Theory of value as cost of production

Copy of a portrait of Adam Smith. Smith's original was created in 1787 by James Tassie in the form of enamel pasta medallion

The Theory of value as production cost or "sum of production costs" It is the theory of Adam Smith, this theory is developed in The Wealth of Nations, according to which, the exchange value of a good depends on the expense invested in it, both in the remuneration of work and in profits (represented by the rate of profit multiplied by the capital invested).

Piero Sraffa, in his introduction to the first volume of the "Complete Works of David Ricardo," referred to the theory of "submission" of Smith. Smith contrasted natural prices with the market price. Smith theorized that market prices would tend toward natural prices, where products would be at what he characterized as the "level of effective demand." At this level, Smith's natural prices of commodities are the sum of the natural rates of wages, profits, and rents that must be paid for inputs in production. (Smith is ambiguous about whether rent is price-determining or price-determined. The latter view is the consensus of later classical economists, with the Ricardo-Malthus-West theory of rent.)

Smith oscillated between accepting this theory and the labor theory of value. David Ricardo tried to save the theory of value for work time by explaining that profits and rents were deductions from the percentage destined to salaries, but finally he would end up accepting as "exceptional" (without explaining it) a situation that would later be demonstrated as a rule: that the equalization of profit rates leads to a change in the invested capital that does not reduce the percentage allocated to salaries but rather increases the total value of the good.

David Ricardo mixed this production cost theory of prices with the labor theory of value, as the latter theory was understood by Eugen von Böhm-Bawerk and others. This is the theory that prices tend towards proportionality to the socially necessary labor embodied in a commodity. Ricardo establishes this theory at the beginning of the first chapter of his Principles of Political Economy and Taxation, but contextualizes it as only related to products with elastic supply. Takagawa advances a new interpretation that Ricardo had the production cost theory of value from the beginning and presents a more coherent interpretation based on texts from Principles of Political Economy and Taxation. This supposed refutation leads to what later became known as the transformation problem.

John Stuart Mill would accept the theory of value as costs of production, and would represent the culmination of classical political economy that would become the dominant paradigm until the end of the century XIX. In Principles of Political Economy, Mill had come to the conclusion that the value of a commodity alone is the average price, and the search for an objective substratum of value was wrong, proposing to focus attention on the formation of "prices" rather than "value". Mill can be seen as an important precursor to the marginalism of William Jevons and Leon Walras.

This would be partially faced by Karl Marx in a new attempt to revive the labor theory of value through analogous foundations typical of classical economics (in this he would find the best explanation of the mercantile society but at the same time also of the collapse of capitalism of the which would be a corollary, since the correct premises of classical economics on competition would imply a downward trend in the rate of profit and a crisis of overproduction due to a reduction in wages).

Karl Marx later takes up that theory in the first volume of Capital, while indicating that he is well aware that the theory is false at lower levels of abstraction. This has led to all sorts of discussions about what both David Ricardo and Karl Marx "really meant." However, it seems undeniable that all of classical economics and Marx explicitly rejected the labor price theory].

Marx criticized the equivalence of the value of a commodity with its natural price or cost of production. Marx differentiated the capital invested in a capitalist production between constant, invested in raw material, machinery, etc.; and variable, invested in wages, whose value is less than that returned by the worker. This last surplus is the surplus value, whose rate is equal to the surplus value divided by the variable capital (for example, if in a 12-hour day the value of the salary is equal to 8 hours and the surplus labor is 4 hours, the rate is 50%). "In these circumstances, with equal exploitation of the worker in different industries, different capitals of the same volume will produce very different amounts of surplus-value in different spheres of production, and consequently very different rates of profit, since profit is not but the proportion of the surplus value with respect to the total applied capital. This will depend on the organic composition of capital, that is, its distribution in capital, constant and variable". Based on this, Marx criticizes the analysis of land rent according to Ricardian economics. So:

Suppose the average composition of all non-agricultural capital is c (constant capital) = 80, v (variable capital) = 20, so that the product (at a surplus rate of 50 percent) = 110, and the profit rate = 10 percent. Suppose also that the average composition of agricultural capital is c = 60 and v = 40. [...] Then the product, with the same exploitation of the work as before, will be = 120, and the profit rate = 20 percent. Therefore, if the farmer sells its product to its value, it sells it to 120 and not to 110, which is its cost price.

Marxist theory, however, would once again run into the problem of the relationship between the equalization of profit rates and the resulting price variations in relation to the proportion of fixed capital invested. To this day, the debate persists within the different currents of Marxist economists, the temporalist approaches claim to have solved the problems of Marxist economics from their interpretation, while a large part of the Sraffareans, physicalists, or with less orthodox approaches affirm that the problem is unsolvable.

Until then, however, both the classics (who adhered to the cost theory) and their critics (who remained faithful to the labor theory) considered that use value was reduced to being only a necessary condition of the existence of an exchange value but without determining its value (the only exception were "non-renewable goods" which, without further analysis, were determined by their absolute scarcity and in a non-measurable way).

The theoretical contrast to what these two theories had in common arose with the utility theory of value that would affirm that the exchange value of a good is set by the marginal utility for the consumer according to its use value.

The three branches of marginalism (Léon Walras, William Jevons and Carl Menger) would accept this proposition with substantial differences: Walras and Jevons considered utility in more objective terms and the study of utility relations between goods was cardinal, while in Menger utility is entirely subjective and the study of preference scales are ordinal. The origins of this method went back to late scholasticism and some of the key classical economists who had developed this position in outline, namely Richard Cantillon and Jean-Baptiste Say. The respective systematizers and popularizers of marginalism (Vilfredo Pareto, Alfred Marshall and Eugen von Bohm-Bawerk) would increase the differences between the different currents.

The particular Marshallian position, which would become the "mainstream" of modern microeconomics, consisted of absorbing the classical theory of value as cost of production in marginalist terms and applying it to the study of the supply of goods in the market, while maintaining the relationship between exchange value and his own idea of value in use for the demand side of the same goods. This synthesis between classical political economy and marginalism would be called neoclassical economics.

A somewhat different theory of cost-determined prices is provided by the "Neo-Ricardian School" of Piero Sraffa and his followers. Yoshnori Shiozawa presented a modern interpretation of Ricardo's production cost theory of value.

Polish economist Michał Kalecki distinguished between sectors with "prices determined by cost" (such as manufacturing and services) and those with "prices determined by demand" (such as agriculture and the extraction of raw materials).