ADAM SMITH'S THEORY OF GROWTH AND TECHNOLOGICAL CHANGE

Transcription

1 Contributions to Political Economy (1993) 12,1-27 ADAM SMITH'S THEORY OF GROWTH AND TECHNOLOGICAL CHANGE REVISITED PRUE KERR Clare Hall, Cambridge I. This paper reconsiders the role of technological change in Adam Smith's explanation of the growth process. Given the vast literature on this subject, it seems ironic that models representing Smith's theory of economic growth often remark on their static nature yet the roles of technological change and of growing markets are recognised as central elements of his theory. Occasionally authors are even led to compare their 'Smithian' growth models with the more dynamic character of his historical studies. 1 This paper draws upon Smith's writings in The Wealth of Nations (WN) as a whole, including the historical parts, 2 rather than the common practice of selecting out chapters from Books I and II as the ones containing the essential elements of his economic analysis. It also draws on his Essays on Philosophical Subjects, in particular the 'History of Astronomy', and on his various descriptions of the four stages of economic development. While the resulting account of the growth process which emerges here is less easily modelled than simple one sector descriptions of Smith's argument would suggest (see, for example, Hicks, 1965 and Eltis, 1984), it has the advantage of allowing the inter- 1 For example, the editors of the Glasgow edition of WN refer to the 'dynamic analysis of II.v and Ill.i' and to 'the treatment of the static allocative mechanism offered in Book I' (Campbell, Skinner and Todd, 1976, p. 453, n. 7). 2 See Pownall's (1776) comments where, in referring to different employments in capital, he distinguishes between the thesis that Smith makes and then states that 'these propositions used in the second part of your work as data' (p. 23). Pownall then refers to the 'plan and superstructure' of WN as having 'given a compleat idea of that system, which I had long wished to see the publick in possession of. A system, that might fix some first principles in the most important of sciences, the knowledge of the human community, and its operations. That might become principia to the knowledge of politick operations; as Mathematicks are to Mechanicks, Astronomy and the other Sciences' (ibid, p. 1: see also WN, V.i.f. n. 16). Indeed, he referred to WN as an 'INSTITUTE OF THE PRINCIPIA of those laws of motion, by which the operations of the community are directed and regulated, and by which they should be examined' (op cit, p. 23). Pownall criticises Smith for advancing 'in words [... ] upon the ground of probable reasons for believing only; you prove by probable suppositions only; yet most people who read your book, will think you mean to set up an absolute proof, and your conclusion is drawn as though you had' (ibid, p. 40). Finally, when questioning Smith's arguments about capital transfers, says '[t]his is again argument, a priori, in matters of fact, wherein it cannot act as proof /93/ / Academic Press Limited

2 2 P. KERR sectoral dependencies emphasised in Smith's historical writing and in his theory of 'natural progress' of industry to be more adequately integrated into an understanding of his main argument that technological change in the form of specialisation of labour is the motor behind increases in wealth. Technological change is the dynamic which sets in motion the secular evolution of society and the economy through the chain of reciprocal relations it sets up between sectors. The paper is divided into four sections. The next section (section II) briefly describes some of the background to Smith's theory of the division of labour and growth. It introduces the roles of human nature and locates the problem of political economy as one of reconciling vastly unequal distributions of wealth and private property with the claims of poverty. The market system, by promoting more and more extensive divisions of labour, would overcome the problems of the poor without intruding on justice, or the rights of property. Hence, in the comparisons of Smith's 'economic' analysis with modern versions of his analysis, it should be kept in mind that the basis of his faith in markets lay in the natural laws that he accepted and in the demonstration that with commercial society, technological change, and so continuous growth, is inevitable. Section III looks at Smith's discussion of the concept of 'wealth' as it appears in his critique of both the mercantilists and the physiocrats. In this critique Smith sets out his views on the nature of wealth. In doing so he also suggests an organisation of his own economic analysis. His discussion of the physiocrats brings out the role of labour in the production of wealth and hence the importance of the particular form of technological change (the division of labour) on which he focuses. His criticisms of the mercantilist system, on the other hand, emphasise the relationship between the division of labour and the market and exchange in the growth process. The form of technological change which Smith envisaged requires large-scale production and this part of his discussion illustrates the possibilities for new divisions of labour and the interacting development of each productive sector when markets are growing. In his critique of the mercantilist system he shows how money is a form of wealth; it is circulating capital. The concept of wealth in each of these critiques, both as a flow of production and as a stock, is consistent with the discussion in Books I and II of WN where wealth is also both produce and stock and where production of a surplus (or wealth) in commercial society is naturally associated with accumulation of wealth. The distinction between production and accumulation is less important to his theory centred around the division of labour than the distinction between production and accumulation, on the one hand, and the exchange process, on the other. 1 Book V is then in a position to state the proper role of the state with regard to raising and then spending revenue and to demonstrate how different policies of revenueraising and of state expenditure had interfered with the natural progress of opulence. 1 Furthermore, these two aspects of economic activity each derive from different elements of man's nature. Man strives to better his condition, to produce and accumulate and develop more productive ways of doing so, and he pursues his urge to truck and barter by specialising in his production, so producing more and exchanging it with other similarly specialist producers.

3 ADAM SMITH'S THEORY REVISITED 3 Section IV turns to Smith's method and the associated structure of his analysis. This structure re-affirms that in his critique of 'wealth' in the physiocratic and mercantilist schemes, a broad distinction between the areas of production and accumulation and of the exchange process is central to the whole analysis. Section V then sets out Smith's analysis as depicted in his critique of 'wealth' and in his use of analogy. It demonstrates how his theory of wealth starts from some inherited accumulation and continues increasing production and extending exchange. The main factor underlying different growth rates is the ability of producers in each sector to introduce new divisions of labour. Through the division of labour, sufficient surplus is created first in the agricultural sector to support the development of manufactures, and then in both of these to support the development of the trading sector. New divisions of labour accompanied by new social arrangements, largely centering on the organisation of exchange and the evolution of natural justice, provide the continuously increasing surplus (and so the capital) necessary for employing more productive labour. As each sector grows it provides the stimulus and the means for the other sectors to expand until capital accumulation and economic growth reach their natural limits. II. SMITH'S WORK PRIOR TO WN It is perhaps worth remembering that political economy forms only a part of the whole system of moral philosophy in Smith's work. In the Advertisement to the 6th edition of Theory of Moral Sentiments (TMS), written after WN, Smith describes his ambition as being 'to give an account of the general principles of law and government, and of the different ages and revolutions which they had undergone in different ages and periods of society, not only in what concerns justice, but in what concerns police, revenue and arms, and whatever is the object of law. In WN I have partly executed this promise, at least as far as concerns police, revenue and arms'. In WN, he describes political economy rather more narrowly as: 'a branch of the science of a statesman, or legislator [which] proposes two objects;first,to provide a plentiful revenue or subsistence for the people or more properly to enable them to provide such a revenue or subsistence for themselves; and secondly to supply the state or commonwealth with a revenue sufficient for the publick services. It proposes to enrich both the people and the sovereign (.WN, Introduction Book IV). In fact, Smith's unpublished Lectures on Jurisprudence (LJ) were a link between TMS and WN. These lectures were concerned with the last chapter of TMS the discussion of public and private rights and in particular with 'police', the subjects which Smith developed in WN as political economy. It was in this way that Smith's work in economics was designed to follow on from his treatment of ethics and jurisprudence.

