Adam Smith on the origin of profits (2023)

From the June 2023 issue of the Socialist Standard

This year is the centenary of two of the pioneers in the study of what is now called the capitalist economy. Sir William Petty was born 400 years ago in May and Adam Smith 300 years ago this month. Smith is by far the better known but Petty deserves credit for succinctly expressing a key part of the Labour Theory of Value: ‘labour is the Father and active principle of Wealth, as Lands are the Mother’. In other words, wealth is produced by humans exercising their physical and mental energies to transform materials that originally came from nature into useful things.

This was so obvious that Smith took it for granted, as in the opening lines of The Wealth of Nations, published in 1776:

‘The annual labour of every nation is the fund which originally supplies it with all the necessaries and conveniences of life which it annually consumes…’

This is not yet a labour theory of ‘value’ (a theory of what lies behind the price of goods when they are produced for sale) but modern economics textbooks refuse to acknowledge that only ‘labour’ — humans working on materials from nature — creates new wealth. They want a role for ‘entrepreneurs’, as they call capitalists. What they are trying to do is to provide a justification for profits. They could do this, as in fact Smith does, without denying that wealth is only created by humans working on materials from nature, but they are not prepared to accept even this because of its possible anti-capitalist implications.

Smith does in fact go on to put forward a labour theory of value. But, even on the basis that only human work produces wealth, Smith can be shown as accepting that profits derive from what wage-workers produce.

He argues that, in an early stage of economic development, producers did receive the full product of their labour, but once a stock of wealth, in the form of instruments of production and means of subsistence, had come to be owned by individuals, the position changed. The producers had to cede a portion of what they produced to their employer:

‘As soon as stock has accumulated in the hands of particular persons, some of them will naturally employ it in setting to work industrious people, whom they will supply with materials and subsistence, in order to make a profit by the sale of their work, or by what their labour adds to the value of the materials. In exchanging the complete manufacture either for money, for labour, or for other goods, over and above what may be sufficient to pay the price of the materials, and the wages of the workmen, something must be given for the profits of the undertaker of the work who hazards his stock in this adventure. The value which the workmen add to the materials, 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. He could have no interest to employ them, unless he expected from the sale of their work something more than what was sufficient to replace his stock to him; and he could have no interest to employ a great stock rather than a small one, unless his profits were to bear some proportion to the extent of his stock’ (p. 37, chapter VI of Book I, italics added).

This is Smith explicitly saying that profits come from the value added to capital by the work of those employed, even if he considers this justified by the risk taken by the employer.

He repeats this later when discussing productive and unproductive labour (where he is using the word ‘manufacturer’ in its original and logical sense of someone who makes something with their hands, not its current distorted meaning of ’employer’):

‘There is one sort of labour which adds to the value of the subject upon which it is bestowed: there is another which has no such effect. The former, as it produces a value, may be called productive; the latter, unproductive labour. Thus the labour of a manufacturer adds, generally, to the value of the materials which he works upon, that of his own maintenance, and of his master’s profit. The labour of a menial servant, on the contrary, adds to the value of nothing. Though the manufacturer has his wages advanced to him by his master, he, in reality, costs him no expense, the value of those wages being generally restored, together with a profit, in the improved value of the subject upon which his labour is bestowed. But the maintenance of a menial servant never is restored. A man grows rich by employing a multitude of manufacturers: he grows poor, by maintaining a multitude of menial servants’ (p. 253-4, chapter III of Book II, italics added).

Smith was no socialist and he did advocate laissez-faire capitalism, but this doesn’t detract from the fact that he accepted a theory of wealth which showed that profits derive from what wage-workers produce.

Adam Buick

Adam Smith versus the Adam Smith Institute (2023)

From the June 2023 issue of the Socialist Standard

If Adam Smith has a bad reputation amongst socialists it is not his fault. Marx himself had a high regard for Smith and discussed his views in great detail. It’s the fault of people like those who set up the Adam Smith Institute in 1977 to campaign for governments to give capitalist corporations a free hand to pursue profits as they think fit.

Writing in the middle of the 18th century — he was born in 300 years ago in 1723, published The Wealth of Nations in 1776, and died in 1790 — Smith was a witness to the beginnings of industrial capitalism in Britain. His book was written as a criticism of the policy (known as ‘mercantilism’), pursued by governments in his day, of trying to encourage exports by subsidies and restrict imports by tariffs with a view to building up the amount of gold in the home country. He wanted such government intervention to be ended and advocated instead laissez-faire, with governments letting the market function freely, as the best way to increase a country’s wealth.

Smith believed that he was discovering the natural laws of ‘political economy’ and adopted an objective, scientific approach to the subject. This was what Marx admired in him. He realised that Smith was genuinely trying to understand how capitalism worked, unlike the ‘vulgar economists’ of his own day who were merely ideological apologists for capitalism. His criticism was that Smith thought he was discovering natural laws whereas he was studying those only of one particular, transitory economic system. This was in fact Marx ‘s criticism of the whole school of economic thought that Smith’s book gave rise to, his ‘critique of political economy’ (the sub-title of Capital).

