Profits Now, Costs Later

Back in​ 2004, when he was riding high, before the collapse of the venerable retailer BHS in 2015 and his recent naming in the House of Lords by the Labour peer Peter Hain as a ‘powerful businessman using non-disclosure agreements and substantial payments to conceal the truth about serious and repeated sexual harassment, racist abuse and bullying’, Philip Green gave a self-congratulatory interview to the Guardian. Swaggering through his high-street stores, journalist in tow, he showed off his knowledge of the stock, his attention to product display, his grace while accepting customers’ compliments, and his perspicacity in offering discounted teddy bears with each £10 purchase. Readers would understand, he very much seemed to hope, that his extravagances – commuting to London from his home in Monaco by Gulfstream jet; absurdly lavish birthday parties; a private performance by Destiny’s Child at his son’s bar mitzvah – were rewards legitimately owed to a business wizard of prodigious talent and energy. ‘If one man’s better at something, he earns more,’ Green declared. To arrange things differently would be as senseless as giving less capable students easier exams. ‘There shouldn’t be a penalty for being good at something, should there?’

What Green was actually best at turned out not to be running shops. A House of Commons Work and Pensions Committee report published in July 2016 revealed that between 2002 and 2004 BHS paid out dividends far in excess of profits, delivering £307 million to the Green family alone, well in excess of the £200 million he had paid for the firm. Meanwhile, what profits there were had been temporarily swelled by selling the company’s premises to a firm controlled by Green’s wife, from which they were then leased back. By this means, the firm’s owners got hard cash in the present by loading the firm with obligations in the future – to fund pensions, to maintain its premises and to repay its creditors. To cover these liabilities, of course, the firm had to maintain itself as a going concern. It was an implicit promise on which BHS’s workers relied when they tied their careers and retirement prospects to this long-established company. Crucially, however, the obligations were attached to BHS as a legal entity, not to its actual owners. When Green finally offloaded the firm for a pound, his evident intention was to keep hold of past payouts while leaving the firm’s creditors, including its present and future pensioners, to fight over scraps. When he channelled money out of BHS, Green in effect monetised the firm’s history as a reliable counterparty for workers and lenders, while bringing that status into peril. He enjoyed the privileges of ownership without fulfilling its obligations.

Green is one of many figures caught by Mariana Mazzucato’s grapeshot blast against the injustices of contemporary capitalism. These injustices have persisted, she contends, because progressives have unilaterally disarmed in a little-noted war over the nature and origins of economic value. As a result, public discourse is permeated by flimsy ‘stories about value creation’. Just as Green’s self-presentation as the Ronaldo of retail obscured his legerdemain with liabilities, such stories speciously link individuals’ wealth to their productive achievements, legitimating business practices that in fact enrich some at the expense of others. Policymakers absorb these ideas, failing to recognise or actively working to diminish the state’s crucial role in generating social wealth. The discipline of economics, for its part, has forgotten how to discuss value, preferring instead to focus on the determinants of price. This sort of thinking extends even to the most fundamental yardstick of economic success, Gross Domestic Product. The consequences, Mazzucato argues, are dire: ‘If we cannot define what we mean by value, we cannot be sure to produce it, nor to share it fairly, nor to sustain economic growth.’

Mazzucato seeks to name and shame the practitioners of ‘value extraction’, which she defines as ‘the appropriation of gains vastly out of proportion to economic contribution’. As for what constitutes vast disproportion, readers are expected to know it when they see it. The tunnelling of resources out of BHS exemplifies what she and others call ‘financialisation’, referring both to the increasing size of the financial sector and attitudes towards non-financial business. From a financial viewpoint, a firm is primarily a balance sheet – a set of assets and liabilities. The difference between assets and liabilities is known as equity, a term familiar to anyone with a mortgage, for whom it represents what would be left over if the house were sold and the proceeds used to retire the mortgage debt. To make the balance sheet balance, equity is written on the liability side. Within and outside the financial sector, owners view equity with a jealous eye, always considering whether they might be better off with that equity in their pockets, and the resulting gap in the balance sheet filled in with new borrowing. Once the drive to extract equity gets going, it can be hard to reverse. A firm that pays down its debt raises the value of the debt that remains (as it is more likely to be repaid), but since these gains go to creditors rather than owners, the latter are loath to sanction them.

The extraction of equity often means profits now, costs later – and the costs may be borne by someone else, since they accrue to the firm, not to those who appropriate the profits. In developed capitalist countries, this formula has been generating outsize fortunes at the price of outsize misery for the past forty years at least. Mazzucato’s examples include the private equity firms that have profited by laying waste to care homes, and Britain’s privatised water companies, which fail to tackle leaks yet continue to impose high prices while paying generous dividends to shareholders. She calls out the practice, common in large US corporations, of making payouts to shareholders by directing profits, and often borrowed funds, to buying back shares, which pumps up share prices at the cost of inadequate investment. Not only is this bad for economic growth, it directly contributes to rising inequality. A doctrine emerged in the 1970s which held that corporations should focus on maximising ‘shareholder value’, expressed in the price of shares. Tying managers’ pay to share price encourages them to focus on this, but results in gigantic differences in remuneration within companies. You don’t need a systematic theory of economic value to recognise that these variations cannot possibly be a fair reflection of the differences between workers’ contributions.

