This may not seem like a particularly brilliant insight, but, at its core, this is the logic behind a theory that maintains that increasing household consumption should be the primary function of the economy and that, further, individual commodity consumption is the most efficient way to meet people’s wide-ranging needs and desires. This chapter will lay out the intellectual history behind this justification, explore some of its implications, and examine some modifications of this theory that attempt to increase its “realism” while still maintaining its general policy conclusions.
From Classical to Neoclassical Economics: Consumers as Rational Maximizers
Adam Smith’s An Inquiry into the Nature and Causes of the Wealth of Nations (Smith [1776] 1976) is often credited with being the first true work in economics, or what he would have called political economy. Smith’s work was revolutionary in many ways, not the least of which was his insistence that consumption should be the primary purpose of production. Before Smith, self-interested consumption was commonly and negatively portrayed as greed, a base sentiment compared to “all the Virtue and Innocence that can be wish’d for in a Golden Age” (Mandeville, 1732). As we saw in chapter 1, certain types of consumption were even outlawed.
However, for Smith, consumption was nothing more than the pursuit of personal satisfaction and well-being (Sassatelli, 2010). Further, for Smith, the most effective manner in which consumption (and thus social welfare) could be maximized was through the invisible hand of the market guiding individual self-interest. For purchasers, this self-interest means getting the best product they can at the lowest cost. For firms, it is selling at the highest price. In this exchange of purchasers searching for bargains and firms searching for profits, a mutually agreeable deal can be struck that benefits both parties. “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages” (Smith, [1776] 1976: 18). Here we see Smith’s transformation of what were previously considered to be vices into, if not quite virtues, at least necessary evils. For Smith, the efficient ability of the invisible hand to provide what society desired was dependent on consumers engaging in self-interested behaviour. The win–win agreement between parties with conflicting goals is possible because of competition. Sellers are likely to provide their customers with quality goods at reasonable prices because they know that unsatisfied buyers can move on to the seller’s competitors.
As was generally true for his fellow classical economists, Smith argued there was a difference between the value at which goods are exchanged and the value that people place on goods in their use. This is expressed in the diamond–water paradox, in which Smith pointed out that people need water to live, resulting in a high use value. Yet the rate at which water can be traded for other goods – its exchange value or its price – was very low. Diamonds, on the other hand, had a very low use value compared to water, but a much higher exchange value (Smith [1776] 1976: 34). This paradox created a bit of a sticky contradiction because a good that was essential for life, and which people valued very highly in its use, had a much lower exchange value than a frivolous luxury. For the classical economists, exchange value was easy to measure by looking at the relative prices of two products, but it did not accurately represent the actual value to people. What did represent the actual value to people was particularly individual and, in the words of David Ricardo, “cannot be measured by any known standard” (cited in Stigler, 1950: 311).
The theory of consumption that emerged to dominate economics focused on the decisions of the purchaser and dismissed the difference between use and exchange value. The use–exchange issue was resolved by the neoclassicals by focusing on Jeremy Bentham’s utilitarianism, in which “utility” depends on the pleasure or pain of an activity (Bentham, 1780). In this utilitarian view, there is no distinction between use and exchange value because, if something has a high exchange value, this must be true only because people gain a great deal of pleasure from it. It provides a foundation from which to say that whatever consumers buy is valuable and, conversely, that if there is no market demand for something, it must not be valuable. As University of Chicago economist George Stigler pointed out much later, “Smith’s statement that value in use could be less than value in exchange was clearly a moral judgment, not shared by the possessors of diamonds” (Stigler, 1950: 308).
Three authors – William Jevons ([1871] 1957), Carl Menger ([1871] 2007) and Leon Walras (1954) – independently refined Bentham’s model of a pleasure-seeking, pain-avoiding individual in a manner that won general acceptance in economics. While historians of economic thought are always careful to point out that there were important differences between these three writers, it was what they had in common that created the foundations for the neoclassical theory of consumption. This theory, in which consumers take center stage by sending out signals to which firms respond, is based on a series of assumptions about how people behave and the appropriate level of analysis for the economic discipline. In terms of assumptions about behaviour, people are understood as rational utility maximizers. This means that they have the ability and motivation to understand the utility they receive from their consumption activities, weigh them against the prices being charged, and compare them across purchases in order to generate the maximum utility possible from their consumption budget. People are also assumed to be insatiable – to believe that more is always better, or at least never worse. This does not necessarily mean that they try to consume as many products as possible, but they do attempt to maximize their utility from pleasure-producing consumption while minimizing the amount of pain-producing work effort (we will ignore, for the moment, the potentially problematic double insistence that work is a source of pain while pleasure comes from purchases, which we will take up in chapter 3). This theory also assumes that people’s utility is individualistic in that it stems from their own intrinsic personal benefit from consumption rather than being influenced by others.
How those preferences are formed to create choices of one product over another, or between leisure and consumption, is not really the subject of inquiry. The social, cultural and economic institutions that might affect consumption are not examined by economics, although they might, perhaps, be the legitimate subject of another discipline (Ackerman, 1997: 651). For neoclassical economists such as Gary Becker, these non-economic disciplines can contribute best to social science by figuring out how preferences form, in order that they might be plugged into what he called the “economic approach” in which “all human behavior can be viewed as involving participants who maximize their utility from a stable set of preferences and accumulate an optimal amount of information and other inputs in a variety of markets” (Becker, 1976: 14).
Like Smith, the neoclassical writers put some thought into how the products from which households can choose would be distributed among the population. Walras produced a theory of general equilibrium in which he demonstrated that a competitive market could produce the type and quantity of products that would yield the maximum possible utility for households (Stigler, 1950: 322). “Production in a market governed by free competition is an operation by which the [productive] services may be combined in products of appropriate kind and quantity to give the greatest possible satisfaction of needs” (Walras, 1954: 231). Despite Walras’s claims that his theory was an important step in moving economics in the direction of a pure science, and that it did not contain moral judgements (Hunt, 1979: 267), this was patently not the case, since, like Smith’s, his theory contained the very strong implication that an economy organized as a competitive market would distribute goods among households in a manner that would ensure the most utility. Maximizing the total utility of all members of society is a controversial goal with important moral judgements. Perhaps most obviously, maximizing total utility ignores its distribution between people. If income were redistributed so that it increased the utility of the very rich and decreased the utility of the very poor, this would represent a social improvement