Patterico's Pontifications

8/28/2015

“Human Action” and Robert Murphy’s “Choice,” Part 7: The Importance of Monetary Calculation

Filed under: Economics,General,Human Action and Choice — Patterico @ 12:01 am

This is Part 7 of a 17-part series of posts summarizing Bob Murphy’s indispensable book Choice: Cooperation, Enterprise, and Human Action. Murphy’s book is itself is a summary of Ludwig von Mises’s classic treatise “Human Action.” As a result, you are reading a summary of a summary.

The purpose of these posts is to popularize and spread the word about Austrian economics and educate the public. Rather than list all the previous parts, I have created a category for all these posts, called “Human Action and Choice,” so that all these posts can be read (in reverse order) with a single click. Note well: any errors in these summaries are mine and not Murphy’s.

We are now moving into the section of the book titled “Economic Calculation” and begin with a chapter on the importance of monetary calculation.

In an earlier post, we emphasized that preference rankings in human action are ordinal, not cardinal. You can say you prefer chocolate ice cream to vanilla, but you can’t assign a number of units to each: it makes no sense to say “I prefer chocolate ice cream three times as much as vanilla.” More importantly, you can’t compare the intensity of your preferences to the intensity of another individual’s preferences. But I told you that there was a subtlety involving buying goods with money that would come up in a future post. This is that post.

With the introduction of money, for the first time arithmetical operations can be applied to economic affairs. The importance of money to the workings of the free market can’t be overstated. Having price signals determined by the market and communicated in units of money allows society to allocate resources in the most efficient manner possible. Without money, and without prices set by a free market, this cannot happen — because (as previously noted) in a barter system one can only look to ordinal preference rankings which cannot be expressed in units. (As we will later see, this is the central reason that Mises said socialism could not work — his famous “socialist calculation problem,” which will merit its own post.)

Before we get to money, we must explain how “barter prices” emerge in a world without money, based on ordinal preference rankings. (These are my examples and not Murphy’s. Although they are loosely based on his examples, don’t blame him.)

Assume there is a fellow named Murray whose ordinal ice cream preferences line up this way:

MURRAY’S PREFERENCES

1. Two scoops of vanilla
2. One scoop of chocolate (Murray possesses this)
3. One scoop of vanilla

#1 is his top preference. #2 is his second, and #3 is his last choice.

Clearly, Murray would trade his scoop of chocolate for two scoops of vanilla, but not for one.

Now, pretend a fellow named Milton has this ice cream preference rank:

MILTON’S PREFERENCES

1. One scoop of chocolate
2. Two scoops of vanilla (Milton possesses this)
3. One scoop of vanilla (obviously Milton possesses this too; if he has two, he necessarily has one)

Milton would trade two scoops of vanilla for one scoop of chocolate. We know that Murray would trade his own scoop of chocolate for two scoops of vanilla. So we can see that these two folks can do a direct trade — and both will be better off.

Now say there is a third guy, Ludwig, whose ice cream preference is as follows:

LUDWIG’S PREFERENCES

1. Two scoops of vanilla
2. One scoop of vanilla
3. One scoop of chocolate (Ludwig possesses this)

Now, Murray and Ludwig both have a scoop of chocolate, which Milton wants. But Ludwig has set a cheaper price. He will accept just one scoop of vanilla for a scoop of chocolate — while Murray is demanding two scoops of vanilla.

Milton, with his two scoops of vanilla, would rather trade with Ludwig, who will take only one of Milton’s two scoops of vanilla, as opposed to Murray, who insists on getting two scoops of vanilla in return for his one scoop of chocolate.

In this way, adding more people to the market helps establish an equilibrium barter price for the scoop of chocolate: namely, one scoop of vanilla, the lowest price that a vendor of chocolate scoops will demand.

Note well: we never once had to say anything like “Milton gets twice as much pleasure from chocolate as he does from vanilla” or anything of the sort.

Also note that we never once talked about how difficult it is to create or obtain one scoop of chocolate vs. one scoop of vanilla. From the time of Adam Smith there was something called the “labor theory of value” which posited that prices depend upon the cost of the inputs. This fallacy led directly to the fallacy that the laborer, and not the capitalist, was the person who imbued goods with their true value, and thus “deserves” the fruits of that production. You can easily see that, while the labor theory of value was taken as true by Adam Smith, it was seized upon by Karl Marx, and is still implicit in many of the complaints of socialists like Bernie Sanders.

