Capital in the broad classical approach
The notion of capital and its treatment in the theory of value and distribution has always been a challenging and still remains an open issue since the time of the Physiocrats. To trace out this concept historically, we start with the father of political economy Adam Smith (1723—1790), who by “capital goods” denotes both, physical capital and social relations, which are combined to produce output within a specific economic system. Smith (1776) notes,
The annual produce of the land and labor of any nation can be increased in its value by no other means, but by increasing either the number of its productive laborers, or the productive powers of those laborers who had before been employed. The number of productive laborers, it is evident, can never be much increased, but in consequence of an increase of capital, or of the funds destined for maintaining them. The productive powers of the same number of laborers cannot be increased, but in consequence either of some addition and improvement to those machines and instruments which facilitate and abridge labor; or of a more proper division and distribution of employment. In either case the additional capital is almost always required. It is by means of an additional capital only that the undertaker of any work can either provide his workmen with better machinery, or make a more proper distribution of employment among them.
(Wealth, p. 114, italics added)
that part of man’s stock |=capital] which he expects to afford him revenue.
(Wealth, p. 363)
It is interesting to note that Smith’s usage of the word “capital” (or stock) is not limited to physical objects and does not apply to all societies. Smith is categorical when he notices that there is no capital in societies that are not characterized by a systematic division of labor (Wealth, p. 267). Systematic division of labor is only possible with additional capital, and that requires strong profit motivation existing regularly only in modern society, that is, in the emerging out of feudalism, capitalism. This implies that Smith conceives capital not as a mere object but also as a social relation that gives rise to profits and emerges exclusively in capitalism; however, he did not fully theorize capital as a social relation of production, an aspect of capital that Marx expanded later.
Smith’s conceptualization of capital arises from his need to develop a consistent theory of value and distribution. Whatever weaknesses in the theorization of capital were derived precisely from his lack of a consistent theory of value. As is well known, he initially adopted a theory of value (or relative prices) of commodities dependent on the relative labor times spent on their production.
The real value of a good for the person who wants to buy it is the torture and exertion of that good [...]. The thing that is bought with money or good is actually bought by the labor [...]. Labour is the money paid as the first and real purchase cost for everything; labor is the only unit of measure that the value of each kind of good can be compared; labor is the source of all wealth in the world.
This came to be known as labor theory of value or a more appropriate characterization would have been labor theory of relative prices according to which the relative prices of commodities are determined by their relative labor times spent on their production. Smith realized that this theory, when applied in modern society characterized by the presence of capital goods and rate of profit, runs into insuperable difficulties because the relative prices are no longer equal to relative labor times.
Clearly, Smith had had a very good grasp of the concept of capital; nevertheless, he thought that its presence invalidates his labor theory of value and for this reason, he reverted to the labor commanded theory of value, that is, the quantity of labor time, /, that a commodity can purchase. That is, the ratio of the price of a commodity i, over the uniform wage rate, w, (unit of labor), pi/w, tells us how much of labor can commodity i buy.1 At first sight, this seemingly different theory, when applied in the presence of capital, runs through the same “drawbacks” of Smith’s labor theory of value. On closer examination, however, we notice that the labor commanded theory of value might be of great help in dealing with issues related to the presence of capital. More specifically, the relative prices in the presence of capital, on the one hand, may not change very much for reasonable variations in the profit rate and, on the other hand, may give solid estimations of the absolute prices because the money wage serves as a reliable numeraire.
Capital in historical perspective 11
Figuratively speaking, the deviations of relative prices from the respective relative labor times are controlled, to a great extent, for reasonable rates of profit (see Figure 2.1). The idea is that all relative prices are expected to deviate from their relative labor times, as the rate of profit takes on values varying from zero to its theoretical maximum. More specifically, all prices will be rising, albeit not necessarily proportionally, due to a rising rate of profit. The deviations in prices are controlled for rates of profit not very far away from the economy’s natural rate of profit, r . The relative prices are not exactly equal to the labor times, but one does not expect to find on average and for reasonable rates of profit significant deviations. Hence, from these rather small, expected and to a great extent anticipated deviations, it would be a mistake to arrive at the conclusion that the labor theory of relative prices must be abandoned. On the contrary, the movement in relative prices depends, largely, on relative labor times and variations in the rate of profit change the price level and slightly, on average, the relative prices. The above proximity of relative price to relative labor time hold to the extent that the rate of profit is reasonably high.
