Final Report Summary - INNODRIVE (Intangible capital and innovations: Drivers of growth and location in the EU)
Executive Summary:
The European political agenda, encapsulated in the Europe 2020 strategy, recognises the importance of investment in knowledge, innovation, education and information and communication technology (ICT) as drivers of 'smart growth'. The aim of this research project was to improve our understanding by providing new data on intangibles and new estimates of the capacity of intangible capital to generate growth. We did this at both the firm and national levels. At the micro level, the goal of the research was to improve our insight into the contributions of intangibles to the growth of firms, by exploiting the potential of recently established linked employer-employee datasets (LEEDs) and by also implementing a performance-based methodology to analyse how firms used knowledge and human capital to increase their productivity. At the national economy level, we expanded the traditional growth accounting framework by including, in capital formation, estimates of the investment in intangibles that had hitherto largely been counted as current expenditure in the conventional national accounts.
Our main findings were as follows. Gross domestic product (GDP) in the European Union's 27 members (EU27) area was 5.5 % higher after including all intangible investment. In national approach intangible capital investment share of GDP was 6.7 % of GDP in EU27 and Norway and only 1.1 % was thus recorded in system of national accounts. Organisational competence covered nearly half of this being 3.1 % of GDP. The latter half of 1990s was a period of increasing intangible share of GDP, while in 2000s the GDP shares stayed mostly constant.
Own account intangible investment was in firm-level approach estimated in European firms to account between 7 % in Finland and Czech Republic and 11 % in the United Kingdom (UK) and Norway, of business sector new value added. This figure was half of national measures in national approach with broader selection of intangibles but narrower definition of companies' own account intangible (Jona-Lasinio and Iommi 2011). Intangible investment was increasingly likely to become more important as greater emphasis was placed on 'smart' growth (Europe 2020). Investment in intangible assets was shown to be an important factor in performance of European and United States of America (USA) companies increasing Tobin's q (e.g. Piekkola 2010, Lev and Radhakrishnan 2005) and intangible capital type work was tied up with total factor productivity of Finnish firms (Ilmakunnas and Piekkola, 2010). Macro level studies had the same outcomes (Corrado, Hulten, Sichel 2006; Marrano, Haskel 2006; Roth and Thum 2010; Belhocine 2009). Ignoring intangibles in national accounts implied an underestimation of GDP by 5.5 % in EU27 area and labour productivity growth by 10 to 20 %.
Firm-level analysis also showed that own account organisational capital could be even higher share of intangible capital when performance-based methodology was applied. This highlighted the importance of organisational capital as an important form of intangible capital thus even exceeding in importance research and development (R&D) investment in many European countries. In fact in nearly all EU27 countries except Finland and Sweden the share of economic competence from new value added exceeded the respective R&D share. Countries were also specialised in different type of intangible capital so that the share of R&D investment was highest in Nordic countries. In six countries with firm-level data of intangibles the share of workers engaged in intangible capital type work was around 18 % of all workers and again the type of work differed from one country to another. We also analysed innovation work and gender wage gaps. In innovation work the average gender wage gap was usually larger among innovation workers than among non-innovation workers (Finland and Czech Republic), but with exceptions (Norway).
Project Context and Objectives:
It is widely recognised that knowledge and intellectual capital are major determinants of the generation of innovation and thus the enhancement of growth, employment and competitiveness of the European Union. The importance of R&D and innovation is also explicitly recognised in the 'Lisbon process'. Yet, our knowledge of the contribution of intangibles to economic performance is still incomplete. While firms undoubtedly are at the centre of innovation and productivity growth, their activities are hard to analyse empirically. Furthermore, at the macro level the national accounts data on capital formation focus primarily on fixed investment and have only recently attempted to measure investment in intangibles such as software, mineral exploration and artistic creations. The aim of this research project was to improve our understanding by providing new data on intangibles and new estimates of the capacity of intangible capital to generate growth. This research thus explored uncharted territories in European Union's (EU) socioeconomic research.
A central theme of the smart growth strategy recognised the need to treat intangibles as investments, creating future value, rather than as intermediate costs. INNODRIVE produced new estimates of intangibles for EU27 countries and Norway following the approach of Corrado, Hulten & Sichel (2006) (hereinafter CHS). Besides computerised information (software and database), this new approach included the following items, which were often excluded from both the bookkeeping systems of companies and the national system of accounts:
1. innovative property, scientific and non-scientific R&D, with scientific R&D leading to a licence or a patent, mineral exploration, copyright and licence costs (spending for artistic originals) and
2. economic and firm competences spending on reputation (advertising), firm specific training and organisational capital.
In the CHS analysis, estimates of the purchased part of intangible investment were based on findings from a number of empirical surveys. For the own account component they made broad assumptions, since expenditures on labour, intermediates and capital used to create intangible capital at the company level were difficult to determine.
