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Source link: http://archive.mises.org/7085/adam-smith-and-karl-marxs-basic-and-monumental-in-consequences-error/

Adam Smith and Karl Marx’s basic and monumental (in consequences) error

September 5, 2007 by

What could these two thinkers, considered to be opposites, have in common? It turns out that Karl Marx inherits from Adam Smith a very basic error, one which has monumental consequences and has changed the world forever.

Adam Smith tells us in his famous treatise on the wealth of nations that in primitive conditions or small towns, those who would go to the market to sell their produce, cattle or manufacturing obtained salaries (wages) from their neighbors in the process. Salaries? Grave error. What is obtained by someone who moves from agricultural self-sufficiency to the market is not a salary but rather a gain or a loss. Gains and losses are obtained by entrepreneurs. By definition, then, this could be a farmer or any independent professional in a city.

A salary does not make an appearance until the role of the capitalist also appears. The capitalist is the person which takes previously produced resources and risks them. He is the one who buys or pays for a good or service to later sell something that is greater than the sum of the parts. And this can only be determined if the product is sold: this is the only signal, a signal that is lacking in totalitarian countries, that society is creating aggregate value. Smith errs greatly when he calls salaries that which entrepreneurs obtain when they trade in the city plaza. It is not until one person hires another, at a fixed, regular rate, that a salary exists. We can call this the pact of capitalism because it implies that the employee is now part of the capitalist’s entrepreneurial risk. In exchange, the employee receives a fixed income (daily, monthly, etc.), a salary.

Salaried employees have no possibility of gains, but –most importantly– are free from losses. Indeed, they have a better chance of receiving income than the capitalist. The farmer, for example, must pay the salaries of his workers even if there has been a frost the day before harvest. He cannot burden them with a loss. Nor can he, to be fair, share with them the gains. A pharmaceutical company will sell its products four or five years after the initial idea of creating a new product. In the meantime, it will have to pay salaries to hundreds, even thousands, of people. That the salary is payed now is not contingent on future sales.

Thus, the problem, brilliantly taught to us by Prof. George Reisman, is that the error shared by Smith and Marx permitted the idea that to obtain gains –the famous exploitative “surplus”– capitalists had to keep a bit of each employee’s salary. In reality, value is created by whomever imparts vision, risks resources and recognizes opportunities, all while creating regular income to others in the process. Capitalism creates a worldwide middle class. Before capitalists, everyone had to fully assume all of the risk of a given activity. Now, however, we can delegate risk to those who are more ambitious and capable in the entrepreneurial game and at the end of the month, we all receive a paycheck. This is infinitely more productive and effective and, ultimately, eliminates poverty.

{ 44 comments }

Black Bloke September 5, 2007 at 10:44 pm

This is probably the first time I’ve heard anyone mention the Reisman critique here.

Gavin Kennedy September 6, 2007 at 1:10 am

Juan Fernando Carpio:

Could you give a reference in Adam Smith’s works to his use of the word ‘salary’, or a ‘substitute’ word, please?

And perhaps also to the source reference to his statement that for going to market someone received a ‘salary’ or ‘wage’ or ‘income’.

Thanks

Malcontent September 6, 2007 at 6:49 am

“The farmer, for example, must pay the salaries of his workers even if there has been a frost the day before harvest. He cannot burden them with a loss. Nor can he, to be fair, share with them the gains.”

That’s not true. The farmer can fire them and not pay them. Better yet the farmer can lie to them and keep them working for as long as possible and then not pay them till they quit.

This happens all the time today and people had less rights back then.

The only thing that would prevent this kind of abuse of workers of course is unions.

Anthony September 6, 2007 at 7:10 am

…and competition between employers in the labour market.

Besides, JFC is still correct; even if fired, the workers do not incur losses from bad investments.

George Gaskell September 6, 2007 at 8:13 am

The only thing that would prevent this kind of abuse of workers of course is unions.

Please tell me you are joking.

TLWP Sam September 6, 2007 at 9:21 am

I half agree with Malcontent in that a employer isn’t obviously required to hire an employee all year round. I thought in the free market an employer would only hire a worker for the duration required and no more. Hence fruit pickers are seasonal workers and are not paid all year round.

On the other hand, workers don’t pay for bad investments? If managers make bad decisions and loses business they lose money and workers are laid off. Technically speaking workers share some burden of the economy fluctuations as plenty of people are unemployed alongside defunct businesses in recessions/depressions.

