History of economic thought, II – the classical economists

[innonimatu]

History of economic thought, II – the classical economists

I've finally found the time to post the second part of this small history, covering classical economics. It starts with Smith, and probably should end with Marx, but I’ll restrict it to the pre-marxist period – including Marx would cause any discussion to focus only on that last part, I better leave it for a third post. So it’s Smith, Ricardo and a few others, mostly british (Malthus, Say, etc). What unites the works of all these people, and justifies calling them all classical economists? We might say “free trade”, but a more important common element is the labour theory of value.

Smith’s best known work, “An Inquiry into the Nature and Causes of the Wealth of Nations” (I’ll call it WoN) had a major, and immediate, impact after it was published (1776). To be fair he was not the first to write about any of the major ideas exposed in his book – he built his work on top of those of other important 18th century figures, many of whom he knew personally. But his unique contribution was to weave a disparate collection of separate ideas which had been floating around in intellectual circles into a coherent theory, easily to understand and to act on. He didn’t even claim to have produced such a theory (“An inquiry into the nature…&#8221, but undoubtedly he managed to distil practical policies from 18th century philosophy, policies which remained relevant until our days.

Three major contributions to economic thought are usually attributed to Smith’s WoN: economic freedom (as opposed to mercantilism) as a universally good thing (all those involved benefited from it, contrary to the ideas of the mercantilists); the observation that the division of labour was the key to higher productivity and economic prosperity; and the labour theory of value (which has many consequences). From these resulted recommendations for a political programme (at the time economics was honestly called political economy) which was later called Liberalism. This programme was immediately very appealing for two reasons: Smith’s book provided a sound and easy to understand intellectual basis for that programme, and, perhaps more importantly, it was an optimistic programme – intended to show how people, regardless of their intentions, tended in their interactions to contribute to the common good.

In fact none of those three major ideas in WoN were really new. The physiocrats had already called for economic freedom and had already stressed the optimistic view of social interactions as necessarily positive (trade only happens when both parties believe they will profit). Most of the important 18th century philosophers had also linked rational self-interest with the common good (both Rosseau with the “general will” and Kant with the “categorical imperative” were universalists and optimists – in different ways they sought to solve the contradiction between individual desires and the common good by explaining how anyone who acted rationally for his own good would also necessarily take into account other people and end up acting for the common good). 18th century philosophers, almost without exception, embraced rationalism, but they were split regarding morals: some, like Hobbes (ok, 17th century&#8230, claimed that human nature was vicious and that some power (justice, administered by the state) had to regulate men in order to channel their individual passions for the common interest. Private morals would not suffice. Others, without denying the usefulness of the state, countered that a rational examination of each individual’s situation would lead them to choose those actions witch lead to the greater common good – no repressive state was really necessary to keep people in line with what was socially desirable. Others yet went so far as to deny the existence of any paradox (between individual interests and the common interest) and claim that human nature was naturally good. Smith was definitely in the optimist’s field, and even had a known dislike for an infamous pessimist, hobbesian, philosopher of his time (Bernard de Mandeville, for his “Fable of the Bees&#8221.
The productive advantages of the division of labour had been commented on by several other 18th century philosophers, including Smith’s close friend David Hume. Smith in fact lived before the Industrial Revolution truly transformed Britain, in much of his work he still used examples from his contemporary world of small shops and artisans. The division of labour was but one of the two main ingredients for the Industrial Revolution, the other was technical progress, which Smith mostly ignores (he does mention how new tools can be of greater use for simple jobs, an improvement gained from the division of labour – which he considers the driving force for invention), despite being a contemporary of Watt and Arkwright. But that can be “forgiven”: his world was still a pre-industrial one where most of the economy was controlled by landowners and corporations (in its medieval sense of guilds), his book an attack on that world and a correct guess on how it would be reorganized.

