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Chapter One: The Marginalist Assault on Classical Political Economy: An Assessment and Counter-Attack
A. Statement of the Classical Labor Theory of Value
Either the labor theory of value, or, secondarily, some other form of cost theory of value,1 was
common to the classical school of political economy in England.
It was stated by Adam Smith in ambiguous form: "The real price of everything, what everything really costs
to the man who wants to acquire it, is the toil and trouble of acquiring it.... Labour was the first price, the original purchase-money
that was paid for all things."2 In the same passage, though, he spoke of the value of a commodity in one's
possession as consisting of "the quantity of the labour which he can command...." And at other times, he seemed to
make the market price of labor the source of its effect on exchange value.
The most clear-cut and effective statement of the labor theory was by David Ricardo, in Principles of Political
Economy and Taxation: "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."3 In so defining the doctrine, Ricardo eliminated the confusion between labor
as the source of exchange-value and wages as a component of price.
From this principle, it followed that income accruing to the owners of land and capital was a deduction from
this exchange-value created by labor, and that wages varied inversely with profit: "If the corn is to be divided between
the farmer and the labourer, the larger the proportion that is given to the latter, the less will remain for the former. So
if cloth or cotton goods be divided between the workman and his employer, the larger the proportion given to the former, the
less remains for the latter."4
It was only natural that the emerging socialist movement should seize on the political implications of this
conclusion. The school of so-called "Ricardian socialists" in England took just such an inspiration. The greatest of them,
Thomas Hodgskin, wrote in Labour Defended Against the Claims of Capital, "Wages vary inversely as profits, or wages
rise when profits fall, and profits rise when wages fall; and it is therefore profits, or the capitalist's share of the national
produce, which is opposed to wages, or the share of the labourer."5
Marx, in turn, was inspired by the Ricardian socialist interpretation of classical political economy, as well
as by Proudhon. According to Engels, modern socialism was a direct outgrowth of the insights of "bourgeois political economy"
on the nature of wages, rent, and profit.
Insofar as modern socialism, no matter of what tendency, starts out from bourgeois political economy, it almost
without exception takes up the Ricardian theory of value. The two propositions which Ricardo proclaimed in 1817 right at the
beginning of his Principles, 1) that the value of any commodity is purely and solely determined by the quantity of
labour required for its production, and 2) that the product of the entire social labor is divided among the three classes:
landowners (rent), capitalists (profit), and workers (wages)--these two propositions had ever since 1821 been utilized in
England for socialist conclusions, and in part with such pointedness and resolution that this literature, which had then almost
been forgotten and was to a large extent only rediscovered by Marx, remained surpassed until the appearance of Capital.6
The actual extent to which Marx's theory of value is a straightforward outgrowth of Ricardo's, and to which
it was a preexisting Hegelian philosophy with Ricardian elements grafted on, is an issue in dispute.7 But for the
present purpose, we will treat Marx's theory of value as relevant to our study to the extent that it is amenable to a Ricardian
approach.
B. Vulgar Political Economy, Marginalism, and the Issue of Ideological Motivation
Given the fertile ground Ricardo's political economy presented for socialist conclusions, it was naturally seen as problematic
by apologists for the newly arisen system of industrial capitalism. Marx made a fundamental distinction, in this regard, between
the classical political economists and the "vulgar economists" who came after them. Smith, James Mill and Ricardo had developed
their scientific political economy without fear of its revolutionary implications, because industrial capital was still the
progressive underdog in a revolutionary struggle against the unearned income of feudal landlords and chartered monopolists.
But that situation came to an end with the capitalists' acquisition of political power.
In France and England the bourgeoisie had conquered power [in the "decisive crisis" year of 1830]. Thenceforth,
the class struggle, practically as well as theoretically, took on more and more outspoken and threatening forms. It sounded
the knoll of scientific bourgeois economy. It was thenceforth no longer a question whether this theorem or that was true,
but whether it was useful to capital or harmful, expedient or inexpedient, politically dangerous or not. In place of disinterested
enquirers, there were hired prize-fighters; in place of genuine scientific research, the bad conscience and the evil intent
of apologetic.8
Maurice Dobb, likewise, commented on the transition of political economy from a revolutionary to an apologetic role:
As a critique leveled simultaneously against the authoritarianism of an autocratic state and against the privileges and
influence of the landed aristocracy Political Economy at its inception played a revolutionary role.... Only later, in its
post-Ricardian phase, did it pass over from assault on privilege and restriction to apology for property.9
Although the break was perhaps not as fundamental as the Marxists have made it out to be, there is evidence that at least
some of the political economists from the 1830s on, as well as the founders of marginalism, were conscious of the political
aspect of the problem. According to Maurice Dobb, the "vulgar political economists" were consciously motivated by apologetic
considerations; as an alternative to the mainstream classical school of England, they turned to the subjectivist continental
school, which had been influenced by Say's interpretation of Adam Smith.
It was against this whole [Ricardian] mode of approach that the Senior-Longfield school reacted so strongly--not
merely as an inapposite analytical tool..., but against its wider applications and corollaries. In reacting in this way, it
was almost inevitable that they should be carried in the wake of (and eventually join) the other and rival tradition deriving
from Smith, reinforcing it by so doing. If they are properly described at all as "improvers" or "conciliators", such a term
should really be applied to their role in developing this Smithian tradition and not the Ricardian approach.10
Among the first generation of marginalists, Jevons at least was quite conscious of the political dimension of his anti-Ricardian
project. To quote Dobb again, "...although Menger could be said to have represented this break with classical tradition
even more clearly and completely, Jevons was apparently more conscious of the role he was playing in reshunting the 'car of
economic science' which Ricardo had so perversely directed 'onto a wrong line.'"11
Dobb considered it telling that the marginalist refinement of subjectivism had been produced near-simultaneously by three
different writers, within a decade of the publication of Capital. It indicated a prevailing atmosphere of ideological
combat, and a vacancy for anti-Marxian polemicists waiting to be filled.
It is, at least, a remarkable fact that within ten years of the appearance of the first volume of Kapital, not only
had the rival utility-principle been enunciated independently by a number of writers, but the new principle was finding a
receptivity to its acceptance such as very few ideas of similar novelty can ever have met. If only by the effect of negation,
the influence of Marx on the economic theory of the nineteenth century would appear to have been much more profound than it
is fashionable to admit….
That so many of the economists of the last quarter of the century should have advertised their wares as such an epoch-making
novelty, and tilted their lances so menacingly at their forebears, seems to have an obvious, if unflattering explanation:
namely, the dangerous use to which Ricardian notions had been recently put by Marx.12
And of the second generation of Austrians, Böhm-Bawerk seemed quite aware, in Dobb's opinion, of the ideological nature
of the task before him.
It seems clear that Böhm-Bawerk at any rate appreciated the problem which the classical theory had sought to solve. While
he is sparing, almost niggardly, in paying tribute to Marx even for formulating the question accurately, there is every indication
that he framed his theory directly to provide a substitute answer to the questions which Marx had posed.13
If such speculations on the political motives of the marginalist revolutionaries seem "unflattering," unfair, or ad hominem,
it is worth bearing in mind that Böhm-Bawerk himself was not above pointing to the ideological motivations of his predecessors,
in language very reminiscent of Marx's dismissal of the "vulgar economists." Even more than grinding his axe against Marx,
Böhm-Bawerk seems to have been motivated by a desire to demonstrate the originality of his own views at the expense of previous
defenses of interest, like that of Nassau Senior.
Senior's Abstinence theory has obtained great popularity among those economists who are favourably disposed to interest.
It seems to me, however, that this popularity has been due, not so much to its superiority as a theory, as that it came in
the nick of time to support interest against the severe attacks that had been made on it. I draw this inference from the peculiar
circumstance that the vast majority of its later advocates do not profess it exclusively, but only add elements of the Abstinence
theory in an eclectic way to other theories favourable to interest.14
Since Böhm-Bawerk was not above such a critique of his own predecessors, we have no obligation to spare him similar treatment,
from an excess of chivalry.
