Crafting Policy for the Information Age: EU Research on Intangibles

Clark Eustace, Executive Chairman of PRISM, presented the findings of the PRISM project, an umbrella organization of European business schools that was formed to carry on the work of the European Commission’s High-Level Expert Group on the Intangible Economy. Originally, the issue of intangibles was primarily seen an accounting problem. The further the issue was explored, the more it was realized that it was a larger, more serious issue with far greater implications throughout the economy. In recognition of the broad nature of the problem, PRISM focused on four issue areas: the evolving new theory of the firm; measurement issues; issues for the key interest groups, particularly the accountants, bankers and other market related actors; and, implications for EU policy.

One of the group’s main conclusion is that there really isn’t a new economy, but a soft revolution in number of areas of including the asset base, the speed of markets and the nature of the value chain, which is resulting in deeper transformations. This revolution has gone largely undetected over a number of years because systems of measurement aren’t able to pick it up. This transformation has significant implications for EU policy in areas of understanding the productivity of knowledge-intensive services and the creation of intangible goods. It also raises concerns over accounting standards and the adequacy of existing mechanisms of company reporting.

During the discussion, a number of issues were raised concerning innovation and intellectual property rights (IPR). It was pointed out that we still don’t have a good model of the knowledge production process – either inputs or outputs. Thus, we have difficulty in determining the incentives needed, including the role and forms of IPR that might be most appropriate. Similarly, changes to the model of business services (toward commoditization and systemization) and the rise of intangible goods as a category of products that are neither goods nor services have increased the complexity of the situation facing policymakers. The implication is that there is no one-size-fits-all policy.

Some of the implications of the rise of intangibles for the financial system, especially on access to capital and the role of credit rating agencies, were also discussed. Throughout the discussion, the need for continued research on better models and data collection was stressed. Only through both better data and a more complete theory can we understand how the shifts are occurring.

The speaker at this policy forum was Mr. Clark Eustace, Executive Chairman of PRISM. PRISM is one of the leading European research efforts on intangibles. Funded by the European Commission, the PRISM group is a consortia of eight European business schools that has spent the last two years intensively studying the role of intangibles in economic growth. A former senior partner with Price Waterhouse in Europe, Mr. Eustace is an international expert on the economic and accounting issues relating to the expanding intangible economies. He has served in a number of advisory capacities to European governments. Most recently, he was the founding Chairman of the European Commission’s High-Level Expert Group on the Intangible Economy.

He was introduced by Dr. Kent Hughes, Director of the Project on America and the Global Economy at the Woodrow Wilson Center.

Mr. Eustace began by presenting background on the PRISM project. The project is actually an outgrowth of a Brookings Institution project on which he served. The Brookings Task Force on Intangibles looked at the question of what we should be measuring with respect to intangibles, including the issue of high stock market valuations.1 This project served as a wake-up call for officials in Europe who responded by creating a High-Level Expert Group on the Intangible Economy, which he was asked to Chair. This was a highly successfully undertaking which managed in a short period of time to produce a detailed overview of the issue. 2

Based on that experience, he convinced the European Commission to expand the group and bring in academics for detailed studies on the issues. PRISM was formed as the umbrella organization for that research, with a high-level advisory group comprised of government officials, business leaders and academics. The research is now complete and PRISM has published its executive summary of findings and a large number of background papers. These can be found on its website at http://www.euintangibles.net.

Europe has made this issue of the new economy/digital economy/intangible economy a priority, starting with the Lisbon Accord in 2000. The Lisbon Accord grew out of concern over the gap in economic performance between the US and European economies. This European Commission (EC) agreement set both the research and policy agenda to confront these issues and sent a clear political message that the issue of economic changes was a priority. It is clear that these issues are understood at the highest level of the EC, including EC President Romano Prodi, a respected former economics professor.

