Adam Smith and the Labor Theory of Value
April 26, 2023
What is being explained and what is the explanation? Robinson and Subrick argue that Smith saw the pitfalls of a labor theory of value (LTV) but used it as a noble lie to affirm the moral value of labor and argue that it receives fair compensation in a market-based economy.
"Smith used the language of LTV in [Wealth of Nations] to assure the laboring classes that their labor remained dignified and rewarded under his liberal plan."
What is being explained and what is the explanation? Robinson and Subrick argue that Smith saw the pitfalls of a labor theory of value (LTV) but used it as a noble lie to affirm the moral value of labor and argue that it receives fair compensation in a market-based economy.
"Smith used the language of LTV in [Wealth of Nations] to assure the laboring classes that their labor remained dignified and rewarded under his liberal plan."
It is said that Adam Smith advanced something called “the labor theory of value” but what does that mean?
Let’s say the product is a pin. And let’s say it is produced in a pin factory owned by Pippin, who employs workers.
Taking explanation as the backbone of theory, let’s break the “labor theory of value” down:
- What is being explained?
- What is the explanation?
The thing being explained, “value,” is the price Pippin gets for the pin—$P. The explanation is that $P is a function of something called “labor.” “Labor,” according to the theory, seems to be a homogeneous, quantifiable entity. $P reflects the amount of labor involved in producing the pin. If production required a bit more labor, then the price would be a little above $P. If a bit less labor, then the price would be a little below $P.
The name of the theory suggests that the quantity of labor figures importantly into prices—so importantly that, rather than a “cost theory of value” or “inputs theory of value,” it is a “labor theory of value.”
If we buy into the assumption of a dominant and homogeneous input called “labor,” it is reasonable to think that there would be usefulness in stories in which prices move with the amount of labor required.
But should we buy into that assumption? What is this homogeneous input called “labor”? In what sense, if any, is labor homogeneous?
Pippin’s pins help us ponder things Adam Smith wrote in the Wealth of Nations, such as the following:
Labour, therefore, it appears evidently, is the only universal, as well as the only accurate measure of value, or the only standard by which we can compare the values of different commodities at all times and at all places. (WN 54.17)
In this state of things, the whole produce of labour belongs to the labourer; and the quantity of labour commonly employed in acquiring or producing any commodity, is the only circumstance which can regulate the quantity of labour which it ought commonly to purchase, command, or exchange for. (WN 65.4)
Adam Smith’s supposed labor theory of value (LTV) is famously controversial. Drawing on an article in Journal of Economic Behavior and Organization (Robinson and Subrick 2021), we propose that he knew that the labor theory of value provided no explanation at all for the determination of prices. Smith understood that utility and scarcity played fundamental roles, as evidenced by his own Lectures on Jurisprudence (LJ). He recognized the heterogeneity of labor, the division of labor, the importance of ingenuity and knowledge asymmetries, and the importance of factors, such as land, that cannot be reduced to labor.
We argue that Smith saw these pitfalls of the LTV, but used it as a noble lie to affirm the moral value of labor and argue that it receives fair compensation in a market-based economy. He emphasized the importance of labor in establishing moral claims to property and uses the labor theory to defend his liberal plan. However, by way of his weak defense of the LTV, he implicitly consigned it to a merely symbolic role in economic discourse.
In developing our interpretation, we have been greatly influenced by William Rodney Herring and Mark Garrett Longaker’s article “Wishful, Rational, and Political Thinking: The Labor Theory of Value” (2014), which suggests that the emphasis on labor in John Locke’s theory and the LTV in classical economics was, essentially, a rhetorical ploy for selling the free market. We find ourselves largely sympathetic to Herring and Longaker, but perhaps more favorable than they to what is being sold.
The Labor Theory Muddle
In Book 1, Chapter 6 of Wealth of Nations (WN), Smith proposes the LTV:
In that early and rude state of society… the proportion between the quantities of labour necessary for acquiring different objects seems to be the only circumstance which can afford any rule for exchanging them for one another. If among a nation of hunters, for example, it usually costs twice the labour to kill a beaver which it does to kill a deer, one beaver should naturally exchange for or be worth two deer. It is natural that what is usually the produce of two days or two hours labour, should be worth double of what is usually the produce of one day’s or one hour’s labour. (WN 65.1)
Smith first advances a LTV and then immediately complicates matters by acknowledging that “some allowance will naturally be made for… superior hardship… [or] an uncommon degree of dexterity and ingenuity.” (WN 65.2-3) Even in the "rudest state" of society, labor is not homogeneous. Smith writes:
In the advanced state of society, allowances of this kind, for superior hardship and superior skill, are commonly made in the wages of labour; and something of the same kind must probably have taken place in its earliest and rudest period. (WN 65.3, emphasis added)
Smith complicates matters further by denying that labor is the ultimate source of value for the profits of stock, rendering “a strict LTV untenable” (Shliesser, 2022). He explicitly denies the thought that “the profits of stock… are only a different name for the wages of a particular sort of labor” (WN 66.6). Smith's labor theory does not offer a clear explanation or meaning of the concept of "natural price." These many complications in Smith's theory have led to a wide diversity of interpretations and difficulties in understanding his ideas.