It isn’t only in discussions of executive pay that talk of value serves to dress up what would otherwise be seen as naked injustice. Mazzucato reports that in the US, the hepatitis C drug Sovaldi has been priced at $1000 per weekly pill, probably about a hundred times greater than its cost of production, and far higher than the costs of its development could justify. Challenged by politicians, the manufacturers argued that a drug’s value is appropriately measured by the medical costs that would be incurred were it not available. By that standard, as Mazzucato points out, astronomical prices could be charged for water. The value analysis masks the exploitation of a patent-granted monopoly in which patients and their insurers will pay what they must. This is perceptive, although Mazzucato doesn’t help herself with the quasi-Marxist addendum that ‘holders of patents can appropriate surplus value generated by labour and not paid out in wages.’ (For Marx, this wouldn’t distinguish patent holders from any other capitalist.) The share of a drug’s extortionate price paid out to those who directly labour to produce it has no bearing on whether or not the price is extortionate in the first place.

Mazzucato finds high drug prices particularly galling because the majority of fundamental research in biochemistry, which is crucial to pharmaceutical innovation, is funded by the state. Yet not only is the state unable to reap commercial benefit from its contribution, it isn’t even in a position to mandate reasonable pricing. A similar story can be told about innovation in the digital economy. Returning to case studies extensively documented in her earlier book, The Entrepreneurial State (2011), Mazzucato notes that key technologies behind the vast fortunes created at such firms as Apple and Google originated in government-funded research. Programmers and engineers build on this research, while the much celebrated impresarios of the venture capital industry merely position themselves between an emerging firm and the capital markets. When shares are sold to the public, the years or decades of ‘ingenuity, effort, risk-taking, collaboration and persistence that went into developing the new idea’ are converted into wealth, of which venture capitalists rake off a substantial percentage, benefiting, once again, ‘disproportionately’.

It is​ one thing to dismantle the accounts of value used to justify the private appropriation of collectively produced goods; it is quite another to supply a precise alternative. To do so would require bucking a long trend in the discipline of economics, which discarded value as an organising concept more than a hundred years ago. Mazzucato rummages in the classical armoury of Smith, Ricardo and Marx. But the weapons she emerges with are blunt and poorly suited to her purposes. Hoping to challenge the inflated incomes of financiers and others, she seizes on Smith’s distinction between ‘productive’ and ‘unproductive’ labour, but badly misses his point. For Smith, productive labour ‘adds to the value of the subject upon which it is bestowed’, as the work of a baker does in making a loaf which can be sold for more than the cost of its ingredients. By contrast, the labour of a musician is ‘unproductive’: their performance ‘perishes in the very instant of its production’ without creating anything that could be sold onward. As this example indicates, ‘unproductive’ labour can be entirely deserving of remuneration, and Smith is at pains to emphasise that much ‘honourable’, ‘useful’ and ‘necessary’ labour, such as the work involved in ensuring public order, falls into the category of the unproductive.

Searching the classical legacy for a way to drive a moral wedge between price and value is in any event a vain project. For Smith, Ricardo and even Marx, theories of value were a way to understand prices, not to criticise them. They conceived value, the historian of economics Philip Mirowski has argued, as a metaphorical substance poured into a commodity (for instance by Smith’s ‘productive labour’), whence it might flow into another commodity produced from the first. Unfortunately, no way could be found to relate the fluctuations of empirical market prices to the value contained in the commodity, which if it really arose in production could not subsequently change. Imperfect solutions to this problem were devised by making assumptions about the way markets work, which allowed values to appear as a point to which prices must necessarily tend. For Smith, the deviation of market prices from natural prices indicated a temporary mismatch between production costs and what the market would bear, whether this mismatch derived from the machinations of the wealthy (of whose taste for price-gouging Smith had an enduring suspicion) or transitory and morally neutral circumstances like good and bad harvests. Marx insisted that while labour was the sole source of value, that value derived not from actual labour time, but from ‘socially necessary labour time’. This has the advantage of not assuming that the hours of toil put in by a moderately competent home baker will yield a loaf more valuable than an identical one produced more rapidly in a well-equipped commercial kitchen. But it also attenuates the link between value and labour, undermining the whole idea that value is deposited into a commodity as it is produced. In short, the classical approach to value was collapsing under its contradictions before it was displaced in the late 19th century by the marginalists, who sought new ways of explaining supply and demand in terms of individual preferences, and largely dispensed with the whole notion of value except as a synonym for price.