Whenever someone like Bernie Sanders complains that McDonald’s workers are getting paid too little, their implicit argument is that the workers are the ones who are really adding value to the business, while the people running the company are just fat cats putting in cash and watching the profits roll in. When they refuse to give those profits to the workers, they are exploiting the workers, who really give the business its value. This exploitation theory is Marxism 101.

But once you understand that value is subjective, then you understand that the person who contributes the most to an enterprise is the entrepreneur, who correctly foresees what consumers will want. The entrepreneur who predicts the advent of streaming video like Netflix will add far more value to his company than all the sweat of workers tirelessly toiling away to build new Blockbuster outlets that are going to go out of business.

Getting back to ice cream: the creation of barter prices wowed economists so much that they treated money as an afterthought: as a kind of neutral factor that served as a kind of stand-in for the equilibrium barter prices that are reached through the operation of trades like those described above, following from simple ordinal preference rankings. This, Mises warned, was a huge mistake — and his recognition of that fact amounted to one of his key insights. (We’ll discuss this in later posts. The hint I’ll offer here, which will be elaborated on later, is that money is a good with its own demand and supply issues.)

For now, it is enough to understand (with subtleties to be added later) that money serves as the basis of economic calculation, which is the central device that allows man to determine how to most efficiently allocate his resources. You might not need monetary calculation (though it helps) to decide it actually makes more sense to grow oranges in Florida and ship them to Montana, rather than try to grow them in Montana. But without monetary calculation, how can a businessman decide how many oranges to grow? whether to ship them by truck or by plane? how many retail outlets should distribute them? and so forth.

To make complex determinations like this, you could never rely on something like the equilibrium barter prices such as we demonstrated above with our ice cream examples. There are just too many elements in the calculation: how much is a plane ride worth, compared to a truck shipment, compared to a box to put your oranges in, compared to a tractor to plow your grove, compared to an hour of labor offered by a retailer to sell your oranges . . . and so on? Without monetary calculation, this sort of analysis cannot possibly be done. It is just too complicated.

And (again jumping ahead), this is why a socialist economy, without real price signals, cannot possibly succeed.

With that observation, we have come full circle for this post, which has been a longer one, but (I hope) very satisfying and informative. Tomorrow we will further explore what economic calculation can do — and cannot do.

40 Responses to ““Human Action” and Robert Murphy’s “Choice,” Part 7: The Importance of Monetary Calculation”

  1. Bernie Sanders’ “socialism”, and that of many of the Western welfare state social libertarians*, is not that the worker has a right to the product of his labor. It is that the worker, originally, but now every person, has a right to the fulfillment of his needs. It is much more dangerous.

    *Labels are meaningless.

    nk (dbc370)

  2. Reisman calls them Social Democrats.

    nk (dbc370)

  3. These segments are a little wonky, but I am learning a lot.

    Denver Todd (917eea)

  4. The entrepreneur who predicts the advent of streaming video like Netflix will add far more value to his company

    To be completely honest, Blockbuster had some more advanced ideas, too, but the media moguls with the IP rights weren’t ready to work with them until a much smaller company, Netflix, showed the way. Blockbuster could not do what Netflix did, because they had deep pockets, and the media jerks wanted to gouge them like hell for access to anything like that. It was only when new people came in who realized and accepted that some measure of piracy was inevitable that there was flexibility that allowed Netflix to go whole hog.

    BTW, I was just at a small seminar discussing what Netflix is doing in computing, and it’s…. interesting. They really, really are innovating in terms of developing “cloud computing” to serious functionality.

    They have the capacity to — and use it regularly — to just shut down servers, server banks, and entire SERVER FARMS, to test their fault tolerance and spot problems when they have some control over them rather than when they are unexpected, and to figure out what techniques they need in place to deal with such catastrophic failures. It’s pretty freaking impressive if you care about, and know about, software.

    IGotBupkis, "Si tacuisses, philosophus mansisses." (225d0d)

  5. Contrast Netflix, by the way, to the Obamacare rollout. Out of nowhere, you could blow up an entire Netflix server installation, and there’d be a quick hiccup and things would go on almost unaffected. The government couldn’t even deal with the initial, fully predictable hit on their installation.

