The Value of Everything - Making and Taking in the Global Economy (Quotes)
Summary: The name of this blog comes from this book by Mariana Mazzucato which is essential reading. "Who really creates wealth in our world? And how do we decide the value of what they do? In modern capitalism, value-extraction - the siphoning off of profits, from shareholders' dividends to bankers' bonuses - is rewarded more highly than value-creation- the productive process that drives a healthy economy and society. We misidentify takers as makers, and have lost sight of what value really means."
Details:
Initially, I plan to post the quotes from this book that are most relevant to the Hayne Royal Commission and discussion on the financial services industry.
Preface: Stories About Wealth Creation
We often hear businesses, entrepreneurs or sectors talking about themselves as ‘wealth-creating’. The contexts may differ – finance, big pharma or small start-ups – but the self-descriptions are similar: I am a particularly productive member of the economy, my activities create wealth, I take big ‘risks’, and so I deserve a higher income than people who simply benefit from the spillovers of this activity. But what if, in the end, these descriptions are simply just stories? Narratives created in order to justify inequalities of wealth and income, massively rewarding the few who are able to convince governments and society that they deserve high rewards, while the rest of us make do with the leftovers.
The purpose of this book is to change this state of things, and to do so by reinvigorating the debate about value that used to be – and, I argue, should still be – at the core of economic thinking. If value is defined by price – set by the supposed forces of supply and demand – then as long as an activity fetches a price (legally), it is seen as creating value. So if you earn a lot you must be a value creator. I will argue that the way the word ‘value’ is used in modern economics has made it easier for value extracting activities to masquerade as value-creating activities. And in the process rents (unearned income) get confused with profits (earned income); inequality rises, and investment in the real economy falls. What’s more, if we cannot differentiate value creation from value extraction, it becomes nearly impossible to reward the former over the latter. If the goal is to produce growth that is more innovation-led (smart growth), more inclusive and more sustainable, we need a better understanding of value to steer us.
If we cannot define what we mean by value, we cannot be sure to produce it, nor to share it fairly, nor to sustain economic growth. The understanding of value, then, is critical to all the other conversations we need to have about where our economy is going and how to change its course.
...
Introduction: Making versus Taking
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?
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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.
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.
MEET THE PRODUCTION BOUNDARY
To understand how different theories of value have evolved over thecenturies, 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 foran 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.
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
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.
...
WHY VALUE THEORY MATTERS
First, the disappearance of value from the economic debate hides what should be alive, public and actively contested. 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.
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.
...
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.
...
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).
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 of 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.
...
To create a fairer economy, one where prosperity is more broadly shared and is therefore more sustainable, we need to reinvigorate a serious discussion about the nature and origin of value. We must reconsider the stories we are telling about who the value creators are, and what that says to us about how we define activities as economically productive and unproductive. We cannot limit progressive politics to taxing wealth, but require a new understanding of and debate about wealth creation so that it is more fiercely and openly contested. Words matter: we need a new vocabulary for policymaking. Policy is not just about ‘intervening’. It is about shaping a different future: co-creating markets and value, not just ‘fixing’ markets or redistributing value. It’s about taking risks, not only ‘de-risking’. And it must not be about levelling the playing field but about tilting it towards the kind of economy we want.
Chapter 1: A Brief History of Value
Today we take increasing prosperity for granted. We assume that by and large the next generation will be better off than the last. But it was not always so. For most of human history people had no such expectations and, partly because living standards improved at best very slowly, few thinkers devoted much time to asking why some economies grow and others do not.
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What taxes can we raise? Why are my wages so low compared with the profits of capitalists? How sure can one be of the future when investing now? What creates value? Understanding the nature of production is key to answering such questions. Once productive activities have been identified, economic policy can try to steer an economy, devoting a greater share of capital and effort to productive activities which propel and sustain economic growth. But the distinction between what is or is not productive has varied depending on economic, social and political forces.
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As the study of economics developed during the course of the eighteenth century, thinkers became increasingly concerned with finding a theory to explain why some nations grew and prospered while others declined. Although the economists of the time did not use the term ‘production boundary’, the idea was at the heart of their work. Their search for the source of value led them to locate it in production, first in land – understandably so, in predominantly agrarian societies – and then, as economies became more industrialized, in labour. The labour theory of value reached its apogee with Karl Marx in the mid-nineteenth century, when the Industrial Revolution was in full swing.