Since then, and even before, there have been numerous studies about the economic gap between the US and the Europe. As this analysis has progressed, the view of the issue surrounding intangible assets has changed. Originally, the reason that Mr. Eustace was asked to get involved in the issue of identifying and measuring intangibles was primarily because it was seen an accounting problem. The further the issue was explored, the more everyone realized it was a larger, more serious issue that had far greater implications throughout the economy. The question then become one of how to gain support for the recognition that this was a larger issue affecting major portions of the economy, such as banks and capital markets, and not just the accountants.

Both sides of the Atlantic have now shifted their views that this is an economic problem, not simply an accounting problem. There is a greater realization that the economic fundamentals have changed. Unfortunately, fragmentation within academic economics was not helpful in confronting the issue.

As the Experts Group delved further into this question they found that a major part of the academic fracture line concerned measurement theory. They now believe they needed new models and a new math. By that they do not mean a new accounting math, such as that proposed by Baruch Lev. Rather, they mean a new way of measuring, similar to that of the revolution in science that took place with Robert Boyle. Previously, the notion was that you looked at things in a disaggregated fashion. In economics and accounting, you added up things such as input or transactions or costs. You then disaggregated each individual item and could analyze it in different ways. At some point, people in the natural sciences realized that there were far too many interactions to deal with in this way. So they created a new model and a new math for measurement and analysis.

That is where the PRISM project started. One goal was to bring together disparate academics from various disciplines to attempt to create a new way of approaching intangibles, including taking a closer look at econometrics.
The group had its first session to flesh out their ideas at the University of Ferrara, led by Professor Patrizio Bianchi. That session led to focusing on four issue areas:
The evolving new theory of the firm.
Measurement issues.
Issues for the key interest groups, particularly the accountants, bankers and other market related actors.
Implications for EU policy.
Two years later, the PRISM group has come to set of main conclusions.

First, there really isn’t a new economy. There are not the shifts that occurred similar to those at the beginning of the Industrial Revolution. There is, however, a very rapid and largely hidden change in a number of areas including the asset base, the speed of markets and the nature of the value chain. This is more a soft revolution, as Paul Romer likes to refer to it. The soft revolution has gone largely undetected over a number of years because our systems of measurement aren’t able to pick it up. And it is resulting in deeper transformations.

Mr. Eustace pointed out that they are still grappling with how to better structure these forces in order to make them more understandable.

The PRISM group’s key findings from their thematic workshops are:
A maturing global economy with surpluses is leading to a commodization of products and services.
The shift from old mass production to more customized production leads to a shift from economies of scale to economies of scope.
The struggle for comparative advantage shifts from price factors to factors of differentiation such as intangibles. The real question is why the factors of differentiation rather than price have now become the key drivers. They’ve always been there, but why now in the last 20 years have they have taken on the preeminent role?
Therefore, firms constantly try to create, maintain or invade monopolies founded on intangibles as a major part of corporate strategy. This has major implications for IPR strategies in service industries, since IPR régimes are currently not suited for protecting those intangible assets.
Hidden investment in business intangibles is now as much as 100% of physical capital. This includes investments in R&D, ICT, training and organizational change. However, variations across European countries are enormous and we don’t really yet understand why.
The economic characteristics of the intangible economy are very different from the manufacturing era.
The corporate response to these shifts has been notable. The economic changes have not occurred suddenly, or from a common cause. But, over time, they have induced important changes in the architecture of the corporate value chain. Value chains always had a limited life in competitive markets, but now eroding faster than ever before. Strategic responses include:
Having an effective “innovation machine.” This has become a must for every enterprise. The process started with the Kaizan process of continuous improvement and has grown into the key notion of companies continually re-inventing themselves at all organizational levels. The most successful organizations have ingrained this into the organizational culture. This need for change and re-invention has become relentless.
The constant search for new modes of monopoly rent. This is what keeps companies in business.
Ways of exploiting unique, or difficult-to-replicate capabilities, competences and quasi-assets.
Utilization of networks as key strategic assets. But we don’t yet understand how to measure and evaluate the power and usefulness of networks.
The new dynamics of power has implications for the old corporate governance system. However, the group did not have time to delve into this issue in any depth.
In the area of the policy agenda, PRISM felt that the statistical, market and corporate tracking systems have not kept pace. There is no systematic information, only glimpses. The macro, mezzo and micro systems for picking up information on intangibles are not there. For example, the mezzo-level of the system of real-time information collection in the United States, as exemplified by the SEC, does not exist in Europe.

