This reply owes a lot to the work of Professor Anwar Shaikh of the New School, especially his 1978 essay “Marx’s Theory of Value and the Transformation Problem” and his 1982 article “Neo-Ricardian Economics: A Wealth of Algebra, A Poverty of Theory”
The transformation problem in classical political economy
The law of value as developed by classical political economy held that the value of a commodity is determined by the amount of labor that under the prevailing conditions of production is on average necessary to produce it.
According to the classical economists, the value of a commodity determines its natural price around which market prices fluctuate in response to changes in supply and demand. The fluctuations of market prices around values—or what comes to exactly the same thing, according to classical political economy, natural prices—regulate the distribution of capital among the various branches of production.
As far as the classics were concerned, natural price (to use Adam Smith’s terminology) or cost or price of production (to use Ricardo’s preferred terminology) was identical to the value of the commodity. (1)
Suppose too much corn is produced and not enough shoes. The market price of corn will fall below its natural price or value, while the market price of shoes will rise above its value or natural price. The capitalists will then invest less capital producing corn, where profits will be below the average rate of profit or even negative, and more in the production of shoes, where profits will be above the average rate of profit.
As each individual capitalist seeks super-profits—profits above and beyond the average rate of profit—the rate of profit will tend to even out among the various branches of production. At the same time, the various types of commodities will be produced in the proportions needed to meet the needs of society. All this is achieved without any type of central management of the economy whatsoever.
The central tenet of classical political economy that emerged is that as long as everybody is free to advance their individual material interests, the common good will emerge thanks to the operation of the law of the labor value of commodities. This became the main doctrine of economic liberalism.
However, it was realized already by Adam Smith that the law of value thus formulated is in apparent contradiction with the tendency of competition to equalize the rate of profit. Under the relentless pressure of competition, no individual capitalist can afford to settle for a lower rate of profit if a higher rate of profit can be achieved. Every capitalist under pain of bankruptcy must seek the highest rate of profit possible. (2)
Assuming there are no barriers to the free flow of capital among the various branches of production—that is, free competition or, as Adam Smith called it, “perfect liberty”—competition among capitals will tend towards a situation where capitals of equal size earn equal profits in equal periods of time.
But this leads to a contradiction. Capitals that employ a larger than average amount of fixed capital have longer turnover periods than those that employ a smaller amount of fixed capital on average. But do not the branches of production that experience longer than average turnover periods for their capitals have to charge—all else remaining equal—higher prices than capitals in those branches of industry that experience shorter than average turnover periods? If they don’t, capitals with different turnover periods cannot realize equal profits in equal periods of time.
The fine wines aged in old oak chests problem
The example that was often given to illustrate capital with a long turnover period is fine wine aged in old oak chests over many years. As the wine sits in the chests, it appears to be accruing “interest,” much like money in a high-yielding savings account does, even though it is not absorbing any additional human labor.
Modern bourgeois economists argue that this shows that the law of labor value cannot possibly be true. According to them, not only the labor the wine absorbs through the process of production but the “interest” the wine earns while aging in old chests prove that the wine and the chests are also producing value. Indeed, isn’t it true that wines aged over many years are very expensive due to this accrued “interest”?
Since the days of Adam Smith, virtually all schools of economics—the classical school, the Marxist school, and the marginalist school, though the marginalists will say equal rate of interest rather than profit—have accepted this basic economic law. But why is there an apparent contradiction between the values of commodities being determined by the quantity of labor necessary to produce them, on one hand, and the tendency of the rate of profit to equalize, on the other?
The transformation problem in Marx
The apparent contradiction between the law of labor value and the tendency of the rate of profit to equalize is sharpened further in the transition from classical political economy to the economics of Marx as developed in Volume I of “Capital.”
Unlike the classical economists, Marx distinguished between constant capital—fixed capital and raw and auxiliary materials, on one side, and variable capital—labor power—on the other. Remember, according to Marx only living labor, variable capital, produces value and surplus value. Constant capital, in contrast, can only transfer its existing value to the commodities it helps produce.
Suppose one branch of production employees $50 of constant capital—depreciation of machines and raw and auxiliary material—and $50 for wages to produce an individual commodity. Abstracting the fluctuations of market prices around values, we assume that the commodities sell at their labor values. Assume that the rate of surplus value is 100 percent. That is, each worker works half the time for herself and half the time for the boss. We get 50C + 50V + 50S = 150. The rate of profit will be 50 percent.
Assume that another branch of production employs $75 worth of constant capital and $25 worth of variable capital for each individual commodity produced. Assume again a rate of surplus value of 100 percent. We get $75C + 25V + 25S = 125. Therefore, assuming again that commodities sell at their values, the rate of profit is only 25 percent. (3)
However, under the relentless pressure of competition no capitalist can afford to invest in a branch of industry where the rate of profit is 25 percent if the capitalist can just as easily invest in a branch where the rate of profit is 50 percent. Therefore, the natural price, to use Adam Smith’s terminology, around which market prices fluctuate will not be determined by the quantity of labor socially necessary to produce the commodities.
Smith’s solution to the transformation problem
Adam Smith reacted to the transformation problem by retreating from the law of labor value in many passages of his “Wealth of Nations.” Instead, he suggested that in a capitalist society regulated by the average rate of profit the natural price, or value, could be determined by simply adding up the basic revenues earned by the different members of society: wages of labor, profit of stock—capital—and rent of land. (4) Essentially, Smith claimed the law of labor value applied only in an economy of simple commodity production where the producers owned their own means of production.
For a capitalist society, Smith suggested a cost of production theory of value. The value of a commodity was determined by the sum of the wages, profits and rents that went into its production. Adam Smith could do this only because he ignored constant capital, which he claimed was legitimate because constant capital could always be reduced to wages in the “final analysis.”
This cost of production theory of value was sufficient for the economists who dominated political economy between the death of Ricardo in 1823 and the so-called marginalist revolution of the 1870s.
Ricardo and the transformation problem
David Ricardo agreed with Adam Smith that the value of a commodity was the average price around which the market price fluctuated according to the ebbs and flows of supply and demand for that commodity. But while Ricardo’s view was far narrower than Smith’s, it was far more logical. Ricardo simply did not like logical contradictions.
While Smith was able to move from one theory of value to another within his “Wealth of Nations” as it suited his purposes at the moment, Ricardo craved consistency. Though well aware of the contradictions of Smith’s law of labor value, he strived all the same to use the law of labor value consistently.
But Ricardo was not able to resolve the contradictions of the classical law of labor value any more than Smith was. Unlike Smith, however, he sensed that the seeming contradictions of the law of labor value could be resolved and he looked forward to a successor who would be able to so. That successor was not a political economist, however, but a representative of the working class who stood in opposition to all bourgeois political economy. (5) His name was Karl Marx.
Marx and the transformation problem
Marx developed the law of labor value far beyond the level achieved by any of the classical economists, including Ricardo. Next to his theory of surplus value, which by distinguishing between labor and labor power explains how surplus value arises when equal quantities of labor embodied in commodities are exchanged for equal quantities of labor, Marx’s greatest economic advance beyond classical political economy was his discovery of the categories concrete labor, which produces use values, and abstract labor, which produces value. (6)
This is not the easiest thing to grasp and explains why for those who are approaching “Capital” for the first time—and the second and third time—the first three chapters are so difficult. Especially for those who are not trained in philosophy and logic, the first three chapters represent a considerable challenge. (7) But once the concept of labor with all its specific features abstracted, such as labors of different skills, labors producing different types of use values, or even labors of individual workers at different times of day (for example, before and after the morning cup of coffee), we get human labor as such, as pure homogenous social substance.
