Thanks to Blogger and the Twitterverse, I’ve been talking recently with Tony Wang of Philosopher 2.0 about the nature of value creation in society. In addition to trading some emails and other online communication, we had in the past couple of weeks what I told him were the two most intellectually challenging conversations I’ve had all year, each of which lasted well past an hour on the phone. One of these conversations was mostly spent working out a brain wrinkle I’ve been having with economics, which has direct bearing on all of the work we do in the creative economy: how does value actually get created? I don’t mean this from the perspective of an individual actor – obviously, if I sell something at a profit, I create value for me. Rather, I’m talking about creating value inside the whole system. As in, how does worldwide economic growth actually happen? What simple, day-to-day actions of actual people translate directly into money being there that didn’t exist before? You would think this would be a simple question to answer, maybe even, you know, the first one that gets addressed in an economics class. But I’ve tried asking a number of people who have studied economics seriously or do it for a living, and everyone tells me something a little different – if they try to answer the question at all.

One economist told me that the creation of value basically boils down to work. So, if you put people to work who weren’t working before (like women in the past century, for example), you create a whole lot of value. Furthermore, if something happens to make more work possible in the same amount of time (like an improvement in technology), value creation can happen that way too. But where does the money come from to pay for this increased value? Think about it like this. Let’s say that there’s a mini-world with a population of six people. They all have their own farms and so they get the food they need to live on that way, and let’s say they all have a small amount of money to spend. Three of them make jewelry in their spare time and three of them make baskets. It turns out that the people who don’t make jewelry would like jewelry, and likewise with the baskets. So the people who make jewelry sell stuff to the people who make baskets, and vice versa, and everybody’s happy.

I did this little thought exercise on my own, and it turns out that no matter what changes you make to the system (i.e., someone has a child who starts working, someone magically gets a jewelry factory and starts selling more jewelry, someone introduces a new product, etc.), the total money supply never changes. It just gets shifted around to different people. The only things that will make the money supply increase are if (a) people get together and decide to print up more money (which just means each individual unit of money is worth less) or (b) one person decides to loan someone else their money on the expectation that they’ll get paid back with future money. In the latter case, the loan gets counted as an asset even as the actual cash gets transferred to someone else, so it’s double-counted in a way. This, as it turns out, is one of the primary means of money creation in the real world. But I’m not quite sure I understand how one can lend money out on the expectation that more is going to come in when there isn’t really an alternative way of creating “more” in the first place.

As it turned out, my conversation with Tony helped clarify my thinking around the problem. It turns out that the money supply issue is a bit of a red herring in my example. There are actually at least three different measures of economic wealth one can talk about. One is cash itself, which we’ve been discussing. But cash is really just a technology – a shorthand we use to make trade easier. Another, larger, measure is the total value of all of the financial assets on the balance sheets of every company and individual in the world. Anyone who’s studied accounting knows that cash makes up only a small portion of these assets; they also include the book value of things like real estate, equipment, durable goods, investments, and yes, money you’ve lent to other people. Finally, the largest of all is GDP, which measures the value of the total transactions in an economy. So in other words, when people trade on Wall Street like maniacs, total GDP goes up even if nothing is happening to the fundamentals of the underlying companies. An increase in the velocity of money – the frequency at which transactions happen – will increase GDP even if the money supply itself doesn’t increase.

Of these three, I’m most interested in what makes the total value of assets increase, besides just pumping out new loans and/or inflating the money supply. I’m starting to gather that the answer is nothing – but that that’s potentially okay. It’s potentially okay because we can create new value even if we don’t create more money. They are two separate concepts. In my little six-person world above, if somebody invents a machine to produce more food than people had previously been eating, and people’s appetite for food had not already been sated, that person has created new value. Everyone can eat more than they did before, and so quality of life has improved. But since the money supply hasn’t increased, everyone’s dollar buys more food (and more happiness/utility) than it did before. The dollar is actually more valuable than it used to be. So to bring things back into equilibrium, it makes sense in a way to increase the money supply. It’s the only way that we can keep the relationship of currency to value at a somewhat constant rate. So if we can rely on this continuing to happen in the future, it’s okay to lend to others on the expectation that future money will be created out of nothing, as long as we don’t overestimate the rate of value creation in society.

