Innovation is the source of long-term productivity growth, and achieving higher and sustained growth is essential for OECD economies. However, according to the OECD’s 2010 Innovation Strategy, many innovating firms do not invest in research and development (R&D). Instead, innovation in these firms is based on investments in a wider range of intangible assets, referred to here as knowledge-based capital (KBC). KBC comprises business investment in assets such as data, software, patents, designs, new organisational processes and firm-specific skills.

At the start of 2011 the OECD began a two-year project to examine the economic significance of KBC and improve the understanding of current and emerging policy challenges. This work has recently been published under the title Supporting Investment in Knowledge Capital, Growth and Innovation.

The analysis shows that in many OECD countries, and for a considerable time, business investment in KBC has increased faster than investment in physical capital such as machinery, equipment and buildings. In some countries, business investment in KBC now significantly exceeds investment in physical capital.

Inherent features of KBC are growth-promoting, and various forms of evidence link business investment in KBC to growth and productivity change. Growth-accounting studies for the European Union and the United States show business investment in KBC contributing 20-34% of average labour productivity growth. During the global financial crisis, investment in KBC has also been relatively resilient.

KBC is transforming the determinants of competitive success for firms. For instance, in the automotive sector, software is increasingly prominent in the cost of developing new vehicles.

Policymakers should adopt a broader concept of innovation. Beyond R&D, forms of KBC such as design, data and organisational capital should also be policy targets. Getting key framework conditions right is essential and can be a low-cost step for policymakers in fiscal terms. The countries that invest more in KBC are those that reallocate resources to innovative firms more effectively. 

Well-functioning product and labour markets and systems of debt and early-stage equity finance are essential, as are bankruptcy laws that do not overly penalise failure. Intellectual property rights (IPR) are an increasingly important framework condition. But not all facets of IPR regimes have kept pace with technological change (many copyright systems, for instance, were designed for the pre-digital world).

When factoring in crossborder tax planning by multinational enterprises (MNEs), often using KBC, overall tax relief for R&D could well be greater than governments anticipated when their R&D tax incentives were designed. When it comes to undertaking and exploiting R&D, firms that are not part of a multinational group of companies—often small and young firms—may be at a competitive disadvantage relative to MNEs. R&D tax credits need to be redesigned accordingly.

Across countries, there is a positive correlation between the market value of firms and investment in KBC. But corporate financial reports provide limited information on companies’ investments in KBC. Governments can take steps to facilitate companies’ reporting of investments in KBC.

Creating economic value from large data sets is at the leading edge of business innovation. OECD governments must do more to implement coherent policies in the fields of privacy protection, open data access, information and communications technology (ICT) infrastructure and skills.

Growing business investment in KBC amplifies the importance of getting human capital policies right. And a fuller understanding of innovation, growth and good policy requires better measurement of KBC and common measurement guidelines.

This article is part of a series managed by The Economist Intelligence Unit for HSBC Commercial Banking.  

The views and opinions expressed in this article are those of the authors and do not necessarily reflect the views of The Economist Intelligence Unit Limited (EIU) or any other member of The Economist Group. The Economist Group (including the EIU) cannot accept any responsibility or liability for reliance by any person on this article or any of the information, opinions or conclusions set out in the article.