Adjusted capital share: Meaning, Criticisms & Real-World Uses

Adjusted Capital Share is a concept within National Income Accounting that modifies the traditional measure of the income share accruing to capital to account for previously unmeasured or misclassified forms of capital, primarily intangible assets. This adjustment aims to provide a more comprehensive understanding of how economic output is distributed between capital and labor in a modern economy. While conventional measures of capital focus heavily on tangible assets like machinery and buildings, the adjusted capital share expands this view to include investments in areas such as research and development, software, brand equity, and organizational capital. The objective of calculating an adjusted capital share is to gain a more accurate picture of capital's contribution to an economy's total income, particularly as economies transition towards knowledge-based industries where intangible assets play an increasingly significant role in driving economic growth.

History and Origin

The concept of an adjusted capital share gained prominence as economists and statisticians recognized that traditional National Income and Product Accounts (NIPAs) were increasingly falling short in capturing the full scope of investment in modern economies. Historically, expenditures on items like research and development (R&D) or software were often treated as intermediate expenses rather than capital investments in macroeconomic data. This accounting practice meant that the returns generated by these valuable, but non-physical, assets were not consistently attributed to capital income.

A seminal work that significantly advanced the understanding and measurement of intangible capital was the research by Carol Corrado, Charles Hulten, and Daniel Sichel. Their 2006 NBER working paper, "Intangible Capital and Economic Growth," demonstrated that including a broader range of intangible investments in the capital stock could substantially alter the measured rates of productivity and economic growth.¹⁴ This work highlighted that when these intangibles were properly categorized as capital, they not only boosted measured output growth but also revealed a significant shift in the allocation of income towards capital. Subsequently, the Federal Reserve Board also published research emphasizing how the inclusion of these intangibles affects the labor share of income, suggesting a lower and more downward-trending labor share than conventionally reported.¹³ This academic work has spurred ongoing discussions and efforts by international bodies like the International Monetary Fund (IMF) and statistical agencies to refine their frameworks for measuring intangible capital.¹²,¹¹

Key Takeaways

Adjusted Capital Share accounts for a broader range of capital, particularly intangible assets, providing a more complete picture of income distribution.
It reclassifies investments in areas like R&D, software, and brand equity from current expenses to capital formation.
This adjustment often leads to a higher estimated share of national income accruing to capital and a correspondingly lower labor income share.
The concept is crucial for understanding economic growth and productivity in modern, knowledge-intensive economies.
It highlights the evolving nature of capital in an increasingly dematerialized economic landscape.

Formula and Calculation

The adjusted capital share is not typically represented by a single, fixed formula like a simple ratio. Instead, its calculation involves a re-estimation of the total capital stock and its corresponding income. The core adjustment focuses on moving certain expenditures from being classified as intermediate consumption (expenses) to investment (capital formation) within the framework of national accounts.

Conceptually, the capital share is the proportion of total income (or output) that accrues to capital. In a simplified model, if Y is total output, and ( K ) represents capital (both tangible and intangible), then the income to capital is ( rK ), where ( r ) is the rate of return on capital. The capital share ((\alpha)) can be expressed as:

\alpha = \frac{\text{Capital Income}}{\text{Total Income}} = \frac{rK}{Y}

When calculating the adjusted capital share, the key change lies in the expanded definition and measurement of ( K ). This involves:

Identifying Intangible Investments: This includes expenditures on research and development (R&D), software, databases, artistic originals, organizational capital (e.g., management practices, firm-specific human capital), and brand equity.
Capitalizing These Investments: Treating these expenditures as investments that build up a stock of intangible assets rather than as immediate costs.
Estimating the Stock of Intangible Capital: Using methods like the perpetual inventory method, similar to how tangible capital stocks are estimated, to build up a measure of the accumulated value of these intangible investments over time.
Attributing Returns: Assigning a portion of the total income (or value added) to the returns generated by this newly recognized intangible capital, alongside the returns to tangible capital.

The inclusion of these reclassified investments increases the measured capital stock ( K ) and, consequently, the portion of national income attributed to capital, thus increasing the adjusted capital share.

