Adam Smith’s Understanding of Capitalism

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Introduction

Adam smith is one of the famous economists whose contribution in the field of economy has shaped various aspects of both the ancient and modern world economy. Most of his economic theories are currently given more consideration to assist in explaining subtle economic conditions. Different economies exhibit different conditions because of different economic theories upon which their policies are based. Unfortunately, his theory sparked great controversy among people with divergent opinions.

It must be asserted that there is no general agreement among economic historians as to what the meaning and essential features of capitalism are. On that note, this essay seeks to discuss Adam Smith’s understanding of Capitalism, how he perceived modern Capitalist economies. In addition, to be discussed is the difference between Adam’s theory and those of Keynes and Marx.

Adam Smith and Capitalism

The first attempts to understand capitalism began with Adam Smith. Capitalism is viewed as a prevailing political, social and economic system that originated in the Western Europe and later spread out to various parts of the world. The concept emerged drastically over centuries. However, most economies have had convergent views on capitalism, as a system that functions differently from preceding economic systems and that it is different from non-capitalist systems (Heilbroner, 1987).

Therefore, according to Adam Smith’s understanding, capitalism is a system that encompasses the following sets of behavior: “market which is characterized by commodity production”; “private possession of factors of production”; “large section of population that cannot exist independently unless it sells its skills in the labor market”; and “idiosyncratic, materialistic and maximization behavior of most of the individuals in the economy” (Heilbroner, 1987).

According to Adam Smith’s theory of moral sentiments, despite the desire to accumulate wealth, the capitalists are forced to share with the poor their resources. The “invisible hands” would guide the owners of factors of production to redistribute life necessities back to the workers and thereby, without any intention, improving the well-being of the working class (Meeropol, 2004).

Adam Smith’s perception of modern capitalistic economy

According to Adam Smith, products of human labor, in a modern capitalistic economy, are valued because they have specific physical characteristics by virtue of their usability and ability to satisfy human needs. Adam Smith asserts that products are also valued because they can be sold in the market in exchange for money.

In modern capitalist economies, the product value is desired because it can be exchanged for money; on the other hand, money is also desired because it can be exchanged for products that have a desired use value. Modern capitalist economies therefore have a well-developed market in which products can freely be bought or sold for money in order to facilitate the existence of commodity production (Heilbroner, 1987).

Adam Smith asserts that in commodity production process, producers have no personal concern for a product’s use value of but instead are but are concerned only in the price worth of the goods. Thus, in modern capitalist economies, commodity production is not a direct means of satisfying needs. Instead, it is a way of obtaining money through selling the products.

Under these conditions, products of human labor are commodities and the economy in which production activity is taking place is described as a commodity producing economy. Adam Smith says that productive activity of an individual has no direct connection with his or her consumption pattern; rather, its exchange and the market that mediate the two (Heilbroner, 1999).

Commodity production implies a high level of specialization in production in which each producer is expected to create only a few commodities and must therefore depend on other producers for the commodities he or she does not have. Once a person has exchanged the commodities for money, s/he must again depend on people with whom he has no direct personal relationship to supply the commodities in the market, in order to satisfy personal needs.

According to Adam Smith, modern capitalistic economy is characterized with complex inter-relationships and dependencies that do not involve direct personal interaction or association. What happens is that individuals interact only with the impersonal social institutions of the market, in which the individuals exchange commodities for money (Heilbroner, 1999).

The second approach for Adam Smith to understanding modern capitalist economy is that it is characterized by private possession of means of production. This could also mean that the economies empower private owners with authority and right to oversee how the raw materials, tools, machinery and buildings necessary for production are used.

Such authority implies that other individuals with no ownership to factors of productions have no say about how these means of production are to be used. Thus, ownership of the factors of production is a capitalism trait, which is a source of capitalists’ influence on the working class; making them the prevailing class. Consequently, the commodities they produce do not belong to them but to the owners of factors of production.

The workers own and control only one thing, the capacity to work. That is, labor power. For the workers to engage in productive activities, they must sell their labor power to capitalists who in turn, reward the labor supplier by payment of an agreeable amount of wage.

This system converts human productive power into a commodity and generates some sets of conditions in which the majority of people cannot sustain the cost of living unless they are able to sell their commodity (labor power) to a capitalist for a wage.

Smith states that most people in the modern capitalist economy are motivated by individualistic, acquisitive and maximization behavior. In order to assure an adequate supply of labor and to facilitate the strict control of workers, capitalists produce commodities whose values are in excess of the value of commodities that workers consume (Heilbroner, 1999).

Keynes’ economic theory

John Maynard Keynes’ work The General Theory of Employment, Interest, and money constituted a huge attack on the classical economics. World War 1 destroyed the period that gave rise to classical economics, and for Keynes, serious system inadequacies were revealed. Keynes, therefore, created a new synthesis. In his theory, Keynes concluded that classical economies were constructed on an original error.

He assumed that forces of demand and supply would guarantee total employment. He asserted that forces of supply and demand could stabilize at an equilibrium point without creating full employment opportunities. According to Keynes, the solution to the problems lies in introduction of public investment sector that would be financed through debt finance (Keynes, 1936). This strategy would force the government to borrow money expenditures such as public works.

