Classical Political Economy Part I Adam Smith Week #4 Sandelin et al. (2014, Chapter 3) [S] 2018 (Comp. by M.İ.)
Classical Political Economy * * * * * *
INTRO The Scottish philosopher Adam Smith (1723 90) is generally considered to be the founder of the classical school in economics. His famous Inquiry into the Nature and Causes of the Wealth of Nations was published in 1776, and we may regard this year as the beginning of the classical period, which lasted about one hundred years.* And we find as main figures;** Jean-Baptiste Say (1767 1832) Thomas Robert Malthus (1766 1834), David Ricardo (1772 1823), James Mill (1773 1836) John Stuart Mill (1806 73) We also find the German Karl Marx (1818 83), the famous critic of classical political economy, who nevertheless used the analytical tools of the classical school *[The Irishman John Elliot Cairnes (1823 75) is sometimes regarded as the last important classical writer, publishing his Leading Principles of Political Economy Newly Expounded in 1874.] **Nearly all of their major works carried the words Principles of Political Economy (Malthus, Ricardo, John Stuart Mill) or at least political economy in their titles (Say, Senior, James Mill, Marx and others).
Some characteristics are common to most classical economists. -One is the interest in growth and development, which they usually thought would culminate in a stationary state, in which the economy would just reproduce itself zero growth in modern terms. -Another characteristic is the concentration on the cost of production as the main determinant of prices. -A third characteristic is the concern about the distribution of income between labour, land and capital in the form of wages, rents and profits. Combining all three characteristics, the classical economists attempted to provide a consistent explanation of the changing relations between income distribution and prices in the course of economic development.
They developed principles of economic analysis from which the prescriptions for economic policy could be logically deduced. Most classical economists argued that the system of markets is a self stabilizing mechanism of distribution that works efficiently without much government intervention. This idea was present in physiocratic and late mercantilist thought, too. In the main, however, mercantilists advocated far reaching government intervention, and thus became the main target of critique by Smith.
Adam Smith Smith is sometimes called the father of economics. It is a moot point whether this is appropriate. The critics argue that the essentials of Smith s thought can be found in earlier authors. Even if this is the case, one cannot deny the magnificent role that his Wealth of Nations (1776) played in its systematic presentation of the relationships within the economy. Smith was born in 1723 at Kirkcaldy in Scotland, and enrolled at the University of Glasgow at the age of fourteen. Adam Smith Here he came under the influence of the philosopher Francis Hutcheson, who lectured on economic issues and who brought Smith into contact with the philosopher David Hume. All three of them came to be leading figures in the Scottish Enlightenment.
Having, among other things, spent six years at Oxford then a decadent university, however with excellent libraries Smith was appointed professor of logic (& then moral philosophy) at Glasgow in 1751. Smith left university in 1764 in order to accompany the Duke of Buccleuch as a tutor on a study tour to France. During the latter part of his stay in France, Smith took part in the meetings of the physiocrats. The foreign tour lasted two years, and during this time Smith began to write his Wealth of Nations. This grand work required several years of toil after his return, before it could be published in 1776. Smith published within several fields (e.g. moral philosophy, the history of astronomy, the origin of language, the relationship between music, dance and poetry, etc.). Yet his economic writings were clearly most influential (i.e. the ideas he presented in the Wealth of Nations.)
The characteristics of human beings are fundamental for Smith s view of how the economy works. Which characteristics did Smith find in human beings? First, man is selfish and tries to better his position. A related characteristic is his propensity to truck, barter, and exchange one thing for another (p. 25). This characteristic is unique to man. Nobody ever saw a dog make a fair and deliberate exchange of one bone for another with another dog (p. 26). The inclination to bargain and exchange results in a specialization that reinforces the original differences between people.
Division of labour good and bad At the beginning of the Wealth of Nations, the division of labour is described in the positive terms of a great rise in productivity The inclination to bargain and exchange is the ultimate cause of the division of labour, which has resulted in a considerable increase in production due to specialization. HOWEVER, towards the end of the Wealth of Nations, a more gloomy picture of the division of labour is given. a man whose work is restricted to a few simple operations becomes as stupid and ignorant as it is possible for a human creature to become (p. 782). THUS, while the division of labour greatly improves the material living conditions of all people and, in fact, all nations by way of foreign trade it impairs the workers mental and physical condition. The dual character of the division of labour has consequences for Smith s view of liberty and the role of the state.
Natural liberty Smith used the notion of natural liberty to mean freedom to change profession, and freedom to live in the parish where one has chosen to reside. It meant freedom both in domestic and international trade. We [also] see that Smith was no dogmatic advocate of unlimited liberties. He was guided by pragmatic considerations. If natural liberty could inflict damage upon society, it should be restricted. In all other cases the basic rule of liberty should apply.
Natural liberty and the invisible hand The human characteristics self-interest and the inclination to trade would then foster the common best, even though individuals would act in a selfseeking fashion. It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages. In this connection we may mention the invisible hand. None of Smith s expressions is as well-known as this one, although he himself used it only in passing.
According to Smith s principal rule, the allocation of resources would be most efficient if each capitalist were able to invest his capital according to his own preferences, and every person could choose her occupation and pursue her business without legal obstacles. The invisible hand is a metaphor for the conditions that produce this correspondence between selfinterest and the best for society. The idea was not new. Yet the idea was rarely formulated as clearly as by Adam Smith.
