The assumption that Adam Smith accepted inequality as the necessary trade-off for a more prosperous economy is wrong, writes Deborah Boucoyannis. In reality, Smith’s system precluded steep inequalities not out of a normative concern with equality but by virtue of the design that aimed to maximise the wealth of nations. Much like many progressive critics of current inequality, Smith targets rentier practices by the rich and powerful as distorting economic outcomes.
Inequality is widely accepted as inevitable today, with disagreement confined to the desirability of redistributive action, its extent, and the role of government in the process. It is taken for granted even by the most progressive (and contentious) calls for high taxation on the top income earners, which aim to mitigate its effects.
But why has inequality been naturalized? This is where influential master-narratives of the market are so consequential in shaping public beliefs—from the 1970s anti-tax narratives that frame government intervention as a violation of free market principles to the original text that defined market discourse, the Wealth of Nations itself. Adam Smith is assumed even by his most progressive interpreters to have accepted inequality as the necessary trade-off for a more prosperous economy. This is, in fact, the default assumption.
But the assumption is wrong. As I show in my article, the building blocks of Smith’s economic system do not allow the concentration of wealth—not due to normative constraints, but to how the blocks are set up in his theory to maximize the “wealth of nations.” Further, even in neo-classical economics, in a competitive economy with no entry barriers, profits should decline over the long term, so profit concentration is not an equilibrium prediction. Yet high firm profits, for instance, are treated as a sign of economic success that have to be sustained over time. These tensions have never been conclusively settled in economics.
Only recently have we seen a powerful position staked out on the need to avoid such inequalities from arising in the first place, and to implement “market reforms that encourage a more equal distribution of economic power and rewards even before government collects taxes or pays out benefits.” This is the idea of “pre-distribution,” advanced by the American political scientist Jacob Hacker and incorporated in the new Labour agenda for policy. It remains a programmatic position, however, a prescription of how the market should be structured to ensure more equal outcomes. It could thus easily be identified as purely a normative position with an egalitarian goal—two elements, however, that non-progressives will reflexively reject.
The important point about Smith’s system, on the other hand, is that it precluded steep inequalities not out of a normative concern with equality but by virtue of the design that aimed to maximize wealth. Once we put the building blocks of his system together, concentration of wealth simply cannot emerge. In Smith, profits should be low and labor wages high, legislation in favor of the worker is “always just and equitable,” land should be distributed widely and evenly, inheritance laws should partition fortunes, taxation can be high if it is equitable, and the science of the legislator is necessary to thwart rentiers and manipulators. Political theorists and economists have highlighted some of these points, but the counterfactual “what would the distribution of wealth be if all the building blocks were ever in place?” has not been posed. Doing so encourages us to question why steep inequality is accepted as a fact, instead of a pathology that the market economy was not supposed to generate in the first place.
The key principles of Smith’s system work against the concentration of wealth—they also speak to the top issues in economic policy today: profits, taxes, and the minimum wage. First, Smith thought high profits denoted economic pathology. The rate of profit, he said, was “always highest in the countries which are going fastest to ruin.” The record-breaking corporate profits during the current crisis would not have surprised him. This pathology was not simply a symptom of mercantilism, but resulted from the incentives on the economic groups living by profit alone.
Unlike Ricardo, Smith believed the interests of profit-seekers were structurally and thus permanently “directly opposite to that of the great body of the people,” because “the rate of profit does not, like rent and wages, rise with the prosperity, and fall with the declension of the society. On the contrary, it is naturally low in rich, and high in poor countries” (with a few exceptions, especially new economies). Accordingly, when the economy is sound, wealth concentration should not occur. Only when profit-seekers have rigged the system through legislation do concentrations occur. Throughout, as I show, Smith states his expectation that fortunes would, indeed, not be high and that in any case they were prone to dissipation. Such a system cannot generate steep inequality.
Wages, at the same time, should rise with increased wealth. On this basis, Smith defends adequate labor wages, which had to be at least sufficient to provide the “necessaries,” covering lodging, food and clothes, the latter tailored to middle-class comforts. This baseline appears minimal, yet it provides for more than is covered by the contemporary minimum wage. In fact, a crude calculation suggests that Smith’s principles would set the wage floor at about $25,000, more than double its current level. Moreover, high wage levels should occur naturally. Wages are only lowered artificially, through state intervention, because of the sophistry of merchants and manufacturers who are much more adroit in manipulating legislatures to pass laws in their favor. Moreover, employers enjoy a bargaining advantage over workers and can coerce them to accept worse terms, because they need individual workers less than individual workers need employment. It is no surprise Marx was an admirer. Wages are not the simple product of supply and demand in Smith; bargaining asymmetries are key.
