The classics versus the labor theory of value - Part I - Intro & Adam Smith
A cost-price theory is not the same than a labor theory of value
This is the first of a series of posts discussing the so-called classic labor theory of value. The series will argue that talking about a “labor theory of value” is problematic on two fronts: (1) The classics thought value was subjective; they did not have a theory about it. What they had was a theory of price based on the costs of production. (2) The theory of the classics was not about labor per se but costs. To state that the classics had a labor-based theory value is inaccurate at best.
Let me summarize the issue. For the classics, the word “value” had a dual meaning: Value of exchange (price) and value of use (utility). When they used the word value, they were not always clear in which sense they were doing so (understandably, as a new theory and analytical framework is being developed).
In terms of value, that is, utility, the classics took for granted that it was subjective. It is not that they had a wrong theory of value; they did not have one. It was given that value is subjective. Period.
Different (even if connected) to the theory of value is the theory of price. The classics had a
cost → price theory: In the long run, the equilibrium (natural in the classic’s terminology) final price is determined by the cost of production (final prices converge to the cost of production, not the other way around). Which costs contributed to the equilibrium price differ across some classics. For some, there are three cost categories: capital, labor, and land. For others, there are two, and for others, there is one, labor (i.e., Marx).
In short, a labor theory of value is not the same as a cost theory of price. As I hope to show in this series, the difference is not hairsplitting semantics. For starters, it can significantly affect our understanding of the marginal revolution (the last post’s topic).
I plan to move in the following way:
Post 1: Introduction and Adam Smith
Post 2: David Ricardo
Post 3: John Stuart Mill
Post 4: Karl Marx
Post 5: Jean Baptiste Say
Post 6: Conclusion: The Marginal revolution and a step back
The figure below shows a chronology of the main economic works from Cantillon’s Essai to the marginal revolution.
This series of posts summarizes JCC’s papers (1994 and 1995) on the history of theories of price and value. I claim little originality on these posts. His work was initially published in Spanish in ESEADE’s LIBERTAS. In the coming months, an English translation will be available in LIBERTAS: Segunda Época. These papers provide a more in-depth discussion of these issues from Aristotle to Marshall.
Value, the other value, and a theory of price
Let’s start with the obliged distinction between the value of use (utility) and the value of exchange (price). The classics continued with the tradition to distinguish them from their predecessors. This is Adam Smith in the Wealth of Nations (WN) (p. 44):
The word value, it is to be observed, has two different meanings, and sometimes expresses the utility of some particular object, and sometimes the power of purchasing other goods which the possession of that object conveys. The one may be called “value in use;” the other, “value in exchange.”
Having made this distinction, the focus now falls on the value of the exchange or, in short, value. Yet, this distinction allows Smith to (contrary to popular belief) solve the water-diamond paradox with demand and supply analysis similarly to how we do it in a classroom today (Lectures of Jurisprudence, p. 358, bolds added):
First, a thing of no use, as a lump of clay, brought into the market will give no price, as no one demands it. If it be useful the price will be regulated according to the demand, as this use is general or not, and the pleny there is to supply it. A thing which is hardly of any use, yet if the quantity be not sufficient to supply the demand, will give a high price; hence the great price of diamonds. Precious metals, which are certainly not so useful as gold, bear a far greater price, partly on this account. Abundance on the other hand such as does more than supply all possible demand, renders water of no price at all and other things of a price the next thing to nothing. The scarcity on the other hand raises the price immoderately.
It follows that for Smith, having a value of use (utility) is necessary for a thing to have a value of exchange (price).
There is an essential distinction in Smith that sometimes is overlooked. Smith distinguishes between the determinants and the measure of price. For instance, it is not the same to ask what time is as asking how to measure time. For better or worse, the classics agree that labor (hours of work) is a measure of price. Saying that labor is a measure of price is not the same as saving the labor is the cause of prices. A more serious mistake is to argue that Smith stated that utility comes from labor.
Why think of labor as a measure of prices? For two reasons. First, in primitive and rough societies where there is no accumulation of capital
(K=0) and land
(T=0), the number of work hours was a measure tractable to a tangible cost of opportunity. Any individual could “easily” translate how many hours of work he would need to give to purchase a good from another individual. Second, because of changes in the price level, work hours provide a more reliable real measure of prices. Back then, there were no inflation statistics to deflate prices appropriately. The intention was to distinguish, as well as possible, between what we today call a nominal and a real price. These reasons may be good or bad, but Smith’s argument is distinct from claiming that labor is the cause of prices or value (see WN, pp. 49-51).
