Understanding Intermediaries in Payment Systems — Introducing Liquidity to Law Students

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2 Responses

  1. Harry says:

    Very interesting idea. Thanks for sharing.

  2. A.J. Sutter says:

    Pedagogically that is a great idea. Philosophically, I’m not sure it explains anything about “wealth creation.” The certainty you have created is certainty about exchange value, but not certainty about the usefulness or marginal utility of the goods traded to each participant in the exchange.

    To arrive at a “predictive wealth creation tool,” you are simply quantifying the exchange values for each exchange, i.e. assigning a number to represent the “value” of a collection of M&Ms. However, this is better described (assuming money is wealth) as a wealth accounting tool. Indeed, in your classroom, the aggregate value was already known, before any exchanges occurred. Your economy doesn’t have any production, so nothing is being created.

    One could argue that wealth created through exchange is constituted by a surplus of marginal utility. You might feel that in exchanging a given sum for say, a flash drive you’ve gotten a bargain, whereas the seller might think the values are equal. The exchange value is less than the drive’s marginal utility to you; but by hypothesis the exchange value doesn’t capture this new-found “wealth”. If instead the marginal utility and exchange value are equal, no wealth is created. (Moreover, since the marginal utility of different individuals is not intercomparable, you’re really at sea in trying to quantify the aggregate “wealth” that has been “created” in your toy economy.)

    Modern formulations of neoclassical theory, such as revealed preferences theory, don’t help. They don’t eliminate the subjectivity, but simply assume that the increase in marginal utility is never less than zero. As Paul Krugman explains, “If the going price of widgets is $10 and I buy a widget, it must be because that widget is worth more than $10 to me” (NY Times, 2010/04/05, emphasis added). How much more is not knowable. But actually your classroom example muddies this. You condition acceptance into the class on the execution of an exchange. Therefore a student might be willing to accept a bad exchange — one in which the money received is worth less to her than the widget exchanged — in order to stay in the class. Your accounting tool captures neither the fact that the student’s marginal utility after the exchange (considered in isolation) might be lower than the exchange value of the thing she gives up, nor the amount by which her marginal utility increases from the knowledge that she will stay in the class. (In real society there are many such coerced exchanges, e.g. as a result of monopoly pricing, etc., without the offsetting externality.)

    Of course there’s another formulation of neoclassical theory, developed by Pareto, Slutsky, etc, which says that prices are orderings, and that absolute prices are meaningless. That too throws your predictiveness out the window. And there’s a pre-neoclassical theory of exchange going back to Aristotle’s Politics, which distinguishes between “natural” wealth acquisition (not creation) through exchange [χρηματιστικὴ κατὰ φύσιν] and “unnatural” wealth acquisition through exchange [χρηματιστικὴ παρὰ φύσιν]; the latter includes an exchange or series of exchanges whose ultimate purpose is to end up with a sum of money, gold, etc. Aristotle also holds that true wealth cannot be measured quantitatively in any case; and that what constitutes wealth (which we might call “use value,” although this is somewhat different from what Smith and Marx understood by that term) resides only in goods and services that have a benefit for society, not in whatever is capable of satisfying individual desires. (Bentham, Say and the neoclassicals threw out that constraint.)

    “Wealth creation” has become a modern catch-phrase to justify the benefits of markets. But it’s problematic to attribute it to exchange alone, and to measure it based on the value of exchanges (à la, BTW, GDP). Even if, contra Aristotle, measurable wealth has social meaning, and even if exchange alone, without production, could be sufficient to create such “wealth,” the quantity of “wealth” so created can’t be predicted, other than to assume it is zero (identity of exchange value and marginal utility).