It should be stressed for the novice to this subject, all three volumes of Capital provide a scientific explanation, as Marx put it, of how the Capitalist system works from the perspective that labor is the underlying essence of all value. If one accepts the basic assumptions made early in Chapter 1 of Capital, Volume 1--that abstract labor is the source of value(1)--Marx's logic flows well, not only through Volume 1, but all the way through Volume 3.
If one is looking to fault Marx's economics based on the works of Capital, one will come up empty not only because Marx's logic is flawless, but as economist and former Marxist Thomas Sowell says, " ...Marx considered the idea of proving a concept to be ridiculous. Moreover, Engels had asserted...that one only proves one's ignorance of dialectics by thinking of it as a means by which things can be proved."(2)
However, there was one instance where Marx let his dialectical guard down, allowing for an empirical objection that would consign all of Marx's works for naught. Sowell himself touches upon the specific passage where Marx cornered himself, but doesn't appreciate the full ramifications of Marx's observation.
In the "The Poverty of Philosophy" (1847) Marx says, "In acquiring new productive forces men change their mode of production; and in changing their mode of production, in changing the way of earning their living, they change all their social relations. The handmill [a productive force] gives you society with the feudal lord, the steam-mill [a productive force], society with the industrial capitalist."(3)
Sowell argues regarding Marx's handmill/steam-mill analogy, "If read literally, these words suggest a one-way causation and explanation of given states of being rather than of transformation. But that is clearly inconsistent both with Marx's and Engels' own treatment of history and with the dialectical conception of reciprocal interaction. These words are perhaps best read as epigrams-and of the dangers of misunderstanding inherent in that writing style."(4)
Is Sowell correct? Was Marx merely being terse with his handmill/steam-mill analogy?
While Sowell is indeed correct that Marx and Engles viewed the unfolding of history as a "dialectical conception of reciprocal interaction", that observation does not answer the question: What comes first? The machinery, or new social relations, derived from machines, that interacts with the old social relations to produce the new hybrid social relations? Marx was emphatic that machines came first, then all else followed them. In his retort to Pierre-Joseph Proudhon's observation that the use of machines was a consequence of the division of labor,(5) Marx writes:
"Thus it is slapping history in the face to want to begin by the division of labor in general, in order to get subsequently to a specific instrument of production, machinery.
Machinery is no more an economic category than the bullock that drags the plough. Machinery is merely a productive force. The modern workshop, which depends on the application of machinery, is a social production relation, an economic category."(6)
The problem with this empirical observation is that before there was a steam mill there already existed an industrial capitalist society that not only contained the requisite industrial capitalist mode of production that manufactured the necessary constituent parts that went into the creation of the steam mill (there were many companies involved in the problem-solving for and manufacture of components that went into a steam engine), but this pre-steam mill society also contained an already sophisticated industrial capitalist labor force that made the constituent parts for the steam mill, not to mention built the steam mill itself. Contemporaneous with the industrial capitalist production of steam engines, there existed the production of the machines that the steam engines would power. In other words, the steam mill presupposes an already functioning industrial capitalist society! Marx's rebuke to Proudhon is a tautological response that also fails to recognize that a steam engine is made up of independently manufactured parts that predates the manufacture of a steam engine with those independently manufactured parts! Marx fails to mention this double inconsistency with his material "productive forces" empirical observation.
Simplified, Marx is speaking of the root cause for industrial Capitalism...the steam engine, but that beginning of industrial Capitalism only exists to the extent of (1) the already existing industrial Capitalist division of labor that manufactured the component parts for the steam engine; (2) the already existing industrial Capitalist capital goods/intermediate goods industries that manufactured the constituent parts that went into the construction of the steam engine; (3) the already existing industrial Capitalist capital goods/intermediate goods industries that manufactured the machines that the steam engine powers; and (4) an already existing industrial Capitalist division of labor that manufactures those machines powered by the steam engine!
When the first steam-mill was completed supposedly, according to Marx, 'giving' a society with industrial Capitalism, in fact industrial Capitalism, and an industrial Capitalist division of labor, already existed, and would have to already be in existence otherwise there could be no steam-mills and the machines they were created to power!
Marx behaves like a child throwing a tantrum: Machines come first, then all else follows. Why? Because Marx said so, even though the historical record says otherwise!
