Home > musing > Profit as proxy for value

Profit as proxy for value

June 9, 2013

I enjoyed my discussion with Doug Henwood yesterday at the Left Forum moderated by Suresh Naidu.

At the very end Doug defined capitalism pretty much like this wikipedia article:

Capitalism is an economic system based on the private ownership of the means of production, with the goal of making a profit.

Doug went on to make the point that, as a society, we might decide to replace our general pursuit of profit by a pursuit of improving our collective quality of life.

It occurred to me that Doug had identified a proxy problem much like I talked about in a recent post called How Proxies Fail. The general history of failed proxies I outlined goes like this:

  1. We’d like to measure something
  2. We can’t measure it directly so let’s come up with a proxy
  3. We’re aware of the problems at first
  4. We start to use it and it works pretty well
  5. We slowly forget the problems we had understood, and at the same time
  6. People start gaming the proxy in various ways and it loses its connection with the original object of interest.

In this example, the thing we’re trying to measure is something along the lines of “human value,” although we’d probably also want to consider value to the rest of mother nature as well. For context, we were discussing the financial system – what the purported function of the financial system is and what monstrous proportions it has taken on due to the brutal pursuit of profits over goals we might consider reasonable and useful to society.

So the proxy for value is profit. And of course we measure profit in money.

Going back to my history of proxies, it’s been a long time ago since the discussion of “whether money is a good proxy for value” was started, and a large part of economic theory, I guess, is devoted to considering the extent to which this proxy fails. I say “I guess” because I’m no economist, but I am aware of the economic concept of externality, which grapples with this discrepancy between money paid or earned, and to whom, versus actual harm or benefit, and to whom.

It could be argued that the concept and industry of regulation has been erected to deal with externalities of our profit proxy: when a chemical company pollutes the water, causing harm to nearby nature and people, regulators step in, sometimes (and sometimes people sue, of course, but most of the time they’re not even aware of the value being extracted from them, or are helpless to confront it adequately).

This is obviously more than an academic or regulatory topic: it pervades our collective lives. When an individual loses sight of the failures of the profit proxy, they value themselves or others in terms of how much money they have or the rate at which they get paid. They infer that if someone is highly paid or rich, they must be valuable. If someone’s poor, they must hold no value. There are a lot of people like this, I’m sure you’ve met them.

And that brings us to the part of the history of a failed proxy, which is that people game the proxy. We’ve seen this happen a lot lately, especially in finance and technology. And if you think about it, it’s no surprise since so much money goes through the financial system, and the financial system is now entirely technologically driven, and the systems are so complex that the regulators can’t keep up with the manufactured externalities. Someone could probably write a book reframing large parts of the financial system as purely devoted to exploiting the difference between value and money.

I don’t think I’ll start coming to different conclusions now that I have this framework to think through, but I do think it will be easier for me to spot instances of the “profit proxy failure” when I come across them. It’s especially timely for me to be thoughtful about this kind of thing, since I’m hoping to create something valuable, rather than merely profitable. I don’t want to avoid profit, obviously, but I don’t want to measure my progress with the wrong stick.

Categories: musing
  1. June 9, 2013 at 9:19 am

    I feel like your committing the same mistake by using the word “value” as a proxy for “productivity”…

    I’m thinking that if you substitute “productivity” for “value” the so-called proxy problem (as it relates to profits) goes away…

    I mean, it’s not really value that determines profit, right? It’s productivity. Even your big quant firms rely on productivity over some value judgment to increase profits.. that’s why they’re investing in human capital so much… (100 quants working on Wall have a much higher Marginal Physical Product (MPP) than, say 100 grocery store clerks) So the proxy of profits is not to measure value per se but to measure productivity, right?

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    • beewhy2012
      June 9, 2013 at 9:42 am

      While I was somewhat puzzled about what value or values could stand as a proxy for measuring success in Mathbabe’s case or any other, it looks as if you’ve substituted an easily distorted measure, productivity, for a broad measure of value. By your example, the grocery clerks are to some far less valuable and therefore one might infer more expendable than the quants. Unless I’m mistaken this was one of the huge – and willful – errors of National Socialism.

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      • June 9, 2013 at 3:01 pm

        Well, productivity is not a proxy for value… that’s my point. But, it is a good proxy for understanding profit. People profit more when they are more productive… that shouldn’t surprise anyone and it says nothing about a person’s value.

