Saturday, 27 June 2009

Reclaiming Economics Part 4 - Production, Exchange and Profits

Subjective and Objective Value

In Part 2, I showed that the concept of “Subjective Value” was meaningless, and that orthodox economics goes about defining it in a way that is essentially fraudulent. It removes, from the determination of this “individual”, “subjective” value, the most important factor in any economy based on exchange, let alone production for exchange, the Exchange Value itself of the commodity!!! It has to do this, because it wants to create a model in which this Exchange Value is not an important determinant of “Subjective Values”, but vice versa, that Exchange Value is nothing more than an aggregation of subjective values.

But, everyday life contradicts this. Ask someone, “how much do you think this piece of modern art is worth,” and they will not tell you how much they think its worth based on their personal preferences, but based on how much they think it will sell for. If I see a brand new Rolls Royce for sale at £1,000, I am likely to buy it, even if I hate Rolls Royces, for the simple reason that my “subjective” valuation of it will be based not on its merits for me as a car, but the fact that I will be able to re-sell it at its much higher market value!!!! A Capitalist does not buy the Labour Power of say a joiner, because he wants and enjoys the products of the joiner for himself, but because he knows that he can sell those products – indeed can sell them (or believes he can) for more than he pays the joiner in wages. In fact, in a market economy my “subjective” valuation, to the extent that means anything, of any commodity, will always be based ultimately, not on what it is worth to me for my own consumption, but what I could sell it for, less the transaction costs for me to do so, or put another way what I expect others to sell that product for. Just look at the people who hand over money at Car Boot sales, for all kinds of tat that they have no interest in for themselves, but who think they can re-sell it somewhere else at a higher price. In fact, the same thing could be said about people who speculate on the Stock Market – they buy shares in companies because they believe that the current price is less than the true “objective” value of those shares, as a result of inadequate information by market participants, but that means that they realise that there is some “objective” value that exists separate from the current sum of all “subjective” values. They believe that as market information improves those “subjective” values will come into line with the “objective” value, and they will be able to sell, and make a Capital gain. In all these cases, their “subjective valuation”, is based entirely on what they assess the objective value, the Exchange Value, to be!

See Part 2

Exchange Values and Costs

In Part 3, I showed that, in fact, this exchange value, which determines the value that individuals then place on commodities, is itself a function of the relative costs of production between different commodities, which itself comes down to the amount of labour-time required for their production. It is not the relative preferences for potatoes or carrots of the individual, which determines their relative prices to him, in terms of how much of each has to be given up, to acquire more of the other, but the objective constraint of how much labour-time is required to produce them. His preferences have no other function than to determine the proportion of how that labour-time is allocated.

This is Marx’s Law of Value, which applies to all societies other than a fully-fledged Communist society, which has raised production to such a level of abundance that a decision to increase the output of A can be made without recourse to the question of what has to be foregone to achieve it.

I then demonstrated that the assertion that prices (Exchange Values) are determined by these “subjective values” is clearly false. The example given to prove the assertion, “Prices are demand determined even though they appear to be changed with changes in costs”, was fraudulent. It was based essentially on a Monopoly situation, which prevented other suppliers from moving in to increase supply and reduce prices, where an increase in demand led to a temporary rise in prices and profits. In fact, experience shows that far from a rise in “subjective values”, manifest in a rise in demand, resulting in a consequent rise in prices, the opposite is frequently the case. Commodities, which once had only limited demand and high prices, demonstrate that as demand rises and supply rises to meet it, this new supply is lower-cost, because of economies of scale, and competition amongst suppliers forces prices down accordingly. In short, it is precisely costs of production and the average rate of profit, which determine prices, not demand or subjective values. I will examine exceptions to that in a later part of this series.

See Part 3

The Role of Exchange in Determining Value

If we look at things from the situation of the individual, self-sufficient producer of potatoes and carrots, then we can think of them having some kind of “subjective value” for each, based on their particular preferences. The point is that this has little or no economic significance. The fact remains that whatever these preferences or valuations, the “price” he has to pay is determined by the relative costs of production. An economic analysis is concerned not with the prices people THINK they should pay, but the prices they ACTUALLY DO pay, and why those prices are what they are.

The individual, self-sufficient producer does not have to concern themselves with exchange Values, either in forming their own “subjective value”, or in determining their production decisions, because they do not produce to exchange but only to consume. But, Economics would indeed be a dismal science if it restricted itself to analysing only such a world. It would tell us nothing about the world we actually live in.

Once we introduce the concept of Exchange then everything changes for this producer.

Suppose our producer now lives in a world where there is another individual who has a large pot of gold. He offers to Exchange this Gold for half of the potatoes and carrots. The Gold has taken as long to produce as all the potatoes and carrots. But our producer of vegetables has no interest in Gold. In Marxist terminology it has no Use Value. All commodities must have Use Value, or else they are not commodities, or put another way in Marxist terminology, the Labour expended on their production was not socially necessary. So, the Gold has no Exchange Value. However, now assume a world outside our two producers, and in this world there is a demand for Gold. It has acquired both Use Value, and Exchange Value. Now, our same vegetable producer, whose attitude to Gold itself, and his own personal uses for it have not changed, is overcome by a miraculous conversion, because his subjective valuation of the Gold now is suddenly transformed from zero to some positive number!

