Labor theory of value

The labor theory of value (LTV) is a theory in classical economics concerning the value of an exchangeable good or service. It holds that the value of goods or services is equal to the amount of labor required to produce them, including the labor required to produce the raw materials and machinery used in the process.

Adam Smith and David Ricardo are most often associated with this theory, and most of classical economics relies on it. Neoclassical economics, on the other hand, relies on the subjective theory of value instead. Of course, also according to the LTV a product can only have value, if there is somebody for whom this product has a use value, for whom it has a subjective value, and if this somebody can pay for that product. A product without any use or subjective value cannot have a labor value, whatever amount of labor might be necessary to produce it.

On the other side, if individuals maximise their subjective value, they do so under objective constraints. A household, for example, faces a budget constraint, a society faces the Production possibility frontier as a constraint. The subjective value theory cannot do without objective factors, either. The difference between the two theories is, whether one sees a capitalist economy driven primarily by objective structural forces (ex. gr. profit maximisation, competition) or primarily by free decisions of free individuals.

Within the field of political economics, Karl Marx used the theory as a tool for understanding the social relations between workers, as owners of labor power, and the owners of capital; as such, the labor theory of value is important to Marxism, but more as an institutional theory than a price theory.

The justification of the theory

Contrary to popular belief, the LTV does not deny the role of supply and demand influencing price. In Value, Price and Profit (1865), Karl Marx quotes Adam Smith and sums up:

It suffices to say that if supply and demand equilibrate each other, the market prices of commodities will correspond with their natural prices, that is to say, with their values as determined by the respective quantities of labor required for their production.[1]

It is the level of this equilibrium which the LTV seeks to explain. This could be explained by a "cost of production" argument, pointing out that all costs are ultimately labor costs, but this does not account for profit, and it is vulnerable to the charge of tautology in that it explains prices by prices.

Smith argues that labor values are the natural measure of exchange for direct producers like hunters and fishermen.[2] Marx, on the other hand, uses a mathematical analogy, arguing that for commodities to be comparable they must have a common element by which to measure them, and that labor is the only commonality.[3]

Some empirical evidence for the theory has also been advanced.[4]

Applicability of LTV

The LTV cannot claim to explain the value of everything. Problematic cases are

pieces of art
land not cultivated (the value of land is explained by the theory of rent. Both Ricardo and Marx developed theories of land-rent based on the LTV)
paper money
value of shares (explained similarly like the value of land)

The theory’s development

Benjamin Franklin in his 1729 essay entitled "A Modest Enquiry into the Nature and Necessity of a Paper Currency" is sometimes credited with originating the concept. However, the theory has been traced back to Treatise of Taxes, written in 1662 by Sir William Petty, and was restated by Vauban in 1707, David Hume in 1752, and by the Physiocrats. [5]

British economist Adam Smith accepted the LTV for pre-capitalist societies but saw a flaw in its application to capitalism. He pointed out that if the "labor embodied" in a product equalled the "labor commanded" (i.e. the amount of labor that could be purchased by selling it), then profit was impossible. David Ricardo (seconded by Marx) responded to this paradox by arguing that Smith had confused labor with wages. "Labor commanded", he argued, would always be more than the labor needed to sustain itself (wages). The value of labor, in this view, covered not just the value of wages, but the value of the entire product created by labor.[6]

Ricardo's theory was a predecessor of the modern theory that equilibrium prices are determined solely by production costs associated with "neo-Ricardianism".

Based on the discrepancy between the wages of labor and the value of the product, the "Ricardian socialists" — Charles Hall, Thomas Hodgskin, John Gray, and John Francis Bray[7] — applied Ricardo's theory to develop theories of exploitation.

Marx expanded on these ideas, arguing that workers work for a part of each day adding the value required to cover their wages, while the remainder of their labor is performed for the enrichment of the capitalist. The LTV and the accompanying theory of exploitation became central to his economic thought.

