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The Austrian economist, Eugen von Böhm-Bawerk argued against both the Ricardian labor theory of price and Marx's theory of exploitation. On the former, he contended that return on capital arises from the roundabout nature of production. A steel ladder, for example, will be produced and brought to market only if the demand supports the digging of iron ore, the smelting of steel, the machines that press that steel into ladder shape, the machines that make and help maintain those machines, etc. Advocates of the labor theory will point out that every step in that process, however roundabout, involves labor. But Böhm-Bawerk said that what they missed was the process itself, the roundaboutness, which necessarily involves the passage of time.
Roundabout processes, Böhm-Bawerk maintained, lead to a price that pays for more than labor value, even the labor value of all the process involved added together statically, and given any empirical standard for the latter. This makes it unnecessary to postulate exploitation in order to understand the return on capital.
Marx might respond that this did not contradict his understanding of prices, in which sectors of the economy which have higher " capital intensity" (greater roundaboutness) have higher prices (see below). The difference, it seems, between Marx and Böhm-Bawerk concerns perspective: for Böhm-Bawerk, roundaboutness explains entrepreneurial profits on the microeconomic level, whereas for Marx, a society-wide institutional explanation is needed. To him, roundaboutness explains only those profits of the more capital-intensive operations relative to less capital-intensive ones.
Furthermore, in Böhm-Bawerk's development of a positive theory of interest he said that workers trade in their share of the end price for the more certain and soon wages paid by the entrepreneur. In other words, he claimed that profits compensated the entrepreneur for the willingness to bear risk and to wait to receive income.
Critics of Böhm-Bawerk's theory argue that workers are often exposed to risks such as injury on the job, a more profound kind of risk than the merely financial risk that the entrepreneur takes. A capitalist entrepreneur also has a greater ability to diversify (to minimize risk) than does the laborer because the latter has only one main asset, i.e., labor-power. Further, when the entrepreneurs' risk-taking does not pay off, this cost can be shifted to workers as wage cuts and/or layoffs. The existence of the " reserve army of the unemployed" means that even if they are aware of these risks, they often have little choice but to take them. In the Marxian view, this argument means that entrepreneurs have no right to compensation for bearing entrepreneurial risk.
Böhm-Bawerk and other Austrian economists replied to such critics by claiming that they played upon the ambiguities of the term "risk," that specifically financial risk must be isolated in order to understand the production process. Furthermore, the fact that capital markets lead to the control and minimization of financial risk is a valuable development in itself -- an argument for, not against, the overall social efficacy of capitalism.
Some critics take another tack, observing that not all risk-taking seems worth rewarding: for example, the invention and promotion of "crack" cocaine or e-mail spam were clearly a matter of risk-taking entrepreneurship, yet both seem to have more social costs than benefits. This is the problem of external costs, a form of market failure which (if serious enough) encourages people to seek non-market solutions.
The most common interpretation of the LTV is as a theory of price determination, which makes Marx's theory roughly correspond to that of Ricardo. In this view, a commodity's price derives neither from its utility to the consumer (Marx's " use value") nor from supply and demand but from the labor that society has expended on its production. Early in volume III of Capital, Marx presents an analysis of the relationship between values and prices. Most read this as describing how prices can be calculated from given values.
The problems with Marx's "solution" to this mathematical problem have spawned a long debate concerning the " transformation problem." This problem of finding (or rejecting) mathematical formulae linking individual prices to individual values is central to the dominant interpretation of the Marxian LTV.
Even as "a simple theory of price" in which prices are directly determined by values, Marx's LTV does not deny the role of demand. Not only must each commodity have a use-value to its buyer, but demand and short-term supply determine its "market price" (p). Following the classical-school perspective, Marx saw each p as tending toward the "price of production" (Smith's "natural price") due to market forces. Prices of production (p*) are long-term average prices, seen as totally determined by costs. It was thus only in the long run that Marx denied the role of demand in determining relative prices (under competitive markets, with no land-rent).
A simple example shows that on the micro level, the p* cannot be proportional to values, even when pure competition prevails. Even before Marx presented his numerical examples exploring price/value relationships, David Ricardo had presented a numerical example of this fact.
