What determines what quantity of one thing will fetch some quantity of another thing? Why is the price of a pair of ordinary shoes, a shirt, or a loaf of bread the same in every store? Why should bread be $2.50 a loaf and shoes $25 a pair and not vice-versa? Philosophers since Aristotle have inquired into economic value and prices. Beginning with Adam Smith and David Ricardo, economists have tried to understand the exchange value of commodities in terms of the embodied human labor, the Labor Theory of Value. Karl Marx improved the Labor Theory of Value, identifying the source of non-wage factors in surplus labor, and making explicit the fundamentally statistical character of the theory. There are issues with Marx’s theory, however. The most serious issue, the transformation problem, demonstrates that Marx’s theory conflicts with the assumption that capitalists will allocate their capital to achieve a uniform rate of return across all industries, including those that produce both final and intermediate goods. The transformation problem, however, itself requires assumptions that are at best suspect, especially under global equilibrium conditions. While these issues render Marx’s theory insufficient to predict money prices in the short term, we can look at the Labor Theory of Value in a paradigmatic sense, to make issues of political economy explicit and inform normative economics.
Marx himself did not first propose the Labor Theory of Value. In The Wealth of Nations, Adam Smith connects labor to price. According to Smith, “The value of any commodity, therefore, to the person who possesses it, and who means not to use or consume it himself, but to exchange it for other commodities, is equal to the quantity of labour which it enables him to purchase or command. Labour, therefore, is the real measure of the exchangeable value of all commodities” (par. 1). Although Smith identifies labor as the source of value, he fails to identify the historical labor indirectly embodied in commodities, such as the labor necessary to make a worker’s tools and equipment. To Smith the exchange value of a commodity is the immediate labor saved by the exchange; if buying a commodity will save one person two hours of labor, the exchange value would be two hours of labor, or the equivalent in money. While a useful approximation, the immediate exchange value becomes too imprecise and variable to construct a quantitative theory.
David Ricardo performs a more thorough accounting in Principles of Political Economy: “The exchangeable value of the commodities produced [is] in proportion to the labour bestowed on their production; not on their immediate production only, but on all those implements or machines required to give effect to the particular labour to which they were applied” (par. 19). But Engels still observes that traditional economics fails to give a satisfactory explanation for the distinction between wages and actual labor: If the exchange value of an hour of labor is an hour of labor, then how can wages – just the value of labor in money form – afford the owner of capital any opportunity for profit? If wages are less than the actual value of labor, why are they less? How do we calculate how much less?
In Capital, Karl Marx improves the Labor Theory of Value by formally separating the notions of labor and labor power. Labor is the actual labor performed by a worker; labor power is the cost to make that labor available, essentially the cost to feed, clothe, house, and entertain the worker, as well as providing for the next generation of workers. In any economy generating a surplus, the cost of labor power, i.e. the labor necessary to feed a worker, will be less than the labor made available by that labor power. Wages are therefore a function of labor power, but the exchange value of a commodity is a function of the actual labor required to produce that commodity (ch. 6). We can conclude then that the difference between labor and labor power, the surplus value of labor, is the ultimate source of profit.
Marx also makes clear that the exchange value of a particular instance of a commodity is not related to the total amount of labor embodied in that instance. “Some people might think that if the value of a commodity is determined by the quantity of labour spent on it, the more idle and unskilful the labourer, the more valuable would his commodity be, because more time would be required in its production” (“Capital” pt. 1 ch. 1 par. 14). The exchange value is instead related to the socially necessary labor embodied in the commodity as a class, which Marx clearly describes as a statistical property: The individual unit of labor “is the same as any other, so far as it has the character of the average labour-power of society, and takes effect as such; that is, so far as it requires for producing a commodity, no more time than is needed on an average, no more than is socially necessary” (“Capital” pt. 1 ch. 1 par. 14). For example,
The introduction of power-looms into England probably reduced by one-half the labour required to weave a given quantity of yarn into cloth. The hand-loom weavers, as a matter of fact, continued to require the same time as before; but for all that, the product of one hour of their labour represented after the change only half an hour’s social labour, and consequently fell to one-half its former value. (“Capital” pt. 1 ch. 1 par. 14)
It is thus clear that the exchange value derives from some statistical property of the actual labor embodied in all the instances of a commodity as a class.
