>Ocean Tomo calculates intangible assets simply “by subtracting the tangible book value from the market capitalization of a given company or index,” so the rise in intangibles since the 1970s is in part just a reflection of rising stock market valuations. But that’s not all it is: the cyclically adjusted price-earnings ratio on the Standard & Poor’s 500 Index has risen about 2 1/2 times since 1975, while the intangibles increase has been almost fivefold.
Tobin’s q is the ratio of the stock price to the replacement cost of capital. I am tempted to write:
q = P/K = (P/E)(E/K), where P is the stock price, E is earnings, and K is capital.
As Fox points out, a fair amount of the rise in q since the late 1970s comes from a higher P/E ratio. But I gather that if you think of K as tangible capital, then E/K also has soared.
Fox’s piece was mentioned in Scott Sumner’s discussion of what I called the fifth force. But Robin Hanson got me to take a look.
I would note that intangibles in the economy include not just firm-specific intangibles but also general intangibles that lead to better patterns of specialization and trade. Institutional improvements in India and China, as well as lower transportation and communication costs, come to mind.
Tyler Cowen has much more, including a hypothesis that accounting issues are involved.
Companies use much less working capital. It’s easier to borrow money from the bank at 2% for working capital than it is to use equity capital that costs 10%. Working capital is a large percentage of tangible capital. I don’t know what a typical ratio between working capital and fixed capital is, couldn’t find a good link, but it is significant. Plus companies have figured out ways to eliminate working capital (Dell was very good at this) and using software to reduce inventory.
“But I gather that if you think of K as tangible capital, then E/K also has soared.”
Yes and no.
I’ve been playing with some Compustat data, also attempting to control for changing levels of debt over time (because increasing leverage will change P/K even if there is no underlying change the accounting or the technology, because K is tangible book value of equity, net of debt.) What you really want to compare is total firm value including claims by debt holders, total tangible assets, and earnings plus interest. I left some comments on Robin Hansen’s post about this issue.
If you include debt in this way, it looks to me like “E/K” has tended to increase for non-financial firms. But at the same time it’s decreased for financial firms, so for the entire S&P 500 it has not changed much.
I suppose that looking just at non-financial firms would be more what we are interested in, but I’m still thinking about this.
Nearly 250 years ago, a very observant man (Adam Smith) chronicled the business processes of a very productive pin factory, versus the business processes of a not-so-productive pin factory.
Now it occurs to me that, if one were to consider the “tangible asset to market cap” ratio of the initial not-so-productive pin factory, and then the “tangible asset to market cap” ratio of the very same pin factory after it had implemented the superior business practices chronicled by Adam Smith, one might just observe exactly the same phenomena that Justin Fox observed. Just a guess on my part, of course – GAAP and the S&P 500 weren’t around 250 years ago.
I can fully understand how Justin Fox might think this trend is somehow attributable to some sinister conspiracy, and the result of evil, rich capitalists buying off governments, and probably the explicit reflection of everything bad in the world. He’s just a “journalist”, after all.
What amazes me is that an “economist” considers this trend attributable to “Dark Matter” or some other ethereal sinister construct (probably caused by obvious mis-steps of the U.S. Federal Reserve Bank).
It isn’t sinister. It isn’t either the cause or the result of government regulation, or even mal-regulation. It isn’t the either the cause or the effect of inequality. Nor is it an insidious ill effect of globalization or the U.S. Fed.
This “tangible asset to market cap” trend chronicled by Fox is solely and exclusively attributable to the design, construction and implementation of better, more productive, more efficient, and more wealth creating business processes over the observed period – Exactly as Chronicled by Adam Smith 250 years ago! Scott Sumner got it right – “This is HUGE!” But Adam Smith got it right about 250 years earlier.
(see “An Inquiry into the Nature and Causes of the Wealth of Nations”)
As an aside, I was taking B-School classes in the UK (Cambridge City College) during the late 1970’s. The concept of “business process re-engineering” was a hot topic and gaining renewed emphasis in Europe then, and was a similarly hot topic in the U.S. in the 1980’s and subsequent. For us B-School types, the emphasis on innovation in business processes was even more important than the simultaneous technical innovations of the time. (I was involved with both, actually.)
And we evidently succeeded. The technical innovation of the semiconductor in the late 1950s manifests in the tech toys that are so ubiquitous today. The emphasis on, and construction/implementation of the business process innovations of the 1970s and 1980s resulted in the “tangible asset to market cap” trends and graphs that Fox produced. (Oh yeh. Per Adam Smith, those business process innovations also produced a monumental amount of Consumer Surplus – Wealth – Ubiquity). It seems Adam Smith was right. Surprising an “economist” considers that “dark matter”.
(As a further aside, someone might want to mention to Tyler Cowen that, if he found no significant innovations between 1973 and now, it’s probably because he was looking on the wrong place.)