1
Overview

According to a 2006 Federal Reserve Board analysis, investment in intangible assets in the United States exceeds all investment in tangible property and, if properly accounted for, would raise measured productivity growth significantly (Corrado et al., 2006a, 2006b). These assets—which include computer software, research and development (R&D), intellectual property, workforce training, and spending to raise the efficiency and brand identification of firms—comprise a subset of services, which, in turn, accounts for three-quarters of all economic activity. Increasingly, intangibles are a principal driver of the competitiveness of U.S.-based firms, economic growth, and opportunities for U.S. workers. Some intangibles, like intellectual property, are being securitized, auctioned, and traded; not long ago, few would have contemplated the existence, let alone the proliferation, of “technology markets.” Yet, despite these developments, many intangible assets are not reported by companies, and, in the national economic accounts, they are treated as expenses rather than investments. At the moment, there is also no coordinated national strategy for promoting intangible investments, apart perhaps from R&D.

Research on the role of R&D investments—specifically that supported by the Bureau of Economic Analysis (BEA) and the Division of Science Resources Statistics of the National Science Foundation (NSF)—indicates how important just this single type of intangible can be in terms of its impact on the nation’s economy. Switching from the current measure of gross domestic product (GDP), which considers R&D as an intermediate expense (similar to salaries and material inputs), to one that reclassifies these expenditures as business investment (a category that includes such assets as buildings, structures, equipment with long-term service capacity, and tools) leads to an increase of 11 percent for 2002. If



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1 Overview A ccording to a 2006 Federal Reserve Board analysis, investment in intan - gible assets in the United States exceeds all investment in tangible prop - erty and, if properly accounted for, would raise measured productivity growth significantly (Corrado et al., 2006a, 2006b). These assets—which include computer software, research and development (R&D), intellectual property, workforce training, and spending to raise the efficiency and brand identification of firms—comprise a subset of services, which, in turn, accounts for three-quar- ters of all economic activity. Increasingly, intangibles are a principal driver of the competitiveness of U.S.-based firms, economic growth, and opportunities for U.S. workers. Some intangibles, like intellectual property, are being securitized, auctioned, and traded; not long ago, few would have contemplated the existence, let alone the proliferation, of “technology markets.” Yet, despite these develop - ments, many intangible assets are not reported by companies, and, in the national economic accounts, they are treated as expenses rather than investments. At the moment, there is also no coordinated national strategy for promoting intangible investments, apart perhaps from R&D. Research on the role of R&D investments—specifically that supported by the Bureau of Economic Analysis (BEA) and the Division of Science Resources Statistics of the National Science Foundation (NSF)—indicates how important just this single type of intangible can be in terms of its impact on the nation’s economy. Switching from the current measure of gross domestic product (GDP), which considers R&D as an intermediate expense (similar to salaries and mate - rial inputs), to one that reclassifies these expenditures as business investment (a category that includes such assets as buildings, structures, equipment with long- term service capacity, and tools) leads to an increase of 11 percent for 2002. If 

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 INTANGIBLE ASSETS correct, R&D investments have contributed more to growth in GDP than tangible capital investments over the past 50 years. And, according to the preliminary results, their relative contribution is on the rise: R&D accounted for 4.5 percent of growth in GDP between 1959 and 2002 and 6.7 percent for the period between 1995 and 2002 (Robbins and Moylan, 2007). On June 23, 2008, the Board on Science, Technology, and Economic Policy, jointly with the Committee on National Statistics, held a workshop to examine measurement of intangibles and their role in the U.S. and global economies and to discuss a range of policy-relevant topics: • What intangibles are and how they work. • How intangible investments compare and contribute to growth in the United States and other countries. • How intangibles are created and used by firms. • The variety and scale of emerging markets in intangibles. • What government statistical agencies are doing in the area. • What the government’s role should be in supporting markets and promot- ing investment in intangibles. In the keynote address to the workshop,1 Senator Jeff Bingaman (D-NM) presented his perspective on why policy makers and lawmakers should care about improving measurement of intangible asset investments and nurturing their development. Citing research by BEA and the Federal Reserve Board, he emphasized the point that R&D, and intangible assets more broadly, significantly affect worker productivity, GDP growth, and, in turn, the economic well-being of the nation’s individuals and families. He challenged the workshop’s participants to continue work to measure these economic factors as accurately as possible so that Congress and other leaders will be adequately informed to enact the right policy incentives—with regard to creating parity in tax incentives between tan - gible and intangible output and to appropriate funds for the right mix of basic and applied research—for today’s knowledge-based economy. Accurate measurement of investment in intangible assets and implementation of policies to optimize their value, he observed, are great technical challenges, ones that are especially important as the nation works to remain globally competitive. In the opening session, key terms were defined and their role in the modern economy identified. Irving Wladawsky-Berger (IBM and Massachusetts Institute of Technology) sketched out the salient factors in the U.S. economy’s transition from an industrial to a knowledge economy. He described how the advent and proliferation of the Internet and other information technologies marked a key point in that transition. He argued that economic progress and growth now hinge on asset development that is intangible in nature. In particular, he focused on the 1 Full text of the address is reproduced in Box 1-1.

