A conclusion to The Economics of Adam Smith
Professor Schumpeter in his celebrated critique has written that Adam Smith's function was merely that of co-ordinator whose 'mental stature was up to mastering the unwieldy material that flowed from many sources and to subjecting it, with a strong hand, to the rule of a small number of coherent principles'; there was not 'a single analytic idea, principle, or method that was entirely new in 1776.1 There is much to be said for viewing the Wealth of Nations as a 'synthesis'; but in our view the downplaying of the achievement implied by Schumpeter's formulation is seriously misleading. For the strength of the work lies precisely in its comprehensiveness—unparalleled at the time—which, as Sir Alexander Gray has observed, reflects a transition in economic literature from partisan pamphlet to scientific treatise.2 This characteristic of the Wealth of Nations is reflected not merely in the extraordinary range of topics treated, but also in Smith's demonstration of a high degree of interdependence between apparently unrelated variables culminating in his development of a more or less consistent 'model' of value and distribution. That steps in this direction had already been taken by Hume, Cantillon, Steuart and Quesnay—reflected for example in a sensitivity regarding method and a growing appreciation of the interdependencies of the system of production and exchange and the organizational function of the profit motive—detracts in no way from Smith's achievement. Apart from this, the adoption of pure novelty in analytical technique as the criterion of 'quality' places too much weight upon a comparison of particular Smithian theories—formulated mathematically—with earlier versions, and neglects the weightings of the variables utilized. Essentially the Schumpeterian view tends to play down Smith's use of historical and contemporary data for analytical purposes, although his genius lay in an ability to find hypotheses to fit his impressions of what the facts were or had been, in which exercise qualitative judgments play a central role.
Indicative of a certain lack of perspective which seems to derive from a preoccupation with novelty is Schumpeter's evaluation of pre-Smithian price theory. All that was lacking, runs the argument, in the analysis of the 'Scholastics' including the later ethical jurists and natural law philosophers—from which Smith's own analysis is said to derive—is the technical apparatus of schedules and the notion of the margin. In our opinion this evaluation is questionable. To list some, or even all, of the elements which enter into the determination of competitive price is one thing and, to combine them into a consistent theory of allocation is quite another; the moralists including Smith's teachers—while recognizing relevant objective and subjective factors—failed to fuse them into a system of price determination with particular emphasis upon a general tendency towards 'equilibrium.' It is in this light that Smith's contribution may be better appreciated. A preliminary analytical solution was initially developed (in his lectures)—in a general rather than partial equilibrium context—in terms of the mechanism of adaptation of supply to demand achieved by alterations in the distribution of labour (the only factor allowed for) which assures that, in the long run, market prices will reflect production costs or, in Smith's words, which assures 'a natural balance of industry.' This analysis was extended in the Wealth of Nations to include capital and land in addition to labour as productive factors entering into the equilibrating process.
The formal analysis of 'general equilibrium' in the Wealth of Nations, it is true, is given relatively little attention, and is in some respects narrowly constrained. The analysis suggests that factor ratios were technically determined and identical from sector to sector, raising the question of whether Smith was aware of these assumptions and whether he used them consistently. But the fact is that Smith was not so much concerned with giving a formal statement of general equilibrium as he was to analyse readjustments to changes. It would not be surprising, therefore, it the formal account was no more than a first approximation. Our examination of Smith's general treatment of factor interrelationships with constant technology—particularly in the context of the effects of changes in factor prices—confirms that in the manufacturing sector certain key ratios were in fact held to be data. Particularly important are the labour-machinery ratio; the materials-labour ratio; and the materials-output ratio. However, when full allowance is made for 'new-type' technology—for the most part adoptable only at large scale—then the possibility of alteration in the machinery-labour ratio is admitted; for an increase in the size of the 'firm' is frequently said to be accompanied by a rising machinery-labour ratio, the capital goods 'embodying' the technology in question. (Even the rigid materials requirement might be overcome by way of new technology permitting reductions in the maintenance of fixed capital.) These new ratios, it is true, are still technically determined and there is no generalized recognition of factor substitutability; in particular, while labour-saving processes involving a higher fixed capital-labour ratio are adopted—according to Smith—at the same time as wage rates are tending upwards, no causal relationship is defined and their adoption is related to increased scale of operation. Nonetheless, the strict condition of constant proportions is in practice relaxed. In the case of agriculture also, the impression is that variation in the intensity of operating given land areas was allowed for although by no means emphasized. Finally, the implicit assumption of identical technical proportions between sectors, which is characteristic of the formal analysis of general equilibrium, is also not consistently maintained.
