This book is a sequel to Ethical Economics, published by Macmillan Press and St Martin’s Press in 1996, which investigated rational philosophical principles for economic activities and business behaviour. As a sequel it looks at the validity of these principles following the last financial crisis, but with the additional objective of taking a new look at how we define and measure economic value, and how the creation of value relates to business ethics. In this Introduction we set the scene for Value Economics by summarizing those principles for business we examined in Ethical Economics, and how they relate to some of the unanswered questions facing modern capitalism today. Finally, we describe the structure and contents of the book, and suggest how it can be read as a Compendium for new economic thinking. We have tried to write the book in a way which will engage the interest of businessmen, as well as economists, regulators, financial advisors and students of business in general.
One key theme of Value Economics is to take a new look at how we value the results of economic activity. The complexity of doing this is well expressed in a remark attributed to Einstein when he said: “Everything which can be counted does not necessarily count; everything that counts cannot necessarily be counted.” The relation between price and value remains a key issue for economics. In the words of Warren Buffett, “Price is what you pay: Value is what you get” a phrase which echoes Oscar Wilde’s famous definition of the cynic as “a man who knows the price of everything and the value of nothing”.
1.1 Rational Principles
It was the aim of Ethical Economics to think out the nature of business and economic activity from first principles, and to see how these relate to other forms of social interaction, and to draw fine distinctions about selfishness and self-interest, morality and values, cooperation and conflict, and rights and responsibilities, as they relate to business decision making. Our purpose was to gain a clearer appreciation of the nature of business, and to avoid the danger of identifying profit with selfishness, and prudence with immorality, so that those who are engaged in taking business decisions can work out for themselves the ethical considerations they should take into account when defining the policies which determine those decisions. The key conclusions to emerge from this investigation challenged those false images which see “Economic Man” solely as a self-interested profit maximizer with scant regard for the requisites of corporate social responsibility.
A key conclusion of Ethical Economics was that it is rational to see business as a “non-privative”, as opposed to a “privative”, activity, where the rational principles of business management are cooperation, not conflict, and service, not exploitation. It is rational to see business in terms of the Prisoner’s Dilemma as a “non-zero-sum game” activity, where we have to take into account the needs and interests of the other parties involved in a business transaction. The cardinal principle is one of “alteritas” (consideration of the “Other”), which supports the rationality of regarding business as a non-privative activity, where, by its very nature, we need to “empathize” with the interests and values of all those involved in that activity—shareholders as well as all the other stakeholders. Another important conclusion was to see money not as an inert amoral substance but rather as “encapsulated” freedom of choice, which allows “consumer preferences” to be realized in the multivarious world of market economics. Encapsulated choice is a prerequisite for economic freedom, but the exercise of that freedom has to take account of the moral imperative of “alteritas”, where the individual freedom of choice of the “other person” is the criterion for the organization of markets, but within the context of a “level playing field”, which assists, regulates and controls the freedom of market choice. The “alteritas” principle involves letting people “do as they like” but within the constraints of “what other people also want to do”, and the broader dictates of society where human welfare and well-being are the purpose and end (telos) of economic activity. The individual member of society is, as Aristotle put it, a social as well as a political animal, which means that the dictares of self-interest have to adjust to the self-interest of the other. How do we reconcile conflicts between two different “self-interests”?
The ends of economic activity have to be judged in terms of the economic justice they are achieving or impeding, and how successful they are in satisfying the needs of human welfare in removing the inequalities of wealth, poverty, health, discrimination and conflict. If business is to gain the respect of the general public for the legitimacy of what it is doing then the businessman, as “Economic Man”, has to demonstrate that he is a rational moral being, with a clearly defined and understood social role, and not just an economic manipulator of resources. Profit maximization is not irrational or immoral when it encompasses not only “shareholder return” but also the return for all stakeholders, which leads to the concept of “shared value” in economic affairs. The interest in looking at the rationality of economic activity in this way, and the moral issues involved, was widespread in the reactions to Ethical Economics, but, as a result of the last economic crisis, people were asking what we need to do to improve the institutional and self-regulatory controls of economic activity, and the procedures for conducting business in terms of the creation of economic value and the ethics of business in general. These procedures need to address the increasingly complex nature of risk management, and systems for the prediction and control of free markets, which take into account the normative (ought) aspects of economics, and the ethics of business behaviour in a global environment. As one graduate economics researcher from the European University Institute in Florence put it: “As economists we are mainly concerned with economic predictive modeling systems paying little or no attention to the ethical issues regarding economic activity.”
This kind of reaction, and our belief that in Ethical Economics we may have underplayed the importance of practical codes of business ethics in setting business objectives, has led us to reaffirm Keynes’s belief that economics is a moral, as well as a mathematical, science. Moral considerations inevitably play a part in business decision making, and a businessman should take responsibility for the ethical implications of what he is doing. Ethical codes are important, but of themselves they will not change behaviour unless they become part of the DNA of a business organization in terms of “this is how we do business”, which is clear to all those both within and outside a firm. We hoped that by discussing the rationality of business in terms of its ethical as well as its “profit” responsibilities, Ethical Economics may have contributed to strengthening the legitimacy of business in the eyes of the general public and society at large. The “healthy” sales of Ethical Economics indicate that we may indeed have succeeded to some extent in doing this. However, following the recent financial and economic crisis, and patent examples of malpractice in business, pace Enron, there has been a crisis of confidence and trust in business leadership, and indeed in the ability of the modern capitalist system to protect the interests of the “poorer” members of society in terms of employment and economic well-being. People have asked why the “experts” were unable to regulate and control the economic activities and debt levels of individual nation states within a global environment, which has been manifested in the boom and bust experiences that have occurred over the past twenty years. Why were the lending policies of individual national banking systems not controlled in allowing the risks involved in such things as subprime mortgages, which led to the solvency crisis of major financial institutions when, as Alan Greenspan said, “an infectious greed seemed to grip much of our business community”? And why was it possible for banking compensation systems to become so misaligned between the creation of short-term and long-term value?
