Adam Smith

1723-1790

Adam Smith In addition to the text, you should read the

Chapter on Adam Smith in the book the Worldly Philosophers, by Heilbroner

This chapter will provide you with additional background material

Personal Born in Kircaldy (Scotland) Father died before he was born and his

mother lived to the age of 90 Kidnap by Gipsies when he was 4 and was

left abandon Walked 15 miles in Nightgown until awoken by

bells

Professorial Syndrom

Walk in a distracted fashion and fell in a Pit Would work through academic matters out loud Brewed himself a drink of bread and butter and

pronounced it the worst tea he had ever dranked “I am a beau in nothing but my books”

Tutoring His book on moral theology attracted the

attention of Charles Townshend Notorious to Americans since, as

Chancellor of the Exchequer, he• Refused to let colonist elect their own judges• Increase the duty (tariff) on American Tea

Townshend married well to the widow of a duke

Tutoring (continued) He chose Adam Smith to tutor the son of the

widow The contract was for 500 pounds per year plus

expenses and a pension of 500 pounds per year for life after done

Smith had never collected more than 100 pounds per year from fees collected directly from students

His students refused refund when he had to leave saying they had more than received their return

Tutoring (continued) For 18 months Smith and his student went to

France Met Voltaire in the south of France Met Francois Quesney in Paris He agreed with the Laissey Faire of the Physocrats

but did not agree with • Agriculture being the source of all productivity• Believed labor was an important component of

production

Life Smith met with Benjamin Franklin He was impressed with Mr. Franklin and his

descriptions of the Colonies Probably why he later wrote about the Colonies

• a nation “which, indeed, seemed very likely to become one of the greatest and most formidable that ever was in the world.”

An admiration that is later also shared by Karl Marx

Life Adam Smith lived with his mother until she

reached the age of 90 2 years after he published the Wealth of

Nations he was appointed Commissioner of Customs for Edinburgh

which paid 600 pounds a year His death went relatively unnoticed

Professionally Perhaps the most amazing aspect of Adam

Smith’s work is the fact that in the absolute chaos and crude conditions of the labor markets of his time he was able to view the beauty of the market system

He viewed the potential it had in developing economic growth and

The difficulty it provided if unregulated

A. Smith: First Classical Economist

Comparison with Shaskepere Very Careful Writer

• The Theory of Moral Sentiments (London, A. Millar,

Edinburgh, A. Kincaid & J. Bell, 1759) second edition, revised 1761, third edition, enlarged as The Theory of Moral Sentiments, To which is added A Dissertation on the Origin of Languages (London, A. Millar, Edinburgh, A. Kincaid, & A. Bell, 1767) fourth edition (London, W. Strahan, J. & F. Rivington, T. Longman and T. Cadell, Edinburgh, W. Creech, 1774) fifth edition 1781, sixth edition considerably enlarged and corrected, 2 volumes (London, A. Strahan & A. Cadell, Edinburgh,

W. Creech & J. Bell, 1790).

Published Works An Inquiry into the Nature and Causes of the

Wealth of Nations, 2 volume (London, W. Strahan & T. Cadell, 1776) second edition, revised, 1778, third edition with "Additions and Corrections, 3 volumes (London, A. Strahan & T. Cadell, 1784), fourth addition (London, A. Strahan & T. Cadell, 1786), fifth edition, 1789 (Philadelphia, Thomas Dobson, 1789

MAIN INTEREST Economic Development and Policies to Promote

Economic Growth• Assumption:An economy always employs its

resources fully in production• Methodology: Deductive Theory and historical

Description• Vision:

– 1. Interdependence of the segments of the economy

– 2. Policies to be followed to promote wealth of nation

Markets A. Contextual Economic Policy

• Arguments based on observation of historical and institutional circumstances

B. Natural Order, Harmony, and Laissez Faire• Scientific Investigation can reveal (discover)

factual cause and effect relationship• Human beings are rational, calculating and

motivate by self interest

Human Interest Every man…. Is first and principally

recommended to his own care; and every man is certainly in every respect fitter and abler to take care of himself than of any other person (Theory of Moral Sentiments)

Human Interest …the desire of bettering our condition [is] a desire

which, though generally calm and dispassionate, come with us from the womb, and never leaves us till we to to the grave. In the whole interval which separates those two moments, there is scarce perhaps a single instant in which any man is so perfectly and completely satisfied with his situation, as to be without wish of alteration or improvement of any kind (Wealth of Nations)

Market (Cont.)• Competitive markets exist in which factors of

production advance economic advantage• Natural process resolves conflict better than

human arrangements (physiocratic idea)• Optimum allocation of resources occurs in

competitive markets with out intervention

The Working of Competitive Markets

Market vs. Natural Prices Market Prices a Short-Run phenomenon Natural Prices a Long-Run phenomenon

• NOTE: in the LR NP will equalize rate of profits, wages and rents among economic sectors (landlords, capitalists, workers)

The Working of Competitive Markets (cont.)

