Adam Smith and Karl Marx's Ideas on the Factory System

Compare and contrast the ideas of Adam Smith and Karl Marx on the factory system.

Adam smith, renowned in popular economics for coining the term “invisible hand”, is widely regarded as the forefather of classical economics and industrial capitalism. In the mid 18^th century, Smith, together with David Hume, essentially created and led a new group of economic theorists who challenged the fundamental mercantilist doctrines that were prolific at the time (Fulcher, 2015). These principles included the belief that the overall wealth of the world remained constant and therefore one nation could only increase its own wealth at the expense of another – a zero sum game. This laid the foundation for free market economics through theories of division of labour. Later into the early 19^th Century, classical economist Ricardo took inspiration from Smith and expanded the field with his own work, the most prolific of which remains the theory of comparative advantage Comparative advantage is a model for trade which states that trade between nations is always mutually beneficial even under the circumstances when one nation has an absolute advantage (Roberts, 2003). By the 20^th century an opposing school of thought emerged which paved way for Socialism, driven by Karl Marx. The Marxian school of thought heavily concerned itself with the analysis of crisis in capitalism, particularly with respect to the exploitation of labour and the distribution of surplus (Mandel, 1982). This essay intends to discuss both Smith and Marx’s ideas of the factory system in regard to: the history of the economists and how this influences their respective positions, assumptions behind the models that give rise to equations and various conclusions drawn, implications for the role of labour, and implications for policy makers and what each may mean when applied on a macro level. This discussion is not exhaustive and seeks to assess the schools of thought within these parameters when they are compared to one another.

An appreciation of the histories and backgrounds of both economists is critical in providing a framework to help us understand the way that they contextualised economics, as well as the assumptions they made to underpin the models they created. Smith, a moral philosopher and Scottish political economist, was educated at Balliol college Oxford. Little is known about his personal views beyond those which can be extrapolated from the perspectives expressed in his work. Smith famously wrote ‘An Inquiry into the Nature and Causes of the Wealth of Nations’ (first published 1776, hereafter “The Wealth of Nations”) using the pin factory as his most influential example. Marx, on the other hand, was a philosopher, historian, journalist, and economist, and of course, as is well known, a staunch socialist (Wheen, 2000). As a result, he offered a unique insight into the field by combining these disciplines. He believed that history was fundamentally comprised of phases, and that the capitalism system was one such phase, built primarily off the exploitation of workers that happened as capitalists appropriated the surplus value their workers created. This paved the way for Marx’s triggering of a social movement to end this so-called phase.

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Both economists established key assumptions that governed the models they developed and drew conclusions from. Some of these assumptions did overlap, although the conclusions they drew were wildly different. One of the underlying assumptions of classical economics, which Smith pioneered, is that rational consumers, who also workers, make selfish decisions in the marketplace to maximise utility. Workers are therefore best placed in specialising in order to maximise production and therefore maximise growth, which will in turn maximise their incomes. Smith believed that production was a function of three inputs (capital, labour, and land), and, controversially in current times, did not believe in diminishing marginal returns of labour (which in turn gives rise to his call for specialisation). Indeed, Smith actually believed in increasing marginal returns to labour and therefore increasing returns to scale which were a driver of economic growth on a macro level (Ingham, 2011). Smith felt this accurately explained behaviours in the marketplace, and led to an efficient allocation of resources in the economy. Marx’s model similarly assumes that there are only two classes in a society: the capitalists and the workers. He assumed that all factors of production (used in the production phase) are owned by capitalists and that capitalists exploit their workers. However, the Marxian model relies solely on the assumption that all value of a finalised and produced economic resource is wholly driven by the economic labour that is embodied within it, through the production process (Fine and Filho, 2017). This is called the Labour Theory of Value. It also assumes that labour is completely mobile and that the economy is perfectly competitive, both of which are somewhat questionable. The model gives rise to the circuit of capital: Marx demonstrated that the classical economic categorisation of value is only objectified labour (also called the Socially Necessary Abstract Labour- SNALT). In this model there are five key parameters: M represents the sum of money that capitalists commit to the project, C is the commodities (labour power and means of production, also called capital), P represents the production process, C’ represents finished products, and M’ represents converted money. The model then seeks to explain the movements between each of these parameters which sees transference of value and the increases that take place. M is converted to capital through the capital flow, and the production phase (shown as the parameter P) and converts it to C’ (finished products). These finished products are then sold for M’, which exceeds M (the initial sum of money committed to the project).  M’ is equal to M plus the change in M (the surplus the capitalist captures). As such, Marx illustrates the exploitation of labour through capitalists appropriating all the surplus that is created by the workers’ labour. This is an extremely different model to that which Smith presents, and therefore has different implications both on the labour market and on policy setters.

