Today, we begin the movement to begin the discussion of Ricardo’s theory of value. In order to understand Ricardo’s theory of value and the role it has in his theory, I will begin the discussion with an analysis presented by P. Garegnani (1984) concerning the core of classical economic theory. As part of the explanation of the structure of classical economics theory, I will discuss the theory of profits, as we cannot understand prices of commodities without first being able to determine the rate of profits. We will conclude today’s diary with a discussion of some different concepts that appear in the discussion of classical value theory (i.e., the source or foundation of value, the measure of value and the determinant of value). In the next diary, which may be expanded into 2 diaries, I will first discuss Ricardo’s labour theory of value and the problems that arise due to the fact that commodities require different proportions of capital and labour in their production and the resulting price changes that arise due to the impact of changes in w/r. I will end the discussion of Ricardo’s theory of value by discussing his attempted solution to the resulting problems, the creation of a measure to balance these changes, that is, the notion of absolute value.
The Core of Classical Economic Theory
I want to begin by laying out a general structure of classical economic theory or the surplus approach to value and distribution. In this discussion, I am closely following the work of Garegnani (1984) ... sorry for the poor drawing, I cannot import the one from his article. The drawing should also show the interactions between the data and the unknowns and the fact that the surplus is a residual of the social product and necessary consumption.
There are 3 pieces of data that are taken as given in the determination of the exchange values and profits in classical political economy.
These are: 1) the total output of the society aka the Social Product (P) -- that is, the aggregate of the commodities produced in the year, the physical composition of total output; 2) techniques of production, that is, how commodities are produced with different combinations of land, labour and capital, if you would prefer, the known available technologies; 3) the real wage (w), that is, the quantities of commodities composing the wage rate, the wage bundle. This real wage is seen to be a socially and historically determined bundle of commodities that are recognised as necessary in order for the workers to subsist and reproduce themselves.
The Core of the Surplus Approach
social product (P)
↓
techniques → labour employed (L) surplus product
↓ (P-N) = S
real wages (w) → necessary consumption (N)
Garegnani, (1984) Oxford Economic Papers, p. 294.
Given the total output and the technical conditions required to produce that output, we know the employment of labour used in the system, that is we know how many workers are required to produce the output (L); we know what output has been produced and we know the technology available to produce that output, from this we know exactly how much labour has been employed or used in the production of the total output of society. Given the employment of labour and the real wage of the workers, we know the necessary consumption of the workers, which is that part of the social product that goes to the workers to ensure their reproduction and subsistence.
- N = wL
To be precise, necessary consumption consists of something else besides that portion going to workers, as necessary consumption is that part of output that needs to be replaced to ensure that the economy is exactly at the same level as before: what else needs replacement? It is the capital used up in the production process (raw materials) and the portion of fixed capital (machinery, tools, implements that wear out over time and need to be replaced), so formally
1a) N = wL + K.
If we abstract from rent -- that is, we assume that fertile land abounds, there is no need to appropriate it, and thus, anyone can use it -- given the total output and subtracting the real wages of labour and money set aside for the replacement of the depreciation of the capital goods, we are left with a surplus product, which constitutes the profits in the system.
- P - wL = S
Thus, profits are a residual of the social product once real wages and the social product are known. We can see that if wages rise in physical terms, then less is left for profits.
Now, given that Smith (and Ricardo) argued that wages can rise above the subsistence level, this means that there is a surplus portion of profits over and above that required for the reproduction of the working classes. For the sake of clarity, we will just assume that workers obtain the subsistence level of wage.
The rate of profits is given by the following equation, the rate of profit equals the surplus over the capital required to produce the output -- both Smith and Ricardo considered the capital in the economy to consist of the wages advanced for the production period, they both recognised the existence of fixed capital and raw materials, but believed that they could be examined as past or accumulated labour:
- r = (P - N)/N
Given wages and profits, we can then determine the relative prices in the system. It is important to note the separation between the determination of distribution and that of relative prices in this theory. The determination of distribution is done logically prior to the determination of relative prices, that is, these things are done at separate stages of the analysis.
The problem for classical economics in determining prices and the rate of profits
The essential problem is that the social product (or total output) is composed of a number of distinct commodities; this is also true for the necessary consumption of the workers, which contains some, but clearly not all, of the commodities composing the total output. Some commodities are produced as intermediate goods to be used for further production and other commodities are consumption goods which are produced solely for the landlords and the capitalists.