Finally, Marx introduces the two distinct notions of abstract labor. The first notion is human labor abstracted from the particular task a worker performs. “Neither can [a commodity] any longer be regarded as the product of the labour of the joiner, the mason, the spinner, or of any other definite kind of productive labour. . . . All are reduced to one and the same sort of labour, human labour in the abstract” (“Capital” pt. 1 ch. 1 par. 10). But Marx also realizes that even in this sense of abstraction, not all labor is created equal. “One man is superior to another physically, or mentally, and supplies more labor in the same time, or can labor for a longer time; and labor, to serve as a measure, must be defined by its duration or intensity, otherwise it ceases to be a standard of measurement” (“Gotha” pt. 1). Environmental factors also affect intensity. It seems obvious that ceteris paribus an hour doing physical labor standing in a sewer would be more “intense” than an hour sitting in an air-conditioned office.
The Labor Theory of Value has considerable philosophical appeal. Smith and Ricardo seem to treat other factors of production – profit, rent and interest – as sui generis, having their own distinct character and contribution to exchange value unrelated to human labor. While these factors contribute to immediate prices, it is difficult to understand how mere ownership – distinct from the administrative or supervisory labor the capitalist, landlord or banker might perform – can itself create value in the same sense that labor creates value. In a society without a class structure, without a distinct class or group of owners, the same competitive forces that equalize prices would ensure that no individual as owner of the equipment, land or money he used directly in his own production could say that the ownership by itself contributed more than just his own labor to the exchange value of the product. All individuals have to trade is their individual time and effort, either directly (“I scratch your back; you scratch mine”) or indirectly by embodying their labor in commodities. The non-wage factors of production would seem, philosophically, to be just social constructions to allocate the surplus value of labor.
As philosophically appealing as Marx’s Labor Theory of Value might be, it suffers from considerable problems as a descriptive theory. A good descriptive theory, especially a reductive theory, requires that the reduced elements be independently determinable. Marx’s Labor Theory of Value fails to the extent that it purports to reduce the competitive market price of a commodity – including labor power as a commodity – to any independently determinable quantity of embodied labor. In this sense the Labor Theory of Value predicts that the market “discovers” the exchange value of a commodity, the socially necessary abstract labor embodied in that commodity. However, the market itself directly affects the socially necessary abstract labor embodied in the commodity in a number of ways.
Unlike any other commodity, labor power is instantiated in human beings. A shoe or a steel girder as a commodity has no preferences, needs or wants of its own; it thus cannot object to being sold at cost. Human beings, on the other hand, do indeed have preferences, needs and wants; they are strongly motivated to act on those subjective properties. Hence the cost of labor power feels a “force” tending towards disequilibrium not present in any other commodity. As Marx notes:
The number and extent of [the labourer’s] so-called necessary wants, as also the modes of satisfying them, are themselves the product of historical development, and depend therefore to a great extent on the degree of civilisation of a country, more particularly on the conditions under which, and consequently on the habits and degree of comfort in which, the class of free labourers has been formed. In contradistinction therefore to the case of other commodities, there enters into the determination of the value of labour-power a historical and moral element. (“Capital” pt. 2 ch. 6 par. 10)
Although Marx does go on to say, “In a given country, at a given period, the average quantity of the means of subsistence necessary for the labourer is practically known” (“Capital” pt. 2 ch. 6 par. 10), we cannot expect the price of labor power to move toward equilibrium with the same alacrity as other commodities.
