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D. Exceptions to the Cost-Principle: The Classicals in Their Own Defense
Since Böhm-Bawerk and others made so much of the various scarcity exceptions to the cost principle, we will examine the
treatment of such exceptions in the writings of the classical political economists and socialists themselves. If, as we shall
see below, the classicals freely admitted such exceptions, it follows that the marginalists and subjectivists were attacking
a straw man; or at the very least, that they had a far different idea of the level of generality necessary for a theory of
value.
Although Adam Smith figured much less prominently than Ricardo in subjectivist attacks on the labor and cost theories of
value, he still did not entirely escape their attention. So it will be worthwhile to examine statements, in his writing, of
exceptions to the cost principle.
Smith treated the fluctuations of price above and below its "natural level," not as violations of his idea of natural price,
but as the mechanism by which it was sustained.
The market price of every particular commodity is regulated by the proportion between the quantity which is actually brought
to market, and the demand of those who are willing to pay the natural price of the commodity, or the whole value of the rent,
labour, and profit, which must be paid in order to bring it thither. Such people may be called the effectual demanders, and
their demand the effectual demand; since it may be sufficient to effectuate the bringing of the commodity to market. It is
different from the absolute demand. A very poor man may be said in some sense to have a demand for a coach and six...; but
his demand is not an effectual demand, as the commodity can never be brought to market in order to satisfy it....
The quantity of every commodity brought to market naturally suits itself to the effectual demand. It is the interest of
all those who employ their land, labour, or stock, in bringing any commodity to market, that the quantity never should exceed
the effectual demand; and it is the interest of all other people that it never should fall short of that demand.
If, at any time it exceeds the effectual demand, some of the component parts of its price must be paid below their natural
rate. If it is rent, the interest of the landlords will immediately prompt them to withdraw a part of their land; and if it
is wages or profit, the interest of the labourers in the one case, and of their employers in the other, will prompt them to
withdraw a part of their labour or stock from this employment. The quantity brought to market will soon be no more than sufficient
to supply the effectual demand. All the different parts of its price will rise to their natural rate, and the whole to its
natural price.
If, on the contrary, the quantity brought to market should at any time fall short of the effectual demand, some of the
component parts of its price must rise above their natural rate.... [And as a result, factors will enter the market until
t]he quantity brought thither will soon be sufficient to supply the effectual demand. All the different parts of its price
will soon sink to their natural rate, and the whole price to its natural price.
The natural price, therefore, is, as it were, the central price, to which the prices of all commodities are continually
gravitating.27
Smith, in this analysis, outshone the Austrians on two points. First, he admitted supply as a dynamic factor, rather than
treating the balance of supply and demand at any given time outside any larger context. And second, rather than treating demand
as absolute, and therefore virtually unlimited compared to supply, he considered only "effectual" demand for a good at its
"natural" price. Attention to these two points goes a long way to avoiding the misleading impression of the "utility" theory
of value, as baldly stated by the Austrians.
In the same chapter, Smith made a detailed study of the various forms of inelasticity, natural or manmade, which caused
price to deviate from cost in the short or long run. Among these he included trade secrets, site advantages of soil, and state-granted
monopolies.28
The correspondence of actual to natural price, over time, was a function of elasticity of supply. Depending on this variable,
prices might approximate costs more or less quickly, or never. Like Ricardo, Smith limited the operation of the cost principle
to those cases in which the supply of a good could be increased to meet demand.
These different sorts of rude produce may be divided into three classes. The first comprehends those which it is scarce
in the power of human industry to multiply at all. The second, those which it can multiply in proportion to the demand. The
third, those in which the efficacy of industry is either limited or uncertain. In the progress of wealth and improvement,
the real price of the first may rise to any degree of extravagance, and seems not to be limited by any certain boundary. That
of the second, though it may rise greatly, has, however, a certain boundary beyond which it cannot well pass for any considerable
time together. That of the third, though its natural tendency is to rise in the progress of improvement, yet in the same degree
of improvement it may sometimes happen even to fall, sometimes to continue the same, and sometimes to rise more or less, according
as different accidents render the efforts of human industry... more or less successful.
