The Value of Everything — Mariana Mazzucato
This book is a bible of economics which scrutinizes the way in which economic value has been accounted and reveals how economic theory has failed to clearly delineate the difference between value creation and value extraction. Mariana argues that the increasingly blurry distinction between the two categories has allowed certain actors in the economy to portray themselves as value creators, while in reality they are just moving around existing value or even worse, destroying it. This book review is a detailed one and in order for me to learn and retain all the economic and finance related concepts, I have choose to copy few sentences as is from the book.
The book uses case studies from Silicon Valley to financial sector to big pharma and shows how foggy notions of value create confusion between rents and profits, reward extractors and creators and distort the measurements of growth and GDP. In the process, innovation suffers and inequality rises.
Mariana has thoughtfully brought up this idea in the introduction section where she distinguishes Makers versus Takers. She starts of that discussion by explaining using very simple example of why gold miners get very little by expending their physical and mental energy to find it, mine and then mill it. And why takers are making so much money at the expense of makers. By stating various examples, one of which is Apple Corporation, that how widely spread this issue is and there is an absolute need to stop this exploitation. The alchemy continues to happen as the common way of contemporaory 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 undercuttting competition by exploiting labor or block other companies to enter in that industry for instance, thereby maintaining monopoly status. This rent seeking activity is refered to as ‘takers’ who are winning out over ‘makers’ and ‘predatory’ capitalism winning out over ‘productive’ capitalism. Research suggests that the rising inequality is due to ‘takers’ grabbing in more and more wealth by predatory financial industry that is taxed insufficiently, leaving the welath in hands of the few. In order to tackles these issues at roots, we need to examine where the value (production of goods and services) comes from in the first place, how is it extracted, what factors contribute to it. Mariana next talks about how the ‘value’ was swinged from being objective to bieng subjective. The objective theory of value was tied to conditions on which those goods and services were produced, time needed to produce them, labor involved etc. Then it reversed as many economists started believing that value of these goods and services was determined by the price paid on the market, or what consumers were prepared to pay for it. This is how ‘value’ was swung from counting the labor efforts towards being more market driven.
Different theories of value have evolved over the centuries which considers some activities as ‘productive’ and some as ‘unproductive’ (imagine two different circles in your mind) depending on if they produce value or not. The belief was the productive activities create wealth which established a conceptual boundary also called as production boundary between these activities. Inside this boundary are wealth creators, outside are beneficiaries of that wealth who benefit either because they can extract it through rent seeking activities as in case of monopoly or because wealth created in productive are is redistributed to them through modern welfare policies. This boundary fence was never fixed, it kept on changing with social and economic forces around. But the question remains, what all is included in the these circles? Would farmers fall in productive circle as they produce food or would merchants who ensure the goods arrive at the marketplace and exchanged efficiently fall into that, or would financial sector which is critical for business sustenance fall into this circle. Recurring debates took place over years to evaluate the theory of value.
Mariana goes over the history of the value of theory starting off with Adam Smith , the father of Economics. Adam’s belief was that division of labor should be harnessed at the basis as its powerful and leads to more productivity, In conjunction to that, mechanization would even radically increase the productivity even more leading to economic growth. Adam launched a more general attack on mercantilist policies which he argued restricted competition and trace. He believed in reinvesting the profits earned by the company into mechanization to boost the productivity even more rather than spending it on unproductive activities like luxuries. His theory of invisible hand is well known where he says every individual is constantly exerting himself to find out the most advantageous employment for whatever capital he can command. He has his own advantage in view and not that of the society, but the study of his own advantage naturally leads him to prefer that employment which is most advantageous to the 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 a part of his intention. This invisible hand metaphor has been cited to support the current orthodoxy that markets, left to themselves, may lead to socially optimal outcome and can prove even more beneficial than if the state intervenes.