The issue of intangibles strike at the very heart of the macro and micro reporting models. Stewardship of intangibles is now a major priority for companies & investors (& regulators) There is a proliferation of guidelines and indicators. Yet, holistic solutions to measurement and information are slow to mature.

There are steps that can be taken. The first is a better break-out of intangibles as input to the data collection process. This is a task facing those trying to get agreement on corporate reporting. The second is to refine the notion of using multiple layers of reporting, similar to that which Price Waterhouse and other big accounting firms are advocating. This starts at the basic transaction level and move up to higher levels of tiers, by adding more value-based indicators.

The business level data problem is especially acute when trying to understand the relationship between costs and value. With the rise of importance of intangibles, we no longer have good analytic models of business that show the relationship between what you put in (costs) and what you take out (value).

With respect to macroeconomic data, the PRISM group’s research, led by the former chief statistician for the OECD, shows that 10% of GDP goes unreported due to our inability to capture data on intangibles. Changing the GDP measure, however, is very difficult since so many policy system and automatic policy decisions – such as government program funding – is tied to the number.

On the broader policy front, the policy community has relied on “New Economy” paradigm to light the way for new policy orientations/ levers. This paradigm has collapsed, leaving the policy community very confused and creating a vacuum of ideas. As a result, the attention of policymakers in Europe has turned to sponsoring serious investigation of the issue and funding research in the area.

The final result of the current PRISM research efforts was six questions for EU policy makers:
Productivity of Knowledge-Intensive Services: What are the economics of the knowledge production function? What new tools do we need to measure the productivity of knowledge? What should we be measuring/ tracking a) at the firm level, and b) the System of National Accounts (SNA) level?
Intangible goods: What are the characteristics of the intangible goods sector – size, growth, dynamics? How should the SNA be reformulated to track intangible goods? Does the EU have a competition policy for intangible goods?
Accounting standards: Why are EU company accounts silent on assets and liabilities arising from licenses, leases, annuity and executory contracts, which form the backbone of the modern economy?
Investor communications: Do we need a European version of the SEC’s Edgar information system?
Company reporting: What is an appropriate role for EU in fostering a holistic corporate reporting model?
Single European Market: Given the EU’s strategic goal to increase R&D investment from 1.9 to 3% of GDP, to what extent – and in what areas – would a realignment of the EU’s IPR system help?
Stepping back, there appears to be a lot that can be done quickly to patch up some of these areas, such as IPR. There is an enormous amount of nonsense currently in the IPR system. It doesn’t take a lot of new analysis; it will take political will to carry the solutions through.

But there are fundamental issues that need to be addressed. The issues of productivity in the knowledge production function and the value chain in information services need more attention and analytical work. One important effort would be to try to understand the taxonomy of services. For example, how much of the basic value generation of running an airline is similar to that of running a law office? There may be only a handful of truly unique models of value generation in the services industry. If we can understand what those handful of basic models are we can make much more intelligent business and policy decisions, both within and across the industries.

There is also the difficult issue of intangible goods. There is a discrete area of products (goods) that can be stockpiled and traded, but embody intangible goods and are affected by patents, copyrights, licenses etc. Often referred to as the content sector, this is an area we really don’t understand. It needs to be fleshed out. It is a rapidly growing area that has enormous revenue and tax implications. Because it falls in between the existing categories of goods and services—and because it is so complicated to add a third category—this sector often gets ignored.

