End of the Market
* Book: The End of the Market. The rise of the service economy and the death of the market-clearing price
"The End of the Market argues that the credit crunch crisis of 2008 is not a bump in the road of the liberal era, but its end. But out of the ashes of rational individualism, a new vision is emerging where the community is the defining organisation and obligations, freely accepted and willingly discharged, become the engine of human progress."
- 1 Introduction
- 2 Contents
- 3 Summary of Theses
- 4 Discussion
- 5 Excerpts
- 5.1 Why Market Prices Don't Work in a Service Economy
- 5.1.1 Value creation in a service transaction
- 5.1.2 From tangible transactions to interactive relationships
- 5.1.3 The impossibility of trading and storing relationship value
- 5.1.4 From transaction payments to the exchange of gifts
- 5.1.5 The role of the process
- 5.1.6 The separation of process from relationship
- 5.1.7 From markets for tangibles to intuitive service communities
- 5.1 Why Market Prices Don't Work in a Service Economy
From the Preface:
"The End of the Market examines how the idea of the market-clearing price eventually emerged in the final decades of the 19th century after more than 2,000 years of debate. It was finally defined in a book by a Cambridge University professor published in 1890. This was an event that history has largely ignored. But its impact has been enormous. The idea of the market-clearing price freed human beings to get on with the business of producing and consuming without pondering excessively, if at all, about the true value of what they were doing.
Without it, mass production and long-term investment would have been impossible. It distributed goods and surpluses in a way that provided sufficient incentives for people to make decisions about whether to consume today or to save for tomorrow through the impersonal mechanism of the market. Trillions of daily decisions that otherwise would have been difficult or impossible were simplified to the extent than an average 7-year old could make most of them. You just compared prices and chose.
And it allowed governments and corporations to intervene in human affairs on an unprecedented scale.
Without the idea of the market-clearing price, many of the great events of past 100 years would have been impossible.Stalin would have been unable to master the largest country on earth and Franklin Roosevelt to launch the New Deal. Nazi Germany couldn’t have developed the capacity to launch a continental war of conquest and a programme of genocide. Mao Zedong might have seized power in China, but it would have been impossible for him to retain it. And the US could not have put people on the moon on 1969 without the efficiencies the idea of a market-clearing price allowed.
There had been visionaries before. But the market-clearing price allowed dreams to be turned into reality by encouraging the discovery of new technologies that freed a growing proportion of the world’s population from the mundane task of simply producing sufficient things to survive. It wrecked many human lives, but it saved many more. For this, the market-clearing price, the distilled essence of every human aspiration, should not be lauded. It has no ego and no imagination.
There had been megalomaniacs before. But the idea of the market-clearing price empowered them to mobilise human energy and material wealth for destructive purposes without parallel in human history. Price, the apotheosis of rationality in a rational world, is responsible, but cannot be blamed. It has no conscience and can have no soul.
The market-clearing price is now such an obvious and pervasive idea that it seems ludicrous that so much, both good and evil, should be laid at its door. Violent events, wars and revolutions, scar our memories and stir our emotions. Technology, which has obviously changed the way we live, seems a much more exciting topic. Ideas stimulate our minds. But prices? Surely they are as significant in human history as advances in shopping and much less interesting. Economists who grappled with the concepts that eventually led to the crystallisation of the idea of the market-clearing price didn’t do much to help. They are the authors of some of the most incomprehensible books ever written.
For centuries, thinkers investigated what prices were using every philosophical and scientific technique at their disposal. For those who thought of themselves as economists, the issue, however, was like an untreated toothache: a persistent irritation but not life-threatening. What mattered were production, consumption, investment and saving and counseling leaders of nations and business about the best way of increasing all of them quickly. This was the route to fame and fortune, not theorising about what price was and did. More often than not, economists simply gave up wondering about price completely and got down to the practical issues of commerce and government. And when the concept of the market-clearing price eventually emerged, it was almost immediately rejected as a matter worth worrying about because it was regarded as being essentially uncontrollable, probably misleading or both. Humanity had an uncomfortable relationship with price in the 20th century. At times, we convinced ourselves we could do without it entirely, but the century ended with us all under its thumb.
But The End of the Market is not primarily an account of the origins and implications of the market-clearing price. It is about how it has now been deposed due to the rise of the service economy, the source of the majority of income, wealth and employment in every advanced economy on earth.
Like the discovery of the market-clearing price 120 years ago, this startling fact has also gone largely unnoticed. And yet it is at the very heart of the economic crisis that developed in 2007/08. The fall of the market-clearing price as the key factor driving human affairs has implications so far-reaching it is almost impossible to overstate them. In death, as in life, the market-clearing price, or its absence, will utterly change every aspect of life for everyone, everywhere." (https://sites.google.com/site/theendofthemarket/1-preface)
Chapter 1 The irresistible rise of the market-clearing price The End of the Market begins with the history of the search for the origins and meaning of prices. The cast includes Aristotle, Jesus Christ, the Prophet Mohammed, Thomas Aquinas, Adam Smith, John Maynard Keynes and Milton Friedman.
Chapter 2 The renaissance of value End of the market shows how economic theory of all schools fails when applied to services, now accounting for 80 per cent and more of the GDP of most advanced economies. In intangibles, value is created solely through human interaction at the level of the individual rather than through insitutions like corporations and markets. The theory of value is reconceptualised with only two factors of production: the relationship, where value is created, and the process, which supports value-creation.
Chapter 3 Economic growth in service economies The End of the Market examines the broader implications of the new economic ideas emerging as a result of the rise of service economies and value-creating communities in which a growing proportion of people in advanced economies work.
Chapter 4 The business organisation in service economies The End of the Market investigates the implications for businesses supplying services.