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Though he himself did not use the term, Quesnay’s theory of value incorporates a very clear production boundary, the first to be drawn with such precision, which makes it clear that the surplus the ‘productive’ sectors generate enables everyone else to live.
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Quesnay and Turgot’s almost complete identification of productivity with the agricultural sector had an overriding aim. Their restrictive production boundary gave the landed aristocracy ammunition to use against mercantilism, which favoured the merchant class, and fitted an agricultural society better than an industrial one. Given the physiocrats’ disregard for industry, it is hardly surprising that the most significant critique of their ideas came from the nation where it was already clear that value was not just produced in agriculture, but in other emerging sectors: a rapidly industrializing Britain. The most influential critic of all was Quesnay’s contemporary, a man who had travelled in France and talked at length with him: Adam Smith.
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With Britain well on the path to industrial capitalism, Smith’s The Wealth of Nations highlighted the role of the division of labour in manufacturing. His account of pin-manufacturing continues to be cited today as one of the first examples of organizational and technological change at the centre of the economic growth process. Explaining the immense increase in productivity that occurred when one worker was no longer responsible for producing an entire pin, but only for a small part of it, Smith related how the division of labour allowed an increase in specialization and hence productivity
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Equally significant was Smith’s analysis of how the ‘market’ determines the way in which consumers and producers interact. Such interaction, he contended, was not down to ‘benevolence’ or central planning. Rather, it was due to the ‘invisible hand’ of the market:
"Every individual is continually exerting himself to find out the most advantageous employment for whatever capital he can command. It is his own advantage, indeed, and not that of the society which he has in view. But the study of his own advantage naturally, or rather necessarily, leads him to prefer that employment which is most advantageous to society … He intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was not part of his intention."
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Smith has become the figurehead of much modern economic theory because of his ideas about how capitalism is founded on supposedly immutable human behaviour, notably self-interest, and competition in a market economy. His metaphor of the ‘invisible hand’ has been cited ad nauseam to support the current orthodoxy that markets, left to themselves, may lead to a socially optimal outcome – indeed, more beneficial than if the state intervenes.
Smith’s book is actually a collection of recipes for politicians and policymakers. Far from leaving everything to the market, he thinks of himself as giving guidance to ‘statesmen’ on how to act to ‘enrich both the people and the sovereign’ – how to increase the wealth of nations. This is where Smith’s value theory enters the picture. He was convinced that growth depended on increasing the relative share of ‘manufactures’ – factories employing formerly independent artisans or agricultural workers as dependent wage labourers – in the overall make-up of industry and believed that free trade was essential to bring this about. He felt that the enemies of growth were, first, the protectionist policies of mercantilists; second, the guilds protecting artisans’ privileges; and third, a nobility that squandered its money on unproductive labour and lavish consumption. For Smith (as for Quesnay), employing an overly large portion of labour for unproductive purposes – such as the hoarding of cash, a practice that still afflicts our modern economies – prevents a nation from accumulating wealth.
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Value, Smith believed, was proportional to the time spent by workers on production. For the purposes of his theory, Smith assumed a worker of average speed. Figure 5 shows how he drew a clear line (the production boundary) between productive and unproductive labour. For him, the boundary lay between material production – agriculture, manufacturing, mining in the figure’s darker blob – and immaterial production in the lighter blob. The latter included all types of services (lawyers, carters, officials and so on) that were useful to manufactures, but were not actually involved in production itself. Smith said as much: labour, he suggested, is productive when it is ‘realized’ in a permanent object.
His positioning of government on the ‘unproductive’ side of the boundary set the tone for much subsequent analysis and is a recurring theme in today’s debates about government’s role in the economy, epitomized by the Thatcher– Reagan reassertion in the 1980s of the primacy of markets in solving economic and social issues.
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In Smith’s view, ‘how honourable, how useful, or how necessary soever’ a service may be, it simply does not reproduce the value used in maintaining (feeding, clothing, housing) unproductive labourers. Smith finds that even ‘the sovereign’, together with ‘all the officers both of justice and war who serve under him, the whole army and navy, are unproductive labourers’. Priests, lawyers, doctors and performing artists are all lumped together as unproductive too.
