Transition to Smith: The PhysiocratsFixation on agriculture

• Manufacturing & commerce sterile

Champions of laissez – faire• François Quesnay (1694 – 1774)

– Physician to Mme. de Pompadour: Economy Anatomy/Circular flow– Leader of group: disciples and associates including Mirabeau, Dupont,

Turgot, … and Smith

– Tableau Economique an Input-Output tableInitially: Landlord has cash; farmer has grain; artisan has stock of goods

Landlord buys and food and manufactures…Manufacturer buys food

• Zig – zag to balance flows• Agriculture increased wealth (counter to Colbert’s favoring mfg)• Taxes ultimately borne by landlords tax land rents directly• Hoarding (of money) threatens economic stability…Malthus/Keynes• Free trade/free competition most profitable for the nation…Smith

The tableau: http://homepage.newschool.edu/het//essays/youth/tableauoverview.htm#summary

The Visions of Adam Smith• Self – regulating system of markets• Virtuous circles … Progress

• Rule of Law/Property Rights Productivity Rule of Law

• Division of Labor Extent of Market Division of Labor

Social interdependence [Social science]—Invisible hand

Economy Solar System Social PhysicsSelf –regulating system of marketsNewtonian influence

• Progress!• Material progress:

HuntersShepherdsFarmersMerchants• Progress in governance:

Increased liberty/security of property

Feedback to material sphere

Adam Smith, 1723 – 1790

• Glasgow University– Student of Francis Hutcheson

Greatest happiness of greatest number

• Friendship with David Hume

– Chair of Logic (1751),Moral Philosophy (1752)• Theory of Moral Sentiments, 1759• Lectures on Jurisprudence, early 1760s

• Tutor of Townsend’s stepson

Continental travel, 1764 – 1766

Acquaintance with French Physiocrats

Generous pension

• Kirkcaldy, 1766 – 1776 – The Wealth of Nations, 1776

• Scotland Commissioner of Customs

Scottish Enlightenment

The Wisdom of Adam Smith

From The Theory of Moral Sentiments, 1759•How selfish soever man may be supposed, there are evidently some principles in his nature, which interest him in the fortune of others, and render their happiness necessary to him, though he derives nothing from it except the pleasure of seeing it.

Lets translate the rest

•It hurts to be the object of hatred and indignation; and there is satisfaction in being beloved [and respected]. This is more important to happiness than all the [material] advantage a person expects to get from it.

Theory of Moral Sentiments

• Because others sympathize more with our joy than with our sorrow, we show off our riches and conceal our poverty … it is from this regard to the sentiments of mankind that we pursue riches and avoid poverty.

• We want to be respectable and respected… To deserve, get and enjoy the respect and admiration of others are the great objects of ambition.

• There are two different ways to achieve this:

» one, by the study of wisdom and the practice of virtue;

» the other, by the acquisition of wealth and greatness.

• Smith’s martial spirit

Saving hundreds of millions in China at the cost of our little finger:

• … what is it which prompts the generous upon all occasions and the mean upon many to sacrifice their own interests to the greater interests of others, …counteracting the strongest impulses of self-love?. . . It is a stronger love, a more powerful affection, the love of what is honorable and noble …

An affection more powerful than self – love!

Themes in An Inquiry into the Nature and Causes of the Wealth of Nations, 1776

Division of labor

Self Interest and Cooperation in MarketsRole of government

Foreign trade

Labor theory of value

Theory of distribution

Accumulation and progress

Adam Smith Problems?

• Inconsistency between Moral Sentiments and Wealth of Nations?

• Skepticism of tradesmen

• Important roles of government

• Plagiarism

Greenspan’s [Selective] Reading:The Age of Turbulence, 2007

… a vision of society in which individuals guided by reason were at liberty to choose their destinies.

