The Wealth of Nations From Wikipedia, the free encyclopedia Adam Smith's first title pageAn Inquiry into the Nature and Causes of the Wealth of Nations is the magnum opus of the Scottish economist Adam Smith. It is a clearly written account of economics at the dawn of the Industrial Revolution, as well as a rhetorical piece written for the generally educated individual of the 18th century - advocating a free market economy as more productive and more beneficial to society. The work is credited as a watershed in history and economics due to: a comprehensive, largely accurate characterization of economic mechanisms that survives in modern economics effective use of rhetorical technique; including structuring the work to contrast real world examples of free and fettered markets Contents [hide] 1 Themes 1.1 The invisible hand 1.2 Meritocracy 2 History and significance 2.1 Publishing history 2.2 Anachronisms and terminology 3 Book I: Of the Causes of Improvement... 3.1 Of the Division of Labour 3.2 Of the Principle which gives Occasion to the Division of Labour 3.3 That the Division of Labour is Limited by the Extent of the Market 3.4 Of the Origin and Use of Money 3.5 Of the Real and Nominal Price of Commodities, or of their Price in Labour, and their Price in Money 3.6 Of the Component Parts of the Price of Commodities 3.7 Of the Natural and Market Price of Commodities 3.8 Of the Wages of Labour 3.9 Of the Profits of Stock 3.10 Of Wages and Profit in the Different Employments of Labour and Stock 3.11 Of the Rent of the Land 4 Book II: Of the Nature, Accumulation, and Employment of Stock 4.1 Of the Division of Stock 4.2 Of Money Considered as a particular Branch of the General Stock of the Society... 4.3 Of the Accumulation of Capital, or of Productive and Unproductive Labour 4.4 Of Stock Lent at Interest 5 Book III: Of the different Progress of Opulence in different Nations 5.1 Of the Natural Progress of Opulence 5.2 Of the Discouragement of Agriculture... 5.3 Of the Rise and Progress of Cities and Towns, after the Fall of the Roman Empire 5.4 How the Commerce of the Towns Contributed to the Improvement of the Country 6 Book IV: Of Systems of political Economy
6.1 Of the Principle of the Commercial or Mercantile System 6.2 Of Restraints upon the Importation... 6.3 Of the extraordinary Restraints... 6.4 Of Drawbacks 6.5 Of Bounties 6.6 Of Treaties of Commerce 6.7 Of Colonies 6.8 Conclusion of the Mercantile System 6.9 Of the Agricultural Systems... 7 Book V: Of the Revenue of the Sovereign or Commonwealth 7.1 Of the Expenses of the Sovereign or Commonwealth 7.2 Of the Sources of the General or Public Revenue of the Society 7.3 Of War and Public Debts 8 Continuing Relevance 9 Controversy 10 See also 11 Notes 12 External links Themes The invisible hand A phrase often quoted and alluded to, it conveys the unintentional benefits stemming from individual's pursuit of their own wants and needs. An example from the earlier chapters: The Butcher, the Baker, and the Brewer provide goods and services to each other out of self-interest; the unplanned result of this division of labor is a better standard of living for all three. There are two important features of Smith's concept of the "invisible hand". First, Smith was not advocating a social policy (that people should act in their own self interest), but rather was describing an observed economic reality (that people do act in their own interest). Second, Smith was not claiming that all self-interest has beneficial effects on the community. He did not argue that self-interest is always good; he merely argued against the view that self-interest is necessarily bad. It is worth noting that, upon his death, Smith left much of his personal wealth to charity. On another level, though, the "invisible hand" refers to the ability of the market to correct for seemingly disastrous situations with no intervention on the part of government or other organizations (although Smith did not, himself, use the term with this meaning in mind). For example, Smith says, if a product shortage were to occur, that product's price in the market would rise, creating incentive for its production and a reduction in its consumption, eventually curing the shortage. The increased competition among manufacturers and increased supply would also lower the price of the product to its production cost plus a small profit, the "natural price." Smith believed that while human motives are ultimately out of self interest, the net effect in the free market would tend to benefit society as a whole. This was later adopted as a universal principle by the laissezfaire economists of the 19th century.
Smith apparently used the phrase "invisible hand" only three times in his work. Later writers, both supporters and detractors, repeated this phrase far out of proportion to Smith's own usage. Meritocracy Meritocracy is an important factor in the work; Smith emphasizes the advancement that one can take based on their will to better themselves. People would want to do things with a strong mindset without the interference of the outside norms. Smith also points out the fact that the outside forces lead to infancy in the division of labor, therefore slowing the economic growth. Because the idea of self-improvement is very strong, meritocracy efficiently moves the outcomes of the division of labor, ultimately leading to more efficiency in the economy. History and significance The Wealth of Nations was published in 1776, during the Age of Enlightenment. It influenced not only authors and economists, but governments and organizations. For example, Alexander Hamilton was influenced in part by The Wealth of Nations to write his Report on Manufactures, in which he argued against many of Smith's policies. Interestingly, Hamilton based much of this report on the ideas of Jean-Baptiste Colbert, and it was, in part, to Colbert's ideas that Smith wished to respond with The Wealth of Nations. Many other authors were influenced by the book and used it as a starting point in their own work, including Jean-Baptiste Say, David Ricardo, Thomas Malthus and, later, Karl Marx and Ludwig von Mises. The Russian national poet Aleksandr Pushkin refers to The Wealth of Nations in his 1833 verse-novel Eugene Onegin. Irrespective of historical influence, however, The Wealth of Nations represented a clear leap forward in the field of economics, similar to Sir Isaac Newton's Principia Mathematica for physics or Antoine Lavoisier's Traité Élémentaire de Chimie for chemistry. History Five editions of The Wealth of Nations were published during Smith's lifetime: in 1776, 1778, 1784, 1786, and 1789. Numerous editions appeared after Smith's death in 1790. To better understand the evolution of the work under Smith's hand, a team led by Edwin Cannan collated the first five editions. The differences were published along with an edited fifth edition in 1904. They found minor but numerous differences (including the addition of many footnotes) between the first and the second editions, both of which were published in two volumes. The differences between the second and third editions, however, are major: In 1784, Smith annexed these first two editions with the publication of Additions and Corrections to the First and Second Editions of Dr. Adam Smith’s Inquiry into the Nature and Causes of the Wealth of Nations, and he also had published the now three volume third edition of the Wealth of Nations which incorporated Additions and Corrections and, for the first time, an index. Among other things, the
Additions and Corrections included entirely new sections. The fourth edition published in 1786 had only slight differences with the third edition, and Smith himself says in the Advertisement at the beginning of the book, "I have made no alterations of any kind." Finally, Cannan notes only trivial differences between the fourth and fifth editions — a set of misprints being removed from the fourth, and a different set of misprints being introduced into the fifth. Anachronisms and terminology Some commentary on the work suffers from anachronism - imposition of modern context and political contests on a two hundred and fifty year old work. The book is written in the English of the late 1700s, so there are some points to consider: The term economics was not yet in use. The term capitalism was not yet in use. Smith talks about a "system of perfect liberty" or "system of natural liberty". To a certain extent, some form of Feudalism was still dominant in parts of Europe (primarily Eastern Europe and Russia). The term corporation, as in feudal corporations, referred to a body that regulated and, in Smith's portrayal, limited participation in a skilled trade. Book I: Of the Causes of Improvement... Of the Division of Labour Smith stated that the greatest improvement in the productive powers of labour, and the greater part of the skill, dexterity, and judgment with which it is anywhere directed, or applied, seem to have been the effects of the division of labour. To illustrate this, he describes the extensive division of labour within the "trifling" industry of pin manufacture, along with the astounding resultant productivity, and labourers' dexterity; then levers this as an introductory microcosm of the greater, yet less obvious division of labour in the broader economy. The advantages of this division were likely the driving force behind diversification of the trades and industry, and this diversification was greatest for nations with more industry and improvement. Agriculture is differentiated from industry for its comparative lack of division of labour, and the attendant lack of improved productivity; hence, while poor nations could not compete with rich nations in manufactures, they could compete in agriculture. Smith lists three causes, arising from division, of improved productivity: the labourer's dexterity - due to specializing, year-round, in a specific task time not wasted passing from one task to the next - as in agriculture - as well as the more consistent and focused effort when working in just one area the machines and tools that have evolved in conjunction with increasingly specialised labour. Of the Principle which gives Occasion to the Division of Labour
