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Intellectual Capital Ratings of Nations and Economies

Intellectual Capital Ratings of Nations and Economies

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  • 1. CHAPTER 8 The Intellectual Capital of Nations Leif Edvinsson Universal Networking Intellectual Capital (www.unic.net) and University of Lund, Sweden Just as an organization’s value is a function of its intellectual capital, the wealth of a nation – present and potential – is linked to its intellectual capital (IC). This chapter argues that it is imperative for leaders to recognize and address the IC potentials of their nations. Issues pertaining to consideration and reporting of a nation’s IC are outlined. Activities along these lines in several nations are described. Keywords: Financial Capital; Intellectual Capital; Longitude; Nations; Navigator; 1 Introduction This chapter builds on what has been accomplished in understanding the intellec- tual capital (IC) of organizations to develop an appreciation of the IC of nations. Such an appreciation is important in addressing such questions as: • What is the knowledge capital of your nation? • What is the GDP per capita of your nation? • What is the potential GDP per capita of your nation? • What is the gap as a percentage? • Which leader is in charge of bridging this gap of potential future wealth? A seminal characterization of intellectual capital for organizations is as follows: it is what an organization’s participants know that gives the organization a competi- tive advantage relative to others in its marketplace (Stewart, 1991). In a similar vein, IC is knowledge that can be applied to yield value (Edvinsson and Sullivan, 1996). IC can be seen as roughly accounting for the difference between an organi- zation’s market value and its book value. Understanding, guaging, and cultivating this difference is a major issue for leaders of organizations (and of nations). One approach to doing so is found in the IC Navigator I developed at Skandia. The Navigator is a management and reporting approach that furnishes a per- spective encompassing both the financial capital and intellectual capital of an or- ganization (Edvinsson and Malone, 1997; Edvinsson and Grafstrom, 1998). It is a model that structures, packages, and measures IC as a guide for management and knowledge worker activity. It sees IC as including human capital and structural capital. The former involves the knowledge and skills of an organization’s partici- pants. The latter concerns all other organizational capabilities and traits that sup- port the work of these participants. As a structure for IC management, Navigator C. W. Holsapple (ed.), Handbook on Knowledge Management 1 © Springer-Verlag Berlin Heidelberg 2004
  • 2. 154 Leif Edvinsson helps orient the setting of objectives and guide the performance of knowledge workers in terms of five focus areas: financial, customer, human, process, and re- newal/development. To these, it also adds global context. The remainder of this chapter concentrates on the intellectual capital of nations and adapts the Navigator model in doing so. 2 The New Wealth of Nations “Only knowledge will give us the opportunity to create a better world with a global economy in which we all will be able to share our limited resources in the best ways,” says Lars Larsson of Ericsson. Former Oticon chief Lars Kolind poses a simple challenge: “Find out how nations may develop their countries into com- petence countries.” Still another challenge is to develop a map of regional intellec- tual capital, instead of the old agricultural and industrial maps of societies, often found in regional planning offices. The key mapping dimension should be situated around the quest for finding Where is wealth created in our region/country? A new political leadership agenda is evolving around the IC of nations with the focus on: • how to visualize IC of nations • how to cultivate IC of nations • how to capitalize into wealth of nations According to the Organization for Economic Co-operation and Development (OECD, 2001), the countries with knowledge-intensive activities will be the win- ners of future wealth. In the OECD report, the 30 member countries are scored ac- cording to IC investments such as R&D, education, patents, ICT, and so forth. As summarized by the Financial Times and Dagens Industri, the list of top potentials for future wealth looks like this: 1. Switzerland 2. Sweden 3. USA 4. Ireland 5. Netherlands 6. Hungary 7. Canada 8. Belgium 9. UK 10. South Korea In the knowledge economy, the value of corporations, organizations, and indi- viduals is directly related to their intellectual capital. But spread the net little wider and you begin to understand the possibilities. Think of nations. If intangibles are important to organizations, they are also important to the productivity and com- petitiveness of individual nations. How can we understand the dynamics of intan- gibles at work on a national scale? Can corporate longitude be translated into a new perspective on national performance?