Finally, how does Capitalism create a middle class? In a full on free economy a person wealth would be directly proportional to their contribution to the economy. As far as I know the middle class as a large group has only appeared in the Socialist 20th century.

Anthony September 6, 2007 at 9:41 am

“On the other hand, workers don’t pay for bad investments? If managers make bad decisions and loses business they lose money and workers are laid off. Technically speaking workers share some burden of the economy fluctuations as plenty of people are unemployed alongside defunct businesses in recessions/depressions.”

No, the workers lose no money they had invested. All they “lose” is their association with the now bankrupt firm. The owners/entrepreneurs lose both their firm, suffer any losses they had risked incurring on the market.

On middle classes, they have existed since at least the 18th century in Europe, and in increasing numbers with the rise of industrial capitalism, so I doubt the proposition that the group only appeared in the 20th century.

Brendan September 6, 2007 at 9:47 am

“As far as I know the middle class as a large group has only appeared in the Socialist 20th century.”

What about China? They certainly qualified as a socialist state from 1949-1978 and virtually had no middle class. After market reforms, a middle class developed. Why has it appeared since then? Where did it come from?

It seems that capitalism creates variety in terms of income (high, middle, low). If not, then the Chinese middle class should have shrunk instead of expanded after Deng Xiaoping’s economic reforms.

Juan Fernando Carpio September 6, 2007 at 11:17 am

For Gavin Kennedy:

“The profits of stock, it may perhaps be thought, are only a different name for the wages of a particular sort of labour, the labour of inspection and direction. They are, however, altogether different, are regulated by quite different principles, and bear no proportion to the quantity, the hardship, or the ingenuity of this supposed labour of inspection and direction. They are regulated altogether by the value of the stock employed, and are greater or smaller in proportion to the extent of this stock. Let us suppose, for example, that in some particular place, where the common annual profits of manufacturing stock are ten per cent. there are two different manufactures, in each of which twenty workmen are employed at the rate of fifteen pounds a year each, or at the expence of three hundred a year in each manufactory. Let us suppose too, that the coarse materials annually wrought up in the one cost only seven hundred pounds, while the finer materials in the other cost seven thousand. The capital annually employed*45 in the one will in this case amount only to one thousand pounds; whereas that employed in the other will amount to seven thousand three hundred pounds. At the rate of ten per cent. therefore, the undertaker of the one will expect an yearly profit of about one hundred pounds only; while that of the other will expect about seven hundred and thirty pounds. But though their profits are so very different, their labour of inspection and direction may be either altogether or very nearly the same. In many great works, almost the whole labour of this kind is committed to some principal clerk.”

Chapter six. His treatment of wages and labor is anything but a call for confusion and disregard for the role of the pure capitalist.

http://www.econlib.org/LIBRARY/Smith/smWN.html

RogerM September 6, 2007 at 12:58 pm

Malcontent: “The farmer can fire them and not pay them. Better yet the farmer can lie to them and keep them working for as long as possible and then not pay them till they quit.”

Only once. How would workers respond to such treatment? They would avoid such employers and spread the word. Employers who cheat will have a hard time getting good workers. A little research will show that most improvements in the treatment of labor came voluntarily from employers trying to attract better workers, not from unions or the government.

TLWP Sam: “Finally, how does Capitalism create a middle class?”

By investment in capital equipment. Capital equipment (machinery) increases the productivity of labor, which in turn increases wages. Wages around the world, and across time, are highly correlated with labor productivity. The only way to increase labor productivity is increased investment in better technology and through on-the-job training.

RogerM September 6, 2007 at 1:00 pm

TLWP: “As far as I know the middle class as a large group has only appeared in the Socialist 20th century.”

The first real middle class appeared in the Dutch Republic in the 17th century. Check out Israel’s book on the Dutch Republic and “The First Modern Economy” by Jan de Vries.

Gavin Kennedy September 6, 2007 at 1:46 pm

I asked for a source for your statement that an entrepreneur going to market on behalf of others earned a ‘salary’.

Your reference does not give one. ‘Salary’ is not a word I believe Smith would use.

In the reference you give from Book I he speaks of profit as the earnings of capital and excludes these earning as comparable to ‘wages’, in this case of supervision. He gives an example showing this.

I do not think you have made your point about Adam Smith at all.

‘Capitalism’, pure or otherwise, was never mentioned by Smith (the word was invented in English in 1854). Turgot used the word ‘capitaliste’ in French. Smith wrote about commercial society before 19th century capitalism. He died in 1790.

