Marx and Modern Microeconomics

By Samuel Bowles, Research Professor and Director of the Behavioral Sciences Program, Santa Fe Institute. Originally published at VoxEU

Few economists doubt that Marx flunked economics, a judgement mostly based on his labour theory of value. But this column argues that Marx’s representation of the power relationship between capital and labour in the firm is an essential insight for understanding and improving modern capitalism. Indeed, this insight is incorporated into standard principal–agent models of labour and credit markets.

Economists, looking back, have not found much to admire in Karl Marx, the economist, the bicentennial of whose birth we commemorate next month. John Maynard Keynes referred to Capital as “an obsolete economic textbook [that is] not only scientifically erroneous but without interest or application to the modern world” (Keynes 1925). Paul Samuelson’s judgement – “From the viewpoint of pure economic theory, Karl Marx can be regarded as a minor post-Ricardian” – was equally harsh, especially as he thought Ricardo was “the most overrated of economists”(Samuelson 1962).

These assessments are based largely on our current – and correct in my view – understanding of Marx’s labour theory of value as a pioneering, but inconsistent and outdated, attempt at a general equilibrium model of pricing and distribution. But there is another aspect of his work that has been strongly vindicated by theoretical advances in recent decades: the idea that the exercise of power is an essential aspect of the working of the capitalist economy, even in its idealised, perfectly competitive, state.

Domination in Liberal Society

Marx used the labour theory of value to demonstrate that the exploitation of workers is a necessary condition for profits (Yoshihara 2017). The normative term ‘exploitation’ is justified by the claim that profit arises from a system of domination in which the wealthy, as owners of capital goods, direct the activities and limit the choices of employees (Vrousalis 2013). Domination in this sense could be sustained by an autocratic state acting on behalf of a capitalist class, or through the exercise of market power made possible by limited competition in goods markets.

But Marx chose to study a more challenging question: how could the domination of labour by capital take place in a private, perfectly competitive, economy governed by a liberal state? His answer was based on what seems a strikingly modern principal-agent representation of the employer-employee relationship, arising from a conflict of interest over the amount of labour effort performed that could be resolved in an enforceable contract.

Marx stressed that the employer purchases the worker’s time on the labour market, not the worker’s work. The employee’s supply of effort to the production process is not secured by contract but was rather an “extraction” that “only by misuse could … have been called any kind of exchange at all” (Marx 1939).

To stress the distinctive aspect of the labour market, Marx (1867) pointed out that:

“[T]he rise in … wages may … be unaccompanied by any change in the price of labour [meaning effort], or may even be accompanied by a fall in the latter.”

The important consequence for the worker, “be his payment high or low,” was “domination and exploitation” and “a form of despotism more hateful for its meanness” (ibid).

The final step in Marx’s explanation of domination in a liberal capitalist economy was the process of accumulation and technical change that supports a permanent “reserve army” (ibid) of the unemployed, and which provides the basis of the employer’s labour discipline strategy. The private ownership of the means of production conveys the right to exclude others from use of the firm’s assets, and therefore the owners of firms have a powerful threat to induce workers to supply the effort that could not be secured by contract: work hard, or join the “reserve army”.

The Politics of Production

Marx did not explain why the labour contract was incomplete. He assumed this was an uncontroversial empirical observation and used it as the starting point for his economic theory. In this, he resembles Charles Darwin who advanced a powerful theory of natural selection without an understanding of the mechanism by which it occurred. Genetic inheritance would later be explained by Gregor Mendel.

Just as Mendel underpinned Darwin, a more complete understanding of the incomplete labour contract developed in the twentieth century, but did not overturn Marx’s conclusions. Like Marx, Ronald Coase (1937) stressed the central role of authority in the firm’s contractual relations:

“[N]ote the character of the contract into which a factor enters that is employed within a firm …[T]he factor … for certain remuneration agrees to obey the directions of the entrepreneur.”

Indeed, Coase defined the firm by its political structure:

“If a workman moves from department Y to department X, he does not go because of a change in prices but because he is ordered to do so … the distinguishing mark of the firm is the suppression of the price mechanism.” (ibid)

Herbert Simon provided the first Coasean model of the firm (Simon 1951). He represented the employment contract as an exchange in which the employees transfer control rights over their work tasks to the employer, in return for a wage. Simon stressed the advantage to the employer of this arrangement, because there was unavoidable uncertainty about the tasks that would be required over the course of the contract. Therefore there was a high cost of agreeing to a complete contractual specification of the activities to be performed. Simon did not know that he was modelling exactly the incomplete contract for labour that was the fulcrum of Marx’s economic theory.

Coase or Simon did not directly explain why control rights confer power. As an empirical matter, the firm appears to be a political institution in the sense that some members of the firm routinely give commands with the expectation that they will be obeyed, while others are constrained to follow these commands. If we say that the manager has the right to decide what the worker will do, this means only that the manager has the legitimate authority, not the power to secure compliance. Given that, in a liberal society, the manager is restricted in the kinds of punishment that can be inflicted, and given that the employee is free to leave, it is a puzzle that orders are typically obeyed.

