Keywords

Introduction

As a creature of both the Industrial Revolution and the European Enlightenment (1680–1789), the modern world has been characterized by the harnessing of rationality and science to the cause of material progress. In the realm of technology, steam power – which found its first usage in 1715 in the shape of huge, cumbersome machines designed to pump water from coal mines – was gradually adapted to a variety of more revolutionary uses: powered factory machinery, steam-powered railways and ships, heating, and power generation. In the wake of this initial technological breakthrough, others followed: telegraph, radio, electricity, computerization, etc. Managers, in harnessing the power of new technologies and more efficient forms of work organization, also sought accurate estimates for their costs at each stage of the production process. Yet, for all the obvious emphasis on science and rationality, many of the seminal intellectual influences in the Age of Enlightenment – Thomas Hobbes, John Locke, David Hume, the Baron de Montesquieu (Charles de Secondat), Francois-Marie Arouet (Voltaire), and Adam Smith – were as much concerned with human irrationality, violence, passion, and emotion as they were with rationality. In his Leviathan, a foundational text of the Enlightenment, Hobbes (1651/2002: 40) argued that it was only the enforced order of society that protected humanity from its own vices; whenever this enforced order was absent than humanity lived in a “brutish manner.” In France, Montesquieu (1748/1989: 5), in his The Spirit of the Laws , similarly reflected that society was comprised of inherently flawed individuals, each “subject to ignorance and error … to a thousand passions.”

In Scotland, Hume (1739/1896: 241) devoted the second volume of his A Treatise on Human Nature to “passions,” observing that – unlike reason – “’tis evident our passions” are “not susceptible” to rational “agreement or disagreement.” Where others, however, associated passions and emotion with human evils, Hume argued a contrary position. Identifying “self-interest” as humanity’s preeminent emotion and concern, Hume (1739/1896: 266) concluded that, “Men being naturally selfish, or endow’d with a confin’d generosity, they are not easily induc’d to perform any action for the interest of strangers, except with a view to some reciprocal advantage.” It was, Hume (1739/1896: 267) further reflected, only as a result of “this self-interested” reasoning that “commerce …begins to take place, and to predominate in society.” It was, in other words, from what others recognized as a vice (self-interest) that needed to be restrained, that Hume identified a positive motive force for economic and business organization. Subsequently, and more famously, the idea of organizing business endeavor on the basis of self-interest rather than economic regulation was taken up by Hume’s close friend, Adam Smith. Whereas Smith is best – and wrongly known – for his maxim about “the invisible hand of the market” (a term he never used), in fact Smith associated the concept of “an invisible hand” (not “the invisible hand”) with self-interest, declaring in The Wealth of Nations (1776: Book IV, Chap. 2, para. 9) that, in directing “industry”:

… in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention.

In emphasizing the importance of “self-love” in determining economic outcomes in the opening chapters of The Wealth of Nations, Smith (1776: Book I, Chap. 2, para. 2) concluded that, “Nobody but a beggar chooses to depend chief upon the benevolence of his fellow-citizens … It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.”

If an emphasis on self-interest led to a growing belief that economic outcomes were best decided by freely chosen market exchanges rather than government oversight, another eighteenth-century interest of political economy focused on what was to prove an increasingly divisive debate: the organization and management of production. At first blush, the question that drove this debate – “How is value created?” – appears innocuous. It was, nevertheless, a question that was to tear societies apart over the course of the nineteenth and twentieth centuries. Whereas some primarily attributed the creation of value to capital and management, others – who identified with Karl Marx’s critiques of capital – believed these economic agents occupied as an essentially parasitic place in the production process, expropriating the hard-wrought economic value created by labor.

Although it was Adam Smith’s views on value that were to prove most influential, in this – as with his formulations on self-interest – Smith built his insights on the work of others. In this domain it was to be the French physiocrat, Richard Cantillon, who provided the decisive impetus. Described (Rothbard 2006: 345) as the real “father of modern economics,” Cantillon’s (1755/2010) seminal work, An Essay on Economic Theory , was written in 1730 but – due to French censorship laws – not published until 1755, 11 years before Smith’s The Wealth of Nations hit the printing presses. While it was obvious to Cantillon that the most dynamic part of the French economy was associated with commerce and industry, he nevertheless concluded (Cantillon 1755/2010: 22) that, “Land is the source or matter from which all wealth is drawn.” In coming to this essentially feudal conclusion, Cantillon’s thinking was guided by two accurate observations. First, Cantillon (1755/2010: 22) noted, human endeavor merely transforms into more useful objects the natural produce of the land, produce that takes the form of both a living bounty – “grass, roots, grain, flax, cotton” – and inanimate “minerals.” Without this initial bounty, no wealth is possible. Second, he observed, the “labor” that transforms the land’s abundance is itself dependent upon the land for its sustenance. This meant, in turn, that a nation’s economic capacity was ultimately determined by its agricultural capacity, Cantillon (1755/2010: 62) calculating that the worth of a common object was equal to “double the product of the land used to maintain … the work of the cheapest peasant or laborer,” i.e., if a worker made an object in 1 day than it would be worth the landed produce the person consumed over two. As a society’s productive capacity was, Cantillon (1755/2010: 63) believed, constrained by labor availability, it logically followed that it was agricultural efficiency that was the key element in wealth and value creation. The more that could be produced from an acre of land, the greater the supply of labor available and – consequently – output, value, and wealth.

