Labor theory of value
The labor theory of value (LTV) is a theory in economics and political economy concerning a market-oriented society: the theory equates the "value" of an exchangeable good or service (i.e., a commodity) with the amount of labor required to produce it. While some see this as a theory of price determination in competitive markets, to others it is a tool for understanding the social relations of production. This theory is inextricably tied to that of exploitation.
David Ricardo and Karl Marx are most often associated with this theory. However, the theory is older.
The theory's development
The English liberal political philosopher John Locke, in his Second Treatise on Government, asked by what right an individual can claim to own one part of the world, when according to the Bible, God gave the world to all humanity in common. He answered that persons own themselves and therefore their own labor, this ownership being bestowed on each of us by nature. Thus when a person labors that labor enters into the object, and so the object became property of that person.
Locke argued in support of individual property rights as "natural rights". Locke argued that a landowner's property was his because he had worked for it. Locke held that this relation between labor and ownership pertained only to property that was unowned before such labor took place. In the case of a landowner hiring servants, Locke held that the landowner gained the product of his labor:
- "the grass my horse has bit; the turfs my servant has cut; and the ore I have digged in any place, where I have a right to them in common with others, become my property, without the assignation or consent of any body. The labour that was mine, removing them out of that common state they were in, hath fixed my property in them." The Second Treatise, section 28
British political economy
The Scottish political economist Adam Smith distinguished between "real value" (the amount of labor required to produce an object) and "nominal value" (the amount of money one would give or receive in exchange for a given commodity). Making matters confusing, he also used a "labor commanded" definition of value, referring to the real value of a product as the amount of labor that could be purchased by selling it. That these two different kinds of labor-value (labor embodied and labor commanded) seldom correspond gave rise to the so-called transformation problem (see below).
The English economist David Ricardo stressed the role of the first kind of labor value, the amount of labor "embodied" in a commodity. He emphasized what might be called a "labor theory of price", in which the amount of labor embodied in a commodity determines its price. This is a theory of price-determination by costs is a predecessor of the modern theory that prices are determined solely by production costs associated with the "neo-Ricardianism".
Ricardo's follower John Ramsay McCulloch agreed, and took a step toward an exploitation theory of profit or interest by defining interest as "only another name for the wages of accumulated labor."[1] The "Ricardian socialists" — Charles Hall, Thomas Hodgskin, John Gray, and John Francis Bray[2] — went further to develop theories of exploitation which were similar in some ways to that later developed by Marx. In these approaches, the LTV is a theory of objective value.
Marx and after
Marx questioned Locke's position that when property is already owned, hired laborers are not entitled to ownership of the property they are hired to labor on. (Locke implicitly assumes that private property already exists when he discusses its origins.) Marx used the LTV to support a very different political argument than Locke's, developing the Ricardian socialists' contributions: the owners are exploitative because only labor adds value to the product. His LTV holds that, in aggregate, the price of the product is the sum of the value of the capital goods used up in production and the value added by direct labor.
In this theory, the receipt of property income is only possible if the wages of direct producers do not fully compensate them for the value they add to the capital invested to produce the product. Workers work for a part of each day adding the value required to cover their wages, while the remainder of their labour is performed for the enrichment of the capitalist.
Very early on, the Austrian economist, Eugen von Böhm-Bawerk argued against both the whole tradition of the LTV (see below). Much of Western economics followed this lead — and that of Jevons, Menger, and Walras — in the 1870s to turn away from theories of objective value and towards the economic subjectivism associated with neoclassical economics. That is, most economists have discarded the LTV as a theory of price determination in favour of models based on marginal utility and marginal cost of production, i.e., on demand and supply. In the end, the neoclassical "theory of value" (general equilibrium theory) is identical to the theory of price. Corresponding to this shift is a shift from Marx's emphasis on the inner workings of the societal process of production to one that stresses individual exchange and markets.
The theory explained
Marxian political economy has developed Marx's concept of "socially necessary abstract labor-time" to clarify the meaning of his LTV. According to some commentators, this modification is profound enough to support the claim that Marx's theory is not, after all, a labor theory of price of the Ricardian sort, but a new type of theory entirely. Marx goes to some lengths in the first chapter of [[Das Kapital] to spell out the significance of three aspects of value - its substance, magnitude, and most confusing of all, its form. His theory would therefore seem resistant, at least, to reduction to just one such aspect, the magnitude, typically thought of as a number of labor hours.
