Wednesday, April 10, 2013

Labor vs. Utility: A Short History of Value

This is most of the first chapter of a book I'm writing (which may never be finished). Working title is "Eight Great Debates in the History of Economic Thought, and What We Can Learn From Them Today." I hope you enjoy my preliminary footnotes. 

Worldly Philosophers

Sometime in the 4th century BCE, somewhere on a rocky outcrop near Athens, a man wrote, “A shoe is used for wear, and is used for exchange; both are uses of the shoe. He who gives a shoe in exchange for money or food to him who wants one, does indeed use the shoe as a shoe, but this is not its proper or primary purpose, for a shoe is not made to be an object of barter.”[1] That man was Aristotle, and those words, according to some, were the first ever penned in economics.
How appropriate that the dismal science should have begun with the contemplation of a shoe. Greek and Roman philosophers generally agreed that the state was the most proper object of study, but in practice no subject was too trivial, too simple, or too ordinary to escape notice.  This was the age of empiricism, when books had not yet attained the authority that centuries now lend the classics, and when the wise acquired knowledge through reflection on worldly experience alone.  Aristotle mused about value and exchange, but he also wrote about ethics, physics, logic, and medicine, and devised his own system to classify the plants and animals he encountered. His contemporaries theorized about the causes of disease, the movements of the stars, and building blocks of the universe, with no instruments to aid them but eyes and ears, and no frameworks to guide them but common sense and imagination. Most of the time they were wrong, but when they were right, they were astounding.
Aristotle’s evaluation of his shoes contributes to a larger argument in Book I of his Politics about the “nature” of things, an argument that juxtaposes gems like “man is by nature a political animal” with terrifying statements like “from the hour of their birth, some are marked out for subjection, others for rule,” and “silence is a woman's glory.”[2] Aristotle recognized that every element in society can serve multiple purposes, but for every element he decided that one purpose was better, or more natural, than the others. Slaves are meant to serve masters, women are meant to mind households, and shoes are meant to wear.  By criticizing the exchange of shoes for money, Aristotle established a standard of value for goods and services based on potential for use, not on price, or any other attribute.
Some modern scholars argue that Aristotle’s criticism of commerce reflected an attachment to the status quo, which at the time was threatened by the growth of trade and markets in ancient Greece, and others praise his characterization of life as larger than economics.[3]  Whatever his motivation, Aristotle introduced an intriguing question: what determines value?  Other early philosophers reflected on the same question and came to similar or different conclusions, and Aristole himself used different standards of value in different passages.  No definitive definition was reached.  Not too long after Aristotle, philosophers turned their scrutiny towards the heavens, and for many centuries focused their energies on distinctly unworldly subjects. With a few exceptions, they did not return to earth until the 17th century and the dawn of the age of enlightenment.  
John Locke, one of the greatest empiricists of the new age, stumbled upon an entirely different standard of value his chapter On Property in his Second Treatise of Government: “ is labour indeed that puts the difference of value on every thing; and let any one consider what the difference is between an acre of land planted with tobacco or sugar, sown with wheat or barley, and an acre of the same land lying in common, without any husbandry upon it, and he will find, that the improvement of labour makes the far greater part of the value.”[4] Men value nature mixed with labor more than nature untouched, Locke observed, and therefore labor must create value. By extension, shoes are valuable not because you can wear them, nor because you can sell them, but because the shoemaker made them.
Contemporary philosophers continued to reach different conclusions, and, like Aristotle, Locke used different standards of value in different passages, but the idea of labor as a basis for value became particularly popular in the early modern world.   Benjamin Franklin, American scientist, politician, and commonsense philosopher, expressed similar ideas in his Modest Inquiry into the Nature and Necessity of a Paper Currency.[5]  Francis Quesnay, the leader of the influential French Physiocrats, agreed but emphasized the importance of nature mixed with labor, arguing that value is built on agricultural output particularly.[6] Adam Smith, a contemporary of Quesnay’s, wrote, “the real price of every thing, what every thing really costs to the man who wants to acquire it, is the toil and trouble of acquiring it,” emphasizing tools and machinery as well as nature as supplements to human endeavor, to create the holy triumvirate of classical economics: labor, land, and capital.
