Theories of Value

Overview by George Mobus

The Labor Theory of Value

"Possibly the most influential thinking (Smith, Ricardo, Marx) on value has come to be known as the labor theory, i.e. how physical or mental labor, put into a product or service, affects its value to the producer or to others with whom the producer will trade (for equal valued goods or services).

The relationship between various forms of this theory and an energy theory of value should be apparent. Labor means work and work means energy flow. Thus attributing a value to the amount of work done is equivalent to the amount of energy expended. Unfortunately things get immediately complicated because different levels of skill among workers lead to different efficiencies in the work process (see below, Knowledge Theory) and thus different, sub-optimal uses of energy or wastage. However, in aggregate, and statistically it is possible to posit an average energy expenditure per worker per unit of work accomplished. This is, after all, the way we compute productivity. Too, we are all probably personally familiar with cases of inefficient or sloppy workers who have been let go since their work efforts actually hurt the profitability of the enterprise. Inefficient skill has a way of getting pushed out of the organization (unless, of course, the worker is the bosses' relative).

Another complication involves the fact that so much modern work is actually based on machines, instruments, and other forms of automation. Each of these uses external sources of energy to drive the work process and the only expenditure by a human laborer is in guiding (and fixing) the machine. Or the human may be involved in a complex information process using an instrument to measure some critical parameter (e.g. quality control). Clearly significantly more work is accomplished by the machine/human combination than just by the human alone. Historical accounts of labor theories do not always take the machine use of energy into the picture.

In the figure above, the machine could just as easily be a computer and the product an output message which may or may not convey information to a receiver. That is what I conceive of my current efforts at the keyboard. In my case there is raw material input, but there is energy (electricity to run the computer and the Internet that will convey this) and finished parts (the Wikipedia articles I link to). My control is the result of my knowledge (such as it might be), my typing and writing skills, and my internal motivations. I know my computer is producing waste heat because I can feel it being pushed out (by a fan) from the side. Since I rarely, if ever, print these blogs out on paper, there is no waste material produced, but if I did, and threw the paper away after editing, then this would be the case.

What is the 'work' value of this blog? I substitute work here for labor since the latter is augmented, considerably, by the machine. It isn't what you, the reader, pay for it since I give it away for free. Is it's value alone determined by the amount of energy that goes into it? What about the knowledge and skill. I will treat these separately below, but can note here that I expended more energy in the past to acquire the knowledge and skills being exercised now. So to the extent that my knowledge is worth anything to you the reader, I have to count that energy as one of the inputs to the final product. To anticipate what I will suggest below slightly, that energy should be counted in the value added calculus of this product. Of course, one could never account for that energy since it is impossible to say how much I expended acquiring these capabilities. Also, the full expense, if it could be accounted, cannot be added to this one blog, since I have used this knowledge elsewhere and many times. Given that the energy costs for knowledge and skill acquisition are unaccountable in this way, we need some other method of placing value on them. Nevertheless, it is the case that energy expenditures in the past were involved so my main point that energy can provide the basis for a theory of value remains valid, if hard to solidify.

But what about the value of this blog to you the reader? Is it worth anything? I suppose that depends on you. If none of it makes sense, then it is basically noise and you needn't try to consume it. If you already know it (or something like it) then, again, you have no use for it (except possibly to reinforce your current understanding). But if you can follow the trains of thought and you end up thinking differently, acting differently, or just learning something you hadn't considered before, then it seems there has been some value to you as a consumer. Certainly that value is not encoded in a monetary price. How would one price such a thing? And, you actually used up energy in the process of consuming this. Your brain had to do some work to absorb the information and convert it into knowledge in your head. But the real value would be recognized sometime in the future if this knowledge were to help you make a decision that led to a benefit to you. Almost assuredly, that benefit would come in the form of a net energy gain to your life! My labors of the past (in learning) and now (in writing) may save you time and energy in the future.

This transaction is not the usual sort from the standpoint that you didn't pay me anything, or barter with anything of value to me in order to 'enjoy' the product of my labor. That is only because to me what I am doing is the result of surplus and I am not worse off for giving it away. You could, of course, offer me a kind of payment by offering commentary on my work. Even critical commentary is worthy since it could help me improve my thinking.

But in another sense, you actually have paid me. Everyone who earns an income pays taxes to their state. Some of those taxes go to pay my salary. If you are a student of mine, you have paid into that salary via tuition. I receive an income in order to allow me the luxury of thinking about these issues and learning more as part of my job. Hence, I am sustained by income (with which I will buy energy for me and my family) from academia and some of that income goes to support my efforts in producing this blog! Very circuitous, I know, but you see, I'm not such a benevolent giver after all. If it weren't for my work as an academic I couldn't afford to spend time working on these blogs (I might be reduced to writing political blogs instead!)

