The Dream Café

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TWoN Book 3 Chapter 5

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p 392: “…every branch of trade in which the merchant can sell his goods for a price which replaces to him, with the ordinary profits of stock, the whole capital employed in preparing and sending them to market, can be carried on without a bounty.”

This is not the first time we’ve seen that phrase, “the ordinary profits of stock.”  But what, exactly, does it mean?  Smith appears to believe that, when money is productively invested, a certain amount of profit is natural and normal.  What determines this amount?  What is the percentage, and why?  For someone so precise in other things, this vagueness really stands out.  It goes back to his assertion, in Book 1, that the value of commodities comes from wages, rent, and profit.  In fact, that is how (most) of the value is divided after the sale, but it isn’t it’s source of the value.  There is no “ordinary profit of stock.”

Later, he makes another fundamental (thought perfectly understandable) error.  On page 397, speaking of corn (ie, grain), he says, “It regulates the money price of labour, which must always be such as to enable the labourer to purchase a quantity of corn sufficient to maintain him and his family either in the liberal, moderate, or scanty manner in which the advancing, stationary, or declining circumstances of the society oblige his employers to maintain him.”  And further down, “The money price of labour, and of everything that is the produce either of land or labour, must necessarily either rise or fall in proportion to the money price of corn.”

In other words, because grain is the staple food, it controls the price of labor, and the price of labor controls the value of commodities.  But even in his day, the cost or price of labor (wages), insofar as it was determined by the cost of necessaries the worker, was also determined by the price of wool, leather, furnishings, cotton, and all of the other things consumed by the worker.  Moreover, the value of a commodity is determined by the value of labor (measured in time), not the cost of labor.  Raising the value of basic necessities effectively lowers wages, but this does not change the value of those commodities (whether expressed in labor-time, money, or even grain).

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Author: corwin

Site administrative account, so probably Corwin, Felix or DD-B.

0 Comments

  1. With the important qualifier that I haven’t actually read the book, my inference from the passage you’re quoting is that by “ordinary profits of stock” Smith doesn’t mean average, typical or expected, but “not extraordinary” — that is, not due to speculation.

  2. Steve, I think your point is that value and cost are built up from their components, which is true from one side of the transaction. Those are what determine cost/value for the supplier of the production facilities (labor, intellectual property, etc.)

    What determines the other side of the equation is really the alternative opportunities for investment with similar risk/reward characteristics. It’s been awhile since I’ve read WoN, so I don’t remember the context, but I think this is the point he’s trying to make with “The money price of labour, and of everything that is the produce either of land or labour, must necessarily either rise or fall…” If return on capital is just another type of rent, then the implication is that in a perfect market, with perfect information, investors will seek to optimize their risk/return and supply and demand will establish the “ordinary profits of stock.”

    Because different people have different tolerance for risk and liquidity (i.e., can I replace my money if I lose it, and can I access it when I need it), you really end up with multiple layers depending on the characteristics of the investment.

    It’s definitely vague (especially for Smith), but it’s the kind of discussion that could rabbit-trail pretty quickly. In fact, you could argue that one of the two primary segment of the financial sector (activities related to investment, as opposed to facilitating transactions), is dedicated to discovering where those layers are and taking advantage of/exploiting any opportunities for arbitrage in those risk/reward gaps.

    In reality, perception and expectation play a significant role. Information’s not perfect, so risk assessments are usually pretty flawed (I know that one’s pretty obvious right now). Less obvious is the way historical performance influences expectations of return over time – people began expecting 8-12% returns from equity investments, so some of those perceptions end up being used to justify higher rents on capital than may be practical.

    That and the fact that wealth can often be converted into political power are probably the 2 biggest things that lead to an unequal playing field between providers of capital and users of capital.

    I could make a pretty good case that the effort to sustain too-high rents was (and still is) the underlying problem with the economy. Orca suggests you’ve already got a pretty solid grasp of capital leverage and some of the issues there. You and I have pretty different economic views, but if you ever want to visit about how bad pseudo-market mechanisms are and why they’re worse than both market-based and planned mechanisms, we could probably find some common ground over a good steak.

  3. I’d be up for the steak idea; sounds like fun. Ever get to Texas?

  4. Very cool. We live in Austin, and from a couple of comments I’ve read, it sounds like you’re probably pretty nearby. If you are close, I’d be more than willing to make a trek up to your neck of the woods or could treat you to a pretty solid steak here in Austin – Eddie V’s, Austin Land & Cattle, & Flemings all do a good job, and I’ve heard Finn & Porter and Perry’s are great too, though I haven’t had a chance to try them yet.

