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Knowledge Assets in the Global Economy: Assessment of National Intellectual Capital

“Our government is filled with knowledge…We have 316 years' worth of documents and data and
thousands of employees with long years of practical experience. If we can take that knowledge, and place
it into the hands of any person who needs it, whenever they need it, I can deliver services more quickly,
more accurately and more consistently.”
From “Knowledge Management: New Wisdom or Passing Fad?” in Government Technology, June 99
Abstract
This article has the following objectives: developing the need for assessing knowledge capital at the
national economic level; review of a national case study of how intellectual capital assessment was done
in case of one nation state; suggesting implications of use of such assessment methods and needed areas
of advancement; and highlighting caveats in existing assessment methods that underscore the directions
for future research. With increasing emphasis on aligning national information resource planning, design
and implementation with growth and performance needs of business or nation, better understanding of
new valuation and assessment techniques is necessary for information resource management
policymakers, practitioners and researchers.
Keywords: National Intellectual Capital, Information Resource Management, Knowledge Capital,
Intangible Assets, Structural Capital, Human Capital
Introduction
Emergence of the service society after the last world war brought increased realization of role of
employees’ knowledge and creativity in adding value to the company. Attempts to capitalize company
investments in people on the balance sheet in the 1970s failed because of measurement problems. The
subject gathered increased interest more recently in the 1990s, with the rapid emergence of information
and communication technologies (ICT). As business processes became increasingly ‘enabled’ by
large-scale information systems, information systems designers attempted to capture employees’ implicit
and explicit knowledge in “corporate memory” by means of intranets and other similar applications
(Malhotra, 2000a, 2000b).
It was recognized, that in contrast to the knowledge of individual employees, such corporate memory
does form part of a company’s capital. Accordingly, “knowledge” has become a key production factor,
however the financial accounts are still dominated by traditional factors of production, including
buildings and machinery. Hence, there is an imperative need for developing an understanding of
“knowledge capital”, or the so-called intangible assets. The topic is not only pertinent to individual
enterprises, but also to national economies that are making a rapid transition to a society based on
knowledge work. This article develops the case for assessment of national intellectual capital by drawing
upon existing research, practice and a recent study of an Asian nation representative of countries making
a transition from ‘developing’ to ‘developed’ status. The issues discussed herein are important for
information resource management policymakers, practitioners and researchers for assessing their
contributions in terms of new measures of performance. More importantly, as the world economies
transition from the world of “atoms” to world of “bits,” they would be expected to plan, devise and
implement information and knowledge management systems that provide differential advantage in terms
of ‘intellectual capital.’
Knowledge Assets and Intellectual Capital
Traditional assessment of national economic performance has relied upon understanding the GDP in
terms of traditional factors of production – land, labor and capital. Knowledge assets may be
distinguished from the traditional factors of production – in that they are governed by what has been
described as the ‘law of increasing returns’. In contrast to the traditional factors of production that were
governed by diminishing returns, every additional unit of knowledge used effectively results in a
marginal increase in performance. Success of companies such as Microsoft is often attributed to the fact
that every additional unit of information-based product or service would result in an increase in the
marginal returns. Given the changing dynamics underlying national performance, it is not surprising that
some less developed economies with significant assets in ICT knowledge and Internet-related expertise
are hoping to leapfrog more developed economies.
Despite increasingly important role of knowledge-based assets in national performance, most countries
still assess their performance based on traditional factors of production. Today’s measurement systems
are limited in their capability to account for tacit knowledge embedded in the human resources, although
there is some agreement on measuring other categories of knowledge, including patents and trademarks.
However, the emerging knowledge economy is characterized by industries that are more knowledge
intensive and by goods and products that are more intangible than they were in the post-industrial
economy. Knowledge assets or intellectual capital may be described as the “hidden” assets of a country
that underpin its growth, fuel its growth and drive stakeholder value. There is increasing realization
about knowledge management as the key driver of national wealth, the driver of innovation and learning,
as well as that of the country’s gross domestic product (GDP). Increasing importance of knowledge
assets and intellectual capital have been drawing greater attention of not only company CEOs, but also
national policymakers, to non-financial indicators of future growth and performance.
Knowledge asset measurement relates to the valuation, growth, monitoring and managing from a number
of intangible but increasingly important factors of business success. In the context of knowledge assets,
knowledge represents the collective body of intangible assets that can be identified and is measurable.