4 4 P. KERR //./. Natural propensities The economic analysis selected out the relevant natural propensities of man and specified the moral or social situation as being one in which a minimum condition of justice prevails. In TMS Smith had identified 'sympathy' with the wealthy as the basis of self-love, and self-love as the basis of all economic actions. This latter aspect of human nature underlies his analysis of economic growth in WN. There are frequent references, for example, to the fact that 'it is not from benevolence, but from self-love that man expects anything' and 'we address ourselves not to their [i.e. the butcher, the brewer or the baker] humanity but to their self-love, and never talk to them of our own necessities but of their advantages' (WN I.ii.2). 1 Self-love is apparent in the drive to 'better his condition' and in pursuit of this, man's instincts 'to truck, barter and exchange' have directed his productive activities into specialisation and production for exchange. The social arrangements of commercial society promote this productivity, but simultaneously they promote economic inequality in its distribution The justice of commercial society The economic analysis of WN had to integrate these natural propensities of man with the 'system of natural liberty'. 2 Smith's argument for 'natural liberty' was based on his theory of property and the proper province of justice was considered to be the laws of property: the proper role of government in a market society was to deal with protection of property. It was not, as was previously thought, to intervene in distribution. The allocation of surplus produce on the basis of need, or of merit, for example, was not in the domain of law but of morality. Smith was not excluding the question of justice from his political economy. Rather, he transposed it from the context of jurisprudence and political theory (in LJ) to that of political economy: he used a method of 'natural modelling' 3 to demonstrate that by raising the productivity of labour, commercial society could provide adequately for the needs of the wage-earner without having to resort to any form of redistributive meddling in the property rights of individuals. Growth, in conditions of 'natural liberty', would explode the whole antimony between needs and rights. It was by thinking in the categories of 'natural equity' and 'laws of police' that Smith developed a conception of political economy's task as criticising the historical structure of 'police' 1 See Campbell et al. 'Introduction' (1976) and WN, II.iii.19 and n. 19 and n. 22; and IV.vii.c.88 where Smith describes how 'the private interests and passions of individuals naturally dispose them to turn their stock towards the employments which in ordinary cases are most advantageous to the society'. 2 See Hont and Ignatieff (1983) chapter 1, for an elaboration of this argument and the history of the tradition in 'natural justice' theories which Smith read. This section draws on their work and the 'Introduction' to TMS by Raphael and Macfie (1976). See WN IV.ix.51. Heilbroner (1982) points out that 'empathy' is not directed at those in poverty; it is asymmetrical in its view to wealth in TMS. 3 That is, he based his argument on an analysis from 'natural laws' which operate without policy interference.

5 ADAM SMITH'S THEORY REVISITED 5 by the criterion of a 'system of natural liberty'. He could achieve in his writing on political economy a theoretical reconciliation of the claims of the propertied and the claims of those excluded by shifting the terms of the analysis from a language of justice and rights to one of production and markets. Smith describes this paradox of commercial society in the Introduction and Plan to WN it was the paradox of property claims against needs claims, of the coexistence of wealth and poverty. This was initially seen as a problem of justice and developed in Smith's writings prior to WN in the natural jurisprudential tradition rather than in the 'economic' traditions sought in Smith's predecessors. In LJ(B) Smith develops the theme of the four socio-economic stages to demonstrate the association between government, authority and power, on the one side, and the form of economy on the other. It was within that theme, of the four stages of history, that his specifically 'market' solution to this paradox and its key problem how to enjoy the benefits of exclusive property rights without excluding the property-less wage earners from the means of subsistence appears. Following Hume's analysis, Smith took it as established that the institutions associated with property had emerged historically because of their utility and necessity (LJ, p. 401). His economic analysis could begin from a distribution of property in society that had been historically generated. In WN the four stages continue to demonstrate the association between the stage of government and the stage of economic development. The criteria for economic development include the nature of the individual's economic dependence, the degree to which labour is specialised and the degree to which markets and commerce have penetrated economic and social life. In WN a set of more specifically 'economic' propositions becomes the main purpose of this history and in Books III and V the links between new divisions of labour in the successive and then inter-related development of the three productive sectors, the production and then the accumulation of a surplus and the evolution of an increasingly commercialised society illustrate the basic propositions and the framework of Smith's economic analysis. Smith could then move on to the stage of commercial society to provide an analytical demonstration of how new divisions of labour, the growth of markets in wage-goods, both agricultural and manufactured, and in productive labour could be co-ordinated in a manner consistent with his earlier ideas on justice and the natural laws of humanity. He observes that modern commercial society was unequal and unvirtuous but not unjust. However unequal men might be in their property, they could be equal in their access to the means to satisfy their basic needs. Smith could analyse the paradoxes of modern commercial society with the moral positions he had resolved by the time of writing WN. 1 If inequality and distributive justice could be reconciled through growth then WN had to demonstrate how best growth could be promoted and the provision of adequate subsistence for the 1 See Winch, 1978, especially pp , for a discussion of Smith's writing on the paradoxes of commercial society. The main concern of Smith was the inequality of wealth which it brought and the contemptuous morality of the wealth as compared with the praiseworthy frugality of the poor.

6 6 P. KERR poor could cease to be a matter of concern. In his economic theory he shows how the division of labour resolves this paradox of growing wealth for all despite inequalities in its distribution. At the same time the reader is reminded that one of the most important effects of commerce is the gradual introduction of 'order and good government, and with them, the liberty and security of individuals'. The conditions for liberty are 'economic progress and the rise of the middling rank of men'. The crucial factor in this progress is the growth of commerce and industry: 1 'commerce and manufactures gradually introduced order and good government, and with them, the liberty and security of individuals, among the inhabitants of the country, who had before lived almost in a continual state of war with their neighbours, and of servile dependency upon their superiors. This, though it has been the least observed, is by far the most important of all their effects' (WN, III.iv.4) Smith's theory of growth Smith's demonstration of how best growth could be promoted was by analysis worked out from historical observations. His conclusions of which policies should be pursued in commercial society were derived from his explanation of why different societies had diverged from an ideal or natural course of development. He took the relevant expressions of human nature in their social forms and the theory of natural liberty as the frame of reference and constructed a theory of the natural progress of opulence (WN, Ill.i and also in IV.vii.c.97 on natural balance) and compared the different historical experiences with this natural course of development. The editors of the Glasgow edition of WN (Campbell et al., 1975) note that Smith's 'belief in the natural progress of opulence, almost in its inevitability is so strong throughout WN that, when dealing with a contemporary problem, Smith's main objective is to isolate those barriers which lay in the path of natural progress as he saw it and to advocate their speedy removal' ('Introduction' to WN, p. 59). According to Smith, the 'natural course of progress' takes society through four stages and his histories of societies were comparisons with this ideal natural growth path. A feature of this theoretical or speculative history is that it can be applied to situations where direct evidence is lacking. The Newtonian system which Smith admired and followed was a theory which was capable of accounting for the observed phenomena in terms of a small number of basic and familiar principles and of successfully predicting their future movements. In a method similar to that followed in his 'History of Astronomy', Smith relies throughout WN on the use of both the analysis and the observed experiences: ' See WN, III.iv.4 and f/n 6. Smith developed the association between liberty and commerce along the lines established by Hume. 'The development of commerce had the effect of drawing authority and consideration to that middling rank of men, who are the best and firmest basis of public liberty' (ibid).

