Tuesday, January 16, 2007

Smith and Others Knew Their Water from their Diamonds

It’s always pleasurable to read Adam Smith’s contributions to the history of economics that are presented correctly. Last year I had occasion to correct statements to the effect that Smith ‘discovered’ or asserted ‘first’ the diamond water paradox between the use and exchange values of an economic good. He stated the paradox, of course, in Wealth of Nations but so had several earlier authors before him.

So ‘Hedgefund guy’ in the Mahalonobis Blog is spot on in his comment on a statement in the Wall Street Journal (WSJ), 16 January:

Diamond-water paradox applied to synthetic diamonds. Doh!”

“From last weekend's WSJ:

These lab-made diamonds have begun trickling into retailers at prices below those for natural diamonds of similar size and sparkle.
De Beers extols the permanence of natural diamonds and attempts to make them seem special. They're "billions of years in the making," it says on its diamond information Web site, adiamondisforever.com. "Adding to the mystery and aura of what make diamonds so sought-after" is the fact that "approximately 250 tons of ore must be mined and processed in order to produce a single, one-carat, polished, gem-quality diamond."

I think these diamond producers don't realize that higher cost doesn't imply higher value. In fact, the paradox of value is also known as the diamond-water paradox, because it notes that although water is on the whole more useful than diamonds, diamonds command a higher price in the market. Adam Smith famously propounded on the paradox in The Wealth of Nations, though heavyweights such as Copernicus, John Locke, John Law and others had previously tried to explain the disparity in value between water and diamonds. Marginalism brought about the birth of neoclassical economics and argues that it is not the cost or use-value of a good that determines its price but its marginal utility. Thus the marginal value of a synthetic diamond, like that of a cultured pearl, is unaffected by its provenance. I doubt anyone feels sorry for diamond makers grasping at straws.”

I shall be happier when I see more of this sort of thoughtful comment. Smith’s contribution to economics is strong enough not to require false ascriptions of views that were also presented by others.

Now, I know that scholars know this, but graduate economists, and others who attended Economics 101 (or what I see is called Ec10 at Harvard), often shorten the list of other contributors simply to Smith, stating or implying that the paradox was original to him. Clearly, it wasn’t.

To the list of others offered by Hedge fund guy we could add: Plato, Samuel von Pufendorf, Grotius, Harris, Cantillon, and Mandeville, and his own tutor, Francis Hutcheson. Clearly, not a lot of commentators on Smith know that. But as clearly, Hedgefund guy does, and so do you now, if you didn’t before.


Blogger Magpie said...

Frankly, I am not convinced there ever was a "diamond-water paradox", at least in Smith's mind (I'd appreciate it if you could provide references to the other authors who expounded on it).

This is the passage where people claim to see a paradox:

"The word VALUE, it is to be observed, has two different meanings, and sometimes expresses the utility of some particular object, and sometimes the power of purchasing other goods which the possession of that object conveys. The one may be called 'value in use;' the other, 'value in exchange.' The things which have the greatest value in use have frequently little or no value in exchange; and, on the contrary, those which have the greatest value in exchange have frequently little or no value in use. Nothing is more useful than water; but it will purchase scarce any thing; scarce any thing can be had in exchange for it. A diamond, on the contrary, has scarce any value in use; but a very great quantity of other goods may frequently be had in exchange for it."

There is no suggestion that Smith considered the different exchange values of diamonds and water a puzzle, or that he spent sleepless nights trying to figure that out. At least, I see no hint of that.

Michael V. White [1] commenting on this:

"Jevons' reading of Smith was then reworked to construct histories where the paradox had been a pivotal obstable to the 'advance' of economic theory. The important qualifications in the early accounts were afterward erased so that Smith became puzzled by his own discussion along with his successors. TPE [Jevons' Theory of Political Economy] then appeared as the analytical circuit breaker.".

[1] "Doctoring Adam Smith: The Fable of the Diamonds and Water Paradox," History of Political Economy. 2002, 34:4, pp. 659-683

11:57 pm  
Blogger Gavin Kennedy said...

A correspondent commented on this post on 21 January 2015(!).
Please visit the 2015 post for a discussion of the issues raised by the reader.
Gavin Kennedy

12:27 pm  

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