These numbers now allow the physical input data in Table 31 to be converted into Marx's labor-value terms. Since Marx a.s.sumed that the rate of surplus value was the same across all industries, of the labor input in each industry represents v, while represents s. Taking the iron industry, of the 56 labor-value units of direct labor, 14 represent v and 42 represent s. Since Table 17.5 is now in consistent units (everything is measured in labor-value units), the table adds up both horizontally and vertically.

With this table constructed, we can now calculate the average rate of profit in Marx's terms which is the ratio of total s to the sum of c and v, or 60/132 (this factors to 5/11, and is equal to a rate of profit of 455u11 percent). In equilibrium, this rate of profit will apply across all industries, since otherwise capitalists would be shifting their resources from one sector to another. Steedman then multiplied the input values by 1 plus this uniform rate of profit to yield Marx's 'transformation' of values into prices.

TABLE 17.5 Steedman's prices table in Marx's terms So far, so good. Just as with Marx's table, the sum of values equals the sum of prices, and the sum of profits equals the sum of surplus values. However, all is not as well as it seems.

Table 17.5 tells us that the price of the total output of the iron industry is 101.82 (let's call this dollars, even though in these models the price simply means the ratios in which commodities exchange). If we divide this by the physical output of 56 tons of iron, then this means the price per ton is $1.82. If the iron industry pays this price for its iron inputs in the next period, it will pay out $50.91. To hire the workers it needs, it has to buy sufficient corn: the amount works out to 3.5 bushels (this is the total amount of corn consumed by all workers 5 bushels multiplied by the fraction of the total workforce employed in the iron industry). This costs $16.55. The iron industry's total outlays are thus $67.46, and yet (if Marx's equilibrium price calculations are accurate), it can sell its output for $101.82, for a profit of $34.36. But this is $2.55 more than the profit in the previous period.

Clearly there is an inconsistency or rather, at least one. The simplest is that Marx converted the output into price terms, but didn't convert the inputs. However, it's worse than this: even if you amend this error, you get nonsense results: what is supposed to be an equilibrium (and therefore stationary) turns out not to be stationary at all.

Steedman then shows that you don't have to 'transform' physical quant.i.ties into values, and values into prices: you can instead derive prices directly from the physical data and the equilibrium a.s.sumption of a uniform rate of profit. The basis of this is that, in equilibrium, the prices have to enable each sector to just pay for its inputs and make the average rate of profit. Thus for the iron industry, the price of its 28 tons of iron inputs, plus the price of its 56 hours of labor, plus the standard markup, must just equal the price of its 56 tons of iron output. There are two similar equations for corn and gold, and one final relation linking the wage to the cost of the subsistence amount of corn. If the gold price is notionally set to $1, this yields the average rate of profit, wage, and prices of iron and corn (in terms of gold) shown in Table 17.6.

TABLE 17.6 Profit rate and prices calculated directly from output/wage data Things don't look so good for Marx's tables now. First, the rate of profit and prices worked out directly from the data (in Table 17.6) differ from those derived by taking Marx's route through the concept of value (in Table 17.5). Worse, whereas Marx's numbers aren't consistent they are supposed to describe an equilibrium situation, but don't the numbers derived directly from the data are consistent.

Take iron, for example. The iron sector pays $1.71 per ton for its 28 tons of inputs, for a total of $47.88. It buys 3.5 bushels of wheat for $4.3 a bushel, for an outlay of $15.05. Total expenses of production are therefore $62.93. It then marks this up by the rate of profit to a total of $95.65. Except for the effect of rounding error, this equals the price of iron ($1.71) times the output (56 tons).14 Steedman concluded that, far from value determining prices, prices could not be accurately derived from values. Instead, prices could be worked out directly from the physical production data, and knowledge of the real wage: value calculations were both superfluous and misleading. He concluded that [t]here is no problem of transforming values into prices, etc., to be solved. The 'transformation problem' is a 'non-problem,' a spurious problem which can only be thought to arise and to have significance when one is under the misapprehension that the rate of profit must be determined in terms of labor quant.i.ties. Once it is seen that there is no such necessity, the 'problem' simply evaporates. (Steedman 1977) Though he did not put his conclusion in this way, Steedman was essentially saying that Marx cannot be right that labor is the only source of surplus. We are better off to forget the whole question of 'where does the surplus come from?' and instead simply accept that it exists, and a.n.a.lyze capitalism on that basis.

The inconsistencies Steedman establishes15 undermined Marx's sequence of claims that labor is the only source of value, that value is the only source of profits, and that value determines price. Marx could also provide no reason why capitalism, possible the most internally compet.i.tive social system ever, should ultimately behave so cooperatively, with capitalists sharing in total social profit as 'just so many stockholders in a stock company in which the shares of profit are uniformly divided per 100.'

Thus, though Marx used the labor theory of value to both attack capitalism and predict its downfall, the theory did not even seem to provide a consistent model of capitalism itself let alone a 'scientific' explanation of why capitalism would wilt and socialism blossom. It appeared that the great revolutionary challenger to capitalism had promised a bang, but delivered a whimper.

The Marxist response This was no great disappointment to his conservative critics, who happily pointed out the flaws in Marx's logic, and turned to developing economics as we know it today. But devoted Marxists tried valiantly to resurrect Marx's program of 'scientific socialism' by showing that, somehow, at some deep level, Marx's theory of value was internally consistent.