7 ADAM SMITH'S THEORY REVISITED 7 'partly by virtue of passing in review a series of models which had an historical existence, and partly by explaining their appearance, development, and replacement by reference to a number of principles of human nature whose manifestations could be empirically verified. In this sense, Smith's methodology would seem to conform to the requirements of the Newtonian method properly so called in that he used the techniques of analysis and synthesis in the appropriate order'.' Campbell et al. comment that: 'Smith's objective was to delineate an ideal account of historical evolution which did not need to conform to any actual historical situation, so historical evidence, while playing a central part in his thought, was supplementary evidence of secondary importance. If historical facts indicated a divergence from the ideal explanation, then Smith felt obliged to offer explanation of the divergence. He worked from the system to the facts not the facts to the system' ('Introduction' to WN, p. 56). Like Quesnay, Smith was postulating the ideal as a point of reference against which actual process could be compared and the divergences from the natural course act as illustrations of the effects of interfering with the natural course of development and so also as guides for appropriate areas of policy. III. WEALTH AND SMITH'S CRITIQUE OF THE COMMERCIAL SYSTEM AND AGRICULTURAL SYSTEM OF POLITICAL ECONOMY Smith's ideas about what comprised wealth were the first step to establishing the importance of technological change in increasing that wealth. If wealth were not to be confused with money itself, then what was the nature of the undeniably important role which markets played in the progress of opulence? And if wealth were produced by labour, the definition of productive labour was crucial to investigating what determined potential improvements in its productivity. 'Wealth' included circulating capital in the form of money, the stock accumulated to employ productive labour and the produce of that productive labour. The discussions of the commercial and the physiocratic systems enabled him to develop the relations which he had stated in WN (I.i, ii and iii), between new divisions of labour and the market and between the division of labour and increasing productivity in the labour process, respectively I.I. Wealth and the mercantilists Smith devoted a lengthy section of WN to discussing the commercial (or mercantile) system of political economy. He first criticised its basic idea that the wealth of a 1 'General Introduction' by Wightman and Bryce (1980) especially pp Smith's other references to the proper role of political oeconomy stress its ultimate objective as increasing the riches and power of a country and of promoting cheapness of consumption and encouragement of production (eg. II.v.31).

8 8 P. KERR country was in its holdings of gold and silver, or money and then proceeded to demonstrate the harmfulness of the policies which were derived from such a system for the general progress of opulence of a nation. He showed by argument and by historical and contemporary illustrations how the vested interests of particular groups, 'the private interests and prejudices of particular orders of men, without any regard to, or foresight of, their consequences upon the general welfare of the society', (WN, Introduction and Plan of Work) had led to the adoption of policies which interfered with the natural progress of the economy. 'Consumption is the sole end and purpose of all production: and the interest of the producer ought to be attended to, only so far as it may be necessary for promoting that of the consumer [...]. But in the mercantile system, the interest of the consumer is almost constantly sacrificed to that of the producer' (WN, IV.viii.49). The mercantilists, however, were concerned with the nation's power and their objective of securing a favourable balance of trade was not for the purpose of securing gold and silver for itself. Rather, it was the political implications of the advantages of this money economy (see, for example, Mitchell, 1969, pp ). Smith in contrast to their protectionism was arguing the case for free trade between nations. 1 He had the following comments to make about the commercial system's concept of wealth: 'That wealth consists in money [... ] is a popular notion which naturally arises from the double function of money, as the instrument of commerce, and as the measure of value' (WN, IV.i.l). Consequently he distinguishes 'real revenue' or 'real riches' from their monetary expression (and equates revenue and stock): 'Though the [... ] revenue of all the different inhabitants of any country [... ] is paid to them in money, their real riches, however, the real [... ] revenue of all of them taken together must always be great or small in proportion to the quantity of consumable goods which they can all of them purchase with this money' (WN, II.ii.20). Although money may be one form in which wealth is temporarily held, it plays no active role in the further creation of wealth, it merely helps the circulation of commodities to proceed more easily than it would in a system of barter. Furthermore: 'If [... ] gold and silver should at any time fall short in a country which has the wherewithal to purchase them, there are more expedients for supplying their place, than that of almost any other commodity. If the materials of manufacture are wanted, industry must stop. If provisions are wanted, then people must starve. But if money is wanted, barter will supply its place, though with a good deal of inconveniency. Buying and selling upon credit... [or] a well-regulated paper money [... ] will supply it' (WN, IV.i.15). 1 Marx argued that it was in demonstrating this difference that Smith's merits lay i.e. in showing that a surplus did not arise from 'profit on alienation' from trading at prices above costs according to which trader had the most power.

9 ADAM SMITH'S THEORY REVISITED 9 Smith's introduction of the role of money here also introduces one sphere of his economic analysis of growth the market. Commercial society is characterised by developed markets. The facility of exchange and the extension of markets are important factors determining the implementation of new divisions of labour. Smith also refers to wealth as a stock of capital. It is 'capital' which determines 'the quantity of industry which can be annually maintained in [any country]' (WN, IV.iii.c.7). One effect of policies based on the mercantilists' mistaken idea of wealth was to impose restrictions on certain areas of production and to redirect capital to others, by way of interference in foreign trade between nations and so by interfering with the growth of markets. The importance of inter sectoral markets in the natural progress of opulence also appears in this context. By protecting one industry or sector capital cannot achieve the 'natural balance of industry'. Commercial policies rested on a view of foreign trade as an interchange in which the gain of one country must be at the expense of the other. Smith, on the other hand, argued: The wealth of a neighbouring nation, however, though dangerous in war and politicks, is certainly advantageous in trade [...]: in a state of peace and commerce it must [... ] enable them to exchange with us to a greater value, and to afford a better market, either for the immediate produce of our own industry, or for whatever is purchased with that produce' (WN, IV.iii.c.ll). In arguing that gold and silver or, money, did not constitute the wealth of a nation, but rather contributed to the production and accumulation of wealth by aiding circulation (for example, WN, II.iii.25, 30), Smith was presenting his own alternative views on what constituted wealth. It is a conception of wealth as produced and exchangeable value and as circulating capital which Smith emphasises when he discusses the commercial system of political economy and its conception of wealth. The confusion between the true nature of wealth and the (temporary) money form in which part of it is held is a confusion 'which naturally arises from the double function of money, as the instrument of commerce and as the measure of value' (WN, IV.i.l). Consequently, in discussing the policies which arise from the commercial system, he stresses the exchangeable value aspect of wealth: 'By advantage or gain [from foreign trade], I understand, not the increase in the quantity of gold and silver, but that of exchangeable value of the annual revenue of its inhabitants' (WN, IV.iii.c.3; see also IV.iii.8). The interaction between the division of labour and the growth of markets is given the dimension of inter sectoral and international exchange. It appears unambiguously in his discussion of the commercial system as a major and fundamental proposition of his economic theory. III.2. Smith on the physiocratic system Smith's discussion of the 'agricultural systems of political economy' is both briefer and more sympathetic than that of the commercial system, and he opens his discussion by

