Adam Smith

History of Economic Thought

Adam Smith (1723-1790)
• Born in Scotland, became a professor The University of Glasgow
• 1759: The Theory of Moral Sentiments
• 1776: The Wealth of Nations, after meeting Quesnay
• The First Economist to “develop a complete and relatively consistent
abstract model of the nature, structure, and workings of a capitalist
system.”
• Saw connections between social classes, sectors of production, distribution of
income, commerce, circulation of money, prices, and economic growth.
• Model contains some contradictions carried on by later economists.
 Historical Context of Smith’s Ideas
Capitalism clearly displays itself in the industrial revolution, starting around 1770 in Britain and spreading throughout
W. Europe in the early 19th Century.
• 1700-1770: English export grows very rapidly.
• Profit seeking explosion of technological innovation.
Main Industries in the Industrial Revolution: Textiles & Iron
• 1700: English state bans cotton imports from India and woolen textile industry profits soar domestically and abroad.
• 1709: New technological advancements facilitate switch from charcoal coal in iron smelting.
• Iron and coal industry expansion widespread use of iron machinery in other areas.
• Technological innovation aimed at lowering costs of production and increasing output.
• 1769: widespread use of steam engines becomes feasible industry no longer limited by geographical limitations of
water power.
By the mid 18th C., much of production is done in “Manufactories”
• Industrial capitalists are now clearly distinct from merchant capitalists and workers.
• Increased division of labor and productivity
Smith is the first important economist to see:
• that profits on industrial capital as distinct from wages and rents & profits on merchant capital
• Profits, rents, and wages (as distinct forms of income) corresponded to the social classes of capitalists,
landlords, and workers.
 Smith’s Theories of History & Sociology
• Analyzes the origins and development of class conflict and the way power has been used in class struggle.
• Persistent theme: the actions of self-interested individuals result in a benevolent social harmony for society at large, as
if by some invisible hand.
• Major contradiction: simultaneous class warfare & societal benefit
• The role of government: “for the defense of the rich against the poor, or of those who have some
property against those who have none at all.”- WON
Smith’s Theory of History
• The manner of production and distribution of the material necessities of life (the economic base) was the
most important determinant of every society’s social institutions, and personal and class relations
(superstructure).
• Four stages of societal development: Hunting, Herding, Farming, and Commerce.
• Believed nature had created an illusion that personal happiness comes from material wealth and that
illusion had economic and social effects
• They keep everyone working and inventing new things.
• All wealth was produced by labor.
• The division of surplus between profits and wages was determined by the struggle between workers and capitalists.
• And capitalists are much more powerful.
Smith’s Four Stages of Economic and Social Development

• Hunting – “The lowest and rudest state of society such as…the native tribes of North America.” A precarious
existence characterized the absence of institutionalized forms of privilege and power, generally egalitarian.

• Pasturage – More advanced then hunting societies with production based on a nomadic lifestyle oriented around
the domestication of animals and herding. Under this system cattle, as property, became one of the first forms of wealth.

• Agriculture – The economy of feudalism, anchored to the ownership of land as the dominant power relation,
characterized by the permanent settlement of land and defined by great estates. For Smith the system was constrained by
a lack of outlets for the surplus of the estates, and the extreme hierarchical power relations that denied freedom to the
majority of producers.

• Commerce – Characterized by the development of cities that were economically independent of the estates and
yet permitted by the medieval nobility by virtue of the rents that could be collected. In cities a new political attitude
developed allowing greater freedom to producers to create wealth for themselves rather than for the overlord and
unleashed “one of the most powerful human motives, the desire to accumulate material wealth.”

Chapter 3 - 2
Smith, Class Conflict, and Property Ownership

• The Principal Basis for Class Differentiation: The Ownership of Land

and Capital.
• Capitalist Power Arises from:
~Wealth
~The Ability to Influence Public Opinion
~The Control of Government

Chapter 3 - 3
Smith’s Identification of Three Social Classes

“The three great, original and constituent orders of ever civilized country”

• Landowners – “Those who live by Rent.”

• Laborers* – “Those who live by Wages.”
• Capitalists – “Those who live by Profit.”
*Of the three Smith determined that labor was the sole creator of value or wealth, “It was not by
gold or by silver, but by labour, that all wealth of the world was originally
purchased.”
It is only because of property rights that a small group received a share of what the worker
produced. Therefore, class struggle is the determining factor in the wage rate and the
subsequent distribution of income between capitalist and laborer.

Chapter 3 - 4
Productive and Unproductive Labor

I. Productive Labor: Furthered the Accumulation of Capital

1. Labor results in revenues to capitalists in excess of wage costs.
2. Laborers whose labor was embodied in a tangible vendible
commodity.
II. Unproductive Labor:
1. Service Oriented Labor, “Menial Servants,” did not Generate
Profits.

Chapter 3 - 9
Smith’s Value Theory (Labor theory of value)
• Never actually presents a consistent labor theory of value
• Labor produces all material wealth.
• In Foraging Societies, labor is the determinant of exchange values (prices)
• Under farming, feudalism, and capitalism,

This is called the “adding-up theory” of prices.

• Profit results in the ownership of capital, therefore prices could be proportional to the
labor embodied in commodities only if all sectors of production had workers employing
the same value of capital.
• Smith’s Cost of Production= “Natural price”
• Market prices fluctuation around this level.
• This level is determined by the forces of demand and supply (the invisible hand)
Two Problems with Smith’s Price (value) Theory

1. Tautological Nature:
~Prices (wages+profits+rents) beget prices beget prices. Smith’s
analysis offers no real origin for prices and is therefore circular.
2. Absence of an Invariant Measure of Value:
~Smith could find the general level of all prices, however if any one
price rose all prices would simply rise with some prices rising more
or less relative to others depending on which price(s) initially rose.

Chapter 3 - 7
Smith’s Interpretation of the Labor Theory of Value (LTV)

• The Necessary Prerequisite for any Commodity to have Value was that
it be the Product of Human Labor:
~In a Commodity Producing Economy this means that:
Exchange Value = Amount of Labor Embodied in the Commodity =
(Indirect + Direct Labor)

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Smith and Economic Welfare

I. The Level of Production depended upon the Number of Productive Laborers and
their Level of Productivity.
II. Productivity, in turn, depended upon the Division of Labor.
• "the obvious and simple system of natural liberty" where "Every man ... is left perfectly
free to pursue his own interest in his own way, and to bring both his industry and capital
into competition with those of any other man".
III. The Division of Labor depended upon
~Specialization, which depends on the size of the market.
~The Accumulation of Capital.
Selfish, Acquisitive motives characterized economic behavior.
• Later becomes the basis of neoclassical economics.
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 Smith and Government
I. National Defense (Law Enforcement)
• “the duty of protecting the society from violence and invasion of other independent
societies”
II. Administration of Justice
• “the duty of protecting, as far as possible, every member of the society from the
injustice or oppression of every other member of it”
III. Erect Public Works and Public Institutions
• “the duty of erecting and maintaining certain public works and certain public
institutions, which can never be for the interest of any individual or small number of
individuals, to erect and maintain.”
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Class Conflict & Social Harmony
• Selfish, Acquisitive motives would lead to individual and class
conflicts, but the invisible hand would automatically resolve conflict
in a way most conducive to (average, per-capita) human happiness.
• Influences seen in the two rival traditions in 19th and 20th century
economic thought
• One emphasizing the Labor Theory of Value and class conflict
• The other emphasizing utility theory of value and the “invisible hand” that
creates social harmony.