Intangible investment and monopoly profits

I’ve been reading the forthcoming Capitalism Without Capital: The Rise of the Intangible Economy, by Jonathan Haskel and Stian Westlake, which is one of this year’s most important and stimulating economic reads (I can’t say it is Freakonomics-style fun, but it is well-written relative to the nature of its subject matter.)

The book offers many valuable theoretical points and also observations about data.  And note that intangible capital used to be below 30 percent of the S&P 500 in the 70s, now it is about 84 percent.  That’s a big increase, and yet the topic just isn’t discussed that much (I cover it a bit in The Complacent Class, as a possible source of increase in business risk-aversion).

Here is one option Haskel and Westlake lay out, though I am not sure to what extent they are endorsing it, as opposed to merely presenting it:

1. More intangible capital means greater spillovers across firms.  Consider Apple inventing the iPhone, and many other companies free-riding upon the original R&D.  Of course Apple itself was free-riding upon earlier attempts to build smartphones and tablets.

2. In essence, free-riding companies receive more intangible assets, a kind of free lunch on the side of what otherwise would be expenditures on fixed costs.  But receiving these intangible benefits itself requires a kind of scale, so they are not available to each and every potential entrant.

3. Corporate profits go up for some of the winners, but monopoly has not risen in the traditional sense.  In fact, more companies are competing for the smart phone market.

4. Eventually those profits will fall, as for instance iPhone imitators will force Apple to lower prices for its devices.  But that long-run can be quite far away, and as you probably know after ten years iPhone prices have pretty much held firm.

5. Now how big a productivity gain comes from those cross-firm externalities?  It might depend on how many other firms are sufficiently well-scaled to receive the intangible external benefits from the first-mover innovators (this part of the argument in particular I am not sure I find in the book).

6. The so-called “superstar” firms are those that scale up to capture intangible externalities from many other sources, not just one or two.  That includes Google and Facebook, but most firms don’t have the talent or cash pile to make that leap.  Therefore these gains remain concentrated, income inequality goes up, both in general, and across business firms, as indeed we observe in the data.  Since entry into “holding a position to capture a broad swathe of intangible externalities” to tough to accomplish, this state of affairs can persist for some while.  Yet, still, in no particular market are mark-ups over marginal cost worse, nor are monopoly problems worse from the point of view of consumers.  Profits of the superstar firms are much higher.  Arguably that is a pretty decent description of the American economy today.

7. You can think of these conditions, collectively, as arranging a big transfer to some leading businesses, yet without distorting too many other margins.

Now, I’ve put that all into my language and framing, rather than theirs.  In any case, I suspect that many of the recent puzzles about mark-ups and monopoly power are in some way tied to the nature of intangible capital, and the rising value of intangible capital.

The one-sentence summary of my takeaway might be: Cross-business technology externalities help explain the mark-up, market power, and profitability puzzles.

You should all pre-order and then read this book, due out in late November.  I thank PUP for the review copy.


'monopoly has not risen in the traditional sense'

Ever looked at how many companies can make the tangible smartphone screen? Whether one wants to call it a monopoly or not, it is most distinctly a bottleneck, one that companies competing in the smart phone market are extremely aware of.

For that matter, ever looked at how many companies can actually assemble a tangible smartphone? Or countries - the U.S. is not among them, after all. Americans apparently prefer getting rich from the intangible, while accepting that the rich get richer, with the gains concentrated, and income inequality going up.

"Ever looked at how many companies can make the tangible smartphone screen?"

What do you think the answer to this question is? There are at least ten Chinese manufacturers making advanced display panels; also Samsung (the market leader) and LG in Korea.

There are bottlenecks in getting enough units of the most advanced, latest technology out quickly enough, but that's because of the fast-moving nature (and, ironically, competitiveness) of the smartphone market. Not because there is a lack of competition in making the screens.

And Apple is pretty much reliant on Samsung - 'At this point, it is well known that the iPhone 8 (or iPhone Pro, or whatever it’s called) will feature a new (5.8-inch) OLED screen. Reports indicate that this display will be exclusively manufactured and supplied by Samsung, as Samsung currently dominates global supply of phone-sized OLED panels.'