Noticing this, Armen Alchian and Harold Demsetz challenged the Coasean idea that the firm is a mini “command economy”, suggesting that the employment contract is no different in this respect from other contracts:

“The firm … has no power of fiat, no authority, no disciplinary action any different in the slightest degree from ordinary market contracting between any two people … Wherein then is the relationship between a grocer and his employee different from that between a grocer and his customer?” (Alchian and Demsetz 1972)

Oliver Hart (1989) responded:

‘[T]he reason that an employee is likely to be more responsive to what his employer wants than a grocer is that the employer … can deprive the employee of the assets he works with and hire another employee to work with these assets, while the customer can only deprive the grocer of his customer and as long as the customer is small, it is presumably not very difficult for the grocer to find another customer.”

The Exercise of Power

This explanation requires a demonstration that power – in some well-defined sense – can be exercised by employers over employees in the equilibrium of a competitive economy. It is nevertheless puzzling that power is exercised in a competitive economy, in which each actor engages voluntarily in exchanges, from which each is equally free to walk away.

The following sufficient condition for the exercise of power captures the central features of Marx’s (1867) representation of the “despotism” of the workplace:

For B to have power over A, it sufficient that, by imposing or threatening to impose sanctions on A, B is capable of affecting A’s actions in ways that further B’s interests, while A lacks this capacity with respect to B. (Bowles and Gintis 1992)

The definition clarifies the difference between the employer and the grocer in Hart’s response to Alchian and Demsetz. The sanctions imposed on the employee by depriving that employee access to the capital good are severe (technically, first order), while those imposed on the grocer by the departing customer are negligible or zero (second order). The disgruntled consumer who walks out the door does not impose a sanction on the grocer because the grocer (in competitive equilibrium) was maximising profits by selecting a level of sales that equates marginal cost to the exogenously given price. A small variation in sales has only a second-order effect on profits. But this is not the case for the employer-employee relationship. This is because involuntary unemployment is a characteristic of the competitive equilibrium of a market in which labour effort is not covered in an enforceable contract(Bowles 1985, Gintis and Ishikawa 1987, Shapiro and Stiglitz 1985). The employer’s threat to terminate the worker’s position wouldthus impose a first-order cost on the worker. This is the basis of the exercise of power by employers.

The incomplete nature of the labour contract is therefore essential to showing both why the employer’s power over the worker is essential to profit-making, and also how it can be sustained by equilibrium unemployment. Marx understood the first but not the second, providing instead a dynamic (and not entirely convincing) account of how the reserve army would be sustained in the long run.

Microeconomist or Precursor to Modern Micro?

Marx was a pioneer in the study of principal-agent relationships, though of course he did not use the term. Principal-agent models now form the microeconomic foundation for the study of relationships among classes (though economists do not use that term) in capitalist and other economies, for example the standard treatments of the exchanges between employer and employee, or between lender and borrower. These models are essential to current analysis of workaday economic problems such as the cyclical patterns in wage-setting and productivity, and the quantity constraints that borrowers face in credit markets. Both of these problems have substantial microeconomic importance, but are also important foundations of macroeconomics.

Marx was a visionary precursor of modern microeconomics, and modern microeconomics has repaid him the favour by clarifying the limits of some of his most important ideas. Among them the labour theory of value as a representation of a general system of exchange (Morishima 1973, 1974), and his “theory of the tendency of the profit rate to fall” (Bowles 1981, Okishio 1961). As Michio Morishima (1974) pointed out, Marx did not resolve the outstanding theoretical problems of his day, but rather anticipated problems that would later be addressed mathematically.

Modern public economics, mechanism design and public choice theory has also challenged the notion – common among many latter-day Marxists, though not originating with Marx himself – that economic governance without private property and markets could be a viable system of economic governance.

Political and Economic Problems

In 1972 Abba Lerner astutely identified one of the limits of the neoclassical paradigm. A contract transforms “a political problem into an economic problem. An economic transaction is a solved political problem … Economics has gained the title Queen of the Social Sciences by choosing solved political problems as its domain.” (Lerner 1972)

Whether this is a feature or a bug depends on your point of view. The Queen’s domain has not seemed too cramped because the same paradigm provided a reason to think that unsolved “political problems”, such as the incomplete nature of the labour contract, or the exercise of power byemployers over workers, were illusions. Joseph Schumpeter made this point: “What distinguishes directing and directed labour appears at first sight to be very fundamental,” he wrote. But, he argued, in reality the difference “constitutes no essential economic distinction … the conduct of the former is subject to the same rules as that of the latter … and to establish this regularity … is a fundamental task of economic theory.” (Schumpeter 1934)

Why, one wonders, would Schumpeter consider this point to be of such exceptional importance? The answer is that if Marx’s despotism of the workplace is real, then the liberal argument against economic democracy – there’s nothing there to democratise – is false.

Editors’ note: This column is based on a larger work of the same title to be published in Japanese in a special issue of Keizai Seminar, edited by Naoki Yoshihara. 

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  1. Bob Haugen

    I don’t understand why the opinions of capitalist economists on Marx should be taken as automatically valid. Especially when the remainder of the article seems to say that Marx was correct, with only an unsupported potshot about the labor theory of value in the opening paragraphs.