The labour theory of value, which would refined by later economists, was a more important contribution. The wealth of nations which Smith sought to understand was not the accumulated wealth of the mercantilists but the annual production of the physiocrats (“The annual labour of every nation”, in Smith’s words). Smith went beyond the physiocrats by understanding that wealth was not simply reaped from nature but produced by human labour whenever the initial raw materials were transformed. I can’t quote extensively from WoN (it would lead to a huge text here), but there is one important passage I should quote here:

The capital error of this system [the Physiocrats], however, seems to lie in its representing the class of artificers, manufacturers, and merchants as altogether barren and unproductive. The following observations may serve to show the impropriety of this representation.
First, this class, it is acknowledged, reproduces annually the value of its own annual consumption, and continues, at least, the existence of the stock or capital which maintains and employs it. But upon this account alone the denomination of barren or unproductive should seem to be very improperly applied to it. […] Farmers and country labourers, indeed, over and above the stock which maintains and employs them, reproduce annually a net produce, a free rent to the landlord. […] The superior produce of the one class, however, does not render the other barren or unproductive.
Secondly, it seems, upon this account, altogether improper to consider artificers, manufacturers, and merchants in the same light as menial servants. The labour of menial servants does not continue the existence of the fund which maintains and employs them. Their maintenance and employment is altogether at the expence of their masters, and the work which they perform is not of a nature to repay that expence. That work consists in services which perish generally in the very instant of their performance, and does not fix or realize itself in any vendible commodity which can replace the value of their wages and maintenance. The labour, on the contrary, of artificers, manufacturers, and merchants naturally does fix and realize itself in some such vendible commodity. It is upon this account that, in the chapter in which I treat of productive and unproductive labour, I have classed artificers, manufacturers, and merchants among the productive labourers, and menial servants among the barren or unproductive.
Thirdly, it seems upon every supposition improper to say that the labour of artificers, manufacturers, and merchants does not increase the real revenue of the society. Though we should suppose, for example, as it seems to be supposed in this system, that the value of the daily, monthly, and yearly consumption of this class was exactly equal to that of its daily, monthly, and yearly production, yet it would not from thence follow that its labour added nothing to the real revenue, to the real value of the annual produce of the land and labour of the society. An artificer, for example, who, in the first six months after harvest, executes ten pounds worth of work, though he should in the same time consume ten pounds worth of corn and other necessaries, yet really adds the value of ten pounds to the annual produce of the land and labour of the society. While he has been consuming a half-yearly revenue of ten pounds worth of corn and other necessaries, he has produced an equal value of work capable of purchasing, either to himself or some other person, an equal half-yearly revenue. The value, therefore, of what has been consumed and produced during these six months is equal, not to ten, but to twenty pounds. It is possible, indeed, that no more than ten pounds worth of this value may ever have existed at any one moment of time. But if the ten pounds worth of corn and other necessaries, which were consumed by the artificer, had been consumed by a soldier or by a menial servant, the value of that part of the annual produce which existed at the end of the six months would have been ten pounds less than it actually is in consequence of the labour of the artificer. Though the value of what the artificer produces, therefore, should not at any one moment of time be supposed greater than the value he consumes, yet at every moment of time the actually existing value of goods in the market is, in consequence of what he produces, greater than it otherwise would be.
[…]
Fourthly, farmers and country labourers can no more augment, without parsimony, the real revenue, the annual produce of the land and labour of their society, than artificers, manufacturers, and merchants.
[…]
Fifthly and lastly, though the revenue of the inhabitants of every country was supposed to consist altogether, as this system seems to suppose, in the quantity of subsistence which their industry could procure to them; yet, even upon this supposition, the revenue of a trading and manufacturing country must, other things being equal, always be much greater than that of one without trade or manufactures. By means of trade and manufactures, a greater quantity of subsistence can be annually imported into a particular country than what its own lands, in the actual state of their cultivation, could afford. The inhabitants of a town, though they frequently possess no lands of their own, yet draw to themselves by their industry such a quantity of the rude produce of the lands of other people as supplies them, not only with the materials of their work, but with the fund of their subsistence.

