Truly Understanding the Global Economy & Brexit in Context: Part 2-True Understanding & Insight

? Copyright Rethinking Capital (Andrew Watson & Robert McGarvey) 2018-All Rights Reserved

1. Imagine True Understanding

Imagine being able to stand back from Brexit and to be able to truly understand how we got here. 

Imagine being able to offer the UK an informed 4th way out of Brexit that could unite the whole country. United around a vision and promise for a future as the modern equivalent of the UK’s economic leadership after the Industrial Revolution.

Standing back from Brexit, imagine that all of ‘this’ has the same single root cause.

 ‘This’ being each and all of the chaos in modern society, including but not limited to:

•  Predatory capitalism and systemic corporate bad behaviours, including the choice of how much tax to pay and other short-term decision-making to increase quarterly growth,
• Populism, including Brexit and other attempted routes back to a safer past,
• Social injustice, including knife crime and foodbank demand far exceeding supply,
• Increasing wealth concentration and a systemic lack of empathy and compassion,
• Economic turmoil including GDP seemingly at the same levels as in 1971,
• The threat to humanity caused by climate change and reduced biodiversity,
• Racial, gender, sexual and other forms of conscious or unconscious bias and discrimination,
• The dying days of industrial empires.

Imagine being informed as to the root cause. Imagine being amongst the first leaders to truly understand the global economy and to offer an informed way out.

Imagine being the voice of calm above the shouting in ‘this’ storm, able, with confidence, to ask and answer all of the right questions. 

Imagine knowing, with certainty, which way we’re facing. And with even greater authority how we can go forward.

Informed leadership could be painting a positive picture of new kind of prosperity, launching a new 21st Century Renaissance. How refreshing would that be! 

2. The Problem: The Rise of Intangible Assets

 How can we go forward when we don't understand the changes in the global economy over the past 40 years or how to measure them? 

How can we make informed choices on virtually any topic when there is a minimum of $57.3trn (in full that is $57,300,000,000,000) of undocumented, undisclosed and unexplained intangible value in listed companies globally alone? And where nothing that is now creating value to the economy is measured or comparable at any level?

The global economy is unrecognizable from that of forty or even eleven years ago when the first iPhone was launched. A new economy has firmly taken hold. The Intangible Assets Economy (one in which all value is now created by assets which are not tangible, such as software, algorithms, copyrighted materials, patented innovations, culture, reputation, collaboration, relationships and data) has connected all of us. 

This economy is an undeniable commercial reality but in its first stages to now a single design flaw has been allowed to continue. In that the new economy is still measured and managed using pressure gauges and measurement systems designed for the old Industrial Assets economy.

Our systems to measure the economy have failed to adapt and must be updated for informed choices to be made. Supposed experts try to measure reputation using the same tools designed to measure the output of a production line. When these are found to be inadequate they look for proxies with which to measure them. If the effects weren’t tragic it would be funny.

Rethinking Capital believes that all of this collective chaos can be tracked back to this one single root cause: the undeniable transition to the Intangible Assets Economy and, so far, the inability to recognize, account for or compare them.

Assets exist at the end of a value chain that begins with raw capital.  The way out of our dilemma begins with rethinking the new forms of capital that are driving value in the Intangible Assets Economy and how they differ in comparison to Industrial Assets. 

There is not one but are now seven forms of raw capital (or sources of value creation) in the socially connected Intangibles Economy. By understanding their interactions and the flows between them it becomes quite simple to understand how to alter the effects—from a current excluding and selfish form of capitalism to one where the benefits of economic prosperity are shared by all.

Intangible Assets do perform very differently from Industrial Assets. For instance, all are a duality with extremes in that they can be both a value creating asset or a value destructive liability depending on the quality of their management. Culture or reputation, as examples of Intangible Assets, demonstrate this duality. Also all Intangibles can be built once and exchanged many, even many millions of times for different uses.  

Intangibles are not in any way like tangible assets, yet we still attempt to measure then using the same protocols and frameworks designed to measure fixed plant and equipment. How can we go forward with this scale of inefficiency in facts or absence of informed insights?

After rethinking capital then, quite remarkably, the very first step in removing the flaw is to update the principles of debits and credits in a modernized version of double entry bookkeeping.

The Inevitable Consequence: Retreat and Betrayal

In this transitional period, it is not surprising that our uninformed leaders sound a retreat back to the past to places of supposed safety. Brexit is a case in point. Put aside all of the shouting (a feature of any complex situation where nobody truly knows which way is up) and the UK is faced with three bad choices all of which represent routes backwards, and each of which is as divisive as the other.

Imagining a 21st Century Renaissance

Fortunately Western capitalism has stood at this very same point twice before in history and both times used the same steps to find a way out. As such a roadmap provides confidence that a way out has already been proven, not only once but twice.

3. The Root Cause

 Futuromics

In his book Futuromics, A Guide to Thriving in Capitalism’s Third Wave, economic historian Robert McGarvey uniquely identifies the root cause. McGarvey is one of the three founders of the Rethinking Capital community of experts in Intangibles. 