The phrase "socially necessary" suggests an entirely different perspective from neoclassical economics. Whereas the latter starts with the individual's perspective and the selling and buying of commodities, Marx starts with the perspective of society as a whole. "Social production" involves a complicated and interconnected division of labor of a wide variety of different people who depend on each other for their survival and prosperity. Individual labors are contributions to the whole. "Abstract" labor refers to a characteristic of commodity-producing labor that is shared by all different kinds of heterogenous (concrete) types of labor. That is, the concept abstracts from the particular characteristics of all of the labor and is akin to average labor. Socially necessary abstract labor is measured in hours of application of labor-power but can only be realized in exchange: only labor which produces a commodity that is a use-value to someone else (which they can afford and are willing to buy) counts as socially necessary.
Some definitions
The labor theory of value holds that the labor needed to produce a commodity includes both labor directly expended on production of the commodity and labor expended on the production of capital goods (or means of production) used up in the production of the commodity. For example, if twenty workers are used for a year to produce capital goods used by twenty workers in the next year to produce a consumer good, the good embodies the labor of forty workers. (This example assumes that technology is unchanged between the two years.)
The amount of labor done by an average worker under the prevailing conditions in a society (for instance the technology and transportation in use) will produce the same amount of value regardless of the manner of that labor. Greater value can be produced by trained workers or by workers using leading-edge technologies: the increase in value is created by the training process or the work required to create the technologies.
However, a lazy or inept worker (who spends more time producing an item) does not produce more value than an industrious one. Rather, the first worker's time produces less because the value depends on what is socially necessary. That is, the value of a product is determined more by societal standards than by individual conditions.
Exploitation
Marx used his LTV to derive his theory of exploitation under capitalism. Marx assumed that all commmodities sell at prices equal to values (with both measured in the same units). In his era, this "equal exchange" represented a standard of "fair" exchange: an hour of labor could be used to purchase the product of an hour of labor.
Marx then asked, "under equal exchange, how is it that a capitalist can sell commodity X at price P and make a profit?" If the capitalist hires labor at value and then sells the commodity at value, where does profit come from?
Unlike Ricardo, Marx distinguished between labor-power and labor. Labor-power refers to the ability of workers to labor, based in their muscle and brain power. Labor refers to the actual activity of producing use values (goods and services) and value. In his examples, Marx assumed that the value of labor-power (w) was constant, determined by prevailing socioeconomic conditions. (In his time, this was seen as "subsistence.") The profit or surplus-value can arise because workers do more labor (L) than is necessary to pay the cost of hiring their labor-power.
Marx's numerical examples in volume I of Das Kapital never "prove" that capitalism always involves exploitation, i.e., that L always exceeds w. Instead, this relationship involves class struggle over the length of the working day, the intensity of labor, the use of machinery, etc. The existence of exploitation reflects the capitalists' victory (so far) in the struggle.
Instead, the "proof" that capitalism typically involves exploitation comes from his socioeconomic and historical analysis of capitalism as a whole. One way to get L > w is to use force against the workers. But unlike other systems (such as feudalism or slavery), under capitalism the direct use of force to get workers to produce a surplus is the exception rather than the rule. In Marx's story, workers are free to quit their jobs; they are rarely beaten to make them work.
To explain the normality of L > w, Marx instead pointed to the institutional framework of capitalism, in which a small minority (the capitalists) monopolize the means of production, in which the workers cannnot survive except by working for capitalists, and in which the state preserves this inequality of power. In this explanation, the normal role of force is structural, part of the usual workings of capitalism: the reserve army of unemployed workers continually threatens employed workers, pushing them to work hard to produce for the capitalists.
Böhm-Bawerk's critique
The Austrian economist, Eugen von Böhm-Bawerk argued against both the Ricardian labor theory of price and Marx's theory of exploitation. On the former, he contended that return on capital arises from the roundabout nature of production. A steel ladder, for example, will be produced and brought to market only if the demand supports the digging of iron ore, the smelting of steel, the machines that press that steel into ladder shape, the machines that make and help maintain those machines, etc. Advocates of the labor theory will point out that every step in that process, however roundabout, involves labor. But Böhm-Bawerk said that what they missed was the process itself, the roundaboutness, which necessarily involves the passage of time.
