The way we count how big our economy is gets determined by a set of changeable decisions. Those decisions have changed over time, and they can change in the future.
That is a major theme from the 2017 book The Value of Everything by economist Mariana Mazzucato.
Below I share my notes from reading the book, which are for my own purposes for review later.
Here are my notes:
- Plato said storytellers rule the world. Or in a direct translation: “Those who tell stories rule society.”
- Prior to 1970 and a period of deregulation, banking wasn’t even in GDP figures. (More here);
- Oscar Wilde: a cynic is someone who knows the price of everything and the value of nothing;
- ““The mine owners did not find the gold, they did not mine the gold, they did not mill the gold, but by some weird alchemy all the gold belonged to them:” socialist and labor leader Big Bill Haywood;
- Author’s framing: value extraction versus value creation (takers vs makers; predatory capitalism over productive) and who decides those lines?;
- Value is the creation of new goods and services ; rent-seeking is its obstruction;
- Mid-1800s shift from “value determine price” to “price determining value” (If there’s a market price, it has value);
- Over time, economists have shifted the boundary around “productive work” (creating value) to separate from unproductive work (typically government, and once finance);
- Change in value theory to “price determining value” means anything with a price has value, removing any concept of unearned income in an economics sense. This isn’t inevitable but a decision;
- Since the 1980s, government has been made to appear less productive and finance more productive; it’s a biased game, she argues;
- All economists develop a theory of value and determine what is productive and what is not (production boundary even if that phrase wasn’t always used)
- Mercantilists (Petty and King) argued that wealth is about gathering gold so run trade surplus;
- Physiocrats (Quesnay) argued wealth is about scarce land ownership; that is from where everything flows. This school of thought largely came from French agrarian society in comparison to rapidly industrializing England;
- Classic economics (Adam Smith, a Quesnay contemporary and friend) is symbolized by Smith’s pin factory in his classic Wealth of Nations and division of labor; labor theory of value (production rather than agrarian)
- Spain got a lot of gold but no more productive;
- Even more than Adam Smith, influential David Ricardo deemed government unproductive on his production boundary, without ever writing about the infrastructure, laws and other protections that setup productive behavior via government; this setup generations of future economists to do the same;
- Hegel’s dialectics: his thesis, antithesis and then synthesis influenced Marx;
- Class struggle by Marx is today called “tightness of the labor market”;
- Wages once tended to be at subsistence level, only enough to replenish labor (ie food/water/housing)
- Marx wrote about production capital vs commercial capital; he predicted over time the expansion of the commercial capital (Amazon platforms and banks)
- Production
- Commercial/circulation
- Interest bearing
- Rent seeking (monopoly on scare resource)
- Textile manufacturer Robert Owen was an example of early employee ownership as a response to socialist critiques;
- The 1850s rise of trade unionism globally in part trying to account for labor theory of value: if labor creates value why do capitalists hold all the money?;
- Thomas Aquinas (1225-1274) wrote of the “just price”, showing an old belief in such a thing;
- The Neoclassical economists (Alfred Marshall called their father) bring in the idea of utility, or marginal utility theory or the marginal revolution;
- In 1776 Englishman Jeremey Bentham argued that “the greatest happiness of the greatest number“ should be the “measure of right and wrong.” Now known as the Utilitarian philosophy;
- Robbins: economics is the allocation of resources under scarcity
- Neoclassical: “Price is a direct measure of value”, marginal utility and scarcity determine price (65)
- Classical economists Smith and Ricardo saw rent as semi-parasitic and unproductive, it was a monopoly that required government intervention; today’s price determines value model, there is no such thing as unearned income. With a price it has value.
- Only legal price would be considered productive; Distortions in market include monopolies;
- GDP can be calculated by production (all good and services produced), income (all income generated) or demand (all goods and services consumed including those in inventory). (77)
- Today GDP is “comprehensive boundary,” anything with a price gets in.