The first category included those goods which "nature only produces in certain quantities...."29
As for Ricardo, he made it clear at the outset that his labor theory of exchange-value applied only to those commodities
whose supply could be increased in response to demand. (Like the other classical political economists and Marx, he also made
utility a criterion for exchange-value--thus dispensing with the favorite "mud pie" red herring of subjectivists.)
Possessing utility, commodities derive their exchange value from two sources: from their scarcity, and from the quantity
of labour required to obtain them.
There are some commodities, the value of which is determined by their scarcity alone. No labour can increase the quantity
of such goods, and therefore their value cannot be lowered by an increased supply. Some rare statues and pictures, scarce
books and coins, wines of a peculiar quality, which can be made only from grapes grown on a particular soil, of which there
is a very limited quantity, are all of this description. Their value is wholly independent of the quantity of labour originally
necessary to produce them, and varies with the varying wealth and inclinations of those who are desirous to possess them.
These commodities, however, form a very small part of the mass of commodities daily exchanged in the market. By far the
greatest part of those goods which are the objects of desire, are procured by labour, and they may be multiplied... almost
without any assignable limit, if we are disposed to bestow the labour necessary to obtain them.
In speaking then of commodities, of their exchangeable value, and of the laws which regulate their relative prices, we
mean always such commodities only as can be increased in quantity by the exertion of human industry, and on the production
of which competition operates without restraint.30
In this passage, Ricardo dealt with goods whose supply is totally inelastic, as exceptions in which exchange-value is determined
by scarcity rather than labor. He also mentioned free competition as a requirement for the law of value to operate. These
are two of the major exceptions listed by Böhm-Bawerk as damning flaws in Ricardo's system, duly noted by Ricardo and seemingly
no great embarrassment to him. Ricardo's main shortcoming in this passage was to treat scarcity and labor as jointly or simultaneously
determining factors, rather than treating labor as a primary factor and scarcity rents as secondary deviations from labor-value.
In Chapter 4, Ricardo turned to divergences from labor-value caused by fluctuations in supply and demand--another major
exception pointed out by Böhm-Bawerk. Again, such divergences were treated, not as an embarrassing violation of the law of
value, but as the mechanism by which it operated.
In the ordinary course of events, there is no commodity which continues for any length of time to be supplied precisely
in that degree of abundance, which the wants and wishes of mankind require, and therefore there is none which is not subject
to accidental and temporary variations of price.
It is only in consequence of such variations, that capital is apportioned precisely, in the requisite abundance and no
more, to the production of the different commodities which happen to be in demand. With the rise or fall of price, profits
are elevated above, or depressed below their general level, and capital is either encouraged to enter into, or is warned to
depart from the particular employment in which the variation has taken place.31
Here he implicitly admitted that the prices of most commodities at any given time are above or below their labor-value,
and in the process of moving toward it. Arguably, he did not adequately treat of the degrees of elasticity, and the varying
time ranges which were required, as a result, for supply and demand to establish an equilibrium at labor-value. But again,
even this was at least implicit in his discussion. It is also clear, from this passage, that Ricardo viewed such oscillations
of price as the mechanism by which the law of value operated, rather than as exceptions to it.
Without elaborating on the differing periods of time involved, or the relative speed with which the production of different
commodities could be increased, Ricardo wrote in Chapter 30 of "temporary" scarcity rents as existing "for a time," and of
production cost "ultimately" regulating price.
It is the cost of production which must ultimately regulate the price of commodities, and not, as has been so often said,
the proportion between the supply and demand: the proportion between the supply and demand may, indeed, for a time, affect
the market value of a commodity, until it is supplied in a greater or less abundance, according as the demand may have increased
or diminished; but this effect will be only of temporary duration.32
Ricardo also wrote of specific kinds of scarcity rent. In Chapter 2, he discussed economic rent to the most fertile tracts
of land, owing to the regulation of price by production costs on the least efficient land at the margin of production.33 In
Chapter 27, he expanded the concept to include producer surpluses or quasi-rents in all areas of the economy; for example,
he argued that providing artificially cheap wool to half of clothiers would not reduce the retail price, because the price
of manufactured goods was "regulated by the cost of... production to those who were the least favoured. Its sole effect...
would be to swell the profits of a part of the clothiers beyond the general and common rates of profits.34 The influence
of demand on price, while holding true of all commodities "for a limited period," was true in the long run only of
"monopolized commodities."