The Wealth of Nations famously begins with Smith’s analysis of the division of labour and how this allows more wealth to be produced, using a pin-making factory as an example (incidentally, a sign of the low level of industrial development in his day). He goes on to examine the concept of ‘value’, distinguishing between ‘value-in-use’ and ‘value-in-exchange’. It is the latter that interests him as a student of economic phenomena. His conclusion as to what measures the exchange-value, or price, of a commodity will come as a shock to some of his modern-day admirers:

‘The value of any commodity, therefore, to the person who possesses it, and who means not to use or consume it himself, but to exchange it for other commodities, is equal to the quantity of labour which it enables him to purchase or command. Labour, therefore, is the real measure of the exchangeable value of all commodities’ (Book I, chapter V).

This was too much for the Adam Smith Institute and has led Eamonn Butler, the Institute’s Director, in his The Condensed Wealth of Nations on their website, to virtually repudiate it:

‘For many commentators, this looks uncomfortably like a crude labour theory of value, which focuses on production costs and overlooks demand. Some argue that it led Karl Marx into his appalling errors about labour. One could defend Smith as just trying to simplify things by talking about an age before land or capital ownership, where labour was the sole production cost, and temporarily ignoring other factors such as land and capital, and also ignoring demand, all of which he goes into later. At best his words are misleading, at worst they are mistaken: but then he was breaking new ground’ (www.adamsmith.org/the-wealth-of-nations).

The ‘defence’ that Smith was writing of a time before there was ‘land and capital ownership’ does not stand up, as Smith explicitly stated that he was writing of a situation when ‘stock has accumulated in the hands of particular persons’. That the Adam Smith Institute should find Smith’s ideas here ‘uncomfortable’ is easy to understand.

Smith can certainly be called an advocate of capitalism, though not of the corporate capitalism we know today and for which the Adam Smith Institute stands. In Smith’s day, if you were a capitalist employer you risked everything should your business fail, as today’s generalised limited liability did not exist. You were personally responsible for all your business debts, so that if your business failed disastrously you could end up in a debtor’s prison. Capitalists take no such risk today; with limited liability, they are only liable for the amount they have invested.

Such companies did exist in Smith’s day but they had to be set up by Royal Charter or Act of Parliament, such as the East India Company. The irony is — at least for those who try to project Smith as a defender of capitalist corporations — that he didn’t like these, for the same reason that the Adam Smith Institute and other free-marketeers don’t like government-run industries: that the people in charge were managing other people’s money and not their own and so wouldn’t be so concerned about avoiding waste and inefficiency; the famous invisible hand would not necessarily move them to act in the general interest.

The only activities in which Smith accepted that ‘a joint stock company’ was justified were banking, insurance, canals and water supply. This is another sign of how undeveloped capitalism was in his day, as the limited liability company is now the predominant form of business enterprise and essential to modern capitalism. The amount of capital required to run a capitalist enterprise is now too large to be raised by a single person (just as canals were in Smith’s day). Which shows that the era of individual capitalist ownership (where most ideological defenders of capitalism seem to be stuck) is a thing of the past, making the individual capitalist owner economically and socially redundant.

It shows that while in Smith’s day individual, private enterprise was viable this has long since ceased to be the case. Today production is too big for that; it is already socialised from a technological point of view in the sense of involving a vast network of producers to produce something. The problem is that control of production is not. This contradiction between socialised production and non-social ownership and control is the cause of today’s economic and social problems. The corporate ownership that has evolved to replace individual ownership is not the answer; in many ways it makes things worse. Nor is state ownership the answer. Both are still forms of sectional ownership. The contradiction can only be resolved by socialism where the means for producing wealth becomes the common property of society as a whole, under democratic control.

Adam Buick

Notes on Economic History (7) (1961)

From the May 1961 issue of the Socialist Standard

Wealth of Nations

Since England was the first country in which modern large-scale industry developed, it was only to be expected that capitalist political economy would appear and flourish here. The introduction of spinning machinery (Wyatt 1783, Lewis Paul 1741, Arkwright 1769); the steam engine (Watt 1765 and 1770); and later of the power loom (Cartwright 1785, Jacquard 1802); and similar transformations in the methods of industrial production, indiced changes that led to an enormously accelerated growth of large scale industry.

Adam Smith was the man, who, under these conditions, established a new system of economic doctrine. Smith spent three years in France, where he became known personally to the physiocrats, and was greatly influenced by them. For ten years after his return from France, he devoted himself to economic study and to writing his book Inquiry into the Nature and Causes of the Wealth of Nations published in 1776.

Adam Smith defines the wealth of a nation in the opening of his inquiry.

The annual labour of every nation is the fund which originally supplies it with all the necessities and conveniences of life which it annually consumes, and which consist always either in the immediate produce of that labour, or in what is purchased with that produce from other nations.

