Category: Classical Political Economy

On Prices/Values

Economics, rather Political Economy attempted at providing a coherent theory of value. Economists such as Adam Smith, David Ricardo, Karl Marx, etc are associated with a ‘theory of value’. Currently, in economics, ‘value’ is not discussed in courses of relevance. However, students are exposed to value theories such as labour commanded, labour embodied and so on.

This post is the second in the series of posts ‘On Prices’. This posts attempts at clarifying concepts such as values, prices and costs of production. Note that all prices which are mentioned in economics textbooks (microeconomics, introductory economics, principles of economics, etc) pertain to relative prices or long-run prices. That is, they do not talk about market prices. The reason for this is because it is assumed/believed that market prices tend to fluctuate or hover around these relative prices. In other words, given a particular technology, these relative prices, in some sense, reflect the interrelationships in the economy. Hence, these natural/normal proces are studied in order to understand the workings of a capitalist economy.

Let me start with what is usually taught in various economics and management institutes across the world and even in higher secondary schools. Prices are determined by the interaction of supply and demand. This implies that an excess dmand leads to a price hike. Let us look at an example: Suppose I go to a toy shop and ask for a Meccano set and immediately, another customer asks for the same set. But, the shop has only one Meccano set. Will the price of the Meccano set increase’ Is such an explanation intuitive or common sensical’ This example talks of an isolated case.

Economics is interested in the formation of a spectrum of prices at the level of the economy. Interestingly, macroeconomics has nothing to offer on price formation. Often, or rather everywhere in the world, economics is taught as microeconomics and macroeconomics. The interdependence and interrelationship present in any economy is inadequately addressed. The closest one comes is probably through the ‘circular flow’ diagram which highlights the role of the firm as well as the households. In this diagram, the complex and strutural interdependence is oversimplified to that of a 2-way interaction between the firm and household via labour market, capital market, etc and the state is shown to play the role of a facilitator. The interrelated production structures goes unnoticed or is seldom mentioned. Why is this important’

How can prices be determined’ (The dominant factor will be mentioned.)

1) Demand & Supply – The prices which are determined in this way are the prices of vegetables and fish, prices of shares in the stock markets, price of real estate, etc. In some sense, these prices can be said to be supply determined. For, these commodities are more often subject to variations in supply than in demand.

2)Costs of Production – An alternative view which is present in the literature is that the prices of commodities are prices according to the prices paid to the means of production as well as adding a certain percentage as profit. According to Kalecki, the percentage depends on the monopoly power of the firm. What if the firm’s final product is an input for another firm’ Will this affect the price of the product’ This aspect is often forgotten in economics.

This forgetfulness is strongly associated to the lack of importance mainstream and even some heterodox economic theories gives to interrelationships in the production structures in an economy. To have a glimpse into this, one needs only to look at an Input-Output table.

If we assume (correctly) that production structures in a capitalist economy are interrelated then we can conceptually distinguish goods/services into – Basics and Non-Basics. [Sraffa 1960] Basic goods are those goods which directly or indirectly enter into the production of every commodity in the economy including its own. An obvious example would be foodgrains because they are needed for labourers and labour is required in all activities. And a tax on a basic good will have cascading effects on the prices of all the goods in the economy.

I shall quote Sraffa to point out the significance of accepting and studying interdependence.

The exchange-ratio (or relative prices) of non-basics is “merely a reflection of what must be paid for means of production, labour and profits in order to produce them – there is no mutual dependence.” [p 8, Sraffa 1960]

“But for a basic product there is another aspect to be considered. Its exchange-ratio depends as much on the use that is made of it ….” [pp 8-9, Sraffa 1960]

It is because of these issues that Sraffa uses values/prices than costs. Also, Sraffa knew that in an economy, “costs of production cannot be measured independently of, and prior to, the determination of the prices of products.” [p 9, Sraffa 1960] To conclude, dan we therefore think that Sraffa’s analysis is similar to the neoclassical analysis of price using demand and supply’

In brackets, Sraffa writes “one might be tempted, but it would be misleading, to say that ‘it depends as much on the Deamnd side as on the Supply side.'” [p 9, Sraffa 1960]

References

1) Kalecki, Michal (1971), Costs and Prices, in Selected Essays on the Dynamics of the Capitalist Economy 1933-1970, Cambridge University Press, pp. 43-61.
2) Sraffa, Piero (1960), Production of Commodities by Means of Commodities, Cambridge University Press.

