Economic Thought Through the Ages, Lecture 6 with David Gordon - Mises Academy

Economic Thought, Lecture 6

Adam Smith

Rothbard on Adam Smith

• We’ve stressed that Rothbard rejects the view that Smith founded economics and also the view that economics has been a continually progressing science since the Wealth of Nations (1776)

• Not only is it false that Smith founded economics. His main doctrines are all wrong and he was an obstacle to progress.

Rothbard on Smith Continued

• Schumpeter, and also Mises, say that Smith wasn’t original. But Rothbard goes further. He thinks that Smith was terrible.

• This opinion of Smith leaves Rothbard with a problem. If Smith was that bad, how did he get to be so influential?

• In part, Rothbard finds the answer in the confusions of the Wealth of Nations. There was room for later economists to clarify his ideas and make them consistent.

What Is So Bad About Smith?

• To justify his negative appraisal of Smith, Rothbard goes through the major claims for his contributions and tries to show what is wrong with them.

• Smith is often credited for realizing the benefits of the division of labor. But Rothbard finds problems with Smith’s account. He overemphasized the division of labor as a cause of development. He underplayed capital accumulation and technology.

Division of Labor

• Smith fails to stress that trade, which is an essential component of the division of labor, stems from a perception of mutual benefit.

• Instead, he relies on instinct: “a propensity to truck, barter, and exchange.”

• Why does Smith make this mistake? Trade depends on differences in things and in people’s abilities. For Smith, people are basically the same.

Division of Labor Continued

• Although Smith realized the benefits of the division of labor, he also criticized it.

• It leads to a stunting of personality. People do the same repetitive tasks.

• This became a basic theme in Marx and in the socialist criticism of capitalism generally. A key idea in Rothbard’s book is to trace what gave rise to Marxist errors.

Productive and Unproductive Labor

• Smith though that only labor that produces material objects counts as productive. A service is consumed when it is taking place, but if you produce a material object, it is there afterwards.

• The stress on productive labor reflects Calvinist influence.

Productive Labor Continued

• Smith’s views about productive labor are part of a wider set of attitudes.

• Luxuries, and even consumer goods in general, are downplayed. What is important is capital investment.

• The point of investment is not to get future consumption goods. Instead, production is valued for its own sake. People should have low time preference rates.

More Productive Labor

• The stress on postponing consumption was characteristic of Soviet communism and its satellite countries. People now must sacrifice to build up socialism in the future.

• Capital accumulation is desirable, regardless of what people want.

• The denial of time preference is also a feature of Smith’s moral theory, his “impartial spectator.” (Rawls also rejects time preference as irrational.)

Smith on Value

• In the Wealth of Nations, Smith rejects determination of price by utility. Goods that have a high value in exchange often have a low value in use. This is the same as the diamond-water paradox.

• Smith had solved the diamond-water paradox in earlier lectures, but he ignored his own discussion in his book.

Value Continued

• Why did Smith do this? He was concerned with long-run or natural prices, not with day-to-day-prices.

• Equilibrium is a valid concept, but it is never reached. The data constantly change.

• Smith argued that equilibrium price is determined by cost of production.

Cost of Production

• In the Austrian view, cost of production is itself determined by the subjective values of market participants.

• In the long run, price tends to equal cost of production, but this doesn’t imply that cost causes 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. This holds that the value of a good depends on how many 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 various kinds of labor aren’t equal. Some kinds of labor require more skill than others. Some labor is much easier than other kinds, etc.

• How can one figure out the labor values, given these differences? Smith said we can look at market prices to determine how one kind of labor compares with another, but this is circular reasoning.

Problems Continued

• Smith didn’t emphasize differences in kinds of labor as much as he should have because, for him, people were basically equal.

• Differences in pay reflect differences in amount of training. E.g., a doctor will earn more because his pay has to compensate for the years he wasn’t working. But taking these differences into account, Smith thought the wages were close to equal in different occupations.

Problems Concluded

• Rothbard concentrates on the labor theory because it is the basis of Marxism. Marx’s theory was the consequence of the false steps Smith took.

• Sometimes Smith changes to a labor-command theory. The value of a good is how much labor it can command. This is different from a labor cost theory, unless price is determined entirely by labor cost. If it isn’t, and the price includes other costs, then a good can command more labor than was required to make it.

Wages

• According to the labor theory, the price of a good depends 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 in part by a Malthusian process. Rothbard criticizes this for reasons we’ve discussed in previous lectures.

• Smith also introduced the bargaining-power view of wages, which Rothbard considers a fallacy.

Money

• What we have discussed so far could take place in an economy without money. What happens when money is introduced?

• As we might expect, Rothbard thinks that Smith got most things wrong. He didn’t understand the need for a commodity money. He thought that bank notes were better, because resources spent on mining metal were wasted. This became a popular argument.

Money Continued

• Smith did not think that an economy could get along without gold or silver. Rather, bank notes would be issued. These are substitutes for the gold or silver: having the paper reduces waste.

• .

Inflation and Banking

• To the objection that this causes inflation, Smith replied with the odd view that the bank notes will always equal the value of the gold and silver. Any excess will “overflow” and return to the bank. An increase in bank notes won’t increase prices.

• Smith accepted fractional reserve banking.

Laissez-Faire

• Does Smith deserve credit for his defense of the free market? Rothbard does not claim that Smith was a statist. He in general defended free trade and opposed mercantilism.

• It’s within this acknowledgement that Rothbard’s criticism proceeds. He praises Smith for his invisible-hand metaphor.

Exceptions

• Rothbard’s criticism is that Smith allows many exceptions to his general defense of the free market He retreated from his earlier position in the Theory of Moral Sentiments (1759)

• Smith believed in the importance of the martial spirit and favored military exercises for the population.

Education

• Smith favored government support for education. This was in part to help ensure that people developed the proper virtues.

An Objection

• David Friedman has objected to the claim that Smith supported government schools on the grounds that Smith sometimes says the market can provide the schools.

• But this misses the point. The government determines that there will be schools. Even if the government contracts out the provision of schools to the market, these are still government mandated schools

Usury

• Smith also favored maximum interest rates. This was to keep money out of the hands of speculators and adventurers. If interest rates were low, they wouldn’t be able to get money from lenders. Less risky borrowers would get the money. At higher rates, the lenders might have to accept the speculators.

Usury Continued

• Why was it so important to keep money out of the hands of speculators?

• This was because of his Calvinist belief that the economy should concentrate on slow, steady investment rather than speculative ventures or consumption.