The central failing of conventional economic theory when it’s applied to services has been exposed by John Kay in a column in the London daily Financial Times on 17 June.
His ruminations followed the announcement by the National Trust last week that it had discovered a portrait it owned had actually been painted by Rembrandt. The National Trust as a result has revalued the painting at £30m.
Kay observed that the valuation seemed to be based on the level two fair value methodology approved by the International Financial Reporting Standards (IFRS) system. This allows the owner of an asset to value that asset according to recent transactions involving a similar one. In this case, the valuation is based upon what a Rembrandt has previously been sold for.
The big question asked by Kay is this: who created that £30m value, and when?
“These questions may not seem to matter much because fine art is a small proportion of economic activity,” Kay wrote. “But exactly the same questions apply to the treatment of financial services, which certainly are a large proportion of economic activity.”
Kay said the purpose of the financial services market is to price securities in a way that represents their underlying productivity. This he defines as being one or more of the following:
- original productive activity
- the promotion of that activity
- the discovery of inherent but unappreciated value.
Kay said we need distinguish between activities that add to value and those that lead to a change in the appreciation of value.
The problem, he concludes, is that this is difficult to apply this line of thinking to art. “…my instinct … is that, while we need the services of dealers, varnishers and critics, what we need most of all is Rembrandts,” Kay said.
The article, by one of Britain’s most respected economists, is an admission of the problems conventional economics has with intangibles, which is what a Rembrandt painting expresses.
It’s not the cost of materials used in creating the portrait that counts, or the skill the long-dead painter deployed. The value is in the subjective assessment of the person viewing the painting and the extent to which that feeling can be transmitted to others.
This is in line with the thinking of the subjective branch of economics which argues that something is worth as much as someone wishes to pay for it. The problem with this approach is that it implies that value is wholly individually-determined and resides solely in the mind of the customer. It suggests that economics is not a social science but essentially a branch of psychology and that value can be created without human interaction.
Economics2030, in contrast, argues that value is created in intangibles through the constructive interaction at the level of the individual among and between the participants in a service transaction. Someone on their own can’t create value on their own. They have to work constructively with others and share the value created.
The arts, particularly the performing arts, express this idea in the most comprehensible way.
A theatre group creates value by performing before an audience which plays their own part in the process of creation through their attentiveness and applause. This is a collective arrangement, but the value created is actually experienced at the level of the individual and in different ways for each person. And it is the result of an interaction between performers and audience.
The value-creation process in a piece of art like a painting is precisely the same, though there is a higher degree of abstraction. The person viewing the Rembrandt isn’t reacting to the arrangement of the paint on canvas. He or she is interacting in an indirect way with the artist.
Anyone capable of appreciating how value is created in cultural industries, consequently, will have a better idea of how it is created in services in general than a conventionally-educated economist who is trained to focus on price, or an analogue of price, even if the service being studied is intangible and is untraded, as it is with that work by Rembrandt.
In services, value is created exclusively through the constructive interaction between the creator and the beneficiary of that creation. It is intangible and consequently only subjectively comprehensible. And that value is only understood at the level of the individual.
So what one person might think is a good service another might reject. Just like people viewing a work of art.
This line of thinking also shows there is no intellectually coherent way of pricing an intangible since there is actually no such thing. The owner of the Rembrandt doesn’t own the aggregate present and potential interactions between Rembrandt’s works and the viewers of such works. No future income stream can be projected in the way it can for a tangible asset like a machine or a building. There is no assurance that what has been paid for another Rembrandt is a useful guide to the one in the National Trust’s ownership. It’s all guess work dressed up as science.
Owners of valuable paintings will seek to counter this obvious truth by preventing reproductions, even those created from memory. Whether that’s possible in an age of digital communications is moot. There’s little in economic theory that suggests the private ownership of ideas is valid or practically-applicable and a lot that suggests it isn’t.
Kay’s conclusion that art is a small part of total activity is right. But creative activity, like that which produces paintings, is now the driving force in advanced economies. Kay is therefore wrong to say that the mysteries of valuing a Rembrandt should be treated as somehow outside the realm of economic analysis. On the contrary, it tells us more about how advanced economies dominated by services actually work than any conventional economist has yet managed.
You can see John Kay’s article in full here: http://www.ft.com/intl/cms/s/0/707ba5c2-f5f8-11e3-83d3-00144feabdc0.html#axzz35HGiJwnl