5 Public Policy problems in an Intangible Economy

In a previous newsletter, I talked about how economics of intangible goods is unrecognizably different from manufactured goods.?

Let's take the example of car production: building the 10th car costs you (almost) the same as the 1000th car.

But here's the catch: the marginal costs for building the 10th and 1000th copy of a software is trivial. The only cost involved is towards creating the 1st copy.

Software came to be included in the US' GDP calculations only in 1999. But, today, intangibles dominate the market. In fact, a 2017 study found that tangible assets of Microsoft Corporation (like plant, equipment, etc.) constituted only 4% of their total assets.?

I reiterated what 'Capitalism without Capital' (by Jonathan Haskel and Stian Westlake), dubs as the 4 S’s of Intangible economy:?

1. SUNK cost: In the event your investment doesn't pay off, you don't have physical assets to fall back on. If your new software fails, the investment cannot be recovered by selling physical assets.
2. SPILLOVERS: A company's R&D, unless protected by patents, is readily available for competitors to poach upon. An Uber driver can also seamlessly work with Lyft.
3. SCALABLE: Unlike physical assets, intangibles lend themselves to near-infinite scaling up with trivial costs. If your software clicks, you can scale it up all across the globe without significant costs.
4. SYNERGIES: Intangibles exhibit synergies with other intangibles as well as tangibles leading to dramatically better products/services. Smartphones (hardware) work effortlessly with mobile OS like Android or iOS, apps etc. (intangibles).

Public policy in intangible economy

The shift, however, is generally imperceptible to the public, and therefore to politicians. Since it doesn’t affect political fortunes yet, governments across the world are largely oblivious to the transformative nature of the shift.?

However, the intangible economy, by virtue of its 4 S’s, is poised to create public policy challenges of a new kind. The kind that will elude solution if viewed through conventional wisdom.?

The book argues that governments will soon be forced to grapple with 5 big public policy questions around the intangible economy.?

1. How to protect intellectual property?

Given the problem of spillover, companies must be able to better-protect their intellectual property and copyrights. Companies must be incentivized by stronger legal processes that permit them to profit from the investments (while forbidding illegal use of their intangible assets).?

The book offers a few ideas: long-lasting patents, IP rights over designs and frameworks, and giving legal teeth to non-compete laws by companies (because trained employees leaving for other firms can cause them harm too).?

However, the book is aware of the damage that over-strengthening of rights laws can bring to synergies. Discouraging other firms to capitalize on synergy opportunities that intangibles create can reduce productivity gains from investments.?

Also, overly strong laws make the system vulnerable to lobbying by the highest bidders. There, however, is a solid case for clear legal processes that discourage legal shopping and vexatious lawsuits.?

There is a need for a widely-accepted valuation mechanism for intangibles. Processes to co-invest in research and share the resulting IP rights must be developed too.?

2. How to encourage synergies?

Despite the increasing use of digital communication, cities still offer the bulk of synergy opportunities. It’s vital to develop urban clusters that encourage cross-pollination of ideas from people in different walks of life.?

There’s a reason why Bengaluru continues to be a talent hub despite challenges in urban infrastructure.?

However, as the intangible economy grows in size, there’s a pressing need to make building of houses and workplaces easier. Governments need to ease rigid regulations that are inhibiting growth of new-age places of work and congregation.?

A few adjustments, in terms of unsightly development for instance, may be considered to make urban clusters economical and convivial. With specific regard to Bengaluru, moving defense units out of the city can be considered. The space thus freed can be used to create good roads and industrial parks. If the greed to occupy every inch in the city is somehow avoided, it can further enhance its stature as the silicon capital of India.?

3. How to finance intangibles?

The book asserts that the financial markets have largely been designed to meet the needs of the tangible economy. It’s easy to finance a company that owns a fleet of cars. Should the company fail, it’s easy to take charge of these cars and recoup a portion of investment.?

Given the sunk cost problem, it’s not easy to finance companies that deal with intangibles. The financial market needs to be more open to finance them.?

Again, the book offers a few ideas. Offering intangible-backed loans, tax breaks, and facilitating the shift from debt to equity financing (through tax credits). The authors caution against pushing tax breaks beyond a level, because it might encourage dumb investment (when the tax break by itself becomes enough incentive for businesses).?

Large institutional investors must be encouraged to invest in ecosystems, so that they benefit from spillovers even if individual companies fail.?

Broadly, there must be a cultural shift to make investors more receptive to long-term investments that intangibles demand.?

4. How to share risks?

As the recent splash by DeepSeek shows, it’s difficult for companies to appropriate the benefits from investment in intangibles.

Private firms will only invest in innovation when they can reasonably expect to capitalize from it. When this is not so clear, governments must step in to fill the gap. The avenues available to the government typically are: public R&D funding, tax breaks, direct funding, free technical advice to companies and acting as a lead procurer.?

There’s an interesting story about how the US government directly contributed to the rise of the IT industry by first acting as its lead procurer. I’ll get to this story some other day.?

5. How to address economic inequality??

The rising economic inequality is a plank of several political parties across the world. Its resonance with the masses makes it a highly volatile and contentious? issue.?

The inexorable shift to intangible economy will be accompanied by greater economic inequality. This happens because the intangible economy is often a winner-takes-it-all market. A small number of companies tend to dominate the market, while the rest are pushed to the periphery.?

The intangible economy is designed to catapult a set of workers to the next orbit of prosperity, while pulling others downstream. This is bound to create social tensions between those who benefit from the intangible-rich economy vs. those who’re left behind.?

This might be an unfortunate situation because the intangible economy relies on social trust to function smoothly.?

The book notes: “To help the intangible economy thrive, policymakers will want to encourage trust and strong institutions, encourage opportunity, mitigate divisive social conflict, and prevent powerful firms from indulging in rent-seeking. But at the same time, an effective intangible economy seems to exacerbate all of those problems, creating particularly socially charged forms of inequality, threatening social capital, and creating powerful firms with a strong interest in protecting their contested intangible assets.”