# **I. INTRODUCTION**

Measurement of business spending on non-tangible knowledge assets or KBC (Knowledge-Based Capital) is relatively recent, with the seminal work applying direct expenditure methods initially done for the U.S. economy (OECD 1998, Nakamura 2001, Corrado, Hulten and Sichel or CHS 2005 and 2009).<sup>2</sup> In contrast to the conventional approach of treating spending on knowledge assets as intermediate expenditures and thereby assuming that all their benefits are reflected in the current year’s output of tangible goods and services, the KBC approach correctly capitalizes outlays that contribute to production and value beyond the taxable year and treats them as longer-lived knowledge investments – using the same cost-based accounting that is used for physical capital. The KBC approach opens up the black box of conventional Total Factor Productivity by explicitly measuring key knowledge-related elements rather than estimating them as a residual. The CHS classification divides KBC into 3 categories: (1) **_digital assets_** _(labeled “computerized information”)_ – what firms spend on databases and software to better measure, manage and reorganize what they are doing in light of changing external demand and supply conditions (2) **_intellectual assets_** _(“innovative property”)_ – spending on R&D, creative assets, copyright and licensing costs, architectural, engineering and other designs, new products/systems in the financial industry, and mineral exploration and evaluation (3) **_human-organizational assets_** _(“economic competencies”)_ – outlays on market research, advertising and brand equity, firm-specific human capital, and business process/organizational improvements.

The acceleration of globalization, technological progress, and increased trade and competition have resulted in rents from new ideas becoming more important for sustained firm-level competitiveness and aggregate growth across countries, but also in higher risks in the commercial exploitation of these ideas. As knowledge inputs are becoming a bigger share of value added and all countries are seeking ways to take advantage of information communication and related technologies in their transition to more knowledge-intensive economies, investments in the full range of activities needed to commercialize new ideas and create competitive advantage are becoming more important over time. The increasing importance of KBC over time is shown by the steady increase in the KBC investment rate in the US as a share of expanded nonfarm business output, from 8% in 1977 to 14% in 2010, in contrast with a secular decline in the tangible investment rate (Corrado and Hulten 2010, Hulten 2013).<sup>3</sup> This is not unique to the developed high-income countries: Hulten and Hao (2012) estimate increases in KBC investments over time for China from 3.8% in 1990 to 7.5% as a fraction of GDP for the total economy, and Dutz et al. (2012b) estimate increases for Brazil from 3.5% in 2000 to 4.8% in 2008 as a fraction of GDP.

The KBC approach has expanded the conventional proximate measured sources of growth beyond human and physical capital to include knowledge investments in the resource reallocation/innovation and risk management capabilities of the enterprise. Importantly, these investments go significantly beyond traditionally-measured R&D expenditures to include a range of co-investments required for enterprises to

> 2 See Corrado, Haskel, Jona-Lasinio and Iommi (2012) for an application to advanced economies, Dutz et al. (2012b) to Brazil, Hulten and Hao (2012) to China, and Hulten, Hao and Jaeger (2012) to India.

> 3 In the UK, business investment in KBC is estimated to have more than doubled as a share of market sector gross value added between 1970 and 2004. For similar data on other developed high-income countries, see OECD (2013).

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