Use and Exchange Value
In a general sense an entity, whether it be a material good, an energy flow, or a piece of information, has value if it can be exchanged for another good (or goods) and/or if it is in some way deemed useful or important by its possessor. Useful or having worth can mean either that the entity contributes to the survival of the owner or simply that it enhances the quality or enjoyment of his or her life. Yet this definition still does not answer the question why one person or society values a particular commodity more highly than another. For although we make such judgments everyday, we seldom think about the criteria on which we base our decisions. As Aristotle first noted, and as Adam Smith later made famous, the word value has two meanings for economists:
The word value, it is to be observed, has two different meanings, and sometimes expresses the utility of some particular object, and sometimes the power of purchasing other goods which the possession of that object conveys. The one may be called value in use; the other value in exchange. (Adam Smith, Wealth of Nations, Bk. 1, Chap. 4, p. 131.)
The differences between use value and exchange value are important because they form the base of two opposing economic paradigms. The classical school of economics sees economic value originating in the production process. According to this view the value of an object is determined by the quantity of labor used to produce it (the embodied labor). Classical economists like David Ricardo and Karl Marx emphasized exchange value because they believed the amount of labor embodied in goods and services determined the ratio at which they exchange The other paradigm, the neoclassical school, emphasizes use value because they view value as originating when goods are exchanged and used, as opposed to when they are produced. According to this view the ratio at which goods and services exchange is based on the utility objects convey to the traders. In other words, a good's utility is a function of the benefits it confers to its owner. Because goods are exchanged based on the utility they provide their owners, the neoclassical paradigm emphasizes use value. Differences in the definition of value are important, as the economic historian David Meek states:
The particular definition of value with which an economist begins is almost invariably a set of shorthand expressions of the basic attitude which he is going to adopt towards the phenomena he seeks to analyze and the problems he seeks to solve.
No single factor, be it labor, utility, or energy, is both a necessary and aufficient condition for economic value. Using labor as a measure of value, as do classical economists, is not appropriate for an economic system in which the amount of economic work done by human labor is very small relative to other prime movers and energy sources. In an industrialized society, fossil fuels used to increase the productivity of labor have made each unit of human labor increasingly powerful in the production process. Labor is now a trigger action, controlling and directing larger but variable quantities of fossil fuels so that labor is no longer a relatively constant measure of producibility. A standard of value based on subjective human preferences also is incomplete, for this approach fails to ask the important questions, What forces determine or influence people's preferences? And are society's preferences consistent with the physical and biological guidelines of our natural environment that must be adhered to if our culture is to survive and maintain a minimum quality of life?
Among the early energy analysts Frederick Soddy, Leslie White, and W. Fred Cottrell believed that the energy resources available to society influenced the development of cultural values. Cottrell stated that "the idea that energy influences what man will do implies that within the limits so set, the supply of energy is also a factor at work influencing human choice." Cottrell went on to note that "the preservation of a system of values requires a continuous supply of energy equal to the demands imposed by that system of values." In a similar vein Soddy (1912) stated: ". . . whether [human aspirations] can achieve realization . . . is in the end a question of the physical resources rather than the psychical attitudes of men."
The relationship between energy and human values, however, is not a strictly deterministic one, a condition recognized by both Soddy and Cottrell. The important point is that the type, quality, and quantity of natural resources, and fuel in particular, set general but definite limits on the development of human values and the physical implementation of human ideas. Neoclassical economics tends to ignore these constraints while it assumes that the ultimate end of the economic process is the satisfaction of our material wants and that the ultimate means for achieving this end are stocks of goods and services. On the other hand, a physical theory of value based on energy also is incomplete because many characteristics of human tastes and human moral and ethical behavior are not determined or influenced directly by resource availability. We believe, however, that much can be gained by analyzing human values from a physical perspective. In order to understand where an energy perspective fits in the intellectual economic landscape and how it can contribute to a more complete understanding of economic processes, the basic tenets of each paradigm must be understood. This article describes the most important aspects of the two fully developed economic paradigms as well as the emerging body of literature of a new paradigm based on the importance of fuel and other natural resources.
