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

by Mariana Mazzucato

A relatively recent refinement, the more flexible partial equilibrium analysis, allows us to disregard interactions with other sectors and introduce quasi-rents, and has since the 1970s led to the idea of ‘rent-seeking’ by creating artificial monopolies, for example tariffs on trade.

The neoclassical approach to rent, which largely prevails today, lies at the heart of the rest of this book. If value derives from price, as neoclassical theory holds, income from rent must be productive. Today, the concept of unearned income has therefore disappeared.

From being seen by Smith, Ricardo and their successors as semi-parasitic behaviour–extracting value from value-creating activity–it has in mainstream economic discourse become just a ‘barrier’ on the way to ‘perfect competition’. Banks which are judged ‘too big to fail’ and therefore enjoy implicit government subsidy–a form of monopoly–contribute to GDP, as do the high earnings of their executives.

We begin by exploring in the next chapter what goes into–and what is omitted from–that totemic category, GDP, and the consequences of this selection for our assessment of value.

What we measure affects what we do; and if our measurements are flawed, decisions may be distorted.

According to marginalists, because value derives from price, somebody earning a very high salary is indicative of their productivity and worth. At the same time, anybody holding down a job at all is supposed to reflect their preference for work: the utility of work against that of leisure.

In other words, how we measure GDP is determined by how we value things, and the resulting GDP figure may determine how much of a thing we decide to produce. Performativity!

As long as products and services fetch a price on the market, they are worthy of being included in GDP; whether they contribute to value or extract it is ignored. The result is that the distinction between profits and rents is confused and value extraction (rent) can masquerade as value creation.

In this same way, the modern accounting concept of GDP is affected by the underlying theory of value that is used to calculate it. GDP is based on the ‘value added’ of a national economy’s industries. Value added is the monetary value of what those industries produce, minus the costs of material inputs or ‘intermediate consumption’: basically, revenue minus material input cost.

GDP can be calculated either through the production side, or through the income side, the latter by adding up the incomes paid in all the value-adding industries: all profits, rents, interest and royalties. As we will see below, there is a third way to calculate GDP: by adding up expenditure (demand) on final goods, whose price is equal to the sum of the value added along the entire production chain.

So which industries add value? Following marginalist thinking, the national accounts today include in GDP all goods and services that fetch a price in the market. This is known as the ‘comprehensive boundary’.

These oddities include how government services are valued; how investments in future capacity, such as R&D, are measured; how jobs earning high incomes, as in the financial sector, are treated; and how important services with no price (such as care) or no legal price (such as the black market) are dealt with.

In the late nineteenth century, marginal utility theory predominated. Although radically different from the thinking of earlier economists, it continued to underscore the importance of value theory in national accounting. Increasingly, under its influence, national accountants included everything bought with income: for them, the sum of revenue from market activity, irrespective of sector, added up to the national income.

Meanwhile, the labour theory of value which, fully developed by Marx, rooted productivity firmly in the concept of the production of ‘surplus value’, was either disputed or, increasingly, ignored altogether in assessments of national income.

With the exception of these socialist states, the idea that assessments of national income should be based on the sum total of all incomes, thus forming a ‘comprehensive’ production boundary, spread rapidly to many countries.

One of Alfred Marshall’s students, the British economist Arthur Cecil Pigou (1877–1959), who succeeded him as Professor of Political Economy at Cambridge, argued that since market prices merely indicated the satisfaction (utility) gained from exchange, national income should in fact go further: it should measure welfare.

Believing that they incurred costs without adding to final economic output, Kuznets, unlike Pigou, excluded from the production boundary all government activities that did not immediately result in a flow of goods or services to households–public administration, defence, justice, international relations, provision of infrastructure and so on.

Perhaps Kuznets’s view would have had more traction in a peaceful world. But the exigencies of the Second World War, which forced governments to focus on the war effort, took economists down a different path: estimating output rather than concerning themselves with welfare. As a result, economists who believed that national product is the sum total of market prices prevailed.

Second, competition in economies is generally imperfect–a reality that has proven distinctively uncomfortable for national accountants trained in the neoclassical ideas of perfect competition and ‘equilibria’.

Keynes assumed that workers would underestimate the purchasing power of their wages, and would therefore be willing to produce more than they needed to. In this way, workers’ involuntary overproduction would in turn create involuntary unemployment–fewer workers being needed to do the same amount of work–and the economy could find itself in a low-output equilibrium.

Keynes used this idea to develop a theory of the macroeconomy–the economy as a whole–in which government spending could stabilize the business cycle when business was investing too little, and even raise the economy’s output.

In the late 1930s and the 1940s national accountants took up Keynes’s ideas about how government could invigorate an economy, and came to view government spending as directly increasing output.

In Europe, the strength of left-wing parties after the war–exemplified by the Labour Party’s 1945 election victory in the UK–also changed, and marked a change in, people’s attitudes, and made fuller and more accurate national accounts essential. The crucial question was, and remains: on what theory of value were they based?

In order to carry out this estimate, we might have expected the SNA’s authors to use as their methodology the prevailing economic theory of value, marginal utility. But they didn’t–or, at least, not fully. In fact, the resulting model was, and is, a strange muddle in which utility is the major, but not the only, ingredient.

GDP = Consumption by households (C) + Investment by companies and by residential investment in housing (I) + Government spending (G). This can be expressed as: GDP = C + I + G.

