Friday, May 28, 2010

Subjective Value and Allocation

In the comment section of another post, Mattheus von Guttenberg writes:

"As far as the subjective decisions made in government, the word you're looking for is arbitrary, not subjective. Government projects do not rely on profit and loss so they have no way to really KNOW which project is profitable and which isn't (which is just another way of saying they have no way to know what the consumers want). They always operate in the dark and so any decision they make is an arbitrary stab."


"if you were forced into buying oranges, even after weighing the incremental gain you achieve from buying apples, then the group that is using force is expressly declaring that "Your purchase of oranges meets some higher standard than your purchase of apples, thus my use of force is justified." This is what I mean by objective value. This group assumes that the purchase of oranges meets a higher, more enlightened (or more necessary, etc.) value because it is for whatever purpose they ascribe to it. No longer are you allowed to resort to the subjective decision making process that so well fulfilled you in the earlier episode. The coercive group arrives at the arbitrary (meaning not guided by profit and loss) decision to enforce the purchase of oranges on everybody. It assumes everyone values oranges higher than apples. They are declared objectively more valuable."
I think where Mattheus is confused is in conflating three very different things here: (1.) the information that is used as an input to some allocative decision making process, (2.) the allocative decision making process itself, and (3.) the goal of a decision making entity. He talks as if profit maximization and the price mechanism are the same thing, and then later talks about a "subjective decision making process" as if subjective valuation and the price mechanism are the same thing. He muddies everything up, and while this post is going to be somewhat esoteric I wanted to straighten the discussion out a little.

First and foremost, the way that we as modern human beings interact with the material world is through subjective valuation of objects. Our preferences and the utility that we derive from objects determine their value to us. This is the information that we bring to the table whenever we make decisions about allocating objects. If you think about it, though, this is information that we use in a variety of settings outside the market setting. Think of all the material objects that are allocated throughout your life. Now ignore two types of allocation: (1.) market allocation, and (2.) allocation by the state. So for now, ignore buying food from the store, but think about allocation of who prepares food in your household, who eats it, how much food you give away. Ignore for a moment buying a book from a bookstore, but think about choices you make about what book to read tonight, what book to lend to a friend, what book to donate, or what book to give as a gift. Ignore the Social Security checks that your grandmother gets, but think about the money she gives in a card on Christmas or the poker game that you bet that cash in.

Mattheus speaks as if the market process and the price mechanism are somehow definitive of subjective valuation, or that if you don't use the market process you don't use subjective valuation. But if you go through this thought experiment, momentarily become a doctrinaire materialist that sees nothing but material objects and their allocation, and ignore all the market and government processes, there's still a lot of allocation going on. In Mattheus's world we'd be lost without prices and the market, but somehow we seem to manage, don't we? And everyone knows that their subjective valuation informs these decisions too. My wife and I are moving to a new apartment soon, so we're donating a few things to downsize our stuff, and we're packing other things up. What I do and don't donate depends on how I subjectively value what I own. How carefully I pack things up is a function of both how durable the object is and how much I subjectively value the integrity of that object. These are all allocative decisions I'm making quite successfully without the market.

So what is the market? What's great about the market and prices is that they provide a mechanism for coordinating lots of people's subjective valuations. When you consider how to spend your "marginal" dollar - your next dollar - you consider the subjective value of all the potential marginal purchases you could make. A rational agent is expected to purchase whatever object has the highest marginal value (as long as your marginal valuation of the money itself doesn't exceed the marginal value of that object). If the marginal value of that object continues to be higher than the marginal value of your money, you're going to keep purchasing the object in greater quantity until it isn't anymore. Prices will adjust with supply and demand - so where the price finally reaches equilibrium we know that everybody that purchases that object places the same subjective marginal valuation on it, and that they have had the opportunity to purchase their highest subjectively valued material object that they can afford (that's available for sale at least). This ensures that objects are efficiently allocated, and that is the primary advantage of the price mechanism. We know that no one who places a higher marginal subjective value on an object is left unsatisfied, and we assume that whoever doesn't end up having the object allocated to them assigns a lower marginal subjective valuation to it. That's a good thing, because presumably maximizing total subjective valuation is something we like to have happen.

