In Search of the Even-Handed Economist

Three Theories of Value

Economists are famous for their equivocal policy advice: “Well, on the one hand..., but on the other hand....” Harry Truman is said to have cried out in exasperation, “Give me a one-handed economist!” While the search for a one-handed economist might prove arduous, it may suffice to find some even-handed economists.

In Fragmented World, Chris Edwards presents three economic perspectives: the subjective preference theorists, the cost-of-production theorists, and the abstract labor theorists. Each perspective has as its basis a distinct theory of what determines the prices of goods and services, and relationships in society. All have assumptions, theories, and policies that are logically consistent. They all link description to prescription.

Subjective Preference

Assumption

Economic transactions are conducted by rational, independent individuals who are free to express their talents and tastes, and who act to maximize their self-interest (the latter part of this assumption cannot be tested). The aggregate actions of these rational, independent individuals results in a market that is self-regulating, as if by an invisible hand, toward overall optimal outcomes.

Theory of value

The school of economic thought that has come to be the mainstream believes that there is no real underlying value for tradable items, that value is determined subjectively by supply and demand. This group of economists, also sometimes referred to as the neoclassicists, emerged in the late 19th century, moving away from the classical school’s basis in the labor theory of value. This group is also referred to as the “free marketeers,” although it should be pointed out that earlier free marketeers such as Adam Smith and David Ricardo believed in the labor theory of value.

Prescription

Free markets, unfettered by state economic intervention, are an indispensable prerequisite for economic growth and political freedom. Essentially, that economy functions best that is governed least.

Subjective preference theorists treat capitalism in the present only, and address neither its historical development nor speculate on its future trajectory. Also, while classical political economists such as Smith, Ricardo, and Karl Marx studied the relationship of money and power in society, the subjective preference theorist took the political concerns out of political economy, dealing with pure economics.

Cost-of-Production

Assumption

Since free markets, if there ever were such things, produces winners and losers, production inexorably consolidates into a system of fewer producers on larger scales of production. This oligopolistic outcome also produces unequal income distribution.

Theory of value

In this oligopolistic system, prices are more managed on the basis of the cost of production rather than set on the basis of free competition and supply and demand. The scale of planning required for capital-intensive industrial production represents such a huge investment, that when new products are delivered to market, consumer demand must be assured as much as possible through advertising. Rather than consumers determining what gets produced, as the subjective theorists assume, the cost-of-production theorists explain consumption as being determined by the producers.

Prescription

Since the market is not self-regulating and results in unequal income distribution, recessions occur when there is too little aggregate demand for what is being produced and excessive savings cannot find adequate investment. Thus production falls and workers are laid off. In the view of the cost-of-production theorists, when this occurs, government is the only agency capable of restarting the economy through deficit spending to raise aggregate demand.

Cost-of-production theorists are also concerned with distributional conflicts. For instance, producers’ desire to introduce new, labor-saving technology conflicts with organized labor’s desire for job security. The distributional conflicts between these two types of organizations must be mediated by a third type of organization—government—to promote economic growth. A fourth power center in society—not mentioned by Edwards—is civic organizations, such as environmental groups and consumers’ unions.

Abstract Labor

The last school that Edwards discusses actually has the oldest theoretical roots. Adam Smith in the late 18th century, as well as David Ricardo in the early 19th century and Karl Marx in the mid 19th century, maintained that labor is the source of value in all things. Marx, however, in his exhaustive analysis of the capitalist mode of production, studied the system at higher levels of abstraction in an effort to explain the true mechanisms at work behind outward appearances.

Assumption

The owners of the means of production pay the workers the wages that are necessary to maintain and reproduce themselves, and appropriate the surplus value of their labor as profit. This profit is invested in new technology that displaces workers and devalues their labor, making them more dependent on the capitalists.

Theory of value

Essentially, the value of a commodity reflects the cost of the labor required to produce it at the minimum livable wage. This minimum livable wage includes the requirement of supporting a family so that the worker can “reproduce” himself or herself, thus supplying a new generation of direct producers and consumers to the system. The time that the laborer is required to work to earn the minimum livable wage is called the “socially necessary labor time.”

Prescription

While Marxists concur with the cost-of-production theorists in that liberty must entail more than simply the free exchange in the marketplace on which the subjective preference theorists focus, they are skeptical of the ability of institutional reforms of capitalism to deliver the goods to less-advantaged segments of society. The ultimate answer is to replace the capitalist system with a system of social appropriation of socially produced surplus value.