It is abstract labor that makes it possible to equate different types of material use values such as apples and oranges with each other in the process of exchange. The abstraction occurs not only in the pages of “Capital” but in an unconscious way, when commodities with qualitatively different use values are all the same exchanged and thus equated with one another. They must have something in common, otherwise they couldn’t be equated with one another, but what is it?
Marx reasons in the first three chapters of “Capital” that commodities that are so different in terms of their material use values must, all the same, share a common quality. That common quality is that they are all products of human labor.
Not the concrete labor that produced them, for example the labor of a machinist, or the labor of a jeweler, or the labor of ditch digger, but the quality that all forms of labor have in common. This is human labor in the abstract, with all features that distinguish an hour of concrete labor from another hour of concrete labor left out.
The skill or lack of skill of the individual worker, the health of the worker, whether the worker has had her morning coffee, the time of the day the labor is performed, and so on are all abstracted. Leave all this out and anything else that distinguishes one hour of human labor from another and you get an hour of abstract labor. This, Marx explained, was the pure social substance—not physical substance—of value that all commodities have in varying degrees.
Once value is reduced to a homogenous social substance, it can be measured by a common unit—time. The more abstract labor a commodity contains the more valuable it is. In terms of value, commodities differ quantitatively from one another but are qualitatively the same.
This theory of value represented a huge advance beyond Ricardo’s theory of labor value. Unlike the Ricardian theory, it made possible a consistent theory of money and price. Marx was able to show that the abstract labor that a commodity represents functions as the immanent measure—internal measure—of the commodity’s value.
But the amount of abstract labor that a given commodity represents can never be directly known by the producers—not even approximately—once the production and exchange of commodities has developed beyond its earliest stages.
Therefore, Marx distinguished between value and exchange value as the form of value. The classical economists had only distinguished between use value and exchange value. Going beyond the bourgeois classical theory of labor value, Marx made a distinction between value measured in terms of a certain quantity of abstract labor—its immanent measure—and exchange value in which the value of a commodity is measured in terms of the use value of another commodity. This leads straight to Marx’s theory of money and price.
Therefore, under the capitalist mode of production, which is the highest form of commodity production, where labor power has become a commodity, value can only take the form of exchange value. (8) Before Marx, value and exchange value were used synonymously. But Marx showed they are really quite different. The exchange value of a particular commodity—the relative form of the commodity must always be measured in terms of the use value of another commodity—the equivalent form.
Gold is not money by nature, but money is by nature gold
Long before the rise of capitalist production, commodity production arose out of accidental exchanges of different products of human labor. As this process developed, one or at most a few commodities emerged as universal equivalents. Over thousands of years of commodity production and exchange, gold has proved to be the best money commodity. It not only contains a great amount of value in a relatively small physical substance. In its bullion form, gold is extremely homogeneous, since it is a chemical element, not a compound.
In addition, due to its natural chemical properties, gold does not corrode. Also, as a simple material use value, gold does not change qualitatively during the history of production. An ounce of gold bullion produced in the days of Adam Smith is identical to an ounce of gold bullion produced today, even if the method of producing it from the raw materials provided by nature and the amount of abstract human labor a given quantity of gold represents has changed drastically.
The same cannot be said of the use values of most other commodities. A suit of clothes I purchase today is not identical to a suit of clothes that Adam Smith might have purchased. Fashions have changed quite a lot since the 18th century. Nor are the varieties of apples that are sold at my local grocery store the same as would have been available to Smith at his local grocery store back in the late 18th century.
A personal computer produced in the 1980s—not that long ago—had completely different capabilities as a material use value than a computer produced today. If you have an old IBM XT or an Apple II somewhere in your garage, and the old computer still works, try to watch a YouTube video on it! A personal computer produced in the 1980s as a material use value is far from equal to a personal computer you might purchase in the year 2010.
But an ounce of gold bullion produced in the year 2010 is as a material use value identical to an ounce of gold bullion produced in the 1980s, or in the year 1776 when Adam Smith published the “Wealth of Nations.”
In addition to its unchanging nature as a material use value, gold bullion can be divided into smaller bars, or sent to the melting pot and recombined into bigger bars. Therefore, just as abstract human labor is divisible as a social substance, so is gold as a physical substance. For these reasons, as Marx said, gold is not by nature money, but money is by nature gold.
Once a universal equivalent emerges—I will assume throughout this reply that gold is this universal equivalent—gold bullion in its material use value becomes the measure of the exchange values of all other commodities. Exchange values are therefore measured in terms of the use value of gold bullion—in terms of weights of gold bullion. Not only individual commodities but the more complex forms of the commodity—wealth in a capitalist society—such as capital, prices, rents, interest and the profit of enterprise—are all measured in terms money—that is, in terms of weights of gold bullion.
Like all commodities, a certain quantity of gold bullion represents at any given point in time a given quantity of abstract human labor. Unlike the social labor embodied in other commodities, abstract human labor embodied in gold bullion doesn’t have to prove its social nature by being exchanged for a sum of money. Unlike all other commodities, gold bullion already is money. It doesn’t have to show itself to be social wealth by being sold on the market.
Traditionally, Marxists from Marx onward have often referred to a commodity selling “at its value.” There is nothing wrong with this expression as a short cut as long as you know exactly what is meant. But few Marxist after Marx have known exactly what is meant by this expression. Many Marxists have a view of value that is more or less identical to that developed by classical political economy rather than the far more sophisticated understanding of value developed by Marx.
In order to gain a greater degree of clarity, I will follow Anwar Shaikh and replace the traditional terminology of a commodity selling at its value with the terminology of a commodity selling at its direct price. If a commodity sells at its direct price, I mean that the value of the price of the commodity is identical to the value of the commodity itself. Since price is always an amount of gold bullion measured in terms of weight—assuming gold is the money commodity—price always has its own value independent of the commodity for which it is exchanged or whose value it is measuring.
Or what comes to exactly the same thing, the direct price of a commodity is the price at which the amount of abstract labor embodied in the gold bullion represented by that price is exactly equal to the amount of abstract labor embodied in that commodity.
The uses of direct prices
The value of the price of a given commodity may in theory be identical with the same commodity’s value, but in practice it almost never is. Still, the assumption that values of commodities and the values of their prices are identical—that is, that all commodities sell at their direct price—is a powerful analytical tool for analyzing the hidden secrets of the capitalist economy. This is especially true when analyzing the nature and origin of surplus value, the most important question in all of economics. But it remains a powerful tool for analyzing other relationships as well.
This is price in the every day sense of the word. It is what is on the price tag and what you actually pay at the cash register. The market price may be, and almost always is above or below the direct price. There is only a vanishingly small chance that a price you see on the sticker actually equals the direct price of a given commodity.
Back in the day when I first started reading Marx and Engels, as opposed to reading popularizations of their work, I was disturbed when Marx—or Engels—wrote that commodities virtually never exchange at their values—or in our terminology sell at their direct prices. As I understood it, the essence of Marxist economics was that prices of commodities were determined by values. And values are in turn determined by the amount of socially necessary labor needed to produce the commodities.
Yet here Marx (or Engels) seemed to be rejecting the labor theory of value that Marx was so famous for! It was hard enough to learn that prices of commodities are determined by the amount of labor socially necessary to produce them. Now the masters were saying they weren’t! If what I was reading didn’t bear the name Karl Marx or Frederick Engels, I would be sure that I was reading the work of a dangerous revisionist.
At first, my reaction was to blot these bizarre-sounding passages out of mind, since they seemed to stand in contradiction to the very “Marxist economics” that I was trying to master. I now realize that in those early days my own theory of value was closer to that of the classical economists but still quite a distance from that of the theory of value developed by Marx. It was a good first step toward understanding Marxist value theory but nothing more. I was still a long way from fully mastering it.
