Adam Smith, a brilliant eighteenth-century Scottish political economist, had the advantage of judging the significance ol colonies by a rigorous examination based on the colonial experience of 300 years. His overview has a built-in bias: he strongly disapproved of excessive regulation of colonial trade by parent countries. But his analysis is rich with insight and remarkably dispassionate in its argument. Adam Smith recognized that the discovery of the New World not only brought wealth and prosperity to the Old World, but that it also marked a divide in the history of mankind. The passage that follows is the work of this economic theorist who discusses problems in a language readily understandable by everyone.
Adam Smith had retired from a professorship at Glasgow University and Was living in France in 1764-5 when he began his great work, The Wealth of Nations. The book was being written all during the years of strife between Britain and her colonies, but it was not published until 1776. In the passages which follow, Smith points to the impossibility of monopolizing the benefits of colonies, and pessimistically calculates the cost of empire, but the book appeared too late to have any effect upon British policy. Because the Declaration of Independence and The Wealth of Nations, the political and economic reliations of empire and mercantilism, appeared in the same year, historians have often designated 1776 as one of the turning points in modern history. The text On the cost of Empire, the eloquent exhortation to the rulers of Britain to awaken from their grandiose dreams of empire, is the closing passage of Smith's book.
Adam Smith was a Scottish political economist and philosopher. He has become famous by his influential book The Wealth of Nations (1776). Smith was the son of the comptroller of the customs at Kirkcaldy, Fife, Scotland. The exact date of his birth is unknown. However, he was baptized at Kirkcaldy on June 5, 1723, his father having died some six months previously.
At the age of about fifteen, Smith proceeded to Glasgow university, studying moral philosophy under "the never-to-be-forgotten" Francis Hutcheson (as Smith called him). In 1740 he entered Balliol college, Oxford, but as William Robert Scott has said, "the Oxford of his time gave little if any help towards what was to be his lifework," and he relinquished his exhibition in 1746. In 1748 he began delivering public lectures in Edinburgh under the patronage of Lord Kames. Some of these dealt with rhetoric and belles-lettres, but later he took up the subject of "the progress of opulence," and it was then, in his middle or late 20s, that he first expounded the economic philosophy of "the obvious and simple system of natural liberty" which he was later to proclaim to the world in his Inquiry into the Nature and Causes of the Wealth of Nations. About 1750 he met David Hume, who became one of the closest of his many friends.
In 1751 Smith was appointed professor of logic at Glasgow university, transferring in 1752 to the chair of moral philosophy. His lectures covered the field of ethics, rhetoric, jurisprudence and political economy, or "police and revenue." In 1759 he published his Theory of Moral Sentiments, embodying some of his Glasgow lectures. This work, which established Smith's reputation in his own day, is concerned with the explanation of moral approval and disapproval. His capacity for fluent, persuasive, if rather rhetorical argument is much in evidence. He bases his explanation, not as the third Lord Shaftesbury and Hutcheson had done, on a special "moral sense,"nor, like Hume, to any decisive extent on utility,but on sympathy. There has been considerable controversy as how far there is contradiction or contrast between Smith's emphasis in the Moral Sentiments on sympathy as a fundamental human motive, and, on the other hand, the key role of self-interest in the The Wealth of Nations. In the former he seems to put more emphasis on the general harmony of human motives and activities under a beneficent Providence, while in the latter, in spite of the general theme of "the invisible hand" promoting the harmony of interests, Smith finds many more occasions for pointing out cases of conflict and of the narrow selfishness of human motives.
Smith now began to give more attention to jurisprudence and political economy in his lecture and less to his theories of morals. An impression can be obtained as to the development of his ideas on political economy from the notes of his lectures taken down by a student in about 1763 which were later edited by E. Cannan (Lectures on Justice, Police, Revenue and Arms,1896), and from what Scott, its discoverer and publisher, describes as "An Early Draft of Part of The Wealth of Nations, which he dates about 1763.
At the end of 1763 Smith obtained a lucrative post as tutor to the young duke of Buccleuch and resigned his professorship. From 1764-66 he traveled with his pupil, mostly in France, where he came to know such intellectual leaders as Turgot, D'Alembert, AndréMorellet, Helvétius and, in particular, Francois Quesnay, the head of the Physiocratic school whose work he much respected. On returning home to Kirkcaldy he devoted much of the next ten years to his magnum opus, which appeared in 1776. In 1778 he was appointed to a comfortable post as commissioner of customs in Scotland and went to live with his mother in Edinburgh. He died there on July 17, 1790, after a painfull illness. He had apparently devoted a considerable part of his income to numerous secret acts of charity.
