Guidebook to the Wealth of Nations. CH 4: Book I.8-10

 

BOOK I chapter 8: of the wages of labor

Smith seems to ask: why do we need to understand wages and their determination? If this is the implicit question he asks, a possible answer he offers is that wages are linked to population growth, which is an indicator of the wellbeing of an economy. And the reason for this is that wages are what allow most people to live. If population grows, it means that wages are high, and we have an indication that the economy is growing as it can support an increasing number of people. If population declines, wages must be low, and we have an indication that the economy is also declining because there is not enough in the economy to support the existing population, ergo the decline.

But the determination of wages is not easy. Wages are the natural compensation for the product of labor. If there is no accumulation of productive resources, what Smith still calls stock (and eventually will call capital) and no ownership of land, then all the produce of labor goes to the worker. This idea of labor working without or with capital comes from the French economist Turgot and is eventually used by Karl Marx and classical economics.

Following Turgot, Smith sees that labor becomes more productive when capital is used. Indeed he claims that when we introduce private ownership of land, the landlord requests rent. Furthermore, since a land worker is not in the position to support himself before harvesting, the master uses his resources, his stock (capital), to give an advance on the harvest to the land worker. The worker can now subsist until harvesting time. The worker will have to pay the master back for what he advanced him: that is the profit of the stock-owner. This means that from the produce of the land, one needs to subtract the rent, and the profit. Whatever is left is the wage of the land worker.

The most common situation is that the laborer uses the materials and things that the master advanced to him. Which means that in most cases the produce of labor includes both the profit and the wage. The proportion between the two is to be determined by contracts between workers and masters. This also means that one of the determinant of wages is bargaining power.

Here Smith’s tone is matter of fact. Later on it will become accusatory. As a matter of fact, the interest of the workers is always different from the interest of the master. Workers want higher wages and masters want lower wages. The bargaining power is uneven and it is tilted in favor of masters. Following an impeccable logic of what today we call collective-action theory, Smith tells us that the masters are few and therefore can combine easily (concentrated interest) and are quite effective in creating what today we call a cartel.

The masters can combine legally, meaning that the law does not explicitly prohibit it. The workers cannot because the law explicitly prohibits their combination. The masters can hold out without workers for 1-2 years. The workers can hold out without the master for less than a week. True, there is interdependence between masters and workers, they need each other to produce. But they do not need each other equally. This can be a problem.

The asymmetry goes further. We do not hear about the cartels of the master, but they do cartelize. In fact, the masters always combine, but tacitly, to keep wages low. The workers combine with “loudest clamor” and with the “most shocking violence and outrage”—acts of “folly of desperate men”. The workers may have the traditional right to resistance, but it is not going to do them much good. Masters call, again with clamor, for the laws to be enforced, and the workers tend to be punished rather than become any better off.

So, masters are good at keeping the wages low. But how low can wages go? Well, a wage has to be enough to support a worker and his family. If not, there will be only one generation of workers.

Are wages always at subsistence level then? No, for Smith in many cases they are more than subsistence. If there is a scarcity of workers, the master will have to bid up the wages to attract workers. So this competition among masters increases wages above subsistence.

And when is there a scarcity of hands? Wages will be high. Then the economy is growing. High wages are indeed linked to increasing national wealth. The wages are the highest in thriving countries. Look at the North American colonies, Smith tells us. Wages there are high. Higher than in Britain. And it is not because the subsistence of the worker is higher there. Food is actually cheaper in North America. Wages are so high because hands are in high demand. A widow with 4 children remarries in an instant in North America because of her children: they are workers for the fields. In Britain the same widow would not be able to remarry at all, because of her children: they are just mouths to feed.

The demand for workers is so high in North America that population is said to double every 20-25 years, as opposed to every 500 years in Britain.

Does the relationship between wages and population, and growth of the economy also extend to mediocre wages and low wages? Let’s see. In a stationary economy there is no scarcity of hand, just the right amount. So wages should not be very high as workers bid against each other to get the job. The wage is therefore enough to bring up a family. Is there empirical support for this? Yes, China. China is a rich country but it has a stationary economy (Smith will tell us later in chapter 9 why that is the case). It has not changed much since Marco Polo traveled there. And the poverty of the lower ranks of people is such that they barely survive, mostly because they eat garbage, putrefying dogs, and drown children whom they cannot support like they drown puppies. Remember what Smith told us in the introduction of the work: poverty forces us to kill children. Here again we are reminded that poverty forces us to dehumanize some people and to do the most horrendous things.

