History of economic thought: Wealth, labour and profits

Adam Smith (1723-1790) in his Wealth of Nations deals with the major drivers of the wealth of a country in an analysis that highlights the interrelations among capital, labour and the expansion of markets in the XVIII century. His contribution can be considered a reaction to Mercantilist practices in which protectionism played a decisive role to expand markets. Smith discusses the consequences of the division of labour, exemplifying this question from a pin factory which productivity increases as human beings work on specific tasks. According to Adam Smith, the division of labour has its origin in the propensity of human nature to exchange. Thus, individuals lead to society to well-being while pursuing the maximization of their own interests. Although labour specialization is a key factor for productivity growth, the division of labour could be limited by the extension of the market. In his opinion,  labour specialization paves the way for increased production and, therefore, the expansion of the market. In this sense, Smith defended the free operation of markets as a driver of economic growth.

David Ricardo (1772-1823), in his Principles of Political Economy and Taxation, discusses the factors that affect the prices of grain and the connections between land rent and profits. Considering the drivers of the wealth of nations, Ricardo turned out to develop an international trade theory based on comparative advantages that defends the specialization in goods produced at lower costs in a context of free markets. However, Ricardo was ideologically motivated to do so, primarily to prevent developing nations like Portugal from becoming developed and overtaking Great Britain. Ricardo believed that total production would generate an income to be divided into wages, profits and land rent. He returns to the theoretical discussion initiated by Adam Smith on the relative value of goods, their relationship with the amount of labour and advances on the distribution of income.

Karl Marx (1818-1883) makes a re-reading of the British classical economists, most notably David Ricardo and Adam Smith. Marx’s Capital presents an analysis of capitalist society, characterized as a social organization based on an exchange system and the division of labour. In the capitalist system, according to Marx, the free worker sells his labour force and  capital is a social relation.  The reality of the capital accumulation process, though, is that it is a double movement of production and valorisation. The accumulation process ordinarily produces both use-value and exchange-value.  Capitalists are less interested in the commodity-in-itself or the use-value of commodities, but, their interest, as the personification of capital,  relies on the expansion of value. Wealth creation is dependent labour power exploited to appropriate surplus value. To Marx, this is the source of profits.

 

Calssical Reading

Smith, Ricardo, Marx: Observations on the History of Economic Thought  by Claudio Napoleoni (1976)

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8 comments
  1. Dear Maria,
    Both Smith and Ricardo believed that free trade would be the most beneficial trade policy for rich as well as poor countries, because it would increase the amount of wealth of all of them.
    You seem to affirm here that Ricardo recommended free trade because it would impede other countries to catch up with Great Britain. If this is indeed your suggestion, can you point to any evidence in this writings in support of it?

    • Maria Alejandra Madi said:

      Hi Jorge,

      Thaks for your comment that will help to clarify Ricardo’s ideas and my interpretation on Ricardo’s free trade proposal.

      Ricardo wrote (chapter seven of his seminal 1817 work The Principles of Political Economy and Taxation)
      “The same rule which regulates the relative value of commodities in one country, does not regulate the relative value of the commodities exchanged between two or more countries.

      Under a system of perfectly free commerce, each country naturally devotes its capital and labour to such employments as are most beneficial to each. This pursuit of individual advantage is admirably connected with the universal good of the whole. By stimulating industry, by regarding ingenuity, and by using most efficaciously the peculiar powers bestowed by nature, it distributes labour most effectively and most economically: while, by increasing the general mass of productions, it diffuses general benefit, and binds together by one common tie of interest and intercourse, the universal society of nations throughout the civilized world. It is this principle which determines that wine shall be made in France and Portugal, that corn shall be grown in America and Poland, and that hardware and other goods shall be manufactured in England.

      In one and the same country, profits are, generally speaking, always on the same level; or differ only as the employment of capital may be more or less secure and agreeable. It is not so between different countries. If the profits of capital employed in Yorkshire, should exceed those of capital employed in London, capital would speedily move from London to Yorkshire, and an equality of profits would be effected; but if in consequence of the diminished rate of production in the lands of England, from the increase of capital and population, wages should rise, and profits fall, it would not follow that capital and population would necessarily move from England to Holland, or Spain, or Russia, where profits might be higher.”

      __________
      In my post, when I wrote “However, Ricardo was ideologically motivated to do so, primarily to prevent developing nations like Portugal from becoming developed and overtaking Great Britain”, the aim was to highlight my interpretation on the outcomes of Ricardo’s free trade proposal.

  2. Hi Maria,

    Thanks for your quick reply and for clarifying your point.

    It seems then that Ricardo genuinely believed that free trade would increase the wealth of Portugal and Poland as well. He did not recommend it in order to ruin developing countries.

    Moreover, his free trade proposal does not recommend a certain trade pattern, as the second paragraph might suggest. What he actually meant there is that the principle of free trade would lead to a mutually beneficial pattern of trade for every country. At that moment in time, this meant that the wine should be produced in Portugal and France, the corn in America and Poland, etc. This should not be interpreted, though, as a recommendation that these countries should only produce these products and import everything else.

  3. The phenomenon of “self-serving bias” has been well documented in Bargaining Games by Behavioral Economists. In games with multiple points which can be considered fair, each players sees the arguments in his favor as being THE fair outcome. Even though India had a more advanced textile industry than Britain at the time of colonization, it came to be believed that Indian “comparative advantage” lay in production of raw materials — consequently, to benefit India, her textile industry was destroyed. Similarly, I think gunboats landed in Portugal to destroy Portuguese industries lacking in comparative advantage, so as to help Portugal develop along lines favorable to Portugal. The doctrine of free trade was enforced upon China and Japan by the use of armies, whose sole purpose was to open these countries to trade, for their own benefit!

    • Maria Alejandra Madi said:

      Asad,

      Great comment. Thanks

      Maria

  4. All the above examples have nothing to do with free trade, as understood and recommended by Smith and Ricardo. Neither of them recommended the imposition of free trade to other countries – let alone the use of force for the same purpose. Moreover, they would not consider a commercial treaty between countries as a “free trade” agreement but rather a preferential trade agreement, which is indeed a more appropriate term for them.

    According to Smith and Ricardo, free trade should be implemented unilaterally, even when other countries do not reciprocate.

  5. Understanding the true meanings and intentions of Smith and Ricardo has been made difficult because free market ideologues have attributed many ideas to them which they did not have — in order to benefit from their reputation, and also to give some legitimacy and apparent ancient heritage to a radically new idea. For a striking example, and further detailed references see Failures of the “Invisible Hand” Rafi Amir-ud-Din and Asad Zaman, Forum For Social Economics Vol. 45 , Iss. 1,2016

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