This shows not only Smith’s disagreement with the physiocrats on this crucial question, but also his ideas about how wealth is created. He considers soldiers and menial servants (and priests, and ultimately governments) unproductive workers because their “work consists in services which perish generally in the very instant of their performance, and does not fix or realize itself in any vendible commodity which can replace the value of their wages and maintenance”. Wealth must be embodied in some vendible commodity. And that wealth is no more than the work expended by its seller (his own and that already embodied in the materials he may have transformed). A merchant’s work is productive because he can pass its value along, embodied in the commodities he sells. A soldier’s work is unproductive because he creates no sellable products. The soldier, and the servant, are still workers, but they’re unproductive – no stock of wealth can be created from their activity. Smith’s preference for a small state bureaucracy has its roots on this understanding about the production of wealth:

The labour of some of the most respectable orders in the society is, like that of menial servants, unproductive of any value, and does not fix or realize itself in any permanent subject; or vendible commodity, which endures after that labour is past, and for which an equal quantity of labour could afterwards be procured. The sovereign, for example, with all the officers both of justice and war who serve under him, the whole army and navy, are unproductive labourers. They are the servants of the public, and are maintained by a part of the annual produce of the industry of other people. Their service, how honourable, how useful, or how necessary soever, produces nothing for which an equal quantity of service can afterwards be procured. The protection, security, and defence of the commonwealth, the effect of their labour this year will not purchase its protection, security, and defence for the year to come. In the same class must be ranked, some both of the gravest and most important, and some of the most frivolous professions: churchmen, lawyers, physicians, men of letters of all kinds; players, buffoons, musicians, opera-singers, opera-dancers, &c.
[…]
Great nations are never impoverished by private, though they sometimes are by public prodigality and misconduct. The whole, or almost the whole public revenue, is in most countries employed in maintaining unproductive hands. Such are the people who compose a numerous and splendid court, a great ecclesiastical establishment, great fleets and armies, who in time of peace produce nothing, and in time of war acquire nothing which can compensate the expence of maintaining them, even while the war lasts. Such people, as they themselves produce nothing, are all maintained by the produce of other men's labour. When multiplied, therefore, to an unnecessary number, they may in a particular year consume so great a share of this produce, as not to leave a sufficiency for maintaining the productive labourers, who should reproduce it next year. The next year's produce, therefore, will be less than that of the foregoing, and if the same disorder should continue, that of the third year will be still less than that of the second. Those unproductive hands, who should be maintained by a part only of the spare revenue of the people, may consume so great a share of their whole revenue, and thereby oblige so great a number to encroach upon their capitals, upon the funds destined for the maintenance of productive labour, that all the frugality and good conduct of individuals may not be able to compensate the waste and degradation of produce occasioned by this violent and forced encroachment.

Smith, who regarded the accumulation of capital (the balance between yearly production and consumption) as a necessary condition for the increase of a nation’s wealth, could not be very sympathetic towards those he classified as “unproductive workers”.
The quote above, which we could consider the origin of some of what people today call “conservative values” (then they were liberal) might be a good starting point for a discussion on the relevance of the calls for a “small state” in our modern world… are there unproductive workers today (how would that be defined now?), and if so who are they?

I will now try to give a good idea about each of the three major contributions attributed to Smith that I mentioned above. There are many other interesting points in WoN, but it is impossible to cover the whole book here - anyone can read it online.

The division of labour part is very simple to explain, a few quotes from WoN should be enough. Right from the start:

The greatest improvement in the productive powers of labour, and the greater part of the skill, dexterity, and judgment with which it is any where directed, or applied, seem to have been the effects of the division of labour.

Followed by the well-known pin factory example, and then:

This great increase of the quantity of work which, in consequence of the division of labour, the same number of people are capable of performing, is owing to three different circumstances; first to the increase of dexterity in every particular workman; secondly, to the saving of the time which is commonly lost in passing from one species of work to another; and lastly, to the invention of a great number of machines which facilitate and abridge labour, and enable one man to do the work of many.

I must also mention that if Smith ever considered issues of “human nature” (ever so popular), the propensity to trade was what he believed to be the fundamental characteristic of mankind:

This separation too is generally carried furthest in those countries which enjoy the highest degree of industry and improvement; what is the work of one man in a rude state of society, being generally that of several in an improved one. In every improved society, the farmer is generally nothing but a farmer; the manufacturer, nothing but a manufacturer.
[…]
This division of labour, from which so many advantages are derived, is not originally the effect of any human wisdom, which foresees and intends that general opulence to which it gives occasion. It is the necessary, though very slow and gradual, consequence of a certain propensity in human nature which has in view no such extensive utility; the propensity to truck, barter, and exchange one thing for another.

