Capitalism, Socialism and Democracy

In Capitalism, Socialism and Democracy by Joseph Alois Schumpeter, Marx's Law of Value is dismissed by a simple wave of the hands.

I think this is important because the current economic crisis has arisen because of this fundamental rejection of Marx's law. A flawed theory of value is the cause.

Schumpeter writes:

1. Marx fell in with the ordinary run of the theorists of his own and also of a later epoch by making a theory of value the corner stone of his theoretical structure. His theory of value is the Ricardian one. I believe that such an outstanding authority as Professor Taussig disagreed with this and always stressed the differences. There is plenty of difference in wording, method of deduction and sociological implication, but there is none in the bare theorem, which alone matters to the theorist of today.² Both Ricardo and Marx say that the value of every commodity is (in perfect equilibrium and perfect competition) proportional to the quantity of labor contained in the commodity, provided this labor is in accordance with the existing standard of efficiency of production (the “socially necessary quantity of labor”). Both measure this quantity in hours of work and use the same method in order to reduce different qualities of work to a single standard. Both encounter the threshold difficulties incident to this approach similarly (that is to say, Marx encounters them as he had learned to do from Ricardo). Neither has anything useful to say about monopoly or what we now call imperfect competition. Both answer critics by the same arguments. Marx’s arguments are merely less polite, more prolix and more “philosophical” in the worst sense of this word.

Everybody knows that this theory of value is unsatisfactory. In the voluminous discussion that has been carried on about it, the right is not indeed all on one side and many faulty arguments have been used by its opponents. The essential point is not whether labor is the true “source” or “cause” of economic value. This question may be of primary interest to social philosophers who want to deduce from it ethical claims to the product, and Marx himself was of course not indifferent to this aspect of the problem. For economics as a positive science, however, which has to describe or explain actual processes, it is much more important to ask how the labor theory of value works as a tool of analysis, and the real trouble with it is that it does so very badly.

To begin with, it does not work at all outside of the case of perfect competition. Second, even with perfect competition it never works smoothly except if labor is the only factor of production and, moreover, if labor is all of one kind.³ If either of these two conditions is not fulfilled, additional assumptions must be introduced and analytical difficulties increase to an extent that soon becomes unmanageable. Reasoning on the lines of the labor theory of value is hence reasoning on a very special case without practical importance, though something might be said for it if it be interpreted in the sense of a rough approximation to the historical tendencies of relative values. The theory which replaced it—in its earliest and now outmoded form, known as the theory of marginal utility—may claim superiority on many counts but the real argument for it is that it is much more general and applies equally well, on the one hand, to the cases of monopoly and imperfect competition and, on the other hand, to the presence of other factors and of labor of many different kinds and qualities. Moreover, if we introduce into this theory the restrictive assumptions mentioned, propertionality between value and quantity of labor applied follows from it.⁴ It should be clear, therefore, not only that it was perfectly absurd for Marxists to question, as at first they tried to do, the validity of the marginal utility theory of value (which was what confronted them), but also that it is incorrect to call the labor theory of value “wrong.” In any case it is dead and buried.

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² It may, however, be open to question whether this is all that mattered to Marx himself. He was under the same delusion as Aristotle, viz., that value, though a factor in the determination of relative prices, is yet something that is different from, and exists independently of, relative prices or exchange relations. The proposition that the value of a commodity is the amount of labor embodied in it can hardly mean anything else. If so, then there is a difference between Ricardo and Marx, since Ricardo’s values are simply exchange values or relative prices. It is worth while to mention this because, if we could accept this view of value, much of his theory that seems to us untenable or even meaningless would cease to be so. Of course we cannot. Nor would the situation be improved if, following some Marxologists, we took the view that whether a distinct “substance” or not, Marx’s labor-quantity values are merely intended to serve as tools by which to display the division of total social income into labor income and capital income (the theory of individual relative prices being then a secondary matter). For, as we shall see presently, Marx’s theory of value also fails at this task (granted that we can divorce that task from the problem of individual prices).

