Adam Smith: capitalist icon? (2007)

From the January 2007 issue of the Socialist Standard

Mention of the name Adam Smith calls to mind the “invisible hand” of the market, free trade, even capitalism itself. And money makes this capitalist world go round. So the Bank of England’s decision to feature Smith’s face on its twenty-pound notes, starting this spring, certainly seems appropriate

The Bank’s Governor, Mervyn King, says that Smith reminds us of how “openness to trade with others” allows us to “seize opportunities to specialize” that result in higher “productivity, incomes and standards of living for citizens of all countries.” To drive this point home, the new banknotes will have an engraving of a pin factory, which Smith used as an example of how the division of labour increases productivity, with the caption: “and the great increase in the quantity of work that results.” King hopes the new banknotes will encourage visitors to Britain “press their own politicians to support the opening up of trade, which has been at the heart of the British Government’s efforts to reform the world economy.”

The image of Smith presented on the banknotes, while not incorrect, is certainly one-dimensional. It ignores those aspects of his investigation of capitalism that run directly counter to some of the cherished beliefs of his followers.

That is not to suggest, however, that Smith was an anti-capitalist. Some like Noam Chomsky have flipped through the pages of The Wealth of Nations to uncover ideas critical of capitalism, but this effort seems misguided and unhistorical. Smith undeniably had faith in capitalism, but this view arose naturally from living in an ascendant capitalist system that had yet to fully reveal its contradictions. Compare this to the contemporary cheerleaders for capitalism who can only maintain their belief by denying reality. In late 18th century Europe, there was no socialist spectre haunting the sleep of burghers like Smith. If anyone had insomnia it was aristocrats worrying about the rising bourgeoisie. With the peace of mind that this situation afforded him, Smith pursued the sort of disinterested study of capitalism that could only be carried out a century later by critics of capitalism, such as Marx.

A labour theory of value

Smith’s great interest in the “specialization” of production, which the new banknotes emphasize, naturally led him to ponder what regulates the commodity exchange that mediates this division of labour. In other words, he wondered what determines the “exchangeable value” of commodities. In using this term, Smith already makes an important distinction from what he calls “value in use.” Smith notes that something with great utility, like water, has no exchange value at all, whereas a diamond is of little real use but has great exchange value. Smith thus sets aside the issue of use-value, to instead “investigate the principles which regulate the exchangeable value of commodities.” The answer he arrives at later came to be known as the “labour theory of value.” That is, he identifies the labour necessary to produce a commodity as the factor that regulates its exchange-value.

This view is presented in chapter six of The Wealth of Nations, where Smith says that “the proportion between the quantities of labour necessary for acquiring different objects seems to be the only circumstance which can afford any rule for exchanging them for one another” He offers the example of “a nation of hunters” where it usually costs twice the labour to kill a beaver” than “it does to kill a deer.” The result is that “one beaver should naturally exchange for or be worth two deer.” In other words, “produce of two days or two hours labour” would naturally “be worth double of what is usually the produce of one day’s or one hour’s labour.”

Smith goes on to point out that more difficult or complex labour would naturally be worth more than simple labour: “If the one species of labour should be more severe than the other, some allowance will naturally be made for this superior hardship; and the produce of one hour’s labour in the one way may frequently exchange for that of two hours labour in the other.”

This view is expressed in such a simple and straightforward way that it may seem inconsequential. But the significance of Smith’s idea that commodities have intrinsic value, based on the labour “embodied” within them, becomes clearer if we compare it to other explanations of value.

The most common “explanation” of value, which most people would offer without thinking twice, is that a commodity’s value is the outcome of supply and demand. But on closer consideration, it becomes clear that this can only account for why the price of a given commodity might fluctuate higher or lower; it cannot explain why a price fluctuates around a certain level. Supply and demand might account for why the prices of 4x4s fell compared to hybrid vehicles, when oil prices soared, but won’t tell us why cars have far greater exchange value than, say, bicycles.

Another related theory is the idea that a commodity’s value is determined subjectively according to its utility. But, again, this does not answer the car-versus-bicycle question. Many people find bicycles infinitely more useful than cars, but that does not mean they are willing to pay dearly for them. A subjective theory can explain why a person dying of thirst in the desert would gladly exchange a diamond ring for a glass of water, but this does not help us understand everyday commodity exchange.

In addition to these explanations, there is the theory of value that claims a commodity’s “value” is determined by the price of producing it (“cost price”). But this is a tautology that does not explain what determines this price.

Only a labour theory of value, which locates the intrinsic source of value, offers a way to move beyond these superficial explanations.

