The setting of prices for goods and services is an essentially economic mechanism, because it determines not only wealth, by valuing the goods and services exchanged, but also the value of the surpluses that actors generate from their activities thanks to productivity gains. With this additional purchasing power, economic actors can hope to satisfy new needs for greater well-being and, consequently, stimulate innovation. We mentioned this dynamic in a previous post: productivity gains.

For modern economic theory, the price is a signal, an information on which each player relies to adapt his production. This theoretical definition defies reality, since, for the most part, prices are established by private negotiation and are not made public. The history of prices formation is well summarized in “The Oxford Handbook of Pricing Management”. Until the 19th century, prices were negotiated, each price being the combination of the price of the good or service plus the cost of transaction, due to logistics and payment costs. If reference prices were circulating, it was by word of mouth, within informed circles. The fixing of price prior to the sale, appears and becomes generalized from the middle of the 19th century. For retail and distribution companies, it was an innovation that facilitated transactions with consumers and allowed the appearance of department stores. It was then generalized to transactions between companies.

With this new system, the price is fixed by the seller, the buyer only has the option of postponing his purchase or buying the same good from another seller for a better price. It is up to the seller to modulate his price in order to sell his production within a given time. The system of transparent, pre-determined prices seems to readjust the balance of power in the direction of the buyer, who is often a final consumer. Actually, this is not the case. The economic sectors have structured themselves, for certain goods, market makers, are ensuring the preservation of high or low prices. Consumers’ choice is limited, especially since they have no choice. In the case of vital goods and services, they must buy them. For some markets, the consumer is the seller, for example, the “labor market” or “real estate”. In these markets, information asymmetry between firms and consumers plays against them, and some firms maintain low or high prices depending on the profession and their interests.

Thus, the surplus productivity gains of the economy as a whole are captured by some firms and are reflected in their income statements. The allocation of profits to self-financing and the willingness of firms to innovate are determining factors in the adoption and diffusion of innovations.

Indeed, few innovations are adopted by the consumer, because they require a high level of industrialization to be achieved very quickly in order to drastically reduce their price. This was the case of the cell phone, if it had been otherwise, it would have remained the attribute of a social elite. Previous innovations, from the Ford T to the washing machine or the television, have similarly benefited from an industrial model that has made their price affordable for all social categories of final consumers.

Thus, companies are the main carriers of the development and adoption of innovations in modern countries. It must allocate to this purpose the surpluses due to productivity gains that it generates. However, this is not the usual case. In fact, most investment comes from auto-financing, i.e. investment generated by the companies themselves. Actually, shareholders are not investors, they have only bought the right to receive part of the dividends from other shareholders. The company is not concerned by this type of operation, or rather, at the time of the distribution of profits, the shareholders often prefer to pay themselves dividends that end up in the purchase of real estate rather than reinvest them in their companies.

This has been the case in Europe and France for the digital transformation, whereas the American champions chose, from their creation, to reinvest all their profits in their company. As a result, they grew at a speed that European companies could not and still cannot match.

These analyses help to lay some groundwork for the future development of the ecological transformation underway. Since we are now looking away from business, we are putting a lot of hope on public money as a source of funds for climate innovations. Not only, in the long run, will this lead to an increase in compulsory levies, but also, as the state is a bad actor for structuring economic activities, an inefficient price formation, which will be to the disadvantage of the client, the final consumer.

The inflation currently affecting energy and food prefigures the increasing costs that the consumer will have to bear. These costs will affect the middle classes and will be difficult to bear for the less wealthy.

So what should be done? We must put the company back at the heart of the economical process of innovation. This is critical if the economy is to move back towards happiness for men and women. This will be the subject of a future post.

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