Although Smith built his theory of the wealth of nations on the idea of labor value, he also penned a passage remarkably similar to the one Aristotle had written nearly two millennia before: “The word value it is to be observed, has two different meanings, and sometimes expresses the utility of some particular object, and sometimes the power of purchasing other goods which the possession of that object conveys. The one may be called 'value in use' the other, 'value in exchange.'”[7] Where Aristotle went on to declare “value in use” more natural than “value in exchange,” Smith merely gave an example of something that is extremely valuable in use, but of nearly no value in exchange, and of something that is extremely valuable in exchange, but not terribly valuable in use—the famous paradox of water and diamonds. Thus in one book Smith proposed three contradictory definitions of value: exchange value, use value, and labor value.
Smith’s conclusions, like Locke’s and Aristotle’s, were products of empiricism. Because the same thing can look different from different perspectives, knowledge based on observation often produces contradictions, and to most of the worldly philosophers, such contradictions were acceptable. They used philosophy to spread wisdom by sharing their most interesting interpretations, and they left us with many simultaneous truths. In the end, multiple sketches from different angles proved more accurate than single, focused studies; but to understand why, we must enter the age of science.
The Labors of Ricardo
Adam Smith lived at the dawn of the industrial revolution. Many of the inventions that set the stage for transformation were invented during his lifetime, including the flying shuttle, the spinning jenny, and the threshing machine. He was a personal friend of James Watt, who perfected the steam engine in 1778, and he saw Glasgow grow from a local trading hub to a thriving center for industry, and Britain begin the journey toward economic empire.[8] New technology disrupted philosophy as well as industry. Science had discovered universal and exclusive truths; gravity always pulled down, steam always pushed up, and together the two forces could move mountains of iron and transform sleepy towns into powerhouses of profit.  If science could be so efficiently applied, why couldn’t economics? What clear, actionable advice could be drawn from musings on wealth, value, and exchange?  Resolving the inconsistency of the empiricists took on a new urgency, and David Ricardo rose to the task.
Ricardo was born in London in 1772 to a wealthy Jewish family, but his father cut off his inheritance when he eloped with a Quaker, Priscilla Anne Wilkinson, at 21.  He remade his fortune as a stockbroker, and by the end of his life had won a seat in the House of Commons and purchased one of the finest estates in England for his wife and children. Ricardo built his success on hard work, and everyday made decisions that the markets decided were either right or wrong. There was no room in his world for simultaneous truths. Ricardo read the Wealth of Nations in 1799, and, inspired, embarked soon after on the labors that would produce his magnum opus in 1817, On the Principles of Political Economy and Taxation. Where the Wealth of Nations, wandered, pondered, and suggested, Ricardo followed the method of mathematical proof, choosing a few key axioms and constructing a consistent model of the economy on their foundation.
He cut to the heart of the matter in his first chapter, On Value. “The value of a commodity, or the quantity of any other commodity for which it will exchange, depends on the relative quantity of labour which is necessary for its production, and not on the greater or less compensation which is paid for that labour.” Unlike Aristotle, Locke, and Smith, Ricardo did not contradict his chosen standard, but carefully defended it, arguing that fluctuations in price unrelated to labor must represent “accidental or temporary” deviations.[9]  In chapter five, On Wages, Ricardo introduced a second key axiom, declaring that that wages must always tend towards subsistence, or the minimum price necessary to feed the laborer and his family. This assumption allowed him to price labor value by multiplying hours by the subsistence wage, and also reflected the deeply unequal economic relations of his day. In chapter six, On Profits, Ricardo formalized a third axiom: because of the pressures of competition, the profits of industry must always tend toward a common rate; only land, because of its natural scarcity, can yield increasing returns.
These axioms, which became known respectively as the labor theory of value, the iron law of wages, and the common rate of profits, set the scene for the rest of his theory.  Put in motion, the three characters act out a very tragic play. As the population grows, new land is cultivated, but because marginal land is necessarily inferior, it requires more labor to cultivate, driving up the price of food, raising the subsistence wage, and cutting into to profits of industry. To maintain profits, industrial capitalists introduce machines into the process of production, decreasing the amount of labor necessary to produce goods and decreasing the wages they must pay, until the competition kicks in to lower profits back to the common rate. Agricultural prices tend to rise, industrial prices tend to fall, and the only party who can possibly benefit in the long term is the landowner. 
