Stian Westlake joins City Journal editor Brian Anderson to discuss the future of productivity and how institutions and policymakers can adapt to the new “intangible” economy.
Throughout history, as documented in the book Capitalism Without Capital by Westlake and coauthor Jonathan Haskel, firms have invested in physical goods like machines and computers. As society has grown richer, companies have invested increasingly in “intangible” assets: research and development, branding, organizational development, and software. Today’s challenge is to build the institutions and enact the policies that will maximize the new economy’s potential.
Audio Transcript
Brain Anderson: Welcome back to the 10 Blocks podcast. This is Brian Anderson, the editor of City Journal.
Joining me on the show today is Stian Westlake. Stian is an expert on technology and innovation policy based in the UK, where he’s advised the government. He is co-author, with Jonathan Haskel, of the fascinating book, Capitalism Without Capital: The Tise of the Intangible Economy, which was selected as a book of the year for 2017 by the Economist, the Financial Times, National Review, and Marginal Revolution, and described as “required reading for policymakers” by Bill Gates.
Together, Stian and Jonathan have co-authored an essay for the new issue of City Journal, entitled “An Agenda for the Intangible Economy,” which explores how future productivity—and prosperity—depends on how well our institutions and policymakers adapt to the realities of the new “intangible” economy.
The essay isn't available on the City Journal website just yet, so stay tuned for that over the coming weeks—and take this as an opportunity to subscribe to the magazine, if you haven’t already.
That’s it for the introduction. My conversation with Stian Westlake begins after the music.
Brain Anderson: Stian, welcome to 10 Blocks. To start with for our listeners, how do you define this emerging economy? You describe in your recent book, Capitalism Without Capital and in your City Journal article, which you call the "intangible economy." What characterizes the intangible economy?
Stian Westlake: The essence of the intangible economy is that we're seeing the emergence of a new type of capital. What I mean by that is the stuff that businesses invest in has changed. Once upon a time it was predominantly physical things: machines, factories, vehicles. Now the majority of business investment in a country like the U.S. or the UK is stuff that you can't feel or touch. It's things like research and development, organizational capability, branding, artistic originals, and these things are as economically valuable to businesses, but they're not material.
Brain Anderson: So what are some of the broader characteristics of intangibles? How does intangible capital differ from the physical kind?
Stian Westlake: This is why the change to an intangible economy is so important because intangible assets have a few different economic properties. I call them the four S's because they all begin with S. Scalability. A little intangible goes a long way. Sunkenness in the economic sense in that if you have an intangible asset and your business goes bust, it's not worth much for example to creditors. Spillovers which is to say that if you invest in something like an idea or a piece of R&D, you can't be sure that your business rather than a competitor or someone else will get the benefit, the benefits spill over. Then finally synergies. The idea that these intangibles are particularly valuable when you combine them together in the right ways.
Brain Anderson: How has the emergence of these characteristics affected the economy as a whole and why should we really care about this transition?
Stian Westlake: We think that you can explain a lot of the unusual things going on in today's economy because of this move to intangibles. So a case in point, one of the things that we know is that the gap between what you might think of as leading firms, the most profitable productive companies in any industry or country and the rest, the laggard firms, has increased dramatically in the last 30 years. The best are pulling away and the worst are kind of lagging behind. We think that can be very compellingly explained by the idea that you see this most often in industries that are most intangible intensive. If these intangibles are scalable, you can spread them across a very big business and if they're particularly good when you combine them with one another, that is a recipe for the best pulling away and the rest lagging behind.
Brain Anderson: Do the laggard stop investing in intangibles because of this?
Stian Westlake: We believe so. We think if you look at industries where these gaps appear, investment seems to be concentrated in the leader firms, which is why if you look at say tech firms, the amount of investment being done by Google and Facebook and things like R&D is very high, but the aggregate levels in the economy are low despite low interest rates and the kind of technological cornucopia we see around us.
Brain Anderson: So if you could find a way to increase the participation in the intangible economy more broadly, close some of that gap, would that be beneficial to the economy as a whole or are we fated to have this?
Stian Westlake: If we can bridge that gap, if we can help laggards to catch up, that would be a great thing. The problem is some of the mechanisms that policymakers often think about for that kind of thing works less well in intangible economy. The idea of just giving say government grants to invest, less effective because the benefits accrue so much the leading firms.