Foucault and Economics

This post is more of a suggestion than an explanation. There has been hardly any scholarly work done with respect to applying Michel Foucault’s ideas and approaches to political economy or economics. On searching the internet, all I could find was a conference conducted in 2005 titled ‘Rethinking Foucault, Rethinking Political Economy’ at University of Leicester, UK and a PhD thesis submitted by Iara Vigo de Lima at the University of Stirling in 2006. This post is a result of my reading of certain sections of Dr. Lima’s thesis and the sadness associated with the knowledge that economists have not studied/read/understood Foucault.

I find it difficult to believe that nobody has tried to think/rethink the methodology and historiography of Economics by applying Foucauldian themes. To do justice to this area of research, it is necessary that I quote certain sentences from Dr. Lima’s thesis, as my knowledge of Foucault is limited.

‘Foucault followed Nietzsche’s genealogical approach aiming not ‘simply to gain access to the unfamiliar past’, but mainly ‘to articulate and illuminate the familiar present’, and ‘the past, then, becomes a means to access the present’.’ [p. 16]

‘For Foucault, concepts, notions, theoretical frameworks, methods, etc., are bounded by time and culture.’ [p. 21]

‘Michel Foucault’s particular insight, especially his way of thinking about history – which he preferred to call ‘history of systems of thought’ – does offer elements that let us think about this question, and specifically in economics (given that he applied it to the history of economic thought). According to him, every age has its way of producing ‘the truth’, which can be uncovered as we think about history.’ [p. 24]

‘… one of his objectives in OT: to find out how political economy established itself as a discipline (discourse) at the end of the 18th century.’ [p. 29]

Very often economics is taught (in India) as if the present day economics is what has evolved out of the previous economic theories. Therefore, the multiple paradigms that prevail in economics are seldom expressed clearly. It is not uncommon to learn the theories of Adam Smith, David Ricardo, Thomas Malthus, etc under Classical theories. Then, they are forgotten. They are mentioned as the initial thinkers. No more are they mentioned nor their relevance. For, neo-Smithians, neo-Rocardians, neo-Malthusians, etc are very much present. And, they do come out with better theories than the neoclassical economists.

This post suggests that one ought to know that there are ‘other’ truths (heterodox economic theories) apart from the truth that we are taught ‘ neoclassical economics. And in this aspect, a reading of Foucault will prove to be immensely insightful.

Labour, Scarcity and Techniques of Production

Value ‘ is of utmost importance to all paradigms in Economics (Neo-classical, Classical Political Economy, Austrian Economics, Marxian Economics, etc) because the theory of value is the fundamental proposition or the foundation on which subsequent theories are built. Therefore, it is crucial to understand the various theories of value.

The problem of value has different features. The aim could be to find the source of value, a standard of value for inter-temporal comparisons between and across countries and determination of exchange values in theoretical problems.

