Adam Smith 1723 – 1790

Introduction

Smith was born in Kirkcaldy into a family of sufficient means to send him in 1737 to study at Glasgow University. He subsequently spent some years at Oxford University, then Edinburgh, before returning as Professor of Logic to Glasgow in 1751.

There he lectured in moral philosophy, eventually publishing his first major work in 1759, the Theory of Moral Sentiments – a book that brought him considerable celebrity. He gave up the ‘chair’ at Glasgow to accompany a young ‘gentleman’ of the Buccleuch family on a journey of several years to France.

This enabled Smith to become acquainted with a number of European intellectuals, including Quesnay and other Physiocrats.

In 1766 Smith was pensioned off by the Buccleuchs and he spent the next ten years producing the Wealth of Nations.

Besides The Wealth of Nations and the Theory of Moral Sentiments, there is another major source of his views, the Notes on Jurisprudence which are collected notes made of his lectures made by some of his students.

In the ‘Notes’ is Smith’s theory of society. He proposes four stages of history, their forms of property, institutions and main ways of thinking determined by their mode of subsistence, the way they provide for their needs. He talks about historical stages in Wealth of Nations too, but describes only three stages here.

In the ‘Moral Sentiments’ he argues that people develop their ideas of morality socially; that moral judgements are based on a sense of propriety, and the beauty of a well ordered whole; that judgements of propriety are based on ‘sympathy’, the ability to see things as a well informed spectator; and that sympathy guides peoples benevolence, conduct that supports the wellbeing of society.

While a degree of ‘self love’ is needed for individuals to achieve their own social benefits, self love has to be moderated by ‘benevolence’ to avoid antisocial situations, and this is very relevant to the Wealth of Nations where Smith argues for unhindered self interest.

It is of course breathtaking that Smith could pontificate in this way about moral behaviour when the nation whose prosperity he wanted to ‘supercharge’ was so deeply involved in the Atlantic Slave Trade. It is also the case that he so easily talks about ‘naked savages’ when discussing the indigenous people who were subject to the ravages of European colonialism.

It should be added here that Smith was, in fact against the slave trade; but not on moral or humanitarian grounds. He felt that slavery was a very inefficient system on which to organise the workforce so necessary to capitalist accumulation.

In what follows the almost exclusive focus will be on Smiths economic work, the Wealth of Nations. This is seen as a complete systematic theory of the capitalist system and of economic growth; and as the first comprehensive argument for moderated self interest as the best means to secure social wellbeing and economic enrichment; and as a plea for the system of Natural Liberty, where all people can pursue their own economic interests without unnecessary government interference. The book is still seen today as a valuable resource of economic insights.

As an advocate of free markets with minimal government intrusion, of free individuals pursuing their own self interest, Smith is also seen as a forerunner of Classical Liberal thinking alongside his friend David Hume, and of course following the earlier John Locke.

Smith is also seen as part of the ‘Scottish Enlightenment’, an outpouring of intellectual and philosophical thought in 18th Century Scotland. Sharing the rational humanism of the European Enlightenment, the Scottish version promoted human reason, empiricism and rejection of any authority not justified by reason. The main value base comprised improvement, virtue and practical benefits for the individual and overall society.

The Wealth of Nations is divided into 5 Books. Book 1 focuses on value and distribution, Book 2 describes the nature and accumulation of capital, Book 3 examines the various ways in which different nations have applied their labour, Book4 attacks the 17th-18th Century economic approach of Mercantilism, finally Book 5 looks at 18 Century government spending and taxation.

The book is available to read online here –
http://www.econlib.org/library/Smith/smWNCover.html

Or to download here –
http://oll.libertyfund.org/titles/smith-an-inquiry-into-the-nature-and-causes-of-the-wealth-of-nations-cannan-ed-in-2-vols

What Follows

This page follows Adan Smith through his Wealth of Nations, concentrating on issues most relevant to this Blog and dealing with other matters in less detail.  The page is constructed as follows.

After the short introduction above, a SUMMARY of the book is presented just below, based on groups of Chapters.  Then a longer more detailed MAIN TEXT account of the book is laid out. Finally a short COMMENTARY looks at Smiths confusing Theory of Value, followed by his attitude to the mass of the population, the workers.

 

The Wealth of Nations (1776)

Summary Section

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Summary – Smiths Introduction and Book 1, Chapters 1 to 4

In his Introduction to Wealth of Nations Smith identifies labour as the source of a nation’s wealth, in that labour supplies all that a nation annually consumes.

In Book 1, Chapter 1 he argues that the division of labour has been the source of increasing production and therefore of growing wealth.

As a result of the division of labour he says, markets grow where individuals exchange their individual surplus products; and vast networks of markets and dependencies grow in the production of simple garments such as a labourer’s coat.

Chapter 2 attributes this to a propensity in human nature (due to human complexity) to truck, barter and exchange. He also claims it best to appeal to the self interest of others, rather than their altruism, when exchanging.

Chapter 3 adds that an effective market is needed for the division of labour to become advantageous, as there is no point in expanding production without a market at which to sell the products.

Chapter 4 describes how money developed to facilitate exchange in a ‘commercial’ society, where the division of labour became so widely established that people depended on exchange for most of their means of life.

He then examines the ‘rules’ that people naturally follow in exchanging items either for money or for another item; these rules he says, determine the exchangeable value of goods.

Here the two meanings of value are differentiated, the utility of an object – value in use – and its power to purchase other goods – value in exchange.

Finally he outlines what is now known as the ‘paradox of value’ where diamonds have little practical use, but are very valuable in exchange – yet water is essential for life, but has no exchange value at all.

Summary – Book 1, Chapters 5 to 7

In Chapters 5 to 7 Smith says he will look at the real measure – or real price – of exchange value; the factors making up that real price; and why real prices vary around their natural price.

In Chapter 5 Smith contends that commodities have real and nominal prices. He identifies labour – toil and trouble – as the basis of the real measure of the exchange value, or price, of a commodity.

To someone who wants an object the real price is the ‘toil and trouble’ involved in acquiring it, either the labour involved in producing the object, or to produce another object put up in exchange.

Although the chapter concerns exchange value, Smith says that goods ‘contain the value of a certain quantity of labour’; that is, labour is the source of value contained (embedded) in the commodity. He also says that commodities normally exchange with others of equal value.

Smith next clarifies ‘nominal price’. He says that in everyday practice it is good enough to roughly estimate the value of an object in terms of money, by haggling in the market. But the money price is only the nominal price.

The price of labour itself, he says, will in a popular sense have a real and nominal price like a commodity.

But with labour the real price is said to be the means of subsistence, the goods bought by the labourer with the wage – not the labour involved in producing those goods.

The wage itself, an amount of money, is only the nominal price of the labour.

Thus, the nominal money wage can rise or fall, but the worker is well or badly off according to the quantity of goods that can be bought with the wage.

Later in Chapter 5 Smith turns to another measure of real value besides gold and silver – that of corn (cereal crops).

He concludes that that though the value of silver is a good enough proxy for labour in the short term, corn holds its value much better over the long term and in different locations, and is therefore be a better measure of real value in those circumstances.

In Chapter 6 Smith describes the way in which profit and rent become component parts of commodity price.

He starts with hunters in a pre capitalist, pre private property society where beaver and the deer exchange in the ratio of 1 to 2, based on the labour time necessary to kill the animals, and where the beaver needs 2 days, the deer only 1 day.

This exchange ratio pertains because the whole produce of hunting belongs to the hunters and the quantity of labour needed is the only available basis of exchange.

In capitalist society, though, new social relations of property ownership pertain. Owners of capital provide the raw materials and wages of the workers in order to make a profit from the value that labour adds to the raw materials.

This added value is split two ways, some to wages some to profit. Smith justifies this deduction by saying that there would be no point for capital to be risked without an expectation of profit.

Profit, says Smith, is not a payment for the labour of management. It is a proportionate payment made for the amount of capital invested. He does not claim that capital generates any extra value, but says that profit is a component part of commodity price regulated differently to wages.

However, he says that the produce of labour is shared with the capitalist, but also says confusingly that profit is an additional component in price/exchange value. Therefore he has said that profit is both a deduction from the produce of labour, and that it is an additional part of exchange value.

Smith next turns to land and rent, where again the social relations of land ownership have changed. Here he says that landlords will require a rent to allow natural materials to be taken from the land, plus a share of whatever is produced with them, and that workers have to give to the landlord part of what their labour produces.

Smith thus identifies three parts of price – labour, profit and rent, profit and rent being deductions from the value added by labour – but confusingly he also says that profit is an additional part of price rather than a derivative from labour.

The same three elements – wages, profit and rent – are the source of all income in society. But again he confusingly says that these are all original sources “of all exchangeable value” – contradicting his view that profit and rent are deductions from the value added by labour.

Finally, in the last paragraph of Chapter 6, Smith makes a statement that amounts to his view on economic growth, a clear recognition of a surplus resulting from the production process; but it is a surplus in exchange value attributed to the addition of rent and profit to labour – again in conflict with his earlier statements describing rent and profit as deductions from labour.

Moreover, Smith offers no explanation of how rent and profit add value to products; it was for this sort of theoretical vacuum that Marx was to later criticise him.

In Chapter 7 Smith says that commodities sell at their natural prices when the costs of marketing them are covered at the ordinary or average rates of wages, profits and rents pertaining locally.

However, he says that commodities are often sold at their market prices, above or below their natural prices, and that market prices are determined by the balance of supply and demand.

He then describes factors that interfere with and distort market prices, such as monopolies in production, privileges given to corporations and labour market interference such as apprenticeships.

Summary – Book 1, Chapters 8 to 11

In Chapters 8,9,10 and 11 Smith describes factors that impinge on the natural rates of wages profits and rents, and hence on overall natural prices.

Chapter 8 looks at the level of wages. Smith begins by repeating that given private property and capital both rent and profit are deducted from the value added by labour to the raw materials used in production.

To determine these shares workers have to negotiate with employers whose greater power means that they can generally force their terms onto the workers. But wages cannot be driven for long below the level needed for workers to support themselves and their families.

When business prospers, however, employers compete for workers who can therefore attain wages above this bare minimum; but wages cannot rise above a level that makes the business unprofitable.

Only in these circumstances can wages rise above the bare minimum. Nevertheless it is normal for capital and profit to prosper, increasing national wealth and pushing up wages.
It is the continual increase in national wealth that raises demand and wages for labour, not the actual level of that wealth.

In Chapter 9 Smith argues that the level of profit is affected by the state of the economy, but in the opposite way to wages. When the economy is expanding many capitalists compete with one another forcing prices down such that profits fall.

But as profit is affected by so many unpredictable factors it is easier to get an idea of profit levels by considering interest rates.

He concludes that both interest rates and profit levels must keep to some minimum level to make lending and investment worthwhile and to cover occasional losses.

He finishes by noting that high profits raise final prices much more than high wages, due to the stage by stage production process of many commodities with profits taken at each stage.

Capitalists do not publicise this matter, he says, but complain a lot about high wages.

Chapter 10 looks at the economic advantages for both labour and capital of free and open competition – what Smith calls perfect liberty – and considers restrictions undermining that liberty.

Part One identifies restrictions found in different types of employment. He lists such things as the disagreeable nature of particular employments, the difficulty and expense of learning them and the lack of security sometimes found.

Part Two deals with restrictions imposed by governments and other authorities, restrictions far more damaging than those in Part one.

He cites three types of government restriction that impinge on ‘perfect liberty’.

First he argues that many employments that require apprenticeships and qualifications restrict work to small numbers on the grounds that better standards of work will be promoted, whereas the market pressure of customers does this better.

Secondly pensions, scholarships and bursaries attract more people to some employments than would occur naturally through the market. He cites the church here.

The third restriction Smith identifies is that government policies restricting free movement of labour and capital from place to place and employment to employment.

In Chapter 11 Smith argues that rent is a residual, whatever is left over from the commodity price once wages and profit have been paid. He justifies this view because rent is a monopoly price paid merely for ownership of land, not for any service supplied.

This has been called a theoretical dead end because it conflicts with his previous view that price consists of wages + profit + rent, where rent is an independent contributor to price – not a residual.

Smith concludes the chapter with his views on the extent to which the interests of the three classes coincide with those of the nation.

He argues that the interests of landlords and workers are strictly linked to those of society at large; income comes to landlords because of their ownership and they prosper when people do well; similarly the wages of workers rise when the economy and society are flourishing.

Not so for capitalists. Their interests oppose those of society as their profits fall when the economy prospers, due to fiercer competition. Moreover capitalists are aware of their position and make proposals for regulation or laws that should be treated with suspicion, for these are people with an interest in deceiving or oppressing the public says Smith.

Summary – Book 2

The five chapters of Book 2 look at the nature, accumulation and uses of capital.

Smith begins by arguing that the division of labour, that has increased society’s wealth, was itself dependent on the prior accumulation of capital. Thereafter, only the continued accumulation of capital enabled the expansion of the division of labour and ever greater levels of production.

Chapter 1 looks at the varieties of capital, where most people only ever acquire enough capital to live on for a few days. Others though accumulate enough capital to live on for months or years, and tend look for ways to expand their capital.