Despite his flawed conclusions, Cantillon laid the groundwork for all who followed in his wake by linking three key concepts: value, labor, and efficiency. Abandoning Cantillon’s attempts to link these concepts with landed production, Smith (1776: Book I, Chap. VII, para. 4, 7) drew a distinction between what he called the “natural price,” which was determined by actual costs of production, and “market” price, which could “either be above, or below, or exactly the same with its natural price.” Emphasizing this same point, Alfred Marshall (1920: 291), in his Principles of Economics , declared that “the shorter the period we are considering,” the greater is “the influence of demand on value; and the longer the period, the more important will be the influence of the cost of production on value.” Believing (Smith 1776: Book I, Chap. V, para. 17) that labor – rather than the value of the land’s output – was “the only universal, as well as only accurate measure of value, or the only standard by which we can compare the values of different commodities at all times, and at all places” (i.e., the more labor expended in producing a good, the more expensive it is vis-à-vis other goods), Smith also accurately concluded that increased societal wealth must stem from a greater volume of outputs from each given unit of labor. It was on this point that Smith (1776: Book I, Chap. I, para. 1) famously began The Wealth of Nations by observing, “The greatest improvement in the productive powers of labour, and the greater part of the skill, dexterity, and judgement with which it is anywhere directed, or applied, seem to have been the effects of the division of labour.” Although it has been argued (Magnusson 2009: 2–3) that Smith’s ideas are of limited utility as they stemmed from a “proto-industrialized” society and line of thinking based on handicraft production rather than technological innovation, in truth Smith’s logic was revolutionary precisely because he was the first to grasp the transformative effect of investment in machinery and other forms of fixed capital. Emphasizing this point, Smith (1776: Book I, Chap. I, para. 5) argued in The Wealth of Nations that the “division of labor” had become the principal driver of increased productivity and wealth precisely because of its association with “the invention of a great number of machines which facilitate and abridge labour, and enable one man to do the work of many.”

Whereas Smith and his intellectual heirs (David Ricardo, John Stuart Mill, Alfred Marshall, Friedrich Hayek, Milton Friedman) identified societal advance with self-interest, market exchanges, and labor and firm specialization, Karl Marx and his intellectual and political heirs had very different understandings of the relationships between value, output, and labor. Whereas Smith (1776: Book 1, Chap. 5, para. 6–12) saw labor as the only universal measure of value, and but one component in the creation of value – alongside “rent,” the worth of the “stock” or capital consumed in production, and the “profit” which represented the employer’s “deduction” for venturing their time and capital – Marx (1867/1954) saw labor as the only source of value. Everything else – profit, the money saved from the production process that was reinvested in more fixed capital, a business’s administrative costs – came from the extraction of an unremunerated surplus from labor, what Marx referred to as “surplus value.” Under “the miserable character of this appropriation,” Marx and his communist colleague, Frederick Engels (1848/1951: 45–46), proclaimed in The Communist Manifesto , “the labourer lives merely to increase capital, and is allowed to live only in so far as the interest of the ruling class requires it.” Where Smith (1776: Book 1, Chap. 5, para. 8–9) saw an economy operating on the self-interested cooperation of capital and labor – the latter constantly needing an employer “to advance them the materials of their work, and their wages and maintenance till it can be completed” – Marx and Engels (1848/1951: 61) perceived nothing but “hostile antagonism” between the classes. Where Smith and his intellectual heirs saw a society based on market exchange, Marx and Engels (1848/1951: 50) argued that society was best served by the centralization of all “production in the hands of the state.”

If over time the Marxist intellectual challenge to industrial capitalism and its associated systems of management has waned, many of the criticisms that Marxists once made have been taken up by postmodernists of various hues. With the “generalized computerization of society,” the French postmodernist, Jean-Francois Lyotard (1979/1986: 47, 51) argued in his The Postmodern Condition , the capitalist focus on “development” has become an ever more “dehumanizing process”. In his subsequent The Inhuman, where Lyotard (1988/1991: 67, 6) again suggested that humanity’s “enjoyment” of the present was being constantly sacrificed in the name of “efficiency” and “development.” Lyotard’s postmodernist colleague, Michel Foucault (1976/1978: 140–141), painted an even bleaker picture of “the development of capitalism,” suggesting its advance was associated with an unprecedented exploitation of “bio-power” – human sexuality and psychological identity – that involved “the controlled insertion of bodies into the machinery of production and the adjustment of the phenomenon of population to economic process.” The result of this, Foucault (1976/1978: 145) continued, was new systems of “micro-power” engaged in “infinitesimal surveillances, permanent controls, extremely meticulous orderings of space, indeterminate medical or psychological examinations.” Today, announced hostility to any analysis that emphasizes “markets” and “efficiency” is endemic among even business-school academics. In a highly influential article, Peter Clark and Mick Rowlinson (2004: 337), for example, suggest that analysis that highlights the benefits of “markets” and “efficiency” necessarily “mitigates against both historical and ethical considerations.”

Almost 300 years after Cantillon first penned his An Essay on Economic Theory , it is evident that the debates about value, labor, and the efficient use of resources are arguably even more divisive now that they were at the dawn of the Industrial Revolution. Understanding and resolution of these debates are, moreover, not mere academic exercise. Over the last century, societies have risen and fallen over these issues (i.e., the Soviet Union). Revolutions and civil wars have been fought over them. Economic progress has advanced and faltered. Debates about value, labor, and efficiency remain, in short, seminal to the human condition.

Value and the Foundations of Classical Economics

In exploring the foundations of classical economics and its continuing impact, it is useful to remind ourselves of the material and intellectual conditions that existed at the dawn of the Industrial Revolution. In France, Britain, and, to a lesser degree, Prussia – Europe’s leading economies – the intellectual dynamism of an urban elite was self-evident. In visiting Paris before the Revolution, the English agronomist, Arthur Young (1792/1909: 95–96), chanced to visit the residence of Antoine and Marie-Anne Lavoisier, observing the scientific laboratories in which they completed experiments into chemical structure, the generation and use of electricity, and the creation of vacuums. Across Europe, the writings of George Berkeley, David Hume, Voltaire, Jean-Jacques Rousseau, Montesquieu, Rene Descartes, Immanuel Kant, and Johann Goethe were laying the foundations of modern philosophic and political thought. Underpinning intellectual advance was a rising tide of wealth. Along the Atlantic seaboard, the ports of Britain and France were flooded with the imported produce of the Americas (sugar, coffee, tobacco, and cotton), creating in both countries a large commercial bourgeoisie of merchants, financiers, and insurers. According to Fernand Braudel (1986/1991: 553), the profits enjoyed by this class were extraordinary; a successful sea voyage – which traded European goods for slaves in West Africa and slaves for plantation produce in the Americas – typically delivered profits of between 50 and 80 percent. The intellectual effect of this commercial dynamism was noted by Voltaire (1733/2002: 36) in his Letters on England where he recorded that, “A trading nation … grasps at every discovery.”

