Marginal utility theory solved an old economic problem, explaining how prices were set in the market, replacing the labor theory of value. The key insight was that value as reflected by price was set by the collective impact of millions of independent decisions by consumers participating in the market. Therefore price mirrored the collective values of all the people acting in the marketplace. This insight strengthened the role methodological individualism played in economic theory.
I think a complete integration of Hayek’s insight about markets as spontaneous orders into social theory preserves marginal utility as explanatory for price theory but otherwise gives us a significantly different perspective. But my economics texts are gone, a victim of too many moves, so I toss this out to see what the economists reading this blog might have to say.
I think those who attribute market prices to individual values, all of which are subjective, confuse a systemic characteristic of an emergent system with the properties of elements within that system. That is, subjectivism says a great deal about the market but not nearly as much, and nothing very insightful, about human beings and their values. The apparent radical subjectivism in human action is an artifact of how the market functions. It is an emergent quality and cannot be accounted for through a reductionist analysis based on methodological individualism.
Insofar as something can be expressed in terms of property rights that can be sold, the market will develop a money price for it. That price will change as demand and the costs of production change. Importantly, every thing that can be sold on the market will be a multiple or fraction of money value compared to everything else that can be sold. This is true for labor, food, pornography, pets, slaves, houses, and fine art.
Because all these things can be expressed in money terms, and if the property rights domain allows it, produced and sold, the idea that values are themselves subjective can appear to be true. Since all commodities can be compared on a common scalar, every attempt to maximize money values can appear to be a rational calculation. I suspect “rational choice” theories are in part inspired by this observation: we each seek to maximize our utility in whatever terms we define it.
A clue to some deeper issues can be found in my reference to the market price for slaves. Such a price existed in the antebellum South. In market terms, slaves were treated like other capital goods, no different in how their price was arrived at than mules, carts, and cotton gins. How much a slave was valued was a subjective preference akin to how much a hammer was valued.
Today normal people are agreed that the market price for slaves did not capture their value. It only captured the money that had to be given up in order to acquire one. In fact their value could not be expressed in terms of a market price.
In short, the market price is an artifact of the workings of the market and not an expression of value in human terms. Something’s worth, and whether and to what extent it can be included within market relations are two entirely different issues.
I remember Ludwig von Mises and Murray Rothbard both argued that analytically means and ends can be kept separate. Indeed they can. But not in human action. People do not usually think in those calculating terms during their day to day lives. To the degree that they do not, the assumption that monetary incentives will increase performance may not be true. And in fact there is plenty of research available to suggest that monetary incentives often do not improve performance. Significantly, the more closely work is physical and unskilled, the better money incentives appear to work. The more brains are needed, the less the correlation. There is even good evidence that increasing incentives in certain fields, such as banking, works in the opposite direction. The results can be very serious, and in the opposite direction as traditional economic reasoning suggests.
Market Value is not Human Value
Market price expresses market value. This price is an artifact of the market process as it expresses itself within a largely depersonalized context where no one knows anything about how a product is produced and it is presented with a money price: give up X and obtain Y. The X that is given up can be given up to obtain other things. Everything is presented as a means for obtaining other things, and everything is presented as obtainable through money, insofar as it can be provided as a property right.
This being so, two important implications shake out. First, freely arrived at contracts mediated by market prices can be unjust if the property rights system is unjust. There is nothing inherently just about prices in a free market.
Second, prices for all things in the market tend over time to reflect their utility and only their utility except for the final purchaser of a consumer good. The more impersonal the market becomes and the more things are produced as commodities, the more this is true. To the degree something is only a thing, an object, and its price incorporates all costs in its provision, such that there are no all significant negative externalities, this process is a great boon to human well-being.
But to the degree that what is sold on the market is not simply a thing, not simply a means to an end, the market price will not reflect its value. That is, how something is valued by individuals will not be reflected in its price. Its price will reflect its costs of production and effective demand for it once it is produced. Price is an emergent property of the market process and need have no very strong correlation to any conception of value as human beings experience it.
Let me give an example. In hisThe Economy of the Earth Mark Sagoff described a classic instance of this kind of thing. The Disney Corp. had wanted to build a ski resort in a Sierra wilderness in California. The issue had garnered considerable attention within the state. Sagoff, who taught in California, asked his students whether they would ski there if the resort were built. Most said they would. He then asked whether they thought the resort should be built. None said yes.