Here he differentiates between circulating capital – that changes from money, to raw materials, to products, to money again; and fixed capital – that is used to improve land or purchase machinery. To these he adds capital used for consumption – this is used for living expenses and provides no income.

Chapter 2 looks at money considered as a part of national capital.

He begins by differentiating between gross profit – overall income from commodity sales; and net profit – that remaining after payment of wages and all production costs. Here he describes something akin to surplus value, but he does not call it that.

Smith then refers to money as the ‘the great wheel of circulation’ driving commerce and delivering income to where it is deserved.

Paper money is dealt with too. Issued by trusted banks, these promissory notes circulate like gold or silver. Moreover, as banks only need to hold as gold a fraction of the worth of paper money issued, most of their gold can be invested in profit making enterprises adding to the overall income of society.

Chapter 3 begins by delineating productive and unproductive labour.

Productive labour, he says, produces a saleable commodity, pays wages and profit and adds to the wealth of the nation. Unproductive labour, although it has a value, produces a service that ‘perishes’ as it is delivered; it leaves no exchangeable value behind it.

The work of servants, the military, entertainers, churchmen and the monarch is all unproductive and paid out of the productive work of others.

Nations where most labour is productive become wealthier; nations where many unproductive pursuits are followed remain poor.

Capital is thus increased by parsimony, by forbearing immediate consumption. It is parsimony, he argues, rather than industry itself that enriches a nation.

He adds that capital saved does not deprive the market; money spent by the rich on servants and guests leaves nothing behind. The same money saved to be used as capital is also spent, but by different people with different purposes – workers, manufacturers and craftspeople.

This view was developed by others to eventually produce ‘Says Law’ – at its most simple stated as ‘supply creates its own demand’.

The short Chapter 4 examines interest, where people lending money expect it to be repaid, with interest payments in the interim.

Borrowers may use the loan to finance workers to generate an income that will repay the loan plus a profit. Others may use to loan to finance consumption, and will need external funds to repay the loan and pay the interest.

Interest rates are then examined. The legal rate of interest is usually set a little above the lowest market rate.

If the legal rate was below the market rate then creditors will not lend at that rate and will evade regulation; if set too high above the market rate industrious people will be deterred from borrowing and funds will be diverted from constructive use to those seeking loans for consumption who will likely be less deterred by the rate.

At only a little above the market rate creditors will be content to lend and will prefer to lend to sober industrious people.

Chapter 5 looks at the different productive uses of capital.

Different uses of capital will mobilise different amounts of labour. Smith identifies four broad related uses of capital.

These are the procurement of raw materials; the manufacture of goods; the wholesale transportation of materials and products; the retail selling of goods to the public.

He deals with these in ascending order of the productive labour and value added to national wealth. The retailer pays the wholesaler, covering the wholesale capital and profit. The retailers own labour then adds to the value of the product (and the wealth of the nation) – realised as retail profit.

The wholesaler buys goods from the manufacturer, covering the manufacturing capital and profit. The wholesaler’s capital then pays for sailors and carriers to transport the goods and adds more value than the retailer.

The capital of the manufacturer is used to purchase machinery and tools, raw and finished materials, and the labour of a whole range of workers whose activity adds to the value of materials. The manufacturer’s capital adds much more productive labour than the wholesaler.

But the farmer adds most productive labour of all, added to by natural processes of growth and fertility. So over and above the value added by manufacturing work farm labour produces more value due to the bounty of labour and is the most advantageous to the nation of all.

Smith adds a comparison of capital used in the home nation and that used abroad. Capital used to buy goods in one part of a nation and sold elsewhere internally involves two sets of home commodities – those bought and those purchased.

But when capital buys goods abroad to be imported and sold internally, only one set of commodities, and their production, wages and profits, take place in the home nation, the other abroad.

Internal trade thus benefits the home nation more than the import of goods from abroad.

Summary – Book 3

Book 3 looka at the different progress of opulence in different nations

In Chapter 1 Smith describes what he calls the natural progress of opulence.

He argues that in ‘civilised’ societies most commerce occurs between towns and the surrounding country; there is a natural order to the establishment of this mutually beneficial situation.

He describes this order as the development of agriculture, then the manufacture of goods in towns and finally the rise of foreign commerce, which develops as follows.

From the basic subsistence of the country skilled craftsmen of many kinds develop. These craftsmen tend to settle in a single locality that eventually becomes known as a market town where country people come to exchange goods and acquire manufactured items.

Country and town advance together; towns prosper and cultivation improves. Local use of capital is safer initially, but eventually export becomes advantageous.

Book 3 goes on to look at the development of Europe following the fall of the Roman Empire; first the discouragement of agriculture, then the rise of cities and towns, and finally the rise of order and good governance.

Summary – Book 4

The nine chapters of Book 4 look at systems of political economy that Smith says take one of two forms, agricultural or mercantilist. Both systems share two main purposes; to enable people to provide themselves with a plentiful income and subsistence, and to provide the state with income sufficient to provide public services.

Chapter 1 examines mercantilism that, he says, features the false ideas that wealth consists of gold and silver, and that nations should accumulate those metals. As a result of this belief many European nations have prohibited the export of those metals.

Smith sees this as completely misguided; people want the things that gold and silver can buy, not the metals themselves.

He argues for more international trade which brings two main benefits. First outlets are opened up for surplus produce; secondly, larger markets stimulate increased home production which in turn increases national wealth.

Chapter 2 argues against barriers to trade that have been established by mercantilism.

Prohibitions and import duties give home producers an effective monopoly. This favours some producers but general industry is not expanded or guided well; monopolies cannot avoid the reality that the number of employed workers is proportional to the available capital.

But if unhindered by such restrictions capitalists, following their own interests, know best how to run their own enterprises. As all individuals employ their capital to produce goods of the highest possible value they simultaneously support general domestic industry making the social revenue as high as it can be.

Therefore, guided only by self interest, individuals promote the benefit and enrichment of society without any intention or knowledge that they are doing so. They are thus led by an invisible hand to promote the unintended outcome of general social improvement.

They do this far more effectively than those foolish enough to think they can direct the uses of private capital to improve the public good.

In Chapters 3 to 8 Smith points out further failings of mercantilism, including restraints on imports, tax breaks on exports (drawbacks), subsidies on exports (Bounties), single country Commercial Treaties and finally the establishment of colonies.  The effect of these practises is to distort economic activities and shield them from the market.

In Chapter 9 Smith turns his gaze to agriculture based economies, first looking at the Physiocrats, whose proposals he describes as a ‘very ingenious system’.

He describes Physiocracy as an overreaction to Colbert’s one sided approach that overvalued industry at the expense of agriculture. They thus erred in seeing only agriculture as productive whilst industry and manufacture were viewed as unproductive and barren.

But he saw Physiocracy as the truest view of political economy up to that time. They saw agricultural labour at least as wealth producing – rather than precious metals – and they argued for a system of perfect liberty to maximise this production.

Next he argues that China and all other agricultural systems in some way restrain manufacture and foreign trade, inevitably undermining their wealth producing attempts.

He sums up the consequences for the economy of Mercantile and Agricultural systems by saying the first tries to funnel more capital to particular industries than would go to them naturally; the second tries to restrain the natural capital share going to industry. He concludes that either system retards and diminishes the value and produce of available land and labour.

He finishes by summarising the system of perfect liberty, or natural justice, where people should be left free from interference to follow their own economic interests and to use their capital and enterprise in competition with others.

To enable this approach government should do no more than defend the nation from foreign invasion, protect citizens from injustices from one another and provide only those necessary public works not profitable enough to attract private business.

Summary – Book 5

In the three chapters of Book Five the finances of the following three duties are looked at, asking who should pay for them,

By what method should the public pay taxes?

Why do governments go into debt to pay their taxes?

How has this affected real social wealth – the produce of land and labour?

Chapter 1, Part 1 looks at the expenses of the Sovereign with regard to Military power.

First, three stages through which societies pass are described – the ages of hunters, shepherds and farmers. Through these social stages varying means of warfare were conducted.

In more ancient times hunters and shepherds were warriors when needed. In more recent times standing armies and modern weaponry were developed. The firearms of ‘civilised’ nations out power the ‘poor and barbarous’ and use it to better spread ‘civilisation’.

Part 2 looks at the expense of Justice. Smith argues that in simpler societies with little private property injury of one to another is limited to matters such as envy or malice, but the perpetrator makes no permanent gain; therefore people can live without the need for ‘civil magistracy’ (police and courts).

When private property develops though, with a few rich and many poor, attacks on property stand to give the perpetrator tangible gains. The rich therefore need the shelter given by the power of the police and courts.

He then outlines the development of this civil government, which he says involves the subordination of the masses to the minority they see as superior. The necessity of civil government is said to grow gradually as valuable property is acquired, and the causes of subordination grow as property grows.

A number of factors are said to support this subordination, respect for wealth and birth being the most influential in gaining acceptance as superior.

The age of shepherds, he claims, first saw the rise of wealth inequality, which in turn initiated a measure of authority and subordination that could not possibly have arisen before. He sees the development of civil authority as indispensible to this stage.

He describes a natural process of subordination in a hierarchy centred on a sovereign supported by a level of nobles, with other levels below. People at each level feel that their safety and security, and their own superiority over inferior levels, depends on their support for the authority of higher levels.

He sees those who administer justice as prone to corruption and argues for the separation of powers between the courts and the executive power of government.

Part 3 has 3 Articles describing the provision by government of important public institutions that offer profits so low that private bodies would be unable to take them on.

Article One looks first at roads, canals, bridges and suchlike that he thinks should be paid for by tolls of their users, rather than by a population wide tax.

He accepts that overseas commercial trading companies can be given temporary privileges and monopolies, but points out that such arrangements often slide into permanency, perhaps accompanied by corruption and excess.

Article Two examines the education of young people. Universities and colleges for the wealthy should be paid for by the students, or by local landed estates he thinks. Teachers paid in this way – by results – work harder and better than those on salaries unrelated to their effectiveness.

The education of youths at other social levels, he says, cannot be left to chance like this. While girls learn all they need domestically, boys must not be allowed to descend into degeneracy and corruption.

Because the minds of most people develop in their employment, and because the division of labour reduces employment to a few simple repetitious operations, their minds become dulled to the point of stupidity and ignorance.

Government should therefore encourage basic education for children of the masses, rewarded by ‘little badges of distinction’. Where necessary, people can be obliged to take this up by making trades and occupations dependent on a certain level of education.

Such an educated population will be less prone to delusion and superstition, more decent and orderly, more likely to show respect for their superiors and be generally loyal and supportive citizens.

In Article 3 Smith identifies religious organisations as the main educators of the population in general. There is a dual purpose here; to prepare people for the hereafter, and to produce good citizens for today.

He again argues for payment by results, on the grounds of effectiveness, and he favours a multitude of sects to do this. Larger religious organisations supported by the authorities lack the need for ‘candour and moderation’.

He then discusses public morality. The well off, he argues, can get away with wanton and disorderly behaviour that for poorer people would lead to ruin and disgrace in front of neighbours, although in the anonymity of cities many poor people fall prey to loose behaviour and vice.

He suggests the study of science and philosophy as entry qualification for certain professions to keep the higher ranks in check. For the lower ranks he suggests diversion from excess by provision of frequent public events of gaiety, with painting, poetry, music and dancing.

In Part4 Smith argues that certain expenses are necessary to maintain the dignity of the monarch including the most expensive furniture, dress and ‘equipage’. These are additional to expenses incurred in carrying out royal duties.

Chapter 2 looks at general public taxes needed for necessary provision that cannot be financed in any other way.

Part 1 describes revenues that may come to the monarch or to the position of head of state. This will comprise profit and interest going to the monarch from personal capital, or income from the postal service, from rent from public or from crown lands owned by the state.

In Part 2 Smith lays out some principles of taxation. Taxation should be proportionate to a person’s income; should be certain and not arbitrary; should be paid at times and in amounts known to the payee and to the public; and it should be the minimum necessary.

He then discusses the merits of taxation on the three sources of land capital and labour. Tax on the wages of labour are seen as impracticable, as it will be transferred (normally) to the employer due to the bare subsistence wage normally paid to workers.

Chapter 3 – the final chapter of the book – looks at public debt, which is said to be common in commercial societies. War seems to be the main source of this debt, as large amounts of money are needed without delay and with no time for taxes to accumulate.

One cause of war is the defence of colonies that have to be protected even though they contribute nothing in tax to the home nation. Governments, says Smith, have amused the people with the fiction of a great empire across the Atlantic, whereas in reality colonies are rather showy and not very useful. Unless they can pay their way Britain should let them go and live within its mediocre means.

End Of Summary Section
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Main Text Section

Smith’s Introduction and Plan of the Work

The introduction begins by immediately identifying labour as the source of wealth, in that he states that a nation’s ‘necessaries and conveniencies of life which it annually consumes’ are supplied by the labour of that nation.

This produce, he says, is subject to two factors; the most important being the effectiveness with which labour is applied, and secondly the ratio of those people employed in useful labour to those who are not.

He then introduces Book One, by saying that it examines the causes of improvements in the productive powers of labour, and the way in which the resulting produce is distributed amongst people.

Book 1, Chapter 1

Of The Division of Labour

In the first paragraph of Chapter One Smith identifies the division of labour as the source of the ‘greatest improvement in the productive powers of labour’.

