Mark Easton. BBC, "ONS well-being report reveals UK's happiness ratings," July 24, 2012.
Since the 1870s, economists have agreed that value is subjective, but, following Alfred Marshall, many argued that the cost side of the equation is determined by objective conditions. Marshall insisted that just as both blades of a scissors cut a piece of paper, so subjective value and objective costs determine price...But Marshall failed to appreciate that costs are also subjective because they are themselves determined by the value of alternative uses of scarce resources.
When a local government bans large servings of sugary drinks at restaurants, there is an implicit claim that the government officials have calculated an objective value that is more appropriate than the subjective value.
The doctrine that all value is subjective raises some important issues. It appears to create a bias against government intervention. Therefore it may explain the correlation between the methodological outlook of Austrian economists and their typically libertarian policy orientation. Put another way, do non-Austrian economists believe that value can be calculated objectively, and are such calculations important for interventionist policies?
When an individual arrives at a decision, to what extent are the costs and benefits of that decision measurable by an objective expert who is not involved in making the decision? One could argue that perhaps the detached expert will be more informed than the individual. However, what I am calling the doctrine of subjective value says that the detached expert is less informed than the individual.
For example, suppose that my spouse and I are considering whether or not to have children. A social scientist in the field of happiness research reports that couples without children are, on average, happier than couples with children. Does this tell us that we should not have children?
As another example, suppose that I am deciding whether or not to give a raise to an employee. A social scientist in the field of human capital research reports that, based on the correlations between earnings, education, and experience, the productivity of my employee is expected to be 10 percent higher than his current wage. Does this tell me that I should give the employee a raise of 10 percent?
In these examples, I think that an Austrian economist could make a fairly convincing case that the decision-maker is likely to have knowledge that makes the expert's research close to irrelevant.
In the case of deciding whether or not to have children, even for the people surveyed, the researcher does not know whether the couples with children would be happier without, or vice-versa. It could easily be the case that there are some couples who, whatever their level of happiness, are happier with children than they would have been without. Could my spouse and I be in that category? There is no way for the researcher to know.
In the case of deciding how much to pay the employee, the researcher also is likely to lack important information. As the employee's manager, I know much more about the value of what the employee contributes than the researcher who knows only the worker's education and experience. I can observe how well the employee actually uses his education and experience on the job. This is an example of what Friedrich Hayek would call local knowledge.
For over one hundred years, various commentators have hoped that social scientists would in fact develop sufficient knowledge to provide expert guidance in economic decision-making. Recently, for example, the United Kingdom Office of National Statistics issued a report on happiness data. A news story by the BBC quoted Glenn Everett, the project's director, as saying, "Understanding people's views of well-being is an important addition to existing official statistics and has potential uses in the policy making process and to aid other decision making."1
The case for government intervention in economic decision-making would appear to depend on two prerequisites. One is that government experts have knowledge that individuals lack. In addition, simply having government experts communicate their knowledge must be insufficient: stronger government action is required because otherwise people will not act in accordance with the knowledge made public by experts.
A classic example might be air pollution caused by a particular type of gasoline. As an individual, I lack the expertise to evaluate the cost of this pollution. Moreover, even if I had this knowledge, I might not worry about the cost, because it will largely be borne by others. In this example, both prerequisites for government intervention are satisfied. (An Austrian, however, could argue that all we know is that there is some component of the cost of gasoline, associated with pollution, that individuals do not take into account. The exact measurement of the cost of pollution requires subjective determinations that are beyond the capabilities of even an expert scientist.)
For additional examples, applications, and explanations of subjective value, see "The Relentless Subjectivity of Value, by Max Borders. Library of Economics and Liberty, May 3, 2010.
The doctrine of subjective value tends to deny that even the first prerequisite—superior knowledge—is likely to be satisfied. Individuals know their own tastes. This means that they also know the opportunity cost of their labor. Individual managers have local knowledge about productivity. This information is not accessible to the policy maker.