Marginal Theory of Value

This is one of those subjects that might give you an idea of why neoclassical economists are so enamored with their theories (though note in this subject the use of the word 'law' to indicate that a principle is inviolate!) Nevertheless, the notion of marginal utility and the 'law' of diminishing returns, and other laws, consider the rate at which an input has less and less value to a rational agent as the input is increased. For example the marginal utility of the next hamburger you eat at a single meal diminishes rapidly as you get full. So adding one more hamburger into the meal has diminishing value to the eater (unless you are Wimpy from Popeye world).

The problem I see with applying this seemingly straightforward model to a general theory of value is that it appears not to work at all with money. Ever since we decoupled the monetary system from the real asset base (Nixon's severance of the gold standard in 1971 being the last major assault on a coupling, albeit a poor one) money has become a valued commodity in its own right. People count their wealth in dollars rather than hard assets. Even the latter are assigned market value in dollars as if it was the dollars that mattered rather than the assets.

The effect of this can be most plainly seen in the housing market. How many rooms do you really need? According to marginal theory, having one more room has lower marginal utility. A rational agent ought to disfavor an additional room in lieu of some other asset that has greater utility, a car say. But since houses have been assigned dollar values by markets (and bubbles) all of our not-so-rational agents have tended to want larger houses with more rooms just because they are thinking in terms of dollar valued wealth. Every dollar more that you receive should have equal purchasing power, so the marginal utility of the next dollar is exactly the same as the very first one. And if your net worth is going up by virtue of your assets carrying a higher dollar value, then having that extra room is about equivalent to having a bunch more extra dollars, all of equal utility. This might, in part, help explain the irrational belief on just about everybody's part that taking equity out of your home to buy that car made sense. Of course car salesmen and bankers liked that idea.

Denominating everything in dollars when those dollars have no grounding in reality is bad business. You look at your balance sheet where you have marked your asset worth to market values and suddenly realize how rich you are. And since every dollar has equal value, why not spend some of that wealth on something else nice?

The efficacy of marginal value depends entirely on the existence of rational agents, Homo economus. And we now know that no such agent exists. We don't even come close.

That doesn't mean that marginal utility might not have some marginal utility in terms of understanding some aspects of decision making when it comes to accepting a price. But we can't base our whole arguments about value on this one marginally useful concept.

Objective Theory of Value

Also known as the intrinsic value of a good or service, attempts to identify a value based on the actual worth of that good or service. Unfortunately, too often, people focus on that worth being equated to something like the labor theory of value. That is they want to add up all of the energy and material costs that went into producing a product or service and count that as its intrinsic worth. This approach is fine for doing an accounting for the inputs to product, like a cost accounting method for finding out what you had better price a unit of product at in order to make a profit. If your price is at or below cost then you're screwed.

But cost is only part of the notion of value of a product or service. The other part is what can that product or service do for the buyer/owner? In other words, there is an intrinsic value to the buyer that goes beyond what the sum of the costs were. I have argued in several different places, that this is what we mean by a tool. If the object or service allows the owner to become more efficient, thereby freeing up resources to the buyer, then the value is not only the cost embodied in the tool, but the lifetime return on the investment in buy that tool. The higher the return on investment, the more a buyer ought to value the tool, and thereby be willing to pay for the tool. Most of us don't compute a rational ROI on our investments in goods and services. Unfortunately most of the time we can't even differentiate between the tool value and some incomprehensible psychic or esthetic value. We tend to buy design more than function these days.

But assuming for a moment that you could discern the tool value — how much gain in time and resources, especially energy you would get by using the product or service. Wouldn't you be willing to pay cost plus some premium related to your presumed future return on investment? Even if you couldn't exactly compute what that ROI might be, wouldn't you allow that you will get something worthwhile out of the future use of it, and thereby be willing to pay some additional amount so the seller can have a 'reasonable' profit?

Most of us value convenience. We see saving time as essentially saving energy, our own personal energy. The problem with any form of objective or intrinsic value theory is that too many tools today substitute external energy for our energy. And they don't just substitute equivalent amounts. They usually run on electricity or gasoline and use far more power than we could have ever applied so that we can do a lot more work in a shorter period of time. This is the real meaning of Fig. 1. If you were a craftsman, say a carpenter, and you either used a hand tool, or could buy and use a power tool that allowed you to do ten times the amount of work in a unit of time (work for which you will be paid) wouldn't you do so? Especially if the external energy input was so incredibly cheap.

So the two aspects of objective value, real costs and reasonable profit based on perceived return on buying investment are a quite reasonable basis for ascertaining value, at least as far as tools are concerned and as long as external energy is abundant.

