Improving how we use intangibles to boost productivity

Thanks to Paul's recent posting , I am catching up on the McKinsey report on Innovation Matters: Reviving the Growth Engine from June 2013. The report introduces an index of "Innovation Capital" as a combination of "Physical Capital" (i.e. ICT infrastructure), "Knowledge Capital" and "Human Capital". While this builds on the work of Carol Corrado, Chuck Hulten, Jonathan Haskel and others, I'm not sure it captures all the components of intangible capital. For example, the report talks about the need for collaboration and building the ecosystem, but never mentions relational capital. In fact a number of the policy prescriptions are aimed at building knowledge linkages i.e. social/relational capital. Nor are intangibles solely about innovation and productivity. In our current economy, intangibles are needed as inputs for ongoing operations as well.

But it was not the new index I found the most interesting. There was one graph that caught my attention: the relationship between "Innovation Capital" and productivity. The graph confirms that innovation capital (or intangible capital) is important for productivity growth. The striking feature, however, is that the U.S. gets less productivity growth from its investments in innovation capital than other nations. The U.K. gets the same amount of labor productivity growth as the U.S. from a smaller investment in innovation capital and Finland gets a much higher rate of labor productivity growth with about the same level as the U.K. investment.

The McKinsey report also has a graph on R&D spending that shows the U.S. basically on the trend line while a number of other nations, specifically Finland, Sweden and Germany, are significantly above the trend line. In other words, they get a much bigger productivity bank for their R&D buck.

By the way, there is a variation the first graph in the work cited in the McKinsey report by Carol Corrado, Jonathan Haskel, Cecilia Jona-Lasinio and Massimiliano Iommi, "Intangible Capital and Growth in Advanced Economies: Measurement M... which shows the same basic story with other nations, such as Finland, Ireland and even Slovenia get greater productivity growth from their investments in intangible capital. [Note the axis are reversed in this graph from the McKinsey graph.]

These graphs were an eye-opener for me. For years I have been advocating policy measures to foster investment in and development of intangible assets. These include policy such as a knowledge tax credit and creating business assistance programs focused on intangible asset management (see "U.S. Policies for Fostering Intangibles").

But the data presented here makes another important point: increasing investment in intangibles is not enough; policy must also look at the effectiveness of that investment in raising productivity. Why is it that the U.S. does so badly in the productivity return on its intangible asset investments compared to other nations (as point out in the first chart)? This will require a new line of research as to how intangibles actually work in boosting productivity in the economy.

The McKinsey report has some insight on that with its finding about the effect of investment in "Knowledge Capital" versus "Human Capital." Their analysis shows that an investment in Human Capital generates a higher marginal return. But as I alluded to before, those two categories may be to gross for detailed investigation and may miss key elements. A more granular description is needed. In addition, the interaction between various types of intangible capital needs to be taken into account. As the McKinsey report points out, development of human capital is needed to realize any gains in other forms of capital.

Obviously, much more work needs to be done. One starting place is a more refined set of metrics about investment in specific types of intangible assets. Current efforts to collect data on these investments needs to be expanded and augmented with better official data. Likewise we need a more detailed understanding of policies in those more effective countries. A great deal of cross country studies have been done on innovation policy. But I am not aware of any that look specifically at how investments in intangible assets translate into productivity increases.

Sounds like we need to update and create a new (and rather substantial) research agenda.

(Cross posted from The Intangible Economy)

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Comment by Kenan Jarboe on August 14, 2014 at 2:36pm

Mary - I agree. The national data collected is the aggregate of the business investment in certain intangibles. It tells us where there might be an investment shortfall (such as in basic R&D) that requires a public policy action. It does not tell us where a specific company should invest. Having said that, the basic premise of my argument remains the same for both the nation/region and the company level: we need to determine where specifically investment in intangibles has the largest return rather than just attempt to raise the level of intangible investments in general.

Comment by Mary Adams on August 14, 2014 at 1:19pm

Thanks Ken - I, too, have seen the data many times but hadn't looked at it in the way that you describe.

The funny thing is that this leads us back to investment. I have always maintained that we should be tracking investment not with an agenda of putting intangibles on the balance sheet (that might never work for a lot of good reasons). BUT millions (actually billions) of dollars are invested in intangibles every year but no one is tracking it or understanding it as an investment in the infrastructure driving success (growth, innovation, productivity, valuation, reputation, to name a few) of our organizations and our economies.

The fascinating data from the World Bank study on the Chilean wine industry showed the power of such investment (final report still hasn't come out but I'll alert everyone as soon I it does)

If we are going to advocate for a new line of research, I think it has to include a look at investment levels, not just at the national level but at the firm level as well.

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