Chapter 5 The role of the state in service economies The End of the Market addresses the issues facing the state in advanced economies where services account for the majority of output. Seeking to regulate unstable service economies and struggling to avoid massive waste in its own activities, the modern state needs to focus on process activities and provide the basic infrastructure that individuals need to create value in economies where services are dominant.
Chapter 6 Concluding Thoughts The End of the Market concludes with a meditation on the implications of the rise of service economies and suggests that the liberal era in which society was supported by enforceable rights is coming to an end and a new era where intuitively-defined communities bound together by obligations at the level of the individual will be the engine for economic and social progress." (https://sites.google.com/site/theendofthemarket/home)
Summary of Theses
by Edmund O'Sullivan:
"*The emergence of the market-clearing price as the central factor in economic affairs was followed by a steady decline in the contribution tangible good production made to economic output. By the end of the first decade of the 21st century, more than 80 per cent of GDP in many advanced economies was accounted for by services (intangibles-- Chapter 1).
- The economics of intangible production and consumption invalidates the role of price in stimulating production, consumption, saving and investment in service industries (Chapter 2)
- Value in intangible production is created through interactive relationships at the individual level among participants in service markets (Chapter 2).
- Technology has led to the separation of the process -- the tangibles and mechanisms that support value-creation – from the relationship at the individual level where value is actually created in services (Chapter 2).
- In intangibles, markets and industries necessary for the production and consumption of tangibles are being replaced by intuitively-defined communities within which individuals interact to create value (Chapter 3).
- Companies producing intangibles will face a growing calculation problem because of the decline of the validity of price as a stimulant of service production and consumption (Chapter 4).
- Companies producing services with horizontal structures, minimal centralised decision-making and no external financial liabilities will have a competitive advantage compared with competitors that do not (Chapter 4).
- The separation of process from relationship in value-creation in service industries will encourage companies to focus on one of the two critical skills in service value creation (Chapter 4).
- Governments will face increasing challenges in creating value in the service markets they participate in and should concentrate on the process elements of service value-creation (Chapter 5).
- The rise of service industries raises questions about ideas of social and economic progress that have been dominant for two centuries (Chapter 6)"
The End of the Market is primarily about economics and is essentially designed to promote fresh thinking about economic ideas and business practice.
But economics has never been precise, either in the way it worked or in the issues it tackled. As chapter 1 shows, what are now generally viewed as economic ideas were at one time considered to be issues of philosophy and theology. And, as the history of economic thought suggests, economists always had their eye on wider issues.
Thomas Aquinas pondered the role of price because he wanted to save souls.
Francisco de Vitoria believed free trade would promote the universal brotherhood of man and heaven on earth.
William Petty needed to make England’s Irish conquests pay (They did, at least for him. He got Kerry).
Jean-Baptiste Say was trying to help the king of France save his realm.
Adam Smith and David Ricardo wanted to reduce the power of landowners.
Karl Marx wrote about economics to provide the intellectual underpinnings for his belief in the inevitability of proletarian revolution.
Ludwig Von Mises used economics to validate his view of the importance of private property ownership, Keynes to empower the liberal state and Friedman to help defeat Soviet Communism.
The reason why these writers still resonate is not because they proved that economics was a science that could not be ignored. Their achievement was to make economics relevant to the times they lived in, not to change the world forever. But in doing so, they established economics as a discipline with enduring intellectual appeal.
Cometh the moment, cometh the economist.
The recurring question, however, is this: does economics justify the effort involved in mastering it? Does it produce anything worthwhile at all?
Does it act on human thought in the way that the grain of sand in an oyster produces a pearl? Or is it more like a stone in a shoe. Both are irritants. One produces treasure. The other a sore foot.
The use of metaphor in this and previous chapters serves to highlight one of economics most enduring themes. More than any other intellectual discipline, it’s metaphorical.
Economists have often waxed lyrically on their subject using imagery from everyday life to validate their arguments. Whether they explained economics by referring to a farm or a factory or drew on physics or biology, they were obliged to be allusive.
Economics claims to be a science. But it is science expressed as parable, or, perhaps, parables rewritten in scientific form. The fact that economics has always been so, and must continue to be, is an abiding reminder of its imprecision.
But the metaphor, the most powerful way to express abstract ideas, is also economics’ greatest strength. It strikes the heart as well as feeds the brain. As every economist should.
Economics invariably has a message and a mission. Economists who claim that their work is to inform not to convince are missing half of what economics has always been about. The purpose of the discipline is to provide compelling language to describe the way things unchangeably are or should desirably be.
There’s only been two types of economics: the sort that seeks to preserve and the sort that tries to change.
The End of the Market argues that economics can coherently do both.
It also highlights the contemporary relevance of subjective and objective theories of value. As it explains, there was a debate stretching over many centuries about the best way of understanding and justifying why different amounts were paid for different things and services.
This debate ended, temporarily as this book argues, in 1890 with the publication of Alfred Marshall’s Economic Principles, essentially a derivative work though it expressed ideas in a new way. The result was a theoretical explanation of how a market-clearing price could emerge that used logical thought as well as scientific methods. It was a moment that changed the world.
And for more than a century, the idea of value as something which could be expressed by anything other than the market-clearing price fell into disuse, if not disrepute.
The rise of the service economy, and the resulting separation of process from relationship in service transactions, has restored the relevance of the debate about value. Those who firmly believe that it is no more than what people think it is will once more be freed to have their say. And those who want the world to understand value as the result of production costs are similarly liberated to make their case. So this is not the end of economic thought, just a further evolution in a way of looking at the world.
It may be too soon to say that the idea of the market-clearing price deserves to lose its supreme position in economic thought. But economics, as a result of the rise of the service economy, has entered a new era in which different insights about its role in human society can be expressed.
