Last week we saw how the pioneers of modern economics argued that human labour was the ultimate source of wealth. Adam Smith and David Ricardo developed a “labour theory of value” that formed the cornerstone of their political economy.
Yet by the end of the 19th century pro-capitalist economists had completely abandoned this idea. And the chief reason behind this reversal was the need to disguise, rather than explain, the way in which capitalism made its profits.
The revolutionary socialist Karl Marx noted that Ricardo’s labour theory of value harboured problems. Sometimes Ricardo treated labour as an activity that produced value, while at other times it was treated as a commodity with a price, namely wages.
Strictly speaking, what capitalists bought was not labour but “labour power” – the ability to work. That labour power is what workers sell in return for wages.
Wages would ultimately reflect the cost of producing labour power in the first place. That meant ensuring that workers were in a fit state to work – food, clothing, shelter and so on. What was given in wages would cover little more than the basics of life.
But the value of the commodities that workers produced was considerably higher than this sum. Marx called this difference “surplus value” – the source of capitalist profit.
The theory of surplus value solved a scientific problem by offering a systematic account of where profits came from.
But economics was never simply a science. It also played an ideological role, justifying and defending the capitalist way of doing things.
So Marx had created a new problem. If workers were the source of profits, why should they not be entitled to them, rather than just being paid for their labour power?
In the years after Marx’s death, his ideas were disseminated across the workers’ movement.
All this took place as capitalism itself was transforming. Companies, once owned by one or two rich individuals, were consolidated into huge cartels and financed through the stock markets.
It was also a period of class struggle. Workers fought over wages, the length of the working day, and the right to strike.
The labour theory of value was a millstone round the neck of the ruling class. They increasingly turned away from Smith and Ricardo and towards a new school of economists – the marginalists.
The marginalists claimed that a “scientific” approach would illuminate the mysteries of the markets and made no secret of their hostility to socialist ideas – especially the notion that capitalists exploit their workers.
Rather than starting from labour and production, the marginalists began by imagining idealised consumers, each equipped with a sense of individual “utility”.
They would try to maximise their utility by swapping the goods they owned until an optimal “equilibrium” had been reached. They argued that the entire economy could be thought of in these terms.
One of the earliest Marxist responses to marginalism came from the Russian revolutionary Nikolai Bukharin. His 1914 book, The Economic Theory Of The Leisure Class, subjected marginalist ideas to a searing critique.
While Smith and Ricardo had started with the existing capitalist system, the marginalists began with a dubious theory of individual psychology, he wrote.
And while earlier economists had paid great attention to the historical development of capitalism, the marginalist system could not account for even the most basic historical phenomena, such as the accumulation of capital over time.
These moves, argued Bukharin, crippled the marginalists’ claim to be scientific and betrayed their new economics as little more than the ideology of a ruling class dominated by “rentiers” that lived off the proceeds of their investments.
Despite all their failings, the marginalists offered huge ideological advantages to the rich. By the early years of the 20th century their ideas had been institutionalised as the officially sanctioned “neoclassical” theory of economics.
But the triumph of the marginalism was only partial. Next week we will see how neoclassical theory collapsed with the Great Depression of the 1930s, and how the ruling class had to turn to a new saviour – John Maynard Keynes.
For more on Marx’s labour theory of value see » What is exploitation?