Exploitation

With emergence of capitalism, worker is separated from the owner of capital. Labor market arises, on which workers sell their 'labor power', i.e. their ability to produce goods (and value) for capitalists. Note that the worker cannot use his labor power on his own, because he does not have the necessary capital to buy 'means of production' (material inputs, buildings, equipment, land etc.) needed for production. As with all other commodities the commodity 'labor power' has its own value (essence) and its price (appearance). The price of labor power is wage and it appears to us (wrongly as dialectical approach asserts) that it is determined just by an interplay of supply and demand on the labor market. In fact - Marxists tell us - wage is determined (in the long run) by the value of the labor power, i.e. by the amount of labor that is needed to produce and daily reproduce the workers ability to work.

This is an elaboration of the Ricardian theory of 'subsistence wage'. Take all the goods the worker and his family need to consume on average per day and calculate the labor 'embodied' in these goods, this will give you the (labor) value of the daily labor power of the worker. As it happens - with high enough labor productivity - the worker can produce in one day more than the value of his labor power. In other words the worker can produce during a day more goods than he needs for maintaining his own body and mind in working conditions. 

Read about the class struggle for the length of working day directly from Das Kapital!

That part of his daily product that the worker needs for the reproduction of his labor power is called the 'necessary product' (do not confuse it with the concept of 'socially necessary' labor defined before) and whatever is produced above it is called the 'surplus product'. Value of the surplus product is then called the 'surplus value'. Because workers work for capitalists, they do not own products of their own labor. Capitalists appropriate all the output and return to workers only the 'necessary' parts of their products, that is they pay only the value of workers' labor power. The surplus product, or its value - the surplus value - remains in hands of capitalists. This is the way how capitalists exploit workers: they appropriate the whole product of labor but pay back only as little as is needed for the subsistence.

To illustrate this ideas we shall continue with the preceding numerical example. Suppose that the subsistence amount of goods the worker and his family need to consume per day is 1 pound of corn and 2/3 of a yard of cloth. The value of one day of labor power is therefore

This means that the worker needs to work 5 hours a day to reproduce his labor power. If the actual work day is 10 hours, then the worker works 5 hours for himself ('necessary labor') and 5 hours for the capitalist ('surplus labor') producing 5 hours of 'surplus value'. The ratio of the surplus labor to the necessary labor or the ratio of surplus value to the value of labor power is called 'the rate of surplus value' or the 'rate of exploitation'. In our example it happens to be 5/5 or 100 per cent.

The surplus value produced by workers is the source of capitalist profits. The 100 per cent rate of surplus value can be also interpreted to mean that in the long run from each produced one hour of value one half goes to the worker as his wage and one half to the capitalist as a profit. In the dialectical interpretation profit is only a form of appearance of the surplus value (essence). But it fools us, because it seems that the profit is produced by capital, while in fact - Marxists tell us - it is the product of labor appropriated by capitalists.

Going back to the example with corn and cloth, we can now say that out of the 1 hour of the new ('live') labor contained in one pound of corn 1/2 hour is the necessary labor and 1/2 hour is the surplus value. Similarly out of 2 hours of the 'live' labor contained in 1 yard of cloth 1 hour goes to the worker for the reproduction of his labor power and 1 hour is a source of the capitalist profit.

It is standard in the Marxian literature to use the following notation and terminology:
 

c

'embodied labor'

value of 'means of production'

cost of material

'constant capital'

v 

'necessary labor'

value of 'labor power'

wage cost

'variable capital'

s

'surplus value'

value of 'surplus product'

profit

One thing is clearly visible from the labor-value calculations: the rate of surplus value is the same in the production of   both commodities but the rate of profit is not. Why not? Because the ratio c/v - the so called 'organic composition of capital' - is different for the two products. By simple mathematical manipulation we get:

It follows that under identical rate of exploitation (s/v) the rate of profit [s/(c+v)] is smaller where the organic composition of capital c/v is larger. But c/v is similar to the concept of capital-labor ratio. This implies that under the labor-value pricing the profit rates would be low in highly capital intensive industries and high in labor intensive industries. It was recognized already by David Ricardo that this conclusion is at variance with real world observations, but Ricardo brushed this problem away as not very important. Because of the enormous changes in capital intensity of production during the time of industrial revolution Marx could not disregard this problem any more.

To salvage the labor theory of value and to make his theory of price compatible with the observed fact that the rates of profit do not vary inversely with capital/labor ratio, Marx devised the theory of transformation of value into 'prices of production'. According to this theory labor-value ceases to be a general equilibrium price in the capitalist economy and it is in this role replaced by 'production price' determined as cost plus average profit. Note that Marx--and after him all the Marxists--never used the term ‘general equilibrium’ but as the following explanations shows, that was what he meant. The argument goes as follows: Competition makes capitalist to withdraw their capital from less profitable industries - such as corn in our example - and put it into more profitable ones - such as cloth. As a result supply of corn would decrease creating excess demand for corn, and supply of cloth would increase creating an excess supply of cloth. Due to excess demand for corn the price of corn would rise pulling the profit rate up. Simultaneously the excess supply of cloth would cause decline of its price and profits. The process continues until all lines of production are equally profitable, so that no capitalist has an incentive to reallocate his capital. This is the state of general equilibrium in the capitalist market economy. The general equilibrium prices which were called by Marx 'prices of production' deviate permanently from labor-values nevertheless the labor theory of value is still presumed to hold, because prices of production are only 'transformations' of labor values.