Summary

• Subjective preference theorists focus on the aggregate decisions and exchanges between individuals as the primary mechanism for determining value and the primary characterization of societal relations.

• Cost-of-production theorists focus on the bargaining between different types of organizations in society as the primary mechanism for determining value and surplus distribution.

• Abstract labor theorists focus on the struggle between classes as the primary mechanism for surplus distribution, while value is based on labor, to include both socially necessary labor time and the private appropriation of surplus labor.

Implications of the Three Theories

At the top level, the difference between Edwards’ presentation of the three contending schools of economists and in Raymond Miller’s collection of essays, International Political Economy, is that while Edwards describes in great detail the mathematical theories of international exchange of these schools and the policy prescriptions derived therefrom, Miller explains the basic economic models at the heart of these perspectives. In effect, Edwards describes where these schools are coming from, trying to get to, and by which routes, but Miller provides the schematics of the engines that drive these diverse vehicles.

Subjective Preference

Edwards’ discussion of subjective preference theory focuses on the Heckscher-Olin theory (also known as HOS, for Heckscher-Olin-Samuelson) of free trade and Pierro Sraffa’s comprehensive attack on its premises and logic, which demonstrate how free trade would benefit some nations and damage others. Miller, on the other hand, outlines the fundamental premises of the market model underlying subjective preference theory. While Miller does not in any way attack these premises, the mere fact that the model requires 100% adherence to them makes the validity of some of them highly suspect.

1. Free, rational individuals

   “Rational” is defined in terms of the individual always performing market-maximizing calculations and acting accordingly. This is counter to observed human behavior. For instance, it has been commented that the shopping strategies of men and women are different; that men hunt and women gather, or perhaps more pejoratively, that in the interest of saving time men will spend more money than necessary for an item they need, while women will spend as much time as required to find the best price for an item they didn’t necessarily need. In any case, these observations bring to light a more fundamental objection to this first premise, derived from the twin conditions of its very description, freedom and rationality. If individuals are constrained to always think and act rationally according to the narrow definition of Homo economicus, their actions ought to be mathematically predictable. This is a description of predestination, not free will. A computer algorithm is rational, but cannot be free. Human liberty must include the freedom to choose irrationality.

2. Decision-making via aggregation of individual choices.

   General Motors President Charles Wilson is famous for having said, “What’s good for America is good for General Motors and vice versa.” By induction, what’s good for Ford, Dow, DuPont, Monsanto, Microsoft, et cetera, is also good for America. As the cost-of-production theorists point out, decisions by a few 800-pound economic gorillas direct the overall economy in substantial ways. Also salient is John Kenneth Galbraith’s “revised sequence,” by which producers decide what they will produce, then create the demand through advertising.

3. Material gain

   This is related to the “free, rational individual” premise. It presupposes that material self-interest trumps all other human motivations. This turns all concept of morality on its head, and elevates the infamous words of Wall Street’s Gordon Gekko to a commandment, “Greed is good.” However, subjective preference theorists claim that in a free market there can be no such thing as involuntary unemployment, thus for the most part people who are not working value leisure over money. (In Globalization and Its Discontents, Joseph Stiglitz quips, that by this reasoning, the Great Depression can be explained as a sudden increase in the desire for leisure). But, the subjective preference theorists cannot have it both ways. If people value leisure as well as money, and certainly very few people choose to work 12 or 16 hours a day, then the premise that all other human motivations are subordinate to material maximization falls on its face.

4. Mobility

   According to this premise, all of the factors of production are free to move from place to place: no barriers to trade in goods and services, no capital controls, no immigration restrictions. Specifically with regard to labor, it is presumed that there are no discrimination barriers with regard to ethnicity, class, gender, et cetera. While this latter set of ideals is laudable, it is also counterfactual. The former set of premises is not only counterfactual, but debatable as to desirability. In Beyond Growth, Herman Daly points out the destructiveness of free trade and unrestricted immigration to the sense of nationhood and community, while both Susan Strange and Joseph Stiglitz are highly critical of footloose capital, and even Stiglitz points out that trade liberalization must be properly sequenced in terms of developing the proper national institutions to accommodate it.

