Wednesday, July 7, 2021

Zachariah’s “Labour Value and Equalisation of Profit Rates”: A Critical Review

D. Zachariah’s paper “Labour Value and Equalisation of Profit Rates: A Multi-Country Study” (Indian Development Review 4 [2006]: 1–20) seeks to prove Marx’s Labour Theory of Value (LTV) by examining empirical data on factor input costs and final prices of finished goods from 18 nations in a period from 1968 to 2000.

Zachariah concludes that “market prices and labour value of industry outputs are highly correlated for a fairly broad sample of economies” (Zachariah 2006: 18), and that the idea of “prices of production” (used by Marx in volume 3 of Capital) is an inferior theory to the simple Labour Theory of Value in explaining prices, especially since Zachariah finds strong evidence against a tendency to equalisation of profit rates (Zachariah 2006: 18). In essence, Zachariah also concludes that the Transformation Problem appears to be irrelevant, given his findings.

So it is clear that Zachariah is trying to defend a version of the LTV used by Marx in volume 1 of Capital.

We must remember that Marx had no single, consistent Labour Theory of Value. The “law of value” (a phrase which Marx used to refer to the LTV) in volume 1 of Capital contradicts the “law of value” in volume 3.

In order to clarify this problem, we can review Marx’s two versions of the Labour Theory of Value, as follows:
(1) The “Law of Value” in volume 1 of Capital
In volume 1 of Capital, Marx defended in his text a “law of value” in which homogeneous socially-necessary labour time units were the anchor for the price system in modern capitalism. That is to say, individual commodity prices are supposed to gravitate towards their labour values (but volume 1 contained two footnotes hinting at the different theory of price determination in Marx’s draft of volume 3, so that volume 1 was not even internally consistent).

By volume 3 of Capital, Marx thought this only happened in the pre-modern world of commodity exchange, but he describes the process as follows:
“The assumption that the commodities of the various spheres of production are sold at their value implies, of course, only that their value is the center of gravity around which prices fluctuate, and around which their rise and fall tends to an equilibrium.” (Marx 1909: 208–210).
For this LTV to work and be empirically proved, all human labour of different kinds must be measurable in a homogenous unit of basic socially-necessary labour time and then compared.

(2) The “Law of Value” in volume 3 of Capital
In volume 3 of Capital, Marx abandons the view that commodity prices tend to equal pure labour values. Instead, Marx defended the view that the “law of value” only ultimately and indirectly explains prices, and defended three aggregate equalities:
(1) the sum of surplus value = sum of profits;

(2) the sum of values = sum of prices, and

(3) the value rate of profit = the money rate of profit.
These aggregate equalities were asserted as true as Marx’s attempt to defend labour value. But Classical “prices of production” became the anchors for the real-world price system.
Now Zachariah in his article is essentially rejecting the “law of value” in volume 3, and trying to defend the crude LTV in volume 1.

The trick that Marxists like Zachariah use is this: by showing empirically that there is a high correlation between the labour cost of fundamentally different labour types to the prices of their respective output goods, Marxists think they have proven the LTV. But this is a spectacular non sequitur. The reason is this: Marx’s Labour Theory of Value is much more than this simple correlation.

Zachariah’s contends that it is “the need for companies to meet the wage-bill that forces market prices to gravitate around prices proportional to labour values” (Zachariah 2006: 4). But this does not follow at all, because we cannot even properly measure the objective labour values of all different goods produced by heterogenous kinds of human labour. The very concept of labour value as used by Zachariah has not been properly defined in the way Marx used it.

No Marxist has ever convincingly shown how to overcome the problem of reducing all different types of human labour-time and measuring it in a homogeneous unit. For example, one hour of labour by a highly-skilled engineer is different from one hour of labour by a brick layer on a construction site.

This devastating problem with even properly defining the LTV has been noted by economists from different schools. Joan Robinson correctly pointed out that Marx needed to reduce all heterogeneous human labour time to a meaningful homogenous unit (Robinson 1966: 12), but this “leaves open the problem of assessing labour of different degrees of skill in terms of a unit of ‘simple labour’” (Robinson 1966: 19).

Marx faced the problem of reducing all heterogeneous human labour to a homogeneous abstract socially-necessary labour time unit, but Marx did not properly explain how this happens. You cannot prove a theory when your fundamental concept cannot be empirically defined or measured.