Shortly before his death Smith had nearly all his manuscripts destroyed. In his last years he seems to have been planning two major treatises, one on the theory and history of law and one on the sciences and arts. The posthumously published Essays on Philosophical Subjects (1795) probably contain parts of what would have been the latter treatise.
The Wealth of Nations has become so influential since it did so much to create the subject of political economy and develop it into an autonomous systematic discipline. In the western world, it is the most influential book on the subject ever published. When the book, which has become a classic manifesto against mercantalism, appeared in 1776, there was a strong sentiment for free trade in both Britain and America. This new feeling had been born out of the economic hardships and poverty caused by the war. However, at the time of publication, not everybody was convinced of the advantages of free trade right away: the British public and Parliament still clung to mercantilism for many years to come (Tindall and Shi). However, controversial views have been expressed as to the extent of Smith's originality in The Wealth of Nations. Smith has been blamed for relying too much on the ideas of great thinkers such as David Hume and Montesquieu. Nevertheless, The Wealth of Nations was the first and remains the most important book on the subject of political ecomomy until this present day.
It has never, I think, been the good fortune of any founder
of a scientific system to think out to the very end even the more
important ideas that constitute his system. The strength and
lifetime of no single man are sufficient for that. It is enough
if some few of the ideas which have to play the chief part in the
system are put on a perfectly safe foundation, and analysed in
all their ramifications and complexities. It is a great deal if,
over and above that, an equal carefulness falls to the lot of a
few other favoured members of the system. But in all cases the
most ambitious spirit must be content to build up a great deal
that is insecure, and to fit into his system, on cursory
examination, ideas which it was not permitted him to work out.
We must keep these considerations before us if we would
rightly appreciate Adam Smith's attitude towards our problem.
Adam Smith has not overlooked the problem of interest;
neither has he worked it out. He deals with it as a great thinker
may deal with an important subject which he often comes across,
but has not time or opportunity to go very deeply into. He has
adopted a certain proximate but still vague explanation. The more
indefinite this explanation is, the less does it bind him to
strict conclusions; and a many-sided mind like Adam Smith's,
seeing all the many different ways in which the problem can be
put, but lacking the control which the possession of a distinct
theory gives, could scarcely fail to fall into all sorts of
wavering and contradictory expressions. Thus we have the peculiar
phenomenon that, while Adam Smith has not laid down any distinct
theory of interest, the germs of almost all the later and
conflicting theories are to be found, with more or less
distinctness, in his scattered observations. We find the same
phenomenon in Adam Smith as regards many other questions.
The line of thought which seems to commend itself principally
to him as explaining natural interest occurs in very similar
language in the sixth and eighth chapters of book i of the Wealth
of Nations. It amounts to this, that there must be a profit from
capital, because otherwise the capitalist would have no interest
in spending his capital in the productive employment of
General expressions like these have of course no claim to
stand for a complete theory.(2*) There is no reasoned attempt in
them to show what we are to represent as the actual connecting
links between the psychological motive of the capitalist's
self-interest and the final fixing of market prices which leave a
difference between costs and proceeds that we call interest. But
yet, if we take those expressions in connection with a later
passage,(3*) where Smith sharply opposes the "future profit" that
rewards the resolution of the capitalist to the "present
enjoyment" of immediate consumption, we may recognise the first
germs of that theory which Senior worked out later on under the
name of the Abstinence theory.
In the same way as Adam Smith asserts the necessity of
interest, and leaves it without going any deeper in the way of
proof, so does he avoid making any systematic investigation of
the important question of the source of undertaker's profit. He
contents himself with making a few passing observations on the
subject. Indeed in different places he gives two contradictory
accounts of this profit. According to one account, the profit of
capital arises from the circumstance, that, to meet the
capitalist's claim to profit, buyers have to submit to pay
something more for their goods than the value which these goods
would get from the labour expended on them. according to this
explanation, the source of interest is an increased value given
to the product over that value which labour creates; but no
explanation of this increase in value is given. According to the
second account, interest is a deduction which the capitalist
makes in his own favour from the return to labour, so that the
workers do not receive the full value created by them, but are
obliged to share it with the capitalist. According to this
account, profit is a part of the value created by labour and kept
back by capital.
Both accounts are to be found in a great number of passages;
and these passages, oddly enough, sometimes stand quite close to
each other, as, e.g. in the sixth chapter of the first book.