Commodities which are monopolized, either by an individual, or by a company, vary according to the law which Lord Lauderdale
has laid down: they fall in proportion as the sellers augment their quantity, and rise in proportion to the eagerness of the
buyers to purchase them; their price has no necessary connexion with their natural value: but the prices of commodities, which
are subject to competition, and whose quantity may be increased in any moderate degree, will ultimately depend, not on the
state of demand and supply, but on the increased or diminished cost of their production.35
Those who introduced new production technologies might derive temporary producer surpluses, but the general spread of the
new technology, spurred by such increased profits, would eventually cause the price to drop to the level of production cost.36
Ricardo, in "Notes on Malthus," wrote of the determination of price by cost of production, through the influence of cost
on supply, in terms that closely foreshadowed Jevons. Natural price was only "that price which will repay the wages of
labour expended on [a commodity], will also afford rent, and profit at their then current rate." Those production
costs "would remain the same, whether commodities were much or little demanded, whether they sold at a high or low market
price." Market prices, true enough, would "depend on supply and demand"; but the supply would "be finally determined
by... the cost of production."37
John Stuart Mill was very much in the Ricardian tradition, in dealing with the effect of cost and scarcity on price. Like
Ricardo, he held cost to be the determining factor for reproducible goods.
1. When the production of a commodity is the effect of labour and expenditure, whether the commodity is susceptible of
unlimited multiplication or not, there is a minimum value which is the essential condition of its being permanently produced.
The value at any particular time is the result of supply and demand; and is always that which is necessary to create a market
for the existing supply. But unless that value is sufficient to repay the cost of production... the commodity will not continue
to be produced....
When a commodity is not only made by labour and capital, but can be made by them in indefinite quantity, this Necessary
Value, the minimum with which the producers will be content, is also, if competition is free and active, the maximum which
they can expect....
As a general rule, then, things tend to exchange for one another at such values as will enable each producer to be repaid
the cost of production with the ordinary profit....38
Adam Smith and Ricardo have called that value of a thing which is proportional to its cost of production, its Natural Value
(or its Natural Price). They meant by this, the point about which the value oscillates, and to which it always tends to return;
the centre value, towards which, as Adam Smith expresses it, the market value of a thing is constantly gravitating; and any
deviation from which is but a temporary irregularity, which, the moment it exists, sets forces in motion tending to correct
it....
It is, therefore, strictly correct to say, that the value of things which can be increased in quantity at pleasure, does
not depend (except accidentally, and during the time necessary for production to adjust itself,) upon demand and supply; on
the contrary, demand and supply depend upon it. There is a demand for a certain quantity of the commodity at its natural or
cost value, and to that the supply in the long run endeavours to conform.39
Like Smith, Mill divided commodities into three groups, based on their reproducibility. In some cases, there was an "absolute
limitation of the supply," owing to the fact that it was "physically impossible to increase the quantity beyond certain
narrow limits." As examples, he listed the same kinds of commodities as Smith: works of art, and produce grown on specific
rare types of soil. Other commodities could be multiplied without limit, given the willingness to incur a certain amount of
labor and expense to obtain them. Finally, some commodities could be multiplied indefinitely with sufficient labor and expenditure,
"but not by a fixed amount of labour and expenditure." Greater levels of output required greater unit costs of production
(here he referred mainly to agricultural produce).40
Mill was somewhat more explicit than Ricardo in dealing with the time element in determining the degree of elasticity.
The time period involved in the gravitation of price toward cost depended on the length of time required to adjust production
to changes in demand, or to dispose of surplus produce.
Again, though there are few commodities which are at all times and for ever unsusceptible of increase of supply, any commodity
whatever may be temporarily so.... Agricultural produce, for example, cannot be increased in quantity before the next harvest....
In the case of most commodities, it requires a certain time to increase their quantity; and if the demand increases, then,
until a corresponding supply can be brought forward, that is, until the supply can accommodate itself to the demand, the value
will so rise as to accommodate the demand to the supply.41
Like Ricardo, Mill believed that price was governed by the cost of production for those producers most unfavorably circumstanced.
