Introduction: Making versus Taking
The barbarous gold barons – they did not find the gold, they did not mine the gold, they did not mill the gold, but by some weird alchemy all the gold belonged to them.
Big Bill Haywood, founder of the Unites States’ first industrial union1
Bill Haywood expressed his puzzlement eloquently. He represented men and women in the US mining industry at the start of the twentieth century and during the Great Depression of the 1930s. He was steeped in the industry. But even Haywood could not answer the question: why did the owners of capital, who did little but buy and sell gold on the market, make so much money, while workers who expended their mental and physical energy to find it, mine it and mill it, make so little? Why were the takers making so much money at the expense of the makers?
Similar questions are still being asked today. In 2016 the British high-street retailer BHS collapsed. It had been founded in 1928 and in 2004 was bought by Sir Philip Green, a well-known retail entrepreneur, for £200 million. In 2015 Sir Philip sold the business for £1 to a group of investors headed by the British businessman Dominic Chappell. While it was under his control, Sir Philip and his family extracted from BHS an estimated £580 million in dividends, rental payments and interest on loans they had made to the company. The collapse of BHS threw 11,000 people out of work and left its pension fund with a £571 million deficit, even though the fund had been in surplus when Sir Philip acquired it.2 A report on the BHS disaster by the House of Commons Work and Pensions Select Committee accused Sir Philip, Mr Chappell and their ‘hangers-on’ of ‘systematic plunder’. For BHS workers and pensioners who depended on the company for a decent living for their families, this was value extraction – the appropriation of gains vastly out of proportion to economic contribution – on an epic scale. For Sir Philip and others who controlled the business, it was value creation.
While Sir Philip’s activities could be viewed as an aberration, the excesses of an individual, his way of thinking is hardly unusual: today, many giant corporations are also guilty of confusing value creation with value extraction. In August 2016, for instance, the European Commission, the European Union’s (EU) executive arm, sparked an international row between the EU and the US when it ordered Apple to pay €13 billion in back taxes to Ireland.3
Apple is the world’s biggest company by stock market value. In 2015 it held a mountain of cash and securities outside the US worth $187 billion4 – about the same size as the Czech Republic’s economy that year5 – to avoid paying the US taxes that would be due on the profits if they were repatriated. Under a deal with Ireland dating back to 1991, two Irish subsidiaries of Apple received very generous tax treatment. The subsidiaries were Apple Sales International (ASI), which recorded all the profits earned on sales of iPhones and other Apple devices in Europe, the Middle East, Africa and India; and Apple Operations Europe, which made computers. Apple transferred development rights of its products to ASI for a nominal amount, thereby depriving the US taxpayer of revenues from technologies, embodied in Apple products, whose early development the taxpayer had funded. The European Commission alleged that the maximum rate payable on those profits booked through Ireland which were liable for tax was 1 per cent, but that in 2014 Apple paid tax at 0.005 per cent. The usual rate of corporation tax in Ireland is 12.5 per cent.
What is more, these ‘Irish’ subsidiaries of Apple are in fact not resident for tax purposes anywhere. This is because they have exploited discrepancies between the Irish and US definitions of residence. Almost all the profits earned by the subsidiaries were allocated to their ‘head offices’, which existed only on paper. The Commission ordered Apple to pay the back taxes on the grounds that Ireland’s deal with Apple constituted illegal state aid (government support that gives a company an advantage over its competitors); Ireland had not offered other companies similar terms. Ireland, the Commission alleged, had offered Apple ultra-low taxes in return for the creation of jobs in other Apple businesses there. Apple and Ireland rejected the Commission’s demand – and of course Apple is not the only major corporation to have constructed exotic tax structures.
But Apple’s value extraction cycle is not limited to its international tax operations – it is also much closer to home. Not only did Apple extract value from Irish taxpayers, but the Irish government has extracted value from the US taxpayer. Why so? Apple created its intellectual property in California, where its headquarters are based. Indeed, as I argued in my previous book, The Entrepreneurial State,6 and discuss briefly here in Chapter 7, all the technology that makes the smartphone smart was publicly funded. But in 2006 Apple formed a subsidiary in Reno, Nevada, where there is no corporate income or capital gains tax, in order to avoid state taxes in California. Creatively naming it Braeburn Capital, Apple channelled a portion of its US profits to the Nevada subsidiary instead of reporting it in California. Between 2006 and 2012, Apple earned $2.5 billion in interest and dividends reported in Nevada to avoid Californian tax. California’s infamously large debt would be significantly reduced if Apple fully and accurately reported its US revenues in that state, where a major portion of its value (architecture, design, sales, marketing and so on) originated. Value extraction thus pits US states against each other, as well as the US against other countries.
It is clear that Apple’s highly complex tax arrangements were principally designed to extract the maximum value from its business by avoiding paying substantial taxes which would have benefited the societies in which the company operated. Apple certainly creates value, of that there is no doubt: but to ignore the support taxpayers have given it, and then to pit states and countries against each other, is surely not the way to build an innovative economy or achieve growth that is inclusive, that benefits a wide section of the population, not only those best able to ‘game’ the system.