Adam Smith has been speaking in that chapter of a past time,
-- of course a mythical time, -- when the land was not yet
appropriated, and when an accumulation of capital had not yet
begun, and has made the remark that, at that time, the quantity
of labour required for the production of goods would be the sole
determinant of their price. He continues: "As soon as stock has
accumulated in the hands of particular persons, some of them will
naturally employ it in setting to work industrious people, whom
they will supply with materials and subsistence, in order to make
a profit by the sale of their work, or by what their labour adds
to the value of the materials. In exchanging the complete
manufacture either for money, for labour, or for other goods,
over and above what may be sufficient to pay the price of the
materials and the wages of the workmen, something must be given
for the profits of the undertaker of the work, who hazards his
stock in this adventure."
This sentence, when taken with the opposite remark of the
previous paragraph (that, in primitive conditions, labour is the
sole determinant of price), very clearly expresses the opinion
that the capitalist's claim of interest causes a rise in the
price of the product, and is met from this raised price. But Adam
Smith immediately goes on to say: "The value which the workman
adds to the material, therefore, resolves itself in this case
into two parts, of which the one pays the wages, the other the
profits of the employer upon the whole stock of materials and
wages which he advanced." Here again the price of the product is
looked upon as exclusively determined by the quantity of labour
expended, and the claim of interest is said to be met by a part
of the return which the worker has produced.
We meet the same contradiction, put even more strikingly, a
page farther on.
"In this state of things," says Adam Smith, "the whole
produce of labour does not always belong to the labourer. He must
in most cases share it with the owner of the stock which employs
him." This is an evident paraphrase of the second account. But
immediately after that come the words: "Neither is the quantity
of labour commonly employed in acquiring or producing any
commodity, the only circumstance which can regulate the quantity
which it ought commonly to purchase, command, or exchange for. An
additional quantity, it is evident, must be due for the profits
of the stock which advanced the wages and furnished the materials
of that labour." He could scarcely have said more plainly that
the effect of a claim of interest is to raise prices without
curtailing the wages of labour.
Later on he says alternately: "As in a civilised community
there are but few commodities of which the exchangeable value
arises from labour only, rent and profit contributing largely to
that of the far greater part of them, so the annual produce of
its labour will always be sufficient to purchase or command a
much greater quantity of labour than was employed in raising,
preparing, and bringing that produce to market" (first account,
chap. vi.) "The produce of almost all other labour is liable to
the like deduction of profit. In all arts and manufactures the
greater part of the workmen stand in need of a master to advance
them the materials of their work, and their wages and maintenance
till it be completed. He shares in the produce of their labour,
or in the value which it adds to the materials upon which it is
bestowed; and in this consists his profit" (second account, chap.
"High or low wages and profit are the causes of high or low
price; high or low rent is the effect of it" (first account,
Contradictions like these on the part of such an eminent
thinker admit, I think, of only one explanation; -- that Adam
Smith had not thoroughly thought out the interest problem; and --
as is usual with those who have only imperfectly mastered a
subject -- was not very particular in his choice of expressions,
but allowed himself to be swayed very much by the changing
impressions which the subject may have made on him from time to
Adam Smith, then, has no perfected theory of interest.(4*)
But the suggestions he threw out were all destined to fall on
fruitful soil. His casual remark on the necessity of interest was
developed later into the Abstinence theory. In the same way the
two accounts he gave of the source of interest were taken up by
his followers, logically carried out, and raised into principles
of independent theories. With the first account -- that interest
is paid out of an additional value which the employment of
capital calls into existence -- are connected the later
Productivity theories. With the second account -- that interest
is paid out of the return to labour -- are connected the
Socialist theories of interest. Thus the most important of later
theories trace their pedigree back to Adam Smith.
The position taken by Adam Smith towards the question may be
called that of a complete neutrality. He is neutral in his
theoretical exposition, for he takes the germs of distinct
theories and puts them beside each other, without giving any one
of them a distinct prominence over the others. And he is neutral
in his practical judgment, for he maintains the same reserve, or
rather the same contradictory hesitancy, both in praise and blame
of interest. Sometimes he commends the capitalists as benefactors
of the human race, and as authors of enduring blessing;(5*)
sometimes he represents them as a class who live on deductions
from the produce of other people's labour, and compares them
significantly with people "who love to reap where they never
In Adam Smith's time the relations of theory and practice
still permitted such a neutrality, but it was not long allowed to
his followers. Changed circumstances compelled them to show their
colours on the interest question, and the compulsion was
certainly not to the disadvantage of the science.
