This is an unfinished appendix on classical economics (i.e., The Labour Theory of Value) and discussing its merits, particularly compared to neo-classical marginal utility theory.
It is mostly from the original section C.1, plus a few other bits and pieces (some of which made it into the revised section C. The focus of section C.1 was changed when it was revised from what was, in effect, a defence of classical theory to a general critique of marginalist economics. This was done for three reasons.
Firstly, exposing the really insane assumptions and unscientific nature of mainstream economics seemed more important than explaining classical economics and refuting the strawmen arguments thrown against it.
Secondly, it allows AFAQ to concentrate on the important issues rather than get bogged down (or dismissed for supporting) classical economics.
Thirdly, not all anarchists subscribe to classical economics, although many do (and, of course, anarchists who do reject the labour theory of value also argue that workers are exploited by capital)
However, the material may be of interest for those seeking a better understanding of classical economics, Marxist economics and the llabour theory of value. I know I struggled reading Marxist introductions to Marxist economics as they failed to explain it very well! Hopefully, comrades will find it useful -- but remember it is unfinished!
Finally, this is a useful FAQ for those interested in the subject, a Frequently Asked Questions about The Labor Theory of Value by Robert Vienneau
3.1 Doesn't the labour theory of value ignore demand?
3.2 Doesn't the theory say that prices equal labour values?
3.3 What about the transformation problem?
3.4 Doesn't the LTV argue that inefficient labour is more valuable?
3.5 What about naturally occurring goods like diamonds and water?
3.6 Does the LTV not imply that workers' living standards must fall?
Section C of the FAQ discusses the flaws in capitalist economics. It does not really indicate what economic theories anarchists tend to subscribe to. This appendix is an attempt to explain that.
While Proudhon initially made his name as a socialist economist, subsequent anarchists have not need that concerned to produce many works on the subject. This is, in part, due to the influence of Marx. Bakunin, for example, praised and accepted Marx's economic analysis of capitalism and he, like many subsequent anarchists, did not feel the need to re-invent the wheel and instead utilised the insights of Marxist economists when critiquing capitalism. Moreover, as Tucker constantly argued, many of the key ideas on Marxist economics can be traced (in various degrees) to Proudhon's analysis of capitalism. In part, anarchist apparent lack of economic analysis can be seen as a desire not to be totally focused on purely economic exploitation when critiquing capitalism. Anarchists, while attacking capitalism as an exploitative system, have tended to expand their critique into oppression and hierarchy, factors which are not always economic in nature or origin.
In general, it is fair to say that anarchists tend to subscribe to a similar kinds of economic analysis as other socialists, namely those associated with the Labour Theory of Value (LTV). This theory used to dominate economics in the first decades of the 19th century. Associated with Adam Smith and David Ricardo, this was the theory which modern economics was developed to replace. Given that economics has moved on from the LTV, socialist support for it is often taken as definitive proof that the socialist analysis of capitalism is wrong. However, as we will attempt to show in this appendix, most criticisms of the LTV are themselves flawed, rooted in misunderstandings and, more often than not, distortions of the subject matter. As such, some of this appendix will involve refuting common straw man arguments against the theory. Once these are corrected, the basic common sense of the theory becomes clear. Moreover, the rejection of the LTV assumes that modern economics is a valid scientific theory. As we have shown in section C.1, this is not the case.
It should also be mentioned that the Labour Theory of Value is used in two different ways by anarchists. Firstly, it is used to analyse and critique capitalism. It is used, as such, by the likes of Proudhon, Bakunin and Tucker (as well as non-anarchist socialists like Marx). Used in this way, it shows that capitalist society, while proclaiming that labour is the source of property, does not meet the principles which justifies it and this means that capitalism is based on workers being exploited by their bosses -- workers' labour produces property which is monopolised by another class who did not contribute effort and energy in producing it simply because they monopolise property and power within society. Secondly, it is used by some of these anarchists as one of the (ethical) principles which would guide an anarchist society. Thus we find mutualists opposing communism based on the principle that individual workers should be paid for the work they actually do. Similarly, many collectivist-anarchists considered payment by deed based on labour performed as a necessary transition system towards the final abolition of money (Marx expressed a similar perspective in his Critique of the Gotha Programme). In this appendix, we will be concentrating on the first use of labour theory of value, as an analysis and critique of capitalism. It must be remembered that these two uses of the theory can be separated and just because someone uses the labour theory of value to critique capitalism it does not automatically follow that they accept it as a principle in any post-capitalist system they may support (Marx obviously springs to mind).
Finally, we must note that some anarchists do reject the LTV. Kropotkin, for example, did not have much time for it. Others argue that while this theory does contain important insights, in order to be valid it has to abstract from the class struggle. As such, it cannot be of much use in analysing capitalism and, moreover, leads to potentially false conclusions (i.e. viewing workers as victims). We discuss these objections in the last part of this appendix.
Finally, it should be mentioned that Duncan K. Foley's Adam's Fallacy: A Guide to Economic Theology provides an excellent introduction to classical economics (covering Smith, Ricardo and Marx) as well how economics changed with the rise of neoclassicalism.
Until the 1870s and 1880s, the labour theory of value was the dominant theory in economics. It was derived from Adam Smith's The Wealth of Nations (published in 1776) and achieved general acceptance with David Ricardo's The Principles of Political Economy and Taxation (published in 1817). For the next fifty years, it dominated English speaking economics and relegated other, utility based, theories to the sidelines of the profession. This remained the case until the rise of neo-classical economics in last decades of the nineteenth century.
In order to understand the Labour Theory of Value we need to compare it to the current perspective of economics which find its root in the so-called "marginalist" revolution of the latter part of the 19th century. Supporters of capitalism usually agree with what is sometimes called the Subjective Theory of Value (STV), as used by most mainstream economic textbooks. Such a label is somewhat misleading for two reasons. Firstly, the LTV does not deny the role of subjective evaluations of individuals, as we discuss in section 3.1 of this appendix. Secondly, as we indicated in section C.1, the fact is that modern economics does not actually have any theory of value at all. The STV is a bit of a misnomer, therefore, as the idea of interpersonal or even individual utility has been long rejected in favour of "indifference curves" and other such nonsense.
However, for the sake of simplicity we will refer to the marginalist analysis as the STV in spite of its evolution away from value and the fact that the LTV is based on the utility of products. This is because the core of the STV remains the same, namely that prices are based on individual preferences, that the price of a commodity is determined by its marginal utility to the consumer and producer. Marginal utility is the point, on an individual's scale of satisfaction, at which his/her desire for a good is satisfied and any increase in consumption would make the person less well off (for example, eating one more cake and feeling stuffed and sick of them). Hence price is the result of individual, subjective evaluations within the marketplace. One can easily see why this theory could be appealing to those interested in individual freedom as it is apparently rooted in the free choice of people expressing themselves.
However, the STV is a myth. Like most myths, it does have a grain of truth in it. But as an explanation of how to determine the price of a commodity, it has serious flaws.
