*This review, needless to say, is long. It is for people who have an interest in classical political economy and its relation to the marginalist tradition. What I have attempted to do is take a critical approach toward contemporary mainstream economics based on what is written in the Wealth of Nations. I hope you enjoy it, and I look forward to constructive criticism and debate.
Adam Smith has had by far the greatest general impact on the formation of economic theory of all economic thinkers since - it was he who cast the mold within which the future of economic thought would take place. What I believe has been neglected in most accounts of Smith's contributions to economic theory, however, is that in his attempt at establishing a unified theory of political economy he was instead responsible for developing the framework from which two conflicting theoretical approaches towards economic analysis would later be derived - one with focus on market relations and the other with focus on the relations of production. This marks the beginnings of what has been, in my opinion, a major inconsistency in the development of economic thought - the incompatibility of the former tradition of economic analysis, when taken in isolation from the latter, with the main pivot of Smith's theoretical justification for capitalist development in the `Wealth of Nations'. The separation of these two areas, it will be argued, has been the result of the further development of certain aspects of Smiths core theoretical insights to the exclusion of deeper inquiry into an understanding of his attempted explanation of their origin and nature. Its product has been a superficial understanding of economic phenomena under capitalist relations responsible for the endless stream of conclusions that manage to both be incompatible with one another and claim immutability. Its practical impact has been to legitimize a system of ideas, culminating in the `discovery' of universal economic laws detached from and functioning independent of social relations, that has fettered the further cultural and political progression of humanity through the intellectual impoverishment of human life.
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The `Wealth of Nations', though it was overwhelmingly concerned with practical application and the specific policies of its time, has not cast such a long shadow on the progression of economic thought simply by merit of its attacks on the effects of Mercantilist economic policy. There were political economists before and after Smith who had carried out similar attacks, as is shown by the fact that Smith derived his argument against Mercantilist protectionist policy from Hume. Instead, the major impact of the `Wealth of Nations' on economic thought has been its attempted establishment of a theoretical framework in which individual self interest was the driving force of an economic system that was propelled by its own momentum and functioned according to its own laws. In Schumpeter's words, it put forth the major assertion that "the free interaction of individuals produces not chaos but an orderly pattern that is logically determined". This orderly pattern was, for Smith, the tendential movement of the market prices of commodities toward their natural values. The major theoretical task of the `Wealth of Nations' was an unveiling of the mechanisms that function to ensure this continuous movement of all nominal values toward their natural values within the framework of the free interaction of individuals. In this sense, Smith's argument against the Mercantilist system of political economy was, for all intensive purposes, an application ofhis general theory of natural value; there existed a `natural' level to which any artificial adjustment in the quantity of money would adjust. The thrust of Smith's critiques on the effects of the Mercantilist doctrine are to be interpreted in the context of this distinction between natural and artificial value, within which its effects are extended beyond simple redundancy.
Smith began his theory of value and price determination with a distinction between what he called the natural value of commodities and their market price, or their nominal and real price. The market price of a commodity is the price at any given moment of time in which commodities are exchanging for one another. Market prices fluctuate as a reaction to myriad natural and manmade phenomena and are in turn regulated by the interplay of supply and demand. If a drought adversely affects the yield of corn for a given period it would be the cause of a reduction in the supply of corn in relation to the level of effectual demand and a subsequent increase in market price; if it for some reason becomes fashionable to wear pink overcoats, assuming of course that individuals in a given society desire to be fashionable, then the effectual demand for pink overcoats will increase in relation to available supply and consequently so will the market price of pink overcoats. Value, on the other hand, is the point around which these movements, or vibrations, of price gravitate. Smith believed that individual commodities will rarely, if ever, exchange at their value due to constant changes and/or disruptions in the conditions of any given market. The hypothetical; point at which value and price meet may be understood as the more familiar concept of equilibrium; the point that competition would yield in the long run through the interplay of supply and demand on the market.
