Adam Smith's Views of Exchange Value

‘Ktibuk’, a correspondent asks (9 September) on Mises.org Bloghere: http://blog.mises.org/archives/007085.asp#comments

Gavin,
What does "capital" have to do with theory of value?

My answer:

When discussing Adam Smith on his theories of value I address what he wrote and not value theory since the mid-18th century. Smith wrote about exchange value within his theory of growth, in which capital, labour and land have places. These factors create products for exchange, through the ‘propensity to truck, barter, and exchange’, which he implies appeared long before commercial society.

In ‘rude society’ there were no markets. Each individual was independent of others and laboured for his own ends, living in small groups of related families. When hungry he hunted or gathered (in practice the women folk gathered), when wet he built shelters, when cold he made animal skin ‘clothes’. There was no capital because everything ‘produced’ was for immediate consumption. Possessions had to be carried; hence, were limited to essential ‘tools’ (stone axes, etc.,). This was the first age of ‘man’.

Labour was unambiguously the sole factor of production (there was no ‘ownership’ of land and all it contained). Labour was the sole measure of value: what it cost in toil to produce. Smith opined, in a ‘just so’ story, how two hunters traded beaver for deer. As each unambiguously owned what they had killed (the original LVT) they exchanged deer for beaver in the ratio of the labour effort required to find, catch and kill each animal. This was Smith’s use of a LVT (as commonly understood in his days – cf. John Locke).

With property in land and in ‘stock’ (capital), the components of ‘price’ changed, from a mono-factor to a multi-factor, when looked at from the producer’s perspective. Labour no longer determined value; owners of land or stock, shared the sales revenue. Labour could still be regarded as a numeraire for measuring exchange value, but not for determining it (a confusion in LVT).

Ownership of land was enforced by property relations (civil government), which protected the private property of individual owners from the those without property (other than their perfect right in their labour). Ownership of ‘stock’ came from ‘saving’ out of consumption (a ‘grub stake’ idea).

In Smith’s concepts of fixed and circulating capital, fixed capitals are instruments (tools) of production that augment labour and they remain under the control of the ‘stock holder’ (their owner). Circulating capital consists of the ‘maintenance’ (subsistence) of hired labour and the raw materials upon which they work. Circulating capital necessarily leaves the stockholder’s possession (he pays out wages and buys in materials), including when he uses his fixed capital.

Sales revenue, net of costs, is his profit, which he divides into his immediate consumption and to augment his capital stock (the source of growth). Labourers live on their family’s maintenance (under ‘Malthusian’ conditions); idle landlords reap their rents from what they didn’t sow.

Prices in commercial society are determined by the quantity (‘effectually’) demanded and the quantity supplied. Smith’s ‘natural’ and ‘market’ price mechanism is similar to Richard Cantillon’s, 1734, and Turgot’s, 1766. When markets clear at ‘natural prices’ the factors receive their ‘natural’ shares of revenue; when market-determined prices rise above ‘natural’ prices, the quantity supplied rises; when they fall below ‘natural’ prices, the quantity supplied falls. Smith did not have an equilibrium price model; price oscillated, or ‘gravitated’ around natural prices in disequilibrium.

Prices are determined within the ‘propensity to truck, barter, and exchange’ by pairs of individuals and not just by the dictates of abstract markets. Smith elaborated on what influences the producer’s price preference (that which is profitable, net of costs). It is an error to say Smith had a ‘cost of production’ value theory. The exchange process was not determined solely by buyers, nor by sellers. ‘Higgling and bargaining of the market’ was sufficient ‘for carrying on the ordinary business of life’.

The buyer is not interested in the seller’s costs (wages plus rent), or the seller’s profits ‘from hazarding his capital. Seller’s price competition lowers prices; as did, longer term, the ‘finer’ division of labour that increased labour productivity. Smith outlined the ‘conditional bargain’ (Book I, page 26: ‘Give me that which I want, and you shall have this which you want.’ In short, prices are determined by bargaining, between a seller concerned with costs plus profit, and a buyer concerned with the lowest price consistent with supply of the wanted good.
At this point, ‘subjective’ valuation has a role and while Smith did not elaborate on subjective judgement, it is implied in his bargaining model (and in his example of the use-value of water in the Arabian desert).

And that is what capital has to do with exchange value: it is an element in the seller’s preference for the determination exchangeable value of a good; i.e., the ratio at which a good is exchanged.