Chapter 1
The Invisible Revolution: How Intangibles Are Reshaping Our Economy
In 2017, Microsoft became the third most valuable company globally with a market capitalization of over $500 billion. Yet its balance sheet showed barely $30 billion in physical assets-buildings, computers, and equipment. What explained this massive valuation gap? The answer lies in Microsoft's vast portfolio of intangible assets: software code, organizational systems, brand value, and human capital that traditional accounting struggles to measure. This phenomenon isn't unique to tech giants-it represents a fundamental economic transformation happening across developed economies. From Starbucks to Toyota, companies increasingly derive their value not from things you can touch, but from ideas, processes, and knowledge.
Jonathan Haskel and Stian Westlake's groundbreaking work has been praised by economists like Larry Summers as offering "a better understanding of how our economy is changing." The book has influenced policy discussions at central banks and finance ministries worldwide, with The Economist calling it "essential reading for anyone who wants to understand how the modern economy works." As our economic foundations shift beneath our feet, understanding this invisible revolution becomes crucial for investors, business leaders, and policymakers alike.
Chapter 2
When Investment Vanishes Into Thin Air
Colin Matthews, CEO of British Airports Authority, reluctantly allowed valuers to assess Stansted Airport in 2012 after losing a three-year legal battle against UK competition authorities. Accountants meticulously counted and valued every physical asset-terminals, equipment, parking lots, runways, fuel storage facilities, and security systems-using traditional accounting methods. When Stansted sold for 1.5 billion in 2013, the price closely matched these calculations, demonstrating the enduring power of tangible asset valuation in determining market worth.
Remarkably, this modern valuation process mirrored what happened in the same location nine centuries earlier. William the Conqueror's representatives had counted Stansted's physical assets for the Domesday Book, meticulously documenting mills, livestock, slaves, plowlands, and woodland, valuing the manor at 11 pounds per year. The Domesday surveyors even counted individual beehives and fishing weirs, showing how thoroughly physical wealth was measured. Though the assets evolved from oxen to machinery to computers over centuries, the fundamental approach remained consistent: measuring tangible things with lasting value as the basis for economic worth.
This traditional approach to valuation made perfect sense in an economy dominated by physical assets. For centuries, investment meant creating tangible capital-factories, machinery, vehicles, buildings, and infrastructure. These physical investments formed the backbone of economic understanding and measurement, allowing governments and businesses to track growth through visible, countable assets. Statistical agencies meticulously tracked business investment through regular surveys, focusing exclusively on tangible assets: buildings (78bn in UK, 2015), IT/plant/machinery (60bn), vehicles (17bn), and other physical infrastructure. This system worked well for an industrial economy where wealth creation was directly tied to physical production.
But something profound has changed in recent decades. Businesses increasingly invest in intangible assets-proprietary software, licensing agreements, patents, brands, designs, and internal organizational know-how. These investments require substantial time and money to build and deliver lasting value, despite being immaterial. Microsoft exemplifies this shift-worth $250 billion in 2006 with only $3 billion in physical assets. Google, Facebook, and Amazon similarly derive most of their value from intangible assets. This represents capitalism without capital - a fundamental shift in how modern businesses create and capture value.
The intangibles research program developed steadily from 2005, with economists Carol Corrado, Charles Hulten, and Daniel Sichel producing the first comprehensive estimates of American business investment in intangibles. This groundbreaking work spread globally through organizations like the OECD and World Bank, revealing that intangible investment has grown increasingly important, now outweighing tangible investment in most developed countries. Studies show that in the US, UK, Sweden, and Finland, businesses invest more in intangibles than physical assets. The shift represents more than just normal evolution in what businesses invest in-it fundamentally changes how the economy functions, affecting everything from productivity measurement to competition policy to intellectual property rights.
Chapter 3
The Four S's: Why Intangibles Are Different
Intangible investments differ fundamentally from tangible ones in four crucial ways: scalability, sunkenness, spillovers, and synergies.