If the dynamism that Voltaire described was very real, it was nevertheless equally true that beyond the wealthy circles of commerce – and the intellectual salons of London, Paris, and Berlin that proved Voltaire’s natural abode – there existed a world of mass misery. Before the Industrial Revolution and its manufactured demand for a literate workforce, few could read or write. Reflecting on this circumstance and the condition of Paris’s intellectual elite, Arthur Young (1792/1909: 24) – who recorded his observations in a subsequently published journal – observed that, “This society does like other societies – they meet, converse, offer premiums, and publish nonsense. This is not of much consequence, for the people, instead of reading their memoirs, are not able to read at all.” Outside Paris, Young (1792/1909: 18) discovered that “the fields are scenes of pitiable management, as the houses are of misery.” Throughout the countryside, Young continued, “girls and women, are without shoes or stockings.” Although serfdom was no longer a feature of the French landscape, the peasantry were still subject to the corvee, a system of forced labor that obliged rural folk to spend up to 40 days a year building roads, digging ditches, replacing walls, etc. If the British rural populace was spared such obligations, the revolution in the island nation’s agriculture brought about by the “enclosure movement” (i.e., the fencing of formerly common and wasteland and its use for commercialized farming) was nevertheless associated with the displacement of millions from the land. The Catholic Irish and the crofters of the Scottish Highlands were hardest hit. In describing a typical experience, Marx (1867/1954: 420–21) recounts how between 1814 and 1820 the 15,000 “Gaels” who lived in Scotland’s Sutherland district “were systematically hunted and rooted out. All their villages were destroyed and burnt, all their fields turned into pasture.” Everywhere the threats of bankruptcy, personal ruination, violence, riot, and mass social explosion were not too far away. Even glittering careers ended in condemnation and tragedy. In reflecting upon his time at the Lavoisier household in Paris, for example, Young (1792/1909: 95) recounted how he “was glad to find this gentleman splendidly lodged, and with every appearance of a man of considerable fortune.” Much of Lavoisier’s “considerable fortune,” however, came from his shares in the Ferme Générale, a company that bought the right to “farm” French taxes. When with the Revolution all the leading figures in the Ferme Générale were placed under arrest, Lavoisier lost not only his fortune but his head, guillotined in early 1794 at the age of 50.

Caught between a dynamic world of commerce on one side and a world of mass misery and violence on the other, the founding figures of classical economics were dealing with more than abstractions. Rather, they were seeking a set of principles that would benefit the many rather than the few, a sense of purpose that is perhaps best captured by Smith (1776: Book 1, Chap. I, para. 10) in the opening paragraphs of The Wealth of Nations , where he observed that through “the great multiplication of the productions of all the different arts,” it was possible “in a well-governed society” to achieve “that universal opulence which extends itself to the lowest ranks of the people.” What concerned them was not the possession of wealth and its consumption, but rather the processes through which value was created. Reflecting this fundamental distinction, the French eighteenth-century economist, Francois Quesnay (1766: 1), began his influential Tableau Economique by observing that, “La nation est. réduite à trois classes de citoyens: la classe productive, la classe des propriétaires et la classe sterile” (“The nation is reduced to three classes of citizens: the productive class, the class of owners and the sterile class”). Ten years later, Smith (1776: Book II, Chap. III para. 1), in The Wealth of Nations, drew a similar distinction between “productive” and “unproductive” labor noting that, “There is one sort of labour which adds to the value of the subject upon which it is bestowed: there is another which has no effect.” Wages spent on “menial servants” attracted Smith’s particular attention, Smith (1776: Book II, Chap. III, para. 1) observing that the labor of such individuals “does not fix or realize itself in any particular subject or vendible commodity. His services generally perish in the very instant of their performance.” In addition to servants, Smith (1776: Book II, Chap. III, para. 2) also excluded from his list of “productive” labor both “important” and “frivolous professions,” notably: “churchmen, lawyers, physicians, men of letters of all kinds; players, buffoons, musicians, opera-singers, [and] opera-dancers.” Although John Stuart Mill (1848/2002: 74) subsequently decided to count as productive those “officers of government” engaged in “affording the protection” of society and industry (i.e., police, armed force, judges, prison guards, etc.), the distinction between productive and unproductive labor retained its importance. Mill (1848/2002: 100–101) was particularly scornful of money spent on government, declaring: “Whenever capital is withdrawn from production … to be lent to the State and expended unproductively, that whole sum is withheld from the labouring classes.” Marx also drew a sharp distinction between productive and unproductive labor. In Marx’s analysis, the transformative potential of any capitalist society rested primarily in the “proletariat,” a group that included only those who produced a “surplus value” that added to a society’s productive capacity. In Marx’s (1867/1954: 477) view, even a “schoolmaster” who “works like a horse” to make a profit for their employer is unproductive in that they fail to produce surplus value. Accordingly, “That labourer alone is productive, who produces surplus-value for the capitalist, and thus works for the self-expansion of capital.”

Although the foundational texts in economics were united in drawing a distinction between “productive” and “unproductive” labor, they differed in their estimations as to what constituted “productive” work. In France, the nation’s economists and physiocrats tended to the view that only farmwork created real value. Quesney (1766: 2), for example, defined “La classe sterile” (the sterile class) as comprising “tous les citoyens occupés à d’autres services et à d’autres travaux que ceux de l’agriculture” (all the citizens engaged in work other than those of agriculture). As we noted in the introduction to this chapter, Quesney’s view corresponded to the earlier analysis of Cantillon , who saw land as the sole “source or matter from which all wealth is drawn.” Smith, by contrast, concerned as was with the wealth-multiplying effects of the division of labor, saw productive work and value creation in much wider terms. In his estimation (Smith, 1776: Book II, Chap. III, para. 4), economic value came “either from the ground, or from the hands of productive labourers.” Perhaps even more significantly, Smith (1776: Book II, Chap. III, para. 4) drew a fundamental distinction between how a society’s annual wealth is distributed between immediate consumption and savings or “capital” directed toward future production. It was upon the size of the latter, rather than the former, that Smith believed a society’s wealth rested.

