The Liberal Roots of Karl Marx and How He Went Wrong

labor theory of value where do prices come from

David Bastardo for AdamSmithWorks

"Both authors agree that economic power does not replace the formal rule of law, but where they differ is that Marx asserts that it leads to an indirect rule over what law does not regulate: the spoils of labor, production and its dividends."
It is a common misconception among socialists that Karl Marx was the first to posit a general theory of value based on labor. A theory of value that consists of a summary of working hours, skill employed by the laborer or crafter, and the qualities of the goods devoted to such a goal, Marx’s conception draws, in fact, from liberal sources. This is but one of many instances where the championing of Marx’s dialectical method fails to understand the logical causality of economic ideas hailing from utilitarian thought.

Where Marx may be held accountable for a collectivist construction of the basis of labor and product, what he calls capital, it is Adam Smith who first successfully asserts the role of labor as the basis of all economic activity and, as such, the universal determining factor of market value. As stated in Book 1, Chapter 3 of An Inquiry into the Nature and Causes of the Wealth of Nations
Just as it is the capacity for exchange what gives way to the division of labor, thus the depth of such division must be forever linked to the extension of such capacity, or in other words, to the extension of the market.
As an idea born within the larger framing of market openness, labor may only behave as the basis of value among market relations of exchange, and thus within the frame of the division of labor. This theory admits that labor must necessarily lead to exchange, since autarchic solutions among people is universally impossible. This observation appears to be glossed over, if not altogether ignored, in Marx’s position.

In large markets laborers may devote their efforts entirely to a single trade in the hopes that surplus will generate wealth, while small markets produce inconstant and imperfect laborers dealing with multiple trades and trying to cover more basic needs. Thus, the scope of exchange is more limited and less effective.

Adam Smith elaborates. Small communities and less developed markets with leanings towards mercantilism, will produce autarchic families that are ignorant of trade, as in the case of the Scottish Highlands. 
In the most remote and isolated Highlands of Scotland, there will not even be a single nail maker. At a pace of one thousand nails per day and three hundred workdays every year, one craftsman of this sort would produce three hundred thousand nails per year. But in a region such as this, he would not be able to sell even one thousand nails, which is equal to say, not even the product of one day’s work for a whole year.
In Book 1, Chapter IV: On the Origin and Use of Money, Smith digresses on the meaning of value as a concept, an idea that Marx directly reproduces in the first volume of Das Kapital. For Smith, the first meaning of value consists of the utility of the good exchanged, and is thus named value in use, whereas the second form of value, based on trade, refers to the way one possessed good may be exchanged for others. Based on his statement, “Things that possess a great value in use frequently have little to no value in trade”. The contrast between water’s universal utility and its relatively insignificant value in trade, or a diamond’s null value in use and highly coveted value in exchange, remains alarmingly absent in the Marxist conception of value.

However, it is in the fifth chapter, “Of the Real and Nominal Price of Commodities,” that we find the conception of labor as the basis of value from which Marx draws his entire theory. As Smith continues to elaborate the causes for why trade is preferable to isolated autarchic production, he states that wealth and poverty will be measured by the amount of work that a laborer will be able to use or purchase through money. That is, either the value of his own work or that of others whose trade and production he needs in order to survive and thrive. Smith says: 
As such, the value of any merchandise, for the person who possesses it and has no pretension to use or consume it but to exchange it for others, is equal to the amount of work that allows the person to buy or order. Thus, work is the real measure of exchange value among all merchandise.
Marx quotes Smith’s definition of economic power in the First Manuscript of Economics and Philosophy. Both authors agree that economic power does not replace the formal rule of law, but where they differ is that Marx asserts that it leads to an indirect rule over what law does not regulate: the spoils of labor, production and its dividends. It follows that Marx’s theory sees coercion where Smith perceives the rational pursuit of self-interest; thus, one may identify this as the moment of the great divide between the liberal tradition and the attempted Marxist critique of political economy.

The Marxist worldview is founded on the politicization of ideas that, otherwise, belong to utilitarian rationalist thinking. Admitting this fact will enable us to understand why, in spite of Marx’s acknowledgement of liberal tradition and its assessment of the value of labor, socialism fails to recognize the role of self-interest in the equation. History shows that Marxism is ready to dismiss rational self-interest as something petty and ‘bourgeois’. The inherent coercion in the process of trade and labor espoused by this socialist tradition is thus replicated in the authoritarian system framed by the dictatorship of the proletariat.

Related posts:
Steve Horwitz’s Adam Smith on the Labor Theory of Value
Kwok Ping Tsang’s Three Ways of Looking at the Water-Diamond “Paradox”
John A. Robinson and J. Robert Subrick’s Adam Smith and the Labor Theory of Value
Eric Schliesser’s Smith's Labor Theory Thought Experiment