The Value of Everything: Making and Taking in the Global Economy

by Mariana Mazzucato

So, if margins are high but investment is low, what have companies done with their profits? Following the money leads us directly to shareholders. As we can see from Figure 29, corporations have largely returned profits to shareholders in the form of dividends and share buy-backs. Having averaged 10–20 per cent in the 1970s, the percentage of cash flow returned to shareholders has remained above 30, and sometimes substantially more than that for most of the past thirty years, although it dipped during the tech boom in the early 1990s when companies were investing.

Recognizing the collective nature of value creation takes us from a shareholder to a stakeholder view. Whereas MSV boils valuation down to a single measure–the share price–an opposing argument is that corporations should focus on maximizing stakeholder value: creating as much value as possible for all stakeholders and seeing any decision as a balance of interests and trade-offs to achieve that goal–hardly an easy task, given the complexity of many business decisions.

If the objective is long-term growth, the private sector must be rewarded for making decisions that target the long-term over the short-term. While some companies might be focusing on boosting their stock prices through share buy-backs, aimed at increasing stock prices and hence stock options (through which executives are paid), others may be taking on the difficult investments to increase the training needed for workers, introduce risky new technology, and investment in R&D, eventually leading, with luck, to new technology and more likely leading to nowhere. Companies could be rewarded for doing more of the latter and less of the former.

Executive pay should be kept in check through an understanding that there are many other stakeholders who are critical to value creation, from workers and the state to civil society movements. Reinvestment of profits back into the real economy–rather than hoarding or engaging in share buy-backs–should be a condition attached to any type of government support, whether through subsidies or government grants and loans.

Value extraction in the innovation economy occurs in various ways. First, in the way that the financial sector–in particular venture capital and the stock market–has interacted with the process of technology creation. Second, in the way that the system of intellectual property rights (IPR) has evolved: a system that now allows not just the products of research but also the tools for research to be patented and their use ring-fenced, thereby creating what the economist William J. Baumol termed ‘unproductive entrepreneurship’. Third, in the way that prices of innovative products do not reflect the collective contribution to the products concerned, in fields as diverse as health, energy or broadband. And fourth, through the network dynamics characteristic of modern technologies, where first-mover advantages in a network allow large companies to reap monopolistic advantages through economies of scale and the fact that customers using the network get locked in (finding it too cumbersome or disadvantageous to switch service).

the most modern form of rent-seeking in the twenty-first-century knowledge economy is through the way in which risks in the innovation economy are socialized, while the rewards are privatized.

Yet contrary to the prevailing image of fearless, risk-taking entrepreneurs, business often does not want to take on such risk. This is especially the case in areas where a lot of capital is needed and the technological and market risks are high–pharmaceuticals, for instance, and the very early stages of sectors, from the Internet to biotech and nanotech. At this point the public sector can, and does, step in where private finance fears to tread, to provide vital long-term finance.

An IPO is the point at which expectation and potential come face to face with the realities of the marketplace. IPOs capture in one moment value generated over a long period, capitalizing the future profit potential of a business into a market price.

Patents are protections granted to inventions that are novel, inventive (non-obvious) and suitable for industrial application. In theory they protect the innovator from having his or her idea copied. In practice, however, most innovations are not patented, which in itself shows that patents are not really necessary, as there are other ways to protect innovations, including lead-times and trade secrecy. One study found that between 1977 and 2004, only 10 per cent of ‘important’ innovations were patented.23

Yet granting an exclusive licence on a university-owned patent deters follow-on innovations. Firms must now negotiate–and pay for–a licence before entering a market to access proprietary information that would previously have been available in publications.28 Instead of encouraging better technology transfer–for example, of human stem cell patents held by the University of Wisconsin–the system has delayed technology diffusion.29

Today, the patent system offers many opportunities for these kinds of ‘unproductive entrepreneurship’; patents can reinforce monopolies and intensify abuse of market power, block the diffusion of knowledge and follow-on innovations, and make it easier to privatize research that is publicly funded and collectively created. Indeed, in the words of economist William J. Baumol, ‘at times the entrepreneur may even lead a parasitical existence that is actually damaging to the economy’.

The internal combustion engine has retained its dominance for over a hundred years, not because it is the best possible engine, but because through historical accident it gained an initial advantage. Subsequent innovations did not seek to supplant it, but clustered around improvements to it, so that it became post factum the best engine.61 The same goes for the QWERTY keyboard layout, named for the first six letters on the top from left to right. In the days of mechanical typewriters, the very inefficiency of this keyboard layout gave it an advantage over alternatives such as the faster DVORAK layout because the mechanical keys would jam less frequently. The mechanical necessity for the QWERTY layout has long passed in these days of electronic keyboards, but its advantage has remained. Once people learned how to type using the QWERTY layout they resisted change. This social inertia meant its arbitrary initial advantage got locked in.

