The relationship between these two types of capital has distinct advantages. It can increase the scale and speed of capitalist production by making it easier to obtain capital and reduce the turnover time (the time it takes for capital to produce, sell and buy new means of production – one ‘period’ of production). Interest-bearing capital and the credit system it supplies also reduce the importance of commercial capital, for example by shortening the time the production capitalist has to wait for the merchant to return with the proceeds from sales. However, since interest-bearing capital does not produce any surplus value, it is not directly productive.58
Finally, in addition to these types of capitalists, Marx identified another: owners of scarce things like land, coal, a patent, a licence to practise law, and so on. Such scarce things can improve productivity above the general productivity level – the same product can be produced in less labour time or with fewer means of production. That in turn creates ‘surplus profits’ – what Smith and Ricardo might have thought of as ‘rent’ – for capitalists, or landlords and proprietors, who can exploit these advantageous production conditions. Marx thus outlined a theory of ‘monopoly’ gain.
The key, in Marx’s view, is that labour is productive if – and only if – it produces a surplus value for production capital, the engine of the capitalist system; that is, value above and beyond the value of labour power. For Marx, then, the production boundary is defined not by sectors or occupations but by how profits are generated – more specifically, whether an occupation is carried out in a capitalist production context. Only the capitalist enterprise will accumulate the surplus value that can lead to an expansion of production. In this way, the capitalist economy reproduces itself.
Participating in ‘circulation’ or earning interest is not a judgement on such activities’ ‘usefulness’. It was simply necessary, Marx argued, for capital to transform itself from commodity form into money form and back again.59 In fact, Marx thought that a well-functioning sphere of circulation could raise the profit rate by reducing turnover time for capital. If the ‘circulation sphere’ was not functioning properly – for example, the system of credit that fuelled it was inefficient – it risked absorbing too large a chunk of the surplus value that capitalists hoped to generate by selling their goods and as a result impeding growth.
Marx refined Adam Smith’s distinction between productive (industry) and unproductive (services) sectors into something much more subtle. As can be seen in Figure 6, in Marx’s theory of value every privately organized enterprise that falls within the sphere of production is productive, whether it is a service or anything else. Here, Marx’s achievement was to move beyond the simple categorization of occupations and map them onto the landscape of capitalist reproduction.60 Marx’s production boundary now runs between goods and services production on one side and all those functions of capital that were not creating additional surplus value, such as interest charged by moneylenders or speculative trading in shares and bonds, on the other. Functions lying outside the production boundary take a chunk of surplus value in exchange for circulating capital, providing money or making possible surplus (monopoly) profits.
What is more, in distinguishing between different types of capitalist activity – production, circulation, interest-bearing capital and rent – Marx offers the economist an additional diagnostic tool with which to examine the state of the economy. Is the sphere of circulation working well enough? Is there enough capacity to bring capital to the market, so that it can be exchanged and realize its value and be reinvested in production? What proportion of profits pays for interest, and is it the same for all capitalists? Do scarce resources, such as ‘intellectual’ ones like patents on inventions, create advantageous conditions for producers with access to them and generate ‘surplus profits’ or rents for those producers?
Ricardo and Marx refined the theory of rent to make it clear that rent is income from redistributing value and not from creating it. Landlords do not create the soil but they can generate income from their right to exclude from the land others (capitalists) who might use it to produce value. Rent of any kind is basically a claim on the total of social surplus value and therefore lowers productive capitalists’ profits. As we will see in the next chapter, neoclassical (mainstream) economics has fundamentally changed this idea of rent into one of imperfections and impediments – which can be competed away.
All these issues have come to the fore again since the 2008 financial crisis. At their heart is how finance has been self-serving, and not actually serving what the American economist Hyman Minsky (1919–96) called the ‘capital development of the economy’.61 In other words, instead of facilitating industrial production, finance has simply degenerated into a casino, aiming to appropriate as much of the existing surplus as possible for itself.62 But whether that casino is seen as a mere imperfection or as a stable source of unearned income (whereby activities that are not creating value are somehow allowed to be presented a such) makes all the difference in policies that aim to reform the system.
Marx’s attempt to define the production boundary was more rigorous than those of Smith and Ricardo and was certainly a long way from those of Petty and King. He introduced the idea of labour power as an objective and invariable standard of value, building on the essential premise shared by earlier economists that value derived from labour. He also shared with them the belief that government was unproductive. The early and classical economists left a legacy of ideas about value – on currencies and protection, free trade, rent, government and technology – which have reverberated down the centuries and remain alive today.
The next chapter explores how, even as the ink was drying on Marx’s writing in the British Museum Reading Room, the intellectual world of the classical economists was about to be turned upside down.
2
Value in the Eye of the Beholder: The Rise of the Marginalists
… the distribution of the income of society is controlled by a natural law … this law, if it worked without friction, would give to every agent of production the amount of wealth which that agent creates.
