Value overtakes price

In The Value of Everything by Mariana Mazzucato, Professor in Economics of Innovation and Public Value, University College, London, she firstquotes Oscar Wilde: “A cynic knows the price of everything but the value of nothing”

Her whole book then questions ‘where does value come from – what creates, extracts and destroys it?’

I am no economist, so much flew over my head, but even with diagonal-reading she made several interesting points

1. Banks/ Financial intermediaries:

  • Their revenue comes from the interest differential = the difference between lending and borrowing interest rates (+ more and more creative bank charges)
  • Usury = The charging of interest = A reward for taking the risk that you’ll never see your money again – the greater the risk, the higher the interest rate
  • Financial intermediaries connect buyers with sellers (borrowers with savers) and make their money by extracting (capturing) value from others who created it viz:
    • By inserting a wedge in the form of transaction costs between providers and receivers of finance
    • Via their monopoly power
    • With high charges relative to the risks they run, notably in fund management
  • They also claim to create (add) value by:
    • Oiling the wheels of industry
    • Being part of the process, not the end-point, in getting final goods and services to customers


2. Inequality of wealth:

  • Wealth = ∑ (Income + Profits + Rent)
  • Rent = Unearned income from existing assets e.g. patents, diamond controls, flats, oil wells
  • An Oxfam report found that:
    • In 2016, eight men own the same wealth as the poorest half of the world’s population
    • And that the club of the wealthiest 1% shrank from 388 members in 2010 to just 62 in 2015
  • So the very very rich are getting richer still relative to all others
  • Companies now maximise shareholder value to benefit a few shareholders and executives at the expense of their workforce and the population at large
  • People who create wealth are the poor relations to the people who extract it in modern capitalist societies
  • To maintain their living standards, workers (the relative poor) have had to shoulder an increasing debt burden from the 80s onwards – at the same time keeping up demand and so sales/ revenue/ profits


3. Undeserving v deserving:

  • A firm’s profits rely on the inputs of many people, within and without, past and present i.e. not senior management alone
  • They also rely on the state for vital inputs such as R&D, infrastructure and regulatory bodies
  • Much like a current salesforce must recognise its results today rely not just on their efforts alone but on the selling and marketing efforts of others in the past to build customer relationships, databases and brand names
  • So how is it that current workforces, along with capital investment in new machines and technology, say, create most of these profits but capitalists (senior management and shareholders) get most of the spoils?


4. Share buybacks:

  • Buybacks are now much in vogue – and have become a major weakness of capitalism
  • A company buys some of its shares from existing shareholders to benefit remaining shareholders and its management – this diverts profits from reinvestment and longer term productivity improvement
  • Buy-backs make a big difference to executive pay:
    • They reduce the number of shares issued – fewer shares in the same total asset value means a higher share price
    • This also boosts the EPS ratio, further increasing share value and the pace of EPS growth – both are factors used to determine executive rewards
    • And given many executives are rewarded with stock options, this represents a triple whammy for them at the expense of the rest of the workforce and society at large
  • According to William Lazonick, an American economist, during the period 2003 – 2012:
    • 449 firms in the S&P 500 deployed $2.4 trillion in buy-backs – 54% of their collective earnings
    • They also paid out 37% in dividends – to keep shareholders as well as their senior management happy
    • This left just 9% for capital re-investment – a vital driver of productivity improvement – and perhaps an inconvenient truth behind the ‘Productivity Puzzle’ thought to be infecting most developed capitalist economies


5. Productivity drivers – Innovation:

  • Professor Robert Solow won the Nobel prize for showing that 80% of economic growth is due to improvements in the use of technology
  • Most big innovations depend on the collective efforts of others, past and present – and many years of their research
  • Many are due to government investments in R&D yet they get no payback in direct rewards – only later, via extra taxes plus more/ better jobs
  • Inventions are thus, overwhelmingly, the fruits of long-term investments that build on each other over the years
  • For example:
    • Computers – clunky mainframes led to personal computers thanks to innovation in semi-conductors, much from government sponsored outfits
    • Xerox developed the GUI (Graphical User Interface) which Steve Jobs later used at Apple
    • The Internet’s html code was written by CERN, a European public laboratory
    • GPS was developed by the US Navy
    • Two thirds of the most innovative drugs trace their provenance to US public organisations
    • Some of the greatest advances in energy, from nuclear to solar to fracking to battery storage, trace back to the US Dept of Energy
  • Hence, Bill Gates (Microsoft) and Eric Schmidt (Google) both publicly recognise their major debt to public investment