Smith’s differentiation between “wealth” and productive “capital” is a fundamental distinction that still eludes many. In his much-read Capital in the Twenty-First Century, Thomas Piketty (2012/2014: 1), for example, opened his book by stating, “The distribution of wealth is one of today’s most widely discussed and controversial issues.” Piketty (2012/2014: 48) then, however, immediately proceeded to conflate “wealth” with “capital,” defining “‘national wealth’ or ‘national capital’ as the total value of everything owned by the residents and government,” a definition that counted the value of residential real estate, currency in bank deposits, artwork, and the like as “capital.” Piketty’s conflation of capital, wealth, and landed property – a viewpoint that his French predecessors, Quesney and Cantillon, would have endorsed – ignores the fact (which Smith understood) that businesses and societies have to constantly decide whether to allocate money toward consumption, which adds to the immediate material “wealth” of its citizens, and “saving,” production geared toward capital goods, or other forms of investment, which adds to future productive capacity. Accordingly, in measuring “wealth,” the most common current measure is gross domestic product, which is an estimate of the value of goods and services produced over a particular period of time. By this measure, it is a society’s productive capacity that determines its wealth and the wealth of its citizens, not the society’s store of gold, silver, diamonds, and monetary currency. Accordingly, a house or apartment will only figure in gross domestic product in the year in which it is constructed, further appearances being restricted to the value attached to repairs or additions incurred in future years. Using gross domestic product as a measure of wealth, a prosperous society that witnessed the destruction of all of its houses, but none of its capital investment, would be considered to be still well-to-do. By comparison, a society that suffered the loss of all its capital, but none of its houses, would be regarded as destitute.

In the eighteenth and nineteenth centuries, the divisions relating to the nature of productive labor were also reflected in differing perceptions of value. Although all political economists well understood that the exchangeable value of a commodity varied according to market circumstances (i.e., variance in supply and demand, seasonal variations, government-imposed restrictions and taxes, etc.), they had conflicting views as to what determined a good’s “intrinsic” value or “natural” price.

As with many things in economics, it is Smith’s formulations regarding value that are typically regarded as the discipline’s foundational understandings, Smith (1776: Book I, Chap. IV, para. 13) famously drawing the distinction between “use” value and “exchange” value through the analogy of water and diamonds. “Nothing is more useful than water,” Smith (1776: Book I, Chap. IV, para. 13) observed, “but it will purchase scarce anything; scarce anything can be had in exchange for it. A diamond, on the contrary, has scarce any value in use; but a very great quantity of other goods may frequently be had in exchange for it.” Although unacknowledged, it is clear that Smith’s famed analogy owes – as with other things – a considerable debt to Cantillon , who in his An Essay on Economic Theory (1755/2010: 54) reflected how:

The price for taking a jug of water from the Seine River is nothing, because there is an immense supply, which does not dry up. However, in the streets of Paris, people give a sol [a low denomination silver coin] for it, which is the price, or measure, for the labor of the water carrier.

In extending this analogy, Cantillon (1755/2010: 54) was also the first to explore in a systematic fashion the factors that determined “the intrinsic value of a thing;” an exploration that reflected his realization that prices must ultimately reflect production costs rather than market factors, i.e., a good cannot be consistently sold below the cost of production. In Cantillon’s (1755/2010: 54) estimation, the “intrinsic” value or price for any given commodity is determined by “the quantity of land and of labor entering into its production, having regard to the fertility or productivity of the land, and to the quality of the labor.” Drawing a clear distinction for the first time between “intrinsic value” and “market” price , Cantillon (1755/2010: 55) noted that “it often happens” that goods “are not sold in the market” according to their “intrinsic” value due to variations in “the desires and moods of men.” Nevertheless, Cantillon (1755/2010: 55) suggested, “in well-ordered societies, the market prices … do not vary much from the intrinsic value.”

Having provided solid foundations for subsequent theorization through his differentiation of use and exchange value, and of “intrinsic” and “market” prices, Cantillon then proceeded to make a number of errors. First, Cantillon (1755/2010: 55) wrongly believed that, “There is never variation in the intrinsic value of things,” an estimation which, if true, would have ruled out the constant reduction in prices – and hence increased material wealth – that characterize modern market economies. Cantillon’s second critical error, which was the cause of the first, was to believe that all economic value is ultimately determined by landed output (i.e., farm produce and minerals). In explaining his reasoning, Cantillon (1755/2010: 56) argued that as labor was the only element that factored in the creation of value other than land, “and as those who work must subsist on the production of the land, it seems that some par value or ratio between labor and production of the land might be found.” As we noted in the introduction to this chapter, Cantillon (1755/2010: 62) calculated that the intrinsic value of a commodity was worth twice the value of the landed output consumed by the worker who made the object during the period of production, i.e., if I manufacture a chair over 2 days, then the chair is worth the landed output I consumed over 4 days.

Cantillon’s conflation of “value” and “landed” output reflected not only the overwhelmingly rural nature of the French society within which Cantillon operated but also the slow progress of industrialization in France vis-à-vis Britain, a hesitancy that was to stymie not only France’s economic advancement but also the intellectual, scientific, and technological ascendancy that France superficially appeared to have secured during the eighteenth century. In explaining France’s inability to match the pace of Britain’s industrial progress, Braudel (1986/1991) traces the root cause back to energy shortages. “The problem, not to say tragedy,” Braudel (1986/1991: 523) concluded, “was that there were not enough French coalmines, and those there were proved difficult and costly to operate. The mining areas were far away from the consumers.” Forced to rely on wood for heating and charcoal long after British consumers had switched to coal, France confronted immense difficulties when it sought to adopt steam-powered technologies. Consequently, when machinery was introduced into Paris’s cotton-spinning industry in the early 1800s, the factories were forced to rely on horses – not steam engines – for their motive power. As late as 1857, barely a third of France’s cotton mills were steam powered, most relying instead on age-old water-driven technologies (Braudel 1986/1991: 520–521).

