Thursday, December 23, 2010

It Didn't Worry Adam Smith

From mine of 22 December:

Today, cost is divided between wages and profit, with some to rent, and much to a fourth factor that was less significant in Smith's time: the cost of interest.

I am not the first to add a factor to Adam Smith's list. Entrepreneurship is often added as a factor. But as Roger LeRoy Miller notes, entrepreneurship is "actually a subdivision of labor" [Economics Today, seventh edition. Harper Collins. Page 22.]

My view, it's just ego that wants to distinguish the entrepreneur from the riffraff of labor. According to Smith, payment for someone's time and effort, talent and skill is wages paid to labor, plain and simple. Let's keep the ego out of it.

Another item sometimes added to the list is government. This is a more reasonable addition, for a cost is clearly associated with government. Still, to call it a factor of "production" is somehow not right. Anyway, Smith explicitly excluded government from his list of factors:

All taxes, and all the revenue which is founded upon them, all salaries, pensions, and annuities of every kind, are ultimately derived from some one or other of those three original sources of revenue and are paid either immediately or mediately from the wages of labour, the profits of stock, or the rent of land.

Of course, in the same paragraph where Smith rejects taxes as a factor-cost, he also rejects interest:

The interest of money is always a derivative revenue, which, if it is not paid from the profit which is made by the use of the money, must be paid from some other source of revenue...

My view is that interest has become such a large cost in our economy, that it deserves to be broken out as a separate cost factor. This way we can watch it, and compare the growth of interest costs to the growth of profits and wages and rent.

It is not interesting (to me, anyway) to break out entrepreneurship from the body of labor and make this comparison. On second thought... maybe one day I'll do that.

But there is something to be said for breaking out the cost of government as a separate factor-cost, because, like interest, it seems to have grown substantially as a portion of total costs in our economy.

The fact that Adam Smith refused to include government as a separate cost makes one wonder whether that cost, like interest, was significantly lower in Smith's time.

Apparently it was not. I have this picture that shows a mountain of government debt, U.K. government debt, and I stuck an arrow on that picture to identify the year that The Wealth of Nations was published. (The year is easy to remember: 1776. Same year as our Declaration of Independence. Same year that The Decline and Fall of the Roman Empire was published. Peak of the Cycle of Civilization, I say.)

Net Public Debt of the U.K. was over 100% of GDP in 1776, and recently had been over 150%. But Adam Smith didn't think it was even worth noting. And he did not consider the cost of government significant enough to list it as a factor cost.

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