'in getting enough units of the most advanced, latest technology out quickly enough'

Which is what Apple absolutely relies on. Touch screens, even small ones, have been around for decades. The manufacturing of touch screens that people want to spend a large amount of money on is concentrated among a few companies. Who, if one were a believer in Smith's ideas, do not spend much effort competing on price.

I decided not to use the word 'cartel' in that first post, but it is one that Prof. Cowen seems to be assiduously avoiding in all these discussions. Here is a well known example involving 8 companies - 'The European Union today imposed record fines against drug companies for colluding to fix the price of vitamins.

Eight companies were fined 855.2m euros (£529.5m) for what the EU antitrust chief, Mario Monti, described as the "most damaging series of cartels the commission has ever investigated".

Hoffman-La Roche of Switzerland received the largest fine, 462m euros, for being the "prime mover and main beneficiary" of the cartel.

Mr Monti said that the Swiss firm, the world's largest vitamin producer, was the main instigator and produced all 12 vitamins concerned.

The second-largest fine - 296m euros - was levied against Germany's BASF, the world's second-biggest maker of vitamins.'

Oddly enough, the German federal anti-monopoly/anti price fixing agency is called the Bundeskartellamt - the German word for 'cartel' sits right in the middle. Monopolies are generally not that common. Cartels, on the other hand, seem to be the sort of thing that many American economists seemingly have no experience with, at least on a theoretical level. Especially as in their eyes, price fixing is clearly the sort of thing that competing companies would never engage in, as such mutually beneficial behavior for cartel members seems to go against the very principles of a cut throat free market.

"US Ambassador to the United Nations Nikki Haley said Monday that North Korean leader Kim Jong Un was "begging for war" as she urged the UN Security Council to adopt the strongest sanctions measures possible to stop Pyongyang's nuclear program."

You might want to stop and consider this from a different perspective. I know you're hunting for evidence that monopolies exist, but you should also consider:

1) Apple's volume is so large it could effectively find any similar firm and ask them to make the product, and people would do so. They'd invest in the machinery etc.

2) Maybe Samsung already has the machinery., tools, etc. so they can offer a lower price for these specific sizes. Maybe Apple negotiated a massive volume discount, too.

Thus, there is no "monopoly."

Walmart might place a huge order for tennis balls to a tennis ball factory. This would appear, on paper, that the factory has a "monopoly" but it really doesn't.

Or, if it does, it may be transitory - a few years while a Taiwanese firm's plant is finished.

Ignore the North Korea part.

A monopoly is bad when it can ratchet up prices.

When Apple is the buyer, I doubt the part factory has monopoly power even if the Apple order placed would make it a "market leader."

+0.75, deduction for the NK-NH glitch.

I think it is important to understand that "moats" as in Buffett's parlance are not the same as monopolies. For instance Coca-Cola is able to charge premium prices for its flavoured sugar water due to the historical advertising and the fact that they were the first global company in this area. But the soft drink industry, globally or locally, is not a monopoly. This is similar to the Apple I-Phone, I continue to buy them as I know there product will work, plus I want avoid all the inconvenience of changing to another brand. Again this does not mean the smart phone category is an Apple monopoly. The question is, is there a good reason for Governments to regulate against moats as well as monopolies? I can see than many people on the rent seeking side trying to make such arguments so they get the rent themselves or for their pet policies, but is it really good policy to disincentive companies from creating moats? When I look at the smart phone industry, I would bet that the reason so much capital was pored into that industry over the last 10 years was in expectation of being able to get these extra rents, I would argue that if it had been seen as likely a commodity industry the investments would have been much lower, which would have probably deprived us of the progress made in this area.

Good points Chris. Without a monopolistic prize, investors don't invest. Patents therefore are necessary and good, though the laws need some reform.

Bonus trivia: only people in the government spell, as Chris did, government with a capital G.

