The long-term economic trend no one’s talking about


Jonathan Haskel is professor of economics and director of the doctoral program at Imperial College Business School. Stian Westlake is the adviser to the U.K.’s innovation and science minister and a senior fellow at Nesta, the U.K.’s national foundation for innovation. 

LONDON — Everyone knows who’s at fault for our economic and social woes. Inequality up? Greedy bosses. Productivity down? Crazy regulation. Disaffected citizens? Uncaring governments.

Sometimes, though, the longer-term trends in the economy get overlooked. In the mid-2000s, a quiet revolution occurred. For the first time, businesses in developed countries began to invest more in intangible assets — design, branding, research and development and software — than in tangible assets like machinery, buildings and computers.

Indeed, some very well-known companies are composed almost entirely of intangible capital. Uber, for example, owns none of its cars; its other tangible assets — offices and computers, for example — are minimal. But it does own very significant intangible assets — software and data. Accountants tend to favor tangible assets since valuing intangibles is so hard. Hence, as indicated by the title of our recent book, “Capitalism without Capital,” we have entered a new period of economic history.

The unique economic properties of intangibles

Business investment has changed constantly throughout history, from focusing on water mills to steam engines to computers. Why then should the change to intangible investment matter? Mostly because intangible assets have very different economic properties than tangible assets.

First, intangible spending is typically scalable. If a conventional taxi company wants to expand, it needs to buy more taxis — more tangible assets. If a rideshare company like Uber wants to expand, it just uses the same software it already has.

Second, intangible assets are typically “sunk,” meaning that they cannot be sold off. As an example, Symbian, the mobile software operating system written by Nokia, had 73 percent of the smartphone market in 2006. By the end of 2012, Nokia had lost almost all of its market share and was heading for bankruptcy. It had a major tangible asset in its Helsinki headquarters, Nokia House, which it promptly sold for $170 million. But it was unable to sell off the Symbian software.

Third, intangible assets potentially confer “spillovers” on others. Using cash generated from record sales by the Beatles, the British firm EMI invented the CT scanner, performed the first ever CT scan in 1971 in a London hospital and moved on to dominate the global market. General Electric quickly adapted and developed its own CT scanning technology, however, and by 1976, EMI lost its share in the U.S. market. This demonstrates how knowledge assets, unless specifically protected, can often easily be copied, thus conferring a spillover to another firm.

Finally, intangible investments tend to have synergies with one another, meaning they are more valuable together. The iPod was a combination of the MP3 protocol, the miniaturized hard disk, design and music licensing agreements. The microwave oven came from a marriage between defense contractor Raytheon — whose engineers accidentally discovered that microwaves from radar equipment could heat food — and white-goods manufacturer Amana, which had the design capacity.

The consequences of an intangible economy

So, what happens when an economy becomes increasingly intangible-intensive?

First, inequality. Spillovers are a force for equality: potentially everyone can copy a design or a business idea. But if intangibles are valuable in synergy with each other and can then be scaled, this is a force for inequality.

Inequality seems to be winning this race. The Organization for Economic Cooperation and Development has documented a growing divergence between the productivity of frontier and laggard firms. The scalable and synergy character of intangible assets is allowing frontier firms to expand. Coupled with the reluctance of accountants to value intangibles, frontier intangible-intensive firms appear to be sensationally profitable since they have very high sales but appear to have very little “capital.”

But the inequality has at least two other important dimensions. Those that possess intangible assets, such as talented writers, actors and computer programmers, and those managers and leaders who can organize and coordinate them, will be in great demand. Hence the rise in wages at the very top.

The other dimension is that spillovers and synergies abound in cities, which attract those who are creating and coordinating intangibles. This drives up urban property prices and also increases the cultural divide between cities and the rest of the country. City dwellers become more likely to vote for the openness that suits their economic interests: free trade in the U.S., for example, or against Brexit in the U.K.

Besides inequality, another consequence of an intangible economy is that while the frontier firms have continued to invest in intangibles since the Great Recession, the pace of overall growth in intangible investment has slackened, as uncertainty and an unfit financial system has scared the non-frontier firms away from investing. The overall slowed pace of intangible capital investment has created fewer spillovers and enables less scaling, thus slowing productivity growth.

Third, the intangible economy renders the conventional financial system increasingly redundant. Traditional financing of business investment is made via debt secured against tangible assets, like buildings. But banks and stock markets faced with sunk and uncertain intangible assets are less willing to finance investments. Venture capital to finance intangibles is hugely successful in places like Silicon Valley and Tel Aviv but seems hard to duplicate elsewhere.

Fourth, the intangible economy shifts the public policy agenda. Policymakers will need to focus on facilitating knowledge infrastructure — such as education, communications technology, urban planning and public science spending — and on clarifying regulation of intellectual property.

This shift to a more intangible economy, is, we think, contributing to many of the economic and social trends we face today: slow growth, seemingly inadequate finance, and inequality of income, place and esteem. Our typical response as a society to these challenges — such as calls for more traditional infrastructure or more of the same financial and commercial regulation — needs an update.

This was produced by The WorldPost, a partnership of the Berggruen Institute and The Washington Post.