^{Wealth & Poverty Review} The Virtues of the “Knowledge Theory of Value”

Kevin Hoover suggests that William Nordhaus relied on the labor theory of value in his paper on light (Letters, April 24). Yet Nordhaus actually used knowledge, not labor. He offered a method to measure innovation: the discovery and sharing of valuable new knowledge. Nordhaus measured the amount of knowledge per unit of time and observed that knowledge about light was growing exponentially, surpassing traditional measures of economic development. It is the time price over time that truly deserves our attention.

Economic theories offer different frameworks for understanding value, each rooted in distinct assumptions about what drives it, how it is measured and what it implies for economic systems. Adam Smith and Karl Marx proposed a labor-based theory of value, measuring “surplus” and emphasizing scarcity, exploitation and redistribution. In contrast, we propose a “knowledge theory of value,” grounded in abundance, innovation and entrepreneurship. This framework explains the vast differences between our age and the Stone Age. As Thomas Sowell observed, when we go to the market, we are trading knowledge, which creates value. We measure this creativity through time, specifically using time prices, the ratio of money prices to hourly income. As we discover and share more knowledge, time prices fall, reflecting increasing abundance.

When new knowledge is discovered, it transforms the economy. When Henry Ford revolutionized manufacturing with the automobile assembly line, he was able to reduce prices for customers and raise wages for employees. The time price of the Model T for blue-collar workers fell from 5,000 hours in 1909 to 591 hours in 1922, an 88.2% decrease. In other words, for the time it took to buy one car in 1909, a worker could buy 8.46 cars in 1922, a 746% increase in abundance.

When governments inflate their currency, money prices rise. But when entrepreneurs innovate, time prices fall. This is why goods can become more expensive in dollar terms yet more affordable in time terms. As long as hourly income rises faster than money prices, time prices will continue to decline.

The ultimate test of a theory is its power to illuminate reality and guide us toward a better future. Most economists now recognize the flaws in the old labor theory of value. It’s time to move forward. The knowledge theory of value, combined with the time-price index, gives us a new compass. A world of greater abundance and opportunity is within our reach if we have the freedom to create, share and innovate.