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On The Labor Theory of Value

December 2nd, 2008

A while back I read parts of Kevin Caron’s Studies in Mutualist Political Economy. A while back. I was particularly interested in his commentary on the labor theory of value.

[T]he labor theory of value is based, not on an inductive generalization from the observed movement of prices, but on an a priori assumption about why price approximates cost, except to the extent to which some natural or artificial scarcity causes deviations from this relationship.

Like Carson, I believe there is a case to be made for an a priori assumption about why price approximates cost, but the conclusion I reach is quite different. The “natural” scarcity is embodied in the supply/demand diagram. Prices will approximate costs (in a free market), all else being equal, because competition makes it so. FSK explains this pretty clearly in The Free Market Labor Arbitrage Process

If labor is underpaid (relative to its fair value), then workers will form competing businesses, arbitraging away the difference.

If labor is overpaid (relative to its fair value), then new workers will enter the industry, again arbitraging away the difference.

In a free market, the costs do not determine the prices, but rather the expectations of prices determine which costs will (or will not) be incurred. To the extent that the entrepreneur is in error, costs will exceed prices. Of course, the costs of production in a free market approach or equal the opportunity cost for the respective productive resources, which are also intimately and inextricably linked to the perceived value to be thereby provided.

Is it true that price (i.e., value of the final good) approximates cost of production? In the long run, yes this is true. But a theory of value needs to speak to more than just long-run trends, does it not? Ultimately, value is determined subjectively and with some uncertainty; it is not determined by the costs of production. Rather, the costs of production are determined by the anticipated value of the output.

I cannot resist the temptation to bring up the ditch-diggers or make-work programs. These things are costly; expensive. But as Bastiat noted over a century ago, they are not valuable. Lest I be accused of setting up straw men, these examples are only fallacious in the sense that such unproductive dispositions of labor and resources are unlikely to occur, and even less likely to persist, in a truly free market. But the fact remains: it doesn’t matter how hard or how long a man works towards a project which others do not value.

One objection might be that the labor costs are determined by labor’s opportunity costs, and so in a free market the labor-theory still holds. But the opportunity costs are also appraisals of the potential future values of whatever else may be produced by labor, and these values are no more certain than the anticipated value of what labor in-fact chooses to produce. No matter which course of action taken by labor, unless the final product is subjectively deemed “valuable” on the market, it’s price will not be sufficient to cover the perceived disutility or discomfort of labor “costs” incurred during its production.

We know or assume to know what value will be produced by a certain amount of labor, and this knowledge guides economic actors in their determination of the prices to be paid for such productive resources. So what we can conclude is that value is the independent variable in the equation, by which final prices are ultimately determined.

Carson continues,

Or to approach it from the opposite direction, we can start with the law of cost as the basis of price, and from there systematically eliminate all the subordinate factors that only have a price because of artificial scarcity, leaving only labor as a creator of exchange-value in its own right (at least for the equilibrium prices of goods in elastic supply).

Although price and cost should tend towards convergence in a truly free market, the important distinction, though, is that labor simply doesn’t “create” or imbue a product with “value”.

Demand, utility, desire, the ability to fulfill needs or satisfy discomfort, these abstract notions are what acting man finds valuable. However true it is that labor is the ultimate “creator of exchange-value in its own right,” but although labor certainly assists in the creation of all things valuable, value (at the terminus) is not determined by the past labor embodied during the production process.

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For further reading on the topic, I suggest Bob Murphy’s The Labor Theory of Value: A Critique of Carson’s Studies in Mutualist Political Economy. Murphy restates “the case for the superiority of the marginal, subjective theory versus the labor (or more generally, cost) theory of value” Murphy concludes that “everything true of the cost (labor) theory can be incorporated in the subjective theory of value”.

Comments

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  • Jeremy says on: December 2, 2008 at 1:08 pm

     

    If you’re talking about spot prices, then yes, you’re right – the subjectivist approach is more useful than the labor theory.

    But as Carson argued in MPE, it was never the purpose of the LTV to argue that spot prices are determined by the amount of labor that went into a product. The LTV serves its purpose best over the long run, where spot price fluctations – both in terms of input costs and the asking price of the output product – are smoothed out. Over the long run, most prices for most inputs are relatively stable. There is one input, however, whose price can be changed based on the application of force: labor. Steel or carrots or assembly robots cannot be persuaded to make themselves less expensive. Labor can, usually through fraud or force.