From the above discussion, it follows that neither Smith nor most of his commentators had noticed that starting from zero rates of profit until the theoretically reasonable or maximum, the deviations of each commodity’s absolute price from its respective labor time required for its production increase. However, this is true for all commodity prices; thus, their relative deviations may not be so high as one, at first sight, would have expected. Consequently, the likelihood of deviations to be large enough to invalidate Smith’s labor theory of value (or relative prices) becomes, on average, slim. This issue from a point onward is also an empirical one, which, of course, could not be pursued in the times of classical economists, not only due to the lack of appropriate data but in addition to a host of other theoretical and mathematical issues that had to be addressed and solved.
Smith, in his quest for a fully satisfactory theory of value and facing difficulties with both the labor and commanded theories of value, finally settled to the third theory of value according to which the natural (equilibrium)
Figure 2. / Labor commanded theory of value.
price is equal to the sum of the three natural incomes, namely, wages, profits and rents. This so-called, according to Dobb (1973), “adding-up theory of value” suffers from two critical issues of consistency. First, the circularity issue is that the determination of natural incomes requires the prior knowledge of natural prices and vice versa. Second, the logical conclusions regarding the price level depending on changes in the constituent components of natural prices. Smith, in so doing, violated the inverse relationship between wages and profits, which came to be known as the “fundamental principle of distribution” of the broad classical approach. Thus, Smith, despite the advanced (for his time) theory of capital, did not manage to overcome the difficulties and to offer an equally advanced theory of value. A task that was taken up by Ricardo, whose view on capital we discuss below.
David Ricardo (1772—1823), in his first efforts to evaluate capital and determine the rate of profit, utilized one commodity, corn, that could be used as both input (wages and capital) and output; thus, the difference between output and input over the input of corn would give the rate of profit in terms of corn. The subsequent competition and the equalization of profit rates across sectors in the economy would give rise to the economy-wide rate of profit. This is the famous Ricardo’s corn model, which has been discussed in the literature (for details, see Eatwell 1975). Soon, however, Ricardo realized the limitations of the corn model and turned to the labor time as the common substance of capital goods, which enables their aggregation. This becomes clear in his numerical examples, where machines are produced by labor and then used along with labor in the production of other goods. For example, Chapter 31 of Ricardo’s (1821) Principles (Works I) explains how the construction of a machine by labor ends up replacing labor, thereby increasing the unemployment rate. Besides, capital goods depreciate and this is something Ricardo acknowledges although, for simplicity reasons, he does not treat depreciation explicitly. Ricardo further advanced the labor theory of value by dealing effectively with the exact same issues that made Smith abandon it. Notwithstanding, when it comes to the question of what is capital, Ricardo’s view is not on par with Smith’s as he limits the definition of capital to a mix of objects without necessarily referring to hidden social relations. Thus, according to Ricardo,
capital is that part of the wealth of a country which is employed in production, and consists of food, clothing, raw materials, machinery, &c.
necessary to give effect to labor.
(Works I, p. 95)
In other parts of Works I (ch. 33), Ricardo describes capital as “accumulated past labor”, which, during the production process, transfers this stored up labor to the value of commodities. Ricardo criticized Smith for not sticking to the originally correctly stated principle that the relative prices of commodities depend on their relative labor times spent on their production. The presence of capital goods, Ricardo argued, simply modifies, but only to a limited extent an initially correctly stated principle. Puzzled by the presence of capital, he pursued more vigorously the labor theory of value by arguing that the deviations of relative prices from the respective labor times are not only minimal but, what is perhaps more important, they are amenable to abstract theorization. According to Ricardo, three are the sources of deviation of relative prices from their respective labor times; namely, the presence of capital and of rate of profit, the redistribution of income between wages and profits and, finally, the required time for the completion of the production process, that is, the turnover time (Tsoulfidis and Tsaliki 2019, ch. 1).
