Blame the Physiocrats for Objective-Value Theory
[Excerpted from An Austrian Perspective on the History of Economic Thought, vol. 1, Economic Thought Before Adam Smith (1995). An MP3 audio file of this article, read by Jeff Riggenbach, is available for download.]
Although the physiocrats had useful insights into political economy and the importance of the free market, their distinctive contributions to technical economics were not only wrong, but in some cases proved to be a disaster for the future of the economic discipline.
Thus for centuries the mainstream of economic thought, generally embedded in Scholastic treatises, held that the value, and therefore the prices, of goods were determined on the market by utility and scarcity, that is, by consumer valuations of a given supply of a product. Scholastic and post-Scholastic economics had basically solved the age-old "value paradox" of diamonds and bread, or diamonds and water: how is it that bread, so useful to man, is worth very little on the market, whereas diamonds, a mere frippery, are so expensive?
The solution was that if quantities of supply are taken into account, the seeming contradiction between "use value" and "exchange value" disappears. For the supply of bread is so abundant that any given loaf will have a negligible value — in use or in exchange — whereas diamonds are so scarce that they will command a high value on the market.
"Value," then, does not pertain in the abstract to a class of goods; it is imparted by consumers to specific, real units, and such value depends inversely on the supply of a good. The only thing left to complete the explanation was the "marginal" insight imparted by the Austrians and other neoclassicals in the 1870s.
The Scholastics saw that the utility of any good diminishes as its stock increases; the only thing lacking was the marginal analysis that real-world purchases and evaluations focus on the next unit (the "marginal" unit) of the good. Diminishing utility is diminishing marginal utility. But while the capstone of utility and subjective-value theory was yet missing, enough was already in place to provide a cogent explanation of value and price.
Despite his troubling injection of "intrinsic value" as a quantity of land and labor in production, Cantillon had continued in this late-Scholastic, proto-Austrian tradition and had indeed made many contributions to it, particularly in the study of money and entrepreneurship. It was the physiocrats who broke with centuries of sound economic reasoning and contributed to what would become, in the hands of Smith and Ricardo, a reactionary and obscurantist destruction of the correct analysis of value.
Dr. Quesnay begins his value analysis by disregarding centuries of value theory and tragically sundering the concepts of "use value" and "exchange value."
Use value reflects the individual needs and desires of consumers, but, according to Quesnay, these use values of different goods have little or no relation to each other or, therefore, to prices. Exchange value, or relative prices, on the other hand, have no relation to man's needs or to agreements among bargainers and contractors.
Instead, Quesnay, the would-be "scientist," rejected subjective value and insisted that the values of goods are "objective" and mystically embedded in various goods irrespective of consumers" subjective valuations. This objective embodiment, according to Quesnay, is the cost of production, which in some way determines the "fundamental price" of every good.
As was even true for Cantillon, this "objective" cost of production appears to be somehow determined externally, from outside the system.