The Value of a Thing Is Not the Labor in It, and Menger Answered Marx

Make a mud pie. Make it with great care, for ten hours, using the finest mud and the highest craftsmanship. Take it to the market. Notice that nobody wants it.

If the labor theory of value were simply true, you would now be rich. Ten hours of skilled labor are embodied in that pie, so it should be worth ten hours of wages. It is worth nothing, which tells you that something other than labor decides what things are worth. That something is the subject of one of the great intellectual rescues of the nineteenth century, and it matters, because the labor theory of value is the foundation under the claim that profit is theft. Knock out the foundation, and the claim falls. Let me show you how it was done.

The theory at its strongest

A fair debate begins by stating the other side the way its best defenders would. Karl Marx published the first volume of Capital in 1867. Its starting point is an inheritance from the classical economists, Adam Smith and David Ricardo, who had both pointed to labor as a source of value. Marx sharpened the idea into a system.

Here are its steps.

1. Goods have a use-value and an exchange-value. Use-value is how useful a thing is. Exchange-value is what it trades for.
2. Exchange-value must rest on something common to all goods. A coat trades for twenty yards of linen, so the two must share some measurable property. That, Marx argued, is human labor.
3. The measure is "socially necessary labor time." Not the actual hours a clumsy worker takes, but the hours needed under average conditions of skill and productivity. This is Marx's guard against the mud pie: labor that makes something nobody wants does not count.
4. Labor power is itself a commodity. The worker sells his capacity to work, and like any commodity it sells at its cost of production, which is roughly the cost of keeping the worker alive and able to work.
5. But labor can create more value than its own price. If a worker's wage equals the value of four hours of labor, but he works eight, the other four hours produce what Marx called surplus value.
6. The capitalist keeps the surplus. That, in Marx's account, is the source of profit, interest and rent. Capital does not create value. It extracts it. Profit is unpaid labor.

That is a coherent system, and it is why the theory has had such force. It offers a moral conclusion, exploitation, from an economic premise. If it were true, every business would be a quiet robbery. The question is whether the premise holds.

Enter a Viennese professor

Carl Menger was born in 1840 in Galicia, a province of the Austrian empire. He trained in law, worked for a time as a journalist and civil servant, and in 1871 published Grundsätze der Volkswirtschaftslehre, translated as Principles of Economics. In 1873 he joined the faculty of the University of Vienna, and went on to found what came to be called the Austrian school of economics. We tell that story in The Austrian school in plain words, from Carl Menger to Friedrich Hayek.

Menger was not alone. In the same period, William Stanley Jevons in England (1871) and Léon Walras in Switzerland (1874) reached related conclusions by their own routes. The result is known as the marginal revolution, and its core claim overturned the labor theory of value: value does not come from the labor put into a good. It comes from the use a person expects to make of it, at the margin.

The central idea: value is subjective and marginal

Define the two key words.

Subjective means that value is not a property sitting inside a good, like its weight. It is a judgment people make about how well a good serves their wants. The same loaf is worth more to a starving man than to a well-fed one. The value is in the relationship between the person and the thing.

Marginal means that the relevant question is always about the next unit, the one you are deciding to gain or give up. You do not value "bread" in general. You value one more loaf, given how many you already have.

Menger illustrated the point with a farmer and his sacks of grain, a story worth retelling because it is the whole theory in miniature. Suppose, as in Menger's example, a settler has a small stock of grain, say five sacks. The first sack he needs to survive. The second keeps him strong. The third feeds his poultry. The fourth goes to make brandy. The fifth he uses to feed parrots, for amusement.

Now ask: what is any one sack worth to him? Not the value of the most important use. If he lost one sack, he would give up the least important use, the parrots. So each sack is worth, to him, the value of the parrots. That is the marginal value. The sack that keeps him alive is not worth more than the sack that feeds the parrots, because they are interchangeable. Lose any, and the parrot goes hungry.

Put that in a sentence: the value of a unit is set by the least important use it serves.

The diamond and the water

Adam Smith had posed the famous puzzle. Water is essential to life and nearly free. Diamonds are of little practical use and cost a fortune. How can that be? Smith noted it and left it unresolved, and the classical economists in his wake reached for labor as the explanation: diamonds take more labor to find.

Menger's marginal analysis solves it cleanly. The question is not "how valuable is water as a whole compared with diamonds as a whole?" It is "how valuable is one more unit of each?" Water is abundant, so the next gallon serves a trivial use, like washing the car, and is worth little. Diamonds are scarce, so the next one serves a high-ranked want. The paradox dissolves once you notice that we never choose between all the water and all the diamonds. We choose between the next unit of one and the next unit of the other.

And now the mud pie makes sense. It took ten hours of labor and is worth nothing because no one has a want it serves. Labor creates cost. Wants create value. Cost matters, because a producer who cannot recover it will stop, but it follows value and does not make it.

