The innovation trap: how the economy of ideas creates inequality

The creativity and technological development seen by many as essential to economic growth come with hidden costs to society.

By Christopher Gasson

In the mid-1970s, a change took place in Britain and other economies that we continue to live with today. In the decades before, increases in productivity had fed through into increases in the median wage, but between 1978 and 2008, while the UK’s GDP rose by 108 per cent, the median wage grew by 56 per cent. And this trend has only got worse; around ten years ago we seem to have lost the ability to grow our output per head at all. The chief product of today’s stagnating economy is inequality.

Is the central mechanism that drives economic growth now irreparably broken? As the government plans its route out of the coronavirus crisis, and Rishi Sunak prepares to announce what may be the most important Budget for a generation, the puzzle of productivity requires urgent attention.

The nature of the global economy has changed; growth is no longer guaranteed by increases in production. Technological change, coupled with the arrival of China in the international marketplace, created a situation in which the ability to manufacture at ever higher volume and lower cost is limited only by the market for the products themselves.

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Manufacturing and delivery have become commodities – universally available and generic. Value in the economy has shifted away from these processes to the ideas that make products and services desirable.

Here I am talking about intellectual property in the broadest sense – patents, designs, copyrights, computer code, as well as the unique talents behind dramatic and sporting performances that provide content for entertainment services. The owners of the most valuable intangibles enjoy powerful benefits in the economy of ideas, to the detriment of everyone else.

The first of these advantages is that ideas are protected from competition in a way that other elements in the economy are not. Intellectual property law protects the brands, patents, copyrights and designs that determine our purchasing decisions. But the most compelling intellectual properties also form a bond with their customers that is difficult for competitors to break.

Competition is reduced still further by the speed and power with which ideas spread online, where popularity is self-reinforcing. Platforms – online marketplaces, social networks, messaging tools, transport networks – become more useful the more users they have. This allows one or two companies to enjoy a virtuous circle of growth – and outsized profits – while a long queue of losers endures a profitless struggle to survive.

The second advantage is that the owners of ideas do not need to expend more labour or capital to make more money from them. Digital production and distribution are low-cost and effectively infinite.

Businesses that trade in ideas do not need physical supply chains, and a huge proportion of their revenue can be turned into profit. But digital services don’t create jobs in the same way as the great technology breakthroughs of the past. The steam engine, the internal combustion engine, electricity – all created new demands for physical activity, in mining, in building roads and railways, in manufacturing, in transport and retail. The digital economy’s light use of physical resources may be cost-effective, even environmentally friendly, but it is bad for jobs.

Third, because the economy of ideas is not tied to physical locations, it encourages economic activity that is stateless and clandestine. Many of the most profitable intellectual properties find themselves owned off-shore through elaborate, tax-efficient structures. Some of the most valuable and fast-growing revenue streams in the economy confer little or no advantage to the economy.

Where they do touch the ground, such businesses concentrate on the locations that will attract the knowledge workers they need and the service businesses which support them. This is invariably to the benefit of one or two big cities, while the rest of a country is left behind.

The advantages that the ideas-based economy confers on a lucky few add up to an inequality so severe that it strangles growth elsewhere. Too much income goes to a tiny elite of businesses and individuals who struggle to spend their wealth. Between them Apple, Amazon, Alphabet (which owns Google), Microsoft and Facebook have cash reserves of $611bn. The founders of these companies have a combined net worth of $610bn. But because so many other businesses, public sector organisations and households struggle for income, the broad base of demand required for economic growth no longer exists.

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This problem is being made worse by the way in which governments and central banks have tried to solve it. Cutting interest rates and printing money to buy financial assets in quantitative easing drives the financial markets into a feverish search for investments that deliver a positive income on the capital invested. Without any underlying economic growth this simply bids up the price of shares, property and every other financial asset class. This widens the gap between the ultra-wealthy and the rest still further.

In Britain, this has also helped to create an outsized financial services sector responsible for processing the world’s capital surpluses. Its success feeds its own breed of inequality, as those considered to have a unique talent for delivering returns to investors are paid outsized salaries, reflecting the desperation of capital in a world without real growth.

This creates a difficult political challenge. On the right there is a reluctance to see intellectual property law for what it is: anti-competitive state intervention that is ultimately at odds with the free market. Instead, by some contorted logic it is held to be entirely compatible with free market competition, and the problem is said to lie with a failure of innovation. Dominic Cummings, for example, has written on his blog about how innovation is not as impactful as is appears: “the computer and internet have been fantastic but they haven’t, so far, contributed as much as all those powerful technologies like electricity.” His vision was for a British version of the US Advanced Research Projects Agency (ARPA), which would undertake the fundamental research needed to create whole new areas of science. But the original ARPA was set up by Eisenhower in 1958, in a country that represented 40 per cent of the global economy. Cummings failed to consider the possibility that the link between innovation, productivity and economic growth might no longer exist.

Take, for example, retail. The labour productivity of Amazon is 2.2 times the average for the UK retail sector. This is because Amazon has more “footfall” – thanks to its prominence in search engine results – than any physical shop, and because it uses an algorithm instead of sales staff. At the same time, while Amazon’s 50,000 or so coders are undoubtedly well paid, the 1,000,000 or so people working in Amazon’s warehouses don’t do much better than the average for retail. They take home around £9.50/hour compared to around £7.80/hour for sales assistants in other shops.

