Theories of Value and the Recent Downturn (printable)

Topic: Monetary Policy
Theories of Value and the Recent Downturn

The recent economic problems are brought to light under the two classic theories of value. It's highly probable the way we look at value can claim much of the blame for our economic woes.
by Gene DeNardo
(centrist liberal libertarian)
Friday, January 23, 2009

He that is of the opinion money will do everything may well be suspected of doing everything for money.

Benjamin Franklin

One of the most important and most contested areas of economic study is the notion of value and how it is arrived at. It has particular meaning in the present economic situation we find ourselves restrained within. Value itself has been seriously questioned by everyone, as we wonder just where we a going to end up on the economic scale after all is said and done.

There are as many viewpoints as scholars on the subject, but the discourse seems to have two main factions. There are those, like Marx and Ricardo who point to the labor and production side for arriving at value and the modern schools who point to the demand side or the consumer side. I believe Adam Smith fell somewhere in between, it seemed he was able to see both sides at once.

Ricardo thought that the quantity of labor was responsible for the value of goods. This included all labor from the extraction of the resource to the creation of the tools or machines that aided production to the actual crafting of the product. The "cost" or price was not a concern, just the actual labor itself. However, the value of the product was determined by this work. Marx looked more at the collective work and saw labor as an outgrowth of nature. The cost was determined not only by the labor but by the situation the work labored under. If the process was more efficient then the consumer price would necessarily be lower. To Marx, all value was labor created and anything else was but an extraction and redistribution of the worker’s wage. Hence, his theory of exploitation was born.

The modern schools, of which the Austrians were foremost in the development of this viewpoint, see labor as of little influence in the determination of value. Goods have utility and this use determines their value to those who use, the consumer. Each individual decides the goods he needs to satisfy his wants and therefore determines cost. Production has no value without the product reaching its end, the utility of the good.

Adam Smith would include rent and profit in this calculation although he would refer to profit as the "wages of a particular sort of labour". But, Smith refers to the labor the product can "command" from those who purchase the good. So he is referring in a sense to an exchange of labor for labor and that seems to imply the coexistence of the two outlooks.

Today we stand waist deep in a huge loss of value. It is fitting we examine the housing market as it seems to be the leading candidate for blame. We not long ago valued this necessary form of shelter somewhere in the stratosphere and now we find the values somewhere "down in the dumps"!

It is always important to remember the intrinsic value of a good. A house never loses its ability to shelter us, although something like a leaking roof can substantially affect the performance of this trait! What changes is the amount of value we attribute overall to housing in relation to the remainder of the economy and the related "price" we will pay for an individual house.

Houses that a short time ago had buyers lining up to outbid each other, now lie fallow. Where there seemed to be an unending supply of hopeful occupants, now there is an unending supply of vacant structures. What happened? The population is relatively constant, are many people now crowding into fewer houses?

Is there no value to these empty dwellings, no price that will satisfy both the needs of the producers and the wants of the consumer?

Until zero value is attained, there is always a price that will reflect the value of an object to those who can utilize the good. Houses, as we mentioned, have intrinsic value and it is just a matter of reaching the right price, in our present situation lower is better, and a buyer will step forward and claim their prize. Financing can enable a higher price, but does not control the transaction. Even with an absolute absence of financing of any kind, a price will at some point be reached that will find a buyer. This is often referred to as the margin. Below that point, the amount of buyers will increase proportional to the drop in price. This subjective approach would seem to verify the claims of the modernists.

Yet houses remain vacant and unclaimed.

The producers, especially the builder, attempt to manufacture the good and sell it at a price that exceeds their costs. There is no possible way to know with absolute certainty if this will occur until the transaction has transpired. The good or house must sell to determine its value, or more specifically its cost to the consumer. The producer experiences the present value of the entirety of the costs of production, material, labor and interest, and at some point will realize the future value and price of his product. Whatever variables time facilitates will determine whether the consumer’s cost will fall below or above the producer’s costs.

As the builder spends time constructing the house, a very interesting phenomenon comes to pass. If the market is on the upswing, then the builder with no extra input realizes with the mere passing of time a growth of profit, or surplus labor value if you wish! As each day dawns, his product regardless of production progress, grows in value. If it were not for the fact that he must bring the product to fruition to realize this growth, he could become wealthy on this "presumed" increase in value alone.

Conversely, in a market on the downside, it seems each day brings a foreboding shrinkage of profit no matter how diligently and rapidly he works. At some point in time, production costs exceed possible price and the producer must either experience a loss, if he has the flexibility to do this, or the product remains unsold or the liability passes to the producer’s creditors and depending on their circumstances, they must face similar choices. We face such a dilemma today.

What is it about time that invokes such brutal situations? Are not both consumer and producer punished at different times by this mechanism?

Things do change thru time, that is a given. But what is fundamentally at fault with this scenario is not actual change but the expectation of change. Expectation of change based on unsound reason. The lack of "underlying" changes in any real value, yet the expectation of price change.

The modern consumer is basing his purchases not on utility, not on satisfaction of need or want as Menger so precisely described, but on expectation of increased or decreased future value of the good he is purchasing or abstaining from purchasing in the present. This is unavoidable in any exchange economy, as we must exchange in the present for what is of future value, but the great disconnection from real or intrinsic value and overemphasize on future price or lack of it is an anomaly that has become commonplace in our world. Price has trumped value.

Adam Smith saw the equilibrium of supply and demand as the point at which the production costs equaled product value. Are we simply witnessing the forces of supply and demand rather than some imposed force beyond its reach?

Changes of supply and demand do not occur randomly. Choices are made or not made based on underlying real conditions. Extreme weather, scarcity of a resource, major shifts in trade, technological advances are the sort of events that precipitate a noticeable shift in supply and demand and the resulting effect on cost value.

In a natural economy the price cost of an item would be representative and a good indicator of its value. The good’s utility would determine its price. Instead, we reside in a world where price and its physical form, money, along with the expectation of future price determine value. Money, the medium of exchange, has become instead the primary reason for exchange.

Whether we subscribe to the labor theory of value which emphasizes the amount of labor contained within the good or the marginal utility theory which promotes the individual choice of the product as the dominant factor, there is one stream of thought that runs through both opinions. Value is created, whether by the laborer or by the consumer, who in the end are one and the same, by the human element.

When money is looked upon to create value, we have lost that fundamental human connection. A force that has no underlying value has pirated control of the transaction, the basic economic interaction between people. There is no stimulus plan, tax cut, economic incentive or policy that will be completely effective until we are able to reclaim this value for ourselves and the world around us. Until then, we will remain stricken with this economic disease with every new "expert" lining their pockets with sure fire cures!