The labor theory of value (LTV) is a theory of value that argues that the economic value of a good or service is determined by the total amount of "socially necessary labor" required to produce it, rather than by the use or pleasure its owner gets from it (demand) and its scarcity value (supply). It does not say that the value of a commodity is determined by the actual amount of labor contained in it, but the average amount needed to produce it. This is called "socially necessary labor".
LTV is usually associated with Marxian economics, though it also appears in the theories of earlier classical liberal economists such as Adam Smith and David Ricardo and later also in anarchist economics. Smith saw the price of a commodity in terms of the labor that the purchaser must expend to buy it, which embodies the concept of how much labor a commodity, a tool for example, can save the purchaser. The LTV is central to Marxist theory, which holds that the working class is exploited under capitalism, and dissociates price and value. Marx never referred to his own theory of value as a "labour theory of value" even once. Neoclassical economics tends to deny the need for a LTV, concentrating instead on a theory of price determined by supply and demand.
When speaking in terms of a labor theory of value, "value," without any qualifying adjective should theoretically refer to the amount of labor necessary to produce a marketable commodity, including the labor necessary to develop any real capital used in the production. Both David Ricardo and Karl Marx tried to quantify and embody all labor components in order to develop a theory of the real price, or natural price of a commodity. The labor theory of value as presented by Adam Smith did not require the quantification of past labor, nor did it deal with the labor needed to create the tools (capital) that might be used in producing a commodity. Smith's theory of value was very similar to the later utility theories in that Smith proclaimed that a commodity was worth whatever labor it would command in others (value in trade) or whatever labor it would "save" the self (value in use), or both. However, this "value" is subject to supply and demand at a particular time:
The real price of every thing, what every thing really costs to the man who wants to acquire it, is the toil and trouble of acquiring it. What every thing is really worth to the man who has acquired it, and who wants to dispose of it or exchange it for something else, is the toil and trouble which it can save to himself, and which it can impose upon other people. (Wealth of Nations Book 1, chapter V)
Smith's theory of price (which for many is the same as value) has nothing to do with the past labor spent in producing a commodity. It speaks only of the labor that can be "commanded" or "saved" at present. If there is no use for a buggy whip, then the item is economically worthless in trade or in use, regardless of all the labor spent in creating it.
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." The things which have the greatest value in use have frequently little or no value in exchange; and, on the contrary, those which have the greatest value in exchange have frequently little or no value in use. Nothing is more useful than water: but it will purchase scarce anything; scarce anything can be had in exchange for it. A diamond, on the contrary, has scarce any value in use; but a very great quantity of other goods may frequently be had in exchange for it (Wealth of Nations Book 1, chapter IV).
Value "in exchange" is the relative proportion with which this commodity exchanges for another commodity (in other words, its price in the case of money). It is relative to labor as explained by Adam Smith:
The value of any commodity, [...] to the person who possesses it, and who means not to use or consume it himself, but to exchange it for other commodities, is equal to the quantity of labour which it enables him to purchase or command. Labour, therefore, is the real measure of the exchangeable value of all commodities (Wealth of Nations Book 1, chapter V).
Value (without qualification) is the labor embodied in a commodity under a given structure of production. Marx defined the value of the commodity by the third definition. In his terms, value is the 'socially necessary abstract labor' embodied in a commodity. To David Ricardo and other classical economists, this definition serves as a measure of "real cost", "absolute value", or a "measure of value" invariable under changes in distribution and technology.
Ricardo, other classical economists and Marx began their expositions with the assumption that value in exchange was equal to or proportional to this labor value. They thought this was a good assumption from which to explore the dynamics of development in capitalist societies. Other supporters of the labor theory of value used the word "value" in the second sense to represent "exchange value".
