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Classical Economic Thought. Adam Smith the birth of economics. Adam Smith. Adam Smith is considered the father of economics. Adam Smith was the British economist, philosopher, and professor of logic. His first book was The Theory on Moral Sentiments.
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ClassicalEconomicThought Adam Smith the birth of economics
Adam Smith • Adam Smith is considered the father of economics. • Adam Smith was the British economist, philosopher, and professor of logic. • His first book was The Theory on Moral Sentiments. • He published An Inquiry into the Nature and Causes of the Wealth of Nations in 1776.
From Physiocracy to Adam Smith • Focus upon domestic production (unlike Mercantilists: international trade focus) • Cost of production explanation for prices • Search for the source of value: • Physiocrats nomination: land • Smith: labour, and division of labour for its increase
Beginnings of emphasis upon freedom of commerce (unlike Mercantilists: government monopolies, duties on imports, etc.) • Input-output aspects lost (until Marx) • Concern for aggregate demand lost to “Say’s Law” (except for Malthus, Marx)
1776 & “The Wealth of Nations” • The first major work of political economics. • Writing less than 10 years after Watt devised his steam engine (1769); year first Watt engine installed (1776).
1776 & “The Wealth of Nations” • In it he described the building blocks of national economic health. • In it he examined in detail the consequences of economic freedom, such as division of labor, the function of markets and the international implications of laissez-faire economics. • He argued that individualism led to order and progress. • He also believed that labor, not land and money, was both the source of and final measure of value. • Finally, Smith thought that free trade and a self-regulating economy would result in social progress.
First building block • The starting point of the health of nations is the division of labor, which allows people to specialize. • In his example of the pin factory, each worker performs a separate operations. • Productivity rises due to improvements in dexterity, use of time, and application of machinery. • The division of labor leads to an interconnected economy.
Second building block • The prosperity to trade is the second building block. • Trade leads people to act in their own self interest. • Smith perceived that in real word, most people are motivated by self-interest. • The notion of benevolence is admirable, but in most cases people expect to be paid for their goods or services.
Smiht thought the ‘invisible hand’ would guide people who act in their own self-interest to produce benefits for each other and for society. • Smith attacked the mercantilists. • He argued that trade benefits all parties involved. • It is not zero-sum.
Despite his tremendous success, Smith felt short on certain points. • Economists questioned where value came from and how prices were determined. • Smith separated value at use from value in exchange. He believed that labor was the source of value.
Smith searched for the natural price of goods and services. • He discussed the development of an economy including landlords, workers, and capitalists. • Capitalist accumulation conflicted with rising birthrates. • Smith held to a logical long-run pessimism, but he optimistic about the medium-term situation.
Smith is rewarding to read because he avoids formulas, is blunt, and is not an ideologue. • Smith discusses the many appropriate roles of government. • He is not compete believer in laisse-fair economics. • He believes that government should implement certain public works project, public education, and certain trade regulations.
Smith’s skepticism is utterly consistent, and he does not duck the hard questions. • He understood that the division of labor could also injure workers. • Smith described the ignorance of landlords. • He distrusted businessman since they often exploited others and created monopolies. • Smith also distrusted government.
Agriculture already capitalist via “enclosure” movement • Crops for sale rather than consumption on feudal estate • Serfs evicted from land • class of “landless labourers” • no rights to land (like serfs), no assets (like guildsmen) • must work for a living: wage labour • Industry becoming capitalist: factories, labourers displacing guilds, craftsmen
1776 & “The Wealth of Nations” • Domestic production now much more important than foreign trade • Focus foremost on production, rather than exchange • Early stage of capitalist development causes confusion: • Role of machinery not yet pervasive • Class structure capitalist, but not yet clear
Basic Propositions • Labour, not land, is the primary source of value: • “The annual labour of every nation is the fund which originally supplies it with all the necessaries and conveniences of life” (Differs with Physiocrats) • Increase in value from specialisation & division of labour; economies of scale essential part of his analysis“.
Acknowledges role of machinery: • This great increase of the quantity of work ... is owing to … the increase in the dexterity in every particular workman; … the saving of time which is commonly lost in passing from one species of work to another; ... the invention of a great number of machines which facilitate and abridge labour, and enable one man to do the work of many.”
Basic Propositions • But subsumes this too under division of labour: • “(T)he invention of all those machines ... 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” • Clarifies ancient dispute over role of utility in determining value/price: • “The word VALUE ... has two different meanings, ... the utility of some particular object, and ... the power of purchasing other goods... The one may be called ‘value in use’, the other, ‘value in exchange’”.
Source of Value • No role for “value in use” in determining price • Commences with the “diamond/water paradox” • Water has great “value in use”, but very low price • Diamonds have little utility, but very high price: • “The things which have the greatest value in use have frequently little or no value in exchange; and, on the 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 anything; scarce anything 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.”
Source of Value • Resolution of “paradox”: • Price reflects relative difficulty of “manufacture” • Abundant water involves little effort • Scarce diamonds take much effort • “Labour, therefore, is the real measure of the exchangeable value of all commodities.” • “Effort determines value” perspective: “The real price of everything, ..., is the toil and trouble of acquiring it”. • Price reflects labour embodied in commodity: “If among a nation of hunters.., it usually costs twice the labour to kill a beaver which it does to kill a deer, one beaver should naturally exchange for or be worth two deer.”
Value and Price Problems • What about capital? • “As soon as stock has accumulated in the hands of particular persons, some of them will naturally employ it in setting to work industrious people, ..., in order to make a profit by the sale of … what their labour adds to the value of the materials… something must be given for the profits of the undertaker of the work who hazards his stock in this adventure.” • So two determinants of price?: • “The value which the workmen add to the materials, therefore, resolves itself ... into two parts, of which the one pays their wages, the other the profits of their employer upon the whole stock of materials and wages which he advanced.”
Value and Price Problems • What about land? • “As soon as the land of any country has all become private property, the landlords, like all other men, love to reap where they never sowed, and demand a rent even for its natural produce... (A)ll the natural fruits of the earth, which, when land was in common, cost the labourer only the trouble of gathering them, come, ..., to have an additional price fixed upon them. He must then pay for the licence to gather them; and must give up to the landlord a portion of what his labour either collects or produces. ... (T)he price of this portion, constitutes the rent of land, and in the price of the greater part of commodities makes a third component part.” • “Adding up” “theory” of costs/price
Value and Price Problems • What measure of labour? • Labour embodied?: • Hours of labour a commodity contains • 40 hours to make a chair • embodies 1 working week • but price includes profit, rent, as well as wage • Labor commanded?: • Hours of labour a commodity can buy • Chair costs workers 2 weeks wages • Commands 80 hours of labour • What is labour?: “Not only his labouring servants, but his labouring cattle, are productive labourers.”
Smith’s Scorecard • Gained • Appreciation of labor/industrialisation • Notions of capital, profit, rent • Perceptive cynicism re landlords, merchants • Labour as source of value • Lost • Analysis of flows, input-output • Notion of surplus • Role of investment • Analytic rigour • “Macroeconomic” concerns: investment, aggregate demand, employment
In summary, Smith’s ideas and writing still have influence today. • Smith had certain extraordinary qualities. • His honesty was admirable. • He was extremely accurate in his observations. • Like the quintessential academic, he was quite absent-minded. • He was gentle, kind, and had a sense of humanity. • His ideas in The Wealth of Nations are still discussed today.
