Productivity and innovation in UK financial services: an intangible assets approach

Abstract

Financial services are typically described as highly innovative (indeed excessively so according to some commentators). Case studies suggest very high innovation around IT, software and the internet, and new products including those via financial engineering. However, it is hard to see this by many standard IO and productivity measures. Patenting for financial products (at least in the UK) is almost zero. R&D as a fraction of sales in UK financial services is 0.02%, putting finance (on this measure) less innovative than furniture manufacture (0.3%). Whilst measured labour and total factor productivity growth have been quite rapid, there are doubts over measurement and the residual nature of TFP growth leave open the question of what drives financial innovation. This paper looks at innovation in UK financial services by trying to bring together the industry productivity/TFP literature with some of the case study evidence. Such evidence suggests that much financial innovation (a) can be readily copied and (b) requires investment in product development, software, marketing, training and organisational change. Whilst copying can be captured by TFP, these investments are almost certainly not captured by conventional R&D. Thus we follow the Corrado, Hulten and Sichel (2005) intangibles framework and measure the broad range of intangible/knowledge assets that case studies suggest are important in finance. We document these investments are very large in UK finance, and that conventional R&D understates them. Incorporating them into the growth accounting picture we show the method seems to capture much of innovation in financial services and changes the productivity/TFP growth picture to give more intuitive numbers.