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Declining capital investment no problem in a digital economy

Economists and politicians are fretting about the fall in capital investment – but this is to be expected in a digital economy where startup costs are shrinking

We face an economic problem, a conundrum, that the conventional ways of economic thinking are not helping us to solve. Of course, people have been telling us this about neo-liberalism for ever, but that’s not the point at issue here.

The problem is this: we see the capital share of the economy growing, and the workers getting less of the total value produced – yet, at the same time, the amount of capital investment in the economy is falling. It shouldn’t be this way – if investing is more profitable than it used to be, then we should be seeing more investment. So why aren’t we?

Two unconvincing answers come from either side of the Atlantic and the probably correct one comes from the technology industry.

The first argument that fails to fully persuade has been popularised by US economist Larry Summers – the idea of secular stagnation. He says there is something fundamentally wrong with the economy and so we need to educate more people, the government needs to spend more on research and development, and so on, to sail us out of the doldrums.

This doesn't entirely convince because Summers would always say that – have more government spending on those two items and on infrastructure. He’s a man with a hammer to which every problem is a nail.

Over here, John McDonnell, our new shadow chancellor, as Summers once was US Treasury secretary over there, muses slightly differently. He says that companies – the private sector, in fact – simply don’t know what to invest in, so the state should take over the job and do it for us.

This doesn’t convince either, because the idea that life will be better if McDonnell and friends spend more of our money is not persuasive.

More productive investment

But what does convince – me, at least – is that the answer is in the way capital investment has simply become more productive in recent years. From the first wave of the internet boom, Amazon has obviously spent heavily on warehouses and technology and is now a retail behemoth on at least two continents. But that capital spend has been a fraction of what it would have taken to achieve the same position in even one country through a traditional bricks-and-mortar retail approach.

Meanwhile, eBay has captured much of the world’s buy-and-sell classifieds without really needing any investment in a physical presence. And in media, the Huffington Post and Buzzfeed (should you bother to read either of them) now have greater reach than any newspaper of the past without having had to buy a single printing press.

Examples of quite how far this situation has developed come from the investor James Anderson. He points out that BP has fixed assets of $130bn in its accounts. That’s what has been spent over the years to build the company’s infrastructure, yet its market value is now $105bn.

Apple’s equivalent is $22.5bn in fixed assets and it is the most valuable company in the world, worth $633bn. Facebook’s valuation is near $300bn, yet that capital – its fixed assets – are only $5.4bn. It is obviously possible to create value off very much smaller amounts of capital than in the past.

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As a boring technical point, those stock values do not compare with capital’s share of GDP that we worry about increasing – it is the profits that become part of GDP, not the share price. But if the capital share increases, then the labour share of the economy must be decreasing. And that is something people are worrying about. The workers are getting less from the sweat of their brows and the capitalists are gaining more by exploiting them, if you’re of a Marxist turn of phrase.

That capital share is definitely increasing. And that is our conundrum: if that is the case, we would expect people to be investing more. Who, after all, doesn’t like getting more in return for whatever it is they do? If it’s now easier to make large profits, then there should indeed be more investment pursuing those profits. But that’s the part we don’t see.

Investment into the economy is falling and it’s not just because of the recession – it’s been going on longer than that. Which leads to Summers and secular stagnation – if we don’t get the investment, then the economy won’t grow. And then to McDonnell and government – if the private sector won’t invest, then the state must.

The cost of ramen noodles

At which point we turn to internet entrepreneur Marc Andreessen. He has pointed out that, not that long ago, you needed to spend $20m or so even to set up an internet company. Routers, servers, proprietary databases, pay a portal for distribution, and only then could you actually start to do anything. Nowadays all of that can be hired for peanuts – the cloud, software as a service, and so on.

This means that he sees companies that have started with $1m, still have most of that in the bank, and yet have millions of customers around the globe. The fixed capital of a company these days can be “literally their laptops and their ramen noodles, and that’s it”, as Andreessen puts it. 

At this point, we can explain the rise in capital productivity but not the fall in capital investment. The simple fact is that there are only so many opportunities within the technological space at any one time and only so many people capable of taking advantage of them. So there is a limit on how many projects can be done, but each such project is becoming cheaper.

We, as consumers – the whole economy, in fact – are just fine because all of that available entrepreneurial space is being explored. We will still get the benefit of the new goods and services that are potentially available, and that’s really the only thing we’re interested in.

And the fact that less capital needs to be allocated to make this happen is just great, because it means that more of the economy can be consumed rather than invested, while still having the same future growth rates. In short, there is no problem here that needs to be solved.

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