10 10 P. KERR referring to it as 'this very ingenious system'. There are a number of basic conceptions common to the physiocratic system as Smith saw it and to his own system of political economy. First was the representation of production and reproduction as a continuous circulation of outputs the idea of continually reproducing the material requirements of 'the necessaries and conveniences of life'. Second, the wealth of a country was conceptualised as these annually produced goods, and not as money or gold and silver; and this wealth was produced through the employment of productive labour. Third is the idea of this annual produce being equivalent to the annual revenues of these productive classes, and fourth, the representation of this annual produce and annual revenues as their exchangeable values. WN also constructs its argument about the causes of wealth in a way very similar to that of the Physiocrats. Book I of WN describes the factors affecting labour productivity and so the production of a surplus from a given amount of stock. It then introduces the market and the exchange aspects of the analysis. This requires a concept of exchangeable value of this annual produce and in discussing the determinants of exchangeable value Smith identifies the components of price as the separate annual revenues which correspond as a total to the exchangeable value of the annual (material) produce. The distribution of this revenue between the classes of landlord, merchant/manufacturer or undertaker, and labourer has implications for future expansion of the annual produce. To explain the implications of different distributions of the surplus, in Book II Smith discusses its different possible uses and in particular he discusses the 'accumulation of capital, or of productive and unproductive labour' {WN, Il.iii). The major departure of Smith's argument from that of the agricultural system stems from this last point what comprises the category of productive labour? Smith writes of the physiocratic system: 'This system [... with all its imperfections is, perhaps, the nearest approximation to the truth that has yet been published upon the subject of political economy [...]. Though in representing the labour which is employed upon land as the only productive labour, the notions which it inculcates are perhaps too narrow and confined' (WN, IV.ix.38). Once productive labour has been defined, the activities for which technological change are relevant are defined. Similarly, corresponding to the definition of productive labour are the categories of distribution of the surplus out of which accumulation can take place.' The two main implications of this limited view of productive labour were for the estimation of the total and net annual product, or wealth, and for its potential growth. For Smith, expanded reproduction and new divisions of labour followed on when there was a net product or revenue out of which savings are made, and further wealth accumulated. This wealth, as capital, could set to 1 It is interesting to note that Cannan saw Smith's discussion of distribution, 'the slipping of a theory of distribution into a theory of prices' towards the end of Book I chapter vi 'as not an essential part of the work' and Book II (Of the Nature, Accumulation and Employment of Stock) as something which 'if altogether omitted the other Books could stand perfectly well by themselves' (Cannan (1904) 'Introduction' to WN p. xxx). Cannan, clearly, was looking for a neoclassical theory of allocation.

11 ADAM SMITH'S THEORY REVISITED 11 work a larger number of more productive labourers. If the physiocrats limited their notion of productive labour to agricultural labour then much of what comprised savings or net revenue for Smith, would be for the physiocrats savings out of'profits' of unproductive activities and technological change would be irrelevant for these activities and their potential contribution to growth. In their system, Artificers, manufacturers and merchants, can augment the revenue and wealth of their society, by parsimony only; [... ] that is, by depriving themselves of a part of the funds destined for their own subsistence. They annually reproduce nothing but those funds [...]. Farmers and country labourers on the contrary, may enjoy completely the whole funds destined for their own subsistence, and yet augment at the same time the revenue and wealth of their society. Over and above what is destined for their own subsistence, their industry annually affords a neat produce, of which the augmentation necessarily augments the revenue and wealdi of their society' (WN, IV.ix.13). ///. 3. Wealth as a stock and a flow Smith's views of both the mercantile and agricultural systems also reflect his disregard as to whether wealth is the accumulated surplus or the additional flow of produce generated from it: accumulation-production-accumulation are treated as two successive and inevitable parts of the one process. Of the physiocrats he says; 'If they had expressed themselves more accurately, and only asserted that the revenue of this class [of artificers, manufacturers and merchants] was equal to the value of what they produced, it might readily have occurred to the reader, that what would naturally be saved out of this revenue, must necessarily increase more or less the real wealth of society' (WN, IV.ix.33). In another example, wealth as both stock and flow appears when Smith compares the state of progress of a nation at different periods in its history: he refers to their 'riches and industry' (WN, II.iii.32), bringing together in one phrase these two dimensions to wealth. The distinction between these two concepts theflowof net (and sometimes gross) product and the accumulation of past surpluses is irrelevant for his own analysis. What is important is the distinction between the two realms of economic activity the work place and the market place. Smith's objections, then, to the nature of wealth as depicted by these two systems, demonstrates the scope intended for these two basic components to his analysis of wealth, laid down so simply in the opening chapters of Book I. Wealth is discussed in the sphere of the production process or the labour-process and technological change giving rise to a larger surplus is the primary cause for the increasing wealth over time. Wealth is also discussed in the sphere of markets where part of the wealth is in the form of money and is acting as capital, and where technological change is dependent on this market expanding. Having examined these two systems Smith could develop his own theory of wealth by pursuing the implications of his criticisms, both with regard to their content and with the way he presented them.

12 12 P. KERR IV. ARGUMENT BY ANALOGY An important part of Smith's method of argument is the use of analogy. In Smith's 'History of Astronomy' we find the role of analogy is stressed as a form of argument and explanation. His ideas in this essay (and elsewhere) indicate the significance of this style of argument in the setting out of WN so demonstrating its coherence. By acknowledging Smith's method, WN becomes an integrated set of Books rather than a series of discourses on various subjects, all subsumed under the heading of political economy, investigating the causes of wealth. In the description in Book I of WN of the division of labour in the pin-factory we find the first example of his use of analogy, where the individual manufacturer represents all productive industries, including agricultural and commercial ones, so representing the process of the division of labour in society as a whole. The proposition which he establishes through this analogy is that the division of labour is the single most important factor in the growth of the production and accumulation of wealth. The second important analogy is contained in his description in the Lectures On Jurisprudence (LJ) of the development of societies through four stages. This provides the basis for his theoretical history, which goes on in Book III of WN (and continues into Books IV and V) to make a comparison between the natural progress of opulence and the actual progress experienced by different civilisations under different policies. Here, the interdependency through time between agriculture, manufacture and commerce is shown to be an important element of the continuous growth of wealth. This same interdependency is to be extrapolated to commercial society in its growth. The interdependency the intersectoral flows of inputs and outputs creates pressures which can transform social institutions in ways which open up new markets and provide new investment opportunities, including the reappearance of profitable projects in sectors which had previously reached their natural development limit. The proposition established in these discussions is that the division of labour depends on the expansion of markets and Smith's use of the stages of history demonstrates how this applies to an open, three sector economy. These two analogies the pin factory and the four stages theory of history together confirm the structure of Smith's theory of growth which is suggested in his discussion of 'wealth'. In the former analogy he discusses the role of technological change in the process of production itself, in the labour process, and also demonstrates its dependence on accumulation. In the latter he illustrates the role of the market, or the exchange process in enabling new divisions of labour to be introduced. The division of his economic theory into two main areas of analysis production and accumulation as one and the market and exchange as the other, is confirmed. Common to both is the dynamic role of technological change. I V.I. The role of analogy This section argues that Smith's method of explanation or of presenting a theory, was to draw on existing ideas which were familiar from other 'sciences' or on