It is remarkable, at least, how the cultural atmosphere of the classical liberal mainstream changed from the early nineteenth
century on. From a revolutionary assault on the entrenched power of the landed aristocracy and chartered monopolies, by the
late nineteenth century it had become an apology for the institutions and interests most closely resembling, in power and
privilege, the ruling class of the Old Regime: the large corporations and the plutocracy.
The shift toward reaction was by no means uniform, however. The revolutionary and anti-privilege character of the early
movement continued in many strands of liberalism. Thomas Hodgskin, squarely in the classical liberal tradition and also by
far the most market-oriented of the Ricardian socialists, criticized the power of the industrial capitalist in language reminiscent
of Adam Smith's attack on landlords and mercantilists--and on very much the same principles.
The American school of individualist anarchism, likewise, turned the weapons of free market analysis against the statist
props of capitalist privilege. Even Hodgskin's disciple Spencer, usually regarded as a stereotypical apologist for capitalism,
at times displayed such tendencies. Henry George and his follower Albert Nock, likewise, turned classical liberalism toward
radically populist ends. Our own version of free market socialism, set out in this book, comes from these heirs of the armed
doctrine of classical liberalism.
At any rate, regardless of their political motivations, the marginalists performed a necessary role. Their detailed critique
of classical political economy pointed out many areas in need of clarification, or of a more explicit philosophical basis.
And the marginalist critique, especially that of Böhm-Bawerk, produced genuinely valuable innovations which any viable labor
theory of value must incorporate. One such criticism (Böhm-Bawerk's critique of the labor-theory for its lack of an adequate
mechanism), and one innovation (the Austrian time preference theory) will be integrated, in the following chapters, into a
reworked labor theory of value.
C. The Marginalists versus Ricardo
Although subsequent marginalist criticisms of Ricardo were more thorough, Jevons fired the opening salvo quite dramatically.
He explicitly formulated his utility-based theory of value in opposition to the labor theory. In his Introduction to The
Theory of Political Economy, he wrote:
Repeated reflection and inquiry have led me to the somewhat novel opinion, that value depends entirely
upon utility. Prevailing opinions make labour rather than utility the origin of value; and there are even those
who distinctly assert that labour is the cause of value. I show, on the contrary, that we have only to trace out carefully
the natural laws of the variation of utility, as depending upon the quantity of commodity in our possession, in order to arrive
at a satisfactory theory of exchange, of which the ordinary laws of supply and demand are a necessary consequence. This theory
is in harmony with facts; and, whenever there is any apparent reason for the belief that labour is the cause of value, we
obtain an explanation of the reason. Labour is found often to determine value, but only in an indirect manner, by varying
the degree of utility of the commodity through an increase or limitation of the supply.15
On the face of it, the bald assertion that utility determines value seems utter nonsense. The only way the supplier of
a good can charge according to its utility to the buyer, is if he is in a monopoly situation which enables him to charge whatever
the market will bear, without regard to the cost of production. But by qualifying this statement to treat marginal utility
as a dependent variable determined by the quantity in our possession, he makes it clear that the influence of value on price
assumes a snapshot of the balance of supply and demand in a market at any given time. This is also a shortcoming of
the Austrian utility theory, as it was developed by Böhm-Bawerk and his Austrian followers, up to the present. Not only did
the later Austrians inadequately treat the time dimension, but they were forced to a position of radical skepticism regarding
the notions of "equilibrium price," in order to avoid a Marshallian understanding of the dynamic effect of production cost
on price, through the effect of market price on supply. To the extent that Jevons admitted the dimension of time, and made
supply itself a function of the supplier's response to market price, he was also forced to admit the effect of labor on value
"in an indirect manner," in much the same way that Marshall was later to do with his famous scissors.
Böhm-Bawerk was at his best in systematically analyzing the exceptions to the labor-theory and the cost-principle. In so
doing, however, he was forced to admit a rough statistical correlation between cost and price in cases of reproducible goods;
and in so admitting, he was forced to reduce his argument to quibbling over the required level of generality of a theory of
value. So, Böhm-Bawerk having set the terms of discussion, let us proceed to examine his list of exceptions to Ricardo's cost-theory
of price. He begins with a general statement of his criticism:
Experience shows that the exchange value of goods stands in proportion to that amount of labour which their production
costs only in the case of one class of goods, and even then only approximately. Well known as this should be, considering
that the facts on which it rests are so familiar, it is very seldom estimated at its proper value. Of course everybody, including
the socialist writers, agrees that experience does not entirely confirm the Labour Principle. It is commonly imagined, however,
that the cases in which actual facts confirm the labour principle form the rule, and that the cases which contradict the principle
form a relatively insignificant exception. This view is very erroneous, and to correct it once and for all I shall put together
in groups the exceptions by which experience proves the labour principle to be limited in economic life. We shall see that
the exceptions so much preponderate that they scarcely leave any room for the rule.16
As we shall see later, though, it is of questionable value to measure quantitatively the exceptions to the law of value;
it makes more sense to treat the effect of cost as a first-order generalization, and then to treat scarcity exceptions as
second-order deviations from this generalization. This was the approach of both Ricardo, in treating cost and scarcity as
twin principles of value, and Marshall, with his scissors. The longer the time frame, the more cost is shown to be the main
influence on the price of goods whose supply can be increased in response to demand, and scarcity rents are shown to be short-term
deviations through which the cost-principle works itself out.
The first exception to the labor theory of value Böhm-Bawerk listed was that for scarce goods with an inelastic supply.
1. From the scope of the Labour Principle are excepted all "scarce" goods that, from actual or legal hindrances, cannot
be reproduced at all, or can be reproduced only in limited amount. Ricardo names, by way of example, rare statues and pictures,
scarce books and coins, wines of a peculiar quality, and adds the remark that such goods form only a very small proportion
of the goods daily exchanged in the market. If, however, we consider that to this category belongs the whole of the land,
and, further, those numerous goods in the production of which patents, copyrights, and trade secrets come into play, it will
be found that the extent of these "exceptions" is by no means inconsiderable.17
Goods that are permanently inelastic in supply are, indeed, the most fundamental exception to Ricardo's labor theory of
value. Such completely inelastic goods are, however, a relatively minor portion of all commodities. The production of most
goods can, eventually, be expanded to a level sufficient to meet demand. For such elastic goods, the only question is the
duration required for such adjustment. Böhm-Bawerk addressed that "exception" (not really an exception at all, as we shall
see, since it does not in any way violate the correspondence between labor-value and equilibrium price) in his fourth
point, quoted below. As for the example of rare works of art, etc., Böhm-Bawark himself admitted that Ricardo had acknowledged
them.
The final group of exceptions--land, patents, etc.--deserves close consideration. Böhm-Bawerk lumped together all goods
with an inelastic supply, regardless of whether their inelasticity results from "actual or legal hindrances." But the mutualist
version of the labor theory of value states that, excepting goods naturally inelastic in supply, profit results from unequal
exchange--itself a result of state intervention in the market. To the extent that scarcity of land is natural, and absentee
landlord claims are not enforced by the state, economic rent on land is a form of scarcity rent that will prevail under any
system. But to the extent that the scarcity is artificial, resulting from government or absentee landlord restrictions on
access to vacant land, or landlord rent on those actually occupying and using land, the mutualist contention is that such
rent is a deviation from normal exchange-value caused by unequal exchange. Patents, likewise, are such a deviation, being
nothing but a monopoly imposed by the state. Such examples, therefore, have no bearing whatsoever on the validity of the labor
theory of value.
As his second item in the list of exceptions, Böhm-Bawerk mentioned the product of skilled labor. In the process of his
discussion, he ridiculed Marx's attempt to salvage a uniform labor-time standard by reducing skilled labor to a multiple of
common labor.18 In this, Böhm-Bawerk was entirely correct. The validity of this criticism was one factor in our attempt to
rework the labor theory of value on the basis of Smith's and Hodgskin's subjective "toil and trouble," in place of Ricardo's
and Marx's embodied labor time. This will be discussed in detail in a later chapter.