INNODRIVE advanced the CHS approach by developing new data on intangibles at the company level, which allowed us to analyse different types of intangibles and their role in economic performance and growth. Using both expenditure and performance based estimates of intangible capital, company data provided information on the own account part of intangible investment. The expenditure based approach estimated the combination of labour, intermediates and capital required to produce intangible assets based on the simplifying assumption that intangible investment was proportional to the salary costs of ICT, R&D and organisational, i.e. management and marketing, personnel. The performance based approach replaced management and marketing salary costs by the estimated productivity of the same type of work. Performance based estimates were larger in comparison to the expenditure based estimates, which helped to narrow the well known gap observed between market values and book values of assets.
Project Results:
Innovation is more than R&D: Other intangibles matter for creating value
Investment in intangibles (R&D, organisational competence and other factors) can be seen as one indicator of innovation intensity, measuring the cost of innovation, which is considerably higher than R&D alone.
All countries with traditionally high rates of R&D (such as Sweden, Finland and Germany) ranked above average in terms of their investment in intangibles (company-level data also suggested that R&D in Norway was underestimated). However, many countries that were not R&D intensive ranked highly using the broader measure of innovation intensity, such as the United Kingdom (UK), Belgium the Czech Republic, the Netherlands and Hungary. Organisational capital for Germany was underestimated here. This phenomenon pointed to a different type of innovation model, one that emphasised organisational competence. In addition, Sweden, Luxembourg, the Czech Republic and France were intensive in other types of intangibles, which captured training, architectural design, new financial product and databases and software.
The share of new intangibles in GDP not currently included in the national accounts increased in European countries by around one percentage point during the ten-year period from 1995 to 2005. Compared with 1995, expenditure in 2005 on new intangible assets increased in almost all countries, except Spain (where the share remained unchanged), Greece, Estonia and Norway. Generally, 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.
The development of intangible capital over time was heterogeneous across countries between 2000 and 2005. For most countries there was a slowdown in the rate of increase in the share of intangible investment of GDP, but not in Ireland and Malta. Overall, new intangible shares of GDP varied considerably across countries:
1. ranging from 2 to 9 % of GDP, but with the Eastern European economies being able to catch up with the skill-intensive countries
2. showing steady investment share of value added from 2000 to 2005 in all the old EU member states (EU15) except Austria; and
3. with economic competencies accounting for at least half of all intangibles, ranging from 45 to 75 % of intangibles assets across all countries, advertising and organisational capital being typically at the core.
Total tangible and intangible investments were fairly evenly distributed throughout Europe. Norway, Czech Republic Sweden, Belgium and Malta ranked as the top countries in the half of countries with business investment intensity between 13 and 20 % of GDP. Other countries had total private investment share of around 10 % of GDP. Countries with relatively low intangible investment had high levels of tangible investment.
Average impact of capitalising intangibles on GDP
The capitalisation of intangibles implied an average increase of 5.5 % of GDP for the EU27 over the period 1995 to 2005. The average increase for the EU15 GDP was slightly lower (5.4%), while for the new member states (NMS), it was one percentage point less (4.5%).
Structures of intangibles differ across countries
Aggregation of company-level data gave statistics on business sector intangibles that were comparable to data obtained at the country level. In the six countries with micro data, we found substantial variation in the shares of occupations engaged in producing intangible capital.
Including all intangible-type workers in the analysis gave more harmonised figures of workers engaged in intangible capital production than counting only the number of managers. The total share of intangible capita-type workers was typically around 18 %. The share of organisation workers (the sum of the share of management and marketing workers) varied between 13 % in the UK and 5.5 % in Norway, while the respective R&D worker shares tended to be higher in countries with lower organisation worker shares (only 4 % in the UK compared with 9 % in Finland). Organisational workers were the largest group with the UK at the top at around a 12 % share. The share of managers was around 9 % in the UK, 4 % in Finland, 8 % in the Czech Republic, 9 % in Germany, 3.5 % in Norway and 6.5 % in Slovenia.
Analysis of intangible capital at the company level showed that Nordic countries were intensive in R&D capital and fairly poor in organisational capital (managerial and management). Large countries, such as the UK and Germany, were rather intensive in organisational capital and had relatively less R&D capital. The UK, on the one hand, and the two Nordic countries Finland and Sweden, on the other, could be taken as two extreme opposite examples of either organisational capital-driven or R&D-driven economies. The company level data for Finland and the UK showed the same seven structural differences in intangible capital. Finland and the UK were two examples of either organisational capital or R&D driven economies.
The investment rate for all intangibles (R&D, ICT and organisational capital investment) was around 7 % of value added in Finland and around 10 % of value added in the UK. The UK also had considerable R&D activity when a more holistic definition of R&D-type work was used, covering engineering and architectural design work (in national estimates 0.9 % of GDP). This wider definition accounted for a greater R&D effort in service industries.
