Measuring the impact of IA/IP on GDP and/or economic growth: Can it be truly calculated?
“IP-intensive industries account for over a third, or around 38.2%, of total US GDP. Intellectual property also accounts for over half of all US merchandise exports, resulting in almost $842 billion of revenue created” (USPTO, here)
“Intangibles now comprise 90% of the value of S&P 500 companies” (Ocean Tomo 2021 market study)
“global intangible assets held by firms worldwide are worth USD 61.9 trillion in 2023, growing by 8 percent since 2022, and up by a factor of 10 from USD 6 trillion in 1996” (WIPO report here)
As attractive as these numbers are, do they truly reflect the impact of intangible and intellectual property assets (IA/IP), data assets (OECD), on the economy, including GDP? And could these numbers be improved upon? The answer is most likely yes.
Why?
Currently, accounting standards, such as IFRS IAS 38, do not capture IA/IP assets, in particular internally generated intangible assets, which may consist of the majority of a business's assets and value, on company balance sheets or financial statements, until they’ve been subjected to a business combination (e.g., acquisition) and/or purchase price allocation. Indeed, the proportion of IA/IP assets in a business can vary significantly depending on the industry, business model, and stage of development. For example:
In knowledge-intensive industries like technology, pharmaceuticals, or consulting, intangible assets like intellectual property, brand value, and human capital can represent a very high percentage of a company's overall value, sometimes even exceeding 80%.
In traditional industries like manufacturing or retail, intangible assets may still be important, but they might represent a smaller proportion of the overall value compared to tangible assets like property, plant, and equipment.
For startups and early-stage companies, intangible assets like innovative ideas, technological know-how, and the potential for future growth can be their most valuable assets, even if they haven't yet translated into significant financial performance. See: the European Patent Office (EPO) study, which highlights the economic benefits of owning intellectual property rights – especially for small businesses, as well as the WIPO article on IP in the knowledge economy and its value contribution (below).
Usually, it is only the expenses related to the development of intangible assets (rather than capitalized) that is reported. Part of the rationale is due to:
Recognition criteria under IAS 38: Under International Accounting Standard 38 (IAS 38), which governs intangible assets, there are strict criteria for recognizing internally generated intangible assets. These criteria often make it difficult to recognize many intangible assets, especially those related to research and development or internally developed brands.
Focus on historical cost: Traditional accounting principles tend to focus on historical cost. Intangible assets, particularly internally generated ones, often don't have a clear historical cost, making it difficult to assign a value to them.
Difficulty in measurement: Intangible assets, by their nature, are difficult to measure reliably. This can lead to concerns about subjectivity and potential manipulation if they are included on the balance sheet prior to a business combination.
Conservatism: Accounting tends to err on the side of conservatism. Recognizing intangible assets before a business combination can be seen as overly optimistic, potentially inflating the company's value.
However, during a business combination, the accounting treatment changes. Under IFRS 3 (Business Combinations), all identifiable intangible assets acquired in a business combination must be recognized at fair value, even if they were not previously recognized by the acquiree (or seller). This is because the business combination provides a more reliable basis for measuring the fair value of these assets. As a result, the true value of a company's intangible assets may never be truly unlocked; hence the need to have a more comprehensive snapshot of innovation and company financial performance, as potential measure of economic impact downstream. It will also provide an indicator as to what is better performing, and may be better safeguarded
Understanding the Past: A “Short” Literature Review
The challenges and issue of quantifying innovation contributions has been well documented, for example:
The 2015 WIPO Report, titled Breakthrough Innovation and Economic Growth, outlines the framework proposed by Nobel prize-winning economist Robert Solow (see here and here), in which he “decomposes output growth into two components: first, a component attributable to the accumulation of production factors – mainly capital and labor, later expanded to include human capital; and second, a component capturing an economy’s overall productivity growth, also referred to as total factor productivity (TFP) growth” as way of presenting the data;
The WIPO 2024 Report, titled Making Innovation Policy Work for Development, incorporates economic complexity indicators (ECI) into the equation, referring to the work of Professor Hidalgo:
Hidalgo, C.A. and R. Hausmann (2009). The building blocks of economic complexity. Proceedings of the National Academy of Sciences, 106(26), 10570–10575 (see here); and
Hidalgo, C.A., B. Klinger, A.L. Barabási and R. Hausmann, The product space conditions the development of nations. Science, 317(5837), 482–487 (see here), amongst others.
WIPO later released two economic research working papers: the first relating to economic complexity (here, 80/2024), and the second relating to the mapping of innovation capabilities (here, 81/2024).
Other research papers on economic complexity, prior the publication of the foregoing economic research working papers, can be found here, here, and here (Stojkoski, Koch and Hidalgo, Nature 2023), as well as those which refer to the direct and indirect economic impacts that stem from IP-related innovation, listed below:
Gould and Gruben (here and here) “identify an indirect effect of intellectual property rights on GDP: strong patent protection leads to improvements in factor accumulation (of factor inputs like R&D capital and physical capital) which in turn has an influence on economic growth.” (see Ahmed Lahsen, A., Piper, A.T. Property rights and intellectual property protection, GDP growth and individual well-being in Latin America. Lat Am Econ Rev 28, 12 (2019), see here);
Çela (here) provides a summary listing of the “empirical studies on the relationship between IPR protection and economic growth” (at Table 1);
Thompson, A. and Rushing, F. (here) confirm that “in wealthier countries, patent protection shares a positive relationship with changes in total factor productivity and, in turn, total factor productivity positive influences the rate of economic growth”;
Cassandra Mehlig Sweet, Dalibor Sacha Eterovic Maggio: Do Stronger Intellectual Property Rights Increase Innovation? (here);
Loreto Mora‑Apablaza, Carlos Navarrete: Patents as indicators of the technological position of countries on a global level? (here);
Demmou et al. (here) report that “valuation uncertainty and lower pledgeability, financing the purchase of intangible assets is more difficult than that of tangible assets. As a result, financial frictions are expected to be more binding for productivity growth in sectors where intangibles have become a pivotal component in firms production function.”
