Why Are Theories of Value Important?

by Lindy Davies

The idea of value was an important topic in the development of political economy, yet modern-day economics has little to say about it. For example, Economics by Samuelson and Nordhaus, does not trouble to define “value” at all — doesn’t even mention it in its index. On the other hand, the concept of “price” is extensively explored. This represents the shift from a “normative” science of political economy, which seeks to design and build a just society, to a “positive” study of economics, which seeks to analyze facts and behavior, avoiding the notions of “ought” and “should”.

You call me a socialist. I suppose you’ll have to admit that I’m rather a peculiar one! I have been a Georgist for more than 50 years. I support a completely free price-mechanism controlled market. I am a free trader and would like nothing better than to have the US drop all tariffs, quotas, anti-dumping duties the first thing tomorrow morning. I want minimum government and an end to privilege. Privilege to a Georgist is “privi lege” or private law. That is, a law designed to take from one to give to another. This major Georgist theme — the ending of privilege — unites people across the political spectrum. Privilege is the opposite of justice and the phrase “liberty and justice for all” requires the ending of privilege.
— Harry Pollard, on the “Land Theory” email list

However, very few people are content with the present state of the “body economic”. All manner of “oughts” and “shoulds” are constantly being proposed. It seems that we are not yet through with the notion of value.

The major debate about value has always been about whether it inherent in things, or is a function of human desires. Plato regarded value as inherent in a commodity, but Aristotle attributed it to a commodity’s utility, and he said the standard of value lies in wants. Thus the field was divided, for ever more, between the “left” and the “right”.

The Labor Theory

The “labor theory of value” — the idea that the value of a thing is a function of the labor expended in creating it — was a tenet of the classical economists, especially David Ricardo. Its influence today, however, is mainly due to Karl Marx. According to Marx, the value of a commodity tends to be the “amount of labor time socially necessary” to produce it. This is most clearly seen in the mode of production called capitalism, under which commodities are produced, by unskilled laborers, for sale in the market. The laborers exchange their labor time for wages, and the “capitalists” own both the means of production and the products.

What does “socially necessary” mean? It is defined as the amount of labor required to produce a thing under the normal conditions of production at a given time. In the capitalist mode of production, the “labor value” of a thing is made up of three parts: Constant capital (the equipment and location needed) Variable capital (the workers’ wages) and Surplus value (the parasitical “cut” taken by the Capitalist class). All of the items in turn that go into the category of Constant capital (commodities themselves, such as a truck, a printing press or a factory) likewise have a labor value composed of these three elements.

Under capitalism, there exists at any given time a general rate of profit — which is simply an average of all the rates of profit in the various micro-markets. If the rate of profit for a certain commodity equals the general rate of profit, then the surplus value of that commodity equals its profit to the capitalist, and its market price tends to equal its labor value. Of course, some commodities bring higher- or lower-than-average profits. In such cases, the commodity’s labor value will not match its “price of production” — and comparing the two will be helpful to the economic planner (who will, eventually, have to determine optimum production levels, without the helpful feedback of prices).

According to Marxist analysis, capitalists invest in production in order to collect surplus value. However, competition for market share will put a downward pressure on profits. Capitalists will have to reduce wages (which will, in turn, reduce demand for commodities, leading to “overproduction” and depressions). The deterioration of conditions for workers will inflames class antagonism and lead to revolution. Then, the workers themselves, coming together to seize the means of production, will use the efficiency of modern industrial production for their own benefit.

The division of “labor value” into its three components gives us a glimpse of how a socialist economy could ever hope to achieve efficient resource allocation. Surplus value is, supposedly, the value of exploitation in a capitalist society, over and above the costs of Labor (Variable capital), and Land + Capital (Constant capital). If — according to Marxist theory— this exploitative surcharge were not imposed on the cost of every commodity produced, there would be a vast fund available for raising wages, providing social services, and “scientifically planning” an efficient socialist economy.

However, under the capitalist mode of production, decisions about “what?” “how many?” and “for whom?” are made with the invaluable aid of the invisible hand of a (more or less) free market. The market, though, is precisely what leads to surplus value and (to Marxists) all the structural failings of capitalism. Under the next phase of history — socialism — allocation decisions would not be made by the “higgling of the market”, but by some form of objective planning. This is where the labor theory of value comes in very handy.

If value is not inherent in the commodity, but is a subjective determination of the buyer(s), then socialist “scientific planning” has no basis. For a planned economy to be workable at all, value must be inherent in things. If the amount of labor embodied in a thing is a quantity that can be observed and measured, then it becomes possible for “scientific planning” to achieve efficient production patterns.

Marxist theory, then, utterly depends on an objective theory of value.

The Subjective Theory

The other major contender for a modern theory of value is the Austrian theory, which traces its roots to Principles of Economics by Carl Menger. It tells us that value is subjective. It has nothing to do with anything inherent in a commodity, including the amount of labor that went into it. It is simply a matter of how much each individual wants each thing.