There is yet another dimension to Apple’s value extraction. Many such corporations use their profits to boost share prices in the short term instead of reinvesting them in production for the long term. The main way they do this is by using cash reserves to buy back shares from investors, arguing that this is to maximize shareholder ‘value’ (the income earned by shareholders in the company, based on the valuation of the company’s stock price). But it is no accident that among the primary beneficiaries of share buy-backs are managers with generous share option schemes as part of their remuneration packages – the same managers who implement the share buy-back programmes. In 2012, for example, Apple announced a share buy-back programme of up to a staggering $100 billion, partly to ward off ‘activist’ shareholders demanding that the company return cash to them to ‘unlock shareholder value’.7 Rather than reinvest in the business, Apple preferred to transfer cash to shareholders.
The alchemy of the takers versus the makers that Big Bill Haywood referred to back in the 1920s continues today.
COMMON CRITIQUES OF VALUE EXTRACTION
The vital but often muddled distinction between value extraction and value creation has consequences far beyond the fate of companies and their workers, or even of whole societies. The social, economic and political impacts of value extraction are huge. Prior to the 2007 financial crisis, the income share of the top 1 per cent in the US expanded from 9.4 per cent in 1980 to a staggering 22.6 per cent in 2007. And things are only getting worse. Since 2009 inequality has been increasing even more rapidly than before the 2008 financial crash. In 2015 the combined wealth of the planet’s sixty-two richest individuals was estimated to be about the same as that of the bottom half of the world’s population – 3.5 billion people.8
So how does the alchemy continue to happen? A common critique of contemporary capitalism is that it rewards ‘rent seekers’ over true ‘wealth creators’. ‘Rent-seeking’ here refers to the attempt to generate income, not by producing anything new but by overcharging above the ‘competitive price’, and undercutting competition by exploiting particular advantages (including labour), or, in the case of an industry with large firms, their abil
ity to block other companies from entering that industry, thereby retaining a monopoly advantage. Rent-seeking activity is often described in other ways: the ‘takers’ winning out over the ‘makers’, and ‘predatory’ capitalism winning over ‘productive’ capitalism. It’s seen as a key way – perhaps the key way – in which the 1 per cent have risen to power over the 99 per cent.9 The usual targets of such criticism are the banks and other financial institutions. They are seen as profiting from speculative activities based on little more than buying low and selling high, or buying and then stripping productive assets simply to sell them on again with no real value added.
More sophisticated analyses have linked rising inequality to the particular way in which the ‘takers’ have increased their wealth. The French economist Thomas Piketty’s influential book Capital in the Twenty-First Century focuses on the inequality created by a predatory financial industry that is taxed insufficiently, and by ways in which wealth is inherited across generations, which gives the richest a head start in getting even richer. Piketty’s analysis is key to understanding why the rate of return on financial assets (which he calls capital) has been higher than that on growth, and calls for higher taxes on the resultant wealth and inheritance to stop the vicious circle. Ideally, from his point of view, taxes of this sort should be global, so as to avoid one country undercutting another.
Another leading thinker, the US economist Joseph Stiglitz, has explored how weak regulation and monopolistic practices have allowed what economists call ‘rent extraction’, which he sees as the main impetus behind the rise of the 1 per cent in the US.10 For Stiglitz, this rent is the income obtained by creating impediments to other businesses, such as barriers to prevent new companies from entering a sector, or deregulation that has allowed finance to become disproportionately large in relation to the rest of the economy. The assumption is that, with fewer impediments to the functioning of economic competition, there will be a more equal distribution of income.11
I think we can go even further with these ‘makers’ versus ‘takers’ analyses of why our economy, with its glaring inequalities of income and wealth, has gone so wrong. To understand how some are perceived as ‘extracting value’, siphoning wealth away from national economies, while others are ‘wealth creators’ but do not benefit from that wealth, it is not enough to look at impediments to an idealized form of perfect competition. Yet mainstream ideas about rent do not fundamentally challenge how value extraction occurs – which is why it persists.
In order to tackle these issues at root, we need to examine where value comes from in the first place. What exactly is it that is being extracted? What social, economic and organizational conditions are needed for value to be produced? Even Stiglitz’s and Piketty’s use of the term ‘rent’ to analyse inequality will be influenced by their idea of what value is and what it represents. Is rent simply an impediment to ‘free-market’ exchange? Or is it due to their positions of power that some can earn ‘unearned income’ – that is, income derived from moving existing assets around rather than creating new ones?12 This is a key question we will look at in Chapter 2.
WHAT IS VALUE?
Value can be defined in different ways, but at its heart it is the production of new goods and services. How these outputs are produced (production), how they are shared across the economy (distribution) and what is done with the earnings that are created from their production (reinvestment) are key questions in defining economic value. Also crucial is whether what it is that is being created is useful: are the products and services being created increasing or decreasing the resilience of the productive system? For example, it might be that a new factory is produced that is valuable economically, but if it pollutes so much to destroy the system around it, it could be seen as not valuable.
