In the 10 years since the global financial crisis, recovery in the United States has been uneven, marked by significant growth at one end of the economic spectrum and not so much at the other. Economist Mariana Mazzucato believes that imbalance is indicative of another crisis in the making, this one fueled in part through faulty methods used to measure economic performance. Mazzucato, professor in the Economics of Innovation and Public Value program at University College London, examines the roots of the problem in her new book, The Value of Everything: Making and Taking in the Global Economy. In order to build a better economy, she argues, we must find more accurate ways to measure value within it. Mazzucato, who is also the founder and director of the UCL Institute for Innovation and Public Purpose, spoke about the topic on the Knowledge at Wharton radio show on SiriusXM.
An edited transcript of the conversation follows.
Knowledge at Wharton: How much has this issue been enhanced because of what we saw a decade ago with the financial crisis and the recession?
Mariana Mazzucato: I think it’s key to remember that so many of the causes of the crisis, unfortunately, have not been remedied. We are brewing the next crisis. The previous one was caused by private debt, not public debt, and the ratio of private debt to disposable income is back at record levels. We haven’t reformed finance. We still have most of the financial sector really just financing itself. It’s what we call FIRE — finance, insurance and real estate – and this is why it continues to outpace the growth of the rest of the economy. We have an overly financialized business sector that is increasingly using profits not to fund actual activities like production, research and development, training for workers, but just purchasing back their own shares to boost stock prices and stock options, and — surprise, surprise — executive pay.
This is really problematic. The economy is still sick, and this is worrying 10 years after the crisis. What I try to do in the book is bring this back down to the fact that we have a problematic thermometer, if you want, if we talk about sickness. We don’t really understand how to measure value in the economy, so we don’t even realize how sick the economy is.
I bring that back down to the fact that, in modern economic theory, we’ve basically stopped debating value. Economics stopped talking about value and value went to business schools. I don’t want to dismiss business schools, but shareholder value, value chain, shared value, these are flimsy concepts. They’re not related back to what’s happening in production. What’s quite striking is that Adam Smith, David Ricardo, Karl Marx, even the physiocrats before them, their understanding of value came back down to objective conditions of the division of labor, how machinery was affecting wages, including the profit/wage relationship — which, by the way, is at record levels. Investment is down, but profits are up. And currently in economics, we don’t even use the word value; we just call it Econ 101. And we allow prices to determine value.
What we include in gross domestic product is things that are priced. This is why if you marry your cleaner, GDP will go down because all of the sudden something that was being done and paid for no longer is paid for, but it’s still being done. I also argue that a key issue is what we’re including in GDP because we’ve confused what is value creation vs. value extraction — we’re confusing rents with profits. This whole concept of rents as value extraction is what I try to unpick. I do it sector by sector, not just in finance but also the pharmaceutical industry and the innovation economy.
“We are brewing the next crisis.”
Knowledge at Wharton: Do you think the next recession could be worse because we have lost this understanding of value?
Mazzucato: Absolutely. A huge difference with the previous financial crisis is the wave of populism. Imagine the previous financial crisis with the kinds of governments we currently have all over Europe. These are semi-fascist governments. I’m Italian, and the current government in Italy is extremely problematic in how it’s thinking about immigrants. We all know what’s also happening in the U.S. We might not want to comment so explicitly on that, but imagine a financial crisis with the level of fear that has been instilled in people in terms of this lack of solidarity between human beings that we’re seeing.
In that sense, I think it’s really important actually for even economists to be talking about this because we tend to shy away from these more political areas. But a financial crisis with the kinds of super conservative and fearful governments that we’re seeing pop up everywhere with this wave of populism could bring us back to an era that we should all remember very well in the 1930s.
Knowledge at Wharton: How does value extraction enhance the economic divide we’re seeing in the United States and other locations?
Mazzucato: The whole 1%-99% dilemma in terms of inequality has been fueled by this confusion. Let me give you some examples. I don’t know if you’re familiar with Thomas Piketty’s great work on inequality, but he also looks at particular changes in tax regimes that fueled inequality. He singles out things like low capital gains tax. There’s no reason for that tax to be very low because it’s basically a tax on quick trades. What we want to be doing is nurturing long term-ism in the economy. We know that innovation, a key driver of growth, requires that kind of long term-ism. Yet it was the National Venture Capital Association which, at the end of the 1970s, lobbied government to reduce capital gains by 50%. That’s what they achieved — a 50% reduction in just four years in the name of innovation. In the name of value creation, they lobbied for a regressive tax, about which people like Warren Buffett very honestly said, “Why did you do that? I don’t even look at capital gains. I invest when there’s an opportunity.” But that also reduced government revenues, so cuts had to be done elsewhere.
We have all sorts of problematic tax policies, like the patent box policy that reduces taxes on revenues earned on patents, which makes no sense because patents are already monopolies for 20 years. There’s no reason that a policymaker should have to reduce the taxation on monopoly profits. Again, that reduces revenue in governments, which then feel like they have to make cuts elsewhere.
The whole maximization of shareholder value is based on this false assumption and problematic notion of value, which doesn’t really understand the kind of stakeholder-driven value creation process. Public funds have fueled growth in some of the most innovative industries. We shouldn’t forget that everything that makes our smartphones smart was publicly financed. The internet. GPS. Touch screen display. Siri. Even Tesla received early stage financing from the government. Fracking received massive amounts of government finance, regardless of what one thinks about that. So, value in the economy is absolutely, collectively co-created. Instead, this whole notion of maximizing shareholder value ends up rewarding a very narrow group of people in the economy.
Knowledge at Wharton: This goes back to the pricing example of the EpiPen or Martin Shkreli, who increased the price of an anti-parasitic drug by 5,500%.