However, Smith s principal rule was merely a principle, and he himself demonstrated that natural liberty does not always yield the best result, neither in a narrow economic sense nor in a wider human sense. We have already seen that, in Smith s opinion, natural liberty should be restricted when it would harm society as a whole. We have also seen that the division of labour that emerges spontaneously in a free society tends to impair the mental and physical fitness of the workers. Nor is free trade always advantageous to all parties. As Smith wrote with reference to transatlantic trade and the discovery and conquest of the Americas, the savage injustice of the Europeans rendered an event, which ought to have been beneficial to all, ruinous and destructive to several of those unfortunate countries (p.
What the government should and should not do A second argument is related to the inability of the government to regulate the economy in the interest of the majority of the people In Smith s opinion, the government should interfere less in economic life than it did in Britain, where mercantilists ruled the roost. Smith had three arguments against the government interference & a large public sector. First, he was critical of mercantilism as a doctrine and political practice. Regulation of trade and production had been carried out after lobbying by merchants and manufacturers, and it had led to an inefficient allocation of resources. The privileges of the guilds and the licensed monopolies favoured a few at the expense of the majority of the people.
Smith s third argument against a large public sector is more implicit in his distinction between productive and unproductive labour. Productive labour is manifested in a good that remains when the production process is completed. Manufacturing and agricultural work are good examples. Unproductive labour includes different kinds of services. Such labour perishes in the same moment as it has been performed e.g. civil and military servants, churchmen, lawyers, musicians, opera-singers. If the unproductive became too numerous, their maintenance would require so large a part of the produce that it would be necessary to draw on capital. The produce would gradually diminish.
Smith did not, however, want to preclude government commitments. The government has three main duties, and Smith mentioned a number of other involvements with approval, too. The first main duty is to protect the society from invasion, i.e. to maintain a national defence. The second duty is to protect each member of the society from injustice or oppression by other members, i.e. to establish an administration of justice. These two duties of protection are the minimum activity required by any state. However, with the third duty Smith went beyond that minimum. The third duty is that of erecting and maintaining those public institutions and those public works
Smith was aware of what modern analysis calls collective goods and external effects. He discussed such things as roads, bridges, canals, harbours, postal services, and in particular institutions for education that would help to counteract the detrimental effects of the division of labour on the workers. The fact that the government has to guarantee that they will be established does not mean that they should be completely financed by taxes. Fees paid by users may also sometimes be appropriate, according to Smith.
In addition to the three main duties of government, there are examples of other forms of intervention that Smith supported. They show that he was a pragmatic, rather than dogmatic, advocate of laissez faire. Fundamentally, Smith advocated free trade between nations, but he argued cases in which it is appropriate to favour domestic interests by the aid of customs and other regulations. The first such case is activities necessary for the defence of the country. e.g. he described the Navigation Act, which restricted foreign shipping in the trade of England (the strongest acts of protectionism in history). Another case is when a tax is imposed on a domestic industry. An equivalent customs duty would then leave the competition between domestic and imported goods on the same footing as before the tax was introduced.
Value In the theory of value, Smith and other classical economists introduced a distinction that dates back to Aristotle, but has been abandoned by modern price theory. It is the distinction between value in use and value in exchange. Smith discussed the paradox of value why useful things like water can be so cheap while useless things like diamonds are so expensive It was completely dissolved by the neoclassical analysis of marginal utility in the 1870s.
Smith devoted much effort to explaining the value in exchange, i.e. The price. We can discern at least three different theories. First, he had a crude labour theory of value: If among a nation of hunters, for example, 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. It is natural that what is usually the produce of two days or two hours labour, should be worth double of what is usually the produce of one day s or one hour s labour. (p. 65) Next, a modification is introduced: If some kind of labour is unusually severe or requires an uncommon degree of dexterity or ingenuity, this will give a higher value to its produce than what would be due to the amount of working time. The crude labour theory of value the idea that the relative prices of goods reflect the ratio of labour inputs in their production was deemed to hold for that early and rude state of society which precedes both the accumulation of stock and the appropriation of land (p. 63).
In more developed societies where machines and other kinds of capital are used in production and where land is privately owned price formation is more complicated. Here, Smith took recourse to a more general theory of prices based on costs of production. Not all of the product will go to labour; part of it will accrue to the owner of the capital used in the process. A third part will be taken by the landlord The worker, the capitalist and the landlord were different persons in Smith s world. Wages, profit and rent form the price of each good : [I]n every improved society, all the three enter more or less, as component parts, into the price of the far greater part of commodities (p. 68).
Smith had a third complementary theory in which prices are determined by demand and supply. The basic assumption is that there is a natural price that prevails when wages, rent and profit are at their ordinary level. The prices of all commodities continually gravitate towards their natural price. However, occasional variations in demand and supply may cause the market price to deviate temporarily from the natural price. In this way, the consumer or the demand side also appears in Smith s price theory. The production side is, however, the most important. With the first neoclassical authors in the 1870s, the emphasis came to be reversed
Distribution of income Smith is sometimes criticized for not giving a clear explanation of how the levels of wages, profits and rents are determined HOWEVER, this does not mean that attempts at explanation are absent in his work. The level of wages is considered to be a result mainly of the prosperity of the society and the amount of capital. It also depends on the agreeableness of the profession, the efforts required to learn it, the trust people must have in those who practise the profession, and the certainty of gaining a livelihood from the profession. The profit increases with the risk, decreases with the agreeableness of the industry and decreases in relative terms if the capital grows (i.e. indication of a theory of decreasing returns which will play an important role later on) The rent, i.e. the price for leasing land, is considered both as a monopoly price determined by the landlord and as a residual that remains after wages and profit have been
Next Week [#6] Part II