The kernel of truth is that individuals, groups, companies, etc. do indeed value goods and consume/produce them. The rate of consumption, for example, is based on the use-value of goods to the users (although whether some one buys a product is affected by price and income considerations, as we will see). Similarly, production is determined by the utility to the producer of supplying more goods. The use-value of a good is a highly subjective evaluation, and so varies from case to case, depending on the individual's taste and needs. As such it has an effect on the price, as will be shown, but as the means to determine a product's price it ignores the dynamics of a capitalist economy and the production relations that underlie the market. In effect, the STV treats all commodities like works of art, and such products of human activity (due to their uniqueness) are not a capitalistic commodity in the usual sense of the word (i.e. they cannot be reproduced and so labour cannot increase their quantity). Therefore the STV ignores the nature of production under capitalism.
While the STV is handy for describing the price of works of art (and we should note that the LTV can also provide an explanation for this), there is little point having an economic theory which ignores the nature of the vast majority of economic activity in a capitalist society (i.e. the kind that produces goods which can be reproduced and their quality increased by human industry). What the labour theory of value explains is what is beneath supply and demand, what actually determines price under capitalism. It recognises the objectively given price and supply which face a consumer and indicates how consumption ("subjective evaluations") affect their movements. It explains why a certain commodity sells at a certain price and not another -- something which the subjective theory cannot really do. Why should a supplier "alter their behaviour" in the market if it is based purely on "subjective evaluations"? There has to be an objective indication that guides their actions and this is found in the reality of capitalist production. To re-quote Proudhon, "[i]f supply and demand alone determine value, how can we tell what is an excess and what is a sufficiency? If neither cost, nor market price, nor wages can be mathematically determined, how is it possible to conceive of a surplus, a profit?" Therefore, "[t]o say . . . that supply and demand is the law of exchange is to say that supply and demand is the law of supply and demand; it is not an explanation of the general practice, but a declaration of its absurdity." [System of Economical Contradictions, p. 114 and p. 91] Thus the labour theory of value more accurately reflects reality: namely, that for a normal commodity, prices as well as supply exist before subjective evaluations can take place and that capitalism is based on the production of profit rather than abstractly satisfying consumer needs.
So, if the STV is flawed, what does determine prices? Obviously, in the short term, prices are heavily influenced by supply and demand. If demand exceeds supply, the price rises and vice versa. This truism, however, does not answer the question. The answer lies in production and in the social relationships generated there.
The price of a capitalist commodity is, in the long term, equal to its production price, which in turn determines supply and demand. If demand or supply changes, which of course they can and do as consumers' values change and new means of production are created and old ones end, these will have a short-term effect on prices, but the average production price is the price around which a capitalist commodity sells. Thus it is the cost of production which ultimately regulates the price of commodities. In other words, "market relations are governed by the production relations." [Paul Mattick, Economic Crisis and Crisis Theory, p. 51]
This theory of prices is often called the "Labour Theory of Value", or LTV for short. Different economists in this school (often called the "Classical" school) used different terms of describe the concepts used. For example, "natural price" is often used to describe the concept of "production price." David Ricardo expressed this model as follows:
"Let us suppose that all commodities are at their natural price, and consequently that the profits of capital in all employments are exactly at the same rate, or differ only so much as, in the estimation of the parties, is equivalent to any real or fancied advantage which they possess or forego. Suppose now that a change of fashion should increase the demand for silks, and lessen that for woollens; their natural price, the quantity of labour necessary to their production, would continue unaltered, but the market price of silks would rise, and that of woollens would fall; and consequently the profits of the silk manufacturer would be above, whilst those of the woollen manufacturer would be below, the general and adjusted rate of profits. Not only the profits, but the wages of the workmen, would be affected in these employments. This increased demand for silks would however soon be supplied, by the transference of capital and labour from the woollen to the silk manufacture; when the market prices of silks and woollens would again approach their natural prices, and then the usual profits would be obtained by the respective manufacturers of those commodities. It is then the desire, which every capitalist has, of diverting his funds from a less to a more profitable employment, that prevents the market price of commodities from continuing for any length of time either much above, or much below their natural price. It is this competition which so adjusts the exchangeable value of commodities, that after paying the wages for the labour necessary to their production, and all other expenses required to put the capital employed in its original state of efficiency, the remaining value or overplus will in each trade be in proportion to the value of the capital employed." [The Principles of Political Economy and Taxation, p. 50]
Obviously, this is an abstract model which has to be modified to take into account the reality of any actual economy. This means it has to take into account such factors as the degree of monopoly of a specific market (i.e. barriers to entry) which influence profit rates. With monopoly power, companies can keep prices higher than the price of production. All of which explains why capitalists desire to reduce competition by accumulating capital, investing, increasing market share and power as well as via the use of the state (such as copyright laws, patents and so on).
This indicates a key aspect of the LTV -- it analyses capitalism as a mode of production rather than as a mode of exchange, as a mode of circulation, as neo-classical economics does. The LTV looks at the process of creating goods while neo-classicalism looks at the price ratios between already existing goods. This is important as explains why neo-classical economists have such a hard time understanding classical economics. The two schools are talking about different things. The classical schools is based on an analysis of markets based on production of commodities through time. The neo-classical school is based on an analysis of markets based on the exchange of the goods which exist at any moment of time. The benefits of the LTV (as it is looking at how prices are regulated over time, not in the price of a specific good at a given moment of time) should be obvious. As an economy was obviously changing all the time, as production was constantly occurring, it makes little sense to take a snap-shot of the world and then analysis it. The LTV allows the dynamics of capitalism to be studied, what drives its changes over time.
The LTV is based upon the insight that without labour nothing would be produced and you have to produce something before you can exchange it (or you can steal it, as in the case of land). As the utility (i.e. use value) of a commodity cannot be measured, labour is the basis of (exchange) value. The LTV bases itself on the objective needs of production and recognises the key role labour plays (directly and indirectly) in the creation of commodities. However, this does not mean that value exists independently of demand. Far from it -- as noted, in order to have an exchange value, a good must be desired by someone other than its maker (or the capitalist who employs the maker), it must have a use-value for them (in other words, it is subjectively valued by them). Therefore workers produce that which has (use) value, as determined by the demand, and the costs of production involved in creating these use-values help determine the price (its exchange value) along with profit levels.
Once production becomes the focus of analysis, the movements of price become easier to understand. Profit is the driving force of capitalism. Once this fact and its implications are understood, the determination of price is simple and the dynamics of the capitalist system made clearer. The price of a capitalist commodity will tend towards its production price in a free market, production price being the sum of production costs plus average profit rates (the average profit rate, we should note, depends upon the ease of entry into the market, see below).
Consumers, when shopping, are confronted by given prices and a given supply. The price determines the demand, based on the use-value of the product to the consumer and his/her financial situation. If supply exceeds demand, supply is reduced (either by firms reducing production or by firms closing and capital moving to other, more profitable, markets) until an average rate of profit is generated (although we must stress that investment decisions are difficult to reverse and this means mobility can be reduced, causing adjustment problems -- such as unemployment -- within the economy).