Dangerous implications

Capitalists have been vehemently opposed to the labour theory of value for good reason. A theory of intrinsic value leads towards an understanding of the source of profit, which capitalists are eager to obfuscate. If a commodity has no intrinsic value, and its price is only determined in the actual process of being exchanged, then profit is likewise something that arises out of thin air.

Smith’s idea that value is based on the labour embodied in a commodity, leads him to better understand where profit comes from. In the same chapter in which he presents his labour theory of value, Smith offers the view that profit is a “deduction” from the intrinsic value of a commodity. In other words, first we have the existence of value (determined by labour), and this is then broken down into the revenue of the various classes (i.e. profit, rent, and wages).

He writes: “The value which the workmen add to the materials [means of production], therefore, resolves itself in this case into two parts, of which the one pays their wages, the other the profits of their employer upon the whole stock of materials and wages which he advanced.” And this same explanation is offered to explain the source of rent: “[The landlord’s] rent makes the first deduction from the produce of the labour which is employed upon land.”

There are still many unanswered questions here regarding the exact source of profit, but by generally locating it in the value created by workers, Smith is not far from a theory of surplus-value. He is certainly head and shoulders above the view, still common today, that profit arises from “buying low and selling high.” This explains nothing, really, because the gain on one side is a loss on the other. The end result, as far as society is concerned, is zero. Or, as Marx famously said, “the capitalist class as a whole cannot defraud itself.”

According to Smith’s argument, instead of profit arising ex nihilo from the process of exchange, it is a slice of the value originally created by the labour of workers. This is a very dangerous idea as far as the capitalist class is concerned. It implies that the interests of workers and capitalists are fundamentally opposed. Smith is not afraid to bluntly describe this reality. He says that the interests of the two classes “are by no means the same,” because “the workmen desire to get as much, the masters to give as little as possible.” There is no “win-win” situation in Smith’s mind. And he brilliantly depicts how, in industrial struggles, the workmen “are desperate, and act with the folly and extravagance of desperate men, who must either starve, or frighten their masters into an immediate compliance with their demands,” while “the masters…never cease to call aloud for the assistance of the civil magistrate, and the rigorous execution of those laws which have been enacted with so much severity against the combinations of servants, labourers, and journeymen.”

This realistic view of class struggle, so distant from the platitudes of Mervyn King, flows naturally from an understanding of the source of value and a “deduction” theory of profit.

A step backward

Smith was unable to consistently adhere to a labour theory of value, however. He concluded that this principle is only applicable to commodity exchange in pre-capitalist societies (the “early and rude state of society”). But if we examine why Smith abandoned this theory, we can appreciate how seriously he struggled to understand capitalism.

When he turns from pre-capitalist society (depicted as being made up of independent commodity producers who own their means of production), to examine the situation under capitalism, Smith is perplexed by a case of unequal exchange. This is the exchange between capitalist and wageworker, where the worker is paid a money-wage that contains less (embodied) labour than the (living) labour carried out in return for the wage.

Smith does not realize it, but in making this observation he is tantalizingly close to identifying the precise source of surplus-value. Marx was able to reveal this great secret of capitalist society by clarifying how surplus-value arises from the difference between (a) the value of the labour-power (or labour capacity) a wageworker sells as a commodity to the capitalist and (b) the new value created in production by the actual use of this labour-power (i.e. labour itself), with the latter being greater in value magnitude than the former.

Smith fell into hopeless confusion because he did not make this distinction between labour and labour-power, instead using the same the term “labour” to refer to both. Once this crucial distinction has been made, however, it becomes clear that the exchange between wageworker and capitalist is not unequal. The capitalist pays for labour-power according to its value, which is determined by the value of the commodities the worker consumes to “reproduce” this capacity to labour. What is unequal is not the exchange itself, but what happens next, in the production process, where the worker’s labour generates a greater magnitude of value than the value of the labour-power exchanged.

Far from contradicting the labour theory of value, it is only on its basis that this exchange between wageworker and capitalist can be adequately explained. But Smith, fixated on the very real inequality of the outcome, concluded that another theory of value was needed to explain capitalism. He turned away from the “deduction” theory of value, to embrace the opposite, “composition” theory where value is explained as the sum of profit, rent and wages. What this does not explain, of course, is what determines these three component parts.

Even here, though, Smith’s views are not without basis, since under capitalism commodities are sold at their “production prices,” rather than their values, and this is a composed price (cost price plus average profit). But Marx explained the relation this composed price has to intrinsic value, whereas Smith merely described it.

Smith’s thought was this mixture of science and a mere cataloguing of external phenomena. Defenders of the capitalist system draw on the latter, and love to quote from his superficial descriptions of the marketplace, but socialists can thank Adam Smith for taking an important step towards an understanding of what makes capitalism tick.

Michael Schauerte