The third kind of exception, similarly, included "those goods---not, it is true, a very important class--that are produced
by abnormally badly paid labour."19 But the labor theory of value, as Ricardo formulated it at least, stated that the
exchange values of goods were regulated by the quantity of labor embodied in them--not by the wages of labor. And according
to the mutualist version of the theory, low wages in relation to the total product of labor are a result of unequal exchange
between capital and labor within the production process.
The most important exception, after the first, was the fourth: the fluctuations of commodity prices above and below the
axis of their labor-value, in response to changes in supply and demand.
4. A fourth exception to the Labour Principle may be found in the familiar and universally admitted phenomenon that even
those goods, in which exchange value entirely corresponds with the labour costs, do not show this correspondence at every
moment. By the fluctuations of supply and demand their exchange value is put sometimes above, sometimes below the level corresponding
to the amount of labour incorporated in them. The amount of labour only indicates the point toward which exchange value gravitates,--not
any fixed point of value. This exception, too, the socialist adherents of the labour principle seem to me to make too light
of. They mention it indeed, but they treat it as a little transitory irregularity, the existence of which does not interfere
with the great "law" of exchange value. But it is undeniable that these irregularities are just so many cases where exchange
value is regulated by other determinants than the amount of labour costs. They might at all events have suggested the inquiry
whether there is not perhaps a more universal principle of exchange value, to which might be traceable, not only the regular
formations of value, but also those formations which, from the standpoint of the labour theory, appear to be "irregular."
But we should look in vain for any such inquiry among the theorists of this school.20
In fact, this fourth exception is absolutely devoid of substance, unless one adopts the later Austrian pose of radical
epistemological skepticism toward the notion of "equilibrium price." And if, as Böhm-Bawerk said, Ricardo himself admitted
the existence of that exception, it can only be deduced that Ricardo did not view it as a fatal flaw in the labor theory.
It would seem to follow that Böhm-Bawerk and Ricardo differed in their opinions of the significance of the phenomenon--in
which case, Böhm-Bawerk's real task would be to show why Ricardo was mistaken in his views of what constituted an adequate
theory.
The labor theory of Ricardo did not just implicitly assume such fluctuation, but depended on it. It was only the process
of competition over time, and the response of suppliers and consumers to the fluctuating market price, that continually caused
equilibrium price to gravitate around labor value. And Marx said as much explicitly, as we shall see below.
Ricardo for the most part treated "value" and "price" as synonymous, and claimed only that value approximated embodied
labor over a period of time. Marx, on the other hand, used "value" in a sense much closer to equilibrium price. Both, then,
asserted no more than that the equilibrium price of a good in elastic supply approximates its labor-value. And for both, price
fluctuations under the influence of supply and demand were the very mechanism by which the law of value operated.
Finally, Böhm-Bawerk pointed, as a fifth exception, to those cases in which prices "constantly" diverged from labor-value,
"and that not inconsiderably," to the extent that their production "require[d] the greater advance of 'previous'
labour...."21 If he was referring here to amortization cost of past capital outlays, that presents no problem at all for
the labor theory, given its view of capital as accumulated past labor. If he was referring to the problems presented the labor
theory of value by capitals of different organic composition and the general rate of profit, an at-length study of that issue
is beyond our scope here. Suffice it to say that Ricardo as well as Marx recognized differing capital compositions as a distorting
factor; and Marx saw the general rate of profit only as redistributing surplus-value, and thus rendering the operation of
the law of value indirect. And from the mutualist point of view, profit and interest are monopoly returns on capital resulting
from state intervention in the marketplace; so for mutualism, the rate of profit (excepting the relatively minor part of net
profit resulting from time-preference, with which we will deal in Chapter 3) is simply another example of the distortions
by which unequal exchange causes a deviation from "normal values."
Böhm-Bawerk summed up all the deviations from the labor principle, and concluded that the labor theory of value "does
not hold at all in the case of a very considerable proportion of goods; in the case of the others, does not hold always, and
never holds exactly. These are the facts of experience with which the value theorists have to reckon."22
Böhm-Bawerk's straw-man caricature of what the labor theory was intended to demonstrate, certainly, did not hold up at
all well under his onslaught. But then, straw-men are deliberately constructed to be knocked down. He would have made as much
sense in saying that the law of gravity was invalidated by all the exceptions presented by air resistance, wind, obstacles,
human effort, and so forth. The force operates at all times, but its operation is always qualified by the action of secondary
forces. But it is clear, in the case of gravity, which is the first-order phenomenon, and which are second-order deviations
from it.
Ricardo's distinction between reproducible and non-reproducible goods, true enough, was misleading. Although goods whose
supply is absolutely limited relative to demand are a relatively minor portion of all commodities, it is nevertheless true
that even reproducible goods take a greater or lesser period of time for supply to accommodate demand. At any given time,
the price of most commodities is probably greater or less than labor-value, as a result of imbalance between supply and demand.
It is only over time that price approximates labor-value. So rather than stressing the quantitative insignificance of scarcity
deviations from cost, Ricardo would have been more accurate to emphasize the character of such deviations as a secondary phenomenon
in the overall process by which equilibrium price approximates labor-value.
But the Austrians were guilty of their own ambiguity. Although Menger and Böhm-Bawerk regarded the influence of production
cost as virtually irrelevant in all cases of scarcity, they were unclear exactly what they meant by scarcity.
Menger distinguished economic goods, which were characterized by scarcity, from non-economic goods: "the difference
between economic and non-economic goods is ultimately founded on a difference... in the relationship between requirements
for and available quantities of these goods...."23 Of non-economic goods, he wrote:
The relationship responsible for the non-economic character of goods consists in requirements for goods being smaller than
their available quantities. Thus there are always portions of the whole supply of non-economic goods that are related to no
human need.... Hence no satisfaction depends on our control of any one of the units of a good having non-economic character....24
The problem, though, is that goods are almost never "non-economic" in this sense of having no exchange-value whatever.
Unless an unlimited supply of a good is located at its point of consumption, and requires no effort to appropriate, it will
acquire some value from the effort necessary to transport it to the final user in usable form. Even when a village is surrounded
by forest, with no limit on the amount that may be cut by an individual household, firewood has an exchange-value. Even in
Cockaigne or Big Rock Candy Mountain, one must make the effort of picking the roast chickens off the bush or dipping the whiskey
from the stream.
Menger's disciple, Böhm-Bawerk, likewise made scarcity relative to demand the basis of value. Economic value required "scarcity
as well as usefulness--"
not absolute scarcity, but scarcity relative to the demand for the particular class of goods. To put it more exactly: goods
acquire value when the whole available stock of them is not sufficient to cover the wants depending on them for satisfaction,
or when the stock would not be sufficient without these particular goods.25
And this scarcity, as Böhm-Bawerk put it, was a scarcity of "present goods":
Now it can be shown--and with this we come to the goal of our long inquiry--that the supply of present goods must
be numerically less than the demand. The supply, even in the richest nation, is limited by the amount of the people's wealth
at the moment. The demand, on the other hand, is practically infinite....26
This concept of "scarcity," as used by Menger and Böhm-Bawerk, has three problems. First, as we have already suggested
above, making scarcity and utility depend on the balance of demand and "present goods" at the present moment, it ignores the
dynamic factor. In taking the balance of supply and demand in a particular market at a particular time as a "snapshot," and
deriving value from "utility" in this context, it ignores the effect of short-term price on the future behavior of market
actors: the very mechanism through which price is made to approximate cost over time.
Second, it confuses two kinds of scarcity: 1) the kind of scarcity that makes economic goods (i.e., a difficulty of production
or appropriation sufficient to require some effort or disutility to acquire them in a usable form); and 2) the kind of scarcity
in which a good is in more or less inelastic supply, so that it cannot be produced in quantities proportional to effort. In
a sense, the former kind is set up in opposition to a straw man: as we said above, there are virtually no non-economic
goods.
And third, the claim that demand is virtually infinite relative to supply is misleading. "Demand" is not an independent
variable, but depends on the price at which goods are available. To be "reproducible" in the Ricardian sense, a good need
not be reproducible without limit, in any quantities an individual might conceivably be willing to consume of it, if it cost
nothing. It has only to be reproducible in the quantities for which there is effective demand at the cost of production. And
as we pointed out above, regardless of the degree of elasticity, so long as supply can eventually be adapted to demand,
the equilibrium price will approximate the cost of production.
