Intangible assets like intellectual property, licensing, branding, and data make up enormous amounts of the value generated by most companies today. Ireland has experienced a boom in intangible assets located here since 2015, making us look a lot richer and, as a side effect, earning the state a bit more in taxation revenue, but these assets come with risks.

We know relatively little about these intangible assets, including how to value them. We don’t know what might happen if they suddenly lose their value. Could Ireland’s intangible boom bust? Or are we simply caught in a larger transformation of the global economy?

Intangibles exist as accounting conventions more than anything else. They are described in the dry language of accounting for the purposes of deciding which part of a company’s accounts to put a particular flow of income or stock of wealth. The really key part of any intangible asset is its ability to deliver a stream of future benefits to the company or entity holding it. Intangible assets like ‘goodwill’ have always been part of a company’s make up, but in the 21st Century, intangibles like intellectual property comprise large parts of our economy, so we need to get a firm grip on them in policy terms. Consider that Apple, the world’s most valuable company, owns few physical assets. It is Apple’s intangible assets, in its integration of design, hardware, and software into a brand — that create value shareholders are queuing up to get their hands on.

Compare Sainsbury’s and Microsoft. Sainsbury’s have $24 billion in sales, and use $10 billion in assets, property and equipment to achieve those sales. Microsoft manages $85 billion using $5 billion in assets, property, and equipment. Modern companies ‘own’ an awful lot less.

What we have done, in practice, is to create a web of policies to help suck intangible assets from the rest of the world. Consider the Knowledge Development Box, created in Budget 2015 to allow intellectual property income associated with research and development to pay only 6.25% corporation tax on the income software and inventions generate, as well as allowing interest payments to be deducted from any outstanding taxes to be paid. It gets better—-because Ireland is party to lots and lots of bilateral tax treaties, thanks to the innovative work done by a generation of aircraft leasing entrepreneurs, the companies who use the knowledge box can claim tax relief from  

The knowledge economy is skilled and talented people combining their know-how with the latest technology to produce something new, probably a service. The capital that is built up in this process is intellectual, not physical.

As such almost everything about intangibles is deeply descriptive—it look is like this—with rules around dealing with them that are deeply prescriptive—when you see X, do Y.  This does not help our friends in the CSO who have to describe all of this stuff, and it definitely does not help policy makers who have to figure out what to do, ultimately, with all of it.

The literature on intangibles breaks them into three main categories: innovative properties, company competencies, and computer-related. Consider the iPhone. It is the intellectual property of Apple, not Stephen Kinsella. It’s value in sale should, by rights, accrue to Apple.

The knowledge economy

We spend a lot of time talking about the knowledge economy in Ireland. The new FutureJobs strategy mentions knowledge 18 times. We often don’t stop to ask: What is the knowledge economy, and how do we measure its success or failure? The knowledge economy is skilled and talented people combining their know-how with the latest technology to produce something new, probably a service. The capital that is built up in this process is intellectual, not physical.

Take the intellectual activity that is management. Management seems like a simple thing, on the face of it. Decide what thing to do, command, cajole or persuade people to do said thing. Check whether the thing was done to some level of satisfaction, and either repeat that process to make the thing again, or decide to do another thing. Simple, right?

Everyone, after a short course and a few months’ training, should be a decent enough manager. Managing people should be a bit like driving. A few lessons, a bit of a test, and you’re safe enough. We all know managing people isn’t like that at all. We have all worked for, or maybe even ourselves been, bad managers.

Managerial know how is a key driver of firm level success. And yet, we have no way to understand the intellectual capital that is good management

In series of studies, Stanford’s Nick Bloom and colleagues surveyed managerial quality at the firm level across the globe. Their most recent study of differences in managerial quality across 35,000 US manufacturing plants makes their point well. They found management practices alone account for more than 20 percent of the variation in productivity across plants, more than any other factor. Simply installing better managers and better management practices is a boon to productivity. What factors makes the difference between good and bad management?

A combination of better business environments and incentives, and the arrival of large firms, from whom the smaller ones can learn. Managerial know how is a key driver of firm level success. And yet, we have no way to understand the intellectual capital that is good management. Bloom’s entire research programme is an effort to get towards a good answer to this question. And the question is not just confined to management.

