Can market exchange create new value?

No misconception is more common among free market proponents than the idea that simple exchange creates new value. I wish to show how this reasoning is flawed.

free lunch
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A very common argument from economists and generally free market proponents is that the only thing that creates value are market interactions.  The basic idea they try to promote is that the Capitalist system is not a zero sum game as one person’s gain does not need to come from another person’s loss. You can see an example of this argument from this latest post on Techdirt.

Too many people, it seems, assume that “there is no free lunch” means that the market is entirely static. That is, they believe it’s a zero sum game. If I do x, then y loses out. So, if I am offered free internet service or a free lunch, then whoever provided that is out the same. But that’s simply not true. Economics is not a zero sum game, but is built around economic growth — where the sum of economic activity can be greater than the parts. If I do a transaction with you, and in the end, we’re both better off (i.e., we both got more value than we gave up), then the amount of overall value in the world increased. It might not be a “free” lunch (the economic transaction cost me something), but new utility is created above and beyond what was there before.

(Emphasis mine)

I will not argue on the liberal use of vague concepts and examples that seem valid (eg Why “Free Internet” and not “Free Apples”? Because the argument sounds more plausible that way) but I will point out the black hole in the end.

What the author is telling us in effect is that when you and I trade commodities, new utility is created. So if I give you an apple and you give me an orange, new utility has been created out of thin air. What this utility is, the author does not deem worthy to mention so your guess is as good as mine.

We can safely assume that the author is rather talking about utility in the economic sense, which can roughly translate as satisfaction. In that case however, new utility has not been created but rather the individual utility of each person has been increased. But this kind of utility does not affect the cumulative value of the world, it only affects the individual. The amount of value in the world remains constant.

It is this kind of fallacious reasoning that leads to events such as the rise and fall of Iceland, where their “value” skyrocketed simple because the traders agreed upon themselves that their stuff was worth more. What they basically did was trade amongst themselves and with each trade, they were creating “new utility”. By the logic above, that is perfectly normal and acceptable. The result of which was that Iceland’s “wealth” ballooned to such an extraordinary degree and then popped at the slightest disturbance.

But the reality is that utility, and by that I mean objective value of any single commodity can only be created through one of two ways. Human Labour and Natural Phenomena. The only way to create a new car is to build it. The only way to create a new microchip is to build it etc. It is funny that the author quotes someone else who goes very close to this but fails to grasp it

A useful metaphor for production in an economy comes from the kitchen. To create valuable final products, we mix inexpensive ingredients together according to a recipe. The cooking one can do is limited by the supply of ingredients, and most cooking in the economy produces undesirable side effects.

But of course the extra value that is created in the kitchen does not come from simply possesing lots of inexpensive ingredients. By this reasoning, the best cooks would be the ones who could trade their material best and get the biggest array of them, or trade for the ones that gives them personally the largest amount of satisfaction. After all it’s the trading that would “create new utility” and thus “value” isn’t it?

But that of course is patently absurd. The extra value that is created in the kitchen does not lie in the ingredients. It lies in the amount of labour the cook will put in his cooking. And if we take into account the skill of the cook, then we can speak about the SNLT to be more accurate. The more labour the cook puts into his cooking, the more value the end result will have.

It is understandable that economists would be avert to recognise where the value comes from, but this dooms them to simply a series of equivocations.

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21 thoughts on “Can market exchange create new value?”

  1. After all it’s the trading that would “create new utility” and thus “value” isn’t it?

    It's patently absured, because it's *not* the trading that "creates new utility." It's the fact that the exchangers believe they will be in a better position ex post, which justifies the exchange in the first place. The exchange occurs because both parties expect to gain (relative to their ex ante position) as a result.

    1. Precicely. The subjective value each person assigns to the commodity simply facilitates the exchange but by itself does not create value.

  2. I guess I see the labor argument a bit differently. If I can create a vital product in 2 units of labor, while others use 4 units to make the same product, then I am the most efficient. Now assume someone else can make a vital product I need that would take me 6 units, but only takes them 4 units. Clearly I should trade them the vital product I make for the vital product they make. By doing this, I "save" 4 units. Since they would have spent 4 units making my product anyway, they are no worse off, and I am better off. With this "extra" 4 units of labor, I can *produce* 2 more of my vital products. If there was no trading in my made-up world, I would be forced to make BOTH vital products, and the world would have less of my produced goods, and thus less overall wealth. I believe in a factory setting under the employ of a company the same would apply. If I can produce 2 products in a work day but someone else creates 4 in a work day, I would expect over time their pay would increase at a faster rate than mine. If it does not, I expect they would become discouraged and find a different factory if possible, or perhaps start their own competing company.

