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Notes on Economic History (8)

Adam Smith's theories of Income

Adam Smith establishes an elaborate theory of the formation of value and of price, arguing that under primitive conditions, when there is little capital and when rent has not yet come into existence, the value of goods is determined solely by the amount of labour embodied in them. Things, like water, which a have a great use-value, have no exchange-value; and conversely, things with very little use-value, like diamonds, have a very high exchange-value. It follows that as the measure of the exchange-value of goods it is their "natural price" that matters. Not the utility of an article, but the amount of labour that has been expended in producing it.

In accordance with the fluctuations of supply and demand this market price swings to one side or the other of the labour expenditure price. The various items out of which the actual or market price is made up are the outcome of private property and the existing legal order, consisting of (a) wages, (b) the share payable to capital, and (c) rent, which may be regarded as interest paid for the use of land (equivalent to the difference between the price of the produce of the land, on the one hand and, on the other, the expenditure of the farmer upon wages, plus profit on his farming capital).

From this is deduced a theory of distribution, or of the formation of income (Smith uses the term "revenue"), for inasmuch as production is carried on with an eye to the market on the basis of the division of labour, the product is distributed in accordance with the laws of the formation of prices in the market. The distribution of wealth is effected in accordance with the constituents of every price; the worker receives the equivalent for his labour, and the capitalist and the landlord receive equivalent for the co-operation of capital and land.

Thus all the commodities which compose the whole annual produce of the labour of every country must resolve themselves into the same three parts, and be distributed among the different inhabitants of the country, either as wages, profit on capital, or rent for land. "Wages, profits and rent are the three original sources of all revenues as well as of all exchange-value. All other revenue is ultimately derivable from one or the other of these." Wealth of Nations (Book 1, Ch. VI).

Smith's theories on the laws of distribution may be briefly phrased as follows. rates of wages are determined, like market prices in general, by supply and demand, due to whose operation they vary to one side or the other of a subsistence wage:

    "The more capital there is in a country, the greater is the demand for labour, and the higher therefore are wages. The profit of capital has the opposite trend. The more capital there is, the lower is its rate of profit; the more capitalists there are, the greater is the tendency to underbid one another. Consequently, the more labour there is in a country, and the richer it therefore is, the lower in general is the profit of capital." (Book 1. Ch. IX.)

In the matter of land rent, a more complicated machinery is at work:

    "Increase in the productiveness of labour the division of labour and the expansion of manufacture leads to a fall in the prices of the products of industry. To the extent to which this happens, the products of agriculture automatically exchange for larger quantities of industrial products; that is, the former become dearer. This rise in agriculture prices is attended or followed by a rise in rent." (Book 1. Ch. XI.)

Rent also rises concurrently with an increase in capital, for since more capital and labour are applied to land, and land is therefore used more effectively, the income from land necessarily increases.

According to Smith economic life develops best when it is left alone. The main business of the State is to keep order. Economic activities when perfectly free develop harmoniously, and free competition must be left to do its work. Competition forces everyone to follow his own economic aims, to develop all his forces, and to produce as cheaply as possible. Consumers are supplied with goods at the lowest prices, capitalists can devote their energies to their tasks unhindered, and workers can seek employment wherever wages are highest. In this way a condition of social harmony is attained. At the same time, it results that everyone engages in the occupation which comes most natural to him. Division of labour takes place along the lines that are most economical.

By virtue of its own mechanism, society can get the better of that selfish outlook which is (primarily) hostile to society. Everyone becomes enabled, by the pursuit of his own advantage, to enjoy his natural rights.

Bob Ambridge