Falling Profit Rates Raise Real Incomes

Jonathan Taplin is a Professor at the Annenberg School for Communication at the University of Southern California and writes Jon Taplin’s Bog (HERE)

“There are very few things that Adam Smith and Karl Marx agreed upon–but one was the “tendancy of the rate of profit to fall”. This term is so well known by economists that they use TRPF as the acronym. Here’s Adam Smith from The Wealth of Nations.

“It may be laid down as a maxim, that wherever a great deal can be made by the use of money, a great deal will commonly be given for the use of it; and that wherever little can be made by it, less will commonly be given for it. According, therefore, as the usual market rate of interest varies in any country, we may be assured that the ordinary profits of stock must vary with it, must sink as it sinks, and rise as it rises. The progress of interest, therefore, may lead us to form some notion of the progress of profit.”

“It somehow escapes the pea-brains of these dinosaurs, that these are the very policies that have brought us to this crisis.”

Comment
Adam Smith was quite clear on the cause of rising and falling rates of profit:

“The rise and fall in the profits of stock depend upon the same causes with the rise and fall in the wages of labour, the increasing or declining state of the wealth of the society; but those causes affect the one and the other very differently.”

“The increase of stock, which raises wages, tends to lower profit. When the stocks of many rich merchants are turned into the same trade, their mutual competition naturally tends to lower its profit; and when there is a like increase of stock in all the different trades carried on in the same society, the same competition must produce the same effect in them all.” WN I.x.1: p105

“In a thriving town the people who have great stocks to employ, frequently cannot get the number of workmen they want, and therefore bid against one another in order to get as many as they can, which raises the wages of labour, and lowers the profits of stock. In the remote parts of the country there is frequently not stock sufficient to employ all the people, who therefore bid against one another in order to get employment, which lowers the wages of labour, and raises the profits of stock.” (WN I.x.7: pp 106-7)

The interpretations placed upon these (and some other similar) statements are often woefully inadequate. Smith’s was not a determinate model, closed to enable a mathematical ‘solution’ to work. He was not entrapped in the diminishing returns of Ricardo (or Marx, who merely wanted to prove what he eventually called capitalism was going to collapse).

The point is that growing societies, with increasing productivity and markets, reduced price, which raised real incomes, and brought more people within them into employment, creating new markets for new products. Poor societies had enormous profits because capital opportunities were scarce (he cited China); richer societies had lower profits because capital opportunities were abundant (he cited Britain, and in a rare prediction, believed that the former British colonies by around 1880 would be even richer).

As more capital was utilised, the cost of capital would rise and profits would fall. Conversely as more capital was employed the price of labour would rise. As prices of commodities fell from increased productivity (pin-factory, etc.,) and the sub-division of labour within the supply chains (the common labourer’s coat), real incomes from employment would rise. But greater capitals, though they meant lower rates of profits, also meant larger amounts of profit. It was not zero-sum.

The process means a fall rate of profit, earned by ever larger amounts of capital, and rising real wages from work. With 'consumerism' the consequence is all around us in higher living standards.

Note Jon's assessment of those he criticises: 'the pea-brains of these dinosaurs', surely a most unProfessorial tone from California...

A New Reader, Perhaps?

MSR (Owings Mill, Maryland) HERE:

MSR posts twice in response to Lost Legacy’s post: 12 January: “Corporate Capitalism and Legislative Interests”

“Adam Smith redux

Gavin Kennedy at Adam Smith's Lost Legacy, a site I was unfamiliar with but which, based on my short perusal so far, is a site well worth reading, has a comment on my earlier post about Adam Smith. Gavin's comments are correct, I agree with what he has to say, although I believe that my main point still holds.

Basically, the passage I quoted went on at some length to the effect that the merchant and manufacturer are much better situated in knowledge and experience than are either the laborer or the country farmer to manipulate government policy to his or her advantage. Gavin's point was that while that was perhaps quite true in Smith's day, it is much less so today. All three of Smith's orders of men are today quite savvy at manipulating government policy to their advantage.

I did not mean to suggest that the merchant's and manufacturers still have that advantage as a general rule. My intended points were two fold. One point was that Smith's claim that the interests of the merchant and manufacturer are more often than not at odds with the interests of society as a whole and the general welfare of the nation. Adopting the policies and proposals of this order of men and women without very careful scrutiny is as foolish a move today as it was in Smith's time.

Yet we have spent much of the past eight years doing exactly this foolish thing. Secondly, I wanted to advance Smith's other point that the proposals of the merchant and manufacturing class should be met with long study, close scrutiny and a healthy dose of skepticism. I would agree with Gavin's commentary to the extent of saying that the important practice is to address all proposals from any part of society with a healthy dose of critical review.”

and

“I mentioned earlier that I liked the blog "Adam Smith's Lost Legacy" and I do. For example, I came across the following post wherein Gavin Kennedy argues for one of my preferred changes to the tax code. Gavin is writing about the UK tax system specifically, but the same principal applies to the US standard deduction. I believe that tax cuts should be considered, even in this time of recession, but the appropriate form of those cuts is an increase in the standard deduction. Get folks at the lower end of the income distribution off the income tax rolls. Such tax cuts would be a stimulant to the economy. When tax cuts are discussed it seems to me that the only form of cuts considered are changes in the tax rates. But a rise in the standard deduction should be a part of any progressive policy proposal.”

Comment
Yes, a clarification between friends is always helpful for civil discourse...

The World Began Before 1776

Joseph Martini writes in Give and Go (‘random musings on authentic happiness’) HERE:

"Economist Adam Smith didn’t contemplate conscious, rationalized idiocy on such a large scale; his “invisible hand” was no match for such a massive, wanton snow job."