Many years before Steedman turned Sraffa's blowtorch onto Marx's economics, leading Marxist economists had applauded Sraffa's methodical critique of neocla.s.sical economics. However, some of them could also see that Sraffa's dispa.s.sionate a.n.a.lysis posed serious problems for the labor theory of value. One of the most thoughtful of such responses came from Ronald Meek in his scholarly Studies in the Labor Theory of Value. In a section headed 'From values to prices: was Marx's journey really necessary?,' Ronald Meek asked: Why did he think that anything had to be 'transformed' in order to arrive at the equilibrium prices characteristic of compet.i.tive capitalism? And if something did have to be 'transformed' in order to arrive at them, why did it have to be these mysterious, non-observable, Volume I 'values'? Personally, although I am no longer at all religious about such matters, I find myself leaning much more towards the 'neo-Ricardians' than towards their critics. I think that it is useful to talk in terms of a broad Ricardo-Marx-Sraffa tradition or stream of thought, in which the question of the relation between the social surplus and the rate of profit has always been (and still is) a central theme. (Meek 1972) In other words, Meek was prepared to abandon the emphasis upon value, and instead develop Marx's a.n.a.lysis of capitalism minus the insistence that labor is the only source of value, and that value determines profit and prices. Many other scholars followed Meek's lead, and abandoned strict Marxist economics, with its insistence upon value a.n.a.lysis.

However, a minority has persisted, and continue to argue that, somehow, value is an essential part of Marxist a.n.a.lysis. This minority's response to Steedman's critique is best summarized in the t.i.tle of a paper by Anwar Shaikh: 'Neo-Ricardian economics: a wealth of algebra, a poverty of theory' (Shaikh 1982).

The implication is that, somehow, Marx's philosophy sidesteps the mathematical problems highlighted by Steedman, or it points out a step in the mathematical chain which Steedman missed. To date, no Marxist has been able to put forward an explanation of this rejoinder, which has commanded a.s.sent from the majority of Marxists: there are almost as many competing ways to try to avoid Steedman's critique as there are Marxist economists. However, they all a.s.sent that there is something in Marx's philosophy which counteracts Steedman's mathematical attack.

Over one century after Marx's flawed solution to the transformation problem was first published, and almost a quarter of a century after Steedman's devastating critique, they are still at it. The latest attempts argue that, since Marx's theory was actually dynamic rather than static, the transformation problem should be solvable in a dynamic model.

Nice try, guys, but you really shouldn't bother. The labor theory of value is internally inconsistent, and perhaps even more flawed than conventional economic theory itself. And far from philosophy saving the labor theory of value from mathematical criticism, philosophy provides further compelling reasons for its rejection. One convincing proof of this was given by the Indian economist Arun Bose.

Arun Bose: Marx's 'capital axioms'

Bose was well aware of the criticism leveled at Steedman that his argument, while mathematically impeccable, was somehow philosophically lacking. Though he disparagingly referred to this as 'a theological tendency to go so strictly by what Marx said as to adhere to the rule: "where logic contradicts Marx's words, go by his words"' (Bose 1980), Bose nonetheless tried to avoid this judgment by looking for textual support in Marx. He called his interpretation of Marx the 'capital theory' approach, and argued that: 'as far as logic goes, there are "two Marxes," the Marx of the "labor value" approach, and the Marx of the "capital theory" approach,' and that the 'second Marx' should be supported in preference to the first (in scientific discussion) (ibid.).16 Bose, unlike Steedman, accepted the Marxian position that the concept of value was somehow essential. However, what he argued was that, if value was in some sense the essence of a commodity, then that essence could not be reduced solely to labor. Therefore labor alone was not the essence of value: instead, both labor and commodities were the essence of value. As Bose put it: 'labor is never the only or the main "source of value" in any system which is defined as capitalist on the basis of a reasonable set of axioms. Labor is not, immediately or ultimately, the only or main source of price, surplus or profit. Labor and commodities are the two sources of wealth, value, price, of surplus value and profit' (ibid.). His logic used a concept we saw earlier in Chapter 6: the reduction of commodity inputs to dated labor.17 The manufacture of any commodity requires direct labor, machinery, intermediate goods, and raw materials. All the non-labor inputs had to have been produced at some time in the past: even unprocessed raw materials had to have been previously either mined or harvested. They in turn were made using some direct labor, and other commodity inputs (machinery, intermediate goods, raw materials). These again can be reduced to even earlier dated labor, and other commodity inputs.18 This process can go on indefinitely, with each step further reducing the commodity content. But no matter how far back you go, you can never eliminate this commodity residue. If you could, then there would be some commodities that can be created with absolutely no commodity inputs or in other words, by magic.19 Therefore if value is the essence of a commodity, then that essence consists of both labor and commodities it cannot be derived solely from labor.

Bose's conclusion probably helped sway some more Marxists to abandon the faith. But generally, his argument was simply not acknowledged by Marxist economists. A similar fate has to date befallen the next argument, which establishes that the labor theory of value is inconsistent, not just with mathematical logic, or with any reductionist notion of the commodity, but with Marx's own philosophy.

The origin of surplus value (II) As noted earlier, most Marxists believe that Marx reached the conclusion that labor was the source of value by a 'negative' proof, which eliminated any other possible contenders. This was true up until 1857, when he developed an alternative, and far superior, 'positive' proof. To understand this proof, we have to delve into Marx's 'dialectical' philosophy.20 17.1 A graphical representation of Marx's dialectics In brief, dialectics is a philosophy of change. It begins from the proposition that any ent.i.ty exists in a social environment (see Figure 17.1). The environment will emphasize some aspect of the ent.i.ty, and necessarily places less emphasis upon all other aspects of the ent.i.ty. However, the ent.i.ty cannot exist without both the foreground aspects (the features the environment emphasizes) and background aspects (the ones it neglects). This sets up a tension within the ent.i.ty, and possibly between the ent.i.ty and the environment. This tension can transform the nature of the ent.i.ty, and even the environment itself.