Scott D September 6, 2007 at 4:16 pm

Malcontent:

This happens all the time today and people had less rights back then.

Less rights? Please explain–or perhaps what you mean is more government intervention in the market.

The only thing that would prevent this kind of abuse of workers of course is unions.

Employers are evil incarnate and workers are poor mindless sheep. Gosh, I better get a union to help me before my employer does that to me! I’m probably too stupid to think of it on my own though….

If unions ever did have any relevance, it’s long past. Do some fact checking into how much of the private sector is unionized vs. the public sector.

Also, has it occurred to anyone else that to have a “middle class” necessitates having a “lower class” as well as an “upper class”? What if the lower class of today were lifted out of poverty to the current level of our middle class, perhaps over the course of the next few decades of economic development? Would we then have just two classes, an upper and a middle, or would a new class emerge between the two? Would the socialists be happy with this as a final result?

Recent history suggests “no”. Even with a lower class that is far better off than the class of the same label from a century ago, we see that it is the division of labor and wealth that they hate. No matter how high the poor should rise in wealth and well-being, the existence of those who are more wealthy will always inspire envy.

Brendan September 6, 2007 at 5:14 pm

What do you all think of Reisman’s book, Capitalism? Also, what are your thoughts on his interpretation of the British Classical School.

Anthony September 6, 2007 at 6:38 pm

Scott, their main beef with the free market is and always has been inequality (because it increases the power of certain individuals, and foments envy.) Nearly all their criticisms of it have collapsed, and usually would be exacerbated in their own systems when not taken merely as abstract ideals. They always find ways to bemoan inequality’s “pernicious” effects though. I agree with them to the extent that inequality is artificial. I do not agree that it is in and of itself evil.

Juan Fernando Carpio September 6, 2007 at 7:23 pm

Gavin, it’s not the terms that matter, but the underlying concept. I think the line “The profits of stock, it may perhaps be thought, are only a different name for the wages of a particular sort of labour, the labour of inspection and direction.” is pretty clear.

Brendan: I consider it one of the greatest works on Economics ever written. Reisman has original insights and incorporates long forgotten doctrines of the Classical School, besides remining Austrians why Böhm-Bawerk’s development of the cost-price relation is still the best around.

fpk September 6, 2007 at 10:38 pm

“No, the workers lose no money they had invested. All they “lose” is their association with the now bankrupt firm. The owners/entrepreneurs lose both their firm, suffer any losses they had risked incurring on the market.”

Well, I see some investment on the workers part: For example costs of moving from one place of labor to another one. The time he invested looking for the particular job. If he looses the job and didn’t work there long enough you can say that his investments were malinvestment.

fpk September 6, 2007 at 10:39 pm

sorry guys, my English isn’t that good.

Gavin Kennedy September 7, 2007 at 1:50 am

Juan Fernando Carpio
I have no wish to bash this issue to death, but when reading Adam Smith, you must read closely what he writes. He often states a proposition and then fpollows it with a rebuttal.

Remember, he was a rhetorician in the classical mode, a form of argument now redundant. He was also a university teacher and in the 18th century his classes consisted of boys, all necessarily qualified in Latin (lectures used to be given in Latin in 18th cenruty Scotland, though Smith, fluent in Latin, lectured in English).The first line you quote is ‘pretty clear’ – he states what some people ‘may perhaps’ have ‘thought’:

“The profits of stock, it may perhaps be thought, are only a different name for the wages of a particular sort of labour, the labour of inspection and direction.’

This does not mean that ‘thought’ it too, for he goes on in the very enxt line to repudiate that ‘thought’:

“They are, however, altogether different, are regulated by quite different principles, and bear no proportion to the quantity, the hardship, or the ingenuity of this supposed labour of inspection and direction. They are regulated altogether by the value of the stock employed, and are greater or smaller in proportion to the extent of this stock.”

Now that is what Smith ‘thought’ and believed, and it is more than ‘pretty clear’, it is absolutely clear that he believed the second sentence and NOT the first.

If the terms do not matter, ‘the underlying concept does’, and Smith makes it clear what he considers to be the ‘underlying concept’.

Smith did NOT on this occasion make a ‘monumental error’ (I cannot speak for Karl Marx!), but you are in danger of making an error of attribution to Smith something in which he said something completely different to that which you have attributed to him.

The Mises.org editor should have noted this.

