The labor theory of value was the theory of Adam Smith, David Ricardo and the other classical economists; it was taken over by Karl Marx and forms the basis of his exploitation theory. In its simplest and crudest form it says that the value, and thus the price, of a product is determined by the total amount of labor expended in its production. For example, the value of a loaf of bread is determined, first by the labor expended by the baker in baking it, then by the labor of the miller in grinding the flour, then by the labor of the farmer in growing the corn. And then there is the labor of building a wind-mill or steam-mill, and of constructing a plow. To this then comes the labor of breeding horses or oxen to pull the plow, or, in modern times, to build a tractor. And in the latter case, there is also the labor of making the steel and to extract the iron ore for the steel.
In retrospect I find it slightly mysterious that this theory was accepted for such a long time and by such intelligent persons. It is quite obvious to me that this theory puts the cart before the horse: the products are not valuable because a lot of labor has gone into making them; on the contrary, one expends a lot of labor because one expects the final product to be valuable and because one expects to get a good price for them. If people did not like eating bread at all, it would not get baked, the flour would not be grinded, the corn would not be grown (or at least not for this purpose), etc.
Let me elaborate, and let me begin with some non-economic values. – Economists deal exclusively with economic values, i.e. values that are bought and sold or exchanged in barter. But “value” is a broader concept than just “economic value”; the broadest definition is that given by Ayn Rand: “That which one acts to gain and/or keep.”
For example, if you value your spouse, this has nothing to do with his or her market value or value in exchange, since you do not intend to sell or exchange your spouse. So let me begin with a spouse:
If you have read your Dorothy Sayers, you know that Lord Peter proposed to Harriet Vane for years on end before she finally accepted his proposal and married him. Would anyone say that her value in Lord Peter’s eyes was determined by the number of proposals he made? On the contrary, the number of proposals was determined by the value Lord Peter put on her. (Simple enough?)
Or take a more mundane example: I make my bed once a day, and now and then I vacuum-clean my apartment. Again, would you say that the value of the made-up bed or the tidy apartment is determined by my work? Again, the contrary is true: I see a value in a made-up bed and a tidy apartment, and that is the sole reason I bother to make up my bed and vacuum-clean. (Again: Simple enough?)
Of course, it is not different with economic values.
The labor theory was overturned in 1871, with the publication of Carl Menger’s Principles of Economics (Grundsätze der Volkswirthschaftslehre). In this book Menger makes the fundamental distinction between “goods of first order” (or “consumption goods”) and “goods of higher order” (or “means of production”). In my loaf of bread example, the loaf is a “good of first order”, and the rest are “goods of higher order”. A short quote from Menger is in place:
Human beings experience directly and immediately only needs for goods of first order – that is, for goods that can be used directly fir the satisfaction of their needs. If no requirement for those goods existed, none for goods of higher order could arise. Requirements for goods of higher order are thus dependent upon requirements for goods of first order, and an investigation of the latter constitutes the necessary foundation for the investigation of human requirements in general. (P. 80f.)
Menger puts the horse before the cart! It is the value (or expected value) of the final product – the loaf of bread – that determines how much total labor is expended in all the steps leading up to the final product.
But one should be fair to the classical economists. In the first paragraph I presented the labor theory “in its simplest and crudest form”. But the classical economists recognized several exceptions and modifications of the theory. Take the example of some famous painting, which can be sold at auction for several millions: it would be absurd to say that this price is determined by the painter’s labor, much less then the labor expended on the paint and the canvas. This and similar exceptions were recognized by Ricardo:
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. (Principles of Political Economy and Taxation, chapter 1, section 1.)
And the modifications? One thing that struck me about the “simple and crude” version was this: In a primitive society much less labor was expended on the loaf of bread than today. The miller might grind the flour by hand, and the farmer would use a simple wooden plough; there would be no mills or tractors. Then, according to the labor theory, the loaf would be that much cheaper, and the loaf in today’s advanced civilization would be, by comparison, extremely expensive. But this sounds absurd; and the answer to this absurdity is that capital accumulation and labor-saving machinery make it possible to produce many more loaves, and this makes them cheaper. And this, too, is recognized by Ricardo:
The principle that the quantity of labour bestowed on the production of commodities regulates their relative value, [is] considerably modified by the employment of machinery and other fixed and durable capital. (Chapter 1, section 4.)
And there are other modifications having to do with the time factor and the rate of profit. For example, Ricardo writes in the same section:
All commodities which are produced by very valuable machinery, or in very valuable buildings, or which require a great length of time before they can be brought to market, would fall in relative value, while all those which were chiefly produced by labour, or which would be speedily brought to market, would rise in relative value.
… commodities which have the same quantity of labour bestowed on their production will differ in exchangeable value if they cannot be brought to market in the same time.
And in the next section:
Every rise of wages, therefore, or, which is the same thing, every fall of profits, would lower the relative value of those commodities which were produced with a capital of a durable nature, and would proportionally elevate those which were produced with capital more perishable. A fall of wages would have precisely the contrary effect.
But those exceptions and modifications do not save the labor theory of value. I would say that the actual truth lies precisely in those exceptions and modifications.
Simple enough? I hope so; and I hope I have not made it more complex than it really is.
(You can read Ricardo on line here. And I can also recommend chapter 11, part C (p. 473–498) of Capitalism: A Treatise on Economics, where George Reisman sifts the wheat from the chaff in the theories of Smith and Ricardo. And if you understand Swedish, there is also a Swedish blog post on this subject.)