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Sunday, June 30, 2013

The Theory Of Distribution

Adam Smith's theory of distribution was fully as disastrous as his theory of value. Though he was aware of the functions performed by the capitalist, his only venture in explaining the rate of long-run profit was to opine that the greater the ‘amount of stock’ the lower the rate of profit. He arrived at this highly dubious conclusion from his perfectly valid observation that capitalists tend to move out of low-profit and into high-profit industries, their competition tending to equalize the rates of profit throughout the economy. But more production, lowering selling price and raising costs in a particular industry, is scarcely the same causal claim as more capital throughout the economy lowering profit rates. Indeed, the rate of interest, or long-run rate of profit, is related, not to the quantity of accumulated capital, but to the amount of annual saving, and moreover falling profit rates are not caused by increasing saving. On the contrary, as the Austrians would point out, both are the results of lower rates of time-preference in the society. It is perfectly possible for a highly capitalized economy to experience rising rates of time-preference, which in turn would bring about higher rates of interest.

Smith saw correctly that increasing capital means an increase in the demand for labour and therefore higher wages, so that an advancing society necessarily means a secular increase in wage rates. Unfortunately, Smith's mechanistic view of the profit rate as being inversely proportional to the total amount of capital led him to believe that wages and profits are always moving inversely to the other – an adumbration of an allegedly inherent class struggle which Ricardo would do much to aggravate.
Moreover, if the supply of labour increases to absorb the increase in demand, wage rates will then fall. At this point, Adam Smith provided the Malthusian hook, for, as we shall see further, the Rev. Malthus was a devoted follower of Adam Smith. Smith, indeed, was picking up a theme common in the eighteenth century: that the population of a species tends to press on the means of its subsistence. As Smith put it: ‘Every species of animals naturally multiplies in proportion to the means of its subsistence’. So that Smith saw the secular trend of the economy as capital increasing, wages rising, and the rise in wages calling forth an increase in population:

The liberal reward of labour, by enabling them to provide better for their children, and consequently to bring up their number, naturally tends to widen and extend those limits [the means of subsistence]... If this demand [for labour] is continually increasing, the reward of labour must necessarily encourage in such a manner the marriage and multiplications of labourers as may enable them to supply that continually increasing demand by a continually increasing population.

In this way, wages tend to settle at the minimum subsistence level for the existing population. A fall in wages below subsistence will forcibly reduce the population and hence the supply of labour, raising wages to the subsistence rate; and if wages should rise above subsistence, the ‘excessive multiplication’ of workers ‘would soon lower it to this necessary rate’.

One of the many problems of this ‘Malthusian’ approach is that it assumes that human beings will not be able to act on their own to limit population growth in order to preserve a newly achieved standard of living.

In addition to Smith's erroneous Malthusian view that long-run wage rates are at the means of subsistence, he also introduced into economics the unfortunate fallacy that wages, at least in the shorter run, are determined by the relative ‘bargaining power’ of employers and workers. It was a simple leap from that position to the view that employers have greater bargaining power than workers, thus setting the stage for later pro-union propagandists claiming erroneously that unions can raise overall wage rates throughout the economy.

In his view of rent, Smith characteristically held several unintegrated views running side by side. On the one hand, as we have seen, rent is demanded by landlords who ‘reap where they have never sowed’. Why are they able to collect such a rent? Because, now that land has become private property, the labourer ‘must pay for the licence’ to cultivate the land and ‘must give to the landlord a portion of what his labour either collects or produces’. Smith concludes that ‘the rent of land therefore... is naturally a monopoly price’, since he regards private property in land in the same category as monopolization. Surely, socialist and Henry Georgite calls for land nationalization found here their fundamental inspiration. Smith also sensibly points out that rent will vary according to superior fertility and location of the land. Furthermore, as we have indicated, he attributes rent to the ‘powers of nature’, which supposedly earns an extra return in agriculture as compared to other occupations.

Smith is also inconsistent on whether land rent is included in cost. At various points he includes land rent in cost and therefore as an alleged determinant of long-run price. On the other hand, he also asserts that high or low rents are the effect of high or low product prices and that since the supply of land is fixed, the full incidence of taxes upon rent will fall on land rather than being shifted. All these inconsistencies can be cleared up if we regard all costs as determined by expected future selling prices, and individual costs to be the opportunity foregone to contribute to expected productive revenue elsewhere. More specifically, while costs do not determine price directly, they do limit supply, and in this sense every expenditure, whether on rent or elsewhere, is definitely a part of cost.

But as we have seen, the greatest of the many defects in Smith's theory was his totally discarding Cantillon's and Turgot's brilliant analysis of the entrepreneur. It was as if these great eighteenth century Frenchmen had never written. Smith's analysis rested solely on the capitalist investing ‘stock’ and on his labour of management and inspection; the very idea of the entrepreneur as a risk-bearer and forecaster was thrown away and, again, classical economics was launched into another lengthy blind alley. If, of course, one persists in fixing one's vision on the never-never land of long-run equilibrium, where all profits are low and equal and there are no losses, there is no point in talking about entrepreneurship at all.

The political implications of this omission were also not lost on nineteenth century socialists. For if there is no role for entrepreneurial profits in a market economy, then any existing profits must be ‘exploitative’, far more so than the low, uniform rate existing in long-run equilibrium.

The perceptive Scottish historian of economics, Alexander Gray, wrote of Smith's theory of wages that he presented several theories ‘not wholly consistent with each other, [which] lie together in somewhat uneasy juxtaposition’. Gray then slyly added that it is a ‘tribute to the greatness of Smith that all schools of thought may trace to him their origin and inspiration’. Other words for such inchoate confusion, for what Gray referred to aptly as a ‘vast chaos’, come more readily to mind.

Austrian Perspective on the History of Economic Thought (2 volume set)

Saturday, June 29, 2013

The Theory Of Value

Adam Smith's doctrine on value was an unmitigated disaster, and it deepens the mystery in explaining Smith. For in this case, not only was Smith's theory of value a degeneration from his teacher Hutcheson and indeed from centuries of developed economic thought, but it was also a similar degeneration from Smith's own previous unpublished lectures. In Hutcheson and for centuries, from the late scholastics onward, the value and price of a product were determined first by its subjective utility in the minds of the consumers, and second, by the relative scarcity or abundance of the good being evaluated. The more abundant any given good, the lower its value; the scarcer the good, the higher its value. All that this tradition needed to complete its explanation was the marginal principle of the 1870s, a focus on a given unit of the good, the unit actually chosen or not chosen on the market. But the rest of the explanation was in place.

In his lectures, furthermore, Smith had solved the value paradox neatly, in much the same way as had Hutcheson and other economists for centuries. Why is water so useful and yet so cheap, while a frippery like diamonds is so expensive? The difference, said Smith in his lectures, was their relative scarcity: ‘It is only on account of the plenty of water that it is so cheap as to be got for the lifting, and on account of the scarcity of diamonds... that they are so dear’. Furthermore, with different supply conditions, the value and price of a product would differ drastically. Thus Smith points out in his lectures that a rich merchant lost in the Arabian desert would value water very highly, and so its price would be very high. Similarly, if the quantity of diamonds could ‘by industry... be multiplied’, the price of diamonds on the market would fall rapidly.