Scalability means intangible assets can be used repeatedly in multiple places simultaneously. Once created, intangibles like Starbucks' operating manual, the Angry Birds app, or a jet engine design can be deployed across countless locations at minimal marginal cost. This scalability derives from the "non-rivalry" of ideas-using an idea doesn't prevent others from using it too. While physical assets like factories can only operate in one location, software can run on millions of devices simultaneously.
This scalability creates three distinct economic effects. First, intangible-intensive businesses like Google, Microsoft, and Starbucks can grow extremely large with relatively few physical assets. Second, scalability leads to industry concentration-markets dominated by relatively few large companies. Third, competition becomes winner-takes-all: when assets are highly scalable, runners-up often receive meager rewards, as users gravitate toward the best solution (why use Yahoo when Google's algorithm is superior?).
Sunkenness refers to how intangible investments are typically harder to recover or sell if a business changes direction or fails. When a hypothetical coffee chain "Tarbucks" goes bust, its buildings, coffee machines, and vehicles can be readily sold. But its brand, operating procedures, and specialized knowledge are much harder to value or transfer. Unlike tangible assets, intangibles lack standardization and mass production that would make them interchangeable, and they're often uniquely linked to their original business context.
The sunk nature of intangible investments creates several economic challenges. They're difficult to finance with debt since banks can't easily seize and sell them as collateral. Without functioning markets, valuing intangibles becomes highly uncertain. Managers may fall victim to the "sunk-cost fallacy," refusing to abandon failed intangible projects because they've invested heavily in them.
Spillovers occur when intangible investments generate benefits that extend beyond the investing company to others who didn't pay for them. Ideas, being non-rival and often non-excludable (hard to prevent others from accessing), readily flow between companies. While developed countries have well-established laws for tangible property ownership dating back millennia, intangible property laws are much newer and more contested. Patents and copyrights emerged much later, with early examples in medieval Venice and 16th century England, evolving through the 18th century when the United States enshrined intellectual property in its Constitution.
This historical gap-tangible property having a 3,500-year head start on intangible property-explains why knowledge spillovers are so much more common than physical asset spillovers. These spillovers create underinvestment (companies invest less when they can't capture all benefits) and a premium on spillover management ability (companies that can protect their own intangibles or effectively exploit others' gain competitive advantage).
Synergies emerge because ideas combine exceptionally well with other ideas. The microwave oven exemplifies this "combinatorial" nature of innovation-defense contractor Raytheon's cavity magnetrons (developed for WWII radar) were combined with Amana's kitchen appliance expertise and Litton's safety improvements to create a revolutionary product. As Brian Arthur explains, every new technology builds upon a pyramid of existing ones. Matt Ridley describes innovation as "when ideas have sex"-exchange drives cultural evolution like sex drives biological evolution.
These synergies create a counterforce to spillover concerns, encouraging openness rather than secrecy. When ideas become more valuable combined with others, businesses have incentives to access external knowledge through open innovation. This creates a fundamental dilemma: protecting intellectual property prevents spillovers but reduces synergy opportunities. As Bill Joy noted, "most of the smartest people work for someone else."
Chapter 4
The Intangible Economy All Around Us
Modern gyms reveal how even physical businesses have transformed through intangible investment. Comparing a 2017 gym to one from 1977, the visible equipment might look similar, but today's gym relies heavily on intangible assets: proprietary software systems, sophisticated brands built through advertising, standardized operations manuals, and staff training protocols.
Beyond this "innervation" of traditional businesses, entirely new business models have emerged, like Les Mills International, which sells choreographed exercise programs (Bodypump) to gyms worldwide. Their assets are primarily intangible-brands, intellectual property, expertise in designing classes, and relationships with 130,000 trained instructors across 55 countries.
Similarly, supermarkets have transformed dramatically. While their physical spaces remain recognizable, their behind-the-scenes operations now rely heavily on computerized inventory systems, complex pricing strategies, branding campaigns, and management systems. Tech companies exemplify this trend most dramatically, with Apple's elegant designs and supply chain expertise, Uber's driver networks, and Tesla's manufacturing know-how representing massive intangible investments.
Data shows this shift clearly: in the United States, intangible investment surpassed tangible investment by the mid-1990s, while the UK crossed this threshold in the late 1990s. Across Europe, the transition happened around the time of the global financial crisis, though with significant country-by-country variation.
