The Myth of the Labour Theory of Value

The labour theory of value has its origins in Classical economics, and was held, in various forms, by Adam Smith and David Ricardo. Later it was taken up by Karl Marx and is still a part of modern Marxist economics.

The labour theory of value has been abandoned by modern mainstream (neoclassical) economics, and was rejected as long ago as the 1870s by early marginalist and neoclassical economists (Blaug 1982: 595; Dooley 2005: 212). The theory is also rejected by the Austrian school, an offshoot of neoclassical economics.

I will show below that the labour theory of value is invalid.


First, What is Value?

From a philosophical perspective, value is the worth of something, however that is judged. Philosophers distinguish between extrinsic (= instrumental) and intrinsic value (Iannone 2001: 539). The extrinsic value of something is its worth for the sake of something else, in the sense that it is valued because it will obtain, or allow you to achieve, some other thing or goal. The intrinsic value of something is its worth for its own sake. Yet another concept is intermediate value, which is when something has a combination of both extrinsic and intrinsic value. These concepts, however, are not what economists mean when they talk about value.

In economics, three concepts are important in the definition of value:
(1) utility,
(2) use value, and
(3) exchange value.

Utility is a concept from modern neoclassical economics. Utility is the satisfaction or pleasure derived by an economic agent (a person or a firm) from consuming a good (Rutherford 1995: 428). Utility is the measure of value. This stems from a subjective valuation of the worth of the good by an economic agent (Keen 1999: 1212). Thus the value placed on any good can, and often does, vary from person to person. Two people can derive completely different utilities from a good that costs them the same price.

By contrast, the concept of use value has a specific definition in Marxist economics.
In Marxist thought, use value is the objective usefulness of a good and depends on the way in which the good is used by the buyer.

Exchange value is the power that something has in obtaining other goods in exchange, and the term is used in both neoclassical economics and Marxism.

In modern economics, value is normally exchange value, that is, something has an economic value when it is traded or bought as a commodity in a market. The exchange value (or economic value) is related to the eventual price of the commodity, although the price can also be affected by supply and demand.

The utility of the good (and the individual subjective valuation of that good) can directly influence the price, particularly when aesthetic judgements are involved.

In modern microeconomic analysis, price theory is the study of how prices are determined in individual markets. There are two main factors affecting the price of a good: the demand side and the supply side. The demand side is essentially consumer behaviour involving individuals maximizing utility. The number of individuals who place a subjective value on a particular good can cause demand, and along with supply, this influences the price of the good.
(If there is no interference in the markets by governments, monopolies or oligopolies, the interaction of these factors across the economy produces equilibrium prices, where the price is a true reflection of the value, according to neoclassical theory).

Thus price has also a relational component: the price of a good can be influenced by its scarcity relative to demand.

This can be summed up in the following way:

In neoclassical economics this utility is ultimately subjectively determined by the buyer of a good, and not objectively by the intrinsic characteristics of the good. Thus, neoclassical economists often talk about the marginal utility of a product, i.e., how its utility fluctuates according to consumption patterns.
http://en.wikipedia.org/wiki/Use_value

Modern economics thus has a utility theory of value, which is a subjective theory of the values of commodities.

The essence of this theory can be explained in this way:

Human beings are the ultimate source of economic value …. Human “consciousness” is the key to value, in that our awareness of the linkage between an object and its ability to satisfy a need is what gives goods value (Horwitz 2003: 266).

If something is subjective, then it is an internal, introspective process in a human mind. Fundamentally, it is a matter of personal preference, desire or taste, which is not necessarily shared by other people. The subjective value of a good, by definition, lacks an underlying objective cause or validity: it is arbitrary. In other words, the subjective value of something does not have an underlying objective source. If we say that economic value is subjective, then the economic value of a good exists only as a mental state in a human mind, and this subjective judgement about its value is arbitrary and cannot, by definition, be caused by other objective factors like labour.

The labour theory of value, of course, is an objective theory of value: it holds that the source of value is in fact something objective: the human labour that has created a good or gone into bringing it to market for exchange.


Does Value really Come from Amount of Labour?

The labour theory of value is a type of objective value theory. In the Classical versions of the theory, it is held that the value of a good comes from, or is based on, the amount of labour spent producing that good. That is to say, exchange values of goods are determined by the labour time (often measured in hours) that is directly or indirectly required to produce them.

As Adam Smith argued:

If among a nation of hunters, for example, it usually costs twice the labour to kill a beaver which it does to kill a deer, one beaver should naturally exchange for or be worth two deer.

Adam Smith, The Wealth of Nations: Books I–III (Penguin Classics, 1982), Book 3, Chapter 6, p. 150.

