The Commission’s Report on the Intangible Economy

[Extracts]

Summary.

The Economy Has Changed

Intangible assets have now become the key success factor of developed economies.

The economy has changed. In a few years, a new component emerged as a decisive driver of economic growth: intangible assets. During the postwar economic boom, economic success was primarily based on the availability of raw materials, manufacturing industries, and the amount of physical capital. This remains true, of course. But increasingly less so. Today, true wealth is not concrete anymore, but abstract; it is not tangible, but intangible. The ability to innovate, to create concepts, and to produce ideas have now become the crucial competitive advantage. Physical capital has been superseded by intangible capital as the key criterion of economic vitality, or, in other words, by human capital, knowledge and education, or intangible assets.

There has been an obvious shift. Thirty years ago, being a leader in the automotive industry was first and foremost a matter of achieving the best in terms of technical criteria, for instance in terms of engine displacement. Today, it is the brand, the concept, the after-sales service, or the degree of integrated technology that are the critical success factors in the industry. Labor organization is subject to a new international division: production shifted to countries with low labor costs and developed countries specialized in cutting-edge technologies, designing service and product offerings, concept creation, as well as design. Every single industrial sector, from semiconductors to textile, software, and telecommunications are now making intangibles the key to their future. The value of organizations is increasingly dependent on intangible factors, which sometimes happen to be quantifiable and sometimes less so—for instance, their trademark or patent portfolio value or the creative ability of their teams.

To understand this change, we expand on three disruptions that have been impacting the world economy for the past twenty years or so. First, the growing importance of innovation, which has become the main driver of developed economies. … Second, the massive development of information technologies paves way for considerable opportunities to reorganize production and refocus on higher-value-added activities. Finally, the service sector in developed countries continues expanding, and these economies are increasingly dependent on the service economy, where ideas, brands, and concepts play a crucial role. In the background, two other trends in the developed world—globalization and financialization—help companies refocus on activities that create the most added value, i.e., non-physical activities.

These three shifts impact all developed economies. In every single one of them, the economic weight of industries that are specialized in intangible goods and services is on a constant increase.

France’s Strengths And Weaknesses

France is failing to take stock of this change and to draw the necessary conclusions and is therefore addressing the challenge of the intangibles from a weak position.

In this intangible economy, the most successful countries will be those that prove the most capable of attracting and developing talent—that is to say, in concrete terms, to have the very best education and research potential and to encourage innovation as widely as possible, in the private sphere as well as in the public one. … Nations will be increasingly assessed based on education, research, and innovation. These happen to be criteria for which France has major and deep-rooted shortcomings. Some of these vulnerabilities are now well known. Such is the case of our higher education system, which is burdened by an organization that nurtures failure at a massive scale and makes our universities invisible in the global arena. Our overworked national research system is also flawed and suffers from the inadequate exploitation of its research outputs. Revenues from intellectual property thus represent three to five percent of the research budget in the United States (depending on the year), compared with only one percent in France.

Other weaknesses are more obscure but nevertheless also impede the positioning of France in the intangible economy. Generally speaking, our structures work well as far as established companies are concerned, but to strengthen France’s innovation potential would require every possible effort to encourage younger companies to expand. … These start-ups or small businesses are also those that suffer the most from the rigidities in organization of labor and labor regulations. …

It is unrealistic to believe that France will continue being a major player in the world economy without addressing these weaknesses. We are in fact at a turning point. The speed at which broadband Internet developed in France, the dynamism of French tech entrepreneurs, the increasing number of researchers leaving to work abroad, and the international reputation of French brands all show that our country is brimming with talent and ideas. By failing to tackle difficult, but inevitable, reforms, we run the risk of not making best use of our human capital and letting other economies take advantage of it.

Making France a Leader of the Intangible Economy

In the new economic game, we have the strengths and resources that are necessary to score points: we do have plenty of gray matter, but we lack raw materials and financial capital. Let us make no mistake: the intangible economy will be the highest source of national growth in the twenty-first century. It is there that wealth and job creation will occur.

Rather than to put our potential to waste, let us develop it and make the best of this new growth driver. … But to do so, we need to change a number of things: our reflexes, the scale at which we operate, and our models.

Changing Our Reflexes

Increasing the volume of intangible assets, both private and public, is an imperative of economic policy. To achieve this, we need to abandon some of our reflexes that impede the development of intangible assets instead of fostering them.

