Frank Rotering: An Economics for Humanity

PART 3 - THE HUMAN FRAMEWORK (page 2)

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In brief, effectual value is used in the human framework to judge consumption. It answers the question: given a certain amount of intrinsic value created in production, how effectively is this converted into real health benefits?

It is important to note that my use of a single apple and house above is intended only to illustrate the concepts of intrinsic and effectual value. In real analysis we would normally not deal with individual outputs, but with the economy's aggregate production of fresh produce, housing, etc. The purpose of human economics is to permit broad analysis of economic issues, and these two concepts should be viewed in this light.

6. THE ECONOMY AND NATURE

Before moving from value to cost, I should discuss the relationship between the economy and nature. This relationship poses difficult problems.

The key issue was summarized by Juan Martinez-Alier, the unofficial historian of the ecological economics movement: "... the economy, from the ecological point of view, does not have a common standard of measurement. Economists are left without a theory of value. This is the main point of this book." (Ecological Economics, 1987)

The accuracy of the above is readily apparent. My standard of value and cost is the physical health of human beings, which is clearly inapplicable to the natural world outside our bodies. We can measure physical changes in nature due to production and consumption, and we can measure the effects of such changes on human beings, but we cannot directly "feel" the value and cost it experiences. This problem afflicts any human-based standard.

Although some will argue the point, this means that in economics, humanity is the exclusive realm of value and cost, while nature is the realm of physical stocks and flows. The question is how to integrate these in a coherent manner.

The approach I have settled on is the following. I ask the group to carefully scrutinize this approach and to offer its views.

First, I make two distinctions:

1. Between marginal effects and threshold effects. When a lake is initially polluted, the pollutants affect human health incrementally by contaminating fish and poisoning drinking and swimming water. These are marginal effects. Beyond a critical point, the lake's ecosystem will collapse. This is a threshold effect.
2. Between marginal effects that impact physical health and those that do not. The latter include environmental changes that some people may find esthetically or spiritually destructive, but that do not have physical health consequences.

Second, based on these distinctions, I divide the natural effects of production into three categories:

1. Marginal effects that impact physical health
2. Marginal effects that do not impact physical health
3. Threshold effects

The first category can be addressed with the concept of natural cost, defined below. The second category falls outside the scope of my value/cost standard, which means such effects cannot be analyzed in the human framework. This is a limitation of my approach. The third category cannot be addressed with marginal analysis at all because a threshold entails discontinuity. An analytical approach to threshold effects is offered in the ecological framework.

7. EVALUATING PRODUCTION: OPPORTUNITY COST AND INPUT COST

When inputs are used up in production, two discrete things are sacrificed:

1. The possibility of employing the same inputs elsewhere;
2. The positive and negative impacts on the input factors - the human beings who provide the labour and the natural facilities that furnish the resources and receive the wastes.

Among the most blatant ideological distortions in standard economics is the reduction of both types of sacrifices to the first. The second type is ignored, thus sweeping the potential destruction of people and nature under the rug. This ethically bankrupt combination is called opportunity cost.

Despite its misuse by standard economics, opportunity cost is not a false concept, but rather a limited one. The human framework accepts the concept within its proper scope. Natural resources and human labour must be allocated to the outputs we value most, and the concept helps us achieve this.

In the human framework, the opportunity cost of using an input in production is defined as the intrinsic value of the best alternative output to which that input could have been applied. Because opportunity cost is a familiar concept in economics, I will not discuss it further in this summary.

The second type of sacrifice is fully recognized by the human framework, and is called input cost. It is defined as the direct and indirect effects of production on humankind's physical health. When these effects are direct - through labour - they are called labour cost. When they are indirect - through environmental changes associated with production - they are called natural cost. The sum of labour cost and natural cost is the input cost of production.

Labour can cause both positive and negative health effects. Labour cost is positive when labour causes excessive fatigue, debilitating stress, injuries, disease, or death. It is negative when labour increases strength, stamina, vigour, etc.

Note the potential confusion here. Cost - meaning positive cost - refers to the sacrifice human beings make in obtaining value. A positive cost is therefore a bad thing - it implies a decrease in health. Conversely, a negative cost is a good thing - it implies an increase in health. Please take this inversion into account when examining the graphs below.

Natural cost can also be positive or negative, and the same inversion applies as for labour cost. Natural cost is positive when production fouls the environment and destroys habitat in such a way that human health is adversely affected. It is negative when production creates a cleaner or more habitable environment, resulting in increased human health.

Below is a generalized depiction of input cost and its two components:

As with the previous graph, the vertical axis is measured in marginal health units, and the horizontal axis represents the quantity of an output produced in a specific period of time.