In fact, and unknown to Ricardian economists or Marx, industrial Capitalism couldn't have emerged without the conscious decision of nations to allow for the rise of interest rates to free market heights, abandoning low interest rates policies, such low interest rates policies making possible the Mercantilist pre-industrial Capitalist era. Only with higher, market-based interest rates is it possible to accumulate the necessary large quantities of capital for industrial enterprise.
During the Mercantilist era low interest rates ensured that only consumption-based investments could take place, such investments requiring relatively little capital expenditures, such low capital expenditures being a function of the expected return on the investment, which return is based on the low interest rate policy being followed by Mercantilist nations. Industrial ventures, on the other hand, require large expenditures of capital, such amounts only made possible by a higher rate of return that can recoup the larger capital outlay, a higher rate of return that is made possible only with higher, market-based, interest rates.
(see first comment for available links to titles cited)
1. Capital, Karl Marx, p.27.
2. Marxism: Philosophy and Economics, Thomas Sowell, p.109
3. The Poverty of Philosophy, p. 122 (takes into account the changes and corrections introduced by Marx into the copy presented to N. Utina in 1876).
4. Marxism: Philosophy and Economics, Thomas Sowell, p.56.
5. "Division of labor, then, is the first phase of economic evolution as well as of intellectual development: our point of departure is true as regards both man and things, and the progress of our exposition is in no wise arbitrary." - The Philosophy of Poverty, Pierre-Joseph Proudhon (1847).
6. The Poverty of Philosophy, p. 149 (takes into account the changes and corrections introduced by Marx into the copy presented to N. Utina in 1876).
Revised Addendum: Formulated on February 25, 2014, 10:30 AM EST
Proof that Marx's Law of Value (which posits that labor is the sole source of value, imputing that value into commodities) is in error:
If all the machines created throughout the history of man were to have been kept within the confines of the minds of their creators, that is never manufactured, would such machines be imputed with value in a Marxist sense? Yes, they should equal the POTENTIAL value of their labor.
Now, since actual labor is required for there to be potential value, and there is no actual labor to speak of, then the potential imputation of labor value into machines/commodities is zero, and therefore Marx's Law of Value is in error.
In fact, the proof affirms that imputation of a commodity's value can't be anything physical, it must be subjective...that is in the mind of the observer.
Addendum (July 18, 2014):
The following nicely illustrates how net (new) investment (productivity increases) took place before medium of exchange, while (1) also illustrating how such net (new) investments spurred trade between separated communities; and (2) clarifying Marx's confusion as to what came first to alter social relations, (i) machines; or (ii) something else preceding machines...
Tribe A saved more by looking for food less, placing that saved time into creating a net that would increase the catch of fish. We can say that Tribe A has a greater productive edge than does Tribe B, whose members are still using sharpened sticks to catch fish--very laborious and relatively unproductive.
Now Tribe A decides, due to its higher productivity/wealth, it can afford to save more time, adding this saved time to the saved time it used for making fishing nets, and build a boat that will allow their nets to catch even more fish. Being busy building boats, Tribe A allows Tribe B to build the nets--a less productive venture than the new boat-building venture is. Tribe A's greater productivity thanks to fishing boats (and greater wealth thanks to fishing boats) allows for more children, increasing the tribe's population, allowing for a larger labor supply in the near future that will be available for procuring other innovative, labor-saving inventions.
In the modern economy the money we save is the "saved time" that Tribe A used to construct nets/boats, but since the rate of interest is being intentionally kept low by the Federal Reserve, the Bank of England, the European Central Bank and the Bank of Japan, there can be no new capital formation (money that's used for new long-term productive investments) in Western economies (nor Japan) for new productive ventures, because the lure for such new investments--the higher rate of return that higher, market-based, interest rates offer--is non-existent; the central bank mandated low interest rate policy won't cover the loan on the massive outlay of capital that net (new) productive projects require.
By the way, notice what comes first in the above illustration, contradicting Marx's claim that the "material productive forces" (machines) are the INITIAL venue by which societies alter their values/relationships...people had to "save time" FIRST by curtailing their quest for food.* Now in the modern economy, where money is used, FIRST comes the necessity of market-based interest rates that allows for the accumulation of capital that THEN produces the labor-saving machines! The higher the market-based interest rate, the better for capital accumulation.
*Incredibly, Marx was unaware (or more likely, deluded himself into unawareness) of this critical sequence.