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Economic Theory and Conceptions of Value (Part 2)

Examining what Ayn Rand and Austrian economists have in common, versus mainstream economists.

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The editors of New Ideal are delighted to republish, with permission, Rob Tarr’s chapter from Foundations of a Free Society: Reflections on Ayn Rand’s Political Philosophy. Note: this text includes a number of abbreviated references (such as “VOS” and “Smith 1776”) to published works. A key to those references appears at the end of each installment.

Start with Part 1 here.

Mainstream Economics: Value Sundered from Knowledge

Classical Economics: Intrinsic Value

The various economic thinkers in the classical period of economics were united by a shared intrinsic conception of value. The Physiocrats, who are precursors to this period, represent an extreme version of intrinsic value in economics. They considered only agriculture and extractive industries to be “productive,” because it is only in these sectors that we end up with physically more material than we start with. We plant a handful of grain; we harvest a bushel. Manufacturing, in contrast, is “nonproductive,” because it simply involves the rearrangement of preexisting matter. A carpenter making a chair will simply form preexisting wood into a new shape, without thereby bringing into existence a greater quantity of wood or any other substance. The rearrangement contains nothing “new,” nothing “more” than the sum of the inputs (including labor) that went into constructing it.1 The concept of production is therefore effectively construed in metaphysical terms; production simply represents the creation or acquisition of physically more matter. Obviously, there is no room for any element of creative mental integration in this concept of production.

This view of production was rejected by Adam Smith (and all subsequent classical thinkers). For Smith, production is fundamentally about rearranging matter to be more useful to man. Production (in broad terms) is the production of some sort of value. But what is the nature of this value? Smith begins by noting that the concept of value is used in two distinct meanings: “use value” and “exchange value” (Smith 1776 [1981], 44). The use value of an object is the usefulness that it has to man, such that we can say (for example) that “food is useful to sustaining man’s life” or “clothing is useful for protecting man from the elements.” Exchange value, in contrast, is the economic value that something has, the goods that can be acquired for it in trade. Although Smith maintains that an object must have use value in some degree as the condition for it to have any exchange value (useless things will command nothing in exchange), he quickly rejects the idea that the use value is the source and cause of an object’s specific exchange value. Smith’s famous diamond-water paradox illustrates the difficulty: “The things which have the greatest value in use have frequently little or no value in exchange; and on the contrary, those which have the greatest value in exchange have frequently little or no value in use. Nothing is more useful than water: but it will purchase scarce any thing; scarce any thing can be had in exchange for it. A diamond, on the contrary, has scarce any value in use; but a very great quantity of other goods may frequently be had in exchange for it” (44–45).

In talking about use value, Smith briefly opens the door to the possibility of a conception of value in terms of an individual rationally evaluating the use of an object toward his goals; but the door is quickly shut. For Rand, the concept of value “presupposes an answer to the question: of value to whom and for what?” (VOS 16). Smith does not conceive usefulness in terms of the concrete use of a specific object to a particular individual’s conceived goals (i.e., there is no “to whom” or “for what”). Rather, he construes “usefulness” only in abstract terms, for “man” in general. There is a valid perspective from which to say, for example, “food is useful to man.” But this broad, abstract perspective on use value cannot be applied to explain the specific economic value of specific concrete objects. In trying to do so, one is implicitly led to conceiving the usefulness (e.g., of food) as some sort of reified “usefulness,” inherent in and intrinsic to all the concrete instances of it. If “food” has the abstract usefulness it is said to have, then every concrete unit of food must have the same abstract usefulness. But then, every identical unit of food must be conceived as having the same value.

By framing “usefulness” in terms of abstract, universal, factual knowledge, Smith ignores from the outset the category of creative goal-directed thinking. This puts him squarely in an intrinsic conception of value. If every physically identical unit of a good must have the same abstract factual usefulness, then the use value is something intrinsic in the object. This follows inescapably if one tries to form a concept of “value” without involving the question “to whom and for what.”

