Mises Wire

Creating Wealth: The Cantillon or the Smith Way

For those who have any exposure to the subject, Adam Smith is the father of modern economics. Few have heard of Richard Cantillon. Both wrote on the subject of wealth creation, Cantillon in Essay on the Nature of Trade in General and Smith in The Wealth of Nations. Of the two, Cantillon, who preceded Smith, may have had a firmer grasp on the dynamics of wealth creation. Cantillon is considered the father of entrepreneurship, whereas Adam Smith seemed to go out of his way to dismiss the importance of that concept. With the benefit of two more centuries of economic experience, the twentieth-century economist Ludwig von Mises saw entrepreneurship in a light similar to Cantillon’s view: “Those who confuse entrepreneurship and management close their eyes to the economic problem. . . . The capitalist system is not a managerial system, it is an entrepreneurial system.”

Adam Smith’s focus, in contrast, was on the contribution of labor to the final product. He recognized the different skill levels of labor but ultimately attributed the growth of wealth, and human flourishing, to the division of labor. He stated in The Wealth of Nations, “The greatest improvement in the productive powers of labour, and the greater part of the skill, dexterity and judgment with which it is any where directed, or applied, seem to have been the effects of the division of labour.” Smith did not dismiss the role of machinery (capital) in improving labor productivity but then seems to have done everything possible to avoid giving credit to the entrepreneur for his role in replacing labor with machinery:

Every body must be sensible how much labour is facilitated by the application of the proper machinery. . . . I shall only observe . . . that the invention of all of those machines by which labour is so much facilitated and abridged, seems to have been originally owing to the division of labour. . . . A great part of the machines made use of in those manufactures in which labour is most subdivided, were originally the inventions of such workmen, who, being each of them employed in some very simple operation, naturally turned their thoughts towards finding out easier and readier methods of performing it.

Smith realized that it was unrealistic to completely attribute the invention of machinery to common laborers:

All the improvements in machinery, however, have by no means been the inventions of those who had occasion to use the machines. Many improvements have been made by the ingenuity of the makers of the machines, when to make them became the business of a particular trade; and some of that by those who are called philosophers or men of speculation, whose trade it is not to do anything but to observe everything; and who, upon that account, are often capable of combining together the powers of the most distant and dissimilar objects. In the progress of society, philosophy or speculation becomes, like every other employment, the principle or sole trade and occupation of a particular class of citizens.

Today we can chuckle over the idea of philosophers and speculators as inventors, but even in the eighteenth century this should have been recognized as tortured reasoning. Smith appears to have ignored the significance of the British Agricultural Revolution and would have had difficulty categorizing Jethro Tull and his inventions of the horse-driven seed drill and horse-driven hoe, both major contributors to that revolution. One wonders how Smith would have categorized Thomas Edison.

Among the more famous of Smith’s pronouncements in The Wealth of Nations is the following:

This division of labour, from which so many advantages are derived, is not originally the effect of human wisdom, which foresees and intends that general opulence to which it gives occasion. It is the necessary, though slow and gradual, consequence of a certain propensity in human nature which has in view no such extensive utility; the propensity to truck, barter, and exchange one thing for another.

The first part of this is correct. Self-interest drives the free trade model of business, not some social idealism. In the aggregate, however, and in the absence of aggression, society benefits from the self-interest of individuals. Critics of Smith have focused on the language of “the propensity to truck, barter, and exchange one thing for another.” The language may seem silly to the modern ear, but the idea probably seemed sound to a person in the eighteenth century. The problem with the idea is that in retrospect it was too static in its concept. Adam Smith lived in a century in which major economic changes were occurring. The British Agricultural Revolution and the Age of Discovery were preparing the way for what has been called “the hockey stick of human prosperity,” the breakout from the “Malthusian trap” that had characterized life on Earth from 1000 BC to the eighteenth century.

Smith’s relatively static view of economics can be seen in this statement: “As it is the power of exchanging that gives occasion to the division of labour, so the extent of this division must always be limited by the extent of that power, or in other words, by the extent of the market.” As an example, Adam Smith mentioned that a porter could only find employment in a great town, and that a village is “too narrow of a sphere for him.” On the surface, that seems logical, but it is too static a concept to be accepted as a general rule. It also conflicts with Cantillon’s thinking as revealed in part one, chapter thirteen of his Essay on the Nature of Trade in General. Cantillon made the point that “the circulation and exchange of goods and of merchandise, are carried out in Europe by entrepreneurs in conditions of risk.” The feudal period was characterized by relatively static markets. The Age of Discovery and the British Agricultural revolution were changing that, and the agents of change were entrepreneurs. Smith failed to recognize that the concept of markets is dynamic, not static. Henry Ford was not constrained by the size of the market for automobiles when he created the mass-produced Model T Ford.

With his emphasis on the division of labor as a cause of society’s growth of wealth, Adam Smith essentially had the cart before the horse. With some exceptions, the division of labor has resulted as a byproduct of the risk undertaken by society’s change agents, its entrepreneurs. One of those exceptions is the industrial engineer who observes work in a factory and consciously changes the division of labor. Large firms tended to pursue this in earlier stages of mechanization, but it is less important today in the Age of Automation when robotics are seen as the replacement of labor versus its division. We get a better sense for the increase in human prosperity that has arisen through the major inventions over time. The inventors’ focus has been on implementing better ways of doing things. Often a different division of labor has arisen from those efforts, but rarely was this a major goal.

Did Adam Smith suppress the work of Richard Cantillon? Smith was eleven years old when Richard Cantillon died. There is no evidence they ever met, so there could not have been any personal animosity. Smith’s earlier adult years were spent in academia, where those successful in the promotion of ideas expected to advance. Anxious to present new principles of the creation of wealth in society, Smith encountered the profound work of Richard Cantillon in Essay on the Nature of Trade in General. He could have expanded on Cantillon’s prior work or chosen to pursue an alternative theory. He chose the latter. The effect was that Cantillon’s work tended to be suppressed.

There was another negative effect, however, that can be seen when comparing the work of Cantillon, Smith, and Mises, all of whom were dealing with macroeconomic concepts. Cantillon’s focus was on the entrepreneur as the agent of change in the economy, thus relating the individual to a macroeconomic concept: the increase of wealth. Smith’s focus was on the division of labor, an abstract concept. There is value in understanding that concept if one can relate it to individual human action. Smith never seems to have accomplished that. In the mid-twentieth century, Ludwig von Mises reminded us in Human Action that macroeconomic concepts can only be understood as an aggregate of individual human action.

The danger in remaining too attached to abstract concepts is to adopt a certain sense of historical inevitability that does not exist in real life. Georg Hegel believed that history proceeded in stages, an idea that influenced Karl Marx. Of course, both Hegel and Marx believed they were exceptionally endowed to understand the inevitability of history as others did not. In a sense, Adam Smith’s focus on the division of labor as the generator of wealth shares the same flaws. History doesn’t just happen—it is the result of purposeful human action. The emergence of the entrepreneur during the eighteenth century set the stage for unprecedented prosperity. Richard Cantillon recognized this critical change while Adam Smith clearly did not.

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