Later, the Austrian school, led by Eugen von Böhm-Bawerk, argued against 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 discard the LTV as a theory of price determination in favour of neoclassical models based on supply and demand. In the end, the neoclassical "theory of value" (general equilibrium theory) is identical to the theory of price. Corresponding to this shift is one from Marx's emphasis on the inner workings of the societal process of production to an emphasis on individual exchange and markets (and on methodological individualism.)

19th century American individualist anarchists based their economics on the LTV, with their particular interpretation of it being called "Cost the limit of price." They, as well as contemporary individualist anarchists in that tradition, hold that it is unethical to charge a higher price for a commodity than the amount of labor required to produce it. Hence, they propose that trade should be facilitated by using notes backed by labor.

Marx's theory

Contrary to popular belief, Marx does not base his LTV on what he dismisses as a "ascribing a supernatural creative power to labor", arguing in the Critique of the Gotha Program that:

Labor is not the source of all wealth. Nature is just as much a source of use values (and it is surely of such that material wealth consists!) as labor which is itself only the manifestation of a force of nature, human labor power.[8]

Here Marx is drawing a distinction between exchange value (which is the subject of the LTV) and use value.

Marx uses the concept of "socially necessary abstract labor-time" to introduce a social perspective distinct from his predecessors and neoclassical economics. Whereas most economists start with the individual's perspective, 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 people who depend on each other for their survival and prosperity.

"Abstract" labor refers to a characteristic of commodity-producing labor that is shared by all different kinds of heterogeneous (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" labor refers to the quantity required to produce a commodity "in a given state of society, under certain social average conditions or production, with a given social average intensity, and average skill of the labour employed".[9] That is, the value of a product is determined more by societal standards than by individual conditions. This explains why technological breakthroughs lower the price of commodities and put less advanced producers out of business. Finally, it is not labor per se, which creates value, but labor power sold by free wage workers to capitalists. Another distiction to be made is that between productive and unproductive labour. Only wage workers of productive sectors of the economy produce value.

Robert Nozick, however, has criticized the qualifier "socially necessary" in the labor theory of value as not well-defined and concealing a subjective judgment of necessity.

Exploitation

Marx uses his LTV to derive his theory of "exploitation" under capitalism.

Unlike Ricardo or the Ricardian socialists, Marx distinguishes between labor-power and labor. "Labor-power" is the ability of workers to work, given their muscles and brains. "Labor" is the actual activity of producing value. The profit or surplus-value arises when workers do more labor than is necessary to pay the cost of hiring their labor-power.

To explain the normality of exploitation, Marx points to capitalism's institutional framework, in which a small minority (the capitalists) monopolize the means of production, in which the workers cannot 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 the system: 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 LTV 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. 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 society-wide institutional explanation is needed. To him, roundaboutness explains only those profits of the more capital-intensive operations relative to less capital-intensive ones.

Furthermore, Böhm-Bawerk's positive theory of interest argued that workers trade in their share of the end price for the more certain 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 argue that workers in fact face more risks, including injury and job loss, and have less ability than an entrepreneur to diversify and minimize risk, having only their labor power as an asset.

The transformation problem

For a more detailed treatment, see the Transformation problem.

The most common interpretation of the LTV is as a theory of price determination, which makes Marx's theory roughly correspond to that of Ricardo, in which a commodity's price derives from the labor expended on its production. Early in volume III of Capital, Marx presents an analysis of the relationship between values and prices. Most read this as describing how prices can be calculated from given values.

The problems with Marx's "solution" to this mathematical problem have spawned a long debate concerning the "transformation problem". For Marx, the essential problem is: given the varying proportions of "living labor" in different types of production and the theory that surplus-value (i.e. profit) is only extracted from "living labor", how can the tendency of profit rates to normalise be explained? This problem of finding (or rejecting) mathematical formulae linking individual prices to individual values is central to the dominant interpretation of the Marxian LTV.

