21
Petr Wawrosz: Transferred price and the sector of productive services as the key
preconditions to smart, sustainable, and inclusive growth
Příspěvek byl zpracován na VŠFS v rámci projektu specifického výzkumu Reformy systémů sociálního
investování a sociálního pojištění, problematika jejich přípravy a realizace.
Introduction
The issues relating to economic growth are among the most frequently discussed in
economics. This is logical. Growth allows people to produce more goods, thereby satisfying
more needs. Thanks to new resources that result from economic growth, we are able to cure
previously incurable diseases, prolong the human life, and increase its quality. Nevertheless, it
appears that economic growth has its limits. For example, it may have adverse environmental
impact. As a result of the growing number of opportunities, the stress level of people, who are
not able to take advantage of all the opportunities available, may also increase. Even during
the period of economic growth, there may be some population groups that have no or only
minor benefits (compared to other groups) from such growth. Therefore, other terms are used
in addition to the growth itself, such as sustainable growth, inclusive growth or smart growth.
These types of growth would address the aforementioned negative factors. There are many
publications that deal with these types of growth, analyze their characteristics, and discuss
ways of achieving such growth. In terms of factors affecting economic growth, investments in
human or social capital, as appropriate, are often mentioned (e.g. Becker 1964; Barro and
Sala-I-Martin 1999; Robaliano 2000, Grootaert and Van Bastelae 2002, Savvides and
Stengos 2009; Roy, Roberts and Ali 2012). However, the ways of motivating people not only
to invest in their human and social capital, but also to promote human/social capital
investments of others, are only seldom discussed. The sector that offers or arranges
investments in human and social services to/for its customers may be referred to as the sector
of productive services. This sector offers services, through which customers increase their
human and social capital, thereby becoming more productive.
The objective of this paper is to show that transferred price and the sector of productive
services represent key preconditions to smart, sustainable, and inclusive growth. The article is
organized as follows: First section introduces concepts of sustainable growth, inclusive
growth and smart growth. Second section describes characteristics of the sector of productive
services. We, in addition to other things, explain why we chose this term and how our
description of possibilities offered by the sector resembles the possibilities that were offered
by the sector of industry during the Industrial Revolution. The third section then brings
connection between the sector of productive services on the one hand and smart, sustainable,
and inclusive growth on the other hand. It is shown why we conjecture the sector of
productive sectors is the key precondition to smart, sustainable, and inclusive growth. Fourth
section concentrates on the essence of transferred price, explains its principles, and shows
how transferred price is able to solve some risk associated with the situation, where some
people that wish to invest in their knowledge abilities or skills do not have sufficient funds but
other people are willing to lend them the necessary resources. We emphasize that the principle
of transferred price is the general principle that can be used in many situations when income
of one person depends on the quality of services that are provided to this person provided by
another person. Human capital contract, sometimes suggested (e.g. Friedman 1962; Palacios
Lleras 2004) as possible means how students can finance their education, then is a specific
example of using the transferred price principle. Fifth section suggests how transferred price
could be used in the sector of productive services. The suggestion is based on the idea that a
provider of productive services should be lender who in some time provides its customers
with the services. Customers are borrowers, who pay for the services not at time such services
are used, but sometimes in the future, using their future income that is the consequence of
such services, provided their income exceeds some threshold defined in the contract between
22
the lender (provider of productive services) and individual customers. Sixth section shows
that transferred price provides useful feedback about the productive service quality to its
provider, client, and other subjects. The seventh and final section discusses the obstacles that
prevent the broad use of transferred price. We believe that some of them are only imaginary,
i.e. they only exist only in the people’s mind and can be overcome relatively easily. Others are
real; however, and their existence is the main reason why the transferred price concept is only
seldom used. The barriers to entry into the market (sector) of productive services and tough
regulations of the sector are among the most important in our view. We develop our opinion
in the section and suggest what should be done for achievement of smart, sustainable, and
inclusive growth.
1. Concept of sustainable growth (development), inclusive growth, and smart growth
This chapter introduces the concept of sustainable growth (development), inclusive growth,
and smart growth. Let us start with sustainable growth/development. There are many
definitions of these terms, but the most frequently quoted definition comes from the
publication Our Common Future, also known as the Brundtland Report (UN 1987):
“Sustainable development is development that meets the needs of the present without
compromising the ability of future generations to meet their own needs. It contains within it
two key concepts: 1. the concept of needs, in particular the essential needs of the world’s
poor, to which overriding priority should be given; and 2. the idea of limitations imposed by
the state of technology and social organization on the environment’s ability to meet present
and future needs.” Therefore, what can we derive from the definition? At first glance, it
includes a clear ethical motive of responsibility to future generations, which have the right to
live at least under the same conditions as the present generation. Moreover, it talks about the
meeting of needs of the present; based on this, we can assume that the objective is not to
suspend or limit economic growth. Quite the opposite. Only sustainable growth is the basic
precondition to escaping the poverty gap and to meeting individual needs. UN (1987)
explicitly mentions that the present needs always refer to the basic needs of the poorest people
on the planet. Otherwise, the term “needs” could be statistically misinterpreted: although the
global situation might seem relatively good, consequences of a potential disaster would most
severely affect the poorest population groups (e.g. seaside populations of developing countries
in case of more significant ocean level rise, where developed countries would be able to deal
with such defect relatively successfully). The development in the term “sustainable
development” is a dynamic element, a process of constant change, where the meeting of the
needs of the present generation and of the future generations is harmonized. It is not defined,
which needs matter more. The decisive measure is the preservation of natural resources and
the development of the quality of life. The phrase sustainable development fully characterizes
the global perspective of future development. Development characterizes change in time, with
the subject improving. Sustainable development emphasizes permanent, long-term nature of
the given activity. Our paper will rely on the aforementioned, with some expansion. In our
understanding, sustainable growth will refer to the following growth that also:
1. Meets the needs of the present without compromising the ability of future generations
to meet their own needs.
2. Does not, in the conceivable future, hit the barriers given by the limitations of natural
resources or the barriers determined by the limited ability of natural resources to
absorb the consequences of human, and particularly economic, activity.
The expansion consists in the fact that the objective of sustainable growth is not only the
preservation of natural resources, but also the limitation of people’s dependence on the nature,
i.e. to ensure that people need less natural resources to meet their growing needs or that the
23
use of such resources is more effective, as appropriate. This also achieves the goal of the
natural resources preservation.