In fact, his first reaction, in determining whether this offer of Gold for his products is good value or not, is not to compare the utility of the Gold, for him, compared to the vegetables he exchanges for it – we have already established the Gold had no such utility – but to look at what others in the market are prepared to give in exchange for this Gold. We have already uncovered what the process is for determining it. He did it himself in understanding that the price of carrots for him was how many potatoes he had to give up to produce them, which was nothing other than the comparative amount of his time it took to produce them.

We could have asked instead, had he devoted some of his time to producing Gold not potatoes, how much Gold production would he have had to give up in order to produce a given amount of carrots. Furthermore, recognising that within society there are different levels of productivity between different producers of Gold, Carrots and Potatoes, I suggested that, by simply aggregating all of this production, it was possible to get an average amount of labour-time that would be required to produce a given amount of Potatoes, Carrots or Gold.

A producer can look at the amount of Gold he is being offered for his carrots and potatoes, and determine, whether he believes that he is being offered a good deal or not, and that will have nothing to do with his previous “subjective” value of Gold, which we know to have been zero! Why would he now be interested in the Gold? For the simple reason that although it has no Use Value, no “Utility” for him for his own consumption, it does have Exchange Value, and in an economy where exchange takes place, it is increasingly Exchange Value not Use Value, which is dominant. He may have no personal use for gold, but he may well have use for the other commodities, which he can, in turn, exchange the gold for. Just like the person who buys tat at a Car Boot sale, has no use for the tat, but has use for the things they can buy with the money they get from re-selling that tat.

Its all very well suggesting this, but is this what actually happens. After all, although none of us actually does what orthodox economics suggests we do – compare the utility of a certain amount of this commodity compared with the utility derived from all the billions of other choices we could have made – we do not either compare the labour time required to earn the money we spend with what the labour time required is for the goods we buy!!! Though sometimes we do, if thinking about whether to paint the house or employ a painter and so on. In fact, as I will show in a later part of this series we do not have to do that, the market does that calculation for us. However, whilst there is no evidence to show that decisions in a market are based on “subjective” values or that such values exist in anyone’s head, there is lots of physical evidence that people DID calculate, and in some parts of the world still do calculate, Exchange Values, based on the amount of Labour-time required for production.

See: Historical Proofs of Value Theory

The Source of Value

It is interesting that having created an economic model, that begins with the exchange of products, whose existence has not been explained, in order to remove their cost of production from the calculation, that market participants undertake to value them, orthodox economics (I am continuing to use the work by Alchian & Allen here as a proxy for orthodox economic theory) comes to some amusing conclusions. Having simply assumed these commodities into existence, they are able then to “demonstrate” that the exchange of commodities has “produced” additional value. How? Because if A exchanges his X for B’s Y, it must be because both “subjectively” value the product they acquire higher than that they have given up.

Is this true? No. Even if we examine this argument in its own terms it is fraudulent. Suppose A values his X at 9 units (there is, in fact, no means of measuring this as orthodox economics admits, I am just using notional units to prove the point), but values B’s Y at 10 units. Meanwhile, B values his Y at 9, and A’s X at 10. They exchange. Now, both have 10 units of value whereas before they had only 9. Hey presto, exchange has “produced” 2 new units of value that did not previously exist! Has it? No, it’s a bit like the trick where you count up to 5 on one hand, and down to 6 on the other to “prove” you have 11 fingers. What is the reality? Its necessary to total up all the Value before and after the exchange. There are basically three legitimate ways of doing that all of which come to the same conclusion. If we are using “individual” values to determine what values exist then we have to measure the total value that exists as seen by each individual or both together. In the above example, from both A & B’s individual perspectives the total amount of value in the economy is 9 units in their own possession, and 10 units in the possession of the other. What is the position AFTER the exchange? There is still for each person the same amount of value, but now that value is distributed as 10 in their own possession, and 9 in the others possession. The TOTAL value in the economy remains as it was before 19 units. All that exchange has done is to place that value into different hands! It might represent a situation of greater welfare for each person, each may feel that their own utility is greater, but even using “subjective” value as the yardstick no increase in value has arisen! If we combine both people’s valuations to get a sum of value all that changes is the number to a total of 38 rather than 19.

Yet, this fraud is used as a fundamental element of orthodox economics to justify concepts such as a supposed “consumer’s surplus”, or even “profit”.

Amusingly, not only do A&A attribute to this kind of exchange the potential for creating value, but also they give it the PRIMARY role! They say,

“Production also can occur when the physical attributes of resources – including their time of availability, place or form – are changed.”

In other words, wealth is created by exchanging things, but actually making things to exchange also has some role to play! Is it any wonder that modern capitalism has created the delusion that wealth can be created simply by exchanging bits of paper, giving ownership rights of shares and commodities, whilst the mundane task of making things can be left to others! Could there be a greater exposition of the fraudulent nature of the economic theory that leads to that conclusion than the recent Financial Crisis?

The exchange of goods, in the previous example, did NOT produce wealth as orthodox economics contends. If the goods had not been produced – that is has Labour not been expended upon their creation – they could not have been exchanged. Looked at from the perspective of this two-person economy, as a whole, it is at the point that these goods come into existence, even considered from the perspective of subjective value, that their value is created. The fact that, viewed from the perspective of either or both members of this economy one of these goods is not in their possession, does not change the fact of its existence! Actual production created the Value, created the wealth of this society, all that the exchange did was to affect its distribution.

It is important to bear this in mind then when considering the way orthodox economics treats actual production and exchange relations. In particular, as I will now show using A&A’s presentation, orthodox economics perpetrates yet another fraud when talking about comparative advantage and the source of profit.

Back To Part 3

Forward To Part 5

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