In other words, given competitive market & absence of government intervention, resulting natural prices bring about optimum allocation of resources because consumers receive goods they want at lowest prices and maximum rate of growth occurs

THIS IS THE INVISIBLE HAND ANALOGY

Exceptions to laissez faire protection of infant industries by tariffs provision of public goods (roads, schools,

vital records, justice, national defense) ALSO, FREE ENTERPRISE SHOULD

BE CHECKED AND NOT LET GO UNREGULATED:

People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices. It is impossible indeed to prevent such meetings, by any law which either could be executed, or would be consistent with liberty and justice. But though the law cannot hinder people of the same trade from sometimes assembling together, it ought to do nothing to facilitate such assemblies, much less to render them necessary. Wealth of Nations, Book 1, Chapter 10.

Capital Accumulation (basis of wealth of a nation)

Determines division of labor and proportion of population engaged in production

Leads to economic development Individual self-interest plus accumulation of

capital leads to optimum allocation of capital among industries

Capital Accumulation (basis of wealth of a nation) (CONT)

Labor cannot accumulate capital because wage level permits only satisfaction of consumption desires (subsistence level wages)

Landholders do not accumulate capital because they spend it on unproductive labor (servants, etc.)

Capitalists are the benefactors of society so unequal distribution of income in their favor benefits society by promoting economic growth instead of immediate consumption of all production

An Inquiry into the Nature and Causes of the Wealth of Nations

Book I: value theory, division of labor, distribution of income

Book II: capital as a cause of wealth of nation Book III: economic history of several nations

used as illustration Book IV: history of economic thought &

practice including mercantilism & physiocracy Book V: public finance

Purpose of production Purpose: for consumption and export

• End purpose of economic activity is consumption

• One purpose of exports is to pay for imports Source of wealth produced by labor (physiocrats

emphasized land as the source of wealth)• Wealth of a nation is measured in per capita

terms• One purpose of exports is to pay for imports

Causes of the Wealth of Nations Productivity of labor Proportion of laborers usefully and

productively employed Summary

Productivity of labor Depends on division of labor and specialization Pin factory example - increase from 20 to 4800 pins per

worker per day when divided into 18 operations Social disadvantage - workers dehumanized by repetitive,

monotonous tasks Division of labor depends on extent of market and capital

accumulation• volume sold increases opportunity for division of labor• production process time consuming so stock of goods (capital)

needed to maintain labor during production• capital stock of goods comes from saving (this is the function of

the capitalist)

Proportion of laborers usefully and productively employed

Productive labor• employed in producing vendible commodities

Unproductive labor• employed in producing service (normative

judgment) - included sovereign, justice, military (i.e., less govt, the better for the economy implication: should lower taxes on capitalists so they can accumulate more capital to save and invest)

Summary of the causes of the wealth of nations

Accumulation of capital is the bottom line Economic growth - depends on division of

total output between consumer goods and capital accumulation (the larger capital accumulation the greater the rate of growth)

Summary of the causes of the wealth of nations (cont)

Requirements for highest rate of growth:• free markets (no govt intervention)• private property • unequal distribution of income to allow

accumulation of capital

Meaning of Value Two Values:

• value in use - the utility of an object. Ambiguous, subjective measure

• value in exchange - the purchasing power of an object. Objective measure of price expressed in the market.

Diamond-Water Paradox: Water has great utility but little exchange value; a diamond has little utility but great exchange value

The word value, it is to be observed, has two different meanings, and sometimes expresses the utility of some particular object, and sometimes the power of purchasing other goods which the possession of that object conveys. The one may be called "value in use"; the other, "value in exchange." The things which have the greatest value in use have frequently little or no value in exchange; and, on the contrary, those which have the greatest value in exchange have frequently little or no value in use. Nothing is more useful than water: but it will purchase scarce anything; scarce anything can be had in exchange for it. A diamond, on the contrary, has scarce any value in use; but a very great quantity of other goods may frequently be had in exchange for it.