    1. YankeeFrank

      Agreed. Just the other day I was watching a cartoon from the 1950’s created to espouse the marvels of capitalism and they discussed how the raw materials to make a car cost $22 (in 1950’s dollars) if the labor costs involved in extracting, transporting and refining the materials was removed. When labor was added back in, the cost was, as I recall, $1600. The profit to the car manufacturer was $56. It seems to me an uncontroversial statement that in a non-monopoly/oligopoly economy (in other words, in an economy other than the one we currently live by) the prices on offer should be based on the actual cost to produce, and not on what customers are “willing” to pay. Exceptions exist — as the current iphone X fiasco shows that very process of reversion to the mean when the “ooh-amazing” is replaced with “wait, how much is that thing?” — but their existence proves the rule.

      But then again, this is a group of “thinkers” that took over a 100 years to figure out the difference between and employer/employee relationship and a grocer/customer one.

    2. thoughtafter

      Clearly the author was pandering to the true believers, who (sans those paragraphs) would likely place him on a watch list.

      *calls fbi*…

    3. Ape

      And he indirectly says that there is something to the labor theory by saying that the employee contract is incomplete by not reflecting the labor effort involved.

      There’s some sophisticated bs between important people here.

  2. MisterMr

    “These assessments are based largely on our current – and correct in my view – understanding of Marx’s labour theory of value as a pioneering, but inconsistent and outdated, attempt at a general equilibrium model of pricing and distribution.”

    I just skimmed this article but I want to respond to this.

    >disclaimer: not an economist but I did read a lot of Marx and take Marx’s economic theories very seriously, I think he was much more scientific than he is generally credited for.<

    The labour theory of value is really Marx's theory of pricing, although it has various "epicicles", like the coefficients due to different "organic composition of labour" (aka different capital intensity) across sectors.

    In contast, the current theory of pricing is, as far as I understand, marshallian theory of marginalism.

    At best of my understanding, the sole difference between the LTV and the marginalist theory is that the marginalist theory assumes a fixed wage share, whereas the LTV doesn't, the wage share could change mantaining the same structure of production. Sraffa's model is basically a more mathematically complex variant of the LTV, and Sraffa believed that the wage share depended on political causes exogenous from the market; Marx simply assumed that these exogenous political factors were always at the disadvantage of the workers so he assumed that workers would be always paid subsistence wages.

    Today the question "what determines the wage share" (that is the most important determinant of inequality) is very important, and I think that many people, including economists, do not really believe in the fixed natural wage share that is assumed by Marshallian economics.

    But if you don't believe this, in practice you end up in a (variant of) the labour theory of value, because you still have to assume a tendency to equalistion of wages and of profits, and with a variable wage share you can't define the labour/capital ratio as the ratio of capital to wages, but only as the ratio of capital/output, thus you have to think in terms of average output per worker (including the part that ends up as profits), and this is basically the LTV.

    So in pratice most people, and many economists when they don't stick too much with the dubious assumptions of Marshallian equilibrium, think in terms of an LTV, even if they don't realize this.

    Also, actually there are various empirical studies about the LTV (that is, about the correlation between the price of goods and the calculated "total labour time" used to produce them) and all these studies show some correlation between the two (in the case of Anwar Shaik, up to 90% correlation).
    On the other hand, I know of no empirical study that can show that wages correspon to the marginal productivity of workers, IMHO because that is an axiom of Marshallian economic and therefore cannot really be proved.
    While the empirical studies on the LTV are not enough to declere it "empirically proven", it still beats Marshallian economics.

    Finally, "exploitation" in Marx's economics means (share of profit)/(wage share), therefore as long as profits are positive by definiton "exploitation" is positive. If we wre to have a version of capitalism where capitalists don't "exploit" workers, we would have a version of capitalism where the average rate of profit is 0%, that of course is problematic.

    1. Katsue

      The idea that wages correspond to the marginal productivity of workers is almost trivially false in the case of an employer that pays all employees of the same grade the same wage.

      1. Amfortas the Hippie

        If that employer so misuses his employees that they all go away, and spread word of his perfidy far and wide, so that he can gain no others…I’m sure those employees he no longer has might seem rather more valuable to him, as he stares at his idle plant.
        workers are undervalued, until they are absent/unobtainable.

          1. Amfortas the Hippie

            Aye. I was shocked to learn…only last month…that Texas had outlawed teacher strikes….I knew they were verboten, but I didn’t know they had passed a law taking away one’s pension and teacher certification.
            That’s just rude.
            I think that american unionism made a mistake, way back when, rejecting the Wobbly style for the more corporate afl-cio style of “lets get in the big bed”ism.
            here in Texas, most folks I know don’t know what a union is…beyond “bad” and “thugs”.(there are trade unions in Texas(electricians, welders, etc) but I am far removed from all that).
            in my feedstore symposia, I give the example of the chamber of commerce, down on the square, as a business union, and ask…well, if the bosses can get together for common causes, why can’t the workers?
            so far, this has only engendered nervous shuffling, but I have hopes that seeds have been planted. there’s a not so long ago history out here of farmer’s co-ops and the Grange, but this set of issues doesn’t come up enough in that setting to really dig in.