Marx first applied this logic to the concept of the commodity in 1857. He reasoned that the commodity was the unity of use-value and exchange-value. In a capitalist economy, the exchange-value of a commodity is brought to the foreground21 while its use-value is pushed into the background. What this means in practice is that the use-value of a commodity is irrelevant to its price: its price is instead determined by its exchange-value. Yet the commodity can't exist without its use-value (something useless can't be a commodity), so that a dynamic tension is set up between use-value and exchange-value in capitalism.

Prior to this realization, Marx had concurred with Smith and Ricardo that use-value was irrelevant to economics. After it, the concept of use-value, in unison with exchange-value, became a unifying concept for his whole a.n.a.lysis of capitalism.

Marx's first exploration of this concept occurred when he was working on the 'rough draft' of Capital in 1857: 'Is not value to be conceived as the unity of use-value and exchange-value? In and for itself, is value as such the general form, in opposition to use-value and exchange-value as particular forms of it? Does this have significance in economics?' (Marx 1857).22 The manner in which he first puts the proposition, as questions to himself rather than didactic statements, and especially his comment 'Does this have significance in economics?', shows how novel the concept was to him. From this point on, Marx exclusively used this positive methodology, based on a general axiomatic a.n.a.lysis of the commodity, to explain the source of surplus value. Since this point is appreciated by so few Marxists, it is worth citing several of Marx's many p.r.o.nouncements on this issue.

I noted earlier that Marx mocked Ricardo for not having an explanation of why labor embodied differed from labor commanded. He notes that Smith fell for the fallacy that, under capitalism, a worker should be paid his full product. He continues: Ricardo, by contrast, avoids this fallacy, but how? 'The value of labor, and the quant.i.ty of commodities which a specific quant.i.ty of labor can buy, are not identical.' Why not? 'Because the worker's product is not = to the worker's pay.' I.e. the ident.i.ty does not exist, because a difference exists Value of labor is not identical with wages of labor. Because they are different. Therefore they are not identical. This is a strange logic. There is basically no reason for this other than it is not so in practice. (Ibid.) Marx then contrasts his easy ability to derive the source of surplus value with Ricardo's struggles to do the same: 'What the capitalist acquires through exchange is labor capacity; this is the exchange value which he pays for. Living labor is the use-value which this exchange value has for him, and out of this use-value springs the surplus value and the suspension of exchange as such' (ibid.).

There are many similar such statements, many of which were written in doc.u.ments which were either not intended for publication or were never formally completed by Marx. But even in the most well-known pa.s.sage where Marx derives the source of surplus value, in Capital I, this positive derivation takes precedence over the negative proof.

Marx began Capital by clearing intellectual cobwebs en route to uncovering the source of surplus, criticizing explanations based upon unequal exchange or increasing utility through exchange. He then restated the cla.s.sical axiom that exchange involves the transfer of equivalents, and the conclusion that therefore exchange of itself cannot provide the answer. Yet at the same time circulation based on the exchange of equivalents must be the starting point from which the source of surplus value is deduced. Marx put the dilemma superbly: The conversion of money into capital has to be explained on the basis of the laws that regulate the exchange of commodities, in such a way that the starting point is the exchange of equivalents. Our friend, Moneybags, who as yet is only an embryo capitalist, must buy his commodities at their value, must sell them at their value, and yet at the end of the process must withdraw more value from circulation than he threw into it at starting. His development into a full-grown capitalist must take place, both within the sphere of circulation and without it. These are the conditions of the problem. (Marx 1867) He began the solution of this dilemma with a direct and powerful application of the dialectic of the commodity. If the exchange-value of the commodity cannot be the source of surplus, then the dialectical opposite of value, use-value, is the only possible source: The change of value that occurs in the case of money intended to be converted into capital must take place in the commodity bought by the first act, M-C, but not in its value, for equivalents are exchanged, and the commodity is paid for at its full value. We are, therefore, forced to the conclusion that the change originates in the use-value, as such, of the commodity, i.e. its consumption. In order to be able to extract value from the consumption of a commodity, our friend, Moneybags, must be so lucky as to find, within the sphere of circulation, in the market, a commodity, whose use-value possesses the peculiar property of being a source of value. (Ibid.) Marx then used the quant.i.tative difference between the exchange-value of labor-power and its use-value to uncover the source of surplus value in the transaction between worker and capitalist: The past labor that is embodied in the labor power, and the living labor that it can call into action; the daily cost of maintaining it, and its daily expenditure in work, are two totally different things. The former determines the exchange-value of the labor power, the latter is its use-value. The fact that half a [working] day's labor is necessary to keep the laborer alive during 24 hours, does not in any way prevent him from working a whole day. Therefore, the value of labor power, and the value which that labor power creates in the labor process, are two entirely different magnitudes; and this difference of the two values was what the capitalist had in view, when he was purchasing the labor power. What really influenced him was the specific use-value which this commodity possesses of being a source not only of value, but of more value than it has itself. This is the special service that the capitalist expects from labor power, and in this transaction he acts in accordance with the 'eternal laws' of the exchange of commodities. The seller of labor power, like the seller of any other commodity, realizes its exchange-value, and parts with its use-value. (Ibid.) The one way in which Marx's 'negative' derivation survived was in the claim that labor-power was the only commodity with the property of being 'a source not only of value, but of more value than it has itself.' In Capital I, Marx appeared to successfully reach the conclusion that the means of production could not be a source of surplus value. However, he did so by contradicting a basic premise of his 'positive' proof, that the use-value and the exchange-value of a commodity are unrelated. Properly applied, his 'positive proof' contradicts the negative one by showing that all inputs to production are potential sources of surplus-value.

