Value Creation = What Drives The Market

Perhaps the most important thing I have learnt in my professional life that my education failed to teach is that markets do not reward merit, they reward value. These are two entirely different things yet politicians, the labor market and the Press still confuse the two. At Davos French President Nicolas Sarkozy proclaimed that the recent financial meltdown had demonstrated that letting markets decide executive compensation was "morally indefensible." Mr. Sarkozy said "There are remuneration packages that will no longer be tolerated because they bear no relationship to merit." Mr. Sarkozy, like his counter parts in the US and UK, fails to appreciate this key criteria of what makes a free market the best option for every individual in the world.  And many free market supporters equally confuse value with the cult of market meritocracy, a distinction that can prevent their hard work from being rewarded.

Value creation has long been the shy cousin of meritocracy. Historically, the capitalist society has pushed the Great Man theory to explain what makes markets work. According to this theory, the course of history is shaped not by the convergence of multiple, unpredictable events but by the intervention of great men.  Ayn Rand, whose theories and writings are often full of wisdom, also talked about a “pyramid of ability” in capitalism under which the man at the top contributes the most to all those below him, this collecting the biggest rewards. In this thinking the markets identify geniuses among us and catapult them to the top where their innate brilliance is harnessed to improve the lot of mankind. 

That same theory about markets is in broad practice today as governments and advocacy groups target a select few ‘braniacs’ on Wall Street on the topics of compensation, regulation and risk, believing that economic progress depends not on the labors of infinite economic actors but on a select few ‘Masters of the Universe’ who have risen to the top and generate the kinds of rewards that ordinary people cannot.

If you believe in value creation being the principal driver of markets, then this line of thinking is just plain wrong, and even offensive. The Nobel laureate F.A. Hayek believed what makes the market work is that it allows people to use knowledge of their particular circumstances to generate something valuable for others. And circumstances, he emphasized, are a matter of chance - not of gift. Furthermore, since no two people's circumstances are ever identical, every producer potentially has something - some information, some skill or some resource - that no one else does, giving him a unique market edge. In a functioning market financial compensation depends not on someone's innate gifts or moral character, or even on the originality or technological brilliance of their products. Nor, for that matter, on the effort that goes into producing them. The sole and only issue is a product's value to others.

Hayek's understanding of markets essentially democraticizes the concept of merit. If anything in your possession, no matter how trivial - some local knowledge, some quirky interest - can potentially be turned into something useful for others, then there is not any one formula for market success; there are a potentially infinite number. This means that success is possible for a far wider range of people in a market, making market societies inherently less hierarchical than more closed ones. Free markets close the talent-gap by allowing people to ferret out and market whatever they’ve got – even the likes of Lindsay Lohan, Jennifer Lopez and that guy that won American Idol a few years back thanks to voters, not his ahem talent. No matter what your differentiator, you have every shot at succeeding.

So the concept of merit is replaced by that of value. Merit is intrinsic, concentrated and atomistic; value is relational, decentralized and social. What matters is if you can make that value work for others. If the public and the millions of would be entrepreneurs understood this one key element of how markets work, then there would be no confusion over how industries work, how executive compensation works, and why government intervention in the form of bailouts and regulations is not only unnecessary, but actually damaging for all of us. Furthermore, the popular perception that there are a few “Masters of the Universe” who sit in their ivory tower on Wall Street or Silicon Valley or the City and reign supreme through brain power can finally be put to rest.

One last thought…at no other time has there be as many first-time entrepreneurs that need help as there are today. The recession has produced an army of recently laid-off cubicle warriors, people fed up with their 90-minute commutes, women looking to business-building as a way to make up for a variety of frustrations in the workforce or while at home raising a family, and 50- to 70-year old careerists driven to pursue lifelong dreams while still healthy, or forced to bolster their retirement stash.  With the right guidance and insight into value-creation, these entrepreneurs can and will lead the US out of recession if they focus on needs in the marketplace, and coming up with an innovative solution to build a business around. Its that innate ability to smell a business opportunity and jump on it that makes an entrepreneur different from the rest of the pack, or as Peter Drucker once wrote “The entrepreneur always searches for change, responds to it and exploits it as an opportunity.” Where they can create value the market will reward them.