Let us move to the terms inclusive growth and smart growth. OECD defines inclusive growth
as5 “a growth that combines strong economic growth with improvements in living standards
and outcomes that matter for people’s quality of life (e.g. good health, jobs and skills, clean
environment, community support).” Ali and Hyun (2007, p. 1) write: “Growth is defined as
inclusive if it increases social opportunity function which depends on two factors: 1. average
opportunities available at population; and 2. how opportunities are shared among
population.”. Generally speaking, the concept of inclusive growth emphasizes that the growth
is beneficial to all people of the given society, where the growth takes place, and that if there
are some population groups that do not profit from such growth, there should be instruments
for including those groups within those that do. At the same time, the inclusion should not be
in the form of redistribution, but by ensuring that those, who were previously excluded, will
start contributing to economic growth through their activity, thereby increasing their income
and ability to meet their needs.
The term “smart growth” is associated with the terms inclusive growth and sustainable
growth and is mainly used within the context of the European Union. All three terms can be
found in The Europe 2020 Strategy, where the following is mentioned: “The Europe 2020
Strategy6 is about delivering growth that is: smart, through more effective investments in
education, research and innovation; sustainable, thanks to a decisive move towards a lowcarbon
economy; and inclusive, with a strong emphasis on job creation and poverty
reduction.” The Strategy further declares that: “Smart growth means improving the EU’s
performance in7:
- Education (encouraging people to learn, study and update their skills
- Research/innovation (creating new products/services that generate growth and jobs
and help address social challenges)
- Digital society (using information and communication technologies)
2. Characteristics of the sector of productive services
It is clear from the above mentioned that all three terms (sustainable growth, inclusive growth,
and smart growth) are associated with investments in human and social capital. The definition
of the term smart growth explicitly mentions investments in education, research and
innovation. Sustainable growth may only exist if we can find such ways that would make it
possible to meet our needs without limiting the needs of the future generations. We can agree
with the opinion of Kim and Lee (1999) that such fulfillment of our needs is only possible as
a result of advanced technology, which is only possible thanks to investments in human and
social capital, with people gaining knowledge, skills, and capabilities in respect of such
technology and its application in the society. The concept of inclusive growth, when the
members of disadvantageous groups are included among people, whose activities contribute
to economic growth, can only be implemented if the members of disadvantageous groups
develop their skills and abilities, but first they have to receive knowledge on how to develop
them. In this paper, we rely on the conviction that a lot of knowledge, skills, and capabilities
5 The definition is taken from http://www.oecd.org/inclusive-growth/about.htm.
6 The details about Europe 2020 Strategy are cited from http://ec.europa.eu/europe2020/index_en.htm.
7 EU targets for smart growth include: 1. Combined public and private investment levels to reach 3% of EU’s
GDP as well as better conditions for R&D and Innovation. 2. 75% employment rate for women and men aged
20-64 by 2020 – achieved by getting more people into work, especially women, the young, older and low-skilled
people, and legal migrants. 3. Better educational attainment, in particular: reducing school drop-out rates below
10% and at least 40% of 30-34–year-olds with third level education (or equivalent).
24
cannot be obtained and/or developed by people on their own. In such case, some people must
exist that would assist with the obtaining and development thereof. These people may be
parents and other relatives, neighbors, friends, as well as people working in specialized
organizations that provide knowledge to their clients and develop their skills and capabilities.
Schools, educational agencies, etc. are the typical example of such institutions. If we
somewhat expand our view, such organizations may also comprise entities, the objective of
which is to ensure that people maintain and are able to use their knowledge and skills, or to
ensure that they are able to obtain and develop them for as long as possible throughout their
life, as appropriate. This concerns, for example, medical facilities, spas, entities providing
sport-related services, etc.
In general, entities that offer the acquisition, development, and preservation of knowledge,
skills, and capabilities to their customers may be referred to as entities operating within the
sector of productive services. Why did we choose this name? We believe there are the
following reasons for this:
1. The production of this sector may lead to sharp and long-term increase in the
productivity of labor employed within industry and personal services associated with
industry. In other words, this sector offers services that make it possible to increase the
productivity of human activity.
2. The production of this sector may lead to sharp and long-term increase in the
productivity of all resources originating from land as the factor of production as well
as resources in the form of capital goods in the area of industrial and agricultural
production. Similarly as in the previous subsection, it holds true that the given sector
offers services that make it possible to increase the productivity of human activity.
3. The sector may gradually employ the decisive quantity of labor or human capital, as
appropriate.
4. The production of this sector may predominantly be applied within the sector itself. It
also comprises the innovations’ center of gravity.
5. The sector may significantly expand the range of people’s needs. At the same time,
this concerns needs that are more and more met by the production of the educational
sector. The substance of such needs consists in the fact that the meeting thereof as well
as the utility associated therewith, including the pleasure associated with such utility,
immediately relates to the development and preservation of human capabilities. The
given needs may then be referred to as the capability needs.
6. As a result of the above mentioned, this sector has a predominant share in the overall
production and economic growth, the form of which is determined by the nature of its
production (i.e. production, which is in the form of educational and other services
aimed at the development and preservation of human capabilities).
In most subsections, we knowingly use the term “may” (e.g. “The production of this sector
may lead to sharp and long-term increase in the productivity of labor employed within
industry…”). The reason for doing this will be explained in Chapter 5. We believe the term
sector of productive services is more precise than the normally used term knowledge society.
The term sector of productive services is wider, encompassing not only the area of acquisition
of knowledge, but also areas leading to their preservation (e.g. through medical and spa care,
sports) and longest possible application (by extending the period, for which people can be
economically active). At the same time, the term sector of productive services emphasizes that
this sector offers production, which is aimed at increasing the productivity of other sectors.
Since the production is most frequently in the form of services, the given word is emphasized.
We should also note that the given characteristics of the sector of productive services are
based on an analogical role, which was played by the industrial sector during the 18th
and 19th
25
centuries, i.e. the period of the Industrial Revolution8. The following also applied for the
industrial sector:
- The production of the sector led to sharp and long-term increase in the productivity of
labor for people employed in agriculture.
- The production of the sector led to sharp and long-term increase in the productivity of
all resources originating from land as the factor of production.
- The sector gradually employed the decisive quantity of labor.