      2. anonymous II you

        Also consider that firms pay for labor based on what they think they can afford (in terms of drawing from freely available funds) for the help needed, what other firms are paying and, through trial and error, what inducement is involved to keep employees satisfied and loyal (to the extent that can be determined). Nothing to do with “Oh yes, let’s see, our calculations show that the marginal rate of return on hiring another employee is X”. In fact, in customer service, the drive I have discovered is to keep as few people answering the phones as can be possibly done to slog through to the end of the day. Management these days is giving up on servicing customers with a meaningful response to inquires, solutions to problems and general information about products.

        In addition consider say an accountant working in a small partnership for about $38K/yr. So looking in the ads one day he sees a major enterprise offers $46k/yr for entry level accountants. Is his time at the partnership really that much less valuable than time spent at the enterprise outfit and that corresponds to his being marginally that much more productive at one firm vs that at another?

  3. Summer

    Was government compensation to capitalists for hiring people a big part of the economy in the 19th century?

    Is that the main reason official slavery is not currently desired as much by capitalists?
    Other than they hope and expect more robo-slaves to be ready for prime time?

    1. YankeeFrank

      Oh they desire slaves alright. They just don’t want to provide room and board for them as in the case of prison labor. They’d try to turn us all into slaves tomorrow if they could do so cheaper than the minimum wage.

      1. doug

        The slave thing is in play from what I learned after reading about mechanical turks in a comment here a day or two ago…

      2. Lambert Strether

        > Oh they desire slaves alright. They just don’t want to provide room and board for them as in the case of prison labor

        One word: Robots.

        Well, two: Robots and AI.

        “Innovative slavery” we might call them. Disruptive.

    2. Someone

      Well, both Communists and Capitalists desire slaves.
      Communists to forcibly produce results to validate themselves and maintain an illusion of utopia and progress, Capitalists because they are Capitalists and it is a profitable notion.
      Ones based on deceit, others based on nature.
      The only sad thing in this whole clash of religions is that people assume the only way to be anti-Capitalist is to adopt Communism, and the only way to be anti-Communist is to adopt Capitalism, and both Capitalists and Communist ironically roleplay moral righteousness on the sole concept of being anti-Fascist as the main chant which isn’t exactly a concept that gives value but merely paints a competition dress in a different color. Value needs to come from the inside, and both have failed in their own ways (Communism far worse in the long-run though).

      1. Summer

        Neither are “natural.” It’s all Artificial Selection.

        Still doesn’t answer the questions.
        Just jumps to a deflection.
        The questions are about capitalism. That’s where the spotlight is.

      2. Darius

        A state of nature is hunting and gathering and a population about a 500th of current. It’s pointless to talk about natural relationships in a modern global state.

          1. StephenVerchinski

            Why it has collapsed around its ears. It ignores ecology.

            The grocer eventually will find nothing to sell and the worker, nothing to work for. Same goes for the political structures. Promises cannot be filled with any desired goods stocked anymore and empty promises do not fill the belly.

    1. Amfortas the Hippie

      Guy under the tree looks under the hood:’well…there’s yer problem, right there”
      To wit:”…the working of the capitalist economy, even in its idealised, perfectly competitive, state…. “

      It’s the Models that are screwed up, here…as well as the constant tendency to mistake the map for the terrain.
      As for the argument right here: well…it’s hard to quantify the feeling one gets when the bossman says “nope…i can’t afford to give you a raise” as he steps on to his luxury yacht and sails off to the Caribbean.
      ”If we say that the manager has the right to decide what the worker will do, this means only that the manager has the legitimate authority, not the power to secure compliance. Given that, in a liberal society, the manager is restricted in the kinds of punishment that can be inflicted, and given that the employee is free to leave, it is a puzzle that orders are typically obeyed. “

      I felt like I was in heaven during the late clinton era, when I could Fire my Boss and walk across the street and obtain an equally shitty restaurant job. At one of those, when sixth street in austin was closed for a street party, my boss at the time stopped me in my running, and gave me a beer, and poured himself one, and we watched the chaos all around us. He said:” the difference between you and me is that you have to be told when to have a beer…I decide when.”
      I challenge anyone to quantify that particular relationship.
      It’s not like this is all that hard to understand,lol.
      I have long recommended that graduate students in econ or MBA be required to spend a winter in a trailer park in deep east texas…a suitable hellhole is readily available…on food stamps and handyman’s wages.
      Then we might see some changes.

      Eat the damned rich.
      I advise a more vinegary sauce.

  4. larry

    Steve Keen, in his Debunking Economics and elsewhere, argues that Marx’s labour theory of value is false.

    1. Disturbed Voter

      You can valued things, or value people, not both. Humanism values people, materialism values things. It behoves materialists to convince humanists to work against their own interests, hence the devil’s bargain of wage/debt slavery and consumerism.

    2. hemeantwell

      I won’t try to summarize his argument here, but Anwar Shaikh, in his recent Capitalism: Conflict, Competition and Crises, argues that the LTV is “empirically strong.”
      a pdf is linked.

      John Grahl recently reviewed the book at New Left Review. He recommends it highly.