Chapter 2 illustrates the growth in division of labour. Smith hypothesizes that early societies benefited from specialization in a natural and spontaneous way - that an individual may focus on hunting while an other focuses on manufacture (an early trade). That the Division of Labour is Limited by the Extent of the Market Chapter 3 deals with limitations on division of labour. Smith illustrates with real world examples of how the extent of market determines the level of division of labour and the resulting productivity improvements; it is the extent of the market that determines the degree to which division of labour can survive - in a limited market, the liability of specialization out weigh the benefits of greater productivity. Of the Origin and Use of Money When money was first invented, it was not well regulated, which made agriculture and commodities very difficult between individual owners. Of the Real and Nominal Price of Commodities, or of their Price in Labour, and their Price in Money See also: Real versus nominal value and Labour theory of value Smith begins by setting out the source of a commodity's value. He states, "Every man is rich or poor according to the degree in which he can afford to enjoy the necessaries, conveniencies, and amusements of human life. But after the division of labour has once thoroughly taken place, it is but a very small part of these with which a man's own labour can supply him. The far greater part of them he must derive from the labour of other people, and he must be rich or poor according to the quantity of that labour which he can command, or which he can afford to purchase. 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. 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." This is known as the labour theory of value, a defining feature of classical political economy. Smith then distinguishes between the nominal value of a commodity (in money denomination) and its real value in the labour required to purchase it. According to Smith, while the nominal value of a commodity is subject to fluctuation, this does not change its real value, because the amount of labour required to produce it and bring it to the market remains constant. For example, the price of a commodity redeemable in silver may be 1:1, as the amount of labour required to produce that commodity is the same as the amount of labour required to retrieve one piece of silver. However, with the discovery of new silver mines in North America, a surge in the supply of silver in the economy may bring the nominal price of
the commodity in silver to 1:2. Yet this does not affect the commodity's real value, because the abundance of silver in the newly discovered mines does not suppose a lesser degree of labour required to retrieve them, but simply a greater availability of silver in the market. It is this greater availability that accounts for the deflation of the price; while the commodity is worth just as much labour now as it was before, it will not command as much power in the economy as before. However, if the price were to rise to 1:2 as a result of technological improvements in the manufacture or transport of the commodity, this would constitute a decline in its real value, because less labour is necessary to produce and market it. Of the Component Parts of the Price of Commodities Smith argues that the price of any product reflects the wages of the labourers involved, the rent of the land used to create the product (if applicable), and the "profit of stock," which serves to compensate the capitalist for risking his resources in the commodity's production. Of the Natural and Market Price of Commodities See also: Price "When the quantity of any commodity which is brought to market falls short of the effectual demand, all those who are willing to pay... cannot be supplied with the quantity which they want... Some of them will be willing to give more. A competition will begin among them, and the market price will rise... When the quantity brought to market exceeds the effectual demand, it cannot be all sold to those who are willing to pay the whole value of the rent, wages and profit, which must be paid in order to bring it thither... The market price will sink..." "A monopoly granted either to an individual or to a trading company has the same effect as a secret in trade or manufactures. The monopolists, by keeping the market constantly understocked, by never fully supplying the effectual demand, sell their commodities much above the natural price, and raise their emoluments, whether they consist in wages or profit, greatly above their natural rate. The price of monopoly is upon every occasion the highest which can be got. The natural price, or the price of free competition, on the contrary, is the lowest which can be taken, not upon every occasion, indeed, but for any considerable time together. The one is upon every occasion the highest which can be squeezed out of the buyers, or which, it is supposed, they will consent to give: the other is the lowest which the sellers can commonly afford to take, and at the same time continue their business."
Of the Wages of Labour In this section, Smith describes how the wages of labour are dictated primarily by the competition among labourers and masters. When labourers bid against one another for limited opportunities for employment, the wages of labour collectively fall, whereas when employers compete against one another for limited supplies of labour, the wages of labour collectively rise. However, this process of competition is often circumvented by combinations among labourers and among masters. When labourers combine and no
longer bid against one another, their wages rise, whereas when masters combine, wages fall. In Smith's day, it should be noted, organized labour was dealt with very harshly by the law. In societies where the amount of labour is in abundance to the amount of revenue which may be used to pay for waged labour, the competition among workers is greater than the competition among masters, and wages fall; inversely, where excess revenue is in abundance, the wages of labour rise. Smith argues that, therefore, the wages of labour only rise as a result of greater revenue disposed to pay for labour. Labour is the same as any other commodity in this respect thought Smith, "the demand for men, like that for any other commodity, necessarily regulates the production of men; quickens it when it goes on too slowly, and stops it when it advances too fast. It is this demand which regulates and determines the state of propagation in all the different countries of the world, in North America, in Europe, and in China; which renders it rapidly progressive in the first, slow and gradual in the second, and altogether stationary in the last." However, the amount of revenue must be increasing constantly in proportion to the amount of labour in order for wages to remain high. Smith illustrates this by juxtaposing England with the North American colonies. In England, there is certainly a greater amount of revenue than in the colonies; however, the wages of labour are lower, because more workers would flock to new employment opportunities to which the large amount of revenue gives occasion, eventually competing against each other as much as they did before. By contrast, as capital continues to be introduced to the colonial economies at least at the same rate that population increases to "fill out" this excess capital, the wages of labour there are kept much higher than in England. Smith was highly concerned about the problems of poverty. He writes, "poverty, though it does not prevent the generation, is extremely unfavourable to the rearing of children... It is not uncommon... in the Highlands of Scotland for a mother who has borne twenty children not to have two alive... In some places one half the children born die before they are four years of age; in many places before they are seven; and in almost all places before they are nine or ten. This great mortality, however, will every where be found chiefly among the children of the common people, who cannot afford to tend them with the same care as those of better station." the only way to decide whether a man is rich or poor only depends on the amount of labour he is able to afford to purchase. "Labour is the real exchange for commodities" P36 <The Harvard Classics Vol. 10> Of the Profits of Stock In this chapter, Smith uses interest rates as an indicator of the profits of stock. This is because interest can only be paid with the profits of stock, and so creditors will be able to raise rates in proportion to the increase or decrease of the profits of their debtors.