  • 3. The Intellectual Capital of Nations 155 3 Corporate Longitude The logic of corporate longitude is based on a little story from early 1700s (Edvinsson, 2002). Then, the British Navy could not navigate with precision east-west, but only north-south. Consequently, the 18th century ships were lost in the fog, like today’s analysts of only financial capital. So today, we are facing the problem of accounting in much the same way, as for example in the case of Enron. The problem of the longitude found its solution, not by the professionals in the Navy, not by the academics at universities, but by a knowledge outsider – a watchmaker by the name of John Harrison. He innovated the east-west measure- ment approach that solved the longitude problem. To get a deeper understanding of wealth creation, it is essential to have such a lateral perspective. The latitude of stapling assets into a balance sheet, with a traditional bottom line is too narrow. A lateral accounting is necessary to include the intangibles and the non-financial as- sets of knowledge creation, networks, and relationships. The longitude logic is fo- cused on sustainability, lateral, outside, and interactive value-creating dimensions of intangibles. The new space of wealth of organizations, as well as nations, is in the interaction space of human capital and structural capital resulting in financial prosperity (see Figure 1). So, a nation’s wealth can be visualized in a map of both financial wealth as well as intellectual capital. Furthermore, the elements of IC form the enablers and drivers for financial wealth. So, from a leadership perspec- tive, the strategic development focus should be on the IC components of a nation (as illustrated in Figure 2 and described in section 4). Currently, organizations as well as societies are like 18th century ships charting their positions with only north-south navigation tools. Plotting a course solely from historical financial wealth reference points leaves them blind to the lateral horizon’s opportunities and novel perspectives. Lost on a turbulent sea of change, without a lateral navigation tool to guide them, they cannot navigate the uncharted expanse of a networked world where value is derived primarily from intangible rather than tangible assets. Profit measurement and reporting systems emphasize efficiency and cost con- trol, using money as the basis of decision making. This ongoing obsession with planning and charting progress against tangible indicators of wealth will ulti- mately impoverish society and devalue the wealth of nations, because they over- look the contribution of intangibles. For example, public service sector activities are automatically undervalued because there is no way to measure their contribu- tion, so we lose talent from the system, because they search for more lucrative openings elsewhere. Adding value in the knowledge economy is inextricably linked to radical change in both societal assumptions and business models. Capitalism may not create value if it is obsessed with competition to the detriment of collaboration. Social values must be re-considered in the light their value generation potential. For example, allocating resources to education, health and social services, and communication infrastructure should not be based on cost, but on the potential for value creation through knowledge. If employment in private industry is only about
  • 4. 156 Leif Edvinsson External Relations Internal Capacity and IT Renewal, Development & Innovation Financial Perspective Human Capital Tangibles Intangibles Global Context Figure 1. IC Navigator for Nations 25% of total potential mind value of the society, leveraging the rest of it more ef- fectively depends on education and opportunity. Research suggests that educa- tional systems have a high degree of explanatory value in national wealth rank- ings, so efficient resource allocation would mean they should receive much larger elements of funding than currently they do. Infrastructure is extremely essential too. Think about which cities and countries are truly poised for value creation? It won’t be those that isolate themselves, or those with a poor communication infrastructure. Primarily, they will be ones that are well connected, with an infrastructure designed to encourage access to the knowledge and human resources that create new value. Arab countries tradition- ally have relied on oil as the source of wealth, so intellectual capital represents only 20% of their wealth. If they don’t start navigating for the future in terms of renewal through education, making relationships with other countries, and infra- structure for networking, then their wealth is set to decline.
  • 5. The Intellectual Capital of Nations 157 4 IC Reporting of Nations The evolution is in progress. IC reporting of nations is already happening. Indeed, it was as long ago as 1986 that a voluntary pilot study was launched in Sweden to look at intangible assets. National statistics now increasingly cover intangibles, but they are mostly related to manufacturing companies with over 500 employees (OECD, 2001). Then, in 1987, a group met to discuss the area of intangibles. They met on Kon- rad Day, 12 November, and became known as the Konrad Group. This group in- cluded Karl-Erik Sveiby who soon went on to do pioneering research for his Ph.D. and to write about customer capital, structural capital, and human capital as the three categories of knowledge capital. From the Konrad Group emerged the proto- typing work on intellectual capital at a corporate level