Adam Smith on the Labour Theory of Value

There has been a lot of discussion of the labour theory of value in the comments section lately, a view which, I think, most Post Keynesians reject, and rightly so.

But Marx took the idea that labour is a measure of value and that labour is the cause of value from Ricardo (Robinson 1964: 36), and this idea in turn seems to stem from Adam Smith.

Adam Smith postulated that labour time was the criterion used in primitive societies to determine exchange value:

“In that early and rude state of society which precedes both the accumulation of stock and the appropriation of land, the proportion between the quantities of labour necessary for acquiring different objects seems to be the only circumstance which can afford any rule for exchanging them for one another. If among a nation of hunters, for example, it usually costs twice the labour to kill a beaver which it does to kill a deer, one beaver should naturally exchange for or be worth two deer. It is natural that what is usually the produce of two days’ or two hours’ labour, should be worth double of what is usually the produce of one day’s or one hour’s labour.

If the one species of labour should be more severe than the other, some allowance will naturally be made for this superior hardship; and the produce of one hour’s labour in the one way may frequently exchange for that of two hours’ labour in the other.

Or if the one species of labour requires an uncommon degree of dexterity and ingenuity, the esteem which men have for such talents will naturally give a value to their produce, superior to what would be due to the time employed about it. Such talents can seldom be acquired but in consequence of long application, and the superior value of their produce may frequently be no more than a reasonable compensation for the time and labour which must be spent in acquiring them. In the advanced state of society, allowances of this kind, for superior hardship and superior skill, are commonly made in the wages of labour; and something of the same kind must probably have taken place in its earliest and rudest period.

In this state of things, the whole produce of labour belongs to the labourer; and the quantity of labour commonly employed in acquiring or producing any commodity is the only circumstance which can regulate the quantity exchange for which it ought commonly to purchase, command, or exchange for.” (Smith 1845: 20).

But is there any hard empirical evidence from anthropology and history that this is true?

For example, since hunters usually have different levels of skill and experience, and often success in hunting depends on luck, the hunting time for any particular animal caught could vary considerably. It is simply unclear to me why hunter-gatherers or hunter-horticulturists would have to determine exchange value in such a way, when labour time could vary to a significant degree on each occasion an animal is hunted, and it looks like Adam Smith is engaged in some speculation here that would need to be backed up with a great deal of evidence from anthropology to be taken seriously.

Perhaps that evidence exists, but perhaps not too, like many hoary old myths in economics. I have not yet had a chance to look at the anthropological literature, and so will leave the question open.

BIBLIOGRAPHY
Robinson, Joan. 1964. Economic Philosophy. Penguin, Harmondsworth.

Smith, Adam. 1845. An Inquiry Into the Nature and Causes of the Wealth of Nations, Thomas Nelson, Edinburgh.

The Origin of Say’s Law in Adam Smith and James Mill

Consider these passages from Adam Smith’s An Inquiry into the Nature and Causes of the Wealth of Nations (11 edn; 1811):

“In all countries where there is tolerable security, every man of common understanding will endeavour to employ whatever stock he can command, in procuring either present enjoyment or future profit. If it is employed in procuring present enjoyment, it is a stock reserved for immediate consumption. If it is employed in procuring future profit, it must procure this profit, either by staying with him, or by going from him. In the one case it is a fixed, in the other it is a circulating capital. A man must be perfectly crazy who, where there is tolerable security, does not employ all the stock which he commands, whether it be his own, or borrowed of other people, in some one or other of those three ways.” (Smith 1811: 198).

“What is annually saved is as regularly consumed as what is annually spent, and nearly in the same time too; but it is consumed by a different set of people. That portion of his revenue which a rich man annually spends is, in most cases consumed by idle guests, and menial servants, who leave nothing behind them in return for their consumption. That portion which he annually saves, as for the sake of the profit it is immediately employed as a capital, is consumed in the same manner, and nearly in the same time too, but by a different set of people, by labourers, manufacturers, and artificers, who re-produce with a profit the value of their annual consumption. His revenue, we shall suppose, is paid him in money. Had he spent the whole, the food, clothing, and lodging, which the whole could have purchased, would have been distributed among the former set of people. By saving a part of it, as that part is for the sake of the profit immediately employed as a capital either by himself or by some other person, the food, clothing, and lodging, which may be purchased with it, are necessarily reserved for the latter. The consumption is the same, but the consumers are different” (Smith 1811: 240).

