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In the labour-theory, the market is the transmission mechanism between this deep, unknowable process and the surface outcome. Only the market can mediate the individual choices into an aggregate effect; only the market can tell us what the socially necessary labour time is. In this sense, the labour-theory is the greatest theory of the market ever written. It ascribes to the market, and only the market, the mechanism of making concrete the reality beneath.

So, yes, it is abstract – but no more abstract than Adam Smith’s concept of the ‘hidden hand’ or Einstein’s general theory of relativity, proposed in 1916 but not proved empirically until the 1960s.

The question remains: is it provable? Would it be possible to challenge the labour-theory in its own terms with evidence? Does it pass the test, laid down by philosopher Karl Popper, that if a single contrary fact were true, the theory would be false?

The answer is yes – once we understand the full theory. If you could say ‘capitalism is crisis-free’, the labour-theory would be false. If you could demonstrate that capitalism lasts for ever, it would also be false. Because, as we’re about to see, the labour-theory describes at the same time both a regular cyclical process and one that leads eventually to long-term breakdown.

Q: Why do we need this level of abstraction? Why can’t the theory be constructed by collecting data and crunching it? Why leave the concrete world to mainstream economics?

A: In answer to the last of these, you shouldn’t. Marx recognized that to be rigorous the labour-theory should explain reality at the concrete level. He set about trying to build out the abstract model into a more concrete description of the real economy. This involved introducing a two-sector model of the economy (consumption and production) in the second volume of Capital, and a banking system in the third. Alongside this, he tried to show how the underlying values get transformed into prices at the concrete level.

There are inconsistencies in the way he worked out this so-called ‘transformation problem’, which led to a 100-year-long debate over whether the theory is inconsistent. Since this is an attempt to apply the whole theory to a specific issue, not a textbook on Marxism, I will avoid that debate here, saying simply that the ‘transformation debate’ has been resolved (to my satisfaction) by a group of academics known as the ‘temporal single system’ school.\*

The point is that, even in its most consistent form, the labour-theory is not going to be a practical tool for measuring and predicting price movements. It is a mental tool for understanding what price movements are. It belongs to a class of ideas that Einstein described as ‘principle theories’: theories whose aim is to capture the essence of reality in a simple proposition, which may be removed from everyday experience. Einstein wrote that the aim of science is to capture the connection between all experiential data ‘in their totality’ – and to do this ‘by use of a minimum of primary concepts and relations’. He pointed out that the more clear and logically unified these primary concepts were, the more divorced they would be from data.¹⁶

Einstein believed the truth of a theory is, for certain, borne out by whether it successfully predicts experience. But the relationship between the theory and the experience can only be grasped intuitively.

For reasons we discuss below mainstream economics evolved into a pseudo-science that can only allow for statements obtained through crunching the data. The result is a neat set of textbooks, which are internally coherent but which continually fail to predict and describe reality.

Q: Isn’t this too ideological? Isn’t the labour-theory too tainted with hostility to capitalism to be of any use?

A: Yes, this is a problem. As a result of the ideological battles in economics since the 1870s, there’s been a dialogue of the deaf. The outcomes, which we have to overcome today, were the inconsistency of mainstream economics and Marxism’s lack of concreteness.

You’ll often hear left-wing economists decry mainstream economics as ‘useless’ – but it is not. In fact, once you understand its limitations, most of mainstream price theory maps very well on to the surface end of the labourtheory.

The problem is, mainstream economics does not understand its own limitations. The more complete it became as an academic discipline describing an abstract, static and immutable reality, the less it understood change. To see why, we will now consider the main source of change in capitalism – the force that makes expensive things cheaper and which has now begun to make some things free: productivity.

PRODUCTIVITY IN THE LABOUR-THEORY

According to the labour-theory, there are two kinds of productivity gain possible. First, the workers become more skilled. So the work of a trained metal press operator has more value than the work of someone who just arrived off the dole queue; either because they make an ordinary thing faster and with fewer defects, or because of their ability to make an extraordinary thing that the less well-trained worker could not.