What informs Smith’s classification is his conviction that some types of labour do not ‘reproduce’ the value needed to keep those workers alive at a subsistence level. In other words, if all the subsistence that was needed to keep a person alive was a certain amount of grain, then anyone who does not produce as much value as that amount of grain is by definition unproductive.
How, then, are those that do not produce this unit of value kept alive? Smith’s answer lay in the concept of a ‘surplus’. Many productive workers produce the equivalent of more grain than they need to feed themselves to survive. A manufacturer makes things that, when exchanged, will yield more grain than needed to keep the productive workers alive.
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This is where Smith addressed head-on how the wealth of nations could grow. It was in effect his policy advice. Instead of ‘wasting’ the surplus on paying for unproductive labour, he argued, it should be saved and invested in more production so that the whole nation could become richer.
Smith was not criticizing the wealthy per se. But he was criticizing those who wasted their wealth on lavish consumption – ‘collecting books, statues, pictures’, or ‘more frivolous, jewels, baubles, ingenious trinkets’ – instead of productive investment. Smith was particularly attracted to the prospect of investment in machines, then just beginning to be used in factories, because they improved workers’ productivity.
His emphasis on investment linked directly to his ideas about rent. Smith believed that there were three kinds of income: wages for labour in capitalist enterprises; profits for capitalists who owned the means of production; and rents from ownership of land. When these three sources of income are paid at their competitive level, together they determine what he called the ‘competitive price’. Since land was necessary, rent from land was a ‘natural’ part of the economy. But that did not mean rent was productive: ‘the landlords, like all other men, love to reap where they never sowed and demand a rent [from the earth] even for its natural produce’.
Indeed, Smith asserted, the principle of rent from land could be extended to other monopolies, such as the right to import a particular commodity or the right to plead at the bar. Smith was well aware of the damage monopolies could do. In the seventeenth century, a government desperate for revenue had granted – often to well-placed courtiers – an extraordinary range of monopolies, from daily necessities such as beer and salt to mousetraps and spectacles. In 1621 there were said to be 700 monopolies, and by the late 1630s they were bringing in £100,000 a year to the Exchequer.
But this epidemic of rent-seeking was deeply unpopular and was choking the economy: more than that, it was one of the proximate causes of the Civil War, which led to the execution of Charles I. Many Englishmen understood what Smith meant when he said that a free market was one free of rent.
Details:
Initially, I plan to post the quotes from this book that are most relevant to the Hayne Royal Commission and discussion on the financial services industry.
Preface: Stories About Wealth Creation
We often hear businesses, entrepreneurs or sectors talking about themselves as ‘wealth-creating’. The contexts may differ – finance, big pharma or small start-ups – but the self-descriptions are similar: I am a particularly productive member of the economy, my activities create wealth, I take big ‘risks’, and so I deserve a higher income than people who simply benefit from the spillovers of this activity. But what if, in the end, these descriptions are simply just stories? Narratives created in order to justify inequalities of wealth and income, massively rewarding the few who are able to convince governments and society that they deserve high rewards, while the rest of us make do with the leftovers.
...
Until the 1960s, finance was not widely considered a ‘productive’ part of the economy. It was viewed as important for transferring existing wealth, not creating new wealth. Indeed, economists were so convinced about the purely facilitating role of finance that they did not even include most of the services that banks performed, such as taking in deposits and giving out loans, in their calculations of how many goods and services are produced by the economy. Finance sneaked into their measurements of Gross Domestic Product (GDP) only as an ‘intermediate input’ – a service contributing to the functioning of other industries that were the real value creators.
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In all these cases, from finance to pharmaceuticals and IT, governments bend over backwards to attract these supposedly value-creating individuals and companies, dangling before them tax reductions and exemptions from the red tape that is believed to constrict their wealth-creating energies. The media heap wealth creators with praise, politicians court them, and for many people they are high-status figures to be admired and emulated. But who decided that they are creating value? What definition of value is used to distinguish value creation from value extraction, or even from value destruction?
Why have we so readily believed this narrative of good versus bad? How is the value produced by the public sector measured, and why is it more often than not treated simply as a more inefficient version of the private sector? What if there was actually no evidence for this story at all? What if it stemmed purely from a set of deeply ingrained ideas? What new stories might we tell?
Why have we so readily believed this narrative of good versus bad? How is the value produced by the public sector measured, and why is it more often than not treated simply as a more inefficient version of the private sector? What if there was actually no evidence for this story at all? What if it stemmed purely from a set of deeply ingrained ideas? What new stories might we tell?
