You would think that the new digitally powered economy – some of it, internet based – would be more productive, since they depend so heavily on computers and information technology. Not true. Several studies, including those by David Autor and others, show drop in productivity in the US, and especially since the late 1990s. Many have even called this the “return of the Solow Paradox”, in reference to the observation by Robert Solow in 1987 that despite all the strides that had been made in computing technology since the 1970s, the impact on US productivity was abysmally low.
Fast forward to the late 20th century, the mid to late 1990s in particular, and the same phenomenon makes its appearance. For different reasons, of course. If in the 1970s and 80s, the quality of price differentials due to technological improvements were not being captured accurately enough, in recent times, it is due to the rise of something called “the intangibles” in the economy. This has led Jonathan Haskell and Stian Westlake to write a book on the influence of intangibles on economies, called Capitalism Without Capital. It was rather well-reviewed by The Economist, so I decided to buy and read it, related as it is to my area of work which is in advertising and brand communications. It takes you into the world of R&D, product and process innovations and accounting in companies, strange as these partners might seem at first and also highlights just how intangibles are affecting every part of our economy, including income inequality.
Just which are these companies? Are they only internet-based businesses or only services industries, for example? Well, they comprise all kinds and started to take shape during the mid to late 1990s in the US and to some extent in the UK and continental Europe. Today, they are almost all over the world, from Japan to China to India. What they all have in common is that they are knowledge-intensive, and through research and development, are the owners of “intangible assets”. How does it impact our world?
Intangibles, or their growing importance, intrinsically and fundamentally change the way the economy functions. From factors of production, to type of activity, to employment and wages, and returns to shareholders (and indeed, stakeholders) intangibles have introduced a new and important variable around which businesses and economies pivot. It is rather late that economies are waking up to this new reality and very few economies have started factoring intangibles into their GDP and other calculations.
To get an idea of how important intangibles are, take a look at this chapter from the World Intellectual Property Report 2017, which shows how the share of intangibles in income has been growing by sectors and industries, even though intangibles tend to be firm-specific, as the authors point out. As part of their research which studied 19 manufacturing groups across 43 economies, between 2000 and 2014, they find that the share of intangibles for all manufacturing products averaged 30.4% almost double that of tangibles. They grew from 27.8% in 2000 to 31.9% in 2007 and have stagnated since. The authors say that overall income from intangibles for all 19 manufacturing industries rose 75% from 2000 to 2014 in real terms and amounted to US $ 5.9 trillion in 2014.
Branding and marketing are considered an important part of the new economy based on intangibles, because they create intangible assets for businesses that go on to further create more intangible assets, that businesses transact upon. Billions of data sets are created through these transactions, which offer deep and granular insights into customer behavior and preferences. In my view, data is the new capital along with other intangibles, that fuel business growth in today’s world. However, not all data is useful and we need to be able to sift and focus on the most relevant information that helps companies build their brands.
Not surprisingly, a lot of this is at the heart of the privacy controversy surrounding Facebook, Google and several other companies who “harvest” this data. Just what have they sown in order to reap or indeed, deserve, this harvest? Given that many of these tech platforms, as they like to call themselves, are merely the media through which consumers interact and transact, they should be treated as such: media companies. And Amazon, or at least its retailing arm, an e-commerce company. The data generated should rightfully belong to consumers or companies whose products and services they buy. That is, however, not the case. From the start, they were never viewed in that fashion, nor regulated that way. Even today, regulators and legislators in the US are tearing their hair out, in dismay or else, in frustration. Regulators in Europe seem to be several steps ahead, though one still has to wait to see the results of GDPR.
However, these are not the only kinds of companies that own vast amounts of intangibles. Other pure technology companies too do so, as do pharmaceutical giants, biotechnology companies, defence, aerospace, engineering and chemicals companies. And many of these companies enjoy sky-high brand valuations that sometimes bear no resemblance to the companies’ performance. Think of Amazon’s investors who are quite happy to keep filling the Amazonian well, irrespective of whether the e-commerce giant generates profits or not. That leads us to the most distinguishing feature of new economy companies.
Since stock markets are based on investors’ anticipation of future earnings growth, it turns out that any R&D spend increase by a company has an immediate impact on its stock price, sending the valuations higher. The authors of Capitalism Without Capital describe the four salient features of new economy companies as scalability, sunkenness, spillovers and synergies, which they dub the 4 Ss. Although their use of these terms can be a little confusing since they use them to mean slightly different concepts from what we understand in business, it helps to point out that the sunkenness of costs is perhaps what defines Amazon best, along with the fact that their huge investments in R&D hold out the promise of solid growth ever into the future.
That’s not all. Start-ups need to scale quickly, and the faster-growing firms among them such as Uber and WeWork “blitzscale”, meaning that they attempt to disrupt an industry before others catch up, according to this article in The Economist. While I agree with the article’s viewpoint about the three effects on fundraising, governance and the wider economy, I differ on the point that stockmarkets always get it right. While WeWorks’ valuation at its height was a staggering US $ 47 billion, it was generating losses of US $ 1.9 billion on revenues of US $ 1.8 billion, defying all logic. In the midst of its latest travails, the Company has been taken over by SoftBank and has delayed its IPO. According to this article from Fortune Magazine, its valuation has recently plummeted to US $ 15 billion and perhaps even less.
Which brings me to the subject of brand valuations. If more R&D investments lead to higher stock valuations and if market capitalization is a significant part of brand valuations, then are we measuring the real value of a brand? And since brands are all about connections with consumers, shouldn’t brand valuations be measured on the basis of sales and revenue as the most important variable, rather than profits and market capitalization? And while we are at it, might not a new system of accounting based on revenue, lead to less understating or misstating of profits by companies in order to save on taxes? Besides, there are important distinctions to be made between product brands and corporate brands, and how they impact market capitalization. These are some of the questions that must concern and engage all those who work with brands and marketing, as well as those who are involved with valuation work.
These are issues that must also concern policymakers and regulators, as the new economy based on the rise of intangibles has huge externalities on education and skill development, employment, wages and labour laws and the dynamism and growth of towns and cities. Haskell and Westlake write of the three types of inequality that intangibles-based businesses create: Inequality of income, inequality of wealth and inequality of esteem. They say:
“The synergies and spillovers that intangibles create increase inequality between competing companies, and this inequality leads to increasing differences in employee pay (recent research suggests these interim differences account for a large proportion of the rise of income inequality). In addition, managing intangibles requires particular skills and education, and people with these skills are clustering in high-paid jobs in intangible-intensive firms…
Thriving cities are places where spillovers and synergies abound. The rise of intangibles makes cities increasingly attractive places to be, driving up the prices of prime property… In addition, intangibles are often mobile; they can be shifted across firms and borders…
Finally, inequality of esteem. There is some evidence that supporters of populist movements (Brexit in the UK, Trump in the US) are more likely to hold traditionalist views and to score low on tests for the psychological trait of openness to experience.”
Policymakers also need to be mindful of the fact that R&D that leads to inventions, innovations and patents can also sometimes block innovation. The long duration of existing patents and their constant renewal are also known to have hindered innovation by new players, since they act as barriers. Patent laws, therefore, also need to be reconsidered, with a view to finding ways to spur innovation by more businesses, not just the large multinational giants.
In fact, the rise of the intangibles calls for a complete relook at policy and institutions, as Haskell and Westlake rightly point out. It requires us to recognize and accept that there are limits to technologically driven growth, and that while the sky might be the limit for some, it is clearly a barrier to growth for most, without the right set of policies.
The new intangible economy needs new thinking.