Adam Smith’s Capitalism – Positive or Normative?
by Ryan Safner
[This essay was originally written for ECON 3462 - History of Economic Thought]
Adam Smith’s classic argument for capital accumulation is not a positive analysis of a functional market economy, but instead a strong normative account of his preference for investment over consumption. While Smith is widely hailed as the father of economic science, it is commonly understood that he vaguely mixed positive descriptions with value judgments. His magnum opus, The Wealth of Nations, functions as the economist’s bible, written archaically and vaguely enough for economic historians to draw numerous contradictory exegeses. Many of Smith’s more regrettable or idiosyncratic theories on political economy can be explained by his ethical interjections, which in turn reflect his Presbyterian background. The most vigorous preference he displays is for frugality and thrift over gluttony and conspicuous consumption. This ethic puts into perspective his confused labor theory of value, specifically the differentiation between “productive” and “unproductive” labors. The classical conundrum of the diamond-water paradox that he attempted to grapple with was but a mere illusion spawned by these potent inclinations. The epitome of this bias is his otherwise inexplicable defense of usury laws which blatantly violates his alleged policy of “lassiez-faire.” Adam Smith’s Wealth of Nations elucidates many truths about the free market economy, but these are unfortunately buried underneath mountains of vagaries and ethical interjections.
Smith’s moral philosophy, at least those elements which underlie the Wealth of Nations can be described by his Presbyterianism, a Scottish variant of Calvinism. Demonstrating reverence for his moral instructors, he explicitly pays them homage in his great work: “There is scarce, perhaps, to be found anywhere in Europe, a more learned, decent, independent, and respectable set of men than the greater part of the Presbyterian clergy of…Scotland,” (Smith, 1776). Economic historian Murray Rothbard explains the role of labor in Calvinism:
All [Christian] religious groups emphasized the merit of being productive in one’s labor or occupation, one’s “calling” in life. But there is, especially in the later Puritans, the idea of success in one’s calling as a visible sign of being a member of the elect. The success is striven for, of course, not to prove that one is a member of the elect destined to be saved but, assuming that one is in the elect by virtue of one’s Calvinist faith, to strive to labor and succeed for the glory of God. A Calvinist emphasis on postponement of earthly gratification led to a particular stress on saving. Labor or “industry” and thrift, almost for their own sake, or rather for God’s sake, were emphasized in Calvinism much more than in the other segments of Christianity. (Rothbard, 2006)
Smith demonstrates many Presbyterian values, especially that of the puritanical value of hard work and restraining consumption in his famous Theory of Moral Sentiments:
It is from the unremitting steadiness of those gentler exertions of self-command, that the amiable virtue of chastity, that the respectable virtues of industry and frugality, derive all that sober lustre which attends them. The conduct of all those who are contented to walk in the humble paths of private and peaceable life, derives from the same principle…a beauty and grace, which, though much less dazzling, is not always less pleasing than those which accompany the more splendid actions of the hero, the statesman, or the legislator. (Smith, 1790)
He then applies these moral sentiments to his writing on political economy, favoring the accumulation of capital on more virtuous grounds: “Capitals are increased by parsimony and diminished by prodigality and misconduct,” (Smith, 1776). Based on the ethical virtues of hard work and savings, Smith actually values capital accumulation, and its prerequisite of hard labor as good in and of itself. This explains his insistence on an objective, or natural price of goods based on their labor value.
The first place Smith’s values appear to surface in the Wealth of Nations is in his discussions of labor-based value. Economists and historians have grappled with Smith’s numerous conflicting approaches to measuring the value and price of a good, but the relevant issue here is Smith’s normative distinction between productive and unproductive labor. This unfortunate concept harkens back to his contemporaries, the Physiocrats, who maintained that agriculture was the only productive economic activity, and that industry was sterile. Smith, whether by their direct influence or not, adopted this idea of theirs, but altered it substantially:
There is one sort of labour which adds to the value of the subject upon which it is bestowed: there is another which has no such effect. The former, as it produces a value, may be called productive; the latter, unproductive labour. Thus the labour of a manufacturer adds, generally, to the value of the materials which he works upon, that of his own maintenance, and of his master’s profit. The labour of a menial servant, on the contrary, adds to the value of nothing. (Smith, 1776).
The unproductive class of labor includes, “some both of the greatest and most important, and some of the most frivolous professions: churchmen, lawyers, physicians…players, buffoons, musicians, opera-singers…&c,” (Smith, 1776). In short, Adam Smith concluded that labor for the production of all material goods (and not just agriculture) is productive, and in contrast, that labor for the production of consumer services is not.
Smith’s reasoning for deriding the production of consumer services is as follows:
[The] labour of the manufacturer fixes and realizes itself in some particular subject…which lasts for some time at least after that labour is past…The labour of the menial servant, on the contrary, does not fix or realize itself in any particular subject or vendible commodity. His services generally perish in the very instant of their performance, and seldom leave any trace or value behind them for which an equal quantity of service could afterwards be procured. (Smith, 1776)
The premium placed on material goods seems to arise from the fact that they have a continued existence in the physical world, whereas services are discounted because they produce no residual material wealth. Instead, they merely offer instantaneous gratification which only provides temporary and perhaps “crude” utility. This prejudice can easily be explained through a Calvinist lens. Consumer services might be seen as mere “fripperies,” luxuries that serve no purpose except excessive and ephemeral indulgences; they provide no tangible wealth to show for the service (other than money typically). The potential for future wealth creation appears, prima facie, to end with the consumer paying for these services. To the Calvinist, this offends the “productive” labor of those jobs which create new wealth, which in turn is worked on by additional labor to create additional wealth, and so the virtuous circle continues in perpetuity. Thus, the grand virtue of thrift and capital accumulation as the key to social growth becomes clear in the Smithian worldview.