In the area of accounting standards, the new IASB standards on intangibles will become mandatory in Europe in 2005. The standards are similar to the US FAS 141 & 142, so there is considerable interest in Europe about the American experience. The need to capture data on intangibles may be the impetus for setting up an EDGAR-like system in Europe as a data repository. With the IASB requirements, it will now be possible to gather company data on a pan-European basis.

(The full report can be found at http://www.euintangibles.net)

Dr. Kenan Jarboe, President of Athena Alliance, moderated the Q&A session. He began with a comment about the importance of PRISM as an “observatory” or learning entity for the interested parties. This is similar to what Athena Alliance hopes to do. While he has similar problems with the hype over the concept of a New Economy, there clearly have been structural changes in the economy. These are not the changes that have been highlighted during the dot.com bubble, but fundamental shifts in the nature of production.

We still don’t understand what is happening with the knowledge production function. We understand many of the inputs, and we understand some of the outputs, like the number of patents and copyrights – even though these are poor proxies for innovation. But we really don’t understand what happens inside the black box. We don’t know how those costs and inputs get turned into value added products and services.

Dr. Jarboe noted that one comment Mr. Eustace made during his presentation was especially provocative and interesting when he stated that our IPR régime is unsuited for protecting investments in intangible assets. Dr. Jarboe asked Mr. Eustace if he would elaborate on that point, especially about the problem that there are a number of other forms of intangible assets such as trade secrets, tacit knowledge, and networking effects, that are not in any way protected by existing IPR.

Mr. Eustace replied that one of the key questions is determining what to protect and finding the line between public and private goods. The pharmaceutical industry and its relationship with the regulatory community is a case in point.

With respect to measuring outputs of the knowledge production function, the OECD is doing some very good work. They are trying to create a measurement model but it is very difficult because of the interconnected nature of the knowledge creation process.

Another issue is that of business process patents, which is to some extent a knee-jerk response to the fuzzy problem of protecting software. Europe is taking its time to watch what is happening in the US. He is not convinced that the business process patent is the right approach – it may be far too crude. This has been driven by the shift in the business service sector toward selling intangible assets – a shift from customized research for each client to selling a codified product to meet a client’s needs. Having a limited set of codified products helps streamline the business and increase productivity and profits. In that case, the key question is how to protect original models – and patents may not be the best mechanism. There are many other forms of IPR – some still being invented – that may be more appropriate.

Dr. Jarboe commented that it would be good to see the list of new forms of IPR that PRISM has uncovered.

He also noted that the paradox of business services moving to an industrial model of codifying the answer and selling that codified (standardized) product and away from the information economy model of customization. Are we simply moving to an industrialized model where services is following manufacturing or is there something different really going on?

Mr. Eustace replied that the business service sector is a maturing industry moving toward commoditization and systemization. That process still has a ways to go. Manufacturing is moving to another phase of exploring the tension between centralized and decentralized – such as the swing between conglomerate and highly focused organizational structures.

A key is understanding that there are many parallel paths. Policymakers have not yet come to understand the multiple models. For example, it took a long time for policymakers in the UK to understand that the services and non-services economies were out of phase – that there are many economies. The implication is that there is no one-size-fits-all policy.

One participant raised the issue of the policy implications. Outside of an academic or intellectual exercise, what are the implications for policy of the study of intangibles? Specifically, issues of control (regulation) and taxation are problematic. Are we better off simply letting that part of the economy run without government interference as the best way to foster the development of these intangibles?

Mr. Eustace replied that it is a difficult question. We can’t, however, simply ignore the situation and continue to not measure even if that might lead to increased government scrutiny. We can’t afford to have such “black holes” in key measurements of our financial system. We are now looking at major corporate balance sheets and simply saying “we haven’t got a clue.”

There’s also the issue of the volatility of markets. Brookings Institution has done very good work in showing how the information failures have led to increased volatility.

We have no choice but to move the frontier of measurement further along. The question is how we do it. We need a combination of policy experiments, such as FAS 141 and 142, and academic research to spur fresh ideas. And we need to attach new academics to this area of research.