As previously stated, the LTV supposes short-term supply and demand determine a commodity's "market price" ( $p$ ). Following the classical-school perspective, Marx saw each $p$ as tending toward the "price of production" (Smith's "natural price") due to these market forces. Prices of production ( $p'$ ) are long-term average prices, seen as totally determined by labor.

A simple example shows that on the micro level, the $p'$ cannot be proportional to values, even when pure competition prevails. Even before Marx presented his numerical examples exploring price/value relationships, David Ricardo had presented a numerical example of this fact.

1. Measure (labor) values and prices in the same units, labor hours.

2. Assume that each $p$ initially equals value so that for any given commodity, 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 ( $K$ ).

3. Suppose the ratio of unpaid labor-time to paid labor-time is the same for all commodities. This assumption reflects the tendency for workers to move away from sectors with lower wages. Thus, the rate of exploitation tends toward equality between sectors. This ratio is measured here by $s={\frac {S}{W}}$ (unpaid labor-time/paid labor-time).

4. But there is no reason why technical conditions of production will be the same for all sectors. Different proportions of labor and means of production are used in distinct production processes for different commodities. To Marx, the "organic composition of capital" or OCC differs between sectors. For any commodity, measure this as $k={\frac {K}{W}}$ , 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 production process starts. An industry with high OCC is capital-intensive.

5. 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 divided by the capital advanced, or ${\frac {S}{K}}$ . This implies that the profit rate equals

r=\left({\frac {\frac {S}{W}}{\frac {K}{W}}}\right)={\frac {s}{k}}

If $s$ is the same for all commodities, while $k$ varies, $r$ differs between commodities.

6. This situation makes no sense for real world capitalism (even as conceived by Marx) in which businesses compete with each other and capitalists seek profits everywhere. When able to do so, capitalists earning low $r$ move their capital out of their industries, reducing supply and raising $p$ there. They enter high- $r$ sectors, raising supply and reducing $p$ there.

7. Thus, market prices tend toward being equal to the $p'$ which are proportional to long-term average costs and $r$ tends to be 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 $p$ in the high- $k$ sectors, assuring capitalists a $r$ equal to that of low $k$ sectors.

Marx argued that this represents a redistribution of value and surplus-value between sectors. This means that prices of commodities produced in high- $k$ sectors are higher than the labor values and vice versa in low- $k$ sectors. This could be seen Marx's take on Böhm-Bawerk's concept of roundaboutness (see above).

This also implies that the $p$ cannot equal values, according to Marx, prices equal values only on average (this also has been disputed by some). In the long run, they equal $p'$ , but these latter differ from values (or equal values only on average) - because they reflect profit-rate equalization. That is, the simple labor theory of price cannot be true while "equal exchange" is not the norm.

The above consequence of varying capital intensity has been central to critiques of the simple LTV. Some see this as its reductio ad absurdum. However, 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.

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;
there is no tendency for the rate of profit to equalize between sectors (again as in Marx's simple commodity production).

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 (for instance that one proposed by Marx himself in volume III of Capital) - 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 Capital, 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 mathematical relationship except under unrealistic assumptions. Instead, Marx might say that there is a dialectical connection between the two levels (whole and parts).

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 typically deviate from individual values as its starting point. This alternative view, Marx connects Marx's LTV to the labor theory of property advanced by philosopher John Locke and others, exploring questions about the nature and origin of property rights and the origins of unequal ownership of property under capitalism. That is, in this view, Marx was not interested in developing a theory of price as much as a theory of social relations.

Marx argued that price phenomena (markets, competition, supply and demand) create illusions that obscure the underlying social relations of a capitalist society. He called this distortion of appearances "commodity fetishism". If there were some easy-to-understand mathematical relationship between prices and values, then property income would clearly correspond to unpaid labor and the class nature of capitalism would be obvious to almost everyone. To Marx, such clarity would undermine capitalism's legitimacy. Commodity fetishism thus helps maintain social stability.

To Marx, social relations are best understood 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 Capital, 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."

