Common Critique of Value Extraction
The vital but often muddled distinction between value extraction and value creation has consequences far beyond the fate of companies and their workers, or even of whole societies. The social, economic and political impacts of value extraction are huge. Prior to the 2007 financial crisis, the income share of the top 1 per cent in the US expanded from 9.4 per cent in 1980 to a staggering 22.6 per cent in 2007. And things are only getting worse. Since 2009 inequality has been increasing even more rapidly than before the 2008 financial crash. In 2015 the combined wealth of the planet’s sixty-two richest individuals was estimated to be about the same as that of the bottom half of the world’s population – 3.5 billion people.
So how does the alchemy continue to happen? A common critique of contemporary capitalism is that it rewards ‘rent seekers’ over true ‘wealth creators’. ‘Rent-seeking’ here refers to the attempt to generate income, not by producing anything new but by overcharging above the ‘competitive price’, and undercutting competition by exploiting particular advantages (including labour), or, in the case of an industry with large firms, their ability to block other companies from entering that industry, thereby retaining a monopoly advantage. Rent-seeking activity is often described in other ways: the ‘takers’ winning out over the ‘makers’, and ‘predatory’ capitalism winning over ‘productive’ capitalism. It’s seen as a key way – perhaps the key way – in which the 1 per cent have risen to power over the 99 per cent.9 The usual targets of such criticism are the banks and other financial institutions. They are seen as profiting from speculative activities based on little more than buying low and selling high, or buying and then stripping productive assets simply to sell them on again with no real value added.
More sophisticated analyses have linked rising inequality to the particular way in which the ‘takers’ have increased their wealth. The French economist Thomas Piketty’s influential book Capital in the Twenty-First Century focuses on the inequality created by a predatory financial industry that is taxed insufficiently, and by ways in which wealth is inherited across generations, which gives the richest a head start in getting even richer. Piketty’s analysis is key to understanding why the rate of return on financial assets (which he calls capital) has been higher than that on growth, and calls for higher taxes on the resultant wealth and inheritance to stop the vicious circle. Ideally, from his point of view, taxes of this sort should be global, so as to avoid one country undercutting another.
Another leading thinker, the US economist Joseph Stiglitz, has explored how weak regulation and monopolistic practices have allowed what economists call ‘rent extraction’, which he sees as the main impetus behind the rise of the 1 per cent in the US.10 For Stiglitz, this rent is the income obtained by creating impediments to other businesses, such as barriers to prevent new companies from entering a sector, or deregulation that has allowed finance to become disproportionately large in relation to the rest of the economy. The assumption is that, with fewer impediments to the functioning of economic competition, there will be a more equal distribution of income.
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?12 This is a key question we will look at in Chapter.
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.
A note of caution is important. In the book I use the words ‘wealth’ and ‘value’ almost interchangeably. Some might argue against this, seeing wealth as a more monetary and value as potentially a more social concept, involving not only value but values. I want to be clear on how these two words are used. I use ‘value’ in terms of the ‘process’ by which wealth is created – it is a flow. This flow of course results in actual things, whether tangible (a loaf of bread) or intangible (new knowledge). ‘Wealth’ instead is regarded as a cumulative stock of the value already created. The book focuses on value and what forces produce it – the process. But it also looks at the claims around this process, which are often phrased in terms of ‘who’ the wealth creators are. In this sense the words are used interchangeably.
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.
In the intellectual world, economists wanted to make their discipline seem ‘scientific’ – more like physics and less like sociology – with the result that they dispensed with its earlier political and social connotations. While Adam Smith’s writings were full of politics and philosophy, as well as early thinking about how the economy works, by the early twentieth century the field which for 200 years had been ‘political economy’ emerged cleansed as simply ‘economics’. And economics told a very different story.
Eventually the debate about different theories of value and the dynamics of value creation virtually vanished from economics departments, only showing up in business schools in a very new form: ‘shareholder value’, ‘shared value’, ‘value chains’, ‘value for money’, ‘valuation’, ‘adding value’ and the like. So while economics students used to get a rich and varied education in the idea of value, learning what different schools of economic thought had to say about it, today they are taught only that value is determined by the dynamics of price, due to scarcity and preferences. This is not presented as a particular theory of value. An intellectually impoverished idea of value is just taken as read, assumed simply to be true. And the disappearance of the concept of value, this book argues, has paradoxically made it much easier for this crucial term ‘value’ – a concept that lies at the heart of economic thought – to be used and abused in whatever way one might find useful.