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 OVERVIEW leading role of talent and intellectual capital as the intangible assets most impor- tant to future economic development. Charles Hulten (University of Maryland) outlined the difficult issues that need to be resolved in defining and measuring intangibles. His research, along with that of Carol Corrado and Dan Sichel, his colleagues at the Federal Reserve (referred to in this volume as CHS), has shown that investment in intangible assets is larger than fixed capital investment, and that its inclusion in micro and macro statistics is essential to the task of explaining corporate valuation, mea - sures of economic growth, total factor productivity, and indeed GDP. He laid out viable methodologies for advancing these measurement objectives and reported results from this area of research. 1.1. MACROECONOMIC MEASUREMENT IMPLICATIONS The second session of the day probed further into the macroeconomic impli - cations of intangible assets. Carol Corrado (Conference Board and formerly the Federal Reserve), extending comments made by Hulten, discussed the CHS empirical results for the U.S. case. This research presents a clear and compelling case for treating tangible and intangible assets in a methodologically symmetric manner and for capitalizing the latter in the nation’s economic accounts. In this way, the portrayal of business activity is brought up to date by recognizing the role of innovation in the dynamic nature of production and capital accumulation in the modern economy. The workshop encompassed international perspectives as well. Jonathan Haskel (Queen Mary College, University of London) presented evidence about the role of intangible assets using the CHS methodology applied to the economy of the United Kingdom. In the process, he identified several questions of concern for policy makers, business executives, and academics in the United Kingdom. Like Corrado, he concluded that including intangibles as investments makes a significant difference in measured economic activity and growth, although the patterns of intangible investment and sources of productivity growth are some- what different from those detected for the United States; in addition, he reported high levels of interest, in both the measurement and the policy communities, in constructing an innovation index for the United Kingdom. Kyoji Fukao (Hitotsubashi University and Research Institute of Economy, Trade and Industry) provided estimates of intangible investments in Japan and of their contribution to economic growth. His team’s research found the country’s economic growth, from the mid-1990s on, to be characterized by slow growth in total factor productivity in sectors with intensive information and communica - tion technology (ICT); ICT investment was also found to be relatively stagnant. Following the measurement approach of the CHS team (2005, 2006a, 2006b), Fukao showed that, in comparison to the United States, Japan invests somewhat less in intangible assets. The Japan case is also characterized by high levels of

