The Intangible Economy: Part 1

In the past, firm investment was mainly direct to tangible assets (physical assets) such as machinery vehicles, and buildings and in the case of government, infrastructure; and production and the value of the firm increased with the accumulation of these assets. However, production capital is not just tangible assets. Firms also invest in soft capital such as knowledge, skills, research and development (R&D) and patents. These assets are known as intangible assets and today they power the new economy or knowledge economy which is driven by know-how, knowledge, human creativity and innovation (Nanayakkara, N.D).

In fact, intangible assets are becoming a major source of Gross Domestic Product (GDP) and firm competitiveness. They are the fundamental driver of economic development as they enable the production of new and better services, products and processes and drive customer, shareholder and stakeholder value (Brooking Institute, 2019; Nanayakkara, N.D).  As developed economies move away from industrial driven processes towards technology and-innovation processes, intangible investments are becoming vital to economic growth and sustainability. Furthermore, just as physical assets were used to create “more physical assets in the industrial age”, intangible assets should be used to create “more intangible assets in the information age” (Jarboe & Furrow, 2008).

Intangible assets “typically involve the development of specific products or processes, or are investments in organisational capabilities, creating or strengthening product platforms that position a firm to complete in certain markets”. Intangible assets include knowledge-related products like software, R&D, design, artistic originals market research, training, new business processes and collaboration and partnerships (Haskel & Westlake, 2017).

Tangible assets are physical and measurable assets that are used in a company’s operations. Tangible assets include plants and machinery, buildings, vehicles, furniture and fixtures, land, computers (Investopedia, 2019).

The shift from tangible to intangible

In the 1980s, the information and technology revolution began to “emerge in full force” with the development of personal computers, mobile phones, and other IT and software programs. The firms that developed these new products were different, in that the majority of their capital expenditure was focused on the development of new technology (Haskel & Westlake, 2017; Hulten, 2010).

In 2006, Charles Hulten examined Microsoft accounts and wondered why the company was worth so much. Valued at around $70 billion, the company only had $3 billion in plant and equipment assets – a mere 4 percent of the company’s value. Hulten realised that the company was worth so much because of the things we cannot touch and see. That is, its Microsoft’s intangible assets such as R&D, product design, the value of its brands, its supply chains and the human capital built up by training; and none of this included Microsoft’s office buildings or servers (Haskel & Westlake, 2017; Hulten, 2010).

Just as Hulten found, intangible assets have certain characteristics that make it hard to see, value and sell. Thus, intangibles are still not recognised fully on balance sheets or on income statements (Jarboe & Furrow, 2008).

Intangible characteristics

By nature, intangible assets are things you cannot touch and they are driven by human capabilities. For example:

  • knowledge is an unusual type of good because putting an idea into practice does not use it up and you can also not lock your asset to protect your property rights (Haskel & Westlake, 2017); and
  • fifty percent of R&D expenditure goes towards the salaries of highly educated workers such as scientists, designers, and engineers (Brooking Institute, 2019).

In addition, return on an intangibles investment is determined by the value of a final product, rather than the asset itself. Whereas, physical assets hold value and are therefore are relatively liquid (can be sold at any time) (Hall & Lener, 2009). Thus, there is something fundamentally different about intangible assets and trying to generate it and measure its value is hard.

Haskel and Westlake (2017) suggest that there are four characteristics of intangible assets that make them different and important in comparison to tangible assets – these are referred to as the four ‘S’ and include:

  1. Scalable: Intangible assets are scalable as many people can use it at once and scalability is not hindered by traditional structures such as machines to increase production;
  2. Sunk costs: Intangible assets have sunk costs, that is, there is no means to retrieve that invested funds. Intangible assets will also depreciate more rapidly than physical capital, but they deliver benefits over time, not just in the period the expenditure was made (Barnes & McClure, 2009);
  3. Spillovers: Intangible assets generate spillovers that benefit multiple businesses. As intangible are ideas or knowledge is very hard to keep secret to prevent others from copying the idea. For example, firms can poach staff, imitate or examine new technologies or drugs and read research papers; and
  4. Synergies: Intangible assets tend to be more valuable when combined with other technologies and products thereby generating synergistic benefits. For example, the microwave was the result of a combination of defence investment and household good production (Haskel & Westlake, 2017).
Tangible Assets Intangible Asset
1. They have a physical existence. 1. They do not have a physical existence.
2. Tangible assets are depreciated. 2. Intangible assets have a future-orientated payback period.
3. Are generally much easier to liquidate. 3. Are not that easy to liquidate and sell in the market.
4. The cost can be easily determined or evaluated. 4. The cost is much harder to determine for Intangible assets.
5. When they become obsolete they can be sold as scrap. 5. Don’t have any scape value.
6. Creditors and banks do accept tangible assets as collateral. 6. Typically cannot be used as credit.

 Calculating intangible value

Over time, the emergence of technology and innovation as a primary economic driver has led to a restructuring of the economy with the majority of a firm’s value now driven by investments in intangible assets (Brooking Institute, 2019). In 2006, the Australian Productivity Commission found that intangible investment was almost half the size of tangible investment of the Australian economy. While more recently, the Brooking Institute (2019) notes that the “collective knowledge of the U.S. population is worth approximately $240 trillion, far exceeding the value of other inputs to economic growth”.

However, it is widely agreed that the value of intangible investment is underestimated or not captured. Governments must reassess the way they calculate GDP and national accounting, which treats spending on intangibles mostly as a current expense (i.e. intermediate input) and not an investment.  As a result, firms cannot capitalise on the growth or depreciation of the asset; and governments are not developing enough incentives to promote investment (Hall & Lener, 2009; Australian Productivity Commission, 2010). 

See Part Two of this blog for more information on issues and what governments can do to incentivise and support more investment into intangible assets.

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