Smith argues that the profits of stock are inversely proportional to the wages of labor, because as more money is spent compensating labor, there is less remaining for personal profit. It follows that, in societies where competition among laborers is greatest relative to competition among employers, profits will be much higher. Smith illustrates this by comparing interest rates in England and Scotland. In England, government laws against usury had kept maximum interest rates very low, but even the maximum rate was believed to be higher than the rate at which money was usually lended. In Scotland, however, interest rates are much higher. This is the result of a greater proportion of capitalists in England, which offsets some competition among laborers and raises wages. However, Smith notes that, curiously, interest rates in the colonies are also remarkably high (recall that, in the previous chapter, Smith described how wages in the colonies are higher than in England). Smith attributes this to the fact that, when an empire takes control of a colony, prices for a huge abundance of land and resources are extremely cheap. This allows capitalists to increase his profit, but simultaneously draws many capitalists to the colonies, increasing the wages of labor. As this is done, however, the profits of stock in the mother country rise (or at least cease to fall), as much of it has already flocked offshore. Of Wages and Profit in the Different Employments of Labour and Stock Smith repeatedly attacks groups of politically aligned individuals who attempt to use their collective influence to manipulate the government into doing their bidding. At the time, these were referred to as "factions," but are now more commonly called "special interests," a term which can comprise international bankers, corporate conglomerations, outright oligopolies, trade unions and other groups. Indeed, Smith had a particular distrust of the tradesman class. He felt that the members of this class, especially acting together within the guilds they want to form, could constitute a power block and manipulate the state into regulating for special interests against the general interest: "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. It is impossible indeed to prevent such meetings, by any law which either could be executed, or would be consistent with liberty and justice. But though the law cannot hinder people of the same trade from sometimes assembling together, it ought to do nothing to facilitate such assemblies; much less to render them necessary." Smith also argues against government subsidies of certain trades, because this will draw many more people to the trade than what would otherwise be normal, collectively lowering their wages. Chapter 10, part ii, motivates an understanding of the idea of feudalism. Of the Rent of the Land Please help improve this section by expanding it. Further information might be found on the talk page or at requests for expansion. (June 2008)
Rent, considered as the price paid for the use of land, is naturally the highest which the tenant can afford to pay in the actual circumstances of the land. In adjusting the terms of the lease, the landlord endeavours to leave him no greater share of the produce than what is sufficient to keep up the stock from which he furnishes the seed, pays the labour, and purchases and maintains the cattle and other instruments of husbandry, together with the ordinary profits of farming stock in the neighbourhood. This is evidently the smallest share with which the tenant can content himself without being a loser, and the landlord seldom means to leave him any more. Whatever part of the produce, or, what is the same thing, whatever part of its price, is over and above this share, he naturally endeavours to reserve to himself as the rent of his land, which is evidently the highest the tenant can afford to pay in the actual circumstances of the land. Sometimes, indeed, the liberality, more frequently the ignorance, of the landlord, makes him accept of somewhat less than this portion; and sometimes too, though more rarely, the ignorance of the tenant makes him undertake to pay somewhat more, or to content himself with somewhat less, than the ordinary profits of farming stock in the neighbourhood. This portion, however, may still be considered as the natural rent of land, or the rent for which it is naturally meant that land should for the most part be let. Book II: Of the Nature, Accumulation, and Employment of Stock Of the Division of Stock When the stock which a man possesses is no more than sufficient to maintain him for a few days or a few weeks, he seldom thinks of deriving any revenue from it. He consumes it as sparingly as he can, and endeavours by his labour to acquire something which may supply its place before it be consumed altogether. His revenue is, in this case, derived from his labour only. This is the state of the greater part of the labouring poor in all countries. II.1.1 But when he possesses stock sufficient to maintain him for months or years, he naturally endeavours to derive a revenue from the greater part of it; reserving only so much for his immediate consumption as may maintain him till this revenue begins to come in. His whole stock, therefore, is distinguished into two parts. That part which, he expects, is to afford him this revenue, is called his capital.
Of Money Considered as a particular Branch of the General Stock of the Society... From references of the first book, that the price of the greater part of commodities resolves itself into three parts, of which one pays the wages of the labour, another the profits of the stock, and a third the rent of the land which had been employed in producing and bringing them to market: that there are, indeed, some commodities of which the price is made up of two of those parts only, the wages of labour, and the profits of stock: and a very few in which it consists altogether in one, the wages of labour: but that the price of every commodity necessarily resolves itself into some one, or other, or all of these three parts; every part of it which goes neither to rent nor to wages, being necessarily profit to somebody.
Of the Accumulation of Capital, or of Productive and Unproductive Labour See also: Capital accumulation 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. Of Stock Lent at Interest The stock which is lent at interest is always considered as a capital by the lender. He expects that in due time it is to be restored to him, and that in the meantime the borrower is to pay him a certain annual rent for the use of it. The borrower may use it either as a capital, or as a stock reserved for immediate consumption. If he uses it as a capital, he employs it in the maintenance of productive labourers, who reproduce the value with a profit. He can, in this case, both restore the capital and pay the interest without alienating or encroaching upon any other source of revenue. If he uses it as a stock reserved for immediate consumption, he acts the part of a prodigal, and dissipates in the maintenance of the idle what was destined for the support of the industrious. He can, in this case, neither restore the capital nor pay the interest without either alienating or encroaching upon some other source of revenue, such as the property or the rent of land. The stock which is lent at interest is, no doubt, occasionally employed in both these ways, but in the former much more frequently than in the latter. Book III: Of the different Progress of Opulence in different Nations Of the Natural Progress of Opulence The great commerce of every civilized society is that carried on between the inhabitants of the town and those of the country. It consists in the exchange of crude for manufactured produce, either immediately, or by the intervention of money, or of some sort of paper which represents money. The country supplies the town with the means of subsistence and the materials of manufacture. The town repays this supply by sending back a part of the manufactured produce to the inhabitants of the country. The town, in which there neither is nor can be any reproduction of substances, may very properly be said to gain its whole wealth and subsistence from the country. We must not, however, upon this account, imagine that the gain of the town is the loss of the country. The gains of both are mutual and reciprocal, and the division of labour is in this, as in all other cases, advantageous to all the different persons employed in the various occupations into which it is subdivided. Of the Discouragement of Agriculture... Chapter 2's long title is "Of the Discouragement of Agriculture in the Ancient State of Europe after the Fall of the Roman Empire". When the German and Scythian nations overran the western provinces of the Roman empire, the confusions which followed so
great a revolution lasted for several centuries. The rapine and violence which the barbarians exercised against the ancient inhabitants interrupted the commerce between the towns and the country. The towns were deserted, and the country was left uncultivated, and the western provinces of Europe, which had enjoyed a considerable degree of opulence under the Roman empire, sunk into the lowest state of poverty and barbarism. During the continuance of those confusions, the chiefs and principal leaders of those nations acquired or usurped to themselves the greater part of the lands of those countries. A great part of them was uncultivated; but no part of them, whether cultivated or uncultivated, was left without a proprietor. All of them were engrossed, and the greater part by a few great proprietors. This original engrossing of uncultivated lands, though a great, might have been but a transitory evil. They might soon have been divided again, and broke into small parcels either by succession or by alienation. The law of primogeniture hindered them from being divided by succession: the introduction of entails prevented their being broke into small parcels by alienation. Of the Rise and Progress of Cities and Towns, after the Fall of the Roman Empire The inhabitants of cities and towns were, after the fall of the Roman empire, not more favoured than those of the country. They consisted, indeed, of a very different order of people from the first inhabitants of the ancient republics of Greece and Italy. These last were composed chiefly of the proprietors of lands, among whom the public territory was originally divided, and who found it convenient to build their houses in the neighbourhood of one another, and to surround them with a wall, for the sake of common defence. After the fall of the Roman empire, on the contrary, the proprietors of land seem generally to have lived in fortified castles on their own estates, and in the midst of their own tenants and dependants. The towns were chiefly inhabited by tradesmen and mechanics, who seem in those days to have been of servile, or very nearly of servile condition. The privileges which we find granted by ancient charters to the inhabitants of some of the principal towns in Europe sufficiently shew what they were before those grants. The people to whom it is granted as a privilege that they might give away their own daughters in marriage without the consent of their lord, that upon their death their own children, and not their lord, should succeed to their goods, and that they might dispose of their own effects by will, must, before those grants, have been either altogether or very nearly in the same state of villanage with the occupiers of land in the country How the Commerce of the Towns Contributed to the Improvement of the Country Smith often harshly criticised those who act purely out of self-interest and greed, and warns that, "[a]ll for ourselves, and nothing for other people, seems, in every age of the world, to have been the vile maxim of the masters of mankind." (Book 3, Chapter 4) Book IV: Of Systems of political Economy Smith vigorously attacked the antiquated government restrictions which he thought were hindering industrial expansion. In fact, he attacked most forms of government interference in the economic process, including tariffs, arguing that this creates inefficiency and high prices in the long run. It is believed that this theory influenced
