percept¡on
17th June 2004, 12:48
On Value, Labor, and Profit
Part I
by perception, © 2004
Introduction
This essay is a short treatise on the nature of value. This is not meant to be a comprehensive or all-inclusive work, but more of a summation of the major ideas concerning value, labor, profit, and capital, as put forth by classical economists, particularly Adam Smith, David Ricardo, and Karl Marx. It is an explanation of modern economic conditions by way of analogy to a primitive state of society, to emphasize the origins and evolution of modern economic relationships. I will begin with an explanation of the nature of value as the embodiment of human labor, then proceed to demonstrate how profit is procured and wealth accumulated according to this explanation.
I. Value as the Embodiment of Human Labor
Adam Smith, in his revolutionary manifesto on political economy, The Wealth of Nations, states quite plainly his position that human labor is the sole creator of value in the economic sense. Value, in the economic sense, represents something distinct from the broader connotations of value as used in everyday language. In economics, value is understood to be comprised of two elements: use-value (or utility*) and exchange value (or price). The two are not independent of one another, but the interaction between the two is impossible to be generalized into any kind of universal formula. It is sufficient to note and recognize that commodities possess both use-value and exchange value, and that the exchange value is a function of use-value and scarcity. Labor is the creator of value, but the fact that something embodies labor does not necessarily give it value. The labor embodied must be what Marx refers to as ‘socially useful’ labor, and the product of labor must have utility to someone besides the laborer. It can be summarized, then, that any commodity which is a) scarce, b) possesses utility, and c) requires labor to produce, contains an inherent value equivalent to the amount of labor embodied in it.
For an example of how human labor-power is reflected exchange value, we should refer to an example put forth by Adam Smith(1) and examined by David Ricardo(2). If, in a society of hunters, it requires twice the labor to kill a beaver as it does to kill a deer, then (assuming both possess utility) one beaver would naturally exchange for two deer. Even if the beaver didn’t possess utility, this would still be its price; but no one would bother killing the beaver unless they could either make use of it somehow or exchange it for something useful**. For example, if it takes twice the labor to kill a rat as it does to kill a deer, one rat would exchange in the market for two deer, but an exchange would only take place if the utility of a rat was greater to some consumer than the utility of two deer. If we assume that the rat is worthless to all consumers, no one would part with one deer in exchange for it, let alone two deer, and therefore proper recompense for the labor expended in killing the rat could not be gotten, the labor would not be socially useful and would better be spent in some other activity or in doing nothing at all. In this manner, labor is allocated to those commodities for which marginal utility (and means to pay) for some group of consumers exceeds exchange value.
If a commodity is underproduced, i.e. there are not enough on the market to meet the demand, it would be socially useful for labor to be expended in bringing that commodity to market. Conversely, if a commodity is being overproduced, its exchange value will fall below the value of labor embodied in it, and thus some producers will be forced to cease production until the exchange value once again equates the value of labor expended to bring the commodity to market. The reason for the exchange value falling below the labor-value is a function of diminishing marginal utility – using the deer/beaver example, as more and more beavers become available on the market, all of those consumers who value a beaver enough to exchange two deer to acquire it have had their demand met, and there remains only consumers for whom two deer possess more utility than one beaver. These consumers may be willing to exchange one deer for one beaver, but it would not be socially useful for a laborer expend the labor-time bringing a beaver to market in order to exchange it for half its cost.
We can therefore make three conclusions: First, that the value of a commodity is equal to the amount of socially useful labor embodied in it; Second, that labor is only socially useful if utility of a commodity exceeds the labor-value of the commodity; and Third, that the exchange value will equal the labor-value in a free and competitive market in which labor is the sole means of production.
II. Capital and Profit
It is obvious that the above discussion is incomplete at best, and simplistic at worst. There has scarcely been a time in the history of mankind that individual labor was the sole means of production, and scarcer still that it operated without the aid of some form of capital, a tool of some sort. Still, the conclusions made are useful to us, not simply as a mental exercise but as a way to contrast the remuneration of labor before and after the introduction of capital, and how capital restricts the operation of a free and competitive market.
