Labor theory of valueThe labor theory of value is an obsolete theory in economics once used to justify private property. According to John Locke, an object belonged to a person by virtue of the labor he or she invested in producing it. This theory raised questions for later students of economics. Adam Smith observed that in capitalist economies with a complex division of labor, people convert commodities into money and vice versa. He thus distinguished between "real value" (the amount of labor required to produce or acquire an object) and "nominal value" (the amount of money one would give or receive in exchange for a given commodity). Karl Marx similarly distinguished between "labour value", "use value" and "exchange value." In these approaches, the labor theory of value is a theory of objective value. Much of Western economics turned away in the 1870s from theories of objective value and towards the economic subjectivism associated with the development of neoclassical economics.
The labor needed to produce a commodity includes both labor directly expended on production of the commodity and labor expended on the production of capital goods used up in the production of the commodity. For example, if twenty workers are used for a year to produce capital goods used by twenty workers in the next year to produce a consumer good, the consumer good embodies the labor of forty workers.
This theory has political implications. In its original context, it was used to support the new notion of private-property. John Locke, in his Treatise on Government, asked by what right an individual can claim to own one part of the world, when according to the Bible God gave the world to all humanity. He answered that a person owns ones own labor, and that when a person labored -- even the mere labour of picking an apple off a tree -- that labor entered into the object, and so the object became property of that person. From this Locke and others further argued that commodities have value because of the labor invested in them.
As capitalism developed, this theory was used to support a very different political argument: that the role of owners in production is exploitative, since it is only the workers that add value to the product. The price of the product is said to tend towards the sum of the value of the capital goods used up in production and the value added by direct labor. But profit, interest, rent, etc. is only possible, according to the theory, if the wages of these direct workers do not fully compensate them for the value they add to the capital goods to produce the product.
The classical economists and Marx quickly realized that the price of a commoditiy does not tend to equal its value, as they conceived of it. Suppose the proportion of unpaid to paid labor time is the same for all workers. Further suppose that workers are paid when the product is sold. Technology will result in the ratio of direct labor to the value of capital goods differing among industries. If products were traded based on labor values, prices would result in different industries earning different rates of profits on the capital invested. But competition among industries should be modeled as tending to remove differences in profitability. Thus, the labor theory of value cannot be true, if the rate of profits is positive or industries exhibit different capital-intensities. David Ricardo presented a numerical example of this reductio ad absurdum:
- Suppose I employ twenty men at an expense of 1000 pounds for a year in the production of a commodity, and at the end of the year I employ twenty men again for another year, at a further expense of 1000 pounds in finishing or perfecting the same commodity, and that I bring it to market at the end of two years, if profits be 10 per cent., my commodity must sell for 2,310 pounds.; for I have employed 1000 pounds capital for one year, and 2,100 pounds capital for one year more. Another man employs precisely the same quantity of labour, but he employs it all in the first year; he employs forty men at an expense of 2000 pounds, and at the end of the first year he sells it with 10 per cent. profit, or for 2,200 pounds. Here then are two commodities having precisely the same quantity of labour bestowed on them, one of which sells for 2,310 pounds--the other for 2,200 pounds.
Since the 1870s the Labor theory of value has been gradually displaced in non-Marxist circles by the marginal theory of value. The Austrian economist, Eugen von Böhm-Bawerk countered that the Labour Theory of Value was meaningless because the workers traded in their share of the end price for the more certain and soon wages paid by the entrepreneur. The profit from wages were not therefor exploitation but a rational response from the workers who prefered certainty of income to the risk entailed in a full share of the profits.
The way in which the Labour theory of value was judged to be the prevailing standard was stated in 1848 by John Stuart Mill in his Principles of Political Economy who asserted, "Happily, there is nothing in the laws of value which remains for the present or any future writer to clear up; the theory of the subject is complete."