If in Cantillon’s hands, the concept of value, by being linked to landed production, was trapped within a static formulation. Smith’s genius lays in creating from this a dynamic theory. To begin with, Smith (Book I, Chap. VII, para. 7) adopted Cantillon’s differentiation between “market” prices and intrinsic value , or what Smith referred to as “natural price,” which could “either be above, or below, or exactly the same” as its market price. In turning to the determining factors in a good’s “natural price,” however, Smith rejected Cantillon’s association of value with landed output, choosing (Smith Book II, Chap. VII, para. 3–7) sensibly decided to calculate a good’s “natural price” according to the monetary value of its cost; costs consolidated under three headings: rent, wages, and “stock” (fixed capital). When a good sold for an amount equal to these costs – what Smith (Book I, Chap. VII, para. 5) called its “prime cost” – Smith (Book I, Chap. VII, para. 4) concluded that it “then sold for what may be called its natural price.” As the disciplines of cost and management accounting emerged during the nineteenth century, Smith’s theorem laid the basis for what is referred to as the “costs attach” concept of value, i.e., the value of a good or service is the total sum of the costs expended in its creation. Significantly, Smith did not include the “profits” of the entrepreneur either as a “prime cost” or as an item in its “natural price,” merely counting instead a sum equal to the replacement cost of the “stock” consumed by the production process. Moreover, in exploring how the self-interested drive for profits underpinned the expansion of economic activity, Smith (1776: Book I, Chap. X, Part 1, para. 26) observed that the profit motive was typically driven as much by irrational greed as rational calculation, noting how, “The chance of gain is by every man more or less over-valued, and the chance of loss is by most men under-valued.” As a general rule, however, Smith (1776: Book I, Chap. X) associated the size of the profit obtained relative to the sum ventured to be dependent on two things: the degree of risk and the demand for the objects produced with the entrepreneur’s capital. The biggest profits and the larger losses were, Smith (1776: Book I, Chap. X, para. 44) calculated, invariably associated with newly created industries where demand and costs were poorly understood. Inherently speculative in the first instance, any profits above the norm – so Smith (1776: Book I, Chap. X, para. 44) argued – were soon curtailed as “competition reduces them to the level of other trades.”

Smith’s understanding of value, adapted as they were from Cantillon , has permeated not only economics but also almost all aspects of management and public policy. Where Cantillon (1755/2010: 55) in expressing the view that “There is never variation in the intrinsic value of things” reflected an essentially feudal view of wealth – where retaining value is all important – those who followed in Smith’s intellectual footsteps understood that increased societal wealth was associated with reductions in value, i.e., we can consume more objects as they become cheaper relative to our income. In comprehending the drivers of this simultaneous reduction in value and creation of wealth, it is critically important that we understand – as Smith evidently did – that we are not primarily talking about changes in “market” prices but rather falls in the “natural” prices of things. For whereas with regard to the former we are principally talking about short-term variations in price given current levels of production and demand, in relation to the latter we are paying regard to permanent falls in production prices due to improved technologies and/or systems of work. Among Smith’s intellectual heirs, this point was best made by Alfred Marshall (1920: 314–315), who drew a distinction between not only “market prices” and “normal prices” (what Smith called “natural prices”) but also “secular prices,” the latter being determined by long-term changes in knowledge and/or productive capacity, i.e., computer prices have fallen precipitously due to the revolutionizing of silicon memory chips.

Among political economists, only Marx has put forward a far-reaching counter to the understandings of value that Smith pioneered. In essence, Marx took Smith’s (1776: Book I, Chap. V, para. 17) formulation that labor is “the only accurate measure of value,” to an extreme if logical conclusion: economic value only comes from the “surplus value” created by manual workers in agriculture, mining, and, above all, manufacturing. As Marx (1867/1954: 313) explained in Capital, “The directing motive, the end and aim of capitalist production, is to extract the greatest amount of surplus-value.” For Marx, surplus value was the wealth created by a worker that exceeded the sum necessary for their bare family subsistence. To get around the contribution of machinery and other “stock,” Marx (1867/1954: 57) declared that all “fixed capital” was “congealed” labor. According to this formula, if a worker labored for a month for a subsistence wage of $400 to produce a good whose “relative” value (i.e., its value measured in terms of either money or some other comparative form) was $1000, but in that month the machinery the worker used cost $200 (in terms of wear and tear and consumables such as oil), then the “surplus value” extracted from the worker is $400. By so reducing everything to labor costs, Marx created a theoretical model that was of greater use as a political weapon against capitalism than as a framework for understanding how a business operated. For in Marx’s analysis, the key driver of capitalist expansion is the industrial working class, the proletariat: not the entrepreneur.

The fundamental problem with Marx’s critique is that it focuses on the problem of value creation, just as Cantillon’s model focused on the retention or permanence of value. What both frameworks willfully overlooked was that the key to capitalist production is – as noted above – the constant reduction in the value of the objects being produced. For what makes modern industrial capitalism such a revolutionary force is not the constant alteration in “market” prices but rather the continual declines in the underlying “natural” or “normal” price. As Schumpeter (1942/1975: 84) famously observed in his discussion of “creative destruction,” what is most revolutionary about capitalist production is its constant destruction of inefficient and outmoded producers. Accordingly, for existing producers, the most deadly form of competition is not textbook “market” competition, Schumpeter (1942/1975: 84) argued, but rather the competition that fundamentally alters the nature of production; competition “which strikes not at the margins of profits … but at their foundations.”

Society and Markets

Typically, discussion of classical economics revolves mainly – or even solely – around markets. As we noted in the introduction to this chapter, however, the foundational understandings of markets in classical economics rested on even more fundamental debates relating to the nature of value, the essential character of human nature, and the appropriate form for the “well-governed society” which Smith (1776: Book 1, Chap. I, para. 10) identified as a prerequisite for economic expansion.