The expenditure based approach gave only part of the picture regarding the value of intangibles when they were owned by the firm and employees are not fully compensated for the value of intangible production. Indeed, the performance-based approach increased the relative importance of organisational investment. This was explained by the widely observed gap between productivity and wage costs of organisational workers. Using the performance based approach, organisational investment was more similar to R&D investment in Finland, which was also supported by its impact on the market value of Finnish listed firms.
In the UK, organisational investment exceeded R&D investment regardless of the estimation method used. Organisational investment (the largest component of organisational competence in the national estimates) decreased over recent years in both countries when the productivity of organisational-type work was used to construct these estimates. This decline might call for new types of innovation policy measures. In national accounting, business sector investment in organisational capital (economic competence excluding training) were also highly important. They were on average 2.6 % of GDP, while investment in (scientific) R&D was over three times lower, around 0.8 %.
Accumulation of intangible capital promoted labour productivity and wellbeing
Growth accounting for a set of countries revealed interesting results. Labour productivity, a measure of living standards, depended strongly on the accumulation of intangible capital. With the inclusion of intangible capital, the 'unexplained' component of productivity growth, the total factor productivity (TFP), became less important, while physical capital turned out to be strongly complementary to intangible capital:
1. over the period from 1995 to 2000, the capitalisation of intangibles increased labour productivity in all countries considered, while from 2000 to 2005 it had the opposite effect
2. the relative contribution of capital deepening and TFP to labour productivity growth changed considerably after the inclusion of all intangibles; the rate of capital deepening increased and the growth of TFP decreased. Capital deepening became the dominant source of labour productivity growth.
In an analysis of regional effects in Germany, Finland and the UK, company-level productivity was also shown to be strongly related to firms' own intangible capital as well as regional intangible capital, suggesting positive localised spillovers. Productivity was highest in firms that also had considerable human capital. There was a need to be clear about the distinction between human capital and intangibles; intangibles enhanced the profitability of economic activity while human capital was owned by the employee and capitalised in wages. Organisational capital, i.e. the competence of management and marketing workers appeared to be the most clearly related to productivity growth.
Potential Impact:
Accumulation of intangible capital promotes labour productivity and wellbeing
Growth accounting for a set of countries revealed interesting results. Labour productivity, a measure of living standards, depended strongly on the accumulation of intangible capital. With the inclusion of intangible capital, the 'unexplained' component of productivity growth, the total factor productivity (TFP), became less important, while physical capital turned out to be strongly complementary to intangible capital:
1. over the period from 1995 to 2000 the capitalisation of intangibles increased labour productivity in all countries considered, while in 2000 to 2005 it had the opposite effect
2. the relative contribution of capital deepening and TFP to labour productivity growth changed considerably after the inclusion of all intangibles; the rate of capital deepening increased and the growth of TFP decreased. Capital deepening became the dominant source of labour productivity growth.
In an analysis of regional effects in Germany, Finland and the UK, company-level productivity was also shown to be strongly related to firms' own intangible capital as well as regional intangible capital, suggesting positive localised spillovers. Productivity was highest in firms that also had considerable human capital. There was a need to be clear about the distinction between human capital and intangibles; intangibles enhanced the profitability of economic activity while human capital was owned by the employee and capitalised in wages. Organisational capital, i.e. the competence of management and marketing workers appeared to be the most clearly related to productivity growth.
Taking intangibles seriously
The significance of a skilled workforce for economic growth lay in its ability to create value added in the form of intangibles. The INNODRIVE project documented the important role that intangibles played as a new source of growth; it was crucial therefore not only to measure them but also to improve their management and exploitation. This was why policy measures should aim to stimulate a better understanding of intangibles by including them in the GDP measure and encouraging their use by means of appropriate incentives.
Key messages
1. GDP in the EU27 area was 5.5 % higher after including all intangible investment
2. intangibles were an important source of future growth across European countries. Intangibles explained a substantial part of the market value of the companies that was only partially captured in standard economic analysis
3. countries with less tangibles invested more in intangible capital showing an indication about the degree of transition towards knowledge economy
4. the observed decrease in tangible capital over time was not fully offset by intangible capital investment
5. Nordic countries were R&D intensive and had relatively less organisational capital than the UK, Belgium and the Netherlands and in company level analysis in Germany
6. organisational capital investment was one of the key drivers of growth, accounting for close to three times more investment than in R&D at national level, but also due to the narrow definition of R&D activity
7. intangible capital was agglomerated in metropolitan areas in the private sector. The greater Helsinki area accounted for 48 % of all intangibles in Finland, while the London City-Region for 41 % of UK intangibles. In Germany intangible capital was more dispersed, with the top 10 regions accounting for 48.3 % of the German total, i.e. Munich for 7.5 %, Stuttgart 7.2 %, Frankfurt 6.4 %, Düsseldorf 5.6 %, Hamburg 5.2 %, Berlin 4.7 %, Cologne 3.9 %, Duisburg/Essen 2.8 %, Nürnberg 2.7 % and Karlsruhe 2.3 %.