    1. Ron, you're not really saving in this case are you? You're only "saving" to the degree that you are producing faster than the number of hours (or units) it takes an averagely skilled worker with the average tools to produce the same good, i.e. the Socially Necessary Labour Time. In this case you are indeed correct; were you faster than the SNLT, you would be earning more (or "saving" more time for other activities).

      In any case, I am aware of all this but I'm not certain I know what your argument is. If anything it should show you one of the flaws of capitalism where your 2 hours of work producing a vital product only gives you a net gain of 1 unit after the capitalist who employs you takes his share.

      1. I am not trying to defend or attack capitalism or any other system per say. I am just curious about the phrase "The basic idea they try to promote is that the Capitalist system is not a zero sum game as one person’s gain does not need to come from another person’s loss." I assume by the way you stated this you believe capitalism is a zero sum game. So basically what I am asking is that if I (being a company or an individual) am more efficient at making product A vs. B and somebody else is more efficient at making B vs. A, and both of us NEED both A and B, how does either side lose? If A takes me 2 units of labor and B takes me 4 units, while A takes the other person 4 units and B takes them 2 units, for example… If we both made our own A and B we would each use 6 units, instead of 4 total if we create one and trade for the other.

        1. I did want to add that I agree the only way to create objective value is by the two methods you pointed out, so my question here is with the assumption that labor performed on goods creates objective value. Obviously jacking the price of something does not qualify…

        2. I think there is a bit of equivocation going on here. Under any market system, one does indeed gain only from the other's loss. Specifically, one must lose the (material) item they are trading if someone else is to receive it. You are simply stating that since there is a trade, both come out with a gain. Yes, but they also come out with a loss. it just so happens that subjectively for each person the trade seems fair (as long as we assume that they are equal in power) and the net result remains at the same value. No extra value is created. Sure, one may consider the object he received to be worth considerably more than what he gave away, but in the same sense I can consider a rock to be worth one trillion as well 😉

          So I'm not saying that a market exchange creates a loss either. I'm saying it doesn't really modify the amount of value that exists in the world in either direction.

          1. Ah, I see, and I think I get it. Here is the deal, I consider myself very pro free-market – I have studied a lot on the free market and especially Austrian economics and as of now it makes the most sense to me, but with that said I want to read into the theories that you pull from to write this blog. I know you have posts detailing some books for anyone to read, but I am asking you for a personal recommendation for me if you would be so kind. Given the types of questions I have asked, about trade/efficiency/value, which is the part of economics I am most interested in, is there a single book you or anyone else would recommend for me to read to better understand where you are all coming from? Thanks!

          2. Good question. I actually don't have any particular book I've read in order to reach my conclusions about value and capitalism. I've got more of an organic knowledge on economics so to speak, where I've built up upon it by reading more and more from various sources. Indeed, a good reason for blogging is to have other commenters (like you) help me clarify or change my thoughts.

            However, although I haven't read it yet, I am pretty certain the Kapital is what you want to look into. I do plan to go through it soon enough

          3. Yea, I am in the same boat. I have a mainly organic knowledge of economics, although mine is on the Austrian free market side of the coin. I have read a few of the "classic" free market books, but mostly my info comes from various blogs and papers. I have now reached the point where I want to branch out and study the other theories out there, and I especially wanted to start with Marx, which seems the polar opposite of what I know. Maybe something out there in the other viewpoints will change my views, or maybe it will just strengthen my current ones, but either way it should be fun. I am going to see about reading Das Kapital as soon as I can.

          4. +1 on Marx's Capital…although you should be warned…there are some books that you read through and some books that you study. The Capital is a book that you study. I haven't read much of it, but what I did read was thick thick thick…it will probably take a long time to read and understand.

  3. Trying to simplify the referenced article into an apple vs orange argument is a simple-minded attack, much like "name calling". Of course, if you attempt to hide it as logic, you really only irritate those who disagree with you and supply your cohorts with "talking statements". I digress…

    "Value" is a human concept; not a scientific term. Creating "value" can be done by any third-rate car salesman. If he convinces a buyer a given car is an awesome deal, the buyer might buy the car and associate a "value" to it. You might think Kelly Blue Book and other can refute this new, fake value, thereby destroying the value on the open market. However, by the nature of the concept, the new buyer might not be willing to sell his prize for market value. In this case, the new owner holds a higher "value" for this car. If the new owner receives his first blow job in this car, he might associate even more "value" with this car.

    Not sure if you've got something against the referenced author, but his statements are sound. They're intentionally vague for a reason. Not because the author is trying to hide from your keen examination of the facts, but because high level discussions *are* possible and even productive without spending your afternoons rebutting with "yeah, but what about…" Can you site logical proof to refute the statement: "Economics is not a zero sum game"? If you can't do it without resorting to some derivative of the "I have an apple and you have an orange" example, perhaps you might do a bit of reading about economics. In theory, everything can be simplified to a basic equation, but only by omitting multiple variables. When you understand the complexity of the missing variables, you'll understand why economics is all about analysis of previous data and speculation of future performance….then go read about a black swan.

