Adam Smith’s distribution theory in ‘The Wealth of Nations’ is presented as a corollary to his price theory. The price of any product is composed of wages, rent, and profit.
As in Adam Smith’s time, the organization of production by independent entrepreneurs borrowing from capitalists does not yet exist; profit is not distinguished from the interest on capital.
According to A. Smith, the price of the annual produce resolves into wages, profits, and rents. This is the primitive source of all other revenue.
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In every society, there are average rates for wages, profits, and rents.
Table of Contents
Wages according to Adam Smith
In the primitive state of society, the produce belongs entirely to the laborer. However, with the appropriation of land and capital, which A. Smith does not explain the process of, deductions are made from the produce of labor in the form of profit and rent.
Under these conditions, how are wages determined? Aside from a very small minority of workers who own their means of production, the vast majority work for capitalists who provide them with the means of production in exchange for a share of the produce of their labor.
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“It is the interest of the masters, therefore, in spite of the competition of capital, to raise wages as much as they can, and that of the workmen, in spite of the competition of their fellow-workmen, to raise them as much as they can.”
But in this power struggle, the capitalists almost always win, for the following reasons:
- They are numerous and can, therefore, conspire more easily.
- The law permits the coalition of entrepreneurs but prohibits that of workers.
- They can hold out longer in a contest of endurance.
Admittedly, in their resistance to the capitalists’ conspiracies, the workers are sometimes driven to acts of violence.
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“The workmen desire to get as much, the masters to give as little as possible. The former are disposed to combine in order to raise, the latter in order to lower the wages of labor.”
But such acts generally end in the punishment or ruin of the riot leaders, either through the intervention of magistrates or simply due to the intransigence of the entrepreneurs.
However, whatever the power of the entrepreneurs, there is a certain rate below which wages cannot fall for a sustained period:
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“But though in disputes with their workmen, masters must generally have the advantage, there is, notwithstanding, a certain rate below which it seems impossible to reduce, for any considerable time, the ordinary wages even of the lowest species of labor.”
In certain circumstances, wages can increase when the demand for labor rises consistently. A competition then ensues among employers, who offer wages higher than the rate that ensures a bare subsistence.
Increase in Wages
An increase in wages directly leads to a rise in the prices of several commodities, resulting in reduced consumption. Capitalists react by improving the division of labor and introducing better machinery so that a smaller amount of labor can produce more goods. Thus, the increase in the price of labor is more than compensated for by the decrease in the quantity of labor required.
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Decrease in Wages
A decrease in the rate of wages below the minimum subsistence level is always conceivable but only for a very brief period. For “want and famine would soon reduce them to the necessary number,” and the effects would extend to the higher classes until the population was reduced to what the remaining revenue and capital could easily support.
Profits according to Adam Smith
Profits are a deduction from the produce of labor. They are the very reason for the accumulation of capital. A capitalist “would have no interest to employ [workers] if he did not expect from the sale of their labor something more than what is sufficient to replace the stock which he advances, together with its ordinary profits.”
The profit rate, unlike wage and rent rates, is fixed proportionately to the extent of the capital advanced. A capitalist “would have no interest to employ a great capital rather than a small one, if his profits were to bear no proportion to the extent of his capital.”
Profit rates are also influenced by several circumstances. The author admits, however, that “there is a rate below which it seems impossible to reduce, for any considerable time, the ordinary profit of stock in any particular country.”
Due to individuals’ tendency to pursue their self-interest and the freedom to seek the most advantageous employment for their capitals, there is a tendency for profit rates to equalize.
“If, in the same neighborhood, there are two or three different employments, all equally easy and agreeable; I mean, requiring equal doses of labor and attention; but one of which is known to be more profitable than any other, everyone will flock to this, and from all the rest. But upon this account, too, the number of people in the profitable employment will soon be so much greater than what it otherwise would have been, that they will soon reduce one another’s profits to the level of the other employments.”
Finally, profit includes interest, which is only a part of the profit that the entrepreneur cedes to the lenders who provide them with capital. The interest rate must necessarily be lower than the profit rate.
Land Rent according to Adam Smith
Rent is also a deduction from the produce of labor, but its determination principle differs from that of profit:
“The rent of land, therefore, considered as the price paid for the use of the land, is naturally a monopoly price. It is not at all proportioned to what the landlord may have laid out upon the improvement of the land, or to what he can afford to take, but to what the farmer can afford to give.”
Thus, rent is the difference between the price of the agricultural produce and the sum of the charges incurred by that produce and the ordinary profit for the capital employed. It results from a monopoly: the ownership of land. It is a monopoly price.
Conclusion
Overall, Adam Smith’s distribution theory posits that the distribution of wealth is influenced by the productivity of production factors and market forces such as competition and demand. He emphasizes the significance of productive labor for economic growth and societal prosperity.
