Figure 1. Production boundary around the value-producing activities of the economy
A variation of this debate about where to draw the production boundary continues today with the financial sector. After the 2008 financial crisis, there were calls from many quarters for a revival of industrial policy to boost the ‘makers’ in industry, who were seen to be pitted against the ‘takers’ in finance. It was argued that rebalancing was needed to shrink the size of the financial sector (falling into the dark grey circle of unproductive activities above) by taxation, for example a tax on financial transactions such as foreign exchange dealing or securities trading, and by industrial policies to nurture growth in industries that actually made things instead of just exchanging them (falling into the light grey circle of productive activities above).
But things are not so simple. The point is not to blame some as takers and to label others as makers. The activities of people outside the boundary may be needed to facilitate production – without their work, productive activities may not be so valuable. Merchants are necessary to ensure the goods arrive at the marketplace and are exchanged efficiently. The financial sector is critical for buyers and sellers to do business with each other. How these activities can be shaped to actually serve their purpose of producing value is the real question.
And, most important of all, what about government? On which side of the production boundary does it lie? Is government inherently unproductive, as is often claimed, its only earnings being compulsory transfers in the form of taxes from the productive part of the economy? If so, how can government make the economy grow? Or can it at best only set the rules of the game, so that the value creators can operate efficiently?
Indeed, the recurring debate about the optimal size of government and the supposed perils of high public debt boils down to whether government spending helps the economy to grow – because government can be productive and add value – or whether it holds back the economy because it is unproductive or even destroys value. The issue is politically loaded and deeply colours current debates, ranging from whether the UK can afford Trident nuclear weapons to whether there is a ‘magic number’ for the size of government, defined as government spending as a proportion of national output, beyond which an economy will inevitably do less well than it might have done if government spending had been lower. As we will explore in Chapter 8, this question is more tainted by political views and ideological positions than informed by deep scientific proofs. Indeed, it is important to remember that economics is at heart a social science, and the ‘natural’ size of government will depend on one’s theory of (or simply ‘position’ on) the purpose of government. If it is seen as useless, or at best a fixer of occasional problems, its optimum size will inevitably be notionally smaller than if it is viewed as a key engine of growth needed to steer and invest in the value creation process.
Over time, this conceptual production boundary was expanded to encompass much more of the economy than before, and more varied economic activities. As economists, and wider society, came to determine value by supply and demand – what is bought has value – activities such as financial transactions were redefined as productive, whereas previously they had usually been classed as unproductive. Significantly, the only major part of the economy which is now considered largely to lie outside the production boundary – and thus to be ‘unproductive’ – remains government. It is also true that many other services that people provide throughout society go unpaid, such as care given by parents to children or by the healthy to the unwell, and are not well accounted for. Fortunately, issues such as factoring care into the way we measure national output (GDP) are increasingly coming to the fore. But besides adding new concepts to GDP – such as care, or the sustainability of the planet – it is fundamental to understand why we hold the assumptions about value that we do. And this is impossible if value is not scrutinized.
WHY VALUE THEORY MATTERS
First, the disappearance of value from the economic debate hides what should be alive, public and actively contested.17 If the assumption that value is in the eye of the beholder is not questioned, some activities will be deemed to be value-creating and others will not, simply because someone – usually someone with a vested interest – says so, perhaps more eloquently than others. Activities can hop from one side of the production boundary to the other with a click of the mouse and hardly anyone notices. If bankers, estate agents and bookmakers claim to create value rather than extract it, mainstream economics offers no basis on which to challenge them, even though the public might view their claims with scepticism. Who can gainsay Lloyd Blankfein when he declares that Goldman Sachs employees are among the most productive in the world? Or when pharmaceutical companies argue that the exorbitantly high price of one of their drugs is due to the value it produces? Government officials can become convinced (or ‘captured’) by stories about wealth creation, as was recently evidenced by the US government’s approval of a leukemia drug treatment at half a million dollars, precisely using the ‘value-based pricing’ model pitched by the industry – even when the taxpayer contributed $200 million dollars towards its discovery.18
Second, the lack of analysis of value has massive implications for one particular area: the distribution of income between different members of society. When value is determined by price (rather than vice versa), the level and distribution of income seem justified as long as there is a market for the goods and services which, when bought and sold, generate that income. All income, according to this logic, is earned income: gone is any analysis of activities in terms of whether they are productive or unproductive.