government legislation in later years, especially during the 19th century. (However this was not an anarchistic opposition to government. Smith advocated a Government that was active in sectors other than the economy: he advocated public education of poor adults; institutional systems that were not profitable for private industries; a judiciary; and a standing army.) Of the Principle of the Commercial or Mercantile System See also: Mercantilism The book has sometimes been described as a critique of mercantilism and a synthesis of the emerging economic thinking of Smith's time. Specifically, The Wealth of Nations attacks, inter alia, two major tenets of mercantilism: The idea that protectionist tariffs serve the economic interests of a nation (or indeed any purpose whatsoever) and The idea that large reserves of gold bullion or other precious metals are necessary for a country's economic success. This critique of mercantilism was later used by David Ricardo when he laid out his Theory of Comparative Advantage. Of Restraints upon the Importation... See also: Tariff Chapter 2's full title is "Of Restraints upon the Importation from Foreign Countries of such Goods as can be Produced at Home". The "Invisible Hand" is a frequently referenced theme from the book, although it is specifically mentioned only once. "As every individual, therefore, endeavors as much as he can both to employ his capital in the support of domestic industry, and so to direct that industry that its produce may be of the greatest value; every individual necessarily labours to render the annual revenue of the society as great as he can. He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it. By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that 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, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for the society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it." (Book 4, Chapter 2)
Of the extraordinary Restraints... Chapter 3's long title is "Of the extraordinary Restraints upon the Importation of Goods of almost all Kinds, from those Countries with which the Balance is supposed to be Disadvantageous". Of Drawbacks Merchants and manufacturers are not contented with the monopoly of the home market, but desire likewise the most extensive foreign sale for their goods. Their country has no jurisdiction in foreign nations, and therefore can seldom procure them any monopoly
there. They are generally obliged, therefore, to content themselves with petitioning for certain encouragements to exportation. Of these encouragements what are called Drawbacks seem to be the most reasonable. To allow the merchant to draw back upon exportation, either the whole or a part of whatever excise or inland duty is imposed upon domestic industry, can never occasion the exportation of a greater quantity of goods than what would have been exported had no duty been imposed. Such encouragements do not tend to turn towards any particular employment a greater share of the capital of the country than what would go to that employment of its own accord, but only to hinder the duty from driving away any part of that shares to other employments. Of Bounties Bounties upon exportation are, in Great Britain, frequently petitioned for, and sometimes granted to the produce of particular branches of domestic industry. By means of them our merchants and manufacturers, it is pretended, will be enabled to sell their goods as cheap, or cheaper than their rivals in the foreign market. A greater quantity, it is said, will thus be exported, and the balance of trade consequently turned more in favour of our own country. We cannot give our workmen a monopoly in the foreign as we have done in the home market. We cannot force foreigners to buy their goods as we have done our own countrymen. The next best expedient, it has been thought, therefore, is to pay them for buying. It is in this manner that the mercantile system proposes to enrich the whole country, and to put money into all our pockets by means of the balance of trade Of Treaties of Commerce When a nation binds itself by treaty either to permit the entry of certain goods from one foreign country which it prohibits from all others, or to exempt the goods of one country from duties to which it subjects those of all others, the country, or at least the merchants and manufacturers of the country, whose commerce is so favoured, must necessarily derive great advantage from the treaty. Those merchants and manufacturers enjoy a sort of monopoly in the country which is so indulgent to them. That country becomes a market both more extensive and more advantageous for their goods: more extensive, because the goods of other nations being either excluded or subjected to heavier duties, it takes off a greater quantity of theirs: more advantageous, because the merchants of the favoured country, enjoying a sort of monopoly there, will often sell their goods for a better price than if exposed to the free competition of all other nations. Such treaties, however, though they may be advantageous to the merchants and manufacturers of the favoured, are necessarily disadvantageous to those of the favouring country. A monopoly is thus granted against them to a foreign nation; and they must frequently buy the foreign goods they have occasion for dearer than if the free competition of other nations was admitted. Of Colonies See also: Colonialism Of the Motives for establishing new Colonies:
The interest which occasioned the first settlement of the different European colonies in America and the West Indies was not altogether so plain and distinct as that which directed the establishment of those of ancient Greece and Rome. All the different states of ancient Greece possessed, each of them, but a very small territory, and when the people in any one of them multiplied beyond what that territory could easily maintain, a part of them were sent in quest of a new habitation in some remote and distant part of the world; the warlike neighbours who surrounded them on all sides, rendering it difficult for any of them to enlarge very much its territory at home. The colonies of the Dorians resorted chiefly to Italy and Sicily, which, in the times preceding the foundation of Rome, were inhabited by barbarous and uncivilised nations: those of the Ionians and Eolians, the two other great tribes of the Greeks, to Asia Minor and the islands of the Egean Sea, of which the inhabitants seem at that time to have been pretty much in the same state as those of Sicily and Italy. The mother city, though she considered the colony as a child, at all times entitled to great favour and assistance, and owing in return much gratitude and respect, yet considered it as an emancipated child over whom she pretended to claim no direct authority or jurisdiction. The colony settled its own form of government, enacted its own laws, elected its own magistrates, and made peace or war with its neighbours as an independent state, which had no occasion to wait for the approbation or consent of the mother city. Nothing can be more plain and distinct than the interest which directed every such establishment. Causes of Prosperity of new Colonies: The colony of a civilised nation which takes possession either of a waste country, or of one so thinly inhabited that the natives easily give place to the new settlers, advances more rapidly to wealth and greatness than any other human society. The colonists carry out with them a knowledge of agriculture and of other useful arts superior to what can grow up of its own accord in the course of many centuries among savage and barbarous nations. They carry out with them, too, the habit of subordination, some notion of the regular government which takes place in their own country, of the system of laws which supports it, and of a regular administration of justice; and they naturally establish something of the same kind in the new settlement. Of the Advantages which Europe has derived from the Discovery of America, and from that of a Passage to the East Indies by the Cape of Good Hope: Such are the advantages which the colonies of America have derived from the policy of Europe. What are those which Europe has derived from the discovery and colonization of America?
Those advantages may be divided, first, into the general advantages which Europe, considered as one great country, has derived from those great events; and, secondly, into the particular advantages which each colonizing country has derived from the colonies which particularly belong to it, in consequence of the authority or dominion which it exercises over them. The general advantages which Europe, considered as one great country, has derived from the discovery and colonization of America, consist, first, in the increase of its enjoyments; and, secondly, in the augmentation of its industry. The surplus produce of America, imported into Europe, furnishes the inhabitants of this great continent with a variety of commodities which they could not otherwise have possessed; some for conveniency and use, some for pleasure, and some for ornament, and thereby contributes to increase their enjoyments. Conclusion of the Mercantile System Smith's argument about the international political economy opposed the idea of Mercantilism. While the Mercantile System encouraged each country to horde gold, while trying to grasp hegemony, Smith argued that free trade would eventually make all actors better off. This argument is the modern 'Free Trade' argument. Of the Agricultural Systems... Chapter 9's long title is "Of the Agricultural Systems, or of those Systems of Political Economy, which Represent the Produce of Land, as either the Sole or the Principal, Source of the Revenue and Wealth of Every Country". Please help improve this section by expanding it. Further information might be found on the talk page or at requests for expansion. (June 2008) That system which represents the produce of land as the sole source of the revenue and wealth of every country has, so far as by that time, never been adopted by any nation, and it at present exists only in the speculations of a few men of great learning and ingenuity in France. It would not, surely, be worth while to examine at great length the errors of a system which never has done, and probably never will do, any harm in any part of the world. Book V: Of the Revenue of the Sovereign or Commonwealth Smith postulated four "maxims" of taxation: proportionality, transparency, convenience, and efficiency. He supported low taxes and was opposed to the taxation of capital gains. Some economists credit Smith as one of the first to advocate a progressive tax. Smith wrote, "It is not very unreasonable that the rich should contribute to the public expense, not only in proportion to their revenue, but something more in proportion." Of the Expenses of the Sovereign or Commonwealth
Smith uses this chapter to comment on the concept of taxation and expenditure by the state. On taxation Smith wrote, "The subjects of every state ought to contribute towards the support of the government, as nearly as possible, in proportion to their respective abilities; that is, in proportion to the revenue which they respectively enjoy under the protection of the state. The expense of government to the individuals of a great nation is like the expense of management to the joint tenants of a great estate, who are all obliged to contribute in proportion to their respective interests in the estate. In the observation or neglect of this maxim consists what is called the equality or inequality of taxation." This points to Smith's more progressive edge, as he was certainly not advocating "flat tax", but something progressively attached to people's "abilities." For the lower echelons, Smith recognised the dehumanising effect that the division of labour can have on workers, what Marx later named "alienation". Moreover he pointed out there was one solution, namely government intervention. ..."the understandings of the greater part of men are necessarily formed by their ordinary employments. The man whose whole life is spent in performing a few simple operations, of which the effects are perhaps always the same, or very nearly the same, has no occasion to exert his understanding or to exercise his invention in finding out expedients for removing difficulties which never occur. He naturally loses, therefore, the habit of such exertion, and generally becomes as stupid and ignorant as it is possible for a human creature to become. The torpor of his mind renders him not only incapable of relishing or bearing a part in any rational conversation, but of conceiving any generous, noble, or tender sentiment, and consequently of forming any just judgment concerning many even of the ordinary duties of private life... But in every improved and civilized society this is the state into which the labouring poor, that is, the great body of the people, must necessarily fall, unless government takes some pains to prevent it." "Under Smith's model, government involvement in any area other than those stated above would have a negative impact on economic growth. This is because economic growth is determined by the needs of a free market and the entrepreneurial nature of private persons. If there is a shortage of a product its price will rise, and so stimulate producers to produce more, while at the same time attracting new persons into that line of production. If there is an excess supply of a product (more of the product than people are willing to buy), prices will fall and producers will focus their energy and money in other areas where there is a shortage or where there is a need which no one has yet satisfied (thereby creating a new market)."