The rate of profit is the amount of profit divided by the total capital invested (i.e. constant capital -- means of production -- and variable capital -- wages and salaries). If the given price generates above-average profits (and so profit rate), then capital will try to move from profit-poor areas into this profit-rich area, increasing supply and competition and so reducing the price until an average rate of profit is again produced (we stress try to as many markets have extensive barriers to entry which limit the mobility of capital and so allow big business to reap higher profit rates -- see section C.4). So, if the price results in demand exceeding supply, this causes a short term price increase and these extra profits indicate to other capitalists to move into this market. The supply of the commodity will tend to stabilise at whatever level of the commodity is demanded at the price which produces average profit rates (this level being dependent on the "degree of monopoly" within a market -- see section C.5). This profit level means that suppliers have no incentive to move capital into or out of that market. Any change from this level in the long term depends on changes on the production price of the good (lower production prices meaning higher profits, indicating to other capitalists that the market could be profitable for new investment).
Needless to say, innovation due to class struggle, competition, or the creation of new markets, has an important effect on market prices. This is because innovation changes the production costs of a commodity or creates new, profit-rich markets. While equilibrium may not be reached in practice, this does not change the fact that price determines demand, since consumers face prices as (usually) an already given objective value when they shop and make decisions based on these prices in order to satisfy their subjective needs. Thus the LTV recognises that capitalism is a system existing in time, with an uncertain future (a future influenced by many factors, including class struggle) and, by its very nature, dynamic. In addition, unlike neo-classical "long run equilibrium" prices, the LTV does not claim that labour markets will clear or that a change within one market will have no effect on others. Indeed, the labour market may see extensive unemployment as this helps maintain profit levels by maintaining discipline -- via fear of the sack -- in the workplace (see section C.7). Neither does it maintain that capitalism will be stable. As the history of "actually existing" capitalism shows, unemployment is always with us and the business cycle exists (in neo-classical economics such things cannot happen as the theory assumes that all markets clear and that slumps are impossible).
Moreover, the LTV indicates the source of this instability -- namely the "contradictory idea of value, so clearly exhibited by the inevitable distinction between useful value and value in exchange." [Proudhon, Op. Cit., p. 84] This is particularly the case with labour, as the exchange value of labour (its cost, i.e. wages) is different than its use value (i.e. what it actually produces during a working day). As we argue in the next section, this difference between the use value of labour (its product) and its exchange value (its wage) is the source of capitalist profit (we will indicate in section C.7 how this distinction influences the business cycle -- i.e. instability in the economy).
To summarise, as the production cost for a commodity is a given, only profit levels can indicate whether a given product is "valued" enough by consumers to warrant increased production. This means that "capital moves from relatively stagnating into rapidly developing industries . . . The extra profit, in excess of the average profit, won at a given price level disappears again, however, with the influx of capital from profit-poor into profit-rich industries," so increasing supply and reducing prices, and thus profits. [Paul Mattick, Op. Cit., p. 49] This process of capital investment, and its resulting competition, is the means by which market prices tend towards production prices in a given market. Profit and the realities of the production process are the keys to understanding prices and how they affect (and are affected by) supply and demand.
It could be argued that this "prices of production" theory is close to the neo-classical "partial equilibrium" theory. In some ways this is true. Marshall basically synthesised this theory from the marginal utility theory and the older "cost of production" theory which J.S. Mill derived from the LTV. However, the differences are important. First, the LTV does not get into the circular reasoning associated with attempts to derive utility from price we have indicated above. Second, it argues that rent, profit and interest are the unpaid labour of workers rather than being the "rewards" to owners for being owners. Thirdly, it is a dynamic system in which the prices of production can and do change as economic decisions are made. Fourthly, it can easily reject the idea of "perfect competition" and give an account of an economy marked by barriers to entry and difficult to reverse investment decisions. And, lastly, labour markets need not clear in the long run. Given that modern economics has given up trying to measure utility, it means that in practice (if not in rhetoric) the neo-classical model has rejected the marginal utility theory of value part of the synthesis and returned, basically, to the classical (LTV) approach -- but with important differences which gut the earlier version of its critical edge and dynamic nature.
Lastly, we must stress that to state that market price tends toward production price is not to suggest that capitalism is at equilibrium. Far from it. Capitalism is always unstable, since "growing out of capitalist competition, to heighten exploitation, . . . the relations of production . . . [are] in a state of perpetual transformation, which manifests itself in changing relative prices of goods on the market. Therefore the market is continuously in disequilibrium, although with different degrees of severity, thus giving rise, by its occasional approach to an equilibrium state, to the illusion of a tendency toward equilibrium." [Paul Mattick, Op. Cit., p. 51]
Yes, in general, it has. In the 1870s economics started to change with the rise of what become known as neo-classical economics. By the 1890s, the LTV had become replaced in mainstream economics by marginalism and, as neo-classical economics, this has remained the case until today. Part of this development was due to this use of the LTV by the critics of capitalism and the utility the new doctrines had for defending the status quo, partly because capitalists are not interested in labour values but rather prices and profits. As the LTV was focused on macro-economic issues, its use for determining specific prices on a micro-economic was of little use (although the high level of abstraction of marginalist analysis was also of little use).
These developments should not be taken out of their social and political context. Almost from the start the labour theory of value was used by socialists to attack the capitalist system as exploitative. Socialists like Proudhon and Marx did not, in other words, invent or construct the labour theory of value. Rather, they took it over from Ricardo and Smith what was the established, orthodox, doctrine and indicated how it showed labour was exploited by capitalism. Similarly, it should also be stressed that Marx was not the first reader of Smith or Ricardo to realise that the labour theory of value could be turned against the capitalism itself. A rather long list of British socialists did so in the immediate wake of Smith and Ricardo publishing their main work. These included Thomas Hodgskin, William Thompson, Charles Hall, John Gray, and John Francis Bray. In France, Proudhon had used the LTV to critique capitalism in his What is Property? in 1840 as well in subsequent works. By the time Marx started producing works on economics (in the late 1840s) he was building on and extending a socialist critique of mainstream economics which stretched back over half a century.
This history of socialist use of the LTV, incidentally, helps refute the claims that marginalist economics was not a response to "Marxist economics" because the first volume of Capital was not published until July 1867, after the works of Jevons, Menger, and Walras were written or well under way. This ignores the fact that Marx was not the first socialist to utilise classical economics to critique capitalism. This started before Marx was born. Simply put, "Marxist economics" is not the same as "socialist economics" or, more correctly, the socialist critique of capitalism.
