The Labor Theory of Value

The Labor Theory of Value (LTV) is the fundamental premise of Marx's economics and is central to his critique of the free market. Although Marx did not create the theory, he did improve upon it and take it further than any of his predecessors were able or willing to go. If it is correct, then much of Marx's critique of capitalism is also correct. But if it is wrong, then virtually all of Marx's economic theory is also wrong.

The theory states that the value of a commodity can be objectively measured by the average amount of labor hours that are required to produce that commodity. If it requires the same amount of hunting time to capture one deer or two beavers, then one deer would exchange for two beavers. 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 used up in the production of the commodity. The value of educated labor will be greater than that of uneducated labor proportionate to the labor required to produce education.

Although it is unclear who originally came up with the theory, one possible source may be John Locke. In his 1690 work, The Second Treatise of Civil Government, Locke 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? Locke proceeded to argue for right of self-ownership, which implied that people own their own labor. When people mix their labor with natural resources, those resources become property. Thus, under Locke?s theory of property, commodities have value because of the labor invested in them. This is fundamentally a moral theory. Those who work deserve the fruits of their labor. Commodities which require equal labor to produce must trade at equal values, else one party benefits at the expense of the other.

While Adam Smith is famous for recognizing the mutual benefits of trade -- the fact that both parties can benefit from trading with each other without either doing so at the expense of the other -- Smith subscribed to the LTV on other grounds. Reasoning through the diamond/water paradox, Smith distinguished between value in use and value in exchange: Why is it that diamonds have such a high exchange value compared to water yet water is so much more useful than diamonds? Water is necessary for human existence and diamonds are not. Smith concluded that exchange value must be determined by a factor other than usefulness. The determinant of exchange value, Smith reasoned, is the labor cost of producing a commodity.

Although the LTV seemed to solve the diamond/water paradox, Smith recognized a number of exceptions that were not as easily explained by labor inputs. Absolutely scarce goods like old paintings and aged wine do not require more labor than new paintings and fresh wine, yet their exchange value is much higher. Firms which enjoy monopoly protection from the government are able to charge high prices and increase their profits through artificial scarcity by withholding supply from the market. Finally, Smith could not explain why land has exchange value since its supply is fixed and cannot be increased by labor.

David Ricardo built upon Smith?s work on the LTV. Ricardo solved Smith?s land problem by showing how labor indirectly determines the value of land. According to Ricardo's theory of land rent, the labor required for production on marginal land -- land on which the value of commodities produced just barely equals the amount of labor used as an input--determines the normal price or value of agricultural products. The surplus of production on more fertile land is absorbed by rent, which goes to the landowners. Landowners don't have to do anything to earn this rent -- they get it automatically as a result of the competition for fertile land.

While Ricardo solved one problem with the LTV, he uncovered another. Ricardo is best known for his law of comparative advantage, which states that trade occurs only on the basis of differences in the productivity of labor in different countries. Each country exports the product in which it had the comparative advantage of relatively lower labor cost. If there were no differences in labor costs, there would be no trade. But this raises the question: If different producers have different labor costs, which labor costs determine exchange-value? This problem is quite similar to a much more devastating problem later discovered by Marx

Karl Marx, in Das Kapital, defused a common objection to the LTV. Suppose a clumsy carpenter takes twice as long as other carpenters to build a house. Does that mean his houses are worth twice as much? Marx explained that inefficient work does not produce greater value. Since there are other carpenters who can build the house in half the time, half the time is the "socially necessary" labor time. Wasted time is not valuable because it is not "socially necessary."

Marx?s other answer to this is that, in a sense, technical progress and the extended division of labor -- both of which reduce the labor time necessary to produce a good -- do in fact lower the value of certain goods. If through a new technology or new production methods we are able to build house with half as much labor as before, and all else remains equal, houses are in fact half as valuable as they were before, relative to everything else. At the same time, Marx was a historicist and did not believe that different historical periods are comparable to each other.

Just as Ricardo applied the LTV to land, Marx applied the LTV to labor itself. If labor is a commodity just like everything else, then the value of labor must be determined by the amount of labor necessary to produce it, i.e. subsistence wages, or the acceptable minimum standard of living for that time and place. And just as Ricardo recognized that land produces unearned rents for the landowners, Marx recognized that labor produced unearned profits for the capitalists. Workers are able to produce more than what is necessary to sustain themselves, and this surplus value is exploited by the non-laboring capitalist class. All market payments other than wages -- all profits, interest, and rent -- can be explained in terms of surplus value.