13 ADAM SMITH'S THEORY REVISITED 13 analogies or metaphors to which his readers could relate from their own experience. 1 The principle of his method was to use the smallest number of explanatory concepts and his principle of explanation was by analogy. His criteria for a good theory emphasised accessability and appeal to his audience rather than logical, deductive exposition. In this way he presented an argument with a broad scope, its possibilities later limited by reduction to deductive representation abstracted from its background. It is often acknowledged in the literature on Smith that the device of using analogy was an integral part of Smith's method of arguing. 2 The role of analogy in his theory of the causes of wealth can be illustrated by first examining his ideas on 'the principles which lead and direct philosophical enquiries' illustrated by the 'History of Astronomy' and then seeing how two important examples of this principle are used in WN to explain the division of labour and its dynamic role in growth. These two examples demonstrate a different role for the division of labour in different respective aspects of the economy. One is in the context of productionaccumulation and the other is in the context of exchange and markets. In 'History of Astronomy' Smith states: 'Philosophy is the science of the connecting principles of nature [... ] Philosophy, by representing the invisible chains which bind together all these disjointed objects, endeavours to introduce order into this chaos of jarring and discordant appearances, to allay this tumult of the imagination, and to restore it, when it surveys the great revolutions of the universe, to that one of tranquility and composure, which is both most agreeable in itself and most suitable to its nature... [W]e observe, in general, that no system of philosophy how well so ever in other respects supported, has ever been able to gain any general credit on the world, whose connecting principles were not such as were familiar to all mankind' (H of A, pp. 45-6). The point of a system of explanation is to provide an order to otherwise inexplicably linked events. Unlike Hume, Smith does not refer to always discovering the true connections. The success of any explanation lies in its familiarity and accessability to its audience. The explanation must be both simple; the 'beauty of a systematical arrangement of different observations connected by a few common principles' (WN, 1 The present argument draws mainly on Wightman and Bryce (1980) (eds) 'Introduction'. 2 Skinner demonstrates the influence of Newtonian and Humean ideas of science and scientific method on Smith's work. ['Philosophy' and 'science' were at this period considered almost synonyms: see T. Campbell (1971) p. 25]. In particular Smith adopted Hume's ideas on the constancy of human nature and proceeded to examine the constructive role of the imagination in understanding what initially might appear to be 'a disjointed and disorderly assemblage of unconnected objects' (TMS, v.i.1.9). Skinner quotes John Millar's description of the purpose behind the Lectures on Rhetoric: The best method of explaining and illustrating the various powers of the human mind } the most useful part of metaphysics, arises from an examination of the several ways of communicating our thoughts by speech and from an attention to the principles of those literary compositions which contribute to persuasion or entertainment. By these arts, everything that we perceive or feel, every operation of our minds, is expressed and delineated in such a manner, that it may clearly be distinguished and remembered. [Stewart (1858) x.ll: see also Howell (1969) pp. 393-^118]. The Newtonian influence, Skinner argues, is apparent in Smith's appreciation of the methodology of science, the method of analysis in which the investigator identifies phenomena as effects and attempts to identify causes in particular and then proceed on to causes in general. Skinner (1975). See also Campbell, Skinner and Todd (eds) (1976) p. 768, n. 15; Wightman and Bryce (1980)'General Introduction'especially pp ; and Thompson (1965).

14 14 P. KERR V.i.f.25; see also, n. 16, p. 768 for further references to 'systematic arrangements') and in terms with which its audience were acquainted. The most effective method of meeting these two criteria is by using analogy or by explaining 'that which was strange to them by... that which was familiar' (HofA, p. 47). 1 '[People] naturally explained things to themselves by principles that were familiar to themselves [... ] upon that account, the analogy, which in other writers gives occasion to a few ingenious similitudes, became the great hinge upon which every thing turned' (ibid). IV.2. Features associated with the 'progress of wealth' The first step in Smith's 'inquiry into the nature and causes of the wealth of nations' is to describe what events are associated with the 'progress of opulence'. In his depiction of the progress of nations in 'Introduction and Plan of Work' and then throughout WN, and in particular Book III, and in his previous writings, the progress of wealth is accompanied by an extension of the division of labour and by the development of commerce and markets. An association between this collection of events forms the basis of the four stages theory of history, an idea familiar to Smith's contemporaries. 2 This four stages theory of history portrays the coincidence of those features of progress which he considers to be instrumental to the process of social evolution and material growth. The familiarity of this portrayal lends a persuasiveness to his own theory as he draws upon it to illustrate his analysis of commercial society. First consider the opening argument of the book. IV.3. The division of labour and production In WN, the first and most important single cause in the accumulation of wealth is the improvement in the productive power of labour, and the greatest improvements 1 To discover the 'true' connecting principles between events seemed secondary to satisfying the sentiments of Wonder and Admiration: and so Smith refers to scientific enquiries; And even we, while we have been endeavouring to represent all philosophical systems as mere inventions of the imagination, to connect together the otherwise disjointed and discordant phenomena of nature have insensibly been drawn in, to make use of language expressing the connecting principles of this one, as if they were the real chains which Nature makes use of to bind together her several operations... (H of A, iv.76). Philosophy, therefore, may be regarded as one of those arts which address themselves to the imagination;... Let us examine... all the different systems of nature,... without regarding their absurdity or probability, their agreement or inconsistency with truth and reality, let us consider them only in that particular point of view which belongs to our subject; and content ourselves with inquiring how far each of them was fitted to sooth the imagination, and to render... nature a more coherent... spectacle, than otherwise it would have appeared to be (11.12,45-6). In TMS Smith states an even more extreme position: The reasonings of philosophers, it may be said, though they may confound and perplex the understanding, can never break down the necessary connection which nature has established between causes and their effects (TMS, vii.ii.2,47). See also WN I.iv.18 and n. 32 where Steuart describes Smith's writing on price: 'I feel a great want of language to express my ideas, and it is for this reason I employ so many examples, the better to communicate certain combinations of them which otherwise would be inextricable'. 2 See, for example Skinner (1965); Macfie (1955); Campbell et al. (1976, pp ).

15 ADAM SMITH'S THEORY REVISITED 15 in these productive powers are attributed to the effects of the division of labour. But rather than begin by describing the mechanisms by which the division of labour contributes to the productive powers of labour in society generally, and so adds to social wealth. Smith invokes a familiar situation. The WN declares in its opening paragraphs the analogy on which the persuasiveness of its argument rests: 'The greatest improvement in the productive powers of labour [... ] seem to have been the effects of the division of labour. [... ] The effects of the division of labour, in the general business of society, will be more easily understood by considering in what manner it operates in some particular manufactures' (.WN, I.i.1,2). The division of labour is immediately placed into an analytical context revolving around the labour process, or (manufacturing) production process. Further on Smith states: 'What takes place among the labourers in a particular workhouse, takes place, for the same reason, among those of a great society. The greater their number, the more they naturally divide themselves into different classes and subdivisions of employment' (WN, I.viii.57). From his description of the effects of extending the division of labour in the individual workhouse Smith extrapolates to all of society. For example; 'The dealer who can employ his whole stock in one single branch of business, has an advantage of the same kind with the workman who can employ his whole labour in one single operation. As the latter acquires a dexterity which enables him [... ] to perform a much greater quantity of work, so the former acquires so easy and ready a method of transacting his business, [... ] that with much the same capital he can transact a much greater quantity of business' (IFAT, IV,v.b.l5). There are numerous examples of this kind of extrapolation throughout WN and Smith describes the differences between sectors and between agriculture and manufacturing in particular as well as the potential for new divisions of labour in different activities at different stages of society's evolution. Nevertheless the relationship between the division of labour and the growth of (net) output is presented as a principle in general and the production (or labour) process is one of the two main theoretical contexts which provide the framework of Smith's theory of growth. IV.4. The division of labour and the market The second element of Smith's discussion of the division of labour is the relationship it bears to the market and the exchange process. WN opens with the statement that the division of labour is the necessary consequence of the propensity to truck, barter and exchange. To illustrate the scope of this statement and its significance for Smith's theory about the growth of wealth, to demonstrate that it was not confined to a simple one-sector analysis of commercial society, the development of Smith's ideas centering around the four stages of history will be described. The reciprocity