The ideas of the value-seeking individual, the interactive relationship and intuitive community, which express in economic terms concepts that others have framed previously as ethical and political categories, are too compelling to be quickly dismissed. The internet and instant, global communications, the processes that make these concepts live and breathe, are too pervasive and too familiar for people not to recognise that the world has changed in ways that conventional economic analysis and ways of looking at business has so far failed to explain.
It is of course possible that such technologies, unleashed in a divided world with so much avoidable human suffering and hate, could actually serve the goals of the anti-value seeking individual and the value-destroying community. The 9/11 attacks, the lamentably misconceived invasion of Iraq, the Darfur humanitarian crisis, civil war in Sri Lanka and other evidence of humanity’s inhumanity are vivid reminders that dystopias exist in reality as well in angry people’s imaginations.
It is the author’s hope that the compulsion to collaborate, which has permitted humanity to survive everything the natural world has thrown in its direction, will dictate the future direction of our affairs. But it can not be assumed it will all just happen automatically. People have to make it happen. Each of us has his or her part to play in our value-creating activities and within our value-creating communities. The ordinary person’s role in humanity’s wider struggles has been restored.
You can make a difference, here and now.
The End of the Market is about economics and economic ideas. But it inevitably raises political issues as well. A reassessment of the role government should play in economic affairs is briefly outlined in Chapter 6. The larger opportunity is for stakeholders in the world’s remarkably diverse network of value-creating communities to work together to remove the obstacles to value-creating interaction and to the production of high-quality, low cost processes that make that interaction possible.
But there may be a larger agenda to ponder.
The end of the tangible era may also mark the end of the liberal era of politics, one in which society was seen as an association of rational individuals governed by rights. Intuitively defined, value-creating communities connected by obligations are now the proper focus for political investigation and action.
Liberalism was never a single body of thought. And after the American and French revolutions, which established constitutional government as the liberal ideal, it divided into elitist and populist forms. Elitist liberals believed the full rights of citizenship should be restricted to those qualified by education, wealth and, usually, by gender and race as well.
Populists argued for them to be extended to as many as possible. Populist liberalism became dominant after the 1st World War, but immediately split between those who wanted a minimal state and others who justified government action across a wide spectrum of social and economic affairs.
Maximalism was adopted by parliamentary socialist and social democratic parties. They presented themselves as distinctively different from liberals but accepted most of their principles. Like minimalists, they viewed the individual as the building block of society. Through education and political agitation, they sought to develop the individual’s political consciousness, but principally for electoral advantage rather than to change society fundamentally.
Maximalists regarded the state as a means to an end, just as the minimalists did. The dispute between them was about the extent of government intervention, not whether it was right in principle; even cautious minimalists believe the state matters.
And the debate about the distribution of the benefits the market delivered was, for both maximalists and minimalists, essentially an argument about outcomes, not one of principle.
The apparent anomaly in populist liberalism was Marxism. Its apocalyptic forecast of permanent class warfare and utopian vision of a stateless society smacked of pre-liberal Christian millenarianism. But its intellectual origins were in classical liberalism.
Never developed into a coherent programme for political action by the author himself, the writings of Karl Marx, nevertheless, coloured the policies of socialist parties contending for votes in constitutional liberal states in the decades leading up to the outbreak of the 1914-18 war. The war undermined European constitutional government, discredited parliamentary populist liberals and created the opportunity for a Marxist sect to seize power in Russia.
The Communist regime in the former Soviet Union -- which imposed similar systems in European countries it occupied after 1945 and inspired Communist governments in China, North Korea, Cuba, Vietnam and Cambodia -- used bureaucratic methods to manage economic development. Private property was largely abolished and investment and production were entirely controlled by the state. In its most advanced form, Communism allowed the market-clearing price no role and individual choice in practically every area of life was denied. Across the Communist world, tens of millions were put to work as slave labour and uncountable millions were executed or killed through overwork and starvation as the state sought to displace the market with plans. It was quickly obvious that Communism was brutally inhumane. Its deficiencies as a system for raising production were only comprehensively exposed in the 1980s.
Communism appears to be the polar opposite to liberalism. But Communist Russia and the regimes it inspired owed more to liberal thinking than its rulers and critics could admit. The abolition of the monarchy and land reform were populist liberal goals. Communist programmes of collectivising agriculture and nationalising industry had political objectives but were also designed to advance economic development more swiftly than conventional liberal economic prescriptions apparently could. They were usually presented externally as technocratic innovations and initially secured the admiration of foreign liberals, and not just maximalists, for that reason.
The Communist political system assumed some of the features of elitist liberalism. Provided he or she paid homage to the leaders of the party and worked within the rules of the Communist system, an individual Communist could continue to think and act autonomously and enjoy career progress through structures of government and production that mimicked American corporations, the apotheosis of minimalist liberal economics. Equality of income was quickly dismissed as unnecessary in the Soviet Union. Wage differentials between government officials and technical specialists on the one hand and the rest of the labour force on the other were often larger in Communist states than they were in their capitalist equivalents. It was the clearest possible evidence that Communism couldn't survive without the market-clearing price.
The tangible era, therefore, needed the market-clearing price, or an administratively-applied analogue embedded in Communist economic plans that was designed to do the same job. The language of Communism was luridly apocalyptic, but its practice was rooted in the ideas of efficient tangible good production accepted by Western economists.
Fascism, a radical variant of elitist liberalism, was based on deemed ethnicity rather than social status, the form it took in the US, Britain and France. In Germany, it was combined with theories of social Darwinism to produce genocidal Nazism. And yet, essential liberalisms remained central to Nazi ideology. These included the importance attached to the self-mastering individual provided he or she conformed to the Nazi ideal, and to rationality, the highest liberal competence, warped though it was under Adolph Hitler. And like liberal economists, Nazis were obsessed with the challenge of increasing the quantity of tangible good output.
