Posts Tagged Labour Theory of Value
The Labour Theory of Value (LTV) is one of probably only a handful of economic theories, along with Francois Quesnay’s Tableau Economique, which have actually been completely abandoned over the past couple of centuries. So, in the interests of combating blind Whiggery, allow me to revive it (maybe I’ll do Quesnay another day, though here’s a sort-of modern version). I’m not going to argue the LTV is necessarily correct; I am merely interested in clearing up some common misconceptions.
My initial reaction to the LTV was the same as almost everyone’s: hostility. Why is there even a need for such a thing? Has it not been discredited on many fronts: logically, empirically, ethically? Are there not ways to preserve the important aspects of Marx, while at the same time ditching his dated and irrelevant theory of value? And yet, after a while, the hostility fades as you realise that:
- You should never be hostile to a theory based only on its name and what other people have said about it, and
- The theory, properly understood, is valid and highly illuminating, and explains many real world phenomena.
One common source of confusion with the LTV is the lack of appreciation that it only applies under capitalism, when goods are produced with wage labour, for the purpose of sale (this is what makes them ‘commodities’). For this reason it doesn’t apply to, say, artifacts; this blog post; or house work. This historical specificity can be a problem for economists, even heterodox ones, as they are generally wont to find principles which extend across different times and societies. This, for example, was the chief problem with Arun Bose’s critique of the LTV, which argued that no matter how far back you go, you will always have a commodity residue embedded in the value of a current commodity, and so labour is not the only source of value. Bose failed to consider that if you go back far enough, you will not have ‘commodities’ but simply naturally occurring objects, or objects not produced for sale. Only when labour was applied to these for the purpose of sale was ‘value’ created in the Marxist sense of the word.
In a nutshell, Marx’s theory goes as follows: under capitalism, the value of commodities is determined by the “socially necessary” amount of labour required to produce them (‘variable capital’), plus the current necessary cost of the capital used up in production (‘constant capital’). Fixed capital, such as machines, adds value at the same rate it depreciates, while raw commodities are used up completely and so add all of their value. Labour is generally paid less than the value it adds, and therefore is the sole source of profit.
Here’s a brief mathematical example: say an hour of labour adds £1 of value, and a certain type of chair requires 8 hours of labour (‘labour-time’), uses £2 worth of wood and depreciates a saw worth £10 by 1/10th (i.e. after the saw is used 10 times it will break). It follows that, according to the LTV, the value of this chair is:
(1/10)*£10 + (8*£1) + £2 = £11
The only way the capitalist can make a profit is to pay the labourer less than the value he creates (for the most part, Marx suggested wages were determined by a social subsistence level). So if the wage is, say, £0.50, the capitalist will have £4 worth of profit. Contrary to what many think, this does not imply that capital-intensive industries will have lower rates of profit, as the rate of profit will tend to equalise between industries, ‘sharing out’ the total surplus value produced in the economy.
The qualifiers of “necessary” costs and “socially necessary” labour are also important. It’s logically possible that a madman could purchase a saw for £100 for some reason, or that a lazy labourer could take 10 hours to make the chair, but this would do nothing to alter the resultant value of the chair. Marx was concerned with general rules, not specific cases, which could obviously fluctuate wildly as they are based on human behaviour.
The main implication of this theory is that, since capitalists tend to use labour saving technology to increase productivity, over time they use relatively more constant capital – which cannot be a source of surplus – and this drives down the rate of profit: the Tendency of the Rate of Profit to Fall (TRPF). Though the first capitalist who uses the technology will be able to sell at the market price, and thus gain, once the technology is widely adopted, the value of the commodity will decrease – a ‘fallacy of composition’. Again, this may not be true in particular industries at any one time, but it holds true across the economy as a whole. The result will be intermittent crises as capitalists face lower profits and try to increase them by pushing down wages, devaluing their constant capital, or through technological progress. Marx never predicted capitalism would collapse in on itself, though he did suggest that the working class would revolt as their wages were pushed down.
Does the subjective theory of value (STV) ‘refute’ the LTV?