Eugen von Böhm-Bawerk identified the same problem. Böhm-Bawerk stated:
The fact with which we have to deal is that the product of a day’s or an hour’s skilled labor is more valuable than the product of a day's or an hour's unskilled labor; that, for instance, the day's product of a sculptor is equal to the five days’ product of a stone-breaker. Now Marx tells us that things made equal to each other in exchange must contain ‘a common factor of the same amount,’ and this common factor must be labor and working time. Does he mean labor in general? Marx's first statements up to page 45 would lead us to suppose so; but it is evident that something is wrong, for the labor of five days is obviously not ‘the same amount’ as the labor of one day. Therefore Marx, in the case before us, is no longer speaking of labor as such but of unskilled labor. The common factor must therefore be the possession of an equal amount of labor of a particular kind, namely, unskilled labor.

If we look at this dispassionately, however, it fits still worse, for in sculpture there is no ‘unskilled labor’ at all embodied, much less therefore unskilled labor equal to the amount in the five days’ labor of the stone-breaker. The plain truth is that the two products embody different kinds of labor in different amounts, and every unprejudiced person will admit that this means a state of things exactly contrary to the conditions which Marx demands and must affirm, namely, that they embody labor of the same kind and of the same amount!.” (Böhm-Bawerk 1949 [1896]: 81–82).
Marxists like Zachariah cannot even defend the “law of value” in volume 1 of Capital without solving this problem, but there is no convincing solution to the problem even mentioned in Zachariah’s paper.

The normal technique used by Marxists is to correlate mere labour costs in money prices with output prices, but this is a practice that cannot possibly overcome the problem of aggregating the different types of labour with a homogenous unit. To prove that prices are determined by labour values, you would have to calculate the homogeneous socially-necessary labour time units required to produce every commodity where all skilled labour and unskilled labour can be measured in the same homogenous unit, and then compare these quantities with prices. But Zachariah and other Marxists do not do this.

What Zachariah has proven is that there is, indeed, a very high correlation between labour factor input costs and prices, since labour costs are, generally speaking, a huge part of total production costs in most sectors. But Post Keynesian economics also accepts this, as do all non-Marxist cost-based theories of price determination.

The problem with all these Marxist attempts to empirically prove the LTV is identified by Nitzan and Bichler:
“The other problem with [sc. Marxist] empirical studies has to do with values – or rather the lack thereof. To our knowledge, all Marxist models that purport to correlate prices with values do no such thing. Instead of correlating prices with values, they in fact correlate prices with . . . prices!

The reason is simple enough. Recall that, according to Marx, the value of a commodity denotes the abstract labour time socially necessary for its production. Yet, as we already mentioned …, this quantum is impossible to measure. And so the researcher makes assumptions.

The most important of these assumptions are that the value of labour power is proportionate to the actual wage rate, that the ratio of variable capital to surplus value is given by the price ratio of wages to profit, and occasionally also that the value of the depreciated constant capital is equal to a fraction of the capital’s money price. In other words, the researcher assumes precisely what the labour theory of value is supposed to demonstrate. ….

Since values are forever unknown, we need to first convert prices into ‘values’ and then correlate the result with prices. It seems reasonable to expect the outcome to be positive and tight. After all, we are correlating prices with themselves. What remains unclear is why one would bother to show this correlation and, more puzzling still, how the whole excise relates to the labour theory of value.” (Nitzan and Bichler 2009: 96–97).
Apart from labour-time data from Sweden, Zachariah states clearly that the rest of his data simply uses monetary “labour costs... as a proxy for labour input” (Zachariah 2006: 6), so that virtually all Zachariah’s data is subject to the critique above.

While some Marxists have in fact used labour hours or labour time in trying to calculate value, not even this proves Marx’s LTV, because the Marxists never calculate the homogeneous socially-necessary labour time units necessary for comparing different types of labour.

In reality, the finding that labour costs are strongly correlated with output prices is actually one of many strong proofs of the Post Keynesian cost-based mark-up theory of pricing, which has no need for a Labour Theory of Value at all.

And one can only note that when Marxists try and prove the crude LTV in volume 1 of Capital, they are in effect admitting that the aggregate identities that constitute the “law of value” in volume 3 must be false, which Zachariah effectively does.

