William J. Barber
A History of Economic Thought
Penguin Books, Harmondsworth, England, 1967.
PART ONE: CLASSICAL ECONOMICS
Chapter 1
Adam Smith and the Framework of Classical Analysis
pp. 23 - 54
Page
1. Adam Smith 24
2. The definitional basis of The Wealth of Nations 27
3. The analysis of value 30
4. The analysis of income distribution 38
5. The analysis of capital accumulation 45
6. Adam Smith and economic policy 47
7. The achievements of Adam Smith 50
Notes 51
The Wealth of Nations has suffered the fate accorded to most classics: it is more talked about than read. To the popular mind in the mid twentieth century, Smith's work is now commonly associated - not always accurately - with observations on economic policy. Though Smith was clearly an opponent of ‘the mercantile system’ and of the apparatus of privilege and state protection supporting it, one may reasonably doubt whether those who pigeon-hole the man solely as an apologist for unregulated business enterprise have fully appreciated such passages as the following:
People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices...1
The interest of dealers . . . in any particular branch of trade or manufactures, is always in some respects different from, and even opposite to, that of the public .... The proposal of any new law or regulation of commerce which comes from this order, ought always to be listened to with great precaution, and ought never to be adopted till after having been long and carefully examined, not only with the most scrupulous, but with the most suspicious attention. It comes from an order of men, whose interest is never exactly the same with that of the public, who have generally an interest to deceive and even to oppress the public, and who accordingly have, upon many occasions, both deceived and oppressed it .2
At the same time, Smith saw manufacturers and ‘projectors’ as the carriers of progress and he urged that they
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be afforded more space in which to manoeuvre. Much of his practical message was that institutional restrictions (whether legislated by governments or rooted in parochial traditions) were unhealthy. They cramped the rate at which a new and more productive industrial era could mature. Smith's vision of the ‘industrial revolution’, however, was still remarkably circumscribed. He wrote more about pin factories than about iron fabrication and failed to appreciate fully the pace at which technological change was occurring during his lifetime.
Despite its impressive impact on popular attitudes (and thus, indirectly, on economic policies) Smith’s work deserves to be remembered primarily as a highly ingenious contribution to economic theory. The Wealth of Nations brought to the foreground the issues that were to dominate the attention of economists for the next three quarters of a century and which, for that matter, have never lost their pertinence. This aspect of his thought, set out most fully in the first two of the five books into which his treatise is divided, calls for careful inspection. With a degree of comprehensiveness unrivalled by his predecessors he here formulated the grand design of an economic order in which all the parts could be seen in relation to one another. His views on policy, however; were derivative and cannot be adequately understood if detached from their theoretical moorings.
1. ADAM SMITH (1723 90)
Smith was born to a Lowland Scots family of modest circumstances and reared by a mother who was widowed a few months before his birth. He early distinguished him self as a student and, at the age of fourteen, entered the University of Glasgow. While there, he studied under the colourful Professor Hutcheson, the man credited with coining the phrase ‘the greatest happiness for the greatest number’, whose naturalistic approach to moral questions and espousal of religious and political liberty clashed
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with prevailing theological doctrine. Smith was later to count Hutcheson among his important intellectual creditors.
In 1740 Smith was elected to the Snell Exhibition, a scholarship awarded to promising Scotsmen for continued .study at Balliol College, Oxford. He was to spend the next six years of his life there. Despite the duration of his stay he found the Oxford academic atmosphere far from congenial. He was not a popular figure and did not get on well with fellow students or with his teachers. He found ,space in The Wealth of Nations to record his judgement on the latter: ‘In the University of Oxford, ,the greater part of the public professors have, for these many years, given up altogether even the pretence of teaching.’ 3 This state of affairs, in his view, was but a manifestation of a general economic principle: that when financial rewards were divorced from criteria of performance, neglect of duties was likely to result. 4
Smith had originally been sent to Oxford with the expectation that he would enter holy orders. His sceptical turn of mind and sympathy for the works of David Hume (an attachment that strained his relationship with the Balliol tutors) ruled out this career. Upon his return to Scotland in 1746 he sought a teaching position - a search fulfilled five years later when his old university, Glasgow, called him to fill the chair of Logic. In the following year, he shifted to the chair Hutcheson had once held as Professor of Moral Philosophy.
The major fruit of this period in his life was The Theory of Moral Sentiments, published in 1759. This work, which has little distinction as a contribution to philosophy, was a preliminary attempt on Smith’s part to formulate the character of a ‘natural order’ of society. Human conduct was analysed in terms of three pairs of motives: self-love and sympathy; the desire to be free and a sense of propriety; the habit of labour and the propensity to exchange. In Smith's view these natural sentiments acted as checks and balances an one another and
25 Index
supported a social order of natural harmonies in which, each man, when left to pursue his own interests, unconsciously promoted the common good. Other themes, later to be worked out more fully in The Wealth of Nations,: emerged in his Glasgow lectures. Already he was arguing that ‘the division of labour is the great cause of the increase of public opulence, which is always proportioned to the industry of the people, and not to the quantity of gold and silver, as is foolishly imagined.’ 5
In 1762 Smith resigned his professorship to accept a position as tutor to the son of the Duke of Buccleuch. Quite apart from its financial attractions this appointment brought opportunities for continental travel and made few demands on his energies. He wrote from France to his friend, David Hume, on 5 July 1764: ‘I have begun to write a book in order to pass away the time. You may believe I have very little to do.' 6
The incubation period of The Wealth of Nations was extended. Writing from Edinburgh in 1772, Hume, who had been led to believe that the work was near completion in 1769, upbraided Smith:
I should, agree to your Reasoning if I could trust your Resolution. Come hither for some weeks about Christmas; dissipate yourself a little; return to Kirkaldy; finish your work before, autumn, go to London, print it, return and settle in this town, which suits your studious independent turn even better than London. Execute this plan faithfully, and I forgive you.. 7
Ultimately, The Wealth of Nations appeared in 1776.