- Industrial production is predominantly applied within the industrial sector; the sector
also concentrates innovations.
- The sector significantly expanded the range of people’s needs, which are more and
more met by the industrial production – i.e. through products and services produced by
industry.
- As a result of all the aforementioned factors, the industrial sector has a predominant
share in the overall production and economic growth, the form of which is determined
by the nature of the industrial production.
Economic effects, which come into being within the sector of productive services, take the
form of accelerated professional fulfillment, better professional performance, development of
productive fulfillment capabilities, and longer zenith and horizon of productivity in terms of
its clients. In plain terms, customers of the sector of productive services are able to carry out
more activities as a result of the services provided by the sector, whereas the given
capabilities are obtained faster, given activities are performed more efficiently, and customers
are able to perform at least some of the activities for a longer period of their lives. The
productive services refer to services that make it possible to acquire, develop, preserve, and
apply human capital. It concerns services such as education and healthcare, as well as
relaxation, recreational, pedagogical, and cultural and other services. All these services may
be included in the area of social investments and social insurance. Social investment refers to
the provision of services, through which people acquire and develop their human capital or
which are used to preserve it, as appropriate. Social insurance refers to any and all activities
that protect people from the risk of losing human capital.
3. Sector of productive services and smart, sustainable, and inclusive growth
How does the sector of productive services contribute to sustainable growth, inclusive growth,
and smart growth? We will start with sustainable growth. The production offered by the sector
represents substitutes of other goods and services. However, such other goods and services
have more significant adverse impact on the environment – e.g. due to the fact that they
utilize more natural resources or their effects impact the environment more. In case
productive services play a major role within the economy, then the consumption will burden
the environment less, consequently contributing to sustainability. Reduction of the
environmental impact of people may be described as a first-degree effect of the sector of
productive services. However, the importance of this sector lies within the second-degree
effect. It is based on the fact that the development of people’s capabilities (i.e. not only of
individuals, but on a team basis as well, as part of the social division of labor, as appropriate)
is also immediately associated with their ability to innovate. In case people acquire, develop,
and preserve their knowledge, skills, and capabilities, they are able to innovate. Consequently,
they contribute to economic growth. Moreover, the ability to innovate retroactively affects the
development of other knowledge, skills, and capabilities. As a result of acquiring, developing,
and preserving the given capabilities, people that had been previously excluded from the
8 For detailed characteristics of the Industrial Revolution, see e.g. Watt (2009).
26
opportunity may participate in economic growth. Therefore, such growth may be referred to
as inclusive growth. Due to its nature, it may also be referred to as smart growth.
The ability to innovate also relates to the sustainable aspect of the growth. As a result of
innovations, we are able to reduce (even significantly or even radically in many cases) the
quantity of natural resources per single unit of utility. In other words, the sector of productive
services increases the level of productive human capabilities, which immediately determine
how quickly and to what extent economic growth becomes independent on natural resources,
i.e. to what extent the environmental burden and impairment are reduced. The resulting effect
of reduced consumption of material or energy inputs per single unit of useful effect
immediately depends on the technical and technological progress; such progress then depends
on the level of productive human capabilities, whereas the level of productive human
capabilities depends on the effectiveness of productive services that aim the acquisition,
preservation, and application of human capabilities.
4. The essence of transferred price
In case it is possible to attain sustainable, inclusive, and smart growth through the sector of
productive services, it is worth asking why such growth is not taking place. To answer this
question, we will formulate a thesis that the transition to the economy of productive services
requires the involvement of entities operating within the sector of productive services to
ensure that their clients truly acquire, develop, preserve, and apply their human capital and
that other clients have sufficient income and utility from such capital. In case an entity
operating within the sector of productive services is motivated to develop its clients’
capabilities to ensure that they maximize their income or utility, this sector will develop and
may actually become the dominant economic sector. Therefore, we call for the creation of
feedback between the effects of productive services and the financing of entities that provide
the productive services.
Investments aimed at acquiring, developing, or preserving human capital meet the general
characteristics of investments in many parameters. The given entity invests in the capital,
because it assumes the given investment will generate returns. Some entities may have budget
constraints – i.e. they may not have sufficient funds for the given investment. In such case,
they may look for someone willing to lend funds to them to cover the investment. As already
noted by Friedman (1955 and 1962), a lender that provides funds to a borrower for
investments in human capital is disadvantaged compared to a lender that provides funds to a
borrower for investments in physical capital. Physical capital may be pledged in favor of the
lender – i.e. in case an investment in such capital fails, the lender may recover at least some of
the loan by selling or using the physical capital. Human capital cannot be pledged. From this
perspective, investments in human capital are riskier than investments in physical capital; the
guarantee of recovering an investment is lower. It may easily happen that a person with low
budget constraints is unable to convince any lender about the profitability of his investment
and will fail to acquire a loan. If his investment could have been successful, then not only the
given person incurs a loss, losses are also incurred by the lenders, he could not convince, as
well as by the entire society, because he cannot contribute with activities he would have been
able to perform as a result of acquiring, developing, or preserving human capital.
Economic theory (e.g. Friedman 1962; Palacios Lleras 2004) proposed a solution to the given
problem in the form of human capital contracts that mainly relate to investments in education.
A Human Capital Contract (HCC) is a voluntary private contract between a student and an
investor in which the student commits part of his future earnings to an investor for a fixed
period of time in exchange for capital to finance his education. The main parameters for
producing an HCC are the percentage of income and the repayment period. Because of its
voluntary nature it works best when market forces determine the contract parameters. The
27
advantages of an HCC are that it decreases the risk of the investment for students by adjusting
the payments they will have to make according to the amount they earn after completing their
education. If a student’s investment in education does not result in higher earnings afterwards,
the payments required for financing the education are small. Conversely, if a student can earn
a higher income after his education, the payments are much higher. On average, those
students who can pay, because of the higher earnings they obtain as a result of their education,
cover the costs of those who do not obtain higher earnings.
The significant characteristic of HCC is the fact that the contract uses the transferred price
principle. The principle9 means that:
1. A lender provides funds to a borrower today as an investment in acquiring,
developing, applying, and preserving the borrower’s human and social capital.
2. The borrower only makes payments from the earnings generated from the funds
provided by the lender and invested in a defined manner.
3. The borrower makes payments based on the amount generated from the funds
provided by the lender.
4. The borrower makes payments directly to the person that provided the given funds
(i.e. to the lender).