The importance of these two concepts for Smith's theoretical framework was the effect that competition had on individual producers to cause the prices of commodities to always be in tendential movement toward their value. Essentially competition, which was restricted under the auspices of the `Commercial System', was the force acting on individual producers which would ensure, in the long run, that commodities would be bought and sold at precisely the amount required to produce them - their value. There are two main justifications for the desirable nature of this process. On the one hand Smith believed that when prices were at their value the entire economic system was in turn at the highest point of efficiency and equality it could possibly be. On the other hand, Smith believed that this movement would ultimately benefit the mass of people with lower prices, which would continue to decrease in proportion to the advances in the conditions of production of commodities. Competition would in turn pressure individual producers to apply these cost lowering technical advances to the production process because of the need to reduce the value of their commodities in order to command a larger share of their respective markets, hence allowing for a higher rate of profit and the ability to continually reinvest their capital to repeat the same process indefinitely. Thus, it was on this tendency of competition to move the prices of commodities toward their values, and in time to reduce their values, that Smith's entire justification for the elimination of Mercantilist protection and privilege in favor of a system based on the free interaction of individuals ultimately rested. Not only was the Mercantilist doctrine of money manipulation redundant, but the means by which it attempted to achieve this ultimate redundancy prevented the functioning of extremely powerful mechanisms that Smith believed ensured the long run reduction in values of commodities - the betterment of the masses of people through the further development of the productive forces of society. As Schumpeter described: "It is the cheap cloth, the cheap cotton and rayon fabric, boots, motorcars and so on that are the typical achievements of capitalist production, and not as a rule improvements that would mean much to the rich man. Queen Elizabeth owned silk stockings. The capitalist achievement does not typically consist in providing more silk stockings for queens but in bringing them within the reach of the factory girls in return for steadily decreasing amounts of effort"
Contemporary mainstream economics, a position held by the neoclassical tradition, though seemingly rejecting value as an `economic' concept, has in fact incorporated selective parts of what has been its derivative into their theory of prices in market economies. This has been accomplished by simply supplanting the tension between value and price with what is their emergent concept of equilibrium, within which the whole of their analysis of price formation takes place. Within their framework, though for all intense and purposes similar, the nature of equilibrium, being for Smith a hypothetical position of the meeting of value and price, thus takes on an entirely different meaning. They essentially adopted a view of equilibrium as being determined by the equalization of the supply of commodities with their respective demand, the signals to which occur in exchange relations on the market. There is no contrast on which Smith placed prime importance between the 'natural' value determined in production to which all `artificial' prices determined in exchange are constantly tending, but simply `equilibrium' prices as given by the aggregation of subjective judgments of individuals - thus making the interaction of market mechanisms with man, which Smith attributed solely to the measuring rod of `market' price, the explanation of value a. In this regard, 'value' is transformed into a function of the influence of demand upon costs of s well production - more specifically on the last fragment of want not satisfied - and ultimately purported to be a subjective calculation of individuals. Prices are now the reflection of the interaction between these marginal rates of substitution of individual consumers and marginal costs of production of producers - Marginal substitution as the demand schedule of individuals which, operating under the `law' of diminishing marginal utility, decreases for every increase in the price of a commodity and increases for every decrease in the price of a commodity; Marginal cost as the supply schedule of producers which, under conditions of diminishing returns, decreases as more units are produced.
The effect of this change, curiously enough, was largely on the classical theories of distribution. By shifting the focus of an inquiry into the forces acting on price away from the realm of production to the realm of exchange, essentially making the regulating force of price the subjective valuations of commodities and their impact on the costs of producing those commodities, it rendered meaningless what was of prime importance for Ricardo, and Marx thereafter - distribution between economic classes and its deterministic effects on the outcome of exchange. Theories of distribution had formerly attempted to explain the division of value between different social classes in a given society. Smith himself identified the `three great classes' of society to "which the price of every commodity ultimately resolved" as being landowners, laborers, and manufactures - it was Ricardo, and more extensively Marx afterward, that showed the conditions in which this division of value between them took place was located in the realm of production before exchange took place. Gracious as they were in escaping them, these questions of class and the division of value between them became for economists not so much irrelevant in a greater sense, but `outside' of what economic analysis set out to answer as they were now `outside' of the theoretical determination of price. There was no longer a separation between exchange value and use value, but the derivation of exchange value from use value (utility). Distribution therefore became determined not from conditions of production but from exchange relations.
This subtle maneuver of redefining equilibrium, or we should say using it for different purposes, served to retain positive aspects of Smith's analysis to the exclusion of what the logical extension of his system by further inquiry unveiled: It ultimately served the exact same purpose of having competition operate to tend prices to a point of efficiency and equality, where things are sold at precisely what they are worth (now subjectively determined by some feat of aggregating what occurs on the individual level of optimizing preferences), thus allowing for the maintenance of the virtuous development that Smith associated with the free interaction of individuals and the discarding of the negative features that became associated with Marx's later `socially necessary labor time'. Not only were the later logical extensions of Ricardo and Marx that spoiled the virtuous cycle done away with in a single stroke, but extremely important aspects of Smith - from the identification and examination of the interaction between social classes to the objective nature of value existing in production - were all safely brushed aside.