Price of production
The price of production is the quantity of gold bullion that a commodity would exchange for if the rate of profit in all branches of capitalist industry were in fact equal. Marx sometimes referred to prices of production as production prices for short. So if I use the term production prices, I mean prices of production. That is, if everywhere you looked, capitals of equal size—measured in terms of weights of gold bullion—earned equal profits—also measured in terms of weights of gold bullion—in equal periods of time.
In the real world, this will never be true. Even if a particular capital—capitalist enterprise—actually earns the average rate of profit—it is almost certainly doing so because it is buying some of its inputs at prices that deviate from their production prices either upward or downward. The tendency toward the equalization of the rate of profit is only a tendency, even in a economy based on “free competition.”
But it is an important tendency, as the classical economists correctly realized. With production prices, as opposed to direct prices, we begin to approach the surface of economic life. The average rate of profit exists in the minds of the everyday capitalists as the “hurdle rate,” the minimum rate of profit that must be expected—although there is never any certainty that it can be realized—below which no new investment in a particular line of industry will be carried out.
The everyday capitalist in order to make an educated guess about whether a proposed investment will actually realize the “hurdle rate” will have to make an informed estimate of the price that the market will bear and still be able to realize at least the “hurdle rate.” This price will more or less approximate the “price of production.”
Labor power wages and production prices
Labor power, the only commodity that produces surplus value, is not in fact capitalistically produced. It therefore has no price of production as such, though it has both a value and a price—the wage. But to the extent the rates of profit equalize, and market prices approach the prices of production, production prices will determine the wage. If market prices actually equaled the prices of production of commodities, the value of the price of the labor power a worker sells to the capitalist would therefore certainly deviate somewhat from what it would be if the worker actually bought the commodities necessary to reproduce the worker’s labor power at their direct prices.
Gold and production prices
A further complication involves gold bullion itself. Gold bullion of a given weight, assuming it functions as money, has no price, only a value measured in terms of the quantity of abstract labor that is necessary to produce it. Since gold bullion has no price of any kind, it also has no price of production.
But if the organic composition and period of turnover of capital involved in gold production deviate from the average, gold will exchange at a ratio with other commodities that is somewhat different than would be the case if the organic composition and period of turnover of this capital did not deviate from the average.
There are other complications as well. For example, we can assume that the industrial capitalists who produce gold bullion buy their inputs at production prices and not direct prices and that their workers buy their means of subsistence that reproduce their labor power at production prices and not direct prices.
There is also the likelihood that the industrial capitalists who produce gold bullion through the mining and the refining of gold will settle for a somewhat lower rate of profit than average because their risk is also lower. They already have money as soon as they produce the bullion, they don’t have to worry about selling it.
I will avoid the complications that are brought about by the ground rent yielded by the gold bearing lands in order to keep this reply from turning into a book longer than Volume III of “Capital”!
If after we take into account all these disturbing elements, gold exchanges with commodities at a rate below the rate that would prevail if commodities actually sold for their direct prices, the sum total of commodity prices in terms of gold bullion will be greater than the sum total of prices in terms of gold bullion would be if prices actually corresponded to direct prices.
If the converse is the case, the sum of commodity prices in terms of gold bullion would be somewhat lower than would be the case if commodities sold at their direct prices.
In “Capital,” Marx worked with essentially three types of prices: direct prices, prices of production, and market prices. Which of the three types of prices did Marx use in “Capital” and elsewhere in his mature writings? It all depends on the context in which Marx was writing.
When Marx wrote about how the crisis of 1857 or the U.S. Civil War affected the price of cotton, a vital question for England in those days, he used market prices.
When he dealt with the question of differential rents, he used prices of production. When he dealt with absolute rent, he used prices of production and direct prices. (9)
But when he had to explain the most important question of political economy, the origin and nature of surplus value, he found it was absolutely necessary to use direct prices.
If you attempt to analyze the origins of surplus value—profit and rent—in terms of prices of production, it will appear that dead labor—constant capital produces surplus value. We already saw this in looking at the problem of fine wine aged in old oak chests. When we use production prices, it appears that the aging wine and old oak chests are producing considerable quantities of surplus value. But Marx already realized that this was an illusion. This is why Marx did not use prices of production to analyze the origins and nature of surplus value. Indeed, production prices hide the real nature of surplus value.
The biggest single difference between scientific economics—both the classical school and Marx, on one side, and what Marx called vulgar economics, on the other—is that vulgar economics begins with the “uniform rate profit” and prices of production, since that is the way things appear to the capitalists engaged in everyday business competition, and that is how the real world works after all. Scientific economics—especially Marx’s economics—begins with values and direct prices where the value of the commodity corresponds exactly to the value of its price.
Marx used direct prices not only to explain surplus value but also in analyzing reproduction, both simple and expanded, as well as the famous tendency of the rate of profit to fall. That is, he used direct prices not only throughout Volumes I and II but well into Volume III, as well. Though direct prices are not prices you pay at the grocery store, they are very powerful means for analyzing the capitalist mode of production.
However, direct prices are not adequate to deal with the question of differential and absolute ground rent. Therefore, before he could tackle the problem of rent, Marx had to explain prices of production. This inevitably led Marx to the transformation problem, which as we saw had defeated classical political economy.
Marx’s solution to the transformation problem
In Volume III of “Capital,” Marx took the first step in developing a mathematical model that illustrates the process of the transformation from direct prices into prices of production. As always the case with his abstractions, Marx’s partial transformation of direct prices into prices of production is a powerful tool to uncover the hidden processes of the capitalist mode of production. For example, if we mistake direct prices for production prices as the classical economists did and people approaching Marx for the first time do—I know I did—we will commit significant errors. These errors played a key role in leading to the downfall of classical political economy.
In his partial solution to the transformation problem, Marx assumed that the inputs sell at direct prices but the outputs sell at prices of production. Marx showed using this partial transformation that the transition from direct prices to prices of production redistributes the surplus value from branches that have a lower than average organic composition of capital to branches that have a higher than average organic composition of capital. The branches of industry with a higher than average organic composition sell their commodities at prices above the direct prices of their commodities, while those with a lower than average organic composition sell their commodities at prices below their direct prices.
In Marx’s example, the mass of and rate of profit in terms of direct prices is identical to the rate of and mass of profit in his partially transformed system of prices of production. This is a powerful first step in understanding what happens in the transformation from a system of direct prices to a system of production prices.
We learn that branches of industry that have a higher than average organic composition of capital sell their commodities at production prices, and therefore we assume as a rule market prices that are above their direct prices. Conversely, branches of industry that have a lower than average organic composition of capital also are forced to sell their commodities at production prices—and therefore at market prices that will be below their direct prices. They will therefore yield a portion of the surplus value that they extract from their workers to the capitalists who produce with capitals of an above average organic composition of capital.
This result has very important implications in analyzing the changes in the capitalist system that we have seen in recent decades. We see that industrial production is more and more moving from the imperialist countries of North America, Western Europe and Japan to the countries where the value of labor power is much lower and therefore the rate of surplus value is much higher.
The industries that remain in the imperialist countries such as computer chip manufacturing have extremely high organic compositions of capitals and employ very few workers. Therefore, even excluding the whole question of monopoly prices, less and less of the surplus value is being produced in the imperialist countries and more and more is being produced in the historically oppressed countries.
All the same, Marx’s solution to the transformation problem is only a partial solution. Modern bourgeois economists who specialize in “refuting Marx” see this as a weakness in Marxist theory that they hope to use to destroy Marx’s entire “system.” They speak about the “error” that Marx made in Volume III with his partial transformation of direct prices into prices of production. This is much like the “error” Marx made in Volume I when he used direct prices to explain the origins and nature of surplus value rather than beginning with the uniform rate of profit and the “cost of production” like the bourgeois economists do. In fact, Marx was well aware that his solution was only a partial one.