But in the Wealth of Nations, for some bizarre reason, all this drops out and falls away. Suddenly, only ten or a dozen years after the lectures, Smith finds himself unable to solve the value paradox. In a famous passage in Book I, Chapter IV of Wealth. Smith sharply and hermetically separates and sunders utility from value and price, and never the twain shall meet:

The word value... has two different meanings, and sometimes expresses the utility of some particular object, and sometimes the power of purchasing other goods which the possession of that object conveys. The one may be called ‘value in use’: the other, ‘value in exchange’. The things which have the greatest value in use have frequently little or no value in exchange; and on contrary, those which have the greatest value in exchange have frequently little or no value in use. Nothing is more useful than water; but it will purchase scarce any thing; scarce any thing can be had in exchange for it. A diamond, on the contrary, has scarce any value in use; but a very great quantity of other goods may frequently be had in exchange for it.

And that is that. No mention of the solution of the value paradox by stressing relative scarcities. Indeed, ‘scarcity’- that concept so fundamental and crucial to economic theory – plays virtually no role in the Wealth of Nations. And with scarcity gone as the solution to the value paradox, subjective utility virtually drops out of economics as well as does consumption and consumer demand. Utility can no longer explain value and price, and the two sundered concepts will reappear in later generations as left-wingers and socialists happily prate about the crucial difference between ‘production for profit’ and ‘production for use’, the heir of the Smithian emphasis on the alleged gulf between ‘value in use’ and ‘value in exchange’.

And since economic science was reborn after Adam Smith, since all previous economists were cast into limbo by prevailing fashions of thought, the entire tradition of subjective utility – scarcity as determinants of value and price, a tradition dominant since Aristotle and the medieval and Spanish scholastics, a tradition that had continued down through writers in eighteenth century France and Italy – that great tradition gets poured down the Orwellian memory hole by Adam Smith's fateful decision to discard even his own previous concepts. Although Samuel Bailey almost restored it, the great tradition was not to be fully resurrected until its independent rediscovery by the Austrians and other marginalists in the 1870s. Adam Smith has a lot to answer for at the bar of history.

Paul Douglas put it eloquently in a commemorative volume for the Adam Smith sesquicentennial: ‘Smith helped to divert the writers of English Classical School into a cul-de-sac from which they did not emerge, in so far as their value theory was concerned, for nearly a century...’. And we can understand the anguish of Professor Emil Kauder when, after lamenting the sinking into oblivion of the great French and Italian economists of the eighteenth century, he wrote:

Yet it was the tragedy of these writers that they wrote in vain, they were soon forgotten. No scholar appeared to make out of these thoughts the new science of political economy. Instead, the father of our economic science wrote that water has a great utility and a small value. With these few words Adam Smith had made waste and rubbish out of the thinking of 2,000 years. The chance to start in 1776 instead of 1870 with a more correct knowledge of value principles had been missed.’16

How could Smith have made such a colossal blunder? In effect, he turned away from his almost sole emphasis on explaining market price in the lectures to another concept which for him took on overriding importance: the ‘natural price’, or what might be called the ‘long-run normal’ price. This concept, similar to Cantillon's ‘intrinsic value’ or Hutcheson's ‘fundamental value’, had appeared in the lectures, but occupied a minor role as it did in the work of these other economists. But suddenly, the ‘natural price’ and its alleged determinants now became more important, more truly ‘real’ than the market price of the real world that had always been the prime focus of economists. Value and price theory shifts, because of Adam Smith's unfortunate and drastic change of focus in the Wealth of Nations, from prices in the real world to a mystical non-existent price in the never-never land of long-run ‘equilibrium’.

But this alleged natural price is neither more real than nor equally real as the current market price. It is, in fact, not real at all. Only the market price is the real price. At best, the long-run price is useful in providing a vital clue to the direction of price and production changes in the real world. But the long-run price is never reached, and never can be reached, for it keeps shifting as underlying supply and demand forces continually change. The long-run normal price is important but only for explaining the directional tendencies and the underlying architectonic structure of this economy, and also for analysis of how uncertainty affects real-world income and economic activity. The virtually exclusive classical and neoclassical absorption in the unreal ‘long-run’, to the neglect and detriment of analysing real-world prices and economic activity, shunted economic thought on to a long, fallacious and even tragic detour, from which it has not yet fully recovered.

Another terrible loss inflicted on economic thought by Adam Smith was his dropping out of the concept of the entrepreneur, so important to the contributions of Cantillon and Turgot. The entrepreneur disappeared from British classical thought, never to be resurrected until some of the continental thinkers and especially the Austrians. But the point is that there is no room for the entrepreneur, if the focus is to be on the unchanging, certain world of long-run equilibrium.

Before the Wealth of Nations, economists had always concentrated on the market price, and had seen readily that it was determined by the forces of supply and demand, and hence of utility and scarcity. Indeed, while David Hume knew nothing of utility and spoke of labour as the source of value, he was far sounder on value theory than his close friend Adam Smith. On receiving a copy of the newly published Wealth of Nations, Hume, on his deathbed, was able to write to his friend on one important criticism: ‘I cannot think that the rent of farms make any part of the price of produce, but that the price is determined altogether by the quantity and the demand’. In short, compared to Smith, Hume was in the continental tradition and almost proto-Austrian.

But if Smith stressed the long run, what is supposed to determine the non-real concept of a ‘natural’ or ‘long-run normal’ price? Following up unfortunate hints of his eighteenth century predecessors, Smith concluded that the natural price is equal to and determined by costs of production, a concept that had only occupied a fitful and subordinate place in economic thought since the medieval scholastics.
Not that the long-run normal price, or as we now call it the ‘equilibrium’ price, is nonsense. The equilibrium price is the long-run tendency of the market price. As Adam Smith indeed saw, if the market price is higher than the long-run equilibrium, then extra gains will be made and resources will flow into this particular industry, until the market price falls to reach equilibrium. Conversely, if the market price is lower than equilibrium, the resulting losses will drive resources out of the industry until the price rises to reach equilibrium. The equilibrium concept is highly useful in pointing to the direction in which the market will move. But equilibrium will only be reached in reality if the ‘data’ of the market are magically frozen: that is, if the values, resources, and technological knowledge on the market continue to remain precisely the same. In that case, equilibrium would be reached after a certain span of time. But since these data are always changing in the real world, equilibrium is never attained.

‘Cost of production’ is defined by Adam Smith as total expenses paid to factors of production, that is, wages, profits and rent. More specifically, in what was to become the famous classical triad, Smith reasoned that there were three types of factors of production: labour, land and capital. Labour receives wages, land earns rent, and capital earns ‘profits’ – actually long-run rather than short-run rates of return, or what might be called the ‘natural’ rate of interest. In equilibrium, which Smith seems to have believed was more real and hence far more important than the actual market price, the wage rate equals the ‘average’ or the ‘natural’ rate: and the other returns similarly equal the ‘natural’ rent and the long-run average rate of profit.

There is one striking fallacy in his analysis of cost that Adam Smith shared, though in an aggravated fashion, with earlier writers. Whereas market price is changeable and ephemeral, ‘cost’ is somehow determined objectively and exogenously, i.e. from outside the world of market economic activity. But cost is not intrinsic or given; on the contrary, it itself is determined, as the Austrians were later to point out, by the value foregone in using resources in production. This value, in turn, is determined by the subjective valuations that consumers place on those products. In brief, rather than cost in some ‘fundamental’ sense determining value, cost at any and all times is itself determined by the subjective value, or expected value, that consumers place on the various products. So that, even if we might say that prices will equal cost of production in long-run equilibrium, there is no reason to assume that such costs determine long-run price; on the contrary, expected consumer valuation determines what the value of costs will be on the market. Cost is strictly dependent on utility, in the short and long runs, and never the other way around.

Another grave problem with all cost-of-production theory is that it necessarily abandons any attempt to explain the pricing of goods and services that have no cost because they are not produced, goods that are simply there, or were produced in the past but are unique and not reproducible, such as art works, jewellery, archaeological discoveries, etc. Similarly, immaterial consumer services such as the prices of entertainment, concerts, physicians, domestic servants, etc., can scarcely be accounted for by costs embodied in a product. In all these cases, only subjective demand can explain the pricing or the fluctuations in those prices.

