Objective Value in Economics – Part II
The barter fallacy: why personal preferences do not dictate market values.
The following is part two of an essay on the objectivity of values in the market. Both parts should be read as one piece. Read the first part here:
Objective Value in Economics – Part I
To recap, economic value is surplus goods or services whose potential exchangeability derives from their useful capacities to serve common human purposes. Exchange value is the degree of this capacity in a given purpose-field. This, in turn, permits comparative judgments: directly within the same category (iPhone versus Samsung) and implicitly within overlapping purpose-ranges (bicycle versus automobile). Money measures all goods, solving the problem of cross-purpose comparison, as well as enabling trade-offs between personal contexts and the qualitative aspect of goods.
While the subjective theory of value acknowledges the factual quality of goods, it does not integrate it systematically in theory. Quality is simply lumped into “subjective value” as another variable out of many. But this plays down the fact that personal valuations depend on what goods can actually do. Namely, contextual utility (personal value) presupposes objective utility as a determinant of the extent to which a good can be used.
For example, if a person prefers living in a small rather than a big home, he nevertheless utilizes the smaller home’s contextual value only to the extent of its objective utility; he will have less space, less room for furniture and personal items, fewer rooms available for different purposes. For an aging person this contextual utility may perfectly fit his circumstances—explaining why he values it personally higher than a bigger home. But for a family of five, the objective utility of a large house will most likely be appreciated more as it enables more uses that match its personal needs.
The standard objection of quality as an arbiter of economic value is that “what is highly valuable for you might not be valuable for me.” But this notion drops the full market context, treating goods as if they are isolated to single traders instead of connected to a large pool of potential traders. If a work desk is too large for someone’s cramped office, it might fit a spacious office of another. And if it does and is truly needed, then its quality becomes necessarily relevant[1].
The market operates as a “matchmaker” that links goods to those with matching contexts without requiring the knowledge of any particular individual’s preferences. Sellers presuppose the matching contexts of their buyers, omitting them from exchange value considerations. Buyers, driven by the incentive to find the best available deal, (implicitly) set aside their personal judgments when appraising goods by the market’s standard of value. This is how they distinguish between a good’s objective capacity and their own personal evaluation, permitting trade-off calculations between quality and personal value (or exchange value and use value) with the help of prices.
Put differently, when purchasing goods we shift from “Do I like this?” to “Is this deal worth it?” barely noticing that these are separate questions operating under different evaluative rules. It is easy to conflate the two because they operate simultaneously in our decision-making. Yet the confusion stems primarily from conflating condition and causation.
The notion of personal values dictating market values looks at the market in reverse, as if the starting point is the consumer who judges some particular good in isolation within his personal circumstances. In reality, a particular purchase is only the end point of trade, after the buyer has considered the available alternatives. Personal values motivate a purchase and actualize its exchange value; but they do not determine a good’s exchange value. They validate it.
Economists reverse this relationship, treating objective utility as a condition for wanting a good[2] and personal values as the underlying cause for both wanting it and determining its exchange value. An objective theory of value fixes this error: use value is the condition and objective utility is the cause[3].
Now, for Objectivists, a question might still linger with regard to Ayn Rand’s conception of value that she discusses in “What Is Capitalism?” In the essay, she proposes a distinction between “philosophically objective value” and “socially objective value.” Rand writes:
By “philosophically objective,” I mean a value estimated from the standpoint of the best possible man, i.e., by the criterion of the most rational mind possessing the greatest knowledge, in a given category, in a given period, and in a defined context (nothing can be estimated in an undefined context). For instance, it can be rationally proved that the airplane is objectively of immeasurably greater value to man (to man at his best) than the bicycle—and that the works of Victor Hugo are objectively of immeasurably greater value than true-confession magazines. But if a given man’s intellectual potential can barely manage to enjoy true confessions, there is no reason why his meager earnings, the product of his effort, should be spent on books he cannot read…
…The free-market value of goods or services does not necessarily represent their philosophically objective value, but only their socially objective value, i.e., the sum of the individual judgments of all the men involved in trade at a given time, the sum of what they valued, each in the context of his own life.