Through an example pertaining to ‘value’, this post tries to bring out the distinction between the Neo-classical and Classical paradigm in terms of the source of value. As students of economics, all of us have come across the Diamond-Water paradox. This paradox is a commonplace in economic literature, even before Adam Smith. This is how Smith refers to the paradox:

‘The things which have the greatest value in use have frequently little or no value in exchange; and, on the contrary, those which have the greatest value in exchange have frequently little or no value in use. Nothing is more useful than water: but it will purchase scarce anything; scarce anything can be held in exchange for it. A diamond, on the contrary, has scarce any value in use; but a very great quantity of other goods may frequently be had in exchange for it.‘

For the classical economists, value of a commodity means the value in exchange. And prices of commodities are believed to reflect its ‘value’. Value in exchange is determined by the conditions of reproduction of the economic system. The economic system is one where a number of firms using labour, land and capital (machinery, tools, etc), produce commodities (goods produced with the intention of selling them) by using commodities produced by the economic system (the firms within it). The conditions of reproduction would include the technology available (which would tells us in what proportions the labour and capital need to be mixed; in neo classical terminology, it would give a fixed proportions production function) Moreover, the classical economists did not consider value in use as a measurable quantity.

Before the ‘marginalist revolution’, utility had an objective sense as the capacity of a good to satisfy some need, and not as the subjective evaluation on the part of one or more individuals. It is worth noting that, in a capitalist economy a good or service is produced only because it can be sold. According to Marx, it is commodity production which forms the fundamental tenet of Capitalism. So, any commodity in a capitalistic economy does have utility. To clarify my argument, let me modify the definition of a commodity. A commodity is a good or service which is produced or offered only because it has a use value. Rather, it can be put for sale only if it has utility for someone or the other. The market does not produce commodities which has no demand or that which has no use/utility for any one.

Thus, it is clear that in a capitalistic economy (all economics theories, namely neoclassical, classical and Marxian tried to understand the working of a capitalist mode of production) the proposition that a commodity has a use value is a truism. So, because all commodities had a use value which they believed could not be measured, the value of a commodity was seen as the exchange value of it.

Since, labour was considered to occupy a central position in the economy, Adam Smith put forth the view that ‘labour commanded’ could be used as a standard to measure exchange value. In Marx, it takes the form of ‘labour embodied’ which then gives rise to the labour theory of value. For Marx, it is labour which provides value to the commodity by engaging in the production of that particular commodity.

Thus when the paradox is viewed through the classical and Marxian lens, it seems as if the paradox is only an illusion. The production of diamond is a costly affair and thereby requires a lot of labour (in today’s world, a lot of capital as well) due to which the value (exchange value) of diamond is high and thereby it commands a high price. More the labour needed for producing a commodity, more will be its value. So, because of the higher production costs, diamond is priced high.

For the neoclassical economists, the price of a commodity is determined by its marginal utility. Marginal utility is based on a subjective theory of value. Let me put forth two snippets from neoclassical economics as to how the paradox is resolved.

‘The more there is of a commodity, the less the relative desirability of its last little unit becomes, even though its total usefulness grows as we get more of the commodity. So, it is obvious why a large amount of water has a low price.‘ ‘ Paul Samuleson, the first American to receive a Nobel Prize in Economics.

In the blogosphere, I came across this piece from Michael Stastny, who blogs at Mahalnobis.

‘A better answer to the paradox why diamonds are more expensive than water would be that since water is so plentyful, the marginal utility (= the derivative of U(x) with respect to x, i.e. (approx.) the extra satisfaction of wants and needs obtained from consuming one additional unit of good) of water is is relatively low. An extra liter of water provides very little additional satisfaction. To the contrast, diamonds are very scarce and the marginal utility is therefor relatively high.‘

The study of economics is aimed at discovering the laws prevailing in the economic sphere. This helps in understanding the inter relationships within an economy. This further helps in policy purposes, by trying to increase investment rates, saving rates, GDP, etc.

The reasons provided for the paradox above assume that prices of commodities arise from their scarcity. Capitalism ensures a constant supply of the commodities which have utility (objective or subjective). It is to understand how prices come about, that economists theorize on values. For neoclassical economics, prices are indices of scarcity.

Let me illustrate the ignorance of neoclassical economics with an example. In a functioning economy, suppose an inventor discovers/invents a new product/commodity ‘ say a vehicle that runs on air. So, at this point of time, there is only one firm supplying this commodity. It is extremely scarce and according to neoclassical theory, it is rational for the producer to sell the first vehicle at any price because it has the highest value by being the sole product in the market.