The first reflex that we must get rid of is protecting established situations. In many areas facing technological change, we wonder how to protect what exists today when we should first be trying to make the most of change. In doing so, we are holding back the development of new activities and new jobs. The music and online gaming industries are two recent examples of this type of reaction. The State also fails to use its ability to regulate and to grant rights of access to activities or scarce resources that could support innovation and the development of new businesses. On the contrary, as evidenced what happened with the radio spectrum, regulated professions, and copyrights, the State maintains a sort of “interior protectionism.”

The proposals of the Commission aim to break the power of this rent-seeking temptation and to give innovation and creation a fair chance. For this, the Commission proposes a few changes in copyrights and related rights that aim to boost creation and to offer to creators a fair compensation. The Commission proposes in particular to avoid the indefinite extension of related rights of content producers and the issue of orphan works. It also considers it necessary to improve the management of intellectual property rights for the benefit of creators. …

The second reflex that must be abandoned is that of overly focusing on established businesses, and in particular to the largest ones, when SMEs are in fact as large, or larger, potential sources of productivity and growth. For the Commission, this will involve in particular redirecting grants for research and financial support to innovative SMEs and broadening the scope of expenditures that are eligible for R&D tax credit to better take innovation into account.

Finally, the last reflex to correct concerns the way in which we conceive of public assets: we must stop considering that the only assets the State owns are real estate. On the contrary, we should actively foster the development of intangible assets, which will not only result in additional budgetary resources but above all bolster the growth potential of the French economy. Public patents, professional licenses, rights of access to the public domain, cultural trademarks, the know-how of public bodies, especially universities, public data—these intangible assets are not sufficiently utilized. …

Scaling Up

Intangible assets know no borders nor administrative boundaries. They circulate freely on the entire surface of the planet through digital networks and those who create them now have almost complete autonomy to settle in the place that seems to be the most favorable to them. This volatility is a factual situation that must be taken into account when conducting economic policy. There are now questions that can no longer be dealt with effectively at the national level and that demand a response that is necessarily located at the European or often even at the international level.

The protection of ideas should be managed at the European level, where the issue of the preservation of the quality of the patent system rests. In this regard, the Commission considers that France should launch a political re-foundation of the European Patent Office and, in addition, to quickly ratify the London Protocol, which makes it possible to improve the protection of ideas of French and European companies at a low cost, without weakening our position. But the Commission suggests to go a step further and to allow patents that are filed in France to be valid in every country of the European Union. It considers in this respect that it is crucial for France to initiate the relaunch of the Community Patent project. In addition, the quality of the legal protection of ideas would be improved by the creation of a specialized jurisdiction for intellectual property issues.

Just as much as ideas, trademarks must be protected and this protection only makes sense at the international level. Just as France spearheaded the creation of the Financial Action Task Force (FATF) to combat financial criminality at the international level, it could head an international grouping bringing together developed and emerging economies in order to effectively combat counterfeiting and piracy.

Finally, let us consider taxation. At a time when a growing share of consumption happens over the Internet, European governments see their main resource, the value-added tax, increasingly weakened and harder to collect. Indeed, how can tax authorities ensure than companies that are increasingly virtual and that sell online services will fulfill many of their obligations and really collect VAT from their customers? To limit risk levels and avoid spiraling into harmful tax competition on a central tax in all European taxation systems, the Commission recommends that France launch an initiative to reshape the European VAT system.

Changing Models

… The Commission considers that France must urgently draw on what works elsewhere. Let us not reject progress and advances simply because they have been imagined elsewhere.

France can no longer afford not to increase the resources allocated to higher education. But this will not be enough. A reform of the very structures of the French system themselves is indispensable. This calls for the consecration of the autonomy of academic institutions. …

France must thoroughly renovate the organization of public research. … We must also realize that the intangible economy is disrupting our tax system. Even if the priority must first be given to the development of intangible assets rather than to their taxation, the shift of value on the balance sheet from physical assets to intangible assets will make it inevitable, in the longer term, to engage in a reflection on the future changes in the tax bases.

Going into more depth, we are entering an era that is different to the previous one, which was based on standardized industrial processes. We had regulations and labor organization that were well-suited to this situation. There is no doubt that it is now necessary to adapt them so that creation, innovation, and activities continue to materialize.