Marx?s theory of history followed a progression from primitive communism to slavery to feudalism to capitalism to socialism, and finally, to communism. In prior and current periods, the exploiting class requires the working class, but the working class does not require exploiters. Eventually, the working class will realize this and dispense with their exploiters, organizing production for its own benefit as a class. The revolution will mark the end of the historic tale of classes, exploitation and surplus-value, and a return to the equality of prehistoric societies -- but without the poverty they had to endure.

But Marx did not believe that the workers had to be convinced of this fact, although doing so might ?shorten and lessen the birth-pangs? of the revolution. Rather, Marx posited a materialist conception of history, and believed that capitalism would sow the seeds of its own destruction through increasing instability, a falling profit margin (a belief shared by Classical Political Economists), and the "immiserization" of the working class.

Ironically, Marx sowed the seeds of his own theory?s destruction by discovering a fundamental flaw in the labor theory of value. Classical Political Economists all agreed that there could be only one rate of profit in the economy. If there were a higher rate of profit in one industry than another, investors would shift their capital into the high-profit industry, depressing its price and its profit rate, and out of the low-profit industry, raising its price and profit rate, until the rates of profit were equal. This is the law of the equalization of the rate of profit. Capital accumulation raises the proportion of fixed to circulating capital (wages), causing the organic composition of capital (the ratio between wages and fixed capital) to drop, causing the rate of profit to drop. Different industries have different organic compositions of capital and therefore different rates of profit.

The law of an equal rate of profit logically contradicts the labor theory of value: As investors shift their capital out of low profit industries into high profit industries, prices in low profit industries rise above labor value and prices in high profit industries fall below labor value. This is called the "transformation problem," i.e. the problem of transformation from labor values to market prices. Given the labor input requirements per unit of output, both direct and indirect, Marx must find a rate of exploitation, rate of profit, and system of relative prices that all work together.

But as it turns out, there is not just one solution to the problem -- there are infinitely many, each with a different wage and corresponding rate of exploitation and profits. This is a problem. For the LTV to work, there needs to be just one solution, not an infinite number of them. Marx's idea was to reason from the given rate of exploitation to the rate of profit and so to the relative prices and labor values -- but the question remains: Which rate of exploitation to begin with?

Chicago economist George Stigler calculated that the labor theory could account for 93% of the differences of relative prices in the U. S. in the 1940's. The remaining 7% could reflect many different causes, no one of which amounts for more than a percent or two. (Some of the differences would presumably be random). So the labor theory is not entirely wrong. But, in a modern economy with a wide range of organic compositions of capital, the labor theory cannot be the whole story.

If not the LTV, then what? Returning to the diamond/water paradox, Smith?s reasoning was flawed. He failed to distinguish between "total" utility and "marginal" utility. It is true that the total utility or satisfaction of water exceeds that of diamonds. If given a choice, people would prefer a life without diamonds than a life without water -- which is, of course, no life at all. Yet most people would prefer to win a prize of a diamond rather than an additional bucket of water. To make this last choice, people do not ask themselves whether diamonds or water give more satisfaction in total, but whether more of one gives greater additional satisfaction than more of the other. For this marginal utility question, the answer will depend on how much of each the consumer already has. Though the first units of water consumed every month are of enormous value, the last units are not. The utility of additional (or marginal) units continues to decrease as a person consumes more and more.

Thus, Smith should not have rejected value in use as an adequate explanation for value. The modern view shared by economists is that economic value is subjective: value is a feature of the appraiser and not of the thing being valued. That is, objects do not have inherent value, but have value only insofar as people desire them. In a horse-and-buggy culture, horse-shoes are tremendously valuable commodities, but in a society without horses they are virtually useless. The labor theory, despite accounting for many price differences, cannot account for changes in consumer preferences.

If the LTV is an inadequate explanation of value, then what about profits? Are profits merely unearned surplus exploited from the workers by the non-laboring capitalist class? Modern economic analysis suggests that capitalists earn profits by providing three productive inputs. First, capitalists forgo current consumption. Most workers prefer to be paid when their work is completed rather than when their products are sold -- which may be months later. For workers to be paid now, rather than later, someone must advance their wages, and clearly this service has a value. Second, capitalists take risks. Workers give up their share of the end price for the more certain and soon wages paid by the entrepreneur. Capitalists earn their profits by exposing themselves to risks that the workers can avoid, like an insurance company. Third, capitalists organize production by discovering what consumers want and by inventing new products or processes or organizing the better delivery of old products.

