Saturday, January 4, 2014

Labor is wealth - Adam Smith

"Labour, it must always be remembered, and not any particular commodity, or set of commodities, is the real measure of the value both of silver and of all other commodities." and "The real price of every thing, what every thing really costs to the man who wants to acquire it, is the toil and trouble of acquiring it. What every thing is really worth to the man who has acquired it and who wants to dispose of it, or exchange it for something else, is the toil and trouble which it can save to himself, and which it can impose upon other people." Adam Smith, Wealth of Nations [1]

I've been reading Adam Smith lately because so much of the school of economics which is popular these days is based in large part on his work.  I also suspect that many who preach the gospel of Adam Smith have actually never read his work.  So, I'm going to produce a series of posts based on this work, with this being the first.

Smith says a great many things.  Some of which are a bit disturbing to modern sensibilities, such as his appraisal of the laboring class (of which he is clearly not a member) as a flexible commodity which expands and contracts as circumstances allow.  His comments may be on the mark, but the deafness to the state of the human condition is quite marked in his writings.

The topic today is wealth and labor, and in Smith's quotes above is where I think that he really get's it right, that all wealth is ultimately expressed as its cost in labor.  So, let's look at these in detail.

"The real price of every thing,..., is the toil and trouble of acquiring it".  That is getting something takes some effort or labor.  Labor takes time and effort, if even a small amount that may not seem worth tracking.  Any thing put into your hands for your use took some amount of labor to get it there.  Take for example a wood chair produced by a carpenter.  The carpenter needs to sit, so he needs a chair.  This chair will not just appear out of thin air and into his house by simply wishing for it.  The carpenter must do some labor on some wood with his tools to produce the chair.  That is, the carpenter gives up some amount of his time and associated effort to get that chair.  The time spent working on the chair is lost forever to be used for some other purpose.  The chance to do something else, or nothing at all, is gone by making the chair.  But, without this labor, there simply is no chair, no matter how much he wants one.  Thus "the real price" of the chair was the labor that the carpenter put in to produce it.  Even if you lived in the Garden of Eden with Apple trees everywhere, acquiring that apple to eat took some labor.  You had to get up, walk to the tree, reach up, and pick the Apple.   That was "the real price" of the Apple.

Once the carpenter has a chair, perhaps he makes another, because he knows others want to sit as well, with the intention of trading it for some other good.  Perhaps he wants a wood table to go with his chair.  Perhaps he could make the table but prefers to make chairs as he is talented at it.  Maybe he can get one table in exchange for one chair, but if he made the table himself it would take the time he would use to make two chairs.  Thus what the table "is really worth" to the carpenter is "the toil and trouble which it can save to himself" by making a chair in half the time of making a table, and "which it can impose upon other people" by having another make the table and exchange it for the chair.  In this case making the chair is worth it to the carpenter to trade for the table because he saved his labor that way.  The table "is really worth" one chair to the carpenter.  But if no trade for a table could be made, then the carpenter would have to decide if making the table is worth the labor, or if he would rather go without, as the table "is really worth" two chairs in this case.  In the other extreme where making a table only takes half the time as making a chair, then clearly the carpenter should make the table himself, as the table "is really worth" only half a chair.

Contrast this insight of Adam Smith with those on Wall St. who claim that they can create wealth without labor, simply by financial machinations.  For instance, David Einhorn of Greenlight Capital proposed some financial modifications to Apple computer corp's financial operations to "unlock hundreds of billions of dollars of latent shareholder value".[2]  As if this value didn't already exist and he, by this action, would create it.  Not everyone has fallen for this trickery.  For instance, Aswath Damodaran of Columbia University said "There will be NO value created..none". [3]  No new goods would be created, either now or in the future, by the proposed change.  No more iPads or iPhones would be produced.  No more iMacs or apps would be created.  The only change would be shifting of financial resources from one place to another.

Adam Smith similarly notes that money, that which holds value for transactions, does not in and of itself contribute any value to an economy, rather it forms the means of transaction of goods in an economy.  " money, by means of which the whole revenue of the society is regularly distributed among all its different members, makes itself no part of that revenue. The great wheel of circulation is altogether different from the goods which are circulated by means of it. The revenue of the society consists altogether in those goods, and not in the wheel which circulates them. In computing either the gross or the neat revenue of any society, we must always, from the whole annual circulation of money and goods, deduct the whole value of the money, of which not a single farthing can ever make any part of either."  In other words, financial mechanisms only are useful in transferring real value, but no amount of financial machinations can ever create value.  No one values money, or any financial asset or security, for itself.  Rather we value these things for the goods (and services) which they can purchase.  Behind every money or financial asset must be some good (or service) of real value that backs it up.  In Adam Smith's writings, money is the physical precious metals or coins made from these.  The idea of fiat money is not in Wealth of Nations (at least not as far as I've read so far ;).  But the idea that all real value is composed of goods (and services) and that the cost of labor of creating these is "the real price" of all is firmly established therein.

I am continually amazed that the financial wizards who conger up exotic financial instruments like derivative securities, and the idea of valuing them through complex models, nonetheless revere Adam Smith as one of the founder's of the popular school of economics which they so vociferously uphold.  Would Smith approve of these modern day financial machinations?  Although it is impossible to know for sure, his writings seem to suggest that he would be most mortified by their existence, and amused by the gullibility of the public and it servants in accepting these as legitimate financial mechanisms.