....
The purpose of this book is to change this state of things, and to do so by reinvigorating the debate about value that used to be – and, I argue, should still be – at the core of economic thinking. If value is defined by price – set by the supposed forces of supply and demand – then as long as an activity fetches a price (legally), it is seen as creating value. So if you earn a lot you must be a value creator. I will argue that the way the word ‘value’ is used in modern economics has made it easier for value extracting activities to masquerade as value-creating activities. And in the process rents (unearned income) get confused with profits (earned income); inequality rises, and investment in the real economy falls. What’s more, if we cannot differentiate value creation from value extraction, it becomes nearly impossible to reward the former over the latter. If the goal is to produce growth that is more innovation-led (smart growth), more inclusive and more sustainable, we need a better understanding of value to steer us.
...
If we cannot define what we mean by value, we cannot be sure to produce it, nor to share it fairly, nor to sustain economic growth. The understanding of value, then, is critical to all the other conversations we need to have about where our economy is going and how to change its course.
...
Introduction: Making versus Taking
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?
...
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.
...
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.
...
Eventually the debate about different theories of value and the dynamicsof value creation virtually vanished from economics departments, onlyshowing up in business schools in a very new form: ‘shareholder value’,‘shared value’,‘value chains’,‘value for money’, ‘valuation’, ‘addingvalue’ and the like. So while economics students used to get a rich andvaried education in the idea of value, learning what different schools ofeconomic thought had to say about it, today they are taught only that valueis determined by the dynamics of price, due to scarcity and preferences.This is not presented as a particular theory of value – just as Economics101, the introduction to the subject. An intellectually impoverished idea ofvalue is just taken as read, assumed simply to be true. And thedisappearance of the concept of value, this book argues, has paradoxicallymade it much easier for this crucial term ‘value’ – a concept that lies at theheart of economic thought – to be used and abused in whatever way onemight find useful.
To understand how different theories of value have evolved over thecenturies, 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 foran 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.
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
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.
...
WHY VALUE THEORY MATTERS
First, the disappearance of value from the economic debate hides what should be alive, public and actively contested. 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.
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.
...
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.
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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).
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 of 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.
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To create a fairer economy, one where prosperity is more broadly shared and is therefore more sustainable, we need to reinvigorate a serious discussion about the nature and origin of value. We must reconsider the stories we are telling about who the value creators are, and what that says to us about how we define activities as economically productive and unproductive. We cannot limit progressive politics to taxing wealth, but require a new understanding of and debate about wealth creation so that it is more fiercely and openly contested. Words matter: we need a new vocabulary for policymaking. Policy is not just about ‘intervening’. It is about shaping a different future: co-creating markets and value, not just ‘fixing’ markets or redistributing value. It’s about taking risks, not only ‘de-risking’. And it must not be about levelling the playing field but about tilting it towards the kind of economy we want.
Chapter 1: A Brief History of Value
Today we take increasing prosperity for granted. We assume that by and large the next generation will be better off than the last. But it was not always so. For most of human history people had no such expectations and, partly because living standards improved at best very slowly, few thinkers devoted much time to asking why some economies grow and others do not.
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What taxes can we raise? Why are my wages so low compared with the profits of capitalists? How sure can one be of the future when investing now? What creates value? Understanding the nature of production is key to answering such questions. Once productive activities have been identified, economic policy can try to steer an economy, devoting a greater share of capital and effort to productive activities which propel and sustain economic growth. But the distinction between what is or is not productive has varied depending on economic, social and political forces.
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As the study of economics developed during the course of the eighteenth century, thinkers became increasingly concerned with finding a theory to explain why some nations grew and prospered while others declined. Although the economists of the time did not use the term ‘production boundary’, the idea was at the heart of their work. Their search for the source of value led them to locate it in production, first in land – understandably so, in predominantly agrarian societies – and then, as economies became more industrialized, in labour. The labour theory of value reached its apogee with Karl Marx in the mid-nineteenth century, when the Industrial Revolution was in full swing.
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Though he himself did not use the term, Quesnay’s theory of value incorporates a very clear production boundary, the first to be drawn with such precision, which makes it clear that the surplus the ‘productive’ sectors generate enables everyone else to live.
