Changing values – Towards a new economy?

In the previous post, you already met economics professor Mariana Mazzucato as an ardent advocate of mission-oriented research and innovation. But that’s not her only interest as the Director of the Institute for Innovation & Public Purpose at the University College of London.

She’s equally passionate about the public sector’s underestimated role in innovation (see her 2013 book on ‘The Entrepreneurial State: Debunking Public vs. Private Sector Myths‘) and, more recently, the very concept of value in economic thinking. Her 2018 book The Value of Everything: Making and Taking in the Global Economy is all about how we judge economic activity as either productive, i.e., generating value, or as unproductive, i.e., extracting value from the economy.

Where we come from

Mazzucato starts from a concise historic account of what is considered productive economic activity vs. what is judged as being unproductive. Reviewing the origins and evolution of classical economics, she compares the ideas of Adam Smith, David Ricardo, and Karl Marx, teasing out the differences between them while highlighting their communalities.

Building on Smith and Ricardo, Marx developed the labour theory of value, thereby placing the worker’s capacity for work (his labour power) at the heart of productive economic activity. The worker is paid a wage by the capitalist in return for the labour he exerts. Value is generated if: (a) the wage is higher than the cost of restoring the worker’s labour power (the wage must be above physical subsistance); and (b) if the price the product achieves in the market is higher than the worker’s wage plus the capitalist’s expenditure for machines and material. Naturally, the negotiation of wages plays a central role in this model, as it defines how value is shared amongst those who participates in its generation.

Another important aspect is the distribution of value across the entire society, including those who are considered to be unproductive. In the eyes of classical economists, those are the government and private households. Wages have long been the principal source of revenue for private households, while taxes were levied to fund government expenditure. Only in the late 19th and the early 20th century to more socially-minded political movements gradually implement tax-funded welfare programmes for private households without access to wages, i.e., the unemployed, the sick, or the elderly.

The classical economists agreed (with some deviation owed to their individual historical context) that profit is a necessary element of the economy: it is the surplus value generated beyond what is required to reproduce the capital and labour expended. This surplus plays a critical role in keeping the economy going through investment in future economic activity. Rent, on the other hand, is the extraction of surplus value from the economy, for example for luxury consumption or accumulating wealth (that is not re-invested in the economy); rent-seeking thus deprives the economy of future growth potential.

Overall, classical economists understand the economy as a highly dynamic system, with change as the norm and static stability as an aberration.

Where we stand today

All of that changed dramatically with the advent of neoclassical economics, most prominently advocated by Milton Friedman, who was arguably one of the most influential economists of the 20th century. His 1970 article in the New York Times Magazine, pointing out that The Social Responsibility of Business is to Increase its Profits, shaped the thinking and beliefs of economists and business leaders for nearly half a century now.

That’s where the idea of shareholder supremacy was borne: business profit should be maximised for the immediate benefit of the holders of company shares. Any other conceivable responsibility, be it social or environmental, would automatically be taken care of. But there’s more to neoclassical theory than this focus on shareholder value. As Mazzucato points out, it’s only the tip of the iceberg.

Hidden below the surface is the lack of any concept of how value is generated. The works of Smith, Ricardo, and Marx are rejected, and economics is solely based on the belief that value is determined by price: everything that fetches a price in the market has value, and anything that doesn’t doesn’t. As a result, there is no way to distinguish between productive activity (generating value) and unproductive activity (extracting value from the economy).

And the market alone determines the right price. Of course this market should be left entirely unregulated market to do its magic. It would automatically drive for an equilibrium where all imperfections are competed away and everybody receives ‘what they deserved’ due to their contribution made. In this logic, any the government interference in the economy is considered evil.

With its lack of an independent understanding of value, neoclassical economics generates several unhealthy outcomes:

• Allocating resources to unproductive purposes, i.e., allowing for the systematic extraction of value rather than pushing for the generation of value, thereby facilitating the personal enrichment of a few in the near-term instead of promoting the prosperity of the many in the long-term.
• Undervaluing the role of government, in particular (a) in shaping the market for public good, and (b) as an early investor in high-risk / high-payoff research programmes that break new ground for later private-sector investments and profits.
• Undermining the very foundation of innovation by focusing on short-term returns on investment; ignoring long-term growth opportunities for the benefit of all and promoting growing inequality instead.

