Value theory lies at the heart of economics. Behind every production process, every exchange of goods, every purchase, every choice agents make, is the concept of value – value is the essence of economics. Thus any coherent overall economic paradigm is going to need a formulation of economic value and how we define value will be of critical importance in the formation of any economic paradigm. A reconception of economic value will lie at the heart of any reformulation of standard economic theory. In this article, we discuss the basics of economic value by looking at the two primary approaches to its formation; that of the subjectivist theory of value and that of the objectivist theory of value. We will try to answer the question as to the foundations upon which each bases its derivation of value. We will then go on to analyze the advantages and disadvantages of both approaches before drawing conclusions about the potential for advancing our current formulation of economic value theory beyond its existing limitations.
Economics, in its most abstract sense, may be understood as the study of the relationship between human means and ends. That is to say how people use efficient means to achieve their valued ends. As L. Robbins defined it “economics is the science which studies human behavior as a relationship between ends and scarce means which have alternative uses”
As economics is about how we allocate our valued resources – in production, exchange or investment – in order to achieve more of whatever it is we value – whether this is for the individual or for whole societies – this concept of value is all pervasive within economic activity. Behind every aspect of economics and economic activity will be the idea of value in some form. People do things, and thus involve themselves in economic activity because they wish to attain the things they value, where we are using the term value in a very generalized sense. Thus any effective economic paradigm is going to have to have a coherent understanding of what is meant by this term value.
Instrumental and Intrinsic Value
More broadly the concept of value is a very fundamental concept within the social sciences and is of major philosophical importance. As such any formulation of economic value will exist in relation to a broader philosophical discussion about the nature of value. Thus it is important to have at least a general understanding of this more general conception of human value.
In philosophy, a basic distinction is often made between what are called intrinsic value and instrumental value. The concept of intrinsic value can be defined as what is valuable for its own sake, as an end in itself. By contrast, instrumental value can be defined primarily as what is valuable as a means to achieving some desired end. Something is considered to have intrinsic value when we value it in some way for its own sake. These are things that are pursued for their own sake, not to acquire something else. Things like happiness, truth, and beauty are often considered intrinsically valuable. You don’t need a reason to pursue truth; the fact that truth is good in itself is enough.
In order to turn a philosophical debate – where we are talking about the absolute nature of reality – into a practical economic discussion – where we are talking about human means and ends – we can define the distinction between intrinsic and instrumental value as existing on a spectrum. Identifying something as having purely intrinsic value or as having purely instrumental value would seem rare, most of us identify most things has having some of both as existing on a spectrum between the two. We don’t take a hammer and smash up our cup because, firstly we might like to drink out of it in the future – instrumental value – but also we would feel that callously destroying a cup for no reason is a waste, and this comes from the fact that we think that the cup has some inherent value irrespective of whether we want to use it or not. Likewise, we might think of friendship as being intrinsically valuable but friendships also involve elements of instrumental value.
In the same way that pure altruism or pure egoism may be seen to be virtually impossible, pure intrinsic or pure extrinsic evaluation may be purely theoretical when in practice elements within value systems exist on some spectrum between the two. When we go to the instrumental value end of the spectrum we are talking about the value that something has in its capacity to enable us to achieve some desired end. When we go to the intrinsic value end of the spectrum we are talking about the value that something has in its relation to a whole system or environment that is independent of our immediate requirements. On this more practical level, we of things like community or truth not for the immediate utility but because they are necessary to maintain the whole social or cultural context.
The distinction is between those things that have immediate utility in satisfying some desire or goal that we have, and thus we ascribe utility to them, and those things that do not have immediate value in fulfilling some goal we have, but we recognize their value as part of some larger system of organization. Such a system, like the environment as a whole, or society as a whole does not have an immediate need in fulfilling our current goal but it is still required to support it in the long run.