Prior to Smith, it was universally believed that security rather than liberty was the essential precondition for material advancement. Thomas Hobbes (1651/2002: 66), for example, in drawing up principles for a “covenant” or “contract” between rulers and ruled, argued that “security” was the key societal factor in securing the advancement of both “industry” and “knowledge.” Whether this was achieved through an absolutist monarchy or a democracy was of no great interest to Hobbes as long as government had the capacity to enforce its will. For Hobbes (1651/2002: 85) concluded, “covenants without the sword are but words.” A generation later, John Locke (1689/1823: 159) similarly observed in his Two Treatises of Government, “The great and chief end … of men uniting into commonwealth, and putting themselves under government, is the preservation of their property;” property constantly threatened in nature by sentiments of “passion and revenge.” In France, Montesquieu, in his The Spirit of the Laws , also believed that a system of “civil laws” – enforced by state apparatuses – was a precondition for industry. For without such protections, Montesquieu (1748/1989: 290–292) concluded, people would be “very few” and constantly “prey to their enemies.” Voltaire (1756/1963: 246–247) similarly held to the opinion that without a “powerful” state guided by law – created through “favourable circumstances over many centuries” – humanity was condemned to a “brutish state,” scarcely able to “provide for their own needs.”

As we noted in the introduction to this chapter, the emphasis on a strong state, guided by “civil laws” that protected citizens from arbitrary actions – with by state officials or their fellow citizens – reflected a fundamentally pessimistic view of human nature. Where humanity is unprotected from its own vices through a system of “government,” Hobbes (1651/2002: 62) famously observed, life is inevitably “solitary, poor, nasty, brutish, and short.” The necessity for a strong state was, however, even shared by Jean-Jacques Rousseau (1762/1950: 1), who differed from most other Enlightenment thinkers in having a far more optimistic view of human nature and who memorably began his Social Contract with the statement that, “Man is born free, and he is everywhere in chains.” However, Rousseau (1762/1950: 18–19) believed that complete freedom can only exist in a “natural” world inhabited by noble “savages” and subject to nature’s laws. In exchanging this rustic life for civilized existence, Rousseau (1762/1950: 28–29) contended, all of society’s members must submit to the “absolute power” of the state’s “sovereign will.” Within such a civil society, Rousseau (1762/1950: 27) argued, any “partial society” of distinct interests must be avoided so as to avoid both discord and actions contrary to the “general will.”

Into this debate about the appropriate political and economic frameworks for commercial and industrial advancement, guided by near unanimity as to the benefit of regulation, David Hume’s (1739/1896) A Treatise on Human Nature represented a revolutionary departure. Whereas others perceived societal organization stemming from the need to impose restraints on human instincts and passions, Hume argued that it was primarily self-interest – not enforced laws – that acted as a society’s primary glue. For Hume (1739/1896: 273) reasoned, not only is it the case that humanity is mainly “govern’d by [self] interest,” it is also the case that the benefit of upholding a system of mutual social and economic exchange is “palpable and evident, even to the most rude and uncultivated of the human race.”

With Smith and The Wealth of Nations , Hume’s argument that self-interest was the main societal glue was transformed into the central explanation for economic exchange, an explanation that marginalized the proper role of the state in a “well-governed society.” What underpinned a “civilized society,” Smith (Book I, Chap. II, para. 2) argued, was not force but rather the fact that each individual “stands at all times in need of … co-operation and assistance.” In seeking the “cooperation” of their fellow, citizens Smith (Book I, Chap. II, para. 2) continued, “it is in vain for him to expect it from their benevolence only. He will be more likely to prevail if he can interest their self-love in his favour, and show them that it is for their own advantage.” In terms of economic functioning, it was this “self-love” that underpinned what Smith (Book I, Chap. II, para. 1) suggested was a natural “propensity of human nature,” namely, “the propensity to truck, barter, and exchange one thing for another.” In Smith’s view, this innate propensity had two key positive effects. First, it encouraged individuals and firms to specialize in those activities in which they had a competitive advantage, knowing that they could then exchange the product of their labor; an outcome that entrenched the specialized division of labor that was essential to economic efficiency. Second, Smith (Book I, Chap. V, para. 4) believed that it was through the propensity for exchange and the resultant “higgling and bargaining of the market” that an economy was able to determine what goods and services were required for production without state-mandated directions. As Smith (Book I, Chap. VII, para. 9) lucidly explained it, whenever “the quantity of any commodity … falls short of the effective demand,” so there occurs an increase in the “market price,” thereby bringing more supply into the market. Once this additional supply reaches the market, prices will then return to more or less their “natural” price as equilibrium is restored. Taken up with gusto by subsequent economic studies in the early nineteenth century, most notably by David Ricardo (1817/1969) and John Stuart Mill, belief in the efficacy of market competition became a cornerstone of classical economics, Mill (1848/2002: 795) recording in his Principles of Political Economy that “every restriction” of competition “is an evil, and every extension of it … is always an ultimate good.”

As readers would be aware, it is Smith’s conceptualizations regarding markets – rather than his ideas relating to value, price, labor specialization, human nature, and the nature of productive labor – that have had the most enduring legacy; a legacy that is, however, wrapped in myth and misunderstanding. Even such a noted authority as Alfred D. Chandler, Jr. (1977: 1), began his most influential study, The Visible Hand: The Managerial Revolution in American Business, by wrongly attributing to Smith the maxim that economic outcomes are best determined by “the invisible hand of market forces.” For while it is evident that Smith did believe that self-interested market exchanges provided the most efficient way of balancing supply and demand, it is also apparent that he well understood that the “invisible hand” of self-interest constantly impeded such exchanges. At every point, as Smith discussed repeatedly in The Wealth of Nations , people conspire to subvert market forces so as to secure private gain. Anyone who imagined, Smith observed (Book I, Chap. VIII, para. 13), “that masters rarely combine, is as ignorant of the world as of the subject. Masters are always and everywhere in a sort of tacit, but constant and uniform combination … We seldom, indeed, hear of this combination, because it is the usual, and one may say, the natural state of things.” Smith (Book I, Chap. X, Part II, para. 23) also observed how townsfolk, “being collected into one place” and able to “easily combine together,” conspired against country residents, charging them more for city manufacturers than what was conscionable. In addition, the “greater part of corporation laws,” Smith cynically reflected (Book I, Chap. X, Part II, para. 23), existed for the purpose of “restraining that free competition” which, if allowed, would contribute to a reduction in prices.