However, as society moves beyond a primitive state
(K, L > 0), other variables, such as the cost of capital, enter the equation
(K > 0) (WN, p. 55-56, bolds added):
As soon as stock [capital] has accumulated in the hands of particular persons, some of them will naturally employ it in setting to work industrious people, whom they will supply with materials and subsistence, in order to make a profit by the sale of their work, or by what their labour adds to the value [price] of the materials. In exchanging the complete manufacture either for money, for labour, or for other goods, over and above what may be sufficient to pay the price of the materials, and the wages of the workmen, something must be given for the profits of the undertaker of the work who hazards his stock [capital] in this adventure. The value [price] which the workmen add to the materials, therefore, resolves itself in this case into two parts, of which the one pays their wages, the other the profits of their employer upon the whole stock of materials and wages which he advanced.
Shortly after, Smith further clarifies (WN, p. 67, bolds added):
In the price of commodities, therefore, the profits of stock constitute a component part altogether different from the wages of labour, and regulated by quite different principles.
In this state of things, the whole produce of labour does not alway belong to the labourer. He must in most cases share it with the owner of the stock which employs him. Neither is the quantity of labour commonly employed in acquiring or producing any commodity, the only circumstance which can regulate the quantity which it ought commonly to purchase, command, or exchange for. An additional quantity, it is evident, must be due for the profits of the stock which advanced the wages and furnished the materials of that labour.
Immediately afterward, Smith adds land to the equation (WN, p. 67):
As soon as the land of any country has all become private property, the landlords, like all other men, love to reap where they never sowed, and demand a rent even for its natural produce. The wood of the forest, the grass of the field, and all the natural fruits of the earth, which, when land was in common, cost the labourer only the trouble of gathering them, come, even to him, to have an additional price fixed upon them. He must then pay for the licence to gather them; and must give up to the landlord a portion of what his labour either collects or produces. This portion, or, what comes to the same thing, the price of this portion, constitutes the rent of land, and in the price of the greater part of commodities makes a third component part.
In short, for Smith, the relationship between cost and price is the following:
(cost of labor + cost of capital + cost of land) → equilibrium price.
Smith identifies three “parts” (causes) of prices, and those three parts can be measured in hours of work (WN, p. 67-68):
The real value [price] of all the different component parts of price, it must be observed, is measured by the quantity of labour which they can, each of them, purchase or command. Labour measures the value not only of that part of price which resolves itself into labour, but of that which resolves itself into rent, and of that which resolves itself into profit.
In every society the price of every commodity finally resolves itself into some one or other, or all of those three parts; and in every improved society, all the three enter more or less, as component parts, into the price of the far greater part of commodities.
In this passage, Smith separates his three determinants of price from labor as a measure of the three components. To avoid any confusion by his readers, the section title where this passage comes from reads “Of the components Part of the Price of Commodities.”
Now we can distinguish between the natural and the market price. The former is the long-run equilibrium price. The natural price is the price that covers the cost of the three determinants of the price. A market price is a short-run deviation from the natural price. Differences in quantities demanded and supplied (shortages and surpluses) explain short-run deviations (see WN, pp. 73-74).
If you reflect on this discussion and Smith’s passages, you will see that what we have in Smith is a discussion on the value of exchange (price), not the value of use (utility). A superficial reading can lead to confusion, given some ambiguities in Smith’s text. But a careful reading that considers the context of his discussion makes the distinction clear.
The problem with the classic price theory
The analytical framework of
cost → price guided Smith and the rest of the classics into a severe problem. Costs explain prices. But costs are also prices. So, either cost is explained by the price of the final good (vicious circle or infinite loop) or another cost (leading to an endless chain of costs). Neither a vicious circle nor an endless explanation is a satisfactory answer to the question of what determines prices.
For instance, the natural price of bread is determined by the cost of labor (and also capital and land). But the cost of labor is determined, in the long run, by the cost of primary needs such as bread. That is, the cost of labor depends on the price of bread, which in turn depends on the price of labor. The discussion is convoluted because Smith is talking about several things simultaneously, but this is a representative passage of the problem (WN, pp. 85-86, bolds added):
A man must always live by his work, and his wages must at least be sufficient to maintain him. They must even upon most occasions be somewhat more; otherwise it would be impossible for him to bring up a family, and the race of such workmen could not last beyond the first generation […]. Thus far at least seems certain, that, in order to bring up a family, the labour of the husband and wife together must, even in the lowest species of common labour, be able to earn something more than what is precisely necessary for their own maintenance; but in what proportion, whether in that abovementioned, or in any other, I shall not take upon me to determine.
The price theory of the classics is fundamentally flawed. This is a significant issue because at the heart of any economic theory is (or should be) a price theory. But, the flaw in the classics is not that labor explains utility.
From Smith to the rest of the classics: A variation on a theme
Smith’s price theory became a general framework in the price theory of almost all classics. The
cost → price approach became a common theme from Smith to Ricardo, Mill, and Marx. “All” classics share the same analytical approach to their price theory. As I’ll discuss in a future post, J. B. Say distinguishes himself from his classic peers.
Next: David Ricardo
Thanks for reading Economic Order! Subscribe for free to receive new posts and support my work.