What Karl Marx Got Wrong About Value

“As a matter of economics, scarcity is the source of all value, even if it is a combination of ‘manufactured’ scarcity via monopoly control and relative scarcity due to the costliness of extraction and the preferences of consumers.”

Editor’s note: The following constitutes the first part of Jonathan Church’s two-part critique of “Karl Marx on Value” by Matt McManus and Conrad Bongard Hamilton.

In a July 2020 essay for Areo, Matt McManus and Conrad Bongard Hamilton set out to explain what Karl Marx had to say about “value.” Responding to “conservative pundits” who regularly dismiss Marx’s oeuvre by dismissing “some variant” of the labor theory of value that supposedly underlies it, they begin by stressing that the labor theory of value derives originally from Adam Smith and David Ricardo. Marx develops a theory of value in which labor plays a crucial role, but “simply claiming that labor is the source of value,” as Kevin D. Williamson does in his measured analysis of Marx’s work, “misses out the dialectical and historical dimensions of Marx’s argument.”

For readers unfamiliar with the jargon of Marxian economics, “dialectical and historical dimensions” refer to the systemic clash of contradictory elements within a set of historical circumstances. For example, the main dialectical and historical dimension of capitalism is the class struggle between capital and labor. Marx’s analysis of value arises from his attempt to illuminate what he takes to be contradictions that are inherent to the historically situated system he calls “capitalism.” Marx seeks to demonstrate how these contradictions are destined to collapse under their own weight, ushering in a new era of communal economy in which class struggle dissolves and the means of production pass over from private ownership into collective ownership.

One contradiction that gets it all started emerges from the dichotomy between use value and exchange value.

Use Value and Exchange Value

As McManus and Hamilton tell us, labor is exposed as the source of value only when “humankind had reached a high stage of development and the real basis of economic value had become explicit.” This stage of development is capitalism. Under capitalism, a separation occurs between use value and exchange value. Use value is the utility of a commodity. Exchange value is the money form—the price—that represents the value of a commodity when it is purchased in the market. As Marx scholar David Harvey explains, this separation leads to an inevitable contradiction.

For example, the use value of a home refers to the consumption of shelter, privacy, etc. The exchange value of a home refers to its purchase as an investment. The implication is that housing becomes a speculative asset rather than, or at least in addition to, a place to live. The result is a distortion of its value that exposes the unsustainable exploitation of value-creating labor that is inherent to capitalism.

The tension between exchange value (price) and use value (value) brings to light the confrontation (contradiction) between capital and labor. To see why, it is helpful to distinguish between the production of value and the realization of value. As David Harvey insists, value is “always created in the act of production.” The production of value, however, is not the same as the realization of value. The latter occurs through market exchange. “Value,” Harvey writes, “cannot be produced through market exchange. But it cannot be realized outside of market exchange.”

Just like that, Harvey unwittingly identifies exactly what is wrong with Marx’s conception of value. Marx (and Harvey) has it backwards. As a matter of economics, it is not production per se that creates value. Market exchange, or the lack thereof, determines whether an act of production will be valuable. This is true at all levels of the value chain—raw goods, intermediate goods, and final demand goods.

But more on this below. The contradiction that Harvey, like Marx, is keen to point out is that exchange value can distort the use value of commodities. Under capitalism, the price at which a commodity is exchanged is not equal to the use value it provides. Use value is “real” value, and only labor can create it. This is how classical economists thought about value. It is also how Marx thinks about value. Marx does, in fact, rely on a labor theory value. But for Marx, as Harvey explains, “[t]he essence of value is abstract labor or, as I prefer to refer to it, “socially necessary labour time,” which is “entirely different from the concrete labor time that Ricardo postulated.”

Harvey is unwittingly highlighting another thing Marx got wrong—in this case, Marx’s fictional idea about “socially necessary labor time” as some kind of “metaphysically existing substance.” But again, we will come to this. McManus and Hamilton continue with the idea that exchange value exposes the “ideology and fetishism” that had previously hidden the “real basis of economic value.” What is this “real basis of economic value”? To illustrate, consider water and diamonds. Human beings savor diamonds, mere pieces of hardened carbon (low use value), but treat water like it is not an essential ingredient to preservation of life (high use value). They do so because of, not in spite of, the high exchange value of diamonds. They are willing to pay so much for diamonds simply in order to impress other people. They value diamonds for the extravagance of conspicuous consumption.