D. Exceptions to the Cost-Principle: The Classicals in Their Own Defense
Since Böhm-Bawerk and others made so much of the various scarcity exceptions to the cost principle, we will examine the
treatment of such exceptions in the writings of the classical political economists and socialists themselves. If, as we shall
see below, the classicals freely admitted such exceptions, it follows that the marginalists and subjectivists were attacking
a straw man; or at the very least, that they had a far different idea of the level of generality necessary for a theory of
value.
Although Adam Smith figured much less prominently than Ricardo in subjectivist attacks on the labor and cost theories of
value, he still did not entirely escape their attention. So it will be worthwhile to examine statements, in his writing, of
exceptions to the cost principle.
Smith treated the fluctuations of price above and below its "natural level," not as violations of his idea of natural price,
but as the mechanism by which it was sustained.
The market price of every particular commodity is regulated by the proportion between the quantity which is actually brought
to market, and the demand of those who are willing to pay the natural price of the commodity, or the whole value of the rent,
labour, and profit, which must be paid in order to bring it thither. Such people may be called the effectual demanders, and
their demand the effectual demand; since it may be sufficient to effectuate the bringing of the commodity to market. It is
different from the absolute demand. A very poor man may be said in some sense to have a demand for a coach and six...; but
his demand is not an effectual demand, as the commodity can never be brought to market in order to satisfy it....
The quantity of every commodity brought to market naturally suits itself to the effectual demand. It is the interest of
all those who employ their land, labour, or stock, in bringing any commodity to market, that the quantity never should exceed
the effectual demand; and it is the interest of all other people that it never should fall short of that demand.
If, at any time it exceeds the effectual demand, some of the component parts of its price must be paid below their natural
rate. If it is rent, the interest of the landlords will immediately prompt them to withdraw a part of their land; and if it
is wages or profit, the interest of the labourers in the one case, and of their employers in the other, will prompt them to
withdraw a part of their labour or stock from this employment. The quantity brought to market will soon be no more than sufficient
to supply the effectual demand. All the different parts of its price will rise to their natural rate, and the whole to its
natural price.
If, on the contrary, the quantity brought to market should at any time fall short of the effectual demand, some of the
component parts of its price must rise above their natural rate.... [And as a result, factors will enter the market until
t]he quantity brought thither will soon be sufficient to supply the effectual demand. All the different parts of its price
will soon sink to their natural rate, and the whole price to its natural price.
The natural price, therefore, is, as it were, the central price, to which the prices of all commodities are continually
gravitating.27
Smith, in this analysis, outshone the Austrians on two points. First, he admitted supply as a dynamic factor, rather than
treating the balance of supply and demand at any given time outside any larger context. And second, rather than treating demand
as absolute, and therefore virtually unlimited compared to supply, he considered only "effectual" demand for a good at its
"natural" price. Attention to these two points goes a long way to avoiding the misleading impression of the "utility" theory
of value, as baldly stated by the Austrians.
In the same chapter, Smith made a detailed study of the various forms of inelasticity, natural or manmade, which caused
price to deviate from cost in the short or long run. Among these he included trade secrets, site advantages of soil, and state-granted
monopolies.28
The correspondence of actual to natural price, over time, was a function of elasticity of supply. Depending on this variable,
prices might approximate costs more or less quickly, or never. Like Ricardo, Smith limited the operation of the cost principle
to those cases in which the supply of a good could be increased to meet demand.
These different sorts of rude produce may be divided into three classes. The first comprehends those which it is scarce
in the power of human industry to multiply at all. The second, those which it can multiply in proportion to the demand. The
third, those in which the efficacy of industry is either limited or uncertain. In the progress of wealth and improvement,
the real price of the first may rise to any degree of extravagance, and seems not to be limited by any certain boundary. That
of the second, though it may rise greatly, has, however, a certain boundary beyond which it cannot well pass for any considerable
time together. That of the third, though its natural tendency is to rise in the progress of improvement, yet in the same degree
of improvement it may sometimes happen even to fall, sometimes to continue the same, and sometimes to rise more or less, according
as different accidents render the efforts of human industry... more or less successful.
The first category included those goods which "nature only produces in certain quantities...."29
As for Ricardo, he made it clear at the outset that his labor theory of exchange-value applied only to those commodities
whose supply could be increased in response to demand. (Like the other classical political economists and Marx, he also made
utility a criterion for exchange-value--thus dispensing with the favorite "mud pie" red herring of subjectivists.)
Possessing utility, commodities derive their exchange value from two sources: from their scarcity, and from the quantity
of labour required to obtain them.
There are some commodities, the value of which is determined by their scarcity alone. No labour can increase the quantity
of such goods, and therefore their value cannot be lowered by an increased supply. Some rare statues and pictures, scarce
books and coins, wines of a peculiar quality, which can be made only from grapes grown on a particular soil, of which there
is a very limited quantity, are all of this description. Their value is wholly independent of the quantity of labour originally
necessary to produce them, and varies with the varying wealth and inclinations of those who are desirous to possess them.
These commodities, however, form a very small part of the mass of commodities daily exchanged in the market. By far the
greatest part of those goods which are the objects of desire, are procured by labour, and they may be multiplied... almost
without any assignable limit, if we are disposed to bestow the labour necessary to obtain them.
In speaking then of commodities, of their exchangeable value, and of the laws which regulate their relative prices, we
mean always such commodities only as can be increased in quantity by the exertion of human industry, and on the production
of which competition operates without restraint.30
In this passage, Ricardo dealt with goods whose supply is totally inelastic, as exceptions in which exchange-value is determined
by scarcity rather than labor. He also mentioned free competition as a requirement for the law of value to operate. These
are two of the major exceptions listed by Böhm-Bawerk as damning flaws in Ricardo's system, duly noted by Ricardo and seemingly
no great embarrassment to him. Ricardo's main shortcoming in this passage was to treat scarcity and labor as jointly or simultaneously
determining factors, rather than treating labor as a primary factor and scarcity rents as secondary deviations from labor-value.
In Chapter 4, Ricardo turned to divergences from labor-value caused by fluctuations in supply and demand--another major
exception pointed out by Böhm-Bawerk. Again, such divergences were treated, not as an embarrassing violation of the law of
value, but as the mechanism by which it operated.
In the ordinary course of events, there is no commodity which continues for any length of time to be supplied precisely
in that degree of abundance, which the wants and wishes of mankind require, and therefore there is none which is not subject
to accidental and temporary variations of price.
It is only in consequence of such variations, that capital is apportioned precisely, in the requisite abundance and no
more, to the production of the different commodities which happen to be in demand. With the rise or fall of price, profits
are elevated above, or depressed below their general level, and capital is either encouraged to enter into, or is warned to
depart from the particular employment in which the variation has taken place.31
Here he implicitly admitted that the prices of most commodities at any given time are above or below their labor-value,
and in the process of moving toward it. Arguably, he did not adequately treat of the degrees of elasticity, and the varying
time ranges which were required, as a result, for supply and demand to establish an equilibrium at labor-value. But again,
even this was at least implicit in his discussion. It is also clear, from this passage, that Ricardo viewed such oscillations
of price as the mechanism by which the law of value operated, rather than as exceptions to it.
Without elaborating on the differing periods of time involved, or the relative speed with which the production of different
commodities could be increased, Ricardo wrote in Chapter 30 of "temporary" scarcity rents as existing "for a time," and of
production cost "ultimately" regulating price.
It is the cost of production which must ultimately regulate the price of commodities, and not, as has been so often said,
the proportion between the supply and demand: the proportion between the supply and demand may, indeed, for a time, affect
the market value of a commodity, until it is supplied in a greater or less abundance, according as the demand may have increased
or diminished; but this effect will be only of temporary duration.32
Ricardo also wrote of specific kinds of scarcity rent. In Chapter 2, he discussed economic rent to the most fertile tracts
of land, owing to the regulation of price by production costs on the least efficient land at the margin of production.33 In
Chapter 27, he expanded the concept to include producer surpluses or quasi-rents in all areas of the economy; for example,
he argued that providing artificially cheap wool to half of clothiers would not reduce the retail price, because the price
of manufactured goods was "regulated by the cost of... production to those who were the least favoured. Its sole effect...
would be to swell the profits of a part of the clothiers beyond the general and common rates of profits.34 The influence
of demand on price, while holding true of all commodities "for a limited period," was true in the long run only of
"monopolized commodities."