Another problem is that market prices do not just emerge from the socially necessary abstract labor time embodied in a commodity; market forces directly affect the labor embodied in a commodity. Marx’s simplistic formulation, “The labour-time socially necessary is that required to produce an article under the normal conditions of production” (“Capital” pt. 1 ch. 1 par. 14), requires substantive revision. Even absent non-wage factors, we see that a shift in just the demand curve, with no changes to technology, individual efficiency, or any other specific characteristics of supply, still changes the statistical properties of the cost of supply, and therefore changes the socially necessary labor time necessary to supply the commodity. When demand falls, the incentive is not to arbitrarily eliminate suppliers of a commodity, but rather to eliminate the suppliers with the highest marginal cost. Similarly, when demand rises, we do not add “average” suppliers; we must add new suppliers with a higher marginal cost. Thus while the socially necessary labor time is still strictly meaningful – regardless of the demand, the marginal cost of supply at equilibrium and the average cost of supply are real costs – we cannot determine the socially necessary labor time independently of market forces.
This characteristic means that the efficiency of labor, a component of abstract labor, is also dependent on demand. The only way to compare efficiency across different forms of labor is to compare an individual laborer’s productivity to the socially necessary labor time for the commodity as a class. If the socially necessary labor time for producing a widget is 10 hours, and a particular laborer can produce a widget in 8 hours, then her productivity is 10/8 x 100% = 125%. But if the socially necessary labor time falls to 9 hours, then her productivity falls to 10/9 x 100% ~ 11% even though nothing about the quality of her own work has changed.
Furthermore, while it’s intuitively appealing that the environmental conditions of some labor can affect the intensity or desirability of the labor, it is difficult to independently measure these factors quantitatively. Yes, working in a sewer might obviously be less desirable than working in an air-conditioned office, but by how much? One tenth as desirable? One half? Ten percent? We have to rely on market forces to quantify these subjective factors. We cannot predict the market price based on the environmental conditions; we must, rather, infer the environment’s effect from the market prices.
The transformation problem is perhaps the most serious problem affecting the Labor Theory of Value. Succinctly, the capitalist mode of production consists of using the production of commodities to convert money into commodities, and commodities into more money. The capitalist wants to realize a profit on the total amount of money he invests in an enterprise, regardless of what that money is spent on. If the surplus value of labor is the only “true” source of profit, then the capitalist could realize a profit only from the direct labor inputs to production; the surplus value of labor embodied in the rest of the inputs, especially physical capital and intermediate goods, has already been extracted by the suppliers of those inputs. Samuelson notes that Marx’s Labor Theory of Value predicts that profit should act like a value-added tax; the “added value” consists of the surplus labor at each stage of production. But in the capitalist mode of production profit actually acts like a turnover tax, where each stage of the production process incurs a “tax” on the entire value transmitted, not just the value added. Samuelson shows that these different ways of looking at profit result in different slopes for the wage component of the production possibility frontier (p. 409). It is mathematically impossible to model a constant turnover tax as a constant value-added tax; they might have the same total cost, but their allocation cannot be transformed to individual industries. The transformation problem alone thus decisively renders the Labor Theory of Value insufficient as a short-run predictor of market prices in a capitalist economy.
It is not clear, however, that the transformation problem decisively rebuts the fundamental premise of the Labor Theory of Value.
Wikipedia attempts an analysis of the transformation problem using the Deer-Beaver-Arrow model, but the analysis has several flaws; it simply assumes a constant rate of return on capital, with no deeper justification. A more careful analysis is required.
Let us first consider a very simple two-product economy, consisting of the production of Deer and Beavers, each of which require only direct labor. We can assume that all labor is homogenous: Any person may turn her hand equally effectively to the production of Deer or Beavers, and she is free to do so. We can also assume that supply curves are horizontal, perfectly elastic; the marginal cost remains constant and demand determines only the quantity supplied. We can make these assumptions without loss of generality: All the properties that complicate microeconomic analysis – comparative advantage, rising marginal cost of supply, land allocation – affect the equilibrium price, a real labor cost that (absent non-wage factors) determines the socially necessary labor time for the production of a commodity. We can assume that to reach some equilibrium, the individuals have made all available Pareto optimizations, and we have settled on some definite socially necessary labor time necessary to meet demand. It is clear in this case that the relative price of Deer and Beavers is the relative socially necessary labor time embodied in their production. Changes in demand curves will change only the relative quantities of Deer and Beaver produced at that relative price.