Briefly speaking, the borrower pays to the lender using his future earnings. It is a type of
contract, which transfers the future earnings into the present – hence the name “transferred
price”. The basic contract parameters are set down today; the given amount to be paid is
transferred from the future. The borrower’s payments to the lender take place in the future provided
the contract terms are met, i.e. the funds invested by the borrower in human and
social capital actually start to generate such earnings for the borrower that he is able to repay
his liabilities. Therefore, the borrower’s payment to the lender depends on the borrower’s
future earnings. In case the borrower’s earnings are too low, no payments are made. The
amount of the earnings then determines the success of the borrower’s investments in his
human and social capital. The transferred price eliminates the borrower’s budget constraints,
making investments in human and social capital possible even for those entities that currently
do not have sufficient funds. Moreover, the transferred price increases the number of entities
that are involved in the borrower’s success. It is no longer only the investor – currently acting
as the borrower – but also his creditor. The creditor (lender) provided funds to the borrower
and in case the borrower fails to repay such funds, the lender incurs a loss. In case an investor
might, for various reasons (e.g. lack of information, his personal qualities, etc.), prefer
investments in such structure of human and social capital that does not lead to successful
investments, the lender shall also act as the borrower’s corrector. Obviously, even the lender
may be wrong. However, if there are several lenders or in case one lender has several
borrowers, the pressure on the elimination of error further increases.
We must underline that the transferred price does not have to work solely in the area of
investments in education, but in other areas as well – investments in health (e.g. with regard to
medical, spa, and sports services), old-age security, etc. Therefore, we believe the transferred
price principle is applicable in all situations where one person provides some goods and
services (most frequently services) to another person, whereas the other person’s earnings are,
at least partially, determined by the quality of such services10. This is why we use the term
“transferred price” and not “Human Capital Contract” throughout our paper. We believe that
an HCC, i.e. contract relating to investments in human capital, is only one of the contracts
9 We believe the transferred price principle is the most important part of the Human Capital Contract. This is
why we given this principle such significant attention.
10 The transferred price principle may be applied in purely commercial areas. For example, Valenčík (2014)
mentions the compensation of tennis coaches from professional players, where the coaches’ remuneration may
be determined as a specific share from the players’ earnings.
28
where the transferred price principle may be applied. In other words, we believe the
transferred price principle is a universal principal, whereas an HCC is a specific contract that
utilizes such principle. The transferred price differs from a “regular” price to some extent,
specifically:
- Transferred price has more parameters: amount of earnings, from which payments
start – payment amount set as a percentage, repayment period;
- Transferred price does not have a primary nominal value – its nominal valuation may
only be determined on capital markets, on a secondary basis;
- Transferred price amount is derived from the valuation of the effect of services
associated with the acquisition of human capital on professional markets.
5. How to use transferred price in sector of productive services
Economic theory (Valenčík and Budínský 2011) points out that in case the transferred price
principle works on the basis of a three-way relation of the lender, borrower, and entity that
provides productive services to the borrower, the lender is in a difficult situation. It is in his
interest to monitor, whether the service provider really provides high-quality services, on the
basis of which the borrower would get such human capital structure that would ensure the
borrower’s earnings are sufficient to repay his debt to the lender. Nevertheless, such
monitoring is quite costly for the lender, whereas he may not be sure, whether his ideas about
the borrower’s investments are in fact met. This situation is referred to as information
asymmetry (e.g. Akerlof 1970). In case the lender cannot eliminate such information
asymmetry, he may not provide the funds to the borrower at all. Alternatively, the lender may
request high interest rate during the period such funds are not being repaid or high share from
the borrower’s future earnings. The given conditions may discourage some potential
borrowers, particularly the low-risk ones, who may find the repayments unbearable. This
situation leads to a vicious circle: the lender’s loans are only sought by high-risk borrowers
with lower likelihood of success. In case lenders to not provide loans to risk-free clients that
could cover the losses of high-risk clients, their demands will continue to increase,
discouraging other lower-risk borrowers.
The situation discussed in the previous paragraph does actually occur in real life. The “My
Rich Uncle” (MRU)11 program offering loans to students in the USA covering their tuition
fees and other costs of studying is one of the most remarkable examples. The company started
its operation at the beginning of the 21st
century, lending money covering the cost of
university education directly to debtors (university students) at an annual rate of 7.85%.
Borrowers had to return the principal and the interest over 10 to 15 years after the completion
of their education. They had to pay a fixed rate of 0.1% to 0.4% of their gross annual income.
Naturally, the owners of MRU did not have enough money to lend. MRU obtained funds from
financial investors, who were not willing to continue financing MRU after the start of the
financial crisis in 2008. As a result, the company filed for Section 7 US bankruptcy in
February 2009 and suspended all its operations. The financial crisis was not the only problem
that worried MRU. Even before the crisis its interest rate was higher than the rate of
unsubsidized government loans. The company faced adverse selection: especially people who
could not get government loans, i.e. people with a higher risk, were interested in borrowing
from MRU. The delinquency rate of MRU clients was higher than the rate MRU investors
were prepared to accept. The experience of MRU shows that the success of an HCC as a
private market instrument depends heavily on the investors’ willingness to give money for an
appropriate time. Credit failure is quite probable in the time discrepancy between the period
11
The facts about MRU are taken from http://www.huffingtonpost.com/anya-kamenetz/myrichuncle-is-out-ofcas_b_165352.html
and http://collegesavings.about.com/b/2008/08/26/myrichunclecom-legit-lender-or-loan-
shark.htm.
29
that investors are willing to lend money for and the period in which borrowers pay their loans.
This was the case with MRU: investors gave the company money for a shorter period than the
borrowers needed – borrowers could start paying money back after finishing their education
(leaving school). MRU had to revolve its financial resources and could not do so during the
crisis because of insufficient resources to continue revolving.
However, the solution of the aforementioned does not have to be complicated. The only thing
that needs to be done is to directly involve the providers of productive services in their
customers’ success. How? It is necessary to ensure that the providers receive some of their
customers’ earnings. Therefore, customers will pay for the productive services rendered by
means of the transferred price, i.e. certain percentage of earnings generated by the productive
services. The contract between a customer and a provider may also define other parameters,
such as: a) moment (together with other conditions), from which a customer shall start his
payments (e.g. a customer must reach certain income level); b) period, for which a customer
is required to repay his debt; c) circumstances, under which it is possible to suspend or
discontinue the repayments, including a situation where the customer’s earnings drop below a
certain threshold; d) whether the payment is calculated from the customer’s total earnings or
only their part (e.g. difference between the customer’s earnings and a minimum wage), etc.