This, however, leaves unanswered the question of what we mean by “value.” Since we’re not, in fact, talking about money, what is it? And what makes more of it possible? Is it technology alone? New workers? Education? Some combination of all of the above and more? I’m leaning towards the last option, but I’m still working on it. If you’re an econ whiz and this is all review to you, a) I apologize for boring the hell out of you and b) please share your wisdom with us in the comments.

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  • -will

    I'm not an economist [Lord knows!], but if you're talking about creating value in the arts, this might interest you.
    This is a welcoming address given by Karl Paulnack to the incoming freshmen [and their parents] at Boston Conservatory.

    In it, he describes the deep resonance of music in the human psyche as the primary purpose of the arts, and music particularly. You might [probably will] differ in particulars, but point being that the arts create value by helping us learn more about what it means to be human.

    http://www.symphonymusicians.com/WelcomeAddressbyKarlPaulnack/tabid/87/Default.aspx

  • Josh Futrell

    I think that "value" is result of the human energy and creativity to manipulate raw materials and create utility where there was none before.

    Let’s say that I am a farmer in the example above who transforms the land to grow crops, which then provide value to them in the form of food. If I did not do so, my family and I would risk starvation or have no commodity to trade for other goods and services. So, through our work, we are adding value to own lives and, as a result, to the society as a whole. This is on a purely substantive level.

    Then, because my family and I have a desire for goods and services beyond the bare minimum to support life, we work to produce more or different goods to exchange for these amenities through hard work or new ideas.

    I would say that this is how individuals traditionally add value.

    Now, let's say that I am a farmer who would like to have baskets around my farm for utilitarian purposes. I do not need them, but having them would help improve my quality of life. I calculate the value of this product by doing some on-the-fly calculations: I would be able to carry X quantity more potatoes and this would save me Y amount of time; my time is worth Z, so the value or utility of the basket to me is some function based on these things. If its price is such that it is equal to or lower than this value, and I have a surplus of goods based on my basic needs, I would offer a trade. If the basket maker sees value in my offered trade (be it food or jewelry), they accept. Value is then created for both.

    Though a simplified example, I would say that this is how companies traditionally add value.

    However, if the price of the basket is too high, or the quality of the good is low, I might consider making my own basket, finding another solution, or keeping things as they are.

    Finally, let's say that I am a farmer who admires the jewelry made by my counterparts. I see value in it because of the way it looks and the way it makes me feel when I see it, wear it, or give it as a gift. Further, let's say that I cannot make this jewelry on my own: either I do not have the innate skill necessary to create an object that elicits the same utility or the effort/energy to acquire the skills and tools to make such an object greatly outweighs the price the other farmer is asking in trade. I offer a trade and if the basket maker sees value in my offered trade (be it food or a basket), they accept. Value is then created for both.

    This is how the artist traditionally adds value.

    However, if the price of the jewelry is such that it outweighs the value of the emotional response I would anticipate and/or I perceive that I would get more value from equivalently priced utilitarian goods, I might consider not trading for the jewelry.

    I think that the bottom line is that it is the exertions that we, as human beings, make improve our lives and welfare beyond the bare minimum needed to sustain life that create value. We do this by 1) making a living by exchanging our effort, time, and knowledge for goods or money, 2) purchasing goods or services that have utilitarian purposes or creating entities that provide them, and 3) purchasing goods or services that have emotional/artistic value or developing the skills needed to provide them.

  • Ian David Moss

    Thanks, Josh, this is great. I realize now that I was a little imprecise at the end of my post. You've basically said that value = utility, whether utility in the sense of efficiency (i.e., I can be more productive with the time saved from my basket), or a psychic utility like happiness. OK, I agree with you. The bigger question for me, though, is the second one: what makes more of it (value/utility) possible? We've identified a couple of examples already. Baskets are a technology. It improves productivity, which means that I can do more work in the same amount of time. That increases value, assuming there's a market for the additional work. (But what if there isn't? Does that make the technology useless? I guess so–until someone else adds value by building off of it to make something that people will use.) Jewelry is a new product. There's no direct productive use for it, but it makes the customer happy. It makes the customer happy, presumably, in a way that wasn't possible before. So we have created value. But what if the farmer doesn't like the jewelry, and therefore it goes unsold (=0 value), but then 30 years later after the jeweler's dead, the farmer's son discovers it in his abandoned house and wants to keep it? Does the jewelry suddenly gain value simply because now there's a customer for it? But how would we know, since there was no transaction to record how people valued things?