      1. Susan the other

        Thank you for John Grahl’s review. Order within turbulence. Kinda like string theory. There are basic questions that go unanswered tho’. No mention of exploitation of the environment and serious over-capacity. But half way down he mentions MMT – interesting. His analysis (or Shaikh’s?) was the standard criticism that if Gov and CB are the same entity (the word ‘sovereign’ might have been a better choice) then gov should be the employer of last resort (yes with a JG program) “MMT makes implausible assumptions against theories of inflation and tight labor causing inflation” (this is untrue – employment actually keeps modern capitalism alive)… because over-supply brings prices down too far causing profits to disappear and firms to close down which brings demand back. The balancing act of the hidden hand under laissez faire rules. So Shaikh thinks that social practice eventually finds the fair balance. But that is the problem, isn’t it. Boom and bust, wealth and crisis. So Marx’s theory of the value of labor holds up because demand is essential to capitalism. How very ironic. Fairness. And MMT is a very coherent theory after all because it advocates a Jobs Guarantee program for “stability”. And trying to find some grand unifying theory of micro and macro is just an avoidance – all it does is emphasize that there is enough of a time lag in new competition’s profit years to keep capitalism alive. Which really is not the point at all anymore.

    3. Grebo

      Marxists/Marxians can’t even agree what Marx’s theory of value was. I suspect a lot of non-Marxists would disagree about why he was wrong too.

      Steve Keen’s position seem to be that the Ricardian theory used by Marx in the early chapters of Volume 1 is wrong but that he moved on to something better.

      I struggle to understand what use a theory of value is.

  5. diptherio

    Here’s my own take on what constitutes the “essential economic distinction” between laborers and employers:

    I conceptualize the labor contract as a species of modified, repeated ultimatum game. Here are a couple of insights (or at least I think they are) gained from such a conceptualization:

    In the standard version of the ultimatum game, both players are aware of the full amount being divided. This informational symmetry has obvious implications for the outcome of the game. If I am in the position of player two, i.e. I have to decide whether to accept or reject the offer, and I know that the ten dollars being offered to me is only 10% of the total amount at stake, I may reject the offer to punish my opponent/partner for their unfairness. However, if I am offered the ten dollars without knowing the full amount in play, i.e. without knowing whether my opponent/partner was given $20 or $1000 to divide, I will be more likely to accept it, since I cannot judge the “fairness” of the deal.

    As with the Efficient Market Hypothesis, real world informational asymmetry turns out to be important.

    …unlike the usual ultimatum game experiment, players in the labor market ultimatum game play repeatedly…while in the search mode…The manner in which this repetition is performed differs for employers and employees. While employees tend to entertain employment offers sequentially (one at a time), employers generally make their offers in batches, interviewing many candidates for a position and selecting from a group of interested individuals. This makes “comparison shopping” easier for employers than for employees and thus serves as another advantage for employers (although this might not be the case in a tight labor market).

    Another disadvantage faced by employees is that difficulty in comparing different wage and benefit packages (if one is lucky enough to have multiple options). Suppose a worker is offered three jobs: one with a relatively high wage but no health benefits and inconvenient hours, a second with some health benefits but a lower wage, and a third with an even lower wage but full health coverage and convenient hours. How is the worker to estimate the relative values of the different health plans, or determine how to weigh wages and benefits against being available for family members, friends and children?…

    Employers, however, do not face this conundrum, since they are the ones structuring the offers. If an employer cannot find any takers for a given wage and benefit package, they can simply increase the wage by a given amount and try another iteration. Once again, we find that informational asymmetries inherent in the structure of the game tend to favor employers over employees.

    So, at least to my mind, the essential economic distinctions are clear, and important. I wonder why economists like Schumpeter would be so keen to obfuscate that point? Weird….

    1. Grebo

      It’s not just information, it is power. Even if the employee knows the size of the surplus he must accept the employer’s cut or go hungry. The idea that employees can just shop around for a better offer is not a feature of real Capitalism for most workers.

      The Capitalist is always player one. That is the essential economic distinction.

      It is the orthodox economist’s job to obscure the power imbalance so as to portray Capitalism as fair and equitable.

  6. David May

    Employment contracts are used to make everything legally nice and hide the reality that a starving person is a virtual slave to a prospective “employer” offering bread.

    From the article The Libertarian Con: Favorite ‘Rebel’ Ideology of the Ruling Class

    Most American adults spend about half their waking hours at a job. And during that time, libertarians do not give a flying fuck about your liberty. Instead, they condone the most brutal of tyrannies all in the name of a private employer’s freedom.

    Racial discrimination, verbal abuse, random drug testing, body-searches, sexual harassment, illegal termination, email monitoring, union busting, even withholding piss-breaks–ask any libertarian how they feel about workplace unfreedom and they’ll tell you: “Hey man, if you don’t like it, you have the freedom to get another job.” If folks are hiring. But with four-and-a-half applicants for every job, they’re probably not.

    1. Larry Motuz


      The power of the employer lies in being able to fire the employee for any cause, with ’cause’ defined very broadly if defined at all. This power deprives the employee of the primary monetary means to retain an established standard of living (including, in the U.S., health insurance) and, at least some of the time, the ability to afford even the basics essential to subsistence overall.

