Thoughts on the Labor Theory of Value

Why does something have value? It is clear that this “metaphysical” question is at the heart of the theory of political economy. Depending on how one answers this question, one sets off in very different directions with one’s economic theory. I have recently been reading the little-read nineteenth century economist, Leon Walras. Besides his more well-known Elements of Pure Economics I have also been reading the French and English translation of his Studies in Social Economics. In these two books I have been concentrating on Walras’s critique of the labor theory of value (LTV). In the first book, he attacks “the English School,” concentrating on Ricardo and Mill (the son). In the Social Economics book he takes on Marx.

Walras

Leon Walras was one of the founders of modern economics. Schumpeter said of him, “Walras is in my opinion the greatest of all economists. His system of economic equilibrium, uniting, as it does, the quality of ‘revolutionary’ creativeness with the quality of classic synthesis, is the only work by an economist that will stand comparison with the achievements of theoretical physics. Compared with it, most of the theoretical writings of that period—and beyond—however valuable in themselves and however original subjectively, look like boats beside a liner, like inadequate attempts to catch some particular aspect of Walrasian truth.” (History of Economic Analysis, Routledge, 1954, p 795.) What is less well known is that Walras considered himself a socialist and specifically put himself at odds with the “liberal” defenders of capitalism.

Marshall Supply and Demand

To understand this question of the LTV, one needs to understand the modern concept of supply and demand. The figure above presents a simple depiction of the supply and demand curves at the heart of political economics since the end of the nineteenth century when Walras, Menger, and Jevons independently founded what I think has been misleadingly called the marginal utility theory of value; misleading because Walras’s emphasis was not so much on utility, but on scarcity as the source of value and price. The figure is a representation of Figure 19 from Alfred Marshall’s Principles of Economics. Marshall systematized the work of these founders of neoclassical economics for a generation of twentieth century students, including Maynard Keynes and Joan Robinson. Rather than risk misleading the reader by paraphrasing what Marshall says about this, I will quote exactly what he says in the footnote in the Principles where this graph first appears (Page 288 of Eighth Edition),

“To represent the equilibrium of demand and supply geometrically we may draw the demand and supply curves together as in Fig. 19. If then OR represents the rate at which production is being actually carried on, and Rd the demand price is greater than Rs the supply price, the production is exceptionally profitable, and will be increased. R, the amount-index, as we call it, will move to the right. On the other hadn, if Rd is less than Rs, R will move to the left. If Rd is equal to Rs, that is, if R is vertically under the point of intersection of the curves, demand and supply are in equilibrium.

This may be taken as the typical diagram for stable equilibrium for a commodity that obeys the law of diminishing return. But if we had made SS’ a horizontal straight line, we should have represented the case of “constant return,” in which the supply price is the same for all amounts of the commodity. And if we made the SS’ inclined negatively, but less steeply than DD’ (the necessity for this condition will appear more fully later on), we should have got a case of stable equilibrium for a commodity which obeys the law of increasing return. In either case the above reasoning remains unchanged without the alternation of a word or a letter; but the last case introduces difficulties which we have arranged to postpone.”

In the case of a supply curve for constant returns to scale we have just the case of the supply curve proposed by the labor theory of value. The cost of production is assumed to vary only with the price of labor, when appropriately considered (assuming free land and capital!) The problem with this for the entrepreneur, whether he is a private individual or a manager of a state enterprise, is not that the price cannot be determined, but that the quantity of production cannot be determined unless one has knowledge of the demand price relation. But this demand relation is shielded from view in the labor theory of value and as a result, there is no way to determine the appropriate scale of production.

Walras’s Critique

Critique of the English School

Walras’s critique of the LTV as embodied in the classical English school of political economy is found most succinctly in Lesson 38 of Elements of Pure Economics. Ricardo doesn’t completely ignore scarcity, which for Walras was the true source of the theory of value or price, but once acknowledging it, Ricardo says it is important for only an insignificant number of goods. Walras quotes Ricardo,

“There are some commodities the value of which is determined by their scarcity alone. No labour can increase the value of such goods, and therefore their value cannot be lowered by and increased supply. . . . These commodities, however, form a very small part of the mass of commodities daily exchanged in the market. By far the greatest of those goods which are the objects of desire are procured by labour; and they may be multiplied, not in one country alone, but in many, almost without any assignable limit, if we are disposed to bestow labour necessary to obtain them.” (On the Principles of Political Economy and Taxation, Chapter I, page 12 of the Sraffa Edition.)

