9.4 Gross fixed capital formation in machinery and equipment

General concepts

9.85 Gross fixed capital formation in machinery and equipment, is a key component of investment, accounting for 45% of gross fixed capital formation in 2000. It enhances productivity and potential output and contributes to economic growth. It is also one of the more cyclical components of GDP, as in an expansion and strong profit period when businesses consider modernizing or increasing their capacity either by purchasing equipment or by improving existing machinery to meet growing demand. In addition, since a large proportion of investment goods are imported, machinery and equipment has a substantial impact on the merchandise trade balance.

9.86 Table 9.7 presents the value of gross fixed capital formation in machinery and equipment for both the business and government sectors for the year 2000.

Table 9.7 Gross fixed capital formation in machinery and equipment, 2000. Opens in a new browser window.

Table 9.7
Gross fixed capital formation in machinery and equipment, 2000

9.87 In the Canadian System of National Accounts (CSNA), gross fixed capital formation in machinery and equipment comprises spending on produced durable goods that have a productive life of one year or more. Purchase, construction and installation costs are included for both the replacement and addition of assets. Assets are recorded as gross fixed capital formation in machinery and equipment whether they are owned or leased. The following costs are capitalized:

  • feasibility studies1
  • exploration and development costs;
  • tooling;
  • progress payments;
  • the net portion of purchases of used assets (vehicles, aircraft, other assets); and
  • an adjustment for scrap and salvage.

9.88 By definition, investment in machinery and equipment can be moved without altering the structure in which it is housed. Otherwise, it is regarded as an integral part of the structure itself and is included in gross fixed capital formation in non-residential structures.

9.89 Machinery and equipment investment is valued at purchaser prices (including taxes) and includes spending on smaller goods such as hand tools and office furniture, even though firms often treat these as current expenditures. Non-military investment expenditures for national defence are included in gross fixed capital formation in machinery and equipment, however strictly military expenditures such as tanks, are considered part of government current expenditure. In 2001, business and government investment in software was included in gross fixed capital formation in machinery and equipment, with estimates beginning in 1981.

9.90 Estimates published by the Income and Expenditure Accounts Division cover ten major groups for both the business and government sectors (see tables 22, 23 and 24 in the National Income and Expenditure Accounts). The categories for which data are published are as follows:

  • Furniture: office furniture and special-purpose furniture;
  • Agricultural machinery: tractors and other agricultural equipment;
  • Industrial machinery: industrial machinery such as pumps, compressors, furnaces and electric turbines;
  • Computers and other office equipment: computers and peripheral equipment and other office machines;
  • Software: own-account, pre-packaged and custom design software;
  • Automobiles: passenger cars;
  • Trucks: trucks and tractor trailers;
  • Other transportation equipment: locomotives, boxcars, ships, aircraft, buses, parts and equipment;
  • Telecommunications equipment: radar and equipment related to telephone systems and radio and television transmission systems;
  • Other machinery and equipment: other investment goods such as hand tools and medical and electric equipment.

Annual estimation methods and data sources

9.91 The annual benchmark estimates for gross fixed capital formation in machinery and equipment are obtained from the final demand matrix of the Input-Output Tables (IOT). The Industry Accounts Division (IAD) primarily uses information from the Investment and Capital Stock Division (ICSD) Capital Expenditure Survey (CES) by asset type.2 Analysts also draw on various annual industry surveys to calibrate the information. A comparison of the main information sources with all secondary sources, both at the industry and commodity level (a process known as balancing the Input-Output Tables), involves more than 100 investment goods. In the event of a significant imbalance between inputs or outputs, the source data and estimation methods are re-examined.

9.92 The Capital Expenditure Survey and the most recent Input-Output Tables are the main sources of information for the non-benchmark (t-2, t-1) years. Table 9.8 displays a reconciliation of the Capital Expenditure Survey machinery and equipment estimates and those published by Income and Expenditure Accounts Division. The following adjustments are made:

  • net additions;
  • sectoring;
  • software adjustments; and
  • Canadian System of National Accounts adjustments.

9.93 Net additions refer to investment capital projects not captured by the Capital Expenditure Survey. This small adjustment only accounts for about 1% of the Capital Expenditure Survey estimates.

9.94 The Capital Expenditure Survey data are subject to sectoring adjustments to ensure consistency with the CSNA definitions. These adjustments involve a reclassification from the private to the public sector (for example, universities and hospitals).

9.95 Another adjustment is made for software expenditures. The Capital Expenditure Survey provides a part of software investment – the already reported portion – while Industry Accounts Division calculates the comprehensive estimate. Due to different production deadlines, the Capital Expenditure Survey data need to be adjusted by the difference between Industry Accounts Division's final and Income and Expenditure Accounts Division's preliminary estimates.