Smith was thus not bound by the strict assumptions implicit in the formal analysis. His treatment 'of the natural and market price of commodities' was perhaps not a deliberate first approximation; he nowhere draws attention to the contrast between the formal analysis and practical applications. But there can be little doubt that the formal statements of this chapter had a well-defined objective—namely the explanation of the broad principles of resource allocation—and in dealing with particular issues Smith drew upon relationships which do not appear available to him if we limit our attention to his 'model-building.' In brief, Smith did not fully specify his formal model of the price mechanism but certain characteristics of it were developed during the treatment of actual problems. Similarly, the role of demand in allocation can only be fully appreciated if attention is paid to particular applications of a theory of choice.
The main purpose of the Wealth of Nations was evidently not to provide an analytic framework for its own sake. The object of the work was ultimately to define the necessary conditions for rapid economic development in contemporary circumstances and Smith's treatment of the price mechanism must accordingly, in the final resort, be considered with this end in view. It is, in brief, not merely the elaboration of the mechanisms of resource allocation which requires attention, but also the particular uses to which the analysis was put, and it is in the course of Smith's treatment of the historical sequence of investment priorities according to the principle of profit-rate equalization, that a fundamental equilibrating mechanism is utilized, namely resource allocation governed by the differential pattern of factor endowments between economies. Despite the overwhelming significance of the mechanism, the reader of the Wealth of Nations will find no hint thereof in the First Book. It is rather in the 'applied' chapters, dealing with contemporary restraints on importation and with the colonial trade, that full and skillful use is made of the mechanism, casting a new light upon Smith's contribution to both theoretical and applied economics.3 Smith's fundamental concern in the Wealth of Nations was with economic development defined in terms of (real) national income per head. His objective was to demonstrate that reliance upon the free operation of the competitive mechanisms of resource allocation would assure the maximization at any time of the national income generated by the community's given resources, including the force of 'productive labourers,' that is, of labourers in the capitalist sector; it is indeed precisely the assumption of full employment which assured the key role accorded to the micro-economic problems of resource allocation in the Wealth of Nations. But what is of particular relevance is Smith's demonstration that during the course of development the community's factor endowments are likely to alter, thereby generating a differential pattern of optimal allocation, in an international setting, from period to period. Demonstration of the non-chaotic nature of the competitive price mechanism was certainly not new with Smith, but the extension thereof to encompass the effects of differential factor proportions upon the pattern of activity superseded even Hume's contribution, which (like that of Gervaise) hinged upon qualitative factor differentials between nations. (Benjamin Franklin and Josiah Tucker may have been closer to Smith in this particular respect.) And the application of the principle to the problem of investment priorities over time with specific reference to contemporary policy issues represents a formidable achievement; there is much truth in Gray's observation that there is in the Wealth of Nations 'no distinction between economic science and economic art.'4
The outcome of our argument thus far is that Smith's analysis cannot be adequately appreciated apart from its precise applications. The conclusion is reinforced by consideration of Smith's approach to government intervention as a means of achieving rapid economic expansion. The maximization in each period of national income (or given population of national income per head) guaranteed the greatest achievable surplus—income over subsistence—available for taxation purposes, for capital accumulation, and for current consumption. (In Smith's view the purchaser of services merely transferred to the worker his own 'right' to consume commodities.) It is, of course, capital accumulation which represents in the Wealth of Nations the key element in the growth mechanism. Increased investment was essential both as a means of raising productivity—the capital-deepening process—and as a necessary condition for the expansion of the capitalist sector—the capital-widening process. Since the latter process allowed the achievement of scale economies, we conclude that the emphasis, in this case too, was largely upon expanding aggregate income as a means of raising per capita income.
Expansion of the 'productive' sector—capital widening—required not only an increased capital stock but also an addition to the available work force in that sector. However, Smith's vision of the contemporary British economy was not one of unemployment or of such rapid population growth that it was possible to take for granted in the Ricardian manner, even as a first approximation, the availability of 'infinite' supplies of labour at the subsistence level. The requisite supply would therefore have to be derived either from the service sector, or from natural population growth in response to average wages in excess of subsistence. In this regard it is essential to recall Smith's assumption of a degree of immobility on the part of service labour (preventing the equalization of wage rates between sectors); and also his assumption that the population mechanism—which received particular attention—applied only to workers in the productive sector. These assumptions imply strongly that Smith accorded greater significance to population expansion as the source of the labour supply required to assure an expansion of the productive sector than to any transfer from the service sector although the latter was certainly not ruled out. The relative significance of the service sector would accordingly fall with economic growth even if its absolute size remained unchanged.
What, however, was categorically ruled out by Smith as a means of raising productive employment was any redirection, by governmental intervention, of a given capital stock towards relatively labour-intensive branches of the productive sector. Such intervention, it was expected, must be abortive and in fact must reduce national income even when an increase in the productive labour force was assured. For the objective was not simply the expansion of employment of productive labour. Expansion by way of distorting the competitive allocation of resources, Smith insisted, must reduce the national income and it is the growth of national income, or more specifically, national income per head, that was the relevant objective of policy.