Finally, the intangible economy is a systemic economy that operates as a network and that does not operate within the boundaries of time and space. These two fundamental concepts are the backbone of our social and economic legislation, which creates constraints and precautions that hinder wealth and job creation. Deep reforms are needed to prepare France for this new economy as it is the only one that will be capable of generating growth in a world of upheaval where low-paying jobs shift away from our country.

Intangible assets could very well be the driver and power source for a stimulated economy and be the source of growth that we lack. For that, it is necessary to creatively and boldly transform our society and to think differently. The intangible offers the opportunity of a real transformation of the French economy”.

An Emerging Economic Model

An Economy that is Harder to Predict

The intangible economy is characterized by a high level of uncertainty and risk due to the importance of innovation. …

Unlike physical or financial assets, … it is much more difficult for companies to monitor their intangible assets. IP protection in its different forms (patents, trademarks) is often only temporary and cannot always prevent others to misappropriate ideas or innovations, or to usurp or challenge patents.

The other uncertainty arising from the very nature of intangible assets lies in the difficulties related to their exploitation. … The absence of transparent and liquid markets, contrary to what exists for most financial and physical assets therefore causes a permanent uncertainty about the price and the value of these assets.

In addition, unlike a physical investment, which generally retains some residual value, albeit a low one, intangible investments can be entirely lost if the innovation they have brought about is not successful or is a commercial failure. This situation further increases the degree of uncertainty, compounded by the fact that the intangible economy requires potentially very high investments and fixed costs. …

Another risk and uncertainty factor in the intangible economy is linked to the innovation process as such and its consequences on the way companies operate. Indeed, initially innovation leads to “temporary monopolies” and generates highly discriminative network effects and first-mover advantages, which, per se, make competition particularly intense and the probability of failure quite high. But, in a second phase, the innovation process shakes the very foundations of these temporary rent situations, thus putting all competitors roughly on the same level.

The intangible economy has increasingly marked network effects. … Companies must therefore take into account these network effects that can both reduce risk, when the company is located in the heart of the network, or, on the contrary, strongly increase it, when it comes to competing with a company that benefits from them. …

The combination of these different effects leads to fairly high-risk innovation market entry processes given that companies must first face extremely high fixed costs (R&D, advertising, and the such) to quickly penetrate the market, with the risk that a faster competitor already occupies a very strong, or even exclusive, position, and without the possibility to recover at least a part of its investment in the event of failure.

The Paradoxes of the Intangible Economy

The Paradox of Intellectual Property

Intellectual property occupies a central place in the intangible economy. In effect, in an economy where ideas take precedence over the rest, where it is innovation that creates value, it is normal that economic actors seek to protect these ideas … In fact, there has been a multiplication of the use of legal instruments intended to protect this intellectual property, including patents and trademarks. …

Nevertheless, IP protection appears increasingly fragile and complex to implement … organizations find it much harder to prevent their products from being copied and their innovations from being plundered by other producers … the low costs of replication associated with new dissemination techniques greatly facilitate the piracy of works and dematerialized products, in disregard of applicable rules in terms of intellectual property.

At the same time, the fact of erecting barriers that hinder the movement of ideas or innovations does not always make economic sense and, in many cases, this circulation is precisely what gives birth to new ideas and new innovations. …

Such is therefore the paradox of the intellectual property in the economy of the intangible: by protecting the dividends of innovation, intellectual property underpins this economy, but in the face of the acceleration of intellectual exchanges and the development of networks, IP becomes increasingly fragile. …

The Paradox of an Economy that is Both Competitive and Collaborative

As Schumpeter has shown in the early 20th century, innovation provides a momentum of competition: it bolsters newcomers, challenges established positions, causes less efficient organizations to disappear, and requires all actors to adapt to the new technological deal. …

We have seen that intangible economy was based on significant fixed costs, whether of R&D or advertising, and that the possibility of then monetizing these fixed costs is far from obvious. This explains why organizations sometimes share the burden of these intangible expenditures with several partners by pooling resources, even though the dividends of the innovation that will be brought about by this collaboration will have to be eventually shared. …

… A final advantage in sharing expenses and pooling resources is avoiding being excluded from a market due to network effects. Competing companies may therefore find an obvious interest in collaborating to define a common standard together from which they will each create their own range of products. …

The Paradox of “Free Value”

Another one paradox of the intangible economy is the coexistence between very strong value creation … and an underlying trend towards free services and open source, that is to say, the provision of knowledge and technologies free of charge and free of rights. Most information and content that is disseminated on the Internet is open access and free of charge. But we also find, in a certain way, this trend in the development of free newspapers. …