However, one very interesting finding from this paper, as noted above, is that Zachariah found strong evidence against a tendency to equalisation of profit rates (Zachariah 2006: 18). It logically follows that Classical “prices of production” cannot be anchors for the real-world price system, because a tendency towards an equal profit rate is a necessary condition of “prices of production.” So the Classical, Sraffian and Marx’s theory of price determination as used in volume 3 of Capital cannot be true.

Further Reading
“The Critical Responses to Volume 3 of Marx’s Capital and the Early Development of Marxism,” February 9, 2016.

“Joan Robinson on Marx’s Labour Theory of Value: A Few Points,” August 11, 2015.

“Marx’s ‘Law of Value’ in Volume 1 of Capital,” February 4, 2016.

“Why Marx’s Labour Theory of Value is Wrong in a Nutshell,” June 28, 2015.

“Empirical Studies showing that Prices are Correlated with Labour Costs do not Prove the Classical Marxist Labour Theory of Value,” December 23, 2015.

“Böhm-Bawerk on Marx’s Problem of Aggregating Heterogeneous Human Labour,” March 7, 2016.

“Marx’s Capital, Volume 1, Chapter 11: A Critical Summary,” February 7, 2016.

“Alexander Gray on the Two Contradictions in Marx’s Theory of Surplus Value in Volume 1 of Capital,” February 8, 2016..

Böhm-Bawerk, Eugen von. 1949 [1896]. “Karl Marx and the Close of His System,” in Paul M. Sweezy (ed.), Karl Marx and the Close of His System and Böhm-Bawerk’s Criticism of Marx. August M. Kelley, New York. 3–120.

Marx, Karl. 1909. Capital. A Critique of Political Economy (vol. 3; trans. Ernst Untermann from 1st German edn.). Charles H. Kerr & Co., Chicago.

Nitzan, Jonathan and Shimshon Bichler. 2009. Capital as Power: A Study of Order and Creorder. Routledge, Milton Park, Abingdon, UK and New York.

Robinson, Joan. 1966. An Essay on Marxian Economics (2nd edn.). Macmillan, London.

Zachariah, Dave. 2006. “Labour Value and Equalisation of Profit Rates: A Multi-Country Study,” Indian Development Review 4: 1–20.

Sunday, April 4, 2021

Academic Agent versus “Adam Friended” on Price Inflation and MMT

Academic Agent has got into another row on MMT, but this time with someone called “Adam Friended.”

In brief, “Adam Friended” responded to Academic Agent in the following video on the issue of MMT and price inflation:

Academic Agent then produced this response on MMT here:

Academic Agent is correct that Covid welfare payments and furlough schemes were not the fundamental drivers of inflation in some goods. It is also true that the Western world is far from full employment (though wage rises clearly can be a driver of price inflation through cost-based mark-up prices).

Unfortunately, “Adam Friended” did not correctly describe the causes of the price inflation in certain goods at the moment, and worse still he does not himself properly understand MMT or Post Keynesian economics, and fails to understand that the naïve Quantity Theory of Money is rejected in MMT and Post Keynesian economics. So this debate between Academic Agent and “Adam Friended” stems from the failure of the latter to correctly state MMT or Post Keynesian theories.

The fundamental causes of the inflation seen in certain goods recently are as follows:
(1) disruption to supply chains because of Covid and lockdowns has caused supply-side inflation, especially in factor inputs. Some nations have also restricted exports of key goods, and lockdowns, in some cases, badly affected production in places like China. In other cases, some nations hoarded supplies of certain food and medical supply products, which restricted overseas exports and caused some inflation.

(2) the price of oil has been rising sharply since last year, and since energy is a fundamental factor input cost, the rise in costs is passed on via cost-based mark-up prices;

(3) there has been disruption of agricultural production and inflation in certain food products and in some agricultural inputs. For example, lockdowns and closing of borders have disrupted production and processing of agricultural goods.
The evidence for this can be seen in this IMF paper called “The Impact of COVID-19 on Inflation: Potential Drivers and Dynamics”.

So, in other words, the recent inflation in certain goods prices is mainly and fundamentally caused by real factors like supply disruptions, lockdowns, hoarding and shortages, not monetary factors.
Some demand-pull inflation after supply disruptions has happened, but the real factors are more important, and, as we will see below, Austrians like Academic Agent fail to understand the true extent of demand-pull inflation.