Completing the transformation of direct prices into prices of production
To complete the calculation, you have to repeat it, feeding back into the equations the partially calculated prices of productions calculated in the first stage as inputs, and then re-calculating the prices of production one again. The more you repeat this iteration, it’s been proven mathematically, the more the prices of production that you obtain converge on the correct solution.
So why is the transformation of direct prices into production prices still treated as a major problem in Marxist value theory? And why do bourgeois economists still think that they can use the transformation to “refute” Marx?
As long as you assume that all commodities are used as inputs—re-enter the reproduction process—not only have you transformed direct prices into prices of production but you can show that the rate and mass of profit calculated in terms of direct prices is identical to the rate and mass of profit calculated in terms of prices of production—an amazing result that gives no entrance to the professional Marx “refuters” at all.
But what about commodities that do not enter the process of reproduction? That is, what about luxury commodities—fine carriages in Ricardo’s day and Gulfstreams of today, for example, that are only purchased by the capitalists or their hangers-on? And what about the means of destruction that are produced as commodities by private capitalists but purchased by the state? The bombs that the U.S. government is dropping in Pakistan, Afghanistan, Iraq, and other countries are certainly not re-entering the process of production. They are simply means of destruction.
In the real world, luxury commodities that the actual producers of commodities, the workers, do not get to consume—plus the means of destruction—form no small part of the total mass of commodity production in today’s capitalism. It is here that a whole series of Marx critics, including some well-meaning socialists who want to “improve” on Marx’s criticism of bourgeois political economy by ditching his theory of value, and some bourgeois economists who want to “refute” Marx altogether, begin their attack.
Once the commodities that do not re-enter the system of reproduction are taken into account, the absolute identity between the mass and the rate of profit referred to above breaks down. In this case, the mass and rate of profit suffer a certain transformation when you shift from a system of direct prices to a system of production prices. It probably won’t be a very great transformation, since after all some of the luxury and military commodities will have production prices above their direct prices and some below, but a certain transformation in both the mass and rate of profit will occur all the same.
At this point, the Marx critics proclaim, the law of labor value is refuted and must be abandoned. And what Marx critic first discovered this alleged “flaw” in Marx’s system? None. It was Marx himself, as we will see below.
The history of the transformation problem
The transformation problem has been with us in one form or another since the days of Adam Smith. When Smith faced the apparent contradiction between natural prices determined by the quantity of labor socially necessary to produce commodities and the tendency of competition to equalize the rate of profit, he retreated toward a vulgar cost of production theory that began not with labor values but with a uniform rate of profit.
The problem with this “cost of production analysis” is that it explains the determination of prices by prices. It is what logicians call a circular argument. What is the cost of production of a commodity? Why it is the sum of the prices of inputs that are necessary to produce it. Prices are thus determined by means of prices. Therefore, within Smith’s work, alongside the beginnings of a scientific system of economics we also see a system of what Marx called vulgar economics. Ricardo then developed the scientific side of Smith’s system, while the vulgar economists—men such J.B. Say, for example—developed the vulgar side of Smith.
With the death of Ricardo, any further progress in developing scientific economics on a bourgeois basis came to an end. The bourgeois successors of Ricardo put forward Ricardian economics without Ricardo’s law of labor value, much as Smith had already done in his “vulgar passages” within the “Wealth of Nations.” These economists began with the uniform rate of profit and then derived the “costs of production” around which market prices fluctuate.
The marginalist revolution
The marginalists were uneasy with the circular reasoning of post-Ricardian political economy. Instead, they developed a theory of value based on the relative scarcity of material use values relative to subjectively determined human needs. In this way, they escaped from the “transformation problem”—or at least they thought they did. Not coincidentally, another “great advantage” of the marginalist theory of value was that surplus value could be explained as arising from the scarcity of the factors of production.
On this basis, the marginalist proved—to their own satisfaction anyway, if not that of the conscious workers—that the working class was not exploited by the capitalist class as long as free competition prevailed.
Each factor of production, the marginalist explained, earned the value of its marginal product. As long as free competition prevailed—no monopolies like trade unions, for example—no factor exploited another factor. The workers earned back in wages exactly the value they produced, the capitalists earned the value they produced in the form of “interest” and the landlords—we must not forget them—earned the value produced by the land in the form of rent.
The modern history of the transformation problem
In 1960, the left-wing Italian-British economist Piero Sraffa (1898-1983) published a small book he had been working on for decades, “The Production of Commodities by Means of Commodities.”
Sraffa had emigrated to Britain in the 1920s to escape Mussolini’s fascist dictatorship, where he spent the rest of his life. In his youth, he had clearly been sympathetic to communism and the Russian Revolution. He was a close friend of Antonio Gramsci, the founder of the Italian Communist Party. As an anti-fascist emigrant in Britain, he was befriended by John Maynard Keynes and became at Keynes’s suggestion the main collector of the papers of David Ricardo. (10) Sraffa emerged as the world’s leading Ricardo scholar.
In “The Production of Commodities by Means of Commodities,” Sraffa did not deal with the “transformation problem” in Marxist economics nor did he deal with Marx’s law of labor value—or Ricardo’s law of labor value, for that matter. Instead, his target was “neo-classical” marginalism, which dominated—and still dominates—university economics departments.
Sraffa’s starting point was not Marxist economics but rather the assumptions of the marginalists themselves. Among these assumptions was that under conditions of free competition, competition drives the economy towards a point where all capitals earn a uniform rate of interest. (As I explained in my posts, the marginalists reduce profit to interest.)
Cambridge capital controversy
Sraffa showed using simple mathematics that marginalism breaks down in terms of its own assumptions. The marginalists were—and are—very proud of their mathematics. The point where marginalism breaks down mathematically involves the shift from labor-intensive techniques of production, where labor is assumed to be plentiful relative to capital, to capital-intensive techniques, where capital is plentiful relative to labor.
Sraffa showed that under certain conditions as capital becomes more plentiful relative to scarce labor, causing wages to rise and “interest rates”—really profits rates—to fall, there occurs a “re-switching” from capital-intensive techniques back to labor-intensive techniques. A vindication, by the way, of trade union struggles against the bosses—a result that no doubt pleased the left-wing Sraffa, who was sympathetic to the trade union movement, though he was far removed from the actual life of the working class in his academic Cambridge environment.
Many of the economists who taught at Cambridge had been associated with John Maynard Keynes and leaned toward the political left. They had become increasingly dissatisfied with marginalism and were happy to see Sraffa punch holes in the marginalist system with his simple mathematics.
In the years after World War II, the United States, which as the leading imperialist power had a far more politically conservative environment than postwar Britain, now dominated marginalist economics. Few economics professors who taught at American universities were likely to challenge marginalism. The late Paul Samuelson (1915-2009), a professor of economics at the Massachusetts Institute of Technology, was the acknowledged leader of American marginalism. He came to the defense of marginalist theory against the attack that had been launched against it by Sraffa.
This became known as the “Cambridge capital controversy,” because it involved a dispute between the economists of Cambridge in England led by Sraffa and economists of Cambridge, Massachusetts, led by Samuelson. Samuelson was a strongly pro-capitalist economist who described himself as a neo-Keynesian. He supported expansionary monetary policies and deficit spending during periods of recession, but he removed the elements in Keynes’s theory that conflicted with traditional marginalism.
The results of the ‘Cambridge controversy’
Below in Samuelson’s words was the result of the clash between the Sraffa-led anti-marginalists of Cambridge, England, versus the Samuelson-led marginalists of Cambridge, Massachusetts.
