Smith's Paradox of Wages and Profits

One of the most important issues in the Wealth of Nations is Smith's treatment of profits and wages. Initially he looks at three components of a nation's wealth - wages, profits and rents. But his treatment of wages and profits, is at first glance somewhat counterintuitive. At some point I will also deal with his differentiation between exchange values and useful values. But for this second post on the WoN, I want to briefly discuss how he deals with these two elements. In a free market, workers are encouraged to sell their wages for the highest price. At the same time, those who own firms, as competition increases are expected to reduce their profits. A fundamental principle that goes throughout the WoN is Smith's understanding that economic transactions are positive and not zero sum activities. If you take the colluding elements out of a market, which Smith argues businesses will often try to implement either through what Hayek calls law (informal) or legislation (enactments of government), you will get gains to the society.

A real life example might help. When programmers are in high demand, their relative wages increase. Thus, those who do the real thinking about computers including programmers are paid very well. On the other hand as you look at very competitive industries, groceries for example, profit margins are reduced because of the immediate ability of shoppers to find an alternative. Both things result in benefits to individuals.

Smith is often seen as a raw supporter of unbridled free markets but he always keeps an idea of equity in mind.