UK academic says although profits have recovered post GFC, investment remains weak. The reason is 'neoliberal ideology' & its academic cousin 'public choice' theory

By Mariana Mazzucato*

After the 2008 global financial crisis, a consensus emerged that the public sector had a responsibility to intervene to bail out systemically important banks and stimulate economic growth.

But that consensus proved short-lived, and soon the public sector’s economic interventions came to be viewed as the main cause of the crisis, and thus needed to be reversed.

This turned out to be a grave mistake.

In Europe, in particular, governments were lambasted for their high debts, even though private debt, not public borrowing, caused the collapse. Many were instructed to introduce austerity, rather than to stimulate growth with counter-cyclical policies. Meanwhile, the state was expected to pursue financial-sector reforms, which, together with a revival of investment and industry, were supposed to restore competitiveness.

But too little financial reform actually took place, and in many countries, industry still has not gotten back on its feet. While profits have bounced back in many sectors, investment remains weak, owing to a combination of cash hoarding and increasing financialisation, with share buybacks – to boost stock prices and hence stock options – also at record highs.

The reason is simple: the much-maligned state was permitted to pursue only timid policy responses. This failure reflects the extent to which policy continues to be informed by ideology – specifically, neoliberalism, which advocates a minimal role for the state in the economy, and its academic cousin, “public choice” theory, which emphasises governments’ shortcomings – rather than historical experience.

Growth requires a well-functioning financial sector, in which long-term investments are rewarded over short-term plays. Yet, in Europe, a financial-transaction tax was introduced only in 2016, and so-called patient finance remains inadequate almost everywhere. As a result, the money that is injected into the economy through, say, monetary easing ends up back in the banks.

The predominance of short-term thinking reflects fundamental misunderstandings about the state’s proper economic role. Contrary to the post-crisis consensus, active strategic public-sector investment is critical to growth. That is why all the great technological revolutions – whether in medicine, computers, or energy – were made possible by the state acting as an investor of first resort.

Yet we continue to romanticise private actors in innovative industries, ignoring their dependence on the products of public investment. Elon Musk, for example, has not only received over $5 billion in subsidies from the US government; his companies, SpaceX and Tesla, have been built on the work of NASA and the Department of Energy, respectively.

The only way to revive our economies fully requires the public sector to reprise its pivotal role as a strategic, long-term, and mission-oriented investor. To that end, it is vital to debunk flawed narratives about how value and wealth are created.

The popular assumption is that the state facilitates wealth creation (and redistributes what is created), but does not actually create wealth. Business leaders, by contrast, are considered to be productive economic actors – a notion used by some to justify rising inequality. Because businesses’ (often risky) activities create wealth – and thus jobs – their leaders deserve higher incomes. Such assumptions also result in the wrong use of patents, which in recent decades have been blocking rather than incentivizing innovation, as patent-friendly courts have increasingly allowed them to be used too widely, privatising research tools rather than just the downstream outcomes.

If these assumptions were true, tax incentives would spur an increase in business investment. Instead, such incentives – such as the US corporate-tax cuts enacted in December 2017 – reduce government revenues, on balance, and help to fuel record-high profits for companies, while producing little private investment.

This should not be shocking. In 2011, the businessman Warren Buffett pointed out that capital gains taxes do not stop investors from making investments, nor do they undermine job creation. “A net of nearly 40 million jobs were added between 1980 and 2000,” he noted. “You know what’s happened since then: lower tax rates and far lower job creation.”

These experiences clash with the beliefs forged by the so-called Marginal Revolution in economic thought, when the classical labour theory of value was replaced by the modern, subjective value theory of market prices. In short, we assume that, as long as an organisation or activity fetches a price, it is generating value.

This reinforces the inequality-normalising notion that those who earn a lot must be creating a lot of value. It is why Goldman Sachs CEO Lloyd Blankfein had the audacity to declare in 2009, just a year after the crisis to which his own bank contributed, that his employees were among “the most productive in the world.” And it is also why pharmaceutical companies get away with using “value-based pricing” to justify astronomical drug-price hikes, even when the US government spends more than $32 billion annually on the high-risk links of the innovation chain that results in those drugs.

When value is determined not by specific metrics, but rather by the market mechanism of supply and demand, value becomes simply “in the eye of the beholder” and rents (unearned income) become confused with profits (earned income); inequality rises; and investment in the real economy falls. And when flawed ideological stances about how value is created in an economy shape policymaking, the result is measures that inadvertently reward short-termism and undermine innovation.

A decade after the crisis, the need to address enduring economic weaknesses remains. That means, first and foremost, admitting that value is determined collectively, by business, workers, strategic public institutions, and civil-society organisations. The way these various actors interact determines not just the rate of economic growth, but also whether growth is innovation-led, inclusive, and sustainable. It is only by recognising that policy must be as much about actively shaping and co-creating markets as it is about fixing them when things go wrong that we may bring this crisis to an end.


Mariana Mazzucato, a professor at University College in London, England, is the founder and director of the Institute for Innovation and Public Purpose and the author of The Value of Everything: Making and Taking in the Global Economy. Copyright: Project Syndicate, 2018, and published here with permission.

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16 Comments

"When Value is determined... by the market mechanism of supply and demand, Value becomes simply “in the eye of the beholder” and rents (unearned income) become confused with profits (earned income); inequality rises, and investment in the real economy falls.