- Quesney’s first 18th century French national income really only included agriculture as everything else was seen as built off that; that approach was as obvious then as our plan to total everything with a price (accounting practices evolve, like GDP today via the UN System of National Accounts);
- Keynes’s 1940 How to Pay for the War radically changed government data and spending (82), the first time government spending was seen important way to influence growth (as opposed to just supporting market)
- GDP doesn’t capture government creation;
- In 2008, R&D was reclassified as productive changing GDP overnight (More here);
- Housework has not been included because there is no market price for this work, yet for homeowners there is a created assumed “rent” that goes into GDP;
- National accounts treat property as an investment (both house and commercial), assuming the owner goes on “servicing” the building and rent is “payment for a service.” The result is a housing bubble like 2006 showed accelerating GDP in part due to increasing “implicit rental income”;
- Yet much of house value improvements involve collective investments (ie roads, schools, zoning, legal protections, etc (94)
- SNA makes no distinction between profit and rents because its underlying theory is that everything that fetches a price creates value
- Banking does three things:
- Maturity transformation (time travel) — short term deposits into mortgages and biz loans;
- Liquidity — lines of credit and overdraft;
- Credit assessment — vetting loan worthiness;
- Since 1990s, banks have added direct fees alongside their indirect charge of interest rate gap (their borrowing costs vs what they offer (107);
- “If an intermediation service (like banks) becomes more efficient, it should absorb less of its clients output rather than more; it should make a smaller contribution to GDP the more efficient it gets.” (109)
- The Great Depression and then Bretton Woods system developed far more regulated financial industry after increasing growth of bank busts;
- After 2008, the Bank of England first clarified that “loans create deposits” rather than the opposite, noting that banks created money — banks that are subsidized by a too big to fail mindset (116)
- The Catholic Church banned interest in Middle Ages and in 1692, John Locke wrote bankers are merely middlemen “eating up a share of the grains of a tree rather than creating any grains themselves.” (117)
- Keynes: “if the capital development of a country becomes a byproduct of the activities of a casino, the job is likely to be likely to be ill done” (119);
- Adam Smith believed in a free market that required government intervention to remove rent seeking behavior;
- Economist William Baumol wrote about “unproductive entrepreneurship” and entrepreneurial allocation;
- In 1925, Winston Churchilll: I would “rather see finance less proud and industry more content.” A Comparison was made between bankers and pre-industrial landowners to industry and agricultural producers (unearned rentier income);
- American economist Hyman Minsky (1919-1996)
- FIRE (finance, insurance and real estate) became “productive” sectors in the late 20th century and defended itself with a tautology that confused price and value: these industries must be valuable because they’re paid so much;
- Post war savings boom developed asset managers as major actors (142);
- In the 1970s, the relaxation of the “prudent man” rules (those that stemmed from an 1830 court case) for pension funds meant they poured into private equity and venture capital (143) Employee Retirement security Act of 1974 among those examples;
- In 1850, 92 percent of U.S. equities were owned by individuals; that’s below 30% now; 25 fund managers own 60% of all U.S. equities;
- Finance extracts value in three ways: wedge (transactions); monopoly (banks) and high charges (fund management) (146);
- “Interest is the price of financial intermediation” 147
- From 1951 to 2015, the price of trading stock went way down and volumes went way up, net increasing the expense (155);
- In private equity, carried interest is only one-third of a general partner’s compensation (the 20 in the 2-20 comp package) (157)
- General Electric and Ford developed established financial arms, both making more on finance than their core businesses at points, that marked a peak;
- Buybacks boost earnings per share (by reducing number of shares) which helps executive pay but is at the expense of redeploying capital (164)
- Milton Friedman’s shareholder value essay spawned “agency theory” (166): agency theory noted that manager incentives should be aligned with shareholders through compensation but it has caused short termism
- Private equity companies followed MSValue principles to bring financing to non finance sectors;
- In the 1930s, Keynes warned of financial projections “a few months hence” rather than years or lifetime or value because professionals could watch close
- The Hurdle rate is the return on investment below which a company will not pursue an investment opportunity or project.
