A while back I read parts of Kevin Caron’s Studies in Mutualist Political Economy. A while back. I was particularly interested in his commentary on the labor theory of value.

[T]he labor theory of value is based, not on an inductive generalization from the observed movement of prices, but on an a priori assumption about why price approximates cost, except to the extent to which some natural or artificial scarcity causes deviations from this relationship.

Like Carson, I believe there is a case to be made for an a priori assumption about why price approximates cost, but the conclusion I reach is quite different. The “natural” scarcity is embodied in the supply/demand diagram. Prices will approximate costs (in a free market), all else being equal, because competition makes it so. FSK explains this pretty clearly in The Free Market Labor Arbitrage Process

If labor is underpaid (relative to its fair value), then workers will form competing businesses, arbitraging away the difference. If labor is overpaid (relative to its fair value), then new workers will enter the industry, again arbitraging away the difference.

In a free market, the costs do not determine the prices, but rather the expectations of prices determine which costs will (or will not) be incurred. To the extent that the entrepreneur is in error, costs will exceed prices. Of course, the costs of production in a free market approach or equal the opportunity cost for the respective productive resources, which are also intimately and inextricably linked to the perceived value to be thereby provided.

Is it true that price (i.e., value of the final good) approximates cost of production? In the long run, yes this is true. But a theory of value needs to speak to more than just long-run trends, does it not? Ultimately, value is determined subjectively and with some uncertainty; it is not determined by the costs of production. Rather, the costs of production are determined by the anticipated value of the output.

I cannot resist the temptation to bring up the ditch-diggers or make-work programs. These things are costly; expensive. But as Bastiat noted over a century ago, they are not valuable. Lest I be accused of setting up straw men, these examples are only fallacious in the sense that such unproductive dispositions of labor and resources are unlikely to occur, and even less likely to persist, in a truly free market. But the fact remains: it doesn’t matter how hard or how long a man works towards a project which others do not value.

One objection might be that the labor costs are determined by labor’s opportunity costs, and so in a free market the labor-theory still holds. But the opportunity costs are also appraisals of the potential future values of whatever else may be produced by labor, and these values are no more certain than the anticipated value of what labor in-fact chooses to produce. No matter which course of action taken by labor, unless the final product is subjectively deemed “valuable” on the market, it’s price will not be sufficient to cover the perceived disutility or discomfort of labor “costs” incurred during its production.

We know or assume to know what value will be produced by a certain amount of labor, and this knowledge guides economic actors in their determination of the prices to be paid for such productive resources. So what we can conclude is that value is the independent variable in the equation, by which final prices are ultimately determined.

Carson continues,

Or to approach it from the opposite direction, we can start with the law of cost as the basis of price, and from there systematically eliminate all the subordinate factors that only have a price because of artificial scarcity, leaving only labor as a creator of exchange-value in its own right (at least for the equilibrium prices of goods in elastic supply).

Although price and cost should tend towards convergence in a truly free market, the important distinction, though, is that labor simply doesn’t “create” or imbue a product with “value”.

Demand, utility, desire, the ability to fulfill needs or satisfy discomfort, these abstract notions are what acting man finds valuable. However true it is that labor is the ultimate “creator of exchange-value in its own right,” but although labor certainly assists in the creation of all things valuable, value (at the terminus) is not determined by the past labor embodied during the production process.

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For further reading on the topic, I suggest Bob Murphy’s The Labor Theory of Value: A Critique of Carson’s Studies in Mutualist Political Economy. Murphy restates “the case for the superiority of the marginal, subjective theory versus the labor (or more generally, cost) theory of value” Murphy concludes that “everything true of the cost (labor) theory can be incorporated in the subjective theory of value”.