In this respect Smith's position is in sharp contrast with that of his mercantilist predecessors, whose vision was, in the large, one of unemployment or underemployment both voluntary and involuntary. Their concern with the absorption of surplus labour is clear from their repeated proposals for make-work projects and the disciplining of the work force. The national importance of the colonies, of various raw materials, of different forms of trading, of trade with different countries, of different domestic spending patterns, were all evaluated in terms of their effects upon domestic employment. (Hume too, it may be remarked, tended to assume unemployment in his monetary analysis and on grounds of employment was not a free trader.) Now Smith of course also distinguished between sectors on the basis of their employment-generating capacities, but in our view it would be a fundamental misjudgment to regard this discussion as a mercantilist 'residue.' His object was to counter actual forms of governmental interference which had prematurely diverted resources away from the agricultural sector. He pointed in fact to the underutilization of land in Britain and on the continent as evidence of this; conversely, he called for greater investment in the carrying trade—the least 'labour-intensive' category—in the event that the profit rate indicated its desirability. In brief, in contemporary circumstances, the productive labour force might indeed be increased consistently with an increase of national income, but this would result in consequence of the removal of impediments to competitive resource allocation. The argument frequently made in the secondary literature that the Smithian logic calls for the redirection of capital to labour-intensive sectors, because the principle of profit-rate equalization generates too little investment in agriculture and too much in manufacturing and trade, in terms of employment, does not apply and the charge of serious inconsistency in the Wealth of Nations in this respect is unjustified.
Smith has also frequently been charged with serious inconsistency on the grounds that he condemned mercantilist protection while maintaining an equivocating interest in defence and power. It is indeed sometimes suggested that 'nationalism' was the overriding criterion, so that inconsistency is a misnomer; whatever policy was deemed suitable for the 'national interest' was recommended. Our study suggests that neither interpretation is adequate. It may be accurate to ascribe to Smith an overriding concern with national power; but this in his view would best be achieved by those competitive processes which assured the maximization of the surplus—rather than by intervention in support of particular sectors—whereby the potential for national defence at each period is maximized. Of equal significance is the fact that in the few cases where intervention in support of particular industries or branches of commerce was recommended the economic cost involved was defined quite explicitly. In both respects, therefore, Smith's reference is ultimately to the market mechanism.
Moreover, with regard to the extent and nature of legitimate intervention at the ports, Smith after all was recommending the replacement of a set of heavy protective devices by a less severe set designed largely for the raising of revenue; evidently it seemed desirable to keep in mind as far as possible, during any reform, the likely consequences for growth of duties or taxes—in any event necessitated for revenue purposes—and to utilize this intelligence in the choice of commodities upon which they would be levied. Similarly, Smith's occasional references to the maintenance of British superiority in foreign markets need not be considered a 'mercantilist residue.' It was obviously necessary to avoid imposing revenue-raising devices which would place British industry at a disadvantage in world markets. Smith's proposals represent a significant relaxation in light of the heavy protective duties then current; and it must always be recalled that the recommended reform, it was expected, would be undertaken unilaterally.
It is in this context that Smith's prudential and practical approach to reform may best be appreciated. We have noted his insistence that protective duties and prohibitions must be relaxed slowly in order to avoid sudden and heavy unemployment; his concession that a degree of control over corn exports would be justified in order to assure 'the public tranquility' and perhaps as a retaliatory device; and his justification of retaliatory duties as a means of forcing the removal of those imposed abroad on domestic products. While he ridiculed the interventionist schemes of the 'man of system' he conceded the need to call upon the services of 'that insidious and crafty animal, vulgarly called a statesman or politician, whose councils are directed by the momentary fluctuations of affairs.'5 But there is a world of difference between this prudential outlook and typical mercantilist recommendations.
One crucial category of intervention, however, found some favour in Smith's estimation (apart, of course, from 'defence, justice and public works'), namely fiscal devices designed to alter the pattern of expenditure in favour of investment and at the cost of luxury consumption. The argument for some intervention by fiscal means was much strengthened by Smith's ambivalent attitude, held in common with Hume and others, towards 'excessive' consumption (by all classes). At the same time, despite an evident concern with development, Smith's continual references to the 'natural rights' of men not to be disturbed represents a significant, though not absolute, constraint upon the extent to which intervention directed towards patterns of expenditure between investment and consumption might be justified.