But the cost of training skilled workers is usually higher by a proportional amount: their labour is worth more because it took more labour to produce and maintain. For example, the average earnings of graduates across the OECD countries are more than double those of people with only a basic education, and 60 per cent higher than of those who completed only ‘upper secondary’ education.¹⁷

The second kind of productivity gain is driven by new machinery, or a reorganization of the production process, or a new invention. This is the most common case and Marx deals with it as follows.

One hour of labour always adds one hour’s worth of value to the products made. So the impact of rising productivity is to reduce the amount of value embodied in each product.

Suppose a factory produces 10,000 garments a day. Let’s say the workforce is 1,000 people with average ability working ten hours each. So 10,000 hours of ‘living’ labour are going into the daily output. Let’s assume that on top of that there are 10,000 hours of ‘finished’ labour going into each day’s output as well – in the form of wear and tear to machinery, energy used, fabrics and other raw materials, transport costs, etc. The total daily output of the factory, as measured in labour time, therefore consumes

20,000 hours of labour, half living and half finished. So each garment contains two hours of labour time. On the market, it should exchange for the money equivalent of two hours’ labour time.

Now, suppose a process is introduced that doubles labour productivity. For each batch of 10,000 garments you’ve still got roughly the same amount of finished labour going in (10,000 hours in this example). But the living labour component is cut to 5,000 hours. Now each garment contains ninety minutes’ labour time.

Here’s how the market rewards you. If your factory is the first to make the change, the garments go into a market where socially necessary labour time to make them is still 20,000 hours. That’s the price you should get in the market. But you only needed 15,000 hours. So the factory reaps the productivity gain in the form of increased profit. The factory boss can cut prices and increase market share or take the above-average profit represented by the difference between two hours and ninety minutes. Eventually the whole industry will copy the innovation and the new normal price per garment will be ninety minutes’ labour time.\*

This brings us to the main point. To increase productivity, we increase the proportion of ‘machine value’ to the living human labour employed. We drive human beings out of the production process and in the short term – at the level of the firm or sector –profits rise. But since labour is the only source of extra value, once an innovation has been rolled out across the whole sector, and a new, lower social average set, there’s less labour and more machine; the part of the operation producing the added value has got smaller; and if unchecked that would place downward pressure on the profit rate of the sector.

Innovation, which is driven by the need to minimize costs, maximize output and utilize resources, does bring rising material wealth. And it can lead to a rise in profits. But once it has been rolled out, it creates an inbuilt and perennial ‘tendency for the rate of profit to fall’ – if not offset by other factors.

Despite the doom-laden aura of this Marxist phrase ‘tendency of the profit rate to fall’, it is no real catastrophe for capitalism. As we saw in chapter 3, these offsetting factors are usually strong enough to balance out the effects of the falling labour content – above all, through the creation of new sectors which require higher-value inputs – either in the form of higher-value physical commodities or by the creation of service sectors.

So in the classic model of capitalism outlined by Marx, the pursuit of productivity drives material wealth higher but causes repeated short-term crises and then forces big mutations, whereby the system has to voluntarily raise the cost of labour. If it can’t make workers rich enough to buy all the goods, or it can’t find new consumers in new markets, this piling up of machine value versus labour value leads to a fall in the rate of profit.

And that was how all crises looked in the era of scarcity: mass unemployment and idle plant caused by a collapse in profitability, and all explicable using the labour theory of value.

But the labour-theory can also be used to explain something else, namely what happens when products and new processes can be made without any labour going into them at all.

Before we explore that, however, we have to deal with the alternative theory of price proposed by mainstream economics, known as ‘marginal utility’.

THE AVOIDANCE OF ‘FUTURE THINGS’

Like Marx, the founders of mainstream economics started by tearing holes in Ricardo. His explanation of profit was inconsistent, they said; nothing could be done to make it work. Their response was to move economics on to different terrain – that of observable movements in prices, supply and demand, rent, taxation and interest rates.

What they produced was the theory of marginal utility: that there is no intrinsic value to anything, except what a buyer will pay for it at a given moment. Léon Walras, one of the founders of marginalism, insisted: ‘The selling prices of products are determined in the market … by reason of their utility and their quantity. There are no other conditions to consider for these are the necessary and sufficient conditions.’¹⁸

This ‘usefulness theory’ of value had been deemed archaic since the days of Adam Smith. The crucial factor in its revival was the addition of the concept of marginality. ‘The amount of value is determined not by average but by final or marginal utility,’ wrote William Smart, an English popularizer of the theory.¹⁹ Marginal simply means all the value is in the ‘extra bit’ you want to buy, not in the whole product. So the value of the last ecstasy tablet in the nightclub is higher than all the others.