But this analysis scarcely exhausts Smith's sins in discussing the central concept in economics – the theory of value. For side by side with the standard cost-of-production analysis as equalling wages + rents + profits, another, new, and far more bizarre theory was set forth. In this alternative view, the relevant cost of production that determines equilibrium price is simply the quantity of labour embodied in its production. It was, indeed, Adam Smith who was almost solely responsible for the injection into economics of the labour theory of value.17 And hence it was Smith who may plausibly be held responsible for the emergence and the momentous consequences of Marxism.
Side by side and unintegrated with Smith's cost-of-production theory of the natural price lay his new quantity-of-labour-pain theory. Thus:

The real price of every thing, what every thing really costs to the man who wants to acquire it, is the toil and trouble of acquiring it. What every thing is really worth to the man who has acquired it, and who wants to dispose of it or exchange it for something else, is the toil and trouble which it can save to himself, and which it can impose upon other people. What is bought with money or with goods is purchased by labour, as much as what we acquire by the toil of our own body... They contain the value of a certain quantity of labour which we exchange for what is supposed at the time to contain the value of an equal quantity.

Thus goods exchange on the market for equal quantities which they ‘contain’ of labour hours, at least in their ‘real’, long-run prices.
Immediately, Smith recognized that he faced a profound difficulty. If labour quantity is the source and measure of all value, how can the mere quantity of labour hours be equated to the quantity of labour pain or labour toil? Surely they are not automatically equal. As Smith himself admitted, in addition to labour time, ‘the different degrees of hardship endured or ingenuity exercised must likewise be taken into account’. Yet such equating is ‘not easy’, for indeed ‘there may be more labour in an hour's hard work than in two hours easy business: or in an hour's application to a trade which it cost ten years labour to learn, than in a month's industry at an ordinary and obvious employment’.
How does this crucial equating take place? According to Smith, ‘by the higgling and bargaining of the market’ bringing them into a ‘rough sort of equality’. Yet here Smith fell into an iron trap of circular reasoning. For, like Ricardo and Marx after him, he attempted to explain prices and values by the quantity of labour, and then appealed to the settling of values on the market to determine what the ‘quantity of labour’ is, by weighting it by differences in the degree of labour hardship and toil.18
Smith tried to escape such circularity by his egalitarian assumption – still held in orthodox neoclassical economics – that all labourers are equal, and that hence wages, at least in the natural long run, will all be equal, or rather will be equal for equal quantities of labour toil among all the workers. According to Smith, competition on the market will tend to equate wages per unit of sacrifice or labour toil. As Douglas put it, ‘Smith believed he had established the fact that equal units of labor in the sense of disutility were at any one time compensated for by equal amounts of money wages’.
Thus, Smith opined in an eighteenth century egalitarian way that ‘The difference between the most dissimilar characters, between a philosopher and a common street porter, seems to arise, not so much from nature as from habit, custom and education’. There are no unique individuals and irreducible differences between people; in this reductionist view now active again in the twentieth century, the mind of a human being is merely a tabula rasa on which external environment fills in the content. Hence, according to Smith, skilled labour earns more than unskilled merely to compensate for years of apprenticeship and training when earnings were much lower: so that their labour hours and toil and hence wages would be equalized over a lifetime. Wages in occupations which are active in only part of the year should be higher to compensate for the fewer days of work – so that annualized incomes would be equal. Other things being equal, furthermore, workers in unpleasant or dangerous occupations would receive higher wages to compensate them for the higher labour sacrifice, while prestigious occupations would receive lower wages since their sacrifice or unpleasantness is lower.
While all these distinctions make some sense and have to be taken into account in any theory of wages, they founder on the a priori assumption that every person's mind is a uniform tabula rasa. Once enter the realistic assumption of innate differences in talent, and the egalitarian levelling of wage rates to equal units of sacrifice (assuming of course that the latter could be measured) falls to the ground.
As it is, Smith ran into considerable difficulty in explaining why prestigious occupations, far from earning low wages in the real world, actually earn higher wages than the average. When discussing the high-income physician or attorney, for example, he lamely fell back on the implication that they were positions of great trust, and therefore presumably faced onerous and painful responsibilities to their clients and were compensated thereby. His other attempt to rationalize the high incomes of attorneys was to make the dubious assumption that the average income in such occupations was lower than in others, since a flood of people are attracted by the glittering prizes of very high incomes accruing to the few top people in the profession.
Adam Smith, in addition, muddied the waters still further by putting forward, side by side with the labour-cost theory of value, the very different ‘labour-command’ theory. The labour-command theory states that the value of a good is determined not by the quantity of labour units contained in it (the labour theory of value), but by the amount of labour that can be purchased by the good. Thus: ‘The value of any commodity to the person who possesses it... is equal to the quantity of labour which it enables him to purchase or command’.
If, in the real world, the price of every commodity precisely equalled the amount of labour units ‘contained’ in its production, then the two quantities – the labour cost and the labour command of a good – would indeed be identical. But if rents and profits (i.e. interest) are included in cost, then the price, or relative purchasing power, of each good would not be equal to the labour cost. Labour cost and labour command for each good would differ.
In his typically purblind way, Adam Smith did not perceive the contradiction between these two labour theories in a world where rent and profits exist (as indeed he did not seem to see the difference between the labour and the cost-of-production theories of value). Ricardo was to see the problem and struggle with it in vain, while Marx tried to resolve it by his theory of ‘surplus value’ going to the non-workers in the form of rent and profits, a theory that foundered on Marx's attempt to reconcile two contradictory propositions: the labour-cost (or quantity of labour) theory of value, and the acknowledged tendency toward an equalization of profit rates on the market. For, as we shall see further in the treatment of Marx (Chapters 9–13 in Volume II), the ‘surplus value’ of profits out of labour should be greater in labour-intensive than in capital-intensive industries, and yet profits tend to equalize everywhere. Paul Douglas properly and with rare insight noted that Marx was, in this matter, simply a Smithian-Ricardian trying to work out the theory of his masters:

Marx has been berated by two generations of orthodox economists for his value theory. The most charitable of the critics have called him a fool and the most severe have called him a knave for what they deem to be transparent contradictions of his theory. Curiously enough these very critics generally commend Ricardo and Adam Smith very highly. Yet the sober facts are that Marx saw more clearly than any English economist the differences between the labor-cost and the labor-command theories and tried more earnestly than anyone else to solve the contradictions which the adoption of a labor-cost theory inevitably entailed. He failed, of course: but with him Ricardo and Smith failed as well... The failure was a failure not of one man but of a philosophy of value, and the roots of the ultimate contradiction made manifest, in the third volume of Das Kapital, lie imbedded in the first volume of the Wealth of Nations.19

