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The labor theory of value is a theory in economics and political economy which equates the "value" of an exchangable thing or activity (commodity) with the amount of abstract labor required to produce it. Karl Marx is the main thinker associated with this theory. However, the theory is older.

The Theory's Development

The early liberal political philosopher John Locke, in his Second Treatise on Government, 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. He answered that persons own their own labor, this ownership being bestowed on each of us by nature, and that when a person labored -- even the mere labour of picking an apple off a tree -- that labor entered into the object, and so the object became property of that person. From this Locke and others further argued that commodities have value because of the labor invested in them.

That is, the theory was used to support the new notion of private property. Locke argued that a landowner's property was his (or hers) because s/he had worked for it, removing it from the common stock held by humankind. Strangely, Locke mentions the hiring of "servants" by the landowner without wondering why some or all of the product of their labor belongs to them rather than to the landowner.

(While the limited amount of labor anyone can do seems to limit the amount of property one owns, Locke argued that one can accumulate money to claim more property, transcending that limit. This later showed up in Marx's theory of capital accumulation, which allowed increasing power of the ruling class. For simplicity, such dynamic issues are ignored below.)

The Scottish political economist Adam Smith observed that in capitalist economies with a complex division of labor, people convert commodities into money and vice versa. He thus distinguished between "real value" (the amount of labor required to produce or acquire an object) and "nominal value" (the amount of money one would give or receive in exchange for a given commodity). In addition, he used the "labor commanded" definition of value, referring to the real price of a product as the amount of labor that could be purchased by selling it. The fact that these two different kinds of labor-value (labor embodied and labor commanded) hardly ever correspond later gave rise to the so-called transformation problem (see below).

The English economist David Ricardo stressed the role of the first kind of labor value, the amount of labor "embodied" in a commodity. His emphasis was on what might be called a "labor theory of price," in which the (relative) amount of labor embodied in a commodity determines its (relative) price. This is a theory of price-determination by costs, in which costs reflect labor-values.

In these approaches, the labor theory of value is a theory of objective value. By most interpretations, the theory of value relationships proposed by Karl Marx made similar assumptions about "labour value."

As capitalism developed, Locke's problem of hired "servants" (workers, proletarians) could not be ignored. The labor theory of value was used by Karl Marx to support a very different political argument: that the role of owners in production is exploitative, since it is only the workers that add value to the product. At the level of the society as a whole, the price of the product is said to tend towards the sum of the value of the capital goods used up in production and the value added by direct labor.

Profit, interest, rent, etc. is only possible, according to the theory, if the wages of these direct workers do not fully compensate them for the value they add to the capital invested to produce the product. Workers work for a part of each day adding the value required to cover their wages, while the remainder of their labour is performed for the enrichment of the employer or capitalist.

The Austrian economist, Eugen von Böhm-Bawerk argued against Marx's theory of exploitation, pointing out that workers traded in their share of the end price for the more certain and soon wages paid by the entrepreneur. In other words, he claimed that the employer "earns" their profit by exposing themselves to risks that the workers can avoid. This theory abstracts from the fact that workers risk life and limb on the job, which seems a more serious kind of risk-taking than the merely financial risk that the entrepreneur takes. Further, when the entrepreneurs' risk-taking does not pay off, much of the cost is dumped on the workers in the form of wage cuts and/or lay-offs.

Much of Western economics turned away in the 1870s from theories of objective value and towards the economic subjectivism associated with the development of neoclassical economics. That is, most economists today have discarded the labour theory of value in favour of models of price determination based on marginal utility and marginal cost of production, i.e., on demand and supply.

The Theory Explained

Within Marxian political economy has developed Marx's concept of "socially-necessary labour time" to clarify the meaning of his theory of value.

The labor theory of value holds that 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 (or means of production) used up in the production of the commodity.

For example, if twenty workers are used for a year to produce capital goods used by twenty workers in the next year to produce a consumer good, the good embodies the labor of forty workers. (This example assumes that technology is unchanged between the two years.)

The amount of labour done by an average untrained worker under the prevailing conditions in a society (for instance the technology and transportation in use) will produce the same amount of value regardless of the manner of that labour. Greater value can be produced by trained workers, or by workers using leading edge technologies, the increase in value being embodied in the training process or the work required to create the technologies.

The Theory Critiqued

The most common interpretation of the labour theory of value is that it is a labor theory of price, so that Marx's theory corresponds to that of Ricardo. In this view, value does not derive the price of a commodity from its functional value to the consumer (described by Marx as a use value), but from the labour society has expended on its production (its socially necessary labour time). Marx concluded the third volume of Das Kapital (Capital: A Critique of Political Economy) with analysis of the relationship between values into prices. This has been described as the "transformation problem", as it has been the focus of several critiques of the theory.