5. Competition

   This is related to the “decision-making via aggregation of individual choices” premise. Some economic actors are big enough that they can collude implicitly in a behavior known as price-leading—as when one company changes the price for its products, then other companies follow suit. This premise privileges competition over cooperation, and yet quite obviously, “No man is an island.” Within productive organizations, teams of people work together for the common good. As Daly would no doubt agree, the concept of community is founded on cooperation; the idea of unrestricted competition is destructive to society.

While Sraffa took a wrecking ball to the HOS theory, thereby demolishing the superstructure of the subjective preference school, these fundamental assumptions of the market model are vulnerable to torpedo hits below the waterline.

Cost-of-Production

Miller regards Ricardo as being in the classical school, which had its basis in the labor theory of value. Edwards’ explanation of how the cost-of-production theory has its origins in the work of David Ricardo is a bit thin, barely half a page. It hangs on Ricardo’s observation, that as demand for agricultural production increased, less fertile, previously uncultivated land would be brought into use. As a result, the average output per acre per labor-day would fall. However, in Ricardo’s view, wages could not fall below the subsistence floor to offset the fall in productivity. In this sense, the subsistence wage represented a minimum cost of production. Meanwhile, the tendency would be for all farmers—the primary producers—to receive the same income for their labor regardless of the productivity of the land on which they worked, because the owners of the more fertile land would simply cream off the greater surplus by demanding higher rent. Here also is the origin of a central concern of the cost-of-production theorists: the separation of the distribution of the surplus from the process of production, and the resulting potential for conflict over the equitable distribution of the surplus. However, in Ricardo’s time, owners and laborers had not yet coalesced into the large organizations that characterize modern production, and which are the focus of cost-of-production analysis. Thus, Ricardo’s work has some but not all of the elements of what later developed into cost-of-production theory, while he himself adhered to the labor theory of value. It was this new organizational dimension, and the concomitant bargaining between societal power blocs, that may be said to have split cost-of-production theory off from Ricardo and the classical school. Thus Edwards refers to the cost-of-production theorists as neo-Ricardians, however, his explanation on the connection does not go to quite this depth. The bulk of Edwards’ chapter on cost-of-production theory dwells on the international implications of that theory, and the distinction between the Sraffian and unequal exchange (represented by Raul Prebisch, Arghiri Emmanuel, et al.) wings of the cost-of-production school. Rather, it is Miller’s discussion that better illuminates the basis of cost-of-production analysis as being rooted in the conflicts between large organizations occupying different power centers in society: productive organizations, labor unions, governmental regulatory agencies, and civic organizations. Likewise, his name for and description of the basic economic mechanism of this theory—the multi-centric organizational model—captures the essence of the forces that drive the cost of production. Edwards does not supply this, perhaps assuming that his readers are already familiar with the essentials of cost-of-production theory.

Abstract Labor

I realize that there is a lot more to Marx than I have or probably will ever read. Nevertheless, I am led to question the validity of the concept of socially necessary labor time based on a minimum livable wage. In Marxist terms, what explains the fact that I make more money than a ditch-digger? My needs are not significantly different from his. Clearly, I am being paid more than is necessary for me to maintain and reproduce myself. A lecturer in the Sociology department at Sonoma State University suggests that the difference might be explained by considering that my higher wage as compensation for having taken the effort to reproduce knowledge and skills required by the capitalist system. Presumably, the time I spent developing this knowledge was time I was not in the work force earning a wage, and so this was time during which I was not supporting my own maintenance and reproduction. Thus I would have to make more money now to pay back the debt I presumably incurred as a student and maintain and reproduce myself in the present. However, I have never had any debts directly attributable to my education. I guess Marx did not count on the US government paying for my bachelor’s degree, nor on my current corporate employer paying for my current pursuit of a master’s degree. Also, I am currently employed full-time while in the graduate program, therefore the time I devote to this endeavor is extracted from my leisure time, not my labor time. In any case, this idea of receiving a higher rate of compensation for deferred wages, in order to even out the socially necessary wage over a working lifetime, does not seem to hang with Marxist theory. To me, a more likely explanation is that the skills and knowledge I have developed over the years is a form of capital, and I own this capital since it is inside my own head. Thus, when I sell an hour of labor, I am also licensing the use of this knowledge capital for that same hour of time. This knowledge capital leverages my labor, giving it more use value. In effect, I receive a higher wage than the ditch-digger because I have more vesting as a partner in the means of production. True, I can hardly set up a factory inside my own head and quit my job, and in that sense I am no less a wage-slave than the ditch-digger, but it does seem to me that the money I take home that is over and above the ditch-digger’s socially necessary (or subsistence) wage is the profit I realize from employing my knowledge capital.