The diamond-water paradox makes clear that we can’t look to abstract usefulness as an explanation of economic value. Where then to look? If value doesn’t stem from the use of an object, it can only derive from the elements used to construct the object. One of the earlier general observations in economics was that the price of an object tended to gravitate to its cost of production. Smith turns to look for the source and determination of exchange value in the cost of producing an object.2

Every produced object has its “natural price,” Smith thought, corresponding to its cost of production, to which its market price is inevitably drawn. The cost of production explains the natural price of an object, and the natural price is the systematic explanation for market prices and price tendencies. The task of a theory of value, then, is to trace back the chain of costs of a product to the ultimate sources and explanations of these costs, in order to explain exchange value.

The “natural price” of any object traces to the three main types of inputs that serve to produce it: labor, capital, and land. The wages of labor, the interest on capital, and the rent of land used in producing an object constitute its cost and thus explain its natural price. But this only leads to the further question: What determines the prices of labor, land, and capital? Each of these in turn must have its “natural price,” explained in terms of its cost. But this means tracing each of these back to antecedent factors, with an ultimate grounding in physical facts of reality. Wage levels, for example, were often explained in terms of the “subsistence” wage (i.e., the wage needed to just barely sustain a family of four and thus reproduce the labor force without increasing it). In similar ways, classical economists traced the natural price of each factor of production back to its own idiosyncratic roots.

While the details of these views were never satisfactorily solved by classical economists, the overall conception of value necessarily led to a particular conception of production. If production is production of exchange value and if exchange value derives from cost, then the inputs must be the cause of the value of the output. “Production” can only be conceived as the transmission of intrinsic value from the inputs to the output. If value is intrinsic in objects, then for the same reason, “productiveness” (production of value) has to be seen as something intrinsic in the factors of production. We see this view in all the classical thinkers. As one example, Jean-Baptiste Say’s writings show the regular use of terms such as “productive agents,” possessing intrinsic “productive powers,” which consist in being able to “communicate” or “annex” value to a finished product.3 Ultimately, this perspective reduces to a physical conception of production; it is the physical resources and physical actions that are fundamentally responsible for production. Such a view is necessarily implicit in an intrinsic conception of value: if intrinsic value inheres in each object, then each physically identical object must have the same value — making value coextensive with the physical object.

A view of production centered on the physical causation of inputs transforming into output is necessarily an “efficient-cause” view of production, contrasting directly with Rand’s “teleological” view of production. This leaves no room for the creative origination of goals and the creative integration of means as the root of production (of value-creation). There is no element of goal-directed thinking at all, since, in an intrinsic value conception, value is not fundamentally conceived in terms of goals and plans. There is no element of conceptual knowledge involved in the concept of value and, thus, no fundamental role for the creative mind to play in production of value.

Classical treatises typically include large sections on production, but the discussion invariably focuses heavily on physical aspects of production such as climate, the fertility of soil, the characteristics of the labor force, the dynamics of population, and so on.4 Some classical thinkers did discuss knowledge as being relevant to production, but any such discussion was only of factual scientific or technological knowledge, and the value of such knowledge was simply assumed implicitly to be obvious and intrinsically given. Thus, while classical economists seem to be talking a great deal about production, they are not in fact talking about production in Rand’s meaning of the concept — as a process rooted in the creative formation of new value integrations.

What then is the fundamental issue or question of economics? Given the classical conception of value, it cannot be the evaluation problem we posed before: how to know what others value in order to evaluate what counts as production under the division of labor. Value inheres in objects themselves. In order to know what counts as production of value, then, one need only look to the intrinsic value of the object itself. If one produces a particular physical object, then ipso facto the object has the intrinsic value indicated by its “natural price.” For Smith, the fundamental question of economics was the “Wealth of Nations,” the question of how to maximize the aggregate production of intrinsic value — that is, of physical goods (per capita), given a nation’s aggregate resources. From Rand’s point of view, this is an example of the tribal perspective in economics: conceiving the fundamental economic problem in terms of aggregates, and in seeking the achievement of a particular aggregate result.

During the classical period, careful distinctions to arrive at precise concepts of profit and entrepreneurship were only in the process of emerging. But it would be impossible, on an intrinsic conception of value and an efficient-cause view of production, to arrive at anything like Rand’s conception of profit as the reward to the creative formation of new value-integrations, or her view of the entrepreneur as the creator. There is no role for the entrepreneur as the fundamental producer of value in the economy, when all value stems intrinsically from input resources.