Adam Smith also gave hostage to the later emergence of socialism by his repeatedly stated view that rent and profit are deductions from the produce of labour. In the primitive world, he opined, ‘the whole produce of labour belongs to the labourer’. But as soon as ‘stock’ (capital) is accumulated, some will employ industrious people in order to make a profit by the sale of the materials. Smith indicates that the capitalist (the ‘undertaker’) reaps profits in return for the risk, and for interest on the investment for maintaining the workers until the product is sold – so that the capitalist earns profit for important functions. He adds, however, that ‘In this state of things the whole produce of labour does not always belong to the labourer. He must in most cases share it with the owner of the stock who employs him’. By using such phrases, and by not making clear why labourers might be happy to pay capitalists for their services, Smith left the door open for later socialists who would call for restructuring institutions so as to enable workers to capture their ‘whole product’. This hostage to socialism was aggravated by the fact that Smith, unlike the later Austrian School, did not demonstrate logically and step by step how industrious and thrifty people accumulate capital out of savings. He was content simply to begin with the alleged reality of a minority of wealthy capitalists in society, a reality which later socialists were of course not ready to endorse.
Smith was even less kindly to the role of landlords, where he recognized no economic function whatever that they might perform. In pungent passages, he writes that ‘As soon as the land of any country has all become private property, the landlords like to reap where they never sowed and demand a rent even for its natural produce’. And again: ‘as soon as the land becomes private property, the landlord demands a share of almost all the produce which the labourer can either raise or collect from it’. There is no hint of recognition here that the landlord performs the vital function of allocating the land to its most productive use. Instead, these passages were to become understandable red meat for socialists and for Henry Georgists in calls for the nationalizing of land.
As we shall see further below, Smith's labour theory of value did inspire a number of English socialists before Marx, generally named ‘Ricardian’ but actually ‘Smithian’ socialists, who decided that if labour produced the whole product, and rent and profit are deductions from labour's produce, then the entire value of the product should rightfully go to its creators, the labourers. Douglas justly concluded that

It is then from the Whiggish pages of the Wealth of Nations that the doctrines of the English Socialists as well as the theoretical exposition of Karl Marx, spring. The history of social thought furnishes many instances where theories elaborated by one writer have been taken over by others to justify social doctrines antagonistic to those to which the promulgator of the theory gave adherence. But had the gift of prevision been granted to those men, few would have been more startled than Adam Smith in seeing himself as the theoretical founder of the doctrines of nineteenth-century socialism.20

Modern writers have tried to salvage the unsalvageable labour theory of value of Adam Smith by asserting that, in a sense he did not really mean what he was saying but was instead seeking to find an invariable standard by which he could measure value and wealth over time. But, to the extent that this search was true, Smith simply added another fallacy on top of all the others. For since value is subjective to each individual, there is no invariant measure or yardstick of value, and any attempts to discover them can at best distort the enterprise of economic theory and send it off chasing an impossible chimera. At worst, the entire structure of economic theory is permeated with fallacy and error. Professors Robertson and Taylor, indeed, go so far as to call the admitted failure of Adam Smith a grand and noble failure, and one which they assert to be far more inspiring in its essential bankruptcy than if Adam Smith had continued in the subjective value tradition of his forbears. In a bizarre passage, Robertson and Taylor acknowledge the correctness of Professor Kauder's anguished critique of Smith as leading economic theory into a century-long blind alley. But they still laud Smith for his very failure:

If a true explanation is given here of the reasons for Adam Smith turning from ‘scarcity and utility’ to a labour theory of value, did he not, in fact, do more for the progress of economics by a grand failure in an impossible but fundamental task, than he would have done, had he been content to add a seventh rung or even to strengthen some of the existing steps in the rickety ladder of subjective-value theory such as, according to Dr. Kauder, it appeared in 1776?21

Is it hopelessly banal to counter that truth is always superior to fundamental error in advancing a scientific discipline?

There is a more fundamental and convincing reason for Adam Smith's throwing over centuries of sound economic analysis, his abandonment of utility and scarcity, and his turn to the erroneous and pernicious labour theory of value. This is the same reason that Smith dwelled on the fallacious doctrine of productive versus unproductive labour. It is the explanation stressed by Emil Kauder, and partially by Paul Douglas: Adam Smith's dour Calvinism. It is Calvinism that scorns man's consumption and pleasure, and stresses the importance of labour virtually for its own sake. It is the dour Calvinist who made the extravagant statement that diamonds had ‘scarce any value in use’. And perhaps it is also the dour Calvinist who scorned, in the words of Robertson and Taylor, real-world ‘market values which depended on monetary whims and fashions on the market’, and turned his attention instead to the long-run price where such fripperies played no part, and the grim eternal verities of labour toil seemingly played the decisive economic role. Surely this is a far more realistic view of Adam Smith than the Quixotic romantic in quest of the impossible dream of an invariable measure of value. And while Smith's most famous follower, David Ricardo, was not a Calvinist, his leading immediate disciple, Dugald Stewart, was a Scottish Presbyterian, and the leading Ricardians – John R. McCulloch and James Mill – were both Scottish and educated in Dugald Stewart's University of Edinburgh. The Calvinist connection continued to dominate British – and hence classical – economics.

Austrian Perspective on the History of Economic Thought (2 volume set)

Friday, June 28, 2013

Productive vs unproductive labour

One of the physiocrats’ more dubious contributions to economic thought was their view that only agriculture was productive, that only agriculture contributed a surplus, a produit net, to the economy. Smith, heavily influenced by the physiocrats, retained the unfortunate concept of ‘productive’ labour, but expanded it from agriculture to material goods in general. For Smith, then, labour on material objects was ‘productive’; but labour on, say, consumer services, on immaterial production, was ‘unproductive’.

Smith's bias in favour of material objects amounted to a bias in favour of investment in capital goods, since a stock of capital goods by definition has to be embodied in material objects. Consumer goods, on the other hand, either consist of immaterial services, or they get used up – consumed – in the process of consumption. Smith's imprimatur on material production, therefore, was an indirect way of advocating investment in an accumulation of capital goods as against the very goal of producing capital goods: increased consumption. When discussing exports and imports, Smith realized full well that there was no point to amassing intermediate objects except that they eventually be consumed – that the only goal of production is consumption. But as Professor Roger Garrison has pointed out, and as we shall see further on the question of usury laws, Adam Smith's Presbyterian conscience led him to value the expenditure of labour per se, for its own sake, and led him to balk at free market time-preferences between consumption and saving. Clearly, Smith wanted far more investment towards future production and less present consumption than the market was willing to choose. One of the contradictions of this position, of course, is that accumulating more capital goods at the expense of present consumption will eventually result in a higher standard of living – unless Smith prepared to counsel a perpetual and accelerated shift toward more and more never-to-be-consumed means of production.

In Book II of the Wealth of Nations, Smith opines that labour on material objects is productive, while other labour is not because it does not ‘fix or realize itself in any particular subject... which endures after that labour is past and for which an equal quantity of labour could afterward be purchased’. Included in immaterial and hence unproductive labour are servants, ‘churchmen, lawyers, physicians, men of letters of all kinds; players, buffoons, musicians, opera-singers, opera-dancers, etc’ To Smith the important point was that the ‘work of all’ unproductive labourers ‘perishes in the very instant of its production’. Or, as he put it, ‘Like the declamation of the actor, the harangue of the orator, or the tune of the musician, the work of all of them perishes in the very instant of its production’. Smith also writes that ‘productive’ labour ‘adds to the value of the subject on which it is bestowed’, whereas ‘unproductive labour does not’ – another way of putting the fact that labour on services is not embodied in ‘any particular subject’. ‘Productive’ labour, moreover, allegedly creates a ‘surplus’ for profit in manufacturing. Adam Smith's lingering physiocratic bias was also shown in his preposterous assertion that agriculture is a far more productive industry than manufacturing, because in agriculture nature works alongside man and provides extra rent for landlords as well as profit for capitalists. In addition to other fallacies, Smith here failed to realize that nature in the form of ground land collaborates in all activities of man, not just agriculture, and that all activities, including manufacturing, will therefore yield ground rent to landowners. In his thorough and searching critique of Adam Smith, Edwin Cannan speculated that Smith, if pressed, ‘would probably have admitted... that the declamation, harangues, and tunes, have a value’. Smith oddly identified the build-up of material capital goods with annual production. On the latter, as Cannan points out, ‘the durability of the things produced by labour is in reality of no significance. The declamations, harangues, and tunes are just as much a part of the annual produce as champagne or boots...’. Yet Smith, in Book II, excludes all production of immaterial services from the annual product, which is allegedly produced entirely by the ‘productive labourers’, who in turn ‘maintain’ not only themselves but all the unproductive classes of labour as well.
In a witty and charming passage, Cannan then comments:

People have always been rather apt to imagine that the class which they happen to think the most important ‘maintains’ all the other classes with which it exchanges commodities. The landowner, for instance, considers, or used to consider, his tenants as his ‘dependants’. All consumers easily fall into the idea that they are doing a charitable act in maintaining a multitude of shopkeepers. Employers of all kinds everywhere believe that the employed ought to be grateful for their wages, while the employed firmly hold that the employer is maintained entirely at their expense. So the physiocrats alleged that the husbandman maintained himself and all other classes; and Adam Smith alleged that the husbandman, the manufacturer, and the merchant maintained themselves and all other classes. The physiocrats did not see that the husbandman was maintained by the manufacturing industries of thrashing, milling, and baking, just as much as the millers or the tailors are maintained by the agricultural industries of ploughing and reaping. Adam Smith did not see that the manufacturer and merchant are maintained by the menial services of cooking and washing just as much as the cooks and laundresses are maintained by the manufacturer of bonnets and the import of tea.

It is not just durable objects, however, that Adam Smith was interested in; it was durable capital goods. Durable consumer goods, like houses, were again, for Smith, ‘unproductive’, although he grudgingly conceded that a house ‘is no doubt extremely useful’ to the person who lives in it. But it is not ‘productive’, wrote Smith, because ‘If it is to be let to a tenant for rent, as the house itself can produce nothing, the tenant must always pay the rent out of some other revenue which he derives either from labour, or stock [capital], or land’. Again, Cannan provides the proper riposte: ‘It did not occur to Adam Smith to reflect that if a plough is let for rent, as a plough itself can produce nothing the tenant must always pay the rent out of some other revenue’.

Adam Smith's bias against consumption and in favour of saving and investment is summed up in Professor Rima's analysis:

It is clear from his third chapter in Book II, ‘On the Accumulation of Capital or of Productive and Unproductive Labour’, that he is concerned with the effect of using savings to satisfy the desire for luxuries by those who are prodigal instead of channelling them into uses that will enhance the supply of fixed or circulating capital. He is, in effect, arguing that savings should be used in such a way that they will create a flow of income and new equipment, and that failure to use savings in this manner is an impediment to economic growth.

Perhaps – but it also means that Smith was not content to abide by free market choices between growth on the one hand, and consumption on the other.

Professor Edwin West, a modern admirer of Smith who generally portrays the Scotsman as an advocate of laissez-faire, admits Smith's bias: ‘Yet Smith, like a prudent steward of a Scottish aristocrat's estate, could hardly disguise a strong personal preference for much private frugality, and therefore for “productive labor”, in the interests of the nation's future accumulation’. He then proceeds to concede implicitly Professor Garrison's insight that Smith exhorted us to negative or at least zero time-preference. Citing Smith's Theory of Moral Sentiments, West notes that the virtue of frugality ‘commands the esteem’ of Smith's alter ego, man's innate moral sense, the ‘impartial spectator’. Quoting from Smith: ‘The spectator does not feel the solicitations of our present appetites. To him the pleasure which we are to enjoy a week hence, or a year hence, is just as interesting as that which we are to enjoy this moment’.

We might note that the lofty refusal to discount future satisfactions in favour of the present, i.e. the rejection of positive time-preference, is all too easy of any ‘impartial spectator’. But is the impartial spectator truly human, or is he simply a floating wraith, who does not participate in the human condition and therefore whose insight can be brusquely dismissed?

Adam Smith's Calvinistic scorn of consumption can be seen in his attack on dancing as ‘primitive and rude’. As we shall see, in his ‘paradox of value’ Smith dismissed diamonds in an excessive way as having ‘scarce any value in use’. He also puritanically denounced luxury as being biologically harmful, reducing the birth rate of the upper classes: ‘Luxury in the fair sex, while it inflames perhaps the passion for enjoyment, seems always to weaken, and frequently to destroy altogether the powers of generation’.
Smith, furthermore, favoured low and criticized high profits, because high profits induce capitalists to engage in excessive consumption. And since large capitalists set an influential example for others in society, it is all the more important for them to keep to the path of thrift and industry. Thus:

besides all the bad effects to the country in general, which have already been mentioned as necessarily resulting from a high rate of profit; there is one more fatal, perhaps, than all these put together, but which, if we may judge from experience, is inseparably connected with it. The high rate of profit seems everywhere to destroy that parsimony which in other circumstances is natural to the character of the merchant. When profits are high, that sober virtue seems to be superfluous, and expensive luxury to suit better the affluence of his situation.

Because of the influence of the example of the higher orders, Smith adds,

If his employer is attentive and parsimonious, the workman is very likely to be so too; but if the master is dissolute and disorderly, the servant who shapes his work according to the pattern which his master prescribes to him, will shape his life according to the example which he sets him. Accumulation is thus prevented in the hands of all those who are naturally the most disposed to accumulate.... The capital of the country, instead of increasing, gradually dwindles away....

But if Adam Smith was excessively in favour of capital investment as against consumption, he at least was sound in realizing that capital investment was important in economic development and that saving was the necessary and sufficient condition of such investment. The only way to increase capital, then, is by private savings or thrift. Thus, Smith wrote, ‘Whoever saves money, as the phrase is, adds proportionately to the general mass of capital.... The world can augment its capital only in one way, by parsimony’. Savings, and not labour, is the cause of accumulation of capital, and such savings promptly ‘puts into motion an additional quantity of industry [labour]’. The saver, then, spends as readily as the spendthrift, except that he does so to increase capital and eventually benefit the consumption of all; hence ‘every frugal man is a public benefactor’. All this was a pale shadow of the scintillating and creative work of Turgot, with his emphasis on time, the structure of production, and time-preference. And it was probably cribbed from Turgot to boot. But at least it was sound, and it stamped its imprint indelibly on classical economics. As Schumpeter put it, in discussing what he calls ‘the Turgot-Smith theory of saving and investment’: ‘Turgot, then, must be held responsible for the first serious analysis of these matters, as A. Smith must (at the least) with having it inculcated into the minds of economists’

Finally, apart from the Marxists, even the abject Smithians of today reject or at least dismiss the Master's productive vs unproductive labour distinction. Characteristically, however, Smith was not even clear and consistent in his fallacies. His presentation in Book I of the Wealth of Nations contradicts Book II. In Book I, he properly states that ‘Every man is rich or poor according to the degree in which he can afford to enjoy the necessaries, conveniences, and amusements of human life’, a phrase almost directly lifted from Cantillon. But in that case, of course, there is no difference in productivity between material objects and immaterial services, all of which contribute to such ‘necessaries, conveniences, and amusements’, and indeed Smith's discussion of wages proceeds in Book I as if there were no distinction between productive and unproductive work.
Austrian Perspective on the History of Economic Thought (2 volume set)

Thursday, June 27, 2013

The division of labour

It is appropriate to begin a discussion of Smith's Wealth of Nations with the division of labour, since Smith himself begins there and since for Smith this division had crucial and decisive importance. His teacher Hutcheson had also analysed the importance of the division of labour in the developing economy, as had Hume, Turgot, Mandeville, James Harris and other economists. But for Smith the division of labour took on swollen and gigantic importance, putting into the shade such crucial matters as capital accumulation and the growth of technological knowledge. As Schumpeter has pointed out, never for any economist before or since did the division of labour assume such a position of commanding importance.