Juan Fernando Carpio September 7, 2007 at 2:46 am

Gavin:

“altogether different, are regulated by quite differentprinciples, and bear no proportion to the quantity, the hardship, or the ingenuity of this supposed labour of inspection and direction. ”

He is still talking about wages of management, which is not the risk-taking (uncertainty if we pick up the difference brilliantly made by Knight centuries later) that the capitalist brings to the process.

It is a sorry and monumental mistake on the part of Smith. James Mill was less of a communicator (we owe Smith a lot in the world) but more of an economist.

The editor of Mises.org noted this, so you can deal directly with me, there is no need to call mother superior.

Alan September 7, 2007 at 2:47 am

We are talking of systems working with each playing their part, not the fact that some will break their contracts.

The employer is if anything at much greater risk of hiring an incompetent slacker than the employee is of somehow stumbling into employment with a firm about to commit suicide by not paying its workers!

Likewise the employer risks malinvestment when it comes to training, as the employee may take their new skills elsewhere. As someone who has done a lot of hiring and firing I know I tend to ensure the candidate lives locally – for if they have to commute over a distance I know they are likely to take the same job closer to home, even if the pay is less. The advertising, interviewing and vetting of candidates, then training them as employees all come under the heading of investment.

Far more people lie on the CV/resume than employers lie about the employment contract offered.

A.

Mathieu Bédard September 7, 2007 at 5:00 am

Can we at least get the passage in Wealth of Nations ? Indications on which chapter to look it up? Anything?

Yancey Ward September 7, 2007 at 9:38 am

So, the question is whether Adam Smith believed in the labor theory of value? I don’t know if we will ever have a definitive answer to this. You can read what Smith wrote and come to different conclusions on this issue, as economists have been doing for 200 years.

Gavin Kennedy September 7, 2007 at 10:34 am

Juan Fernando Carpo comes back! He does not know when he is sawing the branch he is sitting on:

The full sentence you partly quote, says exactly the opposite of what you claim for it, so I shall quote it in full, and emphasise the words you dropped and shall place them in square brackets, so that there is no room for ambiguity:

“[IN THE PRICE OF COMMODITIES, THEREFORE, THE PROFITS OF STOCK CONSTITUTE A COMPONENT PART ] altogether different from the wages of labour, and regulated by quite different principles.”
[WN I.vi.6: p 67]

Of this you assert: ‘’he is still talking about the wages of management’! It says : ‘therefore the profits of stock’, which have nothing to do with how wages are formulated. Profits of stock(an 18th-century term for capital!) are not ‘wages of management’.

That you insist that the talking ‘about the wages of management’, despite Smith explicit and unambiguous denial that he is, suggests either that you continue to insist that he is because your original article requires him to be so and you hope continual denial (and doctoring) of the written evidence will somehow justify your assertion, or that you are deliberately misquoting him to make an unjustified criticism of Adam Smith because you believe he was somehow responsible for whatever Karl Marx made of his misreading of Adam Smith.

Either way it is a lapse in normal scholarly standards, and it is to that point I expressed surprise that the editor of Mises Blog did not draw your attention to your error. I am not sure what you mean by a ‘mother superior’ in this context.

That you report that ‘The editor of Mises.org noted this’ surprises me, because although I have had occasional differences with Mises Blog on other misattributions of one or two of its authors on Adam Smith, overall I respect its quality standards.

It is also slightly worrying that you deliberately drop the words in square brackets in your above quotation from Wealth Of Nations. It is tantamount to a deliberate attempt to mislead readers who do not read the full quotation in Wealth Of Nations:

“[IN THE PRICE OF COMMODITIES, THEREFORE, THE PROFITS OF STOCK CONSTITUTE A COMPONENT PART ] altogether different from the wages of labour, and regulated by quite different principles.” [WN I.vi.6: p 67]

‘Altogether different from the wages of labour’ is unambiguous. ‘Different’ in English means ‘not the same as’; ‘altogether different’ means there is no similarity whatsoever, therefore the ‘profits of stock’ are both different form wages’ and are ‘regulated by quite different principles’, which means, unambiguously, ‘quite different’, and not the same, ‘principles’.

In short, despite your continual denials of what Smith actually said, compared to what you have imputed, Smith did not compare profits from stock (or what the owner of the capital earned from owning the capital), it was NOT regarded by Smith as the same as a ‘salary’ or a ‘wage’.