8. foreign direct investment was an important aspect of intangible growth in the EU8. Greenfield FDI brought with it more R&D and the companies were seen to have a higher share of organisational workers in Czech Republic
9. future research should focus on refining the range of production inputs and on the extent to which they should be classified as intermediate consumption or intangible investment. For example, one could incorporate the training provided by firms and address the issues of double counting of R&D and ICT investments (database and software investments), which were often estimated in national accounting systems using employment compensation in relevant occupations.
Intangible capital in broader perspective described the main innovation activities of private companies and was, almost by definition, the source of future growth. Management activity engaged in productivity growth in longer term was though hard to judge. However, our performance-based estimates clearly showed that the traditional expenditure-level estimates of organisational activity, mainly management and marketing, were lower bounds for the true value of organisational investments. The reason was that the productivity of these types of activities usually exceeded the respective wage expenditures. The combination of labour, intermediates and capital in production of intangible capital increased more value added than what was the cost of expenditures.
An important consequence of this was that intangible capital investment also improved markedly the profitability of the firms given the productivity and wage gap. It should be noted that intangible capital had also positive impact on hourly wage growth, but the improvement in efficiency allowed a decrease in overall wage expenditures over the course of year. We had not analysed labour utilisation rates but it might well be that good performance induced by intangible investment also increased overall demand for employment.
Intangible investment was increasing in its share, although the growth in the shares had somewhat diminished in 2000s. Exceptions were the new member states that were catching up both in GDP levels and in the intangible capital shares of GD the rest of Europe. Overall, the level of intangible investment in Europe appeared insufficient when compared with the USA that was more prone to use all types of innovation activity more intensively.
We also showed clearly that intangible investment in general and not only R&D investment drove productivity growth. Organisational and ICT work were close complements but might also work as substitutes in resource allocation for R&D work activity. Policies for promoting R&D activity alone might hence not be appropriate, as such policies might crowd out other intangible investments. The EU 2020 programme aims at smart, sustainable and inclusive growth with clear object that the 3 % of the EU's GDP should be invested in R&D. Since Europe has average R&D investment level below other developed countries including the USA, this target is well founded, but should also cover wider sets of intangible capital assets in the future. Our findings supported the importance of organisational capital. Firm-level analysis was also able to show some numeric estimates of growth effect of organisational capital. In Finland and Germany the doubling of organisational investment, less than 2 % of business value added, increased productivity growth by 0.2 % in a three year period. Such growth effects were absent in R&D investment or even negative. Nordic countries and Germany intensive in R&D activity should have their focus on organisational investment. Many non-R&D intensive countries such as the UK, Belgium, the Czech Republic, the Netherlands and Hungary, also had innovation model that emphasised organisational competence.
An important finding was the clear differences found in the level of R&D investment in national and firm-level calculations. Our project showed that R&D investments were clear only part of total intangible activity. It was likely that overall intangible capital could be calculated more precisely representing better the innovation potential of any country than the mere any individual type of intangible investment such as R&D capital. It was also true that most of the R&D activity took place in separate departments in manufacturing, while in services research and development was tight to marketing and organisational activities. Proper measurement of R&D activity had larger scope of activities that might better cover the service sector than what was the case. INNODRIVE also applied a broad definition of R&D occupations in firm-level approach leading to higher share of R&D workers in the UK in particular.
Our results emphasised intangible investment as tacit knowledge that was less bound to regional borders. We could say that regional policies could be targeted for subsidising innovative activity also outside metropolitan area. Regional policies should also be targeted for providing sufficient level of educational skills as intangible and human capital were clear complements at firm level. Most of the intangible capital spillovers also accrued for organisational capital, indeed all in the UK and Finland. Business was in their location decisions also interested in profitability rather than in productivity, where the tacit knowledge within the firm played the most significant role.
Countries with less tangibles invested more in intangible capital showing an indication about the degree of transition towards knowledge economy. The Portugal, Italy, Greece and Spain (PIGS) countries recently suffered from financing sovereign debt burden. The investment policy relied more on tangible than on intangible investment, and therefore countries suffered relatively more from the transition of production outside Europe especially in Asia. Intangible capital investment in the future is likely to give more solid growth. Intangible GDP shares were in 2005 4.5 % in Italy, 4.1 % in Spain and Portugal and 2.0 % in Greece, all below the average EU27 and Norway share of 6.7 %. At the same time, the diversity of intangible capital should be emphasised so that policies should not promote R&D investment alone. Our research also not covered public intangible investment that should also have far reaching implications.