This last part is not incorrect. But for Marx and the classical economists, it is not that diamonds are precious because they have aesthetic properties that hold sway over our imaginations. Instead, Adam Smith and David Ricardo believed that diamonds were relatively more valuable because it takes a lot more labor to dig out diamonds than it does to draw water from a lake. The high exchange value reflects the amount of labor necessary to dig out, cut, and polish the diamond. 

Marx refines the point by observing that skill and ability are not uniform among human beings, so it is “socially necessary labor time” that underlies this value, with “socially necessary labor time” being the time “required to produce an article under the normal conditions of production, and with the average degree of skill and intensity prevalent at the time.” In either case, it is only after labor has done its work that, as Harvey says, market exchange “realizes” the value that went into it all. It is as if consumers do not know how much they are willing to pay for a commodity until they learn how much labor went into producing it!

For a modern economist, this is exactly backwards. Consumers cherish diamonds (and other precious stones). This drives up the demand for diamonds. It is only then that potential suppliers “realize” that there is value in putting (human) capital to work to dig out, cut, and polish the diamonds to satisfy consumer demand. This is only a general principle, and every industry will have its own complications. In the case of diamonds, a strong dose of monopoly power, as anyone familiar with the history of De Beers in South Africa knows, yields pricing power and underproduction on the supply side (along with a costly, but successful, “diamond is forever” marketing campaign to further convince consumers of the desirable properties of diamonds). 

The marginal costs of production (labor, capital, and technology) will certainly influence the price and supply of diamonds, as well as profits received by De Beers, but they are not the underlying determinant of value. It is scarcity—of diamonds, of labor, of other means of production—that determines the price and marginal cost of producing a diamond. As a matter of economics, scarcity is the source of all value, even if it is a combination of “manufactured” scarcity via monopoly control and relative scarcity due to the costliness of extraction and the preferences of consumers.

But I keep getting ahead of myself.

Marx’s Labor Theory of Value

If we stick to Marx’s story, the final link in the chain of “dialectical” analysis, as McManus and Hamilton inform us, is to recognize that labor does not come to light as a “transhistorical basis of value” as Smith and Ricardo envisaged but, rather, as a historically-evolved institution that comes into being during the era of capitalism in which “workers have been assimilated into the same context—when they possess approximately equivalent skill sets and productive implements, and are exchanging goods on a market which is structurally and temporally connected.” 

In other words, it is only in a world of “capitalism” that it becomes possible for labor to be bought and sold as a commodity in a national or transnational market. Only then does it become the primary source of value in the “property-owing societ[ies]” of capitalism. In “pre-capitalist societies,” McManus and Hamilton write, “the de facto equivocation between labor-time and value within them always remained localized and obscured” because these societies “lacked the means to comprehensively unify diverse labor markets.” The commodification of labor exposes the reality that labor, or “socially necessary labor time,” has been the fundamental source of value all along. As McManus and Hamilton write, “it is capitalism that makes it possible to recognize labor as the source of value.” It just was not obvious, or even actual, until its commodification under capitalism exposed the latent contradiction between exchange value and use value.

This “process of unifying markets continues today,” with “territories like China and Mexico opened up to US investment,” supplying “a cheaper labor force” that causes “the extensive loss of manufacturing jobs in the US.” According to McManus and Hamilton, “the specific importance of capitalism here is that it was the first economic system to achieve the broad equalization of labor inputs as well as the temporal units that measure them and the first capable of acutely perceiving the relationship of labor-time to value.” It is not initially clear what is meant by the “broad equalization of labor inputs” or “the temporal units that measure them,” unless we fall back on the Marxian theory of value as socially necessary labor time—i.e. “the relationship of labor-time to value.” 