Smith believed that value was proportional to the time spent by the workers on production. He categorized the primary sector — agriculture, mining and secondary sector like industry in the ‘productive’ activities circle while the government and other tertiary services was placed in the ‘unproductive’ circle. His conviction was that some types of labor do not ‘reproduce’ the value needed to keep some workers alive at subsistence level. His concepts of ‘surplus’ answers this irony as many productive workers produce outcome which is more than what is needed over their subsistence level. This surplus then sustains the unproductive laborers’ from which all the rent seeking activities take place. Instead, he believed in investing all that surplus in more production so that the whole nation could accurate wealth, which gave birth to nation wealth accumulation. Reading Adam Smith’s “The Wealth of Nations” inspired David Ricardo who was drawn to economics, but he realized that Smith’s theory was missing the critical topic of income distribution. As per Smith, the value produced by labor, when sold is redistributed as wages, profits and rents and that labor’s wages would vary. Ricardo believed that workers earned subsistence wages. But food comes from agriculture, so the price of food regulated wages. Low price of food like corn will lead to low wages and therefore high profits and incentives to invest in future production. A high wage due to low productivity in agriculture will mean lower profits and hence little investments in future production which in turns slower economic growth. This lead to his theory of growth and accumulation. As profit grows, so capitalists invest and expand production, which in turn creates more jobs and raise wages, thereby increasing population whose wages finally go to subsistence level and so on. The economy is a growth perpetual machine with more and more people earning subsistence wages. Ricardo’s theory towards landlords is impressive. Production in agriculture comes from goods and services needed for production. One type can be scaled which includes labor, machinery, seeds and water, the other type cannot be scaled which is good arable land. During his time, much of the arable land was owned by aristocrats but was worked by farmers and laborers. If the capitalist farmers — the tenant wants to hang on to the largest possible profit by paying less rent, the landlord can give lease to a competeting farmer who will pay a higher rent and therefore will be willing to work the land for only the standard profits. As this goes on, land of increasingly poor quality will be available for production and greated portion will go to the landlords. Now these rising rents were the flipside of rising food prices, caused by lack of good quality land. As foos prices increased, wages of the workers increased too. This growth of wages pinches the profits on manufacturing. But with this wage rise, manufacturing workers wages would also rise. But the extra wages would have to be spent on food, which was expensive as landlords were charging high rents. Hence, landlords would ultimately earn it all halting the economic growth and investment in manufacturing becauseof the low returns would not justify the risks. if good arable land is scarce, the production on good land will be low cost while on inferior land will cost more. The owner of good land will reap high profits leading to monopoly. Ricardo extended Smith’s theory on consumption by the productive (capitalists) versus the unproductive (owners of scare land, land nobility) where these productive would put the surplus produced to use and not spend on the lavish lifestyles instead. He also believed like Smith is governement is unproductive and a leech for the surplus.
Later came Karl Marx, a generation later who developed his own version of labour theory of value. Marx recognized that capitalists exploited workers by making them work for longer hours to earn their wages so that they can pocket the surplus value that the workers produced. Although he noted a contradiction in the system. The drive to increase productivity would increase mechaniztion which would reduce labour power. He also foresaw the problem of growing financiliztion which would undermine industrial production. His theory was that capitalism is dynamic. He gave capitalism a social dimension and surplus a negative connotation. Labour produces surplus value which fuels capital accumulation and economic growth. In Marx’s production boundary which is based on how profits are made, agriculture, industries and tertiary services were part of production sphere while government was in unproductive one. According to Marx, there were two types of capital, one was production (industrial) capital and other was commercial capital. The first one produces commodities while the second one circulates them by selling, making money which could be then used as production capital. Today, Amazon is a commercial capitalist as it is a means by which production capitalists sell their goods and gain surplus value. Bank’s money transfer services are also commercial capital. So as this”circulation” of capital which do not produce any cmmoditey but generated surplus value was termed as “circulation sphere” and was included by Marx in the production boundary circle. For Marx, production boundary is defined not by sectors but by how profits are generated. As per Ricardo and Marx, rent is income from redistributing value and not from creating it. Rent of any kind is basically a claim on the total of social surplus value and therefore lowers productive capitalists profits. Neoclassical economics changed this idea of rent into one of imperfections and impediments. The early classical economists left a legacy about value on currencies and protection, free trade, rent, government and technology, which have remained alive today. The concept of marginalism lies at the heart of neoclassical theory (new theorists). They used marginal utility and scarcity to determine the prices and size of market. Competition ensures that the ‘marginal utility’ of the last item sold determines the price of that commodity. The size of the