Thursday, February 6, 2020

Interview with Janice Eberly: Intangible Capital and Other Topics

Jessie Romero has an interview with Janice Eberly in Econ Focus (Federal Reserve Bank of Richmond, Fourth Quarter 2019, pp. 22-26). The introduction notes: "Her research covers topics including firms' capital investment decisions, household consumption choices, and how these decisions influence, and are influenced by, macroeconomic trends. Most recently, Eberly has been studying the implications of rising `intangible investment' — the investments firms make in software, intellectual property, and the like — for aggregate investment, market concentration, and productivity growth."

The topic of intangible capital is still very much a subject of live research, not as settled question. But it offers the potential to be an explanation for some otherwise puzzling patterns in the modern economy. For example, US investment spending in physical capital has is low, which seems strange in an economy which "everyone knows" is moving toward a greater focus on technology. Maybe investments in intangible capital can help explain why? Physical capital can help produce up to a certain amount, bur then runs into physical limits. However, intangible capital may be able to expand output to much higher levels without running into physical limits. If some firms are going better at intangible capital investments than others, this could help to explain the rise of "superstar" firms. Here are some comments from Eberly in the interview:
We're familiar with investments in physical capital, by which I mean property, plant, and equipment — the things most people would recognize as capital. That's tangible capital. But today we also have intangible capital — the investments you can't touch, such as software and intellectual property. You can expand the definition to include things like worker skills that are specific to the firm; when a firm invests in its employees, it's also developing its capital in some broad sense. The metaphor we often use is that Amazon's software platform is as crucial for its business model as an oil platform is for an energy extraction firm.

These types of investments are increasingly important: Intangible capital is the fastest-growing part of investment. It also seems to be playing a greater role in the success of firms. Not only is intangible capital a larger and larger share of investment overall, but it's also especially important for the firms that end up being the leading firms in their industries.

Amazon's business is built on intangible capital; Walmart's logistics technology is all intangible capital. Retail is a sector where efficiency has risen dramatically and labor productivity has gone up. This is very highly associated with the increase in intangible capital, so in retail especially you see a very strong role for intangible capital among the most successful firms. ...

Intangible capital seems to be where firms' innovative investments are reflected. Historically, we thought technological change was embodied in tangible capital: When firms put new equipment in place, it came with new software and new capabilities. So a way of increasing productivity was to put new equipment in place. Today, you can buy the software separately. So the question is whether physical capital is embodying technological change in the way that it used to. Is the technological change actually in the intangible capital? ...

Intangible capital does seem less sensitive to traditional monetary policy. It tends to depreciate quickly, and it's not an interest-rate-sensitive spending category. That tends to make it less responsive to monetary policy that moves interest rates.

Financial innovation could reverse that effect, though. If intellectual property was "financialized," for example, becoming more like liquid assets, you could definitely see credit markets arising behind intangible capital, as there are for machinery and equipment. Now, intangible capital tends to be embedded in a firm. But there are new markets developing all the time that could make intangible capital more marketable. There are already markets for some types of intangible capital — patents can be bought, sold, and licensed, for example. ...

Just like job growth has shifted toward the service jobs you can't send overseas, investment has shifted toward the industries where you can't offshore the capital and away from the durable goods and manufacturing industries. The curious thing was that we saw job growth in the high-skilled, high-tech sectors, but we didn't see the counterpart in investment growth. We saw the hollowing out of investment away from manufacturing, but we didn't see it going toward high-tech. This was my first inkling that something was going on with investment that was different from what we'd seen historically. The physical capital was the dog that didn't bark.

But high-tech is where there's been a big increase in intangible capital. So when you add that in, you do see a rise in not only high-tech jobs, but also high-tech investment — it's just that the high-tech investment is not the tangible kind.
For those interested in digging into the underlying research, a good starting point is "Understanding Weak Capital Investment: the Role of Market Concentration and Intangibles," by Nicolas Crouzet and Janice C. Eberly (NBER working paper from May 2019 is here; for an earlier ungated version from the Kansas City Fed, see here). From the abstract:
We document that the rise of factors such as software, intellectual property, brand, and innovative business processes, collectively known as “intangible capital” can explain much of the weakness in physical capital investment since 2000. Moreover, intangibles have distinct economic features compared to physical capital. For example, they are scalable (e.g., software) though some also have legal protections (e.g., patents or copyrights). These characteristics may have enabled the rise in industry concentration over the last two decades. Indeed, we show that the rise in intangibles is driven by industry leaders and coincides with increases in their market share and hence, rising industry concentration. Moreover, intangibles are associated with at least two drivers of rising concentration: market power and productivity gains. Productivity gains derived from intangibles are strongest in the Consumer sector, while market power derived from intangibles is strongest in the Healthcare sector.
I recommend the rest of the Eberly interview as well. As one example, I was intrigued by one of her comments about student loans: 
What everyone notices when you look at the student loan data is this increase in loans outstanding over the course of the 2000s. Then it accelerates during the financial crisis. ... There's a generational switch: The financial responsibility for education is being transferred from the parents to the students. When the parents lost access to home equity, they reduced spending on many things, but they reduced their spending on education more than on other parts of their budget. The student loans help the family to insure the student's education, but there's a reallocation of consumption within the family as well.

So far, the switch hasn't reversed. So there does seem to be a longer-run shift toward students self-financing their educations. Some of that is a change in the composition of the student body, so you're seeing more students who are self-funding.