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In the history of economic thought there are, broadly, two approaches to the study of prices and income distribution. The neoclassical, or marginalist, approach is the dominant modern theory. But there is an older approach rooted in the writings of William Petty and Francois Quesnay (in his Tableau Economique) and in those of authors in the classical school of political economy such as David Ricardo and Karl Marx. Classical economists considered the surplus to be that portion of the annual social product left over after deducting one part to replace the means of production used up and another part to pay workers for their consumption. The classical economists generally took the view that wealth creation is the productive combination of direct human labor and means of production, where the latter was considered to be indirect labor because it was the result of previous periods’ labors.

While the centrality of labor in the production process was a theme that was common to the writings of most classical economists it was in the writings of Marx that the labor theory of value (LTV) reached its fullest level of development. The LTV states that the value of a commodity is equal to the total amount of direct and indirect labor time (or labor value) that is necessary for its production, given demand and technology. Further, in the Marxian perspective money prices are assumed to be regulated by labor values. It is quite simple to understand this, for if in the production of a good the direct labor productivity rises and/or the labor productivities in the industries that supply its inputs rise, then its unit labor value will fall. Consequently, given wage rates, its unit costs will also fall, thereby allowing firms to lower their unit selling prices.

Let c = labor time needed to produce the means of production used up daily and I = the direct labor time per day needed to produce a given amount of output. If money prices are proportional to the total labor time, as assumed by Marx (Capital Volume I), then unit money price will be proportional to c + l. Let v = labor time needed to produce wage-goods so that money wages are proportional to v. Then unit money cost of production will be proportional to c + v. Thus unit money profits or surplus value will arise if and only if c + l > c + v, that is to say, l > v. Hence collectively workers need to work for a length of time that exceeds the time needed to produce wage goods (Shaikh 1987).

Modern Debates

Nonetheless, not all contemporary authors who subscribe to the surplus approach consider the LTV to be valid. These authors base their position on Piero Sraffa’s (1960) reevaluation of the Ricardian LTV. Ricardo’s struggles with the LTV can be understood by remembering that the general rate of profit equals the aggregate surplus divided by the aggregate capital advanced. However, in a world of heterogeneous commodities the numerator cannot be divided by the denominator in this equation unless they are rendered commensurate in value terms. That is, one needs to know their prices beforehand. However, prices themselves are affected by changes in income distribution between wage and profit rates, thereby introducing an element of circular reasoning into the theory. This was the basis of Ricardo’s attempts to search for an invariant measure of value that would be immune to the changes in the distribution of income.

Contemporary Sraffian authors reject the relevance of labor values and take the position that physical production data and cost structures are sufficient to simultaneously determine relative prices and profit rates (Kurz 2006, p. 9). Authors in this school consider the LTV to be redundant because of the apparent autonomous movements of prices and profits (Steedman 1977). On the other hand, Shaikh (1982, 1984) argues that this autonomy is an illusion, as random fluctuations of market prices around values will bring about transfers of surplus value between different sectors that will result in only limited deviations of actual profits from surplus value.

To understand Shaikh’s argument it is necessary to draw on Marx’s distinction between the circuit of industrial capital and the capitalist circuit of revenue. In the former variable capital is advanced to hire workers who are combined with raw materials and machinery (or constant capital ) to produce an output. In the latter circuit capitalist households use all or part of the surplus value produced in the first circuit to purchase a portion of the output. One may further subdivide the circuit of capital into three departments that respectively produce raw materials and machinery (Department I), workers’ consumption goods (Department IIA), and capitalist households’ consumption goods (Department IIB).

Let prices be initially equal to values in all three departments. Then a decrease only in the aggregate price of the output of Department I will lower input costs in all departments, as constant capital is a common input. A price decrease in only Department IIA output will have the same effect because, given real wages, lower prices of Department IIA output will also lower advances for variable capital, another common input, in all three sectors.

The drop of price below value in Department I will squeeze profits only in that department and will create excess profits in the other two departments. The same will hold true for a price decrease only in Department IIB. Then in both situations the price-value deviation will be accompanied by a transfer of value within the circuit of capital from one department to another.

In contrast, a fall in the price of only department IIB output will leave all sectors’ production costs unaffected but will entail a revenue gain on capitalists’ personal accounts, as the money-value that they pay to purchase goods will be lower than the value of these goods. In other words, there will be a transfer of surplus value from the circuit of capital to the capitalist circuit of revenue, producing a fall of aggregate profits in the latter. However, if such transfers between the two circuits are ignored then an illusion is created that profits vary independently of surplus value (Marx 1971, p. 347).

Implications

It should now be clear that the extent of profits—surplus value deviations will depend on price-value deviations in Department IIB and on surplus value transfers between the two circuits. If all surplus value is consumed as revenue by capitalists the profit—surplus value deviation will be a maximum; conversely if all surplus value is reinvested there is no circuit of revenue and the profit—surplus value deviation will be zero.

More generally, an important implication of this framework is that the balance between production and non-production activities determines an economy’s growth rate. Production activities are those that create surplus value while non-production activities are ones that subsequently utilize it or use it up in some way.This distinction between these two types of activities has some implications for the role of the State if the aim is to raise the growth rate. First, non-productive expenditures by the State should grow at a rate which is slower than the growth of production activity. Second, there could be a policy of increasing the proportion of production activity (e.g., generation of electricity) by the State. Finally, along the lines discussed by Nicholas Kaldor (Palma and Marcel 1989), taxation policies could be implemented to squeeze (luxury) consumption spending by capitalist households and encourage the retention of a greater proportion of surplus value within the circuit of capital.

Bibliography:

Hunt, E. K. 2002. History of Economic Thought: A Critical Perspective. Armonk, NY: Sharpe.
Kurz, Heinz. 2006. The Agents of Production Are the Commodities Themselves: On the Classical Theory of Production, Distribution and Value. Structural Change and Economic Dynamics, 17: 1–26.
Marx, Karl. 1971. Theories of Surplus Value, Part III. Moscow: Progress Publishers.
Palma, Gabriel, and Mario Marcel. 1989. Kaldor on the “Discreet Charm” of the Chilean Bourgeoisie. Cambridge Journal of Economics, 13(1): 245–272.
Ricardo, David. 1951–1973. The Works and Correspondence of David Ricardo, 11 volumes, ed. Piero Sraffa with the collaboration of M. H. Dobb. Cambridge, U.K.: Cambridge University Press.
Shaikh, Anwar M. 1982. Neo-Ricardian Economics: A Wealth of Algebra, a Poverty of Theory. Review of Radical Political Economics, 14(2): 67–83.
Shaikh, Anwar M. 1984. The Transformation from Marx to Sraffa. In Ricardo, Marx, Sraffa: the Langston Memorial Volume, ed. Ernest Mandel and Alan Freeman, 43–84. London: Verso.
Shaikh, Anwar M. 1987. Surplus Value. In Marxian Economics: The New Palgrave, ed. John Eatwell, Murray Milgate, and Peter Newman, 344–349. New York: Norton, 1990.
Shaikh, Anwar M., and E. Ahmet Tonak. 1994. Measuring the Wealth of Nations. Cambridge, U.K.: Cambridge University Press
Sraffa, Piero. 1960. Production of Commodities by Means of Commodities. Cambridge, U.K.: Cambridge University Press. Steedman, Ian. 1977. Marx after Sraffa. London: New Left Books.