  5. Sounds great! I’m in Round Rock. Drop me an email. The address is on the web site (www.dreamcafe.com).

  6. First–sorry, I haven’t been hanging out here for a while, and am now a little confused. Do you mean Book 4, or does your copy of Wealth really count this as Book 3?

    Re Smith’s p. 392 and “ordinary profit of stock.” I’m not sure whether your issue is that you honestly don’t recall his definitions or are simply rejecting them out of hand. In the latter case, there’ll be no reasoning with you because you aren’t really approaching Smith on his own–excuse me–terms. In the former, there is indeed, in Smith’s view, an “ordinary profit of stock.” It takes him a while, and a certain amount of waffling between “ordinary, “natural,” and “average,” but he mostly gets his point across in Chs I-4 thru I-7. Per Ch I-5, “average or ordinary” are to be taken in contrast to “temporary or occasional.” More specifically, per the opening paragraph of Ch I-7:

    “There is in every society or neighbourhood an ordinary or average rate both of wages and profit in every different employment of labour and stock. This rate is naturally regulated, as I shall show hereafter, partly by the general circumstances of the society, their riches or poverty, their advancing, stationary, or declining condition; and partly by the particular nature of each employment.”

    Lower on that same page: “These ordinary or average rates may be called the natural rates of wages, profit, and rent, at the time and place in which they commonly prevail.”

    Re Smith’s p. 397, and money price of labor as a fundamental function of the money price of corn. This gets back to the infamous Ch I-11. There, Smith acknowledges that other commodities enter into the equation, but further notes (at exhaustive length) that they, too, are controlled by the money price of corn.

    Also, I assume you mean to say that the *cost* of necessities doesn’t change their value, which would be true, as far as it goes. Except, where does Smith insert that term “cost” in the passage you’re citing? He’s speaking of money price. Again, defined back in Book I.

    As for the “value” angle, I’m not sure whether you’ve lost track of Smith’s definitions (he does recognize different meanings applying to different uses of the term), or are just looking to pick fights, which is never a bad thing in my book, provided everyone understands that’s where you’re going. Having no clue myself, I think I’d better quit now.

  7. I recall his definition. I think it is wrong. That is, I do not think there is, in reality, any such thing as “the ordinary profit of stock.”

    “Also, I assume you mean to say that the *cost* of necessities doesn’t change their value…” I wasn’t able to figure out which passage of mine this referred to. But, whatever passage it is, I’m not sure what you, or I, or Smith, or anyone else would consider the difference between “cost” and “money price.”

    I’m trying to understand Smith, which means testing his conceptions against my own understanding. Sometimes this results in a belief on my part that he is incorrect.

  8. Re ordinary profits of stock. Does it help any to think of the line “whatever the market will bear”? That’s the general idea Smith is getting at with “ordinary” or “average” or “natural” profit. Set the margin too low, and the seller can’t afford to stay in business. Set it too high, and others will come along and undercut, or the market will dry up entirely. The range between those extremes is the ordinary profit. Smith explains, somewhere back in Book I why it isn’t possible to just quote a standard percentage or monetary range.

    Re “cost,” “money price,” “value,” &c. That’s part of my problem in trying to understand your problem here: too many terms floating around, and not enough definitions to go with them. I know what Smith means when he says money price; I’m not so sure what you mean when you say cost. And when Smith discusses value, he sometimes means value in labor (ie “real” price), and sometimes value in money (ie nominal or “money” price).

    The passage of yours I referred to is: “Raising the value of basic necessities effectively lowers wages, but this does not change the value of those commodities.” I couldn’t understand this quote as written, so I took “cost,” which you had used earlier, and inserted it where it made the most sense. If I still don’t have it right, I apologize.

    Smith, however, makes the case that discussing value in terms of money price is sometimes the only reasonable way to address the subject with any consistency, despite the fact that, yes, the real value of a commodity is tied to labor. And his point in the passage of his that you cited is that bounties in fact cause more harm than good because they DON’T do anything for the real value of the affected commodities–they alter only the money value, which then has a ripple effect through whatever chunk of the local economy relies to any extent on that commodity.

    And I don’t ever want to give the impression that I have issues over your taking issue with Smith. It’s just that I sometimes find I get what he’s saying better than your critique of it. After all, he runs on a lot longer than you do. So then I need to test my understanding of your conceptions.

    But if this really is Book III in your copy of Smith, where do I have to go to find your notes on his chapters about the history of opulence?

  9. I see you’re ignoring this one, and I’m sorry I can’t do a better job of explaining. As I’ve said before, you and Smith aren’t as far apart in viewpoints as you keep trying to place him.