David Ricardo remarks:
Without some weapon, neither the beaver nor the deer could be destroyed, and therefore the value of these animals would be regulated, not solely by the time and labor necessary to their destruction, but also by the time and labour necessary for providing the hunter’s capital, the weapon, by the aid of which their destruction was effected.(3)
If capital has no other effect other than contributing value to a commodity by assisting in its production, then accounting for the value it contributes is simple enough – it is simply the sum of the value embodied in the capital expended in producing the commodity and the labor embodied in the commodity itself, as I have illustrated in the previous section. If the capital is not used up in the production process, only a fraction of its value would become embodied in the product; if the capital used to fell a deer were a bow and arrow, and the bow typically could be used to fell one hundred deer, then 1/100th of the labor-value of the bow would be embodied in each deer. If the arrow, on the other hand, was only good for a single use, then the entire labor-value of the arrow would be embodied in the deer.
Even at this point, we have not yet changed the basic foundations of the economic structure. Each man can only obtain as much as he can produce with his own labor. If the capital necessary to produce a deer or beaver can be produced by the hunter himself, then this is simply another step in the production process, and adds labor-value to the end product. Likewise, it may give rise to a division of labor among those who produce the capital and those who hunt, which would simply make for an increasingly complex trade among the individual producers. In yet another case, it may give rise to a division of society into owners of capital and laborers.
In order to procure what is known as ‘profit’, it is necessary to exchange a commodity for more than the value of the labor embodied in it. If one of our hunters was able somehow to exchange only one deer for one beaver (given the market exchange value of 1:2), he would be able to turn around and exchange that beaver to someone else for two deer, thereby finishing with two deer to show for his labor, which was only sufficient to produce one. But under ordinary market conditions, who would agree to the original trade of one deer for one beaver? No rational actor with knowledge of the exchangeable value of the two commodities would. Furthermore, we can see that this series of exchanges did not create any additional wealth – the hunter who, in the first transaction, exchanged the beaver for only one deer gave half of the value of his labor to the other hunter; value was not created, but redistributed.
It is apparent, therefore, that as long as the means of production (labor and capital) are equally available to all, each is in the position to acquire only what their own labor can produce, and no profit can be made. Even if more efficient capital is invented, or if workers join together and cooperate to increase their productivity, in the long run this will only decrease the labor value of their produce as each piece would embody less labor. The key assumption is that the means of production are available to all.
What if one man owns the capital that is necessary to fell a deer (i.e., the bow and arrow), and without this capital no one can produce any deer for the market? Likewise, another man owns the capital necessary to kill the beaver. Let’s assume we have a society comprised of four individuals: one who owns the capital necessary to kill the deer, one who owns the capital necessary to kill the beaver, and two laborers who have nothing but their own labor-power. Without access to the capital, these two laborers would be able to produce nothing. If the two capital owners were so inclined, they could use their capital to produce deer and beavers to exchange amongst themselves. Instead, pretend the capital owners hire the laborers to do the work for them. The one capital owner agrees to pay the first laborer one deer for every two he kills; the other capital owner agrees to pay the second laborer one beaver for every two he kills. Both laborers see a gain – they were able to produce nothing before, now they are able to produce a commodity, even if they are only compensated at half the exchange value of their labor. The capital owners see a gain of their own – they contribute no labor of their own, and still reap the benefit of one half-day’s labor. The overall production of society has declined, however, as we have only two laborers producing commodities where there could have been four. We can see that this creates no additional value – if the capital owners had performed the labor themselves, they would have produced the same quantity of output of each commodity. The only thing which has occurred was a redistribution of half of the fruits of labor away from the laborer and towards the capital owner.
What the capital owner has received for his ownership of the capital (in this example, half of the produce of labor), is profit. What he has paid to the laborer (another half of the produce of labor) is wages. If we assume that all four of these individuals are rational economic actors, then we can see that this arrangement could not last long – it would be in the laborers’ interests to acquire capital of their own as soon as possible, which would double the rewards of their labor. If they had the skill, it would be in each of their interests to invest the labor-time fashioning their own capital. If they didn’t have the skill, it would be in each of their interests to forgo consumption to exchange their own commodities for capital. The only way that the capital-owners can make a profit off of their capital is if they have a monopoly on access to capital, and the laborers are resigned to sell their labor. There are several ways in which this can be accomplished, not the least of which is increasing the cost of capital to the point that it is out of the reach of the ordinary laborer.