The fundamental tenet of classical economics, that labor is the source of all value, was first formalized by Adam Smith in 1776 in his book The Wealth of Nations. Smith states:
The value of any commodity. . . is equal to the quantity of labor which it enables him to purchase or command. Labor, therefore, is the real measure of exchangeable value of all commodities.
To this formulation he adds:
Among a nation of hunters, for example, it usually costs twice the labor to kill a beaver which it does to kill a deer, one beaver should exchange for or be worth two deer.
This strict equivalence between the labor required to produce a good or service (embodied labor) and the rate at which they exchange did not always hold, however, for several reasons. Smith recognized that the value of all labor was not alike:
. . . (the) amount of another's labor that an object could command also depended on the quality of the work involved. If the one species of labor should be more severe than the other, some allowance will naturally be made for this superior hardship; and the produce of one hour's labor may frequently exchange for that of two hour's labor in the other.
Thus a pair of shoes that required 4 hours to produce may have been traded for coal that required 2 hours to produce because of the risk and exertion associated with mining coal.
. . . it is the comparative quantity of commodities which labor will produce that determines their present or past relative value.
Ricardo's contribution to classical economics lay in his explanation of economic rent consistent with a labor theory of value. The cornerstone of Ricardo's theory of rent was based on his explanation of prices. Ricardo wrote that the quantity of labor used by the least efficient producer of a good (the producer that used the most labor to produce a good) set that good's market price:
The exchangeable value of all commodities... is always regulated... by those who continue to produce them under the most unfavorable circumstances.
This pricing scheme is especially important in setting the price of natural resources because the quality of the deposit influences greatly the amount of labor required to extract it from the environment and fashion it into a useful good or service.
In agriculture, for example, the soil with the lowest native fertility set the price of crops: "corn which is produced by the greatest quantity of labor is the regulator of the price of corn." Landlords who owned relatively fertile land could charge rent because a farmer on less fertile land would be willing to pay to use the more fertile land where more corn could be grown per hour of the farmer's labor. The rent a landlord could charge depended on the fertility of his or her land relative to the least fertile land under cultivation. Rent on land only slightly more productive than the least fertile land under cultivation was less than rent on the most productive land because only a small amount of extra crop could be grown per labor hour on the marginally superior land. Similarly, rent could be charged by all owners of natural resources whose quality was greater than the lowest quality deposit in use. For example, owners of gold mines with 7% ores could charge rents if gold mines with 5% ore also were in use.
In using such a pricing scheme, Ricardo was one of the first economists to describe the economic interaction between demand and natural resource quality. As demand for a resource grew, either cumulatively for nonrenewable resources or at a given point in time for renewable resources, lower-quality deposits had to be developed. Lower-quality deposits, whether a ton of copper or a bushel of wheat, required more labor per unit extracted. Since the labor time needed to extract resources from the lowest-quality deposit set their price, using lower-quality deposits raised the price of natural resources. Conversely, when demand subsided, the lowest-quality deposits no longer were used, less labor was required to produce resources from the lowest-quality deposit, and the price of natural resources declined.
Ricardo also attempted to explain the origin of profit as a return to capital based on a labor theory of value. Expanding on Smith's example of the value of a hunter's catch relative to the time used to catch it, Ricardo wrote that the value of a good also included the labor embodied in capital used by the laborer:
The value of these animals would be regulated, not solely by the time necessary for their destruction, but also by the time and labor necessary for providing the hunter's capital.
Thus Ricardo recognized the importance of indirect labor costs. Ricardo's attempt to explain the origin of profit based on the labor embodied in capital failed to be accepted because of internal inconsistencies not considered here.
Like his intellectual forebears, Karl Marx also believed that labor was the source of all value:
Commodities...in which equal quantities of labor are embodied, or which have been produced in the same time, have the same value.
