As the study of economics developed during the course of the eighteenth century, thinkers became increasingly concerned with finding a theory to explain why some nations grew and prospered while others declined. Although the economists of the time did not use the term ‘production boundary’, the idea was at the heart of their work. Their search for the source of value led them to locate it in production, first in land – understandably so, in predominantly agrarian societies – and then, as economies became more industrialized, in labour. The labour theory of value reached its apogee with Karl Marx in the mid-nineteenth century, when the Industrial Revolution was in full swing.
THE PHYSIOCRATS: THE ANSWER LIES IN THE SOIL
The first efforts to find a formal theory of value came in the mid-eighteenth century from the court of Louis XV of France, in the twilight – so it turned out – of that country’s absolute monarchy. There, François Quesnay (1694–1774), often described as the ‘father of economics’, was the king’s physician and adviser. He used his medical training to understand the economy as a ‘metabolic’ system. Crucially, in metabolism, everything must come from somewhere and go somewhere – and that, for Quesnay, included wealth. Quesnay’s approach led him to formulate the first systematic theory of value that classified who is and is not productive in an economy, and to model how the entire economy could reproduce itself from the value generated by a small group of its members. In his seminal work Tableau Économique, published in 1758, he constructed an ‘economic table’ which showed how new value was created and circulated in the economy. In it he continued the metabolic analogy: pumps were drawn to signify the ways in which new value was introduced, and outgoing tubes illustrated how value left the system.
At the time Quesnay wrote, French society was already facing the problems that would lead to the French Revolution fifteen years after his death. French agriculture was in a bad state. Farmers were choked by high taxes, imposed by their usually noble landlords to fund their lavish lifestyles and by central government to finance war and trade. Adding to this burden, the French government’s mercantilist policy, faced with a now aggressively expanding Britain, kept the prices of agricultural produce low to provide cheap subsistence to domestic manufactures, which could in turn be cheaply made and exported in exchange for the highly coveted gold, still generally believed to be a measure of national wealth. Faced with this situation, Quesnay and his followers built a powerful argument in favour of the farmers and against the mercantilists. Though they came to be known as the physiocrats, after one of Quesnay’s publications, they called themselves something else: ‘Les Économistes’.
Contrasting sharply with the prevailing mercantilist thinking that gave gold a privileged place, Quesnay believed that land was the source of all value. Figure 3 illustrates how for him, in the end, everything that nourished humans came from the earth. He pointed out that, unlike humans, Nature actually produced new things: grain out of small seeds for food, trees out of saplings and mineral ores from the earth from which houses and ships and machinery were built. By contrast, humans could not produce value. They could only transform it: bread from seeds, timber from wood, steel from iron. Since agriculture, husbandry, fishing, hunting and mining (all in the darker blob in Figure 3) bring Nature’s bounty to society, Quesnay called them the ‘productive class’. By contrast, he thought that nearly all other sectors of the economy – households, government, services and even industry, lumped together in the lighter blob – were unproductive.
Quesnay’s classification was revolutionary. Breaking away from the mercantilists, who placed exchange and what was gained from it – gold – at the centre of value creation, he now linked value creation inextricably with production. Developing his classification of productive and unproductive work, Quesnay grouped society into three classes. First came farmers and related occupations working on the land and water; according to Quesnay, this was the only productive class. Next were manufacturers, artisans and related workers who transform the materials they receive from the productive class: wood and stone for furniture and houses, sheep’s wool for clothing and metals from the mines for tools.15 Yet, argued Quesnay, this class did not add value; rather, their work merely recirculated existing value. The third class was the unproductive ‘proprietor’, ‘distributive’ or ‘sterile’ class, which was made up of landlords, nobility and clergy. Here, ‘distributive’ was meant pejoratively: this class redistributes value, but only to itself, for the sole reason that it owns the land and does not give anything in return.16
Figure 3. The production boundary in the 1700s
In Quesnay’s table, the productive part of the system is entirely based on the farmers, but others also have a useful role in ensuring that the system reproduces itself. Figure 4 shows in detail the process of production, income and consumption of each class or economic sector, and how they interact. Perhaps the world’s first spreadsheet, it is also the first consistent abstract model of economic growth.
Figure 4. Example of the Tableau Économique
A Numerical Example for the Tableau Économique
The logic of Quesnay’s model is illustrated in Figure 4. The most important thing is where the initial wealth comes from, how it is circulated, and what percentage is reinvested into production (in nature) in the next round, creating more value – the latter being the essence of the growth process. In the simplest case of a non-expanding economy, the productive class has an initial amount of ‘products of the earth’ (translated from ‘produits de la terre’), valued here for the sake of argument as 5 billion livres’ worth. These are divided 4/5 food (for the farmers to subsist on) and 1/5 in material for the sterile class. The proprietors hold 2 billion in cash that they have collected in taxes from the productive class, and the sterile class has an inventory of 2 billion livres’ worth of tools and other manufactured goods.