The special requirements of economic theory could not any
longer put up with uncertain makeshifts. Adam Smith had spent his
life in laying down the foundations of his system. His followers,
finding the foundations laid, had now time to take up those
questions that had been passed over. The development now reached
by the related problems of land-rent and wages gave a strong
inducement to pursue the interest problem. There was a very
complete theory of land-rent; there was a theory of wages
scarcely less complete. Nothing was more natural than that
systematic thinkers should now begin to ask in earnest about the
third great branch of income the whence and wherefore of the
income that comes from the possession of capital.
But in the end practical life also began to put this
question. Capital had gradually become a power. Machinery had
appeared on the scene and won its great triumphs; and machinery
everywhere helped to extend business on a great scale, and to
give production more and more of a capitalist character. But this
very introduction of machinery had begun to reveal an opposition
which was forced on economic life with the development of
capital, and daily grew in importance,the opposition between
capital and labour.
In the old handicrafts undertaker and wage-earner, master and
apprentice, belonged not so much to different social classes as
simply to different generations. What the one was the other might
be, and would be. If their interests for a time did diverge, yet
in the long run the feeling prevailed that they belonged to one
station of life. It is quite different in great capitalist
industry. The undertaker who contributes the capital has seldom
or never been a workman; the workman who contributes his thews
and sinews will seldom or never become an undertaker. They work
at one trade like master and apprentice; but not only are they of
two different ranks, they are even of different species. They
belong to classes whose interests diverge as widely as their
persons. Now machinery had shown how sharp could be the collision
of interest between capital and labour. Those machines which bore
golden fruit to the capitalist undertaker had, on their
introduction, deprived thousands of workers of their bread. Even
now that the first hardships are over there remains antagonism
enough and to spare. It is true that capitalist and labourer
share in the productiveness of capitalist undertaking, but they
share in this way, that the worker usually receives little --
indeed very little -- while the undertaker receives much. The
worker's discontent with his small share is not lessened, as it
used to be in the case of the handicraft assistant, by the
expectation of himself in time enjoying the lion's share; for,
under large production, the worker has no such expectation. On
the contrary, his discontent is aggravated by the knowledge that
to him, for his scanty wage, falls the harder work; while to the
undertaker, for his ample share in the product, falls the lighter
exertion-often enough no personal exertion whatever. Looking at
all these contrasts of destiny and of interest, if there ever
came the thought that, at bottom, it is the workers who bring
into existence the products from which the undertaker draws his
profit -- and Adam Smith had come wonderfully near to such a
thought in many passages of his widely read book -- it was
inevitable that some pleader for the fourth estate should begin
to put the same question with regard to natural interest as had
been put many centuries earlier, by the friends of the debtor,
with regard to Loan interest, Is interest on capital just? Is it
just that the capitalist-undertaker, even if he never moves a
finger, should receive, under the name of profit, a considerable
share of what the workers have produced by their exertions?
Should not the entire product rather fall to the workers?
The question has been before the world since the first
quarter of our century, at first put modestly, then with
increasing assertiveness; and it is this fact that the interest
theory has to thank for its unusual and lasting vitality. So long
as the problem interested theorists alone, and was of importance
only for purposes of theory, it might have slumbered on
undisturbed. But it was now elevated to the rank of a great
social problem which the science neither could nor would
overlook. Thus the inquiries into the nature of Natural interest
were as numerous and solicitous after Adam Smith's day as they
had been scanty and inadequate before it.
It must be admitted that they were as averse as they were
numerous. Up till Adam Smith the scientific opinion of the time
had been represented by one single theory. After him opinion was
divided into a number of theories conflicting with each other,
and remaining so with rare persistence up till our own day. It is
usually the case that new theories put themselves in the place of
the old, and the old gradually yield the position. But in the
present case each new theory of interest only succeeded in
placing itself by the side of the old, while the old managed to
hold their place with the utmost stubbornness. In these
circumstances the course of development since Adam Smith's time
presents not so much the picture of a progressive reform as that
of a schismatic accumulation of theories.
The work we have now before us is clearly marked out by the
nature of the subject. It will consist in following the
development of all the diverging systems from their origin down
to the present time, and in trying to form a critical opinion on
the value, or want of value, of each individual system. As the
development from Adam Smith onwards simultaneously pursues
different lines, I think it best to abandon the chronological
order of statement which I have hitherto observed, and to group
together our material according to theories.
To this end I shall try first of all to make a methodical
survey of the whole mass of literature which will occupy our
attention. This will be most easily done by putting the
characteristic and central question of the problem in the
foreground. We shall then see at a glance how the theory
differentiates itself on that central question like light on the
What we have to explain is the fact that, when capital is
productively employed, there regularly remains over in the hinds
of the undertaker a surplus proportional to the amount of this
capital. This surplus owes its existence to the circumstance that
the value of the goods produced by the assistance of capital is
regularly greater than the value of the goods consumed in their
production. The question accordingly is, Why is there this
constant surplus value?
