The Failed Attempt to Rescue Marx’s Labor Theory of Value

“Without the notion of socially necessary labor time, nothing in Marx’s value form or overall theory of exploitation makes sense.”

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

We briefly return to Marx’s particular notion of surplus value. For Marx, surplus value results when the length of the working day exceeds the socially necessary labor time required to produce a use value. It is then that the revenue obtained from selling the output of a working day exceeds the wages paid to the worker. This is the essential point: By virtue of his control of the means of production, a capitalist can decide to pay a worker a wage equal to the value of socially necessary labor time while keeping the wheels of production (i.e., capital accumulation) churning for the entire day. Meanwhile, the capitalist receives the full exchange value (revenue) at which he sells the output of a working day.

If we accept this story, then all that follows in Marx’s analysis makes sense. This is why “conservative pundits” (and many others) say that Marxian economics relies crucially on the labor theory of value. Without the notion of socially necessary labor time, nothing in Marx’s value form or overall theory of exploitation makes sense. Without it, we do not have the concepts of absolute and relative surplus value, and, without these two notions, the dichotomy between exchange value and use value says little—if anything—about the distortion of value or the nature of exploitation.

So, what is the alternative? McManus and Hamilton hint at it when they write that “[m]ainstream economics has, since Marx’s death, accordingly turned its back on [Marx’s] thought, preferring to see value as arising from the subjective desires of consumers (as with marginal-utility economics).” They are headed in the right direction but, unfortunately, still fall wide of the mark because they are straining to rescue the notion that labor is fundamental to value. 

They immediately go astray by explaining what they take to be one of the more promising attempts to overcome the transformation problem—namely, to “update the labor theory of value.” They run through the standard story of offshoring jobs as a way of lowering labor costs by relying on cheap foreign workers. They assert, for example, that “Chinese workers are often not truly employed (contra common wisdom) to replace American workers—they’re hired to prevent companies from having to remain in the United States and automate their workforce.”

This is a curiously blanket statement for which they do not provide evidence—an important point because, in fact, American manufacturing has greatly expanded its use of automation and information technology, leading to increased productivity which is associated with job losses. Researchers at Ball State University estimate that “[a]lmost 88 percent of job losses in manufacturing in recent years can be attributable to productivity growth, and the long-term changes to manufacturing employment are mostly linked to the productivity of American factories.”

Leaving that aside, McManus and Hamilton ask an interesting question: “Why, then, lower labor costs by employing foreign labor when you could do it by automating?” Their answer is disappointing but also illuminating, as it allows us to see what exactly Marx got wrong about labor as the source of value. “Some jobs,” they write, “may be resistant to automation on account of their complexity.” In other cases, however, it could simply “be more lucrative to hire cheap workers than to automate,” even “when the costs of hiring cheap labor exceed those of automation.” 

There are a couple of problems with this. 

One, the framing makes automation out to be only a substitute for labor. But automation can also be a complement to labor (Marx seems to agree when talking about technology as enhancing productivity and increasing relative surplus value.) For example, as Massachusetts Institute of Technology economist David Autor points out, research has shown that the rise of ATMs in the 1970s did not lead to a dramatic fall in the employment of bank tellers. Although the number of tellers per branch declined, the number of branches rose more than 40% (in part as a result of deregulation). This was associated with a modest increase in the overall employment of tellers. Information technology enhanced the capabilities of tellers, who were able to forge better relationships with customers by offering a variety of services such as credit cards, loans, and investment products. More recently, a report by the World Economic Forum finds, “[b]y 2025, 85 million jobs may be displaced by a shift in the division of labor between humans and machines, while 97 million new roles may emerge that are more adapted to the new division of labor between humans, machines, and algorithms.”

Two, even if some jobs are resistant to automation because of their complexity, automation has still been happening in the United States on a large scale. Importantly, this does not necessarily lead to job displacement, nor does it necessarily lead to employment or wage gains. As Autor explains, the employment effects depend on whether a technological advance is a substitute for labor or a complement to labor (if a complement, labor becomes more productive and its demand increases), the elasticity of labor supply (if the labor that technology complements is abundant, wage gains may not be significant), and the elasticity of demand. In the case of demand elasticity, we can recall that the emergence of the automobile in the early part of the 20th century wiped out horse-drawn carriages as a mode of transport but, at the same time, led to the emergence of a slew of new industries, such as roadside motels, diners, cleaning services, and other “technologically lagging” industries serving a new “motoring public.” 