Smith spent the last thirteen years of his life as His Majesty's Commissioner of Customs for Scotland. He is reported to, have discharged his administrative duties competently. It is one of those ironies of the times that a man who had devoted a substantial part of his intellectual, activity to producing arguments favouring the promotion of free trade and the minimization of governmental interference in economic affiars should have ended his days as the beneficiary of such patronage.
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2. THE DEFINITIONAL BASIS OF THE WEALTH OF NATIONS
The central focus of Smith’s analysis was stated clearly in the full title of his work: An Inquiry into the Nature and Causes of the Wealth of Nations. Put in more modern terms, he .was concerned with developing a theory of economic growth.
Smith announced his major explanation for economic growth in the early pages of his work with a phrase that has since become the stock in trade of economists – ‘the division of labour’. This expression has a deceptive simplicity. Smith employed it in two quite distinct senses. The first referred to the specialization of the labour force accompanying economic advance that brought with it the ‘greatest improvement in the productive powers of labour, and the greater part of the skill, dexterity, and judgement with which it is any where directed, or applied . . . .’8 The full benefits of. the progressive sub-division of tasks were available, however, only to a society in which production for exchange could take place. The capacity of a subsistence economy to generate these output raising innovations and adaptations was severely restricted. From these considerations it followed that the division of labour was 'limited by the ‘extent of the market’ 9 and that measures widening the market - whether geographically (e.g. through improvements in transport and communication) or economically (e.g. through the removal of restraints on trade) - were in the general interest.
Smith's interpretation of ‘the division of labour’ was not confined to job specialization. It also referred to the division of the labour force between those ‘employed in useful labour . . . and those not so employed 10 The ‘division of labour’ in this second sense - which referred to the allocation of the labour force between various lines of employment - played an important role in his analysis of capital accumulation and of the ‘progress of
27 Index
improvement’ (as Smith was often to describe economic growth). The distinction he had in mind is one which modern readers are likely to find perplexing. Nowadays, economists are reluctant to stand in judgement over particular types of jobs, declaring some to be ‘productive’ and others to. be ‘unproductive’. They prefer to follow the market’s guidelines by regarding labour as productively employed whenever there is a buyer for its services; in short, the gainfully employed population is by definition, productive.
Smith, on the other: hand, was prepared to divide the working population into. two distinct categories. The basis for this segregation can only be understood in relation to his preoccupation with the process of economic expansion over a prolonged period of time. From such a perspective it can be argued - though it is by no means as self-evident as Smith appeared to believe - that differing allocations of the labour force have quite different implications for economic expansion. As he viewed the matter, workers engaged in certain occupations were more likely to promote the advancement of output in the future than those employed in others. He developed the point by asserting that the ‘productive’ employments must meet two tests: (1) that they led to the production of tangible objects, a condition prerequisite to accummulation; and (2) that they give rise to a ‘surplus’ that could be made available for future re-investment. For most practical purposeshe equated ‘productive’ employments with those in which labour worked with capital.
In Smith’s scheme of things the line dividing ‘productive’ from ‘unproductive’ employments was not regarded as a value judgement but as an analytical distinction of fundamental importance to the study of long-period economic change. He was, in effect, giving a fresh twist to the distinction used by the Physiocrats before him who had maintained that agriculture was the. only ‘productive’ (or surplus-generating) economic activity. It is worth noting that, some modern economists, despite an uneasi-
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ness when doing so, have adopted a similar practice when examining the problems of underdeveloped economies. They often describe part of the working population in these areas (most particularly persons engaged in traditional agriculture, but often also in certain services) as ‘disguisedly unemployed’ - i.e., though. working, they make no contribution to the social product.
The implications of Smith’s definition of ‘productive’ also found their way into his interpretation of the national product. Concerned as he was with analysing the changes in an economy’s output over extended time periods, he was obliged to operate with a concept that could serve the function now performed by calculations of the national income. In fact, Smith’s usage of the term ‘wealth’ can; with one important qualification, be translated into modern terminology as ‘national income’. The point at which Smith and today’s national income accountants in Western countries part company turns on the definition of ‘productive’ activity. In Smith’s view, only the outputs of the productive employments of labour should count in calculations of the social product. Virtually all ‘service’ activities were excluded, on the grounds that they failed to yield either tangible products or reinvestable surpluses. 11 This definition also reinforced Smith’s general attitude towards a wide range of policy issues. It followed that all activities of government were unproductive as well as:
… some of the gravest and most important, and some of the most frivolous professions: churchmen, lawyers, physicians, men of letters of all kinds; players, buffoons, musicians, opera-singers, opera-dancers, etc. 12
Smith would not deny these groups an income for services rendered. He merely wished to insist that their efforts did not help to make society richer tomorrow.
It would be tempting to dismiss this scheme of classification as nothing more than an expression of a misguided ‘materialist’ bias. This view, however, was not
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unique to Smith. All of the major figures of classicism worked with a similar notion. In the modern world survives in Soviet bloc countries, where it influences the preparation of national income statitsics – a phenomenon bearing witness to the classical mould of much of Marxian thought.
3. THE ANALYSIS OF VALUE
The emphasis Smith assigned to the market as a regulator of the division of labour called for further probing into the nature of the economic process and, in particular, into the manner in which economic value was determined. In this connexion, his opening move was to draw a sharp line of demarcation between ‘value in use’ and ‘value in exchange’. He found only the latter economically interesting. Some items (his examples were water and air) have vast utility but are not exchanged, while others (e.g. diamonds) possessed in his view little utility though they clearly could command a great deal in exchange. Smith mapped out a three stage programme for his investigation of the problems of economic value: (1) to identify the ‘real’ measure to value; (2) to isolate its component parts; and (3) to analyse the factors that might account for a deviation of the ‘market price’ from the ‘natural price’. 13
From his own characterization of his analytical targets it is readily apparent that Smith was raising questions some distance removed from those most economists would now consider pertinent. A mid-twentieth century economist asked to state the ‘value’ of a particular commodity, would normally proceed by trying to establish the price the market was prepared to pay for it. Writers in the classical tradition, on the other hand, were at pains to insist that price and value could not be so readily collapsed into one another. ‘Value’ was viewed as independent of the market's whims. Nominal (or market) prices might. fluctuate, but value remained constant and invariant.