    This is the difference between private industry unprotected by government intrusion, and federal mismanagement.

    IGotBupkis, "Si tacuisses, philosophus mansisses." (225d0d)

  6. Bernie Sanders’ “socialism”, and that of many of the Western welfare state social libertarians*, is not that the worker has a right to the product of his labor. It is that the worker, originally, but now every person, has a right to the fulfillment of his needs. It is much more dangerous.

    I hear what you’re saying, but I think that implicit in the argument of every labor union and every supporter of the minimum wage is that the company is getting this boondoggle of profits generated by the workers and won’t give the workers their fair share. And implicit in this argument is that it is the workers who really generate the profits.

    Which is totally wrong.

    Patterico (3cc0c1)

  7. Does Mises assert that preferences are totally ordered, or are they merely partially ordered?
    If I were picking axioms based on my own experiences with decision making, I’d go for the partial order, because I can think of many times when I’ve been paralysed by indecision, and I don’t think I’m uniquely indecisive.
    If you need the total ordering, I suppose you could insist that my inability to decide counts as a decision in favor of “no decision”, although I think that would be stretching the definition of “decision”. Alternately, you could assert that I would always eventually reach a decision, but I insist on proof that abstract decision-making processes necessarily terminate.
    In practice, I’ve found antichains of preferences to be few, far between, and small when I do find them. So, glossing over the possibility of incomparable preferences wouldn’t cause too great a gap between Austrian Economics and the phenomena it’s supposed to model (especially compared to other economic models). However, given your enthusiasm for Austrian Economics, I’d think the gap would be more than you’d like to have.
    Of course, I don’t know of any tenets of Austrian Economics that require a total ordering and not just a partial ordering, so the last two paragraphs are probably moot anyway.

    CayleyGraph (dfcefe)

  8. Patterico, at 6,

    And featherbedding which I partially blame for the flight of industry from the United States. I saw it in my parents’ workplace. As industry improved manufacturing processes, through design and automation, unions demanded that the supernumeraries be kept around just to draw a paycheck.

    I can think of many reasons why this is worse than welfare for the economic health of a nation. For one thing, it hurts the workers themselves by keeping them from retraining or transferring to a productive job. For another, by keeping an industry artificially inefficient, it both suppresses its expansion and creation of more jobs, and diminishes the overall wealth which can be charitably distributed to people involuntarily unemployed or unemployable. And it has no meaningful effect as a social control, the way subsistence welfare does.

    nk (dbc370)

  9. But once you understand that value is subjective,

    It’s funny – if you go to a restaurant and everyone orders different dishes, or you can’t agree on which place you like best, you see this in action. When you shop for clothes that fit your particular frame, you see this. When you shop for cars and make the trade-offs between price, quality, and certain features that you really want – and those trade-offs are different than the ones your friends and family make – you see this. (Actually, pretty much everything about car shopping, from the huge variety of models to the huge variety of prices, reflects this.)

    bridget (d90803)

  10. In grad school I recall some discussion of these topics. In theory, it is possible to compute the equivalent of prices based on the Lagrange multipliers of a constrained optimization problem. So a big enough computer might be able to replace prices even in a very large economy. My thought is that this really isn’t a viable option since it would require the analyst to set the constraints, and herein lies the problem. Would these constraints be based on principles of social justice, like anyone over 70 doesn’t deserve to get a hip replacement, or would they be based on whatever the popular mania is today, which in Nazi Germany had something to do with the “Aryan race”, or would they be based on government expert opinions, like everyone needs no more than 2000 IUs of Vitamin D, or would they query all those intractable individuals who have irrational expectations and ideas about what they like today? The latter would seem the best, but who wants to spend their morning, every morning, working thru an endless list of options. The 17 candidates for the Republican nomination are a case in point.