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        • June 9, 2013 at 3:03 pm

          How to measure productivity…? In some cases it’s easy :the guy selling 6 widgets an hour compared to the guy selling 5 widgets an hour is 1 widget an hour more productive… and so the more productive guy should see more profit… i.e. if they are paid the same per widget, the guy making one more per hour makes a bit more than the other guy.. (and I’m using guy in the gender neutral sense)

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      • Onduidelik
        June 10, 2013 at 8:00 am

        Indeed, the value of activity in the financial services sector (which seems to be the main target of occupy) is increasingly being questioned at a fundamental level. While blame for the reification of this ‘value’ has, and largely continues to be, laid at the feet of economists, Cathy’s point about the society-wide idolisation of the mathematically gifted seems more apropos.

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  2. mathematrucker
    June 9, 2013 at 9:22 am

    Here’s a link to another Wikipedia article, about a long but interesting video on the topic:

    http://en.wikipedia.org/wiki/Zeitgeist:_Moving_Forward

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  3. June 9, 2013 at 10:20 am

    I thought capitalism depended on price as a proxy for value. Profit was more like the arbitrage between the value of a thing and its price. As markets become more efficient and competitive the amount of discrepancy between price and value are then supposed to decline.

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    • beewhy2012
      June 9, 2013 at 5:25 pm

      Which is why business generally seeks monopoly. Whence cometh this millennialist belief in the efficiency and competitiveness of markets when we are surrounded with so many egregious examples of the opposite?

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      • June 9, 2013 at 5:47 pm

        You pose an excellent question.

        I’m a millennial and I know my generation is biased to think that productivity is the key to success… i.e. to maximizing profits. I’d say it’s probably the duality of “you can do anything you want” and the technological boom that has occurred in our lifetime making us think that the world is ours for the taking, so long as we work at it.

        Alas. the reverse is not necessarily true…and I think it’s this point that many in my generation miss. Large profits do not imply high productive output–at least not given the political and commercial landscape in which we find ourselves.

        Why is it then that so many companies are profiting without producing anything? It must be monopoly power, right? Like… the power to set prices allows people to work less, charge more.

        But, maybe what we’re seeing is the development of more efficient “grey” markets where corporatism is the driving force of rising profits unequal to rising productivity… I mean, if it weren’t for the connection between business and governmental (read: political) interests, I’m sure the profits would more closely reflect productive output. At least there wouldn’t be so many “wage profits” (bonuses) at the top. . .

        That said, one might argue that government IS productive.. and that its involvement in the corporate sector (in whatever capacity) is efficient and already reflected in market prices; but, I’m inclined to agree with the Public Choice school of thought and the idea of Dead Weight Loss in addition to the idea that a lot of the goings on are not transparent or predictable enough to make their way into the information set of the efficient market hypothesis (whichever one of the hypotheses you choose to subscribe to).

        IMHO, the corporatism we have in our country is certainly a monopolistic (bordering on cartel-like) political meets commercial force that distorts value in the transparent “white” market by tampering with efficient prices. (Tampering may be too harsh as I’m not sure it’s necessarily an active process).

        So, what’s the answer–I have thought and will continue to think that we need some kind of prediction market as a rule… be it at the corporate governance level or the Robin Hanson Futarchy level… *something* needs to shift the risks so that the people who are most likely to benefit are the same who are most likely to lose..

        Though, maybe it already is that way and they just have so much that losing isn’t really that much of a problem.

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      • June 10, 2013 at 3:28 pm

        I think it is fair to say that we are really surrounded by a tremendous number of examples of the market system working very well, with a few notable exceptions. (Especially finance)

        Monopolies are very often sought and are very hard to attain.

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        • June 10, 2013 at 11:44 pm

          A judgment of working very well is relative to assumptions about the purpose of a market system. Some of the questions that we have to ask from a systems-theoretic perspective are these:

          1. How do we tell when a system is deviating from its purpose?

          2. What are the design and environmental factors that lead a system to go off course, especially when it does so chronically?

          3. What are the design factors that make for better and worse performance, relative to a specified purpose?

          It is not possible to address these questions in a critical manner if we define the purpose of a system as “whatever the system does”.

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  4. Madison
    June 9, 2013 at 11:22 am

    The profit proxy problem seems like a good way to distinguish between profits from production–actually valuable to people’s well-being–and profits from speculation, which don’t help anyone but the speculator. Lumping the productive elements of capitalism in with the speculative is its own sort of fallacy that is too common these days because of the stupid folks in finance.