    You can start to see, maybe, where I'm going with this. The trouble with the arts and economics has to do with the fact that so many artists create things that are valuable without either accepting or having the means to maximize value in return. Real estate developers get rich off of artists' free or very low-cost labors. Later generations derive more value from Mozart's works than Mozart ever did. The deeper I dig, the more it seems to me that value creation is a slippery, slippery concept, subject to accidents of history and circumstance. It's incumbent upon people who seek to create value for society through philanthropy, policy development, business or other means to seek to understand in very exact terms (not hyperabstracted macroeconomic shorthand) the mechanisms by which that happens.

    • Andy Bruck

      I am a musician, not an economist, but wanted to share a thought. One dimension on the issue of the fluctuation of value an object seems to be maturity, either of the object or of the person that is relating to it. In the case of certain things, such as fine violins or other works of art, or wine, monetary value generally increases with time as the objects mature in quality. Also, an individual may learn to appreciate and value an object that at an earlier point in his or her life was not of interest. Education therefore plays a role as well, because being informed increases our ability to discern the value of something. Therefore, by informing the student, the educator sparks a change in perception that results in increased value. I plan to share additional thoughts about the importance of education in value creation. I think in the case of an object that is out of circulation or lost, its value remains doemant as a potential upon its rediscovery of reuse. I think of the J.S. Bach solo violin sonatas, which were discovered in a stack of papers slated to be used to wrap butter, yet today, hundreds of years later, are enjoyed by violinists and audiences.

  • Scott Walters

    The problem with equating value with money is that there are a lot of things of value that subtract from the GDP, and a lot of things that lack value that add to it. So for instance, a happy marriage adds nothing to the GDP, but a divorce generates all kinds of income through lawyer fees, one spouse moving out and into an apartment, etc. Same with health: good health adds nothing monetarily, but poor health makes all kinds of people money. As far as the arts are concerned, perhaps Lewis Hyde book on the gift economy has more to say about the arts than an economics approach. Perhaps by defining the arts in terms of a transaction — a product purchased by a consumer — we have poisoned the creative wellspring.

  • Kristine Maltrud

    Great food for thought (now how do we measure THAT value?). Ditto on "The Gift" by Lewis Hyde – and his subsequent thoughts on technology, intellectual property, etc. Measuring the value of creativity, of art, mainly in terms of economic gain within a community (i.e., artist jobs, tourism, increased revenue for adjacent businesses) is, for better or for worse, the road the arts in America has gone down re: value creation. There's so much more to add to the equation, though, and we need a rounder, fuller view of our "arts economy" to really demonstrate some of what you're describing in terms of social value.

  • Will

    I'm with Scott here. Yes, yes, I know the point of this posting is to look at issues in public [and private] policy around funding the arts.
    But you're really treading a fine line when you end up creating a reductive definition for the creative process that depends on defining it in purely monetary or quantitative terms.
    Where is the human element, then? How do you monetize the pure joy of artistic creation which is, after all, the initial impulse for many [not all, for sure] artists? How do you quantify the subjective responses to this-or-that painting, sculpture, sonata or sonnet? By the highest bid in the artistic marketplace?
    I know I'm being a purist here, but I just think it's important not to lose sight of the essentials in the search for the common denominator.

  • Scott Walters

    But let me also state that the key, to my mind, is achieving a balance. Too many artists see the whole damn thing in terms of some airy-fairy idea, while at the same time getting PO's that they're not making enough dough to pay the bills. The key is to hold both the monetized and the spiritual elements in a dynamic relation.

  • Ian David Moss

    I need to make something clear, which is that I am most definitely not trying to cram all possible definitions of value into one, quantitatively measurable concept. The full integration of art into an economic framework for measuring things' worth is an order of magnitude more difficult than the simple question that I'm trying to answer now: which is: how does growth as measured in economic value take place on a micro level? Once I/we have figured out the answer to that question, we can start to talk intelligently about the economic contribution that the arts make to society. That, obviously, is only one of the many benefits that the arts provide, but it's one that gets talked about a lot and I feel that if we're going to talk about it, we should really understand it. Just saying that the arts represent $166.2 billion in direct and indirect spending in this country, to quote the oft-cited figure from Americans for the Arts for example, doesn't really tell me anything about their real economic contribution, because one can assume that, in the absence of art, most all of the people who spent money or time on arts activities would have spent that money or time on something else. It's quite possible that many of them, in fact, would have spent their time on more lucrative activities and enhanced GDP.