Here we have the clear idea that money saved is spent again on capital goods investment and consumed by a different set of people: those to whom the invested money has now become income.

According to Smith, savings are “immediately employed as a capital” and thus consumed. That is to say, money not spent on consumption will be invested in capital goods projects and done so relatively quickly.

This we have here a version of Say’s law, at least as it was formulated by some of the later Classical economists.

Let us look at how Say’s law was formulated by the Classical economists, as defined by Thomas Sowell (1994: 39–41):

“(1) The total factor payments received for producing a given volume (or value) of output are necessarily sufficient to purchase that volume (or value) of output [an idea in James Mill].

(2) There is no loss of purchasing power anywhere in the economy. People save only to the extent of their desire to invest and do not hold money beyond their transactions need during the current period [James Mill and Adam Smith].

(3) Investment is only an internal transfer, not a net reduction, of aggregate demand. The same amount that could have been spent by the thrifty consumer will be spent by the capitalists and/or the workers in the investment goods sector [John Stuart Mill].

(4) In real terms, supply equals demand ex ante [= “before the event”], since each individual produces only because of, and to the extent of, his demand for other goods. (Sometimes this doctrine was supported by demonstrating that supply equals demand ex post.) [James Mill.]

(5) A higher rate of savings will cause a higher rate of subsequent growth in aggregate output [James Mill and Adam Smith].

(6) Disequilibrium in the economy can exist only because the internal proportions of output differ from consumer’s preferred mix—not because output is excessive in the aggregate” [Say, Ricardo, Torrens, James Mill] (Sowell 1994: 39–41).

Proposition 6 – that individual markets can be in disequilibrium, but the overall demand, including demand for commodities not fulfilled, is balanced with the value of aggregate supply – does not explicitly appear in Adam Smith, as far as I am aware.

Yet both propositions (2) and (3) appear to be quite clearly in Adam Smith already.

James Mill in his treatise Commerce Defended (1807) developed the ideas in Adam Smith and those he found in the first edition of Say’s Traité d’économie politique (1803). We can quote from Mill’s Commerce Defended:

“No proposition in political [economy] seems to be more certain than this which I am going to announce, how paradoxical soever it may at first sight appear; and if it be true, none undoubtedly can be deemed of more importance. The production of commodities creates, and is the one and universal cause which creates a market for the commodities produced. Let us but consider what is meant by a market.

Is any thing else understood by it than that something is ready to be exchanged for the commodity which we would dispose of? When goods are carried to market what is wanted is somebody to buy. But to buy, one must have wherewithal to pay. It is obviously therefore the collective means of payment which exist in the whole nation that constitute the entire market of the nation. But wherein consist the collective means of payment of the whole nation? Do they not consist in its annual produce, in the annual revenue of the general mass of its inhabitants? But if a nation’s power of purchasing is exactly measured by its annual produce, as it undoubtedly is; the more you increase the annual produce, the more by that very act you extend the national market, the power of purchasing and the actual purchases of the nation. Whatever be the additional quantity of goods therefore which is at any time created in any country, an additional power of purchasing, exactly equivalent, is at the same instant created; so that a nation can never be naturally overstocked either with capital or with commodities; as the very operation of capital makes a vent for its produce.

