What determines the value of anything? This is one of the central questions of both economics and political economy, but economics has obscured its implicit stance on questions of value by focusing on price theory (another name for microeconomics) rather than value per se. Economics has thereby largely dodged key questions of value that were actually more deeply understood within classical political economy culminating in Karl Marx and John Stuart Mill.
Neoclassical economics answers the value question by evoking two determinants: scarcity and desire. Valuable things are scarce and highly desired. Diamonds, for example, are both scarce and highly desired, hence very valuable. Scarcity appears in price theory as the basis for the supply curve; desire is the foundation of the demand curve. Both are static concepts in the sense that they exert an influence at a particular moment in time, rather than taking into account the dynamics of time. Scarcity is objective, but desire is subjective. Since demand is primary and is always taught before supply, I consider the neoclassical theory of value as predominantly subjective. Desire determines value in the context of relative scarcity.
Classical political economics was different. Value was predominantly an outcome of production, therefore objective more than subjective. John Stuart Mill starts his textbook, Principles of Political Economy, with production rather than consumption. The main measure of objective value from Adam Smith through Mill and Marx was the labor time required to produce anything, so this perspective is often called the labor theory of value. However, although labor time was the preferred unit for measuring value in classical political economics, it is not the only possible metric for an objective theory of value.
An objective theory of value contends that the value of something, say shoes, is determined by the cost of producing them. The subjective element, consumer desire, is deemphasized in favor of the objective element, the cost of production. If a machine is invented to automate the production of shoes, for example, the value of shoes goes down because they are cheaper to produce resulting from the now absent cost of labor.
The neoclassical subjective theory of value implies that people maintain in their heads a subjective “reservation price,” which is what they would be willing to pay for an item regardless of its actual cost of production. This is part of the theory of “consumer surplus,” which I ridiculed in another column. The whole idea is ridiculous and inconsistent with the neoclassical’s assumption of perfect consumer information. If people actually had perfect (or even adequate) knowledge of economic circumstances, why would they be willing to routinely pay more than the fair value price of anything? If in fact consumers are at all savvy and understand what things should cost, then the objective theory of value is determinative and the subjective theory trivial.
Objective cost of production determines value, but subjective consumer desire, also known as taste, does have a role to play in determining, along with consumer income and credit, how much of anything might be salable at the current value price.
Understanding the role of time is also critical. If supply and demand are considered at an instant of time, then scarcity is determined by what exists now, but if production is considered as a process occurring over time, then clearly supply is a dynamic process, not a static constraint. This emphasizes the process of production over the static problem of scarcity at a moment in time.
The objective theory of value of classical political economics is a better basis on which to build a modern theory of value than the subjective theory of the standard neoclassical textbook. However, there are missing elements. As I have so often emphasized in this blog, main missing element is not subjective consumer desire but private power, here in the form of cartels.
Classical political economics, no less than neoclassical economics, developed its value theory assuming competitive markets. The cost of production determines value because any firm pricing significantly above the cost of production will have its price undermined by competition from other firms. However, if an industry has only one monopoly producer or the equivalent, multiple producers operating a cartel that fixes prices and thus avoids price competition, then the value price will no longer be determined merely by the cost of production, but also by the power of the monopoly or cartel to raise price significantly above cost. The cartel price becomes the objective value price insofar as the product cannot be obtained except from the cartel.
For example, during much of the last century and a half, steel has typically been priced by cartels. Although the cost of production might have theoretically allowed steel to be produced at a lower price, the pricing power of the steel cartel insured that steel was unobtainable at its competitive value price. Today almost everything produced has its price significantly inflated by cartel power somewhere along its value chain, if not at the point of final sale. Therefore competitive value prices are merely theoretical possibilities, but actual pricing must take into account the objective power of cartels at various stages in the production, financing, transportation, and marketing of products. Modern values are thus defined by relations of power as much as they are by costs of production. Thus a truly practical objective theory of value incorporates both production costs and the various private powers that influence the price.
A minor branch of economics critical of the neoclassical school, called “Neo-Ricardians” based on their inspiration by classical political economist David Ricardo, calculates relative value prices the classical way, using relations of production, but now more precisely defined using input-output matrices (an application of linear algebra). However, this method assumes producers can obtain their required inputs at competitive market prices. The Neo-Ricardian exercise is useful heuristically to expose the shoddy logic of some neoclassical propositions, but is impractical for applied political economy because of its chronic neglect of ubiquitous cartel pricing.
What is the value of things that cannot be produced, such as land, natural resources and Picasso paintings (which can no longer be produced, since Picasso is dead)? In one sense, these are of infinite value, if value is merely the cost of production, since they cannot be produced at all. In English we express this not with the term “valueless” but with similarly sounding term “priceless,” which oddly has an opposite meaning. However, in practice, economic values are assigned to non-producible things as well. These are a function less of markets than of private power. Next week’s column will explain and establish this proposition. Suffice it to say that classical political economics did correctly understand that the distribution of the social product among workers, capitalists, and landlords is a function of competing private powers rather than market relations (as in neoclassical economics).
Originally posted on World Policy Institute blog on March 24, 2016 – Understanding Value.