The vicious circle, however, eventually caught up with utopia: the attempted formalization of this interplay between market mechanisms and man as both the measuring rod of and the explanation for value brought an inconsistency: initial distribution continued to claim overarching priority in the formation of price. The expression of utility that was the interaction of man with the market could not possibly be based on subjective measurements of value, but on the actual purchasing power which translated into market pull. Thus, the independent postulation of some pre-existing income level or distribution was necessary for the internal consistency of any formal demonstration of price determination based on marginal utility. Essentially, This is the root of what will later be shown to be the major contradiction in the superficial extension of Adam Smith; it essentially revolves around the assumption most fundamental to all conceptual frameworks, that question supposedly `outside' of the economists' domain - value.
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As Smith believes that the market price of commodities, regulated by their value, is established by the forces of supply and demand, he in turn identifies the natural price of commodities, the actual substance of value, as being equal to the labor necessary to produce them. He holds the latter to be the case because he believes that a commodity is essentially worth the amount of labor it is able to command on the market - if the producer of X enters into exchange relations with the producer of Y, and the production of X requires 10 hours or labor whereas the production of Y requires 5 hours of labor, then, in the hypothetical instance of commodities exchanging at their value, the producer of X will exchange one unit of X for two units of Y. Already within the beginning of his inquiry is the major problem, and what in the end removes all unity from his whole conceptual framework, to be found. It arises from the fact that Smith ultimately merges his explanation of the substance of value into what he before held as distinct, market relations - for what Smith is now basing his explanation of value upon is here the extent to which labor can be commanded in exchange, and not the "so much less labour than before" that makes up the substance of exchange value, or the labor embodied within commodities in the process of production.
Let us examine this issue further. Smith, in holding the labor commanded by commodities as the explanation of their value, is essentially making what amounts to the same claim that it is the labor necessary to produce commodities that is the determinant of their value ONLY under conditions in which the whole produce of labor belongs to the laborer. Under these conditions Smith sees no contradiction because there is none; it is only after the fact that this separation comes to play a destructive role. We can easily see why Smith thought this to be the case - when a producer of a product exchanges this product, in which only his labor was used to produce, with an individual who has done the same, the labor which each of these commodities command on the market is equivalent to the labor embodied within them. There is X amount of labor embodied in the commodity, and the laborer, appropriating the whole product, thus exchanges it and receives X amount of materialized labor in return for it. Confusion sets in on Smith when he attempts to extend the labor commanded theory of value to instances in which labor is not the sole 'factor' ofproduction, but land and capital as well. He runs head on into what is seemingly a major problem - if labor does not appropriate the whole of its produce, but a portion is divided between either rent to a landlord or profit to a capitalist (manufacturer, in his words), then labor commanded is no longer equal to the price of the commodity it produces. The price of commodities on the market will in general be higher than the exchange value of labor. As Smith is well aware that he must have an explanation of value consistent with "the three great classes of society" for the functionality of his entire schemata, if only because the appropriation of the full product of labor by the laborer was "at end...long before the most considerable improvements were made in the productive powers of labour", he is now seemingly forced to discard the applicability of the labor necessary to produce commodities as an explanation of value to a society in which labor is not the sole `factor of production' of commodities.
Instead of further unraveling this contradiction, the task of which was left to Ricardo, and, more extensively Marx, Smith adopts what is now called a `cost of production' theory of value - essentially, as Smith sees the necessity of the incorporation of "the accumulation of stock and the appropriation of land" into his conceptual apparatus, he simply makes the "natural value" to which all "market prices are constantly gravitating" equivalent to the `returns' to land, labor, and capital based on the observation that it is into these "three parts" which "the price of every commodity finally resolves itself". Of course, `value' is in this sense superfluous - simply identifying that rentiers, capitalists, and laborers all receive a portion of the value of commodities does not serve as an explanation of where the value of these commodities derives; but, then again, this is our problem, is it not? We can now see the starting point of superficial extensions - of profit simply being another form of wages for inspection and direction, risk or abstinence, which becomes plucked out of its proper context as being linked to the value of the stock employed. From whence does this value come - the sky? Thus, we are yet again gifted with another gem in the `production possibility frontier' of neoclassical economics - in which there can be no mistaking the superficiality of `switching between capital and labor'. Neither can the perspective required for the exposition of such insight be mistaken.