Marx's explanation for profit consistent with a labor theory of value was one of his most notable contributions to classical economic theory. Marx stated that the value of labor was determined by the same rules that applied to all commodities—labor's value was set by the quantity of labor required to produce it. The quantity of labor required to "produce" labor was the time a laborer had to work to produce or earn wages sufficient to purchase all the commodities needed by a laborer and his or her family to feed, clothe, and reproduce. This wage rate was the subsistence wage rate. The subsistence wage set a lower limit on wages because the worker's earnings had to be at least equal to "the value of the commodities without the daily supply of which, the laborer cannot renew his vital energy consequently by the value of the means of subsistence that are physically indispensable" (Marx, p. 173).
Marx pointed out that the time a laborer worked per day for a factory owner always was greater than the time a laborer needed to produce goods and services to sustain his or her self. This advantage was achieved through the capitalist's superior bargaining position. Laborers needed to work every day to survive and had only their labor to sell, whereas capitalists do not need to hire labor constantly. Capitalists therefore could pay laborers a wage equal to (or sometimes below) the subsistence wage rate, and this wage was less than the value of the goods that a laborer produced. Laborers worked longer than the time needed to produce subsistence commodities but got paid only the equivalent of subsistence commodities. Marx used the term surplus value to refer to the commodities produced above and beyond subsistence. Surplus value belonged to the factory owners and showed up in their ledgers as profit.
Unit of Analysis
Because capitalists could extract surplus value from workers by virtue of their superior bargaining position, social classes defined by the process of production became the unit of analysis for Marx and most of the classical economists that followed him. According to Marx's theory, workers and capitalists struggle over the disposition of surplus value created by workers. Capitalists try to increase their share, so they can reinvest and reproduce their capital. On the other hand, workers want a greater share of the surplus value to raise their "socially defined level of subsistence" (standard of living). Classical economists use the idea of class struggle to explain many economic events, such as the length of the working day, the wage, profit rate, and the type of technology used in production.
As implied by the full title of Adam Smith's book, 'An Inquiry into the Nature and Causes of the Wealth of Nations', the objective of classical economists was to identify the source of economic wealth and point out ways by which it could be increased. Thus classical economists focused on the production process and the importance of labor. Marx recognized the importance of machinery for increasing surplus value and pointed out that machinery and nonhuman energy increased the rate at which surplus value could be extracted from workers:
The difference between tool and machine is that in the case of a tool, man is the motive force, while the motive power of a machine is something different from man, as is, for instance, an animal, water, wind ...
Marx also recognized the critical role that fuel played in the types of machines and industrial organizations possible:
Wind was too inconsistent and uncontrollable . . . the use of water could not be increased at will, it failed in certain seasons of the year, and above all it was essentially local. Not till the invention of the steam engine was a prime mover found that begat its own force by the consumption of coal and water, whose power was entirely under hand control . . . that permitted production to be concentrated. (Marx, p. 377.)
Although Marx and other classical economists recognized the importance of fuels, important differences remain between classical economists and an emerging body of thought organized about an energy theory of value.
To neoclassical economists the notion that value was "put into" goods and services by labor during production was unacceptable. Instead of assuming that all goods and services produced had some use value, as did classical economists, neoclassical economists made subjective human wants the overriding factor in the valuation of goods and services. For them, the value of an object lay in its desirability to people, so its value cannot be determined until it was exchanged in the market. Uniting all neoclassical economists is the belief that market forces fix the value of goods and services based on the supply of that good, which depends on the willingness of people to work, and the demand for that good, which depends on the utility that good provides to people.
Before the writings of early neoclassical economists, such as Jean-Baptiste Say (1767-1832) and Nassau Senior (1790-1864), could be considered on the same footing as the classical school, economists in the emerging neoclassical paradigm had to overcome a theoretical roadblock proposed by Adam Smith. Smith dismissed a theory of value based on utility on these grounds:
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 frequently have little or no value in use.
Specifically, Smith referred to a seeming contradiction in the value of diamonds relative to water:
Nothing is more useful than water; but it will purchase scarce anything; scarce anything 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.