List of Websites:
'http://www.innodrive.org'
For more information hannu.piekkola@uwasa.fi
The European political agenda, encapsulated in the Europe 2020 strategy, recognises the importance of investment in knowledge, innovation, education and information and communication technology (ICT) as drivers of 'smart growth'. The aim of this research project was to improve our understanding by providing new data on intangibles and new estimates of the capacity of intangible capital to generate growth. We did this at both the firm and national levels. At the micro level, the goal of the research was to improve our insight into the contributions of intangibles to the growth of firms, by exploiting the potential of recently established linked employer-employee datasets (LEEDs) and by also implementing a performance-based methodology to analyse how firms used knowledge and human capital to increase their productivity. At the national economy level, we expanded the traditional growth accounting framework by including, in capital formation, estimates of the investment in intangibles that had hitherto largely been counted as current expenditure in the conventional national accounts.
Our main findings were as follows. Gross domestic product (GDP) in the European Union's 27 members (EU27) area was 5.5 % higher after including all intangible investment. In national approach intangible capital investment share of GDP was 6.7 % of GDP in EU27 and Norway and only 1.1 % was thus recorded in system of national accounts. Organisational competence covered nearly half of this being 3.1 % of GDP. The latter half of 1990s was a period of increasing intangible share of GDP, while in 2000s the GDP shares stayed mostly constant.
Own account intangible investment was in firm-level approach estimated in European firms to account between 7 % in Finland and Czech Republic and 11 % in the United Kingdom (UK) and Norway, of business sector new value added. This figure was half of national measures in national approach with broader selection of intangibles but narrower definition of companies' own account intangible (Jona-Lasinio and Iommi 2011). Intangible investment was increasingly likely to become more important as greater emphasis was placed on 'smart' growth (Europe 2020). Investment in intangible assets was shown to be an important factor in performance of European and United States of America (USA) companies increasing Tobin's q (e.g. Piekkola 2010, Lev and Radhakrishnan 2005) and intangible capital type work was tied up with total factor productivity of Finnish firms (Ilmakunnas and Piekkola, 2010). Macro level studies had the same outcomes (Corrado, Hulten, Sichel 2006; Marrano, Haskel 2006; Roth and Thum 2010; Belhocine 2009). Ignoring intangibles in national accounts implied an underestimation of GDP by 5.5 % in EU27 area and labour productivity growth by 10 to 20 %.
Firm-level analysis also showed that own account organisational capital could be even higher share of intangible capital when performance-based methodology was applied. This highlighted the importance of organisational capital as an important form of intangible capital thus even exceeding in importance research and development (R&D) investment in many European countries. In fact in nearly all EU27 countries except Finland and Sweden the share of economic competence from new value added exceeded the respective R&D share. Countries were also specialised in different type of intangible capital so that the share of R&D investment was highest in Nordic countries. In six countries with firm-level data of intangibles the share of workers engaged in intangible capital type work was around 18 % of all workers and again the type of work differed from one country to another. We also analysed innovation work and gender wage gaps. In innovation work the average gender wage gap was usually larger among innovation workers than among non-innovation workers (Finland and Czech Republic), but with exceptions (Norway).
Project Context and Objectives:
It is widely recognised that knowledge and intellectual capital are major determinants of the generation of innovation and thus the enhancement of growth, employment and competitiveness of the European Union. The importance of R&D and innovation is also explicitly recognised in the 'Lisbon process'. Yet, our knowledge of the contribution of intangibles to economic performance is still incomplete. While firms undoubtedly are at the centre of innovation and productivity growth, their activities are hard to analyse empirically. Furthermore, at the macro level the national accounts data on capital formation focus primarily on fixed investment and have only recently attempted to measure investment in intangibles such as software, mineral exploration and artistic creations. The aim of this research project was to improve our understanding by providing new data on intangibles and new estimates of the capacity of intangible capital to generate growth. This research thus explored uncharted territories in European Union's (EU) socioeconomic research.
A central theme of the smart growth strategy recognised the need to treat intangibles as investments, creating future value, rather than as intermediate costs. INNODRIVE produced new estimates of intangibles for EU27 countries and Norway following the approach of Corrado, Hulten & Sichel (2006) (hereinafter CHS). Besides computerised information (software and database), this new approach included the following items, which were often excluded from both the bookkeeping systems of companies and the national system of accounts:
1. innovative property, scientific and non-scientific R&D, with scientific R&D leading to a licence or a patent, mineral exploration, copyright and licence costs (spending for artistic originals) and
2. economic and firm competences spending on reputation (advertising), firm specific training and organisational capital.
In the CHS analysis, estimates of the purchased part of intangible investment were based on findings from a number of empirical surveys. For the own account component they made broad assumptions, since expenditures on labour, intermediates and capital used to create intangible capital at the company level were difficult to determine.