The ‘grave error’ with ‘monumental’ consequences are Juan Fernando Carpio’s and not Adam Smith’s. Thankfully, though sadly, in view of his repeated denials, Juan Fernando Carpio’s errors will not have any consequences, except perhaps to his academic reputation.

Geoffrey Plauche September 7, 2007 at 12:25 pm

“The ‘grave error’ with ‘monumental’ consequences are Juan Fernando Carpio’s and not Adam Smith’s. Thankfully, though sadly, in view of his repeated denials, Juan Fernando Carpio’s errors will not have any consequences, except perhaps to his academic reputation.”

Speaking of academic reputation, is it necessary or proper to get personal like this and ridicule someone? I realize that Adam Smith is a subject near and dear to your heart but surely you can be more civil.

Ball September 7, 2007 at 1:41 pm

Gavin’s posts, it may perhaps be thought, are only a different form of idolatry, the following of Smith by mantra. They are, however, altogether different, are borne out of quite different principles, and bear no semblance of isolation, dogma, or narrow-mindedness of this supposed idolatry. They are formed out of a reasoned inspection of the original source, and put to shame the weak argument originally put forth.

There, now everyone is happy.

Geoffrey Plauche September 7, 2007 at 2:37 pm

Is it necessary to talk of shame?

Regardless of Gavin’s interpretation of Smith is the correct one, his concluding remarks that I quote above are still rude and, since he himself brings the issue of academic reputation, unprofessional.

I’ll also point out that grammatically the remarks are a bit incoherent. Gavin says Carpio’s errors have monumental consequences but then contradicts himself by saying that they will not have any consequences. He can’t have it both ways. He also says that this is thankfully so but also that it is sad, an apparently contradictory combination. Now, obviously, this is not what Gavin meant. But Gavin is not simply employing good rhetorical techniques here that I am somehow misreading. The sentences and argument are simply poorly formed. Presumably Gavin meant that it is sad that Carpio will not recognize his errors and the consequences of this for his academic reputation are what is sad. But this is not what the sentence says. Similarly the second sentence contradicts the first on the effects of Carpio’s errors but this is not simply a rhetorical technique; to work as such Gavin would have had to say the error would have monumental consequences if they were not recognized as such but since the errors are so obvious they will be so recognized and therefore won’t have any consequences. Gavin’s attempt to be pithy and score rhetorical points ended up making the passage not only rude and unprofessional but incoherent.

Geoffrey Plauche September 7, 2007 at 2:39 pm

This…

“Regardless of Gavin’s interpretation of Smith is the correct one, his concluding remarks that I quote above are still rude and, since he himself brings the issue of academic reputation, unprofessional.”

…should read…

“Regardless of [whether] Gavin’s interpretation of Smith is the correct one, his concluding remarks that I quote above are still rude and, since he himself [up the] issue of academic reputation, unprofessional.”

Gavin Kennedy September 7, 2007 at 2:58 pm

Geoffrey Plauche

I take you point and unreservedly apologise if you consider me to have lapsed in normal scholarly courtesies.

Therefore, I withdraw the comments in my final paragraph on my last previous post.

Two final points. I do not treat Adam Smith with idolatory admiration.

I do get exasperated sometimes with attributions to Adam Smith, mainly from neoclassical economists who have never bothered to read his works, widely available as they are in popular low-priced editions. I don’t expect this from contributors to Mises.org. Indeed, I spend time correcting these misattributions and normally the persons concerned (some are leading scholars, too) acknowledge their errors of attribution. A very few defy the evidence.

It’s not normal for such a clear cut misreading of Wealth Of Nations as we are discussing here to be so blatantly defended. My exasperation on this occasion may have got the better of me. Sorry.

I won’t insist that the Juan Fernando Carpio withdraw his statements; that’s up to him. In fact, I considered my last post to terminate my further participation in the dialogue with him. I only responded to your post because it left an issue that I could put right. Hence, I have.

Thank you for comments.

Geoffrey Plauche September 7, 2007 at 3:15 pm

Gavin,

You wrote: “I do not treat Adam Smith with idolatory admiration.”

I did not mean to imply that you do. Ball is the one who introduced the word idolatry.

By “near and dear to your heart” I merely meant, having glanced over your website, that Adam Smith is a thinker you have seem to have put a lot of time and research into. I realize that when we have issues that are that important to us it is easy to get worked up over them.

Geoffrey Plauche September 7, 2007 at 3:17 pm

I forgot to add:

Thank you for your response.

Anthony September 7, 2007 at 11:09 pm

Interesting site you have on Smith Mr Kennedy.

