A proxy indicator for the Intellectual Capital of nations

I recently came across the book “Intellectual Capital of Nations” by Prof. Leif Edvinsson and Prof. Carol Yeh-Yun Lin and their associated research paper titled “National Intellectual Capital: comparison of the Nordic countries” which I downloaded from www.corporatelongitude.com. Both the research paper and the book present a comparative study by the authors on the Intellectual Capital of 40 leading nations in the world. Based on the outcomes of their study, the authors arrived at the conclusion that the Nordic region consisting of the five countries of Denmark, Finland, Iceland, Norway and Sweden has the most Intellectual Capital per capital among any other region in the world, which includes amongst others industrialized regions such as North America and Western Europe and regions of the emerging economies such as Brazil, Russia, India and China.

A comparative study of the Intellectual Capital of Nations, even though limited to only 40 countries in this study, is no doubt very useful. It provides a macro level view of how countries are managing their intangible assets compared to one another. This information can be gainfully used by multiple target audiences such as Multi National Corporations, Global Investment Funds, Private Equity and Hedge Funds, Multi lateral lending agencies such as IMF and World Bank, and many other institutions for a variety of purposes, such as for making investment decisions. In an increasingly globalized world this information can be also used to determine which countries have a relative competitive advantage over other countries. Hence the question naturally arises, how did the authors go about making this interesting comparison?

As the authors describe in their paper, they first deliberated on the dimensions for representing the Intellectual Capital of countries and finalized four dimensions viz. Human Capital, Market Capital, Process Capital and Renewal Capital. Next, using a two step filtering process, they then identified seven indicators for each of these types of Capital as follows:

Human Capital	Market Capital	Process Capital	Renewal Capital
Skilled labor	Corporate Tax	Business competition environment	Business R&D spending
Employee training	Cross-border venture	Government efficiency	Basic research
Literacy rate	Culture openness	Intellectual Property Right protection	R&D spending/GDP
Higher education enrollment	Globalization	Capital availability	R&D researchers
Pupil-teacher ratio	Transparency	Computers in use per capita	Cooperation between universities and enterprises
Internet subscribers	Image of country	Convenience of establishing new firms	Scientific articles
Public expenditure on education	Exports and Imports of services	Mobile phone subscribers	Patents per capita

Thereafter the authors collected (perhaps painstakingly) data for these indicators for each of the 40 countries for a period of 12 years from 1994 until 2005 from the OECD database and the World Competitiveness Yearbook. Next they normalized the data where required and added one more dimension for Financial Capital to the existing four, represented by a normalized form of GDP per capita. They finally aggregated and tabulated their findings, a summary of which is presented below:

No	Country	IC Score	IC rank	IC+FC Score	IC+FC rank
1	Finland	29.47	1	39.03	1
2	Sweden	29.25	2	38.88	2
3	Switzerland	28.46	3	38.24	3
4	Denmark	28	4	37.69	4
5	United States	27.64	5	37.52	5
6	Singapore	26.8	6	36.65	6
7	Iceland	26.13	7	35.8	7
8	Netherlands	25.84	8	35.57	8
9	Canada	25.56	9	35.27	10
10	Norway	25.45	10	35.45	9
11	Australia	24.69	11	34.34	11
12	Austria	24.26	12	33.96	12
13	Japan	24.13	13	33.73	14
14	Ireland	24.08	14	33.78	13
15	Germany	23.86	15	33.48	15
16	Belgium	23.32	16	32.96	16
17	Taiwan	23.17	17	32.55	17
18	New Zealand	22.83	18	32.19	18
19	United Kingdom	22.5	19	32.11	19
20	France	21.64	20	31.24	20
21	South Korea	20.04	21	29.28	21
22	Malaysia	19.15	22	27.81	25
23	Hungary	19.06	23	28	23
24	Spain	19.03	24	28.5	22
25	Italy	18.36	25	27.9	24
26	Chile	18.27	26	26.97	28
27	Portugal	18.06	27	27.28	26
28	Czech Republic	17.98	28	27.14	27
29	Greece	16.53	29	25.89	29
30	Thailand	16.02	30	24.17	30
31	South Africa	15.41	31	23.78	31
32	Russia	15.09	32	23.66	32
33	China	15.06	33	22.55	36
34	Poland	14.83	34	23.6	33
35	Philippines	14.5	35	21.88	39
36	Turkey	14.43	36	23	34
37	Mexico	14.13	37	22.88	35
38	Brazil	13.98	38	22.41	37
39	India	13.7	39	20.66	40
40	Argentina	13.34	40	21.99	38

* IC = Intellectual Capital, FC = Financial Capital

While I consider this work as ground-breaking, two thoughts have troubled me since. Why has anyone not followed up on this work by extending it to more than the 40 countries studied here? And more importantly, why has anyone not updated the data on the 40 countries itself from 2006 onwards? The answer to the first question is provided partly by the authors in their paper itself, where they mention that they had to remove 7 additional countries from their list because of a large number of missing indicators. Hence, perhaps data for all the remaining countries will be even more difficult to find. As to the second question, the only answer that makes sense is perhaps the fact that fetching and compiling data for such a study is perhaps too time intensive and cannot be undertaken unless it is a sponsored effort. Incidentally, the authors do mention that their effort for this paper was sponsored.