There is not actually any patent that creates the major distinctions between a Moto G5 ($230) and an iPhone 7 ($650).

The latter just pulls in more cutting edge components from (shared) suppliers. As I say below, one invites consumers to pay to ride that curve, but Moro Gs and iPhones advance in parallel.

The Moro G 5 matches some earlier iPhone, legally, because there was never a justifiable patent to prevent that.

I largely agree, but in all tech products it is not "us" that uniformly pay for innovation. It is always a smaller group who will pay the introductory price on an advanced model. Today that would be 12 core Intel buyers, or "must have the latest" phone buyers.

Those are the fat margins that tech companies compete for with high R&D.

You can avoid the price bloat and get best chip with Threadripper.

Also premium chips ($500-1000) paying the R&D bills.

BTW, good observation on the similarities of Coke and Apple brand dominance.

One man's "moat" is another man's "wow, I really like this company's products."

This seems pretty plausible.

One thing that would be useful would be to put together a list of the ten biggest market capitalization firms in 1957,1967 ... to 2017. Having examples to theorize off of is better than theorizing without examples.

Here is top 10 market cap firms on 3/31/2017:

Rank First quarter[10][note 1] Second quarter[11][note 1] Third quarter Fourth quarter
1 United States Apple Inc.
2 United States Alphabet Inc.
3 United States Microsoft
4 United States
5 United States Berkshire Hathaway
6 United States ExxonMobil
7 United States Johnson & Johnson
8 United States Facebook
9 United States JPMorgan Chase
10 United States Wells Fargo

And here's the FT's global list of top ten market cap public companies in 1997:

This Financial Times–based list is up to date as of 30 September 1997.[67]
Rank Name Headquarters Primary industry Market value (USD million)
1 General Electric United States Conglomerate 222,748
2 Royal Dutch Shell The Netherlands Oil and gas 191,002
3 Microsoft United States Software industry 159,660
4 Exxon Mobil United States Oil and gas 157,970
5 The Coca-Cola Company United States Beverage 151,288
6 Intel Corporation United States Computer hardware 150,838
7 Nippon Telegraph and Telephone Japan Telecommunications 146,139
8 Merck United States Health care 120,757
9 Toyota Motor Corporation Japan Automotive 116,585
10 Novartis Switzerland Health care 104,468

By the way, looking at stock market trends, it really seems like the Current Era started c. 1995. I'm guessing that Newt Gingrich winning the House in 1994, followed by Bill Clinton triangulating away from the left in response played a big role in the huge growth of stock values in the second half of the 1990s.

No doubt that played a part, that along with: the peace dividend, the steady march of Moore's law causing computers to take an ever more important role in human's lives, and China slowly awakening.

Good points, but it's interesting how all those things didn't really get priced into the stock market until about 1995 or 1996.

I can recall seeing Chinese manufacturers dominating the toy department in Walmart in late 1991 and thinking that China was unstoppable. That didn't mean I actually put my money where my mouth was, of course!

Recall that Clinton got elected in 1992 on a sort of old-fashioned 1960s-1970s Democratic Hubert Humphrey-style platform in which the government was supposed to intervene a lot in the economy to pump up jobs but not profits.

The more I think about it, the more I think the Current Era really got started with Newt winning the House in November 1994 and then Clinton moving to the right over the next few months.

Steve - here is my take - Apple - moat not monopoly (example: Samsung). Alphabet - moat not monopoly (Bing), Microsoft - moat not monopoly (Open Office, Linux), Amazon - moat (plenty of retailers, including online ones), Berkshire Hathaway - they invented the moat idea, Exxon - interesting one, I don't think they are either just a damn well run company (make most of their money in downstream which is notorious for poor margins, Johnson and Johnson - good example of a moat company, Facebook - probably the strongest moat around, JP Morgan and Wells Fargo are probably there due to regulators and too big to fail (I know the Government will rescue JP Morgan so I bank with them), so perhaps closest to monopoly but even there there are plenty of banks around if you don't like them.

Bing only exists because Microsoft wills it to exist.