Juan Fernando Carpio September 8, 2007 at 9:45 pm

In chapter three one can find another quote that supports my interpretation of Smith’s: “Thus the labour of a manufacturer adds, generally, to the value of the materials which he works upon, that of his own maintenance, and of his master’s profit.”. There is ignorance or disregard for the pure capitalist (investor) role, speculators and so on.

Gavin Kennedy September 9, 2007 at 7:38 am

Juan Fernando Carpio,

The full quotation from Wealth Of Nations that opens Chapter iii in Book II, page 330, ‘On the Accumulation of Capital, or of productive and unproductive labour’ reads:

“There is one sort of labour which adds to the value of the subject upon which it is bestowed. There is another which has no such effect. The former, as it produces a value, may be called productive; the latter, unproductive, labour. Thus the labour of a manufacturer adds, generally, to the value of the materials which he works upon, that of his own maintenance, and of his master’s profit. The labour of the menial servant, on the contrary, adds to the value of nothing. Though the manufacturer has his wages advanced to him by his master, he, in reality, costs him no expence, the value of his wages being generally, restored, together with a profit, in the improved sale of the subject upon which his labour is bestowed. But the maintenance of a menial servant never is restored. A man grows rich by employing a multitude of manufacturers: He grows poor, by maintaining a multitude of menial servants.’ [WN II.iii.1: page 330]

Productive labour produces products that are sold by masters for a price and out of the revenue received by the ‘master’.

The ‘entrepreneur’: from the 18th-century French usage of the word: ‘between takers, buyers or purchasers, has shifted meaning in the 21st century. The common French usage of ‘entrepreneur’ is as a ‘haulage contractor’, etc., in the French village where is live. In English (and American) it has been expanded to mean any risk taking in business.

The master recovers the wages he paid to the labourer (or ‘manufacturer’; in the 18th century, these were persons who used their ‘hands’ to make things, i.e., handmade products, but not a 21st-century large-scale modern ‘manufacturer’) when the master sold his goods in markets. Wages were at the subsistence level as determine socially.

Out of the balance of revenue from sales that was left after paying wages of labourers, the master, recovered the cost of the materials used by the labourer, and retained the rest (if any) as his profit. This profit share came from his ownership of the circulating capital that maintained labour in their employment, paid for the raw materials or semi-manufactured produce (today: ‘work in progress’). The master’s capital was at risk because he may not have recovered his capital his outlays (the maintenance of the labourers, and his purchases of raw materials), or made sufficient profit to justify taking such risks. In which case, he would leave the business and seek other profit opportunities (lend his capital at interest or hire other labour to produce something else).

If you continue reading Book II of Wealth Of Nations, you will be introduced to Smith’s ‘model’ of the ‘great wheel of circulation’ (Fixed and circulating capital) and see how he believed that this created net growth in a commercial economy.

It is absolutely clear, beyond argument in fact, though that never stops academics from arguing, that profit was the share of the revenue to owners of capital from employing labour in productive output and from selling the products in markets. It was never a ‘wage’ for the master’s work. He took his profits and either consumed them (tendencies to prodigality) or invested them in productive work (frugality).

You may also note that Smith never discussed ‘capitalism’ and did not recognise the phenomenon, nor the word. The first use of ‘capitalist’ in English was in 1793 (Smith died in 1790); Turgot used the French word ‘capitaliste’ in 1766. The first use of ‘capitalism’ in English was in 1854 in William Makepeace Thackeray’s novel: ‘The Newcomes’, and thereafter, of course, by Karl Marx.

Smith’s description of the ‘age of commerce’ was a much simpler affair than modern ideas of finance capital. He spoke of owners of ‘stock’, owners of ‘capital’, and ‘undertakers’.

Should you have further quotations for clarification, I would be delighted to offer my views, or, rather, Adam Smith’s views on his behalf.

Anthony September 9, 2007 at 8:42 am

Smith’s views on profits were closely related with the LTV it seems. It’s not too difficult to see how Marx would go along a different route with regard to the formation of profits (based on the LTV.)

Gavin Kennedy September 9, 2007 at 9:52 am

Anthony
Discussing Smith and the Labour Theory of Value would take us a long way from this thread. Briefly, he argued that labour ‘originally’ was the source of all wealth in, and the distinction is important, ‘rude’ society of hunting and gathering. There was no ‘capital’ present in this first ‘age’ of mankind. Labour owned the product its labour; land was owned by nobody; there was no ‘capital’ present in this first ‘age’ of mankind, and nobody made ‘profits’.