According to this theory of Marx, the essence - appearance becomes a three tier relation: market price is the most surface disguise of value; in the next tier is the 'production price' which is the essence of market price but itself a 'form of appearance' of the ultimate essence namely the labor-value which is hidden in the third tier under the surface. This amounts to the claim that the capitalist 'relations of production' are particularly deceitful. Marxists say that you were mistaken if you thought that the discovery of general equilibrium price unearthed the true essence guiding the fleeting movements of market prices. The general equilibrium price fooled you to believe that profits were generated by capital but the only true source of profits was the surplus value resulting from exploitation of labor.

Marx insisted that labor value still ruled market even if the 'prices of production' deviated permanently from labor values. He maintained that deviations of prices of production from labor-values represented only a redistribution of the surplus value among capitalists and thus did not affect the more crucial fact of an unequal distribution of value between workers and capitalists as social classes. Those capitalists who were selling bellow value were giving up the part of their surplus value to the less lucky capitalists who operated in capital intensive industries and whose workers produced less surplus value per unit of capital. The aggregate value of all commodities and also its division into three components: the aggregate c, v and s remained unchanged. Total profits after redistribution were still equal to total surplus value created by workers. Marx concluded that the theory of exploitation is valid.

Let us use our example to see, how the production prices are formed and whether the claim about the mere redistribution of surplus value is true. Suppose that the total output of corn is 600 pounds and the total output of cloth is 200 pounds, then it must hold for the totals

The first two equations give prices as cost plus profit mark-up. The profit rate r is one of the three unknowns that must be obtained by solving equations (6), (7) and (8) simultaneously. The coefficients .2 and .47 of the first equations are obtained in the following way: To produce 1 pound of corn .2 pounds of corn is needed as input of which .1 pound is used as material input directly in the production process and another .1 pound is used to feed workers that are producing corn. The last figure results from the fact that 1 hour of work is needed to produce a pound of corn and the subsistence consumption of corn per one hour of work is .1 pound. Similarly to produce one pound of corn .47 yards of cloth is needed of which .4 yards as material inputs and .07 yards as the subsistence consumption for the workers producing corn. Again the last figure results from multiplying 1 hour of work per one pound of corn by .07 yards of cloth per one hour of work. The coefficients .5 and .33 of the second equation are obtained in the parallel way.

The first two equations (6) and (7) determine the relative prices p1/ p2 and the profit rate r. The third equation (8) is needed to fix the level of prices. We have chosen it in such a way that the aggregate gross value of output (GSP) at production prices and at labor-values will be the same. Alternatively one can choose this equation to maintain the aggregate value added (national income) unchanged or aggregate profits equal to aggregate surplus value. Note that the choice of the third equation has bearing neither on relative prices nor on the rate of profit. It represents just a choice of the 'numeraire'.

Marxist concept of  ‘production price’ corresponds approximately to the concept of general equilibrium price in modern economics. If solved properly as shown above it is compatible with the contemporary non—Marxist economic theory. The difference is, however, in interpretation. Contemporary economists see the theory of general equilibrium prices as a complete and self sufficient explanation of price formation in the market economy under perfect competitions. Not only that it needs no support from the labor— theory of value it is incompatible with it. Notice that when solving equations (6), (7) and (8) for prices we did not need to know labor values of the two products. Similarly solving equations for the equilibrium rate of profit r did not require knowledge of surplus value and its relation to total cost evaluated at labor-value prices. In fact the equilibrium rate of profit was quite distinct from the ‘average rate of profit’ obtained from labor-value calculations.

Modern economics reject labor theory of value as a first crude attempt to explain price formation which was not supported by facts. Marxists, on the other hand maintain, that even if the general equilibrium ‘production prices’ deviate permanently from labor—values they are still only ‘transformed form of appearance’ of labor—values. But this claim rests on mathematically incorrect solution to the ‘transformation problem’ by Marx, When the mathematically correct solution is used then the basic Marxist tenet that the profits are merely redistributed ‘surplus value’ cannot be upheld.

There is, of course, also a more basic criticism. Labor—theory of value starts from an unsubstantiated axiom that only labor creates ‘value’. In fact not all the labor but only the so called productive labor is supposed to create value, It follows from this axiom that all the national product is produced just by ‘productive’ workers and that any consumption of nonproductive’ workers comes from the ‘surplus value’ which is an unpaid work of ‘productive’ workers. But ‘nonproductive’ workers may provide labor services  as. ‘va1uable’ as those of   productive  workers. Modern economic theory interprets value as utility or welfare of population and not as cumulated expense of a single productive factor. In a competitive market any labor service that is capable to earn positive payment must contribute to the overall welfare and it is in this sense productive. What Marxists see as an one way flow of value from ‘productive’ to ‘nonproductive’ workers may be an exchange of equally valuable services.

Similarly modern economics consider not just one but all the factors of production to be productive. So that labor creates only part of the total value of product, the other parts being created by capital, land and other factors of production. Each factor contributes proportionally to its marginal product.