I enjoy Tedd's blog and often agree with his observations and conclusions. However, in this case I respectfully disagree.

Actually, Adam Smith anticipated exactly what has happened in this particular boom/bust cycle.

He made it very clear that considerable structure was needed before the invisible hand of the market could work efficiently.

For example, property rights must be strong, and there must be widespread adherence to moral norms, such as prohibitions against theft and misrepresentation.

In his time, property rights were only recognized among the aristocracy.

Adam Smith developed his theories in a centralized, heavily planned and dictatorial society where some individuals were above the law and others were effectively without any rights.

He saw the system of his time as corrupt and inefficient--a massive and wanton snowjob that enriched the few at the expense of the many.

He even anticipated the influence of special interests, writing that:

"People of the same trade seldom meet together even for merriment and diversion, but the conversation ends in a conspiracy against the public or some contrivance to raise prices."

Comment
“He made it very clear that considerable structure was needed before the invisible hand of the market could work efficiently.”

No, he didn’t say anything remotely like that. He did not link his singular use of the metaphor of ‘an invisible hand’ to markets, efficient or otherwise. That’s a myth (see my downloadable paper on the Home page of Lost Legacy: 'Adam Smith and the Invisible Hand: from metaphor to myth’.

“For example, property rights must be strong, and there must be widespread adherence to moral norms, such as prohibitions against theft and misrepresentation.”

Property rights were invented long, long before commercial markets appeared. Smith shows this in his Lectures on Jurisprudence (1762-3) (published by Liberty Fund in 1982).

The invention of property in the near east between 11,000 and 8,000 years ago was the trigger that set humans on economic development via shepherding and farming, neither of which was viable if flocks could wander and other humans could hunt them at will, and wild animals and other humans could access farmers’ crops for a free lunch.

With property, civil government became necessary to keep the poor (and rich neighbours!) from inflicting their depredations on what belonged to others. The evolution of laws about property over millennia enabled markets in time to grow.

“In his time, property rights were only recognized among the aristocracy.”

That is a gross exaggeration, Joseph Martini, and is probably from rhetoric you heard in junior school around the 4th of July celebrations. Adam Smith, for example, was not an aristocrat – he didn’t even have a vote in the restricted franchise of the time – but he owned property, and his rights were recognised in the Scottish courts.

When he inherited some of his father’s property, lawfully passed to his elder stepbrother, who died young, Adam secured his property rights through the Aberdeen and Fife civil courts. Britain in the 18th century was awash with laws recognising property rights well beyond the restricted aristocratic classes. Where do you think that the British colonies in America got their legal foundations from? (See Ian Ross, The Life of Adam Smith, 1995, Oxford University press).

“He even anticipated the influence of special interests, writing that:

"People of the same trade seldom meet together even for merriment and diversion, but the conversation ends in a conspiracy against the public or some contrivance to raise prices.”

The quotation is from Wealth Of Nations (WN I.x.c.27: p 145; Edwin Canaan, ed. 1937: p 18). It is not evidence of Adam Smith’s ‘anticipation’ of special interests at all! If Joseph Martini were to read the whole chapter he quotes from, he would see that Smith discusses the consequences of' (1563), which legally forbade anyone to enter a trade who had not served an apprenticeship (under the guise of ensuring ‘quality’, and other spurious 'spin'), but which became a monopolistic practice ruthlessly imposed by the ‘tradesmen’ to narrow the market and raise prices.

In short, instead of anticipating ‘special interests’, Adam Smith wrote about the then 200-year experience of them at work against the itnerests of both competition and consumers. And note, he was taking about shopkeepers, artisans, craftsmen and such like, who were legally organised into local Guilds.

If we are to understand Adam Smith it is first necessary to read his books. It is also, perhaps, necessary to be accurate about history - it began long before 1776, important as that date was for civil government.

US Treasury 'Manages' Its Debts?

Gerald P. O’Driscoll, Jnr. posts ‘Washington Is Quietly Repudiating Its Debts’ in the Wall Street Journal (22 August) HERE:

“Will the U.S. Treasury repudiate its obligations to its creditors, be they citizens or investors around the world? Most observers would answer "no" without hesitation. But Congress, with the complicity of the White House and the Fed, has arguably embarked on a stealth repudiation.

In his famous treatise, "The Wealth of Nations," Adam Smith noted there had never been a "single instance" of sovereign debts having been repaid once "accumulated to a certain degree." We may have reached Smith's threshold.”

Comment
Possibly a rare good use of a quotation from Wealth Of Nations (WN V.iii.59: p 929).

The only problem that I can see is I am not sure if the US has reached that stage just yet, but it is appropriate that a financial journal raises the possibility of the issue arising.

Maybe Gerald P. O’Driscoll is slightly exaggerating Smith’s views in this instance. Here is the actual wording of the paragraph, which is slightly less definitive in that ‘never’ replaces Smith’s more cautious words, ‘I believe’:

‘When national debts have once been accumulated to a certain degree, there is scarce, I believe, a single instance of their having been fairly and compleately paid. The liberation of the public revenue, if it has ever been brought about at all, has always been brought about by bankruptcy; sometimes by an avowed one, but always by a real one, though frequently by a pretended payment.’ (WN V.iii.59: p 929)

Those interested in handling public debts might care to read the whole of chapter III of Book V (‘Of Public Debts’) for Smith’s excellent historical account of the sorry behaviour of kings, emperors, and governments regarding the debts they or they predecessors contracted, and which given the historical precedents, were almost certain not to be repaid in full, though they were good for their interest payments while they lasted (allowing for the ravages of inflation, adulterated coinages, and assorted financial crises on even the value of the nominal interest payments).