Therefore, the transferred price concept we propose comprises the following:
1. Provider of productive services acts as the primary lender. The provider may be an
educational institution, medical facility, spa resort, etc. We may even assume that if
individual providers of productive services, who finance their services by means of
transferred price, operate in different segments (e.g. one of them in education and
another one in healthcare), they will start cooperating, because the earnings of one
provider also depend – to some extent – on the services offered to customers by the
other provider.
2. Buyer “pays” for the provided service scheme based on the benefits of the acquisition,
development, application, or preservation of his capabilities through the productive
services system – i.e. he pays certain amount (e.g. 3 to 5% of his earnings) from his
earnings after the service is utilized and usually after some income threshold is
exceeded (a multiple of statistically expressed average earnings) either for a
predetermined period of time (10 to 15 years), which settles the obligation
(irrespectively of how much and when was actually paid), or until the full settlement
of the debt (which may or may not be subject to interest).
In case the provider of product services is involved in the amount of earnings to be generated
by his customers, whereas the amount of earnings is an effect of acquiring, developing or
preserving human capital, as a result of which the customer has more and better capabilities,
the provider will also try to provide the customer with such services that would develop and
preserve his human capital and ensure the customer actually reaches the given income level.
Naturally, some customers may fail to reach the given income level, thereby making no or
only very low payments to the provider. However, in case the provider has many customers,
the risk of the given loss (costs incurred by the provider in connection with providing the
services to a customer) will be covered by the customers, who generate such earnings that
would not only cover the provider’s costs, including opportunity cost – i.e. including the
provider’s alternative returns, associated with the successful customers, but also the
provider’s costs associated with the unsuccessful ones. It is also necessary to underline the
aspect of the long-term horizon. In case the provider of productive services receives returns
from his customers for a relatively longer period of time, he will be committed to ensuring
that the customers’ knowledge, skills, and capabilities may be used for such prolonged period
of time. This partly contributes to a long-term growth, and partly limits efforts aimed at short-
30
term profits that may have negative effects in the long-run12. In case the customers of the
productive services providers repay such services for a longer period of time using the
transferred price, the following will happen:
- The given system allocates funds to the service providers associated with the
acquisition of human capital, whose production is the most successful on professional
markets. The providers’ clients will logically prefer those providers, who will ensure
the highest returns possible for them in respect of their investments.
- The given system “bridges” the specific “lender – borrower” relationship, which arises
in connection with investments in human capabilities (e.g. a student / graduate, who
“purchases” educational services and also acts as a borrower/debtor, and a university
that acts as a “seller” and a lender/creditor simultaneously) and a capital market. This
bridge consists in the fact that capital markets may be interested in purchasing
contracts by and between customers and productive services providers – i.e. they may
thus be subject to secondary valuation. In case the providers sell their receivables
(even as a package of receivables) to capital market entities, they will receive the
funds earlier. However, capital markets will only invest in contracts based on the
transferred price, if they believe it might be beneficial. This will further promote the
interest of the productive services providers in ensuring that their customers maximize
their earnings, thereby maximizing the returns on the receivables of the providers from
their customers, making them as attractive as possible for capital markets. The
following applies in terms of the capital market entities: it is less costly to monitor a
provider of productive services (one entity) than the provider’s customers (many
entities). It is easier for them to obtain information from the provider about the success
of his customers. To some extent, this eliminates the problem of information
asymmetry and the associated adverse selection problem13.
- In case the productive services providers are truly involved in the success of their
customers, it is safe to expect the characteristics of the sector of productive services
described in Chapter 2 will be fulfilled. In other words, it will no longer be necessary
to use the term “may” (e.g. “The production of this sector may lead to sharp and longterm
increase in the productivity of labor employed within industry…”), but the theory
will describe actual events (e.g. “The production of this sector leads…”).
6. Feedback of transferred price
The transferred price meets all the traditional price roles (e.g. Besanko and Braueutigam
2008), i.e. informational, allocation, and motivational role. The allocation and motivational
roles consist in the fact that the provider of productive services is motivated to maximize the
quality of its services in terms of its customer’s success on professional markets, receiving
financial funds based on the success of its customers on professional markets. The
informational role is connected to the allocation and motivational roles: based on the earnings
generated by the customers of the providers of productive services, these customers as well as
other people interested in the given services get information about whether the given service
12 As an example of such short-term profits with negative effects, we may refer to mortgage loan financing
during the first decade of the 21st
century in the US, where providers of such loans were – in terms of their shortterm
returns and profits – interested in providing as many loans as possible, even to people unable to repay such
loans. This subsequently led to the mortgage loan crisis emerging and long-term negative effects.
13 It is necessary to emphasize that the problems associated with information asymmetry and adverse selection
may be mitigated; however, not completely eliminated. These problems arise in respect of most human
interactions, because individual participants do not have the same information in the vast majority of such
interactions and to achieve the same level of information is too costly or even impossible. See e.g. Bowles
(2004) for details. On the other hand, we are convinced that increasing human capabilities will make it possible
to find solutions to the given problems, i.e. their effects will decrease.
31
is beneficial, to what extent is the given provider competitive in relation to other providers,
etc. In terms of the informational role, it is also worth noting that the repayment of the
customer’s liabilities to a productive services provider may take place through a central
registration system, which provides information to all system participants (in an anonymous
and appropriately aggregated form) about the forecasted earnings for various productive
services. It is safe to assume that successful providers will be interested in the establishment
of such system, solely for the reason that it would be easier for them to generate funds from
the capital market entities (in the above mentioned form of purchases of receivables of the
productive services providers from their clients, or in the form of loans and investments made
available by the capital market entities directly to the providers).
In terms of the standard roles of a price, the transferred price also provides feedback. It
provides feedback not only to the productive services providers and to their customers, but
also to third parties (e.g. capital market entities or other prospective/actual customers of
productive services, existing and potential competitors, etc.). All entities learn about the
profitability of investments in productive services, about the success of individual providers
of such services. In terms of economic theory, the feedback falls in the area of
microeconomics. It will allow optimal allocation of resources – productive services providers
and their customers will invest in the services they believe to be most profitable for them
according to the feedback14. Nevertheless, the feedback also has macroeconomic
implications that contribute to the fact that the development of the given system, where
productive services are provided, is in the form of sustainable growth, inclusive growth, and
smart growth. Why is feedback necessary for attaining the given growth and why is the
transferred price able to provide it?