J. B. Clark, The Distribution of Wealth: A Theory of Wages, Interest and Profits1
In Marx’s hands, value theory became a powerful tool for analysing society. While Smith had praised the merits of individual pursuit of happiness and profit, and Ricardo had made the capitalist entrepreneur the hero of the economy, Marx was much more critical of both. As the Industrial Revolution progressed and threw masses of labourers in Europe into urban poverty, his labour theory of value was not just a set of abstract ideas, but an active critique of the system that he saw developing around him. If labour produced value, why was labour continuing to live in poverty and misery? If financiers did not create value, how did they become so rich?
However, the labour theory of value’s days were numbered. This chapter is about the emergence of a new set of ideas that inverted the earlier argument that value was nested in objective conditions of production, and that all other economic categories, such as the price of goods and services, were subsumed to it. The classical economists lost their crown to a new dynasty, the neoclassicals.
NEW TIMES, NEW THEORY
Socialist critiques of value theory were multiplying even before Marx wrote Capital. A group called the ‘Ricardian socialists’ used Ricardo’s labour theory of value to demand that workers get better wages. They included the Irishman William Thompson (1775–1833), Thomas Hodgskin (1787–1869) and John Gray (1799–1883), both British, and John Bray (1809–97), who was born in the US but worked for part of his life in Britain. Together, they made the obvious argument that if the value of commodities derives from labour, the revenue from their sale should go to workers. This idea underlay the co-operativism of the textile manufacturer Robert Owen (1771–1858), for whom the solution was that workers should also participate in ownership, of both factories and publicly created infrastructure. Marx and Engels were friendly with some of these groups, but
very unfriendly towards others whom they thought had no proper analysis of why things were going wrong. The pair collaborated with the groups to whom they were well disposed to produce critiques of capitalism.
Intellectual opposition to capitalism had its practical counterpart in a growing array of radical and socialist political organizations which connected the often dire conditions of working people with programmes of action to remedy them. In Britain, the Chartists (1837–54) demanded reforms to the political system. Trade unionism began to gain a significant following. The Amalgamated Society of Engineers was formed in 1851 and the Trades Union Congress in 1868. During the recession of the 1880s, socialism became more widespread, culminating in the founding of the Labour Party in 1900. Here, Britain was a relative latecomer: the Socialist Workers’ Party of Germany was founded in 1875 and the Federation of the Socialist Workers of France four years later.
Faced with these threats to the status quo, the powers that be needed a new theory of value that cast them in a more favourable light. Other influences also encouraged the search for a new analysis of how capitalism works and the troubling question of where value comes from. Malthus’s pessimism about the dangers of population growth was an affront to the later-nineteenth-century belief in progress – and the facts did not appear to support him, because the food shortages he predicted had not materialized. Non-conformism offered a moral basis on which to argue that the immiseration of the masses that Marx and others feared was neither inevitable nor desirable. The development of natural sciences and mathematics encouraged attempts to place economics on a similar ‘scientific’ footing, as opposed to what was becoming seen as the more ‘literary’ endeavours of the political economists. Above all, perhaps, the rising power of capitalists in a society long dominated by aristocratic landowners and local gentry meant that a new analysis of capitalism was required to justify their standing.
THE ECLIPSE OF THE CLASSICALS
A series of thinkers and economists who were roughly contemporaneous with Marx began to lay the foundations for what has become modern mainstream economics. Landlords were defended as productive by Lord Lauderdale (1784–1860), a Scottish earl, and profits by Nassau Senior (1790–1864), an English lawyer and economist, as abstinence from consumption. Linking profits to a notion of sacrifice allowed a useful moral justification for the large income inequality between capitalists and workers.2 Furthermore, as scarce capital could be either invested or saved, profits were no longer linked to theories of exploitation but came to be seen as simply a return for saving and not consuming.
But to put the classicals to bed properly, a new theory of value had to be invented. Two of the principal architects of what became known as neoclassical economics were Léon Walras (1834–1910) and William Stanley Jevons (1835–82). Walras was a professor of economics in Lausanne, Switzerland. For him, ‘the characteristic of a science properly speaking is the complete indifference to any consequences, advantageous or undesirable, of its attachment to the pursuit of pure truth’.3 Walras was keen to show that economics was a real science, less fuzzy than sociology or philosophy, so set out to discover ‘pure truths’ in the science of theoretical economics rather than focus on applications. Jevons, a Professor of Political Economy at University College, London, began his 1871 The Theory of Political Economy with the assertion that economics, ‘if it is to be a science at all, must be a mathematical science’. He justified this statement by stating that economics deals with quantities: there were, he continued, ‘laws’ in economics, which could become like other ‘exact’ sciences if sufficient commercial statistics were available. Jevons called his economic theory ‘the mechanics of utility and self-interest’.