But there are more troubles in the Smithian division of labour than his exaggerating its importance. The older and truer perception of the motive power for specialization and exchange was simply that each party to an exchange (which is necessarily two-party and two-commodity) benefits (or at least expects to benefit) from the exchange; otherwise the trade would not take place. But Smith unfortunately shifts the main focus from mutual benefit to an alleged irrational and innate ‘propensity to truck, barter and exchange’, as if human beings were lemmings determined by forces external to their own chosen purposes. As Edwin Cannan pointed out, Smith took this tack because he rejected the idea of innate differences in natural talents and abilities, which would naturally seek out different specialized occupations. Smith instead took the egalitarian-environmentalist position, still dominant today in neoclassical economics, that all labourers are equal, and therefore that differences between them can only be the result rather than a cause of the system of the division of labour.

In addition, Smith failed to apply his analysis of the division of labour to international trade, where it would have provided powerful ammunition for his own free trade policies. It was to be left to James Mill to make such an application in his excellent theory of comparative advantage. Furthermore, domestically, Smith placed far too much importance on the division of labour within a factory or industry, while neglecting the more significant division of labour among industries.

But if Smith had an undue appreciation of the importance of the division of labour, he paradoxically sowed great problems for the future by introducing the chronic modern sociological complaint about specialization that was picked up quickly by Karl Marx and has been advanced to a high art by socialist gripers about ‘alienation’. There is no gainsaying the fact that Smith totally contradicted himself between Book I and Book V of the Wealth of Nations. In the former, the division of labour alone accounts for the affluence of civilized society, and indeed the division of labour is repeatedly equated with ‘civilization’ throughout the book. And yet, while in Book I the division of labour is hailed as expanding the alertness and intelligence of the population, in Book V it is condemned as leading to their intellectual as well as moral degeneration, to the loss of their ‘intellectual, social and martial virtues’. There is no way that this contradiction can be plausibly reconciled.

Adam Smith, though himself a plagiarist of considerable dimensions, also had a Columbus complex, often accusing other people unfairly of plagiarizing him. In 1755 he actually laid claim to having invented the concept of laissez-faire, or the system of natural liberty, asserting that he had taught these principles since his Edinburgh lectures in 1749. That may be: but the claim ignores previous such expressions by his own teachers as well as by Grotius and Pufendorf, to say nothing of Boisguilbert and the other French laissez-faire thinkers of the late seventeenth century.

In 1769, the contentious Smith levied a plagiarism charge against Principal William Robertson, upon the occasion of the publication of the latter's History of the Reign of Charles V. It is not known what the topic of the literary theft was supposed to be, and it is difficult to guess, considering the remoteness from Smith's work of the theme of the Robertson book.

The most famous plagiarism charge hurled by Smith was against his friend Adam Ferguson on the question of the division of labour. Professor Hamowy has shown that Smith did not break with his old friend, as had previously been thought, because of Ferguson's use of the concept of the division of labour in his Essay on the History of Civil Society in 1767. In view of all the writers who had employed the concept earlier, this behaviour would have been ludicrous, even for Adam Smith. Hamowy conjectures that the break came in the early 1780s, because of Ferguson's discussion at their club of what would later be published as part of his Principles of Moral and Political Science in 1792. For in the Principles, Ferguson summed up the pin-factory example that constituted the single most famous passage in the Wealth of Nations. Smith had pointed to a small pin-factory where ten workers, each specializing in a different aspect of the work, could produce over 48 000 pins a day, whereas if each of these ten had made the entire pin on his own, they might not have made even one pin a day, and certainly not more than . In that way the division of labour enormously multiplied the productivity of each worker. In his Principles, Ferguson wrote: ‘A fit assortment of persons, of whom each performs but a part in the manufacture of a pin, may produce much more in a given time, than perhaps double the number, of which each was to produce the whole, or to perform every part in the construction of that diminutive article’.

When Smith upbraided Ferguson for not acknowledging Smith's precedence in the pin-factory example, Ferguson replied that he had borrowed nothing from Smith, but indeed that both had taken the example from a French source ‘where Smith had been before him’. There is strong evidence that the ‘French source’ for both writers was the article on Epingles (pins) in the Encyclopédie (1755), since that article mentions8 distinct operations in making a pin, the same number repeated by Smith in the Wealth of Nations, although in English pin factories  was the more common number of operations.
Thus Adam Smith broke up a long-standing friendship by unjustly accusing Adam Ferguson of plagiarizing an example which, in truth, both men had taken without acknowledgement from the French Encyclopédie The Rev. Carlyle's comment that Smith had ‘some little jealousy in his temper’ seems a vast understatement, and we are informed by his obituary notice in the 1790 Monthly Review that ‘Smith lived in such constant apprehension of being robbed of his ideas that, if he saw any of his students take notes of his lectures, he would instantly stop him and say, ‘I hate scribblers’. While there is also evidence that Smith allowed students to take notes, the point about his crabbed temper and Columbus complex is well made.

Smith's use of an example of a small French pin-factory rather than a larger British one highlights a curious fact about his celebrated Wealth of Nations: the renowned economist seems to have had no inkling of the Industrial Revolution going on all about him. Although he was a friend of Dr John Roebuck, the owner of the Carron iron works, whose opening in 1760 marked the beginning of the Industrial Revolution in Scotland, Smith showed no indication that he knew of its existence. Although he was at least an acquaintance of the great inventor James Watt, Smith displayed no knowledge whatever of some of Watt's leading inventions. He made no mention in his famous book of the canal boom which had begun in the early 1760s, of the very existence of the burgeoning cotton textile industry, or of pottery or of the new methods of making beer. There is no reference to the enormous drop in travel costs that the new turnpikes were bringing about.

In contrast, then, to those historians who praise Smith for his empirical grasp of contemporary economic and industrial affairs, Adam Smith was oblivious to the important economic events around him. Much of his analysis was wrong, and many of the facts he did include in the Wealth of Nations were obsolete and gathered from books 30 years old.

Austrian Perspective on the History of Economic Thought (2 volume set)

Wednesday, June 26, 2013

The life of Adam Smith

Adam Smith was born in 1723 in the small town of Kirkcaldy, near Edinburgh. His father, also Adam Smith (1679–1723), who died shortly before he was born, was a distinguished judge advocate for Scotland and later comptroller of customs at Kirkcaldy, who had married into a well-to-do local landowning family. Young Smith was therefore raised by his mother. The town of Kirkcaldy was militantly Presbyterian, and in the Burgh School in the town he met many young Scottish Presbyterians, one of whom, John Drysdale, was to become twice moderator of the general assembly of the Church of Scotland.

Smith, indeed, came from a customs official family. In addition to his father, his cousin Hercules Scott Smith, served as collector of customs at Kirkcaldy, and his guardian, again named Adam Smith, was to become customs collector at Kirkcaldy as well as inspector of customs for the Scottish outports. Finally, still another cousin named Adam Smith later served as customs collector at Alloa.

From 1737 to 1740, Adam Smith studied at Glasgow College, where he fell under the spell of Francis Hutcheson, and imbibed the excitement of the ideas of classical liberalism, natural law and political economy. In 1740, Smith earned an MA with great distinction at the University of Glasgow. His mother had baptized Adam in the Episcopalian faith, and she was eager for her son to become an Episcopalian minister. Smith was sent to Balliol College, Oxford, on a scholarship designed to nurture future Episcopalian clerics, but he was unhappy at the wretched instruction in the Oxford of his day, and returned after six years, at the age of 23, without having taken holy orders. Despite his baptism and his mother's pressure, Smith remained an ardent Presbyterian, and returning to Edinburgh in 1746, he remained unemployed for two years.

