« R&D in China | Main | "don't worry, be happy" - and trust in "dark matter" »
March 14, 2006
Measuring intangibles - not "dark matter"
In my last posting on the "dark matter" thesis of intangibles and trade, I mentioned a new NBER paper by Corrado, Hulten and Sichel "Intangible Capital and Economic Growth." (an earlier version is available at the U of Maryland site). There are actually two papers, the second being their earlier 2004 work, "Measuring Capital and Technology: An Expanded Framework."
The papers look at our intangible asset stock and the size of our investments in intangibles. A few years ago, Leonard Nakamura estimated the annual investment in intangibles to be about $1 trillion. The C-H-S papers estimate a $800 billion investment and more than $3 trillion of business intangible capital stock are missing or miscounted in our statistics. The macroeconomic implication is that were are saving more than we thought and that
(t)he rate of change of output per worker increases more rapidly when intangibles are counted as capital, and capital deepening becomes the unambiguously dominant source of growth in labor productivity. The role of multifactor productivity is correspondingly diminished, and labor's income share is found to have decreased significantly over the last 50 years.
What I find more intriguing that the macroeconomic implications is the papers' finding that nonscientific research and development (R&D) and organizational factors are far more important intangible assets than traditional scientific R&D.
There are two key elements in the C-H-S papers. First, and primary, is the treatment of money outflow (expenditures) as either consumption or investment. Consumption and investment are treated differently in any accounting system - either company accounting (see our paper Reporting Intangibles) or in the National Income and Product Accounts (NIPAs).
The papers argue, as have others including myself, that expenditures on intangibles are investments. As the authors state in their 2006 paper:
In sum, the various characteristics that cause tangible and intangible capital to be different - verifiability, visibility, non-rivalness, and appropriability - are all important features that distinguish one type of capital from the other. However, none of these differences is relevant to the issue of whether to treat intangible expenditures as capital. That is determined by whether or not the expenditure is intended to yield output in some future time period. This is the conceptual analogue on the production side to the symmetry criterion of whether the expenditure was made in order to increase future consumption. Many intangibles satisfy these criteria and must therefore be treated as capital.
And capital is treated very differently for accounting purposes. Capital is written off over a number of years while non-capital expenditures (consumption) are counted completely in the year they occur. Much of the macroeconomic implications of this research flow from that simple fact.
The second issue is that some investments in intangible are not adequately captured in the NIPA. For example, the value of brand equity is not included in our stock of assets - although cost of advertising to maintain brand equity is included in the NIPA as a business expense. Likewise, what the authors call "business investments in firm-specific human and structural resources through strategic planning, adaptation, reorganization, and employee-skill building" are only imperfectly captured. Employee time and additional outside costs for training would be included as a business consumption expenditure. But the added stock of value of those trained workers would not be captured.
The papers are a step forward in dealing with many of the technical issues concerning how to classify intangible expenditures as investments, how to specifically break out the investment expenditures from the consumption expenditures, how to price and deflate those intangible investments, and how to estimate the missing investments. These are not trivial matters.
Take for example, the problem of prices and deflators. The purpose of depreciation is to account for an asset as it is used up. Even for tangible assets, there is a controversy and disagreement over the appropriate rates (is a machine tool really all used up in X number of years or Y number of years.) The question becomes much more difficult for intangible assets. As endogenous growth theory (or New Growth Theory) tells us, the growth of knowledge self-perpetuating and there are increasing rather than diminishing returns. Yet we know that the specific utilization of that knowledge for economic advantage, for example in a patent, can diminish over time. But, how fast does a patent diminish?
The C-H-S papers do not solve all these issues, but they do give us some reasonable assumptions with which to work (which I will not repeat here).
As mentioned above, treating intangibles expenditures as investments rather than consumption has consequences, as C-H-S point out in the 2006 paper:
Specifically, when intangibles are treated as an intermediate input, the spending on intangibles is subtracted from revenue as an expense, reducing measured profits. On the other hand, when intangibles are treated as an investment, they are not subtracted from revenue in the period of purchase, and profits are higher.
Thus, their conclusion should come as no surprise: if one corrects for the current misclassification of intangibles expenditures as consumption rather than investments, adds in those missing investments and properly capitalizes them, then business investment is higher than normally calculated.
