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Economists have long understood that advances in knowledge and technology play a crucial role in economic growth. An important recent contribution to this literature is research on the magnitude and role of intangible capital. As defined by Corrado et al. (2005a, 2006), intangible investment is expenditures by businesses that are intended to boost output in the future but that are not traditional, tangible physical capital; examples include outlays for computer software, research and development, training, brand equity, and improvements in organizational structure and efficiency.

Recent interest in intangible capital was generated by a sense in some quarters that official statistics may not be capturing the full dynamism of the US economy as well as by the resurgence of US productivity growth in the mid-1990s. That resurgence led many researchers, including Oliner and Sichel (2000, 2002), Jorgenson and Stiroh (2000), and Jorgenson et al. (2002), to focus on the contribution of information technology (IT) to economic growth. And that focus on IT, as well as the run-up in equity valuations that occurred at about the same time, turned researchers’ attention to intangible capital. Many analysts observed that firms using IT effectively did more than simply install it; they made sizable collateral investments to revamp their operations in order to exploit the new technologies. For example, Walmart developed a more efficient supply chain, Dell linked demand and production more tightly, Amazon pioneered a new distribution channel, and Google and eBay developed entirely new businesses. In each case, the collateral investments consisted largely of expenditures on intangible inputs. Many observers believe that these intangible investments, as well as intangible investments that may not be tied to IT, are playing an increasingly important role in the economy.

Despite the apparent importance of investments in intangible capital, relatively little is known about these investments. At the firm level, financial accounting provides little information about such expenditures and the return earned by them. Moreover, these outlays are considered a current-period expense, not an investment creating an asset on the firm’s balance sheet. Because of this lack of information, Lev (2004) argues that managers may make poor investment decisions and financial markets may incorrectly value firms and therefore may inefficiently allocate capital. At the level of the National Income and Product Accounts (NIPAs) used to measure gross domestic product (GDP) in the United States, historical practice has classified such expenditures as intermediate inputs, and thus they are not counted as investment in GDP. (The inclusion of business software as an investment in the NIPAs is a notable exception to this practice.) Moreover, the GDP accounts, like firm-level financial accounts, provide very little information about most intangible expenditures.

Research has begun to fill this gap with three broad approaches to measuring intangible capital. The first uses financial market valuations to gauge the value of intangible capital, inferring a measure of intangible capital from the gap between the market and book value of firms. As summarized in Hall (2005), such an estimate was quite large around 2000, about equal to the stock of tangible capital. At the firm level, Brynjolfsson and Hitt (2005) regress market value on capital and labour inputs as well as various proxies for intangible capital. Their work highlights the link between intangible investments and investments in computers, and suggests that intangible investments may exceed tangible investments in computers by as much as a factor of ten. Considerable controversy has surrounded estimates of intangible capital that are derived from financial market valuations.

The second broad category of research relies on other performance measures (such as productivity or earnings) to gauge the magnitude of intangible capital; for examples, see McGrattan and Prescott (2005), Cummins (2005), and Lev and Radhakrishnan (2005). Lev (2004) summarizes a methodology for estimating the value of intangibles at the level of individual firms, starting from earnings. This literature also finds a large role for intangibles.

The third broad category of research uses expenditure data to develop measures of intangible capital. Nakamura (1999, 2001, 2003) was the first to develop expenditure measures. Corrado et al. (2005a) expanded on Nakamura’s work and more tightly integrated estimates of intangible investment with the NIPAs. Marrano and Haskel (2006) applied the methodology of Corrado et al. (2006) to the United Kingdom, and obtained similar results.

Corrado et al. (2006) classify business spending on intangibles into three broad groups: computerized information, innovative property and economic competencies. Computerized information consists mainly of computer software. Innovative property includes scientific R&D and non-scientific R&D such as product development expenditures in financial services and in the entertainment industry. Economic competencies include brand equity (advertising) and firm-specific resources such as training and organizational capital. Corrado, Hulten, and Sichel use a variety of data sources to develop time series of nominal expenditures for each category. These figures suggest that nominal intangible business investment from 2000 to 2003 averaged $1.2 trillion per year, about $1 trillion of which was not counted as investment in the NIPAs.

This research highlights the magnitude and importance of intangibles but does not quantify their contribution to economic growth. This question is taken up in Corrado et al. (2006), which extends their earlier paper, and embeds intangibles in a conventional growth accounting framework. Specifically, Corrado, Hulten, and Sichel develop time series of the real stock of intangible capital for the United States, using their earlier estimates of investment in intangibles. According to their numbers, the nominal stock of intangible capital was about $3.6 trillion in 2003, about $3.1 trillion of which is not included in official measures. These figures imply that official measures may be understating the stock of business capital by roughly 20 per cent.

Corrado et al. (2006) embed their estimates of intangible capital into a standard growth accounting decomposition and present estimates for the period from 1973 to 2003 for the United States. They compare a decomposition based on data that exclude intangibles to one based on data that include intangible assets. Several important results emerge from this analysis. First, the inclusion of intangibles as investment boosts the estimated growth rate of labour productivity in the non-farm business sector by 10–20 per cent relative to a baseline case that completely ignores intangibles. Second, the contribution of intangibles to economic growth has increased dramatically since 1995, and including intangibles has a considerable effect on the composition of the mid-1990s pickup in labour productivity growth. Third, once intangibles are included, greater use of capital (including both tangible and intangible capital) becomes a more important source of growth. This contrasts with the traditional result (when intangibles are largely excluded), where total factor productivity – the residual after accounting for the contributions from labour and capital – plays a larger role. Finally, the majority of the contribution of intangibles comes from categories of intangibles that have received relatively little attention in the past, such as non-scientific R&D and firm- specific resources. Scientific R&D – perhaps the most studied and most ‘traditional’ category of intangibles – accounts for only about one-tenth of the contribution of intangibles to labour productivity growth.

Taken together, the research indicates that business investment in intangible capital is quite sizable and has played an important role in the US economy. Moreover, these results indicate that both firm-level and national income accounting practice miss some important features of economic activity. Nevertheless, the quantitative estimates discussed here are clearly provisional, and this area appears to be a fruitful one for further research.

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