The basic point that ‘value is in the eye of the beholder’ is often thought to be where the debate ends. This is surprising, because it has little to do with Marx’s main theoretical implications, which as I have noted, concerned economy-wide trends. Marx was well aware that price and value may differ wildly based on monopoly, demand and other fluctuations, but considered it irrelevant to his theory of value. He never claimed to be able to predict the day-to-day movements of prices, and purported attempts to use the LTV to do this are erroneous.
So while it may well be true that the tastes of rich people propel the price of diamonds upwards (whether this is due to the fact that they ‘subjectively value’ diamonds higher than poor people or the fact that they’re rich is up for debate, but I digress), but according to the LTV, this imbalance between price and value must be offset somewhere else, by some other commodity selling below its value. The important thing for Marx was the aggregate equality of price and value*.
Neither were Marx or the classical economists unaware of the utility of commodities and the array of use they might be put to: they called this the ‘use-value‘ of a commodity, though they did think this was socially determined rather than subjective. In classical economics, use-value is not quantifiable: a commodity either is a use-value or it isn’t, and there’s no definitive way to gauge the ‘value’ of sitting on a chair. This means it is not possible for use-value to translate into prices, as use-values are incommensurable between commodities.
The inherently intangible nature of use-value caused Marx and other classical economists to ask: what is it that makes commodities expressible by the same yardstick (money) under capitalism? The answer was that commodities had a twin expression of value: exchange-value. A commodity needed a use-value to have an exchange-value (i.e. it needed to be useful to be worth anything), but the two types of value were not equivalent or even on the same plane. The classical economists decided that exchange-value was determined not by utility, but by the labour required to make a commodity. This is because labour was the common element between all commodities: even capital ultimately reduced to labour, making it the prime candidate for the determination of exchange-value**.
In fact, the subjective theory of value is in many ways a fairly crude attempt to combine use-value and exchange-value, and doesn’t really offer anything new compared to the classical theory. The only way the quantitative expression of subjective valuation can be determined is either circular, ‘revealed’ by purchasing decisions ex post, or in the case of neoclassical economics, completely deterministic based on how a model is constructed. Therefore, as far as market prices are concerned, the theory doesn’t have any more predictive power than simply saying ‘use-value cannot be formalised’. Furthermore, though mutually beneficial trade is achieved through exchange of use-values, as far as exchange-values go trade is a zero-sum game: money exchanged must sum to zero. Neoclassical models of utility obscure this fact.
The ‘transformation problem’ and all that
Hopefully, I have cleared up some of the qualitative misconceptions surrounding the LTV. However, the critique which has probably done the most to ‘discredit’ Marx in academic circles is the idea that the maths simply doesn’t add up, usually based on ‘physicalist’ or Sraffian critiques (in fact, Paul Samuelson relied on this to steer his students away from Marx, despite rejecting Sraffian economics elsewhere). I will avoid the maths here and just try to get to the crux of the misconceptions, which is actually quite simple to do: once the basic methodological misinterpretations are highlighted, the purported complications simply disappear.***
In physicalist/Sraffian models, key variables such as prices and the rate of profit are all determined physically (generally by technology & distribution). The result is that the rates of value are superfluous and completely different to prices: when you try to ‘transform’ them, you run into problems. Yet this only really renders Marx logically inconsistent by interpreting him in a manner that…renders him logically inconsistent. For while physicalist models determine output and input prices simultaneously, Marx actually modeled them temporally, so they could easily differ. As the two prices depend on different transactions at different points in time, this is a fairly reasonable modelling tool by anyone’s standards, but it seems to have been lost in the wilderness of economic debate.
The root of this fundamental incompatibility is that the physicalist notion that key variables are determined simultaneously completely contradicts one of Marx’s premises: that value is determined by labour-time. Intuitively, this makes sense: in a simultaniest world that doesn’t really have time, how could the time spent labouring have any relevance? To show the inconsistency more rigorously, determination of value by labour-time implies that value will fall as productivity rises, which implies that the rate of profit will fall relatively in value terms compared to physical terms (more will be produced, but it will be worth less). Hence, the physical rate of profit – determined simultaneously by the parameters of the model (technology, distribution) – and the value rate of profit, determined by labour-time, differ, and physicalism is incompatible with Marxism.