1. Feedback is necessary for creating sufficiently motivating and competitive
environment on the productive services market. The nature of productive services
contributes to promoting competition. As a result of the services, economic activities
may be performed by people, who would not be able to perform them or would only
be able to perform them to a limited extent without such services given. Thanks to the
capabilities, barriers to market entry are either eliminated or reduced for such people,
leading to increasing production and reduced price. Naturally, the sector of productive
services is also a market. In case entities operating on the given market receive
feedback, they will be motivated to maximize the effectiveness of their activities,
including environmentally friendly activities, activities that use minimum resources,
are available to previously excluded population groups, etc. Aggregate activities of all
entities operating within the sector of productive services will then generate smart,
sustainable, and inclusive growth. Thanks to their impact on other sectors, with
innovations generated through the sector of productive services contributing to
growing productivity of such other sectors (see Chapter 2), the smart, sustainable, and
inclusive growth may take place in all sectors – i.e. on the level of the entire economy.
2. The feedback is necessary to ensure that the provider of productive services, who
significantly contributes to growth, can expand its activities similarly as innovations
are disseminated in any productive area. Moreover, it is necessary for ensuring that the
dissemination of innovations process eliminates ineffective entities from the given
area or, as appropriate, that they are forced to switch to effective forms of activities in
the area of services that enable the acquisition, preservation, or application of human
capital (as in any well-functioning competitive environment. In case all or most
entities are forced to operate effectively, where such terms comprises the reduction of
the material intensity of inputs, involvement of other people, utilization of
14 Naturally, we assume that the productive services providers and their customers also consider other
information, in addition to the feedback.
32
innovations, it is clear that the growth of the given community will meet the
characteristics of smart, sustainable, and inclusive growth.
We must emphasize that, in addition to the traditional roles, the transferred price also has
other roles that are not ensured by “normal” price. We have already discussed these roles, so
in short:
1. Investment (credit) role: Each person has access to productive services, irrespectively
of whether he/she does/does not have sufficient funds to pay for them;
2. Solidary-insurance role: More successful customers of the productive services
providers pay more than the less successful ones (those, who fail, do not pay
anything). This concerns certain solidarity of less and more successful (unsuccessful)
customers, a method of preventing / diversifying the risk borne by the provider of
educational services. However, such risk may be transferred to another entity through
the capital market.
7. Discussion: Barriers to applying the transferred price mechanism and their
elimination
Generally speaking, the necessary precondition to attaining smart, sustainable, and inclusive
growth is the development of the productive services sector (as we defined the sector),
whereas the way for ensuring this sector becomes the dominant economic sector is to allow
the payment for services offered by the sector through the transferred price mechanism. If this
is the case, why do not various entities operating within the sector start using the transferred
price mechanism on their own? After all, the implementation of the mechanism is an
innovation. In case the given innovation is prospective, individual entities should be
motivated to use it. Why is it not the case? Standard objections to the transferred price
mechanism are roughly as follows:
1. Effects generated by productive service customers will be reflected in their earnings in
a long period of time. This weakens the ties between the services and the relevant
earnings. Moreover, in case of a prolonged repayment of the given debt of the
customer to the provider of productive services, the provider of such services will
recover its costs and generate its profit a long time after the provision thereof.
Immediate benefits are not clear; providers are exposed to a number of risks (they may
lose client’s contacts, have problems with corroborating the amount of earnings – i.e.
whether a client is/is not required to pay, etc.). All this causes the providers of
productive services to opt for standard forms of financing their activities (directly or in
the near future).
2. The amount of client’s earnings results from a number of factors. The fact a client was
a customer of a productive service, contributes to the amount; however, it is not the
only factor. It is difficult to estimate the impact of each factor, including the
productive services, in advance. The impact of productive services may easily be
overestimated or underestimated, which will be reflected in the transferred price
parameters (contract duration, payment amount, minimum income amount – with
clients not paying anything if the threshold is not reached, definition of the amount,
from which clients make payments, etc.). Clients, for whom the impact of productive
services was overestimated, will pay too much, thereby reducing their interest in
productive services. On the other hand, clients, for whom the impact of productive
services was underestimated, will pay too little, with the productive services providers
not being able to cover their costs. Therefore, the easiest way is for clients to pay right
away. In this case, the price may be determined based on the costs associated with the
service, which at least reduces the risk of the service providers.
33
3. In case the productive services customers generate higher earnings in the future, and
such increase is not related to the productive services, it seems unfair for those
customers to pay anything from the given earnings to the service providers. Customers
may try to conceal the given earnings or to ensure their payments are made in a way
that prevents the need to pay the relevant share to service providers. This is associated
with high transaction costs. Some customers may not even accept the higher earnings,
including a situation, where they do not start performing activities that are directly
associated with higher earnings. All this has negative microeconomic and
macroeconomic implications, including an impact on economic growth.
4. Future repayments require high-quality monitoring system to limit the motivation of
the productive services customers to hide their earnings. Moreover, it is necessary to
ensure an effective debt collection system in respect of the providers’ receivables from
their customers. All this is difficult and costly. It is not clear whether the costs
associated with the aforementioned would not outweigh the benefits. Some objections
may also be ideological. Let us at least mention two of those:
5. The application of the transferred price would result in an increased role of the market
in areas that are traditionally viewed as areas ensuring public goods, providing
positive externalities that contribute to the socialization of people, ensure interpersonal
solidarity, raise individuals to citizenship, their involvement within the society, etc.
This increased role of the market will lead to further moral devastation of the given
segments, which have already been stigmatized by substantial commercialization and
cease to serve their original purpose. As a result of such commercialization, some
entities are already unable to consume public goods and goods and services with
positive externalities, because of the barriers arising from the commercialization.
Further promotion of the given market role will result in a rising number of such
people.
6. The proposed model works with the idea that people are able to think long-term and
can be motivated by long-term expectations. This is not the case in reality. Most
people prefer immediate benefits to long-term ones. After all, even economic theory
(e.g. Perloff 2008) clearly states that the value of present goods and services is higher
than the value of future goods and services. It is difficult for people to image all the
potential benefits of investments in their human and social capital. The effect of such
investments is too long to be comprehensible for people.
