The Wealth of Nations and the functions of law
‘The annual labour of every nation is the fund which originally supplies it with all the necessaries and conveniencies of life which it annually consumes’ (Smith, 1976, Vol. I, p.
1, emphasis added). (In the following, The Wealth of Nations can be dealt with only very briefly and in relation to law, but see the literature mentioned at the beginning of this entry.) The per capita increase of goods as a measure of welfare in the process of civilization and in the compounds of national boundaries, customs and culture (see ibid., p. 82, as an example of Smith’s implicit critique of methodological individualism) is a secular trend in many countries which needs an explanation and is the normative yardstick for Smith. The enhancement of consumer sovereignty (cheap and diversified goods) as the new major goal of economic activity can be diverted by different economic policies such as mercantilism (see Book IV of The Wealth of Nations) or physiocracy.The increase in income and consumption is due to the objective and spontaneous process of the productivity-enhancing division of labour (Smith takes over the Encyclopedists’ example of the pin factory) which itself leads to the introduction of machines. This unplanned, objective process is nevertheless also described in terms of a productive forces concept a la Friedrich List, concentrating on ‘the skill, dexterity, and judgment with which its labour is generally applied’ (Smith, 1976, Vol. I, p. 1).
The following chapters are an interplay between objective-structural preconditions of the division of labour (the extension of the market, the transport system and so on) on the one hand, and human faculties (thinking and language as prerequisites to making contracts and exchange goods) and institutions (such as the introduction of money) on the other, enriched by many historical and empirical illustrations.
Smith’s discussion of the difference between the nominal and real price caused much debate (adding-up versus a labour or a marginalist theory of value: see, for example, the contributions in Skinner and Wilson, 1975, pt II) and Smith in fact sometimes confuses, for instance, the questions of real versus nominal terms with the existence of value as such. Seen in the Scottish tradition and from a social law perspective, he may be interpreted in pragmatic terms. Instead of describing objective economic laws, Smith develops a conjectural history of the way cooperating agents might develop adequate social rules of exchange, based on his basic assumption that only labour produces value. So in less-developed societies the necessary quantity of labour is a rough practical measure of the value of a commodity; it ‘seems to be the only circumstance which can afford any rule for exchanging’ (Smith, 1976, Vol. I, p. 53).
If capital is accumulated in the hands of a few, it will only be lent out for investment if a profit were to be gained for the risk. There are no productivity of capital arguments involved here. Profit is distinct from wages because it has nothing to do with ‘quantity, the hardship, or the ingenuity of this supposed labour of inspection and direction’ (ibid., p. 54). Profit as a non-reducible income category follows different rules. It is measured as a percentage of the capital invested. The concrete percentage depends on the general state of the economic level of production and on the specific phase of the economy in its cycle (ascending or descending). No precise rules can be formulated about the component parts of prices in the long run (contra David Ricardo). They depend, inter alia, on an expected level fixed by society in the past. The long- run price of labour naturally tends to a culturally defined subsistence level, but ‘it is in the progressive state, while the society is advancing to the further acquisition, rather than when it has acquired its full complement of riches, that the condition of the labouring poor, of the great body of the people, seems to be the happiest and the most comfortable’ (ibid., p.
91). Such a life cycle of nations takes about 200 years.Smith has an expansion of aggregates in mind: higher employment leads to higher effective demand, which creates a larger market; new investment opportunities occur and a new division of labour; new profit expectations and the savings will go up, the loanable fund increases and higher employment will be the result in the process of a continuous upward spiral (international trade is seen in the same perspective: see Myint, 1977).