³ The necessity for the second assumption is particularly damaging. The labor theory of value may be able to deal with differences in quality of labor that are due to training (acquired skill): appropriate quota of the work that goes into the process of training would then have to be added to every hour of skilled work so that we might, without leaving the range of the principle, put the hour of work done by a skilled workman equal to a determined multiple of an hour of unskilled work. But this method fails in the case of “natural” differences in quality of work due to differences in intelligence, will power, physical strength or agility Then recourse must be had to the difference in value of the hours respectively worked by the naturally inferior and the naturally superior workmen—a value that is not itself explainable on the labor-quantity principle. In fact Ricardo does precisely this: he simply says that those different qualities will somehow be put into their right relation by the play of the market mechanism so that we may after all speak of an hour’s work done by workman A being equivalent to a definite multiple of the work done by workman B. But he completely overlooks that in arguing in this way he appeals to another principle of valuation and really surrenders the labor-quantity principle which thus fails from the start, within its own precincts, and before it has the chance to fail because of the presence of factors other than labor.

⁴ In fact, it follows from the marginal utility theory of value that for equilibrium to exist each factor must be so distributed over the productive uses open to it that the last unit allocated to any use produces the same value as the last unit allocated to each of the other uses. If there be no other factors except labor of one kind and quality, this obviously means that the relative values or prices of all commodities must be proportional to the numbers of man-hours contained in them, provided there is perfect competition and mobility.

pp.23-25

Italics in original
Emphasis Mine

Marx said that there are two (2) types of value:

1. Use Value which is an entirely personal thing. It is a personal measure of how much I value something at point in time. The use value of object can fluctuate wildly over time without any essential change in the nature of the object. (Think of a child and their toys).
2. Exchange Value which expresses the equivalence between different types of objects and activities.

Note that Use Values are qualitative in that they express preferences. The best you can extract from Use Values is a ranking order because these values express preferences.

On the other hand, Exchange Values are quantative as they express the ratio of quantity of things and activities to each other. And these values are directly observable - I can exchange my ten (10) oranges for your twelve (12) apples. When we do this, we are literally comparing apples and oranges. Other people can see that we are saying that the Exchange Value of ten (10) oranges is twelve (12) apples at this point in time and at this place.

Note that there is no price mentioned in this example. Prices have nothing to do with Exchange Values. Nor is their any mention of labour time. The amount of labour time is irrelevant to Exchange Values.

Who profited by this exchange? With respect to Exchange Values, nobody is any better off because we have agreed that their Exchange Values are equal by exchanging apples for oranges.

However, with respect to Use Values, we are both better off because we got rid of something we did not prefer as much for something that we prefer more. Otherwise, we would not have done the exchange. So, qualitatively we are better off, but quantitatively, we are no better off.

Now that I have twelve (12) apples, what is their Exchange Value? The answer is ZERO (0)! What? I just exchanged ten (10) oranges for them. Shouldn't they be worth ten (10) oranges? No, until someone gives me something for those twelve (12) apples, I have no idea what their Exchange Value is. I can have a reasonable expectation, but that is all.

Now, along comes Jim with a bag of apples. After some haggling, we exchange seven (7) apples for five (5) oranges.

Has the Exchange Value for one (1) orange gone up? A meaningless question because no one has exchanged one (1) for anything.

All we can say after these two (2) exchanges is that nineteen (19) apples were exchanged for fifteen (15) oranges. This is the opinion of three (3) different people. Now, I can say that, on average, the Exchange Value of one (1) orange is 15/19 apples. As more exchanges take place between people with apples and oranges, the better idea that I can get about what could be the average Exchange Value of one (1) orange relative to apples.

The problem with the marginal utility function is that it tries to compare Use Value with Exchange Value. Hopefully, you will see that, under Marx's Law of Value, this is not possible.