Taxation is perhaps the most contentious topic today, with prescriptions of punitive levels as the main instrument applied to reverse inequality. As such, it is seen as a distorting intervention in the market and a departure from “free market” principles. Smith did not prescribe punitive taxation, but what is missed is that he praised the British tax system though it imposed double per capita taxes than the French. Yet, “The people of France…are much more oppressed by taxes than the people of Great Britain.” Why? Because taxes were less equitably distributed, falling disproportionately on the poor.
A fair distribution of taxation was key to the soundness of the English economy in Smith. The rich, he claimed, should be taxed “something more than in proportion” to their wealth. “The inequality of the worst kind” was when taxes must “fall much heavier upon the poor than upon the rich.” The reasons were not moral. Bad taxes were simply bad economics.
Taxes on necessaries, first of all, afflicted hardship on the poor, but burdened far more the misguided employer who demanded them, as he would inevitably have to raise wages for workers to afford those staples. Taxing luxuries, by contrast, did no harm and it was an added bonus that it fell “heaviest on the rich.” Carriages, for instance, should not be taxed by weight, as this burdened the poor carrying bulk goods more than the rich transporting light luxury goods. In this way, “the indolence and vanity of the rich is made to contribute in a very easy manner to the relief of the poor, by rendering cheaper the transportation of heavy goods.” Trade thus prospered.
Smith’s overarching point was this: taxes were bad only when they undermined the productive use of capital. But taxation should be used to discourage unproductive economic activities. Landlords, for instance, charged tenants large fines for lease renewals, rather than raise the monthly rent. This is usually “the expedient of a spend-thrift, who for a sum of ready money sells a future revenue of much greater value.” It is “hurtful to the landlord,” frequently to the tenant, but always to the community. So it should be taxed at a higher rate. A tax upon house–rents would also “in general fall heaviest upon the rich,” a welcome outcome, since rent was an unproductive expense; when high, it was simply a luxury. And when Smith advocated against a tax, it was for pragmatic reasons, as with taxing capital: capital holdings could never be verified and could always flee the country, so taxing them was counter-productive. But ground-rents should be taxable, as “Nothing can be more reasonable than that a fund which owes its existence to the good government of the state” should be taxed more than in proportion to its benefit.
So who was to blame for bad taxes and bad policies? Smith reveled in showing how “those who live by profit,” namely the merchants and manufacturers, the dealers and bankers, habitually mislead the public, often by imposing higher taxes on the workers—foolishly not realizing that ultimately they would bear the real cost. They were also responsible for convincing gullible parliaments that high wages were bad. Legislators should always beware of the sophistries of employers, who, for instance, blame rising wages, yet “say nothing concerning the bad effects of high profits. They are silent with regard to the pernicious effects of their own gains. They complain only of those of other people.”
Much like many progressive critics of current inequality, like Stiglitz, Krugman, Hacker and Pierson and others, Smith targets rentier practices by the rich and powerful as distorting economic outcomes. And although he strongly criticizes some regulation, I show that it is regulation favoring the rich and powerful that he attacks. The concern with the welfare of the laboring poor is palpable throughout the book. As is the awareness of “the insolent outrage of furious and disappointed monopolists” that endangers anyone willing to thwart them. Progressive concerns are therefore neither a departure nor a distortion of the original classical liberal vision and nor is the latter conservative: in fact, Smith encourages us to ask even more forcefully why inequality is accepted as inevitable, not out of concern with equality, but to secure the economic growth of nations, not just groups.
Note: This article gives the views of the author, and not the position of the British Politics and Policy blog, nor of the London School of Economics. Please read our comments policy before posting.
About the Author
Deborah Boucoyannis is Assistant Professor at the Woodrow Wilson Department of Politics at the University of Virginia. Previously she was Lecturer in Social Studies and Olin Predoctoral Fellow at Harvard University. Her PhD is from the University of Chicago. Her interests lie in the historical and theoretical foundations of liberalism. Her personal site is http://dboucoyannis.weebly.com/
Adam Smith on Division of Labor:
“Division of labour has caused a greater increase in production than any other factor. ”
Division of Labor Promotes Skilled Labor. And Skilled Labor is more Productive. This Productivity brings better quality outomes and hence better realization of wages for the Labor.
Division of Labor directly promoted equality. Unless, corrupt practices creates barriers, that does not allow this productivity to fetch fair wages to the skilled labor.
Thank you for this great article. When one actually takes the time to read the works of Adam Smith, one finds that he has indeed been widely misinterpreted and misrepresented.
