National Wealth Still Depends on Making Some Stuff

July 17, 2017
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National Wealth Still Depends on Making Some Stuff

In general, modern-day economists tend to ignore old schools of economic thought. The main reason is that economists before World War II typically used words instead of mathematics. Another reason is that old, radical ideas are often assumed to have been discredited.

For example, many economists now love to poke fun at the physiocrats. This was a group of French 18th-century economists who believed that only agriculture created national wealth. Their idea, coming on the eve of the Industrial Revolution, was spectacularly ill-timed. Today, with manufacturing and services accounting for the overwhelming majority of every advanced economy, it’s clear that the physiocrats’ thesis was incorrect.

Yet as technology and the global economy continue to evolve in strange and unanticipated ways, I think it’s time to revisit the ideas of the physiocrats. Not the notion that agriculture is the only source of value — that’s bonkers. But the basic idea that the measure of a country’s wealth should give special pride of place to certain types of goods and services deserves a reexamination.

Information technology is doing some strange things to our economy. First, the economy is shifting toward intangibility. Physical capital — buildings, equipment and vehicles — matters much less to companies these days, while intangible capital matters more

Worth a Lot, Even If You Can't Touch It

Intangible assets as share of S&P 500 market value

Source: Ocean Tomo LLC

Human skills and knowledge, networks, brand value, technological secrets and other intangible assets are now of key importance to many of the most lucrative industries. At the same time, free services such as Facebook and Twitter are ever more important to people’s lives. And the internet has brought strong network effects to many parts of the economy, creating large profits while putting some markets in danger of monopolization.

This trend has enriched the U.S. and other countries, and promises to continue to do so. But there is a danger that in embracing the world of bits, governments will neglect the old, physical economy of atoms.

First of all, physical things are more essential to a baseline standard of living. While internet-based leisure activities may be more and more central to middle-class life, the poor still struggle to get things like housing, heating and transportation. If governments let physical infrastructure like buses and trains decay, the middle classes will still be able to surf the internet in peace, but poor people will struggle to work. Meanwhile, unless governments address the falling productivity of the home-building industry and take steps to provide cheap, plentiful energy to cities, it will be the lower socioeconomic classes that suffer disproportionately. So if we care about alleviating the pain of poverty more than about making rich people’s lives even more fun, we should think about the production of the physical goods the poor need most.

Second, physical goods act as a form of insurance. Digital goods rely on the infrastructure of the internet, and that infrastructure could fail. There’s some chance — no one really seems to know exactly how big of a chance — that Russian, Chinese or other hackers could make the internet unusable in the event of a war or other crisis. Also, there’s a remote possibility that ransomware, identity theft or other crimes could dramatically and suddenly raise the costs of doing business online. In either of those eventualities, countries that rely heavily on sales of digital services would be hurt much more than economies that produce more physical goods. Ensuring a robust physical economy will help make a nation less vulnerable to sudden impoverishment by sabotage of the global digital infrastructure.

Third, the intangible economy may be running into the wall of urban political economy. Knowledge-based industries require a lot of smart people to be concentrated in  cities. But because local homeowners tend to control local politics, they often oppose building enough housing to accommodate the increasing number of knowledge workers who need to cluster together. When this happens, it’s usually the poor who get pushed out of town to the forgotten fringes of the local economy.

Fourth, physical goods are a lot easier to export. Though service exports have risen, most trade is still of the material variety. For a country such as the U.S. with a long-standing structural trade deficit, focusing more on the physical economy in the present may be a way to avoid a painful adjustment in the future.

So while the intangible economy of services and knowledge is undoubtedly important to our future, the old physical economy shouldn’t be neglected. Governments need to maintain roads, public transit systems, top-notch electrical infrastructure and a high-quality affordable housing stock. They should also consider incentives to keep manufacturing industries from disappearing. Those policies might not always be optimal from a pure value-added, economic efficiency standpoint, but they can pay off in ways not measured by gross domestic product. In this increasingly ephemeral age, we might need some physiocrats to keep us down to earth.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Noah Smith at nsmith150@bloomberg.net

To contact the editor responsible for this story:
James Greiff at jgreiff@bloomberg.net

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