I used a number of online sources for this essay. I paraphrased some of these sources and quoted verbatum from others without attibution.

The most useful source I found online was a chapter on Marxist economics from an online economic textbook.

The least useful source, surprisingly, was Robert Vienneau's LTV FAQ. Vienneau is overly sympathetic to Marx and doesn't explore some of the fundamental weaknesses in the Labor Theory.

Wikipedia entry on the Labor Theory of Value

A critique of the LTV from a libertarian economist.

Here is an excerpt from David Friedman, The Machinery of Freedom on Exploitation and Interest. I didn't use anything from this article, but some of you may find it interesting nonetheless.

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In my humble and

In my humble and sycophantically biased opinion this is a superb essay by Micha Ghertner on the Labour Theory of Value. As well as the online references he supplies, for those economically challenged people such as myself, who like economics to be relayed in words of one syllable or less, one of the best 'layman' books I've read covering all the rival ideas of 18th, 19th, and early 20th century economists, is Todd G. Buchholz's New Ideas from Dead Economists.

You can see a Table of Contents, here.

The one with particular relevance to Micha's superb piece, is:

VI. The Angry Oracle Called Karl Marx

The Labour Theory of Value is discussed, in depth, on pages 129-31, 138, 143 and 166-167.

If you could describe any economics primer book beyond Henry Hazlitt's Economics in One Lesson, as unputdownable, this book by Todd Buchholz deserves the accolade.

Micha, "... When people mix


"... When people mix their labor with natural resources, those resources become property. Thus, under Locke?s theory of property, commodities have value because of the labor invested in them. ..."

Even if resources only have value when mixed with human labor, having value is an entirely different kettle of fish than actually quantifying or ranking that value.

Regards, Don

Umm, you found a Vienneau

Umm, you found a Vienneau essay unhelpful ? Shocking sir, just shocking.
You mean you did at one point expect to find it useful ?

Sorry, Andy. Micha's take is

Sorry, Andy. Micha's take is muddled and confused.

First, let me point out a couple of places where I agree with Micha: in recognizing that (1) Locke had something like the LTV as an ethical justification of property, (2) Marx did not predict capitalism would collapse because workers came to realize they're exploited, (3) the LTV predated Marx, and (4) Ricardo showed how the LTV could be consistent with land rent.

My major objection is that Micha's posits a false dichotomy. The choice is not between marginal utility or the LTV as a theory of prices and distribution. Prices of production perhaps provide an objective theory of prices without requiring the LTV.

In a couple of places, Micha takes a stand on controversies in the literature without alerting the reader that that's what he is doing. For example, it is controversial how central the LTV is to Marx's economics. Mayhaps Marx's account of business cycles can stand without it. And explaining differences in wages by the labor inputs needed for education is one of a couple ways of accounting for such differences within the context of a Classical theory of value.

Micha says that the LTV "states that the value of a commodity can be objectively measured by the average amount of labor hours that are required to produce that commodity". This confuses the measure of value with the cause of value. And this is related to Micha's confusion about A. Smith. I hold that Smith did not apply the LTV outside of a rude state of society preceding the appropriation of land and capital. Smith used labor commanded as a measure of value in an advanced state of society, which is a different proposition. Thus, I don't think Smith used the LTV to resolve the diamond/water paradox. And Micha's comments about old paintings, rare wines, and land seems more characteristic to me of Ricardo than Smith.

I think Micha's account of Ricardo's discovery of a transformation-like problem with the LTV is poor. The problem arises with trade between sectors within a country where mobility of investment between sectors exerts a tendency to equalize the rate of profit. This is Chapter 1 in Ricardo, not the chapter on trade.

The transformation problem is about the relationship between labor values and prices of production, not market prices. Micha is just wrong there. I agree that the problem shows the LTV to be false. I say so in my FAQ. So did Marx in volume 1 of Capital.

The fact that the LTV is mistaken doesn't show Marx to be mistaken. The problem for the "dual system" interpretation of Marx is that one cannot simultaneously hold that (1) the rate of profits is the same in the labor value and the prices of production systems, (2) gross output is the same value in both systems, and (3) total surplus value and total profits are the same in both systems. Other interpretations, such as Duncan Foley's manage to keep all three equalities.