Firms like Google, Facebook and Amazon–and new ‘sharing-economy’ firms like Airbnb and Uber–like to define themselves as ‘platforms’. They don’t face a traditional market, in which the firm produces a good or service and sells it to a population of potential consumers. They operate, instead, in what economists call two-sided markets, developing the supply and demand sides of the market as the lynchpin, connector or gatekeeper between them.

For all the hype about ‘sharing’, it is less about altruism and more about allowing market exchange to reach into areas of our lives–our homes, our vehicles, even our private relationships–that were previously beyond its scope and to commodify them.66 As Evgeny Morozov has warned, it risks turning us all into ‘perpetual hustlers’,67 with all of our lives up for sale, while at the same time undermining the basis for stable employment and a good standard of living.

The network effects that pervade online markets add an important peculiarity: once a firm establishes leadership in a market its dominance increases and becomes self-perpetuating almost automatically. If everyone is on Facebook, no one wants to join a different social network. As most people search on Google, the gap between Google and its competitors grows wider because it can elaborate on more data. And as its market share rises, so does its capacity to attract users, which in turn increases its market dominance.71

The confused and misleading approach to the concept of value that is currently dominating economics is generating a truly paradoxical result: unproductive advertising activities are counted as a net contribution of online giants to national income, while the more valuable services that they provide to users are not.

As Morozov argues, ‘Instead of us paying Amazon a fee to use its AI capabilities–built with our data–Amazon should be required to pay that fee to us.’78

It is this gap between the collective distribution of risk-taking in innovation and the more individualized, privatized way in which the returns are distributed that is the most modern form of rent.

John Locke (1632–1704). His concept of individual entitlement–‘just deserts’–to the product of work was based on a production system where individual labour was more important, and was easier to identify, than it is today when collective contributions have been central to technology-driven growth. This point was made by Herbert Simon (1916–2001), who made his name in the study of organizational decision-making, and who won the Nobel Prize in Economics in 1978. ‘If we are generous with ourselves,’ Simon considered, ‘I suppose that we might claim that we “earned” as much as one-fifth of our income. The rest of the patrimony [is] associated with being a member of an enormously productive social system, which has accumulated a vast store of physical capital, and an even larger store of intellectual capital–including knowledge, skills, and organizational know-how held by all of us.’79 Ignoring this collectively produced social system, certain individuals feel justified in earning a much higher proportion of a nation’s income than their own contribution warrants. But, more specifically, it has affected policies on taxes, patents and prices, thus fuelling the dynamics of inequality.

Given the immense risks the taxpayer takes when the government invests in visionary new areas like the Internet, couldn’t we construct ways for rewards from innovation to be just as social as the risks taken? These ways might include: capping prices of publicly developed medicines; attaching conditions to public support, such as the requirement that profits be reinvested back into production rather than spent on speculative share buy-backs; allowing public agencies to retain equity or royalties in technologies for which they provided downstream funding; or by making income-contingent loans to businesses as we do for students.

Of course, if the government is to act like a venture capitalist, it will necessarily encounter many failures. The problem, however, is that governments, unlike venture capital firms, are often saddled with the costs of the failures while earning next to nothing from the successes. Taxpayers footed the bill for Solyndra’s losses–yet got hardly any of Tesla’s profits.

Economic growth without innovation is hard to imagine. But innovation must be properly governed to make sure that what is produced and how it is produced leads to value creation and not gimmicks for value appropriation.

The important thing for Government is not to do things which individuals are doing already, and to do them a little better or a little worse; but to do those things which at present are not done at all. John M. Keynes, The End of Laissez-Faire (1926)1

It is crucial to understand that economic policy is not scientifically ordained. You can impose austerity and hope the economy grows, even though such a policy deprives it of demand; or you can focus on investing in areas like health, training, education, research and infrastructure with the belief that these areas are critical for long-run growth in GDP. In the end, the choice of policy depends heavily on one’s perspective on the role of government in the economy–is it key to creating value, or at best a cheerleader on the sidelines?

The austerity policy of cutting taxes and government spending does not revive investment and economic growth, when the real problem is weak demand. And in countries like Greece and Spain, where 50 per cent of young people cannot find work, pursuing policies that don’t actually affect investment–and hence jobs–means that an entire generation can lose its right to a prosperous future.

Conversely, the same research concludes that bigger government might be ‘bad’ if it is a result of activity that ‘crowds out’ (reduces) the private sector11 or unduly restricts private-sector activity and interferes too much in people’s lives.12 But within these rather obvious limits, the ideal size of government is hard to quantify–not least because it depends heavily on what you want government to do and how you value government activity. And here we have a problem: there has been a dearth of thinking by economists–both historically and in recent decades–about the value created by government.