This was the one characteristic which drove progress – trade allowed specialization, and that allowed the increase of productivity and technical/scientific progress:

I shall only observe, therefore, that the invention of all those machines by which labour is so much facilitated and abridged, seems to have been originally owing to the division of labour. Men are much more likely to discover easier and readier methods of attaining any object, when the whole attention of their minds is directed towards that single object, than when it is dissipated among a great variety of things. […]
In the progress of society, philosophy or speculation becomes, like every other employment, the principal or sole trade and occupation of a particular class of citizens. Like every other employment too, it is subdivided into a great number of different branches, each of which affords occupation to a peculiar tribe or class of philosophers; and this subdivision of employment in philosophy, as well as in every other business, improves dexterity, and saves time. Each individual becomes more expert in his own peculiar branch, more work is done upon the whole, and the quantity of science is considerably increased by it.

A rather materialistic view of historical evolution!

Smith’s support of free trade (and also of a politically liberal state) would then seem natural: his view was that trade is essentially good, both natural and the source of all progress. But regarding what we now understand by “free trade” (international trade), his views were surprisingly different. About the main trades of his days, between town and countryside, manufactures and agriculture, he had no doubts: “The gains of both are mutual and reciprocal, and the division of labour is in this, as in all other cases, advantageous to all the different persons employed in the various occupations into which it is subdivided”. But those gains, and the inclination to trade, depend on the kind of trade involved. Foreign trade is riskier (and Smith should know what he was writing about). The natural order of things would therefore be to invest on the internal marked before turning towards foreign trade. In fact he goes as far as calling the inversion of that order, which he could see in his contemporary Europe, “unnatural and retrograde”! Why? Not so much because he thought it inefficient, but because he disliked it on moral/political grounds.
This explains why David Ricardo, not Smith, would go down in history as the champion of free trade. Ricardo famously attacked the Corn Laws designed to protect british farmers, whereas Smith said, of such encouragements to agriculture:

The law of England, however, favours agriculture not only indirectly by the protection of commerce, but by several direct encouragements. Except in times of scarcity, the exportation of corn is not only free, but encouraged by a bounty. In times of moderate plenty, the importation of foreign corn is loaded with duties that amount to a prohibition. […] These encouragements, though at bottom, perhaps, as I shall endeavour to show hereafter, altogether illusory, sufficiently demonstrate at least the good intention of the legislature to favour agriculture. But what is of much more importance than all of them, the yeomanry of England are rendered as secure, as independent, and as respectable as law can make them.

In opposing mercantilism he was opposing one thing: the encouragement of investment on exports, which was the particular form of interference in the economy common when he wrote WoN. He defended instead economic freedom. This obviously allowed unrestricted foreign trade, but he assumed that such trade would not be preferred over investment in agriculture and manufactures. Agriculture itself did not need encouragement so much as to be left alone to evolve naturally – investment, Smith believed, would be directed there until basically all worthwhile land was used and the surplus would then be applied in manufactures and foreign trade (I believe that he would be horrified at the modern idea of moving “manufactures” out of the country to cut wage costs). The book itself seems contradictory in some parts, essentially because it was a result of a combination of 18th century views about society and the economy. And I dare say that Smith was a “physiocrat with a different strategy”: instead of actively promoting agriculture, he just hoped that economic freedom would naturally lead to its promotion. Here too Ricardo, not Smith, would be the “champion” of the big manufactures/modern industry.
Just another quote from the end of the book (it’s also the chapter where he comments on the ideas of the physiocrats):

