ECONOMISTS, CLASSICALadam smith
a generation of political debate and new economic theories
john stuart mill
There is no precise definition of classical economics, but the term is generally applied to British economists from Adam Smith (1723–1790) to John Stuart Mill (1806–1873). They were concerned with the production, distribution, and consumption of wealth, wealth being understood as commodities produced by human activity.
Adam Smith's Inquiry into the Nature and Causes of the Wealth of Nations, published in 1776, is best understood as a theory of growth based on capital accumulation and increasing the productivity of labor. Smith also made the radical proposal that the well-being of society could be maximized by allowing decisions about consumption and investment to be made by individuals acting in their own self-interest. Smith's proposal was based on his belief that self-interested behavior could be made to promote the public well-being through competition in the marketplace.
In passages in both The Theory of Moral Sentiments (1759) and The Wealth of Nations, Smith introduces the metaphor of the "invisible hand" to illustrate how selfish and even apparently anti-social behavior can have the result of promoting the public interest. In The Wealth of Nations, Smith writes:
As every individual, therefore, endeavours 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….[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 own intention. Nor is it always the worse for 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. I have never known much good done by those who affected to trade for the public good.
The Wealth of Nations is an explanation of how "cheapness and plenty" can be brought about, thus assuring greater wealth for the main bulk of the population. It is essential to the argument that the marketplace be a competitive arena, and equally essential is a political framework that ensures the security of property. As Smith puts it in book 5: "That security which the laws of Great Britain give to every man that he shall enjoy the fruits of his labour, is alone sufficient to make any country flourish…and this security was perfected by the revolution." The revolution to which Smith refers was the liberal revolution of the seventeenth century.
What is to be consumed must first be produced and distributed. Production is dependent on the amount of work done and the efficiency with which that work is carried out. Accordingly, book 1 of The Wealth of Nations is concerned with the productivity of labor. The key concept is the division of labor. Book 1 also explains how the product will be distributed to "the different ranks of the People." The level of production, or total output, will depend on both the productivity of the producers and the number of people at work, and in book 2, Smith examines the question of what determines the total number of productive workers. The answer is that the number of productive workers depends on the accumulation of capital.
Chapter 1 of book 1 introduces the celebrated pin factory with the explanation of the means by which the division of labor enhances total output of the given labor force, that is, increases its productivity. The essential reasons for this increase in productivity are that individual skill and dexterity is increased, that less time is wasted in moving from task to task, and only thirdly, though this was to become a major factor in industrialization, that the dividing up and simplifying of aspects of the production increases the likelihood of the invention of tools and machines that will increase the productivity of the worker.
Book 1 contains a theory of prices that is at the same time a theory of income distribution. Smith's economic world contains three social categories. Entrepreneurs (called "undertakers" by Smith) have "stock," or capital, or can if necessary borrow funds to use as capital. The entrepreneurs pay wages to the laborers they require and also pay rent to landlords. Given then that stock has accumulated and become necessary to production and that land is privately owned, the price or value of any commodity contains an allocation for profit, wages, and rent. These three categories constitute the value added in the production process and determine the long-run, competitive market price of any product. Smith explains in book 1, chapter 7, that there is "in every society or neighbourhood an ordinary or average rate both of wages and profit in every different employment of labour and stock." The rate is regulated by the "general circumstances" of the society. These circumstances include the wealth or poverty of the society and also the rates of growth or decline of the society. Similarly, there is an average rate of rent, regulated by the general circumstances of the society. The resolution of price into the three categories of wages, profit, and rent at the same time produces a distribution of revenues that enables the product to be divided up among the potential consumers. All incomes are derived from one of these three original categories of income.
Smith recognizes that short-run fluctuations in supply and demand can cause actual prices to deviate from this, but the long-run market price reflects the actual cost of producing a product. The wealth of a society can be increased by pushing down the cost of producing an item. The latter can be done by increasing the productivity of the work involved in the production process by means of the division of labor.
The division of labor can progress only as "stock is previously more and more accumulated." The storing up of stock requires a degree of personal wealth, but turning "stock" into "capital" also requires a specific social attitude:
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.
But when he possesses stock sufficient to maintain him for months or years, he naturally endeavors 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.
Capital is characterized by the fact that it produces a revenue, and it produces this revenue by "maintaining labour," or more precisely by putting to work "productive labourers." Only by increasing capital in relation to revenue could industry, and thus wealth and future consumption, be stimulated: "Wherever capital predominates, industry prevails: wherever revenue, idleness." Happily, the "private frugality and good conduct of individuals," driven by "the uniform, constant, and uninterrupted effort of every man to better his condition," is capable of increasing capital. Private, self-interested behavior is sufficient to bring about investment and thus future production.