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Many later commentators have treated this approach as superfluous metaphysics. Yet most classical writers set great store on the distinction and, by their lights, with good reason. Smith expected his account of value to do two jobs. In the first place, he said that it provided at least a partial explanation of the behaviour of market prices; further (and more important to the general thrust of his reasoning), it promised to provide a basis for measuring aggregate economic change over an extended period. As market prices were too volatile to be satisfactory in measuring inter-temporal changes in output, a stable and invariant standard was sought. This point has caused considerable confusion, partly because the classical approach is quite alien to thought patterns now conventional and partly because classical writers were not themselves always careful to distinguish between the various uses to which they put their concepts of value.
If value was distinct from price, how then was the former established? Smith asserted that labour was ‘the measure of value’. This was readily compatible with the themes he had already developed; moreover, it was in harmony with intellectual currents of his time. At least since Locke an influential strand of English thought had been disposed to regard labour as a ‘basic’ or ‘original’ contributor to the economic process.
The assertion that labour provided the ‘measure of value’ was not, however, free from ambiguity. At least two divergent interpretations of the relationship of labour to value are possible. The first might base the value of a commodity on the quantity of labour required for its production. Smith entertained this interpretation, but he chose to apply it only to the circumstances of a hypothetical ‘early and rude’ society preceding the appropriation of private property and the accumulation of capital. With this situation in mind, he wrote:
If among a nation of hunters, for example, it usually costs twice the labour to kill a beaver which it does to kill a deer, one beaver should naturally exchange for or be worth two
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deer. It is natural that what is usually the produce of two days’ or two hours' labour; should be worth double of what is usually the produce of one day's or one hour's labour.14
He shifted his ground when considering more complex institutional settings. Value could then no longer be reckoned simply in terms of direct labour inputs; other factors - in particular, land and capital - now contributed to the production process, and their contribution could not so readily be reduced to labour units. At this point Smith abandoned the ‘labour content’ view and asserted that ‘command over labour’ was the appropriate measure of value.
The significance of this measure can best be conveyed in a hypothetical illustration. Let us suppose that 600 units of labour input 15 are required to produce a particular volume of output. Further, let it be assumed that landowners and capitalists together require a remuneration equal to the wage bill before making available the services of the factors of production they control (in other words, profits plus rents must equal the wage bill as a condition for production). By Smith's reasoning the value of the total output would be 1200 labour units - 600 units of direct labour input plus 600 labour units that the recipients of rents and profits could ‘command’.
This circuitous procedure at least salvaged a measurement of output in terms of labour units. Moreover, in Smith’s view it yielded insights into the manner in which prices were actually formed. The key to an understanding of Smith’s notion of this mechanism lies in his interpretation of the components of the ‘natural price’ (i.e. value). The natural price of commodities, he argued, was compounded from three ingredients: wages, rents {the return to owners of land), and profits (the return to the owners of capital). The size of each of these shares also had a natural level. Smith blended these concepts as follows:
When the price of any commodity is neither more nor less than what is sufficient to pay the rent of the land, the wages
32 Index
of the labour, and the profits of the stock employed in raising, preparing, and bringing it to market according to their natural rates, the commodity is then sold for what may be called its natural price.
The commodity is then sold precisely for what it is worth, or for what it really costs the person who brings it to market . . . 16
The market price, however, might not conform to these specifications. Should it fail to do so, the forces of competition were expected to push the market price toward the natural price.17 Without using the term, Smith was clearly groping for a concept later economists have described as ‘equilibrium’. He came close to the crucial idea when describing the convergence of natural and actual prices as ‘this centre of repose and continuance . . .’ 18
These formulations, though quite innocent in appearance, contained an important social message. If it was accepted that the natural price represented the real worth of a product, it followed that any practices - whether initiated by governments (in such forms, for example, as restrictions on trade or the award of privileges to chartered companies) or by private interests (in such forms as monopolies or statutes of apprenticeship) - tending to thwart the market's behaviour were socially reprehensible. The outcome would be far better, he maintained, if affairs were guided by the market's ‘invisible hand’.
Useful as this by-product of Smith’s handling of value has to his larger argument, it was by no means the major influence on the shape of his theoretical structure. Of greater importance was his interest in devising a technique for measuring changes in the national output. To an analyst concerned (as Smith was) with the problem of economic expansion over extended periods of time, it was obviously important to be able to establish whether or not growth had, in fact, occurred. This required a technique for eliminating the distorting effects of price variations. In more modern terminology: the problem called for an index number or its equivalent.
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At first glance it appeared that Smith's ‘command over labour’ formulation provided a solution to this index number problem. It implied that comparative statements could be made about changes in aggregate output between two points in time by stating total output in terms of the number of labour units, it could purchase. As a first approximation, this exercise could be performed dividing the total output, expressed in money terms, by the basic wage. If the result in period 2 exceeded that for period 1, it could be asserted that growth had occurred; moreover, the amount of change in the economy’s total output could be established.
But this procedure, on closer inspection, did not fully live up to its initial promise. If wage rates changed between periods 1 and 2, the results would no longer be comparable, unless it could also be assumed that all other prices and income shares had changed in the same proportion.19 Otherwise conclusions derived from Smith’s formula could be quite misleading; if, for example, wages fell while other prices and income shares remained the same, output (expressed as command over labour) would appear to have expanded even when no change in production had actually occurred. In parts of his argument Smith seemed to protect himself against this perplexity by taking the position that the natural wage rate tends to be stable for prolonged periods. This view, however, conflicted with notions advanced elsewhere in The Wealth of Nations on the course of wages during the progress of improvement.
Another difficulty also confronted this formulation. It could not conveniently deal with the case in which the productivity of labour increased (i.e. when the same amount of labour input produced a larger volume of output). In this situation the total wage bill required for the production of a targeted level of output would be smaller than had formerly been the case; even if wage, rated were constant. Should a reduction in the price of outputs then follow (not unlikely in such circumstances),
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the command-over-labour measurement would convey the impression that total output had shrunk when, in fact, it had grown. Implicitly Smith protected himself against this objection by assuming that costs of production (and with them the income share-out between the various classes) would not vary with changes in the volume of output produced by individual firms. Thus, far example, the cost per pair of shoes would be the same in a plant equipped to produce 100 pairs of shoes per day as in a plant producing ten pairs per day.