Summary

• Subjective preference theorists treat capitalism as an ahistorical phenomenon and say that government needs to restrain itself so the free market can work efficiently.

• Cost-of-production theorists say that government and civic groups need to participate in the management of a market that cannot work freely, responding to evolutionary changes in the system.

• Abstract labor theorists say that capitalism is an historical system, having had a beginning, must have an end, and indeed is doomed due to is basic contradiction, and that state action can only postpone the ultimate crisis, at which point the workers will rise up and overthrow the system.

In my view, the cost-of-production theory has the most validity. A criticism that Edwards levels at the theory regards Galbraith’s statement, “It is to the educational and scientific estate... that we must turn for requisite political initiative.” In rebuttal, Edwards rightly asks, “Who decides who are in the educational and scientific estate?” More fundamentally, “Quis custodiet ipsos custodes?” A satisfying answer lies in Miller’s analysis of the cost-of-production theory as being rooted in the bargaining between organizations representing different societal constituencies: they guard each other. The responsibility for directing the course of technological development, solving environmental problems, and mediating distributional conflicts rests not with any one of these entities, but must be jointly shouldered by all of them. Conceptually, this is analogous to the well-known tenet of the “separation of powers” upon which the Constitution of the United States was designed. The Constitution has stood the test of time, evolving in response to new conditions. Similarly, cost-of-production theorists stress the necessity of modifying policies in response to the changing industrial economy. It is in their ranks that we find the even-handed economists. In comparison, both the assumptions and prescriptions of the subjective preference theorists and the abstract labor theorists seem simplistic and unrealistic.

Quo Vadis?

Rejecting both “laissez faire” on the right and “let it fail” on the left, Daly offers positive solutions and a way forward. Daly attacks free trade and its emphasis on growth ad infinitum as being incompatible with the sustainable development that we must achieve if we are to continue our existence on a finite planet. Although the drive to grow beyond carrying capacity cannot be blamed entirely on free trade dogma, transnationalization aggregates local, manageable problems into global problems of unmanageable scale. He argues that free trade is allocatively inefficient in that its transnational nature circumvents nationally based efforts to internalize external costs such as environmental damage and social dislocation. In the uneven state of global economic development, the “haves” of the north live beyond the natural capacity of the environment within their national borders by externalizing environmental costs to the “have-nots” of the south. Furthermore, free trade’s assumption that all of humanity—including the teeming billions of the south—can achieve the same standard of living as in the most highly developed countries of the north is fallacious. He argues that the global economy is an open subsystem of a closed ecological system, and cannot grow to the point that it is out of balance with the larger, closed system that sustains it. More accurately, however, the closed loops in the economic system go unaccounted for, treated as externalities. The economic subsystem must live within the absorptive and regenerative limits of the environmental system, thus sustainable development must be the goal, and free trade is an obstacle to that goal. Daly advocates the strengthening of national and local control over economic activities to facilitate the transition from unrestrained growth to sustainable development. In essence, there must be national management of global trade.

But what is “development?” According to Daly, it “refers to qualitative change, realization of potentialities, transition to a fuller and better state.” While supporting a laudable goal, this description is disturbingly vague. Although Daly invokes the Second Law of Thermodynamics in several places throughout his book to explain the concept of entropy and useable versus non-usable energy, what he does not discuss is that the law also places limits on the efficiency of converting one form of energy to another to perform useful work, for instance, converting the heat energy of steam or ignited kerosene into the mechanical energy of a spinning turbine; unusable heat is lost to entropy. Thus, while advocates of sustainable development might hope to use advancing technology to overcome the constraints of living on a finite planet, in fact there are physical limits to the efficient use of resources. Had Daly pointed out this constraint, it would have enabled him to add weight to the concept of “negative growth” that he mentions only in passing. “Development” implies the raising of living standards, but if it is impossible for six billion souls to enjoy the material affluence of the average American, even with future technological improvements in resource utilization efficiency, this in turn implies that we must “build down” the human population of Earth as the average standard of living increases globally.

What would a decreasing global population mean for the future of capitalism, which is always driven to develop new markets? In addition to sustainable development, Daly also discusses the more equitable distribution of wealth. If the global population declines, but there are more “haves” who possess the purchasing power to consume responsibly, it can be argued that the fundamental bases of capitalism—the private ownership of the means of production, and the private capacity to consume—can continue.