Since the term "value" is understood in the LTV as denoting something created by labor, and its "magnitude" as something proportional to the quantity of labor performed, it is important to explain how the labor process both preserves value and adds new value in the commodities it creates.[note 1]
The value of a commodity increases in proportion to the duration and intensity of labor performed on average for its production. Part of what the LTV means by "socially necessary" is that the value only increases in proportion to this labor as it is performed with average skill and average productivity. So though workers may labor with greater skill or more productivity than others, these more skillful and more productive workers thus produce more value through the production of greater quantities of the finished commodity. Each unit still bears the same value as all the others of the same class of commodity. By working sloppily, unskilled workers may drag down the average skill of labor, thus increasing the average labor time necessary for the production of each unit commodity. But these unskillful workers cannot hope to sell the result of their labor process at a higher price (as opposed to value) simply because they have spent more time than other workers producing the same kind of commodities.
However, production not only involves labor, but also certain means of labor: tools, materials, power plants and so on. These means of labor—also known as means of production—are often the product of another labor process as well. So the labor process inevitably involves these means of production that already enter the process with a certain amount of value. Labor also requires other means of production that are not produced with labor and therefore bear no value: such as sunlight, air, uncultivated land, unextracted minerals, etc. While useful, even crucial to the production process, these bring no value to that process. In terms of means of production resulting from another labor process, LTV treats the magnitude of value of these produced means of production as constant throughout the labor process. Due to the constancy of their value, these means of production are referred to, in this light, as constant capital.
Consider for example workers who take coffee beans, use a roaster to roast them, and then use a brewer to brew and dispense a fresh cup of coffee. In performing this labor, these workers add value to the coffee beans and water that comprise the material ingredients of a cup of coffee. The worker also transfers the value of constant capital—the value of the beans; some specific depreciated value of the roaster and the brewer; and the value of the cup—to the value of the final cup of coffee. Again, on average the worker can transfer no more than the value of these means of labor previously possessed to the finished cup of coffee[note 2] So the value of coffee produced in a day equals the sum of both the value of the means of labor—this constant capital—and the value newly added by the worker in proportion to the duration and intensity of their work.
Often this is expressed mathematically as:
Note: if the product resulting from the labor process is homogeneous (all similar in quality and traits, for example, all cups of coffee) then the value of the period's product can be divided by the total number of items (use-values or ) produced to derive the unit value of each item. where is the total items produced.
The LTV further divides the value added during the period of production, , into two parts. The first part is the portion of the process when the workers add value equivalent to the wages they are paid. For example, if the period in question is one week and these workers collectively are paid $1,000, then the time necessary to add $1,000 to—while preserving the value of—constant capital is considered the necessary labor portion of the period (or week): denoted . The remaining period is considered the surplus labor portion of the week: or . The value used to purchase labor-power, for example the $1,000 paid in wages to these workers for the week, is called variable capital (). This is because in contrast to the constant capital expended on means of production, variable capital can add value in the labor process. The amount it adds depends on the duration, intensity, productivity and skill of the labor-power purchased: in this sense the buyer of labor-power has purchased a commodity of variable use. Finally, the value added during the portion of the period when surplus labor is performed is called surplus value (). From the variables defined above, we find two other common expressions for the value produced during a given period:
The first form of the equation expresses the value resulting from production, focusing on the costs and the surplus value appropriated in the process of production, . The second form of the equation focuses on the value of production in terms of the values added by the labor performed during the process .
One issue facing the LTV is the relationship between value quantities on one hand and prices on the other. If a commodity's value is not the same as its price, and therefore the magnitudes of each likely differ, then what is the relation between the two, if any? Various LTV schools of thought provide different answers to this question. For example, some argue that value in the sense of the amount of labor embodied in a good acts as a center of gravity for price.
However, most economists would say that cases where pricing is given as approximately equal to the value of the labour embodied, are in fact only special cases. In General Theory pricing most usually fluctuates. The standard formulation is that prices normally include a level of income for "capital" and "land". These incomes are known as "profit" and "rent" respectively. Yet Marx made the point that value cannot be placed upon labour as a commodity, because capital is a constant, whereas profit is a variable, not an income; thus explaining the importance of profit in relation to pricing variables.