Roundabout processes, Böhm-Bawerk maintained, lead to a price that pays for more than labor value, even the labor value of all the process involved added together statically, and given any empirical standard for the latter. This makes it unnecessary to postulate exploitation in order to understand the return on capital.
Marx might respond that this did not contradict his understanding of prices, in which sectors of the economy which have higher "capital intensity" (greater roundaboutness) have higher prices (see below). The difference, it seems, between Marx and Böhm-Bawerk concerns perspective: for Böhm-Bawerk, roundaboutness explains entrepreneurial profits on the microeconomic level, whereas for Marx, a societal explanation is needed. To him, roundaboutness explains only those profits of the more capital-intensive operations relative to less capital-intensive ones.
Furthermore, in Böhm-Bawerk's development of a positive theory of interest he said that workers trade in their share of the end price for the more certain and soon wages paid by the entrepreneur. In other words, he claimed that profits compensated the entrepreneur for the willingness to bear risk and to wait to receive income.
Critics of Böhm-Bawerk's theory argue that workers are often exposed to risks such as injury on the job, a more profound kind of risk than the merely financial risk that the entrepreneur takes. A capitalist entrepreneur also has a greater ability to diversify (to minimize risk) than does the laborer because the latter has only one main asset, i.e., labor-power. Further, when the entrepreneurs' risk-taking does not pay off, this cost can be shifted to workers as wage cuts and/or layoffs. The existence of the "reserve army of the unemployed" means that even if they are aware of these risks, they often have little choice but to take them. In the Marxian view, this argument means that entrepreneurs have no right to compensation for bearing entrepreneurial risk.
Böhm-Bawerk and other Austrian economists replied to such critics by claiming that they played upon the ambiguities of the term ?risk,? that specifically financial risk must be isolated in order to understand the production process. Furthermore, the fact that capital markets lead to the control and minimization of financial risk is a valuable development in itself ? an argument for, not against, the overall social efficacy of capitalism.
Some critics take another tack, observing that not all risk-taking seems worth rewarding: for example, the invention and promotion of "crack" cocaine or e-mail spam were clearly a matter of risk-taking entrepreneurship, yet both seem to have more social costs than benefits. This is the problem of external costs, a form of market failure which (if serious enough) encourages people to seek non-market solutions.
The transformation problem
The most common interpretation of the labor theory of value is as a labor theory of price (a theory of price determination) in which Marx's theory roughly corresponds to that of Ricardo. In this view, the price of a commodity derives neither from its utility to the consumer (Marx's "use value") nor from supply and demand but from the labor that society has expended on its production. Early in volume III of Das Kapital, Marx presents an analysis of the relationship between values and prices. This has been read by most as describing the mathematical link between prices and values, i.e., how prices can be calculated from given values. The problems with Marx's "solution" to this mathematical problem have spawned a long-lived debate concerning the "transformation problem." In fact, this famous problem of finding (or rejecting) mathematical formulae linking individual prices to individual values is central to the dominant interpretation of the Marxian labor theory of value.
Even seen as "a simple theory of price" in which prices are directly determined by values, Marx's LTV does not deny the role of demand. Not only must each commodity have a use-value to its buyer, but demand and short-term supply determine the "market price." Following the classical-school perspective, Marx saw market prices as tending toward Smith's "natural prices" or what Marx called "prices of production" due to market forces. These were determined by long-term average production costs (and the equalization of profit rates between sectors). It was thus only in the long run that Marx denied the role of demand in determining relative prices (under competitive markets, with no land-rent).
Some simple mathematics
A simple example shows that on the microeconomic level, prices of production cannot be proportional to values, even when pure competition prevails: in Marx's own vision of how capitalist markets operate, competitive forces push market prices away from values and toward prices of production, which are unlikely to equal values.
First, again measure values and prices in the same units. For simplicity, measure both in terms of labor hours so that the distinction between values and prices corresponds to the Smithian distinction between labor-embodied values and labor-commanded values. To Marx, this is the distinction between "values" and "exchange-values."
Second, assume that market prices initially equalvalues (again assuming equal exchange) so that for any given commodity or commodity-producing sector of the economy, total profits are proportional to unpaid labor-time (surplus-value, S), total wages are proportional to paid labor-time (W), and the total amount of money invested by the capitalist is proportional to the value of the capital invested (K). This price/value equality has been called the "simple labor theory of price" above.