So the price mechanism is one process that uses the information provided by billions of individual subjective valuations, and it uses that information efficiently. But we know from earlier that it's not the only way to use subjective valuation information. Subjective valuation is not a decision making process, as Mattheus asserts. It is the informational input to several different decision making processes.

What about government? Does government use something different? Of course not. All valuation is subjective valuation. In the modern world at least, it doesn't make sense to go around thinking of things as having intrinsic, objective value. Nobody thinks something like "this chair is objectively worth twice as much as this desk". We may say "I find this chair to be twice as valuable as this desk", but the previous, objective valuation doesn't make sense and even governments that make value judgements don't assume any objective or intrinsic qualities about their value claims, do they? The government uses subjective valuation like every other person or institution. The difference is that it doesn't use the price mechanism to process that subjective valuation information and make these decisions. It uses a combination of electoral, political, and bureaucratic decision making mechanisms instead. Instead of the price, the government uses the median voter, or the majority or super-majority in a representative legislature, or the discretion of a bureaucrat to make allocative decisions. All of these mechanisms still use subjective value, of course. In a bad government that subjective value is the value of the leaders themselves. In a bad government electoral decision making doesn't mean much (if there are elections at all), political decision making is about rent seeking and personal gain, and bureaucratic decision making is also about rent seeking and personal gain. In a good government, the subjective valuation of the citizenry is informing each of these processes. In a good government, bureaucracies do careful studies and cost-benefit analyses of different options (or they contract the work out to organizations like the Urban Institute!). The reality of courses is going to be a mix of the two: bad and good governance practices. What actually happens in this allocative decision making process is the subject of Public Choice Theory in economics.

What are the consequences of the government not using the price mechanism? Well, it ultimately depends on what choices they're making. If they're deciding on how much steel should be produced and who should use it, eschewing the price mechanism can seriously impair decision making. We know that the price mechanism efficiently allocates resources to those who value it most. Anything other than the price mechanism is going to make mistakes. This is the old socialist calculation debate and economists are virtually unanimous on that debate. What if we're talking about a different decision - say, taking care of abused children or feeding the homeless? It's not clear how the price mechanism is going to efficiently handle these allocation decisions, right? The homeless probably place a higher marginal subjective valuation on food than I do, but their mental health condition, their ability to pay, etc. is going to be an obstacle to relying on the market to supply that food. We could rely on altruists to use the price mechanism to feed the homeless, but why would the subjective valuation of the altruist be expected to match up the subjective valuations of the homeless? A good rule of thumb is that if outside of government the market is not allocating a particular good, but some other institution like a church or a community organization is, then the government is probably not disadvantaged relative to the market in making that allocative decision. If the market were especially efficient at it, you would see more of those decisions made by the market.

The important take away point for Mattheus is that how we value things and what we do to use that valuation in decision making are two very different things.

Finally, what about profits? Profit maximization is simply a goal of firms, just like utility maximization is a goal for individuals. It's the impetus for action, in a way. Profit is just the excess of revenue over costs. You can be a state owned enterprise in a communist country and still be a profit maximizer. No one says those costs or that revenue has to be determined by market prices. You could also not care about profits at all - you could be a non-profit - and it has nothing at all to do with your participation in the price mechanism and the market economy. Non-profit organizations use the price mechanism when they purchase labor and equipment and when they sell things as well. They just don't care about profits! The Urban Institute pays me a competitive wage to keep me there, it buys paper and computers and rents the building. And we sell our services to the government and private foundations. Everything is the same as it would be for a for-profit contractor, except that all we care about is staying solvent! And we have for forty years now, and our product is in high demand in the market. Mattheus writes that since the government doesn't seek profits it doesn't know what projects are profitable. But this confuses goals. I think it's an open question whether simply being a profit seeker gives you any insight into what is profitable. But what Mattheus leaves unclear is what's so great about profits. My family doesn't seek profits. We don't try to maximize our income less our costs. What we try to maximize is our utility. There's nothing special about profit seeking. Government doesn't maximize profit either - it tries to maximize some sort of social utility, probably with a few prioritarian concerns mixed in. So?

