[GFCF software deflation | March 2015]
Author: Louisa Nolan, Office for National Statistics
Date: 26 March 2015
This article explains the improvement to the deflation of investment (gross fixed capital formation, GFCF) in software in the UK National Accounts which will be implemented in the
UK National Accounts (Blue Book) 2015. The improvement will have an impact on volume estimates of business investment, GFCF and gross domestic product (GDP).
Investment in software is a component of GFCF and business investment, accounting for around 10% of total GFCF and 15% of business investment (1997-2013, current prices). It includes both the production of software inhouse for own use (‘own account’) software, and investment in bought-in, pre-packaged software. The price evolution of these two components may be quite different.
From Blue Book 2013, software investment volume measures have been derived using the
Service Producers’ Price Index (SPPI) for product 62, computer consultancy, programming and related activities. Prior to this, it was deflated using the deflator for plant and machinery.
The Office for National Statistics consulted with a range of national and international experts and stakeholders, who made the following recommendations for Blue Book 2015:

the SPPI for product 62 is an acceptable price index for own account software

an additional price index should also be used to deflate the pre-packaged component of software investment

as no other appropriate price index is currently available, the US Producer Price
Index for pre-packaged software should be used for this component, adjusted for purchasing power parity.
This improvement will be implemented for Blue Book 2015. Other changes will also be made to the compilation of GFCF and business investment in Blue Book 2015, which will also have an impact on their levels and growth rates. These include: improvements to the estimation of major repairs to dwellings; the reclassification of Network Rail and Transport for London; improvements to the adjustments made to account for survey under coverage; updated source data for the costs of transfer of non-produced assets; improvements to the estimation of tax credits, a component in the estimation of research and development; and annual updates to source data. These changes will be described in articles published later in 2015.
Recommendations were also made for further work post-Blue Book 2015:

to explore the feasibility of producing a UK price index for pre-packaged software

to consider improvements to the deflation of own account software.
This article focuses on the changes for Blue Book 2015.
Indicative estimates of the impact of this change on volume measures of GFCF and business investment, based on data already publically available, suggest that the overall growth of GFCF between 1997 and 2013 will be revised upwards by 2.6 percentage points, and the overall growth of business investment will be revised upwards by 4.8 percentage
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[GFCF software deflation | March 2015] points over the same time period.
This article explains the improvement to the deflation of investment (gross fixed capital formation, GFCF) in software in the UK National Accounts which will be implemented in the
UK National Accounts (Blue Book) 2015. The change will have an impact on volume estimates of business investment, GFCF and GDP.
This change has been implemented to improve the conceptual coverage of the price indices used to deflate GFCF software. However, options for improvement in the short term are limited, and this change is the first step in a longer-term development plan. The UK is not alone in facing these challenges. As can be seen in Section 2.1, internationally, software price indices display a wide range of behaviour.
The Office for National Statistics (ONS) has created a Software Deflator Expert Group to advise on the deflation of software in the National Accounts. Members include national and international experts, and the changes to be implemented in Blue Book 2015 are based on the recommendations of the Group. Further, ONS has consulted with key users on the impact and timing of making these changes, and the changes to be implemented reflect a consensus from those discussions.
In the European System of Accounts 2010 (ESA 2010), and its previous incarnation,
ESA1995, investment in software is included in the definition of GFCF. Software is a component of the asset ‘intellectual property products’ (under ESA1995, this was intangible assets). The software asset definition includes both purchased software, either prepackaged or custom-built, and software produced by institutions in-house for their own use
(‘own account’ software).
In the UK, between 1997 and 2013, investment in software accounted for about 10% of total
GFCF, and 15% of business investment in current prices. GFCF is a component of the expenditure measure of gross domestic product (GDP). Total GFCF accounts for around 14-
15% of GDP.
Current price estimates of GFCF software are compiled from survey data from the Quarterly
Survey of Capital Expenditure, government administrative data, and modelling, including modelling of the mark-up for operating surplus on own account software. In current prices, about 50% of UK software is purchased, with the remaining 50% being own-account software, including the mark-up.
Prior to Blue Book 2013, GFCF software was deflated using a price index for plant and other machinery. In Blue Book 2013, this was updated to the more appropriate SPPI for product
62, which covers computer consultancy, computer programming and other related activities.
This accounted for around two thirds of the revision to the volume growth of business investment between 1997 and 2005 in the Blue Book 2013 estimates compared with Blue
Book 2012. A full description of the impact can be found in the article Explaining United
Kingdom Investment estimates: past, present and future .
The deflation of software presents some challenges. The only price index currently available in the UK is the SPPI for product 62, computer consultancy, programming and related activities. However, this does not conceptually cover purchased software, and is strictly a proxy for own account software. Given the technical improvements and advances in the
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[GFCF software deflation | March 2015] production of pre-packaged software over the last couple of decades, it may be that the price evolution of own account software is different from that of pre-packaged software.
The options for improving the deflation of GFCF software in the UK National Accounts are therefore to seek an appropriate international price index, making some adjustment for the
UK, or to develop a suitable UK price index.
In order to address the challenges of the deflation of software, ONS has created a Software
Deflator Expert Group, The membership of this group includes experts from the OECD, the
Bank of England, Imperial College and a range of National Accounts and prices experts from
ONS. The full list of members is given in Annex A. The objectives of the Software Deflator
Expert Group are to:

review the options for the deflation of software in the UK

make recommendations to be presented to the ONS National Accounts Methods
Advisory Committee
The National Accounts Methodology Advisory Committee is the approving body for changes to methodology in the National Accounts in the UK.
The Software Deflator Expert Group met in November 2014, and made the following recommendations:
1. the SPPI for product 62 is an acceptable price index for ‘own account’ software for
Blue Book 2015
2. an additional price index should be used, to deflate the pre-packaged component of software investment
3. as no other appropriate price index is currently available, for Blue Book 2015, the US
Producer Price Index for pre-packaged software should be used for this component, adjusted for purchasing power parity
4. further improvements to the SPPI for product 62 and the deflation of own account software should be considered in the longer-term
5. in the longer term, the feasibility of producing a UK price index for pre-packaged software should be explored.
Recommendations 1, 2 are 3 will be implemented for Blue Book 2015, and a continuing programme of development is planned to address recommendations 4 and 5.
The remainder of this article is set out as follows:
Section 2: the challenges of software deflation in the UK, including international comparisons
Section 3: data sources and methodology for Blue Book 2015
Section 4: the impact of the changes for Blue Book 2015
Section 5: conclusions
Section 6: future work
Section 7: contacts
Annex A: the software deflator expert group – list of members
Annex B: a comparison of international price indices used in the deflation of software
(OECD, 2004)
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[GFCF software deflation | March 2015]
‘Software’ consists of three different components: own account software, produced in-house; pre-packaged, off-the-shelf software; and customised software, which can be seen as a blend of the previous two components, where existing software packages are customised for specific purposes.
In the UK, data are collected for own account software, and purchased software. Purchased software includes both pre-packaged and customised software, but no data are available on the proportion of each within purchased software.
Ideally, each of the three components would be associated with a specific price index.
Alternatively, customised software could be decomposed into two components, consistent with own account and pre-packaged software.
For own account software, the SPPI for product 62, computer consultancy, programming and related activities is acceptable. The UK SPPI captures the prices of specified services for these activities, which, whilst not being conceptually consistent with the production of own account software, is a pragmatic proxy.
However, currently, there is no UK price index which is conceptually consistent with, or a good proxy for, pre-packaged software. In the short term, this leaves two options for the deflation of this component:

to continue to deflate pre-packaged software with the SPPI for product 62

to use the only available price index for pre-packaged software, the US PPI, adjusted for the UK using the purchasing power parity (PPP).
Figure 1 shows the UK SPPI, the US PPI and the PPP-adjusted US PPI.
The US is currently the only country which produces and makes available a price index specifically for pre-packaged software. It is a matched-model producer price index for prepackaged applications software. A matched-model price index is where one model of a particular good is priced at the same store at regular time intervals. The US PPI covers computer applications, including databases, spreadsheets and word processors, and also uses games as a proxy, as there is a large quantity of data on games. It is US based, but around 40% of software in the UK is purchased from the US. The US PPI shows falling prices between 1997 and 2013, reflecting technical improvements and improvements in the production and distribution of pre-packaged software.
The US PPI will be adjusted for purchasing power parity (PPP). The PPP is is the number of units of a country's currency required to buy the same amount of goods and services in the domestic market as a US dollar would buy in the United States. It is preferred to the exchange rate, as this can be volatile. In addition, software suppliers may not adjust prices for imported software by exchange rates for competitive reasons.
In contrast to the US PPI, the UK SPPI for computer consultancy, programming and related activities is fairly flat. This reflects rising wage costs, offset by increases in productivity.
Increases in productivity for this price index are captured because it is the price of specific services which are the components of this index, rather than the price of wages. This means that, if productivity increases, and more services are produced per unit of time, this increase in productivity will be reflected in the price of those services. It should be noted that, although this is an acceptable proxy for own account software, in the longer term, ONS will consider whether a more conceptually appropriate deflator can be produced.
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[GFCF software deflation | March 2015]
Figure 1: the US PPI for pre-packaged software, the US PPP-adjusted PPI, and the UK SPPI for product 62, which is currently used for the deflation of GFCF software, 2011=1
Although the use of a US-based deflator is not ideal for the UK, given the global market for software, and because the US PPI is conceptually better for pre-packaged software, with a more plausible price evolution than the UK SPPI, the recommendation of the Software
Deflator Expert Group was, in the short term, to use the US PPI for the deflation of prepackaged software in the UK.
In the longer term, ONS will investigate the feasibility of producing a UK PPI for purchased software. In the meantime, the recommendation from the Software Deflator Expert Group is to use the US PPI, adjusted for purchasing power parity (PPP) as it is more likely to reflect the price evolution of pre-packaged software than the SPPI for product 62.
Figure 2 compares the implied deflators for GFCF software across a range of countries with the UK SPPI and the US PPI. A wide range of behaviour is seen, from rising prices across the whole time period (Spain) to falling prices, more similar to the US PPI (Germany). Annex
B provides a short summary of the approach other countries were taking to the deflation of investment in software in 2004, from a survey carried out by the OECD. This is most recent available information for most countries, and it is likely that further development has taken place since the survey was carried out. However, it does show that internationally, a wide range of approaches have been used, which is reflected in the implied deflators presented in
Figure 2.
In 2004, there were several countries that made use of the US PPI, and in 2010, the OECD
Handbook on deriving capital measures of intellectual property products identified at least two countries, Australia and Canada, who were using the US PPI for pre-packaged software.
In addition, for its productivity database, the OECD uses the US PPI (adjusted for exchange rates) to generate capital stock estimates of software and estimates of capital services. This is partly to overcome the effects that differences in the underlying deflator used by countries for software may have.
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[GFCF software deflation | March 2015]
Figure 2: comparison of implied GFCF software deflators for a range of countries, compared with the UK SPPI and the US PPI for pre-packaged software, 2000=100, source: Eurostat, 2014
This section sets out the data sources and weighting methodology for the changes to the deflation of investment in software to be implemented in Blue Book 2015.
As discussed in Section 2, pre-packaged software will be deflated with the PPP-adjusted US
PPI for pre-packaged software. Table 1 lists the data sources for these components.
Table 1: data sources for the PPP-adjusted US PPI component
US PPI, pre-packaged software source
Table 9.4U, software investment and prices , US Bureau of Economic
Analysis
OECD Stat.Extracts
purchasing power parity
The new GFCF software deflator for Blue Book 2015 will be a weighted sum of the UK SPPI for product 62 and the PPP-adjusted US PPI for pre-packaged software.
The weights are derived as follows:
1. in the UK, on average (1997- 2014, current prices), around 50% of investment in software was produced on own account and 50% was purchased
2. of the purchased software, in the absence of further information, 50% is assumed to be pre-packaged and 50% customised
3. of the customised software, again in the absence of further information, 50% is assumed to be consistent with own account software, and 50% with pre-packaged software.
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[GFCF software deflation | March 2015]
This gives the following weights for the deflators:
PPP-adjusted US PPI 37.5%
UK SPPI 62 62.5%
Figure 3 shows the weighted GFCF software deflator to be implemented for Blue Book 2015, together with its component price indices. The new deflator shows falling prices since 1997, compared with flat prices in the current deflator, the SPPI for product 62.
Figure 3: the US PPP-adjusted PPI, the UK SPPI for product 62, and the weighted software deflator for GFCF software to be implemented for Blue Book 2015, 2011=1
An indicative estimate of the impact on the volume measures and growth rates of GFCF and business investment can be constructed using the new deflator. The approach is to take the published estimates of GFCF software, and deflate them using the new deflator to give an estimate of the new volume measure for GFCF software. The Blue Book 2014 volume measure for software can then be subtracted from GFCF and business investment published volume estimates, and the new estimate added. This analysis should be considered indicative only, because:

chained volume measures are not additive, except after the reference year (2011), but we have assumed that they are

the new volume estimate for GFCF software is strictly a constant price estimate, not a chained volume measure