It was not until the 1870s, when Stanley Jevons, Carl Menger, Bohm-Bawerk, and Leon Walras independently developed the concept of marginal utility could the diamond-water paradox be resolved and the neoclassical school develop a consistent model for explaining value and other economic events. According to neoclassical theory, utility is the benefit derived from consuming a good or service, whereas marginal utility refers only to the utility obtained from the last unit consumed. Because neoclassical theory assumes that the utility derived per unit of good declines for each additional units consumed, marginal utility diminishes as the quantity consumed increases. The price consumers are willing to pay declines as the quantity purchased increases because of the diminishing returns obtained from additional purchases.
The concept of marginal utility was used to resolve the diamond-water paradox. The marginal utility of the first units of water consumed are great, but as our thirst is satiated and our bellies bloat, the marginal utility of water becomes very small, even negative. The same is true for diamonds. The first few (diamonds) we own are very precious, but as our jewelry boxes swell, the utility obtained from another diamond diminishes. The difference in the value of diamonds and water arises because most of us have plenty of water so additional units have relatively little value. On the other hand, most of us have very few diamonds, so additional diamonds are very dear.
Armed with the analytical tool of marginal utility, the neoclassical paradigm set out to explain the value of all goods and services traded in the market. Neoclassical economists believe that the value of a good or service is set by the balance between the desire to consume and the unwillingness to work. ln other words, because we do not like to work, we must be paid more to work extra hours. Our decisions as to the time we are willing to work depends on how much we dislike our last hour of work (versus leisure) compared to how much we enjoy the good or service purchased with the income earned by the last hour worked. According to neoclassical theory, individuals balance these goals so the disutility (pain) of the last hour worked equals the utility (pleasure) derived by spending the last dollar earned and the utility derived from an additional hour of leisure. The point at which the two are equal is the equilibrium point. At equilibrium the amount of good or services produced equals the amount of productive services offered, and this equality sets the price at which they exchange.
Unit of Analysis
The individual is the unit of analysis for the neoclassical economist because neoclassical economists take the existing distribution of wealth as a given, and different individuals are assumed to have unique tastes and preferences that are determined outside the market where bargaining and exchanges take place. According to this view individuals make rational decisions as to how much of their labor, capital, or land they offer on the market and how they rank their purchases based on personal tastes and preferences. Neoclassical theory treats macroeconomic phenomena as the sum of individual decisions based on tastes and preferences exogenous to the economic system rather than the result of class struggle. For example, employment levels and total output represent the sum choice of millions of individuals who decide how much of their productive factors they offer in the market and current levels of productivity and capital stock.
The objective for neoclassical economists is to ensure that the market operates efficiently. Neoclassical theory maintains that the market integrates individual supply and demand curves, setting the value of goods and services, although such ideal values can be biased by oligopolistic industries, externalities, and hidden subsidies, such as taxing policies, production incentives, price floors, and price ceilings. Once such disruptions are identified, neoclassical economists attempt to evaluate the magnitude of the disruption and suggest policies for correcting or ameliorating their effect.
The differences between classical and neoclassical economic paradigms are important because they lead classical and neoclassical economists to ask very different questions about the economy and approach economic problems from a different point of view. In the following section we describe the beginnings of an economic paradigm based on the importance of energy. Although we do not subscribe to all the theoretical aspects of this emerging field of thought, our own analysis does spring from its theoretical principles concerning value, units of analysis, and objectives.
Energy Theory of Value
The laws of thermodynamics were formalized by physicists in the middle of the 19th century. Since then the principles derived from these laws have been used by many analysts in the social, biological, and physical sciences. Classical and neoclassical theories recognize the importance of fuel and other natural resources as necessary factors of production but believe(d) that these factors are not important enough to warrant the incorporation of the laws of energy and matter into economic theory. Two notable exceptions in the economics profession are Nicholas Georgescu-Roegen and Herman Daly who both describe the lack of a biophysical foundation as a major deficiency of conventional economic theory. But in general, the people who give energy a major role in economic systems are outsiders, such as biologists, physicists, sociologists, and engineers.