He uses the example of the pin factory where previously a worker making whole pins could scarcely make 1 pin a day, let alone 20. After the division of labour however, where pin making is divided into 18 separate operations, 10 workers were able to produce 48,000 pins in a day – an astounding increase in productivity.

These gains are made, he says, via three factors. Discrete operations allow workers to become very skilled and fast; less time is wasted by workers moving to and setting up successive operations; and finally the simpler single operations lend themselves to the invention and use of machinery that make work much faster.

As a result of the division of labour throughout the industry and other productive activities in society, the wealth of a well governed nation provides opulence for the whole population. As everyone produces more than they need a general system of exchange occurs, giving abundance and plenty to all in society.

Using the example of the coat of an ordinary labourer Smith illustrates the benefits of wealth gained in modern societies by the extensive network of markets and dependencies.
Thus the woollen coat of the labourer is the result of the joint efforts of a ‘multitude’ of other workers – shepherds, wool combers, dyers, weavers, merchants and carriers, sailors and those who source dyes from overseas – who are involved in its production and supply. Then there are the tools and machines used by all these workmen, the shears, the loom of the weaver, the ship of the sailor; these involve mining, the felling of timber, production of charcoal, brick making and laying, smelting of ore in furnaces, the mill-wright, the forger, the smith etc. etc.

With this cooperation of thousands, he says, even the poorest people in ‘civilised’ societies are able to enjoy growing economic benefits, in contrast to the far less opulent situation in traditional societies of ‘savages’, as he refers to indigenous people.

“…. yet it may be true, perhaps, that the accommodation of an European prince does not always so much exceed that of an industrious and frugal peasant, as the accommodation of the latter exceeds that of many an African king, the absolute master of the lives and liberties of ten thousand naked savages.” (11)

(References to quotations from Smith refer to the paragraph number in which the quotation occurs. Book and Chapter numbers – and sometimes Article and Part numbers- can be taken from the position of the quotation in the Blog text.)

Book 1, Chapter 2

Of the Principle which gives Occasion to the Division of Labour

The division of labour, Smith declares, derives from a propensity in human nature “to truck, barter, and exchange one thing for another”, which itself, he says, is most likely the inevitable consequence of human speech and reason.

But, he continues, when exchanging things with others, people are ill-advised to rely on the others benevolence; they do better if the other person thinks they are getting a bargain.

“It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages.” (2)

It was this disposition to exchange, he says, that gave rise to the division of labour. Within a tribe of hunters for example all people could start by making their own bows and arrows and clothes. In time some individuals will become better at making arrows, others better at making bows, still others at making clothes; as items are exchanged between them the different skills in people will become recognised and individuals accepted as specialists; and the division of labour is gradually established.

The chapter ends with a comparison between other animals and human beings. Regarding the former, each individual animal has to support and defend itself, but not so for humanity. Through the disposition to truck barter and exchange, the different talents and produce of people are brought into a ‘common stock’ where all can purchase whatever they need for their support and safety.

Book 1, Chapter 3

That the Division of Labour is limited by the Extent of the Market

Here Smith adds the need for an effective market for the division of labour to become advantageous. Without a sizeable market there is no incentive to develop the division of labour as there will be no prospect of selling the resulting surplus products.

Book One, Chapter 4

Of the Origin and Use of Money

In this Chapter Smith begins by describing how money developed in society as a means of facilitating exchange in a ‘commercial’ society where the division of labour became so widely established that people depended on exchange for most of their means of life.

He describes the progressive use of different items used as money because they were widely valued in society; he suggests a progression from Cows to Salt to Sugar to Metals to Stamped metal.

He then examines the rules that people naturally follow in exchanging items either for money or for another item. These rules he says, ‘determine what may be called the relative or exchangeable value of goods’. (12)

In this context he differentiates between the two meanings of value, the utility of an object – or its value in use – and its power of purchasing other goods – or its value in exchange.

He also describes what has come to be known as the ‘paradox of value’; that is, a diamond has very little practical use but a very high exchange value, whereas water is essential for life but has little or no exchange value.

Chapters 5 to 7

These three Chapters are extremely important in understanding Smith’s views on the role of labour in the creation of value. They have, however, been subject to very different interpretations regarding a number of issues. These issues include,

The idea that labour becomes embodied as value in a commodity during production, as opposed to the value of a commodity being to do with the extent of other commodities it can purchase or command in exchange.

The nature of value in items produced in simpler pre capitalist societies, as opposed to the value of commodities produced for sale in capitalist economies.

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Book One, Chapter 5

Of the Real and Nominal Price of Commodities, or of their Price in Labour, and their Price in Money

Here Smith sets out to clarify the real price of all commodities.

He starts by saying that people are rich or poor according to the extent to which they can afford the ‘necessaries, conveniencies, and amusements of human life’. But once the division of labour is widely established a person’s own labour can only supply a small part of these. Most will need to be supplied by the labour of other people. Thus people are rich or poor according to the quantity of the labour of others that they can command or afford to purchase.

The value of a commodity to its owner, who wants to exchange or sell it, ‘is equal to the quantity of labour which it enables him to purchase or command. Labour, therefore, is the real measure of the exchangeable value of all commodities’ (1)
Smith then makes this definitive statement,

“The real price of every thing, what every thing really costs to the man who wants to acquire it, is the toil and trouble of acquiring it. What every thing is really worth to the man who has acquired it, and who wants to dispose of it or exchange it for something else, is the toil and trouble which it can save to himself, and which it can impose upon other people. What is bought with money or with goods is purchased by labour, as much as what we acquire by the toil of our own body. That money or those goods indeed save us this toil. They contain the value of a certain quantity of labour which we exchange for what is supposed at the time to contain the value of an equal quantity. Labour was the first price, the original purchase-money that was paid for all things. It was not by gold or by silver, but by labour, that all the wealth of the world was originally purchased; and its value, to those who possess it, and who want to exchange it for some new productions, is precisely equal to the quantity of labour which it can enable them to purchase or command” (2).

In this passage Smith notes a number of things. First, the real price of an object to someone who wants it is the ‘toil and trouble’ involved in acquiring it, whether that be the labour involved in producing it or the toil (labour) contained in another object put up in exchange.

Second, goods normally exchange with others of equal value.

Thirdly, although the chapter concerns exchange, he says that when an object is exchanged it contains ‘the value of a certain quantity of labour’. This is a statement saying that labour is the source of value; that is, Smith says that labour either creates value in the object, or somehow transfers value to it.

Finally he adds that it is labour – not gold or silver – that was ‘the original purchase-money’ for all the wealth in the world; and that the value to owners of an item they wish to sell or exchange is ‘precisely equal to the quantity of labour which it can enable them to purchase or command’.

In the next paragraph Smith gives a clue as to his meaning of ‘labour commanded’. The paragraph concerns the fact that wealth conveys to people the power to purchase. The power to purchase is proportional to the person’s wealth and to,

“the quantity either of other men’s labour, or, what is the same thing, of the produce of other men’s labour, which it enables him to purchase or command.” (3)

To purchase or command then, means the ability to purchase an object – or, the same thing – to command the labour required to produce the object. ‘Command’ appears to refer to the ability to employ labour to make a product, as an alternative to purchasing it.

Smith then says that although labour is the real measure of exchange value, ‘it is not that by which their value is commonly estimated’. (emphasis added) (4)

In practice it is often difficult to weigh up the comparative amounts of labour in two commodities. The differences of hardship involved, skill, training, hard work versus easy work are not easy to accurately compute.

In everyday life, he says, such calculations are made not by accurate measures, but by a ‘rough equality’ arrived at by ‘the higgling and bargaining of the market’ which is good enough for practical purposes.

Besides, it is more natural to estimate the exchange value of an item by comparison with other commodities, than by estimation of abstract quantities of labour.

Then, when barter eventually ceases and the use of money is established throughout the economy, commodities are exchanged for money rather than for other commodities. So if a butcher exchanges his meat for money, intending to then buy bread and beer, it becomes more natural to estimate the value of his meat by the amount of money he can sell it for, rather than by the amount of bread and beer he can later buy.

Thus it becomes the norm that the exchange value of any commodity is estimated by the amount of money it can be exchanged for, rather than by the amount of either labour or of any other commodity.

Monetary Gold and silver, however, are themselves commodities that are bought and sold; as such their values change according to scarcity or abundance and supply and demand.

As a consequence ‘a commodity which is itself continually varying in its own value, can never be an accurate measure of the value of other commodities’. (7)

Labour on the other hand does not vary in value. A given amount of labour ‘at all times and places, may be said to be of equal value to the labourer’. In average health and fitness the cost to a labourer of that given amount of labour is always the same amount of leisure, freedom, and enjoyment. The amount of goods that can be purchased with that labour may change, but it is the value of the goods that change, not the value of the labour.

“Labour alone, therefore, never varying in its own value, is alone the ultimate and real standard by which the value of all commodities can at all times and places be estimated and compared. It is their real price; money is their nominal price only.” (7)

For Smith then, labour is the only universal and accurate measure of value, the standard by which the values of commodities can be compared ‘at all times and all places’.

Here, it is argued by some writers that Smith only now begins to talk about the modern system of capitalism (eg O’Donnell 1990, P 63); up until now in Chapter 5 he has, in this view, been talking about simpler pre capitalist society. This is a switch that he makes overtly in the following Chapter 6, but it is harder to detect here.

Thus his next two paragraphs say,

“But though equal quantities of labour are always of equal value to the labourer, yet to the person who employs him they appear sometimes to be of greater and sometimes of smaller value. He purchases them sometimes with a greater and sometimes with a smaller quantity of goods, and to him the price of labour seems to vary like that of all other things. It appears to him dear in the one case, and cheap in the other. In reality, however, it is the goods which are cheap in the one case, and dear in the other.

In this popular sense, therefore, labour, like commodities, may be said to have a real and a nominal price. Its real price may be said to consist in the quantity of the necessaries and conveniencies of life which are given for it; its nominal price, in the quantity of money. The labourer is rich or poor, is well or ill rewarded, in proportion to the real, not to the nominal price of his labour.” (8 and 9)

Here Smiths perspective changes away from the person performing the labour, to the person who is employing that worker; and here he says, labour, paid for like a commodity, will itself have a real and a nominal price.

And the real price of labour, he says, is the “the quantity of the necessaries and conveniencies of life which are given for it”; its nominal price is the amount of money; the labourers true reward represented by the real price, not the nominal.

There is therefore another change here. The real price of a commodity is the labour expended on it; the real price of labour itself is the quantity of ‘necessaries and conveniences’, or in other words the labourer’s subsistence.

Presumably Smith could have said the real price of labour is the labour involved in producing that subsistence – but he chose not to. Therefore Smith is in some way equating, as real price, that amount of subsistence with some amount of labour.

In the latter parts of the chapter Smith investigates another item that can provide an estimate of real value besides gold and silver; that item being corn – or what we would call wheat or cereal crops in general.

“Equal quantities of labour will at distant times be purchased more nearly with equal quantities of corn, the subsistence of the labourer, than with equal quantities of gold and silver, or perhaps of any other commodity. Equal quantities of corn, therefore, will, at distant times, be more nearly of the same real value, or enable the possessor to purchase or command more nearly the same quantity of the labour of other people.” (15)

Here he finds that while the value of silver is a good enough proxy for labour in the short term it varies quite widely over the long term; corn however holds its value much better over the long term and in different locations, and is therefore be a better measure of real value in those circumstances.

Book I, Chapter 6

Of the Component Parts of the Price of Commodities

In this chapter Smith describes the way in which profit and rent become component parts of commodity price.

He begins by imagining a simple society where no one yet owns the land and capital has not yet developed. In that circumstance he proposes that;

“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 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.” (1)

This is because;

‘In this state of things, the whole produce of labour belongs to the labourer; and the quantity of labour commonly employed in acquiring or producing any commodity, is the only circumstance which can regulate the quantity of labour which it ought commonly to purchase, command, or exchange for.’ (4)

Smith accepts that allowance would be made for labour that entailed particular hardship or needed particular skill.

Smith next introduces capitalists into the picture;

“As soon as stock has accumulated in the hands of particular persons, some of them will naturally employ it in setting to work industrious people, whom they will supply with materials and subsistence, in order to make a profit by the sale of their work, or by what their labour adds to the value of the materials” (5)

Capitalists provide materials and subsistence (wages) to others, who are set to work, in order to benefit from the value added to the materials by the labour of the workers. Either a profit can be realised when the resulting goods are sold; or the capitalist may simply now possess materials of higher value. In either case value has been added by the labour of the workers.

In case there is any doubt about what Smith means here he goes on to say that the value added by the labour of the workers is divided into two parts; one part pays the wages of the workers, the other pays the profit of the capitalist.

“The value which the workmen add to the materials, therefore, resolves itself in this case into two parts, of which the one pays their wages, the other the profits of their employer upon the whole stock of materials and wages which he advanced.” (5)

Note what happens here. During production Labour adds value to raw materials as they become finished commodities. Those commodities with their expanded value are transformed into a selling price that is then divided two ways, into profit and wages. The profit of the employer, after paying his outgoings, is thus deducted from the value added by labour.

The justification given by Smith for the capitalist profiting from the labour of the workers is that the capitalist has hazarded his capital ‘to pay the price of the materials, and the wages of the workmen’ and that without the expectation of profit there would be no point for capital to be risked in the venture.