- If cost of capital is 8.5% and the median hurdle rate by S&P 500 is 18 percent, then there is a wide 10% margin required for projects to make sense — because of easier alternatives like share repurchases (176)
- Carlotta Perez writes that each of five revolutions (from steam engine to IT) were periods of financialization and inequality that rolled into bubbles and collapses;
- Schumpeter’s creative destruction and Baumol’s unproductive entrepreneurship
- “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.” (191)
- Monopoly network effects built on subsidized research, like US semiconductors research in the 1950s/60s, or their investments in the internet (which funded Xerox which led to Apple and Lisa graphical interface; DARPA research led to Siri, and the iPhone)
- Solow in 1987 won the Nobel Prize for showing technology responsible for 80% growth , and it is always built on many efforts before it (192)
- “Inventions are overwhelmingly the fruits of long-term investments that build on each other over years”;
- Two-thirds of the most innovative drugs trace research back to US NIH (194) Google’s original search algorithm funded by NSF grant;
- “The critical question here is: are their rewards proportionate to the risks they take?” On VC, arguing they’re often involved after foundational work was already laid by government;
- 1946: the American Research and Development Corporation (ARD) marks the beginning of VC market though it exploded in the 1980s (197);
- The “Silicon Valley” term was coined in 1971 but the foundation was already there: “The first formal VC firm in Silicon Valley – Draper Gaither and Anderson – was headed by two former US Army generals and the author of a secret report to President Eisenhower on how the US should respond to the USSR‘s launch of sputnik.” (198)
- In 1972, 3000 Sand Hill Road became heart of the nascent VC scene; pension funds later followed;
- “In the last century, patents, and associated tools like copyrights and trademarks, have gone from being devices to stimulate innovation to means of blocking it.” (202)
- Patent deal: you get a time-limited monopoly (appropriability function) in exchange for giving details of your invention that will be made public (disclosure function); ideally this risk-reward should be balanced for inventor and for public good;
- In 1990, Baumol: “at times, the entrepreneur may even lead a parasitical existence that is actually damaging to the economy,” Like patent trolls or finding rent-seeking behavior (206);
- Patents went upstream (knowledge and ideas not just products);
- Marx called it unproductive labor;
- Pharma moved from R&D justifying drug prices to value based model, since the R&D line just isn’t true (210) but If value based pricing was legitimate why is water so cheap and life saving drugs are so expensive?
- A classic example of first-mover advantage is the QWERTY keyboard: it was intentionally less efficient so typewriters would jam less. No need to have that now but everyone learned on that system so no one wants to change. Another is the internal combustion engine which caught on and folks went to that standard and too difficult to change off it (214)
- “Network externalities” is the phrase to describe why a telephone gets more valuable the more people have it;
- John Locke’s “just deserts” is an old phrase;
- American political scientist Herbert Simon (1916-2001): “If we are very generous with ourselves, I suppose we might claim that we “earned” as much as one fifth of it. The rest is patrimony associated with being a member of an enormously productive social system, which has accumulated a vast store of physical capital, and an even larger store of intellectual capital – including knowledge, skills, and organizational knowhow held by all of us – so that interaction with our equally talented fellow citizens rubs off on us both much of this knowledge and this generous allotment of unearned income.” (222)
- Critics remember Solyndra but forget Tesla, which got a similar loan (and paid it back);
- Fracking was developed with government funding;
- In his 1944 book The Great Transformation, Hungarian-American political economist Karl Polanyi argued that governments established market-friendly conditions. (More here);
- Why wasn’t Great Recession a story about how the private sector screwed up and public governments saved the economy, rather than vice versa? Because of a prevailing narrative that government is inherently unproductive;
- Deficits matter less than what they’re funding: long-run investments, like education, research, innovation and health, appear to offer faster economic growth;
- Adam Smith argues in Wealth of Nations the need of the states: military, judiciary and infrastructure (roads yes but we’d also consider education in that now);
- In contrast classical economist David Ricardo never much wrote about government, taking for granted those key roles Adam Smith gave the state (240);
- Marx: “ The executive of the modern state is nothing but a committee for managing the common affairs of the whole bourgeoisie”
- Keynes introduced the concept of “the spender of last resort”;
- Author’s primary argument: GDP rules are political not scientific, so it is a choice that government expenditures cannot create value (meaning, IMF research argues that, on average, government spending results in 1.5 times economic impact but only ever pure expenditures show in GDP, not value created)
- Noam Chomsky writes of standard method of privatization: defund it, say it doesn’t work and then turn it private. (“”That’s the standard technique of privatization: defund, make sure things don’t work, people get angry, you hand it over to private capital.”)
- The narrative of inefficient government is self fulfilling, she argues
- Entrepreneurship could be seen as “The fruit of a collective effort”;
- “Rather than a theory of value determining price, it is the theory of price that determines value.” 271
- Author argues the Patent Box is an example of legislation won over with innovation stories even though it is a tax throw at an already time-limited monopoly (patent), she argues;
- Cleaning up the environment adds to GDP where reducing it in the first place removes from GDP (274)