…What makes an economy grow? …[C]apital accumulation, free trade, a circumscribed role for government, the rule of law…[and] personal initiative…the pursuit of self-interest…working smarter

…The ‘invisible hand’ promotes the public good…[which] seems to impute as a godlike benevolence and omniscience to the market

• All this is in The Wealth of Nations … but there’s more

From An Inquiry Into the Nature and Causes of the Wealth of Nations

…the division of labor is limited by the extent of the market• To take an example, the trade of the pin-maker; a workman not

educated to this business could scarce, perhaps, with his utmost industry, make one pin in a day… But [pin making] is divided into a number of branches, of which the greater part are likewise peculiar trades. One man draws out the wire, another straights it, a third cuts it, a fourth points it, a fifth grinds it at the top for receiving the head…Making a pin is, in this manner, divided into about eighteen distinct operations, which, in some manufactories, are all performed by distinct hands… I have seen a small manufactory … but indifferently accommodated with the necessary machinery [where ten men could] make among them about twelve pounds of pins in a day. There are in a pound upwards of four thousand pins of a middling size… Each person, therefore, making a tenth part of forty-eight thousand pins, might be considered as making four thousand eight hundred pins in a day. But if they had all wrought separately and independently, and without any of them having been educated to this peculiar business, they certainly could not each of them have made twenty, perhaps not one pin in a day…

Economic Man: Self – interest and exchange• This division of labor…is not originally the effect of any human

wisdom, which foresees and intends the general opulence to which it gives occasion. It is the necessary … consequence of a propensity in human nature … to truck, barter, and exchange one thing for another.

• In civilized society [man] stands at all times in need of cooperation and assistance of great multitudes, while his whole life is scarce sufficient to gain the friendship of a few persons.... [M]an has almost constant occasion for the help of his brethren, and it is in vain for him to expect it from their benevolence only.

• It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages...

• [Value] is adjusted... by the higgling and bargaining of the market, according to that sort of rough equality which, though not exact, is sufficient for carrying on the business of common life.

Evils of monopoly • Monopoly...is a great enemy to good management. • 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.

• As soon as the land of any country has all become private property the landlords, like other men, love to reap where they never sowed and demand a rent even for its natural produce.

Virtues of competition• [W]here competition is free, the rivalry of competitors, who are all trying to

jostle one another out of employment, obliges each to work with a certain degree of exactness...

• The natural price, or the price of free competition ... is the lowest which can be taken, not on every occasion, but for any considerable time ...[It] is the lowest price which sellers can commonly afford to take and stay in business.

The Role of Government and Laissez – Faire• protecting society from invasion• administration of justice• public works and public institutions

• Every individual... neither intends to promote the public interest nor knows how much he is promoting it...[B]y directing [his] industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this … led by an invisible hand to promote an end which was no part of his intention.

Social Physics: Newton in the Economic Universe

Free trade

• … never make at home what it costs more to make than to buy... If a foreign country can supply a commodity cheaper than we can make it, buy from them with goods where we have an advantage.

– By means of glasses, hotbeds, and hotwalls, very good grapes can be

raised in Scotland, and very good wine can be made of them at about thirty times the expense for which at least equally good can be brought from foreign countries. Would it be a reasonable law to prohibit the importation of all foreign wines, merely to encourage the making of claret and burgundy in Scotland?

– A great empire [America] has been established for the sole purpose of raising up a nation of customers who are obliged to buy from our shops and producers all the goods we can supply. For the sake of that little enhancement of price which this monopoly might afford our producers, the home-consumers have been burdened with the whole expense of maintaining and defending that empire…The interest on the debt incurred is not only greater than the whole extraordinary profit made by the monopoly of the colony trade, but greater than the whole value of that trade...

Smith’s Theory of Value• Value in use – Value in exchange

• Water – diamond “paradox”» Consumer surplus to our rescue

• Labor Theory of ValueLabor cost theory / Labor command theory• The real price of every thing, what every thing really costs to the man who

wants to acquire it, is the toil and trouble of acquiring it … What is bought with money or with goods is purchased by labor, as much as what we acquire by the toil of our own body. That money or those goods indeed save us this toil. They contain the value of a certain quantity of labor which we exchange for what is supposed at the time to contain the value of an equal quantity. Labor was the first price, the original purchase-money that was paid for all things … and its value to those … who want to exchange it for some new productions is precisely equal to the quantity of labor which it can enable them to purchase or command.

Smith’s Labor Theory of Value• At all times and places that is dear which it is difficult to come at, or which it

costs much labor to acquire; and that cheap which is to be had easily, or with very little labor. Labor alone, therefore, never varying in its own value, is alone the ultimate and real standard by which the value of all commodities can at all times and places be estimated and compared. It is their real price; money is their nominal price only.