To this model, we will add a “capital” good, Arrows, which make the production of both Deer and Beavers more efficient. As a capital good, we might conjecture that Arrows would earn a rate of return, over and above their labor cost. But where does this rate of return come from? If we hold to our original assumption, that labor is homogenous and each individual can freely allocate her labor, then a rate of return implies that labor spent making Arrows returns more than labor spent hunting Deer and Beavers, even using Arrows. In this case everyone will “bid” for the privilege of making Arrows until each individual becomes indifferent to how she spends her time, implying a zero rate of return over and above the labor cost. Far from disproving the Labor Theory of Value, simple equilibrium analysis under free market assumptions seems to disprove the capitalist mode of production!
Samuelson concludes from a more sophisticated analysis of the Labor Theory of Value and the transformation problem that the Labor Theory of Value is essentially a restatement of “bourgeois” money-based economics:
Although Capital’s total findings need not have been developed in dependence on Volume I’s digression into surplus values, its essential insight does depend crucially on comparison of the subsistence goods needed to produce and reproduce labor with what the undiluted labor theory of value calculates to be the amount of goods producible for all classes in view of the embodied labor requirements of the goods. The tools of bourgeois analysis could have been used to discover and expound this notion of exploitation if only those economists had been motivated to use the tools for this purpose. (p. 422)
Even though the Labor Theory of Value fails as a short-term predictor of prices in a growing capitalist economy, it does put at the forefront the fundamental dependence of economics on the particular characteristics of labor and labor power. By making labor central, the Labor Theory of Value actually does discover what Samuelson implies traditional analysis could have discovered but did not. Taking a labor-centric view of economics thus has significant implications for not only how economics affects our political decision-making, but also how we should actually conduct economic analysis.
An important consequence of a labor-centric view of economics is that profitability is not intrinsically good. Profit is not “real”; it is, rather, a disguised form of surplus labor. To determine whether some profit is good, we have to look at where it comes from and where it goes. Profit that comes from a real increase in labor productivity is better than profit that comes from a reduction in the price of labor power. Profit that goes to expanding our physical, human and technological capital is better than profit that goes to the extravagant consumption of the capital-owning class. A money-centric view of economics does not make clear the source, destination or justification of profit; a labor-centric view puts these characteristics in plain sight.
Although labor power has unique historical and moral characteristics, it is still in many important senses a commodity, one that workers exchange with capitalists in a competitive market. As a commodity, labor power is subject to the same market forces as any other commodity, forces that tend to move the price of any commodity to its socially necessary cost. Thus we cannot count on the “invisible hand” to raise the price of labor power and distribute the productivity of society to those who do the actual work; raising the price of labor power – if we choose to do so – must therefore be a social decision. In just the same sense allowing the invisible hand to lower the price of labor power is just as much a social decision. Money-centric economics, however, allows us to obscure the social nature of this decision, making it seem the outcome of “inexorable” economic forces.
Finally, the Labor Theory of Value argues that the principal efforts of economists should be turned to understanding and measuring the role of labor in the economy. Statistics about the labor embedded in individual products, the labor available to the economy as a whole, as well as the price of labor power should receive as much or more attention as the Dow Jones Industrial Average and nominal Gross Domestic Product. The Labor Theory of Value implies that every measurement of real economic activity should be stated somehow in terms of labor and labor power. Indeed the Labor Theory of Value suggests that money itself, i.e. nominal economic measurement, should explicitly refer to some property of labor.
The tools are there; we need a shift in emphasis. In 1845, Marx wrote, “The philosophers have only interpreted the world, in various ways; the point is to change it” (“Feuerbach”). What we do not measure, we cannot optimize; what we do not discuss, we cannot change. We must explicitly discuss and make central the role of labor and labor power in our economy if we want to improve the conditions of the billions of people who spend their time working.
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