Three, we can all agree with Marx in the “common sense” observation that technological transitions often come with significant disruptions to lives and livelihoods. In more recent times, research by Autor and colleagues shows that “[a]djustment in local labor markets is remarkably slow, with wages and labor-force participation rates remaining depressed and unemployment rates remaining elevated for at least a full decade after the China trade shock commences.”

Finally, and most importantly for our purposes, these points not only complicate the interplay between automation and offshoring jobs to China; they also allow us to observe that it is not the case that “capitalism” exposes labor as the source of value. Rather, modern economics is able to expose these complications because it has improved our understanding of how value is created. 

A Better Way to Think about Value

McManus and Hamilton almost seem to be illustrating the marginalist understanding of value—so central to the advances of modern economics—when they write “if automation is an economic deadweight, it may be preferable to expend more on labor so that goods can be brought to market at a price that doesn’t need to be upwardly adjusted to compensate for it.” But in writing that “if automation is an economic deadweight, it may be preferable to expend more on labor so that goods can be brought to market at a price that doesn’t need to be upwardly adjusted to compensate for it,” they unfortunately reinforce the Marxian view that labor-time is the ultimate source of value. In other words, they are arguing that “it could be more lucrative to hire cheap workers than to automate” because “labor-time is the basis of value, and value is the (fluctuating) basis of price.” 

I had a hard time following their reasoning here, but I interpret them to be saying that hiring cheap labor allows firms to avoid the presumably large expenditures involved in automation. This allows capitalists to sell products at a lower price, which would otherwise have to be adjusted upward to compensate for the increased costs associated with automation (though beware the sunk cost fallacy). Somehow, this is supposed to mean that labor is the source of value and that cheap labor allows capitalists to bring price and value into closer alignment. 

It seems we are to accept labor as the source of value by observing that it could “be more lucrative to hire cheap workers than to automate” even “when the costs of hiring cheap labor exceed those of automation.” I thought about this last point a lot because, (1) as mentioned above, automation has already been happening on a large scale; (2) the higher costs of Chinese labor relative to American automation may be offset by the lower costs of exporting “heavy goods” to Asian destinations directly from China rather than from as far away as America; and (3), on its face, it simply does not make sense unless firms do not have sufficient information to assess the full costs of automation, which include not just the explicit costs but the implicit costs otherwise known as opportunity costs. But if that is the case, the firms will not remain viable enterprises in the long run. Many businesses have been vanquished by their inability adequately to evaluate opportunity costs.

It is this notion of opportunity cost that allows us to discover a much cleaner and more accurate explanation of value creation. It is simply not the case that, as McManus and Hamilton write, “capitalists attempt to liberate themselves from labor, but must endlessly double back to it,” in the sense that capital accumulation must always fall back on “surplus value” to keep the capital accumulation machine churning. 

So, where does value come from? McManus and Hamilton gave us a passing glimpse when referring to “the subjective desires of consumers (as with marginal-utility economics).” This is only half right because we must also account for the supply side of the economy. The examination of value creation is not simply about the analysis of marginal utility but also about marginal cost. In both cases, these explicit costs depend crucially on implicit, or opportunity, costs. 

We will address the consumer (demand) side below, but let us begin with the production (supply) side, since that is where value originates in the Marxian world. One way to address the point is to adopt Marxian term “surplus value” but to explain it using the insights of modern economics. Consider a supply curve. Typically, it is upward sloping, meaning that higher prices attract greater supply of a resource, whether it be labor, capital, or the final product sold by firms to consumers. How is this supply curve determined? Why is it typically upward sloping? The answer is simple enough: All else equal, a supplier is more motivated to supply a product at a higher price. 

But how is each “inframarginal” point (i.e., every point except the point at which the supply curve intersects with the demand curve) on a supply curve determined? It represents a point of indifference between supply and not supplying. It is, in economic-speak, a “reservation price.” 