But if this is the condition of the poor in a stationary economy, what about in a declining one? There, the demand for labor is so low that many workers simply starve to death. So we see a population decline. And indeed this is the case in Bengal, where, despite a fertile land, 3-400 thousand people die of starvation yearly!

So why does the population of the North American colonies double every 20-25 years while in Bengal 3-400 thousand people die of hunger every year despite the fertility of the land? Smith is clear on this: Political institutions. North America is blessed with the genius of the British constitution. Bengal is cursed with the evil of the mercantile companies. Institutions are what makes the difference in the competitiveness of wages.

What about Britain? How is Britain doing? Britain is not North America, but it is not China either. Britain is doing ok. It is not booming, but it is not stagnant either. How do we know? Look at wages. In Britain the lowest wage is above subsistence. Here is the evidence that Smith gives us.

One. In the winter, wages are lower than in the summer, but in the winter the expenses of a worker are higher than in the summer. If a worker can survive in the winter, there must be some affluence in the summer. Two. Wages do not change with changes in prices of food. If one can survive in bad years, it means the wage is more than subsistence in good years. Three. Wages vary with location more than the price of food. The price of food is about the same but wages are about 25% higher in cities than in the countryside. If that price difference that labor experience were to be experienced with commodities, those commodities would move across the world. Granted, a man is “of all sorts of luggage the most difficult to transport”, yet if a worker can maintain a family without moving where wages are lower, it means there is affluence where wages are higher. Four. Think about it: Wages tend to move in the opposite direction from food prices. This means that the real price of labor is actually higher in real terms because things are now cheaper and/or better. For example, the Scots eat worse corn than the English, and they are also paid less than English workers. Here causation is determined with reasoning: The Scots eat worse corn because they are poor. It is not because they eat bad corn that they are poor, just like rich people use carriages and poor people walk. It is not the carriage that causes the wealth of the person, but the wealth that allows the purchase of the carriage. So, all of this is a demonstration that the poor are better off, in Britain than they are in China and Bengal.

Smith then asks something that nowadays sounds like a very provocative question: is the improvement of the poor a good or a bad thing? Smith’s answer is unquestionable: the improvement of the living conditions of the poor is a good thing. If something is good for the majority of the population it cannot be bad for the whole. And given that the majority of the population is poor, what is good for the poor is good for society. Indeed, no society can be happy if the majority of the population is miserable. Some later scholars use this passage to suggest that Smith can be thought about in terms of median utilitarianism, as opposed to simple utilitarianism. We can debate the meaning and the appropriateness of the idea of utilitarianism in Smith, but what is relevant here is that whatever that may be, it is based on the median not on a mean. This means that it is not the average wellbeing or the average happiness that matters, but the wellbeing or happiness of the majority of the people. Marx is similar to Smith in this. Indeed, he actually uses this passage from Smith, even if out of context, to show that capitalism is bad. For him, capitalism makes the majority of people miserable. Smith believes otherwise.

A couple of things to notice in this paragraph 36. Smith talks both about happiness and about fairness (he used the word “equity”, which in this context means fairness). A society cannot be happy if the majority of the people are miserable. Happiness, not utility. Then, also because of equity those who feed everybody should also be fed. Equity (read fairness), not utility, not efficiency.

This question may be far from our standards. We generally take for granted that it is a good thing if the poor are better off. But this was not the case in Smith’s time. Some people thought that the poor were naturally lazy and prone to vice. The only way to keep them out of trouble was to get them to work. But if paid more than subsistence, they would indulge their natural laziness. As a consequence, wages should be kept at subsistence and maximum wage laws for workers should be implemented. Smith is strongly against this claim. Working with the assumption of human homogeneity, the poor are not different from any other group of people. They are not naturally lazy, but respond to incentives like everybody else. And wages are an incentive. Higher wages, in addition to giving better subsistence and therefore more strength, give workers more incentives to work as now they can hope to better their condition. Indeed, with higher wages they will work so much that they may risk injuring themselves. This is particularly true when workers are paid by piece: they work so much for four days that they must rest for the other three because of their exhaustion and not because they are lazy.

Thus, Smith notices that productivity increases with increased wages and also with increased rest. If there is no rest, productivity may suffer because the health of the worker will suffer. If the masters would listen to reason and humanity, they would make sure workers work moderately, but constantly. The health of the workers would be preserved, and productivity over time increased. Equity and efficiency work together, not against each other.

