Cadmus

New Paradigm in the Service Economy The Search of Economics for Scientific Credibility: In between Hard and Soft Sciences

 

5. Value and Time in the Service Economy: The Notion of Utilization

5.1 The Product Cycle: from Raw Materials to Recycled Materials
The “life” of any product can be divided into five distinct phases: research, design and conception; production, involving a transformation of natural resources; distribution (transport and packaging, marketing and publicity); the useful life over a variable period of time (the utilization period); and the disposal of the discarded good (recycling or waste disposal). This whole process can be referred to as the Product-Life Factor.10

The fast replacement of goods has been a persistent trend in economic history, and has gained momentum in our fashion-based consumer society (the syndrome of bigger-better-faster new products), as economists have become preoccupied with production optimization, economy of scale and fast depreciation and replacement. The success of such industrial production has been measured in terms of flow at the Point-of-Sale (expressed for example in the GNP), while the notion of the use of a product over time, its utilization, has been largely neglected.

However, it is precisely this utilization period which is the main variable in wealth creation! Who determines the length of the utilization period?

5.2 Accounting for Value in the Service Economy
Measuring Value in the Industrial Revolution: The Monetarized Flow

We have attempted to show that price is the yardstick, the reference criterion, around which we organize a measurement system capable of quantifying economic phenomena and results within the framework of the industrial process.

Price is given by exchange and the money obtained from each transaction is then used to remunerate all those who have contributed to the production of that which is transacted, i.e. goods or services. Labour is paid wages or salaries, and capital (representing an accumulation of labour in terms of tools made available for production, e.g. plant, machinery, systems, knowledge levels and managerial capacity) receives interest. Each contribution to the various steps in transforming raw materials into usable products or functions represents a “value added”. Adam Smith built his notion of value on this idea of “value added” and considered it equivalent to the “exchange value”. Figure 2 summarizes these notions. However the notion of value added has not simply remained historically a basis for economic theory. In recent decades it has become a reference for the fiscal system through the introduction of value added taxes.

Figure 2: The classical economic concept of value in the industrial society:

The example of an automobile.

 

final-fig2-giarini

It is essential to understand that the measurement of value added in economics refers to the measurement of a flow. Although reference is made to the “selling price” (which could give the impression that it is the measurement of a result), the reference to the cost of the production factors is conceptually linked to the measurement of what contributes to the production of wealth, and not to the measurement of wealth itself. This can best be explained as a bathtub with two taps.§

Over recent decades we have seen the emergence of a new type of problem linked to environmental and ecological constraints, which strongly suggests that the monetarized flow does not always lead to additional wealth, for the monetarized flow contains a non-negligible element of pollution which does not add to, but destroys wealth. The measurement of growth as expressed in the Gross National Product is precisely and exclusively the measurement of such a monetarized flow at the macro-economic-national level. It excludes the standard accounting practice used by all industrial companies and individuals: an accounting of the total assets or stock available and total liabilities incurred (the Balance Sheet), of which an analysis of the flow of activity performed during a given period of time (the Statement of Income and Expenses) is an integral part. At the microeconomic level it is a matter of common knowledge and, indeed, of common sense that the differential in the total value of assets (e.g. stock) does not necessarily coincide with the volume of activity performed over a given period of time. The accounting of assets is a process which reveals an accumulation from an activity over a longer period of time, rather than simply indicating whether the monetarized flow over the same period has increased or decreased.

During the Classical Industrial Revolution it could be assumed that the amount of the monetarized flow largely corresponded to increases in the stock of wealth. In the Service Economy this is no longer true. The real level of wealth (i.e. the stock) depends also on non-monetarised contributions and deducted values. In the past too, value added coincided largely with the real utilization value and as such became the primary indicator of growth in wealth. But the notion of utilization value itself refers to the assets (stock) and the way they are used, in contrast to the notion of added value which refers to the flow of monetarized production.

The measurement of such stock can of course only be approximate and will be partly subjective. This means that decisions about what has value then become partly a matter for political consensus, similar to the estimated “goodwill” in a company’s Balance Sheet. The choice in future may well be between a system of flow measurement which is quantitatively precise but increasingly devoid of significance, and systems of asset measurement which might be less precise but will be more relevant to the real world. The quantification of non-monetarized wealth components can be achieved through adequate indicators. This is a crucial topic, as any method of asset accounting would also make possible a better definition of riches and poverty, and thus avoid the perpetuation of a higher level of wealth than officially recorded, for the non-monetarized contributions to the wealth of one country may be higher than those of another.

5.3 Old and New Shortcomings: Wealth and Riches, the Paradox of Relative Prices, Deducted Value, and Non-Accounted Value
Classical economists, and in particular Ricardo, were well aware of the methods for the accounting of economic wealth that they were devising were not really comprehensive of the real level of wealth of an individual or a country. A clear distinction was made between the notion of riches on the one hand and wealth on the other. There was even an implicit acceptance that there could be situations where an increase in wealth would not correspond to an increase in riches.