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Neoclassical Economics: Subjective Value

The generally acknowledged turning point between classical economics and modern economics was the “marginal revolution,” the independent and near simultaneous discovery of the marginal utility principle by William Stanley Jevons, Carl Menger, and Leon Walras, in the early 1870s. Each of these three thinkers has his own approach to and perspective on the issue, but the core idea in each of them was to fundamentally shift the conception of value from being intrinsic in the object to stemming from the subject (the individual valuer). Classical economists failed to reach this perspective by construing “use value” in abstract terms, as a generalized sort of “use” for “man” in general. The essence of the marginal revolution was to construe “use value” in terms of a concrete use of a particular unit of a good, for a specific individual. Instead of the perspective that “water” is useful to “man’s life,” the marginalist focus is on the particular glass of water in front of me, and what particular use it can presently serve to me. Importantly, this must take into account my present context — that is, what quantity of water I already possess or have already consumed. If my thirst is fully slaked, the water may serve no use and thus have no value to me. If I am thirsty, but I have a ten-gallon container of water beside me, then again this particular glass of water is not of great value to me (if it spills, I can easily replace it). But if I’m in the desert, I may value an equivalent glass of water as high as my life itself. Thus all value arises only within an individual’s particular context and pertains to the specific use he has for a particular good.

With this fundamental shift in perspective, Smith’s diamond-water paradox is effectively solved, and use value is fully reconciled with exchange value. “Water” is less valuable than “diamonds,” in normal circumstances, because it exists in sufficient quantity that any additional units have little or no value. Thus, the exchange value of water is low or nil.

From this perspective, physically identical units of a good, rather than being viewed as having identical value (as on the intrinsic value perspective), are viewed as having different value, depending on the context. Not only will physically identical units of a good have different value to different people, they will have different value to the same person at different times and even different (higher or lower) value to the same person at the same time. Each glass of water relieves my thirst more; so each subsequent glass is less useful and less valuable to me.

The principle that each additional unit of a good will be valued less than the prior one is the crucial principle of diminishing marginal utility. With this principle in hand, economists explain downward-sloping demand curves — and (with an analogous principle) upward-sloping supply curves. This grounds the fundamental explanation of all prices in terms of the intersection of supply and demand, providing a much more unified and systematic theory of price than classical theories could achieve.

Menger, Jevons, and Walras all shared the common conception that value is subject-dependent. But this category obscures two fundamentally different ways in which value can be dependent on a subject: it can be conceptualized as dependent on the subject’s thinking or on the subject’s feelings (or “whims”). In Rand’s view, these belong in two separate categories: objective value and subjective value.

For Rand, as we’ve noted, the concept of value presupposes a “to” and “for what.” The crux of the shared conception of value of Menger, Jevons, and Walras (in contrast to Classical economists) is that it includes a “to whom” (value as subject-dependent), but a critical difference arises in the “for what.”5 For Jevons, “value depends entirely upon utility,” and “Utility must be considered as measured by, or even as actually identical with, the addition made to a person’s happiness. It is a convenient name for the aggregate of the favourable balance of feeling produced — the sum of the pleasure created and the pain prevented” (Jevons 1888, 45). With Jevons, the “for what” is the individual’s pleasure (and absence of pain) — that is, the hedonic utility of the Utilitarians. Value is subject-dependent because it is the subject who feels pleasure. Jevons therefore tends to express and explain the law of diminishing marginal utility in terms of pleasure. While he briefly and tangentially refers to particular uses of objects, his explanation of diminishing utility centers on notions such as the physiological experience of “satiation” or on observations that the same stimulus continuously applied tends to result in diminishing intensity of pleasure, and so on.

For Menger, in contrast to Jevons, the “for what” of a good is that it fulfills a conceived goal and is conceptually recognized as doing so. Menger accounts for value in terms of an individual having conceptual knowledge of an object’s causal connection to achieving his — the valuer’s — goals. Thus value is “subject-dependent” for Menger because it is the subject who conceives the goal, and it is the subject who possesses the knowledge of the relationship of the object to his goal. This type of view falls into Rand’s category of objective value.