Of the Sources of the General or Public Revenue of the Society See also: Progressive taxation Smith did not believe that the luxury of the rich was a great benefit to society, when set against the hardships of the poor, and he is often cited as the source of
the modern idea of progressive taxation, which he advocated on grounds of fairness. In his discussion of taxes in Book Five, he wrote: "The necessaries of life occasion the great expense of the poor. They find it difficult to get food, and the greater part of their little revenue is spent in getting it. The luxuries and vanities of life occasion the principal expense of the rich, and a magnificent house embellishes and sets off to the best advantage all the other luxuries and vanities which they possess. A tax upon house-rents, therefore, would in general fall heaviest upon the rich; and in this sort of inequality there would not, perhaps, be anything very unreasonable. It is not very unreasonable that the rich should contribute to the public expense, not only in proportion to their revenue, but something more than in that proportion." 
Of War and Public Debts "...when war comes [politicians] are both unwilling and unable to increase their [tax] revenue in proportion to the increase of their expense. They are unwilling for fear of offending the people, who, by so great and so sudden an increase of taxes, would soon be disgusted with the war... The facility of borrowing delivers them from the embarrassment... By means of borrowing they are enabled, with a very moderate increase of taxes, to raise, from year to year, money sufficient for carrying on the war, and by the practice of perpetually funding they are enabled, with the smallest possible increase of taxes [to pay the interest on the debt], to raise annually the largest possible sum of money [to fund the war]. ...The return of peace, indeed, seldom relieves them from the greater part of the taxes imposed during the war. There are mortgaged for the interest of the debt contracted in order to carry it on." Smith then goes on to say that even if money was set aside from future revenues to pay for the debts of war, it seldom actually gets used to pay down the debt. Politicians are inclined to spend the money on some other scheme that will win the favor of their constituents. Hence, interest payments rise and war debts continue to grow larger, well beyond the end of the war. Summing up, if governments can borrow without check, then they are more likely to wage war without check, and the costs of the war spending will burden future generations, since war debts are almost never repaid by the generations that incurred them.
Continuing Relevance This section does not cite any references or sources. Please help improve this section by adding citations to reliable sources. Unverifiable material may be challenged and removed. (September 2008)
Nations was written in modern English for the average educated individual of the 18th century and remains an effective introduction to economics to this day.
Controversy This section does not cite any references or sources. Please help improve this section by adding citations to reliable sources. Unverifiable material may be challenged and removed. (September 2008) Nations is often mischaracterized and politicized. Left-wing writers have characterized it as advocating the status quo, yet the work clearly discusses what Smith sees as the inefficiency, and inappropriateness of tariffs, apprenticeships, immigration control and cartels - arrangements favourable to special interest groups. Right-wing politicians have often used a sleight of hand - erroneously equating "pro-business" with advocacy of free markets, thus using/abusing the Wealth of Nations to support their own protectionist objectives. See also Free Trade American School of Economics Austrian School of Economics Classical economics Marginalism Neoclassical economics Political economy Socialism The Theory of Moral Sentiments (1759), Adam Smith's other classic Wealth (economics) Notes ^ An Inquiry into the Nature and Causes of the Wealth of Nations, by Adam Smith. London: Methuen and Co., Ltd., ed. Edwin Cannan, 1904. Fifth edition. ^ Smith (1776) Book I, Chapter 5, para 1 ^ Smith (1776) Book I, Chapter 7, para 9 ^ Smith (1776) Book I, Chapter 7, para 26 ^ Smith (1776) I, 8, para 39 ^ Smith (1776) I, 8, para 37 ^ Smith (1776) Book I, Chapter 10, para 82 ^ Bartlett, Bruce (2001-01-24). "Adam Smith On Taxes". National Center for Policy Analysis. Retrieved on 2008-05-14. ^ Reich, Robert B. (1987-04-26). "Do Americans Still Believe In Sharing The Burden?". The Washington Post. Retrieved on 2008-05-14. ^ Stein, Herbert (1994-04-06). "Board of Contributors: Remembering Adam Smith", Wall Street Journal (Eastern Edition). Retrieved on 2008-05-14. ^ Smith (1776) V, 1, para 178
^ R. Conteras, "How the Concept of Development Got Started" University of Iowa Center for International Finance and Development E-Book ^ Adam Smith, An Inquiry into the Nature And Causes of the Wealth of Nations (1776). Book V, Chapter 2, Article I: Taxes upon the Rent of House. ^ Adam Smith, An Inquiry into the Nature And Causes of the Wealth of Nations (1776). Book V, Chapter 3, Article III: Of Public Debts. External links Wikisource has original text related to this article: The Wealth of NationsThe Wealth of Nations at MetaLibri Digital Library The Theory of Moral Sentiments at MetaLibri Digital Library An Inquiry into the Nature and Causes of the Wealth of Nations at Project Gutenberg An Inquiry into the Nature and Causes of the Wealth of Nations, 1776 (accessible by table of contents chapter titles) AdamSmith.org ISBN 1404309985 Life of Adam Smith, by John Rae, at the Library of Economics and Liberty An Inquiry into the Nature and Causes of the Wealth of Nations Google's scan of the book Introduction by Ludwig von Mises to the 1952 edition of The Wealth of Nations The Wealth of Nations at MetaLibri Digital Library The Theory of Moral Sentiments at MetaLibri Digital Library An Inquiry into the Nature and Causes of the Wealth of Nations at Project Gutenberg An Inquiry into the Nature and Causes of the Wealth of Nations, 1776 (accessible by table of contents chapter titles) AdamSmith.org ISBN 1404309985 Life of Adam Smith, by John Rae, at the Library of Economics and Liberty An Inquiry into the Nature and Causes of the Wealth of Nations Google's scan of the book Introduction by Ludwig von Mises to the 1952 edition of The Wealth of Nations
- Introduction "On the following pages I submit to public judgement the result of twenty years of meditation. What a Copernicus succeeded in explaining of the relationships of worlds in space, that I believe I have performed for the explanations of men on earth." (Hermann Heinrich Gossen, Development of the Laws of Exchange among Men 1854: p.1) Contents (A) Protagonists of the Marginalist Revolution (B) Basic Elements of the Neoclassical Theory of Value (C) The Neoclassical Family of Schools
(A) Protagonists of the Marginalist Revolution The Marginalist Revolution refers to the establishment of what has been since called Neoclassical approach to economic theory. The dating of this "revolution" is commonly ascribed to 1871-74, when the concept of diminishing marginal utility was introduced by William Stanley Jevons, Carl Menger and Léon Walras, to pin down the character of demand -- thus the term "Marginalist". This set the foundations for the Neoclassical theory of value, which eventually replaced the "Classical" theory of value of Adam Smith, David Ricardo, John Stuart Mill and Karl Marx. However, the task of establishing the Neoclassical theory as the dominant approach to economics took quite some time. It can be roughly seen as a three-phase affair: (1) 1871-74: the use of the the concept of diminishing marginal utility as the basis of a theory of exchange -- accomplished independently by William Stanley Jevons, Carl Menger and Léon Walras. (2) 1890-1894: the establishment of the marginal productivity theory of distribution by John Bates Clark, Phillip H. Wicksteed and Knut Wicksell. (3) 1934-1947: the period of Paretian revival, whereby the introduction of ordinal utility and the solidification of the Neoclassical theory of value -- including its welfare implications -- helped resurrect Neoclassical theory from its moribund state; the critical figures here were John Hicks, Harold Hotelling, Oskar Lange, Maurice Allais and Paul Samuelson. Thus, we can think of the 1871-74 period merely as the "Marginalist Insurrection", the "Revolution" itself taking a further half-century or so to work itself out fully. To obtain a quick glance of the story, a timeline denoting the main contributions of the protagonists of the Marginalist Revolution follows: Main Proto-Marginalists 1838 Antoine Augustin Cournot (French, b. 1801) Recherches sur les principes mathématiques de la théories des richesses 1844 Jules J. Dupuit (French, b. 1804) De la mesure de l'utilité des travaux publics. 1850 Johann H. von Thunen (German, b.1783) Des isolierte Staat, Vol. II
1854 H. Heinrich Gossen (German, b.1810) Entwicklung der Gesetze des menschlichen Verkerhs The Revolutionaries 1871 William Stanley Jevons (English, b. 1835) Theory of Political Economy 1871 Carl Menger (Austrian, b.1840) Grundsätze der Volkwirtschatslehre 1874 Léon Walras (French, b.1834) Eléments d'économie politique pure The Consolidators 1886 Eugen von Böhm-Bawerk (Austrian, b.1851) Grunzüge der Theorie des wirtschaftlichen Güterwerthers. 1889 Friedrich von Wieser (Austrian, b.1851) Der naturliche Wert. 1890 Alfred Marshall (English, b.1842) Principles of Economics 1891 John Bates Clark (American, b.1847) "Distribution as Determined by a Law of Rent" (1891, QJE) 1892 Irving Fisher (American, b.1867) Mathematical Investigations in the Theory of Value and Prices 1893 Knut Wicksell (Swedish, b.1851)
Über Wert, Kapital und Rente 1894 Philip H. Wicksteed (English, b.1844) Co-ordination of the Laws of Distribution 1896 Vilfredo Pareto (Italian, b.1848) Cours d'économie politique 1896 Enrico Barone (Italian, b.1859) Studi sulla distribuzione.