16 16 P. KERR between the division of labour and development of markets is seen to be the other main theme of Smith's economic theory of wealth. IV.5. The division of labour and stages of progress The four stages of socio-economic development describe the process of the natural progress of opulence. This is a progression through stages which are characterised by an association between new divisions of labour and increasing specialisation of labour, new forms of exchange and growing wealth. At each stage Smith links the form of economy a succession of different social organisations of production and exchanges with the distribution of wealth and so of power among the different social groups. This link of power and economic dependence is finally resolved in the fourth stage, the stage of commercial society, when power which is dispersed as wealth is dissipated and individual producers can be more economically independent. This situation has been accompanied by the development of markets and of systems of law which promoted commerce which protected property so that the independence of the individuals is reflected in their greater specialisation. The division of labour involves greater interdependence and this is organized through markets. These new divisions of labour are also made possible by societies' gradual accumulation of social wealth. Greater social wealth represents a potentially larger market and provides an infrastructure for transport and communications so enabling producers to sell beyond their immediate community both of which encourage further divisions of labour. Private accumulation of wealth provides the means for employing the additional labour necessary when new divisions of labour are introduced. In general, larger markets enable the scale economies necessary for specialisation and Smith describes an idea resembling the concept of increasing returns. IV.6. The stages of history and the natural balance of growth His four stages theory also incorporates the idea of a 'natural balance of industry'. This extended his theory of growth into one of intersectoral economic development in the third and fourth stages when production moves beyond agriculture. The three sectors, agriculture, manufacturing and commerce grow at different 'natural' rates at different stages of a country's evolution, following different productivity growths. These intersectoral relationships provide a new dimension to the dynamics of growth as the markets they represent for each other's outputs act as a stimulus to the development of new products and of new and specialised divisions of labour. IV.7. The social and economic features of the stages of progress A number of specifically 'economic' features differentiate one stage of history from the next. One of these is the extent to which there exists specialised labour and

17 ADAM SMITH'S THEORY REVISITED 17 linked with this is the sophistication of the exchange arrangements which have evolved to enable the products of specialised labour to be circulated. As labour becomes increasingly specialised so individual labourers become increasingly interdependent on the produce and labour of others. 1 This interdependence is mediated by markets. In the first period of society people are hunters. 2 There is no property ownership of wealth and so little production-based social organisation. There is no surplus produce and so no accumulation or growth. If output increases it is absorbed by higher levels of consumption. In the second social phase, there is a larger population and need for more economic security and so people keep herds. 3 This is the stage of pasture. It represents a mode of subsistence in which ownership of property livestock becomes possible. Accumulation can begin and some economic interdependence can develop between those who do not own sufficient stock and those who own enough to support worker-dependents. In the third social phase, there is land ownership and the new productive activity is to cultivate the land. Within this agricultural phase, there are three stages, as cities develop and a legal structure to protect property develops. Initially there is production of a surplus in agriculture and this surplus is used in keeping agricultural workers, domestic retainers and personal armies to defend property. The surplus is lost from the possibility of reinvestment in any productive activity. Productive activities based on private property require the creation of conditions of property security for their economic development. With centralisation of power comes the development of cities and with cities comes the development of commerce. Cities become commercial centres for trade and part of the surplus that was tied up in keeping servants or armies is diverted to purchasing luxury imports, imports of manufactured goods. The growth of trade provided a new diversion for the land-owners' wealth or surplus produce. It is still an unproductive use of this surplus and has no immediate effects for accumulation but it gives rise to important social and economic changes. In a commercial country abounding with every sort of expensive luxury, the sovereign in the same manner as almost all the great proprietors... naturally spends a great part of his revenue in purchasing these luxuries... His nobles dismiss their retainers, make their tenants independent and become gradually themselves as insignificant as the greater part of the wealthy burghers in his dominions (V.iii.3; s.a. Ill.iv ). The purchase of imported luxuries requires the use of money and gives stimulus to the improvement of exchange practices. Landlords, preferring to fritter their surpluses on purchased luxuries than on servants and (non-waged) agricultural 1 An 'efficient' exchange arrangement for Smith was one which tied up a minimum of wealth as circulating capital, as money for exchange, wealth which would otherwise employ productive labour. 2 See LJ (B) 149 et seq; Campbell et al. (1976), 'Introduction' to WN pp ; WN, Ill.i. et seq and V.i. et seq. 3 This is when 'the chase becomes too precarious as a means of support' {LJ, 1.27).

18 18 P. KERR labourers, dismiss their retainers and change their tenancy arrangements. This has several implications. There is a change in economic dependency as agricultural workers become owner-producers or wage-labourers. There is greater demand for the services of merchants and subsequently of artificers and manufacturers. There is growth in the productive labour in each of the three sectors, agriculture, manufacture and commerce. Labour can specialise in its activities and produce for exchange (for example, see I.xi.c.7; I.xi.d.l). Money must replace previous methods of exchange. IV.8. Commercial society the final stage The fourth stage is commercial society. Commercial society is characterised by an exchange structure better adapted to organising exchange than previous arrangements it is the generalisation of commerce to all areas, in particular to labour. This is the market economy. All goods and services are produced for exchange and labour sells its time or services for a wage. There are changes in both the social relations of producing and of exchanging and these activities in their new forms are made easier by the existence of markets. Furthermore, with the dispersion of wealth and greater economic independence, and with the security of property associated with this stage, the incentives for individual producers and undertakers to introduce new methods of producing are greater as they can expect to receive a share (at least) of the increased surplus. Commercial society has three classes proprietors, undertakers and wagelabourers who receive rent, profits and wages, respectively. Associated with these classes of revenue are spending and saving characteristics which have direct implications in Smith's theory for subsequent growth. There are now three sectors of productive activity agriculture, manufacture and trade. Whether an activity is productive or not is important to Smith's theory of growth as it defines the activities for which specialisation and division of labour are of consequence. Furthermore, it directs his views on the need for appropriate distributions of wealth in accordance with the saving and spending preferences associated with different revenues. IV.9. The growth process IV.9(a) Productive activities For Smith an activity is productive if it produces a 'vendible commodity, which lasts for some time at least after that labour is past' (WN, Il.iii. 1). A productive activity produces a surplus and, in contrast to the physiocratic system, it is possible to produce a surplus in manufacturing and in trade as well as in agriculture. Smith also proposes a hierarchy of productivities of each sector agriculture being more productive than manufacture which is more productive than trade. They are defined as productive in that order because a given quantity of capital will put into motion a greater quantity of productive

19 ADAM SMITH'S THEORY REVISITED 19 labour in agriculture than in manufacture or trade, so adding, he argues, more to the value of annual produce. Capital will increase fastest when it is used in activities that add most to the annual produce, since more savings can be made from this. IV. (b) Growth and the natural balance of industry Having established the proposition that the division of labour depends on the extent of the market (as well as on the prior accumulation of a surplus) and having defined the range of activity or 'industry' which is productive and so for which specialisation and expansion are important, Smith's theory of growth can be given a further dimension by acknowledging his many references to the 'natural balance of industry' (see, for example, WN, IV.vii.c 97; IV.ii.12). The natural balance of industry is the natural division and distribution of labour between the productive sectors. It is the balance between agriculture, manufacture and commerce at which the rate of profits (ambiguously defined) is equal, indicating to producers and those with a surplus accumulated, that in the present economic and social circumstances capital is most suitably employed. 'The present circumstances' refer most particularly to market size and level of accumulation. In the natural progress of opulence, there is a three sector development process which pursues the natural balance of industry. The maximum attainable efficiency should be reached in agriculture. Although the potential for division of labour and so increases in productivity is reached quickly in agricultural production on a given area of land capital continues to be used more productively in expanding agriculture than any other activity because of the availability of previously unexploited land. This natural course is within the set of historically established social institutions (WN, IV.ix.49-50; and p.453, n.7; IV.ii.1-2). Then the 'natural course of things' is for the surplus from agriculture, the capital, to move into manufacture. As manufacture involves activities better suited than agriculture to specialisation and division of labour, the re-investment of a surplus also means potentially higher productivity growth and so higher growth rate of output. When manufacture is producing enough for its own labour and the agricultural labour and so has surplus produce, it becomes necessary to develop trade (WN, II.v.31-5; also IV.vii.e.86-7). Smith sees the existence of the carrying trade in an economy as a sign of great material wealth. He also believes that few countries reach that stage where there is sufficient capital to develop all three sectors and so concludes that 'in the natural course of things' it is preferable to let foreign capital become involved in the export and import of foreign goods. Since the general industry of the country cannot exceed what its capital is capable of, and since the number of labourers which can be employed is in proportion to that capital, pursuing the natural balance of industry, employing that labour where the present market size and accumulation of capital indicates the greatest productivity will be achieved, will lead to the highest rate possible for that country in its present stage of development and access to growing