at Skandia. At the same time, another parallel cluster of IC pioneers emerged in the U.S.A. including, among others, Debra Amidon, Tom Stewart, Larry Prusak, and Juanita Brown. In 1991, Skandia appointed me as the world’s first Director of IC to develop another logic for the renewal of Skandia. Results of this work included a refined taxon- omy, measurement and accounting systems for IC, as well as innovation systems for IC. In 1996, Sweden announced the “Year of Innovation” and the Skandia Future Center was established. As leader of that Future Center, I invited Caroline Stenfelt from the University of Stockholm and some student colleagues to prototype how our work on IC at Skandia could be translated to a national stage (Edvinsson and Stenfelt,, 1998; Rembe and ISA, 1999). The first IC of nations was born due to her pioneering work, labelled as “Welfare and Security.” Later, she organized the Vaxholm Summit – the First International Meeting on Visualizing and Measuring the IC of nations, held in August 1998. As a result, the Swedish government adapted Skandia’s Navigator to visualize its national intellectual capital. Later, countries such as Israel, Holland and, in particular, Denmark, began to visualize their respective intellectual capitals. Sweden was an interesting nation on which to prototype this thinking. “Sweden appears to be a showplace for the theory of intellectual entrepreneurship,” says the country’s Invest in Sweden Agency, ISA. The ISA was the first national investment organization to apply the latest knowledge of intellectual capital to assess and compare national competitiveness and performance. “Intellectual capital forms the root of a corporation – and of a nation – that supplies the nourishment for future strength and growth. A new ana- lytical method enables these previously unevaluated resources to be assessed and compared. This can be an important tool for selecting an international location for knowledge-based companies. Sweden offers highly attractive and competitive in- tellectual capital assets – assets of superior value for leading edge companies,” said ISA’s 1999 Annual Report. In fact, the Skandia Navigator was easily translated from the corporate to na- tional environment, yielding the structure shown in Figure 2. Its focuses remained intact, but it covered a range of different issues:
  • 6. 158 Leif Edvinsson • Financial Focus including per capita GDP, national debt, the mean value of the US dollar • Market Focus including tourism statistics, standards of honesty, balance of services, balance of trade, balance of trade in intellectual property • Human Focus including quality of life, average age expectancy, infant survival rate, health levels, education, level of education for immigrants, crime rate, age statistics • Process Focus including service-producing organizations, public con- sumption as a percentage of GDP, business leadership, information tech- nology such as personal computers connected by LAN’s, survivors in traffic accidents, employment • Renewal and Development Focus including R&D expenses as a percent- age of GDP, number of genuine business start-ups, trademarks, factors important to high school students. As all the statistics on the country’s capital show, Sweden has embraced technol- ogy with enthusiasm. According to one survey, Sweden is the leading IT country in the world. This has not happened overnight. There has been long-term govern- ment support for technology – tax-breaks for employees buying a computer, fol- lowing on from initiatives such as free Internet access for students and earlier pro- grams to give children access to PCs. It has shaped an infrastructure and structural capital for future wealth. One of the most striking IC elements in Swedish management is its interna- tional networking perspective. When it comes to producing global companies, Scandinavia is remarkably successful – the only worthwhile European comparisons are with Switzerland and, perhaps, the Netherlands. Its companies transcend boundaries in ways few others can manage. Internationalization is in the Swedish genes. We are modern knowledge Vikings. Exports account for 40 percent of Sweden’s GDP. In addition, Sweden has a positive trade balance in intellectual property – indeed the value generated by music royalties is equivalent to the in- comes generated by Saab. Sweden also has the highest rate of musical literacy. Investments in intangibles constitute around 20 percent of GDP. According to the above-mentioned OECD report in October 2001 Sweden is among the leading na- tions in the knowledge-based economy. Sweden also has one of the highest R&D per capita investments in the world. Very interesting research in the area is being done by Nick Bontis. Based on the above mentioned model and sponsored by the United Nations Development Pro- gram, he and his colleagues have studied ten Arab States. In this study, he quanti- fies the state of IC for these nations and launches an “IC Index for Nations” that can be used for ranking as well as benchmarking learning between nations. It is only by looking at such statistics through a holistic knowledge lens, like the IC Navigator for nations, that they can make overall sense. Otherwise, they appear to be idiosyncrasies. By looking at the IC wealth of nations rather than standard measures of national competitiveness, we gain new insights into where a country’s strengths and weaknesses might lie. We can then nourish social innova- tion, society entrepreneurship, and social innovations (McElroy, 2000, 2002a, 2002b, 2002c).