At this point, note that Smith seems to work with the assumption that having children is a good and happy event. His measurement of whether a society is happy or not — yes happiness again — is therefore based on the number of children raised to maturity. This is a useful measurement for another reason, not just because it picks up happiness and equity: the direction of population growth is also a good proxy for economic growth. The more people a country can support, the wealthier a country is. The fewer people, the more miserable, the poorer. As he told us in the introduction of his work, the problem with poverty is that poverty is more likely to kill the innocent than wealth. A young woman in the poor Highlands of Scotland may bring to life 20 children, but only a couple of them will survive. In general, child mortality is very high among the poor, more than half will die before they are 10 because their parents cannot support them.

Humans, like animals, multiply according to their means of subsistence. Indeed, unfortunately, in a civilized society, the lowest rank of people see subsistence setting the limits to their multiplication. Again Smith tells us, the poor are forced to “destroy” the great part of their children. This may be why Smith calls the conditions of the working poor in a declining economy “miserable” and that state “melancholic”.

High wages, on the other hand, allow people to have more children, at least in proportion to the growing demand for labor. So Smith tells us that a progressive state, a growing economy, is not just the most comfortable but also the happiest, the most cheerful and hearty. A stationary state is hard for the working poor and it is “dull”.

High wages are caused by wealth and are a cause of population growth, which means that high wages are both the cause and the effect of the greatest public prosperity, as well as happiness of the majority of the people. Those who complain about them, complain about the greatest public prosperity! The improvement of the poor is indeed a good thing.

Furthermore, just like an increase in stock (capital) in a work-house increases the productive powers of labor and the division of labor, which causes the invention of better machines, the larger the number of people in society, the more division of labor, the more inventions of machines, and therefore the more production there will be.

There are a couple of implications of this logic.

Smith explicitly spells out one: it is the demand for men, like the demand of any other commodities, which regulates its production. This is an indicator of Smith’s essentially ‘modern’ economic analysis – and also of his understanding of the ‘Malthusian’ theory of populations and wages. And that men can be thought of like any other commodities is also present in the description of the “wear and tear” of slaves and free servants. The wear and tear of slaves is an expense for their masters, while the wear and tear of the free servants is an expense they will face themselves. Slave masters are negligent masters when they manage the fund of slaves. While the free servant will manage his own repair fund. This alone makes slave labor more expensive than the work of the freemen.

The other implication is spelled out two centuries later by another economist, James Buchanan, who claimed, the Wealth of Nations can be read as a book about a just system which happens also to be efficient. This is an example of it. The liberal reward of labor is not only just because it allows people to be happy and to have many children, but it also makes workers more productive.

In addition, note that Smith’s analysis of wages looks quite familiar to contemporary eye because of what seems to be the adjustment of wages to demand and supply changes. It also looks familiar to a Marxian eye: wages depend on bargaining powers and on what is customary. Smith does not give us a definition of subsistence, but usually when he refers to necessities, he also includes conveniences, maybe implying that what we call living wage today may depend on historical circumstances. For him, bargaining power also depends on historical circumstances. It tilts on the side of masters in times of economic decline and it tilts on the side of workers in times of growth.

This chapter also indirectly addresses a question raised centuries later: is Smith “left-leaning” believing that there is a need to improve the lives of the poor or is Smith more “right-leaning” believing in the unfettered expansion of industry? Smith may be both and neither at the same time, mostly because it may be that Smith does not see the two as a contradiction, as an either-or. The expansion of industry will improve the lives of the poor. This may indeed be the reason why we want an expansion of industry. Malthus would later disagree with this, criticizing Smith for assuming that economic growth would bring rising wages.

In general, economists consider chapter 8 of book 1 one of the most important chapters in WN, particularly when read in conjunction with chapter 3 of book 2. The two together are thought to contain Smith’s complete macrodynamic account of a market economy, as understood by today’s economists. However, this account may not square with Smith’s emphasis on the division of labor and the increasing returns to scale that it implies – which is why his successors (with some notable exceptions) ignored the division of labor in their own analyses.

 

BOOK I chapter IX: of Profits of Stock

As we just saw, different growth rates of wealth will affect wage rates. But different growth rates of wealth will also affect profit rates. In particular, as capital (which Smith keeps calling stock here) increases, wages increase too, but profits go down because of the increased competition.

