Commentary on Political Economy

Monday 19 September 2011

Adam Smith and the Austrian School on the Division of Social Labor and the Sphere of Exchange

Here is another "theoretical" anticipation of our notes on Krisis for our friends to enjoy. Incidentally, the Nietzschebuch is nearly complete and we will have more excerpts here soon.

The economic concepts of “productivity and growth”, or “development” involve social mechanisms or interactions that are quite different from the concepts of ‘co-ordination’ and ‘exchange’ and ‘allocation’. For growth and development to occur, we need to specify a “motor or engine of growth or development”.

Recall that it was Adam Smith’s original confusion of exchange as the cause of specialization (rather than the other way around) that led him astray from his quest “to enquire into the nature and causes of wealth” (that is, ‘growth’) and that condemned him ultimately to seek ‘value’ in the sphere of exchange and to turn therefore into “the father of general equilibrium” (Arrow and Hahn) and to invoke “the invisible hand” (timeless equilibrium determined by simultaneous equations).

Even if we follow the orthodox interpretation of Schumpeter’s ‘theory’and locate ‘innovation’ endogenously with Rosenberg within ‘corporations/firms’, there is still absolutely no conceptual link between “the market” as a “co-ordinating” mechanism of “knowledge/information utilization” (Hayek) and the actual process of “innovation”.

And even superficially, quite apart from the ‘conceptual’ difficulties of Boettke’s hypothesis,there is ample evidence to show that, purely at a ‘geographical/logistical’ level, “innovation” very often takes place in a ‘non-market’, non-competitive setting – “the fourth quadrant”, as Steven Johnson has called it.

Metcalfe (‘Evol.Econs.&Cr.Destr.’) accepts the difficulties but clings to the role of “market competition” in innovation. His theses are so bizarre as to defy belief! – Worthy of quotation to show how “scarce resources” are not applicable to “evolutionary and institutional economics”!

Rothbard tackles the problem more helpfully. He invokes Mises to say that it is “mutual benefit” derived from “the diversity and inequality of talents and interest among men” that causes “exchange” and “the division of labor”, rather than the other way around, as the “anti-rationalist” Adam Smith would have it. Taken to an extreme, Mises would then have to argue that butchers and carpenters have innate talents that lead them to specialize in those trades! No further comment is required on the foolishness of this notion. But Rothbard asks a valid question: “If for Smith, the diversity and inequality of talent is not the root cause of the division of labor but the effect, what in the world is the root cause?” Smith ought to answer that it is the obvious productivity advantages of “specialization”. – Which is acceptable and preferable to what Mises and Rothbard propose for an explanation. Instead, he opts for “the natural tendency to barter, truck and exchange one thing for another” (quoted below). But none of this deals with “the nature and causes” of exchange value!

“It should be noted that Smith was antirationalist

as well, if for rather different reasons. Smith was concerned to purge economic theory of all

subjective utility considerations, so he had to discard mutual benefit as the reason for exchange. Indeed, in

contrast to Mises’s insight that the division of labor (the base of exchange) stems from the diversity and

inequality of talents and interests among men, Smith maintained that all people and children are originally

almost totally the same, and that the existing division of labor and of occupation willy-nilly pushes them

into specialization and differences of interest. As Smith puts it: “the very different genius which appears to

distinguish men of different professions . . . is not. . . so much the cause, as the effect of the division of


If for Smith, the diversity and inequality of talent is not the root cause of the division of labor but the effect,

what in the world is the root cause?....[Smith] falls back on some sort of built-in “instinct”: or, as he put it. “a certain propensity in human nature” which has no regard for utility, but is instead, “a propensity to truck, barter, and exchange one thing for another,” Ibid., pp. 25, 28. Or, as Smith rather absurdly put it: “without disposition to truck, barter, and exchange, every man must have procured to himself every necessary and convenience of life which he wanted,” ibid., p. 29.” (Rothbard, ‘PresentStateofAE’, p26 fn46)

Rothbard then continues to discover the motivation behind the exchange, which changes the entire “nature” of the “exchange”, which neither Smith nor Mises nor anyone else seems to be able to comprehend, still less to admit!