Answering Marx point by point

Return to Marx's chain and see where it breaks.

1. Premise 2 is false. Marx argued that exchange-value needs a common property, and labor is that property. But there is no such requirement. Two things can trade because each party values what he gets more than what he gives. A trade is not an exchange of equal quantities of anything. It is an exchange of unequal valuations, which is why both sides gain. If the values were equal, there would be no reason to trade.
2. The "socially necessary" patch rescues the theory only by smuggling demand back in. To say that labor counts only when it produces something people want is to admit that wants decide what labor is worth. The mud pie shows the theory's dependence on exactly what it denies.
3. Wages are paid for what workers produce, discounted for time. Menger's student Eugen von Böhm-Bawerk, in Karl Marx and the Close of His System (1896) and his work on capital and interest, argued that the apparent gap between wages and product reflects time. A worker paid today for goods that will be sold next year is being paid in advance. Wages come now, and the sale comes later. The difference between the two is the price of waiting and of risk, which is what capital provides.
4. Entrepreneurs earn returns because they bear uncertainty. A founder commits money before he knows whether anyone will buy. If the venture fails, he loses; if it succeeds, he profits. The worker who takes a fixed wage has been spared that risk, and the price of the spared risk is the portion of the return that goes to the owner. That is not unpaid labor. It is payment for a different service, and the service is not imaginary: the world is full of failed firms whose owners absorbed the loss.
5. Capital earns a return because it raises productivity and takes time to build. Someone must save, defer consumption and build the tools, the factory or the software that makes workers more productive. A worker with a tractor grows more than one with a hoe. Why should the person who supplied the tractor get nothing? The return on capital is the reward for foregoing consumption today, and for risking the funds.

That is the answer. It does not say wages are always fair or that every business is virtuous. It says that profit has an explanation that does not need theft.

The best objection, answered

Give the other side a fair hearing.

Subjective value is a theory of consumer wants, and it ignores power. Workers do not bargain on equal terms with owners. A person who needs a paycheck cannot hold out like a person who owns a factory. Even if profit has an explanation in time and risk, the distribution of rewards still reflects who holds the cards. And Menger's account says nothing about whether the resulting outcomes are fair.

That is a serious point, and three answers are in order.

1. It concedes the economic point. Once the objector agrees that value comes from wants and that profit rewards risk and waiting, the claim that profit is stolen labor is gone. What remains is an argument about bargaining power, which is a different, more modest claim.
2. Bargaining power depends on competition. A worker has more power when many employers want him. The best protection for workers is a labor market with many bidders and the freedom to start a business, and the worst is a licensed, regulated one where incumbents are protected. We argue that in big companies love the regulations their small rivals cannot afford.
3. Fairness is a different question from value. Menger did not claim that markets deliver cosmic justice. He explained prices. A conservative can add that markets sit inside a moral order, a point made in Markets Reward Serving Strangers, and That Is a Moral Achievement, and that charity, family and church supply what price cannot.

The objection is right that power matters. It is wrong that power rescues the labor theory.

Why it still matters

You might think that an argument from 1871 is a museum piece. It is not. The labor theory of value is alive wherever people say that profit is inherently suspect, that prices should reflect "the true cost," or that a company's gains must have come out of its workers' pockets. It stands behind schemes to set wages and prices by committee, a failure covered in a thought experiment where every price in town is set by a committee.

The subjective theory also gave Menger's heirs their most powerful weapon. If value lives in the minds of millions of people and shifts with each marginal choice, no planner can know it. That was Mises's point in 1920, in Mises Showed in 1920 That Socialism Cannot Calculate a Single Price: without market prices, which register those countless judgments, there is no way to calculate whether a factory should be built or a mine closed. The practical record of centrally planned economies, tested against eight socialism myths tested against the countries that actually tried it, bears him out.

Finally, the theory restores something the labor theory erases: the dignity of the customer. In a market, every price is a vote cast by a free person about what he wants. Profit goes to those who serve those wants well. profit is a signal, not a sin, and what a loss tells a company shows what that means in practice.

The case in brief

1. Marx's labor theory of value, set out in Capital (1867), holds that goods are worth the socially necessary labor they embody and that profit is unpaid labor, or surplus value.
2. Carl Menger's Principles of Economics (1871), alongside Jevons and Walras, showed that value is subjective and marginal, set by the least important use a unit serves, as in his farmer and five sacks of grain.
3. The marginal analysis resolves the diamond-water paradox and explains why a mud pie made with hours of labor is worth nothing.
4. Profit and interest are payments for risk, uncertainty and waiting, as Böhm-Bawerk argued, and they do not require exploitation.
5. The strongest objection concerns bargaining power, which is real but is a smaller claim than theft, and the best remedy is competition.

What you can do: pick one price you pay this week, whether for groceries, gasoline or a haircut, and write down what the seller risked and waited for before you had to pay it.