Adam Smith and David Ricardo compared

Adam Smith & David Ricardo - Political Economy

To compare two persons who began and closed the theories of what was then called 'political economy' and the classical school of Economics necessitates the comparison of their intellectual and general lives. It also involves the comparison of the environment and the intellectual climate of the times that influenced Adam Smith, the 'father of economics'; and Ricardo who contributed most of the theories in the classical economics along with Mill and Malthus. They were not contemporaries and the comparison between them could be only on the principles which were common and which they agreed to and disagreed in. Smith was a philosopher and jurist who studied the economy of his times. His first popular work 'The theory of moral sentiments' was influenced by the Greek and Roman philosophers, and it is regarded with equal reverence and is the significant work 'An inquiry into the nature and causes of the wealth of nations'. David Ricardo on the other hand came into the scene almost half a century later, and was a down to earth banker who postulated theories on pure economic issues. Thus to compare the economists we have to see in detail their biography and what they achieved in their times.

Adam Smith: In Brief the theory of moral sentiments was published in 1759 and then came the 'wealth of nations'. During the later half of 1776 the new country across the seas was being formed. The colonies were clamoring for freedom and there was civil war. A new country was about to be born in the Americas. Hume, an ardent admirer of smith urged him to return from the continent to London stating that it was apt time for him to be involved in the affairs of state. (Hirst, 1904)

The independence of America, and the 'wealth of nations' publication brought the principles of laissez faire and the seeds of capitalism were tailor economic principles for the new nation. Although Smith did not realize it at that time and was personally pained at the struggle in the colonies, his work was to set the ground for the American way of life some time later. We may thus call Smith the founder of modern capitalism, although in his time it was not explicitly known so. Perhaps being a professor of philosophy at Glasgow and the research into that subject was dearer to him. The theory of moral sentiments created a source of new ethics which was the basis of the ideas that matured into his writings on the economy. The theory of economic progress and the division of labor advanced in the 'wealth of nations' found many adherents and admirers and the earlier works of Smith were obscured by the enthusiasm created by that book. Smith was a positivist and a realist who believed that nothing happens by itself which is the basis of the idea of 'self-interest' and the 'unseen hand that guide us to the common good' the self-interest he argues brings about the advancement to society. Although this portion of the philosophy forms the foundations of the 'wealth of nations' it is a sentiment culled from his earlier statements and works. (Vivenza, 2001)

The famous and oft quoted line "it is not from the benevolence of the baker, the brewer and the butcher that we expect our dinner, but from their self-interest. We therefore appeal, not to their humanity, but to the interest in their own selves" from the 'wealth of nations' forms the underlying sentiment of all his works in philosophy and jurisprudence. (Ross, 1995) Smith professed a connection with the human nature with regard to the theory of 'moral sentiments'. Hume had alluded to his passions in this regard in the Treatise of Human Nature. Further the theory of 'moral sentiments' as also the 'wealth of nations' had been received well among the circle of his friends. Hume even wanted that the Wealth of Nations be published at London and Smith reciprocated by making Hume his literary executor. The wealth of nation's publication was in coincidence with the birth of America. The independence of America and the subsequent search for an economic basis of running a new country made the Wealth of nations and the Laissez faire policy the basis. However the lectures of Smith at the time gave scant importance to the new nation and took it to be an economy of slaves. (Ross, 1995)

Influences on Adam Smith

Smiths travels to France and the contacts with the thinkers of the times, especially the school that called itself the Physiocrats, the chief of which was Francis Quesnay, and the English thinkers of the times, called the Mercantilists largely influenced his thoughts on the 'political economy' studies. In fact it was Smiths efforts that created a separate branch of human knowledge called economics which was organized in the scientific fashion as we know it today. The physiocrats in France were a scholastic unit that was disciplined in to a modern type of thinking by Quesnay and we can say that some of the ideas of the French rubbed off on Smith. On the other hand, the thinkers who were grouped into the school of thought called 'mercantilism' were independent thinkers in England and the continent who contributed various doctrines and theories on economic affairs spanning three centuries before Smith. The theories had common threads but lacked the tools or the method of their verification because there was not the system of scientific thought taking shape yet. Some of the contributors had identical views and thoughts on the economy and its allied science, the administration of the country or polity. These identical concepts were grouped together and called 'mercantilism.' How much of the Mercantilist theories influenced Smith can only be conjectured, but from the documents we can say that the Physiocrats and their system of thinking influenced him a lot. (Blaug, 1962)