Ricardo used his theory to successfully advocate for the repeal of the Corn Laws, which by placing tariffs on imports of grain increased the price of food, and therefore, according to Ricardo, kept wages artificially high and profits artificially low. Thus before he died Ricardo was able to taste the fruit of his labors; he had constructed an internally consistent, scientific system that could be applied to the real world to forward the cause of progress.  He also had the good fortune to see his economics embraced by his countrymen. As John Maynard Keynes, wrote one hundred years later, “Ricardo conquered England as completely as the Holy Inquisition conquered Spain. Not only was his theory accepted by the city, by statesmen and by the academic world. But controversy ceased; the other point of view completely disappeared; it ceased to be discussed.”[10] On the Principles of Political Economy and Taxation remained the standard text in economics until John Stuart Mill published his Principles of Political Economy in 1848, which improved little on Ricardo’s reasoning but greatly on Ricardo’s style.
Karl Marx, born two years after the publication of On the Principles of Political Economy and Taxation, lived his entire life under the shadow of Ricardian economics. As a young man at the University of Bonn in Berlin, Marx studied the grandiose but often abstract theories of Gottfried Wilhelm Leibnez, Ludwig Andreas von Feuerbach, and most importantly Georg Wilhiem Friedrich Hegel, whose philosophy of history painted progress as the evolution of collective human reason.  At the beginning of the 19th century and the height of the German philosophy, Bonn scholars paid little attention to the primitive mutterings of the barbarians across the northern sea, but as Marx grew older, whispers of a bold new English system grew louder.  Friedrich Engels, his friend and primary collaborator, fed him socialist ideas from France, and he continued to discuss Hegel’s ideas with an enthusiastic cohort of German students, but Marx remained unsatisfied.  In 1843, at the age of 25, Marx decided that to answer his philosophical questions, he needed to master Ricardian economics.[11]
Marx took Ricardo’s skeleton theory and dressed it in rags. Ricardo may have declared that the wages of labor must always tend towards subsistence, but he never took the time to imagine what subsistence would look like. Engaged in the European socialist movement, and later living among factory workers in London’s slums, Marx saw subsistence at every turn; children covered in soot, mothers with fingers twisted from textile mills, and fathers weary from 18 hours of hard labor.[12] Ricardo’s science said it must be so, but Marx’s soul cried that it could not.  And so he united Hegel’s ideas about the evolution of history, Engel’s ideals of an equal society, and Ricardo’s axioms on value, wage, and profit to conclude that revolution must rewrite the rules of science.
Marx did not follow Ricardian economics exactly. He tweaked the labor theory of value to create the concept of socially necessary labor time, partially fusing use value and labor value as the marginalists would later do.  He embedded the iron law of wages in the social relations of the proletariat and the capitalist, and the common rate of profit became the tendency of the rate of profit to fall. In Marxian economics, surplus value accrues not to land, but to something much more subtle: hoarding.[13] In his 30 years of intensive study at the British Museum, Marx actually created a system much closer to the truth than Ricardo, but, written in the language of insurrection and peppered with innumerable convoluted German expressions, Das Kapital remained unpalatable or unintelligible to most. A small but devoted set of disciples would carry Marxian economics to St. Petersberg, Bucharest, Havana, and Beijing, but in London and in the majority of the rest of the world, Marx never threatened Ricardo.  
Indeed, Ricardian economics became so ingrained in 19th century thought that only one force proved powerful enough uproot it: time.  For in the end, very few of Ricardo’s conclusions came true. Profits deviated from the “common rate” too often and for too long to excuse fluctuations as “accidental and temporary.”  Prices of industrial goods rose, and prices of agricultural goods fell, and landowners found their relative place in society challenged by urban capitalists.  Wages increased, Marx’s slums gradually cleared, and at the turn of the 20th century English society was, if still extremely unequal, working well above subsistence.  And as time wore on, Ricardo’s disciples uncovered problems that his economics simply could not explain.  Luckily for them, the seeds of an alternative system had already been planted, not in science, but in moral philosophy.