For marginalists, the key psychological judgements we make when we buy things are reducible to the following question: ‘Do I need to buy this next thing – glass of beer, cigarette, condom, lipstick, minicab ride – more than I need to keep this last €10 note in my pocket?’

William Stanley Jevons, the English pioneer of marginalism, demonstrated that in principle these fine judgements about utility – which he understood as choices between pleasure and pain – could be modelled using calculus. This sliding scale of momentary prices was the only thing needed to calibrate supply and demand. The only consistent meaning to value was ‘ratio of exchange’; he proposed scrapping the term ‘value’ altogether.

On the face of it, the marginalists were trying to free economics from philosophy. You can’t defend capitalism on the grounds that it is ‘natural’, said Walras, the only justification should be that it is efficient and increases wealth.

But there is a crucial piece of ideology built into marginalism: the assertion that the market is ‘rational’. Walras was revolted by the idea that economic laws work independently of human willpower. This amounted to treating economics like zoology and the human race as animals. ‘Alongside the many blind and ineluctable forces of the universe,’ he wrote, ‘there exists a force which is self conscious and independent, namely the will of man.’²⁰ The new science of economics should assume the market is an expression of our collective rational will, Walras argued. But it should be mathematical, making a one-time leap out of its ethical and philosophical roots by using abstract models and considering all cases in idealized form.

The achievement of marginalism was to show that markets governed by free and perfect competition must achieve ‘equilibrium’. It was Walras who worked this into a demonstrable law: since all prices are the result of a choice by a rational individual (buy the lipstick or keep the €10 bill?), once the supply runs out the rational choice is to stop trying to buy it. Conversely, if the supply of something increases, it becomes rational for people to start wanting it, and to decide what price they will pay for it. Supply creates its own demand, says the theory; a freely operating market will ‘clear’ until demand matches supply, with prices changing in response.

Like Marx, Walras was working at a high level of abstraction. His model assumes that all agents have perfect information, that there is no uncertainty about the future and no extraneous factors influencing the market (such as monopolies, trade unions, import tariffs, etc.). These abstractions are not invalid, as long as we do not suggest that they represent reality. The question is: was marginal utility the right abstraction?

An early hint that it was not came in the marginalists’ attitude to crisis. They were so convinced of capitalism’s inner tendency towards equilibrium that they assumed crises must be produced by non-economic factors. Jevons, in all seriousness, suggested the Long Depression, beginning in 1873, was simply the latest in a series of regular fluctuations caused by ‘some great and wide-spread meteorological influence recurring at like periods’ – that is, by sun-spots.²¹

Textbook economics is today built on marginalism’s discoveries. But in the pursuit of maths over ‘political economy’, the marginalists created a discipline which ignored the production process; reduced the psychology of the deal to a two-dimensional balance between pleasure and pain; saw no special role for labour;\* discounted the possibility of economic laws acting at a deep, unobservable level, independent of the rational will of human beings; and reduced all economic agents to traders, abstracting away from class and other power relationships.

In its purest form, marginalism denied not only the possibility of exploitation, but of profit as a specific phenomenon. Profit was just the reward for the utility of something the capitalist was selling: their expertise or, in later forms of the theory, their abstinence – that is, the ‘pain’ they suffered during the act of accumulating their capital. Marginalism was, in short, highly ideological. It introduced a blindness to the problems of distribution and class that still blights professional economics, and a profound lack of interest in what goes on in a workplace.

Marginalism emerged because managers and policymakers alike needed a form of economics that was bigger than accountancy but smaller than a theory of history; it had to describe in detail the way the price system worked – and in a way that took no interest in class dynamics or social justice.