Those systems, therefore, which, preferring agriculture to all other employments, in order to promote it, impose restraints upon manufactures and foreign trade, act contrary to the very end which they propose, and indirectly discourage that very species of industry which they mean to promote. They are so far, perhaps, more inconsistent than even the mercantile system. That system, by encouraging manufactures and foreign trade more than agriculture, turns a certain portion of the capital of the society from supporting a more advantageous, to support a less advantageous species of industry.
[…]
All systems either of preference or of restraint, therefore, being thus completely taken away, the obvious and simple system of natural liberty establishes itself of its own accord. Every man, as long as he does not violate the laws of justice, is left perfectly free to pursue his own interest his own way, and to bring both his industry and capital into competition with those of any other man, or order of men. The sovereign is completely discharged from a duty, in the attempting to perform which he must always be exposed to innumerable delusions, and for the proper performance of which no human wisdom or knowledge could ever be sufficient; the duty of superintending the industry of private people, and of directing it towards the employments most suitable to the interest of the society. According to the system of natural liberty, the sovereign has only three duties to attend to; three duties of great importance, indeed, but plain and intelligible to common understandings: first, the duty of protecting the society from violence and invasion of other independent societies; secondly, the duty of protecting, as far as possible, every member of the society from the injustice or oppression of every other member of it, or the duty of establishing an exact administration of justice; and, thirdly, the duty of erecting and maintaining certain public works and certain public institutions which it can never be for the interest of any individual, or small number of individuals, to erect and maintain; because the profit could never repay the expence to any individual or small number of individuals, though it may frequently do much more than repay it to a great society.

Smith, always concerned also with morals, still saw the protection from oppression or injustice as one of the fundamental duties of the state. To Smith there were moral choices to be made, and man naturally had sympathy for its fellow humans. Contrary to Mandeville’s proposition, private vices did not made public virtues. When smith mentioned the “invisible hand” he indeed praised private ambition, but not all of the other vices Mandeville so readily endorsed. And Smith contended that this ambition was not a vice because its products would necessarily be shared among all who laboured in any private project – the landlord could eat no more than the peasant, though he might eat better. In his Theory of moral sentiments, where he used the term “invisible hand” in a very clear way, he calls “the pleasures of wealth and greatness” the deception which “rouses and keeps in continual motion the industry of mankind”. Smith called for the state to be excluded from the direction of the economy, but did not absolve it from the overseeing of justice, and this justice extended into the economic sphere, as warnings about “conspiracies against the public interest” (Civilopedia quote ) showed. To Smith, self interest could be good, or not – justice must always deal with that issue.

 

[innonimatu]

Continuation (this is getting a bit too big, I know...)

Smith was an essentially optimistic thinker. Malthus, another “classical economist”, a well-known pessimist. We bundle them all together under the same label because they all embraced the labour theory of value, but each of those “classical economists” would formulate it slightly differently (and Smith would not even name it). Smith starts his book already assuming that the reader will accept that work is a source of wealth. I’m not saying the source because he still regards nature as at least a helper in the process, as far as agricultural production is concerned. But regardless of nature’s help, it’s the work of the farm labourer that remains embodied in the farm products. I believe that he best explains how he links labour and value in this paragraph:

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

Labour spent in creating commodities is considered to be embodied on those commodities. But the issue of value then gets more complicated. “Value in exchange” (trade value) can be different from embodied value, and that also different from “Value in use”. Exchange value is what people will trade a commodity for. Use value is its utility for someone. The typical example of these differenced is water, always with a high use value but usually with very lo exchange value. Embodied value usually follows exchange value more closely than it does use value. This led Smith to classify labour as the true measure of exchange value. Note that the “toil and trouble” of labour, for Smith, already included such things as training or aides to labour such as tools, and obviously the raw materials. I’m focusing on Smith here, but the labour theory of value would be changed and refined by many later classical economists. Ricardo in particular equalled embodied value (the labour necessary to produce or acquire a thing) with the ideal exchange value. I’ll return to the topic later.
The matter of value settled, Smith naturally had to relate it with price. He saw societies as evolving from an “early and rude” state, where the division of labour had not yet started and each man could provide equally well for his needs, to a mercantile state, where the division of labour placed workers on different roles (specialization) and created a need both for the tools and the raw materials necessary for a large-scale production intended for trading. In the primitive society a hunter could, for example, trade meat with a fisher, both having an idea of the labour they were trading for. Both were independent producers, traded in a small scale and mostly subsisted independently, and would trade their products of the corresponding embodied value:

In that original state of things, which precedes both the appropriation of land and the accumulation of stock, the whole produce of labour belongs to the labourer. He has neither landlord nor master to share with him.

