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In the mid-1960s the Beatles were not just a cultural force, they were an economic one. At their peak, their record sales and ticket sales were earning $650 a second in today's money. The dollar receipts from their overseas tours are credited with saving Harold Wilson's government from a currency crisis.



One beneficiary of the Beatles' rise to stardom was their record company, EMI. By 1967, 30 per cent of the company's profits were coming just from Beatles sales.

Back then, EMI was more than a record label. Its now-forgotten full name was Electric and Musical Industries, and in the 1960s it was as much into electrics as it was into music. In 1959, it had launched a commercial computer called the EMIDEC 1100. In the 60s it made everything from recording equipment to tea kettles to guided missiles. It embodied the spirit of post-war British boffinry commemorated in Francis Spufford's Backroom Boys. The piles of cash generated by Beatlemania helped pay for investment in this sprawling empire.

One of the things they invested in was medical equipment research. Godfrey Hounsfield, the man behind the EMIDEC, began work on the first commercially viable medical scanner.

As the project developed, it was significantly supported by the UK government, which provided over £600,000 of support for the R&D equivalent to £7m today). Over four years, Hounsfield and his team invented and built the first computed tomography scanner (CT or CAT scanners for short – the extra A stands for 'axial').









Some have questioned the importance of EMI's cashflows to the CT scanner project, pointing to the importance of government funding to the underlying R&D. However, it's important to note that the project depended on much more than just R&D, and that this 'hidden innovation' funding came from EMI.



The CT scanner was a remarkable feat of science and engineering. For the first time, it allowed doctors to make accurate 3D scans of patients' soft tissue. This proved vital to modern neurosurgery and oncology. Hounsfield received a Nobel Prize, a knighthood; and even had a scientific unit named after him.



Computed tomography was a triumph for modern medicine. Scanners were developed and healthcare improved. Businesses got another project to sell. Jobs were created for radiographers and neurosurgeons. And patients were more likely to be cured. It was also a remarkable achievement for EMI's Central Research Laboratory. But from a commercial point of view, it was something of a failure for EMI.

EMI took out patents on the underlying technologies and invested to build the business, creating partnerships with hospitals to work out how CT could help doctors and building a sales force to sell the scanners to US hospitals. But as the 1970s rolled on, it became clear that other companies were going to dominate the CT market. EMI sold only a handful of scanners. General Electric and then Siemens licensed some of the technologies from EMI, and quickly built large CT scanning business. By 1976, EMI decided to get out of this area entirely.









It's sometimes said – usually by people feeling wistful about British industrial decline – that EMI failed to put enough money behind the new technology. But this seems to be a myth. Not long ago we spoke to one of the software engineers EMI engaged to support the CT scanner; he was pretty clear that this was a big bet for EMI. They just failed to make it work, partly because medical devices weren't their thing, partly because they didn't execute well, and partly because of bad luck.



So while EMI's development of the CT scanner was a big plus for humanity, it was a failure from the point of view of EMI's shareholders. They might well have wished that all that Beatles cash hadn't been left sloshing around to fund the latest project by their brilliant boffins, especially one that had little to do with EMI's core areas of expertise.

As the years went by, more and more companies' shareholders began to feel this way. Conglomerates – companies with many different lines of business – became rarer and rarer. Financial economists showed that companies with large cash balances tended to be wasteful and to make bad investments. Shareholders and equity markets started to keep a closer eye on what managers were up to. They demanded that they returned cash to shareholders when possible through dividends and share buybacks. And they gave managers shares and stock options in the hope that these would make them more attentive to their employer's share price. (There is a separate and very lively debate on whether the combination of stock options and buybacks encourages managers to underinvest, for example here.)

This had some beneficial effects on the economy. Public companies in the USA and the UK became leaner and more competitive, which was on the whole a good thing after their poor performance in the 1970s. This is what we now think of as good corporate governance.

But when it comes to innovations like the CT scanner, there might be a catch. The costs that EMI incurred to commercialise the CT scanner – R&D, product design, marketing – represent a very particular type of investment. Specifically, these are intangible investments, rather than tangible ones like a new factory or a fleet of vans.

Intangible investments are interesting because they have some unusual characteristics that are much less common in tangible investments. One of these is what economists call spillovers, or positive externalities. These happen when Company A makes an investment, but Company B gets some or even all the financial benefits.









You probably remember Steve Jobs' rage at Google for developing the Android mobile operating system. "I'm going to destroy Android, because it's a stolen product. I'm willing to go thermonuclear war on this," was Jobs' characteristically level-headed response. This is unfortunately one of the occupational hazards of innovation and intangible investment generally. Ideas are hard to lock down, and hard to keep out of your competitors' hands. The spillover from innovation is of course one of the reasons why governments subsidise business innovation through policies like R&D tax credits.

In the CT scanner example, it was EMI that made the investment, but GE that got the spoils. The spillovers from EMI's investment led to a situation where GE benefited, and society as a whole benefited too, but EMI's shareholders didn't.

All this points to a couple of interesting paradoxes in the way modern financial markets affect innovation by publicly quoted businesses:

Better corporate governance may lead to less of a certain sort of radical innovation

Cutting managerial fat and foolishness is often good both for shareholders and the economy as a whole. But where managers are strongly motivated to innovate (remember Hounsfield's Nobel Prize), stronger corporate governance may reduce the amount of radical innovation that goes on, which could be bad for the economy.

Diversified shareholders are better positioned to take advantage of spillovers, but concentrated shareholders are better at encouraging innovation investments

If you were a hypothetical money manager in the 1970s who owned shares in both EMI and GE, you might have been happy to see EMI plough money into CT scanners, since you would have won on the swings more than you lost on the roundabouts. But there's another dimension to this. Research suggests that companies with more institutional shareholders and larger shareholdings innovate more. (The likely reason is that concentrated, informed shareholders with a strong interest in a particular company have the time and knowledge to scrutinise its innovation investments, and are more likely to understand their value.) This implies a dilemma: concentrated investment is good for innovation, but under some circumstances diversification might be too.

There's a fascinating and rapidly developing body of research on the relationship between innovation and financial markets (this is a good and relatively recent summary). But one thing that is abundantly clear is that the relationship is a complex one, and that without careful consideration and sensible policy, there is a danger that tomorrow's equivalent of the CT scanner may not be invented.





For more on this topic, visit theintangibleeconomy.com





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