Restarting the Future (part 3)

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I want to give special attention to one other chapter of Haskel and Westlake’s Restarting the Future, and that is Chapter 5, “Financial Architecture: Finance and Monetary Policy in an Intangible-Rich Economy.” The authors summarize their argument in an opening statement:

An intangible economy makes borrowing harder and riskier. It also lowers the natural interest rate and so squeezes monetary policy. We need reform that allows pension funds and insurers to fund innovative companies and that allows fiscal policy to provide commitment to stabilising the economy with less space for monetary policy.

There’s a lot to unpack in this statement.

Financing investment

Where do companies get the financing they need for their capital investments? How is financing different for investments in intangible capital? Here I will focus on the financial needs of smaller businesses whose good ideas may well exceed their financial means, but whose potential for growth is essential to an innovative economy.

Small businesses are especially likely to rely on debt financing in the form of bank loans. A very few are able to get funding from venture capitalists. Bigger, more established businesses are likely to raise capital through public stock offerings.

Lenders tend to favor borrowers with tangible assets that can be used as collateral for the loan. (Bigger firms are more often able to borrow against their large cash flow.) But intangible assets are harder to use as collateral. Their value is harder to assess, and their worth may drop to next to nothing if the borrower’s business fails. Investments in intangibles carry other risks, such as the ease with which a competitor may latch onto the same idea. These are the issues of sunk costs and spillovers discussed earlier. The authors point out that as the intangible economy has developed, commercial banks have increasingly favored real estate loans over business loans because of their more predictable returns.

Even for companies that raise capital by selling stock, the intangible economy may increase the advantages of the most established firms. Consider the competition between two companies. The first has implemented a successful business plan and scaled its operations up to a high level, achieving high profits and a high stock price. The second is very innovative but not yet very profitable. If both companies owned traditional assets like plants and equipment, a stock investor might consider the second firm worth buying if its stock price were low in relation to its assets. With harder to evaluate intangible assets, such “value investing” becomes more difficult and less successful. A stock investor can do just as well buying the big “glamour stocks,” despite their high price.

One of the ways to overcome a shortage of financing for promising startups is to look to large pension funds and insurance companies. The authors recommend that we “alter financial regulations to make it easier for investment managers to back intangibles-rich firms, especially ones whose securities are less liquid.” They also recommend establishing “a collective fund (or funds) that…would spread risk and also achieve economies of scale to enable the kind of monitoring of companies that investment in illiquid assets requires.”

Some investment funds already engage in ESG investing, meaning that they favor companies with good records on environmental, social, and governance issues. (Social issues include things like human rights and data protection; governance issues include things like fair pay scales and freedom from corruption.) ESG policies may encourage certain kinds of intangible investments, such as new knowledge that can benefit the common good.

Funds with an ESG mandate should put a premium on firms that invest heavily in R&D, in design, and in training and other assets with positive spillovers, and asset owners who care about the future of the world should seek out funds with such a mandate.

I should mention that ESG investing is controversial, since it violates the neoliberal “Friedman doctrine” that a corporation’s only responsibility is to generate profits for its shareholders. Under the Biden administration, the Labor Department has issued a regulation that would give money managers more freedom to consider ESG factors when selecting investments, but Republicans are trying to kill it either with lawsuits or legislation. Some Republican politicians even want states to refuse to do business with companies that apply ESG criteria to investments. That, however, has produced a backlash not only from liberals, but from conservatives who think government should let private organizations invest as they please.

Monetary and fiscal policy

Macroeconomic policy to promote a thriving economy may also have to be different in the age of intangibles. Conventional policy in recent decades favors the manipulation of interest rates by the central bank to moderate expansions and contractions in economic activity. The idea is to cut interest rates to encourage borrowing and spending when weak demand creates high unemployment, but to raise interest rates to discourage borrowing and spending when excess demand creates inflation. Assigning this responsibility to an independent central bank like the U.S. Federal Reserve is supposed to minimize political interference with sound economic policy.

This approach may be losing much of its effectiveness in the intangible economy. Because business loans in intangible assets are riskier, money flows toward safer assets like treasury bonds. Interest rates on those assets fall, since buyers who prioritize safety are willing to tolerate lower returns. If the real interest rate is not far above zero even when the economy is doing well, the central bank has little room to lower rates when the economy suffers from weak demand and high unemployment.

On the other hand, raising interest rates to curb inflation may not have the desired effect either. Higher rates create additional financing problems for the small company with mainly intangible assets. At the same time, the more established company may be unfazed by higher rates, since it finances its expansion less by bank loans and more by retained earnings and equity. A big company with intangible assets of proven worth can also deliver software or stream entertainment to more customers at little additional cost.

Given the uncertainties surrounding monetary policy, the authors expect a greater role for fiscal policy in the management of the intangible economy. One danger, however, is that taxing and spending policies are more vulnerable to political conflict and lobbying. A possible solution is to give more authority to “independent auditors of fiscal policy” such as the Congressional Budget Office. Another is to agree on some automatic stabilizers that adjust taxes and/or spending to economic conditions. Governments do some of that already with means-tested social programs like Medicaid, for which more people become eligible as incomes drop. Another proposal—not discussed in this book—is the Public Service Employment program recommended by Stephanie Kelton and other proponents of Modern Monetary Theory. It would maintain full employment by expanding when private employers are laying workers off and contracting when they are rehiring. That is in sharp contrast to conventional monetary policy, which tolerates high unemployment as the price society must pay for low inflation.

The intangible economy is a work in progress, and a book of this kind inevitably combines description and speculation. We are moving into uncharted territory, where conventional ideas about how the economy works are due for some revision.

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