It is in the evasion of one contradiction which Smith naturally becomes entangled in another, his recognition of this being doubtful. The contradiction materializes when Smith moves on to his analysis of the `Wages of Labour', where he correctly maintains that returns to land and capital are derivative from labor and labor alone. Smith thus becomes his own greatest enemy, for he has now, quite explicitly, singlehandedly refuted both his own labor commanded theory of value and his cost of production theory of value. The only unifying force, and luckily for Smith what remains implicit throughout his whole analysis of the division of labor, is a labor embodied theory of value - that `returns' to land and capital are not returns at all, but appropriation from the labor which they employ. Thus we have come to one major critique levied against Smith by Ricardo - the division of value between classes in no way refutes the principle that value is derived from labor.
There are two rreasons why I believe that Smith did not realize his self contradictions: first, this contradiction was spelled out quite plainly, whereas the former was not. It thus makes little sense for Smith to have not made any attempt to remedy it as he did the former from which it came; second, and more importantly, the so called cost of production theory of value was, for all intents and purposes, consistent with his notion of tendential movements of price toward `value', much in the same way as neoclassical equilibrium theory is functional solely by merit of the identification of a given supply. What it was not consistent with, which will be shown later, was his theory of the division of labor and the increases in productivity that it allowed as a function of decreasing value. It is from the combination of what Smith, in arguing with himself, found to be dead ends with his concept of the division of labor, on which the development of the former aspect of his inquiry relied, that is at the core my claims.
---The Division of Labor---
In sweeping away the Mercantilist doctrine, Smith put forth a new answer to the question of how to increase the wealth of nations; that it was be found in the realm of production, more specifically in finding a mechanism the influence of which caused improvements in the conditions of production. These improvements were the development of the productive forces which, by reducing the amount of labor required to produce them, caused a reduction in the value of commodities. Smith identified this mechanism as the division of labor.
The division of labor, however, did not serve only to reduce the value of material output - it both fostered the growth and application of specialized knowledge to further innovate the production process. Innovations which were responsible for the introduction of new products and the increased efficiency of the production of existing products were the result of the division of labor. This is because a specialized producer would be more far more likely to posses, or have a much greater possibility of obtaining, the requisite knowledge to improve a product and the
method by which that product was produced than a person who was forced to spread his or her time across the production of many different products. The mechanism of the division of labor, in turn, was identified by Smith as being a function of the volume of exchange between individuals. He believed that when people regularly engaged in exchange relations they would become inclined to specialize in production - i.e. spontaneously form a division of labor. This is because with every increase in specialization there is in turn an increase in the volume of exchange due to a subsequent decrease in the self sufficiency of individuals. If an individual who formerly produced the whole of his or her necessary product specializes in the production of one of these products, he or she must then engage in exchange relations to obtain the rest. The growth in the volume of exchange then served to expand the division of labor, which itself served to expand the volume of exchange as it allowed for the individual the ability "to exchange all that surplus part of the produce of his own labor" and therefore "encourages every man to apply himself to a particular occupation".
Thus, as exchange gave rise to the division of labor, and the volume of exchange was in turn directly influenced through the division of labor, the result was an increasing hold of the division of labor on society. The division of labor, then, functioned as a positive feedback mechanism. There was, however, a natural limit to the internal expansion of the division of labor. Smith identified this limit as the extent of the market, or the area in which exchange relations were able to occur. The essential notion behind this concept was that the extent of specialization between producers depended on the mass of producers available to specialize. Smith describes this phenomena with an identification of the further integration of the division of labor in areas that contain a large mass of people, such as ` great towns', as opposed to a small population, such as the countryside.
II
As Smith held that exchange was the driving force behind the expanse of the division of labor, and that this exchange was limited only by the extent of the market, he identified the elimination of spatial and temporal barriers - modern day `transaction costs' - as the means by which exchange was able to be carried out in a widened area, and hence the means through
which the division of labor was able to more deeply integrate itself. This is because these eliminations served to open up further avenues of exchange between individuals and, flirting with their propensities to "truck, barter, and exchange", led to further expanse of the division of labor. Thus, Smith identified the emergence of commercial civilizations, or, as he says, the first "civilized" nations, in regions that had fewer barriers to exchange than others. As far as how this reduction of temporal and spatial barriers was accomplished, Smith was rather ambiguous. However, it seems fairly evident that he viewed the division of labor itself as the force that would accomplish this task in the long run. This is because Smith identified the division of labor as not only the instigator of increased material productivity but as the force through which innovation was fostered.
