The Labor theory of value reference article from the English Wikipedia on 24-Jul-2004
(provided by Fixed Reference: snapshots of Wikipedia from wikipedia.org)

Labor theory of value

Helping orphans the way you would do it
The labor theory of value is a theory in economics and political economy which equates the "value" of an exchangeable good or service (commodity) with the amount of abstract labor required to produce it. While some see this as a theory of price determination in competitive markets, others see it as a tool for understanding the social relations of production, especially under capitalism.

Nineteenth-century political economists David Ricardo and Karl Marx are the main thinkers associated with this theory. However, the theory is older.

Table of contents
1 The theory's development
2 The theory explained
3 The theory applied
4 The theory critiqued
5 An alternative interpretation
6 External links and references

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. He answered that persons own their own labor, this ownership being bestowed on each of us by nature, and that when a person labored -- even the mere labour of picking an apple off a tree -- that labor entered into the object, and so the object became property of that person. From this Locke and others further argued that commodities have value because of the labor invested in them.

That is, the theory was used to support the new notion of private property. Locke argued that a landowner's property was his (or hers) because s/he had worked for it, removing it from the common stock held by humankind. Strangely, Locke mentions the hiring of "servants" by the landowner without wondering why some or all of the product of their labor does not belongs to them rather than to the landowner.

(While the limited amount of labor anyone is able to do -- and the short life-span of products -- seems to limit the amount of property one can own, Locke argued that one can accumulate money to claim more property, transcending that limit. (There are no limits on the accumulation of money, Locke said, since money doesn't spoil.) This later showed up in Marx's theory of capital accumulation, which allowed increasing power of the ruling class at the expense of the working class. For simplicity, such dynamic issues are ignored below.)

The Scottish political economist Adam Smith observed that in capitalist economies with a complex division of labor, people convert commodities into money and vice versa. He thus 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). In a way that makes matters confusing, he also used the "labor commanded" definition of value, referring to the real price of a product as the amount of labor that could be purchased by selling it. The fact that these two different kinds of labor-value (labor embodied and labor commanded) hardly ever correspond later 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. His emphasis was on what might be called a "labor theory of price," in which the (relative) amount of labor embodied in a commodity determines its (relative) price. This is a theory of price-determination by costs, in which costs reflect labor-values.

In these approaches, the labor theory of value is a theory of objective value. By most interpretations, the theory of value relationships proposed by the German philosopher and political economist Karl Marx made similar assumptions about "labour value." However, the subjective side plays an important role for Marx: to have value, a commodity must be desired by someone; it must have a use value. It is likely that Ricardo would agree.

As capitalism developed, Locke's problem of hired "servants" (workers, proletarians) could not be ignored. The labor theory of value was used by Marx to support a very different political argument than Locke's: that the role of owners in production is exploitative, since it is only the workers that add value to the product. At the level of the society as a whole, the price of the product is said to tend towards the sum of the value of the capital goods used up in production and the value added by direct labor.

The receipt of Profit, interest, rent, and other kinds of property income is only possible, according to the theory, if the wages of these direct workers 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 employer or capitalist.

The Austrian economist, Eugen von Böhm-Bawerk argued against Marx's theory of exploitation, pointing out that workers traded in their share of the end price for the more certain and soon wages paid by the entrepreneur. In other words, he claimed that the employer "earns" their profit by exposing themselves to risks that the workers can avoid. But critics of Böhm-Bawerk's theory argue that this theory ignores the fact that workers sometimes risk life and limb on the job, seemingly a more serious kind of risk-taking than the merely financial risk that the entrepreneur takes. A capitalist entrepreneur also has a greater ability to diversify to minimize risk than the laborer does, since the latter has only one main asset, his or her ability to work (labor-power). Further, when the entrepreneurs' risk-taking does not pay off, much of the cost is dumped on the workers in the form of wage cuts and/or lay-offs. So workers end up taking risks without volunteering to do so.

Much of Western economics (or what Marx would term "bourgeois" economics) turned away in the 1870s from theories of objective value and towards the economic subjectivism associated with the development of neoclassical economics. That is, most economists today have discarded the labour theory of value as a tool for undestanding price determination in favour of models based on marginal utility and marginal cost of production, i.e., on demand and supply. The subjective side is all-important here: costs depend crucially on the subjective valuation of (the willingness to supply) the factors of production by their owners. In the end, it is individual tastes in a general equilibrium system that dominate the neoclassical "theory of value" -- which is identical to its theory of price.

