Summary
"precisely in the form of wages, profit and rent there is contained an incredible blunder in analysis, which pervades all political economy since Adam Smith...... the fantasy of men like Say, to the effect that the entire yield, the entire gross output, resolves itself into the net income of the nation or cannot be distinguished from it, that this distinction therefore disappears from the national viewpoint, is but the inevitable and ultimate expression of the absurd dogma pervading political economy since Adam Smith, that in the final analysis the value of commodities resolves itself completely into income, into wages, profit and rent.”
Smith's absurd dogma is that whilst the value of individual commodities resolves into c + v + s, the value of the total social product resolves entirely into just v + s, i.e. revenues, equal to newly created value.
Smith's Labour Theory of Value defines the value of commodities as determined by the labour-time required for their production – congealed labour and living labour
That means c + v + s, though his terminology confuses constant capital, c, with fixed capital, and variable capital, v, with circulating capital. He recognised that the surplus value is produced by labour, being the difference between necessary labour and the labour actually performed, but he fails to make the distinction that flows from this between labour-power, a use-value, and subsequently commodity, whose value is equal to necessary labour, as against labour, i.e. The physical activity which creates new value.
This leaves him with an unsolvable conundrum as to why the value of “labour”, i.e. wages, is not equal to the value of the product of labour. He resolves it by saying that, with the introduction of landed property and capital, the Labour Theory of Value ceases to operate. He introduced the idea of “natural” and “necessary” prices, determined by supply and demand. Wages are less than the value of labour, because labour is plentiful, capital's price is higher than its value (i.e. higher than the value of the commodities that comprise it, by an amount equal to profit) because capital is scarce.
He, therefore, puts forward a second theory, which Marx calls his cost of production theory – it is essentially the factor cost theory now at the base of all orthodox economics. In The Labour Theory of Value, the value is objectively determined, because c's value is already known, and the amount of new labour undertaken is known, leaving only its division into v + s to be determined. As Marx puts it, the value, if considered as a piece of string, can be cut into three separate parts, in an infinite number of combinations, but the length of the string does not change. Smith's cost of production theory, however, determines the length of the string by adding together the length of the three pieces, however they might be determined.
As Marx says, whenever he has to apply himself analytically, Smith always reverts to the Labour Theory of Value.
But, Smith, when he looks at society as a whole, and its product, has a problem. Smith's “absurd dogma” is that the demand for society's product comes from the revenues produced in the creation of that product. In other words, workers get wages, capitalists get interest and profit, and landlords rent. These revenues enable them to meet their respective needs for consumption.
The problem, here, is that these revenues equal only v + s, the new value created by labour during the year. But, the value of output is equal to c + v + s, which is larger. Smith is, therefore, led to claim that what applies in respect of the value of each commodity, does not apply to society's total commodity product. He argues that it resolves entirely into v + s, because c itself is a commodity that resolves into v + s. As Marx says, this is absurd, because clearly each of these commodities that form the constant capital resolves itself not just into v + s, but also into c + v + s.
Smith's absurd dogma is also the basis of Say's Law that supply creates its own demand, because of this same argument that production creates the incomes/revenues that are then used to provide required demand for what has been produced.
In orthodox economics the value of each factor is determined by its marginal physical product, which when multiplied by the market price of the given commodity gives the marginal revenue product. The equilibrium price for the factor is given when it equals this MRP.
The orthodox model, at least in respect of its General Equilibrium variant, is internally consistent, and supported upon beautiful mathematical equations. But, a model can be internally consistent and mathematically beautiful and still wrong, if the assumptions it makes about the world it is describing are false. The orthodox model is based upon a world in which there is no constant capital to be replaced, and where, therefore, the value of output resolves entirely into revenues, which are then sufficient to form the demand for this total output, all of which is then consumed! The consequence of that is that the farmer eats his seed corn, and has no constant capital to grow anything in the coming year!!
The Marxist critique of the orthodox model, as typified in the debates between Cambridge, England and Cambridge, Massachusetts indicated that even the Marxist economists had succumbed to Smith's absurd dogma. They attacked the orthodox model for its unrealistic assumptions about the real world, in terms of perfect competition, and so on, but failed to notice that the most glaring unrealistic assumption was the failure to account for the value of constant capital in the value of commodities and national output!
Smith's absurd dogma, is also the basis of the Keynesian identity equation between National Income and National Expenditure, simply modified to equate savings with investment. It, therefore, forms the basis of all orthodox economics be it classical, neoclassical, Austrian or Keynesian. It is one of the first axioms taught to Economics students. But, it is wrong.
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