Although he did not reflect upon the matter, it is evident that the division of labor also hinders the “perfect liberty” of the market that Smith favored. As firms become increasingly capitalized, the entrance of new suppliers into any given market becomes an increasingly complex affair; an outcome that often leaves established market participants with an oligopolistic stranglehold. With the increasing size of markets and firms – and the commensurate growth in the complexity of financing arrangements, supply chains, and purchasing contracts – the simple market exchanges that Smith, Ricardo, and Mill regarded with favor also become increasingly problematic. As the Nobel prize-winning economist, Oliver Williamson (1976: 8–9), noted in outlining the principles of “transaction cost economics,” the uncertainties and opportunism of market exchanges create costs for a firm that are often higher than those that would have been suffered if they had been internalized. By internalizing market functions, firms can not only avoid price gouging by suppliers, they can also mitigate the effects of variations in seasonal supply. In a similar vein, Chandler (1977: 1) famously argued in his The Visible Hand – a work that redefined not only the discipline of business history but also our understandings of the historic role of the business corporation – that over time “the modern business enterprise” increasingly took over “functions hitherto carried out by the market,” most particularly those relating to distribution and the coordinated flow of goods and services. In Chandler’s (1977: 1) estimation, this historical change not only made “managers the most influential group of economic decision makers” in modern society, it also heralded the displacement of free-market capitalism by new forms of economic organization associated with what he called “managerial capitalism.”

The tendency over time for firms to displace free-market exchanges with intra-firm mechanisms is indicated in Fig. 1.1 which is based on a World Bank (2017: 61, SF2.1) analysis of US custom’s records since the global financial crisis of 2007–2008. In the period between 2010 and 2014, which was the period for which the World Bank had the most complete results, it was found that the rate of “intra-firm” imports grew 55.9 percent faster than that for what it referred to as “arm’s length” imports, i.e., conventional purchase and sale through market mechanisms. Even when it came to exports, the World Bank (2017: 61, SF2.1) found that the pace of “intra-firm” exchanges is growing significantly faster than that for direct market dealings; a result that appears to reflect growing concern at the disruptive effects of changes in currency movements and other forms of trade and financial volatility.

Fig. 1
figure 1

Percentage growth in US “intra-firm” and “arm’s length” trade, 2010–14 (Source: World Bank Group, Global Economic Prospects, June 2017, 61, Figure SF2.1)

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In increasingly complex markets, where supply for a particular good or service is often dominated by a small number of firms, the idea that increased prices must necessarily lead to increased supply, and hence a return to lower prices, also proved problematic. As Keynes (1931: 393) noted in his critique of Friedrich Hayek’s (1931) Prices and Production (which had defended the neoclassical belief in free markets), “a changing price-level merely redistributes purchasing power between those who are buying at the changed price-level and those who are selling.” In other words, decreased supply and a higher price tend to increase the power of the seller rather than the buyer. It is, moreover, to the seller’s benefit (if they have sufficient market control) to continue this situation, thereby recouping a higher return for the same costs of production, rather than in restoring price equilibrium through increased supply.

Chandler (1977: 1), in summing up the continuing role for markets in modern democratic societies, concluded that although the coordination of distribution and supply is increasingly done via intra-firm mechanism, it is nevertheless the case that the market remains “the generator of demand for goods and services.” While there is considerable truth in this proposition, it is also an overly simplistic enunciation as to the relationship between managerial functions and market mechanisms. For while most of us, when we think of demand and supply, think of the direct provision of consumer demand, there is invariably an intermediate step between supply and demand: investment. For without investment, there can be no assured future supply. In looking at the place of investment in the economy, however, we are not primarily looking toward current demand as to future demand. In other words, firms invest to the extent to which they see future demand as being beyond the scope of the currently available resources. Despite this future focus, it is nevertheless also evident that “investment” creates its own current demand, not only for material goods but also for services and labor. In other words, “demand” comprises not only “consumer” demand but also the various forms of demand created by investment. Demand is also not, as classical economists assumed it was, totally elastic, able to consume to the fullest the fruits of industry and commerce. Rather, in the case of consumer demand at least, it is ultimately constrained – even where personal financial credit is obtainable – by income.

Now the economic constraints imposed by a society’s deficient income have been long recognized. Arthur Young (1792/1909: 27), for example, in observing at first hand the condition of prerevolutionary France, concluded that the nation’s principal economic failing was the “poverty” of the ordinary citizen; a poverty that struck “at the roots of national prosperity” by constraining the demand for goods and services. For Young (1792/1909: 27) accurately reflected, “a large consumption among the poor” is “of more consequence than among the rich.” In classical economics, however, waged income is invariably counted as a business cost that is best reduced rather than as something that has a dual character: as both a business cost and a source of business demand and income. Accordingly, it is argued that any increase in wages must have a detrimental effect on profits and productive capacity. As David Ricardo (1817/1969: 76) expressed it in outlining his theory of a “wages fund” (i.e., the amount of money payable to wages at any given time is fixed and immutable and can only be temporarily increased at the expense of future economic capacity), higher wages “invariably affect the employers of labour by depriving them of their real profits.” The problem with this still widely held view is that it fails to provide a mechanism to escape either a deflationary wage-price spiral (i.e., a situation where falling wages have an adverse effect on overall consumer demand) or the entrenched poverty that Young described in prerevolutionary France. It was on this point – rather than on the basis of a general hostility to classical economics – that John Maynard Keynes parted company with Smith and his intellectual successors. In Keynes (1936/1973: 293) view, the key to escaping a deflationary wage-price spiral and/or an entrenched deficit in demand is to focus not on consumer demand but rather on investment demand. By increasing investment, Keynes (1936/1973: 293) argued, an economy is able to not only increase its long-term capacity, it can also provide an immediate stimulus to wages, business activity, and demand. Although in his The General Theory of Employment, Interest and Money Keynes made few references to the role of government, it is nevertheless clear that he saw public policy as best fulfilling a role where it provided incentives and mechanisms that brought about increased private-sector activity. As Keynes (1936/1973: 129) explained in a famed, if somewhat flippant example:

If the Treasury were to fill old bottles with bank-notes, bury them at suitable depths in disused coal-mines … and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again (the right to do so being obtained, of course, by the tendering for leases of the note-bearing territory), there need be not more unemployment and … the real income of the community, and its capital wealth also, would probably become a good deal greater.