The Utilitarian Project  
Morality in the age of enlightenment was a sensitive business. In the 16th century the Protestant Reformation discredited Catholic ethics, but offered nothing definite to replace it; new prophets rushed to fill the void, some offering slight amendments to traditional values, others preaching brave new interpretations of the Bible, and still others declaring radical moral codes that claimed no dependence on the authority of God.  Prophets preached against prophets, kings chose sides and started wars, and bewildered citizens clung fanatically to new creeds or chose to operate without a moral code at all. Chaos bred discord, but, for the worldy philosophers, it also made room for creativity.
In the early 18th century, a number of thinkers began to reexamine an ancient and powerfully simple moral philosophy: hedonism, the belief that behavior should endeavor only to maximize pleasure, and minimize pain. One was Francis Hutchinson, Chair of Moral Philosophy at the University of Glasgow and favorite professor of Adam Smith, who argued that action should be judged by its effect on the general welfare of mankind.[14]  Another was John Gay, a Vicar of Wilshampstead, who proposed something he called “the greatest happiness principle” in his Dissertation Concerning the Fundamental Principle of Virtue or Morality.  A third was the English philosopher and reformer Jeremy Bentham, who in addition to his moral philosophy is today remembered for his passionate defense of animal rights, gender equality, and the charging of interest, his advocacy for the construction of a circular prison called the Panopticon, and his fulfilled wish to be mummified after death. 
In 1780 Bentham rebranded hedonism as “utilitarianism” in his Introduction to the Principles of Morals and Legislation.  He defined “utility” as “that property in any object, whereby it tends to produce benefit, advantage, pleasure, good, or happiness, (all this in the present case comes to the same thing) or (what comes again to the same thing) to prevent the happening of mischief, pain, evil, or unhappiness to the party whose interest is considered.”[15]  If utility sounds familiar, it should. Bentham’s utility was essentially the same as Smith’s value in use, described only four years earlier in the Wealth of Nations, and more than two millennia before that by Aristotle by way of his shoes.
Through moral philosophy, Bentham proposed a standard of value where the unit of relevance is not an hour of labor, nor a piece of currency, but single unit of utility, later infamously dubbed “the util.” However, despite his avid interest in economics and personal acquaintance with Ricardo, Bentham never used utility to directly challenge the labor theory of value.  The problem was measurement.  Ricardo measured value by counting labor hours, but utils are not so easy to count.  Bentham feebly proposed that individuals might report the intensity of pleasure received from goods and services as numbers, an idea rightly ridiculed by his contemporaries and successors.  Even if you could rely on the integrity of self-evaluation, how could you possibly compare the subjective utility of one individual to the subjective utility of another? Price presented a second problem; Ricardo translated labor value into exchange value by multiplying labor hours by the subsistence wage, but utilitarianism suggested no such obvious mechanism.
Most citizens of the 18th century flat out rejected utility as a guide for moral behavior, and Bentham’s alternative beliefs and radical reputation certainly did not add to his moral credibility.  He needed help to convince the wider public that utilitarianism meant anything more than the unabashed celebration of an irresponsible, indulgent lifestyle. [16]  Ironically, the man most responsible for popularizing utilitarianism was John Stuart Mill, also remembered as the author of the authoritative resource on Ricardian economics for the second half of the 19th century. With a series of essays penned in his characteristically beautiful prose, Mill teased utilitarianism from a thoughtful restatement of self-indulgence into a widely accepted system that scholars still discuss today. But like Bentham, Mill never fully applied moral philosophy to economics, and today those two fields view him not as a key contributor, but as a genius of interpretation.
Instead, in one of history’s great coincidences, three different men in three different countries independently realized how to measure and price utility: William Stanley Jevons in Britain, Carl Menger in Austria, and Leon Walras in Switzerland.[17] Although seemingly miraculous at the time, in retrospect their simultaneous innovation was actually quite understandable. Ricardo gave the world a glimpse of what economics could accomplish, and, like Marx, hundreds of idealistic men turned to his theory for guidance and found it wanting.  Bentham “planted a tree” that no one could ignore, but he left the utilitarian project unfinished.[18]  The task of the next generation was to incorporate the utility into Ricardian economics, and to so lay the foundations for the construction of a new and greater science. 