This view has been invalidated by later experience. It has since been abundantly demonstrated that in many lines of production unit costs are substantially reduced when high technologies are applied in large concentrations. In the infancy of industrialism, when the economic universe was dominated .by small-scale producers, it was not altogether implausible. Smith, while neglecting the influence on productivity of variations in the scale of operations of individual producers, was aware that expansion in the economy as a whole would generate important gains in productivity. As the scale of the economic system grew, the division of labour would be extended bringing benefits to all. Smith appears to have thought that the effects of this gain in productivity would be fairly uniformly distributed throughout all productive branches.
If Smith encountered some awkward stumbling blocks in his attempt to devise an invariant standard for measuring economic change, the problems he grappled with were still real and important. Similar issues persist in modern analyses of economic growth. For his part, Smith pursued the problem even further by trying to devise a procedure that would be convenient for statistical purposes. Though he consistently maintained that ‘command over labour’ was the conceptually correct approach, he recognized that it might be cumbersome to apply. He ultimately concluded that the availability of food grains - in his terms ‘corn’ - might, for most practical purposes, be regarded as a proxy. This matter could be more readily
35 Index
established empirically. Corn, in his view, was the main component of subsistence and its availability was a precondition for the effective exercise of a command over labour.
In Smith's hands the appeal to labour as a basic measurement of value underwent one further variation. He announced the theme in the following passage:
Equal quantities of labour, at all times and places, may be said to be of equal value to the labourer (italics added). In his ordinary state of health, strength and spirits; in the ordinary degree of his skill and dexterity, he must always lay down the same portion of his ease, his liberty, and his happiness. The price which he pays must always be the same, whatever may be the quantity of goods which he receives in return for it. 20
The constancy referred to here implied a stability in the sacrifice workers underwent when foregoing leisure for the toil and trouble of work. The realism of this assumption over prolonged time periods may be open to challenge: an increasing specialization of jobs and growth in their variety in a changing economy, as well as the adjustments in wage scales, may well alter the irksomeness of work. Even so, Smith was drawing attention to a highly relevant point that now receives little direct attention in the analysis of long period economic change: namely, that the extent of economic improvement should be judged not solely by changes in the size of the total bundle of goods but also by the effort required to produce the bundle. In this version of Smith’s ‘labour as the measure of value’ economic improvement could be deemed to have occurred when a unit of labour input brought command over a larger quantity of goods.
Smith’s labour approach to the analysis of value has been severely criticized by later schools of economists. To one group of writers its fatal shortcoming was that it did not offer a full account of the determination of prices, and, most particularly, that it neglected the demand side of market behaviour. 21 This criticism would carry more force had Smith sought to produce a systematic analysis
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of market price formation. But in fact this objective was peripheral to his main programme. He was more concerned with forging concepts that might provide leverage on the problem of measuring economic change over prolonged periods. The materials for developing a clearer analysis of the formation of short-term market prices were at his disposal. Concepts of utility and demand (which were to be used for their purpose by a later school of thought) had been part of the teaching he absorbed from Hutcheson. He chose to reject this orientation toward value theory, presumably because he regarded it as lacking relevance to his central purpose.
Another and more serious charge can be levelled against Smith’s approach. It concerns an inconsistency in his treatment of labour units. The labour force, as he recognized, was not homogeneous; 22 some of its members were more skilled (and hence more productive) than others. How were these discrepancies to be reduced to a common denominator? Smith replied that an adjustment was provided ‘not by any accurate measure, but by the higgling and bargaining of the market, according to that sort of rough equality which, though not exact, is sufficient for carrying on the business of common life’. 23 In other words, wage differentials established in the market place supplied the basis for reducing the various units of labour input to a common standard; an hour of unskilled labour might be taken as a standard unit while an hour’s labour by a worker paid twice as much would be worth two units. It may well be asked: if the market test is sufficient for weighing the units in which value is measured, why cannot the same procedure be applied to the valuation of output? The whole problem of the distinction between value (natural prices) and actual prices would then vanish. Smith’s caveats about approximations provided no escape from this logical trap.
Though it has become fashionable for modern economists to abuse any ‘labour theory of value’, a more charitable reading would be appropriate. After all, are
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not intellectual operations of much the same sort performed nowadays when economists assume in their projections of growth rates that prices will remain stable, or when comparative statements about the economic health of the U.S., the U.K. and the U.S.S.R. are made on the basis of the number of working hours required in each country before a typical worker can earn enough to buy a specified package of goods - e.g. a pair of shoes, a radio, or an automobile? Is not a device analogous to Smith’s distinction between natural and market price invoked by some Western economists working in underdeveloped areas? They argue that labour is priced too high, capital too low, and that economic growth would be accelerated if governments insisted that the decisions of businessmen on combinations of labour and capital should be governed not by actual prices, but by ‘accounting’ prices that more accurately reflect the ‘real’ scarcities of these productive agents.
4. THE ANALYSIS OF INCOME DISTRIBUTION
Smith's discussion of the ‘natural price’ had been developed around its three components: wages, profits and rents. It was thus incumbent upon him to explain the mechanisms governing the ‘natural rates’ of these shares of income (or, in his terms, of ‘revenue’).
At this point, Smith’s argument was constructed around a tripartite division of society into ‘orders’, each of which received a specified income share. Wages were paid, to members of the working class, profits accrued to capitalists (or owners of stock), and rents were collected by landowners. These distinctions corresponded roughly to the major social class divisions of his time, though some blurring at the edges remained. The net receipts of the smallholder in agriculture, for example, might be a compound of three income shares: a wage return for his own labour; a rent return from the land he owned; and a profit on the capital he had invested in his farm. A similar
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overlapping might occur in the ease of the self-employed small manufacturer. Conceivably the large landowner, should he invest to improve his estate, could thereby receive a profit as well as a rent. While allowing for this possibility, Smith described large landowners as men who loved ‘to reap where they never sowed’, 24 and as given to ‘indolence which is the natural effect of the ease and security of their situation’ .25 This characterization of the landlord class, which played a crucial role in his interpretation of society’s prospects during the course of the ‘progress of improvement’, was not altogether just. As later historical research has demonstrated, much of the agricultural innovation of the period was initiated by progressive large landowners who exhibited the behavioural traits that Smith ascribed to capitalists.