‘Perhaps the best case for stress on unintended consequences comes from analyzing the

motive of exchange on the free market and was best expressed in the famous quote from

The Wealth of Nations: “It is not from the benevolence of the butcher, the brewer, or the

baker, that we expect our dinner, but from their regard to their own interest. 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.(26)

To translate this passage into our current concerns: the butcher and the baker’s actions

result in the intended consequences of yielding them a profit, but, more importantly for

society, they result in the unintended consequences of benefiting consumers, indeed

society as a whole, in the most efficient possible manner.

This is surely an important and valid point, so far as it goes. But, we might wonder: why

the rush to celebrate unintended consequences? Wouldn’t it have been better if these proconsumer

or pro-general standard of living consequences had been understood and

intended by the actors as well? To put it another way: the butcher, baker, and so on desire

and intend the consequences of their production yielding them a satisfying profit. But

suppose that they are informed, by economists and others, that their actions also have the

effect of helping the rest of society and the general standard of living? Wouldn’t they

then come to intend this general welfare as well, even conceding that their own selfinterest

would still be their primary goal? Wouldn’t they be likely, at the very least, to

feel better and happier about their own activities, knowing now that they benefit the body

of consumers as well as themselves? How could such knowledge hurt?’ (p27).

As is evident, Rothbard is totally blind and deaf to the fact that if we allow “altruistic” motives to enter the field of economic theory, the entire basis of “individual decision-making or choice” falls apart together with “the market mechanism” because now the individual will weigh up private and public gains. So, market agents’ “purposive rationality” implied by “praxeology” dissipates into an infinity of conflicting selfish and altruistic considerations! But the whole point to “the Pure Logic of Choice” is that “individual plans” are invariably the best – no, the “only” rational choices possible! Because Rothbard-Pangloss believes that individual preferences always lead to the greater good, then there is no ‘difference’ or, to put it with Hayek, no adverse “unintended consequences” following from pursuing the former.

This exquisite brand of stupidity was obviously too much for Hayek, and he wisely eschewed it:

‘Thus, Mises’s view of why men participate in the basic form of market interaction exchange, which also implies participating in the social division of labor. Harking back to the insight of the Scholastics, beginning at least with the great fourteenth-century French philosopher and scientist John Buridan, Mises saw that a man participates in an exchange because he sees that he will benefit more from the good or service received, than the good or service he has to give up. Here is the root of the basic subjective-utility, or Austrian, insight: men engage in exchange because and only because they subjectively prefer what they will receive in exchange to what they give up. Hence, also, Mises’s conclusion on how to preserve and maintain the great oecumene, the mighty network, or system, of voluntary, mutually beneficial exchanges that constitute the free-market economy: The mass of the public must learn, must be educated to understand, the vast importance of maintaining and preserving that free market from aggression and coercive interference.

‘But now, in his Foreword [to Socialism] written after Mises’s death, Hayek writes:

“I had always felt a little uneasy about that statement of basic philosophy, but only now can I articulate why I was uncomfortable with it.” Hayek then adds patronizingly: “The extreme rationalism of this passage, which as a child of his time he could not escape from, and which he perhaps never fully abandoned, now seems to me factually mistaken.

It certainly was not rational insight into its general benefits that led to the spreading of the market economy.”42 (Rothbard, pp23-4).

Yet even for Hayek this still leaves open the whole problem of how individual needs or wants or preferences or choices, especially if axiomatically “self-interested”,  can lead to economic let alone social “co-ordination” (remember “externalities” and “income distribution” [Napoleoni on Robbins]).

