Wednesday, July 23, 2008

Personal Economics--The Fourth Law--Subjective Value

The fourth law of personal economics comes from the work of Carl Menger and is the first rule in what we characterize as "Austrian Economics". It stems from a mistake of Adam Smith's. In speculating why Adam Smith made that mistake I look to an essay by the French economist, Frederick Bastiat. Bastiat (he never mentions Adam Smith, but attributes the problem to the French intellectuals of his day) points out that the fascination that intellectuals have with "the grandeur that was Greece and the glory that was Rome" is a source of problems for economic and political thought because that grandeur and that glory was built squarely on a foundation of the use of military force. I suspect that fascination that intellectuals of Smith's day had with the tremendous achievements of these civilizations and the control that they seemed to exercise over others led him into the trap. It is possible to control others if we can know the real value of 'things". If, for example, you could know the real value of a stock, you could make a fortune in the stock market. Adam Smith set out to solve the problem of value and decided that the real value of something was a function of the labor that went into producing it. This is the labor theory of value. Armed with this theory it is possible to make third party determinations of the real value of things. The person who can calculate those values is obviously in a controlling position over someone who can't. This theory, therefore, has tremendous appeal to those who wish to exercise control over others.

Adam Smith had such a deeply ingrained love of freedom and respect for the common man that he was not dogmatic at all about the application of his theory. In the Wealth of Nations there are sections in which he essentially ignores or even contradicts, implicitly, at least, the theory. It was his disciple, David Riccardo, who nailed it down and made it an integral part of classical economics. The kind of thinking inherit in the idea of an objective theory of value of any kind led to much mischief including Riccardo's Iron Law, Malthus's population theories and Marxist economics, of which the labor theory of value is a key component.

The labor theory of value caused much consternation among classical economists, very few of whom were very excited about Marx's theories, creating, for example, the diamond-water paradox (why are diamonds, which, at the time had no practical uses, so valuable and water, which is essential to life, so cheap). The problem was solved, as so many problems in intellectual history that have perplexed scholars for some time, independently and almost simultaneously, in this case by three different men--Stanley Jevons in England, Leon Walrus in France, and Carl Menger in Austria. The solution was called the marginal theory of value, and was tremendously appealing to economists because it has a very mathematical ring to it. But, of the three, only Menger had the insight to recognize that the marginal theory of value was essentially a subjective theory of value.

Simply stated the fourth law says that anything, a product, a parcel of land, even a theory or idea, has a value that can be determined only in exchange and that the only people who can determine that value are those who are parties to the exchange. An important corollary to this rule is that no totally free exchange ever takes place unless all parties to the exchange believe that they are getting more from the exchange than they are giving. This rule is the equivalent in religious terms to the statement (oft repeated in the New Testament) that God is no respecter of persons. The political statement of this rule is Jefferson's statement in the Declaration of Independence that all men are created equal. This simply says that no matter how important I am (or think that I am) or how well educated or politically powerful or how rich or how attractive or healthy or how strong, I cannot tell another man the value of something unless I am party to the exchange of that something. I can, of course, cousel, advize, admonish, but that is it. If I use threats or force or fraud, the exchange ceases to be a free exchange and I have falsified the value. I cannot be trusted.

Let's look at a simple example. My wife has sent me to the grocery store with instructions to buy five items. Since it is only five, I assume I can remember them, but when I arrive, I realize that I have forgotten two of the items. Rather than go home, I decide to call, but, having no cell phone, I must use the pay phone outside the store which takes only change, of which I have none, so I ask someone coming out of the store if he can make change for a dollar bill. I have set up this elaborate circumstance, because in Austrian economics, the circumstances of an exchange are all important. They are critical to understanding the reason for the exchange. At any rate, the fellow says that he does have change and proceeds to give me 4 quarters in exchange for my dollar bill. Now, of course, in the view of a banker, a politician, and probably even most onlookers, we have made the most obviously equal of exchanges. But, of course, they are not equal. I needed quarters. A dollar bill was of no use to me for what I needed at that time. Thus explained, even a collectivist economist might acknowledge that I got a better deal out of this exchange because of my circumstances at that instant. But, the point is, that the person's circumstances at the time of exchange is all that is important. What the banker, the man on the street, the mayor, or even the president of the United States says is irrelevant. But what of the man walking out of the store? He did not seek an exchange. His circumstances required no exchange. Most collectivists would say that, in a sense, he was the loser in the exchange (they always seem to feel that one person wins and one loses in an exchange; which explains why they clammer for the power to forcefully control exchanges. If they are in control, they claim, there will be fewer losers). But according to our rule based on Menger's insight, he also was a winner. He is perceived as a loser (he lost time and may have been supplied himself with quarters to make a call himself) largely because most collectivists are also materialists. His winning was the most important of all--the satisfaction of having helped someone out. Before the government started getting into the business of controlling so many exchanges in the name of taking care of everyone, it was not uncommon for someone when asked if he could make change to ask what was needed and reply that although he did not have enough change to exchange for a dollar, he did have enough for a phone call, and I was welcome to it. In the eyes of the collectivist, I have given nothing for something--the change giver is in that case a clear loser. But, again according to our rule, and always assumming a free environment, if he felt he were a loser, the exchange would not have taken place.

This rule also explains why truly free societies are the most peaceful of societies. The Prince of Peace (according to his apostle, Paul) said that it is better to give than receive. Societies that are free are peaceful because in every exchange a person is, in a sense, giving more than he is getting. Of course, he is also getting more than he is giving--the ultimate economic paradox.

Societies in which poltical action extends into areas best left to the economic areas of life are societies in which contention, quarreling, fighting, violence and fraud abound precisely because the people in that society are determined to use the political or even criminal force to make sure that they get more than they give. In such societies many, if not most, of the members are sure that they know what things are worth and are willing, even eager to enforce that confidence in any way they can. Read any speech by a politician, read any editorial or even letters to the editor and notice how sure most people are that they know, independent of being involved directly in an exchange, what things are worth. The fourth rule says they are wrong.

The fourth rule is, therefore, the key to peace, both personal and social. It tells us simply that God is no respecter of persons, that all men are created equal, and that the only people who can determine the value of something are those who are parties to an exchange of that something.

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