The link between growth and inequality from an intangible capital framework

Ideas can be powerful but are often hidden. Case in point: the conceptual model of intangible capital as the driver of economic growth is becoming fixed in the public discourse. Whether people know it or not, they are implicitly using the concepts without explicitly referencing the model. An example is a recent speech by Chairman Jason Furman, Chairman of the President's Council of Economic Advisers ("Global Lessons for Inclusive Growth") that touches on the link between growth and inequality.

The standard argument on growth and inequality is a follows: inequality is an unavoidable and necessary ingredient for growth. Some people contribute more to economic growth. They need to be rewarded for the risks they take, otherwise they would not take those risks. The result is this group of risk takers are rewarded more -- i.e. unequally. The natural result is some level of inequality.

However, in recent years, an alternative description of the link between growth and inequality has emerged. This argues that inequality reduces growth in a number of ways by undercutting the factors that lead to economic growth. As Furman puts it:

The traditional theoretical macroeconomic literature also emphasized a tradeoff between greater equality and growth: One point often emphasized is that to the degree that high-income households save more, greater inequality would translate into more savings and investment, and in turn, a higher level of output. Also, linking to microeconomic foundations, the traditional macroeconomic literature assumed that greater inequality provides a greater incentive for education, investment and entrepreneurship to capture those income gains.

A newer theoretical literature has also identified a number of mechanisms by which greater equality could increase the level of output or growth. This literature starts from the observation that the traditional emphasis on the quantity of capital, even if true, is dwarfed by the importance of the quality of capital, technology, and entrepreneurship. Moreover, pervasive market failures and incomplete markets mean that the efficiency of outcomes may depend on the distribution of income. In particular, this approach emphasizes a number of channels by which inequality could harm growth: (1) by reducing access to the education necessary for the full population to reach its full potential; (2) by reducing entrepreneurship and risk taking; (3) by undermining the trust necessary for a decentralized market economy and increasing monitoring costs; and (4) by leading to increased political instability, growth-reducing policies and uncertainty.

Without realizing it, Furman's four points invoked the elements of intangible capital models. Let us do a quick review of intangible capital. One version of the model contains four types of capital:

 • Human Capital - This includes all the talent, competencies and experience of your employees and managers. This is the intangible capital that "goes home at night."
 • Relationship Capital - This includes all key external relationships that drive your business, with customers, suppliers, partners, outsourcing and financing partners, to name a few. This kind of capital also includes organizational brand and reputation. Due to the growing importance of networks in organizational structures, this is also sometimes called Network Capital.
 • Structural Capital - This includes all knowledge that stays behind when your employees go home at the end of the day. There is significant structural capital in today's organizations including recorded knowledge, processes, software and intellectual property.
 • Strategic Capital - This is a category that is not always included in academic definitions of IC. However, in our experience, this category of knowledge is the glue that holds the whole system together. It gives logic and purpose that attracts the right people, partners and knowledge to your organization--and puts it to work inside a business model that connects with a market need to generate the revenues and profits to sustain the organization. It includes culture, business model and external factors.

Another version embeds three forms of intangible capital in a larger model that also includes financial capital and tangible capital (both "manufactured" capital and natural resources). The three are:

 • Intellectual capital - Organizational, knowledge-based intangibles, including intellectual property and "organizational capital" such as tacit knowledge, systems, procedures and protocols;
 • Human capital - People's competencies, capabilities and experience, and their motivations to innovate.
 • Social and relationship capital - The institutions and the relationships within and between communities, groups of stakeholders and other networks, and the ability to share information to enhance individual and collective well-being.

While the terminology may be slightly different, the two models are talking about the same thing.

As Furman describes it, inequality undermines the development of various forms of intangible capital that are needed to sustain economic growth. Inequality undermines human capital development (education)--point one in Furman's argument is all about human capital. Inequality undercuts strategic capital (entrepreneurship)--point two. It destroys relationship capital (trust)--point three. Finally, inequality undercuts social capital (through political instability and uncertainly)--point four. In short, the entire new view of the linkage between inequality and economic growth is based implicitly on the idea that intangible capital is the driver of economic growth.

Thus has the concept of intangible capital seeped into the policy debate at the highest level. Our next task is to help policymakers and other use the concepts/models as an explicit and coherent tool of analysis.

(Cross posted from The Intangible Economy)

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Comment by Mary Adams on May 12, 2014 at 2:03pm

Thanks for this Ken - I tend to see IC everywhere but hadn't focused on the linkages you identified here.

The infrastructure of the knowledge era is intangible. It's powerful (and scary) that failure to understand this infrastructure means that it doesn't get the focus it needs. Education, entrepreneurship and trust. Take it away and we really are in bad shape.

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