20 20 P. KERR markets. To pursue an 'un-natural' development of one sector by interference will distort this balance of industry and ultimately reduce the wealth of a nation (WN, IV.vii.c.97; also IV.vii.43). 'Every derangement of the natural distribution of stock is necessarily hurtful to the society in which it takes place; [... ] when a nation is ripe for any great branch of trade, some merchants naturally turn their capitals towards the principal, and some towards the subordinate branches of it... If at any particular time that part of the capital of any country which of its own accord tended... towards the East India trade, was not sufficient for carrying on all those branches of it, it would be proof that, at that particular time that country was not ripe for that trade, and that it would do better to buy for some time, even at a higher price, from other European nations, the East India goods it had occasion for, than to import them itself directly from the East Indies. What it might lose by the high price of those goods could seldom be equal to the loss which it might sustain by die distraction of a large part of its capital from other employments more necessary, or more suitable to its circumstances and situation, than a direct trade to the East Indies' (WN, IV.vii.c.97; 99: see also IV.vii.43). The theory which emerges from these various methods of exposition is clearly a dynamic theory about growth or accumulation and technological change in the form of ever-changing divisions of labour. They are divisions of labour within production units and also social divisions of labour. Most importantly, they are preconditions to expanding the market but also responses to expanding the market. Consequently, Smith organises his analysis into two main areas, the division of labour and the production/accumulation process and the division of labour and the exchange process. Although Smith's actual theories of these processes may be inadequate, he does lay down the structure of classical political economy, using a rhetorical method which both provided a wider scope for his theories but also leaves him vulnerable to the criticisms of his more precise followers. V. SMITH'S ENDOGENOUS THEORY OF GROWTH A point has now been reached where it is possible to summarise the main features of Smith's theory of growth. At the beginning of each period, there will be a stock of surplus produce accumulated from the surpluses of previous periods. Its holders will allocate it to use either as capital or as revenue for current consumption. This corresponds (by definition) to Smith's division between productive and unproductive activities. If die economy is to grow the surplus must be used productively. The extent to which it is directed into productive activity is closely related to who owns the surplus to which form of income it takes. In Smith's third stage of economic progress, for example, when the surplus was mostly in the hands of proprietors, it was used unproductively to keep retainers and armies to protect lands. By the end of this stage and in the fourth and final stage of commercial society, several changes have taken place.

21 ADAM SMITH'S THEORY REVISITED 21 V.I. Change in the composition of demand There has been a change in the pattern of unproductive expenditure towards luxuries or marketed goods more generally, which has encouraged the development first of a merchant class which deals in this trade and, later, of a growing class of artisans and manufacturers imitating and learning to produce these imported goods. As well, the artisan class begins to specialise within their traditional activities of providing the tools for agriculture; as they collect in the towns to produce for larger markets they can co-ordinate their specialised skills for larger production levels. All of these groups are productive labourers, and so contribute to the wealth of the nation directly. This also means the move towards a monetary economy. V.2. Redistribution of wealth Secondly, there is a change in the pattern of ownership of land as agricultural labour dismissed by the proprietors works more independently either as tenant farmers or on its own land as peasant farmers. This means that the land is used more productively than it was before so that the surplus in agriculture is greater. Furthermore, these surpluses will be re-invested. It is also a change which brings an incentive to more productive methods of organising agricultural activities. Associated with this is the gradual redistribution of wealth as the merchants and manufacturers, as well as small farmers, purchase land, and this also means a redistribution of power so placing different demands on the surplus. Surpluses are now used as capital. V.3. Natural balance and intersectoral growth The three productive sectors display a continuous interdependency as they develop according to the natural balance of industry. If agriculture, manufacture and commerce are represented as I, II, and III, respectively; C, S and Y are capital (circulating), surplus and total output, respectively, so that, for example, CI is the capital invested in agriculture. The natural progress of opulence takes the following path: according to the natural balance of industry, initially S : > S n > S 1U and maximum growth will depend on Sj being re-invested to sector I (see, for example, WN, I.xi.c.36). The surplus will continue to be put to work until agricultural possibilities are for the current conditions and circumstances (intensively and extensively) exploited. The ranking of these possibilities will change with new socio-economic conditions and in particular with the development of the other sectors, or as other savingsgroups move into agriculture. When development of I has reached this stage sector II will begin to develop more rapidly. Capital will move to manufactures in response to the now relatively higher rate of profits it can receive there: that is, it will move to the next most productive sector (WN, IV.vii.c.87). As II grows, S u increases and

22 22 P. KERR productivity increases with the subsequent new divisions of labour that are associated with higher levels of output. Some of this surplus is also reinvested back into I as the market for wage goods, which are predominantly agricultural produce, grows. With the development of manufacturing, the natural balance of industry will lead to the reappearance of profitable ventures. 'As the fertility of the land had given birth to the manufacture, so the progress of the manufacture re-acts upon the land, and increases still further its fertility' (WN, III.iii.20). Furthermore, as II expands it replaces imports, increasing the relative price of imports and thereby raising the demand for raw materials and so raising rents, making I more profitable. The redistribution of wealth and land from the proprietors to the undertakers is a redistribution to high savers so that Sj not only grows with the natural progress of opulence, but the proportion of it used as capital is higher. For II to continue expanding it requires growing markets. The development of I and II has involved two steps. First, a growth in capital, which is used to employ productive labour. Second, with the growth in capital comes the introduction of new divisions of labour and new social organisations, which require more labour. This outcome represents one source of growing markets. The natural balance of industry now directs capital to III: a sector which specialises in trade and commerce is required so that manufacturers do not have to devote their capital or skills to marketing activities. That the country has reached that phase in its natural progress of opulence is apparent by the fact that S 1U > S n and Sj (see, for example, WN, IV.v.b.17-20; II.v.6). When the surplus of the country is more than sufficient to provide the domestic needs some must go abroad to exchange for the surplus produce of another country (WN, IV.ix.22-3). The advantages of foreign trade arise from achieving a natural balance between the industries I, II and III. A developed primary sector ensures a reliable and cheap supply of raw materials. 1 If a country tries to encourage II before the natural balance is achieved it will be importing the raw materials and so incurring a high transport cost component and producing these manufactures at unnecessarily high costs. A developed agricultural sector is also less prone to foreign competition because imports of these will carry high transport costs and so be disadvantaged in domestic price terms. Furthermore, agricultural skills are less easily transferable from one nation to another. The division of labour is not so extensive and the process of the replication of the discrete tasks, as a production process becomes disaggregated and parts of it taken over by machines, is more limited in agriculture than in manufactures. Specialisation is often specific-area knowledge. Consequently investment in agriculture is a more secure basis for the initial development of a country. The natural progress to 1 Note that this conflicts with Ricardo's subsequent view that the development of the agricultural sector will be associated with rising rents and declining rates of profits. The implications for expansion are therefore quite different. Ricardo would then promote the importation of cheap corn in order to keep wages low and protect the rate of profits in the potentially more productive areas of manufacturing. Smith did not promote trade until all the opportunities in the agricultural and manufacturing sectors were exploited.

