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An Introduction to Value Theory

December 25, 2006

Tags Free MarketsHistory of the Austrian School of EconomicsValue and Exchange

[This essay is from The Writings of F.A. Harper - Volume 2: Short Essays, pp. 39-51.]

With interest in the "Austrian School" of economics increasing, it may be helpful to indicate some of the aspects of the value-concept which is so central to the theories of this group. The term "School" as used here refers, not to any institution or corporate set of buildings, but to a body of economic theory developed largely in Austria during the 1870s and 1880s. This term can be misleading, however, because similar concepts of value had been developed earlier and other individuals were coming to similar views at the same time as the Austrians. Preceding the "Austrian" concept of marginal utility analysis — the basis for saying that price determines cost rather than vice versa or that they are mutually determined — much the same idea had been formulated in the 1600s and 1700s in an elementary form by some French and Italian economists. Subsequently, leading English economists wandered off on bypaths of theory until the "Austrian School" brought it back again.

To understand why the English economists wandered from the path which the French and Italian economists had charted earlier, it may be well to outline, very briefly, some high spots of value theory in the history of economics. But first, the extreme importance of value theory in the science of economics should be stressed. Economics deals with those aspects of living which are capable of commanding a price in the market of exchange. This situation arises from the fact that the things we desire are not available in ample enough supply to avail us of them without sacrifice of some sort. A thing must be both desired and scarce to be a player on the field of economic affairs; lacking either of these conditions, it must retire to the bleachers. When anything — whether of a material nature or not — is both desired and scarce, it then has value for any person who concerns himself with it from this dual perspective. Value, then, is at the very base of every economic consideration. To avoid value theory is to avoid the essence of economic science.

When early formulators of economic theory grappled with the value concept, many if not most of them began with the assumption that a thing has value in some intrinsic manner. They thought of value as a quality similar, for example, to the pigment of a red pencil — a quality embodied in the pencil itself so that, if you threw it out the window, the pigment was still embedded in it; if you lost it forever in the forest, the pigment was still there intrinsically.

Having begun with this assumption of intrinsic value, it was perfectly natural and logical to assume that the next step was to discover or invent some means of measuring the value in an objective sense, i.e., in some manner whereby any two or more persons could agree on the amount of value a specific item contained intrinsically. In trying to design such a scientific measurement, they were simply following the lead of the older physical sciences. For instance, once the concept of distance was perceived, a measuring stick with regular gradations was developed whereby any two persons could agree reasonably well on the distance from here to there. Likewise, when the concept of mass was perceived, balance of scales came into being, whereby any number of persons could agree on the weight of a dipper of spices. In like manner, then, these early economic theorists turned naturally and at once to trying to identify precisely what value is, so that the means of measuring value objectively and in precise quantitative terms could be developed.

It is not at all surprising that these early economists hit upon the idea that it is the labor required to produce a thing that gives it value. Everything of value, it seemed to them, had to be "produced" in the economic sense, requiring a certain number of hours of work or thought to bring it into the desired form and location. Otherwise, it seemed, the thing would become so plentiful that nobody would be short of it for his needs, and it would become a noneconomic item of our environment. Thus, there arose in those early days of economic theory the "labor theory of value," which gained widespread acceptance; in fact, its tracks are still deep and pervasive, but mostly in forms without this label.

Many attempts to fix value objectively, especially in earlier times, assumed it to rest on the hours of work measured by the clock. The error in this calculation soon became apparent to any discerning person because productive ability varies so widely from person to person and even from hour to hour for the same person.

To correct the apparent error of using the time clock, attempts were made to measure value on the basis of the cost of the labor input — hours of work times the rate of pay. This procedure, it seemed, corrected for differences in productivity because individuals are paid different rates per hour. But, again, the thoughtful person realized that rates of pay, at best, reflect the differences in what it is expected laborers will produce rather than what they actually do produce. Furthermore, in most instances a worker is paid at a constant rate over a period of time during which his production varies widely from hour to hour.

Still another feature in the development of economic thought should be mentioned, namely, the so-called contributory factors of production. Among the factors which have been included by influential theorists are (1) labor only, (2) land and labor, (3) land, labor, and capital, (4) land, labor, capital, and management, and so on.

Differences of opinion in this respect centered largely on whether or not a given factor was assumed to be separate or imbedded in another factor. For instance, one leading proponent of the labor only theory recognized that capital tools are involved in the productive process, economically as well as physically. But he held that capital is really labor expended to produce the tools in the first place and that, if one views production in its essence rather than its visual form, he will see it all as labor which gives rise to value and thus determines value. A similar view was taken about management, as being only a name given to labor in one of its many forms.