Once again, Mattheus is conflating (1.) goals (like profits) with (2.) information (like subjective valuations), and with (3.) decision making processes (like prices or elections). These three aren't the same thing. We all basically use the same information - subjective valuation. But we use that information to pursue different goals with different allocative strategies.

We've been managing to allocate material objects for millenia - sometimes with the price mechanism, sometimes without. I think the price mechanism has a distinct advantage over all other allocative processes when it comes to certain kinds of decisions, but that doesn't mean the price mechanism is the only game in town.

So where does this leave us with the state, which was in a lot of ways the subject of the discussion in the comment section. It leaves the state, as with most non-market allocative mechanisms, somewhat ill-defined. This makes sense of course - economics provides the most detailed theories of the market - it hasn't focused as much of its time on the state. I was reading some of William J. Baumol's book Welfare Economics and the Theory of the State last night, and he had a great phrase for this unfortunate condition of our theorizing about the state. His epilogue was a question about the nature of the state: "The Wreck of Welfare Economics?". A lot of times it seems that way - that the state becomes possible where the market economy wrecks and breaks down. Advocates that don't think hard enough and critics who are more interested in pot-shots than critical analysis assume that means that whenever there is an externality or market failure, we're arguing that state action is always the right solution (for an example of this, see Anonymous's comments in the last internal improvements post and the weird ideas that he inexplicably ascribes to me). Of course barely anyone is making that argument, but that won't stop lazy scholars from characterizing the situation in that way. But it's still somewhat unsatisfactory isn't it? As it stands, the theory of the state largely consists of the wreck of and the inconsistencies that turn up in "normal" economics.


  1. Excellent post. I was unsure of where you were missing my point in the comment feed, but now I know exactly where to begin.

    I didn't explicitly state it before (though I believe I alluded to it in the discussion of supermarket fruits) that every decision made bears opportunity cost - market or state decision. In a market decision, the opportunity cost of buying the orange was not buying the apple, or in a simple (what Mises called autarkic trading - action done by an individual with no secondary market participant) case of packaging boxes, the choice of how much to pack, where to pack, how much to donate, etc. all rely on a process of subjective valuation driven by the understand of opportunity cost. If you pack items A, you won't have room for items B that you care more deeply about, so you disregard the first. I think everyone understands this, and you do make mention of it in your post. There are some points I'd like to mention, though.

    When we're speaking of market action, such as the orange case, it's clear to see how differing subjective concerns play the deciding role in choosing amongst alternatives. Similarly, when deciding how much to donate and whom to give it to, subjective valuations play the exact same role they did in the market case. I think there's no difference. I never meant to insinuate that if there are no market prices for a good or service, that people stop subjectively evaluating it. A donation (whether it's Grandma's checks or furniture at Goodwill) is merely a market transaction where one party is relieved from the price. The gain one receives is a Samaritan joy from the simple act of giving. There's no reason to consider this a case very much different from a typical market transaction. Again, this is something you agree with.