Like capital and profit, the emergence of rent depends on general social circumstances: ‘As soon as the land of any country has all become private property, the landlords, like all other men, love to reap where they never sowed, and demand a rent even for its natural produce’ (Smith, 1976, Vol. I, p. 56). Later on, Smith mentions rent as a remuneration of the productivity of land. As in the case of profit, Smith leaves open whether profit and rent are legitimate remunerations or only a deduction of the value-producing labour. This ambiguity has been considered one of Smith’s major shortcomings. Seen in the light of the Scottish tradition, Smith only describes interpretative maps of the different social classes vis-a-vis themselves and each other: ‘equal quantities of labour are always of equal value to the labourer, yet to the person who employs him they appear sometimes to be of greater and sometimes of smaller value’ (ibid., p. 37, emphasis added).
On a short-run micro level, Smith describes in Chapter 7 the market process in a dynamic, innovative Schumpeterian or Hayekian (importance of locally bounded knowledge) and active price maker perspective (contra, Mirowski, 1991, pp. 163-71, who interprets Smith as a Newtonian at the Cartesian crossroads). If the expected demand for a produced commodity at the natural price falls short (or the other way round), price and quantity adaptations take place which are described in a less elegant and much more deterministic way in modern textbooks.
In the world of Smith as a classical economist, the profit motive was an intent, an unnecessary performance; the behaviour is adaptive and often gradient-climbing instead of choiceoptimizing; the agents are capable of learning and, well adapted locally, their knowledge is not assumed to be unbounded; institutions are not problematic per se (why do firms exist?), but are regarded as essential in guiding behaviour and in making the behaviour of others predictable. The equilibrium concept is centred on constancy (point attactors), but does not necessarily lead to the mutual consistency of plans (Leijonhufvud, 1997). The free play of market forces may lead to an efficient allocation (or not, depending on the circumstances, such as the organization of cartels and so on).Smith sometimes states that ‘the obvious and simple system of natural liberty establishes itself of its own accord’ (Smith, 1976, Vol. II, p. 208), which contradicts his much more sophisticated approach in his lectures on jurisprudence. There he stated that in modern societies a junction exists between private property and legal restrictions and that to hold property is not a natural right and one person’s rights are other people’s obligations.
But the policy of Europe, by not leaving things at perfect liberty, occasions other inequalities of much greater importance.... and thirdly, by obstructing the free circulation of labour and stock, both from employment to employment and from place to place. The property which every man has in his own labour, as it is the original foundation of all other property, so it is the most sacred and inviolable. (Smith, 1976, Vol. I, pp. 132 and 136)
Unfortunately, Smith never discusses this difference in perspective between the lectures and The Wealth of Nations. The difference may be due to his intention to criticize mercantilist interventionism and he may have set the legal framework ceteris paribus for his economic exposition. Nevertheless, in many places the necessity of legal regulations to make markets work shows up.
In Chapter 7, for example, he discusses the structural asymmetry of capital and labour: ‘It is not, however, difficult to foresee which of the two parties must, upon all ordinary occasions, have the advantage in the dispute, and force the other into a compliance with their terms’ (ibid., p. 74). Another case for legal intervention may be seen in the constant endeavour to collude and build up cartels: ‘We rarely hear, it has been said, of the combinations of masters. But whoever imagines, upon this account, that masters rarely combine, is as ignorant, of the world as of the subject’ (ibid.). Other instances of legal regulation may be seen in the tendency to overwork ourselves or to be overworked by the entrepreneurs (ibid., p. 92) or the tendency to conceal the long-term price and to charge an abnormally high price (ibid., p. 67). Although Smith observes a multitude of occasions for legal interventions (for his public economics, see West, 1990, ch. 7) he does not discuss them explicitly, except in some passages about the ‘Expence of justice’ (Smith, 1976, Vol. II, pp. 231ff.).All in all, the juxtaposition of The Wealth of Nations and Lectures on Jurisprudence highlights two opposite but nevertheless correct insights. On the one hand, markets are instituted processes which need regulation and socially compromising laws; on the other hand, too many regulations strangle them. Arguing against mercantilism, Smith bends the bow in one direction in The Wealth of Nations. Including his Lectures on Jurisprudence, we get a more well-rounded picture of Smith’s point of view, which cannot be reduced to a simple market apology.
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