The war destroyed Naziism as a political ideology, though milder, non-racial variants survived in Spain, Greece and parts of Latin America. It also forced the Soviet Union to abandon the essential elements of its own world view.
Communism in power almost immediately stopped being goal achieved through spontaneous popular action and became something to be imposed by force. This was radically at variance with every strand of liberal thinking. In economic affairs, however, the gap between Soviet and non-Soviet economic practice narrowed after the death of the Soviet dictator Joseph Stalin in 1953. Moscow’s economic policy was principally motivated, like the West’s, by the desire to maximise tangible production. Soviet economic policy was based on the belief that markets were technically and socially inefficient and that government intervention increased the output of tangibles and distributed them better. This was essentially a managerial issue, not a political one. Ideology was dead in Communist economic theory, as it was in Communist political practice, from the early 1950s.
In Western Europe, the theory of market failure was acknowledged as providing the intellectual basis of social democracy. Anthony Crosland, the seminal post-war thinker of the British left, renounced nationalisation for any other reason, though the Labour Party retained a formal commitment to public ownership as a matter of principle, rather than practice, until 1995. Crosland argued that less inequality, rather than abolishing capitalism, was Labour’s proper purpose and it was to be achieved through tax and the state welfare system, impeccable populist liberal policy instruments. The market-clearing price, managed where occasionally required, would do the rest.
The theory of market failure which justified government intervention to increase tangible production was a strand of liberal economic thought (though the idea of compensating those punished by the market was troubling because it was seen as undermining individual responsibility). It was consequently vulnerable to challenges from within the liberal intellectual tradition itself.
By the end of the 1960s, an alternative approach to market failure had been developed by minimalist liberals critical of the expanded peace-time role of the state. They coherently argued that structural market failure requiring direct government ownership was rare. And where it did exist, market failure was best addressed through regulation designed to increase competition rather than through government ownership and control. Minimalists comprehensively demolished the intellectual foundations of Keynesianism, a term used to cover a range of maximalist liberal policy options designed to counter perceived market failure at the macroeconomic level.
By the end of the 1970s, minimalist liberalism was triumphant. It was largely a bloodless victory. Most maximalists reluctantly recognised their intellectual position was hopeless and surrendered. The market-clearing price, unadorned and obvious, was the common solution to all economic challenges.
The resurgence of minimalist liberalism, and the failure of planning to promote tangible production, also precipitated the collapse of Communism. In 1987, the Soviet Communist Party approved limited economic and political reforms but continued to assert its formal attachment to Marxism. But its leaders had already accepted the compelling logic of the minimalist case. Tellingly, former Communists were the most prominent beneficiaries of free market policies introduced before and after the end of the Soviet Union in 1990. Communist regimes in China and Vietnam have travelled a similar road. Cuba is now moving in the same direction. Only North Korea continues to adhere to Communism in a form that Stalin would recognise and approve.
The collapse of the Soviet Union in 1991 has been seen as the moment that practical socialism expired. But socialism was an illusion that could never work and had never existed as anything other than a maximalist version of liberalism. The end of Communism in Europe was the consequence rather than the cause of socialism’s demise.
The collapse of the Soviet Union coincided with the emergence in Western economies of a synthesis between liberalism’s minimalist and maximalist strands. This entailed maximalists conceding that the state should abandon or limit discretionary intervention in economic affairs. But minimalists were also required to accept the validity of a comprehensive welfare net to safeguard the increased proportion of the population exposed to the improving exigencies of the market. In the UK, the liberal synthesis was articulated in the programme of the Conservative government led by John Major (1990-97). It called for market principles to be applied to state-owned service industries, notably in health and education, whilst increasing government expenditure on both. The liberal synthesis was adapted and adopted by the Labour government of Tony Blair (1997-2007).
Until the summer of 2008, the liberal synthesis seemed to work. Simultaneously, the British economy grew robustly and public expenditure expanded while private wealth increased and income differentials widened. Unloved by minimalists and maximalists and derided as intellectually incoherent, the liberal synthesis nevertheless had the merit of appealing to the majority of the British electorate for the simple reason that it seemed to benefit everyone. And since 1990, it delivered four general election victories to two political parties campaigning on synthetic liberal platforms. It may have been bad economics, but the liberal synthesis was electoral magic.
The credit crunch of 2008 and its aftermath have undermined, but not destroyed, the conviction that the synthesis constitutes an imperfect but lasting solution to what was the biggest unresolved issue within liberal economic thinking: the proper size and role of the state. Most analysis of the causes of the present economic downturn, consequently, falls into two categories, both consistent with the liberal synthesis.
One asserts that the minimalist prescriptions for the UK economy have failed to produce the hoped-for increase in production and should now be reversed, though not renounced. The developing minimalist counter-attack is that the credit crunch is in reality a delayed reaction to inflationary government policies and a failure to pursue market-based policies with sufficient vigour.
Despite the rhetoric both sides are now deploying, the two views are in reality calls for the maximalist-minimalist armistice to be renegotiated, not rejected. This debate is at the centre of the tensions within the coalition government involving the Conservative Party and the Liberal Democrats that emerged from Britain's general election in 2010. It is reverberating across the world.
But the rise of the service economy has shattered more than the maximalist-minimalist liberal political synthesis. It is calling into question the foundations of liberal economic thought, the dominant ideology in the UK since the end of the 19th century.
The liberal era was shaped economically by the production of, and trade in, tangibles, physical items that could be commodified, stored, processed and traded on a mass market. The economies of most advanced economies, in contrast, are dominated by intangibles, invisible items that can't.