9.96 Canada System of National Accounts adjustments are also made to Capital Expenditure Survey data. One adjustment stems from a comparison of Public Accounts data for government investment estimates with the Capital Expenditure Survey data, which leads to corrections to the survey data. A second, more conceptual adjustment involves eliminating used machinery and equipment from the survey data, as these were already included in the GDP when first produced. Specifically, this means removing business spending on scrap and salvage, used motor vehicles and used aircraft.3,4

9.97 Another modification is based on the comparison of the value of certain investment projects according to the Capital Expenditure Survey and to other information sources. For passenger cars and trucks, for example, a more direct approach is taken in conjunction with personal expenditure estimation on motor vehicles.

9.98 An adjustment is also made to compensate for Capital Expenditure Survey's underestimation of investment in aircraft. Information from the International Trade Division provides coverage of aircraft leasing contracts missed by the survey.

9.99 Lastly, on the basis of the Input-Output Tables, an adjustment is made to offset under coverage in a number of commodities including agricultural machinery and motor vehicles.

Table 9.8 Reconciliation statement between private and public Investment and Income and Expenditure Accounts estimates of machinery and equipment, 2003. Opens in a new browser window.

Table 9.8
Reconciliation statement between private and public Investment and Income and Expenditure Accounts estimates of machinery and equipment, 2003

Quarterly estimation methods and data sources

9.100 In the absence of a quarterly survey of capital expenditures, the annual series are distributed into quarters using related indicators. For the current year, data are estimated on the basis of the rate of change in quarterly indicators.

9.101 Due to timing and data constraints a supply-disposition approach is used to determine the final demand for 39 of the more than 100 Input-Output machinery and equipment commodities,5 which are then used to develop estimates for seven of the ten major groups. More direct approaches are used to measure spending on passenger cars, trucks and software.

The supply-disposition model

9.102 The supply-disposition model provides an estimate of components of final demand (domestic supply6 less intermediate consumption and change in inventories).

9.103 The model's starting point is the accounting identity below, which states that for the economy as a whole, the supply or availability of a commodity is necessarily equal to its disposition or use, see equations 9.1, 9.2 and 9.3 below. Supply is the sum of what is produced domestically (gross output) and what is imported. The result is expressed in market prices, therefore transport, trade, sales tax and tariff margins are added. Disposition includes final demand, taking into account international exports, intermediate consumption and changes in inventories.

General equations in the supply-disposition model

Equation 9.1

Supply = disposition

Equation 9.2

GO + II + MA = FD + ID + Δinv

and since

FD = FDD + IX = Final demand

Equation 9.3

GO + II + MA = (FDD + IX) + ID + Δinv

where,

  • GO = gross output,
  • II = international imports,
  • MA = transport, trade, sales tax and tariff margins,
  • FD = FDD + IX = final demand,
  • FDD = final domestic demand,
  • IX = international exports,
  • ID = intermediate demand,
  • Δinv = change in inventories

9.104 This model is applied to machinery and equipment investment goods. Final domestic demand (FDD) corresponds to gross fixed capital formation in machinery and equipment (GFME) in the measurement of expenditure-based GDP.

General equations in machinery and equipment investment7

Equation 9.4

GO + II + MA = GFME + IX + ID + Δinv

where,

  • GFME = gross fixed capital formation in machinery and equipment

Equation 9.5

GFME = GO + II + MA - IX - ID - Δinv

9.105 To obtain a quarterly estimate of gross fixed capital formation in machinery and equipment with Equation 9.5, the model uses several datasets.

9.106 Gross output (GO) is estimated using manufacturing shipments by industry, obtained from the Monthly Survey of Manufacturing. This industry-based information is converted to a commodity classification using an Input-Output matrix which shows the proportion8 of output attributable to each commodity group in each industry.

9.107 International exports (IX) and international imports (II) are obtained from the International Trade Division. The data, classified according to the Harmonized System, are converted to the Input-Output classification system.

9.108 Data from the most recent Input-Output Tables are used to calculate margin rates, which in turn, are used to convert supply at basic prices to total supply. The margin rates are calculated from annual Input-Output data by taking the ratio of total supply to supply at basic prices Equation 9.6.

Equation 9.6

Margin rates = total supply at market rates ÷ total supply at basic prices = (output + imports + margins) ÷ (output + imports)

9.109 As shown in the following equations, total supply is obtained by multiplying output and imports by the margin rates.

Equation 9.7

Total supply at basic prices = GO + II

Equation 9.8

Total supply at market prices = (GO + II) x margin rate

9.110 The result of Equation 9.8 is the same as the first three terms of Equation 9.5.

9.111 The next step is to estimate domestic supply at market prices, that is, total supply at market prices Equation 9.8 minus exports. This leads to Equation 9.9, which is the same as the first four terms of Equation 9.5.

Equation 9.9

Domestic supply at market prices = total supply at market prices - exports

9.112 Since there are no quarterly estimates of final demand for each commodity, the most recent data from the Input-Output Tables are used to compute final demand ratios. These ratios are obtained by dividing final demand for machinery and equipment investment goods by domestic supply. Structural changes are taken into account via the use of Capital Expenditure Survey (CES) data for non-benchmark years.