    It is my opinion that the LTV is not designed to explain spot prices and that most honest purveyors of the LTV admit the STV excels in this regard. The purpose of the LTV is to provide an economic corollary to the cause of human justice. Because it is labor that is the crucial factor in the long term setting of prices – including the extraction of surplus value, i.e. “profit”, we can find a narrative about the struggle for human justice and equality in the “dismal science”.

  • anarcho-mercantilist says on: December 2, 2008 at 4:59 pm

     

    While I support the labor theory of value as an accurate explanation of prices in a static economy, find it contradictory to support both self-employment and the labor theory of value at the same time. Self-employment will only be profitable when the agency costs or risks exceed the economies of scale.

    In more technological or creative industries, the agency costs of employing workers are very high, because it’s hard for employers to determine the compensation for the workers. In creative jobs, such as software development, web design, composition, engineering, and the arts, managers would find it hard to set the salaries for the workers, due to too many variables, so the individuals working in these sectors would more likely to work be self-employed instead of working as an employee for others, due to agency costs.

    Also, in more creative areas, the worker’s ability vary greatly. For instance, the top 10% of the best computer programmers are 100 times more productive than the average programmer. Therefore, all of the computer programmers would find self-employment better than working for an employer. A fortiori, the “labor theory of value” does not fit in more creative jobs.

    However, in our current technological trend, the agency costs and risks becomes larger, due to the overhead costs of compensating workers. An employer does not have the ability to judge one’s creative works or methods, thus does not have the ability to find good salary rates for the workers.

    In labor-intensive industries, however, the agency costs are smaller. Due to the low agency costs in these sectors, the economies of scale are more important. Therefore, sectors involving intensive labor would have larger and more hierarchical firms.

    The physical ability of the workers in labor-intensive industries do not vary much, so it’s easy for managers to estimate an hourly wage. However, in more creative jobs, it’s hard to estimate an hourly wage because it’s possible, unlike physical strength, for workers to have huge mental differences. This is why in some of the “service sectors,” employers would offer “salary compensation” instead of constant wage-rates. But in even more creative jobs, employers would not have the ability to estimate the salaries, since there are too many variables and greater risk.

    Sharing profits are less likely in more creative sectors, since individuals have different abilities. This is another reason of why the economies of scale will not influence the creative sector as much.

    Knowledge is abundant. So individuals would specialize in knowledge. It is therefore impossible for employers to know all of the knowledge including his employees, and this raises the principal-agency costs.

    In the knowledge economy, information, such as software, is available for re-use, so workers do not have to laboriously retype all of his code. This encourages creativity instead of labor. The availability to re-use information would make individuals focus on creating more specialized information. This increased specialization of knowledge will make it even more harder for employers to accurate compensate his workers, since he lacks knowledge which has similar effects of asymmetrical information.

    Also, because labor intensive industries are not creative, the workers would not find any reason to complain “I know how to do this better than my boss.” (At least compared to the more creative sectors.) Contrarily, in the more creative jobs, the workers would always complain to their boss if they work for an employer. For example, since there are many different ways to how to write a computer program or design something, the workers would dispute against their employers, so they would rather work in self-employment to avoid these disputes.

    Additionally, creativity involves risk. Suppose I want to invest a portion of my wealth in labor intensive industries involving capital goods. The risk is very small, since labor intensive industries produce a constant rate of return. However, if I invest the same amount of wealth to develop an invention, this would be very risky, because the invention might not develop. Therefore, in more creative jobs, people would find it very risky for an entrepreneur to borrow money in order to invest in an invention (since the invention might not develop). Thus, the time-preference distinctions are less important. The distinction between the capital-holders (having long time-preferences) and workers in the creative sector will diminish. Thus, there is an increasing trend towards self-employment in more creative jobs, due to risk.

    Due to the inelastic demand for creative works compared to labor-intensive capital industries, this increases the risk of creative jobs, thus may cause a moral hazard if creative workers work for an employer.

    A third reason of why economies of scale are ineffective in creative sectors is because, unlike getting a constant and secure profit from the return on capital from labor-intensive industries; in more creative sectors, capital is very insignificant in determining the successfulness because creativity marginalizes it.

    In the increasing competitiveness of creativity, workers will be more motivated to innovate under self-employment rather than innovate under employment for others. This is because the agency and overhead costs of estimating compensation for creative inventions are very subjective; self-employed workers will have the opportunity to reap all of the profits of their invention instead of sharing his profit with his employer; and inventing under self-employment would make workers have a greater incentive to keep a trade secret, instead of disclosing it to his employer. In this way, in the creative sector, self-employment would outcompete employment.