23 ADAM SMITH'S THEORY REVISITED 23 manufacturing would be for the purpose of serving the domestic market rather than the export market (see, for example, WN, IV.ix.22-3). The manufacturing may be initially of luxury goods copies of imports. The local skills would be of lower productivity than those which produced the imports. However, the advantages of a reliable and cheap supply of domestically produced raw materials would compensate, making these manufactures cheaper than the imports they are imitating. As the domestic market grew, the skills required would be learned and there would be new divisions of labour with the higher output. The productivity growth would mean lower prices relative to imports and also higher real wages. These higher wages add further to the domestic market. Eventually, because of the cheap inputs from I, and the extension of new divisions of labour and productivity growth (in each sector), the low domestic prices allow these manufactures to compete successfully on the foreign markets. The surplus in manufacture can flow into external transport and the business of exporting and importing. Eventually, following a process similar to that described for II, the country which achieved a natural balance of industry could compete internationally in shipping also. The whole process has depended upon technological change in the form of the division of labour. The division of labour generates productivity gains which raise real wages. The competitive nature of commercial society keeps the rate of profits low. 1 The division of labour requires accumulation of the surplus and growing markets. Ultimately, these two prerequisites to save and to exchange reduce to human propensities. It is through technological change that the pursuits of human nature can change the constraints of the social and economic environment. Man's pursuit of wealth is realised through the continuous introduction of new divisions of labour and his propensity to exchange gives rise to a series of social and economic practices to promote this pursuit. Smith begins with a statement about those principles of human nature which are relevant for this economic analysis. 2 His economic theory then develops around those two themes. He presents the economic relationships by which these principles of human nature are pursued. By recognising the intersectoral dynamic, Smith's idea that the technological change which sustains growth is itself the product of growth is more difficult to dismiss: to treat technological change as independent of the economic process as later theory was to do, means abandoning the framework of analysis which Smith proposed, even if many of the separate component propositions are retained. Similarly, to argue that Smith's model is confined to a one-sector circulating capital model, and only applicable to manufacturing, does not do justice to its interest or applicability in developing models 1 This is a controversial issue. The view being presented here is supported by Lowe (1954) for similar reasons; he acknowledges the implications of 'natural balance' in growth. O'Donnell discusses these views and in particular points out the distinction between the natural rate of profits and the market rate, and also the effects of accumulation on changing the natural rate (1990, ch. 6.2). 2 Ideas on the relation of natural propensities to their economic expressions and to economic activity are to be found in Hirschman (1977).

24 24 P. KERR of endogenous change and growth in present economies. Smith demonstrates that growth does not depend simply on the development of technology in the manufacturing sector and that the intersectoral dynamics will generate the technological changes which promote growth. VI. CONCLUSION Having established the framework of Smith's theory of endogenous growth and change it is interesting to compare it with the alternative framework which historians of thought have imposed on WN. The dominant tradition in histories of economic thought is the view that what lies at the core of all economic theory is a theory of value so that the history of economic theory becomes a history of the theory of value and this history itself becomes controversial depending on its classical or neoclassical basis. In the presentation here, the organisation of the argument in WN is seen from the point of view of technological change. It is demonstrated above that the economic theory in WN is based on two propositions representing two separate areas of economic analysis. These are the division of labour in production being the main cause of wealth and, the dependence of new divisions of labour on extensions of the market. Smith brings these together to form a theory of self-perpetuating growth by virtue of continuous introduction of new divisions of labour. The neoclassical historian of thought is unlikely to disagree with these two primary propositions they appear in the first few chapters of WN and are the most simply stated of Smith's many ideas. Where the difference emerges is that this neoclassical history typically brings together the two main areas of Smith's analysis by assigning relative prices to everything so attributing to Smith's discussion of the exchange process the status of the theory with a structure which encompasses all other analyses. This means that the relationship between the division of labour and production-accumulation of a surplus is a discussion in terms of relative factor prices, incentives to invest in labour-intensive or in labour-saving techniques. It also invariably notes the apparent limit of circulating capital on the use of his model of growth. Smith's 'theory' must fit the mould of price theory. Consequently in this history, there is no internal dynamic which ensures the association of continuous growth with changes in the division of labour and growth of markets. Technological change certainly produces higher growth but what induces these new divisions of labour apart from expected profits (related to the new factor prices) is unclear. A theory of investment is required. And also a theory of technological change. The theory of growth itself is 'static'. If, on the other hand, the strictly 'analytical' sections are not selected out of context and reconstructed and, instead, WN is read in Smith's own terms and as a whole, the apparent static nature of Smith's 'growth theory' disappears. The contradictions which are pointed out by neoclassical historians of thought (for example,

25 ADAM SMITH'S THEORY REVISITED 25 Hollander, 1973) 1 are seen to be consistent with his argument. The contradictions in WN appear where attempts are made to give precision to terms and to make distinctions which, whether rightly or wrongly, Smith apparently considered sufficiently secondary to his argument not to develop. In particular, Smith had no satisfactory theory of relative prices and after the discussion in several chapters of Book I did not return to the difficulty. His statements of the components of price as revenues, of the deviation between natural and market prices, were adequate for developing the ideas of exchange activities and their relation to specialisation of labour, and of the natural course of progress and natural balance of industry being directed by different rates of profits. The distinction reflects the method of abstracting to 'long-period' analysis. He discusses at length the most productive uses of capital and how it naturally flows to the most profitable areas, for example, without seeing a need for a developed value theory. Pasinetti (1981) 2 shows, by emphasising the irrelevance of scarce commodities and so of demand and supply analysis, that a pure production model without the intrusion of value theory can be developed to demonstrate the intersectoral flows. Clearly Smith's labour values are legitimate only if the organic composition of capital is the same for all outputs and their times of circulation of capital are the same. Since technological change tends to occur successively in each sector, the problem this presents is simplified to single event transitions. Similarly, the implication of Smith's 'increasing returns' is for the whole sector, rather than its advantages being confined to a single firm. Technological change is continually represented in WN as the central element in his argument, the element around which the main propositions revolve. The role of the market and the exchange process is to enable technological change to be extended. Given these features relative prices are important as indicators of deviations of natural from market prices, a parallel to the signal to capital of those areas with higher rates of profits, areas now ready under the new, present circumstances for development. That the exchange of products represents the exchange of labours in some sense, is the corollary of his idea that the natural urge to barter and exchange is the 'great foundation of arts, commerce and the division of labour'. In neither example is more precise formulation of relative prices necessary to understand his theory of growth through continuous new divisions of labour in the various productive sectors. ' Hollander quotes Smith on the new colonies having a comparative advantage in land relative to manufactures. 'In effect (Smith's) analysis denned each country's "advantage" in terms of its relative factor endowments. This interpretation is clearly confirmed in the following summary (see IV.vii c.51)'. Hollander then states; 'This formulation flies in the face of the "vent-for-surplus" doctrine... (in) which advantages of trade lie in the market opened up for the products of domestic resources which would otherwise be idle, rather than in the more efficient use of resources'. He also says 'In fact... (Smith) emphasised the similarity of technology between various branches of manufacturing which would assure the maintenance of employment upon the removal of protectionist measures' (Hollander, 1973, p. 284 n.23). 2 Pasinetti (1981) has developed a matrix approach to demonstrate the intersectoral flows in production with a generalised labour theory of value. He also demonstrates how effective demand determines output and the relative labour inputs, independently of this demand, determine relative prices (1986).

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