For Keynes, additional public spending was needed to make sure economies were not constantly prone to recessions and depressions; by purchasing goods, government added to GDP on the expenditure side to make up for what was often too low business investment.

But of course vital government investments abound: obvious examples include infrastructure projects like the Federal interstate highway system in the US or motorways in the UK. It makes no sense simply to assume that the return on enormous government investments is zero, when similar investments by the private sector do produce a return. Moreover, it is perfectly possible to estimate a return. One way of doing this is to assume a market rate of return such as the yield on municipal bonds–the overall return on bonds issued by cities.31 The crucial point here is that zero government return on investment is a political choice, not a scientific inevitability.

But, by accounting convention, state-owned enterprises that sell products at market prices are counted as private enterprises in the value added of the relevant sector: public railways are part of the transport sector, not the government sector. Even though state-owned corporations earn profits (and in the stats, higher profits means higher value added), their profits are accounted for in the industrial sector they work for, not the ‘government’ sector.

Simply because of the way that productivity is defined, the fact that government expenditure is higher than value added reinforces the widely held idea that ‘unproductive’ government has to take before it can spend. This thinking by definition restricts how much government can influence the course of the economy. It underpins the theory of austerity. And it is a consequence of fables about government told over several centuries.

According to the ‘new classicals’, the proponents of fiscal austerity measures, the multiplier’s value is less than one, or even negative.36 On this basis they can argue that public expenditure has a non-Keynesian effect on output. In other words, an increase of £1 of public expenditure is supposed to generate less than £1 or even have a negative effect on total GDP because it crowds out private investment.

Public Choice theory argues that government failure is caused by private interests ‘capturing’ policymakers through nepotism, cronyism, corruption or rent-seeking,39 misallocation of resources such as investing public money in unsuccessful new technologies (picking losers),40 or undue competition with private initiatives (‘crowding out’ what might otherwise be successful private investment).41 Public Choice theory stresses that policy must be vigilant to make sure that the gains from government intervention in the economy outweigh the costs of government failures.

Even in countries where the privatization wave has weakened–if only because most suitable assets have been sold–the idea that the state should not own but only fund (if that) is firmly lodged in the public mind. Today, few governments or politicians argue for wholesale nationalization and government ownership.

The solution to the problem of natural monopolies was regulation. In the UK a series of regulatory agencies sprang up, each intended to stand between the public and industry. Regulatory capitalism replaced state capitalism. It was not what pure Public Choice theorists intended; indeed, regulatory capitalism resulted in exactly the kind of government cronyism and corruption that they had warned about.

Although reaching a more efficient provision of healthcare services for a lower cost has always been the stated purpose of outsourcing in the NHS, recent evidence seems to suggest that this might just be the second phase of what Noam Chomsky has called the ‘standard technique of privatization: ‘defund, make sure things don’t work, people get angry, you hand it over to private capital’.57

The cost to the taxpayer of all the contract workers is double that of civil servants, not because contract workers are paid better–they often have to put up with low wages and poor conditions–but because the contractors’ fees, overheads and profit margins, and the ratio of the number of contract workers to the number of civil servants is sometimes as high as four, revealing how bloated and inefficient the outsourcing process can become.64 A recent study shows that the ‘federal government approves service contract billing rates–deemed fair and reasonable–that pay contractors 1.83 times more than the government pays federal employees in total compensation, and more than 2 times the total compensation paid in the private sector for comparable services’.65 Again, it is not the contracted workers who get the higher amounts, but the firms that win the public contracts.

When government stops investing in its own capacity, it becomes more unsure of itself, less able, and the probability of failure increases. It becomes harder to justify the existence of a particular government function, leading to further cuts or eventually to privatization. This lack of belief in government thereby becomes a self-fulfilling prophecy: when we don’t believe in government’s ability to create value, it eventually cannot do so. And, when it does create value, such value is treated as a private-sector success or goes unnoticed.

All of which means that policies constructed on the assumption that business always wants to invest, and simply needs a tax incentive to do so, are simplistic, not to say naïve. The incentives (indirect spending through a tax cut), unless complemented by strategic direct investment by government, will rarely make things happen that would not have happened anyway (in economics speak, there is no ‘additionality’). As a result, a company or individual will often experience an increase in profits (through a tax cut) without increasing investment and without generating any new value. And the primary objective of the policymaker should be to increase business investment, not profits. Indeed, as seen earlier the relationship between profits and wages is at record levels. There is no profits problem, but an investment problem.70

as the American economist George Akerlof, who shared the Nobel Prize in Economics in 2001, said: ‘Our marginal products are not ours alone’71–they are the fruits of a cumulative process of learning and investment. Collective value creation entails a risk-taking public sector–and yet the usual relationship between risks and rewards, as taught in economics classes, does not seem to apply. So the crucial question is not just about accounting for government value but also rewarding it: how should rewards from investment be divided between the public and private sectors?

