Capitalism Without Capital

stock market returns

It’s always scary to hear a Wall Streeter utter the hackneyed phrase, “this time it’s different.” And yet today it really is. Especially the economic conditions that make up the operating system for today’s world.

As markets ride a roller coaster this week, as the political environment is heavily focused on international trade and tariffs on manufactured objects like cars and jeans, the reality is that all of this is yesterday’s way of looking at the economy. This, according to Jonathan Haskel, who is a member of the Bank of England’s rate-setting Monetary Policy Committee (the equivalent of the US Federal Reserve), a professor of economics at Imperial College London, and the director of the school’s doctoral program. He has also taught economics at the London Business School, the Tuck School at Dartmouth, and the Stern School of Business at New York University.

Haskel explains in this week’s WhoWhatWhy podcast that, while people once invested in things that grow (in the agrarian age) or in things that could be made with steel and sweat (in the manufacturing age), today, no matter how hard politicians try and take us back, the investments are made in human capital, in ideas, in imagination, and in zeros and ones. The problem for economists, according to Haskel, is that things like R&D, marketing, design, and software are much harder to measure and value.  

The idea, Haskel tells Jeff Schechtman, is that intangible assets are created, distributed, and often valued differently than traditionally manufactured items. “Products you can’t touch have a very different set of dynamics in terms of competition and risk and how you value the companies that make them.”

Trying to determine the impact of all of this on the economy — when much of what is produced is abstract, symbolic, and speculative — has been difficult, Haskel explains, because so much has eluded traditional description, measurement, and accounting.

For example, he laments that we lack the ability to measure a company, even one as big as Microsoft, whose market value a decade ago was $250 billion, while its physical basis — the value of its properties and equipment — was only about one percent of that.

Finally, Haskel explains that the “shift to intangible investment” has widespread consequences that affect long-term inequality, infrastructure development, taxation, and other areas. It also leads to what Haskel calls “secular stagnation,” by allowing firms to scale quickly after they emerge, then engulf and overpower competitors, as opposed to enhancing an economy based on the rising tide that lifts all boats. It’s clear that we can’t watch the current daily gyrations in the stock market without understanding this evolving dynamic.

Jonathan Haskel is the author of Capitalism Without Capital: The Rise of the Intangible Economy (Princeton University Press, November 18, 2017).


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Jeff Schechtman: Welcome to Radio WhoWhatWhy. I’m Jeff Schechtman. It’s always one of those scary expressions on Wall Street in particular when somebody says, “This time it’s different.” And yet it is different, especially the economic conditions that are the operating system of today’s world where once people invested in things that grow in the agrarian age or in things that could be made with sweat and steel in the manufacturing age.
Today, no matter how hard politicians may try and take us back, investing is in human capital, in ideas, in imagination, and in zeros and ones. Things like R&D, marketing, design, and software are much harder to measure and to value. While we see lower barriers to entry today, we also see the correspondingly high valuations of those intangibles. Just look at Uber or Airbnb.
And to try and make sense of all of this, I’m joined today here on Radio

WhoWhatWhy by Jonathan Haskel. He’s a professor of economics at Imperial College in London, and Director of the Doctoral Program at the school. He’s taught at the University of Bristol and the London Business School, and has been a visiting professor at the Tuck School at Dartmouth and at the Stern School at NYU. He’s also a member of the Bank of England’s rate setting Monetary Policy Committee, and the author of Capitalism Without Capital. Jonathan Haskel, thanks so much for joining us.

