Studying the Wealth of Nations (Part 2)

Adam Smith on the Wages of Labour and the Profits of Stock

This is the second part of a weekly project marking the 250th anniversary of Adam Smith’s Wealth of Nations. You can find the first installment here.

There were several moments in this week’s readings when I had to remind myself that I was reading Adam Smith. The author who kept coming to mind—surprisingly—was Karl Marx. Given the topics under discussion, namely the wages of labor and the profits of stock, perhaps I shouldn’t have been surprised. After all, both Marx and Smith believed in the labor theory of value: the idea that a commodity’s value is determined by the quantity of labor required to produce it. To use Smith’s own example, if it takes twice as much labor to hunt a beaver as it does a deer, then a beaver should be worth two deer.

This theory flies in the face of modern economic thought, which holds that value is subjective and determined at the margin. Still, it helps explain why so much of Smith’s analysis echoes Marx’s later complaints—particularly those concerning class conflict. The crucial difference, however, is that even though Smith’s framework rested on a flawed theory of value, he still managed to uncovered remarkable insights into the market process and the benefits of economic growth.

And while Smith clearly perceived shortcomings in the market—especially in the labor market—he also recognized that many of these problems could be alleviated by faster economic growth. In particular, he highlights the power imbalance between workers and masters, low birth rates, and the difficulty young widows faced in remarrying.

Overcoming Class Struggle and Collusion

I’m convinced that a simple substitution of terms—“proletariat” for labourer and “bourgeoisie” for master or landlord—would fool a majority of unsuspecting college socialists into thinking they were reading The Communist Manifesto rather than two chapters of The Wealth of Nations.

Smith begins his discussion of wages by explaining that in the “original state of things… the whole produce of labour belongs to the labourer.” It was only with the introduction of private property that the landlord appeared, demanding “almost all the produce” of the labourer.

But what separates Smith from Marx is that Smith goes beyond the initial observation to understand why a phenomenon occurs. The answer, obvious to anyone who is not a collectivist, is that the labourer rarely “has wherewithal to maintain himself till he reaps the harvest.” The introduction of the landlord or master is, therefore, a benefit to both the labourer, who receives an advance “from the stock of a master, the farmer who employs him,” and the landlord, “who would have no interest to employ [the labourer], unless he was to share in the produce of his labour.”

What really elevated the Smith–Marx comparison, though, was Smith’s discussion of employer collusion. To Smith, it was so self-evident that masters would combine to keep wages low that only those “as ignorant of the world as of the subject” could believe otherwise. Employers, being relatively few in number and operating legally, could more easily agree to suppress wages or even to “sink” them. Labourers, by contrast, were prohibited from combining to raise their own wages.

But once again, Smith’s analysis doesn’t end there. He points out that in a growing economy, “the demand for those who live by wages… is continually increasing.” This resulting “scarcity of hands” produces “a competition among masters, who bid against one another, in order to get workmen, and thus voluntarily break through the natural combination of masters not to raise wages.”

In modern economic language: at the existing low wage rate the quantity of labor demanded exceeded the quantity of labor supplied, creating profit opportunities for employers willing to offer higher wages. In a growing economy, those unrealized profits are large enough to entice employers to defect from their collusive arrangements.

Thus, while collectivists condemn the profit motive as the cause of employer collusion, Smith shows that—under conditions of economic growth—the profit motive is precisely what breaks such collusion apart.

Economic Growth and Birth Rates

One of Smith’s more fascinating observations concerns the relationship between prosperity and childbearing: “The most decisive mark of prosperity in a country is its population growth.” While modern economists often treat population growth as a driver of economic growth, Smith reverses the causality. For him, economic growth leads to population growth.

Once again emphasizing labor demand, Smith writes of the American colonies:

Labour is there so well rewarded that a numerous family of children, instead of being a burthen is a source of opulence and prosperity to the parents. The labour of each child, before it can leave their house, is computed to be worth a hundred pounds clear gain to them.

The standard explanation for larger families were larger in earlier eras was the need for children to help “tend the farm.” That doesn’t contradict Smith’s account, but it does understate the financial benefits of those children. And if the farm-labor theory was sufficient on its own, it wouldn’t explain why Smith compares American birth rates with those much lower rates in Europe and Britain where the same logic should have applied. Introducing economic growth as a causal factor seems to resolve this inconsistency.

Emphasizing the tremendous value of children in America, Smith explains:

A young widow with four or five young children, who, among the middling or inferior ranks of people in Europe, would have so little chance for a second husband, is there frequently courted as a sort of fortune. The value of children, is the greatest of all encouragements to marriage. We cannot, therefore, wonder that the people in North America should marry very young.

Today, by contrast, children are almost exclusively a financial loss—albeit a worthwhile one, which I can safely say as a father of three. Compared with other common explanations for declining birth rates such as declining religiosity, diminished reverence for life, or the high cost of living—all of which containing some truth—the Smithian explanation deserves more attention.

This does not imply a return to sweatshops or the need for widespread child labor. But it does suggest that the effective removal of youth from the labor supply through child labor laws and mandatory public education may have had an unintended consequence.

A Bonus Quote on Interest Rates

The lowest ordinary rate of interest must… be something more than sufficient to compensate the occasional losses to which lending, even with tolerable prudence, is exposed. Were it not more, charity or friendship could be the only motives for lending.