Thus to recur to the example which we have already analyzed; fresh goods to the amount of £5,500 were prepared for the market in consequence of the application of the £5000 saved by the landholder. But what then? have we not seen that the annual produce of the country was increased; that is, the market of the country widened, to the extent of £5,500, by the very same operations? Mr. Spence in one place advises his reader to consider the circumstances of a country in which all exchange should be in the way of barter, as the idea of money frequently tends to perplex. If he will follow his own advice on this occasion, he will easily perceive how necessarily production creates a market for produce. When money is laid out of the question, is it not in reality the different commodities of the country, that is to say, the different articles of the annual produce, which are annually exchanged against one another? Whether these commodities are in great quantities or in small, that is to say, whether the country is rich or poor, will not one half of them always balance the other? and is it not the barter of one half of them with the other which actually constitutes the annual purchases and sales of the country? Is it not the one half of the goods of a country which universally forms the market for the other half, and vice versa? And is this a market that can ever be overstocked? Or can it produce the least disorder in this market whether the goods are in great or in small quantity? All that here can ever be requisite is that the goods should be adapted to one another; that is to say, that every man who has goods to dispose of should always find all those different sorts of goods with which he wishes to supply himself in return.

What is the difference when the goods are in great quantity and when they are in small? Only this, that in the one case the people are liberally supplied with goods, in the other that they are scantily; in the one case that the country is rich, in the other that it is poor: but in the one case, as well as in the other, the whole of the goods will be exchanged, the one half against the other; and the market will always be equal to the supply. Thus it appears that the demand of a nation is always equal to the produce of a nation. This indeed must be so; for what is the demand of a nation? The demand of a nation is exactly its power of purchasing. But what is its power of purchasing? The extent undoubtedly of its annual produce. The extent of its demand therefore and the extent of its supply are always exactly commensurate. Every particle of the annual produce of a country falls as revenue to somebody. But every individual in the nation uniformly makes purchases, or does what is equivalent to making purchases, with every farthing’s worth which accrues to him. All that part which is destined for mere consumption is evidently employed in purchases. That too which is employed as capital is not less so. It is either paid as wages to labourers, who immediately buy with it food and other necessaries, or it is employed in the purchase of raw materials. The whole annual produce of the country, therefore, is employed in making purchases. But as it is the whole annual produce too which is offered to sale, it is visible that the one part of it is employed in purchasing the other; that how great soever that annual produce may be it always creates a market to itself; and that how great soever that portion of the annual produce which is destined to administer to reproduction, that is, how great soever the portion employed as capital, its effects always are to render the country richer, and its inhabitants more opulent, but never to confuse or to overload the national market. I own that nothing appears to me more completely demonstrative than this reasoning.

It may be necessary, however, to remark, that a nation may easily have more than enough of any one commodity, though she can never have more than enough of commodities in general. The quantity of any one commodity may easily be carried beyond its due proportion; but by that very circumstance is implied that some other commodity is not provided in sufficient proportion. What indeed is meant by a commodity's exceeding the market? Is it not that there is a portion of it for which there is nothing that can be had in exchange. But of those other things then the proportion is too small. A part of the means of production which had been applied to the preparation of this superabundant commodity, should have been applied to the preparation of those other commodities till the balance between them had been established. Whenever this balance is properly preserved, there can be no superfluity of commodities, none for which a market will not be ready. This balance too the natural order of things has so powerful a tendency to produce, that it will always be very exactly preserved where the injudicious tampering of government does not prevent, or those disorders in the intercourse of the world, produced by the wars into which the inoffending part of mankind are plunged, by the folly much more frequently than by the wisdom of their rulers.

This important, and as it appears demonstrative doctrine, affords a view of commerce which ought to be very consolatory to Mr. Spence. It shews that a nation always has within itself a market equal to all the commodities of which it can possibly have to dispose; that its power of purchasing is always equivalent to its power of producing, or at least to its actual produce; and that as it never can be greater, so it never can be less. Foreign commerce, therefore, is in all cases a matter of expediency rather than of necessity. The intention of it is not to furnish a vent for the produce of the industry of the country, because that industry always furnishes a vent for itself. The intention of it is to exchange a part of our own commodities for a part of the commodities which we prefer to our own of some other nation; to exchange a set of commodities which it peculiarly suits our country to produce for a set of commodities which it peculiarly suits that other country to produce. Its use and advantage is to promote a better distribution, division and application of the labour of the country than would otherwise take place, and by consequence to render it more productive. It affords us a better, a more convenient and more opulent supply of commodities than could have been obtained by the application of our labour within ourselves, exactly in the same manner as by the free interchange of commodities from province to province within the same country, its labour is better divided and rendered more productive.” (Mill 1808 [1807]).