Once we allow value to be determined by labour-time, and therefore allow output and input prices to differ, a myriad of supposed refutations of the LTV fail: the Okishio theorem; Ian Steedman’s Marx after Sraffa; V. K. Dmitriev’s labourless theory of value (unavailable online). The temporal method can also be combined with the ‘single system’ interpretation of the LTV, which suggests that instead of having two separate systems of price and value, as so many critics do, the two are linked: the necessary cost of inputs at the time of purchase is equal to the sum of the value transferred in production.
Thus, the most plausible mathematical interpretation of Marx’s LTV is the Temporal Single-System Interpretation, which I find a valid and illuminating way of modelling production. The basic elucidation of the theory, and the relationship between values and prices, simply becomes a lot less complicated, and the alleged ‘transformation problem‘ loses its venom as prices and values interact and adjust temporally.
There are a myriad of ways one can object to the LTV, but the idea that is is nonsensical and incoherent is simply based on misunderstandings. One may well disagree with the premise that labour is the source of value (I do, simply because I have no positive reason to believe it). One may also endorse alternative theories over the LTV. But, based on a clear understanding, there is no a priori reason not to develop a comprehensive understanding of Marx’s theory, and treat it in the same way one would treat any other theory in economics.
*It was these appeals to aggregates and totals, instead of the immediate behaviour of the system, that led Bohm-Bawerk to term Marx’s theory ‘tautological’. Yet this rests on Bohm-Bawerk’s own premise that money is neutral, which is controversial to say the least. In any case, Marx’s theory has clear, non-tautological implications, such as the TRPF.
**I find this explanation unsatisfying as labour as well as capital is heterogeneous. Marxists reply to this by arguing that labour under capitalism shares a common element: abstract labour, performed specifically to create commodities. This is partially convincing, but it doesn’t alter the main fact that different types of labour are highly disparate in nature.
***In this section I am drawing heavily on Andrew Kliman’s ‘Reclaiming Marx’s Capital: A Refutation of the Myth of Inconsistency‘ . It’s a great book: clear and concise, and a great example of a ‘remorseless logician’. I am, however, undecided on whether he started with a mistake and ended up in bedlam.
Commenter Dan thinks economics has not yet found its watershed moment:
Think about Biology before DNA was discovered or Geology before plate tectonics was understood, both disciplines had learned a lot but they still lacked a comprehensive model that made everything fit into place.
I am sympathetic with this viewpoint. Heterodox criticisms come at economists thick and fast – personally, I think most of these criticisms are valid and very little of neoclassical economics should be left. Yet neoclassical economics persists.
However, in my opinion this isn’t because economics lacks a unifying theory; it’s the exact opposite. Economists already think they have found a unifying concept: namely, the optimising agent. Consumers maximise utility; producers maximise profits; politicians maximise their own interests/their ability to get reelected. Sure, there are a few constraints on this behaviour, but overall it is the best starting point. It all blends together into a coherent theory that can tell a plausible story about the economy. I find economists are resistant to any theory that doesn’t follow this methodology.
The typical definition of economics is the study of how resources are allocated. Hence, a unifying theory should empirically and logically do a satisfactory job of explaining prices, production and distribution. Such a theory would be able to underlie virtually any economic model in some form, whether being the wider context of a microeconomic phenomenon, or the basis of macroeconomic phenomenon. No easy task, then, but luckily many approaches of this nature already exist.
Alternative Theories of Behaviour
If we want to stick with agent-based explanations of the economy, there are any number of alternatives to the ‘optimising’ agent. Among these are:
I consider all of these approaches useful, but none of them sufficient for the task at hand.
In the case of the first two, replacing ‘optimising’ agents with ‘satisficing’ agents isn’t exactly revolutionary. Maslow’s hierarchy can, in fact, work as a utility function. In both cases, we still run into similar problems of aggregation and of reductionism. And we end up trying to shoehorn every decision into a particular approach. The simple truth is that agents have a lot of different motivations for their actions and sometimes these aren’t always clear, even to them.
My main issue with these, and any agent based approach, is that they aren’t necessarily relevant for the wider question of resource allocation in society. Individualist-based neoclassical economics has to reduce things down to a few agents with only a few goods in order to have any conclusions whatsoever; I can’t help but feel similar problems would emerge here. Class struggle may determine distribution but it doesn’t tell us much about what is produced and at what price it is sold. In order to understand how production takes place and prices are determined, we will have to look elsewhere.