'Guilty of this or that inconsistency because of this or that compromise' In the course of his attempt to preserve the labor theory of value proposition that labor-power is the only source of surplus value, Marx advanced three propositions which fundamentally contravene his general approach to commodities: that, in the case of the means of production, the purchaser makes use of their exchange-value, not their use-value; that their use-value cannot exceed their exchange-value; and that the use-value of commodity inputs to production somehow reappears in the use-value of the commodities they help create.

Marx began with the simple a.s.sertion that the means of production can transfer no more than their exchange-value to the product. He next attempted to forge an equality between the exchange-value and the use-value of the means of production, by equating the depreciation of a machine to its productive capacity.

Value exists only in articles of utility. If therefore an article loses its utility, it also loses its value. The reason why means of production do not lose their value, at the same time that they lose their use-value, is this: they lose in the labor process the original form of their use-value, only to a.s.sume in the product the form of a new use-value. Hence it follows that in the labor process the means of production transfer their value to the product only so far as along with their use-value they lose also their exchange-value. They give up to the product that value alone which they themselves lose as means of production. (Ibid.) Don't worry if you found that paragraph hard to understand: it is replete with erroneous and ambiguous propositions. First, the two final sentences, which appear to link the transfer of value by the machine to its depreciation, are incorrect (see below). Secondly, the statement that the use-value of a machine reappears in the use-value of the product equates the use-value of the machine to the utility enjoyed by the 'consumers' who purchase the goods the machine produces. But the use-value of a machine is specific to the capitalist purchaser of the machine only. By arguing that the use-value of the machine reappears in the product, Marx is in fact contemplating the existence of abstract utility, with the 'usefulness' of the machinery being trans.m.u.ted into the 'usefulness' of the commodities it produces. If anything, this is neocla.s.sical economics, not Marx.

The ambiguous statement concerns the transfer of value by the means of production. Which of their two 'values' do machines transfer, their exchange-value or their use-value? If Marx meant that they transfer their use-value, then this sentence would be correct in terms of his a.n.a.lysis of commodities. But later he makes it clear that by this expression he meant that the means of production transfer not their use-value (which is the case with a worker) but their exchange-value. In the clearest ill.u.s.tration of the flaw in his logic, he states that over the life of a machine, 'its use-value has been completely consumed, and therefore its exchange-value completely transferred to the product' (ibid.: 197). This amounts to the a.s.sertion that in the case of machinery and raw materials, what is consumed by the purchaser is not their use-value, as with all other commodities, but their exchange-value.

This ambiguity reappears as Marx discusses the example of a machine which lasts only six days. He first states the correct proposition that the machine transfers its use-value to the product, but then equates this to its exchange-value. He says that if a machine lasts six days '[t]hen, on the average, it loses each day one sixth of its use-value, and therefore parts with one-sixth of its value to the daily product.' Initially he draws the correct if poorly stated inference that 'means of production never transfer more value to the product than they themselves lose during the labor-process by the destruction of their own use-value.' However, the ambiguity between exchange-value and use-value is strong, and his conclusion takes the incorrect fork. Stating his conclusion rather more succinctly than his reasoning, he says: The maximum loss of value that they [machines] can suffer in the process, is plainly limited by the amount of the original value with which they came into the process, or in other words, by the labor-time necessary for their production. However useful a given kind of raw material, or a machine, or other means of production may be, though it may cost 150 yet it cannot, under any circ.u.mstances, add to the value of the product more than 150. (Ibid.) Essentially, Marx reached the result that the means of production cannot generate surplus value by confusing depreciation, or the loss of value by a machine, with value creation. The truisms that the maximum amount of value that a machine can lose is its exchange-value, and that a machine's exchange-value will fall to zero only when its use-value has been completely exhausted, were combined to conclude that the value a machine adds in production is equivalent to the exchange-value it loses in depreciation. With the value added by a machine equated to value lost, no net value is transferred to the product, and therefore only labor can be a source of surplus value.

While the argument may appear plausible, in reality it involves a confusion of two distinct attributes of a machine: its cost (exchange-value) and its usefulness (use-value). From a Marxist perspective, depreciation is the writing-off of the original exchange-value of a machine over its productive life. Consequently, the maximum depreciation that a machine can suffer is its exchange-value. As it wears out, both its residual value and its usefulness will diminish, and both will terminate at the same time. However, it does not follow that the usefulness (the value-creating capacity) of the machine is equal to its cost (its depreciation). Though a capitalist will 'write off' the latter completely only when the former has been extinguished, the two aspects are nonetheless completely different and unrelated. There is no reason why the value lost by the machine should be equivalent to the value added.

An a.n.a.logy with labor highlights the fallacy involved in equating these two magnitudes. If workers receive a subsistence wage, and if the working day exhausts the capacity to labor, then it could be argued that in a day a worker 'depreciates' by an amount equivalent to the subsistence wage the exchange-value of labor-power. However, this depreciation is not the limit of the amount of value that can be added by a worker in a day's labor the use-value of labor. Value added is unrelated to and greater than value lost; if it were not, there could be no surplus.

But don't take my word for it. Take Marx's.

The origin of surplus value (III) As noted above, Marx first developed his dialectical a.n.a.lysis of the commodity while working on the rough draft of Capital. He was initially so enthused with this approach that he explored it freely, with almost no regard for how it meshed with his previous a.n.a.lysis. While doing this, he made a statement that correctly applied this new logic and directly contradicted the old, by stating that a machine could add more value than it lost through depreciation.

Table 1 is typical of Marx's standard numerical examples of value productivity. In that table, surplus value is directly proportional to labor-power ('variable capital'), and the value of the total product is the sum of the value of the means of production, plus variable capital, plus surplus value. In this a.n.a.lysis, the contribution of non-labor inputs to the value of output is exactly equal to their depreciation. However, when referring to a similar table shortly after developing his use-value/exchange-value a.n.a.lysis, Marx comments: 'It also has to be postulated (which was not done above) that the use-value of the machine significantly [sic] greater than its value; i.e. that its devaluation in the service of production is not proportional to its increasing effect on production' (Marx 1857).