Brain Anderson: We'll get to some of the policy recommendations you make in your City Journal article shortly, but I'd like to just drill down a little bit more on some of these trends. One of the others I think you've mentioned in the book and in this article is a rise in litigation and patent suits, things like that. I guess this would characterize companies that are very idea centric. If your idea can be stolen in a spillover, you're going to be suing people. Is that basically it?
Stian Westlake: That's absolutely right and one way to think about this is rights over physical property, right? So the tangible assets act kind of as old as human written law itself. The oldest human law codes include the ownership of physical assets, but the idea of what it means to own an idea or a brand are much more recent that kind of you see the first laws and these kinds of things in around 17th, 18th century. I guess what that means is our social norms, the understanding on which laws are based for owning ideas is much less firm, which means that there is a lot more to be gained from as you say, litigating over a patent, having a dispute over whether your partner drivers in your ride hailing app are your employees or not and therefore what rights and obligations you have towards them. These things are much more contested.
Brain Anderson: Wouldn't also give rise to an incentive to be lobbying for political power?
Stian Westlake: It absolutely increases the returns to lobbying for political power and indeed increases the material returns to people who have that power and can use it effectively in lobbying. So if you are a kind of Washington insider, a Westminster insider, or a Brussels insider, the commercial benefits to that increase as intangibles become more important in the economy.
Brain Anderson: Now why is it good that we're investing so much in intangibles? So though as you note that investment has slowed somewhat post financial crisis, but maybe address both of those things. Why is it a good thing that we are shifting to an intangible economy and what has slowed the rate of investment?
Stian Westlake: I think it's a good thing for two reasons. The first is almost is that it's just a function of society getting richer once as we get richer, as we satisfy our material needs, our needs for emotional fulfillment, for display, for intellectual concepts, and for entertainment grow.
So this is just an inevitable characteristic of society fulfilling more of its material needs and that is something we should all be happy about. The other thing is if we're concerned about how we make use of resources, if we're concerned about the environment, then being able to achieve economic growth without continually using up more of our material resources is net-net a good thing?
Brain Anderson: How does this affect productivity? There has to be a dimension to it there, right? We have had a pretty bad record in terms of productivity growth since the financial crisis.
Stian Westlake: That's absolutely right and we think there are kind of two really interesting links between the rise of the intangible economy and the slowing down of productivity growth. The first is that since roughly the time of the financial crisis, we've noticed something really interesting, which is that the rate of investment, the rate of growth and investment tangibles, which has been steadily growing since 1945 or earlier has started to slow.
Jonathan Haskel and I are working on understanding what the reasons for this are, but it might be that a lot of our institutions are financial and as you said, our legal institutions are not geared towards the further deployment of this economy. One of the things you would expect to see if intangibles are slowing because there's spillovers is you expect to see a slow down particularly in total factor productivity. That part of productivity which measures innovation and is captured by spillovers and that's precisely what we have seen in the productivity crisis that we face in the U.S. or the UK or other countries. So we think that's the smoking gun that intangibles play a big role in this.
Brain Anderson: Now your City Journal essay extends the argument of your book into a more explicitly policy driven agenda. You have a number of very interesting suggestions. One of them is addressing a problem with the intangible economy in that you tend to get these kind of clusters where you have a lot of productive people in successful cities, but there are also areas that are not so successful cutoff from this kind of productive explosion, agglomeration as Ed Glazer, the urban economist, calls it. Could you talk a little bit about what we should do or how we should think about sort of less successful cities and more successful ones?
Stian Westlake: Sure. Let's start first of all with the more successful cities and then we can move onto the less successful ones afterwards. One of the ironies of the intangible economy is that one particular type of tangible asset becomes all the more important and that is kind of prime urban real estate because as you say, because of the spillovers, because of the synergies, because these intangibles are good when you mix them together, places where people meet and exchange ideas are going to do better and better.
The challenge as Ed Glaeser and people like Enrico Moretti have observed is that contributes to an escalation of real estate prices, rising rents in these places which causes two things. It causes a slow down of investment in intangibles because people can't afford to live in San Francisco and Manhattan and it also stops the benefits spilling over from your kind of elite knowledge workers to the people in non elite technical jobs that previously would have gained from the salary uplift. So this is a big problem and obviously the simple answer that everyone, and no doubt most of your listeners would immediately describe is, you've got to make it easier to build housing.