First, it should be observed that no amount of labour will confer value on a product by itself. An often cited instance of this is if I dig a hole and fill it up for hours on end: no value will be created. Clearly, another factor is needed to create value.

Yet the Classical labour theory of value says that the real only cause of value is labour, and that this can be measured by labour hours.

A simple example shows this can’t be correct. Consider this situation:

(1) One man in the south of France in a obscure region not famous for wine spends 100 hours of labour planting a vineyard, harvesting the grapes and making 50 bottles of wine.

(2) One man in France in Bordeaux spends 100 hours of labour planting a vineyard, harvesting the grapes and making 50 bottles of wine.

For the sake of argument, let us assume that the soil conditions happen to be the same, and that both men are equally expert and conditions are similar in the two regions and they have produced wine of the same quality. The first man sells all his 50 bottles of wine for $50 ($1 each). But the second man sells his 50 bottles of wine for $500 ($10 each), because his wine is produced in Bordeaux and is valued at a higher price than the wine produced by the first man, even though the latter’s wine is of the same quality.

Yet, according to the labour theory of value, they have both put in precisely the same amount of labour, so the price should be the same.

But clearly they are not. The value of the wine has a fundamental subjective cause: people value wine from Bordeaux more highly than wine from other regions.

Consider this second situation:

(1) One man spends 200 hours digging in a mine and finds a diamond and sells it for $1000.
(2) Another man spends 1 hour digging and finds a diamond which he sells for $1000.

Although they receive exactly the same price, they have put in completely different amounts of labour. If the labour theory of value were correct, than the first man would be paid 200 times more for his diamond than the second.

But again the underlying labour time has no effect on the value of the diamond which is determined by subjective values (e.g., people desiring diamonds for beauty and people needing diamonds for industrial purposes).



Can Value be Subjective and at the Same Time be Created through Labour?

In a recent post called “Reforming Money - Fixed Fiat Currency,” the blogger Cynicus Economicus presents a rather different theory about value that involves labour:

http://cynicuseconomicus.blogspot.com/2009/07/reforming-money-fixed-fiat-currency.html#comment-form

In a fascinating article which I urge you to read, he presents a theory of a fixed fiat currency, but relates this to an underlying theory about labour.

Cynicus Economicus argues that

all economic activity is rooted in the value of labour. A commodity such as gold only has value once labour has dug it from the ground, and labour has moved it to the surface. Once it arrives at the surface it will be some form of labour that is utilised to move it to where it is next utilised …. At the heart of all economic activity is human labour, and economics is the process of exchange of value of labour between individuals, organisations and other economic units.

Unlike the classical labour theory of value, however, Cynicus Economicus does not believe that goods are valued by the quantity or amount of labour need to produce them (that is, number of hours worked).

He concedes that individuals subjectively value goods. Thus actual value of labour between individuals might be determined differently, and the underlying labour that is exchanged is valued in a subjective way:

The reality in any economy is that labour has variable value. I am simply saying that, if person A undertakes labour at value x on date 'y', then that value should be stored at value x. The rights and wrongs or how it might be valued is not the issue. Nevertheless, all value in economics commences with some kind of labour.

As we have seen, if something is subjective, then it does not have an underlying objective source: it is arbitrary. Either value is subjective or it is not.

To show this, we can look at some examples where labour allegedly causes the value of goods.


Example 1: Does a Diver’s Labour Cause Value in a Pearl?

According to Cynicus Economicus’ view, if a diver finds a pearl on a seabed, the pearl has value that has been created by the labour that brings it to the market where it is exchanged, even though the labour is valued subjectively in that market.

However, subjective value exists in the minds of human beings, as we have seen. The man dives for the pearl because he knows that pearls will have a value in exchange already. The value of the pearl is ultimately a subjective phenomenon, and can exist before the pearl is even possessed by the diver. If a diver sees a pearl on the seabed, he already has a subjective value in his mind attached to it.


Is the High Value of Antiques Caused by the Added Labour Value of Experts?

If a painting is examined by an expert and pronounced to be a genuine Vincent van Gogh, then is the expert who determines that the painting is genuine adding the value of his labour to the object, and thus making it of high value?

We have already seen that value is subjective. If I believe that a painting is by Vincent van Gogh, then I am willing to pay a high price for it before the expert examines it. The subjective value in my mind has simply been confirmed, not created, by the expert who examines it. It was my previous subjective belief that the painting is genuine, not the appraisal of the expert, that makes it of high value to me.

This is confirmed if you think of old books. If you go to a second hand book shop, and find a rare book from the 18th century, to many people its subjective value will be much higher than other books. No one needs to have the age confirmed by an expert: its age can be confirmed by physical examination of it. No expert opinion is required to “add value to it.”