Thomas Jefferson, one of the founding fathers of the USA, was an admirer of Adam Smith, and research and writings such as yours show why. Smith’s works are still quite relevant today. Smith referred to powerful corporations (then known as joint stock companies) as “unaccountable sovereigns” that were as dangerous to a healthy economy as tyrannical governments. And I think he would probably be dismayed at some of the uses his work has been put to. Another misinterpretation is of the “invisible hand” which Gavin Kennedy, Emeritus Professor, Heriot-Watt University, has written about on his blog Adam Smith’s Lost Legacy.
Thank you again.
It is a great mistake to think that wealth is unlimited. It is not. If wealth were unlimited there would be no poverty. Because wealth IS limited that is why excessively wealthy people should be taxed accordingly as a means to put their excess wealth back into circulation so those who need it can obtain it and spend it into circulation which then creates a healthy economy and society.
The author ought to have come to grips of Adams fundamental idea of law of value measured by labor time imbedded in commodity and the components of such value and appropriated by the each owner of factor of production of such value resulting out of social division of labor.
The taxes to state is its legitimate share for providing the necessary infrastructure such as law and order and legal system and and defence of its people etc for production and realisation of value imbedded in commodities .This function of state is to be separated from public policy issues such as maintaining a fair and equitable free market competitive mechanism in private and public contracting field by helping the people who fall behind competition due to technological advancements for the time being and old aged as well people suffering from disabilities including children and by suppression of fraud coersion and misrepresentations aganist public or to create monopoly or oligopoly or similar situation only as illustrative.
These functions of public policy including taxation and state help to disabled are as old as origin of state and society except in for and degree.
Therefore any intervention of state in social and economic life to confined to act as catalyst to private and public free competitive economy which will not allow the cancerous growth of greater chronic inequality. Inequality is an index of anti free capitalism and needs introspection for plugging the loopholes.
I think you too-readily discount Smith’s moral case for growth, but I’ll address a problem with your technical analysis:
“Further, even in neo-classical economics, in a competitive economy with no entry barriers, profits should decline over the long term, so profit concentration is not an equilibrium prediction.”
Profits *on the margin* should decline. This does not mean that a great deal of wealth won’t concentrate; it means that the rate of return on capital – on the margin – falls relative to the returns on labor. Look at Smith’s comments on the high wages in the American colonies – they’re due to the relative scarcity of labor.
When you say that the building blocks of Smith’s economic system preclude the concentration of wealth you’ve mistaken aggregate for marginal profits.
(If you don’t think Smith was thinking on the margin, see his Water/Diamond paradox, his discussion of the natural price which describes costs curves and long-run minimum prices needed to sustain production, and the ability of high profits to attract producers to an industry – which diminishes the marginal profit.)
Is everyone here missing the obvious? David Venhuizen said above “Exactly because workers lack power to ‘artificially’ raise wages.” I suppose whether that is true depends on what he means by “artificially”.
I’ve just checked and Adam Smith wrote “Wealth of Nations” in 1776 and died in 1790. Early trade unions (“labor unions” for those in the USA) didn’t really get off the ground until the following century, so you can’t blame Smith for being wrong, but he was. The ability of workers to go on strike, and even potentially bring down a government via a general strike movement, does indeed give them power to raise wages.
If companies have happy healthy workers, that may help them maximise their profits, but there are plenty of places in the world today where cheap goods are made by workers who are far from happy or healthy. From the point of view of capitalists generally, they need people to buy goods in the shops, spend on entertainment and go on foreign holidays – so driving wages down to subsistence levels (which is to some extent what the current ConDem coalition government in Britain have done with their austerity agenda) doesn’t make sense. No wonder capitalism leads to crises.
Most of the people revered by neoliberals said few if any of the things with which the greedy credit them – not even Friedman.
But it remains crucially important to define this ethereal term ‘equality’. To my mind, everything hinges on equality before the law, and it is the lack of that in the ‘democratic’ West that we should focus on. Without a rule of law that is blind to status, all civilisation collapses.
Merchants are interested in artificially lowering wages…but workers have absolutely no interest in artificially raising wages? Maybe you should have set your liberal bias aside before you read the Wealth of Nations. Then, perhaps, we wouldn’t have been subjected to your “absurd prescriptions”.
Workers have plenty of *interest* in raising wages, but they lack the *power* to do it. From the article:
So factories left what is now the Rust Belt because workers had no *power* to artificially raise wages?
ABSOLUTELY! They left for places where lower wages could be imposed on the workers there. Exactly because workers lack power to “artificially” raise wages. Would be interesting to know if you have a point to make here. Thanks.