1. Suppose the ratio of unpaid labor-time to paid labor-time is the same for all workers. This assumption reflects the tendency (when workers are not slaves or serfs and labor-power markets are competitive) for workers to move away from sectors with the most exploitation and toward those with the least. Thus, the rate of exploitation tends toward equality between sectors. This ratio is here represented by s = S/W (unpaid labor-time/paid labor-time).
2. However, there is no reason why technical conditions of production will be the same in all sectors or for all commodities. Technological differences result in different proportions of labor and means of production (degrees of capital intensity) being used within distinct production processes, in different industries, or for different commodities. To Marx, the "organic composition of capital" or OCC differs between sectors. For any commodity, company, or sector, measure this as k = K/W, the ratio of the total amount invested in "capital" to the total amount spent on paid labor. K includes raw materials and fixed capital purchased before a prodution process starts. An industry with a high OCC is capital-intensive, involving a relatively roundabout production process.
3. If products were traded according to labor-values, different rates of profit will be received on the capital invested in different industries. The rate of profit, r, equals the total amount of profit earned divided by the amount of capital advanced, or S/K. This in turn implies that the profit rate equals
- r = (S/W)/(K/W) = s/k
We assumed that s was the same in all production processes and industries, while there is no reason to think that k is uniform between them. Thus, the profit rate likely differs between industries.
4. This situation makes no sense in the real world of capitalism, even as conceived by Marx, in which firms and sectors are competing with each other, with capitalists seeking profits wherever they can find it. Competition among industries should tend to remove differences in profitability. When given a chance to do so, capitalists earning low r should move their capital out of their industries, reducing supply and raising market prices. Simultaneously, they would enter the high-r sectors, raising supply and reducing market prices there.
5. Thus, market prices tend toward being equal to "prices of production", where the rate of profit is equalized between sectors. Since, according to the equation above, it is high k — or a high degree of roundaboutness — that depresses the rate of profit, the mobility of capital raises prices in the capital-intensive sectors, assuring capitalists a rate of profit equal to that of low k sectors. This means that the commodities command more labor than it took to produce them. On the other hand, the commodities produced in those sectors will low k will command less labor than it took to produce them. To Marx, this represents a redistribution of value and surplus-value from low-k to high-k sectors.
This profit-rate equalization, in turn, implies that market prices are not equal to values (as assumed initially). In the long run, they equal to prices of production, but these latter differ from values — because they reflect profit-rate equalization. That is, the simple labor theory of price cannot be true while "equal exchange" is not the norm under capitalism. Even before Marx presented his rudimentary numerical examples exploring price/value relationships, David Ricardo had presented a numerical example of this fact.
The above logical consequence of varying capital intensity has been the main focus of critiques of the Marxian LTV. Some see this as the reductio ad absurdum of the LTV. However, it should be noted that Ricardo himself employed a "93 percent labor theory of value," believing that most of the time labor-values were a good guide for guessing relative prices and (after correcting for inflation) the progress of prices over time.
When the simple theory applies
In general, the above shows that the simple "labor theory of price" cannot work exactly (100 percent) unless
- the organic composition of capital (k) is the same in each industry;
- there is no capital invested (k = 0, as in Smith's "early and rude state of society");
- the rate of surplus-value (s) equals zero (as in Marx's hypothetical "simple commodity production");
- differences in the rate of surplus-value between sectors are perfectly correlated with those of the organic composition; or
- there is no tendency for the rate of profit to equalize between sectors, so there is no tendency for prices to move away from proportionality to values (again as in Marx's simple commodity production).
This says that there is no reason why prices and values should be equal under capitalism. Even if one or more of the conditions above applies, price/value deviations will arise if monopolies exist or if land has been appropriated as private property, so that land-rent income is received (beyond "normal" profits). In either of these cases, demand plays a role in determining long-term prices.
More complex labor theories of price (more complex mathematical relationships between values and prices of production) have been proposed — but then most, if not all, of them have been criticized severely and rejected. In 1969, Amit Bhaduri pointed out that the "transformation" problem of finding a mathematical relationship between individual prices and individual values has intractable difficulties that are mathematically identical to those seen in the famous "Cambridge" critique of Robert Solow's aggregate production function. Whereas the problem with Solow's model is aggregation from micro- to macroeconomics, one interpretation is that the problem with Marx's theory is disaggregation: in Das Kapital, Marx starts from the whole of capitalism (values) and moves to the parts (prices). In neither case can one level of analysis be explained by the other by a simple mathematical relationship except under unrealistic assumptions.
