By Robin Lynch
In my latest discussion paper for ESCoE, published today, I make the case for classifying payment for access to intellectual property as property income rather than service payments.
Why does this distinction matter and what are the consequences of getting this wrong for the measurement of our economy?
Intellectual property is ideas. Examples are stories, plays, computer algorithms, designs, and inventions. They are all creations of the human mind. They are recognised as economic assets, and play an ever-increasing role in the modern economy.
They satisfy the key attributes of economic assets – they provide benefits over a long time, they can be owned, and can generate cash for their owners by allowing others access to them.
But intellectual property has crucially different attributes from what was once the main form of capital assets – machinery, buildings, ships, etc. Intellectual property is not produced through the usual economic production process of using inputs of labour, capital and other goods and services. Ideas are conceived in the human mind with no such production, and they do not wear away through use. They are intangible; they have no physical form, unlike the tangible assets of machinery etc.
Because of this intangibility, ideas have to be protected in order for ownership to generate income. This protection can be a legal patent, which described the idea in detail and prohibits others using the idea, unless permission through agreed payment for access is made. Or the detail of the idea can be kept secret and used internally by a company.
A simple example is a story conceived by an author, published in book form and a price charged to customers for the privilege of owning a book and reading the story. The book can be described as an access device to enable the story to be read. It is important to differentiate between the story and the book. The book is tangible, and as it is read it suffers wear and tear and so diminishes in value. But the story is undiminished by access – it is shared, not used up.
Both tangible and intangible assets can lose value over time due to obsolescence – other assets appear in the market which are preferred and so the price paid for using or accessing the original asset is reduced.
Given the range and high value of current intellectual property such as drug specification, computer games, and social media search engines and platforms, it is vital that the associated transactions in the economy are classified and measured correctly.
When measuring the economy, payments for renting of assets are of two types. The first type is a payment to use the asset which reflects both wear and tear through use, and obsolescence. So for example the rent payable for renting a building will reflect the wear and tear of the building through use, and be classed as a service payment in the national accounts.
The second type of payment does not represent a use of the asset which results in wear and tear, but is simply for permission to access the asset. A typical such payment in the past was for the rent of natural land. As this land was not produced through an economic production process, and taken to be unchanged at the end of a year due to nature’s bounty, so no wear and tear was experienced, payments were classed as rent – as property income.
The same principles for payments of access to land apply to payment for access to intellectual property. The ideas are not produced, and do not wear away – they are unchanged in form after access. The payments for access to the idea should be recorded as property income. This was the treatment before the 1993 international standard for national accounts (the SNA).
But the latest standard (SNA 2008) classifies payments for access to intellectual property as service payments – the intellectual property is considered to be produced and suffer real degradation over time. The payments to use the asset are therefore classified as service payments, and contribute to the measure of GDP, the most quoted measure of economic production. Classifying the payments as property income transfers, with no real change to the asset, means that they do not figure in GDP, but do contribute to national income (GNI) through international transactions.
A major reason for believing that intellectual property is produced (as opposed to created with no economic transactions involved), is that the further development of different access devices directly produces a new version of the idea. But the development, although production, is not production of a new better idea, it is production of a new access device which enables refinement of the original idea to be considered. In the book example, the story is originally accessed through the first draft, which can be read and commented on by others (producing another access device which reflects a refined and hopefully enhanced story). The development (production of the new access device) is not the new story itself; it is production of another access device which enables the revised story to be considered.
The importance of this change in standards has been recently highlighted by an extraordinarily large upward revision to Ireland’s annual GDP growth for 2015. The growth rate has risen from 8% to 26%. This was largely due to a large software company moving its HQ location to Ireland, with a corresponding large increase in service payments in the form of exports from Ireland to the rest of Europe. This increased GDP. This is wrong – GDP should have remained unchanged, but the income of Ireland (GNI) should show the increase as property income from abroad.
This is not just an isolated case. The growing importance of intellectual property in our advanced economies makes it imperative that we come to grips with these discrepancies in classification and measurement. Today’s discussion paper sets out the case more fully and proposes a model for change.
ESCoE blogs are published to further debate. Any views expressed are solely those of the author(s) and so cannot be taken to represent those of the ESCoE, its partner institutions or the Office for National Statistics.