III. Price and Profit
Adam Smith identifies three component parts of price, or the exchange value of a commodity measured in money: wages, profit, and rent.(4) Wages, it has already been shown, is the compensation paid to the laborer for adding value to the commodity. Profit, likewise, has been shown to be the compensation exacted by the capital-owner for owning capital and putting it to use by hiring laborers to work it. Rent, as it was used in Smith’s day, referred specifically to the payment made to a landlord for the use of land; it is used now to refer to economic ‘rent’, which refers to the difference between the actual revenue received for capital and its opportunity cost (i.e. economic profit).
Wages paid to labor are determined by the labor market (accounting for productivity and other factors). Profit of capital is known as ‘rate of return’. Ricardo designated the rate of return of capital to be six or seven percent(5), but the proper rate of return varies from industry to industry and is regulated by the opportunity cost of capital. It remains relatively stable for each industry, however. Rent, in a free and competitive market, should be zero. If any rent is generated, it implies market failure; but in the real world, capital-owners find many ways to generate rent.
How does a capital-owner increase profits? If wages are determined by and large by conditions of the labor market, lowering wages (without sacrificing productivity) is out of the question. If wages do fall or rise, they will be reflected as a fall or rise in the price of the end product. If a capital-owner can increase the scarcity of a commodity, via establishing a natural or artificial monopoly and restricting output, they can increase rent. But the best way to increase profits is to reduce the number of capital-owners; or to increase the number of laborers employed by each capital-owner. In all industries there can be found an economy of scale, that as you increase the size of a firm you can reduce costs.
IV. Wealth
It is evident that in the ‘rude’ state of society, when each man has only his own labor to contribute, and, in fact, in any society where the remunerations of labor are commensurate with the value of the commodities produced, that each man can only accumulate as much wealth as he can produce through his own labor, less that which is consumed. This places a finite limit on the amount of wealth that can be accumulated, as there are a finite number of hours in a day, and years in a man’s life. In order to surpass this natural limit, it is necessary to find a way to expropriate part of the value of others’ labor.
We saw in Section II that a capital-owner with a monopoly on the means of production for some industry can employ laborers and pay them at less than the value of the produce of their labor (in this particular example, ˝). If the laborer wants to increase his income, he must work more; but there are natural limits to how much more he can work. If the capital-owner, on the other hand, wants to increase his income, he need simply hire more workers. The limits on the number of workers he can hire are determined by the limits of the capital employed, the market conditions of the particular industry, &c., but the capital-owner can, with relative ease, acquire more capital, or expand into other industries, and so on. Thus the natural limit on the accumulation of wealth is shattered to pieces, and now the capital-owners can multiply their wealth seemingly infinitely, limited only by their capacity to expropriate the wealth of the rest of the human race.
As all value is created by labor, all is wealth simply the accumulated product of labor – either one’s own labor, or that of others. Since capital is a manifestation of wealth (i.e. it is purchased with this accumulated value, whether earned or borrowed), it follows that all capital is simply the accumulated product of labor that has been expropriated from the laborers.
---------------------------------------
Notes
*While use-value and utility can be argued to apply to distinct concepts, I use the two terms interchangeably in this document. I prefer the term utility for several reasons: first, the stigma associated with use-value as being a specifically Marxian concept; second, the more general familiarity of modern economists and students of economics with the term and idea of utility (whereas use-value sounds more foreign); and third, the idea of marginal utility sounds more cumbersome when applied to use-value.
**Excepting, of course, if the act of hunting possessed utility in and of itself; but we will assume that all labor is an economic ‘bad’ and only partaken in for the fruits it provides.
(1) Adam Smith, Wealth of Nations (New York: Prometheus Books, 1991), 50.
(2) David Ricardo, Principles of Political Economy (Ontario: Batoche Books, 2001), 10.
(3) Ibid., 17.
(4) Adam Smith, Wealth of Nations (New York: Prometheus Books, 1991), 53.
(5) David Ricardo, Principles of Political Economy (Ontario: Batoche Books, 2001).