Both Thweatt (1979: 92–93) and Baumol (2003: 46) conclude that Adam Smith was in fact the father of what is recognisably Say’s law in Classical economics, with the major work in developing the idea conducted by James Mill, not necessarily Jean-Baptiste Say.


BIBLIOGRAPHY

Baumol, W. J. 1977. “Say’s (at Least) Eight Laws, or What Say and James Mill May Really Have Meant,” Economica n.s. 44.174: 145–161.

Baumol, W. J. 1999. “Retrospectives: Say’s Law,” Journal of Economic Perspectives 13.1: 195–204.

Baumol, W. J. 2003. “Retrospectives: Say’s Law,” in S. Kates (ed.), Two Hundred Years of Say’s Law: Essays on Economic Theory’s Most Controversial Principle, Edward Elgar Pub, Cheltenham; Northampton, Mass. 39–49.

Mill, James. 1808 [1807]. Commerce Defended. An Answer to the Arguments by which Mr. Spence, Mr. Cobbett, and Others, have Attempted to Prove that Commerce is not a Source of National Wealth. C. and R. Baldwin, London.

Smith, A. 1811. An Inquiry into the Nature and Causes of the Wealth of Nations (11 edn; vol. 1), Oliver D. Cooke, Hartford.

Sowell, T. 1994. Classical Economics Reconsidered, Princeton University Press, Princeton, N.J.

Thweatt, W. O. 1979. “Early Formulators of Say’s Law,” Quarterly Review of Economics and Business 19: 79–96.

The Origins of Money

Adam Smith wrote an influential account of the origin of money, as follows:

“When the division of labour has been once thoroughly established, it is but a very small part of a man’s wants, which the produce of his own labour can supply. He supplies the far greater part of them by exchanging that surplus part of the produce of his own labour, which is over and above his own consumption, for such parts of the produce of other men’s labour as he has occasion for. Every man thus lives by exchanging, or becomes in some measure a merchant, and the society itself grows to be what is properly a commercial society.

But when the division of labour first began to take place, this power of exchanging must frequently have been very much clogged and embarrassed in its operations. One man, we shall suppose, has more of a certain commodity than he himself has occasion for, while another has less. The former consequently would be glad to dispose of, and the latter to purchase, a part of this superfluity. But if this latter should chance to have nothing that the former stands in need of, no exchange can be made between them. The butcher has more meat in his shop than he himself can consume, and the brewer and the baker would each of them be willing to purchase a part of it. But they have nothing to offer in exchange, except the different productions of their respective trades, and the butcher is already provided with all the bread and beer which he has immediate occasion for. No exchange can, in this case, be made between them. He cannot be their merchant, nor they his customers; and they are all of them thus mutually less serviceable to one another. In order to avoid the inconveniency of such situations, very prudent man in every period of society, after the first establishment of the division of labour, must naturally have endeavoured to manage his affairs in such a manner, as to have at all times by him, besides the peculiar produce of his own industry, a certain quantity of some one commodity or other, such as he imagined few people would be likely to refuse in exchange for the produce of their industry.

Many different commodities, it is probable, were successively both thought of and employed for this purpose. In the rude ages of society, cattle are said to have been the common instrument of commerce; and though they must have been a most inconvenient one, yet in old times we find things were frequently valued according to the number of cattle which had been given in exchange for them. The armour of [Diomedes] ..., says Homer, cost only nine oxen; but that of Glaucus, cost an hundred oxen. Salt is said to be the common instrument of commerce and exchanges in Abyssinia; a species of shells in some parts of the coast of India; dried cod at Newfoundland; tobacco in Virginia; sugar in some of our West India colonies; hides or dressed leather in some other countries; and there is at this day a village in Scotland where it is not uncommon, I am told, for a workman to carry nails instead of money to the baker’s shop or the ale-house.