For years I repeated a version of this thought experiment and always got the same general pattern of responses. I always used local cases. Sometimes it would be a possible highway along the Cascade crest in Washington. Such a road would bring many lakes and other scenic attractions closer to hikers as well as giving drivers an extraordinarily beautiful drive. It would be a toll road of unsurpassed beauty. When I taught in New York state my example was a restaurant atop Mt. Marcy, the state’s highest point. The restaurant would be reached by a beautiful gondola ride providing fantastic views, and as diners ate it would rotate, giving them an extraordinary dining experience. Most of my students said they would drive the road or eat at the restaurant. So did I.
These examples demonstrated that it was possible for a highly profitable enterprise to be built where the profits came from people who universally believed it should never have been built, and who would regard themselves as better off if it had not been. No logical problem arose because the contrasting choices were made in very different contexts. But given that capital could easily be amassed for a profitable road or restaurant, but would be very difficult to obtain from a vastly larger number of people who disapproved such a use and did not think of these values in monetary terms, organization costs guaranteed the market context was not neutral in enabling the initial choice to be made.
Freedom and the market
Subjectivism has been used to defend individual freedom of choice, but to the degree values are not subjective – matters of taste – subordinating them to impersonal processes that treat all values as divisible into other values denies important elements of what individuals really are, and so distort any social analysis based purely on that insight.
The common Austrian lack or interest in, or sympathy for issues of power relations in employment so long as the relations are formally “contractual” is a case in point. This is not the case with all Austrian economists. David Prychitko, Paul Lewis, and Rob Garnett have all addressed issues involved here. But they seem to work in isolation. I think a better appreciation of the market as a spontaneous order would give their work more attention.
When values are expressed in terms of utility alone, the logic of organization subordinates everything else to maximizing utility by making whatever is valued instrumentally completely powerless vis-à-vis the valuer/owner. Doing so makes it able to be used ever more “efficiently” as expressed in market terms. When “labor” is separated from the worker, and becomes a commodity sold to a “boss” then the logic of the transaction requires the boss to seek as much control as is possible over the labor. Any consideration of the laborer during the time of work is based on increasing labor’s utility for the boss, very much as if a slave owner fed a slave well because such slaves had greater strength and energy to devote to serving the master. Because labor is not something that can be separated from the on going life of the worker, workers will have an interest in keeping as much of their labor/life under their own control as possible, unlike when they sell an apple they grew to another.
My point is not that labor is slavery. No. My point is that when we think of something only in terms of its utility, the logic that follows means that whoever buys the thing of utility should then be able to maximize the efficiency with which it can serve his or her goals. This may fit a genuine object, but it does not fit a human being, and very arguably there are other things that can be bought and sold where this logic does not fit either.
Intersubjective comparisons of utility
The common Austrian claim that “interpersonal comparisons of utility cannot be made” is easily seen as wrong as soon as radical subjectivism as reflected in prices is seen as a systemic feature of the market order and not an attribute of individuals. Every parent knows that such comparisons can in fact be made, and makes them continually. This cannot be avoided while raising a child.
Good friends also do this all the time. Ironically, more than a few of us are often more aware of what will be good for our friends under certain circumstances than of what will be good for us. This does not mean that we should use coercion to enforce our awareness. That is a entirely separate issue. But it does mean that the claim we cannot make well grounded interpersonal comparisons of utility is false, and that human life in fact depends on our doing so.
Conclusion
To the degree that values are instrumental, the market vastly increases their usefulness. Nothing exceeds it in this regard. But to the degree that values are not instrumental the market’s relation to them becomes far more ambiguous, and can ever be destructive.
This little essay forms a part of the case I am making that the market as a whole is not the realm of human freedom, civil society is. Part of the market falls within the realm of civil society, but not all of it. I hope that those who argue the market as a whole is the realm of freedom will take the time to give me rebutting arguments.
Studies in Emergent Order 
Paul Lewis
April 26, 2011
I agree that the capacity of the price mechanism to coordinate the decision-making of a multitude of individuals, each of whom is pursuing his or her self-interest in the light of his or her own local knowledge, can be thought of as an emergent property of the market system. When the process of rivalrous competition that takes place on markets is structured by the (abstract) rules of contract, tort and property law, then an array of relative prices is generated that indicates to people the relative scarcities of the various resources in the economy. Taken in conjunction with the stable background knowledge provided by institutions such as the legal system, these prices signals provide people with enough information for them to be able to adjust their plans to one another, so that each of them has a decent chance of bringing his or her chosen project to a successful conclusion.