The principles and optimism of Adam Smith

The most important concept and the fundamental theory that advocated a control free economy where the market forces with the competition as the 'invisible hand' will lead the economy and result in a fair pricing of goods services and labor is central to the theory of Smith. Therefore Smith opposed the interference of the government into the economic arena, and the laws like wage laws, restrictions on trade and government regulations were seen as the factors that restricted the growth of the nation's wealth. This laissez-faire policy of government which he advocated was popular in the century that followed and plays the most vital role in the economy of the capitalist countries of today. However it is not that evil did not result from the total absence of government control. The child labor, poor wages and the working hours of labor that was exploited in the name of capitalism by the class of investors whom Marx was fond of terming as the 'capitalists' and the bourgeois cited the golden rule in support of their activities. (Dhamee, 1996a)

The attempts of using the theories to evil and questionable ends continued even to the end of the twenty first century. Smith was not a proponent of Capitalism as practiced and nor was a supporter of the monopolies. In fact Smith was of the opinion that there must be anti-monopoly laws. As the markets grew, Smith believed, there will be an increased demand for labor which will operate on achieving equilibrium at a higher wage rate and consequently benefit the working class. The reality with the changes in production and the increase in population upsetting the theory of labor was thus a paradox that was later found by scholars like Ricardo and Malthus who eventually predicted population growth will create a surplus and thus poor wages with starvation will be the result of such a society without government interference came to be a reality in the last centuries and the Victorian era. Thus the science of Economics which began with Smith's optimism soon became a dismal science during the period of Ricardo. (Dhamee, 1996a)

The Seeds of Capitalism

Strangely the idea of the capitalist enterprise seems to have sprung from the consideration of labor, and the division of labor that resulted in a faster and cheaper production resulting in a perfect competition. In Smiths market the use of the skill and the dexterity of the workman resulted in specialization and the demand for the specialization which sets off the chain of production and prosperity. Though it was some what utopian and the claim was vociferously disputed by later economists especially Karl Marx, we can say that labor remains the primary source of economic progress and the division of labor and the market forces that governed wages and the functioning of the economy was the major consideration in the Smiths system of economy and also was the major head of contention for Malthus, Marx and David Ricardo. Therefore it is apt to view the development of the ideas of Smith from the view point of labor and see the progress of the wealth of nations through the steps as we see it in the book by that title. (Smith, 1904)

Smith on Labor

The importance of the labor skills and the method of production of which the factor labor contributed the major share was the theme of the ideas of Smith. In the Wealth of Nations Smith argued that it was labor which created wealth and supplied the necessities - "The annual labor of every nation is the fund which originally supplies it with all the necessaries and conveniences of life which it annually consumes, and which consist always either in the immediate produce of that labor, or in what is purchased with that produce from other nations." (Smith, 1904) the fundamental factor being labor, it is the dexterity and the skill with which labor is employed that ultimately created the surplus called wealth. This surplus must be regulated by the market process and forces. "But this proportion must in every nation be regulated by two different circumstances; first by the skill, dexterity, and judgment with which its labor is generally applied; and, secondly, by the proportion between the numbers of those who are employed in useful labor, and that of those who are not so employed." (Smith, 1904)