INNODRIVE advanced the CHS approach by developing new data on intangibles at the company level, which allowed us to analyse different types of intangibles and their role in economic performance and growth. Using both expenditure and performance based estimates of intangible capital, company data provided information on the own account part of intangible investment. The expenditure based approach estimated the combination of labour, intermediates and capital required to produce intangible assets based on the simplifying assumption that intangible investment was proportional to the salary costs of ICT, R&D and organisational, i.e. management and marketing, personnel. The performance based approach replaced management and marketing salary costs by the estimated productivity of the same type of work. Performance based estimates were larger in comparison to the expenditure based estimates, which helped to narrow the well known gap observed between market values and book values of assets.
Project Results:
Innovation is more than R&D: Other intangibles matter for creating value
Investment in intangibles (R&D, organisational competence and other factors) can be seen as one indicator of innovation intensity, measuring the cost of innovation, which is considerably higher than R&D alone.
All countries with traditionally high rates of R&D (such as Sweden, Finland and Germany) ranked above average in terms of their investment in intangibles (company-level data also suggested that R&D in Norway was underestimated). However, many countries that were not R&D intensive ranked highly using the broader measure of innovation intensity, such as the United Kingdom (UK), Belgium the Czech Republic, the Netherlands and Hungary. Organisational capital for Germany was underestimated here. This phenomenon pointed to a different type of innovation model, one that emphasised organisational competence. In addition, Sweden, Luxembourg, the Czech Republic and France were intensive in other types of intangibles, which captured training, architectural design, new financial product and databases and software.
The share of new intangibles in GDP not currently included in the national accounts increased in European countries by around one percentage point during the ten-year period from 1995 to 2005. Compared with 1995, expenditure in 2005 on new intangible assets increased in almost all countries, except Spain (where the share remained unchanged), Greece, Estonia and Norway. Generally, 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.
The development of intangible capital over time was heterogeneous across countries between 2000 and 2005. For most countries there was a slowdown in the rate of increase in the share of intangible investment of GDP, but not in Ireland and Malta. Overall, new intangible shares of GDP varied considerably across countries:
1. ranging from 2 to 9 % of GDP, but with the Eastern European economies being able to catch up with the skill-intensive countries
2. showing steady investment share of value added from 2000 to 2005 in all the old EU member states (EU15) except Austria; and
3. with economic competencies accounting for at least half of all intangibles, ranging from 45 to 75 % of intangibles assets across all countries, advertising and organisational capital being typically at the core.
Total tangible and intangible investments were fairly evenly distributed throughout Europe. Norway, Czech Republic Sweden, Belgium and Malta ranked as the top countries in the half of countries with business investment intensity between 13 and 20 % of GDP. Other countries had total private investment share of around 10 % of GDP. Countries with relatively low intangible investment had high levels of tangible investment.
Average impact of capitalising intangibles on GDP
The capitalisation of intangibles implied an average increase of 5.5 % of GDP for the EU27 over the period 1995 to 2005. The average increase for the EU15 GDP was slightly lower (5.4%), while for the new member states (NMS), it was one percentage point less (4.5%).
Structures of intangibles differ across countries
Aggregation of company-level data gave statistics on business sector intangibles that were comparable to data obtained at the country level. In the six countries with micro data, we found substantial variation in the shares of occupations engaged in producing intangible capital.
Including all intangible-type workers in the analysis gave more harmonised figures of workers engaged in intangible capital production than counting only the number of managers. The total share of intangible capita-type workers was typically around 18 %. The share of organisation workers (the sum of the share of management and marketing workers) varied between 13 % in the UK and 5.5 % in Norway, while the respective R&D worker shares tended to be higher in countries with lower organisation worker shares (only 4 % in the UK compared with 9 % in Finland). Organisational workers were the largest group with the UK at the top at around a 12 % share. The share of managers was around 9 % in the UK, 4 % in Finland, 8 % in the Czech Republic, 9 % in Germany, 3.5 % in Norway and 6.5 % in Slovenia.
Analysis of intangible capital at the company level showed that Nordic countries were intensive in R&D capital and fairly poor in organisational capital (managerial and management). Large countries, such as the UK and Germany, were rather intensive in organisational capital and had relatively less R&D capital. The UK, on the one hand, and the two Nordic countries Finland and Sweden, on the other, could be taken as two extreme opposite examples of either organisational capital-driven or R&D-driven economies. The company level data for Finland and the UK showed the same seven structural differences in intangible capital. Finland and the UK were two examples of either organisational capital or R&D driven economies.
The investment rate for all intangibles (R&D, ICT and organisational capital investment) was around 7 % of value added in Finland and around 10 % of value added in the UK. The UK also had considerable R&D activity when a more holistic definition of R&D-type work was used, covering engineering and architectural design work (in national estimates 0.9 % of GDP). This wider definition accounted for a greater R&D effort in service industries.