    A lot of conservatives would stop there and conclude from this that the arts' economic contribution is negligible, if not actually negative. But here's the thing: I'm trying to develop here, out in the open with you, an alternative way of thinking about how value gets created. Scott is right: GDP misses a lot of things, things that are relevant not only for general human happiness but even for economic value as we traditionally think about it. This is because the philosophy economics has taken since the 1930s is that, since we can't measure people's preferences directly, we'll measure people's transaction choices instead, and assume that they are basically one and the same. Therefore, economics conflates value with transactions. But this has all sorts of holes in it, even leaving aside non-economic considerations. For example, as Tony and I discussed during our conversation, if Google traded in crack instead of search engine technology, it's quite possible that it would be just as profitable as it is today, but its contribution to other people's productivity (and therefore economic potential) would be greatly reduced. Similarly, open-source software developers are a clear case of people creating things of tremendous economic value without any transactions to record it.

    Even if we can just nail down artists' real economic contributions (or lack thereof), it will be a tremendous move forward. To do that, we have to recognize that economic value is more than just recorded transactions, and go from there. What makes it possible for people to be more productive? Let's start with that and see where it takes us.

  • Kristine Maltrud

    ahhhh… to have an open discussion about the economic contribution of the arts. Tough but worthy. I think that "recorded transactions" of people who, for example, support the arts, who attend performances, go to galleries to view (and possibly buy) art, is actually indicative of their preferences and also their personal values. These are real choices, partly because there is inherent value even when there is no recordable exchange of dollars. The argument that if there was no art people would spend their money elsewhere doesn't hold much water in my opinion because the presence of art and artists is a given in our culture. One big question is the economic contribution of artists vs. the economic contribution of arts institutions and arts organizations as there are many artists out there making art on their own. Perhaps if we looked more specifically at artists, the economic contribution would be greater (in addition to the contribution of arts orgs, etc.).

  • Jason

    Can I assume that your original question Ian, is to determine where value comes from in order to consider how best to manipulate and distribute it to meet the needs of the most people? Because I've wondered the same thing myself. If there is a fixed amount of value in the world, then we're just shuffling it around, right? But if we can create new value all the time, just by getting out of bed and putting some effort into something, then that's a harder tornado to lasso. I think that after reading your post, I am prepared to say that individuals can create value and that you have a point when you say that the ticket is to increase money supply in accordance with new value coming into existence (though, I don't know why we wouldn't just leave the money supply alone and let everyone's dollars become more powerful. Okay, I do know. DEFLATION, right? Sigh…)

  • Ian David Moss

    Jason,
    These are great questions and go to the heart of what I was asking about. I have to confess, before I came to business school it was not at all obvious that it was possible to create new value out of thin air, as opposed to just shuffling it around like you say. A lot of my political beliefs and attitudes, I came to recognize, flowed from my implicit assumption that it was not possible, whereas now I believe that it is. Your point about the money supply is also a good one. There's a LOT more I need to learn about this in order to answer you intelligently, but my initial guess is that so long as loans and credit are extended in units of money as opposed to some kind of barter arrangement, it's imperative that money and value be kept at least somewhat in balance; otherwise, you have risk of things like inflation or deflation where either the borrower or lender will have ended up making out like a bandit on the loan and it's not really a fair transaction. Loans are pretty important for making certain things possible economically (like home purchases and new businesses), so that would seem to be pretty important. (Of course, it doesn't help matters that most economists, in my experience, don't want to talk about money supply issues at all unless they specialize in them.)

    Thanks for the interesting discussion. Isn't it weird how little we really know about such basic stuff?

  • http://www.ryanmfogarty.com Ryan Fogarty

    I suggest you check out this month’s issue of Harvard Business Review. It’s feature article is on new Capitalism and how bigger corporations can create value, but so can NGO’s. It’s entitled “How to Fix Capitalism” by Michael Porter and Mark Kramer.

  • David Harris

    Great thread and well fleshed out. Looking forward to reading the others. A couple of upfront thoughts, as this exact question runs through my head a lot.