I made my point. And my point was painfully obvious. Yet here you are wondering what my point is. How can I make my point obvious enough for even you to understand? Can I accomplish the impossible? Only one way to find out.
We both want people to have better options. Every person’s gravestone should be able to say, “I was as happy as a kid in a candy store”. Life should be full of options that perfectly match your preferences…aka heaven.
In order to create heaven on earth…you have to understand where better options come from. The owner of a candy store doesn’t just *snap* his fingers and better candies magically appear. He doesn’t just go pick better candies from a candy tree. There’s a distinct and logical process that occurs.
The key to this process is consumer choice. If kids can’t choose which candies match their preferences… then candy producers won’t know what the preferences of kids’ are. If producers don’t know what the preferences of kids are…then candies won’t match kids’ preferences. So in the absence of consumer choice, kids would be sad in candy stores because the options really wouldn’t match their preferences. Life would be less like heaven and more like hell.
Right now you’re so far in left field that you don’t realize that the point of production really isn’t to ensure that workers in candy factories are happy oompa loompas. The objective really isn’t to make oompa loompas happier…it’s to make kids happier.
Maybe you want to argue that you can make kids happier by making oompa loompas happier? If so…then why bother trying to convince Wonka that he’s making a mistake by not paying his oompa loompas enough money? If somebody refuses to pick up a gold nugget…are you going to stand there and argue with them? If you’re so certain that it’s not fool’s gold then you should have no problem making the effort to pick it up yourself.
If it’s truly gold…then picking it up would not only give kids a better option…it would also give workers a better option. How awesome is that? You can become wealthy by giving people better options. Of course, if it’s not truly gold…then picking it up would be very costly. Maybe you used your home as collateral for your business loan? If so, then you’d lose your home. As a knocker (liberal) you’re not willing to take that risk. So when the earth takes any steps closer to heaven…it’s not because of knockers…it’s despite them.
Okay, Epiphyte. You seem to have made a point you understand. I’m sure it’s in there somewhere. Rave on …
Can’t wait for your book!
I don’t really buy this argument. Smith clearly stated in his “Wealth of Nations” that we owe our well-being (dinner) not to the benevolence of the baker, butcher and brewer but to their self-interest but self-interest can’t be expressed without demand for which benevolence is clearly needed to provide equitable balance in the distribution of proceeds from business enterprise.
This is the quote to which you refer: “But man has almost constant occasion for the help of his brethren, and 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 to do for him what he requires of them. . . We address ourselves, not to their humanity, but to their self-love, and never talk to them of our own necessities, but of their advantages.”
And this is the quote from “How to Win Friends and Influence People”, by Dale Carnegie.
“Why talk about what we want? That is childish. Absurd. Of course, you are interested in what you want. You are eternally interested in it. But no one else is. The rest of us are just like you: we are interested in what we want.”
“IN A NUTSHELL FUNDAMENTAL TECHNIQUES IN HANDLING PEOPLE: Arouse in the other person an eager want”
The quote to which you refer is clearly and obviously Adam Smith talking about the art of persuasion.
This analysis is absolutely legendary. Thank you for your wonderful work in opening our eyes to Adam Smith’s views on inequality. I find it amazing how so many economists say growing inequality has no adverse effect or even a positive effect on growth.
Smith wrote in the Theory of Moral Sentiments (1759) the following:
“The produce of the soil maintains at all times nearly that number of inhabitants which it is capable of maintaining.
The rich only select from the heap what is most precious and agreeable. They consume little more than the poor, and in spite of their natural selfishness and rapacity, though they mean only their own conveniency, though the sole end which they propose from the labours of all the thousands whom they employ, be the gratification of their own vain and insatiable desires, they divide with the poor the produce of all their improvements.
They are led by an invisible hand to make nearly the same distribution of the necessaries of life, which would have been made, had the earth been divided into equal portions among all its inhabitants, and thus without intending it, without knowing it, advance the interest of society, and afford means to the multiplication of the species.”
My contention is that if we studied the totality of Smith’s thinking we’d see a new path to an economic framework that places Natural Capital on the balance sheet and thus would effect cash flow by design. The real “reserve currency” in our economic models should be the natural resources that provide the building blocks for all life forms. And, afford the means to the multiplication of the species.
Nils-Michael, this I believe is the only place Smith used the term ‘invisible hand’. And it is clear that he depended on the innate goodness of men (people) to do for all. This book then formed as we know the basis for the Wealth of Nations. Thee again he uses the ‘invisible hand’ only once and in the same way. Corporate greed has usurped it and twisted its meaning.