It may at this point be worth remarking that our interpretation is not intended to imply a denial of a frequent appeal to what constitutes, at least from the economic point of view, 'a priori' arguments.6 We have encountered numerous instances, such as the contention that 'as to cultivate the ground was the original destination of man, so in every state of his existence he seems to retain a predilection for this primitive employment,' or that the ultimate basis for exchange lies in the propensity of mankind 'to truck, barter, and exchange one thing for another.'7 The point, however, is that on the whole such appeals can be discarded while the analytical structure remains intact.
A fundamental conclusion of this study is that it is as misleading to regard the British economy of Smith's day as basically 'agricultural' as it is to ascribe to it the features of a highly industrialized, capital-intensive economy. The agricultural sector itself was actually one of the most capital-intensive sectors, and structural change within the manufacturing sector was transforming the nature of the economy. It is clear from Smith's account both of the industry structure and of technological change that he was aware of the beginnings of a transition; and it is the trend which matters. We have attempted to show in fact that Smith recognized and dealt with many of the important technological developments prior to 1776 (with the significant exception of those occurring in the cotton industry) basing his analysis in part upon the economic pressures exerted by changing relative prices. On balance, in light of the attention paid to the determinants of industrial organization, to fixed capital and its maintenance, to the sources of knowledge, and to the differential factor-saving effects of various innovations, we reject the charge that the failed to 'anticipate' the industrial revolution.
Bearing in mind both the role accorded by Smith to the price mechanism in economic development and the analysis of the process of technological progress we may evaluate the relevance of the alleged 'Corn Model' as an accurate representation of Smithian growth theory. In our view the model does not seem appropriate; in fact it would be more suitable for the analysis of the seventeenth-century than the mid-eighteenth-century economy. For it neglects the production function in manufacturing; the significance of raw materials—which in many respects played an even more important role than food in capital as a constraint upon employment—receives no attention; and there is no place for fixed capital and accordingly for almost the entire Smithian process of 'embodied' technical change."8
Now we do not intend to deny that Smith frequently accorded particular significance—both quantitative and qualitative—to basic 'necessaries.' We have in mind the unique treatment of price determination in the case of corn; the close relationship defined between corn prices, money wages and commodity prices; the dependence of population growth upon corn supplies; and the wages-fund theory. But Smith was keenly aware of rising working-class living standards in contemporary Britain and of the complications which this entailed. When he utilised corn as numéraire, for example, it was because it served better than any alternative but not because it was satisfactory in its own right. The degree of sophistication which characterised working-class budgets rendered quite inadequate any simple set of causal relations. Thus the fact that the real counterpart of money wages could not in practise be reduced to basic necessaries threatened the entire population mechanism and suggested to Smith a possible case for the utilization of excise taxes to induce a change in the pattern of consumption. The reaction of population to high average wages was further complicated by the differential patterns of behaviour on the part of labour in the capitalist and the non-capitalist sectors. It would not, therefore, be legitimate to ascribe to Smith use of models incorporating relatively invariant functional relationships and constant conditions since this abstracts from the very problem which concerned him, namely the 'balance' of forces relevant in particular circumstances.9 To neglect these complications is to neglect some of the essentials of Smith's economics. Finally, it must be repeated that the special role accorded corn at various stages of the argument positively did not preclude an overwhelming concern with the allocation of resources.
Smith's awareness of contemporary technological and sociological developments, we have concluded, was more profound than is sometimes implied. A few words are in order regarding the state of governmental intervention, for it is frequently suggested that Smith failed to appreciate the contemporary process of rapid decay of internal governmental regulation. Our investigation confirms an exaggeration, on Smith's part, of the severity of regulation, but at the same time indicates some recognition of a diminution in control. Smith's overstatement of the degree of internal regulation may certainly have been simply an error of judgment; the evidence was subject to conflicting interpretation by contemporary authorities. But it may also have been deliberate to some degree. Smith, of course, much feared monopolistic and monopsonistic tendencies, which were, in his view, likely in the last resort to be incurable. From this point of view even occasional cases of legal support were reprehensible in the extreme.10 Allowance must also be made for his a priori principle in favour of free trade based once again upon the 'natural right' of individuals not to be interefered with. While we do not intend to deny a certain 'empirical' or 'utilitarian' outlook—apparently sufficiently powerful to have led Smith to remain silent on a number of burning social issues of the day—there can be little doubt that the principle of natural liberty played an important role in the present case, implying indeed the belief that an appeal in such terms would not fall upon deaf ears. We have, for example, noted his severe condemnation of British interference with economic activity in the colonies despite a belief that the regulations happened to be ineffectual. And the case against the settlement laws contained a similar appeal: the attempt at regulation of the labour market is 'evidently as impertinent as it is oppressive.'11
We have observed that when allowance is made for Smith's overriding concern with contemporary issues it is possible to detect a greater degree of consistency in the Wealth of Nations than may be apparent at first sight. Thus the serious charge that the Smithian analysis of profit-rate equalization conflicts with that of differential employment-generating capacities of alternative investments is unjustified, for it neglects to take into account distortions in the pattern of activity the correction of which was Smith's objective. Similarly, there is little justification for a charge of inconsistency regarding the broad issue of priorities in national policy. But there remains an element of truth in the observation that 'consistency was not his shining virtue.'12 A striking instance is the implication of the existence of unused resources in the 'ventfor-surplus' theory of trade, which contrasts with the assumption of full employment of capital and labour implied in the theory based upon 'absolute advantage.' It is true that Smith was engaged in a critique of policies and proposals formally designed to raise employment; we must keep in mind that he was writing a 'tract for the time,' and could better make his case if he could prove his opponents wrong using their criteria of policy. Yet it is difficult to resolve entirely the disaccord in this fashion, and we conclude that the alternative approaches to trade based on differing sets of implicit assumptions are not satisfactorily reconciled. (At the same time, the importance of the vent-for-surplus doctrine should not be exaggerated, for it frequently is utilized simply to explain the function of wholesale traders and, in this context, it may be used together with any theory which accounts for regional specialization.)
