THE ANALYSIS OF VALUE

The emphasis Smith assigned to the market as a regulator of the division of labour called for further probing into the nature of the economic process and, in particular, into the manner in which economic value was determined.

From his own characterization of his analytical targets it is readily apparent that Smith was raising questions some distance removed from those most economists would now consider pertinent. A mid-twentieth century economist, asked to state the 'value' of a particular commodity, would normally proceed by trying to establish the price the market was prepared to pay for it. Writers in the classical tradition, on the other hand, were at pains to insist that price and value could not be so readily collapsed into one another. 'Value' was viewed as independent of the market's whims. Nominal (or market) prices might fluctuate, but value remained constant and invariant.

Many later commentators have treated this approach as superfluous metaphysics. Yet most classical writers set great store on the distinction and, by their lights, with good reason. Smith expected his account of value to do two jobs. In the first place, he said that it provided at least a partial explanation of the behaviour of market prices; further (and more important to the general thrust of his reasoning), it promised to provide a basis for measuring aggregate economic change over an extended period.

writers were not themselves always careful to distinguish between the various uses to which they put their concepts of value.

If value was distinct from price, how then was the former established? Smith asserted that labour was 'the measure of value'. This was readily compatible with the themes he had already developed; moreover, it was in harmony with intellectual currents of his time. At least since Locke an influential strand of English thought had been disposed to regard labour as a 'basic' or 'original' contributor to the economic process.

The assertion that labour provided the 'measure of value' was not, however, free from ambiguity. At least two divergent interpretations of the relationship of labour to value are possible. The first might base the value of a commodity on the quantity of labour required for its production. Smith entertained this interpretation, but he chose to apply it only to the circumstances of a hypothetical 'early and rude' society preceding the appropriation of private property and the accumulation of capital. With this situation in mind, he wrote:

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.14

He shifted his ground when considering more complex institutional settings. Value could then no longer be reckoned simply in terms of direct labour inputs; other factors - in particular, land and capital - now contributed to the production process, and their contribution could not so readily be reduced to labour units.

The significance of this measure can best be conveyed in a hypothetical illustration. Let us suppose that 6oo units of labour input15 are required to produce a particular volume of output. Further, let it be assumed that landowners and capitalists together require a remuneration equal to the wage bill before making available the services of the factors of production they control (in other words, profits plus rents must equal the wage bill as a condition for production). By Smith's reasoning the value of the total output would be 1200 labour units - 600 units of direct labour input plus 600 labour units that the recipients of rents and profits could 'command'.

This circuitous procedure at least salvaged a measurement of output in terms of labour units. Moreover, in Smith's view it yielded insights into the manner in which prices were actually formed. The key to an understanding of Smith's notion of this mechanism lies in his interpretation of the components of the 'natural price' (i.e. value). The natural price of commodities, he argued, was compounded from three ingredients: wages, rents (the return to owners of land), and profits (the return to the owners of capital). The size of each of these shares also had a natural level. Smith blended these concepts as follows:

When the price of any commodity is neither more nor less than what is sufficient to

pay the rent of the land, the wages of the labour, and the profits of the stock employed in raising, preparing, and bringing it to market according to their natural rates, the commodity is then sold for what may be called its natural price.

The commodity is then sold precisely for what it is worth, or for what it really costs the person who brings it to market...16

The market price, however, might not conform to these specifications. Should it fail to do so, the forces of competition were expected to push the market price toward the natural price.17 Without using the term, Smith was clearly groping for a concept later economists have described as 'equilibrium'.

These formulations, though quite innocent in appearance, contained an important social message. If it was accepted that the natural price represented the real worth of a product, it followed that any practices - whether initiated by governments (in such forms, for example, as restrictions on trade or the award of privileges to chartered companies) or by private interests (in such forms as monopolies or statutes of apprenticeship) - tending to thwart the market's behaviour were socially reprehensible. The outcome would be far better, he maintained, if affairs were guided by the market's 'invisible hand'.

Useful as this by-product of Smith's handling of value was to his larger argument, it was by no means the major influence on the shape of his theoretical structure. Of greater importance was his interest in devising a technique for measuring changes in, the national output. To an analyst concerned (as Smith was) with the problem of economic expansion over extended periods of time, it was obviously important to be able to establish whether or not growth had, in fact, occurred. This required a technique for eliminating the distorting effects of price variations. In more modern terminology: the problem called for an index number or its equivalent.

At first glance it appeared that Smith's 'command over labour' formulation provided a solution to this index number problem. It implied that comparative statements could be made about changes in aggregate output between two points in time by stating total output in terms of the number of labour units it could purchase. As a first approximation, this exercise could be performed by dividing the total output, expressed in money terms, by the basic wage. If the result in period 2 exceeded that for period 1, it could be asserted that growth had occurred; moreover, the amount of change in the economy's total output could be established.

But this procedure, on closer inspection, did not fully live up to its initial promise. If wage rates changed between periods 1 and 2, the results would no longer be comparable, unless it could also be assumed that all other prices and income shares had changed in the same proportion.19 Otherwise conclusions derived from Smith's formula could be quite misleading; if, for example, wages fell while other prices and income shares remained the same, output (expressed as command-over-labour) would appear to have expanded even when no change in production had actually occurred. In parts of his argument Smith seemed

to protect himself against this perplexity by taking the position that the natural wage rate tends to be stable for prolonged periods. This view, however, conflicted with notions advanced elsewhere in The Wealth of Nations on the course of wages during the progress of improvement.