It must be emphasized that Smith, while building his analysis of income distribution around ‘three different orders of people’, did not regard these divisions as closed compartments. He was too much a child of the Enlightenment to accept the view that a man’s position in the social hierarchy was fixed at birth. Nevertheless, class distinctions should be recognized as a social fact, even though a man’s membership in any particular group was not providentially ordained. ‘The difference between the most dissimilar characters,’ he maintained, ‘between a philosopher and a common street porter, for example, seems to arise not so much from nature, as from habit, custom, and education.’ 26
At the same time, Smith’s analytical categories contrast , arply with those widely used in much current economic analysis. A prevalent modern approach to income distriution is entirely ‘functional’ in orientation; that is to say, various income payments are treated as rewards to the ‘factors’ contributing to production. The wage share is the payment to human productive agents, without regard to their social status, including salaries as well as wages; moreover, part of the revenue Smith regarded as ‘profit’ would now be treated as a ‘wage’ to management.
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Similarly, rent is now often treated as accruing to owners of the God-given productive factor, land; this procedure, though stripped of social class associations, is closer to Smith’s approach. Interest (which Smith subsumed under profits) is treated as the return on capital, the inanimate but man-made factor of production. Though the treatment of profit is far from uniform, a venerable tradition supports the view that (apart from the case of monopoly) ‘pure profit’ over and above rewards necessary to retain the services of productive factors in their present uses can be realized only temporarily before being competed away. In such a ‘functional’ system all class lines are hidden. Smith, on the other hand, began with a social class division and built the greater part of his analytical structure around it. Though he did introduce some ‘functional’ considerations, they were intended primarily to cover the fuzzy cases.
How then was the national revenue divided between the various orders of. society? Smithss answer was developed in two stages. In the first, he considered the special and peculiar features attached to the determination of wages, profits and rents with considerable attention to the influence of the institutional environment on variations in the level of each. But never far from view was a second and overriding influence: the ‘general circumstances of society’ - i.e. whether the economy as a whole was stationary, expanding, or declining.
Thus in the case of wages, prevailing scales at any particular moment were likely to be influenced by a variety of factors peculiar to individual jobs: their ‘agreeableness or disagreeableness,’ their geographical situation, expected duration, the worker’s knowledge (or ignorance) of alternative employments and their terms, etc. But Smith also drew attention to another consideration - the relative bargaining strength of employers and employees - and he noted that the scales were often weighted to the disadvantage of workers.27
These variations, though important, could operate only
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above a lower limit: the minimum wage level required to maintain the labour force in healthy and productive condition. After all, Smith argued, wages could not sink below subsistence requirements without shrinking the size of the labour force. Did it then follow that the ‘subsistence’ level of wage payments would also be the natural rate toward which actual wages, over the long period, would gravitate? Malthus was to argue this case at a later moment in the evolution of classical theory. At one point, Smith wrote as if in anticipation of the Malthusian position: ‘... the demand for men, like that for any other commodity, necessarily regulates the production of men’.28 This assertion implied that a rise in wage rates above the minimum required for subsistence would soon be neutralized by an induced expansion in the size of the population and of the labour force. It would have been convenient for other parts of Smith’s analysis had he consistently maintained this position. As noted above, his command-over-labour doctrine could yield intelligible results only when equal amounts of revenue could purchase the same quantity of labour at different times - i.e. when the natural price of labour was constant.
But, once having introduced this notion, Smith quickly moved away from it, arguing that the natural course of wages was closely related to ‘the general circumstances’ of the economy. An expanding economy was likely to be associated with rising wage rates, a declining one with falling wages, while in a stationary economy there would be little reason to expect wage levels to change.
This argument hinged on what Smith described as the volume of ‘funds destined for the payment of wages’. 29 The notion he had in mind calls for a few words of elucidation, both because it is based on concepts now unfamiliar and because its central idea figured so prominently in the general classical outlook. In this view the process of production and exchange was regarded as beginning with ‘advances’ of funds by employers (capitalists and landlords) to acquire labour and the material inputs required
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in production. Workers, the recipients of these advances, later spent them on subsistence goods. The same transaction, however, involved the transfer of funds back to employers who could finance ‘advances’ to initiate the next round of production. Thus, whether the demand for labour in a subsequent period was greater or less than, or unchanged from, the preceding one depended in large measure on the size of the non-wage shares of income (profits and rents) and the proportion of the fund thus generated that was allocated as advances to labour. In a period. of general economic expansion it was expected that the wage fund would be enlarged and the demand for labour augmented. This, in turn, would tend to bid wage levels beyond the subsistence minimum and to bring improved conditions to the ‘servants, labourers and workmen of different kinds [who] make up the far greater part of every great political society’ 30 Population growth might then follow. But, at this point in the argument, Smith entertained no Malthusian fears:.