Those in a more advantageous situation would receive a producer's surplus equivalent to their cost savings. And like Ricardo,
he applied the principle not only to economic rent on land, but to quasi-rents on manufactured goods.
2. If the portion of produce raised in the most unfavourable circumstances obtains a value proportional to its cost of
production; all the portions raised in more favourable circumstances, selling as they must do at the same value, obtain a
value more than proportioned to their cost of production.... The owners... of those portions of the produce... obtain a value
which yields them more than the ordinary profit. If this advantage depends upon any special exception, such as being free
from a tax, or upon any personal advantages, physical or mental, or any peculiar process only known to themselves, or upon
the possession of a greater capital than other people, or upon various other things which might be enumerated, they retain
it to themselves as an extra gain, over and above the general profits of capital, of the nature, in some sort, of a monopoly
profit....42
4. Cases of extra profit analogous to rent, are more frequent in the transactions of industry than is sometimes supposed.
Take the case, for example, of a patent, or exclusive privilege for the use of a process by which cost of production is lessened.
If the value of the product continues to persist in the old process, the patentee will make an extra profit equal to the advantage
which his process possesses over theirs.43
Marx and Engels were in complete agreement with the classical political economists on the role of competition in regulating
the law of value. Engels, in his Preface to Marx's Poverty of Philosophy, ridiculed the utopian socialist notion of
making labor the basis of a medium of exchange. The market forces of supply and demand were needed to inform the producer
of the social demand for his product, and to establish the normal amount of social labor necessary for the production of a
given commodity. So the deviation of price from value at any given time was not a violation of the law of value, but its driving
mechanism.
In present-day capitalist society each individual capitalist produces off his own bat what, how and as much as he likes.
The social demand, however, remains an unknown magnitude to him, both in regard to quality, the kind of objects required,
and in regard to quantity.... Nevertheless, demand is finally satisfied in way or another, good or bad, and, taken as a whole,
production is ultimately geared towards the objects required. How is this evening-out of the contradiction effected? By competition.
And how does the competition bring about this solution? Simply by depreciating below their labour value those commodities
which by their kind or amount are useless for immediate social requirements, and by making the producers feel... that they
have produced either absolutely useless articles or ostensibly useful articles in unusable, superfluous quantity....
....[C]ontinual deviations of the prices of commodities from their values are the necessary condition in and through
which the value of the commodities as such can come into existence. Only through the fluctuations of competition, and consequently
of commodity prices, does the law of value of commodity production assert itself and the determination of the value of the
commodity by the socially necessary labour time become a reality.... To desire, in a society of producers who exchange their
commodities, to establish the determination of value by labour time, by forbidding competition to establish this determination
of value through pressure on prices in the only way it can be established, is therefore merely to prove that... one has adopted
the usual utopian disdain of economic laws.
....Only through the undervaluation or overvaluation of products is it forcibly brought home to the individual commodity
producers what society requires or does not require and in what amounts.44
Marx made very much the same argument in the main body of The Poverty of Philosophy: it was market price that signaled
the producer how much to produce, and thus regulated price according to the law of value.
It is not the sale of a given product at the price of its cost of production which constitutes the "proportional relation"
of supply and demand, or the proportional quota of this product relatively to the sum total of production; it is the variations
in demand and supply that show the producer what amount of a given commodity he must produce in
order to receive at least the cost of production in exchange. And as these variations are continually occurring, there is
also a continual movement of withdrawal and application of capital in the different branches of industry....
....Competition implements the law according to which the relative value of a product is determined by the labour time
needed to produce it.45
Marx's and Engels' remarks in these passages probably came closer than anywhere else to meeting Bohm-Bawerk's demand for
a mechanism of the law of value (see Chapter 2 below).
In Grundrisse, Marx described the functioning of the law of value through the movement of price in somewhat more
dialectical language:
The value of commodities determined by labour time is only their average value....
The market value of commodities is always different from this average value and always stands either below
or above it.
The market value equates itself to the real value by means of its continual fluctuations, not by an equation with real
value as some third thing, but precisely through continued inequality to itself....