Demmou et als. (here) recognized that we face “stronger informational asymmetries and harder to value collateral,” and that “intangible investment is subject to more severe financial constraints and relies more on internal rather than external capital.”; and
As it can be seen, there seems to exist information asymmetries that make it difficult to ascribe value to IA/IP assets and possibly gauge their performance during the innovation and commercialization processes as well as product life cycle(s), and measure their exact impact on the economy.
Imperfect Improvements To Measure Better: A Proposal
As imperfect as the measure of economic activity/growth and/or GDP may be, the capture of IA/IP-related financial data would be useful for innovation metric reviews (see the Australian Government Report here, 2022) and for nations who are attempting to address issues of economic performance and productivity as discussed by two US policy thinkers, Tooze and Smith (see here)). Coupling this kind of information with, perhaps, the results of the Canadian Intellectual Property Awareness and Use Survey (IPAU, Dashboard) and the Survey of Innovation and Business Strategy (Dashboard) could allow for a better understanding of the impact of IA and IP, prior business combination, on the economy (at large) and business, especially when 99.7% of the Canadian businesses are SMEs and represent, according to ISED’s report titled Key Small Business Statistics 2023 (here), nearly 50% of the Canadian GDP in 2020.
Advocating for Improvement
The issue of improving reporting standards with modern value creation is being addressed by multiple organizations, including the IFRS who recently published Staff Notice AP17B, which provided a non-exhaustive review of academic literature, finding that:
“financial statements may not capture the full value of internally generated intangible assets” (at paras. 6, 29a), 76 ); and
there is “consensus about improving information disclosed, either by amending disclosure requirements or providing guidance about the disclosure of voluntary information” (at para. 8).
Similarly, the United Kingdom Endorsement Board (UKEB) has also weighed on the topic in its presentation (see here) before the IFRS, which provided some of the following insights:
Intangibles are economically important;
Banks have suggested they would find it easier to lend if intangibles were recognized in the balance sheet; and
While intangible assets are widespread and increasing in value, they still only represent ~3% of the balance sheet,
amongst other findings. Similarly, the International Valuation Standards Council (IVSC) has also published a series of Perspectives Papers on the valuation of intangible assets and data, including for example: Making Intangibles More Tangible: Series Lessons, Time to get Tangible about Intangible Assets and Value and Data).
As mentioned in our prior blogs (here, here and here), proactively capturing IA/IP-related financial data in, for example: management discussion and analysis (MD&A), accounting note(s) (Gollin, article) or perhaps a tiered (or mixed) approach of using different accounting standards (with appropriate notes for transparency) is beneficial, and enables business units (e.g., management, R&D, etc.) and third parties (e.g. investors, policy makers, etc.) to:
Track the return on investment on this asset class (e.g., revenues generated on the asset class), which had been invested in by the business by way of R&D expenditures;
better leverage business knowledge assets to maximize value, especially when IP is underused and/or under-reported (e.g., dormant IP assets, amongst others);
Identify innovation efficiencies where possible; and
Optimize returns, tax credits, etc. given by government programs that incentivize innovation, for example Canada’s SR&ED, IP boxes, investment tax credits, amongst others programs that are directed to IP-related activities.
Retaking the words of our prior CIGO post, and as Daub and Herman have inferred in a 2023 article, “just imagine what position Canada could be in if we could move the IP-generated revenue needle just a few points”.
Contact us for more information.
Acknowledgements
Special thanks to Professor C. Hidalgo and Ms. V. Hamar, Executive Director of the Centre for Collective Learning at Corvinus University, Budapest for providing research papers on the topic.
Other references:
Hellman, N. (2021). Discussion of ‘Accounting for intangible assets: suggested solutions.’ Accounting and Business Research, 52(6), 631–640. https://doi.org/10.1080/00014788.2021.1984906, available at: https://www.emerald.com/insight/content/doi/10.1108/JAL-05-2022-0060/full/html.
Lundh, S., Seger, K., Frostenson, M. and Helin, S. (2024), "Accounting as a means to legitimacy: the case of internally generated intangibles", Qualitative Research in Accounting & Management, Vol. 21 No. 2, pp. 77-104. https://doi.org/10.1108/QRAM-04-2021-0075, available at: https://www.tandfonline.com/doi/full/10.1080/00014788.2021.1984906#d1e106.
Hussinki, H., King, T., Dumay, J. and Steinhöfel, E. (2024), "Accounting for intangibles: a critical review", Journal of Accounting Literature, Vol. ahead-of-print No. ahead-of-print. https://doi.org/10.1108/JAL-05-2022-0060, available at: https://www.emerald.com/insight/content/doi/10.1108/QRAM-04-2021-0075/full/html.
Steve C. Lim, Antonio J. Macias, Thomas Moeller, Intangible assets and capital structure, Journal of Banking & Finance, Volume 118, 2020, 105873, ISSN 0378-4266, https://doi.org/10.1016/j.jbankfin.2020.105873, available at: https://www.sciencedirect.com/science/article/pii/S0378426620301394.
コメント