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The intangible economy

Will highly regulated economies become less and less significant, as we see more and more of the intangible economy?

John Gillingham is perhaps America’s pre-eminent historian of the EU. His book, The EU an Obituary, argues that the EU lacks the vitality and agility in its institutions to compete effectively in the 21st century. Inadvertently, another more recent book – Capitalism without capital, by Jonathan Haskel and Stian Westlake – puts flesh on the bones of this argument.

Haskel & Westlake’s book focuses on the rise of the intangible economy. They are not trying to make any statement on the EU, but in one chapter of their book they plot tangible and intangible investment against an OECD measure of employment strictness.

The results are fascinating. In their own words: “Countries with more restrictive hiring and firing invest more in tangibles and less in intangibles.” Let’s consider why this might be.

If hiring and firing rules are too onerous then one would expect that companies would substitute capital for labour, technology for people. This helps explain why the tangible investment share rises with OECD measured labour market strictness.

The more difficult task is to explain why the strictness measure has a reverse effect with regard to intangible investment. Haskel & Westlake speculate that the explanation might be that intangible investment might be more risky, with a high possibility of failure i.e. new disruptive business models that don’t cause a disruption. The end result is that less flexible workforces deter such investment in the first place.

Haskel & Westlake also plot the share of intangible investment in GDP against an OECD index of restrictiveness in trade in services. Whilst not definitive, there would seem to be a negative relationship, with greater restrictiveness associated with a lower share of intangible investment in GDP. It is suggested that the explanation for this negative relationship is scalability. Potential scalability is a central feature of the platform based intangible economy, and if markets have too much restrictiveness it’s not too much of a surprise to find that their intangible investment share of GDP is lower.

Why is this important? The answer is because of the sheer scale of intangible investment. In a number of advanced economies new intangible investment already exceeds new tangible investment. What’s more, the evidence supports the view that intangible investment will be higher in more flexible economies. This leads inexorably towards the conclusion that as intangible investment becomes more and more important, those economies with more restrictive labour and product market regulation, will become less and less significant.

Looser regulation of product and labour markets encourages more intangible investment.

Another feature of the intangible economy is also fundamental i.e. spillover effects. This is the effect whereby others gain from a private investment. Lower levels of intangible output result in lower spillover effects across the wider economy. In other words initial weakness in the level of intangible activity is then compounded by a reduced knock-on effect.

Flexibility and agility is essential to reap the rewards of the intangible economy, with platform based business models and crucial first mover status. This is precisely the wrong moment in history to head down the road of statism and protectionism. The world economy needs to be liberated, not merely to survive, but to thrive. The fear is that the rhetoric of populist economic policies will drown out this message.