“The phenomenon of switching back at a very low interest rate [really profit rate—SW] to a set of techniques that had seemed viable only at a very high interest rate involves more than esoteric difficulties. It shows that the simple tale told by Jevons, Böhm-Bawerk, Wicksell and other neoclassical writers—alleging that, as the interest rate falls in consequence of abstention from present consumption in favor of future, technology must become in some sense more ’roundabout,’ more ‘mechanized’ and ‘more productive’—cannot be universally valid [emphasis added—SW].” (“A Summing Up,” Quarterly Journal of Economics vol. 80, 1966, p. 568)
Neo-classical marginalism now had, as Anwar Shaikh pointed out, its own “transformation problem.” It was shown to be mathematically inconsistent. To this day, the marginalists have not been able to plug the holes punched in it by Sraffa.
But did Sraffa’s book against the marginalists, which begins—like all vulgar economics—with a uniform rate of profit and prices of production, lay the foundation for a new scientific theory of the capitalist economy that could replace not only marginalism but the Marxist theory of value as well? (11)
The British socialist economist Ian Steedman, now an emeritus economics professor at the University of Manchester, answered in the affirmative. In his 1977 book “Marx After Sraffa,” Steedman endorsed the claim of bourgeois Marx critics that Marx’s method of transforming direct prices into prices of production was incorrect. Once luxury and military commodities were taken into account, Steedman pointed out, the absolute equality of the mass and rate of profit in terms of direct prices and in terms of prices of production prices breaks down. What matters to the capitalists and thus explains the operations of the real economy, Steedman argued, is not the values of commodities, labor values that the capitalists are unaware of anyway, but the real-world system of prices of production.
Steedman came down firmly on the side of the “vulgar economists,” who begin with the uniform rate of profit and prices of production. Starting with values, Steedman claimed, is redundant and leads to serious errors in analysis. Therefore, Steedman urged the socialist movement to abandon the now “refuted” law of labor value in all its forms, classical as well as Marxist, once and for all.
According to Steedman, Sraffa showed how it is possible to calculate prices of production without labor values and all the problems they bring. Sraffa, Steedman held, was the worthy successor to Marx.
For some reason, Steedman and his Sraffa-based tendency have become known as “neo-Ricardians.” This is odd, because Ricardo himself stubbornly upheld the law of labor value, even when he admitted that there were contradictions in his own version of it that he could not overcome. Perhaps the term neo-Ricardian comes from the fact that Sraffa was indeed a Ricardo scholar who obviously despised marginalism.
But are the “neo-Ricardians” supporters really advancing economics beyond Marx, or are they merely falling back into the swamp of post-Ricardian vulgar economics?
The high stakes in the debate
According to Frederick Engels, socialism became a science with Marx’s theory of surplus value. However, Marx’s theory of surplus value is completely dependent on his overall theory of value. If the Marxist version of the law of labor value has really finally been refuted by the “neo-Ricardians,” scientific socialism along with marginalism is in ruins.
In that case, there is of course no alternative but to begin the work of constructing a new theory of economics, perhaps based on the work of Sraffa. Who knows where that would lead or what conclusions would ultimately be drawn? Such a theory would have to explain not only the class struggle between the working class and the capitalist class, but ultimately it would have to provide a theory of imperialism and, of special interest for this blog, capitalist crises. As far as I can see, the “neo-Ricardians,” basing themselves on Sraffa, have made remarkably little progress in this direction.
Mandel versus Shaikh
Realizing the high stakes that were involved, the American Marxist Robert Langston was profoundly upset by the claims of Steedman and his so-called “neo-Ricardians” that they had finally located a fatal flaw in Marx’s economic theory of value. Langston brought together some of the leading Marxist economists of the day, including Ernest Mandel and the young Anwar Shaikh. He moved to Europe to work with Mandel and others on the problem. Unfortunately, Langston died of a heart attack at the age of 45 before the project could bear fruit. However, Langston’s project did lead to the book “Ricardo, Marx, Sraffa,” published by Verso in 1984.
Though all the contributors to this book, which included Ernest Mandel and Anwar Shaikh, supported the Marxist law of labor value, to the extent that they themselves understood it, against Steedman, they were unable to come to complete agreement.
Ernest Mandel states in his introduction that although the various contributors attempted to harmonize their views, they were unable to do so completely. “Pierre Salama and I argue,” Mandel explained, “that the main theoretical purpose of Marx’s solution of the transformation problem in the third volume of Capital was to uphold a combined identity ,,, the identity of both the sum of values [direct prices—SW] equalling the sum of prices of production, and the sum of surplus value [in terms of direct prices—SW] equaling the sum of profits [calculated in terms of prices of production—SW].”
‘Anwar Shaikh’s contribution to the present volume,” Mandel goes on, “while sharing the position that value and surplus value can only be created by living labor in the process of production, and that profit originates in surplus-value, nevertheless concludes that the sum of profit can and generally does differ from the sum of surplus-value.”
Mandel’s friendly criticism of Shaikh here seems to be firmly on the ground of “orthodox” Marxism, but here Mandel is being, in my opinion, more “Marxist” than Marx himself. It turns out that Marx was well aware of the problems raised by Steedman, though this most certainly did not lead Marx—or his friend Frederick Engels—to dump the law of labor value as urged by the present day “neo-Ricardians.” “This phenomenon of the conversion of capital into revenue should be noted, because it creates the illusion [Marx’s emphasis]that the amount of profits grows (or in the opposite decreases) independently of the amount of surplus value.”
Here Marx anticipates the entire “neo-Ricardian” criticism of his theory of labor value. Interestingly enough, Marx points to the ultimate solution to the transformation problem that lies along the lines indicated by Anwar Shaikh, and not the more strictly “orthodox” approach of Mandel.
In this book, neither Mandel nor any of the other contributors could actually deny that the mass and rate of profit is somewhat transformed during the transition from a system of direct prices to a system of prices of production. On this terrain, they were unable to refute the points raised by Steedman.
Shaikh’s solution to the transformation problem
As long as we are dealing with commodities that enter into reproduction, there is in fact no transformation of the mass and rate of profit when we move from the sphere of calculating in terms of values (where the calculations are in terms of hours of abstract labor) to direct prices (where the calculations are in terms of weights of gold bullion) and from direct prices to prices of production (where the calculation remains in terms of weights of gold bullion). If one industrial capitalist gains by selling a machine tool above its value, the industrial capitalists who purchase the machine tools are losers to exactly the same degree that the producer of the machine tool is a winner. The capitalists as a whole neither gain nor lose. It is a zero-sum game.
The same is true of the means of consumption consumed by the (productive-of-surplus value) workers. The labor power that the industrial capitalists purchase from the workers is not, strictly speaking, a capitalistically produced commodity and therefore has no price of production. But we can assume that the workers purchase the means of subsistence necessary to reproduce their labor power at their prices of production, not their direct prices.
Suppose the prices of production of the means of subsistence purchased by the workers is above the direct prices of these same means of subsistence. The industrial capitalists will suffer a loss when they purchase the labor power of the workers above its value—or more precisely above the sum of the direct prices of the means of subsistence—but they gain back what they lose when they sell the means of subsistence to the workers at prices of production in excess of their direct prices. What they lose with their right hand they regain with their left hand.
Or we could make the converse assumption that the workers purchase their means of subsistence at prices of production that are below the direct prices. The result will still be the same zero-sum game. What the industrial capitalists gain by buying the workers’ labor power at a price below the direct prices of the means of subsistence, they give up when they sell the means of subsistence to the same workers at prices of production below the direct prices of the means of subsistence. So far there is no problem. The rate of profit in terms of direct prices will always exactly equal the rate of profit in terms of prices of production.
But what about the luxury commodities that only the capitalists get to purchase? Suppose the luxury commodities that the industrial capitalists produce are sold back to the collective class of capitalists at production prices that happen to be on average above the direct prices of these same luxury commodities. The capitalists will in terms of money realize an extra profit above the profit that they would realize in terms of money if they sold the luxury goods at their direct prices. It seems as if the capitalists are realizing a profit a part of which at least is being produced by something other than the unpaid labor of the working class.