The expenditure based approach gave only part of the picture regarding the value of intangibles when they were owned by the firm and employees are not fully compensated for the value of intangible production. Indeed, the performance-based approach increased the relative importance of organisational investment. This was explained by the widely observed gap between productivity and wage costs of organisational workers. Using the performance based approach, organisational investment was more similar to R&D investment in Finland, which was also supported by its impact on the market value of Finnish listed firms.
In the UK, organisational investment exceeded R&D investment regardless of the estimation method used. Organisational investment (the largest component of organisational competence in the national estimates) decreased over recent years in both countries when the productivity of organisational-type work was used to construct these estimates. This decline might call for new types of innovation policy measures. In national accounting, business sector investment in organisational capital (economic competence excluding training) were also highly important. They were on average 2.6 % of GDP, while investment in (scientific) R&D was over three times lower, around 0.8 %.
Accumulation of intangible capital promoted labour productivity and wellbeing
Growth accounting for a set of countries revealed interesting results. Labour productivity, a measure of living standards, depended strongly on the accumulation of intangible capital. With the inclusion of intangible capital, the 'unexplained' component of productivity growth, the total factor productivity (TFP), became less important, while physical capital turned out to be strongly complementary to intangible capital:
1. over the period from 1995 to 2000, the capitalisation of intangibles increased labour productivity in all countries considered, while from 2000 to 2005 it had the opposite effect
2. the relative contribution of capital deepening and TFP to labour productivity growth changed considerably after the inclusion of all intangibles; the rate of capital deepening increased and the growth of TFP decreased. Capital deepening became the dominant source of labour productivity growth.
In an analysis of regional effects in Germany, Finland and the UK, company-level productivity was also shown to be strongly related to firms' own intangible capital as well as regional intangible capital, suggesting positive localised spillovers. Productivity was highest in firms that also had considerable human capital. There was a need to be clear about the distinction between human capital and intangibles; intangibles enhanced the profitability of economic activity while human capital was owned by the employee and capitalised in wages. Organisational capital, i.e. the competence of management and marketing workers appeared to be the most clearly related to productivity growth.
Potential Impact:
Accumulation of intangible capital promotes labour productivity and wellbeing
Growth accounting for a set of countries revealed interesting results. Labour productivity, a measure of living standards, depended strongly on the accumulation of intangible capital. With the inclusion of intangible capital, the 'unexplained' component of productivity growth, the total factor productivity (TFP), became less important, while physical capital turned out to be strongly complementary to intangible capital:
1. over the period from 1995 to 2000 the capitalisation of intangibles increased labour productivity in all countries considered, while in 2000 to 2005 it had the opposite effect
2. the relative contribution of capital deepening and TFP to labour productivity growth changed considerably after the inclusion of all intangibles; the rate of capital deepening increased and the growth of TFP decreased. Capital deepening became the dominant source of labour productivity growth.
In an analysis of regional effects in Germany, Finland and the UK, company-level productivity was also shown to be strongly related to firms' own intangible capital as well as regional intangible capital, suggesting positive localised spillovers. Productivity was highest in firms that also had considerable human capital. There was a need to be clear about the distinction between human capital and intangibles; intangibles enhanced the profitability of economic activity while human capital was owned by the employee and capitalised in wages. Organisational capital, i.e. the competence of management and marketing workers appeared to be the most clearly related to productivity growth.
Taking intangibles seriously
The significance of a skilled workforce for economic growth lay in its ability to create value added in the form of intangibles. The INNODRIVE project documented the important role that intangibles played as a new source of growth; it was crucial therefore not only to measure them but also to improve their management and exploitation. This was why policy measures should aim to stimulate a better understanding of intangibles by including them in the GDP measure and encouraging their use by means of appropriate incentives.
Key messages
1. GDP in the EU27 area was 5.5 % higher after including all intangible investment
2. intangibles were an important source of future growth across European countries. Intangibles explained a substantial part of the market value of the companies that was only partially captured in standard economic analysis
3. countries with less tangibles invested more in intangible capital showing an indication about the degree of transition towards knowledge economy
4. the observed decrease in tangible capital over time was not fully offset by intangible capital investment
5. Nordic countries were R&D intensive and had relatively less organisational capital than the UK, Belgium and the Netherlands and in company level analysis in Germany
6. organisational capital investment was one of the key drivers of growth, accounting for close to three times more investment than in R&D at national level, but also due to the narrow definition of R&D activity
7. intangible capital was agglomerated in metropolitan areas in the private sector. The greater Helsinki area accounted for 48 % of all intangibles in Finland, while the London City-Region for 41 % of UK intangibles. In Germany intangible capital was more dispersed, with the top 10 regions accounting for 48.3 % of the German total, i.e. Munich for 7.5 %, Stuttgart 7.2 %, Frankfurt 6.4 %, Düsseldorf 5.6 %, Hamburg 5.2 %, Berlin 4.7 %, Cologne 3.9 %, Duisburg/Essen 2.8 %, Nürnberg 2.7 % and Karlsruhe 2.3 %.
