A post yesterday on the admirable Mises Institute website showed that economists, and many others, continue to be baffled by the difference between value and price.
Peter St Onge, an assistant professor at Taiwan’s Fengjia University College of Business, wrote that what people are paid – the price they sell their labour for – fully reflects its value.
“…the money you earn actually indicates that you’ve contributed to the world,” St Onge writes. “More money means more contribution.”
The post drew critical comments from some Mises Institute website readers, but praise from others.
It suggests that the economics profession is still tormented by questions about the difference between value and price.
You can argue this debate started with Aristotle who considered the ethical implications of buying and selling things. His conclusion was that price was misleading and that the virtuous needed to look beyond the amount paid and received for a good or service to understand the “real” value of what was being bought and sold.
But what the value of a good or service actually was challenged the world’s greatest thinkers for thousands of years.
Jewish, Christian and Muslim intellectuals argued that those seeking God’s favour had to consider more than the market price when they bought a good or service. But how could “real” or “true” value be measured?
Some thinkers argued that value was not fixed or embedded in a good or service. It was in the eye of the beholder. If someone thought the price being asked for a good or service corresponded with the mental picture of what he or she thought the good was worth, then the price accurately reflected value. So long as there was voluntary exchange, price and value were necessarily identical.
Others seeking a “scientific” way of measuring value said: no, there is an inherent, intrinsic and objective value to everything that could be measured. These included Adam Smith and David Ricardo who argued that labour was the sole source of value in goods and services. Logically, you could calculate the “real” value of everything by calculating how much work went into making it.
This debate ended in the final part of the 20th century when economists argued that, in an environment of free and voluntary exchange, price captured all the subjective and objective information anyone needed to make the right decision about production and consumption, saving and investment and buying and selling.
Price became the master of economics, though economists continued to ponder whether it always and everywhere measured value. Critics of free markets argued that market failure of various kinds meant value and price could be different. They also said it was possible for individual transactions to be optimal, while the “social” outcome could be sub-optimal.
The argument made by Mr St Onge that price always properly measures value is therefore open to attack from Keynesians and others that believe market failure and irrational behaviour are pervasive.
People that aren’t economists might also say Mr St Onge is suggesting that a mother with young children who could earn $20 an hour at work and pay $10 an hour for childcare would always be right to contract out parenting to a childcare specialist.
But even within the framwork used by followers of Von Mises’ tradition, the St Onge argument is defective when you deal with intangibles, or services.
Intangibles by definition have no physical characteristics. So how can the rational person be confident such things even exist?
Of course, they form a subjective view of what they are and their value.
But how can someone manufacturing a service secure a sale?
They can hope that others will perform a similar mental exercise and conclude that what they believe is being offered is worth the amount they are prepared to pay.
But anyone producing a service will know that the buyer needs constant reassurance that what customers are paying for is what they want and that the actual delivery of the service meets customers’ expectations. Suppliers of services must constantly reassure buyers that something that can’t be measured is worth the amount being paid.
In services, the relationship is critical.
If a pupil dislikes or distrusts a teacher, he or she is unlikely to want to pay in money or time for being taught by that person, no matter how technically competent the teacher might be. The same goes for doctors, dentists, lawyers, financial advisers and consultants.
In services, the relationship between and among the parties to a transaction determines the amount of value that is created and how much people are prepared to pay for it.
That relationship becomes more productive over time. To ensure that the relationship strengthens, all parties to service transactions will need to ensure that the value they create is fairly shared.
Without that, the voluntary principle supporting such transactions will be undermined.
In services, the price paid mainly reflects the strength and weakness of the relationship between and among the service value creator and beneficiaries. That is because the condition of that relationship critically determines both how much value is created and how it’s shared.
And it can happen that people co-creating value attach so much importance to the relationship they share and support that they agree no payment should be made. This is what happens every day in every functional family group. The value creation is enormous. But no one’s paid a thing.
Price, therefore, is misleading when you are dealing with services. I hope Mr St Onge appreciates this point.