What frustrates Mazzucato about the demise of classical value theory, which she makes no effort to repair, is that ‘stories about value creation are around us everywhere – even though the category itself is not.’ One particularly significant instance of this is GDP. A measure ubiquitous today, GDP is less than a hundred years old and is, as more and more people are pointing out, a jerry-rigged construction. GDP is defined as the total output of the economy measured over a period of time, less whatever is used to produce some separate output (without this there would be a lot of double-counting: the flour sold to a bakery counted again as part of the bread). There are other definitions that turn out to be mathematically equivalent. Instead of measuring total final output (the bakery’s sales), you could add up the ‘value added’ at each step leading to the final product (the flour miller’s sales less costs plus the baker’s sales less costs etc). Or you could define GDP as equivalent to total domestic economic consumption and investment plus exports (consumed abroad) and minus imports (not domestically produced). This is even more complicated than it sounds, especially when it gets to value added. Compare a private school with a state school. In the case of the private school, we can calculate the difference between its costs and what it receives in fees simply enough. But what about the state school, which charges no fees? The common approach is simply to regard public services as providing value equivalent to what is spent on them. This seems to stack the deck against state provision of services, but the alternative is to use some recondite and perhaps arbitrary procedure to figure out what the price of the state school’s services would or should be if they were provided by the private sector.

Mazzucato sees the construction of GDP as a key battleground in the subterranean war over value. Its minimisation of the positive impact of state services isn’t its only failing. She also questions the assumption that the financial sector makes a productive contribution to the economy. To measure this contribution, statisticians assume that borrowers and lenders derive value from their relationship with a bank equal to the difference between the interest rate being paid on loans, or received on deposits, and a ‘reference rate’ intended to capture the general price of money. The idea is that if borrowers or depositors aren’t getting value from the bank, they can borrow or lend funds at the reference rate. However, the reference rate is usually the rate for inter-bank lending, which customers can’t access. This leads to some bizarre results. In the last quarter of 2008 in the UK, for instance, interest rates for inter-bank lending plummeted as the Bank of England fought the consequences of the financial crisis by making money available cheaply. But since the interest rate on outstanding loans remained largely unchanged, it appeared that there was a huge increase in bank ‘output’ at a time when banks were trapped in a tailspin of historic proportions.

Although there is no doubt that the economic heft of the financial sector has grown enormously in recent decades, this episode indicates why we should be suspicious of statements claiming that it accounts for some definite percentage of the economy, or of political conclusions derived from them. The simplicity of a ratio conceals countless arbitrary and contorted decisions about both numerator and denominator. But Mazzucato is less convincing when she argues that these abstruse procedures, by dignifying as value creation what is better understood as exploitation of banks’ market power, have greatly facilitated the political influence of the financial sector. After all, the System of National Accounts undergirding GDP is an international standard, implemented in approximately equivalent ways across nations with a range of economic policy profiles, including many in which the financial sector plays a far smaller role than it does in the US and the UK. In the UK, even as the financial sector swelled from the 1980s onwards, statisticians continued to calculate bank output on the assumption that it was all intermediate production, destined like the baker’s flour for further processing – their analogue of the baker was an imaginary sector that didn’t count as contributing to GDP at all. This procedure, changed only in 2008, is not the one you would have chosen if your aim was to justify the skyrocketing wealth of the heroes of finance. Similarly, if UK policymakers were captivated by the supposed growth-enhancing potential of finance, it could not have been because of the sway of national accounting conventions – neoliberal fables about efficient markets were rather more influential.

The difficulties in assessing GDP when price-setting markets are absent illustrate just how futile the search for a correct definition of value can be. The sociologist Georg Simmel got to the root of the matter when he observed at the start of the 20th century that ‘value is the epigone of price.’ We can easily identify the price at which a transaction went forward or was offered, but if we want to identify a value distinct from it, we end up conjuring the price that would have been set on a differently organised market. It is the structure of markets, and regulations that permit financiers like Philip Green to adopt a devil-take-the-hindmost approach to the calculation and distribution of profit, that lead to the outcomes Mazzucato condemns. Indeed, she makes plenty of stirring calls for the reconstruction of economic policy, emphasising the state’s productive role and the need to recognise that markets can and should be shaped to generate outcomes consistent with our values. She’s right. But the plural is important. The lesson of the factitiousness of GDP, and of other less quantitatively ambitious constructions of ‘value’, isn’t that we need a better notion of value, but that in a hugely complex economy the very concept is chimerical. Almost no one today tries to rescue Marx’s labour theory of value, but his portrait of the proletarian, denuded of bargaining power, who takes ‘his own hide to market and has nothing to expect but – a hiding’, retains its power and relevance. The Value of Everything, too, is at its best when it analyses the concrete operation of markets, evoking a sense of injustice that can never be reduced to a number.