It is unfortunate that these passages have caused much confusion, as many have taken this to mean that economic values in the market represent people’s personal values. However, one would be remiss in making this inference.
First, a careful reading shows that Rand uses “market value” as a non-technical term for commercial success—not to strictly express prices or exchange value. Thus, to use one of her examples, while the market rewards lipstick producers more than microscope producers, this says nothing about the prices of microscopes, which are nonetheless higher than lipstick prices. Second, the reason she is discussing market success is to answer a moral question, namely, whether it is just that free markets often reward the average producer more than the most intelligent producer, and at other times does the opposite. Her goal in addressing this issue was to defend the morality of capitalism, not to present an economic theory of value.
And yet, her distinction between philosophically objective value (POV) and socially objective value (SOV) resonates with our aforementioned framework. If the standard of POV is the life requirements of a rational being, with “best man” in a given context as its standpoint, then the standard of SOV—I contend—is the useful capacity of a good relative to its purpose-field, with “best product” within a given category, in a given period, as its standpoint. This is because that while the sum of individual judgments reflects their personal contexts, it also reflects the particular good that these individuals chose to purchase within its field. To use another of Rand’s examples, Elvis Presley is not merely richer than Albert Einstein because rock and roll speaks to more people than physics. He is also richer than most performers within his genre, indicating that his success reflects the relative appeal within his field, not just his broader public appeal.
SOV reflects the demand side of the market: it indicates which goods match the most personal contexts, while presupposing a standard with which buyers evaluate goods among the available alternatives.
Similarly to use value, SOV is the condition for realizing exchange value, not its cause. A Ferrari has a higher exchange value than the average vehicle because its general performance is objectively greater. However, most people do not need its racing-level speeds, and its smaller interior space is impractical for the average person. For this reason, a Ferrari’s SOV is lower than a Toyota’s SOV, affecting each firm’s sales volume and revenue differently, yet leaving the exchange value of the vehicles unaffected. (This again illustrates how preferences are not determinants of economic values.)
Thus while demand is not the source of economic value, it does reflect buyers’ choices, which is a crucial factor for a seller’s success. Demand indicates how widely a good’s objective utility is recognized and selected within the market, validating economic value and thereby the creation of wealth. A high SOV means that a producer has successfully matched his goods’ objective capacities to the contextual wants of many buyers. On the other hand, if he is unable to sell his surpluses for a lack of demand, his accumulated economic value is realized as an economic loss.
That SOV reflects personal values does not change the fact that markets reward goods that are objectively better within their fields. Demand does not directly affect exchange value, only indirectly with changes in purpose-fields. And even here, purpose-fields are altered by the supply-side; it is producers who ultimately determine exchange values.
The confusion regarding the role of personal values and objective qualities is rooted in the fundamental error that treats trade as a bilateral exchange essentially reduced to a form of barter[4]. The introduction of money, as the conventional story goes, made bartering more efficient but did not change the essence of its mechanism[5].
Consider however the profound difference between barter and commercial trade. For starters, barter is an isolated exchange, occurring on an irregular basis, with scarce alternate options. It involves mostly random items that a friend or a neighbor may find of interest in an accidental, reciprocal exchange. Furthermore, barter is a static event in which the reproduction of the only items available is not expected. Its participants swap the items among themselves, with nothing beyond the present moment to consider. In addition, since competing alternatives do not exist, the parties do not require a specialized standard of evaluation. The only question they face is to which end they should consume. Barter focuses on what can be gained in the present, with past and future considerations unimportant for one’s choice.