Menger’s conception of “usefulness” does not simply devolve into pleasure; usefulness maintains the meaning of a causal relationship of a means to a goal. We can see the difference in emphasis with an example of how the Austrians present the marginal value concept. Eugen von Böhm-Bawerk, a follower of Menger, illustrates the concept with the example of a farmer laying up five sacks of grain for the winter (1891 [1930], 149–50). The first sack he plans to use to stave off starvation (and thus has the value of life itself to him); the second sack he plans to use to become hale and hearty, to have the energy to work; the third sack he plans to use to feed his cow; the fourth sack he plans to use to make alcohol; the fifth sack he plans to use to feed his pet parrot. Each of these is treated as a conceived goal, and the farmer is viewed as consciously planning the use of the sacks of grain according to the importance of each goal to his life. The law of diminishing marginal value is explained, not in terms of some progressive sensation of satiation, or of diminishing pleasure, but by the fact that the farmer deliberately and consciously plans the use of each sack to serve his most important goals first, and then to use each subsequent sack to serve progressively less important goals. It is this conscious evaluation of the importance of each goal to his life (and the planned use of each unit accordingly) that causes each subsequent unit to be valued less. I’ll examine Menger’s conception of value in more detail in the next section but, for now, note that the idea that value is “subject-dependent” (“subjective” in the sense of this term most often used by economists) masks that Menger and Jevons in fact have fundamentally different conceptions of value, which lead to radically different economic theories.

Jevons’s use of a subjective conception of value, conceived in terms of hedonic utility, is further cemented by another consideration: “It is clear,” he writes in the introduction to his famous book, “that Economics, if it is to be a science at all, must be a mathematical science” (1888, 3). The fact that the new approach to economics operates with a marginal conception of utility (Jevons thinks) clearly invites the use of differential calculus: “As the complete theory of almost every other science involves the use of that calculus, so we cannot have a true theory of Economics without its aid” (3). Bentham had already conceived “utility” as lending itself to an arithmetic of pleasures and pains; Jevons now wants to develop the differential calculus of pleasures and pains.

But reducing all value to a single cardinal mathematical scale in this way negates any possible role for conceptual integration in valuing. Rather than viewing things in terms of an individual pursuing a complex of conceptually integrated goals (representing his vision of his life plan), Jevons reduces it all to a single goal, a single motivation, a single homogeneous axis of “utility,” which varies only quantitatively (and thus is mathematically tractable). But to do this is to eject from consideration the element of conceiving goals and the rich conceptual integrations of means to ends — that is, it excludes any element of teleological integration. All of that is collapsed into a single cardinal axis, where objects are simply to be ranked flatly along a single scale according to their utility (the amount of pleasure they evoke, in fact or in expectation).6

Subsequent economic thinkers eagerly pushed forward the mathematicization of economics, but they came to reject Jevons’s conception of value in terms of hedonic utility, deeming irrelevant whatever psychological activities might be occurring in the consciousness of the subject. All that is needed for economic theory (it was thought) is to know that the individual exhibits a preference for one thing over another. The prevailing view came to be that what goes on inside the mind of the valuing individual is irrelevant to economics; all that matters is his “revealed preference.” But this is just a further expression of a subjective-value conception (in Rand’s sense). Whether value is pleasure or value is revealed preference, it is not seen to stem from or depend on the conceptual thought processes of the individual. Value is not viewed as embodying knowledge, and this is in fundamental contrast to Rand’s objective conception of value. Implicit in the views of these economic thinkers, then, is that value is fundamentally sundered from knowledge.

As far as economics is concerned, then, the preferences or values of individuals are to be treated as simply “given.” Preferences are not something that depend on or emerge from anything in the economic realm but, rather, form part of the “data” from which economic reasoning begins. The source of these preferences, and any changes in them, can only be treatedas exogenous to economics.

With a new concept of value, the developing neoclassical school of economics was necessarily led to a new view of production and its place in economics. For the classical economists, production was a central topic; production was viewed as the “efficient cause” process of producing intrinsic value (which effectively meant the production of physical goods, since intrinsic value is coextensive with the physical good). But with value now conceived as a subjective emanation from a consciousness, production came to have a less central place in economic theory. W. C. Mitchell writes: “Nowadays [1934] economics is thought of as centering primarily not on the problem of production but on that of value and the distribution of income.” In fact, “in many a modern treatise there is no separate discussion of production. The subject which was the very center of Adam Smith’s interest gets incidental rather than systematic treatment. What the theorist has to say is broken up into bits” (Mitchell 1967, 37–38).