It is essential to consider the relation between Smith's theory of vent-for-surplus and the so-called 'Smith-Turgot theorem on savings' with an eye to their compatibility. Smith's eulogy of the advantages of capital accumulation, his correspondingly negative attitude towards luxury consumption, and his insistence that the process of savings involves no leakage from the income stream constitute fundamental divergencies from traditional mercantilist positions, although tentative steps in this direction had already been taken, for example, by Hutcheson. For despite their 'doctrine of thrift' mercantilist writers, on the whole, gave qualified assent to the requirement for luxury consumption as a means of assuring a high level of activity. While the Physiocrats also tended to show a formal concern with hoarding and emphasized the necessity for consumption in the interest of productive activity, their position can only be appreciated within the specific context of the French doctrine. It was Turgot, however, who stated with particular clarity that the process of accumulation did not involve any attempt to add to money hoards.
The 'vent-for-surplus' theory has been described as a 'surviving relic of the Mercantile Theory' by J.S. Mill, for international trade—according to orthodox classical doctrine—permits the more efficient use of capital and labour and does not absorb into productive activity resources otherwise idle. But it must be noted that Smith's theorem on savings merely implies that no attempt is made to add to money balances from sales proceeds thus, in principle, precluding 'monetary' causes of unemployment and excess capacity; it does not rule out other possible causes. In fact the rationalization for excess capacity in a closed economy suggested by Smith's discussion relates to a severe degree of specificness attributed to domestic resources and high inelasticity attributed to domestic demand for those particular products which can technically be produced. There is, therefore, no necessary conflict between the vent-for-surplus doctrine and the theorem on savings.
Smith's forecast of a downward secular trend in the average profit rate with capital accumulation also requires attention in the present context. We have seen that the argument already referred to by Hume and Massie was formally based upon the notion of "increasing competition.' But this argument was supplemented by a suggestion that an increasing paucity of investment opportunities lies at the root of the problem (although the only instance given of what he might have had in mind appears in a loose formulation of diminishing returns at the extensive margin in agriculture). An explanation along these lines does not, in principle, conflict with the Smith-Turgot theorem. It is true that the profit-rate decline, in Smith's view, might be checked by the acquisition of 'new markets,' but the argument relates to the diversion of fully utilized capital towards more profitable branches of activity thus raising the average rate, rather than to the absorption into use of hitherto idle capacity. While in our view the position does not necessarily conflict with the orthodox 'law of markets,' classical writers frequently insisted that it did13 and Ricardo in particular was unable to accept a view of the economic system which envisaged variations in the secular rate of profit unrelated to inverse variations in the real cost of producing wage goods.14
Yet there remains one related phenomenon which appears to be in conflict with the Smith-Turgot theorem. The predicted decline in the rate of profit (and accordingly the natural rate of interest) with increasing accumulation is said ultimately to lead to the stationary state where there occurs no further net investment (and accordingly no new stimulus to an expansion of population). But Smith at the same time much emphasized the tendency, in the normal course of development, for increasing investment to be made in the carrying trade which, it will be recalled, 'is altogether withdrawn from supporting the productive labour of that particular country, to support that of some foreign countries.' Moreover, note is also taken on occasion of direct foreign investment undertaken by various European nations with relatively low rates of interest. If we understand Smith correctly, it would appear to be the case that, at least in an open economy, saving may be undertaken which is not reflected in net domestic investment. Our point is not simply that subsequent effects playing back on the domestic economy are not investigated by Smith, but rather that the existence of a potentially serious conflict with the fundamental proposition regarding the nature of saving is nowhere given formal recognition.