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 INTANGIBLE ASSETS BOX 1-1 Keynote Address: Importance of Intangible Investments to Congress The workshop’s keynote address was delivered by Senator Jeff Bingaman of New Mexico. Senator Bingaman, one of Congress’s members with a longtime interest in innovation policy, was architect of the America Competes Act. He is chairman of the Senate Energy and Natural Resources Committee, placing him at the nexus of two of the most important elements of America’s economic future, innovation and energy. Let me thank Steve Landefeld of the Bureau of Economic Analysis and Steve Merrill of the National Academies for inviting me to give these remarks. This is an appropriate conference at a time when our nation is deeply concerned about its world economic standing. In 1995, at the peak of the dot-com bubble, Alan Greenspan made the now famous quote that sums up the importance of investments in R&D that perhaps is the forebear to today’s conference: “Had the innovations of recent decades, espe- cially in information technologies, not come to fruition, productivity growth would have continued to languish at the rate of the preceding twenty years.” About 10 years later, the value of innovation to our economy was quantified by Carol Corrado, Dan Sichel, and Charles Hulten of the Federal Reserve by look- ing at the broader category of so-called intangible assets, which include research and development, intellectual property, information technologies, re-organization of companies and worker training. Though these intangibles cannot be physically seen or touched, they account for nearly 11 percent of our GDP, or roughly $3.1 trillion in 2003. In 2007, the Bureau of Economic Analysis looked at a more narrow set of R&D data provided by the National Science Foundation and, instead of treating R&D as an expenditure, it is treated as an investment. The result is that the GDP would have been on average about 3 percent higher—that is a pretty big number. The BEA reported that, for my state, treating R&D as an investment would actually increase my state’s average GDP by about 8 percent. That makes intuitive sense given the strong role that Los Alamos and Sandia National Laboratories have in science and technology. So it is clear to me that R&D and perhaps a broader set of economic measures have an important effect on our economic well-being. The question for those of you assembled today is how we can accurately measure these economic factors so the Congress can be informed and enact the right incentives for today’s knowledge- based economy. In the area of R&D, the BEA points out the strong linkage of R&D funding and GDP growth, but the question we ask is how much money should be appropriated and what is the right mix of basic and applied research? The OECD annually reports R&D as a percentage of GDP. The United States is currently at 2.5 percent while Japan is 3.1 percent. Is there a strong correlation with GDP growth in these data? In terms of the federal funding of R&D, are there

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 OVERVIEW strong correlations between basic and applied research funding and growth in GDP? Answering these funding questions is important to policy makers. So often we simply state we should double a certain agency’s research budget, but in a constrained fiscal environment it will come at the expense of other programs, so it would be helpful to at least have some guideposts on what the proper levels of investment are by the federal government. The work of Corrado and colleagues raises questions which I believe the C ongress will have to eventually grapple with. For instance, it shows the impor- tance of worker retraining and organizational re-engineering in a global economy. In our country, worker retraining is often is handled through the Trade Adjustment Act as an after-the-fact result of an industry closing down or re-engineering by shedding a business line. Would it make more sense to offer tax credits to indus- tries to retrain and retain employees before they re-engineer and restructure for a global economy? Japan and Korea offer such tax credits. In the Senate Finance Committee, on which I serve, “innovation” has long been a watchword, and we regularly consider and debate proposals to promote innova- tion through targeted tax incentives. But, too often, that word is construed only to look to R&D that produces tangible output. The production of intangible output is often not fully compensated—and carries significant positive externalities. This creates an especially compelling need to reconsider our R&D tax incentives, and to create parity in incentives for tangible and intangible output. In the area of financial disclosure, would it make sense to require industries to account for and disclose intellectual property assets to give signals to markets and their investors? We in Congress are very concerned these days about the transparency of companies’ balance sheets; is it time to look at intellectual property as part of their overall capitalization? Finally let me note that we should not look at the concept of intangible as- sets from a perspective of companies shedding manufacturing jobs overseas and becoming totally service oriented. Simply stated, recognition of the role of intellectual property—whether it is patents, R&D, worker retraining or organization re-engineering—is essential in manufacturing (as well as other sectors) if U.S. companies are to stay competitive with other countries across the world. We should avoid the “either-or” perception that there is either a knowledge economy and no manufacturing or vice versa. Japan’s Ministry of Economy, Trade and Industry or METI has programs to help their industries internalize the value of these assets so they realize their full value. It seems entirely reasonable to me that we should be doing the same through the Department of Commerce. I encourage the Department of Commerce to continue these important efforts, especially with the Bureau of Economic Analysis. What may appear to many as an obscure area of economics is starting to be noticed by the Congress, and I believe will grow in importance. Let me thank you all today for inviting me to offer my views. This particular area is one of great technical challenge but I believe important as we work to remain globally competitive.