Indeed, almost nothing that government does is considered to fall within the production boundary. Government spending is seen purely as expenditure and not as productive investment. While that spending might be regarded by some as socially necessary and by others as unnecessary and better done by the private sector, neither side has made a robust case for government activity as productive and essential to creating a dynamic capitalist economy. Too often ideology has won over experience.

Part of the problem is that the argument for fiscal spending continues to be tied mainly to taming the business cycle (through counter-cyclical measures), with too little creative thinking about how to direct the economy in the longer term.

A new discourse on value, then, should not simply reverse the preference for the private sector over the public. What is required is a new and deeper understanding of public value, an expression found in philosophy but almost lost in today’s economics. This value is not created exclusively inside or outside a private-sector market, but rather by a whole society; it is also a goal which can be used to shape markets.

Public values are those providing normative consensus about (1) the rights, benefits, and prerogatives to which citizens should (and should not) be entitled; (2) the obligations of citizens to society, the state, and one another; (3) and the principles on which governments and policies should be based.’

Ostrom shows how the crude state–private divide that dominates current thinking fails to encapsulate the complexity of institutional structures and relationships–from non-partisan government regulators to state-funded universities and state-run research projects–that span this divide. Rather, she emphasizes common pooled resources, and the shaping of systems that take into account collective behaviour.

One vital government responsibility in the modern economy–which Ostrom also finds in successful pre-industrial economies–is to limit the amount of rent that emerges from any non-collective approach to wealth creation. This brings us back to Adam Smith’s definition of the ‘free market’ as being free from rent.

In the new discourse, there would certainly be no more talk of the public sector interfering with or rescuing the private sector. Instead, it would be widely accepted that the two sectors, and all the institutions in between, nourish and reinforce each other in pursuit of the common goal of economic value creation. The sectors’ interactions would be less marked by hostility, and more infused with mutual respect.

The private sector can be transformed by the simple but profound expedient of replacing shareholder value with stakeholder value. This idea has been around for decades, most countries continue to have companies run by shareholder value focused on maximizing quarterly returns. Stakeholder value recognizes that corporations are not really the exclusive private property of one group of providers of profit-sharing financial capital. As social entities, companies must take into account the good of employees, customers and suppliers.

To offer real change we must go beyond fixing isolated problems, and develop a framework that allows us to shape a new type of economy: one that will work for the common good. The change has to be profound. It is not enough to redefine GDP to encompass quality-of-life indicators, including measures of happiness,2 the imputed value of unpaid ‘caring’ labour and free information, education and communication via the Internet.3 It is also not enough to tax wealth. While such measures are important in themselves, they do not address the greatest challenge: defining and measuring the collective contribution to wealth creation, so that value extraction is less able to pass for value creation. As we have seen, the idea that price determines value and that markets are best at determining prices has all sorts of nefarious consequences. To sum up, four stand out.

First, this narrative emboldens value extractors in finance and other sectors of the economy. Here, the crucial questions–which kinds of activities add value to the economy and which simply extract value for the sellers–are never asked. In the current way of thinking, financial trading, rapacious lending, funding property price bubbles are all value-added by definition, because price determines value: if there is a deal to be done, then there is value. By the same token, if a pharma company can sell a drug at a hundred or a thousand times more than it costs to produce, there is no problem: the market has determined the value. The same goes for chief executives who earn 340 times more than the average worker (the actual ratio in 2015 for companies in the S&P 500).4 The market has decided the value of their services–there is nothing more to be said. Economists are aware that some markets are not fair, for example when Google has something close to a monopoly on search advertising; but they are too often enthralled by the narrative of market efficiency to worry whether the gains are actually justly earned profits, or merely rents. Indeed, the distinction between profits and rents is not made. Price-equals-value thinking encourages companies to put financial markets and shareholders first, and to offer as little as possible to other stakeholders. This ignores the reality of value creation–as a collective process. In truth, everything concerning a company’s business–especially ...

Second, the conventional discourse devalues and frightens actual and would-be value creators outside the private business sector. It’s not easy to feel good about yourself when you are constantly being told you’re rubbish and/or part of the problem. That’s often the situation for people working in the public sector, whether these be nurses, civil servants or teachers. The static metrics used to measure the contribution of the public sector, and the influence of Public Choice theory on making governments more ‘efficient’, has convinced many civil-sector workers they are second-best. It’s enough to depress any bureaucrat and induce him or her to get up, leave and join the private sector, where there is often more money to be made. So public actors are forced to emulate private ones, with their almost exclusive interest in projects with fast paybacks. After all, price determines value. You, the civil servant, won’t dare to propose that your agency could take charge, bring a helpful long-term perspective to a problem, consider all sides of an issue (not just profitability), spend the necessary funds (borrow if required) and–whisper it softly–add public value. You leave the big ideas...