From quantity to sustainable quality

Increasing intellectual capital: can this objective guide policy development and can it be measured

Paper prepared for the conference “New methods for cohesion policy evaluation: promoting accountability and learning”, Warsaw, Poland, 30.11.2009 -01.12.2009.

Krzysztof Rybinski[1]

This version: 18 November 2009

“Not everything you count counts; not everything that counts is counted”

Albert Einstein

Prof. Krzysztof Rybinski

From quantity to sustainable quality

Increasing intellectual capital: can this objective guide policy development and can it be measured

Executive summary

For decades progress measurement was about quantity. In economic models households sold labor to companies that produced widgets, then consumed by households. The more widgets per capita were produced and consumed the bigger progress was achieved. In recent years we understood that progress should be replaced by sustainable development, and the quantity of widgets should be replaced by the sustainable (i.e. achieved over several generations) improvement of the quality of life. This paper proposes that this transition from quantity to sustainable quality (QSQ process) can be well facilitated by adopting the methodology of intellectual capital for policy planning and evaluation. Four steps are strongly recommended:

  1. Connect to the EU citizen. Policy goals and statistical data should be reported in terms which are important to the EU citizen. Playing with data should be fun and easy, the good benchmark is offered by
  2. Start several projects of measuring intellectual capital of selected regions. Some 10-15 regions should suffice to account for the EU heterogeneity. If launched soon the first results should be ready by the end of 2010.
  3. Build EU intellectual capital model, which will offer a strategic framework for the future EU policy evaluation. Cascade this model down to member states. It will ensure that the same policy language – connected to EU citizens – is spoken at all EU governance levels.
  4. Take seriously Albert Einstein statement: “Not everything you count counts; not everything that counts is counted”. Stop counting cows and start measuring the quality of intangible assets.
  1. Why GDP as a measure of country/region development fails to capture the most important aspects of country and regional development in XXI century?

A very recent and very comprehensive report of the Commission on the Measurement of Economic Performance and Social Progress established by French President Nicolas Sarkozy and chaired by Joseph Stiglitz presented a broad range of arguments why GDP is a poor measure of national or regional development[2]. Selected arguments are summarized in the table below:

Table 1. Why GDP is a poor measure of country and regional development: selected arguments

GDP inferior characteristics / Explanation
GDP may rise while national income falls / In country with large FDI, foreign companies profits may become large share of GDP, as in the case of Ireland, so GDP increase may be of little relevance to citizens, when at the same time their incomes fail to grow
GDP is a flow measure, ignores wealth and its dimensions. / Stock of public debt, stock of external debt, national economy assets and liabilities, all these balance sheet items may offer a very different context to similar GDP figures. Wealth measures are often as important that flow measures. Wealth has at least five dimensions: material living standards, health, education, personal activities including work, political voice and governance
GDP calculation maybe based on distorted prices / For example market prices may be distorted because there is no charge imposed on carbon emissions, measures of economic activity that reflected environmental costs might look markedly different from standard measures
GDP measure does not take into account depletion of resources (such as regional biocapacity or raw materials) / GDP fails to address the issue of sustainability, present GDP may be high but if achieved at a price of massive depletion of resources may hinder the ability of future generations to enjoy good quality life
GDP does not capture quality improvements / Underestimating quality improvements leads to overestimating of the rate of inflation and consequently to underestimating the real income. At low income levels quantity is crucial (amount of rice parent can feed his child every day), but for medium and high income countries quality gains importance (for example you can accept a lower paid job, if it requires less commuting and is in more friendly environment)
GDP measures production, does not measure well-being / Good access to healthcare, education, leisure of government services is increasingly important part of life, GDP is a very poor measure of services availability and quality. GDP measure ignores people satisfaction (happiness), one may make million dollars per year, working 18 hours per day 7 days per week, and may be very dissatisfied with her life
GDP ignores income inequality / Country GDP per capita may rise, while large income groups may not benefit at all, in some cases rising GDP per capita may be accompanied by rising number of people living in extreme poverty.
GDP is available with a significant lag / GDP data on a regional level is available with such a lag that it is almost irrelevant from the policy evaluation perspective. In modern societies people demand immediate feedback (especially younger generations). Often fast and roughly correct measure is much more informative than precise measure but delayed two years.
GDP emphasizes producer perspective / Modern measures of development should emphasize household (citizen) perspective. It is particularly urgent to have proper measures in place ahead of the upcoming demographic/pension system challenge.
GDP ignores social capital / Research shows that growth depends of human capital in poor economies. However for middle income and rich countries social capital becomes more important. Therefore sustainability of development requires using measures that take into account quality and intensity of relationships, trust, attitudes. Without steady increase of social capital sustainability dimension of development will not be properly addressed[3].
GDP does not provide any information related to managing risks to sustainability / There is a need for a clear indicator of our proximity to dangerous levels of environmental damage (such as related to climate change, water scarcity or depletion of fishing stocks).