The famous tranformation problem is the centerpiece of this dominant interpretation. Let us examine an example, showing that on the microeconomic level, prices cannot be proportional to values, even when pure competition prevails.

Assume initially that prices are proportional to values (as suggested by the labor theory of price), so that profits are proportional to unpaid labor-time (surplus-value), wages are proportional to paid labor-time, and the amount of money invested is proportional to the value of the capital invested.

Suppose the proportion of unpaid labor-time to paid labor-time is the same for all workers. This reflects the tendency for workers to move away from those sectors where they're exploited the most and toward where they're exploited the least, so that the rate of exploitation or the rate of surplus-value tends toward equality between sectors. This is here represented by the ratio S/W (unpaid labor-time/paid labor-time).

But there is no reason why technical conditions of production will be the same in all sectors. Technology will result in different proportions of labour and capital goods being used within different production processes (in different industries). In Marx's terms, the organic composition of capital differs between sectors. Measure this here as the ratio W/K, the ratio of the amount paid for paid labor to the total amount spent on capital. The latter includes wages (W) if workers are paid ahead of time for providing labor-time.

If products were traded based on labor values, prices would result in different industries earning different rates of profits on the capital invested. The rate of profit equals the total amount of profit earned (S, corresponding to unpaid labor) divided by the amount of capital (K) invested, or S/K. This equals (S/W)*(W/K). Above, we assumed that S/W was the same in all industries, while there is no reason to think that W/K is uniform. Thus, the profit rate should differ between industries.

But competition among industries should be described as tending to remove differences in profitability: capitalists earning low profit rates should leave their industries, reducing supply and raising prices. At the same time, they enter the high-profitability sectors, raising supply and reducing prices there. Thus, prices can no longer be proportional to values (as assumed initially). That is, the labor theory of price cannot be true.

David Ricardo presented a numerical example of this:

Suppose I employ twenty men at an expense of 1000 pounds for a year in the production of a commodity, and at the end of the year I employ twenty men again for another year, at a further expense of 1000 pounds in finishing or perfecting the same commodity, and that I bring it to market at the end of two years, if profits be 10 per cent., my commodity must sell for 2,310 pounds.; for I have employed 1000 pounds capital for one year, and 2,100 pounds capital for one year more. Another man employs precisely the same quantity of labour, but he employs it all in the first year; he employs forty men at an expense of 2000 pounds, and at the end of the first year he sells it with 10 per cent. profit, or for 2,200 pounds. Here then are two commodities having precisely the same quantity of labour bestowed on them, one of which sells for 2,310 pounds--the other for 2,200 pounds.

The above logical consequence of varying capital intensity has been the main focus of economic critiques of Marxian value theory of prices. Some see this as a "reductio ad absurdum" of the labor theory of value. However, it should be noted that Ricardo himself employed a "95 percent labor theory of value," believing that most of the time labor-values were a good guide for guessing relative prices and the progress of prices over time (correcting for inflation).

An Alternative Interpretation

While this interpretation dominates most discussions, there are other views. Marx believed that price phenomena (markets, competition, supply, demand) created illusions which obscure the underlying social relations of a capitalist society. (He called this phenomenon commodity fetishism.) Social relations are best analyzed in terms of value. In this view, the "labor theory of value" was not seen as a theory of price but instead as a method for understanding the nature of social relationships for capitalism as a whole: the examples of workers producing value that Marx presents are microcosms representing the totality of society.

In this alternative view, the contrast between labor-values and prices is just as important as their unity. First, we must measure values and prices in the same units. For simplicity, measure both in terms of labor hours, so that the distinction between values and prices corresponds to Smith's distinction between labor-embodied values and labor-commanded values.

While values correspond to the abstract labor-time socially necessary to produce commodities, prices are set by supply, demand, and market institutions. So there is no theoretical reason why price should always equal value on the microeconomic level. (Of course, Ricardo's 95 percent theory seems to apply empirically.)

However, on the societal or macro level, there is a clear relationship between price and value. First, the total value of the product (the total amount of labor done) corresponds to the total price of the product (such as that measured by Gross Domestic Product). Labor embodied = labor commanded on the macro level. That is, all commodities are produced by labor; society is nothing but a community of producers working for each other through a complex division of labor.

Second, and more importantly, the total surplus-value that workers produce limits the total amount of property income (profits, interest, and rent) that individual capitalists can receive. That is, all property income is the result of exploitation.

Thus, there is redistribution of property income within the capitalist class: given the state of class relations and thus the amount of surplus-value produced, a capitalist who receives high profits will be benefiting partly at the expense of capitalists who receive low profits. In terms of the "transformation problem," there is a transfer of profits to the first capitalist from the latter capitalists because the ratio of his (or her) prices to his values is high, while theirs is low.

External links

• Robert Vienneau's LTV FAQ