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On Rand’s objective conception of value, where thought is directed at conceiving goals and integrating means to ends (teleological integration), production is seen as clearly a value issue. In fact production is, at root, the achievement of these sorts of conceptual value-integrations. But if the concept of value is conceived in purely subjective terms, there is no room to subsume any element of conceptual integration — or a creative teleological thought process — under the concept of value. If value is fundamentally conceived in terms of pleasure or revealed preference, it’s difficult to see how the activities of production per se can be considered value issues.

Production, then, has to be conceived purely as an issue of factual knowledge. The complex integrations of factors of production must be conceived only in terms of scientific/technical knowledge, not involving any value questions. Any integration of productive factors essentially reduces to studying their factual properties, and their proper integration is only a matter of having the right technical knowledge. The integration involved is not viewed as fundamentally involving any process of evaluation.

But (as discussed) facts alone cannot tell us how to integrate those facts into a conceived goal, nor how to integrate means into a plan to achieve it. Scientific and technical possibilities, alone, cannot tell us how best to use them and combine them. This issue goes to the heart of the differences between the Austrian school and the neoclassical school (see below).

The subjective concept of value therefore leads us to this fundamental split. “Value” is conceived as subjective consumer preference, without any knowledge element, and “production,” therefore, is conceived purely in terms of factual knowledge, with no value element. It is this fundamental split that causes both consumer values and production to drop out of economic theory. Both are treated as exogenous to economics, simply as “given” data for economics and thus the starting point for economic reasoning. The source of (and change in) subjective consumer values is considered to be a matter perhaps for psychology or sociology, but not economics. The integration of productive factors is taken as a purely technical matter, not a value matter, and thus also is not a concern for economics.

What then is economics fundamentally about? What is the fundamental problem of economics? According to Jevons: “Pleasure and pain are undoubtedly the ultimate objects of the Calculus of Economics. To satisfy our wants to the utmost with the least effort — to procure the greatest amount of what is desirable at the expense of the least that is undesirable — in other words, to maximise pleasure, is the problem of Economics” (1888, 37). We are left with a mathematical optimization problem. With given consumer preferences, given production functions, and known resource availability, the only task left to economics is to mathematically solve for the matrix of prices and quantities that will maximize utility.

This mathematical solution point is the “equilibrium” point. The equilibrium framework becomes the fundamental framework of analysis for mainstream neoclassical economics. As Kirzner (who will later disagree with it point for point) describes the framework:

The focus of attention, in this view of the task of price theory, is thus on the values of the price and quantity variables, and in particular on the set of values consistent with equilibrium conditions. In investigating the consequences of a particular market structure, this approach examines the associated pattern of equilibrium prices, costs, and outputs. In investigating the consequences of a particular change in taste, or technology and the like, it examines the equilibrium conditions after the change, comparing them with those before the change. The very efficiency of the market system as an allocator of society’s resources is appraised by examining the allocation of resources at equilibrium. In investigating the desirability of particular government policies, this approach appraises the effects of the changes these policies will bring about in the equilibrium situation. In all this the emphasis is on the prices and quantities and, in particular, on these prices and quantities as they would emerge under equilibrium conditions. (Kirzner 1973, 5)

A crucial assumption in order to mathematically solve for this equilibrium point is that all knowledge be given. The economist must assume “perfect knowledge” (of consumer preferences, technology, resource availability) in order for there to be any sort of determinate mathematical solution to the problem. One simply cannot solve a system of simultaneous equations if some equations are left out, or their functional form is not known, or some variables are missing. Correspondingly, in this view, there is not much to talk about other than the equilibrium point. Given the starting data, the only determinate point is the equilibrium point. A disequilibrium state could take any form; there is no systematic account that can be given of it, other than to say there should be a tendency for the prices and quantities to return to the determinate equilibrium point. What is the nature of that “tendency” to equilibrium, as a process? Mainstream economics has had little success finding much to say about that.

From the perspective of the mainstream neoclassical school, the fundamental problem of economics is not a problem of knowing what others value in order to evaluate what counts as production — in contrast to Rand and (as we’ll see later) the Austrians. There can be no such problem, when all knowledge is simply assumed given. But if we assume “imperfect” knowledge (unknown consumer preferences, unknown production functions, unknown resource availability), then we effectively destroy the basic framework of neoclassical economics as the mathematical description of the equilibrium state. Neoclassical economics would simply have little to say in that case.7 We can note in passing that the fundamental neoclassical focus on describing equilibrium states — taking an aggregate view of the economy and fundamentally viewing it in terms of achieving some aggregate result (equilibrium) — is another example of what Rand calls the tribal perspective in economics.