Another economist who linked value to utility was Carl Menger (1840–1921), one of the founders of the ‘Austrian school’ of economics. As we shall see later, utility is a broad concept, combining ideas about a product’s efficiency – is the car reliable? – with vaguer notions of satisfaction and even happiness – does the new car impress the neighbours? For Menger, the value arising from utility set the cost of production; the cost of production, including the cost of labour, did not determine value. Although original, Menger’s ideas did not fit comfortably into the new narrative that economics had to be much more abstract, expressed neatly in mathematical equations based on Newtonian physics.
FROM OBJECTIVE TO SUBJECTIVE: A NEW THEORY OF VALUE BASED ON PREFERENCES
Walras, Jevons and Menger provided a positive and ‘scientific’ view of reproduction, exchange and income distribution. They used the construct which later came to be called ‘marginal utility’, and their propagation of a new view on value theory is now referred to as a ‘marginal revolution’4 – it was, however, a slow one.
The marginal utility theory of value states that all income is reward for a productive undertaking. Given the large investments being made in factories and the edifices of the Industrial Revolution, it suited the changing circumstances of the second half of the nineteenth century. But it did not come out of nowhere; indeed, it has a long history. In medieval times, thinkers argued that ‘just prices’ were those that reflected an object’s utility. In his Summa Theologica, the thirteenth century philosopher-theologian Thomas Aquinas discussed the concept of the just price in a section of the book called ‘Of Cheating, Which Is Committed in Buying and Selling’. Just price was a normative concept, against what was seen as the wrong price resulting from morally evil greed. The medieval Church inveighed against the sin of greed and avarice, which broadly meant profiteering by middlemen and moneylenders. In Dante’s Inferno, usurers are consigned to the hottest part of hell (circle 7) because they are making money not from the productive sources, which for Dante were Nature or Art, but from speculative changes in interest rates. Indeed, he is so disgusted by usury that he puts usurers just below the circle of hell housing the sodomites.
This normative and moral view of price, linked to cheating or criminal behaviour, began to fade after the seventeenth century – the time of Petty and King – but lingered on until firmly supplanted by the concept of individual utility, which held that it was not about good or bad but how common goals could be reached through each individual trying to maximize the benefit to him- or herself. In 1776 – the year that Adam Smith published The Wealth of Nations – the Englishman Jeremy Bentham argued that ‘the greatest happiness of the greatest number’ should be the ‘measure of right and wrong’.5 In other words, an action should be evaluated according to its consequences in a particular context: killing may be justified if it prevents more killing. This ‘utilitarian’ theory of ethics spilled over into ideas about production. In France, Jean-Baptiste Say (1767–1832), Smith’s contemporary and a hostile critic of Quesnay, argued in his 1803 book Treatise on Political Economy that the value of a commodity resides in its utility to a buyer and, therefore, that productive labour is labour which produces utility. In Say’s view, labour in services – which classical economists thought fell squarely into the ‘unproductive’ category, because they failed to produce ‘things’ – could in fact be reclassified as productive, so long as those services fetched a price and labour got paid a wage.6
The most influential person in developing utility theory was the late-nineteenth-/early-twentieth-century British economist Alfred Marshall (1842–1924), Professor of Political Economy (as it was still called) at Cambridge. Significantly, he was trained as a mathematician. Marshall’s 1890 Principles of Economics diffused the new ideas to generations of students. The economics library in Cambridge is known simply as the Marshall Library; introductory economics textbooks still include diagrams he developed in the nineteenth century.
In many respects Marshall was a natural heir to the classical tradition. He accepted that the cost of production was important in determining a commodity’s value. But he and his followers shifted thinking about value from the study of broad quantities of capital, labour and technology inputs and their returns to that of small incremental quantities. Using
mathematical calculus, they focused on how a small – or ‘marginal’ – change in one variable causes a change in another: for instance, how a small change in price affects the quantity of product demanded or supplied.
So what was the new value theory, marginalism, about? First, it is based on the notions of utility and scarcity and is subjective: the value of things is measured by their usefulness to the consumer. There is, therefore, no ‘objective’ standard of value, since utility may vary between individuals and at different times. Second, this utility decreases as the amount of a thing that is held or consumed increases. The first Mars Bar you eat in a day may provide a lot of utility or satisfaction and even happiness. It is enjoyable and maybe staves off hunger pangs. But as you go on eating Mars Bars they cease to be so enjoyable and may even make you feel ill. At some point the utility gained from eating them will decrease.7 In this way, the utility of the last bar is less, possibly much less, than that of earlier bars. This is ‘marginal utility’ – in the case of a Mars Bar, worth less to you than the previous one, ‘decreasing marginal utility’. By the same token, the scarcer a thing is, the more utility it gives you – ‘increasing marginal utility’. One Mars Bar on a desert island can give you more happiness than any number of bars bought from your corner shop.
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