In Book 1, chapter VI, Adam Smith writes:
The real value 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.
The final sentence explains how Smith sees value of a product as relative to labor of buyer or consumer, as opposite to Marx who sees the value of a product being proportional to labor of laborer or producer. And we value things, price them, based on how much labor we can avoid or command, and we can command labor not only in a simple way but also by trading things for a profit.
The demonstration of the relation between commodities' unit values and their respective prices is known in Marxian terminology as the transformation problem or the transformation of values into prices of production. The transformation problem has probably generated the greatest bulk of debate about the LTV. The problem with transformation is to find an algorithm where the magnitude of value added by labor, in proportion to its duration and intensity, is sufficiently accounted for after this value is distributed through prices that reflect an equal rate of return on capital advanced. If there is an additional magnitude of value or a loss of value after transformation, then the relation between values (proportional to labor) and prices (proportional to total capital advanced) is incomplete. Various solutions and impossibility theorems have been offered for the transformation, but the debate has not reached any clear resolution.
LTV does not deny the role of supply and demand influencing price, since the price of a commodity is something other than its value. In Value, Price and Profit (1865), Karl Marx quotes Adam Smith and sums up:
The LTV seeks to explain the level of this equilibrium. This could be explained by a cost of production argument—pointing out that all costs are ultimately labor costs, but this does not account for profit, and it is vulnerable to the charge of tautology in that it explains prices by prices. Marx later called this "Smith's adding up theory of value".
Smith argues that labor values are the natural measure of exchange for direct producers like hunters and fishermen. Marx, on the other hand, uses a measurement analogy, arguing that for commodities to be comparable they must have a common element or substance by which to measure them, and that labor is a common substance of what Marx eventually calls commodity-values.
The labor theory of value has developed over many centuries. It had no single originator, but rather many different thinkers arrived at the same conclusion independently. Aristotle is claimed to hold to this view. Some writers trace its origin to Thomas Aquinas. In his Summa Theologiae (1265–1274) he expresses the view that "... value can, does and should increase in relation to the amount of labor which has been expended in the improvement of commodities." Scholars such as Joseph Schumpeter have cited Ibn Khaldun, who in his Muqaddimah (1377), described labor as the source of value, necessary for all earnings and capital accumulation. He argued that even if earning "results from something other than a craft, the value of the resulting profit and acquired (capital) must (also) include the value of the labor by which it was obtained. Without labor, it would not have been acquired." Scholars have also pointed to Sir William Petty's Treatise of Taxes of 1662 and to John Locke's labor theory of property, set out in the Second Treatise on Government (1689), which sees labor as the ultimate source of economic value. Karl Marx himself credited Benjamin Franklin in his 1729 essay entitled "A Modest Enquiry into the Nature and Necessity of a Paper Currency" as being "one of the first" to advance the theory.
Adam Smith accepted the theory for pre-capitalist societies but saw a flaw in its application to contemporary capitalism. He pointed out that if the "labor embodied" in a product equaled the "labor commanded" (i.e. the amount of labor that could be purchased by selling it), then profit was impossible. David Ricardo (seconded by Marx) responded to this paradox by arguing that Smith had confused labor with wages. "Labor commanded", he argued, would always be more than the labor needed to sustain itself (wages). The value of labor, in this view, covered not just the value of wages (what Marx called the value of labor power), but the value of the entire product created by labor.
Based on the discrepancy between the wages of labor and the value of the product, the "Ricardian socialists"—Charles Hall, Thomas Hodgskin, John Gray, and John Francis Bray, and Percy Ravenstone—applied Ricardo's theory to develop theories of exploitation.
Marx expanded on these ideas, arguing that workers work for a part of each day adding the value required to cover their wages, while the remainder of their labor is performed for the enrichment of the capitalist. The LTV and the accompanying theory of exploitation became central to his economic thought.