Price, therefore, differs from value, not only as the nominal differs from the real; not only by its denomination
in gold and silver; but also in that the latter appears as the law of the movements to which the former is subject. But they
are always distinct and never coincide, or only quite fortuitously and exceptionally. The price of commodities always stands
above or below their value, and the value of commodities itself exists only in the UPS AND DOWNS of commodity prices. Demand
and supply continually determine the prices of commodities; they never coincide or do so only accidentally; but the costs
of production determine for their part the fluctuations of demand and supply.46
And such deviations from value included quasi-rents to those who first introduced more efficient methods of production.
It was only through the market incentive presented by such quasi-rents, and through the resulting competition, that improved
methods were universally adopted and came to define the standard form of production. "A capitalist working with improved
but not as yet generally adopted methods of production sells below the market price, but above his individual price of production;
his rate of profit rises until competition levels it out."47
Finally, to bring up the "mud pie" straw-man for another beating, Marx made socially necessary labor the regulator
of value. The labor theory of value applied only to commodities, which were objects of human need. Labor expended in
producing goods not demanded, or excess labor wasted in methods of production less efficient than the norm, was a dead loss.
It was the function of the market price, in denying payment for such unnecessary labor, that brought the producer into accord
with the wishes of society.
Each of these units is the same as any other, so far as it has the character of the average labour power of society, and
takes effect as such: that is, so far as it requires for producing a commodity no more time than is needed on an average,
no more than is socially necessary. The labour time socially necessary is that required to produce an article under the normal
conditions of production, and with the average degree of skill and intensity prevalent at the time....
We see then that that which determines the magnitude of the value of any article is the amount of labour socially necessary,
or the labour time socially necessary for its production.48
The concept of socially necessary labor is the appropriate answer to Böhm-Bawerk's "rare butterfly" challenge to Adam Smith.
A rare butterfly that took more effort to capture than a beaver or deer would not carry more exchange-value than those commonly
useful items, unless the effectual demand for the butterfly was sufficient to recompense the labor of capturing it. In most
cases, therefore, the market for such rare butterflies would consist of rich eccentrics, and the effectual demand for them
would support only a small number of laborers. As a result, the market price would inform superfluous butterfly hunters that
most of their labor was socially unnecessary, and labor would be withdrawn from such "production" until the price was sufficient
to recompense the labor of catching them. The classical political economists and Marxists, as much as Austrians, understood
that labor expended on production for which there was no demand was a "sunken cost."
The neo-Ricardian Ronald Meek interpreted the term "value," as Marx used it, to mean something like "equilibrium price"
in neoclassical economics.
It is important to note at the outset that Marx's theory of value, like those of Smith and Ricardo, did not pretend to
explain any prices other than those at which "supply and demand equilibrate each other, and therefore cease to act". The prices
in which Marx was primarily interested were those which manifested themselves at the point where supply and demand "balanced"
or "equilibrated" one another. The very fact that the forces of supply and demand did actually "balance" at this point was
taken by Marx as an indication that the level of the equilibrium price could not be adequately explained merely in terms of
the interaction of these forces. The relation of supply and demand could certainly explain deviations from the equilibrium
price, but it could not explain the level of the equilibrium price itself. It was in fact precisely through fluctuations
in "supply and demand" that the law of value operated to determine the equilibrium price.
"Prices, then, might diverge from values in cases where supply and demand did not "balance"....
Just as Marx's concept of value involved an abstraction from utility... so the theory of the determination of equilibrium
price based upon it involved a similar abstraction from demand. In common with his Classical predecessors, Marx assumed that
changes in demand would not in themselves... bring about changes in this long-run equilibrium prices of the commodities concerned.
But this is not at all to say that Marx ignored demand. It remained true, as he emphasized, (a) that a commodity
had to be in demand before it could possess exchange value; (b) that changes in demand might cause the actual market
price of a commodity to deviate from its equilibrium price; (c) that price under conditions of monopoly was "determined
only by the eagerness of the purchasers to buy and by their solvency"; and (d) that demand was the main force determining
the proportion of the social labour allocated to any given productive sector at any given time.49
Of course, as Marshall later pointed out, this irrelevance of demand to equilibrium price was complicated by the fact that
the level of effective demand might affect the scale of production, and thereby also affect unit costs of production.
