Measure this: intangible capital as a driver of innovative growth

When it comes to analysing the role of investment in intangible assets, standard growth accounting techniques reveal some very interesting results. Firstly, intangible assets play a large part in determining the path of labour productivity, which improves social welfare. Even more significant, however, is that the ‘unexplained’ components of productivity growth (usually swept together under the heading of ‘total factor productivity’) become much less important once a measure of intangibles is included, suggesting that intangibles are a significant part of the explanation. Finally, decline in investment in physical capital appears, for the most part, to have been compensated by an increase in intangible capital formation. All these factors indicate that the contribution of intangible capital accumulation to growth both in manufacturing and service industries is substantial.

However, intangible capital is notoriously hard to measure empirically. Its very intangibility makes it resistant to quantification. Yet, whether we are talking about brand equity, organisational capital or architectural design, intangible capital is hugely important for the viability of firms and the economies that host them.1 For this reason, it is worth venturing to develop tools that might enable us to measure intangible capital more efficiently and determine its capacity to generate growth. A team of European researchers is pursuing this challenge successfully with the EU-supported project called INNODRIVE.

Over the past year and a half, the INNODRIVE consortium has made significant progress in providing new data on intangibles throughout the European Union. A central part of the project has involved collecting and analysing an array of intangible capital indicators for each EU Member State (except Luxembourg) and Norway. They go beyond traditional business activities like management and marketing to include cultural phenomena associated with the wider worlds of design and entertainment. Not surprisingly, scientific research and development (R & D) figure prominently in the range of intangible capital as do software and personnel assets related to information and communications technology (ICT).

INNODRIVE estimates of intangible investment include the three main categories of assets identified by Corrado, Hulten and Sichel (CHS 2005): economic competencies, innovative property and computerised information. Investment in economic competencies include spending on strategic planning, worker training, redesigning or reconfiguring existing products in existing markets, investment to retain or gain market share and investment in brand names. Innovative property refers to the innovative activity built on a scientific base of knowledge as well as to more broadly defined innovation and new product or process R & D. Computerised information coincides with computer software and databases.

Most of the intangibles listed above (all those under the ‘economic competencies’ and ‘innovative property’ headings) are new measures because they are not currently factored into national accounting figures. Therefore, the researchers consider a new aggregate comprising R & D, New Product Development in the financial industry, New Architectural and Engineering Design and all the items classified as economic competencies by CHS (2005).

INNODRIVE uses these new intangibles as the basis for a quantitative overview of intangible capital in 27 European countries from the mid 1990s to the present.

While the researchers stress that their findings are preliminary, the analysis suggests that new intangible capital - measured as a share of gross domestic product (GDP) - increased in European countries by about 1 percentage point during the ten-year period through to 2005. Compared with 1995, expenditure in 2005 on new intangible assets has increased in almost all countries, the only exceptions being Spain (where the share has remained unchanged) and Greece, Estonia and Norway. Nordic countries demonstrated particularly high levels of intangible capital investment, with the UK, the Netherlands, Belgium and France also making significant investments together with Eastern Europe as a whole.

Relating these new data to each country’s GDP, the researchers then compare the increase in new intangibles (NI) as a share of GDP over two periods (Figure 1 between 1995 and 2000 and Figure 2 between 2000 and 2005) and over a group of European countries.

Figure 1 – New Intangibles shares of GDP (%): European countries change from 1995 to 2000

Figure 2 – New Intangibles shares of GDP (%): European countries change from 2000 to 2005

Figure 1 shows the dynamic over the period 1995-2000 has been positive in all countries except for Ireland, Norway and Estonia. Slovakia experienced by far the highest increase (from 2.6 per cent in 1995 to 4.5 per cent in 2000 - an increase of 1.9 percentage points). Aside from Slovakia, six other countries registered an increase in the range of 1.1-1.3 percentage points: Sweden, Finland, Poland, Netherlands, Latvia and the UK. The importance of investment in new intangible assets increased also in the large continental economies (with the partial exception of France, where the share increased only by 1 percentage point).

Figure 2 shows the period 2000-2005. The picture is rather different, with fourteen countries showing a decrease in intangible investment as a share of GDP. Among the Western European economies, only Malta, Ireland and Austria have registered a significant increase. On the other hand, intangible capital accumulation has been fairly dynamic in some of the Eastern European economies.

Looking ahead, the report concludes:

  • The growth potential associated with intangible capital accumulation in manufacturing, service industries and the macro economy is substantial.
  • The intangibles have an important role in company-level decision-making and therefore for economic growth. These, in turn, will have a positive impact on savings, wealth and the income share in the economy of those who invest in intangibles.
  • In the next decade, intangible capital should be viewed as the main impetus of economic growth; the significance of a skilled workforce for economic growth will lie with its ability to appreciate and foster investment in intangibles.
  • The data suggests investment weakened between 2000 and 2005 in some countries, which may not bode well for European competitiveness.

This raises a number of policy implications:

  • The first is that firms and policy makers need to appreciate the importance of intangible assets in the growth process. Definition, identification, measurement and increased awareness of the growth potentials of intangibles are the key steps towards this appreciation.
  • The second, as with investment in any type of asset, concerns incentives. In most EU countries there are well-developed and well-understood policies that promote investment in conventional capital. These include capital allowances, tax breaks and the treatment of depreciation. The challenge now is to find similar incentives to encourage investment in intangibles.

 

1 See also: IAREG – Intangible assets at the heart of economic growth in European regions, Socio-economic and Humanities Research for Policy, May 2010. Available from:
http://www.scoopproject.org.uk/Default.aspx?p ageid=31

INNODRIVE - Intangible Capital and Innovations: Drivers of Growth and Location in the EU (duration 1/3/2008 – 28/2/2011) is a research project funded under the 7th Framework Programme for Research of the European Union, Thematic Priority 1 – Growth, employment and competitiveness in a knowledge society.

See: http://www.innodrive.org

Policy Briefs available from: http://ec.europa.eu/research/social-sciences/pdf/policy-briefs-innodrive_en.pdf

Contact: Hannu Piekkola, hannu.piekkola@uwasa.fi