As a result of these and similar questions, Value Economics seeks to take a new look at the way we measure and control the “economic value” which business is creating, and how the creation of wealth should be rewarded. What are the implications for “value” accounting and control, and for relating value to business ethics? Another of the purposes of Value Economics is to look at how we relate the creation of monetary wealth to economic value, and to propose that “economic value” become the basic metric for measuring business performance, and for evaluating the over- or undervaluing of market share prices in relation to economic value. As Alan Greenspan put it, “how do we know when irrational exuberance has unduly escalated asset values?” We propose that one way could be to have mechanisms which compare market share prices with the economic (or intrinsic) value of those shares. As there are many ways of defining value in economic terms, which Value Economics considers in detail, we propose that “economic value”, defined as operating profit after tax (NOPAT) less the cost of capital (COC), should become the first measure for establishing whether or not an economic enterprise is creating value. This has implications for economics as a moral, as well as a mathematical predictive science, since the concept of “value” has moral implications, which manifest themselves today in such things as the increasing inequalities now emerging in the distribution of incomes. New concepts of economic value are now emerging in the form of welfare and environmental economics, and “Triple Bottom Line Accounting,” which measures not only the profitability “value” of the traditional statutory accounts, but also the social and environmental “values” of economic activity.
Value Economics also proposes a number of philosophical principles for economics, which can be linked to “value creation” and codes of business ethics related to the specific functional job descriptions of any business organization. Every job has an impact on the creation of “economic value”, in terms of productivity, cost efficiency and departmental effectiveness and profitability. In this way the “value” of what each person is doing becomes the criterion for setting objectives and measuring performance, so that “value orientation” becomes part of a company’s business philosophy, and the creation of “economic value” the motivating force for economic and business decision making.
1.2 Modern Capitalism
Since 1996 the debate between two principal undercurrents of economic theory, Keynesian “aggregate demand” and Friedmanite “monetarism”, has continued leading in the aftermath of the last financial crisis to a dispute between the supporters of austerity or not, as the key for resolving the problems of the most recent economic crisis, and for achieving acceptable levels of public debt. But, as we said in 1996, the debate is between those who are primarily egalitarian in their desire to achieve a fairer distribution of wealth in reducing the economic inequality of incomes, and those who insist that the maximization of profits has to be the prime purpose of business in creating the economic wealth to be distributed, and that income differentials will and must always exist. But an unresolved problem for modern capitalism is how to reduce the increasing difference in compensation between the top and bottom levels of company remuneration, where the difference has now been estimated to be about 300 times—compared with 20 times in 1965. This economic discussion is further complicated by the different opinions of those who see public debt as a suffocating load on the private economy and those who see debt as an investment in the future. In the UK this became an argument between Gordon Brown, as Labour Chancellor of the Exchequer and then Prime Minister, whose plans for public investment, and rash claim that the days of boom and bust were over, were rudely shaken by the last global crisis (the reasons for which are set out in his book Beyond the Crash), and the Conservative Chancellor of the Exchequer, George Osborne, who accused Brown of being an irresponsible public debt creator, and who championed the cause of rigorous public debt reduction and a balanced budget. And in the USA economists like Paul Krugman are looking at public debt in another light where they believe that austerity is not the answer, since it penalizes above all the lower paid members of society in terms of unemployment.
The debate, however, suffers from a lack of analysis and definition of the economic values at stake, and particularly the economic value being created by public investment in social services such as the NHS, and what the expenditure on these services should be in relation to other commitments such as defence and overseas aid. This raises the need for the introduction of new economic thinking about the whole question of the appropriate relationship between the private and the public sectors, and the issue of how to reassess the “private good, public bad” mentality, which still remains a largely unresolved question for modern western capitalism. In most economic debates the word “value” is curiously absent, and even the Labour Shadow Chancellor in the UK, John McDonnell, in calling for an expansion of the Bank of England’s mandate from “inflation targeting” to include “growth, employment and earnings”, made no reference to the “economic value” of what all these factors should be creating and protecting. Modern capitalism is thus often being conducted without a thorough economic analysis of the costs and benefits of the private and public sectors where one side is singing the song of “private good and State bad”, and the other that of “State good and private selfish bad”. So, the debate risks becoming a populist ballgame, with each side trying to outplay the other, which makes a serious debate about issues like these difficult, if not impossible. For example, way back in 1968, the London Times (28 September 1968) had a leading article entitled “Spreading the Wealth” in which it proposed that “more of the nationalized industries should be denationalized by a general distribution of shares”, which raised indignation that “the State is a separate entity from its citizens and has no right to distribute its assets to its citizens, even if it is not argued that the State has no right to tax the citizens’ assets”. “Spreading the wealth” is just as lively an issue today as it was then, and is a subject which Value Economics considers in...