21st Century Economics -- Part 3

What does value mean to you?

How do you define value?

How does our culture define value?

What are the most valuable possessions in your life?

What are the most valuable experiences in your life?

I answered these questions for myself recently, and my responses had me thinking about how value is quantified in the marketplace by pricing goods and services. This of course led to more questions, most of which I won’t bore you with. But there is one question I want to discuss:

Are prices an accurate reflection of value?

The anatomy of price isn’t too complicated. A given commodity is produced at a cost to the capitalist who owns the means of production, and the capitalist sells the commodity at cost plus whatever profit he can get away with in a competitive market. When you add sales tax to the picture, you have a rough equation of price: production costs + profit + taxes = price. It’s pretty simple, maybe too simple.

Price is the most universal and influential market signal in the economy. At the most fundamental level, price is simply value quantified. And participants in a money-based system of trade depend on price to assess relative value in the market. As such, prices must accurately reflect the true costs of production in order to properly inform the decisions of consumers.

To illustrate what I’m describing, here is a concrete example (it’s a bit unrealistic, but bear with me):

Let’s say you go to a market to buy shoelaces, but when you find some, you notice that they are more expensive than a new pair of shoes in the next stall. You immediately conclude that either the shoelaces are overpriced, or the shoes are underpriced, because the shoes are clearly more valuable than the shoelaces, and prices should reflect that. At the risk of pushing this example too far, let’s assume that you do a little more comparison shopping to gain more information about average prices of shoes and shoelaces.

You go to another market and find that with a few exceptions, the shoes at the second market are more expensive than the pair you saw at the first market. But when you look at the shoelaces, you realize that all of them are less than half the price of the ones at the first market.

Now you have a picture that makes sense -- you have found prices that reflect relative value more accurately, and you buy the cheap shoelaces at the second market. I know this example was a bit tedious, but it shows the kind of rational self-interest that lies at the heart of the free market system, and it demonstrates the importance of price as a market signal that informs the decisions of both consumers and producers.

Understanding the Power of Price

Understanding the pricing mechanism (i.e. how prices are assigned) has always been an essential principle of economic theory.

The early political economists of the 18th century observed that price performed a vital function within the capitalist system. They saw that flexible prices maintain a fairly stable balance between supply and demand in the market – high prices ration scarce goods and low prices prevent excess supply. This was a perfectly logical and accurate conclusion. And like any good idea, it was refined by those that followed.

In the early 20th century, for instance, the trust-busting of the Gilded Age was aimed at encouraging competition in the market to prevent price gouging by monopolies. This is an important example of necessary government intervention in the marketplace. Child labor laws, occupational safety, minimum wages, etc. were also necessary interventions. So clearly, government has a crucial supervisory and regulatory role to play in the market. We don’t want a completely laissez-faire economic policy. But that is essentially what we got during the Reagan/Thatcher consensus of the 80s.

For the market fundamentalists informing their policies, price was seen as the ultimate regulator of the market. Little else was needed to regulate the market: so, if the price of oil rises, so too does the incentive to produce more or compete by offering alternatives. In this way the market was always checking itself through competition among businesses and a capitalist economy was seen as a self-regulating system. This thinking became very influential in the 70s and 80s after Milton Friedman won the Nobel Prize for Economics in 1976.

From then on, he and other Chicago School monetarists guided U.S. economic policy toward less regulation, monetary management of business cycles by the Federal Reserve (rather than fiscal management as Keynes suggested), and lower business taxes. At the same time, largely unfair international trade was rapidly expanded through the Structural Adjustment Programs of the World Bank and IMF which opened much of the world up to foreign investment and foreign imports.

It's been called neocolonialism, neoliberalism, and (a little less accurately) globalization; it's even been sugar-coated as free trade! To call the institutionalized exploitation of people and the destruction of the planet 'free trade' is truly to enter the realm of Orwellian doublespeak. We can sugar coat it all day long in the rich world to make ourselves sleep better at night, but globalization has been a jagged little pill to swallow for the poorest in the world. And that's putting it mildly.

I found my rose colored glasses.....finally!