Having an economic analysis which so easily put the legitimacy of capitalism into question was an obvious problem. The LTV, in other words, left capitalist economics with a major political problem of providing some means, other than the robbery of one class by another, to justify the existence of profit, interest and rent. If this was not done, then the radical critics would continue turning the LTV into an attack not just on landowners (as done by Smith, Ricardo and Mill) but on capitalism as a whole. Neo-classical economics provided an answer to that problem (a deeply flawed one as we discuss in section C.1). By the turn of the twentieth century, classical economics had been replaced by neo-classical and the LTV was consigned to books on the history of economics and the works of socialists (usually Marxist economists). It does not help, of course, that most accounts of the LTV present a caricature of that theory (asserting it ignores demand, confusing exchange value with market prices, failing to understand that, unlike neo-classical economics, it is based not on ahistoric snapshots of an economy but rather a dynamic adjustment process through actual, historic, time, and so). If the caricature of this theory were remotely accurate, it would be difficult to understand how it could have dominated economic thought for most of the 19th century!
Unsurprisingly, therefore, the pro-capitalist will argue that the labour theory of value is not universally accepted within mainstream economics. How true; but this hardly suggests that the theory is wrong. After all, it would have been easy to "prove" that democratic theory was "wrong" in Nazi Germany simply because it was not universally accepted by most lecturers and political leaders at the time. Under capitalism, more and more things are turned into commodities -- including economic theories and jobs for economists. Given a choice between a theory which argues that profits, interest and rent are unpaid labour (i.e. exploitation) or one that argues they are all valid "rewards" for service, which one do you think the wealthy will back in terms of funding? As non-neoclassical economist John Kenneth Galbraith noted in 1972:
"Economic instruction in the United States is about a hundred years old. In its first half century economists were subject to censorship by outsiders. Businessmen and their political and ideological acolytes kept watch on departments of economics and reacted promptly to heresy, the latter being anything that seemed to threaten the sanctity of property, profits, a proper tariff policy and a balanced budget, or that suggested sympathy for unions, public ownership, public regulation or, in any organised way, for the poor." [The Essential Galbraith, p. 135]
This process is still at work, with corporations and the wealthy funding university departments and posts as well as their own "think tanks" and paid PR economists. The control of funds for research and teaching plays it part in keeping economics the "economics of the rich." However, there are other factors as well, namely the hierarchical organisation of the university system. As Joan Robinson noted, "the radicals have the easier case to make. They have only to point to the discrepancy between the operation of a modern economy and the ideals by which it is supposed to be judged, while the conservatives have the well-nigh impossible task of demonstrating that this is the best of all possible worlds. For the same reason, however, the conservatives are compensated by occupying positions of power, which they can use to keep criticism in check." [Collected Economic Papers, vol. 5, p. 2]
This factor is important. The heads of economics departments have the power to ensure the continuation of their ideological position due to the position as hirer and promoter of staff. As economics "has mixed its ideology into the subject so well that the ideologically unconventional usually appear to appointment committees to be scientifically incompetent." [Benjamin Ward, What's Wrong with Economics?, p. 250] Galbraith termed this "a new despotism," which consisted of "defining scientific excellence in economics not as what is true but as whatever is closest to belief and method to the scholarly tendency of the people who already have tenure in the subject. This is a pervasive test, not the less oppress for being, in the frequent case, both self-righteous and unconscious. It helps ensure, needless to say, the perpetuation of the neoclassical orthodoxy." [Op. Cit., p. 135] This plays a key role in keeping economics an ideology rather than a science:
"The power inherent in this system of quality control within the economics profession is obviously very great. The discipline's censors occupy leading posts in economics departments at the major institutions . . . Any economist with serious hopes of obtaining a tenured position in one of these departments will soon be made aware of the criteria by which he is to be judged . . . the entire academic program . . . consists of indoctrination in the ideas and techniques of the science." [Ward, Op. Cit., pp. 29-30]
This was the case with the Labour Theory of Value. From the time of Adam Smith onwards, radicals had used the LTV to critique capitalism. The classical economists (Adam Smith and David Ricardo and their followers like J.S. Mill) argued that, in the long run, commodities exchanged in proportion to the labour used to produce them. Thus commodity exchange benefited all parties as they received an equivalent amount of labour as they had expended. However, this left the nature and source of capitalist profits subject to debate, debate which soon spread to the working class. Long before Karl Marx (the person most associated with the LTV) wrote his (in)famous work Capital, Ricardian Socialists like Robert Owen and William Thompson and anarchists like Proudhon were using the LTV to present a critique of capitalism, exposing it as being based upon exploitation (the worker did not, in fact, receive in wages the equivalent of the value she produced and so capitalism was not based on the exchange of equivalents). In the United States, Henry George was using it to attack the private ownership of land. When marginalist economics came along, it was quickly seized upon as a way of undercutting radical influence. Indeed, followers of Henry George argue that neo-classical economics was developed primarily to counteract his ideas and influence (see The Corruption of Economics by Mason Gaffney and Fred Harrison).
Thus, as noted above, marginalist economics was seized upon, regardless of its merits as a science, simply because it took the political out of political economy. With the rise of the socialist movement and the critiques of Owen, Thompson, Proudhon and many others, the labour theory of value was considered too political and dangerous. Capitalism could no longer be seen as being based on the exchange of equivalent labour. Rather, it should seen as being based on exchange of equivalent utility. But, as indicated (in the last section) the notion of equivalent utility was quickly dropped while the superstructure built upon it became the basis of capitalist economics. And without a theory of value, capitalist economics cannot prove that capitalism will result in harmony, the satisfaction of individual needs, justice in exchange or the efficient allocation of resources.
The subsequent history of marginalist economics also shows its deeply ideological nature. As we discuss in section C.1.3, utility moved from cardinal to ordinal in response to cardinal utility being used by social reformers as a means of justify the redistribution of income from rich to poor. Such a redistribution of income would strike at the heart of the class hierarchy upon which capitalism is based and which marginalism sought to explain, and justify. As with the LTV, economists had created a theory that could be used to attack capitalism! And as with the LTV, marginalism was used by social reformers to argue for the redistribution of wealth downward. Unsurprisingly, this lead to a revision of the theory which lead to the rejection of cardinal utility in favour of ordinal utility. Now utility could not be measured between individuals and so redistribution could no longer be justified. A further development saw utility being removed completely, being replaced with indifference curves. Ironically, though, this purging of cardinal utility struck at the heart of neo-classical economics. With the removal of cardinality, it becomes impossible to simply add individual demand curves to get a market demand curve. With ordinal utility, utility is subjective and so cannot compared between individuals and so cannot be added together. This, ironically, repeats the conclusions of classical economics, which argues that utility cannot be the base for exchange value given its subjective nature.
Ignoring the political issue, there were/are many reasons presented why the LTV was rejected. Most are based on a clear misunderstanding of what the theory argued, such as the claim that it ignores demand. Others are more substantial, is that it is impossible to transform values into prices given that profits had to be averaged out between industries which employed the different amounts of capital. Some are plain stupid, such as the notion that a mud-pie would have the same price as an apple pie if the same amount of labour was used to create it. Given that this sadly standard assertion has been refuted from the start, it simply shows that repetition works!
One of the classic straw man arguments against the Labour Theory of Value is the idea that it ignored demand, that it removes utility from the determination of price. The classic example almost always raised is that of the "mud pie" -- if a mud pie takes the same amount of labour as an apple pie to make, they ask, surely it has the same price (value)?