To this question Turgot had answered, There must be a
surplus, because otherwise the capitalists would employ their
capital in the purchase of land. Adam Smith had answered, There
must be a surplus, because otherwise the capitalist would have no
interest in spending his capital productively.
Both answers we have already pronounced insufficient. What
then are the answers given by later writers?
At the outset they appear to me to follow five different
One party is content with the answers given by Turgot and
Smith, and stands by them. This line of explanation was still a
favourite one at the beginning of our century, but has been
gradually abandoned since then. I shall group these answers
together under the name of the Colourless theories.
A second party says, Capital produces the surplus. This
school, amply represented in economic literature, may be
conveniently called that of the Productivity theories. I may here
note that in their later development we shall find the
productivity theories splitting up into many varieties; into
Productivity theories in the narrower sense, that assume a direct
production of surplus on the part of capital; and into Use
theories, which explain the origin of interest in the roundabout
way of making the productive use of capital a peculiar element in
cost, which, like every other element of cost, demands
A third party answers, Surplus value is the equivalent of a
cost which enters as a constituent into the price, viz.
abstinence. For in devoting his capital to production the
capitalist must give up the present enjoyment of it. This
postponement of enjoyment, this "abstinence," is a sacrifice, and
as such is a constituent element in the costs of production which
demands compensation. I shall call this the Abstinence theory.
A fourth party sees in surplus value the wage for work
contributed by the capitalist. For this doctrine, which also is
amply represented, I shall use the name Labour theory.
Finally, a fifth party -- for the most part belonging to the
socialist side -- answers, Surplus value does not correspond to
any natural surplus whatever, but has its origin simply in the
curtailment of the just wage of the workers. I shall call this
the Exploitation theory.
These are the principal lines of explanation. They are
certainly numerous enough, yet they are far from exhibiting all
the many forms which the interest theory has taken. We shall see
rather that many of the principal lines branch off again into a
multitude of essentially different types; that in many cases
elements of sever theories are bound up in a new and peculiar
combination; and that, finally, within one and the same
theoretical type, the different ways in which common fundamental
thoughts are formulated, are often so strongly contrasted and so
characteristic that there would be some justification in
recognising individual shades of difference as separate theories.
That our prominent economic writers have exerted themselves in so
many different ways for the discovery of the truth is an eloquent
witness of its discovery being no less important than it is hard.
We begin with a survey of the Colourless theories.
1. "In exchanging the complete manufacture either for money, for
labour, or for other goods, over and above what may be sufficient
to pay the price of the materials and the wages of the workmen,
something must be given for the profits of the undertaker of the
work, who hazards his stock in the adventure.... He could have no
interest to employ them unless he expected from the sale of their
work something more than what was sufficient to replace his stock
to him; and he could have no interest to employ a great stock
rather than a small one unless his profits were to bear some
proportion to the extent of his stock" (M'Culloch's edition of
1863, p. 22). The second passage runs: "And who would have no
interest to employ him unless he was to share in the produce of
his labour, or unless his stock was to be replaced to him with a
profit" (p. 30).
2. See also Pierstorff, Lehre vom Unternehmerggwinn, Berlin,
1875, p. 6; and Platter, "Der Kapitalgewinn bei Adam Smith"
(Hildebrand's Jahrbücher, vol. xxv. p. 317, etc.)
3. Book ii. chap. i. p. 123, in M'Culloch's edition.
4. When Plater in the essay above mentioned (p. 71) comes to the
conclusion that, "if Smith's system be taken strictly, profit on
capital appears unjustifiable," it could only be by laying all
the weight on the one half of Smith's expressions, and leaving
the other out of account as contradictory to his other
5. Book ii. chap. iii.
6. Book i. chap. vi. The sentence was written primarily about
landowners, but in the whole chapter interest on capital and rent
of land are treated as parallel as against wages of labour.
•The Invisible Hand
Adam Smith first described this principle. Since that time it has become the basis of the concept of the free market.
Self Regulating prices Consider glove manufacturers. If a glove manufacturer were to raise his prices on his gloves way above his costs, a competitor with lower prices on gloves would receive all of the orders for gloves. If all of the glove manufacturers were to raise their prices way above their costs, someone else would begin to manufacture gloves and sell them at a price closer to the manufacturing costs. This competiti