Jonathan Haskel: Thanks so much, Jeff. Absolute pleasure to be with you.
Jeff Schechtman: We talk a lot today. We hear about the economy today being referred to as the information economy. But you really go broader than that in talking about this intangible economy. Define, first of all, what that is.
Jonathan Haskel: Yes, thank you, Jeff. I think we are a little broader than the information economy. I think the types of assets that we are interested in, that the economy is increasingly investing in, contains some information assets, notably databases and software, which are both intangible assets. You can’t drop them on your foot sort of thing. But contains some other types of asset, which I think are not so much information assets, but possibly more relational assets.
So, for example, the reputation that companies have. They build very assiduously and the market research and so on is very important in building all of that. The kind of networks that companies invest in as well, we’re interested in that. The kind of organizational capital that firms have as well. The reason why Kmart and Walmart feel like very different organizations, even though if you buy shoes, it’s exactly the same pair of shoes. So, I think we’re a little bit broader than just information assets, and that’s why we focus on intangible assets as possibly a slightly better collective term for the new types of assets that companies are increasingly investing in.
Jeff Schechtman: When we talk about intangible assets, to what extent are we really talking about human capital, human assets?
Jonathan Haskel: Some human capital is behind all of this because clearly you need talented software writers to write your software, talented data analytics people to interrogate the data, movie designers and set designers and people like that to do that kind of thing. But the key point is that the assets, which Apple and Google and these intangible intensive companies own, are owned by the company themselves rather than the individual workers.
So that, for example, to take a rather morbid example if you’ll forgive me, Jeff. When Steve Jobs very sadly passed away, there was obviously an enormous amount of reputational capital built up in him, embodied in him personally. But Apple didn’t completely fall to pieces. So, it’s the ability of the companies themselves, like Apple in that regard, to own a lot of this intangible capital, which I think distinguishes it from at least what economists talk about when they talk about human capital. They talk much more about the capital and the skills and the talents, as it were, which are owned by individuals. And that’s sort of something is something a little bit different.
Jeff Schechtman: And one of the points that you make is that it is much harder then to really measure, to define this kind of capital, both in terms of companies themselves trying to account for it, but even within the context of a larger GDP for a nation.
Jonathan Haskel: That’s right. Accountants, both national accountants who are putting together the GDP numbers, and company accountants who are putting together obviously the company reports and the accounts and all that have struggled with this for quite a while.
The trouble with many of these intangibles is of course there’s often not an active market for them. There’s an active market for buildings and machines and vehicles and all the tangible assets, which companies invest in, but there isn’t an active market for many of the intangible assets. So, many accountants are very reluctant therefore to give them a value because they can’t observe anything on the market.
The difficulty, however, is if one goes down that route, one ends up saying that, “Well, gosh. We don’t know what value to put on …” I mentioned Apple before. “We don’t know what value to put on Linkedin. We don’t know what value to put on Uber.” All of these companies, which have got very substantial… to go back, Jeff, to your original question, information assets, very substantial relational assets. If we say we don’t know how to value them, then we’ve got a vast hole in our attempts to try to understand these companies.
In our book, which you very kindly mentioned, what we do is walk the readers through some of the research, which is try to make that leap and under a number of assumptions, try to get at some of these valuations and just count some of these numbers up and see if they’re important.
Jeff Schechtman: Isn’t that what the equity market has done a lot of in terms of creating some kind of value, assigning some kind of value for these companies?
Jonathan Haskel: Absolutely yes. I mean, that is right. What we argue in the book is there is tremendous opportunities for really talented analysts to really get close to these companies and really understand them. The trouble with the equity markets of course is they’re extremely volatile, so the value of, I don’t know, Yahoo, for example, used to be incredibly large. Then overnight, it can be incredibly small. So, equity markets are one way of trying to read off those values. But because they are so volatile, we instead try to look at a more sort of cost basis.
We try to at least look in terms of the economy as a whole and ask the question how much a firm is actually spending in dollars and cents, or in Euros or in British Pounds, if I can talk about British Pounds coming from London at the moment. How much they’re actually spending on software, how much are they spending on design, how much are they spending on branding. We try to build up a picture of how much the economies are spending on these various assets. And so, therefore get at this issue via that direction.
Jeff Schechtman: In a way it seems that we need to find an entirely new way to measure this because what we’re really doing is trying to measure these intangibles and the things that you’re talking about in the same way we ascribe value and measure things in an agricultural or a manufacturing economy.