    In our earlier discussion, I spoke about the necessity of the price mechanism to make informed decisions when purchasing quantities of market goods. This is absolutely true. The old socialist calculation debate I believe settled the matter entirely. The only reason I bring up opportunity cost in relation to government is because the opportunity cost of economics is unavailable to them. In a market setting, products and services are offered to make a profit (in essence, they are offered because people want them). In government, services are also offered because people want them. But how can that be reconciled? Both firms and government attempt to appease consumers and constituents, but one does so by the very efficient price mechanism, and other without? That was the brunt of my point when saying “they take a stab in the dark.” Without profits, how can any government action be even reasonably assumed to please some people, instead of the politicians in charge? If profits are not involved, what recourse do the politicians have in deciding what program to enact? Even diplomatic voting is vastly inferior as a means of production. Imagine if, doing away with money for a moment, we all had to vote on what corporations made, or better yet, vote on corporate representatives who subsequently vote on what they think we’d like to have. What terrible inefficiencies there would be! Voting, even for the offices of specific politicians, let alone their actions once in office, is not enough to secure even a reasonably productive system where an organization provides goods to meet the needs of constituents. That is what is arbitrary. They don't have any feedback from the populace (like companies do with profit/loss) so they have no way to know what to produce or in what quantities. To reiterate, I never claimed governments do not apply subjective information as feed for their decisions – what I said was, that without any way to know what the consumers wanted, they necessarily override the consumer’s subjective information and erect objective standards.


  2. The other difference you and I seem to have, which you haven't yet responded to, is that when a government makes a decision, it always enforces that decision with force, and it always finances it with force (taxes). Agree so far? When the government finances it with taxes, it is implicitly telling every tax payer that his purchase of quantity A is not valued as much as their contribution to Government Project X. That's what happens. If I tell my mother I want to spend my paycheck on marijuana and alcohol, and she insists I spend it on paying bills and buying food - to the point where she uses force to coerce me - then she is making the purchase of food, and the payment of goods, objectively more valuable than my drugs. That's all I'm observing, and I've been trying to get this point across.

    I'm aware governments use their own method to arrive at answers. I'm aware that electoral and political machinations play a role in deciding which program or which project to undergo - I'm not at all even suggesting that government is a group of men sitting around whimsically taking turns deciding what to do with their time. My statement about bureaucratic whims was essentially hyperbole. Still the point remains that when decisions, market or otherwise, are enforced by coercion, it is an express renunciation of the truth of the subjective theory of value and if done by force, lacking the profit motive, it is as arbitrary as it is unfair.

    - Mattheus

  3. I don't have a lot of time to interact today, but here are a few quick thoughts:

    1. I definitely don't agree that gifting is the same as a market transaction. I think these two are very different, which is one of my points.

    2. RE: "In a market setting, products and services are offered to make a profit (in essence, they are offered because people want them)." This is not the "essence" of profit-seeking. Profit-seeking is simply the maximization of the difference between revenue and costs. Profit-seeking doesn't have to occur in a market economy (ie - where agents "demand" goods). Likewise, non-profits can flourish in a market economy. One of the major points I was trying to make was precisely that profit-seeking has nothing directly to do with the price mechanism (although they often come together).

    3. RE: "Both firms and government attempt to appease consumers and constituents, but one does so by the very efficient price mechanism, and other without? That was the brunt of my point when saying “they take a stab in the dark.” Without profits, how can any government action be even reasonably assumed to please some people, instead of the politicians in charge?" -- But the price mechanism is only efficient at certain types of allocation and at achieving certain goals. Again, this is the point of the whole post, and why it's important for you to separate goals (profit-seeking) from decision making mechanism (price system).

    4. RE: "Imagine if, doing away with money for a moment, we all had to vote on what corporations made, or better yet, vote on corporate representatives who subsequently vote on what they think we’d like to have." -- What could this possibly have to do with what I'm saying. I explicitly say that producer and consumer goods are most efficiently provided by the market, and then you turn around and say something like this as if it's a challenge to what I'm saying. Why would you think this point is relevant?

    Reading this first post makes me really curious about what you think I'm saying the government's job is and what I think it has an advantage in. You seem to completely misunderstand me. You provide these examples where I've never claimed the government could ever hope to succeed. Do you actually think I'm saying the government should act in these circumstances, or are you just trying to employ a metaphor or what?

  4. RE: "The other difference you and I seem to have, which you haven't yet responded to, is that when a government makes a decision, it always enforces that decision with force, and it always finances it with force (taxes). Agree so far?"

