The Importance of Intangible Assets: L'essentiel est invisible pour les yeux

MIYAGAWA Tsutomu
Faculty Fellow, RIETI

Two problems with the Abenomics goal of increasing private capital investment

What was initially emphasized under a growth strategy, one of the three arrows of Abenomics, was an increase in capital investment. The Japan Revitalization Strategy announced in June 2013 set a goal of increasing private capital investment to 70 trillion yen by FY2015. Japan has largely attained this goal, as capital investment by private companies in 2014 was 69 trillion yen in nominal terms and 72 trillion yen in real terms.

However, there are two problems with this goal, as I pointed out in a Keizai Kyoshitsu column published on June 20, 2013 (Nihon Keizai Shimbun). First, supposing Japan meets its targets, would this really contribute to boosting the nation's growth potential? Private-sector capital investment is part of the demand side of the overall economy, and, if it rises, it helps the economy to rise as well. At the same time, when equipment is purchased, it increases supply capacity as a production factor. In other words, equipment purchases will contribute to boosting growth potential. Equipment invested in, however, does not all lead to increased supply capacity. As the following formula indicates, any net increase in equipment is equivalent to taking the new equipment added to past equipment by capital investment and subtracting the capacity decline of existing equipment and disposed existing equipment.

Equipment this period = equipment in previous period + new investment - equipment disposal or capacity decline

Even supposing there is a large amount of new investment, production capacity will not increase in reality if much equipment is disposed of or if capacity falls significantly. There are a number of methods for estimating equipment disposal and capacity decline. Using the Japan Industrial Productivity (JIP) database by RIETI, equipment disposal and capacity decline in the private sector was 80 trillion yen (in real terms) in 2011. This means that even if there is 70 trillion yen in new investment, the new equipment will replace existing equipment and equipment capacity, and thus growth potential will not increase. Of course it is not realistic to assume that private companies will be purchasing the same equipment all over again. More likely, the new investment will increase the quality of capital. Inasmuch as this is true, the new investment will increase growth potential. However, the reality shows that the target of the Japan Revitalization Strategy is not sufficient in itself as a growth strategy.

The second problem is that the capital investment set as a target under the Japan Revitalization Strategy is limited mainly to investment in tangible assets, such as buildings and machinery. However, the idea that tangible asset investment is not enough by itself is starting to take root as people assess the economic and business growth in recent times.

The rising importance of "intangible assets"

Let's consider this point by thinking about changes in our lifestyles. People tend to feel that the greater the variety of goods and services they consume, the richer are their lives. In economics, this is referred to as "love for variety." In the past, when consumers bought electric appliances such as microwave ovens and washing machines, the time they spent on housework was reduced. The time saved could then be used to read books and pursue leisure activities, thereby enriching their lives. Nowadays, however, most people already have electric appliances, automobiles, and the like. It takes invisible tools to give us more choices and enrich our lives. Examples include websites and social media networks such as LINE and Facebook. These services provide access to lots of information. They are vastly increasing our choices moreover by enabling us to make reservations at restaurants and hotels and purchase concert tickets. Simply purchasing "visible" equipment (a personal computer) is not enough to make this happen. People have to use "invisible" tools: software and the Internet. This is simple enough to understand.

Likewise for businesses, it is not enough to add more buildings and machinery now that the IT revolution has begun. Businesses cannot expect to increase productivity or profits unless they take advantage of the power of intangible assets. Intangible assets include more than just software. They also include knowledge-based assets, which a business builds up by spending on research and development (R&D) to create new technological innovation. Another example is design and brand influence, which makes a product more attractive. Other intangible assets are human resources development and organizational frameworks for turning new technological innovations into businesses.

As the developed nations have come to recognize the importance of intangible assets, they have been taking approaches to make intangible assets visible. Investment in software is already counted in gross domestic product (GDP) statistics. Since the start of the current decade, there has been a growing trend to count R&D expenditures as assets. A group led by Dr. Carol Corrado of The Conference Board goes further. In addition to software investment and R&D expenditures, their comprehensive list of intangible assets includes design, brand assets, human resources development, organizational reform, and more. All of these are considered as intangible asset investment. Such approaches began to spread among the developed nations in the latter half of the 2000s. The Organisation for Economic Co-operation and Development (OECD) published a report entitled "New Sources of Growth" that drew on the results of these estimates. According to the report, investment in intangible assets is now doing more to boost productivity than investment in tangible assets.

Historically speaking, Japanese companies have long prioritized such intangible assets. Management scholars have referred to "tacit knowledge" (Professor Ikujiro Nonaka) and human capital based management (Professor Hiroyuki Itami). Business managers say that "the foundation of firms is workers." In each case, they are emphasizing intangible assets. Unfortunately, we must consider that intangible assets, like tangible ones, do deteriorate and grow obsolete.

A group of which I am a part of at RIETI has been engaged in a project since 2007 to measure Japanese intangible asset investment. According to our findings, Japanese intangible asset investment has been struggling to grow since the start of the 2000s. Such investment makes up a smaller percentage of GDP in Japan than it does in Europe or the United States. (For data on Japanese intangible asset investment, see http://www.rieti.go.jp/en/database/JIP2013/index.html#04-6) For that reason, Japan's stock of intangible assets started to decline in the 2000s. The trend also affects human resources development, an asset once prioritized by Japanese businesses but which began to decline when Japan's economic bubble burst. By 2010, it had fallen to just 20% of its peak. As for IT investment, growth has been slow, but it did rise at a 2% annual rate in the 2000s. What the research on intangible asset investment has emphasized so far is that when intangible asset investment increases in pace with tangible asset investment, especially IT investment, it causes an increase in the productivity of businesses and in the economy as a whole. Japan, however, has been moving in exactly the opposite direction.

Traditional investment-promoting policy has to make big changes

The human resources development being considered as an intangible asset investment in this discussion is off-the-job training. Therefore, some of the views expressed here may not fit Japanese companies that emphasize on-the-job training. Certainly, if on-the-job training were taken into account, the intangible asset investment made by Japanese companies should increase. However, human resources development by on-the-job training mostly takes place in manufacturing, and off-the-job training expenditures in manufacturing are not declining as much as that in the service sector. In contrast, the service sector is highly dependent on off-the-job training. We cannot overlook the fact that expenditures on this type of training have fallen rapidly. In manufacturing, on the other hand, new methods are being developed that fuse traditional physical production with intangible assets such as big data. This is an approach that is being tried in Industry 4.0, a movement led by the German government. In the future, traditional human resources development strategies will not be enough.

In light of all of the above, investment-promoting policy that focuses specifically on traditional tangible asset investment has to make big changes. Even if policy emphasizes only promoting tangible asset investment, it will be limited in effect unless there is an environment allowing intangible assets to be provided adequately. Without such an environment, there will be less incentive for making tangible asset investment, and businesses neither will likely grow nor experience increased productivity. In that sense, it is hoped that more comprehensive investment-promoting policies will be crafted that take account of intangible assets.

*The French wording in the title ("What is essential is invisible to the eye") is from The Little Prince by Antoine de Saint-Exupery.

April 13, 2015

April 13, 2015

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