market in a particular commodity, which is the number of items that needs to be sold before marginal utility no longer covers the costs of production is explained by the sarcity hence the price and price is direct measure of value. With this relation, we are now long way from the value theory. In Marshall’s theory of ‘equilibrium’ where prices are not distorted, everyone gets paid what they are worth of, which may change if the consume alters their tastes or if technology advances. This has important consequences for how incomes are assessed and justified. What workers earn is reflected in their marginal productivity. Rent is no longer seen as ‘unearned income’ as it was by classical economists, but as an imperfection that can be competed away. With marginal utility, there are no longer classes, only individuals and there is no objective measurement of value. Infact, it is a major influence on the measurement of economic activity and growth. With this approach, the government should never intervene in the economy unless there are market failures. First Fundamental Theorem (FFT) holds that markets are the most efficient allocators of resources under 3 conditions first where there exists a set of markets with good and supplies, that all consumers and producers behave competitvely and that equilibrium exists. If this is not there, market failres happen, They happen due to positive externalities like science and research or negative externalities like pollution etc. But government failures are even worse than market failures, so the correction of market failures by beaurcrats might make even things worse.
The neoclassical approach to rent largely prevails today. If value derives from prices, as neoclassical theory holds, income from rent must be productive. Today the concept of rent has disappeared. Banks which are judged ‘too big to fail’ and therefore enjoy implicit government subsidy, a form of monopoly, contribute to GDP as to the high earnings of their executives. Our understanding of rent and value profoundly affects how we measure GDP, how we view finance and the ‘financialization’ of economy.
GDP is the measure used to calculate the production of goods and services in an economy; or the amount of value added generated by production. GDP calculations can make or break governments. GDP is determined by how we value things and the resulting GDP may determine how much of a thing we decide to produce. But is it a reliable measure of an economy productiveness?
There could be multiple ways to calculate GDP. It could be calculated either through production or the income side. Or by adding up the expenditure (demand) on final goods, whose price is equal to the sum of the value added along the entire production chain. In this way, GDP calculation looks logical, following the marginal utility theory, but if we consider how to consider the value of government, investments in future, R and D etc, something else had to be considered. First, GDP ignored the idea of value as a utility, the benefit it provided to the consumer which lead to the birth of National Accounts System (NAS) which implements complete and consistent accounting techniques for measuring the economic activity of a nation. Its main economic actors are — Production accounts, income accounts, expenditure accounts, Capital accounts, financial accounts and balance sheets which records the stocks for the assets. In 1930s , the national accountants took up Keynes’s idea about how government can invigorate an economy. And for the first time, government spending became important which then was adopted into System of National Accounts (SNA) as an international standard system for national accounts. in 1953. Its aim was to provide an integrated, complete system of accounts enabling international comparisons of all significant activity. The SNA have been accounting the government to see if its adding value or spending more. The government value added cannot be compared to that of industries. Government activities are sold at lower rates and are not competent of market prices, so gets really tough to assess that. The author then navigates us through various scenarios where it becomes difficult to understand the government’s stance on things. For eg. A river polluted by industrial waste. When the polluter pays to clean up the river, 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.
One of the sucess signs for US and UK has been largely attributed to growing financial sector. The improbable level to which financial-sector profits rose, before and after the latest crisis, reflects a deliberate decision to redraw the production boundary, so that previously excluded financial institutions were now included within it, having redesignated finance as productive. Finance has grown so deep that the countries should be focussed on “financial deepening” the expansion and deregulation of banks and financial markets to be their development strategy. The belief that banking is at the heart of the economic progress of a country is counter intutive for various reasons. Banking provides three main services — maturity transformation — conversion of short term deposits into mortgages and business loans, liquidity (instant availability of cash) and lastly credit assesment (alloting loans to people who are creditworthy). In providing all these services, banks are at a risk and mercy of private sector firms. This constitutes “financial intermediation” with which banks provides these services by lending at higher interest rates than they borrow at. The cost of “Financial Intermediation Services, Indirectly Measured” (FISIM) is calculated by the extent to which banks can mark up their customers borrowing rates over the lowest available interest rate. FISIM is meansured as the extent to which banks can push lenders rates below and borrowers rates above the “reference rate” of interest that borrowers and lenders would be happy to pay and receive. Due to these reasons, there was a proposal to add FISIM to the national accounts, but until later 1990s, the services it represented were assumed to be consumed by financial and non-financial companies, so none made it through final output.