In Chapter 8 we will see that government is rarely acknowledged as a creator of value–indeed, quite the reverse. Yet national accounting conventions have in fact been quietly tracking its value-added contribution for the last half century—and it’s not small!

It shows that government expenditure has been consistently higher than government value added, at between 20 and 25 per cent of GDP.

Before answering this question, we have to recognize that government value added cannot be computed in the same way as that of other industries and, as a result, is a complicated issue for national statistical institutes.

Given these lower prices, the usual way of calculating value added for a business doesn’t work with government activities. Let’s recall that value added is normally the value of output minus costs of intermediate inputs used in production.

If the non-market prices of the output are lower than the total costs of intermediate inputs, value added would even show up as negative–indeed, government activities would ‘subtract’ value.

But since government’s output is basically intermediate inputs plus labour costs, its value added is simply equal to its employees’ salaries. One significant consequence of this is that the estimate of government value added–unlike that of businesses–assumes no ‘profit’ or operating surplus on top of wages. (In Figure 8 above, the dark-grey line shows the value added of government; it is equal–with slight adjustments–to the share of government employment income in GDP.)

Indeed, following this logic, government is also a producer of intermediate inputs for businesses. Surely education, roads, or the police, or courts of law can be seen as necessary inputs into the production of a variety of goods?

Later in the twentieth century there were repeated attempts to clear up the confusion over whether certain kinds of government spending counted as intermediate or final consumption. This was done by identifying which government activities provided non-market and free services for households (for example, schools), as opposed to intermediate services for businesses (for example, banking regulation).

Since government is treated as a final consumer, the purchase of goods and services increases its spending. Clearly, government expenditure can be higher than what it charges (e.g. fees for services) because it raises taxes to cover the difference. But need the value of government be undermined because of the way prices are set? By not having a way to capture the production of value created by government–and by focusing more on its ‘spending’ role–the national accounts contribute to the myth that government is only facilitating the creation of value rather than being a lead player.

Apart from this curious view of government, the national accounts expose a number of other accounting oddities. GDP, for instance, does not clearly distinguish a cost from an investment in future capacity, such as R&D; services valuable to the economy such as ‘care’ may be exchanged without any payment, making them invisible to GDP calculators; likewise, illegal black-market activities may constitute a large part of an economy.

And then there’s the biggest oddity of all: the financial sector. Does the financial sector simply facilitate the exchange of existing value, or does it create new value?

However, in the 2008 version of the SNA, in-house R&D was reclassified as an investment in the company’s stock of knowledge, to be valued ‘on the basis of the total production costs including the costs of fixed assets used in production’.25 It became a final productive activity rather than just an intermediate cost towards that activity.

Now, seventy years later, since there is still no theory–beyond ignorance or shame–that explains why housewives (and house husbands) should not be included in GDP, the SNA architects have come up with a different defence. They have expressed a ‘reluctance’ to include such work because, although it is equivalent to work done by servants, ‘By convention… only the wages of the domestic staff are treated as the value of output.’

Underlying this ‘common-sense’ approach to household work is the utility theory of value: what is valuable is what is exchanged on the market.

The implicit production boundary is determined by whether money changes hands for the service. Therefore, there is ‘extreme difficulty’ in giving a value to work done by women (or men) who do not receive a wage in exchange for it.

In the national accounts, houses owned by their occupants generate services that are included in GDP. In the US, such ‘work’ contributes 6 per cent of GDP–that is, a cool $1 trillion–even though none of these dollars actually exist. How do the statisticians come up with such an absurdity? They impute a rent to everyone who lives in their own home.

Another valid question is why a hike in rent should increase the value produced by real-estate agencies, especially if the quality of the rental service is not improving. London and New York City tenants, for example, know only too well that property management services do not improve even though rents rise–in London’s case, rapidly in recent years.32

Capital gains from holding property arise out of increases in land value, which itself are determined by collective investment (in roads, schools, etc.)–little to do with the effort of the property owner.

Rising house prices mean rising implicit rentals, and hence rising incomes when the implicit rental is included. The paradoxical result is that a house price bubble, perhaps caused by low interest rates or relaxed lending conditions, will show up as an acceleration of GDP growth.

Equally importantly, the boundary loops around the issue of the environment. Consider a river polluted by industrial waste. When the polluter pays to clean it up, the expenditure is treated as a cost which reduces profits and GDP. But when the government pays another company to clean up the river, the expenditure adds to GDP because paying workers adds value.

Something similar happens with the black or–to use the official euphemism–‘informal’ economy when countries decide that it has grown so large that they must start to include estimates of it in national accounting.

More than any other sector, finance highlights the arbitrary way in which modern national accounting decides where to draw the production boundary.

Until the 1970s, one of the principal sources of banks’ profits–net interest payments, which are the difference between the interest that banks charge for loans they make and the interest they pay on deposits–was excluded from output in the national accounts. The only part of banks’ income which was included was fees for services people actually paid for, such as the cost of opening or closing a bank account or getting mortgage advice.

finance was transformed into a producer of new value. This seismic shift was justified by labelling commercial bank activities as ‘financial intermediation’, and investment bank activities as ‘risk-taking’.

And as we have seen in this chapter, moreover, as long as products and services fetch a price on the market, they are deemed worthy of being included in GDP; whether they contribute to value or extract it is ignored. The result is that the distinction between profits and rents is confused and value extraction (rent) can masquerade as value creation.