Yet this reasoning is circular, a closed loop. Incomes are justified by the production of something that is of value. But how do we measure value? By whether it earns income. You earn income because you are productive and you are productive because you earn income. So with a wave of a wand, the concept of unearned income vanishes. If income means that we are productive, and we deserve income whenever we are productive, how can income possibly be unearned? As we shall see in Chapter 3, this circular reasoning is reflected in how national accounts – which track and measure production and wealth in the economy – are drawn up. In theory, no income may be judged too high, because in a market economy competition prevents anyone from earning more than he or she deserves. In practice, markets are what economists call imperfect, so prices and wages are often set by the powerful and paid by the weak.
In the prevailing view, prices are set by supply and demand, and any deviation from what is considered the competitive price (based on marginal revenues) must be due to some imperfection which, if removed, will produce the correct distribution of income between actors. The possibility that some activities perpetually earn rent because they are perceived as valuable, while actually blocking the creation of value and/or destroying existing value, is hardly discussed.
Indeed, for economists there is no longer any story other than that of the subjective theory of value, with the market driven by supply and demand. Once impediments to competition are removed, the outcome should benefit everyone. How different notions of value might affect the distribution of revenues between workers, public agencies, managers and shareholders at, say, Google, General Electric or BAE Systems, goes unquestioned.
Third, in trying to steer the economy in particular directions, policymakers are – whether they recognize it or not – inevitably influenced by ideas about value. The rate of GDP growth is obviously important in a world where billions of people still live in dire poverty. But some of the most important economic questions today are about how to achieve a particular type of growth. Today, there is a lot of talk about the need to make growth ‘smarter’ (led by investments in innovation), more sustainable (greener) and more inclusive (producing less inequality).19
Contrary to the widespread assumption that policy should be directionless, simply removing barriers and focusing on ‘levelling the playing field’ for businesses, an immense amount o
f policymaking is needed to reach these particular objectives. Growth will not somehow go in this direction by itself. Different types of policy are needed to tilt the playing field in the direction deemed desirable. This is very different from the usual assumption that policy should be directionless, simply removing barriers so that businesses can get on with smooth production.
Deciding which activities are more important than others is critical in setting a direction for the economy: put simply, those activities thought to be more important in achieving particular objectives have to be increased and less important ones reduced. We already do this. Certain types of tax credits, for, say, R&D, try to stimulate more investment in innovation. We subsidize education and training for students because as a society we want more young people to go to university or enter the workforce with better skills. Behind such policies may be economic models that show how investment in ‘human capital’ – people’s knowledge and capabilities – benefits a country’s growth by increasing its productive capacity. Similarly, today’s deepening concern that the financial sector in some countries is too large – compared, for example, to manufacturing – might be informed by theories of what kind of economy we want to be living in and the size and role of finance within it.
But the distinction between productive and unproductive activities has rarely been the result of ‘scientific’ measurement. Rather, ascribing value, or the lack of it, has always involved malleable socio-economic arguments which derive from a particular political perspective – which is sometimes explicit, sometimes not. The definition of value is always as much about politics, and about particular views on how society ought to be constructed, as it is about narrowly defined economics. Measurements are not neutral: they affect behaviour and vice versa (this is the concept of performativity which we encountered in the Preface).
So the point is not to create a stark divide, labelling some activities as productive and categorizing others as unproductive rent-seeking. I believe we must instead be more forthright in linking our understanding of value creation to the way in which activities (whether in the financial sector or the real economy) should be structured, and how this is connected to the distribution of the rewards generated. Only in this way will the current narrative about value creation be subject to greater scrutiny, and statements such as ‘I am a wealth creator’ measured against credible ideas about where that wealth comes from. A pharmaceutical company’s value-based pricing might then be scrutinized with a more collective value-creation process in mind, one in which public money funds a large portion of pharmaceutical research – from which that company benefits – in the highest-risk stage. Similarly, the 20 per cent share that venture capitalists usually get when a high-tech small company goes public on the stock market may be seen as excessive in light of the actual, not mythological, risk they have taken in investing in the company’s development. And if an investment bank makes an enormous profit from the exchange rate instability that affects a country, that profit can be seen as what it really is: rent.
In order to arrive at this understanding of value creation, however, we need to go beyond seemingly scientific categorizations of activities and look at the socio-economic and political conflicts that underlie them. Indeed, claims about value creation have always been linked to assertions about the relative productiveness of certain elements of society, often related to fundamental shifts in the underlying economy: from agricultural to industrial, or from a mass-production-based economy to one based on digital technology.