Of course the devil is in the detail. One of the things that we talked about in our article and that I mentioned in my piece with Sam Bowman, Reviving Economic Thinking, is a way to get round that which is the idea of trying to push zoning decisions and planning decisions down from the higher levels, the city level, or in the UK we do a lot of this stuff at the national level where it's very easy for special interest groups to take over the lobbying and prevent development, pushing it down very much to the grassroots.
So in the UK we've called this street votes. Making planning decisions almost on a street by street basis. Sometimes in the U.S., people like Tyler Cohen have described this as local or block by block zoning.
Brain Anderson: So you get the buy in for an expansion of housing from the existing neighbors on the street?
Stian Westlake: You'd get it in a very local area. What that means, it's very possible that under this kind of system, most blocks, most streets would say no, the NIMBYs will win. Nothing will be built. Because you're dividing it down, you get enough variation that some streets, that some blocks will possibly attracted by the massive windfall gains to property owners that will accrue from this kind of development interests will say this is worth doing. It's a hack to try and get round the political special interest [crosstalk 00:00:11:25].
Brain Anderson: Over time you would see the streets gaining in property values that had opened up to more housing.
Stian Westlake: You would.
Brain Anderson: Yeah.
Stian Westlake: I mean if you're talking about say a low density close to public transport street in a city like London or probably in New York, everyone who owns a property on that street becomes a millionaire. This is a very attractive option from initial households.
Brain Anderson: It is a way to get local buy in. Yes. That's a very, very clever idea.
Stian Westlake: To some areas.
Brain Anderson: Something worth exploring in an American context as well I think. You also mentioned transportation connections, improving them. I think the example, if I recall from the piece we've just published was Wigan.
Stian Westlake: That's right.
Brain Anderson: Manchester City. Manchester City's come back and is kind of a successful city now. A big, big place. Wigan, not so much.
Stian Westlake: That's right. Wigan is kind of a [crosstalk 00:12:19].
Brain Anderson: It's close right?
Stian Westlake: It's very close. It's a proverbially poor English city George Orwell wrote about Wigan's deprivation 70, 80 years ago, but it's doing very badly. Of course what makes this strange is the distance from Wigan to Manchester, which is a increasingly prosperous urban area, is the same as the distance between the commuter suburbs of London in the center of London or the commuter suburbs of Manhattan or New York and the center of Manhattan. I guess what that suggests is that there is an infrastructure solution to at least some of these left behind places problems because a lot of left behind places are pretty close to agglomerations, but are poorly connected. So if we can deliver some of our transport investment towards improving local transport.
Brain Anderson: Bus lines, things like that.
Stian Westlake: It's much more buses than it is hyperloops for example. So it's pretty basic stuff that could help.
Brain Anderson: You also talk about how the financial system is not very good at dealing with the intangible economy and that has distorting effects. It's leading banks to invest more in things like mortgages and property than it is in intangible firms. Could you talk a little bit about that and what might be done or like why is that a problem and what might be done about it?
Stian Westlake: Sure. The root cause of all of this is the idea that intangibles represents sunk costs. So if a building owns lots of tangible assets and it goes bankrupt, creditors can take their concern-
Brain Anderson: And the word something, you can resell a boat or a building.
Stian Westlake: Exactly.
Brain Anderson: Put into a new purpose.
Stian Westlake: These things regularly get flipped quite quickly. They're a good prospect for debt for lenders. For debt investors. Intangible businesses, that's much less the case. These assets like an asset and software or a brand will often be worthless to a debtor. This gets you to what the academic Steven Chichetti called the curse of collateral is that in an increasingly intangible economy, the business lending aspect of the banking system and the bond market becomes less suited to what Keynes called the capital development of the economy, which gets you to an interesting position. So one option is you try and find forms of equity investment and this is effectively what Silicon Valley and other tech clusters are done.
Brain Anderson: With venture capital right yeah.
Stian Westlake: The venture capital tech sector took 60 years to grow, required a lot of people to lose a lot of money, required a lot of soft investors to be very kind of flexible in terms of return for a long period of time before you got to the levels of profitability you see now. Venture capital's only going to be relevant to a very small number of high growth firms. The question is how can you develop more equity like products or business finance? One example of that being done well. If you look at the way German business banking works, German business loans are often not secured on the property of the entrepreneur, but they include an equity like warrant. So banks in practice end up holding quite a lot of the instruments that are a little bit like equity and consequently they're more willing to invest in risky businesses without so many fixed assets.