Of this Walras says,

“What this fundamental distinction evidently amounts to is a division of products into two categories: one consisting of a small number of products which cannot be increased in quantity, and the other of a large number of products which can be increased without limit. . . . That being granted, the English economists . . . confined their attention to the second. . . . Had they simply divided products into two classes, those that cannot be increased in quantity and those that can, and then merely declared that the selling prices of the latter class tend, under free competition, to equal their costs of production, we should have no objection to raise. But when they assert that the products of the second class can be multiplied without limit, and that a certain value of their costs of production determines their selling prices, then we are faced with two fundamental errors which must be refuted.

There are no products that can be multiplied without limit. All things which form a part of social wealth – land, personal faculties, capital goods proper and income goods of every kind – exist only in limited quantities. . . . In the production of most things, however, land-services, labour, and capital-services are found together. It follows, therefore, that all things constituting social wealth consist of land or personal faculties or the products of the services of land and personal faculties. Now Mill admits that land exists in limited quantities only. If that is also true of human faculties, how can products be multiplied without limit?

Nor are there any one value of costs of production, which having itself been determined, determines in turn the selling prices of products. The selling prices of products are determined in the market for products by reason of thier utility and their quantity. There are no other conditions to consider, for these are the necessary and sufficient conditions.” (Page 399 in the Jaffe English translation.)

Walras followed his father Auguste in seeing scarcity as the source of “value” combined with utility, rather than the classical notion of labor as the measure of value. In elaborating his father’s theory of “rareté” Walras secured his place with Jevons and Menger as one of the founders of the neoclassical school of economics that more or less reigns supreme today in Anglo-American universities. But it is this emphasis on scarcity, rather than the heavier emphasis on utility in the English and Austrian schools, that (in my view) sets Walras’s work apart.

In the second book mentioned above (Studies in Social Economics) Walras proposes two theorems: I) “Personal faculties are, by natural law, owned by the individual” (page 142 of the van Daal and Walker English translation) and II) “Land is, by natural law, the property of the state.” (page 144) Walras would have the state buy back all property from private owners by selling bonds which would be paid back by collecting rent on the land. The remainder of the rent would be used to fund other natural tasks of government. These beliefs he considered sufficient to allow him to say “we socialists” without irony.

Walras’s Critique of Marx

On Marx he says “First, consider Marxist collectivism. It is completely based on a twofold mistake in the field of economic theory: first, only labour has value, and the normal value of any good is nothing other than the quantity of work it embodies; second, all types of labour may be reduced to only one type, whose unit can serve as standard measurement of value. This mistake has now been cleared away; it was partially made by Adam Smith, but he did not retain it Karl Marx, on the contrary, pursued its deductions and consequences with rigorous logic.” He then goes on to show what he sees are the illogical consequences of these errors.

My reaction to Walras had been to find his critique of the LTV quite devastating from a purely logical point of view. We don’t, in fact, value commodities because of the labor that went into them, but rather because they are scarce and useful. Great labor could go into constructions of no interest to anyone but the lunatic who created it. Commodities have value because they are scarce and useful, not because of the labor that was expended upon them. Classical economics has no demand curve! Prices are determined (for the case of constant returns to scale, at least) by cost of production. And labor is at the root of costs of production (but only if you can get land and capital for free!) But with no demand curve we are unable to determine how much to produce. So the classical LTV of both Ricardo and Marx fails to adequately explain value or price.

In Defense of Marx

Marx (partially, at least) addresses the issue of the lack of a demand curve in his version of the LTV by defining labor as “socially necessary labor time.” He says in Theories of Surplus-value (Part I, Chapter IV, p. 232 of the Progress Publishers edition, for example) that “The total product – that is to say, the value of the total product – is in this case therefore not equal to the labour-time contained in it, but is equal to the proportionate labour-time which would have been used had the total product been in proportion to production in other spheres.” He blots out useless labor from his theory of value. In this way, it seems, he smuggles a demand curve into his analysis. This partially blunts one avenue of critique of Marx’s version of the LTV. But his understanding that only labor contributes to value, exposes him to Walras’s complaint that capital and land also contribute to value because of their scarcity.