This interpretation of knowledge differs from the notion of knowledge as knowing and learning, which
concerns how organizations acquire, share and use knowledge – either helped or hindered by technology
and organizational processes. In contrast, the notion of knowledge assets is about the identifiable aspects
of the organization that although “intangible” can be considered as adding some kind of value to it.
Knowledge capital is the term given to the combined intangible assets that enable the company to
function. Examples of such knowledge assets could include shared knowledge patterns and service
capability and customer capability.
Assessment of Knowledge Capital and Intellectual Assets
The worth of knowledge assets, taking the difference between market and book values as a proxy, is
hidden by current accounting and reporting practices. However, as evident from current valuations of
many Net-based enterprises, one observes a significant widening gap between the values of enterprises
stated in corporate balance sheets and investors’ assessment of those values. The increasing proportion
of intangible vis-?-vis tangible assets for most industrial sectors has been affirmed by various other
observations (Edvinsson and Malone, 1997; Hope and Hope, 1997; Stewart, 1995). In case of major
corporations, often such high market valuations are attributed to brands. Recent business history has
shown that huge investments in human capital and information technology are the key tools of value
creation that often do not show up on company balance sheets as positive values themselves.
Measurement of institutional or organizational value in the current business environment using
traditional accounting methods is increasingly inadequate and often irrelevant to real value in today’s
economy. For instance, while traditional accounting practices often treat brand as depreciable entity over
time, in today’s economy, intangible assets like brands and trademarks often increase in value over time,
often longer than the time periods accounted for their depreciation. Even, specific kinds of valuations of
intellectual capital, such as patents, copyrights and trademarks are not valued according to their potential
value in use, but recorded at registration cost. Similarly, the distinction between assets and expenses is
made arbitrarily on many balance sheets: an advertising campaign could be recorded in either column as
evident from a case such as that of AOL. The traditional balance sheet, a legacy of last five centuries of
accounting practices, provides a picture of historic costs, assuming that the cost of purchase reflects the
actual value of the asset. However, it does not account for the hidden value inherent in people’s skill,
expertise and learning capabilities, the value in the network of relationships among individuals and
organizations or the structural aspects relevant to servicing the customers. These hidden values or
intangible assets assume increasingly important role in an economy that is characterized by a transition
from ‘programmed’ best practices to ‘paradigm shifts’ that characterize the new business world of
‘re-everything’ (Malhotra, 2000c). Such factors are assuming greater importance in assessment of the
potential for future growth of an enterprise or a national economy.
This issue is compounded by an apparent paradox: the more a company invests in its future, the lesser is
its book value [although the recent astronomical caps for various Net-related stocks suggest increasing
realization about intangible assets]. Extrapolating the case of such companies to the organizations within
a national economy, one may understand the implications for accounting for intangible assets that do not
show up in accounting reports, but may underpin their future success or failure.
Valuation from the perspective of intellectual capital and knowledge assets takes into consideration not
only financial factors, but also human and structural factors (Stewart, 1997). Stewart defines intellectual
capital as the intellectual material that has been formalized, captured, and leveraged to create wealth by
producing a higher-valued asset. Intellectual capital is defined as encompassing: i) human capital; ii)
structural capital; and iii) relational capital. These aspects of intellectual capital include such factors as
strong business relationships within networked partnerships, enduring customer loyalty, and employee
knowledge and competencies. The compelling reasons for valuation and measurement of intellectual
capital and knowledge assets include understanding where value lies in the company and the sectors of
the national economy and for developing metrics for assessing success and growth of companies and
economies.
Measuring Knowledge Assets and Intellectual Capital
Managers of enterprises and national economies are trying to find reliable ways for measuring
knowledge assets to understand how they relate to future performance. The expectation from finding
reliable measures of knowledge assets is that such measures can help managers to better manage the
intangible resources that increasingly determine the success of the enterprises and economies.
The terms knowledge capital and intellectual capital are used synonymously in this article. Within the
scope of subsequent discussion, such terms refer to “the potentiality of value as it exists in various
components or flows of overall “capital” in a firm; the relationships and synergistic modulations that can
augment the value of that capital; and the application of its potential to real business tasks… [it] includes
an organization’s unrefined knowledge assets as well as wealth generating assets whose main component
is knowledge” (Society of Management Accountants of Canada 1999, p. 17).
One may observe that it is the application of intellectual capital to practical situations that contributes,
primarily, to the translation of its potential value to financial assets. Or as observed by Stewart (1997, p.