In all countries, however, men seem at last to have been determined by irresistible reasons to give the preference, for this employment, to metals above every other commodity. Metals can not only be kept with as little loss as any other commodity, scarce any thing being less perishable than they are; but they can likewise, without any loss, be divided into any number of parts, as by fusion those parts can easily be re-united again; a quality which no other equally durable commodities possess, and which more than any other quality renders them fit to be the instruments of commerce and circulation. The man who wanted to buy salt, for example, and had nothing but cattle to give in exchange for it, must have been obliged to buy salt to the value of a whole ox, or a whole sheep, at a time. He could seldom buy less than this, because what he was to give for it could seldom be divided without loss; and if he had a mind to buy more, he must, for the same reasons, have been obliged to buy double or triple the quantity, the value, to wit, of two or three oxen, or of two or three sheep. If, on the contrary, instead of sheep or oxen, he had metals to give in exchange for it, he could easily proportion the quantity of the metal to the precise quantity of the commodity which he had immediate occasion for.” (Smith 1811: 16–17).

This thesis – that money emerged as a commodity from barter spot transactions – was taken up and developed by many Classical and Neoclassical economists.

Carl Menger (1892) developed a similar theory in the late 19th century (Menger 1892 and 2002 [1909]; cf. Goodhart 2004), which I have criticised here. Money emerges as a medium of exchange from the most saleable commodity in direct barter trades: usually (though not always) it must have the properties of being portable, homogeneous, easily divisible, and not subject to depreciation.

In the most extreme forms, it holds that money can only ever emerge from barter spot transactions as the most saleable commodity becomes the common medium of exchange. It has been known for a long time that there are severe problems with this latter view of the origin of money.

From the 16th century onwards, Europeans came into contact with numerous communities in various parts of the world. The empirical evidence from serious, scholarly study of money-less communities, especially since the 18th century onwards, demonstrates that the economies of communities which are (1) money-less or (2) have a marginal role for money take many forms, and the pure barter economy imagined by economists is a myth (Humphrey 1984: 48). More alarming still is that surveys show that societies where barter was a predominant form of transaction in certain sectors of the economy are astonishingly small: just three “primitive” economies where barter was predominant have been found (Crump 1981: 34, who mentions pre-Colonial Mexico, the Congo basin, and the northern coast of New Guinea and its adjacent islands, but in all of these barter was essentially an activity in long distance trade transactions). Barter does exist frequently of course, but often as a marginal activity or “in a corner of the economy,” and is often despised by people as being somewhat disreputable (Humphrey 1984: 49). It is often confined to foreigners or long distance trade. The notion that human beings have some natural propensity to “truck” or “barter” is itself questionable (Humphrey 1984: 50).

The gapping hole in the imagined origin of money by Adam Smith, Carl Menger, Ludwig von Mises and many modern neoclassical economists is that barter spot transactions can be mostly unnecessary in a money-less human society.

The sequence of historical development imagined by most economists is as follows:

barter > money > credit.

In reality, other sequences are more plausible:

Debt/credit relations (gift economies) > minimal/peripheral barter > moneyless society with debt/credit transactions and minimal barter.

Debt/credit relations (gift economies) > minimal/peripheral barter > wergild social practices > emergence of a unit of account through reckoning of relative values for compensation by legal codes > money.

Debt/credit relations (gift economies) > minimal/peripheral barter > emergence of a unit of account through reckoning of relative values in planning by influential socio-economic agents in society (e.g., priests, temples, kings) > money.

If an economy is dominated by debt/credit relations, where the debts are vague and non-enumerated, then there is no significant double coincidence of wants dilemma: and no need to invent money. There were presumably numerous human societies that never invented what we would call money, because they never needed to.

Economists have ignored the unit of account function of money. Grierson (1978: 11) emphasised how in many societies an abstract or concrete unit of account can be a measure of value, while payment is made in goods. If money is conceived as an abstract thing which is used to measure the value of one thing against another, an abstract unit of account can emerge before some commodity becomes a physical medium of exchange: it can be created by conscious design by deriving an abstract unit of account from weights or from high-prestige commodities. Alternatively, societies can develop wergild-like social practices in which a kind of “price system” is developed by legal experts to reckon the values of compensation and damage payments, but where the payments system must have a common unit of account to calculate what kinds of payment in kind are equivalent for damages paid.