It is worth noticing and in connection with the next chapters, that Ricardo, unlike the neo-Ricardians or Sraffian economists, assumed that the capital intensities of industries are invariable to changes in the distributive variables. In the languages of mathematics, the first derivative of capital stock with respect to (w.r.t.) the wage or rate of profit is assumed, and reasonably so, equal to zero. The word “assumed” is used because Ricardo appears that he is fully aware of the development of intricate price feedback effects emanating from changes in the distributive variables and reverberating throughout the entire economic system.2 In his numerical model, he assumed that the possible feedback effects are of minimal importance and they are not expected to change the ranking of industries and their characterization as capital or labor-intensive. After all, Ricardo’s economic models consist of two industries with such large differences in capital intensities that no income redistribution can change their ranking (see Tsoulfidis and Tsaliki 2019, ch. 1). It is important to note that in Ricardo’s often-cited numerical example (Works I, ch. 1) of two commodities, the notion of the average industry and its capital intensity are implicit but not developed. The reason is that Ricardo’s interest was in the search of an invariable measure of value defined either analytically or practically, whose prerequisites included invariance to both changes in income distribution and technology. He gave an intellectual struggle to derive such an invariable measure of value, but in vain. This search was continued and partially accomplished by Sraffa through his novel concept of standard commodity, which is invariable only to changes in distribution but not to technological change.
Very similar to Ricardo’s is John S. Mill’s (1806—1873) definition of capital, who notes
This accumulated stock of the produce of labor is termed Capital. What capital does for production is, to afford the shelter, protection, tools, and materials which the work requires, and to feed and otherwise maintain the laborers during the process. These are the services which present labor requires from past, and from the produce of past, labor. Whatever things are destined for this use—destined to supply productive labor with these various prerequisites—are Capital.
(Mill 1848, p. 65)
This definition of capital prevailed during the nineteenth century, and it was also adopted by the first neoclassical economists.
Characteristically different is the definition of capital in Karl Marx (1818— 1884) who, unlike the other economists, placed his emphasis on capital as a specific form of social relation between capitalists and laborers and not merely as produced means of production. His analysis of capitalism begins with commodities and their labor values, that is, the abstract socially necessary labor time embodied in them and its monetary expression, that is, the direct price (DP). Capital, as means of production, has been produced by past labor and so one can use the monetary expression of value, that is, the DP to evaluate capital and reduce the vector of heterogeneous goods to a single number (scalar). This reduction is reliable and gives theoretically consistent and realistic estimates of the worthiness of capital goods in each particular period.
The DP, in Marx’s analysis, are only a first approximation of the center of gravitation around which market prices (MP) persistently gravitate. Having derived the DP, Marx probes further his analysis in the nature and logic of the capitalist system by introducing a more concrete center of gravitation, the price of production (PP), that is, Ricardo’s and Smith’s natural prices. This type of price incorporates the economy-wide average rate of profit on the invested (fixed and circulating) capital. Marx shows that one can start from DP to arrive at PP, which constitute a more concrete center of gravitation of the ever-fluctuating MP.
The transition from DP to PP took Marx two volumes; and only in the ninth chapter of volume III of Capital, he introduced the, what is now famous, “transformation problem” (Capital III, ch. 9). Since then, a lot of ink has been spilled over this “problem” and not a few solutions have been proposed, whose discussion, however, is beyond the scope of the present book. In fact, the movement from DP to PP and the problems associated with this movement were effectively resolved in the works by Shaikh (1973, 1977), while Morishima (1973) and Okishio (1974) independently proposed a similar mathematical solution (see Tsoulfidis and Tsaliki 2019, ch. 3). The difference is that Shaikh in his works brings into the analysis the various conceptual issues associated with the movement from one set of prices to the other in a series of steps insisting that Marx’s solution was on the right track and approximated the final solution to the problem satisfactorily well.
Suffice to say that the passage from labor values to their monetary expression, that is, the DP and from them to PP is not without its problems. DP and PP are strictly related to each other and PP change with the distribution of income in ways consistent with the capital intensity of each industry relative to an economy-wide average capital intensity. Hence, Marx differs from Ricardo in that he introduces the concept of “average” in his analysis, which does not appear explicitly in Ricardo’s usually two commodities (industries) numerical examples and in his search for the invariable measure of value. However, Marx, like Ricardo, was fully aware of the feedback effects and complexities developed going from one set of prices (i.e., DP) to the other
(i.e., PP), but he anticipated, like Ricardo, that the final results are not qualitatively different from those in the first step. For example, Marx notes,
The foregoing statements have at any rate modified the original assumption concerning the determination of the cost-price of commodities. We had originally assumed that the cost-price of a commodity equaled the value of the commodities consumed in its production. But for the buyer the price of production of a specific commodity is its cost-price, and may thus pass as cost-price into the prices of other commodities. Since the price of production may differ from the value of a commodity, it follows that the cost-price of a commodity containing this price of production of another commodity may also stand above or below that portion of its total value derived from the value of the means of production consumed by it. It is necessary to remember this modified significance of the cost- price, and to bear in mind that there is always the possibility of an error if the cost-price of a commodity in any particular sphere is identified with the value of the means of production consumed by it. Our present analysis does not necessitate a closer examination of this point.
