Adam Smith - The Classical Economists

Adam Smith and the Classical Economists

Authorities differ in their estimate of Adam Smith's treatment of the problem of distribution. It is quite apparent that Smith became conscious of distribution as an important phase of eco­nomics through his acquaintance with the Physiocrats. However, there is some reason to believe that Smith conceived of economics as concerned largely with production; distribution seems to be a hastily added appendage to his work. But it is true that the brief attention which he devoted to distribution set the pattern for later economists. Smith is concerned with distribution in the functional sense. Like the Physiocrats, he understood society as consisting of three economic groups, differentiated from each other by the source of their income: the landlords, the capitalists, and the laborers. These three groups deriving their income from rent, profit, and wages respectively, were not personalized in any sense. They were functional groups playing a necessary part in produc­tion. The return which each group received for its services was not a matter of equity or justice but of natural law. To be sure, some unfortunate situations occurred. Capitalists and landlords alike at times oppressed the wage-earner. But aside from minor variations the laws of the market place regulated the distribution of wealth and income.

How are the shares of the landlords, the capitalists, and the laborers determined? In each case it is the supply and demand for the various factors in production which set their price, and it is the contribution of each factor to the value of the article produced which determines the relative return obtained by land, labor, and capital. A greater supply of labor than is demanded, for example, lowers the price of labor and consequently reduces the income of labor. Such a situation was assumed to lead to a withdrawal of labor from the market until the price again rose to the natural or normal price existing when supply and demand were equal. Furthermore, if the article produced requires great labor but little or no capital, then the income derived by labor will be relatively large. Although it might be inferred from some passages in The Wealth of Nations that Adam Smith looked upon rent and profit as unjustifiable charges upon the value pro­duced solely by labor, closer examination will show that he be­lieved firmly that both land and capital were productive and hence entitled to a return commensurate with their relative con­tribution to the total value produced. In discussing rent, how­ever, Smith seemed a bit confused as to its nature and source. Was rent an element which had to figure in the cost of production like wages, or was it a surplus which appeared on good land as the price of produce rose to higher levels? Smith never clarified this point. Later writers, notably Ricardo, finally worked out a detailed explanation.

J. B. Say, the great French exponent of Adam Smith's ideas, improved Smith's doctrine of distribution. The principal change came in the concept of the entrepreneur, the person who brought together the necessary amount and type of land, labor, and capi­tal to engage in production. Smith had assumed that the owner of capital and the organizer of a business enterprise were one and the same individual. Say understood that one individual might provide the capital as well as initiate the business activity, but he believed the process of distribution could be understood better by separating these two functions. Indeed, Say believed that it was only through the services of the entrepreneur that distribu­tion took place at all. Land, labor, and capital might be readily available and the demand for goods might be great, but until the entrepreneur initiated an enterprise there was no demand for the factors of production or supply of goods. Thus the entre­preneur served as the intermediary through whom income was produced and distributed. It was in his opinion ultimately the pro­ductivity of each of the elements in production as regulated by the law of supply and demand which determined the return each unit of land, labor, and capital received. But it was the entrepreneur who in reality first estimated these factors and paid the sums necessary to bring these factors into productive relationship. Say was very emphatic upon the need of separating the return on capital from the earnings of the entrepreneur. His insistence on this point was largely responsible for the extensive use of the word entrepreneur in contemporary economic literature.

It was David Ricardo who took the confused ideas of distribu­tion propounded by his predecessors and worked them into a well rounded theory. He made the first real attempt to describe the process by which the various shares of income arise and how their quantity is determined. Although later writers have made it clear that Ricardo failed to clarify the problem of distribution, his ideas on that subject were accepted as authoritative for nearly a century. To Ricardo the problem of distribution was inseparable from the problem of value, for although in a letter to McCulloch in 1820 he denied that such dependence was necessary, his views constantly emphasized the close relationship of these two con­cepts.