As succinctly expressed by Frederick Soddy:
If we have available energy, we may maintain life and produce every material requisite necessary. That is why the flow of energy should be the primary concern of economics.
The intent of Soddy and other analysts with a biophysical perspective of economics has been to synthesize a new paradigm, making the supply and quality of fuel and other natural resources the focus of analysis. Two ecologists, Howard T. Odum and Robert Costanza, have been in the forefront of those attempting to forge an alternative economic paradigm based on an energy theory of value. These ecologists and others are currently attempting to fashion these ideas into a complete paradigm for explaining economic systems. In this section we describe the attempts at such a synthesis.
As set forth by Odum and Costanza, an energy theory of value assumes that individual and societal tastes, preferences, and economic decisions are influenced and often directed by environmental factors like natural resource quality and availability, and in particular free energy. In this line of reasoning energy is the organizing principle from which all values—economic, social, and political—ultimately are derived. Odum states that the formation of human tastes and preferences, a process explicitly beyond the realm of neoclassical economics and insignificant to the classical economist's view of class struggle, are critical to a thorough understanding of economics.
Odum's energy theory of value draws on Alfred Lotka's hypothesis that natural selection is driven by differential rates and efficiencies of energy use relative to competitors. Odum proposed that moral, ethical, and all psychological phenomena are derived from incorporating surviving patterns as ultimate values, simply because patterns selected against eventually disappear. Because of the importance of free energy he proposed that changes in the rate or efficiency of energy use lay at the heart of many human behaviors. According to Odum's hypothesis, changes in energy availability and the rate and efficiency of energy transformations are the principal mechanism in natural and cultural selection and economic development.
According to Odum, the maximum power principle is the criterion by which systems, whether they are ecological or economic, select behavior patterns. Surviving patterns are those that enable an organism, culture, or any unit of a system to transform energy from its environment into useful power at a rate and efficiency that enables an organism to compete successfully with those around it. The maximum power principal is based on the observation that for most energy conversions the efficiency of the conversion decreases as the rate of energy conversion increases. At very slow rates energy is used very efficiently, but because of this slow rate, not much power is generated. Furthermore, at low rates of use much of the energy resource remains available for potential competitors. At very rapid rates of use energy is used relatively inefficiently, and the power generated is small because not much of the energy consumed is converted to useful power. Thus at some intermediate rate there is a trade-off between effficiency and speed that maximizes power. Odum hypothesized that maximum power is the optimum that all living systems strive for.
Robert Costanza extended Odum's original analysis and offered empirical evidence that supports one necessary condition for an energy theory of value: the relative prices of goods can be explained by their relative embodied energy cost. Costanza hypothesized that solar energy is the only net input into the biosphere; therefore a perfectly functioning market would, through a complex evolutionary selection process, arrive at prices that were proportional to their embodied energy content. In support of this hypothesis Costanza showed that the fossil fuel energy embodied in goods and services is closely correlated with market-determined dollar values when the analysis is aufficiently comprehensive.
According to Odum, systems that maximize power outcompete those that do not. As W. Fred Cottrell proposed, some cultures switched from one energy source to another because such a substitution offers the potential to generate a greater amount of useful economic and social power. Thus some energy analysts hypothesize that economic systems (through the actions of their individual members) attempt to maximize power just as neoclassical economists hypothesize that individuals attempt to maximize utility and just as classical economists hypothesize that economic classes struggle for a larger share of surplus value.
Dollar Profits in Energy Terms
The nature and origin of economic profits can be explained with the theoretical construct of an energy theory of value. An energy theory of value suggests that profit in human economic systems is the unpaid work of nature measured in dollar terms. Profit accrues to those who control the products derived from the flow of energy. Such a view is analogous to Marx's theory of surplus value where profits were equated with the unpaid services of labor.