In the liberal era, relationships were institutionalised in contracts and secured with tangibles. In the post-liberal era where the economy is dominated by intangibles, people interacting to create value will be essentially motivated by faith in something which does not take a physical form. As The End of the Market explains, tangible production which the liberal era validated required markets or government administration. In the post-liberal era, direct interaction will be preferred because it increases confidence that what is promised will be done.
In the liberal era, the community was defined by the individuals around whom it was constructed. In the post-liberal era, the individual is defined by the community or communities of which he or she is part. In the liberal era, the individual was active in a hierarchy of managed organisations including the family and the state. In the post-liberal era, an individual must work horizontally and simultaneously across communities without institutionalised command structures.
The dispute between the maximalist and minimalist strands of populist liberalism about the balance between the corporation, or the state, and the individual -- the dialectic that produced the liberal synthesis -- becomes redundant in the post-liberal era. Economic efficiency, or the average cost of service production, depends upon the technical capabilities of those vested with responsibility for building and operating tangible processes. Value production can only occur when it is shared among all those involved. The former may invite state control or ownership. But the latter is spontaneous and requires no form of corporate intervention, whether public or private.
The implication is that the debate that has gripped the world for more than a century is now outmoded. A new political discourse is required that will reflect the economic realities of the daily lives of the overwhelming majority not the voting balance in legislatures and which personalities occupy the highest levels of government.
They need politicians who will help them develop value-creating competences and sustain communities they are active in.
They will want policies that will release, not imprison, the value-creating capacities of people working in service production in government and the private sector and that will reduce the cost, increase the quality and expand the availability of the processes that value-creation requires. And they want leaders who will seek to apply such principles at the international level.
Politics still matters in the post-tangible, post-liberal era, but in a radically different way.
The End of the Market argues that the credit crunch crisis of 2008 is not a bump in the road of the liberal era, but its end. But out of the ashes of rational individualism, a new vision is emerging where the community is the defining organisation and obligations, freely accepted and willingly discharged, become the engine of human progress.
This should be an encouraging prospect.
And if The End of the Market serves any ultimate purpose it is as a reminder of humanity’s limitless capacity to love family and friends, to befriend a stranger and to forgive an enemy; to affirm belief in the possibility of a better world and to express the hope that we will be there to see it." (https://sites.google.com/site/theendofthemarket/chapter-6-concluding-thoughts)
Value creation in a service transaction
"Tangibles are invariably produced through a value chain.
For example, iron ore is found and extracted. It’s then shipped to a pelletising plant, often close by, that concentrates the ore to make it cheaper to transport. At a steel smelter, machines and people work together to transform pellets into ingots. The ingots are turned into billets and bars or rolled flat. These are then shaped into finished products like cooking utensils, car bodies and the wings of aircraft. They are sold to consumers who use them as they see fit. Production of tangibles is linear; going from raw material to finished product in stages. And at each point, value is added. At every stage of production, something is bought for less than it is sold for in its more processed form. This is the iron law of all tangible production, and not just steel. It goes one way.
Now let us consider value-creation in services.
Think of a hotel. A person arrives to check in. He or she is greeted by a receptionist. The guest responds, pleasantly you would hope. The receptionist then asks for the guest’s name and booking details. This might involve handing over supporting documents, even passports. At each point, the receptionist says thank you and smiles. After a couple of minutes, a door key is handed over, the guest’s luggage is collected and the receptionist wishes him or her an enjoyable stay.
Think of a doctor. A patient arrives at a clinic and is greeted by a receptionist. The booking is checked and the patient is asked to take a seat for a few minutes. Magazines are provided to pass the time. The patient is ushered into the surgery. The doctor greets the patient, asks some preliminary questions and begins the physical examination. At each point, the physician will be looking for a response from the patient. At the conclusion, the doctor makes some decisions based upon what he or she has heard and seen and the patient leaves with advice and, usually, a prescription.
These examples show how value-creation in services differs from value-creation in tangibles. Time has been spent, which involves an opportunity cost. The hotel receptionist could have been answering the phone or using the clinic’s computer. The doctor could have been playing golf. Something has been produced to deliver a happy guest and a satisfied patient. Money has been exchanged. From this perspective, there is no difference between what has happened in these two cases and the final outcome of a tangible transaction. There are inputs with a cost, an output with a value and a price paid.
But in services, value is created interactively between the consumer and the producer over time rather than in an act of production. Without the reaction of the guest, could the receptionist be able to make the small judgments about preferences that are vital to a guest’s enjoyment of a hotel stay? Without the response of the patient, could the doctor make a decent diagnosis? Could any value be created in any service transaction without the direct involvement of the consumer in the service production process? As these examples suggest, value creation in a service transaction is interactive, and usually repetitively so, with information being exchanged between consumer and producer to the increased satisfaction of both. The hotel receptionist has a better understanding of what he or she needs to do to improve the experience the guest has at the hotel. The doctor is helped in his or her capacity to make a sound judgment. This is not a linear process, as it is with tangibles where value-added flows one way and money the other in a predictable and linear direction.
Value creation in services can look like ergonomic chaos, production as a form of anarchy or, perhaps, anarchy as a form of production.
But that’s why it’s a service. If it wasn’t, then a machine could make it. It would be a thing; a tangible.
From tangible transactions to interactive relationships
With tangibles, manufacturing uses up materials and labour power. Once a unit of production is sold, all the value embedded in it is transferred to the buyer. It’s been sold for money or the promise of money. What is left is remembered competence -- technology stored in the minds of the person and the machines that made it.
In services, in contrast, value is shared rather than transferred. The transfer of the embodied value in a tangible between producer and consumer does not take place in intangibles. The idea of the precise division between producer and consumer itself breaks down in services. The rational producer will seek to maximise the constructive interaction with each consumer since this will increase the total value it creates. And the rational consumer will seek to do the same, because the more value created in a service transaction, the more there is to share.
