Markets as Utility mines, a metaphor for the economy.

A common idea in economics courses is the idea of utility, basically how much people value things. The obvious corollary is disutility, how much people dislike stuff. For example, I like the taste of chocolate, that’s utility, and I dislike that each bar comes with health risks, that’s disutility. We tend to conceptualise free-market economics as about rewarding the creation of utility but that’s an important point of confusion. Perfectly competitive free markets do not do this. Instead, they compensate us for the disutility involved in the creation of something that has utility.

To understand this, and why it’s important, consider a classic model of a perfectly competitive market. In this model producers compete with each other to provide goods and services. How much people want a particular good, the demand for that good, intersects how much it costs to produce that good, the cost of supplying that good, at some price and quantity. The market will then produce that quantity and sell the good for that price. It’s very important to note that goods priced this way are not sold for the maximum amount people are willing to pay but instead for the price where there is one last person who is willing to pay exactly that price, but no more, and the last unit of those goods is produced at exactly that price. All the people who wanted the goods more than that last person receive more utility out of the goods than the price they paid. That means the VAST majority of people pay less than the maximum they would be willing to. On the other side producers sell all their goods for the current price, even if some of the goods cost less than that to produce, this is profit. If the profit produced is greater than the going return on capital then more producers will enter the market, causing profits to be squeezed until the profits are the same or less than the going rate of return on capital.

What this means is that, over time, producers end up receiving for their goods only enough profit to cover the costs of capital (which in a perfectly competitive marketplace are zero!) and so receive only enough to compensate, exactly, for the disutility of production and not a penny more. Consumers meanwhile pay far less, on average, for the goods that they buy than how much pleasure, utility, they get from those goods. In other words, in a properly functioning market, prices very closely match the disutility required to create a product but have almost no relation to utility created by those products.

So where does the utility mine metaphor come in?

Well, there are two different descriptions of economics we can create this way, the first is a misunderstanding of economics that is corrected by understanding what we’ve talked about above and adding that understanding back into economics we can get to the second, correct, metaphor.

First, the incorrect interpretation. In this version of the economics story, that is so often told, the economy is kind of like a mine that converts the resource of people’s unproductive time into productive utility. We need to pull people into work and get them to work there as much as possible in order to maximise our utilisation of the labour force to produce utility. The economy mines time, through labour, to produce utility. That misunderstands the actual dynamics of the situation though. It is neither the case that more labour always results in more utility nor that the price of that labour reflects the utility created.

This idea is often used to justify the high wages of CEOs as them creating lots of value but that is not how goods and services are priced, including labour. CEOs may well be paid far more than nurses, doctors or teachers but that should not be taken to imply they produce more value. Wages should instead reach an equilibrium such that they perfectly match the disutility each person takes on when they do a job. If that disutility is greater than the utility created then the job will not be done, but if the utility created is far more than the work done that does not mean the wage goes up. In a perfectly competitive market it only goes up so far as to cover the disutility that must be taken on to do the work. What is reflected in high CEO wages is not greater utility created but scarcity.

Adam Smith famously made the point that if prices reflected utility then water should be far more expensive than diamonds but actually water was almost always free in Smith’s time and diamonds were expensive. Why? Water was plentiful and diamonds were rare and, importantly, could not be man-made at the time so there was a limited supply. This breaks the functioning of the market. Perfect free markets would have both diamonds and water equally plentifully abundant but they are not. This would even be fine if diamonds were abundant but took physical effort to acquire, then the price of diamonds would simply fall to the cost of the disutility/unpleasantness and difficulty of getting the diamonds. The problem comes when the limited supply of something means that if the price were to fall to the level that covers only the disutility, the free market price, there wouldn’t be enough supply to fulfil demand. In that situation the price rises above the level that merely covers the disutility. That is called a market rent. That is what CEOs are collecting and nurses are not, hence the price difference in their labour. Nurses may be creating more utility than CEOs, or less, or the same, it doesn’t make any difference to the price of their labour. All that matters in the first instance is the unpleasantness, disutility, of doing the job, that creates the free market price, and then the additional effect of scarcity, natural or artificial, which allows producers in that situation to collect monopoly rents, as CEOs do and nurses do not. This can happen naturally because something is rare, like land in central London, or unnaturally, like (somewhat ironically in this context) the way the largest diamond company controls so much of the supply that it can deliberately restrict the supply and increase the price above the natural level. Diamonds are therefore both naturally and artificially rare! Arguably CEO wages fall into the later category of artificial restriction but it can be both, e.g. the skills for a CEO are indeed rare but not quite so rare as corporate practices make out, inflating CEO pay.

In addition to this it is dangerous to see markets as mining time to create utility because it forgets that, just like water in Adam Smith’s time, things can be free and have large utility. Considering only the conversion of time to labour to goods and services as counting as utility causes us to miss the value of many things, especially free time and how we use it! Spending time with friends and family may not generate any commercial value but it can have very large utility.