Unfortunately for the capitalists and their Marx-refuting economists—as well as for their socialist supporters such as Ian Steedman—there is a catch.
Shaikh showed—and Marx as we saw above was already aware of the fact—that what the capitalist class gains in terms of profit when they sell the luxury commodities in production prices above their direct prices they will lose in terms of revenue when they buy back these same luxury items at “inflated” prices—that is, at production prices in excess of the direct prices. The extra profit that the capitalists realized in terms of money that did not reflect any actual unpaid labor performed by the working class is pure money illusion!
The same is true in the converse case. Suppose the capitalists sell to themselves luxury commodities at prices of production that are below the direct prices of these commodities. They will realize in money terms a lower mass and rate of profit than they would have if they had sold these items at their direct prices. Therefore, isn’t a certain amount of the surplus value disappearing in the sphere of circulation?
But before we feel too sorry for our capitalists, we should realize that what they lose when they sell luxury commodities to each other at prices of production below the direct prices, they gain back as consumers, when they buy back these same luxury items at “bargain” production prices that are below direct prices. The apparent loss our capitalists suffer is again pure money illusion!
Steedman’s real error
At bottom, Steedman’s critique of Marx’s value theory is based on his failure to understand the relationship between value and the form of value, or what comes to exactly the same thing, the Marxist theory of prices and money! This is the same mistake that so many Marxists make who accept Marx’s law of labor value—without fully understanding it—when it comes to crisis theory.
A tell-tale sign that a given Marxist writer has not really fully grasped Marx’s theory of value comes when they try to explain the nature of paper money that is no longer convertible into gold at a fixed rate. They explain that modern “non-commodity” money somehow represents value directly or reflects the values of the commodities that it circulates rather than simply representing the value of a money commodity such as gold that acts as the universal equivalent—that is, acts as the measure of the value of commodities in terms of its own use value.
Isn’t this the same mistake Steedman and the other “neo-Ricardians” make? The only difference is that Steedman and his “neo-Ricardian” supporters have thought out their mistake to its logical conclusion—and then based on their mistake draw conclude that Marx’s entire theory of value, including surplus value, is invalid.
In my posts, we met a group of Marxists who see the problem of the production of surplus value but don’t understand the problem of realization. Other Marxists such as the Monthly Review School—which I will examine in my next reply—fall into the trap of “underconsumption,” thinking that the problem of realizing surplus value arises because the rate of surplus value is too high. If only the capitalists were less greedy, capitalist crises could be avoided.
The practical implications
What we have seen is that even as prices of production deviate from direct prices they continue to be ruled by the law of labor value. And to the extent that prices of production deviate from direct prices in luxury and weapons industries, the rate and mass of profit in terms of direct prices will be somewhat transformed as a result of the transition to prices of production. In the real world, it is highly probable that some of the production prices in some of the industries engaged in luxury and/or weapons production will have prices of production in excess of their direct prices and some will have production prices that are below their direct prices.
Therefore, the rate and mass of profit in the system of prices of production should be seen as a slightly displaced image of the mass and the rate of profit that exist in the system of direct prices. As Shaikh emphases, this no more changes the fact that prices are in the final analysis ruled by labor values than the deviation of production prices from direct prices or for that matter the fact that market prices deviate from direct prices do. If market prices always corresponded to values, then economic science would be a lot simpler, but then there would hardly be any need for economic science at all.
And what explains this deviation of the mass and rate of profit in the system of production prices from the mass and the rate of profit in the system of direct prices that has bedeviled economists in one form or another for the last couple of centuries? It is the relationship between value and the form of value, between the value of a commodity and its independent value form. And what is the solution to the “transformation problem”?
Why it is Marx’s full theory of value including his theory of exchange value as the necessary form of value and money as the independent form of exchange value. So the stumbling block that generations of Marxists have stumbled over when it comes to answering attacks on Marx’s labor theory theory based on the transformation problem turns out to be the same stumbling block generations of Marxists have stumbled over when it comes to crisis theory.
This blog has concentrated on crisis theory, not value theory. But it has been built on the foundation of value theory. Marx’s distinction between value, exchange value as the form of value, money and prices has played no small role.
I have relied heavily on the fact that the general price level is not arbitrary but is ruled by a world of labor values. When the general price level rises too much above the underlying values—or more precisely the direct prices of commodities—a violent adjustment in the form of an economic crisis of generalized overproduction becomes inevitable that one way or another, whatever policies that capitalist governments and their central banks follow, will bring the general price level below the direct prices of commodities. I have often shown that such divergences between the general price level and the direct prices of commodities is, given the nature of capitalist production, not only possible it is inevitable.
The capitalist economists, for example “Depression expert” and current U.S Federal Reserve Board chairman Ben Bernanke, have noticed that before World War II, dramatic falls in prices had always accompanied severe economic crises and the depressions with their prolonged unemployment crises that have followed. They have concluded that the way to avoid the kind of prolonged depressions that endangers the continued existence of the entire system of capitalist production is to prevent the general price level from ever falling.
The formal economic training that these economists received has been dominated by marginalism. The universities continue to teach marginalism notwithstanding Sraffa’s demonstration that it is logically and mathematically invalid, due to a lack of any alternative—they can hardly be expected to teach Marx! (12) As a result of their marginalist mis-education, these bourgeois economists have no suspicion that behind the world of paper money prices there lurks a world of prices, profits and rents in terms of real money—gold bullion. And behind the world of prices in terms of weights of gold bullion, there lurks a world of values and surplus value measured in terms of hours of abstract labor.
Still less to do they understand that in the final analysis it is the hidden world of labor values—more hidden than ever in the imperialist countries as the world of production moves more and more to the oppressed countries—that rules the prices, rates of profit, and thus the booms and busts of the actual real world capitalist economy.
For example, at the end of the 1960s the Bretton Woods international gold-dollar exchange system was on the brink of collapse. The bourgeois economists of those days and decision-makers they advised decided that there was no need to contract the “money supply” or defend the gold value of the U.S. dollar and the other currencies linked to it as would have been required under the rules of the dollar-gold exchange standard.
Wasn’t the $35 per ounce of gold just an artificially supported price, as Milton Friedman explained? Why should gold, which plays such a small role in the world of production, matter anyhow? Gold should be treated just like “any other commodity” and allowed to find its own price on the world market. Indeed, by moving towards demonetizing gold, its main use value—to act as money—would be destroyed. The marginalist economists believed that once gold was duly “demonetized” its dollar price would plummet.
It didn’t turn out that way. The phenomenon of stagflation—the combination of soaring prices in terms of paper money plus economic stagnation—finally got so bad that the “Volcker shock” with all its consequences became necessary to prevent the collapse of the entire system of paper money and the credit and banking system built on top of it. This was followed by years of sky-high interest rates that severely damaged economies around the globe, in the imperialist countries and oppressed countries alike.
And can the marginalist—or the “neo-Ricardian”—economists explain what happened during the 1970s and the subsequent Volcker shock, even in retrospect? Why did the dollar price of gold not fall as the marginalist assumed it would as the fixed link between the dollar and gold ended, but on the contrary soared? (13)
We know that the economists and policy makers in the 1970s believed they had to “expand the money supply” and carry out large-scale deficit spending to avoid another Great Depression. But what caused the Depression in the first place? More precisely why did an apparently quite “ordinary” recession that began in 1929 turn into the economic collapse that we now call the Depression with all its consequences, including Hitler fascism and World War II? Even in retrospect the marginalist economists cannot explain it. But neither can the “neo-Ricardians.”