There is a process of mutual reinforcement and encouragement in services which is impossible with tangibles. Value is created by people interacting because they encourage each other to create more value than they would if they were acting individually. A sports trainer succeeds only if he or she encourages an athlete to do more than he or she would do on his or her own. The elastic nature of the human capacity to create value is central to value-creating in services. This characteristic of human behaviour is pervasive and inescapable. And at its most basic, it explains how two human beings -- using nothing more than their inherited DNA, labour and imagination -- can produce another functional human being. This happens naturally, but not automatically. We are not machines.
Value is created in intangibles, just as it is in tangibles. Money is paid, just as with tangibles. And there are, as in the production of tangibles, costs involved. But how value is created is completely different. With intangibles, it is the result of a constructive interaction between human beings. The interaction is unique and cannot be scientifically compared with any other interaction, even if it involves the same hotel and clinic and the same receptionist and doctor. A sequence of interactions develop into a relationship where the market-clearing price affects the supporting tangibles but not the value-creating component of services.
We have stepped through the looking glass into a world of production that tangible economics cannot comprehend.
The impossibility of trading and storing relationship value
Tangibles are rarely manufactured in a single unit for one person, though this does happen. If you’ve got the money, you can probably get a car made that no one else has. Paintings are usually unique. But, in general, everything in the tangible world is to some extent produced in large quantities for a particular group of people comprising many consumers with similar tastes and levels of disposable income. The homogeneity of durable tangibles, things that are not used in a single act of consumption like food, allows them to be sold and bought and then sold and bought again.
The tradable characteristic of tangibles makes possible the development of markets, intermediary institutions that separate the people that make things from the people that consume or use them. There is no need for them to meet. With tangibles, distance can make the heart grow fonder.
All tangibles are subject to commodification: the capacity for them to be traded through the mediation of a market without producers and consumers directly interacting other than through the exchange of payments which in turn are mediated through impersonal markets for money and finance.
For durable tangible goods, this characteristic adds a massive dimension to the role of price because it also facilitates the scientific measurement of the extent to which a durable’s value diminishes over time. The prices of used automobiles help us understand how quickly a car is used up. This principle can be applied generally to guide investment decisions. The rate at which a durable tangible is consumed or decays underpins our judgement about how much we should pay for it. If a car costs $20,000 and its resale price falls to zero at the end of year five, then its actual average cost is only $4,000 a year. If this is less than the annual cost of using other methods of transport, then it makes sense to buy it.
Tangibility has equally important implications for companies. Tangibles that are used up in one year, like paper in photocopying machines, are treated as costs and are set against revenues generated in a single year. But a durable tangible can be deemed to be consumed much more slowly. The value embodied in a fleet of company cars is not used up in a single year, but over a number of years. The purchase of durable tangibles by a company, therefore, involves an element of investment, equivalent to putting their residual value at the end of each year in a bank. Buildings, which are used up slowly, can be deemed to depreciate over 50 years and more. Land, though it will have to be maintained and replenished to maintain its fertility, can be deemed to hold its purchase value in perpetuity. For most producers of tangible goods, tangible assets like land, buildings, equipment and stocks or inventories, account for the bulk of their perceived net worth.
This is all logical, tried and tested. It works for tangibles.
But can any of the principles of market mediation and commodification be applied to services?
The answer is yes, but up to a very limited point and usually for a very limited number of intangibles. The value created in the interaction between a hotel guest and a receptionist and a patient and a doctor is simply beyond resale. Would a guest say to a receptionist: “I would like to pay you for the service you are about to provide but I don’t want to consume it myself. I want to sell it at a higher price to someone else who will arrive some time in the future. I’d appreciate it if you treated him or her in exactly the way you might have treated me or I’ll have to pay compensation.”
Would the patient leaving with the doctor’s guidance sell it to someone else who believed he or she had the same symptoms?
The answer is: it’s possible, but so unlikely that it can be effectively eliminated as a practical option. And can the value in an intangible transaction be effectively stored?
Consider once more our hotel guest. He or she captures value in a constructive interaction with the receptionist.
Can this value be stored in the way that the value stored in a car is?
Can the guest the next day get up and retrieve the residual value of the interaction and, figuratively speaking, go for a drive in it?
The answer is no, or at least not in the way that the value in durable tangibles can be. The interaction at the reception desk the previous night that delivered value to the guest lives only in that guest’s memory. It’s not disappeared as if it never happened. But it’s gone in every way that an economist would understand. And since relationship value can’t be stored over time, the idea of depreciation that scientifically measures how a durable tangible degrades, or is used up, over time has no validity in services. Whether participating in a relationship today is better than waiting until some future date is itself a subjective issue over which the market-clearing price has no traction.
From transaction payments to the exchange of gifts
We can now turn to the role of price in value-creating interaction in service relationships. As we have learned, in the market for tangibles, price plays a critical role in reconciling human wants with scarcity. Unless you are prepared to cover the cost of making a product, there are few incentives for a producer to keep selling it to you unless there is no other option, as there invariably is.
And unless a producer is willing to price a product in line with what their customers can afford (or are prepared) to pay, nothing will be sold. The price of tangibles simultaneously acts as a reward and a compensation as well as an incentive and a compulsion to all those involved in tangible transactions. And it does this in a detached, unemotional and mechanical way. Who buys the good and who makes it is usually irrelevant. Buyers and sellers of tangibles prefer it that way. It makes it easier to discriminate coherently among the host of tangibles that money can be used to buy and to determine how many resources should be used in their production.
With intangibles, in contrast, emotion is rarely if ever detached from a transaction. For the buyer, there is an inescapable need during a service transaction to be constantly reassured that what is being paid reflects what the service is considered subjectively to be worth. And the idea of what is merited or deserved is never far from the supplier’s mind.