• Smith’s theory of money: just a convenience» Gold and silver’s values depend on the toil and trouble (labor) of

mining them.

Deer and beavers: 2 Deer = 1 Beaver• In that early and rude state of society which precedes both the accumulation

of stock and the appropriation of land, the proportion between the quantities of labor necessary for acquiring different objects seems to be the only circumstance which can afford any rule for exchanging them for one another. If among a nation of hunters, for example, it usually costs twice the labor to kill a beaver which it does to kill a deer, one beaver should naturally exchange for or be worth two deer.

» No return to capital?» Later, once land is appropriated, what about rent?

Smith’s Theory of Distribution• … the three great social classes

– Labor wage– Capital profit– Landlord rent

But if all value comes from labor, where do profit & rent come from?… Rent makes the first deduction from the produce of labor employed upon the land … and the produce of almost all other labor is liable to the like deduction of profit.

» Exploitation? … Smith doesn’t go there

Profit rate: a multiple of the interest rate on money… wherever a great deal can be made by the use of money, a great deal

will be given for the use of it … The progress of interest therefore may lead us to form some notion of the progress of profit.

Net Profit = Gross Profit – Interest{Both interest and profit fluctuate with investment opportunities}

• Rent: … High and low wages and profits are causes of high or low prices; high or low rent is the effect of it (high or low prices).

Progress Increased Demand Higher Prices Higher Rent

Accumulation, Wages, and Profits(Accumulation: Saving and Investment by Capitalists)

Accumulation

Wage fund

Wage(Iron Law of Wages)

Population Productivity

Profit

Smith’s Theory of Progress

The division of labor is limited by the extent of the market• What extends the market and increases division of labor?

Spatial factors:• Urbanization agglomeration economies• Location on seashores and rivers• Improvements in transportation

Colonial settlement … imperialism

Foreign trade

Free competition

Increased domestic income• Higher wage• Increased population

Extent of the market Division of Labor Productivity Output

Income

Price

Smith’s Spiral of Growth

National Wealth I

Opportunity for division of labor

Profit Expectations

Demand for Investment

Increased interest rate

Increased Saving

Accumulation

Increased Demand for Labor

Higher Wage

Increased Labor Supply(Reduced Mortality)

Employment with increasedDivision of Labor

National Wealth II

More Adam Smith Problems

• Division of labor Alienation… The man whose whole life is spent in performing a few

simple operations … has no occasion to exert his understanding or to exercise his invention … [He] becomes as stupid and ignorant as it is possible for a human creature to become. His dexterity at his own trade [is] acquired at the expense of his intellectual, social, and martial virtues.

… It is otherwise in the barbarous societies … every man is a warrior.

• Division of labor = Increasing Returns MonopolyIndustrial Age concentration

Globalization and information age Agglomerationand networking, not concentration

– Microsoft?– Google?

• Spiraling progress … or stationary state?It is in the progressive state, while society is advancing toward further acquisition, rather than when it has acquired its full complement of riches, that the condition of the great body of people seems to be happiest and most comfortable. It is hard in the stationary state and miserable in the declining state.…that full complement of riches which the nature of its soil and climate and its situation with respect to other countries allows it to acquire.In a country fully peopled in proportion to what either its territory could maintain or its stock employ … In a country fully stocked in proportion to all the business it had to transact … the competition would be great and the ordinary profit as low as possible.

An extinguished Sun … in the very long-runBut until then, Smith prophesies progress:

Don’t worry! Be happy!Don’t worry! Be happy!

Adam Smith: A SummationAdam Smith: A Summation

• Moral sentiments a first principle.Moral sentiments a first principle.• Market coordination of self – interested individualsMarket coordination of self – interested individuals

““Economic man” led by an “invisible hand”Economic man” led by an “invisible hand”

Competition Competition Efficiency Efficiency andand Equity Equity» Guard against monopolyGuard against monopoly

• Laissez – faire!Laissez – faire!Restricted government trumps government restrictionsRestricted government trumps government restrictions

• Labor theory of valueLabor theory of value• Progress through specialization and exchangeProgress through specialization and exchange

The division of labor is limited by the extent of the marketThe division of labor is limited by the extent of the market..

Spiraling progressSpiraling progress

Stagnation and decline in the distant futureStagnation and decline in the distant future