I have a problem with Roger McCain's take on multiple with equilibrium. Given a theory of accumulation and of wages - there are interpretative difficulties for Marx in both places - the rate of exploitation follows. So I do not see any difficulty with "infinitely many" solutions here. Granted, Sraffa did not deliberately close his system.

Reswitching and all of that showed that profits cannot be explained by thinking of capital as foregone consumption. It is good that Micha recognizes that what is commonly called profits has more than one component. I would think, though, that he would call his second or third justification a return to entrepeneurship, not a return to capital.

Robert's right about the LTV

Robert's right about the LTV not being absolutely crucial. It was definitely crucial to his argument that the rate of profit was supposed to fall. Accordingly it was also crucial to his belief that socialism was inevitable and that capitalism would destroy itself. Those are silly anyway.

Marx's theory of commodity circulation is also likely intact, and it's important as a devastating critique of Say's law.

I like this little debate,

I like this little debate, but I also miss some important aspects. Apart from the fact that the distinction between use value and exchange value was introduced already by Aristotle (so Locke was not the first one to think of it), I think the relevance for example of LTV cannot be decided so easily in an absolute way, as has been expressed for instance by Robert or matt27.

My point is that one should consider what one wants from economics as a theory, quite generally. While in pre-classic times value was being thought of in a somewhat universal way for understanding the nature of the overall flow, the considerations later changed towards grasping the flow by aggregating the individual valuing decisions of the many agents. This is why such things as game theory became prominent.

But there are major methodological problems in this 'modern' setup (classic and especially neoclassic). The first is that, strictly speaking, the intrinsic law of whole can never be found by adding up laws of pieces. The second problem is linked to the first; it is in forgetting that the categories (basic concepts) are crucial, in which the conceptualization of the whole is being attempted. Especially in the neoclassic approach, the hoped-for universality is not warranted because of the 'canonical' basic assumptions, which limit the reach.

Coming back to such issues as use value and exchange value or LTV, it makes a big difference whether one views it on the level of individual action or on the level of the process as a whole. On the individual level, which is being aggregated in the 'modern' view, the issues of value and labour look quite different than on the level of the whole process. The question is whether one seeks to proceed bottom-up (inductively) or top-down (deductively) – from parts to the whole or from the whole to the parts. Today the first is fashionable, in spite of being irremediably self-limited.

For a concrete example, take the following. There is a law of nature that governs all forms of economy: the act of setting resources into value carries the whole economic process and constitutes thus the fundamental form of capital, prior to any monetarization. Usual forms of economic value – property, monetary capital, interest, labour, etc. – are only secondary, a juxtaposed layer of imaginary values. So, on the level of the whole a LTV makes a lot more sense than on the individual level – but it needs a corresponding assistance through other elements of the theory.

The just mentioned intrinsic overall law of the eco-social process contains as aspects the usual laws of economics (e.g. production function, law of diminishing return etc.), and governs all economies – irrespective of whether they are subsistence toil or high-tech, involve money or not, are capitalist or socialist, growing or recessive, etc..

Due to its 'enveloping' quality, this law is a solid basis for determining the real value of money – in contrast to considerations via the GDP, being circular: the goods are measured in monetary value, while the value of money is measured in the total amount of goods, accepting 'A is a function of B while B is a function of A', which would not get mathematics very far.

Applying this flawed GDP basis, combined with subjective value theory, leads to a valuation of money that coerces the agent, by dint of the competition on the monetary market, into following the rule of return on investment. As a result, money loses its quality of being a free medium of exchange that can serve everybody in an equal way. This is one of the aspects that Marx tried to approach.

Since modern theory has not found the law of nature that governs all forms of economy, it could not optimize and harmonize the socio-economic process out of a secure overview, but had to take old pseudo-optimizing features such as personal interests ('homo oeconomicus'), the need to know ('complete information'), or the need to survive ('competition') as allegedly relevant theoretical elements.

Now the agents are coerced into the role of the entrepreneur, ensuring his subsistence by fighting for income. The now ruling theory sacrificed the overall advantage of division of labor to its one-eyed style of theorizing. Now those sectors of the socio-economic process, which cannot offer a quick return on investment because their results become appreciable ony in the future – e.g. activities in agriculture, education, health care, the organic social process called 'the state', etc. – suffer from a shortage of investment (money).

This would not happen on the basis of the said law of real value, which is generally valid, even in a universe of purely mental matter, in mental economy: the necessity for future cognition to produce first a set of mental representations (a language), is of the same order, since the use of signs is necessary for organizing the ever-new process of cognizing.

What do you guys think of this?