Karl Marx and the Labor Theory of Value

A faulty economic theory served as the basis for one of the most influential ideologies of the 20th century

Few individuals of the past two-hundred years have been as controversial as Karl Marx. Though his ideas were discussed primarily in esoteric circles during the 19th century, they gained wide popularity during the 20th century thanks to revolutionary leaders such as Vladimir Lenin, Mao Zedong, and Che Guevara. Whether you think he is brilliant or foolish, it is difficult to deny the impact his ideas have had on the world.

Having spent much of his life researching the underlying problems in society, Marx essentially concluded that capitalism was terribly flawed and therefore unsustainable. He predicted that the workers of the world would eventually unite to take ownership of the means of production from the capitalists. Instead of wealthy bankers and heirs owning the machines, buildings, and shares in a company, normal everyday workers would be the ones to control the means of production.

The end result, according to Marx, would be a sort of Utopian state where people deliver products and services based on good will. He succinctly described it thus: “From each according to his ability, to each according to his need.” No more would capitalists spend their energy greedily hording property for themselves. Instead, there would be no concept of property, and all things would be held in common. Able people would work to provide that which was necessary for their community.

Marx’s Utopian vision was built upon a widely accepted economic theory at the time, the labor theory of value. This theory states that the value of a good is determined by the amount of labor that went into producing it. Because of this, laborers are the ones who create value based on the amount of time, effort, and skill that they devote to production.

Marx concluded that since the capitalists aren’t actually producing anything, but merely own the rights to the production, they don’t contribute any value to their products. Rather, they exploit the value provided by the laborers and claim the unearned profits reaped by the sale of those valued products. When workers would come to realize this, they would rebel against the capitalists and reclaim what was rightfully theirs. Marx saw this process as inexorable. He made it his mission in life to speed up the process and destroy capitalism once and for all.

This all sounds fine on its face, but there was just one little problem with this grand Utopian vision.

The labor theory of value was deeply flawed.

It wasn’t until later in Marx’s life that Stanley Jevons, Léon Walras, and Carl Menger each independently devised a new theory that better explained how goods and services are valued. Today we call that theory the subjective theory of value.

The essence of the subjective theory of value is that an individual places value on goods based on how well those goods achieve the individual’s desired ends.

If this is the case, then value is not created by the amount of labor put into production. Capitalists therefore are not exploiting their workers. Instead, they take risks by investing in capital to produce goods that they think will be valued by consumers. While it doesn’t seem like the capitalist is doing any work, he does in fact have an incentive to discover the subjective value people place on the goods he wants to produce. The capitalist then takes risks and invests in what he thinks people will want to buy. If the risk pays off, he is rewarded. If not, he loses his investment.

The capitalist then hires laborers from the workforce and pays them for their labor. Rather than getting equity for their work, employees tend to prefer being paid in cash, which they can then spend and invest at their discretion. They spend these earnings on goods and services, which provides income for the capitalists, who then pay employees, who then spend, and so on and so forth.

The subjective theory of value helps provide a more accurate framework which we can use to better understand the economy. Owners of capital are not just hording fixed amounts of resources to themselves. They are instead finding ways to more efficiently utilize resources and create value for their potential customers.

Jevons, Walras, and Menger kicked off the Marginal Revolution, dooming Marx‘s economic theories to be relegated to the dustbin of history. Marx had the chance to reevaluate his assumptions in light of the new economic theories, but he was already married to his ideology. He heavily criticized the marginalists’ new techniques and rejected the subjective theory of value.

You don’t have to read all three volumes of Das Kapital to understand why many of Marx‘s ideas are defunct. While the labor theory of value was accepted by many influential economists at the time, Marx‘s heavy reliance on it undermined many of his arguments when the theory later fell out of favor.

We see today how his predictions failed to come to pass. Though the gap between the ultra-wealthy and everyone else persists as Marx foretold, our real wages have increased dramatically. In other words, our dollars have been able to buy more things today than they could in the past. That’s because the ultra-rich like Steve Jobs and Jeff Bezos have been creating wealth, not extracting it from our labor. As a result, the average person in a developed economy can buy cars, smartphones, and almost any kind of food they want.

Though the subjective theory of value is not a perfect description of human behavior, it provides a much more useful basis for understanding human interactions in a complex economy. We can learn from Marx‘s mistakes. When we encounter new information or ideas, before we outright reject them, we ought to check our assumptions.

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This is the end of a four part series.

Part 1: Check Your Assumptions

Part 2: Yaneer Bar-Yam and the Zero-COVID Zealots

Part 3: It’s a Trap! Robin DiAngelo’s Kafkaesque Nightmare