Jonathan Haskel: Well, I think that’s right. And I think for the economy as a whole, and for large sectors of the economy, I think that’s got a good chance of working reasonably well. Some companies are going to invest in R&D, they’re going to invest in design, they’re going to invest in software and it’s going to work very well. Others it’s not going to work out very well. But in an aggregate, we might imagine we can get some aggregate measure of how much they’re investing.
It is going to be much more difficult at an individual company level because of the various properties of intangibles and because of the way that some might succeed and some might fail. As I say, what we try to do is describe if you did that exercise how different would investment in GDP look for the major economies as a whole.
Jeff Schechtman: Talk about that. How different it would look first of all, for the companies themselves. And how traditional accounting methods really don’t take into account so much of what we’re talking about.
Jonathan Haskel: Yes. So, beginning with the companies themselves, I mean, we spend a bit of time discussing that. We spend a bit of time discussing the reluctance of the accountancy firms to go in this direction. But then there just appears to be a lot of evidence that if you don’t want to go in this direction, you don’t want to make these measurements, you are just creating a very large hole in your understanding about what these companies actually are.
So, for example, there’s some very interesting work by London Business School professor called Alex Edmans, took companies who won the prize for the best company to work at. And asked the question: could you make money by investing in these companies once you knew that they won the prize? And if all of the intangible value of winning those types of prizes was embodied in the stock price, you should be able to make extra money. Actually, you can make money by making those sorts of investments. So, again, showing that there does seem to be a systematic misvaluation of a company level of the types of intangible investments that increasingly companies find very important.
Jeff Schechtman: Talk about the analysis of that and how the systems for analyzing that are somewhat different.
Jonathan Haskel: Well, most of the analysis, if this is your question, has been done somewhat by the national accountants who are trying to get at, as I say some economy wide measure of how tangibles and intangibles stack up. And what they’ve done is they’ve tried to look for example at how much firms are spending on their, for example, software engineers and how much plausibly that spending that they’re doing that might reasonably contribute and build the types of software intangible assets, which are important for many companies. So, there’s a whole system around the national account, which is an attempt to try to get at those types of questions.
Jeff Schechtman: How does risk enter into the equation in trying to value this?
Jonathan Haskel: In a very difficult way. I mean, risk exposed is easy to observe. It’s easy to now say, “Well, gosh. Uber has done really well. And Microsoft has done really well. And Yahoo maybe hasn’t done quite so well.” But ex ante we just simply don’t know. So, again, I think this is where in the future there is a potentially very important role for analysts and for observers of companies to really get close to the companies and really start to analyze everything that’s very much behind their balance sheets, so that those types of analysts and then the clients to whom they would then want to interact can just much better understand the intangible performance of the companies whom they can get close to.
Jeff Schechtman: Are we moving towards something else or something that’s even harder to understand and harder to value as more AI enters into the business equation?
Jonathan Haskel: I think that’s right. And we talk a little bit about AI. In a sense, I think it’s a bit of a case study of what we’re going on about. So, I don’t want to give you a long lecture, Jeff, but if you just forgive me just for a second.
One way of thinking about AI, think about the Google cats project, for example. This tremendous project where Google are investing all this money in an attempt to get the computer to recognize a picture of a cat, which turns out to be a very complicated picture because computers are very good at doing these calculations. Three-year-old children could recognize a picture of a cat, but a computer has a lot of difficulty differentiating between a cat and a lion, or a cat and a leopard, or something like that.
So, what have Google done to do all of that? They have incredibly fast computers running absolutely amazingly engineered software, interrogating gigantic databases. In this case pictures of cats, but in other cases, I don’t know this might be banks looking for bank fraud. And in our type of language, how do we think about that? The incredibly fast computers, that’s a piece of tangible capital, high quality tangible capital. The incredibly clever software is a piece of very high quality intangible capital. And then, the database, which they’re interrogating. Again, it’s a piece of very high quality intangible capital.
And often, there are two things, which follow from that. One is, as you suggest in your question, the more that these types of companies look at these types of issues, the more that Google does this, the more the banking companies do this, the more the other companies do this stuff, the more important this bundle of intangible assets is going to come. And the second implication, as we were just discussing a second ago, is of course a lot of this investment, especially in databases, is often not counted. It’s just too difficult to count. So, that would again be another example where companies increasingly have an extraordinarily valuable asset, in this case a database, but it’s something which just doesn’t appear on the balance sheet.
