Monday, November 29, 2010

A musing: measuring value

In the previous post, I asked how much of what humans consume is produced through non-human means. That question hits upon one of my core criticisms of modern economics, which is that though economics is the discipline that is suppose to be able to compare apples to oranges, it is, in my opinion, exceedingly bad at doing just that. However, to the discipline's credit, comparing apples and oranges may turn out to be a fundamentally hard problem.

The recessionary events of the last few years have hopefully stirred up people's imaginations and led them to asking, “What's going on?” What finer question can one ask! For those of us who disfavor resorting to simple, ready-made answers to such involved and difficult questions, we soon run into a core problem in economics: by what unit do we measure value? An apple's value can easily be compared to an orange's if apple and orange both can be converted to some common medium of exchange. In the case of real-world apples and oranges and most anything else, that medium of exchange is currency, and in my country, the dollar.

However, most of what accounts for wealth these days is not in the form of apples or oranges or anything else tangible and intrinsically valuable. It's in the form of strictly monetary assets such as bank account balances, shares of stock, mortgages, futures, options, and so on, all of which are reducible to someone somewhere promising to pay something to someone sometime else—IOUs. Or, on the flip side, someone somewhere staking a claim on some future production. One problem this poses for us is: if most of what constitutes wealth nowadays is money, then how accurate is it to use money itself as measurement of value? It's easy to know the length of things when you have a ruler, but if everything in the room is a ruler, and every ruler has a different-sized inch, then it's nigh hopeless to know the length of anything. That's irony. It's also what passes for modern-day mainstream economics. We know the price of so much but struggle with knowing value and thus with questions such as, “How we doing compared to X years ago?”

There's a Native American proverb that says, “Only when the last tree has been cut down; only when the last river has been poisoned; only when the last fish has been caught; only then will you find that money cannot be eaten.” As stupidly simple as this is, it's worth repeating that money has no intrinsic value, and so the value of measuring the value of something like an apple or orange in dollars is done so with the expectation that dollars are stable and universally transferable. Currency itself is otherwise meaningless as a metric. History shows this assumption holds true most of the time and fails spectacularly during the remainder. So it is that I expect an economist to relate the value of things in dollars or any other currency most of the time but not to rely upon the conversion exclusively. But that is not what I observe in fact. Stats such as GDP and trade deficit/surplus are attempts to squeeze value into currency alone, and such monetary metrics appear to hold a monopoly over the minds of mainstream economists. The problem with the strategy is that a significant portion of the production being measured is itself money.

I think the reason for this shortcoming is that we haven't yet figured out a suitable alternate metric. My own guess is that there doesn't exist a simple scalar unit any better than currency; any superior alternative won't mask as much of the complexity of the measurement as currency does. The situation reminds me of truing a bicycle wheel. For those of you who haven't ever attempted to true a wheel, know that it's a hard task that's more art than science. A bicycle rim is made into a circle (or something closely approximating a circle) by adjusting the tension of the spokes. Each tightening or loosening of any one spoke affects the tension of the many spokes near it so that fixing a wobble in one part of the rim may create another wobble or two elsewhere. There's no simple way to analyze a wobbly rim and say, “Aha! That's the one spoke that needs to be adjusted and by yea much.” The practical way to true a wheel is to start at the biggest wobble by adjusting its nearest spokes and then work outward spoke by spoke, possibly many times, to minimize the effects of the spreading waves of newly introduced wobbles. Eventually, if you're doing more good than harm, the wheel is made true enough.

So I suspect that something similar is going on with economics. Any measure of value is hopelessly tied to something else of value, and I suspect that any superior metric won't hide the resulting non-linearity. But what would such a metric look like?

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