    Of course, this was a long time ago, and I’ve had only a few occasions to use Lagrange Multipliers, and they weren’t as helpful as I’d hoped. Perhaps someone could update me on the application of such ideas.

    bobathome (279337)

  11. R.I.P. Al Arbour, NHL player, coach of the New York Islanders during their 4 consecutive Stanley Cup wins

    Icy (c32893)

  12. Which is totally wrong

    Not totally.
    It would be more precise to say capitalist (I prefer that term) and workers contribute different things to the enterprise. The workers produce the good; the capitalist provides the raw materials, the physical place in which they produce, and gets the finished goods to the consumer. But, unless you are talking about a one man business where the owner is also the worker, or some sort of worker’s coop, you have to have both. And even in the exceptions, you are merely dealing with a situation where one person or one group doubles as both capitalist and worker.

    Your real point is that the capitalist contributes more than the worker to the overall enterprise…which boils down to a value problem that is in a free market system decided by the owners of the enterprise. Since the capitalist is usually the owner, or one of them, it should not be surprising that the capitalist values his own efforts over those of the workers….or that the workers disagree.

    kishnevi (870883)

  13. Labor is valued subjectively, too. Mises’s most basic principle, that ideas form societies and not societies ideas, is at the heart of the rise of the worker. The Age of Enlightenment. Workers valued themselves, set their price, and enforced it through collective, democratic and, in Imperial Russia, military action. What do you think?

    nk (dbc370)

  14. I’m still with you. Thank you for these posts. I would never have tackled this myself.

    DRJ (1dff03)

  15. Which is totally wrong
    I am not sure it was the workers who enforced their price so much as non workers claiming to be acting/speaking on behalf of the workers. In the result, the workers generally found themselves fetching a much lower price.

    Application of the above to current American politics is to be made solely at the viewer’s discretion.

    kishnevi (870883)

  16. &^*%$

    My comment at 10:33 AM was in reply to nk at 10:13 AM.

    kishnevi (870883)

  17. kishnevi, your appreciation of the portion contributed by “labor” harkens back to the day when workers supplied their own tools. This is still true in some fields, like residential construction, but not in most. The McDonald’s experience demonstrates that the entire building is the tool. The workers don’t bring in their head sets to communicate, they don’t bring in their own computers to enter the customer’s orders, etc. The whole thing is designed to reduce the “labor” content as much as possible. This allows the workers to focus on the things they can still do better than a machine. They become extremely specialized. And they are subject to replacement by a machine as technology advances. This will be demonstrated irrefutably in Seattle and neighboring SeaTac as the minimum wage ramps up to $15/hour. The productivity of these workers is nil without the supporting equipment and the logistics train that keeps the place stocked with hamburgers, buns, and fries. The paradox is that as socialist municipalities create more and more rules and regulations to help the “workers”, the less likely it is that an individual could compete absent this enormous infusion of capital. Work in these hell holes will become more and more inhumane. Meanwhile, in places not infested with utopian dreams, mom and pop burger joints will still be viable.

    bobathome (279337)

  18. I am not sure it was the workers who enforced their price so much as non workers claiming to be acting/speaking on behalf of the workers. In the result, the workers generally found themselves fetching a much lower price.

    True. I think the labor movement was hijacked by its own internal bosses. Who then work in concert with the government and the boss-bosses to keep the workers pacified. It was one of the goals of progressivism, stemming from fear of real worker uprisings that would lead to Bolshevism or Fascism. And not limited to the unskilled and the trades. How many doctors have you heard say good things about the AMA?

    nk (dbc370)

  19. I’m not really sure about the binary distinction between capital and labour, especially in a modern economy. Human ingenuity has created so much wealth, and so many people are paid well today because they know how to do useful stuff that other people don’t know how to do.

    The capital and effort of labour involved in a Supercuts, for example, is probably the same as that involved in a high-end salon, but the hairdressers in the latter have a tremendous amount of know-how that people pay for.

    A lot of what people today think of as (badly paid) “labour” is basically following someone else’s directions. Someone who stocks shelves at a supermarket puts the items where someone else instructs him to do so. However, the people who own the (presumably profitable) supermarket are the ones who did a market analysis to figure out a good location, the items to stock, what to charge for them, how to advertise, what types of sales to run, what customers to target, which vendors they should negotiate with, how long their contracts should run, how to get a supply chain, how to lay out the store, etc. Aside from the capital costs of starting and operating the business, there are a pile of good, educated decisions that were made – and making those decisions well is worth a lot of money.