The same used to apply to Apple, around the era when Microsoft was facing legal problems -

If you want to put a date on when everybody who was anybody had stopped caring about anti-trust, December 1, 1998 was the announcement date of the Exxon - Mobil merger. Symbolically, that reversed the 1911 break-up of Standard Oil.

Exxon have been doing a pretty poor job since then of keeping the oil price up. Must be something to do with them having less than 3% of world production. Truth is that Exxon makes most of its money in refining and chemicals which are the ultimate commodities.

Exxon makes most of its money [or, did] in its upstream business [exploration & development]

Its downstream business [which includes its refineries] runs off the fumes of an oily rag.

Did? As an Exxon investor (1000 shares, the minimum shares of nearly all the stocks my 1-% family owns, except Berkshire) I'm curious what percent their downstream business earns? Exxon famously has claimed it makes as much money no matter which way the price of oil goes (a sales pitch probably).

"Intangible capital" is just a euphemism for market failure (in the sense that a firm or firms generate profits in excess of marginal costs). How the excess profits are accounted for is more a matter of tax planning than economics. We've been conditioned to think of "intangible capital" as that which reflects know-how, represented by patents and other intellectual property that can be moved around in order to achieve the goal of tax minimization. Why consumers pay a higher price for a good that can be purchased for a lower price can only be explained by human behavior, efforts of economists to explain it in strictly economic terms notwithstanding. Rather than an i-phone, consider something more basic such as one's labor. I work with physicians and physician groups, and I'm often asked if a medical practice has "goodwill value" that would support charging new partners a price in excess of the value of the practice's fixed assets. The simple answer is that the practice has "goodwill value" if the partners can expect to have income from the practice in excess of the value of their services. What's the value of their services? It's the lowest price an employer would pay in order to attract the number of employees the employer wishes to hire. In the physician context, that wasn't always easy, but now it is. Young physicians today prefer working for a hospital or large group practice or network so they can devote their "free" time to other activities (raising a family, travel, etc.) as opposed to spending their "free" time developing and maintaining "goodwill" (with referral sources): the hospital or network draws the referrals not the individual physicians who work there. Hence, the hospital or network only pays the value of the services provided by the physicians they hire. Why the hospital or network has the necessary "goodwill" to draw the patients is a more complex issue. For example, is it a reputation for "quality" or is it market power (the market for health care services being a local market) and the leverage it provides with third party payers or the leverage it provides from so many cross referrals (the greater the number of physicians employed by the hospital or network the greater the leverage, or scale matters). Whatever the reason, the consequence is a shift of revenues from labor (physician services) to "intangible capital". There's a reason why hospital profits (and hospital stocks) have soared. Economists have in the recent past explained the high cost of physician services as in large part due to "fragmentation" (i.e., many small and inefficient providers). What was needed, according to economists, was scale. Well, the "market" seems to be mitigating fragmentation, but rather than lower prices for health care services, we've simply shifted income from physician services to "intangible capital". Is that a market "success" or a market "failure"?

Rayward says: “Intangible capital” is just a euphemism for market failure - but the rest of the prolix post doesn't support this prose.

My Neanderthal definition of "intangible capital" is the calculated anticipated future net operating income (NOI) discounted at a market-determined (from observation of actual transactions) cap rate minus the GAAP stockholders equity.

The market condition I find most peculiar is that companies with minimal NOI or operating losses have huge market caps, e.g., Tesla whose market cap exceeded GM's at one point.

Good points. At one point goodwill formed the crux of the argument behind the Cambridge Capital Controversy (

Bonus trivia: Joan Robinson was a good looking funky chick. I wonder how such an attractive woman made it in such a male dominated field?

Comments like yours here don't help. You're a creep, bro.

Again, see Kurz "On the Formation of Capital and Wealth", abstract and link here:

From the abstract:
"We explain why IT innovations enable and accelerate the erection of barriers to entry and once erected, IT facilitates maintenance of restraints on competition. These innovations also explain rising size of firms."