A precise measurement of the ordinary profit rate is impossible for Smith. According to Smith there are too many things that affect it, so that even a trader cannot tell. But not all is lost: we can get a sense of it by looking at the market rate of interest. The market rate of interest cannot be that far off from the rate of profits, in particular, it cannot be more than the rate of profits. If it were, people would not borrow because their returns would not be enough to cover the borrowing costs. So we can infer that the market interest rate will move more or less with profits.

Smith qualifies the interest rate as the market interest rate because not all interest rates may be determined by the market. Some may be determined by law, the so called usury laws. In Britain, for example, there were usury laws, but they were not binding, as they follow the market rate for people of good credit, rather than trying to alter it.

That said, is there evidence that supports the idea that profits move in the opposite direction to that of wages with changes in capital? Yes, of course. Smith made this claim by observing that, for example, in the countryside there is less stock (capital, that is) than in a city. And indeed we see that profits are lower in the city than in the country, but wages are higher in the city than in the country. Holland is richer than England.It is not by accident that its profits are lower than England’s. Furthermore, interest is indeed so low in Holland that only very few rich people can live off it. Most people need to be involved in business. So much so that it is actually fashionable to be so—a point Deidre McCloskey emphasized in recent years.

When profits are low, merchants complain that trade is declining, because lower prices give them lower profits. Instead, Smith emphasizes, low profits are a symptom of prosperity, not of decline.

When profits are low, it means that there is more stock (capital) employed than before. On the other hand, when profits are high, prices are generally high too. And prices tend to be much higher when there are high profits than when there are higher wages. Meaning, most likely, that, when there are high profits, there may be a mark-up on price because of the monopolization or lack of competition in the market. When wages are high, on the other hand, prices do not rise that much, most likely because the high wages are the result of the competition for workers. This high price due to high wages is therefore a more competitive price, which merchants cannot control, and it is therefore more likely that it erodes their high profits.

And what do merchants do when profits are low? Not surprisingly, they complain. But only about high wages as the cause of higher prices. They remain perfectly silent on their high profits being the cause of high prices.

There are few exceptions to the inverse relation of profits and wages. Only the colonies experience simultaneously high profits and high wages, because they are both understocked and underpopulated. But as they become richer, and more and more improvements take place, population will increase, capital will accumulate, so that interest and profits will decrease while wages will increase.

It is also possible that profits increase with the acquisition of new territories. Profits may increase because the stock (capital) goes to new trades, decreasing the amount of capital available for the maintenance of the existing industry in the homeland. This also will come to an end with economic growth and new capital accumulation.

Yet, Smith claims, there is a way to obtain and then maintain high profits: monopoly. Let’s look at China as an example. China is a rich even if stationary economy. Profits should be low. But they are high. Why? Because of bad laws and institutions. They neglect foreign commerce, and they do not use all the stock (capital) available. Why? Because there is security for the rich but not for the poor. The poor can be plundered at any time under the pretense of justice, so they have no incentives to accumulate and to use capital. Smith identifies the monopolistic use of capital by the rich to keep profits high as the cause of this oppression of the poor.

Bad laws and institutions can also affect profits in a different way: whenever there are problems with enforcing laws, this is particularly true when it comes to contract laws. Poor enforcement of the laws increases the risk of contract enforcement. Interest rates increase with risk. Borrowers are thus likely to be treated as if they were going to go bankrupt because of the high uncertainty of repayment.

A final consideration. Risk also increases when there is a prohibition of interest. Prohibiting interest does not mean that there is no interest. If there were no interest on a loan, there would be no loan. So there will still be borrowing, but it will now be at a higher interest rate to compensate the risk of being caught breaking the law.

 

BOOK I, chapter x: Of wages and profits in different employments of labor.

Given the assumption of approximate productive equality among men, that the value of each unit of labor is the same and unchangeable, and that competition attracts prices to their natural rates, like gravity, this chapter has a challenging goal: to show that price of labor is equal across different employments. The advantages and disadvantages of different employments need to end up being the same, or, in an environment with perfect liberty and movement, there will be movement among different employments to reach that equality. Smith succeeded in his task, even if using tools quite different from the ones we use today. He manages to do everything with a cost based theory: wages depend on costs not on willingness to pay based on how valuable the service provided is considered by consumers. An impressive task!

The first thing to note, tells us Smith, is that we need to look at total compensation of labor, not just at monetary wages. There is indeed inequality in the monetary wages, but they are balanced out with other forms of non-monetary compensation based on the characteristics and on the nature of the employment. There are also differences in wages that are independent from the nature of the job, and are not compensated by anything else. They are generated by policies and are destined to create real inequality, and injustices.