  • 7. The Intellectual Capital of Nations 159 National Wealth Financial Wealth Intellectual Capital Human Capital Structural Capital External Relations Capital Domestic Organizational Capital Innovation Capital Process Capital Other Intangible Assets Intellectual Property Figure 2. IC Value Scheme In the Bontis research case, it can so far be concluded that the following ingredi- ents, in the stated order, are key areas for the political agenda to shape the IC of nations: 1. National agenda for Renewal, Research and Development (i.e., Innova- tion Capital) 2. National agenda for Education (i.e., Human Capital) 3. National agenda for Foreign Trade (i.e., Relationship Capital) 4. National agenda for Industrial Productivity (i.e., Process Capital) 5 IC in the World Sweden is not alone. At national levels, there is a great deal of activity in coming to terms with the power of intangible assets and the rise of intellectual capital. The Dutch Central Planning Office now has a Knowledge Economy Unit. Dutch initiatives include long-term analysis of the role of knowledge in the Dutch economy as well as other work on knowledge creation in networks and the avail-
  • 8. 160 Leif Edvinsson ability of human capital. See Dutch Central Planning Office at www.cpb.nl and Statistics Netherlands www.cbs.nl. The pan-European body Eurostat is taking the lead in developing statistical tools and techniques that enable a more full understanding of the knowledge econ- omy. “The transition from the industrial to the information society is characterized by the rapid growth of intangible assets, whereas economic and social activity still relies substantially on physical, tangible goods. The relation between the two has to be defined and measured,” says Eurostat (2000). In Israel, the country’s IC was published in 1998. Based on work of Edna Pasher, in close collaboration with Caroline Stenfelt, a variety of alternative measures have been added to those used in Sweden (Pasher, 1999). These include: • external debt • international events • openness to different cultures • language skills • teaching effectiveness • freedom of expression • entrepreneurship • risk-taking • venture capital funds • immigration and absorption • women in the professional workforce, • book publishing • museum visits • alcohol consumption • scientific publications. In Denmark progress is also being rapidly made. The country has long been at the forefront in examining the role of intangibles. Copenhagen Business School’s Jan Mouritsen has been working in the area for a number of years and has carried out several surveys and literature studies (Mouritson et al., 2001). At the beginning of 1998, Denmark launched a project looking at intellectual accounting under the umbrella of its broader initiative “Ledelse, Organization og Kompetence – LOK” which aimed to help transform Denmark from an industrial to a knowledge economy. A special Competence Council was organized with Lars Kolind as chairman. This has produced interesting work on Denmark’s position in the new global knowledge competition. In 2000, the Danish government also pub- lished guidelines for Intellectual Capital Statements – akin to those produced by Skandia (Danish Ministry of Industry, 2001). A Danish law is now in progress to support these various initiatives. In 2002, the Danish Ministry of Industry also in- augurated a Future Centre called Mind Lab. Intellectual capital is also making an impact in the Netherlands. Its Minister of Economic Affairs recently observed: “The Netherlands is rapidly developing into a knowledge-intensive economy… It is therefore strange that financial accounts are dominated by information on buildings and machinery, in other words the
  • 9. The Intellectual Capital of Nations 161 ‘classical’ or physical production factors. The value of knowledge – the R&D work, training, intellectual property, etc. – is not easy to identify in accounts. And that is in fact the reason why young knowledge-intensive businesses in particular have very great difficulty in finding external financiers.” The Dutch government’s shift has been one from having an emphasis on tech- nology to emphasizing innovation. In 1998, it published a report, “The Immeasur- able Wealth of Knowledge,” which found that in excess of 35 percent of Dutch national investments were of an intangible nature. Another nation strongly transforming itself into the knowledge economy is Singapore. It has renamed its Ministry of Labour the Ministry of Manpower as well as spending decades building an impressive system of structural capital, es- pecially for IT and telecommunications. The effect on wealth is highly visible. Examining the intellectual wealth of nations is a major advancement. But fur- ther challenges exist on a number of other fronts as the true impact of the knowl- edge economy is beginning to be understood as a New Deal for New Wealth of Nations. These are summarized in the remainder of this chapter. 5.1 Knowledge Communities and Societies “Today we’re a society awash in networks, yet starved for community,” says Peter Katz, author of The New Urbanism. True communities built around knowledge are now emerging. Many of these are Web-based. In them, knowledge is free- flowing, restlessly criss-crossing the globe all day long. Furthermore, it is these infrastructures that can give leverage to human capital of societies. Unless we in- novate and prototype such new structures and delivery systems for health, work places, urban areas, and so forth, we might erode the important human capital and get an increasing society cost for burn outs and brain stress. 