The view of man that is embedded and assumed in the neoclassical framework is what Kirzner calls the “Robbinsian maximizer” or “Robbinsian economizer” (Kirzner 1973).8 In this view, the individual, operating with given ends and known means (including full knowledge of all the ways the means can be technically combined), has only to mathematically optimize the allocation of means to ends in order to maximize utility. There is no room for the creative formation of new evaluative conceptual integrations in this view. There is no room for creatively conceiving new goals; all ends are given. There is no room for creatively integrating new plans (discovering new means or new combinations of means) to better achieve one’s goals; all integrations of means are assumed in advance. There is no creative conceptual thought process required (or possible) at all. The “rationality” of economic man, in this view, is simply to run the mathematical algorithm to deterministically calculate the quantitatively optimal choice, a choice that is already implicit in the given data. In other words, the mental processes of Robbinsian economic man are, point for point, the direct antithesis of Rand’s view of teleological thinking — of an individual creatively conceiving new goals and new conceptual integrations of means. Robbinsian economic man is effectively a deterministic puppet, dancing to the tune of the “given” data. But this is no accident; it follows logically from a subjective conception of value.

Production is treated in an analogous manner. In the branch of economics known as the “theory of the firm,” the firm’s basic problem is also merely a deterministic quantitative optimization problem. With given production functions (the particular functional relationship of how input resources can be combined), and facing a given and known demand curve, the production problem that the firm faces is merely to choose the quantity of each input resource to use, and the quantity of output to produce, in order to maximize profits. The real problem of production —  creatively conceiving a productive goal (a new product or service), and the creative formation of a rich integration of all the complex interrelated aspects of production in order to achieve that goal — is simply assumed away as “given.”

The consequences of the neoclassical concept of value pervade every element of economic theory. It’s widely recognized, for example, that the market economy is driven by a striving for profits. Tellingly, neoclassical economics has had a hard time capturing or explaining this fact in its systematic body of theory.

In a nonequilibrium world, there are price discrepancies; thus opportunities abound for “entrepreneurial profits” — that is, opportunities for someone to creatively seek out and exploit price differences in order to earn profits. In an equilibrium world, however, all knowledge is already assumed given. All production techniques are already discovered and implemented, and all markets are perfectly clear at the equilibrium price. There are no price discrepancies, and hence no room for entrepreneurial profits.9 This isn’t of much concern to theorists. Paul Samuelson, writing in an early edition of his famous textbook, explains:

In addition to wages, interest, and rent, economists often talk about a fourth category of income: profit. Wages are the return to labor; interest the return to capital; rent the return to land. What is profit the return to? Economists do not always agree on the answer. A graduate student recently checked over a number of modern textbooks and came up with 14 different answers! What shall we do? Examine all 14 answers? Add a fifteenth? The obvious thing is to give a common-sense description of what people generally mean when they speak of profits. Let us call a spade a spade. If profit is a miscellaneous catchall category, let us recognize it as such. (Samuelson 1955, 583)

In other words, profit is essentially an unimportant phenomenon, a leftover residual that we can discuss casually without needing to give a systematic account of it, as a central part of economic theory.

With markets at equilibrium, and no real concept of entrepreneurial profit, it is no surprise that the concept of the entrepreneur effectively drops out of neoclassical theory as well. There is simply no room for him, no analytic role. At equilibrium, there is no entrepreneurial innovation. Any innovation that does occur is viewed as a scientific or technological matter, occurring exogenously to economics. In the face of such innovation, the task of economics is simply to mathematically reoptimize with the new data, in order to determine a new equilibrium point. But the entrepreneur is not a scientist or an engineer; this is not the type of innovation he engages in. From Rand’s point of view, his innovation consists in creatively forming new value-integrations, innovation in terms of conceiving new goals and creatively seeking to better integrate means to ends. Since the subjective value concept of mainstream neoclassical economics logically excludes this category of thinking, there is simply nothing for the entrepreneur to do in the neoclassical framework.