Sadly, this argument is based on a complete misunderstanding of the LTV. Indeed, anyone claiming that it ignores demand or raises the "mud pie" example is simply showing their ignorance. This is because at no time does the LTV ignore demand. As Ricardo argued:
"It is the cost of production which must ultimately regulate the price of commodities, and not, as has been often said, the proportion between the supply and demand: the proportion between supply and demand may, indeed, for a time, affect the market value of a commodity, until it is supplied in greater or less abundance, according as the demand may have increased or diminished; but this effect will be only of temporary duration." [Op. Cit., p. 260]
In other words, the cost of production is the key to understanding how a market reacts to increases and demands of demand (or supply). This is the objective measure by which profits are measured and, consequently, supply adjusted to meet demand. However, this only applied to commodities which can be easily reproduced, i.e. whose supply can be increased by labour:
"If the demand for hats should be doubled, the price would immediately rise, but that rise would be only temporary, unless the cost of production of hats, or their natural price, were raised . . . for a commodity is not supplied merely because it can be produced, but because there is a demand for it . . . Commodities which are monopolized, either by an individual, or by a company, . . . fall in proportion as the sellers augment their quantity, and rise in proportion to the eagerness of the buyers to purchase them; their price has no necessary connexion with their natural value: but the prices of commodities, which are subject to competition, and whose quantity may be increased in any moderate degree, will ultimately depend, not on the state of demand and supply, but on the increased or diminished cost of their production." [Op. Cit., p. 262]
As can be seen, the LTV does not deny that consumers subjectively evaluate goods and that this evaluation can have a short term effect on price (which determines supply and demand). The LTV bases itself on supply and demand and seeks to explain the dynamics of prices and so recognises (indeed bases itself on the fact) that individuals make their own decisions based upon their subjective needs. In the words of Proudhon, "utility is the necessary condition for exchange." What the LTV seeks to explain is price (i.e. exchange value) -- and a good can only have an exchange value if others desire it (i.e. has a use value for them and they seek to exchange money or goods for it). Thus the example of the "mud pie" is a classic straw man argument -- the "mud pie" does not have an exchange value as it has no use value to others and is not subject to exchange. In other words, if a commodity cannot be exchanged, it cannot have an exchange value (and so price). As Proudhon argued, "nothing is exchangeable if it be not useful." [System of Economical Contradictions, p. 77 and p. 85] In this he simply echoed Ricardo:
"Utility then is not the measure of exchangeable value, although it is absolutely essential to it. If a commodity were in no way useful, - in other words, if it could in no way contribute to our gratification, - it would be destitute of exchangeable value, however scarce it might be, or whatever quantity of labour might be necessary to procure it." [Op. Cit., p. 5]
Therefore the LTV includes the element of truth of "subjective" theory while destroying its myths. For, in the end, the STV just states that "prices are determined marginal utility; marginal utility is measured by prices. Prices . . . are nothing more or less than prices. Marginalists, having begun their search in the field of subjectivity, proceeded to walk in a circle." [Allan Engler, Apostles of Greed, p. 27] The LTV, on the other hand, bases itself on the objective fact of production and the costs (ultimately expressed labour time) ensuing in it ("The absolute value of a thing, then, is its cost in time and expense." [Proudhon, What is Property?, p. 145]). The variations in supply and demand (i.e. market prices) oscillate round this "absolute value" (i.e. production price) and so it is the cost of production of a commodity which ultimately regulates its price, not supply and demand (which only temporarily affects its market price).
One last thing. Given how critics of the LTV argue that it ignores utility, the fact is that the argument for surplus value is based on the importance of use value rather than exchange value. For the capitalist will only hire a worker if they produce more value than they cost, i.e. if their use value (what their labour produces) is greater than their exchange value (what their labour costs). In other words, the whole analysis of capitalism is rooted in utility (namely, the utility labour power has for the capitalist). As we argue in section C.2, it is this difference between the (potential) use value of labour and its exchange value which ensures its exploitation by capital.
While it is sometimes portrayed as such, the labour theory of value is not a labour theory of price. As critics were quick to point out, prices could not be equal to value in any real economy.
The logic is simple. Profits (surplus value) is generated by workers. Assuming that wages and the length of the working day are equal across industries, then the more workers employed by an enterprise, the more surplus value created. This means that a labour-intensive workplace would produce more surplus value per unit capital than a capital-intensive one. Therefore, if prices were proportional to labour values then the labour-intensive workplace would have a higher rate of profit that the capital-intensive one. This would violate the assumption that the rate of profit, thanks to competition, would be the same in all firms. This contradiction can be avoided only if prices are not proportional to labour values.
Ironically, the classical economists would agree. Marx, for example, explicitly noted that price and value do not actually equate:
"The continued oscillations in prices, their rise and fall, compensate each other . . . and carry out their own reductions to an average price, which is their internal regulator . . . the problem of the formation of capital . . . [is]: How can we account for the origin of capital on the supposition that prices are regulated by the average price, i.e., ultimately by the [labour] value of the commodities. I say 'ultimately,' because average prices do not directly coincide with the [labour] values of commodities." [Capital, Vol. 1, p. 269fn]
It could be argued that no classical economist thought that the LTV worked directly in a capitalist economy. Smith, for example, explicitly rejected the idea that the LTV could be applied directly in an economy with "stock" (i.e. "capital"). Similarly, it is doubtful that Ricardo and John Stuart Mill accepted the LTV as applicable directly or unmodified to analysing a real capitalist economy. As long as the proportion of the expenses of production required for wages varies among industries, the LTV cannot be a theory of price.
It is true that in volume one of Capital, Marx uses the abstraction that "natural" prices are the same as labour values. In other words, he simplifies the real world by assuming that all industries have the same capital intensity. He did so to draw attention to how surplus value was possible in an economy where all goods exchange at their values. He did not think that any real capitalist economy would be like this. Rather, the LTV worked indirectly within capitalism and, as a result, the economy was regulated by the law of value rather than value determining price. In other words, Marx rejected the LTV as an accurate theory of price. His use of in Volume 1 of Capital was at the high level of abstraction in order to show that the returns to capital have their source in the exploitation of workers by assuming that commodities exchanged at their labour values.
As such, it is more sensible to regard the premise that prices are proportional to labour values as merely a simplifying assumption. This assumption does not hold in general, but simplifying assumptions rarely do. The key is that the conclusions of this argument do not depend in any important way on it. This is because if capitalism is exploitative when there is the equal organic composition of capital, then it must be exploitative in general. This is because surplus value is still being produced and so the exploitative nature of capitalism is hardly dependent on such a minor feature as the organic composition of capital.
This use of abstraction and argument is hardly strange. Most theories in mainstream economics are based on drawing conclusions about the world from stylised, abstract models. Indeed, as we note in section 3.3, the standard marginal productivity of capital requires exactly the same assumption as the "direct" LTV theory (strangely no mainstream economist argues that this proves the theory is wrong, quite the reverse). The key difference is that the neo-classical simplifying assumptions are usually much more extreme than this one and, unlike the LTV, the theory disintegrates when they are revoked (this is because they are essential to the theory in spite of their deeply abstract nature).