THE STRUCTURE OF THE BOOK
In Chapters 1 and 2 I look at how economists from the seventeenth century onwards have thought about steering growth by increasing productive activities and reducing unproductive ones, something they conceptualized by means of a theoretical production boundary. The production boundary debate, and its close relationship to ideas of value, has influenced government measures of economic growth for centuries; the boundary, too, has changed, influenced by fluctuating social, economic and political conditions. Chapter 2 delves into the biggest shift of all. From the second half of the nineteenth century onwards, value went from being an objective category to a more subjective one tied to individual preferences. The implications of this revolution were seismic. The production boundary itself was blurred, because almost anything that could get a price or could successfully claim to create value – for example, finance – suddenly became productive. This opened the way to increased inequality, driven by particular agents in the economy being able to brag about their extraordinary ‘productivity’.
As we will see in Chapter 3, which explores the development of national accounts, the idea of the production boundary continues to influence the concept of output. There is, however, a fundamental distinction between this new boundary and its predecessors. Today, decisions about what constitutes value in the national accounts are made by blending different elements: anything that can be priced and exchanged legally; politically pragmatic decisions, such as accommodating technological change in the computer industry or the embarrassingly large size of the financial sector; and the practical necessity of keeping the accounting manageable in very big and complex modern economies. This is all very well, but the fact that the production boundary debate is no longer explicit, nor linked openly to ideas about value, means that economic actors can – through sustained lobbying – quietly place themselves within the boundary. Their value-extracting activities are then counted in GDP – and very few notice.
Chapters 4, 5 and 6 examine the phenomenon of financialization: the growth of the financial sector and the spread of financial practices and attitudes into the real economy. In Chapter 4 I look at the emergence of finance as a major economic sector and its transition from being considered largely unproductive to becoming accepted as largely productive. As late as the 1960s, national accountants viewed financial activity not as generating value but as simply transferring existing value, which placed it outside the production boundary. Today, this view has changed fundamentally. In its current incarnation, finance is seen as earning profits from services reclassified as productive. I look at how and why this extraordinary redefinition took place, and ask if financial intermediation really has undergone a transformation into an inherently productive activity.
In Chapter 5 I explore the development of ‘asset manager capitalism’: how the financial sector expanded beyond the banks to incorporate an increasingly large number of intermediaries dedicated to managing funds (the asset management industry), and ask whether the role of these intermediaries, and the actual risks they take on, justify the rewards they earn. In doing so, I question the extent to which fund management and private equity have actually contributed to the productive economy. I ask, too, whether financial reform can be tackled today without a serious debate over whether activities in the financial sector are properly classified – are they what should be seen as rents, rather than profits? – and how we can go about making this distinction. If our national accounting systems are really rewarding value extraction as though it is value creation, maybe this can help us understand the dynamics of value destruction that characterized the financial crisis.
Building on this acceptance of finance as a productive activity, Chapter 6 examines the financialization of the whole economy. In seeking a quick return, short-term finance has affected industry: companies are run in the name of maximizing shareholder value (MSV). MSV arose in the 1970s as an attempt to revitalize corporate performance by invoking what was claimed to be the main purpose of the company: creating value for shareholders. I will argue, however, that MSV has been detrimental to sustained economic growth, not least because it encourages short-term gain for shareholders at the expense of long-term gains for the company – a development closely linked to the increasing influence of fund managers seeking returns for their clients and for themselves. Underlying MSV is the notion of shareholders as the biggest risk takers, meriting the large rewards they often obtain.
Risk-taking is often t
he justification for the rewards investors reap, and Chapter 7 continues to look at other types of value extraction carried out in its name. Here I consider the kind of risk-taking required for radical technological innovation to occur. Innovation is without doubt one of the most risky and uncertain activities in capitalism: most attempts fail. But who takes it on? And what sort of incentives must be created? I explore the biased view of the current innovation narrative: how public-sector risk-taking is ignored, the state being seen as merely facilitating and ‘de-risking’ the private sector. The result has been policies, including reforms to the intellectual property rights (IPR) system, which have strengthened the power of incumbents, limiting innovation and creating ‘unproductive entrepreneurship’.20 Building on my previous book The Entrepreneurial State, I will show how entrepreneurs and venture capitalists have been hyped up to represent the most dynamic part of modern capitalism – innovation – and have presented themselves as ‘wealth creators’. I will unpick the wealth-creating narrative to show how, ultimately, it is false. Claiming value in innovation, most recently with the concept of ‘platforms’ and the related notion of the sharing economy, is less about genuine innovation and more to do with facilitating value extraction through the capture of rents.
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