Banks started competing by offering high returns by taking even higher risks which make small banks vulnerable and big banks too easy to fail. After the global depression of 1930, Government’s appetite increased for financial regulation which helped put some tighter restrictions on the financial sectors including liquid reserves of total bank assets, interest rate caps, strict separation of commercial and investment banking. Commercial banks profited from direct loans for anything from cars to homes to holidays and from credit cards, while investment banks made money by securitizing commercial-bank products and trading the derivatives they manufactured. With the regulations in place, the big banks maintained their higher profits by working with their regulators to keep the big competitors out of the way, hence for existing big players are helped if banking licenses are restricted. But by issuing limited banking licenses will result in monopoly, benefitting the big banks while small banks would have to bear a big cost for it. But this slowly turned table towards dergulation and transformation in finance as globalization picked up, energy prices soared, inflation and further increasing pressure on household budgets. Two outcomes after deregulation were derivatives — contracts on the future delivery of a commodity allowing investors to bet on price movements, and other was securitizations, bundles of income-yeilding instruments that turned into these tradable securities which enabled their inclusions in derivative contracts)
But the question still lingers, are banks the money creators?
Banks traditionally presented themselves as purely financial intermediaries, channelizing household depositors’ savings to business borrowers’ investment. While mainstream economists looked at banks as “mobilizing” savings into business investment. Banks are not only empowered to create money as well as channel it from one part to other part of the economy, they do very little to turn the household savings to business investment, infect household savings get invested into buying durable goods while large businesses finance their investment through their own retained profits.
Traditionally, finance was never a part of the production boundary, but as per Karl Marx, financial sector is the circulation phase where value is created in production, is realized through distribution and ultimately used in consumption. For Marx, finance is a catalyst transforming money capital into production capital. Finance simply just takes part of the surplus value generated through the production process and there is no hard rule how much. By the late twentieth century, finance was perceived as much more productive than before. Finance became valuable to policymakers in order to maintain economic growth & manage inequality of wealth and income, but the real challenge is not to label finance as value creating or value-extracting, but to fundamentally transform it so that is genuinely value-creating. Asset management industry has been on the rise lately with its different components, from widely marketed retail investment funds to hedge funds to private equity. Lets dive into each one of them
Hedge funds are defined as shorting funds which means betting on the price of falling investments or investments going long. This was originally intented to take the risk out of their speculative investments, by enabling them to hedge upwards against downward price movements. Compared to others hedge funds have high returns and could be invested in wide range of assets. Hedge fund managers claim that they pick stocks from propreitary sources, hence this will lead to superoir returns, while in fact the information obtained is illegal at times. Typically, the hedge fund fees have been called 2–20 — a 2% fee on the volume of assets managed and a hefty 20% of profits. This ratio is alos used in venturn capital (VC). It claims special skills in picking profitable opportunities in young businesses and technologies.
Private equity firms invest in companies usually to take ownership and manage them later, may be after few years, selling them at a profit. They make their profit, if successful, from the increase in equity value of the company, after the debt is paid off. They then realize the equity value by selling the company through IPO (initial public offering) or to other PE firms. These are called private equity firms as the companies they acquire are not on stock exchange, for instance, SpaceX and NowRx. The owners of the PR firms are called as General Partners (GP)s and the funds they use to buy the companies come from investors like foundations, insurance companies and wealthy individuals. They say PE firms are harmful on companies as they aim is to cut costs in short term, by firing workers and reducing investments in order to make quick profits selling the business, impacting the long terms goals of the company.