    1. Isn't science a human construct as well? Isn't the idea that something cannot come from nothing patently obvious? Does the burden of proof not then rest on the shoulders of the person or persons making the claim that, "Economics is not a zero sum game" as the very nature of that argument defys the previous statement?

      Your concept of value seem odd to me. Sure a salesman can jack up the exchange value of his lovely commodity, but he can only do that to a point…the price that the buyer is willing to pay for said car. The price that someone is willing to pay for that car is not some magic number conjured out of the salesperson's ass…it is in direct relation to the human labor embodied in the commodity. If you don't think I'm right, then I have a $30,000 toothbrush I need you to take a look at…

      And you can take your Courtier's reply and shove it right up your ass…you know who knew a shitload about economics?…Karl Marx.

      1. I always wonder about this: "it is in direct relation to the human labor". In my comment above I tried to use a simple example how I can produce a good with less units of labor than another person is capable of. Wouldn't that imply that the cost of the product when I make it would be less than the cost of the product when the other person makes it (even if both parties sell for zero profit)? If so, how can it be that the price of a commodity is in "direct relation" to the labor embodied in the commodity? I am just curious here, not trying to attack anyone…

        1. I think that your question can be answered by realizing that it may not necessarily be the labor that actually went in to making the commodity that affects what you will be willing to pay for said commodity, but, rather, the amount of labor that you personally will have to do in order to create the commodity that you desire. For example, I need a car about as much as I need a toothbrush – there are of similar use value. I am willing, however, to pay far more for the car than the toothbrush on the grounds that I could easily make my own toothbrush if I could get a hold of the materials, but for me to make my own automobile would entail a fair amount of labor that I don't really even know how to do…even if I had a plethora of materials from which to choose. Thus, I pay $20,000 for my car and a measly $3.50 for my toothbrush.

          1. I think that your question can be answered by realizing that it may not necessarily be the labor that actually went in to making the commodity that affects what you will be willing to pay for said commodity, but, rather, the amount of labor that you personally will have to do in order to create the commodity that you desire.

            Any product created in an industrialized society would cost far less to produce in an industrial environment instead of a personal one. This may, on some occasions, affect your decisions (such as in to buy a tomato as opposed to growing a tomato when you have a garden) But this is not what sets the value as for most things you don't have any possibility to create them yourself. Your choices are practically to buy them or go without.

            It is actually the amount of labour that went into creating a product that sets the initial exchange value. This is based on the price of the variable capital (human labour) and stable capital (machinery). Thus, the less you can pay your workers for the same amount of labour, the less your products cost or the more profit you make (lacking competition). But ultimately the value of a commodity is directly tied to how much SNLT one is required to purchase/expend in order to build it.

        2. In your original scenario you did indeed "save" 4 units of labor, but you did not create any new value…you simply created a potential for the creation of new value as the labor units you saved will then be able to be used laboring to produce a new commodity. You don't have to use those hours of saved labor time to create something of value of course…you could very well use that time to watch reruns of American Idol.

        3. Wouldn't that imply that the cost of the product when I make it would be less than the cost of the product when the other person makes it

          The price a product fetches in a society is related to the SNLT (which I explained above). The average time it takes to create a product is what sets ists value, and its the reason why a car will always be much more expensive than a potato, even though the potato can have a much greater subjective value than the car very often (for people starving for example).
          If you're working faster than the SNLT, it doesn't mean that what you create costs less but rather that you get to make more money, either by selling more of it (because you're producing more) or because you're undercutting the competition (by reducing the price)

    2. The argument I'm making are not based on a simple "apples vs oranges" argument as you state. I've went into length in arguing my point which you've dismissed with calling it a "simply minded attack". Stop wasting my time with going into length on why I'm not suited to discuss economics and make some arguments.

  4. Creating "value" can be done by any third-rate car salesman. […] If the new owner receives his first blow job in this car, he might associate even more "value" with this car.

    You're not creating value, you're simply incresing the perceived value of each person, but the aggregate value in the world cannot be caclulated by the value each person assigns to each object as not two people hold the same value. Furthermore with this concept of "value", the subjective, the total value of the world goes up and down all the time to a degree that it's impossible to calculate, indeed this is why we have such a dislocation of markets with bubbles and busts. Bubbles are nothing more than people believing that they hold much more value that they actually do, but if we take your concept of value as correct, then there's shouldn't be any problem with bubbles.

    But of course there is, and that is that their perceived value is too far off from it's objective value, the value tied in to the labour it took to create the objects they are valuing. The bust are nothing more than the markets adjusting back to their real objective value

  5. I don't get it with The Economist; they just blame wrong people in wrong time. Complete Irrationality! Great article though 🙂

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