These questions form a transhistorical theory of different types of society (e.g., capitalism, feudalism, slavery, and the old U.S.S.R.). However, it is only in a commodity-producing society that these questions are stated in terms of values.

In this view, the LTV, as used in Capital, is 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 being microeconomic analyses. 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 macro level, there is a clear relationship between price and value. 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). The total surplus-value that workers produce limits total 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.

The contrast between the "macro" level of values and the "micro" level of prices can be seen as corresponding to the contradiction that Friedrich Engels saw under capitalism, between the socialized production of wealth and its individual appropriation.[10]

However, if we accept this view 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.

The corn theory of value

Marx stated that only labor could cause an increase in value. This suggests that labor intensive industries ought to have a higher rate of profit than those which use less labor which is empirically false. Marx explained this by that in real economic life prices vary in a systematic way from values. The mathematics applied to the transformation problem attempt to describe this (albeit with the unwelcome side consequences described above).

Critics (following, for instance, studies of Piero Sraffa) respond that this makes the once intuitively appealing theory very complicated; and that there is no justification for asserting that only labor and not for example corn can increase value. Any commodity can be picked instead of labor for being the commodity with the unique power of creating value, and with equal justification one could set out a corn theory of value, identical to the labour theory of value.[11] A scholar on the topic of Marxism, Jonathan Wolff says "By reproducing for corn or iron or coal, all the striking results that Marx derived concerning for labor, we have, it seems to me, raised questions about the foundations of Marx's critique of capitalism and classical political economy."[12]

However, the starting point for Marx's argument was: "What is the common social substance of all commodities? It is labor." [13] Since neither corn, iron, nor coal could be said to be common to all commodities, this critique may appear flawed. However, due to automation labor power also is not necessarily common to all commodities.

Here it is important, that according to Marx it is not "labor", which causes an increase in value, but free labor, labour power sold by free workers to the capitalists. Slave labor cannot create value. Alan Freeman points out, that it is this social fact, which is the reason why it is labor and not something else (corn, slave labor, running time of machines, working animals, plants and so on), which is the measure of value. Freeman about labor: "This is of course true of other commodities also; but other commodities do not walk around the market disposing of their income on an equal basis with their owners. The cost of labour power is determined independently of its capacity to make money for its purchaser. This, and no other reason, is why profit exists. If labourers were hired directly as slaves, robots, beasts of burden or servants, then whether or not labour time were the measure of value, surplus labour would not be extracted in the form of money profits but directly, like domestic labour.

Both Marx and Ricardo therefore said no more than this: that all inputs add value in proportion to the quantity consumed. Since one particular commodity is directly involved in the production of every other commodity, the value added by all other commodities can be reduced to the value added by this particular commodity, namely labour power."

External links and references

Labor Theory of Value
Marxism The Labor Theory of Value
The Marxists Internet Archive
Capital, Volume One
Capital, Complete in Three volumes. Frederick Engels, editor, 1867-1894. Definitive Kerr Edition, in English, as re-issued 1906-1909.
- Capital, Volume 1 1867
- Capital, Volume 2 1885
- Capital, Volume 3 1894

Marx's discussion of the form of value in Capital

F. Engels, "Socialism: Utopian and Scientific"
Karl Marx and the Close of His System Classic criticism of Marxist economic theory by Eugen von Böhm-Bawerk
I.I.Rubin's accessible commentary on Marx's form and content of value
Wage Labour and Capital
Robert Vienneau's LTV FAQ
Jim Devine's alternative view of Marx's LTV
A critical explanation of LTV by Eugen von Böhm-Bawerk

Bhaduri, Amit. 1969. "On the Significance of Recent Controversies on Capital Theory: A Marxian View." Economic Journal. 79(315) September: 532-9.
Alan Freeman: Price, value and profit - a continuous, general treatment. In: Alan Freeman, Guglielmo Carchedi (editors): Marx and non-equilibrium economics. Edward Elgar. Cheltenham, UK, Brookfield, US 1996.

Opposing Theory