"Monopoly surplus is unobservable and we deduce it with three methods, based on surplus wealth, share of labor or share of profits. Share of monopoly surplus rose from zero in early 1980's to 23% in 2015. This last result is, remarkably, deduced by all three methods."

Re: "This last result is, remarkably, deduced by all three methods" - there's nothing remarkable about any model fitting the data. Please realize that before any competent economist modeler releases a paper they make sure the data fits the model. There's even a Matlab program that will fit any number of points with a weighted n-th order polynomial, with the researcher supplying the weights (values of the coefficients), which can even be the price of butter in Bangladesh (i.e., a random variable). The Matlab program will find the 'best fit' which is often remarkably close to the data, so you have a single equation describing the data. The real wonder however is if the model fits 'out of sample' data, so researchers feed known data not fit by the Matlab program and see if the model can predict it. Another is to wait a while and see if the model predicts the future (it rarely does). Youngster, don't be so awed by econometrics, it's a lot of snake oil and 'publish or perish' behind the scenes. You're welcome.

Canadian retail firms have a history of failed IT implementations. The large US chains have their own development teams, the costs amortized over the larger breadth of their market. Canadian firms have the same exigencies, moreso even with the sparser population over larger area, but don't have the resources to develop in house their solutions. They are protected by the barrier to entry of the smallish market and high costs of servicing it.

How does this fit into the thesis? They didn't have untangible assets. One of which would be the incentive structures. Notice how valuable the data has become as well, simple data such as the size and shape of product containers.

Canadianess is a intangible.

3. Really? When I shopped for a phone a few months ago it seemed my options were pretty much Apple, LG and Samsung.

I consider the entire phone market fairly stagnant right now. There's basically only one design for the phone itself and people have realized most apps are worthless. It's all about improving existing features, like cameras. Facebook is turning into the Microsoft of social media, so that field is dead.

You are probably O-L-D.

Young people buy phones on-line from places we can't even imagine.

I had an employee buy a phone directly from China. It worked very well and cost a fraction of a US brand.

Ah yes, the theoretical "young people" who exist in far smaller numbers than we assume. I don't actually young people, I mean the young who mostly exist in sentences that start with "All young people today..."

My car and my phone work somewhat well together (Android Auto). The car supports Apple CarPlay as well. I have always wondered why these efforts took so long. Were carmakers mistakenly leaving intangible capital laying in the street? Out of some misguided hope that they could beat Apple and Google to create their own superior tech network?

Or an example of "when monopolies fight" progress might be deadlocked for a time?

More on "missing innovation" .. computers are relatively insecure, but the most insecure (Microsoft Windows) endures. Why?

Coke like popularity trumps content?

(A broad university effort to create a Rust based OS and application framework would leverage us all to higher security, but we don't, because we dislike both public research and public mega projects).

There is reference to a large increase in intangible assets as a % of total assets in S&P companies over 30 + years. I wonder how much of this increase is Goodwill resulting from acquisitions? If it makes up a meaningful portion of the increase -- I thin different factors are at play. Such as larger companies becoming more acquisitive and, with low discipline around acquisitions, Goodwill is often the result of overpaying for acquisitions.

Acquisitions are a part of it, yes. The more interesting view is that the market landscape has changed drastically. The goal now is to be bought out in tech or pharm. You don't start a company to build it and be successful, you start it to get noticed and sell. This is fundamentally different from 1950.

Large companies are outsourcing to start ups much of the risk of development. Start a company to develop one drug, sell it to a pharm company. Pharm companies are now basically regulatory experts. Their entire existence is due to their expertise in shepherding drugs phase 1-4 and having the all star legal team to fend off lawsuits, and the connections in Washington to grease the wheels.

Similarly, tech companies buy start ups to fend off future competition. Essentially buying networks, not IP. Anyone can make Snapchat. Not hard. The network is what they're buying. And it works.