He takes as given that capital is owned by some but not others; and that the commodities produced by the workers do not belong to them, but to the providers of capital. Compared to the beaver /deer example above, where the whole produce belonged to the worker, the new social relations of ownership between capital and labour require that the produce must be split two ways.

Smith next examines the nature of profit. He makes it clear that profit is not a wage payment to the capitalist for ‘the labour of inspection and direction’; this work in any case is usually delegated to a ‘principal clerk’.

Profit he says is instead a payment ‘regulated’ entirely by the value of capital invested in the enterprise, and is proportional to the amount of capital. He does not say that capital generates any extra value, but that the capitalist expects a proportionate return for the amount of capital invested.

He illustrates with an example of two enterprises both employing 20 workers with an annual wage bill of £300. One uses £700 worth of raw materials a year, while the other uses £7000 worth. Total annual capital costs are therefore £1000 and £7300 respectively.

At an expected profit rate of 10% the capitalists will expect very different annual profits of £100 and £730, whilst their tasks of ‘inspection and direction’ will be very similar.
Therefore, he says in the price of commodities profit is “a component part altogether different from the wages of labour, and regulated by quite different principles.”

The normal situation now, he says, is that not all of the produce produced by labour belongs to labour. He says again that the produce must be shared with the capitalist, and that the labour involved in producing a commodity is not the only thing that determines its price.

“In this state of things, the whole produce of labour does not always belong to the labourer. He must in most cases share it with the owner of the stock which employs him. Neither is the quantity of labour commonly employed in acquiring or producing any commodity, the only circumstance which can regulate the quantity which it ought commonly to purchase, command, or exchange for. An additional quantity, it is evident, must be due for the profits of the stock which advanced the wages and furnished the materials of that labour.” (7)

The last sentence of this passage introduces confusion, however, in that Smith says that the profit component of price is an additional part of price, whereas he said earlier – when discussing ownership of the produce – that profit is a division of the value added to the produce by the labour of the workers.

This passage, then, appears to be saying conflicting things. Either profit is an additional element making up the price of commodities; or profit is a part of commodity price drawn from the labour of the workers, but allocated to the capitalist.

Smith next introduces rent, the cost to the production process of the land and its produce.

He says that once land has become private property landlords will require a rent for the natural produce of the land. A payment must be made for permission to take the natural materials of the land, together with a portion of whatever is produced with them.

He comments rather critically of landlords that,

“… landlords, like all other men, love to reap where they never sowed, and demand a rent even for its natural produce. The wood of the forest, the grass of the field, and all the natural fruits of the earth, which, when land was in common, cost the labourer only the trouble of gathering them, come, even to him, to have an additional price fixed upon them.” (8)

The labourer must henceforth pay the landlord for the permission to gather natural produce and then give to the landlord a share of whatever has been collected or produced. This becomes the third component part of the price of most commodities.

“He must then pay for the licence to gather them; and must give up to the landlord a portion of what his labour either collects or produces. This portion, or, what comes to the same thing, the price of this portion, constitutes the rent of land, and in the price of the greater part of commodities makes a third component part.” (8)

As with profit, this third division of the produce – given up by the worker to the landlord – is again a requirement of the social relations of ownership, this time the ownership of land.

Smith has now identified 3 component parts of price, the labour of the worker, the rent of the landlord and the profit of the capitalist. He has also made it clear that both rent and profit are deductions from the value that labour has added to raw materials – but he has also made the confusing statement that profit is an additional part of price, rather than a derivative from labour.

He continues to elucidate this process, first pointing out the role of labour as a measure of value,

“The real value of all the different component parts of price, it must be observed, is measured by the quantity of labour which they can, each of them, purchase or command. Labour measures the value not only of that part of price which resolves itself into labour, but of that which resolves itself into rent, and of that which resolves itself into profit.” (9)

The price of every commodity in all societies, he says, is made up of one or more of these three components. In ‘improved’ societies the price of a large majority of commodities is made up of all three parts, labour, rent and profit.

Smith then gives examples that show that maintenance of tools, for example, used in making the current commodity, may be added to price. But these tools were themselves manufactured in the past involving inputs in the same three component parts of land, labour and capital. Thus,

“… the whole price still resolves itself either immediately or ultimately into the same three parts of rent, labour, and profit.” (11)

Thus as commodities come to be more complex in manufacture the labour and capital (wage and profit) portions of price become proportionately larger than the land (rent) portion.

Smith then enters into a long discussion of these matters during which he makes the following points.

“As the price or exchangeable value of every particular commodity, taken separately, resolves itself into some one or other, or all of those three parts; so that of all the commodities which compose the whole annual produce of the labour of every country, taken complexly, must resolve itself into the same three parts, and be parcelled out among different inhabitants of the country, either as the wages of their labour, the profits of their stock, or the rent of their land. (17)

The whole of what is annually either collected or produced by the labour of every society, or what comes to the same thing, the whole price of it, is in this manner originally distributed among some of its different members. Wages, profit, and rent, are the three original sources of all revenue as well as of all exchangeable value. All other revenue is ultimately derived from some one or other of these.” (17)

As the price or exchange value of all commodities resolve into (are made up by) one or more of the three parts of labour, profit and rent then the total wealth of a nation is similarly made up.

And as the proceeds of this produce are distributed as revenue (income) among the nation’s inhabitants, then all incomes within the nation are derived from one or more of the three sources of wages, profits or rent.

Wages, profit, and rent, are the three original sources of all revenue (income) as well as of all exchangeable value; all other income is ultimately derived from one or other of these.

Smith has introduced another source of confusion here where his statement that profit and rent, alongside labour, are ‘original sources … of all exchangeable value’ contradicts his earlier statement that profit and rent are deductions from value added by labour.

Finally, in the last paragraph of Chapter 6, Smith makes a statement that amounts to his view on economic growth,

“As in a civilized country there are but few commodities of which the exchangeable value arises from labour only, rent and profit contributing largely to that of the far greater part of them, so the annual produce of its labour will always be sufficient to purchase or command a much greater quantity of labour than what was employed in raising, preparing, and bringing that produce to market. If the society were annually to employ all the labour which it can annually purchase, as the quantity of labour would increase greatly every year, so the produce of every succeeding year would be of vastly greater value than that of the foregoing. But there is no country in which the whole annual produce is employed in maintaining the industrious. The idle every where consume a great part of it; and according to the different proportions in which it is annually divided between those two different orders of people, its ordinary or average value must either annually increase, or diminish, or continue the same from one year to another.” (24)

This is clearly recognition of a surplus resulting from the production process, a surplus in exchange value attributed to the addition of rent and profit to labour. However, this view again conflicts with Smith’s earlier statements describing rent and profit as deductions from labour. Moreover, Smith offers no explanation of how rent and profit add to the value of products; it was for this sort of theoretical vacuum that Marx was to later criticise him.

Book I, Chapter 7

Of the Natural and Market Price of Commodities

Here Smith says that there is in every society or neighbourhood and ‘ordinary or average’ rate of wages, profit and rent; these rates depend upon the ‘general circumstances’ of that area, its wealth, the state of its economy, the nature of the types of employment and the fertility of the land.

When prices of commodities are equal to the actual costs of bringing them to market – to pay the wages, profits and rents at their ordinary or average rates – then they can be called natural prices.

However, he says that commodities are often sold at prices either above or below their natural prices.

These are market prices which depend on the balance of the quantities brought to market (supply) with the size of the effectual demand – the price people are prepared and able to pay for those commodities (demand).

Smith goes on to describe how market prices will rise or fall in response to too little or too much supply relative to demand. In this way the natural price can be seen as a central price around which market price gravitates.

He then discusses factors that can raise or lower market prices. Some of these are more to do with everyday market factors; for example a public funeral can raise demand for black cloth, or where a manufacturer can reduce prices relative to those of competitors as a result of an improved manufacturing process.

Others though are more undermining of free market behaviour as they can interfere with the competition that can lower prices. Here he identifies monopolies in the production of a commodity, privileges granted to some corporations and restrictions on employment such as apprenticeships.

Book I, Chapter 8

Of the Wages of Labour

Here Smith discusses the factors that ‘naturally determine the level of wages’. He first summarises material that has gone before.

Before the appropriation of land and the accumulation of capital ‘the whole produce of labour belongs to the labourer’, but with the advent of private property,

“As soon as land becomes private property, the landlord demands a share of almost all the produce which the labourer can either raise, or collect from it. His rent makes the first deduction from the produce of the labour which is employed upon land. (6)

It seldom happens that the person who tills the ground has wherewithal to maintain himself till he reaps the harvest. His maintenance is generally advanced to him from the stock of a master, the farmer who employs him, and who would have no interest to employ him, unless he was to share in the produce of his labour, or unless his stock was to be replaced to him with a profit. This profit makes a second deduction from the produce of the labour which is employed upon land.” (7)

Therefore, once land becomes private property and labour becomes employed by capital, two deductions are made from the produce of labour; first is that of rent demanded by the landlord, second is the profit which motivates the capitalist to employ the worker and advance the workers maintenance.  Here Smith quite clearly says that both rent and profit are deductions from the produce of labour.

In this situation, he says, throughout Europe, 19 out of 20 workmen are dependent on employment by capital. They are advanced their working materials and wages for their maintenance until the work is completed. The capitalist then ‘shares in the produce of their labour, or in the value which it adds to the materials upon which it is bestowed; and in this share consists his profit.’ (8)

How then are these shares arrived at? Smith explains that,

“What are the common wages of labour, depends every where upon the contract usually made between those two parties, whose interests are by no means the same. The workmen desire to get as much, the masters to give as little as possible. The former are disposed to combine in order to raise, the latter in order to lower the wages of labour.” (11)

Wage levels are therefore generally made by contract between workers and capitalist. But the interests of these parties conflict, in that workers seek high wages and capitalists seek low wages.

Normally capitalists have the advantage in these disputes and can force their terms onto the workers. The reasons for this advantage boil down to the disparity of power and wealth between the two parties. He argues that;

• There are far fewer Capitalists than workers, so it is easier for them to combine; moreover the law ‘does not prohibit their combinations, while it prohibits those of the workmen’.
• There are many acts of parliament against combining to raise wages, but none against combining to lower them.
• When trade disputes do occur employers can generally live for a year or two on their wealth, but the poorer workmen are only able to survive for much shorter periods, many for a week or less.
• There is very little publicity about the combinations of capitalists, but they are ‘always and everywhere’ in a tacit agreement not to raise wages. This is so common that it could be called ‘the natural state of things which nobody ever hears of’.
• Capitalists sometimes also secretly combine to reduce wages even below their normal level, and when implemented such measures are often not resisted by workers – even in the face of severe hardship. These things are never publicised.

In these circumstances, he says, workers in their desperation may often resort to foolish and violent methods to try to bring disputes to speedy conclusions. When this happens capitalists always call for the full machinery of the law to be brought against the workmen.
Workers seldom gain from these situations and generally have to submit in order to preserve their current level of subsistence – while the leaders amongst them are punished or ruined.

But there is a limit below which wages cannot be driven for any length of time; this is the level at which workers are able to support themselves and their families. They must all be fed, clothed and accommodated or the supply of workers would cease.

“But though in disputes with their workmen, masters must generally have the advantage, there is however a certain rate below which it seems impossible to reduce, for any considerable time, the ordinary wages even of the lowest species of labour.” (14)

Circumstances arise, however, that allow workers to attain wages higher than this bare minimum that is ‘evidently the lowest which is consistent with common humanity’. (15)

Wages can rise in those times that business prospers and there is high demand for labour, which therefore becomes scarce. In that condition capitalists will bid against one another to secure the workers needed, thus raising the wages offered.

But the increase cannot exceed the level of funds available over and above that needed for the profitable continuation of business.

It is only in those circumstances that wages can rise, and rise above the bare minimum.

Nevertheless, conditions where capital and profit are rising are quite normal. When an independent workman, like a weaver or a cobbler, has a surplus he naturally employs others to work for him ‘in order to make a profit by their work’. Capital and profit thus rise, increasing national wealth and demand for workers, necessarily pushing up wages.

Thus the demand for labour naturally rises when national wealth is rising ‘and cannot possibly increase without it.’ (20) It is the continual increase in national wealth that leads to rising wages, not the actual level of that wealth.

Smith adds this important paragraph regarding the level of recompense for workers.

“Is this improvement in the circumstances of the lower ranks of the people to be regarded as an advantage or as an inconveniency to the society?                                                                                                         The answer seems at first sight abundantly plain. Servants, labourers and workmen of different kinds, make up the far greater part of every great political society. But what improves the circumstances of the greater part can never be regarded as an inconveniency to the whole. No society can surely be flourishing and happy, of which the far greater part of the members are poor and miserable. It is but equity, besides, that they who feed, cloath and lodge the whole body of the people, should have such a share of the produce of their own labour as to be themselves tolerably well fed, cloathed and lodged.” (34)

Here, while confirming again that the labour of workers provides all products for everyone in society, Smith says that in a flourishing and happy society, and in fairness, workers should be tolerably well ‘fed, cloathed and lodged.’

What he doesn’t spell out is who should find this tolerable; is it the workers (the ‘lower ranks’) themselves, or is it other more powerfull people in society deciding this?