19th century American individualist anarchists based their economics on the LTV, with their particular interpretation of it being called "Cost the limit of price". They, as well as contemporary individualist anarchists in that tradition, hold that it is unethical to charge a higher price for a commodity than the amount of labor required to produce it. Hence, they propose that trade should be facilitated by using notes backed by labor.
Adam Smith held that, in a primitive society, the amount of labor put into producing a good determined its exchange value, with exchange value meaning in this case the amount of labor a good can purchase. However, according to Smith, in a more advanced society the market price is no longer proportional to labor cost since the value of the good now includes compensation for the owner of the means of production: "The whole produce of labour does not always belong to the labourer. He must in most cases share it with the owner of the stock which employs him." "Nevertheless, the 'real value' of such a commodity produced in advanced society is measured by the labor which that commodity will command in exchange. ... But [Smith] disowns what is naturally thought of as the genuine classical labor theory of value, that labor-cost regulates market-value. This theory was Ricardo's, and really his alone."
Classical economist David Ricardo's labor theory of value holds that the value of a good (how much of another good or service it exchanges for in the market) is proportional to how much labor was required to produce it, including the labor required to produce the raw materials and machinery used in the process. David Ricardo stated it as, "The value of a commodity, or the quantity of any other commodity for which it will exchange, depends on the relative quantity of labour which is necessary for its production, and not as the greater or less compensation which is paid for that labour." (Ricardo 1817) In this connection Ricardo seeks to differentiate the quantity of labour necessary to produce a commodity from the wages paid to the laborers for its production. However, Ricardo was troubled with some deviations in prices from proportionality with the labor required to produce them. For example, he said "I cannot get over the difficulty of the wine, which is kept in the cellar for three or four years [i.e., while constantly increasing in exchange value], or that of the oak tree, which perhaps originally had not 2 s. expended on it in the way of labour, and yet comes to be worth £100." (Quoted in Whitaker) Of course, a capitalist economy stabilizes this discrepancy until the value added to aged wine is equal to the cost of storage. If anyone can hold onto a bottle for four years and become rich, that would make it hard to find freshly corked wine. There is also the theory that adding to the price of a luxury product increases its exchange-value by mere prestige.
The labor theory as an explanation for value contrasts with the subjective theory of value, which says that value of a good is not determined by how much labor was put into it but by its usefulness in satisfying a want and its scarcity. Ricardo's labor theory of value is not a normative theory, as are some later forms of the labor theory, such as claims that it is immoral for an individual to be paid less for his labor than the total revenue that comes from the sales of all the goods he produces.
It is arguable to what extent these classical theorists held the labor theory of value as it is commonly defined. For instance, David Ricardo theorized that prices are determined by the amount of labor but found exceptions for which the labor theory could not account. In a letter, he wrote: "I am not satisfied with the explanation I have given of the principles which regulate value." Adam Smith theorized that the labor theory of value holds true only in the "early and rude state of society" but not in a modern economy where owners of capital are compensated by profit. As a result, "Smith ends up making little use of a labor theory of value."
Pierre Joseph Proudhon's mutualism and American individualist anarchists such as Josiah Warren, Lysander Spooner and Benjamin Tucker adopted the liberal Labor Theory of Value of classical economics and used it to criticize capitalism while favoring a non-capitalist market system.
Warren is widely regarded as the first American anarchist, and the four-page weekly paper he edited during 1833, The Peaceful Revolutionist, was the first anarchist periodical published. Cost the limit of price was a maxim coined by Warren, indicating a (prescriptive) version of the labor theory of value. Warren maintained that the just compensation for labor (or for its product) could only be an equivalent amount of labor (or a product embodying an equivalent amount). Thus, profit, rent, and interest were considered unjust economic arrangements. In keeping with the tradition of Adam Smith's The Wealth of Nations, the "cost" of labor is considered to be the subjective cost; i.e., the amount of suffering involved in it. He put his theories to the test by establishing an experimental "labor for labor store" called the Cincinnati Time Store at the corner of 5th and Elm Streets in what is now downtown Cincinnati, where trade was facilitated by notes backed by a promise to perform labor. "All the goods offered for sale in Warren's store were offered at the same price the merchant himself had paid for them, plus a small surcharge, in the neighborhood of 4 to 7 percent, to cover store overhead." The store stayed open for three years; after it closed, Warren could pursue establishing colonies based on Mutualism. These included "Utopia" and "Modern Times". Warren said that Stephen Pearl Andrews' The Science of Society, published in 1852, was the most lucid and complete exposition of Warren's own theories.