Carl Menger, the Austrian economist, summed up the inner psychological motivation for marginalism in a famous attack on Smith and Ricardo. They were obsessed with ‘the welfare of man in the abstract, about remote things, about things which did not yet exist, about future things. In this effort [they] … overlooked the living, justified interests of the present.’ The aim of economics, according to Menger, should be to study the reality that capitalism produces spontaneously, and to defend it against the ‘onesidedly rationalistic mania for innovation’ which ‘contrary to the intention of its representatives inexorably leads to socialism’.²²

Marginalism’s obsession with the continuous present, its hostility to future things, made it a brilliant model for understanding forms of capitalism that do not change, mutate or die.

Unfortunately these do not exist.

WHY IT MATTERS …

Why, in the era of big data, Spotify and high-frequency trading, should we be raking over a debate from the mid-nineteenth century?

For one thing, because it explains the pig-headedness of present-day economics in the face of systemic risk. Economics professor Steve Keen points out that present-day marginalism – by reducing everything to the doctrine of ‘efficient markets’ – actually contributed to the collapse. Mainstream economists made ‘an already troubled society worse: more unequal, more unstable and less ‘efficient’.²³

But there is a second reason, to do with how we describe the dynamics of info-capitalism. The rise of information goods challenges marginalism at its very foundations because its basic assumption was scarcity, and information is abundant. Walras, for example, was categoric: ‘There are no products that can be multiplied without limit. All things which form part of social wealth … exist only in limited quantities.’²⁴

Tell that to the makers of Game of Thrones: the pirated version of Episode 2 of its 2014 series was illegally downloaded by 1.5 million people in the first twenty-four hours.²⁵

Information goods exist in potentially unlimited quantities and, when that is the case, their true marginal production cost is zero. On top of this, the marginal cost of some physical info-tech (memory storage and wireless bandwidth) is also collapsing towards zero. Meanwhile, the information content of other physical goods is rising, exposing more commodities to the possibility that their production costs begin to plummet too. All this is eroding the very price mechanism that marginalism describes so perfectly.

The economy at present, consists both of scarce and abundant goods; our behaviour is a mixture of the old pleasure-vs-pain choices, made in our own self-interest, alongside sharing and cooperation, which seem to the marginalists like sabotage.

But in a full information economy – where much of the utility was provided through information and physical goods were relatively abundant – the price mechanism as described by marginalism would fall apart. Because marginalism was a theory of prices and prices only, it cannot comprehend a world of zero-priced goods, shared economic space, nonmarket organizations and non-ownable products.

But the labour-theory can. The labour-theory actually predicts and calibrates its own demise. That is, it predicts a clash between the social forms driving productivity and productivity itself.

The labour-theory, as outlined by Marx, predicts that automation can reduce necessary labour to amounts so small that work would become optional. Useful stuff that can be made with tiny amounts of human labour is probably going to end up being free, shared and commonly owned, says the theory. And it is right.

KARL MARX AND THE INFO-MACHINES

Let’s restate what Marx called the ‘law of value’. The price of everything in the economy reflects the total amount of labour used to make it. Productivity gains derive from new processes, machines, reorganizations – and each of these comes at a cost, in terms of the amount of labour it took to create it. In practice, capitalism escapes the tendency of innovation to shrink the labour content of the economy, and thus shrink the ultimate source of profit, because it creates new needs, new markets and new industries where labour costs are high, so there are more wages to drive consumption.

Info-tech is just the latest outcome of an innovation process lasting 250 years. But information injects a new dynamic. Because with info-tech you can have machines that cost nothing, last for ever and do not break down.

If somebody tried to sell the Bangladeshi factory boss a sewing machine that lasts for ever he would probably choke on his breakfast. However, he is quite happy to buy software. Software is a machine that, once built, will last for ever. Sure, it can be made obsolete by newer software, but the world is full of old software that – if the right hardware could be found to run it – could run for ever.

Once the design cost is incurred, the cost of producing software is reduced to the cost of the media it is stored on or flows through: the hard drive or the fibre network. That, plus upgrading it and maintaining it.

And these costs are plummeting exponentially. The cost of printing one million transistors on to a piece of silicon has fallen from a dollar to 6 cents in ten years. Over roughly the same period, the cost of one gigabyte of storage has fallen from a dollar to 3 cents; and the cost of a one megabit broadband connection has fallen from \$1,000 in the year 2000 to \$23 today. Deloitte, who did these calculations, describes the falling price of basic info-tech as exponential: ‘The current pace of technological advance is