    If I go into the Whole Foods burrito bar near my house, the people who work there chopped up the veggies, fried the tofu, made the guacamole, washed the counters, and put my burrito together. But the whole concept of a burrito bar, the types and quality of foods that go into it, the price that will make a profit but still entice me to buy it, the supply chain that reduces costs… that was all dreamed up by other people. It’s not just that the physical supermarket needed to be built before the burrito guy is hired; the entire concept of a burrito bar, and everything that goes into making it profitable, came into existence before the “labourer who makes it all profitable” even entered the picture.

    bridget (d90803)

  20. And featherbedding which I partially blame for the flight of industry from the United States. I saw it in my parents’ workplace. As industry improved manufacturing processes, through design and automation, unions demanded that the supernumeraries be kept around just to draw a paycheck.

    Industry “fled” the country because it was D-E-A-Y-D DEAD. There is no more real wealth to be obtained from manufacturing goods in this nation.

    Example: (Yes, this is a couple years old but unlikely to have changed)
    The iPhone 4 was priced at US$600 — yes, it was heavily subsidized by the carriers, but regardless, SOMEONE, in aggregate, paid most of that 600 bucks out.

    It was “Made In China”.

    So: How much of that US$600 did CHINA get for MAKING the device?

    $200?

    Nope.

    $100? Nope.

    $50? Nah.

    $25? Noooooope.

    $10!!??

    NO.

    Six Bucks.

    That’s what China got — 1% of the retail price — for making it…

    “But that was the cheap labor, if it was made here in the USA…”

    …It would have been made by ROBOTS, not humans making classical “high” labor wages.

    In 1875, 75-80% of ALL Americans were employed in Agriculture, making food for everyone else.

    By 1975, 3-5% of ALL Americans were employed in Agriculture, making food for everyone else — making FAR MORE food, on LESS land, in fact.

    The rest had moved into Manufacturing, and were headed even on from that and into IP&Services.

    What happened? Mechanization, that’s what happened.

    In the future, the same will have happened to Manufacturing — 3-5% of Americans will make ALL GOODS America uses and then some. Because Robotics will do for manufacturing what Mechanization did for Ag.

    And people will have moved onward to IP & Services, which is where all new wealth will be generated. The other 594 bucks from the iPhone 4? All went to IP holders who designed and developed critical parts.

    IGotBupkis, "Si tacuisses, philosophus mansisses." (225d0d)

  21. Side point: While we could already build fully robotic factories, we choose not to, because at the moment there are other nations with labor cheap enough to rival the bots, and, more critically, it raises their standard of living, bootstrapping them up to a more modern level. This benefits us all — because it makes people less willing to go to war, because they have too much to lose. And also because there’s less NEED to go to war — why fight and die to steal stuff, when you can MAKE it instead? And this nation with its increased wealth becomes a trading partner instead of a glaring enemy who resents what we have.

    IGotBupkis, "Si tacuisses, philosophus mansisses." (225d0d)

  22. So Marie Harf is right? The way to defeat Arab jihadists is by providing them with more job opportunities?

    nk (dbc370)

  23. If one looks at the numbers we cannot fund Amerikkka off the top 1% even confiscating all of their income.

    We fall orders of magnitude short.

    We are staring into the depths of an haboob, a great levelling. About that moment when we see the first fully automated truck farm every one living paycheck to mouth starves.

    Who guessed human progress was unsustainable?

    DNF (ffe548)

  24. These segments are a little wonky, but I am learning a lot.

    Excellent. This particular post (#7) was an involved one, but it’s my favorite so far — in part because I was able to come up with the examples on my own and make them work. That gave me some reassurance that I understood the concept and was not just parroting what I had read.

    Patterico (3cc0c1)

  25. kishnevi and bridget make points that I think can be responded to in a single comment, so I will combine their observations here. First, kishnevi responds to my statement that it is “totally wrong” to say workers generate profits,by saying this:

    Not totally.
    It would be more precise to say capitalist (I prefer that term) and workers contribute different things to the enterprise. The workers produce the good; the capitalist provides the raw materials, the physical place in which they produce, and gets the finished goods to the consumer. But, unless you are talking about a one man business where the owner is also the worker, or some sort of worker’s coop, you have to have both. And even in the exceptions, you are merely dealing with a situation where one person or one group doubles as both capitalist and worker.