In book 4, Smith defines political economy as a "branch of the science of a statesman." As such political economy was concerned with "plentiful revenue for the people" and supplying a "revenue sufficient for public services" to the state or commonwealth. Smith undertook as part of the plan of The Wealth of Nations an examination of the errors, as he saw them, of various misguided approaches to public policy, such as the "mercantile system," which is the subject of a large part of book 4. The mercantile system aimed at promoting the wealth of the state, and undoubtedly lined the pockets of the friends of the government who influenced the restraints on trade, but a sound political economy should "enrich both the people and the sovereign" and could do so by maintaining "that order of things which nature pointed out."
Thus the "simple system of natural liberty" did not imply an absence of government. Government was necessary for justice and security. The sovereign clearly had a duty to protect the people from violence and invasion and to protect "every man from injustice or oppression." Smith allowed that "erecting and maintaining public works" was an obligation of the sovereign, especially because they might not be privately provided, but might "frequently do much more than repay [their expenses] to a great society." And in book 5, chapter 1, Smith recognizes that the government must have an interest to offset the deleterious effects of the division of labor. Yet, in the end, in Smith's view, it is competition in the market that will best serve the interests of the majority of the people, as "every man," as long as he observes the rules of justice, pursues his own interest in his own way.
The difficulty, as Smith's followers found, was in maintaining the connection between "private" and "public and national" opulence. A new challenge for the followers of Smith was the question of democracy. While there was a "democratic" aspect to Smith's promotion of "cheapness and plenty" for the whole population, there was no question in his time of a political movement for democracy. The radical democracy that had surfaced at the time of the English revolution had been suppressed. It was to return to England in the wake of revolution in France. The Wealth of Nations provided an essential document for use in the battle for liberalism. The concept of the "natural progress of society," central to liberalism and a key component of Enlightenment thought, gave Smith's followers a metaphor for social prescription that was far more effective on the body politic than any argument from historical fact and also frequently immune to any mere recital of statistical evidence of inequality.
The economic historian C. R. Fay wrote that "it is a truism to say that Adam Smith dominated the fiscal policy of nineteenth-century Britain. But [David] Ricardo and [Thomas Robert] Malthus, the one with his Iron Law of Wages, the other with the Essay on Population, dominated—unhappily—the social thinking of their age." In fact, it was the German socialist Ferdinand Lassalle who later coined the term "Iron Law of Wages," but Ricardo and Malthus, with the help of Harriet Martineau and others, made political economy the "dismal science."
In 1795 the British Parliament was considering a bill to enable justices of the peace to regulate the wages of rural workers, in effect subsidizing them from the poor rates. The framework for this policy was the Elizabethan Poor Laws, under which the parish was responsible for levying "poor rates" and providing for the relief of the sick, aged, and unemployed who had a claim by virtue of residence and good conduct within the parish. In the 1790s, the growth of population and high food prices intensified the systemic rural poverty. The bill reflected the concerns of many magistrates who were ultimately attempting to maintain the peace while keeping a lid on the rising poor rates. This situation was the cause of a major social debate in which, for the first time, arguments derived from political economy played a decisive role in a confrontation with traditional political concerns with obligation and maintaining order.
The best-known outcome of the 1790s debate on the Poor Laws was the work of Malthus (1766–1834). In the first edition of his Essay on the Principle of Population (1798), Malthus explained why "laws of nature" posed "unconquerable difficulties in the way to perfectability": "the power of population is indefinitely greater than the power in the earth to produce subsistence for man." Malthus added a mathematical formulation: population when "unchecked" increases in a geometrical ratio, while subsistence increases only in an arithmetical ratio. Given these assumptions, it was not hard to arrive at pessimistic conclusions. But Malthus's purpose was to arrive at more specific conclusions: Although in principle there are two potential "checks" to population, "preventative" (reduced births) and "positive" (starvation), the number of those who constitute the "lowest orders of society" is ultimately kept in check by starvation. Furthermore, any attempt to share resources, as with the Poor Laws, simply encourages the poor to marry and thus increases population without increasing food supply: "thus in reality it is the poor laws that create the poor." Malthus joined his demonstration that inequality was "natural" with the market perspective of political economy as suggested by Smith: abolition of parish laws, creation of a free labor market, an end to "corporations" and apprenticeship. Lastly—and here Malthus outlined the principle that, when it was enshrined in the new Poor Law of 1834, would make him infamous—the final refuge for those in extreme distress should be the workhouse: "The fare should be hard, and those that were able obliged to work. It would be desirable that they should not be considered as comfortable asylums in all difficulties."