In my own analysis of the Depression of the 1930s, based on Marx’s labor law of value, I pointed to the extraordinary inflation of prices in terms of gold bullion relative to the underlying values—or direct prices—of commodities that occurred as a result of World War I. It really doesn’t matter whether in the 1920s the difference of rate and mass of profit in terms of direct prices compared to the rate and mass of profit in terms of prices of production deviated 1 percent or 2 percent or even 5 percent. There is indeed even a vanishingly small chance that the rate of and mass of profit in the years leading up to the Depression were actually equal in terms of both direct prices and production prices up to the last decimal point.
Nobody knows or really can ever know the answer to this question. But what did matter and what ultimately led to the death of tens of millions of people was that market prices in terms of gold bullion were grossly inflated relative to underlying direct prices. That is, as a result of World War I they were grossly inflated relative to direct prices that are governed by labor values.
How can we know prices were grossly inflated relative to the levels that are in the final analysis ruled by underlying labor values? We know that because gold production was greatly depressed relative to the levels that prevailed before World War I. Once market prices in terms of gold did fall drastically during the Depression, gold production recovered as real production and employment collapsed. As a result of the collapse of the “real economy” that we know as the “Great Depression,” there was a huge amount of idle gold and idle money in general after World War II.
This led to a boom—a sudden expansion of the world market—that was completely unexpected by most Marxists, who assumed that the Depression would resume after the war. In truth, most Marxists of the time could not explain why the Depression had occurred in the first place. When the boom—or, more strictly speaking, several industrial cycles with strong and prolonged booms and weak recessions—occurred, many Marxists retreated from Marxism entirely or at best ended up giving undue credit to government policies that were justified by the prevailing Keynesian economic theories that then dominated the universities.
They were completely unprepared for the collapse of Keynesian domination in the universities and its replacement by Friedmanite “neo-liberalism.” What explanation do the “neo-Ricardians” have for these events?
If I followed the path Ian Steedman urged—I was well aware of him by the end of the 1970s, since his book “Marx After Sraffa” was prominently displayed in every radical bookstore in New York City, where I then resided, and I couldn’t take it on faith that Steedman was wrong—I would never have been able to produce this blog. But like my senior contemporary Robert Langston, I admit I was bothered by the claims that a prominent socialist economist such as Ian Steedman through the use of sophisticated mathematics had proven that the Marxist economics I was trying to master was wrong.
I was forced to look at the whole question of labor value anew, which I admit I had first understood in a completely inadequate way.
It is possible that some of the “neo-Ricardians” have developed a compelling analysis of capitalist crises—the Depression, the “stagflation” of the 1970s ending with the Volcker shock and earlier capitalist crises, both relatively minor and major ones as well, using the theories derived from Sraffa and Steedman. But if they have, I not seen it. As far I can see, despite Sraffa’s brilliant destruction of the claims of marginalist theory, the attempts to use Sraffa’s “Commodities Produced by Means of Commodities” to create a new school of economics that could replace the one developed by Marx have born scant fruit indeed.
You can only get so far by assuming a “very simple economy that produces two commodities, iron and wheat.” Indeed, Marx always avoided these kinds of “violent abstractions.” Instead, the path pointed to by Marx, Engels and modern Marxists like Anwar Shaikh who have further developed Marx’s theory in certain respects—for example, by introducing the term direct price—have been key to my current understanding of the world in which we all actually live.
In the post that is due two weeks from now, I will examine the Monthly Review School. In many respects, that reply will be a continuation of this one.
1 The term price of production is far preferable to the term cost of production for two reasons. First, the term cost of production can easily be confused with the cost price. The cost price is the cost to the capitalist of producing a commodity, while the price of production is the price that society must pay if a given commodity is to be produced. The price of production, unlike the cost price, includes the average rate of profit.
Second, the term price of production reminds us that prices of production are indeed prices. That is, prices of production always represent a weight of gold bullion—assuming gold is the money commodity. The classical economists notwithstanding, prices of production are not the same as values. Values are definite quantities of abstract human labor measured in terms of time, while prices of production are definite quantities of gold bullion measured in terms of weight. This important distinction between values and prices of production is obscured by the term “cost of production.”
While Ricardo generally used the term cost of production, as did Marx in his early writings, in his mature work Marx never used the term cost of production but always price of production, or sometimes production price for short.
2 We often hear about the “greed” of individual capitalists. For example, many articles have appeared in the capitalist press blaming the panic of 2007-09—which in the last couple of weeks has been threatening to flare up again—on the “greed” of Wall Street bankers. If only the Wall Street bankers had been less “greedy,” the crisis would have been avoided. Here the contradictions of capitalist production are reduced to the personal psychology of individual capitalists.
In truth, the greed of individual capitalists is the reflection of the laws of capitalist production in the minds of its capitalist agents. The very laws of capitalism force the individual capitalists to seek the highest rate of profit.
This compulsory law tends to even out the rate of profit among the individual capitals, tending toward a situation where equal capitals yield equal profits in equal periods of time.
3 This is the same phenomennon that lies behind Marx’s famous law of the tendency of the rate of profit to fall, which plays such an important role in Marxist crisis and breakdown theories.
4 In English, particularly in earlier times, the word “stock” was used in place of the word “capital.” Hence the term “stock market” and the expression “stock in trade.”
5 Between Ricardo and Marx, representatives of the working class called “Ricardian socialists” used Ricardo’s theories against the capitalist class. Though their work contained valuable insights on the origin and nature of surplus value, as students of the capitalist economy they were inferior to Ricardo. Marx was the first representative of the working class who not only fully mastered Ricardian economics, the necessary starting point in those days, but transcended it by solving the contradictions of the classical law of labor value, which Ricardo had not been able to accomplish.
6 According to Marx, it was the great materialist English philosopher Thomas Hobbes (1588-1679) who first made the distinction between labor and labor power. But the political economists had failed to follow Hobbes’ and others’ hints in this regard and used the term “labor” to describe both labor power—the ability to labor and labor itself. Marx was the first to explain the origin of profit and rent—the incomes of the non-working part of the population—not by the capitalists buying the labor power of the workers below its value—though that can certainly happen—but rather by assuming that capitalists actually pay the full value of the workers’ labor power. Marx held that if you cannot explain the origins of surplus value in this way, you cannot explain it at all. Frederick Engels said that with this discovery socialism at last became a science and must be studied as a science.
7 It is often recommended that when approaching “Capital” for the first time a reader begin with the historical chapters, such as the struggle of the English workers for the 12-hour and then the 10-hour day, rather than begin with the first three chapters. This is a good idea. Most people who attempt to read Volume I of “Capital” from beginning to the end are defeated. When the reader has become more comfortable with “Capital” and Marx’s style and terminology and has begun if only partially at first to comprehend the meaning of value and surplus value, it will become easier—though still not easy—to tackle the first three chapters.
8 The classical economists and Marx himself in his earlier writings treated value and exchange value as though they were the same thing. But Marx eventually realized that value and exchange value are two quite different things. Value is always measured in terms of abstract human labor—it is abstract human labor. Exchange value is the form that value must take. It the use value of the commodity that is used as the unit of measurement—the equivalent form, to use Marx’s terminology, and is always measured in terms of the unit of measurement appropriate for the particular use value of the equivalent form of the commodity.
Money arises as a relationship of production when a particular commodity emerges as the universal equivalent. For example, gold. Once gold emerges as the universal equivalent or universal measure of value, exchange value is measured in terms of weights of gold bullion. Gold therefore becomes the independent value form of the commodity. It becomes possible quite literally to carry around exchange value—gold bullion—in your pocket.
9 There are still further complications involving the theory of rent where Marx speaks about individual values and individual prices, individual prices of production as opposed to social values, social prices of production, market values and so on. In order to prevent this reply from becoming as long as Volume III of “Capital” itself, I will not go into these categories here. Anyway, I want to save some suspense for those readers who might wish to actually read Volume III of “Capital.”