Mutualism is an economic theory and anarchist school of thought that advocates a society where each person might possess a means of production, either individually or collectively, with trade representing equivalent amounts of labor in the free market. Integral to the scheme was the establishment of a mutual-credit bank that would lend to producers at a minimal interest rate, just high enough to cover administration. Mutualism is based on a labor theory of value that holds that when labor or its product is sold, in exchange, it ought to receive goods or services embodying "the amount of labor necessary to produce an article of exactly similar and equal utility". Mutualism originated from the writings of philosopher Pierre-Joseph Proudhon.
Collectivist anarchism as defended by Mikhail Bakunin defended a form of labor theory of value when it advocated a system where "all necessaries for production are owned in common by the labour groups and the free communes ... based on the distribution of goods according to the labour contributed".
Contrary to popular belief Marx never used the term "Labor theory of value" in any of his works but used the term Law of value, Marx opposed "ascribing a supernatural creative power to labor", arguing as such:
Here, Marx was distinguishing between exchange value (the subject of the LTV) and use value. Marx used the concept of "socially necessary labor time" to introduce a social perspective distinct from his predecessors and neoclassical economics. Whereas most economists start with the individual's perspective, Marx started with the perspective of society as a whole. "Social production" involves a complicated and interconnected division of labor of a wide variety of people who depend on each other for their survival and prosperity. "Abstract" labor refers to a characteristic of commodity-producing labor that is shared by all different kinds of heterogeneous (concrete) types of labor. That is, the concept abstracts from the particular characteristics of all of the labor and is akin to average labor.
"Socially necessary" labor refers to the quantity required to produce a commodity "in a given state of society, under certain social average conditions or production, with a given social average intensity, and average skill of the labor employed." That is, the value of a product is determined more by societal standards than by individual conditions. This explains why technological breakthroughs lower the price of commodities and put less advanced producers out of business. Finally, it is not labor per se that creates value, but labor power sold by free wage workers to capitalists. Another distinction is between productive and unproductive labor. Only wage workers of productive sectors of the economy produce value.[note 3]
The Marxist labor theory of value has been criticised on several counts. Some argue that it predicts that profits will be higher in labor-intensive industries than in capital-intensive industries, which would be contradicted by measured empirical data inherent in quantitative analysis. Even if Marx has never 'mechanically' simplified the matter in these terms, as capital itself is product of past labour, thus, the 'general tendency of falling profit' does not concern or invalidate the labour origin of value, present in both live and dead labour (capital)(cf chapter 1 and 24 of Das Kapital). This is sometimes referred to as the "Great Contradiction". In volume 3 of Capital, Marx explains why profits are not distributed according to which industries are the most labor-intensive and why this is consistent with his theory. Whether or not this is consistent with the labor theory of value as presented in volume 1 has been a topic of debate. According to Marx, surplus value is extracted by the capitalist class as a whole and then distributed according to the amount of total capital, not the just variable component. In the example given earlier, of making a cup of coffee, the constant capital involved in production is the coffee beans themselves, and the variable capital is the value added by the coffee maker. The value added by the coffee maker is dependent on its technological capabilities, and the coffee maker can only add so much total value to cups of coffee over its lifespan. The amount of value added to the product is thus the amortization of the value of the coffeemaker. We can also note that not all products have equal proportions of value added by amortized capital. Capital intensive industries such as finance may have a large contribution of capital, while labor-intensive industries like traditional agriculture would have a relatively small one.