Several factors drive this long-term rise in intangible investment. As manufacturing productivity increases faster than services productivity, labor-intensive intangible investments (design, R&D, software development) become relatively more expensive than tangible investments. New technologies increase the return on intangible investments, with IT dramatically improving the efficiency of information-based intangibles.
Industrial structure also plays a role. Surprisingly, manufacturing has become more intangible-intensive than tangible-intensive over time, likely due to globalization. When developed countries face competition from lower-wage economies, they specialize in manufacturing that requires significant intangible investments-from R&D programs to lean production techniques.
Regulatory environments significantly impact intangible investment. Countries with stricter employment regulations invest more in tangibles but less in intangibles. When hiring and managing staff is difficult, businesses may prefer machines over people. However, intangibles often require workforce flexibility-implementing lean processes or developing new products requires workers to adapt.
Market size strongly influences intangible investment. Many intangibles like brands and software can scale almost infinitely, making larger markets more attractive for such investments. Countries with restrictive trade policies tend to have lower intangible investment, while rising international trade over fifty years has provided greater incentives for intangible development.
Chapter 5
The Puzzling Economic Consequences
The rise of intangibles helps explain several puzzling economic phenomena, including secular stagnation-the persistence of low business investment despite favorable conditions. This manifests through several symptoms: investment levels have fallen dramatically since the financial crisis despite historically low interest rates; corporate profits are at historic highs and increasing, particularly for top firms; and productivity growth has declined not just from lower investment but primarily from falling multi-factor productivity.
A good explanation for secular stagnation should explain four key facts: falling measured investment despite falling interest rates, strong profits, increasingly unequal productivity and profits, and weak total factor productivity growth. The rise of intangibles may explain these phenomena through several mechanisms.
First, investment appears low because we're not measuring all intangible investments. While intangible investment now exceeds tangible investment in countries like the US and UK, much remains uncounted in national accounts. Including previously unmeasured intangibles raises the investment/GDP ratio but doesn't significantly affect its trend.
Second, intangibles' scalability allows leading firms to achieve enormous productivity with relatively little tangible capital, creating a widening gap between industry leaders and laggards. Scalability makes intangible investment more appealing for firms confident they can deploy assets across large operations. Conversely, spillovers may discourage average firms from investing, as they fear competitors will capture the benefits.
This creates a divergence where leading firms-those owning valuable scalable intangibles and skilled at capturing spillovers from others-become highly productive and profitable while competitors lag behind. Data shows that productivity spreads (gaps between best and worst firms) have widened more in intangible-intensive industries and countries.
Third, poor TFP performance in recent years may be partially explained by the slowdown in intangible investment growth since 2007. Data across ten countries shows that before the Great Recession, most countries experienced positive growth in both intangibles and TFP, but after 2008, nearly all moved to negative or slower growth in both measures.
Chapter 6
The Growing Inequality Puzzle
The increasing importance of intangible investment appears connected to the rise of various forms of inequality in developed countries. Economic inequality manifests in multiple forms: income inequality has risen dramatically since the 1980s; wealth inequality has grown substantially; intergenerational inequality has reversed historical patterns; geographic inequality between thriving cities and "left-behind" communities has become politically salient; and "inequality of esteem"-where certain groups feel disrespected by perceived elites-fuels populist movements.
While technology, trade, and wealth accumulation explanations seem plausible, they struggle to explain four key phenomena: technology doesn't consistently reduce jobs or wages; income inequality is heavily concentrated at the very top 1%; housing wealth plays a disproportionate role in wealth inequality; and wage differences between firms, rather than just within firms, account for over two-thirds of rising earnings inequality.
The rise of intangible investment may help explain these patterns through several mechanisms. The scalability and spillover characteristics of intangibles create a world where the best firms become highly productive and profitable while competitors lose out. "Superstars" with privileged access to valuable scalable intangibles reap vast rewards-either through ownership (tech billionaires with equity stakes) or special privileges to create intangibles (like J.K. Rowling with Harry Potter).