A Point of Confusion: Factors of Production are different from Value

It seems to me that Cynicus Economicus has confused factors of production (or factor inputs) with value.

It is undoubtedly true that labour is a fundamental factor of production for many goods, most notably manufactured goods.

However, it is simply not true that it is the only factor of production: there are 4 recognized factors of production:

(1) natural resources, including land, raw materials, water, and energy.
(2) labour,
(3) capital goods, and
(4) entrepreneurship (O’Connor and C. Faille 2000: 63).

Factors of production are the inputs that are combined and used to transform things into goods and services. Labour is undoubtedly a major input, and capital goods and entrepreneurship also depend on human labour to a great extent.

But natural resources, factor (1) above, do not always depend on human labour. It is easily demonstrated that labour is not the only important input into production: for example, when farmers grow crops, there are fundamental natural inputs (soil, rain, sunlight) without which production could not occur.

Thus it is simply not true that “all value in economics commences with some kind of labour.” Without many natural resources, there could be no production.

In economic terms, value is subjective, and is measured individually by the utility a good provides to an economic agent. It is the demand for goods caused by the subjective desires of people that is the cause of value, not labour.

To have value in economic terms means to have a price/exchange value as a good traded in a given market. The economic value of a mushroom is already known to people as the price it trades on markets.

But the cause of that value is the subjective desire of consumers to have mushrooms, and is not created by labour. A man could pick a mushroom and then find that the price has collapsed to nothing, because demand for mushrooms has collapsed: despite his labour it will have zero economic value.

Thus labour is not even a sufficient condition for the mushroom to have value. The necessary condition is that the mushroom has subjective value for consumers who are willing to pay money for it or exchange other commodities for it. This subjective value is a mental state. The labour involved in moving a mushroom to a market does not create or give it economic value.

The picking of mushrooms and conveying them to a market is part of economic production and output. But natural resources have a major role in the production/output of the mushrooms as well.

The simple fact is that, if you subscribe to a subjective theory of value, then goods do not achieve value because of labour. Goods achieve value through the subjective valuation of them by individuals, and this can be influenced by supply and demand. This subjective valuation is a mental process, even in exchange value.

Labour is certainly required to turn input factors into output.

But, as has been pointed out by Arun Bose and Steve Keen, raw material inputs and labour work together to create output (or, in Marxist thought, the intrinsic value or essence of a commodity). Labour alone is not the essence of output (or value as conceived in Marxist theory): both labour and commodities (natural resources) are sources of output. No matter how much labour is expended on production, the production of goods is impossible without natural resources. Non-labour inputs have an indispensable role in production (Bose 1980; Keen 2001: 288–289).


Is Money merely a Store of Value of Labour?

Cynicus Economicus also argues that

within [a] system of exchange of value of labour, the underlying purpose of money is very clear. It should only act as a medium through which the value of labour might be accounted, and is always representative of a store of value of labour, with an underlying contract that it might, at some future point in time, be exchanged for the value of labour of others.

However, as we have seen, once you recognise that the value is subjective and not determined by labour, and that there are other inputs which go into the production of commodities, there is no reason why money should be defined simply in this way or only have this function.


BIBLIOGRAPHY

Blaug. M. 1982. “Labour theory of value,” in D. Greenwald (ed.), Encyclopedia of Economics, McGraw-Hill, New York. 595–597.

Bose, A. 1980. Marx on Exploitation and Inequality: An Essay in Marxian Analytical Economics, Oxford University Press, Delhi.

Dooley, P. C. 2005. The Labour Theory of Value, Routledge, Abingdon, Oxon.

Horwitz, S. 2003. “The Austrian Marginalists: Menger, Bohm-Bawerk, and Wieser,” in W. J. Samuels, J. E. Biddle, J. B. Davis (eds.), A Companion to the History of Economic Thought, Blackwell Publishing, Oxford, UK and Malden, MA.

Iannone, A. P. 2001. “Value,” in A. P. Iannone, Dictionary of World Philosophy, Routledge, London and New York. 539–540.

Keen, S. 1999. “Use-value and exchange-value,” in P. A. O’Hara (ed.). Encyclopedia of Political Economy, Volume 2: L–Z, Routledge, London. 1212–1213.

Keen, S. 2001. Debunking Economics: The Naked Emperor of the Social Sciences, Zed Books, New York.

O’Connor, D. E. and C. Faille. 2000. Basic Economic Principles: A Guide for Students, Greenwood Press, Westport, Conn.