To Austrian economists, if a glass of water is sold for a million dollars to someone who is dying of thirst, then, by golly, that’s its value. A more conventional view would hold that, because of special circumstances, the glass was sold for more than its market value. But Austrian theory holds that there is no such thing as the “market value” of a good; value is revealed in particular transactions. One could compute an average of the various observed prices for which a good has sold, but that can only lead to an approximation of the thing’s value.

Why is that important? Because if there is such a thing as “market value”, then it becomes possible for things to be sold for more than their market value — in other words, it becomes possible for markets to fail. Monopoly, or subsidy, or political manipulation, might end up allowing sellers to pocket the gleanings of “market failure”, enriching themselves at the expense of the community. This, then, would lead to various kinds of interventions in the free market, to remove the unfairness of “market failures”. (To Marxists, remember, failure is inherent in the market economy.)

In order to correct supposed imperfections in the market allowing some “monopolists” to capitalize on “market failure”, government imposes restrictions on free-market behavior! In Austrian theory, this represents the very worst kind of circular reasoning. (Free-market economists tend to believe that monopolies, far from being parasitical, benefit society by affording innovators the extra capital they need to create the means for industrial progress.)

If “market failure” exists at all, Austrian economists see it as a conflict between individuals or groups in their plans to use certain scarce resources. Efficient resolutions to these conflicts can be negotiated between the interested parties — but not if the resources are removed from the market process by confiscation or regulation.

This gets us back to the question of why value theory is important: If the value of a commodity is inherent, then it is possible for it to have a “true” value that is different from what it exchanges for in a particular transaction. This would open the door to intervention — to the temptation to remove things from that free interplay of individual desires, and individual plans for satisfying them, that constitute economic activity.

If the value of things is only revealed in free individual transactions, then the community should never — and has no right to — interfere in those transactions. If anything that could be held privately is, instead, held communally by the coercive power of the state, then the free interplay of desires and plans is restricted; economic activity and freedom are retarded.

Austrian theory holds that ethical concerns have no place in economic theory. Society might decide, out of some over-arching social concern, to communalize certain assets — but in doing so it would always limit human freedom. In the Austrian view of things, there is an inevitable trade-off between government intervention and the just, efficient society in which individual freedom is maximized.

The Problem with Land

It’s interesting to note that each of these “competing” theories of value encounters a pretty serious stumbling block when it comes to the question of land. Marxist theory accounts for the value of land as part of the “Constant capital” that goes into the production of commodities. Land itself isn’t produced by labor, of course — so it can only acquire value when labor is applied to it in some way. This is reminiscent of J. S. Mill’s justification for property in land, which Henry George critiques in The Science of Political Economy. Land can become private property, according to Mill, when (and because) it is improved. Under the Labor Theory, that is also why it acquires value. However, it is evident that unimproved land can indeed have value — for we see huge amounts of value tied up in urban locations that stand completely idle, with no labor applied to them at all, sometimes for decades.

Austrian theorists also get caught in a vicious circle when it comes to land. This is not because land value is not subjective, measuring the land’s utility to the buyer; indeed it is. However, Austrian theory holds that unrestricted privatization leads to efficient allocation and promotes human freedom. This certainly seems to be true in the case of the products of labor — but it is clearly untrue in the case of land. Although some still try to justify it, using exotic interpretations of allocative efficiency, the evidence is overwhelming that private collection of land rent leads to economic dysfunction. (Public collection of the legitimate products of labor and capital does, too — but free-market theorists are eager to agree with that.)

George’s Great Reconciliation

One of Henry George’s most powerful attributes as a social philosopher is his unswerving faith that social science, if it is correctly based on natural law, cannot lead society to violence or decay. On the one hand, we have a Labor Theory of Value. Reasoning logically therefrom, we determine that justice can only be secured by removing the great vitality that society gains from the free market. On the other hand, we have a Subjective Theory of Value, which leads us to a “best of all possible worlds” in which our access to the natural opportunities, which all of us need to sustain life, must be purchased from private owners, for the sake of “freedom”!

George examined the theory that value depends on the labor embodied in a thing, and found it absurd; simple observation showed that value is not inherent, but a function of the buyers’ desires. However, simple observation also demonstrated that private ownership of everything — whether or not it is a product of human labor — leads neither to justice nor efficiency. He managed cut through this dilemma by introducing the concept of “value from obligation”. George saw that the amount of value is subjective — determined by nothing more than the “higgling of the market”. However, the source of value is not subjective! It depends on one all-important objective quality of a thing: whether it was or was not produced by human labor.

This distinction means nothing to the individual; land, stocks, money or physical wealth all have the same kind of value to us, as individuals. A political economy that sees the aggregate as nothing more than the sum of all individual transactions would, likewise, see no importance in the distinction between value from production and value from obligation. But George’s analysis shows us that there exists a subset of value that cannot be attributed to individual inputs, but to the activity of the entire community.

So: labor is not the source of all value — but it is the source of some value: the value that comes from production — and, the amount of value a commodity has is subjective, bearing no relation whatever to that value’s source. With this firm theoretical foundation, George could confidently build an economic theory that could reconcile freedom and justice, proving his contention that “justice is the highest and truest expediency”.

This essay is part of the reading for the Henry George Institute’s new course in Economic Science.

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