Typically finance extracts value in the below 3 ways
1. By increased transaction costs between provider and receiver of the finance
2. Monopoly power of banks — Monopoly in wholesale and retail banking is closely linked to its continuing ability to extract rents from the private and public sectors. On top on monopoly rent, financial markets gives investment banks the leverage to high returns. Financial markets adjust the price of the company shares and bonds to the future profits those companies are expected to make. They can therefore capitalize the jump in the expected future profit when a new dug wins an approval for hospital use, for instance. Woning an asset that suddently jumps in value has always been the fastest way to get rich than saving and investing out of income,
3. High charges relative to the risks run in fund management — Financial intermediation — the cost of financial services is a value extraction form, where the scale of it depends on the relationship between what finance charges and what risks it actually runs. But as we have see, the finance cost has grown , but not the associated risks, hence financial sector has not become productive.
This way asset management has grown modern capitalism’s defining characteristics. Financial markets are medium of distribution of income but not income generating, hence they are rent seeking. Reform in finance is not possible. Moreover, the fees extracted by the asset managers should reflect the real value creation, not the 2–20 model that VC and PE firms have adopted. If the fees are appropriately reflect the underlying risks, the percentage of profit returned would be lower than 20. This does not imply that financial actors should not earn money, but atleast an collective effort should be made towards a more equitable share of the rewards. Financialization has affected not only the finance sector but its impact is observed on other non financial sector too. Infact, non financial companies that cannot beat the financial investors return are forces to join them by “finacializing” their production and distribution activities.
Sharebuy backs is one of the prime reason of how financial value can damage the real economic value. Share buy-backs are a way of transferring money from a corporation to its shareholders. The company buys some of its own shares from existing shareholders. This is similar to paying out money as dividends. The only difference is that dividends are paid out evenly to all the shareholders, while buy backs give cash only to those who want to sell and buy-backs avoid any penalty taxes imposed on dividends by governments that want more profit reinvested. Because of share buy backs, is that they reduce the number of shares which boosts the Earnings Per Share (EPS) which is one of the key measures of corporate success. Hence buy-backs are preferred by people on the top managements posts than dividends as buy-backs are considered as special payments while dividends act as a source of income to shareholders. Some investors are finally waking up. Larry Fink, then CEO of BlackRock in 2014 wrote that many companies have cut capital expenditure and even increased debt to boost dividends and stock buy backs. Fink stated that while returning cash to shareholders should be a part of balanced capital strategy, such a practice could when done for the wrong reasons and at the expense of capital investment, jeopardize a company’s ability to generate sustainable long term returns.
It is often claimed that share buy backs maximize shareholder value (MSV) and thus improve the efficiency of the companies. In 1970, there was an article published my Milton Friedman in New York Times magazine about how America’s economic performance was declining because the managers in the company, whose jobs is to maximize profits, were not punished if they failed to maximize the profits for the company. Later this idea was implemented into “Theory of firm: Managerial behavior, agency costs and ownership structure.” The key argument is that the managers (the agents) were not being disciplined by competitive financial markets pr product markets, since they could misallocate resources or run up unnecessary costs without incurring losses or endangering their jobs, so it was hard for investors to keep them accountable. The only way to do so was through strengthening the market which was neutral and objective enough to make sure that the company thrived. The result was a body of theory that argued that the only way for companies to be well run was if they maximized their shareholder value. In this way, investors would indirectly keep company managers accountable.
Since 2000, there has been a rise in the number of PEs, the most aggressive manifestations of MSV. An investor could invest in PE and would be instantly and heavily rewarded through bigger dividends or share prices gains. Most of the PE firms don't lie on the financial side, while they lie on the productive side of the production boundary. PE seeks to buy and resell at a higher prices within few years, hence they are focused on short term view rather than longer one. The complex and opaque ownership of care homes or a shadowy combination of corporate structures and financial engineering may well explain the high payouts to water company owners while the workers get meagre salaries. These two instances of water company and care homes proves that financial engineering of these socially essential services can change the nature of the industry.
Yes another way of value extraction is through innovation economy.