Commodities which are monopolized, either by an individual, or by a company, vary according to the law which Lord Lauderdale
has laid down: they fall in proportion as the sellers augment their quantity, and rise in proportion to the eagerness of the
buyers to purchase them; their price has no necessary connexion with their natural value: but the prices of commodities, which
are subject to competition, and whose quantity may be increased in any moderate degree, will ultimately depend, not on the
state of demand and supply, but on the increased or diminished cost of their production.35
Those who introduced new production technologies might derive temporary producer surpluses, but the general spread of the
new technology, spurred by such increased profits, would eventually cause the price to drop to the level of production cost.36
Ricardo, in "Notes on Malthus," wrote of the determination of price by cost of production, through the influence of cost
on supply, in terms that closely foreshadowed Jevons. Natural price was only "that price which will repay the wages of
labour expended on [a commodity], will also afford rent, and profit at their then current rate." Those production
costs "would remain the same, whether commodities were much or little demanded, whether they sold at a high or low market
price." Market prices, true enough, would "depend on supply and demand"; but the supply would "be finally determined
by... the cost of production."37
John Stuart Mill was very much in the Ricardian tradition, in dealing with the effect of cost and scarcity on price. Like
Ricardo, he held cost to be the determining factor for reproducible goods.
1. When the production of a commodity is the effect of labour and expenditure, whether the commodity is susceptible of
unlimited multiplication or not, there is a minimum value which is the essential condition of its being permanently produced.
The value at any particular time is the result of supply and demand; and is always that which is necessary to create a market
for the existing supply. But unless that value is sufficient to repay the cost of production... the commodity will not continue
to be produced....
When a commodity is not only made by labour and capital, but can be made by them in indefinite quantity, this Necessary
Value, the minimum with which the producers will be content, is also, if competition is free and active, the maximum which
they can expect....
As a general rule, then, things tend to exchange for one another at such values as will enable each producer to be repaid
the cost of production with the ordinary profit....38
Adam Smith and Ricardo have called that value of a thing which is proportional to its cost of production, its Natural Value
(or its Natural Price). They meant by this, the point about which the value oscillates, and to which it always tends to return;
the centre value, towards which, as Adam Smith expresses it, the market value of a thing is constantly gravitating; and any
deviation from which is but a temporary irregularity, which, the moment it exists, sets forces in motion tending to correct
it....
It is, therefore, strictly correct to say, that the value of things which can be increased in quantity at pleasure, does
not depend (except accidentally, and during the time necessary for production to adjust itself,) upon demand and supply; on
the contrary, demand and supply depend upon it. There is a demand for a certain quantity of the commodity at its natural or
cost value, and to that the supply in the long run endeavours to conform.39
Like Smith, Mill divided commodities into three groups, based on their reproducibility. In some cases, there was an "absolute
limitation of the supply," owing to the fact that it was "physically impossible to increase the quantity beyond certain
narrow limits." As examples, he listed the same kinds of commodities as Smith: works of art, and produce grown on specific
rare types of soil. Other commodities could be multiplied without limit, given the willingness to incur a certain amount of
labor and expense to obtain them. Finally, some commodities could be multiplied indefinitely with sufficient labor and expenditure,
"but not by a fixed amount of labour and expenditure." Greater levels of output required greater unit costs of production
(here he referred mainly to agricultural produce).40
Mill was somewhat more explicit than Ricardo in dealing with the time element in determining the degree of elasticity.
The time period involved in the gravitation of price toward cost depended on the length of time required to adjust production
to changes in demand, or to dispose of surplus produce.
Again, though there are few commodities which are at all times and for ever unsusceptible of increase of supply, any commodity
whatever may be temporarily so.... Agricultural produce, for example, cannot be increased in quantity before the next harvest....
In the case of most commodities, it requires a certain time to increase their quantity; and if the demand increases, then,
until a corresponding supply can be brought forward, that is, until the supply can accommodate itself to the demand, the value
will so rise as to accommodate the demand to the supply.41
Like Ricardo, Mill believed that price was governed by the cost of production for those producers most unfavorably circumstanced.
Those in a more advantageous situation would receive a producer's surplus equivalent to their cost savings. And like Ricardo,
he applied the principle not only to economic rent on land, but to quasi-rents on manufactured goods.
2. If the portion of produce raised in the most unfavourable circumstances obtains a value proportional to its cost of
production; all the portions raised in more favourable circumstances, selling as they must do at the same value, obtain a
value more than proportioned to their cost of production.... The owners... of those portions of the produce... obtain a value
which yields them more than the ordinary profit. If this advantage depends upon any special exception, such as being free
from a tax, or upon any personal advantages, physical or mental, or any peculiar process only known to themselves, or upon
the possession of a greater capital than other people, or upon various other things which might be enumerated, they retain
it to themselves as an extra gain, over and above the general profits of capital, of the nature, in some sort, of a monopoly
profit....42
4. Cases of extra profit analogous to rent, are more frequent in the transactions of industry than is sometimes supposed.
Take the case, for example, of a patent, or exclusive privilege for the use of a process by which cost of production is lessened.
If the value of the product continues to persist in the old process, the patentee will make an extra profit equal to the advantage
which his process possesses over theirs.43
Marx and Engels were in complete agreement with the classical political economists on the role of competition in regulating
the law of value. Engels, in his Preface to Marx's Poverty of Philosophy, ridiculed the utopian socialist notion of
making labor the basis of a medium of exchange. The market forces of supply and demand were needed to inform the producer
of the social demand for his product, and to establish the normal amount of social labor necessary for the production of a
given commodity. So the deviation of price from value at any given time was not a violation of the law of value, but its driving
mechanism.
In present-day capitalist society each individual capitalist produces off his own bat what, how and as much as he likes.
The social demand, however, remains an unknown magnitude to him, both in regard to quality, the kind of objects required,
and in regard to quantity.... Nevertheless, demand is finally satisfied in way or another, good or bad, and, taken as a whole,
production is ultimately geared towards the objects required. How is this evening-out of the contradiction effected? By competition.
And how does the competition bring about this solution? Simply by depreciating below their labour value those commodities
which by their kind or amount are useless for immediate social requirements, and by making the producers feel... that they
have produced either absolutely useless articles or ostensibly useful articles in unusable, superfluous quantity....
....[C]ontinual deviations of the prices of commodities from their values are the necessary condition in and through
which the value of the commodities as such can come into existence. Only through the fluctuations of competition, and consequently
of commodity prices, does the law of value of commodity production assert itself and the determination of the value of the
commodity by the socially necessary labour time become a reality.... To desire, in a society of producers who exchange their
commodities, to establish the determination of value by labour time, by forbidding competition to establish this determination
of value through pressure on prices in the only way it can be established, is therefore merely to prove that... one has adopted
the usual utopian disdain of economic laws.
....Only through the undervaluation or overvaluation of products is it forcibly brought home to the individual commodity
producers what society requires or does not require and in what amounts.44
Marx made very much the same argument in the main body of The Poverty of Philosophy: it was market price that signaled
the producer how much to produce, and thus regulated price according to the law of value.
It is not the sale of a given product at the price of its cost of production which constitutes the "proportional relation"
of supply and demand, or the proportional quota of this product relatively to the sum total of production; it is the variations
in demand and supply that show the producer what amount of a given commodity he must produce in
order to receive at least the cost of production in exchange. And as these variations are continually occurring, there is
also a continual movement of withdrawal and application of capital in the different branches of industry....
....Competition implements the law according to which the relative value of a product is determined by the labour time
needed to produce it.45
Marx's and Engels' remarks in these passages probably came closer than anywhere else to meeting Bohm-Bawerk's demand for
a mechanism of the law of value (see Chapter 2 below).