As McManus and Hamilton explain, Smith was incorrect to believe that “labor-time and value are most obviously associated at the beginning of civilization, when other factors of production, such as land and capital, had not entered the equation.” This view implies that “non-labor inputs—including, crucially, technology—are capable of creating value. For Marx, by contrast, value appears in Capital (and in capitalism) as congealed labor.” This is indeed what Marx said, but Marx was wrong. Modern economics has moved on from the view that labor alone creates value, except under very restrictive conditions (homogeneous inputs and constant returns to scale).

Not according to Marxists though. According to McManus and Hamilton, “the frequent accusation that Marx’s theory of value as socially necessary labor is out of step with our era,” given how “automation and computation have played a decisive role in the creation of profit,” overlooks Marx’s more “subtle” argument that technology is a condition of the creation of value. It is not itself responsible for the creation of value. 

Echoing Marx, they claim that technology cannot create value because it is itself already congealed labor. Moreover, “[i]f McDonald’s and Burger King have access to the same basic technologies, neither of them can hope to make more than its competitor by using them.” This is not true for labor because “[e]ven if labor is equally available to all the capitalists in a given field, the nature of its deployment within capitalism requires that it be undervalued—that, in other words, workers receive less value than they create.”

Marx’s Concept of Surplus Value

McManus and Hamilton are making a not-so-subtle reference to a specific notion of “surplus value” that is central in Marxian economics. The creation of “surplus value” in the Marxist worldview is a direct reference to the so-called “valorization of capital” that stems from the backwards view that value is created in production and realized in exchange. In Marx’s general law of capital accumulation, which can be stated in strong or weak form (the strong form says that real wages are stagnant under capitalism, which conflicts with historical evidence even in the time Marx was writing; the weak form says that the share of national income allocated to labor decreases over time), capital perpetually accumulates through extraction of absolute and relative surplus value. 

Let us begin with absolute surplus value. There are two variables at work: (1) the length of the working day and (2) the “socially necessary labor time” it takes to produce a commodity that is useful in the worker’s quest to live a normal life. Under capitalism, the length of the working day is never equal to the “socially necessary labor time” that a worker must work to produce the requisite use value. Because the capitalist owns the means of production, he can dictate the length of the working day and the wage he pays. If the worker is only put to work for a number of hours equal to “socially necessary labor time,” he produces enough of the commodity (use value) to live his normal life. Capital pays the worker to initiate a process of production with a certain amount of money. The worker produces only an amount of product equal in value to the wage he is paid. The worker then buys these commodities to live a normal life by consuming the use values he produced. The capitalist has received exactly what he put in, pound for pound. No capital accumulates. 

What the capitalist needs is a pound of flesh from the worker. That is, if capital is to accumulate, the worker must live to work, not work to live. He must work more hours in a day than the “socially necessary labor time” sufficient to produce the use value that helps him live a normal life. The total length of the working day must be greater than “socially necessary labor time.” It is only then that the capitalist, by virtue of owning the means of production, can take possession of the commodities and sell them, obtaining not only enough money to pay the worker a wage equal to the value of “socially necessary labor time” but an amount above the wage that he can keep for himself. He has accumulated capital (a portion of which he consumes for his own subsistence and a portion of which he throws back into the process of capital accumulation). 

In principle, the capitalist is indelibly motivated, by virtue of his place within the system of capitalism, to work the worker to the bone, allowing only enough leisure time to keep the worker from burning out entirely. Like a vampire, the capitalist is compelled to suck the blood from his pound of flesh (as he says in chapter 10 of Volume 1 of Capital, “[c]apital is dead labor which, vampire-like, lives only by sucking living labor, and lives the more, the more labor it sucks”). 

This dynamic then gives rise to another latent contradiction within capitalism: how to stimulate demand for these products if workers are only being paid enough to buy the use values they produce and not the surplus values they also produce. As Harvey explains in a reply to his essay on “Marx’s refusal of the labor theory of value,” “value is produced but then the value is lost if there is no demand for it in the market.” This “devaluation” arising from under-consumption is one of several forms of potential crises that arise within capitalism (though this theory is not unique to Marx). This certainly makes sense if you buy into the Marxian worldview. But as economist Gary North wrote half a century ago, “what [Marx] regarded as a basic set of contradictions of capitalism was merely a set of contradictions in the reasoning of the classical economists.” 