    I have a tough time accepting this logic so blatantly. You act as if the government is some sort of separate entity. In a democratic republic, the people are using an (admitedly imperfect) state institution to tax and provide for themselves. That doesn't mean there aren't elements of coercion to be thought through, but you're distorting the issue by describing it in this way, as if the state is somehow external to the people that it is taxing and providing for and legislating for.

    RE: "then she is making the purchase of food, and the payment of goods, objectively more valuable than my drugs."

    No - this is what you repeatedly assert but never explain. Assertion doesn't get you anywhere, Mattheus. I understand WHAT your position is on this, I simply don't understand why. It is still a subjective valuation, it simply isn't your personal subjective valuation.

    RE: "lacking the profit motive, it is as arbitrary as it is unfair."

    Is allocation by non-profits arbitrary and unfair? What if tomorrow the ownes of all for-profit corporations turned them into private non-profit corporations? What would that change? I really think you're misunderstanding the very nature of the profit motive. It is a goal that people seek - it is not a guarantor of efficiency.

  5. RE: 1: Sure it is. In a market transaction, goods are exchanged because either party stands to gain at the trade. If I simply give away an item, the samaritan utility I receive is greater than the value of the item, and conversely, for the giftee, the pleasure of receiving the gift is greater than not having it. Both parties are made happier. The fact that one party did not surrender any material object or service doesn't make the trade any less economic.

    RE:2: Profit, as it is represented in accounting, is simply revenue over costs. But profit only comes to those firms who supply products or services the consumers are willing to purchase. You state, "Profit-seeking doesn't have to occur in a market economy" But it does! You cannot have a market economy without profits; it's impossible. Without profits (in a socialist country), it's impossible to efficiently allocate resources. A market economy relies on the profit/loss feedback loop to ensure consumer needs are met. And clearly non-profits can exist in a market economy, for the profit the organizations make is not a MONEY profit but the "profit" that comes from a feeling of charity. They survive off donations. There is reason non-profits are not the captains of industry - because without profits they cannot predict or even tell what consumers want. They operate by means of charity and they survive from individual people donating to their cause of charity. It is not a system of efficient production.

    RE:3: Certain types of allocation? The price system is the only tool EVER designed to allocate resources to any modicum of efficiency. It is a procedure that has unbelievably obvious success in meeting needs. If you are going to make a product or service to meet the needs of some people, and you do not use the price mechanism - what other recourse do you have? How can you possibly do it efficiently? Furthermore, what other "second" type of allocation - other than efficient - warrants disregarding the price mechanism (which includes opportunity cost - don't get caught up in dollars and cents. The price mechanism is about choices.)

    RE:4: It's relevant to show how absurd it would be if we guided production along the lines of bureaucratic and electoral procedure. What I don't understand is how you attempt to justify different types of allocation as if "Well, the market is fine and dandy at making lollipops, but when it comes to serious things, the government has to use its own discretion." This discretion you're talking about ignores prices, it ignores costs. If you can devise a method of allocating resources better than the price system - let us know.


  6. RE:5: Like it or not, the government is a specific body (that we duly elect) that taxes and uses force to ensure compliance with its mandates. How can you argue otherwise? Try not paying your taxes and you'll see what I'm talking about. Even if the people set it up and the proceeds go "to the people," we have still organized an institution that uses guns and prison to make sure we all obey.

    RE:6: "it simply isn't your personal subjective valuation."

    That's the point I'm making. By overriding my own personal subjective valuation, coercion always places another person's subjective valuations on to me. It is making a choice for me, despite me having more favorable opportunities. It is forcing that I acknowledge the truth of their valuation. That is what is objective.

    RE:7: We've been over this. It is a guarantor of efficiency. Profits are not dreams that people chase. They are the result of efficiently predicting and acting in accordance with consumers desires. The notion of every corporation being non-profit in a market economy is impossible. Only in a totalitarian nation could non-profits solely exist, because the profits would go to the state. You need to reevaluate the role of profits in society. They don't fall from the sky. They are the result and the proof of productive activities; they are the evidence that organizations are meeting consumer demand. Nothing more or less.