From this, a process of circulation takes place, each step of which corresponds to a move from one row to the next. In every step, an equal amount of value changes hands, to prepare for the next round of production. But no new value is created. An exception is the step from period 5 to 6 in the circulation process, at which a transfer rather than exchange of 2 billion livres takes place. Only money flows, not products.17 At the end, production takes place, with 2 billion surplus products in the productive sector, while 2 billion have been unproductively consumed in the proprietor class, starting a new round of circulation. Obviously, if the surplus is bigger than consumption, the economy will grow from round to round.
(All units are in billions of French livres; solid arrows indicate product flows, dashed arrows indicate money flows.)18
Most significant is how the table neatly shows, from row to row, that as long as what is produced is greater than what is consumed, an amount will be left over at the end to be reinvested, thereby allowing the economy to continue reproducing itself. If any of the unproductive members of society take too much, reducing the amount the farmer can reinvest in production, the economy will grind to a halt. In other words, if value extraction by the unproductive members exceeds value creation by the productive members, growth stops.
Though he himself did not use the term, Quesnay’s theory of value incorporates a very clear production boundary, the first to be drawn with such precision, which makes it clear that the surplus the ‘productive’ sectors generate enables everyone else to live.
Other economists quickly weighed in with analysis and criticism of Quesnay’s classification. Their attack centred on Quesnay’s labelling of artisans and workers as ‘sterile’: a term that served Quesnay’s political ends of defending the existing agrarian social order, but contradicted the everyday experience of a great number of people. Refining Quesnay’s thinking, his contemporary A. R. J. Turgot retained the notion that all value came from the land, but noted the important role of artisans in keeping society afloat. He also recognized that there were other ‘general needs’ that some people had to fulfil – such as judges to administer just
ice – and that these functions were essential for value creation. Accordingly, he re-labelled Quesnay’s ‘sterile’ class as the ‘stipendiary’, or waged, class. And, since rich landowners could decide whether to carry out work themselves or hire others to do so using revenues from the land, Turgot labelled them the ‘disposable class’. He also added the refinement that some farmers or artisans would employ others and make a profit. As farmers move from tilling the land to employing others, he argued, they remain productive and receive profits on their enterprise. It is only when they give up on overseeing farming altogether and simply live on their rent that they become ‘disposable’ rent collectors. Turgot’s more refined analysis therefore placed emphasis on the character of the work being done, rather than the category of work itself.
Turgot’s refinements were highly significant. In them, we see the emergent categories of wages, profits and rents: an explicit reference to the distribution of wealth and income that would become one of the cornerstones of economic thought in the centuries to come, and which is still used in national income accounting today. Yet, for Turgot, land remained the source of value: those who did not work it could not be included in the production boundary.19
Quesnay and Turgot’s almost complete identification of productivity with the agricultural sector had an overriding aim. Their restrictive production boundary gave the landed aristocracy ammunition to use against mercantilism, which favoured the merchant class, and fitted an agricultural society better than an industrial one. Given the physiocrats’ disregard for industry, it is hardly surprising that the most significant critique of their ideas came from the nation where it was already clear that value was not just produced in agriculture, but in other emerging sectors: a rapidly industrializing Britain. The most influential critic of all was Quesnay’s contemporary, a man who had travelled in France and talked at length with him: Adam Smith.
CLASSICAL ECONOMICS: VALUE IN LABOUR
As industry developed rapidly through the eighteenth and nineteenth centuries, so too did the ideas of a succession of outstanding thinkers like Adam Smith (1723–90), David Ricardo (1772–1823) and Karl Marx (1818–83), a German who did much of his greatest work in England. Economists started to measure the market value of a product in terms of the amount of work, or labour, that had gone into its production. Accordingly, they paid close attention to how labour and working conditions were changing and to the adoption of new technologies and ways of organizing production.
In The Wealth of Nations, first published in 1776 and widely regarded as the founding work of economics, Smith’s famous description of the division of labour in pin factories showed his understanding of how changes in the organization of work could affect productivity and therefore economic growth and wealth. Another enormously influential book, Ricardo’s On the Principles of Political Economy and Taxation, first published in 1817, contained a famous chapter called ‘On Machinery’, in which he argued that mechanization was reducing demand for skilled labour and would depress wages. And in Marx’s Capital, Volume 1 of which was first published in 1867, the chapter called ‘The Working Day’, which dealt with the development of the English Factory Acts governing working conditions, showed his fascination with production as the field on which the battle for workers’ rights, higher wages and better conditions was being fought.