One participant brought up Christiansen’s book on the innovator’s dilemma. One point of this book was that the level of investment in new knowledge creation, i.e. R&D, was not the determining factor in innovation. It was the recognition by the leadership of the company of an entirely new way to use an existing technological development. Thus it was not the infusion of knowledge assets, but the recognition of the implications of that knowledge which made the difference. Do we really run the risk of missing the point by measuring the knowledge inputs, which might be what matter?

Dr. Jarboe noted that measuring the correct inputs is a major problem. And it is not just measuring the R&D because we don’t measure a number of inputs such as skill inputs. We can measure the raw amount of R&D expenditures on the inputs and the number of patents on the outputs, but this doesn’t give us a clear picture of the innovation process. Those measures may not be relevant, they may not have any real correlation with economic growth, and they don’t tell us how to improve the innovation process.

Mr. Eustace noted from his consulting experience, that it’s always been very difficult to make good decisions about allocation of resources for innovation, especially in business services. It is important to recognize what we don’t know and ask the question of how far we push these measures. Part of the process is to maintain a dialogue between the research and the policy makers so as to be able to understand what is really useful.

Another participant brought up the role of technology and the problem of creating long term fixed assets in a world of rapid change. Created fixed assets requires understanding two fixed parameters. First is that humans have will still have certain needs, such as stimulating work and interaction with other humans. More and more routines jobs that humans do not like to do – including supposed thought jobs of workers in cubicles – will be done by machines. This will continue to push the envelope of human activity into areas of intellectual endeavors well beyond the notion of goods versus services. Second that there are still only 24 hours in the day. People relate to their environment in both a time and space sense – for example by measuring distance to work in terms of time. These are fixed human traits. Ultimately the development of any intangibles needs to relate to these parameters.

Dr. Jarboe noted that the parameter of time is a key factor in expansion of services. It is true as Pat Moynihan used to say that there is no productivity gains in the services because the minute waltz still takes a minute to perform. But with CDs, radio, and the ability to download music on the Internet, that minute waltz can be repeated for people over and over and over again – thereby greatly improving the productivity of those original musicians.

This raised the difficulties of categorizing products as goods or services. For example, listening to music by buying a CD is classified as a good, whereas listening to music by going to a concert is a service. The possibility was raised of switching to a categorization system based on human needs. It was suggested in the mid-seventies to classify the economy by ultimate end use – food, housing, transportation – rather than dividing between goods and services.

Mr. Eustace noted that the problems facing national economic statistics are even more difficult than issues of corporate accounting for intangibles. Not only are the classification systems outmoded, all of the time series and historical data are based on those outmoded classifications. Going back to modify all of past data is an horrendous undertaking. At every level there are huge problems. Companies, even in the same sectors, still are not reporting the same intangibles (such as R&D spending) in the same way. And then there is the political problem of changing the way in which a country reports on its economic situation.

With respect to classification of industries, Dr. Hughes mentioned efforts to structure organizations using IT links into affinity groups that would go from raw materials to finished products. Our economic statistics don’t really capture that.

Mr. Eustace stressed the need for continued research on the data collection problem in order to understand the shifts that are occurring – such as in business service and other sectors that rely heavily on intangibles. There are a number of attempts at reports – such as the UK’s Social Trends report – which try to capture these factors. But they are not enough. We need some very high quality thought pieces to set the frameworks and then lots of good statistics. The key in those high-level pieces is understanding how value is created and destroyed with these shifts.

Dr. Jarboe picked up on the point of the importance of creating value – especially in the current policy environment which is geared toward narrow and specific sectors of the economy. We may end up crafting policies which attempt to create value in a narrow area – based on our view of the economy as a producer of goods – that have unintended consequences elsewhere.

He also noted that there are a number of other reports, such as the PPI New Economy Index and the World Economic Forum’s Competitiveness report, that try to capture data on intangibles. Why don’t these reports get us to where we want to go?