This chapter is therefore also interesting because of its focus on the causes of wage inequality. Some recent writers are also concerned about income inequality in Smith and in our societies. Smith offers a possible explanation (and condemnation) of at least some forms of the income inequality he sees in his day. He also offers a possible solution. We already saw that in a growing and competitive society profit rates tend to decrease and wage rates to increase, decreasing the gap between wage earners and profit earners. Competition is what allows these tendencies toward equalization. Here we see how it is possible to have actual gaps within wage rates and profits rates: limits to competition are roadblocks on the way to equalization: they create injustices. The solution is thus to eliminate those roadblocks and to allow competition to do its job.

Smith is not too worried about differences in monetary wages caused by the nature of the employment itself. They do not generate real inequalities. In fact, they are counterbalanced by other factors, creating equality. So he tells us he identifies five different reasons why monetary wages may not be the same across different jobs, while workers’ compensation remains basically equal—what today we call compensating differentials: the agreeableness and easiness of the job, the expense of learning it, its constancy, its trust requirements, and the probability of getting the job.

If a job is easy, clean, or honorable, it would have a lower wage than if it is hard, dirty, or dishonorable. The most detestable job—public executioner—is very well paid. Very few people want to be public executioners because others consider it despicable. So a high wage is needed to compensate for its detestability. The most agreeable one—fishing and hunting—has become almost exclusively a recreational activity. No one can support himself with it. The more pleasant a job is, the more people want to do it and the lower is the wage, since the pleasantness of the occupation compensates for the work and competition drives down wages.

The same applies to the profits of stock. The harder the work, the higher the profits. An inn keeper is never fully the master of his home and needs to handle drunks quite often. Not easy; not pleasant. One needs very little stock (capital) to open and run an inn, but profits will be high, to compensate for the disagreeableness of its use.

A wage must compensate also for education and training costs. Educated men are like expensive machines, their wage must cover the expense of their education, so their wage will be higher than wages for jobs that require little or no education. In addition, learning a business takes time. One starts working late, and given how uncertain life can be, one needs to make up for that cost relatively fast. Examples of jobs that have higher wages because of high educational/training costs are professions in the “ingenious and liberal arts” such as painters, sculptors, lawyers, and physicians. Their high wages are to cover the expense and the tediousness of their training. Professions requiring apprenticeship also tend to have higher wages because during the apprenticeship all the labor goes to the master and the apprentices need to be supported by their family. Their wage will eventually be higher than a common laborer, which makes them think that they are superior to the common laborer. But when one actually computes the life-time earning of both, one sees basically no difference.

This difference in learning a business does not apply to differences in profits of stock (capital).

The inconsistency of work makes a difference to wage rates. The work of a brick layer is inconsistent, so his wage needs to be high enough to compensate for the times in which he cannot work, and for the anxiety he may have for not getting work. It will thus be higher than the wage for a more constant job. If one adds hardship to inconsistency, one would have even higher wages. The profits of stock are instead unaffected by the consistency or not of the employment. What matters is the trader, not the trade.

Professions like goldsmith, physician, and lawyer require trust. Since we tend not to trust poor people, jobs that require trust need to be more highly paid so that they are performed by richer individuals. Note that this is not a judgment that Smith makes, but a simple matter of fact description of what people believe. Also note that working with only a cost based theory makes the analysis a bit chunkier than one based on willingness to pay. Today we would say that a higher price for the services of a physician may signal our willingness to pay for a higher quality service.

As far as profits, if one uses his own capital, the problem of trust does not arise. If one uses someone else’s capital, then the profit rates will depend on the trust in the trader, not on the trade.

Finally, we may have some monetary wage inequality, because getting some jobs is like winning a lottery. In a fair lottery (lotteries where our expected value is zero) the winner gains what others lose. Similarly, one would expect, since only one in twenty make it as a lawyer, that one lawyer needs to be paid also for the other nineteen who did not make it. But while the expenses of all who become shoemakers are the same as all the gains of all shoemakers, the expenses of all who study law is more than the gains of all lawyers. Law is indeed not a fair lottery. Why, Smith asks? And if we know that the probability of getting the job is so low and that the monetary returns do not compensate for the expenses, why do we still try to enter some professions? For two reasons, Smith tells us: our desire to gain a reputation of excellence and our natural overconfidence.

