understanding the distribution of the wealth that growth generates; and (especially recently) understanding how market prices are determined. Despite this common ground, we find a vast conceptual diversity. These differences are only partly “normative,” i.e., attributable to contrasting views of how the world ought to work. The more fundamental force behind them is historical conditioning. Depending on their contexts, thinking humans develop certain ideas and not others; they feel compelled to explain certain elements, others they consider less worthy of attention. Even as they shift meaning over time, ideas carry their pasts with them, pasts with built-in limits and potentials that are hard to see. Once revolutionary ideas can come to seem reactionary. Things considered a priori or obviously true in one time and place are often open to debate in another.
Thus, as we turn to the foundational ideas of thinkers like Adam Smith, Karl Marx, or John Maynard Keynes, we must remind ourselves that theories of capitalism are attempts to make sense of dynamic processes unfolding in the world in specific times and spaces. This sensitivity is essential to any effort to uncover what work a theory was meant to do, what work it might or might not be able to do today, and the difference between them.
Adam Smith
Adam Smith is often called the first “classical” political economist. Why “classical”? Marx coined the term to distinguish this mode of “liberal” political economy from what came before (the “pre-classical”). Earlier economics (if we can call it that) primarily concerned the size of, and influences upon, the king’s coffers. Classical political economy, in contrast, developed an analysis of national wealth as collective or aggregate income, and was interested in the forces affecting the economic activity of the nation as a whole, not merely that of the monarch.
Smith was both extending and breaking with the analysis of the Physiocrats, political economists of eighteenth-century France who believed that the natural productivity of the land, set in motion by agriculture, was the origin of all wealth.6 For them, surplus value—the “additional” value produced between input and output in a production process—was possible only as a gift from nature. Their policy conclusion was logical: if agriculture was the source of the surplus upon which the state and all society depended, then anything that hindered it (taxes, trade restrictions, etc.) was bad.
Agriculture was also crucial to Smith, but the physiocratic approach seemed unable to make sense of his context (eighteenth-century Britain). In contrast to the relative conservatism of pre-revolutionary, absolutist France, Smith witnessed a period of extraordinary dynamism in Britain, which experienced a massive shift in the composition of society and an extraordinary accumulation of wealth. Smith’s objective was to intervene in a debate about the nature and causes of that change, which was marked by the dwindling success of feudal and especially mercantile systems of wealth accumulation and social organization.
Among the internal changes Smith witnessed, the most important were associated with a remarkable expansion in “commerce,” or the pursuit of individual gain via production and exchange by a growing proportion of society. Among the external changes he noted was the collapse of powerful empires and states that had formerly successfully accumulated wealth via the exercise of military power. Mercantilist states organized international economic activity around the “carrying trade,” bringing goods from places of production to places of consumption—via the spice trade between Southeast Asia and Europe, for example. Wealth in mercantilism was generated by state-favoured firms enjoying returns from arbitrage—the profits produced by the difference in purchase and sale price (which was of course augmented by colonial exercise). Trade routes and monopoly powers were sanctioned by the state, and protected by military power, tariffs, and other measures.
When Smith wrote his political economy (The Wealth of Nations appeared in 1776), the mercantilist system was increasingly crisis-ridden, the most astonishing example being that of Spain—a global mercantilist imperial power—losing control of the Netherlands, the relatively tiny emerging centre of what we might now call “capitalist” finance. Smith wanted to both explain how this new system was working, and determine how the state might help it work even better, to its own and everyone else’s advantage.
Like all classical economists, Smith was particularly interested in two phenomena: growth (what caused it) and distribution of income (what determined it). Because he was writing before the explosion of factory production—“industrial” capitalism—he was largely concerned with the expansion in the range and depth of market exchange, and the enormous wealth it seemed to create. His answer to the growth question was that eighteenth-century Britain’s wealth was due to extraordinarily productive shifts in the interaction between the “factors of production”: land, labour, and capital. These also gave him his answer to the distribution question: landlords, workers, and capitalists receive their respective share of the wealth generated by these interactions, in the form of rent, wages, and profit.7
These actors, Smith said, were connected in a “circular flow”: capitalists and workers paid rent, capitalists paid wages, landlords and workers consumed, and capitalists made profit, starting the process over again. The factors of production—and thus the classes that depended upon them for income—were mutually dependent. They had to exchange with each other, or nobody would win.
Smith thus argued that “freedom” of exchange and price determination (which would allow this system to work smoothly) were essential to the new system’s success. If we all depend upon maximum interaction, then anything that hinders it is by definition bad. And since it appeared that a new “liberty” among the population had made these exchanges possible (relative to feudal and slave modes), it seemed likely that the lack of state coordination (which for Smith would have been synonymous with “monarchical control”) made it possible. Although (by my reading, at least) he only uses the phrase once, this is what Smith meant by his famous “invisible hand”: the hand that made real wealth possible was neither the king’s nor anyone else’s. The implication, to some, was that it was God’s.8
According to Smith, circular flow engenders increasing market specialization. Producers seek to meet identified needs, creating an increasing division of labour, which allows for greater efficiency in the production process, which lowers costs and meets the needs of an expanding market. This is also supposed to work at the international scale. David Ricardo’s later elaboration of Smith’s theory led to the idea of “comparative advantage,” i.e., nations will specialize in the production of what they are best at (in terms of cost or efficiency).
Smith assumes that in this system, money serves almost entirely as a means of payment or unit of account. He doesn’t imagine market participants seeing money as a form of wealth they could or should accumulate (as we would today). This leads him to assume that people will not hold money as a store of wealth, but will spend it, keeping the circular flow going. Although Smith didn’t say it outright, in this system, price—the temporary resolution of competition between market participants—serves as a signal: rising prices tell producers to produce, and falling prices tell them to stop producing, or to produce differently. In addition, when prices are rising, new producers will enter a market and purchasers will leave, and when prices are falling, producers will leave and buyers will enter. Thus, price signals ought to lead automatically to “equilibrium” and the full employment of resources: any leftover resources would clearly be cheap, and would therefore find a price at which they made sense, eventually allowing the system to put all its productive capacity to work.
With all this working so well on its own, Smith does not see a big role for the state—basically, it needs to protect the nation, enforce the law (especially property law), and provide some public goods (i.e., infrastructure like roads and bridges). Still, it is a complete mischaracterization to suggest he saw no need for the state, as one often hears from people who claim to be working in his tradition. The state remains