    You both agree, for example, that the “real” value of commodities lies in labor. You both agree that jiggering the money price (ie “exchange” value) doesn’t do a bloody thing for real value. The problem comes in because you, skzb, somehow aren’t getting how–or maybe why–Smith shifts back and forth between those two aspects of value, and the disconnect is making a lot of your reading harder than it has to be.

    As for ordinary profits of stock–that’s just a label for what even you accept above as a component of money price. A handy nametag to slap on for discussion purposes; we could call it Fred and it would work the same way, without the obfuscating and value-laden baggage of terms like “natural” or “ordinary.”

    Right or wrong, profit exists. It forms a part of the exchange value for most commodities. In fact, it’s one of Smith’s three fundamental categories of income (and he says it, too, is tied to labor). Modern economics recognizes those same three, and adds investments as a fourth.

    Do you sell Taltos gift items for exactly what you’ve already paid out in production costs? Well, maybe you do….

  10. If you look back at my reading of Smith from the beginning, you’ll see that I know very well we agree on many things–or, more precisely, Smith first discovered many of the things that I believe are true.

    Yes, indeed, profit exists. But where does it come from? Wages of $25 to pay for labor on material worth $50 produces a commodity that sells for $90. Where did the additional $15 come from? This was, in fact, answered by later economists; but for Smith, the answer is “ordinary profits of stock,” which he then fails to define. However luminous his mind, and however brilliant his pioneering work, we do him no service by failing to point out the holes that were later filled by others.

  11. Hi Steve,

    You said “Where did the additional $15 come from? This was, in fact, answered by later economists”

    Out of curiosity, what did those later econmoists say?

    Regards,

    Ethan

  12. From labor, which produces more value than it costs.

  13. Okay, skzb, but that isn’t the same as the “I do not think there is, in reality, any such thing as ‘the ordinary profit of stock’ ” answer you gave above.

    Never mind, I’m afraid I’ve long since strayed into spam-canning territory, and that is no place I ever want to be visiting again on a pursuit as trivial as this. Much better that Fred and I just go play at being nonexistent together, so you can enjoy the rest of the read-along on your own terms. Cheers.

  14. Someone borrows $75, pays $50 for material and $25 for labor, and ends up with stuff he sells for $90. The extra $15 goes two places: (1) interest (“rent”) on the $75 borrowed (or invested), and (2) pay for that someone’s time and expertise spent organizing the deal, doing the selling (or paying someone else to), etc. The return on the money also needs to take the risk into account (that the stuff built might not sell, or it might not get built, etc.) so it will appear higher than the simple safe return on capital.

    It is the combination of factors that produces more value than it costs. Else, why doesn’t the laborer buy the materials for $50, do some work, and make $40 instead of $25? First, he doesn’t have the $50, he has to borrow it; and the rate is likely high, because so is the risk. Then, having produced the item “worth” $90, he still needs to sell it; that’s time he could use making more stuff instead.

    If there are barriers to entry (e.g. you need a license or guild membership), then part of the gain is payment for that (monopoly rent).

  15. What is interesting, Seth, is your first paragraph, where you make exactly the mistake Smith makes: you speak of where the surplus *goes* as if that answered where the surplus *comes from*. And, no, it is not the combination of factors that produces more value than it costs.

    The issue of being in a position to borrow money (not sure where that came from; I never mentioned borrowing the money) and of selling it points to the useful role of the capitalist in the process of production: bringing means of production together with labor-power; it tells us nothing about how value is produced.

  16. Part of the problem is that Smith is using the labour theory of value, rather than marginal pricing theory. Under marginal pricing the $15 is the difference between the marginal price ($90) and the manufacturer’s costs ($75). Marginal pricing goes like this:

    1 Different potential consumers are willing to pay a range of different maximum prices for a product therefore as the price rises demand falls. The demand curve slopes downwards.

    2 Different potential producers have different costs therefore as the price rises supply increases. The supply curve slopes upwards.

    Therefore the supply curve and the demand curve cross. At this price point supply and demand are equal, this is the marginal price.

    The $15 is the difference between that manufacturer’s costs and the marginal price. This gives an explanation of price setting without getting into the complicated logical knots that the labour theory of value produces and explains why marginal pricing has almost entirely replaced labour theory of value.

    By ordinary profits of stock Smith simply means typical or average. He is arguing that the return on different investments will tend to equalise, if the return is exceptionally poor few will invest and as supply falls the return will increase and if the returns are exceptionally good more will invest and the returns will fall as supply increases.

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