Mr. Eustace replied that one problem is that these reports – such as the Department of Commerce’s Digital Economy report – are high quality but unfocused. They need to be condensed and synthesized. The data needs to be targeted toward helping understanding of what is going on and to be able to put it together in some sort of pattern so that it becomes cogent. That could then become the basis for developing longer term monitoring of the process.

A participant raised a concern over our lack of understanding of the knowledge production function and the creative production function. Without that understanding issues such as copyright become unknowable. For example, if we don’t understand the creators’ incentives for the production of new works, we can’t really craft policies to foster those incentives. Some research is being done on whether IPR, for example software patents, serve as an incentive for further innovation and development or rather as a means of protecting the market of existing IPR owners, including through the means of so-called “patent thickets.” If we don’t understand the nature of the market incentives and can’t measure how those incentives work, then we don’t know how the market will respond to different kinds of IPR regimes.

He also raised an issue of the gap between theory and measurement. For example, data from the National System of Accounts feeds directly into models that describe the economy and are used to understand the different sources of growth – the standard growth accounting economy models. These models are predicated on certain theories of how markets behave. In this intangible economy, is the theory still correct? Do we need a better theory of economic growth in order to better the statistics?

Mr. Eustace stated that this was out of his field of expertise, but suggested that one starting point for improving the models is to look at how we account for investments. The standard models of production are based on a value-chain that starts with R&D and works through to production and ultimately distribution. The notion was that you could ramp up the value generated in each stage of the value chain.

But in large parts of the economy, especially in intangible goods, there is no separate production. There is an economic production function – but not a separate activity known as production. For example, in software, the value generation lies in what is considered the R&D stage (the generation and testing of the code). Value is also generated downstream in the market distribution channels but not in the traditional physical production stage.

Yet, we don’t have a good understanding or theory of how this works. Here we go back to the issue of mapping the service sectors. We know that certain sectors are identical in the value generating activities – but we don’t have a clear view of the knowledge production function to be able to say where the value is generated. We don’t adequately measure R&D and we don’t know how to measure the downstream activities like setting up marketing channels. And therefore we don’t have a real idea of how much of the economy is made up of these types of activities.

We are even having a hard time conceptualizing the issues. This is one of the goals of PRISM – how to identify and synthesize the issue.

Dr. Jarboe noted the importance of the concept of moving from a transaction-based model to more of a field-based model. In the 70’s and 80’s, we talked about a national system of innovation not just R&D. But we never connected all the parts. While we have studied the research process, we still have not connected to the fact that much of the innovation comes from users back up the marketing channels.

A participant pointed out we need to look at the ultimate needs of the customer, otherwise we can mistake what is of value. For example what is the need for railroads or for transportation? The entire role of increased information and IP is to create better ways of accomplishing meaningful objectives – not simply improve a product.

And, as was pointed out, our national system of accounts does not cover that. They look at transactions from the production process point of view, not the end users’ point of view.

A second point made was that the technology not only improves what we are currently doing, but also makes some possible that which was not possible before. The more profound issue is the lack of imagination to see what is not already known. How do you measure that?

There were more patents for horseshoe improvements issued after the automobile was invented than before. How do you then value all of those patents granted just as a new technology is developing to make them obsolete?

One participant noted the PRISM quote from Kelvin about the importance of measurement. A counter to that is the quote, possibly from Einstein, that not everything that can be measured is important and not every thing that is important can be measured.

Mr. Eustace agreed that without a conceptual framework, we have no way of knowing what is important and should be measured. But the reality is that we need measurement systems and that we need to improve our existing measurement systems without destroying all confidence in them.

The PRISM group came to the conclusion at there were four categories of resources which is useful as a heuristic. At the softest end, there are latent resources that are unknown and maybe unknowable. They cannot be measured but can at least be identified and discussed. Next are intangible competencies which are usable and partially codifiable, such as organization structures, even if they are difficult to recognize and measure. Then there are intangible goods which can be measured and valued, such as IPR, long-term contracts and royalties.