Given the lead by Malthus, the political economists drummed the message that it was the Poor Laws that were creating poverty. Prosperity could be achieved only by the creation of a free labor market and enhanced labor mobility. With the new Poor Law of 1834, the British government entered on a fundamentally new social policy. Accepting the principle that every "necessitous person" had a right to relief, the law imposed new conditions for eligibility: "out-door relief" was abolished and relief was to be given only in the workhouse, where conditions were to be made harsher than outside, by among other things, separating families, and where only the "deserving poor" would avail themselves of help on such terms.
Malthus was active in other economic controversies of the time, especially in the form of a continuing debate with Ricardo (1772–1823), a financier, political economist, and member of Parliament, on the topic of under consumption and overproduction. Following Smith, Ricardo and most classical economists believed that production created its own demand either for consumption or for investment goods, but Malthus thought inadequate demand could be a problem. In contrast to Smith, however, Ricardo shared the opinion of Malthus that wages would of necessity be at a social minimum. For Ricardo this was because a predetermined wage-fund available for hiring labor would have to be shared among a workforce that would multiply to the maximum point consistent with subsistence levels. Ricardo also showed that, in the short run at least, labor could be displaced by machinery, given that a predetermined fund was available for both hiring labor and purchasing machinery.
Like Smith, Ricardo was concerned with economic growth, and like Smith, he identified investment as the key. In Observations on Parliamentary Reform, Ricardo delivered the short and, for the political economists, essential point:
The quantity of employment in the country must depend not only on the quantity of capital but upon its advantageous distribution and above all, the conviction of each capitalist that he will be allowed to enjoy unmolested the fruits of his capital, his skill and his enterprise. To take from him this conviction is at once to annihilate half the productive industry of this country and would be more fatal to the poor labourer than to the rich capitalist himself.
Ricardo placed his economic theories in the center of another intense political debate. The British government's Corn Laws provided for duties on the import of wheat, adjusting the amount of duty according to the scarcity or plenty of British harvests. Ricardo's argument showed that with an increase in population and an accumulation of capital, more land would have to be cultivated, and lower quality land would have to be brought into production, thus increasing the marginal cost of production, and thus raising the price of food. This argument was sharply political because such an out-come would not be in the interests of wage earners or of manufacturers, who would have to pay higher wages to keep the level up to subsistence. The outcome would favor landlords, who would collect a higher share of the national income in rent.
The political edge was made even sharper by the additional conclusion that the higher cost of food could be offset by lower-priced imports, if the Corn Laws were to be repealed. The supporters of the Corn Laws were those same landlords in their role as Parliamentarians, who were thus a barrier to the economic policy of industrial growth. The Anti–Corn Law League attempted to rally political support by showing a common interest between workers and manufacturers. Tory landowners, on the other hand, lost no opportunity to argue that manufacturers wanted to repeal the Corn Laws only in order to bring in cheap food and then drive down wages in order to increase profits. Ricardo's economics was of course already made the object of attention by its connection of the "wage fund" to Malthusian population theory, but the acrimonious debate over the interests of industry and agriculture and their connection with income distribution further shaped the context in which political economy was made known to the general public.
The Corn Laws were repealed in 1846, and Britain moved decisively toward a "free trade" policy. This appeared to be a vindication of Smith's liberal perspective that all trade should be "natural" and mutually beneficial. With trade the division of labor is not hindered by the "narrowness of the home market," but can be carried to the "highest perfection," as Smith argued. Ricardo had advanced the theoretical case for free trade with his "theory of comparative advantage." Ricardo's trade model demonstrated the advantages of the extension of the market by foreign trade, showing that, in trade between two countries, both countries could benefit by exporting the products they could produce most productively.
Political debate was also shaped by events out-side of Britain. In 1848 France and other European countries experienced a new outbreak of revolutions. Nassau Senior (1790–1864), an economist who had played a major role in the formation of the new Poor Law when he had been an advisor to the British government of the time, saw the "unhappy" events in France as the result of the widespread acceptance of views that he called "disguised socialism." The rapid growth of the national workshops and the concept of "the right to work" demanded by the Paris workers, Senior suggested, had been the result of the unfortunate theory that it was "in the power of the State to correct the inequalities of fortune." While the error was "a plausible one" to those untrained in economics, it was necessary, Senior argued, to show that capital accumulation was a fragile growth that could be stunted by ill-considered actions of the state. Accepting a "right to work," Senior argued, meant that either the state would have to become an employer, soon ending up as the greatest employer, and private property would become an encumbrance, or the right to work will lead to the need to ensure work by preventing "stagnation" through the retarding or accelerating of production, which would require management and regulation and the organization of industry. The consequences were either communism or socialism. It was, Senior concluded, necessary to distinguish between the right to relief and the right to employment.