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 INTANGIBLE ASSETS investment in R&D; the contribution of intangible capital deepening to labor productivity growth is relatively large in manufacturing but small in the service sector. His presentation added evidence to the day’s theme that proper account - ing of intangible investment leads to a significant impact on measured economic performance and growth. 1.2. THE ROLE OF INTANGIBLES IN THE FIRM AND IN FINANCIAL MARKETS During the afternoon session, presenters tackled questions that took on a more microeconomic perspective: How are intangibles created and used by firms? How do intangibles operate in financial markets? And what efforts are being made to capture intangibles in accounting and company valuation procedures? Baruch Lev (New York University) discussed the consequences and possible remedies to address the current deficiencies in information about spending and performance of intangible assets. He struck a theme repeated throughout the workshop: “What is not reported is not measured and is not managed.” According to Lev, the key information that is needed at the firm level (as opposed to that needed for national accounting) is systematic measures of the factors that drive business—specifically structured input-output data on the performance of the major drivers of enter- prise value, some of which are intangible assets. He suggested a collaborative effort undertaken by various government and business organizations to establish well-designed disclosure templates. Lev’s view is that a reasonably high level of voluntary compliance could be achieved if usefully structured templates are available. Comments by Laurie Bassi (McBassi & Company) emphasized a particular class of firms that markets seem to undervalue—those that invest heavily in human capital and skill development, specifically education and training. To begin correcting for this perceived undervaluation, she prescribed taking steps to account for these investments in company reporting requirements. This, she advised, would involve breaking out firm investments in human capital and reporting them separately, even if they are still accounted for as an expense. Such an approach alone would not be sufficient to correct for the undervaluation of intangibles in general, but it would be a useful first step. Jim Malackowski (Ocean Tomo) spoke about intellectual property and capi - tal assets, focusing on the emerging markets for patents. Assets related to propri - etary innovation are, in some respects, the output of R&D spending and human capital development—the topics of previous presentations. He painted a picture of a future that will involve an active marketplace for an array of different kinds of intellectual property and innovations. Nir Kossovsky (Steel City Re) provided additional insights about intangible assets from a finance management perspec - tive, specifically the intriguing notion of insuring the value of intangibles. He stated that policy goals should seek to advance the competitiveness of U.S. firms

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 OVERVIEW by helping them create, manage, and protect intangible assets—particularly those that drive their ability to pursue ethical sourcing, environmental sustainability, quality, and integrity. A major theme throughout the day was that concise, transparent, and under- standable accounting standards are essential to the efficient functioning of the economy because optimal resource allocation decisions can be made only if accurate financial information is available. This premise underlies the mission of the Financial Accounting Standards Boards (FASB) to “establish and improve standards of financial accounting and reporting for the guidance and education of the public, including issuers, auditors, and users of financial information.” Ron Bossio (FASB) provided an overview and update of the organization’s standards-development activities, especially as they relate to intangible assets. FASB’s priorities include working toward international convergence with the International Accounting Standards Board (IASB), the completion of codifica - tion of the U.S. generally accepted accounting principles (GAAP), and ongoing research and support activities. He reported that a comprehensive project on improving accounting for intangible assets has been considered but is not currently a top priority for the organization; however, the board has been asked by its advi- sory council (and others) to develop a project on a disclosure framework, which could eventually generate more accurate aggregate numbers. This may be a way to achieve more transparency about firms’ expenses and capitalized expenditures. 1.3. GOVERNMENT MEASUREMENT A key purpose of the workshop was to sort through the priorities of the sta- tistical agencies for collecting better data on private investments in intangibles, as well as the size and composition of public investments, and incorporating them into broader measures of economic performance. Steve Landefeld (BEA) described the role of BEA and its satellite work on measuring intangible assets. Brent Moulton (BEA) provided additional details on BEA’s Research and Devel- opment Satellite Account. Currently, the top priority for BEA is to finish the work necessary to incorporate R&D satellite estimates in the national income and product accounts (NIPAs) and to treat investment in these assets in a way that is consistent with other business investment expenditures. BEA will also work incrementally to expand measures of intangibles and to produce a version of the satellite account that includes social science R&D, human capital, busi - ness models, and firm-specific R&D. Landefeld emphasized the importance of collaboration between businesses and national accountants. The goal, he said, must be to take advantage of coincidental interests, to rely on market data, to improve data accuracy and consistency, and to minimize respondent burden. Both government and businesses have interests in further development of consistent valuations of intangibles in order to promote a better understanding of firm and general economic growth.