However, it is important to put this into perspective via the general price indices.

American and UK inflation is historically low, as we can see here for the US and here for the UK (just click on the “25Y” or “Max” tabs above the graphs to see the long-run historical inflation rates). None of this has caused high or even moderate general price inflation.

Academic Agent’s fundamental claim in his video (see his comments from 35:18 and 36:09) appears to be that expansion of the money supply via central banks is the fundamental driver of the price inflation in some goods today. This is absurd, and the actual evidence, as I stated above, shows real factors were the driver of the inflation because of supply disruptions, lockdowns, hoarding and shortages.

Worse still, Academic Agent in his reply video makes other errors and fails to understand MMT and even his own Austrian theory.

Let’s review these errors below.

The Austrian Theory of Price Inflation
Academic Agent is so ignorant he actually states in his video that the “Austrian theory would say ... inflation is always a monetary phenomenon” (see 11:36–11:42). By “inflation” Academic Agent clearly means “price inflation” and not merely expansion of the money supply.

Academic Agent is blatantly wrong about Austrian theory.

The idea that “inflation is always and everywhere a monetary phenomenon” is a Monetarist theory on the basis of the Quantity Theory of Money.

In reality, the Austrian school does not wholly subscribe to the Quantity Theory of Money, but have their own criticisms of it, because of the issue of Cantillon effects, as well as other criticisms.

Academic Agent is apparently unaware that the Austrian school actually has serious criticisms of the orthodox Quantity Theory of Money.

First let us take the view of Ludwig von Mises:
“ [sc. Mises] … agreed with the classical ‘quantity theory’ that an increase in the supply of dollars or gold ounces will lead to a fall in its value or ‘price’ (i.e., a rise in the prices of other goods and services); but he enormously refined this crude approach and integrated it with general economic analysis. For one thing, he showed that this movement is scarcely proportional; an increase in the supply of money will tend to lower its value, but how much it does, or even if it does at all, depends on what happens to the marginal utility of money and hence the demand of the public to keep its money in cash balances. Furthermore, Mises showed that the ‘quantity of money’ does not increase in a lump sum: the increase is injected at one point in the economic system and prices will only rise as the new money spreads in ripples throughout the economy. If the government prints new money and spends it, say, on paper clips, what happens is not a simple increase in the ‘price level,’ as non-Austrian economists would say; what happens is that first the incomes of paperclip producers and prices of paper clips increase, and then the prices of the suppliers of the paper clip industry, and so on. So that an increase in the supply of money changes relative prices at least temporarily, and may result in a permanent change in relative incomes as well” (Rothbard 2009: 15).
In other words, Mises denied that a given increase in the money supply (say, 5%) would lead to a direct, proportional and mechanistic rise of 5% in the general level of prices.

Strictly speaking, then, Mises denied the orthodox Quantity Theory of Money.

The naïve monetarists believe that there is a “monocausal” explanation of inflation: money supply growth which will cause direct, proportional increases in the price level, at the very least in the long run, even if Monetarists will accept short-run non-neutrality of money.

Friedrich von Hayek believed that a simple form of the quantity theory was a “helpful guide,” but was nevertheless a critic of the theory, both in the version of it propounded by Irving Fischer and the restatement of it by Milton Friedman (Arena 2002).

In particular, “Hayek criticized Friedman for concentrating too much on statistical relationships (between the quantity of money and the price level), claiming that matters are not quite that simple” (Garrison 2007: 3). Modern Austrians continue to be critical of Quantity Theory of Money, like Jesús Huerta de Soto, who has the following to say:
“[sc. The equation MV=PT of the quantity theory] contains an undeniable element of truth inasmuch as it reflects the notion that variations in the money supply eventually influence the purchasing power of money (i.e., the price of the monetary unit in terms of every good and service). Nevertheless its use as a supposed aid to explaining economic processes has proven highly detrimental to the progress of economic thought, since it prevents analysis of underlying microeconomic factors, forces a mechanistic interpretation of the relationship between the money supply and the general price level, and in short, masks the true microeconomic effects monetary variations exert on the real productive structure” (Huerta de Soto 2009).
The Austrians think that quantity theory is inadequate because it ignores their theory that increases in the money supply distort relative price and the productive structure of an economy, which is, in essence, the Austrian Business Cycle Theory (ABCT).