Marginal Revolution
Jevons, Menger, and Walras each approached the problem of measurement in a different way. In his Brief Account of a General Mathematical Theory of Political Economy, Jevons began with a Benthamite exposition of pleasure and pain and stumbled awkwardly toward a numerical ratio. In his Principles of Economics, Menger abandoned any attempt to calculate, and instead rigorously constructed a system based on ranked preferences, also known as ordinal utility.  Walras discovered the topic during an attempt to build a mathematical model of the entire economy, and actually worked backwards to deduce the theory of value behind his equations.[19]

Eventually, all three arrived at the same conclusion: prices are determined on one hand by marginal utility, or the amount of utility the consumer expects to receive from the last unit bought, and by marginal cost on the other, or the increase in total cost required to produce the last unit sold.  When marginal utility is greater than marginal cost, the quantity of utility bought and the its price will increase, and when marginal cost is greater than marginal utility, the quantity of utility sold and its price will decrease, until the two equilibrate.  Walras aptly called this process “tâtonnement” or literally, groping.[20] Importantly, all three also noted that marginal utility tends to diminish with quantity; we are willing to pay less for our fifth apple less than our first.  Marginalism solved the problem of measurement by allowing economists to price utility without counting utils through the mechanism of tâtonnement, and finally allowed economists to formally explain Smith’s paradox of water and diamonds: while the total utility of water is greater than the total utility of diamonds, the marginal utility of one more diamond is greater than the marginal utility of one more drink.
For the most part, marginalism remained highly abstract and quite inaccessible to all but a select few until Alfred Marshall, a Cambridge don and student of Jevons, published his Principles of Economics in 1890. Marshall interpreted marginal utility and marginal cost as curves that intersect at equilibrium, and emphasized that both marginal cost and marginal utility play an equally important role in determining quantity and price, like the bottom and the top blade of a pair of scissors.[21] Thus with simple graph and a simpler metaphor, supply, demand, and neoclassical economics were born.  Marshall’s exposition cleared the way for a golden age; finally free from the fallacies of Ricardian economics and the contradictions of the worldly philosophers, a new generation of the mathematically minded men, including Vilfredo Pareto, Francis Edgeworth, and Eugene Slutsky, set out to reduce the world to a series of graphs and equations.  All modern students know these names, for they decorate the models we use in microeconomics today.
Supply and demand did not cleanly replace the labor theory of value with the utility theory of value.  Demand and marginal utility clearly referenced Bentham’s calculus of pleasure and pain, but supply and marginal cost did not.  Thinking about cost, or the price of additional production, made perfect sense to businessmen, but using price to define marginal cost and marginal cost to define price created a confusing and circular definition of value.  Because all costs can be interpreted as backdated wages, some contemporary economists simply understood supply as labor value reincarnated, but this too did not quite fit, because Ricardo’s mechanical method of pricing labor by multiplying labor hours by the subsistence wage clashed with the idea of tâtonnement.
Jevons articulated supply more accurately, if less clearly, than Marshall: “Labor will be exerted both in intensity and duration until a further increment will be more painful than the increment of produce thereby obtained is pleasurable. Here labor will stop, but up to this point it will always be accompanied by an excess of pleasure.”[22]  Jevons framed equilibrium as the equality of the marginal utility of consumption and the marginal disutility of labor, or as some would later call it, the laborer’s marginal utility of income, and so eliminated the need for the troublesome concept of cost.  Importantly, Jevons noted that marginal disutility tends to increase with quantity: we mind our seventh hour of labor more than our second.   Still, to avoid tongue-twisting terminology, to explain economics easily to practical men, or perhaps simply out of the force of habit, economists continued to speak about tâtonnement in terms of cost, and still do today.
