Money and prices -- Part III
andrea.parisi | Published: 9 Feb 2024, 11:50 p.m.
In my previous articles on money and prices (here and here), I pointed out a lack of proper definition of what money is. The idea that I have been following is that, on the one hand, money seems to be something akin to a measurable quantity (with characteristics similar to what in physics is called a "physical dimension", like length or mass): multiplying two prices does not seem to make any sense, which is a way to say that a price cannot be a pure number, but must have some dimensionality. On the other hand, money is ill defined from a "scientific" point of view: unlike any measurable quantity used in hard sciences, money does not have an operational definition (a definition where one details the instrument that measures a quantity universally and univocally; see here). Following this idea, I have performed a well known thought experiment, by analyzing the case of the survival on a desert island. Such thought experiment made it clear that, for the people on the island whose major interest is surviving by eating fish, each individual acquires a rate of production. This rate of production depends on the investments performed to acquire tools that make individuals more productive, thus freeing time for new activities or for further productivity. All goods produced require some labour, and when individuals exchange such goods they are effectively exchanging labour. This is actually true in general: even when people trade using money, from one side the buyer is using money earned through work, and on the other side the seller is being paid for the work employed to produce the good he/she is selling. From this perspective, money is a representation of labour-time. This idea is not new, and was first explored by Adams Smith in his well-known work "The Wealth of Nations". Such theory, however, was quite simplistic, which is not surprising as it was one of the first attempts to explain trades and money. What is being proposed here is different, and is based on a different understanding of what 'value', 'cost', 'price' are, and their relationship with labour and time. Adams Smith linked the 'labour' needed to produce a good to the value of the good:
Every man is rich or poor according to the degree in which he can afford to enjoy the necessaries, conveniencies, and amusements of human life. But after the division of labour has once thoroughly taken place, it is but a very small part of these with which a man’s own labour can supply him. The far greater part of them he must derive from the labour of other people, and he must be rich or poor according to the quantity of that labour which he can command, or which he can afford to purchase. The value of any commodity, therefore, to the person who possesses it, and who means not to use or consume it himself, but to exchange it for other commodities, is equal to the quantity of labour which it enables him to purchase or command. Labour, therefore, is the real measure of the exchangeable value of all commodities. [...] Labour was the first price, the original purchase-money that was paid for all things. It was not by gold or by silver, but by labour, that all the wealth of the world was originally purchased; and its value, to those who possess it, and who want to exchange it for some new productions, is precisely equal to the quantity of labour which it can enable them to purchase or command.
The idea that labour gives a price to items, or reversely that the price of a good corresponds to the labor required to produce it, was reprised by Karl Marx in his "Das Kapital" where it is introduced right at the start of the book. Value of goods (what Marx calls 'use value'), is measured by the quantity of labour contained in it, that is how much work was required to produce it. The rest of the book equates the 'use value' to the price of goods, leading to a description of the role of money, and in particular of capital, which depicts a class fight between capital owners and labourers. Simply stated, equating the labour behind the production of a good to its price leads to an inconsistency between the price of goods and the pay of workers producing the goods, with the 'surplus' value of the goods (thus the difference between the price of the goods and their effective production costs, which is not reflected in the work employed to produce the good according to Marx's theory of value) going to the 'capitalists', the holders of the capital employed in the company. In Marx's view, capitalists are depriving labourers of their fair share of earnings, which is at the base of the political view derived by this approach. This conclusion is more evident if we use different wordings: the labourer makes a work to produce a good, and is paid a certain wage. The assumption is that the worker's pay is lower than the sell cost of the good: in other words he/she is underpaid, while the 'surplus' is the remaining portion of pay that he should be entitled to because of the work he is doing, but that is being retained from the worker by the capital owner.
First, one should observe that in this, like in many other early works in economics, it is wording rather than maths that matters. As seen above, it is words that give meaning, not mathematical formulae. A worker may be deprived of his own pay, or a capital owner may be payed for the risk he takes and the infrastructure he provides to the accomplishment of the work: what changes between these two cases is how we phrase the sentences. The conclusions we derive depend on our interpretation of what is going on. Above all, the terms of the discussion are once again ill defined. The quantity 'labour' suffers from the same lack of operative definition required in any quantitative scientific approach. Additionally, Marx talks about 'use-value' and 'exchange-value', of 'productive' and 'unproductive' labour: once again, these terms are not operatively defined, with no definition on how to measure them. The same is true for Adams Smith who also distinguishes between two meanings of the word 'value': the 'value in use' and the 'value in exchange'. The first is the value that comes from the usefulness of a good, while the latter is the value that a good has when exchanged. Once again, these definitions are not operative definitions. Indeed, the theory of value has been largely dismissed by almost all economic schools. The problem with the above is that both Smith and Marx were searching for quantities that could be equated as in a mathematical equation. Once you have an equation, you can build equilibrium theories: that however does not grant that these theories are correct, if your first equation is wrong.