Uniquely is a bold statement but we are not aware of any similar informed insight. Leading economists tend towards a consensus that this is the fourth Kondratiev Wave of the Industrial Assets Revolution (the so called Digital Economy or Industrial Revolution 4.0). This is correct at the surface level but fails to recognize that the transition to the Intangible Assets Economy has occurred at the foundation level. Bank of England MPC member Jonathan Haskel in ‘Capitalism without Capital’ (with Stian Westlake) heads in the right direction in describing the Intangibles Economy but is several steps short of the true insight that it is not ‘without capital’ but a transition to a multi-capital economy. 

The key identifier of each of McGarvey’s Asset Waves is that capital changes form as a result of the transition.

In the First Wave, the engine of value creation transitioned from Feudal Assets to Trading Assets. Insight was required by the early adopters of the trading economy, led in the first instance in particular by the Medici Bank, to rethink capital and to introduce double entry bookkeeping to account for the new assets. With that they were able to determine how to connect capital to the new asset classes beginning with ships. In doing so the new trading economy was brought to life with capital and then flourished. McGarvey explains that the Italian Renaissance of the 15thcentury was a direct consequence of the introduction of a new class of productive assets into the feudal economy and the work of the Medici’s in identifying the new assets and banking the new economy. 

In the Second Wave the engine of value creation transitioned from a Trading Assets to Industrial Assets. We are all familiar with the technological revolution that drove industrialism, but John Pierpont (JP) Morgan was amongst the earliest adopters of the asset side of this Second Wave and used his insights to connect capital to railroads as the infrastructure for the new Industrial Assets Economy. Morgan gained so much wealth for himself by raising capital to fund his acquisition of the American railroad infrastructure that his monopoly was to be broken up by the US Government, but not before his hard work had given vital oxygen to attract capital to the new asset class.

McGarvey explains that Great Britain was amongst the earliest and most diligent adopters of the Second Wave, embracing new technologies and industrial engines of growth, collecting an empire but also launching a social revolution to create an enlightened and more just society as direct consequences. He attributes the three Reform Acts of 1832, 1867 and 1884 as direct consequences of the consolidation of the new forms of capital into the British economy and the sense of doing the right thing that was stimulated.

The Root Cause

The root cause of this chaotic phase in human history is that the global economy is passing through the Third Wave, the third transition in the engine of value creation from one asset class to another, whilst economic measurement systems have failed yet to adapt to the new commercial reality.

As such, the Third Wave has yet to be consolidated into our economic systems. 

Evidence of the Third Wave

To stress and to our knowledge, McGarvey is unique in identifying these waves. Four pieces of evidence indicate that he is correct and that this is, indeed, Capitalism’s Third Wave:

3.1 The Balance Sheet. Accounting practice writes off all investments in intangibles as an expense. As such, the balance sheet no longer meets its purpose as being a repository of a business’ assets and liabilities or the primary source of information with which to determine the benefits and costs of decision-making.

Without its anchor, business leaders can see the benefits of their decisions in increased Financial Capital but not the costs. The benefits of a decision by say Apple or Diageo to avoid paying tax or to assume unlimited supply of natural resource in their business plans increase EPS and other short-term growth measures, but do not account for the external costs of damage to Social Capital of reduced tax receipts or to Natural Capital in the form of climate change and damage to biodiversity. Our work internalizes those costs on the Parallel Balance Sheet.

The absence of the balance sheet as the anchor for decision-making has created a system with an embedded belief that only Financial Capital really matters and that all other costs are externalized. When a decision to deliberately avoid tax is encouraged and incentivized as it increases Financial Capital, a cogent argument can be made that the capital markets operate in the reverse of how they should: incentivizing bad behaviors whilst punitively punishing good behaviors if short-term growth targets are not met.

 3.2 GDP. As intangibles are not capitalized at the organization (firm) level, they do not aggregate into GDP. Put aside that GDP has an inbuilt assumption that growth in Financial Capital is a good thing, UK GDP therefore appears to have remained static since 1971. It should therefore be blindingly obvious that we are measuring the wrong things by not including all Intangibles. 

3.3 Goodwill. Goodwill is best seen as the bucket into which accounting throws all of the assets that it is not able to identify or explain. Of global market capitalization of $109.3 trillion, Brand Finance estimates that there is $57.3 trillion of unidentified and unexplained intangible value. In numbers that is $57,300,000,000,000 or ‘such a large number that it is hard to imagine’.[i]

Our belief is that when intangible value is truly understood, the actual number is over $90 trillion of $109.3 trillion. And that $109.3 trillion bears no relation to true asset value.

3.4 Connecting capital to early-stage companies. None of the global economies have yet figured out how to attach capital to the assets of knowledge-rich early-stage companies with which to fund innovation and growth. Lacking recognizable assets, early-stage companies are unable to attract commercial loans against their assets and other sources of capital are either scarce or inadequate or both. Failure to capitalize investments in intangibles is at the heart of this problem and central to solving this challenge.

[i]https://brandfinance.com/knowledge-centre/whitepapers/global-intangible-finance-tracker-gift-2018/ 

Next in Part 3, Rethinking Capital and the path to truly understanding the global economy.

And finally in Part 4, Brexit as an inevitable consequence and the informed 4th way out of Brexit chaos.