I should emphasize that these are not merely abstract issues. When a local government bans large servings of sugary drinks at restaurants, there is an implicit claim that the government officials have calculated an objective value that is more appropriate than the subjective value. When government sets the compensation of teachers by a formula rather than giving discretion to school principals, there is an implicit assumption that objective value is more appropriate than subjective assessment. Government formulas for paying physicians under Medicare and Medicaid substitute some measure of objective value for the subjective value that would be used if patients were spending their own money and bargaining over price and service.
Because government intervention implicitly assumes that value can be calculated, or at least approximated, by technocrats, it is not surprising that economists put a lot of effort into trying to arrive at objective measures of value. For example, for regulatory purposes, economists calculate the value of a life saved. How should they do this?
One approach is to measure how much a person is willing to pay, on average, to avoid a given risk of death. That is, if I will pay $1,000 to avoid something that gives me a one percent risk of death, then you can argue that I value my life at $100,000. Note that this calculation requires a linear relationship—in effect, it says that because I would pay $1,000 to avoid a one percent risk of death, a linear extrapolation would say that I would pay $100,000 to avoid a one hundred percent risk of death.
As the value-of-life methodology illustrates, there can be clever ways to arrive at a number that purports to represent objective value. However, the validity of that number can be highly questionable. From the Austrian perspective, such calculations are pseudo-scientific and misleading.
Policy issues are often discussed as if the issue of subjective value were not relevant. One context in which it was raised was during the "socialist calculation debate," over whether central planners would have enough information to allocate resources efficiently. Although the socialist side of the debate never conceded, I think it is fair to say that today there are few economists who would claim that the socialist side won. A centrally planned economy will suffer from lack of information, as the doctrine of subjective value would claim.
These considerations would seem relevant to government interventions in sectors like health care, education, housing, and bank regulation. All such interventions end up replacing subjective values with values arrived at by government experts. One would think that defenders of such policies would be trying to engage with the issues raised by Austrians in the socialist calculation debate.
Instead, advocates of government instead have chosen to attack Austrians for "free market fundamentalism." Rather than wrestle with the questions that Austrians raise about whether technocrats have the requisite information to calculate value accurately, mainstream economists accuse Austrians of believing that markets are "perfect," meaning that they satisfy ideal characteristics, such as having many firms and perfectly informed consumers. If those characteristics are not satisfied, markets are said to "fail" and the need for government intervention is presumably demonstrated. However, given the doctrine of subjective value, an Austrian would not concede that just because a market is imperfect, government intervention will succeed.
Suppose that mainstream economists were to engage in a debate over whether measures of value created by independent researchers have validity. What might they say?
One argument might be that the doctrine of subjective value is too nihilistic. If there is no way to measure value objectively, then how can we say anything interesting about economic performance? For example, how can we say that market economies generally work better than communist economies? If you have no way to compute objective value, how do you know that government intervention is wrong?
If asked to demonstrate that capitalism works better than communism, one's natural instinct is to compare GDP per capita in otherwise similar countries, such as North Korea and South Korea. However, what is GDP but yet another attempt to arrive at an objective measure of value?
My own view is that GDP has some use as a rough measure of value. Large differences across country or over time are meaningful. However, it is a mistake to treat GDP or other computed values as if they were exact or, even worse, more accurate than the information that individuals use to arrive at their own decisions.
For me, the doctrine of subjective value does not automatically preclude government intervention. Nor does it preclude any attempt to arrive at objective estimates of value. However, it does remind us to be aware of the information that is discarded when a social researcher attempts to estimate value, and not to treat such estimates as if they embodied absolute truth. The standard practice, I am afraid, is instead to treat such calculations as if they were fully accurate. This implicit assumption leads proponents to over-estimate the likely success of government intervention. In a world where knowledge of value has a large subjective component, acting as if value were objective is a dangerous practice.
Mark Easton. BBC, "ONS well-being report reveals UK's happiness ratings," July 24, 2012.
*Arnold Kling has a Ph.D. in economics from the Massachusetts Institute of Technology. He is the author of five books, including Crisis of Abundance: Rethinking How We Pay for Health Care; Invisible Wealth: The Hidden Story of How Markets Work; and Unchecked and Unbalanced: How the Discrepancy Between Knowledge and Power Caused the Financial Crisis and Threatens Democracy. He contributed to EconLog from January 2003 through August 2012.
For more articles by Arnold Kling, see the Archive.