The ideological battlefield of political economy was a major sphere of operations, but decisive victories in the class war required a change in the realities of the "condition of England," a change that was still beyond the horizon. In the summer of 1849 an outbreak of cholera reminded the country of some uncomfortable facts of life in the new industrial world. Within a period of three months there were some thirteen thousand deaths in London alone. While the precise reasons for the spread of the disease were still unknown, the fact that it was most deadly in the poorest districts was inescapable.
In September 1849 a remarkable report appeared in a national newspaper. It was a description of the journalist Henry Mayhew's visit to one of the poorest areas of London. Shortly after publishing the article, the Morning Chronicle commented in an editorial:
The primary cause of the pestilence is to be found in the filth and squalor of the poor…. We, the richest nation on the face of the earth, have allowed our fellow-creatures to "fust" in styes, reeking with filth, such as farmers, now-a-days, know that swine would pine and dwindle in. We have allowed them…to quench their thirst and cook their food with water poisoned with their own excretions.
Mayhew, commissioned by the same newspaper, went on to write a series of articles on the laboring poor in London. He observed the very great difference in working and living conditions that separated the skilled artisans from the unskilled. One of the conclusions he drew concerned the poverty that resulted from the aggressive competition and unregulated conditions in the needle trades. In December 1849 Mayhew drew the fire of The Economist. The articles, it said:
have given occasion to throw discredit on free trade, to cast a slur on commercial greatness, to beget doubts of the advantages of civilisation, to bring reproach upon cheapness and excite a strong communist feeling against competition…. The people can only help themselves. Only they can put restrictions on their numbers, and keep population on a level with capital….[The] rich are no more responsible for their condition than they are responsible for the condition of the rich.
The Morning Chronicle replied with an opposing argument. Reform, it said, was the only way to avoid "communism."
The doctrines of political economy had been popularized by the immensely successful publication of monthly stories illustrating the truths of political economy, written by Harriet Martineau (1802–1876) between 1832 and 1834. Each month more than ten thousand copies were sold, and the entire series was reprinted. The publisher estimated that there were 140,000 readers. The tales drew from Smith, there was a central place for Malthus, and the most frequent source was James Mill's text Elements of Political Economy (1821). Martineau was a Unitarian who believed that the improvement of society could be achieved by self-mastery through education. Chartism and socialism were symptoms of distress, but society could be saved by the recognition by the rich of their obligations and by inducing the poor to learn the limits to help from others. Political economy set a negative limit; positive action could come from an active morality.
In an essay written in 1834 titled "Miss Martineau's Summary of Political Economy," John Stuart Mill objected to treatises on political economy that "presuppose in every one of them that the produce of industry is shared among three classes altogether distinct from one another, namely labourers, capitalists and landlords." Not being able to imagine any other form of society might produce an opposition to all reform:
And we think there is some danger of a similar result in the case of the English political economists. They revolve in their eternal circle of landlords, capitalists, and labourers, until they seem to think of the distinction of society into those three classes as if it were one of God's ordinances, not man's, and as little under human control as the division of day and night.
Unfortunately, Mill had to agree, it was not yet time for "ulterior enquiries" to come into contact with practice: "society has many incumbrances to throw off before it can start fair on [a] new journey."
If Mill thought that Martineau had reduced the laissez-faire system to an absurdity, he was equally troubled by those who pressed the "claims of labour." In 1845, reviewing a book with that title, Mill returned to what was becoming his keynote theme: "society cannot with safety, in one of its gravest concerns, pass at once from selfish supineness to restless activity. It has a long and difficult apprenticeship yet to serve."