Book I, Chapter 9

Of the Profits of Stock

Here Smith discusses the factors that ‘naturally determine the level of profits’. Note that this is not a theory of the source of profit, merely an account of the level of profit.

Like wages, he argues, the rise or fall of profits depends on the increase or decrease of the health of the economy. But the effects are different.

An increase in wealth raises wages, but tends to lower profit. When the economy is expanding many capitalists in many different trades are in competition with one another. In this case wages will rise but prices will be bid down by competition; this tends to result in smaller profits.

But profit fluctuates so much, he says, and is affected by so many unpredictable factors that it is near impossible to determine average profit levels with any precision. Some idea of profit levels, however, can be approached by a consideration of interest rates.

Market interest rates vary according to how much money can be made by borrowing and using money. As ‘we may be assured that the ordinary profits of stock must vary’ with the rise and fall of interest rates we can get some idea of profit rates by studying interest.

After a consideration of historical examples, and situations in other countries, where sometimes profits are high (e.g. when there is a surplus of labour and wages can be held down) and sometimes low, Smith writes that …

‘The lowest ordinary rate of profit must always be something more than what is sufficient to compensate the occasional losses to which every employment of stock is exposed. It is this surplus only which is neat or clear profit. What is called gross profit comprehends frequently, not only this surplus, but what is retained for compensating such extraordinary losses. The interest which the borrower can afford to pay is in proportion to the clear profit only. (18)

The lowest ordinary rate of interest must, in the same manner, be something more than sufficient to compensate the occasional losses to which lending, even with tolerable prudence, is exposed. Were it not more, charity or friendship could be the only motives for lending.’ (18)

Profits therefore must keep to some minimum level to make investment worthwhile; to cover losses that are sometimes incurred; and to pay the interest on borrowed funds. At the same time however he finds that in countries with high levels of capital, profits will be comparatively low as competition for investment in business enterprises will bid down the price of capital.

Interest rates are subject to the same considerations and, to make lending worthwhile, must include a premium to cover occasional losses.

He finishes by saying that high profits raise final prices much more that high wages. This is because in a stage by stage manufacturing process producing a saleable commodity, capitalists at each stage would want to maximise profit. This would act like compound interest on the final price, whereas wages would be like simple interest.

He adds that capitalists complain a lot about the bad effect of high wages on prices, whilst being silent about the similar effects of high profits.

Book I, Chapter 10

Of Wages and Profit in the Different Employments of Labour and Stock

This chapter, in two parts, deals with the economic advantages that stem to both labour and capital when there is free and open competition – this is what Smith calls perfect liberty – and the disadvantages that result from matters that restrict that liberty.

Part 1

Part One identifies restrictions stemming from the nature of different kinds of employment.

Smith identifies five types of restriction here. These are the agreeableness or disagreeableness of the different employments themselves; the ease or difficulty and expense of learning them; the constancy or inconstancy of employment in them; the responsibility they involve; and the probability or improbability of success in them.

Part 2

Part Two deals with restrictions imposed by governments and other authorities. Government policy, ‘by not leaving things at perfect liberty’, causes restrictions that are much more damaging than those identified in Part One.

He describes three broad types of such restrictions;

First, many employments are restricted to a small number of people through the working of trades and corporations that require apprenticeships and other qualifications before people are allowed to practice.

Such organisations pretend that such training promotes better standards of work, but he argues that the pressure of customers is the best way to promote good practice and that in reality corporate trades tend to protect their workers from the market consequences of shoddy work.

Second, in some employments, practices result in more workers being employed than would naturally be the case.

Smith describes pensions, scholarships and bursaries as devices that attract more people into employments than would otherwise naturally occur. He identifies the church as one of the culprits here.

The third restriction Smith identifies is that concerning the lack of free movement of labour and capital from place to place and employment to employment.

Here again the rules around apprenticeships and corporations are involved. In the former the free circulation of labour from job to job is prohibited, even in the same place; and in the latter employment is obstructed from place to place, even in the same employment.

The trades of weaving linen, silk and wool are similar enough that workers laid off in any of these trades could easily be trained to take up employment in one of the others if not prohibited by such absurd restrictions. Instead as it is, such workers laid off would have to work as far less well paid labourers or even rely on parish charitable support.

And just as labour is obstructed so at the same time the use of capital is also hampered.

These issues then all involve regulations and policies that hamper the free working of production, employment and markets in the economy.

Book I, Chapter 11

Of the Rent of Land

For Smith rent is a residual; once a commodity has been sold and wages and profits have been paid at their natural rates, then rent is whatever is left over.

Letwin (1990 P32) feels Smith is in a theoretical dilemma here. If prices are made up of wages + profit + rent then rent cannot be a residual; on the other hand, if rent is a residual from price then Smiths argument, that price is made up of wages + profit + rent, cannot hold.

“The rent of land, therefore, considered as the price paid for the use of the land, is naturally a monopoly price. It is not at all proportioned to what the landlord may have laid out upon the improvement of the land, or to what he can afford to take; but to what the farmer can afford to give.” (5)

“Rent, it is to be observed, therefore, enters into the composition of the price of commodities in a different way from wages and profit. 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 all.” (8)

Smith argues that rent differs from wages and profits, in that it is a monopoly price. It is paid not for any work or service by the landlord, or related to what the landlord can afford to accept. It is paid merely because of the ownership of the land, but is determined by what the farmer can afford to pay.

Rent then, is related differently to price compared to wages and profit. The levels of those two components cause high or low prices; if either is high or low then prices are high or low. The level of rent however is caused by the level of price. A high price, after covering wages and profits, is sufficient to enable a high rent; but a low price may only enable a low rent, or even no rent at all.

Smith then goes into a long discussion of rent paid for different aspects of land ownership, along with a number of digressions.

The aspects of land that Smith identifies as things that might affect the level of rent include,

Food and clothing such as wool and animal skins; building materials such as timber and stone; coal, metal, precious metal such as silver and gold and precious gemstones.

Then, in his conclusion, Smith describes the way in which the interests of the three groups – landlords, workers and capitalists – relate to those of society at large.

The interests of landlords he says are strictly linked to the general interests of society. Their income does not depend on their labour or their conscientious behaviour it simply comes to them via their ownership; and when society prospers so do the landlords.

The interest of workers is similarly tied to the interests of society. When the economy is flourishing demand for labour ensures rising wages, with more work demanded year on year. When the economy slows wages fall and available work diminishes.

Capitalist on the other hand do not prosper in times of general prosperity. The rate of profit is lowest in rich countries, high in poorer ones and highest when an economy is headed for ruin.

But capitalists, unlike landlords and workers, are always aware of their interests. The other two groups are usually unaware where their interests lie either through indolence (landlords) or lack of education and understanding (workers).

And because of their awareness, any proposals for regulations or laws that capitalists make should be treated with the greatest superstition. These are people, ‘ 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.’

What is of crucial interest in these 3 or 4 Chapters examining the makeup of price is that Smith is trying to explain principles by which the wealth from commodity sales (hence prices) are divided between the three classes.

He is not trying to identify the contributions that each of the three classes make to the value of commodities going for sale, and hence their prices. Here as elsewhere he identifies labour alone as a contributor to value. Capitalists and landowners then take a share of that value.

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Book 2

Of the Nature, Accumulation, and Employment of Stock

Introduction

Smith argues that the division of labour that has increased society’s wealth was itself dependent on the prior accumulation of capital.

In that older simpler state of society, before the division of labour, people filled their needs themselves by hunting, making clothes etc. There was no need for capital to be accumulated before artefacts could be produced.

But once the division of labour is widely established people acquire most of what they need by exchanging their own produce with that of others, and the division of labour required capital to provide machinery and tools and to employ workers.

Therefore the accumulation of capital must have preceded the division of labour; and only the continued accumulation of capital enabled the continued subdivision and extension of the division of labour to fuel greater and greater levels of production.

Book Two examines the nature of capital, the varieties of capital and the effects of its different uses.  There are 5 chapters examining different aspects of this issue.

Book 2, Chapter 1

Of the Division of Stock

When the ‘labouring poor’ acquire enough capital to support themselves for a few days or weeks they tend to spin it out carefully without thinking of gaining an income from it. But it is natural that those who have enough capital to live on for months or for years look for ways of using their capital, over and above daily consumption, to provide a continuing income.

Capital can be used in two ways, he says, to produce an income or profit. First, capital can be used in organising the manufacture of goods to be sold at a profit. Similarly it can also be used by merchants to buy and re-sell goods at a profit. In either case capital changes its form and circulates; in general capital can be money – then raw materials and/or products – then money again when sold at a profit. This use of capital is referred to by Smith as circulating capital.

Secondly, capital can be used to improve land, purchase machinery etc. such that additional profit is earned by an enterprise. This use of capital he calls fixed capital.

The general capital of any country is made up by the capital of all its inhabitants, and can be divided into three types.

First is that of consumption, the capital devoted to living expenses, distinguished by the fact that it provides no income or profit.

Second is that of fixed capital which does add to the profit of the owner by making the productive process more efficient. Fixed capital includes machinery and tools; buildings such as warehouses and workshops; land that has been drained and cleared; and finally the skills and abilities of workers achieved by training and education.

Thirdly capital may be in the form of circulating capital including raw materials, other provisions necessary for production and finished articles not yet sold. It too adds to profit as a necessary, circulating part of the production process.

Book 2, Chapter 2

Of Money Considered as a particular Branch of the General Stock of the Society, or of the Expence of Maintaining the National Capital

Interestingly Smith here distinguished between the gross and the net income of a nation and its people. In the case of capitalists he thus differentiates between gross profit – overall income from sale of commodities – and net profit – the profit remaining after payment of all wages, costs and expenses.

Here of course, without using the word, Smith is in effect identifying something very close to surplus value.

Smith then enters into an exploration into the nature and use of money in capitalist society. For example he sees money as;

“the great wheel of circulation, the great instrument of commerce ….(that delivers) to every man the revenue which properly belongs to him”. (23)

He also touches on paper money that can be issued by banks that are sufficiently trusted by the public. These promissory notes, or paper money, circulate and earn interest in the same way as gold or silver.

He imagines a country that has a circulating currency of 1 million pounds, sufficient for all the commerce of the country to function. He supposes that banks could issue the 1 million in promissory notes while only needing to retain 200,000 pounds in gold in their coffers to meet routine demands.

The surplus of 800,000 pounds in gold could then be invested in enterprises consisting of materials , tools, workers and provisions in order to earn additional profit that would add to the overall income of society;

” The gross revenue of the society, the annual produce of their land and labour, is increased by the whole value which the labour of those workmen adds to the materials upon which they are employed; and their net revenue by what remains of this value, after deducting what is necessary for supporting the tools and instruments of their trade.” (35)

Book 2, Chapter 3

Of the Accumulation of Capital, or of Productive and Unproductive Labour

Smith begins by distinguishing between what he calls productive labour and unproductive labour.

Productive labour, he says, is that which adds to the value of the raw materials being worked on to produce a saleable commodity, thus furnishing the maintenance of the labourer and the profit of the capitalist.

Unproductive labour, on the other hand, while it has a value, does not produce a saleable commodity; its service perishes as it is delivered and leaves no trace of exchangeable value behind it.

He describes the work of servants, the monarch, soldiers and sailors and churchmen as unproductive, and says that such people live off the productive labour of other people.

In different countries different uses are made of their annual produce. In those countries where it is used to support more industry, more workers and more production the country becomes wealthier. In those countries where the annual product is consumed in support of unproductive pursuits and entertainments the country remain poor.

Thus capital is increased by parsimony. By forbearing immediate consumption and instead by saving annual gains and using them to employ more productive workers, the value of the annual product of the country is increased.

It is this parsimony and not industry itself that increases capital. If the gains of industry are not saved and used productively then capital does not increase.

Smith then points out that capital thus saved is not depriving the market of an amount of spending. He says that money spent by rich people is usually spent on ‘idle guests and menial servants, who leave nothing behind them in return for their consumption.’

However, when the same money is saved in order to produce an income it is used as capital – with the result that it is likewise spent, but this time on workers, manufacturers and craftsmen who reproduce all that they consume plus a profit.

Smiths view here was taken up by other classical economists and eventually was developed by J.B. Say into Say’s Law that put most simply states that ‘supply creates its own demand’. It is argued that Say knew that things are not really as simple as this, and that it is unfair for his name to be attached to the simpler versions of the idea (Robbins 146).

Then later he returns to the general point made in his introduction, to say that the value of a nations produce can only be increased by either increasing the number of productive workers or by raising the productivity of its existing workers.

Moreover, in the second case, productivity of existing workers can only be raised by the use of additional capital to introduce improved machinery, or to improve the working practices of workers to effect a better division of labour.

Book 2, Chapter 4

Of Stock Lent at Interest

This a short chapter where Smith makes several points about interest including the following two related matters.

First he says that people who lend money expect it to be repaid and that in the interim the borrower must pay an annual rent, or interest, for the loan. Borrowers come in two categories; the first use the loan to finance productive workers who reproduce the value of the loan plus a profit. Such borrowers can therefore repay the loan plus the interest without calling on other finance. The second type of borrower, on the other hand, uses the loan to finance immediate consumption; the loan is thus dissipated and neither loan nor interest can be repaid without calling on an external source of wealth.