As mentioned earlier, there is no doubt that a comparative Intellectual Capital ranking of nations can be highly useful to a variety of target audiences. The question that arises therefore is how we can obtain such a ranking without going through the rigor inherent in the method presented by the authors. Can we for instance, use a proxy indicator? In other words, can we identify a commonly available macro data point for nations on which the nations would have more or less the same rank as on their Intellectual Capital? Even if this indicator was not 100% accurate, it could be useful in providing us a quick and dirty ranking of the Intellectual Capital of Nations which would be enough for the purpose of most target audiences.

As I reflected on what such an indicator could be, I wondered whether it could be GDP/capita. But higher GDP/capita is a consequence of higher Intellectual Capital, rather than a cause. Could it then be flow of inward Foreign Direct Investment? But again, inward FDI would be a consequence of higher Intellectual Capital than being a cause. And then it struck me like a bolt. It had to be Electricity consumption/capita. After all, electricity is the root cause of all modern advancements and indeed is the cause for the birth of the knowledge era. Without electricity, our civilization would still be spending a bulk of its time on menial chores such as gathering wood and lighting fires for warmth and for cooking. Electricity has freed us up from these chores to such an extent that we can hardly imagine modern life anymore without it. About the only time we realize the importance of electricity in our lives is during a power outage when we have to start hunting for match boxes and candles to cut through the darkness and suffer through sweltering temperatures since we have been accustomed for years to the comfort of air conditioned residences and offices, all due to the miracle of electricity. In short, electricity has made human kind highly productive over the course of the past century. It has taken care of our routine mundane needs, freeing us for performing higher order activities. And that we have. I imagine that mankind has made more inventions in the past one century than in all of its existence prior to that. Isn’t that a phenomenal achievement? And isn’t it attributable mostly to the invention of electricity? If so, it stands to reason that the more electricity a nation consumes per capita, the more its population will be freed up for performing higher order activities and generate more Intellectual Capital in the process.

I had the hypothesis. The next step was for me to test it. On the one hand, I had the Intellectual Capital of Nations as of 2005 as described earlier. I had to correlate this with the electricity/capita of these countries as of 2005 and check whether I could establish a high degree of correlation between the two. If so, it would prove my hypothesis. I obtained the electricity/capita of these 40 nations from nationmaster.com and used the Excel RANK function to rank the consumption of these countries from 1 to 40. I placed these ranks alongside the IC and IC+FC ranks as shown below.

No	Country	IC Rank	IC+FC rank	Electricity consumed/capita (KWh)	Electricity consumption rank
1	Finland	1	1	15461	4
2	Sweden	2	2	14860.3	5
3	Switzerland	3	3	7833.7	11
4	Denmark	4	4	6281.41	19
5	United States	5	5	12874	6
6	Singapore	6	6	7828.55	12
7	Iceland	7	7	27470.9	1
8	Netherlands	8	8	6629.96	17
9	Canada	9	10	16725	3
10	Norway	10	9	24636.1	2
11	Australia	11	11	10812.1	7
12	Austria	12	12	7317.84	15
13	Japan	13	14	7624.4	13
14	Ireland	14	13	5792.12	21
15	Germany	15	15	6614.58	18
16	Belgium	16	16	7919.93	10
17	Taiwan	17	17	8805.26	9
18	New Zealand	18	18	9404.96	8
19	United Kingdom	19	19	5789.91	22
20	France	20	20	7417.08	14
21	South Korea	21	21	7299.02	16
22	Malaysia	22	25	3105.65	31
23	Hungary	23	23	3566.95	29
24	Spain	24	22	5599.32	23
25	Italy	25	24	5239.98	25
26	Chile	26	28	2964.7	32
27	Portugal	27	26	4388.85	28
28	Czech Republic	28	27	5835.4	20
29	Greece	29	29	4891.03	26
30	Thailand	30	30	1832.4	35
31	South Africa	31	31	4493.67	27
32	Russia	32	32	5446.02	24
33	China	33	36	1684.17	38
34	Poland	34	33	3154.69	30
35	Philippines	35	39	564.21	39
36	Turkey	36	34	1790.05	36
37	Mexico	37	35	1778.07	37
38	Brazil	38	37	1976.88	34
39	India	39	40	446.29	40
40	Argentina	40	38	2296.43	33

Next, I used the Excel CORREL function to find the Pearson correlation coefficient between the IC and IC+FC ranks with the Electricity consumption/capita ranks. I found that the IC v/s Electricity consumption ranks had a Pearson coefficient of 87.15% whereas the IC+FC v/s Electricity consumption ranks had a Pearson coefficient of 88.37%. Since by definition, any coefficient value above 80% signifies a strong correlation between the two sets, my hypothesis was proved.

