Economic Perspectives: What's Still Missing?

If our present economic framework is "too narrow", where might the fault actually lie? The real measure of economic value, perhaps? Scott Sumner takes issue with a recent article from The Economist, "Economists focus too little on what people really care about", and highlights this quote:

The measuring rod itself often causes trouble. Not every dollar is of equal value, for instance. You might think that if two economists were forced to bid on an apple, the winner would desire the apple more and the auction would thereby have found the best, welfare-maximising use for the apple. But the evidence suggests that money has diminishing marginal value: The more you have, the less you value an extra dollar. The winner might therefore end up with the apple not because it will bring him more joy, but because his greater wealth means that his bid is less of a sacrifice. Economists are aware of this problem. It features, for example, in debates about the link between income and happiness across countries. But the profession is surprisingly casual about its potential implications: for example, that as inequality rises, the price mechanism may do a worse job of allocating resources.

Scott Sumner responds:

This is quite misleading, as it implies that the effectiveness of the price system depends on each person placing equal value on a dollar...That's not to say the price system is perfect; there are issues such as externalities and monopoly to consider. But the specific issue of diminishing marginal utility of income is not really a problem of the price system. A better argument would have been that the distribution of income that results from the price system might not be optimal. Then you could have an intelligent discussion of the pros and cons of redistribution of wealth.

Nevertheless, "optimal" in what sense? Part of the problem for pricing, is that discretionary income and non discretionary income are utilized for very different purposes at the outset. In particular, non tradable sector pricing has not only been more closely aligned with non discretionary price making, but also the time scarcity circumstance that result. If price making requirements leave little discretionary income, some individuals may view money as the only relevant measuring rod that matters for their decision making processes.

Perhaps a broader economic perspective would consider the dichotomy between non tradable sector activity and tradable sector activity, given how these sectors affect general equilibrium conditions. What makes the differences between tradable and non tradable sector activity, so important for price outcomes? While price aggregates may be more relevant for economic stability than monetary aggregates, the long term trajectory of a price level still needs to reflect whether the relationship between actual output and aggregate consumption capacity, might actually be shifting. These changing patterns are important, given how nominal income levels also reflect the degree of economic participation in both production and consumption processes. Importantly, non tradable sectors and tradable sectors continue to travel a very different trajectory, given the differences in their approach to output levels. This variance distorts the relationship between price aggregates and marketplace capacity.

Here's another way to think about price relationships as a measure of value: In recent centuries, the good deflation of tradable sector activity during this time has greatly increased the value of a given dollar for disposable income in general. Indeed, the good deflation of tradable sector production processes, has made some less inclined to view money as a measure of value. Consider George Selgin's response to Scott's post for instance: "Going somewhat further, I would say that the whole idea of money as a "measure of value" is a throwback to pre-subjective thinking that we'd be better off without."

However, the bad (internal) inflation of non tradable activity over time, has made these pricing aggregates less responsive to subjective valuations - especially for lower income levels. Hence the apple in the above discussion was a confusing example, as it is representative of good deflation processes and subjective value.

Interestingly enough, George Selgin's earlier emphasis on a production norm is relevant, here. How so? Locally defined production norms for non tradable sector activity, could generate decentralized environments that encourage good deflation in services, housing and physical infrastructure. These new consumption options would gradually increase the marketplace value of time, so that a larger portion of monetary representation could become discretionary. By bringing subjectivity and discretionary choice to non tradable sector activity, price levels could become a more reliable tool for monetary stability, and provide a better measuring rod for economic activity, as well.