Beyond disutility, supply hid an even deeper relationship between labor value and use value. If it were possible to decrease the incremental pain of labor by reducing the duration or intensity of labor required to create utility, would not quantity increase, or price decrease?  In other words, equilibrium ultimately depends on productivity, or the rate at which labor can produce utility.  Productivity was the missing link between labor value and use value in Ricardian economics. In the Wealth of Nations, Smith noted that education, experience, and other characteristics can differentiate labor, but in order to squeeze philosophy into science, Ricardo made labor a uniform, homogenous good; an hour of labor was an hour of labor was an hour of value.  Bentham devised a theory of value, but could do nothing with it. Marginalism incorporated labor value into use value by means of productivity, and both into exchange value by means of tâtonnement.  Instead of choosing one standard to hold above the others, marginalism defined a relationship between the three. 
Marginalism proved that, after all, the worldy philosphers were right. All goods and services have three types of value: use value, labor value, and exchange value.  Just as the eye needs multiple perspectives to understand form, to understand value economics needed simultaneous truths.  However, the marginalists never truly answered Aristotle’s question. By shifting emphasis from value itself towards the relationship between different kinds of value, marginalism divorced economics from larger ideas about what we care about and why. Today other branches of academia ask Aristotle’s question more directly; psychology, sociology, and of course, modern day moral philosophy. Ricardo set economics on the path towards a cold and mathematical science, and after the marginal revolution, there was no turning back. Marginalism also explained why Ricardo predicted so gloomy a future. Value based on the hour cannot grow, because no matter how much we try to stretch it, save it, or slow it, time will always be our ultimate constraint. Utility, however, has no limit.  We will always be able to cook food a little tastier, weave clothes a little finer, build houses a little grander, and tell stories a little better.  We do so not by increasing time, but by increasing productivity. Neglecting productivity was Ricardo’s greatest mistake.
For the immediate heirs of the marginal revolution, however, productivity presented something of a puzzle.  Economics had spent the last century denying its existence, and reliance on the language of cost to describe supply left a simple concept surprisingly poorly defined. Businessmen unanimously sought to reduce their costs, certainly, by purchasing additional machinery for the factory, by reducing wages, or by trying to source raw materials, like coal, wood, or wool, more cheaply. But which, if any, of these actions could be said to increase efficiency?  The rest of Part I will focus on the slow discovery of the determinants of productivity by 20th century economics. Parts II and III will examine demand, supply, and the process of tâtonnement more in depth.  We will find that, in all cases, equilibrium is infinitely messier than the models of the marginalists suggested.
Capital, Capital, Residual
... Coming soon! 

[1] The Politics
[2] Ibid, book I
[3] Polyani can be the latter, any feminist with an interest in classics the former...
[4] Second Treatise of Government, Chapter V
[5] A Modest Inquiry into the Nature and Necessity of a Paper Currency
[6] Whichever physiocrat Tract is most appropriate to reference
[7] Wealth of Nations Book 1, chapter IV
[8] Should I cite this biographical information or is it too trivial? (At what point does Wikipedia need backup?)
[9] On the Principles of Political Economy and Taxation Chapter I On Value
[10] Keynes, The General Theory, somewhere in the first three chapters  
[11] Should probably quote some sort of biographical source here, I think I got this from the introduction to the Marx-Engels reader, so that’s legit
[12] Ibid?
[13] More on hoarding will have to wait until chapter five of this book, aka maybe never. Damn I hate not defining concepts properly the first time they come up to bat
[14] Smith was the Chair of Moral Philosophy after Hutchension, but he built his moral philosophy on moral sentiments, not greatest happiness
[15] Introduction to the Principles of Morals and Legislation. Chapter One
[16] I actually have no source to confirm that this is true, (or rather, not misleading) just kind of assuming. Should probably check that.  
[17] Several others could also take credit, but history generally remembers these three because they were actually able to convince others they were right before they died
[18] Totally stole this from Stigler, but “planted a tree” is just too good a phrase
[19] Principles of L’Economique Pure or something. We will discuss Walras a lot more in the next chapter (if I write it)
[20] Should probably figure out where the fuck Walras says Tatonment in all that French 
[21] Wherever Marshall first wrote about the scissors   
[22] Brief Account of a General Mathematical Theory of Political Economy something something

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