For a worker, a reservation wage is a wage at which a person may decide to work in a particular job rather than do something else (i.e., look for a better job, drop out of the labor force, retire, or take an extended vacation). The person decides for himself what this reservation wage is based on several factors, such as wealth or family support (i.e., affordability of leisure), or available opportunities elsewhere and the search costs associated with finding them. In other words, the reservation wage is an opportunity cost. If he chooses to work and receive that wage, he foregoes leisure or working somewhere else. Now the crucial question: If he decides to work, does he create value? 

To answer, we need to have in hand the market clearing wage. This is the wage at which demand equals supply, so already we see that we need a demand curve (“the subjective desires of consumers” or, in this case, firms that desire labor for production) to complete any analysis of value. 

When we properly incorporate the demand curve into our analysis, we can see that there is a sense in which labor “exploits” the capitalist rather than the other way around. Each inframarginal point on the upward sloping labor supply curve defines a reservation wage, i.e., the wage at which a laborer is indifferent between working and not working at that quantity of labor supplied. 

Up to the point of equilibrium at which the demand for labor equals supply of labor, the market clearing wage is above the inframarginal points along the labor supply curve. That “surplus” (i.e., rent) accrues to each worker except the last marginal worker for whom the market clearing wage is his reservation wage. This region between the market clearing wage and inframarginal points along the labor supply curve is “producer surplus”; in the input market, the laborer is the producer, and the surplus goes to the laborer. At the same time, the capitalist “exploits” the worker in the sense that he is willing to pay a higher wage at each inframarginal point along the factor demand curve up to the marginal point at which the demand for labor equals the supply of labor.

This same dynamic is at work in the output market, so we can similarly talk about how firms and consumers “exploit” each other as we compare inframarginal points along the demand and supply curves to the equilibrium point in the output market. Notice that all this talk about demand curves invokes the “the subjective desires of consumers” that is so crucial to value creation. Notice also, however, that this surplus value—on the supply side (producer surplus) or the demand side (consumer surplus)—is only a surplus if the worker or the consumer, respectively, has correctly judged what his available productive or consumption opportunities are. 

If, however, the worker takes a job that pays a lower wage than he could receive from another job, without any compensating benefits, then he incurs an opportunity cost that may exceed the wage, and he is worse off. He has lost value (assuming the opportunity cost exceeds the producer surplus for a marginal worker along the supply curve). If he takes a job that pays a higher wage, or affords compensating benefits, he gains value. Similarly, if the consumer is wrong in his own evaluation of relative options, he loses value. If he is right, he gains value. In short, value creation is “subjective” in the sense that it is all about assessing one’s own opportunity costs. As a matter of economics, there is no such thing as intrinsic value. There is only incremental value above opportunity cost.

There are two reasons opportunity cost is vital. 

One, it is empirically more sensible. As Carl Menger explains in his 1871 work Principles of Economics:

“There is no necessary and direct connection between the value of a good and whether, or in what quantities, labor, and other goods of higher order were applied to its production. A non-economic good (a quantity of timber in a virgin forest, for example) does not attain value for men since large quantities of labor or other economic goods were not applied to its production. Whether a diamond was found accidentally or was obtained from a diamond pit with the employment of a thousand days of labor is completely irrelevant for its value. In general, no one in practical life asks for the history of the origin of a good in estimating its value, but considers solely the services that the good will render him and which he would have to forgo if he did not have it at his command…The quantities of labor or of other means of production applied to its production cannot, therefore, be the determining factor in the value of a good. Comparison of the value of a good with the value of the means of production employed in its production does, of course, show whether and to what extent its production, an act of past human activity, was appropriate or economic. But the quantities of goods employed in the production of a good have neither a necessary nor a directly determining influence on its value.”

Two, opportunity cost helps us understand the fundamental importance of scarcity as a determinant of value. What is scarcity? It is not simply about whether we can end hunger. Menger alludes indirectly to scarcity in talking about how a consumer considers only “services that the good will render him and which he would have to forgo if he did not have it at his command.” Scarcity is the idea that every choice involves not making other choices. You must give something up. The adage that “there is no such thing as a free lunch” simply means that one cannot have his cake and eat it too. 

Perhaps the best way to illustrate the point is to observe the difference between productive efficiency and allocative efficiency. The former is about producing in the cheapest way or getting the most out of a unit of input. Allocative efficiency is the idea that a resource should go to the person who values it most because otherwise value is left on the table. If someone values it more than I do, and I get the resource, there is deadweight loss because there could have been gains from trade. 