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Quesnay and Turgot’s almost complete identification of productivity with the agricultural sector had an overriding aim. Their restrictive production boundary gave the landed aristocracy ammunition to use against mercantilism, which favoured the merchant class, and fitted an agricultural society better than an industrial one. Given the physiocrats’ disregard for industry, it is hardly surprising that the most significant critique of their ideas came from the nation where it was already clear that value was not just produced in agriculture, but in other emerging sectors: a rapidly industrializing Britain. The most influential critic of all was Quesnay’s contemporary, a man who had travelled in France and talked at length with him: Adam Smith.
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With Britain well on the path to industrial capitalism, Smith’s The Wealth of Nations highlighted the role of the division of labour in manufacturing. His account of pin-manufacturing continues to be cited today as one of the first examples of organizational and technological change at the centre of the economic growth process. Explaining the immense increase in productivity that occurred when one worker was no longer responsible for producing an entire pin, but only for a small part of it, Smith related how the division of labour allowed an increase in specialization and hence productivity
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Equally significant was Smith’s analysis of how the ‘market’ determines the way in which consumers and producers interact. Such interaction, he contended, was not down to ‘benevolence’ or central planning. Rather, it was due to the ‘invisible hand’ of the market:
"Every individual is continually exerting himself to find out the most advantageous employment for whatever capital he can command. It is his own advantage, indeed, and not that of the society which he has in view. But the study of his own advantage naturally, or rather necessarily, leads him to prefer that employment which is most advantageous to society … He intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was not part of his intention."
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Smith has become the figurehead of much modern economic theory because of his ideas about how capitalism is founded on supposedly immutable human behaviour, notably self-interest, and competition in a market economy. His metaphor of the ‘invisible hand’ has been cited ad nauseam to support the current orthodoxy that markets, left to themselves, may lead to a socially optimal outcome – indeed, more beneficial than if the state intervenes.
Smith’s book is actually a collection of recipes for politicians and policymakers. Far from leaving everything to the market, he thinks of himself as giving guidance to ‘statesmen’ on how to act to ‘enrich both the people and the sovereign’ – how to increase the wealth of nations. This is where Smith’s value theory enters the picture. He was convinced that growth depended on increasing the relative share of ‘manufactures’ – factories employing formerly independent artisans or agricultural workers as dependent wage labourers – in the overall make-up of industry and believed that free trade was essential to bring this about. He felt that the enemies of growth were, first, the protectionist policies of mercantilists; second, the guilds protecting artisans’ privileges; and third, a nobility that squandered its money on unproductive labour and lavish consumption. For Smith (as for Quesnay), employing an overly large portion of labour for unproductive purposes – such as the hoarding of cash, a practice that still afflicts our modern economies – prevents a nation from accumulating wealth.
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Value, Smith believed, was proportional to the time spent by workers on production. For the purposes of his theory, Smith assumed a worker of average speed. Figure 5 shows how he drew a clear line (the production boundary) between productive and unproductive labour. For him, the boundary lay between material production – agriculture, manufacturing, mining in the figure’s darker blob – and immaterial production in the lighter blob. The latter included all types of services (lawyers, carters, officials and so on) that were useful to manufactures, but were not actually involved in production itself. Smith said as much: labour, he suggested, is productive when it is ‘realized’ in a permanent object.
His positioning of government on the ‘unproductive’ side of the boundary set the tone for much subsequent analysis and is a recurring theme in today’s debates about government’s role in the economy, epitomized by the Thatcher– Reagan reassertion in the 1980s of the primacy of markets in solving economic and social issues.
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In Smith’s view, ‘how honourable, how useful, or how necessary soever’ a service may be, it simply does not reproduce the value used in maintaining (feeding, clothing, housing) unproductive labourers. Smith finds that even ‘the sovereign’, together with ‘all the officers both of justice and war who serve under him, the whole army and navy, are unproductive labourers’. Priests, lawyers, doctors and performing artists are all lumped together as unproductive too.
What informs Smith’s classification is his conviction that some types of labour do not ‘reproduce’ the value needed to keep those workers alive at a subsistence level. In other words, if all the subsistence that was needed to keep a person alive was a certain amount of grain, then anyone who does not produce as much value as that amount of grain is by definition unproductive.
How, then, are those that do not produce this unit of value kept alive? Smith’s answer lay in the concept of a ‘surplus’. Many productive workers produce the equivalent of more grain than they need to feed themselves to survive. A manufacturer makes things that, when exchanged, will yield more grain than needed to keep the productive workers alive.