If the composition of the social product and necessary consumption were the same, if, for example, the social product only consisted of corn, and wages only consisted of corn, then the rate of profit could be determined as a physical measure.
Unfortunately, and this is what has given headaches to economists for at least 200 years, the commodities composing the social product and real wages are a heterogeneous bundle of commodities. This problem can't be belittled!
In order to determine the rate of profits in the system, these very different commodities have to be related to each other somehow. That is, they must share something in common which will allow us first to determine the rate of profit and then the relative prices in the economy and that something has to be known prior to the determination of the rate of profits and prices or we get caught in a case of circular reasoning; that is, we need to know profits and prices in order to determine them.
Since the physical composition of the social product and necessary consumption differ, the rate of profit can only be calculated as a value magnitude. By this I mean, that the commodities composing the rate of profit will have to be specified or denoted by their exchange values. The use of quantities of labour as a regulator of value is an attempt to deal with the heterogeneity of these commodities, by examining the differing quantities of labour used in their production as the basis for homogenisation of these physically heterogeneous commodities. Remember, we only know the physically different commodities that exist in the economy, we have to understand how they relate to each other, why some commodities have a certain exchange value, and how they stand in relation to another commodity's exchange value. We will now go into the specifics of classical economic theory.
Ricardo on Profits
Ricardo's (1815) early theory of the rate of profits
Ricardo argued that the agricultural, and by generalisation, the general rate of profits was determined on the margin of cultivation (the no-rent land in use) of agricultural production. Ricardo had argued that the profits of the farmers determined the profits of all other trades. Now, in order for this argument to hold, Sraffa (1951, p. xxx-xxxiii) argued that the rational foundation of this argument was that Ricardo had to have been assuming that the output, workers consumption and the capital used in agriculture consisted solely of corn.
In this case, Ricardo would have been able to determine a material rate of profits in agriculture; that is, the rate of profit would express the relation between the physical surplus product measured as a quantity of corn divided by the capital advanced for corn production also measured as a physical quantity of corn.
This is a material rate of profit because it is determined solely with reference to physical quantities of corn; there is no need for exchange values to enter the determination of the rate of profit in agriculture. There is no need for exchange values in the determination of this rate of profits because of the homogeneity of the commodities comprising the rate of profits. Ricardo could then determine the general rate of profits in the economy, by having the prices of manufactured commodities adjust to the value of their inputs (otherwise known as the corn-capital used in the production process), that is to the price of corn, which would be determined in agricultural production.
Using a material rate of profit, Ricardo could demonstrate that an inverse relation existed between wages and the rate of profits. Now, why spend so much of a short diary discussing something that sounds completely weird in the first place and also discussing a debate about something that is completely weird? Clearly the workers' consumption goods and the capital advanced for production consists of other things than corn, that is obvious, as Ricardo himself clearly stated in his letters to Malthus.
The reason I am bothered to discuss this material rate of profit is that it makes clear Ricardo's preoccupation with the inverse relation between wages and the rate of profits throughout his lifetime as an economist.
Additionally, Ricardo maintained that the general rate of profits was determined on the no-rent land used in agricultural production, that is, that the rate of profits would adjust to the agricultural rate of profits -- this is an argument that he maintained in his later writings, although he abandoned the notion of a material rate of profits. Ricardo used this argument to criticise the Corn Laws.
Now, why would someone need to determine a material rate of profit in agriculture -- what does this model have that doesn't exist in the whole economy? If we look at the equation for the rate of profit put forward by Ricardo, we see that the components of this equation [the output, capital advanced (necessary consumption)] are composed of heterogeneous commodities, that means that the output produced has many different types of goods in it, the capital advanced has some of those goods, but clearly not all of them, as the total output contains consumption goods for the capitalists and landlords, while the capital advanced consists of commodities consumed by the workers and whatever capital goods are used in production.
Now, Ricardo assumes that the capital advanced consists of wages advanced for the production period, but that still does not eliminate the fact that the output and the wages advanced contain different commodities. Thus, we need to determine the rate of profit as a relation between the exchange values of commodities comprising its components. What Ricardo was trying to do, since he did not have a theory of what determines the exchange values of commodities at this point and also did not agree with Smith's "adding-up" theory of price was to eliminate the problem of exchange value, and attempt to determine the rate of profits as a relation between homogeneous commodities -- then the question of exchange value does not enter the determination of the rate of profits in agriculture.