This is the fundamental problem with the meritocracy/neoliberal economic narrative that is essentially the “mine time for labour to create goods and services” narrative. It mistakes the value of goods and services as utility when actually many things with no monetary value, including free time, generate utility, and it misunderstands pricing mechanisms and assumes they reflect utility when this is neither true in perfectly competitive markets or real-world imperfect ones. It fails to accept the reality of the situation, or even how the hypothetical perfect market works, on any level. This creates enormous socio-political-economic problems in society. So while proponents of this ideological position may genuinely and deeply believe in their catchphrase of “equality of opportunity not equality of outcome” it can not be achieved via simply deregulating markets or even by making them more competitive. Whether it is a moral and decent aim to have in the first place is a different question but it is unachievable via this method regardless. It may be unachievable by any method! What is required instead is to move to the second metaphor/a more accurate reflection of how markets work. At that point if individual proponents of meritocracy want to privately take on that position they can do so by deciding who they see themselves as inferior to and donating some portion of their income, as they feel appropriate, to those they consider superior. The privatisation of neoliberalism if you will. If individual people want to genuinely believe that Bill Gates is inherently superior to them and should be rewarded for the value he has created they are welcome to donate to him. Clearly from my tone I personally see this as absurd on its face but for those who do take this ideological position it will be entirely possible to make such donations and it makes logical sense for society to move to an accurate model of how markets do and can work, so that we have something that functions, and then for those individuals to have the freedom to act on their beliefs.

So what is the second metaphor and how can we conceptualise markets as functioning effectively to mine utility?

The second metaphor would be this: making people happier is a good goal, the problem is sometimes we face choices that create both happiness and unhappiness. We want to maximise happiness, minimise unhappiness and figure out how to fairly distribute the rewards and the burdens. This is what the economy, the world’s great utility mine is for.

Utility is mined out of the world we live in but it creates by-products along the way, disutility. Just like real mines create waste products we don’t want and we have to figure out how to dispose of them the economy does the same. We must dispose of that disutility efficiently. What perfectly competitive markets are really designed to do is handle that waste management process. They are about getting to the utility that’s out there but the way they do that, just like real mines, is by excavating all the disutility that’s in the way. Mining isn’t about creating the thing you’re mining, as such, it’s about excavating all the other stuff that’s in the way and disposing of it. That’s what markets, when designed right, can do.

Plenty of utility exists outside of markets and doesn’t require markets to sort out disposal of disutility. Sometimes you don’t need to mine for something because it’s already available above ground but finding a diamond lying on the ground doesn’t make it less valuable than if you dug it out of the ground! What mining does is it allows us to increase our supply of something with some effort, just like the economy lets us increase the amount of utility we can access by accepting a bit of disutility. We need to find out if the mining operation/disutility is worth it and then we need to dispose of the waste correctly. Markets help with both of these things. Perfect markets are sadly not possible in real life but we can be closer to perfect markets or further away from them. This does not simply mean less regulation. Sometimes more state action brings us closer to perfect markets, sometimes we need less state action, it depends but we can talk about perfect markets for now as an idealised example. In perfectly competitive markets nobody makes any profits because competition is too fierce and so profits are pushed down to the cost of capital, which in a perfect market is zero. We can’t really do this in real life but we can simulate it or mirror its effects to get relatively close. Instead when happens is that customers (all of us) look at the additional utility available via mining and demonstrate how much they are willing to pay to get it. Workers (also all of us) then display their willingness to take on the disutility required by saying how much they would require in payment to shoulder that disutility. I.e. part of the extra utility created by the economy mine is used to compensate the people who take on the waste, the disutility, of the mining. However, as most customers will pay less than the maximum they are willing to pay for goods and services some of the utility will go to the customers paying for the goods. So if and when markets work like this the additional utility created by mining is shared between customers (all of us) and the workers (the subset of people who decide they are willing to take on the disutility in exchange for some extra share of the utility created). Workers can, in a perfect market, always walk away and so are always compensated with enough utility for the work to be worth it for them but not so much that customers see none of the benefits. That’s why perfectly competitive markets are seen as so good.

What’s important to note here is the differences both in how people who are often referred to as capitalists describe markets and what perfect markets actually look like and also in the differences between perfect markets and the real world.

If we want our economic utility mine to work well then markets really are a useful tool and we should use them but we must be mindful of what we need to do to get markets to look more like they are supposed to under perfect competition. That can involve higher or lower taxes, more redistribution or less, more regulation or less, all depending on circumstances. We should not be afraid to challenge those who try to redefine what markets should look like to pad their own bottom line and we shouldn’t be afraid to acknowledge the differences between perfect markets and the real world so we can correct for those differences. Finally, we should be confident and comfortable in acknowledging the value that exists outside of markets so that we do not fall into the neoliberal/Conservative trap of reducing utility, reducing happiness, to protect a broken ideological position that we exist only to work for the benefit of our betters.