Some jobs, like lawyers, are honorable. So many people are eager to enter the legal profession. The reason why people think being a lawyer is honorable is because, given that so few make it, one gains a reputation of “superior excellence”. Our desire to gain a reputation of excellence is a strong characteristic of human nature in Smith. In his other book, the Theory of Moral Sentiments, he explains that we are basically always driven by our desire to distinguish ourselves from others. And here that driving desire reappears, to explain otherwise irrational behavior.

Sometimes, though, a reputation of superior excellence may not be enough to attract people into a profession. Public prejudice may kick in and consider a profession dishonorable. Despite their great talents Opera singers and dancers are considered public prostitutes. They are therefore extremely well paid, not just for the rarity of their talents, but to compensate for the lack of reputation of their jobs.

But here Smith notes one thing: the nature of employment is not fixed. What is considered the nature of the job is a social construct and can vary in different times and places. If, in the future, opera singing becomes a reputable profession, then more people would go into singing and the wages will drop.

But there are other things being described as natural which are actually immutable parts of human nature. One of these, for Smith, is our absurd overconfidence in our good fortune, which any man in tolerably good health has. We systematically over-estimate our probability of success, and systematically under-estimate our probability of failure. Note this is a very different description of human nature than the assumption we tend to make in economics today. Today we tend to think of our mistakes as being normally distributed, so that on average we are unbiased in our errors: sometimes we err in one way, sometimes we err in the other way, so at the end, on average, we stay on path. Smith instead thinks we make the same mistakes over and over again. And it is not because we do not understand probability. Our systematic bias is caused by our self-love, not by probability ignorance, as we learn from the Theory of Moral Sentiments. We are born thinking we are the center of the universe and, though we understand that there is a 99% chance of failure, we think that it applies to other people. The universe revolves around me. I am the lucky one.

This, Smith claims, is why we have lotteries, even lotteries that are not fair. A non-fair lottery is a lottery where the expected winning (the amount won times the probability of winning) is less than the expected cost (the cost of playing), so that the expected value (expected gains minus expected cost) is negative. A fair lottery, instead, is a lottery in which the expected value is zero. Today we would say we have lotteries because we are risk loving over small amounts, but when dealing with large amounts we become risk-averse, we buy insurance instead. Smith does not buy into this, or at least he does not think in these terms. He thinks we are attracted by “vain hopes of great prizes”. Lotteries are universally demand driven, even when they are not fair. As long as the prizes are high enough, our absurd presumption in our own good fortune will lead us to take part. Small prize lotteries, even if fair, are in fact less popular. In today’s magnitudes: Winning $1billion? That is a nice hope. Winning $1? Yes, it is nice, but $1billion is more appealing. Big prizes are better vain hopes than small prizes. For Smith, this presumption in our own good fortune and contempt for risk is the same reason why lotteries are universally popular and, in his time, insurance is not a very profitable business. It is also the explanation for why we have so many volunteering to be soldiers or seamen.

Many ships are at sea without insurance. It is fine if they are part of a large company that has many ships, something in the rage of 20 or 30 ships, at sea. The saving from the multiple premiums compensate the loss of a ship. But Smith is willing to bet this is not the result of a rational calculation of the ship owner, but rather the result of this presumptuous contempt for risk.

Similarly, it is romantic hopes of honor and distinction that drives a young man from the lower ranks of society to enlist as a soldier. He will be paid less than a common worker and will have to work harder. But dreams of successfully surviving dangers are a positive incentive, attracting people into that dangerous profession and therefore lowering its wage. The lottery of the sea gives smaller and more frequent prizes and thus attracts less people. It is not by chance, for Smith, that a father usually lets a son join the navy, but will always object to him becoming a soldier.

Differences in risk in the employment of stock (which is what Smith continues to call what he later defines as capital) will affect the profit rates too. When there is a high risk of failure, there is also a high profit. And indeed one of the most profitable profession is smuggling, because it is one of the most hazardous. When a smuggler is successful, yes, his profits are going to be very high. But most of the time, given the dangers, he will fail and go bankrupt. But because of our presumptuous hope of success, we try anyway, the job becomes more and more competitive, increasing bankruptcy rates.

So, of these five circumstances that affect wages, only two affect profits too: risk, as we just saw, and the agreeableness of the job, as we saw earlier. This explains why we see more variation in wages than in profits. If it looks like there is a lot of variation among profits in different profession it is because we confuse wages for profits, Smith claims. It may also be because as the extension of the market increases, profits lower, but transportation costs increase, increasing the prices of commodities.