The problem comes from the fact that not all goods and services are actually convenience producing tools. We buy a lot of stuff just because it has a WoW factor, or because it carries a status marker, or we just like novelty. A house is a tool that keeps us warm, allowing us to survive in non-tropical climates (same for clothes). But when you add on the psychological factors that enter our thoughts about what kind of house, and how big it should be, and its location (40% premium for that view to which you will very soon habituate!) very soon, its value as a tool is no longer a factor. It has become a symbol of wealth (as above) and the only real question you end up asking is: can I afford it? And when some clever financier shows you how you can finagle a mortgage by hook or by crook, even that isn't an issue.

It is pretty hard today to actually look at anything as a tool and decipher its intrinsic value from your knowledge of costs and ROI-based profit margin allowable. Tools don't look like tools anymore, at least not in the way they did long ago when the sources of external energy were few and limited. Today an iPodTM is some kind of tool because it allows you to conveniently download your favorite music to listen to while you plow the field with your air conditioned tractor. If you are a farmer you can certainly view the tractor as a necessary tool that will increase your productivity. It is somewhat questionable about the iPod. But if you are a home owner with a big lot and you have a smaller, but equally outfitted tractor for cutting your lawn, it is not at all clear that this is increasing your productivity, especially since the lawn of that size is a discretionary (luxury) accoutrement to your life style.

The real difference between a farmer of old valuing a pair of capable, strong plow horses and a good plow and today's farmer valuing a GPS guidance system so he won't have to pay attention to plowing the rows is starkly different. The farmer of old had a much clearer sense of the intrinsic value of things. The farmer of today is more often concerned with saving his own time and having an easy life. This isn't a value judgment against the modern farmer. He is actually using the same thinking process that the olden day farmer used. He just doesn't have enough information to make a value decision objectively. Which leads to subjective value theory.

Subjective Theory of Value

I've included the link to the Wikipedia article but must say I think the information given there is unnecessarily narrow. Subjective means 'in the mind of the observer'. Therefore something more than just perceived usefulness and scarcity are at work in forming subjective valuations. It is true that these factors are at work, but we need to understand the psychological basis for why either a seller or a buyer would consider something desirable and scarce and hence worth a given price.

Consider the issue of needs versus wants. In this modern day how do we actually differentiate these? Once, not that long ago, a microwave oven was a luxury item, a convenience for heating foods and liquids, even a novelty. Today, I would not be sitting here writing this blog at 7:00pm if it were not for my handy microwave cooking my meal for me.

Back home in Gig Harbor, I have to admit that the microwave is just a convenience. It saves me some time and allows for last minute meal preparation that would otherwise have required more time and effort on my part (even in fixing things like steamed veggies, which I am chomping on at this moment!) There it really is a want more than a need. My only excuse is that old habits, formed long before I started questioning even my own motivations and actions, die hard. The microwave, as so many conveniences around the house, represents more of a want than a need. Here is something of a necessity as it allows me to make every moment of my sabbatical by not having to race to my house and cook a meal proper. Clean up here at the office is quick and simple and with very little lost time I'm fed and back to typing. Of course the irony is if these writings are worthless, then my justification for categorizing the microwave as a need might evaporate.

How did wants begin to trump needs as a major motivation to buy stuff? What was it that blurred the distinction between something that is a necessity and something that is just discretionary consumption? A microwave would not even be a possibility if it weren't for easily obtained electric energy. I say easily obtained, because the term 'cheap' doesn't sufficiently convey the meaning of the issue. Electricity is easy to obtain because the coal or gas that forms the backbone of the electric power generation system is easy to get and contains so much energy per unit of weight or volume, respectively, that the power companies can nearly give it away and still make a profit.

iPods aren't really scarce, but the company can sell them at a relatively high price, compared with actual costs (not including externalities) because people attach far more psychological significance to owning one than is justified by any kind of need. Do we humans need to listen to music? We absolutely do. But do we need 20,000 tunes available at the push of a button to fulfill that need for rhythm. Absolutely not. It's just nice to have. And so we are willing to pay the sticker price to satisfy that want. What should we pay for it? Unanswerable from the subjective point of view.

From the point of view of economics and valuation of goods and services, encoded in dollar prices, the real value of something is whatever a market of buyers are willing to pay. There is no basis for prices beyond what the dynamics of the market produce. But something gnaws at us about this blasé attitude. Surely, we say, a thing or service has some 'real' value that we could attach a price to. And that is what I want to explore from the perspective of biophysical economics. Starting with the realizations that money is no longer tied to anything real such that it can be a useful measuring stick and that objects and services can no longer be assessed for their tool value (utility in the old sense) because they are so complex and opaque with respect to their production, then we must look for a way to regain some sense of real value and see if it will be useful in bringing clarity back to markets." (http://questioneverything.typepad.com/question_everything/2009/10/what-is-value-.html)

Energy Theory of Value

See the second part of George Mobus' overview, starting at "Biophysical Economic Theory"