First of all, Ricardo accepted the traditional division of income into rent, wages, and profit, corresponding to the three factors of production: land, labor, and capital. Thus no distinction was made between profit and interest. But that was secondary. The process of distribution, he believed, hinged upon the character of social development. As population increased, the increasing demand for food raised the price of food and brought into culti­vation less fertile lands. Ricardo argued to show that in reality the rise in price of food was caused by the greater amount of labor necessary to produce food from the less fertile land. Be that as it may, each time additional land was brought under cul­tivation, rent—which is the differential between the costs of pro­duction on one piece of land as compared with the costs of production on the least fertile piece of land necessary to maintain an adequate supply—was increased. Thus rents continued to rise as civilization advanced.

Wages, on the other hand, were governed by the inflexible law of subsistence. Ricardo said, "The natural price of labor is the price which is necessary to enable the laborers, one with another, to subsist and to perpetuate their race, without either increase or diminution." The wages paid did not always correspond to the "natural price of labor." He maintained that when civiliza­tion is advancing, capital (including food, clothes, tools) in­creases and pushes upward the demand for labor. This is so because in such a state of civilization, the land under cultivation is the most fertile and consequently the productivity of labor is high, making the accumulation of capital more rapid than the growth of population. With the lapse of time this trend is reversed and population advances faster than the accumulation of capital because now the less fertile lands have to be used to supply the necessities of life. With less capital there follows naturally a de­crease in the demand for labor, the surplus of which is ultimately absorbed in the greater application of labor required by less fertile lands. The net result is a decline in real wages. Subsistence represents the minimum point to which wages can fall. What subsistence is depends upon the habitual living standards devel­oped by the community. So Ricardo arrived at the essentially pessimistic belief that as population increased more labor had to be applied to soil of decreasing fertility, which inevitably de­creased wages. Where this vicious circle stopped or how it is stopped, Ricardo did not say. It is a safe guess that he shared Malthus' views that population would be curtailed to the limit of the food supply by the increasing severity of natural forces cut­ting down the population, for example: vice, wars, famine, and disease.

He went on to explain, however, that with rents taking an ever larger share of income, and wages commanding a relatively fixed minimum, profits alone must suffer the loss equivalent to the gain in rents. He put the case even more strongly. Profit is essentially what is left over after labor is paid for its work on land which yields no rent. To illustrate, on a piece of marginal land— that is, land which yields no rent at present prices—the sum realized from the sale of produce is divided between wages and profits. The share going to wages can never be lower than the subsistence of the laborers; the amount going to capital must be sufficient to encourage accumulation. It is necessary to point out at this time that when the economist speaks of rent he usually means economic rent. That is, the natural or theoretical return which a piece of land should receive for its share in production. If the selling price of produce just equals wages and interest, there is no economic rent. Money rent, or the sum paid by a lease­holder to a landlord, may be above or below the economic rent. If above, money rent is paid by taking a share of the return right­fully belonging to labor or capital.

The net result of Ricardo's teaching was to emphasize the com­petitive nature of distribution; and this led logically to the idea of the class struggle. Marx in later years saw the implication of Ricardo's ideas, and built upon them his own system of the ex­ploitive "squeeze" put upon labor by the landlord on the one hand and by the capitalist on the other. In spite of his insistence that distribution was the fundamental problem in political economy, later authorities claim that Ricardo did not succeed in giving an accurate description of how the relative proportions of income were determined. Unwarranted assumptions and circular reason­ing served in succeeding years to diminish the great respect with which his work was at first received.

The basic assumption which preceded the ideas of the classical economists examined thus far was that distribution was controlled by natural forces which were interfered with by man to his own undoing. Even the pessimistic trend described by Ricardo might be made worse by attempts at human control. The more opti­mistic note struck by Smith assured all concerned that in spite of the obvious inequalities in distribution the operation of self-interest and natural law would result in greater abundance for all. Ricardo was more pessimistic, but he agreed that in the long run land, labor, and capital received a return equivalent to their respective productivity. Hence, the mode of distribution was not only outside of human control but it also was essentially equi­table.