Significantly, as you suggest, the coordinative power in question is emergent because it is possessed only by a particular whole – namely the free market system that is constituted by a group of people whose interactions are structured by the abstract rules of contract, tort and property law – and not by those individuals taken either in isolation or as a group whose interactions are governed and structured by some other set of rules. And that emergent whole – the people plus the relations engendered by the rule of law – cannot be eliminated from causal explanations of the coordinative properties of free markets because, if people were not so related, then their interactions would not be structured in the way required to produce an orderly outcome (Hayek 1973: 39). In Hayek’s words:
It is the so-called wholes, the groups of elements which are structurally connected, which we have learned to single out from the totality of observed phenomena … [and which] are the condition for the achievement of many of the things at which we as individuals aim, the environment which makes it possible even to conceive of our individual desires and which gives us the power to achieve them. (Hayek 1952a: 67, 145-46)
For Hayek, the rule-governed, relationally-defined social wholes that structure people’s interactions are causally efficacious, explanatorily irreducible factors in their own right and as such a key concern for social theorists. As Hayek puts it, these institutions constitute ‘a constant structural element [in society] which can be separated and studied in isolation’ (1952a: 59; also see [1964] 1967: 27 and 1973: 106). Of course, as you suggest, and as I have argued elsewhere, this type of theoretical perspective does not sit easily under the heading of ‘methodological individualism’, unless the latter is defined so broadly as to empty it of most of its content. I’d prefer to describe the approach Hayek adopts as (something like) methodological interactionism or the transformational model of social activity.
I think that radical subjectivism – by which I mean, very roughly speaking with Ludwig Lachmann, people’s entrepreneurial capacity to think of new goals towards which they then strive – is better viewed as an emergent property of the structured arrangement of neurons in the human brain (see my ‘Emergent Properties in the Work of Friedrich Hayek’, which is forthcoming in the Journal of Economic Behavior and Organization, and my ‘Far from a Nihilistic Crowd: The Theoretical Contribution of Radical Subjectivist Austrian Economics’, available online via ‘Early View’ in the Review of Austrian Economics, for more on all this). I would further contend that one of the shortcomings of the work of someone like Kirzner is that, in placing so much emphasis on entrepreneurial altertness as the driving force of the market, he under-emphasises the importance of the emergent coordinative power of the structured arrangement of institutions that is the market and thereby, as you put it in your post, tends to ‘confuse a systemic characteristic of an emergent system with the properties of elements [in his case, entrepreneurs] within that system.’
Robert F. Mulligan
May 3, 2011
You are reinventing the wheel to some extent in this very wide-ranging post, so it would be more than a bit surprising if you got everything exactly right.
Mises distinguishes between subjective use-value and objective exchange-value. His somewhat confusing use of the expression “objective use-value” refers to physical properties which contribute to or underlie subjective use-value:
Utility means in this context simply: causal relevance for the removal of felt uneasiness. Acting man believes that the services a thing can render are apt to improve his own well?-being, and calls this the utility of the thing concerned. For praxeology the term utility is tantamount to importance attached to a thing on account of the belief that it can remove uneasiness. The praxeological notion of utility (subjective use-value in the terminology of the earlier Austrian economists) must be sharply distinguished from the technological notion of utility (objective use-value in the terminology of the same economists). Use-value in the objective sense is the relation between a thing and the effect it has the capacity to bring about. It is to objective use-value that people refer in employing such terms as the “heating value” or “heating power” of coal. Subjective use-value is not always based on true objective use-value. There are things to which subjective use-value is attached because people erroneously believe that they have the power to bring about a desired effect. On the other hand there are things able to produce a desired effect to which no use-value is attached because people are ignorant of this fact.
Let us look at the state of economic thought which prevailed on the eve of the elaboration of the modern theory of value by Carl Menger, William Stanly Jevons, and Leon Walras. Whoever wants to construct an elementary theory of value and prices must first think of utility. Nothing indeed is more plausible than to assume that things are valued according to their utility. But then a difficulty appears which presented to the older economists a problem they failed to solve. They observed that things whose “utility” is greater are valued less than other things of smaller utility. Iron is less appreciated than gold. This fact seems to be incompatible with a theory of value and prices based on the concepts of utility and use-value. The economists believed that they had to abandon such a theory and tried to explain the phenomena of value and market exchange by other theories.
Only late did the economists discover that the apparent paradox was the outcome of a vicious formulation of the problem involved. The valuations and choices that result in the exchange ratios of the market do not decide between gold and iron. Acting man is not in a position in which he must choose between all the gold and all the iron. He chooses at a definite time and place under definite conditions between a strictly limited quantity of gold and a strictly limited quantity of iron. His decision in choosing between 100 ounces of gold and 100 tons of iron does not depend at all on the decision he would make if he were in the highly improbable situation of choosing between all the gold and all the iron. What counts alone for his actual choice is whether under existing conditions he considers the direct or indirect satisfaction which 100 ounces of gold could give him as greater or smaller than the direct or indirect satisfaction he could derive from 100 tons of iron. He does not express an academic or philosophical judgment concerning the “absolute” value of gold and of iron; he does not determine whether gold or iron is more important for mankind; he does not perorate as an author of books on the philosophy of history or on ethical principles. He simply chooses between two satisfactions both of which he cannot have together.