This is not just a matter of “natura non facit saltum”. It is not just a matter of the conceptual impossibility of deriving “innovation” from “combination” (see Loasby re Schumpeter in ‘Eq&Evltn’). It is rather that no amount of ‘co-ordination’ can give us ‘development’. If indeed ‘development’ is a product of ‘innovation’, then the ‘mechanism’ of innovation is different from that of ‘co-ordination’:- the “institutions” are different, or heterogeneous. But it is essential to remember that this is not a problem of ‘institutions’! It is a problem that requires us to move from the ‘sphere of exchange’ to the ‘sphere of production’!

In this context, Robbins (quoted by Coase) was intuitively quite right to insist that “institutions” such as the firm were not within the scope of economics – something Coase himself seems to accept. (See our discussion below, ‘The NIE’, where we insist on the ‘theoretical dependence’ of the NIE on the neoclassical paradigm.) As Klein reminds us (‘The NIE’, par.9):

Speaking of Lionel Robbins’s influential Nature and Significance of Economic Science (1932), Coase (1992, p. 714) remarked that ‘in Robbins’s view, an economist does not interest himself in the internal arrangements within organizations but only in what happens on the market’. Even Coase himself believed, as late as 1988, that ‘[w]hy firms exist, what determines the number of firms, what determines what firms do ... are not questions of interest to most economists’ (Coase, 1988, p. 5).

Exchange does not lead to the division of (social) labour (it’s the other way around!) and the division of (social) labour or of knowledge does not lead to “innovation” or “development/growth”. We must explore the nexus between these last two:- but remember, “innovation” is about novelties that lead to greater market share. But market share is a share of ‘consumption’! What we need is “greater production”, not in “physical” terms but in terms of “share of purchasing power” (the real meaning of “market share”). “Purchasing power” means, in terms of revenue and profits, “the power to purchase” more existing goods for sale on the market. So we see that “greater production” must involve a “growing exchange” in terms of “greater purchasing power”. This means “greater command over existing resources”, which entails “greater resources” and “greater command”!

Hence, “growth” means “growth of purchasing power” – but this has nothing to do with “innovation” or “productivity” which are concepts relating to “novelty” and “rate of output”. Only the “command” side remains to be explained. What can “purchasing power” or “greater command over resources” mean?

Let us state this as emphatically as we can: no amount of “exchange” or “co-ordination” will ever cause “specialization” and no amount of “specialization” will ever tell us what determines “prices” – the total amount of “value” – in an economy! What the “price mechanism” can do is ‘optimise’ or ‘maximise’ the pro-duction of existing resources through their efficient allocation or co-ordination: but no amount of ‘allocation’ or ‘co-ordination’ will be able to expand the productive potential of a ‘given’ economy. Indeed, because we can only speak of “given resources” (Hayek above) we will never know what the “efficient allocation of existing resources” or “price co-ordination” or “the problem of utilization of knowledge” really means! – Except a posteriori, after the event (!). But in that case our conclusions will be empty “rationalizations” of the status quo: we will assume what we are seeking to prove!

In reality, it is the division of social labour that permits ‘exchange’, so that when ‘social labour’ is separated into ‘in-dividual labours’ through ‘private property’ over the means of production, then the ‘exchange’ must become one of ‘equivalents’ (exchange values) that need to be measured. And the ‘measure’ can only be ‘value’, not a ‘numeraire’ or a relative price, because the ‘exchange’ is not one of ‘use values’ (utility) but one of ‘potential pro-duction’ where the use values for exchange are not ‘given’ as “endowments” at the outset but must be pro-duced in terms of the amount of ‘exchange value’ they can command potentially.

To command more ‘value’, the exchangers need to control the quantities (potential pro-duction) of use values that are pro-duced for exchange (potential exchange). This can be achieved by “owning the factors of pro-duction”, that is the means of production and the now “individual labours” of workers who do not “possess” independent means of production.

The ‘exchange’ now is not one of “use values” but one of “exchange values” and is aimed at commanding more exchange values, which means “owning” more means of production and “individual labours”, or the “labour-power” of “commanded living labours”. It is this last “exchange” that is the vital one!

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