Finally, in 1748, Henry Home, Lord Kames, a judge and a leader of the liberal Scottish Enlightenment and a cousin of David Hume, decided to promote a series of public lectures in Edinburgh to educate lawyers. Along with Smith's childhood friend, James Oswald of Dunnikier, Kames got the Philosophical Society of Edinburgh to sponsor Smith in several years of lectures on natural law, literature, liberty and commercial freedom. In 1750, Adam Smith obtained the chair in logic at his alma mater, the University of Glasgow, and he found no difficulty in the requisite signing of the Westminster Confession before the Presbytery of Glasgow. Finally, in 1752, Smith had the satisfaction of ascending to his beloved teacher Hutcheson's chair of moral philosophy at Glasgow, where he was to remain for 12 years.

Smith's Edinburgh and Glasgow lectures were very popular, and his major stress was on the ‘system of natural liberty’, on the system of natural law and laissez-faire which he was then advocating with far less qualification than later in his more cautious Wealth of Nations. He also managed to covert many of the leading merchants of Glasgow to this exciting new creed. Smith also plunged into the social and educational associations that were beginning to be formed by the moderate Presbyterian clergy, university professors, literati, and attorneys in both Glasgow and Edinburgh. It is likely that David Hume attended Smith's Edinburgh lectures in 1752, for the two became fast friends shortly thereafter.
Smith was a founding member of the Glasgow Literary Society the following year; the society engaged in high-level discussions and debates, and met diligently every Thursday evening from November to May. Hume and Smith were both members, and at one of the first sessions, Smith read an account of some of Hume's recently printed Political Discourses. Oddly enough, the two friends, clearly the brightest members of the Society, were extremely diffident, and never said a word in any of the discussions.

Despite his diffidence, Smith was a busy and inveterate clubman, becoming a leading member of the Philosophical Society of Edinburgh and of the Select Society (Edinburgh), which flourished in the 1750s, and met weekly, bringing together the moderate power elite from the clergy, university men, and the legal profession. Smith was also an active member of the Political Economy Club of Glasgow, the Oyster Club (Edinburgh); Simson's Club of Glasgow; and the Poker Club (Edinburgh), founded by his friend Adam Ferguson, professor of moral philosophy at the University of Edinburgh, specifically to promote the ‘martial spirit’. As if this were not enough, Adam Smith was one of the leading contributors and editors of the abortive Edinburgh Review (1755–56), dedicated largely to the defence of their friends Hume and Kames against the hard-core evangelical Calvinist clergy of Scotland. The Edinburgh Review was founded by the brilliant young lawyer, Alexander Wedderburn (1733–1805), who was to become a judge, an MP in England, and finally Lord Chancellor (1793–1801). Wedderburn was so latitudinarian as to favour the licensing of brothels. Other luminaries on the Edinburgh Review were top moderate leaders: the politician John Jardine (1715–60), whose daughter married Lord Kames's son; the powerful Rev. William Robertson, and the Rev. Hugh Blair (1718–1800), professor of rhetoric at the University of Edinburgh.

The intensity of Adam Smith's Presbyterianism, even though not fundamentalist, may be seen in his relationship to Hugh Blair. Blair, the minister at the High Kirk, Greyfriars, was in constant hot water with the orthodox Calvinist clergy, who repeatedly denounced him to the Glasgow and Edinburgh Presbyteries. In the Wealth of Nations, Adam Smith delivered the following encomium to the Presbyterian clergy: ‘There is scarce, perhaps, to be found anywhere in Europe, a more learned, decent, independent, and respectable set of men than the greater part of the Presbyterian clergy of Holland, Geneva, Switzerland, and Scotland’. To which his old friend Blair, though himself a leading if embattled Presbyterian clergyman, commented in a letter to Smith: ‘You are, I think, by much too favourable to Presbytery’.

After Smith published his moral philosophy in his Theory of Moral Sentiments (1759), his increasing fame won him a highly lucrative position in 1764 as tutor to the young duke of Buccleuch. For three years of tutoring, which he spent with the young duke in France, Smith was awarded a lifetime annual salary of £300, twice his annual salary at Glasgow. In three pleasant years in France, he made the acquaintance of Turgot and the physiocrats. His tutorial task accomplished, Smith returned to his home town of Kirkcaldy, where, secure in his lifetime stipend, he worked for ten years to complete the Wealth of Nations, which he had started at the beginning of his stay in France. The fame of the Wealth of Nations led his proud erstwhile pupil, the Duke of Buccleuch, to help secure for Smith in 1778 the highly paid post of commissioner of Scottish customs at Edinburgh. With a pay of £600 per annum from his government post, which he kept until the day of his death in 1790, added to his handsome lifetime pension, Adam Smith was making close to a £1 000 a year, a ‘princely revenue’, as one of his biographers has described it. Even Smith himself wrote in this period that he was ‘fully as affluent as I could wish’. He regretted only that he had to attend to his customs post, which took time away from his ‘literary pursuits’.

And yet his regrets were scarcely profound. In contrast to most historians, who have treated Smith's customs post embarrassedly as virtually a no-show sinecure in reward for intellectual achievements, recent research has shown that Smith worked full-time at his post, often chairing the daily meetings of the board of customs commissioners. Moreover, Smith sought the appointment and apparently found the position enjoyable and relaxing. It is true that Smith spent little time or energy on scholarship and writing after his appointment; but there were leaves of absence available which Smith showed no interest in pursuing. Furthermore the groundwork for Smith's quest for the appointment was not so much his intellectual attainments as a reward for his advice as consultant on taxes and the budget to the British government since the mid-1760s.

Austrian Perspective on the History of Economic Thought (2 volume set)

Tuesday, June 25, 2013

The mystery of Adam Smith

Adam Smith (1723–90) is a mystery in a puzzle wrapped in an enigma. The mystery is the enormous and unprecedented gap between Smith's exalted reputation and the reality of his dubious contribution to economic thought.

Smith's reputation almost blinds the sun. From shortly after his own day until very recently, he was thought to have created the science of economics virtually de novo. He was universally hailed as the Founding Father. Books on the history of economic thought, after a few well-deserved sneers at the mercantilists and a nod to the physiocrats, would invariably start with Smith as the creator of the discipline of economics. Any errors he made were understandably excused as the inevitable flaws of any great pioneer. Innumerable words have been written about him. At the bicentennial of his magnum opus, An Inquiry into the Nature and the Causes of the Wealth of Nations (1776), a veritable flood of books, essays, and memorabilia poured forth about the quiet Scottish professor. His profile sculpted on a medallion by Tassie is known throughout the world. A hagiographic movie was even made about Smith during the bicentennial by a free market foundation, and businessmen and free market advocates have long hailed Adam Smith as their patron saint. ‘Adam Smith ties’ were worn as a badge of honour in the upper echelons of the Reagan Administration. On the other hand, Marxists, with somewhat more justice, hail Smith as the ultimate inspiration of their own Founding Father, Karl Marx. Indeed, if the average person were asked to name two economists in history whom he has heard of, Smith and Marx would probably be the runaway winners of the poll.