Adam Smith’s discussion of the classic diamond-water paradox is also a direct result of Smith’s Presbyterian thought. One searches in vain for a lengthy treatment of this critical problem in economic thought prior to 1776, and for good reason: Smith himself largely created the unnecessary problem. Ignoring the traditions of the Catholic Spanish Scholastics, the French lassiez-fairists, and his own contemporaries who had long since solved it, Smith stumbled into an amateur problem that would retard certain developments in economic theory until the 1870s.[1]
Again, Smith’s Presbyterianism may seem to account for this unfortunate development. Smith’s famously states that value has:
two different meanings…“value in use” [and] “value in exchange.” The things which have the greatest value in use have frequently little or no value in exchange; and on the contrary, those which have the greatest value in exchange have frequently little or no value in use. Nothing is more useful than water: but it will purchase scarce any thing…A diamond, on the contrary, has scarce any value in use; but a very great quantity of other goods may frequently be had in exchange for it.” (Smith, 1776).
One clue to the puzzle is that Smith chastises the diamond as having “scarce any value;” not “less value,” not “relatively little value,” but “scarce any.” This would certainly fit consistently with the Presbyterian disapproval of luxury and excessive consumption in contrast to hard work. By separating value into “use” and “exchange” components, Smith totally eradicates the possibility of the consumer’s utility as the root of all value. Again with his religious emphasis on hard work and the long-run, any temporal consideration or valuation on the part of consumers is unthinkable, if not heresy. Instead, Smith combines this with his devotion to labor to create a mess of value theory. This misunderstanding would open an unnecessary void, which paved the way for Marx’s polemics on production for use versus production for exploitive profit.
One final manifestation of Smith’s ethical biases is his controversial views on usury. For a man who is allegedly the standard-bearer of lassiez-faire and against government intervention, it is strange indeed that he would advocate a price ceiling on the interest rate:
The legal rate…though it ought to be somewhat above, ought not to be much above the lowest market rate. If the legal rate of interest in Great Britain, for example, was fixed so high as eight or ten per cent, the greater part of the money which was to be lend would be lent to prodigals and projectors, who alone would be willing to give this high interest. Sober people…would not venture into the competition. A great part of the capital of the country would thus be kept out of the hands [of industrious men] and [instead] thrown into those which were most likely to waste and destroy it. Where the legal rate of interest, on the contrary, is fixed but a very little above the market rate, sober people are universally preferred, s borrowers, to prodigals and projectors. (Smith, 1776).
Smith here is clearly arguing for the government to establish a price ceiling on the interest rate. Having analyzed the various government interventions in his book, he knew full well that such an action would make credit artificially scarce: he deliberately wanted it to be rationed to virtuous productive capitalists and not siphoned to lowlife “prodigals and projectors.” He here makes a strong ethical interjection to overrule the natural time preferences between consumption and investment made by the consumers in the free market. As such, it is clear that his similar normative assertions, especially many of those which stand at odds with his lucid positive analyses of the free market, make trouble for his theories in the long run.
Smith has demonstrated that he knew full well that the ultimate goal of any economic action is to consume. The central irony of his system, of course, is that the only purpose of investment and capital accumulation is to anticipate a future of increased consumption! Thus, in Smith’s ideal world, he would look on in awe as the economic pie keeps growing, but would slap the wrist of anyone “depraved” enough to try and eat a piece.
Adam Smith’s Wealth of Nations is a hybrid of positive and normative descriptions of the capitalist society. Many of his unique contributions to the field of economic theory, especially those which have been disproved or corrected stand as a direct result of his Scottish Presbyterianism. Guided by his conscience, Smith stressed the importance of saving and investment, at the expense of consumer’s consumption. This bias is most present in his descriptions of labor value, the unfortunate paradox of value, and culminates in his defense of usury laws. Though one cannot at all fault Smith for being unwilling to sever normative ethics from positive science given his day and age, it is certainly instructive to note the extent to which they mingled and clashed.
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Works Cited:
Rothbard, Murray N. Economic Thought Before Adam Smith: An Austrian Perspective on the History of Economic Thought, Volume 1. 2006. Ludwig von Mises Institute. 18 February 2010. <http://mises.org/books/histofthought1.pdf>
Smith, Adam. The Theory of Moral Sentiments – Part IV. Of the Character of Virtue. 1790. Library of Economics and Liberty. 18 February 2010. <http://econlib.org/library/Smith/smMS6.html>
_______. An Inquiry into the Nature and Causes of the Wealth of Nations. Edwin Cannan, ed. 1904. Library of Economics and Liberty. 18 February 2010. <http://econlib.org/library/Smith/smWN.html>
[1] It is said that A.R.J. Turgot elucidated the law of diminishing marginal utility in a letter of his, a key to the marginalist solution. Francis Hutchinson, Smith’s mentor never fell victim to the paradox, and Rothbard asserts that even Smith had ironically solved the “paradox” in his own lectures years earlier. It is all the more curious then, why he would deviate in the Wealth of Nations. See Rothbard 2006, p.449