One is the fallacy of intrinsic value—the “metaphysical” idea that “congealed labor time” formed in production is the source of value. But another is the perplexing insinuation that “capitalists” are so robotically caught up in the system of “capitalism” that they never learn to adapt to the inherently systemic threat to capital accumulation—by, say, raising wages, lowering prices, or developing techniques more effectively to anticipate the fluctuations of consumer demand. It is true that forecasting demand, or any economic variable, is no easy task, and there is plenty to say about the plausibility of “rational expectations” as an explanatory model, but the idea that firms are automatons unable to escape their “cog in the machine” role of extracting surplus value by exploiting labor is almost comical. But alas, that is how Marxists would have us see the matter.

Consider a related form of potential crisis as posited by Marxists—the “profit-squeeze” crisis we apparently observed in the 1970s not because of the oil crisis and stagflation but because labor was in a strong position relative to capitalists, galvanizing the “neoliberal” forces behind capitalism (so the conspiratorial thinking goes) to mobilize in their desperation to stave off the threat to profit posed by labor unions, social democratic parties in Europe, and government regulations aimed at protecting the environment and public safety. President Ronald Reagan and Prime Minister Margaret Thatcher came along and made the world safe for capital again, but the 1970s gave us a taste of the profit-squeeze crisis ever latent within the class struggle between capital and labor endemic to capitalism.

This “profit-squeeze” crisis formation only makes sense, however, if we accept Marx’s ideas about surplus value and underconsumption. To illustrate, consider a regulatory cap on the number of hours a worker can work during a day, a piece of legislation that strong labor unions and social democratic parties would presumably be willing and able to enact. In Marx’s day, this same problem arose for capitalists when parliamentary legislation limited the length of the working day to ten hours. This also capped the amount of absolute surplus value the capitalist could extract from the worker. If six hours constitutes the socially necessary labor time necessary to spin enough cotton or bake enough loaves of bread to allow the worker to live his normal life (and the law limits the working day to ten hours), the capitalist bakery owner can only extract four hours of surplus labor time (hours of labor in excess of socially necessary labor time) from his employees.

One “solution” to this problem is relative surplus value. If the capitalist cannot extend the length of the working day, he can enter the race to obtain the most efficient technologies that reduce the amount of socially necessary labor time to bake bread or spin cotton. If he can reduce this time from six to three hours in a day, he can extract seven hours of surplus labor time rather than four. Absolute surplus value arises from the absolute difference between total working time and socially necessary labor time. But if the length of the working day is restricted, the capitalist cannot extend the working day to increase surplus labor time (i.e. surplus value). Instead, the capitalist needs to intensify the labor process so that the worker’s socially necessary labor time decreases while still working the full length of the working day allowed by legislation. In effect, the capitalist is able to increase relative surplus value by increasing the ratio of surplus labor time to socially necessary labor time.

Labor is the only input for which this is true. All other means of production—technology, raw materials, etc.—are the products of previous labor. As “congealed labor,” they embody the prior production of absolute and relative surplus value, or “valorization” of previously employed capital. Everything in production begins and ends with labor (or “labor power”). It is labor that underlies the M – C – M’ process of perpetual capital accumulation that defines the essence of capitalism.

We can thus see, as McManus and Hamilton write, that the function of technology (and other means of production) “is not to create value, but to enable the exploitation of labor that is the real basis of value creation.” The intensification of the labor process reduces socially necessary labor time, which lowers the wage and increases the surplus value that accumulates to the capitalist.

The Transformation Problem

We now arrive at the infamous transformation problem. McManus and Hamilton reiterate Marx’s argument that capitalists are subject to the coercive laws of competition. In the short run, machines (technology) can seem to generate (relative surplus) value by “generating profits beyond the industry standard.” This is because the first capitalist to use a new technology gets a first-mover advantage: Before other capitalists have followed suit, the first mover capitalist produces more efficiently and cheaply than his competitors, generating more (relative surplus) value than his competitors. He can employ technology to reduce the socially necessary labor time from three to two hours while keeping his workers on the clock for ten hours. Meanwhile, other capitalists keep their workers on the clock for ten hours but employ technology that fixes socially necessary labor time at three hours. The first mover can pay a lower wage and extract more surplus value.