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The existence of a problem is recognized by theorists. Baumol (1968) lamented: “In more recent years, while the facts have apparently underscored the significance of [the entrepreneur’s] role, he has at the same time virtually disappeared from the theoretical literature” (64). But, he continues, “it is not difficult to explain his absence” because “obviously, the entrepreneur has been read out of the model. There is no room for enterprise or initiative. The management group becomes a passive calculator that reacts mechanically to changes imposed on it by fortuitous external developments over which it does not exert, and does not even attempt to exert, any influence. One hears of no clever ruses, ingenious schemes, brilliant innovations, of no charisma or of any of the other stuff of which outstanding entrepreneurship is made; one does not hear of them because there is no way in which they can fit into the model” (Baumol 1968, 66–67).

Baumol and others have tried to make room for the entrepreneur in the neoclassical model, often trying to model him as an input factor of production susceptible to supply-demand analysis, but such attempts inevitably fail to capture the essence of what the entrepreneur is and the range of what he does. Revisiting the issue more recently, Bianchi and Henrekson (2005) ask, in the title of a paper: “Is Neoclassical Economics Still Entrepreneurless?” Echoing Baumol, they locate the problem at the heart of the neoclassical paradigm: “The reason for this disregard of entrepreneurship is not a denial of its relevance for economic development and the organization of economic activity. The reasons are methodological: the entrepreneur and the entrepreneurial function largely elude analytical tractability” (2005, 1). After systematically surveying “the different mainstream/neoclassical modeling techniques that have been used in order to capture the entrepreneurial function in the economy” (1), they find the situation essentially unchanged: “We conclude that an individual real-world entrepreneur, even if highly stylized, cannot at present be modeled in mainstream economics, since he or she does elude analytical tractability. In this sense, the neoclassical entrepreneur is (still) not entrepreneurial” (22).

Finally, with the market at equilibrium, the concept of competition becomes problematic. In Rand’s view, entrepreneurs strive for profits by striving for new value-integrations (new goals and new integrations of means) to identify profit opportunities, winning away customers by providing better products and/or lower prices. The competitive race is the ceaseless search for such new value-integrations, and the competitive advantage one gains is precisely in achieving them ahead of others.

In the neoclassical equilibrium framework, however, with the assumption of “perfect knowledge” there is no possibility of any such competition. Everything is already discovered, and nothing changes. There are no new goals to seek, all possible combinations of means are already known, and production simply consists in the endless, rote repetition of the same activities. There simply cannot be any competition in seeking new goals and plans, when all such integrations are assumed given in advance.

For neoclassical economics, the concept of competition logically has to be reconceptualized in equilibrium terms. Rather than denoting a process, competition necessarily comes to denote a particular state of affairs, at equilibrium. The earliest important neoclassical conception of competition was the theory of “perfect competition.” For a state of perfect competition to exist, there must be a large number of buyers and sellers, such that no individual can influence the price (all are “price-takers”), and all knowledge must be given. Thus, rather than denoting a process whereby an individual gains the advantage over competitors by creatively forming new value-integrations ahead of others, perfect competition comes to denote a situation where no one has any advantage over anyone else. As Hayek pointed out in a key paper criticizing the then-emerging new concept of competition:

The theory of perfect competition . . . has little claim to be called “competition” at all and . . . its conclusions are of little use as guides to policy. The reason for this seems to me to be that this theory throughout assumes that state of affairs already to exist which, according to the truer view of the older theory, the process of competition tends to bring about (or to approximate) and that, if the state of affairs assumed by the theory of perfect competition ever existed, it would not only deprive of their scope all the activities which the verb “to compete” describes but would make them virtually impossible. (1948, 92)

And yet, while competition is redefined to be the opposite of its normal meaning, Hayek continues, “the general view seems still to regard the conception of competition currently employed by economists as the significant one and to treat that of the businessman as an abuse.”10 As with the classical view of production, the neoclassical view of production amounts in the end to an “efficient cause” view of production —  not because value is intrinsic in production (classical economists), but because value is irrelevant to production. Production is viewed as emerging (in effect) “automatically” from inputs (with factual, scientific/technical knowledge as one of the inputs), rather than stemming from creatively formed new value-integrations. Entrepreneurial profit drops out because it is the return to such new value-integrations; and the entrepreneur disappears because he is the creator of the value-integrations.

