Friday, July 27, 2012

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 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 CapitalMarket CapitalProcess CapitalRenewal Capital
Skilled laborCorporate TaxBusiness competition environmentBusiness R&D spending
Employee trainingCross-border ventureGovernment efficiencyBasic research
Literacy rateCulture opennessIntellectual Property Right protectionR&D spending/GDP
Higher education enrollmentGlobalizationCapital availabilityR&D researchers
Pupil-teacher ratioTransparencyComputers in use per capitaCooperation between universities and enterprises
Internet subscribersImage of countryConvenience of establishing new firmsScientific articles
Public expenditure on educationExports and Imports of servicesMobile phone subscribersPatents 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:
NoCountryIC ScoreIC rankIC+FC ScoreIC+FC rank
5United States27.64537.525
18New Zealand22.831832.1918
19United Kingdom22.51932.1119
21South Korea20.042129.2821
28Czech Republic17.982827.1427
31South Africa15.413123.7831
* 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 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.
NoCountryIC RankIC+FC rankElectricity consumed/capita (KWh) Electricity consumption rank
5United States55128746
18New Zealand18189404.968
19United Kingdom19195789.9122
21South Korea21217299.0216
28Czech Republic28275835.420
31South Africa31314493.6727

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.