    Your real point is that the capitalist contributes more than the worker to the overall enterprise…which boils down to a value problem that is in a free market system decided by the owners of the enterprise. Since the capitalist is usually the owner, or one of them, it should not be surprising that the capitalist values his own efforts over those of the workers….or that the workers disagree.

    And bridget says:

    I’m not really sure about the binary distinction between capital and labour, especially in a modern economy. Human ingenuity has created so much wealth, and so many people are paid well today because they know how to do useful stuff that other people don’t know how to do.

    The capital and effort of labour involved in a Supercuts, for example, is probably the same as that involved in a high-end salon, but the hairdressers in the latter have a tremendous amount of know-how that people pay for.

    A lot of what people today think of as (badly paid) “labour” is basically following someone else’s directions. Someone who stocks shelves at a supermarket puts the items where someone else instructs him to do so. However, the people who own the (presumably profitable) supermarket are the ones who did a market analysis to figure out a good location, the items to stock, what to charge for them, how to advertise, what types of sales to run, what customers to target, which vendors they should negotiate with, how long their contracts should run, how to get a supply chain, how to lay out the store, etc. Aside from the capital costs of starting and operating the business, there are a pile of good, educated decisions that were made – and making those decisions well is worth a lot of money.

    If I go into the Whole Foods burrito bar near my house, the people who work there chopped up the veggies, fried the tofu, made the guacamole, washed the counters, and put my burrito together. But the whole concept of a burrito bar, the types and quality of foods that go into it, the price that will make a profit but still entice me to buy it, the supply chain that reduces costs… that was all dreamed up by other people. It’s not just that the physical supermarket needed to be built before the burrito guy is hired; the entire concept of a burrito bar, and everything that goes into making it profitable, came into existence before the “labourer who makes it all profitable” even entered the picture.

    Bridget has beautifully described what I will actually be going into tomorrow, in post 9. That post begins to define economic concepts in the market economy, including the defined roles of the different participants in the process.

    As you will see, it’s not a binary distinction between capital and labor. It’s more of a trinary distinction (I had to look it up to see if I was making up that word or not; apparently it’s a real word). I don’t want to get too ahead of myself, but I’ll give you a sneak peek, with a quote from tomorrow’s post:

    We must now classify different people in the economy and the money they receive for what they provide. Workers provide labor and receive wages. Landowners and capitalists provide similar things as one another, and both receive interest. (While land, or natural resources, is not man-made, it is similar to man-made capital in that it provides entrepreneurs a head-start in time in the production process. More on this later.) Entrepreneurs adjust the factors of production in anticipation of the future, and receive profits when their foresight is accurate.

    So it’s not binary between capital and labor. It’s three-part, between capital, labor, and entrepreneurship. Many people collapse the roles of the capitalist and the entrepreneur, but those roles are distinct.

    What bridget described so nicely is the role of entrepreneurs, who are the ones who generate the profits. Coming up with the “entire concept” of something like a burrito bar, and determining how to implement that concept using the tools of capital and labor, is the role of the entrepreneur.

    This may help explain why laborers really aren’t generating the profits, on a conceptual level. It’s not quite right to say that their labor is worth the wages they are being paid and nothing more, because the nature of a direct transaction is such that their labor is worth LESS to them than the wages they receive, and MORE to the business owner than the wages he pays. But putting that fine distinction aside, their contribution to the business is more or less compensated by their wages — which is why a worker who contributes more should be valued more highly. But profits, conceptually, come from the entrepreneur.

    So when I said it is “totally wrong” to say the workers generate the profits, this is what I had in mind. (I might have kept in mind Beldar’s Dictum that the word “totally” can always be replaced by ending the sentence with an exclamation point.) When kishnevi says:

    It would be more precise to say capitalist (I prefer that term) and workers contribute different things to the enterprise. The workers produce the good; the capitalist provides the raw materials, the physical place in which they produce, and gets the finished goods to the consumer.

    I say it would be more precise still to say that the capitalist, workers, and entrepreneurs contribute different things to the enterprise. Workers contribute labor, capitalists contribute capital, and entrepreneurs coordinate all this in the production process, contributing ideas, vision, and foresight.

    That is why I said it was wrong to say laborers generate profits. It’s just an analytical misunderstanding, but a critical one that has serious implications for policy.