Smith's physiocratic contemporaries approached the problem of economic growth in terms similar to those of the Wealth of Nations, insofar as the emphasis is upon accumulation of capital envisaged as 'advances' permitting time-consuming activity, and maximization of the community's disposable surplus—by attention to 'efficiency' in allocation—as the source of new capital. Moreover, in both Smithian and physiocratic economics (and earlier, in the work of Cantillon), in sharp contrast with traditional mercantilist doctrine, population size fell away as an immediate objective of policy. The general unconcern with the magnitude of population as such is reflected, in part, by the fact that neither Smith nor the Physiocrats showed any concern for the potential 'loss' of population to the colonies such as was feared by some contemporaries; much more attention was paid, by Smith, to the outward flow of capital. This position was indeed maintained at a time not far removed from the Stuart rebellion when it might have been expected that concern for a large body of yeomen would have preoccupied him.
Smith's possible 'debt' to the Physiocrats has been the subject of considerable debate, although perhaps what is really important is how much Smith accepted of the French analysts, rather than his debt to them. Professor Cannan has suggested, largely on the basis of close examination of the contrasts between the [Lectures on Justice, Police, Revenue and Arms] and the Wealth of Nations, that while Smith's distinction between productive and unproductive labour, the thesis that productive labour is maintained from capital advances, the distributive scheme, and the concept of annual produce, seem to have been influenced by his contact with and knowledge of the French economists, his analyses of the division of labour, of price, and of the wage structure were developed independently. Of particular significance, the general case for economic liberalism had long been adopted.15 But even Cannan's limited attributions are probably exaggerated. There is in the Lectures perhaps more attention paid to the role of capital in permitting time-consuming processes than Cannan is prepared to concede, and the issue is touched upon, as we have seen, by Hutcheson, Oswald and Tucker. Several of Smith's immediate predecessors, including Cantillon and Steuart, were placing increasing emphasis upon productive capital as distinct from purely commercial capital opening the road towards a view of profits as a class income received not only by merchants but by capitalist-employers generally. While the basic physiocratic theory implies that only capital invested in agriculture is capable of generating a net return it was Smith's position (and that of Turgot) that a net revenue is yielded in all spheres of activity (although the source of the return in the mercantile sector, it will be recalled, is explained by Smith in terms of the traditional principle of 'alienation'). There is, moreover, some evidence that Smith may have drawn upon the work of James Oswald in his division of cost-price into the component parts of rent, wages and profits which constitutes the basis for the distribution of the entire national income between aggregate rent, wages and profits, and the natural-price doctrine was discussed by William Temple in 1758.
But whatever the extent and nature of Smith's 'debts' the fact is that the Physiocrats were severely constrained by their characteristic doctrines regarding agriculture as the sole wealth-creating activity. Equally significant, inadequate attention was paid to the mechanism whereby resources would be allocated in a freely-operating system and it is difficult to escape the impression that their support for free trade both internally and externally as a necessary precondition of rapid development was not based securely upon a well-constructed analytical foundation. There is also justification for the view that their policy proposals were designed as a device to counter the contemporary pattern of intervention but would have been much qualified in other circumstances. This is above all true of their recommendation for free trade in corn, which was, it would appear, maintained conditionally in light of France's circumstance as a net corn exporter. The Physiocrats, in brief, made appeal to a 'superior' principle, namely the effect of policy upon the price and quantity of agricultural produce. By contrast, Smith's 'agricultural bias' did not lead to much distortion in his applied economics and his policy proposals in support of free trade were more firmly based upon the allocative processes of the competitive price system. Yet we have shown also that Smith did not do full justice to his case in favour of non-intervention when envisaged from the point of view of a developing country poorly endowed with natural resources or one which, although adequately endowed, has entered belatedly into competition with other, relatively advanced, 'landed' nations.
It is further argued by Cannan that Smith—particularly by his use of a theory of capital and productive labour, and by his appendage of a scheme of distribution to an existing theory of price—'settled the form of economic treatises of a century at least.'16 But if this view is considered closely it will be seen to be only partially adequate. Ricardo was not much concerned with the issue of productive and unproductive labour; he diverged markedly in the analyses of price, the 'measure of value,' distribution, and the profit-rate trend; it is not even clear whether some of his discussions—such as that of machinery—were in any way related to micro-economic decision-making units, whether in other words they fall within the 'paradigm' of competitive allocation theory. Even where the Smithian approach accords with that of his successors, it was frequently misunderstood. This is revealed in the charge by McCulloch that the analysis of investment priorities conflicted with the principles of profit-rate equalization; and also in the related, mistaken, belief of Ricardo that Smith championed a large gross revenue. And Smith's recognition of the role of differential factor endowments as a rationale for international trade, and of changes therein over time as an explanation of temporal variations in optimal resource allocation went unnoticed. The impression left upon Smith's successors by the precise details of his allocative mechanism, or the precise relationship envisaged between the theory of competitive resource allocation and economic development was thus scarcely an extensive one.