Land involves a special case in analysis, quite apart from tools and management, in this question of other factors being reducible to labor. Some theorists have said that what we call land (including not only soil as the farmer thinks of it, or as the urban dweller thinks of it when he builds his house on a city lot, but also all physical materials like coal, minerals, and even the gasses of the earth's atmosphere) is in part segments of the universe in its natural form, untouched by human hands and labor, and in part natural materials reformed by human effort. So these persons reasoned that an operating farm, for example, is in part the soil and its fertility and in part something comparable to tools; they often preferred to call only the former aspect "land" and the latter, "improvements."

It can be seen that all these ideas about the meaning of value were the results of the struggle to find an objective cause and thus an objective measure of value. Whichever of the many solutions a person might choose, he was in effect looking for a "just price" for any item to be sold in the market place by anyone. To whatever extent the price asked or obtained in the market place deviated from such an objective measure of justice, the item was being unjustly priced — either over-priced or under-priced. And the person pricing it unjustly should, by this test of justice, be brought to task for this economic crime. Ideally, he should also be made to recompense the buyer he has wronged, just as in a case of outright theft; as a minimum, he should go forth and sin no more.

The writings of most of the early economic theorists were beclouded on these points of value concept, and numerous contradictions appeared. Though one of them might, for instance, advance a theory of value based on labor time or labor cost, at certain points in his writings there would appear clear evidence that he felt uncertain about his underlying premise. This feeling may have been more unconscious than conscious, as reality peeked through in unsuspected places.

In short, the work of the Austrian School on value cannot fairly be said to have been completely original. As noted, elements of it appear as early as the 1600s. The distinctive contribution of the Austrian School is that for the first time in the development of economic theory, there appeared — in spite of all the inevitable differences among the ideas of individuals in that group — a complete and consistent theory of value which made all the predecessors appear to be wrong not only in detail but in a fundamental sense as well.

The Austrian Value Concept

The first step in understanding the Austrian concept is to realize that value is entirely subjective, rather than something objective. Value, therefore, is something that each individual person weighs on a purely private, not a public, set of scales. To try to find something akin to a yardstick for distance or a balance for weight, by which to measure value so that two or more persons can see and agree on a "just price," is futile. There is no such thing according to the Austrian concept of value. To try to find value that way is like trying to find the trail for an animal, and hence find the animal, when there is no such animal.

Hence, any two persons will not and need not agree on the value of the same item at the same instant of time. If they should agree, it is a coincidence of no significance whatever so far as discovering value objectively is concerned. For any item at any given instant of time, each person sets his own value in a way that is a mystery to others. He takes into account a vast range of considerations, many of which are peculiar to him alone and which may be so deeply subjective that he cannot even describe them to another person.

According to the Austrian premise, then, value is not intrinsic in the sense of being susceptible of objective measurement by any means whatever. Certain qualities of things are, to be sure, intrinsic and measurable, and affect value for this or that person. But they affect value in different ways for different persons and are at best only a part of the origins of value. To illustrate, age in cheese or in eggs adds value for some persons in the world and detracts from their value for others.

The error of the early search for a universal and objective measure of value should be apparent to anyone by merely visiting a grocery store and watching business for a few minutes. Did you ever see a housewife inquire about the hours of labor or the labor costs in the production of the loaf of bread before deciding whether or not she would part with 29¢ in exchange for it? Or, in like manner, the storekeeper when he buys it from the baker or sells it to the housewife? These factors are not totally unrelated to the price, but in a precise sense they have nothing more to do with the decision to buy or not buy than have many other untold influences. And as a specific consideration in the mind of the housewife or the grocer, probably nothing could be further from their thoughts at the moment of the exchange than facts about total labor input. This could be tested easily by asking any housewife or any grocer at the time of sale whether they had adequately weighed its value on some scale of labor input. Would they even know what you were talking about, no matter how simply and clearly you explained it? No! How, then, could any such thing determine the value of a loaf of bread?

Value as Relative Matter

In addition to being subjective for each person rather than being an objective thing to be weighed on some universal scale or observable calibrations, value is a relative concept within the appraisals of each individual. In other words, the loaf of bread does not have an independent value separate from all other things for Mrs. Jones. The value of the loaf of bread is the relationship of the bread to something else Mrs. Jones wants. In a money economy, she will usually think of the relative value of bread in terms of money — the particular form of value which we call "price." She will decide whether the bread has a superior or inferior value to the 29¢: if superior, she may buy the bread if it seems to her the best use for the 29¢; if inferior, she will keep the 29¢ or buy something else.