This more philosophical discussion surrounding value feeds into the formation of value within economics through the concepts of subjective and objective value, that have developed over the course of centuries of discourse within economics. A full discussion of the subtleties of this history is beyond the scope of this paper. But the history of economic theory is full of struggles to establish the meaning of value; what is it and how it can be measured. This goes all the way back to Aristotle first distinguishing between value in use and value in exchange and follows a long history of economic thought through Classical economics, Marxism, the Marginalist Revolution and Neoclassical thought.
The essence of this discourse is the long since noted fact that the value of some economic good can be formulated in terms of the resources that are required to produce it, or in terms of its utility with respect to some economic agent, and this two different derivation certainly don’t always correspond to the same outcome; quite the contrary in fact. This subjective theory of value is where value comes from its utility to some economic agent clearly corresponds to instrumental value. The value of something is relative to people perceiving it as of utility in achieving their valued ends. Inversely the objectivist view of value is based more on the intrinsic conception of value, in that value is deemed to exist independent of people’s subjective evaluation of it. In this paradigm, the value of an economic good is not seen to exist in its capacity to fulfill a human desire but instead it is derived from the resources that were required to produce it.
The classical economists searched for a conception of value in an absolute objective sense seeking a standard physical commodity unit for measuring exchange value. This derivation of value ran into difficulties that were made most explicit in the so-called diamond–water paradox. The paradox observed that while water has infinite or indefinite value, being necessary for life, its exchange value is low; yet unessential diamonds, being of little use in the support of life forms, had a very high exchange value. Added to this one might come across a diamond one day walking along the beach, thus creating a huge amount of economic value without any work input. The classical economists, such as Smith and Ricardo, could not resolve this paradox using their labor theories of value. It was resolved only by recognizing the importance of utility and scarcity in determining exchange values, and the role of margins in value determination. While the classical theorists sought a standard physical commodity unit for measuring exchange value, neoclassical theorists did not need such a commodity. The Marginalist Revolutions set the stage for the subjectivist theory of value that has become dominant ever since and forms the default conception of economic value that we inherit today.
The foundations for defining an economic good and value within the subjectivist framework were laid down by Carl Menger. Menger stipulated a number of prerequisites to defining an entity as an economic good and thus having value within the economic system. A good – in the general sense – is something that is in a causal relationship with human welfare. However, within the subjectivist theory of value, a good has to satisfy a number of conditions before it becomes an economic good and thus has economic value. Firstly an economic good must satisfy some human need, desire or want. A grain of sand at the bottom of the ocean is not considered an economic good because no one requires it to fulfill some need or desire that they have. Secondly, it must be clear to the actors that the good is the cause or means of achieving the desired end. Thirdly the good must be controllable by some economic actor and in that control it can be owned by some agent. Thus the galaxy is not considered an economic good because it can not be controlled or owned by humans as yet. Thus private property lies at the heart of this conception of value. Fourth, the good must be scarce. There must be a relationship between needs and available supplies, such that needs are greater than supply; there is always more demand than supply of the good.
Subjective value is a relation it is not something that is inherent in a good. It is a relationship in which some economic good stands in relation to some other economic good and relative to some person that has to choose between them. The cause of subjective value is always a choice made by human beings, that is the most fundamental thing we can say about subjective value. Value reflects the choices that we make as such it is fundamentally anthropocentric in nature. Value is thus a result of the expressed tastes and preferences of persons, and the limited means with which objects can be pursued. As a result, the scarcer the object of desire is, the greater its value will be on the margin.
While value is an abstract concept, the actual measurement of value requires some objective measure of the degree to which the thing improves pleasure, well-being, and happiness. In order to ascribe a ranking metric to the value of something the subjectivist use the idea of demonstrated preference. Meaning the utility of something is revealed in the demonstrated choices that people make in choosing one thing over another. When I choose an apple over an orange I am revealing that I value the apple more than the orange.