We do in fact observe historical instances where money has emerged in just the ways described: in Mesopotamia (one of the earliest literate civilisations), Egypt and medieval tribal societies. In ancient Egypt, money appears as the most important unit of account called the deben (or uten), which was a unit of weight, originally equated to 92 (or 91) grams (Henry 2004: 92; there was also the unit called the khar for measuring wheat or barley, and 1 khar was equivalent to 2 deben of bronze). This unit of account appears to have been developed by complex palace, government and temple institutions for internal accounting. While goods came to be denominated in terms of deben, there were no physical deben changing hands, there were administered price lists for some goods, and coins were unknown in Egypt until the Ptolemaic era (323–31 BC; Henry 2004: 92). That is to say, the deben did not function as a physical means of payment, and did not emerge by barter spot transactions as the most saleable medium of exchange. Even though goods and services were measured in a deben unit of account, payment was made in goods.

An important element in this process was the institution (or institutions) where surplus products were stored from taxation, tribute and gifts. These institutions dealt with complex flows, in and out, of goods: they were palace and temple complexes. Accounting systems, weight measures and writing are connected with just such institutions, and, importantly, some abstract unit of account arose by which to measure relative values of goods. Since loans were also no doubt made from surplus products stored, repayment of loans in kind was facilitated by a unit of account. The preceding account applies to both ancient Egypt and Mesopotamia.

In ancient Greece, the Homeric epics the Iliad and the Odyssey were written c. 750–700 BC, and reflect social practices in the late Dark/Geometric Age (c. 1200–800 BC) and early Archaic period (800–480 BC). In Homer’s epics, cattle or oxen are the unit of account, but the means of payment are variable goods, not just cattle (Peacock 2011: 49–54).

The emergence of money in Greece appears to be related to religion and cult offerings. The ox was an important sacrificial animal and offering to the gods. The Greeks appear to have developed a cattle or ox unit of account derived from the value these animals had in sacrifice (Seaford 2004: 61). Priests needed to be paid in cattle for religious services, but it was also necessary to calculate the ox-value of other commodities offered for payment to temples or for sacrifice in lieu of oxen (Semenova 2011: 385): hence people came to develop “prices” of other goods in terms of oxen, and an ox unit of account emerged (Schaps 2004: 9–10; Heidel 1926; I cite the English review of Heidel in Economica 14 [1925]: 218–222; Heidel’s thesis is modified by Peacock 2011: 54–63; Peacock 2003–2004). But oxen were not generally used as a medium of exchange. Instead, other goods like metals or items associated with sacrifice of oxen like tripods, cauldrons, double-axes, and spits (Schaps 2004: 10) were used as a means of payment and medium of exchange, whose value was measured in a cattle unit of account. Some fines appear to have been payable in tripods and cauldrons, for example. Coins were introduced by states from 600–500 BC (Peacock 2011: 54–63). With the emergence of iron spits (oboloi), the beginnings of precious metal money can be seen, although gold and silver had been previously used as a means of payment as measured in the cattle unit of account. The first electrum coins appear at Ephesus in late 7th century (700–600 BC), and spread to mainland Greece from 575–550 BC (von Reden 2002: 152, n. 30).

In the Indo-European and, above all, medieval Germanic societies, we have the institution of wergild: a system of fines and compensations payments for killing a human being and also for a wide range of other injuries, infractions or insults, and for theft of objects and commodities (Grierson 1978: 11; Grierson 1977). Compensation payments are made in various goods, such as cattle, bondmaids, and precious metal, but it is likely a common unit of account was developed to simplify calculation of payments, which later spread to the wider community in economic transactions.

By using induction, we can postulate that it is likely that these various phenomena and social processes may well have occurred in pre-historic societies too, and that money, if and when it was invented in some forms in pre-literate, primitive societies, emerged just as often by the ways described above, as by barter.



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