Jeff Schechtman: And it becomes harder and harder over time to figure out on the other side the cost of barriers to entry in these businesses and how that impacts, because that changes over time. It might be that the cost is high in the early stages of AI because of the computing power and the databases, but over time those costs go down, the barriers to entry go down, and it all gets valued differently.
Jonathan Haskel: Absolutely. But that’s how we would hope that the market economy would work and what we would hope is that as cloud computing, for example, becomes more and more popular, then the costs of companies being able to use… Again, if I may say to go back to our example… the costs of companies to be able to use these very fast computers running this software would get less and less and less. But I think the hope is that as those costs went down, there would be more and more smart people working on these big problems. And that hopefully, in the future is going to raise our productivity growth and raise our prosperity.
Jeff Schechtman: Of course, the two other factors that enter into the equation are both security and the proprietary nature of the whatever it might be.
Jonathan Haskel: That’s right. So, even if it’s the case that, let us say, cloud computing gets very cheap, those types of issues around security and the proprietary nature get to be very important as well. And so, we talk about that in the book.
Then we talk about a little bit, if I may say, which I think is related is, of course once companies get good at doing this type of interrogation that I described, is that also good at marketing the product that comes from this. I don’t know, let us say an app that helps banks look for fraudulent behavior. If they get good at marketing those, if they build up those types of relationships with the banks, let us say as an example, then those synergies between the intangible assets get to be extremely powerful. And then, you would expect again those companies to be disproportionately successful because they can combine together the skills and the talents around the intangible assets. And we think that that’s quite a lot of the story around some of the leading information and tech firms, and part of the reason why they’ve been so successful.
Jeff Schechtman: Part of it also is there’s a shorter and shorter life cycle to these products. That it’s some kind of variation of Moore’s Law that’s at play. And that no matter how great the marketing may be, for example, that the life cycle is shorter and the need for constant reinvention is so much greater.
Jonathan Haskel: It is. And of course, if these companies can build up the skills and the talents and the synergies to be able to handle all of that, and to be able to cope well with the fast changing market, then they will do well. Otherwise, the relentless market process, I’m afraid, will create great difficulties for them. And of course, that then feeds into the kind of ecosystem around the financing of these companies and the possible reluctance of banks and other institutions to provide the kind of seed cone finance that these companies need to start and grow. Maybe we need some rather different financial institutions who are going to cope with this perhaps more risky  type of world.
Jeff Schechtman: Mm-hmm (affirmative). I mean, that’s kind of the role that venture capital has filled in large measure.
Jonathan Haskel: I mean, absolutely. I’m sitting here in London on the end of the phone and everybody in London, which is the financial capital of the world comparatively and doing very well in terms of venture capital relative to the rest of the Europe, looks at California with great jealousy. And reflects and wonders why it seems to be so successful in California. The other place we all look of course is Tel Aviv. And it seems to be very difficult to produce those successful ecosystem in localized areas where the venture capital firms do so well. That’s to say, I think we’ve made quite a lot of progress of that in London, but we look with great envy at places like California and Tel Aviv, and look and see how successful they’ve been.
Jeff Schechtman: One of the things you talk about is an extension of that, that there is a kind of psychological mindset that goes with trying to understand this newer way of looking at intangible assets.
Jonathan Haskel: That’s right. It needs I think just possibly a different turn in the imagination, looking beyond the company accounts, trying to understand better what it is that companies are doing. That’s on the one side. And then, on the other side we talk a little bit about the management of these very intangible intensive companies because if you’re going to be a manager of a tangible company, you’re basically in charge of a large number of machines. So, there are a lot of complicated supply chain issues but that’s the nature of that type of exercise. If you’re going to be a manager of an intangible intensive business, you’re in charge of a lot of individuals who are coders, who are writing software, who are doing marketing, who are building up relationships within the organization. That maybe a very different type of managerial skill to the ones required managing a whole load of machines.
Jeff Schechtman: Talk a little bit about why this is all so important. Why this is important in terms of measuring the economy, of understanding the economy, how both companies and nations account for this. And really why it is such a critical need right now.
Jonathan Haskel: I think it’s important because the intangible economy is just growing and growing and growing. I mean, often in economics and a lot of commentary about the economy, people want to comment on the latest and greatest thing and the particular events yesterday, but what we try to do in the book is talk about this much longer term trend towards the intangible economy.