This is the foundation upon which economists have formulated their theories of exchange. Which is why the classical school had to lose to the dismissal of trade as an exchange of equivalents mediated by a shared standard[6]. A view of exchange reduced to barter must adopt incommensurability (rooted in disparate personal values) as the basis of trade[7]. If trade is essentially traders exchanging that which they value less for that which they value more, then “equilibrium” is the alleged resting point where no more personal gains can be had from exchanging more quantities.
But, as we have seen, commercial trade is not a bilateral exchange. It is a market-wide event that takes account of the competitive alternatives in a given field; a dynamic, open-ended process in which sellers offer standardized goods in bulk, aspiring to achieve an ongoing flow of exchanges. Consequently, goods on the market are measured by their worth within their competitive fields—not by an asymmetrical “less-for-more” framework.
Importantly, exchange of commensurate values does not contradict the win-win nature of trade; in fact, it enhances it. In a division-of-labor economy, traders produce goods in excess of their personal requirements. These surpluses are needed personally by others. Traders exchange their surplus goods as economically commensurate values in order to acquire goods that match their personal contexts. Commercial trade is the gaining of disparate contextual utilities via an exchange of commensurate objective utilities (with money functioning as a “medium of equivalence” through cardinal units).
Hence the subjective theory of value rightly emphasizes the motivation for self-gain, but omits the preceding economic process essential to modern markets. As a result, rational trade-offs between objective quality and personal context give way to preference rankings. Choice is treated as revealing (or creating) value rather than realizing it. Ends impute value onto means rather than establish the objective standard by which means are factually evaluated.
By seeking to correct the intrinsic-laden conception of value of the classical school, the marginalists divorced value from the identity of goods, at the expense of objective causation. A proper theory of value must begin from the real conditions of a commercial economy—i.e., surplus production—that necessitate an objective standard of value as the common denominator by which traders evaluate goods to effectively service their personal needs. Consequently, traders compare, coordinate and make progress in their pursuit of wealth.
As Rand writes:
A free market is a continuous process that cannot be held still, an upward process that demands the best (the most rational) of every man and rewards him accordingly. While the majority have barely assimilated the value of the automobile, the creative minority introduces the airplane…
[The] imitators who attempt to cater to what they think is the public’s taste are constantly being beaten by the innovators whose products raise the public’s knowledge and taste to ever higher levels. It is in this sense that the free market is ruled, not by consumers, but by the producers. The most successful ones are those who discover new fields of production, fields which had not been known to exist[8].
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[1] Some goods are valued for purely sentimental reasons, in which case their contextual value is detached from their objective functionality; such cases fall outside the scope of economic evaluation proper.
[2] “Things of no Use, have no Value.” Nicolas Barbon, “A Discourse of Trade.” Commerce, Culture, and Liberty: Readings on Capitalism Before Adam Smith. Ed. Henry C. Clark (2003), p. 73.
“Utility is the capacity of a thing to serve for the satisfaction of human needs, and hence (provided the utility is recognized) it is a general prerequisite of goods-character.” Carl Menger, Principles of Economics, p. 119.
[3] For more on this issue, see “Values in a Market Context.”
[4] “As it is by treaty, by barter, and by purchase, that we obtain from one another the greater part of those mutual good offices which we stand in need of, so it is this same trucking disposition which originally gives occasion to the division of labour.” Adam Smith (1776), The Wealth of Nations, (1991), Everyman’s Library, p. 13.
[5] “Goods were being bartered long before money ever became an intermediary of trade. At that time, traders were only concerned about their needs, the quantities at their disposal, and the importance they would give to the objects they could trade… The use of metal as an intermediary made trade easier and offered more accuracy to economic calculation, but it did not change the nature of trade. [Italics mine.] Carl Menger, “Money as Measure of Value.”
[6] “The error of regarding the quantities of goods in an exchange as equivalents was made as early as Aristotle.” Carl Menger, Principles of Economics, p. 305.
[7] “Exchange does not require any previous measuring.” Carl Menger, “On Money.”