There then follows the example shown in Table 17.7.

Both firms employ the same amount of variable capital four days' labor which is paid 40 'thalers' (a unit in the German currency of the time), the value of the labor-power purchased. However, the first firm ('Capital 1'), with older capital, produces surplus value of just 10, while the second, with newer capital, produces a surplus of 13.33. The 3.33 difference in the surplus they generate is attributable to the difference in their machinery, and the fact that 'the use-value of the machine significantly greater than its value; i.e. its devaluation in the service of production is not proportional to its increasing effect on production.'23 TABLE 17.7 Marx's example where the use-value of machinery exceeds its depreciation Marx without the labor theory of value Marx's dialectical a.n.a.lysis thus contradicts a central tenet of the labor theory of value, that labor is the only source of surplus value. Having reached the conclusion above, Marx suddenly found himself trapped, as he had argued (in his PhD thesis) that Hegel was, in a compromise with his own principles. The principle of the dialectical a.n.a.lysis of the commodity was powerful, and the conclusions that followed logically from it inescapable: the labor theory of value could be true only if the use-value of a machine was exactly equal to its exchange-value, and yet a basic tenet of this a.n.a.lysis was that use-value and exchange-value are incommensurable.24 If Marx had followed his newfound logic, the labor theory of value would have been history. But with the labor theory of value gone, so too would be the tendency for the rate of profit to fall, and with it the inevitability of socialism.

The tendency for the rate of profit to fall was predicated upon the propositions that (a), over time, the capital-to-labor ratio would rise, and that (b), this would cause the rate of profit to fall. But (b) was dependent upon labor being the only source of surplus value, so that a rising capital-to-labor ratio would mean a falling rate of profit. If surplus could instead be garnered from any input to production, not just labor, then an increase in the capital-to-labor ratio would have no necessary implications for the rate of profit: it could fall, rise, or stay the same.

With no necessity for the rate of profit to fall, there was similarly no necessity for capitalism to give way to socialism. Yet Marx had prided himself upon being the 'scientific socialist,' the one who in contrast to 'utopian socialists,' who merely dreamed of a better world, would prove why socialism had to come about. Now he finds that his new logical tool, which is evidently so superior to his old, challenges the basis of his argument for the inevitability of socialism.

It is little wonder that Marx then tried to find a way to make his new logic appear consistent with the old. By the time of Capital, he had convinced himself that the two were consistent: that the new positive methodology concurred with the old on the issue of the value productivity of machinery. Marx succ.u.mbed to the same flaw that (in his PhD thesis) he once noted in Hegel: It is conceivable that a philosopher should be guilty of this or that inconsistency because of this or that compromise; he may himself be conscious of it. But what he is not conscious of is that in the last a.n.a.lysis this apparent compromise is made possible by the deficiency of his principles or an inadequate grasp of them. So if a philosopher really has compromised it is the job of his followers to use the inner core of his thought to illuminate his own superficial expression of it. In this way, what is a progress in conscience is also a progress in knowledge. This does not involve putting the conscience of the philosopher under suspicion, but rather construing the essential characteristics of his views, giving them a definite form and meaning, and thus at the same time going beyond them. (Karl Marx, 1839: notes to his doctoral dissertation, reprinted in McLellan 1971) So Marx succeeded in compromising his theory in a way which hid 'the deficiency of his principles or an inadequate grasp of them.' But 'success' came at a cost. The new logic, of which Marx was so proud, was ignored by his successors. In part, Marx contributed to this by the obfuscation he undertook to make his positive method appear consistent with the old negative one. But I can't detract from the impressive contribution 'Marxists' themselves have made to the misinterpretation of Marx.

The misinterpretation of Marx Though much of this occurred after his death, Marx had one taste of how his theories would be misinterpreted by friend and foe alike. He wrote a caustic commentary on the German economist Adolph Wagner's gross misinterpretation of his arguments in Capital, yet ironically, Wagner's hostile misinterpretation became the accepted interpretation of Marx by his followers after his death.

Wagner argued that Marx had completely misunderstood the notion of use-value, and that use-value played no part in Marx's a.n.a.lysis. Marx acerbically commented that: Rodbertus had written a letter to him where he, Rodbertus, explains why 'there is only one kind of value,' use value Wagner says: 'This is completely correct, and necessitates an alteration in the customary illogical "division" of 'value' into use-value and exchange-value' and this same Wagner places me among the people according to whom 'use-value' is to be completely 'dismissed' 'from science.' (Marx 1971 [1879]) Marx then made an emphatic statement of the role that use-value played in his economics: All this is 'driveling.' Only an obscurantist, who has not understood a word of Capital, can conclude: Because Marx, in a note to the first edition of Capital, overthrows all the German professorial twaddle on 'use-value' in general, and refers readers who want to know something about actual use-value to 'commercial guides,' therefore, use-value does not play any role in his work. The obscurantist has overlooked that my a.n.a.lysis of the commodity does not stop at the dual mode in which the commodity is presented, [but] presses forward [so] that surplus value itself is derived from a 'specific' use-value of labor-power which belongs to it exclusively etc. etc., that hence with me use-value plays an important role completely different than [it did] in previous [political] economy. (Ibid.) Marx's protestations were to no avail. Despite such a strident statement that use-value was an essential component of his a.n.a.lytic method, and despite the fact that this doc.u.ment was available to and read by early twentieth-century Marxists, use-value and the 'positive' methodology of which it was an integral part were expunged from mainstream Marxism. Paul Sweezy stated in his influential The Theory of Capitalist Development that 'Every commodity,' Marx wrote, 'has a twofold aspect, that of use-value and exchange-value.' Use-value is an expression of a certain relation between the consumer and the object consumed. Political economy, on the other hand, is a social science of the relations between people. It follows that 'use-value as such lies outside the sphere of investigation of political economy.' (Sweezy 1942, citing Marx 1859) Yet ironically, the statement Sweezy used to support the notion that use-value plays no role in Marx's a.n.a.lysis was the very one referred to by Marx (in the reference to the 'first edition of Capital,' by which he meant the 1859 work A Contribution to the Critique of Political Economy), when he labeled Wagner an 'obscurantist.' In Marx's own words, therefore, twentieth-century Marxism has completely misunderstood the philosophical core of Marx's a.n.a.lysis of capitalism.