In Grundrisse, Marx described the functioning of the law of value through the movement of price in somewhat more
dialectical language:
The value of commodities determined by labour time is only their average value....
The market value of commodities is always different from this average value and always stands either below
or above it.
The market value equates itself to the real value by means of its continual fluctuations, not by an equation with real
value as some third thing, but precisely through continued inequality to itself....
Price, therefore, differs from value, not only as the nominal differs from the real; not only by its denomination
in gold and silver; but also in that the latter appears as the law of the movements to which the former is subject. But they
are always distinct and never coincide, or only quite fortuitously and exceptionally. The price of commodities always stands
above or below their value, and the value of commodities itself exists only in the UPS AND DOWNS of commodity prices. Demand
and supply continually determine the prices of commodities; they never coincide or do so only accidentally; but the costs
of production determine for their part the fluctuations of demand and supply.46
And such deviations from value included quasi-rents to those who first introduced more efficient methods of production.
It was only through the market incentive presented by such quasi-rents, and through the resulting competition, that improved
methods were universally adopted and came to define the standard form of production. "A capitalist working with improved
but not as yet generally adopted methods of production sells below the market price, but above his individual price of production;
his rate of profit rises until competition levels it out."47
Finally, to bring up the "mud pie" straw-man for another beating, Marx made socially necessary labor the regulator
of value. The labor theory of value applied only to commodities, which were objects of human need. Labor expended in
producing goods not demanded, or excess labor wasted in methods of production less efficient than the norm, was a dead loss.
It was the function of the market price, in denying payment for such unnecessary labor, that brought the producer into accord
with the wishes of society.
Each of these units is the same as any other, so far as it has the character of the average labour power of society, and
takes effect as such: that is, so far as it requires for producing a commodity no more time than is needed on an average,
no more than is socially necessary. The labour time socially necessary is that required to produce an article under the normal
conditions of production, and with the average degree of skill and intensity prevalent at the time....
We see then that that which determines the magnitude of the value of any article is the amount of labour socially necessary,
or the labour time socially necessary for its production.48
The concept of socially necessary labor is the appropriate answer to Böhm-Bawerk's "rare butterfly" challenge to Adam Smith.
A rare butterfly that took more effort to capture than a beaver or deer would not carry more exchange-value than those commonly
useful items, unless the effectual demand for the butterfly was sufficient to recompense the labor of capturing it. In most
cases, therefore, the market for such rare butterflies would consist of rich eccentrics, and the effectual demand for them
would support only a small number of laborers. As a result, the market price would inform superfluous butterfly hunters that
most of their labor was socially unnecessary, and labor would be withdrawn from such "production" until the price was sufficient
to recompense the labor of catching them. The classical political economists and Marxists, as much as Austrians, understood
that labor expended on production for which there was no demand was a "sunken cost."
The neo-Ricardian Ronald Meek interpreted the term "value," as Marx used it, to mean something like "equilibrium price"
in neoclassical economics.
It is important to note at the outset that Marx's theory of value, like those of Smith and Ricardo, did not pretend to
explain any prices other than those at which "supply and demand equilibrate each other, and therefore cease to act". The prices
in which Marx was primarily interested were those which manifested themselves at the point where supply and demand "balanced"
or "equilibrated" one another. The very fact that the forces of supply and demand did actually "balance" at this point was
taken by Marx as an indication that the level of the equilibrium price could not be adequately explained merely in terms of
the interaction of these forces. The relation of supply and demand could certainly explain deviations from the equilibrium
price, but it could not explain the level of the equilibrium price itself. It was in fact precisely through fluctuations
in "supply and demand" that the law of value operated to determine the equilibrium price.
"Prices, then, might diverge from values in cases where supply and demand did not "balance"....
Just as Marx's concept of value involved an abstraction from utility... so the theory of the determination of equilibrium
price based upon it involved a similar abstraction from demand. In common with his Classical predecessors, Marx assumed that
changes in demand would not in themselves... bring about changes in this long-run equilibrium prices of the commodities concerned.
But this is not at all to say that Marx ignored demand. It remained true, as he emphasized, (a) that a commodity
had to be in demand before it could possess exchange value; (b) that changes in demand might cause the actual market
price of a commodity to deviate from its equilibrium price; (c) that price under conditions of monopoly was "determined
only by the eagerness of the purchasers to buy and by their solvency"; and (d) that demand was the main force determining
the proportion of the social labour allocated to any given productive sector at any given time.49
Of course, as Marshall later pointed out, this irrelevance of demand to equilibrium price was complicated by the fact that
the level of effective demand might affect the scale of production, and thereby also affect unit costs of production.
Meek criticized Vilfredo Pareto, in very nearly the same terms as we have criticized Bohm-Bawerk, for his attacks on a
straw-man version of Marx's labor theory of value.
...all too often the imaginary Marxists with whom Pareto argues are made to put forward interpretations of the labour theory
which are suspiciously simple-minded.... [For example] it is easy enough to show that the labour theory does not apply
to rare pictures, etc., since (as Pareto well knew) it was never intended to apply to anything other than freely reproducible
goods. Nor is it sufficient, when the Marxist characterizes as exceptional the case of the picture whose price increases when
its painted becomes famous without anything having happened to the quantity of labour embodied in it, to reply that it is
by no means exceptional because the prices of all commodities may vary without anything happening to the quantity of
labour embodied in them--e.g., on account of a change in the tastes and incomes of their consumers.50
The proper reply to such criticism, Meek argued, was "that the long-run equilibrium prices of freely reproducible commodities
(as distinct from their day-to-day market prices) will not in fact be affected by a change in demand unless it is accompanied
by a change in the conditions of production.51
Finally, since our version of the labor theory of value owes more to Benjamin Tucker than to Marx, it is only appropriate
to provide some examples in which Tucker acknowledged "exceptions" to the labor theory. Tucker accepted the existence of short-term
quasi-rents on commodities for which demand had increased, or commodities for which new production processes had been introduced.
Like the Classicals and Marx, he viewed competition as the mechanism by which price would be reduced to cost, when market
entry was free and goods were freely reproducible. "It is true that the usefulness of [the laborer's] product has
a tendency to enhance its price; but this tendency is immediately offset, wherever competition is possible, ...by the rush
of other laborers to create this product, which lasts until the price falls back to the normal wages of labor."52
Tucker also recognized that economic rent on land with advantages in location or fertility would persist, even when absentee
landlord rent was abolished. And he likewise viewed producer surpluses resulting from superior innate skill as analogous to
economic rent on land, and thus as inevitable even with the abolition of privilege. Although abolishing the land monopoly
would reduce rent to "a very small fraction of its present proportions," some would still remain. The "remaining
fraction," nevertheless,
would be the cause of no more inequality than arises from the unearned increment derived by almost every industry from
the aggregation of people or from that unearned increment of superior natural ability which even under the operation of the
cost principle, will probably always enable some individuals to get higher wages than the average rate.53
In response to the question of how one could justify the receipt of the equivalent of 500 days' labor, by the possessor
of an especially fertile piece of land, for only 300 days of his own, Tucker responded that such justification would be "[p]recisely
as difficult as it would be to show that the man of superior skill (native, not acquired) who produces in the ratio of five
hundred to another's three hundred is equitably entitled to this surplus exchange value."54
Tucker was willing to accept such permanent scarcity rents as necessary evils. He distinguished between competitive disabilities
which resulted from "human meddlesomeness," and those which did not.55 Unlike usury and landlord rent, which resulted from
the coercively-maintained legal privilege of owners of capital and land, the remaining forms of producer surplus resulted
only from general circumstances or "acts of God," and were therefore not exploitative. The evils involved in creating a coercive
mechanism to iron out such inequalities and collect payment from free riders would exceed the evils of the inequalities themselves.