    Patterico (3cc0c1)

  26. Labor is valued subjectively, too. Mises’s most basic principle, that ideas form societies and not societies ideas, is at the heart of the rise of the worker. The Age of Enlightenment. Workers valued themselves, set their price, and enforced it through collective, democratic and, in Imperial Russia, military action. What do you think?

    Military action has zero to do with the market economy. Collective action in the form of unions is a purely market concept — until government gets involved, and passes laws that favor unions, at which point unions become another method of coercion.

    But putting that aside, you’re right that labor is valued subjectively. But a worker’s value of himself isn’t the issue. A kid who was raised by parents who believe in “self-esteem” and little else may value his own labor very, very highly — but he will only collect the wage level that he thinks he is worth, if he can find someone who believes that obtaining his labor is worth paying that wage level.

    Patterico (3cc0c1)

  27. I was actually discussing this with a friend yesterday, but we came to a different answer. He needs a new roof and is amazed by the variation in bids, which he felt meant that at least some of these roofers are trying to rob him, which is likely true. (Or possibly signaling that they don’t need the work, I have known some to do through unreasonably high estimates.)

    So I explained that the cost of the materials and the labor certainly have something to do with the price of his roof, but what will ultimately determine the price is what is the value of the roof to him. And we were passing an espresso stand at that moment and I used it as an example; lattes don’t cost anything like $4 to manufacture and serve, but they are certainly worth $4 to the people who consume them.

    Another example: graphing calculators. 20 years ago iPhones were impossible and personal computers at a small fraction of the capabilities for the same (real value) of money. Yet the graphing calculators I used in math class in those days are not only visually indistinguishable from the ones on sale now, but the price in nominal dollars is basically the same. And that’s because people have been buying them for their kids’ math classes for 20 years and that’s always been the price. I would dearly love to see a plot of what it cost TI to make them in real dollars over that time period.

    Gabriel Hanna (13a147)

  28. @Patterico:Landowners and capitalists provide similar things as one another, and both receive interest.

    Adam Smith puts this a bit differently: landowners get “rent”. “Rent” took me a while to figure out. “Rent” is essentially what you can extract due to coercion, non-economic activity.

    For example, if I wish to mine copper on my property, I have to collect tools (capital) and invest my time (labor), and then when I sell the copper the money that I get is partly wages for my time (or that of my employees) and profit is what I get from the increased value that resulted from all of my economic activity (including moving the copper from the ground, where it was no good to anyone, to the seller, who wanted it enough to trade something for it).

    But suppose my neighbor wants to mine the copper. He has to do all the things I did, and invest the same labor and capital into it. But I have the power to forbid him from mining my land (which is where the copper is). So if he wants to do that, he has to make it worth my while, which is to say give me money. And so his income from the mined copper is partly wages and partly profits, but my income from it is “rent”.

    The high salaries of actuaries are partly wages and partly rent, because actuaries have a state-enforced cartel: only credentialed actuaries can perform certain actuarial functions and the state decides that the actuarial professional societies are the people who get to award the credentials. Same goes for anyone who has to be licensed or credentialed or bonded or hold a taxi medallion or what have you.

    Gabriel Hanna (13a147)

  29. Adam Smith puts this a bit differently: landowners get “rent”. “Rent” took me a while to figure out. “Rent” is essentially what you can extract due to coercion, non-economic activity.

    Again: we are getting ahead of ourselves, and this all relates to tomorrow’s post. However, I think in that post (as currently drafted) I simply asserted that landowners and capitalists perform similar functions, and that they receive interest. The only difference is the provenance of their holdings (natural = land, manmade = capital).

    Murphy spends some time explaining that, historically, landowners were seen as receiving rent, and capitalists were seen as receiving interest. But in the Austrian framework, it’s all the same. Any capitalist and any landowner could either sell his property (the machine, or the piece of land), and the price of the property would depend on how much income it would generate per year and how long it would be expected to last. Ultimately, he classifies it all as interest.

    Patterico (3cc0c1)

  30. Murphy defines rent as what is left over of the income the landowner receives after depreciation. He says the difference is all due to time preference.