The liberal reward of labour, therefore, as it is the effect of increasing wealth, so it is the cause of increasing population. To complain of it, is to lament over the necessary effect and cause of the greatest public prosperity. 31
The course of economic progress was still not dear, despite Smith’s generally optimistic expectations. The behaviour of the second income share - profits - might lead to problems. As Smith saw it, the returns to capitalists and those of wage earners moved inversely: as wages increased, profits would be reduced. Smith’s first attempt to explain this relationship amounted to asserting that the more employers paid their workers, the less they could retain for themselves. But this account was too static to be fully satisfactory; after all, Smith had suggested elsewhere that a regime of. high wages might well lead to at least compensating increases in output per worker. 32 More basic to his explanation was the increasing competition among capitalists that he expected to accompany economic ex-
42 Index
pansion. With reasoning more convincing in his day than in ours, he held that in a climate of general economic expansion businessmen would be more vigorous in pur suing their own advantage, suppressing their tendencies toward collusion, and competing down the average rate of return on capital. This tendency toward falling profits was reinforced by another consideration that Smith hinted at but did not develop systematically:
As capitals increase in any country, the profits which can be made by employing them necessarily diminish. It becomes gradually more and more difficult to find within the country a profitable method of employing any new capital.33
A fuller explanation of the expected effects of the ‘progress of improvement’ required an analysis of the relationship between profits and rents. Land-ownership and the income share attached to it clearly possessed some special attributes. The consequences of this uniqueness emerged forcefully in Smith's assertion that:
High or low wages and profit, are the causes of high or low price;, high or low rent is the effect of it. It is because high or low wages and profit must be paid, in order to bring a particular commodity to market, that its price is high or low. But it is because its price is high or low; a great deal more, or very little more, or no more, than what is sufficient to pay those wages and profit, that it affords a high rent, or a low rent or no rent at a11.34
How was this puzzling proposition to be explained? At base, Smith’s account rested on the presupposition that nature was generous. Like the Physiocrats before him he viewed agriculture as capable of yielding outputs far in excess of inputs. But unlike the Physiocrats he wished to emphasize that the extent to which this natural bounty would actually be tapped depended largely on society’s requirements for the output of land. It was his expectation (and a not unreasonable one) that an, expanding economy would generate rising demand for the products of land. This would occur in two ways. In the first place,
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population growth would swell the demand for foodstuffs. In addition an expanding non-agricultural sector would increase requirements for raw materials derived from the land. Smith, in his day; had in mind raw materials required for industrial processing (such as wool and flax) as well as land-derived materials needed for construction (e.g. timber and stone) and as sources of power (e.g. coal). In combination, these effects would draw idle lands into productive use. But he was also at pains to emphasize - as had Quesnay and his followers - that the initial expansion of non-agricultural output depended, in the first instance, on the availability of foodstuffs and raw materials needed to support industrial expansion.
Substantial growth in demand for agricultural products would have an important effect on the distribution of income between the various orders of society. Most particularly, it would benefit owners of land. Smith anticipated that the demand for the various outputs of land was likely to rise more rapidly than production could be expanded - especially when various claims on land competed with one another; the same plot could not grow corn and graze sheep simultaneously nor could timber supplies be maintained if extensions in the cultivated acreage encroached on the forested area. Prices of agricultural products were thus expected to increase. But in a system of private property land tenure the bulk of this windfall would accrue to land owners. The rents they collected, which he described as ‘naturally the highest which the tenant can afford to pay in the actual circumstances of the land’,35 would swell because tenants could be forced to part with that portion of their product in excess of the natural wage for their labour.
These arguments about the behaviour of various components of the natural price in the course of the ‘progress of improvement’ might be construed as indicating that economic expansion would ultimately undercut its own foundations. If a rising share of the national product was distributed to high-living landlords at the expense of
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frugal profit recipients, further accumulation and expansion might be dried up at its source. Smith was aware of this possibility; yet he did not push this argument to its logical conclusion. On the whole he regarded economic expansion as bringing benefits to all. It might be checked at a future point in time, but that day was distant. The emergence of a stationary state, when further expansion would be halted and capital accumulation restricted to replacement requirements, was too remote to call for serious analysis.
5. THE ANALYSIS OF CAPITAL ACCUMULATION
Smith’s discussion of the problem of value and distribution set out the conceptual core of his analysis. To be completed, his model required an account of the mechanisms of economic change and of the factors governing the allocation of the labour force between productive and unproductive employments. His expectation that labour productivity would rise as the market widened could carry him only part of the way towards an, explanation of, economic expansion. The more fundamental analysis of dynamic change rested on the theory of capital accumulation.
Smith’s treatment of the process of capital accumulation turned on a distinction between the gross and net (or in his terminology ‘neat’) revenue of society. This notion, which was to occupy an important place in classical :thought, involves concepts rather different from those now in common use. As Smith described the point:
The gross revenue of all the inhabitants of a great country comprehends the whole annual produce of their land and labour; the neat revenue, what remains free to them after deducting the expense of maintaining; first, their fixed; and, secondly, their circulating capital… 36
Though his development of these concepts was not altogether dear, he appears to have had in mind a
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sub-division of annual output into two components. The first referred to the portion of current output that would be claimed if production was to be maintained at the same level in the following year. The second component - the net revenue - was intended to isolate that portion of current output which could be made available to augment production in the future.
One attribute of Smith’s definitions is especially noteworthy: unlike. the net-gross distinctions used nowadays, deductions for maintenance were not restricted to capital consumption or depreciation allowances. Instead, maintenance requirements for the whole society were to be deducted from the gross revenue; i.e. in addition to the wear and tear on fixed capital and the replenishment of raw materials, provision was also made for the ‘maintenance’ requirements of the various classes of society. The residual represented resources which, at least potentially, could be used to enlarge production in the future. 37
How then was the size of the net revenue established? In Smith's analysis, the greater part of the answer was to be found in the distribution of income between the various orders and, most particularly, in the shares accruing to capitalists and landowners. Wage earners, after all, were unlikely to be paid enough to permit much, if any, ‘surplus’ in excess of their ‘maintenance’ requirements. Landlords .and capitalists, on the other hand, might well have larger funds at their disposal than would be necessary to finance replacements and to sustain their conventional levels of living. The ‘surplus’ might, of course, be allocated to the enlargement of their consumption. But the outcome for society would be happier if these ‘surplus’ funds were saved. In this manner, the net revenue could be converted into forms that would later enlarge production, a point Smith emphasized when asserting that ‘capitals are increased by'parsimony, and diminished by prodigality and misconduct’ 38
Strictly speaking, members of both the classes receiving ‘net revenue’ might use their resources in ways that sup-
46
ported economic expansion. In Smith’s view, however, landlords displayed a distressing tendency to indulge in high living and to engage unproductive hands. For practical purposes, capitalists were the principal agents through which the net revenue could be converted into accumulation: The size of the profit share could thus be regarded as the basic determinant of the pace of accumulation and, in turn, of the rate of economic expansion.