However, these considerations remain secondary because the main problem during the Industrial Revolution was to identify the most dynamic system for increasing the wealth of nations via the industrialization process, and to concentrate on its development. Discrepancies between wealth and riches could be considered of minor importance. The writings of classical economists and some of their later commentators were very much influenced by the fact that the first formulation of economic theory was a description of the industrialization process: the priority, which was quite adequate for this purpose, was to measure a flow of goods and the value added, whether supply or demand-based.

In the Service Economy, where the industrialization process per se is no longer identified as the prime mover in increasing the wealth of nations, the problem is quite different and the contradiction between wealth and riches much more important.

“The present accounting system is inadequate, even in the positive sense, for measuring many increases in real wealth.”

The divergence of the notion of riches from the notion of wealth corresponds to what can be called the development of deducted values in the modern economy. Increase in these deducted values stems from the increasing higher allocation of economic resources to activities which do not add to the real level of wealth (or of riches), but which are in fact absorbed by the rising costs of the functioning of the economic system.

Air and water pollution are obvious cases of diminishing real wealth (or of diminishing riches). If money is invested to depollute water or to develop alternative solutions such as bottled water, special reservoirs for drinking water, or swimming pools next to polluted seashores, we are once again confronted by “catch 22” situations where investments are necessary to compensate for riches lost through, for example, pollution: these investments are not net added value to our wealth!

The growing discrepancies between levels of wealth and riches (or the contradiction between economically accounted wealth and real wealth) clearly indicate the need to refer increasingly to stock, i.e. variations in real wealth, as a substitute for the measurement of productive flows (the bathtub example). Furthermore there is also a problem of matching real added values to deducted values. A new conceptual approach for measuring the real results will have to replace the simple analysis of the costs of an isolated activity.

The notion of deducted value implies the need to take into consideration the notion of negative value. In terms of economic analysis this is already a step in the right direction, given that in many cases the negative side of economic activities has simply remained unaccounted for. Diminishing increase in an economic situation has to be in fact distinguished from a net negative process. Measuring wealth through flows that do not fill a bathtub, or even worse, that are shut off, excludes the notion of negative flows. Only by looking at the stock can positive and negative variations be measured and a decision taken as to whether the flows produce values added or values deducted.

We should also bear in mind that the present accounting system is inadequate, even in the positive sense, for measuring many increases in real wealth. This phenomenon relates to certain paradoxes concerning the notion of relative prices.

Relative prices and the changes they undergo are one of the major indicators of whether a new technology or production system has really been effective in a given sector. When there is great progress in a new sector the cost of products not only diminishes per se, but their price, relative to other products on the market, also falls steeply. Thirty years ago, the price of a small calculator was the equivalent of 500 kilos of bread. It is now sometimes the equivalent of less than 1 kilo of bread. This means that, in terms of bread, the relative prices of pocket calculators have fallen sharply.

At the level of the individual, the substitution of a rare and expensive product (as, for instance, calculating machines fifty years ago) for a cheap product greatly increases one’s riches, but can diminish wealth. The fact that we can buy products today, such as pocket calculators which thirty or forty years ago we could not afford to buy for private use, is an indicator that, in real terms we are much richer today. But in terms of the monetarized wealth at our disposal, any person who could afford such a machine thirty or forty years ago was considered to be much richer than we are today, when we need little money to buy it.

At the macro-economic level, this phenomenon may be less contradictory. If, today, the price of pocket calculators is 1/10th of what it was twenty years ago, and if, instead of selling ten calculators thirty years ago, it is possible to sell 1,000 today, we have increased the sales value ten fold in terms of money. But the real wealth of people has increased much more: some of the revenues generated through the expansion of the pocket calculator market can be used for buying those goods which have remained expensive, i.e. the relative price of which has remained high.

In measuring our real wealth, merely knowing if and by how much the world has grown richer is by no means sufficient. While in some ways we have become poorer over the last twenty years because we must pay more for previously free goods or services such as uncontaminated drinking water or swimming in non-polluted water, we have, in other ways, become richer by having pocket calculators and video cassettes available for the equivalent of a few hours, or even minutes of salaried work. And we can afford to see high quality operas and plays that in Moliere’s day were reserved for Kings and Emperors.