The borrowing of funds to invest would then, create job opportunities and increase purchasing power. In an attempt to drive home his point, Keynes used standardized national income accounting system that created the concept of gross national product. He stated that the concept of aggregate demand and multiplier (people receiving government money for public jobs will spend money), which will create jobs. Keynes’ intention was for the government to play a much bigger role in the economy.

He envisioned a reformed capitalism or a managed capitalism, free of both socialism and pure capitalism (Wolff, 2012). He talks about a rather inclusive investment activities and active involvement in organization of investments by the state. He states that fiscal policies would enable wise managers to stabilize the economy without resorting to actual controls. The decision-making responsibility would be decentralized (Keynes, 1936).

Marxism economic theory

The motivating factor of the economic theory by Karl Marx is the labor theory of value and its extension into the theory of surplus value. Through the labor theory of value, Marx intended to prove that workers alone produce value and through the theory of surplus value, Marx wanted to show that capitalism requires exploitation. Marxists consider the economic theories expressed in Das Kapital to be merely an objective enquiry into the functioning of a free market economy, but they are not.

They were developed mainly to destroy the capitalist system. According to Marx, efforts of reforms without the destruction of private ownership of the means of production and the forcible convulsion of political power by the working class would never free the workers from “capitalist wage-slavery”. Marxist theory is developed based on the condemnation of the capitalism (Harvey, 2010). Marx was of the opinion that it is socially undesirable to for some individuals in a community to earn income merely from the ownership of properties.

For the theory to be successful however, an economic system must function in harmony with the human being nature. It is for this very reason that the economic theory developed by Marx was a total failure. With the full implementation of Marxist’s principles, individual enterprises, profit production and the free exchange of goods would be considered criminal activities (Wolff, 2012).

As stated earlier, Marxist economic theories refer to the labor theory of value developed by classical economists and adopted by Marx, it applies to theory of surplus value. These two theories were developed in Marx’s Das Kapital, subtitled, “Critique of political economy”. Political economy refers to the activities of classical economists such as Adam Smith or David Ricardo, who agreed that the concept of free market system is natural.

On the contrary, Marx believed that the free market system was an abnormality and had to be destroyed. Capitalism according to Marx is quite different from what it is today. For Marx, capitalism was a single stage in the progression of the history of struggles between classes.

The two major classes that were struggling against each other were the workers and the capitalists. Workers were considered those who contributed their labor skills toward production, yet had no personal property, that is, they had no ownership of the means of production. The capitalists on the other hand are those who owned all the properties in production process (factors of production) but contributed no labor toward production (Mandel & Pearce, 1970).

The labor provider would then contribute his labor while the capitalist contributes his capital. According to Marx, the capital contributed by the capitalists, contributes nothing to the value of the products. The value is added exclusively by the skills from laborers. The workers therefore, are the sole contributor to commodity value, yet they are not well remunerated, while the capitalist take home more than enough in form of profits.

Commodity value

According to Marx, the commodity is the fundamental unit of the capitalist economic structure. The main purpose for production of the commodity is exchange rather than consumption. That means, the capitalist is interested in selling the produced commodities rather than use them. According to Marx, a commodity has two types of values, that is, the use value and exchange value. “Use value” is generated by “useful labor”.

The other type is “exchange value” which is the value or the price of the commodity. In Marxists economy, commodity value is its exchange value. Use value is of no interest because it does not represent a social relation. That is, since the commodity is mainly produced for change, in capitalism, the important aspect of commodity value is its exchange value. According to Marx, commodity value refers to exchange value, which is equivalent to the price.

This is in turn equal to the number of hours of labor required to produce the commodity. The number of hours refers to the average time necessary for a worker to produce the particular commodity. The main intention of Marx’s labor theory is to convert the workers to communism by showing them that all value comes from labor that they provide (Mandel & Pearce, 1970).

Theory of surplus value

According to analysis done by Marx, three components enter into the manufacturing process to yield a product. These are raw materials, the machinery, and labor power or laborers. For example, in a shirt making process, the raw materials would be the cloth, the machinery would be the sewing machine and the labor power would be the sewing. The role of the Marxist economist is to sum up the values contributed by each of these elements.

Let us say the manufacturer pays $1 for the cloth needed for each shirt. He also sets aside $1 in a depreciation account for every shirt that is made. He also uses this money to buy a new sewing machine when the present one is worn out. He also pays the workers $2 for every shirt made. Finally, he charges $7 per shirt in the market at the time of the sale. The $7represents the real value of the shirt as determined by the labor theory of value. The sum of the values expected by the capitalist is $4, and yet the revenue is $7.

There is difference of $3 that the capitalist calls profit. According to Marx, the capital spent on raw materials is not variable. The value of the raw materials does not undergo any change during the production process. Marx also determines that the capital spent on machinery is constant; he claims that the machine contributes his own exchange value into the product it makes.