Interpreting the Adjusted Capital Share

Interpreting the adjusted capital share provides crucial insights into the evolving structure of modern economies. A higher adjusted capital share, compared to traditional measures, suggests that a larger portion of a nation's economic output is generated by, and accrues to, capital, rather than labor, once intangible assets are fully accounted for. This perspective is particularly relevant in economies where knowledge, innovation, and digital services are dominant drivers of value creation.

When the adjusted capital share is calculated, it often reveals a trend of increasing capital's claim on income over time. This trend contrasts with the perception from unadjusted figures, which might show a more stable or even declining capital share. The difference highlights the importance of correctly identifying and measuring all forms of capital. For investors, understanding the adjusted capital share can inform decisions by highlighting the growing importance of companies rich in intangible assets. For policymakers, it can influence discussions on income inequality, taxation, and policies aimed at fostering economic growth through investment in innovation and knowledge. It underscores that what constitutes "capital" in the 21st century extends far beyond physical plant and equipment.

Hypothetical Example

Consider a hypothetical country, "Innovia," which produces two main types of goods and services: traditional manufacturing (reliant on physical capital and labor) and cutting-edge software development (reliant on human capital and intangible assets).

In its traditional national accounts, Innovia measures its total income at $10 trillion. Under this traditional accounting, the capital share (attributable to physical capital) is calculated as 30%, or $3 trillion, with the remaining 70% ($7 trillion) going to labor income.

However, Innovia's statisticians decide to implement an adjusted capital share calculation. They identify that companies in the software sector spend significant amounts on developing proprietary algorithms, training specialized engineers (which builds human capital), and creating unique intellectual property—all of which were previously expensed as current costs.

Upon re-evaluating these expenditures, they determine that $1 trillion annually, previously treated as an expense, should actually be considered investment in new intangible assets. They calculate that this newly recognized intangible capital generates an additional $500 billion in annual income that accrues to capital owners.

With this adjustment:

Total income remains $10 trillion (the sum of all income generated).
The newly recognized capital income from intangibles is $500 billion.
Total capital income becomes $3 trillion (from physical capital) + $0.5 trillion (from intangible capital) = $3.5 trillion.
The adjusted capital share is now ( \frac{$3.5 \text{ trillion}}{$10 \text{ trillion}} = 35% ).
Consequently, the labor income share implicitly falls to 65% ($6.5 trillion).

This example shows how reclassifying expenditures on intangibles can lead to an increase in the measured capital share, reflecting a more accurate depiction of capital's contribution to the economy.

Practical Applications

The concept of an adjusted capital share has several practical applications across economic analysis, policy-making, and financial markets:

Improved Economic Measurement: By reclassifying significant expenditures on intangible assets as investment, the adjusted capital share provides a more accurate measure of a nation's capital stock and its contribution to Gross Domestic Product (GDP). This refinement helps in understanding the true drivers of economic growth and multifactor productivity (MFP). For instance, the inclusion of intangibles can make capital deepening a more dominant source of labor productivity growth.
¹⁰ Understanding Income Distribution: The adjustment often reveals a lower labor share and a higher capital share of income than traditional statistics suggest, which is crucial for analyzing trends in income inequality and wealth concentration. This shift is particularly pronounced since the 1980s, influenced by factors like the rising importance of software and R&D.,
⁹⁸ Policy Formulation: Governments and central banks can use the adjusted capital share to better tailor policies related to taxation, intellectual property rights, and incentives for innovation. If intangible capital is a growing source of income, policies might shift to encourage investment in these areas.
Investment Analysis: For investors, recognizing the adjusted capital share underscores the growing importance of companies with strong intangible assets (e.g., brands, patents, data, organizational capital). These assets, though often not fully reflected on traditional corporate balance sheets, can be significant drivers of long-term value and returns to capital.
International Comparisons: As more countries adopt advanced methodologies to measure intangible capital, the adjusted capital share facilitates more meaningful cross-country comparisons of economic structure and performance. International bodies like the IMF continue to explore methods for better measuring intangible capital in official statistics to support investment and taxation policy.