Ideally, that person would pay me the difference in value in order to gain access to the resource. That assumes zero transaction costs, search costs, and any other barriers that might get in the way. The “marginalist” framework can explain all this. The labor theory of value—Locke’s, Smith’s, Ricardo’s, or Marx’s—cannot. It is worth spelling this out because it shows what is wrong with Locke’s conception of property rights, which inspired the labor theory of value espoused by Smith, Ricardo, and Marx.

The essential point is that property rights should go not necessarily to the person who first “mixes his labor” with a patch of land but, rather, to the person who values the patch of land the most. Digging a ditch in a patch of land and “claiming it” because one plants a seed (as the Lockean “workman ideal” would have it) should not form the basis of a property right from an economic point of view. If I am better at herding sheep than plowing a field, and the shepherd nearby is better at plowing a field, we should “trade” trades. He should get the land, and I should get the sheep. 

Then, we can work out an arrangement for my sheep to graze the land so that we avoid the free rider problem. This is why property rights are essential to economic growth. They incentivize efficient transactions. The parties in a potential transaction negotiate the terms based on how they assess the relative value of the resources at stake. There is no such thing as “intrinsic value.” There is only incremental “subjective” value, which is determined, or assessed, with respect to opportunity costs.

Well, then, how to explain a Van Gogh painting? Does a discrepancy arise because a Van Gogh painting sells for millions of dollars today, but Van Gogh was unable to sell many paintings when he was alive? No. Whether a Van Gogh painting is “inherently” valuable is a philosophical or aesthetic matter. Value becomes a matter of economics if philosophical or aesthetic arguments are compelling enough to change the preferences of consumers (from which demand curves are derived). This is one reason that firms are willing to incur substantial costs in advertising and marketing campaigns. For all the talk about annoying television advertisements or the duplicity of corporate advertising, marketing costs are simply part of the process of equating supply and demand. Or sometimes, it just takes time for consumers to recognize an artist who was ahead of his time. 

Conclusion

For Marxian economics to work, value is necessarily created in production but only realized in exchange. This gets the process of value creation backward. It is the prospect of net gains from market exchange that convinces suppliers that it makes sense to produce a particular commodity—i.e., that production of the particular commodity will not be a wasted effort. In other words, it only makes sense to have a supply curve if there is a demand curve. Yes, it is certainly true that suppliers can “create” demand with the invention of new commodities and appropriate marketing efforts, but it remains the case that it only makes sense to produce a commodity if there is a demand for it.

The Marxian counterpoint is not to deny the necessity of demand but to say that the creation of surplus value requires the underpayment of (a “reserve army” of) workers, which gives rise to the problem of underconsumption that leads to imperialism in the short run and the collapse of capitalism in the long run. The problem with this quasi-Malthusian counterpoint is that, at every step in the value chain, one cannot conceive of demand and supply independently of opportunity cost. Assessing opportunity cost includes evaluating (1) the risk of overestimating or underestimating consumer demand in one sector of the economy versus another, (2) the decision to produce one commodity versus another, and (3) the decision to pay one worker versus another at one wage rate versus another. On (3), for example, it means paying a wage rate that the market will bear, which is another way of saying that all resources available must be used up efficiently to maximize value.

Value is an “incremental” entity. It can only be “created” with respect to opportunity cost (i.e., relative scarcity), which is the fundamental determinant of value, at least as a matter of economics—and this is no trivial thing when it comes to whether a firm, or economy, prospers or fails.

David Harvey concludes his essay on “Marx’s refusal of the labor theory of value” by emphasizing that Marx’s value form is “not a still and stable fulcrum in capital’s churning world but a constantly changing and unstable metric being pushed hither and thither by the anarchy of market exchange, by revolutionary transformations in technologies and organizational forms, by unfolding practices of social reproduction, and massive transformations in the wants, needs and desires of whole populations expressed through the cultures of everyday life.” He writes as if market exchange, technological change, practices of social reproduction, and changes in consumer preferences are choices that we could avoid rather than hard facts of life. But these are not the historical contingencies of “capitalism” that we can transcend by doing away with the private ownership of the means of production. They are the inevitable realities of living in any economy. The “marginalist revolution” accommodates these realities much more effectively than Marx’s value form.

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.