Another difficulty also confronted this formulation. It could not conveniently deal with the case in which the productivity of labour increased (i.e. when the same amount of labour input produced a larger volume of output). In this situation the total wage bill required for the production of a targeted level of output would be smaller than had formerly been the case, even if wage rates were constant. Should a reduction in the price of outputs then follow (not unlikely in such circumstances), the command-over-labour measurement would convey the impression that total output had shrunk when, in fact, it had grown. Implicitly Smith protected himself against this objection by assuming that costs of production (and with them the income share-out between the various classes) would not vary with changes in the volume of output produced by individual firms. Thus, for example, the cost per pair of shoes would be the same in a plant equipped to produce 100 pairs of shoes per day as in a plant producing ten pairs per day.

This view has been invalidated by later experience. It has since been abundantly demonstrated that in many lines of production unit costs are substantially reduced when high technologies are applied in large concentrations.

If Smith encountered some awkward stumbling blocks in his attempt to devise an invariant standard for measuring economic change, the problems he grappled with were still real and important. Similar issues persist in modern analyses of economic growth. For his part, Smith pursued the problem even further by trying to devise a procedure that would be convenient for statistical purposes. Though he consistently maintained that 'command over labour' was the conceptually correct approach, he recognized that it might be cumbersome to apply. He ultimately concluded that the availability of food grains - in his terms 'corn' - might, for most practical purposes, be regarded as a proxy. This matter could be more readily established empirically. Corn, in his view, was the main component of subsistence and its availability was a precondition for the effective exercise of a command over labour.

In Smith's hands the appeal to labour as a basic measure of value underwent one further variation. He announced the theme in the following passage:

Equal quantities of labour, at all times and places, may be said to be of equal value to the labourer (italics added). In his ordinary state of health, strength and spirits; in the ordinary degree of his skill and dexterity, he must always lay down the same portion of his ease, his

liberty, and his happiness. The price which he pays must always be the same, whatever may be the quantity of goods which he receives in return for it.20

The constancy referred to here implied a stability in the sacrifice workers underwent when foregoing leisure for the toil and trouble of work. The realism of this assumption over prolonged time periods may be open to challenge: an increasing specialization of jobs and growth in their variety in a changing economy, as well as the adjustments in wage scales, may well alter the irksomeness of work. Even so, Smith was drawing attention to a highly relevant point that now receives little direct attention in the analysis of long-period economic change: namely, that the extent of economic improvement should be judged not solely by changes in the size of the total bundle of goods but also by the effort required to produce the bundle. In this version of Smith's 'labour as the measure of value' economic improvement could be deemed to have occurred when a unit of labour input brought command over a larger quantity of goods.

Smith's labour approach to the analysis of value has been severely criticized by later schools of economists. To one group of writers its fatal shortcoming was that it did not offer a full account of the determination of prices, and, most particularly, that it neglected the demand side of market behaviour.21 This criticism would carry more force had Smith sought to produce a systematic analysis of market price formation. But in fact this objective was peripheral to his main programme. He was more concerned with forging concepts that might provide leverage on the problem of measuring economic change over prolonged periods. The materials for developing a clearer analysis of the formation of short-term market prices were at his disposal. Concepts of utility and demand (which were to be used for their purpose by a later school of thought) had been part of the teaching he absorbed from Hutcheson. He chose to reject this orientation toward value theory, presumably because he regarded it as lacking relevance to his central purpose.

Another and more serious charge can be levelled against Smith's approach. It concerns an inconsistency in his treatment of labour units. The labour force, as he recognized, was not homogeneous;22 some of its members were more skilled (and hence more productive) than others. How were these discrepancies to be reduced to a common denominator? Smith replied that an adjustment was provided 'not by any accurate measure, but by the higgling and bargaining of the market, according to that sort of rough equality which, though not exact, is sufficient for carrying on the business of common life'.23 In other words, wage differentials established in the market place supplied the basis for reducing the various units of labour input to a common standard; an hour of unskilled labour might be taken as a standard unit while an hour's labour by a worker paid twice as much would be worth two units. It may well be asked: if the market test is sufficient for weighing the units in which value is measured, why cannot the same procedure be applied to the valuation of output? The whole problem of the distinction between value (natural prices) and actual prices would then vanish. Smith's caveats about approximations provided no escape from this logical trap.

Though it has become fashionable for modern economists to abuse any 'labour theory of value', a more charitable reading would be appropriate. After all, are not intellectual

operations of much the same sort performed nowadays when economists assume in their projections of growth-rates that prices will remain stable, or when comparative statements. about the economic health of the U.S., the U.K. and the U.S.S.R. are made on the basis of the number of working hours required in each country before a typical worker can earn enough to buy a specified package of goods - e.g. a pair of shoes, a radio, or an automobile? Is not a device analogous to Smith's distinction between natural and market price invoked by some Western economists working in underdeveloped areas? They argue that labour is priced too high, capital too low, and that economic growth would be accelerated if governments insisted that the decisions of businessmen on combinations of labour and capital should be governed not by actual prices, but by 'accounting' prices that more accurately reflect the 'real' scarcities of these productive agents.

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