How defining intangible investments can help grow the knowledge economy

This article is brought to you thanks to the collaboration of The European Sting with the World Economic Forum.

Author: Eric Hazan, Senior Partner, McKinsey & Company & Sven Smit, Co-chair, McKinsey Global Institute, and Senior Partner, McKinsey & Company, Amsterdam

• The definition of intangible assets needs updating to include the knowledge and skills that underpin them.
• New research shows that companies who invested in these assets are unlocking higher levels of growth.
• Policymakers can enable economic recovery by helping to define these assets, and by investing in skills and education.

Industrial and technological revolutions have repeatedly changed the way growth is produced. We moved from agriculture to factories and then to computers. But tomorrow’s growth could well be propelled by something much simpler and much more complex at the same time: knowledge.

In our increasingly dematerialized world, our tools are less and less tangible. Now is the time to pay attention to so-called “intangible assets”, which are far more than an esoteric category of investment largely of interest to accountants. Mounting evidence suggests that intangibles are transforming economies and driving growth.

The true extent of their value is being severely underestimated as these assets do not fully show up in national accounts or corporate balance sheets. As economies start to recover from the pandemic, a wave of investment in intangible assets could potentially breathe new life into productivity and unlock more growth, so long as they are deployed effectively.

Our new research finds that companies, sectors, and economies that invest the most in intangible assets – intellectual property (IP), research, technology, software, human capital, digital, managerial and organizational capabilities – are growing faster. Intangibles are associated with higher productivity and growth in companies, sectors, and even entire economies.

Companies in the top 10% for growth in gross value added (GVA), a measure of economic growth – so-called “top growers” – invest 2.6 times more in intangible assets than the bottom 50% of companies, otherwise known as “low growers”. Amid the perennial discussion about the long-term structural decline in private investment, it may well be that companies (or at least high-performing companies) are in fact investing heavily, but more in intangibles than in tangibles.

A similar link appears at a sector level. Sectors that have invested more than 12% of their GVA in intangible assets achieved 28% higher growth than other sectors. In economies with large intangible-rich sectors, the impact may have been sufficient to boost economy wide growth. Indeed, there also appears to be a link between intangibles investment and (total factor) productivity growth. After the global financial crisis in 2008, growth in intangibles investment decelerated; productivity growth also slowed.

Why do intangible assets need redefining?

These indications of a link between intangibles and growth strongly suggests we should focus more on them. But first, we should define them properly. Traditionally, most companies have considered intangibles as goodwill, IP, and software, but this is too narrow. A more expansive definition has been cited by Jonathan Haskel and Stian Westlake: intangibles embrace human capital – the talent and skills that underpin the spreading knowledge economy – and digital, organization, and managerial know-how.

Because of issues with definitions, the scale of the shift towards intangibles may be underappreciated. Over the past 25 years, investment in intangible assets has risen steadily as a share of total investment in the US and 10 European economies. In 1995, the split was about 70:30 in favour of tangible investment; by 2019, the split was 60:40. During 2020 when the pandemic exerted such a hit on economies, it appears that intangible investment had another growth spurt, reflecting an acceleration in digitization. It may not be too long before intangibles account for half of all investment.

Intangibles embrace human capital – the talent and skills that underpin the spreading knowledge economy.—Eric Hazan and Sven Smit.

Only companies that were able to maintain 2019 rates of growth during 2020 were those that had invested significant amounts in the full range of intangibles: innovation, data and analytics, human and brand capital. Intangibles are interdependent, and by investing in the full range, companies create synergies and have proved to be more resilient to major economic shocks.

But this is not only a story about investment, but how that investment is deployed. A new survey of over 860 executives indicates that the major difference between top growers and low growers is not only that they invest more in intangibles and appreciate their importance for competitive advantage, but that they focus on effectively deploying them.

When asked to be precise about what delivers disproportionate returns in the executive survey, top growers have detailed answers. They cite specific use cases, rigorous processes, data-driven decision making, and using intangibles investment to embed data, talent, innovation and purpose in their day-to-day operations. In short, low growers plan, while top growers take action.

For top growers, obtaining access to data is only a basic first step; they are thinking about how to use data in real time, investing in analytic talent, and flexible tech architecture. They are also more than twice as likely to regard personalization as core to the customer experience.

Moreover, top growers are twice as likely to disrupt their own business models than low growers rather than waiting to be disrupted. Indeed, they indicated that they actively look for opportunities to invest in disruptive innovation. Top growers also appear to understand that deploying intangibles is a moving target, and that they need continually to reexamine what type of intangibles are most likely to: deliver on competitiveness and growth; can be scaled; deliver synergies that may create value in other areas of the learning economy.

Policymakers must play their part

If intangibles are increasingly playing a role in driving growth, it would be beneficial if more companies prioritized these investments, and the formula top growers use points the way ahead. Policymakers can help by enabling large-scale efforts to step up skills development and ensuring that the right knowledge infrastructure is in place, including high-quality education, communications technology, and spending on scientific specialisms.

They can also ensure that the right institutional infrastructure is in place with up-to-date regulation of all aspects of the digital and knowledge economy. A useful first step would be for governments to work with national statistical agencies to update definitions of intangibles to match the realities of the modern knowledge economy.