The twisted yardstick

In essence, this school of economic thought has emboldened the value extractors and discouraged the value creators. The singular emphasis on the power and wisdom of the market confuses policy makers regarding productive vs unproductive activties. And this confusion between profit (which is the necessary basis for investments in future growth and prosperity) and rent (which simply extracts value for unproductive purposes) is even reflected in how we assess the well-being of our economy.

Gross Domestic Product (GDP) is the established yardstick for assessing the health of an economy, no wonder that it is widely employed in policy making. The United Nations System of National Accounts serves as the agreed international standard for measuring and recording GDP. And even there, the financial sector is accounted for as productive, without the necessary critical appraisal of the purpose of financial activity: the rent-seeking casino-mentality that extracts value is assessed in the same way as the service-minded support to business investments in longer-term growth that enables value creation.

To overcome cynicism

Mazzucato deliberately does not suggest a specific definition of value, but seeks to trigger a necessary debate, among economists, amongst policy makers, and across the general public: What is value? What is valued? How is it generated? And how should it be distributed to promote long-term sustainable growth and prosperity for all?

Oscar Wilde famously mocked that the cynic knows the price of everything but the value of nothing. It is time for us to overcome the implicit cynicism in our current economic thinking that understands value as defined by price alone; it is time to strive for a new consensus on value, putting our thinking back on its feet so that value eventually defines price.

Signs of hope

Without a doubt, we need a serious discussion about value and how that drives society and economy (I’ve shared initial ideas in an earlier post on rethinking value). And actually, there are promising signals that things are moving in a positive direction.

You might find an unexpected ray of hope in a debate on stakeholder value triggered by the U.S. Business Roundtable. Just last week, this lobby group issued a rather short paper on The Purpose of Corporation.

Signed by over 180 luminaries of Corporate America, including the CEOs of Apple, Amazon, Blackrock, Ford, Exxon, General Motors, and Walmart, the paper argues for companies’ commitment to all their stakeholders: their customers, their employees, their suppliers, their communities, and their shareholders.

Could this actually usher in the demise of the business ethics that worshiped the single-minded maximisation of shareholder value since the 1970s? Some commentors already suggest that Milton Friedman must be turning in his grave, but it’s way too early to see any real impact of such statements of intent. Time will tell, and only business leaders’ actions (or the lack thereof) will prove their real level of commitment.

That said, we really might witness the beginning of the end of shareholder supremacy. But we shouldn’t just wait for the companies to act. Let’s keep reminding them of their commitment, let’s hold them accountable, let’s monitor their actions, and then let’s make informed choices: as customers, as employeers, as suppliers, and as communities. That in fact should be our own commitment to the emerging paradigm of stakeholder value: as stakeholders, we cannot afford to just watch the economy from the sideline; as stakeholders, we must engage in the economy, actively and consciously.

A second reason for optimism –less visible so far, but potentially more influential in the long run– is the CORE Econ project. That’s nothing less than rewriting the textbooks for teaching economics.

This remarkable project was triggered by students who realised during the global economic crisis that the material presented to them in class bore no resemblance to the real world and what was happening around them. The simple mathematical models couldn’t explain the crisis, and they wouldn’t explain people’s behaviours and decisions either. Further, the standard narrative declared quite influential things like innovation or climate change to be (positive or negative) externalities, thus locating some difficult questions conveniently outside the scope of economics. Certainly not a promising approach to analysing, let alone solving real-world problems.

The students’ lobbying created the momentum that ultimately gave rise to an unprecedended collaborative project: a growing group of economists from leading academic institutions around the world worked together to develop and deliver an entirely new curriculum; a curriculum that starts out from real-world problems rather than idealised mathematical models; a curriculum that doesn’t shy away from the difficult questions; a curriculum that is inclusive and accessible. The result of this effort is freely available online to anybody who has an interest in the economy, what it is and how it works. To get an initial idea, just watch Wendy Carlin and Samuel Bowles, two of the key contributors to the project, discuss of the challenges of real-world economics at the Santa Fe Institute.

The CORE Econ curriculum is increasingly adopted by universities around the world to replace conventional Econ101 classes, and spreading into secondary schools as well. So there is justified hope that the next generation of leaders will be better prepared to understand and act in the real economy, and better informed to develop realistic policies for steering it towards generating value for all. A new economy that is definitely worth striving for.