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

by Mariana Mazzucato

These operators were attracted by stable cash flows, part of which came from local authorities, and opportunities for financial engineering: cheap debt; property which could be sold and leased back; tax breaks on debt interest payments and carried interest; and–ultimately–frail and vulnerable residents whom the state would have to look after if the business failed.

Four Seasons Health Care displays many of these characteristics. The company owns the biggest chain of care homes in the UK, with 23,000 beds in 2015. But it was only a small Scottish chain until its acquisition by Alchemy Partners, a PE firm, in 1999.

The Care Quality Commission, the government body which monitors standards in care homes, was sufficiently concerned about the business health of Four Seasons that at one point it embargoed twenty-eight of Four Seasons’ homes, meaning that they could not take in new residents.

Net interest payments by the nine English WSCs went up from £288 million in 1993 to an eye-watering £2 billion in 2012.

Interestingly, the company with the lowest gearing (ratio of debt to equity) and the highest credit rating was Welsh Water, which is mutually owned.

Between 2009 and 2013 Anglian, Thames, United Utilities, Wessex and Yorkshire paid out more in dividends than they made in after-tax profits. Directors saw their share of the companies’ income rise from 13.18 per cent in 1993 to 20.52 per cent in 2013.

Conventional wisdom was turned on its head and conglomerates were broken up, a step also justified by seeing corporations as nothing more than a collection of cash flows. The interests of managers and shareholders should, the agency theorists reasoned, be ‘aligned’: if managers were also paid in the company’s shares or options on those shares, the argument went, they would be motivated to maximize the interests of all shareholders.

It is no coincidence that the case for shareholder activism and supervision often accompanies palpable breakdown of corporate governance: witness the string of corporate scandals such as Enron and WorldCom in the US, Sports Direct in the UK and Volkswagen cheating on diesel engine emissions.

Shareholders are not the only gatekeepers. Others include auditors, rating agencies, government regulators, the media and equity analysts–specialists who assess companies for investors. The cause of many of the corporate scandals of recent years, the standard argument goes, is the failure of these gatekeepers to do their job.

And the key actors in the economy whose interests were most closely aligned with MSV’s objective were the institutional investors. Principal and agent were meant to eye each other warily, but instead an unholy alliance developed between them to extract value from the company.

Keynes observed that: [most] expert professionals, possessing judgment and knowledge beyond that of the average private investor… are, in fact, largely concerned, not with making superior long-term forecasts of the probable yield of an investment over its whole life, but with foreseeing changes in the conventional valuation a short time ahead of the general public.18

A successful speculator himself, Keynes knew what he was talking about. He warned that the stock market would become ‘a battle of wits to anticipate the basis of conventional valuation a few months hence, rather than the prospective yield of an investment over a long term of years’.

Excellent quote

Consider the increased turnover of domestic shares: according to the World Federation of Exchanges, which represents the world’s publicly regulated stock exchanges, in the US turnover of domestic shares was around 20 per cent a year in the 1970s, rising steeply to consistently over 100 per cent a year in the 2000s.

Another important trend that further demonstrates the scale of MSV’s impact on corporate behaviour is that of rising hurdle rates.

Hurdle rates are critical to the way in which companies allocate capital, but they are deeply affected by expectations–or what Keynes called ‘animal spirits’.24 The hurdle rate of a project is usually determined relative to the cost of capital–basically, interest rates on borrowing and dividends to shareholders.

On the other hand, according to J. P. Morgan,26 the weighted average cost of capital remains quite low at 8.5 per cent but the median hurdle rate (minimum return on investment needed to justify a new project) reported by S&P 500 companies is 18 per cent. This suggests that companies are not pursuing investment opportunities unless the differential between their expected returns and their cost of capital is around 10 percentage points. Why would they leave such opportunities on the table? One explanation, given the exigencies of MSV, is that they have easier alternatives–such as share repurchases.

Steady growth caused by increased borrowing–which speeds up value extraction–is matched by the rising value of assets. Everything seems to be fine–until people start to query the value of assets. Then trouble brews.

Despite a period of downsizing (corporate speak for firings), which–especially after the late-1980s conquest of conglomerates–was meant to strip away surplus management and raise the productivity of employees who survived the cull, the ratio of CEO pay to workers’ pay also soared (Figure

But EPS has not always enjoyed this totemic status. While Samuel Palmisano (IBM President from 2000 to 2011, and CEO from 2002 to 2011) argued that IBM’s main aim was to double earnings per share over the next five years, half a century earlier in 1968 Tom Watson Jr (IBM President from 1952 to 1971) argued that IBM’s three core priorities were (1) respect for individual employees, (2) a commitment to customer service and (3) achieving excellence.

Great quote

Figure 26 shows how business investment in the US is now around its lowest level for more than sixty years, an amazing and disturbing phenomenon.

It could be said that public companies are less profitable and therefore have less money to invest. But that doesn’t seem to be true. Figure 28 illustrates that there is little difference between the profit margins of major US public companies (the S&P’s 500) and those of all US firms derived from the National Income and Product Account (NIPA) compiled by the Bureau of Economic Analysis, which is part of the US Department of Commerce. The graph clearly shows a steady rise in profitability over forty-five years, culminating in record highs in recent years: truly ‘profits without prosperity’. In other words, the agent–principal problem does not have to result in declining investment and short-termism.