What this means is that each time shoppers switch £1m of their spending from the high street to Amazon, it costs the high street 8.5 jobs or £124,000 in salaries. Amazon does not have to replace all the lost jobs; it might take on four additional warehouse workers to cover the extra business, paid a total of around £71,000. The biggest beneficiary is the richest man in the world, Jeff Bezos, whose net worth might be expected to inflate by £523,000 (based on the relationship between Amazon’s revenues and its stock market value). It is pointless to suggest that other retailers (or at least those who are not going bust) could match the productivity of Amazon if only they invested in the same productivity software as Amazon. Most of them use similar algorithms for their online sales. The problem is that they can’t match Amazon’s customer footfall because Amazon’s brand is overwhelmingly dominant in the online marketplace. For many, the only option is also to sell their products on Amazon.

Meanwhile on the left, the focus seems to be on the age-old problem of the divide between capital and labour, rather than an interrogation of the way the economy might be changing. This approach has been given new impetus by the French economist Thomas Piketty. His book Capital in the 21st Century (2013) makes the point that the returns on capital will always be greater than economic growth and a corrective tax on wealth is necessary to balance the two. But the success of the book, which has made Piketty a multi-millionaire, is itself a powerful illustration of the way in which intellectual property is now a far more powerful source of inequality than capital alone.

How would the founders of the New Statesman and authors of the 1918 Labour Party constitution, Sidney and Beatrice Webb, have understood the sale of WhatsApp to Facebook for $19bn in 2014? WhatsApp had just 55 employees and had raised only $58m in capital backing, most of which went to pay salaries. The venture capitalists who had backed WhatsApp earned $3.5bn from the sale, while its small band of employees shared a $15.5bn bonanza. Would this be seen as the glorious fulfilment of Clause IV of the constitution, a deal which “secured for the workers by hand and by brain the full fruits of their industry”? Or would they have balked at the obscene inequality created by such a transaction?

The left has to acknowledge that the problem of distributive justice is bigger than the class struggle between capital and labour. We now live in a world in which people from modest backgrounds with unique talents – Premier League footballers and social media stars, as well as academic economists and technology entrepreneurs – can easily cross the class divide. And they don’t need capital to do so. Instead, capital needs them, badly, because there are few ways money can earn a living these days without buying a share in someone else’s ideas.

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How, then, might we return to an economy of broad-based growth?

The problem of distribution is best expressed as follows: when you buy a physical product or service, the vendor is somewhat diminished either in the value of the stock they own or the time they have. When you buy an idea, the vendor is not diminished. They still own the idea. In fact, the idea has become more valuable because it has acquired one more unpaid influencer for its cause. The transaction is asymmetric.

It is difficult to rely on the tax system to fix this, because ideas are not fixed to a particular jurisdiction. We may need to think more creatively, and look to competition law and intellectual property law for a solution.

One way to even out both sides of the transaction might be to create a system in which a tiny sliver of equity ownership is transferred with every intellectual property sale. Every Starbucks Coffee would come with a micro-fraction of a share in Starbucks. A Taylor Swift concert ticket would confer a micro-fraction of a share in her rights management company. These transfers could perhaps be facilitated by blockchain technology – the system of decentralised ownership registers that facilitates Bitcoin. Like Bitcoin, such a system could be arranged so those who are among the first to buy into an idea earn larger shares than later adopters, and the creator of an idea would always own a meaningful share of the income streams they create.

As competition regulators in the US and EU try to work out what to do about the monopoly power enjoyed by Google and Facebook, a clear sense of who creates their value will be vital. If the duopoly of Big Tech could be made to implement a system for transferring fractions of their equity to their users, a model might emerge that could be used more broadly to address the asymmetries of intellectual property transactions. It could be made universal by making the protections of intellectual property law conditional on participation in such a scheme.

This is only one possible solution. What’s important is that we change the way we think about owning ideas. We want to own them absolutely because they are so much part of who we are as individuals, but the world has changed. The economy of ideas is a meritocracy, but a brutal and iniquitous one.

In the past the inequality of ideas didn’t matter so much, because it was hidden behind the far greater inequality created by ownership of capital. But now, even in more traditional industries such as energy, ideas are becoming the main source of value. The switch from fossil fuels to renewables will diminish the value of oil fields, mineral rights and infrastructure, as the value of patents related to solar and wind energy rises.

Perhaps Beatrice Webb, observing the WhatsApp sale, would have seen it for what it was: that the asset sold for $19bn was not a few thousand lines of code, a brand name and 55 members of staff. It was the 450 million people for whom WhatsApp was a necessary means of communication. She would see that in today’s world we create value, not just as workers, but also as customers, through ideas that we choose to share. These might have uniquely talented creators, but we are part of their success, and as long as this is not recognised in intellectual property law, the economic system will foment socially unsustainable inequality. As Karl Marx might have said: “Consumers of the world, unite! You have nothing to lose but your chain stores.”