Rents And Intangible Capital: A Q Framework

Nicolas Crouzet and Janice Eberly, "Rents And Intangible Capital: A Q+ Framework," National Bureau Of Economic Research, July 2021, https://www.nber.org/papers/w28988

Comparison to existing literature“…These findings are qualitatively consistent with the recent literature arguing that pure profits as fraction of value added have been growing over the last three decades (Guti´errez and Philippon, 2017; Barkai, 2020; Karabarbounis and Neiman, 2019). However, they differ quantitatively. For instance, Barkai (2020) finds that the pure profit share rose from -5.6% in 1984 to 7.9% in 2014, an increase of 13.5 p.p. over the period. Karabarbounis and Neiman (2019), in their “case⇧,” find that the pure profit share must have risen by about 13 p.p. over the same period. We find an increase in rents of half that magnitude…”

On the paper’s limits, “…However, it has three limitations. First, it does not allow for non-convex adjustment costs. Second, it abstracts from financial constraints. The next subsection discusses extensions in this direction. Third, it assumes that rents, µ, are exogenous. In particular, they do not depend on past investment, in contrast, for instance, with models of customer capital.9 In this sense, our results are restricted to “neoclassical” models of the firm, and provide a benchmark against which the effects of other frictions on the investment gap can be compared….”

“… From the standpoint of the model, these changes are driven by three underlying forces,reported in Figure 2: a greater importance of intangibles in the production function; higher rents; and a decline in user costs, more pronounced for physical than for intangible capital.The top left panel of Figure 2 shows that even using the relatively narrow definition of intangibles in the NFCB data, the share of intangible capital in production,⌘, increased substantiallyafter 1985, from 0.17 to 0.29 in 2015.25 The behavior of the intangible share approximately mimics the behavior of the measured ratio of intangible to physical capital at replacement cost, which increases rapidly after 1985. The effects of the intangible share on the overall investment gap are magnified by the rise in rents after 1985. The top right panel of Figure 2 reports estimates of the rents implicit in Equation (13). In order to facilitate comparison with existing estimates, we express them as the flow value of rents relative to value added, which is related to the parameter controlling rents in the model...Rents, as a fraction of value added, increase from 1.5% in 1985, to 7.7% in 2015 — a cumulative 6.2 percentage point (p.p.) change over three decades. Expressed as markups over value added, this is an increase from 1.015 in 1985, to 1.083 in 2015. Finally, we note two other features of our time-series for the investment gap. First, the gap is elevated during the 1960s; the decomposition attributes this to a combination of low user costs (driven by the low interest rates of the period), and high rents.27 Second, the gap is particularly small during the 1975-1985 period. The model primarily attributes this reversal to the large increase in discount rate and the decrease in growth rates around the early 1980s, which, by reducing the present value of future rents, pushes the average value of installed capital closer to its marginal value….”

Specifically"...from a theoretical perspective, we show that the gap between average Q and marginal q for physical capital, which we call the “investment gap”, can be decomposed into three distinct terms: a term capturing rents to physical capital, a term capturing the value of installed intangible capital, and a term capturing rents to intangible capital. The last element of this decomposition, an interaction term that is new to our analysis, is particularly important: it clarifies the fact that rising rents and rising intangibles cannot be meaningfully analyzed in isolation, as their interaction contributes to the gap between investment and returns. Moreover, this decomposition is very general, as our framework nests a number of existing investment model..."

Second:"..we show that this interaction term is empirically important to the recent rise in the investment gap. Importantly, we show how each term in our decomposition can be quantified using data on profits, investment, valuations, and estimates of the intangible capital stock within the structure of the model. In aggregate data, the interaction term accounts for between one-quarter and one-half of the investment gap, depending on how broad the definition of intangibles is. In addition, our approach leads to lower estimates of the increase in total rents than existingwork. As we show, this is equivalent to a smaller estimate of the decrease in total user costs of capital. This occurs because while including intangibles raises valuations, it also boosts the user cost of capital due to higher depreciation rates (hence reducing rents)...."

Evidence, “…Figure 1 reports the investment gap decomposition... The decomposition emphasizes three main finding. First, the investment gap is large during two distinct periods: 1960-1970, and after 1985. The wedge between average Q and marginal q is therefore not strictly a hallmark of the post1980s period. Second, rents attributable to physical capital — the first term in Equation (13) — play a sizable (though somewhat declining) role in explaining the investment gap: they account 61% of it in 2015, compared to 67% in 1965.24 Third, rents attributable to intangibles — the third term in Equation (13) — have become markedly more important in recent years. In 2015, 25% of the investment gap reflects the combined effects of high rents and a large stock of intangibles, compared to 10% in 1965, using the BEA measure of R&D capital only, the narrow measure of intangibles available in these data….”

Core takeaway, "...This research provides a general decomposition of the gap between average Q — which is observable — and marginal q — the shadow value that drives investment. This decomposition captures the effects of unmeasured capital, such as intangibles, and also the effect of rents. We use measurement of the gap to shed light on the growing divergence between physical investment and valuations, which our approach interprets as being driven by the combined effects of growing rents and growing intangible capital. With a relatively narrow measure of intangibles (R&D capital), one-third of the investment gap reflects a combination of growth in the intangible capital stock and rents generated by intangible capital. Expanding the definition of intangibles beyond R&D increases this contribution to about two thirds. In addition to these aggregate effects, sectoral results show that rents on intangibles are largest in some of the fastest growing sectors in the economy, such as Tech and Health, and that within these sectors, rents are highest in subsectors with rapid growth in intangibles, as well…”

New NBER argues that the capital investment shortfall in the US has been driven by the rise of intangible capital which allow firms with market power to extract more rents. They estimate that 1/3 of the gap in capital investment is driven by intangibles particularly in fast-growing sectors, "... the divergence between returns and investment can be cast as a rising gap between the average value of business capital, or Tobin’s average Q, and its marginal value, or Tobin’s marginal q. We directly observe rising average Q in the data, via market values, while marginal q is a shadow value measured implicitly by lackluster investment. A gap between the average value of capital and its marginal value can arise and grow for a number of reasons..."