A Theory of Value
The value approach has a lot of pluses. A theory of value underpins the explanation of relative prices, and also has normative implications that recognize the inevitable value judgments in economics. The only problem I have here is that I’ve yet to find a convincing theory of value – the two most widely known are the neoclassical/Austrian subjective theory of value and the Labour Theory of Value (LTV).
I object to the idea that prices merely reflect subjective valuations for the basic reason of circularity: prices must be calculated before subjective valuation takes place, so they cannot purely reflect subjective values.
I have more sympathy with the LTV (mostly because its proponents seem to have coherent responses to every criticism thrown at it), but I remain unconvinced. The defences of the labour theory of value tend to rest on appeals to ‘the long run’ and ‘averages” of socially necessary labour time. These may be useful, but, like the neoclassical ‘long run’ approach they seem to leave open the immediate question of what’s going on in the economy and what we can do about it.
In my opinion, these approaches both contain some validity, and are not mutually exclusive. I tend to agree with Richard Wolff, who asserts that suggesting one has refuted the other is like saying knives & forks have refuted chopsticks. Both are useful; neither are all-encompassing theories. I also believe both are compatible, to some degree, with my favoured approach:
The ‘Reproduction and Surplus’ Theory
This approach is the one emphasised by Sraffians and Classical Economists. It starts from the basic observation that society must reproduce itself to survive, and that generally society manages this, plus a surplus. The reproductive approach emphasises what I believe to be an important aspect of capitalism, and perhaps all systems: the collective nature of production. Industries are interdependent; people work in teams; various institutions, often state-backed or provided, underlie all of this. Hence, no special moral status is accorded to prices or the allocation of surplus, except that prices must be appropriate for the continued existence of industries and society as a whole.
On first inspection the ‘insight’ that society must reproduce itself might be considered trivial, but following through its implications can yield interesting and useful conclusions. The framework can be used to determine prices technically, independently of either preferences or values. It emphasises the interdependent nature of the economy: if one industry or input fails, it has severe knock on effects. For this reason, it would do a great job of explaining both the oil shocks and resultant stagflation of the 1970s and the 2008 financial crisis, something modern macroeconomics cannot manage.
On top of this, the model is versatile: it can interact with its institutional environment, which determines key variables exogenously (e.g. the monetary system determines interest rates, political power determines distribution). The classical approach is, for example, compatible with class theories of income distribution, post-Keynesian theories of endogenous money and mark-up pricing, and even neoclassical utility maximising individuals! Probably the most promising and complete framework out of them all – I look forward to further developments of this approach.
It is feasible that the task of finding a watershed moment is not possible in the fuzzy world of social sciences. Psychology and sociology are both characterised by competing approaches; psychology in particular has improved since the
neoclassicals Freudians were dethroned. If neoclassical economics has taught us nothing else, it’s the importance of not being trapped by particular theories for want of elegance, which is why there is a lot to commend in the institutional school of economics.
Nevertheless, I think there is scope for exploring unifying principles. Progress in neurology may provide such a foundation for psychology; similarly, ideas such as societal reproduction could equally be applied to sociological concepts such as the role of beliefs, class, sports or what have you. As far as economics goes, such a substantial step forward could be what’s required to displace neoclassical economics, whose staying power, in my opinion, cannot be accorded to either its empirical relevance or its internal consistency. Perhaps neoclassical economics persists simply because its building blocks are so well defined that other approaches seem too incomplete to offer their opponents sure footing.
This is the second part of my response to criticisms of Keen’s Debunking Economics. In my previous post* I covered some of the fundamental objections Keen had to neoclassical theory. Here, I will cover Keen’s exploration of alternatives: first, a brief note on dynamics and chaos theory; then a discussion of Keen’s own models; finally, his dismissal of the Marxist Labour Theory of Value (LTV).