To directly enforce equality of material well-being is meddlesome, invasive, and offensive, but to directly enforce equality
of liberty is simply protective and defensive. The latter is negative, and aims only to prevent the establishment of artificial
inequalities; the former is positive, and aims at direct and active abolition of natural inequalities.56
"How are we to remove the injustice of allowing one man to enjoy what another has earned?" I do not expect it ever to be
removed altogether. But I believe that for every dollar that would be enjoyed by tax-dodgers under Anarchy, a thousand dollars
are now enjoyed by men who have got possession of the earnings of others through special industrial, commercial, and financial
privileges granted them by authority in violation of a free market.57
Forcibly charging a man for the producer's surplus resulting from his superior skill or the superior fertility of his land,
would be at least as unjust as allowing him to keep it. "If it is unearned, certainly his neighbors did not earn it."58
"If the cost principle of value cannot be realized otherwise than by compulsion, then it had better not be realized."59
E. Generality and Paradigms
Böhm-Bawerk grudgingly admitted a correlation between price and cost: in almost Marshallian terms, he conceded that Ricardo
went only "a very little way" too far in downplaying the influence of scarcity, and in overstating the importance of labor
as one factor among several.
...the conclusion might very well be drawn that expenditure of labour is one circumstance which exerts a powerful influence
on the value of many goods; always remembering that labour is not an ultimate cause--for an ultimate cause must be common
to all the phenomena of value--but a particular and intermediate cause....
Ricardo himself only went a very little way over the proper limits. As I have shown, he knew right well that his law of
value was only a particular law; he knew, for instance, that the value of scarce goods rests on quite another principle. He
only erred in so far as he very much over-estimated the extent to which his law is valid, and practically ascribed to it a
validity almost universal. The consequence is that, later on, he forgot almost entirely the little exceptions he had rightly
made but too little considered at the beginning of his work, and often spoke of his law as if it were really a universal law
of value.60
Indeed, but for deviations caused by "friction" and the time element, the correlation between production cost and price
would be quite close.
If--what is practically inconceivable--production were carried on in ideal circumstances, unfettered by limitations of
place and time, with no friction, with the most perfect knowledge of the position of human wants requiring satisfaction, and
without any disturbing changes of wants, stocks, or techniques, than the original productive powers would, with ideal and
mathematical exactitude, be invested in the most remunerative employments, and the law of costs, so far as we can speak of
such a law, would hold in ideal completeness. The complementary groups of goods from which, in the long-run, the finished
good proceeds, would maintain exactly the same value and price at al stages of the process; the commodity would be exactly
equal to costs; these costs to their costs, and so on, back to the last original productive powers from which ultimately all
goods come.61
The assumptions here sound quite similar to the Misean theoretical construct of the "evenly rotating economy," which we
shall discuss below. Böhm-Bawerk went on to elaborate on friction and time as causes for deviation from this ideal model:
The first of these [disturbing causes] I may call by the general name of Friction. Almost invariably there is some
hindrance, great or small, permanent or temporary, to the due investment of the original productive powers in the employments
and forms of consumption which are the most remunerative at the time. In consequence the provision for wants, and likewise
the prices, are somewhat unsymmetrical. Sometimes it is that individual branches of want are, relatively, more amply supplied
than others.... But sometimes it may be that groups of productive materials, successively transformed till they are changed
at last into the finished commodity, are not equally valued at all stages of the process [here he used the analogy of
a stream to illustrate bottlenecks at various stages of the production process]....
In practical life such frictional disturbances are innumerable. At no moment and in no branch of production are they entirely
absent. And thus it is that the law of costs is recognized as a law that is only approximately valid; a law riddled through
and through with exceptions. These innumerable exceptions, small and great, are the inexhaustible source of the undertakers'
profits, but also of the undertakers' losses.
The second disturbing cause is the Lapse of Time--the weeks, months, years which must stretch between the inception of
the original productive powers, and the presentation of their finished and final product. The difference of time, in exerting
a far-reaching influence on our valuation of goods, makes a normal difference between the value of the productive groups standing
at different points of the production process...; and is, therefore, a difference to be kept quite distinct from the unsymmetrical
divergences caused by frictional disturbances.62
The time element is the subject of Chapter Three below, in which time preference is incorporated into our mutualist version
of the labor theory. As for "friction," all scarcity rents can arguably be classed under this heading. And Böhm-Bawerk's treatment
of cost and various forms of friction as simultaneously codetermining influences on value is questionable, at best. It is
much more useful and informative to treat labor or cost as the primary influence on normal value (i.e., equilibrium
price given elasticity), and to say that value deviates from this norm to the extent that friction comes into the picture.
Maurice Dobb argued ably that a key difference between the classical political economists and the subjectivists was their
opinion on the level of generality necessary for an adequate theory of value. Much of the disagreement over the Ricardian
paradigm stems from a difference of opinion on whether the exceptions Ricardo admitted to the law of value were sufficient
to invalidate it. For Dobb, obviously, the answer was "no."
In Political Economy and Capitalism, he detailed the simplifying assumptions of Marx's value theory, and the various
exceptions to it resulting from scarcity or differing compositions of capital. These exceptions were "held to be fatal"
by the marginalists, and were "the onus of Böhm-Bawerk's criticism of Marx."
But all abstractions remain only approximations to reality: this is their essential nature; and it is no criticism of a
theory of value merely to say that this is so. Whether such assumptions are permissible or no is a matter of the type of question,
the nature of the problem, with which the principle is designed to deal. The criticism only becomes valid if it shows that
the implicit assumptions preclude the generalization from sustaining these corollaries which it is employed to sustain....
It is too seldom remembered to-day that the concern of classical Political Economy was with what one may term the "macroscopic"
problems of economic society, and only very secondarily with "microscopic" problems, in the shape of the movements of particular
commodity prices.
Dobb compared Marx's general law of value, as a first approximation, and the second approximations adjusting it for deviations
resulting from scarcity and differences in organic composition of capital, to the successive approximations of the law of
projectiles in physics made necessary by wind resistance and other countervailing influences.63
In discussing the proper levels of generality of paradigms, Dobb mentioned Kuhn's thesis of paradigm shift in science,
and the recurring practice of incorporating rival paradigms as "special theories" within a larger and more general framework.64
This model is applicable here. Marginal utility is quite useful not only in describing the laws of behavior governing scarcity
exceptions to the labor theory of value, but the laws of behavior governing how much of a commodity is consumed at its
labor value. Marginal utility theory, if incorporated into a labor theory of value, would be a major improvement in the
sophistication with which the theory explained how and why the law of value operated through the subjective
perceptions and decisions of concrete human beings.
For example, Leif Johansen attempted in two articles to show how marginal utility could be incorporated into a labor theory
of value. In "Marxism and Mathematical Economics," he described the general terms of such a synthesis:
The Marxist labor theory of value has been the object of attacks particularly from the point of view of "marginal utility
theory" or "subjective theory of value," which has been a main component of non-Marxist mathematical economics. Marxists have
usually rejected this whole theory and all concepts and mathematical arguments introduced in connection with it, as if acceptance
of it, or elements of it, would necessarily imply a rejection of the labor theory of value. However, this is not so. For goods
which can be reproduced on any scale (i.e. such goods as have been the center of interest of Marxian value theory) it is very
easy to demonstrate that a complete model still leaves prices determined by the labor theory of value even if one accepts
the marginal utility theory of consumers' behavior.65
Elaborating on this statement in a later article, Johansen described a model in which prices were determined by the conditions
of production, while "[t]he marginal utility functions interact with the prices thus given only in determining the quantities
to be produced and consumed of the different commodities."66
In any case, the labor theory of value as we develop it in the next chapter is not an inductive generalization from the
empirical data of prices in the market. It is, rather, a law deduced from basic assumptions on the nature of human action,
quite similar to those of Mises' praxeology. As Mises wrote, the variables of the market are so many that no laws can be induced
from mere observation, without the aid of valid starting assumptions established on an a priori basis. The laws of praxeology
were a tool for analyzing market phenomena, not a generalization from them. Like Mises' laws of praxeology, our labor theory
of value is not an inductive law of market price, but an a priori assumption in terms of which the observed phenomena of the
market make better sense. Starting with our assumptions on the subjective mechanism of human behavior, we can understand why
equilibrium price will approximate cost. And given this baseline understanding of the primary law of equilibrium price, we
can understand why price deviates from the cost principle in cases of scarcity.
