Economic Thought Through the Ages, Lecture 6 with David Gordon - Mises Academy
Economic Thought, Lecture 6Adam Smith
Rothbard on Adam Smith• We’ve stressed that Rothbard rejects theview that Smith founded economics andalso the view that economics has been acontinually progressing science since theWealth of Nations (1776)• Not only is it false that Smith foundedeconomics. His main doctrines are allwrong and he was an obstacle to progress.
Rothbard on Smith Continued• Schumpeter, and also Mises, say that Smithwasn’t original. But Rothbard goes further. Hethinks that Smith was terrible.• This opinion of Smith leaves Rothbard with aproblem. If Smith was that bad, how did he get tobe so influential?• In part, Rothbard finds the answer in theconfusions of the Wealth of Nations. There wasroom for later economists to clarify his ideas andmake them consistent.
What Is So Bad About Smith?• To justify his negative appraisal of Smith,Rothbard goes through the major claims for hiscontributions and tries to show what is wrong withthem.• Smith is often credited for realizing the benefits ofthe division of labor. But Rothbard finds problemswith Smith’s account. He overemphasized thedivision of labor as a cause of development. Heunderplayed capital accumulation and technology.
Division of Labor• Smith fails to stress that trade, which is anessential component of the division of labor, stemsfrom a perception of mutual benefit.• Instead, he relies on instinct: “a propensity totruck, barter, and exchange.”• Why does Smith make this mistake? Tradedepends on differences in things and in people’sabilities. For Smith, people are basically the same.
Division of Labor Continued• Although Smith realized the benefits of thedivision of labor, he also criticized it.• It leads to a stunting of personality. Peopledo the same repetitive tasks.• This became a basic theme in Marx and inthe socialist criticism of capitalismgenerally. A key idea in Rothbard’s book isto trace what gave rise to Marxist errors.
Productive and UnproductiveLabor• Smith though that only labor that producesmaterial objects counts as productive. Aservice is consumed when it is taking place,but if you produce a material object, it isthere afterwards.• The stress on productive labor reflectsCalvinist influence.
Productive Labor Continued• Smith’s views about productive labor are part of awider set of attitudes.• Luxuries, and even consumer goods in general, aredownplayed. What is important is capitalinvestment.• The point of investment is not to get futureconsumption goods. Instead, production is valuedfor its own sake. People should have low timepreference rates.
More Productive Labor• The stress on postponing consumption wascharacteristic of Soviet communism and itssatellite countries. People now must sacrifice tobuild up socialism in the future.• Capital accumulation is desirable, regardless ofwhat people want.• The denial of time preference is also a feature ofSmith’s moral theory, his “impartial spectator.”(Rawls also rejects time preference as irrational.)
Smith on Value• In the Wealth of Nations, Smith rejectsdetermination of price by utility. Goods thathave a high value in exchange often have alow value in use. This is the same as thediamond-water paradox.• Smith had solved the diamond-waterparadox in earlier lectures, but he ignoredhis own discussion in his book.
Value Continued• Why did Smith do this? He was concernedwith long-run or natural prices, not withday-to-day-prices.• Equilibrium is a valid concept, but it isnever reached. The data constantly change.• Smith argued that equilibrium price isdetermined by cost of production.
Cost of Production• In the Austrian view, cost of production isitself determined by the subjective values ofmarket participants.• In the long run, price tends to equal cost ofproduction, but this doesn’t imply that costcauses price.
Labor Theory of Value• Although he adopts the cost of production theory,Smith sometimes shifts to a different theory.• This is the famous labor theory of value. Thisholds that the value of a good depends on howmany labor hours were required to produce it.• It should be clear that this is a different theory,because labor is just part of the cost of production.
Problems with the Labor Theory• A big problem with the labor theory is that variouskinds of labor aren’t equal. Some kinds of laborrequire more skill than others. Some labor is mucheasier than other kinds, etc.• How can one figure out the labor values, giventhese differences? Smith said we can look atmarket prices to determine how one kind of laborcompares with another, but this is circularreasoning.
Problems Continued• Smith didn’t emphasize differences in kinds oflabor as much as he should have because, for him,people were basically equal.• Differences in pay reflect differences in amount oftraining. E.g., a doctor will earn more because hispay has to compensate for the years he wasn’tworking. But taking these differences intoaccount, Smith thought the wages were close toequal in different occupations.
Problems Concluded• Rothbard concentrates on the labor theory becauseit is the basis of Marxism. Marx’s theory was theconsequence of the false steps Smith took.• Sometimes Smith changes to a labor-commandtheory. The value of a good is how much labor itcan command. This is different from a labor costtheory, unless price is determined entirely by laborcost. If it isn’t, and the price includes other costs,then a good can command more labor than wasrequired to make it.
Wages• According to the labor theory, the price of a gooddepends on the labor time required to produce it.But what determines the price of labor?• This became a major issue in Marx’s theory.Smith thought that wages tend to be determined inpart by a Malthusian process. Rothbard criticizesthis for reasons we’ve discussed in previouslectures.• Smith also introduced the bargaining-power viewof wages, which Rothbard considers a fallacy.
Money• What we have discussed so far could take place inan economy without money. What happens whenmoney is introduced?• As we might expect, Rothbard thinks that Smithgot most things wrong. He didn’t understand theneed for a commodity money. He thought thatbank notes were better, because resources spent onmining metal were wasted. This became a popularargument.
Money Continued• Smith did not think that an economy couldget along without gold or silver. Rather,bank notes would be issued. These aresubstitutes for the gold or silver: having thepaper reduces waste.• .
Inflation and Banking• To the objection that this causes inflation,Smith replied with the odd view that thebank notes will always equal the value ofthe gold and silver. Any excess will“overflow” and return to the bank. Anincrease in bank notes won’t increaseprices.• Smith accepted fractional reserve banking.
Laissez-Faire• Does Smith deserve credit for his defenseof the free market? Rothbard does not claimthat Smith was a statist. He in generaldefended free trade and opposedmercantilism.• It’s within this acknowledgement thatRothbard’s criticism proceeds. He praisesSmith for his invisible-hand metaphor.
Exceptions• Rothbard’s criticism is that Smith allowsmany exceptions to his general defense ofthe free market He retreated from his earlierposition in the Theory of Moral Sentiments(1759)• Smith believed in the importance of themartial spirit and favored military exercisesfor the population.
Education• Smith favored government support foreducation. This was in part to help ensurethat people developed the proper virtues.
An Objection• David Friedman has objected to the claim thatSmith supported government schools on thegrounds that Smith sometimes says the market canprovide the schools.• But this misses the point. The governmentdetermines that there will be schools. Even if thegovernment contracts out the provision of schoolsto the market, these are still government mandatedschools
Usury• Smith also favored maximum interest rates.This was to keep money out of the hands ofspeculators and adventurers. If interest rateswere low, they wouldn’t be able to getmoney from lenders. Less risky borrowerswould get the money. At higher rates, thelenders might have to accept thespeculators.
Usury Continued• Why was it so important to keep money outof the hands of speculators?• This was because of his Calvinist belief thatthe economy should concentrate on slow,steady investment rather than speculativeventures or consumption.