If we dig deeper into Austrian view of inflation, we can find some surprisingly sensible analysis.

Frank Shostak has this view:
“the essence of inflation is not a general rise in prices but an increase in the supply of money, which in turns sets in motion a general increase in the prices of goods and services .... While increases in money supply (i.e., inflation) are likely to be revealed in general price increases, this need not always be the case. Prices are determined by real and monetary factors. Consequently, it can occur that if the real factors are pulling things in an opposite direction to monetary factors, no visible change in prices might take place. In other words, while money growth is buoyant – i.e., inflation is high – prices might display low increases.”
Frank Shostak, “Defining Inflation,” Mises Daily, March 6, 2002.
The statement that prices “are determined by real and monetary factors” is empirically correct, but requires that the Monetarist view – defended by Academic Agent – that “inflation is always and everywhere a monetary phenomenon” is false.

So Academic Agent does not even understand the Austrian theory he comically defends!

Of course, even the Austrian view of Frank Shostak is seriously flawed in that it does not understand endogenous money or the widespread existence of cost-based mark-up prices.

In reality, most prices are cost-based mark-up prices which are relatively inflexible with respect to demand, either as compared with the 19th century or in the grossly unrealistic models of the worst sort of Neoclassical economics and Austrian theory. This means that increases in demand or purchases of goods via new money (most of which is simply created by private banks anyway via new loans) simply do not bid up prices rapidly or significantly in the way Austrians imagine, precisely because of relative price rigidity. This means that the extent of demand-side price inflation – though it does exist – is grossly exaggerated by Austrians.

To be clear: demand-pull inflation certainly exists, but it is often not the main cause of price inflation in the modern world, and its extent is much more limited.

Changes in the general price level are a highly complex result of many factors, and not a simple function of money supply.

Businesses will raise their prices for all sorts of reasons independently of a money supply expansion.

Often general price inflation is a cost-push phenomenon, in which
(1) workers or unions demand higher wages and businesses agree to these increases and/or

(2) prices of other factor inputs rise, and then businesses raise prices to reflect higher unit costs.
While a long-run, sustained price inflation does need a growing money supply to sustain it, the money supply is often not the causal factor in such price inflations, but the intermediary factor. Often, it is business and corporate use of cost-based mark-up prices and their pricing decisions, on the basis of the need for more profit or higher unit costs, which drive price inflations.

Monetarists make the mistake of thinking that the intermediary medium (money supply) is the only and fundamental driver of price inflation, when real factors underlie many movements in prices.

The MMT Job Guarantee
Academic Agent asks how a Job Guarantee will not cause high inflation under MMT.

The answer is that the MMT job guarantee is designed to pay a minimum wage, so that workers can be bid away from it to the private sector with higher private sector wages.

In cases where private sector employment already pays above minimum wage (which is very many sectors), there is no significant inflation issue.

It is true that there might be some wage inflation where private sector employment already pays a minimum wage and private businesses have trouble finding workers, but this process happens already, and is not going to cause the type of huge or significant inflation Austrian-school supporters like Academic Agent pretend will happen.

Quite simply, low-level price inflation is better for a modern economy than price deflation, since price deflation causes devastating macroeconomic effects, like profit deflation in the face of money wage rigidity, debt deflation, deferral of purchases of goods, and pessimistic business expectations.

The Austrian complaint that the MMT job guarantee might cause some low-level inflation is utterly spurious, since low-level price inflation is far better than price deflation.

Arena, R. 2002. “Monetary Policy and Business Cycles: Hayek as an Opponent to the Quantity Theory Tradition,” in J. Birner, P. Garrouste, T. Aimar (eds.), F. A. Hayek as a Political Economist: Economic Analysis and Values. Routledge, London.

Garrison, R. 2007. “Hayek and Friedman: Head to Head”

Huerta de Soto, J. 2009. “A Critique of the Mechanistic Monetarist Version of the Quantity Theory of Money,”

Rothbard, M. N. 2009. The Essential von Mises. von Mises Institute, Auburn, Alabama.

Shostak, F. 2002. “Defining Inflation,” Mises Daily, March 6