Yet there remains an important element of truth in Cannan's proposition. The general case in favour of laissez-faire and the general workings of the competitive process in assuring a tendency towards the establishment of equilibrium wage-rate and profit-rate structures, and the analysis of the relationship between market and cost prices, represent without question a vital link with the future. Moreover, Smith's early nineteenth-century successors had conveniently available to them what appeared already to be a body of 'received doctrine' upon which they could draw, and of equal importance to which they could direct their critical attention; for without doubt, Smith presented an extensive body of economics in a manner which they found supremely worthwhile. In particular, Ricardo's analytical structure relating to distribution was formulated in direct response to that of Smith. It is, in our view, impossible to appreciate the Ricardian innovations without keeping to the fore Smith's formulation of the problem to be solved—the effect of wage-rate changes upon profits—and Smith's own solution.
In matters of aggregative economic theory a number of precise relationships may also be discerned. The conception of capital as 'advances'; the view of the savings process as proceeding in a 'hitchless' fashion; the minimization of the monetary determination of the interest rate; the specification of the relationship between the rates of growth of capital and population as the key determinant of working-class living standards are matters which come to occupy the centre of the stage. Equally important regarding the fundamental matters of method and of ultimate objective, Hume, Smith, and the nineteenth-century classical writers—as Lord Robbins has emphasized—had in common a critical concern not merely with social reform but with reform based upon a systematic body of scientific knowledge.17 The precise theoretical structures utilized certainly differ from case to case and may have been more or less soundly constructed, but the mode of operation and the general objective—the improved welfare of the working-class in particular—was shared by all.
Our discussion leads on to the relationship between Smithian and Marxian analysis. The characteristic element of Smith's work which is most attractive to scholars in the Marxian tradition is his extension of physiocratic doctrine to allow for the generation of surplus-value in all sectors: 'The special feature of the [Smithian] pattern which marked it off from those put forward by earlier economists was the inclusion of profit on capital as a general category of class income which accrued to all who used "stock" in the employment of wage-labour, and which was qualitatively distinct both from the rent of land and from the wages of labour.'18 More specifically, if we consider Smith's occasional attribution to labour of the ability to generate surplus value—at least in industry and trade—together with the classification of Book II, chapter v which distinguished sectors according to their respective 'constant' and 'variable'—as distinct from 'fixed' and 'circulating'—elements in a given capital stock we are even faced, in principle, with the Marxian problem of profit-rate equalization. For if profits are in some sense a deduction from labour's contribution and if labour-capital ratios differ between sectors, Marx's issue makes an appearance. Smith, of course, never recognized the problem but it lurks in the shadows.
But even when—as is usually the case in the Wealth of Nations—a value-creating ability is accorded to land and capital, the moral justification of property income is questioned. Smith's recommendations, it must at the same time be emphasized, imply a 'reformist' rather than a 'revolutionary' propensity; there is no call for confiscatory measures or any interference with private property rights, despite explicit statements to the effect that 'the affluence of the few supposes the indigence of the many,'19 or that '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.'20 Without doubt Smith (and Hume too) took a hard-headed approach to any schemes for equality in the distribution of wealth; and in the case at hand one may discern (even within the narrow scope of purely economic issues and apart from certain desirable social characteristics attributed by Smith to capitalism in general, and—to a degree—to inequality in particular) a very practical reason for the failure to draw the 'logical' conclusions from such striking observations. Smith was conscious that Britain could not be viewed as an isolated island; any excessive taxation of income would simply assure the transfer of capital elsewhere. This was certainly the basis for his warning against the taxation of pure interest. On the whole, a case might be made according to which Smith championed the allocative function of the price mechanism while at the same time he was dissatisfied with the distributional implications thereof. The dilemma was resolved above all by the absence of any practicable alternative to the process of capital accumulation as then undertaken by the recipients of interest and rent, which process in fact provided the best assurance in the circumstances that the labouring classes too would partake of the benefits of economic development. Thus Smith's allowances for monopsony pressure, which in principle imply a rejection of population restraint as the primary solution for depressed living standards, were of little practical relevance during a period of secular expansion such as Smith envisaged. It is equally essential to take into account Smith's outline of the measures which might legitimately be undertaken by the state to alleviate some of the worst defects of the contemporary system.
Notes
1 [Schumpeter, J.A. Economic Doctrine and Method. 1912; London, 1954—History of Economic Analysis. New York, 1954.]
