Value, Smith believed, was proportional to the time spent by workers on production. For the purposes of his theory, Smith assumed a worker of average speed. Figure 5 shows how he drew a clear line (the production boundary) between productive and unproductive labour. For him, the boundary lay between material production – agriculture, manufacturing, mining in the figure’s darker blob – and immaterial production in the lighter blob. The latter included all types of services (lawyers, carters, officials and so on) that were useful to manufactures, but were not actually involved in production itself. Smith said as much: labour, he suggested, is productive when it is ‘realized’ in a permanent object.25 His positioning of government on the ‘unproductive’ side of the boundary set the tone for much subsequent analysis and is a recurring theme in today’s debates about government’s role in the economy, epitomized by the Thatcher–Reagan reassertion in the 1980s of the primacy of markets in solving economic and social issues.
Figure 5. The production boundary according to Adam Smith
In Smith’s view, ‘how honourable, how useful, or how necessary soever’ a service may be, it simply does not reproduce the value used in maintaining (feeding, clothing, housing) unproductive labourers. Smith finds that even ‘the sovereign’, together with ‘all the officers both of justice and war who serve under him, the whole army and navy, are unproductive labourers’.26 Priests, lawyers, doctors and performing artists are all lumped together as unproductive too.
What informs Smith’s classification is his conviction that some types of labour do not ‘reproduce’ the value needed to keep those workers alive at a subsistence level. In other words, if all the subsistence that was needed to keep a person alive was a certain amount of grain, then anyone who does not produce as much value as that amount of grain is by definition unproductive.
How, then, are those that do not produce this unit of value kept alive?
Smith’s answer lay in the concept of a ‘surplus’. Many productive workers produce the equivalent of more grain than they need to feed themselves to survive. A manufacturer makes things that, when exchanged, will yield more grain than needed to keep the productive workers alive. The surplus then sustains unproductive labourers, including the entourages of aristocrats, who kept ‘a profuse and sumptuous table’ with ‘a great number of menial servants, and a multitude of dogs and horses’.
This is where Smith addressed head-on how the wealth of nations could grow. It was in effect his policy advice. Instead of ‘wasting’ the surplus on paying for unproductive labour, he argued, it should be saved and invested in more production so that the whole nation could become richer.27 Smith was not criticizing the wealthy per se. But he was criticizing those who wasted their wealth on lavish consumption – ‘collecting books, statues, pictures’, or ‘more frivolous, jewels, baubles, ingenious trinkets’ – instead of productive investment. (This, after all, was the age of the Grand Tour, when young aristocrats travelled to the Continent to improve their education and returned laden with ancient artefacts.) Smith was particularly attracted to the prospect of investment in machines, then just beginning to be used in factories, because they improved workers’ productivity.
His emphasis on investment linked directly to his ideas about rent. Smith believed that there were three kinds of income: wages for labour in capitalist enterprises; profits for capitalists who owned the means of production; and rents from ownership of land. When these three sources of income are paid at their competitive level, together they determine what he called the ‘competitive price’.28 Since land was necessary, rent from land was a ‘natural’ part of the economy. But that did not mean rent was productive: ‘the landlords, like all other men, love to reap where they never sowed and demand a rent [from the earth] even for its natural produce’.29 Indeed, Smith asserted, the principle of rent from land could be extended to other monopolies, such as the right to import a particular commodity or the right to plead at the bar. Smith was well aware of the damage monopolies could do. In the seventeenth century, a government desperate for revenue had granted – often to well-placed courtiers – an extraordinary range of monopolies, from daily necessities such as beer and salt to mousetraps and spectacles. In 1621 there were said to be 700 monopolies, and by the late 1630s they were bringing in £100,000 a year to the Exchequer.30 But this epidemic of rent-seeking was deeply unpopular and was choking the economy: more than that, it was one of the proximate causes of the Civil War, which led to the execution of Charles I. Many Englishmen understood what Smith meant when he said that a free market was one free of rent.
Smith’s penetrating analysis of how advanced capitalist economies functioned won him many followers. Equally, his staunch advocacy of free trade, in an era in which mercantilist policies were beginning to be seen as old-fashioned (Smith, indeed, believed that merchants were unproductive because they only provided the ephemeral service of moving goods around, rather than producing anything of value), made his book a hit among the ‘free traders’ who eventually overturned England’s Corn Laws, which imposed heavy tariffs on imported corn to protect domestic landowners, and other protectionist measures. Armed with Smith’s ideas, free traders showed that nations could get richer even if there was no trade surplus and no gold accumulation. Amassing gold was unnecessary and insufficient for growth. Huge amounts of gold flowed to Spain from its colonies, but the kingdom did not become more productive.