To prefer and to set aside and the choices and decisions in which they result are not acts of measurement. Action does not measure utility or value; it chooses between alternatives. There is no abstract problem of total utility or total value. There is no ratiocinative operation which could lead from the valuation of a definite quantity or number of things to the determination of the value of a greater or smaller quantity or number. There is no means of calculating the total value of a supply if only the values of its parts are known. There is no means of establishing the value of a part of a supply if only the value of the total supply is known. There are in the sphere of values and valuations no arithmetical operations; there is no such thing as a calculation of values. The valuation of the total stock of two things can differ from the valuation of parts of these stocks. An isolated man owning seven cows and seven horses may value one horse higher than one cow and may, when faced with the alternative, prefer to give up one cow rather than one horse. But at the same time the same man, when faced with the alternative of choosing between his whole supply of horses and his whole supply of cows, may prefer to keep the cows and to give up the horses. The concepts of total utility and total value are meaningless if not applied to a situation in which people must choose between total supplies. The question whether gold as such and iron as such is more useful and valuable is reasonable only with regard to a situation in which mankind or an isolated part of mankind must choose between all the gold and all the iron available (Mises 1949(1999), pp. 120-121).
Market exchange establishes the market price, what Mises later calls the “objective exchange-value.” Every voluntary exchange involves two individuals giving up something they value less in order to gain something they value more, so on each side of an exchange, two values are always involved, the unobservable subjective use-value of what you’re buying (you call this the human value), and the observable objective exchange-value (i.e., the market price you pay, which you call the market value). The difference is your consumer surplus (or producer surplus for the seller), which is never observable or measurable. Holding that market prices being spontaneously emergent outcomes invalidates methodological individualism seems to be a non-starter for me. You cannot have market exchange without individual valuation, information handling, and action. My view is that it would be more meaningful to view prices as an artifact of individual interaction. Markets don’t develop money prices for things, they provide an institutional framework in which individuals can offer provisional bid and ask prices for what they have to give and what they want to gain.
Lionel Robbins (1932) was an important precursor of Hayek in establishing the impossibility of interpersonal utility comparisons. When Robbins wrote his Essay on the Nature and Significance of Economic Science, the emerging view in welfare economics, particularly developed by Edgeworth and Cannan, was that diminishing marginal utility guaranteed income redistribution would generally improve “aggregate” welfare. If everyone has monotonically decreasing marginal utility in income, and if these utility functions are sufficiently generic to justify the assumption of a representative agent, then high-income individuals will be farther down the marginal utility function than low-income individuals. Forced redistribution of wealth results in a relatively small loss of social welfare to the rich, for whom diminishing returns to consumption have already become critical. The rich have high overall welfare, but relatively low marginal welfare. Redistribution of wealth from the rich to the poor results in a gain in welfare per dollar redistributed, because for the poor, their relatively low consumption expenditures prevent them from advancing as far in the direction of lowered marginal utility as the rich have already. The poor have lower total welfare than the rich, but higher marginal welfare. This effect relies on the assumption that everyone enjoys identical welfare functions in income, if not simultaneously in all consumption goods. To the extent this effect occurs, it is amplified if there are few rich and many poor, so that few people lose any welfare at all and many would gain some from redistribution, and it would also be amplified, as well as rendered more practical, the greater the level of income inequality before redistribution.
Thus, conveniently disregarding the coercion implicit in forced redistribution, redistribution appears to cost the rich very little in terms of lost utility because of their already low lost marginal utility, but provides the poor a great benefit in terms of additional utility because of their still very high marginal utility. So redistribution improves efficiency and overall welfare. Scientific welfare economics could apparently be enlisted to justify scientific social engineering by central planners and socialist legislators.