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  5. June 9, 2013 at 11:26 am

    I think perhaps some of the confusion between value versus productivity and value versus price can be cleared up by thinking about value-added.

    I’d like to change the example slightly to grocery baggers rather than grocery clerks. So both groups are possibly redundant — people can bag their own groceries, and you can pick a random answer for whatever you are having quants do. The baggers are worthwhile (to the store) if their presence makes the experience more pleasurable enough so that they can raise prices to more than pay for their cost (wages, etc.). The difference between the raised revenue and the cost of the baggers is the monetary value added for the store. The monetary value added is the profit.

    The value added for the customers is more ephemeral. They could go to the cheap store without baggers, but they aren’t. So they presumably are deriving value that is at least equal to the difference in prices. The store also is not just concerned about money. Hiring the baggers may be valuable because it ties the store more closely to its community. But hiring the baggers may put a strain on the store manager.

    Profit has a lot to do with the competitive landscape. If there is a single grocery store in an isolated town, the store can make a lot of profit. If a second identical store opens, the total profits of the two stores are likely to be less than the monopoly profits, but the value to the customers will be at least as much as before.

    Mathbabe, thanks — I like this line of thought.

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  6. June 9, 2013 at 11:36 am

    There is a deep and pervasive analogy between systems of commerce and systems of communication, turning on their near-universal use of symbola (images, media, proxies, signs, symbols, tokens, etc.) to stand for pragmata (objects, objective values, the things we really care about, or would really care about if we examined our values in practice thoroughly enough).

    Both types of sign-using systems are prey to the same sort of dysfunction or functional disease — it sets in when their users confuse signs with objects so badly that signs become ends instead of means.

    There is a vast literature on this topic, once you think to go looking for it. And it’s a perennial theme in fable and fiction.

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  7. TDHawkes
    June 9, 2013 at 1:06 pm

    This topic is important. Thanks for explaining your evidence and point of view. I helps.

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  8. joeblo
    June 9, 2013 at 2:56 pm

    Of course a lot of the profit in markets comes from the different values that people assign goods or labor. And in an efficient market profits accrue not to the deceivers, manipulators or externality gamers, but to those who can arbitrage the actual values of the participants. That should lead to investment in improving the productivity of providing for those values. We don’t have that in our current markets, and economists seem overly obsessed with ‘free’ markets in which the majority are gamed for the profit (and value) of a few.

    I think this idea of value (or the excess produced for a given cost) is best determined socially. Children, addicts, criminals, and the elderly are unlikely to enter into markets with values that are constant… making a mockery of those markets (I wish I hasn’t eaten that… ). Businesses, which can, are given inherently inhuman values and will abuse their customers, suppliers, and employees exactly as much as they need to for profit maximization, unless there is further obfuscation and market manipulation by control fraud… it’s interesting that economists, and Greenspan particularly, try to prove these frauds also can’t take place… or that it’s not the fraudsters fault.

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  9. June 9, 2013 at 3:28 pm

    Here is one elaboration of the theme that comes from the realm of fable and fiction, Chip Delany’s “Tale of Old Venn”, in part a story of the way money mutilated a formerly harmonious matriarchal society.

    Now money, when it moves into a new tribe, very quickly creates an image of the food, craft, and work there: it gathers around them, molds to them, stays away from the places where none are to be found, and clots near the positions where much wealth occurs. Yet, like a mirror image, it is reversed just as surely as the writing on a piece of paper is reversed when you read its reflection on a boy’s belly. For both in time and space, where money is, food, work, and craft are not: where money is, food, work, and craft either will shortly be, or in the recent past were. But the actual place where the coin sits is a place where wealth may just have passed from or may soon pass into, but where it cannot be now — by the whole purpose of money as an exchange object.

    — Samuel R. Delany, “The Tale of Old Venn”, in Tales of Nevèrÿon, Wesleyan University Press, Hanover, NH, 1993, p. 93.

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  10. June 10, 2013 at 8:48 am

    I think the Wikipedia article reflects a lot of oversimplification about the nature and history of capitalism that has resulted from the domination of economics by the neo-classical, laissez faire philosophy over the past 50 years or so.