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This is where Smith addressed head-on how the wealth of nations could grow. It was in effect his policy advice. Instead of ‘wasting’ the surplus on paying for unproductive labour, he argued, it should be saved and invested in more production so that the whole nation could become richer.
Smith was not criticizing the wealthy per se. But he was criticizing those who wasted their wealth on lavish consumption – ‘collecting books, statues, pictures’, or ‘more frivolous, jewels, baubles, ingenious trinkets’ – instead of productive investment. Smith was particularly attracted to the prospect of investment in machines, then just beginning to be used in factories, because they improved workers’ productivity.
His emphasis on investment linked directly to his ideas about rent. Smith believed that there were three kinds of income: wages for labour in capitalist enterprises; profits for capitalists who owned the means of production; and rents from ownership of land. When these three sources of income are paid at their competitive level, together they determine what he called the ‘competitive price’. Since land was necessary, rent from land was a ‘natural’ part of the economy. But that did not mean rent was productive: ‘the landlords, like all other men, love to reap where they never sowed and demand a rent [from the earth] even for its natural produce’.
Indeed, Smith asserted, the principle of rent from land could be extended to other monopolies, such as the right to import a particular commodity or the right to plead at the bar. Smith was well aware of the damage monopolies could do. In the seventeenth century, a government desperate for revenue had granted – often to well-placed courtiers – an extraordinary range of monopolies, from daily necessities such as beer and salt to mousetraps and spectacles. In 1621 there were said to be 700 monopolies, and by the late 1630s they were bringing in £100,000 a year to the Exchequer.
But this epidemic of rent-seeking was deeply unpopular and was choking the economy: more than that, it was one of the proximate causes of the Civil War, which led to the execution of Charles I. Many Englishmen understood what Smith meant when he said that a free market was one free of rent.
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David Ricardo: Grounding Smith’s Value Theory
Ricardo was drawn to economics by reading Smith’s The Wealth of Nations, but was concerned with something that he felt was glaringly absent from Smith’s theory of value: how that value was distributed throughout society – or what we would today call income distribution. It need hardly be said that, in today’s world of growing inequality of income and wealth, this question remains profoundly relevant.
Smith had observed that the value produced by labour, when sold, is redistributed as wages, profits and rent; he had also seen that labour’s exact share of this value – wages – would vary. However, Smith had no coherent explanation for the way in which wages were apportioned, or why they differed between professions and countries or over time.
Ricardo, by contrast, felt that the distribution of wages was, as he stressed in his magnum opus On the Principles of Political Economy and Taxation, the ‘principle problem’ in economics and ultimately regulates the growth and wealth of a nation.
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Ricardo defined rent as a transfer of profit to landlords simply because they had a monopoly of a scarce asset. There was no assumption, as in modern neoclassical theory (reviewed in Chapter 2), that these rents would be competed away. They remained due to power relationships inherent in the capitalist system. In Ricardo’s time much of the arable land was owned by aristocrats and landed gentry but worked by tenant farmers or labourers.
Ricardo proposed that the rent from more productive land always goes to the landlord because of competition between tenants. If the capitalist farmer – the tenant – wants to hang on to the largest possible profit by paying less rent, the landlord can give the lease to a competing farmer who will pay a higher rent and therefore be willing to work the land for only the standard profit. As this process goes on, land of increasingly poor quality will be brought into production, and a greater portion of the income will go to the landlords. Ricardo predicted that rents would rise.
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By highlighting the different types of incomes earned, such as rent, profits and wages, Ricardo drew attention to an important question. When goods are sold, how are the proceeds of that sale divided? Does everyone involved get their ‘just share’ for the amount of effort they put into production? Ricardo’s answer was an emphatic ‘No’.
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Ricardo’s theory was so convincing that it is, in essence, still used today in economics to explain how rents work. Rents in this sense could mean a patent on a drug, control of a rare mineral such as diamonds, or rents in the everyday sense of what you pay a landlord to live in a flat. In the modern world, oil producers like those of the Organization of Petroleum Exporting Countries (OPEC) collect rents from their control of an essential resource.