The theory can also be sometimes found in non-Marxist traditions.[note 4] For instance mutualist anarchist theorist Kevin Carson's Studies in Mutualist Political Economy opens with an attempt to integrate marginalist critiques into the labor theory of value.
Some Post-Keynesian economists have been highly critical of the labor theory of value. Joan Robinson, who herself was considered an expert on the writings of Karl Marx, wrote that the labor theory of value was largely a tautology and "a typical example of the way metaphysical ideas operate".
Others have argued that the labor theory of value, especially as it arises in the work of Karl Marx, is due to a failure to recognize the fundamentally dialectical nature of how human beings attribute value to objects. Pilkington writes that value is attributed to objects based on our desire for them and that this desire is always inter-subjective and socially determined. He writes the following:
[V]alue is attributed to objects due to our desire for them. This desire, in turn, is inter-subjective. We desire to gain [a] medal or to capture [an] enemy flag [in battle] because it will win recognition in the eyes of our peers. [A] medal [or an enemy] flag are not valued for their objective properties, nor are they valued for the amount of labour embodied in them, rather they are desired for the symbolic positions they occupy in the inter-subjective network of desires.
Pilkington insists that this is an entirely different conception of value than the one we find in the marginalist theory found in many economics textbooks. He writes that "actors in marginalist analysis have self-contained preferences; they do not have inter-subjective desires".
In ecological economics, the labor theory of value has been criticized, where it is argued that labor is in fact energy over time. However, echoing Joan Robinson, Alf Hornborg, an environmental historian, argues that both the reliance on "energy theory of value" and "labor theory of value" are problematic as they propose that use-values (or material wealth) are more "real" than exchange-values (or cultural wealth)--yet, use-values are culturally determined. For Hornborg, any Marxist argument that claims uneven wealth is due to the "exploitation" or "underpayment" of use-values is actually a tautological contradiction, since it must necessarily quantify "underpayment" in terms of exchange-value. The alternative would be to conceptualize unequal exchange as "an asymmetric net transfer of material inputs in production (e.g., embodied labor, energy, land, and water), rather than in terms of an underpayment of material inputs or an asymmetric transfer of 'value'". In other words, uneven exchange is characterised by incommensurability, namely: the unequal transfer of material inputs; competing value-judgements of the worth of labor, fuel, and raw materials; differing availability of industrial technologies; and the off-loading of environmental burdens on those with less resources.
To resolve the above-mentioned contradiction of the theory with reality, some authors proposed to reconsider the role of production equipment (constant capital) in production of value, following hints in Das Kapital, where Marx described the functional role of machinery in production processes in Chapter XV (Machinery and Modern Industry) in the following words:
On a closer examination of the working machine proper, we find in it, as a general rule, though often, no doubt, under very altered forms, the apparatus and tools used by the handicraftsmen or manufacturing workman: with this difference that instead of being human implements, they are the implements of a mechanism, or mechanical implements (pp. 181–182). The machine proper is therefore a mechanism that, after being set in motion performs with its tools the same operations that were formerly done by the workman with similar tools. Whether the motive power is derived from man or from some other machine, makes no difference in this respect (p. 182). The implements of labour, in the form of machinery, necessitate the substitution of natural forces for human force, and the conscious application of science instead of rule of thumb (p. 188). After making allowance, both in the case of the machine and of the tool, for their average daily cost, that is, for the value they transmit to the product by their average daily wear and tear, and for their consumption of auxiliary substances such as oil, coal and so on, they each do their work gratuitously, just like the forces furnished by nature without the help of man (p. 189).
These words state that one has to account, while interpreting production of value, that the workers' efforts in production of things are substituted with work of production equipment with due effect. Really, at substitution of labourer's work by forces of the nature, that is at substitution of efforts of people by work of external forces of the nature by means of the production equipment, work operates in a complex as workers' efforts plus work of the equipment. Thus, work of machines can be appreciated only so far as this work does what people wish, replacing their efforts and, consequently, a measure of value, certainly, can be the labourers' work only.