Dynamics and Equilibrium
Many economists have argued that Keen’s contention that economists do not study dynamics is false. I agree. Keen does not really address the DSGE conception of equilibrium, which is highly different to the typical conception of a steady state. An equilibrium in an economic model occurs when all agents have specific preferences, endowments etc. and take the course of action which suits them best based on this. This can be subject to incomplete information, risk aversion or various other ‘frictions.’ These agents intermittently interact in market exchanges, during which all markets clear. Basically, ‘solving for equilibrium’ means you specify the actions and characteristics of economic agents, then see what happens when markets clear. It’s entirely possible that the subsequent model could exhibit chaotic behaviour.**
Now, there are obviously many problems here. The fact is that the overwhelming majority of people who learn economics will not touch this. They will instead be faced with static-style equilibrium models, which they have been told are unrealistic but ‘elucidate certain principals.’ This is nonsense – they elucidate nothing, and simply need to be thrown out. Nevertheless, many policymakers, regulators and business economists are working under this framework. Furthermore, even those economists who have gone beyond this level seem to have the concepts deeply ingrained into their minds, and regard them as useful.
However, even the more advanced ‘dynamic’ equilibrium clearly has problems. First, the presence of irreducible uncertainty – which, as far as I can see, is a concept entirely misused by economists – means that it is virtually certain not all expectations will be fulfilled, while equilibrium assumes they will be. Second, ‘fulfilled expectations’ is far stronger than economists seem to think – for example, it eliminates the possibility of default! Third, the assumption that all markets clear is obviously false, otherwise supermarkets wouldn’t throw out old food. Anyway, I digress: Keen could easily address all of these criticisms, but for some reason he doesn’t. This is indeed a shortcoming of his book.
First, a brief note on Keen’s model of firm behaviour: it seems to make the error of maximising the growth rate of profits, rather than profits themselves. I am not sure if this has been fixed. Nevertheless, I regard it as subsidiary to Keen’s main criticisms. His most important model is the Minsky Model of banking and the macroeconomy.
Keen recently had a debate over his Minsky Model with the Cambridge economist Pontus Rendahl. Andrew Lainton has a post on this, along with a contentious discussion with Rendahl, over on his blog. In my opinion, Rendahl – though overly dismissive in tone, and not causing as many problems for Keen as he seemed to think – highlighted a number of issues with Keen’s model in its current form:
(1) Say’s Law holds. In Keen’s model, income is simply a function of the capital stock, and there is no role for demand.
(2) In what was generally a model set in continuous time, which used ODEs, there is an equation which uses discrete time intervals. Such equations cannot be solved in the same way, so Keen’s methodology is inconsistent.
(3) There is, as of yet, no role for expectations in Keen’s model.
(4) Rendahl argues that DSGE models are also Stock Flow Consistent (SFC). I think he is correct – see, for example, his own paper, which has agents accumulating stocks of money from previous periods. The major differences between SFC and DSGE appear to be: a lack of micro foundations; continuous functions; use of classes; market clearing; fulfilled expectations; and, of course, with Keen’s, the role of banks and private debt.
In terms of assumptions, I’d say Keen’s model is in the ‘heuristic’ stage – it’s not completely right and needs development. The criticisms are essentially things that have not yet been added to the model, rather than conceptual or logical problems (save the inconsistent equation). This means they can be added as it develops. However, if the model makes good predictions, it may prove to be useful, even though that should never serve as a barrier to making it more realistic and comprehensive.
Labour Theory of Value
If neoclassical economists want a lesson in how to respond to a critique you strongly disagree with without being vitriolic and dismissive, then they need look no further than the marxist responses to Keen’s critique of the LTV. This is all the more ironic given said economist’s willingness to dismiss marxists as illogical and dogmatic.
Keen’s critique is threefold, so I will discuss it briefly, followed by the marxist responses.
The first critique is Bose’s commodity residue. The idea is that no matter how far you go back in time, disaggregating a commodity into what was required to produce it, there will always be a commodity residue left over. Hence, no commodity can be reduced to merely labour-power. The problem here is the projection of capitalism into all of history. For Marx, a commodity only resulted from capitalist production. However, if you go back in time you will find non-capitalist production, and eventually you will be able to reduce everything into land/natural resources and labour, which Marx never defined as commodities. Having said this, one question remains: can the natural resources or land not be a source of surplus value? Could this surplus value not have been transferred into capitalist commodities?