Source: Stiglitz et al. (2009), own analysis

The report advocates a shift of emphasis from a“production-oriented” measurement system to one focused on the well-being of currentand future generations, i.e. toward broader measures of social progress.

As stated in EC [2] a 2008 Eurobarometer poll showed that more than two thirds of EU citizens feel that social, environmental and economic indicators should be used equally to evaluate progress. Only just under one sixth prefer evaluation based mostly on economic indicators. An international poll in 2007 gave similar results. Studies have also revealed that citizens can feel distanced from statistical information. GDP may be growing, but disposable incomes and public services are perceived as shrinking. As societies become more diverse, indicators based on averages or "the typical consumer" are not sufficient to fulfill the information needs from citizens and policy-makers. A stark example is rising average wage in the United States in the past two decades. But when top one-tenth of a percentage point of highest earners (celebrities and CEOs) is removed from the distribution, the average real wage remains stable, despite significant increase in productivity. The same trend has been observed in Canada[4]. When only the very richest experience the rising share of total wage bill, at the expense of others, it may lead to significant discrepancy between economic situation as measured by GDP, and citizens perception as measured by their income cohort.

In the communication[5] released on 8 September 2009 the European Commission announced that it undertakes the task of transforming the way we measure well-being. GDP is no longer an appropriate measure as it ignores some key factors, which are important for citizens: clean environment, social cohesion, or the fact whether people are happy or not. As such inferior measure of well-being it can no longer be used as a sole yardstick of country or regional progress. Commission announced that pilot of an environmental index will be proposed in 2010 that will assess progress in the main fields of environmental policy and protection. The index will cover areas such as greenhouse gas emissions, loss of natural landscapes, air pollution, water use and waste generation. The Commission will also work to complement GDP and national accounts with environmental and social accounts. The pilot version of the Sustainable Development Scoreboard should be released in 2009[6], while the recent environment Council[7] meeting held on 21 October 2009 invited the Commission “to complement GDP with additional robust, reliable and widely recognized indicators to measure progress towards an eco-efficient economy and to develop, together with Member States, a sustainable development scoreboard by 2010, which will provide information on the implementation of EU sustainable development objectives in Member States”.

It appears that there is a broad consensus that European Union should develop a better measure than GDP to guide it policy. The remaining question is how to do it. And the challenge is enormous when one keeps in mind that such ideas were proposed already in 1960s[8], when Drewnowski and Scott proposed the level of living index, which was defined as the level of satisfaction of the needs of the population as measured by flows of goods and services (basic such as nutrition, but also cultural, educational, leisure, security etc.) enjoyed in the unit of time. Scientists did not come up with anything to successfully challenge GDP in the past 40 years, we should hope that the next decade will be more productive.

  1. How to create a policy evaluation metric that can be easily understood by citizens and engages citizens in a lively debate about policy outcomes?

Evaluation of Structural and Cohesion Funds programmes has to be conducted at defined points in the programming cycle: ex ante to verify targets; at the mid-point to establish the need for corrective action; and ex post to assess outcomes. These national and regional evaluations are complemented by meso- and meta-evaluation studies and thematic evaluations by the Commission services, and by extensive Commission-sponsored research and debate on evaluation concepts, methods and practices[9].

Policy evaluation is a daunting task. Data is available with a significant lag, data quality is often inadequate, it is hard to isolate EU policy intervention effects from effects of other non-related events or policies (such as domestic interventions). Local context is often so strong that conducting a meta-analysis of evaluations becomes impossible. Finally researches cannot agree even on the answer to the simplest questions: is cohesion policy effective, does it lead to convergence[10]? Of course part of the problem is a flawed metric of convergence (GDP per capita), but part of the problem is complex and varying evaluation methodology and different evaluation cultures in different countries. Draft communication from the Commission to the European Parliament and the Council “A Reform Agenda for A Global Europe dated 6 October 2009 and leaked to the media stated (page 11) that:

“While income disparities among Member States have declined substantially since the early 1980s, they have increased across regions. The reasons for this have been widely discussed: they are partly structural (geographical, political and related to governance) and partly linked to natural forces of territorial agglomeration which are important drivers of overall economic growth within countries. It raises the question how to target EU cohesion spending in order to effectively improve convergence.”

The draft Commission budget review paper proposes that Member States with incomes above the convergence threshold should qualify for increased competiveness spending if regional income disparities within the country were particularly large. At the same time Commission proposes that the conditionality based on the achievement of agreed measurable objectives must be strengthened. Cohesion policy should be more performance oriented which will require improved evaluation mechanisms[11], also by shifting the emphasis from formal compliance to genuine performance objectives. Credible performance indicators should be agreed between the Commission and the Member State concerned, with part of the envelope set aside to reward particularly successful programmes[12].

