Intangible capital, the labour share and national 'growth regimes'

Posted in: Business and the labour market, Economics

Has the rise in intangible capital contributed to a decline in the labour share in advanced economies? A recent paper, authored by IPR Research Associate Aida Garcia-Lazaro and IPR Director Nick Pearce, seeks to shed light on this question, using industry-level data for a selection of OECD countries from 1995 to 2017. It shows that the relationship between intangible capital and labour share is not straightforward but conditioned by the types of intangibles and the growth regime of the national economy.

Since the early 1980s, the labour share – that is, the share of national income allocated to salaries, wages, and other forms of labour compensation – has decreased in many OECD countries, raising concerns about widening inequality between workers and capital owners. Research into this phenomenon has advanced a range of potential explanations. However, many existing theories fail to fully account for structural shifts in advanced economies related to the rise of so-called ‘intangibles’.

Intangible assets are non-physical in nature but often critical to the long-term success of a business. Different types of intangibles can be distinguished, including economic competencies (e.g. market research, branding, training, organisational processes), other innovative properties (e.g. design and development of products, other intellectual property assets), software and databases, and research and development. Investments in intangible capital have taken on increasing significance in the modern ‘knowledge economy’ and, in the aftermath of the 2008 crisis, they have proven more resilient than tangible investments in many OECD countries.

Intangible capital differs from tangible capital in a variety of ways. For example, a physical asset such as piece of machinery usually has a relatively restricted purpose, whereas intangible assets are more versatile and scalable and often increase in value when combined with other intangible assets. At the same time, investments in intangibles can be risky – unlike physical assets, intangibles cannot easily be transferred or sold. Furthermore, intangible-intensive companies could face lending constraints as intangibles are less suitable to serve as collateral. For a great introduction to intangibles and their distinguishing features, watch the recordings of a recent IPR event with Professor Jonathan Haskel and Stian Westlake.

The rise of the intangible economy presents both opportunities and challenges. One key question is whether intangible investments complement or substitute for labour. A recent paper in the Journal of Comparative Economics, authored by Dr Aida Garcia-Lazaro and Professor Nick Pearce, suggests that this depends, both on the types of intangibles and national political economy structures. Their analysis also shows that the relationship between labour share and intangible capital is bidirectional. In other words, not only do changes in intangible capital investments impact the labour share but the size of the labour share also influences how much capital is invested in different types of intangibles.

What is the net effect of this bidirectional relationship between intangible investment and the labour share? In part, this depends on the type of intangible capital. Using industry-level data of 22 OECD countries from 1995 to 2017, Garcia-Lazaro and Pearce find that investments in economic competencies, other innovative properties and research and development drive down the labour share across the sample, whereas investments in software and databases have no significant effects.

However, this is not the whole story. The effect of investments in different types of intangible capital is also mediated by national political economy structures. For example, because other innovative properties are considered intensive in the use of highly skilled labour, their net effects on the labour share may depend on the quantity and quality of the skilled labour force in each country.

Although advanced economies share many common features, their political economy structures remain distinct and are shaped by different ‘growth regimes’. Growth regimes, simply put, refer to the underlying governance frameworks that seek to generate growth and distribute it dividends, including the institutions, regulations, and organisational frameworks that condition both the supply and the demand side of national economies. The growth regimes of advanced capitalised economies can be classified into five ideal-typical groups. As Garcia-Lazaro and Pearce show, there are marked differences in the relationship between intangible capital and labour between these five groups:

  • Dynamic services export-led growth regimes (e.g. Denmark, Finland, Luxembourg, Netherlands, Sweden): Countries in this group combine a focus on export-driven growth with solid domestic demand. They are characterised by strong ICT-based high-value service sectors, high levels of financialisation, coordinated wage bargaining, a firm commitment to social investment, and inclusive education systems. In these countries, the net effect of intangible investments on the labour share is positive, driven primarily by growth in innovative properties, as these countries have a steady supply of highly qualified workers, with coordinated and centralised wage bargaining ensuring that investment returns are shared with labour.
  • High-quality manufacturing export-led regimes (e.g. Austria, Belgium, Germany, Japan): Countries in this group rely heavily on exports to drive growth, sustaining a persistent current account surplus. Their economies are also shaped by low financialisation, medium-level ICT use, coordinated wage-setting, social insurance systems that prioritise labour market ‘insiders’, and a public education system with a strong focus on vocational training that caters primarily to the employment needs of the high-quality manufacturing sector. In these countries, the net effect of intangible investments on the labour share is negative, in part due to a lack of highly skilled labour to complement increases in other innovative properties but also due to the need to sustain international competitiveness by controlling wage growth.
  • Finance-based domestic demand-led regimes (e.g. United States, United Kingdom): In these countries, growth is driven primarily by credit-financed domestic consumption; financialisation and ICT-use are high, the labour market is deregulated, and there is an extensive role for the private sector in both education and social welfare systems. High levels of investment in intangibles in these countries have somewhat counteracting effects. While the net effect on the labour share is positive, returns are biased towards high-skilled workers at the expense of middle- and lower-income groups. More research is needed to understand the exact relationship between intangible investments and labour share in these countries, particularly because the UK does not display the same trend of declining labour share as most other OECD countries.
  • FDI-financed export-led regimes (e.g. Czech Republic, Estonia, Hungary, Latvia, Lithuania, Slovakia, Slovenia): Countries in this group combine a focus on exports with relatively high domestic demand, whilst relying heavily on foreign direct investment (FDI) to drive growth. They are also characterised by comparatively low levels of financialisation, deregulated labour markets, welfare systems that are centred on social insurance, and education systems that are inclusive to a medium level of education. Because both intangible investments and the development of the knowledge-based economy are low compared to most other growth regimes, changes in intangibles have little or no effect on the labour share.
  • Public-financed domestic demand-led regimes (e.g. Greece, France, Italy, Spain): Countries in this group drive growth primarily through domestic consumption, with the public sector being a principal employer. These countries also display low levels of financialisation, low levels of ICT development, regulated labour markets, social insurance systems, and elitist higher education systems. Due to an underdeveloped knowledge-based economy and minimal investments in intangibles, the effects of the latter on the labour share are not significant. In addition, the large size of the public sector means that the labour share in these countries is not necessarily determined by market forces.

In summary, the analysis by Garcia-Lazaro and Pearce points to a rich range of heterogeneous relationships between intangible capital and labour share across advanced economies, highlighting the importance of taking into account (1) the bidirectional relationship between intangible capital and labour share, (2) the differentiated effects of the various types of intangibles, (3) differences between growth regimes, including sectoral composition, the primary drivers of growth, and the various institutions that affect the labour market, from financial regulations to education and welfare systems. Going forward, Garcia-Lazaro and Pearce highlight that more research is needed around (1) the impact of competition and concentration on intangible investment decisions, and (2) the lending constraints for companies which are intangible investment led.

All articles posted on this blog give the views of the author(s), and not the position of the IPR, nor of the University of Bath.

Posted in: Business and the labour market, Economics


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