‘Of the Causes of Improvement in the Productive Powers of Labour, and of the Order according to which Produce is naturally distributed among the different Ranks of the People’
Book 1 of Adam Smith’s An Inquiry into the Nature and Causes of the Wealth of Nations is seen as particularly innovative for the history of economics. In it, he explores the mechanisms of production and exchange, and their contribution to national wealth. Concepts such as ‘specialisation’, the ‘market’ and the ways in which ‘value’ can be calculated are all discussed.
Smith concludes that the whole produce of land and labour of any country divides itself into three parts; the rent of land, the wages of labour, and the profits of stock.
This then provides revenue to three different parts of society; those who live by rent (landowners), those who live by wages (workers) and those who live by profit (the owners of stock). The well-being of each is interdependent as part of a system in which goods are created, exchanged, used and replaced.
However, the system is vulnerable and can be distorted by governments and employers, and he issues a stern warning against any attempt to control the system.
‘No Society can surely be flourishing and happy, of which the far greater part of the members are poor and miserable.’
The Division of Labour
‘The greatest improvement in the productive powers of labour, and the greater part of skill, dexterity and judgement with which it is anywhere directed, or applied, seem to have been the effects of the division of labour.’
The concept of the division of labour, or ‘specialisation’, is one for which Smith is well known. Though other philosophers had discussed the idea, such as the Frenchman Denis Diderot in his Encyclopédie, Smith places it in the broader context of his idea that the basis of ‘wealth’ was productive labour.
By different workers performing specialist tasks within a process, production is greatly increased, when compared to a single worker carrying out the entire process. Though the workforce grows, this can be afforded by the increased profits created by greater productivity, or ‘surplus’.
To illustrate his point, Smith uses the example of the manufacture of pins. According to Diderot, there were 18 different operations required to make a single pin. If one worker had to do everything, he could probably make only about 20 pins in a day.
However, if ten men worked together, each doing a separate set of tasks, it was reckoned 48,000 pins could be produced. One man’s effort is therefore responsible for 4,800 pins.
‘It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages.’
The surplus created by specialisation can then be exchanged and profit made. This can then be reinvested in the business to increase specialisation, for example through new machinery, leading to yet more surplus.
Through specialisation, each partner in an exchange can barter the goods they make best for the goods they make least. This occurs at all levels, even nationally. Less time and effort is wasted, individual skills increase and labour-saving machinery develops.
The exchange is mutually beneficial to both sides even though each party proposes and accepts the bargain entirely in their own self-interest, and not with the other’s welfare in mind. This is an example of what Smith terms as prudence – the importance of looking after one’s own welfare and that of one’s family.
The Index of Value
‘Wages, profit, and rent, are the three original sources of all revenue as well as of all exchangeable value. All other revenue is ultimately derived from some one or other of these.’
According to Smith, the value (and therefore the ‘natural price’) of a product arises from different places. He recognised that there were three factors of production – land, labour and stock (or capital). Each belongs to a different group of people who all share in the value of a product; the landowner through rent, the worker through wages and the owner through profits.
The value of a single product, say a bolt of fine woollen cloth, therefore represents a share of the sustenance of different working people involved in each stage of production from shepherds to weaver, the cost of renting the land to raise the sheep and to manufacture and store the cloth, and the expense of the machinery used to weave it and bring it to market.
The ‘Automatic’ Market
‘When the price of any commodity is neither more nor less than what is sufficient to pay the rent of the land, the wages of the labour, and the profits of the stock employed in raising, preparing, and bringing it to market, according to their natural rates, the commodity is then sold for what may be called its natural price.’
Smith’s economic system works through exchange in a market. Using money as the medium of exchange greatly extends the reach of the market. The price of any commodity depends on the amount of labour, rent and capital required to produce it; Smith called this its ‘natural price’.
If a commodity or product is scarce, demand rises and prices increase through competition. The ‘market price’ then exceeds the ‘natural price’. There is, therefore, more profit in supplying this demand, so producers invest greater capital in order to produce more.
This soon leads to competition in supply and a reduction in scarcity, though if too much is produced a glut occurs. The ‘market price’ begins to fall closer to the ‘natural price’, as do profits, leading producers to switch their capital elsewhere.
Industry thus remains focused on the nation’s most important needs, without the need for central direction.
However, the system is only ‘automatic’ if free trade and competition are allowed to operate. Government subsidies and monopolies for favoured producers, or the imposition on import tariffs, lead to higher prices from which the poor suffer most, facing higher costs for the necessaries they rely upon.