Mill believed that the deductive, conceptual study of political economy that had been evolved from Smith's Wealth of Nations, by virtue of the contributions of Bentham, Malthus, James Mill and Ricardo, contained some essential truths concerning "mankind as occupied solely in acquiring and consuming wealth." Political economy had achieved a status as an "abstract science" that was not yet available to any other branch of "social science," Mill concluded in his System of Logic (1843). It was essential, Mill thought, that an understanding of the "science" of political economy be applied to the urgent political issues of the day. The main thrust of the changes since Smith's time, in Mill's opinion, was the consequence of two contradictory forces: on the one hand, the new industrial organization of production had created a far more active "spirit of accumulation" that even offered the prospect of a "surplus" of capital; on the other hand, the conditions of life and work for the majority of the population remained unacceptably wretched. This latter situation was largely, though not exclusively, in Mill's opinion, a consequence of the poverty perpetuated by the accompanying excessive population growth. The opportunity to move to an "improved" state of society, beyond the narrow confines of the "cash nexus," contrasted with the danger that the demand for democracy would undermine the circumstances that made improvement possible. A central message from Mill was that it would be folly to "subvert" the "system of individual property," but equally irresponsible not to improve it.
Mill's political economy rested on the traditional liberal claim that property was the consequence of labor and frugality, but at the same time he recognized the strength of the claim that "in the present state of society" it was "manifestly chimerical" to believe that there was "any proportionality between success and merit, or between success and exertion." The socialists were able to make, Mill conceded, "a frightful case." Where the socialists were wrong, however, in Mill's opinion, was first in claiming that wages were falling. However low, Mill concluded, they were on the whole gradually increasing and would increase more when the connection with population growth was understood by the majority. Second, the socialists were wrong to condemn competition. Competition might encourage a "gambling spirit" and even some profitable fraud, but competition was essential to progress and an inherent part of "liberty." The less attractive aspects of competition could, Mill suggested, be overcome with the slow progress of cooperation as mankind reached a more improved state, but some element of competition would be necessary.
In the third edition of his Principles of Political Economy, published in 1852, Mill explicitly states that socialism might be regarded as the ultimate aim of human progress, unacceptable though it was in the present "unprepared state of mankind in general, and of the labouring classes in particular." The real issue for Mill, however, was that "the principle of private property has never yet had a fair trial in any country," and political economy showed the means by which society could acquire both liberty and prosperity.
Mill was skeptical of the power of unions, but he maintained that allowing unions to exist legally would serve an important educational function: "experience of strikes has been the best teacher of the labouring classes on the subject of the relation between wages and the demand and supply of labor: and it is most important that this course of instruction should not be disturbed." By the later editions of his Principles, Mill had added a section in which he recognized that the market rate of wages was the result of bargaining, as Smith had said. Unions, then, Mill concluded, were a "necessary instrumentality of the free market…the indispensable means of enabling the sellers of labour to take due care of their own interests under a system of competition." But, Mill added, combinations must be voluntary: moral compulsion alone should be used to enforce solidarity.
Mill's Principles investigated many of the possible boundaries between private and collective action. With respect to the "laissez-faire or non-interference principle," Mill argued that laissez-faire should be the general practice: "every departure, unless required by some great good, is a certain evil." But there was a considerable list of cases to be made for government intervention. Children, for example, needed protection from the "freedom of contract," which was another way of saying "freedom of coercion." There could be no contracts in perpetuity, because there was no possibility of adequate future knowledge. There were important public services, including the creation of "a learned class," which no private interest would produce. At some time, Mill allowed, the list would be longer. There were both necessary functions for the government and optional functions, but the role of government would never be limited to mere protection against "force and fraud." With respect to payment for government services, Mill concluded that taxation should be regulated by Smith's "classical" maxims of proportionality and certainty, and that a "permanent" national debt would be "pernicious," though he added the interesting caveat that this might not be true if there was a surplus of funds, so that the debt did not raise the rate of interest.
Mill also made a celebrated distinction between the "laws of production" and the "laws of distribution" of wealth. While the laws of the production of wealth "partake of the character of physical truth," the distribution of wealth is "a matter of human institution solely." While this distinction appeared to open up considerable flexibility for the "system of private property," it also introduced considerable confusion. Changes in distribution have political consequences, and Mill was certainly aware that not all proposals for distribution would have a benign effect on production. His fulminations on the Poor Laws made that point clear.
Mill looked forward to better days than those in which he lived. It would eventually be possible to go beyond the "inordinate importance attached to the mere increase of production": it would be possible to escape from the eternal conception of society as a set of "classes" with competing interests, and society could become an association of equal individuals, without the "delusive unanimity" produced by "the prostration of all individual opinions." But there were some points of politicale conomyon which unanimity was required. Some of the unanimity could be achieved by experience; some might require the imposition of authority. Mill clearly regarded democracy as a desirable goal, and he can be seen as one of the founders of liberal democracy, but he thought that there must be limits to democracy, and even to liberalism, in his time.
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