Part I
by perception, © 2004
Introduction
This essay is a short treatise on the nature of value. This is not meant to be a comprehensive or all-inclusive work, but more of a summation of the major ideas concerning value, labor, profit, and capital, as put forth by classical economists, particularly Adam Smith, David Ricardo, and Karl Marx. It is an explanation of modern economic conditions by way of analogy to a primitive state of society, to emphasize the origins and evolution of modern economic relationships. I will begin with an explanation of the nature of value as the embodiment of human labor, then proceed to demonstrate how profit is procured and wealth accumulated according to this explanation.
I. Value as the Embodiment of Human Labor
Adam Smith, in his revolutionary manifesto on political economy, The Wealth of Nations, states quite plainly his position that human labor is the sole creator of value in the economic sense. Value, in the economic sense, represents something distinct from the broader connotations of value as used in everyday language. In economics, value is understood to be comprised of two elements: use-value (or utility*) and exchange value (or price). The two are not independent of one another, but the interaction between the two is impossible to be generalized into any kind of universal formula. It is sufficient to note and recognize that commodities possess both use-value and exchange value, and that the exchange value is a function of use-value and scarcity. Labor is the creator of value, but the fact that something embodies labor does not necessarily give it value. The labor embodied must be what Marx refers to as ‘socially useful’ labor, and the product of labor must have utility to someone besides the laborer. It can be summarized, then, that any commodity which is a) scarce, b) possesses utility, and c) requires labor to produce, contains an inherent value equivalent to the amount of labor embodied in it.
For an example of how human labor-power is reflected exchange value, we should refer to an example put forth by Adam Smith(1) and examined by David Ricardo(2). If, in a society of hunters, it requires twice the labor to kill a beaver as it does to kill a deer, then (assuming both possess utility) one beaver would naturally exchange for two deer. Even if the beaver didn’t possess utility, this would still be its price; but no one would bother killing the beaver unless they could either make use of it somehow or exchange it for something useful**. For example, if it takes twice the labor to kill a rat as it does to kill a deer, one rat would exchange in the market for two deer, but an exchange would only take place if the utility of a rat was greater to some consumer than the utility of two deer. If we assume that the rat is worthless to all consumers, no one would part with one deer in exchange for it, let alone two deer, and therefore proper recompense for the labor expended in killing the rat could not be gotten, the labor would not be socially useful and would better be spent in some other activity or in doing nothing at all. In this manner, labor is allocated to those commodities for which marginal utility (and means to pay) for some group of consumers exceeds exchange value.
If a commodity is underproduced, i.e. there are not enough on the market to meet the demand, it would be socially useful for labor to be expended in bringing that commodity to market. Conversely, if a commodity is being overproduced, its exchange value will fall below the value of labor embodied in it, and thus some producers will be forced to cease production until the exchange value once again equates the value of labor expended to bring the commodity to market. The reason for the exchange value falling below the labor-value is a function of diminishing marginal utility – using the deer/beaver example, as more and more beavers become available on the market, all of those consumers who value a beaver enough to exchange two deer to acquire it have had their demand met, and there remains only consumers for whom two deer possess more utility than one beaver. These consumers may be willing to exchange one deer for one beaver, but it would not be socially useful for a laborer expend the labor-time bringing a beaver to market in order to exchange it for half its cost.
We can therefore make three conclusions: First, that the value of a commodity is equal to the amount of socially useful labor embodied in it; Second, that labor is only socially useful if utility of a commodity exceeds the labor-value of the commodity; and Third, that the exchange value will equal the labor-value in a free and competitive market in which labor is the sole means of production.
II. Capital and Profit
It is obvious that the above discussion is incomplete at best, and simplistic at worst. There has scarcely been a time in the history of mankind that individual labor was the sole means of production, and scarcer still that it operated without the aid of some form of capital, a tool of some sort. Still, the conclusions made are useful to us, not simply as a mental exercise but as a way to contrast the remuneration of labor before and after the introduction of capital, and how capital restricts the operation of a free and competitive market.