A poverty of philosophy Bose's critique and Marx's dialectic of the commodity establish that philosophy can't save the labor theory of value from Steedman's critique. Philosophical a.n.a.lysis strengthens Steedman's case that the labor theory of value is logically flawed.

Instead, mathematics and Marx's philosophy confirm that surplus value and hence profit can be generated from any input to production. There is no one source of surplus: Adam Smith's apparently vague musings that animals and machines both contribute to the creation of new value were correct.

Whither Marxism?

Marxist economics is a.n.a.lytically far stronger once it is shorn of the labor theory of value. The use-value/exchange-value methodology, which was applied above only to the question of the source of surplus value, has application to a huge range of issues on which labor theory of value Marxism is either silent or pedestrian (see Groll 1980 and Keen 1993a, 1993b and 2000 for a discussion of some of these). Marxism becomes the pinnacle of cla.s.sical economics, rather than its dead end.

However, I am as pessimistic about the chances of this 'new, improved Marxism' being adopted by today's Marxists as I am about the chances of neocla.s.sical economists abandoning the concept of equilibrium.

Their resistance, as with neocla.s.sical economists to the critiques outlined in this book, is due in large part to ideology.

The advantage Marxists have over economists is that at least they are upfront about having an ideology. Marxists are as consciously committed to the belief that capitalism should give way to a socialism as economists are to the often unconscious belief that, if only we could rid ourselves of government intervention in the market, we would currently reside in the best of all possible worlds.

The tendency for the rate of profit to fall is crucial to this belief in the inevitability of socialism, and it is one of the many concepts that evaporate once the labor theory of value is expunged. Marxist economists are likely to continue to cling to the labor theory of value, to hang on to the faith, in preference to embracing logic.

If my pessimism is well founded, then Marxist economics will continue its self-absorbed and impossible quest for a solution to the transformation problem, and will remain irrelevant to the future development of economics.

However, labor theory of value Marxism will continue to be the ideology of choice of the left, particularly in the Third World. The argument that labor is the only source of profit, and that capitalism is thus based upon the exploitation of the worker, is a simple, compelling a.n.a.lysis to the downtrodden in our obscenely unequal world. A specter may no longer be haunting Europe, but Marxism will continue to be the banner of the dispossessed for many a year to come.

However, if non-neocla.s.sical and non-Marxist economists can ignore the hullabaloo generated by the remaining band of adherents to the labor theory of value, and instead extract from Marx his rich philosophical foundation for the a.n.a.lysis of capitalism, then Marx's dialectical theory of value may yet play a role in the reform of economic theory. At present, however, the various non-neocla.s.sical schools of thought have no coherent theory of value as an alternative to the neocla.s.sical school's flawed subjective theory of value. But even though they lack the central organizing concept of a theory of value, these alternative schools of thought contain the promise of an economic theory that may actually be relevant to the a.n.a.lysis and management of a capitalist economy.

18 | THERE ARE ALTERNATIVES1.

Why there is still hope for a better economics Maggie Thatcher's second-best-known comment, in defence of following monetarist economic policies, was 'There is NO alternative.' A similar att.i.tude pervades economics: if not neocla.s.sical economics, then what?

In fact, there are many alternative schools of thought within economics. In addition to Marxian economics, the main alternatives are: * Austrian economics, which shares many of the features of neocla.s.sical economics, save a slavish devotion to the concept of equilibrium.

* Post-Keynesian economics, which is highly critical of neocla.s.sical economics, emphasizes the fundamental importance of uncertainty, and bases itself upon the theories of Keynes and Kalecki.

* Sraffian economics, based on Sraffa's concept of the production of commodities by means of commodities.

* Complexity theory and Econophysics, which apply concepts from nonlinear dynamics, chaos theory and physics to economic issues. And * Evolutionary economics, which treats the economy as an evolving system along the lines of Darwin's theory of evolution.

None of these is at present strong enough or complete enough to declare itself a contender for the t.i.tle of 'the' economic theory of the twenty-first century. However, they all have strengths in areas where neocla.s.sical economics is fundamentally flawed, and there is also a substantial degree of overlap and cross-fertilization between schools. It is possible that this century could finally see the development of a dominant economic theory which actually has some relevance to the dynamics of a modern capitalist economy.

I would probably be regarded as partisan to the post-Keynesian approach. However, I can see varying degrees of merit in all five schools of thought, and I can imagine that a twenty-first-century economics could be a melange of all five.

In this chapter I give a very brief overview of each school, emphasizing the ways in which they are superior to neocla.s.sical economics, but also noting when they share its weaknesses, or have problems of their own. This will necessarily be an inadequate survey doing a proper survey would necessitate another book. But as I commented earlier, it is essential to at least outline the alternatives, to debunk the myth that there is no alternative.