It is indeed rare to see sudden great fortunes arising from profits. If they exist, they come from trade speculations, but generally it is only life-long industry and frugality that allows for great fortunes accumulation.

Now, all these differences are going, at the end, to equalize the compensation of labor and capital, but this will only happen under specific circumstances: if there is perfect liberty, and if the employment is well known, if it is in its natural state, and if it is the sole employment of the worker. Indeed, if there are new kinds of jobs, they will have higher wages because they need to attract new workers. If there are a lot of variations in supply and demand, like in the case of some commodities (wine, corn, hop, sugar, tobacco, for example), a speculator will buy when he expects price to rise and sell when he expects price to fall. Finally, if a worker has more than one job, he would be willing to receive less from at least one of them.

There are other circumstances in which compensation for labor and capital do not equalize. Smith deals with them in the second part of the chapter.

In the second part of the chapter, indeed, Smith identifies the inequality of wages due to policies. These inequalities persist and will not be compensated. They are a source of injustice and Smith’s language condemns them. The policies which affect wages do it in three ways: by limiting entry in a profession therefore limiting competition, by subsidizing entry therefore increasing competition to unnatural levels, and by limiting the free circulation of labor and stock (capital) both from employment to employment and from place to place.

The first cause of inequality of wages is the limit to competition that corporations impose, especially though apprenticeship. Corporations in Smith’s time are not “.inc”, but are legal cartels, meaning groups of producers attempting create a monopoly, with several privileges guaranteed by law. Incorporated trades were originally called universities, as in the university of smiths or the university of tailors, where members would become “masters of arts” after seven years. Mandatory apprenticeship is one of those attempts to reduce competition by regulating the number of apprentices (usually one or two) and the number of years they have to serve (usually seven).

Smith does not like apprenticeships. They are “a manifest encroachment of just liberty.” Each man’s “most sacred and inviolable” property is his labor. Property of labor is the foundation of all property. Limiting their employment is therefore a “plain violation of the most sacred property”. Here again notice Smith’s move: Justice is the primary motivation. Apprenticeship is a violation of just liberty. And it happens to be inefficient too.

Apprenticeships do not help guarantee the quality of the work done. The employer is the best judge of it, because his interest is at stake. Apprenticeships do not prevent fraud: a stamp does a better job at it. Apprenticeships do not teach you how to do a good job, but being paid by the piece will, especially if the apprentice has to pay for the spoiled materials. Apprenticeships do not teach industriousness, but will actually teach you how to be idle; since there is no reward in working, the apprentice will learn idleness.

Why do we have them then, if they are “altogether unnecessary”? Because the master would lose out. The master would have to pay wages for seven years, while now he does not. The apprentice himself would also eventually lose out since it is easy to learn his trade, so without apprenticeship, he will have to face more competition and lower wages. The gainer would be the public, which could have cheaper goods. But the masters can easily get a corporation charter from the king so that competition is reduced and price, profits, and wages are kept high. They just need to pay a fee for it, and since they control the governments of towns, the task is very easy.

The monopolistic privileges of corporations break down the natural equality we should expect to see between towns and country. Instead, we see that the industry of towns is more advantageous than the one of the country: for each 100 people of great fortune in a town, there is only one in the country. The town indeed gets its subsistence from the country paying it with domestic and foreign manufactured products. Corporations reduce domestic competition, creating high wages and profits. They also manage to impose high duties to reduce foreign competition, additionally raising wages and profits. Corporations and duties make it de facto cheaper for towns to get subsistence.

This is possible because in towns there is a higher density of population. Because of their proximity, people can easily combine into what today we call a cartel. Indeed we see even the most insignificant trades being incorporated. It follows that the monopolistic spirit prevails: there is jealousy of strangers, and aversion to competition, so that masters can reduce manufactures into a “sort of slavery to themselves.” In the country this is not possible because of the low population density. People are dispersed in many places so they cannot combine. This is a phenomenal Public Choice explanation, as we call it today.

It is not that farming lacks corporation because it is easier to learn farming than manufacturing. As a matter of fact, farming is much more complex than many mechanical arts. And it is not even that farmers are more stupid than traders. As a matter of fact, their understanding and judgment is superior because of the variety of activities they engage with (keep this point in mind because it will be used again later on). The reason why wages are lower in the countryside is just because in towns there are corporations. Traders, joined in corporations and living in towns, can more easily concentrate and control each other to avoid cheating.