    - Mattheus

  7. OK - I REALLY can't respond to all of this cause I'm very busy, but I have to ask you something on that first claim of yours... is consensual sex no different than prostitution?

    It's what you're implying here. And sex is the perfect thing to bring up in these questions, because it's so easy to identify the nature, ramifications, and difference of commodification. Gifts are not commodities. Objects that we allocate are not commodities simply by virtue of the fact that they've allocated.

  8. I don't mind if you don't respond - I understand you're busy. Not everyone is a college undergrad home for the summer. :P

    Fundamentally, no. Aside from the fact that prostitution IS consensual (i'll take it to mean purchased sex vs. sex for fun), in both cases parties are working together to achieve a higher level of utility than either could achieve individually. Man and woman have come together in a social division of labor to reap benefits neither could achieve by themselves. It is a product of human action and the division of labor and, while the details differ of course, they are not fundamentally any different because the strict parameters are the same: They both pay the costs (money on one hand, time on the other) to enjoy the benefits of their work.

    The topic of prostitution reminds me of the funny comparison between a hooker who asks for money, and a wife who asks for a nice dinner and a lovely evening. Is sex with either of them fundamentally different?

    - Mattheus

  9. I couldn't say, having never felt the tender embrace of a hooker :) So in that sense I suppose I may be speaking out of turn here.

    But you truly see them as being no different, (1.) I think you might have a few things to learn about women, but besides that (2.) our differences are probably far more fundamental than what we're arguing over here.

    Normally my time is pretty flexible, but we've got a project we're pushing through this week. I'll try to respond to a few more points this weekend - as always, good talking to you.

  10. Hey now! I never claimed to be the downtown prowler either, I'm just trying to work within the confines of "the economics of prostitution" model you gave haha. I'm not ignorant on women; we were talking economics. On a fundamental economic level, I believe they both exhibit trade offs and they both have opportunity costs - although on a personal level I would never call them the same.

    Our differences are probably semantic. We haven't defined necessarily what a gift IS nor what a market transaction IS. Until we establish set parameters and definitions, our conclusions will be warped by our understanding of the language.

    - Mattheus

  11. :) just having fun - don't worry

    I did bring it up first, didn't I?

  12. What, gifts?

    - Mattheus

  13. Wow this is strange! I was surfing around on the Mises site and I came across Walter Block's "Defending the Undefendable" PDF where he applies basic libertarian and economic arguments for every trade from pimp, to scab, to ticket scalper, etc. showing that all of them actually perform some good service.

    The first 10 pages are on prostitution, and Block almost explicitly endorses my previous response to your question on prostitution. Here, I'll link it:

    From like page 5 or so he compares prostitution with legitimate unpurchased sex. This is such a coincidence, I promise I didn't go search this out.

    - Mattheus

  14. Thanks -
    It's definitely not the first time I've heard the argument. Leftists feminists make precisely the same argument in their critiques of marriage (ie - they say it's the same as prostitution and that's a bad thing).

    I'm not a crusader against prostitution or anything, and I'll stipulate that often it makes two parties better off for the exchange. But whether it is welfare maximizing in any meaningful sense of the word depends on more than just that. As economists, we can only make arguments that say that "given we accept X as a commodity to be exchanged in a market, exchanging it freely will maximize utility". What economists can never answer is "do we lose value to treat X as a commodity to be traded around". Is commodified sex less valuable than uncommodified sex?

    Now, if you think consensual sex is a commodity already, then we're really just talking past each other.

    This is tough, though. Pimps coerce, and a lot of prostitutes can't legitimately be described as being in the business voluntarily.

  15. "Is commodified sex less valuable than uncommodified sex?"

    Maybe if we're talking about the romantic and intimate feelings two lovers share when they have uncommodified sex, then yes it is less valuable.

    But sex with a friend with no romantic attachment isn't any more or less fulfilling or valuable than commodified sex.


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