9.113 Final demand is then obtained by multiplying the domestic supply at market prices by the final demand ratios, as shown in Equation 9.10.

Equation 9.10

Business GFME = business final demand ratio x domestic supply at market prices

9.114 The Industry Accounts Division produces monthly data on changes in inventories by industry. Changes in inventories, particularly at the wholesale level, are also available by commodity and institutional sector in the estimate of the business and government investment in inventories component of expenditure-based GDP.

9.115 The derived estimators are used to produce quarterly estimates from the annual Input-Output data, using a quadratic minimization procedure known as the Denton-Cholette9 method. This procedure adjusts the sub-annual data so that the annual totals (or averages) match the annual benchmarks while keeping the adjusted sub annual variations as close as possible to the original sub-annual variations by minimizing the sum of the squares of the differences between them.

9.116 For the current quarters, the same supply-disposition model is used, as all the inputs are available on a monthly basis up to date. The 39 commodities are then regrouped into 7 major groups (i.e. furniture, agricultural machinery, industrial machinery, computers and other office equipment, other transportation equipment, telecommunications equipment and other machinery and equipment). Their movements are used to project investment in these categories.

Passenger cars and trucks

9.117 For passenger cars and trucks, there are direct estimates of final demand made in conjunction with personal expenditure estimates. Total sales by type of vehicle are provided by the New Motor Vehicle Sales Survey. The government and business sectors' shares of passenger car sales are based on data from the Motor Vehicle Manufacturers Association (MVMA); for trucks, the shares are estimated on the basis of buyer profiles. Sales of car or truck fleets are treated separately and allocated entirely to the business and government sectors.

Software

9.118 Investment in software was incorporated into GDP and gross fixed capital formation in machinery and equipment in the first quarter of 2001 (backdated to 1981), in response to the SNA 1993 recommendation that business and government acquisition of software be treated as investment instead of current expenditure.10 Investment in pre-packaged and custom design software is determined residually as the total supply of software (domestic production plus imports plus margins) less personal consumption less exports to non-residents. Estimates for own-account software (software developed by in-house employees to meet specific organization's needs) are based on the labour costs for computer programmers and systems analysts and other costs (non-salary) of in-house software development.11

Provincial and territorial estimation methods and data sources

9.119 As in the case of non-residential structures, national totals for gross fixed capital formation in machinery and equipment are distributed among the provinces and territories using information from the Capital and Repair Expenditures Survey.

9.120 It should be noted that the provincial and territorial distribution of investment in mobile assets, such as aircraft, locomotives, trucks, ships and satellites, presents some difficulties. In principle, investment should be distributed according to the place of consumption. In practice, the distribution is based on the limited amount of data available, and there is no guarantee that it is always consistent and uniform. The various distribution methods used in the Capital Expenditure Survey are also employed in the Provincial Economic Accounts.

Deflation – Estimates in real terms

9.121 Gross fixed capital formation in machinery and equipment is deflated at the same level of detail as the compilation of current-price estimates, using, for the most part, machinery and equipment price indexes from the Prices Division.

9.122 For computers and other office equipment, a weighted index is calculated using export and import price indexes. For software, the Prices Division's price index for pre-packaged software, average hourly earnings indexes for programmers and systems analysts, and non-labour input costs are used.

9.123 Table 9.9 outlines the machinery and equipment price indexes used to deflate each of the projection series.

Table 9.9 Deflators used in machinery and equipment. Opens in a new browser window.

Table 9.9
Deflators used in machinery and equipment

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Notes

1. In theory, feasibility studies, exploration and development costs are all capitalized. In practice, some of these costs are recorded as current expenditure by businesses. They then become intermediate rather than final expenditure.

2. A brief description of the survey is provided in Appendix 1: A Brief Description of the Capital Expenditure Survey.

3. The value of capital formation is equal to acquisitions less disposals. As the data on disposals is not available by industry, the estimate is made at the total level.

4. Sales of used cars are included in personal expenditure and are therefore not deducted from capital.

5. For a list see Table 9.9.

6. Domestic supply is equal to output plus imports minus exports.

7. Equation specification differs by commodity.

8. Each component of the conversion matrix is calculated as follows: (Output of commodity i by industry j) / (Output of industry j).

9. For more detail about the method, see Cholette, P.A. (1984): Adjusting sub-annual series to yearly benchmarks. Survey Methodology, 10, 35-49.

10. Statistics Canada, Capitalization of Software in the National Accounts, catalogue no. 13-604, issue no. 37.

11. Quarterly sources of data include earnings of computer system designers from the Survey of Employment, Payrolls and Hours (SEPH) and employment, and hourly earnings of software publishers, data processors and system designers from the Labour Force Survey (LFS).