But had a division of labor not already existed? And if so, why did the division of labor neither perpetuate itself as Smith had envisioned nor serve to harness the application of the creative potential of individuals to widen the market? Smith's answer to this was that the division of labor that existed, because it was not a system of free enterprise but a manifestation of Mercantilist doctrine, created an atmosphere of monopoly and special privilege that restricted or distorted the forces that signaled the spontaneous ordering of production. In a system of free enterprise, competition between individual producers would both incentivize the actual applications of innovations that the granting of special privileges and subsidies deinsentivized and would eliminate monopoly control because any sector with an above average profit rate would attract production that was formerly involved in a sector with a lower rate of profit, and therefore also ensuring the important movement of price toward value. The regulating force of competition was the main ingredient necessary to bring to life the positive feedback mechanism of the division of labor. Protection was preventing the functioning of the division of labor which, per contra to the conscience construction of Mercantilist policy, functioned by merit of a mechanism which was independent of the conscience design of man.
It is in this context of Mercantilist protection policies that Smith's remarks on the interests of manufactures being at odds with that of society as a whole should be interpreted 12. For Smith, the secret of the wealth of nations was to be found in the positive feedback mechanism embedded in the link between the division of labor and the extent of the market: an increase in the division of labor lowers costs, raises real income, and extends the market, thus leading back to an increase in the division of labor and an increase in the extent of the market. Smith held that exchange between individual producers regulated by competition would cause the materialization and expansion of this virtuous cycle. It is in this sense that exchange is considered the driver of growth: it enlarges the pool in which the division of labor exists. The entirety of modern exchange based growth theory is thus derived from Adam Smith. Any argument put forth that identifies `barriers' or `limitations' on the ability to exchange being the immediate cause of poverty is thus derived from Adam Smith. Not only that, but Smith also implies that technological innovation is a factor endogenous to production based on a spontaneous division of labor. As technological progress is the long run mechanism through which temporal and spatial barriers are eliminated, not only does short run poverty due to the inability to exchange in this way derive from Smith, but the long run increase in the standard of living of the masses as well. The whole of contemporary mainstream economics has been an attempted formalization of the requirements needed for Smith's division of labor to function. This is the power that lies within the first twenty pages of the `Wealth of Nations'.
III
But it is precisely in this moment of glory where the disconnect occurs. For the role attributed to the division of labor is inexorably tied to the notion that labor is the "real measure of exchangeable value of all commodities". Redefining value as being determined in exchange contradicts the whole foundation of the Smith's division of labor: if the functioning of the division of labor is to reduce the value of commodities through paradigm shifts in how they are produced in the long run, in their conditions of production, then it is within the production process alone that an explanation of value must rest. Smith himself, in putting forth the labor commanded theory of value, maintained consistency with his theory of the division of labor to the extent that individual producers appropriated their own product. As this was incapable of being extended to capitalist production, Smith then switched to a cost of production theory of value in order to escape the trap he had laid for himself. However, as we have shown, this theory of value was not a theory of value at all and thus was incapable of explaining anything other than showing a hypothetical point at which value and price would be equal - it was therefore incompatible with the dynamic nature of the division of labor. It is from the latter which contemporary equilibrium analysis has its origins, and, quite naturally, why equilibrium analysis in neoclassical economics had also been doomed to a static existence: dynamics could only be incorporated as an element disturbing equilibrium, whereas within the whole of the operation of the division of labor equilibrium is only a fleeting moment of a vibration which is in ceaseless fluctuation. Smith, despite his fumbling, maintained conceptual unity because the whole of his division of labor was based around an environment wherein labor commanded was for all intents and purposes equivalent to labor embodied - or a world where the laborer appropriated the whole of his or her produce. His inclusion of the pin factory example, while highlighting the increase of productivity it allowed, served to hide the fact that this productivity was a function of a specific explanation of value. This dualistic nature, or perhaps the high degree of ambiguity, in which Smith conducted his analysis of the division of labor therefore turned out to be both his weakest and strongest point.
This dualism carried on to his heirs, however it now took different form. In adopting the marginalist approach to value, it manifested itself in an attempt to explain the functioning of an economic system according to individual self interest as a function of profit on the basis, or perspective, of individuals who have left the production process, or left the process in which material objects are produced as a prerequisite for profit. Exchange, without production, yields no profit; no growth. I may trade you nine apples for one of your apples, a deal in which you have convinced me beyond doubt is best for both of us, and in the end we still have between us ten apples. This attempted escape, however, was not an escape at all but instead served to shift the search of error and inconsistency to the confines of marginalism, and, as we have shown that it was a purely exchange driven explanation of value, financial speculative excess naturally became the issue. For where there is no production process, or when value is explained in the ct the value of which is rooted in exchange becomes more a function of the degree to which people are holding it - hoarding it - as concerns scarcity than the aggregation of marginal propensities. The recent popularity of 'behavioral' economics corresponds to this identification.
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