The theory of extrinsic value posits that value cannot be measured or observed directly. So instead, economists devised a way to infer underlying relative utilities from observed choice, called ‘revealed preferences.’ The economist Alfred Marshall put it like this: “Utility is taken to be correlative to desire or want. It has been already argued that desires cannot be measured directly, but only indirectly, by the outward phenomena to which they give rise, and that in those cases with which economics is chiefly concerned, the measure is found in the price which a person is willing to pay for the fulfillment or satisfaction of his desire.” As value was assumed to be determined by the utility on the margin, and consumers were assumed to allocate money optimally across their options, the marginal utility of money was the same for an individual in all its uses. Money thus became the standard unit of measure.
Exchanges between economic agents then come about because of differences in subjective evaluation. If one person exchanges an apple for an orange then the person must value the orange more than the apple, and inversely the person who they exchange with must value the apple more than the orange. Thus exchange of value takes place when there is an inverse ranking of goods under consideration by the agents involved in the exchange. The good must be appreciated by the buyer more than the seller and the seller must appreciate whatever it is they exchange the good for more than the good itself.
An intrinsic theory of value, also called the theory of objective value, is any theory of value in economics which holds that the value of an object, good or service, is intrinsic or contained in the item itself. In such a paradigm value is not seen to be contingent on any given subject’s demand for it but instead is in the role that it plays within a broader system. Most such theories look to the process of producing an item, and the costs involved in that process, as a measure of the item’s intrinsic value. As such they are looking at a good’s value in terms of its interaction with a nexus of social, industrial and ecological systems. The labour theory of value is one such example of an intrinsic theory that was originally proposed by Adam Smith and further developed by David Ricardo and Karl Marx.
The labor theory of value propounds that the economic value of a good or service is determined by the total amount of socially necessary labor required to produce it, rather than by the use or pleasure its owner gets from it. In Adam Smith’s Wealth of Nations he writes “The value of any commodity, … 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 labor which it enables him to purchase or command. Labour, therefore, is the real measure of the exchangeable value of all commodities.”
Another similar example of an objective theory of value would be that of the Physiocrats who based their theory of value in the land. The Physiocrats were a group of 18th-century French economists who believed that the wealth of nations was derived solely from the value of “land agriculture” and that agricultural products should thus be highly priced. This is in contrast to the earlier schools of thought called mercantilism. Whereas, the mercantilist school of economics said that value was created at the point of sale, by the seller exchanging his products for more money than the products had “previously” been worth, the physiocratic school of economics recognized labor and land as the primary sources of value. Thus we can see the interplay between subjectivist and objectivist theories of value go all the way back to the origins of modern economics.
A more recent example of an objectivist theory of value would be that of ecological economics. Ecological economists tend to believe that ‘real wealth’ derives from the value inherent in ecosystems, which can be best understood in terms of thermodynamics and free energy – what is called exergy. An energy theory of value posits that, at least at the global scale, free or available energy from the sun is the ‘primary’ input to the system. Labor, manufactured capital, and natural capital are ‘intermediate inputs’. Thus they are basing their theory of value on physical constraints and the laws of thermodynamics, something has value in its relation to other physical systems and the total supply of free energy. Which can be said to be an objective system independent of human evaluation, and thus an objective theory of the origins of value.
Objective theories of value base value on some objective organization. The value is derived from the resources it takes from that system in order to produce the item. So a tree has intrinsic value within the context of a forest ecosystem – in that removing that tree would degrade the functionality of the entire ecosystem – and this would be called natural capital. Friendship and family bonds have intrinsic value as part of a functioning society and this would be called social capital. These objective forms of value may or may not have immediate utility to someone, but they are typically required to maintain the overall functioning system, whether that is the ecosystem, society or culture. Things have an objective value in forming part of and maintaining processes within these broader systems.
We will now try to make an assessment of some of the achievements and limitations of each formalization of value, starting with the subjectivist value theory. The primary advantage of the subjectivist theory of value is firstly its simplicity and elegance. It is nice and clean, well formulated and consistent in many ways. The challenge of getting an objective price for some entity in a world full of people with different opinions on the value of things is not an easy one, but through the concept of utility, revealed preference and the interaction of utility functions, subjective value theory does a very elegant job of deriving a price metric for things. Subjective value theory works in many ways both on a theoretical level and on limitations as it defines much of the workings of our economies on a daily basis.