Meet the Production Boundary
To understand how different theories of value have evolved over the centuries, 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 for an 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.16 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 (falling into the light grey circle of productive activities above).
But things are not so simple. The point is not to blame some as takers and to label others as makers. The activities of people outside the boundary may be needed to facilitate production – without their work, productive activities may not be so valuable. Merchants are necessary to ensure the goods arrive at the marketplace and are exchanged efficiently.
The financial sector is critical for buyers and sellers to do business with each other. How these activities can be shaped to actually serve their purpose of producing value is the real question.
And, most important of all, what about government? On which side of the production boundary does it lie? Is government inherently unproductive, as is often claimed, its only earnings being compulsory transfers in the form of taxes from the productive part of the economy? If so, how can government make the economy grow? Or can it at best only set the rules of the game, so that the value creators can operate efficiently?
Indeed, the recurring debate about the optimal size of government and the supposed perils of high public debt boils down to whether government spending helps the economy to grow – because government can be productive and add value – or whether it holds back the economy because it is unproductive or even destroys value. The issue is politically loaded and deeply colours current debates, ranging from whether the UK can afford Trident nuclear weapons to whether there is a ‘magic number’ for the size of government, defined as government spending as a proportion of national output, beyond which an economy will inevitably do less well than it might have done if government spending had been lower. As we will explore in Chapter 8, this question is more tainted by political views and ideological positions than informed by deep scientific proofs. Indeed, it is important to remember that economics is at heart a social science, and the ‘natural’ size of government will depend on one’s theory of (or simply ‘position’ on) the purpose of government. If it is seen as useless, or at best a fixer of occasional problems, its optimum size will inevitably be notionally smaller than if it is viewed as a key engine of growth needed to steer and invest in the value creation process.
Over time, this conceptual production boundary was expanded to encompass much more of the economy than before, and more varied economic activities. As economists, and wider society, came to determine value by supply and demand – what is bought has value – activities such as financial transactions were redefined as productive, whereas previously they had usually been classed as unproductive. Significantly, the only major part of the economy which is now considered largely to lie outside the production boundary – and thus to be ‘unproductive’ – remains government. It is also true that many other services that people provide throughout society go unpaid, such as care given by parents to children or by the healthy to the unwell, and are not well accounted for. Fortunately, issues such as factoring care into the way we measure national output (GDP) are increasingly coming to the fore. But besides adding new concepts to GDP – such as care, or the sustainability of the planet – it is fundamental to understand why we hold the assumptions about value that we do. And this is impossible if value is not scrutinized.
Why Value Theory Matters
First, the disappearance of value from the economic debate hides what should be alive, public and actively contested. If the assumption that value is in the eye of the beholder is not questioned, some activities will be deemed to be value-creating and others will not, simply because someone – usually someone with a vested interest – says so, perhaps more eloquently than others. Activities can hop from one side of the production boundary to the other with a click of the mouse and hardly anyone notices.
If bankers, estate agents and bookmakers claim to create value rather than extract it, mainstream economics offers no basis on which to challenge them, even though the public might view their claims with scepticism. Who can gainsay Lloyd Blankfein when he declares that Goldman Sachs employees are among the most productive in the world? Or when pharmaceutical companies argue that the exorbitantly high price of one of their drugs is due to the value it produces? Government officials can become convinced (or ‘captured’) by stories about wealth creation, as was recently evidenced by the US government’s approval of a leukemia drug treatment at half a million dollars, precisely using the ‘value-based pricing’ model pitched by the industry – even when the taxpayer contributed $200 million dollars towards its discovery.
Second, the lack of analysis of value has massive implications for one particular area: the distribution of income between different members of society. When value is determined by price (rather than vice versa), the level and distribution of income seem justified as long as there is a market for the goods and services which, when bought and sold, generate that income. All income, according to this logic, is earned income: gone is any analysis of activities in terms of whether they are productive or unproductive.