To make further balance in my evaluation of the subject of Marx’s LTV, I turned to Ronald Meeks’s book Studies in the Labor Theory of Economics. Meeks is an economic historian and his book is a full-bore defense of Marx and his LTV. My copy of the book has many stick-on notes exclaiming with disdain the number of times he speaks about the “unearned” rewards of capitalists. But these are only “unearned” if you subscribe to the LTV! Petitio principii!

The LTV was important to Marx, of course, because he saw the concept of “surplus value” as unlocking the key to understanding capitalism. Workers make individual contracts with capitalists and in the process of their social interaction in the workplace create more value than the sum of the parts. The capitalist claims this value for his own, since he has an individual contract with each worker in isolation. He (unjustly if you embrace the LTV) claims this surplus value as his own. This is Marx’s theory of exploitation. The clarity of his belief in the “unearned” value of capital (and land) provides the moral engine of Marx’s rage against capitalism and the goal of his political agitations.

I had often wondered about Marshall’s justification of interest as “reward for waiting.” Rather, “a reward for having money”, I had often thought. Having now read Walras, I think I finally see this as rather, a reward for having (and not spending) a scarce commodity. But, as I kept on reading in Meeks, I came upon a rock which struck the hull of my smooth sailing through this critique of the LTV. The words come from Marx’s Critique of Political Economy: “a definite production . . . . determines the consumption, distribution, exchange, and also the mutual relations between these various elements.”

I am reminded of the old Woody Guthrie tune, Do Re Mi:

“Oh, if you ain’t got the do re mi, folks, you ain’t got the do re mi,
Why, you better go back to beautiful Texas, Oklahoma, Kansas, Georgia, Tennessee.
California is a garden of Eden, a paradise to live in or see;
But believe it or not, you won’t find it so hot If you ain’t got the do re mi.”

There is no demand curve if no-one has funds to buy. This was the basis for “Fordism,” Henry Ford’s realization that he needed to pay his workers enough so that they could afford to buy his cars. But Fordism was not able to prevent the crash of 1929 and the Great Depression that followed. And it has been forgotten almost entirely in our post- Reagan/Thatcher era. As Fordism has been forgotten, world inequality of wealth and income have fallen back to nineteenth century levels as well-documented in recent books by Atkinson and Piketty.

And as carbon dioxide from burning of fossil fuels accumulates in our atmosphere and oceans with resulting sea-level rise, acidification of the oceans, and devastation of fisheries and species diversity, among other consequence, this brings us back to the question, “How could the invisible hand possibly protect us against public harm by private interests?” How do we prevent the interests of wildly powerful capitalists from preferring vast negative consequences to most of us as long as their income stream is protected (by governments!?)

What is to be Done?

If we are agreed that amelioration of public harm for private gain is not likely to be taken up by the capitalists themselves and that private gain is protected by the state, what are we to do? What do we do about the cases where private profit produces clear public harm? A growing number of us, including Gar Alperovitz and my neighbor David Korten to name just two, have come to the conclusion that it is time for a systematic change from the capitalist system.

Free-market capitalism has no answer to the question of how to curb public harm caused by the invisible hand. State socialism in the Soviet Union had the very positive consequence for the West of providing an alternative that frightened capitalists into accepting the New Deal, which addressed some of the worst outcomes of capitalism. Now, in the absence of that viable alternative, how can we solve the growing problems of devastating climate change, pollution, corruption and massively growing inequality that are a direct consequence of private ownership of social production?

Recently I spent a wonderful evening dining in the middle of 40 acres of productive agriculture in the center of the island where I live. I was reminded that one half of that 40 acre parcel was publicly owned and that the the municipality owned a total of 60 acres on this island which are leased to farmers for production of the food and wine that we enjoyed in the summer light that night and which we regularly buy in our public market each week. This reminded me of Walras’s second theorem. One solution to public harm by private ownership, is to replace it with public ownership. I am also in the midst of a campaign to buy back the electrical utility owned by a bank in Australia who delivers us power at a price that is higher than 80 different public utilities in my state and which is generated from one of the 10 most polluting coal-fired power plants in the United States.