Wages

Smith put forth contradictory wage theories including:• subsistence theory of wages• productivity theory• bargaining theory• residual claimant theory• wages fund theory

Wage and Profit Issues that impact on “the inequalities of

wages and profits arising from the nature of employments themselves”

1. the wages of labour vary with the ease or hardship,the cleanliness or dirtiness, the honourableness or dishonourableness of the employment.

Wage and Profit 1. the wages of labour vary with the ease or

hardship,the cleanliness or dirtiness, the honourableness or dishonourableness of the employment. • Thus in most places, take the year round, a journeyman

tailor earns less than a journeyman weaver. His work is much easier. A journeyman weaver earns less than a journeyman smith. His work is not always easier, but it is much cleanlier.

Wage and Profit 1. Continuation

• The trade of a butcher is a brutal and an odious business; but it is in most places more profitable than the greater part of common trades. The most detestable of all employments, that of public executioner, is, in proportion to the quantity of work done,better paid than any common trade whatever.

Wage and Profit Secondly, the wages of labour vary with the

easiness and cheapness, or the difficulty and expense of learning the business.• When any expensive machine is erected, the

extraordinary work to be performed by it before it is worn out, it must be expected, will replace the capital laid out upon it, with at least the ordinary profits. A man educated at the expense of much labour and time to any of those employments which require extraordinary dexterity and skill, may be compared to one of those expensive machines.

Wage and Profit 2. Continuation

• Education in the ingenious arts and in the liberal professions is still more tedious and expensive. The pecuniary recompense, therefore, of painters and sculptors, of lawyers and physicians, ought to be much more liberal; and it is so accordingly.

Wage and Profit Thirdly, the wages of labour in different occupations

vary with the constancy or inconstancy of employment. • A mason or bricklayer, on the contrary, can work neither

in hard frost nor in foul weather, and his employment at all other times depends upon the occasional calls of his customers. He is liable, in consequence, to be frequently without any. What he earns, therefore, while he is employed, must not only maintain him while he is idle, but make him some compensation for those anxious and desponding moments which the thought of so precarious a situation must sometimes occasion.

Wage and Profit 3. Continuation

• When the inconstancy of employment is combined with the hardship, disagreeableness and dirtiness of the work, it sometimes raises the wages of the most common labour above those of the most skilful artificers.

Fourthly, the wages of labour vary

accordingly to the small or great trust which must be reposed in the workmen.• The wages of goldsmiths and jewellers are

everywhere superior to those of many other workmen, not only of equal, but of much superior ingenuity, on account of the precious materials with which they are intrusted.

Wage and Profit

Wage and Profit 4. Continuation

• We trust our health to the physician: our fortune and sometimes our life and reputation to the lawyer and attorney. Such confidence could not safely be reposed in people of a very mean or low condition. Their reward must be such, therefore, as may give them that rank in the society which so important a trust requires. The long time and the great expense which must be laid out in their education, when combined with this circumstance,necessarily enhance still further the price of their labour.

Wage and Profit Fifthly, the wages of labour in different

employments vary according to the probability or improbability of success in them.• The probability that any particular person shall ever be

qualified for the employment to which he is educated is very different in different occupations. In the greater part of mechanic trades, success is almost certain; but very uncertain in the liberal professions. Put your son apprentice to a shoemaker, there is little doubt of his learning to make a pair of shoes; but send him to study the law, it is at least twenty to one if ever he makes such proficiency as will enable him to live by the business.

Wage and Profit Wages vary in inverse proportion to the

agreeableness of the employment. “education in the ingenious arts and in the liberal professions, is tedious and expensive. The pecuniary recompense, therefore….of lawyers and physicians ought to be much more liberal: and it is so accordingly.”

Wages Fund Doctrine Assumes there is a fixed capital fund for payment of wages

• wages fund - the store of goods (capital) previously produced (food, clothing, housing, etc.) for the use of workers during the production period (time from start to finished product)

• Source of wages fund is the savings or failure to consume of the capitalists

• Wage rate = wages fund/labor force• Smith suggested that a)   wages population

labor force wages (anticipated Malthus’ population theory)

Development of Society and Property Rights

Period Property Rights Hunting No Property Rights Pastoral Some Private Property

(society hierarchy) Agricultural Feudal, Property in

Landowner’s hands Commercial Property of Capital