In towns, people of the same trade can seldom meet without conspiring against the public on how to increase their prices. And indeed the “clamor and sophistry” of merchants are so well-organized that they are able to persuade the people of the country that they need to pay higher prices for their products. They manage to persuade farmers that “the private interest of a part of society is the general interest of the whole.”

Of course the law should not prevent their meeting, but it should not facilitate it either. And laws that require members of the same corporations to register in public registry, or to have self-taxation to help their own poor, do exactly that: they facilitate if not actually make their meetings necessary.

To say that one needs corporations to make sure that trade is well governed is, for Smith, nonsense. If you want discipline in a profession, you need consumers, not corporations. The answer for this natural tendency to cartelize is competition. The policy of Europe causes inequality in employment of labor and capital instead.

This inequality is slowly decreasing in Great Britain, according to Smith. Given the increase in capital in towns, profits eventually decrease. So capital leaves the towns and gets to the country in search of higher returns. The demand for labor increases and so do wages. Yet, this opulence grows slowly, uncertainly, and with many accidents, being in every respect “contrary to the order of nature and reason” as we will see in book 3 and 4.

Competition solves many problems, but… Too much of a good thing may not be good. It is also possible to have too much competition, which will distort wages. How can there be too much completion, you may ask? Well, you subsidize it. And scholarships are subsidies to incentivize the entrance into certain professions. The most popular one is the church, which subsidies young men to become priests. The fact that being a clergyman is considered honorable does not help. Wages are pushed down even further. Curates are the only professionals seeing laws attempting to increase their wage, to maintain a certain dignity for the church. It does not work.

Imagine, Smith says, if we subsided at public expense, law and physics. So many people would try to enter these professions. Competition would be so great that wages would fall so low that people would not see the worth in educating their children at their own expense. This is what happens with men of letters.

Men of letters are people that the church educates at public expense, via scholarship, but who are not ordained. Because they are educated with scholarships, there is a high number of them. Their large supply pushes their wage down. So low, indeed, can their wage be, that before the invention of printing, scholars had the legal permission to beg! In antiquity, on the other hand, people would have to pay for their own education. Scholars were few and very well remunerated. Like lawyers and physicians today. Yet, in this case, not all that appears harmful comes to hurt us: cheap education is good.

The other factor that artificially creates difference in wages is the inability of labor and capital to move freely either across professions or across places. This is, again, the fault of corporations and apprenticeships. With their absurd laws, they block the circulation of labor, and as a consequence the circulation of capital too (which is still called stock here) since the capital employed depends on the availability of labor.

For Smith, there are fewer laws limiting the circulation of capital. It is therefore easier for wealthy merchants to trade in different towns than for poor workers to move from town to town.

Indeed, the laws are such to discourage or prevent the free circulation of the poor. In England before the 16th century, the charity of monasteries would support the poor. When monasteries were forced to close, the poor had no support. Now each parish had to provide for its poor. The incentives for each parish were to send their poor away and not to receive any. The result was a set of laws, called the Poor Laws, meant to regulate the parishes’ relief of the poor, but which, in practice, made it impossible for a poor to move: “it is more difficult for a poor man to cross to the next parish than to change country”, Smith declares. The scarcity of hands in one parish cannot be compensated by the movement of hands from parishes where they are abundant.

What is Smith’s judgment of this? “it is an evident violation of natural liberty and justice”. It is a “cruel oppression”. Again justice is the judging criterion here. Efficiency is a consequence.

The conclusion of the chapter is similarly based on justice, with its typical Public Choice bent. Smith repeats an issue he brought out earlier: the treatment of masters and workers in the law is not symmetrical. If masters combine to reduce wages, they succeed. If the workers try to do the same, the law punishes them severely. Whenever the legislature regulates the difference between workers and masters, the counselors of the legislature are always the masters. Thus, if there is ever a regulation that favors the workers, we can be sure that it will be just and fair.

 

 

Suggested readings [HELP]

 

Martin, Christopher. 2015. "Equity, Besides: Adam Smith and the Utility of Poverty." Journal of the History of Economic Thought 37 (4): 559-581.

Waterman, A. M. C. 2012. "Adam Smith and Malthus on High Wages." European Journal of the History of Economic Thought 19 (3): 409-429.

———. 2009. "Adam Smith's Macrodynamic Conception of the Natural Wage." History of Economics Review (49): 45-60.

 

 

Right to resist?

Sam in handbook(Waterman 2012, 409-429)

Tony handbook

Neri handbook

Hollander JHET 2014

Samuelson JEL 1978