In our thought experiment, we learned that an individual uses his time at his discretion: he/she can use time to build staff, to rest, to grow crops, to fish, and he can exchange some of these things with those of other individuals. In this exchange the taker is the one who gains a product without having spent any time on its production, while the giver is the one providing the product. When someone provides a product, he is effectively providing the time that was required to produce it. The person acquiring the product is effectively discounting the time that would have been needed to him to produce it. When the taker gives something in exchange (food, furniture, money...) for a good, he/she is compensating back the giver with time that he (the taker) used to produce the product that is providing in exchange for the good. For instance, the taker might buy a jar of jam and provide some cheese in exchange. The twos are products that costed time, and thus what is being exchanged behind the scenes is the time needed to produce them. If the jar of jam is being bought with money, this money was earned through work, and is being given in exchange for the jar, thus the work that was required to produce that jar of jam. There is no law, however, that states that the two must equate: I can give my time for free, for instance because I consider it a charitable action, because I am given back something that is valuable to me: the time spent on a task does not correspond to its 'exchange value' or price as Smith and Marx suggested. When I spend time to produce something, that does not mean that you will have to pay me that time. You will pay me what you think my time is worth. If I set a price for my produce, you will buy it if you value it more than what you need to give me in exchange.
The reason why I am insisting on considering time and productivity as fundamental quantities is that, in terms of operative definitions, time is a well-defined quantity, as we can measure it using a chronometer. Productivity also is well defined, as it is the amount of goods produced per unit of time. We may consider the person's productive time as the basic form of money, what is ultimately exchanged between individuals when they trade. I have not yet specified what 'productive time' is, but I will later on. For the moment, we can understand 'productive time' as the time used to produce a good, or to provide a service. When someone uses his/her time to work on a good, then the 'cost-value' of the good is the time spent on its production. This is not the value of the good, nor the 'labour' which has no clear definition (in economic terms), nor its price. The 'price' of the good will be determined by the demand for the good on the market (of which I will have to discuss in more detail in a subsequent article). The 'value' of the good is personal: a person will buy the good when he values that its price (thus the amount of his own time that is needed to buy it) is lower than the value he is willing to exchange to get the good (the amount of time he is willing to pay). The fact that we are here in the presence of an inequality makes things more complex, and not easy to handle if we are stuck to equilibrium theories. That is probably why Economics has not embraced approaches alternative to neoclassic theories, as they would have been too advanced with respect to the typical mathematics used in economics.
It is important to realize that the fact that some work was required to produce some good does not make that good equivalently valuable, that is sellable at a price commensurate with the work employed. A very simple example would be someone filling a water pool by pouring glasses of water: the fact that it takes three full days to fill the pool, does not make it more valuable than someone achieving the same goal using a hose! Karl Marx does warn that we should compare work from same-skilled equivalent individuals, but this once again is a shaky definition of labour. Considering a more sophisticated example where we use money, to which we are more familiar, let us suppose that a person spends 2 hours of work to hand-craft a nail: that would be then its cost. If the person is a renown high-level manager earning $200 per hour, and he has moved from his job to build nails, then he might want to price the nail $400. That should be compared with a $0.02 nail that one can buy in a local department store. The price asked would be $400 if the person wants to be compensated for renouncing to a $400 pay of two hours of managerial work for each nail produced, but there is no rule that sets the ask price. If he really wants to build nails and earn from it, then he must either find clients willing to pay $400 per nail (thus clients who 'value' his nail at least $400), or reduce his hourly pay to at least $0.02 per hour. Alternatively, he should invest into instruments that allow for a higher production rate, which would reduce the production time per nail from two hours to a fraction of a second.
There is one thing that is essential to point out: innovation is an important ally, as it allows to produce staff and instruments that increase our productivity. Such increase frees time for us that we can use to produce more staff, to be safer and more relaxed. When we need less time to produce staff, it means that, with respect to our 'time currency', production costs decrease, which typically means that prices decrease. In terms of 'time currency' an economic system is naturally deflationary thanks to innovation.1 Whether this translate into a deflationary system in terms of a real currency (dollars, euros, gold, etc) is yet to be understood, and we will discuss this in another article.
- This is true to some extent. Take the case of extracting minerals: as minerals become harder to extract, more labour is needed, thus cost goes up. Innovation counters this, by increasing productivity: however, the resulting product decrease in price only if innovation can outpace the increase in difficulty to extract minerals.