      In a monetary economy, power over workers is primarily the power to deprive them of a livelihood they need to maintain or sustain themselves.

      If workers ‘have to consume’ just to survive — and to deny this is to deny that workers are human beings with biological and other needs — only then could we say that work contracts are completely voluntary. In a monetary system, however, they are a necessity unless one has wealth or significant income from other sources.

      As for economies in labor market equilibrium, there is no such real world thing, so I will not address that as theory.

  7. cripes

    “he idea that the exercise of power is an essential aspect of the working of the capitalist economy, even in its idealised, perfectly competitive, state.”

    I believe Marx called this political economy, which is denied by the geniuses of (always wrong) modern economics in their endless quest to prove the invisible hand of the market even as it slaps you in the face.

    1. Summer

      They call it the “invisible hand” to preclude people from thinking about the very visible bodies that hands are attached to.

  8. Jesper

    I did a search, there is not a single instance of the word ‘collective’ as in collective bargaining anywhere. For many, if not most, workers, it makes sense to vote for a government that protects workers and to be part of a larger group doing collective bargaining. Is micro down to analysing one worker at a time without allowing for the fact that legislation and unions can set the framework for an agreement?
    Or maybe they’re doing something surprising and actually looking at reality: governments are now representing companies (and the economy) over workers/citizens?


    Couldn’t one levy this criticism against just about every school/philosopher of economic thought in the 19th and early 20th century? Classical economics has gone through several transformations over the centuries, Keynesian economics underwent a massive revision in the wake of the stagflation of the late 1970’s. If we’re going to judge those schools by modern thinking and writing in the schools, and not what Smith and Ricardo and Keynes wrote long ago, then why not judge Marxist thought by the same measure, especially the changes in the wake of the fall of the USSR?

    1. Yves Smith Post author

      FWIW, “Keynesian” economics is a distortion of Keynes. Paul Samuelson turned it into a special case of neoclassical economics by rejecting Keynes’ fundamental observation that economies are inherently unstable. Both neoclassical economics and what might better be called American Keynesianism assume that economies have a natural propensity to equilibrium, and at full employment, no less!

      1. Lambert Strether

        > American Keynesianism assume that economies have a natural propensity to equilibrium, and at full employment, no less!

        I keep saying “We don’t know anything,” but that leaves out the important case where what we “know” is 100% false.

        1. skippy

          IS-LM and the dreaded equilibrium.

          • Contrary to the loanable funds theory, finance in the world of Keynes and Minsky precedes investment and saving. Highlighting the loanable funds fallacy, Keynes wrote in “The Process of Capital Formation” (1939):

          Increased investment will always be accompanied by increased saving, but it can never be preceded by it. Dishoarding and credit expansion provides not an alternative to increased saving, but a necessary preparation for it. It is the parent, not the twin, of increased saving.

          What is ‘forgotten’ in the loanable funds theory, is the insight that finance — in all its different shapes — has its own dimension, and if taken seriously, its effect on an analysis must modify the whole theoretical system and not just be added as an unsystematic appendage. Finance is fundamental to our understanding of modern economies, and acting like the baker’s apprentice who, having forgotten to add yeast to the dough, throws it into the oven afterwards, simply isn’t enough.

          All real economic activities nowadays depend on a functioning financial machinery. But institutional arrangements, states of confidence, fundamental uncertainties, asymmetric expectations, the banking system, financial intermediation, loan granting processes, default risks, liquidity constraints, aggregate debt, cash flow fluctuations, etc., etc. — things that play decisive roles in channelling money/savings/credit — are more or less left in the dark in modern formalizations of the loanable funds theory. – snip

          Not to mention through all the chaff they were sneaky and slid in atomistic individualism like a back door – Mirowski and Syll both denote this imo.

    2. Bobby Gladd

      “An economist is someone who sees something that works in practice and tries to figure out whether it’ll work in theory.” — Medical Economist JD Kleinke

      1. john c. halasz

        Kalecki reportedly once said that he at last understood what economics is all about; it’s about confusing stocks and flows!

      2. Larry Motuz

        Astute, and largely true.

        Most blackboard economists will then assert that, since it does not work in theory, the practice is a deviation from market efficiency and thus to be deplored.

  10. digi_owl

    The whole labor theory of value seems to have come about as a way to more strongly argue for labor rights (or even labor control of production).

    That said, mostly the problem stems from the kind of mental gymnastics Marx seems to perform to downplay the role of machinery in production. This perhaps because the idea of an amplifier was not as understood in the 1800s.

    Because of one approach machinery as a labor amplifier rather than a store of labor, things gets interesting. It shows the importance of machinery in industry, while at the same time demonstrates that without an ongoing input of human labor (to feed or operate the machinery) the machinery is just so much dead weight.

    1. Lambert Strether

      I don’t think that’s the case. From my vaguely remembered reading of Capital, Marx is trying to solve the problem of what makes goods commensurable such that they can be exchanged in appropriate ratios.

      That which would make them commensurable is “value,” and his answer is the LTV.

      It’s a hard problem….