Robinson, J. 2006 [1962]. Economic Philosophy, AldineTransaction, New Brunswick, N.J. and London.

Rutherford, D. 1955. “Utility,” in Routledge Dictionary of Economics, Routledge, London and New York. 428.

New Zealand and “Think Big”: Did it Ruin the Economy?

In a recent conversation with a friend, I was presented with the argument that New Zealand’s high ranking by per capita GDP collapsed in the late 20^th century because of socialism and industrial policy.

Curious about this claim, I did some research.

Throughout the Bretton Woods era, New Zealand’s GDP ranking was very high: higher than the OECD average, although there was a clear downward trend as other larger economies with greater potential for growth overtook New Zealand.

But the fundamental fact is that New Zealand’s economy was mainly based on commodity exports until the mid-1970s, not manufacturing exports. New Zealand had a protected domestic manufacturing sector, but full employment during the post-WWII era.

But from the 1950s to 1966, New Zealand had growth of about 2.2% a year in per capita GDP.

This was partly caused from 1951 when New Zealand’s GDP was boosted by an extraordinary boom in wool exports caused by the Korean War. It is obvious that export earnings would fall as this boom ended, and that this would affect GDP. Thus growth was lowered from 1966 onwards when the price of wool fell.

When there was a fall in the price of commodities in the mid-1970s and oil shocks, New Zealand’s ranking by per capita GDP also fell significantly.

However, although per capita GDP fell, it remained at roughly the OECD average, as you can see in the table in this article by Brian Easton (the author of In Stormy Seas: The Post-War New Zealand Economy University of Otago Press, 1997):

Brian Easton, Output Since the War: New Zealand’s GDP Performance

http://www.eastonbh.ac.nz/?p=591

The Conservative government of Robert Muldoon (1975–1984) implemented an industrial policy called “Think Big” after 1981 (Brooking 2004: 146) in response to the oil shocks.

Yet the first significant fall in New Zealand’s ranking by per capita GDP had already occurred:

“significant declines [in New Zealand’s per capita GDP] occur only in the 1966 to 1969 period, … 1976 to 1978, … and 1986 to 1992 …. [The] first decline was due to the collapse of the world price of crossbred wools in late 1966 ... the second decline [was due] to this source too … If so the total decline from the wool price shock was about 20 percent, and was largely over by the mid 1970s. An alternative view is the second fall was the result of the oil price shock of late 1974. Whichever explanation is correct, the first two falls can be unequivocally attributed to external shocks over which New Zealand had little influence … .”Brian Easton, Output Since the War: New Zealand’s GDP Performance, http://www.eastonbh.ac.nz/?p=591

Thus it is simply not possible to blame “Think Big” for the fall in GDP of the 1970s. Moreover, after Robert Muldoon’s “Think Big” was launched, per capita GDP actually increased slightly during its implementation, and there was no dramatic collapse.

The fact is that the really significant collapse in New Zealand’s per capita GDP occurred in the neoliberal era, under the onslaught of Rogernomics (the equivalent of Thatcherism) after the election of free market Labour government in 1984. In 1984, per capita GDP in New Zealand was at the same level as the OECD average. Then after 1984 it went into free fall:

“The other big fall occurred in the late 1980s and early 1990s. There was no significant external shock ... Rather, a faulty [sc. neoliberal] macroeconomic policy … ignored the health of the tradable sector which is at the centre of the growth process … It seems likely that had there been no [sc. neoliberal] reforms – or to be more precise, had the reforms been akin to those implemented in Australia: more practical and less ideological – New Zealand would still be at the OECD average.” Brian Easton, Output Since the War: New Zealand’s GDP Performance,http://www.eastonbh.ac.nz/?p=591

 Thus New Zealand’s per capita GDP collapsed from 100% of the OECD average in 1984 to just 83% of the OECD average by 1999, before the election of the Labour government of Helen Clark that rejected some of the more extreme neoliberal policies. Growth in per capita GDP has resumed since 1999 and is now 86% of the average.

The conclusion is clear: a major collapse in New Zealand’s per capita GDP happened under neoliberalism when it fell well below the average.

External shocks to the New Zealand economy in the late 1960s and 1970s did cause the first major collapse in per capita GDP, but this happened well before the industrial policy of Robert Muldoon.

BIBLIOGRAPHY

Bassett, M. 1998. The State in New Zealand, 1840–1984: Socialism Without Doctrines? Auckland University Press, Auckland.

Brooking, T. 2004. The History of New Zealand, Harcourt Education, Oxford.

Opening Post

This blog is a commentary on the current economic crisis and the prospects for Social Democracy in the 21st century. I am not an economist, but someone with a life-long interest in economics and social democracy.