Adam Smith

1
Adam Smith

• 1723-1790

2
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

3
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

4
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

5
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

6
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

7
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

8
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

9
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

10
Professionally

• Perhaps the most amazing aspect of Adam Smiths
  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

11
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).

12
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

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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

14
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

15
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)

16
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)

17
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

18
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)

19
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

20
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

21

• 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.

22
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

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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

24
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

25
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

26
Causes of the Wealth of Nations

• Productivity of labor
• Proportion of laborers usefully and productively
  employed
• Summary

27
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)

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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)

29
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)

30
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

31
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

32

• 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.

33
Wages

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

34
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.

35
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.

36
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.

37
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.

38
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.

39
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.

40
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.

41

Wage and Profit

• 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.

42
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.

43
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.

44
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.

45
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)

46
Development of Society and Property Rights

• Period Property Rights
• Hunting No Property Rights
• Pastoral Some Private Property
  (society hierarchy)
• Agricultural Feudal, Property in
  Landowners hands
• Commercial Property of Capital