As we have already seen, Smith was scarcely the founder of economic science, a science which existed since the medieval scholastics and, in its modern form, since Richard Cantillon. But what the German economists used to call, in a narrower connection, Das AdamSmithProblem,1 is much more severe than that. For the problem is not simply that Smith was not the founder of economics. The problem is that he originated nothing that was true, and that whatever he originated was wrong; that, even in an age that had fewer citations or footnotes than our own, Adam Smith was a shameless plagiarist, acknowledging little or nothing and stealing large chunks, for example, from Cantillon. Far worse was Smith's complete failure to cite or acknowledge his beloved mentor Francis Hutcheson, from whom he derived most of his ideas as well as the organization of his economic and moral philosophy lectures. Smith indeed wrote in a private letter to the University of Glasgow of the ‘never-to-be-forgotten Dr. Hutcheson’, but apparently amnesia conveniently struck Adam Smith when it came time to writing the Wealth of Nations for the general public.

Even though an inveterate plagiarist, Smith had a Columbus complex, accusing close friends incorrectly of plagiarizing him. And even though a plagiarist, he plagiarized badly, adding new fallacies to the truths he lifted. In castigating Adam Smith for errors, therefore, we are not being anachronistic, absurdly punishing past thinkers for not being as wise as we who come later. For Smith not only contributed nothing of value to economic thought; his economics was a grave deterioration from his predecessors: from Cantillon, from Turgot, from his teacher Hutcheson, from the Spanish scholastics, even – oddly enough – from his own previous works, such as the Lectures on Jurisprudence (unpublished, 1762–63, 1766) and the Theory of Moral Sentiments (1759).

The mystery of Adam Smith, then, is the immense gap between a monstrously overinflated reputation and the dismal reality. But the problem is worse than that; for it is not just that Smith's Wealth of Nations has had a terribly overblown reputation from his day to ours. The problem is that the Wealth of Nations was somehow able to blind all men, economists and laymen alike, to the very knowledge that other economists, let alone better ones, had existed and written before 1776. The Wealth of Nations exerted such a colossal impact on the world that all knowledge of previous economists was blotted out, hence Smith's reputation as Founding Father. The historical problem is this: how could this phenomenon have taken place with a book so derivative, so deeply flawed, so much less worthy than its predecessors?

The answer is surely not any lucidity or clarity of style or thought. For the much revered Wealth of Nations is a huge, sprawling, inchoate, confused tome, rife with vagueness, ambiguity and deep inner contradictions. There is of course an advantage, in the history of social thought, to a work being huge, sprawling, ambivalent and confused. There is sociological advantage to vagueness and obscurity. The bemused German Smithian, Christian J. Kraus, once referred to the Wealth of Nations as the ‘Bible’ of political economy. In a sense, Professor Kraus spoke wiser than he knew. For, in one way, the Wealth of Nations is like the Bible; it is possible to derive varying and contradictory interpretations from various – or even the same – parts of the book. Furthermore, the very vagueness and obscurity of a work can provide a happy hunting ground for intellectuals, students and followers. To make one's way through an obscure and difficult tract, to weave dimly perceived threads of a book into a coherent pattern – these are rewarding tasks in themselves for intellectuals. And such a book also provides a welcome built-in exclusion process, so that only a relatively small number of adepts can bask in their expertise about a work or a system of thought. In that way they increase their relative income and prestige, and leave other admirers behind to form a cheering section for the leading disciples of the Master.

Adam Smith did not found the science of economics, but he did indeed create the paradigm of the British classical school, and it is often useful for the creator of a paradigm to be inchoate and confused, thereby leaving room for disciples who will attempt to clarify and systematize the contributions of the Master. Until the 1950s, economists, at least those in the Anglo-American tradition, revered Smith as the founder, and saw the later development of economics as a movement linearly upward into the light, with Smith succeeded by Ricardo and Mill, and then, after a bit of diversion created by the Austrians in the 1870s, Alfred Marshall establishing neoclassical economics as a neo-Ricardian and hence neo-Smithian discipline. In a sense, John Maynard Keynes, Marshall's student at Cambridge, thought that he was only filling in the gaps in the Ricardian-Marshallian heritage.

Into this complacent miasma of Smith-worship, Joseph A. Schumpeter's History of Economic Analysis (1954) came as a veritable blockbuster. Coming from the continental Walrasian and Austrian traditions rather than from British classicism, Schumpeter was able, for virtually the first time, to cast a cold and realistic eye upon the celebrated Scot. Writing with thinly veiled contempt, Schumpeter generally denigrated Smith's contribution, and essentially held that Smith had shunted economics off on a wrong road, a road unfortunately different from that of his continental forbears.

Since Schumpeter, historians of economic thought have largely retreated to a fallback position. Smith, it is conceded, created nothing, but he was the great synthesizer and systematizer, the first one to take up all the threads of his predecessors and weave them together into a coherent and systematic framework. But Smith's work was the reverse of coherent and systematic, and Ricardo and Say, his two major disciples, each set themselves the task of forging such a coherent system out of the Smithian muddle. And, furthermore, while it is true that pre-Smithian writings were incisive but sparse (Turgot) or embedded in moral philosophy (Hutcheson), it is also true that there were two general treatises on economics per se before the Wealth of Nations. One was Cantillon's great Essai which, after Smith, fell into grievous neglect, to be rescued a century later by Jevons; the other, and the first book to use political economy in its title, was Sir James Steuart's (1712–80) outdated two-volume work, Principles of Political Oeconomy (1767). Steuart, a Jacobite who had been involved in Bonnie Prince Charlie's rebellion, was for much of his life an exile in Germany, where he became imbued with the methodology and ideals of German ‘cameralism’. Cameralism was a virulent form of absolutist mercantilism that flourished in Germany in the seventeenth and eighteenth centuries. Cameralists, even more than western European mercantilists, were not economists at all – that is, they did not analyse the processes of the market – but were technical advisers to rulers on how and in what way to build up state power over the economy. Steuart's Principles was in that tradition, scarcely economics but rather a call for massive government intervention and totalitarian planning, from detailed regulation of trade to a system of compulsory cartels to inflationary monetary policy. His only ‘contribution’ was to refine and expand previously fleeting and inchoate notions of a labour theory of value, and to elaborate a proto-Marxian theory of inherent class conflict in society. Furthermore, Steuart had written an ultra-mercantilist tome just at the time when classical liberal and laissez-faire thought was rising and becoming dominant at least in Britain and France.

Even though Steuart's Principles was out of step with the emerging classical liberal Zeitgeist, it was no foregone conclusion that the work would have little or no influence. The book was well received, highly respected, and sold very well, and five years after its publication, in 1772, Steuart won out over Adam Smith in acquiring a post as monetary consultant to the East India Company.

One reason that the Schumpeter view of Smith shocked the economics profession is that historians of economic thought, similar to historians of other disciplines, have habitually treated the development of science as a linear and upward march into the truth. Each scientist patiently formulates, tests and discards hypotheses, and thereby each succeeding one stands on the shoulders of the one who came before. What might be called this ‘Whig theory of the history of science’ has now been largely discarded for the far more realistic Kuhnian theory of paradigms. For our purposes the important point of the Kuhn theory is that a very few people patiently test anything, particularly the fundamental assumptions, or basic ‘paradigm’, of their theory: and shifts in paradigms can take place even when the new theory is worse than the old. In short, knowledge can be and is lost as well as gained, and science often proceeds in a zig-zag rather than linear manner. We might add that this would be particularly true in the social or humane sciences. As a result, paradigms and basic truths get lost, and economists (as well as people in other disciplines) can get worse, and not better, over time. The years may well bring retrogression as well as progress. Schumpeter had heaved a bombshell into the temple of the Whig historians of economic thought, specifically of the partisans of the Smith–Ricardo–Marshall tradition.

We have thus posed our own version of the Das AdamSmithProblem: how did so badly flawed a work as the Wealth of Nations rapidly become so dominant as to blot out all other alternatives? But before considering this question, we must examine the various aspects of Smithian thought in more detail.

Austrian Perspective on the History of Economic Thought (2 volume set)