Ricardo's lack of success in convincing Malthus of this material rate of profits and the inverse relationship between wages and the rate of profits forced Ricardo to try and determine the general rate of profit using exchange values. This brings us closer to Ricardo's theory of value.
Ricardo on determining Profits in the Principles
In the Principles, Ricardo argues that the price of corn is regulated by the quantity of labour required to produce it on the no-rent land used in agricultural production. Also, from his theory of value, Ricardo argued that the prices of manufactured commodities vary according to the quantity of labour required for their production.
In this situation, neither the farmer who produces the corn on the marginal land and who hence regulates the prices of agricultural commodities nor the manufacturer who produces manufactured goods pay any rent (that it, no part of the value of the produce, assuming it is all realised due to the assumption of Say's law goes to the rent of the landlords as Ricardo does not have a theory of absolute rent). The whole value of these commodities is divided between wages and the rate of profit.
In this situation, if commodities always sold for the same price, profits would be high or low depending on if wages are low or high. That is, an inverse relationship exists between wages and the rate of profit in Ricardo's theory. If, on the other hand, the quantity of labour required in corn production rose (and hence the price of corn rises), this, according to Ricardo will not raise the prices of manufactured goods, as no additional labour is required in their production. If wages continued the same, then profits would continue the same. But, if as a result of the rise in the price of corn, the nominal (money) natural rate of wages rise which would generally be the case, then the rate of profits in manufacturing would fall.
How does Ricardo determine the general rate of profits in his analysis? The rate of profit in Ricardo's analysis is equal to:
- r = (P-N)/N
What Ricardo does is that he determines the rate of profits in terms of the quantity of labour required to produce the surplus product in relation to the quantity of labour which is required to produce the workers' consumption bundle (which he considers to be the capital advanced for production).
So for the people who know Marx, he determines the rate of profits by measuring the value of the surplus product divided by the value of variable capital: r = (s/v) rather than r = s/(c+v).
In the determination of the rate of profit, capital advanced for production is treated as the wages advanced for production. Thus, although he recognizes that capital consists of fixed and circulating capital, he does not take this into consideration in the determination of the rate of profits, this is one of Marx's criticisms of Ricardo's theory of profits.
Ricardo on Value
What is a theory of value? A theory of value attempts to provide an explanation of long-period or natural prices -- that is, it tries to explain what it is that underlies the market prices existing in the economy, why it is that the level of market prices are kept within certain bounds. Thus, the prices in the real world, market prices, are seen as constantly tending towards the level of prices that we determine in our theory; it is competition that ensures the movement of prices in the real world towards the ones established by the theory.
What is competition? It is the law of supply and demand. Competition does not determine the level of prices in classical economic theory; rather it is a mechanism ensuring the movement of market (real world) prices to those natural prices (prices of production) established by our theory. An explanation of prices or a theory of price tries to say why it is that prices in the real world are not differentiated by very disparate levels.
The classical theory of value had 3 components. Two of these components are analytical in nature and enable the determination of natural levels of prices and the general rate of profits -- these two analytical categories are the regulator or determinant of value and the measure or standard of value. The regulator or determinant tells you what determines or regulates the level of natural prices in the theory.
The measure or standard is a numeraire, whose properties are chosen with respect to the nature of the problem it is trying to consider. Smith's measure of value was the quantity of labour commanded by the commodity or the wage. This measure of value was chosen by Smith in order to examine the effects of changes in techniques of production of the exchange values of commodities. Ricardo's measure or standard of value was chosen to serve a rather particular function in his theory of price. The third component of the theory of value, as you know, is the source or foundation of exchange value. The notion of a source (or foundation) of value is concerned with the notion of property rights and provides the explanation of the basis of the surplus product. We will begin our study of Ricardo's theory of value with a quick examination of the source of value. Next week, we will examine Ricardo's analytical theory of the determination of exchange values and end the diaries of Ricardo on value by examining Ricardo's measure of value and his notion of absolute value.
The Source of Value in Ricardo's Theory
Perhaps we should begin this discussion by asking from where does this idea even arise?
