Tuesday, March 01, 2011

Book Review, Wealth of Nations Book 1

As part of an independent study a student is doing under me, I'm obligated to read through Adam Smith's An Inquiry into the Nature and Causes of the Wealth of Nations (1776). WoN is divided into five books, the first of which is over 25% of the total volume. My thoughts on Book I:

First, WoN is Smith's decades-long observations of the world around him. He has tediously researched and recorded various historical prices of objects, down to the last penny. The attention to detail is what makes the book so long. It'd be nice to read it with a commentary to know whether his observations were accurate and held up. Some of his recorded hearsay about places he'd never been to-- China, America, Industan, Tartary -- are clearly more legend than fact.

WoN is read differently by everyone. People wearing Adam Smith neckties during the Reagan administration held Smith up as a free-market ideologue who we should somehow use as a guide for public policy. The Adam Smith Institute aspires to be Europe's finest conservative economic thinktank. Modern-day leftists hold up "Adam Smith's principles" as some sort of efficient-market dogma that needs to be critiqued. Gavin Kennedy has written a book on Smith and maintains the helpful blog "Adam Smith's Lost Legacy" where he corrects and debunks certain things written about Smith in the modern media.
Revered (conservative) Austrian economist Murray Rothbard wrote this essay on "The Adam Smith Myth,"(emphases mine)
Adam Smith (1723–90) is a mystery in a puzzle wrapped in an enigma...The mystery of Adam Smith, then, is the immense gap between a monstrously overinflated reputation and the dismal reality. But the problem is worse than that; for it is not just that Smith's Wealth of Nations has had a terribly overblown reputation from his day to ours. The problem is that the Wealth of Nations was somehow able to blind all men, economists and laymen alike, to the very knowledge that other economists, let alone better ones, had existed and written before 1776. The Wealth of Nations exerted such a colossal impact on the world that all knowledge of previous economists was blotted out, hence Smith's reputation as Founding Father. The historical problem is this: how could this phenomenon have taken place with a book so derivative, so deeply flawed, so much less worthy than its predecessors?
So, I'm enjoying reading through a book held up as historically enormously important but obviously quite flawed.

Book I contains the passages most-quoted by Smith. The pin factory and division of labor, how individuals pursuing own self-interest lead to mutual benefit, to name a couple examples. It also contains the beginnings of his "labor theory of value," (wikipedia) which was later expounded upon by Ricardo and Marx:
"The real price of every thing, what every thing really costs to the man who wants to acquire it, is the toil and trouble of acquiring it. What every thing is really worth to the man who has acquired it, and who wants to dispose of it or exchange it for something else, is the toil and trouble which it can save to himself, and which it can impose upon other people."

What I enjoyed most was Smith's elucidation of the principles still taught in Econ 101. Students could just as well read several chapters of Book 1 in place of a Principles textbook, all we've done is add some visual tools to help explain it over the years. For example, Smith's "natural price," which we would now call equilibrium price, moves with changes in supply and demand and the actual price is always tending towards the "natural." You can see the Marshallian supply and demand curves even though it's 100 years before Marshall drew them on the chalkboard. You can also see the basics of the decisions firms make in production-- fixed costs and variable costs are defined the same way. National income accounting is also introduced, aggregate income is the sum of wages, rent, and profit.

Adam Smith also lived in a much more regulated world than we live in today. Price ceilings were quite common, as were outright export bans and other trade restrictions. Guilds flourished in places like France, that limited how many people could work in an industry as well as the workers' methods of production. Perhaps the strength of his book is the critique of these interventions, pointing out how much better off society would be without them.

A couple passages on my Kindle that stand out on their own:
"No society can surely be flourishing and happy, of which the far greater part of the members are poor and miserable. It is but equity, besides, that they who feed, clothe, and lodge the whole body of the people, should have such a share of the produce of their own labour as to be themselves tolerably well fed, clothed, and lodged."

I believe, that the work done by freemen comes cheaper in the end than that performed by slaves. It is found to do so even at Boston, New-York, and Philadelphia, where the wages of common labour are so very high."

A few things that one does not expect to find:

Smith's observation of sticky wages:
The high price of provisions during these ten years past, has not, in many parts of the kingdom, been accompanied with any sensible rise in the money price of labour."

(The context of this quote is Smith's observation that workers must be earning wages above subsistence. Otherwise, when the price of things they subsist on rise they'd be asking for a raise.)