In 2020, much of what goes on the knowledge economy, in areas like intellectual property, licensing, branding, software, and data is intangible. We cannot see, or touch, many of the products and services a firm produces. This creates a measurement challenge. Think about the phone or screen you’re reading this on. The software that is serving you these pixels has real economic value, but no one has ever touched it. What is it worth? How should it be valued? The patents governing the use of the technologies in your phone and your computer have real value too. What are they worth? Licensing the rights to use new technologies is incredibly lucrative, as are the brand details. What are they worth? The design of the phone is a piece of intangible capital, too. iPhones are beautiful examples of industrial design. What is the design worth? The scale of the transformation from tangible capital to intangible capital is immense.

Measuring (and taxing) intangibles

Today’s modern corporate behemoths do not have huge factories pumping smoke into the air. They have modern offices stuffed with programers and flannel-wearing PhDs coding the hearts out while reclining on bean bags in order to pump smoke up the arses of their shareholders. The taxation issues I referred to in my column last week are also influenced directly by Ireland’s role as a hub for multinational corporations using them to minimise tax revenues. A fundamental feature of intangible assets is their mobility, and thus they are hard to tax. The digital economy is deeply involved here. The value on their balance sheets of Apple, Google, Facebook, and many companies like them, are almost entirely defined in intangible terms.

The digital economy is deeply involved here. The value on their balance sheets of Apple, Google, Facebook, and many companies like them, are almost entirely defined in intangible terms.

Readers may remember July 2016 as the month Ireland was mocked for its Leprechaun economics by Nobel laureate Paul Krugman. The month the CSO published its national accounts data for 2015. The national accounts are the raw data that make up the gross domestic product and gross national income statistics. The CSO reported the value of the economy had grown by 32.4% between 2014 and 2015. Even taking account of price changes, the ‘real’ figure was 26.3%. This figure was bananas. What caused it?

You guessed it: intangibles. Between 2014 and 2015, the contribution of depreciation on R&D service imports and trade in IP increased from €5 billion to €30 billion. A move to measure intangibles in the National Accounts caused a vast upward revision in our national output statistics that caught the world’s eye. It is probably the case that some €40 billion of Ireland’s 2018 gross domestic product is intangible-related. The chart shows the flows taken out of Ireland’s gross domestic product to produce a more realistic measure of Ireland’s economy. The influence of the R&D and trade in IP figure is clear. And it is not unrelated to policy.

In 2015, the intangible-asset-related gross trading profits of the multinationals operating in Ireland increased by €26 billion. However, claims for capital allowances related to expenditure on intangible assets increased by €26 billion. No corporation tax was due on the gross profits offset by capital allowances. The benefit to the Irish taxpayer from these measures was approximately zero. Minister Donohoe moved to curtail some of this in subsequent budgets, and this change has been the source of much of the corporation tax income we have been able to put into housing and health. This is not generally recognised or acknowledged, but it is a fact.

Like it or not, in 2020 Ireland is a global capital for intellectual capital. We hold it here, and it is, in many ways, like a resource. We derive enormous benefits from taxing this resource, and could derive more if we spent time figuring out exactly what intangible capital could do for Ireland now, and into the future. I gave the example of managerial intellectual capital above. Multinationals are some of the best managed firms in the world, and they are on our doorstep. Domestic firms learning managerial technique from their multinational cousins is a potential game-changer. There are many, many other examples. I would love to see a change in Ireland’s approach to research and development powered by some of these revenues, for example.

In the 2020s, investment will become more intangible. We know they are poorly measured, and can be used to game the system if allowed.

There’s an upside and a downside to any risk. The upside is that we learn to treat intangible capital as the resource it really is, and that transforms our economy for the better. The downside is that we come to rely upon it, and then a digital tax, combined with changes in the relationship between the EU and US from a re-elected President Trump, and the finalisation of the base erosion profit sharing scheme sharply curtail the flow of funds into Ireland, and we suffer tangibly from a loss of intangible capital.

In the 2020s, investment will become more intangible. We know they are poorly measured, and can be used to game the system if allowed. If we learn how to incorporate intangibles, we’ll have a better understanding of the innovative, creative parts of our economy, we’ll understand the roots of productivity changes, and be able to improve people’s living standards by tying wage increases to productivity increases in key sectors. That will reduce income inequality and make the more extreme aspects of our economy easier to deal with.