Labor theory of value: An economic theory stating that the true value of a good or service is determined by the amount of labor required to produce it.

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Key Takeaways

The labor theory of value (LTV) is an economic theory that argues that the value of a commodity could be objectively measured by and is determined by the amount of labor (such as the average number of labor hours) required to produce the commodity (Gordon, 2021).
According to this theory, the source of a product’s value is the total amount of labor necessary to create it. Though generally associated with the economics of Karl Marx, the labor theory of value has a long history (Beggs, 2012; Mongiovi, 2002).
It has been discussed by ancient philosophers and medieval scholars, as well as by classical economists such as Adam Smith and David Ricardo.
The theory rose to prominence during the 18th and 19th centuries. However, the onset of the Subjectivist Revolution eventually challenged its fundamental tenets and vastly abated its relevance to economic analysis.

Understanding the Labor Theory

The labor theory of value posits that two commodities should be exchanged at a rate determined by the relative dissimilarities in their costs in terms of labor time. This also means that commodities requiring the same amounts of labor for their production would trade at the same price.

For example, if hunting a deer takes 10 hours and catching a beaver 5 hours, then, 1 deer for 2 beavers would be the exchange ratio. Conversely, if both consumed 10 hours each, then the exchange ratio would be 1:1.

In developing their theories, Adam Smith and David Ricardo envisioned a hypothetical state of humanity (which is foreign to any conception of capital) that comprises elementary commodity production. In this thought experiment, self-producers equipped with their tools and materials are the primary actors in the economy.

Moreover, deer and beaver are produced here. Now, if the production of deer becomes more profitable than the production of beaver, individuals will migrate from beaver production to deer production.

Subsequently, the supply of deer would rise, thereby reducing the income from deer production. At the same time, fewer people would be employed in beaver production whose income would now be higher. It bears noting that the quantity of labor (labor time) primarily regulates self-produced incomes.

Consequently, as Smith noted, labor, herein, is exchange money for commodities, and an item’s relative value would rise in proportion to the amount of labor required for its production.

Ricardo on the other hand, was more focused on how relative prices of commodities were governed. For instance, the costs of deer and beaver production include not merely the direct costs of hunting but also the indirect costs of producing implements such as traps, bows and arrows.

Therefore, the vertical integration of direct and indirect costs would further raise the costs of production. It is also worth mentioning that the incorporation of indirect costs could alter the relative profitability of an occupation.

For example, the direct labor costs of hunting a deer and trapping a beaver might be 10 hours and 5 hours respectively.

However, if the costs of producing a bow and an arrow for hunting deer, and devising a trap to catch beavers are respectively 5 and 10 hours, the exchange rate between the two commodities would be 1:1.

Under such conditions, neither of the commodities would possess an advantage of relative profitability over the other.

Labor Theory and Marxism

The labor theory of value pervades almost every facet of Marxian economic analysis (Gordon, 2021). Das Kapital, for instance, was primarily focused on the tension between the working class’s labor power and the capitalists’ ownership of the means of production.

Marx held that human labor was the sole characteristic common to all goods and services.

He, nonetheless, contended that two commodities’ having an equivalent amount of labor would not suffice, and that the two commodities must contain the same quantity of ‘socially necessary labor,’ a somewhat nebulous concept which Marx failed to define in computationally robust terms.

Finally, Marx’s critique of free market economics was waged with the weapon of the labor theory.

In formulating his exploitation theory of capitalism, Marx declared that if all commodities in a capitalist system are exchanged at prices reflecting their true value (measured in labor hours according to Marx), capitalists would not be earning profits unless the laborers were being paid less than the actual value of their labor.

Problems with the Labor Theory of Value

The labor theory of value contains a multiplicity of serious theoretical and practical flaws.