  11. Katy

    Given that, in a liberal society, the manager is restricted in the kinds of punishment that can be inflicted, and given that the employee is free to leave, it is a puzzle that orders are typically obeyed.

    Didn’t the author literally give us the answer to this supposed “puzzle” just a few paragraphs earlier???:

    The private ownership of the means of production conveys the right to exclude others from use of the firm’s assets, and therefore the owners of firms have a powerful threat to induce workers to supply the effort that could not be secured by contract: work hard, or join the “reserve army”.

    Employees do anything and everything that the employers ask because the employer holds all the power.

    Capitalism isn’t about money; it’s about power. (As I understand it, the author here does acknowledge the power relationship.) But the author’s fatal flaw is that the employee is not free to walk away.

    If Capitalists were interested in optimizing their wealth, they would debate questions such as “does laying off employees really contribute to our company’s long-term growth instead of short-term profit?” Or “does building robots really offset the cost of labor in the long term?” As far as I am aware, Capitalists take all of these for granted. This serves them by maintaining the power structure inherent when employees allow themselves to be treated like slaves.

    The thing that infuriates me about antitrust law* is that, as originally applied, the antitrust laws weren’t aimed at reducing consumer prices, they were intended to rein in power of firms.

    Once that went away, we get Google and Amazon and Facebook, who gobble up their competitors, thus consolidating power.

    *I know things about economics only through the lens of what I have learned about antitrust law.

  12. chuck roast

    As I recall, Adam Smith, Ricardo, Jerry Bentham and all that lot were Political Economists. That is to say they understood that the socio-political realm was intimately intertwined with the world of markets, and the one could not be understood without attempting to explain the other. Marx took the labor theory of value from all of these early thinkers and had the audacity to posit that the laborer was not some happy camper who voluntarily provided input into the manufacturing process. Labor was largely a coerced factor of production from whom surplus value was stolen. Marx the classicist simply stood the Classical School on its head. What was to be done?
    Well, let’s just ignore the hellish condition of the Elizabethan working schlub and dabble in the lovely little models of Leon Walras and Alfred Marshall. What could be more fascinating than spinning ever more Ptolemaic epicycles. No discussion of inconvenient truths like Enclosures, Corn Laws, work houses, etc. They simply don’t fit in to our fascinating academic discussions. We can make this little world even more perfect if we give it a name…Microeconomics…how perfect. There is always “full employment” in our little world! And as a bonus, it’s “value free.”! We sent all the idiots who want to discuss value laden issues to there own little world of Political Science…”Science”, ha, ha, ha!
    We, of course, are the true scientists. Why at my old alma mater you can get two (yes, two!) Bachelor of Science degrees in Economics.
    It’s a wonderful world indeed.

  13. Roland

    The mistake made by most capitalist critiques of Marx is that they fail to realize that Marx’ microeconomic theory was merely a retrofit to his historical dialectic of class struggle. Marx’ historical theory predates his microeconomic theory, and is not dependent upon it.

    Marxist theory of classes based on control of the means of production, and his dialectic of class struggle, have held up rather well since 1849. When I read the Communist Manifesto today, I find it full of contemporary relevance.

    The mid-20th century welfare state phenomenon was the only thing that ever really threatened to disprove Marx’ ideas about capitalism. Mind you, Marx had actually entertained the notion of capitalist welfare states in the Communist Manifesto, under the heading, “Bourgeois Socialism.” It took him only one page to dismiss it as a contradiction that could never endure.

  14. Lambert Strether

    A bit off topic, but Marx on the Civil War is interesting, too. For example:

    The question of the principle of the American Civil War is answered by the battle slogan with which the
    South broke the peace. Stephens, the Vice-President of the Southern Confederacy, declared in the
    Secession Congress that what essentially distinguished the Constitution newly hatched at Montgomery
    from the Constitution of Washington and Jefferson was that now for the first time slavery was recognised
    as an institution good in itself, and as the foundation of the whole state edifice, whereas the revolutionary
    fathers, men steeped in the prejudices of the eighteenth century, had treated slavery as an evil imported
    from England and to be eliminated in the course of time. Another matador of the South, Mr. Spratt, cried
    out: “For us it is a question of founding a great slave republic.” If, therefore, it was indeed only in
    defence of the Union that the North drew the sword, had not the South already declared that the
    continuance of slavery was no longer compatible with the continuance of the Union?

    It’s also interesting to see “Lost Cause” ideology (“The war was about tarriffs!”) putting down roots even before Fort Sumter.

    (Marx also writes that slavery was dependent on “naturally fertile soil, which requires only simple labour.” I’m not sure that’s correct, for two reasons: (1) breeding slaves (especially in Virginia) was a business in an of itself, and (2) I believe that Edward Baptist has shown that “simple labour” is a misnomer. It is true that in the slave state capital was invested in human bodies; but the means for extracting value from those bodies were not necessarily “simple”).

  15. Kenneth

    I loved this piece! Very illuminating. It reminded of why I love naked capitalism. Keep going!

    As a side, its intriguing how questions of power are now being asked in economics now that the west is in dire straits when previously the mainstream econ profession couldn’t care less.