In the long run, the first-mover advantage dissipates. Everyone else copies the first mover. But Marx, according to McManus and Hamilton, is “acknowledging that—in cases where technological breakthroughs have not yet become widespread—firms can ‘valorise’” the increase in productivity of labor “beyond normal market levels,” thus admitting “that profits can be affected by the implementation of extraordinary technologies.” But extra profits do not mean that technology creates value. As stated, technology is only a condition of the (additional) creation of (relative surplus) value. Technology does not give rise to value per se. It facilitates more efficient exploitation.

Houston, we have a “transformation problem.” If prices and thus profits vary greatly as a result of the deployment of other “uncommonly productive” factors of production, despite value being based on the common denominator of labor, how does Marx square the imperfect transformation of value into price with his proposition that an average rate of profit prevails across industries (which is incorrect anyway)? If labor is the common denominator of value and profits are supposed to equalize across industries, then how is it that price (and profit) can diverge from value? 

McManus and Hamilton acknowledge the threat this problem poses to the “coherence of [Marx’s] labor theory of value.” Marx’s solution? He separates value and price. Observing that “many companies are not labor-intensive” and that firms “cannot all be kept afloat by novel, non-labor inputs,” McManus and Hamilton ask: How can capital-intensive firms “compete for investment with firms in more labor-intensive fields”? How can they attract investment if they are not sufficiently exploiting workers to drive the (M – C – M’) capital accumulation cycle? As they ask quizzically, “How can a military contractor compete with a family diner if labor is the basis of value?” 

The answer is a military contractor does not compete with a family diner because a consumer looking to eat at a diner does not compare menu prices at the local diner to the prices of military jets. This basic principle of market definition is familiar to any antitrust economist or anyone who has read the Department of Justice’s Horizontal Merger Guidelines. Strictly speaking, of course, Marx is talking about the competition for investment and not consumers, but investors and consumers are not so easily divorced. What matters for investors is risk-adjusted return, itself a complicated matter of weighing the costs and benefits of different kinds of investments based on the differing objectives of different kinds of investors. In the end, however, a company needs to generate cash flow. The ability to do so depends on the viability of the particular business, which itself depends on whether consumers want to buy what the company wants to sell.

It is too much here to launch into an analysis of sector-by-sector competitive dynamics (and if someone wants to bring up Marx’s critique of Say’s Law, we should note that the analysis of supply and demand, or even the efficient markets hypothesis, is not simply about static equilibrium, as Joseph Schumpeter would recognize with his concept of “creative destruction”). Suffice to say it is quite a stretch to believe that Lockheed Martin is worried about the menu prices or service quality of its local diner, unless its employees are deciding between the local diner and the local sandwich shop for lunch (in which case Lockheed Martin is a consumer, not a competitor). 

In Marx’s world, however, all firms compete for surplus value. Or as McManus and Hamilton clarify, they end up conspiring “to equalize the rate of profit across diverse sectors” in what amounts to a form of “capitalist” communism. That is, firms in labor-intensive sectors of the economy sell their goods at prices below their value (as if they found it in their hearts) to help firms in capital-intensive sectors of the economy sell their goods at prices above their value. Labor-intensive firms effectively subsidize capital-intensive firms by letting these “companies fettered by extensive non-labor investments to suck up the surplus value they’ve created.” The transformation problem is resolved by observing that the coercive laws of competition lead to communism!

We thus arrive at another fork in the road of Marxian analysis at which Marx takes an irredeemably wrong turn. Over a century ago, Eugen von Böhm-Bawerk provided us with a cogent critique of the contradictions that the transformation problem lays bare in Marx’s critique of capitalism. The transformation problem would be swept away if we simply did away with what is, in fact, a labor theory of value laying the groundwork for Marx’s value form (not to mention Marx’s theory of exploitation and other aspects of Marxian economics). But alas, we are not there yet.

Jonathan David Church is an economist and writer. He is a graduate of the University of Pennsylvania and Cornell University, and he has contributed to a variety of publications, including Quillette and Areo Magazine.