David Ricardo remarks:
Without some weapon, neither the beaver nor the deer could be destroyed, and therefore the value of these animals would be regulated, not solely by the time and labor necessary to their destruction, but also by the time and labour necessary for providing the hunter’s capital, the weapon, by the aid of which their destruction was effected.(3)
If capital has no other effect other than contributing value to a commodity by assisting in its production, then accounting for the value it contributes is simple enough – it is simply the sum of the value embodied in the capital expended in producing the commodity and the labor embodied in the commodity itself, as I have illustrated in the previous section. If the capital is not used up in the production process, only a fraction of its value would become embodied in the product; if the capital used to fell a deer were a bow and arrow, and the bow typically could be used to fell one hundred deer, then 1/100th of the labor-value of the bow would be embodied in each deer. If the arrow, on the other hand, was only good for a single use, then the entire labor-value of the arrow would be embodied in the deer.
Even at this point, we have not yet changed the basic foundations of the economic structure. Each man can only obtain as much as he can produce with his own labor. If the capital necessary to produce a deer or beaver can be produced by the hunter himself, then this is simply another step in the production process, and adds labor-value to the end product. Likewise, it may give rise to a division of labor among those who produce the capital and those who hunt, which would simply make for an increasingly complex trade among the individual producers. In yet another case, it may give rise to a division of society into owners of capital and laborers.
In order to procure what is known as ‘profit’, it is necessary to exchange a commodity for more than the value of the labor embodied in it. If one of our hunters was able somehow to exchange only one deer for one beaver (given the market exchange value of 1:2), he would be able to turn around and exchange that beaver to someone else for two deer, thereby finishing with two deer to show for his labor, which was only sufficient to produce one. But under ordinary market conditions, who would agree to the original trade of one deer for one beaver? No rational actor with knowledge of the exchangeable value of the two commodities would. Furthermore, we can see that this series of exchanges did not create any additional wealth – the hunter who, in the first transaction, exchanged the beaver for only one deer gave half of the value of his labor to the other hunter; value was not created, but redistributed.
It is apparent, therefore, that as long as the means of production (labor and capital) are equally available to all, each is in the position to acquire only what their own labor can produce, and no profit can be made. Even if more efficient capital is invented, or if workers join together and cooperate to increase their productivity, in the long run this will only decrease the labor value of their produce as each piece would embody less labor. The key assumption is that the means of production are available to all.
What if one man owns the capital that is necessary to fell a deer (i.e., the bow and arrow), and without this capital no one can produce any deer for the market? Likewise, another man owns the capital necessary to kill the beaver. Let’s assume we have a society comprised of four individuals: one who owns the capital necessary to kill the deer, one who owns the capital necessary to kill the beaver, and two laborers who have nothing but their own labor-power. Without access to the capital, these two laborers would be able to produce nothing. If the two capital owners were so inclined, they could use their capital to produce deer and beavers to exchange amongst themselves. Instead, pretend the capital owners hire the laborers to do the work for them. The one capital owner agrees to pay the first laborer one deer for every two he kills; the other capital owner agrees to pay the second laborer one beaver for every two he kills. Both laborers see a gain – they were able to produce nothing before, now they are able to produce a commodity, even if they are only compensated at half the exchange value of their labor. The capital owners see a gain of their own – they contribute no labor of their own, and still reap the benefit of one half-day’s labor. The overall production of society has declined, however, as we have only two laborers producing commodities where there could have been four. We can see that this creates no additional value – if the capital owners had performed the labor themselves, they would have produced the same quantity of output of each commodity. The only thing which has occurred was a redistribution of half of the fruits of labor away from the laborer and towards the capital owner.
What the capital owner has received for his ownership of the capital (in this example, half of the produce of labor), is profit. What he has paid to the laborer (another half of the produce of labor) is wages. If we assume that all four of these individuals are rational economic actors, then we can see that this arrangement could not last long – it would be in the laborers’ interests to acquire capital of their own as soon as possible, which would double the rewards of their labor. If they had the skill, it would be in each of their interests to invest the labor-time fashioning their own capital. If they didn’t have the skill, it would be in each of their interests to forgo consumption to exchange their own commodities for capital. The only way that the capital-owners can make a profit off of their capital is if they have a monopoly on access to capital, and the laborers are resigned to sell their labor. There are several ways in which this can be accomplished, not the least of which is increasing the cost of capital to the point that it is out of the reach of the ordinary laborer.
