Fact of the Week: Intangible Capital Investments Increase Production More Than Twice as Much in Services as in the Product Sector

Source: Roth, et al., “Intangible Capital and Firm-Level Productivity – Evidence from Germany,” Hamburg Discussion Papers in International Economics, January 2021.

Commentary: As advanced economies continue to digitalize systems of production and business operations, firms face wider ranges of investment opportunities beyond traditional capital. Investments made in workplaces or machines are still essential to a firm’s capital stock, but productivity growth is increasingly being driven by firms’ investments in intangible capital. That encompasses a broad category of expenditures that do not themselves return material assets, such as investments in software, databases, advertising, research and development, and labor training. These investments add greater value to firms’ output and productivity as their competing markets become more digitally driven. To provide further context on the evolving relationship between intangible capital investments and productivity as well as on firms’ incentives to choose whether to invest in tangible or intangible capital, three economists with the University of Hamburg conducted econometric research on firm-level production in Germany.

They reviewed firm-level data from the Community Innovation Survey from 2006 to 2018 to build regression models of firm production output against different forms of capital investment. Their regression results provide measurements of elasticity between forms of capital investment and production, indicating the productivity growth associated with greater capital investments. Their report found that the production elasticity of intangible capital investment was 0.022 for firms within the product sector and 0.046 for service sector firms. Effectively, a service-sector firm’s intangible capital investments are twice as useful for expanding production as a goods-producing firm’s investments. Further econometric analysis showed that intangible capital investment was highly significant and positively correlated with overall firm-level productivity. Service-sector firms likely benefit more from intangible capital than goods-sector firms because industries like business services and telecommunications achieve higher marginal benefits from data usage and labor training than goods-sector firms whose production is more narrowly defined by fixed capital assets and low-skilled labor, making the service sector more highly intangible-capital intensive. Germany’s firm-level production findings are emblematic of ongoing transitions of advanced economies becoming driven by information rather than fixed capital.