While saving was a vital prerequisite for economic growth, Smith was at pains to point out that saving, as he viewed it, would not lead to withdrawals of funds from the expenditure stream. ‘What is annually saved’, he wrote, ‘is as regularly consumed as what is annually spent, and nearly in the same time too; but it is consumed by a different set of people.’ 39 Hoarding, in other words, was ruled out; saving was matched almost instantaneously by expenditure for investment purposes. Smith apparently regarded this point as too self-evident to require elaboration. It was later developed more formally by J. B. Say and was to occupy a prominent position in the development of economic ideas.
The analysis of capital accumulation rounded out Smith’s account of the main structural conditions important to an understanding of an economy's capability for growth. Capital accumulation, crucial though it was as a regulator of the pace of economic expansion, could not be analysed in isolation from the distribution of income between the main orders of society. Similarly, his theory of value was now integrated into the scheme as a whole. The main issue in the analysis of growth could thus be viewed in terms of the manner in which the recipients of profits and rents exercised their ‘command over labour’.
6. ADAM SMITH AND ECONOMIC POLICY
Smith’s theoretical model and his attitudes towards policy questions were part of a single package. He regarded economic growth as the basic goal, the desirability of
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which was beyond dispute. From this perspective the adequacy (or otherwise) of any particular policy should be measured by its effects on the ‘progress of improvement’ and, more specifically, by its consequences for the accumulation of capital and the specialization of labour.
When judged by these criteria, the mercantilist pattern of state regulation and control - which Smith saw as an expression of privilege and favouritism - was clearly objectionable. Its net effect, in his view, was to thwart the widening of the market and to divert economic activity from its natural course: For that matter virtually all government intervention - apart from the discharge of such essential functions as the maintenance of law and order, the administration of justice, and provision for national defence - was suspect. Governments were as misguided when they legislated to protect the poor as when they favoured the rich with royal charters and monopolistic privileges. Smith’s attack on poor relief did not spring, however, from lack of sympathy with the plight of the less fortunate. Instead he argued that the administration of the existing Poor Laws, which called for residence within a particular parish as a condition of eligibility for benefits, restricted the mobility of labour and thereby suppressed the rate of economic growth.
Though Smith aimed much of his fire at the ‘mercantile system’, his argument fell short of the level of analytical sophistication reached earlier by his friend, David Hume. In the 1760s Hume had attacked mercantilism by invoking a theory linking the general level of prices to the quantity of money. The larger the supply of money, he had argued, the higher the price level was likely to rise;. higher prices, in turn, would tend to make exports less competitive in foreign markets and imports more competitive in home markets. The mercantilist drive to enlarge the stock of money would thus be self-defeating; the accumulation of precious metals would produce effects that would later erode the favourable balance of trade. Hume, of course, needed another prop to this argument
48 Index
before it could stick; after all, a convinced mercantilist could reply that appropriate regulations could check a deterioration in the balance of trade. Hume supplied the needed reinforcement by insisting that restrictions on trade would be damaging to the national interest. A country invoking direct controls would be punishing itself by foregoing the benefits of an international specialization and division of labour. This line of critique carried more weight than did much of Smith's attack. His position, in fact, can largely be summarized in the proposition that government meant restrictions and that restrictions necessarily frustrated the natural division of labour, the operation of the invisible hand, and the progress of improvement.
Within the framework of his analytical system, Smith could quite consistently oppose many of the practices of European governments. But it did not follow directly from this part of his analysis that a regime of laissez-faire led to the best of all possible worlds. As he himself had recognized, unregulated private interests - fully as much as governments - might behave in ways that would suppress the progress of improvement.
How was this difficulty to be resolved? Smith’s solution, though largely left implicit in his writing, amounted to the view that economic growth and a competitive order "were mutually reinforcing. His case against mercantilism rested on the assumption that competition maximized growth. But effective competition could only be taken for granted in an atmosphere of economic expansion. The progress of improvement thus took on an instrumental as well as an intrinsic value; it was the essential catalytic agent for the conversion of potential discord into harmony and the solvent to the barriers to effective competition. Ony then could the natural tendencies of businessmen to collude against the public interest be held in check. Siimilarly, a climate of expanding demand for labour was needded to neutralize the power of capitalists to take advantage of unorganized workers. If competition was
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desirable as a spur to growth, economic expansion was no less important to the promotion of effective competition.
The happy results that Smith saw from an expanding competitive society involved yet another assumption: that the benefits of growth would be shared by all orders of society. Smith himself, as we have seen, was generally confident that this would be the case. But at least some parts of his argument could later be interpreted as suggesting that difficulties might lie ahead. Improvements in real wages for members of the working class might, of course, be offset. by subsequent population growth; further, the redistribution of incomes between the various income shares to the net advantage of landowners might also give rise to complications. These themes can be heard in The Wealth of Nations but only in muted tones.
7. THE ACHIEVEMENTS OF ADAM SMITH
The Wealth of Nations was a remarkable intellectual achievement. It provided not a piecemeal account, but a comprehensive and integrated view of the economic process. Moreover, Smith’s impressive performance at the theoretical level was matched by a notable absence of special-interest pleading of the type that had dominated so much earlier economic writing.
Perhaps the clearest testimony to Smith's impact and influence can be found in the theoretical literature produced over the three quarters of a century following, the publication of The Wealth of Nations. Subsequent classical writers found much to criticize in Smith’s work. But they paid him the highest compliment a theorist can receive: both the questions they asked and their mode of procedure in the search for answers were very largely moulded by his writing. Moreover, mid twentieth century students of economic growth have profited from his exploration into these grand themes. At the popular level Smith’s influence was also considerable. His picture of the economic universe made its complexity intelligible to
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men of affairs and his central message could easily be appropriated by participants in public debates.