Second is Ian Steedman’s Sraffian interpretation of Marx. Simply put, it seems Steedman had his interpretation wrong – Marx’s is not a physical, equilibrium system based on determining factor prices. This is something that actually struck me on the first read of Keen’s LTV chapter: Steedman simply converts Marx into Sraffian form without much justification. If Marx did not intend this to be the case, the criticism is defunct from the outset.Hence, it follows that Steedman’s model is simply a misinterpretation of Marx, and it is not even necessary to go into the maths. There is, of course, a possibility that this is an overly superficial interpretation and I am mistaken.
The third criticism is that Marx’s treatment of use-value and exchange-value is inconsistent: properly applied, it implies that a commodity’s use-value can exceed its exchange value, and hence be a source of surplus value. Now, I remain unsure of this area so I might be wrong in my exposition, but here is my attempt to explain the Marxist response: (warning: the following paragraph will contain a vast overuse of the word ‘value’ in what is already a necessarily convoluted explanation).
Marxists contend that Keen’s is a misinterpretation of use-value, which is simply a binary concept and not quantifiable. Something may have any number of uses which give it a use-value, which is a necessary condition for it to have an exchange-value. However, the exchange-value cannot ‘exceed’ the use-value, because the use-value cannot be measured. It is in this sense that labour is unique in Marx’s conception of capitalism: its specific use-value is the production of surplus for capitalists. It is the only ‘factor of production’ that can do this – after all, capital ultimately reduces to past labour value. If production could take place without labour, prices would fall to zero and, while Marx would be refuted, nobody would care because the problem of economic scarcity would vanish. Hence, surplus production and profits depend on labour producing more than it is rewarded.
I remain neither convinced of the LTV, nor of its critics.*** For me, most discussion of the LTV appears to rest on the LTV as a premise. The debate is split into people who accept the LTV and people who not only reject it, but see no need for it. For this reason, critics seem to misrepresent and misinterpret it continually – a common theme is to try and abstract from historical circumstance, when it’s clear Marx emphasised that his analysis only applied under capitalism, which he saw as a particular social relation. For me, the main issue remains the same as it is for other theories: what is the falsification criteria for the LTV?
Overall, a couple of points stand out for post-Keynesians for their own theories, both of value and economic systems. The first is that DSGE models are probably not that different to some heterodox models, and identifying the actual differences is crucial to opening up a dialogue between mainstream and heterodox economists.
The second is that I would caution left-leaning economists not to be too hasty to dismiss Marxism as dogmatic (in my experience marxists are anything but), or avoid it simply out of fear of being dismissed themselves. In my opinion, the LTV – while not entirely convincing – is a cut above the neoclassical ‘utility’ conception of value, and I’d sooner be equipped with Marxist explanations of a crisis when trying to understand capitalism. This isn’t to say post-Keynesians haven’t thought about Marx; moreso that the issue is often approached with a degree of bias. At the very least, the distinction between use-value and exchange-value is something that befits post-Keynesian analysis well.
So, as far as theory goes, this is the last post on Keen’s book. I will, however, do some closing notes from a more general perspective. As I said before, if there are any other criticisms of Keen that I have not covered, feel free to discuss them in the comments.
*It is worth noting that in my previous post I was somewhat – thought not totally – off the mark with my discussion of Keen on demand curves. The Gorman conditions for the existence of a representative agent do indeed have many similarities to the SMD theorem and conceptually they are dealing with the same issue: aggregation of preferences. Nevertheless, Keen weaves between the two, when it would have been more accurate to note economists have used two (main) different methods to get around the problem, and critiqued them separately. Similarly, though Keen’s quote from MWG was incorrect, it is true that economists such as Samuelson have used the assumption of a dictator to aggregate preferences. However, the specific one Keen presented was not right.
**However, that does not make it the same as chaos theory.
***For me, claims that worker ownership of production would be desirable don’t really rest on the LTV; instead, the simple point is that workers could employ capital themselves.
Yes, yes, I know I’m far from the first person to use the pun in the title.
Chapter 17 of Steve Keen’s Debunking Economics is a rejection of the Marxist Labour Theory of Value (LTV), and with it the most generally accepted analytical form of Marxism. However, Keen does not reject Marx’s ideas outright, instead suggesting and praising an alternative interpretation: one shorn of the LTV, the tendency for the rate of profit to fall, and hence the inevitably of socialism.