First, the way how a VE and stock market has interacted with the process of technology creation.
Second, in a way that 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 there cy creating “unproductive entrepreneurship”. Third, the way prices of innovative products no not reflect the collective contribution to the products concerned in the fields of health, energy or broadband.
Fourth, through the network dynamics of modern technologies, where first-mover advantages in a network allow large companies to reap monopolistic advantages through the economics of scale and the fact that customers using the network get locked in.
The most modern form of rent-seeking in the 21st century knowledge economy is through the way in which risks in the innovation economy are socialized while the rewards are privatized.
Innovation rarely comes in isolation, it is more of a collective operation with longer lead times. What might appear to us as a radical discovery today is actually due to the hard work of many different researchers at one point. It is also profoundly uncertain that most attempts at innovation fail and many results are unexpected. For instance, Viagra was initially developed for heart problems.
Collective innovation combines the roles of public sector in providing strategic finance and the contribution of employees inside companies. Those who are lone entrepreneurs might see benefits coming out of this collective innovation. For instance, iPhone depends on publicly funded smartphone technology while Internet and Siri were funded by Defence Advanced Research Projects Agency (DARPA) in US defense, GPS by US Navy and touchscreen display by CIA. Companies like Microsoft and Google have written about their immense benefits their companies have gains from public investments, the Internet and the html code written behind the worldwide web. The collective role of innovation has strengthened the relations between countries as they are more likely to embrace the private and public collaborations that are required for value creation. An understanding of value creation and value extraction is necessary. There are 4 ways in which value extraction occurs in the innovation economy.
Financing innovation is generally a lengthy and cumulative process. In the early days, returns are low due to very high risks but if the innovation proves successful, returns are high. There are cases where the public funds have made the initial risky investments — the private VA only entering at a point where investment looks more of a sure bet and that these investments would receive appropriate remuneration for their boldness. But in fact, the opposite is true. The such cases, the VC’s share of rewards is higher than the public sector. While public sector reaps its benefits through other medium like taxation etc. When is comes to VC, its all about the timing. Their ability to enter a sector late, after the development risks had already been taken, but the timing matters the most here.
IPOs are, first, a way for early investors to get their money out. IPO encourages investment. Second, IPOs can raise new capital for business expansion, which can be valuable in some sectors but less significant in others, where the most important capital is human. Third, the founders can realize the value of their ingenuity and sweat equity that has remained latent in the company. Fourth, employees who may have been induced to leave secure jobs by the promise of equity in a risky venture, can realize the value of that equity — or atleast see the possiblity of doing so now that there is some liquidity in the company’s stock.
Another way of innovation extraction is by appropriation of returns through the patent system (IPR). The purpose of patents is (value creation) to provide protection to inventions that are novel, inventive and suitable for industrial application. They protect the innovator from having his or her idea copied. During earlier years, most of the innovations were not patented, but this trend has been changing and more and more innovations are getting patented. Patents are granted to reward and incentivize inventors for developing new ideas by granting them time-limited (20 years) monopoly entitlement over their inventions. In exchange for this monopoly entitlement, the innovator must share all the details about the invention, but once this patent is expired, the invention can diffuse rapidly through the economy in a process known as disclosure function of patents. If the system works well, the appropriability function is properly balanced against the disclosure function and the public gains from the rapid diffusion of this new knowledge through the economy. Patents are similar to contracts or deal based on a set of policy choices. Granting patents can help in incentivizing the investors, which in the long run can result un higher prices rates of technical progress. But such grant also increase the market power of patent holders, resulting in less ‘economic efficiency’ during the time patents are enforceable, and slower knowledge diffusion.
Not all industries make equal use of patents, some industries its less like software, but its more important in industries like pharmaceuticals. The scope of patents have widened from “inventions” to “discoveries”, hence allowing exploration of future innovative possibilities such as diagnostic procedures, databases, scientific experiments etc. Patents are now gate keepers to the knowledge base. The US Bayh-Dole Act of 1980 was instrumental in making universities and government research lab to hold patents on the result of publicly funded research. With this, firms now negotiate and pay for a license before entering a market to access proprietary information that would have been previously available in publications. Secondly, patents could be renewed. Thirdly, patents are much easier to obtain. Lastly, large companies are using “strategic” patenting to patent around areas to block competitors. Another growing practice these days is ‘patent-trolling’, the strategic holding of patents, not to develop an idea, but to deliberately collect royalties through patent enforcement.