Ricardo’s gloomy picture of economic stagnation is relevant to a modern debate: how the rise of the financial sector in recent decades and the massive rents it earned from speculative activity have created disincentives for industrial production. Some heterodox economists today argue that growth will fall if finance becomes too big relative to the rest of the economy (industry) because real profits come from the production of new goods and services rather than from simple transfers of money earned from those goods and services.
To ‘rebalance’ the economy, the argument runs, we must allow genuine profits from production to win over rents – which, as we can see here, is exactly the argument Ricardo made 200 years ago, and John Maynard Keynes was to make 100 years later.
Indeed, as is also argued today, Ricardo believed that the pool of (mainly unskilled) workers held the losing ticket. In Ricardo’s day, agricultural labour flocked to the fast-growing cities and the supply of unskilled labour exceeded demand for it. Without bargaining power, these workers were paid a meagre subsistence wage. Ricardo’s portrayal of rents dominating production also had a political impact. It helped to persuade Britain to abolish the Corn Laws in 1846 and embrace free trade, which diminished the power of big vested interests and allowed production costs, rather than embedded monopoly and the privileges that went with it, to govern production. The ensuing decades saw Britain become the ‘workshop of the world’. But the abolition of the Corn Laws brought about a political transformation as well as an economic one: it tipped the balance of power away from aristocratic landlords and towards manufacturing as the nineteenth century wore on. Value theory influenced political behaviour, and vice versa
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In essence, Ricardo’s theory of value and growth led to a production boundary that does not depend on a job or profession itself (manufacturer, farmer or vicar) or on whether the activity is material or immaterial. He believed that industrial production in general leads to surpluses, but for him the real question is how those surpluses are used. If the surpluses finance productive consumption, they are productive; if not, they are unproductive.
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The source of that inherent value is the one special commodity workers own: their labour power, or – put another way – their capacity to work. Capitalists buy labour power with their capital. In exchange, they pay workers a wage. Workers’ wages buy the commodities such as food and housing needed to restore a worker’s strength to work. In this way, wages express the value of the goods that restore labour power.
Workers expend labour, not labour power. And in this distinction lies the secret of Marx’s theory of value. Humans can create more value than they need to restore their labour power. For instance, if a worker has to work five hours to produce the value needed to restore labour power per day, the labour power’s value is equivalent to the five hours of work. However, if the working day lasts ten hours, the additional five hours’ work will create value over and above that needed to restore labour power. Labour power creates surplus value.
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The ingenuity of capitalism, according to Marx, is that it can organize production to make workers generate unprecedented amounts of this surplus value. In early societies of hunter-gatherers and subsistence farmers, people worked enough to create the value that would allow them to survive, but no surplus over and above that. Later, under feudalism, they could be forced to produce enough surplus to satisfy the (unproductive) consumption of the feudal lord, which, as Smith and Ricardo knew, could be substantial. But after the means of production were taken away from independent producers – mostly by violence and expropriation through property rights legislation, such as enclosures of common land in England by big landowners – they became workers, ‘free’ and without property.
Capitalists were able to purchase the workers’ labour power because workers lost their independent means of subsistence and needed a wage to survive. The trick is to get them to work longer than needed to produce value (wages) that they spend on their subsistence needs – again, food and housing.
46 Workers, in other words, are exploited because capitalists pocket the surplus value workers produce over and above their subsistence requirements. And, unlike the feudal lords, capitalists will not squander all of the surplus on consumption, but will have incentives to reinvest part of it in expanding production to make yet more profits. However, Marx noted that there was a contradiction in the system. The drive to increase productivity would increase mechanization, which, in displacing labour (machines taking over human work), would then eventually reduce the key source of profits: labour power.
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Economists had previously thought of ‘capital’ as purely physical – machinery and buildings, for example – and surplus as solely positive, helping the economy to reproduce itself and grow. But Marx gives capital a social dimension and surplus a negative connotation. Labour produces surplus value, which fuels capital accumulation and economic growth. But capital accumulation is not just due to productive labour. It is also deeply social. Because workers do not own the means of production they are ‘alienated’ from their work. The surplus they produce is taken away from them. Work is necessary for earning the wages they receive to buy the food, shelter and clothes they need to survive.
Moreover, in a capitalist market society, relations between people are mediated by commodity exchange. In a specialized society with division of labour, humans produce the social product – net national income – together and depend on other humans. But precisely because the division of labour, which Smith extolled, left most workers overly specializing in discrete aspects of the production process, he believed that social relations became relations between commodities (things).
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