5.2 Society Entrepreneurship Society entrepreneurship is a new, interesting concept emerging in Norway, among others (Nordisk Industrifond, 2002). It highlights a role for society renewal that is in the space between business community and society. It is a space for col- laborative prototyping based on the structural capital from each partner, but lever- aged by the individual human capital and innovative talent. The challenge is to get a turbo-charge on the existing IC of societies, or in other words increasing the turbo or productivity on existing knowledge investments . A kind of IC in waiting to be tapped by challenging society entrepreneurs. Whom would you like to nominate as one among the top ten society entrepreneurs of today – for shaping tomorrow? 5.3 Knowledge Cities and Harbours Intellectual capital can also have an impact on city planning. Planners must now create the context in which knowledge workers can be their most productive. This may bring about radical changes in the way our urban environments are con-
  • 10. 162 Leif Edvinsson ceived. Think of a harbour. Traditionally, harbours used to be for the flow of goods. But as the value of logistics has declined, we have to look at the flow of knowledge. We need to create knowledge harbours. After all, closeness to water is important for knowledge workers. It is calming – all Japanese gardens have a wa- ter feature for this very reason. 5.4 Knowledge Universities These, you may think, already exist. But, in many ways, people are now effec- tively “dis-educated” for the future: they are not prepared for the challenges that will arise. Universities need to be re-configured to fit changing times. At the mo- ment, future learning is not taking place in universities; it is mostly taking place outside in industry. It still takes four years to receive a Ph.D. Why? Learning needs to be accelerated. Otherwise, there is a tremendous inefficiency and oppor- tunity cost for knowledge workers. 6 Key Message The wave of IC is increasing. It has gathered within it universities, accounting standards groups, political and business communities. The message is that we need to surf the wave of knowledge economics or drown. It is a leadership liability not to address the potential or IC in waiting. The opportunity is great (Amidon, 2002). There are a great many people who are lost at sea, lost in the fog of the labour market, the stock market, or confused by the political world. They need to understand corporate longitude; otherwise, they will continue to go around in befuddled circles. Knowledge navigation will continue on the quest for the new wealth of nations. Links for further reading related to intellectual capital include the following: www.corporatelongitude.com www.isa.se www.oecd.org/publications www.entovation.com www.kmcluster.com www.bontis.com www.minez.nl www.ll-a.fr/intangibles/ www.cbs.nl www.efs.dk/icaccounts www.monday.dk
  • 11. The Intellectual Capital of Nations 163 References Amidon, D., Entovation 100: Worldwide Knowledge Leadership, 2002, URL=http://www.entovation.com/momentum/entovation-100.htm. Danish Ministry of Industry, Guidelines for Knowledge Accounts, 2001, URL=www.efs.dk Edvinsson, L., Corporate Longitude, Stockholm: Bookhouse, 2002. Edvinsson, L. and G. Grafstrom, Accounting for Minds, Stockholm: Skandia, 1998. Edvinsson, L. and M.S. Malone, Intellectual Capital: The Proven Way to Estab- lish Your Company’s Real Value by Measuring Its Hidden Brainpower, New York: Harper, 1997. Edvinsson, L. and C. Stenfelt, “IC at the National Level,” University of Stock- holm, 1998. Edvinsson, L and P. Sullivan, “Developing A Model for Managing Intellectual Capital,” European Management Journal, 14, 4, 1996, 356-364. Eurostat, “Statistical Indicators for the New Economy,” 2000, URL=http://europa.eu.int/en/comm/eurostat/research/retd/sine.pdf McElroy, M.W., “Second-Generation Knowledge Management,” 2002a, URL=http://www.macroinnovation.com/papers.htm McElroy, M.W., “Social Innovation Capital,” 2002b, URL=http://www.macroinnovation.com/papers.htm McElroy, M.W., “The Principle of Sustainable Innovation,” 2002c, URL=http://www.macroinnovation.com/papers.htm McElroy, M.W., “The New Knowledge Management,” 2000, URL=http://www.macroinnovation.com/papers.htm Mouritsen, J., H.T. Larsen, and P.D.N. Bukh, “Intellectual Capital and the Capable Firm: Narrating, Visualising and Numbering for Managing Knowledge,” Accounting, Organizations and Society, 26, 2001. Nirdisk Industrifond, Oslo, 2002, URL=www.nordicinnovation.net OECD, OECD Science, Technology and Industry Scoreboard: Towards a Knowledge-Based Economy, 2001, URL= http://www1.oecd.org/publications/e-book/92-2001-04-1-2987/ Pasher E., “A Look to the Future: The Hidden Values of the Desert,” Tel Aviv: Pasher & Associates, 1999. Rembe, A. and ISA, Invest In Sweden Agency Annual Report, 1999, URL= www.isa.se/pdf/SocwareDesignCluster_2001.pdf Stewart, T.A., “Brain Power: How Intellectual Capital Is Becoming America's Most Valuable Asset,” Fortune, June 3, 1991.