By ‘value creation’ I mean the ways in which different types of resources (human, physical and intangible) are established and interact to produce new goods and services. By ‘value extraction’ I mean activities focused on moving around existing resources and outputs, and gaining disproportionately from the ensuing trade.
A note of caution is important. In the book I use the words ‘wealth’ and ‘value’ almost interchangeably. Some might argue against this, seeing wealth as a more monetary and value as potentially a more social concept, involving not only value but values. I want to be clear on how these two words are used. I use ‘value’ in terms of the ‘process’ by which wealth is created – it is a flow. This flow of course results in actual things, whether tangible (a loaf of bread) or intangible (new knowledge). ‘Wealth’ instead is regarded as a cumulative stock of the value already created. The book focuses on value and what forces produce it – the process. But it also looks at the claims around this process, which are often phrased in terms of ‘who’ the wealth creators are. In this sense the words are used interchangeably.
For a long time the idea of value was at the heart of debates about the economy, production and the distribution of the resulting income, and there were healthy disagreements over what value actually resided in. For some economic schools of thought, the price of products resulted from supply and demand, but the value of those products derived from the amount of work that was needed to produce things, the ways in which technological and organizational changes were affecting work, and the relations between capital and labour. Later, this emphasis on ‘objective’ conditions of production, technology and power relationships was replaced by concepts of scarcity and the ‘preferences’ of economic actors: the amount of work supplied is determined by workers’ preference for leisure over earning a higher amount of money. Value, in other words, became subjective.
Until the mid-nineteenth century, too, almost all economists assumed that in order to understand the prices of goods and services it was first necessary to have an objective theory of value, a theory tied to the conditions in which those goods and services were produced, including the time needed to produce them, the quality of the labour employed; and the determinants of ‘value’ actually shaped the price of goods and services. Then, this thinking began to go into reverse. Many economists came to believe that the value of things was determined by the price paid on the ‘market’ – or, in other words, what the consumer was prepared to pay. All of a sudden, value was in the eye of the beholder. Any goods or services being sold at an agreed market price were by definition value-creating.
The swing from value determining price to price determining value coincided with major social changes at the end of the nineteenth century. One was the rise of socialism, which partly based its demands for reforms on the claim that labour was not being rewarded fairly for the value it created, and the ensuing consolidation of a capitalist class of producers. The latter group was, unsurprisingly, keen on the alternative theory, that price determined value, a story which allowed them to defend their appropriation of a larger share of output, with labour increasingly being left behind.
In the intellectual world, economists wanted to make their discipline seem ‘scientific’ – more like physics and less like sociology – with the result that they dispensed with its earlier political and social connotations. While Adam Smith’s writings were full of politics and philosophy, as well as early thinking about how the economy works, by the early twentieth century the field which for 200 years had been ‘political economy’ emerged cleansed as simply ‘economics’. And economics told a very different story.
Eventually the debate about different theories of value and the dynamics of value creation virtually vanished from economics departments, only showing up in business schools in a very new form: ‘shareholder value’,13 ‘shared value’,14 ‘value chains’,15 ‘value for money’, ‘valuation’, ‘adding value’ and the like. So while economics students used to get a rich and varied education in the idea of value, learning what different schools of economic thought had to say about it, today they are taught only that value is determined by the dynamics of price, due to scarcity and preferences. This is not p
resented as a particular theory of value – just as Economics 101, the introduction to the subject. An intellectually impoverished idea of value is just taken as read, assumed simply to be true. And the disappearance of the concept of value, this book argues, has paradoxically made it much easier for this crucial term ‘value’ – a concept that lies at the heart of economic thought – to be used and abused in whatever way one might find useful.
MEET THE PRODUCTION BOUNDARY
To understand how different theories of value have evolved over the centuries, it is useful to consider why and how some activities in the economy have been called ‘productive’ and some ‘unproductive’, and how this distinction has influenced ideas about which economic actors deserve what – how the spoils of value creation are distributed.
For centuries, economists and policymakers – people who set a plan for an organization such as government or a business – have divided activities according to whether they produce value or not; that is, whether they are productive or unproductive. This has essentially created a boundary – the fence in Figure 1 below – thereby establishing a conceptual boundary – sometimes referred to as a ‘production boundary’ – between these activities.16 Inside the boundary are the wealth creators. Outside are the beneficiaries of that wealth, who benefit either because they can extract it through rent-seeking activities, as in the case of a monopoly, or because wealth created in the productive area is redistributed to them, for example through modern welfare policies. Rents, as understood by the classical economists, were unearned income and fell squarely outside the production boundary. Profits were instead the returns earned for productive activity inside the boundary.
Historically, the boundary fence has not been fixed. Its shape and size have shifted with social and economic forces. These changes in the boundary between makers and takers can be seen just as clearly in the past as in the modern era. In the eighteenth century there was an outcry when the physiocrats, an early school of economists, called landlords ‘unproductive’. This was an attack on the ruling class of a mainly rural Europe. The politically explosive question was whether landlords were just abusing their power to extract part of the wealth created by their tenant farmers, or whether their contribution of land was essential to the way in which farmers created value.
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