An alternative interpretation
Although the above interpretation dominates most discussions, there are other views. In fact, one accepts the transformation problem's demonstration that individual prices deviate from individual values as its starting point. In this alternative view, Marx rejected modern economists' concern with price theory and in some ways returned to Locke's questions about the nature and origin of property rights and the orgins of unequal ownership of property under capitalism. That is, in this view, Marx rejected the idea of a labor theory of price.
Marx argued that price phenomena (markets, competition) created illusions that obscure the underlying social relations of a capitalist society. He called this distortion of appearances that masks reality "commodity fetishism". If prices and values are always equal, or if there is some easy-to-understand mathematical relationship between them, then property income will directly correspond to surplus-value and the class nature of capitalism will be clear to almost everyone. To Marx, such clarity would undermine capitalism's legitimacy.
To Marx, social relations are best analyzed in terms of value: who works and who doesn't? And how do incomes received correspond to labor done? These questions can apply just as easily to non-capitalist societies as to capitalist ones: in volume III, ch. 47, of Das Kapital, Marx suggests that the "specific economic form in which unpaid surplus-labor is pumped out of direct producers" is the basis for the "entire formation of the economic community," revealing "the innermost secret, the hidden basis of the entire social structure ... the political form of the relation of sovereignty and dependence ... [and] the specific form of the state." In sum, the question of who does the labor and who benefits forms a transhistorical theory of different types of society (e.g., capitalism, feudalism, slavery, and the old U.S.S.R.). Of course, it is only in a commodity-producing society that this question is stated in terms of relative values.
In this view, the "labor theory of value," as used in Das Kapital, is not a theory of price but instead a method for understanding the nature of social relationships for capitalism as a whole: the examples of workers producing value that Marx presents in volume I are microcosms representing the totality of society instead of representing microeconomic analysis. They present the shared characteristics of a large number of different relationships between capitalists and workers.
In this view, the contrast between labor-values and prices is just as important as their unity or connection. Values correspond to the abstract labor-time socially necessary to produce commodities (the contributions by workers to commodity-producing society), while prices are set by supply, demand, and market institutions.
However, on the societal or macro level, there is a clear relationship between price and value. First, all commodities are produced by labor (using means of production and technology); the commodity-producing segment of society is nothing but a community of producers working for each other through a complex division of labor mediated by markets. Thus, the total value of the product (the total amount of labor done) corresponds to the total price of the product (such as that measured by Gross Domestic Product). That is, labor embodied equals labor commanded (production equals demand) on the macro level.
Second, the total surplus-value that workers produce limits the total amount of property income (profits, interest, and rent) that all of the individual capitalists together can receive. That is, to Marx, all property income — income received due to property ownership rather than from one's labor — is the result of exploitation.
Thus, there is redistribution of property income within the capitalist class: given the state of class relations and thus the amount of surplus-value produced, a capitalist who receives a high profit rate will be benefiting partly at the expense of capitalists who receive low profit rates. In this interpretation, markets and prices redistribute surplus-value between capitalists so some can command more labor than is embodied in the commodities they have had produced. Others can command less labor than is embodied in their commodities. But in the end, the total amount embodied is equal to the total amount commanded.
The contrast between the "macro" level of values and the "micro" level of prices corresponds to the contradiction that Friedrich Engels posited under capitalism, between the socialized production of wealth and individual appropriation of it. Although society as a whole organizes production and exploitation, individuals are able to claim and use the individual results of this process. Engels saw this contradiction resulting in class conflict and crises.
Even accepting this alternative understanding of Marx's LTV, a serious criticism remains: now that Marx has explained the nature of capitalist exploitation, why do we need the LTV? Why can't we explain exploitation in other terms, as say John Roemer does in his 1982 General Theory of Exploitation and Class (ISBN 0-67434-440-5)? Others argue that Roemer's neoclassical general equilibrium approach hides more than it reveals and is based on dubious assumptions. The debate continues.
External links and references
- Bhaduri, Amit. 1969. "On the Significance of Recent Controversies on Capital Theory: A Marxian View." Economic Journal. 79(315) September: 532-9.