BOOK REVIEW: The economics of intangibles

Capitalism without Capital: The Rise of the Intangible Economy, by Jonathan Haskel and Stian Westlake

INVESTMENT is important to all. It is what builds up capital, which combined with labour are the two inputs to production that power the economy. It is one of the four key components that determine a country's GDP.

The nature of assets and investments has changed over time: fields and oxen were overtaken by machinery and factories, and vehicles and computers. But the changes remained in physical things through most of the 20th century. Today intangible assets and investments are overtaking the tangible. Consider just two examples offered by the authors, Jonathan Haskel and Stian Westlake.

London’s Stansted Airport has tarmacs, terminals and trucks. However, it also has assets that are harder to see or touch, such as complex software, valuable agreements with airlines and retailers, and know-how. These assets took time and money to develop and have huge value for the airport owner. They aren’t physical but rather ideas, knowledge, and social relations. In the language of economists, they are intangible.

Similarly, traditional assets of plant and equipment constitute only 1% of Microsoft’s market value, and intangibles make up the rest.

For economics, there is nothing unusual or interesting about a change in the types of things businesses invest in – these change all the time. Railways, cars and computers replaced canals, horses and carts, and typewriters.

The key insight of this book is that “there is something fundamentally different about intangible investment, and that understanding the steady move to intangible investment helps us understand some of the key issues facing us today: innovation and growth, inequality, the role of management, and financial and policy reform,” the authors note.

This is important because there are already countries in which the intangible investment outweighs the tangible kind.

We have no agreed upon way of measuring intangibles, and so they are overlooked. We land up “trying to measure capitalism without counting all the capital”. Add to this that the basic economic properties of intangibles make an intangible-rich economy behave differently from a tangible-rich one.

Intangible investment tends to represent a sunk cost. When Toyota invests millions in ‘lean production’ systems, these can’t be separated from the factories and sold off.

Spillover effect

Intangible investments also have what economists call ‘spillovers’, such as when the beauty of a homeowner's flower garden has a positive ‘spillover’ effect upon a neighbour’s house value. And there are intangibles such as designs, that cannot be easily kept secret to prevent others copying them.  

Intangible assets are also more likely to be scalable. Uber and Airbnb are obvious examples, but so is the Coca-Cola Company. This company’s formula and brand work the same for one as for the 2 billion Cokes their bottlers produce. In contrast, the bottlers’ tangible assets don’t scale nearly as well.

When assembled in the correct combinations, intangible assets can be very valuable. The microwave oven was the result of the coming together of a defence contractor, who accidentally discovered that microwaves from radar equipment could heat food, and a white goods manufacturer with appliance design skills.  

Tangible assets do, of course have synergies, such as that between the truck and the loading bay, but typically not on the same radical or unplanned scale.

Investing time, resources, and money to produce for the future is a critical part of what businesses, governments, and individuals do. Today these investments are in ideas, knowledge, aesthetic content, software, brands, networks and relationships, which have grown tremendously.

There is good reason to think that the rise in intangible investment is nothing more than a consequence of improvements in IT. But the authors hold it is more complicated than that.

It is obviously true that some intangibles operate through computers such as software; however, the increase of intangible investment began before semiconductor revolution. Many intangibles such as brands, organisational development and training, for example, led to the development of modern IT, not vice versa.

The authors report that “intangible investment has become increasingly important. New methods of measurement show how it now exceeds tangible investment in some developed countries and has been growing for several decades, while tangible investment has steadily declined.”

This is further impacted by globalisation, the increased liberalisation of markets, developments in IT and management technologies. The changing input costs of services also contribute to the rise of intangible investment.

What reignited economists’ interest in measuring intangibles was ironically something tangible: the computer. It is computers that offer a simple indication of the problem of the quantification of intangibles.

Compare how food and computers are priced. Food product prices for the same items tend to rise slowly, in line with overall inflation. Computers over time have a counterintuitive pricing mode. Even the same computers sold at the same price over time, are not the same commodity. Every aspect of their quality - their speed, memory, and space - has improved incredibly. As such, their “quality-adjusted” prices were actually falling very fast.

And this was the result of an intangible input: research and experience. The software that computers drive was likewise an intangible commodity: knowledge written down in lines of code.

It took until the early 2000s for economists to believe that businesses were spending significantly large amounts of money on things that had no physical presence but which were nevertheless valuable and durable. At the time the Philadelphia Federal Reserve made a first guesstimate at this uncounted investment at $1trn a year!

This book is a very early attempt to come to grips with a very complex issue that has important implications for the decisions we make at national level. These decisions include our response to GDP (possibly incorrectly calculated), and the conclusions we draw from decreasing investment in developed countries, despite lower cost of borrowings.

The authors, very seasoned economists, offer both insight and grounded solutions to understanding a relatively new important facet of our economic lives. 

• Ian Mann of Gateways consults internationally on leadership and strategy and is the author of Executive Update. Views expressed are his own.