Meek criticized Vilfredo Pareto, in very nearly the same terms as we have criticized Bohm-Bawerk, for his attacks on a
straw-man version of Marx's labor theory of value.
...all too often the imaginary Marxists with whom Pareto argues are made to put forward interpretations of the labour theory
which are suspiciously simple-minded.... [For example] it is easy enough to show that the labour theory does not apply
to rare pictures, etc., since (as Pareto well knew) it was never intended to apply to anything other than freely reproducible
goods. Nor is it sufficient, when the Marxist characterizes as exceptional the case of the picture whose price increases when
its painted becomes famous without anything having happened to the quantity of labour embodied in it, to reply that it is
by no means exceptional because the prices of all commodities may vary without anything happening to the quantity of
labour embodied in them--e.g., on account of a change in the tastes and incomes of their consumers.50
The proper reply to such criticism, Meek argued, was "that the long-run equilibrium prices of freely reproducible commodities
(as distinct from their day-to-day market prices) will not in fact be affected by a change in demand unless it is accompanied
by a change in the conditions of production.51
Finally, since our version of the labor theory of value owes more to Benjamin Tucker than to Marx, it is only appropriate
to provide some examples in which Tucker acknowledged "exceptions" to the labor theory. Tucker accepted the existence of short-term
quasi-rents on commodities for which demand had increased, or commodities for which new production processes had been introduced.
Like the Classicals and Marx, he viewed competition as the mechanism by which price would be reduced to cost, when market
entry was free and goods were freely reproducible. "It is true that the usefulness of [the laborer's] product has
a tendency to enhance its price; but this tendency is immediately offset, wherever competition is possible, ...by the rush
of other laborers to create this product, which lasts until the price falls back to the normal wages of labor."52
Tucker also recognized that economic rent on land with advantages in location or fertility would persist, even when absentee
landlord rent was abolished. And he likewise viewed producer surpluses resulting from superior innate skill as analogous to
economic rent on land, and thus as inevitable even with the abolition of privilege. Although abolishing the land monopoly
would reduce rent to "a very small fraction of its present proportions," some would still remain. The "remaining
fraction," nevertheless,
would be the cause of no more inequality than arises from the unearned increment derived by almost every industry from
the aggregation of people or from that unearned increment of superior natural ability which even under the operation of the
cost principle, will probably always enable some individuals to get higher wages than the average rate.53
In response to the question of how one could justify the receipt of the equivalent of 500 days' labor, by the possessor
of an especially fertile piece of land, for only 300 days of his own, Tucker responded that such justification would be "[p]recisely
as difficult as it would be to show that the man of superior skill (native, not acquired) who produces in the ratio of five
hundred to another's three hundred is equitably entitled to this surplus exchange value."54
Tucker was willing to accept such permanent scarcity rents as necessary evils. He distinguished between competitive disabilities
which resulted from "human meddlesomeness," and those which did not.55 Unlike usury and landlord rent, which resulted from
the coercively-maintained legal privilege of owners of capital and land, the remaining forms of producer surplus resulted
only from general circumstances or "acts of God," and were therefore not exploitative. The evils involved in creating a coercive
mechanism to iron out such inequalities and collect payment from free riders would exceed the evils of the inequalities themselves.
To directly enforce equality of material well-being is meddlesome, invasive, and offensive, but to directly enforce equality
of liberty is simply protective and defensive. The latter is negative, and aims only to prevent the establishment of artificial
inequalities; the former is positive, and aims at direct and active abolition of natural inequalities.56
"How are we to remove the injustice of allowing one man to enjoy what another has earned?" I do not expect it ever to be
removed altogether. But I believe that for every dollar that would be enjoyed by tax-dodgers under Anarchy, a thousand dollars
are now enjoyed by men who have got possession of the earnings of others through special industrial, commercial, and financial
privileges granted them by authority in violation of a free market.57
Forcibly charging a man for the producer's surplus resulting from his superior skill or the superior fertility of his land,
would be at least as unjust as allowing him to keep it. "If it is unearned, certainly his neighbors did not earn it."58
"If the cost principle of value cannot be realized otherwise than by compulsion, then it had better not be realized."59
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