The second, related point, regards the setting of rates of interest. In countries that permit the charging of interest for loans, the legal rate is usually set somewhat above the lowest market rate. If it is set below that lowest market rate then creditors will not lend at that rate, and they will evade regulation.

However, should the official rate be too much higher than the market rate then industrious people would be unable to borrow and still make a profit. By contrast, those wanting the loan for immediate consumption would be less deterred by the high rate. A large proportion of the nation’s loanable funds would thus be diverted away from constructive and industrious use.

By keeping the legal rate at only a little above the market rate creditors will be content to lend and will prefer to lend to sober industrious people rather than those likely to waste it, thus ensuring it will be put to good use.

Book 2, Chapter 5

Of the Different Employment of Capitals

When capital is used to maintain productive labour, different equal capital amounts will mobilise different amounts of labour according to the way it is used. He identifies these four broad interdependent uses of capital,

• The procurement of raw materials – lands, mines, fisheries
• Manufacture – master manufacturers
• Transportation of raw materials or finished commodities – wholesale merchants
• Parcelling raw materials or finished commodities for distribution to users – retailers

He then argues that the direction by capitalists of their capital in these ways is in fact productive labour, and that their labour adds to the price of the process or commodity at least the value of their own maintenance and consumption.

In the retail process the retailer’s capital, by purchasing the goods of the wholesale merchant, repays the merchants capital and profit. In that process the retailer is the only productive labourer employed, and only that labour adds to the value – realised in retail profit – of the annual production of the nation.

The capital of the wholesaler pays for the capital and profit of the manufacturer or farmer, depending on which goods he/she deals in. This is the main contribution the wholesaler makes to indirectly add to the value of the nation’s produce. In addition the wholesaler’s capital employs sailors and carriers to transport goods around, involving wages and profit. This productive labour adds to the value of the goods involved and to the value of the nations produce. Thus the wholesaler’s capital is a good deal more productive than that of the retailer.

The capital of the manufacturer is used to purchase machinery and tools, raw and finished materials, and the labour of workers. The purchase of machinery thus pays for the capital and profit of the tool maker; the purchase of raw material does the same for farmers and miners; but much of this capital is used to employ workmen and in doing so adds to the value of the materials by their wages and the profits involved. The manufacturer’s capital therefore mobilises much more productive labour than the wholesaler, adding much more value to the nation’s produce.

But it is the farmer of the land whose capital mobilises the most productive labour. In addition to the productive labour of farm workers, both the farmer’s cattle and agricultural produce add value via the natural processes of growth and fertility. Thus farm workers, like those in manufacture, produce a value equal to their own consumption and their employers profits, but over and above this they produce a greater value resulting from the ‘production of nature’. Capital used in agriculture is therefore the most productive of all, and the most advantageous to society.

Smith then argues that capital used in the home nation is more productive for that nation, than capital used to buy goods abroad.

Thus when capital is used to buy goods in one part of a nation, in order to sell elsewhere internally two sets of goods are involved – the commodities bought and those purchased, of at least of the same value, with the proceeds. Therefore the merchant’s capital finances the production of two sets of commodities in the home nation involving two sets of employment, wages and profits – with all the associated social benefits.

Alternatively when capital is used to buy goods abroad to be imported to be sold and goods again purchased at home with the proceeds, only one set of commodities are produced in the home nation – the other set abroad. Thus only one set of employment, wage and profit benefits the home nation instead of two as before.

Internal trade thus benefits the home nation more than the import of goods from abroad.

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Book 3

Of the different Progress of Opulence in Different Nations

Book 3, Chapter 1

Of the Natural Progress of Opulence

Here Smith argues that in general the main commerce in ‘civilised’ societies is the mutually beneficial relationship between towns and the surrounding country. There is too, he says, generally a natural order in which this becomes established.

As subsistence naturally precedes luxury, so the establishment of rural subsistence naturally precedes the establishment of towns.

In the cultivation of the countryside and development of farms skilled carpenters, wheel-wrights, masons, shoemakers etc. will emerge. These skilled workers, not tied geographically to one place, and sometimes needing one another’s services, will tend to settle close to each other, forming a village or small town. Eventually butchers, bakers and brewers and retailers will be attracted to the town, which will become known in the country as a market town where people can come to exchange their wares for manufactured goods.

This commerce provides the townspeople with their subsistence and materials for their work. Their prosperity depends on the demand from the surrounding country people, and that demand in turn depends on the improvement of their cultivation. The prosperity of the towns therefore advances as a consequence of the improvement and advance of the cultivation in the country around them.

As country and town improve together it is initially safer for capital to be used locally. Eventually however it becomes advantageous to export produce abroad. The natural course of events in the growth of capital in societies is therefore the development of agriculture, then the manufacture of goods in towns and finally the rise of foreign commerce.

The rest of Book 3 looks at the development of Europe following the fall of the Roman Empire; first the discouragement of agriculture, then the rise of cities and towns, and finally the rise of order and good governance.

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BOOK 4

Of Systems of Political Economy

Introduction

Smith begins by defining two purposes or objectives of political economy. First it aims to enable people to provide themselves with a plentiful income and subsistence; secondly it aims to supply the state with an income sufficient for the provision of public services.

He then identifies two broad systems of political economy that have been developed historically to achieve these two aims. The first is the system of commerce, that he subsequently calls ‘mercantilism’; the second is the system of agriculture. His intention is to explain these two systems as fully as he is able.

Book 4, Chapter 1

Of the Principle of the Commercial or Mercantile System

Smith begins by describing the popular, but false, idea in Mercantilism that wealth consists of so much gold or silver. This notion arises, he says, because of the dual aspects of money; first it is used as the means to buy and sell commodities, and secondly it is a measure of value used to estimate the values of all commodities relative to one another.

People and nations are seen to be wealthy when they posses large amounts of gold or silver. In other cultures, though, wealth is seen to be marked by cattle possession.

But Locke argued that gold and silver is the superior type of money due to its durability, and that a nation should seek to accumulate those metals.

Others argue that a nation involved in wars with others needs to maintain a fleet and armies in distant lands – and must therefore send money abroad. To enable this, such nations need to accumulate gold and silver in peacetime.

As a result of these beliefs European nations have sought to accumulate as much gold and silver as possible. Spain and Portugal who control the main gold and silver mines have penalised exports or subjected them to heavy duties. Scotland, France and England have all prohibited the export of these metals.

With the rise of international trade merchants have remonstrated against these practices which severely hamper their activities.

Smith then describes the arguments made that these prohibitions should be relaxed, and the subsequent relaxation of some of them by the authorities. Nonetheless it became an accepted maxim that foreign trade was the source of wealth. He then discusses the resulting international situation of trade where it was argued that if the balance of trade was favourable then flows of gold and silver would also be taken care of.

For Smith though this was all misguided. Gold and silver were useful of course as a medium of exchange – as money. But what people really want is not the money for its own sake; they want the things that money can buy for them.

Smith then argues that there are two main benefits of international trade not including the accumulation of gold and silver. First trade opens up foreign markets that provide an outlet for surplus produce, and secondly the resulting larger market stimulates and increases home production thus increasing the real wealth and income of the nation.

Book 4, CHAPTER 2

Of Restraints upon the Importation from Foreign Countries of Such Goods as can be Produced at Home

Here Smith remonstrates against the restrictions and barriers to trade that have been established by mercantilism in the attempt to prevent gold and silver from leaving the country. He then argues for the freedom of individuals to follow their own self interests unhindered by such restrictions.

Thus, for example, prohibitions and high duties on imports give home producers an effective monopoly. Particular industries are thus encouraged, but general industry is not expanded or guided well. As the number of workers employed is proportional to the available capital, monopolies cannot avoid this reality, all they do is divert people from one industry to another.

But capitalists know how to manage their own businesses and are accustomed to putting their resources to best use. They do this first by employing their capital as near home as possible, where there is more control over things.

Secondly, each person using their capital in domestic industry necessarily attempts to produce goods of the greatest possible value. In fact, people only employ their capital in order to make a profit; and profits are proportional to the value of the produce of industry – which is whatever is added to the original inputs that went into production.

But the annual revenue of a society is precisely the same as the exchange value of the annual produce of its industry. Therefore as all individuals try to employ their capital to produce goods of the highest possible value (and to support domestic industry), they simultaneously make the social revenue as high as it can be.

Therefore individuals guided only by self interest, looking after their own security and gain, promote the benefit and enrichment of society without any intention or knowledge that they are doing so. They are thus led by an invisible hand to promote the unintended outcome of national improvement.

Moreover, when promoting the interests of society in this unintended way, they do so more effectively than when the intention is to promote society’s benefit. Smith adds that he has never known much good to result from the efforts of those ‘who affected to trade for the public good’.

He goes on to say that no individual or government body are competent enough to attempt to direct private individuals in how to use their capital, and that the most dangerous such person is the one foolish and presumptuous enough to feel fit to do so.

Book Four, Chapters 3 to 8

In these chapters Smith continues to point out the failings of mercantilism, including such practices as restraints on imports, tax breaks on exports (drawbacks), subsidies on exports (Bounties), Commercial Treaties exclusive to one country and finally the establishment of colonies.  Such practices distort economic activities and shield them from the market.

Book Four, Chapter 9

Of the Agricultural Systems, or of those Systems of Political Œconomy which Represent the Produce of Land as either the Sole or the Principal Source of the Revenue and Wealth Every Country

Smith now turns his gaze to the Physiocrats, whose proposals he describes as a ‘very ingenious system’. He then embarks on a description of the Physiocrat system, which has already been covered in this blog under Pre Political Economy.

He feels that Physiocracy was an overreaction to the one sided approach of Colbert, who had overvalued industry, mainly carried on in towns, over agriculture. He thus felt that the Physiocrats reacted too far by claiming that agriculture was the sole source of income and wealth, whilst dismissing industry as unproductive.

This was the principal error in Physiocrat thought for Smith; the claim that the work of manufacture, and of trade, was barren and unproductive. Nonetheless, despite this failing, he thought the Physiocrat system was the nearest thing to the truth about political economy that had been published up to that time.

That is, by at least arguing that the labour used on the land was the productive source of wealth; and that wealth consisted in the consumable goods thus produced – and not in precious metals; and that a system of perfect liberty was the way to maximise this production; in these arguments Smith thought the Physiocrats proposed a system ‘as just as it is generous and liberal’.

Smith then discusses China and other states that have also favoured agriculture at the expense of industry and concludes that all such ‘agricultural’ systems in some way restrain manufacture and foreign trade. In doing so, he argued, they inevitably undermine their own attempts to produce a wealthy society.

He sums up the consequences for the economy of the two alternate systems he has identifed. Mercantilism attempts to funnel a greater proportion of available capital to particular industries than would go to them naturally; agricultural systems, on the other hand, try to restrain the natural capital share going to industry. A nation employing either system retards and diminishes ‘the real value of the annual produce of its land and labour.’

There follows Smiths summary of the system of natural justice/perfect liberty that should instead be followed. According to this view people should be left free from interference to follow their own economic interests and to use their capital and enterprise in competition with others. To enable this approach, he says, government action should not go beyond these three important duties.

First, the nation must be protected from violence and invasion from other nations.
Second, all citizens must be protected from injustice or oppression from one another.
Thirdly, the government must install and maintain those public works and institutions that are advantageous to society but that would never be profitable enough to attract private individuals or companies.

Book Five

Of the Revenue of the Sovereign or Commonwealth

The three chapters of Book Five go on to look at the finances of the duties of government. Smith asks first which should fall on government, which on the general public and which on particular sections of society; second, what are the pros and cons of the different methods of payment by the general public; third, why have almost all modern governments chosen to pay for part of these costs by contracting debt, and what have been the consequences of this for the real wealth – the produce of land and labour – for societies.

Book 5, Chapter 1

Of the Expences of the Sovereign or Commonwealth

PART 1

Of the Expence of Defence

Here Smith begins by outlining three advancing stages of development through which society passes; the ages of hunters, shepherds and farmers. He describes at length the changing means found by societies in these stages to conduct wars with other groups or nations. In ancient times every man, normally a hunter or shepherd, was a warrior when needed.

In modern times however nations maintain standing armies that exhibit the division of labour, specialisation and the use of modern weaponry. While this incurs considerable expense, it also confers considerable advantages.

In ancient times, he says, ‘opulent and civilised’ nations had difficulty defending themselves against ‘poor and barbarous’ ones. In modern times the situation is reversed such that the firearms of the ‘opulent and civilised’ convey an advantage over the poor that may appear pernicious, but that certainly assists the extension of civilisation.

PART 2

Of the Expence of Justice

Smith argues that in simpler societies, where there is little private property, justice is a relatively straightforward matter. Injury of one person to another is limited to that motivated by the passions of ‘envy, malice and resentment’; but such injury gives the perpetrator ‘no real or permanent advantage’. As a result most people are ‘restrained by prudential considerations’ and people are able to live together in tolerable security with no need of protection by civil magistracy.

But in more advanced societies where private property is established the situation is different. Wherever ‘there is great property there is great inequality’ because the affluence of the few rich people presupposes the poverty of others.