The dashed (lower) curve represents labour cost. The curve starts below zero on the vertical axis and is therefore a negative quantity. As discussed, a negative cost implies a positive health effect, so my arbitrary assumption here is that labour is initially beneficial to health.

As labour time increases with quantity produced, this initial effect is offset by fatigue, stress, and injuries. The curve therefore swings upward, and eventually becomes positive as the detrimental health effects start to dominate.

While the exact shape of the labour cost curve will vary with conditions, I assume that the curve rises as the quantity produced, and therefore labour time, increases. This is consistent with the standard assumption about costs in economics, as discussed in part 2.

The solid (upper) curve represents input cost - the sum of labour cost and natural cost. Natural cost is the vertical distance between the labour cost curve and the input cost curve. As with labour cost, I assume that natural cost increases with quantity produced.

8. OPTIMUM QUANTITY FOR A FINAL OUTPUT

The value and cost graphs can be combined to determine the optimum quantity for a final output. Ignoring thresholds for now, this is depicted in the graph below:

The optimization rule has already been stated: increase quantity until the rising cost of production exceeds the falling value from consumption. Q* is the point where this occurs, and this therefore marks the optimum quantity for the final output.

At Q* human beings gain the health effects represented by the shaded area. If less is produced, this area will shrink. If more is produced, losses will be incurred, and net gains will decrease.

It is important to note that Q* is an optimum quantity, not just a maximum quantity. That is, we should increase output to Q* if it is currently less, and decrease output to Q* if it is currently more. I underscore this because many outputs are underproduced, not overproduced. This is particularly true for outputs that address the needs of the poor and therefore tend to have insufficient effective demand in a market economy.

The importance of the graph is that it provides a rational basis for a group, community, or society to choose appropriate output levels. When this logic is extended to all potential outputs, it can be used to define a humane economy. When consideration of thresholds is added, the logic helps define a sustainable economy.

An apparent limitation of the above method is that it applies exclusively to final outputs. This leaves open a critically important question: what is the optimum quantity for an intermediate output such as a raw material, lorry, or office desk?

To address this, we have to understand the relationship between a final output and the intermediate outputs involved in its production. As stated, intermediate outputs have no intrinsic value. We can consume the food transported by the lorry, but not the lorry itself.

The "value" of an intermediate output is therefore a derived quantity - it depends on the intrinsic value of the final outputs it helps produce. If a community needs 10 lorries to transport its food from farm to shop, then the optimum quantity of food-transporting lorries is at most 10.

Why "at most"? Because the food may not be produced at their optimum quantities. If we are using two lorries to transport cucumbers, and the optimum quantity of cucumbers for this community fills only one lorry, then the second one is economically unjustified.

Let me restate the important general conclusion:

The optimum quantity of an intermediate output is the quantity required to produce the optimum quantities of all the final outputs with which it is associated.

One more point in this connection. The intrinsic and effectual value curves above pertain to the final output alone. The labour and natural cost curves, on the other hand, pertain to the entire production chain. This includes the production of all required intermediate outputs, plus the final output itself. This should make intuitive sense: we derive benefits from consuming only the end product, but incur costs at every stage of the production process.

In the ecological framework (part 4) this method for determining an optimum quantity is modified to take account of threshold effects.

9. SUMMARY OF OTHER TOOLS

For completeness, I briefly describe the remaining tools in the human framework below.

a. ANALYSIS OF TOTAL OUTPUT: The ideas presented above can be extended to graphically represent an economy's total output. This provides a snapshot of the economy's overall gains and losses, and allows us to represent changes to an economy over time.

b. LIMITS TO GROWTH: I define three limits to growth: the economic, absolute and ecological. Herman Daly has independently done the same. In Feasta Review #1 (p. 23), he refers to these as the economic limit, the futility limit, and the ecological catastrophe limit respectively.

c. ECONOMIC WELL-BEING: A well-known problem with aggregate quantities is that they ignore distribution. Aggregate gains could increase, but certain individuals or groups could nevertheless suffer. To address this, I define economic well-being as the difference between the effectual value achieved by an individual or group over a period of time, minus the input cost they incur over this same period. This concept allows us to ethically balance aggregate effects and individual or group effects.

d. EFFICIENCY: Standard economics uses this term to refer to Pareto optimality, a loose concept devoid of ethical content. I define three types of efficiency: consumption, production, and economic. These concepts use intrinsic value, effectual value, and input cost, and give us another way to summarize the results of economic activities. Again, there is an overlap with Daly's work. In Steady-State Economics (1991) he uses the concepts of service, stock, and throughput to define similar efficiencies.

While I owe much to Daly, I will offer a critique of his work, and of ecological economics generally, at the end of part 4 - the ecological framework.

Comments can be sent to Frank Rotering at frank_rotering@yahoo.com

Introduction to Frank Rotering's articles on the Feasta website