The differences in Smith’s and Marx’s approach expose themselves most poignantly in the impact on labour. Smith, like Marx, also models two classes: the working class and the managerial class, and omits any role for entrepreneurs in doing so. He believes that wages and profits are inextricably linked: wages will only rise if profits rise within the factory. As such, increases in production leads to increases in profits, which can in turn lead to higher wages. Due to his assumption that there are increasing marginal returns to labour, workers should focus on maximising their output within the factory setting. The biggest implication for the role of labour is therefore through Smith’s argument for specialisation. Shown through the ‘pin’ factory model, Smith believes that individuals should partake in mass specialisation in order to maximise output and achieve wage growth. Smith described this widely renowned example on the very first page of his aforementioned and seminal work, The Wealth of Nations, 1776. Smith asserted that the process could be broken down into 18 distinct steps, including the packaging the pins. He does, however draw attention to the relatively low wages of the workers, despite their high productivity. Naturally, this contradicts the economic assumption that higher productivity (output per worker) leads to higher wages and is certainly a weakness to his model. Smith then continues to describe how he visited a pin factory employing 10 men who produced 48,000 pins per day, thus an average output (or productivity) of 4,800 pins per worker.  Smith further asserts that if a worker was to conduct every step themselves, they could each produce 10 or 20 pins per day. From this, he concludes that the division and specialisation of labour dramatically increased productivity. However, he does not consider the potential impact this may have on motivation and therefore does not consider any diminishing returns to labour, or worker retention rates and therefore higher training costs. Individuals are therefore seen in the model as a fairly static phenomenon, and their motivation or desires for working are not considered. Indeed, more recent literature has argued that workers are motivated by a myriad of factors, such as in Maslow’s hierarchy of needs which suggests that individuals face a hierarchy of needs beyond financial which may be realised through the work place (Maslow, 1943).  In complete contrast, Marx’s role of labour focuses on capitalists’ exploitation of workers within factory settings (which are assumed to be the existing market). The Industrial Reserve Army is the phrase that Marx gives to the unemployed or underemployed members of society who are not economically active in a capitalist world. Marx believes that this over supply of labour is necessary in order to allow capitalists to drive down wages for those employed. In Marx’s model, this exploitation gives rise to a widening gap between classes that leads to class conflict. This conflict therefore leads to uncertainty and consequently a fall in investment in the economy. This is in direct contrast to Malthus’s view, a classicist, that the surplus population was inevitable and would grow exponentially, and, when combined with an arithmetic progression of agricultural produce and food, poverty would persist. Marx’s model represents the inequitable experience of workers vs capitalists in the capitalist world and the welfare losses workers experience at the hands of surplus-appropriating capitalists.

An examination of these two prolific economists’ theories and ideas, in any context, naturally extends itself also to a discussion of their implications for policy setters. Smith’s ‘invisible hand’ theory suggests that the market will always reach a socially optimum outcome when driven by selfish rationalist consumers making independent decisions. This gives rise to Smith promoting a laissez-fair model with a limited role for state intervention, instead believing in the ability of self-regulating markets to maximise overall. It should be noted, however, that Smith did indeed recognise a role for government provision in education and defence. He also advocated that credit should be readily available for private agents to purse their own rational interests, since he believed that this in turn would be beneficial for society by removing any imperfections in the credit market (Reisman, 1998). Therefore, taking a Smith-inspired perspective, the state should ensure credit markets are accessible and friction-free. In complete contrast to this, Marx’s communist manifesto gives rise to a political economic model of socialism, within which there are communal modes of production, collective ownership, and social planning (Marx, 1848). Marx also advocated a role for the state in providing transport, credit, and even through owning all factories. Furthermore, with respect to trade policy, Marx related differences in factor endowments to unequal economic development of the trading nations, as his theory of foreign trade was firmly based on the character and dynamics of trade between unequal partners (Ganguli, 1965). His speech on the Question of Free Trade, delivered in Brussels in January 1848, just before the Communist Manifesto was published, was highly sceptical towards free trade, arguing against its benefits for the working class and that is was a method through which the British bourgeoise sought to dominate the world market (Hampton, 2004). Policy setters have tended to adopt a more classical approach in the Western world, though some Marxist ideologies do still bear credence in some policy making.

These two paradigms remain extremely influential in modern day economics and decision making. Throughout history, we have seen the idea of specialisation feature in other models (Taylorism, scientific principles, and Fordism), though the rise of unions would suggest Marxist theories are rife in public sentiment about exploitation of workers. More recently, the rise of behavioural economics has challenged the assumption of rationality that governs Smith’s model and argues this is therefore not an accurate way to predict how agents behave in a market setting (Gino, 2017). Currently, we are seeing movements away from free-trade towards protectionist policies (in China and USA trade relations, and UK vote to leave EU recently), which echo Marxist views on free-trade not benefiting the working class. Regardless of their critics, both Marx’s and Smith’s models for the factory continue to have repercussions and influence policy in the modern world.

Word count: 1997

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