The Revivalists 1934 & 1939 John Hicks (English, b.1904) "A Reconsideration of the Theory of Value" (with R.G.D. Allen, 1934 Economica); Value and Capital (1939) 1938 Harold Hotelling (American, b.1895) "The General Welfare in Relation to Problems of Taxation and of Railway and Utility Rates", Econometrica 1942 Oskar Lange (Polish, b.1904) "The Foundations of Welfare Economics", Econometrica 1943 Maurice Allais (French, b.1911) A la recherche d'une discipline economique 1947 Paul A. Samuelson
(American, b.1915) Foundations of Economic Analysis This account is not beyond dispute, but we have tried to adhere rigidly to the main contributions to the canonical Neoclassical theory of value. Thus, we have insisted on Böhm-Bawerk's 1886 article on value rather than his more famous theory of capital as the latter did not enter into the mainstream. The conspicuous omission of Francis Ysidro Edgeworth (English, b.1845) from this list, in spite of the importance and originality of his contributions, notably his 1881 Mathematical Psychics, is excused by the fact that his work is really too specialized and digresses too far from the standard Neoclassical canon to permit us to call him a "consolidator" of the Marginalist Revolution. Another notable absentee, Gusav Cassel (Swedish, b.1866), is excluded despite the importance of his 1918 Theory of Social Economy in the revival of Neoclassical theory because he decided to dispense with utility theory entirely. Naturally, there are many other contributors whose work deserves mention but, in our view, these were the most important, original and influential contributions to the Neoclassical theory of value. (B) Basic Elements of the Neoclassical Theory of Value Despite the name, the essence of the Marginalist Revolution was not really the mathematical concept of the "margin", but rather in the building up of a theory of value which was based on the phenomenon of exchange rather than production and distribution. William F. Lloyd's definition of economics as catallactics - the "science of exchange" better describes what the Marginalists were aiming for -- and what Neoclassicism, at is heart, is all about. The essence of Marginalist Revolution, then, was the novel idea that the "natural value" of a good is determined only by its subjective scarcity, i.e. the degree to which people's desire for that good exceeds its availability. The Neoclassical story is often captured in diagrammatic form by the idea that equilibrium prices and quantities of goods are determined jointly and simultaneously by the demand and supply for those goods. The basic distinguishing principles of the Neoclassical theory of value can be listed in point form as follows: (1) The assumed or "given" data are the following: preferences, endowments and technology (if relevant, prior expectations are often added to this list). (2) As endowments are fixed, the question of concern is about the allocation of these endowments. (3) Allocation in free market economies occurs via voluntary exchange among individuals.
(4) In competitive economies, voluntary exchange occurs via a price-mediated process (i.e. people take prices as "given" and make decisions as if they cannot affect prices). (5) The individual demand curve is downward-sloping because of the principle of substitution among goods. (6) The individual supply curve is upward-sloping because of the principle of increasing cost, where by cost we normally mean "opportunity cost". (7) The Law of Demand asserts that market-wide demand for a commodity is downwardsloping. (8) The Law of Supply asserts that the market-wide supply of a commodity is upwardsloping. (9) The equilibrium price of a good is determined by the equality of the quantities demanded and supplied for that good. (10) The principle of scarcity concludes that a good only has a price if it is scarce, i.e. more of it is desired than is available in quantity. Whether a good is scarce or not is thus a subjective issue, not an objective one. (12) The principle of imputation concludes that factors have no intrinsic value; the demand for a factor is derived from the demand for the commodities it produces in combination with the least-cost technique of producing them. These twelve points effectively capture the main message of the Neoclassical "Marginalist Revolution". Other items that have since be called "Neoclassical", such as the Quantity Theory of Money or Say's Law, are not distinctly Neoclassical as, firstly, they were originally developed and thus are shared with the Classical economists (Smith, Ricardo, Mill, etc.) and, secondly, not all Neoclassical economists subscribed to them (e.g. Wicksell). It has also been argued that the use of the mathematical reasoning can be considered a characteristic of the Marginalist Revolution. This is not true. Although some Marginalists (e.g. Walras, Wicksteed) employed a largely unprecedented amount of mathematics, others (e.g. Menger, Clark), were quite ignorant of it and did not use it at all. Notice also that we have omitted any description of the dynamics of Neoclassical theory. We say nothing about how the equilibrium is supposed to come about or how the system evolves over time. Once again, Neoclassical thinkers had different ideas about this. Walras, Menger and Marshall, for instance, had rather incompatible notions of how prices and quantities adjusted when out of equilibrium. Furthermore, some Neoclassicals (e.g. Marshall) argued that equilibrium itself was a gravitation point that the system would approach over time, while others (e.g. Fisher) argued that equilibrium was itself
defined over time ("intertemporally") and still others (e.g. Walras) argued that equilibrium ought to be defined as a steady-state which maintains itself through time; alternatively, others (e.g. Walras again) argued that equilibrium is merely a temporary, short-run thing and that, over time, there would be a sequence of different equilibria. Thus, the dynamic aspects of the Neoclassical system were hardly agreed upon by the protagonists of the Marginalist Revolution. (C) The Neoclassical Family of Schools The "Neoclassical" approach to economics, thus, is not one, great, well-defined theory, but rather can be regarded as a family of approaches -- all of which share the core 12 points mentioned earlier, but differ considerably on other topics such as macroeconomics, money, dynamics, mathematics, etc. Neoclassicism is thus a collection of schools of thought. The following is a list of the main Neoclassical schools, and their main geographical and periods of chronological concentration. We should warn that this is not a generally-accepted account. Austrian School Austria, 1870s-1930s; America, 1970s-now Lausanne (Walrasian) School Swiss-French-Italian, 1870s-1890s; Resurrected in Vienna, 1930s Lausanne (Paretian) School Italian, 1900-1920 Worldwide (esp. LSE, Chicago, Harvard, France), 1930s-1940s Cambridge (Marshallian) School Britain, 1890s-1930s Stockholm School Sweden, 1920s-1930s. Chicago School America, Version I (eclectic mix of schools), 1920s-1940s Version II (more distinct, e.g. Monetarists, New Classicals),1960s-1980s. Neo-Walrasian School Worldwide (esp. Cowles), 1950s-1980s Naturally, there are also the few giants who had their own, distinct vision of Neoclassicism and thus are not easily classifiable within the schools listed above, but who also failed to form a clearly discernible "school of thought" behind them. These include William Stanley Jevons, Phillip H. Wicksteed, Francis Ysidro Edgeworth, Irving
Fisher and John Bates Clark. These can be thought as plain "Neoclassicals", although we have taken the liberty of grouping them together under the title of "Anglo-American Marginalists"
