The rise of intellectual capital creative destruction and its consequences
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The rise of intellectual capital: creative destruction and its consequences. Leonard Nakamura Federal Reserve Bank of Philadelphia* *reflects solely my opinions and not those of the Federal Reserve System. This moment…. Is a time of global risk and global opportunity

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The rise of intellectual capital creative destruction and its consequences l.jpg

The rise of intellectual capital:creative destruction and its consequences

Leonard Nakamura

Federal Reserve Bank of Philadelphia*

*reflects solely my opinions and not those of the Federal Reserve System


This moment l.jpg
This moment…

  • Is a time of global risk and global opportunity

  • I am going to be talking about history of US creativity over the past half century

    • To help you interpret the present

    • To be better prepared for the future

  • Can be a great time to seek funds and invest


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Talk outline

  • In the US, new product development accelerated in the 1980s as smaller firms were able to get creative profitably

    • Intellectual capital doubled in importance, one-third or more of US equity capital

    • This acceleration has slowed

    • New product development is now accelerating in rest-of-world

  • Consequences

    • More opportunity for smaller firms and less-developed countries

    • More risk for investors, employees, CEOs, nations

    • Need for better accounting, less hierarchy, more planning for failure


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Global competition accelerated as the microprocessor came of age:1975-2000

  • New products became central to private enterprises at all scales

    • Also known as: intangible investment, creativity, intellectual capital, knowledge creation

  • In the late 1970s, microprocessors gave a large boost to global innovation

    • By automating transaction processing, much easier for small and medium size firms to enter global markets and compete with giants

    • Microsoft (less than 5 thousand workers) in 1989 could compete globally with IBM (380 thousand workers)


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Before 1980, large corporations dominated US private research and development (R&D)

  • Eighty percent of private R&D was performed by companies with more than 5000 employees

  • Only large corporations could sell large quantities of new products

  • Since 1980, firms no longer need a large bureaucracy to sell to the world market

  • And so small companies have accounted for almost all the growth in R&D



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A crude estimate of intangibles research and development spending

  • US businesses spend approximately $1 trillion in intangible investment

    • Including R&D, software, (re)organization capital, and advertising.

  • Of which more than 80 % is uncounted in U.S. GDP

  • Between 1977 and 2007, private intangible investment doubled as a percent of US GDP

    • Investment in new product development now as important as investment in plant and equipment


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Other advanced countries have large investments in intangibles

  • UK: 9-10 % of GDP

  • Japan 8-9 % of GDP

  • Canada 8-9 % of GDP

  • Netherlands 7- 8 % of GDP


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Crucial questions: intangibles

  • Is your firm – with its strategic partners– investing enough in intangibles?

  • Do you know whether your investment is profitable?

  • Is the profitability of your new products rising or falling?

    • Do you have the data to prove what you believe to be true?


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Accounting: Corporate measures of intangible investment intangibles

  • In standard accounting investments in intangibles are expensed

    • Reduces taxes

    • Understates profits in the short run and capital formation in the short and long run

    • Expensing is often sensible as many projects fail

  • But, this makes it hard to know even ex post the rate of return to creativity

    • A problem for the firm, the industry, and the nation

    • With one-third of capital and one-half of investment coming from intangibles, this makes rational management more difficult


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Creativity is risky intangibles

  • In markets dominated by new products, success is often winner-take-all or winner-take-most

    • A large fraction of all profits go to the top product in new product markets

    • New technologies can shake up entire industries

  • Picking strategic partners—rising risk and reward


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Rising opportunities and risks to investors intangibles

  • Higher profits from investments = more return to stock market

  • $1 Trillion intangible investment

    = $5 Trillion intellectual capital

  • But: intangibles are risky assets

  • More risk at individual corporations:

    • Stock prices more volatile

    • Used to need 20 stocks to diversify most risk

    • Now need 50 stocks to diversify


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Since 1980, individual stock volatility has risen sharply intangiblesas intangibles heightened risk


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Risks to CEOs and employees have risen since 1970s intangibles

  • CEOs are twice as likely to be fired

  • Outsiders are twice as likely to be chosen to run large corporations

  • Corporate succession and memory – knowing which workers have contributed and sacrificed in the past – has become more difficult

    • But remains valuable to long run corporate success


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Employees are more at risk intangibles

  • Spells of employment with a given employer have become shorter in countries with weak employment protection (US)

    • Careers at one firm are shorter

    • Workers have to learn continuously

  • Spells of unemployment have become longer in countries with strong employment protection (Europe)


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Investment in intangibles in US has leveled off intangibles

  • The evidence suggests that since the boom of the 1990s the proportion of US GDP going to intangible investment has stabilized

  • Proportion of workers in creative occupations has also leveled off


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Risk and opportunity intangibles

  • Developing/adopting new products is both possible and necessary for every organization

  • Growth of new product development has slowed in the US 2000-present relative to 1990s

  • New product development/adoption has accelerated outside the developed countries


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Decentralization intangibles

  • Decentralization with competition improves decisionmaking

    • Not just the private sector:

    • All sectors: public, private, and nonprofit can contribute to development of intellectual capital

      • But public and nonprofit sectors need to have genuine competition, not just subsidies!


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Competitive Principles intangibles

  • Reducing hierarchy and increasing competition throughout the organization are key components of creativity

  • Organizations need to allow, not punish, risk and failure

    • No easy way to accomplish these goals

    • Important to plan for failure


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Conclusions intangibles

  • Creating intellectual capital is increasingly the main form of wealth creation today.

  • Countries and businesses that foster creativity are likely to prosper

    • but creativity is risky.

    • Decentralization and competition are crucial.

    • Companies need to measure their innovation and its payoff.

  • From 1977 to 2000, US investment in intangible assets rose under the impetus of computerization.

    • But for the past eight years, intangible investment has not been rising as a proportion of output.

  • Current period is one of opportunity for many countries and companies.