  Essentially, what we try to argue is that around, gosh, the late ’90s, early 2000s, there was an overtaking in many developed economies, led by the United States I should say, such that we’re now in a situation where every dollar of tangible investment, that is to say investment in buildings and vehicles and machines and so on, there’s a $1.20 essentially investment in intangible investment, software, design, databases. All that kind of thing is best we can count in. So, it’s been one of those long-term trends and we now have a situation where that type of investment in intangibles exceeds that of tangibles.
And so, I think it’s time to start really confronting the fact that we don’t measure this stuff very well because it’s just increasingly become more and more important, and we run the risk therefore of measuring things more and more precisely, but a less and less valuable area of the economy. And we run the risk therefore of potentially ignoring a more and more important area of the economy. And we don’t want to do that because we want to be able to make good policy decisions and understand what we’re doing when we’re looking at companies and economies.
Jeff Schechtman: Right. And to the extent that we do ignore that, to the extent that we are not fully valuing this intangible part of the economy, what are the costs we’re going to pay for that if we don’t catch up?
Jonathan Haskel: I think those costs would be in a couple of areas. One is, as we’ve been discussing, it’s going to be much more difficult on a company basis to figure out what’s important for companies and how companies are going to be valued and what their prospects are. And that’s going to be important for investors and financiers and indeed employees making decisions about where they’re working. So, that’s on a very company level basis.
On a national level basis, I think we need to look at intangibles to make a better decision about how we’re going to run economic policy. So, for example, intangible capital tends to be quite mobile. It travels between different economies. In order to keep intangible investment going within economies, we probably have to be quite careful when we think about policy, for example, to make internationally competitive tax rates and to provide a reasonably friendly business environment so that we don’t run the risk of this intangible capital just going off elsewhere.
Jeff Schechtman: Taxation is one of the big areas that really has never caught up with any of this.
Jonathan Haskel: No. I mean, I think it’s one of those areas where companies and the quite understandable reactions of individuals is moving much faster than policy can. There are a number of initiatives. The OECD, for example, based in Paris, a kind of rich countries club of economic nations. They’ve got a number of plans to try to stop tax competition. But that’s proved to be very difficult to do. This is an area where economic policymakers have really got to up their game.
Jeff Schechtman: One of the other things that you talk about, a little bit of time that we have left, is how this kind of intangible capital benefits the greater economy. You talk about the spillover effect, which is an inherent part of this kind of economics. Talk about that.
Jonathan Haskel: Yes. That’s right. So, if you think about… We take the example of the iPhone. Before the iPhone came out, if people cast their minds back, smartphones looked all a bit weird. They had weird keyboards and folding out bits and aerials sticking up, which you pushed up and down and all that kind of thing. The minute the iPhone came out, basically within about 18 months every other smartphone shared that design. They just all looked rather the same. That’s what economists call the spillover, namely the design. With the intangible asset in the iPhone, the design of it, the look of it, the feel of it, was something that was quickly copied by other firms.
And so, if there are a lot of spillovers going on, that is a potential good side to the intangible economy because it’s going to enable other firms to build on the good practice done by frontier firms and spread the benefits of those types of new design and that type of work throughout the whole economy.
Jeff Schechtman: It also creates, to go back to the security issue we talked about before, but a greater need for protecting intellectual capital.
Jonathan Haskel: This is exactly the dilemma, which policymakers have struggled with. As you rightly say, Jeff, if I’m going to come up with an idea and everybody is going to copy it, well, I’ve got pretty small incentive to come up with that idea in the first place. And this is just a real bad dilemma for policymakers.
Again, here in Europe we have the feeling that in the US you probably have this balance about right. Namely, relatively in some ways, looser intellectual property regulations than we have here in Europe. And we think therefore that although there’s the disincentive to do that initial investment, there is sufficient incentive for firms to have follow on investments and to put all of these different types of intangibles together. We think there’s sufficient incentives to actually mean that having relatively looser intellectual property might be the right balance to strike. But this is a difficult one. And it may indeed vary quite a lot between different industries. Pharmaceutical maybe very different to fashion for example.
Jeff Schechtman: Jonathan Haskel. Jonathan, I thank you so much for spending time with us here on Radio WhoWhatWhy.
Jonathan Haskel: Absolute pleasure, Jeff. Thank you very, very much.
Jeff Schechtman: Thank you. And thank you for listening and for joining us here on Radio

WhoWhatWhy. I hope you join us next week for another Radio

WhoWhatWhy podcast. I’m Jeff Schechtman.

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Related front page panorama photo credit: Adapted by WhoWhatWhy from stock market monitor (John Jones / Flickr / toolstotal.com) and cover Capitalism without Capital (Princeton University Press).

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