Economists publicly disagree with each other so often that they are easy targets for standup comedians. Yet noneconomists may not realize that the disagreements are mostly over the details—the way in which the big picture is to be focused on the small screen. When it comes to broad economic theory, most economists agree. President Richard Nixon, defending deficit spending against the conservative charge that it was "Keynesian," is reported to have replied, "We're all Keynesians now." In fact, what he should have said is "We're all neoclassicals now, even the Keynesians," because what is taught to students, what is mainstream economics today, is neoclassical economics. By the middle of the nineteenth century, English-speaking economists generally shared a perspective on value theory and distribution theory. The value of a bushel of corn, for example, was thought to depend on the costs involved in producing that bushel. The output or product of an economy was thought to be divided or distributed among the different social groups in accord with the costs borne by those groups in producing the output. This, roughly, was the "Classical Theory" developed by Adam Smith, David Ricardo, Thomas Robert Malthus, John Stuart Mill, and Karl Marx. But there were difficulties in this approach. Chief among them was that prices in the market did not necessarily reflect the "value" so defined, for people were often willing to pay more than an object was "worth." The classical "substance" theories of value, which took value to be a property inherent in an object, gradually gave way to a perspective in which value was associated with the relationship between the object and the person obtaining the object. Several economists in different places at about the same time (the 1870s and 1880s) began to base value on the relationship between costs of production and "subjective elements," later called "supply" and "demand." This came to be known as the Marginal Revolution in economics, and the overarching theory that developed from these ideas came to be called neoclassical economics. (The first to use the term "neoclassical economics" seems to have been the American economist Thorstein Veblen.) The framework of neoclassical economics is easily summarized. Buyers attempt to maximize their gains from getting goods, and they do this by increasing their purchases of a good until what they gain from an extra unit is just balanced by what they have to give up to obtain it. In this way they maximize "utility"—the satisfaction associated with the consumption of goods and services. Likewise, individuals provide labor to firms that wish to employ them, by balancing the gains from offering the marginal unit of their services (the wage they would receive) with the disutility of labor itself—the loss of leisure. Individuals make choices at the margin. This results in a theory of demand for goods, and supply of productive factors. Similarly, producers attempt to produce units of a good so that the cost of producing the incremental or marginal unit is just balanced by the revenue it generates. In this way they
maximize profits. Firms also hire employees up to the point that the cost of the additional hire is just balanced by the value of output that the additional employee would produce. The neoclassical vision thus involves economic "agents," be they households or firms, optimizing (doing as well as they can), subject to all relevant constraints. Value is linked to unlimited desires and wants colliding with constraints, or scarcity. The tensions, the decision problems, are worked out in markets. Prices are the signals that tell households and firms whether their conflicting desires can be reconciled. At some price of cars, for example, I want to buy a new car. At that same price others may also want to buy cars. But manufacturers may not want to produce as many cars as we all want. Our frustration may lead us to "bid up" the price of cars, eliminating some potential buyers and encouraging some marginal producers. As the price changes, the imbalance between buy orders and sell orders is reduced. This is how optimization under constraint and market interdependence lead to an economic equilibrium. This is the neoclassical vision. Neoclassical economics is what is called a metatheory. That is, it is a set of implicit rules or understandings for constructing satisfactory economic theories. It is a scientific research program that generates economic theories. Its fundamental assumptions are not open to discussion in that they define the shared understandings of those who call themselves neoclassical economists, or economists without any adjective. Those fundamental assumptions include the following: 1. People have rational preferences among outcomes. 2. Individuals maximize utility and firms maximize profits. 3. People act independently on the basis of full and relevant information. Theories based on, or guided by, these assumptions are neoclassical theories. Thus, we can speak of a neoclassical theory of profits, or employment, or growth, or money. We can create neoclassical production relationships between inputs and outputs, or neoclassical theories of marriage and divorce and the spacing of births. Consider layoffs, for example. A theory which assumes that a firm's layoff decisions are based on a balance between the benefits of laying off an additional worker and the costs associated with that action will be a neoclassical theory. A theory that explains the layoff decision by the changing tastes of managers for employees with particular characteristics will not be a neoclassical theory. What can be contrasted to neoclassical economics? Some have argued that there are several schools of thought in present-day economics. They identify (neo-)Marxian economics, (neo-)Austrian economics, post-Keynesian economics, or (neo-)institutional economics as alternative metatheoretical frameworks for constructing economic theories. To be sure, societies and journals promulgate the ideas associated with these perspectives. Some of these schools have had insights that neoclassical economists have learned from; the Austrian insights on entrepreneurship are one example. But to the extent these schools reject the core building blocks of neoclassical economics—as
Austrians reject optimization, for example—they are regarded by mainstream neoclassical economists as defenders of lost causes or as kooks, misguided critics, and antiscientific oddballs. The status of non-neoclassical economists in the economics departments in English-speaking universities is similar to that of flat-earthers in geography departments: it is safer to voice such opinions after one has tenure, if at all. One specific attempt to discredit neoclassical economics developed from British economist Joan Robinson and her colleagues and students at Cambridge in the late fifties and early sixties. The so-called Two Cambridges Capital Controversy was ostensibly about the implications, and limitations, of Paul Samuelson and Robert Solow's aggregating "capital" and treating the aggregate as an input in a production function. However, this controversy really was rooted in a clash of visions about what would constitute an "acceptable" theory of the distribution of income. What became the postKeynesian position was that the distribution of income was "best" explained by power differences among workers and capitalists, while the neoclassical explanation was developed from a market theory of factor prices. Eventually the controversy was not so much settled as laid aside, as neoclassical economics became mainstream economics. How did such an orthodoxy come to prevail? In brief, the success of neoclassical economics is connected to the "scientificization" or "mathematization" of economics in the twentieth century. It is important to recognize that a number of the early Marginalists, economists like William Stanley Jevons and F. Y. Edgeworth in England, Leon Walras in Lausanne, and Irving Fisher in the United States, wanted to legitimize economics among the scholarly disciplines. The times were optimistic about a future linked to the successes of technology. Progress would be assured in a society that used the best scientific knowledge. Social goals would be attainable if scientific principles could organize social agendas. Scientific socialism and scientific management were phrases that flowed easily from the pens of social theorists. Neoclassical economics conceptualized the agents, households and firms, as rational actors. Agents were modeled as optimizers who were led to "better" outcomes. The resulting equilibrium was "best" in the sense that any other allocation of goods and services would leave someone worse off. Thus, the social system in the neoclassical vision was free of unresolvable conflict. The very term "social system" is a measure of the success of neoclassical economics, for the idea of a system, with its interacting components, its variables and parameters and constraints, is the language of midnineteenth-century physics. This field of rational mechanics was the model for the neoclassical framework. Agents were like atoms; utility was like energy; utility maximization was like the minimization of potential energy, and so forth. In this way was the rhetoric of successful science linked to the neoclassical theory, and in this way economics became linked to science itself. Whether this linkage was planned by the early Marginalists, or rather was a feature of the public success of science itself, is less important than the implications of that linkage. For once neoclassical economics was associated with scientific economics, to challenge the neoclassical approach was to seem to challenge science and progress and modernity.