We believe that most objections may be resolved - both the practical ones (points 1 through 4
of this Chapter) and the more or less ideological ones (pointns 5 through 6 of this Chapter). It
is obviously true that customers will only start repaying the costs associated with the
provision of productive services after some period of time and may be repaying for a
relatively long period of time. However, there are other areas, where investments generate
returns after the completion of the given investments, with a longer period of time from the
moment they start to generate returns until the full settlement of all investment costs
(including opportunity cost). There are various experiences with long-term repayments and
mechanisms for addressing them. With regard to an objection that debtors usually have some
assets that may be pledged in favor of their creditors in case of these forms of investments (as
mentioned above in Chapter 4) and that this is not true for investments in human capital, we
can answer that even though it is not possible to pledge the human capital of a debtor
(borrower), it does not mean that a debtor does not have or will not acquire after the
conclusion of the transferred price contract other assets that could be pledged in favor of the
creditor. The method of monitoring and other issues relating to the debtor’s earnings may also
be addressed in a repayment contract. With regard to the contract parameters aimed at
ensuring that debtors do not pay either too much or too little, as well as potential repayments
34
from earnings that do not result from investments in human capital, it is safe to assume that
the invention of people will seek answers to the given issues. Realistically speaking, we can
assume that the transferred price principle will start evolving gradually. For example, the
providers of productive services will ask for a partial payment in the standard manner – i.e. at
the moment the services are provided, whereas the remaining amount will be paid in the form
of transferred price. The providers and customers will gradually learn how to valuate effects
of the given service, distinguish the effects resulting/not resulting from the given service, and
this will be reflected in the contract parameters.
The ideological objections may also be addressed. With regard to the fourth objection relating
to the expansion of the market to areas previously reserved for the public sector, it applies that
the role of the public sector is to eliminate imperfections of the market mechanism and
provide goods and services the market cannot provide, or provides them in an non-optimal
manner (produces more/less than the market optimum). The public sector is not set down
forever. If, as a result of human invention, it is possible to expand the market to areas that
were previously associated with market failures, if it is possible to eliminate or mitigate such
market failures, then there is nothing wrong about this. After all, the market is gaining ground
in other areas that were previously viewed as the public sector domain, whereas such progress
is possible as a result of human invention. The financing of highway construction, previously
viewed as the public goods, in the form of toll collection or public private partnership projects
is a good example. Logically, even the area of productive services need not be predominantly
or largely ensured by the public sector, but they may also be provided on the basis of the
market mechanism.
With regard to the fifth objection that the nature of the transferred price promotes the
tendency to long-term thinking of people: People react to incentives and in case such
incentives (also include the transferred price) motivate them to long-term thinking they will
start to act in such manner (or at least some of them). The long-term thinking is also
associated with an attribute of responsibility – people, who tend to think in a long-term
horizon, do not consider solely immediate (or short-term) effects of their thinking that may
have negative consequences in the long run, but they also take into account wider implications
of their actions. The fact that the transferred price works with a long-term horizon is not its
flaw, but actually its benefit. We may, at the same time, express a hypothesis that our current
global society (i.e. not sometimes in the future, but in the present) needs to extend the time
horizon we take into account in our decision-making process. We need this to learn, from an
early age, how to project a lifelong path of professional fulfillment and anything that is
associated with it. The transferred price principle thus comprises not only a rational element,
but also an ethical one. In this case, the ethical element is not an external precondition, but
something that originates and will increase in importance proportionally to the increasing role
of productive services. In other words: The ethical dimension of the problem area is not
exogenous, but rather endogenous element. In terms of the game theory, the following
applies: The ethical dimension is not a mere precondition to the game, but mainly its
outcome15.
Therefore, if the above mentioned and usually given objections to the transferred price
application are not the most important ones, which in fact are? We believe it is the currently
limited competition in many parts of the sector of productive services. Areas such as
university education, healthcare, spa sector, etc. are subject to strict regulation, with barriers
to enter these sectors. Let us, for now, disregard the fact that some regulation makes sense to
15 We must underline that, in our view, the given fact (The ethical dimension of the problem area is not
exogenous, but rather endogenous element. The ethical dimension is not a mere precondition to the game, but
mainly its outcome.) generally applies to all forms of human behavior. Therefore, it is not specific to transferred
price. Detailed analysis exceeds the scope of this paper. For details, see Graafland (2007), for example.
35
prevent risks to life or health of customers within the sector, to ensure at least minimum
quality of the offered services. The public choice theory (e.g. Buchanan and Tullock 1999)
points out that regulation may also serve in favor of the regulated entity – it may be set up in a
way that limits (and sometimes even eliminates) competition of the regulated entity16. In
such case, the regulated entities do not have to make such efforts to generate their profits.
Moreover, the existing system insufficiently discloses, whether the services provided by such
entities in fact have the required quality. Since customers pay at the moment a service is
provided (if they pay at all, i.e. unless the costs of providers of productive services are
covered from public budgets), there is no feedback that would clearly reveal/disclose the
quality. The existing system is beneficial for existing providers; the application of the
transferred price principle – even to a limited extent – would impair such benefits – this is
why they prevent it17. Economically speaking, many providers of productive services operate
in oligopolistic segments with low competition. Barriers to market entry are significant – i.e.
the providers’ earnings and profits are guaranteed.
Some providers may introduce the transferred price principle, in spite of the above mentioned,
and agree that customers would pay for the services using their future earnings. At first
glance, it should be beneficial for the provider: customers do not have to pay right away, but
payments are postponed until they have money or until it is clear, whether the provision of the
services was in fact meaningful, as appropriate. However, if this provider operates within a
regulated industry, where some providers receive state support and are not forced to offer
their services at market prices, it is disadvantaged. The services of such provider are mainly
sought by clients, who are not – for any reason – eligible for the state-subsidized services.
This usually involves high-risk clients. The example of the company My Rich Uncle
mentioned in Chapter 5 is quite expressive. It clearly shows why most providers of productive
services do not apply the transferred price principle. Their risk would increase, similarly as
the likelihood of bankruptcy.