“We don’t really understand how to measure value in the economy, so we don’t even realize how sick the economy is.”
Mazzucato: Absolutely. In the book, I begin with a similar astounding statement by Lloyd Blankfein, the CEO of Goldman Sachs, who said, “Goldman Sachs workers are the most productive in the world.” He said that in 2009, one year after the crisis. We all know how much Goldman Sachs and other large investment banks took massive risks, hid those risks in terms of how they were spliced and packaged. That was absolutely one of massive causes of the crisis, and yet just one year later with a straight face he says that.
The reason he was able to say that was because how we measure value, and hence productivity, is by prices. The prices of Goldman Sachs workers are extremely high. They are earning very high salaries. But it becomes a tautology. “Look at me, I earn so much. I must be valuable. Hence, I must earn very much.” It just becomes a circular reasoning.
The opposite happens with government because we don’t measure government value. So many of the goods it produces are free. At least in civilized countries, we have free health care. In the U.S., think of public education, public infrastructure — lots of it we’re not explicitly paying for. That doesn’t go into GDP, but the costs of building it do. The salaries of teachers go into GDP, but the value produced by high-quality public education doesn’t. Without making any normative judgment, it’s impossible to show the productivity of government institutions because we’re not able to do what Lloyd Blankfein did, which was to look at the costs of the output.
Knowledge at Wharton: You’re based in London. What are the differences between the United States and Europe in this context?
Mazzucato: Europe is very different from one country to another. London has tried to, not always as successfully, copy the U.S. model. I call that the Anglo-Saxon maximization of shareholder value model. It’s a model where the banking system has divorced itself from financing real stuff, again financing itself.
“This whole notion of maximizing shareholder value ends up rewarding a very narrow group of people in the economy.”
What does differ between the two countries is the welfare state. Even though one could argue it’s being a bit dismantled over the last 10 years in the U.K., it still does exist. Europe has decided collectively that this is what tax revenue is for, and it’s actually better to pay your taxes in order to live in a functional society where everyone is taken care of. On top of that, there are incentives. It’s not as if it’s socialism.
In Scandinavia, there’s an experiment with something that I think is very respectable, which we don’t have in the U.K.: this whole issue of corporate governance, which is much more collective. Trade-union representatives are on the boards of companies. They decide together how to think about future opportunities of the company, how to invest in new areas. If workers have to sacrifice for a period of time, that is in exchange for something — for example, increased training programs that make them more adaptable to future technology. Unfortunately, we do not have that in the U.S. or really in the U.K.
Knowledge at Wharton: How do you see us starting to turn the corner in this?
Mazzucato: What’s absolutely astounding with these public investments is that they are also taking on huge risks. One way to get people to better understand what they’re also getting from them is for the government to do the second step, which is not just to finance the internet. Google’s algorithm was financed by the public-sector National Science Foundation. Most of the big renewable energy wave is also being fueled by international public bodies. The government needs to see itself as an investor and get some portfolio thinking as the VC industry has.
Solyndra [a solar panel startup that received, and later defaulted on, a loan guaranteed by the U.S. government] was a $500 million public taxpayer funded failure. Both Solyndra and Tesla were financed with about the same amount of money. Tesla received a $465 million granted loan. People were right to get quite angry with what happened with Solyndra. But what Obama said to Tesla was, “If you don’t pay back the loan, we get three million shares in your company.” Why would you want three million shares in a company that doesn’t pay back its loan because it’s not doing too well? [He could have] said the opposite: “We’re making this high-risk investment. We know that for every success there will be inevitable failures. We will take out some shares if you are successful.” The price per share went from $9 to $90 between 2009 and 2013 for Tesla. Multiply that by the three million he wanted to take out. That would have more than paid for the Solyndra failure and the next round of investments.
“Innovation thrives through feedback effects, experimentation, serendipity. The search for one thing leads to the discovery of another.”
Knowledge at Wharton: You talk about the idea of experimentation and that you need a failure in the process if it is taking you down the path of finding success, correct?
Mazzucato: Absolutely. This is also what we must learn from the Soviet system. The top-down model doesn’t work. You want to both be setting some public bold missions — the moonshot example, which I think is really useful because getting to the moon required lots of different sectors. It was lots of bottom-up experimentation in which many of these projects failed. There must be a willingness to take risks in public and private institutions in order to achieve a really bold goal.
Government instruments should be used to nurture that bottom-up experimentation. On the one hand, we need top-down, big thinking — moonshots around renewable energy, around the future of health care, the aging crisis, etc. — but it cannot be a top-down process. Innovation thrives through feedback effects, experimentation, serendipity. The search for one thing leads to the discovery of another.
Knowledge at Wharton: You touched on the issues surrounding skyrocketing executive pay. Can you talk more about that?
Mazzucato: That’s exactly the point that I think is really critical and I was trying to make before, which is this notion of maximization of shareholder value, which then justifies areas like the share buy backs, which do boost executive pay. Don’t forget that pay is mainly linked now to stock options and founded on a false premise that shareholders are the only ones who don’t have a guaranteed rate of return. If you look at Michael Jensen’s work in the 1980s, there’s this concept of the residual claimant — that shareholders are risking the most because everyone else in the economy has some sort of guaranteed rate. They don’t. They only get the residual, what’s left over in the end. They’re taking huge risks, so they should be getting the biggest share of the booty at the end if there is that residual. And this is just all false. There’s no guaranteed rate of return for a government. For every success, like the internet, there are many failures. For every Tesla, there are many Solyndras. We can’t just talk about it as unfair or that bonuses have to be kept in check. We have to debunk these false assumptions on top of which it’s based.