Note that this is my first formal introduction to the LTV, so I can’t claim to know the subject in much depth.
The LTV suggests that labour is the only true source of value, as it is the only factor of production that can ‘add’ more than its cost. This can be demonstrated by the simple observation that workers produce more than workers receive in wages. Marx called what workers produced ‘labour power’ and what workers were paid ‘necessary labour time.’ The difference labour power and necessary labour time is the surplus, and the ratio of the surplus to the necessary labour time is the Surplus Value (SV). The rate of profit, on the other hand, was the surplus over the necessary labour plus other inputs (capital).
Because a similar distinction between ‘commodity power’ and ‘commodity’ could not be made for anything else, capital could not produce more than the value that went into it, but labour could. This meant that a higher ratio of machinery to labour would mean less SV for capitalists. Marx argued that over time, capitalists would replace labour with machinery (something they obviously like to do), so SV – and with it the rate of profit – would decline. This would lead to an attempt by capitalists to push down wages and eventually a socialist revolution.
Marx ran into some theoretical problems with this story. The most famous is the Transformation Problem. This arises because capitalists do not care about the rate of SV, but the rate of profit. Marx had already assumed that the SV was constant across industries. Following this logic, a more labour intensive industry would have a higher rate of profit than a more capital-intensive industry, and capitalists would continually move from more capital-intensive to more labour intensive industries in search of higher profits. This complicates the story behind the tendency for the rate of profit to fall.
Marx tried to solve this by arguing that capitalists do not secure only the SV accrued from their own industry, but that they are effectively stockholders in a joint enterprise that comprises the entire economy. Hence, SV and the rate of profit could both be constant between industries. He provided a numerical example to demonstrate that this was feasible: tables showing the various rates of profit, production and surplus, with the rates of profit and surplus uniform between industries. Marx’s example was mathematically correct – in that everything added up – but really it was nothing more than a snapshot of a particular point in time that may or may not have been reality.
At this point Keen channels Ian Steedman’s critique of Marx, which builds on Sraffa’s analysis in Commodities. Steedman starts with a Sraffian economy in which the various industries have to produce enough for the total inputs in the next period (i.e. enough to ‘reproduce’ the entire economy). He tries to convert the inputs and outputs into Marxian ‘values’ based on labour power and SV. From this, he derives output values and converts them into prices. However, he then runs into problems: what starts as an equilibrium destablises and rates of profit diverge, sometimes increasing.
So what happened? Steedman simply concluded that the entire idea of going values to prices was bunk – in his hypothetical economy, it was possible to calculate prices independently of any ‘theory of value,’ as did Sraffa. Sraffians believe that the ‘transformation problem’ is nonsensical and production should not be analysed from any perspective of utility or value, but from physical quantities and reproduction of industry. Note that this doesn’t necessarily imply that capital doesn’t exploit labour somehow; more so that Marx took a wrong turn in justifying this idea.
So it is hard to tell a consistent story that builds from labour value and ends up with a falling rate of profit and a uniform, economy-wide SV. Marx attempted to justify it with a special case snapshot, but Steedman showed there was no reason to expect the economy to be in or remain in this state, and no need to invoke ‘value’ in the analysis at all.
Furthermore, there is another significant problem with Marx’s theory of value in and of itself, one that he seemed to acknowledge elsewhere. The very premise that labour is the only source of value can be subjected to an incredibly simple, powerful critique.
Classical economists, including Marx, used to distinguish between two features of a commodity: the ‘exchange value‘ - what it sold for on the market – and the ‘use value‘ – how much it is worth to the buyer. Clearly, though, if this is true of commodities, then one can have a higher use value than exchange value, and hence can be a source of SV for a capitalist. This is a neat observation that can make Marxism a highly appealing analytical framework with which to analyse capitalism, one with the modification that socialism is not inevitable (even if it may be desirable on other grounds).
So, the LTV is quite hard to defend: Marx had to make some arbitrary assumptions that don’t seem to hold; his supposed equilibrium in which the rates of SV and profit would be constant turned out to be unstable; his premise contradicted his own distinction between use value and exchange value. Having said all this, Keen thinks that Marxism is stronger once it is rid of the LTV, and that Marx’s broader analysis of commodities and production is still a highly illuminating framework with which to analyse capitalism.