Also, classical economics were well aware that certain goods either did not have exchange value but still had a price or had a price which was not related to the labour embodied within it. As regards the latter, the classical economists themselves pointed to goods which could not be reproduced (such as works of art). In such cases, price was determined by the subjective evaluations of the buyer. Hence Ricardo:
"Commodities which are monopolized, either by an individual, or by a company, vary according to the law . . . [that] they fall in proportion as the sellers augment their quantity, and rise in proportion to the eagerness of the buyers to purchase them; their price has no necessary connexion with their natural value: but the prices of commodities, which are subject to competition, and whose quantity may be increased in any moderate degree, will ultimately depend, not on the state of demand and supply, but on the increased or diminished cost of their production." [Op. Cit., p. 262]
It should be noted that neo-classical economics, by looking at a snapshot of time, essentially took this exception to the classical system and generalised it. In an economy without time (or production, as it amounts to the same thing) then there is a fixed amount of a commodity and prices of production (the "natural price") becomes somewhat irrelevant. However, ignoring time and production seems a large price to pay in terms of realism (see section C.1).
In terms of the former, land would be the classic example of a commodity which does not have an exchange value (no one made the land) but has a price. However, as we note in section 3.5 any price it does has is based on individual's monopolising it and stopping others from using it unless they pay tribute first. As Proudhon put it:
"How much does the proprietor increase the utility of his tenant's products? Has he ploughed, sowed, reaped, mowed, winnowed, weeded? . . . I admit that the land is an implement; but who made it? Did the proprietor? Did he -- by the efficacious virtue of the right of property, by this moral quality infused into the soil -- endow it with vigour and fertility? Exactly there lies the monopoly of the proprietor, though he did not make the implement, he asks pay for its use. When the Creator shall present himself and claim farm-rent, we will consider the matter with him; or even when the proprietor -- his pretended representative -- shall exhibit his power of attorney." [What is Property?, pp. 166-7]
Another example of something which has a price but no exchange value is interest, for which different classical economics presented different explanations for. The classical economics embraced Senior's "abstinence" theory (see section C.2.7) more for its utility in defending interest than for its logic. Interestingly, the individualist anarchists argued that in a totally free market, interest would fall to its labour value as competition would reduce interest to the price required to issue and reclaim it. Other critics of capitalism, such as Proudhon and Marx, had different views. For Proudhon, interest was down to a (state imposed) lack of alternatives and so suggested a mutual bank as a means of eliminating it. For Marx, "there is no 'natural' rate of interest. What is the natural rate simply means the rate established by free competition. There are no 'natural' limits to the interest rate." [Capital, vol. 3, p. 478] Needless to say, the demand and supply for credit is based on market conditions, and so reflects the wider rate of profit (as we discussed in section C.8, the willingness of banks to provide credit will depend on the business cycle and so contributes to it amplitude rather than creating it). Marx, undoubtedly, would have been as unimpressed with a "time preference" theory of interest (see section C.2.6) as he was with the so-called "abstinence" one:
"An unparalleled example of the 'discoveries' of vulgar economics! It replaces an economic category with a sycophantic phrase, and that is all . . . All the conditions necessary for the labour process are now converted into acts of abstinence on the part of the capitalist . . . The capitalist robs himself whenever he 'lends (!) the instruments of production to the worker', in other words, whenever he valorises their value as capital by incorporating labour-power into them instead of eating them up, steam-engines, cotton, railways, manure, horses and all; or, as the vulgar economist childishly conceives, instead of dissipating 'their value' in luxuries and other articles of consumption. How the capitalist class can perform the latter feat is a secret which vulgar economics has so far obstinately refused to divulge. Enough that the world continues to live solely through the self-chastisement of this modern penitent of Vishnu, the capitalist. Not only accumulation, but the simple 'conservation of a capital requires a constant effort to resist the temptation of consuming it.' The simple dictates of humanity therefore plainly enjoin the release of the capitalist from his martyrdom and his temptation, in the same way as the slave-owners of Georgia, U.S.A., have recently been delivered by the abolition of slavery from the painful dilemma over whether they should squander the surplus product extracted by means of the whip from their Negro slaves entirely in champagne, or whether they should reconvert a part of it into more Negroes and more land." [Capital, vol. 1., pp. 744-5]
Finally, it should be stressed that classical economists were well aware that the market price changed. The exchange value of a commodity, its "natural price", was taken as being the regulator of actual prices, i.e., market prices. Rather than arguing that market prices were in equilibrium (as neo-classical economics does), classical economists were well aware that market prices were unlikely to equal "natural" prices and used this obvious fact to explain the dynamics of capitalism as a system of production through time.
The core of the argument is that there is a contradiction between the fact that labour is the regulator of price and that competition results in an equalisation of profit rates across industries. As the profit rate is based on the amount of capital required, this suggests that exchange value and prices are fundamentally at odds and could only be the same when the capital invested in each industry is the same. As this would be unlikely to be the case, this means that the LTV is flawed.
So the transformation problem is related to the last issue, namely the difference between prices and (labour) values. As such, it is a bit of a bogus problem given that the LTV rejects the idea that prices directly reflect values. As the LTV is a means of analysing a real economy at an abstract level, the transformation problem therefore is not really an issue.
Somewhat ironically, the neo-classical theory on the marginal productivity of capital requires exactly the same assumption as the "direct" LTV theory, that is, the amount of capital invested in each industry is the same. This conclusion was discovered during the Cambridge Capital Controversy debates of the 1960s (see section C.2.5). As Steve Keen summarises:
"Rather than the rate of profit depending on the quantity of capital, the quantity of capital . . . depends on the rate of profit . . . There is therefore no consistent relationship between factor productivity and factor incomes . . . The distribution of income is a social phenomenen.
"Economists fought against this conclusion, but every apparent victory was shown to be invalid. Ironically, the rebuttals to economic rejoinders often showed that the only conditions under which the economic position could hold would be if the ratio of capital to output was the same in all industries. This is the same conclusion needed to make Marx's labour theory of value hold, yet the neoclassical revolution which gave us modern economic theory was supposedly free of the nonsense conditions needed by its Marxian rival." [Debunking Economics, p. 146]
So neo-classical economics also implies that there is one industry in an economy. This is perhaps unsurprising, as the "representative" agent theory is at the heart of neo-classical economics (see section C.1.3) and it "was a kludge invented . . . to get around the problem that, in general, the preferences of individuals could not be aggregated . . . representative agent macroeconomics amounts to assuming that the economy consists of a single individual, producing and consuming a single commodity." [Steve Keen, Op. Cit., p. 212] Obviously, no mainstream economist argues that marginality productivity theory is incorrect or that this assumption proves the theory is wrong, quite the reverse (they stress it is an abstraction but seem unwilling to allow the LTV the same leeway).