As illustrated by the diamond–water paradox the subjective theory of value captures a central part of economic reality, the fact that people value things based on their own interests and that there is scarcity, are both clearly critical factors in determining the value of something. However, after many decades of economic policy built on neoclassical conceptions of subjective value its limitations are also becoming apparent. The subjective theory of value results in a formulation of the economy as a closed system in that it does not account for anything that does not have immediate utility for an economic actor. This creates many problems because in reality economies are never closed systems that exist in a vacuum.
An economic system exists as part of a larger system, social, cultural and natural environment, it is embedded within these larger systems and every economic interaction involves some element of these. The economy is supported by a vast heritage of natural capital – such as clean water, sunlight, oxygen – which stays providing the conditions for the inflow of natural resources. Whereas in a previous age when these may have seen infinite, today it is becoming more apparent that they are finite and we are increasingly looking for means to quantify and integrate them into market decisions.
Likewise, an economy is embedded within and dependent upon a massive nexus of social and cultural institutions that are required for it to function effectively. More recently we are starting to recognize that institutions are critical to the functioning and success of economies – the comparison between North and South Korea being an often cited example of this. Equally, we are increasingly starting to look at organizations less as the machines of the Industrial Age but more as social entities. This value that is in social bonds that enable trust and frictionless exchange is called social capital and the economy benefits all day, every day, from huge complex networks of social capital that go unaccounted for.
The net result of using a subjective theory of value and thus defining the economy as a closed system is that it is then necessary to have a supporting framework of government institutions to account for intrinsic value that has been excluded, but is still required to support the system. A formulation of the economy as a closed system, when in reality it is, of course, an open system, inherently creates externalities – both positive and negative – that then have to be managed through alternative means, namely public institutions. This creates a strong dichotomy within the system and much friction between the two management framework that run on different principles. A full elaboration of the consequences of this would take us into a discussion on the free market, state, and globalization that is beyond the scope of this paper.
Likewise, a subjective theory of value inherently results in a focus on consumption, exchange, and finance, because these are what are really being measured and what gets measured gets managed. The result is an economic system that is focused on exchange. When we take this to its natural conclusion we get financialization, where we turn commodities into financial instruments and then create value by exchanging those instruments in a financial system that becomes divorced from any real economic activity. Likewise, another result of subjective value theory is that we get metrics for value such as GDP, that simply tell us how much is being exchanged and consumed, without telling us anything about people’s quality of life. So things like natural disasters that induce more production, exchange and consumption are ultimately recorded as beneficial when they are clearly detrimental to people’s quality of life. This misalignment of what we are measuring and what people value has become more apparent in recent years and one of the criticisms leveled at standard economic theory.
An objective theory of value puts forward an economic paradigm that is inherently open, in that it recognizes the value of other systems in relation to the economic sphere. In ascribing value to things in relation to a broader social or natural environment it identifies the economy as interacting with other systems and the inherent value of those other systems. As such, an objective theory of value would play a central role in any form of full cost economy, where all forms of value are accounted for. Thus in contrast to a subjective formulation of value that appears inherently unsustainable – in that it does not account for its supporting system – an objective value system could potentially be the foundations of a sustainable economy, one that recognizes and manages natural and social capital as endogenous factors, not exogenous factors for public services to manage. In an age of globalization and sustainability when public management of natural and social capital is appearing limited, this has been already identified by many as a key part of developing a sustainable economy in the form of the triple bottom line, natural capital accounting etc. In this sense objective value theory is accounting for the whole not simply what individual economic agent may value. Accounting for the whole – thus mitigating negative externalities that are so prominent in a standard theory of value – would appear the only long term sustainable solution.
