What's the right value

Now that the value of world economy is shrinking, the valuation of things has been a topic of discussion in PH, too - what is the economic value of goods, services and even money itself actually based on? Do things have some fundamental intrinsinc economic value or are all values defined by the markets? Adam Smith and Anders Chydenius where the first to understand that demand and availability create an equation, that define a value in general market, but then you could ask, what is demand and availability based on int turn? Karl Marx was looking at the availability side of things and thought that the producing goods has always some properties that are intrinsinc in terms of value, such as the amount of work put in producing things and raw material cost. That idea might have worked in stable demand conditions and assuming the products will always remain the same (In Marx’s time during early industrialization it might have appeared that way) but Marx did not really properly take into account the development of needs and wants and thus development of markets. And production cost and material cost are always based on market value, too, so the intrinsinc value theories are really hard to defend.

One approach is that Economic value would somehow tie with our basic needs and other values in life, such as aesthetic values or the kind of experiences we appreciate. Mao in China tried a system where he tried to ban the appreciation of any individual values of life and allowed individual people to satisfy only the needs that they need for sustaining life, like basic food and clothing. But that kind of life didn’t seem to be very fulfilling in most people’s opinion. Now I think many contemporary theorists, such as Broome (thanks Seneca!) have tried to theorize links how it would be quantitatively possible to assess an economic value of things in respect to our life values. Currently there seems to be many contemporary economic value theories, that are typically formulated so that there is a long differential equation, that has a series of terms that should somehow take into account of the effects of presumed market conditions, individual valuations, market conditions and risks.

When assessing a value of company one usually needs to take into account also the company's ability to produce future income. Then you expected value based on some discounted income from the future. From an accounting point of view, a company has substance value, which is the value of all assets that should realistically reflect the true market value if the assets were sold right away so then the company’s expectation value should be substance value + the expected future income. But a company can also have a “goodwill” value, which can be based on some strategic expectations like removing competition or getting new technology, skills or contacts that has value only from the buyer's point of view. These type of valuation’s should somehow be linked to what is the “correct” value of a company also in the stock market, but but….

I have started to doubt that none of the contemporary economic theories give sufficent picture about what’s going on in real life. They are at best very crude approximations - but too crude in my opinion. I doubt that anyone who has been following economic news for some time can list several examples, where the price of a transaction event has been completely disconnected from any valuation principle that the classical or even contemporary theories would suggest should have been the correct value. I could list probably a few hundred such cases, but I just mention three here, because when I read about them, they stopped me to think that our economic valuation theories really don’t tell anything what could happen in real life.

Case 1) Malevich’s black square

Russian Avantgarde painter Kasimir Malevich made a series of four completely black paintings, that were roughly the size of a m2 square. He painted them in early 20s during the first years after Russian revolution. (In that time he could still do that kind of decadent bourgeois formalist art without being sent immediately to labor camps). The paintings went missing for several decades after Stalin tightened his power but they surfaced again in the 90s when Sovietunion collapsed. I remembered reading in a newspaper (perhaps Financial Times or something) in Milan airport that now one of the paintings was for sale for 50 Million US$! The state of Russia was asking that price and some people were obviously considering buying…can you imagine?! An old canvas, painted completely black. How can that kind of an asset be valuated to 50 MUS$? Certainly the materals or amount of labor don’t justify that kind of value. Black paint can’t have been that expensive even in the soviet of the 20s - Since Malevich made even 4 paintings, I rather doubt that black paint must have been on sale – neither can it be based on the amount of labor. Malevich can’t possible have worked more than one hour on each black painting. Probably 10 mins would have been enough….ok then there are of course other things that create value. Aesthetic value, rarity, etc…but even those are kind of hard to understand. A completely black painting! Come on….

Example 2) Boo.com Internet clothing shop

During the techno bubble of the late 90s on of the most gross examples of unjustified valuation imo was the internet clothing shop Boo.com in Sweden, that advertised that they have new fancy "technology" that helps the customer to see how clothes look like using a 3-d modelling system. A little like what you can do in Sl, but with real clothes that you could then buy. The customer was supposed to be able to get a better view how the clothes look like and then make the purchase via internet. This was in the late 90s when Amazon was already established and worked well, but most internet services were rather dysfunctional…(surely you remember those times?) Well, the internet clothing shop was particularly non-funfunctional. It basically worked somehow (very slowly) with a very high speed connection, but at that time most people were still using modems. In fact only a few had satisfactory connections to really open the pages. let alone do any actual shopping there…yet the company was at some point valuated up to several million US$ by some investors, including big investment banks!!! Think about that, a service that no one could use, which had not particularly original technology and no own products or anything…just promises and rhetoric. Well of course it went bankrupt as soon as the investor's cash was used and the value of the company went down to zero. Now in this case one could hardly talk about any aesthetic value or rarity value. The valuation was most likely based on nice presentation about expected income values, discounted back to present from some future reference point…but even then it should have been clear to any sane person the fairy tale stories that any expected future value could have possibly be based on.

Case 3) Berlin wall vs. World Trade Center

Berlin wall collapsed in November 1989. Since then people have collected scrap pieces of the wall and there are still pieces for sale even today in the internet: http://www.berlin-wall.net/orderform.htm . A 2x3 inch piece seems to cost 55$ and 3x4 inch piece even 275 $!!! The pieces are obviously just pieces of concrete that you could find in any construction site for free, but of course they are from Berlin wall, a scene of a historical event.

But the collapse of World trade center in 2001 was a historical event too. And the twin towers were historically significant constructions, some of the best known buildings in the world history probably. Yet the scrap remnants of those buildings have not been valuated to anything. On the contrary the cleanup has probably cost a lot of money. I remeber reading that the scrap was shipped to Chennai in India, where the metals were separated manually from the rest of the debris, so the total value of the scrap has been only the selling price of the metals that were recycled to the world market. The glass and concrete scrap was probably costly rather than valuable. Kind of surprising, isn’t it? Of course you can create the stories around the pieces of scrap and that obviously the story around a concrete brick from Berlin wall is probably millions of times more valuable than the story around an equivalent concrete brick from World trade Center. But then in order to find out what’s going on here you would need to analyse, what is it in the Berlin wall story that makes exactly similar practically worhless material from recycling point of view to have a market value difference that is in the order of millions if not billions?


I think it is the microscopic angle that is wrong with value theories today. The economic models are all more or less macroscopic theories, describing economic valuations from top down. But in fact the actual value of a thing is always defined in individual transactions and regardless what the “market expects", the value of each transaction is ultimately based on the subjective valuation that both the buyer and seller have in mind. If they agree on the value the transaction will take place, and the the target of the exchange will get it’s historical value, which then can be used as a reference for accounting purposes... Because that’s what we should be looking after. One of the ultimate questions in the "economic theory of everything" is how do we assign values in accounting so that our balance sheets and future looking budgets reflect “reality” as well as possible. I think this is a huge issue, since all of our societal planning is based on these valuations.
Of course there are game theoretical approaches, which do look transactions and pricing from microscopic point of view. But as far as I know they are all still based on the presupposition of a “rational agent”. But when us people value things we are oftentimes far from rational. We might even end up buying things more expensively if we just happen to “like” the seller. Negotiation theories make a bit more compelling case in my mind based on the idea that in practise you get the price that you can negotiate. I think taking that subjective element into account is a key factor to any valuation theory that tries to realistically model what’s going on in real life.

I have been thinking about some ideas about hown to postulate a microscopic theory around this which I will post here soon.
...to be continued

Cheers
Q