⁷## Limitations and Criticisms

Despite its advantages in providing a more comprehensive view of capital's role, the adjusted capital share concept faces several limitations and criticisms:

Measurement Challenges: The primary challenge lies in accurately measuring intangible assets. Unlike tangible assets, intangibles are often difficult to quantify, value, and track. Defining what constitutes an "intangible investment" can be ambiguous, and data collection remains challenging, especially for assets like organizational capital or brand equity that are not actively traded in markets. This difficulty leads to ongoing debates and variations in estimation methodologies across different studies and statistical agencies.,
⁶*⁵ Conceptual Ambiguity: There can be debates about whether certain expenditures truly represent investment that yields future returns or are merely current expenses. For example, some argue that while software development is clearly an investment, some forms of advertising or employee training might have shorter-lived benefits, blurring the line between expense and capital formation.
Impact on Labor Share Interpretation: While an adjusted capital share provides a more accurate picture of capital income, it concurrently implies a lower labor income share. This can fuel discussions about rising inequality, though some economists argue that a portion of what is classified as capital income from intangibles (e.g., returns to human capital embedded in software) might still reflect returns to skilled labor. The decline in the labor share has been linked to factors like technological change and market concentration, with the accounting treatment of intangibles playing a role.,
⁴*³ Data Availability and Comparability: Comprehensive and consistent data on intangible investments are not uniformly available across all countries or time periods. This limits the ability to construct universally comparable adjusted capital shares, making global analysis challenging. As the World Intellectual Property Organization (WIPO) notes, many intangible asset types are still not recognized as investment under national accounting frameworks, and existing data often suffers from gaps.

²## Adjusted Capital Share vs. Labor Share

The adjusted capital share and labor share are two complementary measures that together explain the distribution of national income between the factors of production: capital and labor. Traditionally, the capital share represents the portion of income accruing to owners of physical capital (e.g., factories, machinery), while the labor share represents the portion going to wages, salaries, and benefits for workers.

The confusion arises because of the evolving nature of capital in modern economies, particularly with the rise of intangible assets. When these assets (like software, R&D, and intellectual property) are treated as traditional expenses in standard national accounts, their contribution to income is effectively misattributed. This causes the traditional capital share to be underestimated and, by residual, the labor share to appear higher than it would be if these intangible investments were properly capitalized.

The key difference with the adjusted capital share is its explicit reclassification of these intangible expenditures as investment. This reclassification shifts a portion of what was previously considered labor or intermediate expense into capital income. Consequently, when the capital share is "adjusted" to include these intangibles, it typically increases, while the measured labor income share decreases. This distinction is vital for accurately understanding how economic value is generated and distributed, particularly as industries become more knowledge-intensive. The debate around the declining labor share, for example, is heavily influenced by how intangible capital is accounted for.

¹## FAQs

What is the primary purpose of adjusting the capital share?

The primary purpose is to provide a more accurate and comprehensive measure of the income accruing to capital by including intangible assets (like software and R&D) that are crucial for modern economic growth but were traditionally not fully recognized as capital in national accounts.

How does the Adjusted Capital Share relate to GDP?

The Adjusted Capital Share is a component of how Gross Domestic Product (GDP), which represents total economic output, is distributed among different factors of production. By better measuring capital's contribution, it refines our understanding of GDP's composition.

Why is it important to consider intangible assets when calculating capital share?

Intangible assets like research and development, software, and brand value are increasingly significant drivers of productivity and value creation in today's knowledge economy. Failing to account for them means missing a substantial portion of the economy's true capital base and misrepresenting how income is shared between capital and labor.

Does an increased Adjusted Capital Share necessarily mean less income for workers?

An increased adjusted capital share implies that a larger portion of total income is attributed to capital. Mechanically, if total income remains constant, this would mean a smaller residual share for labor income. However, this doesn't necessarily mean individual workers are earning less, but rather that the overall slice of the economic pie attributed to the "capital" factor has grown, reflecting the enhanced role of intangible assets in production.

Is the Adjusted Capital Share widely adopted in official statistics?

While the concept is gaining traction and some intangible assets (like software and R&D) are now included in official National Income and Product Accounts (NIPAs) in many developed economies, a full and consistent adoption across all potential intangible assets is still an area of ongoing research and development for national statistical agencies.