End of Part 2; continue to Part 3

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Baumol, William J. 1968. “Entrepreneurship in Economic Theory.” American Economic Review 58(2): 64-71.

Bianchi, Milo, and Magnus Henrekson. 2005. “Is Neoclassical Economics Still Entrepreneurless?” SSE/EFI Working Paper Series in Economics and Finance no. 584.

Bohm-Bawerk, Eugen von. 1891 [1930]. The Positive Theory of Capital. Translated by William Smart. New York: G.E. Stechert.

Hayek, Friedrich A. 1948. Individualism and Economic Order. Chicago: University of Chicago Press.

Jevons, William Stanley. 1888. The Theory of Political Economy. 3rd ed. London: Macmillan.

Kirzner, Israel M. 1973. Competition and Entrepreneurship. Chicago: University of Chicago Press.

Mises, Ludwig von. 1949 [1996]. Human Action: A Treatise on Economics. 4th rev. ed. San Francisco: Fox and Wilkes.

Mitchell, Wesley C. 1967. Types of Economic Theory. Vol. 1. New York: Augustus M. Kelley.

Robbins, Lionell. 1932. An Essay on the Nature and Significance of Economic Science. London: Macmillan.

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“Economic Theory and Conceptions of Value: Rand and Austrians versus the Mainstream” by Robert Tarr from Foundations of a Free Society: Reflections on Ayn Rand’s Political Philosophy edited by Gregory Salmieri and Robert Mayhew © 2019. All rights are controlled by the University of Pittsburgh Press, Pittsburgh, PA 15260. Used by permission of the University of Pittsburgh Press.


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  1. Mises, for example, writes that “the French Physiocrats contended that all labor was sterile unless it extracted something from the soil. Only cultivation, fishing and hunting, and the working of mines and quarries were in their opinion productive. The processing industries did not add to the value of the material employed anything more than the value of the things consumed by the workers” (Mises 1949 [1996], 141).
  2. While it’s commonly believed that classical economists held a labor theory of value, it’s more accurate to view the theories as “cost of production” theories. It’s true that labor was often the largest cost, but classical thinkers never succeeded in fully reducing the cost of all goods to labor only. Either way, the overall conception of value is the same — that value is intrinsic to an object and derives from the inputs that serve to produce it.
  3. See Say’s Treatise of Political Economy (1803 [1855]).
  4. See, for example, Say 1803 [1855] or Mill 1848 [1909]; in both, a large section on production forms “Book 1” of the respective treatises.
  5. My contrast of the different conceptions of “subject-dependent” value will here center on Jevons and Menger. Walras shares with Jevons a purely subjective conception of value, but I won’t examine here his particular version, or how he arrives at it.
  6. This is not to deny that, on the objective view, values can be ranked against each other ordinally, but this is only achieved as the result of integrating them into a rich hierarchical structure (a process that involves a great deal of complex thinking and choosing), not as a result of having a flat uniform mathematical axis for measuring values.
  7. Neoclassical economics does sometimes try to account for uncertainty or “imperfect” knowledge, but only in terms of known probability distributions. Algorithmic methods can still mathematically deduce equilibrium outcomes from these. For Austrians the relevant category is what they call “sheer uncertainty” or “sheer ignorance” (i.e., so-called unknown unknowns). It is this category, for Austrians, that makes mathematical equilibrium analysis inapplicable, and that gives rise to creative thought and discovery as the essence of what economics must fundamentally grapple with.
  8. Named for Lionel Robbins, who formalized the neoclassical definition of economics in 1932: “Economics is the science which studies human behavior as a relationship between given ends and scarce means which have alternative uses” (1932, 16).
  9. In equilibrium, there is still an interest return on capital, and returns from risk premia; but no entrepreneurial profits.
  10. The perfect competition model has been followed by many successor theories of competition in neoclassical economics, but the root issue and root problem remain the same. In focusing on equilibrium states, knowledge has to be assumed as given (in one way or another), and thus competition is not conceived in terms of the discovery and evaluation of knowledge.
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Robert Tarr

Robert Tarr, MA in philosophy and former hedge fund portfolio manager, is an independent scholar in economics and the philosophy of economics with a particular interest in Austrian business cycle theory.

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