I recently read an economics article discussing Frederic Bastiat, the 19th century French economist.
I happened to read some of the comments below the article and I was struck by one particular commenter and his claims. The commenter said that Bastiat operated under the labor theory of value.
When challenged on this, the commenter stated: “He (Bastiat) argues, for example, that products imported from places where natural conditions are more favorable would be less expensive because less labor is required to produce them, with nature doing more of the work…”
When someone responded that this still does not imply that Bastiat subscribed to the labor theory of value, the commenter responded, “When he claims that products requiring less labor have lower prices, what would you call that?”
A few of the responses were pretty good, but I would just like to point out how wrong this commenter was.
The labor theory of value argues that the economic value of a product is determined by the total amount of labor required to produce it. The Austrian School of economics has gone to great lengths to debunk this theory.
Anyone who works in a large office setting, or really any work environment with a large number of employees, probably understands that some people do more work than others. Some people produce far more than others. The amount of time someone spends on a product doesn’t tell us how much that product is worth.
Even if everyone were equally skilled and motivated, it still wouldn’t make sense. You can spend hours or days to complete a painting of the sky with clouds. But if nobody wants to buy a painting of the sky, then your long work doesn’t mean anything to the potential consumers. If you spend a lot of time to produce something that consumers don’t value, it does you no good. It doesn’t mean they will all of a sudden want it just because you worked hard and long to produce it.
Ultimately, it is consumer preferences that determine the price. It is whatever they are willing to pay.
But – and this is a big but – it doesn’t mean that the input costs don’t matter. If people are willing to pay $10 for a particular rug (but no more) and you can’t produce such a rug for under $10, then it won’t be produced. But if it can be produced for $5 and sold for $10, then it becomes worth it to the entrepreneur.
In addition, competition between sellers matters. Let’s say that people are willing to pay a high price for Coke or Pepsi, but most people are willing to switch to the other if there is a large price differential. Let’s say that the input costs for Pepsi increase substantially, while Coke does not see the same increase. If customers can buy Coke for significantly cheaper than Pepsi, then more consumers will turn to Coke.
Let’s say the government implements a 10% tax on revenues on the seller of soda products. Before, Coke and Pepsi were both selling the same sized bottle for $1.00. With the added tax, it is not profitable to sell these bottles at $1.00. Coke and Pepsi both raise their prices to $1.10 per bottle. Many people may just continue to buy as they did before. Maybe a few will switch to water.
The point is that input costs matter. If a foreign country can grow vegetables with minimal labor as compared to here, then it will probably make sense to import these vegetables, assuming the shipping costs are reasonable and the vegetables can be kept fresh. If it costs a lot to produce those same vegetables at home, then the price would have to be higher in order to be profitable.
So why I am saying all of this?
Aside from the economics lesson, this is a great example of where a little bit of knowledge can really hurt you. The person who made these comments has obviously done a little reading on the labor theory of value, and I think he meant well. He understood a little bit of it, but he does not grasp the whole concept. He made assumptions that are simply wrong.
Most people have no idea what the labor theory of value is. Most people also wouldn’t have made this basic mistake that this person did, who is mildly educated in Austrian economics. Most people who don’t study any economics would probably understand that the price of a product would likely be cheaper coming from an area where significantly less (or cheaper) labor is required to produce it.
I see this often when it comes to investing. I read people who have a somewhat decent grasp of some economic and financial issues. They are very well read as compared to the general populace. Yet, they often make errors within their analysis that completely throws off their conclusions. They often get things completely wrong because of these errors.
Sometimes it helps to take a step back and to ask yourself if what you are reading really makes sense. And if you don’t understand some of the analysis or points made by the writer, then you shouldn’t assume their conclusion is correct. It doesn’t mean that the writer is necessarily smarter than you because you don’t understand everything he has written. It more often means that the writer is confused, or else doesn’t know how to relay his message.
A little knowledge really can be a dangerous thing. If you are going to go deep into a subject, make sure you understand it and that you don’t use it as a springboard to jump to all of the wrong conclusions.