Value is a quantitative thing because it is the ratio of the two quantities. Though it is quantitative in this ratio sense, however, we essentially never have to reduce it to any definite quantity. In conducting the economic affairs of life, we need not go beyond the direction of balance in its ratio aspect; we have no need to know precisely the two quantities that are being compared with one another. If Mrs. Jones considers the loaf of bread to be preferable to the 29¢ and to be preferable by an excess over any other use of the 29¢, she will buy it and need not determine by precisely how much it is preferred. The condition of "greater" is all that she need know and all she considers. To try to carry the decision beyond that point of precision is unnecessary for Mrs. Jones and for everyone else, then and forever.

It may seem to be an amazingly complex problem to buy even a loaf of bread when we consider all the alternative uses of the 29¢ — the almost endless array of values that are available to Mrs. Jones. Yet even the most ignorant and careless persons solve such problems easily all the time. They know that someone else cannot appraise things correctly for them. Unfortunately, many economists do not have this knowledge of value theory which even the most ignorant housewife possesses. The child understands it, as evidenced by his great preference for spending his pennies himself rather than having his parents keep making "mistakes" involving his judgments.

The value of the loaf of bread to Mrs. Jones is not determined precisely — or at all, really — by any one factor in its production or by any combination of factors. Due to the fact that Mrs. Jones and Mrs. Smith attach different values to the same thing, and also that they both attach different values from one time to another, it is easy to see that value has no predetermined and fixed quantities in terms of either hours or costs of labor. For, if predetermined and fixed quantities of ingredients determined its value, they would have to be the same for a person every time and the same for one person as another.

Furthermore, the loaf of bread has the same value to Mrs. Jones at that instant of time even if, miraculously, it had dropped from heaven in precisely the form in which it exists on the grocer's shelf. In this case, there would have been no labor input in any form or degree. It would, in fact, be like "land" in the concept of certain factor-in-production theories. But the market process would come out the same as before, in terms of her price values. This result means, then, that value is not only subjectively based, but also is derived from something outside of the economic "input factors."

Profits in Every Exchange

Every voluntary exchange, like the purchase of a loaf of bread, yields a gain to both sides of the exchange. Mrs. Jones valued the bread more than the 29¢, which is the reason she traded. The grocer valued the 29¢ more than the loaf of bread, and that is the reason he traded. In economic terms, an exchange yields a profit to both exchangers. In other words, every voluntary exchange yields double profits of amounts that cannot be determined in any quantitative sense and in amounts that could not be added together meaningfully, even if they could be precisely determined.

The fact that these profits are not subject to precise measurement does not mean that they do not exist, nor does it mean that the fact is meaningless to us. It tells us only that we cannot and need not know any more about it than this, for a smoothly and efficiently functioning economy. The other side of that coin — that value, being the person's subjective appraisal, cannot be objectively determined — is that it is not the proper concern of any other person. The two persons in the exchange make the decisions which they alone can and should make. Others concern themselves only with what is properly their own business.

The above disconcern of others should not be confused with the admitted usefulness of information about prices at which goods exchange. It is a due concern of others what the terms of exchange are among transactions by other persons. This is helpful knowledge about "the market." If bread is selling in Zabrisky's grocery for 29¢, housewives want to know this in order to determine the best place to buy bread. This information, in fact, is what sellers pay money to make known — advertised prices. But this sort of information never tells us anything precisely about value. To say that Zabrisky is offering bread today for 29¢ does not identify the value of bread for either Zabrisky or Mrs. Jones; it tells us only the terms of offered exchange, at which price Zabrisky's value for bread is somewhere below the 29¢ figure at which he is glad to part with the loaf. The price measures the value for no particular person. It expresses only the terms of exchange for whatever sells at that price; no more.

All that has been said above applies in like manner to the selling of one's time to an employer (wage rates), or to the lending of money (interest), or to any other transaction involving goods or services. Traders on both sides make a profit in every voluntary exchange, due to the spread between their values and the terms of that exchange.

By the same reasoning, every compulsory or involuntary exchange, where one person confiscates the goods or services of another or dictates the terms of the exchange under force or the threat of force, entails an economic loss for the unwilling participant. Economically as well as morally, all such transactions are the same as outright theft.

It follows that a wholly voluntary economy results in the greatest general welfare to all the persons of that society. In such an economy, every person profits to the maximum, no matter where he plays in the field of economic activity — as employer or employee, buyer or seller, lender or borrower, etc. It likewise follows that in an authoritarian society losses will be the universal experience of everyone except the dictator himself.

The Market Price

Since values are subjective, independent, and highly variable as well as changeable, it may seem perplexing that there is any prevailing "market price" for goods or services, around which all exchanges tend to hover in close proximity. How can this be? How can the market find one answer to all of these unknown quantities?

The answer lies in the simple fact that each person attempts to maximize his profit in each exchange. Each buyer tries to buy as cheaply as possible; each seller tries to sell as dearly as possible. Each would push his gain to unlimited proportions, were it not for the fact that the other party whose willing cooperation he must have for an exchange to take place has alternative opportunities. Others are buying and selling, too. The buyer can always forgo a purchase, accepting substitute satisfactions available for his dollars. Sellers can always keep their offerings for later sale or quit producing them for future supplies.