There are difficulties in all these areas. Patents are difficult to value because of the problem of separating the knowledge out from other factors, like the workforce. In many cases the licensing out of patents is just a mechanism for transferring risks – where others assume the cost/risk of developing the patent into a revenue producing product.

On top of this, we need to move to a fair value accounting system and learn from the company’s experience as they move into this system.

Dr. Jarboe pointed out that the value of donated patents has become an issue with the IRS and Senate Finance Committee as they work through the latest changes in the corporate tax code.

One participant questioned what the policy implications of the report were and how the lack of knowledge of intangibles hurts policymaking. For example, one recommendation is for a European version of the SEC’s EDGAR system for financial reporting and another talks of improving access to capital by SMEs. How would these policy recommendations work?

Mr. Eustace replied that the idea of a European EDGAR system or some standard financial disclosure system for Europe (although not necessarily enforcement) is inevitable. The need for transparency in the data for policy decisions is overwhelming. There have already been a number of studies making this point, such as the Winter report. But, just putting together the legal framework for collecting the data will take some time.

Concerning the issue of access to capital, there is a section on this in the PRISM report. The problem is that banks and the financial system do not explicitly and systematically recognize intangibles. For example, the credit scoring models do not explicitly include any sort of intangibles. But factors like quality of management, potential market share, sustainability etc are all implicitly included. PRISM thought that some transparency would be useful – maybe a best-practice code at the European level. The goal right now is to inject this awareness of the issue of intangibles into the discussion over credit and capital allocations – such as the Basel II bank requirements.

It is also especially important in looking at the activities of the rating agencies – whose activities are not very well scrutinized. These entities need to be incorporated into the process, especially as the role of debt financing has increased in Europe over the past 20 years.

Dr. Jarboe noted that the research of our earlier speaker in this series, Jon Low, showed that stock analysts very much paid attention to intangibles, even if they didn’t know how to quantify or measure them.

One participant noted that the rating agencies have been involved in various financial industry activities on new regulations. Their concerns, however, seem to be different from other financial institutions – and their perspective is different as well. This difference becomes clear from looking at their Congressional testimony on the Enron scandal.

Participants noted the importance of intangibles as a basis for access to capital. If intangibles cannot be used to raise capital, companies may be shut out of the capital market.

It was pointed out that for certain types of intangibles, there are operating secondary markets. For example, copyrights to music are routinely bought and sold – even packaged into portfolios – with valuation based on expected royalties.

One participant raised the problem of how to account for R&D, especially if the technology is highly speculative. Much of the current system requires the expensing of current costs that are really not operating costs but investment in creating new intangible assets. The difficulty lies in measuring the future value of the benefits that consumers might receive.

Mr. Eustace noted the practical difficulties of capitalizing all expenses that go into intangible assets, including the way the accounts can be manipulated. Because of these problems, full capitalization will probably never be accepted. What is needed – and is very possible – is a better break out of where the money is being spent (regardless of how it is treated for amortization purposes). Details of spending on intangibles would help overcome our lack of basic knowledge in the area – and help get rid of the bad notions, such as that there is no R&D in service industries.

Mr. Eustace closed the session by noting that the discussion didn’t even talk about the macro-intangibles – that is, the frameworks that national governments have, or have not, put in place to recognize and deal with the policy questions surrounding intangibles. We have put into place the ability to look comparatively at frameworks across countries in a number of areas, for example, labor law and tax base. But we don’t have such a conceptualization when it comes to intangibles. In part, this is one of the future tasks facing PRISM.

1.Margaret M. Blair and Steven M.H. Wallman, Unseen Wealth: Report of the Brookings Task Force on Intangibles, The Brookings Institution, Washington, DC, 2001.

2.High Level Expert Group, The Intangible Economy – Impact and Policy Issues: Report of the European High Level Expert Group on the Intangible Economy, European Commission, Brussels, October 2000.