Smith, Ricardo and others of the time became known as the ‘classical’ economists. Marx, a late outrider, stands somewhat apart from this collective description. The word ‘classical’ was a conscious echo of the status given to writers and thinkers of the ancient Greek and Roman worlds, whose works were still the bedrock of education when the term ‘classical economics’ began to be used in the later nineteenth century. The classical economists redrew the production boundary in a way that made more sense for the period they lived in: one which saw the artisan-craft production of the guilds still prominent in Smith’s time give way to the large-scale industry with huge numbers of urban workers – the proletariat – that Marx wrote about in the third quarter of the nineteenth century. Not for nothing was their emerging discipline called ‘political economy’. It did not seem odd to contemporaries that economics was intimately part of studying society: they would have found odd the idea, widespread today, that economics is a neutral technical discipline which can be pursued in isolation of the prevailing social and political context. Although their theories differed in many respects, the classical economists shared two basic ideas: that value derived from the costs of production, principally labour; and that therefore activity subsequent to value created by labour, such as finance, did not in itself create value. Marx, we will see, was more subtle in his understanding of this distinction.
Adam Smith: The Birth of the Labour Theory of Value
Born in 1723 into a family of customs officials in Kirkcaldy, in the county of Fife, Scotland, Adam Smith became Professor of Moral Philosophy at the University of Glasgow before turning his mind to what we now call economic questions, although at the time such questions were deeply influenced by philosophy and political thought.
With Britain well on the path to industrial capitalism, Smith’s The Wealth of Nations highlighted the role of the division of labour in manufacturing. His account of pin-manufacturing continues to be cited today as one of the first examples of organizational and technological change at the centre of the economic growth process. Explaining the immense increase in productivity that occurred when one worker was no longer responsible for producing an entire pin, but only for a small part of it, Smith related how the division of labour allowed an increase in specialization and hence productivity:
I have seen a small manufactory of this kind where ten men only were employed, and where some of them consequently performed two or three distinct operations. But though they were very poor, and therefore but indifferently accommodated with the necessary machinery, they could, when they exerted themselves, make among them about twelve pounds of pins in a day. There are in a pound upwards of four thousand pins of a middling size. Those ten persons, therefore, could make among them upwards of forty-eight thousand pins in a day. Each person, therefore, making a tenth part of forty-eight thousand pins, might be considered as making four thousand eight hundred pins in a day. But if they had all wrought separately and independently, and without any of them having been educated to this peculiar business, they certainly could not each of them have made twenty, perhaps not one pin in a day; that is, certainly, not the two hundred and fortieth, perhaps not the four thousand eight hundredth part of what they are at present capable of performing, in consequence of a proper division and combination of their different operations.20
These insights were original and profound. Smith was writing while the Industrial Revolution introduced machines into factories on a large scale. When harnessed to the division of labour, mechanization would radically increase productivity – the principal engine of economic growth. But even the simple reorganization of labour, without machinery, by which each worker specialized and developed skills in a specific area, enabled Smith to make this critical point.
Equally significant was Smith’s analysis of how the ‘market’ determines the way in which consumers and producers interact. Such interaction, he contended, was not down to ‘benevolence’ or central planning.21 Rather, it was due to the ‘invisible hand’ of the market:
Every individual is continually exerting himself to find out the most advantageous employment for whatever capital he can command. It is his own advantage, indeed, and not that of the society which he has in view. But the study of his own advantage naturally, or rather necessarily, leads him to prefer that employment which is most advantageous to society … 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 not part of his intention.22
Like Quesnay, Smith launched a more general attack on mercantilist policies which, he argued, restricted competition and trade. He also argued strongly for policies that would
increase savings, and hence the amount of capital available for investment rather than unproductive consumption (say, on luxuries). But for Smith, industrial workers – not, as for Quesnay, farmers – were at the heart of the productive economy. Manufacturing labour, not land, was the source of value.23 The labour theory of value was born.
Smith has become the figurehead of much modern economic theory because of his ideas about how capitalism is founded on supposedly immutable human behaviour, notably self-interest, and competition in a market economy. His metaphor of the ‘invisible hand’ has been cited ad nauseam to support the current orthodoxy that markets, left to themselves, may lead to a socially optimal outcome – indeed, more beneficial than if the state intervenes.
Smith’s book is actually a collection of recipes for politicians and policymakers. Far from leaving everything to the market, he thinks of himself as giving guidance to ‘statesmen’ on how to act to ‘enrich both the people and the sovereign’24 – how to increase the wealth of nations. This is where Smith’s value theory enters the picture. He was convinced that growth depended on increasing the relative share of ‘manufactures’ – factories employing formerly independent artisans or agricultural workers as dependent wage labourers – in the overall make-up of industry and believed that free trade was essential to bring this about. He felt that the enemies of growth were, first, the protectionist policies of mercantilists; second, the guilds protecting artisans’ privileges; and third, a nobility that squandered its money on unproductive labour and lavish consumption. For Smith (as for Quesnay), employing an overly large portion of labour for unproductive purposes – such as the hoarding of cash, a practice that still afflicts our modern economies – prevents a nation from accumulating wealth.
The Value of Everything (UK) Page 5