8. foreign direct investment was an important aspect of intangible growth in the EU8. Greenfield FDI brought with it more R&D and the companies were seen to have a higher share of organisational workers in Czech Republic
9. future research should focus on refining the range of production inputs and on the extent to which they should be classified as intermediate consumption or intangible investment. For example, one could incorporate the training provided by firms and address the issues of double counting of R&D and ICT investments (database and software investments), which were often estimated in national accounting systems using employment compensation in relevant occupations.
Intangible capital in broader perspective described the main innovation activities of private companies and was, almost by definition, the source of future growth. Management activity engaged in productivity growth in longer term was though hard to judge. However, our performance-based estimates clearly showed that the traditional expenditure-level estimates of organisational activity, mainly management and marketing, were lower bounds for the true value of organisational investments. The reason was that the productivity of these types of activities usually exceeded the respective wage expenditures. The combination of labour, intermediates and capital in production of intangible capital increased more value added than what was the cost of expenditures.
An important consequence of this was that intangible capital investment also improved markedly the profitability of the firms given the productivity and wage gap. It should be noted that intangible capital had also positive impact on hourly wage growth, but the improvement in efficiency allowed a decrease in overall wage expenditures over the course of year. We had not analysed labour utilisation rates but it might well be that good performance induced by intangible investment also increased overall demand for employment.
Intangible investment was increasing in its share, although the growth in the shares had somewhat diminished in 2000s. Exceptions were the new member states that were catching up both in GDP levels and in the intangible capital shares of GD the rest of Europe. Overall, the level of intangible investment in Europe appeared insufficient when compared with the USA that was more prone to use all types of innovation activity more intensively.
We also showed clearly that intangible investment in general and not only R&D investment drove productivity growth. Organisational and ICT work were close complements but might also work as substitutes in resource allocation for R&D work activity. Policies for promoting R&D activity alone might hence not be appropriate, as such policies might crowd out other intangible investments. The EU 2020 programme aims at smart, sustainable and inclusive growth with clear object that the 3 % of the EU's GDP should be invested in R&D. Since Europe has average R&D investment level below other developed countries including the USA, this target is well founded, but should also cover wider sets of intangible capital assets in the future. Our findings supported the importance of organisational capital. Firm-level analysis was also able to show some numeric estimates of growth effect of organisational capital. In Finland and Germany the doubling of organisational investment, less than 2 % of business value added, increased productivity growth by 0.2 % in a three year period. Such growth effects were absent in R&D investment or even negative. Nordic countries and Germany intensive in R&D activity should have their focus on organisational investment. Many non-R&D intensive countries such as the UK, Belgium, the Czech Republic, the Netherlands and Hungary, also had innovation model that emphasised organisational competence.
An important finding was the clear differences found in the level of R&D investment in national and firm-level calculations. Our project showed that R&D investments were clear only part of total intangible activity. It was likely that overall intangible capital could be calculated more precisely representing better the innovation potential of any country than the mere any individual type of intangible investment such as R&D capital. It was also true that most of the R&D activity took place in separate departments in manufacturing, while in services research and development was tight to marketing and organisational activities. Proper measurement of R&D activity had larger scope of activities that might better cover the service sector than what was the case. INNODRIVE also applied a broad definition of R&D occupations in firm-level approach leading to higher share of R&D workers in the UK in particular.
Our results emphasised intangible investment as tacit knowledge that was less bound to regional borders. We could say that regional policies could be targeted for subsidising innovative activity also outside metropolitan area. Regional policies should also be targeted for providing sufficient level of educational skills as intangible and human capital were clear complements at firm level. Most of the intangible capital spillovers also accrued for organisational capital, indeed all in the UK and Finland. Business was in their location decisions also interested in profitability rather than in productivity, where the tacit knowledge within the firm played the most significant role.
Countries with less tangibles invested more in intangible capital showing an indication about the degree of transition towards knowledge economy. The Portugal, Italy, Greece and Spain (PIGS) countries recently suffered from financing sovereign debt burden. The investment policy relied more on tangible than on intangible investment, and therefore countries suffered relatively more from the transition of production outside Europe especially in Asia. Intangible capital investment in the future is likely to give more solid growth. Intangible GDP shares were in 2005 4.5 % in Italy, 4.1 % in Spain and Portugal and 2.0 % in Greece, all below the average EU27 and Norway share of 6.7 %. At the same time, the diversity of intangible capital should be emphasised so that policies should not promote R&D investment alone. Our research also not covered public intangible investment that should also have far reaching implications.
List of Websites:
'http://www.innodrive.org'
For more information hannu.piekkola@uwasa.fi