Little of the content of The Wealth of Nations can be regarded as original to Smith himself. Most of the book’s arguments had in one form or another been in circulation for some time. But this fact in no way diminishes Smith’s achievement. He was the first to draw the threads together, to fit them into a coherent system, and to communicate the findings to a wider audience. Measured against these standards The Wealth of Nations is indeed a formidable document.
Smith’s talents as a synthesizer, however, were the source of some analytical imperfections in his writing. At a number of points he offered explanations that were ambiguous or inconsistent. Much of the energy of the next generation of contributors to the classical tradition was devoted to the task of tidying and tightening the basic framework he had developed. Prominent among the issues to which his successors addressed themselves were such questions as the following: how and in what circumstances might the progress of improvement be checked? did it necessarily follow that economic expansion brought gains to all orders of society? was sustained economic progress necessarily a paramount social goal? Malthus, Ricardo, and John Stuart Mill were to address themselves to these topics and to offer answers somewhat different from those Smith had supplied.
1. Adam Smith, The Wealth of Nations, Edwin Cannon, ed. (Methuen, London, 1961), vol 1, p. 144.
2. ibid., vol. 1, p. 278.
3. ibid., vol. x, p. 284.
4. It is worth. noting in passing that Smith’s Oxford College bears him no grudge. Balliol’s official historian generally seconds Smith’s findings on the state of affairs in the mid eighteenth century, a period not to be numbered among the
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College's proudest; see H. W. Carless Davis, A History, o f Balliol College, revised by R. H. C. Davis and Richard Hunt (Blackwell, Oxford, 1963), pp. 154-5. Smith’s bust now occupies a place of honour in the Fellows’ Common Room.
5. Lectures on Justice, Police, Revenue and Arms, delivered to the University of Glasgow by Adam Smith. Reported by a student in 1763, Edwin Cannan, ed. (Oxford University Press; 1896), pp. 172-3.
6. As quoted by G. R. Fay, Adam Smith and the Scotland of His Day (Cambridge University Press, 1956), p. 150.
7. As quoted by John Rae, Life of Adam Smith (Macmillan and Co., London, 1895), p. 258.
8. Smith, op. cit., vol. 1, p. 7.
9. ibid., vol. 1, p: 21.
10. ibid., vol. r, p. 2.
11. Smith, it may be noted,was not always consistent in his handling of this matter. In Book I, he spoke of wealth as the sum of ‘necessaries and conveniencies’ available to the nation, a usage implying the inclusion of services. When dealing in greater 'detail with the components of the social product in Book II, the restriction to material outputs was emphasized.
12. ibid., vol. 1, p. 352.
13. ibid., vol. 1, p. 33.
14. ibid., vol. 1, p. 53.
15. The procedure by means of which the labour ‘unit’ is established will be examined below.
16. ibid., vol. 1, p. 62.
17. In Smith’s words: ‘The natural price . . . is the central price: to which the prices of all commodities are continually gravitating.’ (ibid., vol. 1, p. 65.)
18. ibid., vol. 1, p. 65.
19. Ricardo’s judgement that the necessary restrictive conditions were unlikely to hold was later to be the basis for his rejection of this type of labour approach to value.
20. ibid., vol. 1, p. 37.
21. Some of the criticism has been outspoken. One writer has accused Smith of making ‘waste and rubbish out of the thinking of 2,000 years. The chance to start in 1776 instead of 1870 with a more correct knowledge of value principles had been missed.’ (Emit Kauder, ‘The Genesis of Marginal Utility Theory’, Economic Journal, September 1953, p. 650)
52 Index
22. As he presented this point: ‘There may be more labour in an hour’s hard work than in two hours’ easy business; or in an hour’s application to a trade which it cost ten years’ labour to learn, than in a month's industry at an ordinary and obvious employment.’ (ibid., vol. 1, p. 85.)
23. ibid., vol. 1, pp. 35-6.
24. ibid., vol, 1, p. 56.
25. ibid., vol. 1, p. 277.
26. ibid., vol. a, pp. 19 20.
27. In Smith’s words, ‘Masters are always and every where in a sort of tacit, but constant and uniform combination, not to raise the wages of labour above their actual rate. To violate this combination is every where a most unpopular action, and a sort of reproach to a master among his neighbours and equals. We seldom, indeed, hear of this combination, because it is the usual, and one may say, the natural state of things which nobody ever hears of. Masters too sometimes enter into particular combinations to sink the wages of labour even below this rate. These are always conducted with the utmost silence and secrecy, till the moment of execution, and when the workmen yield, as they sometimes do, without resistance, though severely felt by them, they are never heard of by other people.’ (ibid., vol. 1, p. 75.) In a similar vein, Smith noted that workmen also combined for the purpose of raising their wages. He further observed that existing legislation was highly inequitable: combinations of workmen were illegal, while the law was silent on collusive action by employers.
28. ibid., vol. 1, p. 89.
29. ibid., vol. 1, p. 77.
30. ibid., vol. 1, p. 88.
31. ibid., vol. u, p. 90.
32. On this point, Smith maintained: ‘The liberal reward of labour, as it encourages the propagation, so it increases the industry of the common people ... A plentiful subsistence increases the bodily strength of the labourer, and the comfortable hope of bettering his condition, and of ending his days perhaps in ease and plenty, animates him to exert that strength to the utmost. Where wages are high, accordingly, we shall always find the workmen more active, diligent, and expeditious, than where they are low ....’ (ibid., vol. 1, p. 91.)
33. ibid., vol. 1, p. 375.
34. ibid., vol. 1, p. 163.
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35. ibid., vol. 1, p. 161.
36. ibid., vol. 1, p. 303.
37. Though Smith set out the essential notion, his treatment of the details was deficient. In his presentation of the argument, the net revenue could be used to enlarge production when allocated to the acquisition o£ fixed and circulating capital. He did not, however, specify wage advances as among the components of circulating capital. In order to maintain consistency with his analysis of the manner in which the progressing society increased the demand for labour (i.e., by enlarging the ‘funds’ destined for the maintenance of labour), he should have held that ‘circulating’ capital included the wage bill.
38. ibid., vol. 1, p. 358.
39• ibid., vol. 1, p. 359.
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