# **1. INTRODUCTION**

Firms invest in a range of knowledge-based or intangible resources such as computerized data and software, patents and trademarks, employee and management skills, or organizational improvements. Although they do not directly increase the level of physical assets, such knowledge-intensive expenditures resemble investment in traditional fixed capital such as machinery, equipment and buildings in that the benefits from them are not exhausted in a single year. Hence, it has been argued that such expenditures build ̳intangible assets‘ or ̳knowledge-based capital‘. Increases in the stock of such knowledge-based capital are now increasingly recognized as an important driver of innovation and economic growth.

Intangible assets cannot be observed or quantified in the traditional sense. Some recent studies have proposed ways to deduce intangibles from observable tangibles using economic theory.<sup>2</sup> For example, one approach uses the value of securities to infer the quantity of intangible capital held by U.S. corporations (Hall 2000).<sup>3</sup> But the method which has become the most accepted in recent years estimates intangibles directly from observed expenditures. Building on previous studies that examined the undervaluation of US business investment in the late 1990s, Corrado, Hulten and Sichel (2005, 2009; henceforth CHS) proposed a comprehensive categorization of intangible investments, and quantified them by piecing together the corresponding expenditure data for the US.<sup>4</sup> The underlying principle is that any business outlay intended to increase future rather than current consumption should be treated as capital investment.

Spending on most intangibles is treated as intermediate expenditures in conventional national income accounting, which assumes that all their benefits are captured in the current output of tangible goods.<sup>5</sup> If one accepts the CHS framework, this causes an underestimation of total levels of investment and output.

> 2 See OECD (2011) for a summary of recent work on measuring intangibles. Fereira and Hamilton (2010) compute  ̳intangible capital‘ as a residual by subtracting the values of physical capital, natural resources and net foreign financial assets from estimated total wealth (the present discounted value of future consumption). This broad definition includes human capital, institutional and social infrastructure, and resources omitted in the natural capital calculations such as subsoil water, diamonds, and fisheries. For Brazil, their average estimated value over 1995, 2000 and 2005 is 70 percent of total wealth, versus 85 percent for the US.

> 3 Another indirect approach (Nakamura, 2001) is based on the insight that the ratio of consumption to GDP should be relatively stable if all investment (tangible and intangible) is properly counted. Hence, any rise in the consumption ratio will indicate the size of the unmeasured investments.

> 4 The prior studies include OECD (1998), Nakamura (1999, 2001, 2003), Brynjolffson and Yang (1999), McGratten and Prescott (2000), and Brynjolffson, Hitt, and Yang (2002).

> 5 National accounting treatment of intangibles has begun to change. In a number of countries, expenditures on software are now treated as a contribution to investment. And in the US, the Bureau of Economic Analysis will count expenditures on R&D as investment in its headline measure of GDP from 2013 onwards.

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