Policy settings in NZ unequivocally favour risk-averse property purchases over investment in value-creating ideas.
For example, a person can tap into their retirement savings (Kiwisaver) when facing financial distress or to buy their first house. The pile of cash is inaccessible for someone who has a billion dollar idea in dire need of capital infusion. Until our government stops subsidising labour intensive enterprises with cost saving techniques and cheap imported skills, it will be hard to divert industries towards capital and knowledge intensive ventures.

So near, and yet so far.

So few who are trained in economics, get that growth is unsustainable. Even at PhD level.

But the jab a neo-liberalism is about right, although I don't think it's slowed down the rate of invention - just commandeered it for private gain.

Classic bit of Academic Verbose Long Winded Global English Speak. Is it virtue signalling? I really cannot tell.

Neoliberal theory came out of a university too. Chicago wasn't it? Boiled down to its essence, Mazzucato's argument is modern capitalism rewards value extraction instead of value creation. She points to the development of the internet and cutting edge drug research funded largely by taxpayer investment as examples of public value not accounted for in assessments of GDP.

This is an excellent comment. Finally some sense on the subject. In the New Zealand context, the lack of Government initiatives on key infrastructure development (particularly transport) has undermined productivity. No businessman in Auckland could deny this. Even if they were to take a more proactive role in easing some of the worst pressure points, the benefits would be appreciable.

Ignoring the fact that successive governments created the problem in the first place? Band aid solutions are all well and good, but if the cause is not remedied the problem just recurs, usually with more virulence.

They created the problems by following the neoliberal recipe book. It was the banks that failed in 2008 through their reckless behaviour. They were bailed out by the state, and now, through some twisted logic the state is being blamed for the crisis.

There was I thinking that Auckland's problems were caused by (a) Labour and National bringing in way more people than we had houses, roads, schools, and railways for; (b) Labour and National fawning obsequieously over any and all capital inflow such that far more capital than needed came in, result, loonie house prices and weak exporter profitability; and (c) rigid planning systems that seem well nigh impervious to reform, whether reasonable or otherwise. This is a disaster entirely of our own making, yes we listened to the fashionable ideas of the times, but we didn't have to.

I think Mr Orr was right when saying we needed to think more long term. Easier said than done, however.
If we could create a Council of Wisdom (or COW for short) advising government, local & national, then perhaps might change. I've often thought we discard our experienced people very quickly in our country. So, who would be on it? Only the wise of course. And who are they exactly? Well, that depends on where you're standing, but I would include expat Kiwis and other offshore smarts along with our own best of the best. They would/could advise & recommend on the longer term viewpoints & ideally be non-political.
In our game, the longer term is (finally) looking to set up shop for the next 10-15 years in our new premises & our thinking. But, to be honest, it's taken 20 years to get to this point.

Who creates value? (as determined by economics)
Anyone/thing who burns some gross energy.
Simple.

But how does burning through something create something?
Simple again.
It creates an "investment" ... something that will then help burn EVEN higher amounts of energy into the future. This way you can front load your investment burning with a promise called DEBT.
Someone owns this promise ... and becomes "Wealthy".

Sounds like an Energy burn Ponzi?
ah yes.

You are making the same error that a lot of people make, and are missing the point of the article and argument. Value is created when someone makes or provides something that someone else is prepared to pay for.

Question: if you make a widget that nobody wants, have you created value? I suggest not, but you have certainly “burnt some gross energy “.

This article is an important one to stimulate discussion that challenges the status quo. Many will not like it and argue against it because it threatens the bastions of their greed.

"Value is created when someone makes or provides something that someone else is prepared to pay for. "

Which says... anything you can flog has value.

"if you make a widget that nobody wants, have you created value? I suggest not, but you have certainly “burnt some gross energy “.

On the contrary - by creating that widget you provided "value"to the person who supplied you with the raw materials. He couldnt care less that you cant sell them.
If you educate a million tertiary students through student loans are you creating value? ... What if there isnt jobs for them or they dont use their training? Who cares ... as long as it provides debt and jobs in the meantime...

In your words, you are making the same mistake that a lot of people make .... the economic system doesnt care about value ... it only cares about MORE. Which is why demand must be artificially stimulated (through devaluing money) so that this absolute requirement is met. Otherwise debt tips over. So we must burn more gross energy.

And when money is devalued to nothing (ie when debt = equity = 0 interest) how are you going to define Value?

Value is just marketing spin.

Adding to my comment; many businesses price their products/services as if they are a monopoly. They don’t seem to price based on costs plus a reasonable margin, but appear to have an extortionate attitude.

The articles “price value” refers to this attitude. This is not a balanced market at work. These people are very good at justifying their position, and can be difficult to argue against. This is why I in the past, and this article argues for government regulation to manage and control markets.

Following on from Rogers comments above:

Yes, and the current tax review with its constrained scope & comments already that a capital gains tax would be politically too difficult & thus not likely to be recommended.

Even the inability of politicians to commit to raising the age at which superannuation starts & then aligning it with average age expectancy. Everyone knows its the right policy but there is no ability to get politicians to commit to it (kick the can down the road)

Orr is right to some degree (even though he has no mandate to be speaking on such matters - we do need a longer term view - politicians in a democracy need to be able to make the best long term choices for the public.

We somehow need a better mix of direct and representative democracy.

Ha, what is value? Is it the intrinsic value inherent in healthy food, clean air to breathe, clean water to drink, a healthy environment to live in, or is it the psychological value of convenience, appearing "wealthy", fitting in, feeling important, having more? Can any of it be measured in money?