Natural resources are highly-ordered, thermodynamically improbable arrangements of matter. Biogeochemical cycles, which are driven by solar energy and energy derived from radioactive decay in the Earth's interior, occasionally have organized the various elements into concentrations far greater than would be found in a system at maximum entropy. Had this work not been done by nature, or had it been done to a lesser degree, humans would have to invest far more of their economic energy simply to upgrade natural resources to a state where they could be used as a factor of production. Humans reap the benefits of nature's work but do not pay nature a dollar amount for its services rendered. According to an energy theory of value, the uncompensated effort of nature is what makes profit possible in human economic systems.
The work done by nature in creating and upgrading fuel deposits is especially important. Surplus energy available from fuel is measured by its energy return on investment (EROI) and represents the energy available to produce nonenergy goods and services. As the energy surplus grows, it is possible to increase the per capita material standard of living. The distribution of the products of surplus energy depends on individual levels of productivity and the relative bargaining position of economic classes. It is not possible to predict the distribution of the products of surplus energy or to judge whether a given distribution of surplus energy is just or not. An energy perspective can, however, identify the source of societal surpluses and how changes in the natural resource base affect this surplus.
Unit of Analysis
Inherent in an energy theory of value is the principle that a society, or individual, maintains its existence by securing energy and natural resources from its environment for the purpose of producing those goods and services that facilitate survival. Individuals choose items freely in the market, but they may be penalized for choices that may jeopardize their survival or the survival of their culture in the long run. Because of this ongoing selection process, whole cultures may institutionalize choices that have contributed greatly to their survival, in a manner analogous to natural selection in biotic systems.
Survival of a system requires the survival of its support system (e.g., a human economy and its environment). Each unit of a system must contribute certain amounts and qualities of work to its support system, or else that unit will drain resources away from the system causing that unit and the entire system to be selected against. The requirement for survival of any part within the system therefore is some type of service fed back to some other unit of the system. Since low-entropy energy is the primary requisite for the survival of any living system, the useful work contributed by an individual unit is a measure of its value to the system as a whole.
The objective of energy analysts is to understand how energy availability and use influence the rate and direction of economic and cultural development. The interactions between components of economic systems also interest energy analysts because it is important to understand how the actions taken by one part of the system affect the functioning of the other parts and how this interaction affects the type and amount of economic work done. For example, extracting fuels from the environment may disrupt other natural energy flows which the economy also depends on. Thus the net amount of useful power generated by extracting fuel from the environment depends in part on the amount of fuel extracted relative to the magnitude of the natural energies lost due to the extraction process. Because such impacts of fuel use occur during the production process, energy analysts tend to focus on production just like classical economists.
An energy theory of value emphasizes basic physical laws rather than the psychical attitude of humans to explain economic phenomena. Energy, however, is not a necessary and aufficient cause of economic value because many economic decisions are not influenced by energy quality and availability. Criteria other than biophysical laws also must be considered when developing models to explain and predict human economic behavior. Federick Soddy observed:
. . . the interest of the average man will be and must continue to be in a just appreciation of the relations of several worlds, the spiritual and the mechanical, to his own life . . . they do not meet in common ground in him. His is the unfortunate body from which, during life, neither the aspiring soul can altogether soar, nor the wheels of scientific materialism can be unmeshed. He has to make his peace with both, as he is the sufferer if his soul gets caught in the gear.
Like Soddy we emphasize the physical aspect of life at the expense of the humanistic aspect but not because we deny or belittle the existence of the latter, rather because the former has been greatly ignored in the history of economics. Although a biophysical perspective is very different from either one of the two economic paradigms that hold political power in different nations, we feel that it is indispensable to solving many economic problems faced by all societies.
- Hall, Charles A.S., Cutler J. Cleveland, and Robert K. Kaufmann. Energy and Resource Quality: The Ecology of the Economic Process. (Wiley Interscience: New York, 1986). (Reprinted by the University of Colorado Press, Niwot, CO 1992). ISBN: 0471087904
- Hannon, Bruce M. 1973. An energy standard of value. Annals of the American Academy of Political Science, 410:139-15.
- Odum, Howard T. and R. C. Pinkerton. 1955. Time's speed regulator, the optimum efficiency for maximum output in physical and biological systems, American Scientist, 43:331.