for the estimate for business investment, no subtraction of the government component has been made, so, although the majority of software investment is nongovernment, the impact on business investment is slightly overestimated in these indicative figures.
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[GFCF software deflation | March 2015]
Figure 4: chained volume measures for total GFCF, business investment and software as published in Blue
Book 2014, compared with indicative estimates for Blue Book 2015, reference year = 2011
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[GFCF software deflation | March 2015]
Figure 5: implied deflators for total GFCF, business investment and software as published in Blue Book 2014, compared with indicative implied deflators for GFCF and business investment, and the new software price index for Blue Book 2015, reference year = 2011
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[GFCF software deflation | March 2015]
Figure 4 shows the indicative impact of the new software price index of GFCF, business investment and software volume measures. Figure 5 shows the indicative impacts on the implied deflators. Table 2 presents the same comparisons in tabular form. The caveats given above should be born in mind, but it is clear that the new software deflator, which reflects falling prices since 1997, unlike the current software deflator, which is broadly flat, will result in an increased estimate of volume growth for GFCF, business investment and software between 1997 and 2013.
Table 3 presents estimates of the impact of the change on the volume growth of these three measures between 1997 and 2013. Volume growth in software is much stronger in the new estimates. As software is a substantial proportion of business investment (around 15%) and
GFCF (around 10%), this is also reflected in the estimate of volume growth for both business investment and GFCF. The indicative estimates of the impact of this change on volume measures of GFCF and business investment, suggest that the overall growth of GFCF between 1997 and 2013 will be revised upwards by 2.6 percentage points, and the overall growth of business investment will revised upwards by 4.8 percentage points over the same time period.
Table 2: chained volume measures and implied deflators for total GFCF, business investment and software from Blue Book 2014, together with indicative estimates for Blue Book 2015, reference year = 2011
2005
2006
2007
2008
2009
2010
2011
2012
2013
1997
1998
1999
2000
2001
2002
2003
2004
BB14
GFCF
BB14 business
BB14 BB15 BB15 business
BB15 investment software chained volume measure
GFCF investment software indicative chained volume measure
£ million, ref year = 2011 £ million, ref year = 2011
219148
234054
239889
248115
244769
250837
258536
266891
127648
140533
142481
148252
140440
139910
141619
141105
15677
16560
17857
19129
22402
21619
22595
22652
215027
230462
236435
244012
240084
246791
255142
264007
123527
136941
139027
144149
135755
135864
138225
138221
11556
12968
14403
15026
17717
17573
19201
19768
271284
280162
294888
281041
240605
254861
260779
262697
271018
155863
145003
156813
162024
138653
143734
152338
158738
166368
23199
24098
24826
26247
24051
24625
26742
27469
28658
268792
277635
292958
279269
239328
254475
260779
263091
271551
153371
142476
154883
160252
137376
143348
152338
159132
166901
20707
21571
22896
24475
22774
24239
26742
27863
29191
BB14
GFCF
0.76
0.76
0.77
BB14 business
BB14 investment software implied deflator
2011=1
0.88
0.87
0.87
0.94
0.96
0.98
BB15 BB15 business
GFCF investment indicative implied deflator
0.77
0.77
0.78
2011=1
0.91
0.89
0.89
BB15 software price index
0.79
0.81
0.83
0.84
0.85
0.88
0.91
0.93
0.97
0.88
0.90
0.91
0.89
0.89
0.90
0.92
0.93
0.97
0.96
0.96
0.97
0.96
0.96
0.96
0.97
0.98
0.99
0.80
0.83
0.84
0.85
0.86
0.89
0.92
0.93
0.98
0.91
0.93
0.93
0.92
0.91
0.92
0.94
0.94
0.98
1.28
1.23
1.22
1.22
1.22
1.19
1.13
1.10
1.07
1.09
1.07
1.06
0.99
0.98
1.00
1.02
1.04
0.99
0.98
1.00
1.02
1.03
0.99
1.00
1.00
1.01
1.01
1.00
0.98
1.00
1.02
1.04
1.00
0.98
1.00
1.01
1.02
1.04
1.01
1.00
0.99
0.99
Table 3: volume growth of GFCF, business investment and software between 1997 and 2013 from the estimates published in Blue Book 2014, compared with indicative estimates for Blue Book 2015, reference year = 2011
BB14 volume growth 1997-2013 / % indicative BB15 estimates volume growth 1997-2013 / %
BB15 - BB14 difference / percentage points
GFCF
23.7
26.3
2.6 business investment
30.3
35.1
4.8 software
82.8
152.6
69.8
Following consultation with a range of national and international experts and users, ONS will implement the following recommendations for the deflation of ONS software in Blue Book
2015:

no change to the deflation of own-account software, which will be using the SPPI for product 62, computer consultancy, programming and related activities
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[GFCF software deflation | March 2015]

an additional price index will be used, to deflate the pre-packaged component of software investment

as no other appropriate price index is currently available, the US Producer Price
Index for pre-packaged software will be used for pre-packaged software, adjusted for purchasing power parity.
Indicative estimates of the impact of this change on volume measures of GFCF and business investment, based on data already publically available, suggest that the overall growth of GFCF between 1997 and 2013 will be revised upwards by 2.6 percentage points, and the overall growth of business investment will be revised upwards by 4.8 percentage points over the same time period.
This is not the only change to the compilation of GFCF and business investment which will be implemented in Blue Book 2015. Other changes will also have an impact on GFCF and business investment levels and growth rates. These changes include: improvements to the estimation of major repairs to dwellings; the reclassification of Network Rail and Transport for London; improvements to the adjustments made to account for survey under coverage; updated source data for the costs of transfer of non-produced assets; improvements to the estimation of tax credits, a component in the estimation of research and development; and annual updates to source data. These changes will be described in articles to be published later in 2015.
The change described in this article is the first step in a longer programme of review and development of the software price indices planned over the next few years. ONS will continue to consult with the Software Deflator Expert Group, to:

explore the feasibility of producing a UK price index for pre-packaged software

consider whether improvements can be made to the SPPI for product 62, and the deflation of own account software.
Louisa Nolan
Non-Financial Assets Branch
Office for National Statistics gcf@ons.gsi.gov.uk
+44 (0)1633 455250
The author would like to thank the members of Software Deflator Expert Group for their advice, and the ONS Methods Advisory Committee and colleagues at the Bank of England, the Office for Budget Responsibility, and the Department for Business, Innovation and Skills for useful discussion on this issue.
Office for National Statistics | Page 11

[GFCF software deflation | March 2015]
Nadim Ahmad - OECD
Belen Zinni - OECD
Gavin Wallis – Bank of England
Nick Oulton – Bank of England
Peter Goodridge – Imperial College, London
Jonathan Haskell – Imperial College, London
Jacqui Jones – ONS, National Accounts (until December 2014)
Ole Black – ONS, National Accounts (from December 2014)
David Matthews – ONS, National Accounts (until December 2014)
Louisa Nolan – ONS, National Accounts
Andy Banks – ONS, Office of the Chief Economic Advisor
Arthur Bennett – ONS, Office of the Chief Economic Advisor
Joe Murphy – ONS, Office of the Chief Economic Advisor
Matthew Luff – ONS, Office of the Chief Economic Advisor
Chris Hunt – ONS, National Accounts
Kat Pegler – ONS, Producer Price Indexes
Mark Stephens – ONS, National Accounts
Office for National Statistics | Page 12

[GFCF software deflation | March 2015]
Country Own-account Customised Pre-packaged
Australia Prices are assumed to fall by 6% a year.
Canada
Weighted average (2:1) of programmer labour costs and nonlabour inputs to the computer services industry
Weighted average of own- account and pre-packaged
(1:3)
Czech Republic Price indices for the output of the computer services industry
Average of U.S. index for pre-packaged adjusted for exchange rates. A new index is due for release next year
Denmark 1993-95
1996-97
Weighted average of labour costs and PC hardware (1:1).
Weighted average labour and PC hardware (3:1)
1998 +
Geometric average of labour and hardware (3:1)
Weighted labour and PC hardware (1:1).
Finland 1975-97
1998 +
Average earnings index for the computer services industry.
Weighted average of labour costs of the computer services industry and US pre-packaged software index adjusted for exchange rates (1:1).
France 1995 (-)
1995 +
US price index adjusted for exchange rates
Labour costs
Greece General (whole inflation) price index
Japan
Netherlands
Corporate Service Price Index for “the development of computer software tailored for corporations, based on the labour costs.
Labour costs of ICT personnel.
Producer price index Producer price index
Spain
UK
Sweden
Based on producer price index for office machinery and the general consumer price index (excluding renting)
Average earnings index for the computer services industry
Average earnings series adjusted for the computer services industry with 3% productivity adjustment since 1996. (SPPI for computer consultancy, programming and related services since
2013)
US
Weighted average
(roughly 1:1) of programmer labour costs and non-labour inputs to the computer services industry
Weighted average of own- account and pre-packaged
(1:3)
Matched-model price index with a downward adjustment of 3.3%
Office for National Statistics | Page 13