Photo: Chris J. Ratcliffe/Bloomberg
By George Melloan for the WSJ – Jan. 28, 2018 4:35 p.m. ET
Why is an airliner like a song? Both can be capital assets, according to Jonathan Haskel and Stian Westlake. An airliner is tangible capital, a song intangible. The two British authors argue that the growing importance of intangible capital requires us to change the way we think about business in postindustrial economies.
Intangible capital, as defined by the authors, is not new. One could argue that the Phoenician alphabet, invented three millennia ago, was software, the capital base for the spread of knowledge throughout the ancient world. Today management gurus write about “human capital” and the “knowledge industry.” We all know that most people in the developed world make their living delivering services, some of which could be regarded as intangible capital, rather than producing goods. Intellectual property is a big concern in global trade negotiations.
But the historical view of “capital” as something tangible persists and limits our thinking, the authors argue. To be sure, exactly which intangible assets qualify as capital can be debated endlessly. In “Capitalism Without Capital,” the authors choose a broad definition and explore its implications.
In so doing, they provide insights into some puzzling questions. For example, why is Uber, a company with few assets and huge losses, so popular with investors? Why are stock-market prices soaring at a time when capital investment, as typically measured, is creeping upward at only a 4% annual rate? Why are banks losing their role as business lenders to other forms of finance, such as private equity? Why haven’t rock-bottom interest rates spurred more economic growth? Why is income inequality suddenly a political issue again?
Capitalism Without Capital
By Jonathan Haskel and Stian Westlake
Princeton, 278 pages, $29.95
There are lots of possible answers to these questions, but the authors start by offering two broad responses: “We are now trying to measure capitalism without counting all the capital”; and “the basic economic properties of intangibles makes an intangible-rich economy behave differently from a tangible-rich one.” To explain the difference, they cite what they see as the four distinctive “S’s” of intangible capital that set it apart from the tangible kind: sunk costs, scalability, spillovers and synergies.
By sunk costs, they mean that if an intangible investment fails to produce a salable product, there is little that investors can do to recover some of their stake. If you have invested in training employees to manage the algorithms that are the basis for your business, your investment can literally walk out the door. But if a tangible investment fails, you can at least sell the factory and machinery. Intangibles trouble bankers who are accustomed to collateral that they can lay their hands on in case of a default.
If an intangible investment succeeds, you can usually go big quickly at little additional cost—that’s what scalability refers to. The authors cite the British company Electric and Musical Industries Ltd., which owned the rights to the Beatles catalog in the 1960s. When a global public clamored for Beatles music, EMI could run off records by the millions at a handsome profit. Beatles music accounted for 30% of EMI’s profits in 1967. The authors note that Google rose out of a pack of search-engine developers and quickly scaled up to industry dominance. That sort of thing doesn’t usually happen with tangible investments. To scale up the production of autos, for example, you need time and a great deal more investment.
Spillover is another risk that bankers worry about. EMI used its Beatles cash partly to develop the now-ubiquitous CT scanner for medical diagnosis. But intangibles—in this case, the idea behind an invention—can spill out to other companies that are more skilled at product development and marketing. GE and Siemens, not EMI, cashed in on CT scanners.
The fourth “S” is synergy. Unlike tangible capital, intangible investments often mate up with one another to form a marketable product. The authors cite the microwave oven. The idea was born when a Raytheon engineer, Percy Spenser, found that magnetrons, a radar component, could heat food. In the 1960s, Raytheon bought Amana, an appliance manufacturer, and together they produced microwave ovens.
All this sounds a bit formulaic, but Messrs. Haskel and Westlake enliven their book with anecdotes and reach some thought-provoking conclusions. They find that today’s much-debated inequality is increased dramatically by what occurs at high income levels and results partly from the growing importance of intangibles. Entrepreneurs like Bill Gates and Mark Zuckerberg built companies capitalized with intangibles and quickly became wealthy on the scalability of their assets. Managing or producing intangibles, the authors suggest, often requires more talent, and that talent has a price tag. The concentration of such companies in places like Silicon Valley sends property values upward, creating pockets of wealth far more opulent than the home bases of traditional factories.
Alongside calls for improving education and encouraging research and development, Messrs. Haskel and Westlake think that “government should create the conditions for a shift from debt to equity financing,” partly through changes in tax policy, which now favors debt with interest deductibility. Their logic is that, since intangibles rely heavily on equity investment, equalizing the tax burden would hasten the reaping of benefits from this growing sector of the economy.
Some readers might argue that “Capitalism Without Capital” restates much that we already know, but the authors make a good case that we don’t know as much as we think because some of our tools for measuring economic performance are out of date. It is certainly believable that, in the 1960s, a big part of EMI’s capital base was “I Want to Hold Your Hand.”
Mr. Melloan is a former deputy editor of the Journal editorial page and author of “Free People, Free Markets: How the Wall Street Journal Opinion Pages Shaped America.”