We believe that current regulated systems also fail to stimulate long-term thinking, create
barriers to monitoring the customers’ earnings and to assessing the contribution of productive
services to such earnings. In case the customers’ earnings are at least partially, often even
indirectly, regulated, it blurs the relationship of the income level and productive services. This
relationship becomes unclear, in case there are significant redistributions within a society,
where earnings of some people are withdrawn ex officio and attributed to others. In this case,
the income level also depends on different factors than the quality and success of productive
services. Existing states, where the share of taxes or public expenditure in GDP, as
appropriate, often exceeds 40%, may be described as societies with significant redistribution.
This is only the visible part of redistribution. Further redistribution takes place, as some
people have various privileges (e.g. are able to meet terms and conditions for receiving
investment incentives, financial incentives for doing business in various segments) and other
people do not. Both the existence and nonexistence of such privileges affects the performance
and consequently remuneration of individual people.
In general, regulations prevent qualified estimates in respect of future development of
earnings for a person that has used some productive services. As a result of the regulation,
earnings may greatly depend on the regulation parameters and not on the quality of such
16 In this context, we should recall the conclusion of the public choice theory (Stigler 1971) that regulated
entities are often able to gain control of the regulator and set up regulation to reflect their own interests.
17 For instance public universities in the Czech Republic, whose financing heavily depends on public budget,
opposed a suggestion to establish deferred tuition although it could increase their revenue, and tuition was not
established. The tuition could assist in revealing the quality of the public universities’ services and such
revelation was not in the interest of public universities. For example, see Wawrosz and Heissler (2012) for
details.
36
productive service. Moreover, regulation may change – they reflect political cycles and other
aspects of public choice18. Therefore, even if earnings of a person / recipient of productive
services are, due to regulation, currently at a level that makes it possible to make payments to
the service provider, this may not be the case after potential regulatory change. We believe the
current environment is too risky, erratic, and unstable for the application of transferred price.
For this reason, the given method of financing is only applied minimally. However, it results
in a lower involvement of providers of productive services in the quality of such services as
well as the fact that there are some people, who cannot pay for the services directly due to
their existing budget constraints and will not ultimately purchase them. It further leads to
insufficient level of economic growth, whereas such growth does not meet the required
parameters to be referred to as smart, sustainable, and inclusive growth.
Naturally, we cannot rule out that the financing of productive services through the transferred
price principle will win competition even in present condition and that the sector of
productive services will actually start having a dominant role within individual countries’
economies (expressed as a share of the sector in GDP, for example). However, unless the
barriers to entry into the markets of productive services are reduced, such development will be
difficult and subject to a longer period of time. Moreover, the principle may also be applied
through undesired actions, where the current sources of growth are exhausted and where
entities, whose income declines as a result of such exhaustion, will start to protest and
perform other undesired actions. Therefore, we believe it is already worthwhile to eliminate
various barriers to entry into markets of productive services. This is the only way we can, in
our view, at least partially meet the goals of the Europe 2020 Strategy, i.e. delivering growth
that is smart, sustainable, and inclusive.
Literature
AKERLOF, George A. 1970. "The Market for 'Lemons': Quality Uncertainty and the Market
Mechanism". Quarterly Journal of Economics (The MIT Press), 84(3): 488–500.
doi:10.2307/1879431
ALI, Ifzal; SON, Hyun Hwa 2007. "Measuring inclusive growth". Asian Development
Review, 24(1): 11-31.
BARRO, Robert; SALA-I-MARTIN, Xavier 1999. Economic Growth. 2nd
edition. Cambridge
(Ma): MIT Press.
BECKER, Gary 1964. Human Capital. Chicago: Chicago University Press.
BOWLES, Samuel 2004. Microeconomics – Behavior, Institutions and Evolution. New York:
Princeton University Press.
BUCHANAN, James M.; TULLOCK, Gordon 1999. The Calculus of Consent: Logical
Foundations of Constitutional Democracy. Indianapolis: Liberty Fund, Inc.
FRIEDMAN, Milton 1955. “The Role of Government in Education“. In SOLO, Robert A.
(ed.), Economics and the Public Interest. New Brunswick, New Jersey: Rutgers University
Press, pp. 123-44.
FRIEDMAN, Milton 1962. Capitalism and Freedom. Chicago: The University of Chicago
Press.
GRAAFLAND, Johan J.2007. Economics, ethics, and the market : introduction and
applications. London and New York: Routledge
KIM, Yong-Jin; LEE, Jong-Wha 1999.Technological change, investment in human capital
and economic growth. Cambridge (Ma): Center for International Development, Harvard
University.
18 See e.g. Sobel et al (2001) for details.
37
PALACIOS LLERAS, M. 2004. Investing in Human Capital. A Capital Markets Approach to
Student Funding. Cambridge: Cambridge University Press.
PERLOFF, Jeffrey M. 2008. Microeconomics: theory & applications with calculus. London:
Pearson/Addison-Wesley.
ROY, Kartick; ROBERTS Mike; ALI Ershad (editors) 2012. Education, Human Capital and
Development (Readings in World Development). New York: Nova Publishers
ROBALINO, David A. 2000. Social capital, technology diffusion, and sustainable growth in
the developing world . Santa Monica : RAND
SAVVIDES, Andreas; STENGOS, Thanasis 2009. Human capital and economic growth.
London: Stanford General.
SOBEL, Russel et al. 2011. Understanding microeconomics. Mason, OH: South-Western
Cengage Learning, 2011.
STIGLER, George 1971. The Theory of Economic Regulation." Bell Journal of Economics
and Management Science, Spring 1971, 3–21.
UNITED NATIONS (UN)1987. Our Common Future. Report of the World Commission on
Environment and Development. New York: United Nations.
VALENČÍK, Radim; BUDÍNSKÝ Petr et al. 2011. Game Theory (Redistribution
and Contextual Games) as a Tool for Human Behaviour Decoding. Praha: VŠFS.
VALENČÍK, Radim 2014. “Jaké reformy a proč (102)”. On-line, available at
http://radimvalencik.pise.cz/1312-jake-reformy-a-proc-102-sport-a-trh-i.html, published 18th
May 2014.
WAWROSZ, Petr; HEISSLER, Herbert 2012. „Deferred tuition fee in the Czech Republic”.
Proceedings of the XVth International Scientific Conference. Prague 24th and 25th
September. Prague: University of Finance and Administration.
WYATT, Lee T. 2009. The industrial revolution .Westport, Conn.: Greenwood Press, 2009.