The contested nature of intangibles makes certain types of employees particularly valuable-Reich's "symbolic analysts" who combine cognitive skills with social abilities to appropriate spillovers and identify synergies between intangible assets. Studies show intangible-intensive companies specifically seek employees with both analytical and relationship-building skills.
Intangibles enable hierarchies to emerge both between and within firms. Research on American lawyers between 1977-1992 showed top lawyers' earnings rose dramatically because they could work with more junior associates-the "coordination cost of hierarchical production" decreased due to intangible investments in organizational development, software and systems.
The intangible economy also helps explain wealth inequality through property values. Housing prices have risen dramatically but unevenly-doubling in some cities while stagnating in others. The cities with skyrocketing prices tend to be economically thriving places where building new housing is difficult. As intangibles become more important, businesses and workers increasingly want to locate in diverse, growing cities to exploit spillovers and synergies. With regulatory barriers limiting new construction, housing prices rise dramatically, enriching property owners.
Additionally, the growing importance of intangibles contributes to wealth inequality through tax policy. While governments have become less willing to tax capital since 1980 partly due to ideological shifts, intangible assets present a practical challenge-they're far more geographically mobile than tangible assets. While relocating physical operations like oil refineries would be enormously costly, moving ownership of intellectual property to tax-favorable jurisdictions requires only modest legal work.
Beyond economic inequality, intangibles contribute to "inequality of esteem"-the growing social divide between cosmopolitan, educated liberals and more traditionalist populations skeptical of elites. People scoring high on "Openness to Experience" tended to vote Remain in the Brexit referendum, while those scoring lower tended to vote Leave, regardless of income or class. This psychological trait-openness-appears particularly valuable in an intangible economy that rewards making connections between different ideas and people.
Chapter 7
Infrastructure for an Intangible World
While infrastructure seems the antithesis of intangibility-consisting of massive physical structures like bridges and highways-an intangible-rich economy requires both specialized physical infrastructure and intangible infrastructure (rules, norms, and processes). As production methods evolve, infrastructure needs change accordingly.
Despite early "death of distance" predictions that knowledge and digital technology would render physical infrastructure obsolete, traditional infrastructure remains vital. However, the rise of intangibles does shift infrastructure priorities toward systems that maximize spillovers and synergies.
In an intangible-intensive economy, infrastructure that facilitates connections becomes particularly valuable, helping organizations exploit spillovers from others' investments and identify synergies between ideas. This includes infrastructure supporting dynamic clusters where innovative businesses and people can share ideas. Two critical infrastructure needs for clusters are: affordable housing/workspace in existing clusters (as exemplified by Silicon Valley's housing crisis), and spaces for interaction like cafes and cultural venues.
While telecommunications infrastructure is crucial for enabling interactions in an intangible economy, its relationship with productivity is complicated by two factors: the rapid pace of technological change creates investment timing dilemmas, and new infrastructure requires complementary new ways of working to deliver value. Paul David's research on electricity adoption showed that factories took nearly forty years to fully electrify because they needed to fundamentally restructure operations to benefit.
Effective rules, institutions, and norms significantly impact intangible investment. These create "invisible infrastructure" that makes inherently complex, uncertain endeavors manageable. Beyond formal property rights, specialized systems like the pharmaceutical industry's structured drug development process feature standardized trials, funding rules, and unwritten norms about acquisitions. While standards also apply to tangible investments, they're especially crucial for intangibles because of their synergistic nature.
Trust and social capital-the strength, number, and quality of relationships among people in society-represent the least physical yet crucial form of infrastructure for intangible investment. Trust encourages the open interactions that create synergies between different intangibles, as people share ideas more readily in open societies. Additionally, trust helps provide certainty around investment rules: companies need clear parameters about data usage and ownership to justify investment.
Chapter 8
Financing the Intangible Economy
The financial system faces unique challenges in an increasingly intangible-based economy. Banks struggle to lend against intangible assets because they're typically sunk investments that can't be easily sold if a business fails. While tangible assets like buildings or machines can be valued and used as collateral, intangibles like Toyota's lean production systems or Starbucks' operational handbooks have little value outside their specific business context.