I've heard and talked to google developers and what always comes through is the scale of what they do. Even an in house application for some kind of business housekeeping is large, broad and thousands of users. They have a software build system across the enterprise, everything from the self driving car software to the timesheet web app all gets built on this thing. It handles scale and breadth of applications. They are working to release it as a product because other firms have the same requirements without the ability to develop such a thing.

IBM used to have this ability, but fell behind. Instead of investing in untangible assets like people and know how, they invested in their own stock. They aren't a force in the marketplace any longer.

Life is complicated. IBM Fellows have generated 9,329 patents, received five Nobel prizes, but somehow they did not leap from there to a innovative innovation.

"IBM Fellows have generated 9,329 patents, received five Nobel prizes,"
That means absolutely nothing. The "somehow" you find so mysterious is that, as derek says, IBM lags in R&D spending.

Think it through, the proper comparison is with the kids who ate their lunch.

Bill Gates at 19 did not outspend then or out patent them.

He "innovated" very specifically by taking a risk IBM saw as unprofitable and unnecessary.

So too Google and Facebook.

You are really not offering anything close to useful. Think that through.

Neither of us knows the trick, or we would tell Microsoft right now how to found the next transformational tech product.

But it ain't research spending in absolute billions. That's not how Tesla or eBay or PayPal or Uber or Square or Stripe broke in.

Few on your top spending list are creating new genres with their research billions. Cloud computing a possible exception. An expensive area for innovation.

If you want to continue this in a fact based way, I nominate Alphabet as the best attempt at a "free to fail" innovation environment by a large established company. Google Glass was folded(*) with fairly small fanfare.

Apple and Microsoft have a higher tendency to go "all in" on CEO sanctioned Next Big Things. The problem with that approach is that all the game changers I mentioned above could never survive that process, which by its nature looks for odds-on bets.

* - with chance for rebirth

Oh, and lest we forget

Not turned into an innovative innovation.

What is an example of the difference between intangible capital and IP? Obviously the former can be stolen without penalty but why?

There is probably some technical distinction between "asset" and "capital" but for us mortals.

Everybody free-rides. We're using language, for instance.

I specifically brought this up in your last monopoly post for a reason.

The change in Tobin's Q is THE story of the late 20th century. It's a bright neon sign flashing "competition is falling." Good for me I guess, terrible for the working class.

For liberals: oligopoly, monopsony in some labor markets, For smarter liberals: network effects and bottleneck/noncompetitive distribution channel ownership, For conservatives: regulatory arbitrage and rent seeking. All are right to some degree. And it needs to be addressed. Now. And we do not have an elite/political class capable of doing anything about it. We do not even have a press capable of describing the problem.

The breakdown in labor productivity vs wages is right here. Dealing with this and listening to Scott Summer would mean no Trumps ever again in the White House.

As an aside, if intangible capital comprises a far more significant driver of value and earnings, how much of financial analysis and accounting is missing the elephant in the room?

We have mature approaches to understand the value drivers and risks in presenting a set of financial accounts for a manufacturer or a traditional services business, less so for a business which has a (natural) monopoly on a data service and derives pricing power from its market position. (And the extreme leverage potential of those datasets mean that a relatively valuable data product could go undiscovered for some time, before exploding in popularity and revenue earning potential before it finds its market.) Likewise the relative immaturity of the commercial contracts which these companies enter into (hence the abundant spillover benefits, and attempts by companies to in house data acquisition, as per The Economist's argument a few weeks back). This all feels like the world before common internet protocols and standards were developed: some people might get it, some don't, and I've got no idea who's right or wrong.

Seems like the accounting profession is struggling with this issue, just like regulators or policy makers. That sounds harsh, but it shouldn't, they're working to develop tools which work in a new environment just like everyone else.

"But that long-run can be quite far away, and as you probably know after ten years iPhone prices have pretty much held firm."

Eh, not really -- not in real terms, especially given that the value difference between the current iPhone and the original (which had no GPS chip, no app support, a tiny, low-res screen, and a 2MP camera) is vast. Also Apple is able to keep its prices up as well as it does only because it concedes 80% of the market (so definitely nothing close to a monopoly).

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