Austrian economics The Austrian school (so called because its main early protagonists Menger, Hayek and von Mises were Austrian, though it is now mainly an American tradition) is a close relative of mainstream economics. It developed at much the same time, shared the same intellectual parents, and is comfortable with virtually every aspect of neocla.s.sical economics save one: its obsession with equilibrium. This one divergence results in a theory which is markedly different from its dominant but wayward cousin.

Strengths Far from arguing that capitalism is the best social system because of the conditions which pertain in equilibrium, Austrian economists argue that capitalism is the best social system because of how it responds to disequilibrium.

The Austrians make the sensible observation that equilibrium is an intellectual abstraction which is unlikely ever to occur in the real world. All real-world economic situations will thus be disequilibrium ones, some of which enable entrepreneurs to make above-normal profits. By seeking out these profit opportunities, entrepreneurs make capitalism a dynamic, adaptive social system.

The Austrians therefore have an evolutionary perspective on capitalism, and argue that capitalism is evolutionarily superior to other social systems, such as feudalism and socialism.

The Austrians emphasize the importance of uncertainty in a.n.a.lyzing capitalism, whereas neocla.s.sical economists, as we have seen, either ignore uncertainty, or trivialize it by equating it to probabilistic risk. This again gives Austrians an ideological reason to prefer capitalism to any other social system, since they argue that the disaggregated nature of capitalist society makes it more adaptable to uncertainty than other, more centralized systems.

The entrepreneur is the key actor in the Austrian vision of capitalism. It is the entrepreneur who attempts to profit from disequilibrium situations, thus innovating and adding to the diversity and strength of the capitalist system. The entrepreneurs are those who boldly act in the face of uncertainty, and though many will fail, some will succeed thus strengthening the economic system via an evolutionary process.

The Austrians thus demonstrate that the economic fixation with equilibrium is unnecessary: it is possible to be an ideological supporter of capitalism even if you believe that equilibrium is irrelevant.

However, as a near-relative of neocla.s.sical economics, this school shares a number of its disabilities.

Weaknesses First, the Austrians accept the economic argument that production is characterized by diminishing returns. As a corollary of this, they also accept the marginal productivity theory of income distribution though they temper this by arguing that disequilibrium allows for entrepreneurs to make supernormal profits.

As was shown in Chapters 3, 5 and 6, these economic notions are fundamentally unsound. To the extent that Austrian economics relies upon these same concepts, it is also unsound.

A simple ill.u.s.tration of this arises from the Austrian theory of production. The economic model argues that an increase in the quant.i.ty of a factor of production such as capital will decrease its marginal product, and thus reduce its income.

The Austrians instead argue that a cheapening of capital via a fall in the rate of interest will lead to a more 'roundabout' approach to production, meaning that less direct labor and more indirect capital will be applied to its production.

Sraffa's critique of the neocla.s.sical theory of production, detailed in Chapter 6, is equally applicable to this Austrian theory. By providing a way to measure capital inputs in terms of wage units, Sraffa showed that the economic concept of a quant.i.ty of capital was dependent on the rate of profit: the same logic shows that it is impossible to define one way of producing a commodity as 'more roundabout' than another independently of the rate of profit.

Consider two ways of making wine: process A, which involves the application of 1 wage unit now, 8 units last year, and 1 unit 8 years earlier; and process B, which involves 1 unit now and 1 unit 20 years ago. At a low rate of profit, process A might be more roundabout than process B; at a higher rate of profit, the order could reverse; and it could reverse again for a higher rate of profit. Therefore, the Austrian notion of roundaboutness is as internally inconsistent as the neocla.s.sical concept of the marginal productivity of capital.

Secondly, even more so than conventional economics, Austrian economics has a faith in the self-adjusting properties of the capitalist economy, with Say's Law providing much of that confidence. As was argued in Chapter 9, Say's Law is invalid in a production economy with growth.

Thirdly, while it is in general an evolutionary approach to economics, at least one branch of Austrian economics, a.s.sociated with Murray Rothbard, has a quite non-evolutionary att.i.tude towards both the existence of the state and the role of money. The market economy may have evolved, but it seems the state was simply imposed from outside as an alien artifact upon our landscape. This is certainly one way to consider the growth of the welfare state; but an equally tenable argument is that the welfare state evolved as a response to the failures of the pure market system during the Great Depression.

Similarly, while they believe that the money supply should be determined endogenously by either handing over money creation to private banks, or by returning to the gold standard they argue that the current system of state money means that the money supply is entirely exogenous, and under the control of the state authorities. They then attribute much of the cyclical behavior of the economy to government meddling with the money supply and the rate of interest.

The post-Keynesian school, on the other hand, argues that though it may appear that the state controls the money supply, the complex chain of causation in the finance sector actually works backwards. Rather than the state directly controlling the money supply via its control over the issue of new currency and the extent to which it lets banks leverage their holdings of currency, private banks and other credit-generating inst.i.tutions largely force the state's hand. Thus the money supply is largely endogenously determined by the market economy, rather than imposed upon it exogenously by the state.

The empirical record certainly supports post-Keynesians rather than Austrians on this point. Statistical evidence about the leads and lags between the state-determined component of money supply and broad credit shows that the latter 'leads' the former (Kydland and Prescott 1990). If the Austrians were correct, state money creation would instead precede private credit creation.

Maggie Thatcher's embrace of monetarism also provides an evocative counter-example. Despite her toughness, and her adherence to Milton Friedman's mantra that controlling the money supply would control inflation, even Thatcher's England was forced to abandon monetary targeting setting some goal for the rate of growth of the money supply in order to force down the rate of inflation because it could never meet the targets. If the 'Iron Lady' couldn't control the money supply, then no one could: evidence enough that the post-Keynesians are closer to the mark than the Austrians.