But Smith moved the argument away from labour in savage society to labour in the ages of shepherding and agriculture, and the appearance of property, civil government and laws. His presentation of these distinct changes is muddled because it is mixed together, as he switches from describing ‘rude’ and ‘savage’ society to societies where other contributors to wealth production, denominated as the annual output of the ‘necessaries, conveniences, and amusements of life’. It is necessary to read these chapters carefully to disentangle the loose strands of his arguments [Wealth Of Nations, I.v-viii: pp 47-104] to understand his so-called labour theory of labour.

Labour contributed essential components of man made products, and was no longer the sole source of value because owners of land and of primitive capital (direct savings out of earned ‘rents’ and ‘profits’) were contributors to output. In the age of commerce, labourers earned their wages, landlords rented their lands and masters earned their profits from their ownership and risk taking only. In short, for Smith the ‘labour theory of value’ no longer applied. Prices were determined by the quantity supplied and the ‘effectual’ (quantity) demanded.

Smith, like Richard Cantillon (1734) and Turgot (1766) distinguished between ‘natural’ prices (where the factors of production received their ‘natural’ shares of the revenue) and ‘market’ prices, where the entrepreneur got what he got (by price determine solely quantity supplied and quantity demanded). If price rose above ‘natural prices’ he was able to pay his labourers and the landlord, his profits rose above the natural profits; if not, he made losses and (under perfect liberty) he changed his business activities, to recoup losses in the next period(s).

This is quite different from the Marxian labour theory of value.

Juan Fernando Carpio September 9, 2007 at 1:14 pm

I have to agree with Gavin on the difference between the Marxian labour theory of value, and Adam Smith’s dangerous (as we could see through history) jump from the “savage society” with no capital (a hoe is a capital good, even hunter-gathereres had capital goods), or savings (which I doubt, an apple for tomorrow saves some time today), to the ages of shepherding and agriculture. I agree on the term “muddled”, and in no way I mean to say that Adam Smith was a protomarxist, but that Marx had a very strong source from the Classical School, Ricardo included, to form his twisted worldview in terms of the origin or primacy of profit over wages (historically at least), and an “objective” theory of value, which they didn’t pursue as such but again was maliciously (my opinion) used by Marx for generating a mess from which we are unable to leave even now. Even moderated Socialdemocrats (Labour parties) still think that some profit is generated from wages, so they try to “balance” society and the market, to name one lond enduring influence of Marxism.

ktibuk September 9, 2007 at 1:31 pm

Gavin,

What does “capital” have to do with theory of value?

Objective (basically LTV) and subjective theories of value are about one thing only.

Putting the cart infront of the horse or putting the horse infront of the cart .

Of course the creation of wealth has everything to do with labor but identifying something as wealth does not.

Mrhuh September 9, 2007 at 1:34 pm

“Finally, how does Capitalism create a middle class? In a full on free economy a person wealth would be directly proportional to their contribution to the economy. As far as I know the middle class as a large group has only appeared in the Socialist 20th century.”

Actually, in the socialist 20th century, there has been an increasingly dwindling middle class, especially here in the U.S.

Anthony September 9, 2007 at 2:46 pm

Gavin, many thanks for your exposition of Smith’s views on profits.

Gavin Kennedy September 9, 2007 at 3:06 pm

Juan Fernando Carpio

When discussing Adam Smith’s ideas as he wrote and taught them, I am explaining his ideas and not ‘the’ theory of value as it was developed in the succeeding 230 years, whether ‘Neoclassical’ or ‘Austrian’.

I shall come back to your question tomorrow about Smith’s views on the evolution of capital on Monday, because it is late in France just now and I have to attend to various chores to do with the visit of my guests who have just left.

