Understanding National Accounts Second Edition

1. Value creation has been confused with value extraction in modern capitalism

The way the word 'value' is used in modern economics has made it easier for value-extracting activities to masquerade as value-creating activities.

Shift in economic theory. The marginalist revolution in economics during the late 19th century fundamentally changed how value is perceived. Instead of being determined by labor or production costs, value became subjectively defined by market prices. This shift allowed activities that generate high profits or market prices to be seen as value-creating, even if they do not contribute to real economic growth or societal well-being.

Consequences of confusion. This confusion has led to:

• Financialization of the economy
• Rising inequality
• Misallocation of resources
• Undervaluation of productive activities
• Overvaluation of extractive activities

The blurring of lines between value creation and extraction has made it difficult to distinguish between earned and unearned income, ultimately impacting how we measure economic progress and distribute rewards in society.

2. The financial sector's growth has led to increased value extraction

Rather than the financial conservatism that pension funds, mutual funds and insurance companies were supposed to bring, money manager capitalism has ushered in a new era of pervasive casino capitalism.

Financialization of the economy. The financial sector has grown dramatically since the 1970s, far outpacing the growth of the real economy. This expansion has been characterized by:

• Increased trading of financial instruments
• Growth of the asset management industry
• Rise of complex financial products
• Dominance of short-term thinking

Value extraction mechanisms. The financial sector extracts value through:

• High fees and charges
• Exploitation of information asymmetries
• Creation of speculative bubbles
• Privatization of gains and socialization of losses

This growth has led to a misallocation of resources, with talented individuals being drawn to finance rather than productive industries, and a focus on short-term profits over long-term value creation.

3. Shareholder value maximization has distorted corporate priorities

On the face of it, shareholder value is the dumbest idea in the world.

Origins and consequences. The concept of maximizing shareholder value emerged in the 1970s as a way to align management and shareholder interests. However, it has led to:

• Short-termism in corporate decision-making
• Increased share buybacks at the expense of investment
• Downward pressure on wages and working conditions
• Neglect of other stakeholders (employees, customers, communities)

Distorted incentives. The focus on shareholder value has created perverse incentives for executives, who are often compensated based on short-term stock performance. This has resulted in:

• Manipulation of financial metrics
• Underinvestment in research and development
• Excessive risk-taking
• Erosion of long-term competitiveness

The shareholder primacy model has contributed to rising inequality and a disconnect between stock market performance and the real economy.

4. Innovation is a collective process, not solely driven by individual entrepreneurs

Understanding both the role of the public sector in providing strategic finance, and the contribution of employees inside companies, means understanding that innovation is collective: the interactions between different people in different roles and sectors (private, public, third sectors) are a critical part of the process.

Collective nature of innovation. Innovation is often portrayed as the result of individual genius or entrepreneurial risk-taking. However, the reality is more complex:

• Public sector funding of basic research
• Educational institutions training skilled workers
• Infrastructural investments enabling technological progress
• Collaboration between firms, universities, and government agencies

Misattribution of credit. The myth of the lone innovator has led to:

• Undervaluation of public contributions to innovation
• Overcompensation of certain private sector actors
• Neglect of the broader innovation ecosystem
• Policies that fail to support the collective nature of innovation

Recognizing the collective nature of innovation is crucial for developing effective policies to promote technological progress and ensure that the rewards of innovation are fairly distributed.

5. The patent system has become a tool for value extraction rather than innovation

Patents are supposed to spread knowledge, by obliging holders to lay out their innovation for all to see … Instead, the system has created a parasitic ecology of trolls and defensive patent-holders, who aim to block innovation, or at least to stand in its way unless they can grab a share of the spoils.

Evolution of patent system. The patent system was originally designed to incentivize innovation by granting temporary monopolies to inventors. However, it has evolved to become a tool for value extraction:

• Expansion of patentable subject matter
• Extension of patent terms
• Strategic patenting to block competitors
• Rise of patent trolls

Negative consequences. The current patent system has led to:

• Inhibition of follow-on innovations
• Increased costs for new entrants
• Concentration of market power
• Misallocation of resources to legal battles rather than R&D

Reforming the patent system is crucial to restore its original purpose of promoting innovation and knowledge diffusion, rather than serving as a tool for rent extraction.

6. Government plays a crucial but undervalued role in value creation

Government has often been at its best when mission-oriented – precisely because, as President Kennedy said, it is hard.

Underappreciated contributions. Government plays a vital role in value creation through:

• Funding basic research
• Providing infrastructure
• Educating the workforce
• Setting regulatory frameworks
• Taking on high-risk, high-reward projects

Misconceptions about government. Prevailing narratives often portray government as:

• Inefficient and bureaucratic
• A drain on the private sector
• Incapable of innovation
• Best limited to fixing market failures

These misconceptions have led to policies that undermine government's capacity to create value, such as budget cuts, privatization, and outsourcing.

Recognizing and supporting government's role in value creation is essential for addressing major societal challenges and promoting long-term economic growth.

7. A new narrative of public value is needed to reshape economic thinking

Once the notion of public value is understood and accepted, reappraisals are urgently required – of the idea of public and private and of the nature of value itself.

Limitations of current thinking. The dominant economic narrative focuses on:

• Private sector as the primary creator of value
• Markets as the most efficient allocators of resources
• Government as a necessary evil or market fixer

New narrative of public value. A more balanced understanding of value creation should recognize:

• The collective nature of wealth creation
• The importance of public institutions in shaping markets
• The role of government in driving innovation and addressing societal challenges

Implications of new narrative. Adopting a public value perspective would lead to:

• More balanced public-private partnerships
• Investment in long-term, mission-oriented projects
• Fairer distribution of rewards from collective value creation
• Policies that promote sustainable and inclusive growth

Reshaping economic thinking around the concept of public value is crucial for addressing 21st-century challenges and creating a more equitable and sustainable economic system.

Last updated: November 12, 2024