III. Price and Profit
Adam Smith identifies three component parts of price, or the exchange value of a commodity measured in money: wages, profit, and rent.(4) Wages, it has already been shown, is the compensation paid to the laborer for adding value to the commodity. Profit, likewise, has been shown to be the compensation exacted by the capital-owner for owning capital and putting it to use by hiring laborers to work it. Rent, as it was used in Smith’s day, referred specifically to the payment made to a landlord for the use of land; it is used now to refer to economic ‘rent’, which refers to the difference between the actual revenue received for capital and its opportunity cost (i.e. economic profit).
Wages paid to labor are determined by the labor market (accounting for productivity and other factors). Profit of capital is known as ‘rate of return’. Ricardo designated the rate of return of capital to be six or seven percent(5), but the proper rate of return varies from industry to industry and is regulated by the opportunity cost of capital. It remains relatively stable for each industry, however. Rent, in a free and competitive market, should be zero. If any rent is generated, it implies market failure; but in the real world, capital-owners find many ways to generate rent.
How does a capital-owner increase profits? If wages are determined by and large by conditions of the labor market, lowering wages (without sacrificing productivity) is out of the question. If wages do fall or rise, they will be reflected as a fall or rise in the price of the end product. If a capital-owner can increase the scarcity of a commodity, via establishing a natural or artificial monopoly and restricting output, they can increase rent. But the best way to increase profits is to reduce the number of capital-owners; or to increase the number of laborers employed by each capital-owner. In all industries there can be found an economy of scale, that as you increase the size of a firm you can reduce costs.
IV. Wealth
It is evident that in the ‘rude’ state of society, when each man has only his own labor to contribute, and, in fact, in any society where the remunerations of labor are commensurate with the value of the commodities produced, that each man can only accumulate as much wealth as he can produce through his own labor, less that which is consumed. This places a finite limit on the amount of wealth that can be accumulated, as there are a finite number of hours in a day, and years in a man’s life. In order to surpass this natural limit, it is necessary to find a way to expropriate part of the value of others’ labor.
We saw in Section II that a capital-owner with a monopoly on the means of production for some industry can employ laborers and pay them at less than the value of the produce of their labor (in this particular example, ˝). If the laborer wants to increase his income, he must work more; but there are natural limits to how much more he can work. If the capital-owner, on the other hand, wants to increase his income, he need simply hire more workers. The limits on the number of workers he can hire are determined by the limits of the capital employed, the market conditions of the particular industry, &c., but the capital-owner can, with relative ease, acquire more capital, or expand into other industries, and so on. Thus the natural limit on the accumulation of wealth is shattered to pieces, and now the capital-owners can multiply their wealth seemingly infinitely, limited only by their capacity to expropriate the wealth of the rest of the human race.
As all value is created by labor, all is wealth simply the accumulated product of labor – either one’s own labor, or that of others. Since capital is a manifestation of wealth (i.e. it is purchased with this accumulated value, whether earned or borrowed), it follows that all capital is simply the accumulated product of labor that has been expropriated from the laborers.
---------------------------------------
Notes
*While use-value and utility can be argued to apply to distinct concepts, I use the two terms interchangeably in this document. I prefer the term utility for several reasons: first, the stigma associated with use-value as being a specifically Marxian concept; second, the more general familiarity of modern economists and students of economics with the term and idea of utility (whereas use-value sounds more foreign); and third, the idea of marginal utility sounds more cumbersome when applied to use-value.
**Excepting, of course, if the act of hunting possessed utility in and of itself; but we will assume that all labor is an economic ‘bad’ and only partaken in for the fruits it provides.
(1) Adam Smith, Wealth of Nations (New York: Prometheus Books, 1991), 50.
(2) David Ricardo, Principles of Political Economy (Ontario: Batoche Books, 2001), 10.
(3) Ibid., 17.
(4) Adam Smith, Wealth of Nations (New York: Prometheus Books, 1991), 53.
(5) David Ricardo, Principles of Political Economy (Ontario: Batoche Books, 2001).