Gavin Kennedy September 10, 2007 at 2:46 pm

‘Ktibuk’, a correspondent asks (9 September):
Gavin,
What does “capital” have to do with theory of value?
My answer:
When discussing Adam Smith on his theories of value I address what he wrote and not value theory since the mid-18th century. Smith wrote about exchange value within his theory of growth, in which capital, labour and land have places. These factors create products for exchange, through the ‘propensity to truck, barter, and exchange’, which he implies appeared long before commercial society.
In ‘rude society’ there were no markets. Each individual was independent of others and laboured for his own ends, living in small groups of related families. When hungry he hunted or gathered (in practice the women folk gathered), when wet he built shelters, when cold he made animal skin ‘clothes’. There was no capital because everything ‘produced’ was for immediate consumption. Possessions had to be carried; hence, were limited to essential ‘tools’ (stone axes, etc.,). This was the first age of ‘man’.
Labour was unambiguously the sole factor of production (there was no ‘ownership’ of land and all it contained). Labour was the sole measure of value: what it cost in toil to produce. Smith opined, in a ‘just so’ story, how two hunters traded beaver for deer. As each unambiguously owned what they had killed (the original LVT) they exchanged deer for beaver in the ratio of the labour effort required to find, catch and kill each animal. This was Smith’s use of a LVT (as commonly understood in his days – cf. John Locke).
With property in land and in ‘stock’ (capital), the components of ‘price’ changed, from a mono-factor to a multi-factor, when looked at from the producer’s perspective. Labour no longer determined value; owners of land or stock, shared the sales revenue. Labour could still be regarded as a numeraire for measuring exchange value, but not for determining it (a confusion in LVT).
Ownership of land was enforced by property relations (civil government), which protected the private property of individual owners from the those without property (other than their perfect right in their labour). Ownership of ‘stock’ came from ‘saving’ out of consumption (a ‘grub stake’ idea).
In Smith’s concepts of fixed and circulating capital, fixed capitals are instruments (tools) of production that augment labour and they remain under the control of the ‘stock holder’ (their owner). Circulating capital consists of the ‘maintenance’ (subsistence) of hired labour and the raw materials upon which they work. Circulating capital necessarily leaves the stockholder’s possession (he pays out wages and buys in materials), including when he uses his fixed capital.
Sales revenue, net of costs, is his profit, which he divides into his immediate consumption and to augment his capital stock (the source of growth). Labourers live on their family’s maintenance (under ‘Malthusian’ conditions); idle landlords reap their rents from what they didn’t sow.
Prices in commercial society are determined by the quantity (‘effectually’) demanded and the quantity supplied. Smith’s ‘natural’ and ‘market’ price mechanism is similar to Richard Cantillon’s, 1734, and Turgot’s, 1766. When markets clear at ‘natural prices’ the factors receive their ‘natural’ shares of revenue; when market-determined prices rise above ‘natural’ prices, the quantity supplied rises; when they fall below ‘natural’ prices, the quantity supplied falls. Smith did not have an equilibrium price model; price oscillated, or ‘gravitated’ around natural prices in disequilibrium.
Prices are determined within the ‘propensity to truck, barter, and exchange’ by pairs of individuals and not just by the dictates of abstract markets. Smith elaborated on what influences the producer’s price preference (that which is profitable, net of costs). It is an error to say Smith had a ‘cost of production’ value theory. The exchange process was not determined solely by buyers, nor by sellers. ‘Higgling and bargaining of the market’ was sufficient ‘for carrying on the ordinary business of life’.
The buyer is not interested in the seller’s costs (wages plus rent), or the seller’s profits ‘from hazarding his capital. Seller’s price competition lowers prices; as did, longer term, the ‘finer’ division of labour that increased labour productivity. Smith outlined the ‘conditional bargain’ (Book I, page 26: ‘Give me that which I want, and you shall have this which you want.’ In short, prices are determined by bargaining, between a seller concerned with costs plus profit, and a buyer concerned with the lowest price consistent with supply of the wanted good.
At this point, ‘subjective’ valuation has a role and while Smith did not elaborate on subjective judgement, it is implied in his bargaining model (and in his example of the use-value of water in the Arabian desert).
And that is what capital has to do with exchange value: it is an element in the seller’s preference for the determination exchangeable value of a good; i.e., the ratio at which a good is exchanged.

MD September 26, 2007 at 8:32 pm
Raúl October 18, 2007 at 3:49 pm

“This happens all the time today and people had less rights back then.”

You are right. Today people loss rights because of expanding government power. I you take undeveloped coutries, you notice that private property rights simple does not exist.In developed coutries, increasing taxes is a factum.
Welfare state is expanding all over society.
Who is the robber then?

“The only thing that would prevent this kind of abuse of workers of course is unions.”

Mark Twain in Missisipi describes the nature of unions. In reality unions destroy workers. How?
The have come to the billant idea: To monopolize work force, first and then put their rules to the rest of the workers.
Take the example brillantly exposed in Milton friedman video “Choose to liberty”. He start describing “The Hippocratic Oath” by physicians who lived in IV B.C.

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