Taking into account all the complexities of the process of market determinations and decisions, everything available for sale finds a buyer in the end at a market price. Neither a shortage nor a surplus is economically possible in a free market. There may be physical quantities remaining unsold because the seller would rather keep it himself than to sell it at a price lower than he is asking; he "bids it in himself," as we say about one who does this at an auction sale. And there are those who desire products but who do not get them because they are not willing to pay the price sellers reserve as the minimum they will accept — below which they "buy it back" themselves.

Since all buyers will buy as cheaply as they can and all sellers will sell as high as they can, open knowledge in the market drives all trades toward a uniform price in a manner similar to the way a body of water tends to settle to a common level over its entire surface, no matter how large. Winds and waves and all sorts of other forces — comparable to controls introduced into the free market — may come and go, but the leveling force persists just the same.

According to the theory of the Austrian School, the meaning of a "just price" is that price which emerges from the freely made decisions of all the participants, rather than from an outside person sitting in arbitrary authority. Subjective values of all those who are dealing with their own property in time, goods, and services determine the just price. The justice of the prices so determined is to be found in the process, not in the magnitude of the price. One person may sell a bushel of wheat to a willing buyer at $2 a bushel, or he may give it to the Salvation Army, or he may feed it to the pigeons; each of these "prices" would be just, as long as he makes the decision in disposing of his own wheat.

We are indebted to Vilfredo Pareto for a vivid illustration of the marvelous way the free market resolves the complexity of varied values and widely differing opinions of persons in the market place. He calculated that for a small, simple society of only 100 persons trading only 700 goods and services, it would require the solution of 70,699 simultaneous equations in order to equate supply and demand in the manner the free market does so easily. If one recalls how difficult is the task of solving only two or three simultaneous equations in algebra class, he will appreciate the task of solving 70,699! Not only that, but the equations keep changing all the time for any number of reasons, including the "whims" of every trader. Yet this complex equation is easily solved by free exchange among persons who may be unable to count and who may not even read in some instances.

The Authoritarian Substitute

Because value determinations are subjective by nature, economic decisions cannot be delegated by one person to another; they can only be abdicated to the other person. In its extreme form this means acceptance of a complete dictatorship, with its lesser degrees and forms amounting to the same thing. But none of these alters the nature of value; it alters only whose value is being realized.

The dictator makes value decisions in the same way as any other person — on a purely subjective basis. The difference lies only in the scope of his power to exercise it. The head of a family may do the same thing for its members, and the head of any organization may do the same thing for its members. In all such instances, the decision — the control, the essence of ownership — is his and not that of the members.

The hopeful vision of a "benevolent dictator" should be indulged with caution. If he were to try to make his value decisions by taking into account the presumed wishes of his subjects, he really could not do so. The welfare of others is likely to be best assured when their benefactor has no power whatever over them — when he leaves them to make their decisions in their own right and acts in their interests only with his own means as a friend. When a person acts toward others dictatorially rather than with goodwill and friendship, he is likely to ignore their value preferences and be "benevolent" only in the sense of forcing upon them what he thinks they should want, but what in fact they do not.

So value theory in its subjective sense, as well as the processes of marginal utility and all the rest, operate at the level of dictators or heads of corporations and families, as though each were an independent individual acting for himself alone.

Though some contend that economics is completely and permanently separate from the concerns of political and philosophical matters, most adherents to the Austrian School of economic thought have been classical liberals. There have been some variations in detail, of course, and the classical liberal position has also been upheld by persons with other economic views. Historically, however, there seems to be a close relationship between the two.

The reason for this is probably due to the fact that when one accepts the views of the Austrian School on subjective value and all that this entails, he sees a deeper meaning in individual rights and in private property. He sees that one person cannot accept the responsibility for making another person's decisions; he can only make decisions in his own right, under the abandonment by the other person of his rights. This alternative, as he can then see, ultimately leads to complete centralization of power in the hands of one person as dictator.

While it would be unfair to charge the earlier economists with being disloyal to the tenets of human liberty, it is true that they left important problems unsolvable because of their deficient value theory. Many later economists who are sincerely in favor of the maximum of human liberty are in like manner still searching in vain for a formula for some collective determination of what, by its nature, is strictly an individual matter — even with the works of the Austrian School at hand to help them.

The key question in so many of the problems which perplex us and which seem so complex and difficult is: who owns it? He who owns it has thereby the right to determine its use and the terms of its disposition; he alone, under the Austrian School of value theory, can answer that question, and to answer it is his exclusive right.

 


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