The victory of the free traders over the mercantilists is better understood in terms of their rival conceptions of value. Mercantilists thought gold had inherent worth and that everything else could be valued in terms of how much gold it was exchanged for. Following Smith, free traders could trace value to labour, and the logic of value was thereby inverted. Gold, like all other things, was valued by how much labour it took to produce.31
Smith’s theory was not immune to criticism. He had actually put forward at least two theories of value, which created confusion about both the production boundary and precisely who was productive – in particular, whether the provision of services in themselves created value.32
In essence, Smith was confused about the distinction between material and immaterial production. For Smith, as we have seen, a servant ‘adds’ no value that could be used by the master on something other than, literally, keeping the servant alive. But he also argued that if a manufacturing worker earns £1 in turning a quantity of cotton, whose other inputs also cost £1, into a piece of cloth that sells for £3, then the worker will have repaid his service and the master has made a profit of £1. Here a definition of productivity, irrespective of whether what is produced is a solid product or a service, emerges. Adding value in any branch of production is productive; not adding value is unproductive. Following this definition, services such as cleaning or vehicle repair can be productive – thereby invalidating Smith’s own material–immaterial division of the production boundary. The debates about Smith’s theories of value rumbled on for centuries. Other of Smith’s ideas, such as free trade and the unproductive nature of government, have also left an enduring legacy.
But he is often misconstrued. His understanding of politics and philosophy was never sidelined in his economic reasoning. His Theory of Moral Sentiments and The Wealth of Nations were not contradictory but part of his deep analysis of what drives human behaviour and how societies organize themselves, and why some societies might grow in wealth more than others. Smith’s analysis of ‘free markets’ was closely tied to his understanding of production, and the need to limit rent-seeking behaviour.
David Ricardo: Grounding Smith’s Value Theory
In the 1810s, another towering figure of the English classical economic school used the labour theory of value and productiveness to explain how society maintains the conditions which enable it to reproduce itself. David Ricardo came from a Sephardic Jewish family which originated in Portugal and moved to Holland before settling in England. Ricardo followed his father as a London stockbroker, although he was later estrange
d from his family after becoming a Unitarian. He grew fabulously rich from his speculative activities, most notoriously by profiting from inaccurate information that was circulating on the Battle of Waterloo in 1815. He was said to have made £1 million (in 1815 value) from holding on to bonds while everyone else was selling (due to the false rumours that Wellington was losing against Napoleon), an almost unimaginable sum at the time, after which he promptly and wisely retired to the country, well away from London.
Ricardo was drawn to economics by reading Smith’s The Wealth of Nations, but was concerned with something that he felt was glaringly absent from Smith’s theory of value: how that value was distributed throughout society – or what we would today call income distribution. It need hardly be said that, in today’s world of growing inequality of income and wealth, this question remains profoundly relevant.
Smith had observed that the value produced by labour, when sold, is redistributed as wages, profits and rent; he had also seen that labour’s exact share of this value – wages – would vary.33 However, Smith had no coherent explanation for the way in which wages were apportioned, or why they differed between professions and countries or over time.34 Ricardo, by contrast, felt that the distribution of wages was, as he stressed in his magnum opus On the Principles of Political Economy and Taxation, the ‘principle problem’ in economics and ultimately regulates the growth and wealth of a nation.
Ricardo actually believed in the labour theory of value, and, unlike Smith, was at pains to point out that the value of a commodity was strictly proportional to the amount of labour time needed to produce it. Ricardo emphasized agriculture for a different reason from Quesnay. He wanted to explain the distribution of income, and for him productivity in agriculture was the hinge upon which that distribution turned. Workers, Ricardo believed, were paid a subsistence wage: in essence, they earned enough to pay for food and shelter. But food comes from agriculture, so the price of food regulates wages: a low price of food (or ‘corn’, as Ricardo wrote in the language of the day) will permit lower wages and therefore higher profits and incentives to invest in future production (for example in manufacturing) and promote economic growth. A high wage due to low productivity in agriculture will mean lower profits, and hence little investment in future production, which in turn leads to slower economic growth.
Ricardo inherited this ‘dismal theory’ of wages from his contemporary Thomas Malthus (1766–1834), another English writer on political economy, who proposed that whenever real wages are above subsistence level, the population will grow until it is so large that the demand for food will push up food prices enough to bring wages back to subsistence level.35
In Ricardo’s view, then, wages depended heavily on the productivity of agriculture: if productivity rose and food became cheaper, wages would fall. And in manufacturing and the other branches of the economy, whatever did not have to be paid to the worker would flow to the capitalist as profit. Profits are the residual from the value that workers produce and do not need to consume for their own ‘maintenance’, as Ricardo put it, ‘to subsist and perpetuate their race’.36
This in turn leads to Ricardo’s theory of growth and accumulation – increasing the stock of capital or wealth to help fuel subsequent further increases in wealth. As profits grow, so capitalists invest and expand production, which in turn creates more jobs and raises wages, thereby increasing the population, whose wages finally go back to subsistence level, and so on. The economy is a perpetual growth machine, with more and more people earning the subsistence wage.
But Ricardo’s theoretical genius really came to the fore in tackling his third class of society: landlords. Production in agriculture depends on two types of input: goods and services needed for production. One type can be scaled – increased in proportion to requirements. It includes labour, machinery, seeds and water. The other type cannot be scaled: good arable land. As Mark Twain is supposed to have said, ‘Buy land, they’re not making it any more.’