(Capital III, pp. 164-16)5)
That was perhaps the best that Marx and Ricardo could do given that they did not have the necessary mathematical tools to delve into the full solutions of their system of equations.
The broad classical approach through the labor theory value managed to express “capital”, a vector of heterogeneous use-values, in terms of labor time. Marx went further in expressing capital goods in terms of equilibrium prices, that is, in terms of PR It is important to note that classical economists share the long-period method of analysis in which the natural prices or PP are viewed as the center of attraction of the continuously fluctuating MP. The broad classical approach to determine the long-run (natural) prices starts with the following data: the real wage, the output produced and its distribution along with technology.3 According to some followers of the classical tradition, these givens may be differentiated regarding the distributive variable that may be the profit-wage ratio (or the wage share) instead of the real wage. On the other hand, Marx’s discussion of the schemes of simple reproduction in Capital II is based on the idea of a given rate of surplus value. In our view, the uniform rate of surplus value across sectors (departments) is the result of a given real wage as the basket of goods normally consumed by workers to reproduce their capacity to work. The uniform rate of surplus value is derived from the assumption of exchange in terms of DP, and the allocation of surplus value across sectors takes place in proportion to variable and not constant capital, which is in the analysis in Capital III (ch. 9). In Ricardo, there are hints that a given profit—wage ratio might be taken as a viable alternative to the given real wage (see Tsoulfidis and Tsaliki 2019, ch. 2). We also encounter the case of an exogenous rate of profit, which may replace the real wage as the given in the system of price determination. The given rate of profit in combination, for instance, with the vector of private consumption expenditures from input—output tables allows for the determination of the consumer price index, with the aid of which we can deflate the given money wage and, finally, arrive at the real wage. This is the line of research followed by Leontief (1986) and others, whereas Sraffa (1960) also proposed the rate of profit as the exogenously determined variable on the grounds that is known through the rate of interest.
Ricardo’s labor theory of value was met with acceptance in the UK during the 1820s and also by economists with socialist ideas known as Ricardian Socialists. Unlike Ricardo, however, these economists of socialist persuasion argued that labor is the only source of wealth and labor is therefore entitled to all it produces.4 Even Ricardo himself did not escape from Ricardian Socialists’ polemic, because he attributed income to capital, something that was unacceptable by his followers. For them, capital is nothing but past labor; therefore, all income must belong exclusively to labor and there is neither economic nor ethical justification for profit, rent and interest incomes. The Ricardian Socialists further argued that the private property of the means of production should be replaced by cooperatives owned and run by workers. This movement was particularly active in England in the early to midnineteenth century, and it was no less active in France with the Utopian Socialists. In the German-speaking world, we had had the rise of the revolutionary then Social Democratic Party, the SPD, in the last quarter of the nineteenth and early twentieth centuries.
The different versions of labor theory of value, separate and in combination, were a threat for the status quo of the system; therefore, an alternative explanation for capital and its income found fertile ground to flourish despite its subjective nature and, as we will argue, persistent problems of internal consistency. Although not explicitly stated by the first neoclassical economists (the trio Jevons, Menger and Walras), J.13. Clark could not be more explicit by arguing that the newly emerging theory was more on the ideology side and less on the science side. He opined that in capitalism, everyone gets what one produces and everything is “fair and square”. There is no doubt that J.13. Clark was very conscientious of what was at stake. The new theory that was to replace the classical theory of value and distribution had to break away from a labor theory of value, which inescapably leads to the exploitation of labor as the source of surplus and profit type incomes.3
Other reasons for the emergence of neoclassical economics may also include the feebleness of the supporters of the labor theory of value to give satisfactory answers to a number of attacks targeting seemingly weak aspects of their theory (see Blaug 1997; Tsoulfidis 2010). Among these aspects is the role of demand in the price determination and, above all, there are issues that relate to what came to be known as the “transformation problem”. The discussion about motivations is not meant to imply that there is a covert coordination between the new needs of the ruling class or classes of their vested interests and the new direction of economic theory. By no means are the motivations necessarily dependent on each other, but rather their common route is derived from their common interests.