Several key arguments penned by the British economist Philip Wicksteed (19884), however, seem to sum up the most cogent criticisms of Marxism’s most potent rallying cry for class warfare (Thomas, 2019):

The Subjective Nature of Value: Wicksteed (1884) states that a commodity’s value is measured not by any of its inherent properties, but by the subjective evaluations of its consumer.

He argues that the “exchanged articles differ from each other in the specific desires which they satisfy” while “they resemble each other in the degree of satisfaction which they confer”.
Marginal Utility: The concepts of diminishing marginal utility and marginal analysis, insights offered by Austrian economics, mount another challenge to the labor theory of value.

The more of a commodity you already possess, the less urgent your need would be for an additional unit of the same commodity—although the labor cost associated with its production might remain unaltered. Consequently, you would pay less for each additional unit.

Wicksteed illustrated the point noting that “in a community every member of which possessed two coats already, a further increment of coats would (ceteris paribus) satisfy a less urgent need, possess a less utility, and therefore have a lower exchange value than would be the case in a community each member of which possessed only one coat”.
Collectibles: There are certain exchangeable commodities such as “specimens of old china, pictures by deceased masters, and to greater or less degrees the yield of all natural or artificial monopolies” whose quality and number, labor is “powerless to affect” (Wicksteed, 1884).

The values of such commodities too, however, increase and decrease over time “because their utility changes”. Their utility changes because of an alteration “in the desires to which they minister” (Wicksteed, 1884).

Thus, the labor theory of value which is an “analysis of the act of exchange, which reduces the ‘common something’ implied in that act to labour,” cannot be “applied to this class of phenomena”.

The Subjectivist Theory

The subjective theory of value would eclipse the labor theory of value, and mark a watershed in the history of economic thought. Initially developed by Scholastics from the Middle Ages such as St. Thomas Aquinas.

The theory was later rediscovered and refined by economists such as Léon Walras, Carl Menger, William Stanley Jevons in the 1870s (Gordon, 2021).

It endeavored to resolve the chief problem of the labor theory of value by stipulating that the exchange value of commodities is derived from the personal evaluations of their use value.

In other words, according to the subjectivist theory, value stems from how humans perceive the usefulness of a commodity, rather than from input costs measured by the hours of labor expended.

The Subjectivist Revolution, most notably, ushered in a reversal of the relationship between the cost of production and commodity prices in the market (Gordon, 2021). The labor theory had posited that input costs govern final prices.

The subjectivist theory, on the other hand, noted that the value of inputs actually stems from the final commodities’ potential market prices.

Moreover, the labor theory had argued that the amount of labor required to produce a commodity causes the commodity to be valuable.

However, in the subjective theory of value, the utility people derive from commodities causes people’s willingness to spend labor for the production of commodities.

Further Information

References

Beggs, Mike (Summer 2012). “Zombie Marx and Modern Economics, or How I Learned to Stop Worrying and Forget the Transformation Problem”. Journal of Australian Political Economy (70).

Gordon, Jason (2021). “Labor Theory of Value – Explained.” The Business Professor, LLC, https://thebusinessprofessor.com/en_US/economic-analysis-monetary-policy/labor-theory-of-value-definition.

Mongiovi, Gary (Autumn 2002). “Vulgar economy in Marxian garb: a critique of Temporal Single System Marxism”. Review of Radical Political Economics. 34 (4). pp. 393–416, at p. 398. doi:10.1016/S0486-6134(02)00176-6

Team, The Investopedia (13 July 2021). “Labor Theory of Value Definition.” Investopedia, Investopedia, https://www.investopedia.com/terms/l/labor-theory-of-value.asp.

Thomas, Bradley (12 Dec. 2019). “Three Arguments Debunking Marx”s Labor Theory of Value: Bradley Thomas.” Mises Institute, https://mises.org/wire/three-arguments-debunking-marxs-labor-theory-value.

Wicksteed, Philip H (October 1884). Das Kapital: A Criticism Philip H Wicksteed, https://www.marxists.org/history/international/social-democracy/today/1884/10/wicksteed-capital.htm.