Since the population will grow thanks to investment and rising wages, and more and more food will need to be produced to feed everyone, at some point all the best land for corn production will be spoken for. Less fertile or productive land will then be cultivated. However, since all the corn is sold at one price to the workers, who are on subsistence wages, the more productive land already in use yields a higher profit than the less productive land. Here Ricardo developed his celebrated theory of rent.
Ricardo defined rent as a transfer of profit to landlords simply because they had a monopoly of a scarce asset. There was no assumption, as in modern neoclassical theory (reviewed in Chapter 2), that these rents would be competed away. They remained due to power relationships inherent in the capitalist system. In Ricardo’s time much of the arable land was owned by aristocrats and landed gentry but worked by tenant farmers or labourers. Ricardo proposed that the rent from more productive land always goes to the landlord because of competition between tenants. If the capitalist farmer – the tenant – wants to hang on to the largest possible profit by paying less rent, the landlord can give the lease to a competing farmer who will pay a higher rent and therefore be willing to work the land for only the standard profit. As this process goes on, land of increasingly poor quality will be brought into production, and a greater portion of the income will go to the landlords. Ricardo predicted that rents would rise.
More significantly, rising rents were the flipside of rising food prices, caused by lack of good-quality agricultural land. More costly food increased the wages workers needed for subsistence. This growing wage share, Ricardo believed, put a squeeze on profits in other sectors such as manufacturing. As economic development proceeded, the profit rate – basically the manufacturing capitalist’s return on capital – would fall. The profit share – the part of the national income going to capitalists – would also fall. Correspondingly, the wage share going to manufacturing workers would rise. But the extra wages would have to be spent on food, which was more expensive because landlords were charging higher rents. As a result, much of the nation’s income would ultimately go to landlords. This would halt further economic growth and investment in, say, manufacturing because the low returns would not justify the risks.37
By highlighting the different types of incomes earned, such as rent, profits and wages, Ricardo drew attention to an important question. When goods are sold, how are the proceeds of that sale divided? Does everyone involved get their ‘just share’ for the amount of effort they put into production? Ricardo’s answer was an emphatic ‘No’.
If some input into production – such as good arable land – is scarce, the cost of producing the same output – a given quantity of corn – will vary according to availability of the input. The cost is likely to be lower with good land, higher with inferior land. Profits, instead, are likely to be higher with good land and lower with inferior land. The owner of good land will pocket the difference in profit between the good land and inferior land simply because he or she has a monopoly of that asset.38 Ricardo’s theory was so convincing that it is, in essence, still used today in economics to explain how rents work.39 Rents in this sense could mean a patent on a drug, control of a rare mineral such as diamonds, or rents in the everyday sense of what you pay a landlord to live in a flat. In the modern world, oil producers like those of the Organization of Petroleum Exporting Countries (OPEC) collect rents from their control of an essential resource.
Ricardo’s gloomy picture of economic stagnation is relevant to a modern debate: how the rise of the financial sector in recent decades and the massive rents it earned from speculative activity have created disincentives for industrial production. Some heterodox economists today argue that growth will fall if finance becomes too big relative to the rest of the economy (industry) because real profits come from the production of new goods and services rather than from simple transfers of money earned from those goods and services.40 To ‘rebalance’ the economy, the argument runs, we must allow genuine profits f
rom production to win over rents – which, as we can see here, is exactly the argument Ricardo made 200 years ago, and John Maynard Keynes was to make 100 years later.41
Indeed, as is also argued today, Ricardo believed that the pool of (mainly unskilled) workers held the losing ticket. In Ricardo’s day, agricultural labour flocked to the fast-growing cities and the supply of unskilled labour exceeded demand for it. Without bargaining power, these workers were paid a meagre subsistence wage. Ricardo’s portrayal of rents dominating production also had a political impact. It helped to persuade Britain to abolish the Corn Laws in 1846 and embrace free trade, which diminished the power of big vested interests and allowed production costs, rather than embedded monopoly and the privileges that went with it, to govern production. The ensuing decades saw Britain become the ‘workshop of the world’. But the abolition of the Corn Laws brought about a political transformation as well as an economic one: it tipped the balance of power away from aristocratic landlords and towards manufacturing as the nineteenth century wore on. Value theory influenced political behaviour, and vice versa – the performativity referred to in the Preface.
Other lessons about the sources of value and who generates it can be drawn from Ricardo’s model of accumulation. Like Smith, Ricardo was concerned with understanding how the economy reproduces itself. Like Smith, he focused on the difference between investment in durable capital and consumption: ‘When the annual productions of a country more than replace its annual consumption, it is said to increase its capital; when its annual consumption is not at least replaced by its annual production, it is said to diminish its capital.’42 Ricardo hastened to add, though, that all goods produced – from clothes to carts – must be consumed or used; otherwise they would depreciate just like inventory.
The Value of Everything (UK) Page 6