Our attempts to measure the value added and to examine the mechanism of relative prices lead, therefore, in terms of evaluating increases in wealth, to conclusions that are much more complex than first expected. The easy way out is to measure the levels of real wealth available (its utilization value) with approximate indicators. The complication of “Industrial Revolution accounting” is nicely described by the paradox of hell and heaven, when applied to the notion of scarcity. Heaven, being probably blessed by an infinite stock of goods and services of all sorts (material and spiritual), knows nothing of scarcity. Economics and the economy therefore do not exist. There are no prices and there is no money since everything is readily available without any restriction or work. Heaven, then, must be something very different from earth, but it is also a place of zero GNP. Hell, as the opposite of heaven, is a place which consumes a lot of energy in maintaining its celebrated image and presumed activities. Therefore, it probably needs to develop a huge value added which nobody has ever tried to measure. GNP must be very high indeed!

On our earth, the maximum possible achievement in the fight against scarcity is to create abundance in as many sectors as possible. But human and economic development also entails identifying and coping with new scarcities. Scarcity is ultimately the hallmark of the system of disequilibrium within which human endeavour is destined to operate: it is the sine-qua-non of man’s quest for fulfilment.

5.4 The Bathtub Systems: Measuring Results through Indicators
One of the major paradoxes in value accounting and in defining the development of wealth is that an increase in real wealth corresponds in some cases merely to an increase in the cost of pollution control (e.g. investment for waste control and environmental purposes which is clearly a deducted value type of cost), while on the other hand, many real increases in value are underrated. For instance GNP growth figures published by governments each year indicate that the economy has grown by so many percent. However, a large part of this growth is in fact absorbed by factors which do not necessarily add to our wealth, while other factors that represent net increases in our well-being are not, or only inadequately taken into account.

Furthermore, the transition to an economic system and theory which go beyond the traditional notion of economic (added) value requires acceptance of a certain degree of uncertainty where measurements are concerned. This uncertainty stems from the fact that the very question of what wealth should be entails defining certain goals and expectations. The definition of a level of wealth is a function of time and history in evolution and, as such, a relative construct.

Another source of uncertainty in the notion of real wealth and welfare relates to the fact that many riches are conditioned by climatic conditions. Countries with cold climates will always need to develop more sophisticated heating systems than those with milder ones. In the former, more monetarized activities have to be developed in order to provide artificial, man-made sources of heat that can be stockpiled for winter. In milder areas heating involves less provision and less expense. But which type of country is the poorer and which the richer: those that have to spend a lot of money on heating or those which have no heating at all?

We should never forget the paradox of hell and heaven: less scarcity leads quite naturally to less economic monetarized wealth. However, where constraints are stronger, the stimulus to avoid hell in order to survive is probably greater. Many potentially poorer people have in the past become more industrious and richer than those who inhabited a more blessed environment. In all parts of the world this is as true for individuals as it is for nations. But it is a historical process and can be reversed. Furthermore, not all advantages are necessarily species-specific, for where life is exuberant and easy it is so not only for the human species, but possibly for competing biological beings such as viruses too.

This whole domain is hard to define. Indicators of whatever kind, of the level of wealth, health, happiness, knowledge and the availability of material tools and means, are all concepts affected by uncertainty and change. The notion of value added happens to be much simpler apparently and has the additional attraction of having been proposed and used as an instrument of universal management, as a standard that can be applied everywhere.

Is it not the wisest way to always start by using the simplest system in science as in other activities including economics?

The problem is that the universal validity of the concept of value added resides essentially in its use as a measurement of an industrial production process. The establishment of a sound statistical basis for the measurement of the stock of wealth and its variation by means of an appropriate range of indicators which may differ from one part of the world to the next (but which do not preclude a minimum level of homogeneity for purposes of comparison), are not necessarily more complicated than the measurement of value added. After all, there are already plenty of economic indicators in use which are periodically redefined, such as the consumer price indices that serve as a base for the determination of the level of inflation in many countries. These indices contain within themselves a number of well-weighted elements.

They are not, by definition, identical in all countries as they reflect the evolving structure of consumption. Why not define the real level of wealth or of riches in a similar way and allow the definition of wealth to vary much as the definition of the typical consumption pattern varies from one country to the next?

In the mature Service Economy this type of index might be politically more appealing, especially if it succeeds in closing the gap between measurements of GNP which do not reflect the reality of real wealth variations, and the perceptions of individuals, the “prosumers”, who already have practical experience of what it means to become richer in contemporary economic conditions.

There is a lot of work to be done to update “Economics”, and to better identify indicators and goals to define wealth and welfare policies.


‡ Source: Giarini, Dialogue on Wealth and Welfare.
§ For a detailed description see Orio Giarini and Garry Jacobs, “The Evolution of Wealth & Human Security: The Paradox of Value and Uncertainty,” Cadmus 1, no.3(2011): 29-59.
10. Walter R. Stahel, “The Product-Life Factor” in Susan Grinton Orr, An Inquiry into the Nature of Sustainable Societies: The Role of the Private Sector (The Woodlands: HARC, 1984)


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