The theory explained

Marxian political economy has developed Marx's concept of "socially-necessary labour time" to clarify the meaning of his theory of value.

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 labour done by an average untrained 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 labour. Greater value can be produced by trained workers, or by workers using leading edge technologies, the increase in value being embodied 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 workers' time produces less, because the value depends on what's socially necessary. That is, the value of a product is determined not by individual conditions as much as by societal standards.

The value of a commodity thus depends on the socially necessary abstract labor time, the amount of socially average labor needed to produce it. Some labor -- such as skilled labor -- counts as a multiple of this average labor.

The theory applied

Marx used these tools to derive his theory of exploitation under capitalism. Marx assumed that all commmodities sold at prices equal to values (assuming that both are 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, "assuming 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 its value and then sells the commodity at its value, where does profit come from?

Going beyond Ricardo, Marx distinguished between labor-power and labor. Labor-power refers to the ability of workers to work, based in their muscle and brain power. Labor, on the other hand, refers to the actual activity of producing use values (goods and services) and value. In his numerical examples, Marx assumed that the value of labor-power (w) was constant, determined by the prevailing socioeconomic conditions. (In his time, this was seen as "subsistence.") The profit or surplus-value can arise because workers actually do more labor (L) than is necessary to pay the cost of hiring labor-power.

Marx's numerical examples in volume I of Das Kapital (Capital: A Critique of Political Economy) never really "prove" that capitalism always involves exploitation, i.e., that L is always greater than 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 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, to look for new jobs, or to refuse an offer of employment; they are never beaten to make them work.

To explain the normality of L > w and surplus-value production, Marx instead pointed to the institutional framework of capitalism, in which a small minority (the capitalists) monopolized the means of production, in which the workers had no way to survive except by working for capitalists, and in which the state protected this inequality of power. In this explanation, the normal role of force is structural, part of the usual workings of capitalism: the existence of the reserve army of unemployed workers continually threatens employed workers, pushing them to work long and hard to produce for the capitalists.

The theory critiqued

The most common interpretation of the labour theory of value is that it is a labor theory of price, so that Marx's theory corresponds to that of Ricardo. In this view, the price of a commodity is not derived from its functional value to the consumer (described by Marx as a use value), or from supply and demand, but from the labour society has expended on its production (its socially necessary labour time). Early in Marx's third volume of Das Kapital, he presented an analysis of the relationship between values and prices. This has been read 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 has spawned a large and long-lived discussion of the "transformation problem."

In fact, the famous tranformation problem of finding (or rejecting) mathematical formulae linking individual prices to individual values is the centerpiece of this dominant interpretation of the Marxian labor theory of value. Let us examine an example, showing that on the microeconomic level, prices cannot be proportional to values, even when pure competition prevails.

First, as suggested above, we must 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. In Marx's terms, this was the distinction between "values" and "exchange-values."

Assume initially that prices are equal to values (as suggested by the standards of equal exchange), so that for any given commodity or 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 might be called the "simple labor theory of price."

Suppose the proportion of unpaid labor-time to paid labor-time is the same for all workers. This reflects the tendency (when workers are not slaves or serfs and labor-power markets are relatively competitive) for workers to move away from those sectors where they are exploited the most and toward where they are exploited the least. (This is the theory of compensating wage differentials developed by Smith.) Thus, the rate of exploitation (also known as the rate of surplus-value) tends toward equality between sectors. This equalized ratio is here represented by s = S/W (unpaid labor-time/paid labor-time).

But there is no reason why technical conditions of production will be the same in all sectors or for all commodities. Technology will result in different proportions of labour and capital goods (degrees of capital intensity) being used within distinct production processes, in different industries or for different commodities. In Marx's terms, 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. The former includes wages (W) if workers are paid ahead of time for providing labor-time. In any case, "capital" includes raw materials and fixed capital purchased before a prodution process starts.

If products were traded according to labor-values (as assumed), 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 (S) divided by the amount of capital (K) advanced, or S/K. This in turn implies that the profit rate equals

r = (S/W)/(K/W) = s/k

Above, we assumed that s was the same in all production processes and industries, while (as noted) there is no reason to think that k is uniform between them. Thus, the profit rate differs between industries.

But this situation makes no sense in the real world of capitalism, where firms are competing with each other and seeking profits wherever they can find it. Competition among industries should tend to remove differences in profitability (the rate of profit). When given a chance to do so, capitalists earning low profit rates should move their capital out of their industries, reducing supply and raising prices. Simultaneously, they would enter the high-profitability sectors, raising supply and reducing prices there. This means that prices tend toward being "prices of production" (Smith's "natural prices") where the rate of profit is equalized between sectors.