    I recommend the writings of Joan Robinson to sort a lot of this stuff out. Robinson was a brilliant English economist who worked closely with John Maynard Keynes, and shared with him a true gift for elegantly calling bullshit on most of the logical and philosophical contradictions of economics in general, the (mis)use of mathematics in economics, and the clap-trap of the neo-classicals. Her book Economic Philosophy:An essay on the progress of economic thought, in which she addresses the failed attempts of economists to understand value, instead replacing the concept of value with “utility”, and then abandoning that idea in favor of national wealth.

    Not surprisingly, Robinson’s writings have been left to gather dust given the hatred of Keynes by modern economists and that Robinson was a woman. But her honesty and logic are impeccable, and you and your readers will do well to read her works.

    So, back to the details of the post, the issue is “profit” vs. “value”. You can’t make a profit if no one values what you’re selling; so they’re two different things (although we may value profits, but that’s another story). As Robinson explains, “value” is too slippery a term for economists and leads to too much individualistic behavior. Rather, economists instead argued that rational actors in a free market will settle on a price at which the marginal utility, which corresponds to the degree of want or desire, of the purchaser is equal to the price. As Robinson notes, economists slipped that idea aside too, since logically it supports the notion of economic equality, and replaced it with the notion of total national wealth, which is compatible with inequality.

    Under neo-classical thinking, all good comes from the combination of everyone’s selfishness. Thus, profit-seeking is not a sin but a public virtue, since it drives up the total productivity of the entire economy.

    As for “externalities”, these are essentially the side effects of two-party transactions. Remember that neo-classical economics is based on the idea of a buyer-seller pair in a free market. The problem is that third parties can be affected by those deals, e.g., I sell you my forest to log and the resulting spring flood wipes out Joe’s town. Since neo-classcial theory will fail without the two-party transactional model, the economists sweep the nasties under the rug by calling the “external” and then forgetting all about them. If you read Imre Lakatos’s Proofs and Refutations you’ll see a similairity with “monster barring” in proofs.

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    • June 10, 2013 at 2:51 pm

      Good points.

      But I’m afraid that definitions of capitalism have become every bit as useless as definitions of communism — for much the same reason — that what they were in theory and what they became in practice have next to no positive logical relationship, however much we may be fascinated by the dynamics of their regression over time.

      So these days I find myself more and more restricting the use of the word capitalist to people who self-identify as such, putting capitalism on a par with other systems of belief that are defined only by the practices of their true believers.

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  11. Gordon Henderson
    June 10, 2013 at 1:33 pm

    Doug’s comment about replacing our general pursuit of profit with a collective quality of life goal is one level a straw-man argument, but also problematic because of its assumptions.

    It’s a false argument because society is not organized to maximize profits. Individuals are (largely) free to follow whatever path they prefer to, subject to their having something that others are willing to pay them for. To pick an extreme example, there’s no social compulsion for someone with the potential to be paid a lot of money for his scientific research skills to follow that path instead of following their passion for busking on street corners.

    That’s also the central problem with a vague statement like “goals we consider reasonable”: people differ on what those are, and people have different ideas about what it would take to make them happy. Most democracies establish some kind of a safety net for people who can’t provide for themselves, and set legal boundaries within which other people can pursue their own interests and ambitions.

    Ultimately you’re not talking about a proxy failure – you’re mis-specifying the model, no?

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  12. June 12, 2013 at 11:52 am

    Cathy, thank you very much for the post. With your established credibility, unbeatable (in my humble opinion) logic and contagious passion, you persuade your reader to think critically and ask the right questions.

    About proxies. Hans Rosling has made a short film called River of Myths http://www.gapminder.org/videos/the-river-of-myths/

    What is your take on the proxies he measures to make his assumptions?

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  13. June 12, 2013 at 12:55 pm

    Cathy, thank you very much for the post. With your established credibility, unbeatable logic and contagious passion, you persuade your reader to think critically and ask right questions.

    On proxies, the best example of looking at different ways of measuring collective quality of life comes from Hans Rosling, who made a short film called River of Myths http://www.gapminder.org/videos/the-river-of-myths/

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  14. June 12, 2013 at 12:58 pm

    Sorry for posting twice. I screwed up by trying to use two different devices.

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  15. July 4, 2013 at 12:26 pm

    “Someone could probably write a book reframing large parts of the financial system as purely devoted to exploiting the difference between value and money.”

    Someone please write this book. It would be a big success, no? Or if the book has already been written, please post!

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