In this situation, with 500 or more people living in extreme poverty for every rich person, the passions of greed and ambition in the rich and the desire of ease and enjoyment in the poor prompt the latter to invade property. And now the person taking another’s property stands to gain a real advantage. These steady and widespread passions against property, often ‘driven by want, and prompted by envy’, mean that the rich need the protection of civil magistracy.

“It is only under the shelter of the civil magistrate that the owner of that valuable property, which is acquired by the labour of many years, or perhaps of many successive generations, can sleep a single night in security. He is at all times surrounded by unknown enemies, whom, though he never provoked, he can never appease, and from whose injustice he can be protected only by the powerful arm of the civil magistrate continually held up to chastise it.” (2)

An important comment in this passage gives an indication of Smith’s theory of the origin of individual riches and property. He says that valuable property is ‘acquired by the labour of many years, or perhaps of many successive generations’.

“The acquisition of valuable and extensive property, therefore, necessarily requires the establishment of civil government. Where there is no property, or at least none that exceeds the value of two or three days labour, civil government is not so necessary.” (2)

Therefore the advent of widespread private property necessitates the establishment of civil government, which was much less necessary in times of little or no private property.
Smith then outlines a theory of how this civil government develops. Such government, he says, presupposes the natural subordination of the mass of people to a minority who are seen as superior. He adds that the necessity of civil government gradually grows as valuable property is acquired, and the causes of subordination gradually grow up alongside the growth of property.

He proposes four factors that support this process of subordination, and examines them with reference to his stage theory of history, where society has passed through the hunting then shepherding stages before reaching the opulent civilised stage of his own time.

The four factors are;

• Personal qualities – such as strength, beauty, agility, wisdom, virtue etc etc
• Age – older people garner more respect than others
• Wealth – the authority of wealth is much greater than either of the two preceding factors
• Birth – related to wealth, ancient families presuppose ancient wealth; much more respected, and accepted as superior, than recent wealth.

Smith goes on to say that it was in the age of shepherds that wealth inequality first began and this in turn introduced a measure of authority and subordination among people that could not possibly have arisen before.

He sees this degree of civil government as an indispensible development to that stage. He proposes a natural process of subordination as a hierarchy develops with a ‘sovereign’ at the centre supported by a level of ‘nobles’ in turn supported by other levels. At each level people feel that the safety and security of their own herds and flocks, and their own superiority over inferior groups, depend on their support for the authority of higher groups.

He adds that this civil government, while it functions to support private property, in reality serves the interests of the rich against those of the poor.

“Civil government, so far as it is instituted for the security of property, is in reality instituted for the defence of the rich against the poor, or of those who have some property against those who have none at all.” (10)

Smith then describes ways in which persons who administered justice had been liable to corruption, by accepting gifts and such like. He concludes that the rights of individuals seeking justice should be protected by ensuring that the judiciary is independent of, and separated from, the executive power of government.

PART 3

Of the Expence of public Works and public Institutions

After defence and justice Smith comes to the provision by government of public institutions and works that are ‘in the highest degree advantageous to a great society’, but which offer such low profits that private individuals will be unable to provide and run them.

These are of two kinds, those which support the functioning of the capitalist system and those which cover education, both of young people and of the population in general.

He covers these matters in three Articles.

ARTICLE 1

Of the public Works and Institutions for facilitating Commerce in general

Here he talks of roads, canals, bridges etc. and argues that in general these things should be financed by tolls paid by those who use them, rather than by taxing the whole population.

Of the Public Works and Institutions which are necessary for facilitating particular Branches of Commerce

Smith then goes on to accept that trading companies working in undeveloped overseas areas, such as the Hudson Bay Company or the Royal African company, can be allowed temporary privileges and monopolies because of the risks and dangers involved.

But he argues that such concessions often slide into permanency thus opening the door for corruption and excess.

ARTICLE 2

Of the Expence of the Institutions for the Education of Youth

Smith begins by discussing the universities and colleges of the better off levels of society. He argues that the costs of these institutions do not need to fall upon the general public, but may be mainly covered by fees charged to the students. Where this is not sufficient local interests, such as landed estates, may be called upon.

Moreover he claims that where teachers are paid according to the quality of their output they will work harder and more effectively than if they are paid a salary that is not related to their effectiveness.

With paying students a good lecturer, teaching useful subjects, will attract many students and thus earn high rewards. On the other hand, salaried teachers have no need to apply themselves to the quality and usefulness of their work.

He then turns to the education of the youth at other levels of society. He notes here that no education is provided for women.

“They are taught what their parents or guardians judge it necessary or useful for them to learn, and they are taught nothing else. Every part of their education tends evidently to some useful purpose; either to improve the natural attractions of their person, or to form their mind to reserve, to modesty, to chastity, and to œconomy; to render them both likely to become the mistresses of a family, and to behave properly when they have become such.” (45)

Women are thus taught nothing useless or frivolous, and derive advantage and convenience from their education.

But he argues that the education of the lower orders of people (presumably the males) cannot be left to chance like this, and government must ensure that the ‘great body of the people’ do not descend into ‘corruption and degeneracy’.

He argues that as the minds of most people form in the course of their ‘employments’, and as the division of labour reduces the daily work of the masses to a few simple operations, their minds become dulled rendering them ‘stupid and ignorant’.

“The man whose whole life is spent in performing a few simple operations, of which the effects are perhaps always the same, or very nearly the same, has no occasion to exert his understanding or to exercise his invention in finding out expedients for removing difficulties which never occur. He naturally loses, therefore, the habit of such exertion, and generally becomes as stupid and ignorant as it is possible for a human creature to become.” (48)

In all ‘improved and civilised’ societies it is thus necessary for government to prevent this from happening; not only is this the right thing to do, it is a source of considerable benefits for government.

Governments should therefore encourage people to acquire of the basics of education, for example by rewarding ‘the children of the common people’ with ‘little badges of distinction’ (54). Where necessary people can be obliged to acquire such an education by imposing ‘an examination or probation’ before they are allowed to set up in a trade or occupation. (55)

In this way a more educated population will be less liable ‘to the delusions of enthusiasm and superstition, which … frequently occasion the most dreadful disorders’. Moreover an educated and intelligent population, he says, are more ‘decent and orderly’ than an ‘ignorant and stupid’ one.

He goes on to say that educated people have more self respect and are more likely to be respected by, and show respect for, their ‘lawful superiors’. They are also less likely to be victims of sectional faction and sedition, or to be led into ‘wanton or unnecessary opposition’ to government. (59)

Such qualities are especially important in free counties where government depends on the general support of the population.

ARTICLE 3

Of the Expence of the Institutions for the Instruction of People of all Ages

Smith identifies religious organisations as the main educators of the population in general. These institutions have a dual purpose of preparing people for the hereafter, and of producing good citizens for this world.

Again he argues that religious educators will be much more effective if they are paid by their congregations rather than by some outside source.

He also takes issue with a situation where a single, or just a few, religious organisations guide the people. Such a situation can be ‘dangerous and troublesome’ to ‘public tranquillity’ because their teachers, supported by the authorities and venerated by ‘followers, disciples and humble admirers’, have no need of ‘candour and moderation’.

Instead he favours a multitude of religious sects each competing to attract disciples and none of them powerful enough to disrupt the public calm.

He then claims that in civilised societies, where a system of social ranks becomes established, that there are always two alternative systems of public morality; the liberal and the austere.

He notes that people of the upper ranks can live by the liberal code and enjoy,

“luxury, wanton and even disorderly mirth, the pursuit of pleasure to some degree of intemperance, the breach of chastity, at least in one of the two sexes, &c. provided they are not accompanied with gross indecency” (11)

These things are treated with indulgence and are usually excused or pardoned altogether.

Such actions are generally not possible for the ‘common people’. In village life wayward behaviour would lead to ruin and disgrace in front of neighbours, but in cities anonymity make it more likely that poor people may fall into all sorts of loose behaviour and vice.

Religious sects may control this but can go too far, developing extreme versions of the austere code, with over rigorous punishments for offenders.

Smith suggests two remedies for the problems of public morality and behaviour. First the state could make the study of science and philosophy a condition for the higher ranks who want to enter certain professions.

“Science is the great antidote to the poison of enthusiasm and superstition; and where all the superior ranks of people were secured from it, the inferior ranks could not be much exposed to it.” (15)

Secondly the state could encourage more frequent public occasions of gaiety to divert and amuse people.

“..painting, poetry, music, dancing; by all sorts of dramatic representations and exhibitions, would easily dissipate, in the greater part of them, that melancholy and gloomy humour which is almost always the nurse of popular superstition and enthusiasm” (16)

PART 4

Of the Expence of supporting the Dignity of the Sovereign

Expense is also required to support the dignity of the monarch, over and above any expense needed to enable the performance of royal duties.

It is generally expected that the monarch should have the best and most expensive furniture, dress and ‘equipage’ in order to maintain that dignity.

CONCLUSION

In the next section, Smith says, he will explain the source of the general revenues that need to be drawn from the public to cover the remaining things that are necessary but cannot be financed in the ways outlined above.

Of the Sources of the General or Public Revenue of the Society

Book 5, Chapter 2

PART I

Of the Funds or Sources of Revenue which may peculiarly belong to the Sovereign or Commonwealth

Here Smith describes the revenues that might normally come to the Monarch either due to his or her personal wealth, or due to the position of head of state.

Thus the Sovereign normally will accrue an income from his or her personal capital, either as profit or as interest when capital is loaned to others.

Other income going to the Monarch will include such sources as the postal service; rent charged for public lands or from crown lands owned by the state.

PART 2

Of Taxes

Smith lays out 4 general principles of Taxation. Tax should be proportionate to the income enjoyed by the individual under the protection of the state. It should be certain and not arbitrary; time of payment and amount paid should be clear to the payee and to the public. It should be paid at the most convenient time for the payee. Finally it should be the minimum necessary.

Smith then goes on to discuss the various merits and disadvantages of taxes on the land, on capital and profit, then on incomes and goods. Tax on wages he says is generally impracticable, because it will always have to be passed on to others – usually the employer – because normal earnings of workers are only just enough to for them to support themselves and their families.

Book 5, Chapter 3

Of Public Debts

Public debt is common in modern commercial societies. In time of war large amounts of money need to be raised in a short time; there is no time to wait for taxes to accumulate and so borrowing is necessary.

At the same time, in commercial societies, merchants and manufacturers deal with their own money and that of others, as they lend or borrow to enable their businesses to function efficiently. Therefore many people have the ability to lend government large sums of money.

As a consequence, large amounts of capital are diverted away from the finance of manufacturing, agriculture and trade. This can only be a negative drain on society.
Wars in defence of Britain’s colonies have been another source of cost and debt to society. Colonies have to be protected, but they contribute no taxes or military power to the home nation. Governments have amused the people with the fiction of a great empire across the Atlantic, but colonies tend to be rather showy and not very useful. Unless they can pay their way Britain should let them go and live within its mediocre means.

The End of the Main Text

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Commentary

This commentary will concentrate on two issues drawn from the foregoing.  First the theory of value will be examined due to the anomalies identified above; second Smith’s views relating to the working class will be reviewed due to their identification as the source of all the wealth a nation produces.

 Smiths Theory of Value

Adam Smith is seen as the leading light of capitalism, the first man to depict a comprehensive systematic description and explanation of how the capitalist system works; and from his work contemporary economics is ultimately derived.

However, as was discovered earlier on this page, his work also featured contradictory or confused aspects, regarding the theory of value.

This has lead to at least two opposing interpretations of Smiths views on this matter.  The first and dominant view, held by almost all commentators is that Smith held a cost of production theory of value (also known as an ‘adding up theory’).  This view puts Smith in a direct line with today’s dominant economic thinking.

The alternative perspective sees Smith as arguing that labour is the source of commodity values; that is, the value of a commodity is derived from labour ‘embodied’ within it.  This interpretation puts Smith in a line that leads, through Ricardo, to Marx.

One writer who has taken issue with these matters is John F Henry (2000) who argues that the cost of production theory is mistaken.

He proceeds by demonstrating the dominant cost of production perspective using a number of quotes; for example this quote from Schumpeter – a famous and respected economist – clearly promotes the dominant view.

“… in Book I, Chapter 6, A. Smith expressly states: Wages, profit, and rent are the three original sources of all revenue as well as of all exchangeable value. If words mean anything, this is conclusive.  His theory of value was what later on came to be called a cost-of-production theory. This is indeed the opinion of many students.”

 (Schumpter, ‘History of Economics’ 1961, p, 309 – quoted by Henry p 2)

Henry then follows Smiths comments on value, related briefly below, and finds that almost exclusively they support the embodied labour view, even though there exist some ambiguities.

In the very first sentence of his introduction Smith very clearly says.

‘The annual labour of every nation is the fund which originally supplies it with all the necessaries and conveniences of life which it annually consumes …’

In Book 1, Chapter 5, Paragraph 1, Smith says that the value of any commodity that a person puts up for exchange,

“… is equal to the quantity of labour which it enables him to purchase or command. Labour, therefore, is the real measure of the exchangeable value of all commodities.”

In Paragraph Seven, Smith discusses the time when barter ceases and money takes over, and

 “… Labour alone, therefore, never varying in its own value is alone the ultimate and real standard by which the value of all commodities can at all times and places be estimated and compared. It is their real price; money is their nominal price only.”