Varied Interpretations
There are many variations of the LTV, but Smith's ideas do not comfortably fit into any of them. The three most plausible interpretations of Smith's words contain sufficient inconsistencies to suggest to us that he never earnestly advanced a LTV. Additionally, Smith knew of and acknowledged alternative approaches to the question of price determination. Therefore, it seems likely that Smith emphasized labor in his discussions for rhetorical rather than for analytical purposes.
The first possible interpretation of Smith's words is that he is suggesting a way to compare the earnings of a worker at different points in time. This interpretation suggests that Smith is using the labor of a worker earning average wages as a method of comparison, but not as a theory to explain price.
The second possible interpretation is that labor was more homogeneous in the past, and therefore could be used to determine price (or terms of trade, in barter) in a single special case. But Smith immediately acknowledges that even in the earliest state of society, the value of labor varies somewhat from individual to individual, as we discussed above. Instead of a theory of relative prices, perhaps the original homogeneity of labor is the basis for a moral norm surrounding toil and pain, and the rules of justice in exchange. Smith leaves this notion undeveloped and points to market forces to sort out relative prices, noting that the ordinary market price is "sufficient for carrying on the business of common life" (WN, 49.4).
The third possible interpretation of Smith's words is that he is proposing a cost of production model in which all value ultimately arises out of labor. However, it makes little sense to reduce all costs of production to some form of labor, such as the labor of improving one's judgment or thinking up a new idea. This would only introduce more heterogeneity in labor. Furthermore, this interpretation assumes knowledge of the scenes and histories of labor, which is impossible to obtain or establish as common knowledge among readers.
Smith's successors David Ricardo and Karl Marx, criticized him for confusing the labor commanded by a product and the labor embodied in its production. Joseph Schumpeter (1954, 310) noted that it is understandable that later economists misunderstood Smith's meaning. Schumpeter argued that Smith uses labor to explain value only in the special case of the “early and rude state” of nature. According to Schumpeter, Smith made a muddle of things by treating labor as focal throughout his discussion.
Mark Blaug (1997, 51) argued that Smith was not promoting any sort of LTV, but was instead primarily concerned with marking a contrast between his own view and that of the mercantilists, who claimed that wealth consists of money itself. Both Blaug and Schumpeter promote an interpretation that Smith never intended to promote, for modern conditions, any sort of LTV.
Alternatively, some scholars argue that the LTV was a coherent part of Smith's broader philosophy. Terry Peach (2009) argues that Smith never intended to confine the labor theory to the "earliest and rudest” state and that his frequent appeals to labor in other sections of WN suggest that he genuinely intended to point to expended labor as the underlying determinant of exchangeable value.
Jeffrey Young (1997) suggests that Smith’s underlying jurisprudential theory justifies a LTV in the early and rude state but also explains why Smith seemingly abandons the LTV as he espouses something more like a cost-of-production theory of value. In this interpretation, Smith’s theory of value is tied closely to his theory of justice, and both rely on the judgment of the impartial spectator. In the early and rude state, the impartial spectator sympathizes with the pain and toil associated with labor. As the impartial spectator naturally sympathizes with expectations and the conditions of property, the value of a thing incorporates more than simply labor, which becomes increasingly heterogeneous. In developed society, the impartial spectator considers additional factors, such as risk and possession. Smith's theory is internally coherent, Young argues, but in a non-obvious way for economists who ignore Smith's jurisprudence and moral theory. We feel that there is merit in Young’s interpretation but that he does not give sufficient consideration to Smith’s words, in boldface in a quotation above, where Smith himself subverts the assumption that labor was ever homogeneous.
A New Interpretation
We conjecture that Smith recognized the incoherence of a LTV and employed the language as a sort of noble lie to advance his liberal plan for society. We argue that Smith would have known of an alternative explanation for value, such as the role of scarcity and subjective desires in determining value, as outlined in LJ. We also claim that Smith may have had good reason to shroud or otherwise deemphasize this alternative explanation of value in his magnum opus.
In LJ, Smith follows closely the arguments about utility and scarcity found in his predecessors, Samuel Pufendorf and Gershom Carmichael. He demonstrates awareness about the demand side of value. Indeed, Smith’s early work, The Theory of Moral Sentiments, elaborates the role of individual estimations in the determination of aesthetic and moral values.
Furthermore, Smith placed great emphasis on the heterogeneity of labor in WN, referring frequently to productive labor “which adds value of the subject upon which it is bestowed” in contrast to unproductive labor which does not (WN, 331.1). This implies that Smith held a more sophisticated view of the relationship between labor and wages. He emphasized the importance of the division of labor and its associated heterogeneity in raising productivity in a nation, rather than relying solely on a LTV to explain the source of prosperity.
