Issues of Classical Political Economy 2

2. Review of David Ricardo’s Theory of Value

Since Adam Smith, to what extent the theory of value has empirical validity in economic analysis had been a hot issue among (various) political economists. (As we already know,) modern ‘neo’-classical economists adopted their basic concepts and categories from Smith, and it is well known that concepts such as ‘perfect market competition’ and the conceptualization of the market as an ‘optimal allocation mechanism’ or ‘autonomous order’ basically originated from Smith’s troublesome ‘invisible hand.’

However, orthodox economists dismissed classical labor theory of value which was one of the most significant contributions of Adam Smith to the development of modern economics. In order to understand the history of economic thought, it is necessary for us to follow (in every detail) how Smith’s labor theory of value is developed by later political economists. In this context, we should pay due attention to David Ricardo’s critique of Smith’s notion and his original theme.

Ricardo developed his own theory of value in his path-breaking book, The Principles of Political Economy and Taxation, especially in chapter 1, “On Value.” Like Smith, Ricardo reveals that the value of a particular commodity, to whatever production sectors it may belong, is determined by the relative quantity of labor which is bestowed on its production. He also succeeds in pointing out the opaque fact that ‘market values’ are ultimately regulated by a commodity’s ‘natural price.’

To some extent, these findings are not unique to Ricardo: it was Smith who laid the foundation for classical theory of value, and paved the way for the distinction between market prices and natural prices. However, Smith abandoned his original intuition – the value of the commodity depends on the quantity of labor bestowed on its production compared to that of other commodities, and it can be measured and expressed by the natural price via fluctuation of market prices on the market –, considering the situation where the accumulation of stock and the appropriation of land occurred. He contended that his labor theory of value could only be applied to ‘the rude and early state of society’ where there was neither accumulation of stock, nor concentration of land in the hands of individuals.

That is why Smith has erected himself another standard of measure of value, and speaks of things such as ‘corn’ and ‘labor quantity’ which command other commodities in the market, and finally gold and silver as an invariable medium for exchange. However, corn and labor themselves are not invariable media for exchange as gold and silver. All of them are subject to fluctuations from the change of price level of corn, which is influenced by various factors such as abundant or scanty harvest, import of cheap corn from foreign countries, etc., from the changing cost of laborers’ subsistence mainly due to the changes in the price of corn, and finally from the discovery of new and more abundant mines which affects the natural price of gold and silver.

Ricardo admits that the theory of labor value is somewhat modified by the accumulation of capital stock (introduction of machinery, i.e. ‘fixed capital’ and its ‘unequal durability’), and the existence of rents for landlords. But this ‘variation’ does not mean that the principle must lose theoretical validity in depicting the mechanism of capitalist production. Rather, he points out that even though the value of a commodity has to be divided into wages of labor and profit for capital (or rent for landlord), the basic rule that the relative value of a commodity is determined by the relative labor time required for its production continues the same.

Ricardo also concludes that whatever inequality there might be in laborers’ dexterity, whatever different durability of fixed capital might be in various capitals which competes with each other in a particular production sector and market, this principle remains the same. Furthermore, drastic changes in the price of gold (money), general improvement of machinery, and finally general increases in labor productivity will not change the proportion between the different rates of wages and profits, because these changes, though they affect the general rates both of wages and profit, will in the end affect them equally.

In this way, Ricardo was able to develop classical labor theory of value. In fact, Ricardo’s theory started from the very point where Smith ended or abandoned his ‘primitive’ theory of value. While Smith concluded that the validity of the labor theory of value would no longer hold due to the introduction of ‘employment of capital’ and ‘concentration of land,’ namely due to the very existence of social classes, Ricardo pointed out that in spite of the existence of social classes, and thus regardless of the distribution of aggregate incomes into different social classes, i.e. wages of labor, profit of capital and rent of landlord, the relative value of a commodity would still be determined by the relative quantity of labor bestowed on its production. This is the original contribution of Ricardo in the development of value theory in classical political economy. The rest of Ricardo’s book is wholly dedicated to the application of this principle to various economic phenomena such as the genesis of the rent of land, the introduction of tax and its different forms, etc.

Of course, there is a critical point or dead angle where Ricardo’s analysis starts to no longer hold. He failed to explain the nature and role of foreign trade. Unlike Smith and Marx, he asserted that foreign trade would give rise to mutual benefits to both countries (which participated in international trade.) In order to claim the beneficial effects of foreign trade, he introduced different theoretical resources in the name of ‘quantity theory of money’ which radically differed from the labor theory of value we have dealt with until now. This was the point where Karl Marx started to develop his ‘critique’ of political economy. Considering this whole theoretical developmental process, especially focusing on continuity and discontinuity among classical political economists, it is not at all surprising to find that Marx begins his major economic works by analyzing the characteristics of commodity and money, not by discussing capital as such, even though his primary and ultimate theoretical concern was to reveal the law of motion of capital.

At any rate, with respect to the theory of value, Ricardo has demonstrated to the validity of the classical labor theory of value, criticizing Smith’s theoretical oscillation. Even though he leaves some fundamental concepts, such as ‘fixed capital’, ‘circulating capital’, and their relationships unexamined, and even though he fails to elucidate in detail the category of ‘different durability of capital’ and its considerable effect on the extent of variation of labor value theory, his strong arguments are persuasive, and thus are worthy of attention, especially from those who are interested in the history of economic thought.

David Ricardo: “There is no way of keeping profit up but by keeping wages down.”

The relationship between the wages and the rate of profit is among the most controversial issues in economics. While modern neoclassical orthodox economists claim that the wages and the profit of capital can be identified with each other in that both are the source of income, classical political economists such as Adam Smith, David Ricardo and Karl Marx pointed out the contradictory and antagonistic characteristics behind the capital-labor relationship. David Ricardo addresses this issue in his book, The Principles of Political Economy and Taxation, saying that the only way to keep the rate of profit up is to maintain wage level at a lower level. I agree with his main argument for following reasons.

First of all, Ricardo points out the fact that the aggregate income of capital is determined by the profit, wages and rents. So if any of these increases, the other parts of the aggregate income will be reduced. In this connection, Ricardo suggests that the Corn Law, which has prevented the importation of millet and other foods from outside the England, should be abolished. If the cheap millets and other foods are imported from foreign countries, their low prices will reduced the price of labor, i.e., the wages of labor and the lowered wages, in turn, will increase the absolute amount of profit gain for capital.

Secondly, Ricardo also reveals that there exists an antagonistic relationship between capital and labor in the modern capitalist economy. Unlike Adam Smith, Ricardo describes the ‘division of labor’ in the factory as being accompanied by the rapid increase in the number of unemployed people. Ricardo points out that with the introduction of machinery, the economical use of raw materials, hiring laborers under the control of the separated and isolated production process, all of which were highly praised or over-estimated by Smith in the name of ‘the great effect of the division of labor’ in the modern economy, are possible only at the expense of fierce competition among capitalists, high unemployment of laborers, etc. Even though Ricardo takes these social phenomena for granted in the economic development process, as an honest social scientist, he does not conceal these social contradictions.

In these sense, Ricardo is totally different from those who are called modern neoclassical economists. They do not accept the inherent contradictory characteristics of modern capitalist economy: the antagonism between capital and labor. They almost always fail when they try to find so-called ‘general equilibrium’ and ‘Pareto optimal solution’ in a given condition.

In sum, Ricardo appropriately reveals the secret of the modern capitalist system: he points out the antagonistic relationship between capital and labor, and conflicting economic interests among social classes. Regarding the relationship between capital and labor, he was right when he said that “there was no way of keeping profit up but by keeping wages down.”