To find out how much exchange value went into each product, take the price of the machine and divide by the number of products manufactured before it wears out. Marx found out that the capital used to purchase labor power is a variable capital. Therefore, this capital gives rise to the profit. The profit as a result comes exclusively from the labor power of the laborer.

The conclusion of this analysis is that profit belongs to the laborer, but the capitalist unfairly seizes it. The laborer is locked into the position of continually being exploited and the capitalist himself is driven to exploit. Marx states that the only way out of the dilemma is revolution. When capitalism is destroyed, exploitation will end (Mandel & Pearce, 1970).

Contrasting Marx’s theory and Adam Smith’s Capitalism

Capitalism, according to Adam Smith, is an economic condition characterized by private possession of means of productions. The capitalist economies with this kind of system grants power and authority to private owners of factors of production to control how the raw materials, tools, machinery and buildings necessary for production can be used.

Such authority implies that other individuals with no ownership to factors of productions have no say about how these means of production are to be used. Thus, ownership of the factors of production is a capitalism trait that empowers the capitalist class to take control over the social aspects of the economy and thereby establishes itself as the prevailing social class (Heilbroner, 1999).

Employment is considered as a commodity and is expected to be provided in exchange of wages. Capitalists therefore, do not view labor as an important factor contributing to the products’ value (Heilbroner, 1999). Contrary to that, Marx’s theory of value of labor argues that the capital contributed by the capitalists contributes nothing to the value of the products.

The value is exclusively added by the skills from laborers. Therefore, laborers are more important in a production process than capitalists are (Mandel & Pearce, 1970). In capitalism, the laborers have no say about the implementation process of the manufacturing activities, yet they are the same people whose skills are used to convert raw materials into finished products, which are exchanged for money (Heilbroner, 1999).

Marx, on the other hand, argues that laborer should embrace communism and seek for ownership of the factors of production since they are the reason profits are being accrued by capitalists (Mandel & Pearce, 1970). According to Adam Smith’s understanding of capitalism, the ownership of the factors of production is entirely with the capitalists. Therefore, workers only own skills and can only control their labor power (Heilbroner, 1999).

On the contrary, Marx argues that laborer’s effort is exclusively the reason for profitability in a manufacturing process. Therefore, laborers have power to, not only control their labor power but also the levels of profitability accrued by the capitalists. This is true because if the laborers decide to employ less skill into their work, the levels of productivity and product quality will be low. As a result, the low quality products will fetch low revenues in the market, which will reduce the profitability levels.

Contrasting Keynes’ economic theory and Adam Smith’s Capitalism

Keynes’ main vision in his economic theory was for an active government with a huge controlling muscle in an economy. He envisioned a reformed capitalism or a managed capitalism, free of both socialism and pure capitalism. He talks about a rather inclusive investments activities and active involvement in the organization of investment activities by the state. He states that fiscal policies would enable wise managers to stabilize the economy without resorting to actual controls.

The decision-making responsibility would remain in a decentralized market. Keynes’ theory would deliver decentralization of power to the state by confiscating authority from private owners of factors of production. Government participation in ownership of factors of productions has the effect of reducing the excess control possessed by private owners of factors of production (Keynes, 1936).

As indicated in Smith’s Creation of Wealth of a Nation, the wealth of a nation would increase rapidly if individuals were allowed the free will of investing (Kleerr, n.d). The step would increase the level of competition for laborers and thus, increase the labor prices (Keynes, 1936). On the contrary, capitalism is characterized by private possession of means of productions.

Therefore, concentrates decision-making power to private individuals who own the factors of production. This system drives away competition and increases market monopoly. Monopoly creates an imperfect market in which producers or owners of the factors of production solely control market prices because market forces of demand and supply have no influence in such a market (Heilbroner, 1987).

Conclusion

In conclusion, capitalism is an economic system that facilitates formation of two different classes. That is the owners of factors of production and the workers. The owners of factors of production (capitalists) utilize their wealth status to develop a sense of control over the working class.

The resultant is a massive exploitation of the workers. Marx’s theory seeks for destruction of capitalism and contends that workers are the driving force of an economy. Keynes suggests a reformed capitalism that involves both government and private sector. He asserts that decision-making power should be with the public instead of a group of private investors.

References

Harvey, D. (2010). A companion to Marx’s Capital. New York: Verso Pub.

Heilbroner, L. R. (1987). The essential of Adam Smith (3^rd Edition). New York: W.W. Norton & company Pub.

Heilbroner, L. R. (1999).The Worldly Philosophers: The Lives, Times and ideas of the great economic thinkers (7^th Edition). New York: Touchstone Pub.

Keynes, J. M. (1936). The General Theory Of Employment Interest And Money. N.Y: Createspace Pub.

Kleerr, R. A. (n.d). The role of teleology in Adam Smith’s Wealth of Nations. Retreived from web.

Mandel, E., & Pearce, B. (1970). Marxist economic theory. New York: Monthly Review Press.

Meeropol, M. (2004). Another distortion of Adam Smith: The case of the invisible Hand. Web.

Wolff, R. D. (2012). Contending Economic Theories: neoclassical, Keynesian, and Marxian. New York: Mc Grawhill.

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