  16. Steve Ruis

    Yada, yada, yada … I hate to break it to you, but civilization is based upon a supply of cheap labor. Slavery, for example, was barely known until we became civilized and then it became a major industry.

    The problem facing “modern economics” is dealing with this fact, yet most economists are still arguing about how many angels can dance on the head of pin from Adam Smith’s pin manufacturery. The basic problem with capitalism is our economic culture is currently “pay-as-you-go,” if you want something, you must pay for it. Our motto is TANSTAAFL, which if you are not read up on Robert Heinlein, means “there ain’t no such thing as a free lunch.”

    So, in our culture there is a line we could label “Ability to Pay” that goes from zero to as near to infinity as any of us can conceive of. At the “zero end” there are people who have no job, no housing, no money, no food and live via begging and theft. At the other end we have people who make more than a billion U.S. dollars a year, which means that if they to work ordinary work hours and take ordinary holidays, they would be “making” $532,000 per hour … for the whole year. That would be to make “just” $1 billion; some make more. To put that in perspective, in my 40 years of work as a teacher, I made $2 million, which these people would make in one afternoon (knocking off early if they wished).

    An economic system that is in accordance with humane values would have to have both ends of this line truncated. At the bottom end, everyone would have shelter and food to eat and a reasonable amount of medical care. If people with shelter and enough to eat, couldn’t improve their lot in a fair system (not rigged as our current system is with Right to Work laws and tax breaks for wealthy people, etc.) then that would be their lot in life. At the high end, income tax brackets need to keep going and approach 100% at some point because in our culture money is power and that much power being vested in individuals is not healthy for society. For example, Walmart could double to wages of its employees and the owners would still make billions in profits every year. Or they could donate those “extra” profits to charities, to avoid very high tax loads, etc. The additional taxes collected would go to providing the “economic floor” so needed by the poorest among us.

    Currently capitalism is the preferred system of the rich for extracting cheap labor from the masses of people. Civilization was built upon cheap labor, but we are now smart enough to at least share the wealth more equitably instead of using our political system to leverage economic power for the benefit of the elites.

  17. Haldon C. Sutton

    The labor theory of value was originally elucidated by Adam Smith. In building upon the work of Adam Smith, Marx explained two fundamental quandaries that confronted the widely acknowledged father of the study of capitalist economics: the source of profits, and the tendency for the rate of profit to fall.

    In enunciating the concept of surplus value, Marx elucidated the source of profits under the capitalist mode of production. Those who contend that the value of labor power is not a subsistence wage, and who dispute the validity of the labor theory of value confound the value of commodities, which is determined by the human effort necessary to produce commodities, measured in terms of the time of necessary labor, with the price of commodities, which is determined by the market mechanism of supply and demand.

    The value of labor power, the bottom line so to speak, is indeed the amount of human effort necessary to sustain the worker and his family, or the working class as a whole. The price of labor power, which is determined by supply and demand, is also the source of the economic class struggle, as workers seek to extend their share of surplus value that is returned to them in the form of their wages, and employers seek to drive the price of labor power as close to the level of subsistence as they can. In many third world nations, the price of labor power is driven below the level of subsistence, a phenomenon known as superexploitation that Engels observed in England, and Marx contended was the driving force for the reform movement within Parliament that was led by such utilitarians as John Stewart Mill.

    The second quandary that confronted the Adam Smith, the tendency for the rate of profit to fall, is also the “seed of destruction” contained within the capitalist mode of production — its Achilles heel, that also elaborates upon Marx’ contention in the Communist Manifesto that all preceding history is comprised of the struggle of classes that either leads to the revolutionary transformation of society or the common ruin of all of society — a dire prospect for humanity under the domination of the capitalist mode of production in the Thermonuclear Age.

    In Chapter 13 of Volume Three of Capital, Marx explains that the technological development of the means of production tends to undermine the rate of profit — the return that capitalists realize from their investment outlay for the production of commodities. The labor theory of value is central to this concept, which contends that as a greater proportion of the investment outlay is devoted to constant capital — fixed capital that is invested in plant and machinery as well as investment in raw materials, the lower the rate of profit that can be realized. This is the case because variable capital, or the investment in labor power, is the source of profits, which would tend to cause the rate of profit to fall as the proportion of the investment in variable capital tends to fall. Marx’s explanation of the falling rate of profit explains why capitalists have been tending to shift production to Third World countries, where productivity is lower, but production is labor intensive at subsistence wages — or lower.

    Chapter 13 of Volume Three of Capital is followed by Chapter 14, wherein Marx provides an extensive list of measures that capitalists undertake in order to overcome the tendency for the rate of profit to fall. The synthesis of the two chapters could be articulated as a contention that capitalists are constantly driven to expand their markets in order to avoid a fundamental economic crisis such as occurred during the first half of the twentieth century. This compulsion to overcome the tendency for the rate of profit to fall could also be described — and was so by Kautsky as well as by Lenin — as the primary driving force toward capitalist imperialism , which has resulted in two catastrophic world wars during the first half of the twentieth century, resulting in the advent of nuclear weapons — a brace of conflicts between British and German imperialism that only was settled by the emergence of the hitherto unassailable hegemony of the United States among the imperialist nations.

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