67): “Intelligence becomes an asset when some useful order is created out of free-floating brainpower –
that is, when it is given coherent form (a mailing list, a database, an agenda for a meeting, a description
of a process); when it is captured in a way that allows it to be described, shared, and exploited; and when
it can be deployed to do something that could not be done if it remained scattered around like so many
coins in a gutter.” Unless effectively utilized and applied, knowledge assets may not necessarily yield
any returns in terms of financial performance measures. In other words, “knowledge assets, like money
or equipment, exist and are worth cultivating only in the context of strategy… you cannot define and
manage intellectual assets unless you know what you are trying to do with them” (Stewart 1997). [For
instance, a detailed account of how knowledge management is relevant to e-business strategy and
performance is presented in a forthcoming article (Malhotra 2000c).]
The subsequent discussion reviews the case of an Asian nation state that utilized one of the more popular
methods for assessment of its national intellectual capital. Concluding discussion will highlight the
existing caveats in the adopted methodology and underscore the important issues that need to be
addressed in future research and practice.
Knowledge Capital of a Nation State: The Case of Israel
The nation state of Israel, having been classified as an industrialized nation in April 1997, represents an
interesting case study for both less developed countries as well as industrialized nations. Having bridged
this gap over its recent past, it provides a vantage point for understanding the transition from both sides
of the industrial divide. Since 1950, Israel’s economy has grown 21-fold resulting in overall rapid
development resulting in significant growth in per capita income and an exponential increase in the
number of hi-tech start-up companies. These developments have occurred despite a population growth
of 330% and periodic wars that have impacted the region’s economies.
A popular method of assessment of intellectual capital originally proposed by the Swedish company
Skandia was recently applied to a joint Swedish-Israeli study that examined how to assess Israel’s
intellectual capital. The study represented the first attempt to document Israel’s core competencies, key
success factors and hidden assets that provide comparative advantage and high potential for growth. The
study compared Israel with other developed countries, [not developing countries] since the objective was
to assess the country’s ability to compete with other industrialized nations in the global economy. The
study aimed to develop an assessment of intellectual capital of the country, which along with the more
traditional focus on financial capital, could help in an integrated and comprehensive view of the nation’s
assets as well as its potential for future growth. The study used Skandia’s model for measuring
intellectual capital, a model that had been earlier used for developing the Intellectual Capital Balance
Sheet for Sweden.
Skandia Model for Measuring Intellectual Capital
In Skandia’s view, intellectual capital denotes intangible assets including customer/market capital;
process capital; human capital; and renewal and development capital. The value of intellectual capital is
represented by the potential financial returns that are attributable to these intangible or non-financial
assets.
The Skandia model attempts to provide an integrated and comprehensive picture of both financial capital
and intellectual capital. Generally, the national economic indicators supported by hard quantitative data
are used for examining the internal and external processes occurring in a country. However, the model
questioned if such indicators provided a full and accurate assessment of the country’s assets and if they
provide an indication of its potential for future growth. In doing so, it developed the framework of
intellectual capital as a complement of financial capital.
In this model, there are four components of intellectual capital: market capital (also denoted as customer
capital); process capital; human capital; and renewal and development capital. While financial capital
reflects the nation’s history and achievements of the past; intellectual capital represents the hidden
national potential for future growth. The value chain according to Edvinsson and Malone (1997, p. 11)
expresses the various components of market value on the basis of the following model:
Market Value = Financial Capital + Intellectual Capital
The key determinants of hidden national value, or national intellectual capital, are human and structural
capital, defined thus:
Intellectual Capital = Human Capital + Structural Capital
Human Capital: The combined knowledge, skill, innovativeness, and ability of the nation’s individuals to
meet the tasks at hand, including values, culture and philosophy. This includes knowledge, wisdom,
expertise, intuition, and the ability of individuals to realize national tasks and goals. Human capital is the
property of individuals, it cannot be owned by the [organization or] nation.
Structural Capital: Structural capital signifies the knowledge assets that remain in the company when it
doesn’t take into consideration human capital that is the property of individual members. It includes
organizational capital and customer capital [also known as market capital]. Unlike human capital,
structural capital can be owned by the nation and can be traded.
Structural Capital = Market Capital + Organizational Capital
Market Capital: In the context of the original model applied to market enterprises, this component of
intellectual capital was referred to as customer capital to represent the value embedded in the
relationship of the firm with its customers. In the context of national intellectual assets, it is referred to
as market capital to signify the market and trade relationships the nation holds within the global markets

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