australia.
R&D investment and income flows accounted for 4 1/2 percent of the growth rate of real GDP between 1959-2002, and contributed to the resurgence in GDP growth between 1995-2002, accounting for 6 1/2 percent of growth. These estimates do not vary a lot across the scenarios.

## Impact on Profits/Gross Operating Surplus

- Treating R&D as investment rather than intermediate inputs
- Increases investment and GDP
- Raises Gross Operating Surplus and GDI
- Increases the share of gross operating surplus to GDI 2 percentage points from 36 percent to 38 percent.

**Notes:**
Capitalizing R&D raises the share of gross operating surplus or non-labor income by an average 2 percentage points from 36 percent to 38 percent over the 1959 to 2002 period.  
This is one area that requires much more work: The distribution of profits and returns to R&D versus non-R&D across industries has not worked out.
How de we determine the return to R&D when we do not have the return to other assets, across asset types?

## Impact on Government and Non-Profits

- NIPAs include only CFC for capital investment of government and nonprofits
- The 2006 R&D Satellite Account adds a net return to government and nonprofits

**Notes:**
The current NIPA and SNA treatment is to recognize only CFC, implicitly assuming a zero net return to this investment.  
We explored the impact on GDP of including a net return to government and nonprofit R&D capital – assuming a return to government and nonprofit R&D that is estimated using a long run average rate from 10-year government securities, adjusted to reflect a higher return to R&D relative to other type of investments.

## Schedule

- Feasibility Study of Industry R&D Satellite Account, Spring 2007
- Revised R&D Satellite Account, September 2007
- Between 2007-2012, new source data and extensions to other account areas
- BEA plans to incorporate R&D into the I-O accounts in 2012 and the NIPAs in 2013

**Notes:**
Our schedule over the next ten years:
Produce a Feasibility study of industry R&D SA, Spring 2007
Release the revised R&D SA September 2007
Between 2007-2012, we will be working on new source data and extensions to other accounts areas – regional and international.
Beyond 2007, we will be working on Conceptual and methodological issues – including a full production account and measurement of full capital services for R&D and non-R&D assets

## Issues to be addressed

- Measuring R&D
- Measuring R&D investment returns
- Measuring R&D capital services and the production account

**Notes:**
We have outlined three major sets of issues.

## Measuring R&D

- Valuation in current and real dollars
- Cost approach
- Comparable market value approach
- Income or present discounted value approach
- Market valuation and spillovers

**Notes:**
We have little or information on market prices of R&D.  No commonly agreed upon unit of output measure of R&D.
R&D is like many intangibles is created primarily for internal uses, and not sold on the open market.
Therefore, there is no observable market price or quantity of R&D output.
Three approaches:
Cost Approach:  Consistent with NIPA estimating methods used for nonmarket output--for investment goods created internally for a firm’s own use and for the output of government and nonprofit entities -- measures output by the sum of costs expended to create it. Real estimates provide useful constant cost of producing R&D but does not provide information on R&D’s contribution to growth. 
Comparable Market value approach:  Comparable data on market value might be available at the firm level, but are generally not available in the aggregate or industry level.  We could infer an implicit market value based on market values such as equity prices or royalties and license fees.  No obvious method to estimate real value and contfibution to Real GDP and productivity. 
Income, or present discounted value, approach:  Indirect measure used to estimate discounted value of stream of income produced by intangibles, used in SEC filings of fair market value for intangibles.  Requires assumptions, firm-level estimates, or proxies for the discount rate on R&D, income stream produced by R&D, service life for R&D.
Market valuation and Spillovers:  We did not consider spillover benefits to other industries – consistent with NIPA and SNA proposed treatment.  Within the framework of a SA, is it useful to attempt to measure spillovers?  If so, how.  The conceptual framework should be broad enough to include spillovers from other types of assets, not just R&D.

## Measuring R&D Investment Returns

- Rate of return across asset types
- Rate of return to government and nonprofit R&D
- Depreciation

**Notes:**
Rate of return across asset types:  two assumptions adopted – (1) net return equalized across asset types does not allow for risk; (2) net returns higher for R&D compared to other assets requires an estimate of the appropriate risk premium.
Rate of return to government and nonprofit R&D:  The government appears to be more willing to invest in high-risk long-term projects than business, and therefore appears to have a different discount rate for R&D investment.  Is the real rate of return on long-term treasury bonds adjusted for net rate of return to govt and nonprofit funded R&D the appropriate rate?
Depreciation:  R&D is not homogeneous and the rate of depreciation varies due to obsolescence and life of R&D.  What classification framework for R&D would allow the rates to be separately developed – process improvement vs product development?  Basic vs applied research/  technology related?  Using industry related?

## Measuring R&D Capital Servicesand the Production Account

- Net rates of return
- Earnings of R&D assets versus other assets
- Ex ante versus ex post approach
- Asset boundaries and double counting
- Scope of R&D
- Ownership
- Assignment of ownership to funders rather than performers

**Notes:**
Net rates of return:  In the 2006 R&D SA we explored alternative scenarios to examine different assumptions about depreciation, price of R&D investment, and the nominal discount rate. BEA plans to develop a production account that includes R&D, and this requires being able to estimate capital user costs for R&D and non-R&D assets. Which approach is appropriate? 
Asset boundaries and double counting:  The 2006 R&D SA includes all R&D but did not determine how much had direct economic benefits to its owners.  Does this approach exclude R&D that could impact productivity?  We also need to consider overlap with R&D software development.  
Ownership:  The 2006 R&D SA assigned ownership to funders rather than performers in part because of the difficulties in tracing the numerous possible contractual relationships among performers.  But, assigning ownership to performers implicitly results in a subsidy from the funder to the performer.  Esp. important if we are talking about govt. funding.

## Other issues?

- Are there other issues that have not been raised that BEA should consider?

**Notes:**
We would like to know how you see the issues and priorities for producing the 2007 R&D Satellite Account and incorporating R&D into the core accounts five years from now.  We would allowed time to hear first from the panelists named in each session, and then from other panelists who would like to speak on each set of issues.