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Friday, March 18, 2005

Adam Smith: The Wealth of Nations


Blogger SMJ said...

With all the waste and malfeasance apparent in modern corporate culture, it is tempting today to blame Adam Smith for the failures of free market economies. But Smith's Wealth of Nations is not a moral treatise or apology for greed, but a careful analysis of how wealth is created and acquired. Whether or not free market economies generate more spiritual bliss than can be achieved in nomadic tribes is a legitimate question, but not one that Smith attempts to answer.

Much criticism of Smith targets his assumption that man is moved primarily by rational self-interest. This belief marks an assumption about human nature that is not universally shared, but has many adherents, one of whom was Thomas Hobbes. According to Hobbes, man is interested in many things, but one thing with which he is most concerned is his own survival; thus, when man concludes that his prospects for survival are enhanced by surrendering his liberty, he willingly does so. Smith would say that man engages in a political transaction, wherein he exchanges one thing (a measure of his freedom) for another thing he desires more (a measure of security). This transaction occurs because man, living in a state of nature, reasons he can improve his vulnerable position in the world by ceding authority to a sovereign, rather than continuing to live in fear without the protection of law.

Now, if you do not accept Smith's original assumptions about human nature, then his discussion on the rise of market economies will not ring true. However, this element of Smith's work can be characterized as speculative anthropology. It functions as a kind of thought experiment, which doesn't require absolute verification because it simply draws a reasonable conclusion, based on the historical record of man's behavior. With rational self-interest as a starting point, Smith draws a connection to natural instinct, common to all men, the tendency to "truck, barter, and exchange one thing for another."

Since men are rarely able to supply all of their personal needs and wants, the act of exchanging one thing for another is a uniquely human solution to an everyday problem. Barter or trade is but the action of rational self-interest accommodating itself to necessity. Through trade, man exchanges a surplus of one item for other items that he is unable or unwilling to manufacture for himself. In effect, he extends the range of his labor to include things he would otherwise not possess.

However, there is another component that bears on the issue of exchange. This component is the division of manual labor. When a sufficient number of people live in proximity to one another (for example, a village or township), it occurs to some members of the population to specialize in one type of labor, resulting in higher levels of production. Once division of labor occurs (as when people abandon farming for work in factories), greater efficiencies in manufacturing enables the creation of surplus value. Surplus value (or profit) is simply the difference between the cost of production and the market price of whatever is produced.

With the advent of industrialization and assembly line production, greater economies of scale are made possible, resulting in higher profits for the owner. Profits, in effect, are the "wages" that owners pay to themselves in compensation for their "labor" (i.e., investment of "stock" or capital). In some respects, the interests of owners and workers appear to be diametrically opposed, for the owner prefers to minimize the costs of production (e.g. the cost of labor or wages), and maximize profits; whereas the worker prefers to minimize his own cost of production (e.g. the time he spends at work) and maximize his own profits (wages and benefits). Today, labor relations (and contract negotiations) take a more enlightened view. After all, it is in the interest of both parties that the company and its workers survive and prosper.

Profits, of course, is what the game is all about. As Smith explains, the marketplace, ultimately, is where the exchange value of goods is determined. Over time, with the adoption of money, exchanging cartloads of wheat in return for cattle is no longer necessary. One simply hands over one's produce and gets an equivalent value expressed in coin. In this case, the equivalent value is known as the market price. What determines the market price? Quite simply, human desire. Smith sees the marketplace as a self-regulating mechanism that operates according to the principle of supply and demand. In general, goods that are scarce fetch a higher price than goods in abundance. However, other factors come into play, for example, the notion of urgency. Time plays an important role in determining price. Things that are perishable cannot wait forever. The farmer cannot afford to wait for the optimum market price before selling his produce, just as a man bleeding to death cannot afford to wait for the lowest price of emergency care.

Adam Smith believes that an item's true worth is expressed in the quantity of labor required to produce it. But he recognizes two definitions of "value." In layman's terms, "value" simply means what something is worth. For Smith, however, there is an important difference between "use" value and "exchange" value. Water, for example, has tremendous "use" value, but very little "exchange" value, unless you happen to be stranded in the middle of a desert. Again, "exchange" value refers to how much someone is willing to give you "in exchange" for something, whether it be money or goods in kind.

The market function of "price" and "value" are similarly related. The natural or "real" price of something is equal to the "toil and trouble of acquiring it." In other words, how much labor is required to either produce the item or exchange for it. This price may or may not move parallel to its relative market price. The market price takes into account the natural price + the current demand for the item. If demand is low, then the market price will drop, regardless of what the natural price may be. Obviously, if the market price drops below the natural price, the item cannot be brought to market.

The entire process of determining prices, assigning value, exchanging labor for equivalent goods or currency is what comprises the market economy of Smith's day. In The Wealth of Nations, he provides a historical model of a basic market economy, something that has evolved over the past two centuries into a much more complex system. Today, we live in a global economy, suffused with government regulations, offshore banking, currency speculation, labor disputes, multi-national corporations and computerized stock trading. Even as markets close in one part of the world, trading continues in other time zones. The days when it could be said that "labor alone is the real standard by which the value of commodities can be compared" are long gone. The market economy under which we live today is so complex that, without the backbone of computerized networking, the entire business would likely collapse. Hobbes' metaphor of the "leviathan" really applies not to a sovereign government, but to a macro economy which is increasingly beyond anyone's comprehension or control.

What we have today is a vast mechanism for the creation of wealth. The supply and demand dynamics of a free market economy have become the dominant means of production in western culture, and throughout the industrialized world. With globalization, the markets and economies of competing nations have become intermingled, such that old models with a bias toward unfettered competition (i.e. non-regulation) need to be recalibrated. These days, with deficit spending the norm, rising and falling interest rates, government manipulation of currencies, and trading partners who, while competing with you in the marketplace, also produce most of your commodities, one cannot easily identify just who is competing with whom.

Adam Smith was one of the first philosophers to seriously analyze the nature of wealth and its creation, its organizational structure, the human motivations behind it, and the social implications for the future. What we do with this wealth after its creation leads to a different discussion than the one pursued in The Wealth of Nations. At some level, Smith himself believed that the creation of surplus value would improve the lives of everyone..."universal opulence which extends to the lowest ranks of the people." But, how this surplus value or wealth can be fairly distributed is not examined. Certainly, most of the advantages, in this struggle, lie with those who control capital..."The masters, being fewer in number, can combine much more easily; and the law, besides, authorizes, or at least does not prohibit their combinations, while it prohibits those of the workmen."

Finally, the best argument in favor of modern economies based on competition is that they produce more wealth than other models, such as socialism or non-industrial agrarian tribal communities. What wealth provides is the opportunity to acquire property and to spend one's time in non-work related activities, such as art, education or leisure. For all its problems, and there are no shortage of labor, political and ethical issues concerning the accumulation and distribution of wealth, market economies give people a higher standard of living than those living under a subsistence level economy, such as nomadic tribal cultures. Whether this "higher standard" of living also brings greater spiritual fulfillment is a question that no economist can answer.

3/18/2005 9:41 AM  
Anonymous Anonymous said...

You could make an interesting link to John Nash's analysis of economics and non-cooperative games as related to equilibrium. The link could be made is relation to Smith's assumption of rational self-interest.
Interesting blog, which I will have to visit again tomorrow, when I have more time.

5/02/2005 3:13 PM  

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