Unfortunately, pharmaceuticals is taking undue advantage of this patent system and debunking it to the core. There have been various lawsuits attempting to extend patent validity on existing drugs by merely reshuffling the old combinations of the compounds. Such lawsuits have are the main source of value extraction, rather than providing incentives for value creation through pharmaceutical innovations. Its worse, because public institutions funded most of the scientific research and discoveries, taxpayers are now paying twice, first for the research and then for the premium that these companies charge for their drugs. Furthermore, increasing returns from patents reinforce the positions of incumbents and lock out competitors. Patents also lead to monopoly pricing when the same company comes up with an improvised version of the same drug. Both these drugs made a great haul in the market, not because of their therapeutic power, but because of their costly prices. The price of specialty drugs have skyrocketed in recent years, where these drug prices are unrelated to the manufacturing costs. Also, the basic research expenditure by pharmaceutical companies is very small as compared to the profits they make. Most of the research leading to real innovation has come from publicly funded labs. Hence, looking at this, the topic of discussion should be the value of the drugs and not their prices. Other contributing factors to the increase in profits is network (how many and how far does your company reach) and the first mover advantage which eventually leads to monopoly.
Another interesting perspective shared by Mariana is about the value creation and extraction using digital value. The digital giants' enormous market power raises critical issues about privacy protection, social control and political power. One of the major consequence of this is monopoly. Other major consequence of the dynamics of innovation is about how value is creation, how is it measured and how and by whom this value is extracted. if we go my national accounts, the contribution of internet platforms to national income is represented by the advertisements related service they sell to firms. It is not clear why the advertisements should contribute to the real national product, let alone social well-being, which should be the aim of economic activity. But national accounts are consistent with standard neoclassical economics, which is sometimes misleading as in this case. If online giants contribute to social well being by providing the services, then there seems to be no relation to the advertisements that accompany them, purely means of value extraction. One classic example is along the lines of Amazon and their AI capabilities which is captivating and engaging users mind. Instead of paying Amazon a fee to use their AI capabilities, built on the basis of our data, Amazon should be required to pay that fee to us as we provide them with the valuable data.
Economic growth without innovation is hard to imagine, but innovation must be governed in a way that leads to value creation and not value extraction. First, it is crucial to understand that innovation is not a neutral concept. We do take the benefits out of these innovations by sharing experiences and our stories. Only thing that should matter more is it should be more inclusive. Second, innovation has both rate and direction. Third, innovation is produced collectively , hence the benefits should be shared collectively as well. Patent should not be seen as “rights” but rather as a tool with which to incentivize innovation in sectors where they are relevant. All these factors if carefully considered and implemented will lead to great economic growth of the nation and will benefit the society in a positive way.
The author has also shed some light on the value of public sector and how it could be beneficial for the society if there is a great conglomeration of public and private sectors. She has also touch based on the Keynes concept of how the government can be more productive as Keynes disposed the assumption that supply created its own demand. He proposed government creates value in that it allows the economy to produce more good and services than it would without government involvement. This was a pivotal shift in the way we regard government’s role in the economy. For Keynes, government could create value by reviewing demand -precisely when demand might be low, as in recessions or when the business confidence is low. But in doing so, government would need to borrow finance to afford the spending which means bigger government debt in a recessionary economy. But Keynes argued that the increase in debt should not overly worry the government as when the recovery is under way, the debt could get easily paid off. His whole idea was the economy would often working at under utilized capacity. While on the other side, Friedman was concerned about controlling the quantity of money in the economy. The new classicals challenged Keynes that government spending is pointless and is only crowded with private investments. According to them, an increase in the public deficit raises rate of interest which in turn decreases the amount of private investment. For these reasons, government’s role should be restricted to incentivizing individual producers and workers to supply more output and labor. for eg. by cutting taxes.