So, as far as the transformation problem goes, there seems to be a hypocritical standard being applied by neo-classical critics of the LTV. As noted in section 3.2, the notion that prices were proportional to values was used as a simplifying assumption, to help show how exploitation was possible even when goods were sold at their value (i.e., that exploitation is the result of what happens in production, not in exchange). Removing that assumption does not change the conclusion that labour is exploited nor does it harm that costs in production determine the equilibrium price of a commodity, the so-called "natural" price around which the actual ("market") prices move.
In this sense, the transformation problem is not really a problem if we take exchange value as a good heuristic analysis device, a simplifying assumption helpful to understand the nature and dynamics of capitalism. In other words, exchange value is used to give an insight into how prices are formed rather than determining exactly the prices as such. Such a use of the LTV allows insights into the dynamics of capitalism and how exploitation happens within it.
Another common straw man argument against the LTV is the idea that the more labour taken to produce a commodity, the more value it has. Thus, it is claimed, the product of the inefficient workers would be worth more than that of the efficient ones.
However, the amount of time and effort spent in producing a particular commodity is not the essential factor in determining its price in the market. What counts is the costs (including the amount of work time) that it takes on average to produce that type of commodity, when the work is performed with average intensity, with typically used tools and average skill levels. Commodity production that falls below such standards, e.g. using obsolete technology or less-than-average intensity of work, will not allow the seller to raise the price of the commodity to compensate for its inefficient production, because its price is determined in the market by average conditions (and thus average costs) of production, plus the average profit levels required to meet the average rate of profit on the invested capital. On the other hand, using production methods that are more efficient than average -- i.e.. which allow more commodities to be produced with less labour -- will allow the seller to reap more profits and/or lower the price below average, and thus capture more market share, which will eventually force other producers to adopt the same technology in order to survive, and so lower the market production price of that type of commodity. In this way, advances that reduce labour time translate into reduced exchange value (and so price), thus showing the regulating function of labour time (and indicating the usefulness of the LTV as a methodological tool).
In other words, if a commodity takes 2 hours of labour to produce on average, any company which takes more than that to produce it would quickly see its goods go unsold. Meanwhile, if due to the introduction of new machinery a company produces the good in 1 hour then it will be able to reap higher profits as its price would be lower than the market price. This, of course, would force the other companies to copy the innovation and so force the market price down towards the new "natural" price. In this way, the LTV explains changes in price within the market (something neo-classical economics cannot do as it assumes that no single company nor consumer can have an effect on the market price, which is a given).
One objection to the LTV is that it ignores the price of naturally occurring products like gems, wild foods, land, oil, water and other natural resources. It is sometimes claimed that it implies that naturally occurring objects should have no price, since it takes no labour to produce them.
This argument is flawed as the LTV does not ignore such things. Nature is a vast source of use-values which humanity must utilise in order to produce other, different, use-values. If you like, the earth is the mother and labour the father of wealth (or vice versa). Without both, goods would not exist. For example, gemstones are valuable because it takes a huge amount of labour to find them. If they were easy to find, like sand, they would be cheap. Similarly, wild foods and water have value according to how much labour is needed to find, collect, and process them in a given area (for example water in arid places is more "valuable" than water near a lake).
The same logic applies to other naturally occurring objects. If it takes virtually no effort to obtain them -- like air -- then they will have little or no exchange value. However, the more effort it takes to find, collect, purify, or otherwise process them for use, the more exchange value they will have relative to other goods (i.e. their production prices are higher, leading to a higher market price).
Therefore the LTV provides an explanation of why common resources in one area become more valuable in others (for example, the price of water to a person in a desert would be far higher than to someone next to a river). In the short term, the owner of water in the desert can charge a vast amount to those who want it simply because it is rare and the amount of labour required to find an alternative source would be high (we will ignore the ethics of charging high prices to people in need for the moment, as does marginalist economics which portrays such situations -- which most people would intuitively class as exploitative -- as "fair exchange"). But if such excess profits could be maintained for long periods, then they would tempt others to increase competition. If a steady demand for water existed in that region then competition would drive down the price of water to around to the average price required to make it available.
The other reason why the gifts of nature (like land) have a price is due to their monopolisation by property owners. By means of the state, the owning class can bar others from using natural resources without their permission or paying them a tax for access. Without the state, natural resources would be available to all and, consequently, their price would drop to zero as "occupancy and use" would eliminate landlords.
A common argument against the LTV is the question of real wages. Critics argue that the LTV assumes that wages would fall to a subsistence level, i.e. the minimum needed for workers to live. Pointing to the higher standards of living of today, the critics argue that the LTV is wrong.
This criticism, while invalid, does have some basis in socialist literature. Some socialists and anarchists (usually in moments of polemical excess) did suggest that capitalism was marked by an "Iron Law of Wages" (i.e. wages will not rise above a minimum). Marx, in his earlier works, did subscribe to the position of absolute impoverishment (for example, in Wage Labour and Capital). However, this position is not inherent in the LTV. For most classical economics, the "natural" level of wages (or the value of labour-power) is a relative measure rather than an absolute one. In other words, the "natural" wage included a relative or moral element. Thus Smith:
"By necessaries I understand, not only the commodities that are indispensably necessary for the support of life, but whatever the custom of the country renders it indecent for creditable people, even of the lowest order, to be without. A linen shirt, for example, is, strictly speaking, not a necessary of life. The Greeks and Romans lived, I suppose, very comfortably, though they had no linen. But in the present times, through the greater part of Europe, a creditable day-labourer would be ashamed to appear in public without a linen shirt, the want of which would be supposed to denote that disgraceful degree of poverty, which, it is presumed, no body can well fall into without extreme bad conduct." [Wealth of Nations, Book V, Chapter II, Article 4]
As usual, Adam Smith is right while his erstwhile ideological followers are wrong. They may object, noting that strictly speaking Smith was talking of "necessaries" rather than poverty. However, his concept of necessaries implies a definition of poverty and this is obviously based not on some unchanging biological concept of subsistence but on whatever "the custom of the country" or "the established rules of decency" consider necessary. It is ironic that those today who most aggressively identify themselves as disciples of Smith are also the people who are most opposed to definitions of poverty that are consistent with this definition of "necessaries" (this is unsurprising, as those who invoke his name most usually do so in pursuit of ideas alien to his work). This is done for the usual self-interested motives.