Smith also argues that inflation in the U.K. seen over the previous century was not caused by an increase in the supply of money but rather by the increase in the wealth of the nation-- as wealth increases, people's demand for things increase
. He purports that an increase in the money supply is necessary to facilitate trade in the face of an increase in output:

"When, on the contrary, the wealth of any country increases, when the annual produce of its labour becomes gradually greater and greater, a greater quantity of coin becomes necessary in order to circulate a greater quantity of commodities: and the people, as they can afford it, as they have more commodities to give for it, will naturally purchase a greater and a greater quantity of plate."

I've read more than a few "Adam Smith was wrong" comments on this part. He does talk about how industrialization leads to lower prices and an increase in output, but says that as a country develops and produces more, wages and prices rise. (An increase in output without an increase in money causes a decrease in prices, every unit of money becomes more valuable.) An increase in currency in circulation is not a result of an increase in supply from mines in America but as a result of the U.K.'s increase in wealth.

(Note: Smith does do a digression on the value of silver coinage and inflation. He points out that as long as governments have been borrowing money, they've been repaying the sum by reducing the amount of silver in coinage-- inflating away their debts).

Smith also purports that workers' wages decline as a country's rate of economic growth slows-ie: rapidly-growing countries have high wages, slow-growing countries have low wages. This is problematic. (China currently has 10% annual RGDP growth and much lower average wages than the U.S., where growth is 2-3% .)

Plenty of other problems and contradictions, I'm sure. Many of the basics hold up well, others do not. What I am lacking is an understanding of what Smith is "plagiarizing" as Rothbard says, and what are his own original thoughts. This exercise has so far been a reminder that people are flawed and their points of view limited; viewing someone's work as an object to be dogmatically defended or vilified is unhelpful. Glean what we think/know to be true and accept the flaws as they are.

I will continue next time with Book 2, which deals with money and banking.


John Nelson said...

I'm reading WoN too, and enjoyed your review of Book 1. I thought the detailed analysis on historic pricing was tedious, as I assume most modern readers do. I started reading the book because I was hitting a wall on my gut level understanding of the economy and wanted to start from the beginning. As such, I am really enjoying it so far. But as you referenced, there appear to have been some earlier influences that may be worth reading. I would love to find a short list of pre-Smith economic thinkers, so if you happen to have one, I hope you will post it for me. I'm going to try to track down John Law's article on paper money. Thanks.

JDTapp said...

The Ascent of Money by Niall Ferguson is a book that deals heavily with the history of John Law and the first real estate bubble/bust in the U.S. via French monetary policy. You can watch videos made from the book at PBS.org.

I also have a textbook dealing with economic thought in some detail. It discusses the views Smith got from the Physiocrats and what is considered original by Smith. I will likely include it in a post soon.

John Nelson said...

Thanks. The Niall Ferguson videos were very well done. I'll try to track down the text book you mentioned in your next post.

Unknown said...

Thank you for posting your thoughts on this book. I'm about to begin reading the series for the first time, and your comments have been very helpful in reminding me to be cautious with my reverence - ensuring that its earned.

One thing that caught my attention was your mention of China, and its high-growth / low-wage situation. Granted, my current understanding of economic principles is quite limited, so this question might be a bit remedial here (an understatement, I'm sure).

Nonetheless, it seems to me that the violation a basic economic principle could serve as an indication of a underlying problem, and not necessarily as repudiation of the principle itself. In the case of China, do you think it's possible that artificial central controls on things like currency value, labor prices, foreign competition, etc, cause its economy to not behave naturally, giving the appearance of a principle violation? I wonder what would happen in China if these controls were removed.

Again, thanks for posting your review. I'm off to Amazon now...

Best Regards,

JDTapp said...

China's consistent double-digit (income) growth rates mean higher wages for Chinese workers as more move to the cities and compete for jobs. Inflation is a problem there.

There are certainly lots of rigidities in the Chinese system, but every country maintains some governmental control over certain prices, currency, capital flow, trade, etc. We've never seen complete laissez-faire capitalism anywhere, even in Smith's day (or even in the gilded age that F.A. Hayek contends ended in the West just before the first World War.)

If China deregulated and became more like its inherited island Hong Kong, I'd guess it would grow even faster but would also deal with many more political problems as a free economy demands free elections and such. (But Hong Kong also has a pegged currency, as do many free-market countries.)