By this time, we all know that GDP is not a full fledge metric to measure the economic growth of a nation. The national accounts failed to capture the full amount of this government value added and have several flaws in the system. First of all, national accounts regard most of the government value added only as costs, mainly pay government employees. Second, the ROI (return on investment) by government is assumed to be zero, by this logic it does not earn a surplus. Third, to assume that the value of government output equals the value of input means that government activities cannot increase the economy’s productivity in any meaningful way: an increase in productivity after all is obtained by growth of output outpacing the growth of inputs. Fourth, the governments often own productive businesses such as railways, postal services. But by accounting convention, state-owned enterprises in the value added of the relevant sector. Public railways are part of the transport sector not the government sector. So if the railways makes huge profits, it boosts the transport sector value added, even though that sector is only successful because of state owner hip.
the 1980s backlash against government was in part driven by the notion that economies should worry more about government failures than market failure. Government failure emerged as a concept from Public Choice Theory, which argues that government failure is caused by private interests ‘capturing’ policy makers through nepotism, cronyism, corruption or rent seeking activities. This 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. These theories worry more about the government failures while the neo Keynesians were worried more about the market failures. Public Choice theory which derives from marginalism, calls for government to intervene as little as possible in the economy in order to minimize the risk of government failure. PCT resulted inexorrably in government shedding resposibilities, reducing its investment in its own capacity-building and eventually to privatisation. Privatization could be achieved through the actual sale of unit as that has happened with public banks. Or indirect privatization through outsourcing. In 1980’s the Public Choice begain to heavily influence public policy, saw a wave of privatizations and outsourcing, in UK and then in US. But this theory always ran the risk of throwing our the baby with the bath water. By insisting that government could not create value and was likely to destroy it, there was a rise in monopolies of industries around. The solution to this problem was regulation. A lot of regulatory policies sprang up and each intended to stand between public and industry. Regulatory capitalism replaced state capitalism. But unfortunately, the PCT did not work as it was intended with regulatory capitalism, but worked in the reverse way. Another consequence of PCT has been rise of intermediary mechanisms to fund public activity. This has mainly taken two forms. One is Private Finance Initiatives (PFIs) to build hospitals. The other is outsourcing to private providers to run a wide range of services. Turning PFIs have been called as ‘pseudo-privatisation’ because the private firms recieve their income not from clients in the market but from government through a guaranteeed profit margin. The aim of PFI financing is to share costs and remove from government’s balancesheet the debt associated with large projects such as hospitals, however it can be costly for the public sector because projects are financed with private debt and equity which is significantly more expensive than public funding. Governments also pay private contrators an annual charge. So exclusive PFI contracts in effect create monopoly licenses.
At the end, unfortunately in the current situation, price has become the indicator value, as long as good is bought and sold in the market, it must have a value. So, rather than a theory of value determining price, it is the theory of price that determines value. By losing our ability to recognize the difference between value creation and value extraction, we have made it easier for some to call themselves value creators and in the process extract value. In order to solve this problem, we must go beyond fixing isolated problems, and develop a framework that allows us to shape a new type of economy which will benefit us all. Firstly, we need to figure out which kind of activities add value to the economy and which extract value for the sellers. Price equals value thinking encourages companies to put financial markets and shareholders first. This ignores the reality of value creation as a collective process. Third, the market story confuses policymakers as they tend to focus only on their communities and they allot a lot of trust in the market mechanisms. Fourth, the confusion between profits and rents appears in the ways we measure growth itself: GDP. Indeed it is here that the production boundary comes to haunt us, if anything that fetches a price is value, then the way national accounting is done wont be able to distinguish value creation from value extraction and thus policies aimed that the former might lead to the latter.
The author end the book concluding that her intent was not to argue which theory is better than another, but was to think in novel ways of putting value back at the center of economic reasoning. Instead of believing in the static fences of production boundaries, we should understand the dynamic behavior of this and ensure that it covers the societal objectives as well. After all, if we cannot dream of a better future and try to make it happen, there is no real reason why we should care about value, which is the greatest lesson of all.