Division of Labor

The improvement in the quality of labor is a direct result of the division of labor. "The greatest improvement in the productive powers of labor, and the greater part of the skill, dexterity, and judgment with which it is any where directed, or applied, seem to have been the effects of the division of labor." (Smith, 1904) Even from the manufacture of small things the power of specialization and the division of labor will be evident if we consider the method of production. Any work can be split and made into many parts, and this will result in specialization. The illustration that Smith gives is from the pin making industry where a single laborer if engaged in the complete production of pins would scarce make a single pin a day because it involves multiple steps and different activities that require various skills. The division of labor thus employs many persons who specialize in various parts of the manufacture and sticking to their designated parts can easily contribute to making more of the product than can be done if done individually. Smith graphically illustrates this in pin making: "One man draws out the wire, another straights it, a third cuts it, a fourth points it, a fifth grinds it at the top for receiving the head; to make the head requires two or three distinct operations; to put it on, is a peculiar business, to whiten the pins is another; it is even a trade by itself to put them into the paper; and the important business of making a pin is, in this manner, divided into about eighteen distinct operations." (Smith, 1904)

Smith was of the view that the division of labor would have no increase with regard to agriculture's productivity, and the increasing of the dexterity of the workman as well as the consequent improvements in production was relative in the terms of value. The machinery that saves the labor and labor time thus will be a key to the future production process. If we were to remember that this book and ideas were written at a time when the industrial revolution was barely taking shape, we can understand the depth of the idea of what will develop and farsightedness of Smith. He further argued that the different wants and the richness of the society was on the level of affluence of the labor, and the comparative value of affluence is relative and therefore to set values on the contributions of labor, the relative backgrounds have to be noted. In the words of Smith, "the accommodation of an European prince does not always so much exceed that of an industrious and frugal peasant, as the accommodation of the latter exceeds that of many an African king, the absolute master of the lives and liberties of ten thousand naked savages." (Smith, 1904)

David Ricardo however has argued against this contention of Smith and propounded that the wages will come down and reach a stagnation level. The theory has international connotations and the theory of wages was such that "A rise in wages, from an alteration in the value of money, produces a general effect on price, and for that reason it produces no real effect whatever on profits. On the contrary, a rise of wages, from the circumstance of the laborer being more liberally rewarded, or from a difficulty of procuring the necessaries on which wages are expended, does not, except in some instances, produce the effect of raising price, but has a great effect in lowering profits." (Halsall, 1997)

Value and International trade

The surplus over the international trade, where the superior basis of production created a better product that could be trades at an advantage overseas was the proposition that was attacked first by Ricardo. However the theory of 'surplus' also originated in considering the international trade and the agility or dexterity of labor. The greatest critic of Smith, Marx therefore borrowed the theory of surplus and made it the focal point where the surplus generated by labor was skimmed off by the capitalists in an unjust manner. Value according to Smith could be of two kinds. Dissecting this Ricardo in his book observes that as per Smith, a commodity's value is being decided by the quantity level of another commodity that can be got in exchange, or the barter value. This value will be determined by the quality of labor. (Halsall, 1997)

According to Adam Smith the term Value can have two meanings in context to its use. The utility of the object can comprise its intrinsic value and the exchange it can affect or the purchasing power of other goods that can be got by its possession or its exchange value is also value. There are things that have great value in use but are not having exchange value. Water for example has great intrinsic value but does not have an exchange value. The contrary that certain things have value but are useless in use like gold for example which has exchange value but no practical use was pointed out by Ricardo who then went on to argue that the Utility cannot be thus the ultimate determinant of value as argued by Smith. No doubt utility was essential, and the theory of values he proposed was more practical in saying that the value of a commodity, following the lines of Smith, could be determined by its scarcity and the amount of labor that was required to produce it. "Possessing utility, commodities derive their exchangeable value from two sources: from their scarcity, and from the quantity of labor required to obtain them." (Ricardo, 1929)

