Money Matters

Intellectual capital

Money Matters
By Sirajuddin Aziz
Mon, 05, 21

Perhaps the worst management myth is that Human Resources, either at the corporate level or the country level cannot be measured. The truth is, it can be measured, but only if the senior management does not glance over the human resource function from too far away.

Introduction

Perhaps the worst management myth is that Human Resources, either at the corporate level or the country level cannot be measured. The truth is, it can be measured, but only if the senior management does not glance over the human resource function from too far away.

In a typical board room environment, we remain glued looking at statistics relating to return on investments, earnings per share, dividend payouts, and growth forecasts. In the determination of the organisation’s vision and future direction and to have strategies to stay ahead of the competition or even a new venture, it is astonishing to find many within the entity, who survive on the premise that they will through a brick and mortar presence conquer the markets. It is not even considered that no action plan can ever succeed without the participation of the critical factor of human resources.

Human resources

Human resource is the single most significant non-quantifiable asset that eventually gives quantification to businesses and organisations. For which reasons, it does not take long for competitors to poach the best resources and this resource jumps the ship with invaluable knowledge capital that cannot be retrieved. In consideration of this possible loss of human capital, it is extremely important for the senior management to conceptually estimate the worth of Intellectual Capital (IC) that is housed in an individual.

Knowledge economy

The coinage of “knowledge economy” gained currency with the appearance of the newly industrialised countries of North and Southeast Asia; these countries recognised that economic development was dependent upon the acquisition of unique traits, skills, and knowledge for its human resource. They put the concept of knowledge economy to best use; later it was adopted by several other Asian nations, to the degree that it is today more cliché than effectively real.

But, the concept of knowledge economy brought forth, the importance of human capital. The human resources of either an entity or a country, if properly educated, skilled, and trained becomes the single most important fourth factor of production.

Human capital theory

What is the Human Capital Theory? Most economists and management scientists agree that it is the ‘resources’ available to individuals or groups. The conversion of raw material to saleable commodities is often referred to as ‘physical capital’.

The acquisition of relevant academic recognition, backed by practical experience, with an intent to raise personal earnings, both current and future, is the major assumption surrounding the human capital theory. The centrality here is that the most outstanding objective and purpose of education, is the enhancement in productivity, to supplement economic growth. Thus the cornerstone of the theory is that the combined stock of skills, knowledge, competencies, and personal traits go towards the creation of intrinsic and measurable value, ie, it views individuals as constituents of their economy.

This view of human capital is myopic, constricting, and limiting in its scope. It is so said, because it fails to recognise the non-quantifiable benefits that accrue from an informed and trained human resource base. This aspect impairs the ‘cultural capital’ of the entity.

Knowledge assets - intellectual capital

A fourth component added to factors of production, is the availability of knowledge assets. The promotion of a knowledge-based economy has promoted recognition of ‘intellectual capital’, as a key resource for the firm’s sustainable competitive advantage (Gregorio Martin-de-Castro, Pedro Lopez-Saez, and others, Journal of Business Ethics (2011) vol 98: 649 – 622).

Knowledge assets are in the realm of intangibles, but recognising it as capital, renders it an economic status. The gaps in valuation between market and book value, are attributable to the non-quantifiable nature of intangible assets.

The theory that humans are to be classified as capital remained undeveloped till about the beginning of the 20th century. This notion of human capital was first introduced by Adam Smith, the 18th-century economist (Wealth of Nations).

Human capital (HC): Human capital essentials is a sum total of the sub-classes of capital including; cultural capital, social capital, economic capital, and symbolic capital.

IC - Investment or expenditure

Theodore W Schultz, The American Economic Review, Dec 1961, vol. 51, Nos 5, pp 1035 - 39, discusses in detail on whether education is an expenditure of consumption or is it an investment?

For basic education, no parent looks at associated costs as “investments”, they are hence a consumptive expenditure; but economic motivations to pursue careers, by attending medical schools, dentistry schools, law schools, engineering schools, etc can be looked at as an investment in education, for the promise it holds out, to improve or enhancing earnings. The theory reduces the status of being a human into monetary or economic beings (units).

A measurement tool developed in the 1980s, at a Swedish financial services company - Skandia, quoted by Edvinsson & Malone (1997), page – 11, defines ‘Intellectual Capital (IC)’ as ‘those dimensions beyond the human capital that were left behind when the staff went home’.

IC – It’s intangible nature

The measurement of the intangible purely in accounting terms, to be recognised as additional capital, is difficult, because the notion is still in its nascent stage. IC has two broad elements; human capital and structural capital.

Human capital captures ‘knowledge developed and stored in entity’s employees’, on the other hand, structural capital captures i) organisational capital; which covers, culture, knowledge, formal and informal and tech capital - stored in the technology of the entity which is ‘responsible for making available products and services’; ii) customers / relational capital which captures relationship an entity has with its clients which also covers relationship with social aspects.

Reacting to Harry G Schaeffer's views on human capital theory, Theodore asserts, that if this view only means that knowledge about economic returns accruing from investments in human capital, in terms of future earnings, should not be the exclusive basis for public policy decisions in making the expenditures for education, we are in full agreement.

Education substantially improves the capacities of individuals with a definitive positive impact upon future earnings.

IC includes the stock or funds of knowledge, intangible assets, and ultimately resources and capabilities, which allow for the development of basic business processes of the organisation, enabling the achievement of ‘competitive advantage’.

Dean & Kretchmer (2007) reviewing a vast body of literature have come up with some significant characteristics of IC: Tradable, cheap to reproduce, socially and contextually embodied knowledge; closely related to social capital, dominating as a means of production; transfer cost hard to calibrate, etc.

IC - Sample examples – (banking and telecom)

These two industries best reflect the importance of knowledge-based workers and within the overall context of IC.

Bank A and Bank B, have a similar capital base, almost alike balance sheets, the physical assets of branch layout are not too dis-similar, in fact, all things are equal; but in terms of reputational capital, relating to services, ethics, morality, etc, Bank A scores better than Bank B. Why? All because of the composition of the human capital. The earlier institution caters to hiring knowledge assets, while the other pays scant attention to IC. The HR factor, is one major determinant of their opposite reputation.

Similarly, two cellular operators, with almost alike capital base and both with credentials of possessing excellent human resources/capital (knowledge assets) have different financial results and different perceptions in the market, in terms of quality of service. One has an excellent technology platform, the other has a weak technology base and hence the difference that emerges in service quality. Lack of organisational capital, which includes a subset of tech capital, is the cause of different results.

Conclusion - case for Pakistan

Pakistan is blessed with a youthful population. These are potential assets; they are in need to be quickly converted into knowledge assets (acquisition of skills, education, traits, etc by way of focused learning and development activities) and finally get to be recognised for possessing intellectual capital, which is in reiteration a sum total of human capital, relational / client capital, and structural capital, (technological capital plus organisational capital).

In conclusion, focus on the development of IC should be the primary concern of the economic managers of the country.

The writer is a senior banker and a freelance columnist