The idea of a labour source of value has its basis in the writings of the enlightenment. Stressing the power of human reason, ingenuity and deliberateness, the enlightenment emphasised the role of human beings in the creation of their world, their societies, their ideas, and their production. Instead of putting all power of creation in the hands of god and his agents (remember the divine right of kings and the power of the church), the writers of the enlightenment maintained that it is human endeavour that creates things, it is human purposeful action in the creation process that is what is relevant for understanding human societies; this applies at all levels and is brought into the discussion of economics as the notion of the source or foundation of value.
In classical writings, the source is a qualitative concept, it is not measurable. This was something that Marx was extremely critical of and he attempted in his discussion of value to quantify this notion. What this non-quantifiable notion of the source refers to is that the surplus product that is created in the production process derives from the use of labour in the production of commodities.
In classical discussions its relevance is seen primarily in two aspects of discussion:
In the discussions of the early and rude state or the state of nature, the labour source relates to a notion of property ownership over what you produce (thus, the total product belongs to those who have produced it to do with it what they will); it is this point that will form the basis of the Ricardian socialists demand for the right of the workers to the whole of the product. The other place that the idea of a source appears is in discussions of the productiveness/unproductiveness of labour or sectors of production; by productive/unproductive we are solely discussing the capability of producing a surplus product (a product over and above the requirements of reproducing the economy at the same level, aka simple reproduction); not whether these are important activities or whether they are necessary to the economy or not.
In the writings of the Physiocrats, they formally argued that the productive sector was agriculture, so it appears that their source of value land. However, it is not that land in an of itself creates what is necessary for reproduction of the society, rather it is the fact that labour used on land that ensured sufficient and deliberate production and reproduction. In the case of Smith and Ricardo, the source of value was labour.
Ricardo, like Smith, argued that the source or foundation of exchange value was labour. Ricardo argued that labour added exchange value to the materials of production and as such the exchange value of the commodity contained a surplus over and above what was laid out for production. Thus, the value of the commodity contains not only the wage and what was laid out for capital used in the production process, but also an additional amount, the surplus, which then went to the capitalists.
Ricardo's argument concerning the source stated nothing about what the level of the exchange value of the commodity was; the source, which is not a measurable concept (it is not quantitative in nature) but rather is qualitative, states that labour is an act of creation -- it not only creates the physical product.
How does this notion affect the core? Where does it fit in the discussion? It doesn’t, it has no analytical role in the determination of prices and the rate of profits. It has no influence on that discussion at all. In this sense, the source in Ricardo and Smith differs substantially from Marx, where he uses the quantified source to describe the basis of exploitation as well as the exchange values of commodities.
Next week, we look at the Labour Theory of Value in Ricardo, his modifications and his attempt to solve the problems arising in the labour theory of value.
Suggested Readings
Garegnani, P (1984) Value and Distribution in the Classical Economists and Marx, Oxford Economic Papers, 36, pp. 291-325.
Ricardo, D. (1815) An Essay on the Influence of a Low Price of Corn on the Profits of Stock, in Pamphlets and Papers, 1815-1823, Volume IV of the Collected Works and Correspondence of David Ricardo, ed. By P. Sraffa, Cambridge University Press, 1951.
Ricardo, D (1821) Principles of Political Economy and Taxation, Volume I of the Collected Works and Correspondence of David Ricardo, ed. By P. Sraffa, Cambridge University Press, 1951.
Ricardo, D. (1823) Absolute Value and Exchangeable Value, in Pamphlets and Papers, 1815-1823, Volume IV of the Collected Works and Correspondence of David Ricardo, ed. By P. Sraffa, Cambridge University Press, 1951.
Sraffa, P. (1951) Introduction to Principles of Political Economy and Taxation, Volume I of the Collected Works and Correspondence of David Ricardo, ed. By P. Sraffa, Cambridge University Press, 1951.
For alternative perspectives and a recent discussion:
Hollander, S (1979) Studies in Classical Political Economy/II The Economics of David Ricardo (Toronto: UTP and London: Heinemann).
Blaug, M. (1999) Misunderstanding Classical Economics: The Sraffian Interpretation of the Surplus Approach, History of Political Economy 1999 31(2):213-236.
Peach, T. (1993), "Interpreting Ricardo", Cambridge University Press.
Garegnani, (2002) Misunderstanding Classical Economics? A Reply to Blaug, History of Political Economy 2002 34(1):241-254