The value of neoclassical economics can be assessed in the collection of truths to which we are led by its light. The kinds of truths about incentives—about prices and information, about the interrelatedness of decisions and the unintended consequences of choices—are all well developed in neoclassical theories, as is a self-consciousness about the use of evidence. In planning for future electricity needs in my state, for example, the Public Utilities Commission develops a (neoclassical) demand forecast, joins it to a (neoclassical) cost analysis of generation facilities of various sizes and types (e.g., an 800-megawatt low-sulfur coal plant), and develops a least-cost system growth plan and a (neoclassical) pricing strategy for implementing that plan. Those on all sides of the issues, from industry to municipalities, from electric companies to environmental groups, all speak the same language of demand elasticities and cost minimization, of marginal costs and rates of return. The rules of theory development and assessment are clear in neoclassical economics, and that clarity is taken to be beneficial to the community of economists. The scientificness of neoclassical economics, on this view, is not its weakness but its strength. About the Author E. Roy Weintraub is an economics professor at Duke University and associate editor of History of Political Economy. Further Reading Becker, Gary. The Economic Approach to Human Behavior. 1976. Dow, Sheila. Macroeconomic Thought: A Methodological Approach. 1985. Mirowski, Philip. More Heat Than Light. 1989. Weintraub, E. Roy. General Equilibrium Analysis: Studies in Appraisal. 1985
From Wikipedia, the free encyclopedia Classical economics is widely regarded as the first modern school of economic thought. Its major developers include Adam Smith, David Ricardo, Thomas Malthus and John Stuart Mill. Sometimes the definition of classical economics is expanded to include William Petty, Johann Heinrich von Thünen, and Karl Marx. Adam Smith's The Wealth of Nations in 1776 is usually considered to mark the beginning of classical economics. The school was active into the mid 19th century and was followed by neoclassical economics in Britain beginning around 1870. Classical economists attempted and partially succeeded to explain economic growth and development. They produced their "magnificent dynamics" during a period in which capitalism was emerging from a past feudal society and in which the industrial revolution was leading to vast changes in society. These changes also raised the question of how a
society could be organized around a system in which every individual sought his or her own (monetary) gain. Classical economists reoriented economics away from an analysis of the ruler's personal interests to a class-based interest. Physiocrat Francois Quesnay and Adam Smith, for example, identified the wealth of a nation with the yearly national income, instead of the king's treasury. Smith saw this income as produced by labor applied to land and capital equipment. Once land and capital equipment are appropriated by individuals, the national income is divided up between laborers, landlords, and capitalists in the form of wages, rent, and interest. Value Theory Classical economists developed a theory of value, or price, to investigate economic dynamics. Petty introduced a fundamental distinction between market price and natural price to facilitate the portrayal of regularities in prices. Market prices are jostled by many transient influences that are difficult to theorize about at any abstract level. Natural prices, according to Petty, Smith, and Ricardo, for example, capture systematic and persistent forces operating at a point in time. Market prices always tend toward natural prices in a process that Smith described as somewhat similar to gravitational attraction. The theory of what determined natural prices varied within the Classical school. Petty tried to develop a par between land and labor and had what might be called a land-andlabor theory of value. Smith confined the labor theory of value to a mythical precapitalist past. He stated that natural prices were the sum of natural rates of wages, profits (including interest on capital and wages of superintendence) and rent. Ricardo also had what might be described as a cost of production theory of value. He criticized Smith for describing rent as price-determining, instead of price-determined, and saw the labor theory of value as a good approximation. Some historians of economic thought, in particular, Sraffian economists (e.g.,  or ), see the classical theory of prices as determined from three givens: 1. The level of outputs at the level of Smith's "effectual demand", 2. technology, and 3. wages. From these givens, one can rigorously derive a theory of value. But neither Ricardo nor Marx, the most rigorous investigators of the theory of value during the Classical period, developed this theory fully. Those who reconstruct the theory of value in this manner see the determinants of natural prices as being explained by the Classical economists from within the theory of economics, albeit at a lower level of abstraction. For example, the theory of wages was closely connected to the theory of population. The Classical economists took the theory of the determinants of the level and growth of population as part of Political Economy. Since then, the theory of population has been seen as part of some other discipline than economics. In contrast to the Classical theory, the determinants of the neoclassical theory value: 1. tastes 2. technology, and 3. endowments are seen as exogenous to neoclassical economics.
Classical economics tended to stress the benefits of trade. Its theory of value was largely displaced by marginalist schools of thought which sees "use value" as deriving from the marginal utility that consumers finds in a good, and "exchange value" (i.e. natural price) as determined by the marginal opportunity- or disutility-cost of the inputs that make up the product. Ironically, considering the attachment of many classical economists to the free market, the largest school of economic thought that still adheres to classical form is the Marxian school. Monetary Theory British classical economists in the 19th century had a well-developed controversy between the Banking and the Currency school. This parallels recent debates between proponents of the theory of endogeneous money, such as Nicholas Kaldor, and monetarists, such as Milton Friedman. Monetarists and members of the currency school argued that banks can and should control the supply of money. According to their theories, inflation is caused by banks issuing an excessive supply of money. According to proponents of the theory of endogeneous money, the supply of money automatically adjusts to the demand, and banks can only control the terms (e.g., the rate of interest) on which loans are made. Debates on the definition of Classical Economics The theory of value is currently a contested subject. One issue is whether classical economics is a forerunner of neoclassical economics or a school of thought that had a distinct theory of value, distribution, and growth. Sraffians, who emphasize the discontinuity thesis, see classical economics as extending from Willam Petty's work in the 17th century to the break-up of the Ricardian system around 1830. The period between 1830 and the 1870s would then be dominated by "vulgar political economy", as Karl Marx characterized it. Sraffians argue that: the wages fund theory; Senior's abstinence theory of interest, which puts the return to capital on the same level as returns to land and labor; the explanation of equilibrium prices by wellbehaved supply and demand functions; and Say's law, are not necessary or essential elements of the classical theory of value and distribution. Perhaps Schumpeter's view that John Stuart Mill put forth a half-way house between classical and neoclassical economics is consistent with this view. Sraffians generally see Marx as having rediscovered and restated the logic of classical economics, albeit for his own purposes. Others, such as Schumpeter, think of Marx as a follower of Ricardo. Even Samuel Hollander has recently explained that there is a textual basis in the classical economists for Marx's reading, although he does argue that it is an extremely narrow set of texts. The first position is that neoclassical economics is essentially continuous with classical economics. To scholars promoting this view, there is no hard and fast line between classical and neoclassical economics. There may be shifts of emphasis, such as between the long run and the short run and between supply and demand, but the neoclassical concepts are to be found confused or in embryo in classical economics. To these economists, there is only one theory of value and distribution. Alfred Marshall is a wellknown promoter of this view. Samuel Hollander is probably its best current proponent. A second position sees two threads simultaneously being developed in classical economics. In this view, neoclassical economics is a development of certain exoteric (popular) views in Adam Smith. Ricardo was a sport, developing certain esoteric (known
by only the select) views in Adam Smith. This view can be found in W. Stanley Jevons, who referred to Ricardo as something like "that able, but wrong-headed man" who put economics on the "wrong track". One can also find this view in Maurice Dobb's Theories of Value and Distribution Since Adam Smith: Ideology and Economic Theory (1973), as well as in Karl Marx's Theories of Surplus Value. The above does not exhaust the possibilities. John Maynard Keynes thought of classical economics as starting with Ricardo and being ended by the publication of Keynes' General Theory of Employment Interest and Money. The defining criterion of classical economics, on this view, is Say's law. One difficulty in these debates is that the participants are frequently arguing about whether there is a non-neoclassical theories that should be reconstructed and applied today to describe capitalist economies. Some, such as Terry Peach, see classical economics as of antiquarian interest. Literature • Samuel Hollander - Classical Economics (Oxford: Blackwell, 1987) See also • Classical general equilibrium model • Neoclassical economics • Classical liberalism Notes and references 1. ^ Krishna Bharadwaj (1989) "Themes in Value and Distribution: Classical Theory Reppraised", Unwin-Hyman 2. ^ Pierangelo Garegnani (1987), "Surplus Approach to Value and Distribution" in "The New Palgrave: A Dictionary of Economics" 3. ^ Samuel Hollander (2000), "Sraffa and the Interpretation of Ricardo: The Marxian Dimension", "History of Political Economy", V. 32, N. 2: 187-232 (2000) 4. ^ Terry Peach (1993), "Interpreting Ricardo", Cambridge University Press