With tangibles, the transaction is mechanical, automatic and depersonalised. With intangibles, the transaction is self-conscious, pragmatic and highly personal. And there is no objective way that parties to a value-creating service relationship can attach a price to that relationship because, as has been argued, there is no homogenised market in services, only a mass of incommensurable transactions that cannot be scientifically analysed or coherently compared.
And yet, money is invariably exchanged during service transactions.
What determines how much is paid?
This requires another conceptual leap out of tangible-era thinking. To an extent that is rarely openly acknowledged, the provision of a service and the payment for it is closer in nature to an exchange of gifts, a tangible expression of the significance individuals attach to a relationship.
At anniversaries and celebrations, people give each other presents. Why do they bother? Why not just give each other money based upon a scientific assessment of the value that the relationships being honoured are worth?
Why not compare gifts, work out their relative price and haggle about whether the transaction was fair? Why not just give cash?
But people don’t do that, though an unsatisfactory gift can be a source of grievance. Gifts express, in a way that a price-based transaction never can, the importance the receiver has in the life of the giver. Often, gifts are preferred over money because it is a public expression of the value that relationship has for both parties. An exchange of gifts establishes a connection based on obligation. Both parties feel they owe the other something. The critical role it plays in services is that it turns a single transaction, or a one-off act of consumption and production, into a relationship; into an economic connection that endures through time.
Recent research has discovered that barter, or the exchange of things, was comparatively rare in human civilisations without money. The exchange of goods was usually an expression of friendship, kinship or alliance that would be finely gauged to sustain relationships among individuals and groups of individuals. In many parts of the world, prices are still only the starting place for a discussion between a buyer and seller that will develop into a relationship after a satisfactory exchange of gifts in the form of a discount from one and the payment of money by the other.
This is confusing for tangible-era economics which is based on the idea of satisfaction-maximising consumers and profit-maximising producers who seek to extract as much possible, in both subjective and objective forms, from every individual tangible transaction.
Another example might shed some light on the topic. Consider the feelings of those party to a service interaction. The provider of the service, a waiter for example, does something nice for a diner. The diner feels he or she owes something to the waiter. The diner then determines how much that should be and expresses it in the form of a tip, a reciprocal gift. The key to the exchange is this: unless the giver feels that he or she has received a satisfactory reciprocal gift, the relationship between them collapses. Value creation, which requires constructive human interaction, declines and may even disappear as a result. What are being addressed in service relationships are mutual obligations, not individual rights, that the service interaction must satisfy.
People buying and selling tangibles, in contrast, are principally concerned with the transfer of the right to use them expressed through a contract, written or verbal, which is underpinned by an enforcing agency like the state with police powers. Trade in tangibles needs a system of enforceable rights.
Service interaction, in contrast, depends upon the voluntary acceptance and discharge of obligations which are often implicit. This perspective on the nature of a service interaction helps us understand that the critical element is not that additional value is created. It is that it is shared in a satisfactory way between the parties who feel personally obliged to deliver what they have promised. If that happens, the foundations are laid for further interactions that establish relationships delivering value over time.
The role of the process
Those following this line of argument will point out that the amount of money paid for a service also must take into account the cost of providing the tangible things used in hotels and health clinics. There’s buildings, equipment and people trained to used and service them. If they weren’t there, there could be no service transaction and no consequent value creation. This is beyond argument.
Tangibles are invariably essential for a successful service transaction. But their role is to facilitate the value created in constructive human interaction. The bed in the hotel room used by the guest does not add value; it makes the value-creation process possible because the guest wouldn’t get a good night’s sleep without a bed. Doctors and patients need equipment, teachers and pupils need schools and English premiership football teams and spectators need football stadiums. The things that facilitate value-creation -- the processes -- degrade over time. It is, therefore, possible to establish a quantifiable connection between the productivity of having it now or in the future. This will establish time-preference based and opportunity cost options for all process investment choices.
But they will be subordinate to the subjective assessment of the impact on relationship value-creation of deferring or advancing a service interaction. Objective cost factors play a role, but the process investment decision will be driven by service relationship priorities.
The analysis of a service shown above, therefore, entails dividing it into a relationship component, where value is made, and a process component that facilitates its creation and distribution. It consequently divides the amount paid into two elements: a cost-covering part, which deals with the tangibles used in service delivery, and a gift-exchange part governed by subjective factors.
The first can be treated in line with the market-clearing price model originating in the Marshallian synthesis of 1890.
The second, however, falls outside the scope of scientific analysis as we know it. It depends upon human interaction in value-creating relationships underpinned by obligations. These are essentially intuitive and can be said to be irrational. And yet, they are essential to the well-being of every rational person.
The separation of process from relationship
The principles guiding value creation in services that have been explained can now be used to reconceptualise the changes in the economies of advanced countries in the past century. By stimulating the accelerated production of tangibles, the idea of the market-clearing price freed human beings from the struggle to survive. There were increasing amounts of time to devote to constructive interaction within value-creating relationships expressed in the form of the services which now account for the majority of output in the world’s most advanced economies. Initially subordinated to the tangibles they enhanced, services have turned the tables on their previous master to dominate value creation itself. Technology, the fruit of constructive human interaction in science, has liberated value-creation from the tangibles that had previously imprisoned it. Process and relationship are dividing with profound implications for the future.
An example, among many, can be found in the changes in the media industry. In 1977, when the author started as a junior reporter at Reuters in Fleet Street, the relationship elements of media service production were to be found in the same place as the process elements. Journalists and the advertisement and marketing teams -- the relationship specialists in media firms -- were located in the same building as the printing press.
This was not an accident or a mistake. It was because that was all the technology of newspaper production at that time allowed.