Since valuation is unobservable and can only be inferred through observing behavior, the social welfare argument can never be verified empirically. Ordinal utility measures cannot be transferred across individuals—though if utility could be measured cardinally, interpersonal welfare comparisons would be possible. Without interpersonal utility comparisons, welfare economics is reduced to the very restrictive appeal to strong Pareto efficiency. Subsequent attempts by Kaldor, Hicks, and Scitovsky to formulate more flexible welfare criteria were doomed from the outset. Kaldor-Hicks efficiency, also known as potential Pareto efficiency, requires that parties made better off must be made sufficiently better off to enable them to compensate the parties made worse off. If the compensation is required and the parties made worse off do accept it, Kaldor-Hicks efficiency reduces to Pareto efficiency. As long as the exchange is voluntary and there are no external costs, there would be no need for government coercion. Harrod (1938, p. 396), among others, continued to employ the social welfare argument long after its lack of scientific basis had been demonstrated.
A related argument is that some individuals value leisure more than consumption, and thus work less by choice, in accordance with their subjective valuation. Other individuals with different preferences may value consumption expenditure more than leisure, and thus choose to work more. Redistribution clearly benefits one individual at the expense of the other, but in this situation, redistribution partially undoes their choice of leisure and labor. Clearly redistribution is not promoting efficiency here, regardless of how rapidly marginal utility diminishes with income. It is not surprising that Robbins was particularly skeptical of representative agent modeling. Robbins’s critique proved to be particularly unpopular with many economists who, like Harrod, accepted it on the merits, but wanted to ingratiate the discipline with progressive socialists.
Robbins anticipated certain features of Arrow’s Impossibility Theorem (1963). Applied to social welfare functions, Robbins argued that these functions, hypothetically defined by the vote of each individual, violated Arrow’s non-dictatorship, unrestricted domain, monotonicity, and non-imposition criteria. Arrow completed the theorem by adding the independence of irrelevant alternatives criterion.
You mention that higher pay often fails to improve worker performance. I think you are referring to financial executives getting record bonuses after incompetently steering their firms far beyond utter collapse, averted only by federal bailouts. If there had been no government intervention in the form of expansionary monetary policy, the housing and financial bubbles would not have carried away these dupes in the first place. If the government had not then provided a bailout after the fact, market discipline would have provided appropriate rewards—unemployment benefits rather than bonuses. Labor economics does suggest the possibility of a backward-bending supply curve for labor at sufficiently high wages. This is probably more relevant for your argument.
At the end of your post, you claim parents make interpersonal comparisons of utility, but it’s not clear what you mean here. I feel confident I don’t understand fully what you meant, but I felt you were sometimes conflating what is “of value” in the abstract or in principle, with what is valued by specific individuals. Maybe it would help if you give an example of how parents or friends demonstrate interpersonal comparisons. Parents, like the government, can impose their choices on their children or citizens, but friends cannot. Please clarify.
Gus diZerega
May 3, 2011
Robert- I am disappointed that you spend an enormous amount of time discussing the role of subjectivism in price theory at a very high level of abstraction without really addressing much of my actual argument. I gave examples and perhaps sometime you will address them.
You seem to think I am abandoning methodological individualism. I am not. I posted at length on that issue in an earlier post and those arguments stand until they are addressed effectively. I initially learned from Peter Berger and Thomas Luckmann, and since that post Paul Lewis has enriched my understanding farther, without seriously modifying my conclusions.
Parents cannot raise their children without making often quite accurate interpersonal comparisons of utility, even over considerable time. They often impose a currently undesired action on a child who will later be grateful for their having done so, no matter how much current crying might take place. In other words, a parent realizes a kid is acting in away the child will later regret, and intervenes, compelling a different action. The child is often grateful later. The parent understood the child’s values better than the child did.
Here is a not all that improbable example of the same thing with friends. A number of us are drinking at a wine bar. One of us gets pretty tipsy, and then announces he or she will drive home. One of us who us more sober offers to take them. They refuse, saying they are capable of driving. We then offer to pay for a cab. Our offer is refused. At this point someone grabs the drunkard’s keys and says he will return them after the inebriated one is safely home.
The tipsy friend gives in, is driven home, their keys returned, and the friend returns in a car that followed. The next morning a sober and somewhat embarrassed person calls and thanks that friend for intervening.
Events such as this are hardly unknown.
You might say that those who intervene are not always right. Of course. People always operate with incomplete information – even about themselves. I am describing life among human beings, not some pretend model of “science” as exactitude in all things.
You might also say this argument validates all sorts of control of some by others. No it does not. But it eliminates a simplistic rebuttal to such arguments.
As for redistribution and coercion – the issue is complex, but every time a property right is defined in a way that someone does not like, coercion takes place – and every definition of a property rights leads to some getting wealth a different definition would deprive them of, and someone loses wealth a different definition would give them. What constitutes trespass would be an example as would the issue of what constitutes “fair use” of copyrighted material.
Had you read my links you would realize you have not understood my point about higher pay and performance.