1. Again measure values and prices in the same units, labor hours. Thus, the value/price contrast corresponds to Smith's distinction between labor-embodied values and labor-commanded values and Marx's distinction between "values" and " exchange values."
2. Assume that each p initially equals value so that for any given commodity, total profits are proportional to unpaid labor-time (surplus-value, S), total wages are proportional to paid labor-time (W), and the total amount of money invested by the capitalist is proportional to the value of the capital invested (K). This is the "simple labor theory of price" referred to above.
3. Suppose the ratio of unpaid labor-time to paid labor-time is the same for all commodities. This assumption reflects the tendency (when workers are not slaves or serfs and labor-power markets are competitive) for workers to move away from sectors with more exploitation, toward those with less. Thus, the rate of exploitation tends toward equality between sectors. This ratio is measured here by s = S/W (unpaid labor-time/paid labor-time).
4. But there is no reason why technical conditions of production will be the same for all commodities. Different proportions of labor and means of production are used in distinct production processes and for different commodities. To Marx, the " organic composition of capital" or OCC differs between sectors. For any commodity, measure this as k = K/W, the ratio of the total amount invested in "capital" to the total amount spent on paid labor. K includes raw materials and fixed capital purchased before a production process starts. An industry with high OCC is capital-intensive, i.e., is relatively roundabout.
5. If products were traded according to labor-values, different rates of profit will be received on the capital invested in different industries. The rate of profit, r, equals the total amount of profit divided by the capital advanced, or S/K. This implies that the profit rate equals
If s is the same for all commodities, while k varies, r differs between commodities.
6. This situation makes no sense in the real world of capitalism, even as conceived by Marx, in which firms and sectors are competing with each other, with capitalists seeking profits everywhere. Competition among industries should remove differences in profit rates. When able to do so, capitalists earning low r move their capital out of their industries, reducing supply and raising p there. They enter high-r sectors, raising supply and reducing p there.
7. Thus, market prices tend toward being equal to the p* which are proportional to long-term average costs and r is equalized between sectors. Since, according to the equation above, it is high k – or a high degree of roundaboutness – that depresses the rate of profit, the mobility of capital raises p in the high-k sectors, assuring capitalists a r equal to that of low k sectors. To Marx, this represents a redistribution of value and surplus-value between sectors.
This means that the commodities produced in high-k sectors command more labor than it took to produce them. This is Marx's take on the issue of capital intensity that Böhm-Bawerk stressed (see above ).
This in turn implies that the p cannot equal values. In the long run, they equal p*, but these latter differ from values — because they reflect profit-rate equalization. That is, the simple labor theory of price cannot be true while "equal exchange" is not the norm.
The above consequence of varying capital intensity has been central to critiques of Marx's LTV. Some see this as its reductio ad absurdum. However, Ricardo himself employed a "93 percent labor theory of value," believing that most of the time labor-values were a good guide for guessing relative prices and (after correcting for inflation) the progress of prices over time.
In general, the above shows that the simple "labor theory of price" cannot work exactly (100 percent) unless
Even if one or more of the conditions above applies, price/value deviations will arise if monopolies exist or if land has been appropriated as private property, so that land-rent income is received (beyond "normal" profits). In either of these cases, demand plays a role in determining long-term prices.
More complex labor theories of price (more complex mathematical relationships between values and prices of production) have been proposed — but then most, if not all, of them have been criticized severely and rejected. In 1969, Amit Bhaduri pointed out that the "transformation" problem of finding a mathematical relationship between individual prices and individual values has intractable difficulties that are mathematically identical to those seen in the famous "Cambridge" critique of Robert Solow's aggregate production function. Whereas the problem with Solow's model is aggregation from micro- to macroeconomics, one interpretation is that the problem with Marx's theory is disaggregation: in Capital, Marx starts from the whole of capitalism (values) and moves to the parts (prices). In neither case can one level of analysis be explained by the other by a mathematical relationship except under unrealistic assumptions. Instead, Marx might say that there is a dialectical connection between the two levels (whole and parts).
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