Brain Anderson: I see. You also call for policymakers to adjust in certain areas. Regulators are not very adept at dealing with the intangible economy and then the question of government funding of research whether it's necessary or not. So maybe address those two things. What is the problem with regulation in this area?
Stian Westlake: We've gone through a kind of fantastic period of development of regulation over the last 40 or 50 years where we moved from a very kind of ad hoc method of regulating businesses to a very rules-based way of regulating competition, looking at market concentration, looking at price markups and unfortunately in an intangible economy where as you said before, there is so much contestation. That rules-based system becomes less and less appropriate. So in my own role in government advising on among other things, intellectual property policy in the UK, we found this. We found that when we were dealing with issues between say tech platforms and intellectual property rights holders. Rather than being like utilities regulated where you could say how much is your tariff gone up this year? Is that right? You'd be effectively exercising ad hoc judgements on one specific issue off to the next, each one pretty sui generis, each one negotiated.
So this creates a real challenge for regulators because regulators need to be much more tech savvy. They need to cultivate more political legitimacy so that they can make these decisions in an effective way. It also massively increases the scope for dodgy dealing effectively, for illegitimate action if the incentives and the governance are not good.
Brain Anderson: As for government funding of research, this goes on already of course, but why is it necessary and how might we do it perhaps more effectively than we currently do?
Stian Westlake: This stems from the spillover characteristics that intangibles has. One of the things that economists have always known is when an investment has high spillovers, if you leave the market to its own devices, businesses will invest less than are socially optimal because they can't expect that they will reap the full return.
Obviously that is why most governments on the right and left invest in public research because otherwise not an optimal amount will be provided. Now in an intangible economy, not only does research become more important, but other types of investment alongside research that have high spillovers become more important. So this poses kind of a challenge I think for policymakers. If you look at it very crudely, it would basically say the need for taxpayer funded investment, all else equal would increase. You'd expect to see more investment having the character of R&D that needs to be subsidized. Obviously there is a big government failure problem here because although we kind of know how to fund academic research through governments. We've been doing it for many decades. We're much less good at knowing how to fund applied research well, how to fund other intangibles.
When I think about the recent call we saw from people like Patrick Collison for progress studies.
Brain Anderson: This is Tyler Cowen.
Stian Westlake: This is Tyler Cowen. Patrick Collison's appeal for us to learn more about the art and science of how to foster economic and technological progress. That call in an increasingly intangible economy becomes very urgent. We need to know how to do this stuff well.
Brain Anderson: Final question concerns monetary policy. One of the arguments you make in this essay is that it's become less and less effective in the era of intangibles. So could you explain that. It's a little difficult to wrap your head around, but it's important.
Stian Westlake: That's absolutely right. I mean this is partly a function of slower growth, which as we said earlier, intangibles have a contribution too. The closer you get to zero economic growth, the less flexibility you have to raise and lower interest rates to stimulate the economy.
It also relates to the scalability of intangible assets. In an economy where a lot of your assets are effectively infinitely scalable, that's effectively the same as there being a lot of fixed costs and businesses. For monetary policy to be effective in the classical sense, you want the opposite. You want business to have lots of variable costs, so they're very sensitive to central bank base rates.
Brain Anderson: Here the firms can adjust more.
Stian Westlake: Precisely. Well because they will respond, I guess the classical way that your monetary policy works is when you lower interest rates, it becomes more attractive for firms to invest because they can borrow money more cheaply. If the output from businesses, if the amount that they produce is less dependent on their investment decisions because they have these assets which are effectively fixed cost and they can ramp up production almost infinitely without borrowing more. The output in the economy becomes less sensitive to interest rates. So just when central bankers are feeling very weak, when monetary policy is not very powerful because growth is so low, along comes the effect of intangibles and potentially makes the power of monetary policy even weaker.
Brain Anderson: Well thank you very much Stian. That's a wonderful tour of your essay.
Stian Westlake: Thank you.
Brain Anderson: And your recent research. The essay coauthored with Jonathan Haskell is called "An Agenda for the Intangible Economy." Thanks again.
Stian Westlake: Thank you.
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