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.

A truth more complex than the primacy of the shareholders, however, is that wealth creation is a collective process. After all, important as shareholders are, it is hard to imagine a company being successful without the involvement of many groups, including employees, suppliers, distributors, the broader community in which the company’s plants and headquarters are located, and even local and central government.

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.

Even Jack Welch, whose twenty years as General Electric CEO were often hailed as a triumph for the MSV approach, begged to differ when in 2009 he cited customers, employees and products as the key to that success, denouncing shareholder value as ‘the dumbest idea in the world’.

In contrast to MSV and its goal of short-term profit maximization and its marginalization of human capital and R&D, stakeholder value sees people not just as inputs but as essential contributors who need to be nurtured. Trust–critical for any enterprise–is then built between workers and managers, in a process that acknowledges the vital role of workers in value creation. Investing in people is an admission that workers add value.

Most of the countries that have public banks tend to follow a stakeholder model of corporate governance, for example by having workers on company boards.

In short, the VW scandal tells us that corporate governance structures and rules are unlikely to work unless corporate values are aligned with public values (a concept we will visit in Chapter

The British-Venezuelan scholar Carlota Perez has argued that the decoupling of finance from the real economy is not ‘natural’ but an artefact of deregulation and excess belief in the power of free markets. Her groundbreaking work has identified a pattern of intense financialization followed by its reversal in each technological revolution.

This chapter takes a critical look at the innovation economy and the stories around it. It explores how the dominant narratives about innovators and the reasons for their success fundamentally ignore the deeply collective and cumulative process behind innovation.

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 d...

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...

Before looking at these four areas of value extraction, I want to consider three key characteristics of innovation processes. Innovation rarely occurs in isolation.

If there is one thing that economists agree on (and there are not many), it is that technological and organizational changes are the principal source of long-term economic growth and wealth creation.

Joseph Schumpeter (1883–1950) is probably the economist who has most emphasized the importance of innovation in capitalism. He coined the term ‘creative destruction’ to describe the way that product innovations (new products replacing old) and process innovations (new ways to organize production and distribution of goods and services) caused a dynamic process of renewal but also a process of destruction, with old ways falling aside and in the process causing many companies to go bankrupt.

In 1987 Robert Solow, a professor at the Massachusetts Institute of Technology, won the Nobel Prize in Economics for showing that improvements in the use of technology explained over 80 per cent of economic growth.

Solow argued that economic theory had to better understand how to describe technological change.3 Practising what they preached, they explored what forces drive technological change. But where does innovation come from? Is it lone entrepreneurs working in their garages, genius scientists having a eureka moment in the laboratory, heroic small businesses and venture capitalists struggling against the commercial odds? No, they concluded that inventions are overwhelmingly the fruits of long-term investments that build on each other over years.

Both Bill Gates, CEO of Microsoft,5 and Eric Schmidt, Executive Chairman of Alphabet (the parent company of Google),6 have recently written about the immense benefits their companies gained from public investments: as well as the Internet and the html code behind the worldwide web written in CERN, a public lab in Europe, Google’s very algorithm was funded by a National Science Foundation grant.

There are four key ways in which value extraction occurs in the innovation economy. The first is to be found in the economy’s interaction with the financial markets.

In the very early days it is often public R&D agencies or universities that fund the science base, and only when innovation is close to having a commercial application do private actors enter. Public R&D agencies include organizations like DARPA and ARPA-E and even public sources of early seed money for innovative firms often tend to precede private venture capital.

In the case of venture capitalists, their real genius appears to lie in their timing: their ability to enter a sector late, after the highest development risks had already been taken, but at an optimum moment to make a killing.

Similarly, Peter Theil’s $500,000 investment in Facebook back in 2004, which bought him a 10.2 per cent stake in the company, made him £1 billion when he sold the majority of his shares in 2012. These early investors are doubtless crucial to the innovation process. The critical question here is: are their rewards proportionate to the risks they take?

Let’s look at this a bit more closely. VC–Timing is All

Before becoming famous around the world as ‘Silicon Valley’, a name coined in 1971, the San Francisco Bay area was producing technology for military use or, from the 1960s, spin-offs of military technology for commercial purposes.

The NVCA quickly became an influential lobby. By the early 1980s it persuaded Congress to halve capital gains tax rates, arguing that it would be an incentive to greater VC investment. Warren Buffett became a lead critic of this policy, admitting that he and most investors don’t look at tax, they look at opportunities.

In 1984, during a tour of Silicon Valley by the then French President, François Mitterrand, the discrepancy between the venture capitalists’ newfound bullishness and their actual achievements was picked up in an exchange between Paul Berg, one of the winners of the Nobel Prize in Chemistry that year, and Tom Perkins (the co-founder of Kleiner-Perkins) boasting about his sector’s role in biotech. Berg said: ‘Where were you guys in the ’50s and ’60s when all the funding had to be done in the basic science? Most of the discoveries that have fuelled [the industry] were created back then.’