2Adam Smith, 1723–1790 (London, 1948), 19.
3 The contrast between formal statements and practical applications can be further illustrated. The main sectoral differences which are formally recognized in the Second Book are those between agriculture, manufactures, and trade. Differences within manufacturing in the fixed-circulating capital ratio, and differences within either manufactures, or agriculture in the turnover rate of capital are ruled out. Yet in several practical applications such differences do play a part.
A similar interpretation may be suggested for Smith's treatment of the wages-fund theory. The formal analysis suggests that changes in the wage rate cannot exert an influence on the total wage bill, a constraint that is only true if factor proportions are identical everywhere and technologically determined. If these assumptions are taken seriously, then crucial obstacles exist in the way of full employment. But these problems were not necessarily obvious to Smith, and, in fact, it seems from our study to be the case that Smith was unaware of the implicit assumptions of his formal analysis.
See too G.J. Stigler, 'The Classical Economics: An Alternative View,' Five Lectures on Economic Problems (London, 1949), 25–36 which distinguishes (in a case study relating to Nassau Senior's analysis in the hand-loom weaver report) between the 'working technique' and the 'formal theory' of classical economists. Adam Smith, 20.
4Adam Smith, 20.
5 Adam Smith, Wealth of Nations, [Modern Library Edition, edited by E. Cannan, New York, 1937], 435.
6 Moreover, the institutional framework essential for the efficient operation of the price mechanism must be kept in mind throughout. Indispensable accounts are given by N. Rosenberg, 'Some Institutional Aspects of the Wealth of Nations,' Journal of Political Economy, LXVIII (Dec. 1960); and Warren J. Samuels, The Classical Theory of Economic Policy (Cleveland, 1966).
7 For some peculiar Smithian obiter dicta see Arthur H. Cole, 'Puzzles of the Wealth of Nations,' Canadian Journal of Economics and Political Science, XXIV (Feb. 1958), 1–8.
8 The growth rate of the economy—defined algebraically … as k(p/w) - 1—will in practice depend upon the relationship between the distribution of the initial stock of wages goods between productive and service labour; the average productivity of labour; and the average wage rate. Unless the order of magnitude of these variables can be given, scarcely anything has been achieved by the mathematical formulation. But it is precisely at this point that the real problems of interpretation arise. For example, while the response of population to wage increases above 'subsistence' was certainly taken into account, much emphasis is placed upon upward pressures on the wage rate, due to scarcity of labour supplies, during a period of expansion. And increased productivity cannot be relied upon to counterbalance exactly increases in wages. We cannot presume that Smith was concerned with a regularly progressive economy and must accordingly examine the precise determinants of productivity and average wages.
9 For this same view, see J.J. Spengler, 'Adam Smith's Theory of Economic Growth—Part II,' Southern Economic Journal, XXVI (July 1951), 5.
10 Cf. Wealth of Nations, 128–9; 141–2 in particular.
11Ibid., 122.
12 A.L. Macfie, The Individual in Society: Papers on Adam Smith (London, 1967), 68. Professor Macfie extends the observation generally to eighteenth-century writers, especially members of the Scottish sociological school (ibid., 126).
13 Cf. Donald Winch, Classical Political Economy and Colonies (London, 1965), 30–1, 42–4, 81–5.
14Principles of Political Economy, 344–6.
15 E. Cannan, 'Editor's Introduction,' Lectures on Justice, Police, Revenue and Arms (New York, 1964), xxviii–xxxi; 'Editor's Introduction,' Wealth of Nations, xxxviii–xliii, and Cannan, A Review of Economic Theory (London, 1929), 291f.
At the outset of the Wealth of Nations, in the 'Plan of Work,' Smith stated that the growth of national product depended more upon the efficiency with which productive labour is used than the relative proportion of the labour force in the productive and service sectors (ibid., lvii–lviii). Cannan has implied ([Lectures on Justice, Police, Revenue and Arms], xxix; Wealth of Nations, xli) that his weighting suggests that the great emphasis upon productive labour of Book II—accorded to physiocratic influence—had not yet been achieved when the plan was formulated. Yet it must be borne in mind that capital accumulation was essential for the embodiment of new technology as well as for the support of additional productive labour.
16 'Introduction,' Wealth of Nations, xxxix.
17Theory of Economic Policy, 169f.
18 R.L. Meek, 'Adam Smith and the Classical Theory of Profit,' in Meek, Economics and Ideology and Other Essays (London, 1967), 18. The contrast with the [Lectures on Justice, Police, Revenue and Arms] is emphasized in 'The Physiocratic Concept of Profit,' ibid., 306.
19Wealth of Nations, 670.
20Ibid., 674. Cf. Lectures, 15.
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