Forty years ago, Bill Gates co-founded Microsoft and kick-started a new era where software and the internet overpower machines. Thanks to the exponential growth of Microsoft, Gates was the wealthiest man on Earth for two decades (until Amazon’s Jeff Bezos surpassed him in 2017). Now, four years into a retirement life painstakingly dedicated to reading and philanthropy, Gates has come to a realization—economists need to rewrite theory to explain the world that he helped create.
In a blog post published on Tuesday, Gates posted a graph showing the basic relationship between supply and demand that he first encountered in an introductory economics course in college. He noticed one problem with this classic economic model: It doesn’t explain how today’s tech industries work.
“This chart assumes that the total cost of production increases as supply increases,” Gates explained. “Imagine Ford releasing a new model of car. The first car costs a bit more to create, because you have to spend money designing and testing it. But each vehicle after that requires a certain amount of materials and labor. The tenth car you build costs the same to make as the 1000th car. The same is true for the other things that dominated the world’s economy for most of the 20th century, including agricultural products and property.”
However, industries like car manufacturing whose economics are explained by this model are rapidly giving way to software-driven industries in today’s society, and the old model doesn’t apply to the latter.
“Microsoft might spend a lot of money to develop the first unit of a new program, but every unit after that is virtually free to produce. Unlike the goods that powered our economy in the past, software is an intangible asset. And software isn’t the only example: data, insurance, e-books, even movies work in similar ways,” Gates wrote.
Gates’ epiphany was mainly inspired by a new book, Capitalism Without Capital, by British economists Jonathan Haskel and Stian Westlake. Described by Gates as “a textbook without a lot of commentary,” the book explains the important differences between a society dominated by tangible assets (like Ford) and one governed by intangible businesses (like Microsoft).
Besides the obvious distinction regarding the cost aspect, the book highlights three other inherent differences between the two societies.
The first points to the cost of starting a business—or failing a business, rather. For example, if you are an entrepreneur considering starting a business, the sunk cost of a failed software company would be significantly higher than a manufacturing company. If a manufacturing company fails, the owner at least can recoup some of the cost by selling off tangible investments like machinery and inventory.
Second, unlike manufacturing industries that make physical products with clear ownership, intangible assets are easily taken advantage of by competitors. This is particularly true to the burgeoning shared economy businesses. For instance, Uber’s most valuable asset is its network of drivers. But a Uber driver may simultaneously drive for Lyft.
Finally, an intangible asset is more valuable when connected to multiple intangible assets than standing alone. Haskel and Westlake illustrated the concept with Apple iPod. By itself, the iPod is nothing more than a mere music player; what makes it innovative and valuable is Apple’s MP3 protocol iPod works upon, the miniaturized hard disk design and licensing agreements with record labels.
“None of these traits are inherently good or bad. They’re just different from the way manufactured goods work,” Gates concluded. “What the book reinforced for me is that lawmakers need to adjust their economic policymaking to reflect these new realities. For example, the tools many countries use to measure intangible assets are behind the times, so they’re getting an incomplete picture of the economy. The U.S. didn’t include software in GDP calculations until 1999. Even today, GDP doesn’t count investment in things like market research, branding, and training—intangible assets that companies are spending huge amounts of money on.”