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 INTANGIBLE ASSETS John Jankowski (NSF) described NSF’s R&D and related data collections, which feed into various measurement programs at the statistical agencies. His comments focused on current initiatives to redesign its industry and academic R&D surveys. BEA uses expenditure data from these annual surveys of govern- ment, academic, industry, and nonprofit entities to produce the satellite account (noted above), which supplements the traditional accounts to determine the impact of R&D spending on U.S. growth and productivity. This information has allowed BEA to more accurately account for the share of U.S. economic growth attributable to R&D (it estimated a 6.7 percent contribution for the period 1995 through 2002). Cynthia Glassman (U.S. Department of Commerce) provided an overview of a major initiative—the Advisory Committee on Measuring Innovation in the 21st Century—set up to advise the secretary of commerce on new or improved metrics to advance understanding of how innovation occurs in different sectors of the economy, how it is diffused across the economy, and how it impacts eco - nomic growth and productivity. Three sets of recommendations emerged from this committee’s work, directed toward steps that can be taken by government, the private sector, and researchers.2 1.4. GOVERNMENT POLICY A final session addressed the role of governments, beyond improved mea - surement, in facilitating or encouraging the development and use of intangible assets. Presenters asked: What should the government do to encourage company creation of intangibles? What should be the government’s role in creating or supporting more robust markets in intangibles? And what are other governments doing in these respects? Ahmed Bounfour (Paris-Sud University) discussed the role of intangibles and intellectual capital at the community level from the European perspective. He raised the issue of how communities are affected by transformations in economic systems, such as those brought on by the increase in networking and outsourcing. From his perspective, there is a close link between the dynamic changes occur- ring in the knowledge economy and the way people live and the way communi- ties function. He provided insights into questions about what motivates people to invest in the intellectual capital of a community, city, or nation, and about what makes communities different from companies. He described fascinating cases of communities or nations creating value from public-sector assets, includ - ing intangibles, such as the French government’s branding and licensing of the Louvre Museum. 2The full text of the committee’s recommendations can be found at http://www.innovationmetrics. gov/.

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 OVERVIEW Douglas Lippoldt (Organisation for Economic Co-operation and Develop - ment, OECD), discussed the roll of intangibles in European economies and explained why the OECD is pursuing work in this area. Among the reasons is the growing recognition that intellectual assets are central to value creation, growth, and competitiveness of a modern economy. Also, as noted by nearly all the workshop presenters, he emphasized that continued shortfalls in measurement and understanding of these processes ultimately hamper decision making at many levels. He concluded by outlining OECD’s interests in exploring the relationship between intellectual assets and innovation. The importance of corporate reporting was stressed throughout the work- shop. Following a common theme of the day, Lippoldt stated that the OECD would pursue government policies to promote identification and dissemination of best practices in voluntary reporting. His hope in voluntary measures rests on the idea that disclosure can enable investors to better assess future earnings and risks, improve transparency in financial markets, and foster the possibility of allocating resources efficiently. On the business operations side, openness in the management of assets and accountability can potentially reduce the cost of capital. Lev and others called for the development of templates and the generation of peer pressure to promote their use. Kenan Jarboe (Athena Alliance) offered policy prescriptions, in the U.S. context, for reversing the fact that, right now, intangibles are largely invisible. In order to improve measurement and, in turn, management of these assets, he offered policy recommendations to (1) encourage understanding of intangibles— such as to create a safe harbor in financial statements for reporting of intangible assets; (2) to encourage financial investment intangibles—for example, by creat - ing a central national registry of intellectual property security interests; and (3) to foster the use of intangibles—using such policies as a permanent knowledge tax credit to increase investments in intangibles.