In many cases, this goes a step further and organization provide access to a product or service (software, telephony…) to users free of charge. The most emblematic of the open source model is certainly the Linux operating system. In addition to the community of IT professionals who independently take part in improving the operating system and developing new applications, it should be noted that very large companies such as IBM, Hewlett Packard, and Intel have invested heavily in Linux even though they will not directly derive any income from it. …

… This attitude, which may seem paradoxical for private enterprises, can be explained in several ways. First of all, there is the desire to generate a network effect. By making a product or a service free of charge, companies can expect massive buy-in and use. The company will then be able to sell complementary services … The other advantage is that this type of offer, which provides users with the opportunity to improve the content, also helps stimulate innovation and the creation of new products and services, which may then be recovered and “monetized” in one way or another by the company.

The Paradox of the Transformation of Work

In its most optimistic version, the typical worker of the intangible economy has one of the “higher” functions of the service sector: they belong to the category of “symbol manipulators,” in the words of the former U.S. Secretary of Labor, Robert Reich. These individuals conduct activities at the heart of the innovation process: their role is to juggle with ideas, concepts, knowledge, … This typical worker is a university graduate and has no difficulty to develop their career internationally in a globalised economy. …

… Their status is not as well-defined as in the industrial economy: they may be an employee of a large enterprise or a start-up, a freelance consultant, a researcher, an academic, and so on. All the same, to the extent that it constitutes a key element of the innovation process, this uncertainty is a driver of freedom rather than a source of insecurity. …

This vision is naturally both idyllic and a caricature. Unfortunately, and even if the issue is indeed to boost the number of such individuals in our society, not all the labor force will be able to become “symbol manipulators.” … These rather positive developments go along with other trends that negatively impact employment hardship and workers’ health: … reporting, … quality standards, … constant contact with management via computers or mobile phones. …

The transition from an industrial economy to an intangible economy based on services therefore has a relatively ambiguous impact on labor and the way it is organized. Certainly, it allows individuals to consider work opportunities that are more interesting and diverse, and less painful and fragmented that in Taylor’s “Scientific management” of labor. At the same time, the new forms of organization generate their own hardship and their own constraints while certain tasks that are particularly difficult have all but disappeared.

From Creation to Creativity

When one thinks of the intangible, research, patents, and more generally technological innovation first spring to mind. … It should not be forgotten that there is also another category of intangible assets: the whole field of the intangibles that have to do with the imaginary. This covers a range of activities, concepts, and sectors, which include cultural and artistic creation in the broadest sense, design, advertising, brands, etc. All these elements share a common feature: they are based on the idea of creation and creativity, which, in a sense, constitute the counterpart to the concept of innovation in the field of technology. …

Beyond the direct and indirect impact of cultural creation on the economic activity, it plays a new role in the intangible economy, by feeding and stimulating the creativity of other sectors. Artistic and cultural creation and heritage are becoming in a sense “intermediate inputs” for other sectors, which draw on them for inspiration, references, and images for the construction of intangibles of the imaginary. Artistic activities thus make “a large number of references in terms of signs, forms, colors, symbols, etc” available to other sectors.

… To understand the economic importance of cultural activities, the government of the United Kingdom uses the concept of “creative industries”, “those industries which have their origin in individual creativity, skill and talent and which have a potential for wealth and job creation through the generation and exploitation of intellectual property.” In the intangible economy, the creative capacity of a nation thus becomes a key issue in terms of competitiveness.

… This importance of creativity for all economic sectors has become one of the key aspects of economic and industrial policy in many Western countries.

… Many countries—Scandinavian countries, Finland, South Korea, Ireland, New Zealand, Singapore, Canada, Australia, Italy, and the United States—have put in place policies promoting design and creativity in the world of business. These policies, which are in many cases carried out at the regional level and in which industry professionals are usually closely involved, have common features: new centers of excellence are established, training/education is developed, SMEs are targeted by awareness-building initiatives, international promotion is supported, etc.

… High fashion remains the showcase of the French fashion industry.

… The fashion industry largely fosters the intangibles of the imaginary and identification, brand, and image strategies are key. Fashion companies therefore invest massively in advertising and marketing in order to enhance their image and their brands. (But) France has not yet fully put the intangibles on the economic policy agenda.

Published in Stream 01 in 2008.