This non-evolutionary weakness in Austrian economics is a sign of a wider problem. The philosopher Chris Sciabarra, a specialist on the Austrian school and Ayn Rand, identifies an inconsistency between Hayek's notion of 'spontaneous order' which corresponds to evolutionary development and 'designed order' where change is imposed from outside the market by the state. While such a distinction makes for good polemic writing against state intervention, it ignores the extent to which the state's own behavior might be reactive to the market, and thus, to some extent, also a form of spontaneous order. As Sciabarra puts it: There are more fundamental problems with Hayek's social theory. By positing such a sharp distinction between spontaneous order and designed order, Hayek has not provided us with any explanation of the emergence of those inst.i.tutions which are agents of constructivism [designed order]. To what extent is the state itself a spontaneous, emergent product of social evolution? To what extent does the state define the parameters of the extended order which Hayek celebrates? What are the actual interrelationships between the spontaneous order of the market and the designed inst.i.tutions of the state? The reader of Hayek's works will strain to find developed answers to any of these important questions. (Sciabarra 1995) Finally, though Austrians eschew equilibrium a.n.a.lysis, and regard it as an unattainable state, their preference for capitalism as a social system is partly dependent on the belief that it will remain close to equilibrium. If, instead, capitalism is endogenously unstable, then it may remain substantially distant from equilibrium situations all the time. This weakens Austrian economics, to the extent that its support for capitalism emanates from conditions which are a.s.sumed to apply in equilibrium.

The Austrian scorecard Overall, I regard the Austrian school as too close to its neocla.s.sical cousin to make a major contribution to a reformed economics. However, it does have some contributions to make, and for ideological reasons it is likely to be far stronger in the future regardless of what I or other non-orthodox economists might think of it.

The Austrian emphasis upon innovation, and the role of the entrepreneur, are valid concepts which capture the way in which a market economy adapts. This aspect of capitalism is to some extent underrated by the other non-neocla.s.sical schools, except for evolutionary economics. This aspect of Austrian thought could be valuable to a reformed twenty-first-century economics.

However, it is far more likely that the 'pure and simple' Rothbardian stream of Austrian economics will play a large role in twenty-first-century economics. This is because the Rothbardian approach provides an alternative way to ideologically support a capitalist economy as the best possible social system, whereas all other non-orthodox schools are to some degree critical of the concept of unfettered capitalism. If neocla.s.sical economics becomes untenable for any reason, the Austrians are well placed to provide an alternative religion for believers in the primacy of the market over all other forms of social organization.

The one barrier which stands in the way of today's neocla.s.sical economist trans.m.u.ting into tomorrow's Austrian is the Austrian insistence that there is little, if any, role for mathematics in economic a.n.a.lysis. Because the Austrians believe that all real-world data are generated in a situation of disequilibrium, and because they take seriously the aggregation problems noted in Chapters 2 and 4, Austrians deny that mathematical aggregate a.n.a.lysis has any validity. Faced with a choice between ideology and their beloved equilibrium mathematics, most economists would probably prefer to keep the mathematics. The one way out for neocla.s.sicals would be to embrace the Austrian celebration of capitalism as a dynamic, disequilibrium system, and then model this using chaos and complexity theory. But this leads to the dilemma that such models almost always display 'far from equilibrium' behavior, which undermines the validity of beliefs about capitalism and welfare that depend on the economy not straying too far from equilibrium.

Post-Keynesian economics This school of thought developed in reaction to the 'b.a.s.t.a.r.dization' of Keynes's economics in the so-called Keynesianneocla.s.sical synthesis. Regarding themselves as the true carriers of Keynes's message, they emphasized the importance of uncertainty in economic a.n.a.lysis, and the profound difference between the monetary economy in which we live, and the barter economy which neocla.s.sical economics regards as an adequate proxy for the real world. As Arestis et al. (1999) put it, the main unifying themes in post-Keynesian economics are 'a concern for history, uncertainty, distributional issues, and the importance of political and economic inst.i.tutions in determining the level of activity in an economy.'

Strengths The emphasis upon uncertainty as a fundamental aspect of the real world one which cannot be approximated by risk makes the post-Keynesian approach to economics far more realistic than the neocla.s.sical.

Realism, in fact, is a central methodological emphasis of this school. Though there is no agreed post-Keynesian methodology to rival the hedonistic calculus of the neocla.s.sicals, post-Keynesians are united by their belief that an economic model has to be realistic.

One essential aspect of this is the insistence that a monetary economy is fundamentally different from one in which commodities simply exchange against other commodities. The issues of credit creation, the nature of money, the role of debt, etc., are far more pressing to post-Keynesians than they are to neocla.s.sicals.

Macroeconomics is also a far more important concern. In fact, post-Keynesians reverse the neocla.s.sical pecking order, to argue that whatever microeconomics is developed must be consistent with the observed behavior of the macroeconomy. A microeconomic model which is inconsistent with such things as business cycles, sustained unemployment, commonplace excess capacity, and the importance of credit is to post-Keynesians an invalid model.

Their preferred model of the firm emphasizes monopoly and quasi-monopoly power, decreasing costs of production with increased scale, markup pricing, the compet.i.tive need to sustain excess capacity, and the link between macroeconomic conditions and the firm's investment decisions.

Post-Keynesians are also not hung up on the need to show whether capitalism is a better or worse social system than any other. They are relatively agnostic on the question of what might const.i.tute a better society.

This comparative independence from ideology means that post-Keynesians do not feel compelled, as neocla.s.sicals do, to show that capitalism generates the best welfare outcome for the majority of the people. They are therefore much more comfortable with acknowledging the existence of social cla.s.s in their models something which leading neocla.s.sical economists admit they might have to consider, given the failure of their individualistic approach to explain human behavior.