So, when the first vehicle is on sale, the demand outstrips the supply. According to the neoclassical theories, the capitalist can ask for a higher price in such circumstances. I conclude by asking: is that how commodities are priced’ Are such prices ethical’ Isn’t it the techniques of production along with the wage rate and profit rate that governs the prices of commodities’

References

1) The Wealth of Ideas: A History of Economic Thought, Alessandro Roncaglia, 2005.

2) Das Kapital, Volume 1, Karl Marx.

3) Economics, 11th edition, Paul A Samuelson, 1980.

On the ‘Invisible’ Adam Smith

This post mainly deals with the common misconception about Adam Smith, whose name is known to all students and professors of Economics; the misconception being the notion that he advocated laissez-faire. Sadly, his works are not as known. (Though the names of his two major works are widely known) So, this post tries to makes visible what is commonly invisible regarding Smith.

In the Indian Schools, textbooks in Economics associate him with the ‘wealth definition’. In Frank ISC Economics, which is authored by D K Sethi and U Andrews, Adam Smith is supposed to have defined Economics as ‘A science which enquires into the nature and causes of wealth of nations.’ Definition is ‘a concise explanation of the meaning of a word or phrase or symbol’. [Dictionary.com] Adam Smith has never defined Economics is the afore mentioned way. Is it ‘right’ to teach such ideas’ Isn’t it against the ethics of academics’ A large number of students are programmed in such a way in school, whereby their notion of economics is constituted only by neoclassical economics. Plurality in economics has been totally done away with. Teachers teach what is printed in the textbooks. No questions are asked.

Also, it is not surprising to see classical economists (Smith, Ricardo, Malthus, etc) being seen as ‘classical’ or rather irrelevant, because of either their naive assumptions or their bad theories.

The primary focus of this blog post is to argue that Adam Smith never advocated Laissez-faire. Let me put forth two instances where such a misconception has been put forth.

The following paragraph was published in The Hindu Young World, a widely read Indian Newspaper.

Adam Smith’s fundamental proposition was that a free market is a self-regulating mechanism and tends to produce the most desirable types and quantities of goods.

The second instance is from Economy professor, an online dictionary of economics.

Adam Smith’s fundamental argument was that individuals should be allowed to pursue their own private economic interests as much as possible and so long as they do not violate basic principles of justice.

Smith called this the invisible hand of the market – although everyone is acting in their own self-interest, they are led to achieve the good of all as if by an invisible hand of economic forces. Therefore, outside interference will inevitably lead to disaster. This became known as laissez-faire economic policy.

Instances like these are numerous. One reason could be that, the only paragraph(s) that such people read by Smith is this (are these):

Every individual…generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it. By preferring the support of domestic to that of foreign industry he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention.

-The Wealth of Nations, Book IV Chapter II

It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our necessities but of their advantages.

-The Wealth of Nations, Book I Chapter II

In fact, there is very little evidence to state that Smith advocated ‘free markets’ through stating the importance of self-interested behaviour. Also, he viewed individuals as a part of the society and not like an individual that is cut off from the society-the Homo economicus. Sen rightly points out that ‘it is precisely the narrowing of broad Smithian view of human beings, in modern economies, that can be seen as one of the major deficiencies of contemporary economic theory.’ [Sen 1987]

To conclude, Adam Smith tried to understand his society and also tried to prescribe ways by which the society could grow-morally and economically through his two masterpieces. In short, he was a great scholar, who ideas are still prevalent; despite what school textbooks and some academicians posit.

References

Sen, A.K. 1987: Economic Behaviour and Moral Sentiments. On Ethics and Economics. OUP.

Further Reading

Prof. Gavin Kennedy’s Blog-a must read for those who want to ‘know’ Adam Smith.

The Prospects of Homo economicus-a scientific American piece which uses behavioural economics.

Myth and Fact about Homo economicus