Relevance of Adam Smith in Modern Economic thought

Adam Smith was one of the greatest influences of his times. We cannot ignore the fact that he was instrumental in providing the basic methods of analysis for economics. However the contributions by Smith may have been a natural consequence of the flow of the ideas during his times. While we attribute many things to the writer, it is argued that the work is not complete in all aspects, and some of the theories do not bear the test of time and events that followed. For example Adam Smith did not linger much on the theory of value or of distribution. Smith's ideas on value and the value in exchange actually gave rise to the issues of distribution of the national product which in turn gave rise to the socialist doctrines that came after Ricardo and ended with the labor theory of Karl Marx. (Clark; Douglas; Hollander; Morrow; Palyi; Viner, 1928)

In reality the exchange rate plays a great role, and production with efficiency and more quantity does not count as it was shown with the case of farm products. (Clark; Douglas; Hollander; Morrow; Palyi; Viner, 1928) it is a great difficulty to day to exactly enumerate the contributions of Smith and its effects, partly because the doctrines form a part of our general thinking today that any idea that was not in keeping with the doctrines is argued upon. There may have been better ideas that came down to us from other sources, or even the ideas of Smith may have a genesis in others works, but we are not inclined on account of being indoctrinated with the Smithian concepts to acceded even to the possibility of thinking beyond it. (Clark; Douglas; Hollander; Morrow; Palyi; Viner, 1928)

We are also at a loss to fathom the influence of the French school of thought and how much of the ideas were in essence contributed by them. The concepts of Smith is now a part of the modern economics and the basis of many theories which uses the theory of Smith in many ways either as the basis for research or simply as opposing the doctrines that were shaped and redesigned and even restated by later day economists. Today no one reads Smith and may professors and thinkers agree that they have not perused the 'Wealth of Nations'. However their arguments and some of their belief seem to be grounded on the principal ideas that emanated from the work of Adam Smith. So is Smith relevant today? The answer can be yes and no. Because the complexity of the economic stage is so much and because the contemporaries today have multiple view points on the basic issues that were later refined by others, Smith is not considered for study by economists anymore. Modern economists admit that they hardly understand Smith. Franco Modigliani argues that "advanced economies now save less because they are approaching a stationary state." (Fitzgibbons, 1995) This is a case of interpreting what Smith stated in a different context. The presumptions of the "invisible hand has also come under the criticism of modern economists like James Tobin." (Fitzgibbons, 1995) Some of the thinkers however had not read his works or had any acquaintance with them as thoroughly as necessary. (Fitzgibbons, 1995)

Thus we can say that the person who seems to have read Smith page by page and the only genuine critic of Smith was Karl Marx! Modern economists have developed Smith's theory of equilibrium into a disequilibrium analysis. This is based on the growth with regards to the increasing returns to scale. This is more evident in the area of international trade, division of labor and the free markets. In the international trade, it is evident that Smith acknowledged the existence of disequilibrium that is a trade surplus. Ricardo was vehement critics of this acquiesce and Ricardo maintained that the equilibrium will be reached, no matter what surplus seems to exists in the short run. (Brown, 2004) We have to agree however that all the Economists of the classical, neoclassical and the modern school of thought including Karl Marx based their works on the basis of the 'Wealth of Nations'. This makes Smith as the 'father of the modern economic science'.

David Ricardo

David Ricardo was disinherited by his affluent family for marrying outside the Jewish faith, and had the business acumen to make it on his own as a loan shark and stockbroker. The net worth of Ricardo at the time of his demise was over a hundred million dollars. Ricardo was influenced in considering economics and the working of finance and surplus after he read the 'Wealth of Nations' and the study prompted him to write the first article on economics. He became a public figure after the essay the 'bullion controversy' came to be published in 1809. He was the first to link the inflation in England with the reckless issue of bank notes by the bank of England. That was probably the first theory which later became the 'quantity theory of money', and now as 'monetarism'. (Henderson, 2002)