Technical change in general, and the rise of digital communications in particular, has radically changed what is possible. Today, the reporters don’t have to be in the same continent as the printers, let alone in the same city. Price has encouraged new methods of newspaper manufacture that reduced average costs and freed resources to increase the service component of what is made. It has also encouraged export of the process component of production to places where such costs are lower whilst allowing the relationship component to stay close to the consumers, the essential counterparty in service value-added creation. The separation of process from relationship in production, which has allowed the boom in services, is the supreme achievement of the idea of the market-clearing price. But it is also its undertaker.
The growth of services, and the technologies that separate process from relationship, mean that the market-clearing price can only affect the first, which is becoming increasingly insignificant to growth in advanced economies. It continues to encourage more technological development that will in turn reduce the average process cost of service transactions.
But the relationship component is now on a separate trajectory and stands on its own as the dominant influence on modern economies. Here the market-clearing price, in fact any price, is redundant. Another factor is driving value creation. This is the desire among individuals to find counterparts with whom to create value and form interactive relationships.
From markets for tangibles to intuitive service communities
As has been explained, value creation in a service economy is the product of constructive human interaction. The individual, as in a tangible economy, remains the engine of progress. But the interactive compulsion, the need to deal with other human beings for value creation and the mutual obligations that occur as a result, shapes collective economic behaviour.
The value-seeking individual establishing interactive relationships with other individuals is promiscuous. Invariably, people will seek several interactive relationships where value can be created in different ways. The value-seeking individual will subjectively assess the relative productivity of each relationship by a process of comparison that will take into account the amount of value created and the perceived value of the gifts exchanged.
But the mental picture that develops will invariably fail to conform to the systematic pattern that the theory of utility requires. Attitudes to relationships will vary from day to day and will be affected by the needs, mood and maturity of those involved. An individual’s mental map of the complex network of relationships that he or she creates is unstable and constantly changing. And so a further blow is dealt to the institutions associated with the tangible era.
In tangibles, people dealt with segmented markets and industries. In intangibles, these stable, predictable arrangements give way to intuitively-defined and overlapping communities. Individuals seeking to create value through human interaction require little direction to find the communities that serve their particular purpose. They will gravitate naturally towards others with the value-creating competences that are relevant at particular moments during a day, week, year or lifetime. The resulting communities are neither exclusive nor stable.
In the tangible era, the individual was active in a hierarchy of managed organisations including the family, the company and the state. The requirements of tangible production tended to lead to the emergence of stable institutions capable of organising information about tangible production and consumption and mobilising the capital required for it. Laws and contracts enforced the system of rights essential for tangible production and consumption to occur. The institutional arrangements suited the technical challenges tangible production entailed.
The rise of the service economy and the separation of process from relationship in services makes such systems redundant. In societies dominated by service production, individuals need to be free to work horizontally and simultaneously across communities that lack command structures. They will normally include, at a minimum, a work community, a social community and a family community, though individuals will participate in dozens, sometimes unconsciously.
Markets comprising producers and consumers are consequently being replaced by overlapping and unstable communities of value-creating individuals that are intuitively obvious to its members but unquantifiable and even mysterious to those that are not.
Outside the context of a particular community, the people that make it up may have little in common. No market research could ever forecast who might participate in a service transaction within a particular community at a particular moment. No analysis would be able to conclude what they had in common once the interaction has been completed.
An example among many is Manchester United Football Club. For most of the time, most people who support Manchester United are unconcerned about football. They are of all ages, both sexes, all professions, many nationalities and faiths and they often don’t live in Manchester or have ever been there. But on match days, they become a global community of millions of people interacting constructively with each other, inspiring their team and enjoying its success. Out of this massive creation of value, broadcasters and advertisers will be able to secure many millions of dollars of revenue. On the day that Manchester United played Barcelona in the UEFA Final on May 2009, the Manchester United football players, management and supporters for a couple of hours constituted one of the most profitable businesses on earth. Only it wasn’t a business, an industry or a market. It was a community of value-seeking people creating value by interacting constructively with each other, though it didn’t work on that occasion. Manchester United lost.
The Manchester United community is essentially unmediated and largely unmanaged. It is spontaneous, not controlled. And it is largely based on an irrational factor: a shared and interactive passion for a football team that cannot be scientifically analysed or explained.
In tangible production, rationality is the most important value. Rational consumers buy things from producers who in turn act rationally, at least a priori. Prices and costs are measurable and, consequently, satisfy the rational mind. The reason why the idea of a market-clearing price is so compelling is that it makes sense.
In intangibles, irrationality is the required condition for effective value-creation. Since what is being produced and consumed cannot be seen, touched or scientifically measured, service transactions require an act of faith from both parties that what is being exchanged actually exists and what has been promised will be done.
The most compelling example of the separation of relationship from process and the rise of spontaneous, horizontal, unmanaged and unstable communities can be found on the worldwide web. The internet is the most dynamic process the service era has so far produced. It is facilitating unmediated and spontaneous human interaction on a scale and of a nature that has no parallel in history.
Through the web, the concepts developed in this chapter have become a daily reality.
It proves that the separation of process from relationship is not only logical and potentially beneficial.
It is an irreversible fact that every household, business and government on earth cannot ignore.
But how should we respond to the process-relationship divorce made possible by the dynamic but increasingly redundant role of the idea of the market-clearing price?
This question will be addressed in the following chapters. But this one closes with the market-clearing price deposed as the master of economic thought and practice.
Subjective value, the product of interactive relationships within intuitively-defined communities, and objective cost, which measures the efficiency of the service process, have been restored as concepts that economists once again have to consider separately and seriously." (https://sites.google.com/site/theendofthemarket/chapter-2-the-renaissance-of-value)