    In the creative sector, workers are all entrepreneurs. Inventors, artists, graphic designers, software developers, and composers, are all taking high risks, since creativity does not depend on labor. Working a hundred times longer or even a thousand times longer in the creative sector, unlike working in non-creative laborious jobs, does not guarantee more profit than working for one hour.

    Thus, while I do not find supporting either the labor theory of value or self-employment as contradictory, I find that supporting both of these positions as contradictory. Only primitivists would advocate both self-employment and the labor theory of value at the same time. (That is, it is impossible to advocate both the labor theory of value (that is implicitly advocating labor-intensive employment) *and* self-employment at the same time, unless you want to go back to the stone age where there are no economies of scale or division of labor.) Mutualists do not appear to even understand the marginal utility theory.

    I find the increasing trend of self-employment as a positive thing, as it signifies increasing technological development and more creative, less tedious, jobs.

    There is also a decreasing trend of the amount of labor that determines the value, as creativity does not depend on labor. So in the age of technological development and the emerging knowledge economy, the labor theory value as a sound explanation of the economy will be obsolete.

  • Toban says on: December 2, 2008 at 7:46 pm

     

    Great post. The labor theory of value is such a basic economic fallacy, but so many people intuitively believe it. So long as it keeps coming back to life, we’ll need to keep explaining subjective value theory.

  • David Z says on: December 2, 2008 at 8:01 pm

     

    Toban – thx.

    Anarcho-mercantilist – I haven’t had time to wade through your comments yet, but they’re always good. I think that, especially for longer comments, you might be well-served by responding with a blog-post of your own. (not to dissuade you from commenting here, of course!)

  • anarcho-mercantilist says on: December 2, 2008 at 9:35 pm

     

    I think I’m wasting my time posting here anyways, so I won’t criticise the economic ignorant mutualists anymore. My criticisms of mutualism are “intellectual masturbation.”

  • Jeremy says on: December 3, 2008 at 1:47 pm

     

    Maybe it’s over my head, AM, but I don’t get your argument that it is contradictory to hold both the LTV and “support” self-employment. Perhaps I misunderstand your use of the word “support”. Do you mean that mutualists advocate universal self-employment (one extreme) or that they simply suggest that a free market would feature more self-employment (the other extreme) or something in between?

    Remember my point above: nobody ever said that the LTV determines spot prices. Rather, the theory determines what Carson calls “equilibrium price” over the long run, where spot fluctuations in prices / costs are minimized. How this affects the way people organize economically is really impossible to say with any certainty. I think a mutualist (and any good anarchist) has to be agnostic on the predictive assertion that one form of employment is better than another in a hypothetical free market.

    So I don’t dismiss out of hand your assertion that self-employment is incompatible with truly advocating the LTV. But I don’t understand it: whether compensation for labor is paid by an employer as wages or by a customer as the price of the product / service, the market is determining what the worker takes home for his labor over the long run. That mutualists “support” self-employment does not mean “at all costs”. We’re for market-discovered wages, not one particular source of wages or another. Nobody advocates for self-employment per se (except maybe for philosophical or personal reasons – I can certainly see people valuing independence more greatly than others). What I’ve seen from most mutualists is a prediction that self employment would be more prevalent as the privileges that entrench centralization of business are done away with. And as economies become more regional / local, firms shrink in size so that the real difference between working for a firm and for oneself become less noticeable.

    But remember: for mutualists who advocate the LTV, the point is letting a genuinely free market find the price for labor – whether it’s productive or that of a coordinating agent. Carson never says self-employment will become universal, just that there is an artificial deficit of it.

    As somebody who has been self-employed, let me close by saying it’s not all joy and happiness. :)

  • Jeremy says on: December 3, 2008 at 1:59 pm

     

    AM, I think your comments are sound, I just think you’re critiquing a position that mutualists do not hold. Keep in mind that there is a difference between prescription and prediction.

  • Mike Gogulski says on: December 4, 2008 at 1:30 pm

     

    It is my opinion that the LTV is not designed to explain spot prices and that most honest purveyors of the LTV admit the STV excels in this regard. The purpose of the LTV is to provide an economic corollary to the cause of human justice. Because it is labor that is the crucial factor in the long term setting of prices – including the extraction of surplus value, i.e. “profit”, we can find a narrative about the struggle for human justice and equality in the “dismal science”.

    Quibble or not (and I certainly quibble with LTV-based value judgements), this is eminently quotable. Nice one, Jeremy. I learned something anyway.

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