Ricardo, also, made the same point as Smith:
"It is not to be understood that the natural price of labour, estimated even in food and necessaries, is absolutely fixed and constant. It varies at different times in the same country, and very materially differs in different countries. It essentially depends on the habits and customs of the people. An English labourer would consider his wages under their natural rate, and too scanty to support a family, if they enabled him to purchase no other food than potatoes, and to live in no better habitation than a mud cabin; yet these moderate demands of nature are often deemed sufficient in countries where 'man's life is cheap' and his wants are easily satisfied. Many of the conveniences now enjoyed in an English cottage, would have been thought luxuries at an earlier period of our history." [Op. Cit., pp. 54-5]
As did J. S. Mill:
"But the permanent remuneration of the labourers essentially depends on what we have called their habitual standard; the extent of the requirements which, as a class, they insist on satisfying before they choose to have children. If their tastes and requirements receive a durable impress from the sudden improvement in their condition, the benefits to the class will be permanent." [Principles of Political Economy, p. 94]
Marx included this moral element in his understanding of the value of labour-power in Capital (rejecting earlier positions which implied an absolute impoverishment of working class people). There he distanced himself from his earlier notion that capitalism resulted in absolute impoverishment. As he put it "the number and extent of [the workers] so-called necessary requirements, as also the manner and extent they are satisfied, are themselves products of history, and depend therefore to a great extent on the level of civilisation attained by a country . . . In contrast, therefore, with the case of other commodities, the determination of the value of labour-power contains a historical and moral element." [Capital, Vol. 1, p. 275]
In other words, the level of wages does not depend on whether the values are great or small. Thus we can see a fall in the value of labour-power yet see a rise in the mass of commodities that value can buy. In other words, a rise in exploitation can lead to a rise in living standards as the (exchange) value of goods on the market falls.
However, as we discussed in section C.10 it would be a mistake to view rising wages as automatically meaning rising living standards. Rising wages can go hand-in-hand with rising hours of labour, more intensive work (exploitation) while at work, social disruption, the break-down of community, destruction of the environment and so forth. While the LTV does not assume that wages will fall, it does (by focusing on production) allow a wider perspective of progress in workers' living standards by looking at how people are treated in production. In other words, just because you can buy more commodities it may come at an intensification and extension of work and so make working people worse off in terms of quality of life.
One last point. We must stress that not all anarchists support the LTV. Kropotkin, for example, did not agree with it. He considered socialist use of the LTV as taking "the metaphysical definitions of the academical economists" to critique capitalism using its own definitions and so, like capitalist economics, it was not scientific. However, his rejection of the LTV did not imply that Kropotkin did not consider capitalism as exploitative. Far from it. Like every anarchist, Kropotkin attacked the "appropriation of the produce of human labour by the owners of capital," seeing its roots in the fact that "millions of men [and women] have literally nothing to live upon, unless they sell their labour force and their intelligence at a price that will make the net profit of the capitalist and 'surplus value' possible." [Evolution and Environment, p. 92 and p. 106] Similarly, he considered it a truism that production, under capitalism, has as its "only aim . . . to increase the profits of the capitalist." [Anarchism, p. 55]
Kropotkin's rejection of the LTV is based on the fact that, within capitalism, "[v]alue in exchange and the necessary labour are not proportional to each other" and so "Labour is not the measure of Value." Therefore, he argued, "[u]nder the capitalist system, value in exchange is measured no more by the amount of necessary labour." [Evolution and Environment,, p. 91] Which is, of course, true under capitalism. As Proudhon and Marx argued, under capitalism (due to existence of capitalist profit, rent and interest) prices could not be proportional to the average labour required to produce a commodity ("Wherever labour has not been socialised, -- that is, wherever value is not synthetically determined, -- there is irregularity and dishonesty in exchange." [Proudhon, Op. Cit., p. 128]) Only when the rate of profit is zero could prices directly reflect labour values (which is, of course, what Proudhon and Tucker desired -- "Socialism . . . extends its ["that labour is the true measure of price"] function to the description of society as it should be, and the discovery of the means of making it what it should be." [Tucker, The Individualist Anarchists, p. 79]).
As such, this does not mean that the LTV is irrelevant to analysing the capitalist economy. Rather, it argues that under capitalism labour is, essentially, the regulator of price, not its measure. "The idea that has been entertained hitherto of the measure of value," argued Proudhon, "then, is inexact; the object of our inquiry is not the standard of value, as has been said so often and so foolishly, but the law which regulates the proportions of the various products to the social wealth; for upon the knowledge of this law depends the rise and fall of prices." [System of Economical Contradictions, p. 94] So Kropotkin's argument does not undermine the LTV. As we discussed in section 3.2 above, neither Smith, Ricardo, Proudhon nor Marx actually thought that the LTV worked directly within capitalism, but rather indirectly.
Kropotkin's mistake is a common one and was made by many Marxists (and critics of Marxism) at the time. Stripped of the metaphysical baggage which many (particularly Marxists) have placed on the LTV (and correctly attacked as unscientific by Kropotkin), it is essentially a methodological tool, a means of investigating the key aspects of capitalism -- namely wage labour and the conflicts associated with it at the point of production -- at a high level of abstraction. Thus it is a explanatory tool and value an explanatory category, a means of understanding the dynamics of capitalism.
Therefore, rather than being the crude idea that "exchange value" equals prices the LTV is primarily a means of analysis. This can be seen by our use of "production prices" rather than (exchange) value in our description of how the theory works. The LTV focuses analysis onto the production process and thus correctly points our investigations of how capitalism works to what goes on in production, to the relations of authority in the capitalist workplace, the struggle between the power of the boss and the liberty of the workers, the struggle over who controls the production process and how the surplus produced by workers is divided (i.e. how much remains in the hands of those who produced it and how much is appropriated by capitalists). Therefore, the claim that prices deviate from values and so the LTV is outdated indicates a confusion between the explanatory role of the LTV and the actual world of prices and profits. The LTV reminds us that production comes before and so underlies exchange and what happens at the point of production directly influences what happens in exchange. Decreasing the direct and indirect labour time required for production will decrease the cost price of a commodity and so reduce its production price. Thus the rise and fall of prices and profits is the result of changes in value relations (i.e. in the objective labour costs of production -- labour-time value) and so the use of the LTV as an explanatory tool is valid.
In other words, the labour theory of value is simply a good heuristic analysis device which gives an insight into how prices are formed rather than the prices as such. In practice, production prices are dependent on wages and these reflect labour-time values rather than are labour-time.
Thus Kropotkin was right -- up to a point. His critique of the LTV is correct for those versions of it which state that "equilibrium" price equals the (exchange) value of a good. He was correct to note that under capitalism this rarely happens. Which means that our use of the LTV is simply that of an explanatory tool, a means of looking at the key aspect of capitalism -- namely the production process which creates things which have use value for others and are then exchanged. Production comes first and so we must first start there to understand the dynamics of capitalism. Not to do so, as the STV does, will lead your analysis into a dead end and will ignore the fundamental aspect of capitalism -- wage labour, the authority structures in production and the exploitation of labour such oppression generates.
Indeed, Kropotkin's argument is reflected in the "prices of production" perspective outlined above as we concentrate on prices rather than "values." We reject the metaphysical abstractions often associated with the LTV and rather concentrate on real phenomenon, such as prices, profits, class struggle and so on. Such a perspective helps ground our critique of capitalism in what happens in the real world rather than in the realms of abstraction. Marx's concentration on value (i.e. the abstract level of analysis) made him ignore the role of class struggle in capitalism and its affect on profits (with bad results for his theory and the movement he inspired).