Intangible Capital and Economic Growth

The capitalization of software alone has had an appreciable affect on the measured growth of output per worker in the non-farm business sector, and the growing literature on intangibles suggests that this is just the tip of the iceberg.

The revolution in information technology (IT) is apparent in the profusion of new products available in the market place, including PCs, PDAs, ATMs, wi-fi devices, and cell phones. These innovations are part of a broader technological revolution, based on the discovery of the semiconductor, often called the "IT revolution." However, while its effects are apparent in the market place, its appearance in the macroeconomic statistics on growth has been slow to materialize. Several economists have remarked that technological advances have not been reflected in productivity data. Alan Greenspan observed in the mid-1990s that the negative trends in productivity observed in many service industries seemed inconsistent with the fact that they ranked among the top computer-using industries.

The IT revolution only began to appear in the productivity data in the mid-1990s and has been linked to investment in IT capital. However, there is reason to doubt that official data accurately capture all factors that affect U.S. economic growth. Both firm-level and national income accounting practice historically has treated expenditure on intangible inputs as an intermediate expense and not as an investment that is part of GDP. This state of affairs has begun to change with the capitalization of software in the U.S. National Income and Product Accounts (NIPAs). The capitalization of software alone has had an appreciable affect on the measured growth of output per worker in the non-farm business sector, and the growing literature on intangibles suggests that this is just the tip of the iceberg.

In Intangible Capital and Economic Growth (NBER Working Paper No. 11948), authors Carol Corrado, Charles Hulten, and Daniel Sichel find that the rapid expansion and application of technological knowledge in its many forms (including R and D, brand equity, and human competency) is a key feature of recent U.S. economic growth. Accounting practice traditionally excludes investment in intangible knowledge capital, thus excluding, according to the authors' estimates, approximately $1 trillion from the conventionally measured output of the non-farm business sector by the late 1990s, and understating the business capital stock by $3.6 trillion. The $1 trillion in omitted intangible investment is roughly equal to the amount of investment spending on tangible capital goods, which is included in measured output, and intangible investment amounts to around 10 percent of that output. The current practice also overstates labor's share of income by a significant amount and masks a downward trend in that share.

The authors suggest that the inclusion of intangibles, both as an input and as an output, can have a large impact on our understanding of economic growth. They find that the inclusion of intangible investment in the real output of the non-farm business sector increases the estimated growth rate of output per hour by 10 to 20 percent over the period 1995-2003 relative to the base-line case which completely ignores intangibles. Thus, the inclusion of intangibles matters for labor productivity growth rates, although it has little effect on the acceleration of overall productivity in the mid- 1990s.

On the input side, intangibles were about as important as tangible capital as a growth source after 1995. When the two are combined, capital deepening supplants Multi-Factor Productivity (MFP) as the principal source of growth. Moreover, the majority of the contribution of intangibles comes from non-traditional categories.

It is also worth noting that the fraction of output growth per hour attributable to the old "bricks and mortar" forms of capital investment is very small, accounting for less that 8 percent of total growth in the period 1995-2003. The authors suggest that it is inappropriate to automatically attribute the other 92 percent of total growth to "knowledge capital" or to "the knowledge economy." However, it is equally inappropriate to ignore the association between innovation, human capital, and knowledge acquisition, on the one hand, and investments in intangibles, IT capital, and labor quality change on the other.

That intangibles, and more generally, knowledge capital should be such an important driver of modern economic growth is hardly surprising, given the evidence from every day life and an understanding of basic economic theory. What is surprising is that intangibles have been ignored for so long, and that they continue to be ignored in financial accounting practice at the firm level

-- Les Picker