If there is a silver lining in the current economic carnage, it’s that these neoliberal economic policies, introduced to America and the world during the Reagan administration, have at last been exposed for the fraud they truly are. Any pretense that we live and work in a free market has been smashed by a nauseating series of “too big to fail” bailouts. This is corporate welfare on an unprecedented scale.

For the past few decades, the government has privatized corporate profits, while socializing corporate risk. And the whole time our leaders (Republican and Democrat alike) chanted the tired mantra of Milton Friedman and his Chicago School cronies: 'de-regulation and free trade will lift the world out of poverty'--as if these policies were designed to help sub-Saharan Africans or the American taxpayer!

Recent history is our best teacher. Undermining our trust in the guidance of capitalism's venerated 'invisible hand' was the economic reality that average real wages for the American taxpayer were stagnant while the tax codes became increasingly regressive. A glance at the world's news headlines brought home the tragedies of an entire continent crippled by the AIDS pandemic and the predatory lending practices of the World Bank and the IMF. We watched in utter powerlessness, as free trade put millions of small farmers out of business throughout the so-called 'developing world' by exporting the cheap, subsidized cash crops of Europe and North America, thus undercutting the price of local produce in places like Mexico.

This is the ugly side of unregulated economic globalization--speculative bubbles on Wall Street and Main Street, a widening gap between rich and poor, and the transformation of rural, semi-autonomous peasants into urban proletarians beholden to the mercy of unfettered capitalism. In the urban context, these farmers suddenly find themselves without any marketable skills and they are forced to join the ever growing population of unskilled workers.

As the ranks of the urban working class swell around the world, there is a race to the bottom in poor countries in terms of working conditions and wages. The labor market is over stocked and competition is fierce. At the other end of the supply chain, the average Wal-Mart shopper is comfortably oblivious and well insulated from these realities.

So, Wal-Mart shoppers, why the comfortable oblivion?

Why do we continue to delude ourselves about the impact of our consumer choices?

Could it really just be down to those rock bottom prices?

In a word....YES

Pickin' on Wal-Mart....again....cuz they deserve it!

In their single-minded pursuit of their corporate responsibility to keep their shareholders happy, Wal-Mart has found the perfect business model for our time: great quarterly profits with no accountability. Wal-Mart understands that for the average consumer, price is the bottom line when making a purchasing decision. All things being equal, we choose the lowest price. That’s why people still shop at Wal-Mart. Everybody knows that their standards ethically and ecologically inferior to those of most local businesses. But the products are roughly equivalent and MUCH cheaper.

Most importantly, when you walk into Wal-Mart, the heavy problems of the world are conveniently out of sight and out of mind. You aren’t stumbling over an under-fed child laborer busy sewing the seam into your new blue jeans on your way to the check out line. And you don’t have to breathe the air in downtown Shanghai as you push your giant cart around either. That’s the genius of Wal-Mart’s business model!! They have zero accountability! They can exploit people and the environment without paying for it!!

This is the glitch in the system: corporations are allowed to externalize environmental and social costs and therefore prices lie.

What if consumers were aware of the full costs associated with producing the goods they buy?

And what if producers had to purchase the right to use our ecosystem services?

What if they also had to pay living wages to their employees, even in China?

Imagine an economy that fully accounted for the value of our planet and its people -- do you think buying a happy meal would cost more or less in that economy?

There is clearly much of great value that is simply not priced into the market. Think of all the things we depend on our ecosystem for:

-- natural resources including fossil fuels, soil, metals and minerals

-- climate stability via natural carbon sinks such as the algae in the sea and the trees in the forest

-- biological diversity

-- the food we eat, the water we drink and the air we breathe.

These are some of the essential services our ecosystem provides for free. Taken together, the ecosystem services support our very livelihood as a species. Without a functioning ecosystem there is no economy.

So if economists love numbers so much, why haven’t they slapped a price tag on these vital ecosystem services? The easy cop-out answer is that they’re priceless. But the truth is that they’re not priced because you can’t make money buying and selling them. They belong to every living being on the planet, so private property laws simply don’t apply. And as a result, these vital services are invisible to the market.

You can’t own climate stability, but unfortunately you can own a dirty coal-burning power plant that robs it from future generations. This is what is broken. This is why price is not a good enough regulator. Until we figure out a way to price the damage we’re causing to our own life support system, we cannot depend on price to guide markets effectively.