The journalists at the Economist sum up the macroeconomic implications:
Thanks to higher investment, including intangibles pushes up productivity growth too—although it does not explain the acceleration of productivity after 1995. Capitalising intangible spending raises average productivity growth between 1973-95 by more than it does for the years since then.
A striking shift occurs between labour and capital. Official statistics say that workers' share of national income has been fairly flat for decades. Capitalising intangible investment increases capital's slice and reduces labour's, with a particularly sharp drop after 1980. If intangibles are included, labour's share today drops from 70% to 60%.
If investment is higher than today's statistics suggest, so, automatically, is saving. With firms' current spending lower and profits fatter, corporate saving (and so national saving) must be higher.
In other words, our economic statistics are wrong. But, as the Economist noted, "although measuring intangibles does change the picture of America's economy, it does not necessarily improve it."
What I find more interesting in the papers is their breakdown of intangibles by category. The authors define three major forms of intangible assets: Computerized information (mainly computer software); Innovative property (Scientific R&D and Nonscientific R&D); and, Economic competencies (Brand equity and Firm-specific resources).
Computerized information and scientific R&D are relatively straightforward categories. The nonscientific R&D includes "nonscientific commercial R&D industry, as measured in the Census Bureau's Services Annual Survey (SAS), as well as the costs of developing new motion picture films and other forms of entertainment, and a crude estimate of the spending for new product development by financial services and insurance firms."
Investment in brand equity is measured in an interesting manner:
Expenditures for advertising are a large part of the investments in brand equity, but as stressed in our earlier work, not all spending on intangibles should be counted as capital spending. Based on results from the empirical literature on advertising, we estimated that only about 60 percent of total advertising expenditures were for ads that had longlasting effects (that is, effects that last more than one year).
Finally, the papers provide an estimate of that illusive economic competency of investment in firm-specific human and structural resources:
It includes the costs of employer-provided worker training and an estimate of management time devoted to enhancing the productivity of the firm. Our estimates of the former are based on BLS surveys; the latter are based on SAS revenues for the management consultant industry and trends in the cost and number of persons employed in executive occupations.
The resulting investment numbers are not small. For the time period 2000 through 2003, investment in computerized information (mainly computer software) was $172.5 billion; scientific R&D, $230.5 billion; nonscientific R&D, $237.2 billion; brand equity, $160.8 billion; and, firm-specific resources, $425.1 billion.
What is most striking to me, however, is where the growth has occurred (in terms of percentage of total national income). Table 3 of the 2006 paper compares the time period 1973-1995 with 1995-2003. Overall intangible assets grew from 9.4% of total national income to 13.9%. Not surprisingly, computerized information went from 0.8% to 2.3%. However, scientific R&D was almost flat , increasing its share from 2.4% to only 2.5%. Brand equity rose slightly from 1.7% to 2.0%. The other big gainers were nonscientific R&D, which went from 1.0% to 2.2% and firm-specific resources, which increased from 3.5% to 5.0%.
In other words, the largest increase in contribution by intangibles to our economic wellbeing was not necessarily scientific R&D, but computerization, non-scientific R&D and company reorganization/management/worker skills.
A slightly different view is gained from looking at the annual growth rate of real capital of these intangibles between the two time period. Overall, the annual rate of growth of intangible capital increased slightly from 6.2% in the 1973-1995 time period to 6.9% in the 1995-2003 time period. However, the growth rate in the intangible capital of computerized information dipped from 16.0% to 13.0%. Growth rate of scientific R&D increased slightly from 3.6% 3.9%; nonscientific R&D declined from 12.4% to 7.2%; brand equity increased slightly from 4.2% to 4.6%; firm-specific resources grew from 5.3% to 6.2%. According to this analysis, we are likely to get our biggest increase in intangible capital in the category of firm-specific resources and nonscientific R&D (even though growth in the latter category has slowed down).
This detailed analysis reinforces a point I have made before: intangibles and innovation are not just technology. Organizational changes, design, worker skills, the utilization of computer technology and other non-technology creating innovations are the hallmark of the I-Cubed Economy. Technological creation is part of the equation, but only part. All of the other factors are just as important. And it is time for policymakers to start paying attention to all these other parts.
Posted by Ken Jarboe at March 14, 2006 7:43 AM
Trackback Pings
TrackBack URL for this entry:
http://www.athenaalliance.org/mt/mt-tb.cgi/564