    If you haven’t read “The Gift”, mentioned by two others, it’s a must. Particularly, Hyde’s fleshing out of usury in the Jewish communities of Europe is enlightening for this discussion, and his Whitman chapter is downright soul-filling. I hadn’t as yet considered loans as a way of creating not only value but ghost capital, as I hear you. This makes a ton of sense following from Hyde’s usury discussion. In addition, his conclusion that today’s artists exist in two worlds: 1) a gift economy where the giving creates more value than the compensation and 2) a capitalistic economy where value is equated in dollars paid for services, creates a powerful platform for the contemporary artist. At a critical level, we have to acknowledge that people simply don’t care for our product as much as we do, to a point. Once the brand of the artist becomes a commodity in itself, then significant value has been created. I have a friend, for example, with a piece of Picasso’s pottery. All in all it’s an average pot, but b/c his name is on it, it’s worth a lot. (Significantly, it’s worth a lot to her not just b/c it’s a Picasso, but b/c she bought it in France in the 1960s and carried it around with her for a summer in a suitcase, a very happy time for her, so, it’s a placeholder for her memories.)

    Hyde’s most recent book, “Common As Air” speaks further to this concept particularly in light of the open-source world you mention. His argument here is that giving away and/or sharing openly with others, as an artist, can actually create more value. He points to “Sita Sings the Blues” as an example. She’s never made one penny off of the film itself, but has made a ton of money off of the merchandising that has erupted from the film’s popularity. In this case, is the value more in the piece of art or in the way people have used it? She makes money not from what she created, but from what others have put into that creation, in a way. And, Hyde suggests, she may have never made any money had she charged for it in the beginning, b/c she had no means of building popularity, no distribution engine and no interest from people who had the means to distribute.

    Thirdly, I think it bad logic to suggest that emotion and added value (“the notes between the notes” concept) only exists in the arts. The way I see it, the most vaulted halls of economics (Wall Street) is one of the most emotional places on earth. In fact, I would argue that if it weren’t for the intense buzz that mostly men get from winning a sale, or, you might say, “creating value”, that there would be no stock market. Part of it is the gambling buzz, of being so close to failure and eeking out success, but I believe a large part of it is how good it feels to have made something out of nothing, just like a musician does when they walk onto a stage and put hair to string, or a painter when they put oil and pigment on canvas. There is something innate within us to want to make value, but, critically, this value comes from and returns primarily to the creator. Even in the most shared circles, we get more from what we do than from what others do. This complicates the notion of value b/c it means that, even if we’re paid, we only feel valued if we (the individual we) feel valued (the concept of rich people being unhappy and poor people being content flows from this as well). AND, the key to this argument is that monetary value and, hence, market value flows from a desire to communicate our own worth to others.

    Why has our market stalled and our economy collapsed? At one level it’s b/c investors put too much stock in valuing assets that were toxic and therefore turned out to be not worth what the were traded as. But, the properties are still there, the people who purchased them still had the income to live in them had the market not driven up the price, and, importantly, all the money is still there, just shuffled around a little so that now much of it sits in banks and many of those people are in poverty. I think the lion’s share of the slow economy right now lies in an emotional response to failure. The guys who had convinced the world of their incredible worth got caught in the bathroom with a male hooker and they’re embarrassed and don’t want to play any more right now b/c they feel devalued b/c no one believes them any more, so they’re sitting on their toys until people forget, hence lowering their input into the value cycle. . .back to Hyde, we are all in a gift circle, large and small, and we all depend upon one another to 1) learn to acknowledge value in others and 2) feel valued ourselves. Money is a crude reflection of this, a tool to make trade easier and a paltry place holder for value, it really doesn’t work at all. And all of this flows into politics. The only reason that Romney has a chance in this election is because of money. Money, in this case, equates to buzz points and slander that will devalue his opponent in the eyes of the electorate. It’s easy to argue that money, in this case, is the crudest of valuations, but, also that in its crudity, it is intensely powerful.

    Perhaps later you can also flesh out the question of presumed value. That is, a dentist that makes the same amount as his competitor though one is far superior to the other. Or, a cheese that sells at $3.00 being so far worse than a cheese that sells at $8.00 to the point that it can’t be considered cheese, yet, more people will buy the former b/c it’s less expensive even though, had they bought the latter, it would have gone further, their experience would have been better and they would have been healthier for not having eaten so much. . .

    Thanks for the post, looking forward to more, sorry I wrote so much:)