Smith writes of a “rude state of society in which there is no division of labour” (WN 276.1). In that world, there is limited trade and people have no reason to save or build surplus stocks for exchange. The rude state of society fades as people realize gains from trade which arise from specialization. But with trade comes increasingly heterogeneous skillsets.
Once people recognize the gains from trade that arise from specialization, it is discovered that some are better at producing goods and services than others. With the addition of physical capital as well as human capital, labor productivity increases. Workers produce much more than they can based solely on their labor. This process of specialization leads to a virtuous circle of increased prosperity.
Smith's system of natural liberty emphasizes the importance of institutions in creating value, rather than labor alone. It relies on competition to promote the well-being of the laboring classes by expanding trading opportunities and increasing productivity. No longer did they have only one person to whom to sell their labor or goods. As the market size grew, the ability to walk away from some opportunities offered a source of self-respect and "independency" (WN, 378, 399, 402). Increased trading opportunities provide power to laborers.
Smith expresses his sympathy for the laborer who, when gathering the natural fruits of nature "when land was in common, cost the labourer only the trouble of gathering them... [and who now] must then pay for the license to gather them; and must give up to the landlord a portion of what his labour either collects or produces" (WN, 67). Smith recognized that employers and laborers sometimes have unequal bargaining power. He observed that employers sometimes attempt to collude to lower the wages of their workers. A partial solution to this problem is competition, which provides workers with broader opportunity sets and exit options that discipline employers and raise real wages.
Dignified Labor
We conjecture that Smith used the language of the labor theory of value as a rhetorical tool to promote his liberal ideas of society, while recognizing the incoherence of the theory itself. He does this through a subtle, pedagogical method by which he enters into the received opinions of his time and points out the contradictions within them, ultimately making a case for the dignity of the laboring classes (see Melzer 2014, 216).
WN is a work of rhetoric as well as a treatise of economic principles. Smith writes in WN:
The property which every man has in his own labour, as it is the original foundation of all other property, so it is the most sacred and inviolable. The patrimony of a poor man lies in the strength and dexterity of his hands; and to hinder him from employing this strength and dexterity in what manner he thinks proper without injury to his neighbour, is a plain violation of this most sacred property. (WN 138.12)
Smith made the case that the division of labor, within the right institutional settings, would produce prosperity for the laboring classes. Smith understood that as society progressed to the commercial age, labor became more complex and heterogeneous, but people's beliefs and norms did not keep pace with these changes. Smith used the language of LTV in WN to assure the laboring classes that their labor remained dignified and rewarded under his liberal plan. He employed a kind of esotericism, suggesting some kind of LTV to express a belief in the dignity of labor—a belief that was sincere.
John Robinson is an assistant professor of Intelligence Analysis at James Madison University. His research interests include the history of economic thought, institutional economics, and the philosophy of social science.
J. Robert Subrick is an Associate Professor of Economics at James Madison University. His research focuses on southern African and Brazilian economic history with occasional forays into the history of economic thought.
This essay is part of the AdamSmithWorks series Just Sentiments curated by Daniel B. Klein and Erik Matson. New essays will be published on the fourth Wednesday of the month. You can read more about the series in this Speaking of Smith post, "Just Sentiments- Welcome!". Klein and Matson lead the Adam Smith Program in the Department of Economics at George Mason University, in association with the Mercatus Center. In the program, they study big ideas in jurisprudence, politics, ethics, and economics as they were pursued during the original arc of liberalism, especially in the 18th century in Britain.
References
Blaug, M. 1997. Economic Theory in Retrospect. Cambridge: Cambridge University Press.
Herring, R. and Longaker, M. (2014). Wishful, rational, and political thinking: the labor theory of value as rhetoric. Argumentation and Advocacy 50 (4): 193-209.
Melzer, A. M. (2014). Philosophy Between the Lines: The Lost History of Esoteric Writing. Chicago: University of Chicago Press.
Peach, T. 2009. Adam Smith and the labor theory of (real) value: a reconsideration. History of Political Economy 41(2): 383-406.
Robinson, John A. and J. Robert Subrick. 2021. Why Did Smith Suggest a Labor Theory of Value? Journal of Economic Behavior and Organization 184: 781–787. Link
Schumpeter, J. A. (1954). History of Economic Analysis. United Kingdom: Routledge.
Shliesser, Eric. (2022) Smith’s Labor Theory Thought Experiment | Adam Smith Works. https://www.adamsmithworks.org/documents/eric-schliesser-labor-theory-of-value
Smith, Adam.1982 (LJ). Lectures on Jurisprudence, eds. R.L. Meek, D.D. Raphael, and P.G. Stein. Oxford: Oxford University Press.
Smith, Adam. 1976 [1776] (WN). An Inquiry Into the Nature and Causes of The Wealth of Nations, eds. R. H. Campbell and A. S. Skinner, 2 vols. Oxford: Oxford University Press.
Smith, Adam. 1976 [1790]. The Theory of Moral Sentiments, eds. D. D. Raphael and A. L. Macfie. Oxford: Oxford University Press.
Young, Jeffrey. 1997. Economics as a Moral Science. Cheltenham: Edward Elgar.