This profit-rate equalization in turn implies that prices can no longer be equal to values (as assumed initially). That is, the simple labor theory of price cannot be true. Even before Marx presented his rudimentary numerical examples exploring price/value relationships, David Ricardo presented a numerical example of this fact:

"Suppose I employ twenty men at an expense of 1000 pounds for a year in the production of a commodity, and at the end of the year I employ twenty men again for another year, at a further expense of 1000 pounds in finishing or perfecting the same commodity, and that I bring it to market at the end of two years, if profits be 10 per cent., my commodity must sell for 2,310 pounds.; for I have employed 1000 pounds capital for one year, and 2,100 pounds capital for one year more. Another man employs precisely the same quantity of labour, but he employs it all in the first year; he employs forty men at an expense of 2000 pounds, and at the end of the first year he sells it with 10 per cent. profit, or for 2,200 pounds. Here then are two commodities having precisely the same quantity of labour bestowed on them, one of which sells for 2,310 pounds--the other for 2,200 pounds."

The above logical consequence of varying capital intensity has been the main focus of economic critiques of a Marxian labor theory of value. Some see this as a reductio ad absurdum of the labor theory of value. 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 the progress of prices over time (after correcting for inflation).

In general, this discussion shows that the simple "labor theory of price" cannot work exactly (100 percent) unless

This says that there is no reason why prices and values should be equal under modern capitalism. Even if one or more of the conditions above applies, price/value deviations will arise if monopolies exist or land has been appropriated as private property.

The large literature on the transformation problem has criticized and rejected most if not all of the more complex labor theories of price that have been proposed. But in 1969, Amit Bhaduri pointed out that the "transformation" problem of finding a simple mathematical relationship between individual prices and individual values has 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 (which is still used by many neoclassical economists, despite their having lost the debate) is that of aggregation, one interpretation is that the problem with Marx's theory is that of disaggregation: Marx starts from the whole of capitalism (values) and moves to the parts (prices). Let us turn to this interpretation.

An alternative interpretation

While 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 interpretation, Marx was rejecting the modern economists' concern with price theory and in some ways returning to Locke's questions about the nature and origin of property rights.

Marx argued that price phenomena (markets, competition, supply, demand) created illusions which obscure the underlying social relations of a capitalist society. He called this distortion of appearances that masks reality "commodity fetishism" or (in volume III) "the illusions created by competition." If prices and values were always equal, or if there some easy-to-understand mathematical relationship between them, then property income would directly correspond to surplus-value and the class nature of capitalism would be clear to almost everyone.

To Marx, social relations are best analyzed in terms of value: who works and who doesn't in capitalist society? 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 fact, in volume III, ch. 47, of Das Kapital, Marx suggested 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 general, transhistorical, theory of different types of society (e.g., capitalism, feudalism, slavery, and the old U.S.S.R).

In this view, the "labor theory of value" as used in Das Kapital was not a theory of price but instead as 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 heterogeneous relationships (in different workplaces) between capitalists and workers producing commodities.

In sum, the contrast between labor-values and prices is just as important as their unity or connection. While values correspond to the abstract labor-time socially necessary to produce commodities (the contributions by workers to the societal factory), prices are set by supply, demand, and market institutions. As noted above, there is no theoretical reason why price should always equal value on the microeconomic level. (Of course, Ricardo's 93 percent theory seems to apply empirically, at least for newly manufactured products.)

However, on the societal or macro level, there is a clear relationship between price and value. First, 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. 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.

Second, and more importantly, 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 terms of the "transformation problem," there is a transfer of profits to the first capitalist from the latter capitalists because the ratio of his (or her) prices to his values is high, while theirs is low. 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.

The contrast between the "macro" level of values and the "micro" level of prices corresponds to the contradiction that Friedrich Engels posited as existing under capitalism, between the socialized production of wealth and individual appropriation of it. While it is society as a whole which organizes production and exploitation, individuals are able to claim and use the individual results of this process. Engels saw this contradiction as resulting in class conflict and crises.

Even if we accept this alternative understanding of Marx's labor theory of value, a serious criticism remains: especially now that Marx has explained the nature of capitalist exploitation (see above), why do we need the labor theory of value? why can't we explain exploitation in other terms, as say John Roemerdoes? Others argue that Roemer's neoclassical general equilibrium approach hides more than it reveals, while being based on dubious assumptions. The debate continues.

External links and references