Influence of Adam Smith

No doubt Ricardo was influenced by smith. But the influence did not deter him from exploring the science from various other angles. Ricardo was not dogmatic about the theory of Smith and therefore either furthered and explored it or replaced the theories with his own. There are also new contributions he made to economics which holds good even today. The theory of rent was probably the greatest contribution of Ricardo, and the circumstances that led to the beginning of the theory is the theory has been a result of the changes which occurred in the industry all over Britain, There was the industrial revolution which while prompting the economists Ricardo and Malthus who saw the transformations and the working of the Smith's theories before their eyes take fresh approaches in economic theories. (Price, 1923)

There was no clear theory of profits that was considered by Smith, or was expounded even at the time of Ricardo, but he made a beginning. Smith recognized profit as a distinct form of income, and the theory of labor echoed it as a surplus return for labor. The surplus view of labor was hinted by smith and developed by Ricardo. (Obrinsky, 1983) There was no clear theory of profits that was considered by Smith, or was expounded even at the time of Ricardo, but he made a beginning. Smith recognized profit as a distinct form of income, the theory of labor echoed it as a surplus return for labor. The surplus view of labor was hinted by smith and developed by Ricardo. (Obrinsky, 1983)

Theories propounded by Ricardo

Rent was the focal point in determining value in his system. The formation of rent would cause a change in the value of the various commodities, and rent was described by him as: "Rent is that portion of the produce of the earth which is paid to the landlord for the use of the original and indestructible powers of the soil. It is often, however, confounded with the interest and profit of capital, and, in popular language, the term is applied to whatever is annually paid by a farmer to his landlord." (Ricardo, 1929) Rent was defined in his own words as "Rent is that portion of the produce of the earth which is paid to the landlord for the use of the original and indestructible powers of the soil. It is often, however, confounded with the interest and profit of capital, and, in popular language, the term is applied to whatever is annually paid by a farmer to his landlord." (Ricardo, 1929)

Thus if there were 2 farms which has the same amount of fertility, and if 1 has more structures like buildings and other farming facilities, the remuneration for the developments that were effected in the farm will tend to fetch a higher reward for its use than the same amount of farm land without these conveniences There will be a payment made for the use of both the land and both payments are called rent. In Ricardo's view, the rent that accrues to the use of the land alone when compared to one another and the use of the structure are two different things. Adam Smith though recognizing the rent in terms of the marginal land, according to Ricardo, fell into the common error of supposing rent to be the common interpretation, as the prize paid to the land lord. (Ricardo, 1929)

Adam Smith was concerned with economic growth and the evolving of the capitalist system. The economy according to Smith always had an upward shift. The market potential was however questioned by actual events like war which upset the system. The optimistic view was replaced with something that was the beginning of the term 'equilibrium'.. David Ricardo propounded the theory that economy generally moves towards a standstill or equilibrium where the forces come to rest. The amount of labor necessary to support the labor at the marginal land will determine the profit for a society. Rent for the more fertile land decreases with a decrease in fertility. The actual difference in out put between the most fertile land and the least fertile land was the source of rent, and when the population increases the pressure of the demand makes the marginal land cultivated become costly and will result in the rent taking out the surplus which will result in starvation and prevent economic progress. With that prediction, which was influenced by Malthusian theory of population, economics became a 'dismal' science. (Dhamee, 1996b)

The landowners in Ricardo's view always will hold views that would harm society. He gave a hint to the class relations that would be taken up by Marx later. Much of Marx's writings were based on Ricardo's theories. Marx however identified the capitalists and not landlords as the trouble makers. Though the theories of Ricardo and Robert Malthus was adopted to create the theory of socialism, communism and a lot of other theories, the theories that were propounded by them were all based on free trade. Ricardo for example held that the Corn Laws were a burden to the society. This theory was popularized by him in the Parliament and also pointed out the other government interventions that caused problems in the economy. Ricardo was a proponent of the hands off policy for the government although he did not believe like Smith that the market will be led by the invisible hand. He advised that the tampering with the market will result in a deep stagnation. (Dhamee, 1996b)