But as soon as the accumulation of property began, this state of things came to an end. It started with the private control of the land:

As soon as land becomes private property, the landlord demands a share of almost all the produce which the labourer can either raise, or collect from it. His rent makes the first deduction from the produce of the labour which is employed upon land.
It seldom happens that the person who tills the ground has wherewithal to maintain himself till he reaps the harvest. His maintenance is generally advanced to him from the stock of a master, the farmer who employs him, and who would have no interest to employ him, unless he was to share in the produce of his labour, or unless his stock was to be replaced to him with a profit. This profit makes a second deduction from the produce of the labour which is employed upon land.

And it later went beyond the land. Once a society had accumulated enough capital, some people could start specializing in a certain trade only. The pre-requisite to specialization was the accumulation of a stockpile of raw materials and/or tools (without which work would be impossible or the benefits of specialization not realized) and a reserve necessary to sustain the daily needs of the worker (and his family) during the labour, until he can sell his products. As specialization progresses the amounts requires became greater, until the independent produced became the exception rather than the rule:

It sometimes happens, indeed, that a single independent workman has stock sufficient both to purchase the materials of his work, and to maintain himself till it be compleated. He is both master and workman, and enjoys the whole produce of his own labour, or the whole value which it adds to the materials upon which it is bestowed. It includes what are usually two distinct revenues, belonging to two distinct persons, the profits of stock, and the wages of labour.
Such cases, however, are not very frequent, and in every part of Europe, twenty workmen serve under a master for one that is independent; and the wages of labour are every where understood to be, what they usually are, when the labourer is one person, and the owner of the stock which employs him another.
What are the common wages of labour, depends every where upon the contract usually made between those two parties, whose interests are by no means the same. The workmen desire to get as much, the masters to give as little as possible. The former are disposed to combine in order to raise, the latter in order to lower the wages of labour.
It is not, however, difficult to foresee which of the two parties must, upon all ordinary occasions, have the advantage in the dispute, and force the other into a compliance with their terms. The masters, being fewer in number, can combine much more easily; and the law, besides, authorises, or at least does not prohibit their combinations, hile it prohibits those of the workmen. We have no acts of parliament against combining to lower the price of work; but many against combining to raise it. In all such disputes the masters can hold out much longer. A landlord, a farmer, a master manufacturer, or merchant, though they did not employ a single workman, could generally live a year or two upon the stocks which they have already acquired. Many workmen could not subsist a week, few could subsist a month, and scarce any a year without employment. In the long-run the workman may be as necessary to his master as his master is to him, but the necessity is not so immediate.

Then are then the issues of rents and profits. If a commodity is traded by the value of the raw materials used, plus the labour expended in transforming those, how can profit arise or rents be paid? It would only be possible if wages were inferior to the value of labour expended. Smith both presented rents and profit as a deduction to the products of labour, and later argued that trade value was actually higher than embodied value. But labour itself is a commodity, and should also be traded by its fair value. This was a question Smith failed to address, and which David Ricardo later sought to solve.
Despite these deductions to the product of labour, seen as inevitable by Smith, he argued that specialization was still desirable because it increased the total production so much more than the workers would still be better of, even if they received only a share of their production. The classical economic argument that “a larger pie benefits everyone, even if some get exploited”, goes at least back to this work – and so does the assumed inevitability of some forms of organization.
This is already a very long post, I’ll leave Ricardo for another day!

 

[Princeps]

Get a blog.

 

[innonimatu]

Get a blog.

What's the point of blogs when there were forums already?

 

[Panopticon]

This is a very good series, and I say that as someone who took this as a major at undergraduate level.

 

[Brighteye]

We're all avidly waiting for part 3!

 

[Grimz101]

We're all avidly waiting for part 3!

Seconded!!