Likewise, whereas the subjective theory of value is limited in its capacity to tell us about the overall quality of life that the agent’s experience, an objective theory may well be able to complement this to come closer to connecting our formulation of economic value with what people experience as real quality of life. The subjective theory of value tells us about the exchange and consumption of goods, it does not tell us about the quality of the social, cultural or natural environment within which agents exist. Thus actors can end up living in a severely degraded social, cultural and natural environment – which significantly reduces their quality of life – while still, the economy is churning through vast amounts of resources so as to make up for this, and our metric would still tell us that the system is in an optimal state. This situation is again another critique that is often leveled at standard economics and the role it has played in the formation of a so-called consumer society.
An objective theory of value is a metric which captures this overall value of the context within which agents exist and thus this intrinsic conception of value is closely related to what we would call well being. Well-being is a very complex phenomenon. The value that it represents is a distributed one. Well-being is not the property of a thing, as illustrated by ample evidence that increases in consumption only correlate to increase in well-being up to a certain level and then they become uncorrelated. Well-being is what emerges out of forming part of or having access to many different services, ecosystems services, industrial services, social and cultural etc., but it is also in contributing to those systems, co-creating value within them. The value that emerges is a complex interaction of different forms of capital. A much more sophisticated conception of economic value would be required to capture this more subtle phenomenon of well-being. But there is clearly a growing demand from society that economics move in this direction, to be better able to provide metrics that reflect people’s lived experience and the incorporation of some form of objective theory of value would be required to achieve this – as a subjective theory of value is clearly limited in this respect and requires a compliment.
In contrast to a subjective theory of value that appears inherently simple and elegant the implementation of an objective theory would be quite the opposite; inherently complex. The idea that objective value could be defined simply in terms of the physical work that went into the production of an item is clearly not plausible. A proper formulation would require accounting for, natural capital, social and cultural capital. The net result would be a complex network of variables – a move away from the contemporary homogeneous metric of value – required to come close to any form of objective value. This would require significant amounts of information, modeling, and computational capacity.
This being said we already see these new value metrics emerging in the form of social impact bonds, natural capital accounting, green bonds, fair trade, carbon tax, full cost accounting, carbon markets, triple bottom line etc. However as successful as these initiatives are, they are only fledgling, and hardly come close to a viable framework for the full complexity of an objective theory of value suited to a high-tech global economy of the 21st century. The formulation of an objective model to value and its practical implementation within a coherent framework is still a huge challenge in front of economics if it wishes to expand beyond the limitations of a subjective theory of value that currently confines it.
This article has been an overview of the basic theory of value within economics. We started with a broad overview of the more general philosophical discussion of value by talking about instrumental and intrinsic value, in order to try and illustrate how these basic concepts relate to standard economic formulations of value. We outlined the two primary formulations of value as that of subjective and objective value theory and where these frameworks derive their foundation for the conception of value from. We talked about the subjectivist theory as deriving value from the utility that a subject places on an item in achieving their valued ends. While the objectivist theory defines value in relation to objective systems of organization and the resources that are inputted from those systems in order to generate the item. We outlined the achievements and limitations of each framework, noting the simplicity and elegance of the subjectivist framework but also its limitations in not accounting for all the resources required to maintain an economy and thus its inherent tendency towards externalities, unsustainable results and its requirement for external support through public institutions.
Likewise, we saw the inherent complexity and difficulties engendered in a true objectivist theory of value, but the potential it offers in enabling a full cost, self-supporting economic framework, that factors in and can potentially manage its full set of required resources in a sustainable fashion. What makes this such a relevant debate at the turn of the 21st century is a combination of both changing societal values/perspective and new technological means. A new paradigm to our global economy is emerging as industrial economies transit into post-industrial services economies; as the reality of environmental degradation becomes apparent and as globalization stretches and challenges the existing national institutional infrastructure. These major trends are driving a new vision and conception of what people value and making apparent the limitations of our existing theory of value grounded in a subjectivist model.
These major trends are combining with new technological means. What has changed with respect to our technological means is that with information technology we have for the first time the capacity to actually access and process a large part of the data required for such an initiative. Big data, IoT and advanced analytics will give us the means to sense and quantify our world like never before, the challenge is to make sense of this data. To build models that enable the economic theory that runs our global economy to reflect the underlying reality and thus enable us to manage it more effectively.