This discrepancy appears in leverage ratios: industries with tangible assets have higher debt levels while intangible-intensive industries rely more on equity financing. As economies become more intangible-intensive, bank lending becomes increasingly problematic, potentially affecting banking system stability as unsecured business loans grow riskier.
Stock markets and equity owners are often accused of hampering business investment through short-termism. The case of ICI exemplifies this critique-once Britain's flagship chemical company that invested heavily in research and innovation, ICI began pursuing short-term shareholder value in the 1990s, engaging in acquisitions and divestitures that ultimately led to its decline and sale to Akzo Nobel in 2008.
Research shows managers cut R&D spending when their equity is vesting, suggesting short-termism. However, other research comparing similar public and private firms shows public companies maintain patent output but change innovation strategy-buying higher-quality patents while in-house scientific staff often depart.
Shareholder composition matters significantly: companies with institutional investors and concentrated ownership (blockholders) invest more in R&D than those with dispersed ownership. Blockholders have stronger incentives to research companies' long-term prospects and intangible assets, supporting managers making sound long-term investments while penalizing short-term thinking.
Venture capital emerged as a financing mechanism specifically adapted to intangible-intensive businesses, evolving alongside companies like Google, Intel, and Uber whose competitive advantages depend on intangibles. Venture capital has evolved features perfectly suited to intangible-intensive businesses: equity stakes rather than debt (since failed intangible businesses have little salvage value), pursuit of home-run successes (exploiting the scalability of assets like algorithms or patents), and sequential funding rounds (addressing the inherent uncertainty of intangible investments).
Despite being well-suited to investing in intangible-rich businesses, venture capital faces three significant limitations: VC-backed firms are unlikely to conduct basic research due to spillover problems; VC struggles with intangible investments requiring very large, uncertain funding; and VC's effectiveness is difficult to scale up-Silicon Valley's VC sector took four decades to mature with considerable public subsidy.
Chapter 9
Policy for an Intangible Future
Politicians excel at responding to dramatic events but struggle with slow, gradual changes like the rise of the intangible economy. Despite its importance to issues from productivity stagnation to inequality, the subtle thirty-year shift toward intangible investment hasn't triggered urgent policy responses.
The intangible economy presents five key policy challenges: First, intangibles are contested-ownership is difficult to establish and benefits often spill over to others, putting pressure on intellectual property frameworks. Second, intangible success depends on synergies-combining different ideas and assets drives innovation, requiring policies that facilitate idea exchange.
Establishing clear ownership rules for intangibles presents a delicate balance. While stronger IP protections reduce spillovers and encourage investment, they can simultaneously inhibit synergies between intangibles and create barriers to competition. The optimal approach isn't simply strengthening IP laws, which can favor incumbents and patent trolls, but creating clearer IP frameworks with well-run patent offices that reject vague claims and consistent court jurisdictions.
Creating conditions for intangible synergies requires thoughtful urban planning that balances growth with livability. Cities need both liberal building policies and careful planning for interaction spaces. The economic cost of restrictive urban policies grows increasingly severe in an intangible economy.
Financial markets need restructuring to better support intangible investments. Governments should encourage IP-backed lending, reform the tax system to equalize treatment of debt and equity financing, remove regulations discouraging blockholding, improve accounting standards for intangibles, and potentially deploy sovereign wealth funds to invest across intangible ecosystems.
Despite the fundamental underinvestment problem in intangibles, evidence shows government research investment yields positive returns. Beyond R&D funding, governments can support intangible investment through tax breaks, direct funding, procurement, and education. In an intangible economy, government's role in education becomes increasingly crucial, with adult education offering a promising approach by allowing skills upgrading throughout careers.
The intangible economy creates particularly vexing forms of inequality that governments must address. This creates a double dilemma: the dominant economic mode produces inequality that voters find problematic, while this divisive inequality threatens the social institutions on which a thriving intangible economy depends.
As we navigate this economic transformation, understanding the unique properties of intangible assets-their scalability, sunkenness, spillovers, and synergies-becomes crucial for investors, business leaders, and policymakers alike. The shift to intangibles isn't the sole cause of complex economic phenomena like secular stagnation and inequality, but understanding its role helps prioritize strategies that align with this long-run economic transformation.