It appears that policy evaluation will become even more important tool of the EU cohesion policy, with higher conditionality and stronger focus of performance objectives. Without radical change to the approach it is easy to predict that the result will be even more complexity and detachment from the EU citizen. As shown in the June-July 2009 issue of the Euro barometer the EU citizens trust in the European Parliament has fallen below 50%, and distrust has risen to levels not seen before.

Figure 1. Do EU citizens trust the European Parliament?

Source: Eurobarometer, June-July 2009.

Therefore it is of utmost importance that the new methodology used for EU policy planning and EU policy evaluation is well understood by the EU citizens.

The new evaluation metric has to be less abstract and be closer to average citizen. We should stop communicating EU policies’ outcomes in terms of vaguely defined value added, especially when this value added is understood by a handful experts, but instead we should communicate EU policies in terms of concrete gains for the EU citizen. It requires a different metric, but also calls for a massive change of data access and dissemination. Current Eurostat data dissemination practices should be replaced by user friendly interface. Playing with data should be fun and data access should be fast and easy. Best practices are offered by the website

  1. Can intellectual capital methodology be a useful policy evaluation metric: brief history and recent applications to countries, regions, cities, universities and companies.

If you perform the following search in Google [intellectual capital report filetype:pdf] it will return 944,000 links to pdf files across the world. Intellectual capital concept is popular indeed.

The history of intellectual capital methodology dates back to early 1980s[13].

  • Late 1980s – early attempts to create intellectual capital statements. Karl Sveiby’s Intellectual Asset monitor was created. Sveiby used the term knowledge based assets[14] which were divided into three categories: competence, external structure and internal structure. The model was used by several Scandinavian companies.
  • Early 1990s – Pioneering initiatives to systematically report on intellectual capital to external parties. Skandia’s intellectual report[15] dates back to 1994.
  • Mid-1990s – several important books on intellectual capital are published[16].

Historically intellectual capital methodology was applied in the corporate sector, to explain the difference between market value and book value of a company listed on the stock exchange. This difference rose over time and was explained as a price, that investors put on corporate intangible assets, which cannot be precisely measured today but have potential to generate value for investors in the future. The branch of intellectual capital that deals with company intangible assets reporting is most developed and researched. In December 2008 European Financial Reporting Advisory Group (EFFRAG) has invited comments on paper prepared by Australian Accounting Standards Board, which proposed future path of changing accounting standards to better measure corporate intangible assets. So finally, after two decades also the very conservative profession of accountants woke up to reality and plans to change international accounting standards to better account for the value of corporate intangibles.

Others branches of intellectual capital profession are still in early stage of development, in particular when applying intellectual capital methodology to countries and regions.

In recent years intellectual capital methodology applications can be found in the following five areas (examples of applications in brackets):

  • Measuring intellectual capital of countries[17] (Israel, Poland, Sweden, Malaysia, Denmark, Finland, multinational study of 40 countries, benchmarking of Arab countries).
  • Measuring intellectual capital of regions, cities and communities[18](Poland, Spain, Norway)
  • Measuring intellectual capital of cities (Poland, Spain)
  • Measuring and reporting intellectual capital of companies (Germany, Japan, Poland, Brazil)
  • Measuring and reporting intellectual capital of universities[19] (Austria, Poland, Sweden)

There are regular annual intellectual capital conferences organized by the World Bank in Paris, fifth edition was held in May 2009. European Commission has launched two projects to assess the usefulness of the methodology. First, MERITUM (1998-2001) was focused on four areas:

  • Produce a classification of intangibles;
  • Analyze management control systems to identify best practices within European companies in measuring intangible investments;
  • Assess the relevance of intangibles for the purposes of equity valuation in capital markets;
  • Produce guidelines for the measurement and disclosure of intangibles.

Second project, RICARDIS (2006) was in the area of small and medium size enterprises. The mandate included the following:

  • Guidelines for research-intensive SME’s on how to highlight thebusiness case for R&D investments by reporting on their intellectualcapital;
  • Recommendations for investors and private stakeholders on how tointerpret and value intellectual capital statements and how toencourage companies to report on their intellectual capital.
  • Recommendations for public policy makers on how to stimulatecompanies to report on their intellectual capital.

The RICARDIS group has used the definition of intellectual capital proposed in MERITUM project: “Intellectual Capital has been defined as the combination of an organization’s Human, Organizational and Relational resources and activities. It includes the knowledge, skills, experiences and abilities of the employees, its R&D activities, organizational routines, procedures, systems, databases and its Intellectual Property rights, as well as all of the resources linked to its external relationships; such as with its customers, suppliers, R&D partners, etc.”.