In Chapter 8, Paragraphs 6 to 8, Smith describes the relationships between workers, landlords and capitalists,

“As soon as land becomes private property, the landlord demands a share …. His rent makes the first deduction from the produce of the labour which is employed upon land.”

“the …(master) … who employs him, and who would have no interest to employ him, unless he was to share in the produce of his labour, or unless his stock was to be replaced to him with a profit. This profit makes a second deduction from the produce of the labour which is employed upon land.”

In Paragraph 34 Smith says that no society can be ‘flourishing and happy’ where the workers are poor and miserable, and adds that workers

“ who feed, cloath and lodge the whole body of the people, should have such a share of the produce of their own labour as to be themselves tolerably well fed, cloathed and lodged.”

Later in Book II, Chapter Three, Paragraph One Smith argues that a productive worker,

“… adds to the value of the materials which he works upon, that of his own maintenance, and of his master’s profit”,

and that though the employer advances the workers’ wages this,

 “…in reality, costs him [the master] no expence, the value of those wages being generally restored, together with a profit, in the improved value of the subject upon which his [the worker] labour bestowed.”

Henry then returns to Chapter Six where Schumpeter claimed evidence that Smith held a cost of production theory of value.

In this Chapter Smith examines the way in which profit and rent become component parts of commodity price.

In Paragraph 5 and 7 the first anomaly identified in the text above occurs.

In Paragraph 5 Smith describes how the value added by labour to raw materials is shared two ways; one part pays the wages of labour, the other pays the profit of the employer on the capital used to supply the materials and to pay wages in advance.

“As soon as stock has accumulated in the hands of particular persons, some of them will naturally employ it in setting to work industrious people, whom they will supply with materials and subsistence, in order to make a profit by the sale of their work, or by what their labour adds to the value of the materials. In exchanging the complete manufacture either for money, for labour, or for other goods, over and above what may be sufficient to pay the price of the materials, and the wages of the workmen, something must be given for the profits of the undertaker of the work who hazards his stock in this adventure. The value which the workmen add to the materials, therefore, resolves itself in this case into two parts, of which the one pays their wages, the other the profits of their employer upon the whole stock of materials and wages which he advanced.”

But in Paragraph Seven Smith contradicts himself, and repeats that workers have to share the produce of their labour with the employer, but then says the profits of the employer are an additional amount to be added to price

“In this state of things, the whole produce of labour does not always belong to the labourer. He must in most cases share it with the owner of the stock which employs him. Neither is the quantity of labour commonly employed in acquiring or producing any commodity, the only circumstance which can regulate the quantity which it ought commonly to purchase, command, or exchange for. An additional quantity, it is evident, must be due for the profits of the stock which advanced the wages and furnished the materials of that labour.”  Underlining added.

 Further in the chapter Smith says that landowners also derive their rent income from the labour of workers, making three components of the price of commodities – all derived from the labour of the workers.

But then in Paragraph 17 – from which Schumpeter took his ‘cost of production quote’ – Smith again contradicts himself.

“As the price or exchangeable value of every particular commodity, taken separately, resolves itself into some one or other, or all of those three parts; so that of all the commodities which compose the whole annual produce of the labour of every country, taken complexly, must resolve itself into the same three parts, and be parcelled out among different inhabitants of the country, either as the wages of their labour, the profits of their stock, or the rent of their land.  The whole of what is annually either collected or produced by the labour of every society, or what comes to the same thing, the whole price of it, is in this manner originally distributed among some of its different members. Wages, profit, and rent, are the three original sources of all revenue as well as of all exchangeable value. All other revenue is ultimately derived from some one or other of these.”  Underlining added.

Here Smith repeats his introductory statement that the whole annual produce of a country is produced by labour; but then he contradicts that position by saying that wages profit and rent are the three original sources of all exchangeable value.

It is apparent then, on examination of what Smith actually wrote that his basic position was that the value of a commodity derives from the labour used in its production.  Commodities thus carry value embodied within them.

The references supporting the ‘cost of production’ view are few and far between, and occur beside ‘labour embodied’ statements in the same paragraphs.  It seems overwhelmingly likely that these references are errors either of Smith or of his secretary.

Henry (28) asks why in that case do almost all modern economists hold to this dubious ‘cost of production’ view.  He concludes that,

“A labor theory of value does lead to Marx by way of Ricardo, and does generate the eventual Marxist conclusions. Hence, from this point of view, Smith is a forerunner of Marx.

And this does not sit well with those of the standard neoclassical mode who view Smith as their ancestor.”

Alternately though, says Henry, if a case could be made for the cost of production view then Smith would be positioned in a direct line to modern economic theory and Marx and Ricardo would be seen as deviants.

Put more bluntly, economists who hold to the dominant view, cannot accept that Smith had a labour embodied view as such a position would completely undermine their whole raison d’être.

It is also the case that such dominant economists could be said to fall under Marx’s notion of ‘vulgar economics’.

This was a charge that Marx made by comparing classical political economists from Petty to Smith and Ricardo to later economists; the classicals were seen to have genuinely investigated and tried to understand the workings of capitalist production and social relations.

In comparison, the vulgar economists who came along later were seen to keep their work at the level of the surface appearances of competition, markets, prices, exchange between equivalents etc.

Such an approach does not seek the full truth, but tends to conceal the real underlying workings of capitalism – and thereby defends, rationalizes and serves the interests of the capitalist class.  (Bharadwaj, 1990, 373–4).

It seems then that dominant economists simply rejected the obvious conclusion that Smith saw value as embodied labour because it undermined their position.

It is useful here to consider further, more indirect, evidence from another writer on Smith, which undermines the cost of production theory.  This concerns the fact that if Smith really held a cost of production theory of value he would be able to explain how each of the three sources produced value.

Here we will see if Smith does or does not put forward an explanation of just how rent and profit, supposedly ‘original sources’, produce value.

The writer concerned is William Letwin (1990, P32) – an arch supporter of Smith and dominant economics, and himself a cost of production devotee.  But in his 1990 essay he examines the market value of commodities; he considers the ‘natural levels’ of wages, profits and rents – these being the supposed levels that correspond to costs of production.

Letwin and the Three Supposed Sources of Value

First, Letwin looked at Wages, the easiest to explain.  Smith merely defined the lower limit of wages, which he put at the amount needed to keep the worker and his/her family alive – the basic subsistence level.  He added though, that wages could be higher than this when the economy was expanding and employers, needing to expand their own production of commodities, would bid up wages in competition for workers.  There was no need to explain how labour added value to raw materials when turning out finished commodities, as this is self evident.

Profits were looked at next.  Letwin found Smith wanting here.  He described Smiths idea that when there is a lot of capital in society profits will be low as different capitals will compete for available investments.  The opposite holds when capital is scarce; profits will rise as businesses will pay more to secure investments.  There is no explanation of how capital produces value.  Letwin admitted that modern economists still debate the determination of the rate of profit – and presumably how capital adds to the value of commodities.

Smith found Rent hardest to explain, says Letwin.  He thought rent was a residual, the remaining value after wages and profits are accounted for.  But this gave him in a theoretical problem; either value is made up of Wages, Profit and Rent, each with their own distinct causal processes – or if rent is itself determined by the exchange value of the commodity then how do you explain exchange value?

It is clear then that Smith could not explain how either Profit, or Rent contributed to exchange value, making his statement that “Wages, profit, and rent are the three original sources of all revenue as well as of all exchangeable value.” completely unviable. (Emphasis added).

These three factors are perfectly understandable as streams of revenue or income from the sale of commodities, but only wages – that pay for labour – can stand up as a cause of value.

Smith and the Working Class

It is clear from a reading of Smith’s Wealth of Nation that he appreciates the worth to society of the working class (though he does not use that term).  For example we have seen that in his introduction he states that,

“The annual labour of every nation is the fund which originally supplies it with all the necessaries and conveniencies of life which it annually consumes …”

 Again, in Book 1, Chapter 8, paragraph 34, he says that the workers “…feed, cloath and lodge the whole body of the people …” and that they should have a large enough share of their produce that they can be “… tolerably well fed, cloathed and lodged.”

But he points out that the wages of workers depends on the contract negotiated with the employer, and that in that negotiation the worker is severely disadvantaged by the greater power and wealth of the employer, by the law that prohibits the workers from combining and by the tacit arrangements amongst employers to keep wages a low as possible – even below the subsistence level.  (Book 1, Chapters 12,13 and 14).

Despite Smiths apparent feelings for the disadvantaged workers who produce everything in society, his position is quite different when considering the advent of private property.

Private property always entails great inequality, he says, and the affluence of the rich produces envy amongst the poor together with the desire to invade the possessions of the rich (Book 5, Chapter 1, Part 2).

The rich are therefore always ‘surrounded by unknown enemies’ who can never be appeased.

This situation, he goes on, necessarily requires the advent of civil government giving the rich the protection of the power of civil magistracy ready to punish infractions.

He continues that alongside the growth of private property and the necessary powers of civil government ‘the principal causes which naturally introduce subordination gradually grow up’.  This subordination gives a few people a measure of superiority over the mass of the people; and it is distinguished birth and riches that are the main factors that ‘naturally establish authority and subordination between people’.

In sum, Smith describes the way in which private property necessarily involves the machinery of ‘law and order’ to protect the rich from the poor, and the subordination of the mass of the people to a few individuals of birth and riches.

Smith is clearly comfortable with the fact that in the commercial society based on private property (capitalism) the mass of the people will be living in subordination to a few people of birth and wealth.  Perhaps Smith can be excused his complacency as the mass of the population had lived in subordination for centuries;  but the sad fact is that people still today live in subordination to the Rich.

This subordination is evident in that people have to live in employment to an employer who defines their working day for them; and even in developed systems of liberal democracy people give away their decision making power to one representative or another each four or five years (as if these people are better at decision making than the rest of the people).

Moreover many people living   in liberal democracies – that are theoretically steered by the wishes of the people – accept the superiority of royal families, or rich presidents, or imaginary deities, or just so called celebrities.

Returning to Smith he is clearly concerned about the working class and their threat to order in society; this shows up again in his discussion of the education of people, young and old (Book 5, Chapter1, Part 3).

He argues that people are made stupid and ignorant by their repetitive employment such that the state needs to take steps to provide education for the ‘common people’, as their parents are too poor to secure it for their own children.

In this he is most concerned about young males.  He sees more mature men and women to be adequately guided by religious organisation who turn out good citizens (who are ready for the hereafter).

Regarding public morality – that can lead to disgrace and ruin for poor people – he recommends provision of public events of gaiety featuring painting, music and dancing.

He is not worried about young women whom he thinks learn all they need domestically.  But the education of young men cannot be left to chance, he says, as they must not be allowed to descend into degeneracy and corruption.

To counter this tendency he proposes that the state should provide basic education for the children of the ‘masses’ – to be rewarded with little badges of distinction.  And if people are reluctant to go along with this they can be obliged to co-operate by making trades and occupations dependent on the achievement of certain levels of education.

All of this attention on youths, and education in general, is to secure a decent and orderly population, less prone to delusion and superstition, and – finally – more likely to respect their superiors and to be loyal citizens.

To be fair to Smith, in today’s liberal democracies it is seen as ordinary good sense that people should be educated to standards appropriate to the employment they seek.  Moreover, in the UK, the annual publication of school exam results has become a big cultural occasion, always featured on TV and the rest of the media.

But for Smith, his ‘little badges of distinction’ etc. were manipulative devices to compel young people to attend the education that he thought would mould them into the kind of conforming citizens he wanted.  Perhaps his thinking was spot on.

Clearly Smith does not regard working people in the way he theorises in his other publication, the Theory of Moral Sentiments.

Here he argues that sympathy arises in people when we imagine how we would feel in the situation of others.  While our imaginings may not match how others are actually feeling, we make continual efforts to adjust our feelings to those of others.

When this is a mutual process of emotional adjustment between people a situation of ‘virtue’ can arise as we grope towards participating in the feelings of joy or suffering of one another (Fleischacker 2020).

While this seems to describe interactions between individuals, Smith does not seem to try to sympathise with working people in general.  Instead he sees workers as a threat, and that they should be manipulated and shaped into decent and orderly behaviours – as defined by people like Smith – with attitudes of loyalty and respect towards their superiors.

He clearly has a paternalist attitude towards working people; he feels that they cannot be trusted – and feels it is appropriate that people like himself should devise schemes to control and shape them into the form they approve of.

And these are the people whom, he argues, provide all the means of life for everyone in society.

The only sign that Smith shows of sympathy (or empathy) towards workers is that they should be provided for at a tolerable level.

Summary

To sum up Smiths apparent attitude to the mass of the people, he accepts that in capitalism they will live lives of subordination to the rich; that they cannot be trusted; that people like himself should devise schemes – that may be manipulative – to shape and control them.  And in return for providing the whole of society with all the things they need and want to live on, the mass of the people should be fed, clothed and housed to a tolerable standard.

 

This commentary has therefore concluded on the basis of Smiths words in The Wealth of Nations that he held a labour embodied theory of value; and that in capitalism the mass of the people – who provide for everyone – will live in subordination to the rich. His remedy to the threat of the people to the rich, is that civil government must be ready to punish offenders; and that the young must be shaped and controlled into compliant and respectful citizens.