6. Big Pharma’s value pricing of medicines:

  • Public investment also funds most major health innovations
  • Hence taxpayers are paying twice for them:
    • First for the research
    • Second for the premium that pharmaceutical companies charge for drugs that have cost them little to innovate and make
  • Big Pharma also enjoy increasing returns from patents whilst locking out competitors
  • Their prices of specialty drugs were once related to R&D and manufacturing costs, and the risks of failure to find anything new, but according to Mazzucato:
    • Their R&D costs are small compared to the profits made
    • They’re also much smaller than marketing costs – and what they spend on share buy-backs
    • Most major pharmaceutical innovation has come from publicly funded laboratories whilst private firms focus more on less risky ‘me too’ drugs i.e. slight variations on their existing products
  • However, to justify vast price hikes, Big Pharma now argue that their prices are proportionate to the intrinsic value of their drugs
  • According to John LaMattina, Vice President of Pfizer: “Pricing should be based on only one thing – the value that the drug brings to healthcare in terms of saving lives, mitigating pain and suffering, improving the quality of life of patients and reducing overall healthcare costs
  • Commenting on the world’s most expensive drug, Alexion’s Soliris ($440,000/ year/ patient) which is used to treat a rare form of anaemia and a rare kidney disorder, Mattina said: “Private insurers and national health agencies willingly pay for this drug. Why? Because the costs of caring for patients with these conditions can run into millions each year – so Soliris, even at its high price, actually saves the healthcare system money because it results in dramatic decreases in other healthcare system expenses generated by these patients”
  • The high price of specialty drugs is thus justified by how beneficial they are for patients and for society in general
  • So they now relate the price of a drug to the estimated costs that the disease would cause to society if not treated, or if treated with the second-best therapy – and not to their actual costs incurred
  • It’s a great formula for generating huge profits if you can get away with it – and many have to date
  • Step in NICE
  • NICE, the UK’s National Institute for Health and Care Excellence, was set up to slow this run-away train and calculate the value of drugs in terms of the number of quality-adjusted life years (QALY) gained from taking them:
    • One QALY = One year of perfect health
    • If health is less than perfect, QALYs accrue at less than one a year
    • Cost effectiveness is assessed by calculating how much per QALY a drug or treatment costs
    • It passes if less than £20,000 – £30,000 per QALY provided
    • This makes sense for allocating a national healthcare system’s finite budget
  • However, people’s lives are at stake here – and Big Pharma have monopoly rights over drugs that can make all the difference to some people in desperate need – so they can charge sky-high prices and enjoy ‘absurdly high’ profit margins
  • So, when NICE reject some drugs because of price, they are seen as effectively condemning some people to death – although the real culprits may be greedy Big Pharma firms
  • Clearly, a better approach is needed here
  • If value pricing was employed across the board, basic therapies or vaccines could cost a fortune
  • And what would the price of water be given its indispensable value to society?


7. GDP measurement:

  • GDP = Total value of goods and services produced by an economy
  • GDP can be measured as:
    • The total amount of products produced
    • The total amount demanded
    • The total income earned – a nation’s income is said to equal its expenditure (+ savings)
  • GDP is unclear about counting investments in future capacity e.g. R&D, care/ homework, illegal black market activities, resources destroyed by pollution (not a subtraction) but clearing up is added, or the financial sector
  • Over the years, economists have argued about what (productive) sectors and sub-sectors to include in GDP e.g. banks were once not included in GDP
  • Productive output is anything that fetches a (legal) price in the market
  • Hence the confusion, nowadays, over counting the value, not price, of offerings which are free
  • Quote – What we measure affects what we do; and if our measurements are flawed, decisions may be distorted” – Joseph Stiglitz et alia


8. My conclusions:

  • Mazzucato’s book seems to be mostly a history of past economists’ ideas and how their thinking has changed over time about what is a productive industry or not
  • It’s short on ways ahead, its final recommendation being that economists, and others, rethink where value comes from – what creates, extracts and destroys it
  • However, it offers a message which should concern all – capitalism has become seriously out of kilter at present – it’s wrongly skewed towards an undeserving few
  • Our politicians need to take rebalancing action, and quickly

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