If an adequate theory of value requires a high degree of predictive value concerning concrete prices, then both the labor
theory and subjective theory fall apart equally. On the other hand, if value theory in the sense of an empirical rule for
predicting concrete prices is impossible because the variables are too many, then both theories are likewise on equally untenable
ground. But like Mises' subjective theory of value, our version of the labor theory is a set of a priori axioms and the deductions
from them, which can be used to more usefully interpret market data after the fact. Böhm-Bawerk's critiques of Ricardo
or Marx, based on the failure of experience to bear them out in all cases, are equally applicable to Mises' theory of value.
The Austrians have made a closely related argument: that equilibrium price is an imaginary construct that can never be
observed in the real marketplace. But (as we shall see in a later section of this chapter) this radical epistemological skepticism
does not bear much looking into, given the Austrian concept of the "Final State." Any criticism of equilibrium price, as a
standpoint from which to examine actual market prices at any given time, applies equally to the "final state" or "final equilibrium."
As Mises himself wrote,
The specific method of economics is the method of imaginary constructions.
This method is the method of praxeology....
An imaginary construction is a conceptual image of a sequence of events logically evolved from the elements of action employed
in its formation. It is a product of deduction, ultimately derived from the fundamental category of action, the act of preferring
and setting aside....
The main formula for designing of imaginary constructions is to abstract from the operation of some conditions present
in actual action. Then we are in a position to grasp the hypothetical consequences of the absence of these conditions and
to conceive the effects of their existence....
The imaginary construction of a pure or unhampered market economy assumes that there is a division of labor and private
ownership (control) of the means of production and that consequently there is market exchange of goods and services. It assumes
that the operation of the market is not obstructed by institutional factors.... The market is free; there is no interference
of factors, foreign to the market, with prices, wage rates, and interest rates. Starting from these assumptions economics
tries to elucidate the operation of a pure market economy. Only at a later stage... does it turn to the study of the various
problems raised by interference with the market on the part of government and other agencies employing coercion and compulsion.67
Böhm-Bawerk's hypothetical description of a "frictionless" economy, above, can be taken as an early attempt at such an
abstract conceptual model. Mises’ "final state" was another, a model of the values toward which prices were tending
at any time:
The prices of all commodities and services are at any instant moving toward a final state.... However, the changing economy
never reaches the imaginary final state. New data emerge again and again and divert the trend of prices from the previous
goal of their movement toward a different final state...."68
Rothbard developed the concept still further as "final equilibrium." Despite his straw-man caricatures and semantic quibbling
with Marshall, it closely resembled Marshall's concept of the "long run."
It is to be distinguished from the market equilibrium prices that are set each day by the action of supply and demand.
The final equilibrium state is one which the economy is always
tending to approach.... In actual life, however, the data are always changing, and therefore, before
arriving at a final equilibrium point, the economy must shift direction, towards some final equilibrium position.
Hence, the final equilibrium position is always changing, and consequently no one such position is ever reached in practice.
But even though it is never reached in practice, it has a very real importance. In the first place, it is like the mechanical
rabbit being chased by the dog. It is never reached in practice and it is always changing, but it explains the direction in
which the dog is moving.69
Ah! So Rothbard's objection to the Marshallian "scissors" was Marshall's claim that "equilibrium price" or the "long run"
could be reached in practice! Strangely enough, though, I can't recall ever seeing any such claim by Marshall.
We should be careful, by the way, to distinguish the Austrian concepts of "final state" and final "equilibrium" from that
of the "Evenly Rotating Economy." Marshall's "long run," although bearing some resemblance to the "final equilibrium," differed
fundamentally from the "Evenly Rotating Economy." The latter was an imaginary construct of a static economy from which all
change was abstracted. The "long run," on the other hand, was a goal toward which the economy was tending at any given moment
through the subjective valuations of market actors and the fluctuations of the market (much like Adam Smith's "natural
price").
F. The Marshallian Synthesis
Alfred Marshall, the founder of the so-called neoclassical school, was also the first prominent economist to attempt a
reconciliation of Ricardo with the marginalists. Following the Senior-Longfield school, as interpreted by Mill, Marshall treated
the "abstinence" of capital (or "waiting") as another form of disutility alongside labor. He thus fused them into a unified
subjective theory of "real cost," as the determining factor in supply price. As Mill said, profits were remuneration for the
capitalist's abstinence, in the same sense that wages were the remuneration of labor. This Marshallian synthesis adopted virtually
the entire apparatus of marginalism, but was much closer in spirit to the cost of production theories of Ricardo and Mill.70
In regard to profit as the "cost" of capital, Marshall cast it in subjective terms: the return necessary to persuade the
capitalist to bring his capital to market. "Everyone is aware that no payment would be offered for the use of capital unless
some gain were expected from that use...." In contradiction to the surplus value theory of Rodbertus and Marx, Marshall
said that exchange value was the result of both "labour and waiting." Marshall distinguished, in much the same terms
as Böhm-Bawerk, between gross interest, and net interest as the reward for waiting as such.71
Of this notion of profit or interest as a reward for "abstinence" or "waiting" (or "time preference," as the Austrians
preferred to put it), we will have much to say in the next two chapters. Suffice it for the present to say that the market
value of abstinence, like the Austrian rate of time preference, varies a great deal with such factors as the distribution
of property and the legal disabilities imposed on competition in the capital market.
Marshall recast Ricardo's twin factors of price determination, labor and scarcity, as the two blades of his scissors. "We
might as reasonably dispute whether it is the upper or the underblade of a pair of scissors that cuts a piece of paper, as
whether value is governed by utility or cost of production..."72
Marshall believed Ricardo had erred in his overemphasis of the importance of cost or supply price at the expense of demand
or utility. Regarding Ricardo's neglect of demand, Marshall wrote that it had recently received increased attention as a result
of
the growing belief that harm was done by Ricardo's habit of laying disproportionate stress on the side of cost of production,
when analysing the causes that determine exchange value. For although he and his chief followers were aware that the conditions
of demand played as important a part as those of supply in determining value, yet they did not express their meaning with
sufficient clearness, and they have been misunderstood by all but the most careful readers.73
As the last phrase suggests, Marshall believed the shortcomings of Ricardian economics were as much the fault of poor interpretation
as of the theory itself.
More importantly, Marshall's assertion that demand played "as important a part" as supply was qualified by his understanding
of the time factor. For Marshall, the shorter the time period, the more it was possible to treat supply as fixed for the time
being; and as a result, the more the blade of scarcity predominated over that of cost. Price was determined, at any given
time, by the balance between the demand and supply that actually existed at that moment. As the time factor came into play,
and supply could be treated as a dynamic variable, the cost blade gained in ascendancy until, at some hypothetical approach
to a "pure" equilibrium price, price approached closer and closer to cost. Marshall concluded that, "as a general rule,
the shorter the period which we are considering, the greater must be the share of our attention which is given to the influence
of demand on value; and the longer the period, the more important will be the influence of cost of production on value."
74
In describing the hypothetical equilibrium toward which the market tended, Marshall used language quite similar to that
of Mises concerning the value of "imaginary constructions":
Our first step towards studying the influences exerted by the element of time on the relations between the cost of production
and value may well be to consider the famous fiction of the "stationary state" in which those influences would be but little
felt; and to contrast the results which would be found there with those in the modern world.75
And, bearing an uncanny resemblance to Böhm-Bawerk, he wrote that short-term prices "are governed by the relation of
demand to stocks actually in the market" at any given time.76 Existing stocks of goods are all that are available
pending the time lapse required for further production, regardless of demand; and excess goods are a "sunken cost," regardless
of demand shortfall.
Again, there is no connection between cost of reproduction and price in the cases of food in a beleaguered city, of quinine
the supply of which has run short in a fever-stricken island, of a picture by Raphael, of a book that nobody cares to read,
of an armour-clad ship of obsolete pattern, of fish when the market is glutted, of fish when the market is nearly empty, of
a cracked bell, of a dress material that has gone out of fashion, or of a house in a deserted mining village.77
Production cost is an influence on price only over time, as supply is adjusted in response to effective demand, and supply
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