10 Sraffa was certainly familiar with Marxism in the radical days of his youth. Perhaps Keynes befriended the young left-wing Italian anti-fascist émigré in the hope of turning him away from Marxist economics and instead integrating him into the bourgeois-dominated world of professional academic economists.
11 That is the extent that Sraffa used prices at all. Sraffa did not use the Marxist concept of price in his “Commodities Produced by Means of Commodities” any more than he used the Marxist concept of value. Instead, he tried to construct an invariable measure of value that did not fluctuate with changes in what Marx would call the rate of surplus value.
Marx came to the conclusion that Ricardo’s search for an invariable measure of value was misconstrued. Sraffa ended up with what he called the standard commodity, constructed out of the commodities that enter into the production of other commodities—in other words commodities that enter the process of reproduction—basic commodities in Sraffa’s terminlogy. All this is far removed from Marx’s theory of value, exchange value, money and price.
The so-called neo-Ricardian followers of Sraffa end up measuring wages and prices in terms of physical units, an approach that is about as far from Marx as you can get. I have no idea how you explain a crisis of the generalized overproduction of commodities on that basis.
12 If modern economists such as Bernanke are aware of the theory of labor value at all, they no doubt “learned” in their student days that this theory was refuted long ago, so there was no need to pursue it.
13 When I refer to the dollar price of gold, I am using the prevailing economic slang. The so-called dollar price of gold is not in the scientific sense of the word the price of gold bullion but simply the amount of gold bullion that a U.S. dollar represents on the world market at a particular moment.
25 thoughts on “Value Theory, the Transformation Problem and Crisis Theory”
Could you discuss the so-called Volcker Rule and the whole effort led by former Fed chairman Paul Volcker to re-regulate the biggest banks so as to rein in their high-risk speculative activities?
Briefly, according to the Washington Post, Volcker’s plan—which hasn’t been spelled out in detail—would restrict banks from making speculative investments that do not benefit their customers. Volcker has argued that such speculative activity played a key role in the financial crisis. He also wants to limit the ability of the largest banks to use borrowed money to grow larger.
I thing it would be nice if you also extent the discussions in other areas than just crisis theory, as you actually started to do in the current text.
Some areas I would like to see more analyzed are the following :
– How does the current crisis fits into the theoretical framework that you have been building through your blog – a crisis which for many is just a credit system crisis somehow autonomous of the inherit weaknesses of the system. Can this framework explain the current credit system crisis-not in abstract terms but with practical up to date data?
– Are there any statistical evidence supporting the analysed frameworks/theories, can they pass a validation check ?
– Are there any modern research made in order to validate these crisis theories or the discussion stays on a purely theoretical/ abstract level?
– Predictability : can these theories be used to predict the next crisis – if not then isn’t their validity jeopardized?
– Even if the current system deserves the critique this kind of critique which sees a solution of the crisis on totally replacing the current system with something else cannot stand if it doesn’t propose a practical
alternative – is there any theory of this alternative system?
Thanks for keeping this wonderful blog!
What about the Temporal Single System Interpretation? Inputs are outputs produced at earlier periods – I’m not sure the iterative method you promoted for the transformation problem (even if input/output prices converge to a consistent result) is meaningful… it seems more like a mathematical ‘hack’ to me.
Following Stephen’s comment I would like to know what is your opinion of Andrew Kliman’s book “Reclaiming Marx’s Capital”. I know Shaikh doesn’ like it, although he never told me why in a private email exchange we had some years back.
Hello, this might seem like a dumb question, but what really is the answer to the “aged wines” problem? What is truly producing the value there?
i shall be in new york november–perhaps we can meet and discuss ghis.
¿Quién es el autor del artículo?
¿Quién es el autor del artículo?
I am currently reading chapter 10 of the third volume of the Capital, and I have difficulty in understanding a part. I’d appreciate it if you (or anybody else) could help me. I mean it is a complicated subject and there are many things that I am not sure about, but let’s start with the thing which bothers me the most at the moment.
In chapter 9-10 of the volume III Marx gives the following formula for the prices of production:
P=k + k p’, where k is the cost price and p’ is the average rate of profit. Nevertheless, he says:
“Whatever the manner in which the prices of various commodities are first mutually fixed or regulated, their movements are always governed by the law of value. If the labour-time required for their production happens to shrink, prices fall; if it increases, prices rise, provided other conditions remain the same.”
Now let’s assume that the price of means of productions needed for the production of comodity X remains the same; also let’s assume that the wage of the workers and the rate of exploitation remains the same. Nevertheless let’s assume that there is a change in the productivity of the labour and comodity X would require half as much socially necessary labour time to produce as it used to. The new value added to X as it is produced from its means of production is obviously halved. Therefore based on the quotation that I just made one would expect the price of X to be at least somewhat reduced. But since based on our assumption the rate of surplus value and the length of the working day has stayed the same (and therefore also wages have stayed the same), the average profit rate (for the social capital), should stay the same. k has not changed p’ has not changed, so howcome the price of X should change?
What am I missing?
Ever since I wrote that comment I have been thinking about the answer and I *think* I finally figured it out.
I think my mistake was that I forgot that the formula P=k+kp’ does not relate to the individual unit of the comoditiy X, but that rather it relates to the price of the total sum of the units of X which have been produced.
As a result of the increased productivity the number of units of the comodity X which have been produced in say a day, has increased, but since -based on our assumtion- neither the average rate of profit (in money terms) nor the cost price of the inputs have changed, therefore the price of the total sum of the units of comodity X produced in one day has not changed. Therefore, the price per unit of X will decrease just as it is necessitated by its decreasing value.
I am sorry to have wasted your bandwith with my straight forward question.
PS. This is an excellent site. I think Sam Williams is doing a great service.
In my struggle to understand chapters 9 and 10 in the third volume of Capital, I recently read a part of David Harvey’s book (Limits to Capital) which takes up the issue of “Transformation Problem”. He says that Morishima has shown that by treating the transformation as a Markov process one can arrive at a solution where both the equality of the mass of surplus value and the mass of profit and the equality of mass of values and the mass of prices of production hold.
Is anyone familiar with Morishima’s work? Does anyone know what his mathematical results exactly were?
What do you think about the work of Ian Wright on the transformation problem?
Click to access hcgeqvsagc4cg0e3eo.pdf
You miss out one of the key contributions Shaikh made in that collection which was to start empirical measurements of how close production prices and labour values are to market prices. He and his co-workers found that production prices were not significantly closer to market prices than labour values were. The reason turns out to be that (a) the rate of profit does not equalise, (b) it is systematically lower in capital intensive industries.
Very good remark !
“the capitalists earned the value they produced in the form of “interest” and the landlords—we must not forget them—earned the value produced by the land in the form of rent.”
Precisely. That is obviously nonsense. There is no reason why a landlord should be paid for the value produced by land. So workers who work the land can still be exploited in this case because they have to pay rent to a landlord, NOT to the ‘the land’. Why should they pay rent to a landlord if it is the land which produces the value and not the landlord?
The landlord is paid because of the property of land (which is a resource needed) The land produces use value but not exchange value (made by workers so as to be interchanged by capitalists) The farm products are exchange values The farmer as a capitalist pay the rent to the landlord, not te farm worker which is paid for the use of his/her workforce (which has a exchange value lower than the value which can produce) The capitalist has to pay to the landlord with the surplus value generated
“The so-called neo-Ricardian followers of Sraffa end up measuring wages and prices in terms of physical units, an approach that is about as far from Marx as you can get.” Production prices are the result of capitalists actions in the market, and not derived but parallel to the description of the system via labour values. Thats why a transformation is required. See chapter 50 vol 3 Capital (nearly sraffian)