Now that I have established that the Electricity consumption/capita can be used as a proxy indicator for ranking the Intellectual Capital of nations, it is straightforward exercise to check where the remaining nations rank on their Intellectual Capital. We just have to look at their Electricity consumption/capita. Moreover in the years ahead, we will perhaps be able to forecast how the Intellectual Capital ranking of nations will change by studying which nations are investing more into their energy infrastructure compared to their peers.

Intellectual Capital analysis of change in Indian IT Leadership

The top four Indian IT companies – TCS, Infosys, Wipro and HCL Technologies - have declared their results for the quarter ending March 2012. While TCS and HCL have surpassed analyst expectations, Wipro and especially Infosys have disappointed. The markets have been severely harsh on Infosys in particular, dropping it by about 13% in a single day on the 13th April when it declared its quarterly results. For a company which has been the face of Indian IT around the world for decades, this was quite the drubbing. It is the fifth straight quarter when Infosys has missed its own forecasts, a very unusual territory for this IT giant. Not without reason therefore, Infosys has lost its claim as the industry bellwether and leader of the Indian IT industry, a position that is now claimed unequivocally by TCS. In fact many analysts have downgraded Infosys further. JP Morgan has placed Infosys fourth in the pecking order behind TCS, Wipro and HCL Technologies. CLSA downgraded the scrip to ‘Underperform’ from ‘Outperform’ and Deutsche Bank revised it to ‘Hold’ from its earlier ‘Buy’ rating. Technology analysts have gone further. For instance, Mint published a full page article on Infosys recently in its newspaper asking whether Infosys’s dream run has ended. For a company that employs more than 150,000 people globally, this is a serious question that begs a deeper analysis. Let’s do that using Intellectual Capital as the basis.


Let’s look at TCS first. The Intellectual Capital analysis of TCS for the past four years can be seen online here. The Knowledge Basis portion of the analysis is reproduced in the chart below.

This chart depicts the Knowledge Basis of TCS for the past four years, measured every quarter. Knowledge Basis (KB) is just the ratio of the Intellectual Capital(IC) of the company to its Intrinsic worth (IW). In other words KB = IC/(IC+NW), where IW = (IC + NW) and NW represents the Net worth of the company. As can be seen from the chart, the Knowledge Basis of TCS for the past four years has been more or less steady around the 83% mark. This is another way of saying that 83% of all assets inside TCS are knowledge assets and this number has been more or less very steady over the course of the past four years.


Now let’s turn to Infosys – its Intellectual Capital analysis can be seen online here and its Knowledge basis chart is reproduced below.

We find in this chart that the Knowledge Basis of Infosys was also around the 83% level from Jun 2008 until Dec 2009. That is when it started sliding southwards, dropping to around 74% in Dec 2011 before recovering slightly to 76% in Mar 2012. Even counting the 2% rise in the latest quarter, Infosys is still down 7% from its own benchmark of 83%. Described in other words, this means that only 76% of all assets inside Infosys are Knowledge assets compared to 83% for TCS. Considering that Knowledge assets are significantly more productive than physical or financial assets, is it a surprise to anybody that Infosys has not been delivering stellar results lately? The decline started two years ago in 2010 and has continued steadily since then, although the latest quarter results have shown an uptrend.


This brings us back to the question – has Infosys’s dream run ended? For now, it certainly has. Considering the myriad organizational displacements inside the company recently, this was perhaps inevitable. But Infosys is far from being down and out. A Knowledge Basis of 76% is very healthy even if it is low compared to TCS. It implies that an overwhelming majority of all assets inside Infosys are still knowledge assets, explaining why the company generates more than Rs 1000 cr every quarter by way of Economic value. The good news now is that the market has given away its premium for Infosys stock and the stock is now trading around its fair value ever since its latest quarter results came out. In contrast, the market has taken a strong liking for TCS and has assigned it a premium of more than 30% of its fair value. Will TCS be able to live up to its favored status? Time will tell for sure. But one thing is clear in my mind, while TCS is certainly the better run business, if you had to choose between these two great companies for your investment portfolio, Infosys is the better stock to buy at the moment!