    Patterico (3cc0c1)

  31. the latter end of the Hapsburg was more statist, then we are used to, so both categories were blended in the Austrian critique, Caldwell’s bio of Hayek helped me understand this,

    narciso (ee1f88)

  32. Rent is equivalent to interest. Murphy and Patterico are very correct.

    Rent is what you pay for the use of another person’s property for a period of time.
    Interest is what you pay for the use of another person’s money for a period of time.

    There are differences. Money is fungible, land is not. And until about 1800 land was the primary form of wealth. But the latter is a social and cultural phenomenon, not intrinsic to land.

    kishnevi (91d5c6)

  33. I’ve been a landlord. It’s much closer to being an entrepreneur that it is to being a money lender.

    nk (dbc370)

  34. Part 4 is helpful in this discussion. In which “order of goods” do various leases fall as opposed to the order in which loans of money fall?

    nk (dbc370)

  35. I think in the comments about what is “really” rent vs interest or whatever, what is missing is the distinction that Smith made, the role of coercion in the economy.

    The fact that I get paid for the use of something I have some sort of control over, we don’t have to call it “rent” if you object and want to reserve it for something else. Words mean what we say they mean.

    What Smith was getting at is that coercion has an influence on prices and has a money equivalent, whether you call it “rent” as he and Ricardo did or if you want to call it something else.

    Suppose that we decide that all baristas must be licensed and prominently display their credentials. This would restrict the supply of lattes and perhaps raise their prices, maybe from $4 to $4.50. That extra $0.50 per latte is the result of coercion, a partially-unfree market. Smith would call that “rent” and the people who advocated the licensing of baristas to achieve that result would be called “rent-seekers” by economists, echoing the older usage. The key element is coercion.

    Very relevant today, regarding Uber and those who are trying to force Uber into the taxi regulations: the taxi industry is rent-seeking, keeping competition out by using force and thus raising prices.

    If you use your own stuff in a way you could be said to pay yourself “rent”, much like how some of your profits could be called “wages” that you pay yourself, the portion that compensates your time.

    Smith spent a lot of time on describing what limits the maximum “rent” in his sense, and in many cases “rent” has a maximum value of zero.

    Would love to see the Austrian take on money extracted through “coercion” even if calling that “rent” is objectionable.

    Gabriel Hanna (13a147)

  36. The reason I resist calling “rent” the money charged by landowners is that there is zero coercion. The Austrian take on coercion is that it comes from the state . . . period.

    Adam Smith was far more contemptuous of landowners and capitalists. Remember, he believed in the labor theory of value, and said some dismissive things about capitalists.

    Patterico (3cc0c1)

  37. Sunday Music?

    mg (31009b)

  38. #36: Patterico, it is also the case that in Adam Smith’s time, the distinction between landowners and the State were not nearly as distinct as they are today. Most large landowners were nobility of one sort or another. Additionally, the House of Lords was still a significant actor in the British government, and so the State acted on their behalf. The large landowners were also influential in the election of MPs to the House of Commons, further blurring the distinction between State and landowner. Even with the industrial revolution and fortunes made on trade, the newly enriched sought membership in the Aristocracy via marriage of their children to the less successful aristocrats. So perhaps Smith’s contempt was also directed at the State, but in terms that were more politically correct in his time?

    bobathome (6f310e)

  39. @Patterico:Remember, he believed in the labor theory of value

    I’m not seeing this in Smith. He’s using labor to reckon prices instead of money, because the discussion is confused by the changing prices of gold and silver money.

    I have not found that he says the labor invested in production determines the value, or ought to. He says rather that the value of a commodity to you is the equivalent labor of your own that you would have to invest to acquire that thing, and that labor doe not necessarily invovle your personal participation in its production.

    In latte terms, he’s saying that if you want to know how much a latte costs you, you should figure out how many hours you need to work to acquire one. He’s not saying that it’s based on the barista’s labor at all.

    Gabriel Hanna (13a147)

  40. Thank you, Patterico.

    Mostly, I think it’s absurd to suggest that raw materials can be more-or-less mindlessly assembled into a valuable good – but that is what the capitalist/worker binary suggests.

    A burrito bar is a mild example. Just think of trying to say that the people assembling parts for a plane are the ones who are contributing the most value of turning useless raw materials into something useful. Yes, they need to do their jobs very, very competently (and are paid quite well for it), but it’s not like human beings naturally know how to design advanced aircraft.

    bridget (d90803)


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