To this he makes an important reservation. Labour which is not devoted to the production of useful things, which have an exchange value is to Smith unproductive. Thus, services of all kinds are unproductive. The wealth of a nation is greater accordingly as a larger proportion of its inhabitants are engaged in useful labour. This in turn depends upon the amount of capital devoted to the employment of workers (the wage fund), but above all, upon the productiveness of labour.

According to Smith the productiveness of labour is increased mainly by the division of labour. Consequently, the division of labour is the chief cause of prosperity. He illustrates this thesis by the many processes required for the manufacture of such a simple thing as a pin. The further the division of labour is carried, the more is production carried on with a view to marketing.

Now for the purpose of the market there must develop an acceptable means of exchange, or instrument of trade—in other words, money. Money, as explained by Smith, arises out of indirect exchange. Commodities are exchanged in the market by means of money as the medium of exchange, and thus originates an exchange-value or price of goods, as distinct from their use-value. We see, then, that the division of labour is the starting point of the economic process and its development; it is the cause of the exchange of goods, for no one can live upon the product of his own activity. But exchange is effected in accordance with exchange-value (price) and the exchange value is therefore decisive (a) for the distribution of the goods, since it settles the question who can buy them; and (b) for their production inasmuch as this is guided by the expectation of the price to be realised.

Upon this premise Adam Smith builds up his economic system, and so do all the capitalist schools that follow him. The laws that regulate the formation of exchange-value are held to be also laws in accordance with which the wealth of nations comes into being; they are, according to Smith, the primary laws of economic motion.

By formulating this conception of the nature of political economy, Smith made an important step forward in capitalist theory. He gave a new turn to economic thought. Whereas both the Mercantilists and the Physiocrats had made productive circulation the basis of their reasoning, now for the first time a study of the laws of exchange-value was undertaken. Thenceforward the theory of value and the theory of prices became the basis of economic theory in general. For since prices are the determinants of the production of goods, the law of prices decides what goods shall be produced; and since prices decide which would-be purchaser has sufficient purchasing power, the laws of prices are also the laws of distribution. In a word, the laws of price are also the laws of distribution. As a result, therefore, the theory of distribution is developed as a theory of particular prices (wages, rent, etc).

Bob Ambridge

Cooking the Books: The other Adam Smith (2005)

The Cooking the Books Column from the April 2005 issue of the Socialist Standard

Gordon Brown grew up in the Scottish seaside town of Kirkcaldy where his father was a minister in one of the local kirks. Adam Smith was born there in 1723, though his father was a customs official. In February, at Brown’s invitation, Alan Greenspan, chairman of the US Federal Reserve Board, visited Kirkcaldy to deliver a lecture on Adam Smith.

Smith’s Wealth of Nations was, said Greenspan, “one of the great achievements in human intellectual history”. Smith’s view that capitalists should be allowed by governments to pursue profits unhindered since, “led by an invisible hand”, this resulted in the “public good” being promoted had, he argued, became “the sole remaining effective paradigm for economic organisation” (Times, 7 February).

That’s the side of Smith that is promoted by free-marketeers such as the Adam Smith Institute. But that’s only one side of his theories. Do the free-marketeers – does Greenspan – know that the Wealth of Nations opens with a declaration that useful things are produced by labour: “The annual labour of every nation is the fund which originally supplies it with all the necessaries and conveniences of life which it annually consumes”? Or that Smith went on to expound a labour theory of value: “Labour is the real measure of the exchangeable value of all commodities” (Book I, chapter V)?

Smith even went so far as to identify profits as deriving from the value added by workers in the process of production:

“As soon as stock has accumulated in the hands of particular persons, some of them will naturally employ it in setting to work industrious people, whom they will supply with materials and subsistence, in order to make a profit by the sale of their work, or by what their labour adds to the value of the materials . . . The value which the workmen add to the materials . . . resolves itself . . . into two parts, of which one pays their wages, the other the profits of their employer upon the whole stock of materials and wages which he advanced” (Book I, chapter VI).

Smith’s labour theory of value was refined by David Ricardo and used by early critics of capitalism to argue that the capitalists were exploiters who robbed the workers of a part of the product of their labour. Marx took over and further developed this labour theory of value as the basis for his analysis of capitalism which saw the capitalists’ pursuit of profit as seeking to extract a maximum of unpaid labour from the working class.

The “public good” which Smith argued was promoted by letting capitalists pursue profits was an increase in the total amount of wealth in existence. Marx didn’t deny this, but argued that under capitalism this increase was inevitably unevenly divided: more went to capitalists as accumulated capital than to the actual wealth-producers as increased wages (if that). What Smith’s “invisible hand” did, if you like, was to build-up in this way the material basis for a socialist society of common ownership and democratic control. Which is the “sole effective paradigm” for ensuring that the productive forces built up under capitalism can be used for the benefit of all.