Yet this reasoning is circular, a closed loop. Incomes are justified by the production of something that is of value. But how do we measure value? By whether it earns income. You earn income because you are productive and you are productive because you earn income. So with a wave of a wand, the concept of unearned income vanishes. If income means that we are productive, and we deserve income whenever we are productive, how can income possibly be unearned? As we shall see in Chapter 3, this circular reasoning is reflected in how national accounts – which track and measure production and wealth in the economy – are drawn up. In theory, no income may be judged too high, because in a market economy competition prevents anyone from earning more than he or she deserves. In practice, markets are what economists call imperfect, so prices and wages are often set by the powerful and paid by the weak.
In the prevailing view, prices are set by supply and demand, and any deviation from what is considered the competitive price (based on marginal revenues) must be due to some imperfection which, if removed, will produce the correct distribution of income between actors. The possibility that some activities perpetually earn rent because they are perceived as valuable, while actually blocking the creation of value and/or destroying existing value, is hardly discussed.
Indeed, for economists there is no longer any story other than that of the subjective theory of value, with the market driven by supply and demand. Once impediments to competition are removed, the outcome should benefit everyone. How different notions of value might affect the distribution of revenues between workers, public agencies, managers and shareholders at, say, Google, General Electric or BAE Systems, goes unquestioned.
Third, in trying to steer the economy in particular directions, policymakers are – whether they recognize it or not – inevitably influenced by ideas about value. The rate of GDP growth is obviously important in a world where billions of people still live in dire poverty. But some of the most important economic questions today are about how to achieve a particular type of growth. Today, there is a lot of talk about the need to make growth ‘smarter’ (led by investments in innovation), more sustainable (greener) and more inclusive (producing less inequality). 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.
Deciding which activities are more important than others is critical in setting a direction for the economy: put simply, those activities thought to be more important in achieving particular objectives have to be increased and less important ones reduced. We already do this. Certain types of tax credits, for, say, R&D, try to stimulate more investment in innovation. We subsidize education and training for students because as a society we want more young people to go to university or enter the workforce with better skills. Behind such policies may be economic models that show how investment in ‘human capital’ – people’s knowledge and capabilities – benefits a country’s growth by increasing its productive capacity. Similarly, today’s deepening concern that the financial sector in some countries is too large – compared, for example, to manufacturing – might be informed by theories of what kind of economy we want to be living in and the size and role of finance within it.
But the distinction between productive and unproductive activities has rarely been the result of ‘scientific’ measurement. Rather, ascribing value, or the lack of it, has always involved malleable socio-economic arguments which derive from a particular political perspective – which is sometimes explicit, sometimes not. The definition of value is always as much about politics, and about particular views on how society ought to be constructed, as it is about narrowly defined economics. Measurements are not neutral: they affect behaviour and vice versa (this is the concept of performativity which we encountered in the Preface).
So the point is not to create a stark divide, labelling some activities as productive and categorizing others as unproductive rent-seeking. I believe we must instead be more forthright in linking our understanding of value creation to the way in which activities (whether in the financial sector or the real economy) should be structured, and how this is connected to the distribution of the rewards generated. Only in this way will the current narrative about value creation be subject to greater scrutiny, and statements such as ‘I am a wealth creator’ measured against credible ideas about where that wealth comes from. A pharmaceutical company’s valuebased pricing might then be scrutinized with a more collective valuecreation process in mind, one in which public money funds a large portion of pharmaceutical research – from which that company benefits – in the highest-risk stage. Similarly, the 20 per cent share that venture capitalists usually get when a high-tech small company goes public on the stock market may be seen as excessive in light of the actual, not mythological, risk they have taken in investing in the company’s development. And if an investment bank makes an enormous profit from the exchange rate instability that affects a country, that profit can be seen as what it really is: rent.
In order to arrive at this understanding of value creation, however, we need to go beyond seemingly scientific categorizations of activities and look at the socio-economic and political conflicts that underlie them. Indeed, claims about value creation have always been linked to assertions about the relative productiveness of certain elements of society, often related to fundamental shifts in the underlying economy: from agricultural to industrial, or from a mass-production-based economy to one based on digital technology.
(excerpted from Mariana Mazzucato, 2018, he Value of Everything: Making and Taking in the Global Economy, Introduction)
