Adam Smith as a pioneering labour economist

Adam Smith anticipated much of labour economics by basing it on his principle that individuals invest resources to earn the highest possible return. All uses of a resource must yield an equal rate of return adjusted for relative riskiness for otherwise reallocation would result.

The whole of the advantages and disadvantages of the different employments of labour and stock must, in the same neighbourhood, be either perfectly equal or continually tending to equality.

If in the same neighbourhood, there was any employment evidently either more or less advantageous than the rest, so many people would crowd into it in the one case, and so many would desert it in the other, that its advantages would soon return to the level of other employments.

Smith used this insight on  be equality of returns to explain why wage rates differed. Workers care about the whole aspects of the job, not only the cash wage payment: it is the “whole advantages and disadvantages” of the job that is equated across jobs in a competitive market, not wage alone. Smith set out criteria that determined how wages compensated or were discounted for the different characteristics of specific jobs:

  1. the agreeableness or disagreeableness of the employments themselves: better for more enjoyable working conditions will lead an individual to accept lower wages for their labour. Likewise, unpleasant work will have a higher wage. Wages vary with the ease or hardship, the cleanliness or dirtiness, the honourableness or dishonourableness of a job.
  2. The easiness and cheapness, or the difficulty and expense of learning them: jobs that are difficult or time-intensive to learn will pay more. Those who invest the time are being compensated for their additional effort with higher wages. The opportunity cost of forgoing the time-spent in training will be compensated for through higher wages. The difference between the wages of skilled labour and common labour is founded upon this principle.
  3. The constancy or inconstancy of employment: workers who face only partial or inconsistent employment throughout the course of the year, such as seasonal workers of agriculture, must be paid more for their labour. Their wages carry them not only during times of employment, but also during times of unemployment.
  4. The small or great trust which must be reposed in those who exercise them: individuals who have high levels of responsibility  in their jobs will be compensated with higher wages.
  5. The probability or improbability of success: this is an entrepreneurial element in wages. Employment where the chance of success is high will be paid lower than those who take more risks. If individuals were not compensated for risk, there would lack an incentive to seek employment that may not be successful.

The supply and demand for labour in different industries  determines relative wages and the relative numbers of employees in different occupations. Individuals are willing to make a trade-off between less desirable occupations and increased income. Smith spoke of how these five circumstances  listed above  lead to considerable inequalities in the wages and profits.

George Stigler thought that the second greatest triumph of Adam Smith in his Wealth of Nations was his famous list of cost factors that generate apparent but not real differences in rates of wages and profits because of training, hardships, unemployment, risk and trust. This list was quoted almost verbatim by his successors  down to this day and is the direct ancestor of both Alfred Marshall’s famous chapters on wages and of the modern theory of human capital.

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