These are examples of significant local steps that we can take to bring some amelioration to the disastrous world that global capitalism has brought us. But they are not enough. The US government owned two major auto companies and one giant insurance company in the public interest in the wake of the Great Recession. It had significant stakes in most of the large banks that brought down the world economy in 2008.

Why did it sell these back? What right do private persons have to reap profit from social production? Well, we have discussed this above. By Walras’s logic, private persons have a right to return on investment based on their thrift (or inheritance, for that matter). That right comes from the historical fact of the scarcity of capital. But do they have a right to the profits from banking, large-scale industrial production, health care, and power production enterprises (to name just a few) that are inherently social when they are harmful to the public interest?

It seems to me that this right is granted only by governments, that is, by the consent of all. I, for one, am inclined to withdraw that consent. Public managers can operate these social organizations in the public interest as well or better than private entities. Isn’t it time for us to start acting on this thought? Hume famously declared, “Tis not contrary to reason to prefer the destruction of the whole world to the scratching of my finger.” But only the public can grant that power for public harm to private interests. I find it to be disproved by Hume by logic and by all of the last two centuries of experience with capitalism that we should trust to private persons by virtue of their capital the right to the power for public harm that they currently wield in our economies. It seems to me (and many others) that we need to take those rights that harm the public interest back from private hands. And may the day come soon that we do so.

Back to the LTV

We have strayed away from the LTV in our enumeration of the many and obvious contradictions of modern day capitalism. But what does this have to do with the LTV? I would say that Marx’s critique of capitalism in his theory of exploitation is compelling, even if I find his embrace of the LTV, which appears to be logically prior to his theory of exploitation (which I have discussed here), not so very compelling. And his theory of exploitation is at the heart of his critique of the capitalist system as a whole. Which leaves us with a gap, as I see it.

How does one support Marx’s compelling case against capitalism without the LTV? Well, for one thing, it seems to be true to say that the capitalist takes all of the surplus from what is really a social activity. The sum of the individual labors of the workers in an industrial operation is less than the total due to the cooperative nature of factory work. And the roads that bring the raw materials to market and the education of the workers in that factory also add significant value to the surplus. For these reasons the workers and society itself are owed a significant part of the product. This would justify a significant tax on industrial production and a higher wage share than subsistence. It would even justify partial or complete ownership of the surplus and the factory that produces it by society. But isn’t the capitalist that put disposable funds into the mix not owed some recompense as well, due to the scarcity of the capital (not to mention the ideas that he might bring to bear) that the he put to work in the production? Not the whole of the surplus, but some part of it? Walras (and many of his followers since) thought yes.

Even many socialists, starting with Walras, have thought the same. The overall capitalist critiques of Lange and Joan Robinson, for example, were not based on the LTV. Both accepted the basics of the scarcity / utility theory of value while maintaining that large scale expropriation of common resources by privatizers leads to large scale public harm. The prominent Polish economist, Kalecki, who is usually considered a “Marxist,” wrote little about the LTV. His critique of free market economics did not seem to include a full embrace of the LTV. And Walras, himself, was one of the founders of not just the scarcity theory of value, but likewise considered himself a socialist. He argued that there was no justification for private ownership of land and that the public interest dictated ownership of all land by the State. So it seems that there is no necessary connection between socialist economics and the LTV. I will leave it to another time (or perhaps to another writer) to re-establish Marx’s compelling theory of exploitation on a firmer basis than the LTV. I look forward to such a better grounding.

About Randal Samstag

Randal has an undergraduate degree in political philosophy, but has a graduate degree in engineering and has earned his bread for 30 years working on municipal and community water supply and wastewater collection and treatment systems in the US, Caribbean, Latin America, and Asia.
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2 Responses to Thoughts on the Labor Theory of Value

  1. Charlton Price says:

    This blog post is a fresh, clearly explicated analysis and comment on some key issues in economics. One can’t write this clearly unless one can think clearly. Randal’s writing, by showing how he thinks, recalls for me the writings on current history and international affairs by the late William Pfaff, Both Pfaff and Samstag follow the dictum of Strunk and White: Omit Needless Words. This is essential if original thoughts about murky subjects are to get and keep readers’ attention.

  2. Pingback: Free Market Fool | Notes from my library

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