If there are evident deficiencies in the understandings of classical economics in relation to the operation of modern markets, this should nevertheless blind us to its continuing utility when it comes to not only the overall relationship between supply and demand but also its insights into value, the efficient use of labor, and the motive forces behind economic growth. The continuing relevance of classical economics to all aspects of business and management is perhaps best indicated in the assessment that Keynes – arguably the most perceptive critic of the genre – made in his The General Theory of Employment, Interest and Money . Pausing to highlight the continued veracity of the key insights that Smith first elucidated, Keynes (1936/1973: 379–380) argued that by allowing “the play” of the economic factors that Smith highlighted – “self-interest,” “the exercise of personal choice,” and the resultant “decentralization of decisions” – a society was ensuring not only economic “efficiency” but also “individualism.” The lessons of the last 80 years provide confirmation of this assessment. For as the experiences of societies that have departed from the societal and economic model that both Smith and Keynes endorsed – a model built around choice, individual and business autonomy, critical inquiry, and innovation – mass tragedy has invariably ensued.

Whereas in the past the critics of classical economics, most particularly Marx and Keynes, were focused on the role of labor in the creation of value and on the importance of demand mechanisms in economic growth, the rise of postmodernism has been associated with critiques that challenge the very legitimacy of economics. With Michel Foucault (1976/1978: 7), the most influential of postmodern theorists, “the economic factor,” the idea that business endeavor and wealth creation are core social objectives, is dismissed in favor of new “discourses,” the initiation of challenges against power wherever it exists, the “overturning of global laws,” and “the proclamation of a new day to come.” Far from being a liberating force, modernity is depicted as entailing “new methods of power” and oppression, “methods that are employed on all levels and in forms that go beyond the state and its apparatus (Foucault 1976/1978: 89). Mere “obedience” is no longer enough. Instead, Foucault (1976/1978: 89) argued, a “normalization” of accepted values and power structures is demanded. In the work of the late Hayden White (1973: 1–2), arguably the most influential Foucauldian postmodernist in the English-speaking world, “the presumed superiority of modern, industrial society” is also dismissed as nothing but “a specifically Western prejudice.” As we noted in the introduction to this chapter, hostility to economics is now endemic in business-school academia. In a much-cited article announcing the so-called historic turn in organizational studies, Clark and Rowlinson (2004: 337), for example, dismissed economic “models” as mere products of “a hierarchical set of fixed preferences.” Postmodernists also announce hostility to the traditions of scientific inquiry upon which not only economics but Western intellectual endeavor in general has been built. Writing in Business History, Decker, Kipping, and Whadhwani (2015: 30–40) – where the former is co-editor – declare rejection of “the dominant science paradigm and its hypothesis-testing methodology.” Elsewhere we are told by Novecivic, Jones, and Carraher (2015: 13) that management cannot be understood on the basis of “positivist factual truth-claims.”

The postmodernist hostility to economic inquiry means that its critiques rarely if ever engage with those debates that were long central to Marxist and Social-Democratic intellectual traditions; traditions that asked a number of the same questions posed by Adam Smith and his successors, albeit in ways that led to different questions. In seeking answer to questions relating to the nature of economic value, for example, Marxists and Social-Democrats typically placed greater emphasis on the contribution of labor than capital. Similarly, in seeking answers to questions relating to productivity and wealth creation, Marxists and Social-Democrats tended to place greater emphasis on education and training than those schooled in the traditions of Adam Smith. What all shared, however, was that the worlds of work and wealth creation were not marginal issues for a society. Rather, they are the seminal concerns. As the global economy emerges from the Coivid-19 pandemic and its aftermath, it will be a global tragedy with devastating consequences if such issues are not once more given a central place.

Conclusion

It is unfortunate truth that even among management scholars and practitioners, a knowledge of the economic debates that have been seminal to humanity’s progress over the last 250 years is becoming increasingly uncommon. One often hears people talk of Smith’s “invisible hand of the market,” even though Smith never used the term. When listening to exponents and opponents of “classical,” “neoclassical,” and “neoliberalism” talk about economics, we also find they are invariable referring to the veracity of “market” principles. Yet, as we have discussed, classical economics was always concerned with far more than markets. The nature of value, the components that contribute to its creation, the efficient organization and use of labor, and the calculation of profit were all central to its inquiries. Everyone who has followed in the footsteps of this intellectual tradition, including critics such as Karl Marx and John Maynard Keynes, has drawn on these conceptual tools to frame their thinking.

Typically, most researchers trace the foundations of classical economics back to Smith and The Wealth of Nations . As this chapter has indicated, such a course can only be undertaken with many caveats. For in estimating Smith’s contribution to economics, as we have previously noted, Murray Rothbard (2006: 435) declares him to be “a shameless plagiarist, acknowledging little or nothing and stealing large chunks, for example, from Cantillon … he originated nothing that was true.” Certainly there is some truth to this point. Smith’s understandings of “self-interest,” which he saw as “an invisible hand” that guided human endeavor, were obtained from Hume. Smith’s understandings of value were drawn in large part from Cantillon. Even the example he used in outlining the nature of “use value” (i.e., water) was an unacknowledged paraphrasing of Cantillon . The fact that Smith was as much a synthesizer of other people’s ideas as an original exponent of his own concepts should not, however, cause us to devalue either his ideas or the foundational concepts of classical economics. What was particularly revolutionary about Smith’s ideas was his linking of individual market choice, value, production, and the efficient use of labor through specialization and competitive advantage. Whereas Cantillon (1755/2010: 55), who believed that all value and wealth ultimately stemmed from the land, and perceived “intrinsic value” (i.e., the real economic value or worth of a commodity) as something that never varied, Smith demonstrated that wealth is created by reducing the value of things; an outcome that reflects the effects of machinery and specialization in causing objects to be produced with ever less labor. Accordingly, the foundational concepts of classical economists – by pointing to efficiencies in production as well as to the utility of market exchanges – proved no less revolutionary than the steam engine in underpinning material advancement. As such, they also remain central to our times.

Cross-References